[Federal Register Volume 78, Number 20 (Wednesday, January 30, 2013)]
[Rules and Regulations]
[Pages 6408-6620]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-00736]



[[Page 6407]]

Vol. 78

Wednesday,

No. 20

January 30, 2013

Part II





Bureau of Consumer Financial Protection





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12 CFR Part 1026





Ability-to-Repay and Qualified Mortgage Standards under the Truth in 
Lending Act (Regulation Z); Final Rule

  Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / 
Rules and Regulations  

[[Page 6408]]


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BUREAU OF CONSUMER FINANCIAL PROTECTION

12 CFR Part 1026

[CFPB-2011-0008; CFPB-2012-0022]
RIN 3170-AA17


Ability-to-Repay and Qualified Mortgage Standards Under the Truth 
in Lending Act (Regulation Z)

AGENCY: Bureau of Consumer Financial Protection.

ACTION: Final rule; official interpretations.

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SUMMARY: The Bureau of Consumer Financial Protection (Bureau) is 
amending Regulation Z, which implements the Truth in Lending Act 
(TILA). 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 final rule implements sections 1411 and 1412 of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank 
Act), which generally require creditors to make a reasonable, good 
faith determination of a consumer's ability to repay any consumer 
credit transaction secured by a dwelling (excluding an open-end credit 
plan, timeshare plan, reverse mortgage, or temporary loan) and 
establishes certain protections from liability under this requirement 
for ``qualified mortgages.'' The final rule also implements section 
1414 of the Dodd-Frank Act, which limits prepayment penalties. Finally, 
the final rule requires creditors to retain evidence of compliance with 
the rule for three years after a covered loan is consummated.

DATES: The rule is effective January 10, 2014.

FOR FURTHER INFORMATION CONTACT: Joseph Devlin, Gregory Evans, David 
Friend, Jennifer Kozma, Eamonn K. Moran, or Priscilla Walton-Fein, 
Counsels; Thomas J. Kearney or Mark Morelli, Senior Counsels; or 
Stephen Shin, Managing Counsel, Office of Regulations, at (202) 435-
7700.

SUPPLEMENTARY INFORMATION:

I. Summary of the Final Rule

    The Consumer Financial Protection Bureau (Bureau) is issuing a 
final rule to implement laws requiring mortgage lenders to consider 
consumers' ability to repay home loans before extending them credit. 
The rule will take effect on January 10, 2014.
    The Bureau is also releasing a proposal to seek comment on whether 
to adjust the final rule for certain community-based lenders, housing 
stabilization programs, certain refinancing programs of the Federal 
National Mortgage Association (Fannie Mae) or the Federal Home Loan 
Mortgage Corporation (Freddie Mac) (collectively, the GSEs) and Federal 
agencies, and small portfolio creditors. The Bureau expects to finalize 
the concurrent proposal this spring so that affected creditors can 
prepare for the January 2014 effective date.

Background

    During the years preceding the mortgage crisis, too many mortgages 
were made to consumers without regard to the consumer's ability to 
repay the loans. Loose underwriting practices by some creditors--
including failure to verify the consumer's income or debts and 
qualifying consumers for mortgages based on ``teaser'' interest rates 
that would cause monthly payments to jump to unaffordable levels after 
the first few years--contributed to a mortgage crisis that led to the 
nation's most serious recession since the Great Depression.
    In response to this crisis, in 2008 the Federal Reserve Board 
(Board) adopted a rule under the Truth in Lending Act which prohibits 
creditors from making ``higher-price mortgage loans'' without assessing 
consumers' ability to repay the loans. Under the Board's rule, a 
creditor is presumed to have complied with the ability-to-repay 
requirements if the creditor follows certain specified underwriting 
practices. This rule has been in effect since October 2009.
    In the 2010 Dodd-Frank Wall Street Reform and Consumer Protection 
Act, Congress required that for residential mortgages, creditors must 
make 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. Congress also established a 
presumption of compliance for a certain category of mortgages, called 
``qualified mortgages.'' These provisions are similar, but not 
identical to, the Board's 2008 rule and cover the entire mortgage 
market rather than simply higher-priced mortgages. The Board proposed a 
rule to implement the new statutory requirements before authority 
passed to the Bureau to finalize the rule.

Summary of Final Rule

    The final rule contains the following key elements:
    Ability-to-Repay Determinations. The final rule describes certain 
minimum requirements for creditors making ability-to-repay 
determinations, but does not dictate that they follow particular 
underwriting models. At a minimum, creditors generally must consider 
eight underwriting factors: (1) Current or reasonably expected income 
or assets; (2) current employment status; (3) the monthly payment on 
the covered transaction; (4) the monthly payment on any simultaneous 
loan; (5) the monthly payment for mortgage-related obligations; (6) 
current debt obligations, alimony, and child support; (7) the monthly 
debt-to-income ratio or residual income; and (8) credit history. 
Creditors must generally use reasonably reliable third-party records to 
verify the information they use to evaluate the factors.
    The rule provides guidance as to the application of these factors 
under the statute. For example, monthly payments must generally be 
calculated by assuming that the loan is repaid in substantially equal 
monthly payments during its term. For adjustable-rate mortgages, the 
monthly payment must be calculated using the fully indexed rate or an 
introductory rate, whichever is higher. Special payment calculation 
rules apply for loans with balloon payments, interest-only payments, or 
negative amortization.
    The final rule also provides special rules to encourage creditors 
to refinance ``non-standard mortgages''--which include various types of 
mortgages which can lead to payment shock that can result in default--
into ``standard mortgages'' with fixed rates for at least five years 
that reduce consumers' monthly payments.
    Presumption for Qualified Mortgages. The Dodd-Frank Act provides 
that ``qualified mortgages'' are entitled to a presumption that the 
creditor making the loan satisfied the ability-to-repay requirements. 
However, the Act did not specify whether the presumption of compliance 
is conclusive (i.e., creates a safe harbor) or is rebuttable. The final 
rule provides a safe harbor for loans that satisfy the definition of a 
qualified mortgage and are not ``higher-priced,'' as generally defined 
by the Board's 2008 rule. The final rule provides a rebuttable 
presumption for higher-priced mortgage loans, as described further 
below.
    The line the Bureau is drawing is one that has long been recognized 
as a rule of thumb to separate prime loans from subprime loans. Indeed, 
under the existing regulations that were adopted by the Board in 2008, 
only higher-priced mortgage loans are subject to an ability-to-repay 
requirement and a rebuttable presumption of compliance if creditors 
follow certain requirements. The new rule strengthens the requirements 
needed to qualify for a rebuttable presumption for subprime loans and

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defines with more particularity the grounds for rebutting the 
presumption. Specifically, the final rule provides that consumers may 
show a violation with regard to a subprime qualified mortgage by 
showing that, at the time the loan was originated, the consumer's 
income and debt obligations left insufficient residual income or assets 
to meet living expenses. The analysis would consider the consumer's 
monthly payments on the loan, loan-related obligations, and any 
simultaneous loans of which the creditor was aware, as well as any 
recurring, material living expenses of which the creditor was aware. 
Guidance accompanying the rule notes that the longer the period of time 
that the consumer has demonstrated actual ability to repay the loan by 
making timely payments, without modification or accommodation, after 
consummation or, for an adjustable-rate mortgage, after recast, the 
less likely the consumer will be able to rebut the presumption based on 
insufficient residual income.
    With respect to prime loans--which are not currently covered by the 
Board's ability-to-repay rule--the final rule applies the new ability-
to-repay requirements but creates a strong presumption for those prime 
loans that constitute qualified mortgages. Thus, if a prime loan 
satisfies the qualified mortgage criteria described below, it will be 
conclusively presumed that the creditor made a good faith and 
reasonable determination of the consumer's ability to repay.
    General Requirements for Qualified Mortgages. The Dodd-Frank Act 
sets certain product-feature prerequisites and affordability 
underwriting requirements for qualified mortgages and vests discretion 
in the Bureau to decide whether additional underwriting or other 
requirements should apply. The final rule implements the statutory 
criteria, which generally prohibit loans with negative amortization, 
interest-only payments, balloon payments, or terms exceeding 30 years 
from being qualified mortgages. So-called ``no-doc'' loans where the 
creditor does not verify income or assets also cannot be qualified 
mortgages. Finally, a loan generally cannot be a qualified mortgage if 
the points and fees paid by the consumer exceed three percent of the 
total loan amount, although certain ``bona fide discount points'' are 
excluded for prime loans. The rule provides guidance on the calculation 
of points and fees and thresholds for smaller loans.
    The final rule also establishes general underwriting criteria for 
qualified mortgages. Most importantly, the general rule requires that 
monthly payments be calculated based on the highest payment that will 
apply in the first five years of the loan and that the consumer have a 
total (or ``back-end'') debt-to-income ratio that is less than or equal 
to 43 percent. The appendix to the rule details the calculation of 
debt-to-income for these purposes, drawing upon Federal Housing 
Administration guidelines for such calculations. The Bureau believes 
that these criteria will protect consumers by ensuring that creditors 
use a set of underwriting requirements that generally safeguard 
affordability. At the same time, these criteria provide bright lines 
for creditors who want to make qualified mortgages.
    The Bureau also believes that there are many instances in which 
individual consumers can afford a debt-to-income ratio above 43 percent 
based on their particular circumstances, but that such loans are better 
evaluated on an individual basis under the ability-to-repay criteria 
rather than with a blanket presumption. In light of the fragile state 
of the mortgage market as a result of the recent mortgage crisis, 
however, the Bureau is concerned that creditors may initially be 
reluctant to make loans that are not qualified mortgages, even though 
they are responsibly underwritten. The final rule therefore provides 
for a second, temporary category of qualified mortgages that have more 
flexible underwriting requirements so long as they satisfy the general 
product feature prerequisites for a qualified mortgage and also satisfy 
the underwriting requirements of, and are therefore eligible to be 
purchased, guaranteed or insured by either (1) the GSEs while they 
operate under Federal conservatorship or receivership; or (2) the U.S. 
Department of Housing and Urban Development, Department of Veterans 
Affairs, or Department of Agriculture or Rural Housing Service. This 
temporary provision will phase out over time as the various Federal 
agencies issue their own qualified mortgage rules and if GSE 
conservatorship ends, and in any event after seven years.
    Rural Balloon-Payment Qualified Mortgages. The final rule also 
implements a special provision in the Dodd-Frank Act that would treat 
certain balloon-payment mortgages as qualified mortgages if they are 
originated and held in portfolio by small creditors operating 
predominantly in rural or underserved areas. This provision is designed 
to assure credit availability in rural areas, where some creditors may 
only offer balloon-payment mortgages. Loans are only eligible if they 
have a term of at least five years, a fixed-interest rate, and meet 
certain basic underwriting standards; debt-to-income ratios must be 
considered but are not subject to the 43 percent general requirement.
    Creditors are only eligible to make rural balloon-payment qualified 
mortgages if they originate at least 50 percent of their first-lien 
mortgages in counties that are rural or underserved, have less than $2 
billion in assets, and (along with their affiliates) originate no more 
than 500 first-lien mortgages per year. The Bureau will designate a 
list of ``rural'' and ``underserved'' counties each year, and has 
defined coverage more broadly than originally had been proposed. 
Creditors must generally hold the loans on their portfolios for three 
years in order to maintain their ``qualified mortgage'' status.
    Other Final Rule Provisions. The final rule also implements Dodd-
Frank Act provisions that generally prohibit prepayment penalties 
except for certain fixed-rate, qualified mortgages where the penalties 
satisfy certain restrictions and the creditor has offered the consumer 
an alternative loan without such penalties. To match with certain 
statutory changes, the final rule also lengthens to three years 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 
that does not meet the definition of open-end credit as an open-end 
plan.

Summary of Concurrent Proposal

    The concurrent proposal seeks comment on whether the general 
ability-to-repay and qualified mortgage rule should be modified to 
address potential adverse consequences on certain narrowly-defined 
categories of lending programs. Because those measures were not 
proposed by the Board originally, the Bureau believes additional public 
input would be helpful. Specifically, the proposal seeks comment on 
whether it would be appropriate to exempt designated non-profit 
lenders, homeownership stabilization programs, and certain Federal 
agency and GSE refinancing programs from the ability-to-repay 
requirements because they are subject to their own specialized 
underwriting criteria.
    The proposal also seeks comment on whether to create a new category 
of qualified mortgages, similar to the one for rural balloon-payment 
mortgages, for loans without balloon-payment features that are 
originated and held on portfolio by small creditors. The new category 
would not be limited to lenders that operate predominantly in rural or

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underserved areas, but would use the same general size thresholds and 
other criteria as the rural balloon-payment rules. The proposal also 
seeks comment on whether to increase the threshold separating safe 
harbor and rebuttable presumption qualified mortgages for both rural 
balloon-payment qualified mortgages and the new small portfolio 
qualified mortgages, in light of the fact that small creditors often 
have higher costs of funds than larger creditors. Specifically, the 
Bureau is proposing a threshold of 3.5 percentage points above APOR for 
first-lien loans.

II. Background

    For over 20 years, consumer advocates, legislators, and regulators 
have raised concerns 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 
foreclosure rates increased dramatically, caused in part by the 
loosening of underwriting standards. See 73 FR 44524 (July 30, 2008). 
The following discussion provides background information, including a 
brief summary of the legislative and regulatory responses to the 
foregoing concerns, which culminated in the enactment of the Dodd-Frank 
Act on July 21, 2010, the Board's May 11, 2011, proposed rule to 
implement certain amendments to TILA made by the Dodd-Frank Act, and 
now the Bureau's issuance of this final rule to implement sections 
1411, 1412, and 1414 of that act.

A. The Mortgage Market

Overview of the Market and the Mortgage Crisis
    The mortgage market is the single largest market for consumer 
financial products and services in the United States, with 
approximately $9.9 trillion in mortgage loans outstanding.\1\ During 
the last decade, the market went through an unprecedented cycle of 
expansion and contraction that was fueled in part by the securitization 
of mortgages and creation of increasingly sophisticated derivative 
products. So many other parts of the American financial system were 
drawn into mortgage-related activities that, when the housing market 
collapsed in 2008, it sparked the most severe recession in the United 
States since the Great Depression.\2\
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    \1\ Fed. Reserve Sys., Flow of Funds Accounts of the United 
States, at 67 tbl.L.10 (2012), available at http://www.federalreserve.gov/releases/z1/Current/z1.pdf (as of the end of 
the third quarter of 2012).
    \2\ See Thomas F. Siems, Branding the Great Recession, Fin. 
Insights (Fed. Reserve Bank of Dall.) May 13, 2012, at 3, available 
at http://www.dallasfed.org/assets/documents/banking/firm/fi/fi1201.pdf (stating that the [great recession] ``was the longest and 
deepest economic contraction, as measured by the drop in real GDP, 
since the Great Depression.'').
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    The expansion in this market is commonly attributed to both 
particular economic conditions (including an era of low interest rates 
and rising housing prices) and to changes within the industry. Interest 
rates dropped significantly--by more than 20 percent--from 2000 through 
2003.\3\ Housing prices increased dramatically--about 152 percent--
between 1997 and 2006.\4\ Driven by the decrease in interest rates and 
the increase in housing prices, the volume of refinancings increased 
rapidly, from about 2.5 million loans in 2000 to more than 15 million 
in 2003.\5\
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    \3\ See U.S. Dep't of Hous. & Urban Dev., An Analysis of 
Mortgage Refinancing, 2001-2003, at 2 (2004) (``An Analysis of 
Mortgage Refinancing, 2001-2003''), available at www.huduser.org/Publications/pdf/MortgageRefinance03.pdf; Souphala Chomsisengphet & 
Anthony Pennington-Cross, The Evolution of the Subprime Mortgage 
Market, 88 Fed. Res. Bank of St. Louis Rev. 31, 48 (2006), available 
at http://research.stlouisfed.org/publications/review/article/5019.
    \4\ U.S. Fin. Crisis Inquiry Comm'n, The Financial Crisis 
Inquiry Report: Final Report of the National Commission on the 
Causes of the Financial and Economic Crisis in the United States 156 
(Official Gov't ed. 2011) (``FCIC Report''), available at http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.
    \5\ An Analysis of Mortgage Refinancing, 2001-2003, at 1.
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    In the mid-2000s, the market experienced a steady deterioration of 
credit standards in mortgage lending, with evidence that loans were 
made solely against collateral, or even against expected increases in 
the value of collateral, and without consideration of ability to repay. 
This deterioration of credit standards was particularly evidenced by 
the growth of ``subprime'' and ``Alt-A'' products, which consumers were 
often unable to repay.\6\ Subprime products were sold primarily to 
consumers with poor or no credit history, although there is evidence 
that some consumers who would have qualified for ``prime'' loans were 
steered into subprime loans as well.\7\ The Alt-A category of loans 
permitted consumers to take out mortgage loans while providing little 
or no documentation of income or other evidence of repayment ability. 
Because these loans involved additional risk, they were typically more 
expensive to consumers than ``prime'' mortgages, although many of them 
had very low introductory interest rates. In 2003, subprime and Alt-A 
origination volume was about $400 billion; in 2006, it had reached $830 
billion.\8\
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    \6\ FCIC Report at 88. These products included most notably 2/28 
and 3/27 hybrid adjustable rate mortgages (ARMs) and option ARM 
products. Id. at 106. A hybrid ARM is an adjustable rate mortgage 
loan that has a low fixed introductory rate for a certain period of 
time. An option ARM is an adjustable rate mortgage loan that has a 
scheduled loan payment that may result in negative amortization for 
a certain period of time, but that expressly permits specified 
larger payments in the contract or servicing documents, such as an 
interest-only payment or a fully amortizing payment. For these 
loans, the scheduled negatively amortizing payment was typically 
described in marketing and servicing materials as the ``optional 
payment.'' These products were often marketed to subprime customers.
    \7\ For example, the Federal Reserve Board on July 18, 2011, 
issued a consent cease and desist order and assessed an $85 million 
civil money penalty against Wells Fargo & Company of San Francisco, 
a registered bank holding company, and Wells Fargo Financial, Inc., 
of Des Moines. The order addresses allegations that Wells Fargo 
Financial employees steered potential prime-eligible consumers into 
more costly subprime loans and separately falsified income 
information in mortgage applications. In addition to the civil money 
penalty, the order requires that Wells Fargo compensate affected 
consumers. See Press Release, Fed. Reserve Bd. (July 20, 2011), 
available at http://www.federalreserve.gov/newsevents/press/enforcement/20110720a.htm.
    \8\ Inside Mortg. Fin., Mortgage Originations by Product, in 1. 
The 2011 Mortgage Market Statistical Annual 20 (2011).
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    So long as housing prices were continuing to increase, it was 
relatively easy for consumers to refinance their existing loans into 
more affordable products to avoid interest rate resets and other 
adjustments. When housing prices began to decline in 2005, however, 
refinancing became more difficult and delinquency rates on subprime and 
Alt-A products increased dramatically.\9\ More and more consumers, 
especially those with subprime and Alt-A loans, were unable or 
unwilling to make their mortgage payments. An early sign of the 
mortgage crisis was an upswing in early payment defaults--generally 
defined as borrowers being 60 or more days delinquent within the first 
year. Prior to 2006, 1.1 percent of mortgages would end up 60 or more 
days delinquent within the first two years.\10\ Taking a more expansive 
definition of early payment default to include 60 days delinquent 
within the first two years, this figure was double the historic average 
during 2006, 2007 and 2008.\11\ In 2006, 2007, and 2008, 2.3 percent, 
2.1 percent, and 2.3 percent of mortgages ended up 60 or more days 
delinquent within the first two years, respectively. By the summer of 
2006, 1.5 percent of loans less than a year old were in

[[Page 6411]]

default, and this figure peaked at 2.5 percent in late 2007, well above 
the 1.0 percent peak in the 2000 recession.\12\ First payment 
defaults--mortgages taken out by consumers who never made a single 
payment--exceeded 1.5 percent of loans in early 2007.\13\ In addition, 
as the economy worsened, the rates of serious delinquency (90 or more 
days past due or in foreclosure) for the subprime and Alt-A products 
began a steep increase from approximately 10 percent in 2006, to 20 
percent in 2007, to more than 40 percent in 2010.\14\
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    \9\ FCIC Report at 215-217.
    \10\ CoreLogic's TrueStandings Servicing (reflects first-lien 
mortgage loans) (data service accessible only through paid 
subscription).
    \11\ Id.
    \12\ Id. at 215. (CoreLogic Chief Economist Mark Fleming told 
the FCIC that the early payment default rate ``certainly correlates 
with the increase in the Alt-A and subprime shares and the turn of 
the housing market and the sensitivity of those loan products.'').
    \13\ Id.
    \14\ Id. at 217.
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    The impact of this level of delinquencies was severe on creditors 
who held loans on their books and on private investors who purchased 
loans directly or through securitized vehicles. Prior to and during the 
bubble, the evolution of the securitization of mortgages attracted 
increasing involvement from financial institutions that were not 
directly involved in the extension of credit to consumers and from 
investors worldwide. Securitization of mortgages allows originating 
creditors to sell off their loans (and reinvest the funds earned in 
making new ones) to investors who want an income stream over time. 
Securitization had been pioneered by what are now called government-
sponsored enterprises (GSEs), including the Federal National Mortgage 
Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation 
(Freddie Mac). But by the early 2000s, large numbers of private 
financial institutions were deeply involved in creating increasingly 
complex mortgage-related investment vehicles through securities and 
derivative products. The private securitization-backed subprime and 
Alt-A mortgage market ground to a halt in 2007 in the face of the 
rising delinquencies on subprime and Alt-A products.\15\
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    \15\ Id. at 124.
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    Six years later, the United States continues to grapple with the 
fallout. The fall in housing prices is estimated to have resulted in 
about $7 trillion in household wealth losses.\16\ In addition, 
distressed homeownership and foreclosure rates remain at unprecedented 
levels.\17\
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    \16\ The U.S. Housing Market: Current Conditions and Policy 
Considerations, at 3 (Fed. Reserve Bd., White Paper, 2012), 
available at http://www.federalreserve.gov/publications/other-reports/files/housing-white-paper-20120104.pdf.
    \17\ Lender Processing Servs., PowerPoint Presentation, LPS 
Mortgage Monitor: May 2012 Mortgage Performance Observations, Data 
as of April 2012 Month End, 3, 11 (May 2012), available at http://www.lpsvcs.com/LPSCorporateInformation/CommunicationCenter/DataReports/Pages/Mortgage-Monitor.aspx.
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Response and Government Programs
    In light of these conditions, the Federal government began 
providing support to the mortgage markets in 2008 and continues to do 
so at extraordinary levels today. The Housing and Economic Recovery Act 
of 2008, which became effective on October 1, 2008, provided both new 
safeguards and increased regulation for Fannie Mae and Freddie Mac, as 
well as provisions to assist troubled borrowers and to the hardest hit 
communities. Fannie Mae and Freddie Mac, which supported the mainstream 
mortgage market, experienced heavy losses and were placed in 
conservatorship by the Federal government in 2008 to support the 
collapsing mortgage market.\18\ Because private investors have 
withdrawn from the mortgage securitization market and there are no 
other effective secondary market mechanisms in place, the GSEs' 
continued operations help ensure that the secondary mortgage market 
continues to function and to assist consumers in obtaining new 
mortgages or refinancing existing mortgages. The Troubled Asset Relief 
Program (TARP), created to implement programs to stabilize the 
financial system during the financial crisis, was authorized through 
the Emergency Economic Stabilization Act of 2008 (EESA), as amended by 
the American Recovery and Reinvestment Act of 2009, and includes 
programs to help struggling homeowners avoid foreclosure.\19\ Since 
2008, several other Federal government efforts have endeavored to keep 
the country's housing finance system functioning, including the 
Treasury Department's and the Federal Reserve System's mortgage-backed 
securities (MBS) purchase programs to help keep interest rates low and 
the Federal Housing Administration's (FHA's) increased market presence. 
As a result, mortgage credit has remained available, albeit with more 
restrictive underwriting terms that limit or preclude some consumers' 
access to credit. These same government agencies together with the GSEs 
and other market participants have also undertaken a series of efforts 
to help families avoid foreclosure through loan-modification programs, 
loan-refinance programs and foreclosure alternatives.\20\
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    \18\ The Housing and Economic Recovery Act of 2008 (HERA), which 
created the Federal Housing Finance Agency (FHFA), granted the 
Director of FHFA discretionary authority to appoint FHFA conservator 
or receiver of the Enterprises ``for the purpose of reorganizing, 
rehabilitating, or winding up the affairs of a regulated entity.'' 
Housing and Economic Recovery Act of 2008, section 1367 (a)(2), 
amending the Federal Housing Enterprises Financial Safety and 
Soundness Act of 1992, 12 U.S.C. 4617(a)(2). On September 6, 2008, 
FHFA exercised that authority, placing the Federal National Mortgage 
Association (Fannie Mae) and the Federal Home Loan Mortgage 
Corporation (Freddie Mac) into conservatorships. The two GSEs have 
since received more than $180 billion in support from the Treasury 
Department. Through the second quarter of 2012, Fannie Mae has drawn 
$116.1 billion and Freddie Mac has drawn $71.3 billion, for an 
aggregate draw of $187.5 billion from the Treasury Department. Fed. 
Hous. Fin. Agency, Conservator's Report on the Enterprises' 
Financial Performance, at 17 (Second Quarter 2012), available at 
http://www.fhfa.gov/webfiles/24549/ConservatorsReport2Q2012.pdf.
    \19\ The Making Home Affordable Program (MHA) is the umbrella 
program for Treasury's homeowner assistance and foreclosure 
mitigation efforts. The main MHA components are the Home Affordable 
Modification Program (HAMP), a Treasury program that uses TARP funds 
to provide incentives for mortgage servicers to modify eligible 
first-lien mortgages, and two initiatives at the GSEs that use non-
TARP funds. Incentive payments for modifications to loans owned or 
guaranteed by the GSEs are paid by the GSEs, not TARP. Treasury over 
time expanded MHA to include sub-programs designed to overcome 
obstacles to sustainable HAMP modifications. Treasury also allocated 
TARP funds to support two additional housing support efforts: An FHA 
refinancing program and TARP funding for 19 state housing finance 
agencies, called the Housing Finance Agency Hardest Hit Fund. In the 
first half of 2012, Treasury extended the application period for 
HAMP by a year to December 31, 2013, and opened HAMP to non-owner-
occupied rental properties and to consumers with a wider range of 
debt-to-income ratios under ``HAMP Tier 2.''
    \20\ The Home Affordable Refinance Program (HARP) is designed to 
help eligible homeowners refinance their mortgage. HARP is designed 
for those homeowners who are current on their mortgage payments but 
have been unable to get traditional refinancing because the value of 
their homes has declined. For a mortgage to be considered for a HARP 
refinance, it must be owned or guaranteed by the GSEs. HARP ends on 
December 31, 2013.
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Size and Volume of the Current Mortgage Origination Market
    Even with the economic downturn and tightening of credit standards, 
approximately $1.28 trillion in mortgage loans were originated in 
2011.\21\ In exchange for an extension of mortgage credit, consumers 
promise to make regular mortgage payments and provide their home or 
real property as collateral. The overwhelming majority of homebuyers 
continue to use mortgage loans to finance at least some of the

[[Page 6412]]

purchase price of their property. In 2011, 93 percent of all home 
purchases were financed with a mortgage credit transaction.\22\
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    \21\ Moody's Analytics, Credit Forecast 2012 (2012) (``Credit 
Forecast 2012''), available at http://www.economy.com/default.asp 
(reflects first-lien mortgage loans) (data service accessibly only 
through paid subscription).
    \22\ Inside Mortg. Fin., New Homes Sold by Financing, in 1 The 
2012 Mortgage Market Statistical Annual 12 (2012).
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    Consumers may obtain mortgage credit to purchase a home, to 
refinance an existing mortgage, to access home equity, or to finance 
home improvement. Purchase loans and refinancings together produced 6.3 
million new first-lien mortgage loan originations in 2011.\23\ The 
proportion of loans that are for purchases as opposed to refinances 
varies with the interest rate environment and other market factors. In 
2011, 65 percent of the market was refinance transactions and 35 
percent was purchase loans, by volume.\24\ Historically the 
distribution has been more even. In 2000, refinances accounted for 44 
percent of the market while purchase loans comprised 56 percent; in 
2005, the two products were split evenly.\25\
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    \23\ Credit Forecast 2012.
    \24\ Inside Mortg. Fin., Mortgage Originations by Product, in 
The 2012 Mortgage Market Statistical Annual 17 (2012).
    \25\ Id. These percentages are based on the dollar amount of the 
loans.
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    With a home equity transaction, a homeowner uses his or her equity 
as collateral to secure consumer credit. The credit proceeds can be 
used, for example, to pay for home improvements. Home equity credit 
transactions and home equity lines of credit resulted in an additional 
1.3 million mortgage loan originations in 2011.\26\
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    \26\ Credit Forecast (2012) (reflects open-end and closed-end 
home equity loans).
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    The market for higher-priced mortgage loans remains significant. 
Data reported under the Home Mortgage Disclosure Act (HMDA) show that 
in 2011 approximately 332,000 transactions, including subordinate 
liens, were reportable as higher-priced mortgage loans. Of these 
transactions, refinancings accounted for approximately 44 percent of 
the higher-priced mortgage loan market, and 90 percent of the overall 
higher-priced mortgage loan market involved first-lien transactions. 
The median first-lien higher-priced mortgage loan was for $81,000, 
while the interquartile range (quarter of the transactions are below, 
quarter of the transactions are above) was $47,000 to $142,000.
    GSE-eligible loans, together with the other federally insured or 
guaranteed loans, cover the majority of the current mortgage market. 
Since entering conservatorship in September 2008, the GSEs have bought 
or guaranteed roughly three of every four mortgages originated in the 
country. Mortgages guaranteed by FHA make up most of the rest.\27\ 
Outside of the securitization available through the Government National 
Mortgage Association (Ginnie Mae) for loans primarily backed by FHA, 
there are very few alternatives in place today to assume the secondary 
market functions served by the GSEs.\28\
---------------------------------------------------------------------------

    \27\ Fed. Hous. Fin. Agency, A Strategic Plan for Enterprise 
Conservatorships: The Next Chapter in a Story that Needs an Ending, 
at 14 (2012) (``FHFA Report''), available at http://www.fhfa.gov/webfiles/23344/StrategicPlanConservatorshipsFINAL.pdf.
    \28\ FHFA Report at 8-9. Secondary market issuance remains 
heavily reliant upon the explicitly government guaranteed securities 
of FNMA, FHLMC, and GNMA. Through the first three quarters of 2012, 
approximately $1.2 trillion of the $1.33 trillion in mortgage 
originations have been securitized, less than $10 billion of the 
$1.2 trillion were non-agency mortgage backed securities. Inside 
Mortgage Finance (Nov. 2, 2012), at 4.
---------------------------------------------------------------------------

Continued Fragility of the Mortgage Market
    The current mortgage market is especially fragile as a result of 
the recent mortgage crisis. Tight credit remains an important factor in 
the contraction in mortgage lending seen over the past few years. 
Mortgage loan terms and credit standards have tightened most for 
consumers with lower credit scores and with less money available for a 
down payment. According to CoreLogic's TrueStandings Servicing, a 
proprietary data service that covers about two-thirds of the mortgage 
market, average underwriting standards have tightened considerably 
since 2007. Through the first nine months of 2012, for consumers that 
have received closed-end first-lien mortgages, the weighted average 
FICO \29\ score was 750, the loan-to-value (LTV) ratio was 78 percent, 
and the debt-to-income (DTI) ratio was 34.5 percent.\30\ In comparison, 
in the peak of the housing bubble in 2007, the weighted average FICO 
score was 706, the LTV was 80 percent, and the DTI was 39.8 
percent.\31\
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    \29\ FICO is a type of credit score that makes up a substantial 
portion of the credit report that lenders use to assess an 
applicant's credit risk and whether to extend a loan
    \30\ CoreLogic, TrueStandings Servicing Database, available at 
http://www.truestandings.com (data reflects first-lien mortgage 
loans) (data service accessible only through paid subscription). 
According to CoreLogic's TrueStandings Servicing, FICO reports that 
in 2011, approximately 38 percent of consumers receiving first-lien 
mortgage credit had a FICO score of 750 or greater.
    \31\ Id.
---------------------------------------------------------------------------

    In this tight credit environment, the data suggest that creditors 
are not willing to take significant risks. In terms of the distribution 
of origination characteristics, for 90 percent of all the Fannie Mae 
and Freddie Mac mortgage loans originated in 2011, consumers had a FICO 
score over 700 and a DTI less than 44 percent.\32\ According to the 
Federal Reserve's Senior Loan Officer Opinion Survey on Bank Lending 
Practices, in April 2012 nearly 60 percent of creditors reported that 
they would be much less likely, relative to 2006, to originate a 
conforming home-purchase mortgage \33\ to a consumer with a 10 percent 
down payment and a credit score of 620--a traditional marker for those 
consumers with weaker credit histories.\34\ The Federal Reserve Board 
calculates that the share of mortgage borrowers with credit scores 
below 620 has fallen from about 17 percent of consumers at the end of 
2006 to about 5 percent more recently.\35\ Creditors also appear to 
have pulled back on offering these consumers loans insured by the FHA, 
which provides mortgage insurance on loans made by FHA-approved 
creditors throughout the United States and its territories and is 
especially structured to help promote affordability.\36\
---------------------------------------------------------------------------

    \32\ Id.
    \33\ A conforming mortgage is one that is eligible for purchase 
or credit guarantee by Fannie Mae or Freddie Mac.
    \34\ Fed. Reserve Bd., Senior Loan Officer Opinion Survey on 
Bank Lending Practices, available at http://www.federalreserve.gov/boarddocs/SnLoanSurvey/default.htm.
    \35\ Federal Reserve Board staff calculations based on the 
Federal Reserve Bank of New York Consumer Credit Panel. The 10th 
percentile of credit scores on mortgage originations rose from 585 
in 2006 to 635 at the end of 2011.
    \36\ FHA insures mortgages on single family and multifamily 
homes including manufactured homes and hospitals. It is the largest 
insurer of mortgages in the world, insuring over 34 million 
properties since its inception in 1934.
---------------------------------------------------------------------------

    The Bureau is acutely aware of the high levels of anxiety in the 
mortgage market today. These concerns include the continued slow pace 
of recovery, the confluence of multiple major regulatory and capital 
initiatives, and the compliance burdens of the various Dodd-Frank Act 
rulemakings (including uncertainty on what constitutes a qualified 
residential mortgage (QRM), which, as discussed below, relates to the 
Dodd-Frank Act's credit risk retention requirements and mortgage 
securitizations). These concerns are causing discussion about whether 
creditors will consider exiting the business. The Bureau acknowledges 
that it will likely take some time for the mortgage market to stabilize 
and that creditors will need to adjust their operations to account for 
several major regulatory and capital regimes.

B. TILA and Regulation Z

    In 1968, Congress enacted the Truth in Lending Act (TILA), 15 
U.S.C. 1601

[[Page 6413]]

et seq., based on findings that the informed use of credit resulting 
from consumers' awareness of the cost of credit would enhance economic 
stability and competition among consumer credit providers. One of the 
purposes of TILA is to promote the informed use of consumer credit by 
requiring disclosures about its costs and terms. See 15 U.S.C. 1601. 
TILA requires additional disclosures for loans secured by consumers' 
homes and permits consumers to rescind certain transactions secured by 
their principal dwellings when the required disclosures are not 
provided. 15 U.S.C. 1635, 1637a. Section 105(a) of TILA directs the 
Bureau (formerly directed the Board of Governors of the Federal Reserve 
System) to prescribe regulations to carry out TILA's purposes and 
specifically authorizes the Bureau, 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 Bureau's judgment are necessary or proper to effectuate the 
purposes of TILA, facilitate compliance thereof, or prevent 
circumvention or evasion therewith. See 15 U.S.C. 1604(a).
    General rulemaking authority for TILA transferred to the Bureau in 
July 2011, other than for certain motor vehicle dealers in accordance 
with the Dodd-Frank Act section 1029, 12 U.S.C. 5519. Pursuant to the 
Dodd-Frank Act and TILA, as amended, the Bureau published for public 
comment an interim final rule establishing a new Regulation Z, 12 CFR 
part 1026, implementing TILA (except with respect to persons excluded 
from the Bureau's rulemaking authority by section 1029 of the Dodd-
Frank Act). 76 FR 79768 (Dec. 22, 2011). This rule did not impose any 
new substantive obligations but did make technical and conforming 
changes to reflect the transfer of authority and certain other changes 
made by the Dodd-Frank Act. The Bureau's Regulation Z took effect on 
December 30, 2011. The Official Staff Interpretations interpret the 
requirements of the regulation and provides guidance to creditors in 
applying the rules to specific transactions. See 12 CFR part 1026, 
Supp. I.

C. The Home Ownership and Equity Protection Act (HOEPA) and HOEPA Rules

    In response to evidence of abusive practices in the home-equity 
lending market, in 1994 Congress amended TILA by enacting the Home 
Ownership and Equity Protection Act (HOEPA) as part of the Riegle 
Community Development and Regulatory Improvement Act of 1994. Public 
Law 103-325, 108 Stat. 2160. HOEPA was enacted as an amendment to TILA 
to address abusive practices in refinancing and home-equity mortgage 
loans with high interest rates or high fees.\37\ Loans that meet 
HOEPA's high-cost triggers are subject to special disclosure 
requirements and restrictions on loan terms, and consumers with high-
cost mortgages have enhanced remedies for violations of the law.\38\
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    \37\ HOEPA amended TILA by adding new sections 103(aa) and 129, 
15 U.S.C. 1602(aa) and 1639.
    \38\ 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. 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 Dodd-Frank Act 
section 1431; TILA section 103(aa). For simplicity and consistency, 
this final rule uses the term ``high-cost mortgages'' to refer to 
mortgages covered by the HOEPA amendments.
---------------------------------------------------------------------------

    The statute applied generally to closed-end mortgage credit, but 
excluded purchase money mortgage loans and reverse mortgages. Coverage 
was triggered where a loan's annual percentage rate (APR) exceeded 
comparable Treasury securities by specified thresholds for particular 
loan types, or where points and fees exceeded eight percent of the 
total loan amount or a dollar threshold.\39\
---------------------------------------------------------------------------

    \39\ The Dodd-Frank Act adjusted the baseline for the APR 
comparison, lowered the points and fees threshold, and added a 
prepayment trigger.
---------------------------------------------------------------------------

    For high-cost loans meeting either of those thresholds, HOEPA 
required creditors to provide special pre-closing disclosures, 
restricted prepayment penalties and certain other loan terms, and 
regulated various creditor practices, such as extending credit without 
regard to a consumer's ability to repay the loan. HOEPA also provided a 
mechanism for consumers to rescind covered loans that included certain 
prohibited terms and to obtain higher damages than are allowed for 
other types of TILA violations. Finally, HOEPA amended TILA section 
131, 15
    U.S.C. 1641, to provide that purchasers of high-cost loans 
generally are subject to all claims and defenses against the original 
creditor with respect to the mortgage, including a creditor's failure 
to make an ability-to-repay determination before making the loan. HOEPA 
created special substantive protections for high-cost mortgages, such 
as 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, HOEPA expanded the Board's rulemaking authority, among other 
things, to prohibit acts or practices the Board found to be unfair and 
deceptive in connection with mortgage loans.\40\
---------------------------------------------------------------------------

    \40\ As discussed above, with the enactment of the Dodd-Frank 
Act, general rulemaking authority for TILA, including HOEPA, 
transferred from the Board to the Bureau on July 21, 2011.
---------------------------------------------------------------------------

    In 1995, the Board implemented the HOEPA amendments at Sec. Sec.  
226.31, 226.32, and 226.33 \41\ of Regulation Z. See 60 FR 15463 (Mar. 
24, 1995). In particular, Sec.  226.32(e)(1) \42\ implemented TILA 
section 129(h)'s ability-to-repay requirements to prohibit a creditor 
from engaging in a pattern or practice of extending a high-cost 
mortgage based on the consumer's collateral without regard to the 
consumer's repayment ability, including the consumer's current income, 
current obligations, and employment status.
---------------------------------------------------------------------------

    \41\ Subsequently renumbered as sections 1026.31, 1026.32, and 
1026.33 of Regulation Z. As discussed above, pursuant to the Dodd-
Frank Act and TILA, as amended, the Bureau published for public 
comment an interim final rule establishing a new Regulation Z, 12 
CFR part 1026, implementing TILA (except with respect to persons 
excluded from the Bureau's rulemaking authority by section 1029 of 
the Dodd-Frank Act). 76 FR 79768 (Dec. 22, 2011). The Bureau's 
Regulation Z took effect on December 30, 2011.
    \42\ Subsequently renumbered as section 1026.32(e)(1) of 
Regulation Z.
---------------------------------------------------------------------------

    In 2001, the Board published additional significant changes to 
expand both HOEPA's protections to more loans by revising the annual 
percentage rate (APR) threshold for first-lien mortgage loans, expanded 
the definition of points and fees to include the cost of optional 
credit insurance and debt cancellation premiums, and enhanced the 
restrictions associated with high-cost loans. See 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 consumer's repayment 
ability.

[[Page 6414]]

D. 2006 and 2007 Interagency Supervisory Guidance

    In December 2005, the Federal banking agencies \43\ 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 consumer to defer repayment of 
principal and sometimes interest. The guidance advised institutions of 
the need to reduce ``risk layering'' with respect to these products, 
such as by failing to document income or lending nearly the full 
appraised value of the home. The final guidance issued in September 
2006 specifically advised creditors that layering risks in 
nontraditional mortgage loans to consumers receiving subprime credit 
may significantly increase risks to consumers as well as institutions. 
See Interagency Guidance on Nontraditional Mortgage Product Risks, 71 
FR 58609 (Oct. 4, 2006) (2006 Nontraditional Mortgage Guidance).
---------------------------------------------------------------------------

    \43\ Along with the Board, the other Federal banking agencies 
included the Office of the Comptroller of the Currency (OCC), the 
Federal Deposit Insurance Corporation (FDIC), Office of Thrift 
Supervision (OTS), and the National Credit Union Administration 
(NCUA).
---------------------------------------------------------------------------

    The 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'' interest 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 consumers in the subprime market obtain loans they can afford to 
repay. Among other steps, the guidance advised creditors: (1) To use 
the fully indexed rate and fully-amortizing payment when qualifying 
consumers for loans with adjustable rates and potentially non-
amortizing payments; (2) to limit stated income and reduced 
documentation loans to cases where mitigating factors clearly minimize 
the need for full documentation of income; and (3) to provide that 
prepayment penalty clauses expire a reasonable period before reset, 
typically at least 60 days. See Statement on Subprime Mortgage Lending, 
72 FR 37569 (July 10, 2007) (2007 Subprime Mortgage Statement).\44\ 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.
---------------------------------------------------------------------------

    \44\ The 2006 Nontraditional Mortgage Guidance and the 2007 
Subprime Mortgage Statement will hereinafter be referred to 
collectively as the ``Interagency Supervisory Guidance.''
---------------------------------------------------------------------------

E. 2008 HOEPA Final Rule

    After the Board finalized the 2001 HOEPA rules, new consumer 
protection issues arose in the mortgage market. 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 (July 30, 
2008). The Board was also urged to adopt additional 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. As discussed above, in 1995 the Board 
implemented TILA section 129(h)'s ability-to-repay requirements for 
high-cost mortgage loans. In 2008, the Board exercised its authority 
under HOEPA to extend certain consumer protections concerning a 
consumer's ability to repay and prepayment penalties to a new category 
of ``higher-priced mortgage loans'' (HPMLs) \45\ with APRs that are 
lower than those prescribed for high-cost loans but that nevertheless 
exceed the average prime offer rate by prescribed amounts. This new 
category of loans was designed to include subprime credit. 
Specifically, the Board exercised its authority to revise HOEPA's 
restrictions on high-cost loans based on a conclusion that the 
revisions were necessary to prevent unfair and deceptive acts or 
practices in connection with mortgage loans. 73 FR 44522 (July 30, 
2008) (2008 HOEPA Final Rule). The Board determined that imposing the 
burden to prove ``pattern or practice'' on an individual consumer would 
leave many consumers with a lesser remedy, such as those provided under 
some State laws, or without any remedy for loans made without regard to 
repayment ability. In particular, the Board concluded that a 
prohibition on making individual loans without regard for repayment 
ability was necessary to ensure a remedy for consumers who are given 
unaffordable loans and to deter irresponsible lending, which injures 
individual consumers. The 2008 HOEPA Final Rule provides a presumption 
of compliance with the higher-priced mortgage ability-to-repay 
requirements if the creditor follows certain procedures regarding 
underwriting the loan payment, assessing the debt-to-income ratio or 
residual income, and limiting the features of the loan, in addition to 
following certain procedures mandated for all creditors. See Sec.  
1026.34(a)(4)(iii) and (iv). 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. 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 the loan.
---------------------------------------------------------------------------

    \45\ Under the Board's 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. The definition of a ``higher-priced mortgage loan'' 
includes practically all ``high-cost mortgages'' because the latter 
transactions are determined by higher loan pricing threshold tests. 
See 12 CFR 226.35(a)(1), since codified in parallel by the Bureau at 
12 CFR 1026.35(a)(1).
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F. The Dodd-Frank Act

    In 2007, Congress held numerous hearings focused on rising subprime 
foreclosure rates and the extent to which lending practices contributed 
to them.\46\ Consumer advocates testified

[[Page 6415]]

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 
consumers. In response to these hearings, the House of Representatives 
passed the Mortgage Reform and Anti-Predatory Lending Act, both in 2007 
and again in 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. Instead, both houses shifted 
their focus to enacting comprehensive financial reform legislation.
---------------------------------------------------------------------------

    \46\ E.g., Progress in Administration and Other Efforts to 
Coordinate and Enhance Mortgage Foreclosure Prevention: Hearing 
before the H. Comm. on Fin. Servs., 110th Cong. (2007); Legislative 
Proposals on Reforming Mortgage Practices: Hearing before the H. 
Comm. on Fin. Servs., 110th Cong. (2007); Legislative and Regulatory 
Options for Minimizing and Mitigating Mortgage Foreclosures: Hearing 
before the H. Comm. on Fin. Servs., 110th Cong. (2007); Ending 
Mortgage Abuse: Safeguarding Homebuyers: Hearing before the S. 
Subcomm. on Hous., Transp., and Cmty. Dev. of the S. Comm. on 
Banking, Hous., and Urban Affairs, 110th Cong. (2007); Improving 
Federal Consumer Protection in Financial Services: Hearing before 
the H. Comm. on Fin. Servs., 110th Cong. (2007); The Role of the 
Secondary Market in Subprime Mortgage Lending: Hearing before the 
Subcomm. on Fin. Insts. and Consumer Credit of the H. Comm. on Fin. 
Servs., 110th Cong. (2007); Possible Responses to Rising Mortgage 
Foreclosures: Hearing before the H. Comm. on Fin. Servs., 110th 
Cong. (2007); Subprime Mortgage Market Turmoil: Examining the Role 
of Securitization: Hearing before the Subcomm. on Secs., Ins., and 
Inv. of the S. Comm. on Banking, Hous., and Urban Affairs, 110th 
Cong. (2007); Subprime and Predatory Lending: New Regulatory 
Guidance, Current Market Conditions, and Effects on Regulated 
Financial Institutions: Hearing before the Subcomm. on Fin. Insts. 
and Consumer Credit of the H. Comm. on Fin. Servs., 110th Cong. 
(2007); Mortgage Market Turmoil: Causes and Consequences, Hearing 
before the S. Comm. on Banking, Hous., and Urban Affairs, 110th 
Cong. (2007); Preserving the American Dream: Predatory Lending 
Practices and Home Foreclosures, Hearing before the S. Comm. on 
Banking, Hous., and Urban Affairs, 110th Cong. (2007).
---------------------------------------------------------------------------

    In December 2009, the House passed the Wall Street Reform and 
Consumer Protection Act of 2009, its version of comprehensive financial 
reform legislation, which included an ability-to-repay and qualified 
mortgage provision. H.R. 4173, 111th Cong. (2009). In May 2010, the 
Senate passed its own version of ability-to-repay requirements in its 
own version of comprehensive financial reform legislation, called the 
Restoring American Financial Stability Act of 2010. S. 3217, 111th 
Cong. (2010). After conference committee negotiations, the Dodd-Frank 
Act was passed by both houses of Congress and was signed into law on 
July 21, 2010. Public Law 111-203, 124 Stat. 1376 (2010).
    In the Dodd-Frank Act, Congress established the Bureau and, under 
sections 1061 and 1100A, generally consolidated the rulemaking 
authority for Federal consumer financial laws, including TILA and 
RESPA, in the Bureau.\47\ Congress also provided the Bureau, among 
other things, with supervision authority for Federal consumer financial 
laws over certain entities, including insured depository institutions 
and credit unions with total assets over $10 billion and their 
affiliates, and mortgage-related non-depository financial services 
providers.\48\ In addition, Congress provided the Bureau with 
authority, subject to certain limitations, to enforce the Federal 
consumer financial laws, including the 18 enumerated consumer laws. 
Title X of the Dodd-Frank Act, and rules thereunder. The Bureau can 
bring civil actions in court and administrative enforcement proceedings 
to obtain remedies such as civil penalties and cease-and-desist orders.
---------------------------------------------------------------------------

    \47\ Sections 1011 and 1021 of the Dodd-Frank Act, in title X, 
the ``Consumer Financial Protection Act,'' Public Law 111-203, secs. 
1001-1100H, codified at 12 U.S.C. 5491, 5511. The Consumer Financial 
Protection Act is substantially codified at 12 U.S.C. 5481-5603. 
Section 1029 of the Dodd-Frank Act excludes from this transfer of 
authority, subject to certain exceptions, any rulemaking authority 
over a motor vehicle dealer that is predominantly engaged in the 
sale and servicing of motor vehicles, the leasing and servicing of 
motor vehicles, or both. 12 U.S.C. 5519.
    \48\ Sections 1024 through 1026 of the Dodd-Frank Act, codified 
at 12 U.S.C. 5514 through 5516.
---------------------------------------------------------------------------

    At the same time, Congress significantly amended the statutory 
requirements governing mortgage practices with the intent to restrict 
the practices that contributed to the crisis. Title XIV of the Dodd-
Frank Act contains a modified version of the Mortgage Reform and Anti-
Predatory Lending Act.\49\ The Dodd-Frank Act requires the Bureau to 
propose consolidation of the major federal mortgage disclosures, 
imposes new requirements and limitations to address a wide range of 
consumer mortgage issues, and imposes credit risk retention 
requirements in connection with mortgage securitization.
---------------------------------------------------------------------------

    \49\ Although S. Rept. No. 111-176 contains general legislative 
history concerning the Dodd-Frank Act and the Senate ability-to-
repay provisions, it does not address the House Mortgage Reform and 
Anti-Predatory Lending Act. Separate legislative history for the 
predecessor House bills is available in H. Rept. No. 110-441 for 
H.R. 3915 (2007), and H. Rept. No. 111-194 for H.R. 1728 (2009).
---------------------------------------------------------------------------

    Through the Dodd-Frank Act, Congress expanded HOEPA to apply to 
more types of mortgage transactions, including purchase money mortgage 
loans and home-equity lines of credit. Congress also amended HOEPA's 
existing high-cost triggers, added a prepayment penalty trigger, and 
expanded the protections associated with high-cost mortgages.\50\
---------------------------------------------------------------------------

    \50\ Under the Dodd-Frank Act, HOEPA protections would be 
triggered where: (1) A loan's annual percentage rate (APR) exceeds 
the average prime offer rate by 6.5 percentage points for most 
first-lien mortgages and 8.5 percentage points for subordinate lien 
mortgages; (2) a loan's points and fees exceed 5 percent of the 
total transaction amount, or a higher threshold for loans below 
$20,000; or (3) the creditor may charge a prepayment penalty more 
than 36 months after loan consummation or account opening, or 
penalties that exceed more than 2 percent of the amount prepaid.
---------------------------------------------------------------------------

    In addition, sections 1411, 1412, and 1414 of the Dodd-Frank Act 
created new TILA section 129C, which establishes, among other things, 
new ability-to-repay requirements and new limits on prepayment 
penalties. Section 1402 of 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.'' TILA 
section 129B(a)(1), 15 U.S.C. 1639b(a)(1). Section 1402 of 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.'' TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2).
    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, credit secured by an interest in a 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 does not exceed 
certain thresholds for points and fees on the loan and which meets such 
other criteria as the Bureau may prescribe.
     Prohibits prepayment penalties unless the mortgage is a 
fixed-rate qualified mortgage that is not a higher-priced mortgage 
loan, and the amount and duration of the prepayment penalty are 
limited.
    The statutory ability-to-repay standards reflect Congress's belief 
that certain lending practices (such as low- or no-documentation loans 
or underwriting loans without regard to principal repayment) led to 
consumers having mortgages they could not afford, resulting in high 
default and foreclosure rates. Accordingly, new TILA section 129C 
generally 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 according to its terms.
    To provide more certainty to creditors while protecting consumers 
from unaffordable loans, the Dodd-Frank Act provides a presumption of 
compliance with the ability-to-repay requirements for certain 
``qualified mortgages.'' TILA section 129C(b)(1) states that a creditor

[[Page 6416]]

or assignee may presume that a loan has met the repayment ability 
requirement if the loan is a qualified mortgage. Qualified mortgages 
are prohibited from containing certain features that Congress 
considered to increase risks to consumers and must comply with certain 
limits on points and fees.
    The Dodd-Frank Act creates special remedies for violations of TILA 
section 129C. As amended by section 1416 of the Dodd-Frank Act, TILA 
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, unless 
the creditor demonstrates that the failure to comply is not material. 
TILA section 130(a). This recovery is in addition to: (1) Actual 
damages; (2) statutory damages in an individual action or class action, 
up to a prescribed threshold; and (3) court costs and attorney fees 
that would be available for violations of other TILA provisions. In 
addition, the statute of limitations 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 most other TILA violations, except for 
actions brought under section 129 or 129B, or actions brought by a 
State attorney general to enforce a violation of section 129, 129B, 
129C, 129D, 129E, 129F, 129G, or 129H, which may be brought not later 
than 3 years after the date on which the violation occurs, and private 
education loans under 15 U.S.C. 1650(a), which may be brought not later 
than one year from the due date of first regular payment of principal). 
TILA section 130(e). Moreover, as amended by section 1413 of the Dodd-
Frank Act, TILA provides that when a creditor, or an assignee, other 
holder or their agent initiates a foreclosure action, a consumer may 
assert a violation of TILA section 129C(a) ``as a matter of defense by 
recoupment or setoff.'' TILA section 130(k). There is no time limit on 
the use of this defense and the amount of recoupment or setoff is 
limited, with respect to the special statutory damages, to no more than 
three years of finance charges and fees. For high-cost loans an 
assignee generally continues to be subject to all claims and defenses, 
not only in foreclosure, with respect to that mortgage that the 
consumer could assert against the creditor of the mortgage, unless the 
assignee demonstrates, by a preponderance of evidence, that a 
reasonable person exercising ordinary due diligence, could not 
determine that the mortgage was a high-cost mortgage. TILA section 
131(d).
    In addition to the foregoing ability-to-repay provisions, the Dodd-
Frank Act established other new standards concerning a wide range of 
mortgage lending practices, including compensation of mortgage 
originators,\51\ Federal mortgage disclosures,\52\ and mortgage 
servicing.\53\ Those and other Dodd-Frank Act provisions are the 
subjects of other rulemakings by the Bureau. For additional information 
on those other rulemakings, see the discussion below in part III.C.
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    \51\ Sections 1402 through 1405 of the Dodd-Frank Act, codified 
at 15 U.S.C. 1639b.
    \52\ Section 1032(f) of the Dodd-Frank Act, codified at 12 
U.S.C. 5532(f).
    \53\ Sections 1418, 1420, 1463, and 1464 of the Dodd-Frank Act, 
codified at 12 U.S.C. 2605; 15 U.S.C. 1638, 1638a, 1639f, and 1639g.
---------------------------------------------------------------------------

G. Qualified Residential Mortgage Rulemaking

    Section 15G of the Securities Exchange Act of 1934, added by 
section 941(b) of the Dodd-Frank Act, generally requires the 
securitizer of asset-backed securities (ABS) to retain not less than 
five percent of the credit risk of the assets collateralizing the ABS. 
15 U.S.C. 78o-11. The Dodd-Frank Act's credit risk retention 
requirements are aimed at addressing weaknesses and failures in the 
securitization process and the securitization markets.\54\ By requiring 
that the securitizer retain a portion of the credit risk of the assets 
being securitized, the Dodd-Frank Act provides securitizers an 
incentive to monitor and ensure the quality of the assets underlying a 
securitization transaction. Six Federal agencies (not including the 
Bureau) are tasked with implementing this requirement. Those agencies 
are the Board, Office of the Comptroller of the Currency (OCC), Federal 
Deposit Insurance Corporation (FDIC), Securities and Exchange 
Commission (SEC), Federal Housing Finance Agency (FHFA), and Department 
of Housing and Urban Development (HUD) (collectively, the QRM 
agencies).
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    \54\ As noted in the legislative history of section 15G of the 
Securities Exchange Act of 1934, ``[w]hen securitizers retain a 
material amount of risk, they have `skin in the game,' aligning 
their economic interest with those of investors in asset-backed 
securities.'' See S. Rept. 176, 111th Cong., at 129 (2010).
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    Section 15G of the Securities Exchange Act of 1934 provides that 
the credit risk retention requirements shall not apply to an issuance 
of ABS if all of the assets that collateralize the ABS are ``qualified 
residential mortgages'' (QRMs). See 15 U.S.C. 78o-11(c)(1)(C)(iii), 
(4)(A) and (B). Section 15G requires the QRM agencies to jointly define 
what constitutes a QRM, taking into consideration underwriting and 
product features that historical loan performance data indicate result 
in a lower risk of default. See 15 U.S.C. 78o-11(e)(4). Notably, 
section 15G also provides that the definition of a QRM shall be ``no 
broader than'' the definition of a ``qualified mortgage,'' as the term 
is defined under TILA section 129C(b)(2), as amended by the Dodd-Frank 
Act, and regulations adopted thereunder. 15 U.S.C. 78o-11(e)(4)(C).
    On April 29, 2011, the QRM agencies issued joint proposed risk 
retention rules, including a proposed QRM definition (2011 QRM Proposed 
Rule). See 76 FR 24090 (Apr. 29, 2011). The proposed rule has not been 
finalized. Among other requirements, the 2011 QRM Proposed Rule 
incorporates the qualified mortgage restrictions on negative 
amortization, interest-only, and balloon payments, limits points and 
fees to three percent of the loan amount, and prohibits prepayment 
penalties. The proposed rule also establishes underwriting standards 
designed to ensure that QRMs have high credit quality, including:
     A maximum ``front-end'' monthly debt-to-income ratio 
(which looks at only the consumer's mortgage payment relative to 
income, but not at other debts) of 28 percent;
     A maximum ``back-end'' monthly debt-to-income ratio (which 
includes all of the consumer's debt, not just the mortgage payment) of 
36 percent;
     A maximum loan-to-value (LTV) ratio of 80 percent in the 
case of a purchase transaction (with a lesser combined LTV permitted 
for refinance transactions);
     A 20 percent down payment requirement in the case of a 
purchase transaction; and
     Credit history verification and documentation 
requirements.
    The proposed rule also includes appraisal requirements, 
restrictions on the assumability of the mortgage, and requires the 
creditor to commit to certain servicing policies and procedures 
regarding loss mitigation. See 76 FR at 24166-67.
    To provide clarity on the definitions, calculations, and 
verification requirements for the QRM standards, the 2011 QRM Proposed 
Rule incorporates certain definitions and key terms established by HUD 
and required to be used by creditors originating FHA-insured 
residential mortgages. See 76 FR at 24119. Specifically, the 2011 QRM 
Proposed Rule incorporates the definitions and standards set out in the 
HUD Handbook 4155.1 (New Version),

[[Page 6417]]

Mortgage Credit Analysis for Mortgage Insurance, as in effect on 
December 31, 2010, for determining and verifying the consumer's funds 
and the consumer's monthly housing debt, total monthly debt, and 
monthly gross income.\55\
---------------------------------------------------------------------------

    \55\ See U.S. Dep't of Hous. & Urban Dev., Housing Handbook 
4155.1, Mortgage Credit Analysis for Mortgage Insurance (rev. Mar. 
2011) (``HUD Handbook 4155.1''), available at http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/handbooks/hsgh/4155.1.
---------------------------------------------------------------------------

    The qualified mortgage and QRM definitions are distinct and relate 
to different parts of the Dodd-Frank Act with different purposes, but 
both are designed to address problems that had arisen in the mortgage 
origination process. The qualified mortgage standard provides creditors 
with a presumption of compliance with the requirement in TILA section 
129C(a) to assess a consumer's ability to repay a residential mortgage 
loan. The purpose of these provisions is to ensure that consumers are 
offered and receive residential mortgage loans on terms that reasonably 
reflect their ability to repay the loans. See TILA section 129B(a)(2). 
The Dodd-Frank Act's credit risk retention requirements are intended to 
address problems in the securitization markets and in mortgage markets 
by requiring that securitizers, as a general matter, retain an economic 
interest in the credit risk of the assets they securitize. The QRM 
credit risk retention requirement was meant to incentivize creditors to 
make more responsible loans because they will need to keep some skin in 
the game.\56\
---------------------------------------------------------------------------

    \56\ See S. Rept. 176, 111th Cong., at 129 (2010).
---------------------------------------------------------------------------

    Nevertheless, as discussed above, the Dodd-Frank Act requires that 
the QRM definition be ``no broader than'' the qualified mortgage 
definition. Therefore, in issuing the 2011 QRM Proposed Rule, the QRM 
agencies sought to incorporate the statutory qualified mortgage 
standards, in addition to other requirements, into the QRM definition. 
76 FR at 24118. This approach was designed to minimize the potential 
for conflicts between the QRM standards in the proposed rule and the 
qualified mortgage definition that the Bureau would ultimately adopt in 
a final rule.
    In the 2011 QRM Proposed Rule, the QRM agencies stated their 
expectation to monitor the rules adopted by the Bureau under TILA to 
define a qualified mortgage and to review those rules to ensure that 
the definition of QRM in the final rule is ``no broader'' than the 
definition of a qualified mortgage and to appropriately implement the 
Dodd-Frank Act's credit risk retention requirement. See 76 FR at 24118. 
In preparing this final rule, the Bureau has consulted regularly with 
the QRM agencies to coordinate the qualified mortgage and qualified 
residential mortgage definitions. However, while the Bureau's qualified 
mortgage definition will set the outer boundary of a QRM, the QRM 
agencies have discretion under the Dodd-Frank Act to define QRMs in a 
way that is stricter than the qualified mortgage definition.

III. Summary of the Rulemaking Process

A. The Board's Proposal

    In 2011, the Board published for public comment a proposed rule 
amending Regulation Z to implement the foregoing ability-to-repay 
amendments to TILA made by the Dodd-Frank Act. See 76 FR 27390 (May 11, 
2011) (2011 ATR Proposal, the Board's proposal or the proposal). 
Consistent with the Dodd-Frank Act, the Board's proposal applied the 
ability-to-repay requirements to any consumer credit transaction 
secured by a dwelling (including vacation home loans and home equity 
loans), except an open-end credit plan, extension of credit secured by 
a consumer's interest in a timeshare plan, reverse mortgage, or 
temporary loan with a term of 12 months or less.
    The Board's proposal provided four options for complying with the 
ability-to-repay requirement, including by making a ``qualified 
mortgage.'' First, the proposal would have allowed a creditor to meet 
the general ability-to-repay standard by originating a covered mortgage 
loan for which the creditor considered and verified eight underwriting 
factors in determining repayment ability, and, for adjustable rate 
loans, the mortgage payment calculation is based on the fully indexed 
rate.\57\ Second, the proposal would have allowed a creditor to 
refinance a ``non-standard mortgage'' into a ``standard mortgage.'' 
\58\ Under this option, the proposal would not have required the 
creditor to verify the consumer's income or assets. Third, the proposal 
would have allowed a creditor to originate a qualified mortgage, which 
provides special protection from liability for creditors. Because the 
Board determined that it was unclear whether that protection is 
intended to be a safe harbor or a rebuttable presumption of compliance 
with the repayment ability requirement, the Board proposed two 
alternative definitions of a qualified mortgage.\59\ Finally, the 
proposal would have allowed a small creditor operating predominantly in 
rural or underserved areas to originate 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.\60\ The Board's proposal also would have implemented 
the Dodd-Frank Act's limits on prepayment penalties, lengthened the 
time creditors must retain evidence of compliance with the ability-to-
repay and prepayment penalty provisions, and prohibited evasion of the 
rule by structuring a closed-end extension of credit that does not meet 
the definition of an open-end plan. As discussed above, rulemaking 
authority under TILA generally transferred from the Board to the Bureau 
in July 2011, including the authority under Dodd-Frank Act section 1412 
to prescribe regulations to carry out the purposes of the qualified 
mortgage rules. 12 U.S.C. 5512; 12 U.S.C. 5581; 15 U.S.C. 1639c. As 
discussed above, TILA section 105(a) directs the Bureau to prescribe 
regulations to carry out the purposes of

[[Page 6418]]

TILA. Except with respect to the substantive restrictions on high-cost 
mortgages provided in TILA section 129, TILA section 105(a) authorizes 
the Bureau to prescribe regulations that may contain additional 
requirements, classifications, differentiations, or other provisions, 
and may provide for such adjustments and exceptions for all or any 
class of transactions that the Bureau determines are necessary or 
proper to effectuate the purposes of TILA, to prevent circumvention or 
evasion thereof, or to facilitate compliance therewith.
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    \57\ The eight factors are: (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.
    \58\ This alternative is based on a Dodd-Frank Act provision 
that is meant to provide flexibility for certain streamlined 
refinancings, which are no- or low-documentation transactions 
designed to refinance a consumer quickly under certain 
circumstances, when such refinancings would move consumers out of 
risky mortgages and into more stable mortgage products--what the 
proposal defined as mortgage loans that, among other things, do not 
contain negative amortization, interest-only payments, or balloon 
payments, and have limited points and fees. TILA section 
129C(a)(6)(E); 15 U.S.C. 1639c(a)(6)(E).
    \59\ The Board's proposed first alternative would have operated 
as a legal safe harbor and define 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; (b) the total points and fees do not exceed 
3 percent of the total loan amount; (c) the consumer's income or 
assets are verified and documented; and (d) the underwriting of the 
mortgage is based on the maximum interest rate in the first five 
years, uses a payment schedule that fully amortizes the loan over 
the loan term, and takes into account any mortgage-related 
obligations. The Board's proposed second alternative would have 
provided a rebuttable presumption of compliance and defined a 
``qualified mortgage'' as including the criteria listed above in the 
first alternative as well as considering and verifying the following 
additional underwriting requirements from the ability-to-repay 
standard: The consumer's employment status, the monthly payment for 
any simultaneous loan, the consumer's current debt obligations, the 
total debt-to-income ratio or residual income, and the consumer's 
credit history.
    \60\ This alternative is based on statutory provision. TILA 
section 129C(b)(2)(E); 15 U.S.C. 1639c. As the Board's proposal 
noted, this standard is evidently meant to accommodate community 
banks that originate balloon-payment mortgages in lieu of 
adjustable-rate mortgages to hedge against interest rate risk.
---------------------------------------------------------------------------

B. Comments and Post-Proposal Outreach

    The Board received numerous comments on the proposal, including 
comments regarding the criteria for a ``qualified mortgage'' and 
whether a qualified mortgage provides a safe harbor or a presumption of 
compliance with the repayment ability requirements. As noted above, in 
response to the proposed rule, the Board received approximately 1,800 
letters from commenters, including members of Congress, creditors, 
consumer groups, trade associations, mortgage and real estate market 
participants, and individual consumers. As of July 21, 2011, the Dodd-
Frank Act generally transferred the Board's rulemaking authority for 
TILA, among other Federal consumer financial laws, to the Bureau. 
Accordingly, all comment letters on the proposed rule were also 
transferred to the Bureau. Materials submitted were filed in the record 
and are publicly available at http://www.regulations.gov.
    Through various comment letters and the Bureau's own collection of 
data, the Bureau received additional information and new data 
pertaining to the proposed rule. Accordingly, in May 2012, the Bureau 
reopened the comment period in order to solicit further comment on data 
and new information, including data that may assist the Bureau in 
defining loans with characteristics that make it appropriate to presume 
that the creditor complied with the ability-to-repay requirements or 
assist the Bureau in assessing the benefits and costs to consumers, 
including access to credit, and covered persons, as well as the market 
share covered by, alternative definitions of a ``qualified mortgage.'' 
The Bureau received approximately 160 comments in response to the 
reopened comment period from a variety of commenters, including 
creditors, consumer groups, trade associations, mortgage and real 
estate market participants, individuals, small entities, the SBA's 
Office of Advocacy, and FHA. As discussed in more detail below, the 
Bureau has considered these comments in adopting this final rule.

C. Other Rulemakings

    In addition to this final rule, the Bureau is adopting several 
other final rules and issuing one proposal, all relating to mortgage 
credit to implement requirements of title XIV of the Dodd-Frank Act. 
The Bureau is also issuing a final rule jointly with other Federal 
agencies to implement requirements for mortgage appraisals in title 
XIV. Each of the final rules follows a proposal issued in 2011 by the 
Board or in 2012 by the Bureau alone or jointly with other Federal 
agencies. Collectively, these proposed and final rules are referred to 
as the Title XIV Rulemakings.
     Ability to Repay: Simultaneously with this final rule (the 
2013 ATR Final Rule), the Bureau is issuing a proposal to amend certain 
provisions of the final rule, including by the addition of exemptions 
for certain nonprofit creditors and certain homeownership stabilization 
programs and a definition of a ``qualified mortgage'' for certain loans 
made and held in portfolio by small creditors (the 2013 ATR Concurrent 
Proposal). The Bureau expects to act on the 2013 ATR Concurrent 
Proposal on an expedited basis, so that any exceptions or adjustments 
can take effect simultaneously with this final rule.
     Escrows: The Bureau is finalizing a rule, following a 
March 2011 proposal issued by the Board (the Board's 2011 Escrows 
Proposal),\61\ to implement certain provisions of the Dodd-Frank Act 
expanding on existing rules that require escrow accounts to be 
established for higher-priced mortgage loans and creating an exemption 
for certain loans held by creditors operating predominantly in rural or 
underserved areas, pursuant to TILA section 129D as established by 
Dodd-Frank Act sections 1461. 15 U.S.C. 1639d. The Bureau's final rule 
is referred to as the 2013 Escrows Final Rule.
---------------------------------------------------------------------------

    \61\ 76 FR 11598 (Mar. 2, 2011).
---------------------------------------------------------------------------

     HOEPA: Following its July 2012 proposal (the 2012 HOEPA 
Proposal),\62\ the Bureau is issuing a final rule to implement Dodd-
Frank Act requirements expanding protections for ``high-cost 
mortgages'' under the Homeownership and Equity Protection Act (HOEPA), 
pursuant to TILA sections 103(bb) and 129, as amended by Dodd-Frank Act 
sections 1431 through 1433. 15 U.S.C. 1602(bb) and 1639. The Bureau 
also is finalizing rules to implement certain title XIV requirements 
concerning homeownership counseling, including a requirement that 
creditors provide lists of homeownership counselors to applicants for 
federally related mortgage loans, pursuant to RESPA section 5(c), as 
amended by Dodd-Frank Act section 1450. 12 U.S.C. 2604(c). The Bureau's 
final rule is referred to as the 2013 HOEPA Final Rule.
---------------------------------------------------------------------------

    \62\ 77 FR 49090 (Aug. 15,2012).
---------------------------------------------------------------------------

     Servicing: Following its August 2012 proposals (the 2012 
RESPA Servicing Proposal and 2012 TILA Servicing Proposal),\63\ the 
Bureau is adopting final rules to implement Dodd-Frank Act requirements 
regarding force-placed insurance, error resolution, information 
requests, and payment crediting, as well as requirements for mortgage 
loan periodic statements and adjustable-rate mortgage reset 
disclosures, pursuant to section 6 of RESPA and sections 128, 128A, 
129F, and 129G of TILA, as amended or established by Dodd-Frank Act 
sections 1418, 1420, 1463, and 1464. 12 U.S.C. 2605; 15 U.S.C. 1638, 
1638a, 1639f, and 1639g. The Bureau also is finalizing rules on early 
intervention for troubled and delinquent consumers, and loss mitigation 
procedures, pursuant to the Bureau's authority under section 6 of 
RESPA, as amended by Dodd-Frank Act section 1463, to establish 
obligations for mortgage servicers that it finds to be appropriate to 
carry out the consumer protection purposes of RESPA, and its authority 
under section 19(a) of RESPA to prescribe rules necessary to achieve 
the purposes of RESPA. The Bureau's final rule under RESPA with respect 
to mortgage servicing also establishes requirements for general 
servicing standards policies and procedures and continuity of contact 
pursuant to its authority under section 19(a) of RESPA. The Bureau's 
final rules are referred to as the 2013 RESPA Servicing Final Rule and 
the 2013 TILA Servicing Final Rule, respectively.
---------------------------------------------------------------------------

    \63\ 77 FR 57200 (Sept. 17, 2012) (RESPA); 77 FR 57318 (Sept. 
17, 2012) (TILA).
---------------------------------------------------------------------------

     Loan Originator Compensation: Following its August 2012 
proposal (the 2012 Loan Originator Proposal),\64\ the Bureau is issuing 
a final rule to implement provisions of the Dodd-Frank Act requiring 
certain creditors and loan originators to meet certain duties of care, 
including qualification requirements; requiring the establishment of 
certain compliance procedures by depository institutions; prohibiting 
loan originators, creditors, and the affiliates of both from receiving 
compensation in various forms (including based on the terms of the 
transaction) and from sources other than

[[Page 6419]]

the consumer, with specified exceptions; and establishing restrictions 
on mandatory arbitration and financing of single premium credit 
insurance, pursuant to TILA sections 129B and 129C as established by 
Dodd-Frank Act sections 1402, 1403, and 1414(a). 15 U.S.C. 1639b, 
1639c. The Bureau's final rule is referred to as the 2013 Loan 
Originator Final Rule.
---------------------------------------------------------------------------

    \64\ 77 FR 55272 (Sept. 7, 2012).
---------------------------------------------------------------------------

     Appraisals: The Bureau, jointly with other Federal 
agencies,\65\ is issuing a final rule implementing Dodd-Frank Act 
requirements concerning appraisals for higher-risk mortgages, pursuant 
to TILA section 129H as established by Dodd-Frank Act section 1471. 15 
U.S.C. 1639h. This rule follows the agencies' August 2012 joint 
proposal (the 2012 Interagency Appraisals Proposal).\66\ The agencies' 
joint final rule is referred to as the 2013 Interagency Appraisals 
Final Rule. In addition, following its August 2012 proposal (the 2012 
ECOA Appraisals Proposal),\67\ the Bureau is issuing a final rule to 
implement provisions of the Dodd-Frank Act requiring that creditors 
provide applicants with a free copy of written appraisals and 
valuations developed in connection with applications for loans secured 
by a first lien on a dwelling, pursuant to section 701(e) of the Equal 
Credit Opportunity Act (ECOA) as amended by Dodd-Frank Act section 
1474. 15 U.S.C. 1691(e). The Bureau's final rule is referred to as the 
2013 ECOA Appraisals Final Rule.
---------------------------------------------------------------------------

    \65\ Specifically, the Board of Governors of the Federal Reserve 
System, the Office of the Comptroller of the Currency, the Federal 
Deposit Insurance Corporation, the National Credit Union 
Administration, and the Federal Housing Finance Agency.
    \66\ 77 FR 54722 (Sept. 5, 2012).
    \67\ 77 FR 50390 (Aug. 21, 2012).
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    The Bureau is not at this time finalizing proposals concerning 
various disclosure requirements that were added by title XIV of the 
Dodd-Frank Act, integration of mortgage disclosures under TILA and 
RESPA, or a simpler, more inclusive definition of the finance charge 
for purposes of disclosures for closed-end mortgage transactions under 
Regulation Z. The Bureau expects to finalize these proposals and to 
consider whether to adjust regulatory thresholds under the Title XIV 
Rulemakings in connection with any change in the calculation of the 
finance charge later in 2013, after it has completed quantitative 
testing, and any additional qualitative testing deemed appropriate, of 
the forms that it proposed in July 2012 to combine TILA mortgage 
disclosures with the good faith estimate (RESPA GFE) and settlement 
statement (RESPA settlement statement) required under the Real Estate 
Settlement Procedures Act, pursuant to Dodd-Frank Act section 1032(f) 
and sections 4(a) of RESPA and 105(b) of TILA, as amended by Dodd-Frank 
Act sections 1098 and 1100A, respectively (the 2012 TILA-RESPA 
Proposal).\68\ Accordingly, the Bureau already has issued a final rule 
delaying implementation of various affected title XIV disclosure 
provisions.\69\ The Bureau's approaches to coordinating the 
implementation of the Title XIV Rulemakings and to the finance charge 
proposal are discussed in turn below.
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    \68\ 77 FR 51116 (Aug. 23, 2012).
    \69\ 77 FR 70105 (Nov. 23, 2012).
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Coordinated Implementation of Title XIV Rulemakings
    As noted in all of its foregoing proposals, the Bureau regards each 
of the Title XIV Rulemakings as affecting aspects of the mortgage 
industry and its regulations. Accordingly, as noted in its proposals, 
the Bureau is coordinating carefully the Title XIV Rulemakings, 
particularly with respect to their effective dates. The Dodd-Frank Act 
requirements to be implemented by the Title XIV Rulemakings generally 
will take effect on January 21, 2013, unless final rules implementing 
those requirements are issued on or before that date and provide for a 
different effective date. See Dodd-Frank Act section 1400(c), 15 U.S.C. 
1601 note. In addition, some of the Title XIV Rulemakings are to take 
effect no later than one year after they are issued. Id.
    The comments on the appropriate effective date for this final rule 
are discussed in detail below in part VI of this notice. In general, 
however, consumer advocates requested that the Bureau put the 
protections in the Title XIV Rulemakings into effect as soon as 
practicable. In contrast, the Bureau received some industry comments 
indicating that implementing so many new requirements at the same time 
would create a significant cumulative burden for creditors. In 
addition, many commenters also acknowledged the advantages of 
implementing multiple revisions to the regulations in a coordinated 
fashion.\70\ Thus, a tension exists between coordinating the adoption 
of the Title XIV Rulemakings and facilitating industry's implementation 
of such a large set of new requirements. Some have suggested that the 
Bureau resolve this tension by adopting a sequenced implementation, 
while others have requested that the Bureau simply provide a longer 
implementation period for all of the final rules.
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    \70\ Of the several final rules being adopted under the Title 
XIV Rulemakings, six entail amendments to Regulation Z, with the 
only exceptions being the 2013 RESPA Servicing Final Rule 
(Regulation X) and the 2013 ECOA Appraisals Final Rule (Regulation 
B); the 2013 HOEPA Final Rule also amends Regulation X, in addition 
to Regulation Z. The six Regulation Z final rules involve numerous 
instances of intersecting provisions, either by cross-references to 
each other's provisions or by adopting parallel provisions. Thus, 
adopting some of those amendments without also adopting certain 
other, closely related provisions would create significant technical 
issues, e.g., new provisions containing cross-references to other 
provisions that do not yet exist, which could undermine the ability 
of creditors and other parties subject to the rules to understand 
their obligations and implement appropriate systems changes in an 
integrated and efficient manner.
---------------------------------------------------------------------------

    The Bureau recognizes that many of the new provisions will require 
creditors to make changes to automated systems and, further, that most 
administrators of large systems are reluctant to make too many changes 
to their systems at once. At the same time, however, the Bureau notes 
that the Dodd-Frank Act established virtually all of these changes to 
institutions' compliance responsibilities, and contemplated that they 
be implemented in a relatively short period of time. And, as already 
noted, the extent of interaction among many of the Title XIV 
Rulemakings necessitates that many of their provisions take effect 
together. Finally, notwithstanding commenters' expressed concerns for 
cumulative burden, the Bureau expects that creditors actually may 
realize some efficiencies from adapting their systems for compliance 
with multiple new, closely related requirements at once, especially if 
given sufficient overall time to do so.
    Accordingly, the Bureau is requiring that, as a general matter, 
creditors and other affected persons begin complying with the final 
rules on January 10, 2014. As noted above, section 1400(c) of the Dodd-
Frank Act requires that some provisions of the Title XIV Rulemakings 
take effect no later than one year after the Bureau issues them. 
Accordingly, the Bureau is establishing January 10, 2014, one year 
after issuance of this final rule and the Bureau's 2013 Escrows and 
HOEPA Final Rules (i.e., the earliest of the title XIV final rules), as 
the baseline effective date for most of the Title XIV Rulemakings. The 
Bureau believes that, on balance, this approach will facilitate the 
implementation of the rules' overlapping provisions, while also 
affording creditors sufficient time to implement the more complex or 
resource-intensive new requirements.
    The Bureau has identified certain rulemakings or selected aspects 
thereof, however, that do not present significant implementation 
burdens for industry. Accordingly, the Bureau is setting

[[Page 6420]]

earlier effective dates for those final rules or certain aspects 
thereof, as applicable. Those effective dates are set forth and 
explained in the Federal Registers notices for those final rules.
More Inclusive Finance Charge Proposal
    As noted above, the Bureau proposed in the 2012 TILA-RESPA Proposal 
to make the definition of finance charge more inclusive, thus rendering 
the finance charge and annual percentage rate a more useful tool for 
consumers to compare the cost of credit across different alternatives. 
77 FR 51116, 51143 (Aug. 23, 2012). Because the new definition would 
include additional costs that are not currently counted, it would cause 
the finance charges and APRs on many affected transactions to increase. 
This in turn could cause more such transactions to become subject to 
various compliance regimes under Regulation Z. Specifically, the 
finance charge is central to the calculation of a transaction's 
``points and fees,'' which in turn has been (and remains) a coverage 
threshold for the special protections afforded ``high-cost mortgages'' 
under HOEPA. Points and fees also will be subject to a 3-percent limit 
for purposes of determining whether a transaction is a ``qualified 
mortgage'' under this final rule. Meanwhile, the APR serves as a 
coverage threshold for HOEPA protections as well as for certain 
protections afforded ``higher-priced mortgage loans'' under Sec.  
1026.35, including the mandatory escrow account requirements being 
amended by the 2013 Escrows Final Rule. Finally, because the 2013 
Interagency Appraisals Final Rule uses the same APR-based coverage test 
as is used for identifying higher-priced mortgage loans, the APR 
affects that rulemaking as well. Thus, the proposed more inclusive 
finance charge would have had the indirect effect of increasing 
coverage under HOEPA and the escrow and appraisal requirements for 
higher-priced mortgage loans, as well as decreasing the number of 
transactions that may be qualified mortgages--even holding actual loan 
terms constant--simply because of the increase in calculated finance 
charges, and consequently APRs, for closed-end mortgage transactions 
generally.
    As noted above, these expanded coverage consequences were not the 
intent of the more inclusive finance charge proposal. Accordingly, as 
discussed more extensively in the Escrows Proposal, the HOEPA Proposal, 
the ATR Proposal, and the Interagency Appraisals Proposal, the Board 
and subsequently the Bureau (and other agencies) sought comment on 
certain adjustments to the affected regulatory thresholds to counteract 
this unintended effect. First, the Board and then the Bureau proposed 
to adopt a ``transaction coverage rate'' for use as the metric to 
determine coverage of these regimes in place of the APR. The 
transaction coverage rate would have been calculated solely for 
coverage determination purposes and would not have been disclosed to 
consumers, who still would have received only a disclosure of the 
expanded APR. The transaction coverage rate calculation would exclude 
from the prepaid finance charge all costs otherwise included for 
purposes of the APR calculation except charges retained by the 
creditor, any mortgage broker, or any affiliate of either. Similarly, 
the Board and Bureau proposed to reverse the effects of the more 
inclusive finance charge on the calculation of points and fees; the 
points and fees figure is calculated only as a HOEPA and qualified 
mortgage coverage metric and is not disclosed to consumers. The Bureau 
also sought comment on other potential mitigation measures, such as 
adjusting the numeric thresholds for particular compliance regimes to 
account for the general shift in affected transactions' APRs.
    The Bureau's 2012 TILA-RESPA Proposal sought comment on whether to 
finalize the more inclusive finance charge proposal in conjunction with 
the Title XIV Rulemakings or with the rest of the TILA-RESPA Proposal 
concerning the integration of mortgage disclosure forms. 77 FR 51116, 
51125 (Aug. 23, 2012). Upon additional consideration and review of 
comments received, the Bureau decided to defer a decision whether to 
adopt the more inclusive finance charge proposal and any related 
adjustments to regulatory thresholds until it later finalizes the TILA-
RESPA Proposal. 77 FR 54843 (Sept. 6, 2012); 77 FR 54844 (Sept. 6, 
2012).\71\ Accordingly, this final rule and the 2013 Escrows, HOEPA, 
and Interagency Appraisals Final Rules all are deferring any action on 
their respective proposed adjustments to regulatory thresholds.
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    \71\ These notices extended the comment period on the more 
inclusive finance charge and corresponding regulatory threshold 
adjustments under the 2012 TILA-RESPA and HOEPA Proposals. It did 
not change any other aspect of either proposal.
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IV. Legal Authority

    The final rule was issued on January 10, 2013, in accordance with 
12 CFR 1074.1. The Bureau issued this final rule pursuant to its 
authority under TILA and the Dodd-Frank Act. See TILA section 105(a), 
15 U.S.C. 1604(a). On July 21, 2011, section 1061 of the Dodd-Frank Act 
transferred to the Bureau the ``consumer financial protection 
functions'' previously vested in certain other Federal agencies, 
including the Board. The term ``consumer financial protection 
function'' is defined to include ``all authority to prescribe rules or 
issue orders or guidelines pursuant to any Federal consumer financial 
law, including performing appropriate functions to promulgate and 
review such rules, orders, and guidelines.'' \72\ TILA is defined as a 
Federal consumer financial law.\73\ Accordingly, the Bureau has 
authority to issue regulations pursuant to TILA.
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    \72\ 12 U.S.C. 5581(a)(1).
    \73\ Dodd-Frank Act section 1002(14), 12 U.S.C. 5481(14) 
(defining ``Federal consumer financial law'' to include the 
``enumerated consumer laws'' and the provisions of title X of the 
Dodd-Frank Act), Dodd-Frank Act section 1002(12), 12 U.S.C. 5481(12) 
(defining ``enumerated consumer laws'' to include TILA).
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A. TILA Ability-to-Repay and Qualified Mortgage Provisions

    As discussed above, the Dodd-Frank Act amended TILA to generally 
prohibit a creditor from making a residential mortgage loan without a 
reasonable and good faith determination that, at the time the loan is 
consummated, the consumer has a reasonable ability to repay the loan, 
along with taxes, insurance, and assessments. TILA section 129C(a), 15 
U.S.C. 1639c(a). As described below in part IV.B, the Bureau has 
authority to prescribe regulations to carry out the purposes of TILA 
pursuant to TILA section 105(a). 15 U.S.C. 1604(a). In particular, it 
is the purpose of TILA section 129C, as amended by the Dodd-Frank Act, 
to assure that consumers are offered and receive residential mortgage 
loans on terms that reasonably reflect their ability to repay the loans 
and that are understandable and not unfair, deceptive, and abusive. 
TILA section 129B(a)(2); 15 U.S.C. 1639b(a)(2).
    The Dodd-Frank Act also provides creditors originating ``qualified 
mortgages'' special protection from liability under the ability-to-
repay requirements. TILA section 129C(b), 15 U.S.C. 1639c(b). TILA 
generally defines a ``qualified mortgage'' as a residential mortgage 
loan 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 loan amount; the income or assets are considered and verified; and 
the underwriting is based on the maximum rate during the first five 
years, uses a

[[Page 6421]]

payment schedule that fully amortizes the loan over the loan term, and 
takes into account all mortgage-related obligations. TILA section 
129C(b)(2), 15 U.S.C. 1639c(b)(2). In addition, to constitute a 
qualified mortgage a loan must meet ``any guidelines or regulations 
established by the Bureau 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 Bureau may 
determine are relevant and consistent with the purposes described in 
[TILA section 129C(b)(3)(B)(i)].''
    The Dodd-Frank Act also provides the Bureau with authority to 
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 
are necessary and appropriate to effectuate the purposes of the 
ability-to-repay requirements, to prevent circumvention or evasion 
thereof, or to facilitate compliance with TILA sections 129B and 129C. 
TILA section 129C(b)(3)(B)(i), 15 U.S.C. 1639c(b)(3)(B)(i). In 
addition, TILA section 129C(b)(3)(A) provides the Bureau with authority 
to prescribe regulations to carry out the purposes of the qualified 
mortgage provisions, such as to ensure that responsible, affordable 
mortgage credit remains available to consumers in a manner consistent 
with the purposes of TILA section 129C. TILA section 129C(b)(3)(A), 15 
U.S.C. 1939c(b)(3)(A). As discussed in the section-by-section analysis 
below, the Bureau is issuing certain provisions of this rule pursuant 
to its authority under TILA section 129C(b)(3)(B)(i).
    The Dodd-Frank Act provides the Bureau with other specific grants 
of rulewriting authority with respect to the ability-to-repay and 
qualified mortgage provisions. With respect to the ability-to-repay 
provisions, TILA section 129C(a)(6)(D)(i) through (iii) provides that 
when calculating the payment obligation that will be used to determine 
whether the consumer can repay a 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. 15 U.S.C. 
1639c(a)(6)(D)(i) through (iii). However, TILA section 129C(a)(6)(D) 
authorizes the Bureau to prescribe regulations for calculating the 
payment obligation for loans that require more rapid repayment 
(including balloon payments), and which have an annual percentage rate 
that does not exceed a certain rate threshold. 15 U.S.C. 
1639c(a)(6)(D).
    With respect to the qualified mortgage provisions, the Dodd-Frank 
Act contains several specific grants of rulewriting authority. First, 
as described above, for purposes of defining ``qualified mortgage,'' 
TILA section 129C(b)(2)(A)(vi) provides the Bureau with authority to 
establish guidelines or regulations relating to monthly debt-to-income 
ratios or alternative measures of ability to pay. Second, TILA section 
129C(b)(2)(D) provides that the Bureau shall prescribe rules adjusting 
the qualified mortgage points and fees limits described above to permit 
creditors that extend smaller loans to meet the requirements of the 
qualified mortgage provisions. 15 U.S.C. 1639c(b)(2)(D)(ii). In 
prescribing such rules, the Bureau must consider their potential impact 
on rural areas and other areas where home values are lower. Id. Third, 
TILA section 129C(b)(2)(E) provides the Bureau with authority to 
include in the definition of ``qualified mortgage'' loans with balloon 
payment features, if those loans meet certain underwriting criteria and 
are originated by creditors that operate predominantly in rural or 
underserved areas, have total annual residential mortgage originations 
that do not exceed a limit set by the Bureau, and meet any asset size 
threshold and any other criteria as the Bureau may establish, 
consistent with the purposes of TILA. 15 U.S.C. 1639c(b)(2)(E). As 
discussed in the section-by-section analysis below, the Bureau is 
issuing certain provisions of this rule pursuant to its authority under 
TILA sections 129C(a)(6)(D), (b)(2)(A)(vi), (b)(2)(D), and (b)(2)(E).

B. Other Rulemaking and Exception Authorities

    This final rule also relies on other rulemaking and exception 
authorities specifically granted to the Bureau by TILA and the Dodd-
Frank Act, including the authorities discussed below.
TILA
    TILA section 105(a). As amended by the Dodd-Frank Act, TILA section 
105(a), 15 U.S.C. 1604(a), directs the Bureau to prescribe regulations 
to carry out the purposes of TILA, and provides that such regulations 
may contain additional requirements, classifications, differentiations, 
or other provisions, and may provide for such adjustments and 
exceptions for all or any class of transactions that the Bureau judges 
are necessary or proper to effectuate the purposes of TILA, to prevent 
circumvention or evasion thereof, or to facilitate compliance 
therewith. A purpose of TILA is ``to assure a meaningful disclosure of 
credit terms so that the consumer will be able to compare more readily 
the various credit terms available to him and avoid the uninformed use 
of credit.'' TILA section 102(a), 15 U.S.C. 1601(a). This stated 
purpose is informed by Congress's finding that ``economic stabilization 
would be enhanced and the competition among the various financial 
institutions and other firms engaged in the extension of consumer 
credit would be strengthened by the informed use of credit[.]'' TILA 
section 102(a). Thus, strengthened competition among financial 
institutions is a goal of TILA, achieved through the effectuation of 
TILA's purposes.
    Historically, TILA section 105(a) has served as a broad source of 
authority for rules that promote the informed use of credit through 
required disclosures and substantive regulation of certain practices. 
However, Dodd-Frank Act section 1100A clarified the Bureau's section 
105(a) authority by amending that section to provide express authority 
to prescribe regulations that contain ``additional requirements'' that 
the Bureau finds are necessary or proper to effectuate the purposes of 
TILA, to prevent circumvention or evasion thereof, or to facilitate 
compliance therewith. This amendment clarified the authority to 
exercise TILA section 105(a) to prescribe requirements beyond those 
specifically listed in the statute that meet the standards outlined in 
section 105(a). The Dodd-Frank Act also clarified the Bureau's 
rulemaking authority over high-cost mortgages under HOEPA pursuant to 
section 105(a). As amended by the Dodd-Frank Act, TILA section 105(a) 
authority to make adjustments and exceptions to the requirements of 
TILA applies to all transactions subject to TILA, except with respect 
to the substantive provisions of TILA section 129, 15 U.S.C. 1639, that 
apply to the high-cost mortgages defined in TILA section 103(bb), 15 
U.S.C. 1602(bb).
    TILA, as amended by the Dodd-Frank Act, states that it is the 
purpose of the ability-to-repay requirements of TILA

[[Page 6422]]

section 129C to assure that consumers are offered and receive 
residential mortgage loans on terms that reasonably reflect their 
ability to repay the loans and that are understandable and not unfair, 
deceptive, or abusive. TILA section 129B(a)(2). The Bureau interprets 
this addition as a new purpose of TILA. Therefore, the Bureau believes 
that its authority under TILA section 105(a) to make exceptions, 
adjustments, and additional provisions, among other things, that the 
Bureau finds are necessary or proper to effectuate the purposes of 
TILA, to prevent circumvention or evasion thereof, or to facilitate 
compliance therewith applies with respect to the purpose of section 
129C as well as the purpose described in section TILA section 
129B(a)(2).
    The purpose of TILA section 129C is informed by the findings 
articulated in section 129B(a) 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 and affordable mortgage credit remains 
available to consumers.
    As discussed in the section-by-section analysis below, the Bureau 
is issuing regulations to carry out TILA's purposes, including such 
additional requirements, adjustments, and exceptions as, in the 
Bureau's judgment, are necessary and proper to carry out the purposes 
of TILA, prevent circumvention or evasion thereof, or to facilitate 
compliance therewith. In developing these aspects of the final rule 
pursuant to its authority under TILA section 105(a), the Bureau has 
considered the purposes of TILA, including the purposes of TILA section 
129C, and the findings of TILA, including strengthening competition 
among financial institutions and promoting economic stabilization, and 
the findings of TILA section 129B(a)(1), 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. The Bureau believes that ensuring that 
mortgage credit is offered and received on terms consumers can afford 
ensures the availability of responsible, affordable mortgage credit.
    TILA section 129B(e). Dodd-Frank Act section 1405(a) amended TILA 
to add new section 129B(e), 15 U.S.C. 1639B(e). That section authorizes 
the Bureau to prohibit or condition terms, acts, or practices relating 
to residential mortgage loans that the Bureau finds to be abusive, 
unfair, deceptive, predatory, necessary or proper to ensure that 
responsible, affordable mortgage credit remains available to consumers 
in a manner consistent with the purposes of TILA section 129C, 
necessary or proper to effectuate the purposes of sections 129B and 
129C, to prevent circumvention or evasion thereof, or to facilitate 
compliance with such sections, or are not in the interest of the 
consumer. In developing rules under TILA section 129B(e), the Bureau 
has considered whether the rules are in the interest of the consumer, 
as required by the statute. As discussed in the section-by-section 
analysis below, the Bureau is issuing portions of this rule pursuant to 
its authority under TILA section 129B(e).
The Dodd-Frank Act
    Dodd-Frank Act section 1022(b). Section 1022(b)(1) of the Dodd-
Frank Act authorizes the Bureau to prescribe rules ``as may be 
necessary or appropriate to enable the Bureau to administer and carry 
out the purposes and objectives of the Federal consumer financial laws, 
and to prevent evasions thereof.'' 12 U.S.C. 5512(b)(1). TILA and title 
X of the Dodd-Frank Act are Federal consumer financial laws. 
Accordingly, the Bureau is exercising its authority under Dodd-Frank 
Act section 1022(b) to prescribe rules that carry out the purposes and 
objectives of TILA and title X and prevent evasion of those laws.

V. Section-by-Section Analysis

Section 1026.25 Record Retention

25(a) General Rule
    Section 1416 of the Dodd-Frank Act revised TILA section 130(e) to 
extend the statute of limitations for civil liability for a violation 
of TILA section 129C, as well as sections 129 and 129B, to three years 
after the date a violation occurs. Existing Sec.  1026.25(a) requires 
that creditors retain evidence of compliance with Regulation Z for two 
years after disclosures must be made or action must be taken. 
Accordingly, the Board proposed to revise Sec.  226.25(a) \74\ to 
require that creditors retain records that show compliance with 
proposed Sec.  226.43, which would implement TILA section 129C, for at 
least three years after consummation. The Board did not propose to 
alter the regulation's existing clarification that administrative 
agencies responsible for enforcing Regulation Z may require creditors 
under the agency's jurisdiction to retain records for a longer period, 
if necessary to carry out the agency's enforcement responsibilities 
under TILA section 108, 15 U.S.C. 1607. Under TILA section 130(e), as 
amended by Dodd-Frank, the statute of limitations for civil liability 
for a violation of other sections of TILA remains one year after the 
date a violation occurs, except for private education loans under 15 
U.S.C. 1650(a), actions brought under section 129 or 129B, or actions 
brought by a State attorney general to enforce a violation of section 
129, 129B, 129C, 129D, 129E, 129F, 129G, or 129H. 15 U.S.C. 1640(e). 
Moreover, as amended by section 1413 of the Dodd-Frank Act, TILA 
provides that when a creditor, an assignee, other holder or their agent 
initiates a foreclosure action, a consumer may assert a violation of 
TILA section 129C(a) ``as a matter of defense by recoupment or 
setoff.'' TILA section 130(k). There is no time limit on the use of 
this defense.
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    \74\ This section-by-section analysis discusses the Board's 
proposal by reference to the Board's Regulation Z, 12 CFR part 226, 
which the Board proposed to amend, and discusses the Bureau's final 
rule by reference to the Bureau's Regulation Z, 12 CFR part 1026, 
which this final rule amends.
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    As discussed below, the Bureau is adopting minor modifications to 
Sec.  1026.25(a) and adding in new Sec.  1026.25(c) to reflect section 
1416 of the Dodd-Frank Act, in Sec.  1026.25(c)(3) as well as other 
exceptional record retention requirements related to mortgage loans.
25(c) Records Related to Certain Requirements for Mortgage Loans
    The Bureau is adopting the revision proposed in Sec.  226.25(a) to 
require a creditor to retain records demonstrating compliance with 
Sec.  1026.43 consistent with the extended statute of limitations for 
violations of that section, though the Bureau is adopting this 
requirement in Sec.  1026.25(c)(3) to provide additional clarity. As 
the 2012 TILA-RESPA Proposal proposed new Sec.  1026.25(c)(1) and the 
2012 Loan Originator Proposal proposed new Sec.  1026.25(c)(2), the 
Bureau concludes that adding new Sec.  1026.25(c)(3) eases compliance 
burden by placing all record retention requirements that are related to 
mortgage loans and which differ from the general record retention in 
one section, Sec.  1026.25(c). Likewise, the Bureau is amending Sec.  
1026.25(a) to reflect that certain record retention requirements, such 
as records related to minimum standards for transactions secured by a 
dwelling, are governed by Sec.  1026.43(c).
    Commenters did not provide the Bureau with significant, specific 
feedback with respect to proposed Sec.  226.25(a), although industry

[[Page 6423]]

commenters generally expressed concern with respect to the compliance 
burden of the 2011 ATR Proposal. Increasing the period a creditor must 
retain records from two to three years may impose some marginal 
increase in the creditor's compliance burden in the form of incremental 
cost of storage. However, the Bureau believes that even absent the 
rule, responsible creditors will likely elect to retain records of 
compliance with Sec.  1026.43 for a period of time well beyond three 
years, given that the statute allows consumers to bring a defensive 
claim for recoupment or setoff in the event that a creditor or assignee 
initiates foreclosure proceedings. Indeed, at least one commenter noted 
this tension and requested that the Bureau provide further regulatory 
instruction, although the Bureau does not deem it necessary to mandate 
recordkeeping burdens beyond what is required by section 1416 of the 
Dodd-Frank Act. Furthermore, the record-keeping burden imposed by the 
rule is tailored only to show compliance with Sec.  1026.43, and the 
Bureau believes is justified to protect the interests of both creditors 
and consumers in the event that an affirmative claim is brought during 
the first three years after consummation.
    The Bureau believes that calculating the record retention period 
under Sec.  1026.43 from loan consummation facilitates compliance by 
establishing a single, clear start to the period, even though a 
creditor will take action (e.g., underwriting the covered transaction 
and offering a consumer the option of a covered transaction without a 
prepayment penalty) over several days or weeks prior to consummation. 
The Bureau is thus adopting the timeframe as proposed to reduce 
compliance burden.
    Existing comment 25(a)-2 clarifies that, in general, a creditor 
need retain only enough information to reconstruct the required 
disclosures or other records. The Board proposed, and the Bureau is 
adopting, amendments to comment 25(a)-2 and a new comment 25(c)(3)-1 to 
clarify that, if a creditor must verify and document information used 
in underwriting a transaction subject to Sec.  1026.43, the creditor 
must retain evidence sufficient to demonstrate having done so, in 
compliance with Sec.  1026.25(a) and Sec.  1026.25(c)(3). In an effort 
to reduce compliance burden, comment 25(c)(3)-1 also clarifies that 
creditors need not retain actual paper copies of the documentation used 
to underwrite a transaction but that creditors must be able to 
reproduce those records accurately.
    The Board proposed comment 25(a)-7 to provide guidance on retaining 
records evidencing compliance with the requirement to offer a consumer 
an alternative covered transaction without a prepayment penalty, as 
discussed below in the section-by-section analysis of Sec.  
1026.43(g)(3) through (5). The Bureau believes the requirement to offer 
a transaction without a prepayment penalty under TILA section 
129C(c)(4) is intended to ensure that consumers who choose an 
alternative covered transaction with a prepayment penalty do so 
voluntarily. The Bureau further believes it is unnecessary, and 
contrary to the Bureau's efforts to streamline its regulations, 
facilitate regulatory compliance, and minimize compliance burden, for a 
creditor to document compliance with the requirement to offer an 
alternative covered transaction without a prepayment penalty when a 
consumer does not choose a transaction with a prepayment penalty or if 
the covered transaction is not consummated. Accordingly, the Bureau is 
adopting as proposed comment 25(a)-7 as comment 25(c)(3)-2, to clarify 
that a creditor must retain records that document compliance with that 
requirement if a transaction subject to Sec.  1026.43 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 Sec.  1026.43(g)(6).
    The Board proposed comment 25(a)-7 also to provide specific 
guidance on retaining records evidencing compliance with the 
requirement to offer a consumer an alternative covered transaction 
without a prepayment penalty when a creditor offers a transaction 
through a mortgage broker. As discussed in detail below in the section-
by-section analysis of Sec.  1026.43(g)(4), the Board proposed that 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 to 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 than the creditor's 
presented alternative covered transaction. The Bureau did not receive 
significant comment on this clarification, and is adopting the comment 
largely as proposed, renumbered as comment 25(c)(3)-2. Comment 
25(c)(3)-2 also clarifies that, to demonstrate compliance with Sec.  
1026.43(g)(4), the creditor must retain a record of (1) the alternative 
covered transaction without a prepayment penalty presented to the 
mortgage broker pursuant to Sec.  1026.43(g)(4)(i), such as a rate 
sheet, and (2) the agreement with the mortgage broker required by Sec.  
1026.34(g)(4)(ii).

Section 1026.32 Requirements for High-Cost Mortgages

32(b) Definitions
32(b)(1)
Points and Fees--General
    Section 1412 of the Dodd-Frank Act added TILA section 
129C(b)(2)(A)(vii), which defines a ``qualified mortgage'' as a loan 
for which, among other things, the total ``points and fees'' do not 
exceed 3 percent of the total loan amount. The limits on points and 
fees for qualified mortgages are implemented in new Sec.  
1026.43(e)(3).
    TILA section 129C(b)(2)(C) generally defines ``points and fees'' 
for qualified mortgages to have the same meaning as in TILA section 
103(aa)(4) (renumbered as section 103(bb)(4)), which defines ``points 
and fees'' for the purpose of determining whether a transaction 
qualifies as a high-cost mortgage under HOEPA.\75\ TILA section 
103(aa)(4) is implemented in current Sec.  1026.32(b)(1). Accordingly, 
the Board proposed in Sec.  226.43(b)(9) that, for a qualified 
mortgage, ``points and fees'' has the same meaning as in Sec.  
226.32(b)(1).
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    \75\ The Dodd-Frank Act renumbered existing TILA section 
103(aa), which contains the definition of ``points and fees,'' for 
the high-cost mortgage points and fees threshold, as section 
103(bb). See Sec.  1100A(1)(A) of the Dodd-Frank Act. However, in 
defining points and fees for the qualified mortgage points and fees 
limits, TILA section 129C(b)(2)(C) refers to TILA section 103(aa)(4) 
rather than TILA section 103(bb)(4). To give meaning to this 
provision, the Bureau concludes that the reference to TILA section 
in 103(aa)(4) in TILA section 129C(b)(2)(C) is mistaken and 
therefore interprets TILA section 129C(b)(2)(C) as referring to the 
points and fees definition in renumbered TILA section 103(bb)(4). 
This proposal generally references TILA section 103(aa) to refer to 
the pre-Dodd-Frank provision, which is in effect until the Dodd-
Frank Act's amendments take effect, and TILA section 103(bb) to 
refer to the provision as amended.
---------------------------------------------------------------------------

    The Board also proposed in the 2011 ATR Proposal to amend Sec.  
226.32(b)(1) to implement revisions to the definition of ``points and 
fees'' under section 1431 of the Dodd-Frank Act. Among other things, 
the Dodd-Frank Act excluded certain private mortgage insurance premiums 
from, and added loan originator compensation and prepayment penalties 
to, the definition of ``points and fees'' that had previously

[[Page 6424]]

applied to high-cost mortgage loans under HOEPA. In the Bureau's 2012 
HOEPA Proposal, the Bureau republished the Board's proposed revisions 
to Sec.  226.32(b)(1), with only minor changes, in renumbered Sec.  
1026.32(b)(1).
    The Bureau noted in its 2012 HOEPA Proposal that it was 
particularly interested in receiving comments concerning any newly-
proposed language and the application of the definition in the high-
cost mortgage context. The Bureau received numerous comments from both 
industry and consumer advocacy groups, the majority of which were 
neither specific to newly-proposed language nor to the application of 
the definition to high-cost mortgages. These comments largely 
reiterated comments that the Board and the Bureau had received in the 
ATR rulemaking docket. The Bureau is addressing comments received in 
response to 2012 HOEPA Proposal in the 2013 HOEPA Final Rule. 
Similarly, comments received in response to the Board's 2011 ATR 
Proposal are discussed in this final rule. The Bureau is carefully 
coordinating the 2013 HOEPA and ATR Final Rules to ensure a consistent 
and cohesive regulatory framework. The Bureau is now finalizing Sec.  
1026.32(b)(1), (b)(3), (b)(4)(i), (b)(5), and (b)(6)(i) in this rule in 
response to the comments received on both proposals. The Bureau is 
finalizing Sec.  1026.32(b)(2), (b)(4)(ii), and (b)(6)(ii) in the 2013 
HOEPA Final Rule.
    Existing Sec.  1026.32(b)(1) defines ``points and fees'' by listing 
included charges in Sec.  1026.32(b)(1)(i) through (iv). As discussed 
below, the Board proposed revisions to Sec.  226.32(b)(1)(i) through 
(iv) and proposed to add new Sec.  226.32(b)(1)(v) and (vi). In the 
2012 HOEPA Proposal, the Bureau proposed to add the phrase ``in 
connection with a closed-end mortgage loan'' to Sec.  1026.32(b)(1) to 
clarify that its definition of ``points and fees'' would have applied 
only for closed-end mortgages. The Bureau also proposed to define 
``points and fees'' in Sec.  1026.32(b)(3) for purposes of defining 
which open-end credit plans qualify as ``high-cost mortgages'' under 
HOEPA. However, that section is not relevant to this rulemaking because 
the ability-to-repay requirement in TILA section 129C does not apply to 
open-end credit. Accordingly, the Bureau is adopting Sec.  
1026.32(b)(1) with the clarification that its definition of ``points 
and fees'' is ``in connection with a closed-end mortgage loan.''
    Payable at or before consummation. In the 2011 ATR Proposal, the 
Board noted that 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(bb)(1)(A)(ii). Prior 
to the Dodd-Frank Act, fees and charges were included in points and 
fees for the high-cost mortgage points and fees test only if they were 
payable at or before closing. 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, the Board stated that, with a few exceptions, the 
statute provides that any charge that falls within the ``points and 
fees'' definition 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 Board noted that 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(bb)(1)(C) (for 
mortgage insurance) and TILA section 103(bb)(4)(D) (for credit 
insurance and debt cancellation and suspension coverage).
    The Board expressed concern that some fees that occur after 
closing, such as fees to modify a loan, might be deemed to be points 
and fees. If so, the Board cautioned that 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. The Board noted that 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. The Board expressed concern that creditors 
therefore might be discouraged from making qualified mortgages, which 
would undermine Congress's goal of increasing incentives for creditors 
to make more stable, affordable loans. The Board requested comment on 
whether any other types of fees should be included in points and fees 
only if they are ``payable at or before closing.''
    Several industry commenters stated that charges paid after closing 
should not be included in points and fees and requested that the Bureau 
clarify whether such charges are included. For example, some industry 
commenters sought confirmation that charges for a subsequent loan 
modification would not be included in points and fees. More generally, 
industry commenters argued that they would have difficulty calculating 
charges that would be paid after closing and that including such 
charges in points and fees would create uncertainty and litigation 
risk. In response to the Bureau's 2012 HOEPA Proposal, one consumer 
advocate noted that there are inconsistent and confusing standards for 
when charges must be payable to be included in points and fees. This 
commenter recommended that the Bureau adopt a ``known at or before 
closing'' standard, arguing that this standard would clarify that 
financed points are included, would prevent creditors from evading the 
points and fees test by requiring consumers to pay charges after 
consummation, and would provide certainty to creditors that must know 
the amount of points and fees at or before closing.
    The Bureau appreciates that creditors need certainty in calculating 
points and fees so they can ensure that they are originating qualified 
mortgages (or are not exceeding the points and fees thresholds for 
high-cost mortgages). The Dodd-Frank Act provides that for the points 
and fees tests for both qualified mortgages and high-cost mortgages, 
only charges ``payable in connection with'' the transaction are 
included in points and fees. See TILA sections 103(bb)(1)(A)(ii) (high-
cost mortgages) and 129C(b)(2)(A)(vii) (qualified mortgages). The 
Bureau interprets this ``in connection with'' requirement as limiting 
the universe of charges that need to be included in points and fees. To 
clarify when charges or fees are ``in connection with'' a transaction, 
the Bureau is specifying in Sec.  1026.32(b)(1) that fees or charges 
are included in points and fees only if they are ``known at or before 
consummation.''
    The Bureau is also adding new comment 32(b)(1)-1, which provides 
examples of fees and charges that are and are not known at or before 
consummation. The comment explains that charges for a subsequent loan 
modification generally would not be included in points and fees 
because, at consummation, the creditor would not know whether a 
consumer would seek to modify the loan and therefore would not know 
whether charges in connection with a modification would ever be 
imposed. Indeed, loan modification fees likely would not be included in 
the finance charge under Sec.  1026.4, as they would not be charges 
imposed by creditor as an incident to or a condition of the extension 
of credit. Thus, this clarification is consistent with the definition 
of the finance charge. Comment 32(b)(1)-1 also

[[Page 6425]]

clarifies that the maximum prepayment penalties that may be charged or 
collected under the terms of a mortgage loan are included in points and 
fees under Sec.  1026.32(b)(1)(v). In addition, comment 32(b)(1)-1 
notes that, under Sec.  1026.32(b)(1)(i)(C)(1) and (iv), premiums or 
other charges for private mortgage insurance and credit insurance 
payable after consummation are not included in points and fees. This 
means that such charges may be included in points and fees only if they 
are payable at or before consummation. Thus, even if the amounts of 
such premiums or other charges are known at or before consummation, 
they are included in points and fees only if they are payable at or 
before consummation.
32(b)(1)(i)
Points and Fees--Included in the Finance Charge
    TILA section 103(aa)(4)(A) specifies that ``points and fees'' 
includes all items included in the finance charge, except interest or 
the time-price differential. This provision is implemented in current 
Sec.  1026.32(b)(1)(i). Section 1431 of the Dodd-Frank Act added TILA 
section 103(bb)(1)(C), which excludes from points and fees certain 
types and amounts of mortgage insurance premiums.
    The Board proposed to revise Sec.  226.32(b)(1)(i) to implement 
these provisions. The Board proposed to move the exclusion of interest 
or the time-price differential to new Sec.  226.32(b)(1)(i)(A). The 
Board also proposed to add Sec.  226.32(b)(1)(i)(B) to implement the 
new exclusion for certain mortgage insurance. In Sec.  226.32(b)(1)(i), 
the Board proposed to revise the 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)'' 
because Sec.  226.4 does not itself require disclosure of the finance 
charge.
    One industry commenter argued that the definition of points and 
fees was overbroad because it included all items considered to be a 
finance charge. The commenter asserted that several items that are 
included in the finance charge under Sec.  1026.4(b) are vague or 
inapplicable in the context of mortgage transactions or duplicate items 
specifically addressed in other provisions. Several industry commenters 
also requested clarification about whether certain types of fees and 
charges are included in points and fees. At least two commenters asked 
that the Bureau clarify that closing agent costs are not included in 
points and fees.
    The Bureau is adopting renumbered Sec.  1026.32(b)(1)(i) and (i)(A) 
substantially as proposed, with certain clarifications in the 
commentary and in other parts of the rule as discussed below to address 
commenters' requests for clarification. For consistency with the 
language in Sec.  1026.4, the Bureau is revising Sec.  1026.32(b)(1)(i) 
to refer to ``items included in the finance charge'' rather than 
``items considered to be a finance charge.''
    As noted above, several commenters requested clarification 
regarding whether certain types of charges would be included in points 
and fees. With respect to closing agent charges, Sec.  1026.4(a)(2) 
provides a specific rule for when such charges must be included in the 
finance charge. If they are not included in the finance charge, they 
would not be included in points and fees. Moreover, as discussed below 
and in new comment 32(b)(1)(i)(D)-1, certain closing agent charges may 
also be excluded from points and fees as bona fide third-party charges 
that are not retained by the creditor, loan originator, or an affiliate 
of either.
    The Board also proposed to revise comment 32(b)(1)(i)-1, which 
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 (iii). 
The Board proposed to revise this comment to state that items excluded 
from the finance charge under other provisions of Sec.  226.4 may be 
included in ``points and fees'' under Sec.  226.32(b)(1)(ii) through 
(vi).\76\ The proposed revision was intended to reflect the additional 
items added to the definition of ``points and fees'' by the Dodd-Frank 
Act and corrected the previous omission of Sec.  226.32(b)(1)(iv). See 
proposed Sec.  226.32(b)(1)(v) and (vi).
---------------------------------------------------------------------------

    \76\ Proposed comment 32(b)(1)(i)-1 contained a typographical 
error. It stated that ``[i]tems 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) through Sec.  
226.32(b)(1)(vi).'' (emphasis added). It should have read that such 
items ``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) through Sec.  226.32(b)(1)(vi).''
---------------------------------------------------------------------------

    The proposed comment also would have added an example of how this 
rule would operate. Under that example, a fee imposed by the creditor 
for an appraisal performed by an employee of the creditor meets the 
general 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 in proposed Sec.  226.32(b)(1)(i) providing that 
finance charges 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 have been counted in points and fees. Proposed Sec.  
226.32(b)(1)(iii), however, would have expressly included 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 would have been 
included in the calculation of points and fees.
    The Bureau did not receive substantial comment on this proposed 
guidance. The Bureau is adopting comment 32(b)(1)(i)-1, with certain 
revisions for clarity. As revised, comment 32(b)(1)(i)-1 explains that 
certain items that may be included in the finance charge under Sec.  
1026.32(b)(1)(i) are excluded under Sec.  1026.32(b)(1)(i)(A) through 
(F).
Mortgage Insurance
    Under existing Sec.  1026.32(b)(1)(i), mortgage insurance premiums 
are included in the finance charge and therefore are included in points 
and fees if payable at or before closing. As noted above, the Board 
proposed new Sec.  226.32(b)(1)(i)(B) to implement TILA section 
103(bb)(1)(C), which provides that points and fees shall exclude 
certain charges for mortgage insurance premiums. Specifically, the 
statute excludes: (1) Any premium charged for insurance provided by an 
agency of the Federal Government or an agency of a State; (2) any 
amount that is 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, provided that the premium, charge, or fee 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; and (3) any premium paid by the consumer 
after closing.
    The Board noted that the exclusions for certain premiums 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. TILA section

[[Page 6426]]

129C(b)(2)(C)(i) cross-references TILA section 103(aa)(4) (renumbered 
as 103(bb)(4)) for the definition of ``points and fees,'' but the 
provision on mortgage insurance appears in TILA section 103(bb)(1)(C) 
and not in section 103(bb)(4). The Board also noted 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(bb)(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 concluded that the better interpretation of 
the statute is that the mortgage insurance provision in TILA section 
103(bb)(1)(C) applies to the meaning of points and fees for both high-
cost mortgages and qualified mortgages. The Board noted that 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),'' i.e., for 
purposes of TILA section 103(bb)(4). The mortgage insurance provision 
contains no caveat limiting its application solely to the points and 
fees calculation for high-cost mortgages. Thus, the Board determined 
that the cross-reference in the qualified mortgage provisions to TILA 
section 103(bb)(4) should be read to include provisions that expressly 
prescribe how points and fees should be calculated under TILA section 
103(bb)(4), wherever located.
    The Board noted that its proposal to apply 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. The Board also cited its 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. 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).
    The Board also expressed concern about the increased risk of 
confusion and compliance error if points and fees were to have 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 Board stated that 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 expressed concern that market distortions 
could result due to different treatment of mortgage insurance in 
calculating points and fees for high-cost mortgages and qualified 
mortgages. ``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(bb)(1)(A)(ii), 
129C(b)(2)(C)(i). Under this general provision standing alone, premiums 
for up-front private mortgage insurance would be excluded from points 
and fees. However, as noted, the statute's specific provision on 
mortgage insurance (TILA section 103(bb)(1)(C)) imposes certain 
limitations on the amount and conditions under which up-front premiums 
for private mortgage insurance are excluded from points and fees. 
Applying the mortgage insurance provision to the definition of points 
and fees only for high-cost mortgages would mean that any premium 
amount for up-front 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. 
The Board noted that, as a result, consumers who obtain qualified 
mortgages could be vulnerable to paying excessive up-front private 
mortgage insurance costs. The Board concluded that this outcome would 
undercut Congress's clear intent to ensure that qualified mortgages are 
products with limited fees and more safe features.
    For the reasons noted by the Board, the Bureau interprets the 
mortgage insurance provision in TILA section 103(bb)(1)(C) as applying 
to the meaning of points and fees for both high-cost mortgages and 
qualified mortgages. The Bureau is also adopting this approach pursuant 
to its authority under TILA sections 105(a) and 129C(b)(3)(B)(i). 
Applying the mortgage insurance provision to the meaning of points and 
fees for qualified mortgages is necessary and proper to effectuate the 
purposes of, and facilitate compliance with the purposes of, the 
ability-to-repay requirements in TILA section 129C. Similarly, the 
Bureau finds that it is necessary and proper to use its authority under 
TILA section 129C(b)(3)(B)(i) to revise, add to, or subtract from the 
criteria that define a qualified mortgage. As noted above, construing 
the mortgage insurance provision as applying to qualified mortgages 
will reduce the likelihood that consumers who obtain qualified 
mortgages will pay excessive private mortgage insurance premiums, and 
therefore will help ensure that responsible, affordable credit remains 
available to consumers in a manner consistent with the purposes of TILA 
section 129C.
    Proposed Sec.  226.32(b)(1)(i)(B) tracked the substance of the 
statute with one exception. The Board interpreted the statute as 
excluding from points and fees not only up-front mortgage insurance 
premiums under government programs but also charges for mortgage 
guaranties under government programs. The Board noted that it was 
proposing the exclusion from points and fees of both mortgage insurance 
premiums and guaranty fees under government programs pursuant to its 
authority under TILA section 105(a) to make adjustments to facilitate 
compliance with TILA and its purposes and to effectuate the purposes of 
TILA. The Board also found that 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. 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).
    The Board noted that both the U.S. Department of Veterans Affairs 
(VA) and the U.S. Department of Agriculture (USDA) expressed concerns 
that, if up-front charges for guaranties provided by those agencies and 
State agencies were included in points and fees, their loans might 
exceed high-cost thresholds and exceed the cap for qualified mortgages, 
thereby disrupting these programs and jeopardizing an important source 
of credit for many consumers. The Board requested comment on its 
proposal to exclude up-front charges for any guaranty under a Federal 
or State government program, as well as any up-front mortgage insurance 
premiums under government programs.
    Several industry commenters argued that premiums for private 
mortgage

[[Page 6427]]

insurance should be excluded altogether, even if the premiums do not 
satisfy the statutory standard for exclusion. These commenters noted 
that private mortgage insurance provides substantial benefits, allowing 
consumers who cannot afford a down payment an alternative for obtaining 
credit. Another commenter noted that the refundability requirement of 
the rule would make private mortgage insurance more expensive.
    One industry commenter asserted that the language in proposed Sec.  
226.32(b)(1)(i)(B)(2) was inconsistent with the statutory language and 
the example in the commentary. The commenter suggested that a literal 
reading of proposed Sec.  226.32(b)(1)(i)(B)(2) would require exclusion 
of the entire premium if it exceeded the FHA insurance premium, rather 
than merely exclusion of that portion of the premium in excess of the 
FHA premium. Another industry commenter maintained that the term 
``upfront'' is vague and that the Bureau instead should use the phrase 
``payable at or before closing.''
    The Bureau is adopting proposed Sec.  226.32(b)(1)(i)(B) as 
reunumbered Sec.  1026.32(b)(1)(i)(B) with no substantive changes but 
with revisions for clarity. The Bureau is dividing proposed Sec.  
226.32(b)(1)(i)(B) into two parts. The first part, Sec.  
1026.32(b)(1)(i)(B), addresses insurance premiums and guaranty charges 
under government programs. The second part, Sec.  1026.32(b)(1)(i)(C), 
addresses premiums for private mortgage insurance.
    Consistent with the Board's proposal, Sec.  1026.32(b)(1)(i)(B) 
excludes from points and fees charges for mortgage guaranties under 
government programs, as well as premiums for mortgage insurance under 
government programs. The Bureau concurs with the Board's interpretation 
that, in addition to mortgage insurance premiums under government 
programs, the statute also excludes from points and fees charges for 
mortgage guaranties under government programs. Like the Board, the 
Bureau believes that this conclusion is further supported by TILA 
sections 105(a) and 129C(b)(3)(B)(i) and that it is necessary and 
proper to invoke this authority. The exclusion from points and fees of 
charges for mortgage guaranties under government programs is necessary 
and proper to effectuate the purposes of TILA. The Bureau is concerned 
that including such charges in points and fees could cause loans 
offered through government programs to exceed high-cost mortgage 
thresholds and qualified mortgage points and fees limits, potentially 
disrupting an important source of affordable financing for many 
consumers. This exclusion helps ensure that loans do not unnecessarily 
exceed the points and fees limits for qualified mortgages, which is 
consistent with the purpose, stated in TILA section 129B(a)(2), of 
assuring that consumers are offered and receive residential mortgage 
loans on terms that reasonably reflect their ability to repay the loans 
and with the purpose stated in TILA section 129C(b)(3)(B)(i) of 
ensuring that responsible, affordable mortgage credit remains available 
to consumers in a manner consistent with the purposes of TILA section 
129C.
    Proposed comment 32(b)(1)(i)-2 provided an example of a mortgage 
insurance premium that is not counted in points and fees because the 
loan was insured by the FHA. The Bureau is renumbering this comment as 
32(b)(1)(i)(B)-1 and revising it to add an additional example to 
clarify that mortgage guaranty fees under government programs, such as 
VA and USDA funding fees, are excluded from points and fees. The Bureau 
is also deleting the reference to ``up-front'' premiums and charges. 
Under the statute, premiums for mortgage insurance or guaranty fees in 
connection with a Federal or State government program are excluded from 
points and fees whenever paid. The statutory provision excluding 
premiums or charges paid after consummation applies only to private 
mortgage insurance.
    The Bureau is addressing exclusions for private mortgage insurance 
in Sec.  1026.32(b)(1)(i)(C). For private mortgage insurance premiums 
payable after consummation, Sec.  1026.32(b)(1)(i)(C)(1) provides that 
the entire amount of the premium is excluded from points and fees. For 
private mortgage insurance premiums payable at or before consummation, 
Sec.  1026.32(b)(1)(i)(C)(1) provides that the portion of the premium 
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 is excluded from points and fees, provided that the premium 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.
    As noted by one commenter, the language in proposed Sec.  
226.32(b)(1)(i)(B) could be read to conflict with the statute and the 
commentary because it suggested that, if a private mortgage insurance 
premium payable at or before consummation exceeded the FHA insurance 
premium, then the entire private mortgage insurance premium would be 
included in points and fees. The Bureau is clarifying in Sec.  
1026.32(b)(1)(i)(C)(2) that only the portion of the private mortgage 
insurance premium that exceeds the FHA premium must be included in 
points and fees. With respect to the comments requesting that all 
private mortgage insurance premiums be excluded from points and fees, 
the Bureau notes that TILA section 103(bb)(1)(C) prescribes specific 
and detailed conditions for excluding private mortgage insurance 
premiums. Under these circumstances, the Bureau does not believe it 
would be appropriate to exercise its exception authority to reverse 
Congress's decision.
    Proposed comment 32(b)(1)(i)-3 explained that private mortgage 
insurance premiums payable at or before consummation need not be 
included in points and fees to the extent that the premium 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 and 
the premiums are required to be refunded on a pro-rated basis and the 
refund is automatically issued upon notification of satisfaction of the 
underlying mortgage loan. Proposed comment 32(b)(1)(i)-3 also provided 
an example of this exclusion. Proposed comment 32(b)(1)(i)-4 explained 
that private mortgage insurance premiums that do not qualify for an 
exclusion must be included in points and fees whether paid at or before 
consummation, in cash or financed, whether optional or required, and 
whether the amount represents the entire premium or an initial payment.
    The Bureau did not receive substantial comments on these proposed 
interpretations. The Bureau is adopting comments 32(b)(1)(i)-3, and -4 
with certain revisions for clarity and renumbered as comments 
32(b)(1)(i)(C)-1 and -2. Comment 32(b)(1)(i)(C)-1.i is revised to 
specify that private mortgage insurance premiums paid after 
consummation are excluded from points and fees. The Bureau also adopts 
clarifying changes that specify that creditors originating conventional 
loans--even such loans that are not eligible to be FHA loans (i.e., 
because their principal balance is too high)--should look to the 
permissible up-front premium amount for FHA loans, as implemented by 
applicable regulations and other written authorities issued by the FHA 
(such as Mortgagee Letters). For example, pursuant to HUD's Mortgagee 
Letter 12-4 (published March 6, 2012), the allowable up-front FHA 
premium for single-family homes is 1.75

[[Page 6428]]

percent of the base loan amount.\77\ Finally, the Bureau clarifies that 
only the portion of the single or up-front PMI premium in excess of the 
allowable FHA premium (i.e., rather than any monthly premium or portion 
thereof) must be included in points and fees. Comments 32(b)(1)(i)(C)-1 
and -2 also have both been revised for clarity and consistency. For 
example, the comments as adopted refer to premiums ``payable at or 
before consummation'' rather than ``up-front'' premiums and to 
``consummation'' rather than ``closing.'' The Bureau notes that the 
statute refers to ``closing'' rather than ``consummation.'' However, 
for consistency with the terminology in Regulation Z, the Bureau is 
using the term ``consummation.''
---------------------------------------------------------------------------

    \77\ See Department of Housing and Urban Development, Mortgagee 
Letter 12-4 (Mar. 6, 2012), available at http://portal.hud.gov/hudportal/documents/huddoc?id=12-04ml.pdf.
---------------------------------------------------------------------------

Bona Fide Third-Party Charges and Bona Fide Discount Points
    The Dodd-Frank Act amended TILA to add nearly identical provisions 
excluding certain bona fide third-party charges and bona fide discount 
points from the calculation of points and fees for both qualified 
mortgages and high-cost mortgages.\78\ Specifically, section 1412 of 
the Dodd-Frank Act added new TILA section 129C(b)(2)(C), which excludes 
certain bona fide third-party charges and bona fide discount points 
from the calculation of points and fees for the qualified mortgage 
points and fees threshold. Similarly, section 1431 of the Dodd-Frank 
Act amended TILA section 103(bb)(1)(A)(ii) and added TILA section 
103(dd) to provide for nearly identical exclusions in calculating 
points and fees for the high-cost mortgage threshold.
---------------------------------------------------------------------------

    \78\ The exclusions differ in only one respect. To exclude two 
or one bona fide discount points from the points and fees test for 
determining whether a loan is a high-cost mortgage, TILA section 
103(dd)(1)(B) and (C) specified that the interest rate for personal 
property loans before the discount must be within 1 or 2 percentage 
points, respectively, of the average rate on a loan in connection 
with which insurance is provided under title I of the National 
Housing Act. TILA section 129C(b)(2)(C), which prescribes conditions 
for excluding bona fide discount points from points and fees for 
qualified mortgages, does not contain analogous provisions.
---------------------------------------------------------------------------

    In the 2011 ATR Proposal, the Board proposed to implement in Sec.  
226.43(e)(3)(ii)(A) through (C) the exclusion of certain bona fide 
third-party charges and bona fide discount points only for the 
calculation of points and fees for the qualified mortgage points and 
fees threshold. In the 2012 HOEPA Proposal, the Bureau proposed to 
implement these exclusions in proposed Sec.  1026.32(b)(5) for the 
points and fees threshold for high-cost mortgages. The Bureau noted 
that proposed Sec.  1026.32(b)(5) was generally consistent with the 
Board's proposed Sec.  226.43(e)(3)(ii)(A) through (C).
    The Bureau believes that it is appropriate to consolidate these 
exclusions in a single provision. The Bureau is now finalizing both 
rules, and the exclusions are nearly identical for both the qualified 
mortgage and high-cost mortgage contexts. Moreover, under the Board's 
ATR Proposal, the points and fees calculation for the qualified 
mortgage points and fees threshold already would have cross-referenced 
the definition of points and fees for high-cost mortgages in Sec.  
226.32(b)(1). Given that the points and fees calculations for both the 
qualified mortgage and high-cost mortgage points and fees thresholds 
will use the same points and fees definition in Sec.  1026.32(b)(1), 
the Bureau believes it is unnecessary to implement nearly identical 
exclusions from points and fees in separate provisions for qualified 
mortgages and high-cost mortgages. Accordingly, the Bureau is 
consolidating the exclusions for certain bona fide third-party charges 
and bona fide discount points for both qualified mortgages and high-
cost mortgages in new Sec.  1026.32(b)(1)(i)(D) through (F). In 
addition, the definition of ``bona fide discount points'' for the 
purposes of Sec.  1026.32(b)(1)(i)(E) and (F), which the 2011 ATR 
Proposal would have implemented in Sec.  226.43(e)(3)(iv), is instead 
being implemented in Sec.  1026.32(b)(3).
    Bona fide third-party charges. TILA Section 129C(b)(2)(C)(i) 
excludes 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.'' Tracking the statute, proposed Sec.  
226.43(e)(3)(ii)(A) would have excluded 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. Proposed 
Sec.  226.43(e)(3)(iii) would have specified that the term ``loan 
originator'' has the same meaning as in Sec.  226.36(a)(1).
    Proposed Sec.  226.43(e)(3)(ii)(A) would also have implemented TILA 
section 103(bb)(1)(C), which requires that premiums for private 
mortgage insurance be included in ``points and fees'' as defined in 
TILA section 103(bb)(4) under certain circumstances. Applying general 
rules of statutory construction, the Board concluded 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, proposed Sec.  
226.43(e)(3)(ii)(A) would have excluded from points and fees any bona 
fide third party charge not retained by the creditor, loan originator, 
or an affiliate of either unless the charges were premiums for private 
mortgage insurance that were included in points and fees under Sec.  
226.32(b)(1)(i)(B).
    The Board noted 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. Creditors may, but are not 
required to, increase the interest rate charged to the consumer so as 
to offset the impact of the LLPAs or increase the costs to the consumer 
in the form of points to offset the lost revenue resulting from the 
LLPAs. The Board noted that, 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'' in TILA section 129C(b)(2)(C).
    The Board acknowledged creditors' concerns about exceeding the 
qualified mortgage points and fees thresholds due to LLPAs required by 
the GSEs. However, the Board questioned whether an exemption for LLPAs 
would be consistent with congressional intent in limiting points and 
fees for qualified mortgages. The Board noted that 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.
    The Board noted that an exclusion for points charged by creditors 
in response to secondary market LLPAs also would raise questions about 
the appropriate treatment of points charged by creditors to offset 
loan-level risks on mortgage loans that they hold in portfolio. The 
Board reasoned that, under normal circumstances, these points are 
retained by the creditor, so it would not be appropriate to exclude 
them from points and fees under the ``bona fide third party charge'' 
exclusion. However, the Board cautioned that 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

[[Page 6429]]

imbalances between loans sold to the secondary market and loans held in 
portfolio.
    The Board also noted that 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 recognized the limits of this approach to loan-level risk 
mitigation due to concerns such as exceeding high-cost mortgage rate 
thresholds. Nonetheless, the Board noted that 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 questioned whether meaningful 
distinctions between points charged to offset loan-level risks and 
other points and fees charged on a loan could be made clearly and 
consistently. In addition, the Board observed that 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 requested 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 loan-level risks on 
mortgages held in portfolio.
    Consumer advocates did not comment on this issue. Many industry 
commenters argued that LLPAs should be excluded from points and fees as 
bona fide third party charges. The GSE commenters agreed that LLPAs 
should be excluded as bona fide third party charges, noting that they 
are not retained by the creditor. One GSE commenter noted that LLPAs 
are set fees that are transparent and accessible via the GSEs' Web 
sites. Some industry commenters contended that including LLPAs in 
points and fees would cause many loans to exceed the points and fees 
cap for qualified mortgages. Other industry commenters argued that 
requiring LLPAs to be included in points and fees would force creditors 
to recover the costs through increases in the interest rate. One of the 
GSE commenters acknowledged the concern that creditors holding loans in 
portfolio could be at a disadvantage if LLPAs were excluded from points 
and fees and suggested that the Bureau consider allowing such creditors 
to exclude published loan level risk adjustment fees.
    One industry commenter urged the Bureau to coordinate with the 
agencies responsible for finalizing the 2011 QRM Proposed Rule to avoid 
unintended consequences. The 2011 ARM Proposed Rule, if adopted, would 
require, in certain circumstances, that sponsors of MBS create premium 
capture cash reserve accounts to limit sponsors' ability to monetize 
the excess spread between the proceeds from the sale of the interests 
and the par value of those interests. See 76 FR 24113. The commenter 
stated that this would result in any premium in the price of a 
securitization backed by residential mortgage loans being placed in a 
first-loss position in the securitization. The commenter argued that 
this would make premium loans too expensive to originate and that 
creditors would not be able to recover LLPAs through interest rate 
adjustments. The commenter maintained that if the LLPAs were included 
in the calculation for the qualified mortgage points and fees limit, 
creditors would also be severely constrained in recovering LLPAs 
through points. The commenter argued that LLPAs therefore should be 
excluded from the points and fees calculation for qualified mortgages.
    The Bureau is adopting Sec.  226.43(e)(3)(ii)(A), with certain 
revisions, as renumbered Sec.  1026.32(b)(1)(i)(D). As revised, Sec.  
1026.32(b)(1)(i)(D) provides that a bona fide third party charge not 
retained by the creditor, loan originator, or an affiliate of either 
the general is excluded from points and fees unless the charge is 
required to be included under Sec.  1026.32(b)(1)(i)(C) (for mortgage 
insurance premiums), (iii) (for real estate related fees), or (iv) (for 
credit insurance premiums). As noted above, the Board proposed that the 
specific provision regarding mortgage insurance, TILA section 
103(bb)(1)(C), should govern the exclusion of private mortgage 
insurance premiums of points and fees, rather than TILA section 
129C(b)(2)(C), which provides generally for the exclusion of certain 
bona fide third-party charges. The Bureau likewise believes that the 
specific statutory provisions regarding real estate related fees and 
credit insurance premiums in TILA section 103(bb)(4)(C) and (D) should 
govern whether these charges are included in points and fees rather 
than the more general provisions regarding exclusion of bona fide 
third-party charges, TILA sections 103(bb)(1)(A)(ii) (for high-cost 
mortgages) or 129C(b)(2)(C) (for qualified mortgages). Thus, Sec.  
1026.32(b)(1)(i)(D) provides that the general exclusion for bona fide 
third-party charges applies unless the charges are required to be 
included under Sec.  1026.32(b)(1)(i)(C), (iii), or (iv).
    The Bureau acknowledges that TILA sections 103(bb)(1)(A)(ii) and 
129C(b)(2)(C) could plausibly be read to provide for a two-step 
calculation of points and fees: first, the creditor would calculate 
points and fees as defined in TILA section 103(bb)(4); and, second, the 
creditor would exclude all bona fide third-party charges not retained 
by the mortgage originator, creditor, or an affiliate of either, as 
provided in TILA sections 103(bb)(1)(A)(ii) (for high-cost mortgages) 
and 129C(b)(2)(C) (for qualified mortgages). Under this reading, 
charges for, e.g., private mortgage insurance could initially, in step 
one, be included in points and fees but then, in step two, be excluded 
as bona fide third-party charges under TILA sections 103(bb)(1)(A)(ii) 
or 129C(b)(2)(C).
    To give meaning to the specific statutory provisions regarding 
mortgage insurance, real estate related fees, and credit insurance, the 
Bureau believes that the better reading is that these specific 
provisions should govern whether such charges are included in points 
and fees, rather than the general provisions excluding certain bona 
fide third-party charges. For example, Congress added TILA section 
103(bb)(1)(C), which prescribes certain conditions under which private 
mortgage insurance premiums would be included in points and fees. The 
Bureau believes that the purpose of this provision is to help ensure 
that consumers with a qualified mortgage are not charged excessive 
private mortgage insurance premiums. If such premiums could be excluded 
as bona fide third-party charges under TILA sections 103(bb)(1)(A)(ii) 
or 129C(b)(2)(C), then the purpose of this provision would be 
undermined. In further support of its interpretation, the Bureau is 
invoking its authority under TILA section 105(a) to make such 
adjustments and exceptions as are necessary and proper to effectuate 
the purposes of TILA, including that consumers are offered and receive 
residential mortgage loans on terms that reasonably reflect their 
ability to repay the loans. Similarly, the Bureau finds that it is 
necessary, proper and appropriate to use its authority under TILA 
section 129C(b)(3)(B)(i) to revise and subtract from the statutory 
language. This use of authority ensures that responsible, affordable 
mortgage credit remains available to consumers in a manner consistent 
with the purpose of TILA section 129C, referenced above, as well as 
effectuating that purpose.
    As noted above, several industry commenters argued that points 
charged

[[Page 6430]]

by creditors to offset LLPAs should be excluded from points and fees 
under Sec.  1026.32(b)(1)(i)(D). In setting the purchase price for 
loans, the GSEs impose LLPAs to offset certain credit risks, and 
creditors may but are not required to recoup the revenue lost as a 
result of the LLPAs by increasing the costs to consumers in the form of 
points. The Bureau believes that the manner in which creditors respond 
to LLPAs is better viewed as a fundamental component of how the pricing 
of a mortgage loan is determined rather than as a third party charge. 
As the Board noted, allowing creditors to exclude points charged to 
offset LLPAs could create market imbalances between loans sold on the 
secondary market and loans held in portfolio. While such imbalances 
could be addressed by excluding risk adjustment fees more broadly, 
including fees charged by creditors for loans held in portfolio, the 
Bureau agrees with the Board that this could create compliance and 
enforcement difficulties. Thus, the Bureau concludes that points 
charged to offset LLPAs may not be excluded from points and fees under 
Sec.  1026.32(b)(1)(i)(D). To the extent that creditors offer consumers 
the opportunity to pay points to lower the interest rate that the 
creditor would otherwise charge to recover the lost revenue from the 
LLPAs, such points may, if they satisfy the requirements of Sec.  
1026.32(b)(1)(i)(E) or (F), be excluded from points and fees as bona 
fide discount points.
    As noted above, one commenter expressed concern that if the 
requirements for premium capture cash reserve accounts proposed in the 
2011 QRM Proposed Rule were adopted, creditors would have difficulty in 
recovering the costs of LLPAs through rate and that, because of the 
points and fees limits for qualified mortgages, creditors would also 
have trouble recovering the costs of LLPAs through up-front charges to 
consumers. The Bureau notes that, as proposed, the premium capture cash 
reserve account requirement would not apply to securities sponsored by 
the GSEs and would not apply to securities comprised solely of QRMs. 
See 76 FR 24112, 24120. Thus, it is not clear, that even if it were 
adopted, the requirement would have as substantial an impact as 
suggested by the commenter. In any event, the requirement has merely 
been proposed, not finalized. The Bureau will continue to coordinate 
with the agencies responsible for finalizing the 2011 QRM Proposed Rule 
to consider the combined effects of that rule and the instant rule.
    The Board proposed comment 43(e)(3)(ii)-1 to clarify the meaning in 
proposed Sec.  226.43(e)(3)(ii)(A) of ``retained by'' the loan 
originator, creditor, or an affiliate of either. Proposed comment 
43(e)(3)(ii)-1 provided that 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.''
    As noted above, several commenters expressed confusion about the 
relationship between proposed Sec.  226.43(e)(3)(ii)(A), which would 
have excluded bona fide third party charges not retained by the loan 
originator, creditor, or an affiliate of either, and proposed Sec.  
226.32(b)(1)(iii), which would have excluded certain real estate 
related charges if they are reasonable, if the creditor receives no 
direct or indirect compensation in connection with the charges, and the 
charges are not paid to an affiliate of the creditor. As explained 
above, the Bureau interprets the more specific provision governing the 
inclusion in points and fees of real estate related charges 
(implemented in Sec.  1026.32(b)(1)(iii)) as taking precedence over the 
more general exclusion for bona fide third party charges in renumbered 
Sec.  1026.32(b)(1)(i)(D). Accordingly, the Bureau does not believe 
that the example in proposed comment 43(e)(3)(ii)-1 is appropriate for 
illustrating the exclusion for bona fide third party charges because 
the subject of the example, appraisals, is specifically addressed in 
Sec.  1026.32(b)(1)(iii).
    The Bureau therefore is revising renumbered comment 32(b)(1)(i)(D)-
1 by using a settlement agent charge to illustrate the exclusion for 
bona fide third party charges. By altering this example to address 
closing agent charges, the Bureau is also responding to requests from 
commenters that the Bureau provide more guidance on whether closing 
agent charges are included in points and fees. As noted above, proposed 
Sec.  226.43(e)(3)(iii) would have specified that the term ``loan 
originator,'' as used in proposed Sec.  226.43(e)(3)(ii)(A), has the 
same meaning as in Sec.  226.36(a)(1). The Bureau is moving the cross-
reference to the definition of ``loan originator'' in Sec.  
226.36(a)(1) to comment 32(b)(1)(i)(D)-1.
    The Board proposed comment 43(e)(3)(ii)-2 to explain that, under 
Sec.  226.32(b)(1)(i)(B), creditors would have to include in ``points 
and fees'' premiums or charges payable at or before consummation 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)). The proposed comment also would have 
explained that these premiums or charges would be included if the 
premiums or charges were 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 would 
have clarified that, under these circumstances, even if the premiums 
and charges were not retained by the creditor, loan originator, or an 
affiliate of either, they would be included in the ``points and fees'' 
calculation for qualified mortgages. The comment also would have cross-
referenced proposed comments 32(b)(1)(i)-3 and -4 for further 
discussion of including private mortgage insurance premiums in the 
points and fees calculation.
    The Bureau is adopting proposed comment 43(e)(3)(ii)-2 
substantially as proposed, renumbered as comment 32(b)(i)(D)-2. In 
addition, the Bureau also is adopting new comments 32(b)(i)(D)-3 and -4 
to explain that the exclusion of bona fide third party charges under 
Sec.  1026.32(b)(1)(i)(D) does not apply to real estate-related charges 
and credit insurance premiums. The inclusion of these items in points 
and fees is specifically addressed in Sec.  1026.32(b)(iii) and (iv), 
respectively.
    Bona fide discount points. TILA section 129C(b)(2)(C)(ii) excludes 
up to two bona fide discount points from points and fees under certain 
circumstances. Specifically, it excludes up to two bona fide discount 
points if the interest rate before the discount does not exceed the 
average prime offer rate by more than two percentage points. 
Alternatively, it excludes up to one discount point if the interest 
rate before the discount does not exceed the average prime offer rate 
by more than one percentage point. The Board proposed to implement this 
provision in proposed Sec.  226.43(e)(3)(ii)(B) and (C).
    Proposed Sec.  226.43(e)(3)(ii)(B) would have permitted 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: (1) The interest rate before the 
rate is discounted does not exceed the average

[[Page 6431]]

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 43(e)(3)(ii)(B)(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.
    Proposed Sec.  226.43(e)(3)(ii)(C) would have permitted 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: (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 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 (3) two bona fide discount points have not been excluded under 
Sec.  226.43(e)(3)(ii)(B).
    Several industry commenters argued that creditors should be 
permitted to exclude from points and fees more than two discount 
points. Some industry commenters maintained that creditors should be 
permitted to exclude as many discount points as consumers choose to 
pay. Another commenter contended that creditors should be able to 
exclude as many as three discount points.
    A few industry commenters requested eliminating the requirement 
that, for the discount points to be bona fide, the interest rate before 
the discount must be within one or two percentage points of the average 
prime offer rate. One industry commenter argued that this requirement 
is too inflexible. Several commenters recommended that this requirement 
be adjusted for jumbo loans and for second homes. Another commenter 
claimed that this requirement would limit the options for consumers 
paying higher interest rates and that these are the consumers for whom 
it would be most beneficial to pay down their interest rates.
    Several commenters argued that the effect of these two limitations 
for excluding discount points from points and fees--the limit on the 
number of discount points that could be excluded and the requirement 
that the pre-discount rate be within one or two points of the average 
prime offer rate--would have a negative impact on consumers. They 
maintained that these limitations would prevent consumers from choosing 
their optimal combination of interest rate and points for their 
financial circumstances.
    One commenter noted that proposed Sec.  226.43(e)(3)(ii)(B) and (C) 
would require that, for the discount points or point to be excluded 
from points and fees, the interest rate before the discount must not 
exceed the average prime offer rate by more than one or two 
``percent,'' respectively. The commenter recommended that, for clarity 
and consistency with the statute, the requirement should instead 
require that the interest rate before the discount be within one or two 
``percentage points'' of the average prime offer rate.
    The Bureau is adopting proposed Sec.  226.43(e)(3)(ii)(B) and (C), 
renumbered as Sec.  1026.32(b)(1)(i)(E) and (F), with certain 
revisions. As suggested by a commenter, the Bureau is revising both 
Sec.  1026.32(b)(1)(i)(E)(1) and (F)(1) to require that, to exclude the 
discount points or point, the interest rate must be within one or two 
``percentage points'' (rather than ``percent'') of the average prime 
offer rate. This formulation is clearer and consistent with the 
statutory language. The Bureau is also adding Sec.  
1026.32(b)(1)(i)(E)(2) and (F)(2) to implement TILA section 
103(dd)(1)(B) and (C), which specify that, to exclude discount points 
from points and fees for purposes of determining whether a loan is a 
high-cost mortgage, the interest rate for personal property loans 
before the discount must be within one or two percentage points, 
respectively, of the average rate on a loan in connection with which 
insurance is provided under title I of the National Housing Act. This 
provision does not apply to the points and fees limit for qualified 
mortgages, regardless of whether a loan is a high-cost mortgage. The 
provision is included in the final rule for completeness. Finally, in 
Sec.  1026.32(b)(1)(i)(F), the Bureau is clarifying that bona fide 
discount points cannot be excluded under Sec.  1026.32(b)(1)(i)(F) if 
any bona fide discount points already have been excluded under Sec.  
1026.32(b)(1)(i)(E).
    As noted above, several commenters urged the Bureau to alter or 
eliminate the limitations on how many discount points may be excluded 
and the requirement that the pre-discount interest rate must be within 
one or two points of the average prime offer rate. A few industry 
commenters also requested that the Bureau adjust the limitation on the 
pre-discount interest rate specifically for jumbo loans and loans for 
vacation homes. These commenters noted that interest rates for such 
loans otherwise would often be too high to qualify for the exclusion 
for bona fide discount points. The Bureau recognizes that these 
limitations may circumscribe the ability of consumers to purchase 
discount points to lower their interest rates. Nevertheless, the Bureau 
does not believe it would be appropriate to exercise its exception 
authority. Congress apparently concluded that there was a greater 
probability of consumer injury when consumers purchased more than two 
discount points or when the consumers were using discount points to buy 
down higher interest rates. The Bureau also notes that, in other 
sections of the Dodd-Frank Act, Congress prescribed different 
thresholds above the average prime offer rate for jumbo loans. See TILA 
sections 129C(c)(1)(B) (prepayment penalties) and 129H(f)(2) 
(appraisals). Congress did not do so in the provision regarding 
exclusion of bona fide discount points.
    The Bureau is adding new comment 32(b)(1)(i)(E)-2 to note that the 
term ``bona fide discount point'' is defined in Sec.  1026.32(b)(3). To 
streamline the rule, the Bureau is moving into new comment 
32(b)(1)(i)(E)-2 the explanation that the average prime offer rate used 
for purposes of for both Sec.  1026.32(b)(1)(i)(E) and (F) is the 
average prime offer rate that applies to a comparable transaction as of 
the date the discounted interest rate for the covered transaction is 
set. The Board proposed comment 43(e)(3)(ii)-5 to clarify that the 
average prime offer rate table indicates how to identify the comparable 
transaction. The Bureau is adding the language from proposed comment 
43(e)(3)(ii)-5 to new comment 32(b)(1)(i)(E)-2, with a revision to the 
cross-reference for the comment addressing ``comparable transaction.''
    Proposed comment 43(e)(3)(ii)-3 would have included an example to 
illustrate the rule permitting exclusion of two bona fide discount 
points. The example would have assumed a covered transaction that is a 
first-lien, purchase money home mortgage with a fixed interest rate and 
a 30-year term. It would also have assumed that the consumer locks in 
an interest rate of 6 percent on May 1, 2011, that was discounted from 
a rate of 6.5 percent because the consumer paid two discount points. 
Finally, assume that the average prime offer rate as of May 1, 2011 for 
first-lien, purchase money home mortgages with a fixed interest rate 
and a 30-year term is 5.5 percent. In this example, the creditor would 
have been able to exclude two discount points from the ``points and 
fees'' calculation because the rate from which the discounted rate was 
derived exceeded the average prime offer rate for a comparable 
transaction as of the date the rate on the covered transaction was set 
by only 1 percent.

[[Page 6432]]

    The Bureau is adopting proposed comment 43(e)(3)(ii)-3 
substantially as proposed but renumbered as comment 32(b)(1)(i)(E)-3. 
The Bureau is also adding new comment 32(b)(1)(i)(F)-1 to explain that 
comments 32(b)(1)(i)(E)-1 and -2 provide guidance concerning the 
definitions of ``bona fide discount point'' and ``average prime offer 
rate,'' respectively.
    Proposed comment 43(e)(3)(ii)-4 would have provided an example to 
illustrate the rule permitting exclusion of one bona fide discount 
point. The example assumed a covered transaction that is a first-lien, 
purchase money home mortgage with a fixed interest rate and a 30-year 
term. The example also would have assumed that the consumer locks in an 
interest rate of 6 percent on May 1, 2011, that was discounted from a 
rate of 7 percent because the consumer paid four discount points. 
Finally, the example would have assumed that the average prime offer 
rate as of May 1, 2011, for first-lien, purchase money home mortgages 
with a fixed interest rate and a 30-year term is 5 percent.
    In this example, the creditor would have been able to exclude one 
discount point from the ``points and fees'' calculation because the 
rate from which the discounted rate was derived (7 percent) exceeded 
the average prime offer rate for a comparable transaction as of the 
date the rate on the covered transaction was set (5 percent) by only 2 
percent. The Bureau is adopting proposed comment 43(e)(3)(ii)-4 
substantially as proposed but renumbered as comment 32(b)(1)(i)(F)-2.
32(b)(1)(ii)
    When HOEPA was enacted in 1994, it required that ``all compensation 
paid to mortgage brokers'' be counted toward the threshold for points 
and fees that triggers special consumer protections under the statute. 
Specifically, TILA section 103(aa)(4) provided that charges are 
included in points and fees only if they are payable at or before 
consummation and did not expressly address whether ``backend'' payments 
from creditors to mortgage brokers funded out of the interest rate 
(commonly referred to as yield spread premiums) are included in points 
and fees.\79\ This requirement is implemented in existing Sec.  
1026.32(b)(1)(ii), which requires that all compensation paid by 
consumers directly to mortgage brokers be included in points and fees, 
but does not address compensation paid by creditors to mortgage brokers 
or compensation paid by any company to individual employees (such as 
loan officers who are employed by a creditor or mortgage broker).
---------------------------------------------------------------------------

    \79\ Some commenters use the term ``yield spread premium'' to 
refer to any payment from a creditor to a mortgage broker that is 
funded by increasing the interest rate that would otherwise be 
charged to the consumer in the absence of that payment. These 
commenters generally assume that any payment to the brokerage firm 
by the creditor is funded out of the interest rate, reasoning that 
had the consumer paid the brokerage firm directly, the creditor 
would have had lower expenses and would have been able to charge a 
lower rate. Other commenters use the term ``yield spread premium'' 
more narrowly to refer only to a payment from a creditor to a 
mortgage broker that is based on the interest rate, i.e., the 
mortgage broker receives a larger payment if the consumer agrees to 
a higher interest rate. To avoid confusion, the Bureau is limiting 
its use of the term and is instead more specifically describing the 
payment at issue.
---------------------------------------------------------------------------

    The Dodd-Frank Act substantially expanded the scope of compensation 
included in points and fees for both the high-cost mortgage threshold 
in HOEPA and the qualified mortgage points and fees limits.\80\ Section 
1431 of the Dodd-Frank Act amended TILA to require that ``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,'' be included 
in points and fees. TILA section 103(bb)(4)(B) (emphasis added). Under 
amended TILA section 103(bb)(4)(B), compensation paid to anyone that 
qualifies as a ``mortgage originator'' is to be included in points and 
fees.\81\ Thus, in addition to compensation paid to mortgage brokerage 
firms and individual brokers, points and fees also includes 
compensation paid to other mortgage originators, including employees of 
a creditor (i.e., loan officers). In addition, as noted above, the 
Dodd-Frank Act removed the phrase ``payable at or before closing'' from 
the high-cost mortgage points and fees test and did not apply the 
``payable at or before closing'' limitation to the points and fees cap 
for qualified mortgages. See TILA sections 103(bb)(1)(A)(ii) and 
129C(b)(2)(A)(vii), (b)(2)(C). Thus, the statute appears to contemplate 
that even compensation paid to mortgage brokers and other loan 
originators after consummation should be counted toward the points and 
fees thresholds.
---------------------------------------------------------------------------

    \80\ Currently, the points and fees threshold for determining 
whether a loan is a high-cost mortgage is the greater of 8 percent 
of the total loan amount or $400 (adjusted for inflation). Section 
1431 of the Dodd-Frank Act lowered the points and fees threshold for 
determining whether a loan is a high-cost mortgage to 5 percent of 
the total transaction amount for loans of $20,000 or more and to the 
lesser of 8 percent of the total transaction amount or $1,000 for 
loans less than $20,000.
    \81\ ``Mortgage originator'' is generally defined to include 
``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(dd)(2). The statute excludes certain 
persons from the definition, including a person who performs purely 
administrative or clerical tasks; an employee of a retailer of 
manufactured homes who does not take a residential mortgage 
application or offer or negotiate terms of a residential mortgage 
loan; and, subject to certain conditions, real estate brokers, 
sellers who finance three or fewer properties in a 12-month period, 
and servicers. TILA section 103(dd)(2)(C) through (F).
---------------------------------------------------------------------------

    This change is one of several provisions in the Dodd-Frank Act that 
focus on loan originator compensation and regulation, in apparent 
response to concerns that industry compensation practices contributed 
to the mortgage market crisis by creating strong incentives for brokers 
and retail loan officers to steer consumers into higher-priced loans. 
Specifically, loan originators were often paid a commission by 
creditors that increased with the interest rate on a transaction. These 
commissions were funded by creditors through the increased revenue 
received by the creditor as a result of the higher rate paid by the 
consumer and were closely tied to the price the creditor expected to 
receive for the loan on the secondary market as a result of that higher 
rate.\82\ In addition, many mortgage brokers charged consumers up-front 
fees to cover some of their costs at the same time that they accepted 
backend payments from creditors out of the rate. This may have 
contributed to consumer confusion about where the brokers' loyalties 
lay.
---------------------------------------------------------------------------

    \82\ For more detailed discussions, see the Bureau's 2012 Loan 
Originator Proposal and the final rule issued by the Board in 2010. 
77 FR 55272, 55276, 55290 (Sept. 7, 2012); 75 FR 58509, 5815-16, 
58519-20 (Sept. 24, 2010) (2010 Loan Originator Final Rule).
---------------------------------------------------------------------------

    The Dodd-Frank Act took a number of steps to address loan 
originator compensation issues, including: (1) Adopting requirements 
that loan originators be ``qualified'' as defined by Bureau 
regulations; (2) generally prohibiting compensation based on rate and 
other terms (except for loan amount) and prohibiting a loan originator 
from receiving compensation from both consumers and other parties in a 
single transaction; (3) requiring the promulgation of additional rules 
to prohibit steering consumers to less advantageous transactions; (4) 
requiring the disclosure of loan originator compensation; and (5) 
restricting loan originator compensation under HOEPA and the qualified 
mortgage provisions by including such compensation within the points 
and fees calculations. See TILA sections 103(bb)(4)(A)(ii), (B);

[[Page 6433]]

128(a)(18); 129B(b), (c); 129C(b)(2)(A)(vii), (C)(i).
    The Board proposed revisions to Sec.  226.32(b)(1)(ii) to implement 
the inclusion of more forms of loan originator compensation into the 
points and fees thresholds. Those proposed revisions tracked the 
statutory language, with two exceptions. First, proposed Sec.  
226.32(b)(1)(ii) did not include the phrase ``from any source.'' The 
Board noted that the statute covers compensation paid ``directly or 
indirectly'' to the loan originator, and concluded that it would be 
redundant to cover compensation ``from any source.'' Second, for 
consistency with Regulation Z, the proposal used the term ``loan 
originator'' as defined in Sec.  226.36(a)(1), rather than the term 
``mortgage originator'' that appears in section 1401 of the Dodd-Frank 
Act. See TILA section 103(cc)(2). The Board explained that it 
interpreted the definitions of mortgage originator under the statute 
and loan originator under existing Regulation Z to be generally 
consistent, with one exception that the Board concluded was not 
relevant for purposes of the points and fees thresholds. Specifically, 
the statutory definition refers to ``any 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 listed in the definition 
(such as offering or negotiating loan terms), while the existing 
Regulation Z definition does not include persons solely on this basis. 
The Board concluded that it was not necessary to add this element of 
the definition to implement the points and fees calculations anyway, 
reasoning that the calculation of points and fees is concerned only 
with loan originators that receive compensation for performing defined 
origination functions in connection with a consummated loan. The Board 
noted that a person who merely represents to the public that such 
person can offer or negotiate mortgage terms for a consumer has not yet 
received compensation for that function, so there is no compensation to 
include in the calculation of points and fees for a particular 
transaction.
    In the proposed commentary, the Board explained what compensation 
would and would not have been included in points and fees under 
proposed Sec.  226.32(b)(1)(ii). The Board proposed to revise existing 
comment 32(b)(1)(ii)-1 to clarify that compensation paid by either a 
consumer or a creditor to a loan originator, as defined in Sec.  
1026.36(a)(1), would be included in points and fees. Proposed comment 
32(b)(1)(ii)-1 also stated that loan originator compensation already 
included in points and fees because it is included in the finance 
charge under Sec.  226.32(b)(1)(i) would not be counted again under 
Sec.  226.32(b)(1)(ii).
    Proposed comment 32(b)(1)(ii)-2.i stated that, in determining 
points and fees, loan originator compensation includes the dollar value 
of compensation paid to a loan originator for a specific 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. Proposed 
comment 32(b)(1)(ii)-2.ii clarified that loan originator compensation 
excludes compensation that cannot be attributed to a transaction at the 
time of origination, including, for example, the base salary of a loan 
originator that is also the employee of the creditor, or compensation 
based on the performance of the loan originator's loans or on the 
overall quality of a loan originator's loan files. Proposed comment 
32(b)(1)(ii)-2.i also explained 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 any time after closing, as long as the compensation 
amount can be determined at the time of closing. In addition, proposed 
comment 32(b)(1)(ii)-2.i provided three examples of compensation paid 
to a loan originator that would have been included in the points and 
fees calculation.
    Proposed comment 32(b)(1)(ii)-3 stated 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. Proposed comment 32(b)(1)(ii)-3 offered an example of 
a loan originator imposing and retaining a ``processing fee'' and 
stated that such a fee is loan originator compensation, regardless of 
whether the loan originator expends the fee to process the consumer's 
application or uses it for other expenses, such as overhead.
    The Board requested comment on the types of loan originator 
compensation that must be included in points and fees. The Board also 
sought comment on the appropriateness of specific examples given in the 
commentary.
    Many industry commenters objected to the basic concept of including 
loan originator compensation in points and fees, urging the Bureau to 
use its exception authority to exclude loan originator compensation 
from points and fees altogether. Several industry commenters contended 
that other statutory provisions and rules, including the Secure and 
Fair Enforcement for Mortgage Licensing Act of 2008 (SAFE Act), the 
Board's 2010 Loan Originator Final Rule, and certain Dodd-Frank Act 
provisions (including those proposed to be implemented in the Bureau's 
2012 Loan Originator Proposal), adequately regulate loan originator 
compensation and prohibit or restrict problematic loan originator 
compensation practices. Accordingly, they argued it is therefore 
unnecessary to include loan originator compensation in points and fees.
    Many industry commenters also asserted that the amount of 
compensation paid to loan originators has little or no bearing on a 
consumer's ability to repay a mortgage, and thus that including loan 
originator compensation in points and fees under this rulemaking is 
unnecessary. They further asserted that including loan originator 
compensation in points and fees would greatly increase compliance 
burdens on creditors, discourage creditors from making qualified 
mortgages, and ultimately reduce access to credit and increase the cost 
of credit.
    Several industry commenters argued that, if the Bureau does not 
exclude all loan originator compensation from points and fees, then the 
Bureau should at least exclude compensation paid to individual loan 
originators (i.e., loan officers who are employed by creditors or 
mortgage brokerage firms). They argued that compensation paid to 
individual loan originators is already included in the cost of the 
loan, either in the interest rate or in origination fees. They 
maintained that including compensation paid to individual loan 
originators in points and fees would therefore constitute double 
counting.
    Several industry commenters also claimed that they would face 
significant challenges in determining the amount of compensation for 
individual loan originators. They noted that creditors need clear, 
objective standards for determining whether loans satisfy the qualified 
mortgage standard, and that the complexity of apportioning compensation 
to individual loans at the time of each closing to determine the amount 
of loan originator compensation to count toward the points and fees cap 
would create uncertainty. They also noted that having to track 
individual loan originators' compensation and allocate that 
compensation to individual

[[Page 6434]]

loans would create additional compliance burdens, particularly for 
compensation paid after closing. Several industry commenters also 
stated that estimating loan originator compensation in table-funded 
transactions would prove difficult because the funding assignee may not 
know the amount paid by the table-funded creditor to the individual 
loan originator.
    Several industry commenters also asserted that including 
compensation paid to individual loan originators would lead to 
anomalous results: Otherwise identical loans could have significant 
differences in points and fees depending on the timing of the mortgage 
loan or the identity of the loan officer. They noted, for example, that 
a loan that qualifies a loan officer for a substantial bonus because it 
enables a loan officer to satisfy a long-term (e.g., annual) 
origination-volume target or a loan that is originated by a high-
performing loan officer could have substantially higher loan originator 
compensation, and thus substantially higher points and fees, than an 
otherwise identical loan. Because the consumers would not be paying 
higher fees or interest rates because of such circumstances, the 
commenters argued that the result would not further the goals of the 
statute.
    Some industry commenters made a separate argument that the proposed 
method for including loan originator compensation in points and fees 
would create an unfair playing field for mortgage brokers. These 
commenters noted that, since a brokerage firm can be paid by only one 
source under the Board's 2010 Loan Originator Final Rule and related 
provisions of the Dodd-Frank Act, a payment by a creditor to a mortgage 
broker must cover both the broker's overhead costs and the cost of 
compensating the individual that worked on the transaction. The 
creditor's entire payment to the mortgage broker is loan originator 
compensation that is included in points and fees, so that loan 
originator compensation in a wholesale transaction includes both the 
compensation received from the creditor to cover the overhead costs of 
the mortgage broker and the compensation that the broker passes through 
to the individual employee who worked on the transaction. By contrast, 
in a loan obtained directly from a creditor, the creditor would have to 
include in points and fees the compensation paid to the loan officer, 
but could choose to recover its overhead costs through the interest 
rate rather than an up-front charge that would count toward the points 
and fees thresholds. One industry commenter provided examples 
illustrating that, as a result of this difference, loans obtained 
through a mortgage broker could have interest rates and fees identical 
to those in a loan obtained directly through a creditor but could have 
significantly higher loan originator compensation included in points 
and fees. Thus, particularly for smaller loan amounts, commenters 
expressed concern that it would be difficult for loans originated 
through mortgage brokers to remain under the points and fees limits for 
qualified mortgages.
    A nonprofit loan originator commenter also argued that including 
loan originator compensation in points and fees could undercut programs 
that help low and moderate income consumers obtain affordable 
mortgages. This commenter noted that it relies on payments from 
creditors to help it provide services to consumers and that counting 
such payments as loan originator compensation and including them in 
points and fees could jeopardize its programs. The commenter requested 
that this problem be addressed by excluding nonprofit organizations 
from the definition of loan originator or by excluding payments by 
creditors to nonprofit organizations from points and fees.
    Consumer advocates approved of including loan originator 
compensation in points and fees, regardless of when and by whom the 
compensation is paid. They asserted that including loan originator 
compensation would promote more consistent treatment by ensuring that 
all payments that loan originators receive count toward the points and 
fees thresholds, regardless of whether the payment is made by the 
consumer or the creditor and whether it is paid through the rate or 
through up-front fees. They maintained that the provision was intended 
to help prevent consumers from paying excessive amounts for loan 
origination services. More specifically, some consumer advocates argued 
that the Dodd-Frank Act provision requiring inclusion of loan 
originator compensation in points and fees is an important part of a 
multi-pronged approach to address widespread steering of consumers into 
more expensive mortgage transactions, and in particular, to address the 
role of commissions funded through the interest rate in such steering. 
The consumer advocates noted that separate prohibitions on compensation 
based on terms and on a loan originator's receiving compensation from 
both the consumer and another party do not limit the amount of 
compensation a loan originator can receive or prevent a loan originator 
from inducing consumers to agree to above-market interest rates. They 
expressed concern that, particularly in the subprime market, loan 
originators could specialize in originating transactions with above-
market interest rates, with the expectation they could arrange to 
receive above-market compensation for all of their transactions. 
Consumer advocates argued that counting all methods of loan originator 
compensation toward the points and fees thresholds was intended to 
deter such conduct.
    Consumer advocates also pointed out that in the wholesale context, 
the consumer has the option of paying the brokerage firm directly for 
its services. Such payments have always been included within the 
calculation of points and fees for HOEPA purposes. The advocates argued 
that when a consumer elects not to make the up-front payment but 
instead elects to fund the same amount of money for the brokerage 
through an increased rate, there is no justification for treating the 
money received by the brokerage as a result of the consumer's decision 
any differently.
    The Bureau has carefully considered the comments received in light 
of the concerns about various issues with regard to loan originator 
compensation practices, the general concerns about the impacts of the 
ability-to-repay/qualified mortgage rule and revised HOEPA thresholds 
on a market in which access to mortgage credit is already extremely 
tight, differences between the retail and wholesale origination 
channels, and practical considerations regarding both the burdens of 
day-to-day implementation and the opportunities for evasion by parties 
who wish to engage in rent-seeking. As discussed further below, the 
Bureau is concerned about implementation burdens and anomalies created 
by the requirement to include loan originator compensation in points 
and fees, the impacts that it could have on pricing and access to 
credit, and the risks that rent-seekers will continue to find ways to 
evade the statutory scheme. Nevertheless, the Bureau believes that, in 
light of the historical record and of Congress's evident concern with 
loan originator compensation practices, it would not be appropriate to 
waive the statutory requirement that loan originator compensation be 
included in points and fees. The Bureau has, however, worked to craft 
the rule that implements Congress's judgment in a way that is 
practicable and that reduces potential negative impacts of the 
statutory requirement, as discussed below. The Bureau is also seeking 
comment in the

[[Page 6435]]

concurrent proposal being published elsewhere in today's Federal 
Register on whether additional measures would better protect consumers 
and reduce implementation burdens and unintended consequences.
    Accordingly, the Bureau in adopting Sec.  1026.32(b)(1)(ii) has 
generally tracked the statutory language and the Board's proposal in 
the regulation text, but has expanded the commentary to provide more 
detailed guidance to clarify what compensation must be included in 
points and fees. The Dodd-Frank Act 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(bb)(4)(B). Consistent with the Board's proposal, 
revised Sec.  1026.32(b)(ii) does not include the phrase ``from any 
source.'' The Bureau agrees that the phrase is unnecessary because the 
provision expressly covers compensation paid ``directly or indirectly'' 
to the loan originator. Like the Board's proposal, the final rule also 
uses the term ``loan originator'' as defined in Sec.  1026.36(a)(1), 
not the term ``mortgage originator'' under section 1401 of the Dodd-
Frank Act. See TILA section 103(cc)(2). The Bureau agrees that the 
definitions are consistent in relevant respects and notes that it is in 
the process of amending the regulatory definition to harmonize it even 
more closely with the Dodd-Frank Act definition of ``mortgage 
originator.'' \83\ Accordingly, the Bureau believes use of consistent 
terminology in Regulation Z will facilitate compliance. Finally, as 
revised, Sec.  1026.32(b)(1)(ii) also does not include the language in 
proposed Sec.  226.32(b)(1)(ii) that specified that the provision also 
applies to a loan originator that is the creditor in a table-funded 
transaction. The Bureau has concluded that that clarification is 
unnecessary because a creditor in a table-funded transaction is already 
included in the definition of loan originator in Sec.  1026.36(a)(1). 
To clarify what compensation must be included in points and fees, 
revised Sec.  1026.32(b)(1)(ii) specifies that compensation must be 
included if it can be attributed to the particular transaction at the 
time the interest rate is set. These limitations are discussed in more 
detail below.
---------------------------------------------------------------------------

    \83\ See 2012 Loan Originator Proposal, 77 FR 55283-88.
---------------------------------------------------------------------------

    In adopting the general rule, the Bureau carefully considered 
arguments by industry commenters that loan originator compensation 
should not be included in points and fees because other statutory 
provisions and rules already regulate loan originator compensation, 
because loan originator compensation is already included in the costs 
of mortgage loans, and because including loan originator compensation 
in points and fees would push many loans over the 3 percent cap on 
points and fees for qualified mortgages (or even over the points and 
fees limits for determining whether a loan is a high-cost mortgage 
under HOEPA), which would increase costs and impair access to credit.
    The Bureau views the fact that other provisions within the Dodd-
Frank Act address other aspects of loan originator compensation and 
activity as evidence of the high priority that Congress placed on 
regulating such compensation. The other provisions pointed to by the 
commenters address specific compensation practices that created 
particularly strong incentives for loan originators to ``upcharge'' 
consumers on a loan-by-loan basis and particular confusion about loan 
originators' loyalties. The Bureau believes that the inclusion of loan 
originator compensation in points and fees has distinct purposes. In 
addition to discouraging more generalized rent-seeking and excessive 
loan originator compensation, the Bureau believes that Congress may 
have been focused on particular risks to consumers. Thus, with respect 
to qualified mortgages, including loan originator compensation in 
points and fees helps to ensure that, in cases in which high up-front 
compensation might otherwise cause the creditor and/or loan originator 
to be less concerned about long-term sustainability, the creditor is 
not able to invoke a presumption of compliance if challenged to 
demonstrate that it made a reasonable and good faith determination of 
the consumer's ability to repay the loan. Similarly in HOEPA, the 
threshold triggers additional consumer protections, such as enhanced 
disclosures and housing counseling, for the loans with the highest up-
front pricing.
    The Bureau recognizes that the method that Congress chose to 
effectuate these goals does not ensure entirely consistent results as 
to whether a loan is a qualified mortgage or a high-cost transaction. 
For instance, loans that are identical to consumers in terms of up-
front costs and interest rate may nevertheless have different points 
and fees based on the identity of the loan originator who handled the 
transaction for the consumer, since different individual loan 
originators in a retail environment or different brokerage firms in a 
wholesale environment may earn different commissions from the creditor 
without that translating in differences in costs to the consumer. In 
addition, there are anomalies introduced by the fact that ``loan 
originator'' is defined to include mortgage broker firms and individual 
employees hired by either brokers or creditors, but not creditors 
themselves. As a result, counting the total compensation paid to a 
mortgage broker firm will capture both the firm's overhead costs and 
the compensation that the firm passes on to its individual loan 
officer. By contrast, in a retail transaction, the creditor would have 
to include in points and fees the compensation that it paid to its loan 
officer, but would continue to have the option of recovering its 
overhead costs through the interest rate, instead of an up-front 
charge, to avoid counting them toward the points and fees thresholds. 
Indeed, the Bureau expects that the new requirement may prompt 
creditors to shift certain other expenses into rate to stay under the 
thresholds.
    Nevertheless, to the extent there are anomalies from including loan 
originator compensation in points and fees, these anomalies appear to 
be the result of deliberate policy choices by Congress to expand the 
historical definition of points and fees to include all methods of loan 
originator compensation, whether derived from up-front charges or from 
the rate, without attempting to capture all overhead expenses by 
creditors or the gain on sale that the creditor can realize upon 
closing a mortgage. The Bureau agrees that counting loan originator 
compensation that is structured through rate toward the points and fees 
thresholds could cause some loans not to be classified as qualified 
mortgages and to trigger HOEPA protections, compared to existing 
treatment under HOEPA and its implementing regulation. However, the 
Bureau views this to be exactly the result that Congress intended.
    In light of the express statutory language and Congress's evident 
concern with increasing consumer protections in connection with high 
levels of loan originator compensation, the Bureau does not believe 
that it is appropriate to use its exception or adjustment authority in 
TILA section 105(a) or in TILA section 129C(b)(3)(B)(i) to exclude loan 
originator compensation entirely from points and fees for qualified 
mortgages and HOEPA. As discussed below, however, the Bureau is 
attempting to implement the points and fees

[[Page 6436]]

requirements with as much sensitivity as practicable to potential 
impacts on the pricing of and availability of credit, anomalies and 
unintended consequences, and compliance burdens.
    The Bureau also carefully considered comments urging it to exclude 
compensation paid to individual loan originators from points and fees, 
but ultimately concluded that such a result would be inconsistent with 
the plain language of the statute and could exacerbate the potential 
inconsistent effects of the rule on different mortgage origination 
channels. As noted above, many industry commenters argued that, even if 
loan originator compensation were not excluded altogether, at least 
compensation paid to individual loan originators should be excluded 
from points and fees. Under this approach, only payments to mortgage 
brokers would be included in points and fees. The commenters contended 
that it would be difficult to track compensation paid to individual 
loan originators, particularly when that compensation may be paid after 
consummation of the loan and that it would create substantial 
compliance problems. They also argued that including compensation paid 
to individual loan originators in points and fees would create 
anomalies, in which identical transactions from the consumer's 
perspective (i.e., the same interest rate and up-front costs) could 
nevertheless have different points and fees because of loan originator 
compensation.
    As explained above, the Bureau does not believe it is appropriate 
to use its exception authority to exclude loan originator compensation 
from points and fees, and even using that exception authority more 
narrowly to exclude compensation paid to individual loan originators 
could undermine Congress's apparent goal of providing stronger consumer 
protections in cases of high loan originator compensation. Although 
earlier versions of legislation focused specifically on compensation to 
``mortgage brokers,'' which is consistent with existing HOEPA, the 
Dodd-Frank Act refers to compensation to ``mortgage originators,'' a 
term that is defined in detail elsewhere in the statute to include 
individual loan officers employed by both creditors and brokers, in 
addition to the brokers themselves. To the extent that Congress 
believed that high levels of loan originator compensation evidenced 
additional risk to consumers, excluding individual loan originators 
from consideration appears inconsistent with this policy judgment.
    Moreover, the Bureau notes that using exception authority to 
exclude compensation paid to individual loan originators would 
exacerbate the differential treatment between the retail and wholesale 
channels concerning overhead costs. As noted above, compensation paid 
by the consumer or creditor to the mortgage broker necessarily will 
include amounts for both the mortgage broker's overhead and profit and 
for the compensation the mortgage broker passes on to its loan officer. 
Excluding individual loan officer compensation on the retail side, 
however, would effectively exempt creditors from counting any loan 
originator compensation at all toward points and fees. Thus, for 
transactions that would be identical from the consumer's perspective in 
terms of interest rate and up-front costs, the wholesale transaction 
could have significantly higher points and fees (because the entire 
payment from the creditor to the mortgage broker would be captured in 
points and fees), while the retail transaction might include no loan 
origination compensation at all in points and fees. Such a result would 
put brokerage firms at a disadvantage in their ability to originate 
qualified mortgages and put them at significantly greater risk of 
originating HOEPA loans. This in turn could constrict the supply of 
loan originators and the origination channels available to consumers to 
their detriment.
    The Bureau recognizes that including compensation paid to 
individual loan originators, such as loan officers, with respect to 
individual transactions may impose additional burdens. For example, 
creditors will have to track employee compensation for purposes of 
complying with the rule, and the calculation of points and fees will be 
more complicated. However, the Bureau notes that creditors and brokers 
already have to monitor compensation more carefully as a result of the 
2010 Loan Originator Final Rule and the related Dodd-Frank Act 
restrictions on compensation based on terms and on dual compensation. 
The Bureau also believes that these concerns can be reduced by 
providing clear guidance on issues such as what types of compensation 
are covered, when compensation is determined, and how to avoid 
``double-counting'' payments that are already included in points and 
fees calculations. The Bureau has therefore revised the Board's 
proposed regulation and commentary to provide more detailed guidance, 
and is seeking comment in the proposal published elsewhere in the 
Federal Register today on additional guidance and potential 
implementation issues among other matters.
    As noted above, the Bureau is revising Sec.  1026.32(b)(1)(ii) to 
clarify that compensation must be counted toward the points and fees 
thresholds if it can be attributed to the particular transaction at the 
time the interest rate is set. The Bureau is also revising comment 
32(b)(1)(ii)-1 to explain in general terms when compensation qualifies 
as loan originator compensation that must be included in points and 
fees. In particular, compensation paid by a consumer or creditor to a 
loan originator is included in the calculation of points and fees, 
provided that such compensation can be attributed to that particular 
transaction at the time the interest rate is set. The Bureau also 
incorporates part of proposed comment 32(b)(1)(ii)-3 into revised 
comment 32(b)(1)(ii)-1, explaining 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. However, revised comment 32(b)(1)(ii)-1 does not include 
the example from proposed comment 32(b)(1)(ii)-3, which stated that, if 
a loan originator imposes a processing fee and retains the fee, the fee 
is loan originator compensation under Sec.  1026.32(b)(1)(ii) whether 
the originator expends the fee to process the consumer's application or 
uses it for other expenses, such as overhead. That example may be 
confusing in this context because a processing fee paid to a loan 
originator likely would be a finance charge under Sec.  1026.4 and 
would therefore already be included in points and fees under Sec.  
1026.32(b)(1)(i).
    Revised comment 32(b)(1)(ii)-2.i explains that compensation, such 
as a bonus, commission, or an award of merchandise, services, trips or 
similar prizes, must be included only if it can be attributed to a 
particular transaction. The requirement that compensation is included 
in points and fees only if it can be attributed to a particular 
transaction is consistent with the statutory language. The Dodd-Frank 
Act provides that, for the points and fees tests for both qualified 
mortgages and high-cost mortgages, only charges that are ``in 
connection with'' the transaction are included in points and fees. See 
TILA sections 103(bb)(1)(A)(ii) (high-cost mortgages) and 
129C(b)(2)(A)(vii) (qualified mortgages). Limiting loan originator 
compensation to compensation that is attributable to the transaction 
implements the statutory requirement that points and fees are ``in 
connection'' with the transaction. This

[[Page 6437]]

limitation also makes the rule more workable. Compensation is included 
in points and fees only if it can be attributed to a specific 
transaction to facilitate compliance with the rule and avoid over-
burdening creditors with complex calculations to determine, for 
example, the portion of a loan officer's salary that should be counted 
in points and fees.\84\ For clarity, the Bureau has moved the 
discussion of the timing of loan originator compensation into new 
comment 32(b)(1)(ii)-3, and has added additional examples to 
32(b)(1)(ii)-4, to illustrate the types and amount of compensation that 
should be included in points and fees.
---------------------------------------------------------------------------

    \84\ In contrast, the existing restrictions on particular loan 
originator compensation structures in Sec.  1026.36 apply to all 
compensation such as salaries, hourly wages, and contingent bonuses 
because those restrictions apply only at the time such compensation 
is paid, and therefore they can be applied with certainty. Moreover, 
those rules also provide for different treatment of compensation 
that is not ``specific to, and paid solely in connection with, the 
transaction,'' where such a distinction is necessary for reasons of 
practical application of the rule. See comment 36(d)(2)-1 
(prohibition of loan originator receiving compensation directly from 
consumer and also from any other person does not prohibit consumer 
payments where loan originator also receives salary or hourly wage).
---------------------------------------------------------------------------

    Revised comment 32(b)(1)(ii)-2.ii explains that loan originator 
compensation excludes compensation that cannot be attributed to a 
particular transaction at the time the interest rate is set, including, 
for example, compensation based on the long-term performance of the 
loan originator's loans or on the overall quality of the loan 
originator's loan files. The base salary of a loan originator is also 
excluded, although additional compensation that is attributable to a 
particular transaction must be included in points and fees. The Bureau 
has decided to seek further comment in the concurrent proposal 
regarding treatment of hourly wages for the actual number of hours 
worked on a particular transaction. The Board's proposal would have 
included hourly pay for the actual number of hours worked on a 
particular transaction in loan originator compensation for purposes of 
the points and fees thresholds, and the Bureau agrees that such wages 
are attributable to the particular transaction. However, the Bureau is 
unclear as to whether industry actually tracks compensation this way in 
light of the administrative burdens. Moreover, while the general rule 
provides for calculation of loan originator compensation at the time 
the interest rate is set for the reasons discussed above, the actual 
hours of hours worked on a transaction would not be known at that time. 
The Bureau is therefore seeking comment on issues relating to hourly 
wages, including whether to require estimates of the hours to be worked 
between rate set and consummation.
    New comment 32(b)(1)(ii)-3 explains that loan originator 
compensation must be included in the points and fees calculation for a 
transaction whenever the compensation is paid, whether before, at or 
after closing, as long as that compensation amount can be attributed to 
the particular transaction at the time the interest rate is set. Some 
industry commenters expressed concern that it would be difficult to 
determine the amount of compensation that would be paid after 
consummation and that creditors might have to recalculate loan 
originator compensation (and thus points and fees) after underwriting 
if, for example, a loan officer became eligible for higher compensation 
because other transactions had been consummated. The Bureau appreciates 
that industry participants need certainty at the time of underwriting 
as to whether transactions will exceed the points and fees limits for 
qualified mortgages (and for high-cost mortgages). To address this 
concern, the comment 32(b)(1)(ii)-3 explains that loan originator 
compensation should be calculated at the time the interest rate is set. 
The Bureau believes that the date the interest rate is set is an 
appropriate standard for calculating loan originator compensation. It 
would allow creditors to be able to calculate points and fees with 
sufficient certainty so that they know early in the process whether a 
transaction will be a qualified mortgage or a high-cost mortgage.
    As noted above, several industry commenters argued that including 
loan originator compensation in points and fees would result in double 
counting. They stated that creditors often will recover loan originator 
compensation costs through origination charges, and these charges are 
already included in points and fees under Sec.  1026.32(b)(1)(i). 
However, the underlying statutory provisions as amended by the Dodd-
Frank Act do not express any limitation on its requirement to count 
loan originator compensation toward the points and fees test. Rather, 
the literal language of TILA section 103(bb)(4) as amended by the Dodd-
Frank Act defines points and fees to include all items included in the 
finance charge (except interest rate), all compensation paid directly 
or indirectly by a consumer or creditor to a loan originator, ``and'' 
various other enumerated items. The use of ``and'' and the references 
to ``all'' compensation paid ``directly or indirectly'' and ``from any 
source'' suggest that compensation should be counted as it flows 
downstream from one party to another so that it is counted each time 
that it reaches a loan originator, whatever the previous source.
    The Bureau believes the statute would be read to require that loan 
originator compensation be treated as additive to the other elements of 
points and fees. The Bureau believes that an automatic literal reading 
of the statute in all cases, however, would not be in the best interest 
of either consumers or industry. For instance, the Bureau does not 
believe that it is necessary or appropriate to count the same payment 
made by a consumer to a mortgage broker firm twice, simply because it 
is both part of the finance charge and loan originator compensation. 
Similarly, the Bureau does not believe that, where a payment from 
either a consumer or a creditor to a mortgage broker is counted toward 
points and fees, it is necessary or appropriate to count separately 
funds that the broker then passes on to its individual employees. In 
each case, any costs and risks to the consumer from high loan 
originator compensation are adequately captured by counting the funds a 
single time against the points and fees cap; thus, the Bureau does not 
believe the purposes of the statute would be served by counting some or 
all of the funds a second time, and is concerned that doing so could 
have negative impacts on the price and availability of credit.
    Determining the appropriate accounting rule is significantly more 
complicated, however, in situations in which a consumer pays some up-
front charges to the creditor and the creditor pays loan originator 
compensation to either its own employee or to a mortgage broker firm. 
Because money is fungible, tracking how a creditor spends money it 
collects in up-front charges versus amounts collected through the rate 
to cover both loan originator compensation and its other overhead 
expenses would be extraordinarily complex and cumbersome. To facilitate 
compliance, the Bureau believes it is appropriate and necessary to 
adopt one or more generalized rules regarding the accounting of various 
payments. However, the Bureau does not believe it yet has sufficient 
information with which to choose definitively between the additive 
approach provided for in the statutory language and other potential 
methods of accounting for payments in light of the multiple practical 
and complex policy considerations involved.
    The potential downstream effects of different accounting methods 
are

[[Page 6438]]

significant. Under the additive approach where no offsetting consumer 
payments against creditor-paid loan originator compensation is allowed, 
creditors whose combined loan originator compensation and up-front 
charges would otherwise exceed the points and fees limits would have 
strong incentives to cap their up-front charges for other overhead 
expenses under the threshold and instead recover those expenses by 
increasing interest rates to generate higher gains on sale. This would 
adversely affect consumers who prefer a lower interest rate and higher 
up-front costs and, at the margins, could result in some consumers 
being unable to qualify for credit. Additionally, to the extent 
creditors responded to a ``no offsetting'' rule by increasing interest 
rates, this could increase the number of qualified mortgages that 
receive a rebuttable rather than conclusive presumption of compliance.
    One alternative would be to allow all consumer payments to offset 
creditor-paid loan originator compensation. However, a ``full 
offsetting'' approach would allow creditors to offset much higher 
levels of up-front points and fees against expenses paid through rate 
before the heightened consumer protections required by the Dodd-Frank 
Act would apply. Particularly under HOEPA, this may raise tensions with 
Congress's apparent intent. Other alternatives might use a hybrid 
approach depending on the type of expense, type of loan, or other 
factors, but would involve more compliance complexity.
    In light of the complex considerations, the Bureau believes it is 
necessary to seek additional notice and comment. The Bureau therefore 
is finalizing this rule without qualifying the statutory result and is 
proposing two alternative comments in the concurrent proposal, one of 
which would explicitly preclude offsetting, and the other of which 
would allow full offsetting of any consumer-paid charges against 
creditor-paid loan originator compensation. The Bureau is also 
proposing comments to clarify treatment of compensation paid by 
consumers to mortgage brokers and by mortgage brokers to their 
individual employees. The Bureau is seeking comment on all aspects of 
this issue, including the market impacts and whether adjustments to the 
final rule would be appropriate. In addition, the Bureau is seeking 
comment on whether it would be helpful to provide for additional 
adjustment of the rules or additional commentary to clarify any 
overlaps in definitions between the points and fees provisions in this 
rulemaking and the HOEPA rulemaking and the provisions that the Bureau 
is separately finalizing in connection with the Bureau's 2012 Loan 
Originator Compensation Proposal.
    Finally, comment 32(b)(1)(ii)-4 includes revised versions of 
examples in proposed comment 32(b)(1)(ii)-2, as well as additional 
examples to provide additional guidance regarding what compensation 
qualifies as loan originator compensation that must be included in 
points and fees. These examples illustrate when compensation can be 
attributed to a particular transaction at the time the interest rate is 
set. New comment 32(b)(1)(ii)-5 adds an example explaining how salary 
is treated for purposes of loan originator compensation for calculating 
points and fees.
32(b)(1)(iii)
    TILA section 103(aa)(4)(C) provides that points and fees include 
certain real estate-related charges listed in TILA section 106(e) and 
is implemented in Sec.  1026.32(b)(1)(iii). The Dodd-Frank Act did not 
amend TILA section 103(aa)(4)(C) (but did renumber it as section 
103(bb)(4)(C)). Although the Board indicated in the Supplementary 
Information that it was not proposing any changes, proposed Sec.  
226.32(b)(1)(iii) would have added the phrase ``payable at or before 
closing of the mortgage'' loan and would have separated the elements 
into three new paragraphs (A) through (C). Thus, proposed Sec.  
226.32(b)(1)(iii) would have included in points and fees ``all items 
listed in Sec.  226.4(c)(7) (other than amounts held for future payment 
of taxes) payable at or before closing of the mortgage loan, unless: 
(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.'' The Board noted that the 
statute did not exclude these charges if they were payable after 
closing and questioned whether such a limitation was necessary because 
these charges could reasonably be viewed as charges that by definition 
are payable only at or before closing. As noted in the section-by-
section analysis of Sec.  1026.32(b)(1), the Board requested comment on 
whether there are any other types of fees that should be included in 
points and fees only if they are payable at or before closing.
    The Board noted that during outreach creditors had raised concerns 
about including in points and fees real-estate related fees paid to an 
affiliate of the creditor, such as an affiliated title company. 
Although these fees always have been included in points and fees for 
high-cost loans, creditors using affiliated title companies were 
concerned they would have difficulty meeting the lower threshold for 
points and fees for qualified mortgages. The Board, however, did not 
propose to exempt fees paid to creditor-affiliated settlement service 
providers, noting that Congress appeared to have rejected excluding 
such fees from points and fees.
    Industry commenters criticized the Board's proposed treatment of 
fees paid to affiliates as overbroad. Industry commenters argued that a 
creditor's affiliation with a service provider, such as a title 
insurance agency, does not have any impact on the consumer's ability to 
repay a loan. They maintained that studies over the past two decades 
have shown that title services provided by affiliated businesses are 
competitive in cost compared to services provided by unaffiliated 
businesses. They contended that the rule should instead focus solely on 
whether the fee is bona fide.
    These commenters also argued that the largest real estate-related 
charge, title insurance fees, are often either mandated by State law or 
required to be filed with the relevant state authority and do not vary. 
Regardless of whether the State sets the rate or requires that the rate 
be filed, these commenters argued that there are so few insurers that 
rates tend to be nearly identical among providers.
    These commenters also argued that including fees to affiliates 
would negatively affect consumers. They claimed that the inclusion of 
fees paid to affiliates would cause loans that would otherwise be 
qualified mortgages to exceed the points and fees cap, resulting in 
more expense to the creditor, which would be passed through to 
consumers in the form of higher interest rates or fees, or in more 
denials of credit. They also claimed that the proposal would harm 
consumers by reducing competition among settlement service providers 
and by eliminating operational efficiencies. One industry trade 
association reported that some of its members with affiliates would 
discontinue offering mortgages, which would reduce competition among 
creditors, especially for creditors offering smaller loans, since these 
loans would be most affected by the points and fees cap. They claimed 
that treating affiliated and unaffiliated providers differently would 
incentivize creditors to use unaffiliated third-party service providers 
to stay within the qualified mortgage points and fees cap.
    Several industry commenters noted that RESPA permits affiliated 
business arrangements and provides protections

[[Page 6439]]

for consumers, including a prohibition against requiring that consumers 
use affiliates, a requirement to disclose affiliation to consumers, and 
a limitation that compensation include only return on ownership 
interest. These commenters argued that charges paid to affiliates 
should be excluded from points and fees as long the RESPA requirements 
are satisfied. Several industry commenters objected to the requirement 
that charges be ``reasonable'' to be excluded from points and fees. 
They argued that the requirement was vague and that it would be 
difficult for a creditor to judge whether a third-party charge met the 
standard. Several commenters also argued that the Dodd-Frank Act 
provision permitting exclusion of certain bona fide third-party charges 
should apply rather than the three-part test for items listed in Sec.  
1026.4(c)(7). See TILA section 129C(b)(2)(C)(i).
    Two consumer advocates commented on this aspect of the proposal. 
They supported including in points and fees all fees paid to any 
settlement service provider affiliated with the creditor.
    The Bureau is adopting Sec.  226.32(b)(1)(iii) as proposed but 
renumbered as Sec.  1026.32(b)(1)(iii). TILA section 103(bb)(4) 
specifically mandates that fees paid to and retained by affiliates of 
the creditor be included in points and fees. The Bureau acknowledges 
that including fees paid to affiliates in points and fees could make it 
more difficult for creditors using affiliated service providers to stay 
under the points and fees cap for qualified mortgages and that, as a 
result, creditors could be disincented from using affiliated service 
providers. This is especially true with respect to affiliated title 
insurers because of the cost of title insurance. On the other hand, 
despite RESPA's regulation of fees charged by affiliates, concerns have 
nonetheless been raised that fees paid to an affiliate pose greater 
risks to the consumer, since affiliates of a creditor may not have to 
compete in the market with other providers of a service and thus may 
charge higher prices that get passed on to the consumer. The Bureau 
believes that Congress weighed these competing considerations and made 
a deliberate decision not to exclude fees paid to affiliates. This 
approach is further reflected throughout title XIV, which repeatedly 
amended TILA to treat fees paid to affiliates as the equivalent to fees 
paid to a creditor or loan originator. See, e.g., Dodd-Frank Act 
sections 1403, 1411, 1412, 1414, and 1431. For example, as noted above, 
TILA section 129C(b)(2)(C)(i), as added by section 1412 of the Dodd-
Frank Act, provides that for purposes of the qualified mortgage points 
and fees test, bona fide third-party charges are excluded other than 
charges ``retained by * * * an affiliate of the creditor or mortgage 
originator.'' Similarly, TILA section 129B(c)(2)(B)(ii), added by 
section 1403 of the Dodd-Frank Act, restricts the payment of points and 
fees but permits the payment of bona fide third-party charges unless 
those charges are ``retained by * * * an affiliate of the creditor or 
originator.'' In light of these considerations, the Bureau does not 
believe there is sufficient justification to use its exception 
authority in this instance as the Bureau cannot find, given Congress's 
clear determination, that excluding affiliate fees from the calculation 
of points and fees is necessary or proper to effectuate the purposes of 
TILA, to prevent circumvention or evasion thereof, or to facilitate 
compliance therewith.
    As noted above, some commenters objected to the requirement that 
charges be ``reasonable.'' The Bureau notes that a ``reasonable'' 
requirement has been in place for many years before the Dodd-Frank Act. 
TILA section 103(aa)(4)(C) specifically provides that charges listed in 
TILA section 106(e) are included in points and fees for high-cost 
mortgages unless, among other things, the charge is reasonable. This 
requirement is implemented in existing Sec.  1026.32(b)(1)(iii). 
Similarly, a charge may be excluded from the finance charge under Sec.  
1026.4(c)(7) only if it is reasonable. In the absence of any evidence 
that this requirement has been unworkable, the Bureau declines to alter 
it. The fact that a transaction for such services is conducted at arms-
length ordinarily should be sufficient to make the charge reasonable. 
The reasonableness requirement is not intended to invite an inquiry 
into whether a particular appraiser or title insurance company is 
imposing excessive charges.
    Some commenters also maintained that the provision permitting 
exclusion of certain bona fide third-party charges should apply rather 
than the three-part test for items listed in Sec.  1026.4(c)(7). See 
TILA section 129C(b)(2)(C)(i). As discussed in more detail in the 
section-by-section analysis of Sec.  1026.32(b)(1)(i)(D), the Bureau 
concludes that Sec.  1026.32(b)(1)(iii), which specifically addresses 
exclusion of items listed in Sec.  1026.4(c)(7), takes precedence over 
the more general exclusion in Sec.  1026.32(b)(1)(i)(D).
    The Board's proposed comment 32(b)(1)(iii)-1 was substantially the 
same as existing comment 32(b)(1)(ii)-2. It would have provided an 
example of the inclusion or exclusion of real-estate related charges. 
The Bureau did not receive substantial comment on the proposed comment. 
The Bureau is therefore adopting comment 32(b)(1)(ii)-1 substantially 
as proposed, with revisions for clarity.
32(b)(1)(iv)
    As amended by section 1431 of the Dodd-Frank Act, TILA section 
103(bb)(4)(D) includes in points and fees premiums for various forms of 
credit insurance and charges for debt cancellation or suspension 
coverage. The Board proposed Sec.  226.32(b)(1)(iv) to implement this 
provision. The Board also proposed to revise comment 32(b)(1)(iv)-1 to 
reflect the revised statutory language and to add new comment 
32(b)(1)(iv)-2 to clarify that ``credit property insurance'' includes 
insurance against loss or damage to personal property such as a 
houseboat or manufactured home.
    Several commenters argued that proposed Sec.  226.32(b)(1)(iv) did 
not accurately implement the provision in Dodd-Frank Act section 1431 
that specifies that ``insurance premiums or debt cancellation or 
suspension fees calculated and paid in full on a monthly basis shall 
not be considered financed by the creditor.'' They argued that comment 
32(b)(1)(iv)-1 should be revised so that it expressly excludes monthly 
premiums for credit insurance from points and fees, including such 
premiums payable in the first month. At least one industry commenter 
also argued that voluntary credit insurance premiums should not be 
included in points and fees. Consumer advocates supported inclusion of 
credit insurance premiums in points and fees, noting that these 
services can add significant costs to mortgages.
    The Bureau is adopting Sec.  226.32(b)(1)(iv) substantially as 
proposed, with revisions for clarity, as renumbered Sec.  
1026.32(b)(1)(iv). As revised, Sec.  1026.32(b)(1)(iv) states that 
premiums or other charges for ``any other life, accident, health, or 
loss-of-income insurance'' are included in points and fees only if the 
insurance is for the benefit of the creditor. The Bureau is also 
adopting proposed comments 32(b)(1)(iv)-1 and -2 substantially as 
proposed, with revisions for clarity and consistency with terminology 
in Regulation Z. The Bureau is also adopting new comment 32(b)(1)(iv)-3 
to clarify that premiums or other charges for ``any other life, 
accident, health, or loss-of-income insurance'' are included in points 
and fees only if the creditor is a beneficiary of the insurance.

[[Page 6440]]

    As noted above, several commenters argued that premiums paid 
monthly, including the first such premium, should not be included in 
points and fees. The statute requires that premiums ``payable at or 
before closing'' be included in points and fees; it provides only that 
premiums ``calculated and paid in full on a monthly basis shall not be 
considered financed by the creditor.'' TILA section 103(bb)(4)(D). 
Thus, if the first premium is payable at or before closing, that 
payment is included in points and fees even though the subsequent 
monthly payments are not.
    Another commenter argued that voluntary credit insurance premiums 
should be excluded from points and fees. However, under the current 
rule, voluntary credit insurance premiums are included in points and 
fees. In light of the fact that the Dodd-Frank Act expanded the types 
of credit insurance that must be included in points and fees, the 
Bureau does not believe it would be appropriate to reconsider whether 
voluntary credit insurance premiums should be included in points and 
fees.
32(b)(1)(v)
    As added by the Dodd-Frank Act, new TILA section 103(bb)(4)(E) 
includes in points and fees ``the maximum prepayment penalties which 
may be charged or collected under the terms of the credit 
transaction.'' The Board's proposed Sec.  226.32(b)(1)(v) closely 
tracked the statutory language, but it cross-referenced proposed Sec.  
226.43(b)(10) for the definition of ``prepayment penalty.''
    Few commenters addressed this provision. One industry commenter 
argued that the maximum prepayment penalty should not be included in 
points and fees because a prepayment that triggers the penalty may 
never occur and thus the fee may never be assessed.
    The Bureau is adopting Sec.  226.32(b)(1)(v) substantially as 
proposed but renumbered as Sec.  1026.32(b)(1)(v), with a revision to 
its definitional cross-reference. As revised, Sec.  1026.32(b)(1)(v) 
refers to the definition of prepayment penalty in Sec.  
1026.32(b)(6)(i). With respect to the comment arguing that prepayment 
penalties should not be included in points and fees, the statute 
requires inclusion in points and fees of the maximum prepayment 
penalties that ``may be charged or collected.'' Thus, under the 
statutory language, the imposition of the charge need not be certain 
for the prepayment penalty to be included in points and fees. In this 
provision (and other provisions added by the Dodd-Frank Act, such as 
TILA section 129C(c)), Congress sought to limit and deter the use of 
prepayment penalties, and the Bureau does not believe that it would be 
appropriate to exercise its exception authority in a manner that could 
undermine that goal.
32(b)(1)(vi)
    New TILA section 103(bb)(4)(F) requires that points and fees 
include ``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.'' The Board's 
proposed Sec.  226.32(b)(1)(vi) would have implemented this provision 
by including 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. The Board stated its belief that this provision is 
intended in part to curtail the practice of ``loan flipping,'' which 
involves a creditor refinancing an existing loan for financial gain 
resulting from prepayment penalties and other fees that a consumer must 
pay to refinance the loan--regardless of whether the refinancing is 
beneficial to the consumer. The Board noted that it departed from the 
statutory language to use the phrases ``current holder of the existing 
mortgage loan'' and ``servicer acting on behalf of the current holder'' 
in proposed Sec.  226.32(b)(1)(vi) because, as a practical matter, 
these are the entities that would refinance the loan and directly or 
indirectly gain from associated prepayment penalties.
    Few commenters addressed this provision. Two consumer groups 
expressed support for including these prepayment penalties in points 
and fees, arguing that many consumers were victimized by loan flipping 
and the resulting fees and charges.
    The Bureau is adopting Sec.  226.32(b)(1)(vi) substantially as 
proposed but renumbered as Sec.  1026.32(b)(1)(vi). In addition to 
revising for clarity, the Bureau has also revised Sec.  
1026.32(b)(1)(vi) to refer to the definition of prepayment penalty in 
Sec.  1026.32(b)(6)(i). Like the Board, the Bureau believes that it is 
appropriate for Sec.  1026.32(b)(1)(vi) to apply to the current holder 
of the existing mortgage loan, the servicer acting on behalf of the 
current holder, or an affiliate of either. These are the entities that 
would refinance the loan and gain from the prepayment penalties on the 
previous loan. Accordingly, the Bureau is invoking its exception and 
adjustment authority under TILA sections 105(a) and 129C(b)(3)(B)(i). 
The Bureau believes that adjusting the statutory language to more 
precisely target the entities that would benefit from refinancing loans 
with prepayment penalties will more effectively deter loan flipping to 
collect prepayment penalties and help preserve consumers' access to 
safe, affordable credit. It also will lessen the compliance burden on 
other entities that lack the incentive for loan flipping, such as a 
creditor that originated the existing loan but no longer holds the 
loan. For these reasons, the Bureau believes that use of its exception 
and adjustment authority is necessary and proper under TILA section 
105(a) to effectuate the purposes of TILA and to facilitate compliance 
with TILA and its purposes, including the purpose of assuring that 
consumers are offered and receive residential mortgage loans on terms 
that reasonably reflect their ability to repay the loans. Similarly, 
the Bureau finds that it is necessary, proper, and appropriate to use 
its authority under TILA section 129C(b)(3)(B)(i) to revise and 
subtract from statutory language. This use of authority ensures that 
responsible, affordable mortgage credit remains available to consumers 
in a manner consistent with and effectuates the purpose of TILA section 
129C, referenced above, and facilitates compliance with section 129C of 
TILA.
32(b)(2)
Proposed Provisions Not Adopted
    As noted in the section-by-section analysis of Sec.  
1026.32(b)(1)(ii) above, section 1431(c) of the Dodd-Frank Act amended 
TILA to require that all compensation paid directly or indirectly by a 
consumer or a creditor to a ``mortgage originator'' be included in 
points and fees for high-cost mortgages and qualified mortgages. As 
also noted above, the Board's 2011 ATR Proposal proposed to implement 
this statutory change in proposed Sec.  226.32(b)(1)(ii) using the term 
``loan originator,'' as defined in existing Sec.  1026.36(a)(1), rather 
than the statutory term ``mortgage originator.'' In turn, the Board 
proposed new Sec.  226.32(b)(2) to exclude from points and fees 
compensation paid to certain categories of persons specifically 
excluded from the definition of ``mortgage originator'' in amended TILA 
section 103, namely employees of a retailer of manufactured homes under 
certain circumstances, certain real estate brokers, and servicers.
    The Bureau is not adopting proposed Sec.  226.32(b)(2). The Bureau 
is amending

[[Page 6441]]

the definition of ``loan originator'' Sec.  1026.36(a)(1) and the 
associated commentary to incorporate the statutory exclusion of these 
persons from the definition. Accordingly, to the extent these persons 
are excluded from the definition of loan originator compensation, their 
compensation is not loan originator compensation that must be counted 
in points and fees, and the exclusions in proposed Sec.  226.32(b)(2) 
are no longer necessary.
    Instead, in the 2013 HOEPA Final Rule, the Bureau is finalizing the 
definition of points and fees for HELOCs in Sec.  1026.32(b)(2). 
Current Sec.  1026.32(b)(2), which contains the definition of 
``affiliate,'' is being renumbered as Sec.  1026.32(b)(5).
32(b)(3) Bona Fide Discount Point
32(b)(3)(i) Closed-End Credit
    The Dodd-Frank Act defines the term ``bona fide discount points'' 
as used in Sec.  1026.32(b)(1)(i)(E) and (F), which, as discussed 
above, permit exclusion of ``bona fide discount points'' from points 
and fees for qualified mortgages. TILA section 129C(b)(2)(C)(iii) 
defines the term ``bona fide discount points'' as ``loan discount 
points which are knowingly paid by the consumer for the purpose of 
reducing, and which in fact result in a bona fide reduction of, the 
interest rate or time-price differential applicable to the mortgage.'' 
TILA section 129C(b)(2)(C)(iv) 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.''
    Proposed Sec.  226.43(e)(3)(iv) would have implemented these 
provisions by defining the term ``bona fide discount point'' 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: (1) 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 (2) accounts for 
the amount of compensation that the creditor can reasonably expect to 
receive from secondary market investors in return for the mortgage 
loan.
    The Board's proposal would have required that the creditor be able 
to show a relationship between the amount of interest rate reduction 
purchased by a discount point and the value of the transaction in the 
secondary market. The Board observed that, based on outreach with 
representatives of creditors and GSEs, 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. The 
Board noted that 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 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 Board indicated that it was offering a flexible proposal 
because of its concern 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 also noted 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.
    The Board also noted a concern 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 therefore requested comment on whether it would 
be appropriate to provide any exemptions from the requirement that the 
interest rate reduction purchased by a ``bona fide discount point'' be 
tied to secondary market factors.
    Many industry commenters criticized the second prong of the Board's 
proposal, which would have required that the interest rate reduction 
account for the amount of compensation that the creditor can reasonably 
expect to receive from secondary market investors in return for the 
mortgage loan. Several industry commenters argued that this test would 
be complex and difficult to apply and that, if challenged, it would be 
difficult for creditors to prove that the calculation was done 
properly. Two industry commenters noted that creditors do not always 
sell or plan to sell loans in the secondary market at the time of 
origination and so would not know what compensation they would receive 
on the secondary market. Several industry commenters emphasized that 
the secondary market test would be impracticable for creditors holding 
loans in portfolio. Consumer groups did not comment on this issue.
    As noted above, the Bureau is consolidating the exclusions for 
certain bona fide third-party charges and bona fide discount points in 
Sec.  1026.32(b)(1)(i)(D) through (F). As a result, the Bureau is 
adopting proposed Sec.  226.43(e)(3)(iv), with the revision discussed 
below, as renumbered Sec.  1026.32(b)(3)(i). In the 2013 HOEPA Final 
Rule, the Bureau is adopting a definition of bona fide discount point 
for open-end credit in Sec.  1026.32(b)(3)(ii).
    After carefully considering the comments, the Bureau is modifying 
the definition of ``bona fide discount point.'' Specifically, the 
Bureau believes it would be difficult, if not impossible, for many 
creditors to account for the secondary market compensation in 
calculating interest rate reductions. This is particularly true for 
loans held in portfolio. Therefore, the Board is removing from Sec.  
1026.32(b)(3)(i) the requirement that interest rate reductions take 
into account secondary market compensation. Instead, as revised, Sec.  
1026.32(b)(3)(i) requires only that the calculation of the interest 
rate reduction be 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.
    The Bureau finds that removing the secondary market component of 
the ``bona fide'' discount point definition is necessary and proper 
under TILA section 105(a) to effectuate the purposes of and facilitate 
compliance with TILA. Similarly, the Bureau finds that it is necessary 
and proper to use its authority under TILA section 129C(b)(3)(B)(i) to 
revise and subtract from the criteria that define a qualified mortgage 
by removing the secondary market component from the bona fide discount 
point definition. It will provide creditors sufficient flexibility to 
demonstrate that they are in compliance with the requirement that, to 
be excluded from points and fees, discount points must be bona fide. In 
clarifying the definition, it also will facilitate the use of bona fide 
discount points by consumers to help create the appropriate combination 
of points and rate for their financial situation, thereby helping 
ensure that consumers are offered and receive residential mortgage loan 
on terms that reasonably reflect their ability to repay the loans and 
that responsible, affordable mortgage credit

[[Page 6442]]

remains available to consumers in a manner consistent with the purposes 
of TILA as provided in TILA section 129C.
    To provide some guidance on how creditors may comply with this 
requirement, the Bureau is adding new comment 32(b)(3)(i)-1. This 
comment explains how creditors can comply with ``established industry 
practices'' for calculating interest rate reductions. Specifically, 
comment 32(b)(3)(i)-1 notes that one way creditors can satisfy this 
requirement is by complying with established industry norms and 
practices for secondary mortgage market transactions. Comment 
32(b)(3)(i)-1 then provides two examples. First a creditor may rely on 
pricing in the to-be-announced (TBA) market for MBS to establish that 
the interest rate reduction is consistent with the compensation that 
the creditor could reasonably expect to receive in the secondary 
market. Second, a creditor could comply with established industry 
practices, such as guidelines from Fannie Mae or Freddie Mac that 
prescribe when an interest rate reduction from a discount point is 
considered bona fide. However, because these examples from the 
secondary market are merely illustrations of how a creditor could 
comply with the ``established industry practices'' requirement for bona 
fide interest rate reduction, creditors, and in particular creditors 
that retain loans in portfolio, will have flexibility to use other 
approaches for complying with this requirement.
32(b)(4) Total Loan Amount
32(b)(4)(i) Closed-End Credit
    As added by section 1412 of the Dodd-Frank Act, 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.'' For purposes of implementing the qualified mortgage 
provisions, the Board proposed to retain existing comment 32(a)(1)(ii)-
1 explaining the meaning of the term ``total loan amount,'' with 
certain minor revisions discussed below, while also seeking comment on 
an alternative approach.
    The proposal would have revised 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. 
Under Regulation Z for purposes of applying the existing points and 
fees trigger for high-cost loans, the ``total loan amount'' is 
calculated as the amount of credit extended to or on behalf of the 
consumer, minus any financed points and fees. 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.  
1026.18(b), and deducting any cost listed in Sec.  1026.32(b)(1)(iii) 
and Sec.  1026.32(b)(1)(iv) that is both included as points and fees 
under Sec.  1026.32(b)(1) and financed by the creditor.'' Section 
1026.32(b)(1)(iii) and (b)(1)(iv) pertain to ``real estate-related 
fees'' listed in Sec.  1026.4(c)(7) and premiums or other charges for 
credit insurance or debt cancellation coverage, respectively.
    The Board proposed 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 have required 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. As a result, the 3 percent limit on 
points and fees for qualified mortgages would have been based on the 
amount of credit extended to the consumer without taking into account 
any financed points and fees.
    The Board's proposal also would have revised one of the 
commentary's examples of the ``total loan amount'' calculation. 
Specifically, the Board proposed 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.'' The Board stated that this change was 
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. See TILA section 129C(d). The Board requested comment on the 
proposed revisions to the comment explaining how to calculate the 
``total loan amount,'' including whether additional guidance is needed.
    The Board also requested comment on whether to streamline the 
calculation to ensure that the ``total loan amount'' would include all 
credit extended other than financed points and fees. Specifically, the 
Board solicited comment on whether to revise the calculation of ``total 
loan amount'' to be the ``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 
Board explained that 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.'' \85\ In general, the revised calculation would have yielded 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 under the alternative outlined by the Board than under 
either the proposed or existing rule.
---------------------------------------------------------------------------

    \85\ Specifically, under the alternative approach, prepaid 
finance charges would not be deducted from the principal loan 
amount. Only financed points and fees would be deducted.
---------------------------------------------------------------------------

    In the 2012 HOEPA Proposal, the Bureau proposed the following for 
organizational purposes: (1) To move the existing definition of ``total 
loan amount'' for closed-end mortgage loans from comment 32(a)(1)(ii)-1 
to proposed Sec.  1026.32(b)(6)(i); and (2) to move the examples 
showing how to calculate the total loan amount for closed-end mortgage 
loans from existing comment 32(a)(1)(ii)-1 to proposed comment 
32(b)(6)(i)-1. The Bureau proposed to specify that the calculation 
applies to closed-end mortgage loans because the Bureau also proposed 
to define ``total loan amount'' separately for open-end credit plans. 
The Bureau also proposed to amend the definition of ``total loan 
amount'' in a manner similar to the Board's alternative proposal 
described above. The Bureau indicated this proposed revision would 
streamline the total loan amount calculation to facilitate compliance 
and would be sensible in light of the more inclusive definition of the 
finance charge proposed in the Bureau's 2012 TILA-RESPA Integration 
Proposal.
    Few commenters addressed the Board's proposal regarding total loan 
amount. Several industry commenters recommended that the alternative 
method of calculating total loan amount be used because it would be 
easier to calculate. At least two industry commenters recommended that, 
for simplicity, the amount recited in the note be used for calculating 
the permitted points and fees.
    After reviewing the comments, the Bureau is following the 2012 
HOEPA

[[Page 6443]]

Proposal and moving the definition of total loan amount into the text 
of the rule in Sec.  1026.32(b)(4)(i). In 2013 HOEPA Final Rule, the 
Bureau is adopting a definition of total loan amount for open-end 
credit in Sec.  1026.32(b)(4)(ii). The examples showing how to 
calculate the total loan amount are moved to comment 32(b)(4)(i)-1. 
However, the Bureau has concluded that, at this point, the current 
approach to calculating the total loan amount should remain in place. 
Creditors are familiar with the method from using it for HOEPA points 
and fees calculations. Moreover, as noted above, the Bureau is 
deferring action on the more inclusive definition of the finance charge 
proposed in the Bureau's 2012 TILA-RESPA Integration Proposal. If the 
Bureau expands the definition of the finance charge, the Bureau will at 
the same time consider the effect on coverage thresholds that rely on 
the finance charge or the APR.
32(b)(5)
    The final rule renumbers existing Sec.  1026.32(b)(2) defining the 
term ``affiliate'' as Sec.  1026.32(b)(5) for organizational purposes.
32(b)(6) Prepayment Penalty
The Dodd-Frank Act's Amendments to TILA Relating to Prepayment 
Penalties
    Sections 1431 and 1432 of the Dodd-Frank Act (relating to high-cost 
mortgages) and section 1414 of the Dodd-Frank Act (relating to 
qualified mortgages) amended TILA to restrict and, in many cases, 
prohibit a creditor from imposing prepayment penalties in dwelling-
secured credit transactions. The Dodd-Frank Act restricted prepayment 
penalties in three main ways.
    First, as the Board discussed in its 2011 ATR Proposal, the Dodd-
Frank Act added new TILA section 129C(c)(1) relating to qualified 
mortgages, which generally provides that a covered transaction (i.e., 
in general, a closed-end, dwelling-secured credit transaction) may 
include a prepayment penalty only if it; (1) Is a qualified mortgage, 
to be defined by the Board, (2) has an APR that cannot increase after 
consummation, and (3) is not a higher-priced mortgage loan. The Board 
proposed to implement TILA section 129C(c)(1) in Sec.  226.43(g)(1) and 
to define the term prepayment penalty in Sec.  226.43(b)(10). Under new 
TILA section 129C(c)(3), moreover, even loans that meet the statutorily 
prescribed criteria (i.e., fixed-rate, non-higher-priced qualified 
mortgages) are capped in the amount of prepayment penalties that may be 
charged, starting at three percent in the first year after consummation 
and decreasing annually by increments of one percentage point 
thereafter so that no penalties may be charged after the third year. 
The Board proposed to implement TILA section 129C(c)(3) in Sec.  
226.43(g)(2).
    Second, section 1431(a) of the Dodd-Frank Act amended TILA section 
103(bb)(1)(A)(iii) to provide that a credit transaction is a high-cost 
mortgage if the credit transaction documents permit the creditor to 
charge or collect prepayment fees or penalties more than 36 months 
after the transaction closing or if such fees or penalties exceed, in 
the aggregate, more than two percent of the amount prepaid. Moreover, 
under amended TILA section 129(c)(1), high-cost mortgages are 
prohibited from having a prepayment penalty. Accordingly, any 
prepayment penalty in excess of two percent of the amount prepaid on 
any closed end mortgage would both trigger and violate the rule's high-
cost mortgage provisions. The Bureau's 2012 HOEPA Proposal proposed to 
implement these requirements with several minor clarifications in Sec.  
1026.32(a)(1)(iii). See 77 FR 49090, 49150 (Aug. 15, 2012).
    Third, both qualified mortgages and most closed-end mortgage loans 
and open-end credit plans secured by a consumer's principal dwelling 
are subject to additional limitations on prepayment penalties through 
the inclusion of prepayment penalties in the definition of points and 
fees for qualified mortgages and high-cost mortgages. See the section-
by-section analysis of proposed Sec.  226.32(b)(1)(v) and (vi); 77 FR 
49090, 49109-10 (Aug. 15, 2012).
    Taken together, the Dodd-Frank Act's amendments to TILA relating to 
prepayment penalties mean that most closed-end, dwelling-secured 
transactions: (1) May provide for a prepayment penalty only if the 
transaction is a fixed-rate, qualified mortgage that is neither high-
cost nor higher-priced under Sec. Sec.  1026.32 and 1026.35; (2) may 
not, even if permitted to provide for a prepayment penalty, charge the 
penalty more than three years following consummation or in an amount 
that exceeds two percent of the amount prepaid; and (3) may be required 
to limit any penalty even further to comply with the points and fees 
limitations for qualified mortgages or to stay below the points and 
fees trigger for high-cost mortgages.
    In the interest of lowering compliance burden and to provide 
additional clarity for creditors, the Bureau has elected to define 
prepayment penalty in a consistent manner for purposes of all of the 
Dodd-Frank Act's amendments. This definition is located in Sec.  
1026.32(b)(6). New Sec.  1026.43(b)(10) cross-references this 
prepayment definition to provide consistency.
    TILA establishes certain disclosure requirements for transactions 
for which a penalty is imposed upon prepayment, but TILA does not 
define the term ``prepayment penalty.'' The Dodd-Frank Act also does 
not define the term. 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).\86\ Comment 18(k)(1)-1 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.
---------------------------------------------------------------------------

    \86\ 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).
---------------------------------------------------------------------------

    The Board's 2011 ATR Proposal proposed to implement the Dodd-Frank 
Act's prepayment penalty-related amendments to TILA for qualified 
mortgages by defining ``prepayment penalty'' for most closed-end, 
dwelling-secured transactions in new Sec.  226.43(b)(10), and by cross-
referencing proposed Sec.  226.43(b)(10) in the proposed joint 
definition of points and fees for qualified and high-cost mortgages in 
Sec.  226.32(b)(1)(v) and (vi). The definition of prepayment penalty 
proposed in the Board's 2011 ATR Proposal differed from the Board's 
prior proposals and existing guidance in the following respects: (1) 
Proposed Sec.  226.43(b)(10) defined prepayment penalty with reference 
to a payment of ``all or part of'' the principal in a transaction 
covered by the provision, while Sec.  1026.18(k) and associated 
commentary and the Board's 2009 Closed-End Proposal and 2010 Mortgage 
Proposal referred to payment ``in full;'' (2) the examples provided 
omitted reference to a minimum finance charge and loan guarantee fees; 
and (3) proposed Sec.  226.43(b)(10) did not incorporate, and the 
Board's 2011 ATR Proposal did not otherwise address, the language in 
Sec.  1026.18(k)(2) and associated commentary regarding

[[Page 6444]]

disclosure of a rebate of a precomputed finance charge, or the language 
in Sec.  1026.32(b)(6) and associated commentary concerning prepayment 
penalties for high-cost mortgages.
    The Board proposal generally received support from industry 
commenters and consumer advocates for accurately implementing section 
129C(c) by using a plain language definition of prepayment penalty. 
Many commenters, particularly consumer groups, supported a rule that 
eliminates or tightly restricts the availability of prepayment 
penalties. Some industry commenters, however, cautioned the Bureau 
against implementing an overbroad definition of prepayment penalty, 
citing primarily a concern over consumers' access to credit. At least 
one commenter argued that a prepayment penalty ban should be more 
narrowly focused on the subprime loan market, noting that the proposal 
affected prepayment penalties on a wider variety of products. Other 
industry commenters expressed a concern about the Board's approach to 
the monthly interest accrual amortization method, as discussed in more 
detail below as part of the discussion of comment 32(b)(6)-1.
    The Bureau adopts the definition of prepayment penalty under Sec.  
1026.32(b)(6) largely as proposed by the Board in order to create a 
clear application of the term prepayment penalty that is consistent 
with the definitions proposed in the Bureau's 2012 TILA-RESPA Proposal 
(which itself draws from the definition adopted in the Bureau's 2013 
HOEPA Final Rule). However, the Bureau adds to Sec.  1026.32(b)(6) an 
explicit exclusion from the definition of prepayment penalty for a 
waived bona fide third-party charge that the creditor imposes if the 
consumer, sooner than 36 months after consummation, pays all of a 
covered transaction's principal before the date on which the principal 
is due. This addition is discussed in detail below. Consistent with 
TILA section 129(c)(1), existing Sec.  1026.32(d)(6), and the Board's 
proposed Sec.  226.43(b)(10) for qualified mortgages, Sec.  
1026.32(b)(6)(i) provides that, for a closed-end mortgage loan, a 
``prepayment penalty'' means a charge imposed for paying all or part of 
the transaction's principal before the date on which the principal is 
due, though the Bureau has added a carve-out from this definition to 
accommodate the repayment of certain conditionally waived closing costs 
when the consumer prepays in full. The Bureau adopts this definition of 
prepayment penalty under Sec.  1026.32(b)(6), rather than under Sec.  
1026.43(b)(10), to facilitate compliance for creditors across 
rulemakings. The definition of ``prepayment penalty'' under Sec.  
1026.32(b)(6) thus will apply to prepayment penalty restrictions, as 
applied under Sec.  1026.43(g). Section 1026.32(b)(6) also contains 
requirements and guidance related to the Bureau's 2013 HOEPA Final 
Rule, such as a definition of prepayment penalty that applies to open-
end credit.
    The Board's 2011 ATR Proposal included as an example of a 
prepayment penalty a fee that the creditor waives unless the consumer 
prepays the covered transaction. Some industry commenters contended 
that such conditional fee waivers should be excluded from the 
definition of prepayment penalties. The commenters argued that 
creditors imposed conditional fee waivers not to increase profit, but 
to ensure compensation for fixed costs associated with originating the 
loan. At least one commenter directed the Bureau to a 1996 National 
Credit Union Administration opinion letter that concluded that a 
conditional waiver of closing costs by a credit union was a benefit to 
the consumer. Other comments characterized the conditional fee waiver 
as a ``reimbursement,'' rather than compensation.
    The Bureau finds such comments persuasive, particularly with 
respect to a situation in which the creditor waives a bona fide third-
party charge (or charges) on condition that the consumer reimburse the 
creditor for the cost of that charge if the consumer prepays the loan. 
In such situations, the Bureau recognizes that the creditor receives no 
profit from imposing or collecting such charges and the Bureau believes 
that treating such charges as a prepayment penalty might very well have 
the effect of reducing consumer choice without providing any 
commensurate consumer benefit. In an effort to provide a sensible way 
to permit a creditor to protect itself from losing money paid at 
closing to third parties on the consumer's behalf, prior to such time 
as the creditor can otherwise recoup such costs through the interest 
rate on the mortgage loan, while balancing consumer protection 
interests, the Bureau has concluded that such fees should be 
permissible for a limited time after consummation. The Bureau thus 
adopts Sec.  1032(b)(6)(i) to clarify that the term prepayment penalty 
does not include a waived bona fide third-party charge imposed by the 
creditor if the consumer pays all of a covered transaction's principal 
before the date on which the principal is due sooner than 36 months 
after consummation. The Bureau concludes that limiting the duration of 
the possible charge to 36 months after consummation is consistent with 
TILA 129C(c)(3)(D), which prohibits any prepayment penalty three years 
after loan consummation, while accommodating the concerns discussed 
above. Moreover, Sec.  1032(b)(6)(i) excludes from the definition of 
prepayment penalty only those charges that a creditor imposes to recoup 
waived bona-fide third party charges in such cases where the consumer 
prepays in full. Thus, for example, if one month after loan 
consummation, the consumer prepays $100 of principal earlier than it is 
due, where the total principal is $100,000, then any fee that the 
creditor imposes for such prepayment is a prepayment penalty under 
Sec.  1032(b)(6)(i) and such a fee is restricted in accordance with 
Sec.  1026.43(g).
    The Bureau believes that Sec.  1026.32(b)(6) accurately implements 
TILA section 129C(c), which significantly limits the applicability and 
duration of prepayment penalties. Some commenters argued that 
restrictions on prepayment penalties should be more narrowly focused on 
specific products or consumers, because not all consumers need 
protection from the pitfalls of prepayment penalties. The Bureau agrees 
that prepayment penalties are not always harmful to consumers and that, 
in some cases, allowing a creditor to charge a prepayment penalty may 
lead to increased consumer choice and access to credit. Congress 
recognized this balance by allowing a creditor to charge a prepayment 
penalty only in certain circumstances, such as requiring the loan to be 
a qualified mortgage, under TILA section 129C(c)(1)(A), and by limiting 
a creditor to charging a prepayment penalty to no more than three years 
following consummation, under TILA section 129C(c)(3)(D). Section 
1026.32(b)(6) remains faithful to that balance, with the Bureau's minor 
clarification with respect to waived bona fide third party charges, as 
described above.
    The Board's 2011 ATR Proposal included several other examples of a 
prepayment penalty under proposed Sec.  226.43(b)(10)(i). For clarity, 
the Bureau incorporates these examples as comment 32(b)(6)-1.i and ii, 
and the Bureau is adding comment 32(b)(6)-1.iii and iv to provide 
additional clarity. Likewise, the Bureau is largely adopting the 
Board's proposed Sec.  226.43(b)(10)(ii), an example of what is not a 
prepayment penalty, as comment 32(b)(6)-3.i, as well as adding comment 
32(b)(6)-3.ii.
    Comment 32(b)(6)-1.i through iv gives the following examples of 
prepayment penalties: (1) A charge determined by treating the loan 
balance as outstanding for a period of time after prepayment in

[[Page 6445]]

full and applying the interest rate to such ``balance,'' even if the 
charge results from interest accrual amortization used for other 
payments in the transaction under the terms of the loan contract; (2) a 
fee, such as an origination or other loan closing cost, that is waived 
by the creditor on the condition that the consumer does not prepay the 
loan; (3) a minimum finance charge in a simple interest transaction; 
and (4) computing a refund of unearned interest by a method that is 
less favorable to the consumer than the actuarial method, as defined by 
section 933(d) of the Housing and Community Development Act of 1992, 15 
U.S.C. 1615(d).
    Post-payoff interest charges. The Board proposal included as an 
example of a prepayment penalty in proposed Sec.  226.43(b)(10)(i)(A) a 
charge determined by the creditor or servicer treating the loan balance 
as outstanding for a period of time after prepayment in full. Some 
industry commenters expressed reservations about treating this monthly 
interest accrual amortization method as a prepayment penalty, arguing 
that such a rule might cause higher resale prices in the secondary 
mortgage market to account for cash flow uncertainty. Other commenters 
noted that this calculation method is currently used by FHA to compute 
interest on its loans (including loans currently in Ginnie Mae pools), 
or that such charges were not customarily considered a prepayment 
penalty. Some commenters expressed concern that the rule would disrupt 
FHA lending.
    After careful consideration of the comments received, the Bureau 
concludes that going forward (e.g., for loans a creditor originates 
after the effective date), it is appropriate to designate higher 
interest charges for consumers based on accrual methods that treat a 
loan balance as outstanding for a period of time after prepayment in 
full as prepayment penalties under Sec.  1026.32(b)(6) and comment 
32(b)(6)-1.i. In such instances, the consumer submits a payment before 
it is due, but the creditor nonetheless charges interest on the portion 
of the principal that the creditor has already received. The Bureau 
believes that charging a consumer interest after the consumer has 
repaid the principal is the functional equivalent of a prepayment 
penalty. Comment 32(b)(6)-1.i further clarifies that ``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 and 
notes, for example, that ``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 any grace 
period). 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.
    With respect to FHA practices relating to monthly interest accrual 
amortization, the Bureau has consulted extensively with HUD in issuing 
this final rule as well as the 2013 HOEPA Final Rule. Based on these 
consultations, the Bureau understands that HUD must engage in 
rulemaking to end its practice of imposing interest charges on 
consumers for the balance of the month in which consumers prepay in 
full. The Bureau further understands that HUD requires approximately 24 
months to complete its rulemaking process. Accordingly, in recognition 
of the important role that FHA-insured credit plays in the current 
mortgage market and to facilitate FHA creditors' ability to comply with 
this aspect of the 2013 ATR and HOEPA Final Rules, the Bureau is using 
its authority under TILA section 105(a) to provide for optional 
compliance until January 15, 2015 with Sec.  1026.32(b)(6)(i) and the 
official interpretation of that provision in comment 32(b)(6)-1.i 
regarding monthly interest accrual amortization. Specifically, Sec.  
1026.32(b)(6)(i) provides that interest charged consistent with the 
monthly interest accrual amortization method is not a prepayment 
penalty for FHA loans consummated before January 21, 2015. FHA loans 
consummated on or after January 21, 2015 must comply with all aspects 
of the final rule. The Bureau is making this adjustment pursuant to its 
authority under TILA section 105(a), which provides that the Bureau'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 Bureau'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). The purposes of 
TILA include the purposes that apply to 129C, to assure that consumers 
are offered and receive residential mortgage loans on terms that 
reasonably reflect their ability to repay the loan. See 15 U.S.C. 
1639b(a)(2). The Bureau believes it is necessary and proper to make 
this adjustment to ensure that consumers receive loans on affordable 
terms and to facilitate compliance with TILA and its purposes while 
mitigating the risk of disruption to the market. For purposes of this 
rulemaking, the Bureau specifically notes that the inclusion of 
interest charged consistent with the monthly interest accrual 
amortization method in the definition of prepayment penalty for 
purposes of determining whether a transaction is in compliance with the 
requirements of Sec.  1026.43(g) applies only to transactions 
consummated on or after January 10, 2014; for FHA loans, compliance 
with this aspect of the definition of prepayment penalties is optional 
for transactions consummated prior to January 21, 2015.
    With regard to general concerns that loans subject to these 
interest accrual methods may be subject to higher prices on the 
secondary market, the Bureau is confident that the secondary market 
will be able to price the increased risk of prepayment, if any, that 
may occur as a result of the limits that will apply to monthly interest 
accrual amortization-related prepayment penalties. The secondary market 
already does so for various other types of prepayment risk on investor 
pools, such as the risk of refinancing or sale of the property.
    Comment 32(b)(6)-1.ii further explains the 36 month carve-out for a 
waived bona fide third-party charge imposed by the creditor if the 
consumer pays all of a covered transaction's principal before the date 
on which the principal is due sooner than 36 months after consummation, 
as included in Sec.  1026.32(b)(6)(i). The comment explains that if a 
creditor waives $3,000 in closing costs to cover bona fide third party 
charges but the terms of the loan agreement provide that the creditor 
may recoup $4,500, in part to recoup waived charges, then only $3,000 
that the creditor may impose to cover the waived bona fide third party 
charges is considered not to be a prepayment penalty, while any 
additional $1,500 charge for prepayment is a prepayment penalty and 
subject to the restrictions under Sec.  1026.43(g). This comment also 
demonstrates that the only amount excepted from the definition of 
prepayment penalty under Sec.  1026.32(b)(6)(i) is the actual amount 
that the creditor pays to a third party for a waived, bona fide charge.
    Minimum finance charges; unearned interest refunds. Although 
longstanding Regulation Z commentary has listed a minimum finance 
charge in a simple interest transaction as an example of a prepayment 
penalty, the Board proposed to omit that example from proposed Sec.  
226.43(b)(10) because the

[[Page 6446]]

Board reasoned that such a charge typically is imposed with open-end, 
rather than closed-end, transactions. The Bureau did not receive 
substantial comment on this omission, but the Bureau has elected to 
continue using this example in comment 32(b)(6)-1.iii for consistency. 
Likewise, the Board did not propose to include the example of computing 
a refund of unearned interest by a method that is less favorable to the 
consumer than the actuarial method, but the Bureau is nonetheless using 
this example in comment 32(b)(6)-1.iv because similar language is found 
in longstanding Regulation Z commentary.
    Examples of fees that are not prepayment penalties. The Board 
included in proposed Sec.  226.43(b)(10)(ii) an example of a fee not 
considered a prepayment penalty. For the sake of clarity, the Bureau is 
moving this example into comment 32(b)(6)-2.i, rather than keep the 
example in the text of the regulation. The Bureau also is adding a 
second example in comment 32(b)(6)-2.ii.
    Comment 32(b)(6)-2.i explains that fees imposed for preparing and 
providing documents when a loan is paid in full are not prepayment 
penalties when such fees are imposed whether or not the loan is prepaid 
or the consumer terminates the plan prior to the end of its term. 
Commenters did not provide substantial feedback on this example, which 
the Bureau has reworded slightly from the Board proposal to provide 
conformity and clarity.
    The Board proposed omitting text from preexisting commentary on 
Regulation Z stating that a prepayment penalty did not include loan 
guarantee fees, noting that 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. The Bureau did not receive substantial comment on 
this omission. While the Bureau agrees with the Board's analysis, the 
Bureau nonetheless elects to include this example in comment 43(b)(6)-
2.ii to clarify that loan guarantee fees continue to fall outside the 
definition of a prepayment penalty. Moreover, including this example of 
a fee that is not a prepayment penalty is consistent with the Bureau's 
efforts to streamline definitions and ease regulatory burden.
    Construction-to-permanent financing. Some industry commenters 
advocated that, for construction-to-permanent loans, the Bureau should 
exclude from the definition of prepayment penalty charges levied by a 
creditor if a consumer does not convert the construction loan into a 
permanent loan with the same creditor within a specified time period. 
The Bureau believes that the concern expressed by these commenters that 
the cost of credit for these construction-to-permanent loans would 
increase if such charges were treated as prepayment penalties is 
misplaced primarily because in many cases, such charges are not, in 
fact, a prepayment penalty. A prepayment penalty is ``a charge imposed 
for paying all or part of a covered transaction's principal before the 
date on which the principal is due.'' First, the case where the 
creditor charges the consumer a fee for failing to convert a loan 
within a specified period after completing the repayment of a 
construction loan as scheduled is not a prepayment penalty; the fee is 
not assessed for an early payment of principal, but rather for the 
consumer's failure to take an action upon scheduled repayment of 
principal. Second, the case where a consumer does convert the 
construction loan to a permanent loan in a timely manner, but incurs a 
fee for converting the loan with another creditor, is also likely not 
prepayment penalty. While such cases depend highly on contractual 
wording, in the example above, the consumer is charged a fee not for 
his early payment of principal, but rather for his use of another 
creditor. Third, the case where the creditor charges the consumer a fee 
for converting the construction loan to a permanent loan earlier than 
specified by agreement, even with the same creditor, likely is a 
prepayment penalty. While this example is not the same as the 
hypothetical described by most commenters, who expressed concern if a 
consumer does not convert the construction loan into a permanent loan 
with the same creditor within a specified time period, this is an 
example of a prepayment penalty, as the creditor has imposed a charge 
for paying all or part of a covered transaction's principal before the 
date on which the principal was due. As the above examples demonstrate, 
whether a construction-to-permanent loan contains a prepayment penalty 
is fact-specific, and the Bureau has decided that adding a comment 
specifically addressing such loans would not be instructive. The Bureau 
sees no policy reason to generally exclude fees specific to 
construction-to-permanent loan from the definition of prepayment 
penalty and its statutory limits. The Bureau was not presented with any 
evidence that the risks inherent in construction-to-permanent loans 
could not be priced by creditors through alternative means, such as the 
examples described above, via interest rate, or charging closing costs. 
The Bureau also notes that, because of the scope of the rule, described 
in the section-by-section analysis of Sec.  1026.43(a), as well as the 
prepayment penalty restrictions, described in the section-by-section 
analysis of Sec.  1026.43(g), construction-to-permanent loans cannot be 
qualified mortgages, and thus under Sec.  1026.43(g)(1)(ii)(B) cannot 
include a prepayment penalty. Construction-to-permanent loans are 
discussed in more detail in the section-by-section analysis of Sec.  
1026.43(a).
    Open-end credit. The Bureau is concurrently adopting comments 
32(b)(6)-3 and -4 to clarify its approach to prepayment penalties with 
respect to open-end credit. As the Board's 2011 ATR Proposal did not 
address open-end credit plans, the Bureau is not clarifying prepayment 
penalties with respect to open-end credit plans in this final rule. 
Instead, guidance is provided in comments 32(b)(6)-3 and -4, which the 
Bureau is adopting in the concurrent 2013 HOEPA Final Rule.

Section 1026.43 Minimum Standards for Transactions Secured by a 
Dwelling 43(a) Scope

    Sections 1411, 1412 and 1414 of the Dodd-Frank Act add new TILA 
section 129C, which requires creditors to determine a consumer's 
ability to repay a ``residential mortgage loan'' and establishes new 
rules and prohibitions on prepayment penalties. Section 1401 of the 
Dodd-Frank Act adds new TILA section 103(cc),\87\ which 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, regardless of 
whether the consumer credit transaction involves a home purchase, 
refinancing, home equity loan, first lien or subordinate lien, and 
regardless of whether the dwelling is a principal residence, second 
home, vacation home (other than a timeshare residence), a one- to four-
unit residence, condominium, cooperative, mobile home, or manufactured 
home.
---------------------------------------------------------------------------

    \87\ Two TILA subsections designated 103(cc) exist due to a 
discrepancy in the instructions given by the Dodd-Frank Act. See 
Dodd-Frank Act sections 1100A and 1401.

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[[Page 6447]]

    However, the Dodd-Frank Act specifically excludes from the term 
``residential mortgage loan'' an open-end credit plan or an extension 
of credit secured by an interest in a timeshare plan, for purposes of 
the 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 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. See TILA 
section 103(cc)(5) and 129C(a)(1).
    TILA Section 103(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.  1026.2(a)(19). To facilitate 
compliance by using consistent terminology throughout Regulation Z, the 
proposal used the term ``dwelling,'' as defined in Sec.  1026.2(a)(19), 
and not the phrase ``residential real property that includes a 
dwelling.'' Proposed comment 43(a)-2 clarified that, for purposes of 
proposed Sec.  226.43, the term ``dwelling'' would include any real 
property to which the residential structure is attached that also 
secures the covered transaction.
    Proposed Sec.  226.43(a) generally defined the scope of the 
ability-to-repay provisions to include any consumer credit transaction 
that is secured by a dwelling, other than home equity lines of credit, 
mortgage transactions secured by an interest in a timeshare plan, or 
for certain provisions reverse mortgages or temporary loans with a term 
of 12 months or less. Proposed comment 43(a)-1 clarified that proposed 
Sec.  226.43 would not apply to an extension of credit primarily for a 
business, commercial, or agricultural purpose and cross-referenced the 
existing guidance on determining the primary purpose of an extension of 
credit in commentary on Sec.  1026.3.
    Numerous commenters requested additional exemptions from coverage 
beyond the statutory exemptions listed at proposed Sec.  226.43(a)(1) 
through (3). The Bureau received requests for exemptions from the rule 
for seller-financed transactions, loans secured by non-primary 
residences, community development loans, downpayment assistance loans, 
loans eligible for purchase by GSEs, and housing stabilization 
refinances. The requested exemptions related to community development 
loans, downpayment assistance loans, and housing stabilization 
refinances are not being included in this final rule, but are addressed 
in the Bureau's proposed rule regarding amendments to the ability-to-
repay requirements, published elsewhere in today's Federal Register. 
The requested exemptions that are not being included in the rule and 
are not being addressed in today's concurrent proposal are discussed 
immediately below.
    The Bureau received numerous letters from individuals concerned 
that the rule would cover individual home sellers who finance the 
buyer's purchase, either through a loan or an installment sale. 
However, because the definition of ``creditor'' for mortgages generally 
covers only persons who extend credit secured by a dwelling more than 
five times in a calendar year, the overwhelming majority of individual 
seller-financed transactions will not be covered by the rule. Those 
creditors who self-finance six or more transactions in a calendar year, 
whether through loans or installment sales, will need to comply with 
the ability-to-repay provisions of Sec.  1026.43, just as they must 
comply with other relevant provisions of Regulation Z.
    An association of State bank regulators suggested that the scope of 
the ability-to-repay requirements be limited to owner-occupied primary 
residences, stating that ability to repay on vacation homes and 
investment properties should be left to an institution's business 
judgment. The Bureau believes it is not appropriate or necessary to 
exercise its exception authority to change the scope of the provision 
in this way for several reasons. First, as discussed in proposed 
comment 43(a)-1, loans that have a business purpose \88\ are not 
covered by TILA, and so would not be covered by the ability-to-repay 
provisions as proposed and adopted. Investment purpose loans are 
considered to be business purpose loans. Second, vacation home loans 
are consumer credit transactions that can have marked effects on a 
consumer's finances. If a consumer is unable to repay a mortgage on a 
vacation home, the consumer will likely suffer severe financial 
consequences and the spillover effects on property values and other 
consumers in the affected area can be substantial as well. Third, the 
Bureau understands that default rates on vacation homes are generally 
higher than those on primary residences, and an exemption could 
increase this disparity.
---------------------------------------------------------------------------

    \88\ 12 CFR 1026.3(a).
---------------------------------------------------------------------------

    For the reasons discussed below, the general scope provision and 
the statutory exemptions in Sec.  1026.43(a)(1) through (3)(ii) are 
adopted substantially as proposed, with minor changes as discussed in 
the relevant sections below, and the addition of Sec.  
1026.43(a)(3)(iii) to provide an exemption for the construction phase 
of a construction-to-permanent loan.
    The general scope provision at Sec.  1026.43(a) now includes 
language making clear that real property attached to a dwelling will be 
considered a part of the dwelling for purposes of compliance with Sec.  
1026.43. Although as discussed above similar language was included in 
the official commentary in the proposed rule, the Bureau believes this 
important legal requirement should be part of the regulatory text.
    Comment 43(a)-1 now includes a reference to Sec.  1026.20(a), which 
describes different types of changes to an existing loan that will not 
be treated as refinancings, to make clear that creditors may rely on 
that section in determining whether or not Sec.  1026.43 will apply to 
a particular change to an existing loan.
43(a)(1)
    The Board's proposal included an exemption from the scope of 
section 226.43 for ``[a] home equity line of credit subject to Sec.  
226.5b,'' \89\ which implemented the exclusion of HELOCs from coverage 
in the statutory definition of ``residential mortgage loan.'' Dodd-
Frank Act section 1401. The Bureau received two comments asking that 
the HELOC exemption be reconsidered. The commenters stated that HELOCs 
had contributed to the crisis in the mortgage market and that failure 
to include them in the ability-to-repay rule's coverage would likely 
lead to more consumer abuse and systemic problems.
---------------------------------------------------------------------------

    \89\ The Regulation Z section on HELOCs has been relocated and 
is now at 12 CFR 1026.40.
---------------------------------------------------------------------------

    The Bureau notes that Congress specifically exempted open-end lines 
of credit from the ability-to-repay

[[Page 6448]]

requirements, even though the Dodd-Frank Act extends other consumer 
protections to such loans, including the requirements for high-cost 
mortgages under HOEPA. The Bureau also notes that home equity lines of 
credit have consistently had lower delinquency rates than other forms 
of consumer credit.\90\ Furthermore, the requirements contained in the 
Dodd-Frank Act with respect to assessing a consumer's ability to repay 
a residential mortgage, and the regulations the Bureau is adopting 
thereunder, were crafted to apply to the underwriting of closed-end 
loans and are not necessarily transferrable to underwriting for an 
open-end line of credit secured by real estate. In light of these 
considerations, the Bureau does not believe there is sufficient 
justification to find it necessary or proper to use its adjustment and 
exception authority to expand the ability-to-repay provisions to HELOCs 
at this time. However, as discussed in detail below, the Bureau is 
adopting the Board's proposal to require creditors to consider and 
verify contemporaneous HELOCs in addition to other types of 
simultaneous loans for the purpose of complying with the ability-to-
repay provisions. See the section-by-section analysis of Sec.  
1026.43(b)(12) below. In addition, the final rule includes the Board's 
proposed anti-evasion provision, which forbids the structuring of 
credit that does not meet the definition of open-end credit as an open-
end plan in order to evade the requirements of this rule. See Sec.  
1026.43(h). Accordingly, Sec.  1026.43(a)(1) is adopted as proposed, 
with the embedded citation updated. However, the Bureau intends to 
monitor the HELOC exemption through its supervision function and may 
revisit the issue as part of its broader review of the ability-to-repay 
rule under section 1022(d) of the Dodd-Frank Act, which requires the 
Bureau to publish an assessment of a significant rule or order not 
later than five years after its effective date.
---------------------------------------------------------------------------

    \90\ See Fed. Reserve Bank of N.Y., Quarterly Report on 
Household Debt and Credit, at 9 (Nov. 2012), available at http://www.newyorkfed.org/research/national_economy/householdcredit/DistrictReport_Q32012.pdf.
---------------------------------------------------------------------------

43(a)(2)
    The Bureau did not receive comments on the statutory timeshare 
exemption included in proposed Sec.  226.43(a)(2). Accordingly, the 
Bureau is adopting Sec.  1026.43(a)(2) as proposed.
43(a)(3)
43(a)(3)(i)
    Proposed Sec.  226.43(a)(3)(i) created an exemption from the 
ability-to-repay requirements in Sec.  226.43(c) through (f) for 
reverse mortgages, as provided in the statute. The Bureau did not 
receive comments on this exemption.\91\ Accordingly, the Bureau is 
adopting Sec.  1026.43(a)(3)(i) as proposed.
---------------------------------------------------------------------------

    \91\ Comments were received regarding the possible description 
of a reverse mortgage qualified mortgage, and they are discussed 
below. These commenters did not discuss or question the general 
exemption from the ability-to-repay rule.
---------------------------------------------------------------------------

43(a)(3)(ii)
    Proposed Sec.  226.43(a)(3)(ii) provided an exemption from the 
ability-to-repay requirements in Sec.  226.43(c) through (f) for ``[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.'' Furthermore, proposed comment 
43(a)-3 provided that, ``[w]here 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.'' The Board solicited 
comment on whether a decision to treat renewals in this manner would 
lead to evasion of the rule. The statute includes the one-year 
exemption implemented in the proposed rule but does not specifically 
address renewals. TILA section 129C(a)(8), 15 U.S.C. 1639c(a)(8).
    Generally, commenters did not specifically address the proposal's 
request for comment on renewals of short-term financing; however, one 
industry commenter stated that the statutory one-year limitation would 
interfere with construction loans, which often require more than a year 
to complete. The Bureau understands that construction loans often go 
beyond a single year. Although the comment did not specify that 
disregarding potential renewals would alleviate this concern, the 
Bureau believes that disregarding renewals would facilitate compliance 
and prevent unwarranted restrictions on access to construction loans.
    Commenters did not respond to the Board's query about whether or 
not disregarding renewals of transactions with one-year terms would 
lead to evasion of the rule. Upon further analysis, the Bureau believes 
that this concern does not warrant changing the proposed commentary. 
However, the Bureau intends to monitor the issue through its 
supervision function and to revisit the issue as part of its broader 
review of the ability-to-repay rule under section 1022(d) of the Dodd-
Frank Act, which requires the Bureau to conduct an assessment of 
significant rules five years after they are adopted.
    One industry trade association commented on the wording of the 
temporary financing exemption, suggesting that the inclusion of the two 
examples, bridge loans and construction loans, would create uncertainty 
as to whether the exemption would apply to temporary financing of other 
types. However, the Bureau believes further clarification is not 
required because the exemption applies to any temporary loan with a 
term of 12 months or less, and the examples are merely illustrative. 
The Bureau is aware of and provides clarifying examples of certain 
common loan products that are temporary or ``bridge'' loans. The 
commenter did not note other common types of temporary loan products. 
The Bureau further believes that the rule permits other types of 
temporary financing as long as the loan satisfies the requirements of 
the exemption.
    Accordingly, Sec.  1026.43(a)(3)(ii) and associated commentary are 
adopted substantially as proposed.
43(a)(3)(iii)
    The Bureau also received comments requesting clarification on how 
the temporary financing exemption would apply to construction-to-
permanent loans, i.e., construction financing that will be permanently 
financed by the same creditor. Typically, such loans have a short 
construction period, during which payments are made of interest only, 
followed by a fully amortizing permanent period, often an additional 30 
years. Because of this hybrid form, the loans do not appear to qualify 
for the temporary financing exemption, nor would they be qualified 
mortgages because of the interest-only period and the fact that the 
entire loan term will often slightly exceed 30 years. However, such 
loans may have significant consumer benefits because they avoid the 
inconvenience and expense of a second closing, and also avoid the risk 
that permanent financing will be unavailable when the construction loan 
is due.
    The Bureau notes that existing Sec.  1026.17(c)(6)(ii) provides 
that construction-to-permanent loans may be disclosed as either a 
single transaction or as multiple transactions at the creditor's 
option. Consistent with that provision, the Bureau is using its 
adjustment and exception authority to allow the construction phase of a 
construction-to-permanent loan to be

[[Page 6449]]

exempt from the ability-to-repay requirements as a temporary loan; 
however, the permanent phase of the loan is subject to Sec.  1026.43. 
Because the permanent phase is subject to Sec.  1026.43, it may be a 
qualified mortgage if it satisfies the appropriate requirements.
    As amended by the Dodd-Frank Act, TILA section 105(a), 15 U.S.C. 
1604(a), directs the Bureau to prescribe regulations to carry out the 
purposes of TILA, and provides that such regulations may contain 
additional requirements, classifications, differentiations, or other 
provisions, and may provide for such adjustments and exceptions for all 
or any class of transactions that the Bureau judges are necessary or 
proper to effectuate the purposes of TILA, to prevent circumvention or 
evasion thereof, or to facilitate compliance therewith. The main 
purpose of section 129C is articulated in section 129B(a)(2)--``to 
assure that consumers are offered and receive residential mortgage 
loans on terms that reasonably reflect their ability to repay the loans 
and that are not unfair, deceptive or abusive.'' Creditors' ability to 
continue originating construction-to-permanent loans in a cost 
effective manner will help to ensure that consumers are offered and 
receive loans on terms that reasonably reflect their ability to repay. 
The construction-to-permanent product avoids the possibility of a 
consumer being unable to repay a construction loan, because the 
permanent financing is already part of the contract. Without the 
ability to treat the permanent financing as a qualified mortgage, and 
the construction phase as exempt, it is not clear how many creditors 
would continue to offer such loans, especially in the short term. In 
addition, consumers will benefit from the potentially lower costs 
associated with qualified mortgages. In addition to effectuating the 
purpose of ensuring ability to repay, this exemption will greatly 
facilitate compliance for creditors providing this product.
    Proposed comment 43(a)(3)-1 provided 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. 
The Bureau is adding comment 43(a)(3)-2 to make clear that if a 
construction-to-permanent loan is treated as multiple transactions in 
regard to compliance with the ability-to-repay requirements, and the 
initial one-year construction phase is renewable, the loan term of the 
construction phase does not include any additional period of time that 
could result from a renewal of that construction phase that is one year 
or less in duration. Comment 43(a)(3)-2 also makes clear that if the 
construction phase of a construction-to-permanent loan is treated as 
exempt, the permanent financing phase may be a qualified mortgage if it 
meets the appropriate requirements.
    Accordingly, Sec.  1026.43(a)(3)(iii) and comment 43(a)(3)-2 are 
added to this final rule.
43(b) Definitions
43(b)(1)
    The definition of ``covered transaction'' restates the scope of the 
rule, discussed above, which implements the statutory term 
``residential mortgage loan'' defined at TILA Sec.  103(cc)(5). The 
Bureau did not receive any comments specifically on this provision and 
is adopting it as proposed in Sec.  1026.43(b)(1). For clarity, the 
Bureau has added comment 43(b)(1)-1 explaining that the term ``covered 
transaction'' restates the scope of the rule as described in Sec.  
1026.43(a).
43(b)(2)
    TILA section 129C(a)(3) requires that ``[a] creditor shall 
determine the ability of the consumer to repay using a payment schedule 
that fully amortizes the loan over the term of the loan.'' In 
implementing this provision, the proposed rule defined a ``fully 
amortizing payment'' as ``a periodic payment of principal and interest 
that will fully repay the loan amount over the loan term.'' The term 
``fully amortizing payment'' is used in the general ``payment 
calculation'' provision in Sec.  1026.43(c)(5)(i)(B), which requires 
the use of ``[m]onthly, fully amortizing payments that are 
substantially equal.'' The Bureau has determined that the definition of 
``fully amortizing payment'' enables accurate implementation of the 
payment calculation process envisioned by the statute, and no comments 
focused on or questioned this definition. Accordingly, Sec.  
1026.43(b)(2) is adopted as proposed.
43(b)(3)
    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 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'' appeared in proposed Sec.  
226.43(c)(5), which implemented TILA section 129C(a)(6)(D)(iii) and 
provided the payment calculation rules for covered transactions. The 
term also appeared in proposed Sec.  226.43(d)(5), which provided 
special rules for creditors that refinance a consumer from a non-
standard mortgage to a standard mortgage.
    Proposed Sec.  226.43(b)(3) defined 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 was consistent with 
the statutory language of TILA sections 129C(a)(6)(D)(iii) and 
129C(a)(7), but revised certain text to provide clarity. First, for 
consistency with current Regulation Z and to facilitate compliance, the 
proposal replaced 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 
interpreted these statutory phrases to have the same meaning as the 
phrase ``at the time of consummation.'' See current Sec.  1026.2(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.''
    In requiring that the fully indexed rate be determined using the 
specified index at consummation, the Board was concerned that the 
possible existence of loans that use more than one index could 
complicate this determination. Given the increasing relevance of market 
indices, the Board solicited 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 would be needed.
    The proposed rule interpreted the statutory 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.'' The Bureau agrees with this 
interpretation, because the statutory use

[[Page 6450]]

of the plural ``rates'' modified by the all-inclusive term ``any'' 
clearly indicates not only that something more than the initial 
introductory rate is meant, but that ``any'' preliminary rate should be 
disregarded. In addition, the statutory term itself, ``fully indexed 
rate,'' appears to require such a reading. 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 and allows for simplicity and consistency with new TILA 
section 103(bb), the high cost mortgage provision.
    Because the proposal required that the creditor use the ``maximum'' 
margin that can apply when determining the fully indexed rate, 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(bb), 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'' under 
HOEPA, 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.'' \92\ Furthermore, 
although the Board was not aware of any current loan products that 
possess more than one margin that may apply over the loan term, the 
Board proposed 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 proposal 
solicited comment on this approach.
---------------------------------------------------------------------------

    \92\ Previous to the passage of the Dodd-Frank Act, the annual 
percentage rate used for this determination was calculated the same 
way as for the rest of the Truth in Lending Act, pursuant to Sec.  
1026.14.
---------------------------------------------------------------------------

    The proposed definition of ``fully indexed rate'' was also 
generally consistent with the definition of ``fully indexed rate'' as 
used in the MDIA Interim Final Rule,\93\ and with the Federal banking 
agencies' use of the term ``fully indexed rate'' in the 2006 
Nontraditional Mortgage Guidance and 2007 Subprime Mortgage Statement.
---------------------------------------------------------------------------

    \93\ See 2010 MDIA Interim Final Rule, 75 FR 58470, 58484 (Sept. 
24, 2010) (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).
---------------------------------------------------------------------------

    Proposed comment 43(b)(3)-1 noted 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 proposed comment explained that this initial rate 
charged to consumers will sometimes be 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 proposed comment clarified 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. The proposed comment further clarified that this 
means, in determining the fully indexed rate, the creditor must not 
take into account any discounted or premium rate. (In addition, to 
facilitate compliance, this comment directed 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 proposed Sec.  226.43(c)). See final rule Sec.  
1026.43(c)(5)(i)(A) and comment 43(c)(5)(i)-2.)
    Proposed comment 43(b)(3)-1 differed from guidance on disclosure 
requirements 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 believed the different approach 
taken in proposed comment 43(b)(3)-1 was required by the statutory 
language and was 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).
    Proposed comment 43(b)(3)-2 further clarified that if the contract 
provides for a delay in the implementation of changes in an index value 
or formula, the creditor need not use the index or formula in effect at 
consummation, and provides an illustrative example. This proposed 
comment was 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 address the fully indexed rate for purposes 
of disclosure requirements.
    Proposed comment 43(b)(3)-3 explained that the creditor must 
determine the fully indexed rate without taking into account any 
periodic interest rate adjustment caps 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. As the proposal noted, the 
guidance contained in proposed comment 43(b)(3)-3 differed from 
guidance contained in current comment 17(c)(1)-10.iii, which states 
that, when disclosing the annual percentage rate, creditors should give 
effect to periodic interest rate adjustment caps.
    Nonetheless, the Board believed the approach in proposed comment 
43(b)(3)-3 was consistent with, and required by, the statutory language 
that states that 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 
section 129C(a)(6)(D)(iii) and (7). In addition, the Board noted that 
the proposed definition of fully indexed rate, and its use in the 
proposed payment calculation rules, was 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). Furthermore, the guidance contained in proposed 
comment 43(b)(3)-3 was 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 clarified 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 explained, 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. In allowing creditors to use the lifetime maximum 
interest rate provided under

[[Page 6451]]

the terms of the obligation, the Board was apparently interested in 
simplifying compliance and benefiting consumers by encouraging 
reasonable lifetime interest rate caps. In doing so, the Board was 
apparently reading its proposed definition of fully indexed rate to 
allow the maximum margin that can apply at any time during the loan 
term to refer to the maximum margin as determined at consummation. In 
other words, when the index value is determined at consummation, the 
maximum margin that can apply at any time during the loan term will be 
the difference between the lifetime interest rate cap and that index 
value. Consequently, adding the index value at consummation to that 
maximum margin, as required by the fully indexed rate definition, will 
yield the lifetime interest rate cap as the fully indexed rate.
    Commenters generally did not focus specifically on the definition 
of ``fully indexed rate'' and associated commentary proposed by the 
Board, or provide examples of loans with more than one index or more 
than one margin. An organization representing state bank regulators 
supported the use of the maximum margin that can apply at any time 
during the loan term, suggesting that it would prevent evasion. (Some 
commenter groups did urge the Bureau to use its adjustment authority to 
require creditors to use a rate higher than the fully indexed rate in 
assessing a consumer's ability to repay; these comments are discussed 
below in the section-by-section analysis of Sec.  1026.43(c)(5)(i)). 
The Bureau is adopting the rule and commentary largely as proposed, 
with some modifications for clarity. Specifically, the Bureau decided 
to include language in the definition that will make clear that the 
index used in determining the fully indexed rate is the index that will 
apply after the loan is recast, so that any index that might be used 
earlier in determining an initial or intermediate rate would not be 
used. This new language is included for clarification only, and does 
not change the intended meaning of the proposed definition.
    In the proposed rule, the Board noted 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 
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), which addressed the 
proposal's scope, and proposed Sec.  226.43(b)(1), which defined 
``covered transaction.'' However, because step-rate mortgages do not 
have a fully indexed rate, it was unclear what interest rate the 
creditor should assume when calculating payment amounts for the purpose 
of determining the consumer's ability to repay the covered transaction.
    As discussed above, the proposal interpreted 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, the proposal clarified in 
proposed comment 43(b)(3)-5 that where there is no fully indexed rate 
because the interest rate offered in the loan is not based on, and does 
not vary with, an index or formula, the creditor must use the maximum 
interest rate that may apply at any time during the loan term. Proposed 
comment 43(b)(3)-5 provided illustrative examples of how to determine 
the maximum interest rate for a step-rate and a fixed-rate mortgage.
    The Board believed this approach was 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 
would help to ensure that consumers could repay their loans. However, 
the Board was also 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 might be overstated 
and potentially restrict credit availability. Therefore, the Board 
solicited comment on this approach, and whether authority under TILA 
sections 105(a) and 129B(e) should be used to provide an exception for 
step-rate mortgages, possibly requiring creditors to use the maximum 
interest rate that occurs in only the first 5 or 10 years, or some 
other appropriate time horizon.
    The Bureau received few comments on the use of the maximum interest 
rate that may apply at any time during the loan term for step-rate 
mortgages. A consumer group and a regulatory reform group stated that 
this method was better and more protective of consumers than using a 
seven- or ten-year horizon. An organization representing state bank 
regulators suggested that the Bureau use a five-year horizon, provided 
that the loan has limits on later rate increases. An industry trade 
association suggested that the maximum rate only be applied to the 
balance remaining when that maximum rate is reached.
    The Bureau believes that the proposal's method of using the maximum 
interest rate that may apply at any time during the loan term for step-
rate mortgages is appropriate. This approach most closely approximates 
the statutorily required fully indexed rate because it employs the 
highest rate ascertainable at consummation, as does the fully indexed 
rate, and it applies that rate to the entire original principal of the 
loan, as the calculation in Sec.  1026.43(c)(5)(i) does with the fully 
indexed rate. In addition, this method most effectively ensures the 
consumer's ability to repay the loan.
    For the reasons stated above, Sec.  1026.43(b)(3) is adopted 
substantially as proposed, with the clarification discussed above 
specifying that the index used in determining the fully indexed rate is 
the index that will apply after the loan is recast. Issues regarding 
the use of the fully indexed rate in the payment calculations required 
by Sec.  1026.43(c)(5) are discussed in the section-by-section analysis 
of that section below.
43(b)(4)
    The Dodd-Frank Act added TILA section 129C(a)(6)(D)(ii)(II), which 
provides that a creditor making a balloon-payment loan with an APR at 
or above certain thresholds must determine ability to repay ``using the 
contract's repayment schedule.'' The thresholds required by the statute 
are 1.5 or more percentage points above the average prime offer rate 
(APOR) for a comparable transaction for a first lien, and 3.5 or more 
percentage points above APOR for a subordinate lien. These thresholds 
are the same as those used in the Board's 2008 HOEPA Final Rule \94\ to 
designate a new category of ``higher-priced mortgage loans'' (HPMLs), 
which was amended by the Board's 2011 Jumbo Loans Escrows Final Rule to

[[Page 6452]]

include a separate threshold for jumbo loans for purposes of certain 
escrows requirements.\95\ Implementing these thresholds for use with 
the payment underwriting determination for balloon-payment mortgages, 
the proposed rule defined a ``higher-priced covered transaction'' as 
one in which the annual percentage rate (APR) ``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 a first-lien 
covered transaction, or by 3.5 or more percentage points for a 
subordinate-lien covered transaction.'' As explained further below and 
provided for in the statute, the designation of certain covered 
transactions as higher-priced affects the ability-to-repay 
determination for balloon-payment mortgages, and requires that those 
higher-priced transactions be analyzed using the loan contract's full 
repayment schedule, including the balloon payment. Sec.  
1026.43(c)(5)(ii)(A)(2).
---------------------------------------------------------------------------

    \94\ 73 FR 44522 (July 30, 2008).
    \95\ See 76 FR 11319 (Mar. 2, 2011).
---------------------------------------------------------------------------

    Proposed comment 43(b)(4)-1 provided guidance on the term ``average 
prime offer rate.'' Proposed comment 43(b)(4)-2 stated that the table 
of average prime offer rates published by the Board would indicate how 
to identify the comparable transaction for a higher-priced covered 
transaction. Proposed comment 43(b)(4)-3 clarified 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 explained that 
sometimes a creditor sets the interest rate initially and then resets 
it at a different level before consummation, and clarified that in 
these cases, the creditor should use the last date the interest rate is 
set before consummation.
    The Board explained in its proposed rule that it believed the 
ability-to-repay requirements for higher-priced balloon-payment loans 
was meant to apply to the subprime market, but that use of the annual 
percentage rate could lead to prime loans being exposed to this test. 
For this reason, the Board was concerned that the statutory formula for 
a higher-priced covered transaction might be over-inclusive. 
Accordingly, the Board solicited comment on whether the ``transaction 
coverage rate'' (TCR) should be used for this determination, instead of 
the annual percentage rate. 76 FR 27412. The TCR had previously been 
proposed in conjunction with a more inclusive version of the APR, in 
order to avoid having the more inclusive, hence higher, APRs trigger 
certain requirements unnecessarily. The TCR includes fewer charges, and 
the Board's 2011 Escrows Proposal proposed to use it in the threshold 
test for determining application of those requirements. 76 FR 11598, 
11626-11627 (Mar. 2, 2011).
    The only comment substantively discussing the possible substitution 
of the TCR for the APR was strongly opposed to the idea, stating that 
it would create unnecessary compliance difficulty and costs. The Bureau 
has determined that possible transition to a TCR standard will 
implicate several rules and is not appropriate at the present time. 
However, the issue will be considered further as part of the Bureau's 
TILA/RESPA rulemaking. See 77 FR 51116, 51126 (Aug. 23, 2012).
    The Board also solicited comment on whether or not to provide a 
higher threshold for jumbo balloon-payment mortgages or for balloon-
payment mortgages secured by a residence that is not the consumer's 
principal dwelling, e.g., a vacation home. 76 FR 27412. The Board 
requested this information due to its belief that higher interest rates 
charged for these loans might render them unavailable without the 
adjustment. The margin above APOR suggested for first-lien jumbo 
balloon-payment mortgages was 2.5 percentage points.
    Two industry commenters supported the higher threshold for jumbo 
loans, arguing that the current thresholds would interfere with credit 
accessibility. One of these commenters also stated that the higher 
threshold should be available for all balloon-payment mortgages. No 
commenters discussed the non-principal-dwelling threshold.
    Many other commenters objected strongly to the statutory 
requirement, implemented in the proposed rule, that the balloon payment 
be considered in applying the ability-to-repay requirements to higher-
priced covered transaction balloon-payment mortgages. These industry 
commenters felt that the percentage point thresholds were too low, and 
that many loans currently being made would become unavailable. They did 
not, however, submit sufficient data to help the Bureau assess these 
claims. Other commenters, including several consumer protection 
advocacy organizations, argued that the higher-priced rule would be 
helpful in ensuring consumers' ability to repay their loans.
    The Bureau has evaluated the proposed definition of ``higher-priced 
covered transaction'' not only in relation to its use in the payment 
determination for balloon-payment mortgages, but also in the light of 
its application in other provisions of the final rule. For example, as 
discussed below, the final rule varies the strength of the presumption 
of compliance for qualified mortgages. A qualified mortgage designated 
as a higher-priced covered transaction will be presumed to comply with 
the ability-to repay-provision at Sec.  1026.43(c)(1), but will not 
qualify for the safe harbor provision. See Sec.  1026.43(e)(1)(ii) and 
(i).
    Specifically, the Bureau has considered whether to adopt a 
different threshold to define high price mortgage loans for jumbo loans 
than for other loans. The Bureau notes that the Board expressly 
addressed this issue in its 2008 HOEPA Final Rule and concluded not to 
do so. The Board explained that although prime jumbo loans have always 
had somewhat higher rates than prime conforming loans, the spread has 
been quite volatile.\96\ The Board concluded that it was sounder to err 
on the side of being over-inclusive than to set a higher threshold for 
jumbo loans and potentially fail to include subprime jumbo loans.\97\ 
The Bureau is persuaded by the Board's reasoning.
---------------------------------------------------------------------------

    \96\ See 73 FR 44537 (July 30, 2008)
    \97\ Id.
---------------------------------------------------------------------------

    The Bureau recognizes that in the Dodd-Frank Act Congress, in 
requiring creditors to establish escrows accounts for certain 
transactions and in requiring appraisals for certain transactions based 
upon the interest rate of the transactions, did establish a separate 
threshold for jumbo loans. The Bureau is implementing that separate 
threshold in its 2013 Escrows Final Rule which is being issued 
contemporaneously with this final rule. However, the Bureau also notes 
that in the ability-to-repay provision of the Dodd-Frank Act, Congress 
mandated underwriting rules for balloon-payment mortgages which vary 
based upon the pricing of the loan, and in doing so Congress followed 
the thresholds adopted by the Board in its 2008 HOEPA Final Rule and 
did not add a separate threshold for jumbo loans. The fact that the Act 
uses the Board's criteria in the ability to repay context lends further 
support to the Bureau's decision to use those criteria as well in 
defining higher-priced loans under the final rule.
    Accordingly, the Bureau is not providing for a higher threshold for 
jumbo or non-principal dwelling balloon-payment mortgages at this time. 
In regard to the possibility of a higher threshold for non-principal 
dwellings such as vacation homes, the Bureau understands that such 
products have historically been considered to be at higher risk of 
default than loans on

[[Page 6453]]

principal dwellings. Therefore, any difference in rates is likely 
driven by the repayment risk associated with the product, and a rule 
meant to ensure a consumer's ability to repay the loan should not 
provide an exemption under these circumstances. And further, the Bureau 
did not receive and is not aware of any data supporting such an 
exemption.
    The Bureau does not believe that these decisions regarding jumbo 
and non-principal-dwelling balloon-payment mortgages are likely to 
create any credit accessibility problems. In this final rule at Sec.  
1026.43(f), the Bureau is adopting a much wider area in which 
institutions that provide credit in rural or underserved areas may 
originate qualified mortgages that are balloon-payment loans than did 
the proposed rule. Because these are the areas in which balloon-payment 
loans are considered necessary to preserve access to credit, and 
higher-priced balloon-payment mortgages in these areas can meet the 
criteria for a qualified mortgage and thus will not have to include the 
balloon payment in the ability-to-repay evaluation, access to necessary 
balloon-payment mortgages will not be reduced.
    Accordingly, Sec.  1026.43(b)(4) is adopted as proposed. The 
associated commentary is amended with revisions to update information 
and citations.
43(b)(5)
    The proposed rule defined ``loan amount'' as ``the principal amount 
the consumer will borrow as reflected in the promissory note or loan 
contract.'' This definition implemented the statutory language 
requiring that the monthly payment be calculated assuming that ``the 
loan proceeds are fully disbursed on the date of consummation of the 
loan.'' Dodd-Frank Act section 1411(a)(2), TILA section 
129C(a)(6)(D)(i). The term ``loan amount'' was used in the proposed 
definition of ``fully amortizing payment'' in Sec.  226.43(b)(2), which 
was then used in the general ``payment calculation'' at Sec.  
226.43(c)(5)(i)(B). The payment calculation required the use of 
payments that pay off the loan amount over the actual term of the loan.
    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 recognized 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.  1026.17(c)(6), 
discussing multiple-advance loans and comment 17(c)(6)-2 and -3. 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 clarified 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. Proposed comment 
43(b)(5)-1 provided an illustrative example and stated that generally, 
creditors should rely on Sec.  1026.17(c)(6) and associated commentary 
regarding treatment of multiple-advance and construction loans that 
would be covered by the ability-to-repay requirements (i.e., loans with 
a term greater than 12 months). See Sec.  1026.43(a)(3) discussing 
scope of coverage and term length.
    The Board specifically solicited comment on whether further 
guidance was needed regarding determination of the loan amount for 
loans with multiple disbursements. The Bureau did not receive comments 
on the definition of ``loan amount'' or its application to loans with 
multiple disbursements. The Bureau believes that the loan amount for 
multiple disbursement loans that are covered transactions must be 
determined assuming that ``the loan proceeds are fully disbursed on the 
date of consummation of the loan'' \98\ as required by the statute and 
the rule, and explained in comment 43(b)(5)-1.
---------------------------------------------------------------------------

    \98\ Dodd-Frank Act section 1411(a)(2), TILA section 
129C(a)(6)(D)(i).
---------------------------------------------------------------------------

    Accordingly, the Bureau is adopting Sec.  1026.43(b)(5) and 
associated commentary as proposed.
43(b)(6)
    The interchangeable phrases ``loan term'' and ``term of the loan'' 
appear in the ability-to-repay and qualified mortgage provisions of 
TILA, with no definition. See TILA section 129C(c)(3), 
129C(a)(6)(D)(ii), 129C(b)(2)(A)(iv) and (v); 15 U.S.C. 1639c(c)(3), 
1639c(a)(6)(D)(ii), 1639c(b)(2)(A)(iv) and (v). The proposed rule 
defined ``loan term'' as ``the period of time to repay the obligation 
in full.'' Proposed comment 43(b)(6)-1 clarified that the loan term is 
the period of time it takes to repay the loan amount in full, and 
provided an example. The term is used in Sec.  1026.43(b)(2), the 
``fully amortizing payment'' definition, which is then used in Sec.  
1026.43(c)(5)(i), the payment calculation general rule. It is also used 
in the qualified mortgage payment calculation at Sec.  
1026.43(e)(2)(iv). The Bureau did not receive any comments on this 
definition, and considers it to be an accurate and appropriate 
implementation of the statutory language. Accordingly, proposed Sec.  
1026.43(b)(6) is adopted as proposed.
43(b)(7)
    The definition of ``maximum loan amount'' and the calculation for 
which it is used implement the requirements regarding negative 
amortization loans in new TILA section 129C(a)(6)(C) and (D). The 
statute requires that a creditor ``take into consideration any balance 
increase that may accrue from any negative amortization provision.''
    The ``maximum loan amount'' is defined in the proposed rule as 
including the loan balance and any amount that will be added to the 
balance as a result of negative amortization assuming the consumer 
makes only minimum payments and the maximum interest rate is reached at 
the earliest possible time. The ``maximum loan amount'' is used to 
determine a consumer's ability to repay for negative amortization loans 
under Sec.  1026.43(c)(5)(ii)(C) by taking into account any loan 
balance increase that may occur as a result of negative amortization. 
The term ``maximum loan amount'' is also used for negative amortization 
loans in the ``refinancing of non-standard mortgages'' provision, at 
Sec.  1026.43(d)(5)(i)(C)(3). The proposed rule included commentary on 
how to calculate the maximum loan amount, with examples. See comment 
43(b)(7)-1 through -3.
    The Bureau did not receive any comments on this definition and 
considers it to be an accurate and appropriate implementation of the 
statute. Accordingly, Sec.  1026.43(b)(7) and associated commentary are 
adopted as proposed.
43(b)(8)
    TILA section 129C(a)(1) and (3), as added by section 1411 of the 
Dodd-Frank Act, requires creditors to consider and verify mortgage-
related obligations as part of the ability-to-repay determination 
``according to [the loan's] terms, and all applicable taxes, insurance 
(including mortgage guarantee insurance), and assessments.'' TILA 
section 129C(a)(2) provides that consumers must have ``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.'' Although the Dodd-Frank Act did not establish or

[[Page 6454]]

define a single, collective term, the foregoing requirements recite 
ongoing obligations that are substantially similar to the definition of 
``mortgage-related obligation'' used elsewhere in Regulation Z. Section 
1026.34(a)(4)(i), which was added by the 2008 HOEPA Final Rule, defines 
mortgage-related obligations as expected property taxes, premiums for 
mortgage-related insurance required by the creditor as set forth in the 
relevant escrow provisions of Regulation Z, and similar expenses. 
Comment 34(a)(4)(i)-1 clarifies that, for purposes of Sec.  
1026.34(a)(4)(i), similar expenses include homeowners association dues 
and condominium or cooperative fees. Section 1026.35(b)(3)(i), which 
addresses escrows, states that ``premiums for mortgage-related 
insurance required by the creditor, [include] 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.''
    Under the Board's proposed Sec.  226.43(b)(8), ``mortgage-related 
obligations'' was defined to mean property taxes; mortgage related 
insurance premiums required by the creditor as set forth in proposed 
Sec.  226.45(b)(1); homeowners association, condominium, and 
cooperative fees; ground rent or leasehold payments; and special 
assessments. The Board's proposed definition was substantially similar 
to the definition under Sec.  1026.34(a)(4)(i), with three 
clarifications. First, the proposed definition of mortgage-related 
obligations would have included a reference to ground rent or leasehold 
payments, which are payments made to the real property owner or 
leaseholder for use of the real property. Second, the proposed 
definition would have included a reference to ``special assessments.'' 
Proposed comment 43(b)(8)-1 would have clarified 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, mortgage-related obligations would have 
referenced proposed Sec.  226.45(b)(1), where the Board proposed to 
recodify the existing escrow requirement for higher-priced mortgage 
loans, 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. The Board solicited 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 
improvements.
    Proposed comment 43(b)(8)-1 would have clarified further that 
mortgage-related obligations include mortgage-related insurance 
premiums only if required by the creditor. This comment would have 
explained that the creditor need not include premiums for mortgage-
related insurance that the creditor 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 have referred to commentary associated with proposed 
Sec.  226.43(c)(2)(v), which sets forth the requirement to take into 
account any mortgage-related obligations for purposes of the repayment 
ability determination required under proposed Sec.  226.43(c).
    Industry commenters and consumer advocates generally supported the 
Board's proposed definition of mortgage-related obligations. One 
industry commenter opposed including community transfer fees, which are 
deed-based fees imposed upon the transfer of the property. This 
commenter was concerned that subjecting these fees to Federal law might 
affect existing contracts, deeds, and covenants related to these fees, 
which are subject to State and local regulation, as well as common law 
regarding the transfer of real property. The commenter also asked that 
special assessments not fall under the definition of mortgage-related 
obligations. The commenter recommended that, if special assessments are 
included, creditors be required to consider only current special 
assessments, not future special assessments. The commenter noted that, 
while common assessments should be included in the definition of 
mortgage-related obligations, the Bureau should provide guidance to 
creditors on the substance of questionnaires seeking information from 
third parties about mortgage-related obligations.
    Certain consumer advocates suggested that voluntary insurance 
premiums be included in the definition of mortgage-related obligations. 
One consumer advocate explained that premiums such as these are 
technically voluntary, but many consumers believe them to be required, 
or have difficulty cancelling them if they choose to cancel them. 
Community advocates and several industry commenters also recommended 
that homeowners association dues, and similar charges, be included in 
the definition of mortgage-related obligations. They argued that such a 
requirement would further transparency in the mortgage loan origination 
process and would help ensure that consumers receive only credit they 
can reasonably expect to repay.
    For the reasons discussed below, the Bureau concludes that property 
taxes, certain insurance premiums required by the creditor, obligations 
to community governance associations, such as cooperative, condominium, 
and homeowners associations, ground rent, and lease payments should be 
included in the definition of mortgage-related obligations. These 
obligations are incurred in connection with the mortgage loan 
transaction but are in addition to the obligation to repay principal 
and interest. Thus, the cost of these obligations should be considered 
with the obligation to repay principal and interest for purposes of 
determining a consumer's ability to repay. Further, the Bureau believes 
that the word `assessments' in TILA section 129C is most appropriately 
interpreted to refer to all obligations imposed on consumers in 
connection with ownership of the dwelling or real property, such as 
ground rent, lease payments, and, as discussed in detail below, 
obligations to community governance associations, whether denominated 
as association dues, special assessments, or otherwise. While the 
provision adopted by the Bureau is substantially similar to the 
provision proposed, the Bureau was persuaded by the comment letters 
that additional clarity and guidance is required. The Bureau is 
especially sensitive to the fact that many of the loans that will be 
subject to the ability-to-repay rules may be made by small 
institutions, which are often unable to devote substantial resources to 
analysis of regulatory compliance.
    To address the concerns and feedback raised in the comment letters, 
the Bureau has revised Sec.  1026.43(b)(8) and related commentary in 
two ways. First, the language of Sec.  1026.43(b)(8) is being modified 
to add additional clarity. As adopted, Sec.  1026.43(b)(8) refers to 
premiums and similar charges identified in Sec.  1026.4(b)(5), (7), 
(8), or (10), if required by the creditor, instead of the proposed 
language, which referred to ``mortgage-related insurance.'' Second, the 
commentary is being significantly expanded to provide additional 
clarification and guidance.
    As adopted, Sec.  1026.43(b)(8) defines ``mortgage-related 
obligations'' to mean

[[Page 6455]]

property taxes; premiums and similar charges identified in Sec.  
1026.4(b)(5), (7), (8), or (10) that are required by the creditor; fees 
and special assessments imposed by a condominium, cooperative, or 
homeowners association; ground rent; and leasehold payments. As 
proposed, comment 43(b)(8)-1 discussed all components of the proposed 
definition. To provide further clarity, the final rule splits the 
content of proposed comment 43(b)(8)-1 into four separate comments, 
each of which provides additional guidance. As adopted by the Bureau, 
comment 43(b)(8)-1 contains general guidance and a cross-reference to 
Sec.  1026.43(c)(2)(v), which contains the requirement to take into 
account any mortgage-related obligations for purposes of determining a 
consumer's ability to repay.
    The multitude of requests for additional guidance and clarification 
suggests that additional clarification of the meaning of ``property 
tax'' is needed. Comment 43(b)(8)-2 further clarifies that Sec.  
1026.43(b)(8) includes obligations that are functionally equivalent to 
property taxes, even if such obligations follow a different naming 
convention. For example, governments may establish independent 
districts with the authority to impose recurring levies on properties 
within the district to fund a special purpose, such as a local 
development bond district, water district, or other public purpose. 
These recurring levies may have a variety of names, such as taxes, 
assessments, or surcharges. Comment 43(b)(8)-2 clarifies that 
obligations such as these are property taxes based on the character of 
the obligation, as opposed to the name of the obligation, and therefore 
are mortgage-related obligations.
    Most comments supported the inclusion of insurance premiums in the 
ability-to-repay determination. However, the Bureau believes that some 
modifications to the proposed ``mortgage-related insurance premium'' 
language are appropriate. The Bureau is persuaded that additional 
clarification and guidance is important, and the Bureau is especially 
sensitive to concerns related to regulatory complexity. The Bureau has 
determined that the proposed language should be clarified by revising 
the text to refer to the current definition of finance charge under 
Sec.  1026.4. The components of the finance charge are long-standing 
parts of Regulation Z. Explicitly referring to existing language should 
facilitate compliance. Therefore, Sec.  1026.43(b)(8) defines mortgage-
related obligations to include all premiums or other charges related to 
protection against a consumer's default, credit loss, collateral loss, 
or similar loss as identified in Sec.  1026.4(b)(5), (7), (8), or (10) 
except, as explained above, those premiums or charges that that are not 
required by the creditor. Comment 43(b)(8)-3 also contains illustrative 
examples of this definition. For example, if Federal law requires flood 
insurance to be obtained in connection with the mortgage loan, the 
flood insurance premium is a mortgage-related obligation for purposes 
of Sec.  1026.43(b)(8).
    Several commenters stated that insurance premiums and similar 
charges should be included in the determination even if the creditor 
does not require them in connection with the loan transaction. The 
Bureau has carefully considered these arguments, but has determined 
that insurance premiums and similar charges should not be considered 
mortgage-related obligations if such premiums and charges are not 
required by the creditor and instead have been voluntarily purchased by 
the consumer. The Bureau acknowledges that obligations such as these 
are usually paid from a consumer's monthly income and, in a sense, 
affect a consumer's ability to repay. But the consumer is free to 
cancel recurring obligations such as these at any time, provided they 
are truly voluntary. Thus, they are not ``obligations'' in the sense 
required by section 129C(a)(3) of TILA. The Bureau shares the concern 
raised by several commenters that unscrupulous creditors may mislead 
consumers into believing that these charges are not optional or cannot 
be cancelled. However, the Bureau does not believe that altering the 
ability-to-repay calculation for all is the appropriate method for 
combatting the harmful actions of a few. The Bureau believes that the 
better course of action is to exclude such premiums and charges from 
the definition of mortgage-related obligations only if they are truly 
voluntary, and is confident that violations of this requirement will be 
apparent in specific cases from the facts. Also, in the scenarios 
described by commenters where consumers are misled into believing that 
such charges are required, the premium or charge would not be voluntary 
for purposes of the definition of finance charge under Sec.  1026.4(d), 
and would therefore be a mortgage-related obligation for the purposes 
of Sec.  1026.43(b)(8). Therefore, comment 43(b)(8)-3 clarifies that 
insurance premiums and similar charges identified in Sec.  
1026.4(b)(5), (7), (8), or (10) that are not required by the creditor 
and that the consumer purchases voluntarily are not mortgage-related 
obligations for purposes of Sec.  1026.43(b)(8). For example, if a 
creditor does not require earthquake insurance to be obtained in 
connection with the mortgage loan, but the consumer voluntarily chooses 
to purchase such insurance, the earthquake insurance premium is not a 
mortgage-related obligation for purposes of Sec.  1026.43(b)(8). Or, if 
a creditor requires a minimum amount of coverage for homeowners' 
insurance and the consumer voluntarily chooses to purchase a more 
comprehensive amount of coverage, the portion of the premium allocated 
to the minimum coverage is a mortgage-related obligation for the 
purposes of Sec.  1026.43(b)(8), while the portion of the premium 
allocated to the more comprehensive coverage voluntarily purchased by 
the consumer is not a mortgage-related obligation for the purposes of 
Sec.  1026.43(b)(8). However, if the consumer purchases non-required 
insurance or similar coverage at consummation without having requested 
the specific non-required insurance or similar coverage and without 
having agreed to the premium or charge for the specific non-required 
insurance or similar coverage prior to consummation, the premium or 
charge is not voluntary for purposes of Sec.  1026.43(b)(8) and is a 
mortgage-related obligation.
    Several commenters supported the inclusion of mortgage insurance in 
the definition of mortgage-related obligations. The Bureau also has 
received several informal requests for guidance regarding the meaning 
of the term ``mortgage insurance'' in the context of certain 
disclosures required by Regulation Z. The Bureau has decided to clarify 
this issue with respect to the requirements of Sec.  1026.43. Thus, 
comment 43(b)(8)-4 clarifies that Sec.  1026.43(b)(8) includes all 
premiums or similar charges for coverage protecting the creditor 
against the consumer's default or other credit loss in the 
determination of mortgage-related obligations, whether denominated as 
mortgage insurance, guarantee insurance, or otherwise, as determined 
according to applicable State or Federal law. For example, monthly 
``private mortgage insurance'' payments paid to a non-governmental 
entity, annual ``guarantee fee'' payments required by a Federal housing 
program, and a quarterly ``mortgage insurance'' payment paid to a State 
agency administering a housing program are all mortgage-related 
obligations for purposes of Sec.  1026.43(b)(8). Comment

[[Page 6456]]

43(b)(8)-4 also clarifies that Sec.  1026.43(b)(8) includes these 
charges in the definition of mortgage-related obligations if the 
creditor requires the consumer to pay them, even if the consumer is not 
legally obligated to pay the charges under the terms of the insurance 
program. Comment 43(b)(8)-4 also contains several other illustrative 
examples.
    Several comment letters stressed the importance of including 
homeowners association dues and similar obligations in the 
determination of ability to repay. These letters noted that, during the 
subprime crisis, the failure to account for these obligations led to 
many consumers qualifying for mortgage loans that they could not 
actually afford. The Bureau agrees with these assessments. Recurring 
financial obligations payable to community governance associations, 
such as homeowners association dues, should be taken into consideration 
in determining whether a consumer has the ability to repay the 
obligation. While several comment letters identified practical problems 
with including obligations such as these in the calculation, these 
issues stemmed from difficulties that may arise in calculating, 
estimating, or verifying these obligations, rather than whether the 
obligations should be included in the ability-to-repay calculation. 
Based on this feedback, Sec.  1026.43(b)(8) includes obligations to a 
homeowners association, condominium association, or condominium 
association in the determination of mortgage-related obligations. The 
Bureau has addressed the concerns related to difficulties in 
calculating, estimating, or verifying such obligations in the 
commentary to Sec.  1026.43(c)(2)(v) and (c)(3).
    One comment letter focused extensively on community transfer fees, 
which are deed-based fees imposed upon the transfer of the property. 
The Bureau recognizes that this topic is complex and is often the 
subject of special requirements imposed at the State and local level. 
However, the Bureau does not believe that the requirements of Sec.  
1026.43 implicate these complex issues. The narrow question is whether 
such obligations should be considered mortgage-related obligations for 
purposes of determining the consumer's ability to repay. The Bureau 
agrees with the argument, advanced by several commenters, that the 
entirety of the consumer's ongoing obligations should be included in 
the determination. A responsible determination of the consumer's 
ability to repay requires an accounting of such obligations, whether 
the purpose of the obligation is to satisfy the payment of a community 
transfer fee or traditional homeowners association dues. As with other 
obligations owed to condominium, cooperative, or homeowners 
associations discussed above, the Bureau believes that the practical 
problems with these obligations relate to when such obligations should 
be included in the determination of the consumer's ability to repay, 
rather than whether the obligations should be considered mortgage-
related obligations. Therefore, the Bureau has addressed the concerns 
related to these obligations in the commentary to Sec.  
1026.43(c)(2)(v) and (c)(3).
    In response to the request for feedback in the 2011 ATR Proposal, 
several commenters addressed the proposed treatment of special 
assessments. Unlike community transfer fees, which are generally 
identified in the deed or master community plan, creditors may 
encounter difficulty determining whether special assessments exist. 
However, as with similar charges discussed above, these concerns relate 
to determining the consumer's monthly payment for mortgage-related 
obligations, rather than whether these charges should be considered 
mortgage-related obligations. Special assessments may be significant 
and may affect the consumer's ability to repay a mortgage loan. Thus, 
the Bureau has concluded that special assessments should be included in 
the definition of mortgage-related obligations under Sec.  
1026.43(b)(8) and has addressed the concerns raised by commenters 
related to calculating, estimating, or verifying these obligations in 
the commentary to Sec.  1026.43(c)(2)(v) and (c)(3).
    New comment 43(b)(8)-5 explains that Sec.  1026.43(b)(8) includes 
in the evaluation of mortgage-related obligations premiums and similar 
charges identified in Sec.  1026.4(b)(5), (7), (8), or (10) that are 
required by the creditor. These premiums and similar charges are 
mortgage-related obligations regardless of whether the premium or 
similar charge is excluded from the finance charge pursuant to Sec.  
1026.4(d). For example, a premium for insurance against loss or damage 
to the property written in connection with the credit transaction is a 
premium identified in Sec.  1026.4(b)(8). If this premium is required 
by the creditor, the premium is a mortgage-related obligation pursuant 
to Sec.  1026.43(b)(8), regardless of whether the premium is excluded 
from the finance charge pursuant to Sec.  1026.4(d)(2). Commenters did 
not request this guidance specifically, but the Bureau believes that 
this comment is needed to provide additional clarity.
43(b)(9)
    TILA section 129C(b)(2)(C) generally defines ``points and fees'' 
for a qualified mortgage to have the same meaning as in TILA section 
103(bb)(4), which defines points and fees for the purpose of 
determining whether a transaction exceeds the HOEPA points and fees 
threshold. Proposed Sec.  226.43(b)(9) would have provided that 
``points and fees'' has the same meaning as in Sec.  226.32(b)(1). The 
Bureau adopts this provision as renumbered Sec.  1026.43(b)(9).
43(b)(10)
    Sections 1414, 1431, and 1432 of the Dodd-Frank Act amended TILA to 
restrict, and in many cases, prohibit a creditor from imposing 
prepayment penalties in dwelling-secured credit transactions. TILA does 
not, however, define the term ``prepayment penalty.'' In an effort to 
address comprehensively prepayment penalties in a fashion that eases 
compliance burden, as discussed above, the Bureau is defining 
prepayment penalty in Sec.  1026.43(b)(10) by cross-referencing Sec.  
1026.32(b)(6). For a full discussion of the Bureau's approach to 
defining prepayment penalties, see Sec.  1026.32(b)(6), its commentary, 
and the section-by-section analysis of those provisions above.
43(b)(11)
    TILA in several instances uses the term ``reset'' to refer to the 
time at which the terms of a mortgage loan are adjusted, usually 
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 low introductory rates convert to indexed rates, 
resulting in ``significantly higher monthly payments for homeowners.'' 
\99\
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    \99\ See Comm. on Fin. Servs., Report on H.R. 1728, Mortgage 
Reform and Anti-Predatory Lending Act, H. Rept. 94, 111th Cong., at 
52 (2009).
---------------------------------------------------------------------------

    Outreach conducted prior to issuance of the proposed rule indicated 
that the term ``recast'' is typically used in reference to the time at 
which fully amortizing payments are required for interest-only and 
negative amortization loans and that the term ``reset'' is more

[[Page 6457]]

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 proposed to use the term 
``recast'' to cover the conversion to generally less favorable terms 
and higher payments not only for interest-only loans and negative 
amortization loans, but also for adjustable-rate mortgages.
    Proposed Sec.  226.43(b)(11) defined the term ``recast,'' which was 
used in two provisions 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, proposed Sec.  226.43(b)(11) defined the term 
``recast'' as follows: (1) For an adjustable-rate mortgage, as defined 
in Sec.  1026.18(s)(7)(i),\100\ 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.  1026.18(s)(7)(iv),\101\ 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.  1026.18(s)(7)(v),\102\ the expiration of the 
period during which negatively amortizing payments are permitted under 
the terms of the legal obligation.
---------------------------------------------------------------------------

    \100\ ``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 
1026.18(s)(7)(i).
    \101\ ``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 1026.18(s)(7)(iv).
    \102\ ``[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, other than a reverse mortgage 
subject to section 1026.33, that provides for a minimum periodic 
payment that covers only a portion of the accrued interest, 
resulting in negative amortization.'' 12 CFR 1026.18(s)(7)(v).
---------------------------------------------------------------------------

    Proposed comment 43(b)(11)-1 explained that the date on which the 
``recast'' occurs is the due date of the last monthly payment based on 
the introductory fixed rate, the last interest-only payment, or the 
last negatively amortizing payment, as applicable. Proposed comment 
43(b)(11)-1 also provided an illustration showing how to determine the 
date of the recast.
    Commenters did not focus specifically on the definition of 
``recast,'' except that an association of State bank regulators agreed 
with the benefit of using a single term for the shift to higher 
payments for adjustable-rate, interest-only, and negative amortization 
loans.
    The Bureau considers the proposed provision to be an accurate and 
appropriate implementation of the statute. Accordingly, the Bureau is 
adopting proposed Sec.  226.43(b)(11) as proposed, in renumbered Sec.  
1026.43(b)(11).
    43(b)(12)
    New TILA section 129C(a)(2) 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,'' that creditor 
must make the ability-to-repay determination for ``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.'' This section, entitled 
``multiple loans,'' follows the basic ability-to-repay requirements for 
a single loan, in new TILA section 129C(a)(1).
    The proposed rule implemented the main requirement of the 
``multiple loans'' provision by mandating in proposed Sec.  
226.43(c)(2)(iv) that a creditor, in making its ability-to-repay 
determination on the primary loan, take into account the payments on 
any ``simultaneous loan'' about which the creditor knows or has reason 
to know. ``Simultaneous loan'' was defined in proposed Sec.  
226.43(b)(12) as ``another covered transaction or home equity line of 
credit subject to Sec.  226.5b \103\ that will be secured by the same 
dwelling and made to the same consumer at or before consummation of the 
covered transaction.'' Thus, although the statute referred only to 
closed-end ``residential mortgage loans,'' the Board proposed to expand 
the requirement to include consideration of simultaneous HELOCs. The 
proposed definition did not include pre-existing mortgage obligations, 
which would be considered as ``current debt obligations'' under Sec.  
1026.43(c)(2)(vi).
---------------------------------------------------------------------------

    \103\ The Board's Sec.  226.5b was recodified in the Bureau's 
Regulation Z as Sec.  1026.40.
---------------------------------------------------------------------------

    The Board chose to include HELOCs in the definition of 
``simultaneous loan'' because it believed that new TILA section 
129C(a)(2) was 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. The Board believed that this increased risk 
would be present whether the other mortgage obligation was a closed-end 
credit obligation or a HELOC. For these reasons, and several others 
explained in detail below, the Board proposed to use its exception and 
adjustment authority under TILA section 105(a) to include HELOCs within 
the scope of new TILA section 129C(a)(2). 76 FR 27417-27418. Because 
one of the main reasons for including HELOCs was the likelihood of a 
consumer drawing on the credit line to provide the down payment in a 
purchase transaction, the Board solicited comment on whether this 
exception should be limited to purchase transactions.
    TILA section 105(a), as amended by section 1100A of the Dodd-Frank 
Act, authorized the Board, and now the Bureau, 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 was 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 found 
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 believed that 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 proposed 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.  1026.34(a)(4), proposed Sec.  226.43(c)(2)(vi) would not 
have distinguished between pre-existing closed-end and open-end 
mortgage obligations. The Board believed consistency required that it 
take the same approach when determining how to consider mortgage 
obligations that come into existence concurrently with a first-lien 
loan as would be 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) was

[[Page 6458]]

also considered generally consistent with current comment 34(a)(4)-3, 
and the 2006 Nontraditional Mortgage Guidance regarding simultaneous 
second-lien loans.\104\
---------------------------------------------------------------------------

    \104\ See 2006 Nontraditional Mortgage Guidance, 71 FR 58609, 
58614 (Oct. 4, 2006).
---------------------------------------------------------------------------

    Second, data indicate that where a subordinate loan is originated 
concurrently with a first-lien loan to provide some or all of the down 
payment (i.e., a ``piggyback loan''), the default rate on the first-
lien loan increases significantly, and in direct correlation to 
increasing combined loan-to-value ratios.\105\ 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 percent 
of consumers who open a HELOC concurrently with a first-lien loan 
borrow against the line of credit at the time of origination,\106\ 
suggesting that in many cases the HELOC may be used to provide some, or 
all, of the down payment on the first-lien loan.
---------------------------------------------------------------------------

    \105\ Kristopher Gerardi et al., Making Sense of the Subprime 
Crisis, Brookings Papers on Econ. Activity (Fall 2008), at 40 tbl.3.
    \106\ 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 was extracted from credit record data in years 2003 through 
2010. See Donghoon Lee and Wilbert van der Klaauw, An Introduction 
to the FRBNY Consumer Credit Panel (Fed. Reserve Bd. Of N.Y.C., 
Staff Rept. No. 479, 2010), available at  http://data.newyorkfed.org/research/staff_reports/sr479.pdf (providing 
further description of the database).
---------------------------------------------------------------------------

    The Board recognized 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 believed 
concerns relating to HELOCs originated concurrently for savings or 
convenience, and not to provide payment towards the first-lien home 
purchase loan, might 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 
recognized that in the case of a non-purchase transaction (e.g., a 
refinancing) a simultaneous loan that is a HELOC might be unlikely to 
be originated and drawn upon to provide payment towards the first-lien 
loan, except perhaps towards closing costs. Thus, the Board solicited 
comment on whether it should narrow the requirement to consider 
simultaneous loans that are HELOCs to apply only to purchase 
transactions.
    Third, in developing this proposal Board 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 percent of its simultaneous loan book-of-business. Industry outreach 
participants generally indicated that it is a currently 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. For these reasons, the Board proposed to use its 
authority under TILA sections 105(a) and 129B(e) to broaden the scope 
of TILA section 129C(a)(2), and accordingly proposed to define the term 
``simultaneous loan'' to include HELOCs.
    Proposed comment 43(b)(12)-1 clarified 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.
    Proposed comment 43(b)(12)-2 further clarified the meaning of the 
term ``same consumer,'' and explained that for purposes of the 
definition of ``simultaneous loan,'' the term ``same consumer'' would 
include any consumer, as that term is defined in Sec.  1026.2(a)(11), 
that enters into a loan that is a covered transaction and also enters 
into another loan (e.g., a second-lien covered transaction or HELOC) 
secured by the same dwelling. This comment further explained 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. The Board believed this comment 
would reflect 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 Sec.  129C(a)(2).
    Both industry and consumer advocate commenters overwhelmingly 
supported inclusion of HELOCs as simultaneous loans, with only one 
industry commenter objecting. The objecting commenter stated that there 
was no persuasive policy argument for deviating from the statute, but 
did not provide any reason to believe that concurrent HELOCs are less 
relevant to an assessment of a consumer's ability to repay than 
concurrent closed-end second liens. As explained in the proposed rule, 
most industry participants are already considering HELOCs in the 
underwriting of senior-lien loans on the same property. 76 FR 27418.
    For the reasons set forth by the Board and discussed above, the 
Bureau has determined that inclusion of HELOCs in the definition of 
simultaneous loans is an appropriate use of its TILA authority to make 
adjustments and additional requirements.
    TILA section 105(a), as amended by section 1100A of the Dodd-Frank 
Act, authorizes the Bureau to prescribe regulations that 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 judgment of the Bureau 
are necessary or proper to effectuate the purposes of TILA, to prevent 
circumvention or evasion of TILA, or to facilitate compliance with 
TILA. 15 U.S.C. 1604(a). The Bureau finds that the inclusion of HELOCs 
is necessary and proper to effectuate the purposes of TILA. The 
inclusion of HELOCs is further supported by the Bureau's authority 
under TILA section 129B(e) to condition terms, acts or practices 
relating to residential mortgage loans that the Bureau finds necessary 
or proper to effectuate the purposes of TILA. 15 U.S.C. 1639b(e). TILA 
section 129B(a)(2) 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. Inclusion of HELOCs as 
simultaneous loans will help to carry out this purpose of TILA by 
helping to ensure that consumers receive loans on affordable terms, as 
further explained above.
    Accordingly, the Bureau is adopting Sec.  1026.43(b)(12) and 
associated commentary as proposed, with clarifying edits to ensure that 
simultaneous loans scheduled after

[[Page 6459]]

consummation will be considered in determining ability to repay.
43(b)(13)
    TILA section 129C(a)(1) requires that a creditor determine a 
consumer's repayment ability using ``verified and documented 
information,'' and TILA section 129C(a)(4) specifically requires the 
creditor to verify 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 Sec.  1026.43(c)(3) and (4). The Board proposed to 
define the term ``third-party record'' to mean: (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.  1026.36(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. The Board 
explained that, in general, a creditor should refer to reasonably 
reliable records prepared by or reviewed by a third party to verify 
repayment ability under TILA section 129C(a), a principle consistent 
with verification requirements previously outlined under the Board's 
2008 HOEPA Final Rule. See Sec.  1026.34(a)(4)(ii).
    Commenters generally supported the Board's broad definition of a 
third-party record as a reasonable definition that allows a creditor to 
use a wide variety of documents and sources, while ensuring that the 
consumer does not remain the sole source of information. Some consumer 
advocates, however, cautioned the Bureau against relying upon tax 
records to provide a basis for verifying income history, pursuant to 
amended TILA section 129C(a)(4)(A), to avoid penalizing consumers who 
may not have access to accurate tax records. The Bureau does not 
address comments with respect to consumers who may not maintain 
accurate tax records because the definition provided in 1026.43(b)(13) 
of third-party record merely ensures that a creditor may use any of a 
wide variety of documents, including tax records, as a method of income 
verification without mandating their use. Rather than rely solely on 
tax records, for example, a creditor might look to other third-party 
records for verification purposes, including the creditor's records 
regarding a consumer's savings account held by the creditor, which 
qualifies as a third-party record under Sec.  1026.43(b)(13)(iii), or 
employment records for a consumer employed by the creditor, which 
qualifies as a third-party record under Sec.  1026.43(b)(13)(iv).
    The Board proposed comment 43(b)(13)-1 to clarify that third-party 
records would include records transmitted or viewed electronically, for 
example, a credit report prepared by a consumer reporting agency and 
transmitted or viewed electronically. The Bureau did not receive 
significant feedback on the proposed comment and is adopting the 
comment largely as proposed. The Bureau is clarifying that an 
electronic third-party record should be transmitted electronically, 
such as via email or if the creditor is able to click on a secure 
hyperlink to access a consumer's credit report. The Bureau is making 
this slight clarification to convey that mere viewing of a record, 
without the ability to capture or maintain the record, would likely be 
problematic with respect to record retention under Sec.  1026.25(a) and 
(c). While it seems unlikely that an electronic record could be viewed 
without being transmitted as well, the Bureau is making this alteration 
to avoid any confusion.
    The Bureau is adopting the remaining comments to 43(b)(13) largely 
as proposed by the Board. These comments did not elicit significant 
public feedback. Comment 43(b)(13)-1 assures creditors that a third-
party record may be transmitted electronically. 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. Thus, 
for example, a creditor may send a Webform, or mail a paper form, 
created by the creditor, to a consumer's current employer, on which the 
employer could check a box that indicates that the consumer works for 
the employer. The creditor may even elect to fill in the creditor's 
name, or other portions of the form, so long as those portions are 
unrelated to the information that the creditor seeks to verify, such as 
income or employment status.
    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.  1026.43(b)(13)(i). 
The Bureau is including comment 43(b)(13)(i)-1 to explain how some 
first-party records, e.g., documents originally prepared by the 
consumer, may become third-party records by virtue of an appropriate, 
disinterested third-party's review or audit. It is the third party 
review, the Bureau believes, that provides reasonably reliable evidence 
of the underlying information in the document, just as if the document 
were originally prepared by the third party. Moreover, this 
clarification allows the creditor to consult a wider variety of 
documents in its determination of a consumer's ability to repay. 
Creditors should be cautioned not to assume, however, that merely 
because a document is a third-party record as defined by Sec.  
1026.43(b)(13), and the creditor uses the information provided by that 
document to make a determination as to whether the consumer will have a 
reasonable ability to repay the loan according to its terms, that the 
creditor has satisfied the requirements of this rule. The creditor also 
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. For a 
full discussion of the Bureau's approach to this determination, see 
Sec.  1026.43(c)(1), its commentary, and the section-by-section 
analysis of those provisions below.
    Finally, comment 43(b)(13)(iii)-1 clarifies that a third-party 
record includes a record that the creditor maintains for the consumer's 
account. Such examples might include records of a checking account, 
savings account, and retirement account that the consumer holds, or has 
held, with the creditor. 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. This comment helps assure industry that such 
records are a legitimate basis for determining a consumer's ability to 
repay, and/or for verifying income and assets because it is unlikely to 
be in a creditor's interest to falsify such records for purposes of 
satisfying Sec.  1026.43(b)(13), as falsifying records would violate 
the good faith requirement of Sec.  1026.43(c)(1). In addition, this 
comment should help

[[Page 6460]]

assure creditors that the rule does not inhibit a creditor's ability to 
``cross-sell'' products to consumers, by avoiding placing the creditor 
at a disadvantage with respect to verifying a consumer's information by 
virtue of the creditor's existing relationship with the consumer.
43(c) Repayment Ability
    As enacted by the Dodd-Frank Act, 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, based on 
verified and documented information, 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) extends the same requirement to a 
combination of multiple residential mortgage loans secured by the same 
dwelling where the creditor knows or has reason to know that such loans 
will be made to the same consumer. TILA sections 129C(a)(3) and (a)(4) 
specify factors that must be considered in determining a consumer's 
ability to repay and verification requirements for income and assets 
considered as part of that determination. Proposed Sec.  226.43(c) 
would have implemented TILA section 129C(a)(1) through (4) in a manner 
substantially similar to the statute.
    Proposed Sec.  226.43(c)(1) would have implemented the requirement 
in TILA section 129C(a)(1) that creditors make a reasonable and good 
faith determination that a consumer will have a reasonable ability to 
repay the loan according to its terms. Proposed Sec.  226.43(c)(2) 
would have required creditors to consider the following factors in 
making a determination of repayment ability, as required by TILA 
section 129C(a)(1) through (3): the consumer's current or reasonably 
expected income or assets (other than the property that secures the 
loan); the consumer's employment status, if the creditor relies on 
employment income; the consumer's monthly payment on the loan; the 
consumer's monthly payment on any simultaneous loan that the creditor 
knows or has reason to know will be made; the consumer's monthly 
payment for mortgage-related obligations; the consumer's current debt 
obligations; and the consumer's monthly debt-to-income ratio or 
residual income. Proposed Sec.  226.43(c)(3) would have required that 
creditors verify the information they use in making an ability-to-repay 
determination using third-party records, as required by TILA section 
129C(a)(1). Proposed Sec.  226.43(c)(4) would have specified methods 
for verifying income and assets as required by TILA section 129C(a)(1) 
and (4). Proposed Sec.  226.43(c)(5) and (6) would have specified how 
to calculate the monthly mortgage and simultaneous loan payments 
required to be considered under proposed Sec.  226.43(c)(2). Proposed 
Sec.  226.43(c)(7) would have specified how to calculate the monthly 
debt-to-income ratio or monthly residual income required to be 
considered under proposed Sec.  226.43(c)(2). As discussed in detail 
below, the Bureau is adopting Sec.  1026.43(c) substantially as 
proposed, with various modifications and clarifications.
    Proposed comment 43(c)-1 would have indicated that creditors may 
look to widely accepted governmental or nongovernmental underwriting 
standards, such as the handbook on Mortgagee Credit Analysis for 
Mortgage Insurance on One- to Four-Unit Mortgage Loans issued by FHA, 
to evaluate a consumer's ability to repay. The proposed comment would 
have stated that creditors may look to such standards in determining, 
for example, whether to classify particular inflows, obligations, or 
property as ``income,'' ``debt,'' or ``assets''; factors to consider in 
evaluating the income of a self-employed or seasonally employed 
consumer; or 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.  1026.2(a)(14). In the Supplemental 
Information regarding proposed comment 43(c)-1, the Board stated that 
the proposed rule and commentary were intended to provide flexibility 
in underwriting standards so that creditors could adapt their 
underwriting processes to a consumer's particular circumstances. The 
Board stated its belief that such flexibility is necessary because the 
rule covers such a wide variety of consumers and mortgage products.
    Commenters generally supported giving creditors significant 
flexibility to develop and apply their own underwriting standards. 
However, commenters had concerns regarding the specific approach taken 
in proposed comment 43(c)-1. Commenters raised a number of questions 
about what kinds of underwriting standards might be considered widely 
accepted, such as whether a creditor's proprietary underwriting 
standards could ever be considered widely accepted. Commenters also 
were uncertain whether the proposed comment required creditors to adopt 
particular governmental underwriting standards in their entirety and 
requested clarification on that point. At least one commenter, an 
industry trade group, noted that FHA-insured loans constitute a small 
percentage of the mortgage market and questioned whether FHA 
underwriting standards therefore are widely accepted. This commenter 
also questioned whether it is appropriate to encourage creditors to 
apply FHA underwriting standards other than with respect to FHA-insured 
loans, as FHA programs are generally designed to make mortgage credit 
available in circumstances where private creditors are unwilling to 
extend such credit without a government guarantee. Finally, consumer 
group commenters asserted that underwriting standards do not accurately 
determine ability to repay merely because they are widely accepted and 
pointed to the widespread proliferation of lax underwriting standards 
that predated the recent financial crisis.
    The Bureau believes that the Board did not intend to require 
creditors to use any particular governmental underwriting standards, 
including FHA standards, in their entirety or to prohibit creditors 
from using proprietary underwriting standards. The Bureau also does not 
believe that the Board intended to endorse lax underwriting standards 
on the basis that those standards may be prevalent in the mortgage 
market at a particular time. The Bureau therefore is adopting two new 
comments to provide greater clarity regarding the role of underwriting 
standards in ability-to-repay determinations and is not adopting 
proposed comment 43(c)-1.
    The Bureau is concerned based on the comments received that 
referring creditors to widely accepted governmental and nongovernmental 
underwriting standards could lead to undesirable misinterpretations and 
confusion. The discussion of widely accepted standards in proposed 
comment 43(c)-1 could be misinterpreted to suggest that the 
underwriting standards of any single market participant with a large 
market share are widely accepted and therefore to be emulated. The 
widely accepted standard also could be misinterpreted to indicate that 
proprietary underwriting standards cannot yield reasonable, good faith 
determinations of a consumer's ability to repay because they are unique 
to a particular creditor and not employed throughout the mortgage 
market. Similarly, the widely accepted standard could be misinterpreted 
to encourage a creditor that lends in a limited geographic area or in a 
particular market niche to apply widely accepted underwriting standards 
that

[[Page 6461]]

are inappropriate for that particular creditor's loans.
    The Bureau also is concerned that evaluating underwriting standards 
based on whether they are widely accepted could have other undesirable 
consequences. In a market bubble or economic crisis, many creditors may 
change their underwriting standards in similar ways, leading to widely 
accepted underwriting standards becoming unreasonably lax or 
unreasonably tight. A regulatory directive to use underwriting 
standards that are widely accepted could exacerbate those effects. 
Also, referring creditors to widely accepted governmental and 
nongovernmental underwriting standards could hinder creditors' ability 
to respond to changing market and economic conditions and stifle market 
growth and positive innovation.
    Finally, the Bureau is concerned that focusing on whether 
underwriting standards are widely accepted could distract creditors 
from focusing on their obligation under TILA section 129C and Sec.  
1026.43(c) to make ability-to-repay determinations that are reasonable 
and in good faith. The Bureau believes that a creditor's underwriting 
standards are an important factor in making reasonable and good faith 
ability-to-repay determinations. However, how those standards are 
applied to the individual facts and circumstances of a particular 
extension of credit is equally or more important.
    In light of these issues, the Bureau is not adopting proposed 
comment 43(c)-1. Instead, the Bureau is adopting two new comments, 
comment 43(c)(1)-1 and comment 43(c)(2)-1. New comment 43(c)(1)-1 
clarifies that creditors are permitted to develop and apply their own 
underwriting standards as long as those standards lead to ability-to-
repay determinations that are reasonable and in good faith. New comment 
43(c)(2)-1 clarifies that creditors are permitted to use their own 
definitions and other technical underwriting criteria and notes that 
underwriting guidelines issued by governmental entities such as the FHA 
are a source to which creditors may refer for guidance on definitions 
and technical underwriting criteria. These comments are discussed below 
in the section-by-section of Sec.  1026.43(c)(1) and (2).
43(c)(1) General Requirement
    Proposed Sec.  226.43(c)(1) would have implemented TILA section 
129C(a)(1) by providing that a creditor shall not make a loan that is 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. Commenters generally agreed that creditors should not make 
loans to consumers unable to repay them and supported the requirement 
to consider ability to repay. Accordingly, Sec.  1026.43(c)(1) is 
adopted substantially as proposed, with two technical and conforming 
changes.
    As adopted, Sec.  1026.43(c)(1) requires creditors to make a 
reasonable and good faith determination at or before consummation that 
the consumer will have a reasonable ability to repay the loan according 
to its terms. Section 1026.43(c)(1) as adopted omits the reference in 
the proposed rule to determining that a consumer has a reasonable 
ability ``at the time of consummation'' to repay the loan according to 
its terms. The Bureau believes this phrase is potentially misleading 
and does not accurately reflect the intent of either the Board or the 
Bureau. Mortgage loans are not required to be repaid at the time of 
consummation; instead, they are required to be repaid over months or 
years after consummation. Creditors are required to make a predictive 
judgment at the time of consummation that a consumer is likely to have 
the ability to repay a loan in the future. The Bureau believes that the 
rule more clearly reflects this requirement without the reference to 
ability ``at the time of consummation'' to repay the loan. The 
creditor's determination will necessarily be based on the consumer's 
circumstances at or before consummation and evidence, if any, that 
those circumstances are likely to change in the future. Section 
1026.43(c)(1) as adopted also omits the reference in the proposed rule 
to mortgage-related obligations. The Bureau believes this reference is 
unnecessary because Sec.  1026.43(c)(2) requires creditors to consider 
consumers' monthly payments for mortgage-related obligations and could 
create confusion because Sec.  1026.43(c)(1) does not include 
references to other factors creditors must consider under Sec.  
1026.43(c)(2).
    As noted above, the Bureau is adopting new comment 43(c)(1)-1, 
which provides guidance regarding, among other things, how the 
requirement to make a reasonable and good faith determination of 
ability to repay relates to a creditor's underwriting standards. New 
comment 43(c)(1)-1 replaces in part and responds to comments regarding 
proposed comment 43(c)-1, discussed above.
    New comment 43(c)(1)-1 emphasizes that creditors are to be 
evaluated on whether they make a reasonable and good faith 
determination that a consumer will have a reasonable ability to repay 
as required by Sec.  1026.43(c)(1). The comment acknowledges that Sec.  
1026.43(c) and the accompanying commentary describe certain 
requirements for making ability-to-repay determinations, but do not 
provide comprehensive underwriting standards to which creditors must 
adhere. As an example, new comment 43(c)(1)-1 notes that the rule and 
commentary do not specify how much income is needed to support a 
particular level of debt or how to weigh credit history against other 
factors.
    The Bureau believes that a variety of underwriting standards can 
yield reasonable, good faith ability-to-repay determinations. New 
comment 43(c)(1)-1 explains that, so long as creditors consider the 
factors set forth in Sec.  1026.43(c)(2) according to the requirements 
of Sec.  1026.43(c), creditors are permitted to develop and apply their 
own proprietary underwriting standards and to make changes to those 
standards over time in response to empirical information and changing 
economic and other conditions. The Bureau believes this flexibility is 
necessary given the wide range of creditors, consumers, and mortgage 
products to which this rule applies. The Bureau also believes that 
there are no indicators in the statutory text or legislative history of 
the Dodd-Frank Act that Congress intended to replace proprietary 
underwriting standards with underwriting standards dictated by 
governmental or government-sponsored entities as part of the ability-
to-repay requirements. The Bureau therefore believes that preserving 
this flexibility here is consistent with Congressional intent. The 
comment emphasizes that whether a particular ability-to-repay 
determination is reasonable and in good faith will depend not only on 
the underwriting standards adopted by the creditor, but on the facts 
and circumstances of an individual extension of credit and how the 
creditor's underwriting standards were applied to those facts and 
circumstances. The comment also states that a consumer's statement or 
attestation that the consumer has the ability to repay the loan is not 
indicative of whether the creditor's determination was reasonable and 
in good faith.
    Concerns have been raised that creditors and others will have 
difficulty evaluating whether a particular ability-

[[Page 6462]]

to-repay determination is reasonable and in good faith. Although the 
statute and the rule specifies certain factors that a creditor must 
consider in making such a determination, the Bureau does not believe 
that there is any litmus test that can be prescribed to determine 
whether a creditor, in considering those factors, arrived at a belief 
in the consumer's ability to repay which was both objectively 
reasonable and in subjective good faith. Nevertheless, new comment 
43(c)(1)-1 lists considerations that may be relevant to whether a 
creditor who considered and verified the required factors in accordance 
with the rule arrived at an ability-to-repay determination that was 
reasonable and in good faith. The comment states that the following may 
be evidence that a creditor's ability-to-repay determination was 
reasonable and in good faith: (1) The consumer demonstrated actual 
ability to repay the loan by making timely payments, without 
modification or accommodation, for a significant period of time after 
consummation or, for an adjustable-rate, interest-only, or negative-
amortization mortgage, for a significant period of time after recast; 
(2) the creditor used underwriting standards that have historically 
resulted in comparatively low rates of delinquency and default during 
adverse economic conditions; or (3) the creditor used underwriting 
standards based on empirically derived, demonstrably and statistically 
sound models.
    In contrast, new comment 43(c)(1)-1 states that the following may 
be evidence that a creditor's ability-to-repay determination was not 
reasonable or in good faith: (1) The consumer defaulted on the loan a 
short time after consummation or, for an adjustable-rate, interest-
only, or negative-amortization mortgage, a short time after recast; (2) 
the creditor used underwriting standards that have historically 
resulted in comparatively high levels of delinquency and default during 
adverse economic conditions; (3) the creditor applied underwriting 
standards inconsistently or used underwriting standards different from 
those used for similar loans without reasonable justification; (4) the 
creditor disregarded evidence that the underwriting standards it used 
are not effective at determining consumers' repayment ability; (5) the 
creditor consciously disregarded evidence that the consumer may have 
insufficient residual income to cover other recurring obligations and 
expenses, taking into account the consumer's assets other than the 
property securing the covered transaction, after paying his or her 
monthly payments for the covered transaction, any simultaneous loan, 
mortgage-related obligations and any current debt obligations; or (6) 
the creditor disregarded evidence that the consumer would have the 
ability to repay only if the consumer subsequently refinanced the loan 
or sold the property securing the loan.
    New comment 43(c)(1)-1 states the Bureau's belief that all of these 
considerations may be relevant to whether a creditor's ability-to-repay 
determination was reasonable and in good faith. However, the comment 
also clarifies that these considerations are not requirements or 
prohibitions with which creditors must comply, nor are they elements of 
a claim that a consumer must prove to establish a violation of the 
ability-to-repay requirements. As an example, the comment clarifies 
that creditors are not required to validate their underwriting criteria 
using mathematical models.
    New comment 43(c)(1)-1 also clarifies that these considerations are 
not absolute in their application; instead they exist on a continuum 
and may apply to varying degrees. As an example, the comment states 
that the longer a consumer successfully makes timely payments after 
consummation or recast the less likely it is that the creditor's 
determination of ability to repay was unreasonable or not in good 
faith.
    Finally, new comment 43(c)(1)-1 clarifies that each of these 
considerations must be viewed in the context of all facts and 
circumstances relevant to a particular extension of credit. As an 
example, the comment states that in some cases inconsistent application 
of underwriting standards may indicate that a creditor is manipulating 
those standards to approve a loan despite a consumer's inability to 
repay. The creditor's ability-to-repay determination therefore may be 
unreasonable or in bad faith. However, in other cases inconsistently 
applied underwriting standards may be the result of, for example, 
inadequate training and may nonetheless yield a reasonable and good 
faith ability-to-repay determination in a particular case. Similarly, 
the comment states that although an early payment default on a mortgage 
will often be persuasive evidence that the creditor did not have a 
reasonable and good faith belief in the consumer's ability to repay 
(and such evidence may even be sufficient to establish a prima facie 
case of an ability-to-repay violation), a particular ability-to-repay 
determination may be reasonable and in good faith even though the 
consumer defaulted shortly after consummation if, for example, the 
consumer experienced a sudden and unexpected loss of income. In 
contrast, the comment states that an ability-to-repay determination may 
be unreasonable or not in good faith even though the consumer made 
timely payments for a significant period of time if, for example, the 
consumer was able to make those payments only by foregoing necessities 
such as food and heat.
    The Board proposed comment 43(c)(1)-1 to clarify that a change in a 
consumer's circumstances after consummation of a loan, such as a 
significant reduction in income due to a job loss or a significant 
obligation arising from a major medical expense, that cannot reasonably 
be anticipated from the consumer's application or the records used to 
determine repayment ability, is not relevant to determining a 
creditor's compliance with the rule. The proposed comment would have 
further clarified that, if the application or records considered by the 
creditor at or before consummation indicate that there will be a change 
in the consumer's repayment ability after consummation, such as 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. Commenters generally supported proposed 
comment 43(c)(1)-1. Proposed comment 43(c)(1)-1 is adopted 
substantially as proposed and redesignated as comment 43(c)(1)-2.
    The Board also proposed comment 43(c)(1)-2 to clarify that Sec.  
226.43(c)(1) does not require or permit the creditor to make inquiries 
or verifications prohibited by Regulation B, 12 CFR part 1002. 
Commenters generally supported proposed comment 43(c)(1)-2. Proposed 
comment 43(c)(1)-2 is adopted substantially as proposed and 
redesignated as comment 43(c)(1)-3.
43(c)(2) Basis for Determination
    As discussed above, TILA section 129C(a)(1) generally requires a 
creditor to make a reasonable and good faith determination that a 
consumer has a reasonable ability to repay a loan and all applicable 
taxes, insurance, and assessments. TILA section 129C(a)(2) requires a 
creditor to include in that determination the cost of any other 
residential mortgage loans made to the same consumer and secured by the 
same dwelling. TILA section 129C(a)(3) enumerates several factors a 
creditor must consider in determining a consumer's ability to repay: 
credit

[[Page 6463]]

history; current income; expected income; current obligations; debt-to-
income ratio or residual income; employment status; and other financial 
resources other than equity in the property securing the loan.
    Proposed Sec.  226.43(c)(2) would have implemented the requirements 
under these sections of TILA that a creditor consider specified factors 
as part of a determination of a consumer's ability to repay. Proposed 
Sec.  226.43(c)(2) would have required creditors to consider the 
following factors in making a determination of repayment ability, as 
required by TILA section 129C(a)(1) through (3): the consumer's current 
or reasonably expected income or assets, other than the dwelling that 
secures the loan; the consumer's employment status, if the creditor 
relies on employment income; the consumer's monthly payment on the 
loan; the consumer's monthly payment on any simultaneous loan that the 
creditor knows or has reason to know will be made; the consumer's 
monthly payment for mortgage-related obligations; the consumer's 
current debt obligations; the consumer's monthly debt-to-income ratio 
or residual income; and the consumer's credit history. As discussed in 
detail below, the Bureau is adopting Sec.  1026.43(c)(2) substantially 
as proposed, with technical and conforming changes.
    As indicated above, the Bureau also is adopting new comment 
43(c)(2)-1. New comment 43(c)(2)-1 provides guidance regarding 
definitional and other technical underwriting issues related to the 
factors enumerated in Sec.  1026.43(c)(2). New comment 43(c)(2)-1 
replaces in part and responds to comments received regarding proposed 
comment 43(c)-1, as discussed above.
    New comment 43(c)(2)-1 notes that Sec.  1026.43(c)(2) sets forth 
factors creditors must consider when making the ability-to-repay 
determination required under Sec.  1026.43(c)(1) and the accompanying 
commentary provides guidance regarding these factors. New comment 
43(c)(2)-1 also notes that creditors must conform to these requirements 
and may rely on guidance provided in the commentary. New comment 
43(c)(2)-1 also acknowledges that the rule and commentary do not 
provide comprehensive guidance on definitions and other technical 
underwriting criteria necessary for evaluating these factors in 
practice. The comment clarifies that, so long as a creditor complies 
with the provisions of Sec.  1026.43(c), the creditor is permitted to 
use its own definitions and other technical underwriting criteria.
    New comment 43(c)(2)-1 further provides that a creditor may, but is 
not required to, look to guidance issued by entities such as the FHA, 
VA, USDA, or Fannie Mae or Freddie Mac while operating under the 
conservatorship of the Federal Housing Finance Administration. New 
comment 43(c)(2)-1 gives several examples of instances where a creditor 
could refer to such guidance, such as: classifying particular inflows, 
obligations, and property as ``income,'' ``debt,'' or ``assets''; 
determining what information to use when evaluating the income of a 
self-employed or seasonally employed consumer; or determining what 
information to use when evaluating the credit history of a consumer who 
has few or no extensions of traditional credit. The comment emphasizes 
that these examples are illustrative, and creditors are not required to 
conform to guidance issued by these or other such entities. The Bureau 
is aware that many creditors have, for example, existing underwriting 
definitions of ``income'' and ``debt.'' Creditors are not required to 
modify their existing definitions and other technical underwriting 
criteria to conform to guidance issued by such entities, and creditors' 
existing definitions and other technical underwriting criteria are not 
noncompliant merely because they differ from those used in such 
guidance.
    Finally, new comment 43(c)(2)-1 emphasizes that a creditor must 
ensure that its underwriting criteria, as applied to the facts and 
circumstances of a particular extension of credit, result in a 
reasonable, good faith determination of a consumer's ability to repay. 
As an example, new comment 43(c)(2)-1 states that a definition used in 
underwriting that is reasonable in isolation may lead to ability-to-
repay determinations that are unreasonable or not in good faith when 
considered in the context of a creditor's underwriting standards or 
when adopted or applied in bad faith. Similarly, an ability-to-repay 
determination is not unreasonable or in bad faith merely because the 
underwriting criteria used included a definition that was by itself 
unreasonable.
43(c)(2)(i)
    TILA section 129C(a)(3) provides that, in making the repayment 
ability determination, a creditor 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), a creditor may consider the seasonality or irregularity of 
a consumer's income in determining repayment ability. The Board's 
proposal generally mirrored TILA section 129C(a)(3), but differed in 
two respects.
    First, proposed Sec.  226.43(c)(2)(i) used 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.  1026.51(a) 
(requiring consideration of a consumer's assets in determining a 
consumer's ability to pay a credit extension under a credit card 
account). The Board explained that the terms ``financial resources'' 
and ``assets'' are synonymous as used in TILA section 129C(a), and 
elected to use the term ``assets'' throughout the proposal for 
consistency. The Bureau is adopting this interpretation as well, as 
part of its effort to streamline regulations and reduce compliance 
burden, and uses the term ``assets'' throughout Regulation Z.
    Second, the Board's proposal provided that a creditor may not look 
to the value of the dwelling that secures the covered transaction, 
instead of providing that a creditor may not look to the consumer's 
equity in the dwelling, as provided in TILA section 129C(a). The Bureau 
received comments expressing concern that the Board had proposed 
dispensing with the term ``equity.'' These comments protested that the 
Board had assumed that congressional concern was over the foreclosure 
value of the home, rather than protecting all homeowners, including 
those who may have low home values. The commenters' concerns are likely 
misplaced, however, as the Board's language provides, if anything, 
broader protection for homeowners. TILA section 129C(a)(3) is intended 
to address the risk that a creditor 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. For 
example, the rule addresses the situation in which, several years after 
consummation, the value of a consumer's home has decreased 
significantly. The rule prohibits a creditor from considering, at or 
before consummation, any value associated with this home, even in the 
event that the ``underwater'' home is sold at foreclosure. The rule 
thus avoids the situation in which the creditor might assume that 
rising home values might make up the difference should the consumer be 
unable to make full mortgage payments, and therefore the rule is more 
protective of consumers

[[Page 6464]]

because the rule forbids the creditor from considering any value 
associated with the dwelling whether the consumer's equity stake in the 
dwelling is large or small.
    The Bureau is adopting the Board's proposal, providing that a 
creditor may not look to the value of the dwelling that secures the 
covered transaction, instead of providing that a creditor may not look 
to the consumer's equity in the dwelling, as provided in TILA section 
129C(a). The Bureau is making this adjustment pursuant to its authority 
under TILA section 105(a), which provides that the Bureau'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 Bureau'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). The purposes of 
TILA include the purposes that apply to 129C, to assure that consumers 
are offered and receive residential mortgage loans on terms that 
reasonably reflect their ability to repay the loan. See 15 U.S.C. 
1639b(a)(2). As further explained above, the Bureau believes it is 
necessary and proper to make this adjustment to ensure that consumers 
receive loans on affordable terms and to facilitate compliance with 
TILA and its purposes.
    The Board proposed comment 43(c)(2)(i)-1 to clarify that a creditor 
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. The Bureau did 
not receive significant comment on the proposal and has adopted the 
Board's proposed comment. In congruence with the Bureau's adoption of 
the phrase ``value of the dwelling'' in Sec.  1026.43(c)(2)(i), instead 
of the consumer's equity in the dwelling, as originally provided in 
TILA section 129C(a), comment 43(c)(2)(i)-1 likewise notes that the 
creditor may not consider the dwelling that secures the transaction as 
an asset in any respect. This comment is also consistent with comment 
43(a)-2, which further clarifies that the term ``dwelling'' includes 
the value of the real property to which the dwelling is attached, if 
the real property also secures the covered transaction. 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 Bureau did not receive significant comment on 
the proposal and has adopted the Board's proposed comment. The Bureau 
notes that there may be assets other than those listed in comment 
43(c)(2)(i)-1 that a creditor may consider; the Bureau does not intend 
for the list to be exhaustive, but merely illustrative.
    The Board proposed comment 43(c)(2)(i)-2 to explain 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. The Bureau did not receive significant comment and 
has adopted the Board's comment largely as proposed. This comment 
clarifies that a creditor need not document and verify every aspect of 
the consumer's income, merely enough income to support the creditor's 
good faith determination. 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 the full-time job is 
sufficient to repay the covered transaction, the creditor need not 
consider the consumer's income from the part-time job. Comment 
43(c)(2)(i)-2 also cross-references comment 43(c)(4)-1 for clarity.
    The Board proposed comment 43(c)(2)(i)-3 to clarify that the 
creditor may rely on the consumer's reasonably expected income either 
in addition to or instead of current income. This comment is similar to 
existing comment 34(a)(4)(ii)-2, which describes a similar income test 
for high-cost mortgages under Sec.  1026.34(a)(4).\107\ This 
consistency should serve to reduce compliance burden for creditors. The 
Bureau did not receive significant comment on the proposal and is 
adopting the Board's comment as proposed. Comment 43(c)(2)(i)-3 further 
explains that, if a creditor relies 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. Comment 43(c)(2)(i)-3 also 
gives examples of reasonably expected income, such as expected bonuses 
verified with documents demonstrating past bonuses or expected salary 
from a job verified with a written statement from an employer stating a 
specified salary. As the Board has previously stated, in some cases a 
covered transaction may have a likely payment increase that would not 
be affordable at the consumer's income at the time of consummation. A 
creditor may be able to verify a reasonable expectation of an increase 
in the consumer's income that will make the higher payment affordable 
to the consumer. See 73 FR 44522, 44544 (July 30, 2008).
---------------------------------------------------------------------------

    \107\ The Bureau has proposed revising comment 34(a)(4)(ii)-2, 
though not in a manner that would affect the ``reasonably expected 
income'' aspect of the comment. See 77 FR 49090, 49153 (Aug. 15, 
2012). The Bureau is concurrently finalizing the 2012 HOEPA 
Proposal.
---------------------------------------------------------------------------

    TILA section 129C(a)(9) provides that a creditor may consider the 
seasonality or irregularity of a consumer's income in determining 
repayment ability. Accordingly, the Board proposed comment 43(c)(2)(i)-
4 to clarify that a creditor reasonably may determine that a consumer 
can make periodic loan payments even if the consumer's income, such as 
self-employment or agricultural employment income, is seasonal or 
irregular. The Bureau received little comment on this proposal, 
although at least one consumer advocate expressed concern that 
creditors might interpret the rule to allow for a creditor to 
differentiate among types of income. Specifically, the commenter 
expressed concern that some creditors might differentiate types of 
income, for example salaried income as opposed to disability payments, 
and that these creditors might require the consumer to produce a letter 
stating that the disability income was guaranteed for a specified 
period. The Bureau understands these concerns, and cautions creditors 
not to overlook the requirements imposed by the Equal Credit 
Opportunity Act, implemented by the Bureau under Regulation B. See 15 
U.S.C. 1601 et seq.; 12 CFR 1002.1 et seq. For example, 12 CFR 
1002.6(b)(2) prohibits a creditor from taking into account whether an 
applicant's income derives from any public assistance program. The 
distinction here is that 43(c)(2)(i)-4 permits the creditor to consider 
the regularity of the consumer's income, but such consideration must be 
based on the consumer's income history, not based on the source of the 
income, as both a consumer's wages or a consumer's receipt of public 
assistance may or may not be irregular. The Bureau is adopting this 
comment largely as proposed, as the concerns discussed above are 
largely covered by Regulation B. Comment 43(c)(2)(i)-4 states that, for 
example, if the creditor determines that the income

[[Page 6465]]

a consumer receives a few months each year from, for example, selling 
crops or from agricultural employment is sufficient to make monthly 
loan payments when divided equally across 12 months, then the creditor 
reasonably may determine that the consumer can repay the loan, even 
though the consumer may not receive income during certain months.
    Finally, the Bureau is adding new comment 43(c)(2)(i)-5 to further 
clarify, in the case of joint applicants, the consumer's current or 
reasonably expected income or assets basis of the creditor's ability-
to-repay determination. This comment is similar in approach to the 
Board's proposed comment 43(c)(4)-2, discussed below, however, proposed 
comment 43(c)(4)-2 discussed the verification of income in the case of 
joint applicants. The Bureau is adding comment 43(c)(2)(i)-5 to clarify 
the creditor's basis for making an ability-to-repay determination for 
joint applicants. Comment 43(c)(2)(i)-5 explains that when two or more 
consumers apply for an extension of credit as joint obligors with 
primary liability on an obligation, Sec.  1026.43(c)(i) does not 
require the creditor to consider income or assets that are not needed 
to support the creditor's repayment ability determination. Thus, the 
comment explains that if the income or assets of one applicant are 
sufficient to support the creditor's repayment ability determination, 
then the creditor is not required to consider the income or assets of 
the other applicant.
43(c)(2)(ii)
    TILA section 129C(a)(3) requires that a creditor consider a 
consumer's employment status in determining the consumer's repayment 
ability, among other requirements. The Board proposal implemented this 
requirement in proposed Sec.  226.43(c)(2)(ii) and clarified that a 
creditor need consider a consumer's employment status only if the 
creditor relies on income from the consumer's employment in determining 
repayment ability. The Bureau did not receive significant comment on 
the Board's proposal and is adopting Sec.  1026.43(c)(2)(ii) as 
proposed. The Bureau sees no purpose in requiring a creditor to 
consider a consumer's employment status in the case where the creditor 
need not consider the income from that employment in the creditor's 
reasonable and good faith determination that the consumer will have a 
reasonable ability to repay the loan according to its terms.
    The Board proposed, and the Bureau is adopting, comment 
43(c)(2)(ii)-1 to illustrate this point further. The comment 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 consider or verify the consumer's employment status. 
The proposed comment further clarifies that employment may be full-
time, part-time, seasonal, irregular, military, or self-employment. 
Comment 43(c)(2)(ii)-1 is similar to comment 34(a)(4)-6, which 
discusses income, assets, and employment in determining repayment 
ability for high-cost mortgages.
    In its proposal, the Board explained that a creditor generally must 
verify information relied on to determine repayment ability using 
reasonably reliable third-party records, but may verify employment 
status orally as long as the creditor prepares a record of the oral 
information. The Board proposed comment 43(c)(2)(ii)-2 to add that a 
creditor 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.'' \108\ The Board solicited comment on whether 
creditors needed additional flexibility in verifying the employment 
status of military personnel, such as by verifying the employment 
status of a member of the military using a Leave and Earnings 
Statement. As this proposed comment was designed to provide 
clarification for creditors with respect to verifying a consumer's 
employment, this proposed comment is discussed in the section-by-
section analysis of Sec.  1026.43(c)(3) below.
---------------------------------------------------------------------------

    \108\ The Talent Amendment is contained in the John Warner 
National Defense Authorization Act. See Public Law 109-364, 120 
Stat. 2083, 2266 (2006); 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/.
---------------------------------------------------------------------------

43(c)(2)(iii)
    Proposed Sec.  226.43(c)(2)(iii) implemented the requirements under 
new 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. Proposed 
comment 43(c)(2)(iii)-1 clarified the regulatory language and made 
clear that mortgage-related obligations must also be considered.
    The Bureau did not receive comments on this provision. Accordingly, 
the Bureau is adopting Sec.  1026.43(c)(2)(iii) as proposed. Comment 
43(c)(2)(iii)-1 has been edited to remove the reference to mortgage-
related obligations as potentially confusing. The monthly payment for 
mortgage-related obligations must be considered under Sec.  
1026.43(c)(2)(v).
43(c)(2)(iv)
    Proposed Sec.  226.43(c)(2)(iv) implemented the requirements under 
new TILA section 129C(a)(2), in part, by requiring that the creditor 
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), for purposes of 
determining the consumer's repayment ability. As explained above in the 
section-by-section analysis of Sec.  1026.43(b)(12), ``simultaneous 
loan'' is defined, in the proposed and final rules, to include HELOCs.
    Proposed comment 43(c)(2)(iv)-1 clarified 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 
explained that a HELOC that is a simultaneous loan that the creditor 
knows or has reason to know about must be considered in determining a 
consumer's ability to repay the covered transaction, even though the 
HELOC is not a covered transaction subject to Sec.  1026.43.
    Proposed comment 43(c)(2)(iv)-3 clarified 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). Proposed comment 43(c)(2)(iv)-4 
provided guidance on the verification of simultaneous loans.
    The Bureau received several industry comments on the requirement, 
in the regulation and the statute, that the creditor consider any 
simultaneous loan it ``knows or has reason to know'' will be made. The 
commenters felt that the standard was vague, and that it would be 
difficult for a creditor to understand when it ``has reason to know'' a 
simultaneous loan will be made.
    The Board provided guidance on the ``knows or has reason to know'' 
standard in proposed comment 43(c)(2)(iv)-2. This comment provided 
that, in regard to ``piggyback'' second-lien loans, the creditor 
complies with the standard if it follows policies and procedures that 
are designed to

[[Page 6466]]

determine whether at or before consummation that the same consumer has 
applied for another credit transaction secured by the same dwelling. 
The proposed comment provided an example in which the requested loan 
amount is less than the home purchase price, indicating that there is a 
down payment coming from a different funding source. The creditor's 
policies and procedures must require the consumer to state the source 
of the down payment, which must be verified. If the creditor determines 
that the source of the down payment is another extension of credit that 
will be made to the same consumer and secured by the same dwelling, the 
creditor knows or has reason to know of the simultaneous loan. 
Alternatively, if the creditor has verified information that the down 
payment source is the consumer's existing assets, the creditor would be 
under no further obligation to determine whether a simultaneous loan 
will be extended at or before consummation.
    The Bureau believes that comment 43(c)(2)(iv)-2 provides clear 
guidance on the ``knows or has reason to know'' standard, with the 
addition of language clarifying that the creditor is not obligated to 
investigate beyond reasonable underwriting policies and procedures to 
determine whether a simultaneous loan will be extended at or before 
consummation of the covered transaction.
    The Bureau considers the provision to be an accurate and 
appropriate implementation of the statute. Proposed Sec.  
226.43(c)(2)(iv) and associated commentary are adopted substantially as 
proposed, in renumbered Sec.  1026.43(c)(2)(iv), with the addition of 
the language discussed above to comment 43(c)(2)(iv)-2 and other minor 
clarifying changes. Comment 43(c)(2)(iv)-3 now includes language making 
clear that if the consummation of the loan transaction is extended past 
the traditional closing, any simultaneous loan originated after that 
traditional closing may still be interpreted as having occurred ``at'' 
consummation. In addition, as discussed below, comment 43(c)(2)(iv)-4, 
Verification of simultaneous loans, has been grouped with other 
verification comments, in comment 43(c)(3)-4.
43(c)(2)(v)
    As discussed above, TILA section 129C(a)(1) and (3) requires 
creditors to consider and verify mortgage-related obligations as part 
of the ability-to-repay determination ``according to [the loan's] 
terms, and all applicable taxes, insurance (including mortgage 
guarantee insurance), and assessments.'' Section 1026.34(a)(4), which 
was added by the 2008 HOEPA Final Rule, also requires creditors to 
consider mortgage-related obligations in assessing repayment ability. 
See the section-by-section analysis of Sec.  1026.43(b)(8) for a 
discussion of the Bureau's interpretation of ``mortgage-related 
obligations'' and the definition adopted in the final rule.
    The Board proposed to require creditors to consider the consumer's 
monthly payment for mortgage-related obligations as part of the 
repayment ability determination. Proposed comment 43(c)(2)(v)-1 
explained 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.
    Proposed comment 43(c)(2)(v)-2 clarified that, in considering 
mortgage-related obligations that are not paid monthly, the creditor 
may look to widely accepted governmental or non-governmental standards 
to determine the pro rata monthly payment amount. The Board solicited 
comment on operational difficulties creditors may encounter when 
complying with this monthly requirement, and whether additional 
guidance was necessary.
    Proposed comment 43(c)(2)(v)-3 explained that estimates of 
mortgage-related obligations should be based upon information known to 
the creditor at the time the creditor underwrites the mortgage 
obligation. This comment explained that information is known if it is 
``reasonably available'' to the creditor at the time of underwriting 
the loan, and cross-referenced current comment 17(c)(2)(i)-1 for 
guidance regarding ``reasonably available.'' Proposed comment 
43(c)(2)(v)-3 further clarified that, for purposes of determining 
repayment ability under proposed Sec.  226.43(c), the creditor would 
not need to project potential changes.
    Proposed comment 43(c)(2)(v)-4 stated 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 explained that guidance regarding verification of mortgage-
related obligations could be found in proposed comments 43(c)(3)-1 and 
-2, which discuss verification using third-party records.
    The Board solicited comment on any special concerns regarding the 
requirement to document certain mortgage-related obligations, for 
example, ground rent or leasehold payments, or special assessments. The 
Board also solicited comment on whether it should provide that the HUD-
1 or -1A or a successor form could serve as verification of mortgage-
related obligations reflected by the form, where a legal obligation 
exists to complete the form accurately.
    Industry commenters and consumer advocates generally supported 
including consideration and verification of mortgage-related 
obligations in the ability-to-repay determination. Several industry 
commenters asked that the Bureau provide creditors more flexibility in 
considering and verifying mortgage-related obligations. They suggested 
that a reasonable and good faith determination be deemed sufficient, 
rather than use of all underwriting standards in any particular 
government or non-government handbook. Community banks asserted that 
flexible standards were necessary to meet their customers' needs. Some 
consumer advocates suggested that creditors be permitted to draw on 
only widely accepted standards that have been validated by experience 
or sanctioned by a government agency.
    Some industry commenters asked for more guidance on how to 
calculate pro rata monthly payment amounts and estimated property 
taxes. One industry commenter asked that creditors be permitted to use 
pro rata monthly payment amounts for special assessments, not quarterly 
or yearly amounts. The commenter requested that estimates of common 
assessments be permitted. This commenter also recommended that 
creditors be permitted to verify the amount of common assessments with 
information provided by the consumer. One commenter noted that 
verification using HUD-1 forms should be permitted because there is a 
legal obligation to complete the HUD-1 accurately.
    The Bureau is adopting the rule as proposed. For the reasons 
discussed below, the Bureau concludes that a creditor should consider 
the consumer's monthly payment for mortgage-related obligations in 
determining the consumer's ability to repay, pursuant to Sec.  
1026.43(c)(1). As commenters confirmed, obligations related to the 
mortgage may affect the consumer's ability to satisfy the obligation to 
make recurring payments of principal and interest. The Bureau also 
agrees with the argument raised by many commenters that the failure to 
account consistently for these obligations during the subprime crisis 
harmed many consumers. Thus, the Bureau has determined that it is 
appropriate to adopt Sec.  1026.43(c)(2)(v) as proposed. However, the 
Bureau believes that

[[Page 6467]]

additional guidance will facilitate compliance. As explained below, the 
Bureau has expanded on the proposed commentary language to provide 
additional clarity and illustrative examples.
    The final version of comment 43(c)(2)(v)-1 is substantially similar 
to the language as proposed. As discussed under Sec.  1026.43(b)(8) 
above, the Bureau is revising the language related to insurance 
premiums to provide additional clarity. The modifications to the 
language in proposed comment 43(c)(2)(v)-1 conform to the language 
adopted under Sec.  1026.43(b)(8) and the related commentary. 
Furthermore, the final version of comment 43(c)(2)(v)-1 contains 
additional explanation regarding the determination of the consumer's 
monthly payment, and provides additional illustrative examples to 
clarify further the requirements of Sec.  1026.43(c)(2)(v). For 
example, assume that a consumer will be required to pay mortgage 
insurance premiums, as defined by Sec.  1026.43(b)(8), on a monthly, 
annual, or other basis after consummation. Section 1026.43(c)(2)(v) 
includes these recurring mortgage insurance payments in the evaluation 
of the consumer's monthly payment for mortgage-related obligations. 
However, if the consumer will incur a one-time fee or charge for 
mortgage insurance or similar purposes, such as an up-front mortgage 
insurance premium imposed at consummation, Sec.  1026.43(c)(2)(v) does 
not include this up-front mortgage insurance premium in the evaluation 
of the consumer's monthly payment for mortgage-related obligations.
    As discussed under Sec.  1026.43(b)(8) above, several commenters 
discussed the importance of including homeowners association dues and 
similar obligations in the determination of ability to repay. These 
commenters argued, and the Bureau agrees, that recurring financial 
obligations payable to community governance associations, such as 
homeowners association dues, should be taken into consideration in 
determining whether a consumer has the ability to repay the obligation. 
The Bureau recognizes the practical problems that may arise with 
including obligations such as these in the evaluation of the consumer's 
monthly payment for mortgage-related obligations. Commenters identified 
issues stemming from difficulties which may arise in calculating, 
estimating, and verifying these obligations. Based on this feedback, 
the Bureau has determined that additional clarification is necessary. 
As adopted, comment 43(c)(2)(v)-2 clarifies that creditors need not 
include payments to community governance associations if such 
obligations are fully satisfied at or before consummation by the 
consumer. This comment further clarifies that Sec.  1026.43(c)(2)(v) 
does not require the creditor to include these payments in the 
evaluation of the consumer's monthly payment for mortgage-related 
obligations if the consumer does not pay the fee directly at or before 
consummation, and instead finances the obligation. In these cases, the 
financed obligation will be included in the loan amount, and is 
therefore already included in the determination of ability to repay 
pursuant to Sec.  1026.43(c)(2)(iii). However, if the consumer incurs 
the obligation and will satisfy the obligation with recurring payments 
after consummation, regardless of whether the obligation is escrowed, 
Sec.  1026.43(c)(2)(v) requires the creditor to include the obligation 
in the evaluation of the consumer's monthly payment for mortgage-
related obligations. The Bureau has also addressed the concerns raised 
by commenters related to calculating, estimating, and verifying these 
obligations in comments 43(c)(2)(v)-4 and -5 and 43(c)(3)-5, 
respectively.
    As discussed under Sec.  1026.43(b)(8) above, one comment letter 
focused extensively on community transfer fees. The Bureau agrees with 
the argument, advanced by several commenters, that the entirety of the 
consumer's ongoing obligations should be included in the determination. 
A responsible determination of the consumer's ability to repay requires 
an accounting of such obligations, whether the purpose of the 
obligation is to satisfy the payment of a community transfer fee or 
traditional homeowners association dues. An obligation that is not paid 
in full at or before consummation must be paid after consummation, 
which may affect the consumer's ability to repay ongoing obligations. 
Thus, comment 43(c)(2)(v)-2 clarifies that community transfer fees are 
included in the determination of the consumer's monthly payment for 
mortgage-related obligations if such fees are paid on a recurring basis 
after consummation. Additionally, the Bureau believes that a creditor 
is not required to include community transfer fees that are imposed on 
the seller, as many community transfer fees are, in the ability-to-
repay calculation.
    In response to the request for feedback in the proposed rule, 
several commenters addressed the proposed treatment of special 
assessments. Unlike community transfer fees, which are generally 
identified in the deed or master community plan, creditors may 
encounter difficulty determining whether special assessments exist. 
Special assessments are often imposed in response to some urgent or 
unexpected need. Consequently, neither the creditor nor the community 
governance association may be able to predict the frequency and 
magnitude of special assessments. However, this difficulty does not 
exist for special assessments that are known at the time of 
underwriting. Known special assessments, which the buyer must pay and 
which may be significant, may affect the consumer's ability to repay 
the obligation. Thus, comment 43(c)(2)(v)-3 clarifies that the creditor 
must include special assessments in the evaluation of the consumer's 
monthly payment for mortgage-related obligations if such fees are paid 
by the consumer on a recurring basis after consummation, regardless of 
whether an escrow is established for these fees. For example, if a 
homeowners association imposes a special assessment that the consumer 
will have to pay in full at or before consummation, Sec.  
1026.43(c)(2)(v) does not include the special assessment in the 
evaluation of the consumer's monthly payment for mortgage-related 
obligations. Section 1026.43(c)(2)(v) does not require a creditor to 
include special assessments in the evaluation of the consumer's monthly 
payment for mortgage-related obligations if the special assessments are 
imposed as a one-time charge. For example, if a homeowners association 
imposes a special assessment that the consumer will have to satisfy in 
one payment, Sec.  1026.43(c)(2)(v) does not include this one-time 
special assessment in the evaluation of the consumer's monthly payment 
for mortgage-related obligations. However, if the consumer will pay the 
special assessment on a recurring basis after consummation, regardless 
of whether the consumer's payments for the special assessment are 
escrowed, Sec.  1026.43(c)(2)(v) requires the creditor to include this 
recurring special assessment in the evaluation of the consumer's 
monthly payment for mortgage-related obligations. Comment 43(c)(2)(v)-3 
also includes several other examples illustrating this requirement.
    The Bureau agrees that clear and detailed guidance regarding 
determining pro rata monthly payments of mortgage-related obligations 
should be provided. However, the Bureau believes that it is important 
to strike a balance between providing clear guidance and providing 
creditors with the flexibility to serve the evolving mortgage market. 
The comments identified significant concerns with the use of ``widely

[[Page 6468]]

accepted governmental and non-governmental standards'' for purposes of 
determining the pro rata monthly payment amount for mortgage-related 
obligations. While commenters generally stated that ``widely accepted 
governmental standards'' was an appropriate standard, others commented 
that ``non-governmental standards'' may not be sufficiently clear. The 
Bureau believes that ``governmental standards'' could be relied on to 
perform pro rata calculations of monthly mortgage related obligations 
because such standards provide detailed and comprehensive guidance and 
are frequently revised to adapt to the needs of the evolving 
residential finance market. However, the comments noted that ``non-
governmental standards'' is not sufficiently descriptive to illustrate 
clearly how to calculate pro rata monthly payments. Additionally, the 
Bureau believes that clear guidance is also needed to address the 
possibility that a particular government program may not specifically 
describe how to calculate pro rata monthly payment amounts for 
mortgage-related obligations. Thus, the Bureau believes that it is 
appropriate to revise and further develop the concept of ``widely 
accepted governmental and non-governmental standards.''
    Based on this feedback, the Bureau has revised and expanded the 
comment clarifying how to calculate pro rata monthly mortgage 
obligations. As adopted, comment 43(c)(2)(v)-4 provides that, if the 
mortgage loan is originated pursuant to a governmental program, the 
creditor may determine the pro rata monthly amount of the mortgage-
related obligation in accordance with the specific requirements of that 
program. If the mortgage loan is originated pursuant to a government 
program that does not contain specific standards for determining the 
pro rata monthly amount of the mortgage-related obligation, or if the 
mortgage loan is not originated pursuant to a government program, the 
creditor complies with Sec.  1026.43(c)(2)(v) by dividing the total 
amount of a particular non-monthly mortgage-related obligation by no 
more than the number of months from the month that the non-monthly 
mortgage-related obligation last was due prior to consummation until 
the month that the non-monthly mortgage-related obligation next will be 
due after consummation. Comment 43(c)(2)(v)-4 also includes several 
examples which illustrate the conversion of non-monthly obligations 
into monthly, pro rata payments. For example, assume that a consumer 
applies for a mortgage loan on February 1st. Assume further that the 
subject property is located in a jurisdiction where property taxes are 
paid in arrears annually on the first day of October. The creditor 
complies with Sec.  1026.43(c)(2)(v) by determining the annual property 
tax amount owed in the prior October, dividing the amount by 12, and 
using the resulting amount as the pro rata monthly property tax payment 
amount for the determination of the consumer's monthly payment for 
mortgage-related obligations. The creditor complies even if the 
consumer will likely owe more in the next year than the amount owed the 
prior October because the jurisdiction normally increases the property 
tax rate annually, provided that the creditor does not have knowledge 
of an increase in the property tax rate at the time of underwriting.
    The Bureau is adopting comment 43(c)(2)(v)-5 in a form that is 
substantially similar to the version proposed. One industry commenter 
was especially concerned about estimating costs for community 
governance organizations, such as cooperative, condominium, or 
homeowners associations. This commenter noted that, because of industry 
concerns about TILA liability, many community governance organizations 
refuse to provide estimates of association expenses absent agreements 
disclaiming association liability. This commenter expressed concern 
that the ability-to-repay requirements would make community governance 
organizations less likely to provide estimates of association expenses, 
which would result in mortgage loan processing delays. The Bureau does 
not believe that the ability-to-repay requirements will lead to 
difficulties in exchanging information between creditors and 
associations because the ability-to-repay requirements generally apply 
only to creditors, as defined under Sec.  1026.2(a)(17). However, the 
Bureau recognizes that consumers may be harmed if mortgage loan 
transactions are needlessly delayed by concerns arising from the 
ability-to-repay requirements. Thus, the Bureau has decided to address 
these concerns by adding several examples to comment 43(c)(2)(v)-5 
illustrating the requirements of Sec.  1026.43(c)(2)(v). For example, 
the creditor complies with Sec.  1026.43(c)(2)(v) by relying on an 
estimate of mortgage-related obligations prepared by the homeowners 
association. In accordance with the guidance provided under comment 
17(c)(2)(i)-1, the creditor need only exercise due diligence in 
determining mortgage-related obligations, and complies with Sec.  
1026.43(c)(2)(v) by relying on the representations of other reliable 
parties in preparing estimates. Or, assume that the homeowners 
association has imposed a special assessment on the seller, but the 
seller does not inform the creditor of the special assessment, the 
homeowners association does not include the special assessment in the 
estimate of expenses prepared for the creditor, and the creditor is 
unaware of the special assessment. The creditor complies with Sec.  
1026.43(c)(2)(v) if it does not include the special assessment in the 
determination of mortgage-related obligations. The creditor may rely on 
the representations of other reliable parties, in accordance with the 
guidance provided under comment 17(c)(2)(i)-1.
43(c)(2)(vi)
    TILA section 129C(a)(1) and (3) requires creditors to consider 
``current obligations'' as part of an ability-to-repay determination. 
Proposed Sec.  226.43(c)(2)(vi) would have implemented the requirement 
under TILA section 129C(a)(1) and (3) by requiring creditors to 
consider current debt obligations. Proposed comment 43(c)(2)(vi)-1 
would have specified that current debt obligations creditors must 
consider include, among other things, alimony and child support. The 
Bureau believes that it is reasonable to consider child support and 
alimony as ``debts'' given that the term ``debt'' is not defined in the 
statute. However, the Bureau understands that while alimony and child 
support are obligations, they may not be considered debt obligations 
unless and until they are not paid in a timely manner. Therefore, Sec.  
1026.43(c)(2)(vi) specifies that creditors must consider current debt 
obligations, alimony, and child support to clarify that alimony and 
child support are included whether or not they are paid in a timely 
manner.
    Proposed comment 43(c)(2)(vi)-1 would have referred creditors to 
widely accepted governmental and non-governmental underwriting 
standards in determining how to define ``current debt obligations.'' 
The proposed comment would have given examples of current debt 
obligations, such as student loans, automobile loans, revolving debt, 
alimony, child support, and existing mortgages. The Board solicited 
comment on proposed comment 43(c)(2)(vi)-1 and on whether more specific 
guidance should be provided to creditors. Commenters generally 
supported giving creditors significant flexibility and did not 
encourage the Bureau to adopt more specific guidance.

[[Page 6469]]

Because the Bureau believes that a wide range of criteria and 
guidelines for considering current debt obligations will contribute to 
reasonable, good faith ability-to-repay determinations, comment 
43(c)(2)(vi)-1 as adopted preserves the flexible approach of the 
Board's proposed comment. The comment gives examples of current debt 
obligations but does not provide an exhaustive list. The comment 
therefore preserves substantial flexibility for creditors to develop 
their own underwriting guidelines regarding consideration of current 
debt obligations. Reference to widely accepted governmental and non-
governmental underwriting standards has been omitted, as discussed 
above in the section-by-section analysis of Sec.  1026.43(c).
    The Board also solicited comment on whether additional guidance 
should be provided regarding consideration of debt obligations that are 
almost paid off. Commenters generally stated that creditors should be 
required to consider obligations that are almost paid off only if they 
affect repayment ability. The Bureau agrees that many different 
standards for considering obligations that are almost paid off could 
lead to reasonable, good faith ability-to-repay determinations. As 
adopted, comment 43(c)(2)(vi)-1 includes additional language clarifying 
that creditors have significant flexibility to consider current debt 
obligations in light of attendant facts and circumstances, including 
that an obligation is likely to be paid off soon after consummation. As 
an example, comment 43(c)(2)(vi)-1 states that a creditor may take into 
account that an existing mortgage is likely to be paid off soon after 
consummation because there is an existing contract for sale of the 
property that secures that mortgage.
    The Board also solicited comment on whether additional guidance 
should be provided regarding consideration of debt obligations in 
forbearance or deferral. Several commenters, including both creditors 
and consumer advocates, supported requiring creditors to consider 
obligations in forbearance or deferral. At least one large creditor 
objected to requiring creditors to consider such obligations in all 
cases. The Bureau believes that many different standards for 
considering obligations in forbearance or deferral could lead to 
reasonable, good faith determinations of ability to repay. As adopted, 
comment 43(c)(2)(vi)-1 therefore includes additional language 
clarifying that creditors should consider whether debt obligations in 
forbearance or deferral at the time of underwriting are likely to 
affect a consumer's ability to repay based on the payment for which the 
consumer will be liable upon expiration of the forbearance or deferral 
period and other relevant facts and circumstances, such as when the 
forbearance or deferral period will expire.
    Parts of proposed comment 43(c)(2)(vi)-1 and proposed comment 
43(c)(2)(vi)-2 would have provided guidance on verification of current 
debt obligations. All guidance regarding verification has been moved to 
the commentary to Sec.  1026.43(c)(3) and is discussed below in the 
section-by-section analysis of that provision.
    The Board solicited comment on whether it should provide guidance 
on consideration of current debt obligations for joint applicants. 
Commenters generally did not comment on consideration of current debt 
obligations for joint applicants. One trade association commenter 
stated that joint applicants should be subject to the same standards as 
individual applicants. Because the Bureau believes that the current 
debt obligations of all joint applicants must be considered to reach a 
reasonable, good faith determination of ability to repay, the Bureau is 
adopting new comment 43(c)(2)(vi)-2. New comment 43(c)(2)(vi)-2 
clarifies that when two or more consumers apply for credit as joint 
obligors, a creditor must consider the debt obligations of all such 
joint applicants. The comment also explains that creditors are not 
required to consider the debt obligations of a consumer acting merely 
as surety or guarantor. Finally, the comment clarifies that the 
requirements of Sec.  1026.43(c)(2)(vi) do not affect various 
disclosure requirements.
43(c)(2)(vii)
    TILA section 129C(a)(3) requires creditors to consider the 
consumer's monthly debt-to-income ratio or residual income the consumer 
will have after paying non-mortgage debt and mortgage-related 
obligations, as part of the ability-to-repay determination under TILA 
section 129C(a)(1). This provision is consistent with the 2008 HOEPA 
Final Rule, which grants a creditor in a high-cost or higher-priced 
mortgage loan a presumption of compliance with the requirement that the 
creditor assess repayment ability if, among other things, the creditor 
considers the consumer's debt-to-income ratio or residual income. See 
Sec.  1026.34(a)(4)(iii)(C), (b)(1). Existing 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 FHA Handbook on 
Mortgage Credit Analysis for Mortgage Insurance on One-to-Four Unit 
Mortgage Loans.
    Proposed Sec.  226.43(c)(2)(vii) would have implemented TILA 
section 129C(a)(3) by requiring 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 would 
have cross-referenced Sec.  226.43(c)(7), regarding the definitions and 
calculations for the monthly debt-to-income and residual income. 
Consistent with the 2008 HOEPA Final Rule, the proposed rule would have 
provided creditors flexibility to determine whether to use a debt-to-
income ratio or residual income metric in assessing the consumer's 
repayment ability. As the Board noted, if one of these metrics alone 
holds as much predictive power as the two together, then requiring 
creditors to use both metrics could reduce credit access without an 
offsetting increase in consumer protection. 76 FR 27390, 27424-25 (May 
11, 2011), citing 73 FR 44550 (July 30, 2008). The proposed rule did 
not specifically address creditors' use of both metrics if such an 
approach would provide incremental predictive power of assessing a 
consumer's repayment ability. However, as discussed above in the 
section-by-section analysis of Sec.  1026.43(c), the Board's proposed 
comment 43(c)-1 would have provided that, in evaluating the consumer's 
repayment ability under Sec.  226.43(c), creditors may look to widely 
accepted governmental or non-governmental underwriting standards, such 
as the FHA Handbook on Mortgage Credit Analysis for Mortgage Insurance 
on One-to-Four Unit Mortgage Loans, consistent with existing comment 
34(a)(4)(iii)(C)-1.
    In response to the proposed rule, industry commenters and consumer 
advocates generally supported including consideration of the debt-to-
income ratio or residual income in the ability-to-repay determination. 
Several industry commenters asked that the Bureau provide creditors 
more flexibility in considering and verifying the debt-to-income ratio 
or residual income. They suggested that a reasonable and good faith 
determination be deemed sufficient, rather than use of all underwriting 
standards in any particular government or non-government handbook. 
Community banks asserted that flexible standards are necessary to meet 
their customers' needs. Some consumer advocates suggested that 
creditors be permitted only to draw on widely accepted

[[Page 6470]]

standards that have been validated by experience or sanctioned by a 
government agency. They argued that more specific standards would help 
ensure safe and sound underwriting criteria, higher compliance rates, 
and a larger number of performing loans.
    Section 1026.43(c)(2)(vii) adopts the Board's proposal by requiring 
a creditor making the repayment determination under Sec.  1026.43(c)(1) 
to consider the consumer's monthly debt-to-income ratio or residual 
income, in accordance with Sec.  1026.43(c)(7). The Bureau believes 
that a flexible approach to evaluating a consumer's debt-to-income 
ratio or residual income is appropriate because stricter guidelines may 
limit access to credit and create fair lending problems. Broad 
guidelines will provide creditors necessary flexibility to serve the 
whole of the mortgage market effectively and responsibly. Accordingly, 
the final rule sets minimum underwriting standards while providing 
creditors with flexibility to use their own reasonable guidelines in 
making the repayment ability determination required by Sec.  
1026.43(c)(1). Moreover, and as in the 2008 HOEPA Final Rule, the 
approach would provide creditors flexibility to determine whether to 
use a debt-to-income ratio or residual income, or both, in assessing a 
consumer's repayment ability.
    As discussed above in the section-by-section analysis of Sec.  
1026.43(c), the Bureau is not finalizing the Board's proposed comment 
43(c)-1 regarding the use of widely accepted governmental or non-
governmental underwriting standards in evaluating the consumer's 
repayment ability. Instead, for the reasons discussed above, comment 
43(c)(2)-1 provides that the rule and commentary permit creditors to 
adopt reasonable standards for evaluating factors in underwriting a 
loan, such as whether to classify particular inflows or obligations as 
``income'' or ``debt,'' and that, in evaluating a consumer's repayment 
ability, a creditor may look to governmental underwriting standards. 
See section-by-section analysis of Sec.  1026.43(c)(2).
    The Bureau believes a flexible approach to evaluating debt and 
income is appropriate in making the repayment ability determination 
under Sec.  1026.43(c). However, for the reasons discussed below, the 
Bureau believes a quantitative standard for evaluating a consumer's 
debt-to-income ratio should apply to loans that are ``qualified 
mortgages'' that receive a safe harbor or presumption of compliance 
with the repayment ability determination under Sec.  1026.43(c). For a 
discussion of the quantitative debt-to-income standard that applies to 
qualified mortgages pursuant to Sec.  1026.43(e)(2) and the rationale 
for applying a quantitative standard in the qualified mortgage space, 
see the section-by-section analysis of Sec.  1026.43(e)(2).
43(c)(2)(viii)
    TILA section 129C(a)(1) and (3) requires creditors to consider 
credit history as part of the ability-to-repay determination. Proposed 
Sec.  226.43(c)(2)(viii) would have implemented the requirement under 
TILA section 129C(a)(1) and (3) by adopting the statutory requirement 
that creditors consider credit history as part of an ability-to-repay 
determination. Proposed comment 43(c)(2)(viii)-1 would have referred 
creditors to widely accepted governmental and non-governmental 
underwriting standards to define credit history. The proposed comment 
would have given examples of factors creditors could consider, such as 
the number and age of credit lines, payment history, and any judgments, 
collections, or bankruptcies. The proposed comment also would have 
referred creditors to credit bureau reports or to nontraditional credit 
references such as rental payment history or public utility payments.
    Commenters generally did not object to the proposed adoption of the 
statutory requirement to consider credit history as part of ability-to-
repay determinations. Commenters generally supported giving creditors 
significant flexibility in how to consider credit history. Creditors 
also generally supported clarifying that creditors may look to 
nontraditional credit references such as rental payment history or 
public utility payments.
    Section 1026.43(c)(2)(viii) is adopted as proposed. Comment 
43(c)(2)(viii)-1 as adopted substantially maintains the proposed 
comment's flexible approach to consideration of credit history. Comment 
43(c)(2)(viii)-1 notes that ``credit history'' may include factors such 
as the number and age of credit lines, payment history, and any 
judgments, collections, or bankruptcies. The comment clarifies that the 
rule does not require creditors to obtain or consider a consolidated 
credit score or prescribe a minimum credit score that creditors must 
apply. The comment further clarifies that the rule does not specify 
which aspects of credit history a creditor must consider or how various 
aspects of credit history could be weighed against each other or 
against other underwriting factors. The comment explains that some 
aspects of a consumer's credit history, whether positive or negative, 
may not be directly indicative of the consumer's ability to repay and 
that a creditor therefore may give various aspects of a consumer's 
credit history as much or as little weight as is appropriate to reach a 
reasonable, good faith determination of ability to repay. The Bureau 
believes that this flexible approach is appropriate because of the wide 
range of creditors, consumers, and loans to which the rule will apply. 
The Bureau believes that a wide range of approaches to considering 
credit history will contribute to reasonable, good faith ability-to-
repay determinations. As in the proposal, the comment, as adopted, 
clarifies that creditors may look to non-traditional credit references 
such as rental payment history or public utility payments, but are not 
required to do so. Reference to widely accepted governmental and non-
governmental underwriting standards has been omitted, as discussed in 
the section-by-section analysis of Sec.  1026.43(c), above.
    Portions of proposed comment 43(c)(2)(viii)-1 discussed 
verification of credit history. All guidance regarding verification has 
been moved to the commentary to Sec.  1026.43(c)(3) and is discussed 
below in the section-by-section analysis of that provision.
    Because the Bureau believes that the credit history of all joint 
applicants must be considered to reach a reasonable, good faith 
determination of joint applicants' ability to repay, and for conformity 
with the commentary to Sec.  1026.43(c)(2)(vi) regarding consideration 
of current debt obligations for multiple applicants, the Bureau is 
adopting new comment 43(c)(2)(viii)-2 regarding multiple applicants. 
The comment clarifies that, when two or more consumers apply jointly 
for credit, the creditor is required by Sec.  1026.43(c)(2)(viii) to 
consider the credit history of all joint applicants. New comment 
43(c)(2)(viii)-2 also clarifies that creditors are not required to 
consider the credit history of a consumer who acts merely as a surety 
or guarantor. Finally, the comment clarifies that the requirements of 
Sec.  1026.43(c)(2)(viii) do not affect various disclosure 
requirements.
43(c)(3) Verification Using Third-Party Records
    TILA section 129C(a)(1) requires that a creditor 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 required that a 
creditor verify the

[[Page 6471]]

consumer's income or assets relied on to determine repayment ability 
and the consumer's current obligations under Sec.  1026.34(a)(4)(ii)(A) 
and (C). Thus, TILA section 129C(a)(1) differs from existing repayment 
ability rules by requiring a creditor to verify information relied on 
in considering the consumer's ability to repay according to the 
considerations required under TILA section 129C(a)(3), which are 
discussed above in the section-by-section analysis of Sec.  
1026.43(c)(2).
    The Board's proposal would have implemented TILA section 
129C(a)(1)'s general requirement to verify a consumer's repayment 
ability in proposed Sec.  226.43(c)(3), which required that a creditor 
verify a consumer's repayment ability using reasonably reliable third-
party records, with two exceptions. Under the first exception, proposed 
Sec.  226.43(c)(3)(i) provided that a creditor may orally verify a 
consumer's employment status, if the creditor subsequently prepares a 
record of the oral employment status verification. Under the second 
exception, proposed Sec.  226.43(c)(3)(ii) provided that, 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, the creditor need not independently verify the additional debt 
obligation, as reported. Proposed comment 43(c)(3)-1 clarified that 
records a creditor uses to verify a consumer's repayment ability under 
proposed Sec.  226.43(c)(3) must be specific to the individual 
consumer. Records regarding, for example, average incomes in the 
consumer's geographic location or average incomes paid by the 
consumer's employer would not be specific to the individual consumer 
and are not sufficient.
    Proposed comment 43(c)(3)-2 provided that a creditor 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. As stated in Sec.  1026.43(c)(3), the standard for 
verification is that the creditor must use ``reasonably reliable third-
party records,'' which is fulfilled for reasonably reliable documents, 
specific to the consumer, provided by a third-party service provider. 
Also, proposed comment 43(c)(3)-2 clarified that a creditor may obtain 
third-party records, for example, payroll statements, directly from the 
consumer, again as long as the records are reasonably reliable.
    The Board also solicited comment on whether any documents or 
records prepared by the consumer and not reviewed by a third party 
appropriately could be considered in determining repayment ability, for 
example, because a particular record provides information not 
obtainable using third-party records. In particular, the Board 
solicited 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.
    Commenters generally supported the Board's proposal to implement 
the Dodd-Frank Act's verification requirements. Consumer groups 
generally found the proposal to be an accurate implementation of the 
statute and posited that the proposal would provide much-needed 
protection for consumers. Industry commenters generally also supported 
the proposal, noting that most underwriters already engaged in 
similarly sound underwriting practices. Some industry commenters noted 
that verifying a consumer's employment status imposes a burden upon the 
consumer's employer as well, however the Bureau has concluded that the 
oral verification provision provided by Sec.  1026.43(c)(3)(ii), 
discussed below, alleviates such concerns.
    The Bureau is adopting Sec.  1026.43(c)(3) substantially as 
proposed, with certain clarifying changes which are described below. 
The final rule also adds new comment 43(c)(3)-3. In addition, for 
organizational purposes, the final rule generally adopts proposed 
comments 43(c)(2)(iv)-4, 43(c)(2)(v)-4, 43(c)(2)(vi)-1, 43(c)(2)(viii)-
1, and 43(c)(2)(ii)-2 in renumbered comments 43(c)(3)-4 through -8 with 
revisions as discussed below. These changes and additions to Sec.  
1026.43(c)(3) and its commentary are discussed below.
    First, the final rule adds a new Sec.  1026.43(c)(3)(i), which 
provides that, for purposes of Sec.  1026.43(c)(2)(i), a creditor must 
verify a consumer's income or assets in accordance with Sec.  
1026.43(c)(4). This is an exception to the general rule in Sec.  
1026.43(c)(3) that a creditor must verify the information that the 
creditor relies on in determining a consumer's repayment ability under 
Sec.  1026.43(c)(2) using reasonably reliable third-party records. 
Because of this new provision, proposed Sec.  226.43(c)(3)(i) and (ii) 
are adopted as proposed in Sec.  1026.43(c)(3)(ii) and (iii), with 
minor technical revisions. In addition, the Bureau is adopting proposed 
comments 43(c)(3)-1 and -2 substantially as proposed with revisions to 
clarify that the guidance applies to both Sec.  1026.43(c)(3) and 
(c)(4).
    The Bureau is adding new comment 43(c)(3)-3 to clarify that a 
credit report generally is considered a reasonably reliable third-party 
record. The Board's proposed comment 43(c)(2)(vi)-2 stated, among other 
things, that a credit report is deemed a reasonably reliable third-
party record under proposed Sec.  226.43(c)(3). Commenters did not 
address that aspect of proposed comment 43(c)(2)(vi)-2. The Bureau 
believes credit reports are generally reasonably reliable third-party 
records for verification purposes. Comment 43(c)(3)-3 also explains 
that a creditor is not generally required to obtain additional 
reasonably reliable third-party records to verify information contained 
in a credit report, as the report itself is the means of verification. 
Likewise, comment 43(c)(3)-3 explains that if information is not 
included in the credit report, then the credit report cannot serve as a 
means of verifying that information. The comment further explains, 
however, that if the creditor may know or have reason to know that a 
credit report is not reasonably reliable, in whole or in part, then the 
creditor complies with Sec.  1026.43(c)(3) by disregarding such 
inaccurate or disputed items or reports. The creditor may also, but is 
not required, to obtain other reasonably reliable third-party records 
to verify information with respect to which the credit report, or item 
therein, may be inaccurate. The Bureau believes that this guidance 
strikes the appropriate balance between acknowledging that in many 
cases, a credit report is a reasonably reliable third-party record for 
verification and documentation for many creditors, but also that a 
credit report may be subject to a fraud alert, extended alert, active 
duty alert, or similar alert identified in 15 U.S.C. 1681c-1, or may 
contain debt obligations listed on a credit report is subject to a 
statement of dispute pursuant to 15 U.S.C. 1681i(b). Accordingly, for 
the reasons discussed above, the Bureau is adopting new comment 
43(c)(3)-3.
    As noted above, the Bureau is adopting proposed comment 
43(c)(2)(iv)-4 as comment 43(c)(3)-4 for organizational purposes. The 
Board proposed comment 43(c)(2)(iv)-4 to explain that although a 
creditor could use a credit report to verify current obligations, the 
report would not reflect a simultaneous loan that has not yet been 
consummated or has just recently

[[Page 6472]]

been consummated. Proposed comment 43(c)(2)(iv)-2 clarified that if the 
creditor knows or has reason to know that there will be a simultaneous 
loan extended at or before consummation, then the creditor may verify 
the simultaneous loan by obtaining third-party verification from the 
third-party creditor of the simultaneous loan. The proposed comment 
provided, 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. In addition, proposed comment 43(c)(2)(iv)-2 
cross-referenced comments 43(c)(3)-1 and -2, which discuss verification 
using third-party records. The Bureau generally did not receive comment 
with respect to this proposed comment; however, at least one commenter 
supported the example that a promissory note would serve as appropriate 
documentation for verifying a simultaneous loan. The Bureau is adopting 
proposed comment 43(c)(2)(iv)-4 as comment 43(c)(3)-4 with the 
following amendment. For consistency with other aspects of the rule, 
comment 43(c)(3)-4 does not include the Board's proposed reference to 
widely accepted governmental or non-governmental standards.
    The Board proposed comment 43(c)(2)(v)-4, which stated that 
creditors must make the repayment ability determination required under 
proposed Sec.  226.43(c) based on information verified from reasonably 
reliable records. The Board solicited comment on any special concerns 
regarding the requirement to document certain mortgage-related 
obligations, for example, ground rent or leasehold payments, or special 
assessments. The Board also solicited comment on whether it should 
provide that the HUD-1 or -1A or a successor form could serve as 
verification of mortgage-related obligations reflected by the form, 
where a legal obligation exists to complete the HUD-1 or -1A 
accurately. To provide additional clarity, the Bureau is moving 
guidance that discusses verification, including proposed comment 
43(c)(2)(v)-4, as part of the section-by-section analysis of, and 
commentary to, Sec.  1026.43(c)(3). Additional comments from the 
Board's proposal with respect to mortgage-related obligations are in 
the section-by-section analysis of Sec.  1026.43(c)(2)(v), above.
    Industry commenters and consumer advocates generally supported 
including consideration and verification of mortgage-related 
obligations in the ability-to-repay determination. Several industry 
commenters asked that the Bureau provide creditors more flexibility in 
considering and verifying mortgage-related obligations. Several 
consumer advocate commenters discussed the importance of verifying 
mortgage-related obligations based on reliable records, noting that 
inadequate, or non-existent, verification measures played a significant 
part in the subprime crisis. Industry commenters agreed that 
verification was appropriate, but these commenters also stressed the 
importance of clear and detailed guidance. Several commenters were 
concerned about the meaning of ``reasonably reliable records'' in the 
context of mortgage-related obligations. Some commenters asked the 
Bureau to designate certain items as reasonably reliable, such as taxes 
referenced in a title report, statements of common expenses provided by 
community associations, or items identified in the HUD-1 or HUD-1A.
    The Bureau is adopting proposed comment 43(c)(2)(v)-4 as comment 
43(c)(3)-5 with revision to provide further explanation of its approach 
to verifying mortgage-related obligations. While the reasonably 
reliable standard contains an element of subjectivity, the Bureau 
concludes that this flexibility is necessary. The Bureau believes that 
it is important to craft a regulation with the flexibility to 
accommodate an evolving mortgage market. The Bureau determines that the 
reasonably reliable standard is appropriate in this context given the 
nature of the items that are defined as mortgage-related obligations. 
Thus, comment 43(c)(3)-5 incorporates by reference comments 43(c)(3)-1 
and -2. Mortgage-related obligations refer to a limited set of charges, 
such as property taxes and lease payments, which a creditor can 
generally verify from an independent or objective source. Thus, in the 
context of mortgage-related obligations this standard provides 
certainty while being sufficiently flexible to adapt as underwriting 
practices develop over time.
    To address the concerns raised by several commenters, the Bureau is 
providing further clarification in 43(c)(3)-5 to provide detailed 
guidance and several examples illustrating these requirements. For 
example, comment 43(c)(3)-5 clarifies that records are reasonably 
reliable for purposes Sec.  1026.43(c)(2)(v) if the information in the 
record was provided by a governmental organization, such as a taxing 
authority or local government. Comment 43(c)(3)-5 also explains that a 
creditor complies with Sec.  1026.43(c)(2)(v) if it relies on, for 
example, homeowners association billing statements provided by the 
seller to verify other information in a record provided by an entity 
assessing charges, such as a homeowners association. Comment 43(c)(3)-5 
further illustrates that records are reasonably reliable if the 
information in the record was obtained from a valid and legally 
executed contract, such as a ground rent agreement. Comment 43(c)(3)-5 
also clarifies that other records may be reasonably reliable if the 
creditor can demonstrate that the source provided the information 
objectively.
    The Board's proposal solicited comment regarding whether the HUD-1, 
or similar successor document, should be considered a reasonably 
reliable record. The Board noted, and commenters confirmed, that the 
HUD-1, HUD-1A, or successor form might be a reasonably reliable record 
because a legal obligation exists to complete the form accurately. 
Although the Bureau agrees with these considerations, the Bureau does 
not believe that a document provided in final form at consummation, 
such as the HUD-1, should be used for the purposes of determining 
ability to repay pursuant to Sec.  1026.43(c)(2)(v). The Bureau expects 
the ability-to-repay determination to be conducted in advance of 
consummation. It therefore may be impractical for a creditor to rely on 
a document that is produced in final form at, or shortly before, 
consummation for verification purposes. The Bureau is also concerned 
that real estate transactions may be needlessly disrupted or delayed if 
creditors delay determining the consumer's ability to repay until the 
HUD-1, or similar successor document, is prepared. Given these 
concerns, and strictly as a matter of policy, the Bureau does not wish 
to encourage the use of the HUD-1, or similar successor document, for 
the purposes of determining a consumer's ability to repay, and the 
Bureau is not specifically designating the HUD-1 as a reasonably 
reliable record in either Sec.  1026.43(c)(2)(v) or related commentary, 
such as comment 43(c)(3)-5. However, the Bureau acknowledges that the 
HUD-1, HUD-1A, or similar successor document may comply with Sec.  
1026.43(c)(3).
    The Board proposed comment 43(c)(2)(vi)-1, which discussed both 
consideration and verification of current debt obligations. The Bureau 
discusses portions of proposed comment 43(c)(2)(vi)-1, regarding 
consideration of current debt obligations, in the section-by-section 
analysis of Sec.  1026.43(c)(2)(vi). As noted above, for organizational 
purposes and to provide

[[Page 6473]]

additional clarity, however, the Bureau is moving guidance that 
discusses verification, including portions of proposed comment 
43(c)(2)(vi)-1, as part of the commentary to Sec.  1026.43(c)(3). With 
respect to verification, proposed comment 43(c)(2)(vi)-1 stated that: 
(1) In determining how to verify current debt obligations, a creditor 
may look to widely accepted governmental and nongovernmental 
underwriting standards; and (2) a creditor may, for example, look to 
credit reports, student loan statements, automobile loan statements, 
credit card statements, alimony or child support court orders and 
existing mortgage statements. Commenters did not provide the Bureau 
with significant comment with respect to this proposal, although at 
least one large bank commenter specifically urged the Bureau to allow 
creditors to verify current debt obligations using a credit report. For 
the reasons discussed below, the Bureau is adopting, in relevant part, 
proposed comment 43(c)(2)(vi)-1 as comment 43(c)(3)-6. The Bureau 
believes that the proposed guidance regarding verification using 
statements and orders related to individual obligations could be 
misinterpreted as implying that credit reports are not sufficient 
verification of current debt obligations and that creditors must obtain 
statements and other documentation pertaining to each individual 
obligation. Comment 43(c)(3)-6 therefore explains that a creditor is 
not required to further verify the existence or amount of the 
obligation listed in a credit report, absent circumstances described in 
comment 43(c)(3)-3. The Bureau believes that a credit report is a 
reasonably reliable third-party record and is sufficient verification 
of current debt obligations in most cases. The Bureau also believes 
that this approach is reflected in the Board's proposal. For example, 
proposed comment 43(c)(2)(vi)-2 stated that a credit report is a 
reasonably reliable third-party record; and proposed Sec.  
1026.43(c)(3)(ii) indicated that a creditor could rely on a consumer's 
credit report to verify a consumer's current debt obligations. Unlike 
proposed comment 43(c)(2)(vi)-1, comment 43(c)(3)-6 does not include 
reference to widely accepted governmental and nongovernmental 
underwriting standards for consistency with the amendments in other 
parts of the rule. To understand the Bureau's approach to verification 
standards, see the section-by-section analysis, commentary, and 
regulation text of Sec.  1026.43(c) and Sec.  1026.43(c)(1) above. The 
Board proposed comment 43(c)(2)(viii)-1, which discussed both the 
consideration and verification of credit history. The Bureau discusses 
portions of proposed comment 43(c)(2)(viii)-1, those regarding 
consideration of credit history, in the section-by-section analysis of 
Sec.  1026.43(c)(2)(viii). However, the Bureau is moving guidance on 
verification, including portions of proposed comment 43(c)(2)(viii)-1, 
to Sec.  1026.43(c)(3) and its commentary. Regarding verification, 
proposed comment 43(c)(2)(viii)-1 stated that: (1) Creditors may look 
to widely accepted governmental and nongovernmental underwriting 
standards to determine how to verify credit history; and (2) a creditor 
may, for example, 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 to verify 
credit history. Commenters did not object to the Board's proposed 
approach to verification of credit history. The Bureau is adopting this 
approach under comment 43(c)(3)-7 with the following exception. 
References to widely accepted governmental and nongovernmental 
underwriting standards have been removed, as discussed above in the 
section-by-section analysis of Sec.  1026.43(c). Portions of proposed 
comment 43(c)(2)(viii)-1 regarding verification are otherwise adopted 
substantially as proposed in new comment 43(c)(3)-7.
    The Board proposed comment 43(c)(2)(ii)-2 to clarify that a 
creditor also may verify the employment status of military personnel 
using the electronic database maintained by the DoD to facilitate 
identification of consumers covered by credit protections provided 
pursuant to 10 U.S.C. 987, also known as the ``Talent Amendment.'' 
\109\ The Board also sought additional comment as to whether creditors 
needed additional flexibility in verifying the employment status of 
military personnel, such as by verifying the employment status of a 
member of the military using a Leave and Earnings Statement.
---------------------------------------------------------------------------

    \109\ See supra note 105.
---------------------------------------------------------------------------

    Industry commenters requested that the Bureau provide additional 
flexibility for creditors to verify military employment. For example, 
some industry commenters noted that a Leave and Earnings Statement was 
concrete evidence of employment status and income for military 
personnel and other industry commenters stated that institutions that 
frequently work with military personnel have built their own expertise 
in determining the reliability of using the Leave and Earnings 
Statement. These commenters argued that using a Leave and Earnings 
Statement is as reliable a means of verifying the employment status of 
military personnel as using a payroll statement to verify that 
employment status of a civilian.
    Accordingly, the Bureau is adopting proposed comment 43(c)(2)(ii)-2 
as comment 43(c)(3)-8, for organizational purposes, with the following 
additional clarification. Comment 43(c)(3)-8 clarifies that a creditor 
may verify military employment by means of a military Leave and 
Earnings Statement. Therefore, comment 43(c)(3)-8 provides that a 
creditor may verify the employment status of military personnel by 
using either a military Leave and Earnings Statement or by using the 
electronic database maintained by the DoD.
    The Board solicited comment on whether a creditor might 
appropriately verify a consumer's repayment ability using any documents 
or records prepared by the consumer and not reviewed by a third party, 
perhaps because a particular record might provide information not 
obtainable using third-party records. The Bureau did not receive 
sufficient indication that such records would qualify as reasonably 
reliable and has thus not added additional regulatory text or 
commentary to allow for the use of such records. However, a creditor 
using reasonable judgment nevertheless may determine that such 
information is useful in verifying a consumer's ability to repay. For 
example, the creditor may consider and verify a self-employed 
consumer's income from the consumer's 2013 income tax return, and the 
consumer then may offer an unaudited year-to-date profit and loss 
statement that reflects significantly lower expected income in 2014. 
The creditor might reasonably use the lower 2014 income figure as a 
more conservative method of underwriting. However, should the 
unverified 2014 income reflect significantly greater income than the 
income tax return showed for 2013, a creditor instead would verify this 
information in accordance with Sec.  1026.43(c)(4).
43(c)(4) Verification of Income or Assets
    TILA section 129C(a)(4) requires that a creditor verify amounts of 
income or assets that a creditor relied upon to determine repayment 
ability by reviewing the consumer's Internal Revenue Service (IRS) Form 
W-2, tax returns, payroll statements, financial

[[Page 6474]]

institution records, or other third-party documents that provide 
reasonably reliable evidence of the consumer's income or assets. TILA 
section 129C(a)(4) further provides that, in order to safeguard against 
fraudulent reporting, any consideration of a consumer's income history 
must include the verification of income using either (1) IRS 
transcripts of tax returns; or (2) an alternative method that quickly 
and effectively verifies income documentation by a third-party, subject 
to rules prescribed by the Board, and now the Bureau. TILA section 
129C(a)(4) is similar to existing Sec.  1026.34(a)(4)(ii)(A), adopted 
by the Board's 2008 HOEPA Final Rule, although TILA section 
129C(a)(4)(B) provides for the alternative methods of 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 proposed to implement TILA 
section 129C(a)(4)(B), adjusting the requirement to (1) require the 
creditor to use reasonably reliable third-party records, consistent 
with TILA section 129C(a)(4), rather than the ``quickly and 
effectively'' standard of TILA section 129C(a)(4)(B); and (2) provide 
examples of reasonably reliable records that a creditor can use to 
efficiently verify income, as well as assets. As discussed in the 
Board's proposal, the Board proposed these adjustments pursuant to its 
authority under TILA sections 105(a) and 129B(e). The Board believed 
that considering reasonably reliable records effectuates the purposes 
of TILA section 129C(a)(4), 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.
    Industry and consumer group commenters generally supported proposed 
Sec.  226.43(c)(4) because the proposal would permit a creditor to use 
a wide variety of documented income and/or asset verification methods, 
while maintaining the appropriate goal of ensuring accurate 
verification procedures. Some commenters requested that the Bureau 
allow a creditor to underwrite a mortgage based on records maintained 
by a financial institution that show an ability to repay. Specifically, 
commenters raised concerns with respect to customers who may not have 
certain documents, such as IRS Form W-2, because of their employment or 
immigration status. The Bureau expects that Sec.  1026.43(c)(4) 
provides that the answer to such concerns is self-explanatory; a 
creditor need not, by virtue of the requirements of Sec.  
1026.43(c)(4), require a consumer to produce an IRS Form W-2 in order 
to verify income. Some industry commenters argued that the Bureau 
should also permit creditors to verify information for certain 
applicants, such as the self-employed, by using non-third party 
reviewed documents, arguing it would reduce costs for consumers. The 
Bureau does not find such justification to be persuasive, as other 
widely available documents, such as financial institution records or 
tax records, could easily serve as means of verification without 
imposing significant cost to the consumer or creditor. See also the 
discussion of comment 43(b)(13)(i)-1, addressing third-party records.
    Some industry commenters advocated, in addition, that creditors be 
allowed to employ broader, faster sources of income verification, such 
as internet-based tools that employ aggregate employer data, or be 
allowed to rely on statistically qualified models to estimate income or 
assets. The Bureau, however, believes that permitting creditors to use 
statistical models or aggregate data to verify income or assets would 
be contrary to the purposes of TILA section 129C(a)(4). Although the 
statute uses the words ``quickly and effectively,'' these words cannot 
be read in isolation, but should instead be read in context of the 
entirety of TILA section 129C(a)(4). As noted above, the Bureau 
believes that TILA section 129C(a)(4) is primarily intended to 
safeguard against fraudulent reporting and inaccurate underwriting, 
rather than accelerate the process of verifying a consumer's income, as 
the statute specifically notes that a creditor must verify a consumer's 
income history ``[i]n order to safeguard against fraudulent 
reporting.'' The Bureau further believes that permitting the use of 
aggregate data or non-individualized estimates would undermine the 
requirements to verify a consumer's income and to determine a 
consumer's ability to repay. Rather, the Bureau believes that the 
statute requires verification of the amount of income or assets relied 
upon using evidence of an individual's income or assets.
    For substantially the same reasons stated in the Board's proposal, 
the Bureau is adopting proposed Sec.  226.43(c)(4) and its accompanying 
commentary substantially as proposed in renumbered Sec.  1026.43(c)(4), 
with revisions for clarity. Accordingly, the Bureau is implementing 
TILA section 129C(a)(4) in Sec.  1026.43(c)(4), which 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. Section 1026.43(c)(4) further provides a 
list of illustrative examples of methods of verifying a consumer's 
income or asserts using reasonably reliable third-party records. Such 
examples include: (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. The Bureau also believes that by providing such 
examples of acceptable records, the Bureau enables creditors to quickly 
and effectively verify a consumer's income, as provided in TILA section 
129C(a)(4)(B).
    Comment 43(c)(4)-1 clarifies that under Sec.  1026.43(c)(4), a 
creditor need verify only the income or assets relied upon to determine 
the consumer's repayment ability. 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. This comment also clarifies that 
comments 43(c)(3)-1 and -2, discussed above, are instructive with 
respect to income and asset verification.
    Comment 43(c)(4)-2 clarifies that, if consumers jointly apply for a 
loan and each consumer lists his or her income or assets on the 
application, the creditor need verify only the income or assets the 
creditor relies on to determine repayment ability. Comment 43(c)(2)(i)-
5, discussed above, may also be instructive in cases of multiple 
applicants.
    Comment 43(c)(4)-3 provides that a creditor 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. Comment 43(c)(4)-3 also clarifies that a creditor may obtain a 
copy of an IRS tax-return transcript or filed tax return from a service 
provider or from the consumer,

[[Page 6475]]

and the creditor need not obtain the copy directly from the IRS or 
other taxing authority. For additional guidance, Comment 43(c)(4)-3 
cross-references guidance on obtaining records in comment 43(c)(3)-2.
    Finally, comment 43(c)(4)(vi)-1 states 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.
    As discussed above, the Bureau is adopting Sec.  1026.43(c)(4) as 
enabling creditors to quickly and effectively verify a consumer's 
income, as provided in TILA section 129C(a)(4)(B). In addition, for 
substantially the same rationale as discussed in the Board's proposal, 
the Bureau is adopting Sec.  1026.43(c)(4) using its authority under 
TILA section 105(a) to prescribe regulations to carry out the purposes 
of TILA. 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 Bureau believes that a creditor consulting 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 Bureau further 
believes that TILA section 129C(a)(4) is intended to safeguard against 
fraudulent or inaccurate reporting, rather than to accelerate the 
creditor's ability to verify a consumer's income. Indeed, the Bureau 
believes that there is a risk that requiring a creditor to use quick 
methods to verify the consumer's income would undermine the 
effectiveness of the ability-to-repay requirements by sacrificing 
thoroughness for speed. The Bureau believes instead that 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 Bureau is adopting the examples of reasonably reliable 
records, proposed by the Board, that a creditor may use to efficiently 
verify income or assets, because the Bureau believes that it will 
facilitate compliance by providing clear guidance to creditors.
    The Bureau notes that the Board proposal solicited comment on 
whether it should provide an affirmative defense for a creditor that 
can show that the amounts of the consumer's income or assets that the 
creditor 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. Such an 
affirmative defense, while not specified under TILA, would be 
consistent with the Board's 2008 HOEPA Final Rule. See Sec.  
1026.34(a)(4)(ii)(B).\110\ Consumer group commenters generally opposed 
an affirmative defense, arguing that such an allowance would 
essentially gut the income and asset verification requirement provided 
by the rule. Other commenters noted that providing an affirmative 
defense might result in confusion, and possible litigation, over what 
the term ``material'' may mean, and that a rule permitting an 
affirmative defense would need to define materiality specifically, 
including from whose perspective materiality should be measured (i.e., 
the creditor's or the consumer's). Based on the comments received, the 
Bureau believes that an affirmative defense is not warranted. The 
Bureau believes that permitting an affirmative defense could result in 
circumvention of the Sec.  1026.43(c)(4) verification requirement. For 
the reasons stated, the Bureau is not adopting an affirmative defense 
for a creditor that can show that the amounts of the consumer's income 
or assets that the creditor 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.
---------------------------------------------------------------------------

    \110\ The Bureau's 2012 HOEPA Proposal proposed to amend this 
subsection, though not in a manner that affected the overall effect 
of an affirmative defense. See 77 FR 49090, 49153 (Aug. 15, 2012).
---------------------------------------------------------------------------

43(c)(5) Payment Calculation
    The Board proposed 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 guarantee insurance), and assessments,'' based on 
several considerations, including ``a payment schedule that fully 
amortizes the loan over the term of the loan.'' TILA section 129C(a)(1) 
and (3). The statutory requirement to consider mortgage-related 
obligations, as defined in Sec.  1026.43(b)(8), is discussed above in 
the section-by-section analysis of Sec.  1026.43(c)(2)(v).
    TILA section 129C(a) requires, among other things, that a creditor 
make a determination that a consumer ``has a reasonable ability to 
repay'' a residential mortgage loan. TILA section 129C(a)(6)(D) 
provides the process for calculating the monthly payment amount ``[f]or 
purposes of making any determination under this subsection,'' i.e., 
subsection (a), for ``any residential mortgage loan.'' TILA section 
129C(a)(6)(A) through (D) requires 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) through (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 term ``fully indexed rate'' is defined 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 
Bureau 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 threshold for higher-priced mortgage loans. TILA section 
129C(a)(6)(D)(ii)(I). Second, for loans that ``require more rapid 
repayment (including balloon payment),'' and which exceed the higher-
priced mortgage loan 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

[[Page 6476]]

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) 
implemented these statutory provisions, as discussed in further detail 
below.
    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.  1026.34(a)(4) from the Board's 2008 HOEPA Final Rule and extends 
such requirements to the entire mortgage market regardless of the 
loan's interest rate. Similarly to Sec.  1026.34(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 2008 HOEPA Final Rule with respect to payment 
calculation requirements.
    Current Sec.  1026.34(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.  1026.34(a)(4)(iii)(B). For 
example, Sec.  1026.34(a)(4) does not specify how to calculate the 
periodic payment required for a negative amortization loan or balloon-
payment mortgage 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 TILA section 129C(a). In taking this approach, the statutory 
requirements in TILA section 129C(a)(6)(D) addressing payment 
calculation requirements differ from Sec.  1026.34(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 benchmark, or meets or falls 
below the applicable loan pricing benchmark; and (3) the statute 
expressly addresses underwriting requirements for loans with interest-
only payments or negative amortization.
    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 section 
129C(a)(3) and (6) is generally consistent with this longstanding 
Interagency Supervisory Guidance and largely extends the guidance 
regarding payment calculation assumptions to all loan types covered 
under TILA section 129C(a), regardless of a loan's interest rate. The 
Board proposed Sec.  226.43(c)(5) to implement the payment calculation 
requirements of TILA section 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) did not prohibit the creditor from offering certain credit 
terms or loan features, but rather focused on the calculation process 
the creditor would be required to use to determine whether the consumer 
could repay the loan according to its terms. Under the proposal, 
creditors generally would have been required to determine a consumer's 
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) used the terms ``fully 
amortizing payment'' and ``fully indexed rate,'' which were defined 
separately under proposed Sec.  226.43(b)(2) and (3), respectively, as 
discussed above. Proposed comment 43(c)(5)(i)-1 clarified 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.  1026.18(s)(7)(i), (ii), and (iii), respectively.
    Proposed Sec.  226.43(c)(5)(ii)(A) through (C) created exceptions 
to the general rule and provided special rules for calculating the 
payment obligation for balloon-payment mortgages, interest-only loans 
or negative amortization loans, as follows:
    Balloon-payment mortgages. Consistent with TILA section 
129C(a)(6)(D)(ii)(I) and (II), for covered transactions with a balloon 
payment, proposed Sec.  226.43(c)(5)(ii)(A) provided special rules that 
differed depending on the loan's rate. Proposed Sec.  
226.43(c)(5)(ii)(A)(1) stated 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 stated 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) 
used the term ``higher-priced covered transaction'' to refer to a 
covered transaction that exceeds the applicable higher-priced mortgage 
loan coverage threshold. ``Higher-priced covered transaction'' is 
defined in Sec.  1026.43(b)(4), discussed above. The term ``balloon 
payment'' has the same meaning as in current Sec.  1026.18(s)(5)(i).
    Interest-only loans. Consistent with TILA section 129C(a)(6)(B) and 
(D), proposed Sec.  226.43(c)(5)(ii)(B) provided special rules for 
interest-only loans. Proposed Sec.  226.43(c)(5)(ii)(B) required 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) used the terms ``loan amount'' and 
``recast,'' which are defined and discussed under Sec.  1026.43(b)(5) 
and (11), respectively. The term ``interest-only loan'' has the

[[Page 6477]]

same meaning as in current Sec.  1026.18(s)(7)(iv).
    Negative amortization loans. Consistent with TILA section 
129C(a)(6)(C) and (D), proposed Sec.  226.43(c)(5)(ii)(C) provided 
special rules for negative amortization loans. Proposed Sec.  
226.43(c)(5)(ii)(C) required 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 
clarified that for purposes of the rule, the creditor would first have 
to 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) used the terms ``maximum loan 
amount'' and ``recast,'' which are defined and discussed under Sec.  
1026.43(b)(7) and (11), respectively. The term ``negative amortization 
loan'' has the same meaning as in current Sec.  1026.18(s)(7)(v) and 
comment 18(s)(7)-1.
43(c)(5)(i) General Rule
    Proposed Sec.  226.43(c)(5)(i) implemented the payment calculation 
requirements in TILA section 129C(a)(3), 129C(6)(D)(i) through (iii), 
and stated 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) provided 
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 the 
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 explained that the payment 
calculation method set forth in proposed Sec.  226.43(c)(5)(i) applied 
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 
further explained that the payment calculation method set forth in 
proposed Sec.  226.43(c)(5)(ii) applied to any covered transaction that 
is a loan with a balloon payment, interest-only loan, or negative 
amortization loan. To facilitate compliance, this comment listed the 
defined terms used in proposed Sec.  226.43(c)(5) and provided cross-
references to their definitions.
    The fully indexed rate or introductory rate, whichever is greater. 
Proposed Sec.  226.43(c)(5)(i)(A) implemented 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) also 
provided that when creditors calculate the monthly, fully amortizing 
payment for adjustable-rate mortgages, they would have to use the 
introductory interest rate if it were 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. 
Sometimes 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. 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 believed that requiring 
creditors to assess the consumer's ability to repay on the initial 
higher payments would better effectuate the statutory intent and 
purpose. Proposed comment 43(c)(5)(i)-2 provided guidance on using the 
greater of the premium or fully indexed rate.
    Monthly, fully amortizing payments. For simplicity, proposed Sec.  
226.43(c)(5)(i) used 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) and (ii). As 
discussed above, Sec.  1026.43(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 Sec.  1026.43(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 recognized 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) did not dictate the frequency of payment under the 
terms of the loan agreement, but did require creditors to convert the 
payment schedule to monthly payments to determine the consumer's 
repayment ability. Proposed comment 43(c)(5)(i)-3 clarified 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 establish the calculation method a creditor must use to determine 
the consumer's repayment ability for a covered transaction. This 
comment explained, 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 proposed Sec.  226.43(c)(5)(i)(B). 
This comment also explained 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 provided 
additional guidance to creditors for determining whether monthly, fully 
amortizing payments are ``substantially equal.'' See TILA section 
129C(a)(6)(D)(ii). This comment stated 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 explained 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 
explained that where, for example, no two monthly payments vary from 
each other by more than 1 percent (excluding odd periods, such as a 
long or short first or last

[[Page 6478]]

payment period), such monthly payments would be considered 
substantially equal for purposes of the rule. The comment further 
provided that, in general, creditors should determine whether the 
monthly, fully amortizing payments are substantially equal based on 
guidance provided in current Sec.  1026.17(c)(3) (discussing minor 
variations), and Sec.  1026.17(c)(4)(i) through (iii) (discussing 
payment-schedule irregularities and measuring odd periods due to a long 
or short first period) and associated commentary. The proposal 
solicited comment on operational difficulties that arise by ensuring 
payment amounts meet the ``substantially equal'' condition. The 
proposal also solicited comment on whether a 1 percent variance is an 
appropriate tolerance threshold.
    Examples of payment calculations. Proposed comment Sec.  
226.43(c)(5)(i)-5 provided 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.
    The Board recognized 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.\111\ The Board believed this 
approach was consistent with the statute's intent to ensure consumers 
can reasonably repay their loans, 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 believed that 
maintaining the potentially more lenient statutory underwriting 
standard for loans that satisfy the qualified mortgage criteria would 
help to ensure that responsible and affordable credit remains available 
to consumers. See TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2).
---------------------------------------------------------------------------

    \111\ The Bureau has also determined that in many instances the 
fully indexed rate would result in a more lenient underwriting 
standard than the qualified mortgage calculation. See the discussion 
of non-qualified mortgage ARM underwriting below.
---------------------------------------------------------------------------

    Loan amount or outstanding principal balance. As noted above, 
proposed Sec.  226.43(c)(5)(i) was consistent with the statutory 
requirements regarding payment calculations for purposes of the 
repayment ability determination. The Board believed that the intent of 
these statutory requirements was 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 was 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 would have to 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 could 
take effect under the terms of the loan. The Board was concerned that 
this approach might restrict credit availability, even where consumers 
were able to demonstrate that they can repay the payment obligation 
once the fully indexed rate takes effect.
    For this reason, the proposal solicited comment on whether 
authority should be exercised 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.
    Step-rate and adjustable-rate calculations. Due to concerns 
regarding credit availability, the proposal also solicited comment on 
alternative means to calculate monthly payments for step-rate and 
adjustable-rate mortgages. The proposal asked for comment on whether or 
not the rule should require that creditors underwrite a step-rate or an 
adjustable-rate mortgage using the maximum interest rate in the first 
seven or ten years or some other appropriate time horizon that would 
reflect a significant introductory rate period. The section-by-section 
analysis of the ``fully indexed rate'' definition, at Sec.  
1026.43(b)(3) above, discusses this issue in regard to step-rate 
mortgages. For discussion of payment calculation methods for 
adjustable-rate mortgages, see below.
    Safe harbor to facilitate compliance. The Board recognized that 
under its proposal, creditors would have to comply with multiple 
assumptions when calculating the particular payment for purposes of the 
repayment ability determination. The Board was concerned that the 
complexity of the proposed payment calculation requirements might 
increase the potential for unintentional errors to occur, making 
compliance difficult, especially for small creditors that might be 
unable to invest in advanced technology or software needed to ensure 
payment calculations are compliant. At the same time, the Board noted 
that the intent of the statutory framework and the proposal was to 
ensure consumers are offered and receive loans on terms that they can 
reasonably repay. Thus, the Board solicited comment on whether 
authority under TILA sections 105(a) and 129B(e) should be exercised 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 Sec.  226.43(c)(5)(i) and (ii).
Final Rule
    The final rule requires creditors to underwrite the loan at the 
premium rate if greater than the fully indexed rate for purposes of the 
repayment ability determination using the 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, provides that the Bureau'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 Bureau'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 authority under TILA section 129B(e) to 
condition terms, acts or practices relating to residential mortgage 
loans that the Bureau finds necessary and proper to ensure that 
responsible, affordable mortgage credit remains available to consumers 
in a manner consistent with and which effectuates the purposes of 
sections 129B and 129C, and which are in the interest of the consumer. 
15 U.S.C. 1639b(e). The purposes of TILA include the purpose of TILA 
sections 129B and 129C, to assure that consumers are offered and 
receive residential mortgage loans on terms that reasonably reflect 
their ability to repay the loan, among other things. TILA section 
129B(b), 15 U.S.C. 1639b. For the reasons discussed above, the Bureau 
believes that

[[Page 6479]]

requiring creditors to underwrite the loan to the premium rate for 
purposes of the repayment ability determination is necessary and proper 
to ensure that consumers are offered, and receive, loans on terms that 
reasonably reflect their ability to repay, and to prevent circumvention 
or evasion. Without a requirement to consider payments based on a 
premium rate, a creditor could originate loans with introductory-period 
payments that consumers do not have the ability to repay. Therefore, 
this provision is also in the interest of consumers.
    As discussed above, the Board solicited comment on whether payments 
for non-qualified mortgage ARMs should be calculated similarly to 
qualified mortgage ARMs, by using the maximum rate that will apply 
during a certain period, such as the first seven years or some other 
appropriate time horizon. Consumer and community groups were divided on 
this issue. Some supported use of the fully indexed rate, but one 
stated that underwriting ARMs based on the initial period of at least 
five years may be appropriate. Another suggested that for non-qualified 
mortgage ARMs the rule should require use of the maximum interest rate 
or interest rate cap, whichever is greater, to better protect against 
payment shock. A civil rights organization also advocated that ARMs 
that are not qualified mortgages should be underwritten to several 
points above the fully indexed rate. A combined comment from consumer 
advocacy organizations also supported non-qualified mortgage ARMs being 
underwritten more strictly, suggesting that because this is the market 
segment that will have the fewest controls, the predatory practices 
will migrate here, and there is significant danger of payment shock 
when using the fully indexed rate in a low-rate environment such as 
today's market. They suggested that the rule follow Fannie Mae's 
method, which requires underwriting that uses the fully indexed rate or 
the note rate plus 2 percent, whichever is greater, for ARMs with 
initial fixed periods of up to five years. In addition, one joint 
industry and consumer advocacy comment suggested adding 2 percent to 
the fully indexed rate in order to calculate the monthly payment 
amount.
    Industry groups were strongly in favor of using a specific time 
period for underwriting, generally suggesting five years. One credit 
union association stated that use of the fully indexed rate is 
excessive and unnecessary, and will increase the cost of credit. 
Industry commenters stated that creditors generally consider only the 
fixed-rate period, and ARMs with fixed periods of at least five years 
are considered safe. One large bank stated that the calculation for 
ARMs, whether or not they are qualified mortgages, should be uniform to 
ease compliance.
    The Bureau has determined that it will not use its exception and 
adjustment authority to change the statutory underwriting scheme for 
non-qualified mortgage ARMs. The statutory scheme clearly 
differentiates between the qualified mortgage and non-qualified 
mortgage underwriting strategies. The qualified mortgage underwriting 
rules ignore any adjustment in interest rate that may occur after the 
first five years; thus, for example, for an ARM with an initial 
adjustment period of seven years, the interest rate used for the 
qualified mortgage calculation will be the initial interest rate. In 
addition, the qualified mortgage rules, by using the ``maximum interest 
rate,'' take into account any adjustment in interest rate that can 
occur during the first five years, including adjustments attributable 
to changes in the index rate. In contrast, the non-qualified mortgage 
rules have an unlimited time horizon but do not take into account 
adjustments attributable to changes in the index rate.
    Based on the its research and analysis, the Bureau notes that the 
data indicate that neither the fully indexed rate nor the maximum rate 
during a defined underwriting period produces consistent results with 
regard to ability-to-repay calculations. The Bureau finds that the 
underwriting outcomes under the two methods vary depending on a number 
of complex variables, such as the terms of the loan (e.g., the length 
of the initial adjustment period and interest rate caps) and the 
interest rate environment. In other words, for a particular loan, 
whether the monthly payment may be higher under a calculation that uses 
the fully indexed rate, as opposed to the maximum rate in the first 
five years, depends on a number of factors. Given the fact-specific 
nature of the payment calculation outcomes, the Bureau believes that 
overriding the statutory scheme would be inappropriate.
    The Bureau also believes that adjusting the interest rate to be 
used for non-qualified mortgage ability-to-repay calculations to 
somewhere between the fully indexed rate specified in the statute and 
the maximum interest rate mandated for qualified mortgage underwriting; 
for example through an adjustment to the fully indexed rate of an 
additional 2 percent, would be inappropriate. The fully indexed rate 
had been in use since it was adopted by the Interagency Supervisory 
Guidance in 2006, and Congress was likely relying on that experience in 
crafting the statutory scheme. Adding to the fully indexed rate would 
potentially reduce the availability of credit. Such an adjustment also 
could result in a calculated interest rate and monthly payment that are 
higher than the interest rate and payment calculated for qualified 
mortgage underwriting, given that the qualified mortgage rules look 
only to potential adjustments during the first five years.
    The Bureau recognizes that underwriting practices today often take 
into account potential adjustments in an ARM that can result from 
increases in the index rate. For example, Fannie Mae requires 
underwriting that uses the fully indexed rate or the note rate plus 2 
percent, whichever is greater, for ARMs with initial fixed periods of 
up to five years. The Bureau notes that underwriters have the 
flexibility to adjust their practices in response to changing interest 
rate environments whereas the process an administrative agency like the 
Bureau must follow to amend a rule is more time consuming. The Bureau 
also notes that the creditor must make a reasonable determination that 
the consumer has the ability to repay the loan according to its terms. 
Therefore, in situations where there is a significant likelihood that 
the consumer will face an adjustment that will take the interest rate 
above the fully indexed rate, a creditor whose debt-to-income or 
residual income calculation indicates that a consumer cannot afford to 
absorb any such increase may not have a reasonable belief in the 
consumer's ability to repay the loan according to its terms. See 
comment 43(c)(1)-1.
    Although the Bureau has determined to implement the statutory 
scheme as written and require use of the fully indexed rate for non-
qualified mortgage ARMs, it will monitor this issue through its 
mandatory five-year review, and may make adjustments as necessary.
    As discussed above, the Board also solicited comment on whether or 
not to allow the fully indexed rate to be applied to the balance 
projected to be remaining when the fully indexed rate goes into effect, 
instead of the full loan amount, and thus give a potentially more 
accurate figure for the maximum payment that would be required for 
purposes of determining ability to repay. A consumer group and a group 
advocating for financial reform supported this possibility, saying that 
allowing lenders to apply the fully indexed rate to the balance 
remaining when the rate changes, rather than the full loan amount, will 
encourage longer

[[Page 6480]]

fixed-rate periods and safer lending, as well as preserve access to 
credit. An association representing credit unions also agreed with the 
possible amendment, stating that the new method would yield a more 
accurate measure of the maximum payment that could be owed.
    The Bureau believes it is appropriate for the final rule to remain 
consistent with the statutory scheme. The Bureau believes that changing 
the calculation method, required by the statute,\112\ would not be an 
appropriate use of its exception and adjustment authority. The Bureau 
believes the potentially stricter underwriting method of calculating 
the monthly payment by applying the imputed (i.e., fully indexed) 
interest rate to the full loan amount for non-qualified mortgage ARMs, 
provides greater assurance of the ability to repay. In addition, 
payment calculation using the fully indexed rate can only approximate 
the consumer's payments after recast, since the index may have 
increased significantly by then. Accordingly, the Bureau believes that 
requiring the use of the full loan amount will reduce the potential 
inaccuracy of the ability-to-repay determination in such a situation.
---------------------------------------------------------------------------

    \112\ ``A creditor shall determine the ability of the consumer 
to repay using a payment schedule that fully amortizes the loan over 
the loan term.'' TILA Sec.  129C(a)(3).
---------------------------------------------------------------------------

    In addition, the Board solicited comment on whether to provide a 
safe harbor for any creditor that underwrites using the ``largest 
scheduled payment that can occur during the loan term.'' To provide 
such a safe harbor the Bureau would have to employ its exception and 
adjustment authority because the use of the fully indexed rate 
calculation is required by TILA section 129C(a)(6)(D)(iii). Two 
industry commenters and an association of state bank regulators 
supported this exemption, but none of them provided a developed 
rationale for their support or included information useful in assessing 
the possible exemption. The Bureau does not believe that it would be 
appropriate at this time to alter the statutory scheme in this manner.
    As discussed above, the Board also solicited comment on how to 
lessen any operational difficulties of ensuring that payment amounts 
meet the ``substantially equal'' condition, and whether or not allowing 
a one percent variance between payments provided an appropriate 
threshold. Only two commenters mentioned this issue. One industry 
commenter stated that the 1 percent threshold was appropriate, but an 
association of state bank regulators believed that a 5 percent 
threshold would work better. Because the 1 percent threshold appears to 
be sufficient to allow for payment variance and industry commenters did 
not express a need for a higher threshold, the Bureau does not believe 
that the provision should be amended.
    For the reasons stated above, the Bureau is adopting Sec.  
1026.43(c)(5)(i) and associated commentary substantially as proposed, 
with minor clarifying revisions.
43(c)(5)(ii) Special Rules for Loans With a Balloon Payment, Interest-
Only Loans, and Negative Amortization Loans
    Proposed Sec.  226.43(c)(5)(ii) created exceptions to the general 
rule under proposed Sec.  226.43(c)(5)(i), and provided special rules 
in proposed Sec.  226.43(c)(5)(ii)(A) through (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) through (iii), proposed Sec.  
226.43(c)(5)(ii)(A) through (C) implemented TILA sections 129C(a)(6)(B) 
and (C), and TILA section 129C(a)(6)(D)(ii)(I) and (II). Each of these 
proposed special rules is discussed below.
43(c)(5)(ii)(A)
    Implementing the different payment calculation methods in TILA 
section 129C(a)(6)(D)(ii), the Board proposed different rules for 
balloon-payment mortgages that are higher-priced covered transactions 
and those that are not, in Sec.  1026.43(c)(5)(ii)(A)(1) and (2). 
Proposed comment 43(c)(5)(ii)(A)-1 provided guidance on applying these 
two methods. This guidance is adopted as proposed with minor changes 
for clarity and to update a citation. The language describing the 
calculation method for balloon-payment mortgages that are not higher-
priced covered transactions has been changed to reflect the use of the 
first regular payment due date as the start of the relevant five-year 
period. Pursuant to the Bureau's rulewriting authority under TILA 
section 129C(a)(6)(D)(ii)(I), this change has been made to facilitate 
compliance through consistency with the amended underwriting method for 
qualified mortgages. See the section-by-section analysis of Sec.  
1026.43(e)(2)(iv)(A). As with the recast on five-year adjustable-rate 
qualified mortgages, the Bureau believes that consumers will benefit 
from having a balloon payment moved to at least five years after the 
first regular payment due date, rather than five years after 
consummation.
43(c)(5)(ii)(A)(1)
    The statute provides an exception from the general payment 
calculation discussed above for loans that require ``more rapid 
repayment (including balloon payment).'' See TILA section 
129C(a)(6)(D)(ii)(I) and (II). For balloon-payment loans that are not 
higher-priced covered transactions (as determined by using the margins 
above APOR in TILA section 129C(a)(6)(D)(ii)(I) and implemented at 
Sec.  1026.43(b)(4)), the statute provides that the payment calculation 
will be determined by regulation. The Board proposed that a creditor be 
required to make the repayment determination under proposed Sec.  
226.43(c)(2)(iii) for ``[t]he maximum payment scheduled during the 
first five years after consummation * * *''
    The Board chose a five-year period in order to preserve access to 
affordable short-term credit, and because five years was considered an 
adequate period for a consumer's finances to improve sufficiently to 
afford a fully amortizing loan. The Board believed that balloon-payment 
loans of less than five years presented more risk of inability to 
repay. The Board also believed that the five-year period would 
facilitate compliance and create a level playing field because of its 
uniformity with the general qualified mortgage provision (see Sec.  
1026.43(e)), and balloon-payment qualified mortgage provision (see 
Sec.  1026.43(f)). The Board solicited comment on whether the five-year 
horizon was appropriate. Proposed comment Sec.  226.43(c)(5)(ii)(A)-2 
provided further guidance to creditors on determining whether a balloon 
payment occurs in the first five years after consummation. Proposed 
comment 43(c)(5)(ii)(A)-3 addressed renewable balloon-payment loans. 
This comment discussed balloon-payment loans that are not higher-priced 
covered transactions which provide an unconditional obligation to renew 
a balloon-payment loan at the consumer's option or obligation to renew 
subject to conditions within the consumer's control. This comment 
clarified 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.
    The Board recognized that proposed comment 43(c)(5)(ii)(A)-3 did 
not take the same approach as guidance contained in comment 17(c)(1)-11 
regarding treatment of renewable balloon-payment loans for disclosure 
purposes, or with guidance contained in

[[Page 6481]]

current comment 34(a)(4)(iv)-2 of the Board's 2008 HOEPA Final Rule. 
Although the proposal differed from current guidance in Regulation Z, 
the Board believed this approach was appropriate for several reasons. 
First, the ability-to-repay provisions in the Dodd-Frank Act do not 
address extending the term of a balloon-payment loan with an 
unconditional obligation to renew provision. Second, permitting short-
term ``prime'' balloon-payment 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. See TILA Section 129B(a)(2), 15 U.S.C. 
1639b(a)(2), and TILA Section 129C(b)(2)(A)(v). Moreover, the Board 
believed 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-payment loans is meant 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 was 
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).
    Proposed comment 43(c)(5)(ii)(A)-4 provided 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.
    In regard to the proposed five-year underwriting period, some 
commenters suggested that the payment period considered should be 
increased to ten years, stating that balloon-payment loans were 
repeatedly used in an abusive manner during the years of heavy subprime 
lending. The combined consumer advocacy organizations' comment stated 
that the five-year underwriting might lead to an increase in five-year 
balloon-payment loans, which would be bad for sustainable lending. On 
the other hand, a trade association representing credit unions 
supported the five-year rule. One industry commenter objected to the 
whole balloon underwriting scheme, including the five-year rule, 
apparently preferring something less.
    For the reasons discussed by the Board in the proposal, and 
described above, the Bureau has determined that five years is an 
appropriate time frame for determining the ability to repay on balloon-
payment mortgages that are not higher-priced covered transactions. 
However, for the sake of uniformity and ease of compliance with the 
qualified mortgage calculation and ability-to-repay calculation for 
non-qualified mortgage adjustable-rate mortgages, the proposed 
provision has been changed to state that the five years will be 
measured from the date of the first regularly scheduled payment, rather 
than the date of consummation. The Bureau has made this determination 
pursuant to the authority granted by TILA section 129C(a)(6)(D)(ii)(I) 
to prescribe regulations for calculating payments to determine 
consumers' ability to repay balloon-payment mortgages that are not 
higher-cost covered transactions.
    TILA section 129C(a)(6)(D)(ii)) refers to loans requiring ``more 
rapid repayment (including balloon payment).'' The Board solicited 
comment about whether this statutory language should be read as 
referring to loan types other than balloon-payment loans. The Bureau 
did not receive comments on this matter, and has determined that the 
rule language does not need to be amended to include other types of 
``rapid repayment'' loans at this time.
    The Board also solicited comment about balloon-payment loans that 
have an unconditional obligation to renew. The Board asked whether or 
not such loans should be allowed to comply with the ability-to-repay 
requirements using the total of the mandatory renewal terms, instead of 
just the first term. As discussed above, proposed comment 
43(c)(5)(ii)(A)-3 made clear that this would not be allowed under the 
rule as proposed. The Board also solicited comment on any required 
conditions that the renewal obligation should have, if such an 
amendment were made. However, the Bureau did not receive comments on 
this matter, and the provision and staff comment are adopted as 
proposed. A creditor making any non-higher-priced balloon-payment 
mortgage of less than five years with a clear obligation to renew can 
avoid having the ability-to-repay determination applied to the balloon 
payment by including the renewal period in the loan term so that the 
balloon payment occurs after five years.
    Accordingly, the Bureau is adopting Sec.  1026.43(c)(5)(ii)(A)(1) 
and associated commentary substantially as proposed, with minor changes 
for clarification, as well as new language to reflect that the five-
year underwriting period begins with the due date of the first payment, 
as discussed above. In addition, the Bureau has added a second example 
to comment 43(c)(5)(ii)(A)-2 to demonstrate the effect of the change to 
the beginning of the underwriting period.
43(c)(5)(ii)(A)(2)
    Proposed Sec.  226.43(c)(5)(ii)(A)(2) implemented TILA section 
129C(a)(6)(D)(ii)(II) and provided 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 \113\ (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.'' 
For purposes of proposed Sec.  226.43(c)(5)(i)(A), ``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. See Sec.  1026.43(b)(4).
---------------------------------------------------------------------------

    \113\ See the previous section, .43(c)(5)(ii)(A)(1), for 
discussion of this statutory language.
---------------------------------------------------------------------------

    The proposed rule interpreted 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, either at 
maturity or during any intermittent period, is necessary to fully 
amortize the loan, and so a consumer's ability to pay the balloon 
payment would need to be considered. Proposed comment 43(c)(5)(ii)(A)-5 
provided an illustrative example of how to determine the consumer's 
repayment ability based on the loan contract's payment schedule, 
including any

[[Page 6482]]

balloon payment. The proposed rule applied 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.
    In making this proposal, the Board expressed concern that this 
approach could lessen credit choice for non-prime consumers and 
solicited comment, with supporting data, on the impact of this approach 
for low-to-moderate income consumers. In addition, the Board asked for 
comment on whether or not a consumer's ability to refinance out of a 
balloon-payment loan should be considered in determining ability to 
repay.
    Industry commenters who focused on this provision opposed applying 
the ability-to-repay determination to the entire payment schedule. Two 
trade associations representing small and mid-size banks strongly 
objected to including the balloon payment in the underwriting, and one 
stated that many of the loans its members currently make would fall 
into the higher-priced category, making these loans unavailable. 
However, the statutory scheme for including the balloon payment was 
supported by a state housing agency and the combined consumer 
protection advocacy organizations submitting joint comments.
    None of the commenters submitted data supporting the importance of 
higher-priced balloon-payment mortgages for credit availability, or 
whether consideration of a consumer's ability to obtain refinancing 
would make the ability-to-repay determination less significant in this 
context. The Bureau notes that under Sec.  1026.43(f) a balloon-payment 
mortgage that is a higher-priced covered transaction made by certain 
creditors in rural or underserved areas may also be a qualified 
mortgage and thus the creditor would not have to consider the 
consumer's ability to repay the balloon payment. Because this final 
rule adopts a wider definition of ``rural or underserved area'' than 
the Board proposed, potential credit accessibility concerns have been 
lessened. See the section-by-section analysis of Sec.  1026.43(f), 
below.
    The statute requires the consideration of the balloon payment for 
higher-priced covered transactions, and the Bureau does not believe 
that using its exception and adjustment authority would be appropriate 
for this issue. Accordingly, Sec.  1026.43(c)(5)(ii)(A)(2) and 
associated commentary are adopted substantially as proposed, with minor 
changes for clarification.
43(c)(5)(ii)(B)
    The Board's proposed Sec.  226.43(c)(5)(ii)(B) implemented 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, the proposed 
rule used 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 Sec.  
1026.43(b)(11). The statute does not define the term ``interest-only.'' 
For purposes of this rule, the terms ``interest-only loan'' and 
``interest-only'' have the same meaning as in Sec.  1026.18(s)(7)(iv).
    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) provided 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 paralleled the general rule proposed in Sec.  
226.43(c)(5)(i), except that proposed Sec.  226.43(c)(5)(ii)(B)(2) 
required 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).
    The Board interpreted 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 
believed this approach most accurately assessed 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 2006 Nontraditional 
Mortgage Guidance.
    Proposed comment 43(c)(5)(ii)(B)-1 provided guidance on the monthly 
payment calculation for interest-only loans, and clarified that the 
relevant term of the loan for calculating these payments is the period 
of time that remains after the loan is recast. This comment also 
explained 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.
    Proposed comment 43(c)(5)(ii)(B)-2 provided 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.
    Commenters did not focus on the calculation for interest-only 
loans. The Bureau considers the Board's interpretation and 
implementation of the statute to be accurate and appropriate. 
Accordingly, Sec.  1026.43(c)(5)(ii)(B) and associated commentary are 
adopted as proposed.
43(c)(5)(ii)(C)
    Proposed Sec.  226.43(c)(5)(ii)(C) implemented 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.''
    For such loans, proposed Sec.  226.43(c)(5)(ii)(C) provided 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. The proposed payment 
calculation rule for negative amortization loans paralleled the general 
rule in proposed Sec.  226.43(c)(5)(i), except that proposed Sec.  
226.43(c)(5)(ii)(C)(2) required 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 Sec.  
1026.43(b)(2). The proposed rule used the terms ``maximum loan amount'' 
and ``recast,'' which are defined and discussed at Sec.  1026.43(b)(7) 
and (b)(11), respectively.
    The Board proposed that the term ``negative amortization loan'' 
have the same meaning as set forth in Sec.  226.18(s)(7)(v), which 
provided that the term ``negative amortization loan'' means a loan, 
other than a reverse mortgage subject to Sec.  226.33, that

[[Page 6483]]

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. 
Accordingly, proposed Sec.  226.43(c)(5)(ii)(C) covered only loan 
products that permit or require minimum periodic payments, such as 
payment-option loans and graduated payment mortgages with negative 
amortization.\114\ The Board believed that covering these types of 
loans in proposed Sec.  226.43(c)(5)(ii)(C) was 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 that any potential 
payment shock might have on the consumer's ability to repay the loan. 
See TILA section 129C(a)(6)(C).
---------------------------------------------------------------------------

    \114\ 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.
---------------------------------------------------------------------------

    In contrast, in a transaction such as a seasonal loan 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. Accordingly, the same potential for payment 
shock due to accumulating negative amortization does not exist. These 
loans with a negative amortization feature are therefore not covered by 
the proposed term ``negative amortization loan,'' and would not be 
subject to the special payment calculation requirements for negative 
amortization loans at proposed Sec.  226.43(c)(5)(ii)(C).
    For purposes of determining the consumer's ability to repay a 
negative amortization loan under proposed Sec.  226.43(c)(5)(ii)(C), 
creditors would be required to make a two-step payment calculation.
    Step one: maximum loan amount. Proposed Sec.  226.43(c)(5)(ii)(C) 
would have required 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 comment 43(c)(5)(ii)(C)-1; see also proposed Sec.  
226.43(b)(11), which defined 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 further clarified 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.
    As discussed above, Sec.  1026.43(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.  
1026.18(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 interpreted 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 might result under the loan's terms 
where the consumer makes only the minimum periodic payments required. 
The Board believed the intent of this statutory provision was 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 recognized that the 
approach taken towards calculating the maximum loan amount requires 
creditors to assume a ``worst-case scenario,'' but believed this 
approach was consistent with statutory intent to take into account the 
greatest potential increase in the principal balance.
    Moreover, the Board noted that calculating the maximum loan amount 
based on these assumptions is consistent with the approach in the 2010 
MDIA Interim Final Rule,\115\ 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.\116\
---------------------------------------------------------------------------

    \115\ See 12 CFR 1026.18(s)(2)(ii) and comment 18(s)(2)(ii)-2.
    \116\ See 2006 Nontraditional Mortgage Guidance, at 58614, n.7.
---------------------------------------------------------------------------

    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 
would require 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 clarified that creditors must 
follow this two-step approach when determining the consumer's repayment 
ability on a negative amortization loan, and also provided cross-
references to aid compliance. Proposed comment 43(c)(5)(ii)(C)-2 
provided further guidance to creditors regarding the relevant term of 
the loan that must be used for purposes of the repayment ability 
determination. Proposed comment 43(c)(5)(ii)(C)-3 provided 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.
    In discussing the ability-to-repay requirements for negative 
amortization loans, the Board noted the anomaly that a graduated 
payment mortgage may have a largest scheduled payment that is larger 
than the payment calculated under proposed Sec.  226.43(c)(5)(ii)(C). 
The Board solicited comment on whether or not the largest scheduled 
payment should be used in determining ability to repay. The Bureau 
received one comment on this issue, from an association of State bank 
regulators, arguing that the rule should use the largest payment 
scheduled. However, the Bureau does not believe that a special rule for 
graduated payment mortgages, which would require an exception from the 
statute, is necessary to ensure ability to repay these loans. It is 
unlikely that the calculated payment will be very different from the 
largest scheduled payment, and introducing this added complexity to the 
rule is unnecessary. Also, the one comment favoring such a choice did 
not include sufficient data to support use of the exception and 
adjustment authority under TILA, and the Bureau is not aware any such 
data.
Final Rule
    The Bureau did not receive comments on the proposed method for 
calculating payments for negative amortization

[[Page 6484]]

loans. The Bureau believes that the method proposed by the Board 
implements the statutory provision accurately and appropriately. 
Accordingly, Sec.  1026.43(c)(5)(ii)(C) and associated commentary are 
adopted substantially as proposed, with minor changes for 
clarification.
43(c)(6) Payment Calculation for Simultaneous Loans
43(c)(6)(i)
    The Board's proposed rule provided that for purposes of determining 
a consumer's ability to repay a loan, ``a creditor must consider a 
consumer's payment on a simultaneous loan that is--(i) a covered 
transaction, by following paragraphs (c)(5)(i) and (ii) of this 
section'' (i.e., the payment calculation rules for the covered 
transaction itself).
    Proposed comment 43(c)(6)-1 stated 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. Proposed comment 43(c)(6)-2 explained that for a 
simultaneous loan that is a covered transaction, as that term was 
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 proposed Sec.  226.43(c)(5), taking 
into account any mortgage-related obligations.
    The Bureau did not receive comments on this specific language or 
the use of the covered transaction payment calculation for simultaneous 
loans. For discussion of other issues regarding simultaneous loans, see 
the section-by-section analysis of Sec.  1026.43(b)(12), .43(c)(2)(iv) 
and .43(c)(6)(ii).
    The Bureau considers the language of proposedSec.  226.43(c)(6)(i) 
to be an accurate and appropriate implementation of the statute. 
Accordingly, the Bureau is adopting Sec.  1026.43(c)(6)(i) and 
associated commentary substantially as proposed, with minor changes for 
clarity. The requirement to consider any mortgage-related obligations, 
presented in comment 43(c)(6)-2, is now also part of the regulatory 
text, at Sec.  1026.43(c)(6).
43(c)(6)(ii)
    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. In 
the proposed rule, the Board was concerned that requiring the creditor 
to underwrite a simultaneous HELOC assuming a full draw on the credit 
line might unduly restrict credit access, especially in connection with 
non-purchase transactions, because it would require creditors to assess 
the consumer's repayment ability using potentially overstated payment 
amounts. For this reason, the Board proposed 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. The Board 
solicited comment on whether this approach was appropriate.
    Proposed comment 43(c)(6)-3 clarified 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 explained 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 before consummation 
of the covered transaction. This comment clarified 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.
    Several industry commenters objected that it is difficult to know 
the actual amount drawn on a HELOC if it is held by another lender. One 
commenter suggested finding another way to do this calculation, such as 
by adding 1 percent of the full HELOC line to the overall monthly 
payment. Two banking trade associations said that the full line of 
credit should be considered, and if the consumer does not qualify, the 
line of credit can be reduced in order to qualify safely. One bank 
stated that creditors regulated by Federal banking agencies are bound 
by the interagency ``Credit Risk Guidance for Home Equity Lending'' 
(2005) to consider the full line of credit, and this will create an 
uneven playing field.
    Other industry commenters supported use of the actual amount drawn 
at consummation. Both Freddie Mac and Fannie Mae stated that the 
Board's proposal for considering the actual amount drawn at closing was 
consistent with their underwriting standards. In addition, an 
association representing one state's credit unions stated that 
requiring consideration of a 100 percent draw would be onerous and 
inaccurate. It also asked that we make clear that the creditor does not 
have to recalculate a consumer's ability to repay if the amount drawn 
changes at consummation.
    The Bureau believes that requiring consideration of 100 percent of 
a home equity line of credit would unnecessarily restrict credit 
availability for consumers. Available but unaccessed credit is not 
considered in determining ability to repay a mortgage when the consumer 
has other types of credit lines, such as credit cards. Although HELOCs 
are secured by the consumer's dwelling, and thus differ from other 
types of available but unaccessed credit, this difference does not seem 
determinative. Any potential dwelling-secured home equity line of 
credit that a creditor might grant to a consumer could simply be 
requested by the consumer immediately following consummation of the 
covered transaction. The fact that the potential credit line has been 
identified and enumerated prior to the transaction, rather than after, 
does not seem significant compared to the fact that the consumer has 
chosen not to access that credit, and will not be making payments on 
it. As with the rest of the ability-to-repay requirements, creditors 
should apply appropriate underwriting procedures, and are not 
restricted to the legally mandated minimum required by this rule, as 
long as they satisfy that minimum.
    The requirements of the 2005 ``Credit Risk Guidance for Home Equity 
Lending'' do not change the Bureau's view of this issue. The Guidance 
covers home equity lending itself, not consideration of HELOCs as 
simultaneous loans when determining ability to repay for senior non-
HELOCs. The requirement to consider the entire home equity line of 
credit controls only a bank's granting of that line of credit. For this 
reason, the Bureau does not believe that banks following this guidance 
will be disadvantaged. In addition, the Bureau will not be implementing 
the suggested alternative of adding 1 percent to the calculated monthly 
payment on the covered transaction. The Bureau is not aware of any data 
supporting the accuracy of such an approach.
    In regard to the comments concerning difficulty in determining the 
amount of the draw and the monthly HELOC payment, the Bureau as 
discussed above

[[Page 6485]]

in the section-by-section analysis of Sec.  1026.43(c)(2)(iv) has added 
language to comment 43(c)(2)(iv)-4 providing more specific guidance in 
applying the knows or has reason to know standard. In addition, 
language has been added to comment 43(c)(6)-3, regarding payment 
calculations for simultaneous HELOCs, making clear that a creditor does 
not need to reconsider ability to repay if the consumer unexpectedly 
draws more money than planned at closing from a HELOC issued by a 
different creditor. In addition, the regulation language has been 
clarified to state that the creditor must use the amount of credit ``to 
be'' drawn at consummation, making clear that a violation does not 
occur if the creditor did not know or have reason to know that a 
different amount would be drawn.
    The Board also solicited comment on whether or not a safe harbor 
should be given to those creditors who consider the full HELOC credit 
line. However, commenters did not focus on this possibility. The Bureau 
believes that although a creditor may choose to underwrite using the 
full credit line as a means of considering ability to repay in relation 
to the actual draw, a safe harbor is not warranted. Because the full 
credit line should always be equal to or greater than the actual draw, 
appropriate use of the full credit line in underwriting will constitute 
appropriate compliance without a safe harbor.
    In addition to the amount of a HELOC that needs to be considered in 
determining ability to repay, the Board also solicited comment on 
whether the treatment of HELOCs as simultaneous loans should be limited 
to purchase transactions. The Board suggested that concerns regarding 
``piggyback loans'' were not as acute with non-purchase transactions.
    Consumer and public interest groups opposed limiting the 
consideration of HELOCs to purchase transactions. Several consumer 
advocacy groups suggested that if only purchase transactions were 
covered, the abuses would migrate to the unregulated space. Some 
commenters said they did not see a reason to exclude the cost of a 
simultaneous loan when it is extended as part of a refinance. Industry 
commenters did not focus much on this issue, but an association 
representing credit unions supported limiting consideration to purchase 
transactions in order to reduce regulatory burden on credit unions and 
streamline the refinancing process.
    The Bureau believes that requiring consideration of HELOCs as 
simultaneous loans is appropriate in both purchase and non-purchase 
transactions. In both situations the HELOC is a lien on the consumer's 
dwelling with a cost that affects the viability of the covered 
transaction loan. The Bureau recognizes that a simultaneous HELOC in 
connection with a refinancing is more likely to be a convenience than 
one issued simultaneously with a purchase transaction, which will often 
cover down payment, transaction costs or other major expenses. However, 
the final rule accommodates this difference by allowing the creditor to 
base its ability-to-repay determination on the actual draw. The Bureau 
did not receive and is not aware of any information or data that 
justifies excluding actual draws on simultaneous HELOCs in connection 
with refinances from this rule.
    For the reasons stated above, the Bureau considers the language of 
proposedSec.  226.43(c)(6)(ii) to be an accurate and appropriate 
implementation of the statute. Accordingly, the Bureau is adopting 
Sec.  1026.43(c)(6)(ii) and associated commentary as proposed, with 
minor changes for clarity.
43(c)(7) Monthly Debt-to-Income Ratio or Residual Income
    As discussed above, TILA section 129C(a)(3) requires creditors to 
consider the debt-to-income ratio or residual income the consumer will 
have after paying non-mortgage debt and mortgage-related obligations, 
as part of the ability-to-repay determination under TILA section 
129C(a)(1). The Board's proposal would have implemented this 
requirement in Sec.  226.43(c)(2)(vii). The Board proposed definitions 
and calculations for the monthly debt-to-income ratio and residual 
income in Sec.  226.43(c)(7).
    With respect to the definitions, proposed Sec.  226.43(c)(7)(i)(A) 
would have defined the total monthly debt obligations as the sum of: 
the payment on the covered transaction, as required to be calculated by 
proposed Sec.  226.43(c)(2)(iii) and (c)(5); the monthly payment on any 
simultaneous loans, as required to be calculated by proposed Sec.  
226.43(c)(2)(iv) and (c)(6); the monthly payment amount of any 
mortgage-related obligations, as required to be considered by proposed 
Sec.  226.43(c)(2)(v); and the monthly payment amount of any current 
debt obligations, as required to be considered by proposed Sec.  
226.43(c)(2)(vi). Proposed Sec.  1026.43(c)(7)(i)(B) would have defined 
the total monthly income as the sum of the consumer's current or 
reasonably expected income, including any income from assets, as 
required to be considered by proposed Sec.  226.43(c)(2)(i) and (c)(4).
    With respect to the calculations, proposed Sec.  
226.43(c)(7)(ii)(A) would have required the creditor to consider the 
consumer's monthly debt-to-income ratio by taking the ratio of the 
consumer's total monthly debt obligations to total monthly income. 
Proposed Sec.  226.43(c)(7)(ii)(B) would have required the creditor to 
consider the consumer's residual income by subtracting the consumer's 
total monthly debt obligations from the total monthly income. The Board 
solicited comment on whether consideration of residual income should 
account for loan amount, region of the country, and family size, and on 
whether creditors should be required to include Federal and State taxes 
in the consumer's obligations to calculate the residual income.
    Proposed comment 43(c)(7)-1 would have stated that a creditor 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 proposed comment would have explained 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 would have clarified that if a creditor 
considers both the consumer's debt-to-income ratio and residual income, 
the creditor may base its determination of ability to repay on either 
the consumer's debt-to-income ratio or residual income, even if the 
determination would differ with the basis used. In the section-by-
section analysis of proposed Sec.  226.43(c)(7), the Board explained 
that it did 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 would have provided that creditors may 
consider compensating factors to mitigate a higher debt-to-income ratio 
or lower residual income. The proposed comment would have provided that 
the creditor may, for example, 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. The proposed comment also would have provided that, in 
determining whether and in what manner to consider compensating 
factors, creditors may look to widely accepted governmental and non-
governmental underwriting

[[Page 6486]]

standards. The Board solicited comment on whether it should provide 
more guidance on what factors creditors may consider, and on how 
creditors may include compensating factors in the repayment ability 
determination.
    In addition, the Board solicited comment on two issues related to 
the use of automated underwriting systems. The Board solicited 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 solicited comment on other 
methods to facilitate creditor reliance on automated underwriting 
systems, while ensuring that creditors can demonstrate compliance with 
the rule.
    As discussed above in the section-by-section analysis of Sec.  
1026.43(c)(2)(vii), industry commenters and consumer advocates largely 
supported including consideration of the monthly debt-to-income ratio 
or residual income in the ability-to-repay determination and generally 
favored a flexible approach to consideration of those factors. In 
response to the Board's proposal, some consumer advocates asked that 
the Bureau conduct research on the debt-to-income ratio and residual 
income. They requested a standard that reflects the relationship 
between the debt-to-income ratio and residual income. One industry 
commenter recommended that the Bureau adopt the VA calculation of 
residual income. Another industry commenter suggested that the Bureau 
adopt the same definitions of the debt-to-income ratio and residual 
income as for qualified residential mortgages, to reduce compliance 
burdens and the possibility of errors. One industry commenter asked 
that consideration of residual income be permitted to vary with family 
size and geographic location. The commenter suggested that the residual 
income calculation account for Federal and State taxes. Several 
consumer advocates suggested that the Bureau review the VA residual 
income guidelines and update the cost of living tiers. They affirmed 
that all regularly scheduled debt payments should be included in the 
residual income calculation. They noted that residual income should be 
sufficient to cover basic living necessities, including food, 
utilities, clothing, transportation, and known health care expenses.
    One industry commenter asked that the Bureau provide guidance on 
and additional examples of compensating factors, for example, 
situations where a consumer has many assets but a low income or high 
debt-to-income ratio. The commenter suggested that the Bureau clarify 
that the list of examples was not exclusive. Consumer advocates 
recommended that the Bureau not permit extensions of credit based on a 
good credit history or involving a high loan-to-value ratio if the 
debt-to-income ratio or residual income does not reflect an ability to 
repay. These commenters argued that credit scores and down payments 
reflect past behavior and incentives to make down payments, not ability 
to repay.
    The Bureau is largely adopting Sec.  1026.43(c)(7) as proposed, 
with certain clarifying changes to the commentary. Specifically, 
comment 43(c)(7)-1 clarifies that Sec.  1026.43(c) does not prescribe a 
specific debt-to-income ratio with which creditors must comply. For the 
reasons discussed above in the section-by-section analysis of Sec.  
1026.43(c), the Bureau is not finalizing the portion of proposed 
comment 43(c)(7)-1 which would have provided that the creditor may look 
to widely accepted governmental and non-governmental underwriting 
standards to determine the appropriate threshold for the monthly debt-
to-income ratio or the monthly residual income. Instead, comment 
43(c)(7)-1 provides that an appropriate threshold for a consumer's 
monthly debt-to-income ratio or monthly residual income is for the 
creditor to determine in making a reasonable and good faith 
determination of a consumer's repayment ability.
    Comment 43(c)(7)-2 clarifies guidance regarding use of both monthly 
debt-to-income and monthly residual income by providing that if a 
creditor considers the consumer's monthly debt-to-income ratio, the 
creditor may also consider the consumer's residual income as further 
validation of the assessment made using the consumer's monthly debt-to-
income ratio. The Bureau is not finalizing proposed comment 43(c)(7)-2, 
which would have provided that if a creditor considers both the 
consumer's monthly debt-to-income ratio and residual income, the 
creditor may base the ability-to-repay determination on either metric, 
even if the ability-to-repay determination would differ with the basis 
used. The Bureau believes the final guidance better reflects how the 
two standards work together in practice, but the change is not intended 
to alter the rule.
    Comment 43(c)(7)-3 also clarifies guidance regarding the use of 
compensating factors in assessing a consumer's ability to repay by 
providing that, for example, the creditor may reasonably and in good 
faith determine that an individual consumer has the ability to repay 
despite a higher monthly debt-to-income ratio or lower residual income 
in light of the consumer's assets other than the dwelling securing the 
covered transaction, such as a savings account. The creditor may also 
reasonably and in good faith determine that a consumer has the ability 
to repay despite a higher debt-to-income ratio in light of the 
consumer's residual income. The Bureau believes that not permitting use 
of compensating factors may reduce access to credit in some cases, even 
if the consumer could afford the mortgage. The Bureau does not believe, 
however, that the rule should provide an extensive list of compensating 
factors that the creditor may consider in assessing repayment ability. 
Instead, creditors should make reasonable and good faith determinations 
of the consumer's repayment ability in light of the facts and 
circumstances. This approach to compensating factors is consistent with 
the final rule's flexible approach to the requirement that creditors 
make a reasonable and good faith of a consumer's repayment ability 
throughout Sec.  1026.43(c).
    The Bureau will consider conducting a future study on the debt-to-
income ratio and residual income. Except for one small creditor and the 
VA, the Bureau is not aware of any creditors that routinely use 
residual income in underwriting, other than as a compensating 
factor.\117\ The VA underwrites its loans to veterans based on a 
residual income table developed in 1997. The Bureau understands that 
the table shows the residual income desired for the consumer based on 
the loan amount, region of the country, and family size, but does not 
account for differences in housing or living costs within regions (for 
instance rural Vermont versus New York City). The Bureau also 
understands that the residual income is calculated by deducting 
obligations, including Federal and State taxes, from effective income. 
However, at this time, the Bureau is unable to conduct a detailed 
review of the VA residual income guidelines, which would include an 
analysis of whether those guidelines are predictive of repayment 
ability, to determine if those standards should be incorporated, in 
whole or in part, into the ability-to-

[[Page 6487]]

repay analysis that applies to the entire residential mortgage market. 
Further, the Bureau believes that providing broad standards for the 
definition and calculation of residual income will help preserve 
flexibility if creditors wish to develop and refine more nuanced 
residual income standards in the future. The Bureau accordingly does 
not find it necessary or appropriate to specify a detailed methodology 
in the final rule for consideration of residual income.
---------------------------------------------------------------------------

    \117\ See also Michael E. Stone, What is Housing Affordability? 
The Case for the Residual Income Approach, 17 Housing Pol'y Debate 
179 (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'').
---------------------------------------------------------------------------

    The final rule also does not provide a safe harbor for creditors 
relying on automated underwriting systems that use monthly debt-to-
income ratios. The Bureau understands that creditors routinely rely on 
automated underwriting systems, many of which are proprietary and thus 
lack transparency to the individual creditors using the systems. Such 
systems may decide, for example, whether the debt-to-income ratio and 
compensating factors are appropriate, but may not disclose to the 
individual creditors using such systems which compensating factors were 
used for loan approval. However, the Bureau does not believe a safe 
harbor is necessary in light of the flexibility the final rule provides 
to creditors in assessing a consumer's repayment ability, including 
consideration of monthly debt-to-income ratios. See comments 43(c)(1)-1 
and 43(c)(2)-1.
    Finally, the Bureau notes the contrast between the flexible 
approach to considering and calculating debt-to-income in Sec.  
1026.43(c)(2)(vii) and (7) and the specific standards for evaluating 
debt-to-income for purposes of determining whether a covered 
transaction is a qualified mortgage under Sec.  1026.43(e)(2). For the 
reasons discussed below in the section-by-section analysis of Sec.  
1026.43(e)(2), the Bureau believes a specific, quantitative standard 
for evaluating a consumer's debt-to-income ratio is appropriate in 
determining whether a loan receives either a safe harbor or presumption 
of compliance with the repayment ability requirements of Sec.  
1026.43(c)(1) pursuant to Sec.  1026.43(e)(2). However, the ability-to-
repay requirements in Sec.  1026.43(c) will apply to the whole of the 
mortgage market and therefore require flexibility to permit creditors 
to assess repayment ability while ensuring continued access to 
responsible, affordable mortgage credit. Accordingly, the final rule 
sets minimum underwriting standards while providing creditors with 
flexibility to use their own quantitative standards in making the 
repayment ability determination required by Sec.  1026.43(c)(1).
43(d) Refinancing of Non-Standard Mortgages
    Two provisions of section 1411 of the Dodd-Frank Act address the 
refinancing of existing mortgage loans under the ability-to-repay 
requirements. As provided in the Dodd-Frank Act, TILA section 
129C(a)(5) provides that certain Federal agencies may create an 
exemption from the income verification requirements in TILA section 
129C(a)(4) if certain conditions are met. 15 U.S.C. 1639c(a)(5). In 
addition, TILA section 129C(a)(6)(E) provides certain special ability-
to-repay requirements to encourage applications to refinance existing 
``hybrid loans'' into a ``standard loans'' with the same creditor, 
where the consumer has not been delinquent on any payments on the 
existing loan and the monthly payments would be reduced under the 
refinanced loan. The statute allows creditors to give special weight to 
the consumer's good standing and to consider whether the refinancing 
would prevent a likely default, as well as other potentially favorable 
treatment to the consumer. However, it does not expressly exempt 
applications for such ``payment shock refinancings'' from TILA's 
general ability-to-repay requirements or define ``hybrid'' or 
``standard loans.'' \118\ 15 U.S.C. 1639c(a)(6)(E).
---------------------------------------------------------------------------

    \118\ Section 128A of TILA, as added by Section 1418 of the 
Dodd-Frank Act, includes a definition of ``hybrid adjustable rate 
mortgage.'' However, that definition applies to the adjustable rate 
mortgage disclosure requirements under TILA section 128A, not the 
ability-to-repay requirements under TILA section 129C.
---------------------------------------------------------------------------

    The Board noted in its proposal that it reviewed the Dodd-Frank 
Act's legislative history, consulted with consumer advocates and 
representatives of both industry and the GSEs, and examined 
underwriting rules and guidelines for the refinance programs of private 
creditors, GSEs and Federal agencies, as well as for the Home 
Affordable Modification Program (HAMP). The Board noted that it also 
considered TILA section 129C(a)(5), which permits Federal agencies to 
adopt rules exempting refinancings from certain of the ability-to-repay 
requirements in TILA section 129C(a).
    In proposing Sec.  226.43(d) to implement TILA section 
129C(a)(6)(E), the Board interpreted the statute as being intended to 
afford greater flexibility to creditors of certain home mortgage 
refinancings when complying with the general ability-to-repay 
provisions in TILA section 129C(a). Consistent with this reading of the 
statute, the proposal would have provided an exemption from certain 
criteria required to be considered as part of the general repayment 
ability determination under TILA section 129C(a). Specifically, the 
Board's proposal would have permitted creditors to evaluate qualifying 
applications without having to verify the consumer's income and assets 
as prescribed in the general ability-to-repay requirements, provided 
that a number of additional conditions were met. In addition, the 
proposal would have permitted a creditor 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. The proposal also clarified the 
conditions that must be met in a home mortgage refinancing in order for 
this greater flexibility to apply.
    The Board noted that TILA section 129C(a)(6)(E)(ii) permits 
creditors to give prevention of a ``likely default should the original 
mortgage reset a higher priority as an acceptable underwriting 
practice.'' 15 U.S.C. 1639c(a)(6)(E)(ii). The Board interpreted this 
provision to mean that certain ability-to-repay criteria under TILA 
section 129C(a) should not apply to refinances that meet the requisite 
conditions. TILA section 129C(a) specifically prescribes the 
requirements that creditors must meet to satisfy the obligation to 
determine a consumer's ability to repay a mortgage loan. The Board 
concluded that the term ``underwriting practice'' could reasonably be 
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.
    The Board also structured its proposal to provide for flexibility 
in underwriting that is characteristic of so-called ``streamlined 
refinances,'' which are offered by creditors to existing customers 
without having to go through a full underwriting process appropriate 
for a new origination. The Board noted that section 1411 of the Dodd-
Frank Act specifically authorizes streamlined refinancings of loans 
made, guaranteed, or insured by Federal agencies, and concluded that 
TILA section 129C(a)(6)(E) is most reasonably interpreted as being 
designed to address the remaining market for streamlined refinancings; 
namely, those offered under programs of private creditors and the GSEs. 
The Board stated that in its understanding typical streamlined 
refinance programs do not require documentation of income and assets, 
although a verbal verification of

[[Page 6488]]

employment may be required. The Board further noted that TILA section 
129C(a)(6)(E) includes three central elements of typical streamlined 
refinance programs, in that it requires that the creditor be the same 
for the existing and new mortgage loan obligation, that the consumer 
have a positive payment history on the existing mortgage loan 
obligation, and that the payment on the new refinancing be lower than 
on the existing mortgage loan obligation.
    One difference the Board noted between the statute and typical 
streamlined refinance programs is that the statute targets consumers 
facing ``likely default'' if the existing mortgage ``reset[s].'' The 
Board indicated that, by contrast, streamlined refinance programs may 
not be limited to consumers at risk in this way. For example, 
streamlined refinancing programs may 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. The Board noted 
parallels between TILA's new refinancing provisions and the focus of 
HAMP, a government program specifically aimed at providing 
modifications for consumers at risk of ``imminent default,'' or in 
default or foreclosure.\119\ However, the Board noted that underwriting 
criteria for a HAMP modification are considerably more stringent than 
for a typical streamlined refinance.
---------------------------------------------------------------------------

    \119\ See, e.g., Fannie Mae, FM 0509, Home Affordable 
Modification Program, at 1 (2009).
---------------------------------------------------------------------------

    On balance, the Board interpreted the statutory language as being 
modeled on the underwriting standards of typical streamlined refinance 
programs rather than the tighter standards of HAMP. The Board concluded 
that Congress intended to facilitate opportunities to refinance loans 
on which payments could become significantly higher and thus 
unaffordable. The Board cautioned that applying 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 consumers would be 
compromised and the overall mortgage market potentially disrupted at a 
vulnerable time.
    The Board noted, however, that consumers 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. Accordingly, the 
Board's proposal would have imposed some requirements that are more 
stringent than those of typical streamlined refinance programs as a 
prerequisite to the refinancing provision under proposed Sec.  
226.43(d). For example, the proposal would have permitted a consumer to 
have had only one delinquency of more than 30 days in the 24 months 
immediately preceding the consumer's application for a refinance. By 
contrast, the Board indicated that streamlined refinance programs of 
which it is aware tend to consider the consumer's payment history for 
only the last 12 months.\120\ In addition, the proposal would have 
defined 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 and that the points and fees be capped at 
three percent of the total loan amount, subject to a limited exemption 
for smaller loans.
---------------------------------------------------------------------------

    \120\ See, e.g., Fannie Mae, Home Affordable Refinance Refi Plus 
Options, at 2 (Mar. 29, 2010); Freddie Mac, Pub. No. 387, Freddie 
Mac-owned Streamlined Refinance Mortgage, at 2 (2010).
---------------------------------------------------------------------------

43(d)(1) Definitions
    In the Board's proposal, Sec.  226.43(d)(1) established the scope 
of paragraph (d) and set forth the conditions under which the special 
refinancing provisions applied, while proposed Sec.  226.43(d)(2) 
addressed the definitions for ``non-standard mortgage,'' ``standard 
mortgage,'' and ``refinancing.'' The Bureau believes that paragraph (d) 
should begin with the relevant definitions, before proceeding to the 
scope and conditions of the special refinancing provisions. The rule 
finalized by the Bureau is accordingly reordered. The following 
discussion details the definitions adopted in Sec.  1026.43(d)(1), 
which were proposed by the Board under Sec.  226.43(d)(2).
    Proposed Sec.  226.43(d)(2) defined the terms ``non-standard 
mortgage'' and ``standard mortgage.'' 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 proposed definitions it believed to be 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)(1)(i) Non-Standard Mortgage
    As noted above, the statute does not define the terms ``hybrid 
loan'' and ``standard loan'' used in TILA section 129C(a)(6)(E). The 
Board proposed definitions it believed to be consistent with Congress's 
objectives. Proposed Sec.  226.43(d)(2)(i) substituted the term ``non-
standard mortgage'' for the statutory term ``hybrid loan'' and would 
have defined non-standard mortgage as any ``covered transaction,'' as 
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; \121\
---------------------------------------------------------------------------

    \121\ ``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 
1026.18(s)(7)(i).
---------------------------------------------------------------------------

     An interest-only loan, as defined in Sec.  
226.18(s)(7)(iv); \122\ or
---------------------------------------------------------------------------

    \122\ ``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 1026.18(s)(7)(iv).
---------------------------------------------------------------------------

     A negative amortization loan, as defined in Sec.  
226.18(s)(7)(v).\123\
---------------------------------------------------------------------------

    \123\ ``[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 1026.18(s)(7)(v).
---------------------------------------------------------------------------

    Proposed comment 43(d)(2)(i)(A)-1 explained the application of the 
definition of non-standard mortgage to an adjustable-rate mortgage with 
an introductory fixed interest rate for one or more years. This 
proposed comment clarified that, for example, a covered transaction 
with a fixed introductory rate for the first two, three or five years 
that 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 articulated several rationales for its proposed 
definition of

[[Page 6489]]

a non-standard mortgage. First, the Board noted that 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.'' \124\ The Board also 
stated that the legislative history indicates that Congress was 
concerned about consumers 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.'' \125\
---------------------------------------------------------------------------

    \124\ See Comm. on Fin. Servs., Report on H.R. 1728, Mortgage 
Reform and Anti-Predatory Lending Act, H. Rept. 94, 110th Cong., at 
5 (2009).
    \125\ Id. at 51-52.
---------------------------------------------------------------------------

    The Board interpreted Congress' concern about consumers being at 
risk due to payment shock as supporting 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 consumers 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 was intended to 
increase refinancing options for a wide range of at-risk consumers 
while conforming to the statutory language and legislative intent.
    The proposed definition of ``non-standard mortgage'' would not have 
included adjustable-rate mortgages whose rate is fixed for an initial 
period of less than one year. In those instances, the Board posited 
that a consumer may not face ``payment shock'' because the consumer has 
paid the fixed rate for such a short period of time. The Board also 
expressed concern 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 proposed 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 expressed concern that under its proposed 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, and that it was unclear whether TILA section 129C(a)(6)(E) was 
intended to cover this type of product. The Board solicited 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 did not 
include balloon-payment mortgages. The Board noted that balloon-payment 
mortgages are not clearly ``hybrid'' products, given that the monthly 
payments on a balloon-payment 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. The 
Board stated that consumers of balloon-payment 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.
    The Board solicited comment on whether to use its legal authority 
to include balloon-payment 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 requested comment generally on 
the appropriateness of the proposed definition of non-standard 
mortgage.
    Commenters on this aspect of the proposal generally urged the 
Bureau to expand in various ways the proposed definition of non-
standard mortgage and either supported or did not address the proposed 
definition's inclusion of adjustable-rate mortgages, interest-only 
loans, or negative amortization loans. One consumer group commented 
that it supported the Board's proposed definition of non-standard 
mortgage. Other consumer group commenters stated that the Bureau should 
use its exemption and adjustment authority under TILA to include 
balloon-payment loans within the scope of proposed Sec.  226.43(d). In 
addition, one industry commenter stated that creditors should have 
flexibility to refinance a performing balloon-payment loan within the 
six months preceding, or three months following, a balloon payment date 
without regard to the ability-to-pay requirements. In contrast, one 
industry commenter stated that balloon-payment loans should not be 
included in the definition of non-standard mortgage, because consumers 
are generally well aware of the balloon payment feature in a loan, 
which is clearly explained to customers. This industry commenter 
further stated that during the life of a balloon-payment loan, its 
customers often make regular payments that reduce the principal balance 
and that balloon-payment loans do not make it more likely that a 
consumer will default.
    While the Bureau agrees that many consumers may need to seek a 
refinancing when a balloon loan payment comes due, given the approach 
that the Bureau has taken to implementing the payment shock refinancing 
provision in Sec.  1026.43(d), the Bureau is declining to expand the 
definition of non-standard mortgage to include balloon-payment 
mortgages. As discussed in more detail in the supplementary information 
to Sec.  1026.43(d)(3), as adopted Sec.  1026.43(d) provides a broad 
exemption to all of the general ability-to-repay requirements set forth 
in Sec.  1026.43(c) when a non-standard mortgage is refinanced into a 
standard mortgage provided that certain conditions are met. The point 
of this exemption is to enable creditors, without going through full 
underwriting, to offer consumers who are facing increased monthly 
payments due to the recast of a loan a new loan with lower monthly 
payments. Thus, a key element of the exemption is that the monthly 
payment on the standard mortgage be materially lower than the monthly 
payment for the non-standard mortgage. As discussed in the section-by-
section analysis of Sec.  1026.43(d)(1) below, the Bureau is adopting a 
safe harbor for reductions of 10 percent. Balloon payments pose a 
different kind of risk to consumers, one that arises not from the 
monthly payments (which often tend to be low) but from the balloon 
payment due when the entire remaining balance becomes due. The 
provisions of Sec.  1026.43(d)(1) are not meant to address this type of 
risk. Accordingly, the Bureau declines to expand the definition of non-
standard mortgage to include balloon-payment loans. The Bureau 
believes, however, that where a consumer is performing under a balloon-
payment mortgage and is offered a new loan of a type that would qualify 
as a standard loan with monthly payments at or below the payments of 
the balloon-payment mortgage, creditors will have little difficulty in 
satisfying the ability-to-repay requirements.
    Consumer group commenters and one GSE commenter argued that the 
definition of non-standard mortgage should accommodate GSE-held loans. 
These commenters stated that these loans should receive the same income 
verification exemption as Federal

[[Page 6490]]

agency streamlined refinancing programs. These commenters noted that 
while the GSEs are held in conservatorship by the Federal government, 
GSE-held loans should be treated the same as FHA for purposes of 
streamlined refinance programs, which are ultimately about reducing the 
risk to the taxpayer by avoiding default by consumers who could receive 
lower-cost mortgage loans. Consumer group commenters further urged that 
GSE streamlined refinance programs should be subject to standards at 
least as stringent as those for the FHA streamlined refinance program.
    In addition, one of the GSEs questioned the policy justification 
for the differences between sections 129C(a)(5) and 129C(a)(6)(E) of 
TILA. TILA section 129C(a)(5), which applies to certain government 
loans, permits Federal agencies to exempt certain refinancings from the 
income and asset verification requirement without regard to the 
original mortgage product, in contrast to TILA section 129C(a)(6)(E), 
which as discussed above applies only when the original loan is a 
``hybrid'' loan. This commenter noted that consumers with certain types 
of mortgage loans, such as fixed-rate and balloon-payment loans, may 
have to go through a more costly and cumbersome process to refinance 
their mortgages than consumers with government loans.
    The Bureau declines to adopt regulations implementing TILA section 
129C(a)(5). The Bureau notes that TILA section 129C(a)(5) expressly 
confers authority on certain Federal agencies (i.e., HUD, VA, USDA, and 
RHS) to exempt from the income verification requirement refinancings of 
certain loans made, guaranteed, or insured by such Federal agencies. 
The scope of TILA section 129C(a)(5) is limited to such Federal 
agencies or government-guaranteed or -insured loans. The Bureau also 
declines to expand the scope of Sec.  1026.43(d) to include GSE 
refinancings that do not otherwise fall within the scope of Sec.  
1026.43(d). While accommodation for GSE-held mortgage loans that are 
not non-standard mortgages under Sec.  1026.43(d) may be appropriate, 
the Bureau wishes to obtain additional information in connection with 
GSE refinancings and has requested feedback in a proposed rule 
published elsewhere in today's Federal Register. However, the Bureau 
notes that to the extent a loan held by the GSEs (or a loan made, 
guaranteed or insured by the Federal agencies above) qualifies as a 
non-standard mortgage under Sec.  1026.43(d)(1)(i) and the other 
conditions in Sec.  1026.43(d) are met, the refinancing provisions of 
general applicability in Sec.  1026.43(d) would be available for 
refinancing a GSE-held loan.
    Industry commenters and one industry trade association commented 
that special ability-to-repay requirements should be available for all 
rate-and-term refinancings, regardless of whether the refinancings are 
insured or guaranteed by the Federal government or involve a non-
standard mortgage. One industry trade association stated that such 
special ability-to-repay requirements should incorporate similar 
standards to those established for certain government loans in TILA 
section 129C(a)(5), including a requirement that the consumer not be 30 
or more days delinquent. For such loans, this trade association stated 
that other requirements under TILA section 129C(a)(6)(E) regarding 
payment history should not be imposed, because the consumer is already 
obligated to pay the debt and the note holder in many cases will 
already bear the credit risk. Other commenters stated that because a 
rate-and-term refinancing would offer the consumer a better rate 
(except in the case of adjustable rate mortgages), there is no reason 
to deny the creditor the ability to improve its credit risk and to 
offer the consumer better financing. Several industry commenters and 
one GSE noted that streamlined refinancing programs are an important 
resource for consumers seeking to refinance into a lower monthly 
payment mortgage even when the underlying mortgage loan is not a non-
standard mortgage, and urged the Bureau to considering modifying 
proposed Sec.  226.43(d) to include conventional loans where the party 
making or purchasing the new loan already owns the credit risk.
    The Bureau declines to expand the scope of Sec.  1026.43(d) to 
include rate-and-term refinancings when the underlying mortgage is not 
a non-standard mortgage, as defined in Sec.  1026.43(d)(1)(i). The 
Bureau believes that the statute clearly limits the refinancing 
provision in TILA section 129(C)(6)(E) to circumstances where the loan 
being refinanced is a ``hybrid loan'' and where the refinancing could 
``prevent a likely default.'' The Bureau agrees with the Board that 
TILA section 129C(a)(6)(E) is intended to address concerns about loans 
involving possible payment shock. Where a consumer has proven capable 
of making payments, is about to experience payment shock, is at risk of 
default, and is refinancing to a mortgage with a lower monthly payment 
and with product terms that do not pose any increased risk, the Bureau 
believes that the benefits of the refinancing outweigh the consumer 
protections afforded by the ability-to-repay requirements. Absent these 
exigent circumstances, the Bureau believes that creditors should 
determine that the consumer has the ability to repay the mortgage loan. 
The Bureau does not believe that a consumer who receives an initial 
lower monthly payment from a rate-and-term refinancing actually 
receives a benefit if the consumer cannot reasonably be expected to 
repay the loan. Also, the Bureau notes that some of the scenarios 
identified by commenters, such as offering a consumer a better rate 
with a rate-and-term refinancing where the creditor bears the credit 
risk, would be exempt from the ability-to-repay requirements. A 
refinancing that results in a reduction in the APR with a corresponding 
change in the payment schedule and meets the other conditions in Sec.  
1026.20(a) is not a ``refinancing'' for purposes of Sec.  1026.43, and 
therefore is not subject to the ability-to-repay requirements. As with 
other terms used in TILA section 129C, the Bureau believes that this 
interpretation is necessary to achieve Congress's intent.
    Several other industry commenters urged the Bureau to broaden the 
definition of non-standard mortgage to include refinancings extended 
pursuant to the Home Affordable Refinance Program (HARP) and similar 
programs. One such commenter indicated that under HARP, a loan can only 
be refinanced if the consumer is not in default, the new payment is 
fully amortizing, and both the original and new loans comply with 
agency requirements. This commenter stated that HARP permits consumers 
who would not otherwise be able to refinance due to a high loan-to-
value ratio or other reasons to refinance into another loan, providing 
a consumer benefit. The commenter indicated that HARP loans do not meet 
all of the proposed ability-to-repay requirements and that the Bureau 
should use its authority to provide that HARP and other similar 
programs are exempt from the ability-to-repay requirements, as they 
promote credit availability and increasing stability in the housing 
market. The Bureau acknowledges that HARP refinancings and the payment 
shock refinancings addressed under TILA section 129C(a)(6)(E) are both 
intended to assist consumers harmed by the financial crisis. Although 
both types of refinancings are motivated by similar goals, the Bureau 
does not believe that expanding Sec.  1026.43(d) to include all HARP 
refinancings is consistent with TILA section 129C(a)(6)(E) because HARP 
refinancings are not predicated

[[Page 6491]]

on the occurrence of payment shock and a consumer's likely default. For 
example, a consumer with a mortgage loan that will not recast and who 
is not at risk of default may qualify for a HARP refinancing if the 
consumer's loan-to-value ratio exceeds 80 percent. The Bureau strongly 
believes that Sec.  1026.43(d) should be limited to instances where a 
consumer is facing payment shock and likely default.
    While not limited to the prevention of payment shock and default, 
the Bureau acknowledges that extensions of credit made pursuant to 
programs such as HARP are intended to assist consumers harmed by the 
financial crisis. Furthermore, these programs employ complex 
underwriting requirements to determine a consumer's ability to repay. 
Thus, it may be appropriate to modify the ability-to-repay requirements 
to accommodate such programs. However, an appropriate balance between 
helping affected consumers and ensuring that these consumers are 
offered and receive residential mortgage loans on terms that reasonably 
reflect consumers' ability to repay must be found. To determine how to 
strike this balance, the Bureau wishes to obtain additional information 
in connection with these programs and has requested feedback in a 
proposed rule published elsewhere in today's Federal Register.
    Accordingly, the definition of ``non-standard mortgage'' is adopted 
as proposed, renumbered as Sec.  1026.43(d)(1)(i). In addition, comment 
43(d)(2)(i)(A)-1 also is adopted as proposed, renumbered as 
43(d)(1)(i)(A)-1.
43(d)(1)(ii) Standard Mortgage
    Proposed Sec.  226.43(d)(2)(ii) would have substituted the term 
``standard mortgage'' for the statutory term ``standard loan'' and 
defined this term to mean a covered transaction that has the following 
five characteristics:
     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.
     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).
     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.
    Proposed limitations on regular periodic payments. Proposed Sec.  
226.43(d)(2)(ii)(A) would have required that a standard mortgage 
provide for regular periodic payments that do not result in negative 
amortization, deferral of principal repayment, or a balloon payment. 
Proposed comment 43(d)(2)(ii)(A)-1 clarified that ``regular periodic 
payments'' are payments that do not result in an increase of the 
principal balance (negative amortization) or allow the consumer to 
defer repayment of principal. The proposed comment explained 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. 
Proposed comment 43(d)(2)(ii)(A)-1 further explained 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, with a cross-reference to 
proposed comment 43(c)(5)(i)-3 regarding the meaning of ``substantially 
equal.'' In addition, the comment clarified that ``regular periodic 
payments'' do not include a single-payment transaction and cross-
referenced similar commentary on the meaning of ``regular periodic 
payments'' under proposed comment 43(e)(2)(i)-1. Proposed comment 
43(d)(2)(ii)(A)-1 also cross-referenced proposed comment 43(e)(2)(i)-2 
to explain the prohibition on payments that ``allow the consumer to 
defer repayment of principal.''
    One consumer group commenter stated that it supported the exclusion 
of negative amortization, interest-only payments, and balloon payments 
from the definition of standard mortgage. In addition, several other 
consumer groups commented in support of the Board's proposal to exclude 
balloon-payment loans from the definition of standard mortgage. These 
commenters stated that balloon-payment products, even with self-
executing renewal, should not be permitted to take advantage of an 
exemption from the general underwriting standards in Sec.  1026.43(c). 
Consumer groups expressed concern that, in cases where the consumer 
does not have assets sufficient to make the balloon payment, balloon-
payment loans will necessarily require another refinance or will lead 
to a default. The Bureau agrees with the concerns expressed by such 
commenters and believes that it is appropriate to require that balloon-
payment loans be underwritten in accordance with the general ability-
to-repay standard, rather than under the payment shock refinancing 
provision in Sec.  1026.43(d). Accordingly, the Bureau is not expanding 
the definition of standard mortgage to include balloon-payment 
mortgages.
    The Bureau received no other comment on this proposed definition. 
Accordingly, the Bureau is adopting the definition of standard mortgage 
as proposed, renumbered as Sec.  1026.43(d)(1)(ii)(A). Similarly, the 
Bureau received no comment on proposed comment 43(d)(2)(ii)(A)-1, which 
is adopted as proposed and renumbered as 43(d)(1)(ii)(A)-1.
    Proposed three percent cap on points and fees. Proposed Sec.  
226.43(d)(2)(ii)(B) would have prohibited creditors from charging 
points and fees on the mortgage loan 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-referenced 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'' and the relevant exception for small loans are 
discussed in detail in the section-by-section analysis of Sec.  
1026.43(e)(3) below.
    The Board noted several reasons for the proposed limitation on the 
points and fees that may be charged on a standard mortgage. First, the 
limitation was intended to prevent creditors from undermining the 
provision's purpose--placing at-risk consumers into more affordable 
loans--by charging excessive points and fees for the refinance. Second, 
the points and fees limitation was intended to ensure that consumers 
attain a net benefit in refinancing their non-standard mortgage. The 
higher a consumer's up-front 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 proposed Sec.  
226.43(d), the provision increases the likelihood that the consumer 
will hold the loan long enough to recoup those costs. Third, the 
proposed limitation was intended to be consistent with the provisions 
set forth in TILA section 129C(a)(5) regarding certain refinancings 
under Federal agency programs.

[[Page 6492]]

    The Board requested 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). The Bureau received no 
comments on this proposed points and fees threshold, which is adopted 
as proposed, renumbered as Sec.  1026.43(d)(1)(ii)(B). See the section-
by-section analysis of Sec.  1026.43(e)(3) below for more specific 
information regarding the limitations applicable to ``points and fees'' 
for qualified mortgages and refinancings under Sec.  1026.43(d).
    Proposed loan term of no more than 40 years. Proposed Sec.  
226.43(d)(2)(ii)(C) would have provided 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 stated that this 
condition was 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.
    The Board noted that loans with longer terms may cost more over 
time, but indicated that it was 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 noted 
that prevalent streamlined refinance programs permit loan terms of up 
to 40 years and expressed concern about disrupting the current mortgage 
market at a vulnerable time. The Board specifically requested comment 
on the proposed condition to allow a standard mortgage to have a loan 
term of up to 40 years. The Bureau received no comment on this proposed 
condition, which is adopted as proposed, renumbered as Sec.  
1026.43(d)(1)(ii)(C).
    Proposed requirement that the interest rate be fixed for the first 
five years. Proposed Sec.  226.43(d)(2)(ii)(D) would have required that 
a standard mortgage have a fixed interest rate for the first five years 
after consummation. Proposed comment 43(d)(2)(ii)(D)-1 provided an 
illustrative example. The proposed comment also cross-referenced 
proposed comment 43(e)(2)(iv)-3.iii for guidance regarding step-rate 
mortgages.
    The Board articulated several reasons for requiring a minimum five-
year fixed-rate period for standard mortgages. First, the Board noted 
that a fixed rate for five years is consistent with TILA section 
129C(b)(2)(A)(v), which requires the creditor to underwrite a qualified 
mortgage based on the maximum interest rate that may apply during the 
first five years. The Board indicated that Congress intended both 
qualified mortgages and standard mortgages to be stable loan products, 
and therefore that the required five-year fixed-rate period for 
qualified mortgages would also be an appropriate benchmark for standard 
mortgages. The Board further stated that the safeguard of a fixed rate 
for five years after consummation would help to ensure that consumers 
refinance into products that are stable for a substantial period of 
time. In particular, a fixed payment for five years after consummation 
would constitute a significant improvement in the circumstances of a 
consumer who may have defaulted absent the refinance. The Board 
specifically noted that the proposal would permit so-called ``5/1 
ARMs,'' where the interest rate is fixed for the first five years, 
after which time the rate becomes variable, to be standard mortgages.
    The Board requested comment on the proposal defining a standard 
mortgage as a mortgage loan with 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. One consumer group 
commenter stated that the use of adjustable-rate mortgages should be 
limited in the definition of standard mortgage. This commenter stated 
that adjustable-rate mortgage loans contributed to the subprime lending 
expansion and the financial crisis that followed. In particular, this 
commenter expressed concern that adjustable-rate mortgage loans were 
utilized in loan-flipping schemes that trapped consumers in 
unaffordable loans, forcing such consumers to refinance into less 
affordable mortgage loans. This commenter indicated that standard 
mortgages should be limited to fixed and step-rate loans and, in low or 
moderate interest rate environments, adjustable-rate mortgages with a 
5-year or longer-term fixed period. However, this commenter urged the 
Bureau to consider permitting shorter-term adjustable-rate mortgages to 
be standard mortgages in high interest rate environments because in 
such circumstance, an adjustable-rate mortgage could potentially reduce 
the consumer's monthly payments at recast, which may outweigh the risks 
of increased payments for some consumers.
    The Bureau is adopting the requirement that a standard mortgage 
have a fixed interest rate for the first five years after consummation 
as proposed, renumbered as Sec.  1026.43(d)(1)(ii)(D). The Bureau 
agrees with the Board that the intent of TILA section 129C(a)(6)(E) 
appears to be to facilitate refinances of riskier mortgages into more 
stable loan products, and accordingly, believes that a standard 
mortgage should provide for a significant period of time during which 
payments will be predictable, based on a fixed rate or step rates that 
are set at the time of consummation. The Bureau believes that five 
years is an appropriate standard in part because it is consistent with 
the statutory requirement for a qualified mortgage under section 
129C(b)(2)(A)(v). The Bureau believes that predictability for consumers 
is best effectuated by a single rule that applies in all interest rate 
environments, rather than a rule that depends on the interest rate 
environment in effect at the time of the refinancing. Further, given 
that Sec.  1026.43(d) provides an exemption from the general ability-
to-repay requirements in Sec.  1026.43(c), the Bureau believes that it 
is important that a refinancing conducted in accordance with Sec.  
1026.43(d) result in a stable loan product and predictable payments for 
a significant period of time.
    In addition, the Board solicited comment on whether a balloon-
payment mortgage of at least five years should be considered a standard 
mortgage under the refinancing provisions of proposed Sec.  226.43(d). 
The Board noted that in some circumstances, a balloon-payment mortgage 
with a fixed, monthly payment for five years might benefit a consumer 
who otherwise would have defaulted. The Board further noted that a 
five-year balloon-payment 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.
    As discussed above, several consumer groups stated that balloon 
products, even with self-executing renewal, should not be permitted to 
take advantage of an exemption from the general underwriting standards 
in Sec.  1026.43(c). Consumer groups expressed concern that, in cases 
where the consumer does not have assets sufficient to make the balloon 
payment, balloon-payment mortgages will necessarily require another 
refinance or will lead to a default. For the reasons discussed in the 
supplementary information to Sec.  1026.43(d)(1)(ii)(A)

[[Page 6493]]

above, the Bureau is not expanding the definition of ``standard 
mortgage'' to include balloon-payment mortgages.
    Proposed requirement that loan proceeds be used for limited 
purposes. Proposed Sec.  226.43(d)(2)(ii)(E) would have restricted 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 clarified 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.''
    The Board expressed concern that permitting the consumers to lose 
additional equity in their homes under the proposed refinancing 
provisions could undermine the financial stability of those consumers, 
thus contravening the purposes of TILA section 129C(a)(6)(E). The Board 
requested 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.
    The Bureau received only one comment on this aspect of the 
proposal. An association of State bank regulators agreed that the rule 
should generally restrict the use of the proceeds of the standard 
mortgage to paying off the outstanding balance on the non-standard 
mortgage or to pay closing or settlement costs. However, they urged the 
Bureau to provide an exemption that would permit loan proceeds to be 
used to pay for known home repair needs and suggested that any such 
exemption require the consumer to provide verified estimates in advance 
in order to ensure that loan proceeds are used only for required home 
repairs.
    The Bureau is adopting the limitation on the use of loan proceeds 
as proposed, renumbered as Sec.  1026.43(d)(1)(ii)(E). The Bureau 
declines to permit the proceeds of a refinancing conducted in 
accordance with Sec.  1026.43(d) to be used for home repair purposes, 
for several reasons. First, the Bureau believes that such an exemption 
would be inconsistent with the statutory purposes of TILA section 
129C(a)(6)(E), which is intended to permit refinancings on the basis of 
less stringent underwriting in the narrow circumstances where a 
consumer's non-standard mortgage is about to recast and lead to a 
likely default by the consumer. The Bureau believes that permitting a 
consumer to utilize home equity for home repairs in connection with a 
refinancing conducted pursuant to Sec.  1026.43(d) could further 
compromise the financial position of consumers who are already in a 
risky financial position. The Bureau believes that it would be more 
appropriate, where home repairs are needed, for a creditor to perform 
the underwriting required to advance any credit required in connection 
with those repairs. In addition, the Bureau believes that such an 
exemption could be subject to manipulation by fraudulent home 
contractors, by the creditor, and even by a consumer. It would be 
difficult, even with a requirement that the consumer provide verified 
estimates, to ensure that amounts being disbursed for home repairs 
actually are needed, and in fact used, for that purpose.
43(d)(1)(iii)
    Proposed Sec.  226.43(d)(2)(iii) would have defined the term 
``refinancing'' to have the same meaning as in Sec.  1026.20(a).\126\ 
Section 1026.20(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 
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 are not considered ``refinancings'' for purposes 
of Sec.  1026.20(a): (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.  1026.20(a)(1) and (a)(2), and comment 20(a)-2.
---------------------------------------------------------------------------

    \126\ The Board's proposal originally referred to 226.20(a), 
which was subsequently renumbered as 12 CFR 1026.20(a).
---------------------------------------------------------------------------

    The Board requested comment on whether the proposed meaning of 
``refinancing'' should be expanded to include a broader range of 
transactions or otherwise should be defined differently or explained 
more fully than proposed. The Bureau received no comments on this 
proposed definition. Accordingly, the Bureau is adopting the definition 
of refinancing as proposed, renumbered as Sec.  1026.43(d)(1)(iii).
43(d)(2) Scope
    In the Board's proposal, Sec.  226.43(d)(2) addressed the 
definitions for ``non-standard mortgage,'' ``standard mortgage,'' and 
``refinancing,'' while proposed Sec.  226.43(d)(1) established the 
scope of paragraph (d) and set forth the conditions under which the 
special refinancing provisions applied. The Bureau believes that 
paragraph (d) should begin with the relevant definitions, before 
proceeding to the scope and conditions of the special refinancing 
provisions. The rule finalized by the Bureau is accordingly reordered. 
The following discussion details the provisions adopted in Sec.  
1026.43(d)(2), which were proposed by the Board under Sec.  
226.43(d)(1).
    Proposed Sec.  226.43(d)(1) would have defined the scope of the 
refinancing provisions under proposed Sec.  226.43(d). Specifically, 
proposed Sec.  226.43(d) applied when a non-standard mortgage is 
refinanced into a standard mortgage and 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.''
     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.
    Proposed comment 43(d)(1)-1 clarified 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

[[Page 6494]]

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 12 CFR 1024.2(b). Comment 
19(a)(1)(i)-3 clarifies that an application is received when it reaches 
the creditor in any of the ways applications are normally transmitted, 
such as 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. Comment 19(a)(1)(i)-3 also cross-references 
comment 19(b)-3 for guidance in determining whether or not the 
transaction involves an intermediary agent or broker. The Bureau 
received no comments on this proposed comment, which is adopted as 
proposed, renumbered as 43(d)(2)-1.
43(d)(2)(i)
    Proposed Sec.  226.43(d)(1)(i) would have required that the 
creditor for the new mortgage loan also be either the current holder of 
the existing non-standard mortgage or the servicer acting on behalf of 
the current holder. This provision was intended to implement the 
requirement in TILA section 129C(a)(6)(E) that the existing loan must 
be refinanced by ``the creditor into a standard loan to be made by the 
same creditor.''
    The Board interpreted the statutory phrase ``same creditor'' to 
mean that the creditor refinancing the loan must have an existing 
relationship with the consumer. The Board explained that 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. The Board also noted that this statutory provision is intended 
to ensure that the creditor of the refinancing has an interest in 
placing the consumer into a new loan that is affordable and beneficial. 
The proposal would have permitted the creditor of the refinanced loan 
to be the holder, or servicer acting on behalf of the holder, of the 
existing mortgage. The Board further explained that the existing 
servicer may 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 was intended to apply to a loan 
that has been sold to a GSE, refinanced by the existing servicer, and 
continues to be held by the same GSE. The Board solicited comment on 
whether the proposed rule could be structured differently to better 
ensure that the creditor retains an interest in the performance of the 
new loan and whether additional guidance is needed.
    Several commenters urged the Bureau to impose a specific period 
following a refinancing under Sec.  226.43(d) during which the creditor 
must remain the current holder of the loan. Consumer group commenters 
suggested that to be eligible for the non-standard mortgage refinancing 
the creditor should be required to maintain full interest in the 
refinanced loan for a minimum of 12 months. These commenters expressed 
concern that the lack of such a retention requirement would permit 
creditors to refinance loans that are likely to fail without performing 
the robust underwriting that would otherwise be required for a new 
loan. If such loans were to be immediately sold to a third party, 
consumer groups indicated that it could invite abuse by creditors with 
an incentive to sell riskier loans without providing full value to the 
consumer. An association of State bank regulators urged the Bureau to 
adopt a two-year holding period during which the creditor must remain 
the current holder of the loan.
    One industry commenter indicated that the Bureau should broaden the 
scope to permit a subservicer of the loan to be the creditor with 
respect to the standard loan. Another industry commenter stated that 
the scope should be expanded to allow a creditor to refinance a non-
standard mortgage that it did not originate or is not servicing. This 
commenter indicated that due to the volume of requests for refinancing 
received by some creditors, consumers may benefit from more timely 
refinancing if a third-party creditor is eligible to use non-standard 
refinancing provisions.
    The Bureau is adopting this requirement as proposed, renumbered as 
Sec.  1026.43(d)(2)(i). As discussed in more detail below, as adopted 
Sec.  1026.43(d) provides a broad exemption to all of the ability-to-
repay requirements set forth in Sec.  1026.43(c) when a non-standard 
mortgage is refinanced into a standard mortgage provided that certain 
conditions are met. Section 1026.43(d)(2)(i) is adopted pursuant to the 
Bureau's authority under section 105(a) of TILA. The Bureau finds that 
this adjustment is necessary to effectuate the purposes of TILA by 
ensuring that consumers are offered and receive residential mortgage 
loans on terms that reasonably reflect their ability to repay, while 
ensuring that consumers at risk of default due to payment shock are 
able to obtain responsible, affordable refinancing credit from the 
current holder of the consumer's mortgage loan, or the servicer acting 
on behalf of the current holder. To prevent unscrupulous creditors from 
using Sec.  1026.43(d) to engage in loan-flipping, and to ensure that 
this exemption is available only in those cases where consumer benefit 
is the most likely, the Bureau believes that it is important that the 
creditor of the standard loan be the holder of, or the servicer acting 
on behalf of the holder of, the non-standard loan. In such cases, the 
Bureau agrees with the Board that the creditor has a better incentive 
to refinance the consumer into a more stable and affordable loan. 
Therefore, the Bureau declines to extend the scope of Sec.  1026.43(d) 
to cover cases in which the creditor of the non-standard loan is not 
the current holder of the nonstandard loan or servicer acting on behalf 
of that holder.
    The Bureau believes that the combination of this restriction and 
the other protections contained in Sec.  1026.43(d) is sufficient to 
prevent unscrupulous creditors from engaging in loan-flipping. 
Therefore, the Bureau does not believe that it is necessary to impose a 
specified period during which the creditor of the standard mortgage 
must remain the holder of the loan. As discussed in the section-by-
section analysis of Sec.  1026.43(d)(2)(vi) below, the Bureau has 
conditioned use of Sec.  1026.43(d), for non-standard loans consummated 
after the effective date of this final rule, on the non-standard loan 
having been made in accordance with the ability-to-repay requirements 
in Sec.  1026.43(c), including consideration of the eight factors 
listed in Sec.  1026.43(c)(2). The Bureau believes that this will help 
to ensure that creditors cannot use the refinancing provisions of Sec.  
1026.43(d) to systematically make and divest riskier mortgages, or to 
cure substandard underwriting on a non-standard mortgage by refinancing 
the consumer into a loan with a lower, but still unaffordable, payment. 
TILA section 130(k)(1) provides that consumers may assert as a defense 
to foreclosure by way of recoupment or setoff violations of TILA 
section 129C(a) (of which TILA section 129C(a)(6)(E) comprises a 
subpart). 15 U.S.C. 1640(k)(1). This defense to foreclosure applies 
against assignees of the loan in addition to the original creditor. 
Therefore, given that

[[Page 6495]]

the non-standard loan having been originated in accordance with Sec.  
1026.43(c) is a condition for using the refinancing provision in Sec.  
1026.43(d), a consumer may assert violations of Sec.  1026.43(c) on the 
original non-standard loan as a defense to foreclosure for the standard 
loan made under Sec.  1026.43(d), even if that standard loan is 
subsequently sold by the creditor.
    In addition to believing that imposition of a holding period is 
unnecessary, the Bureau has concerns that imposition of a holding 
period also could create adverse consequences for the safety and 
soundness of financial institutions. In some circumstances, a creditor 
may need for safety and soundness reasons to sell a portion of its 
portfolio, which may include a residential mortgage loan that was made 
in accordance with Sec.  1026.43(d). However, such a creditor may not 
know at the time of the refinancing that it ultimately will need to 
sell the loan, and may even intend to remain the holder the loan for a 
longer period of time at the time of consummation. The Bureau has 
concerns about the burden imposed on issuers by a holding period in 
such circumstances where the creditor does not or cannot know at the 
time of the refinance under Sec.  1026.43(d) that the loan will need to 
be sold within the next 12 months.
43(d)(2)(ii)
    Proposed Sec.  226.43(d)(1)(ii) would have required that the 
monthly payment on the new mortgage loan be ``materially lower'' than 
the monthly payment for the existing mortgage loan. This proposed 
provision would have implemented the requirement in TILA section 
129C(a)(6)(E) that there be ``a reduction in monthly payment on the 
existing hybrid loan'' in order for the special provisions to apply to 
a refinancing. Proposed comment 43(d)(1)(ii)-1 provided that the 
monthly payment for the new loan must be ``materially lower'' than the 
monthly payment for an existing non-standard mortgage and clarifies 
that the payments that must be compared must be calculated according to 
proposed Sec.  226.43(d)(5). The proposed comment also clarified 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.
    Consumer groups and an association of State bank regulators 
supported the adoption of a 10 percent safe harbor for the ``materially 
lower'' standard. In contrast, industry commenters opposed the 
requirement that payment on the standard mortgage be ``materially 
lower'' than the payment on the non-standard mortgage. These commenters 
urged the Bureau not to adopt the 10 percent safe harbor proposed by 
the Board and stated that the 10 percent safe harbor would become the 
de facto rule if adopted. These commenters expressed concerns that the 
``materially lower'' standard would unduly restrict access to credit 
for many consumers and suggested that the Bureau instead adopt a 
standard that would permit more consumers to qualify for the non-
standard refinancing provisions. Several commenters indicated that the 
Bureau should adopt a five percent safe harbor rather than the proposed 
ten percent. One industry commenter recommended that the Bureau permit 
reductions of a minimum dollar amount to satisfy the rule, particularly 
in cases where the monthly payment is already low. Finally, one 
industry commenter asked the Bureau to provide guidance regarding the 
meaning of ``materially lower'' when the reduction in payment is less 
than 10 percent.
    The Bureau is adopting as proposed the requirement that the payment 
on the standard mortgage be ``materially lower'' than the non-standard 
mortgage and the safe harbor for a 10 percent or greater reduction, 
renumbered as Sec.  1026.43(d)(2)(ii) and comment 43(d)(2)(ii)-1. The 
Bureau agrees with the Board that it would be inconsistent with the 
statutory purpose to permit the required reduction to be merely de 
minimis. In such cases, the consumer likely would not obtain a 
meaningful benefit that would help to prevent default. As discussed in 
the section-by-section analysis below, Sec.  1026.43(d)(3) exempts 
refinancings from the ability-to-repay requirements in Sec.  
1026.43(c), provided that certain conditions are met. Given that Sec.  
1026.43(d) provides a broad exemption to the ability-to-repay 
requirements, the Bureau believes that it is important that the 
reduction in payment provide significant value to the consumer and 
increase the likelihood that the refinancing will improve the 
consumer's ability to repay the loan. Accordingly, the Bureau is 
adopting the 10 percent safe harbor as proposed. The Bureau declines to 
adopt a dollar amount safe harbor because the appropriate dollar amount 
would depend on a number of factors, including the amount of the loan 
and monthly payment, but notes that reductions of less than 10 percent 
could nonetheless meet the ``materially lower'' standard depending on 
the relevant facts and circumstances.
43(d)(2)(iii)
    Proposed Sec.  226.43(d)(1)(iii) would have required 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.  
1026.43(b)(11) above, the proposal defined 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 explained that the proposal was intended 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.'' This statutory 
language implies that the special refinancing provisions apply only 
where the original mortgage has not yet ``reset.'' Accordingly, the 
Board concluded that Congress's concern likely was 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.
    However, in recognition of the fact that a consumer may not realize 
that a loan will be recast until the recast occurs and that the 
consumer could not refinance the loan under proposed Sec.  226.43(d), 
the Board also requested comment on whether it would be appropriate to 
use legal authority to make adjustments to TILA to permit refinancings 
after a loan is recast.
    Consumer groups urged the Bureau to expand the scope of the non-
standard refinancing provisions to apply to applications filed after 
the initial recast of a non-standard loan has occurred. These 
commenters stated that the intent of the proposal is to avoid ``likely 
default'' and indicated that for some consumers, notification that the 
consumer's interest rate has adjusted and their payment has increased 
may be their first notice that their payment has gone up and increased 
their likelihood of default. One consumer group commenter stated that 
these consumers may be better credit risks than those consumers whose 
loans have not yet recast and they would clearly benefit from a 
materially lower monthly payment.

[[Page 6496]]

    Several industry commenters similarly urged the Bureau to modify 
the provisions to apply to applications for refinancings received after 
recast of the non-standard loan. One of these commenters stated that 
the timing of the application is irrelevant to the consumer's ability 
to repay or the consumer's need to refinance. One industry commenter 
stated that processing an application and assessing a consumer's 
ability to repay a new loan may require additional time well before the 
recast date. This commenter urged the Bureau to expand the scope of the 
non-standard refinancing provisions to include refinancings after a 
loan is recast that are in the best interests of consumers.
    For the reasons discussed below, the Bureau is adopting Sec.  
1026.43(d)(2)(iii), which provides that Sec.  1026.43(d) applies to the 
refinancing of a non-standard mortgage into a standard mortgage when 
the creditor receives the consumer's written application for the 
standard mortgage no later than two months after the non-standard 
mortgage has recast, provided certain other conditions are met. The 
Bureau believes that the best reading of TILA section 129C(a)(6)(E) is 
that it is intended to facilitate refinancings for consumers at risk of 
default due to the ``payment shock'' that may occur upon the recast of 
the consumer's loan to a higher rate or fully amortizing payments. The 
Bureau acknowledges that the statutory language contemplates that such 
recast has not yet occurred. However, the Bureau does not believe that 
Congress intended to provide relief for consumers facing imminent 
``payment shock'' based on how promptly the consumer filed, or how 
quickly the creditor processed, an application for a refinancing. For 
example, the periodic rate on a mortgage loan may recast on July 1st, 
but the higher payment reflecting the recast interest rate would not be 
due until August 1st. In this example, a consumer may not experience 
payment shock until a month after the consumer's rate recasts. 
Additionally, it may take a significant amount of time for a consumer 
to provide the creditor with all of the information required by the 
creditor, thereby triggering the receipt of an application for purposes 
of the ability-to-repay requirements. The Bureau does not believe that 
Congress intended the special treatment afforded by TILA section 
129C(a)(6)(E) to hinge on paperwork delays such as these. The Bureau 
agrees with the arguments raised by commenters and believes that the 
purposes of TILA are best effectuated by permitting consumers to submit 
applications for refinancings for a short period of time after recast 
occurs. The Bureau has determined that permitting a consumer to apply 
for a refinancing within two months of the date of recast strikes the 
appropriate balance between the language of the statute and the 
practical considerations involved with submitting an application for a 
refinancing in response to payment shock. Pursuant to its authority 
under TILA section 105(a), the Bureau finds that modifying Sec.  
1026.43(d) to apply to extensions of credit where the creditor receives 
the consumer's written application for the standard mortgage no later 
than two months after the non-standard mortgage has recast ensures that 
consumers are offered and receive residential mortgage loans on terms 
that reasonably reflect their ability to repay while ensuring that 
responsible, affordable mortgage credit remains available to consumers 
at risk of default due to higher payments resulting from the recast.
43(d)(2)(iv)
    Proposed Sec.  226.43(d)(1)(iv) would have required 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. Proposed comment 43(d)(1)(iv)-1 provided an 
illustrative example. Together with proposed Sec.  226.43(d)(1)(v), 
proposed Sec.  226.43(d)(1)(iv) would have implemented the portion of 
TILA section 129C(a)(6)(E) that requires that the consumer not have 
been ``delinquent on any payment on the existing hybrid loan.''
    Although TILA section 129C(a)(6)(E) contains a statutory 
prohibition on ``any'' delinquencies on the existing non-standard 
(``hybrid'') mortgage, the Board interpreted its proposal as consistent 
with the statute in addition to being consistent with the consumer 
protection purpose of TILA and current industry practices. In addition, 
the Board noted its authority under TILA sections 105(a) and 129B(e)--
which has since transferred to the Bureau--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 Board provided several reasons for proposing to require a look-
back period for payment history of 24 months, rather than a 12-month 
period. First, the Board noted that consumers 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. Second, the Board noted views expressed during outreach by 
GSE and creditor representatives that consumers with positive payment 
histories tend to be less likely than other consumers to become 
obligated on a new loan for which they cannot afford the monthly 
payments. The Board solicited 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.
    In addition, 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 stated that 
allowing delinquencies of 30 or fewer days is consistent with the 
statutory prohibition on ``any'' delinquency for several reasons. 
First, the Board noted that 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. Accordingly, the 
Board noted that the statute should not be read to prohibit consumers 
from obtaining needed refinances due to payments that are late but 
within a late fee grace period. Finally, the Board indicated that the 
predominant streamlined refinance programs of which it 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, as in the proposal, more than 30 days).
    Proposed comment 43(d)(1)(iv)-2 would have clarified that whether a 
payment is more than 30 days late depends on the contractual due date 
not accounting for any grace period and provided an illustrative 
example. The Board indicated that using the contractual due date for 
determining

[[Page 6497]]

whether a payment has been made more than 30 days after the due date 
would facilitate compliance and enforcement by providing clarity. 
Whereas late fee ``grace periods'' are often not stated in writing, the 
contractual due date is unambiguous. Finally, the Board stated that 
using the contractual due date for determining whether a loan payment 
is made on time is consistent with standard home mortgage loan 
contracts. The Board requested 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.
    Consumer groups supported the Board's proposal to identify late 
payments as late payments of more than 30 days. However, they stated 
that the requirement that consumers not have more than one delinquency 
in the past 24 months to qualify for a refinance under Sec.  1026.43(d) 
was overly stringent and that the appropriate standard would be no 
delinquencies in the past 12 months.
    Several industry commenters similarly urged the Bureau to adopt a 
12-month period rather than the proposed 24-month period in which a 
consumer may have one late payment. These commenters stated that 
permitting only one 30-day late payment in the past 24 months is too 
restrictive and would require a creditor to overlook a recent history 
of timely payments. In addition, one industry commenter stated that the 
standard for defining a late payment should be late payments of more 
than 60 days.
    The Bureau is adopting this provision generally as proposed, 
renumbered as Sec.  1026.43(d)(2)(iv), with one substantive change. The 
Bureau is adopting a 12-month look-back period rather than the 24-month 
period proposed by the Board. The Bureau believes that reviewing a 
consumer's payment history over the last 12 months would be more 
appropriate than a 24-month period, and agrees that a 24-month period 
may unduly restrict consumer access to the Sec.  1026.43(d) refinancing 
provisions. The Bureau believes that the requirement that a consumer's 
account have no more than one 30-day late payment in the past 12 months 
will best effectuate the purposes of TILA by ensuring that only those 
consumers with positive payment histories are eligible for the non-
standard refinancing provisions under Sec.  1026.43(d). Section 
1026.43(d)(2)(iv) is adopted pursuant to the Bureau's authority under 
section 105(a) of TILA. The Bureau finds that this adjustment is 
necessary and proper to effectuate the purposes of TILA by ensuring 
that consumers are offered and receive residential mortgage loans on 
terms that reasonably reflect their ability to repay, while ensuring 
that consumers at risk of default due to payment shock are able to 
obtain responsible, affordable refinancing credit.
    The Bureau also is adopting comments 43(d)(1)(iv)-1 and 
43(d)(1)(iv)-2 generally as proposed, with conforming amendments to 
reflect the 12-month look-back period in Sec.  1026.43(d)(2)(iv), and 
renumbered as 43(d)(2)(iv)-1 and 43(d)(2)(iv)-2. The Bureau has made 
several technical amendments to the example in comment 43(d)(2)(iv)-1 
for clarity. As proposed, the examples in the comment referred to dates 
prior to the effective date of this rule; the Bureau has updated the 
dates in the examples so that they will occur after this rule becomes 
effective.
43(d)(2)(v)
    Proposed Sec.  226.43(d)(1)(v) would have required 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 complemented proposed Sec.  226.43(d)(1)(iv), 
discussed above, in implementing the portion of TILA section 
129C(a)(6)(E) that requires that the consumer not have been 
``delinquent on any payment on the existing hybrid loan.'' Taken 
together with proposed Sec.  226.43(d)(1)(iv), the Board believed that 
this 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)--which has 
transferred to the Bureau--to adjust provisions of TILA and condition 
practices ``to assure that consumers are offered and receive 
residential mortgage loans 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 stated that a six-month ``clean'' payment record 
indicates a reasonable level of financial stability on the part of the 
consumer applying for a refinancing. In addition, the Board noted that 
participants in its outreach 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 provided an illustrative example of 
the proposed rule and clarified 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-referenced 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.
    One industry commenter stated that the prohibition on late payments 
in the past six months should be amended to provide flexibility when 
the late payment was due to extenuating circumstances. The Bureau 
declines to adopt a rule providing an adjustment for extenuating 
circumstances, for several reasons. First, the existence or absence of 
extenuating circumstances is a fact-specific question and it would be 
difficult to distinguish by regulation between extenuating 
circumstances that reflect an ongoing risk with regard to the 
consumer's ability to repay the loan versus extenuating circumstances 
that present less risk. In addition, an adjustment for extenuating 
circumstances appears to be inconsistent with the purposes of TILA 
section 129C(a)(6)(E), which contemplates that the consumer ``has not 
been delinquent on any payment on the existing hybrid loan,'' without 
distinguishing between payments that are delinquent due to extenuating 
circumstances or otherwise. Furthermore, by defining a late payment as 
more than 30 days late, the Bureau believes that many extenuating 
circumstances, for example a payment made three weeks late due to mail 
delivery issues, will not preclude use of Sec.  1026.43(d).
    Accordingly, the Bureau is adopting this provision as proposed, 
renumbered as Sec.  1026.43(d)(2)(v). Similarly, the Bureau is adopting 
comment 43(d)(1)(v)-1 generally as proposed, with several technical 
amendments for clarity and renumbered as 43(d)(2)(v)-1. As proposed, 
the examples in the comment referred to dates prior to the effective 
date of this rule; the Bureau has updated the dates in the examples so 
that they will occur after this rule becomes effective. Pursuant to its 
authority under TILA section 105(a), the Bureau finds that requiring 
that the consumer have made no payments on the non-standard mortgage 
more than 30 days late during the six months

[[Page 6498]]

immediately preceding the creditor's receipt of the consumer's written 
application for the standard mortgage ensures that consumers are 
offered and receive residential mortgage loans on terms that reasonably 
reflect their ability to repay while ensuring that responsible, 
affordable mortgage credit remains available to consumers at risk of 
default due to higher payments resulting from the recast.
43(d)(2)(vi)
    For the reasons discussed in the section-by-section analysis of 
Sec.  1026.43(d)(3), the Bureau is adopting a new Sec.  
1026.43(d)(2)(vi) that generally conditions use of Sec.  1026.43(d) on 
the existing non-standard mortgage having been made in accordance with 
Sec.  1026.43(c), provided that the existing non-standard mortgage loan 
was consummated on or after January 10, 2014. For the reasons discussed 
in the section-by-section analysis of Sec.  1026.43(d)(3), the Bureau 
believes that this provision is necessary and proper to prevent use of 
Sec.  1026.43(d)'s streamlined refinance provision to circumvent or 
``cure'' violations of the ability-to-repay requirements in Sec.  
1026.43(c). Section 1026.43(d)(2)(vi) is adopted pursuant to the 
Bureau's authority under TILA section 105(a). The Bureau finds that 
this adjustment is necessary to effectuate the purposes of TILA by 
ensuring that consumers are offered and receive residential mortgage 
loans on terms that reasonably reflect their ability to repay, while 
ensuring that consumers at risk of default due to payment shock are 
able to obtain responsible and affordable refinancing credit. 
Furthermore, the Bureau believes that this adjustment is necessary to 
prevent unscrupulous creditors from using Sec.  1026.43(d) to engage in 
loan-flipping or other practices that are harmful to consumers, thereby 
circumventing the requirements of TILA.
43(d)(3) Exemption From Repayment Ability Requirements
    Under specific conditions, proposed Sec.  226.43(d)(3) would have 
exempted a creditor in a refinancing from two of the ability-to-repay 
requirements under proposed Sec.  226.43(c). First, the proposal 
provided that a 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 proposal provided that 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).
    For these exemptions to apply, proposed Sec.  226.43(d)(3)(i)(A) 
would have required that all of the conditions in proposed Sec.  
226.43(d)(1)(i) through (v) be met. In addition, proposed Sec.  
226.43(d)(3)(i)(B) would have required that the creditor 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. This proposed provision implemented 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.'' As clarified in proposed comment 
43(d)(3)(i)-1, the Board interpreted TILA section 129(a)(6)(E)(ii) to 
require a creditor to consider whether: (1) The consumer is likely to 
default on the existing mortgage once new, higher payments are 
required; and (2) the new mortgage will prevent the consumer's default. 
The Board solicited comment regarding whether these proposed provisions 
were appropriate, and also specifically solicited comment on whether 
exemptions from the ability-to-repay requirements, other than those 
proposed, were appropriate.
    Several commenters expressly supported this proposed provision. An 
association of State bank supervisors stated that refinancing designed 
to put a consumer in a higher-quality standard mortgage before the 
existing lower-quality mortgage recasts should be given greater 
deference and further stated that it is sound policy to encourage 
refinancing where it protects both the economic interest of the 
creditor and the financial health of the consumer. Consumer groups 
commented that limited and careful exemption from income verification, 
provided that protections are in place, can help consumers and 
communities, while preventing reckless and abusive lending on the basis 
of little or no documentation. Civil rights organizations also stated 
that the streamlined refinance option would provide much-needed relief 
for consumers with loans that are not sustainable in the long term but 
who are not yet in default. These commenters also stated that minority 
consumers have been targeted in the past for unsustainable loans and 
that this provision could help to prevent further foreclosures and 
economic loss in minority communities, as well as for homeowners in 
general.
    Other consumer group commenters stated that an exemption to the 
income verification requirement for refinancing into standard mortgages 
is problematic. One commenter stated that, because the refinance would 
be executed by the same creditor that made the original hybrid loan, 
income verification would not be difficult. This commenter urged the 
Bureau to encourage income documentation when implementing the Dodd-
Frank Act.
    Several industry commenters urged the Bureau to provide additional 
relief for refinancings made in accordance with proposed Sec.  
226.43(d), either by permitting the standard loan to be classified as a 
qualified mortgage or by providing exemptions from other of the 
proposed ability-to-repay requirements. One industry commenter stated 
that in addition to the proposed exemption for the verification of 
income and assets, refinancings conducted in accordance with Sec.  
226.43(d) also should be exempt from the requirements to consider the 
consumer's debt-to-income ratio or residual income, if the consumer is 
still employed and has not incurred significant additional debt 
obligations prior to the refinance. This commenter stated that overly 
rigid standards could significantly reduce the number of consumers who 
qualify for this exemption. Similarly, one industry trade association 
urged the Bureau to exempt refinancings from the requirement to 
consider the consumer's debt obligations, debt-to-income ratio, and 
employment. This commenter stated that the proposed requirement to 
consider these additional underwriting factors was seemingly in 
conflict with the purpose of proposed Sec.  226.43(d) and would 
preclude consumers from taking advantage of beneficial and less costly 
refinancing opportunities. In addition, several industry commenters and 
one industry trade association commented that standard mortgages made 
in accordance with Sec.  226.43(d) should be treated as qualified 
mortgages.
    The Bureau agrees with the concerns raised by commenters that the 
proposed exemptions were drawn too narrowly. The Bureau believes that 
TILA section 129C(a)(6)(E) is intended to create incentives for 
creditors to refinance loans in circumstances where consumers have non-
standard loans on which they are currently able to make payments but on 
which they are likely to be unable to make the payments after recast 
and therefore default on the loan. Accordingly, the Bureau believes 
that in order to create incentives for creditors to use the non-
standard refinancing provision, TILA section 129C(a)(6)(E) must be 
intended to provide at least a

[[Page 6499]]

limited exemption from the general ability-to-repay determination as 
adopted in Sec.  1026.43(c). Otherwise, creditors may have little 
incentive to provide consumers at risk of default with refinancings 
that result in ``materially lower'' payments. The Bureau believes, 
however, that in implementing TILA section 129C(a)(6)(E) it is 
important to balance the creation of additional flexibility and 
incentives for creditors to refinance non-standard mortgages into 
standard mortgages against the likelihood of benefit to the consumer.
    The Bureau notes that under the final rule as adopted, the 
availability of the non-standard refinancing provision contains several 
conditions that are intended to benefit the consumer. First, the 
special ability-to-repay requirements in Sec.  1026.43(d) are available 
only if the conditions in Sec.  1026.43(d)(2) are met. These conditions 
include limiting the scope of Sec.  1026.43(d) to refinancings of non-
standard mortgages into standard mortgages, which generally are more 
stable products with reduced risk of payment shock. The definition of 
standard mortgage in Sec.  1026.43(d)(1)(ii) includes a number of 
limitations that are intended to ensure that creditors may only use the 
provisions in Sec.  1026.43(d) to offer a consumer a product with safer 
features. For example, as discussed in the section-by-section analysis 
of Sec.  1026.43(d)(1)(ii) a standard mortgage may not include negative 
amortization, an interest-only feature, or a balloon payment; in 
addition, the term of the standard mortgage may not exceed 40 years, 
the interest rate must be fixed for at least the first five years, the 
loan is subject to a limitation on the points and fees that may be 
charged, and there are limitations on the use of proceeds from the 
refinancing. Furthermore, Sec.  1026.43(d)(2)(ii) requires that the 
monthly payment on the standard mortgage be materially lower than the 
monthly payment for the non-standard mortgage and, as discussed above, 
the Bureau is adopting a 10 percent safe harbor for what constitutes a 
``material'' reduction.
    The Bureau has concerns that, as proposed by the Board, an 
exemption only from the requirement to consider and verify the 
consumer's income or assets may create insufficient incentives for 
creditors to make refinancings to assist consumers at risk of default. 
For example, the proposal would have required creditors to comply with 
the requirement in Sec.  1026.43(c)(2)(vii) to consider the consumer's 
debt-to-income ratio or residual income. Accordingly, notwithstanding 
an exemption from income or asset verification, the proposal would have 
required consideration of income, as well as consideration of all of 
the other underwriting criteria set forth in Sec.  1026.43(c)(2).
    The Bureau believes that in light of the safeguards imposed by 
other portions of Sec.  1026.43(d), as discussed above, it is 
appropriate to provide an exemption to all of the ability-to-repay 
requirements under Sec.  1026.43(c) for a refinance conducted in 
accordance with Sec.  1026.43(d). The Bureau believes that a broad 
exemption from the general ability-to-repay determination is 
appropriate in order to create incentives for creditors to quickly and 
efficiently refinance consumers whose non-standard mortgages are about 
to recast, thus rendering them likely to default, into more affordable, 
more stable mortgage loans. The Bureau is aware that some consumers may 
nonetheless default on a standard mortgage made in accordance with 
Sec.  1026.43(d), but those consumers likely would have defaulted had 
the non-standard mortgage remained in place. For others, the material 
reduction in payment required under Sec.  1026.43(d)(2) and the more 
stable product type following refinancing may be sufficient to enable 
consumers to avoid default. The Bureau believes that a refinancing 
conducted in accordance with Sec.  1026.43(d) will generally improve a 
consumer's chances of avoiding default. Section 1026.43(d)(3) is 
adopted pursuant to the Bureau's authority under TILA section 105(a). 
The Bureau finds that this adjustment is necessary to effectuate the 
purposes of TILA by ensuring that consumers are offered and receive 
residential mortgage loans on terms that reasonably reflect their 
ability to repay, while ensuring that consumers at risk of default due 
to payment shock are able to obtain responsible and affordable 
refinancing credit.
    However, to prevent evasion or circumvention of the ability-to-
repay requirements in Sec.  1026.43(c), the Bureau is imposing one 
additional condition on the use of Sec.  1026.43(d). Specifically, new 
Sec.  1026.43(d)(2)(vi) conditions the use of Sec.  1026.43(d), for 
non-standard mortgages consummated on or after the effective date of 
this rule, on the non-standard mortgage having been made in accordance 
with Sec.  1026.43(c). The Bureau has concerns that absent Sec.  
1026.43(d)(2)(vi), a creditor might attempt to use a refinancing 
conducted in accordance with Sec.  1026.43(d) to ``cure'' substandard 
underwriting of the prior non-standard mortgage. For example, without 
Sec.  1026.43(d)(2)(vi), if a creditor discovered that it had made an 
error in consideration of the underwriting factors under Sec.  
1026.43(c)(2) for a non-standard mortgage, the creditor might consider 
conducting a refinancing under Sec.  1026.43(d), in order to argue that 
the consumer may no longer raise as a defense to foreclosure the 
underwriting of the original non-standard mortgage. The Bureau believes 
that conditioning the use of Sec.  1026.43(d) on the earlier loan 
having been made in accordance with Sec.  1026.43(c) will better 
effectuate the purposes of TILA by ensuring that consumers are offered 
and receive residential mortgage loans on terms that reasonably reflect 
their ability to repay while preventing unscrupulous creditors from 
evading the ability-to-repay requirements.
    New Sec.  1026.43(d)(2)(vi) applies only to non-standard mortgages 
consummated on or after the effective date of this rule. For non-
standard loans consummated before the effective date of this final 
rule, a refinancing under Sec.  1026.43(d) would not be subject to this 
condition. The Bureau believes that non-standard mortgages made prior 
to the effective date, to which the ability-to-repay requirements in 
Sec.  1026.43(c) did not apply, may present an increased risk of 
default when they are about to recast, so that facilitating refinancing 
into more stable mortgages may be particularly important even if the 
consumer could not qualify for a new loan under traditional ability-to-
repay requirements. The Bureau believes that, on balance, given the 
conditions that apply to refinances under Sec.  1026.43(d), refinances 
of these loans are more likely to benefit consumers than to harm 
consumers, notwithstanding the inapplicability of Sec.  
1026.43(d)(2)(vi). In addition, the concern about a creditor using 
Sec.  1026.43(d) to ``cure'' prior violations of Sec.  1026.43(c) does 
not apply to loans made before the effective date of this rule, as such 
loans were not required to be made in accordance with Sec.  1026.43.
    Proposed condition that the consumer will likely default. Proposed 
comment 43(d)(3)(i)-2 would have clarified 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 
proposal was not intended, however, 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. As discussed in the supplementary information to the 
proposal, the Board

[[Page 6500]]

considered certain government refinancing programs as well as feedback 
from outreach participants, each of which suggested that there may be 
legitimate differences in servicer assessments of a consumer's 
likelihood of default. The Board noted that it considered an ``imminent 
default'' standard but heard from consumer advocates that ``imminent 
default'' 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 a refinancing to avoid payment shock. 
Accordingly, the Board's proposal used the exact statutory wording--
``likely default''--in implementing the provision permitting a creditor 
to prioritize prevention of default in underwriting a refinancing. The 
Board solicited 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.
    Two industry trade associations urged the Bureau to remove proposed 
Sec.  226.43(d)(3)(i)(B) as a condition to the availability of the non-
standard refinancing provisions. One of these commenters noted that a 
creditor would have to underwrite a consumer's income and assets to 
determine whether the consumer would likely default, which would defeat 
the purpose of the proposed provision. Several industry commenters also 
indicated that the ``likelihood of default'' standard is vague and 
accordingly subjects creditors to potential liability for waiving 
certain ability-to-repay requirements, and questioned the extent to 
which creditors would utilize the streamline refinance option in light 
of this potential liability. One such commenter urged the Bureau to 
eliminate this requirement or, in the alternative, to provide 
additional guidance regarding when a consumer is ``likely to go into 
default.''
    An association of State bank supervisors stated that there can be 
no quantifiable standard for the definition of ``likely default.'' 
These commenters further stated that institutions must use sound 
judgment and regulators must provide responsible oversight to ensure 
that abuses are not occurring through the refinancing exemption set 
forth in Sec.  1026.43(d).
    The Bureau is adopting the provision as proposed, renumbered as 
Sec.  1026.43(d)(3)(i)(B), and is also adopting comments 43(d)(3)(i)-1 
and 43(d)(3)(i)-2 as proposed. The Bureau believes that eliminating the 
requirement that a creditor consider whether the extension of new 
credit would prevent a likely default would be inconsistent with TILA 
section 129C(a)(6)(E), which expressly includes language regarding 
consideration by the creditor of ``[whether] the extension of new 
credit would prevent a likely default should the original mortgage 
reset.'' At the same time, the Bureau agrees with the association of 
State bank supervisors that it would be difficult to impose by 
regulation a single standard for what constitutes a likely default. 
Accordingly, the Bureau is adopting the flexible approach proposed by 
the Board, which would permit but not require creditors to look to 
widely-accepted standards for analyzing a consumer's likelihood of 
default. The Bureau does not believe that this flexible approach 
requires a creditor to consider the consumer's income and assets if, 
for example, statistical evidence indicates that consumers who 
experience a payment shock of the type that the consumer is about to 
experience have a high incidence of defaulting following the payment 
shock.
    Proposed payment calculation for repayment ability determination. 
Proposed comment 43(d)(3)(ii)-1 would have explained that, if the 
conditions in proposed Sec.  226.43(d)(1) are met, 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 proposed Sec.  226.43(d)(5)(ii), rather than the 
calculation prescribed under proposed Sec.  226.43(c)(2)(iii) and 
(c)(5). As discussed in the section-by-section analysis above, as 
adopted Sec.  1026.43(d)(3) provides an exemption from the requirements 
of Sec.  1026.43(c) if certain conditions are met. Accordingly, while 
the creditor is required to determine whether there is a material 
reduction in payment consistent with Sec.  1026.43(d)(2)(ii) by using 
the payment calculations prescribed in Sec.  1026.43(d)(5), the 
creditor is not required to use these same payment calculations for 
purposes of Sec.  1026.43(c). Accordingly, the Bureau is withdrawing 
proposed comment 43(d)(3)(ii)-1 as unnecessary.
43(d)(4) Offer of Rate Discounts and Other Favorable Terms
    Proposed Sec.  226.43(d)(4) would have provided 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 
aspect of the proposal was intended to implement TILA section 
129C(a)(6)(E)(iii), which permits creditors of refinancings subject to 
special ability-to-repay requirements in TILA section 129C(a)(6)(E) to 
``offer rate discounts and other favorable terms'' to the consumer 
``that would be available to new customers with high credit ratings 
based on such underwriting practice.''
    The Bureau received no comments on this provision, which is adopted 
as proposed and renumbered as Sec.  1026.43(d)(4). The Bureau is 
concerned that the phrase ``consistent with the creditor's underwriting 
practice'' could be misinterpreted to refer to the underwriting 
requirements in Sec.  1026.43(c). As this final rule provides an 
exemption under Sec.  1026.43(d) for all of the requirements in Sec.  
1026.43(c), subject to the other conditions discussed above, the Bureau 
believes that additional clarification is needed to address this 
potential misinterpretation. Thus, the Bureau is adopting comment 
43(d)(4)-1, which clarifies that in connection with a refinancing made 
pursuant to Sec.  1026.43(d), Sec.  1026.43(d)(4) requires a creditor 
offering a consumer rate discounts and terms that are the same as, or 
better than, the rate discounts and terms offered to new consumers to 
make such an offer consistent with the creditor's documented 
underwriting practices. Section 1026.43(d)(4) does not require a 
creditor making a refinancing pursuant to Sec.  1026.43(d) to comply 
with the underwriting requirements of Sec.  1026.43(c). Rather, Sec.  
1026.43(d)(4) requires creditors providing such discounts to do so 
consistent with documented policies related to loan pricing, loan term 
qualifications, or other similar underwriting practices. For example, 
assume that a creditor is providing a consumer with a refinancing made 
pursuant to Sec.  1026.43(d) and that this creditor has a documented 
practice of offering rate discounts to consumers with credit scores 
above a certain threshold. Assume further that the consumer receiving 
the refinancing has a credit score below this threshold, and therefore 
would not normally qualify for the rate discount available to consumers 
with high credit scores. This creditor complies with Sec.  
1026.43(d)(4) by offering the consumer the discounted rate in 
connection with the refinancing made pursuant to Sec.  1026.43(d), even 
if the consumer would not normally

[[Page 6501]]

qualify for that discounted rate, provided that the offer of the 
discounted rate is not prohibited by applicable State or Federal law. 
However, Sec.  1026.43(d)(4) does not require a creditor to offer a 
consumer such a discounted rate.
43(d)(5) Payment Calculations
    Proposed Sec.  226.43(d)(5) would have prescribed the payment 
calculations for determining whether the consumer's monthly payment for 
a standard mortgage will be ``materially lower'' than the monthly 
payment for the non-standard mortgage. Proposed Sec.  226.43(d)(5) thus 
was intended to complement proposed Sec.  226.43(d)(1)(ii) in 
implementing TILA section 129C(a)(6)(E), which requires a ``reduction'' 
in the monthly payment for the existing non-standard (``hybrid'') 
mortgage when refinanced into a standard mortgage.
43(d)(5)(i) Non-Standard mortgage
    Proposed Sec.  226.43(d)(5)(i) would have required 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. The Board stated 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 introductory terms cease 
and a higher payment results) would promote needed refinances 
consistent with Congress's intent.
    The Board noted that 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 the proposal, 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.
    Accordingly, the proposal would have required 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, 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, 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, the maximum loan amount.
    Proposed comment 43(d)(5)(i)-1 would have explained 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 proposed 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. 
The proposed comment noted that guidance regarding the meaning of 
``substantially equal'' and ``recast'' is provided in comment 
43(c)(5)(i)-4 and Sec.  226.43(b)(11), respectively.
    Proposed comment 43(d)(5)(i)-2 would have explained that the term 
``fully indexed rate'' used for calculating the payment for a non-
standard mortgage is generally defined in proposed Sec.  226.43(b)(3) 
and associated commentary. The proposed comment explained an important 
difference between the ``fully indexed rate'' as defined in proposed 
Sec.  226.43(b)(3), however, and the meaning of ``fully indexed rate'' 
in Sec.  226.43(d)(5)(i). Specifically, under proposed Sec.  
226.43(b)(3), the fully indexed rate is calculated at the time of 
consummation. Under proposed Sec.  226.43(d)(5)(i), the fully indexed 
rate would be calculated within a 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 clarified 
that 30 days would generally be considered a ``reasonable period of 
time.''
    Proposed comment 43(d)(5)(i)-3 would have clarified 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 12 CFR 1024.2(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, 
such as 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 
proposed comment also cross-referenced comment 19(b)-3 for guidance in 
determining whether the transaction involves an intermediary agent or 
broker.
    Proposed payment calculation for an adjustable-rate mortgage with 
an introductory fixed rate. Proposed comments 43(d)(5)(i)-4 and -5 
would have clarified 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 clarified 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. 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. 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. The proposed comment set forth an illustrative 
example. Proposed comment 43(d)(5)(i)-5 would have provided a second 
illustrative example of the payment calculation for an

[[Page 6502]]

adjustable-rate mortgage with an introductory fixed rate.
    Proposed payment calculation for an interest-only loan. Proposed 
comments 43(d)(5)(i)-6 and -7 would have explained the payment 
calculation for an interest-only loan under proposed Sec.  
226.43(d)(5)(i). Proposed comment 43(d)(5)(i)-6 would have clarified 
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), 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.
    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). Third, the payment must be based 
on the fully indexed rate as of the date of the written application for 
the standard mortgage.
    Proposed comment 43(d)(5)(i)-7 would have provided 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 percent, and 
permits interest-only payments for the first two years, after which 
time amortizing payments of principal and interest are required. 
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. 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.
    Proposed comment 43(d)(5)(i)-7 would have further explained that, 
to calculate the non-standard mortgage payment that must be compared to 
the standard mortgage payment, 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 percent, 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.
    The comment concluded 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 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.
    Proposed payment calculation for a negative amortization loan. 
Proposed comments 43(d)(5)(i)-8 and -9 would have explained the payment 
calculation for a negative amortization loan under proposed Sec.  
226.43(d)(5)(i)(C). Proposed comment 43(d)(5)(i)-8 would have clarified 
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. The comment further stated that 
examples of how to calculate the maximum loan amount are provided in 
proposed comment 43(b)(7)-3.
    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. 
Third, the payment must be based on the fully indexed rate as of the 
date of the written application for the standard mortgage.
    Proposed comment 43(d)(5)(i)-9 would have provided an illustration 
of the payment calculation for a negative amortization loan. The 
example assumes a 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 percent of the loan amount, or for the 
first five years of monthly 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 percent.
    The example also assumed 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 percent is reached on July 1, 2013, the due date of the 28th 
monthly payment. 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 percent.
    Proposed comment 43(d)(5)(i)-9 then stated that, to calculate the 
non-standard mortgage payment that must be compared to the standard 
mortgage payment under proposed 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 percent, which is the index 
value of 4.5 percent as of March 15, 2012 (the date on which the 
creditor receives the application for a refinancing) plus the margin of 
3.5 percent.
     The remaining loan term as of July 1, 2013, the date of 
the recast, which is 27 years and 8 months (332 monthly payments).
    The comment concluded 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 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.
    The Board requested comment on the proposed payment calculation for 
a non-standard mortgage and on the appropriateness and usefulness of 
the proposed payment calculation examples.
    The Bureau received no specific comment on the payment calculations 
for non-standard mortgages set forth in proposed Sec.  226.43(d)(5)(i) 
and its associated commentary. Accordingly, the provision that is being 
adopted is substantially similar to the version proposed, renumbered as 
Sec.  1026.43(d)(5)(i). The Bureau also is

[[Page 6503]]

adopting the associated commentary generally as proposed. The Bureau 
has made several technical amendments to the examples in comments 
43(d)(5)(i)-4, -5, -6, -7, and -9 for clarity. As proposed, the 
examples in the comment referred to dates prior to the effective date 
of this rule; the Bureau has updated the dates in the examples so that 
they will occur after this rule becomes effective.
    The Bureau believes that it is necessary to clarify the provisions 
related to payment calculations for interest-only loans and negative 
amortization loans. The provisions adopted clarify that the payment 
calculation required by Sec.  1026.43(d)(5)(i) must be based on the 
outstanding principal balance, rather than the original amount of 
credit extended. Accordingly, as adopted Sec.  1026.43(d)(5)(i)(C)(2) 
requires the remaining loan amount for an interest-only loan to be 
based on 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. Similarly, Sec.  1026.43(d)(5)(i)(C)(3) requires the 
remaining loan amount for a negative amortization loan to be based on 
the maximum loan amount, determined after adjusting for the outstanding 
principal balance. The Bureau has made technical amendments to the 
example in comments 43(d)(5)(i)-6, -7, -8, and -9 to conform to this 
clarification.
    Additionally, the Bureau has added new comment 43(d)(5)(i)-10 to 
add an additional illustration of the payment calculation for a 
negative amortization loan. As adopted, comment 43(d)(5)(i)-10 provides 
an illustrative example, clarifying that, pursuant to the example and 
assumptions included in the example, to calculate the non-standard 
mortgage payment on a negative amortization loan for which the consumer 
has made more than the minimum required payment that must be compared 
to the standard mortgage payment under Sec.  1026.43(d)(1)(i), the 
creditor must use the maximum loan amount of $229,219 as of March 1, 
2019, the fully indexed rate of 8 percent, which is the index value of 
4.5 percent as of March 15, 2012 (the date on which the creditor 
receives the application for a refinancing) plus the margin of 3.5 
percent, and the remaining loan term as of March 1, 2019, the date of 
the recast, which is 25 years (300 monthly payments). The comment 
further explains that, 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 is $1,769. 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. The 
Bureau finds that comment 43(d)(5)(i)-10, which is adopted pursuant to 
the Bureau's authority under section 105(a) of TILA, is necessary to 
facilitate compliance with TILA.
43(d)(5)(ii) Standard Mortgage
    Proposed Sec.  226.43(d)(5)(ii) would have prescribed 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 would have been 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 would have clarified that the meaning of ``fully 
amortizing payment'' is defined in Sec.  226.43(b)(2), and that 
guidance regarding the meaning of ``substantially equal'' may be found 
in proposed comment 43(c)(5)(i)-4. Proposed comment 43(d)(5)(ii)-1 also 
explained 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 percent, the rate for the second two years is 5 
percent, and the rate for the next two years is 6 percent, the rate 
that must be used is 6 percent.
    Proposed comment 43(d)(5)(ii)-2 would have provided 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 an interest rate of 6 percent 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 
percent, subject to a 2 percent 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 percent.
    The Bureau received no specific comment on the payment calculations 
for standard mortgages set forth in proposed Sec.  226.43(d)(5)(ii) and 
its associated commentary. Accordingly, this provisions is adopted as 
proposed, renumbered as Sec.  1026.43(d)(5)(ii). The Bureau also is 
adopting the associated commentary generally as proposed, with several 
technical amendments for clarity.
43(e) Qualified Mortgages
Background
    As discussed above, TILA section 129C(a)(1) prohibits a creditor 
from making a residential mortgage loan unless the creditor makes a 
reasonable and good faith determination, at or before consummation, 
based on verified and documented information, that at the time of 
consummation the consumer has a reasonable ability to repay the loan. 
TILA section 129C(a)(1) through (4) and (6) through (9) requires 
creditors specifically to consider and verify various factors relating 
to the consumer's income and other assets, debts and other obligations, 
and credit history. However, the ability-to-repay provisions do not 
directly restrict features, term, or costs of the loan.
    TILA section 129C(b), in contrast, provides that loans that meet 
certain requirements shall be deemed ``qualified mortgages,'' which are 
entitled to a presumption of compliance with the ability-to-repay 
requirements. The section sets forth a number of qualified mortgage 
requirements which focus mainly on prohibiting certain risky features 
and practices (such as negative amortization and interest-only periods 
or underwriting a loan without verifying the consumer's income) and on 
generally limiting points and fees in excess of 3 percent of the total 
loan amount. The only underwriting provisions in the statutory 
definition of qualified mortgage are a requirement that ``income and 
financial resources relied upon to qualify the [borrowers] be verified 
and documented'' and a further requirement that underwriting be based

[[Page 6504]]

upon a fully amortizing schedule using the maximum rate permitted 
during the first five years of the loan. TILA section 
129C(b)(2)(A)(iii) through (v). However, TILA section 129C(b)(2)(A)(vi) 
authorizes the Bureau to adopt ``guidelines or regulations * * * 
relating to ratios of total monthly debt to monthly income or 
alternative measures of ability to pay * * * .'' And TILA section 
129C(b)(3)(B)(i) further authorizes the Bureau to revise, add to, or 
subtract from the criteria that define a qualified mortgage upon a 
finding that the changes are necessary or proper to ensure that 
responsible, affordable mortgage credit remains available to consumers 
in a manner consistent with the purposes of TILA section 129C, 
necessary and appropriate to effectuate the purposes of TILA sections 
129C and 129B, to prevent circumvention or evasion thereof, or to 
facilitate compliance with TILA sections 129C and 129B.\127\
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    \127\ TILA section 129B contains requirements and restrictions 
relating to mortgage originators. TILA section 129B(b) requires a 
loan originator to be qualified and, when required, registered and 
licensed as a mortgage originator under the Secure and Fair 
Enforcement of Mortgage Licensing Act of 2008 (SAFE Act), and to 
include on all loan documents any unique identifier of the mortgage 
originator provided by the Nationwide Mortgage Licensing System and 
Registry. That section also requires the Bureau to prescribe 
regulations requiring depository institutions to establish and 
maintain procedures designed to ensure and monitor compliance of 
such institutions, including their subsidiaries and employees, with 
the SAFE Act. TILA section 129B(c) contains certain prohibitions on 
loan originator steering, including restrictions on various 
compensation practices, and requires the Bureau to prescribe 
regulations to prohibit certain specific steering activities.
---------------------------------------------------------------------------

    The qualified mortgage requirements are critical to implementation 
of various parts of the Dodd-Frank Act. For example, several consumer 
protection requirements in title XIV of the Dodd-Frank Act treat 
qualified mortgages differently than non-qualified mortgages or key off 
elements of the qualified mortgage definition.\128\ In addition, the 
requirements concerning retention of risk by parties involved in the 
securitization process under title IX of the Dodd-Frank Act provide 
special treatment for ``qualified residential mortgages,'' which under 
section 15G of the Securities Exchange Act of 1934, as amended by 
section 941(b) of the Dodd-Frank Act, ``shall be no broader than the 
term `qualified mortgage,''' as defined by TILA section 129C(b) and the 
Bureau's implementing regulations. 15 U.S.C. 780-11(e)(4).\129\
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    \128\ For example, as described in the section-by-section 
analysis of Sec.  1026.43(g), TILA section 129C(c), added by section 
1414(a) of the Dodd-Frank Act, provides that a residential mortgage 
loan that is not a ``qualified mortgage'' may not contain a 
prepayment penalty. In addition, section 1471 of the Dodd-Frank Act 
establishes a new TILA section 129H, which sets forth appraisal 
requirements applicable to higher-risk mortgages. The definition of 
``higher-risk mortgage'' expressly excludes qualified mortgages.
    \129\ See part II.G for a discussion of the 2011 QRM Proposed 
Rule.
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    For present purposes, however, the definition of a qualified 
mortgage is perhaps most significant because of its implications for 
ability-to-repay claims. 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 [ability-to-repay] requirements of 
subsection (a), if the loan is a qualified mortgage.'' But the statute 
does not describe the strength of the presumption or what if anything 
could be used to rebut it. As discussed further below, there are legal 
and policy arguments that support interpreting the presumption as 
either rebuttable or conclusive.
    Determining the definition and scope of protection afforded to 
qualified mortgages is the area of this rulemaking which has engendered 
perhaps the greatest interest and comment. Although TILA section 
129C(a)(1) requires only that a creditor make a ``reasonable and good 
faith determination'' of the consumer's ``reasonable ability to repay'' 
a residential mortgage, considerable concern has arisen about the 
actual and perceived litigation and liability risk to creditors and 
assignees under the statute. Commenters tended to focus heavily on the 
choice between a presumption that is rebuttable and one that is 
conclusive as a means of mitigating that risk, although the criteria 
that define a qualified mortgage are also important because a creditor 
would have to prove status as a qualified mortgage in order to invoke 
any (rebuttable or conclusive) presumption of compliance.
    In assessing the potential impacts of the statute, it is important 
to note that regulations issued after the mortgage crisis but prior to 
the enactment of the Dodd-Frank Act have already imposed ability-to-
repay requirements for high-cost and higher-priced mortgages and 
created a presumption of compliance for such mortgages if the creditor 
satisfied certain underwriting and verification requirements. 
Specifically, under provisions of the Board's 2008 HOEPA Final Rule 
that took effect in October 2009, creditors are prohibited from 
extending high-cost or higher-priced mortgage loans without regard to 
the consumer's ability to repay. See Sec.  1026.34(a)(4). The rules 
provide a presumption of compliance with those ability-to-repay 
requirements if the creditor follows certain optional procedures 
regarding underwriting the loan payment, assessing the debt-to-income 
(DTI) ratio or residual income, and limiting the features of the loan, 
in addition to following certain procedures mandated for all creditors. 
See Sec.  1026.34(a)(4)(iii) and (iv) and comment 34(a)(4)(iii)-1. 
However, the 2008 HOEPA Final Rule makes clear that even if the 
creditor follows these criteria, the presumption of compliance is 
rebuttable. See comment 34(a)(4)(iii)-1. The consumer can still 
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 
consumer's debt-to-income ratio or residual income, the debt-to-income 
ratio was very high or the residual income was very low. 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 extends a requirement to assess consumers' 
ability to repay to the full mortgage market, and establishes a 
presumption using a different set of criteria that focus more on 
product features than underwriting practices. Further, the statute 
establishes similar but slightly different remedies than are available 
under the existing requirements. Section 1416 of the Dodd-Frank Act 
amended TILA section 130(a) to provide that a consumer who brings a 
timely action against a creditor for a violation 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. The 
statute of limitations is three years from the date of the occurrence 
of the violation. Moreover, as amended by section 1413 of the Dodd-
Frank Act, TILA section 130(k) provides that when a creditor, assignee, 
or other holder initiates a foreclosure action, a consumer may assert a 
violation of the ability-to-repay requirements as a matter of defense 
by recoupment or setoff. There is no time limit on the use of this 
defense, but the amount of recoupment or setoff is limited with respect 
to the special statutory damages to no more than three years of finance 
charges and fees. This limit on setoff is more restrictive than under 
the existing regulations, but also expressly applies to assignees.

[[Page 6505]]

    In light of the statutory ambiguities, complex policy 
considerations, and concerns about litigation risk, the Board's 
proposal mapped out two alternatives at the opposite ends of a spectrum 
for defining a qualified mortgage and the protection afforded to such 
mortgages. At one end, the Board's Alternative 1 would have defined 
qualified mortgage only to include the mandated statutory elements 
listed in TILA section 129C(b)(2), most of which, as noted above, 
relate to product features and not to the underwriting decision or 
process itself. This alternative would have provided creditors with a 
safe harbor to establish compliance with the general repayment ability 
requirement in proposed Sec.  226.43(c)(1). As the Board recognized, 
this would provide strong incentives for creditors to make qualified 
mortgages in order to minimize litigation risk and compliance burden 
under general ability-to-repay requirements, but might prevent 
consumers from seeking redress for failure to assess their ability to 
repay. In Alternative 2, the Board proposed a definition of qualified 
mortgage which incorporated both the statutory product feature 
restrictions and additional underwriting elements drawn from the 
general ability-to-repay requirements, as well as seeking comment on 
whether to establish a specific debt-to-income requirement. Alternative 
2 also specified that consumers could rebut the presumption of 
compliance by demonstrating that a creditor did not adequately 
determine the consumers' ability to repay the loan. As the Board 
recognized, this would better ensure that creditors fully evaluate 
consumers' ability to repay qualified mortgages and preserve consumers' 
rights to seek redress. However, the Board expressed concern that 
Alternative 2 would provide little incentive to make qualified 
mortgages in the first place, given that the requirements may be 
challenging to satisfy and the strength of protection afforded would be 
minimal.
Overview of Final Rule
    As noted above and discussed in greater detail in the section-by-
section analysis below, the Dodd-Frank Act accords the Bureau 
significant discretion in defining the scope of, and legal protections 
afforded to, a qualified mortgage. In developing the rules for 
qualified mortgages, the Bureau has carefully considered numerous 
factors, including the Board's proposal to implement TILA section 
129C(b), comments and ex parte communications, current regulations and 
the current state of the mortgage market, and the implications of the 
qualified mortgage rule on other parts of the Dodd-Frank Act. The 
Bureau is acutely aware of the problematic practices that gave rise to 
the financial crisis and sees the ability-to-pay requirement as an 
important bulwark to prevent a recurrence of those practices by 
establishing a floor for safe underwriting. At the same time, the 
Bureau is equally aware of the anxiety in the mortgage market today 
concerning the continued slow pace of recovery and the confluence of 
multiple major regulatory and capital initiatives. Although every 
industry representative that has communicated with the Bureau 
acknowledges the importance of assessing a consumer's ability to repay 
before extending a mortgage to the consumer--and no creditor claims to 
do otherwise--there is nonetheless a widespread fear about the 
litigation risks associated with the Dodd-Frank Act ability-to-repay 
requirements. Even community banks, deeply ingrained within their local 
communities and committed to a relationship lending model, have 
expressed to the Bureau their fear of litigation. In crafting the rules 
to implement the qualified mortgage provision, the Bureau has sought to 
balance creating new protections for consumers and new responsibilities 
for creditors with preserving consumers' access to credit and allowing 
for appropriate lending and innovation.
    The Bureau recognizes both the need for certainty in the short term 
and the risk that actions taken by the Bureau in order to provide such 
certainty could, over time, defeat the prophylactic aims of the statute 
or impede recovery in various parts of the market. For instance, in 
defining the criteria for a qualified mortgage, the Bureau is called 
upon to identify a class of mortgages which can be presumed to be 
affordable. The boundaries must be clearly drawn so that consumers, 
creditors, and secondary market investors can all proceed with 
reasonable assurance as to whether a particular loan constitutes a 
qualified mortgage. Yet the Bureau believes that it is not possible by 
rule to define every instance in which a mortgage is affordable, and 
the Bureau fears that an overly broad definition of qualified mortgage 
could stigmatize non-qualified mortgages or leave insufficient 
liquidity for such loans. If the definition of qualified mortgage is so 
broad as to deter creditors from making non-qualified mortgages 
altogether, the regulation would curtail access to responsible credit 
for consumers and turn the Bureau's definition of a qualified mortgage 
into a straitjacket setting the outer boundary of credit availability. 
The Bureau does not believe such a result would be consistent with 
congressional intent or in the best interests of consumers or the 
market.
    The Bureau is thus attuned to the problems of the past, the 
pressures that exist today, and the ways in which the market might 
return in the future. As a result, the Bureau has worked to establish 
guideposts in the final rule to make sure that the market's return is 
healthy and sustainable for the long-term. Within that framework, the 
Bureau is defining qualified mortgages to strike a clear and calibrated 
balance as follows:
    First, the final rule provides meaningful protections for consumers 
while providing clarity to creditors about what they must do if they 
seek to invoke the qualified mortgage presumption of compliance. 
Accordingly, the qualified mortgage criteria include not only the 
minimum elements required by the statute--including prohibitions on 
risky loan features, a cap on points and fees, and special underwriting 
rules for adjustable-rate mortgages--but additional underwriting 
features to ensure that creditors do in fact evaluate individual 
consumers' ability to repay the qualified mortgages. The qualified 
mortgage criteria thus incorporate key elements of the verification 
requirements under the ability-to-repay standard and strengthen the 
consumer protections established by the ability-to-repay requirements.
    In particular, the final rule provides a bright-line threshold for 
the consumer's total debt-to-income ratio, so that under a qualified 
mortgage, the consumer's total monthly debt payments cannot exceed 43 
percent of the consumer's total monthly income. The bright-line 
threshold for debt-to-income serves multiple purposes. First, it 
protects consumer interests because debt-to-income ratios are a common 
and important tool for evaluating consumers' ability to repay their 
loans over time, and the 43 percent threshold has been utilized by the 
Federal Housing Administration (FHA) for many years as its general 
boundary for defining affordability. Relative to other benchmarks that 
are used in the market (such as GSE guidelines) that have a benchmark 
of 36 percent, before consideration of compensating factors, this 
threshold is a relatively liberal one which allows ample room for 
consumers to qualify for an affordable mortgage. Second, it provides a 
well-established and well-understood rule

[[Page 6506]]

that will provide certainty for creditors and help to minimize the 
potential for disputes and costly litigation over whether a mortgage is 
a qualified mortgage. Third, it allows room for a vibrant market for 
non-qualified mortgages over time. The Bureau recognizes that there 
will be many instances in which individual consumers can afford an even 
higher debt-to-income ratio based on their particular circumstances, 
although the Bureau believes that such loans are better evaluated on an 
individual basis under the ability-to-repay criteria rather than with a 
blanket presumption. The Bureau also believes that there are a 
sufficient number of potential borrowers who can afford a mortgage that 
would bring their debt-to-income ratio above 43 percent that 
responsible creditors will continue to make such loans as they become 
more comfortable with the new regulatory framework. To preserve access 
to credit during the transition period, the Bureau has also adopted 
temporary measures as discussed further below.
    The second major feature of the final rule is the provision of 
carefully calibrated presumptions of compliance afforded to different 
types of qualified mortgages. Following the approach developed by the 
Board in the existing ability-to-repay rules to distinguish between 
prime and subprime loans, the final rule distinguishes between two 
types of qualified mortgages based on the mortgage's Annual Percentage 
Rate (APR) relative to the Average Prime Offer Rate (APOR).\130\ For 
loans that exceed APOR by a specified amount--loans denominated as 
``higher-priced mortgage loans''--the final rule provides a rebuttable 
presumption. In other words, the creditor is presumed to have satisfied 
the ability-to-repay requirements, but a consumer may rebut that 
presumption under carefully defined circumstances.\131\ For all other 
loans, i.e., loans that are not ``higher-priced,'' the final rule 
provides a conclusive presumption that the creditor has satisfied the 
ability-to-repay requirements once the creditor proves that it has in 
fact made a qualified mortgage. In other words, the final rule provides 
a safe harbor from ability-to-repay challenges for the least risky type 
of qualified mortgages, while providing room to rebut the presumption 
for qualified mortgages whose pricing is indicative of a higher level 
of risk.\132\ The Bureau believes that this calibration will further 
encourage creditors to extend credit responsibly and provide certainty 
that promotes access to credit.
---------------------------------------------------------------------------

    \130\ APOR means ``the average prime offer rate for a comparable 
transaction as of the date on which the interest rate for the 
transaction is set, as published by the Bureau.'' TILA section 
129C(b)(2)(B).
    \131\ As described further below, under a qualified mortgage 
with a rebuttable presumption, a consumer can rebut that presumption 
by showing that, in fact, at the time the loan was made the consumer 
did not have sufficient income or assets (other than the value of 
the dwelling that secures the transaction), after paying his or her 
mortgage and other debts, to be able to meet his or her other living 
expenses of which the creditor was aware.
    \132\ The threshold for determining which treatment applies 
generally matches the threshold for ``higher-priced mortgage loans'' 
under existing Regulation Z, except that the rule does not provide a 
separate, higher threshold for jumbo loans. The Dodd-Frank Act 
itself codified the same thresholds for other purposes. See Dodd-
Frank Act section 1411, enacting TILA section 129C(6)(d)(ii). In 
adopting the ``higher-priced mortgage loans'' threshold in 2008, the 
Board explained that the aim was to ``cover the subprime market and 
generally exclude the prime market.'' 73 FR 44522, 44532 (July 30, 
2008).
---------------------------------------------------------------------------

    The Bureau believes that loans that fall within the rebuttable 
presumption category will be loans made to consumers who are more 
likely to be vulnerable \133\ so that, even if the loans satisfy the 
criteria for a qualified mortgage, those consumers should be provided 
the opportunity to prove that, in an individual case, the creditor did 
not have a reasonable belief that the loan would be affordable for that 
consumer. Under a qualified mortgage with a safe harbor, most of the 
loans within this category will be the loans made to prime borrowers 
who pose fewer risks. Furthermore, considering the difference in 
historical performance levels between prime and subprime loans, the 
Bureau believes that it is reasonable to presume conclusively that a 
creditor who has verified a consumer's debt and income, determined in 
accordance with specified standards that the consumer has a debt-to-
income ratio that does not exceed 43 percent, and made a prime mortgage 
with the product features required for a qualified mortgage has 
satisfied its obligation to assess the consumer's ability to repay. 
This approach will provide significant certainty to creditors operating 
in the prime market. The approach will also create lesser but still 
important protection for creditors in the subprime market who follow 
the qualified mortgage rules, while preserving consumer remedies and 
creating strong incentives for more responsible lending in the part of 
the market in which the most abuses occurred prior to the financial 
crisis.
---------------------------------------------------------------------------

    \133\ See generally, id. at 44533.
---------------------------------------------------------------------------

    Third, the final rule provides a temporary special rule for certain 
qualified mortgages to provide a transition period to help ensure that 
sustainable credit will return in all parts of the market over time. 
The temporary special rule expands the definition of a qualified 
mortgage to include any loan that is eligible to be purchased, 
guaranteed, or insured by various Federal agencies or by the GSEs while 
they are operating under conservatorship. This temporary provision 
preserves access to credit in today's market by permitting a loan that 
does not satisfy the 43 percent debt-to-income ratio threshold to 
nonetheless be a qualified mortgage based upon an underwriting 
determination made pursuant to guidelines created by the GSEs while in 
conservatorship or one of the Federal agencies. This temporary 
provision will sunset in a maximum of seven years. As with loans that 
satisfy the 43 percent debt-to-income ratio threshold, qualified 
mortgages under this temporary rule will receive either a rebuttable or 
conclusive presumption of compliance depending upon the pricing of the 
loan relative to APOR. The Bureau believes this provision will provide 
sufficient consumer protection while providing adequate time for 
creditors to adjust to the new requirements of the final rule as well 
as to changes in other regulatory, capital, and economic conditions.
    A detailed description of the qualified mortgage definition is set 
forth below. Section 1026.43(e)(1) provides the presumption of 
compliance provided to qualified mortgages. Section 1026.43(e)(2) 
provides the criteria for a qualified mortgage under the general 
definition, including the restrictions on certain product features, 
verification requirements, and a specified debt-to-income ratio 
threshold. Section 1026.43(e)(3) provides the limits on points and fees 
for qualified mortgages, including the limits for smaller loan amounts. 
Section 1026.43(e)(4) provides the temporary special rule for qualified 
mortgages. Lastly, Sec.  1026.43(f) implements a statutory exemption 
permitting certain balloon-payment loans by creditors operating 
predominantly in rural or underserved areas to be qualified mortgages.
43(e)(1) Safe Harbor and Presumption of Compliance
    As discussed above, the Dodd-Frank Act provides a presumption of 
compliance with the ability-to-repay requirements for qualified 
mortgages, but the statute is not clear as to whether that presumption 
is intended to be conclusive so as to create a safe harbor that cuts 
off litigation or a rebuttable presumption of compliance with the 
ability-to-repay requirements. The title of section 1412 refers to both 
a ``safe

[[Page 6507]]

harbor and rebuttable presumption,'' and as discussed below there are 
references to both safe harbors and presumptions in other provisions of 
the statute. As the Board's proposal discussed, an analysis of the 
statutory construction and policy implications demonstrates that there 
are sound reasons for adopting either interpretation. See 76 FR 27390, 
27452-55 (May 11, 2011).
    Several aspects of the statutory structure favor a safe harbor 
interpretation. 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 general ability-to repay requirement, and also a 
set of specific underwriting criteria that must be considered by a 
creditor in assessing the consumer's repayment ability. Rather than 
stating that the presumption of compliance applies only to TILA section 
129C(a)(1) for the general ability-to-repay requirements, it appears 
Congress intended creditors who make qualified mortgages to be presumed 
to comply with both the ability-to-repay requirements and all of the 
specific underwriting criteria. 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 meeting the criteria for a qualified mortgage is an 
alternative way of establishing compliance with all of the ability-to-
repay requirements, which could suggest that meeting the qualified 
mortgage criteria conclusively satisfies these requirements. In other 
words, given that a qualified mortgage satisfies the ability-to-repay 
requirements, one could assume that meeting the qualified mortgage 
definition conclusively establishes compliance with those requirements.
    In addition, TILA section 129C(b)(3)(B), which provides the Bureau 
authority to revise, add to, or subtract from the qualified mortgage 
criteria upon making certain findings, is titled ``Revision of Safe 
Harbor Criteria.'' Further, in section 1421 of the Dodd-Frank Act, 
Congress instructed the Government Accountability Office to issue a 
study on the effect ``on the mortgage market for mortgages that are not 
within the safe harbor provided in the amendments made by this 
subtitle.''
    Certain policy considerations also favor a safe harbor. Treating a 
qualified mortgage as a safe harbor provides greater legal certainty 
for creditors and secondary market participants than a rebuttable 
presumption of compliance. Increased legal certainty may benefit 
consumers if as a result creditors are encouraged to make loans that 
satisfy the qualified mortgage criteria, as such loans cannot have 
certain risky features and have a cap on upfront costs. Furthermore, 
increased certainty may result in loans with a lower cost than would be 
charged in a world of legal uncertainty. Thus, a safe harbor may also 
allow creditors to provide consumers additional or more affordable 
access to credit by reducing their expected total litigation costs.
    On the other hand, there are also several aspects of the statutory 
structure that favor interpreting qualified mortgage as creating a 
rebuttable presumption of compliance. With respect to statutory 
construction, TILA section 129C(b)(1) states that a creditor or 
assignee ``may presume'' that a loan has met the repayment ability 
requirement if the loan is a qualified mortgage. As the Board's 
proposal notes, this could suggest that originating a qualified 
mortgage provides a presumption of compliance with the repayment 
ability requirements, which the consumer can rebut with evidence that 
the creditor did not, in fact, make a good faith and reasonable 
determination of the consumer's ability to repay the loan. Similarly, 
in the smaller loans provisions in TILA section 129C(b)(2)(D), Congress 
instructed the Bureau to adjust the points and fees cap for qualified 
mortgages ``to permit lenders that extend smaller loans to meet the 
requirements of the presumption of compliance'' in TILA section 
129C(b)(1).\134\ As noted above, the 2008 HOEPA Final Rule also 
contains a rebuttable presumption of compliance with respect to the 
ability-to-repay requirements that currently apply to high-cost and 
higher-priced mortgages.
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    \134\ In prescribing such rules, the Bureau is to consider the 
potential impact of such rules on rural areas and other areas where 
home values are lower. This provision did not appear in earlier 
versions of title XIV of the Dodd-Frank Act, so there is no 
legislative history to explain the use of the word ``presumption'' 
in this context.
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    The legislative history of the Dodd-Frank Act may also favor 
interpreting ``qualified mortgage'' as a rebuttable presumption of 
compliance. As described in a joint comment letter from several 
consumer advocacy groups, a prior version of Dodd-Frank Act title XIV 
from 2007 contemplated a dual track for liability in litigation: a 
rebuttable presumption for creditors and a safe harbor for secondary 
market participants.\135\ That draft legislation would have provided 
that creditors, assignees, and securitizers could presume compliance 
with the ability-to-repay provision if the loan met certain 
requirements.\136\ However, the presumption of compliance would have 
been rebuttable only against the creditor, effectively creating a safe 
harbor for assignees and securitizers.\137\ The caption ``safe harbor 
and rebuttable presumption'' appears to have originated from the 2007 
version of the legislation. The 2009 version of the legislation did not 
contain this dual track approach.\138\ Instead, the language simply 
stated that creditors, assignees, and securitizers ``may presume'' that 
qualified mortgages satisfied ability-to-repay requirements, without 
specifying the nature of the presumption.\139\ The committee report of 
the 2009 bill described the provision as establishing a ``limited safe 
harbor'' for qualified mortgages, while also stating that ``the 
presumption can be rebutted.'' \140\ This suggests that Congress 
contemplated that qualified mortgages would receive a rebuttable 
presumption of compliance with the ability-to-repay provisions, 
notwithstanding Congress's use of the term ``safe harbor'' in the 
heading of section 129C(b) and elsewhere in the statute and legislative 
history.
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    \135\ See Mortgage Reform and Anti-Predatory Lending Act of 
2007, H.R. 3915, 110th Cong. (2007).
    \136\ See H.R. 3915 Sec.  203. Specifically, that prior version 
of title XIV would have created two types of qualified mortgages: 
(1) a ``qualified mortgage,'' which included loans with prime 
interest rates or government insured VA or FHA loans, and (2) a 
``qualified safe harbor mortgage,'' which met underwriting standards 
and loan term restrictions similar to the definition of qualified 
mortgage eventually codified at TILA section 129C(b)(2).
    \137\ Id.
    \138\ See Mortgage Reform and Anti-Predatory Lending Act of 
2009, H.R. 1728.
    \139\ See H.R. 1728 Sec.  203.
    \140\ Mortgage Reform and Anti-Predatory Lending Act of 2009, H. 
Rept. No. 94, 111th Cong., at 48 (2009).
---------------------------------------------------------------------------

    There are also policy reasons that favor interpreting ``qualified 
mortgage'' as a rebuttable presumption of compliance. The ultimate aim 
of the statutory provisions is to assure that, before making a mortgage 
loan, the creditor makes a determination of the consumer's ability to 
repay. No matter how many elements the Bureau might add to the 
definition of qualified mortgage, it still would not be possible to 
define a class of loans which ensured that every consumer within the 
class could necessarily afford a particular loan. In light of this, 
interpreting the statute to provide a safe harbor that precludes a 
consumer from challenging the creditor's determination of repayment 
ability seems to raise

[[Page 6508]]

tensions with the requirement to determine repayment ability. In 
contrast, interpreting a qualified mortgage as providing a rebuttable 
presumption of compliance would better ensure that creditors consider 
each consumer's ability to repay the loan rather than only satisfying 
the qualified mortgage criteria.
The Board's Proposal
    As described above, in light of the statutory ambiguity and 
competing policy considerations, the Board proposed two alternative 
definitions for a qualified mortgage, which generally represent two 
ends of the spectrum of possible definitions. Alternative 1 would have 
applied only the specific requirements listed for qualified mortgages 
in TILA section 129C(b)(2), and would have provided creditors with a 
safe harbor to establish compliance with the general repayment ability 
requirement in proposed Sec.  226.43(c)(1). Alternative 2 would have 
required a qualified mortgage to satisfy the specific requirements 
listed in the TILA section 129C(b)(2), as well as additional 
requirements taken from the general ability-to-repay standard in 
proposed Sec.  226.43(c)(2) through (7). Alternative 2 would have 
provided a rebuttable presumption of compliance with the ability-to-
repay requirements. Although the Board specifically proposed two 
alternative qualified mortgage definitions, it also sought comment on 
other approaches by soliciting comment on other alternative 
definitions. The Board also specifically solicited comment 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 those loans. In particular, the Board sought comment 
on whether the qualified mortgage definition should require 
consideration of a consumer's debt-to-income ratio or residual income, 
including whether and how to include a quantitative standard for the 
debt-to-income ratio or residual income for the qualified mortgage 
definition.
Comments
    Generally, numerous industry and other commenters, including some 
members of Congress, supported a legal safe harbor while consumer 
groups and other commenters, including an association of State bank 
regulators, supported a rebuttable presumption. However, as described 
below, commenters did not necessarily support the two alternative 
proposals specifically as drafted by the Board. For instance, a 
significant number of industry commenters advocated incorporating the 
general ability-to-repay requirements into the qualified mortgage 
definition, while providing a safe harbor for those loans that met the 
enhanced standards. And a coalition of industry and consumer advocates 
presented a proposal to the Bureau that would have provided a tiered 
approach to defining a qualified mortgage. Under the first tier, if the 
consumer's back-end debt-to-income (total debt-to-income) ratio is 43 
percent or less, the loan would be a qualified mortgage, and no other 
tests would be required. Under the second tier, if the consumer's total 
debt-to-income ratio is more than 43 percent, the creditor would apply 
a series of tests related to the consumer's front-end debt-to-income 
ratio (housing debt-to-income), stability of income and past payment 
history, availability of reserves, and residual income to determine if 
a loan is a qualified mortgage.
    Comments in favor of safe harbor. Industry commenters strongly 
supported a legal safe harbor from liability for qualified mortgages. 
These commenters believe that a broad safe harbor with clear, bright 
lines would provide certainty and clarity for creditors and assignees. 
Generally, industry commenters argued that a safe harbor is needed in 
order: (i) To ensure creditors make loans, (ii) to ensure the 
availability of and access to affordable credit without increasing the 
costs of borrowing; (iii) to promote certainty and saleability in the 
secondary market, and (iv) to contain litigation risk and costs for 
creditors and assignees.
    Generally, although acknowledging ambiguities in the statutory 
language, industry commenters argued that the statute's intent and 
legislative history indicate that qualified mortgages are meant to be a 
legal safe harbor, in lieu of the ability-to-repay standards. Industry 
commenters argued that a safe harbor would best ensure safe, well-
documented, and properly underwritten loans without limiting the 
availability of credit or increasing the costs of credit to consumers. 
Many industry commenters asserted that a legal safe harbor from 
liability would ensure access to affordable credit. Other industry 
commenters argued that a safe harbor ultimately benefits consumers with 
increased access to credit, reduced loan fees and interest rates, and 
less-risky loan features. In contrast, various industry commenters 
contended that a rebuttable presumption would not provide enough 
certainty for creditors and the secondary market. Commenters argued 
that if creditors cannot easily ascertain whether a loan satisfies the 
ability-to-repay requirements, creditors will either not make loans or 
will pass the cost of uncertain legal risk to consumers, which in turn 
would increase the cost of borrowing.
    Numerous industry commenters argued for a legal safe harbor because 
of the liabilities of an ability-to-repay violation and the costs 
associated with ability-to-repay litigation. Generally, commenters 
argued that a rebuttable presumption for qualified mortgages would 
invite more extensive litigation than necessary that will result in 
greater costs being borne by all consumers. Commenters emphasized the 
relatively severe penalties for ability-to-repay violations under the 
Dodd-Frank Act, including enhanced damages, an extended three-year 
statute of limitations, a recoupment or set-off provision as a defense 
to foreclosure, and new enforcement authorities by State attorneys 
general. In addition, assignee liabilities are amplified because of the 
recoupment and set-off provision in TILA section 130(k). Commenters 
asserted that the increased costs associated with litigation could make 
compliance too costly for smaller creditors, which would reduce 
competition and credit availability from the market. In particular, 
community bank trade association commenters argued that the Bureau 
should adopt a safe harbor for qualified mortgage loans and include 
bright-line requirements to protect community banks from litigation and 
ease the compliance burden. Ultimately, community bank trade 
association commenters stated that few, if any, banks would risk 
providing a mortgage that only has a rebuttable presumption attached.
    Industry commenters generally believed that a rebuttable 
presumption would increase the incidence of litigation because any 
consumer who defaults on a loan would be likely to sue for recoupment 
in foreclosure. Commenters were also concerned about frivolous 
challenges in court as well as heightened scrutiny by regulators. In 
particular, a credit union association commenter supported a safe 
harbor because of concerns that a rebuttable presumption would cause 
credit unions to be faced with significant amounts of frivolous 
foreclosure defense litigation in the future. In addition to increased 
incidence of litigation, industry commenters and other interested 
parties argued that the estimated costs of litigation under a 
rebuttable presumption would be overly burdensome for creditors and 
assignees. Some commenters and interested parties presented estimates 
of the litigation costs associated with claims alleging a

[[Page 6509]]

violation of the ability-to-repay requirements. For example, one 
industry trade association commenter estimated that the attorney's fees 
for a claim involving a qualified mortgage under a safe harbor would 
cost $30,000, compared to $50,000 for a claim under a rebuttable 
presumption. That commenter provided a separate estimation from a law 
firm that the attorneys' fees to the creditor will be approximately 
$26,000 in cases where the matter is disposed of on a motion to 
dismiss, whereas the fees for the cost of a full trial could reach 
$155,000. That commenter asserted that safe harbor claims are more 
likely to be dismissed on a motion to dismiss than the rebuttable 
presumption.
    An industry commenter and other interested parties argued that the 
estimated costs to creditors associated with litigation and penalties 
for an ability-to-repay violation could be substantial and provided 
illustrations of costs under the proposal, noting potential cost 
estimates of the possible statutory damages and attorney's fees. For 
example, the total estimated costs and damages ranged between 
approximately $70,000 and $110,000 depending on various assumptions, 
such as the interest rate on a loan or whether the presumption of 
compliance is conclusive or rebuttable.
    Industry commenters also generally argued that a safe harbor would 
promote access to credit because creditors would be more willing to 
extend credit where they receive protections under the statutory 
scheme. One industry trade association commenter cited the 2008 HOEPA 
Final Rule, which provided a rebuttable presumption of compliance with 
the requirement to consider a consumer's repayment ability upon meeting 
certain criteria, as causing a significant drop in higher-priced 
mortgage loan originations, and suggested that access to general 
mortgage credit would be similarly restricted if the final rule adopts 
a rebuttable presumption for the market as a whole. A large bank 
commenter similarly noted the lack of lending in the higher-priced 
mortgage space since the 2008 HOEPA Final Rule took effect.
    In addition to the liquidity constraints for non-qualified 
mortgages, commenters argued that the liability and damages from a 
potential ability-to-repay TILA violation would be a disincentive for a 
majority of creditors to make non-qualified mortgage loans. Further, 
some commenters suggested that creditors could face reputational risk 
from making non-qualified mortgage loans because consumers would view 
them as ``inferior'' to qualified mortgages. Other commenters argued 
that reducing the protections afforded to qualified mortgages could 
cause creditors to act more conservatively and restrict credit or 
result in the denial of credit at a higher rate and increase the cost 
of credit. Many commenters argued that the most serious effects and 
impacts on the availability and cost of credit would be for minority, 
low- to moderate-income, and first-time borrowers. Therefore, industry 
commenters believed that a bright-line safe harbor would provide the 
strongest incentive for creditors to provide sustainable mortgage 
credit to the widest array of qualified consumers. Furthermore, one 
industry trade association commenter argued that not providing strong 
incentives for creditors would diminish the possibility of recovery of 
the housing market and the nation's economy.
    Industry commenters also expressed concerns regarding secondary 
market considerations and assignee liability. Commenters urged the 
Bureau to consider commercial litigation costs associated with the 
contractually required repurchase (``put-back'') of loans sold on the 
secondary market where there is litigation over those loans, as well as 
the risk of extended foreclosure timelines because of ongoing ability-
to-repay litigation. Industry commenters asserted that a safe harbor is 
critical to promote saleability of loans in the secondary market. In 
particular, they stated that clarity and certainty provided by a safe 
harbor would promote efficiencies in the secondary market because 
investors in securitized residential mortgage loans (mortgage backed 
securities, or MBS) could be more certain that they are not purchasing 
compliance risk along with their investments. Commenters asserted that 
without a safe harbor, the resulting uncertainty would eliminate the 
efficiencies provided by secondary sale or securitization of loans. By 
extension, commenters claimed that the cost of borrowing for consumers 
would ultimately increase. Large bank commenters stated that although 
they might originate non-qualified mortgage loans, the number would be 
relatively small and held in portfolio because they believe it is 
unlikely that non-qualified mortgage loans will be saleable in the 
secondary market. Generally, industry commenters asserted that 
creditors, regardless of size, would be unwilling to risk exposure 
outside the qualified mortgage space. One large bank commenter stated 
that the 2008 HOEPA Final Rule did not create a defense to foreclosure 
against assignees for the life of the loan, as does the Dodd-Frank 
Act's ability-to-repay provisions. Accordingly, industry commenters 
strongly supported broad coverage of qualified mortgages, as noted 
above.
    Commenters asserted that the secondary market will demand a ``safe 
harbor'' for quality assurance and risk avoidance. If the regulatory 
framework does not provide a safe harbor, commenters asserted that 
investors would require creditors to agree to additional, strict 
representations and warranties when assigning loans. Contracts between 
loan originators and secondary market purchasers often require 
originators to repurchase loans should a loan perform poorly, and these 
commenters expect that future contracts will include provisions related 
to the ability-to-repay rule. Commenters assert that the risks and 
costs associated with additional potential put-backs to the creditor 
would increase liability and risk to creditors, which would ultimately 
increase the cost of credit to consumers. Furthermore, commenters 
contended that if the rule is too onerous in its application to the 
secondary market, then the secondary market participants may purchase 
fewer loans or increase pricing to account for the additional risk, 
such as is now the case for high-cost mortgages.
    Commenters noted that the risks associated with assignee liability 
are heightened by any vagueness in standards in the rule. One secondary 
market purchaser commenter argued that a rebuttable presumption would 
present challenges because purchasers (or assignees) are not part of 
the origination process. It is not feasible for purchasers to evaluate 
all of the considerations that went into an underwriting decision, so 
they must rely on the creditor's representations that the loan was 
originated in compliance with applicable laws and the purchaser's 
requirements. However, assignees may have to defend a creditor's 
underwriting decision at any time during the life of the loan because 
there is no statute of limitations on raising the failure to make an 
ability-to-repay determination as a defense to foreclosure. The 
commenters argued that defending these cases would be difficult and 
costly, and that such burdens would be reduced by safe harbor 
protections.
    Comments in favor of rebuttable presumption of compliance. Consumer 
group commenters generally urged the Bureau to adopt a rebuttable 
presumption for qualified mortgages. Commenters argued that Congress 
intended a rebuttable presumption, not a safe harbor. In particular, 
commenters contended that the Dodd-Frank Act's

[[Page 6510]]

legislative history and statutory text strongly support a rebuttable 
presumption. Commenters noted that the statute is designed to strike a 
fair balance between market incentives and market discipline, as well 
as a balance between consumers' legal rights and excessive exposure to 
litigation risk for creditors. Commenters asserted that the purpose of 
the qualified mortgage designation is to foster sustainable lending 
products and practices built upon sound product design and sensible 
underwriting. To that end, a rebuttable presumption would accomplish 
the goal of encouraging creditors to originate loans that meet the 
qualified mortgage definition while assuring consumers of significantly 
greater protection from abusive or ineffective underwriting than if a 
safe harbor were adopted. Consumer group commenters contended that 
qualified mortgages can earn and deserve the trust of both consumers 
and investors only if they carry the assurance that they are soundly 
designed and properly underwritten. Many consumer group commenters 
asserted that a rebuttable presumption would provide better protections 
for consumers as well as improving safeguards against widespread risky 
lending while helping ensure that there would be no shortcuts on common 
sense underwriting. They argued that a legal safe harbor could invite 
abusive lending because consumers will have no legal recourse. Several 
commenters also asserted that no qualified mortgage definition could 
cover all contingencies in which such abuses could occur.
    Some commenters argued that a legal safe harbor would leave 
consumers unprotected against abuses, such as those associated with 
simultaneous liens or from inadequate consideration of employment and 
income. An association of State bank regulators favored a rebuttable 
presumption because, although a rebuttable presumption provides less 
legal protection than a safe harbor, a rebuttable presumption 
encourages institutions to consider repayment factors that are part of 
a sound underwriting process. That commenter contended that a creditor 
should not be granted blanket protection from a foreclosure defense of 
an ability-to-repay violation if the creditor failed to consider and 
verify such crucial information as a consumer's employment status and 
credit history, for example. On this point, the rebuttable presumption 
proposed by the Board would require creditors 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.
    Consumer group commenters observed that a rebuttable presumption 
would better ensure that creditors actually consider a consumer's 
ability to repay the loan. Consumer group commenters also asserted that 
the goals of safe, sound, sustainable mortgage lending and a balanced 
system of accountability are best served by a rebuttable presumption 
because consumers should be able to put evidence before a court that 
the creditor's consideration and verification of the consumer's ability 
to repay the loan was unreasonable or in bad faith. To that end, a 
rebuttable presumption would allow the consumer to 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. 
Without this accountability, commenters argued that the Dodd-Frank 
Act's effectiveness would be undermined.
    Ultimately, consumer group commenters believed that a rebuttable 
presumption would not exacerbate current issues with credit access and 
availability, but would instead allow room for honest, efficient 
competition and affordable credit. Consumer group commenters generally 
contended that the fear of litigation and estimated costs and risks 
associated with ability-to-repay violations are overstated and based on 
misunderstanding of the extent of exposure to TILA liability. Consumer 
group commenters and some ex parte communications asserted that the 
potential incidence of litigation is relatively small, and therefore 
liability cost and risk are minimal for any given mortgage creditor. 
For example, consumer group commenters asserted that there are 
significant practical limitations to consumers bringing an ability-to-
repay claim, suggesting that few distressed homeowners would be able to 
obtain legal representation often necessary to mount a successful 
rebuttal in litigation. Consumer groups provided percentages of 
borrowers in foreclosure who are represented by lawyers, noting the 
difficulty of bringing a TILA violation claim, and addressed estimates 
of litigation costs, such as attorneys' fees. Consumer groups provided 
estimates of the number of cases in foreclosure and the percentage of 
cases that involve TILA claims, such as a claim of rescission.
    Furthermore, consumer group commenters argued that the three-year 
cap on enhanced damages (equal to the sum if all finance charges and 
fees paid by the consumer within three years of consummation) for 
violation of the ability-to-repay requirements limits litigation risk 
significantly. Commenters contended that, as a general rule, a court is 
more likely to find that the ability-to-repay determination at 
consummation was not reasonable and in good faith the earlier in the 
process a default occurs, and at that point the amount of interest paid 
by a consumer (a component of enhanced damages) will be relatively 
small. Commenters argued that the longer it takes a consumer to 
default, the harder the burden it will be for the consumer to show that 
the default was reasonably predictable at consummation and was caused 
by improper underwriting rather than a subsequent income or expense 
shock; moreover, even if the consumer can surmount that burden, the 
amount of damages is still capped at three years' worth of paid 
interest. In addition, consumer group commenters contended that the 
penalties to which creditors could be subject on a finding of failure 
to meet the ability-to-repay requirements would not be so injurious or 
even so likely to be applied in all but the most egregious situations 
as to impose any meaningful risk upon creditors.
    Moreover, many consumer group commenters observed that creditors 
that comply with the rules and ensure that their loan originators are 
using sound, well documented and verified underwriting will be 
adequately protected by a rebuttable presumption.
Final Rule
    As described above, the presumption afforded to qualified mortgages 
in the final rule balances consumers' ability to invoke the protections 
of the Dodd-Frank Act scheme with the need to create sufficient 
certainty to promote access to credit in all parts of the market. 
Specifically, the final rule provides a safe harbor with the ability-
to-repay requirements for loans that meet the qualified mortgage 
criteria and pose the least risk, while providing a rebuttable 
presumption for ``higher-priced'' mortgage loans, defined as having an 
APR that exceeds APOR by 1.5 percentage points for first liens and 3.5 
percentage points for second liens.\141\ The final rule also 
specifically defines the grounds on which the presumption accorded to 
more expensive qualified mortgages can be rebutted. In issuing this 
final rule, the

[[Page 6511]]

Bureau has drawn on the experiences from the current ability-to-repay 
provisions that apply to higher-priced mortgages, described above. 
Based on the difference in historical performance levels between prime 
and subprime loans, the Bureau believes that this approach will provide 
significant certainty to creditors while preserving consumer remedies 
and creating strong incentives for more responsible lending in the part 
of the market in which the most abuses occurred prior to the financial 
crisis.
---------------------------------------------------------------------------

    \141\ For the reasons discussed above in the section-by-section 
analysis of Sec.  1026.43(b)(4), the Bureau does not adopt a 
separate threshold for jumbo loans in the higher-priced covered 
transaction definition for purposes of Sec.  1026.43(e)(1).
---------------------------------------------------------------------------

    In issuing this final rule, the Bureau carefully considered the 
comments received and the interpretive and policy considerations for 
providing qualified mortgages either a safe harbor or rebuttable 
presumption of compliance with the repayment ability requirements. For 
the reasons set forth by the Board and discussed above, the Bureau 
finds that the statutory language is ambiguous and does not mandate a 
particular approach. In adopting the final rule, the Bureau accordingly 
focused on which interpretation would best promote the various policy 
goals of the statute, taking into account the Bureau's authority, among 
other things, to make adjustments and exceptions necessary or proper to 
effectuate the purposes of TILA, as amended by the Dodd-Frank Act.
    Discouraging unsafe underwriting. As described in part II above, 
the ability-to-repay provisions of the Dodd-Frank Act were codified in 
response to lax lending terms and practices in the mid-2000's, which 
led to increased foreclosures, particularly for subprime borrowers. The 
statutory underwriting requirements for a qualified mortgage--for 
example, the requirement that loans be underwritten on a fully 
amortized basis using the maximum interest rate during the first five 
years and not a teaser rate, and the requirement to consider and verify 
a consumer's income or assets--will help prevent a return to such lax 
lending. So, too, will the requirement that a consumer's debt-to-income 
ratio (including mortgage-related obligations and obligations on 
simultaneous second liens) not exceed 43 percent, as discussed further 
below.
    Notwithstanding these requirements, however, the Bureau recognizes 
that it is not possible to define by a bright-line rule a class of 
mortgages as to which it will always be the case that each individual 
consumer has the ability to repay his or her loan. That is especially 
true with respect to subprime loans. In many cases, the pricing of a 
subprime loan is the result of loan level price adjustments established 
by the secondary market and calibrated to default risk. Furthermore, 
the subprime segment of the market is comprised of borrowers who tend 
to be less sophisticated and who have fewer options available to them, 
and thus are more susceptible to being victimized by predatory lending 
practices. The historical performance of subprime loans bears all this 
out.\142\ The Bureau concludes, therefore, that for subprime loans 
there is reason to impose heightened standards to protect consumers and 
otherwise promote the policies of the statute. Accordingly, the Bureau 
believes that it is important to afford consumers the opportunity to 
rebut the presumption of compliance that applies to qualified mortgages 
with regard to higher-priced mortgages by showing that, in fact, the 
creditor did not have a good faith and reasonable belief in the 
consumer's reasonable ability to repay the loan at the time the loan 
was made.
---------------------------------------------------------------------------

    \142\ For example, data from the MBA delinquency survey show 
that serious delinquency rates for conventional prime mortgages 
averaged roughly 2 percent from 1998 through 2011 and peaked at 7 
percent following the recent housing collapse. In contrast, the 
serious delinquency rates averaged 13 percent over the same period. 
In late 2009, it peaked at over 30 percent.'' Mortgage Bankers 
Association, National Delinquency Survey. For a discussion of the 
historical performance of subprime loans, see 2008 HOEPA Final Rule, 
73 FR 44522, 44524-26 (July 30, 2008).
---------------------------------------------------------------------------

    These same considerations lead to the opposite result with respect 
to prime loans which satisfy the requirements for a qualified mortgage. 
The fact that a consumer receives a prime rate is itself indicative of 
the absence of any indicia that would warrant a loan level price 
adjustment, and thus is suggestive of the consumer's ability to repay. 
Historically, prime rate loans have performed significantly better than 
subprime rate loans and the prime segment of the market has been 
subject to fewer abuses.\143\ Moreover, requiring creditors to prove 
that they have satisfied the qualified mortgage requirements in order 
to invoke the presumption of compliance will itself ensure that the 
loans in question do not contain certain risky features and are 
underwritten with careful attention to consumers' debt-to-income 
ratios. Accordingly, the Bureau believes that where a loan is not a 
higher-priced covered transaction and meets both the product and 
underwriting requirements for a qualified mortgage, there are 
sufficient grounds for concluding that the creditor had a reasonable 
and good faith belief in the consumer's ability to repay to warrant a 
safe harbor.
---------------------------------------------------------------------------

    \143\ See id.
---------------------------------------------------------------------------

    This approach carefully balances the likelihood of consumers 
needing redress with the potential benefits to both consumers and 
industry of reducing uncertainty concerning the new regime. To the 
extent that the rule reduces litigation risk concerns for prime 
qualified mortgages, consumers in the prime market may benefit from 
enhanced competition (although, as discussed below, the Bureau believes 
litigation costs will be small and manageable for almost all 
creditors). In particular, the Bureau believes that larger creditors 
may expand correspondent lending relationships with smaller banks with 
respect to prime qualified mortgages. Larger creditors may also relax 
currently restrictive credit overlays (creditor-created underwriting 
requirements that go beyond GSE or agency guidelines), thereby 
increasing access to credit.
    Scope of rebuttable presumption. In light of the heightened 
protections for subprime loans, the final rule also carefully defines 
the grounds on which the presumption that applies to higher-priced 
qualified mortgages can be rebutted. The Bureau believes that this 
feature is critical to ensuring that creditors have sufficient 
incentives to provide higher-priced qualified mortgages to consumers. 
Given the historical record of abuses in the subprime market, the 
Bureau believes it is particularly important to ensure that consumers 
are able to access qualified mortgages in light of their product 
feature restrictions and other protections.
    Specifically, the final rule defines the standard by which a 
consumer may rebut the presumption of compliance afforded to higher-
priced qualified mortgages, and provides an example of how a consumer 
may rebut the presumption. As described below, the final rule provides 
that consumers may rebut the presumption with regard to a higher-priced 
covered transaction by showing that, at the time the loan was 
originated, the consumer's income and debt obligations left 
insufficient residual income or assets to meet living expenses. The 
analysis would consider the consumer's monthly payments on the loan, 
mortgage-related obligations, and any simultaneous loans of which the 
creditor was aware, as well as any recurring, material living expenses 
of which the creditor was aware.
    The Bureau believes the rebuttal standard in the final rule 
appropriately balances the consumer protection and access to credit 
considerations described above. This standard is consistent with the 
standard in the 2008 HOEPA Final Rule, and is specified as the 
exclusive means of rebutting the presumption. Commentary to the

[[Page 6512]]

existing rule provides as an example of how its presumption may be 
rebutted that the consumer could show ``a very high debt-to-income 
ratio and a very limited residual income.'' Under the definition of 
qualified mortgage that the Bureau is adopting, however, the creditor 
generally is not entitled to a presumption if the debt-to-income ratio 
is ``very high.'' As a result, the Bureau is focusing the standard for 
rebutting the presumption in the final rule on whether, despite meeting 
a debt-to-income test, the consumer nonetheless had insufficient 
residual income to cover the consumer's living expenses. The Bureau 
believes this standard is sufficiently broad to provide consumers a 
reasonable opportunity to demonstrate that the creditor did not have a 
good faith and reasonable belief in the consumer's repayment ability, 
despite meeting the prerequisites of a qualified mortgage. At the same 
time, the Bureau believes the rebuttal standard in the final rule is 
sufficiently clear to provide certainty to creditors, investors, and 
regulators about the standards by which the presumption can 
successfully be challenged in cases where creditors have correctly 
followed the qualified mortgage requirements.
    Several commenters raised concerns about the use of oral evidence 
to impeach the information contained in the loan file. For example, a 
consumer may seek to show that a loan does not meet the requirements of 
a qualified mortgage by relying on information provided orally to the 
creditor or loan originator to establish that the debt-to-income ratio 
was miscalculated. Alternatively, a consumer may seek to show that the 
creditor should have known, based upon facts disclosed orally to the 
creditor or loan originator, that the consumer had insufficient 
residual income to be able to afford the mortgage. The final rule does 
not preclude the use of such oral evidence in ability-to-repay cases. 
The Bureau believes that courts will determine the weight to be given 
to such evidence on a case-by-case basis. To exclude such evidence 
across the board would invite abuses in which consumers could be misled 
or coerced by an unscrupulous loan originator into keeping certain 
facts out of the written record.
    Litigation risks and access to credit. In light of the continuing 
and widespread concern about litigation risk under the Dodd-Frank Act 
regime, the Bureau, in the course of developing the framework described 
above, carefully analyzed the impacts of potential litigation on non-
qualified mortgages, any qualified mortgages with a rebuttable 
presumption, and any qualified mortgages with a safe harbor. The Bureau 
also considered secondary market dynamics, including the potential 
impacts on creditors from loans that the secondary market ``puts back'' 
on the originators because of ability-to-repay litigation. The Bureau's 
analysis is described in detail in the section 1022(b)(2) analysis 
under part VII; the results of that analysis helped to shape the 
calibrated approach that the Bureau is adopting in the final rule and 
suggest that the mortgage market will be able to absorb litigation 
risks under the rule without jeopardizing access to credit.
    Specifically, as discussed in the section 1022(b)(2) analysis under 
part VII, the Bureau believes that even without the benefit of any 
presumption of compliance, the actual increase in costs from the 
litigation risk associated with ability-to-pay requirements would be 
quite modest. This is a function of the relatively small number of 
potential claims, the relatively small size of those claims, and the 
relatively low likelihood of claims being filed and successfully 
prosecuted. The Bureau notes that litigation likely would arise only 
when a consumer in fact was unable to repay the loan (i.e. was 
seriously delinquent or had defaulted), and even then only if the 
consumer elects to assert a claim and is able to secure a lawyer to 
provide representation; the consumer can prevail only upon proving that 
the creditor lacked a reasonable and good faith belief in the 
consumer's ability to repay at consummation or failed to consider the 
statutory factors in arriving at that belief.
    The rebuttable presumption of compliance being afforded to 
qualified mortgages that are higher-priced reduces the litigation risk, 
and hence the potential transaction costs, still further. As described 
above, the Bureau has crafted the presumption of compliance being 
afforded to subprime loans so that it is not materially different than 
the presumption that exists today under the 2008 HOEPA Final Rule. 
Indeed, the Bureau is defining with more particularity the requirements 
for rebutting this presumption. No evidence has been presented to the 
Bureau to suggest that the presumption under the 2008 HOEPA Final Rule 
has led to significant litigation or to any distortions in the market 
for higher-priced mortgages. As noted above, commenters noted the lack 
of lending in the higher-priced mortgage space since the 2008 HOEPA 
Final Rule took effect, but the Bureau is unaware of evidence 
suggesting the low lending levels are the result of the Board's rule, 
as compared to the general state of the economy, uncertainty over 
multiple regulatory and capital initiatives, and other factors.
    Relative to the Dodd-Frank Act, the Bureau notes that the existing 
regime already provides for attorneys' fees and the same remedies 
against creditors in affirmative cases, and actually provides for 
greater remedies against creditors in foreclosure defense situations. 
Nevertheless, the incidence of claims under the existing ability-to-
repay rules for high-cost and higher-priced loans and analogous State 
laws is relatively low. The Bureau's analysis shows that cost estimates 
remain modest for both loans that are not qualified mortgages and loans 
that are qualified mortgages with a rebuttable presumption of 
compliance, and even more so for qualified mortgages with a safe 
harbor.
    The Bureau recognizes, of course, that under the Dodd-Frank Act 
ability-to-repay provisions, a consumer can assert a claim against an 
assignee as a ``defense by recoupment or set off'' in a foreclosure 
action. There is no time limit on the use of this defense, but the 
consumer cannot recover as special statutory damages more than three 
years of finance charges and fees. To the extent this leads to 
increased litigation potential with respect to qualified mortgages as 
to which the presumption of compliance is rebuttable, this may cause 
creditors to take greater care when underwriting these riskier products 
to avoid potential put-back risk from investors. The Bureau believes 
that this is precisely what Congress intended--to create incentives for 
creditors to engage in sound underwriting and for secondary market 
investors to monitor the quality of the loans they buy--and that these 
incentives are particularly warranted with respect to the subprime 
market.
    At the same time, the Bureau does not believe that the potential 
assignee liability with respect to higher-priced qualified mortgages 
will preclude such loans from being sold on the secondary market. 
Specifically, in analyzing impacts on the secondary market the Bureau 
notes that investors are purchasing higher-priced mortgage loans that 
are subject to the existing ability-to-repay requirements and 
presumption of compliance and that the GSEs have already incorporated 
into their contracts with creditors a representation and warranty 
designed to provide investor protection in the event of an ability-to-
repay violation. The Bureau agrees with industry and secondary market 
participant commenters that investors will likely require creditors to 
agree to similar representations and warranties when assigning or 
selling loans under the new

[[Page 6513]]

rule because secondary market participants will not want to be held 
accountable for ability-to-repay compliance which investors will view 
as the responsibility of the creditor. For prime loans, this may 
represent an incremental risk of put-back to creditors, given that such 
loans are not subject to the current regime, but those loans are being 
provided a safe harbor if they are qualified mortgages. For subprime 
(higher risk) loans it is not clear that there is any incremental risk 
beyond that which exists today under the Board's rule. There are also 
some administrative costs associated with such ``put-backs'' (e.g., 
costs associated with the process of putting back loans from the issuer 
or insurer or servicer on behalf of the securitization trust to the 
creditor as a result of the ability-to-repay claims), but those costs 
are unlikely to be material for qualified mortgages subject to the 
rebuttable presumption and will not affect either the pricing of the 
loans or the availability of a secondary market for these loans.
    In sum, the Bureau has crafted the calibrated presumptions to 
ensure that these litigation and secondary market impacts do not 
jeopardize access to credit. With regard to subprime loans, there is 
some possibility that creditors who are less sophisticated or less able 
to bear any litigation risk may elect to refrain from engaging in 
subprime lending, but as discussed below, the Bureau believes that 
there are sufficient creditors with the capabilities of making 
responsible subprime loans so as to avoid significant adverse impact on 
credit availability in that market.
    Specific provisions. For the reasons discussed above, in Sec.  
1026.43(e)(1), the Bureau is providing a safe harbor and rebuttable 
presumption with the ability-to-repay requirements for loans that meet 
the definition of a qualified mortgage. As explained in comment 
43(e)(1)-1, Sec.  1026.43(c) requires a creditor to make a reasonable 
and good faith determination at or before consummation that a consumer 
will be able to repay a covered transaction. Section 1026.43(e)(1)(i) 
and (ii) provide a safe harbor and rebuttable presumption of 
compliance, respectively, with the repayment ability requirements of 
Sec.  1026.43(c) for creditors and assignees of covered transactions 
that satisfy the requirements of a qualified mortgage under Sec.  
1026.43(e)(2), (e)(4), or (f).
    Section 1026.43(e)(1)(i) provides a safe harbor for qualified 
mortgages that are not higher-priced covered transactions, by stating 
that a creditor or assignee of a qualified mortgage as defined in Sec.  
1026.43(e)(2), (e)(4), or (f) that is not a higher-priced covered 
transaction, as defined in Sec.  1026.43(b)(4), complies with the 
repayment ability requirements of Sec.  1026.43(c). Comment 
43(e)(1)(i)-1 clarifies that, to qualify for the safe harbor in Sec.  
1026.43(e)(1)(i), a covered transaction must meet the requirements of a 
qualified mortgage in Sec.  1026.43(e)(2), (e)(4), or (f) and must not 
be a higher-priced covered transaction, as defined in Sec.  
1026.43(b)(4).
    For qualified mortgages that are higher-priced covered 
transactions, Sec.  1026.43(e)(1)(ii)(A) provides a rebuttable 
presumption of compliance with the repayment ability requirements. That 
section provides that a creditor or assignee of a qualified mortgage as 
defined in Sec.  1026.43(e)(2), (e)(4), or (f) that is a higher-priced 
covered transaction, as defined Sec.  1026.43(b)(4), is presumed to 
comply with the repayment ability requirements of Sec.  1026.43(c). 
Section 1026.43(e)(1)(ii)(B) provides that to rebut the presumption of 
compliance, it must be proven that, despite meeting the requirements of 
Sec.  1026.43(e)(2), (e)(4), or (f), the creditor did not make a 
reasonable and good faith determination of the consumer's repayment 
ability at the time of consummation, by showing that the consumer's 
income, debt obligations, alimony, child support, and the consumer's 
monthly payment (including mortgage-related obligations) on the covered 
transaction and on any simultaneous loans of which the creditor was 
aware at consummation would leave the consumer with insufficient 
residual income or assets other than the value of the dwelling 
(including any real property attached to the dwelling) that secures the 
loan with which to meet living expenses, including any recurring and 
material non-debt obligations of which the creditor was aware at the 
time of consummation.
    Comment 43(e)(1)(ii)-1 clarifies that a creditor or assignee of a 
qualified mortgage under Sec.  1026.43(e)(2), (e)(4), or (f) that is a 
higher-priced covered transaction is presumed to comply with the 
repayment ability requirements of Sec.  1026.43(c). To rebut the 
presumption, it must be proven that, despite meeting the standards for 
a qualified mortgage (including either the debt-to-income standard in 
Sec.  1026.43(e)(2)(vi) or the standards of one of the entities 
specified in Sec.  1026.43(e)(4)(ii)), the creditor did not have a 
reasonable and good faith belief in the consumer's repayment ability. 
To rebut the presumption, it must be proven that, despite meeting the 
standards for a qualified mortgage (including either the debt-to-income 
standard in Sec.  1026.43(e)(2)(vi) or the standards of one of the 
entities specified in Sec.  1026.43(e)(4)(ii)), the creditor did not 
have a reasonable and good faith belief in the consumer's repayment 
ability. Specifically, it must be proven that, at the time of 
consummation, based on the information available to the creditor, the 
consumer's income, debt obligations, alimony, child support, and the 
consumer's monthly payment (including mortgage-related obligations) on 
the covered transaction and on any simultaneous loans of which the 
creditor was aware at consummation would leave the consumer with 
insufficient residual income or assets other than the value of the 
dwelling (including any real property attached to the dwelling) that 
secures the loan with which to meet living expenses, including any 
recurring and material non-debt obligations of which the creditor was 
aware at the time of consummation, and that the creditor thereby did 
not make a reasonable and good faith determination of the consumer's 
repayment ability. The comment also provides, by way of example, that a 
consumer may rebut the presumption with evidence demonstrating that the 
consumer's residual income was insufficient to meet living expenses, 
such as food, clothing, gasoline, and health care, including the 
payment of recurring medical expenses of which the creditor was aware 
at the time of consummation, and after taking into account the 
consumer's assets other than the value of the dwelling securing the 
loan, such as a savings account. In addition, the longer the period of 
time that the consumer has demonstrated actual ability to repay the 
loan by making timely payments, without modification or accommodation, 
after consummation or, for an adjustable-rate mortgage, after recast, 
the less likely the consumer will be able to rebut the presumption 
based on insufficient residual income and prove that, at the time the 
loan was made, the creditor failed to make a reasonable and good faith 
determination that the consumer had the reasonable ability to repay the 
loan.
    As noted above, the Bureau believes that the statutory language 
regarding whether qualified mortgages receive either a safe harbor or 
rebuttable presumption of compliance is ambiguous, and does not plainly 
mandate one approach over the other. Furthermore, the Bureau has the 
authority to tailor the strength of the

[[Page 6514]]

presumption of compliance based on the characteristics associated with 
the different types of qualified mortgages. Accordingly, the Bureau 
interprets TILA section 129C(b)(1) to create a rebuttable presumption, 
but exercises its adjustment authority under TILA section 105(a) to 
limit the ability to rebut the presumption in two ways, because an 
open-ended rebuttable presumption would unduly restrict access to 
credit without a corresponding benefit to consumers.
    First, the Bureau uses its adjustment authority under section 
105(a) to limit the ability to rebut the presumption to insufficient 
residual income or assets other than the dwelling that secures the 
transaction because the Bureau believes exercise of this authority is 
necessary and proper to facilitate compliance with and to effectuate a 
purpose of section 129 and TILA. The Bureau believes this approach, 
while preserving consumer remedies, provides clear standards to 
creditors and courts regarding the basis upon which the presumption of 
compliance that applies to higher-priced covered transactions may be 
rebutted, thereby enhancing creditor certainty and encouraging lending 
in the higher-priced mortgage market. The Bureau finds this approach is 
necessary and proper to ensure that consumers are offered and receive 
residential mortgage loans on terms that reasonably reflect their 
ability to repay the loans, a purpose of section 129 and TILA.
    Second, with respect to prime loans (loans with an APR that does 
not exceed APOR by 1.5 percentage points for first liens and 3.5 
percentage points for second liens), the Bureau also uses its 
adjustment authority under TILA section 105(a) to provide a conclusive 
presumption (e.g., a safe harbor). Under the conclusive presumption, if 
a prime loan satisfies the criteria for being a qualified mortgage, the 
loan will be deemed to satisfy section 129C's ability-to-repay criteria 
and will not be subject to rebuttal based on residual income or 
otherwise. The Bureau finds that this approach balances the competing 
consumer protection and access to credit considerations described 
above. As discussed above, the Bureau will not extend the safe harbor 
to higher-priced loans because that approach would provide insufficient 
protection to consumers in loans with higher interest rates who may 
require greater protection than consumers in prime rate loans. On the 
other hand, an approach that provided a rebuttable presumption of 
compliance for all qualified mortgages (including prime loans which 
historically have a low default rate) could lead creditors to make 
fewer mortgage loans to certain consumers, which could restrict access 
to credit (or unduly raise the cost of credit) without a corresponding 
benefit to consumers. The Bureau finds that this adjustment providing a 
safe harbor for prime loans is necessary and proper to facilitate 
compliance with and to effectuate the purposes of section 129C and 
TILA, including to assure that consumers are offered and receive 
residential mortgage loans on terms that reasonably reflect their 
ability to repay the loans.\144\
---------------------------------------------------------------------------

    \144\ These adjustments are consistent with the Bureau's 
authority under TILA section 129C(b)(3)(B)(i) to 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 this section, necessary and appropriate to 
effectuate the purposes of TILA section 129B and section 129C, to 
prevent circumvention or evasion thereof, or to facilitate 
compliance with such sections.
---------------------------------------------------------------------------

43(e)(2) Qualified Mortgage Defined--General
    As discussed above, TILA section 129C(b)(2) defines the 
requirements for qualified mortgages to limit certain loan terms and 
features. The statute generally prohibits a qualified mortgage from 
permitting an increase of the principal balance on the loan (negative 
amortization), interest-only payments, balloon payments (except for 
certain balloon-payment qualified mortgages pursuant to TILA section 
129C(b)(2)(E)), a term greater than 30 years, or points and fees that 
exceed a specified threshold.
    In addition, the statute incorporates limited underwriting criteria 
that overlap with some elements of the general ability-to-repay 
standard. Specifically, the statutory definition of qualified mortgage 
requires the creditor to (1) verify and document the income and 
financial resources relied upon to qualify the obligors on the loan; 
and (2) underwrite the loan based on a fully amortizing payment 
schedule and the maximum interest rate during the first five years, 
taking into account all applicable taxes, insurance, and assessments. 
As noted above, these requirements appear to be focused primarily on 
ensuring that certain mortgage products--no-documentation loans and 
loans underwritten based only on a consumer's ability to make payments 
during short introductory periods with low ``teaser'' interest rates--
are not eligible to be qualified mortgages.
    In addition to these limited underwriting criteria, the statute 
also authorizes the Bureau to establish additional criteria 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 consumer and other factors 
the Bureau determines relevant and consistent with the purposes 
described in TILA section 129C(b)(3)(B)(i). To the extent the Bureau 
incorporates a debt-to-income or residual income requirement into the 
qualified mortgage definition, several additional elements of the 
general ability-to-repay standard would effectively also be 
incorporated into the qualified mortgage definition, since debt-to-
income and residual income analyses by their nature require assessment 
of income, debt (including simultaneous loans), and mortgage-related 
obligations. As discussed above, the Board proposed two alternatives to 
implement the qualified mortgage elements. Both alternatives under the 
Board's proposal would have incorporated the statutory elements of a 
qualified mortgage (e.g., product feature and loan term restrictions, 
limits on points and fees, payment calculation requirements, and the 
requirement to consider and verify the consumer's income or assets). 
However, Alternative 2 also included the additional factors in the 
general ability-to-repay standard.
Comments
    Qualified mortgage definition. As an initial matter, the majority 
of commenters generally favored defining qualified mortgages to reach a 
broad portion of the overall market and to provide clarity with regard 
to the required elements. Commenters agreed that clarity promotes the 
benefits of creditors lending with confidence and consumers receiving 
loans that comply with the basic requirements of an affordable loan. In 
addition, commenters generally agreed that a qualified mortgage should 
be broad, encompassing the vast majority of the existing mortgage 
market. Numerous commenters indicated that creditors believed that the 
difference between the legal protections afforded (or risks associated 
with) qualified mortgages and non-qualified mortgages would result in 
very little lending outside of qualified mortgages. Commenters asserted 
that a narrowly defined qualified mortgage would leave loans outside 
the legal protections of qualified mortgages and would result in 
constrained credit or increased cost of credit.
    As discussed in the section-by-section analysis of Sec.  
1026.43(e)(1), commenters did not necessarily support the two

[[Page 6515]]

alternatives specifically as proposed by the Board, but suggested 
variations on the definition of qualified mortgage that contain some or 
all of the Board's proposed criteria, or additional criteria not 
specifically included in either of the Board's proposed alternatives. 
For example, as described below, a coalition of industry and consumer 
advocates suggested a tiered approach to defining qualified mortgage, 
based primarily on meeting a specific back-end debt-to-income 
requirement, with alternative means of satisfying the qualified 
mortgage definition (such as housing debt-to-income, reserves, and 
residual income) if the back-end debt-to-income test is not satisfied. 
Similarly, one industry commenter suggested using a weighted approach 
to defining qualified mortgage, which would weight some underwriting 
factors more heavily than others and permit a significant factor in one 
area to compensate for a weak or missing factor in another area.
    Consumer group commenters and some industry commenters generally 
supported excluding from the definition of qualified mortgage certain 
risky loan features which result in ``payment shock,'' such as negative 
amortization or interest-only features. Consumer group commenters also 
supported limiting qualified mortgages to a 30-year term, as required 
by statute. Consumer group commenters and one industry trade 
association strongly supported requiring creditors to consider and 
verify the all the ability-to-repay requirements. These commenters 
contended that the ability-to-repay requirements represent prudent 
mortgage underwriting techniques and are essential to sustainable 
lending. To that point, these commenters argued that qualified mortgage 
loans should represent the best underwritten and most fully documented 
loans, which would justify some form of protection from future 
liability. In addition, several consumer group commenters suggested 
adding a further requirement that when assessing the consumer's income 
and determining whether the consumer will be able to meet the monthly 
payments, a creditor must also take into account other recurring but 
non-debt related expenses. These commenters argued that many consumers, 
and especially low- and moderate-income consumers, face significant 
monthly recurring expenses, such as medical care or prescriptions and 
child care expense needed to enable the borrower or co-borrower to work 
outside the home. These commenters further argued that even where the 
percentage of disposable income in such situations seems reasonable, 
the nominal amounts left to low- and moderate-income consumers may be 
insufficient to enable such households to reasonably meet all their 
obligations. While one consumer group commenter specifically supported 
the inclusion of a consumer's credit history as an appropriate factor 
for a creditor to consider and verify when underwriting a loan, several 
commenters argued that the consumer's credit history should be not 
included in the ability-to-repay requirements because, although credit 
history may be relevant in prudent underwriting, it involves a 
multitude of factors that need to be taken into consideration. In 
addition, one association of State bank regulators also favored 
consideration of the repayment factors that are part of a sound 
underwriting process.
    As noted above, some industry commenters also generally supported 
including the underwriting requirements as proposed in Alternative 2, 
with some adjustments, so long as the resulting qualified mortgage was 
entitled to a safe harbor. These commenters stated that most creditors 
today are already complying with the full ability-to-repay underwriting 
standards, and strong standards will help them resist competitive 
forces to lower underwriting standards in the future. Other industry 
commenters argued that the qualified mortgage criteria should not 
exclude specific loan products because the result will be that such 
products will be unavailable in the market.
    Some commenters generally supported aligning the definition of 
qualified mortgage with the definition proposed by several Federal 
agencies to define ``qualified residential mortgages'' (QRM) for 
purposes of the risk retention requirements in title IX of the Dodd-
Frank Act. For example, one commenter suggested that the required 
payment calculation for qualified mortgages be consistent with the QRM 
proposed requirement that the payment calculation be based on the 
maximum rate in the first five years after the first full payment 
required. An association of reverse mortgage lenders requested that a 
``qualified'' reverse mortgage be defined to ensure that the Federal 
agencies finalizing the QRM rule are able to make a proprietary reverse 
mortgage a QRM, which would be exempt from the risk retention 
requirements. Lastly, numerous consumer group commenters argued that 
high-cost mortgages be excluded from being a qualified mortgage.
    Quantitative standards. Some industry commenters supported 
including quantitative standards for such variables as debt-to-income 
ratios and credit score with compensating factors in the qualified 
mortgage definition. These commenters contended that quantitative 
standards provide certainty and would help ensure creditworthy 
consumers have access to qualified mortgage loans. One consumer group 
commenter argued that, without specific quantitative standards, bank 
examiners and assignees would have no benchmarks against which to 
measure a creditor's compliance or safety and soundness. One industry 
commenter favored quantitative standards such as a maximum back-end 
debt-to-income ratio because that would provide sufficient certainty to 
creditors and investors. One consumer group commenter supported 
including quantitative standards for the debt-to-income ratio because, 
without this, every loan would be open to debate as to whether the 
consumer had the ability to repay at the time of loan consummation.
    As described further below, certain commenters and interested 
parties requested that the Bureau adopt a specific debt-to-income ratio 
requirement for qualified mortgages. For example, some suggested that 
if a consumer's total debt-to-income ratio is below a specified 
threshold, the mortgage loan should satisfy the qualified mortgage 
requirements, assuming other relevant conditions are met. In addition 
to a debt-to-income requirement, some commenters and interested parties 
suggested that the Bureau should include within the definition of a 
``qualified mortgage'' loans with a debt-to-income ratio above a 
certain threshold if the consumer has a certain amount of assets, such 
as money in a savings or similar account, or a certain amount of 
residual income.
    Some industry commenters advocated against including quantitative 
standards for such variables as debt-to-income ratios and residual 
income. Those commenters argued that underwriting a loan involves 
weighing a variety of factors, and creditors and investors should be 
allowed to exercise discretion and weigh risks for each individual 
loan. To that point, one industry trade group commenter argued that 
community banks, for example, generally have conservative requirements 
for a consumer's debt-to-income ratio, especially for loans that are 
held in portfolio by the bank, and consider many factors when 
underwriting mortgage loans, such as payment history, liquid reserves, 
and other assets. Because several factors are considered and evaluated 
in the underwriting process, this commenter asserted that community 
banks can be

[[Page 6516]]

flexible when underwriting mortgage loans and provide arrangements for 
certain consumers that fall outside of the normal debt-to-income ratio 
for a certain loan. This commenter contended that strict quantitative 
standards would inhibit community banks' relationship lending and 
ability to use their sound judgment in the lending process. Some 
commenters contended that requiring specific quantitative standards 
could restrict credit access and availability for consumers.
    Generally, industry commenters and some consumer group commenters 
believed compensating factors are beneficial in underwriting and should 
be permitted. These commenters generally believe compensating factors 
should be incorporated into the qualified mortgage criteria, such as in 
circumstances when a specified debt-to-income ratio threshold was 
exceeded. In their view, lending is an individualized decision and 
compensating factors can, for example, mitigate a consumer's high debt-
to-income ratio or low residual income. One industry trade group 
commenter argued that the inclusion of compensating factors would allow 
for a broader underwriting approach and should include family history, 
repayment history, potential income growth, and inter-family 
transactions. One association of State bank regulators suggested that 
the rule provide guidance on mitigating factors for creditors to 
consider when operating outside of standard parameters. For example, 
creditors lending outside of typical debt-to-income standards can rely 
upon other assets or the fact that a consumer has a high income. Other 
industry commenters argued that the rule should provide for enough 
flexibility to allow for common-sense underwriting and avoid rigid 
limits or formulas that would exclude consumers on the basis of one or 
a few underwriting factors.
    Another commenter stated that the rule should not set thresholds or 
limits on repayment ability factors. Instead, the rule should allow the 
creditor to consider the required factors and be held to a good faith 
standard. Such a rule permits individualized determinations to be made 
based on each consumer, local markets, and the risk tolerance of each 
creditor.
Final Rule
    Section 1026.43(e)(2) of the final rule contains the general 
qualified mortgage definition. As set forth below, the final rule 
defines qualified mortgages under Sec.  1026.43(e)(2) as loans that 
satisfy all of the qualified mortgage criteria required by the statute 
(including underwriting to the maximum interest rate during the first 
five years of the loan and consideration and verification of the 
consumer's income or assets), for which the creditor considers and 
verifies the consumer's current debt obligations, alimony, and child 
support, and that have a total (``back-end'') monthly debt-to-income 
ratio of no greater than 43 percent, following the standards for 
``debt'' and ``income'' set forth in appendix Q.
    While the general definition of qualified mortgage in Sec.  
1026.43(e)(2) contains all of the statutory qualified mortgage 
elements, it does not separately incorporate all of the general 
ability-to-repay underwriting requirements that would have been part of 
the qualified mortgage definition under the Board's proposed 
Alternative 2. In particular, the definition of qualified mortgage in 
Sec.  1026.43(e)(2) does not specifically require consideration of the 
consumer's employment status, monthly payment on the covered 
transaction (other than the requirement to underwrite the loan to the 
maximum rate in the first five years), monthly payment on any 
simultaneous loans, or the consumer's credit history, which are part of 
the general ability-to-repay analysis under Sec.  1026.43(c)(2). 
Instead, most of these requirements are incorporated into the standards 
for determining ``debt'' and ``income'' pursuant to Sec.  
1026.43(e)(2)(vi)(A) and (B), to which the creditor must look to 
determine if the loan meets the 43 percent debt-to-income ratio 
threshold as required in Sec.  1026.43(e)(2)(vi). In particular, that 
calculation will require the creditor to verify, among other things, 
the consumer's employment status (to determine current or expected 
income) and the monthly payment on the covered transaction (including 
mortgage-related obligations) and on any simultaneous loans that the 
creditor knows or has reason to know will be made. In addition, 
although consideration and verification of a consumer's credit history 
is not specifically incorporated into the qualified mortgage 
definition, creditors must verify a consumer's debt obligations using 
reasonably reliable third-party records, which may include use of a 
credit report or records that evidence nontraditional credit 
references. See section-by-section analysis of Sec.  1026.43(e)(2)(v) 
and (c)(3).
    The final rule adopts this approach because the Bureau believes 
that the statute is fundamentally about assuring that the mortgage 
credit consumers receive is affordable. Qualified mortgages are 
intended to be mortgages as to which it can be presumed that the 
creditor made a reasonable determination of the consumer's ability to 
repay. Such a presumption would not be reasonable--indeed would be 
imprudent--if a creditor made a mortgage loan without considering and 
verifying core aspects of the consumer's individual financial picture, 
such as income or assets and debt. Incorporating these ability-to-repay 
underwriting requirements into the qualified mortgage definition thus 
ensures that creditors assess the consumer's repayment ability for a 
qualified mortgage using robust and appropriate underwriting 
procedures. The specific requirements for a qualified mortgage under 
Sec.  1026.43(e)(2) are described below.
    The Bureau notes that the final rule does not define a 
``qualified'' reverse mortgage. As described above, TILA section 
129C(a)(8) excludes reverse mortgages from the repayment ability 
requirements. See section-by-section analysis of Sec.  
1026.43(a)(3)(i). However, TILA section 129C(b)(2)(ix) provides that 
the term ``qualified mortgage'' may include a ``residential mortgage 
loan'' that is ``a reverse mortgage which meets the standards for a 
qualified mortgage, as set by the Bureau in rules that are consistent 
with the purposes of this subsection.'' The Board's proposal did not 
include reverse mortgages in the definition of a ``qualified 
mortgage.'' Because reverse mortgages are exempt from the ability-to-
repay requirements, the effects of defining a reverse mortgage as a 
``qualified mortgage'' would be, for example, to allow for certain 
otherwise banned prepayment penalties and permit reverse mortgages to 
be QRMs under the Dodd-Frank Act's risk retention rules. The Bureau 
believes that the first effect is contrary to the purposes of the 
statute. With respect to the QRM rulemaking, the Bureau will continue 
to coordinate with the Federal agencies finalizing the QRM rulemaking 
to determine the appropriate treatment of reverse mortgages.
43(e)(2)(i)
    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 made by creditors operating 
predominantly in rural or underserved areas, discussed below in the 
section-by-section analysis of Sec.  1026.43(f)). TILA section 
129C(b)(2)(A)(ii) states that the terms of a qualified mortgage may not 
include a balloon payment (subject to an exception for creditors 
operating

[[Page 6517]]

predominantly in rural or underserved areas). The statute defines 
``balloon payment'' as ``a scheduled payment that is more than twice as 
large as the average of earlier scheduled payments.'' TILA section 
129C(b)(2)(A)(ii).
    The Board's proposed Sec.  226.43(e)(2)(i) would have implemented 
TILA sections 129C(b)(2)(A)(i) and (ii). First, the proposed provision 
would have required that a qualified mortgage provide for regular 
periodic payments. Second, proposed Sec.  226.43(e)(2)(i) would have 
provided 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 proposed Sec.  226.43(f); 
or (3) result in a balloon payment, as defined in proposed Sec.  
226.18(s)(5)(i), except as provided in proposed Sec.  226.43(f).
    Proposed comment 43(e)(2)(i)-1 would have explained that, as a 
consequence of the foregoing requirements, 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 would have also provided that, 
because proposed Sec.  226.43(e)(2)(i) would have required that a 
qualified mortgage provide for regular, periodic payments, a single-
payment transaction may not be a qualified mortgage. This comment would 
have clarified a potential evasion of the regulation, as a creditor 
otherwise could structure a transaction with a single payment due at 
maturity that technically would not be a balloon payment as defined in 
proposed 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 would have provided 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 would have clarified 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 Dodd-Frank Act defines ``balloon payment'' as 
``a scheduled payment that is more than twice as large as the average 
of earlier scheduled payments.'' However, proposed Sec.  
226.43(e)(2)(i)(C) would have cross-referenced Regulation Z's existing 
definition of ``balloon payment'' in Sec.  226.18(s)(5)(i), which 
provides that a balloon payment is ``a payment that is more than two 
times a regular periodic payment.'' The Board noted that 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. The Board explained that the 
difference in wording between the statutory definition and the existing 
regulatory definition does not yield a significant difference in what 
constitutes a ``balloon payment'' in the qualified mortgage context. 
Specifically, the Board stated its belief 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.
    Accordingly, to facilitate compliance, the Board proposed to cross-
reference the existing definition of ``balloon payment.'' The Board 
proposed 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. The Board stated that 
this approach is further supported by its 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.
    Finally, in the preamble to the Board's proposal, the Board noted 
that some balloon-payment loans are renewable at maturity and that 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, the Board stated that 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. 
The Board solicited comment on whether it should include an exception 
providing that, notwithstanding proposed 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 sought 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 and on how such an exception might be structured to avoid the 
potential for circumvention.
    As discussed above, commenters generally supported excluding from 
the definition of qualified mortgage certain risky loan features which 
result in ``payment shock,'' such as negative amortization or interest-
only features. Commenters generally recognized such features as 
significant contributors to the recent housing crisis. Industry 
commenters noted that such restrictions are objective criteria which 
creditors can conclusively demonstrate were met at the time of 
origination. However, one mortgage company asserted that such 
limitations should not apply in loss mitigation transactions, such as 
loan modifications and extensions, or to loan assumptions. That 
commenter noted that while negative amortization is not common in most 
loan modification programs, the feature can be used at times to help 
consumers work through default situations. The commenter also noted 
that deferral of payments, including principal payments, and balloon 
payment structures are commonly used to relieve payment default 
burdens. One bank commenter argued that the rule should permit 
qualified mortgages to have balloon payment features 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.
    For the reasons discussed in the proposed rule, the Bureau is 
adopting Sec.  226.43(e)(2)(i) as proposed in renumbered Sec.  
1026.43(e)(2)(i), with certain clarifying changes. In particular, in 
addition to the proposed language, section 1026.43(e)(2)(i) specifies 
that a qualified mortgage is a covered transaction that provides for 
regular periodic payments that are 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.''

[[Page 6518]]

This language appeared in the commentary to Sec.  226.43(e)(2)(i) in 
the proposed rule, but to provide clarity, the Bureau is adopting this 
language in the text of Sec.  1026.43(e)(2)(i) in the final rule.
    Notably, the Bureau is adopting in Sec.  1026.43(e)(2)(i) the 
proposed cross-reference to the existing Regulation Z definition of 
balloon payment. Like the Board, the Bureau finds that the statutory 
definition and the existing regulatory definition do not yield a 
significant difference in what constitutes a ``balloon payment'' in the 
qualified mortgage context. Accordingly, the Bureau makes this 
adjustment pursuant to its authority under TILA section 105(a) because 
the Bureau believes that affording creditors a single definition of 
balloon payment within Regulation Z is necessary and proper to 
facilitate compliance with and effectuate the purposes of TILA.
    In addition, like the proposal, the final rule does not provide 
exceptions from the prohibition on qualified mortgages providing for 
balloon payments, other than the exception for creditors operating 
predominantly in rural or underserved areas, described below in the 
section-by-section analysis of Sec.  1026.43(f). The Bureau believes 
that it is appropriate to implement the rule consistent with statutory 
intent, which specifies only a narrow exception from this general rule 
for creditors operating predominantly in rural or underserved areas 
rather than a broader exception to the general prohibition on qualified 
mortgages containing balloon payment features. With respect to 
renewable balloon-payment loans, the Bureau does not believe that the 
risk that a consumer will face a significant payment shock from the 
balloon feature can be fully eliminated, and that a rule that attempts 
to provide such special treatment for renewable balloon-payment loans 
would be subject to abuse.
43(e)(2)(ii)
    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.'' As discussed above, TILA section 129C(b)(3)(B)(i) authorizes 
the Bureau to revise, add to, or subtract from the qualified mortgage 
criteria if the Bureau makes certain findings, including that such 
revision is necessary or proper to ensure that responsible, affordable 
mortgage credit remains available to consumers in a manner consistent 
with the purposes of TILA section 129C(b) or necessary and appropriate 
to effectuate the purposes of section 129C.
    Proposed Sec.  226.43(e)(2)(ii) would have implemented the 30-year 
maximum loan term requirement in the statute without exception. The 
preamble to the proposed rule explains that, based on available 
information, the Board believed that mortgage loans with terms greater 
than 30 years are rare and, when made, generally are for the 
convenience of consumers who could qualify for a loan with a 30-year 
term but prefer to spread out their payments further. Therefore, the 
Board believed such an exception is generally unnecessary. The Board 
solicited 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 sought 
comment on whether any other exceptions would be appropriate, 
consistent with the Board's authority in TILA section 129C(b)(3)(B)(i).
    As noted above, commenters generally supported the 30-year term 
limitation. One commenter suggested the final rule should clarify that 
a loan term that is slightly longer than 30 years because of the due 
date of the first regular payment nevertheless meets the 30-year term 
requirement. One trade association commenter suggested that creditors 
be provided flexibility to originate 40-year loans in order to 
accommodate consumers in regions of the country where housing prices 
are especially high, but did not provide any information regarding the 
historic performance of 40-year loans or discuss how the Bureau should 
define high-cost areas in a way that avoids abuse. An association of 
State bank regulators also suggested that the rule permit loan terms 
beyond 30 years in high-cost areas and suggested that those areas could 
be determined based on housing price indices. That commenter, two large 
industry trade associations, and one mortgage company commenter argued 
that the 30-year term limitation should not apply to loan modifications 
that provide a consumer with a loan with a lower monthly payment than 
he or she may otherwise face. One such commenter noted that, as a 
general matter, the rule should clarify that modifications of existing 
loans should not be subject to the same ability-to-repay requirements 
to avoid depriving consumers of beneficial modifications.
    For the reasons discussed in the proposed rule, the Bureau is 
generally adopting Sec.  226.43(e)(2)(ii) as proposed in renumbered 
Sec.  1026.43(e)(2)(ii). In response to commenter concern, the final 
rule clarifies in comment 43(e)(2)(ii)-1 that the 30-year term 
limitation in Sec.  1026.43(e)(2)(ii) is applied without regard to any 
interim period between consummation and the beginning of the first full 
unit period of the repayment schedule. Consistent with the Board's 
analysis, the final rule does not provide exceptions to the 30-year 
loan limitation. Like the Board, the Bureau is unaware of a basis upon 
which to conclude that an exception to the 30-year loan term limitation 
for qualified mortgages in high-cost areas is appropriate. In 
particular, the Bureau believes that loans with terms greater than 30 
years are rare and that, when made, generally are for the convenience 
of consumers who could qualify for a loan with a 30-year term.
    The final rule also does not provide additional guidance on the 30-
year loan term limitation in the context of loan modifications. The 
Bureau understands that private creditors may offer loan modifications 
to consumers at risk of default or foreclosure, and that such 
modifications may extend the duration of the loan beyond the initial 
term. If such modification results in the satisfaction and replacement 
of the original obligation, the loan would be a refinance under current 
Sec.  1026.20(a), and therefore the new transaction must comply with 
the ability-to-repay requirements of Sec.  1026.43(c) or satisfy the 
criteria for a qualified mortgage, independent of any ability-to-repay 
analysis or the qualified mortgage status of the initial transaction. 
However, if the transaction does not meet the criteria in 1026.20(a), 
which determines a refinancing--generally resulting in the satisfaction 
and replacement of the original obligation--the loan would not be a 
refinance under Sec.  1026.20(a), and would instead be an extension of 
the original loan. In such a case, compliance with the ability-to-repay 
provision, including a loan's qualified mortgage status, would be 
determined as of the date of consummation of the initial transaction, 
regardless of a later modification.
43(e)(2)(iii)
    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 Bureau 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 Bureau, in prescribing 
such rules, to ``consider the potential impact of such rules on rural

[[Page 6519]]

areas and other areas where home values are lower.''
    Proposed Sec.  226.43(e)(2)(iii) would have implemented 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 proposed Sec.  226.43(e)(3). As 
discussed in detail in the section-by-section analysis of Sec.  
1026.43(e)(3), the Board proposed two alternatives for calculating the 
allowable points and fees for a qualified mortgage: One approach would 
have consisted of five ``tiers'' of loan sizes and corresponding limits 
on points and fees, while the other approach would have consisted of 
three ``tiers'' of 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. Additionally, 
proposed Sec.  226.43(b)(9) would have defined ``points and fees'' to 
have the same meaning as in proposed Sec.  226.32(b)(1).
    For the reasons discussed in the proposed rule, the Bureau is 
generally adopting Sec.  226.43(e)(2)(iii) as proposed in renumbered 
Sec.  1026.43(e)(2)(iii). For a discussion of the final rule's approach 
to calculating allowable points and fees for a qualified mortgage, see 
the section-by-section analysis of Sec.  1026.43(e)(3). For a 
discussion of the definition of points and fees, see the section-by-
section analysis of Sec.  1026.32(b)(1).
    As noted above, several consumer group commenters requested that 
high-cost mortgages be prohibited from receiving qualified mortgage 
status. Those commenters noted that high-cost mortgages have been 
singled out by Congress as deserving of special regulatory treatment 
because of their potential to be abusive to consumers. They argue that 
it would seem incongruous for any high-cost mortgage to be given a 
presumption of compliance with the ability-to-repay rule. However, the 
final rule does not prohibit a high-cost mortgage from being a 
qualified mortgage. Under the Dodd-Frank Act, a mortgage loan is a 
high-cost mortgage when (1) the annual percentage rate exceeds APOR by 
more than 6.5 percentage points for first-liens or 8.5 percentage 
points for subordinate-liens; (2) points and fees exceed 5 percent, 
generally; or (3) when prepayment penalties may be imposed more than 
three years after consummation or exceed 2 percent of the amount 
prepaid. Neither the Board's 2011 ATR-QM Proposal nor the Bureau's 2012 
HOEPA Proposal would have prohibited loans that are high-cost mortgages 
as a result of a high interest rate from receiving qualified mortgage 
status.
    As a general matter, the ability-to-repay requirements in this 
final rule apply to most closed-end mortgage loans, including closed-
end high-cost mortgages. Notwithstanding the Dodd-Frank Act's creation 
of a new ability-to-repay regime for mortgage loans, Congress did not 
modify an existing prohibition in TILA section 129(h) against 
originating a high-cost mortgage without regard to a consumer's 
repayment ability (HOEPA ability-to-repay). Thus, under TILA (as 
amended by the Dodd-Frank Act), closed-end high-cost mortgages are 
subject both to the general ability-to-repay provisions and to HOEPA's 
ability-to-repay requirement.\145\ As implemented in existing Sec.  
1026.34(a)(4), the HOEPA ability-to-repay rules contain a rebuttable 
presumption of compliance if the creditor takes certain steps that are 
generally less rigorous than the Dodd-Frank Act's ability-to-repay 
requirements, as implemented in this rule. For this reason, and as 
explained further in that rulemaking, the Bureau's 2013 HOEPA Final 
Rule provides that a creditor complies with the high-cost mortgage 
ability-to-repay requirement by complying with the general ability-to-
repay provision, as implemented by this final rule.\146\
---------------------------------------------------------------------------

    \145\ The statutory HOEPA ability-to-repay provisions prohibit 
creditors from engaging in a pattern or practice of making loans 
without regard to the consumer's repayment ability. In the 2008 
HOEPA Final Rule, the Board eliminated the ``pattern or practice'' 
requirement under the HOEPA ability-to-repay provision and also 
applied the repayment ability requirement to higher-priced mortgage 
loans.
    \146\ The Bureau notes that, among other restrictions, the 2013 
HOEPA Final Rule also includes in Sec.  1026.32(d)(1) a prohibition 
on balloon payment features for most high-cost mortgages, and 
retains the current restrictions on high-cost mortgages permitting 
negative amortization. As noted, high-cost mortgages will be subject 
to these restrictions in addition to the requirements imposed in 
this final rule. With respect to prepayment penalty revisions, the 
Dodd-Frank Act deleted the statutory restrictions applicable to 
high-cost mortgages. The new Dodd-Frank Act prepayment penalty 
restrictions of section 1414 are implemented as discussed below.
---------------------------------------------------------------------------

    The final rule does not prohibit high-cost mortgages from being 
qualified mortgages for several reasons. First, the Dodd-Frank Act does 
not prohibit high-cost mortgages from receiving qualified mortgage 
status. While the statute imposes a points and fees limit on qualified 
mortgages (3 percent, generally) that effectively prohibits loans that 
trigger the high-cost mortgage points and fee threshold from receiving 
qualified mortgage status, it does not impose an annual percentage rate 
limit on qualified mortgages.\147\ Therefore, nothing in the statute 
prohibits a creditor from making a loan with a very high interest rate 
such that the loan is a high-cost mortgage while still meeting the 
criteria for a qualified mortgage.
---------------------------------------------------------------------------

    \147\ The points and fees limit for qualified mortgages set 
forth in the Dodd-Frank Act, as implemented in Sec.  1026.43(e) of 
this final rule (including separate points and fees limits for 
smaller loans), is lower than the high-cost mortgage points and fees 
threshold. Thus, any loan that triggers the high-cost mortgage 
provisions through the points and fees criteria could not satisfy 
the qualified mortgage definition. Likewise, Sec.  1026.43(g) of 
this final rule provides that, where qualified mortgages are 
permitted to have prepayment penalties, such penalties may not be 
imposed more than three years after consummation or in an amount 
that exceeds 2 percent of the amount prepaid. This limitation aligns 
with the prepayment penalty trigger for the high-cost mortgage 
provisions, such that a loan that satisfies the qualified mortgage 
requirements would never trigger the high-cost mortgage provisions 
as a result of a prepayment penalty.
---------------------------------------------------------------------------

    In addition, the final rule does not prohibit high-cost mortgages 
from being qualified mortgages because the Bureau believes that, for 
loans that meet the qualified mortgage definition, there is reason to 
presume, subject to rebuttal, that the creditor had a reasonable and 
good faith belief in the consumer's ability to repay notwithstanding 
the high interest rate. High-cost mortgages will be less likely to meet 
qualified mortgage criteria because the higher interest rate will 
generate higher monthly payments and thus require higher income to 
satisfy the debt-to-income test for a qualified mortgage. But where 
that test is satisfied--that is, where the consumer has an acceptable 
debt-to-income ratio calculated in accordance with qualified mortgage 
underwriting rules--there is no logical reason to exclude the loan from 
the definition of a qualified mortgage.
    Allowing a high-cost mortgage to be a qualified mortgage can 
benefit consumers. The Bureau anticipates that, in the small loan 
market, creditors may sometimes exceed high-cost mortgage thresholds 
due to the unique structure of their business. The Bureau believes it 
would be in the interest of consumers to afford qualified mortgage 
status to loans meeting the qualified mortgage criteria so as to remove 
any incremental impediment that the general ability-to-repay provisions 
would impose on making such loans. The Bureau also believes this 
approach could provide an incentive to creditors making high-cost 
mortgages to satisfy the qualified mortgage requirements, which would 
provide additional consumer protections, such as restricting interest-
only payments and limiting loan terms to 30 years, which are not 
requirements under HOEPA.

[[Page 6520]]

    Furthermore, allowing high-cost mortgage loans to be qualified 
mortgages would not impact the various impediments to making high-cost 
mortgage loans, including enhanced disclosure and counseling 
requirements and the enhanced liability for HOEPA violations. Thus, 
there would remain strong disincentives to making high-cost mortgages. 
The Bureau does not believe that allowing high-cost mortgages to be 
qualified mortgages would incent creditors who would not otherwise make 
high-cost mortgages to start making them.
43(e)(2)(iv)
    TILA section 129C(b)(2)(A)(iv) and (v) provides 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 assumptions regarding how to calculate the payment 
obligation.
    These statutory requirements differ from the payment calculation 
requirements set forth in existing Sec.  1026.34(a)(4)(iii), which 
provides a presumption of compliance with the repayment ability 
requirements for higher-priced mortgage loans, 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.  1026.34(a)(4)(iii) is 
available for all high-cost and higher-priced mortgage loans, except 
for loans with negative amortization or balloon-payment mortgages with 
a term less than seven years. In contrast, TILA section 129C(b)(2)(A) 
requires the creditor to underwrite the loan based on the maximum 
payment during the first five years, and does not extend the scope of 
qualified mortgages to any loan that contains certain risky features or 
a loan term exceeding 30 years. Loans with a balloon-payment feature 
would not meet the definition of a qualified mortgage regardless of 
term length, unless made by a creditor that satisfies the conditions in 
Sec.  1026.43(f).
    The Board proposed to implement the underwriting requirements of 
TILA section 129C(b)(2)(A)(iv) and (v), for purposes of determining 
whether a loan meets the definition of a qualified mortgage, in 
proposed Sec.  226.43(e)(2)(iv). Under the proposal, creditors would 
have been required to underwrite 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'' would have had the 
meaning as in current Sec.  1026.18(s)(7)(i) through (iii), 
respectively.
    Specifically, proposed Sec.  226.43(e)(2)(iv) would have provided 
that meeting the definition of a qualified mortgage is contingent, in 
part, on creditors meeting the following underwriting requirements:
    (1) Proposed Sec.  226.43(e)(2)(iv) would have required that the 
creditor take into account any mortgage-related obligations when 
underwriting the consumer's loan;
    (2) Proposed Sec.  226.43(e)(2)(iv)(A) would have required the 
creditor to use the maximum interest rate that may apply during the 
first five years after consummation; and
    (3) Proposed Sec.  226.43(e)(2)(iv)(B) would have required 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.
    These three underwriting conditions under proposed Sec.  
226.43(e)(2)(iv), and the approach to these criteria adopted in the 
final rule, are discussed below.
    Proposed Sec.  226.43(e)(2)(iv) would have implemented TILA section 
129C(b)(2)(A)(iv) and (v), in part, and provided that, to be a 
qualified mortgage under proposed Sec.  1026.43(e)(2), the creditor 
must underwrite the loan taking into account any mortgage-related 
obligations. Proposed comment 43(e)(2)(iv)-6 would have provided cross-
references to proposed Sec.  226.43(b)(8) and associated commentary. 
The Board proposed to use the term ``mortgage-related obligations'' in 
place of ``all applicable taxes, insurance (including mortgage 
guarantee insurance), and assessments.'' Proposed Sec.  226.43(b)(8) 
would have defined 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); homeowners 
association, condominium, and cooperative fees; ground rent or 
leasehold payments; and special assessments.
    Commenters generally supported the inclusion of mortgage-related 
obligations in the underwriting requirement in proposed Sec.  
226.43(e)(2)(iv). Several industry trade associations, banks, civil 
rights organizations, and consumer advocacy groups specifically 
supported the requirement. Several commenters requested clear guidance 
on the amounts to be included in the monthly payment amount, including 
mortgage-related obligations. In addition, a civil rights organization 
and several consumer advocacy groups argued that the creditor should 
also be required to consider recurring, non-debt expenses, such as 
medical supplies and child care.
    As discussed above in the section-by-section analysis of Sec.  
1026.43(b)(8), the Bureau is adopting the proposed definition of 
mortgage-related obligations in renumbered Sec.  1026.43(b)(8), with 
certain clarifying changes and additional examples.
    For the reasons discussed above, the Bureau is adopting the 
mortgage-related obligations portion of Sec.  226.43(e)(2)(vi) as 
proposed in renumbered Sec.  1026.43(e)(2)(vi). The final rule does not 
contain a specific requirement that the creditor consider, when 
underwriting the consumer's monthly payment, recurring non-debt 
expenses, such as medical supplies and child care. However, such 
expenses, if known to the creditor at the time of consummation, may be 
relevant to a consumer's ability to rebut the presumption of compliance 
that applies to qualified mortgages that are higher-priced covered 
transactions. See section-by-section analysis of Sec.  
1026.43(e)(1)(ii)(B).
43(e)(2)(iv)(A)
    Proposed Sec.  226.43(e)(2)(iv)(A) would have implemented TILA 
section 129C(b)(2)(A)(iv) and (v), in part, and provided that, to be a 
qualified mortgage under proposed Sec.  1026.43(e)(2), the creditor 
must underwrite the loan using the maximum interest rate that may apply 
during the first five years after consummation. However, the statute 
does not define the term ``maximum rate,'' nor does the statute 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

[[Page 6521]]

the first five years after consummation of the loan. The former 
approach would capture the rate recast for a 5/1 hybrid adjustable-rate 
mortgage that occurs on the due date of the 60th monthly payment, and 
the latter would not.
    The Board interpreted 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 
proposed comment 43(e)(2)(iv)-1. The Board noted that 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 
stated that 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. For the reasons described in the 
proposed rule, the Bureau is adopting the ``maximum interest rate'' 
provision in Sec.  1026.43(e)(2)(iv) as proposed in renumbered Sec.  
1026.43(e)(2)(iv).
    The Board proposed 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). The preamble to the 
proposed rule explains several reasons for this interpretation. First, 
the Board noted that a plain reading of the statutory language conveys 
that the ``first five years'' is the first five years of the loan once 
it comes into existence (i.e., once it is consummated). The Board 
believed that 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 noted that the intent of this underwriting 
condition is to ensure that the consumer can afford the loan's payments 
for a reasonable amount of time and that Congress intended for a 
reasonable amount of time to be the first five years after 
consummation.
    Third, the Board proposed this approach because it 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 existing Sec.  
1026.34(a)(4) of the Board's 2008 HOEPA Final Rule.
    Fourth, the Board believed 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 believed that the proposed timing of the five-
year period could appropriately differ from the approach used under the 
2010 MDIA Interim Final Rule, given the different purposes of the 
rules. The Board amended the 2010 MDIA Interim Final Rule to require 
that creditors base their interest rate and payment disclosures on the 
first five years after the due date of the first regular periodic 
payment rather than the first five years after consummation. See 75 FR 
81836, 81839 (Dec. 29, 2010). The revision clarified that the 
disclosure requirements for \5/1\ hybrid adjustable-rate mortgages 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. The Board believed a different 
approach is appropriate under proposed Sec.  226.43(e)(2)(iv) because 
that requirement seeks to ensure that the loan's payments are 
affordable for a reasonable period of time. For the reasons stated 
above, the Board believed 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.
    For all the above-listed reasons, the Board interpreted 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 solicited comment on its interpretation of the 
phrase ``first five years'' and the appropriateness of this approach. 
The Board also proposed clarifying commentary and examples, which are 
described below.
    As described above, commenters generally supported the payment 
calculation requirements in the proposed rule, including the five-year 
payment calculation. A comment from a coalition of consumer advocates 
suggested that the period may not be long enough to assure a consumer's 
ability to repay given that the average homeowner holds their mortgage 
for approximately seven years, and suggested that the five-year payment 
calculation requirement be extended to reflect the average mortgage 
duration of the first ten years of the loan. Two industry commenters 
suggested that the time horizon in the required payment calculation for 
qualified mortgages be consistent with the proposed requirement in the 
2011 QRM Proposed Rule that the payment calculation be based on the 
maximum rate in the first five years after the date on which the first 
regular periodic payment will be due. One such commenter noted that the 
payment calculation approach in the 2011 QRM Proposed Rule is more 
protective of consumers. Another industry commenter suggested that the 
final rule should measure the first five years from the first regularly 
scheduled payment, for consistency with the 2010 MDIA Interim Final 
Rule. An association of State bank regulators agreed with the Board's 
reasoning, noting that creditors could structure loans to recast 
outside any parameter set by the rule and that an effective way to 
prevent purposeful evasion of the payment calculation provision would 
require legislation.
    Notwithstanding the Board's proposed approach, the Bureau 
interprets 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 the first regular 
periodic payment will be due. Like the Board, the Bureau finds the 
statutory language to be ambiguous. However, the Bureau believes that 
the statutory phrase ``during the first 5 years'' could be given either 
meaning, and that this approach provides greater protections to 
consumers by requiring creditors to underwrite qualified mortgages 
using the rate that would apply after the recast of a five-year 
adjustable rate mortgage. Further, as noted, this approach is 
consistent with the payment calculation in the 2011 QRM Proposed Rule 
and in existing Regulation Z with respect to the disclosure 
requirements for interest rates on adjustable-rate amortizing loans.
    Accordingly, Sec.  1026.43(e)(2)(iv)(A) provides that a qualified 
mortgage under Sec.  1026.43(e)(2) must be underwritten, taking into 
account any mortgage-

[[Page 6522]]

related obligations, using the maximum interest rate that may apply 
during the first five years after the date on which the first regular 
periodic payment will be due. Although the Bureau is finalizing the 
commentary and examples to Sec.  226.43(e)(2)(iv) as proposed in the 
commentary to renumbered Sec.  1026.43(e)(2)(iv), the final rule makes 
conforming changes to the proposed commentary to reflect the adjusted 
time horizon. The proposed commentary and the changes to the proposed 
commentary as implemented in the final rule are described below.
    The Bureau is finalizing comment 43(e)(2)(iv)-1 as proposed, but 
with conforming changes to reflect the new time horizon. In the final 
rule, the comment provides guidance to creditors on how to determine 
the maximum interest rate during the first five years after the date on 
which the first regular periodic payment will be due. This comment 
explains that creditors must use the maximum rate that could apply at 
any time during the first five years after the date on which the first 
regular periodic payment will be due, regardless of whether the maximum 
rate is reached at the first or subsequent adjustment during such five 
year period.
    The Bureau is finalizing comment 43(e)(2)(iv)(A)-2 as proposed. 
That comment clarifies that for a fixed-rate mortgage, creditors should 
use the interest rate in effect at consummation, and provides a cross-
reference to Sec.  1026.18(s)(7)(iii) for the meaning of the term 
``fixed-rate mortgage.''
    The Bureau is finalizing comment 43(e)(2)(iv)-3 as proposed, but 
with conforming changes to reflect the new time horizon. That comment 
provides guidance to creditors regarding treatment of periodic interest 
rate adjustment caps, and explains 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. The comment further explains 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. The comment states 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, the comment clarifies 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 the date on which the first regular periodic 
payment will be due.
    The Bureau is also adopting comment 43(e)(2)(iv)-3.i through .iii 
as proposed, but with conforming changes to the comment to reflect the 
new time horizon. Those comments provide examples of how to determine 
the maximum interest rate. For example, comment 43(e)(2)(iv)-3.1 
illustrates how to determine the maximum interest rate in the first 
five years after the date on which the first regular periodic payment 
will be due for an adjustable-rate mortgage with a discounted rate for 
three years.
    The Bureau is also finalizing comment 43(e)(2)(iv)-4 as proposed, 
but with conforming changes to reflect the new time horizon. Comment 
43(e)(2)(iv)-4 clarifies the meaning of the phrase ``first five years 
after the date on which the first regular periodic payment will be 
due.'' This comment provides that under Sec.  1026.43(e)(2)(iv)(A), the 
creditor must underwrite the loan using the maximum interest rate that 
may apply during the first five years after the date on which the first 
regular periodic payment will be due, and provides an illustrative 
example.
43(e)(2)(iv)(B)
    Proposed Sec.  226.43(e)(2)(iv)(B) would have implemented TILA 
section 129C(b)(2)(A)(iv) and (v), in part, by providing, as part of 
meeting the definition of a qualified mortgage under proposed Sec.  
1026.43(e)(2), 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) states that underwriting 
should be based ``on a payment schedule that fully amortizes the loan 
over the loan term.'' The Board noted 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 proposed to use the terms ``loan amount'' and ``loan term'' 
in proposed Sec.  226.43(b)(5) and (b), respectively, for purposes of 
this underwriting condition.
    However, the Board also believed 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 
proposed 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 
during the first five years after consummation takes effect under the 
terms of the loan, or the loan amount as of the date of consummation. 
The Board believed the former approach more accurately reflects the 
largest payment amount that the consumer would need to make under the 
terms of the loan during the first five years after consummation, 
whereas the latter approach would actually overstate the payment 
amounts required. This approach would have set a minimum standard for 
qualified mortgages, while affording creditors latitude to choose 
either approach to facilitate compliance.
    For the reasons described in the proposed rule, the Bureau is 
finalizing Sec.  226.43(e)(2)(iv)(A) as proposed in renumbered Sec.  
1026.43(e)(2)(iv)(A). However, the final rule makes conforming changes 
to the proposed commentary to reflect the adjusted time-horizon to the 
first five years after the due date of the first regular periodic 
payment. The proposed commentary and the changes to the proposed 
commentary in the final rule are described below.
    The Bureau is finalizing comment 43(e)(2)(iv)-5 as proposed, but 
with conforming changes to reflect the new time horizon. Comment 
43(e)(2)(iv)-5 provides further clarification to creditors regarding 
the loan amount to be used for purposes of this second condition in 
Sec.  1026.43(e)(2)(iv). The comment explains that for a creditor to 
meet the definition of a qualified mortgage under Sec.  1026.43(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 the date on which the first regular periodic payment 
will be due 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.  1026.43(b)(5), 
over the entire loan term, as that term is defined in Sec.  
1026.43(b)(6). This comment provides illustrative examples for both 
approaches.

[[Page 6523]]

    The Bureau is finalizing comment 43(c)(2)(iv)-6 as proposed. That 
comment reiterates that Sec.  1026.43(e)(2)(iv) requires creditors to 
take mortgage-related obligations into account when underwriting the 
loan and refers to Sec.  1026.43(b)(8) and its associated commentary 
for the meaning of mortgage-related obligations.
    The Bureau is also finalizing comment 43(e)(2)(iv)-7 as proposed, 
but with conforming changes to reflect the new time horizon. Comment 
43(e)(2)(iv)-7 provides examples of how to determine the periodic 
payment of principal and interest based on the maximum interest rate 
during the first five years after the date on which the first regular 
periodic payment will be due under Sec.  1026.43(e)(2)(iv). The final 
rule provides an additional example of how to determine the periodic 
payment of principal and interest based on the maximum interest rate 
during the first five years after the date on which the first regular 
periodic payment will be due under Sec.  1026.43(e)(2)(iv) for an 
adjustable-rate mortgage with a discount of seven years, to illustrate 
how the payment calculation applies in a loan that adjusts after the 
five-year time horizon. Comment 43(e)(2)(iv)-7.iv provides an example 
of a loan in an amount of $200,000 with a 30-year loan term, that 
provides for a discounted interest rate of 6 percent that is fixed for 
an initial period of seven years, after which the interest rate will 
adjust annually based on a specified index plus a margin of 3 percent, 
subject to a 2 percent annual interest rate adjustment cap. The index 
value in effect at consummation is 4.5 percent. The loan is consummated 
on March 15, 2014, and the first regular periodic payment is due May 1, 
2014. Under the terms of the loan agreement, the first rate adjustment 
is on April 1, 2021 (the due date of the 84th monthly payment), which 
occurs more than five years after the date on which the first regular 
periodic payment will be due. Thus, the maximum interest rate under the 
terms of the loan during the first five years after the date on which 
the first regular periodic payment will be due is 6 percent. Under this 
example, the transaction will meet the definition of a qualified 
mortgage if the creditor 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 after the date on which the first regular 
periodic payment will be due of 6 percent.
43(e)(2)(v)
43(e)(2)(v)(A)
    TILA section 129C(b)(2)(A)(iii) provides that a condition for 
meeting the requirements of 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 requirement under the general ability-to-repay 
standard to consider and verify a consumer's income or assets using 
third-party records, pursuant to TILA section 129C(a)(1) and (3), as 
discussed above in the section-by-section analysis of Sec.  
1026.43(c)(2)(i) and (c)(4).
    Proposed Sec.  226.43(e)(2)(v) would have implemented TILA section 
129C(b)(2)(A)(iii) by providing 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 proposal used the term ``assets'' 
instead of ``financial resources'' for consistency with other 
provisions in Regulation Z and, as noted above, the Bureau believes 
that the terms have the same meaning. Proposed comment 43(e)(2)(v)-1 
would have clarified that creditors may rely on commentary to proposed 
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 for a qualified mortgage under proposed Sec.  
226.43(e)(2)(v).
    For the reasons discussed in the proposal, the Bureau is finalizing 
Sec.  226.43(e)(2)(v)(A) as proposed in renumbered Sec.  
1026.43(e)(2)(v)(A), with additional clarification that the value of 
the dwelling includes any real property to which the dwelling is 
attached. Renumbered Sec.  1026.43(e)(2)(v)(A) also provides that the 
creditor must consider and verify the consumer's current or reasonably 
expected income or assets other than the value of the dwelling 
(including any real property attached to the dwelling) that secures the 
loan, in accordance with appendix Q, in addition to Sec.  
1026.43(c)(2)(i) and (c)(4). Comment 43(e)(2)(v)-2 clarifies this 
provision, by explaining that, for purposes of this requirement, the 
creditor must consider and verify, at a minimum, any income specified 
in appendix Q. A creditor may also consider and verify any other income 
in accordance with Sec.  1026.43(c)(2)(i) and (c)(4); however, such 
income would not be included in the total monthly debt-to-income ratio 
determination by Sec.  1026.43(e)(2)(vi). As described below, appendix 
Q contains specific standards for defining ``income,'' to provide 
certainty to creditors as to whether a loan meets the requirements for 
a qualified mortgage. The final rule includes this reference to 
appendix Q and additional comment to clarify the relationship between 
the requirement to consider a consumer's current or reasonably expected 
income in Sec.  1026.43(e)(2)(v)(A) and the definition of ``income'' in 
appendix Q. In other words, a creditor who considers ``income'' as 
defined in appendix Q meets the income requirement in Sec.  
1026.43(e)(2)(v)(A), so long as that income is verified pursuant to 
Sec.  1026.43(c)(4). In addition, comment 43(e)(2)(v)-1 provides that 
for guidance on satisfying Sec.  1026.43(e)(2)(v), a creditor may rely 
on commentary to Sec.  1026.43(c)(2)(i) and (vi), (c)(3), and (c)(4).
43(e)(2)(v)(B)
    The Board's proposed Alternative 2 would have required 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, the consumer's monthly debt-to-income ratio or residual 
income, and the consumer's credit history. The commentary would have 
provided that 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 under 
Alternative 2. The Board proposed these additions pursuant to its legal 
authority under TILA section 129C(b)(3)(B)(i). The Board believed 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.
    In the final rule, Sec.  1026.43(e)(2)(v)(B) provides that, to meet 
the requirements for a qualified mortgage under Sec.  1026.43(e)(2), 
the creditor must consider and verify the consumer's current debt 
obligations, alimony, and child support, in accordance with appendix Q 
and Sec.  1026.43(c)(2)(vi) and (c)(3). In addition, new comment 
43(e)(2)(v)-3 clarifies that, for purposes

[[Page 6524]]

of considering and verifying the consumer's current debt obligations, 
alimony, and child support pursuant to Sec.  1026.43(e)(2)(v)(B), the 
creditor must consider and verify, at a minimum, any debt or liability 
specified in appendix Q. A creditor may also consider and verify other 
debt in accordance with Sec.  1026.43(c)(2)(vi) and (c)(3); however, 
such debt would not be included in the total monthly debt-to-income 
ratio determination required by Sec.  1026.43(e)(2)(vi). As described 
below, appendix Q contains specific standards for defining ``debt,'' to 
provide certainty to creditors as to whether a loan meets the 
requirements for a qualified mortgage. The final rule includes this 
reference to appendix Q and additional comment to clarify the 
relationship between the requirement to consider a consumer's current 
debt obligations, alimony, and child support in Sec.  
1026.43(e)(2)(v)(B) and the definition of ``debt'' in appendix Q. In 
other words, a creditor who considers ``debt'' as defined in appendix Q 
meets the requirement in Sec.  1026.43(e)(2)(v)(B), so long as that 
income is verified pursuant to Sec.  1026.43(c)(3).
    The Bureau is incorporating the requirement that the creditor 
consider and verify the consumer's current debt obligations, alimony, 
and child support into the definition of a qualified mortgage in Sec.  
1026.43(e)(2) pursuant to its authority under TILA section 
129C(b)(3)(B)(i). The Bureau finds that this addition to the qualified 
mortgage criteria is necessary and proper to ensure that responsible, 
affordable mortgage credit remains available to consumers in a manner 
that is consistent with the purposes of TILA section 129C and necessary 
and appropriate to effectuate the purposes of TILA section 129C, which 
includes assuring that consumers are offered and receive residential 
mortgage loans on terms that reasonably reflect their ability to repay 
the loan. The Bureau also incorporates this requirement pursuant to its 
authority under TILA section 105(a) to issue regulations that, among 
other things, contain such additional requirements, other provisions, 
or that provide for such adjustments for all or any class of 
transactions, that in the Bureau's judgment are necessary or proper to 
effectuate the purposes of TILA, which include the above purpose of 
section 129C, among other things. The Bureau believes that this 
addition to the qualified mortgage criteria is necessary and proper to 
achieve this purpose. In particular, as discussed above, the Bureau 
finds that incorporating the requirement that a creditor consider and 
verify a consumer's current debt obligations, alimony, and child 
support into the qualified mortgage criteria ensures that creditors 
consider, on an individual basis, and verify whether a consumer has the 
ability to repay a qualified mortgage. Furthermore, together with the 
requirement to consider and verify income, the Bureau believes this 
requirement to consider and verify debt obligations, alimony, and child 
support strengthens consumer protection and is fundamental to the 
underlying components of the requirement in Sec.  1026.43(e)(2)(vi), 
which provides a specific debt-to-income ratio threshold.
    Ultimately, the Bureau believes that the statute is fundamentally 
about establishing standards for determining a consumer's reasonable 
ability to repay and therefore believes it is appropriate to 
incorporate the ability-to-repay underwriting requirements into the 
qualified mortgage definition to ensure consistent consumer protections 
for repayment ability for a qualified mortgage. However, as described 
above, most of the ability-to-repay requirements must be considered and 
verified to satisfy the specific debt-to-income ratio requirement in 
Sec.  1026.43(e)(2)(vi), which requires the creditor to follow the 
standards for ``debt'' and ``income'' in appendix Q, including the 
consumer's employment status, monthly payment on the covered 
transaction, monthly payment on simultaneous loans of which the 
creditor is aware, and monthly payment on mortgage-related obligations. 
For this reason, unlike the Board's proposed Alternative 2, the final 
rule does not separately require consideration and verification of 
these factors that are part of the general ability-to-repay analysis.
43(e)(2)(vi)
    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 Bureau 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 consumer and such other factors as the 
Bureau may determine relevant and consistent with the purposes 
described in paragraph (3)(B)(i).''
Board's Proposal
    Under proposed Sec.  226.43(e)(2)(v) under Alternative 1, creditors 
would not have been required to consider the consumer's debt-to-income 
ratio or residual income to make a qualified mortgage. The Board noted 
several reasons for proposing this approach. First, the Board noted 
that 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. The Board believed this approach 
is contrary to Congress' apparent intent to provide incentives to 
creditors to make qualified mortgages, since they have less risky 
features and terms. Second, the Board noted that 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, the Board stated that data shows that the debt-to-income ratio 
generally does not have a significant predictive power of loan 
performance once the effects of credit history, loan type, and loan-to-
value ratio are considered.\148\ Fourth, the Board noted that although 
consideration of the mortgage debt-to-income ratio (or ``front-end'' 
debt-to-income) might help consumers receive loans on terms that 
reasonably reflect their ability to repay the loans, the Board's 
outreach indicated that creditors often do not find that ``front-end'' 
debt-to-income ratio is a strong predictor of ability to repay. 
Finally, the Board stated its concern 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 who 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 afford the mortgage. A definition of 
qualified mortgage that required consideration of the consumer's debt-
to-income or residual income could limit the availability of credit to 
those consumers.
---------------------------------------------------------------------------

    \148\ The proposal cited Yuliya Demyanyk & Otto Van Hemert, 
Understanding the Subprime Mortgage Crisis, 24 Rev. Fin. Stud. 1848 
(2011); James A. Berkovec et al., Race, Redlining, and Residential 
Mortgage Loan Performance, 9 J. Real Est. Fin. & Econs. 263 (1994).
---------------------------------------------------------------------------

    However, under proposed Sec.  226.43(e)(2)(v) under Alternative 2, 
a qualified mortgage would have been defined as a loan which, among 
other things, the creditor considers the consumer's monthly debt-to-
income ratio or residual income, pursuant to proposed Sec.  
226.43(c)(2)(vii) and (c)(7). The Board noted that, without determining 
the consumer's debt-to-income ratio, a creditor could originate

[[Page 6525]]

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 
reasonable underwriting standards, and be predicted to default soon 
after the first scheduled mortgage payment. Accordingly, the Board 
believed that 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 did not propose a quantitative standard for the debt-to-
income ratio in the qualified mortgage definition, but solicited 
comment on the appropriateness of such an approach. The Board's 
proposal noted several reasons for declining to introduce a specific 
debt-to-income ratio for qualified mortgages. First, as explained in 
the 2008 HOEPA Final Rule, the Board was concerned that setting a 
specific debt-to-income ratio could limit credit availability without 
providing adequate off-setting benefits. 73 FR 4455 (July 30, 2008). 
The Board sought comment on what exceptions may be necessary for low-
income consumers or consumers living in high-cost areas, or for other 
cases, if the Board were to adopt a quantitative debt-to-income 
standard.
    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 consumers. The Board 
believed that setting a quantitative standard would require it to 
address the operational issues related to the calculation of the debt-
to-income ratio. 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.
    For all these reasons, the Board did not propose a quantitative 
standard for the debt-to-income ratio. The Board recognized, 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 solicited 
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.
Comments
    As noted above, the Bureau received comments in response to the 
Board's 2011 ATR Proposal and in response to the Bureau's May 2012 
notice to reopen the comment period. The reopened comment period 
solicited comment specifically on new data and information obtained 
from the Federal Housing Finance Agency (FHFA) after the close of the 
original comment period. In the notice to reopen the comment period, 
the Bureau, among other things, solicited comment on data and 
information as well as sought comment specifically on certain 
underwriting factors, such as a debt-to-income ratio, and their 
relationship to measures of delinquency or their impact on the number 
or percentage of mortgage loans that would be a qualified mortgage. In 
addition, the Bureau sought comment and data on estimates of litigation 
costs and liability risks associated with claims alleging a violation 
of ability-to-repay requirements.
    Comments on general debt-to-income ratio or residual income 
requirement. In response to the proposed rule, some industry commenters 
argued that the final rule should not require consideration and 
verification of a consumer's monthly debt-to-income ratio or residual 
income for a qualified mortgage. They argued that such an approach 
would create a vague, subjective definition of qualified mortgage. 
Certain industry commenters requested that if the Bureau added 
consideration and verification of the debt-to-income ratio or residual 
income to the definition of a qualified mortgage, the Bureau establish 
flexible standards. These commenters argued that imposing low debt-to-
income ratio requirements would be devastating to many potential 
creditworthy homebuyers.
    Other industry commenters suggested that if the Bureau added 
consideration and verification of the debt-to-income ratio or residual 
income to the definition of a qualified mortgage, the Bureau provide 
clear and objective standards. For example, one industry trade group 
commenter noted that, historically, the debt-to-income ratio has been a 
key metric used to assess a consumer's ability to repay a mortgage 
loan, and has been incorporated into both manual and automated 
underwriting systems used in the industry. Some industry commenters 
asked that the final rule adopt the VA calculation of residual income. 
See also the section-by-section analysis of section 1026.43(c)(7). 
Another industry commenter suggested that any mortgage with a residual 
income of at least $600 be sufficient for a qualified mortgage. Another 
industry commenter suggested that, at a minimum, residual income 
considerations would require a workable standard with clear, specific, 
and objective criteria and be explicitly limited to specific expense 
items. An industry trade group commenter recommended that if the Bureau 
requires the use of residual income, creditors be allowed flexibility 
in considering residual income along with other factors in loan 
underwriting. Comments that addressed a specific debt-to-income ratio 
are discussed below.
    Several industry commenters recommended that if the Bureau required 
consideration and verification of the debt-to-income ratio or residual 
income for a qualified mortgage, creditors be permitted to take 
compensating factors into account. They suggested that the Bureau 
provide examples of compensating factors, such as: (1) The property 
being an energy-efficient home; (2) the consumer having probability for 
increased earnings based on education, job training, or length of time 
in a profession; (3) the consumer having demonstrated ability to carry 
a higher total debt-load while maintaining a good credit history for at 
least 12 months; (4) future expenses being lower, such as child-support 
payments to cease for child soon to reach age of majority; or (5) the 
consumer having substantial verified liquid assets.
    Consumer advocates generally supported adding consideration and 
verification of the debt-to-income ratio or residual income to the 
definition of a qualified mortgage. They noted that such inclusion 
would help ensure that consumers receive mortgages they can afford and 
that such factors are basic, core features of common-sense underwriting 
that are clearly related to the risk of consumer default. To that 
point, these commenters contended that residual income is an essential 
component, especially for lower-income families. One consumer group 
commenter stressed that residual income standards should be

[[Page 6526]]

incorporated, and pointed to the FHFA data in the Bureau's notice to 
reopen the comment period to demonstrate that relying solely on debt-
to-income ratios is insufficient to ensure sound lending based on a 
consumer's ability to repay.
    Many industry and consumer group commenters and interested parties 
supported use of a specific debt-to-income ratio threshold. For 
example, some suggested that if a consumer's total debt-to-income ratio 
is below a specified threshold, the mortgage loan should satisfy the 
qualified mortgage requirements, assuming other relevant conditions are 
met. At least one industry commenter supported allowing the use of FHA 
underwriting guidelines to define ``debt'' and ``income.''
    Although many commenters supported the use of a specific debt-to-
income ratio threshold, both industry and consumer group commenters 
noted that relying on debt-to-income is only one element of 
underwriting, and that creditors have used other compensating factors 
and underwriting criteria. Some commenters acknowledged that a 
consumer's debt-to-income ratio is a useful measure of loan 
performance; however, they asserted that the year of origination (i.e., 
vintage) has more bearing on loan performance. In addition, some 
commenters argued that measures of consumer credit history and loan-to-
value are more predictive, and that broader economic factors largely 
determine loan performance. Several industry commenters recommended a 
debt-to-income ratio cutoff that is at the upper end of today's 
relatively conservative lending standards, while permitting creditors 
to consider loans that exceed that debt-to-income ratio threshold if 
the consumer satisfies other objective criteria (such as reserves, 
housing payment history, and residual income), that help creditors 
assess the consumer's ability to repay the loan. These commenters 
argued that the FHFA data in the Bureau's notice to reopen the comment 
period demonstrate that when loans are properly underwritten, debt-to-
income ratios can be relatively high without significantly affecting 
loan performance.
    Numerous commenters argued that the Bureau should consider the 
costs and benefits of selecting a maximum debt-to-income ratio for 
qualified mortgages. Many industry and consumer group commenters argued 
that a debt-to-income threshold that is too low would unnecessarily 
exclude a large percentage of consumers from qualified mortgages. One 
joint industry and consumer group comment letter suggested a 43 percent 
total debt-to-income ratio. In addition to a debt-to-income 
requirement, some commenters and interested parties suggested that the 
Bureau should include within the definition of a ``qualified mortgage'' 
loans with a debt-to-income ratio above a certain threshold if the 
consumer has a certain amount of assets, such as money in a savings or 
similar account, or a certain amount of residual income. For example, 
an industry commenter suggested a 45 percent total debt-to-income 
ratio, with an allowance for higher total debt-to-income ratios of up 
to 50 percent for consumers with significant assets (e.g., at least one 
year's worth of reserves). This commenter asked that the Bureau carve 
out consumers who have shown ability to maintain a high debt-to-income 
ratio or who have a nontraditional credit history. This commenter 
explained that the higher the debt-to-income ratio, the more likely a 
brief interruption in income or unexpected large expense could 
compromise repayment ability. The commenter noted that only a numerical 
standard would provide sufficient certainty for creditors and 
investors, since they may otherwise end up litigating what is a 
reasonable debt-to-income ratio. Another industry commenter asked that 
a 50 percent back-end debt-to-income ratio be sufficient. This 
commenter noted that without clear and objective standards, creditors 
trying to make a qualified mortgage would fall back on the qualified 
residential mortgage standards.
    Another industry trade association commenter argued that a total 
debt-to-income ratio threshold of 43 percent is problematic because 
according to the FHFA data in the Bureau's notice to reopen the comment 
period, there is no appreciable difference in performance for loans 
with a 43 percent debt-to-income ratio and loans with 46 percent debt-
to-income ratio. In other words, commenters argued that the FHFA data 
supports a higher debt-to-income ratio threshold, such as 46 percent. 
Another commenter noted that the FHFA data does not include data on 
portfolio loans.
    Some consumer group commenters suggested that the Bureau conduct 
further research into the role of debt-to-income ratios and the 
relationship between a consumer's debt-to-income ratio and residual 
income. One commenter noted that the Bureau should consider a tiered-
approach for higher-income consumers who can support a higher debt-to-
income ratio. Another consumer group commenter argued that residual 
income should be incorporated into the definition of qualified 
mortgage. Several commenters suggested that the Bureau use the general 
residual income standards of the VA as a model for a residual income 
test, and one of these commenters recommended that the Bureau 
coordinate with FHFA to evaluate the experiences of the GSEs in using 
residual income in determining a consumer's ability to repay.
    Some commenters opposed including a specific debt-to-income ratio 
threshold into the qualified mortgage criteria. For example, one 
commenter argued that though the qualified mortgage criteria should be 
as objective as possible, a specific debt-to-income threshold should 
not be imposed because the criteria should be flexible to account for 
changing markets. Another commenter argued that creditors should be 
able to consider debt-to-income and residual income ratios, but 
creditors should not be restricted to using prescribed debt-to-income 
or residual income ratios. One industry commenter contended that if the 
Bureau were to impose a 45 percent total debt-to-income ratio, for 
example, most larger secondary market investors/servicers would impose 
a total debt-to-income ratio that is much lower (such as 43 percent or 
41 percent) as a general rule of risk management.
Final Rule
    The Bureau believes, based upon its review of the data it has 
obtained and the comments received, that the use of total debt-to-
income as a qualified mortgage criterion provides a widespread and 
useful measure of a consumer's ability to repay, and that the Bureau 
should exercise its authority to adopt a specific debt-to-income ratio 
that must be met in order for a loan to meet the requirements of a 
qualified mortgage. The Bureau believes that the qualified mortgage 
criteria should include a standard for evaluating whether consumers 
have the ability to repay their mortgage loans, in addition to the 
product feature requirements specified in the statute. At the same 
time, the Bureau recognizes concerns that creditors should readily be 
able to determine whether individual mortgage transactions will be 
deemed qualified mortgages. The Bureau addresses these concerns by 
adopting a bright-line debt-to-income ratio threshold of 43 percent, as 
well as clear and specific standards, based on FHA guidelines, set 
forth in appendix Q for calculating the debt-to-income ratio in 
individual cases.
    The Bureau believes that a consumer's debt-to-income ratio is 
generally predictive of the likelihood of default, and is a useful 
indicator of such. At a basic level, the lower the debt-to-income 
ratio, the greater the consumer's ability to pay back a mortgage loan 
would be

[[Page 6527]]

under existing conditions as well as changed circumstances, such as an 
increase in an adjustable rate, a drop in future income, or 
unanticipated expenses or new debts. The Bureau's analysis of FHFA's 
Historical Loan Performance (HLP) dataset, data provided by the 
FHA,\149\ and data provided by commenters all bear this out. These data 
indicate that debt-to-income ratio correlates with loan performance, as 
measured by delinquency rate (where delinquency is defined as being 
over 60 days late), in any credit cycle. Within a typical range of 
debt-to-income ratios for prudent underwriting (e.g., under 32 percent 
debt-to-income to 46 percent debt-to-income), the Bureau notes that 
generally, there is a gradual increase in delinquency with higher debt-
to-income ratio.\150\ The record also shows that debt-to-income ratios 
are widely used as an important part of the underwriting processes of 
both governmental programs and private lenders.
---------------------------------------------------------------------------

    \149\ The FHA's comment letter provided in response to the 2012 
notice to reopen the comment period describes this data.
    \150\ See, e.g., 77 F.R. 33120, 33122-23 (June 5, 2012) (Table 
2: Ever 60+ Delinquency Rates, summarizing the HLP dataset by volume 
of loans and percentage that were ever 60 days or more delinquent, 
tabulated by the total DTI on the loans and year of origination).
---------------------------------------------------------------------------

    The Bureau recognizes the Board's initial assessment that debt-to-
income ratios may not have significant predictive power once the 
effects of credit history, loan type, and loan-to-value are considered. 
In the same vein, the Bureau notes that some commenters suggested that 
the Bureau include compensating factors in addition to a specific debt-
to-income ratio threshold. Even if a standard that takes into account 
multiple factors produces more accurate ability-to-pay determinations 
in specific cases, incorporating a multi-factor test or compensating 
factors into the definition of a qualified mortgage would undermine the 
goal of ensuring that creditors and the secondary market can readily 
determine whether a particular loan is a qualified mortgage. Further, 
the Bureau believes that compensating factors would be too complex to 
calibrate into a bright-line rule and that some compensating factors 
suggested by commenters as appropriate, such as loan-to-value ratios, 
do not speak to a consumer's repayment ability.
    Therefore, as permitted by the statute, the Bureau is adopting a 
specific debt-to-income ratio threshold because this approach provides 
a clear, bright line criterion for a qualified mortgage that ensures 
that creditors in fact evaluate consumers' ability to repay qualified 
mortgages and provides certainty for creditors to know that a loan 
satisfies the definition of a qualified mortgage. A specific debt-to-
income ratio threshold also provides additional certainty to assignees 
and investors in the secondary market, which should help reduce 
possible concerns regarding legal risk and potentially promote credit 
availability. As numerous commenters have urged, there is significant 
value to providing objective requirements that can be determined based 
on loan files. As described below, the final rule generally requires 
creditors to use the standards for defining ``debt'' and ``income'' in 
appendix Q, which are adapted from current FHA guidelines, to minimize 
burden and provide consistent standards. The standards set forth in 
appendix Q provide sufficient detail and clarity to address concerns 
that creditors may not have adequate certainty about whether a 
particular loan satisfies the requirements for being a qualified 
mortgage, and therefore will not deter creditors from providing 
qualified mortgages to consumers. The Bureau anticipates that the 
standards will facilitate compliance with the Dodd-Frank Act risk 
retention requirements, as the 2011 QRM Proposed Rule relied on FHA 
standards for defining ``debt'' and ``income.'' The Bureau has 
consulted with the Federal agencies responsible for the QRM rulemaking 
in developing this rule, and will continue to do so going forward.
    Based on analysis of available data and comments received, the 
Bureau believes that 43 percent is an appropriate ratio for a specific 
debt-to-income threshold, and that this approach advances the goals of 
consumer protection and preserving access to credit. The Bureau 
acknowledges, based on its analysis of the data, that there is no 
``magic number'' which separates affordable from unaffordable 
mortgages; rather, as noted above, there is a gradual increase in 
delinquency rates as debt-to-income ratios increase. That being said, 
the Bureau understands that 43 percent is within the range of debt-to-
income ratios used by many creditors and generally comports with 
industry standards and practices for prudent underwriting. As noted 
above, 43 percent is the threshold used by the FHA as its general 
boundary. Although the Bureau notes that Fannie Mae's and Freddie Mac's 
guidelines generally require a 36 percent debt-to-income ratio, without 
compensating factors, the Bureau believes that a 43 percent debt-to-
income threshold represents an appropriate method to define which loans 
merit treatment as qualified mortgages. In particular, the Bureau 
believes that 43 percent represents a prudent outer boundary for a 
categorical presumption of a consumer's ability to repay.
    As discussed above, there was significant debate among the 
commenters about the precise debt-to-income ratio threshold to 
establish. Although a lower debt-to-income threshold would provide 
greater assurance of a consumer's ability to repay a loan, many 
commenters argued, and the Bureau agrees, that establishing a debt-to-
income ratio threshold significantly below 43 percent would curtail 
many consumers' access to qualified mortgages. One commenter estimated 
that roughly half of conventional borrowers would not be eligible for 
qualified mortgage loans if the debt-to-income ratio was set at 32 
percent, while 85 percent of borrowers would be eligible with a ratio 
set at 45 percent.
    At the same time, the Bureau declines to establish a debt-to-income 
ratio threshold higher than 43 percent. The Bureau recognizes that some 
commenters suggested that debt-to-income ratios above 43 percent would 
not significantly increase the likelihood of default (depending to some 
extent on the presence of compensating factors), and that some 
consumers may face greater difficulty obtaining qualified mortgages 
absent a higher threshold. However, as the debt-to-income ratio 
increases, the presence of compensating factors becomes more important 
to the underwriting process and in ensuring that consumers have the 
ability to repay the loan. The general ability-to-repay procedures, 
rather than the qualified mortgage framework, is better suited for 
consideration of all relevant factors that go to a consumer's ability 
to repay a mortgage loan.
    Thus, the Bureau emphasizes that it does not believe that a 43 
percent debt-to-income ratio represents the outer boundary of 
responsible lending. The Bureau notes that even in today's credit-
constrained market, approximately 22 percent of mortgage loans are made 
with a debt-to-income ratio that exceeds 43 percent and that prior to 
the mortgage boom approximately 20 percent of mortgage loans were made 
above that threshold. Various governmental agencies, GSEs, and 
creditors have developed a range of compensating factors that are 
applied on a case by case basis to assess a consumer's ability to repay 
when the consumer's debt-to-income ratio exceeds a specified ratio. 
Many community banks and credit

[[Page 6528]]

unions have found that they can prudently lend to consumers with a 
higher debt-to-income ratio based upon their firsthand knowledge of the 
individual consumer. As discussed below, many of those loans will fall 
within the temporary exception that the Bureau is recognizing for 
qualified mortgages. Over the long term, as the market recovers from 
the mortgage crisis and adjusts to the ability-to-repay rules, the 
Bureau expects that there will be a robust and sizable market for 
prudent loans beyond the 43 percent threshold even without the benefit 
of the presumption of compliance that applies to qualified mortgages. 
In short, the Bureau does not believe that consumers who do not receive 
a qualified mortgage because of the 43 percent debt-to-income ratio 
threshold should be cut off from responsible credit, and has structured 
the rule to try to ensure that a robust and affordable ability-to-repay 
market develops over time.
    The Bureau also believes that there would be significant negative 
consequences to the market from setting a higher threshold. For 
instance, if the qualified mortgage debt-to-income ratio threshold were 
set above 43 percent, it might sweep in many mortgages in which there 
is not a sound reason to presume that the creditor had a reasonable 
belief in the consumer's ability to repay. At a minimum, adopting a 
higher debt-to-income threshold to define qualified mortgages would 
require a corresponding weakening of the strength of the presumption of 
compliance--which would largely defeat the point of adopting a higher 
debt-to-income threshold. Additionally, the Bureau also fears that if 
the qualified mortgage boundary were to cover substantially all of the 
mortgage market, creditors might be unwilling to make non-qualified 
mortgage loans, with the result that the qualified mortgage rule would 
define the limit of credit availability. The Bureau believes that 
lending in the non-qualified mortgage market can and should be robust 
and competitive over time. The Bureau expects that, as credit 
conditions ease, creditors will continue making prudent, profitable 
loans in non-traditional segments, such as to consumers who have 
sufficient total assets or future earning potential to be able to 
afford a loan with a higher debt-to-income ratio or consumers who have 
a demonstrated ability to pay housing expenses at or above the level of 
a contemplated mortgage.
    Finally, the Bureau acknowledges arguments that residual income may 
be a better measure of repayment ability in the long run. A consumer 
with a relatively low household income may not be able to afford a 43 
percent debt-to-income ratio because the remaining income, in absolute 
dollar terms, is too small to enable the consumer to cover his or her 
living expenses. Conversely, a consumer with a relatively high 
household income may be able to afford a higher debt ratio and still 
live comfortably on what is left over. Unfortunately, however, the 
Bureau lacks sufficient data, among other considerations, to mandate a 
bright-line rule based on residual income at this time. The Bureau 
expects to study residual income further in preparation for the five-
year review of this rule required by the Dodd-Frank Act. See also 
section-by-section analysis of Sec.  1026.43(c)(7).
    The Bureau believes that it is important that the final rule 
provide clear standards by which creditors calculate a consumer's 
monthly debt-to-income ratio for purposes of the specific debt-to-
income threshold in Sec.  1026.43(e)(2)(vi). For this reason, the final 
rule provides specific standards for defining ``debt'' and ``income'' 
in appendix Q. These standards are based on the definitions of debt and 
income used by creditors originating residential mortgages that are 
insured by the FHA. In particular, appendix Q incorporates the 
definitions and standards in the HUD Handbook 4155.1, Mortgage Credit 
Analysis for Mortgage Insurance on One-to-Four-Unit Mortgage Loans, to 
determine and verify a consumer's total monthly debt and monthly 
income, with limited modifications to remove portions unique to the FHA 
underwriting process, such as references to the TOTAL Scorecard 
Instructions. The use of FHA guidelines for this purpose provides 
clear, well-established standards for determining whether a loan is a 
qualified mortgage under Sec.  1026.43(e)(2). This approach is also 
consistent with the proposed approach to defining debt and income in 
the 2011 QRM Proposed Rule, and therefore could facilitate compliance 
for creditors. The Bureau has consulted with the Federal agencies 
responsible for the QRM rulemaking and will continue to do so going 
forward as that rulemaking is completed, as well as to discuss changes 
to FHA guidelines that may occur over time.
    Accordingly, Sec.  1026.43(e)(2)(vi) provides that, as a condition 
to being a qualified mortgage under Sec.  1026.43(e)(2), the consumer's 
total monthly debt-to-income ratio does not exceed 43 percent. For 
purposes of Sec.  1026.43(e)(2)(vi), the consumer's monthly debt-to-
income ratio is calculated in accordance with appendix Q, except as 
provided in Sec.  1026.43(e)(2)(vi)(B). Section 1026.43(e)(2)(vi)(B) 
contains additional requirements regarding the calculation of ``debt,'' 
for consistency with other parts of the qualified mortgage definition 
and Sec.  1026.43. Specifically, that section provides that the 
consumer's monthly debt-to-income ratio must be calculated using the 
consumer's monthly payment on the covered transaction, including 
mortgage-related obligations, in accordance with Sec.  
1026.43(e)(2)(iv), and any simultaneous loan that the creditor knows or 
has reason to know will be made, in accordance with Sec.  
1026.43(c)(2)(iv) and (c)(6). Comment 43(e)(2)(vi)-1 clarifies the 
relationship between the definition of ``debt'' in appendix Q and the 
requirements of Sec.  1026.43(e)(2)(vi)(B). Specifically, the comment 
states that, as provided in appendix Q, for purposes of Sec.  
1026.43(e)(2)(vi), creditors must include in the definition of ``debt'' 
a consumer's monthly housing expense. This includes, for example, the 
consumer's monthly payment on the covered transaction (including 
mortgage-related obligations) and simultaneous loans. Accordingly, 
Sec.  1026.43(e)(2)(vi)(B) provides the method by which a creditor 
calculates the consumer's monthly payment on the covered transaction 
and on any simultaneous loan that the creditor knows or has reason to 
know will be made.
    The Bureau notes that the specific 43 percent debt-to-income 
requirement applies only to qualified mortgages under Sec.  
1026.43(e)(2). For the reasons discussed below, the specific debt-to-
income ratio requirement does not apply to loans that meet the 
qualified mortgage definitions in Sec.  1026.43(e)(4) or (f).
43(e)(3) Limits on Points and Fees for Qualified Mortgages
43(e)(3)(i)
    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 3 percent of the total loan 
amount. TILA section 129C(b)(2)(D) requires the Bureau to prescribe 
rules adjusting this limit to ``permit lenders that extend smaller 
loans to meet the requirements of the presumption of compliance.'' The 
statute further requires the Bureau to ``consider the potential impact 
of such rules on rural areas and other areas where home values are 
lower.'' The statute does not define and the

[[Page 6529]]

legislative history does not provide guidance on the term ``smaller 
loan'' or the phrase ``rural areas and other areas where home values 
are lower.''
    The Board proposed two alternative versions of Sec.  
226.43(e)(3)(i) to implement the 3 percent points and fees cap for 
qualified mortgages and the adjustment to the cap for smaller loans. 
For both alternatives, the Board proposed a threshold of $75,000, 
indexed to inflation, for smaller loans. For loans above the $75,000 
threshold, the 3 percent points and fees cap for qualified mortgages 
would have applied. For loans below $75,000, different limits would 
have applied, depending on the amount of the loan.
    The Board explained that it set the smaller loan threshold at 
$75,000 because it believed that Congress intended the exception to the 
3 percent points and fees cap to apply to more than a minimal, but 
still limited, proportion of home-secured loans. The Board noted that 
HMDA data show that 8.4 percent of first-lien, home-purchase (site-
built) mortgages in 2008 and 9.7 percent of such mortgages in 2009 had 
a loan amount of $74,000 or less. The Board also stated that outreach 
and research indicated that $2,250--3 percent of $75,000--is within 
range of average costs to originate a first-lien home mortgage. Thus, 
the Board concluded that $75,000 appears to be an appropriate benchmark 
for applying the 3 percent limit on points and fees, with higher limits 
below that threshold offering creditors a reasonable opportunity to 
recover their origination costs.
    Both of the Board's proposed alternatives would have separated 
loans into tiers based on loan size, with each tier subject to 
different limits on points and fees. The Board's proposed Alternative 1 
would have consisted of five tiers of loan sizes and corresponding 
limits on points and fees:
     For a loan amount of $75,000 or more, 3 percent of the 
total loan amount;
     For a loan amount greater than or equal to $60,000 but 
less than $75,000, 3.5 percent of the total loan amount;
     For a loan amount greater than or equal to $40,000 but 
less than $60,000, 4 percent of the total loan amount;
     For a loan amount 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 less than $20,000, 5 percent of the 
total loan amount.
    Alternative 2 would have consisted of three tiers of loan sizes and 
corresponding limits on points and fees. The first and third tiers were 
consistent with Alternative 1. The middle tier was a sliding scale that 
reduced the points and fees cap (as a percentage of the loan amount) 
with each dollar increase in loan size. The three tiers of Alternative 
2 would have consisted of:
     For a loan amount of $75,000 or more, 3 percent of the 
total loan amount;
     For a loan amount greater than or equal to $20,000 but 
less than $75,000, a percentage of the total loan amount yielded by the 
following formula:
    [cir] Total loan amount-$20,000 = $Z
    [cir] $Z x 0.0036 basis points = Y basis points
    [cir] 500 basis points-Y basis points = X basis points
    [cir] X basis points x 0.01 = Allowable points and fees as a 
percentage of the total loan amount.
     For a loan amount less than $20,000, 5 percent of the 
total loan amount.
    The approach in Alternative 2 would have smoothed the transition 
from one tier to another and fixed an anomaly of Alternative 1. Under 
Alternative 1, for loans just above and below the dividing line between 
tiers, a greater dollar amount of points and fees would have been 
allowed on the smaller loans than on the larger loans. For example, the 
allowable points and fees on a total loan amount of $76,000 would have 
been $2,280 (3 percent of $76,000), but the permissible points and fees 
on a total loan amount of $70,000 would have been $2,450 (3.5 percent 
of $70,000).
    The Board noted that its proposal was designed 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. The Board stated its belief 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. The Board expressed 
concern that 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.
    The Board requested comment on the proposed alternative loan size 
ranges and corresponding points and fees limits for qualified 
mortgages. The Board also requested comment on whether the loan size 
ranges should be indexed for inflation.
    The Board stated that, instead of using a smaller loan threshold 
with different tiers, it had considered adjusting the criteria for 
smaller loans by narrowing the types of charges that would be included 
in points and fees for smaller loans. The Board indicated that outreach 
participants disfavored this approach because it would have required 
different ways of calculating points and fees, depending on loan size, 
and thus likely would have increased the burden of complying with the 
rules and the risk of error. The Board also stated that it had 
considered proposing an alternative points and fees threshold for 
certain geographical areas. As the Board noted, however, property 
values shift over time, and there is substantial variation in property 
values and loan amounts within geographical areas. Thus, adjusting the 
limits on points and fees based solely on geographic areas would have 
been a less straightforward and less precise method of addressing the 
statute's concern with smaller loans. No commenters supported these 
approaches.
    Several industry commenters argued that points and fees have 
little, if any, relationship to consumers' ability to repay their 
mortgage loans and that qualified mortgages should therefore not be 
subject to limits on points and fees. Although they acknowledged that 
the Dodd-Frank Act generally prescribed a 3 percent limit on points and 
fees for qualified mortgages, they urged the Bureau to use its 
authority to eliminate this requirement.
    Several industry commenters contended that the 3 percent limit on 
points and fees for qualified mortgages is too low. They maintained 
that the 3 percent cap would require creditors to increase interest 
rates to recover their costs and would limit consumers' flexibility to 
arrange their optimal combination of interest rates and points and 
fees. Industry commenters also claimed that the 3 percent limit would 
have a negative impact on consumers' access to affordable credit. Some 
industry commenters noted that the GSEs' seller/servicer guides contain 
standards that limit points and fees for loans that the GSEs purchase 
or securitize, with the current standards limiting points and fees to 
the greater of 5 percent of the mortgage amount or $1,000. The 
commenters argued that Bureau should use its authority adopt the GSEs' 
standards instead of the requirements prescribed by the Dodd-Frank Act. 
One commenter argued that, because of the complexity of the points and 
fees test, the Bureau should adopt a tolerance of one-quarter of 1 
percent or $250 for the 3 percent limit so that de minimis errors in 
calculating points and fees would not prevent a loan from

[[Page 6530]]

retaining the legal protection of a qualified mortgage.
    With respect to the two proposed alternative versions of section 
43(e)(3)(i), industry commenters generally preferred Alternative 1. 
They explained that Alternative 2 was too complex, would be difficult 
to implement, and would increase compliance and litigation costs. Some 
consumer advocates preferred Alternative 2, stating that it would be 
more beneficial to consumers. Other consumer advocates preferred 
Alternative 1, asserting that its simplicity would minimize 
miscalculations that could harm consumers. They stated that the 
difference to the consumer between Alternative 1 and Alternative 2 was 
marginal. Some of these consumer advocates argued that the benefit 
afforded by simplicity would outweigh the small pricing distortions.
    Commenters did not object to the Board's general approach of 
setting a threshold amount for smaller loans and adjusting the points 
and fees cap for loans below the threshold. Instead, the comments 
discussed what the threshold loan amount should be for smaller loans 
and what limits should be imposed on points and fees for loans below 
the threshold.
    Industry commenters contended that the Board's proposed limits on 
points and fees for smaller loans would be too low and would not permit 
creditors to recover their costs. They stated that many origination 
costs are fixed regardless of loan size. They asserted that if a 
creditor could not cover those costs through points and fees, the 
creditor would either not make the mortgage or increase the interest 
rate to cover the costs. Industry commenters expressed concern that, 
for smaller loans, a rate increase might result in the loan becoming a 
high-cost mortgage or in some consumers no longer being eligible for 
the loan. They contended that creditors would be reluctant to make 
these loans and credit availability would be compromised, in particular 
for low-income, minority, and rural consumers, and first-time home 
buyers. One commenter reported that if a consumer were offered a high 
interest rate to cover costs and the rate were increased to offset the 
costs of a smaller loan, the consumer would pay thousands of dollars 
more over the life of the loan. Industry commenters asserted that the 
proposed alternatives did not capture the congressional intent of 
providing creditors sufficient incentives to make smaller loans. 
Industry commenters urged the Bureau to revise the proposal to allow 
creditors to recover more of their costs through points and fees, 
either by increasing the threshold for smaller loans or raising the 
limits for loans below the threshold or by doing both.
    Many industry commenters recommended raising the threshold for 
smaller loans from the $75,000 threshold proposed by the Board. One 
industry commenter suggested setting the threshold at $100,000, indexed 
to inflation. Relying on loan balances for median home prices, another 
industry commenter asked that the Bureau raise the threshold to 
$125,000. Many other industry commenters recommended raising the 
threshold to $150,000. One commenter noted that the average loan size 
in the United States at the end of the second quarter of 2010 was 
$193,800 and suggested using 80 percent of the average loan size, 
rounding off to the nearest $10,000.
    In addition to urging the Bureau to raise the smaller loan 
threshold, many industry commenters recommended that the Bureau revise 
the proposal to permit creditors to charge higher points and fees for 
loans below the smaller loan threshold for qualified mortgages. Several 
industry commenters asked that the Bureau set the cap between 3.5 and 5 
percent, indexed to inflation, for all loans under the smaller loans 
threshold. One industry commenter noted that Fannie Mae and Freddie Mac 
permit points and fees up to 5 percent. An industry commenter suggested 
a cap equal to the greater of 3 percent or $2,000, indexed to 
inflation. A combination of industry commenters and consumer advocates 
recommended a cap equal to the greater of 3 percent or $3,000. One 
industry commenter advocated a 4 percent cap for all loans below 
$125,000. Several industry commenters recommended that the cap be set 
at a fixed amount plus a percentage to lessen the impact of moving from 
one tier to the next.
    In support of their arguments to raise the smaller loan threshold 
and to raise the limits on points and fees for loans below the 
threshold, several industry commenters provided data showing that many 
smaller loans would have exceeded the proposed points and fees caps. 
For example, a trade association commenter drew on data submitted by a 
member bank that showed that the majority of loans under $100,000 would 
exceed the points and fees cap, assuming fees paid to an affiliate 
title company were included, and that many loans between $100,000 and 
$150,000 would also exceed the cap. A trade association industry 
commenter shared data from one of its members, a financial services 
provider. The member reviewed over 250,000 of its recent loans and 
found that none of the loans under $75,000 would meet the proposed cap 
and that 50 percent of the loans under $125,000 would meet the cap. 
Several industry commenters reported that if the Bureau raised the 
smaller loan threshold to $150,000, a significantly smaller percentage 
of loans would exceed the points and fees cap.
    A trade association representing the manufactured housing industry 
noted the Board's concern about setting the points and fees cap so high 
that some qualified mortgages would be deemed high-cost mortgages under 
HOEPA. The commenter argued, however, that the Bureau has authority to 
change high-cost mortgage thresholds and urged the Bureau to exercise 
this authority. The commenter cited section 1431 of the Dodd-Frank Act 
for the proposition that the Board may increase the amount of 
origination costs above $1,000 for loans less than $20,000. The 
commenter also said that section 1022 of the Dodd-Frank Act may grant 
the Board authority to exempt certain smaller sized manufactured home 
loans from the 5 percent points and fees caps on high-cost mortgages 
for loans above $20,000, based on asset class, transaction volume, and 
existing consumer protections.
    Consumer advocates generally endorsed the $75,000 threshold for 
smaller loans. They questioned industry concerns that the 3 percent 
threshold would limit the availability of credit for consumers with 
comparatively low loan amounts. Instead, the commenters emphasized the 
importance of ensuring that qualified mortgages are affordable. In 
their view, the 3 percent points and fees cap is a key factor in 
ensuring affordability, so the exception for smaller loans should apply 
to only a limited proportion of loans. Consumer advocates argued that 
the points and fees cap should not exceed the 5 percent HOEPA trigger. 
They asserted that points and fees should be reasonable, reflect actual 
origination costs, and not result in disparate pricing schemes 
disadvantaging consumers with smaller loans.
    One consumer advocate recommended analyzing the impact of a 3 
percent points and fees cap on access to credit for low- and moderate-
income consumers, in particular for Community Reinvestment Act loans. 
The commenter asked that the Bureau describe in preamble the results of 
any analysis of points and fees by loan amount, and for Community 
Reinvestment Act and non-Community Reinvestment Act loans.
    In light of these comments, the Bureau is adopting revised

[[Page 6531]]

Sec.  1026.43(e)(3)(i) to implement the limits on points and fees for 
qualified mortgages. As noted above, several industry commenters argued 
that points and fees have little if any bearing on consumers' ability 
to repay their mortgage loans and that the points and fees limits would 
result in higher interest rates and reduced access to credit. They 
urged the Bureau to use its authority to eliminate the limits on points 
and fees for qualified mortgages. As an alternative to eliminating the 
points and fees limits entirely, some industry commenters requested 
that the Bureau adopt the GSEs' standards limiting points and fees for 
loans that they purchase or securitize. Those standards currently limit 
points and fees to the greater of 5 percent of the loan amount or 
$1,000.
    The Bureau does not believe it would be appropriate to eliminate 
the limits on points and fees for qualified mortgages. The Bureau also 
declines to adopt the GSEs' current standards and raise the general 3 
percent limit on points and fees. The goal of TILA section 129C is to 
assure that consumers are able to repay their mortgages over the term 
of the loans. Originators that make large sums up front may be less 
careful in assuring the consumers' ability to repay over time. 
Moreover, Congress may have believed that the points and fees limits 
may deter originators from imposing unnecessary or excessive up-front 
charges. In the absence of persuasive evidence that the points and fees 
limits will undermine consumers' access to affordable credit, the 
Bureau does not believe it would be appropriate to eliminate the points 
and fees limits or to raise the general 3 percent limit. As discussed 
in more detail below, however, the Bureau is implementing revised 
points and fees limits for smaller loans. The Bureau also notes that 
the Dodd-Frank Act did not adopt a tolerance that would allow creditors 
to exceed the points and fees limits by small amounts and declines to 
adopt such a tolerance.
    As noted above, a consumer advocate requested that the Bureau 
conduct an analysis of the 3 percent points and fees cap on access to 
credit for low- and moderate-income consumers, in particular for 
Community Reinvestment Act loans. Given the lack of available data, it 
has not been practicable for the Bureau to perform such an analysis 
while finalizing this and other title XIV rules. The Bureau will 
consider whether it is possible and valuable to conduct such an 
analysis in the future.
    Revised Sec.  1026.43(e)(3)(i) employs an approach similar to that 
proposed by the Board to implement the 3 percent cap on points and fees 
and the adjustment to the cap for smaller loans. Like the Board's 
proposal, Sec.  1026.43(e)(3)(i) sets a threshold for smaller loans, 
establishes tiers based on loan size, and sets limits on points and 
fees within each tier. However, Sec.  1026.43(e)(3)(i) uses a mix of 
percentage and flat dollar limits to avoid anomalous results at tier 
margins and also adjusts the definition of smaller loan to include more 
transactions.
    Although most commenters favored this tiering methodology, as noted 
above, some commenters suggested that the Bureau reject the Board's 
tiered approach and instead adopt a simpler mechanism, with all loan 
amounts below the threshold subject to a single percentage cap or 
dollar amount cap on points and fees. Like the Board, the Bureau 
believes the tiered approach provides a more flexible and calibrated 
mechanism for implementing the limits on points and fees for smaller 
loans. A single percentage cap that would apply to all smaller loans 
may not allow creditors a reasonable opportunity to recover costs for 
very small loans. It also may create a distortion in which loans just 
below the smaller loan threshold would be permitted to have 
significantly higher points and fees than loans just above the smaller 
loan threshold. A single dollar amount cap (e.g., $3,000) could result 
in points and fees that are a very high percentage of the very smallest 
loans and, as a result, could result in qualified mortgages also 
triggering the obligations of high-cost mortgages.
    Thus, as in the Board's proposal, the final rule sets a threshold 
for smaller loans and establishes tiers, based on loan size, with 
different limits on points and fees. Specifically, Sec.  
1026.43(e)(3)(i) provides that a transaction is not a qualified 
mortgage unless the total points and fees payable in connection with 
the loan do not exceed:
     For a loan amount greater than or equal to $100,000, 3 
percent of the total loan amount;
     For a loan amount greater than or equal to $60,000 but 
less than $100,000, $3,000;
     For a loan amount greater than or equal to $20,000 but 
less than $60,000, 5 percent of the total loan amount;
     For a loan amount greater than or equal to $12,500 but 
less than $20,000, $1,000 of the total loan amount;
     For a loan amount of less than $12,500, 8 percent of the 
total loan amount.
    The Bureau's final rule departs from the proposal in two ways. 
First, Sec.  1026.43(e)(3)(i) raises the threshold for smaller loans to 
$100,000. Second, for loans below the $100,000 threshold, Sec.  
1026.43(e)(3)(i) revises the points and fees caps for smaller loans 
within the various tiers. The general effect of these revisions will be 
to increase the points and fees that creditors can charge for smaller 
loans while still permitting those loans to meet the standard for a 
qualified mortgage. These two changes are discussed at greater length 
below.
$100,000 Threshold for Smaller Loans
    To fulfill the stated purpose of the adjustment for smaller loans, 
the threshold should be set at a level that is sufficient to permit 
creditors making smaller loans a reasonable opportunity to recoup their 
origination costs and still offer qualified mortgages but not so high 
as to cause loans to exceed the HOEPA threshold to become high-cost 
mortgages. As noted above, the Board proposed to set the smaller loan 
threshold so that three percent of that amount would have provided 
creditors with a reasonable opportunity to recover their costs, with 
loans below that threshold subject to higher caps on points and fees. 
Thus, the Board's proposed $75,000 threshold would have created a 
benchmark of $2,250. The Board stated that its outreach and research 
indicated that $2,250 would be within the range of average costs to 
originate a first-lien home mortgage. However, as noted above, several 
industry commenters reported, based on recent loan data, that 
creditors' points and fees often exceed $2,250 for smaller loans and 
that a significant number of loans above $75,000 would exceed the three 
percent cap.\151\
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    \151\ As the Board noted, resources that provide data on 
origination costs tend to use different methodologies to calculate 
points and fees and do not use the methodology prescribed under TILA 
as amended by the Dodd-Frank Act. The same concerns apply to 
commenters' data on points and fees.
---------------------------------------------------------------------------

    This evidence suggests that the $2,250 benchmark (and the 
corresponding $75,000 smaller loan threshold) in the proposal could 
have been insufficient to permit creditors to recoup all or even most 
of their origination costs. The Bureau is aware that the commenters' 
loan data reflects creditors' points and fees, and not the underlying 
costs. Nevertheless, the evidence that substantial proportions of 
smaller loans would have exceeded the points and fees limits raises 
concerns that the creditors would not be able to recover their costs 
through points and fees and still originate qualified mortgages. 
Creditors that are unable to recover their origination costs through 
points and fees would have to attempt to recover those costs through 
higher rates. If the higher rates would trigger the additional

[[Page 6532]]

regulatory requirements applicable to high-cost loans under HOEPA or 
would render some potential consumers ineligible, then access to credit 
for at least some consumers could be compromised. Moreover, for 
consumers who plan to remain in their homes (and their loans) for a 
long time, a higher interest rate would result in higher payments over 
the life of the loan.
    Some commenters claimed that a substantial portion of loans up to 
$125,000 or $150,000 would exceed the 3 percent points and fees cap and 
that the Bureau should raise the threshold accordingly. The Bureau 
disagrees for two reasons. First, this would stretch the meaning of 
``smaller loans.'' In 2011, slightly under 21 percent of first-lien 
home mortgages were below $100,000 and another 22 percent were between 
$100,000 and $150,000. Thus, increasing the threshold to $150,000 would 
more than double the number of loans entitled to an exception to the 
congressionally-established points and fees cap and would capture over 
40 percent of the market. The Bureau believes that this would be an 
overly expansive construction of the term ``smaller loans'' for the 
purpose of the exception to the general rule capping points and fees 
for qualified mortgages at 3 percent. Such a broad definition of 
``smaller loans'' could allow the exception to undermine the cap on 
points and fees and frustrate congressional intent that qualified 
mortgages include limited points and fees. The function of the smaller 
loan exception to the points and fees cap is to make it possible for 
creditors making smaller loans to originate qualified mortgages. The 
smaller loan exception should provide creditors a reasonable 
opportunity to recover most, if not all, of their origination costs for 
smaller loans and still originate qualified mortgages. It should not be 
transformed into a mechanism that ensures that creditors can continue 
to charge the same points and fees they have in the past and still have 
their loans meet the qualified mortgage standard.
    The Bureau concludes that a $100,000 small loan threshold strikes 
an appropriate balance between congressional goals of allowing 
creditors offering smaller loans to meet the standard for qualified 
mortgages and ensuring that qualified mortgages include limited points 
and fees. The $100,000 threshold (and, as discussed below, the 
corresponding adjustments to the points and fees limits for loans under 
that threshold) should provide creditors with a reasonable opportunity 
to recover most, if not all, of their origination costs through points 
and fees, reducing the likelihood that any increase in rates would 
trigger obligations of high-cost loans or would cause loans to be 
higher-priced covered transactions under Sec.  1026.43(b)(4). At the 
same time, the $100,000 threshold would not render the smaller loan 
exception so broad that it undermines the general 3 percent cap on 
points and fees. It would cover a significant but still limited 
proportion of mortgages. According to the 2011 Home Mortgage Disclosure 
Act \152\ (HMDA) data, 20.4 percent of first-lien home purchase 
mortgages and 20.9 percent of first-lien refinances were less than 
$100,000.\153\
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    \152\ 12 U.S.C. 2801 et seq.
    \153\ The proportion of loans under the $100,000 threshold would 
of course be larger than under a $75,000 threshold. As indicated in 
the Board's proposal, in 2008, 8.3 percent of first-lien home 
purchase mortgages and 7.6 percent of refinances were under $75,000 
for owner-occupied, one- to four-family, site-built properties. 
According to 2011 HMDA data, 10.6 percent of first-lien home 
purchases and 11 percent of first-lien refinances were under 
$75,000. Nevertheless, the Bureau believes that the $100,000 
threshold is sufficiently limited that it remains faithful to the 
statute's framework, with the smaller loan exception not undermining 
the general 3 percent limit on points and fees.
---------------------------------------------------------------------------

Limits on Points and Fees for Smaller Loans
    In addition to raising the smaller loan threshold to $100,000, 
Sec.  1026.43(e)(3)(i) also differs from the Board's proposal by 
setting higher limits on points and fees for smaller loans. As noted 
above, the Bureau is concerned that the Board's proposal would not have 
provided creditors with a reasonable opportunity to recover their 
origination costs. Thus, Sec.  1026.43(e)(3)(i) allows creditors higher 
limits on points and fees for smaller loans. Specifically, for loans of 
$60,000 up to $100,000, Sec.  1026.43(e)(3)(i) allows points and fees 
of no more than $3,000. For loans of $20,000 up to $60,000, Sec.  
1026.43(e)(3)(i) allows points and fees of no more than 5 percent of 
the total loan amount. For loans of $12,500 up to $20,000, Sec.  
1026.43(e)(3)(i) allows points and fees of no more than $1,000. For 
loan amounts less than $12,500, Sec.  1026.43(e)(3)(i) allows points 
and fees of no more than 8 percent of the total loan amount.
    In contrast with the Board's proposed Alternative 1, Sec.  
1026.43(e)(3)(i) creates smooth transitions between the tiers. As noted 
above, under Alternative 1, the one-half percent changes in the points 
and fees cap between tiers would have produced the anomalous result 
that some smaller loans would have been permitted to include a higher 
dollar amount of points and fees than larger loans. While proposed 
Alternative 2 would have avoided this problem, it would also have been 
somewhat more complex, thereby increasing the risk of errors. The tiers 
in Sec.  1026.43(e)(3)(i) all feature easy-to-calculate limits, making 
compliance easier.
    Finally, the three lower tiers are tied to the comparable 
thresholds for high-cost loans to ensure that the points and fees on 
loans that satisfy the qualified mortgage standard do not trigger the 
additional obligations of high-cost mortgages. Under TILA as amended, a 
high-cost mortgage has points and fees equal to 5 percent of the total 
transaction amount if the transaction is $20,000 or more, and points 
and fees equal to the lesser of 8 percent of the total transaction 
amount or $1,000, if the transaction is less than $20,000. See TILA 
section 103(bb)(1)(A)(ii)(I) and (II). Setting the maximum points and 
fees caps based on the HOEPA triggers will help ensure that a qualified 
mortgage is not a high-cost mortgage because of the points and fees.
    Proposed comment 43(e)(3)(i)-1 would have cross-referenced comment 
32(a)(ii)-1 for an explanation of how to calculate the ``total loan 
amount.'' The Bureau adopts comment 43(e)(3)(i)-1 substantially as 
proposed, but it adds an explanation for tiers in which the prescribed 
points and fees limit is a fixed dollar amount rather than a percentage 
and revises the cross-reference because the explanation of calculating 
``total loan amount'' is moved to comment 32(b)(5)(i)-1.
    Proposed comment 43(e)(3)(i)-2 would have explained 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. The 
Bureau adopts comment 43(e)(3)(i)-2 substantially as proposed, but it 
revises some of the limits to reflect the changes described above.
    Proposed comment 43(e)(3)(i)-3 would have provided examples of 
calculations for different loan amounts. The Bureau adopts comment 
43(e)(3)(i)-3 with revisions to reflect the changes to some of the 
limits described above.
Impact on Rural Areas and Other Areas Where Home Values Are Lower
    TILA section 129C(b)(2)(D) requires the Bureau to consider the 
rules' potential impact on ``rural areas and other areas where home 
values are lower.'' The Bureau considered the concerns raised by 
industry commenters that if the limits on points and fees for smaller 
loans were set too low, access to credit could be impaired, in 
particular

[[Page 6533]]

for low income, minority, and rural consumers, and first-time home 
buyers. Setting the threshold for smaller loans too low may also 
negatively affect access to credit for manufactured housing, which 
disproportionately serves lower-income consumers and rural areas. The 
higher threshold and higher limits on points and fees for smaller loans 
should help to ensure that creditors are able to offer qualified 
mortgages in rural areas and other areas where home values are lower.
    The Bureau declines to adopt the recommendation of one commenter 
that it exempt smaller loans for manufactured homes from the points and 
fees triggers for high-cost mortgages. Section 1431 of the Dodd Frank 
Act provides that a loan of $20,000 or more is deemed a high-cost 
mortgage if total points and fees exceed 5 percent of the total 
transaction amount and that a loan of less than $20,000 is deemed a 
high-cost mortgage if total points and fees exceed the lesser of 8 
percent of the total transaction amount or $1,000, or other such dollar 
amount as the Bureau may prescribe by regulations. Such a change is 
beyond the scope of this rulemaking and is more appropriately addressed 
in the parallel HOEPA rulemaking.
43(e)(3)(ii)
Bona Fide Third-party Charges and Bona Fide Discount Points
    As discussed in the section-by-section analysis of Sec.  
1026.32(b)(1)(i), the Bureau is moving the provisions excluding certain 
bona fide third-party charges and bona fide discount points to Sec.  
1026.32(b)(1)(i)(D) through (F). The Board had proposed to implement 
these provisions in proposed Sec.  226.43(e)(3)(ii) through (iv).
Indexing Points and Fees Limits for Inflation
    The Board requested comment on whether the loan size ranges for the 
qualified mortgage points and fees limits should be indexed for 
inflation. A few industry commenters recommended that the loan size 
ranges or the permitted dollar amounts of points and fees be adjusted 
for inflation. The Bureau believes that it is appropriate to adjust the 
points and fees limits to reflect inflation. In addition, the Bureau 
notes that, as prescribed by TILA section 103(aa)(3), what was 
originally a $400 points and fees limit for high-cost loans has been 
adjusted annually for inflation, and that the dollar amounts of the new 
high-cost points and fees thresholds in TILA section 
103(bb)(1)(A)(ii)(II) will also be adjusted annually for inflation. The 
Bureau believes the points and fees thresholds for high-cost loans and 
qualified mortgages should be treated consistently with respect to 
inflation adjustments. Accordingly, in new Sec.  1026.43(e)(3)(ii), the 
Bureau provides that the dollar amounts, including the loan amounts, 
shall be adjusted annually to reflect changes in the Consumer Price 
Index for All Urban Consumers (CPI-U). The adjusted amounts will be 
published in new comment 43(e)(3)(ii)-1.
43(e)(4) Qualified Mortgage Defined--Special Rules
    As discussed above, the Bureau is finalizing the general qualified 
mortgage definition in Sec.  1026.43(e)(2). Under that definition, 
qualified mortgages would be limited to loans that satisfy the 
qualified mortgage product feature criteria in the statute (including 
prohibitions on certain risky loan features, limitations on points and 
fees, and the requirement to underwrite to the maximum rate in the 
first five years of the loan), for which the creditor considers and 
verifies the consumer's income and assets and current debt obligations, 
alimony, and child support, and for which the consumer's total (or 
``back-end'') debt-to-income ratio is less than or equal to 43 
percent.\154\
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    \154\ As noted above, the Board proposed two alternative 
definitions of qualified mortgage, but also solicited comment on 
other alternative definitions. The Board specifically requested 
comment 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 those loans. In 
addition, as described above, the Board's proposed comment 43(c)-1 
would have provided that creditors may look to widely accepted 
governmental or non-governmental underwriting standards when 
assessing a consumer's repayment ability under the general ability-
to-repay standard, including assessing the eight specific 
underwriting criteria under proposed Sec. Sec.  226.43(c)(2) and 
(e)(2)(v)-Alternative 2. Similarly, proposed comment 43(c)(7)-1 
would have provided that, to determine the appropriate threshold for 
monthly debt-to-income ratio or residual income, the creditor may 
look to widely accepted governmental and non-governmental 
underwriting standards. As noted, various commenters suggested that 
the final rule should look to certain Federal agency underwriting 
standards for purposes of determining whether a loan has met certain 
aspects of the qualified mortgage definition (for example, debt-to-
income ratios and residual income).
---------------------------------------------------------------------------

    The Bureau believes this approach establishes an appropriate 
benchmark over the long term for distinguishing which loans should be 
presumed to meet the ability-to-repay requirements under the Dodd-Frank 
Act, while also leaving room for the provision of responsible mortgage 
credit over time to consumers with higher debt-to-income ratios under 
the general ability-to-repay requirements. However, the Bureau 
acknowledges it may take some time for the non-qualified mortgage 
market to establish itself in light of the market anxiety regarding 
litigation risk under the ability-to-repay rules, the general slow 
recovery of the mortgage market, and the need for creditors to adjust 
their operations to account for several other major regulatory and 
capital regimes. In light of these factors, the Bureau has concluded 
that it is appropriate to provide a temporary alternative definition of 
qualified mortgage. This will help ensure access to responsible, 
affordable credit is available for consumers with debt-to-income ratios 
above 43 percent and facilitate compliance by creditors by promoting 
the use of widely recognized, federally-related underwriting standards.
    Under this temporary provision, as a substitute for the general 
qualified mortgage definition in Sec.  1026.43(e)(2), which contains a 
43 percent debt-to-income ratio threshold, the final rule provides a 
second definition of qualified mortgage in Sec.  1026.43(e)(4) for 
loans that meet the prohibitions on certain risky loan features (e.g., 
negative amortization and interest only features) and the limitations 
on points and fees under Sec.  1026.43(e)(2) and are eligible for 
purchase or guarantee by the GSEs, while under the conservatorship of 
the FHFA, or eligible to be insured or guaranteed by the U.S. 
Department of Housing and Urban Development under the National Housing 
Act (12 U.S.C. 1707 et seq.) (FHA), the VA, the USDA, or the Rural 
Housing Service (RHS).\155\ The FHA, VA, USDA, and RHS have authority 
under the statute to define qualified mortgage standards for their own 
loans, so coverage under Sec.  1026.43(e)(4), will sunset once each 
agency promulgates its own qualified mortgage standards, and such rules 
take effect. See TILA section 129C(b)(3)(ii). Coverage of GSE-eligible 
loans will sunset when conservatorship ends.
---------------------------------------------------------------------------

    \155\ Eligibility standards for the GSEs and Federal agencies 
are available at: Fannie Mae, Single Family Selling Guide, https://www.fanniemae.com/content/guide/sel111312.pdf; Freddie Mac, Single-
Family Seller/Servicer Guide, http://www.freddiemac.com/sell/guide/; 
HUD Handbook 4155.1, http://www.hud.gov/offices/adm/hudclips/handbooks/hsgh/4155.1/41551HSGH.pdf; Lenders Handbook--VA Pamphlet 
26-7, Web Automated Reference Material System (WARMS), http://www.benefits.va.gov/warms/pam26_7.asp; Underwriting Guidelines: 
USDA Rural Development Guaranteed Rural Housing Loan Program, http://www.rurdev.usda.gov/SupportDocuments/CA-SFH-GRHUnderwritingGuide.pdf.
---------------------------------------------------------------------------

    Even if the Federal agencies do not issue additional rules or 
conservatorship does not end, the temporary qualified mortgage 
definition in Sec.  1026.43(e)(4) will expire seven

[[Page 6534]]

years after the effective date of the rule. The Bureau believes that 
this will provide an adequate period for economic, market, and 
regulatory conditions to stabilize. Because the Bureau is obligated by 
statute to analyze the impact and status of the ability-to-repay rule 
five years after its effective date, the Bureau will have an 
opportunity to confirm that it is appropriate to allow the temporary 
provision to expire prior to the sunset. Covered transactions that 
satisfy the requirements of Sec.  1026.43(e)(4) that are consummated 
before the sunset of Sec.  1026.43(e)(4) will retain their qualified 
mortgage status after the temporary definition expires. However, a loan 
consummated after the sunset of Sec.  1026.43(e)(4) may only be a 
qualified mortgage if it satisfies the requirements of Sec.  
1026.43(e)(2) or (f).
    The alternative definition of qualified mortgage recognizes that 
the current mortgage market is especially fragile as a result of the 
recent mortgage crisis. It also recognizes the government's 
extraordinary efforts to address the crisis; GSE-eligible loans, 
together with the other federally insured or guaranteed loans, cover 
roughly 80 percent of the current mortgage market. In light of this 
significant Federal role and the government's focus on affordability in 
the wake of the mortgage crisis, the Bureau believes it is appropriate, 
for the time being, to presume that loans that are eligible for 
purchase, guarantee, or insurance by the designated Federal agencies 
and the GSEs while under conservatorship have been originated with 
appropriate consideration of consumers' ability to repay, where those 
loans also satisfy the requirements of Sec.  1026.43(e)(2) concerning 
restrictions on product features and total points and fees limitations. 
The temporary definition is carefully calibrated to provide a 
reasonable transition period to the general qualified mortgage 
definition, including the 43 percent debt-to-income ratio requirement. 
While this temporary definition is in effect, the Bureau will monitor 
the market to ensure it remains appropriate to presume that the loans 
falling within those programs have been originated with appropriate 
consideration of the consumer's repayment ability. The Bureau believes 
this temporary approach will ultimately benefit consumers by minimizing 
any increases in the cost of credit as a result of this rule while the 
markets adjust to the new regulations.
    The Bureau believes this temporary alternative definition will 
provide an orderly transition period, while preserving access to credit 
and effectuating the broader purposes of the ability-to-repay statute 
during the interim period. The Bureau believes that responsible loans 
can be made above a 43 percent debt-to-income ratio threshold, and has 
consciously structured the qualified mortgage requirements in a way 
that leaves room for responsible lending on both sides of the qualified 
mortgage line. The temporary exception has been carefully structured to 
cover loans that are eligible to be purchased, guaranteed, or insured 
by the GSEs (while in conservatorship) or Federal agencies regardless 
of whether the loans are actually so purchased, guaranteed, or insured; 
this will leave room for private investors to return to the market and 
secure the same legal protection as the GSEs and Federal agencies. At 
the same time, as the market recovers and the GSEs and FHA are able to 
reduce their presence in the market, the percentage of loans that are 
granted qualified mortgage status under the temporary definition will 
shrink towards the long-term structure.
    In addition to being a loan that is eligible to be made, 
guaranteed, or insured by the above-described Federal agencies or the 
GSEs while in conservatorship, to meet the definition of qualified 
mortgage under Sec.  1026.43(e)(4), the loan must satisfy the statutory 
qualified mortgage criteria regarding prohibitions on certain risky 
loan features and limitations on points and fees. Specifically, Sec.  
1026.43(e)(4)(i) provides that, notwithstanding Sec.  1026.43(e)(2), a 
qualified mortgage is a covered transaction that satisfies the 
requirements of Sec.  1026.43(e)(2)(i) through (iii). As discussed 
above, those provisions require: that the loan provide for regular 
periodic payments that do not result in an increase of the principal 
balance, allow the consumer to defer repayment of principal, or result 
in a balloon payments; that the loan term does not exceed 30 years; and 
that the total points and fees payable in connection with the loan do 
not exceed the threshold set forth in Sec.  1026.43(e)(3). As described 
further below, the temporary definition does not include requirements 
to (1) verify and document the consumer's income or assets relied upon 
in qualifying the consumer; (2) underwrite a fixed rate loan based on a 
payment schedule that fully amortizes the loan over the term and takes 
into account all applicable taxes, insurance, and assessments; or (3) 
underwrite an adjustable-rate loan using the maximum interest rate 
permitted in the first five years. The Bureau highlights that a loan 
need not be actually purchased or guaranteed by the GSEs or insured or 
guaranteed by the above-listed Federal agencies to qualify for the 
temporary definition in Sec.  1026.43(e)(4). Rather, the loan need only 
be eligible for such purchase, guarantee, or insurance.
    Notably, the temporary qualified mortgage definition does not 
include ``jumbo loans.'' The Bureau does not believe that creditors 
making jumbo loans need the benefit of the temporary exception, as the 
Bureau views the jumbo market as already robust and stable. Jumbo loans 
can still be qualified mortgages if they meet the general rule (i.e. 
are within the 43 percent debt-to-income ratio and underwritten in 
accordance with the general qualified mortgage requirements).
    Section 1026.43(e)(4)(iii) contains the sunset provisions for the 
special qualified mortgage definition in Sec.  1026.43(e)(4). 
Specifically, Sec.  1026.43(e)(4)(iii)(A) provides that each respective 
special rule in Sec.  1026.43(e)(4)(ii)(B) (FHA loans), (e)(4)(ii)(C) 
(VA loans), (e)(4)(ii)(D) (USDA loans); and (e)(4)(ii)(E) (RHS loans) 
shall expire on the effective date of a rule issued by each respective 
agency pursuant to its authority under TILA section 129C(b)(3)(ii) to 
define a qualified mortgage. Section 1026.43(e)(4)(iii)(B) provides 
that, unless otherwise expired under Sec.  1026.43(e)(4)(iii)(A), the 
special rules in Sec.  1026.43(e)(4) are available only for covered 
transactions consummated on or before a date that is seven years after 
the effective date of this rule.
    Comment 43(e)(4)-1 provides additional clarification regarding the 
special qualified mortgage definition. Specifically, the comment 
provides that, subject to the sunset provided under Sec.  
1026.43(e)(4)(iii), Sec.  1026.43(e)(4) provides an alternative 
definition of qualified mortgage to the definition provided in Sec.  
1026.43(e)(2). To be a qualified mortgage under Sec.  1026.43(e)(4), 
the creditor must satisfy the requirements under Sec. Sec.  
1026.43(e)(2)(i) through (iii), in addition to being one of the types 
of loans specified in Sec. Sec.  1026.43(e)(4)(ii)(A) through (E).
    Comment 43(e)(4)-2 clarifies the effect that a termination of 
conservatorship would have on loans that satisfy the qualified mortgage 
definition under Sec.  1026.43(e)(4) because of their eligibility for 
purchase or guarantee by Fannie Mae or Freddie Mac. The comment 
provides that Sec.  1026.43(e)(4)(ii)(A) requires that a covered 
transaction be eligible for purchase or guarantee by Fannie Mae or 
Freddie Mac (or any limited-life regulatory entity succeeding the 
charter

[[Page 6535]]

of either) operating under the conservatorship or receivership of the 
FHFA pursuant to section 1367 of the Federal Housing Enterprises 
Financial Safety and Soundness Act of 1992 (12 U.S.C. 4617), as amended 
by the Housing and Economic Recovery Act of 2008). The special rule 
under Sec.  1026.43(e)(4)(ii)(A) does not apply if Fannie Mae or 
Freddie Mac (or any limited-life regulatory entity succeeding the 
charter of either) has ceased operating under the conservatorship or 
receivership of the FHFA. For example, if either Fannie Mae or Freddie 
Mac (or succeeding limited-life regulatory entity) ceases to operate 
under the conservatorship or receivership of the FHFA, Sec.  
1026.43(e)(4)(ii)(A) would no longer apply to loans eligible for 
purchase or guarantee by that entity; however, the special rule would 
be available for a loan that is eligible for purchase or guarantee by 
the other entity still operating under conservatorship or receivership.
    Comment 43(e)(4)(iii)-3 clarifies that the definition of qualified 
mortgage under Sec.  1026.43(e)(4) applies only to loans consummated on 
or before a date that is seven years after the effective date of the 
rule, regardless of whether Fannie Mae or Freddie Mac (or any limited-
life regulatory entity succeeding the charter of either) continues to 
operate under the conservatorship or receivership of the FHFA. 
Accordingly, Sec.  1026.43(e)(4) is available only for covered 
transactions consummated on or before the earlier of either: (i) The 
date Fannie Mae or Freddie Mac (or any limited-life regulatory entity 
succeeding the charter of either), respectively, cease to operate under 
the conservatorship or receivership of the FHFA pursuant to section 
1367 of the Federal Housing Enterprises Financial Safety and Soundness 
Act of 1992 (12 U.S.C. 4617), as amended by the Housing and Economic 
Recovery Act of 2008; or (ii) a date that is seven years after the 
effective date of the rule, as provided by Sec.  1026.43(e)(4)(iii).
    Finally, comment 43(e)(4)(iii)-4 clarifies that, to satisfy Sec.  
1026.43(e)(4)(ii), a loan need not be actually purchased or guaranteed 
by the GSEs or insured or guaranteed by the FHA, VA, USFA, or RHS. 
Rather, Sec.  1026.43(e)(4)(ii) requires only that the loan be eligible 
for such purchase, guarantee, or insurance. Rather, Sec.  
1026.43(e)(4)(ii) requires only that the loan be eligible for such 
purchase, guarantee, or insurance. For example, for purposes of Sec.  
1026.43(e)(4), a creditor is not required to sell a loan to Fannie Mae 
or Freddie Mac (or any limited-life regulatory entity succeeding the 
charter of either) to be a qualified mortgage. Rather, the loan must be 
eligible for purchase or guarantee by Fannie Mae or Freddie Mac (or any 
limited-life regulatory entity succeeding the charter of either), 
including satisfying any requirements regarding consideration and 
verification of a consumer's income or assets, current debt 
obligations, and debt-to-income ratio or residual income. To determine 
eligibility, a creditor may rely on an underwriting recommendation 
provided by Fannie Mae and Freddie Mac's Automated Underwriting Systems 
(AUSs) or written guide. Accordingly, a covered transaction is eligible 
for purchase or guarantee by Fannie Mae or Freddie Mac if: (i) The loan 
conforms to the standards set forth in the Fannie Mae Single-Family 
Selling Guide or the Freddie Mac Single-Family Seller/Servicer Guide; 
or (ii) the loan receives an ``Approve/Eligible'' recommendation from 
Desktop Underwriter (DU); or an ``Accept and Eligible to Purchase'' 
recommendation from Loan Prospector (LP).
    The Bureau is finalizing Sec.  1026.43(e)(4) pursuant to its 
authority under TILA section 129C(b)(3)(B)(i) to prescribe regulations 
that revise, add to, or subtract from the criteria that define a 
qualified mortgage upon the findings described above. The Bureau 
believes the temporary qualified mortgage definition is necessary and 
proper to ensure that responsible, affordable mortgage credit remains 
available to consumers in a manner consistent with the purposes of TILA 
section 129C and necessary and appropriate to effectuate the purposes 
of TILA section 129C, which includes assuring that consumers are 
offered and receive residential mortgage loans on terms that reasonably 
reflect their ability to repay the loan.
    As described above, the Bureau believes that the provision of 
qualified mortgage status to loans that are eligible for purchase, 
guarantee, or to be insured by the Federal entities described above 
will provide a smooth transition to a more normal mortgage market. 
Similarly, the Bureau believes that including all loans that are 
eligible to be made, guaranteed, or insured by agencies of the Federal 
government and the GSEs while under conservatorship, will minimize the 
risk of disruption as the market adjusts to the ability-to-repay 
requirements of this rule. This adjustment to the qualified mortgage 
definition will also facilitate compliance with the ability-to-repay 
requirements. The Bureau is also finalizing Sec.  1026.43(e)(4) 
pursuant to its 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 Bureau are necessary and proper to effectuate the purposes of TILA, 
to prevent circumvention or evasion thereof, or to facilitate 
compliance therewith. For the reasons described above, the Bureau 
believes the adjustments to the definition of qualified mortgage are 
necessary to effectuate the purposes of TILA, which include the above-
described purpose of TILA section 129C, among other things, and to 
facilitate compliance therewith.
    The Bureau is exercising this authority to remove certain qualified 
mortgage statutory criteria, as discussed further below, and to add 
criteria related to eligibility for Federal agency programs and GSEs 
while conservatorship, as outlined above, in order to create this 
qualified mortgage definition.
    As noted above, Sec.  1026.43(e)(4) applies to loans that are 
eligible for guarantee or insurance by the Federal agencies listed 
above. The provisions of section 1412 apply to all residential mortgage 
loans, including loans that are eligible for and are guaranteed or 
insured by the Federal agencies listed above. However, TILA section 
129C(b)(3)(B)(ii) provides the Federal agencies listed above with 
authority, in consultation with the Bureau, to prescribe rules defining 
the types of loans they insure, guarantee or administer, as the case 
may be, that are qualified mortgages and such rules may revise, add to, 
or subtract from the criteria used to define a qualified mortgage upon 
certain findings. Consistent with this authority, the Bureau leaves to 
these agencies, in consultation with the Bureau, further prescribing 
qualified mortgage rules defining the types of loans they respectively 
insure, guarantee or administer, and their rules may further revise the 
qualified mortgage criteria finalized in this rule with respect to 
these loans. In light of the Federal agencies' authority in TILA 
section 129C(b)(3)(B)(ii), Sec.  1026.43(e)(4) will sunset once each 
agency has exercised its authority to promulgate their own qualified 
mortgage standards.
    As noted above, the final rule does not specifically include in the 
temporary definition the statutory requirements to (1) verify and 
document the consumer's income or assets relied upon in qualifying the 
consumer; (2) underwrite a fixed rate loan based on a payment schedule 
that fully amortizes the loan over the term and takes into account all 
applicable taxes, insurance,

[[Page 6536]]

and assessments; or (3) underwrite an adjustable-rate loan using the 
maximum interest rate permitted in the first five years. As discussed 
above, the Bureau believes it is appropriate, for the time being, to 
presume that loans that are eligible for purchase, guarantee, or 
insurance by the designated Federal agencies and the GSEs while under 
conservatorship have been originated with appropriate consideration of 
consumers' ability to repay where the loans satisfy the requirements of 
Sec.  1026.43(e)(2) concerning restrictions on product features and 
total points and fees limitations. Layering additional and different 
underwriting requirements on top of the requirements that are unique to 
each loan program would undermine the purpose of the temporary 
definition, namely, to preserve access to credit during a transition 
period while the mortgage industry adjusts to this final rule and 
during a time when the market is especially fragile. Accordingly, as 
noted above, the Bureau is using its authority under TILA section 
129C(b)(3)(B)(i) to remove these statutory requirements from the 
qualified mortgage definition in Sec.  1026.43(e)(4). For similar 
reasons the Bureau is not requiring that loans that meet this qualified 
mortgage definition meet the 43 percent debt-to-income ratio 
requirement in Sec.  1026.43(e)(2). The eligibility requirements of the 
GSEs and Federal agencies incorporate debt-to-income ratio thresholds. 
However, the GSEs and Federal agencies also permit consideration of 
certain compensating factors that are unique to each loan program. The 
Bureau declines to layer an additional debt-to-income ratio requirement 
to avoid undermining the purpose of the temporary qualified mortgage 
definition.
43(f) Balloon-Payment Qualified Mortgages Made by Certain Creditors
    TILA section 129C(b)(2)(E) authorizes the Bureau to permit 
qualified mortgages with balloon payments, provided the loans meet four 
conditions. Specifically, those conditions are that: (1) The loan meets 
certain of the criteria for a qualified mortgage; (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 Bureau; (3) retains the balloon-
payment loans in portfolio; and (4) meets any asset-size threshold and 
any other criteria the Bureau may establish, consistent with the 
purposes of this subtitle.
    The four creditor qualifications are nearly identical to provisions 
in section 1461 of the Dodd-Frank Act, which authorizes the Bureau 
under TILA section 129D(c) to exempt small creditors that operate 
predominantly in rural or underserved areas from a requirement to 
establish escrow accounts for certain first-lien, higher-priced 
mortgage loans. Specifically, the statute authorizes creation of an 
exemption for any creditor that (1) operates predominantly in rural or 
underserved areas; (2) together with all affiliates has total annual 
residential mortgage transaction originations that do not exceed a 
limit set by the Bureau; (3) retains its mortgage debt obligations in 
portfolio; and (4) meets any asset-size thresholds and any other 
criteria that the Bureau may establish.
    The Board interpreted the two provisions as serving similar but not 
identical purposes, and thus varied certain aspects of the proposals to 
implement the balloon-payment qualified mortgage and escrow provisions. 
Specifically, the Board interpreted the qualified mortgage provision as 
being designed to ensure access to credit in rural and underserved 
areas where consumers may be able to obtain credit only from community 
banks offering balloon-payment mortgages, and the escrow provision to 
exempt creditors that do not possess economies of scale to cost-
effectively offset the burden of establishing escrow accounts by 
maintaining a certain minimum portfolio size from being required to 
establish escrow accounts on higher-priced mortgage loans. Accordingly, 
the two Board proposals would have used common definitions of ``rural'' 
and ``underserved,'' but did not provide uniformity in calculating and 
defining various other elements. For the balloon balloon-payment 
qualified mortgage provisions, for instance, the Board's proposed Sec.  
226.43(f) would have required that the creditor (1) in the preceding 
calendar year, have made more than 50 percent of its balloon-payment 
mortgages in rural or underserved areas; and (2) have assets that did 
not exceed $2 billion. The Board proposed two alternatives each for 
qualifications relating to (1) the total annual originations limit; and 
(2) the retention of balloon-payment mortgages in portfolio. The 
proposal also would have implemented the four conditions for balloon-
payment qualified mortgages under TILA section 129C(b)(2)(E) and used 
its adjustment and exception authority to add a requirement that the 
loan term be five years or longer.
    In contrast, the Board's proposal for the escrows exemption under 
proposed Sec.  226.45(b)(2)(iii) would have required that the creditor 
have (1) in the preceding calendar year, have made more than 50 percent 
of its first-lien mortgages in rural or underserved areas; (2) together 
with all affiliates, originated and retained servicing rights to no 
more than 100 first-lien mortgage debt obligations in either the 
current or prior calendar year; and (3) together with all affiliates, 
not maintained an escrow account on any consumer credit secured by real 
property. The Board also sought comment on whether to add a requirement 
for the creditor to meet an asset-size limit and what that size should 
be.
    In both cases, the Board proposed to use a narrow definition of 
rural based on the Economic Research Service (ERS) of the USDA's 
``urban influence codes'' (UICs). The UICs are based on the definitions 
of ``metropolitan statistical areas'' of at least one million residents 
and ``micropolitan statistical areas'' with a town of at least 2,500 
residents, as developed by the Office of Management and Budget, along 
with other factors reviewed by the ERS that place counties into twelve 
separately defined UICs depending on the size of the largest city and 
town in the county. The Board's proposal would have limited the 
definition of rural to certain ``non-core'' counties that are not 
located in or adjacent to any metropolitan or micropolitan area. This 
definition corresponded with UICs of 7, 10, 11, and 12, which would 
have covered areas in which only 2.3 percent of the nation's population 
lives.
    In light of the overlap in criteria between the balloon-payment 
qualified mortgage and escrow exemption provisions, the Bureau 
considered comments responding to both proposals in determining how to 
finalize the particular elements of each rule as discussed further 
below. With regard to permitting qualified mortgages with balloon 
payments generally, consumer group commenters stated that the balloon-
payment qualified mortgage exemption is a discretionary provision, as 
TILA section 129C(b)(2)(E) states that the Bureau ``may'' provide an 
exemption for balloon-payment mortgages to be qualified mortgages, and

[[Page 6537]]

stated that such an exemption should not be provided in the final rule 
because such exemption would have a negative effect on consumers' 
access to responsible and affordable credit. Trade association and 
industry commenters generally supported the balloon-payment qualified 
mortgage exemption, with some comments related to the specific 
provisions that are discussed below. One trade association commented 
that the exemption should extend to all balloon-payment mortgages held 
in portfolio by financial institutions; as such a broader exemption 
would achieve Congress's intent as well as reduce the difficulty that 
creditors would have in complying with the requirements in the 
proposal. Three trade associations and several industry commenters 
commented that the balloon-payment qualified mortgage exemption was 
needed to ensure access to credit for consumers in rural areas because 
smaller institutions in those areas use balloon-payment mortgages to 
control interest rate risk.
    The Bureau believes Congress enacted the exemption in TILA section 
129C(b)(2)(E) because it was concerned that the restrictions on 
balloon-payment mortgages under the ability to repay and general 
qualified mortgage provisions might unduly constrain access to credit 
in rural and underserved areas, where consumers may be able to obtain 
credit only from a limited number of creditors, including some 
community banks that may offer only balloon-payment mortgages. Because 
Congress explicitly set out detailed criteria, indicating that it did 
not intend to exclude balloon-payment mortgages from treatment as 
qualified mortgages that meet those criteria, and the Bureau is 
implementing the statutory exemption for balloon-payment mortgages to 
be qualified mortgages provided they meet the conditions described 
below. The Bureau believes those criteria reflect a careful judgment by 
Congress concerning the circumstances in which the potential negative 
impact from restricting consumers' access to responsible and affordable 
credit would outweigh any benefit of prohibiting qualified mortgages 
from providing for balloon payments. The Bureau therefore believes that 
the scope of the exemption provided in this final rule implements 
Congress's judgment as to the proper balance between those two 
imperatives.
    The Bureau believes that there are compelling reasons underlying 
Congress's decision not to allow balloon-payment mortgages to enjoy 
qualified-mortgage status except in carefully limited circumstances. It 
is the rare consumer who can afford to make a balloon payment when due. 
Thus, ordinarily a consumer facing a balloon payment must obtain new 
financing. Depending on market conditions at the time and also the 
consumer's own economic circumstances, consumers may find it difficult 
to obtain affordable credit. Some consumers may be forced to sell their 
homes to pay off the balloon-payment mortgage. Others may find it 
necessary to take on a new loan on terms that create hardships for the 
consumers. Unscrupulous lenders may seek to take advantage of consumers 
faced with the necessity of making a balloon payment by offering loans 
on predatory terms.
    On the other hand, in rural and other underserved areas, it is not 
uncommon for consumers to seek a mortgage loan of a type that cannot be 
sold on the secondary market, because of special characteristics of 
either the property in question or the consumer. Many community banks 
make mortgages that are held in portfolio in these circumstances. To 
manage interest rate risk and avoid complexities in originating and 
servicing adjustable rate mortgages, these banks generally make 
balloon-payment mortgage loans which the banks roll over, at then 
current market interest rate, when the balloon-payment mortgage comes 
due. For example, data available through the National Credit Union 
Administration indicates that among credit unions which make mortgages 
in rural areas (using the definition of rural described below), 25 
percent make only balloon-payment or hybrid mortgages.
    There are also substantial data suggesting that the small portfolio 
creditors that are most likely to rely on balloon-payment mortgages to 
manage their interest rate risks (or to have difficulty maintaining 
escrow accounts) have a significantly better track record than larger 
creditors with regard to loan performance. As discussed in more depth 
in the 2013 ATR Concurrent Proposal, because small portfolio lenders 
retain a higher percentage of their loans on their own books, they have 
strong incentives to engage in thorough underwriting. To minimize 
performance risk, small community lenders have developed underwriting 
standards that are different than those employed by larger 
institutions. Small lenders generally engage in ``relationship 
banking,'' in which underwriting decisions rely at least in part on 
qualitative information gained from personal relationships between 
lenders and consumers. This qualitative information focuses on 
subjective factors such as consumer character and reliability which 
``may be difficult to quantify, verify, and communicate through the 
normal transmission channels of banking organization.'' \156\ While it 
is not possible to disaggregate the impact of each of the elements of 
the community banking model, the combined effect is highly beneficial. 
Moreover, where consumers have trouble paying their mortgage debt 
obligations, small portfolio creditors have strong incentives to work 
with the consumers to get them back on track, both to protect the 
creditors' balance sheets and their reputations in their local 
communities. Market-wide data demonstrate that loan delinquency and 
charge-off rates are significantly lower at smaller banks than larger 
ones.\157\
---------------------------------------------------------------------------

    \156\ See Allen N. Berger & Gregory F. Udell, Small Business 
Credit Availability and Relationship Lending: The Importance of Bank 
Organizational Structure, 112 Econ. J. F32 (2002).
    \157\ See 2013 ATR Concurrent Proposal; Fed. Deposit Ins. Corp., 
FDIC Community Banking Study, (Dec. 2012), available at http://fdic.gov/regulations/resources/cbi/study.html.
---------------------------------------------------------------------------

    The Bureau believes that these kinds of considerations underlay 
Congress's decision to authorize the Bureau to establish an exemption 
under 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 mortgages. 
Thus, the Bureau concludes that exercising its authority is 
appropriate, but also that the exemption should implement the statutory 
criteria to ensure it effectuates Congress's intent. Accordingly, as 
discussed in more detail below, the Bureau adopts Sec.  1026.43(f) 
largely as proposed but with certain changes described below to 
implement TILA section 129C(b)(2)(E).
    In particular, the Bureau has concluded that it is appropriate to 
make the specific creditor qualifications much more consistent between 
the balloon-payment qualified mortgage and escrow exemptions than 
originally proposed by the Board.\158\ The Bureau believes that this 
approach is justified by several considerations, including the largely 
identical statutory language, the similar congressional intents 
underlying the two provisions, and the fact that requiring small 
creditors operating predominantly in rural or underserved

[[Page 6538]]

areas to track overlapping but not identical sets of technical criteria 
for each separate provision could create unwarranted compliance burden 
that itself would frustrate the intent of the statutes. Although the 
Bureau has recast and loosened some of the criteria in order to promote 
consistency, the Bureau has carefully calibrated the changes to further 
the purposes of each rulemaking and in light of the evidence suggesting 
that small portfolio lenders' relationship banking model provides 
significant consumer protections in its own right.
---------------------------------------------------------------------------

    \158\ The Bureau has similarly attempted to maintain consistency 
between the asset size, annual originations threshold, and 
requirements concerning portfolio loans as between the final rules 
that it is adopting with regard to balloon qualified mortgages and 
the escrow exemption and its separate proposal to create a new type 
of qualified mortgages originated and held by small portfolio 
creditors. The Bureau is seeking comment in that proposal on these 
elements and on whether other adjustments are appropriate to the 
existing rules to maintain continuity and reduce compliance burden. 
See 2013 ATR Concurrent Proposal.
---------------------------------------------------------------------------

    For the foregoing reasons, the Bureau is adopting Sec.  
1026.43(f)(1)(vi) to implement TILA section 129C(b)(2)(E)(iv) by 
providing that a balloon loan that meets the other criteria specified 
in the regulation is a qualified mortgage if the creditor: (1) In the 
preceding calendar year made more than 50 percent of its covered 
transactions secured by a first lien in counties designated by the 
Bureau as ``rural'' or ``underserved''; (2) together with all 
affiliates extended 500 or fewer first-lien covered transactions in the 
preceding calendar year; and (3) has total assets that are less than $2 
billion, adjusted annually for inflation. The final rule also creates 
greater parallelism with the escrow provision with regard to the 
requirement that the affected loans be held in portfolio by requiring 
in both rules that the transactions not be subject to a ``forward 
commitment'' agreement to sell the loan at the time of consummation. 
These qualifications and the other requirements under the final rule 
are discussed in more detail below.
43(f)(1) Exemption
    The Bureau believes that the provisions of TILA section 
129C(b)(2)(E) are designed to require that balloon-payment qualified 
mortgages meet the same criteria for qualified mortgages as described 
in TILA section 129C(b)(2)(A), except where the nature of the balloon-
payment mortgage itself requires adjustment to the general rules. In 
TILA section 129C(b)(2)(A), a qualified mortgage cannot allow the 
consumer to defer repayment of principal. 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 
mortgage over the loan term include the balloon payment itself and, 
therefore, are not substantially equal. Thus, balloon-payment mortgages 
permit the consumer to defer repayment of principal. Additionally, a 
qualified mortgage must explicitly fully amortize the loan amount over 
the loan term and explicitly cannot result in a balloon payment under 
TILA section 129C(b)(2)(A). Since TILA section 129C(b)(2)(A) contains 
these provisions, TILA section 129C(b)(2)(E) exempts balloon-payment 
qualified mortgages from meeting those requirements. TILA section 
129C(b)(2)(E) has additional requirements that a creditor consider the 
consumer's ability to repay the scheduled payments using a calculation 
methodology appropriate for a balloon-payment mortgage.
    Accordingly, the Bureau is adjusting the ability-to-repay 
requirements generally applicable to qualified mortgages under Sec.  
1026.43(e)(2) for the balloon-payment qualified mortgage exemption. 
Requirements that are the same in both the generally applicable 
qualified mortgage requirements and the balloon-payment qualified 
mortgage exemption are specifically described in paragraph (f)(1)(i). 
The requirements in the generally applicable qualified mortgage 
requirements that are inapplicable, for the reasons described below, to 
the balloon-payment qualified mortgage exemption are replaced by 
requirements in paragraph (f)(1)(ii), (iii) and (iv) that specifically 
address the provisions inherent in balloon-payment mortgages.
43(f)(1)(i)
    TILA section 129C(b)(2)(E)(i) requires that a balloon-payment 
qualified mortgage meet all of the criteria for a qualified mortgage, 
except for the provisions that require the loan to have: (1) Regular 
periodic payments that provide for the complete repayment of principal 
over the loan term, (2) terms that do not result in a balloon payment, 
and (3) a payment schedule that fully amortizes the mortgage over the 
loan term taking into account all applicable taxes, insurance and 
assessments. The Board's proposed Sec.  226.43(f)(1)(i) would have 
implemented this provision by requiring that balloon-payment qualified 
mortgages meet the same requirements for other qualified mortgages, 
except for specific provisions of Sec.  226.43(e)(2) that would not 
have to be considered. Commenters did not address these requirements 
specifically. The Bureau is adopting Sec.  1026.43(f)(1)(i) to 
implement TILA section 129C(b)(2)(E)(i) by providing that a balloon-
payment qualified mortgage must meet the criteria for a qualified 
mortgage as required by Sec.  1026.43(e)(2)(i)(A), (e)(2)(ii), 
(e)(2)(iii), and (e)(2)(v). These requirements are similar to the 
requirements in the Board's proposal, except that they are stated as 
affirmative requirements instead of excluding qualified mortgage 
requirements that are not required to be considered for balloon-payment 
qualified mortgages.
    Section 1026.43(f)(1)(i), by exclusion, exempts balloon-payment 
qualified mortgages from the requirements in Sec.  1026.43(e)(2)(i)(B), 
(e)(2)(i)(C), (e)(2)(iv), and (e)(2)(vi), which use calculation 
methodologies that would make the origination of balloon-payment 
qualified mortgages difficult, if not impossible. The requirements in 
subsequent provisions of Sec.  1026.43(f)(1) are adopted below to 
require the consideration of scheduled payments and the debt-to-income 
ratio made in conjunction with alternative calculation methodologies 
that are appropriate for balloon-payment qualified mortgages.
    Comment 43(f)(1)(i)-1 clarifies that a balloon-payment qualified 
mortgage under this exemption must provide for regular periodic 
payments that do not result in an increase of the principal balance as 
required by Sec.  1026.43(e)(2)(i)(A), must have a loan term that does 
not exceed 30 years as required by Sec.  1026.43(e)(2)(ii), must have 
total points and fees that do not exceed specified thresholds pursuant 
to Sec.  1026.43(e)(2)(iii), and must satisfy the consideration and 
verification requirements in Sec.  1026.43(e)(2)(v).
43(f)(1)(ii)
    TILA section 129C(b)(2)(E)(ii) requires a creditor making a 
balloon-payment qualified mortgage to determine that the consumer is 
able to make all scheduled payments, except the balloon payment, out of 
income and assets other than the collateral. TILA section 
129C(b)(2)(E)(iii) requires a creditor making a balloon-payment 
qualified mortgage to determine, among other things, that the scheduled 
payments include mortgage-related obligations. Proposed Sec.  
226.43(f)(1)(ii) would have required that the creditor determine that 
the consumer can make all of the scheduled payments, except for the 
balloon payment, from the consumer's current or reasonably expected 
income or assets other than the dwelling that secures the loan. 
Commenters did not address this requirement specifically. The Bureau is 
adopting Sec.  1026.43(f)(1)(ii) to implement TILA section 
129C(b)(2)(E)(ii) and a portion of TILA section 129C(b)(2)(E)(iii) by 
requiring a creditor to determine that the consumer can make all of the 
payments under the terms of the legal obligation, as described in

[[Page 6539]]

Sec.  1026.43(f)(1)(iv)(A), together with all mortgage-related 
obligations and excluding the balloon payment, from the consumer's 
income or assets other than the dwelling that secures the loan. Comment 
43(f)(1)(ii)-1 provides an example to illustrate the calculation of the 
monthly payment on which this determination must be based. 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.
43(f)(1)(iii)
    TILA section 129C(b)(3)(B)(i) permits the addition of additional 
requirements or revision of the criteria that define a qualified 
mortgage upon the finds discussed below. The Board's proposal did not 
include an explicit requirement to consider the consumer's debt-to-
income ratio in relation to a balloon-payment qualified mortgage. The 
Board, however, sought comment 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. One commenter advocated eliminating the balloon-payment 
qualified mortgage exemption completely as they recommended that 
balloon-payment mortgages should not be permitted at all, but rather 
suggested that the Board and Bureau take steps to make the balloon-
payment qualified mortgage exemption rare.
    As discussed above with regard to other categories of qualified 
mortgages, the Bureau believes consideration of debt-to-income ratio or 
residual income is fundamental to any determination of ability to 
repay. A consumer is able to repay a loan if he or she has sufficient 
funds to pay his or her other obligations and expenses and still make 
the payments required by the terms of the loan. Thus, debt-to-income 
comparisons provide a valuable predictive metric in assessing the 
consumer's repayment ability. The Bureau believes that it would be 
inconsistent with congressional intent to have balloon-payment 
qualified mortgages not meet those same requirements, as modified to 
the particular nature of a balloon-payment mortgage.
    Accordingly, the Bureau is adopting Sec.  1026.43(f)(1)(iii) to 
provide that, to make a balloon-payment qualified mortgage, a creditor 
must consider and verify the consumer's monthly debt-to-income ratio or 
residual income in accordance with Sec.  1026.43(c)(7) by using the 
calculation methodology described in Sec.  1026.43(f)(iv)(A), together 
with all mortgage-related obligations and excluding the balloon 
payment. Comment 43(f)(1)(iii)-1 clarifies that the calculation 
required under Sec.  1026.43(c)(7)(i)(A) should be made using the 
payment calculation methodology under Sec.  1026.43(f)(1)(iv)(A), 
together with all mortgage-related obligations and excluding the 
balloon payment, in order to comply with Sec.  1026.43(f)(1)(iii).
    At the same time, however, the Bureau declines to impose a specific 
debt-to-income or residual threshold for this category of qualified 
mortgages because, as discussed above, the Bureau believes that small 
creditors excel at making highly individualized determinations of 
ability to repay that take into consideration the unique 
characteristics and financial circumstances of the particular consumer. 
While the Bureau believes that many creditors can make mortgage loans 
with consumer debt-to-income ratios above 43 percent that consumers are 
able to repay, the Bureau believes that portfolio loans made by small 
creditors are particularly likely to be made responsibly and to be 
affordable for the consumer even if such loans exceed the 43 percent 
threshold. The Bureau therefore believes that it is appropriate to 
presume compliance even above the 43 percent threshold for small 
creditors who meet the other criteria in Sec.  1026.43(f). The Bureau 
believes that the discipline imposed when small creditors make loans 
that they will hold in their portfolio is sufficient to protect 
consumers' interests in this regard. Because the Bureau is not 
proposing a specific limit on consumer debt-to-income ratio, the Bureau 
does not believe it is necessary to require creditors to calculate 
debt-to-income ratio in accordance with a particular standard such as 
that set forth in appendix Q.
    In adopting this requirement, the Bureau is adding a condition for 
a balloon-payment qualified mortgage that is not established by TILA 
section 129C(b)(2)(E). The Bureau adds this condition pursuant to TILA 
section 129C(b)(3)(B)(i), which authorizes the Bureau ``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.'' A purpose of TILA section 129C, among 
other things, is to ensure that consumers are offered and receive loans 
on terms that they are reasonably able to repay. See TILA section 
129B(a)(2). The Bureau believes that a creditor considering and 
verifying the consumer's monthly debt-to-income ratio or residual 
income in order for the balloon-payment mortgage to qualify as a 
balloon-payment qualified mortgage is necessary, proper, and 
appropriate both to effectuate the purposes of TILA section 129C to 
prevent circumvention or evasion thereof and to ensure that 
responsible, affordable mortgage credit remains available to consumers 
in a manner consistent with the purposes of this section. For these 
reasons, the Bureau believes that Sec.  1026.43(f)(1)(iii), in 
requiring a creditor considering and verifying the consumer's monthly 
debt-to-income ratio or residual income in order for the balloon-
payment mortgage to qualify as a balloon-payment qualified mortgage, 
effectuates the purposes of TILA section 129C and prevents 
circumvention or evasion thereof.
    In addition the Bureau invokes its authority under section 105(a) 
in order to add the above qualification for a balloon-payment qualified 
mortgage. Section 105(a) authorizes the Bureau to issue regulations 
that, among other things, contain such additional requirements, other 
provisions, or that provide for such adjustments for all or any class 
of transactions, that in the Bureau's judgment are necessary or proper 
to effectuate the purposes of TILA, which include the above purpose of 
section 129C, among other things. See 15 U.S.C. 1604(a). The Bureau 
believes that this addition to the qualified mortgage criteria is 
necessary and proper to achieve this purpose.
43(f)(1)(iv)
    TILA section 126C(b)(2)(E)(iii) and the Board proposal require that 
the loan be underwritten with specific payment calculation 
methodologies to qualify as a balloon-payment qualified mortgage. The 
underwriting of a loan is based on the terms of the legal obligation. 
The general requirements of a qualified mortgage in Sec.  1026.43(e)(2) 
govern loans secured by real property or a dwelling with multiple 
methods of payment calculations, terms, and conditions. However, unlike 
other the types of qualified mortgage, the balloon-payment qualified 
mortgage deals with a specific type of transaction, a balloon-payment 
mortgage, with specific characteristics that are described in the legal

[[Page 6540]]

obligation. Therefore, the Bureau considers the requirement of TILA 
section 129C(b)(2)(E)(iii) to be requirements relating to the terms of 
the legal obligation of the loan. Accordingly, the Bureau is adopting 
Sec.  1026.43(f)(1)(iv), requiring the legal obligation of a balloon-
payment qualified mortgage to have the following terms: (1) Scheduled 
payments that are substantially equal and calculated on an amortization 
period that does not exceed 30 years; (2) the interest rate does not 
vary during the loan term, and (3) the loan term is for five years or 
longer.
Scheduled Payments
    TILA section 129C(b)(2)(E)(iii) requires 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. The Board's proposed Sec.  226.43(f)(1)(iii) incorporated 
this statutory requirement. Commenters did not address this requirement 
specifically.
    The Bureau is adopting the Board's proposal and implements Sec.  
1026.43(f)(1)(iv) to require that the scheduled payments, on which the 
determinations required by Sec.  1026.43(f)(1)(ii) and (f)(1)(iii) are 
based, are calculated using an amortization period that does not exceed 
30 years. The requirement that the payments include all mortgage-
related obligations is required as part of Sec.  1026.43(f)(1)(ii), 
above. The Bureau 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). Comment 43(f)(1)(iv)-1 clarifies that 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.
    In its proposal, the Board sought comment on whether a balloon-
payment mortgage with interest-only payments should qualify for the 
balloon-payment exemption. One association of State bank regulators 
commented that loans with interest-only payments would be properly 
excluded from the exemption in order to permit the exemption to be 
available only to those institutions that appropriately utilize the 
balloon-payment mortgages to mitigate interest rate risk. The Bureau 
agrees with this assessment and believes that permitting interest-only 
payments would be contrary to the intent of Congress requiring 
amortizing payments as a requirement of a qualified mortgage, as 
interest-only payments do not provide any reduction in principal. 
Accordingly, the Bureau is adding comment 43(f)(1)(iv)-2 which 
clarifies that a loan that provides for interest-only payments cannot 
qualify for the balloon-payment qualified mortgage exemption, because 
it would not require the consumer to make any payments towards the 
principal balance of the loan contrary to the requirement that the 
scheduled payments result in amortization of the loan for a period that 
does not exceed 30 years.
Fixed Interest Rate
    TILA section 129C(b)(3)(B)(i) permits the addition of additional 
requirements upon the finding that such regulations are necessary or 
proper to ensure that responsible, affordable mortgage credit remains 
available to consumers. The Board's proposal did not include any 
restrictions on the interest rate terms of the loan, but did observe 
that community banks appear to originate balloon-payment mortgages to 
hedge against interest-rate risk. The Board sought comment 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.
    The Bureau believes that the purpose of the exemption was to permit 
balloon-payment mortgages to be originated for those consumers that 
still need or want them, and to permit competition between creditors 
that address interest rate risk through the use of adjustable rate 
mortgages and those creditors that address interest rate risk through 
the use of balloon-payment mortgages. The Bureau believes that 
creditors that have the infrastructure and resources to originate 
adjustable rate mortgages do not need to resort to the use of balloon-
payment mortgages to address interest rate risk. Accordingly, the 
Bureau is adopting Sec.  1026.43(f)(1)(iv)(B), which requires that the 
legal obligation of a balloon-payment qualified mortgage must include 
an interest rate that will not increase during the term of the loan.
    In adopting this requirement, the Bureau is adding a condition for 
a balloon-payment qualified mortgage that is not established by TILA 
section 129C(b)(2)(E). The Bureau adds this condition pursuant to TILA 
section 129C(b)(3)(B)(i), which authorizes the Bureau ``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.'' A purpose of TILA section 129C is to 
ensure that consumers are offered and receive loans on terms that they 
are reasonably able to repay. See TILA section 129B(a)(2). The Bureau 
believes that requiring the legal obligation of a balloon-payment 
qualified mortgage to contain an interest rate that does not increase 
during the loan term is necessary, proper, and appropriate both to 
effectuate the purposes of TILA section 129C and to prevent 
circumvention or evasion thereof and to ensure that responsible, 
affordable mortgage credit remains available to consumers in a manner 
consistent with the purposes of this section. For these reasons, the 
Bureau believes that Sec.  1026.43(f)(1)(iv)(B), in requiring the legal 
obligation of a balloon-payment qualified mortgage to contain an 
interest rate that does not increase during the loan term, effectuates 
the purposes of TILA section 129C and prevents circumvention or evasion 
thereof.
    In addition the Bureau invokes its authority under section 105(a) 
in order to add the above qualification for a balloon-payment qualified 
mortgage. Section 105(a) authorizes the Bureau to issue regulations 
that, among other things, contain such additional requirements, other 
provisions, or that provide for such adjustments for all or any class 
of transactions, that in the Bureau's judgment are necessary or proper 
to effectuate the purposes of TILA, which include the above purpose of 
Section 129C, among other things. See 15 U.S.C. 1604(a). The Bureau 
believes that this addition to the qualified mortgage criteria is 
necessary and proper to achieve this purpose.
Loan Term of Five Years or Longer
    TILA section 129C(b)(3)(B)(i) permits the adoption of additional 
requirements upon the finding that such regulations are necessary or 
proper to ensure that responsible, affordable mortgage credit remains 
available to consumers. The Board's proposed Sec.  226.43(f)(1)(iv) 
would have included the addition of a requirement that a balloon-
payment qualified mortgage must have a loan term of five years or 
longer. One association of State bank regulators and an industry trade 
group commented that

[[Page 6541]]

the five-year term requirement was appropriate, as the time period is 
consistent with other provisions of the proposed rule. One industry 
trade group and one industry commenter commented that three years would 
be a more appropriate term because some of the creditors that would 
qualify under proposed Sec.  226.43(f)(1)(v) utilize three-year terms. 
The Bureau is not persuaded that the exemption was meant by Congress to 
permit any current business practice of creditors that would satisfy 
the requirements of proposed Sec.  226.43(f)(1)(v), rather the 
exemption was meant to provide a reasonable exemption for some balloon-
payment mortgages that still meet other requirements of a qualified 
mortgage. The Bureau 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. See TILA Section 
129C(b)(2)(A)(v). Therefore, the Bureau is adopting the Board's 
proposal by implementing Sec.  1026.43(f)(1)(iv)(C) requiring a loan 
term of five years or longer because it reflects the statutory intent 
that five years is a reasonable period to repay a loan. Since other 
requirements of a qualified mortgage include a review of the mortgage 
over a five-year term, it would be more consistent with the intent of 
the exemption for the balloon-payment mortgage to have at least a five-
year term.
    The Bureau believes that it is appropriate to structure the 
exemption to prevent balloon-payment mortgages 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 mortgage's amortization period and 
its loan term, the more likely the consumer would face this problem. 
The Bureau's requirement of a minimum term therefore complements the 
30-year maximum amortization period prescribed by TILA section 
129C(b)(2)(E)(iii).
    In adopting this requirement, the Bureau is adding a condition for 
a balloon-payment qualified mortgage that is not established by TILA 
section 129C(b)(2)(E). The Bureau adds this condition pursuant to TILA 
section 129C(b)(3)(B)(i), which authorizes the Bureau ``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.'' A purpose of TILA section 129C is to 
ensure that consumers are offered and receive loans on terms that they 
are reasonably able to repay. See TILA section 129B(a)(2). For the 
reasons discussed above, the Bureau believes that a minimum loan term 
for balloon-payment mortgages is necessary and appropriate both to 
effectuate the purposes of TILA section 129C and to prevent 
circumvention or evasion thereof. For these reasons, the Bureau 
believes that Sec.  1026.43(f)(1)(iv)(C), in limiting the exemption 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, effectuates the purposes of TILA 
section 129C and prevents circumvention or evasion thereof. The Bureau 
also believes this minimum loan term for balloon-payment qualified 
mortgages is necessary, proper, and appropriate to ensure that 
responsible, affordable mortgage credit remains available to consumers 
in a manner consistent with the purposes of Section 129C.
    In addition the Bureau invokes its authority under section 105(a) 
in order to add the above qualification for a balloon-payment qualified 
mortgage. Section 105(a) authorizes the Bureau to issue regulations 
that, among other things, contain such additional requirements, other 
provisions, or that provide for such adjustments for all or any class 
of transactions, that in the Bureau's judgment are necessary or proper 
to effectuate the purposes of TILA, which include the above purpose of 
Section 129C, among other things. See 15 U.S.C. 1604(a). The Bureau 
believes that this addition to the qualified mortgage criteria is 
necessary and proper to achieve this purpose.
43(f)(1)(v) and (vi)
    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 Bureau; (3) retains the balloon-
payment loans in portfolio; and (4) meets any asset-size threshold and 
any other criteria as the Bureau may establish. The Board proposed 
Sec.  226.43(f)(1)(v) to impose specific requirements to implement some 
of these elements and sought comment on alternatives to implement 
others. Specifically, the Board: (1) Proposed a requirement that the 
creditor in the preceding year made more than 50 percent of its 
balloon-payment mortgages in rural or underserved areas; (2) sought 
comment on whether to adopt an annual originations limit based on 
either the total volume of mortgages or the total number of mortgages 
made in the last year by the creditor, together with affiliates, 
without proposing a specific threshold; (3) sought comment on two 
alternatives to implement the portfolio requirement by revoking a 
creditor's ability to make balloon-payment qualified mortgages if the 
creditor sold any balloon-payment mortgages either in the last year or 
at any time after the final rule was adopted; and alternatives, and (4) 
did not have assets that exceeded $2 billion, adjusted annually for 
inflation.
    In contrast, the Board's escrows proposal would have implemented 
nearly identical statutory requirements under TILA 129D(c) by requiring 
that the creditor (1) in the preceding calendar year, have made more 
than 50 percent of its first-lien mortgages in rural or underserved 
areas; (2) together with all affiliates, originated and retained 
servicing rights to no more than 100 first-lien mortgage debt 
obligations in either the current or prior calendar year; and (3) not 
be permitted to invoke the exception for any first-lien higher-priced 
mortgage loan that was subject to a ``forward commitment'' to sell the 
loan at the time of consummation. The Board also sought comment on 
whether to impose an asset limit without proposing a specific 
threshold, and proposed to impose a further requirement that the 
creditor and its affiliates not maintain escrow accounts for any other 
loans in order to be eligible for the exception.
    As stated above, the Bureau has considered the comments received 
under both proposals regarding implementation of the largely identical 
statutory criteria, and has concluded that it is appropriate to create 
a much higher degree of consistency between the elements in the two 
individual rules. Implementation of each of the

[[Page 6542]]

statutory elements is discussed further below.
Holding of Balloon-Payment Mortgages in Portfolio
    TILA section 129C(b)(E)(iv) requires that the lender keep balloon-
payment mortgages in portfolio. The Board proposed to implement this 
requirement by removing a creditor's eligibility for the exemption 
under proposed Sec.  226.43(f)(1)(v)(C) if it sold a balloon-payment 
mortgage during two alternative periods, one that would cover any time 
after the adoption of the final rule and another that would look only 
to sales during the preceding or current calendar year. The Board 
concluded that this was the best approach to implement the statutory 
requirement in the qualified mortgage context because it would allow a 
creditor to determine at consummation whether a particular balloon-
payment loan was eligible to be a qualified mortgage and allow the loan 
to maintain such status even if it were sold, while creating strong 
safeguards against gaming of the exception by revoking the creditor's 
ability to invoke the provisions if they began selling such loans to 
other holders.
    In contrast, the Board's 2011 Escrows Proposal would have 
implemented a parallel statutory requirement under TILA section 
129D(c)(3) by looking to whether the particular first-lien, higher-
priced mortgage loan was subject to sale under a ``forward 
commitment.'' Forward commitments are agreements entered into at or 
before consummation of a transaction under which a purchaser is 
committed to acquire the specific loan or loans meeting specified 
criteria from the creditor after consummation. The Board believed that 
the proposal was a reasonable way to implement the statutory 
requirement because it would allow the creditor and consumer to 
determine at consummation whether an escrow requirement was required to 
be established; the Board reasoned that fashioning the rule in a way 
that would require that an escrow account be established sometime after 
consummation if the particular loan was transferred to a non-eligible 
holder would be potentially burdensome to consumers, since the consumer 
may not have the funds available to make a large lump-sum payment at 
that time. At the same time, the Board believed the rule would prevent 
gaming of the escrows exception because it thought that small creditors 
would be reluctant to make a loan that they did not intend to keep in 
their portfolios unless they had the assurance of a committed buyer 
before extending the credit.
    Comments received on the escrows proposal had a divergence of 
opinion on how the forward commitment requirement would work in 
practice. One trade association commenter stated that the forward 
commitment requirement would prevent creditors from selling portfolio 
mortgage debt obligations in the future. This appears to be a 
misreading of the Board's 2011 Escrows Proposal, as it would not have 
restricted the sale of higher-priced mortgage loans. Instead, the 
proposed forward commitment requirement provided that, so long as the 
higher-priced mortgage loan was not subject to a forward commitment at 
the time of consummation, the higher-priced mortgage loan could be sold 
on the secondary market without requiring an escrow account to be 
established at that time. One consumer advocacy group, concerned about 
the possibility that creditors would use the provision to skirt the 
escrow requirements, suggested a blanket rule that higher-priced 
mortgage loans that are exempt must be maintained in the portfolio of 
the creditor or, alternatively, that upon sale secondary market 
purchasers must be required to establish escrow accounts for such 
mortgage debt obligations.
    After consideration of these comments and further analysis of 
parallels between the two rulemakings, the Bureau believes that it is 
useful and appropriate to implement the no-forward-commitment 
requirement in both rules. Accordingly, the Bureau is adding Sec.  
1026.43(f)(1)(v) to provide that a loan is not eligible to be a 
balloon-payment qualified mortgage if it is subject, at consummation, 
to a commitment to be acquired by another person, other than a person 
that separately meets the requirements of Sec.  1026.43(f)(1)(vi). 
Comment 43(f)(1)(v)-1 clarifies that a balloon-payment mortgage that 
will be acquired by a purchaser pursuant to a forward commitment does 
not satisfy the requirements of Sec.  1026.43(f)(1)(v), whether the 
forward commitment refers to the specific transaction or the balloon-
payment mortgage meets prescribed criteria of the forward commitment, 
along with an example. The Bureau believes the rationale for the 
balloon-payment qualified mortgage exemption is not present when a loan 
will be or is eligible to be acquired pursuant to a forward commitment, 
even if the creditor is exempt, as the creditor does not intend to 
retain the balloon-payment mortgage in its portfolio.
    In adopting this requirement, the Bureau is adding a condition for 
a balloon-payment qualified mortgage that is not established by TILA 
section 129C(b)(2)(E). The Bureau is adopting Sec.  1026.43(f)(1)(vi) 
pursuant to TILA section 129C(b)(3)(B)(i), which authorizes the Bureau 
``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.'' A purpose of 
TILA section 129C is to ensure that consumers are offered and receive 
loans on terms that they are reasonably able to repay. See TILA section 
129B(a)(2). The Bureau believes that the prohibition on mortgages 
originated in conjunction with a forward commitment from qualifying as 
a balloon-payment qualified mortgage is necessary, proper, and 
appropriate both to effectuate the purposes of TILA section 129C and to 
prevent circumvention or evasion thereof. For these reasons, the Bureau 
believes that Sec.  1026.43(f)(1)(v), in limiting the exemption for 
balloon-payment qualified mortgages to mortgages that are not 
originated in conjunction with a forward commitment, effectuates the 
purposes of TILA section 129C and prevents circumvention or evasion 
thereof and is necessary, proper, and appropriate to do so. Limiting 
balloon-payment qualified mortgages to those that are not originated in 
conjunction with a forward commitment effectively facilitates 
compliance with the statutory requirement that a balloon-payment 
qualified mortgage is extended by a creditor that retains the balloon-
payment qualified mortgages in portfolio.
    In addition the Bureau invokes its authority under section 105(a) 
in order to add the above qualification for a balloon-payment qualified 
mortgage. Section 105(a) authorizes the Bureau to issue regulations 
that, among other things, contain such additional requirements, other 
provisions, or that provide for such adjustments for all or any class 
of transactions, that in the Bureau's judgment are necessary or proper 
to effectuate the purposes of TILA, which include the above purpose of 
Section 129C, among other things. See 15 U.S.C. 1604(a). The Bureau 
believes that this addition to the

[[Page 6543]]

qualified mortgage criteria is necessary and proper to achieve this 
purpose.
``Operates Predominantly in Rural or Underserved Areas''
    Under TILA section 129C(b)(2)(E)(iv)(I), to qualify for the 
exemption, a creditor must ``operate predominantly in rural or 
underserved areas.'' The Board's proposed Sec.  226.43(f)(1)(v)(A) 
would have required a creditor to have made during the preceding 
calendar year more than 50 percent of its total balloon-payment 
mortgages in ``rural or underserved'' areas. The Board sought comment 
generally on the appropriateness of the proposed approach to implement 
the phrase ``operate predominantly.'' Two trade group commenters 
commented that the balloon exemption should extend to all creditors 
that retain balloon-payment mortgages in their portfolio, and to 
eliminate this proposed requirement, which would have the same effect 
as the extension of the exemption proposed generally, discussed above.
    Overall, the Bureau believes Congress enacted the exemption 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 or credit unions offering balloon-payment 
mortgages. The ``operates predominantly in'' requirement serves to 
limit the exemption to these institutions. To remove this portion of 
the qualifications of the creditor would be to circumvent Congress's 
stated requirement that the exemption was intended for creditors 
operating predominantly in rural and underserved areas and would 
potentially extend the exemption to, for example, a national bank that 
makes loans in rural areas and that is fully capable of putting on its 
balance sheet fixed rate 30-year mortgage loans or adjustable rate 
mortgage loans. The Bureau believes that ``predominantly'' indicates a 
portion greater than half, hence the regulatory requirement of more 
than 50 percent.
    The Board also proposed Sec.  226.43(f)(2) to implement this 
provision by defining the terms ``rural'' and ``underserved,'' which 
are not defined in the statute. The Board's proposed Sec.  226.43(f)(2) 
established separate criteria for both rural and underserved areas. 
Commenters addressing the creditor qualifications under Sec.  
226.43(f)(2) discussed the definitions themselves, and did not comment 
on the necessity of creating definitions for the terms rural and 
underserved. The Bureau is adopting the Board's approach by 
implementing section 1026.43(f)(2) which establishes separate criteria 
for both ``rural'' and ``underserved.'' This means that a property 
could qualify for designation by the Bureau under either definition, 
and that covered transactions made by a creditor in either a rural or 
underserved area will be included in determining whether the creditor 
operates predominantly in such areas.
``Rural''
    As described above, the Board's proposed definition of rural for 
purposes of both the balloon-payment qualified mortgage and escrows 
exception relied upon the USDA ERS ``urban influence codes'' (UICs). 
The UICs are based on the definitions of ``metropolitan'' and 
``micropolitan'' as developed by the Office of Management and Budget, 
along with other factors reviewed by the ERS, which place counties into 
twelve separately defined UICs depending on the size of the largest 
city and town in the county. The Board's proposal would have limited 
the definition of rural to certain ``non-core'' counties that are not 
located in or adjacent to any metropolitan or micropolitan area. This 
definition corresponded with UICs of 7, 10, 11, or 12. The population 
that would have been covered under the Board's proposed definition was 
2.3 percent of the United States population under the 2000 census. The 
Board believed this limited the definition of ``rural'' to those 
properties most likely to have only limited sources of mortgage credit 
because of their remoteness from urban centers and their resources. The 
Board sought comment on all aspects of this approach to defining rural, 
including whether the definition should be broader or narrower.
    Many commenters in both rulemakings, including more than a dozen 
trade group commenters, several individual industry commenters, one 
association of State banking regulators, and a United States Senator, 
suggested that this definition of a rural area was too narrow and would 
exclude too many creditors from qualifying for the balloon-payment 
qualified mortgage exemption and constrain the availability of credit 
to rural properties. The comment from a United States Senator suggested 
using the eligibility of a property to secure a single-family loan 
under the USDA's Rural Housing Loan program as the definition of a 
rural property. A trade association argued that because community banks 
use balloon-payment mortgages to hedge against interest rate risk, the 
exemption should not be confined to rural areas.
    The Bureau agrees that a broader definition of ``rural'' is 
appropriate to ensure access to credit with regard to both the escrows 
and balloon-payment qualified mortgage exemptions. In particular, the 
Bureau believes that all ``non-core'' counties should be encompassed in 
the definition of rural, including counties adjacent to a metropolitan 
area or a county with a town of at least 2,500 residents (i.e., 
counties with a UIC of 4, 6, and 9 in addition to the counties with the 
UICs included in the Board's definition). The Bureau also believes that 
micropolitan areas which are not adjacent to a metropolitan area should 
be included within the definition of rural, (i.e., counties with a UIC 
of 8). These counties have significantly fewer creditors originating 
higher-priced mortgage loans and balloon-payment mortgages than other 
counties.\159\ Including these counties within the definition of rural 
would result in 9.7 percent of the population being included within 
rural areas. Under this definition, only counties in metropolitan areas 
or in micropolitan areas adjacent to metropolitan areas would be 
excluded from the definition of rural.
---------------------------------------------------------------------------

    \159\ A review of data from HMDA reporting entities indicates 
that there were 700 creditors in 2011 that otherwise meet the 
requirements of Sec.  1026.35(b)(2)(iii), of which 391 originate 
higher-priced mortgage loans in counties that meet the definition of 
rural, compared to 2,110 creditors that otherwise meet the 
requirements of Sec.  1026.35(b)(2)(iii) that originate balloon-
payment mortgages in counties that would not be rural. The 391 
creditors originated 12,921 higher-priced mortgage loans, 
representing 30 percent of their 43,359 total mortgage loan 
originations. A review of data from credit unions indicates that 
there were 830 creditors in 2011 that otherwise meet the 
requirements of Sec.  1026.35(b)(2)(iii), of which 415 originate 
balloon-payment and hybrid mortgages in counties that meet the 
definition of rural, compared to 3,551 creditors that otherwise meet 
the requirements of Sec.  1026.35(b)(2)(iii) that originate balloon-
payment mortgages in counties that would not be rural. The 415 
creditors originated 4,980 balloon-payment mortgage originations, 
representing 20 percent of their 24,968 total mortgage loan 
originations.
---------------------------------------------------------------------------

    The Bureau also considered adopting the definition of rural used to 
determine the eligibility of a property to secure a single family loan 
under the USDA's Rural Housing Loan program. For purposes of the Rural 
Housing Loan program, USDA subdivides counties into rural and non-rural 
areas. As a result, use of this definition would bring within the 
definition of rural certain portions of metropolitan and micropolitan 
counties. Given the size of some counties, particularly in western 
States, this approach may provide a more nuanced measure of access to 
credit in some areas than a county-by-

[[Page 6544]]

county metric. However, use of the Rural Housing Loan metrics would 
incorporate such significant portions of metropolitan and micropolitan 
counties that 37 percent of the United States population would be 
within areas defined as rural. Based on a review of HMDA data and the 
location of mortgage transactions originated by HMDA reporting 
entities, the average number of creditors in the areas that would meet 
the USDA's Rural Housing Loan program definition of rural is ten. The 
Bureau believes that a wholesale adoption of the Rural Housing Loan 
definitions would therefore expand the definition of rural beyond the 
intent of the escrow and balloon-payment qualified mortgage exemptions 
under sections 1412 and 1461 of the Dodd-Frank Act by incorporating 
areas in which there is robust access to credit.
    Accordingly, the final rule incorporates the provisions of the 
escrow final rule providing that a county is rural if it is neither in 
a metropolitan statistical area, nor in a micropolitan statistical area 
that is adjacent to a metropolitan statistical area. The Bureau intends 
to continue studying over time the possible selective use of the Rural 
Housing Loan program definitions and tools provided on the USDA Web 
site to determine whether a particular property is located within a 
``rural'' area. For purposes of initial implementation, however, the 
Bureau believes that defining ``rural'' to include more UIC categories 
creates an appropriate balance to preserve access to credit and create 
a system that is easy for creditors to implement.
``Underserved''
    The Board's proposed Sec.  226.43(f)(2)(ii) would have defined a 
county as ``underserved'' during a calendar year if no more than two 
creditors extend consumer credit five or more times in that county. The 
definition was based on the Board's judgment that, where no more than 
two creditors are significantly active, the inability of one creditor 
to offer a balloon-payment mortgage would be detrimental to consumers 
who would have limited credit options because only one creditor would 
be left to provide the balloon-payment mortgage. Essentially, a 
consumer who could only qualify for a balloon-payment mortgage would be 
required to obtain credit from the remaining creditor in that area. 
Most of the same commenters that stated that the definition of rural 
was too narrow, as discussed above, also stated that the definition of 
underserved was too narrow, as well. The commenters proposed various 
different standards, including standards that considered the extent to 
which the property was in a rural area, as an alternate definition.
    The Bureau believes the purpose of the exemption is to permit 
creditors that rely on certain balloon-payment mortgage 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 Bureau believes that ``underserved'' should be 
implemented in a way that protects consumers from losing meaningful 
access to mortgage credit. The Bureau 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 Bureau believes that the expanded 
definition of rural, as discussed above, and the purposes of the 
balloon-payment qualified mortgage exemption enable continued consumer 
ability to obtain mortgage credit.
Scope of Mortgage Operations
    The Bureau has made one other change to the final rule to make the 
standards more consistent as between the balloon qualified mortgage and 
escrows exemption with regard to what type of mortgage loan operations 
are tracked for purposes of determining whether a creditor operates 
predominantly in rural or underserved areas. As noted above, the 
Board's proposed rule for balloon-payment qualified mortgages would 
have based a creditor's eligibility on the geographic distribution of 
its balloon-payment mortgages, while the escrows proposal focused on 
the distribution of first-lien mortgages. Given that the underlying 
statutory language regarding ``operates predominantly'' is the same in 
each instance and that tracking each type of mortgage separately would 
increase administrative burden, the Bureau believes it is appropriate 
to base the threshold for both rules on the distribution of all first-
lien ``covered transactions'' as defined in Sec.  1026.43(b)(1).\160\ 
The Bureau believes that counting all transactions will facilitate 
compliance, promote consistency in applying the two exemptions under 
both rulemakings, and be more useful in identifying which institutions 
truly specialize in serving rural and underserved areas. The Bureau 
also believes that it is appropriate to measure first-lien covered 
transactions because the balloon-payment mortgages that will meet the 
requirements of the balloon-payment qualified mortgage exemption will 
be first-lien covered transactions, as having subordinate financing 
along with the balloon-payment mortgage would be rare since it further 
constrains a consumer's ability to build equity in the property and 
able to refinance the balloon-payment mortgage when it becomes due. 
Accordingly, a creditor must have made during the preceding calendar 
year more than 50 percent of its total covered transactions secured by 
a first lien on property in a rural or underserved area, which is the 
same as the requirement of Sec.  1026.35(b)(2)(iii)(A) in the 2013 
Escrows Final Rule.
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    \160\ As discussed above, Sec.  1026.43(b)(1) defines covered 
transactions as closed-end consumer credit transactions that are 
secured by a dwelling, other than certain tractions that are exempt 
from coverage under Sec.  1026.43(a).
---------------------------------------------------------------------------

Total Annual Residential Mortgage Loan Origination
    TILA section 129C(b)(2)(E)(iv)(II) requires the Bureau to establish 
a limitation on the ``total annual residential mortgage loan 
originations'' for a creditor seeking to fall within the balloon-
payment qualified mortgage exemption. The Board's proposed Sec.  
226.43(f)(1)(v)(B) provided two alternatives to meet the statutory 
requirement that the creditor ``together with all affiliates, has total 
annual residential mortgage originations that do not exceed a limit set 
by the Board.'' TILA section 129C(b)(2)(E)(iv)(II). The first 
alternative was a volume based limit, and the second alternative was a 
total annual number of covered transactions limit. The Board's proposal 
did not propose any specific numeric thresholds for either alternative, 
but rather sought comment on the appropriate volume or number of loans 
originated based on the alternatives described in the proposal.
    In contrast, the Board's escrow proposal would have restricted 
eligibility to creditors that, along with their affiliates, originate 
and service no more than 100 new first-lien loans per calendar year. 
Although the Dodd-Frank Act requirement to establish escrow accounts 
applies only to higher-priced mortgage loans that are secured by first 
liens, the Board reasoned that it was appropriate to base the threshold 
on all first-lien originations because creditors are free to establish 
escrow accounts for all of their first-lien mortgages voluntarily in 
order to achieve the scale necessary to escrow cost effectively. The 
Board estimated that a minimum servicing portfolio size of 500 is 
necessary to escrow cost effectively, and assumed that the average life 
expectancy of a mortgage loan is about five years. Based on this 
reasoning, the Board reasoned that creditors would no

[[Page 6545]]

longer need the benefit of the exemption if they originated and 
serviced more than 100 new first-lien loans per year.
    In response to the balloon-payment qualified mortgage loan 
proposal, two trade groups and one association of State bank regulators 
argued that other criteria, such as the asset-size limit or portfolio 
requirement, were sufficient and neither a volume nor a total annual 
number of covered transactions limit would be necessary. One trade 
group commenter suggested combining the proposed alternatives and 
permit creditors to pick which limit they would operate under. Other 
trade group and industry commenters indicated that it would be 
preferable to base the annual originations limit on the number of 
transactions rather than volume because of the varying dollar amount of 
loans originated, which would constrain the number of consumers with 
limited credit options which could obtain balloon-payment mortgages in 
rural or underserved areas. Four trade group and industry commenters 
suggested increasing the threshold for the total annual number of 
covered transactions by various amounts ranging from 250 to 1,000 
transactions. The commenters did not articulate any particular reason 
or data to support the suggested limits, other than one commenter who 
indicated its suggestion was intended to be higher than its own amount 
of total annual covered transactions.
    Similarly in the escrows rulemaking, commenters asserted that the 
100-loan threshold was not in fact sufficient to make escrowing cost-
effective. Suggestions for higher thresholds ranged from 200 to 1,000 
mortgage debt obligations per year originated and serviced, though no 
commenters provided data to support their suggestions for alternative 
thresholds or to refute the Board's cost analysis. One consumer 
advocacy commenter suggested the proposed threshold was too high 
because it counted only first-lien mortgage transactions, instead of 
all mortgage debt obligations, but offered no specific alternative 
amount. Two industry commenters also suggested that the origination 
limit should measure only the number of higher-priced mortgage loans 
originated and serviced by the creditor and its affiliates.
    The Bureau believes that the requirement of TILA section 
129C(b)(2)(E)(iv)(II) reflects Congress's recognition that larger 
creditors who operate in rural or underserved areas should be able to 
make credit available without resorting to balloon-payment mortgages. 
Similarly, the requirement of TILA section 129C(d) reflects a 
recognition that larger creditors have the systems capability and 
operational scale to establish cost-efficient escrow accounts. In light 
of the strong concerns expressed in both rulemakings about the 
potential negative impacts on small creditors in rural and underserved 
areas, the Bureau conducted further analysis to try to determine the 
most appropriate thresholds, although it was significantly constrained 
by the fact that data is limited with regard to mortgage originations 
in rural areas generally and in particular with regard to originations 
of balloon-payment mortgages.
    The Bureau started with the premise that it would be preferable to 
use the same annual originations threshold in both rules in order to 
reflect the consistent language in both statutory provisions focusing 
on ``total annual mortgage loan originations,'' to facilitate 
compliance avoiding requiring institutions to track multiple metrics, 
and to promote consistent application of the two exemptions. This 
requires significant reconciliation between the two proposals, however, 
because the escrows proposal focused specifically on loans originated 
and serviced in order to best gauge creditors' ability to maintain 
escrow accounts over time, while servicing arrangements are not 
directly relevant to the balloon-payment qualified mortgage. However, 
to the extent that creditors chose to offer balloon-payment mortgages 
to manage their interest rate risk without having to undertake the 
compliance burdens involved in administering adjustable rate mortgages 
over time, the Bureau believes that both provisions are focused in a 
broad sense on accommodating creditors whose systems constraints might 
otherwise cause them to exit the market.
    With this in mind, the Bureau ultimately has decided to adopt a 
threshold of 500 or fewer annual originations of first-lien loans for 
both rules. The Bureau believes that this threshold will provide 
greater flexibility and reduce concerns that the specific threshold 
that had been proposed in the escrows rulemaking (100 loans originated 
and serviced annually) would reduce access to credit by excluding 
creditors who need special accommodations in light of their capacity 
constraints. At the same time, the increase is not as dramatic as it 
may first appear because the Bureau's analysis of HMDA data suggests 
that even small creditors are likely to sell off a significant number 
of loans to the secondary market. Assuming that most loans that are 
retained in portfolio are also serviced in house, the Bureau estimates 
that a creditor originating no more than 500 first-lien loans per year 
would maintain and service a portfolio of about 670 mortgage debt 
obligations over time, assuming a life expectancy of five years per 
mortgage debt obligation.\161\ Thus, the higher threshold will help to 
assure that creditors who are subject to the escrow requirements do in 
fact maintain portfolios of sufficient size to maintain the accounts on 
a cost efficient basis over time, in the event that the Board's 
estimate of a minimum portfolio of 500 loans was too low.\162\ However, 
the Bureau believes that the 500 annual originations threshold in 
combination with the other requirements will still assure that the 
balloon-payment qualified mortgage and escrow exceptions are available 
only to small creditors that focus primarily on a relationship-lending 
model and face significant systems constraints.
---------------------------------------------------------------------------

    \161\ A review of 2011 HMDA data shows creditors that otherwise 
meet the criteria of Sec.  1026.43(f)(1)(vi) and originate between 
200 and 500 or fewer first-lien covered transactions per year 
average 134 transactions per year retained in portfolio. Over a five 
year period, the total portfolio for these creditors would average 
670 mortgage debt obligations.
    \162\ Given that escrow accounts are typically not maintained 
for loans secured by subordinate liens, the Bureau does not believe 
that it makes sense to count such loans toward the threshold because 
they would not contribute to a creditor's ability to achieve cost-
efficiency. At the same time, the Bureau believes it is appropriate 
to count all first-lien loans toward the threshold, since creditors 
can voluntarily establish escrow accounts for such loans in order to 
increase the cost-effectiveness of their program even though the 
mandatory account requirements under the Dodd-Frank Act apply only 
to first-lien, higher-priced mortgage loans. Focusing on all first-
lien originations also provides a metric that is useful for gauging 
the relative scale of creditors' operations for purposes of the 
balloon-payment qualified mortgages, while focusing solely on the 
number of higher-priced mortgage loan originations would not.
---------------------------------------------------------------------------

Asset-Size Threshold
    Under TILA section 129C(b)(2)(E)(iv)(IV), to qualify for the 
exemption, a creditor must meet any asset-size threshold established by 
the Bureau. The Board's proposed Sec.  226.43(f)(1)(v)(D) would have 
established the threshold for calendar year 2013 at $2 billion, with 
annual adjustments for inflation thereafter. Thus, a creditor would 
satisfy this element of the test for 2013 if it had total assets of $2 
billion or less on December 31, 2012. This number was based on the 
limited data available to the Board at the time of the proposal. Based 
on that limited information, the Board reasoned that none of the 
entities it identified as operating predominantly in rural or 
underserved areas had total assets as of the end of 2009 greater than 
$2 billion, and therefore, the limitation should be set at $2 billion. 
The Board expressly proposed setting the asset-size threshold

[[Page 6546]]

at the highest level currently held by any of the institutions that 
appear to be smaller institutions that served areas with otherwise 
limited credit options. The Board sought comment on what threshold 
would be appropriate and whether the asset-size test is necessary at 
all. Conversely, in the escrows proposal the Board did not propose an 
asset threshold, but rather simply requested comment on whether a 
threshold should be established and, if so, what it should be.
    In response to the Board's 2011 ATR Proposal, one association of 
State bank regulators suggested that the asset-size threshold be 
included and be the only requirement for a creditor to qualify for the 
balloon-mortgage qualified mortgage exemption. Two trade group 
commenters suggested that a $2 billion asset-size threshold was 
appropriate, with one also suggesting that the asset-size threshold be 
the only requirement for a creditor to qualify for the balloon-mortgage 
qualified mortgage exemption. One industry commenter suggested that the 
asset-size threshold be $10 billion.
    In response to the Board's 2011 Escrows Proposal, the association 
of State bank regulators again suggested that an asset-size threshold 
be the only requirement to qualify for the escrow exception, but did 
not propose a specific dollar threshold. A trade association suggested 
a threshold of $1 billion, but did not provide a rational for that 
amount.
    For reasons discussed above, the Bureau is adopting a mortgage 
origination limit as contemplated by the statute. Given that 
limitation, restricting the asset size of institutions that can claim 
the exemption is of limited importance. Nonetheless, the Bureau 
believes that an asset limitation is still helpful because very large 
institutions should have sufficient resources to adapt their systems to 
provide mortgages without balloon payments and with escrow accounts 
even if the scale of their mortgage operations is relatively modest. A 
very large institution with a relatively modest mortgage operation also 
does not have the same type of reputational and balance-sheet 
incentives to maintain the same kind of relationship-lending model as a 
smaller community-based lender. Accordingly, the Bureau believes that 
the $2 billion asset limitation by the Board remains an appropriate 
limitation and should be applied in both rulemakings. Accordingly, the 
creditor must have total assets of less than $2 billion \163\ as of 
December 31, 2012, which is the same as the requirement of Sec.  
1026.35(b)(2)(iii)(C) in the 2013 Escrows Final Rule.
---------------------------------------------------------------------------

    \163\ The $2 billion threshold reflects the purposes of the 
balloon-payment qualified mortgage exemption and the structure of 
the mortgage lending industry. The choice of $2 billion in assets as 
a threshold for purposes of TILA section 129C(b)(2)(E) does not 
imply that a threshold of that type or of that magnitude would be an 
appropriate way to distinguish small firms for other purposes or in 
other industries.
---------------------------------------------------------------------------

Criteria Creditor Also Must Satisfy in the Final Rule Adopted From the 
Board's 2011 Escrows Proposal
    The Bureau notes that the three criteria discussed above are the 
same in both TILA 129C(b)(2)(E)(iv) and 129D(c). Commenters in both the 
Board's 2011 ATR Proposal and the Board's 2011 Escrows Proposal also 
made a note of the need to have consistent application of requirements 
and definitions across the Title XIV Rulemakings. The comments received 
in both of the Board's proposals identified the same concerns and made 
similar suggestions for each of the criteria in both the Board's 2011 
ATR Proposal and 2011 Escrows Proposal. The Bureau believes the 
balloon-payment qualified mortgage exemption is designed to ensure 
access to credit in rural and underserved areas where consumers may be 
able to obtain credit only from a limited number of creditors. One way 
to ensure continued access to credit for these consumers is to reduce 
and streamline regulatory requirements for creditors so that creditors 
maintain participation in or enter these markets. One method by which 
this can be accomplished is by having one set of requirements that are 
consistent between differing regulatory purposes. These criteria, since 
they are identical in TILA, can be adopted once in one section of 
Regulation Z and referenced by the other section.
    Accordingly, the Bureau is adopting Sec.  1026.43(f)(1)(vi) to 
require the creditor to meet the satisfy the requirements stated in 
Sec.  1026.35(b)(iii)(A), (B), and (C), adopted in the 2013 Escrows 
Final Rule, in order to originate a balloon-payment qualified mortgage 
under Sec.  1026.43(f)(1). Comment 43(f)(1)(vi)-1.i clarifies that the 
Bureau publishes annually a list of counties that qualify as rural or 
underserved in accordance with Sec.  1026.35(b)(2)(iii)(A). The comment 
further clarifies that the Bureau's annual determination of rural or 
underserved counties are based on the definitions set forth in Sec.  
1026.35(b)(2)(iv). Comment 43(f)(1)(vi)-1.ii clarifies that the 
creditor along with all affiliates must not originate more than 500 
first lien transactions during the preceding calendar year in 
accordance with Sec.  1026.35(b)(2)(iii)(B). Comment 43(f)(1)(vi)-1.iii 
clarifies that the initial asset-size threshold for a creditor is $2 
billion for calendar year 2013 and will be updated each December to 
publish the applicable threshold for the following calendar year in 
accordance withSec.  1026.35(b)(2)(iii)(C). The comment further 
clarifies that a creditor that had total assets below the threshold on 
December 31 of the preceding year satisfies this criterion for purposes 
of the exemption during the current calendar year.
43(f)(2) Post-Consummation Transfer of Balloon-Payment Qualified 
Mortgage
    As noted in the discussion related to paragraph (f)(1)(v) above, 
TILA section 129C(b)(E)(iv) requires that the lender keep balloon-
payment mortgages in portfolio, which addressed in both the Board's 
2011 ATR Proposal and 2011 Escrows Proposal in different ways. In light 
of the differences between the two rulemakings and in particular the 
important ramifications of qualified mortgage status over the life of 
the loan, however, the Bureau believes that it is also appropriate for 
this final rule to contain additional safeguards concerning post-
consummation sales that are not pursuant to a forward commitment in 
order to prevent gaming of the balloon-payment qualified mortgage 
exception. As noted above, the Board had proposed an approach under 
which the creditor would lose its eligibility to originate balloon-
payment qualified mortgages once it sold any balloon-payment mortgages. 
Under one alternative, a single sale after the effective date of the 
rule would have permanently disqualified the creditor from invoking the 
exception, while the other alternative would have disqualified the 
creditor from invoking the exception for two calendar years.
    In addition to the comments received on the Board's 2011 Escrows 
Proposal related to the forward commitment requirement discussed in 
paragraph (f)(1)(v), above, two trade group commenters and one industry 
commenter indicated that the second alternative was preferable, but 
urged the Bureau only to look at the last calendar year, instead of the 
current or prior years. Of these commenters, one trade group and the 
industry commenter suggested adding a de minimis number of permitted 
transfers of balloon-payment qualified mortgages. One trade group 
commenter noted that the statute requires that only balloon-payment 
qualified mortgages be kept in portfolio. Another trade group commenter

[[Page 6547]]

questioned the impact that either of the Board's alternatives would 
have on a rural creditors' ability to sell a balloon-payment mortgage 
if the creditor was directed to do pursuant to action requirements of 
prudential regulators, such as a prompt corrective action notice.
    The Bureau agrees with commenters that the first alternative would 
work against the stated purpose of the balloon-payment qualified 
mortgage exemption, as creditors that would not qualify would forever 
be excluded from this exemption in the future. Over time, this would 
further reduce the creditors originating balloon-payment qualified 
mortgages and thereby reduce the availability of credit to those 
markets. In addition, the Bureau believes the Board's second 
alternative mitigates but does not eliminate these difficulties. Under 
the second alternative the disqualification from originating balloon-
payment qualified mortgages would be temporary rather than permanent, 
but even so creditors who found it necessary to sell off a balloon-
payment mortgage would pay a steep price in terms of their ability to 
originate loans in the future, and credit availability would be 
negatively impacted. Commenters that supported the second alternative 
did so with the stated preference for the second alternative to the 
first, instead of the requirements of the second alternative itself.
    The Bureau believes these concerns can be eliminated or reduced by 
providing, as a general rule, that if a balloon-payment qualified 
mortgage is sold, that mortgage loses its status as a qualified 
mortgage, but the creditor does not lose its ability to originate 
balloon-payment qualified mortgages in the future. The rule would be 
subject to four exceptions to permit a balloon-payment qualified 
mortgage to be sold in narrowly defined circumstances without losing 
its qualified mortgage status. The first exception would allow for a 
sale to any person three years after consummation; this would require 
the creditor to keep the balloon-payment qualified mortgage for the 
same period of time that a consumer could bring a claim for violation 
of Sec.  1026.43 under TILA section 130(e). This facilitates managing 
interest rate risk by selling seasoned balloon-payment qualified 
mortgages, but encourages responsible underwriting because the 
originating creditor would keep all risk of affirmative claims while 
those claims could be asserted. The second exemption would permit 
creditors to sell to other qualifying creditors, which would provide 
flexibility and consistency with the portfolio requirement. The third 
exception would address the need of creditors to sell loans to comply 
with requirements of prudential regulators, conservators, receivers and 
others who have the responsibility to ensure creditors are operating 
within the bounds of the law. The fourth exemption addresses changes in 
the ownership of the creditor itself, so that the balloon-payment 
qualified mortgages held by the creditor do not lose their qualified 
mortgage status solely because of the change in ownership of the 
creditor.
    Accordingly, the Bureau is adopting Sec.  1026.43(f)(2) to require 
a creditor to retain a balloon-payment qualified mortgage in its 
portfolio, otherwise the balloon-payment qualified mortgage will no 
longer be a qualified mortgage, with four exceptions as set forth 
above. Comment 43(f)(2)-1 clarifies that creditors must generally hold 
a balloon-payment qualified mortgage in portfolio, subject to four 
exceptions. Comment 43(f)(2)-2 clarifies that the four exceptions apply 
to all subsequent transfers, and not just the initial transfer of the 
balloon-payment qualified mortgage, and provides an example. Comment 
43(f)(2)(i)-1 clarifies the application of the exception relating to 
transfers of the balloon-payment qualified mortgage three years or more 
after consummation. Comment 43(f)(2)(ii)-1 clarifies the application of 
the exemption relating to the transfer of a balloon-payment qualified 
mortgage to a creditor that meets the requirements of Sec.  
1026.43(f)(1)(vi). Comment 43(f)(2)(iii)-1 clarifies the application of 
the exemption related to the transfer of a balloon-payment qualified 
mortgage pursuant to the requirements of a supervisory regulator and 
provides an example. Comment 43(f)(2)(iv)-1 clarifies the application 
of the exemption related to the transfer of a balloon-payment qualified 
mortgage as a result or the merger or sale of the creditor and provides 
an example.
43(g) Prepayment Penalties
    As discussed above regarding treatment of prepayment penalties 
under the points and fees test for qualified mortgages and for high-
cost loans under HOEPA in Sec.  1026.32(b)(1) and the definition of 
prepayment penalty under Sec.  1026.32(b)(6), the Dodd-Frank Act 
restricts prepayment penalties in a number of ways. Section 1026.43(g) 
implements TILA section 129C(c), which establishes general limits on 
prepayment penalties for all residential mortgage loans. Specifically, 
TILA section 129C(c) provides that:
     Only 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.
    Taken together, the Dodd-Frank Act's amendments to TILA relating to 
prepayment penalties mean that most closed-end, dwelling-secured 
transactions: (1) May provide for a prepayment penalty only if the 
transaction is a fixed-rate, qualified mortgage that is neither high-
cost nor higher-priced under Sec. Sec.  1026.32 and 1026.35; (2) may 
not, even if permitted to provide for a prepayment penalty, charge the 
penalty more than three years following consummation or in an amount 
that exceeds two percent of the amount prepaid; and (3) may be required 
to limit any penalty even further to comply with the points and fees 
limitations for qualified mortgages, or to stay below the points and 
fees trigger for high-cost mortgages. Section 1026.43(g) now reflects 
these principles.
    The Board proposal implemented TILA section 129C(c) in Sec.  
226.43(g) without significant alteration, except that under proposed 
Sec.  226.43(g)(2)(ii), the Board proposed to apply the percentage 
tests outlined in the statute to the amount of the outstanding loan 
balance prepaid, rather than to the entire outstanding loan balance, to 
provide tighter restrictions on the penalties allowed on partial 
prepayments.
    Commenters generally supported the Board's proposal, though some 
industry commenters expressed concern that limitations on prepayment 
penalties would reduce prices on the sale of mortgages in the secondary 
market due to increased prepayment risk. Consumer advocates generally 
supported limiting prepayment penalties, as described by amended TILA 
section 129C(c), as an important element in ensuring affordability. 
Other industry commenters expressed concern that

[[Page 6548]]

such a limitation on the imposition of prepayment penalties would lead 
to fewer creditors conditionally waiving closing costs, noting that 
this implication might limit access to credit. At least one industry 
commenter argued that the Board's proposal to limit prepayment 
penalties was too broad in scope, stating the legislative history 
demonstrated that the true target of the prepayment penalty prohibition 
of TILA section 129C(c) was limited to mortgages with teaser rates and/
or balloon payments and to protect subprime consumers, not those 
consumers who chose a product with a lower interest rate in exchange 
for a prepayment penalty provision. The Bureau does not find this 
argument persuasive, given the plain language of amended TILA section 
129C(c).
    After review, the Bureau is adopting most of the Board's proposal, 
although as discussed below the Bureau is altering the prepayment 
limitation in the first year after consummation to reflect the separate 
limitations enacted in sections 1431 and 1432 of the Dodd-Frank Act, 
regarding high-cost mortgages.
Scope; Reverse Mortgages and Temporary Loans
    Section 1026.43(g) implements TILA section 129C(c), which applies 
to a ``residential mortgage loan,'' that is, to a consumer credit 
transaction secured by a dwelling, including any real property attached 
to the 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). Consequently, the regulation refers to ``covered 
transaction,'' which as defined in Sec.  1026.43(b)(1) and discussed 
further in the section-by-section analysis of Sec.  1026.43(a) excludes 
open-end credit plans and transactions secured by timeshares from 
coverage consistent with statutory exclusions. However, neither the 
definition of ``residential mortgage loan'' nor the TILA section 
129C(c)(1) prepayment penalty prohibition 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). Moreover, because under TILA section 
129C(c)(1)(A), only a qualified mortgage may have a prepayment penalty 
and reverse mortgages and temporary loans are excluded from the 
ability-to-repay and qualified mortgage requirements of the Dodd-Frank 
Act (and thus may not be qualified mortgages), prepayment penalties 
would not be permitted on either product absent further accommodation.
    The Board proposal sought comment on whether further provisions 
addressing the treatment of reverse mortgages were warranted. Because 
reverse mortgages are not subject to the ability-to-repay requirements, 
the Board did not propose to define a category of closed-end reverse 
mortgages as qualified mortgages, though it sought comment on the 
possibility of using its authority to do so, given that qualified 
mortgage status affects both application of the Dodd-Frank Act 
prepayment penalty provisions and certain provisions concerning 
securitization and ``qualified residential mortgages.'' See TILA 
section 129C(b)(2)(A)(ix) and (b)(3)(B).\164\ The Board specifically 
requested comment on whether special rules should be created to permit 
certain reverse mortgages to have prepayment penalties. In particular, 
the Board sought comment on how it might create criteria for a 
``qualified mortgage'' reverse mortgage that would be consistent with 
the purposes of qualified mortgages under TILA section 129C(b), and 
requested any supporting data on the prepayment rates for reverse 
mortgages.
---------------------------------------------------------------------------

    \164\ 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).
---------------------------------------------------------------------------

    Consumer advocates generally supported the Board's proposal to 
apply the prepayment penalty requirements to reverse mortgages, and 
industry commenters did not object. Moreover, commenters did not 
provide data or other advocacy to refute the Board's reasoning for 
including reverse mortgages within the scope of Sec.  1026.43(g): (1) 
That the overwhelming majority of reverse mortgages being originated in 
the current market are insured by the FHA, which does not allow reverse 
mortgages to contain prepayment penalties; and (2) excluding 
``qualified'' reverse mortgages from coverage of the prepayment penalty 
prohibition would not be necessary or appropriate to effectuate the 
purposes of TILA section 129C, absent an articulated 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).
    While the Board did not specifically seek comment with respect to 
whether further provisions addressing the treatment of bridge loans 
under Sec.  1026.43(g) were warranted, commenters nevertheless 
discussed the intersection of bridge loans and prepayment penalties. As 
discussed in the section-by-section analysis of Sec.  1026.32(b)(6), 
some industry commenters expressed concern that the availability of, or 
cost of, construction-to-permanent loans might suffer, should the rule 
restrict the permissible prepayment penalty charges levied by a 
creditor if a consumer does not convert the construction loan into a 
permanent loan with the same creditor within a specified time period. 
As discussed in the section-by-section analysis of Sec.  1026.32(b)(6), 
some commenters may have been mistaken with respect to whether certain 
fees were, in fact, a prepayment penalty. To the extent fees charged by 
a bridge loan are a prepayment penalty, however, they are prohibited as 
of the effective date. According to Sec.  1026.43(a)(3)(iii), the 
construction phase of a construction-to-permanent loan cannot be a 
qualified mortgage, and thus under Sec.  1026.43(g)(1)(ii)(B) such a 
loan cannot include a prepayment penalty. Construction-to-permanent 
loans are discussed in more detail in the section-by-section analysis 
of Sec.  1026.43(a).
    Accordingly, the Bureau is finalizing the rule at this time without 
special provisions to otherwise alter the general scope of this rule, 
as discussed in the section-by-section analysis of Sec.  1026.43(a), 
such as by allowing the application of prepayment penalties for either 
reverse mortgages or temporary loans. The Bureau may revisit the issue 
in subsequent years, either as part of a future rulemaking to evaluate 
application of all title XIV requirements to reverse mortgages or as 
part of the five-year review of significant rules required under 
section 1022(d) of the Dodd-Frank Act.
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 
before it is due unless the transaction is a qualified mortgage as 
defined in TILA section 129C(b)(2). TILA section 129C(c)(1)(B) further 
restricts the range of qualified mortgages on which prepayment 
penalties are permitted by excluding qualified mortgages that have an 
adjustable rate or that meet the thresholds for ``higher-priced 
mortgage loans'' because their APRs exceed the average prime offer rate 
for a

[[Page 6549]]

comparable transaction by a specified number of percentage points.\165\
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    \165\ 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.
---------------------------------------------------------------------------

    To implement TILA section 129C(c)(1), the Board proposed Sec.  
226.43(g)(1), which provided 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 
Sec.  226.43(e) or (f); and (3) is not a higher-priced mortgage loan, 
as defined in Sec.  226.45(a). The Board proposed under Sec.  
226.43(g)(1)(i) that a prepayment penalty must be otherwise permitted 
by applicable law. The Board reasoned that TILA section 129C(c) limits, 
but does not specifically authorize, including a prepayment penalty 
with a covered transaction. Thus, TILA section 129C(c) does not 
override other applicable laws, such as State laws, that may be more 
restrictive with respect to prepayment penalties, so 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 under Sec.  1026.32(d)(7)(i) and higher-priced 
mortgage loans under Sec.  1026.35(b)(2)(i).
    The Board proposed Sec.  226.43(g)(1)(ii)(A) to interpret the 
statutory language to apply to covered transactions for which the APR 
may increase after consummation. This regulatory language is consistent 
with other uses of ``variable-rate'' within Regulation Z, such as 
comment 17(c)(1)-11, which provides examples of variable-rate 
transactions.
    Some consumer advocates did not support the Board's proposal, 
arguing that for certain mortgages (specifically step-rate mortgages) 
the interest rate can increase after consummation without affecting the 
APR. These commenters argued that the purpose of TILA section 
129C(c)(1)(B)(i) is to avoid allowing a creditor to lock a consumer 
into a rising-cost mortgage via a prepayment penalty and a rising 
interest rate. Consumer groups expressed concern that a consumer might 
become ``trapped'' by a prepayment penalty on the one hand, and a 
rising interest rate on the other. The Bureau does not find this 
argument persuasive. TILA section 129C(1)(B)(i) prohibits a transaction 
with ``an adjustable rate'' from including a prepayment penalty. 
Longstanding rules under Regulation Z for closed-end transactions 
generally categorize transactions based on the possibility of APR 
changes, rather than interest rate changes.\166\ This distinction is 
relevant because covered transactions may have an APR that cannot 
increase after consummation even though a specific 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. See Sec.  
1026.18(s)(7)(ii) (defining ``step-rate mortgage'' for purposes of 
transaction-specific interest rate and payment disclosures). Thus, the 
danger of an interest rate/prepayment penalty ``trap'' is mitigated in 
a step-rate loan because the consumer knowledge of the exact payments 
to expect each month for the 36 months following consummation during 
which a prepayment penalty might apply. The Bureau therefore is 
adopting Sec.  1026.43(g)(1)(ii)(A) as proposed. A fixed-rate mortgage 
or a step-rate mortgage therefore may have a prepayment penalty, but an 
adjustable-rate mortgage may not have a prepayment penalty. See Sec.  
1026.18(s)(7)(i) through (iii) (defining ``fixed-rate mortgage,'' 
``step-rate mortgage,'' and ``adjustable-rate mortgage'').
---------------------------------------------------------------------------

    \166\ See, e.g., Sec.  1026.18(f) (requiring disclosures 
regarding APR increases), Sec.  1026.18(s)(7)(i) through (iii) 
(categorizing disclosures for purposes of interest rate and payment 
disclosures), Sec.  1026.36(e)(2)(i) and (ii) (categorizing 
transactions for purposes of the safe harbor for the anti-steering 
requirement under Sec.  1026.36(e)(1)).
---------------------------------------------------------------------------

Balloon-Payment Mortgages
    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). The Board proposed to implement 
TILA section 129C(c)(1)(A) in Sec.  226.43(g)(1)(ii)(B) and noted that, 
under section 129C(b)(2)(e), 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.  
1026.43(f); thus, a consumer could face a prepayment penalty if the 
consumer attempts to refinance out of a balloon-payment qualified 
mortgage before the balloon payment is due. The Board solicited comment 
on whether it would be appropriate to use its 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. Most 
commenters generally supported the Board's decision not to extend the 
prepayment penalty ban to all balloon-payment loans, noting the need 
for such financial products in rural and underserved areas. In light of 
the access concerns, the Bureau declines to exercise its exception 
authority under TILA sections 105(a) and 129B(e) to add a blanket 
prohibition of prepayment penalties for all balloon-payment loans. 
Accordingly, the Bureau is adopting Sec.  1026.43(g)(1)(ii)(B) as 
proposed. The Bureau will continue to monitor the use of balloon-
payment qualified mortgages and their use of prepayment penalties.
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 the 
specified threshold for ``higher-priced mortgage loans.'' As discussed 
above, those thresholds are determined by reference to the applicable 
average prime offer rate. The Board proposed under Sec.  
226.43(g)(1)(ii)(C) that a creditor 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, because APRs are based on a broader set of 
charges, including some third-party charges such as mortgage insurance 
premiums, than average prime offer rates. The Board expressed a concern 
that using the APR metric posed a risk of over-inclusive coverage 
beyond the subprime market and instead proposed using the transaction 
coverage rate.
    In August 2012, the Bureau extended the notice-and-comment period 
for comments relating to the proposed adoption of the more inclusive 
finance charge, including the transaction coverage rate. At that time, 
the Bureau noted that it would not be finalizing the more inclusive 
finance charge in January 2013. See 77 FR 54843 (Sept. 6, 2012). The 
Bureau therefore does not address in this rulemaking the numerous 
public comments that it received concerning the proposed alternatives 
for the APR coverage test. The Bureau instead will address such 
comments in connection with its finalization of the 2012 TILA-RESPA

[[Page 6550]]

Integration Proposal, thus resolving that issue together with the 
Bureau's determination whether to adopt the more inclusive finance 
charge. The Bureau is thus adopting the definition of a higher-priced 
loan as defined in Sec.  1026.35(a), which corresponds to the 
thresholds specified in TILA section 129C(1)(B)(ii).
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, TILA section 129C(c)(3) limits the prepayment penalty 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.
    The Board's proposed Sec.  226.43(g)(2) was substantially similar 
to TILA section 129C(c)(3) except that the Board proposed to determine 
the maximum penalty amount by applying the percentages established in 
the statute to the amount of the outstanding loan balance prepaid, 
rather than to the entire outstanding loan balance. The Board reasoned 
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 more strictly 
limiting the amounts of prepayment penalties imposed.
    The Board noted in its proposal that under HOEPA as amended by the 
Dodd-Frank Act, TILA section 103(bb)(1)(A)(iii) now 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. Moreover, under amended TILA section 129(c)(1), 
high-cost mortgages are prohibited from having prepayment penalties. 
Accordingly, any prepayment penalty in excess of two percent of the 
amount prepaid on any closed-end mortgage would both trigger and 
violate HOEPA's high-cost mortgage protections. The Board did not 
propose to implement these limitations on prepayment penalties in Sec.  
226.43(g)(2), but did solicit comment on whether the proposed text 
should be modified to incorporate the limitation of prepayment penalty 
amounts to two percent of the amount prepaid, as provided under TILA 
sections 103(bb)(1)(A)(iii) and 129(c)(1). The Board also solicited 
comment on whether to adopt some other threshold to account for the 
limitations on points and fees, including prepayment penalties, to 
satisfy the requirements for ``qualified mortgages,'' under TILA 
section 129C(b)(2)(A)(vii) and proposed Sec.  226.43(e)(2)(iii).
    The Bureau did not receive significant comment on the proposed 
adjustment of determining the maximum penalty amount by applying the 
percentages established in the statute to the amount of the outstanding 
loan balance prepaid, rather than to the entire outstanding loan 
balance, and therefore is adopting Sec.  1026.43(g)(2) to measure 
prepayment penalties using the outstanding loan balance prepaid, as 
proposed. The Bureau is making this adjustment pursuant to its 
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 Bureau are necessary 
and proper to effectuate the purposes of TILA, to prevent circumvention 
or evasion thereof, or to facilitate compliance therewith. For 
instance, the Bureau believes that it would be inconsistent with 
congressional intent to strong disfavor and limit prepayment penalties 
for the Bureau to allow creditors to charge one or two percent of the 
entire outstanding loan balance every time that a consumer pays even a 
slightly greater amount than the required monthly payment due.
    The Bureau did not receive significant comment on how to resolve 
the differing prepayment thresholds for high-cost mortgages and 
qualified mortgages, as described by the Board. But the Bureau believes 
that it is imperative to provide clear guidance to creditors with 
respect to all new limitations on prepayment penalties in dwelling-
secured credit transactions, as imposed by the Dodd-Frank Act. As noted 
by the Board, new TILA section 129C(c)(3) limits prepayment penalties 
for fixed-rate, non-higher-priced qualified mortgages to three percent, 
two percent, and one percent of the outstanding loan balance prepaid 
during the first, second, and third years following consummation, 
respectively. However, amended TILA sections 103(bb)(1)(A)(iii) and 
129(c)(1) for high-cost mortgages effectively prohibit prepayment 
penalties in excess of two percent of the amount prepaid at any time 
following consummation for most credit transactions secured by a 
consumer's principal dwelling by providing that HOEPA protections 
(including a ban on prepayment penalties) apply to mortgage loans with 
prepayment penalties that exceed two percent of the outstanding loan 
balance prepaid. The Bureau concludes that, to comply with both the 
high-cost mortgage provisions and the qualified mortgage provisions, 
creditors originating most closed-end mortgage loans secured by a 
consumer's principal dwelling would need to limit the prepayment 
penalty on the transaction to: (1) No more than two percent of the 
amount prepaid during the first and second years following 
consummation, (2) no more than one percent of the amount prepaid during 
the third year following consummation, and (3) zero thereafter.
    Accordingly, the Bureau is modifying the final rule to reflect the 
two percent cap imposed by the Dodd-Frank Act amendments to HOEPA. As 
adopted in final form, Sec.  1026.43(g)(2) amends the maximum 
prepayment penalty threshold for qualified mortgages during the first 
year following consummation, specified as three percent in TILA section 
129C(c), to two percent, to reflect the interaction of the qualified 
mortgage and HOEPA revisions. In addition to finalizing this provision 
as a matter of reasonable interpretation of how the statutory 
provisions work together, the Bureau is making this adjustment pursuant 
to its 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 Bureau are 
necessary and proper to effectuate the purposes of TILA, to prevent 
circumvention or evasion thereof, or to facilitate compliance 
therewith. The Bureau is exercising this adjustment to prevent creditor 
uncertainty regarding the interaction of qualified mortgages and high-
cost mortgage rules, thus facilitating compliance. For example, assume 
a creditor issues a loan that meets the specifications of a Sec.  
1026.43(e) qualified mortgage. The loan terms specify that this 
creditor may charge up to three percent of any prepaid amount in the 
year following consummation. If the Bureau implements TILA section 
129C(c) and sections 103(bb)(1)(A)(iii) and 129(c)(1) for high-cost 
mortgages, which effectively prohibit prepayment

[[Page 6551]]

penalties in excess of two percent of the amount prepaid at any time 
following consummation, then the creditor will have complied with 
certain provisions of TILA while violating others. Thus, to avoid this 
complex interaction, the Bureau is eliminating the possibility of 
simultaneous compliance with and violation of TILA by reducing the 
maximum prepayment penalty allowed in the year following consummation 
to two percent under Sec.  1026.43(g)(2)(ii)(A).
    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 Sec.  1026.43(g)(2). 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 one 
percent of the amount prepaid. The Bureau is changing the prepayment 
example in comment 43(g)(2)-1 to reflect the Bureau's adjustment in 
Sec.  1026.43(g)(2)(ii)(A) of the maximum prepayment penalty in the 
first year after consummation from three percent to two percent.
    The Bureau recognizes that TILA section 129C(b)(2)(A)(vii) 
indirectly limits the amount of a prepayment penalty for a qualified 
mortgage, by limiting the maximum ``points and fees'' for a qualified 
mortgage to three percent of the total loan amount. See Sec.  
1026.43(e)(2)(iii), discussed above. The definition of ``points and 
fees'' includes the maximum 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(bb)(4)(E), Sec.  
1026.32(b)(1), and accompanying section-by-section analysis. Thus, if a 
creditor wants to include the maximum two 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. 
See the section-by-section analysis of Sec.  1026.32(b)(1).
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. 
The Board proposed Sec.  226.43(g)(3), which contained language to 
implement TILA section 129C(c)(4) and added provisions to ensure 
comparability between the two alternative offers. Specifically, the 
proposed rule would mandate that 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. 
Proposed Sec.  226.43(g)(3) also provided that the alternative covered 
transaction must be a transaction for which the consumer likely 
qualifies.
    The Bureau did not receive significant comment on the proposal and 
is adopting Sec.  1026.43(g)(3) as proposed. The Bureau is adding the 
additional conditions proposed by the Board to those specified in TILA 
section 129C(c)(4) to ensure that the alternative covered transactions 
is a realistic alternative for the consumer: A loan under substantially 
similar terms as the loan with a prepayment penalty for which the 
consumer likely qualifies. The Bureau is including these additional 
requirements pursuant to the Bureau'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 Bureau are necessary or proper 
to effectuate the purposes of TILA, to prevent circumvention or evasion 
thereof, or to facilitate compliance therewith.
    The Bureau believes that requirements designed to ensure that the 
alternative covered transactions effectuate the purposes of TILA 
section 129C(c)(4) by enabling the consumer 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, under final Sec.  1026.43(g)(3), a consumer is able to compare 
a fixed-rate mortgage with a prepayment penalty with a fixed-rate 
mortgage without a prepayment penalty, rather than with a step-rate 
mortgage without a prepayment penalty. Also, the Bureau believes 
requiring that the alternative covered transaction without a prepayment 
penalty be one for which the consumer likely qualifies effectuates the 
purposes of and prevents circumvention of TILA section 129C(c)(4), by 
providing for consumers to be able to choose between options that 
likely are available.
    Under Sec.  1026.43(g)(1)(i), a covered transaction with an APR 
that may increase after consummation may not have a prepayment penalty. 
The Board proposed in Sec.  226.43(g)(3)(i) 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 may not increase after consummation. The Board 
also proposed that the covered transaction with a prepayment penalty 
and the alternative covered transaction without a prepayment penalty 
must have the same type of interest rate. The Board offered these 
proposals to ensure that a consumer is able to choose between 
substantially similar alternative transactions. The Bureau did not 
receive significant comment on the proposal and is adopting the Board's 
proposal regarding the APR and the type of interest rate for the 
alternative transaction.
    Higher-priced mortgage loans. The Board proposed that, under 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. The 
Board reasoned that TILA section 129C(c)(4) is intended to ensure that 
a consumer has a choice whether 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. 
In fact, all things being equal, one would expect a creditor to cover 
the increased risk of prepayment by increasing the rate, thereby 
increasing the likelihood that the transaction might be a higher-priced 
mortgage loan. Furthermore, the Board noted that restricting the 
pricing of the required alternative covered transaction without a 
prepayment penalty might result in some creditors choosing to offer 
fewer loans. The Board thus did not propose to limit rate increases for 
the alternative covered transaction. The Bureau did not receive 
significant comment on this aspect of the proposal and is adopting the 
rule as proposed.
    Timing of offer. The Board proposal concerning the alternative 
offer without a prepayment penalty that a creditor is required to offer 
under TILA section 129C(c)(4) did not specify that the creditor makes 
this alternative offer at or by a particular time. The Board proposal 
was consistent with Sec.  1026.36(e)(2) and (3), which provide a safe 
harbor for the anti-steering requirement if a loan

[[Page 6552]]

originator presents certain loan options to the consumer. These rules 
also do not contain a timing requirement. The Board solicited 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, such as before the consumer pays a non-
refundable fee or at least fifteen calendar days before consummation. 
The Board also solicited comment on whether, if a timing requirement 
were included for the required alternative offer, whether a timing 
requirement should also be included under the safe harbor for the anti-
steering requirement, for consistency. The Bureau did not receive 
significant comment on the proposal and is not including a specific 
timing requirement. The Bureau will continue to study required 
alternative offers to ensure that creditors offer consumers a 
meaningful alternative transaction that does not contain a prepayment 
penalty, in accordance with the purposes of TILA section 129C(c)(4). In 
the course of its review, if the Bureau determines that more specific 
timing requirements would provide more consumer choice, the Bureau may 
propose to revise Sec.  1026.43(g)(3) accordingly.
    The Board proposed comment 43(g)(3)(i)-1 to clarify that the 
covered transaction with a prepayment penalty and the alternative 
covered transaction without a prepayment penalty both must be either 
fixed-rate mortgages or step-rate mortgages. The Bureau did not receive 
significant comment on the proposal and is adopting the comment with 
some revisions for clarification only. For purposes of Sec.  
1026.43(g)(3)(i), the term ``type of interest rate'' means whether the 
covered transaction is a fixed-rate mortgage, as defined in Sec.  
1026.18(s)(7)(iii), or a step-rate mortgage, as defined in Sec.  
1026.18(s)(7)(ii).
    Substance of offer. As discussed above, Sec.  1026.43(g)(1)(ii)(B) 
provides that a covered transaction with a prepayment penalty must be a 
qualified mortgage, as defined in Sec.  1026.43(e)(2), (e)(4), or (f). 
The Board proposal concerning the alternative offer without a 
prepayment penalty that a creditor is required to offer under TILA 
section 129C(c)(4) did not mandate that the alternative covered 
transaction offered without a prepayment penalty must also be a 
qualified mortgage. But under proposed Sec.  226.43(g)(3)(ii) through 
(iv), the Board proposed to incorporate three conditions of qualified 
mortgages on the alternative offer, so that consumers may choose 
between alternative covered transactions that are substantially 
similar. Accordingly, the Board proposed that the 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.  1026.43(e)(2)(i); and (3) 
satisfy the points and fees condition under Sec.  1026.43(e)(2)(iii), 
based on the information known to the creditor at the time the 
transaction is offered. The Bureau did not receive significant comment 
on the proposal and is adopting the Board's proposal. The Bureau is 
including this provision both as part of its interpretation of TILA 
section 129C(c)(4) and using its authority under TILA sections 105(a), 
which provides that the Bureau'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 Bureau'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), 
1639b(e). This approach is further supported by the authority under 
TILA section 129B(e) to condition terms, acts or practices relating to 
residential mortgage loans that the Bureau finds necessary and proper 
to ensure that responsible, affordable mortgage credit remains 
available to consumers in a manner consistent with the purposes and to 
effectuate the purposes of section 129B and 129C, and that are in the 
interest of the consumer, among other things. 15 U.S.C. 1639b(e). The 
purposes of TILA include the purposes that apply to 129B and 129C, to 
assure that consumers are offered and receive residential mortgage 
loans on terms that reasonably reflect their ability to repay the loan. 
See 15 U.S.C. 1639b(a)(2). The Bureau believes that requiring the 
creditor that offers the consumer a loan with a prepayment penalty to 
also offer the consumer the ability to choose an alternative covered 
transaction that is otherwise substantially similar, besides not 
including a prepayment penalty, is necessary and proper to fulfill such 
purposes by ensuring that the consumer is offered a reasonable 
alternative product that the consumer can repay and which does not 
include a prepayment penalty. For this reason, this provision is also 
in the interest of the consumer.
    The Board proposed comment 43(g)(3)(iv)-1 to provide guidance for 
cases where a creditor offers a consumer an alternative covered 
transaction without a prepayment penalty under Sec.  1026.43(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 transaction. Proposed 
comment 43(g)(3)(iv)-1 clarified 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.  
1026.43(e)(2)(iii). The Bureau did not receive significant comment on 
the proposal and is adopting the comment largely as proposed.
    The Board proposed comment 43(g)(3)(v)-1 to clarify what is meant 
by an alternative transaction for which the consumer likely qualifies. 
In this example, 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.  1026.43(g)(3)(v) are not met. Proposed comment 
43(g)(3)(v)-1 also clarified 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. The Bureau did 
not receive significant comment on the proposal and is adopting the 
Board's comment as proposed. Comment 43(g)(3)(v)-1 is substantially 
similar to comment 36(e)(3)-4, which provides clarification under the 
rules providing 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.\167\ In addition to 
agreeing with

[[Page 6553]]

the Board's reasoning, the Bureau is adopting this rule and comment to 
promote consistency and further the Bureau's initiative to provide 
streamlined regulatory guidance.
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    \167\ Section 1026.36(e) generally prohibits, in a consumer 
credit transaction, a loan originator from ``steering'' 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 to the consumer, unless the consummated 
transaction is in the consumer's interest. Section 1026.36(e)(3) 
explains that there is a safe harbor for this anti-steering 
requirement when the loan originator presents the consumer with: (1) 
The loan option with 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.  1026.36(e)(3)(i).
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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 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).
    The Board proposed Sec.  226.43(g)(4), which would apply when a 
creditor offers a covered transaction with a prepayment penalty through 
a mortgage broker, as defined in Sec.  1026.36(a)(2), to account for 
operational differences in offering a covered transaction through the 
wholesale channel versus through the retail channel.\168\ The Board 
proposed under Sec.  226.43(g)(4) that, if a creditor offers a covered 
transaction to a consumer through a mortgage broker, as defined in 
Sec.  1026.36(a)(2), the creditor must present to the mortgage broker 
an alternative covered transaction without a prepayment penalty that 
meets the conditions in Sec.  1026.43(g)(3). The Board reasoned that 
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 
noted that, if Congress had intended to apply TILA section 129C(c)(4) 
to mortgage brokers, Congress would have explicitly applied that 
provision to ``mortgage originators'' in addition to creditors.\169\ 
The Board's proposal also provided under proposed Sec.  
226.43(g)(4)(ii) 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 in 
Sec.  1026.43(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.
---------------------------------------------------------------------------

    \168\ For ease of discussion, the terms ``mortgage broker'' and 
``loan originator'' as used in this discussion have the same meaning 
as under the Bureau's requirements for loan originator compensation. 
See Sec.  1026.36(a)(1), (2).
    \169\ 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 or 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 Bureau did not receive significant comment on proposed Sec.  
226.43(g)(4) and is adopting Sec.  1026.43(g)(4) largely as proposed. 
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, 
Sec.  1026.43(g)(4) facilitates compliance with Sec.  1026.43(g)(3) and 
with the safe harbor for the anti-steering requirement in connection 
with a single covered transaction, as governed by Sec.  
1026.36(e)(3)(i). Section 1026.43(g)(4) does not affect the conditions 
that a loan originator must meet to take advantage of the safe harbor 
for the anti-steering requirement, however. Thus, if a loan originator 
chooses to use the safe harbor, the originator must present the 
consumer with: (1) The loan option with 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.  1026.36(e)(3)(i). The Bureau believes that 
requiring a mortgage broker to present to a consumer the creditor's 
alternative covered transaction without a prepayment penalty could 
confuse the consumer if he or she is presented with numerous other loan 
options under Sec.  1026.36(e). Presenting a consumer with four or more 
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 
creditor 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.
    The Board proposed comment 43(g)(4)-1 to clarify 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. 
The Board proposed comment 43(g)(4)-2 to clarify 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. 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. The Board proposed comment 43(g)(4)-3 to clarify that a 
creditor's agreement with a mortgage broker for purposes of Sec.  
1026.43(g)(4) may be part of another agreement with the mortgage 
broker, for example, a compensation agreement. The 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 Bureau did not receive significant comment on 
proposed comments 43(g)(4)-1 through -3 and is adopting these comments 
largely as proposed.
Provisions Not Adopted
    As explained in the preamble to the Board's proposal, the Board did 
not propose specific rules under proposed Sec.  226.43(g)(4) to apply 
in the case where the loan originator is the creditor's employee. The 
Bureau did not receive significant comment on that omission and 
likewise is not adopting special provisions under Sec.  1026.43(g)(4) 
to apply where the loan originator is the creditor's employee. The 
Bureau 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.

[[Page 6554]]

    The Board solicited comment on whether additional guidance was 
needed regarding offers of covered transactions through mortgage 
brokers that use the safe harbor for the anti-steering requirement, 
under Sec.  226.36(e)(2) and (3). The Bureau did not receive 
significant comment on the proposal and concludes that additional 
guidance is not currently required. The Bureau will continue to study 
the interaction between prepayment penalty restrictions, as applied to 
mortgage brokers under Sec.  1026.43(g)(4) and the safe harbor for the 
anti-steering requirement, under Sec.  1026.36(e)(2) and (3) to ensure 
that brokers are operating with sufficient guidance. In the course of 
its review, if the Bureau determines that more guidance would provide 
clarity or otherwise reduce compliance burden, then the Bureau may 
propose to add additional guidance.
43(g)(5) Creditor That Is a Loan Originator
    The Board proposed Sec.  226.43(g)(5) to address table funding 
situations, 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 a creditor generally presents to a consumer loan options 
offered by other creditors, and this creditor is a loan originator 
subject to the anti-steering requirements in Sec.  1026.36(e). See 
Sec.  1026.36(a)(1); comment 36(a)(1)-1. Like other loan originators, 
such a creditor may use the safe harbor for the anti-steering 
requirements under Sec.  1026.36(e)(2) and (3). The Board proposed 
that, if the creditor is a loan originator, as defined in Sec.  
1026.36(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 must present the consumer an alternative covered transaction 
without a prepayment penalty offered by (1) the prospective 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. The Board reasoned that its 
proposal provided flexibility with respect to the presentation of loan 
options, which facilitates compliance with Sec.  1026.43(g)(3) and with 
the safe harbor for the anti-steering requirement in connection with 
the same covered transaction. See Sec.  1026.36(e)(3)(i).
    The Bureau did not receive significant comment on the proposal and 
is adopting the Board's proposal. Like Sec.  1026.43(g)(4), Sec.  
1026.43(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 a creditor that is a loan 
originator chooses to use the safe harbor, the creditor must present 
the consumer (1) the loan option with 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.  1026.36(e)(3)(i).
    The Board proposed comment 43(g)(5)-1 to clarify that a loan 
originator includes any creditor that satisfies the definition of the 
term but makes use of ``table-funding'' by a third party. The Bureau 
did not receive significant comment on the proposed comment and is 
adopting it as proposed. The Board proposed comment 43(g)(5)-2 to 
cross-reference guidance in comment 36(e)(3)-3 on determining which 
step-rate mortgage has a lower interest rate. The Bureau did not 
receive significant comment on the proposal and is adopting the Board's 
proposed comment.
43(g)(6) Applicability
    TILA section 129C(c)(1)(A) provides that only a qualified mortgage 
may contain a prepayment penalty and TILA section 129C(c)(4) further 
requires the creditor to offer the consumer an alternative offer that 
does not contain a prepayment penalty. The Board proposed Sec.  
226.43(g)(6) to provide that Sec.  226.43(g) would apply only if a 
transaction is consummated with a prepayment penalty and would not be 
violated if (1) a covered transaction is consummated without a 
prepayment penalty or (2) the creditor and consumer do not consummate a 
covered transaction. The Bureau did not receive significant comment on 
the proposal and is adopting the Board's proposal under Sec.  
1026.43(g)(6).
    Section 1026.43(g)(2) limits the period during which a prepayment 
penalty may be imposed and the amount of any prepayment penalty. As 
provided in Sec.  1026(g)(6), those prepayment penalty limitations 
apply only if a covered transaction with a prepayment penalty is 
consummated. Similarly, Sec.  1026.43(g)(3) requires a creditor that 
offers a consumer a covered transaction with a prepayment penalty to 
offer the consumer an alternative covered transaction without a 
prepayment penalty. Where a consumer consummates a covered transaction 
without a prepayment penalty, Sec.  1026(g)(6) states that it is 
unnecessary to require that the creditor offer the consumer an 
alternative covered transaction without a prepayment penalty. Thus 
Sec.  1026.43(g) applies only if the consumer consummates a covered 
transaction with a prepayment penalty.
43(h) Evasion; Open-End Credit
    TILA section 129C, which addresses the ability-to-repay 
requirements and qualified mortgages, applies to residential mortgage 
loans. TILA section 103(cc)(5) defines ``residential mortgage loans'' 
as excluding open-end credit plans, such as HELOCs. In its proposal, 
the Board recognized 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 that otherwise would have been 
structured as closed-end as open-end instead.
    The Board proposed Sec.  226.43(h) to prohibit a creditor from 
evading the requirements of Sec.  226.43 by structuring a transaction 
that does not meet the definition of open-end credit in Sec.  
226.2(a)(20) as open-end credit, such as a HELOC. The Board proposed 
comment 43(h)-1 to explain that where a loan is documented as open-end 
credit but the features and terms, or other circumstances, demonstrate 
that the loan does not meet the definition of open-end credit, then the 
loan is subject to the rules for closed-end credit, including Sec.  
226.43. The Board proposed these provisions using its authority under 
TILA sections 105(a) and 129B(e) to prevent circumvention or evasion. 
The Board noted that an overly broad anti-evasion rule could limit 
consumer choice by casting doubt on the validity of legitimate open-end 
plans, and the Board thus solicited comment on whether to limit the 
anti-evasion rule's application, for example, 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.
    Consumer groups generally supported the proposed anti-evasion 
provision; some consumer groups suggested that the provision should be 
expanded to require all HELOCs to comply with all Dodd-Frank Act 
requirements, expressing concern over the potential for consumer abuse. 
Industry commenters generally sought clarification on the anti-evasion 
rule, noting that ambiguity with respect to the provision might limit 
creditors' ability, or willingness, to offer HELOCs or other open-end 
credit products.

[[Page 6555]]

    The Bureau is adopting the Board's proposal largely as proposed. 
Section 1026.43(h) is also consistent with the Board's 2008 HOEPA Final 
Rule, Sec.  1026.35(b)(4), which provides a similar anti-evasion 
provision with respect to higher-priced mortgage loans. The Bureau is 
including this provision both as part of its interpretation of TILA 
section 129C and using its authority under TILA section 105(a), which 
provides that the Bureau'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 Bureau's judgment are necessary or 
proper to effectuate the purposes of TILA, prevent circumvention or 
evasion thereof, or facilitate compliance therewith, and TILA section 
129B(e) to prevent circumvention or evasion. 15 U.S.C. 1604(a), 
1639b(e). The purposes of TILA include the purposes that apply to 
section 129C, to assure that consumers are offered and receive 
residential mortgage loans on terms that reasonably reflect their 
ability to repay the loan. See 15 U.S.C. 1639b(a)(2). While some 
industry commenters requested further clarification on this provision, 
so as to avoid limiting consumer choice, the Bureau believes that no 
further commentary is required. A creditor that offers a consumer an 
open-end line of credit in the ordinary course of business need not be 
concerned with running afoul of the anti-evasion requirement, and a 
creditor need not undertake any additional compliance or reporting 
steps to do so. A creditor only violates Sec.  1026.43(h) when the 
creditor structures credit secured by a consumer's dwelling that does 
not meet the definition of open-end credit in Sec.  1026.2(a)(20) as an 
open-end plan in order to evade the ability-to-repay requirements. The 
Bureau's approach should allow creditors acting in good faith to 
continue to provide credit to consumers in the manner best fit for 
business needs and consumer demand, without concern of accidentally 
running afoul of the anti-evasion requirement.

VI. Effective Date

    This final rule is effective on January 10, 2014. The rule applies 
to transactions for which the creditor received an application on or 
after that date. As discussed above in part III.C, the Bureau believes 
that this approach is consistent with the timeframes established in 
section 1400(c) of the Dodd-Frank Act and, on balance, will facilitate 
the implementation of the rules' overlapping provisions, while also 
affording creditors sufficient time to implement the more complex or 
resource-intensive new requirements.
    As noted above, in response to the proposal, some industry 
commenters requested that the Bureau provide additional time for 
compliance because the Bureau is finalizing several mortgage rules at 
the same time. These commenters expressed concern over both the breadth 
and complexity of new rules expected from the Bureau and from other 
regulators. Some commenters stated that small institutions, in 
particular, might face a higher cost of compliance under the timeframes 
established in section 1400(c) of the Dodd-Frank Act. One industry 
commenter explained that the new rules would require creditors to alter 
financial products, modify compliance systems, and train staff. Another 
industry commenter noted that some credit unions and other institutions 
that rely on third-party providers, such as software vendors, to assist 
with compliance might face particular challenges with implementing 
necessary changes over a short time period since such third parties 
will need time to incorporate necessary updates and conduct testing, 
and include the changes in their scheduled releases. Some commenters 
urged the Bureau to coordinate publishing and effective dates among the 
title XIV rules and the QRM rulemaking, in order to assist creditors in 
minimizing compliance burden.
    For the reasons already discussed above, the Bureau believes that 
an effective date of January 10, 2014 for this final rule and most 
provisions of the other title XIV final rules will ensure that 
consumers receive the protections in these rules as soon as reasonably 
practicable, taking into account the timeframes established by the 
Dodd-Frank Act, the need for a coordinated approach to facilitate 
implementation of the rules' overlapping provisions, and the need to 
afford creditors and other affected entities sufficient time to 
implement the more complex or resource-intensive new requirements.

VII. Dodd-Frank Act Section 1022(b)(2) Analysis

A. Overview

    In developing the final rule, the Bureau has considered potential 
benefits, costs, and impacts.\170\ In addition, the Bureau has 
consulted, or offered to consult with, the prudential regulators, SEC, 
HUD, FHFA, the Federal Trade Commission, and the Department of the 
Treasury, including regarding consistency with any prudential, market, 
or systemic objectives administered by such agencies. The Bureau also 
held discussions with or solicited feedback from the United States. 
Department of Agriculture, Rural Housing Service, the Federal Housing 
Administration, and the Department of Veterans Affairs regarding the 
potential impacts of the final rule on those entities' loan programs.
---------------------------------------------------------------------------

    \170\ Specifically, section 1022(b)(2)(A) of the Dodd-Frank Act 
calls for the Bureau to consider the potential benefits and costs of 
a regulation to consumers and covered persons, including the 
potential reduction of access by consumers to consumer financial 
products or services; the impact on depository institutions and 
credit unions with $10 billion or less in total assets as described 
in section 1026 of the Dodd-Frank Act; and the impact on consumers 
in rural areas.
---------------------------------------------------------------------------

    The Board issued the 2011 ATR Proposal prior to the transfer of 
rulemaking authority to the Bureau. As the Board was not subject to 
Dodd-Frank Act section 1022(b)(2), the 2011 ATR Proposal did not 
contain a proposed Dodd-Frank Act section 1022 analysis.
    The Dodd-Frank Act and the final rule establish minimum standards 
for consideration of a consumer's repayment ability for creditors 
originating certain closed-end, residential mortgage loans. These 
underwriting requirements are similar, but not identical, to the 
ability-to-repay requirements that apply to high-cost and higher-priced 
mortgage loans under current regulations.\171\ In general, the Act and 
the final rule prohibit a creditor from making a covered transaction 
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.
---------------------------------------------------------------------------

    \171\ The Bureau notes that under the final rule, ``higher-
priced covered transaction'' is defined in Sec.  1026.43(b)(4). 
``Higher-priced mortgage loan'' (HPML) is defined in Sec.  1026.35. 
``High-cost mortgage'' is defined in Sec.  1026.32. The Bureau 
further notes that interest rate thresholds specified in the 
``higher-priced covered transaction'' definition (higher-priced 
threshold) are similar to the HPML thresholds, except the final 
rule's higher-priced threshold does not include a specified rate 
threshold for ``jumbo'' loans, as provided in Sec.  1026.35.
---------------------------------------------------------------------------

    These documentation and verification requirements effectively 
prohibit no documentation and limited documentation loans that were 
common in the later years of the housing bubble. The final rule 
generally requires the creditor to verify the information relied on in 
considering a consumer's debts relative to income or residual income 
after paying debts, using reasonably reliable third-party records, with 
special

[[Page 6556]]

rules for verifying a consumer's income or assets. The creditor must 
calculate the monthly mortgage payment based on the greater of the 
fully-indexed rate or any introductory rate, assuming monthly, fully 
amortizing payments that are substantially equal. The final rule 
provides special payment calculation rules for loans with balloon 
payments, interest-only loans, and negative amortization loans.
    The final rule provides special rules for complying with the 
ability-to-repay requirements for a creditor refinancing a ``non-
standard mortgage'' into a ``standard mortgage.'' Under the final rule, 
a non-standard mortgage is defined as an adjustable-rate mortgage with 
an introductory fixed interest rate for a period of one year or longer, 
an interest-only loan, or a negative amortization loan. Under this 
provision, a creditor refinancing a non-standard mortgage into a 
standard mortgage does not have to consider the specific underwriting 
criteria a lender must otherwise consider under the general ability-to-
repay option, if certain conditions are met.
    To provide creditors more certainty about their potential liability 
under the ability-to-pay standards while protecting consumers from 
unaffordable loans, the Dodd-Frank Act creates a presumption of 
compliance with the ability-to-pay requirement when creditors make 
``qualified mortgages.'' According to the statute, covered 
transactions, in general, are qualified mortgages where: the loan does 
not contain negative amortization, interest-only payments, or balloon 
payments (except in certain limited circumstances); the term does not 
exceed 30 years; points and fees (excluding up to two bona fide 
discount points) do not exceed three percent of the total loan amount; 
the income or assets and debt obligations are considered and verified; 
the underwriting is based on the maximum rate during the first five 
years, uses a payment schedule that fully amortizes the loan over the 
loan term, and takes into account all mortgage-related obligations.
    Under the final rule creditors have three options for originating a 
qualified mortgage. Under the first option, the loan must satisfy basic 
documentation and verification requirements for income or assets and 
debt, and the consumer must have a total (or ``back-end'') debt-to-
income ratio that is less than or equal to 43 percent. With respect to 
a loan that satisfies these criteria and is not a higher-priced covered 
transaction, there is a conclusive presumption that the creditor 
satisfied the ability-to-pay requirements so that the loan qualifies 
for a legal safe harbor under the ability-to-repay requirements. A loan 
that satisfies these criteria and is a higher-priced covered 
transaction receives a rebuttable presumption of compliance with the 
ability-to-repay requirements.
    The second option for originating a qualified mortgage provides a 
temporary expansion of the general definition. Through this option, a 
loan is a qualified mortgage if it meets the prohibitions on certain 
loan features, the limitations on points and fees and loan terms that 
apply under the general definition and also meets one of the following 
requirements: is eligible for purchase or guarantee by the Federal 
National Mortgage Association (Fannie Mae) or the Federal Home Loan 
Mortgage Corporation (Freddie Mac) (collectively, the GSEs), while 
operating under the conservatorship or receivership of the FHFA; is 
eligible to be purchased or guaranteed by any limited-life regulatory 
entity succeeding the charter of either the GSEs; or is eligible to be 
insured by the FHA, VA or USDA or USDA RHS. This temporary provision 
expires with respect to GSE-eligible loans when conservatorship of the 
GSEs ends and expires with respect to each other category of loans on 
the effective date of a rule issued by each respective Federal agency 
pursuant to its authority under TILA section 129C(b)(3)(ii) to define a 
qualified mortgage. Alternatively, if GSE conservatorship continues or 
the Federal agencies do not issue rules defining qualified mortgage 
pursuant to TILA section 129C(b)(3)(ii), the temporary qualified 
mortgage definition expires seven years after the effective date of the 
rule.
    Unlike loans that are qualified mortgages under the general 
definition, there is no specific monthly debt-to-income ratio threshold 
to be a qualified mortgage under this temporary provision, except as 
may be required to be eligible for purchase or guarantee or to be 
insured by the GSEs or Federal agencies. The temporary qualified 
mortgage definition does not specifically include documentation and 
verification requirements or a specific payment calculation 
requirement. The Bureau understands that, to be eligible for purchase 
or guarantee by the GSE's or to be eligible to be guaranteed or insured 
by the Federal agencies, a loan must first satisfy certain payment 
calculation requirements and repayment ability analyses (which include 
consideration of a consumer's total monthly debt-to-income ratio) and 
the information on which the calculation is based must be documented 
and verified. As is true with respect to the first category of 
qualified mortgages described above, a loan that satisfies these 
criteria and is not a higher-priced covered transaction receives a 
legal safe harbor under the ability-to-repay requirements. A loan that 
satisfies these criteria and is a higher-priced covered transaction 
receives a rebuttable presumption of compliance with the ability-to-
repay requirements.
    The third option for qualified mortgages exists only for small 
creditors operating predominantly in rural or underserved areas, who 
are allowed under the rule to originate a balloon-payment qualified 
mortgage. Specifically, this option exists for lenders originating 500 
or fewer covered transactions, secured by a first lien, in the 
preceding calendar year, with assets equal to or under $2 billion (to 
be adjusted annually), and who made more than 50 percent of their total 
covered transactions secured by first liens on properties in counties 
that are ``rural'' or ``underserved.'' These creditors are allowed to 
offer loans with balloon payments assuming the loan also meets certain 
loan-specific criteria: the creditor must satisfy the requirements 
under the general qualified mortgage definition regarding consideration 
and verification of income or assets and debt obligations; the loan 
cannot permit negative amortization; the creditor must determine that 
the consumer can make all of the scheduled payments (other than the 
final balloon payment) under the terms of the legal obligation from the 
consumer's current or reasonably expected income or assets other than 
the dwelling that secures the transaction; the loan must have a term of 
least five years and no more than 30 years; the interest rate is fixed 
during the term of the loan; the creditor must base the payment 
calculation on the scheduled periodic payments, excluding the balloon 
payment; and the loan must not be subject to a forward commitment at 
the time of consummation.
    Unlike loans that are qualified mortgages under the general 
definition, there is no specific debt-to-income ratio requirement for 
balloon-payment qualified mortgages. However, creditors must generally 
consider and verify a consumer's monthly debt-to-income ratio. Like the 
other qualified mortgage definitions, a loan that satisfies the 
criteria for a balloon-payment qualified mortgage and is not a higher-
priced covered transaction receives a legal safe harbor under the 
ability-to-repay requirements for as long as the loan is held in 
portfolio by the creditor who originated the loan. The safe harbor also

[[Page 6557]]

applies to balloon-payment qualified mortgages which are sold three 
years or more after consummation. A loan that satisfies the balloon 
payment qualified mortgage criteria and is a higher-priced covered 
transaction receives a rebuttable presumption of compliance with the 
ability-to-repay requirements.
    As discussed above, the final rule provides a conclusive 
presumption of compliance with the ability-to-repay requirements for 
loans that satisfy the definition of a qualified mortgage and are not 
higher-priced covered transactions (i.e., APR does not exceed Average 
Prime Offer Rate (APOR) + 1.5 percentage points for first liens or 3.5 
percentage points for subordinate liens).\172\ The final rule provides 
a rebuttable presumption of compliance with ability-to-repay 
requirements for all other qualified mortgage loans, meaning qualified 
mortgage loans that are higher-priced covered transactions. A consumer 
who seeks to rebut the presumption must prove that, at the time of 
consummation, in light of the consumer's income and debt obligations, 
the consumer's monthly payment (including mortgage-related obligations) 
on the covered transaction and any simultaneous loans of which the 
creditor was aware, would leave the consumer with insufficient residual 
income to pay living expenses, including recurring and material 
obligations or expenses of which the creditor was aware.
---------------------------------------------------------------------------

    \172\ The Average Prime Offer Rate means ``the average prime 
offer rate for a comparable transaction as of the date on which the 
interest rate for the transaction is set, as published by the 
Bureau.'' TILA section 129C(b)(2)B).
---------------------------------------------------------------------------

    Finally, the final rule implements the Dodd-Frank Act 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 this rule, in connection 
with credit that does not meet the definition of open-end credit, by 
structuring a closed-end extension of credit as an open-end plan.
    A consumer who brings an action against a creditor for a violation 
of the ability-to-repay requirements within three years from when the 
violation occurs may be able to recover special statutory damages equal 
to the sum of all finance charges and fees paid by the consumer, unless 
the creditor demonstrates that the failure to comply is not material; 
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. After 
the expiration of the three-year time period, the consumer is precluded 
from bringing an affirmative claim against the creditor. At any time, 
when a creditor or an assignee initiates a foreclosure action, a 
consumer may assert a violation of these provisions ``as a matter of 
defense by recoupment or setoff.'' There is no time limit on the use of 
this defense, although the recoupment or setoff of finance charge and 
fees is limited to the first three years of finance charges and fees 
paid by the consumer under the mortgage.

B. Data and Quantification of Benefits, Costs and Impacts

    Section 1022 of the Dodd-Frank Act requires that the Bureau, in 
adopting the rule, consider potential benefits and costs to consumers 
and covered persons resulting from the rule, including the potential 
reduction of access by consumers to consumer financial products or 
services resulting from the rule, as noted above; it also requires the 
Bureau to consider the impact of proposed rules on covered persons and 
the impact on consumers in rural areas. These potential benefits and 
costs, and these impacts, however, are not generally susceptible to 
particularized or definitive calculation in connection with this rule. 
The incidence and scope of such potential benefits and costs, and such 
impacts, will be influenced very substantially by economic cycles, 
market developments, and business and consumer choices, that are 
substantially independent from adoption of the rule. No commenter has 
advanced data or methodology that it claims would enable precise 
calculation of these benefits, costs, or impacts. Moreover, the 
potential benefits of the rule on consumers and covered persons in 
creating market changes anticipated to address market failures are 
especially hard to quantify.
    In considering the relevant potential benefits, costs, and impacts, 
the Bureau has utilized the available data discussed in this preamble, 
where the Bureau has found it informative, and applied its knowledge 
and expertise concerning consumer financial markets, potential business 
and consumer choices, and economic analyses that it regards as most 
reliable and helpful, to consider the relevant potential benefits and 
costs, and relevant impacts. The data relied upon by the Bureau 
includes the public comment record established by the proposed rule, as 
well as the data described in the Bureau's Federal Register notice 
reopening the comment for this rule,\173\ and the public comments 
thereon.
---------------------------------------------------------------------------

    \173\ See 77 FR 33120 (June 5, 2012)
---------------------------------------------------------------------------

    However, the Bureau notes that for some aspects of this analysis, 
there are limited data available with which to quantify the potential 
costs, benefits, and impacts of the final rule. For example, data on 
the number and volume of various loan products originated for the 
portfolios of bank and non-bank lenders exists only in certain 
circumstances. Data regarding many of the benefits of the rule such as 
the benefits from prevented defaults or from prevented injuries to the 
financial system are also limited.
    In light of these data limitations, the analysis below generally 
provides a qualitative discussion of the benefits, costs, and impacts 
of the final rule. General economic principles, together with the 
limited data that are available, provide insight into these benefits, 
costs, and impacts. Where possible, the Bureau has made quantitative 
estimates based on these principles and the data that are available. 
For the reasons stated in this preamble, the Bureau considers that the 
rule as adopted faithfully implements the purposes and objectives of 
Congress in the statute. Based on each and all of these considerations, 
the Bureau has concluded that the rule is appropriate as an 
implementation of the Act.

C. Baseline for Analysis

    The provisions of Dodd Frank concerning minimum loan standards and 
the ability-to-repay requirement are self-effectuating, and the Dodd-
Frank Act does not require the Bureau to adopt a regulation to 
implement these amendments. The Act does require the Bureau to issue 
regulations to ``carry out the purposes of'' the subsection governing 
qualified mortgages, which includes the ``presumption of compliance'' 
accorded those mortgages. In the absence of such regulations, the 
statutory provisions would take effect on January 21, 2013, and there 
would be no clarification beyond the statute as to the meaning of the 
ability-to-repay requirement, which mortgages meet the statutory 
criteria for a qualified mortgage, and the nature of the presumption of 
compliance with respect to such mortgages. Thus, many costs and 
benefits of the final rule considered below would arise largely or 
entirely from the statute, not from the final rule. The final rule 
would provide substantial benefits compared to allowing these 
provisions to take effect alone by clarifying parts of the statute that 
are ambiguous. Greater clarity on these

[[Page 6558]]

issues should reduce the compliance burdens on covered persons by 
reducing costs for attorneys and compliance officers as well as 
potential costs of over-compliance and unnecessary litigation.
    Section 1022 of the Dodd-Frank Act permits the Bureau to consider 
the benefits and costs of the rule solely compared to the state of the 
world in which the statute takes effect without an implementing 
regulation. To provide the public better information about the benefits 
and costs of the statute, however, the Bureau has nonetheless chosen to 
evaluate the benefits, costs, and impacts of the major provisions of 
the final rule against a pre-statutory baseline. That is, the Bureau's 
analysis below considers the benefits, costs, and impacts of the 
relevant provisions of the Dodd-Frank Act combined with the final rule 
implementing those provisions relative to the regulatory regime that 
pre-dates the Act and remains in effect until the final rule takes 
effect. As noted, current regulations have parallel but not identical 
ability-to-repay rules applied to higher-price and high-cost mortgage 
loans.\174\
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    \174\ The Bureau has chosen, as a matter of discretion, to 
consider the benefits and costs of those provisions that are 
required by the Dodd-Frank Act in order to better inform the 
rulemaking. The Bureau has discretion in future rulemakings to 
choose the relevant provisions to discuss and to choose the most 
appropriate baseline for that particular rulemaking.
---------------------------------------------------------------------------

    In the analysis, in addition to referring to present market 
conditions, the Bureau refers at times to data from other historical 
periods--the market as it existed from 1997 to 2003 and the years of 
the bubble and the collapse--to provide the public a fuller sense of 
the potential impacts of the rule in other market conditions.\175\ 
Considering the current state of the market makes clear the near term 
benefits and costs of the provisions. However, at this point in the 
credit cycle, the market is highly restrictive and operating under very 
tight credit conditions.\176\ Against this background, the benefits and 
the costs of the rule may appear smaller than otherwise.
---------------------------------------------------------------------------

    \175\ The statute and final rule are designed to ensure a 
minimal level of underwriting across various states of the housing 
market and credit cycle. As a result, the Bureau determined, as a 
matter of discretion, that it was beneficial to compare certain 
aspects of the rule against different scenarios, using different 
historical data.
    \176\ See Board of Governors of the Federal Reserve System, 
``Monetary Policy Report to the Congress,'' (July 17, 2012), 
available at http://www.federalreserve.gov/monetarypolicy/files/20120717_mprfullreport.pdf.
---------------------------------------------------------------------------

    The Bureau considers the mortgage market as it existed from 1997 
through 2003 useful to assess some of the rule's possible effects when 
credit conditions, and the economy more generally, return to normal. 
During this period, home prices were generally rising and the housing 
market was in a positive phase. Notably, interest rates were falling in 
2002 and 2003, which created a very large surge in refinancing 
activity. This period may not be perfectly representative of an 
``average'' market, but these years span almost a full business cycle, 
capturing the end of 1990's expansion, the early 2000's recession and 
the beginning of the next expansion.\177\
---------------------------------------------------------------------------

    \177\ Reliable loan level data from earlier time periods is 
generally unavailable.
---------------------------------------------------------------------------

    The analysis also uses data from the period 2004 through 2009. 
Beginning in 2004, the mortgage market in the United States was in the 
height of the housing bubble. In 2007 home prices, mortgage lending, 
and the economy more generally collapsed. The period that covers the 
``bubble'' years and the crash that followed is also useful to gauge 
the impacts of the final rule. It is exactly the lending conditions 
during those years, and the damage they caused, that the statute and 
the final rule are primarily designed to prevent. Examining the 
performance and effects of the mortgages offered during this period, 
loans that were largely originated based on the perceived value of 
collateral, offers insights into the potential benefits and costs of 
the rule.

D. Coverage of the Final Rule

    The provisions of the final rule require creditors to determine a 
consumer's ability to repay a ``residential mortgage loan, '' excluding 
reverse mortgages and temporary bridge loans of 12 months or less, 
(referred to as ``covered transactions'') ''and establish new rules and 
prohibitions on prepayment penalties. For these purposes, this rule 
covers with some exceptions, any dwelling-secured consumer credit 
transaction, regardless of whether the consumer credit transaction 
involves a home purchase, refinancing, home equity loan, first lien or 
subordinate lien, and regardless of whether the dwelling is a principal 
residence, second home, vacation home (other than a timeshare 
residence), a one- to four-unit residence, condominium, cooperative, 
mobile home, or manufactured home. However, the Dodd-Frank Act 
specifically excludes from these provisions open-end credit plans or 
extensions of credit secured by an interest in a timeshare plan. The 
final rule generally also excludes reverse mortgages, residential 
construction loans, and bridge loans with a term of 12 months or less.

E. Potential Benefits and Costs to Consumers and Covered Persons

    In the analysis of benefits, costs and impacts, the Bureau has 
chosen to consider the ability-to-repay provisions together with the 
various qualified mortgage provisions. The discussion below first 
addresses the economics of an ability-to-repay standard, and considers 
the specific market failures that the statute and the rule aim to 
address. In general, market failures may include incomplete markets, 
externalities, imperfect competition, imperfect information, or 
imperfect information processing by consumers and several of those are 
discussed here.\178\ The benefits and costs of the requirement to 
assess ability to repay based upon documented and verified information 
are then discussed along with the impacts of the new liabilities, and 
the presumption of compliance that mitigates those liabilities 
established under the Dodd-Frank Act.
---------------------------------------------------------------------------

    \178\ For a general discussion of market failures, including 
incomplete markets, see Chapter 4 (``Market Failure'') in Joseph E. 
Stiglitz. Economics of the Public Sector, 3d edition. New York: W. 
W. Norton & Company, Inc. (2000).
---------------------------------------------------------------------------

    Additional provisions of the rule are considered including the 
impacts of the provisions related to points and fees, prepayment 
penalties and the definition of ``rural or underserved''. The 
relationship between these provisions and other mortgage related 
rulemakings is discussed. The benefits, costs and impacts of the final 
rule in relation to several major alternatives are then discussed.
1. Economics of Ability To Repay
    The basic requirement of Section 1411 of the Dodd-Frank Act is that 
a covered transaction may only be made when the creditor has made a 
``reasonable and good faith'' determination that the consumer will be 
able to repay the loan. In the absence of any market imperfections, 
when negotiating a loan, both the lender and borrower would understand 
and consider the probability of default and the related costs should 
such a default occur. Creditors would extend credit if, and only if, 
the ``price'' of the loan, i.e., the risk-adjusted return (the return 
taking into account the expected loss from default) is high enough to 
justify the investment. Informed consumers would accept the loan if, 
and only if, the benefits of financing the property are worth the 
costs, including any expected costs in the likelihood that they default 
and

[[Page 6559]]

cannot maintain access to the specific property.
    The primary benefits or costs from an ability-to-repay requirement 
therefore derive from situations, where, absent such a requirement, 
these conditions are not met or where certain externalities may exist. 
These may include situations where the originator or creditor is not 
fully informed or has incorrect information about the transaction. More 
likely, a fully informed originator or creditor may not fully 
internalize all of the relevant costs, and is willing to extend credit 
even though the consumer may lack the ability to repay. Since the 
consumer willingly enters into the transaction, he or she must also be 
uninformed of either the true likelihood or true costs of default, or 
must not fully internalize all of the relevant costs. As discussed 
below, some of these situations arise when the lender or the borrower, 
fully understanding the risks of the loan and the inherent costs to 
themselves, do not factor costs borne by parties outside the 
transactions into their decisions.
    Collateral based or ``hard money'' lending is one possible case 
where such lending could occur. If the lender is assured (or believes 
he is assured) of recovering the value of the loan by gaining 
possession of the asset, the lender may not pay sufficient attention to 
the ability of the borrower to repay the loan or to the impact of 
default on third parties. For very low loan-to-value (LTV) mortgages, 
i.e., those where the value of the property more than covers the value 
of the loan, the lender may not care at all if the borrower can afford 
the payments. Even for higher LTV mortgages, if prices are rising 
sharply, borrowers with even limited equity in the home may be able to 
gain financing since lenders can expect a profitable sale or 
refinancing of the property as long as prices continue to rise.
    Other cases may involve loan originators who do not bear the credit 
risk of the loan, and therefore do not bear the ultimate costs of 
default. The common case is lenders who sell their loans: these lenders 
earn upfront origination fees from consumers and gains on sale but 
(absent complete contracts that provide otherwise) may not generally 
bear the costs of a later borrower default. As the relative size of the 
upfront fees increase, the potential agency problems do as well. The 
market recognizes the informational issues in these transactions and 
has developed mechanisms to mitigate adverse selection and moral 
hazard. For example, purchasers of loans engage in due diligence, 
either directly or by hiring third parties, validating the information 
provided about the loans and ensuring that the seller has provided only 
loans that meet agreed upon criteria. In addition, contracts provide 
that ex-post, should a loan perform poorly, the originator may have to 
repurchase the loan. This contracting feature is also designed to 
ensure that the initial creditor of the loan has the proper incentives 
to verify the borrower's ability to repay or the collateral value. 
Still, not all information about the loan may be captured and passed 
among sequential owners of the loan; some tacit information, not passed 
on, may give the creditor an informational advantage over others and 
diminishes the creditors' incentives to verify the consumer's ability 
to repay.\179\
---------------------------------------------------------------------------

    \179\ Some consumers may also benefit from informational 
asymmetries that lead to the secondary market purchasing their 
mortgages without full information about the characteristics of the 
loan.
---------------------------------------------------------------------------

    However, even lenders who maintain loans in portfolio may pay 
insufficient attention to the borrower's ability to repay. Cases where 
the loan creditor can earn sufficiently high up-front compensation, or 
where incentives of the individual loan originators and the creditor 
differ, may lead to lending that does not include a realistic 
assessment of the borrower's ability to repay. For example, a retail 
loan originator who earns commission may not have the same incentives 
as the owners of the bank that employs the loan originator and who will 
bear the ultimate cost of the loan once on portfolio. Even if such loan 
originators do not have final decision-making authority as to whether 
the creditor will make the loan, the loan originator controls the 
information that the underwriter receives and may have an information 
advantage that could systematically bias underwriting decisions.\180\ 
This information problem, and therefore the risk of poorly underwritten 
portfolio loans, may be even greater where the originator is not an 
employee of the creditor as is true in the brokerage and correspondent 
lending contexts.
---------------------------------------------------------------------------

    \180\ Examples of empirical evidence of the persistence of moral 
hazard among employees in commercial and retail lending, include 
originators of residential mortgages, appears in Sumit Agarwal and 
and Itzhak Ben-David, ``Do Loan Officers' Incentives Lead to Lax 
Lending Standards?'' Federal Reserve Bank of Chicago working paper 
(2012); Aritje Berndt; and Burton Hollifield, and Patrik Sandas, 
2010, The Role of Mortgage Brokers in the Subprime Crisis, Working 
paper, Carnegie Mellon University. Cole, Shawn, Martin Kanz, and 
Leora Klapper (2010), Rewarding Calculated Risk-Taking: Evidence 
from a Series of Experiments with Commercial Bank Loan Officers, 
Working paper, Harvard Business School.
---------------------------------------------------------------------------

    In all these cases, the common problem is the failure of the 
originator or creditor to internalize particular costs, often magnified 
by information failures and systematic biases that lead to 
underestimation of the risks involved. The first such costs are simply 
the pecuniary costs from a defaulted loan--if the loan originator or 
the creditor does not bear the ultimate credit risk, he or she will not 
invest sufficiently in verifying the consumer's ability to repay. Even 
in cases where the lender does bear those costs, he or she will usually 
not fully internalize the private costs that a defaulting borrower will 
incur should default occur. Further, there are social costs from 
default that creditors may not internalize, as discussed below.\181\
---------------------------------------------------------------------------

    \181\ With these market failures, even if regulation limits 
opportunities for lenders to extend credit without retaining a 
portion of the risk, there may be cases where lenders will not pay 
enough attention to a borrower's ability to repay.
---------------------------------------------------------------------------

    As noted earlier, the borrower also must decide whether to enter 
into the mortgage, and fully informed, perfectly rational consumers 
should consider their own risk of default and private costs in the 
event of default. However, as with lenders, borrowers may not fully 
anticipate the future probability or costs of default, either because 
they are uninformed or for other reasons. Consumers may underestimate 
the true costs of homeownership or be overly optimistic about their own 
future (or even current) financial condition. This can be exacerbated 
in the case of less sophisticated consumers negotiating with more 
informed mortgage professionals who have an interest in closing the 
loan and who may falsely reassure consumers about the consumers' 
ability to repay.
    Consumers (and as noted above, creditors) may also misjudge the 
current or future value of the property securing the loan.\182\ This 
latter phenomenon was very much in evidence during the later years of 
the housing bubble as many consumers simply assumed that in times of 
financial stress, they could always sell or refinance. Further, 
consumers may not understand or may underestimate the costs they will 
incur in the event of default, such as the loss of the borrower's own 
home, costs of relocation, and the borrower's loss of future credit, 
employment and other

[[Page 6560]]

opportunities for which credit reports or credit scores weigh in the 
decision.\183\
---------------------------------------------------------------------------

    \182\ See Foote, Christopher L., Kristopher S. Gerardi, and Paul 
S. Willen, ``Why Did So Many People Make So Many Ex Post Bad 
Decisions? The Causes of the Foreclosure Crisis,'' Public Policy 
Discussions Papers, Federal Reserve Bank of Boston (2012), available 
at http://www.bostonfed.org/economic/ppdp/2012/ppdp1202.pdf.
    \183\ See for example, Kenneth P. Brevoort and Cheryl R. Cooper, 
Foreclosure's Wake: The Credit Experiences of Individuals Following 
Foreclosure, Working Paper, 2010 available at http://works.bepress.com/kbrevoort/2.
---------------------------------------------------------------------------

    As noted above, neither party to the transaction is likely to 
internalize costs to third parties. Even among very informed consumers 
and creditors, most will not internalize the social costs that 
delinquency or foreclosure can have.\184\ Research has consistently 
shown that a foreclosure will have a negative effect on the other 
homeowners in the vicinity either through the displacement of demand 
that otherwise would have increased the neighborhood prices, reduced 
valuations of future sales if the buyers and/or the appraisers are 
using the sold foreclosed property as a comparable, vandalism, and 
disinvestment.\185\ While the estimated magnitudes and the breadth of 
the impact differ, researchers seem to agree that there is a negative 
impact on houses in the vicinity of the foreclosure, and this impact is 
the highest for the houses that are the closest to the foreclosed house 
and for the houses that get sold within a short period of time of the 
foreclosed sale.\186\
---------------------------------------------------------------------------

    \184\ Section 1022 requires consideration of benefits and costs 
to consumers and covered persons. The ability to pay rule also has 
important potential benefits and costs for other individuals and 
firms, and for society at large. The Bureau discusses these benefits 
and costs here because they are particularly important to the 
Bureau's development, and public understanding of, the final rule. 
The rule implements statutory provisions, enacted in the wake of the 
financial crisis, that seem clearly intended to help prevent the 
potential negative social externalities of poor underwriting while 
preserving the potential positive social externalities of mortgage 
lending. The Bureau reserves discretion in the case of each rule 
whether to discuss benefits and costs other than to consumers and 
covered persons.
    \185\ There are several papers documenting various magnitudes of 
the negative effect on the nearby properties. Data in Massachusetts 
from 1987 to 2009 indicate that aside from a 27% reduction in the 
value of a house (possibly due to losses associated with 
abandonment), foreclosures lead to a 1% reduction in the value of 
every other house within 5 tenths of a mile. See John Y. Campbell, 
Stefano Giglio, and Parag Pathak, Forced Sales and House Prices, 
American Economic Review 101(5) (2011), abstract available at: 
http://www.aeaweb.org/articles.php?doi=10.1257/aer.101.5.2108. Data 
from Fannie Mae for the Chicago MSA, show that a foreclosure within 
0.9 kilometers can decrease the price of a house by as much as 8.7%, 
however the magnitude decreases to under 2% within five years of the 
foreclosure. See Zhenguo Lin, Eric Rosenblatt, and Vincent W. Yao. 
``Spillover Effects of Foreclosures on Neighborhood Property 
Values,'' The Journal of Real Estate Finance and Economics, 2009, 
38(4), 387-407. Similarly, data from a Maryland dataset for 2006-
2009 show that a foreclosure results in a 28% increase in the 
default risk to its nearest neighbors. See Charles Towe and Chad 
Lawley, 2011, ``The Contagion Effect of Neighboring Foreclosures,'' 
SSRN Working Paper 1834805.
    \186\ Frame, W. Scott (2010): Estimating the effect of mortgage 
foreclosures on nearby property values: A critical review of the 
literature, Economic Review, Federal Reserve Bank of Atlanta, ISSN 
0732-1813, Vol. 95, http://hdl.handle.net/10419/57661.
---------------------------------------------------------------------------

    Research is also beginning to examine other spillover effects from 
foreclosures including increases in neighborhood crime \187\ and social 
effects on family members such as hampered school performance.\188\ 
Social policy has long favored homeownership for the societal benefits 
that may ensue; the negative spillovers from foreclosures can be seen 
as the inverse of this dynamic.\189\
---------------------------------------------------------------------------

    \187\ See for example, Ingrid Gould Ellen, Johanna Lacoe, and 
Claudia Sharygin, Do Foreclosures Cause Crime?, Working Paper 2011.
    \188\ A summary of recent and ongoing research is presented in 
Julia B. Isaacs, The Ongoing Impact of Foreclosures on Children, 
First Focus/The Brookings Institution, April 2012. See also Samuel 
R. Dastrup and Julian R. Betts, Elementary Education Outcomes and 
Stress at Home: Evidence from Mortgage Default in San Diego.
    \189\ See for example, the literature summarized in Dwight 
Jaffee and John M. Quigley, The future of the government sponsored 
enterprises: the role for government in the U.S. mortgage market, 
NBER Working Paper Series, Working Paper 17685, available at http://www.nber.org/papers/w17685.
---------------------------------------------------------------------------

    The Dodd-Frank Act and the final rule address these potential 
market failures through minimum underwriting requirements at 
origination and new liability for originators and assignees in cases 
where the standards are found not to be met. For qualified mortgages 
that have earned the conclusive presumption, meeting the qualified 
mortgage product criteria and underwriting requirements and pricing of 
the loan at a prime rate are judged in the rule to be enough to ensure 
that the lender made a reasonable and good faith determination that the 
borrower will be able to repay the loan. For loans where the final rule 
creates a presumption of compliance but leaves room for the borrower to 
rebut the presumption of compliance, or loans for which there is no 
presumption (i.e., loans that are not qualified mortgages) the lender 
may exert greater care in underwriting the loan than would be true in 
the absence of any liability for extending a loan which the consumer 
cannot afford to repay. Lenders therefore face an initial market 
tradeoff when choosing the optimal level of costs to bear in 
documenting and underwriting the loan and assessing the ability to 
repay (subject to the minimum standards all loans must meet): some 
increased effort (and therefore increased cost) at the time of 
origination may lower costs resulting from possible liability should 
the borrower become delinquent or default. Since assignees now share 
this liability, they have an additional incentive to monitor the 
behavior of the original creditor. The ex-post liability to the 
consumer mitigates the incentives for the creditor to shirk on the ex-
ante investments in the underwriting.
    Even creditors making the optimal choice of effort when 
documenting, verifying and underwriting the loan may still face some 
legal challenges from consumers ex-post. This will occur when a 
consumer proves unable to repay a loan and wrongly believes (or chooses 
to assert) that the creditor failed to properly assess the consumer's 
ability to repay before making the loan. This will likely result in 
some litigation expense, although the Bureau believes that over time, 
that expense will likely diminish as experience with litigation 
resolves more precise guidelines regarding what level of compliance is 
considered complete. After some experience, litigation expense will 
most likely result where compliance is insufficient or from limited 
novel sets of facts and circumstances where some ambiguity 
remains.\190\ Regardless of which party incurs the costs, the economic 
costs of these actions are the resources used to litigate these cases, 
thereby helping to ensure compliance and limiting the incidence of 
loosely documented originations. The reimbursement of interest and 
fees, along with the statutory damages, paid to the borrower, 
constitute, in economic terms, a transfer--a cost to the originator or 
assignee and a benefit to the compensated borrower.\191\
---------------------------------------------------------------------------

    \190\ The Bureau recognizes that there may always be some 
frivolous lawsuits for which lenders will pay legal expenses. In 
addition, uncertainty inherent in the legal system also implies a 
base level of litigation.
    \191\ In a cost benefit accounting, the ex-post realization of 
the contingent payment from the creditor to the borrower is a 
transfer, a cost on one side and a benefit on the other. For risk-
averse consumers, the ex-ante insurance value of the contingent 
payment is also a benefit. In other words, consumers are better off 
knowing that if they are harmed, they will recover some damages.
---------------------------------------------------------------------------

2. Potential Benefits of the Ability-To-Repay Provisions for Consumers 
and Covered Persons
    The final rule will help to ensure that loans are not made without 
regard for the borrower's ability to repay and thereby protect 
consumers and as noted above, others affected by defaults and 
foreclosures. (These others are themselves consumers and the adverse 
spillover effect from defaults and foreclosures very much impacts their 
economic well being.) Historically, the conditions under which credit 
is extended have been cyclical in nature. Periods of tight credit, such 
as the

[[Page 6561]]

conditions that exist in the current mortgage market, are marked by 
reduced loan activity, very stringent lending standards, and extreme 
care in underwriting. In such periods, the benefits of a regime 
designed to require prudent underwriting, may be less apparent, and, in 
the near term, adopting such a regime, as the final rule does, will 
likely have little direct and immediate effect either on consumers or 
covered persons. As explained further in the discussion of costs to 
consumers and covered persons, lenders generally are already doing what 
the rule requires and a large majority of their loans will qualify for 
the conclusive presumption of compliance.
    However, as credit expands, as it almost inevitably will, the final 
rule will help to ensure that loans are made properly and with regard 
for the borrower's ability to repay. To assess the benefits of the 
final rule, therefore, it is useful to examine the provisions of the 
final rule in the context of the recent housing bubble and its collapse 
in 2007.
    There is growing evidence that many of the market failures in the 
previous discussion were in play in the years leading up to the housing 
collapse. In some cases, lenders and borrowers entered into loan 
contracts on the misplaced belief that the home's value would provide 
sufficient protection. These cases included subprime borrowers who were 
offered loans because the lender believed that the house value either 
at the time of origination or in the near future could cover any 
default. Some of these borrowers were also counting on increased 
housing values and a future opportunity to refinance; others likely 
understood less about the transaction and were at an informational 
disadvantage relative to the lender. These cases also included Alt-A 
loans taken by borrowers hoping to speculate on housing values.
    In both of these situations, these loans frequently involved less 
traditional products, loans structured with minimal monthly payments in 
order to allow the borrower to qualify and to carry the loan for a 
period of time with minimal expense. Many of these loans were sold into 
the secondary market, limiting the lenders' credit risk, but many 
lenders also retained these loans on their own portfolios either with 
the intent of earning the full anticipated profits from such loans over 
time or with the intent to hold the loans for a period of time before 
selling them. And throughout the housing boom, most lenders and 
borrowers entering into such agreements failed to consider the costs 
that default would inflict on other properties (and the consumers who 
inhabited them) and on the financial system and economy writ large.
    The benefits from the ability-to-repay requirements therefore come 
from further limiting and deterring unaffordable lending, above and 
beyond the current ability-to-pay requirements for higher-priced 
mortgage loans, and thereby reducing the ensuing private and social 
costs of excess delinquency and default. For example, the basic 
requirement that all loans be underwritten based on documented income 
and debt would have eliminated many of the loans made later in the 
bubble that led to crisis. Described as ``stated-income'' loans or 
``liar-loans,'' these mortgages became very prevalent in the later 
years of the expansion and had very poor, and worse than expected, 
performance when the markets collapsed.\192\ There is also growing 
evidence that incomes on many mortgage applications were overstated in 
the years before the crash.\193\ Importantly, while limited and reduced 
documentation loans were a large segment of the subprime market, many 
of these loans were also made to prime, higher credit score borrowers 
and on properties with lower loan-to-value ratios.\194\ This suggests a 
substantial benefit to the documentation and verification requirements 
across all segments of the market, particularly the substantial 
majority of covered transactions that current ability-to-pay 
requirements do not cover now and are not expected to cover in the 
future.
---------------------------------------------------------------------------

    \192\ From 2000 to 2009, reduced documentation loans grew from 2 
percent of outstandings to 9 percent. See FCIC Report pgs 110-111 
for discussion of these loans. Other research documents the poor 
performance of these loans and that the increased risk was not 
properly priced. See, for example, Michael LaCour-Little and Jing 
Yang, Taking the Lie Out of Liar Loans: The Effect of Reduced 
Documentation on the Performance and Pricing of Alt-A and Subprime 
Mortgages, 2012, Working Paper and Wei Jiang, Ashlyn Aiko Nelson, 
and Edward Vytlacil, Liar's Loan? Effects of Origination Channel and 
Information Falsification on Mortgage Delinquency, 2011, Working 
Paper. Some authors have tried to understand the differences between 
cases where lenders offered these loans as a benefit to certain 
customers and cases where customers simply chose a higher-priced 
limited doc alternative. See Irina Paley and Konstantinos Tzioumis, 
Rethinking Stated-income Loans: Separating the Wheat from The Chaff, 
Working Paper, 2011. For evidence that the risk on these loans was 
not fully priced, see Cost of Freddie Mac's Affordable Housing 
Mission, presentation to Board of Directors, 2009 at http://fcic-static.law.stanford.edu/cdn_media/fcic-docs/2009-06-04FreddieMac-CostofAffordableHousingMission.pdf p.12 analyzing the ``unexpectedly 
poor performance of * * * Alt-A purchases''
    \193\ For example, see Robert B. Avery, Neil Bhutta, Kenneth P. 
Brevoort, and Glenn B. Canner, The Mortgage Market in 2011: 
Highlights from the Data Reported under the Home Mortgage Disclosure 
Act, FEDS Working Paper Series, 2012. See also FCIC Report, pgs. 
110-111; LaCour-Little and Yang, 2012; Jiang, Nelson, and Vytlacil, 
2011; Paley and Tzioumis, 2011.
    \194\ See FCIC Report, pgs. 110-111; LaCour-Little and Yang, 
2012; Jiang, Nelson, and Vytlacil, 2011; Paley and Tzioumis, 2011.
---------------------------------------------------------------------------

    As prices rose, aspiring homeowners borrowed money by misstating 
their income; many loan originators were at least indifferent to or 
even complicit or proactive in these endeavors. The systemic effects 
were evident: the extension of credit against inflated incomes expanded 
the supply of credit, which in turn continued the rapid rise of house 
prices in the later years of the housing boom and exacerbated the 
eventual crash.\195\
---------------------------------------------------------------------------

    \195\ See Financial Stability Oversight Council, Macroeconomic 
Effects of Risk Retention Requirements, January 2011, at 12. 
(``[T]here is some evidence that the increased supply in subprime 
mortgage credit was in part responsible for greater home price 
appreciation * * * [and] increases in home prices may have 
reinforced expectations for future appreciation, which may have 
fueled more lending. Increases in loan volume, in turn, may have 
precipitated further increases in home prices.''); Mian, Atif and 
Amir Sufi, ``The Consequences of Mortgage Credit Expansion: Evidence 
from the U.S. Mortgage Default Crisis,'' Quarterly Journal of 
Economics, vol. 124, no. 4 (2009).
---------------------------------------------------------------------------

    The statute and the final rule also require that creditors must 
underwrite based on an amortizing payment using the fully indexed rate 
(or the maximum rate in five years for qualified mortgages) and 
including, with limited exceptions, any balloon payments in the first 
five years. This effectively bans the practice of underwriting loans 
based upon low upfront payments, either the lower interest-only 
payments on interest-only loans or negatively amortizing option ARMs or 
the teaser rates on hybrid ARMs.
    In their later incarnations, interest-only and negatively 
amortizing loans (along with loans with terms greater than 30 years) 
were often sold on the basis of the consumer's ability to afford the 
initial payments and without regard to the consumer's ability to afford 
subsequent payments once the rate was recast. At the peak of the 
market, between 2004 and 2006, the percentage of loans that were 
interest-only, option ARMs or 40-year mortgages rose from just 7 
percent of originations to 29 percent. The lower payment possibility 
for these loans allows borrowers to qualify for loans that they 
otherwise may not have been able to afford; but this comes with the 
same risks just described. The performance of many of these loans was 
also very poor, and worse than expected, with the onset of the 
downturn.\196\ The final rule does not

[[Page 6562]]

ban such products outright, but rather requires that lenders that make 
such loans have a ``reasonable and good faith'' belief in the 
borrower's ability to repay and that in formulating such a belief the 
lender must calculate the monthly payment based on the fully indexed 
rate and fully amortizing payments, and does not allow these loans to 
enjoy the presumption of compliance associated with qualified mortgage 
status. The new underwriting requirements, coupled with the liability 
for violating these rules, should deter improper loans and ensure 
proper underwriting and diligence when making such loans; again 
limiting cases of personal or social harm.
---------------------------------------------------------------------------

    \196\ See Amromin, Gene, Jennifer Huang, Clemens Sialm, and 
Edward Zhong, ``Complex Mortgages,'' Federal Reserve Bank of Chicago 
Working Paper 2010-17 (2010), available at http://www.chicagofed.org/digital_assets/publications/working_papers/2010/wp2010_17.pdf.
---------------------------------------------------------------------------

    Underwriting hybrid ARMs to the teaser rate was also a very common 
practice, in particular among subprime loans of the early 2000's. So 
called ``2/28'' and ``3/27'' loans were often underwritten based on the 
low initial payment,\197\ and exposed the borrower to potential payment 
shocks, and a need to refinance, two or three years into the 
mortgage.\198\ For example, in 2005, the teaser rate on subprime ARMs 
with an initial fixed-rate period of two or three years was 3.5 
percentage points below the fully indexed rate.\199\ As a result, 
mortgages originated in that year faced a potentially large change in 
the interest rate and payment, or ``payment shock,'' at the first 
adjustment even absent any change in the index.
---------------------------------------------------------------------------

    \197\ See for example, Christopher Mayer, Karen Pence, and Shane 
M. Sherlund, ``The Rise in Mortgage Defaults,'' Journal of Economic 
Perspectives 23, no. 1 (Winter 2009): Table 2, Attributes for 
Mortgages in Subprime and Alt-A Pools, p. 31. (showing that from 
2003 to mid-2007, about 70 percent of subprime loans in securitized 
pools were hybrid adjustable rate mortgage loans.)
    \198\ Brent W. Ambrose & Michael LaCour-Little, Prepayment Risk 
in Adjustable Rate Mortgages Subject to Initial Year Discounts: Some 
New Evidence, 29 Real Est. Econs. 305 (2001) (showing that the 
expiration of teaser rates causes more ARM prepayments, using data 
from the 1990s). The same result, using data from the 2000s and 
focusing on subprime mortgages, is reported in Shane Sherland, The 
Past, Present and Future of Subprime Mortgages, (Div. of Research & 
Statistics and Div. of Monetary Affairs, Fed. Reserve Bd., 
Washington, DC 2008); The result that larger payment increases 
generally cause more ARM prepayments, using data from the 1980s, 
appears in James Vanderhoff, Adjustable and Fixed Rate Mortgage 
Termination, Option Values and Local Market Conditions, 24 Real Est. 
Econs. 379 (1996).
    \199\ See Christopher Mayer, Karen Pence, & Shane Sherlund, The 
Rise in Mortgage Defaults, 23 J. Econ. Persps. 27, 37 (2009).
---------------------------------------------------------------------------

    The evidence is mixed on whether payment shock at the initial 
interest rate adjustment causes default.\200\ And indeed, for some 
borrowers, these loans can be efficient contracts that allow for the 
extension of credit (see discussion below).\201\ However, the 
widespread use of the product put many borrowers in precarious 
financial positions and may also have fueled the systemic rise in home 
prices.\202\ The elimination of these products should limit both the 
individual and the systemic harms which ultimately translate, in the 
largest part, into harms to individual consumers.
---------------------------------------------------------------------------

    \200\ Mayer, Pence, & Sherlund, supra note 125, at 37 provide 
data from the 2000s that does not find a causal relationship between 
payment shock at the initial interest rate adjustment and default. 
In contrast, see Anthony Pennington-Cross & Giang Ho, The 
Termination of Subprime Hybrid and Fixed-Rate Mortgages, 38 Real 
Est. Econs. 399, 420 (2010), for evidence that among consumers with 
certain hybrid ARMs originated in the 2000s, a substantial number 
experienced an increase in monthly payment of at least 5% at the 
initial interest rate adjustment, and that the default rate for 
these loans was three times higher than it would have been if the 
payment had not changed.
    \201\ See for example, Gary Gorton, The Panic of 2007, paper 
presented at the Federal Reserve Bank of Kansas City's Jackson Hole 
Conference, August 2008, p. 12-18.
    \202\ .See for example, Mian and Sufi, 2009.
---------------------------------------------------------------------------

    The final rule reduces the likelihood that these products will 
reemerge on a broad scale and thus should limit the potential for 
individual and the systemic harms. The final rule bans no-doc and the 
old low-doc loans since the level of documentation is lower than that 
required by the rule). * * * The rule reduces the incentive to offer 
these other alternative mortgage products by requiring that 
underwriting be done assuming a fully amortizing payment at the fully 
indexed rate. The final rule also does not provide any legal protection 
for the lender that makes these loans (or the investor that acquires or 
guarantees them) as the loans are categorically disqualified from being 
qualified mortgage. These non-amortizing products will likely persist 
only in narrow niches for more sophisticated borrowers who want to 
match their mortgage payment to changes in their expected income stream 
and who have the resources to qualify for the products under the 
stringent underwriting assumptions the statute and regulation require. 
But these products will not likely be marketed as broadly as they were 
during the bubble.
    In addition to the products just described, loans with points and 
fees (except for bona fide discount points) that exceed three percent 
of the total amount cannot be qualified mortgages, except as applicable 
for smaller loans as defined. Creditors may take more care in 
originating a loan when more of the return derives from performance 
over time (interest payments) rather from upfront payments (points and 
fees). As such, this provision may offer lenders more incentive to 
underwrite these loans carefully. As loans with higher points and fees 
are usually assumed to be offered to borrowers in weaker financial 
circumstances, this provision offers protection to that class of 
borrowers.\203\
---------------------------------------------------------------------------

    \203\ In general, smaller dollar loans are more likely to be 
impacted by the points and fees provisions.
---------------------------------------------------------------------------

    As discussed above, the various liability provisions provide the 
incentives for lenders to take proper care judging the borrower's 
ability to repay. This incentive is strongest for loans that are not 
qualified mortgages. Within the qualified mortgage space, higher priced 
mortgage loans (HPMLs) are still subject to ability-to-repay liability 
but afforded a rebuttable presumption of compliance. This liability 
already exists under rules that took effect in October 2009 for HPMLs, 
so that relative to existing rules, there are few benefits (or costs) 
associated with the liability provisions for such loans. However, there 
are some material differences in the underwriting requirements and 
smaller differences in the scope of the presumption where the liability 
now applies where it did not in the past. The new assignee liability 
may also strengthen the incentives relative to the existing rules.
    Comparing the rebuttable presumption for higher priced qualified 
mortgages to the conclusive presumption (safe harbor) provision for 
qualified mortgages below the higher-priced threshold highlights the 
benefit of leaving the possibility of rebuttal in place. Borrowers 
paying higher rates on mortgage loans that meet the qualified mortgage 
product features are most likely to have lower credit scores, lower 
incomes and/or other risk factors; as such, it is among these subprime 
borrowers that a greater possibility exists for lenders to place the 
borrower into a loan that he or she may not have the ability to repay. 
The ability of the borrower to rebut the presumption of compliance 
leaves lenders with the additional incentive to ``double check'' the 
loan to examine further the borrower's financial condition and residual 
income, and to ensure that these higher risk borrowers have the means 
to live in the home they just purchased or refinanced.
    Where a consumer is unable to afford his or her mortgage--and 
proves that the lender lacked a reasonable and good faith belief in the 
consumer's repayment ability at the time the loan was made--the damages 
the borrower recovers are a benefit to that party. The same damages 
should also be considered a

[[Page 6563]]

cost to the lender and as such, estimates regarding the frequency of 
such actions and the dollar amounts involved are in the next section 
discussing costs.
    Another impact of the differentiated structure of the final rule, 
where certain loans enjoy a conclusive presumption, others are given a 
rebuttable presumption and still others are subject to ability to repay 
scrutiny without the benefit of a presumption, is that some borrowers 
may gain ``better'' loans as lenders choose to make loans that qualify 
for the highest level of legal protection. Lenders in less competitive 
environments who have some flexibility over product offerings and/or 
pricing power may find it more profitable to offer a borrower a 
qualified mortgage rather than a non-qualified mortgage if, for such 
lenders, the expected value of the heightened legal protection is 
enough of an expected cost savings to offset any revenue reduction from 
making the qualified mortgage. For example, a creditor may restructure 
the price of a transaction with points and fees otherwise just above 
the points and fees limit for a qualified mortgage to have fewer 
upfront costs, and a higher interest rate, so that the loan is then 
under the limit and a qualified mortgage. Similarly, situations could 
exist where lowering the price on a loan would make the loan eligible 
for the safe harbor rather than the rebuttable presumption. The 
prevalence of these situations, or others similar situations, is hard 
to predict and depends on the future prices for mortgages in each of 
these segments, the competitive nature of the segments, and the 
individual lender's and borrower's situation.
    The benefits of the rule, as discussed above, will be widely shared 
among individual borrowers, creditors, investors, and the public 
(consumers) generally. As discussed above, the loss that occurs when a 
consumer is unable to repay a loan is felt by the consumer, the 
holder(s) of that loan, and other parties outside the transaction 
including other consumers and would-be-consumers. Ensuring that lenders 
make a reasonable and good faith determination of the borrower's 
ability to repay should prevent a widespread deterioration of 
underwriting standards, the extension of excess credit and the broader 
negative effects that can have on these parties. To the extent lenders 
are deterred from making unaffordable loans, or encouraged to make more 
affordable loans, all of these parties will benefit.
3. Potential Costs of the Ability-To-Repay Provisions to Consumers and 
Covered Persons
    In this part the Bureau considers costs to consumers and covered 
persons of the ability to repay provisions of the statute and final 
rule, including any potential cost in the form of reduced access to 
credit for consumers. The primary ongoing costs of the requirements of 
the final rule rest in the underwriting costs, including costs at 
origination to verify information on which the lender relies in the 
underwriting decision and the increased liability on lenders and 
assignees. As previously noted, in the current environment, lenders are 
already largely complying with these requirements and thus the rule 
should impose minimal, if any, ex ante costs. But in other credit 
environments, when creditors may wish to lower their underwriting 
criteria and require less documentation and perform less verification, 
the rule would require them to make a good faith and reasonable 
determination of ability to repay and to require them to incur ex-ante 
costs to document, verify and consider income and debt (and credit 
history). This should increase the quality of underwriting of mortgages 
at origination and thereby limit the prevalence of future delinquency 
and default, and the level of ex-post costs. (Of course, exogenous or 
unanticipated events and borrower behavior will still result in some 
delinquent and defaulting loans and some possible legal actions.) In 
this scheme, the possibility of legal recourse by the borrower serves 
as an incentive for better lender assessment of repayment ability as 
well as offering borrowers redress for wrongdoing. Lenders will 
determine the optimal combination of upfront underwriting cost and ex-
post liability costs; to the extent these costs increase and 
competitive conditions allow lenders to pass this cost onto borrowers, 
some borrowers will pay more for their loans. At the margin, certain 
loans that were made in the past, namely those where the borrower has 
limited ability to repay, will not be made.
a. Costs of the Documentation and Underwriting Requirements
    Two distinct requirements of the final rule--the requirement to 
verify income or assets, debt, and credit history, and the requirement 
to underwrite a mortgage based on an assessment of debt load using the 
fully indexed rate and fully amortizing payment--create costs for 
certain creditors and consumers. The final rule follows the statute in 
requiring that all creditors verify borrowers' income, debt and credit 
history. Reduced documentation loans were originally offered to high 
credit quality borrowers with substantial incomes. However, in the 
2000's, the prevalence of these loans increased substantially and the 
borrowers to whom they were offered changed. Anecdotally, some of these 
loans could have been made with full documentation; however, for that 
subset of loans, it was precisely the reduced processing times and 
paperwork costs of originating these loans that made them popular among 
mortgage brokers and originators during the boom.
    From this perspective, for certain consumers and creditors, 
requiring full documentation and verification may result in the loan 
being made with a less efficient contractual form, or possibly in the 
loan not being made. In these latter cases, consumers would lose the 
benefits they get from the mortgage (the benefits of owning a home, for 
example, or the benefits of obtaining better terms on a loan through a 
refinancing) and creditors would lose any profits on the loan. However, 
for most other originators, and consumers, reduced documentation loans 
were a way to grant credit to unqualified borrowers who did not have 
the means to afford the mortgage. As discussed in the benefits section, 
the elimination of these loans in these circumstances is a principal 
benefit of the rule.\204\
---------------------------------------------------------------------------

    \204\ In these cases, the requirements of the final rule are the 
benefits that were described earlier.
---------------------------------------------------------------------------

    For borrowers for whom the most efficient outcome (from a societal 
perspective) is, in fact, a reduced documentation mortgage, the 
requirements in the final rule have two possible costs. The time and 
material to verify the required underwriting elements with documents 
are true resource costs; depending on competitive conditions, the 
lender or the borrower may bear the actual costs. Precise estimates of 
these costs from time and motion studies or cost function analyses are 
not available, but the required pay stubs or tax records should not be 
a large burden. The final rule allows income to be verified utilizing 
copies of tax returns which the consumer can provide the creditor and 
permits debts to be verified utilizing a credit report. For those with 
more idiosyncratic income sources that would somehow not be reflected 
on a tax return, the costs may be slightly higher. However, it is also 
possible that certain loans that would be made absent the documentation 
requirements would not be made under the rule. This could happen, for 
example, in cases where the

[[Page 6564]]

cost of documenting the required factors is sufficiently high or where 
the borrower pays an exorbitant ``privacy'' cost in disclosing the 
documents. The final rule only requires that income or assets be 
verified to the extent they are relied upon by the creditor in 
assessing the consumer's ability to repay; thus the consumer is not 
required to disclose or document income or assets except if the 
consumer prefers to have her ability to repay assessed without regard 
to the undisclosed information. In the event that there are cases in 
which, despite these rules, a consumer who could qualify for a mortgage 
is unwilling to incur the privacy cost in documenting income or assets, 
the transaction will not occur: and the benefit to consumers and 
lenders from these `lost' transactions is the relevant cost.
    Relative to industry practice today, these requirements are likely 
to impose only a very limited burden for creditors. With the exception 
of the two situations discussed below, most loans today are made under 
very stringent, and perhaps inefficiently high, documentation 
requirements.\205\ The Bureau understands that full documentation is 
required for all purchase loans and many refinance loans being 
supported by government programs such as FHA. In addition, both Fannie 
Mae and Freddie Mac currently require full documentation. The Bureau 
believe that only a small subset of loans that creditors intend to hold 
on portfolio are underwritten today without the documentation that 
meets or is very close to the documentation required by the final rule. 
For this limited set of loans, the rule imposes the costs already 
described: The direct compliance costs to collect the required 
documentation in order to verify the information provided by the 
consumer and any costs from forgone transactions.
---------------------------------------------------------------------------

    \205\ To the extent that these requirements are inefficiently 
high, the cost is due to current practice and not to the final rule 
discussed here.
---------------------------------------------------------------------------

    One exception to the stringent documentation requirements now 
prevailing in the market (and exceeding the requirements of the rule) 
are certain streamlined refinance programs aimed at aiding the housing 
market recovery and certain targeted housing support programs offered 
to low and moderate income borrowers. The Bureau recognizes that the 
requirements of the final rule could greatly increase costs for these 
programs and hinder their success. It also recognizes that the 
possibility of consumer harm is likely limited in these contexts. As a 
result, elsewhere in today's Federal Register the Bureau is proposing 
certain exemptions from these requirements and seeking comment on the 
scope of such exemptions.
    There may also be some situations where lenders may have systems to 
document and verify the required information, but who do so in a manner 
that varies slightly from the provisions of the rule. These lenders may 
have to bear some costs to modify their systems or practices, but as 
noted above the Bureau understands there to be few such cases. Lenders 
who do collect information as required by the final rule, but who may 
use it differently may also incur some costs. For example, certain 
lenders may have systems or procedures in which the calculation of the 
DTI ratio does not conform to the requirements in appendix Q. Such a 
creditor could continue its current practices, which should they 
satisfy the ability-to-repay requirements, albeit without the benefit 
of a presumption of compliance. Lenders that prefer to make qualified 
mortgages with a presumption of compliance would have to bear the costs 
to modify systems or make other changes in order to calculate the 
required figures according to the rule. Modifications to information 
technology systems may also be necessary to enable lenders to label and 
track qualified mortgages.
    More broadly, the Bureau also recognizes that the establishment of 
the ability-to-pay requirements and the related distinction for 
qualified mortgages under the Act, will require modifications to 
existing compliance systems and to creditors' other management policies 
and procedures. For example, review and monitoring procedures may have 
to be altered to ensure compliance with the new requirements. Again, 
given the current state of the mortgage market, it is likely that many 
of these procedures are largely already in place.
    If measured relative to the benchmark of the earlier periods, 
either the period from 1997 to 2003 or the later years of the bubble, 
the requirements of the final rule could be seen to impose more 
substantial costs. Over the former period, there were more limited 
documentation loans than today, however it appears that many of these 
arose in the situations described where such lending is efficient. By 
the latter period, there were even more such loans and the balance 
appears to have shifted to one where many if not most of the limited 
documentation loans had misstated income and other deficiencies.
    During those periods there were likely some lenders, as evidenced 
by the existence of no-income, no-asset (NINA) loans, that used 
underwriting systems that did not look at or verify income, debts, or 
assets, but rather relied primarily on credit score and LTV. Under the 
final rule, these lenders would be impacted in two ways: They would 
have to collect and verify income, assets and debts; and more 
importantly, they would have to change much of their underlying 
business model to consider the required factors. As noted, the Bureau 
does not believe such lending is currently being practiced, and the 
benefits of preventing such lending may be substantial (as discussed 
above).
    The requirements that all loans be underwritten assuming a fully 
amortizing payment and the fully indexed rate (or to obtain qualified 
mortgage status the maximum rate within 5 years of origination) have 
costs similar in nature to the documentation requirements. There are 
some individuals or households with projected increases in income that 
will match the projected increased housing costs; the final rule allows 
the creditor to factor expected future income into the denominator of 
the debt-to-income calculation but does require that the numerator be 
calculated on the fully-indexed payment. There also may be individuals 
with constant income but a housing need that is shorter than the 
introductory period. In at least these latter cases, there may be some 
loans where it is efficient to qualify the borrower only on the current 
payment or some other amount. It is difficult to quantify the set of 
borrowers affected in this way, however to the extent that those loans 
are not made, both the lender and borrower will incur the costs of lost 
profits and lost consumer benefits, respectively.
    The provisions of the rule requiring extended retention times for 
documentation sufficient to show compliance with the rule (from two 
years to three years) will also impose some very limited costs on 
creditors. Electronic storage, communication and backup are very 
inexpensive and are likely to decrease in costs further.
b. Liability Costs
    Creditor may trade off the ex-ante underwriting cost just discussed 
with ex-post liability costs that stem from TILA's liability provisions 
and their interaction with the rule's qualified mortgage and 
presumption of compliance provisions.\206\ Qualified

[[Page 6565]]

mortgages with interest rates below the threshold for higher-priced 
covered transactions enjoy a conclusive presumption of compliance 
(although disputes may arise as to whether a particular loan meets the 
qualified mortgage test); qualified mortgages above the specified 
interest rate threshold enjoy a rebuttable presumption of compliance 
with the ability-to-repay requirements; and, loans that are not 
qualified mortgages are subject to general ability-to-repay provisions, 
under which the borrower will bear the burden of proof for establishing 
a violation. Within each segment, lenders and borrowers (or their 
attorneys in contingency arrangements) must pay for the costs of 
litigation, whether such litigation arises in the context of a private 
right of action brought by the borrower, or a defense raised by the 
borrower to a foreclosure. Originators and assignees also face various 
contingencies that may arise if such a claim is raised or succeeds.
---------------------------------------------------------------------------

    \206\ The Bureau's regulations are accompanied by some form of 
liability for non-compliance, and the Bureau generally does not 
address litigation costs and liability as part of its analysis under 
Section 1022 because the considerations are self-evident and the 
analysis is simplified by assuming full compliance. In general, to 
the extent regulated entities under-comply with a consumer 
protection regulation, they will experience less compliance costs, 
consumers will experience less benefits, and the entities will be at 
a higher risk of litigation costs and liability, including from 
private suits to the extent the relevant statute, such as TILA, 
provides for private liability. In addition, even if there is full 
compliance, there will always be some residual risk of non-
meritorious litigation. The Bureau, however, has chosen to discuss 
litigation costs and liability in this analysis because these 
considerations are particularly important in the context of this 
final rule. The meaning and effect of the presumption of compliance 
that attaches to qualified mortgages is a key issue in this 
rulemaking and has been a major focus for commenters and interested 
parties. As such, the Bureau is addressing these considerations in 
this analysis. In other rulemakings, the Bureau notes that 
consideration of litigation costs is not always necessary and 
remains at its discretion.
---------------------------------------------------------------------------

    Within each segment, the additional costs increase proportionally 
with borrowers' probability of delinquency or default. For example, the 
additional cost for qualified mortgages with a rebuttable presumption 
of compliance is smallest for lower debt-to-income (DTI) ratio loans 
(since these borrowers are less likely to be in a position to need or 
want to bring claims) and increases as the DTI ratio (keeping other 
factors constant) rises. The same is true as the interest rate of a 
loan increases, assuming that interest rate is accurately calibrated to 
risk.
    In estimating empirically the long-run additional liability costs 
from alleged or actual violations of the final rule, the Bureau 
examines the mortgage market as it existed from 1997 to 2003. The 
Bureau applies that market data and the pre-statute baseline to compare 
the liability for creditors under the final rule to the liability they 
would have incurred under the legal regime that existed under federal 
law just before passage of the Act.
i. Size of the Market Segments
    The data used in estimating liability costs comes from several 
sources. Data regarding the loans guaranteed or purchased by Fannie Mae 
and Freddie Mac are from the Historical Loan Performance (HLP) dataset 
maintained by FHFA. The FHFA shared a one percent random sample of 
these loans with the Bureau, along with information about their 
characteristics and performance. In the notice to reopen the comment 
period for this rulemaking, the Bureau detailed these data and 
requested comment. Commenters were generally supportive of using these 
data, but suggested looking at other sources as well including 
proprietary industry datasets available for sale. These data cover a 
large but select portion of GSE loans. In contrast, the HLP data cover 
the entire universe of GSE loans and even the one percent sample is 
more representative. As such, the Bureau believes the HLP data are the 
better data for the GSE segment of the market and has consulted with 
the suggested sources in other parts of the analysis. Over the 1997-
2003 period loans guaranteed or purchased by the GSEs comprised roughly 
47 percent of the mortgage market.
    Similarly, information on loans insured by the FHA was provided by 
the FHA in response to the June 5, 2012 notice. The data cover the 
years from 1997 to 2011 and exclude Home Equity Conversion Mortgages 
(HECM) as well as mortgages with seller-funded downpayment.\207\ 
Combined with loan insured by the Veterans Administration or the Rural 
Housing Service, these loans comprised an estimated 9 percent of the 
market during this period. The Bureau did not get loan-level data from 
the VA or RHS.\208\
---------------------------------------------------------------------------

    \207\ As described in the comment letter, ``the data conform 
generally to the type and kind of FHA data featured in a recent 
Discussion Paper published by the Philadelphia Federal Reserve in 
December 2011, FHA Lending: Recent Trends and Their Implication for 
the Future.'' The letter contains charts and data from that paper.
    \208\ In sizing the mortgage market and various components, the 
Bureau relied on aggregate market data from the Mortgage Market 
Annual, published by Inside Mortgage Finance and on data provided by 
the Market Data section of the FHA Web site which can be found at 
http://www.fhfa.gov/Default.aspx?Page=70.
---------------------------------------------------------------------------

    Data on mortgages in non-agency securitizations were taken from 
proprietary industry sources that the Bureau has licensed. While less 
complete than the HLP files, these data also include data on the 
characteristics and performance of individual loans. Over the 1997 to 
2003 period, this segment comprised roughly 13 percent of originations. 
The remaining loans are those held on the balance sheets of banks, 
thrifts and credit unions. While aggregate data regarding the 
performance of these portfolios is available, comprehensive loan level 
data similar to the enterprise, FHA and private-label loans is 
not.\209\ As a result, the actual characteristics of individual loans 
are not available.
---------------------------------------------------------------------------

    \209\ The proprietary industry data available for sale only 
contains loan level information for portfolio loans that are 
serviced by the largest servicers in the country.
---------------------------------------------------------------------------

    Without the temporary provisions granting qualified mortgage status 
to certain loans that are eligible to be purchased by the GSEs or 
insured by FHA, VA and RHS, of the mortgages originated during the 1997 
to 2003 period, the Bureau estimates that roughly 70 percent of would 
have been qualified mortgages. Most of these loans would qualify for 
the safe harbor, and perhaps one to four percent points of these loans 
would have been qualified mortgages subject to the rebuttable 
presumption. Another 22 percent of loans would have been non-qualified 
mortgages subject to the ability-to-repay requirements. The remaining 8 
percent of loans made over that period were appear to have been made 
without sufficient documentation to be permitted under TILA section 
129C documentation or were subprime hybrid adjustable rate mortgages 
underwritten to teaser rates in a way that is no longer allowed under 
the final rule. An important caveat is that these estimates are not 
adjusted to account for: (1) Loans with total points and fees above the 
thresholds and therefore not eligible to be qualified mortgages; (2) 
the exception of rural balloon loans to qualified mortgages; or the 
exception for streamlined refinancings of non-traditional loans.\210\
---------------------------------------------------------------------------

    \210\ Estimates for the GSE loans and the FHA loans are derived 
from the datasets provided to the CFPB and described above. For 
loans in private label securities, estimates are made based upon 
reported average characteristics of loans in subprime and Alt-A 
securitizations. The aggregate value of loans originated and held on 
balance sheet are estimated using data from Inside Mortgage Finance 
and the distribution of DTI is assumed to mirror the distribution at 
the GSEs. Statistical projections described below support such an 
assumption.
---------------------------------------------------------------------------

    Based on data from 2011, the Bureau estimates that without the 
temporary provisions granting qualified mortgage status to certain 
loans purchasable by the GSEs or insurable by FHA, VA and RHS, 76 
percent of mortgages would have been qualified mortgages inside

[[Page 6566]]

the safe harbor, 2 percent of mortgages would have been qualified 
mortgages with a rebuttable presumption, and 22 percent of mortgages 
would have been subject to the ability-to-repay requirements. These 
estimates are subject to the same limitation stated above.\211\
---------------------------------------------------------------------------

    \211\ The estimates in this analysis are based upon data and 
statistical analyses performed by the Bureau. To estimate counts and 
properties of mortgages for entities that do not report under HMDA, 
the Bureau has matched HMDA data to Call Report data and MCR data 
and has statistically projected estimated loan counts for those 
depository institutions that do not report these data either under 
HMDA or on the NCUA call report. The Bureau has projected 
originations of higher-priced mortgage loans for depositories that 
do not report HMDA in a similar fashion. These projections use 
Poisson regressions that estimate loan volumes as a function of an 
institution's total assets, employment, mortgage holdings and 
geographic presence. Neither HMDA nor the Call Report data have loan 
level estimates of the DTI. To estimate these figures, the Bureau 
has matched the HMDA data to data on the HLP dataset provided by the 
FHFA. This allows estimation of coefficients in a probit model to 
predict DTI using loan amount, income and other variables. This 
model is then used to estimate DTI for loans in HMDA.
---------------------------------------------------------------------------

ii. Liability Costs for Qualified Mortgages
    For qualified mortgages claimed to be within the safe harbor, 
borrowers will have no claim against the lender for ability-to-repay 
violations unless the loan does not in fact meet the requirements for 
safe harbor treatment. Based on the experience of loans originated 
during the 1997-2003 period, the Bureau estimates that roughly four 
percent of qualified mortgages loans will ever be 60 days delinquent 
and less than one percent are expected to result in foreclosure.\212\ 
The performance of the qualified mortgages that have a conclusive 
presumption of compliance is expected to be slightly better than these 
averages.
---------------------------------------------------------------------------

    \212\ In the HLP data, under four percent of loans originated 
from 1997 to 2003 that satisfy most of the requirements of the first 
definition of a qualified mortgage (i.e.,not no-doc or low-doc, not 
IO, not neg-am and with DTI ratio equal to or below 43%) were ever 
60 days delinquent. Among all FHA insured loans over the same years, 
just under 6 percent of loans with a DTI ratio equal to or below 43 
percent were ever 60 days delinquent. Some of these loans would have 
a conclusive presumption of compliance with the ability-to-pay 
requirements and others would have the rebuttable presumption. The 
four percent and one percent figures are likely to slightly 
overestimate the rates for loans in the safe harbor and may be 
underestimates for loans with the rebuttable presumption.
---------------------------------------------------------------------------

    The Bureau believes that only a very small fraction of these 
delinquent or foreclosed-upon borrowers would seek to raise an ability-
to-repay claim. The conclusive presumption precludes liability for 
loans which meet the eligbility criteria for a safe haror, i.e. loans 
whose product features make them eligible; for which the lender 
verified income, assets, and debts and properly calculated the DTI 
ratio to be 43 percent or less; and which are not higher priced. And 
even if a loan is erroneously categorized as a qualified mortgage with 
a safe harbor, a borrower still cannot recover unless the lender has 
violated the general ability-to-repay requirements, including the 
requirement that the lender make a ``reasonable and good faith'' 
determination that the consumer had the ability to repay. Generally, 
only a small percentage of borrowers contest foreclosure and even 
smaller percentage do so with the benefit of legal representation. This 
fact, and the limited chance of success for borrowers to raise 
successful claims, makes it very unlikely that many claims will arise 
from borrowers with these qualified mortgages.
    For qualified mortgage loans above the higher-priced threshold, 
costs (as well as benefits) of the final rule derive from the 
differences, including differences with respect to the originator and 
assignee liability, between the existing liability rules and the final 
rule. Under existing rules, creditors that make a higher-priced 
mortgage loan (HPML) are not allowed to extend credit 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.'' Further, a creditor is presumed to have complied if the 
creditor properly verifies and documents income and assets, made the 
determination using the largest payment of principal and interest 
scheduled in the first seven years following consummation, and took 
into account the ratio of total debt obligations to income, or the 
income the consumer had after paying debt obligations.
    As noted, 1 to 4 percent of loans, based on data from the 1997- 
2003 period, are estimated to be qualified mortgages with a rebuttable 
presumption. As just described, the delinquency rates and default rates 
are expected to be just around 4 percent and 1 percent respectively.
    Nearly all of the mortgages that will be qualified mortgages above 
the higher-priced threshold are currently covered by the existing HPML 
presumption of compliance,\213\ because the requirements in the final 
rule that qualified mortgage loans be fully documented, have verified 
income and be underwritten to the maximum payment in the first five 
years of the loan (with the exception for rural balloon loans) will in 
most cases also satisfy the requirements for obtaining the presumption 
under the 2008 HOEPA Final Rule. The final rule's requirements for 
obtaining the status of a qualified mortgage (and thus the rebuttable 
presumption) are slightly more prescriptive than the existing rules for 
gaining that presumption and this difference in the criteria for 
qualification may leave borrowers with slightly less opportunity to 
rebut the presumption of compliance.\214\
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    \213\ There may be some loans that are currently made with a 
rebuttable presumption that will no longer have that presumption but 
instead will be covered the general ability to repay standards. For 
example, higher priced covered transactions with more than three 
points and fees will not qualify for the presumption under the final 
rule.
    \214\ Under the Board's rule, the presumption of compliance 
attaches if the creditor ``tak[es] into account'' either the ``ratio 
of total debt obligations to income or the income the consumer will 
have after paying debt obligations.'' The consumer may rebut the 
presumption ``with evidence that the creditor nonetheless 
disregarded repayment'' such as by offering ``evidence of a very 
high debt-to-income ratio and very limited residual income.'' Under 
the final rule, however, a creditor cannot claim the benefit of the 
presumption of compliance if the debt to income is very high, since 
the final rule contains specific debt-to-income criteria for 
qualified mortgages. Thus, under the final rule, to rebut the 
presumption the consumer must prove insufficient residual income.
---------------------------------------------------------------------------

    For the subset of these borrowers that are in default more than 
three years into the mortgage, that seek to and are able to 
successfully rebut the lender's presumption of compliance (when seeking 
an offset during foreclosure), and that are therefore entitled to 
compensation, the returns from this action are in fact reduced relative 
to the existing rules which do not limit the recovery period in a claim 
for offset in a foreclosure proceeding brought by the creditor. As 
such, the probability that lenders will have to defend such an action 
is reduced relative to current rules although the subset described 
above is likely to be so small that the impact will be immaterial. As 
discussed below, relative to the existing rules lenders may face 
increased putback risk from investors although that, too, is small.
    For the set of borrowers that are in default within the first three 
years, potential damages are not reduced; however, the increased 
requirements at origination to qualify for qualified mortgage status, 
and the correspondingly more limited grounds on which to rebut the 
presumption reduce the probability of a successful challenge. So here 
too, the probability that lenders will have to defend such an action 
may be reduced or at least held constant relative to current rules. 
Overall, therefore the ex-post liabilities

[[Page 6567]]

for lenders are likely reduced for these loans.
    Relative to current rules for HPMLs, the current rule extends 
liability to assignees.\215\ The establishment of assignee liability 
does not increase the amount that a borrower can obtain from a 
successful legal action; however, it does increase the number of 
parties from whom the borrower can seek redress. Borrowers in a 
foreclosure action in a judicial state can now assert their claim 
against the assignee bringing the foreclosure action, rather than 
having to initiate an affirmative lawsuit against the originator that 
no longer holds the loan. The effect is to reduce the costs of bringing 
these defensive actions and therefore increasing their likely number. 
For loans that are not sold, or for borrowers wishing to bring 
affirmative actions, the establishment of assignee liability has little 
or no effect.
---------------------------------------------------------------------------

    \215\ As amended by section 1413 of the Dodd-Frank Act, TILA 
provides that when a creditor, an assignee, other holder or their 
agent initiates a foreclosure action, a consumer may assert a 
violation of TILA section 129C(a) ``as a matter of defense by 
recoupment or setoff.'' TILA section 130(k). There is no time limit 
on the use of this defense and the amount of recoupment or setoff is 
limited, with respect to the special statutory damages, to no more 
than three years of finance charges and fees. In contrast, for high 
cost loans as under existing law, an assignee generally continues to 
be subject to all claims and defenses, not only in foreclosure, with 
respect to that mortgage that the consumer could assert against the 
creditor of the mortgage, unless the assignee demonstrates, by a 
preponderance of evidence, that a reasonable person exercising 
ordinary due diligence, could not determine that the mortgage was a 
high cost mortgage. TILA 131(d).
---------------------------------------------------------------------------

    The extension of liability to assignees may also increase the cost 
of contracting between the two parties. Under the final rule, the 
borrower now has a contingent claim against two parties. As a result, 
the two parties will want to contract ex-ante about the extent of each 
party's liability under the various contingencies. This increase in 
contracting costs should be small for two reasons. First, even in the 
absence of assignee liability, the market has already included these 
contingencies in standard contracts. For example, following the Board's 
2008 rule, the Fannie Mae seller servicer guide was amended to include 
provisions that HPMLs are ``eligible for delivery to Fannie Mae 
provided [that] * * * lenders represent and warrant when they sell an 
HPML to Fannie Mae that the mortgage complies in all respects with 
Regulation Z requirements for HPMLs, including the underwriting and 
consumer protection requirements.\216\'' The Freddie Mac seller 
servicer guide has similar provisions.\217\ With contracts like these 
already in place, it appears that amending contracts for the 
particulars of the final rule should be small. Second, underwriting 
guidelines, pooling and servicing agreements and other contracts in the 
mortgage market are currently being reworked and refined.\218\ Among 
the myriad of changes, addenda to manage the ability-to-repay 
liabilities of the current rule should be only a small cost.
---------------------------------------------------------------------------

    \216\ See Fannie Mae, ``Delivery of Higher-Priced Mortgage 
Loans, Revised Qualifying Rate Requirements, Assessment of Late 
Charges, Clarifications to Points and Fees Limitation, and Updates 
to Reporting under the Home Mortgage Disclosure Act,'' Announcement 
09-24 (July 10, 2009), available at https://www.fanniemae.com/content/announcement/0924.pdf.
    \217\ See Freddie Mac, ``Higher-Priced Mortgages Loans and Rate 
Spread Data,'' Bulletin 2009-17 (July 8, 2009), available at http://www.freddiemac.com/sell/guide/bulletins/pdf/bll0917.pdf.
    \218\ See Federal Housing Finance Agency, ``Strategic Plan for 
Enterprise Conservatorships,'' (Feb. 21, 2012), available at http://www.fhfa.gov/webfiles/23344/StrategicPlanConservatorshipsFINAL.pdf. 
Also see Federal Housing Finance Agency, ``Building a New 
Infrastucture for the Secondary Mortgage Market,'' available at 
http://www.fhfa.gov/webfiles/24572/FHFASecuritizationWhitePaper100412FINAL.pdf.
---------------------------------------------------------------------------

iii. Non-Qualified Mortgages and Estimation of Costs
    The remaining loans are not qualified mortgages. These include for 
example, mortgage loans with a back-end DTI ratio over 43 percent, 
loans with points and fees above three percent of the loan balance, 
mortgages with a term over 30 years, or balloon loans that do not 
qualify for qualified mortgage balloon definition.\219\ For loans in 
this segment priced below the higher-priced threshold, the obligation 
to assess the consumer's ability to repay and the liability where the 
lender fails to do so is a new liability for both the originator and 
any assignees. For loans in this segment above the higher-priced 
threshold, lenders cannot invoke a rebuttable presumption of compliance 
and for those loans that are not high-cost loans, assignees are subject 
to expanded liability as compared to current rules.\220\
---------------------------------------------------------------------------

    \219\ The Bureau believes that the requirements for higher-
priced balloon loans made by lenders who do not meet the rural or 
underserved test effectively ban these products.
    \220\ Note that several state laws have ability-to-repay 
requirements applicable to conforming loans and/or higher priced 
loans, and there are variations in their applicability, 
requirements, and liability provisions. The benefits and costs of 
the final rule will be attenuated to the extent that certain states 
already provide similar requirements.
---------------------------------------------------------------------------

    The Bureau has estimated litigation costs under the new ability to 
pay standards for non-qualified mortgages. Estimating costs for non-
qualified mortgages should reasonably serve an upper bound for the 
costs for qualified mortgages. Costs for putbacks, or loans the buyers 
of which force the sellers to take back on their books because they do 
not satisfy the final rule are also estimated.
    Estimating the increased liability costs involves a series of 
assumptions about the performance of these loans, the probability that 
borrowers will bring particular actions, and the subsequent behavior of 
lenders and courts. Some assumptions about costs are also necessary.
    Under the ability-to-repay provisions, consumers can bring an 
action against the lender at any point during the first three years of 
the loan or as an offset to foreclosure at any time. In the latter 
cases, the recovery of interest and finance charges is capped at the 
amount paid during the first three years.
    The Bureau has estimated these costs as follows. To begin, assume 
an average loan balance of $210,000 (just below the mean balance for 
first lien loans reported in HMDA in 2011), an average interest rate of 
7 percent (the average mortgage rate for 30 yr. mortgages from 1997 to 
2003) \221\, and an average of $3,150 (1.5 points) paid up front in 
fees. Further, assume that, on average, affirmative cases and contested 
early foreclosures happen at the midpoint of the period, 18 months 
after consummation. This implies that for the affirmative cases, and 
the early foreclosures borrowers contest, successful borrowers are 
reimbursed for fees and interest an average of roughly $29,200.\222\ 
(The Bureau assumes in this calculation that all prevailing borrowers 
receive $4,000 in statutory TILA damages.) For the later foreclosures, 
defined here as foreclosure that occur three or more years after loan 
consummation, borrowers who contest foreclosure are reimbursed for 36 
months of interest or roughly $51,250.
---------------------------------------------------------------------------

    \221\ H.15 monthly series from Federal Reserve Board of 
Governors downloaded from St, Louis Fred at http://research.stlouisfed.org/fred2/series/MORTG/downloaddata?cid=114.
    \222\ Because some of the costs are independent of loan size, 
one has to make assumptions about the underlying loan value; 
otherwise, all calculations could simply be done as percentages of 
loan balances. The figures used here are consistent with those used 
by commenters that provided similar calculations.
---------------------------------------------------------------------------

    Based on data from the FHFA for 1997-2003 for loans with DTI ratios 
above 43 percent, it is reasonable to assume, 3.5 percent of loans 
reach 60 day delinquency during the first three years of the loan but 
do not start a foreclosure process, an additional 1.5 percent of loans 
start the foreclosure process within the first three years, and an 
additional 1.5 percent of loans start the foreclosure process after 
three

[[Page 6568]]

years.\223\ The Bureau believes that consumers who have fallen behind 
on their mortgage payments are unlikely to initiate an ability to repay 
claim in court prior to foreclosure. Rather, they will likely seek to 
work with their servicer and the owner of the loan to cure the 
delinquency through, e.g., forbearance or some form of loan 
modification, or where that is not possible, to reach an agreement to 
enable the consumer to walk away from the property and the loan (i.e., 
deed in lieu or short sale). Once a foreclosure proceeding is 
commenced, however, it will then be in the interest of consumers to 
assert ability-to-repay claims where there is a plausible basis to do 
so; this is especially true in judicial foreclosure states because an 
ability-to-repay claim can be asserted as a defense by way of offset 
against whoever holds the loan at the time of the foreclosure (i.e., 
the originator or assignee).
---------------------------------------------------------------------------

    \223\ These values are derived from GSE loans with at DTI ratio 
above 43% originated during the 1997-2003 period. For these loans, 
roughly 7 percent ever reached 60 days late, one-half of those in 
the first three years. Roughly 3 percent ever reached 180 days 
delinquent which is a rough proxy for foreclosure. One could also 
assume that some additional borrowers simply stop paying their loans 
strategically in order to extract funds from the originator or 
assignee, however that possibility seems unreasonable.
---------------------------------------------------------------------------

    The ability of consumers to assert such claims either defensively 
or, in non-judicial foreclosure states, in affirmative actions will 
depend to some extent upon their ability to obtain legal 
representation. In its notice reopening the comment period for the 
rule, the Bureau specifically requested information and data regarding 
the frequency of such actions. In general, industry commenters 
asserted, that even under the rebuttable presumption standard, future 
legal actions under the rule would be very common. In contrast, 
consumer and community groups pointed to the available evidence and 
experience to suggest that only a very small minority of consumers in 
foreclosure are represented and that very few claims are brought. 
Consumer group commenters pointed out the practical limitations of 
consumers to bring an ability-to-repay claim, noting that few 
distressed homeowners would be able to afford and obtain legal 
representation often necessary to mount a successful rebuttal in 
litigation. Consumer groups also provided percentages of borrowers in 
foreclosure who are represented by lawyers, noting the difficulty of 
bringing a TILA violation claim, and addressed estimates of litigation 
costs, such as attorney's fees. The data provided however are quite 
limited: two commenters (both representing industry) suggest that 
during the recent years there were roughly 900 mortgage-related TILA 
cases filed each year in Federal court while data regarding the number 
of TILA claims brought in state courts were not provided.\224\
---------------------------------------------------------------------------

    \224\ See Mortgage Bankers Association comment letter, docket 
CFPB-2012-0029, submitted Sep. 7, 2012. See also National Consumer 
Law Center comment letter, docket CFPB-2012-0029, submitted Sep. 7, 
2012.
---------------------------------------------------------------------------

    More specifically the Bureau has considered the available evidence 
with respect to the extent of litigation under laws potentially 
analogous to this one, such as the 2008 HOEPA Final Rule (which does 
not provide assignee liability, except as applicable to high cost 
mortgages) and under HOEPA and state anti-predatory lending laws (which 
generally do provide for assignee liability). So far as the Bureau is 
aware, claims under these rules have been very infrequent. Industry 
participants likely have access to the most complete information about 
litigation activity, much of which activity is not reported in legal 
databases such as Lexis and Westlaw. Industry commenters, however, did 
not bring forth any evidence to suggest that claims have been anything 
but rare. Thus, relative to the one to two million annual foreclosure 
starts from 2009 through 2011,\225\ the record supports a conclusion 
that litigation under TILA generally and under the most directly 
analogous federal and state laws has been very limited.
---------------------------------------------------------------------------

    \225\ MBA National Delinquency Survey.
---------------------------------------------------------------------------

    Industry commenters maintained that past experience is not a guide 
because new liability under the Dodd-Frank Act will increase incentives 
for litigation. The Bureau recognizes that the availability of new 
ability-to-repay remedies may make it easier for consumers to obtain 
representation (by providing those consumers whose loans are not 
currently covered by the Board rule with new rights; and those 
consumers whose loans are covered, with more easily asserted, and to 
that extent more valuable claims). Thus, the analysis below of 
litigation costs relies on very conservative (likely unrealistic) 
assumptions about the extent to which the Dodd-Frank liability 
provisions will increase litigation levels above levels under current 
laws.
    Among the three percent of borrowers that are in foreclosure, the 
Bureau assumes that 20 percent will bring an action against the lender 
for failing to meet the ability-to-repay requirements; that implies 
that 0.6 percent of borrowers will bring claims. As noted, this value 
is many times higher than recent experience with the 2008 HOEPA Final 
Rule or analogous state laws would suggest and is a very conservative 
upper bound. One half of these borrowers, should they prevail, are 
assumed to be entitled to 18 months of interest and the other half to 
36 months of interest. Based on our assumed loan size ($210,000), 
interest rate (7%), and origination fees ($3,150) as discussed above, 
on average a successful borrower will have a claim of $40,225 
(including the statutory TILA damages, before legal costs).
    To estimate legal costs, assume that in each case, the lender will 
move for summary judgment based upon what they are likely to claim to 
be undisputed evidence documenting their consideration of borrowers' 
ability to pay. The consumer would likely claim that he or she was 
unable to pay the mortgage from its inception, and would have to 
present evidence from which it could be inferred that the creditor did 
not make a ``reasonable and good faith determination'' of the 
consumer's ability to repay. To estimate legal costs, assume that in 
each case, following any discovery permitted, the lender will move for 
summary judgment, which is a written request for a judgment in the 
moving party's favor (along with a written legal brief in support of 
the motion with supporting documents and affidavits) before a lawsuit 
goes to trial, claiming that all factual and legal issues can be 
decided in the moving party's favor, as a means to avoid trial 
altogether. The opposing party (i.e., the consumer) would need to show 
that there are triable issues of fact. The analysis assumes that, in 
these motions, the lender will succeed four-fifths of the time. In the 
remaining one fifth of cases, the lender settles prior to summary 
judgment and pays the full value of the claim. This assumption is also 
conservative. In evidence provided by industry commenters which the 
commenters suggested were analogous, lenders prevailed in nearly all of 
the cases cited.
    To litigate these cases, the borrower is assumed to spend 60 hours 
of attorney time up to and including responding to the motion for 
summary judgment while the lender, given its resources, is assumed to 
spend 170 hours up to and including filing the relevant motions.\226\ 
In 2011, the average wage for lawyers in the legal services industry 
was $68.75/hr; adjusting that figure to reflect benefits and other 
forms of

[[Page 6569]]

compensation, and a 50 percent mark-up for firm yields an hourly rate 
for legal services of $150/hr. With these assumptions, borrowers are 
willing to bring cases, and lenders will defend them, since on average 
both sides are ahead relative to simply dropping the claim or paying it 
in full.\227\ To reflect the expected value of these costs, the costs 
of non-qualified mortgages would increase by 10 basis points (0.1 
percent of the loan amount, or roughly $212 for the $210,000 
loan).\228\ Assuming loans with a weighted average life of four years, 
this could add roughly 2.5 basis points (0.025 percentage points) to 
the rate of each loan. Were the whole cost passed on to the consumer, 
increasing the rate from 7.0 percent to 7.025 percent, the monthly 
payment would rise by roughly $3.50. The resource cost to litigate this 
case is also roughly 10 basis points since it includes the lenders' and 
the borrowers' legal expenses of $25,500 and $9,000, respectively, and 
excludes the transfer of $40,225 that occurs in successful cases.
---------------------------------------------------------------------------

    \226\ Comment letters submitted to the Board suggest roughly 
this number of hours when assessing the cost of a rebuttable 
presumption. See MBA Comment Letter dated July 22, 2011.
    \227\ For illustration purposes, the Bureau assumes that 20 
percent of the potential litigants have private costs of litigation 
of less than $1,000. Under the assumptions above, the creditor 
prefers to incur the legal costs to file for summary judgment as 
opposed to settling outright (the creditor's expected payoff is 
roughly $5,000 dollars more in this case).
    \228\ This is calculated as 0.6 percent of borrowers bringing 
cases multiplied by $35,345 in expected lender costs per case 
divided by the $210,000 loan amount.
---------------------------------------------------------------------------

iv. Sensitivity Analysis
    As part of a sensitivity analysis, the Bureau has estimated these 
costs under different assumptions. Notably, industry commenters 
provided estimates of the costs for various types of cases related to 
mortgage actions. These comments suggest a much higher cost for legal 
expenses of $300 per hour and closer to 300 hours to litigate cases 
that involve motions for summary judgment. Using these figures (and the 
assumption that borrowers' legal expenses include a proportionally 
higher 150 hours at $300/hr), the increased cost of each loan is 
approximately 31 basis points or an increase in the interest rate of 
just under 8 basis points (0.08 percentage points). Importantly, in 
this scenario, using the assumptions set forth previously about loan 
size and other factors, lenders would spend $107,000 to defend claims 
worth substantially less than the legal costs ($40,225).\229\ It is 
possible, however, that lenders would be willing to litigate such cases 
in order to discourage future litigation but, if so, one would expect a 
corresponding diminution of litigation over time.
---------------------------------------------------------------------------

    \229\ At the same time, higher litigation costs may deter 
certain consumers from bringing suit.
---------------------------------------------------------------------------

    As a second sensitivity test, going back to the original legal cost 
estimates, one can assume that of the 3.5 percent of borrowers who find 
themselves behind on their payments during the first three years, 84 
percent (or 3 percent of total borrowers) chose to bring affirmative 
claims. This would quintuple the original estimates on a per loan basis 
to fifty basis points spread over a four-year average life. Similarly, 
one could assume that a larger percentage of borrowers in default bring 
claims. Raising that assumption from 20 percent to 40 percent results 
in estimated costs of 20 basis points per loan.
    Originators and assignees share the liability for ability-to-repay 
violations. Depending on the contract in place, lenders will bear some 
repurchase risk for those loans that are sold into the secondary 
market. For example, sellers of loans to the GSEs already bear this 
risk for HPMLs since the enterprises have the right to put the loan 
back in case of ability-to-repay violations. In cases where the lender 
is defunct or there are other issues affecting the lender's capacity to 
reassume the risk, the purchaser of the loan may be unable to exercise 
that right and will bear the additional liability costs. The need of 
both the seller and the buyer to budget for expected capital and 
liquidity charges in these situations, and to negotiate the specific 
transactions, will also add some costs. However, in recent work, some 
economists have estimated that even for loans from the 2005 to 2008 
vintage repurchase risk added conservatively about 19 basis points (or 
0.19 percent of the loan amount) to the cost of a loan. Given the much 
lower default rates in the coming years (based on the default rates 
during the 1997-2003 period), and the increased underwriting 
requirements mandated by the final rule even for non-qualified 
mortgages, these costs are likely to be closer to 1-3 basis points at 
most.\230\
---------------------------------------------------------------------------

    \230\ Securitized loans performed very poorly just following the 
bubble, with delinquency rates many times that of loans in more 
typical times. Adjusting the figures to reflect this better 
performance and the increased origination standards in the final 
rule, yields the 1-3 basis points. See Andreas Fuster, Laurie 
Goodman, David Lucca and Laurel Madar, Linsey Molloy, Paul Willen, 
The Rising Gap Between Primary and Seconadary Mortgage Rates, 
November 2012 available at: http://www.newyorkfed.org/research/conference/2012/mortgage/primsecsprd_frbny.pdf.
---------------------------------------------------------------------------

v. Summary of Litigation Costs
    Combining liability costs and repurchase costs, estimated costs for 
non-qualified mortgage loans (loans made under the ability-to-repay 
standard without any presumption of compliance) are estimated to 
increase by approximately twelve basis points (or 3 basis points (0.03 
percentage points) on the rate); under very conservative estimates, 
this figure could be as high as forty basis points (or ten basis points 
(0.01 percentage points) on the rate). Depending on the competitive 
conditions in the relevant product and geographic markets, some of this 
increase will be passed on to borrowers and the rest will be absorbed 
by lenders. Certain borrowers may be priced out of the market as a 
result of the price increase. However, the number of such borrowers is 
likely to be very small given the values above since an increase of 
even ten basis points on the rate on an average mortgage would increase 
the monthly payment by less than $10.
vi. Temporary Provisions for Qualified Mortgages
    As described in the preamble, the final rule recognizes the 
fragility of the current mortgage market and therefore includes 
temporary measures extending qualified mortgage status to loans that in 
the long run may not be qualified mortgages. These include loans with a 
DTI above 43 percent and that nonetheless can be purchased or 
guaranteed by the GSEs, insured by the FHA, VA or RHS. Based on the 
data as of year-end 2011, such loans are approximately 18 percent of 
the market. Without fuller data on the points and fees and product 
features associated with most loans, it is hard to estimate precisely 
the size of this segment or predict how large it would be several years 
from now with, or without, the statute taking effect. Ignoring those 
features, based on information about the rates and fees on these loans 
we believe roughly 97 percent of these loans should qualify for the 
legal safe harbor with the conclusive presumption of compliance (i.e., 
they are not higher-priced covered transactions) and 3 percent are 
estimated to qualify for the rebuttable presumption (i.e., they are 
higher-priced covered transactions). The temporary expansion of the 
definition of a qualified mortgage results in over 95 percent of the 
market being granted qualified mortgage status.
    Extending qualified mortgage status to these loans reduces costs to 
lenders as described above and limits some of the consumer protections 
that an increased possibility of liability would create if a creditor 
were able to satisfy the GSE or federal agency underwriting standards 
without having a reasonable and good faith believe in the consumer's 
ability to repay. However, the added certainty

[[Page 6570]]

from this reduced liability should benefit both consumers and covered 
persons. The mortgage market is still fragile, even four plus years 
past the most turbulent portions of the financial crisis. With lenders 
and the markets in general adjusting to new regulations designed to 
counter the forces behind the crisis, extending qualified mortgage 
status to these segments of loans should limit any disruption to the 
supply of mortgage credit with only limited effects on consumers. The 
extension of qualified mortgage status to these loans should allow the 
market time to digest the rules and for any increase in premia 
associated with uncertainty about litigation and putback costs to 
diminish.
c. Access to Credit
    Overall, the Bureau believes that the final rule will not lead to a 
significant reduction in consumers' access to consumer financial 
products and services, namely mortgage credit. The Bureau notes the 
potential for the ability to repay requirements, including increased 
documentation and amortization requirements, to prevent some consumers 
from qualifying for a loan. First, the final rule generally bans no-doc 
and low-doc loans to the extent the level of documentation is lower 
than that required by the rule. The final rule would by definition 
prevent borrowers who would only qualify for these types of loans from 
receiving a mortgage; as discussed, that is one of the benefits of the 
rule. Second, the final rule generally increases documentation 
requirements for mortgage loans and requires underwriting to be done 
based on an assumed fully amortizing loan at the fully indexed rate.
    As noted above, when measured against the current marketplace, the 
Bureau anticipates the effect of these requirements on access to credit 
to be very small. The Bureau anticipates that, as the economy recovers, 
the currently restrictive credit environment will loosen. Indeed, if 
anything, the Bureau anticipates that the immediate effect of the rule 
may be to contribute to the recovery of the mortgage market by reducing 
legal uncertainty which may be affecting lending. This is especially 
true if the impact of the rule were compared to a post-statutory 
baseline (i.e. to the implementation of the Dodd-Frank ability to pay 
and qualified mortage provisions without implementing regulations.)
    Measured against the years leading up to the financial crisis, when 
lending standards were quite loose, the effects of the final rule on 
access to credit would of course have been significantly larger. The 
final rule will set a floor to the loosening of credit in order to 
prevent the deterioration of lending standards to dangerous levels. A 
primary goal of the statute was to prevent a repeat of the 
deterioration of lending standards that contributed to the financial 
crisis, which harmed consumers in various ways and significantly 
curtailed their access to credit. Such a goal will, by definition, 
entail some potential diminution of access to credit as market 
standards change over time. The Bureau believes that, to the extent the 
final rule reduces credit access, it will primarily reduce inefficient 
lending that ignores or inappropriately discounts a consumer's ability 
to repay the loan, thereby preventing consumer harm, rather than 
impeding access to credit for borrowers that do have an ability to 
repay. The Bureau notes that the rule may have a disproportionate 
impact on access to credit for consumers with atypical financial 
characteristics, such as income streams that are inconsistent over time 
or particularly difficult to document.
    There also exists the potential for both increased documentation 
requirements and increased liability to increase the price of mortgage 
loans for some consumers. As discussed above, price increases from both 
increased documentation requirements and increased liability should be 
small. The documentation requirements, such as providing a pay stub or 
tax return, will impose relatively little additional cost to most 
consumers. Similarly, the increased documentation costs for creditors 
should not be significant, or result in more than relatively small 
increases in the cost of mortgage loans.
    With respect to liability costs, the Bureau notes that over 95 
percent of the current market is estimated to satisfy one of the 
definitions of a qualified mortgage, greatly reducing the expected cost 
of litigation. The Bureau also notes that the clear standards 
established for determining whether a loan is a qualified mortgage 
should reduce uncertainty regarding litigation costs, which will 
mitigate any resulting impact on access to credit. In light of the 
foregoing considerations, the Bureau believes that the ability to repay 
requirements and the accompanying potential litigation costs will 
create, at most, relatively small price increases for mortgage loans. 
These small price increases, in turn, are not likely to result in the 
denial of credit to more than a relatively small number of borrowers, 
some of whom commenters pointed out could be low income, at the margin.
    The Bureau notes that concerns have been raised concerning the 
application of increased documentation and amortization requirements to 
such entities as certain nonprofits and state housing finance agencies, 
as well as certain refinancing programs. As applied to such entities 
and programs, the final rule may restrict access to mortgage credit, 
including for consumers who may otherwise have limited credit options, 
while doing little to further the consumer protection purposes of the 
statute. To address these concerns, the Bureau has proposed separately 
to exempt some such entities and programs from these documentation and 
amortization requirements.
    The Bureau also notes that concerns have been raised regarding the 
application of the qualified mortgage criteria and the general ability 
to repay requirements to certain small creditors. These concerns arise 
from the observation that for many community banks and credit unions, 
for example, compliance resources are scarce and compliance costs as a 
percentage of revenue can be high. At the same time, these institutions 
employ a traditional model of relationship lending that did not succumb 
to the general deterioration in lending standards that contributed to 
the financial crisis. Moreover, because this business model may be 
based on particularized knowledge of customers and the development of 
durable customer relationships, the resulting loans may be beneficial 
to customers even when they do not conform to the general standards set 
forth in the final rule. Further, these institutions have particularly 
strong incentives not only to maintain positive reputations in their 
communities, but also, because they often keep the loans they make in 
their own portfolios, to pay appropriate attention to the borrower's 
ability to repay the loan. Accordingly, the Bureau has proposed 
separately to provide additional criteria by which certain small 
portfolio lenders may make qualified mortgages.
    Greater access to credit can be associated with higher home prices 
and higher homeownership rates, and as discussed in the section on 
costs, there is some evidence of positive social effects from home 
ownership. As such, were the rule to overly restrict credit, it is 
important to note that these positive spillovers would also be limited. 
However, the Bureau does not believe that the rule will result in an 
inappropriate reduction in access to credit; rather, over time, the 
final rule should ensure that lending standards do not deteriorate to 
dangerous levels, while at the same time ensuring that lending not be 
too restrictive.

[[Page 6571]]

4. Potential impacts of other provisions
    Below, the Bureau discusses the impacts of several other provisions 
of the final rule and notes their interaction with other rulemakings. 
These include the points and fees provisions (which interact with the 
HOEPA rulemaking), the provisions of the statute regarding prepayment 
penalties, and the definition of rural or underserved areas (which 
interacts with the current rulemaking regarding escrow account 
requirements for certain higher-priced mortgage loans and with the 2013 
HOEPA final rule). The interagency rule on appraisal requirements for 
high-risk mortgage loans also interacts with the QM definition.
a. Points and Fees Provisions
    To be a ``qualified mortgage,'' the statute requires (among the 
other requirements already discussed) that the total points and fees 
payable in connection with the loan do not exceed 3 percent of the 
total loan amount and requires the Bureau to prescribe rules adjusting 
this limit to ``permit lenders that extend smaller loans to meet the 
requirements of the presumption of compliance.'' As noted earlier, such 
a restriction may have the effect of limiting cases where creditors, 
having received more funds up front, are less concerned about the long-
term performance of the loan.
    In the final rule, that limit is amended to a tiered approach with 
the following limits: for a loan amount greater than or equal to 
$100,000, three percent of the total loan amount; for a loan amount 
greater than or equal to $60,000 but less than $100,000, $3,000; for a 
loan amount greater than or equal to $20,000 but less than $60,000, 
five percent of the total loan amount; for a loan amount greater than 
or equal to $12,500 but less than $20,000, $1,000 of the total loan 
amount; and, for a loan amount of less than $12,500, eight percent of 
the total loan amount.
    The higher limits for smaller dollar loans should allow more loans 
to be made as qualified mortgages. Data on the points and fees 
associated with a representative set of loans is not currently 
available. As a result, the Bureau cannot estimate precisely how many 
loans are impacted by this change. Under TILA as amended, a high-cost 
mortgage has points and fees equal to five percent of the total 
transaction amount if the transaction is $20,000 or more, and points 
and fees equal to the lesser of eight percent of the total transaction 
amount or $1,000, if the transaction is less than $20,000. Setting the 
maximum points and fees caps based on the HOEPA triggers will help 
ensure that a qualified mortgage is not a high-cost mortgage because of 
the points and fees.
    The Dodd-Frank Act substantially expanded the scope of compensation 
included in points and fees for both the qualified mortgage and high-
cost mortgage points and fees limits. In addition to compensation paid 
to mortgage brokerage firms and individual brokers, points and fees 
also includes compensation paid to other mortgage originators, 
including employees of a creditor (i.e., loan officers). Under the 
existing rule, only consumer payments to mortgage brokers are included 
in points and fees for the high-cost mortgage threshold. Also under the 
Act, any fees paid to and retained by affiliates of the creditor must 
be included in points and fees (except for any bona fide third-party 
charge not retained by the creditor, loan originator, or an affiliate 
of either, unless otherwise required under the rule). The final rule 
restates these provisions.
    In a concurrent proposal published elsewhere in today's Federal 
Register, the Bureau proposed one alternative which would permit loan 
originator compensation to be netted against other upfront charges paid 
by the consumer and one that would not. Still, the inclusion of loan 
originator compensation in points and fees under the Final Rule 
(together with the statutory provisions implementing in the Final Rule 
regarding the treatment of charges due to third parties affiliated with 
the creditor) could have the effect of limiting the number of loans 
eligible to be qualified mortgages. For most prime loans, the Bureau 
believes that this change will not have a major impact: current 
industry pricing practices and the exemption for bona fide discount 
points suggest that few of these loans will be constrained by the 
points and fees limits.
    For loans near the border of higher-priced loans (i.e. loans one 
percentage point above APOR), the exemption for bona-fide discount 
points is reduced and for loans priced at two percentage points or more 
above APOR the exemption is eliminated. For these loans, the inclusion 
of loan originator compensation and affiliate fees could limit 
qualified mortgage status for certain loans. Loans that will qualify 
for the safe harbor, but where the borrower pays for these charges 
through a higher interest rate, may lose the conclusive presumption of 
compliance and instead have only the rebuttable presumption. This 
impact is most likely greater for lenders with affiliated companies 
whose charges must be included in the points and fees calculations.
b. Prepayment Penalties
    The Final Rule implements the provisions of Dodd-Frank with respect 
to prepayment penalties. Specifically, in accordance with the statute, 
the rule prohibits prepayment penalties for any mortgage other than a 
fixed-rate mortgage that is a qualified mortgage and not a higher-
priced mortgage.\231\ Where the Final Rule permits prepayment 
penalties, it limits these penalties to 2 percent of the outstanding 
balance on the loan during the first year after consummation and 1 
percent of the outstanding balance during the second year after 
consummation.
---------------------------------------------------------------------------

    \231\ For purposes of this provision of the rule, a higher 
priced mortgage is defined in the Act as a first lien, non-jumbo 
mortgage with an APR that is more than 150 basis points above APOR; 
a first lien, jumbo mortgage with an APR that is more than 250 basis 
points above APOR; and a second lien mortgage with an APR that is 
350 basis points above APOR.
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    Available information from the sources described above suggests 
that loans originated today do not contain prepayment penalties, and 
this is likely to be true for the foreseeable future. Neither loans 
originated for sale to Fannie Mae and Freddie Mac, nor loans insured by 
FHA generally contain prepayment penalties.\232\ Moreover, the Bureau 
understands that prime loans, which make up the vast majority of 
originations today, have in recent years rarely had prepayment 
penalties.\233\ Some originators may make subprime loans they hold on 
portfolio for which they charge prepayment penalties, but data on terms 
of loans on portfolio are not available and at least in the current 
market, this is likely to be a very small number of loans. With the low 
interest rates that prevail today, lenders see little reason to limit 
prepayment risk by charging prepayment penalties.
---------------------------------------------------------------------------

    \232\ As explained in the final rule, FHA loans used a method of 
interest calculaton which results in consumers who pay off loans 
during the course of a month being obligated to pay interest until 
the end of the month. The Final Rule treats that as a prepayment 
penalty and provides an extended compliance period to allow time for 
FHA to change this feature of its loans.
    \233\ See 73 FR 44522 (July 30, 2008).
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    Prepayment penalties by design impose costs on consumers to switch 
from their current loans to loans with lower interest rates. This cost 
can be particularly high for consumers with potentially increasing 
payments and who seek to refinance to avoid the increases. Moreover, 
these penalties are complex and often not transparent to consumers. 
Consumers may not focus on prepayment penalty terms because they are 
more focused on the terms they

[[Page 6572]]

find more salient, such as interest rate and payment amount. Leading up 
to the mortgage crisis, some loan originators sometimes took advantage 
of consumers' lack of awareness or understanding of prepayment 
penalties.\234\ Originators could sell unsuspecting consumers loans 
with substantial expected payment increases as well as substantial 
prepayment penalties that would prevent the consumer from refinancing.
---------------------------------------------------------------------------

    \234\ Over 70 percent of subprime loans from 2001 through 2007 
had prepayment penalties. See Demyank and Hemert, Review of 
Financial Studies, 24,6, 2011.
---------------------------------------------------------------------------

    By limiting prepayment penalties to prime, fixed-rate qualified 
mortgages, the Final Rule benefits consumers by limiting these cases 
and lowering the cost of exiting a mortgage. Consumers will be able to 
refinance at lower cost, either when market rates drop or when the 
consumer's risk profile improves. In other cases, consumers who are 
sold mortgages with rates higher than their risk profile warrants will 
be able to refinance their mortgages to a market rate at lower cost. In 
still other cases, consumers will be able to sell their homes and move 
at lower cost. This cost reduction from restriction of prepayment 
penalties is particularly important to consumers who incur drops in 
income or increases in expenses that cause them to struggle to make 
their mortgage payments.
    However, to the extent prepayment penalties compensate investors 
for legitimate prepayment risk, restricting penalties will reduce the 
value of certain mortgages and limit the returns to creditors and 
investors (which includes entities that are covered persons as well as 
entities that are not covered persons). In these cases, the cost of 
credit for some consumers will rise as creditors raise prices to 
compensate for increased prepayment risk. Currently, the number of 
loans that would have prepayment penalties but for the Final Rule 
appears to be very small, however, so costs to consumers and covered 
persons are expected to be de minimis.
c. Definition of Small Lenders, Rural and Underserved
    The final rule allows certain small creditors operating 
predominantly in rural or underserved areas to originate balloon-
payment qualified mortgages. Specifically, this option exists for 
lenders originating 500 or fewer covered transactions (including their 
affiliates), secured by a first lien, in the preceding calendar year, 
with assets under $2 billion (to be adjusted annually), and who made 
more than 50 percent of their total covered transactions secured by 
first liens on properties in counties that are ``rural'' or 
``underserved.'' For the purposes of the final rule, and the 2013 
Escrow rule published elsewhere in today's Federal Register, the Bureau 
has defined rural to include noncore counties and those micropolitan 
counties that are not adjacent to metropolitan statistical areas using 
the Department of Agriculture's urban influence codes. Relative to the 
proposed rule that only included a subset of rural counties, the final 
rule expands the exemption. The Bureau has not altered the definition 
of underserved from that contained in the proposed rule.
    Although there is no comprehensive evidence with respect to the 
prevalence of balloon loans, the Bureau understands anecdotally from 
outreach that in these rural areas, creditors sometimes have difficulty 
selling certain loans on the secondary market either because of unique 
features of the rural property or of the rural borrower. In these 
instances, the creditors will make a portfolio loan. Because of their 
small size, some of these creditors eschew ARMs and manage interest 
rate risk by making balloon payment loans which the creditors then 
roll-over based on then-current interest rate when the balloon payment 
comes due.
    Relative to a pre-statutory baseline, the rural balloon provisions 
of the rule have minimal effect. Relative to a post-statutory baseline 
in which the statute was implemented without the exception for rural 
lenders, the provisions of the rule have the following impacts on 
consumers and covered persons. Creditors covered by the rule's 
definition are permitted to make balloon loans which are qualified 
mortgages, potentially mitigating consumer access to credit issues that 
might arise if balloon payment mortgages were restricted. The rule 
creates certain minimum, consumer-protective requirements with respect 
to such balloon loans, such as a minimum term of five years and a 
requirement that the interest rate be fixed for that period of time. 
The rule also requires that creditors verify and consider income and 
debts before making such loans (albeit without a fixed debt-to-income 
requirement). However, to the extent these creditors rely on this 
permission to make balloon loans rather than other types of qualified 
mortgages, the rule also denies these consumers the consumer 
protections associated with not giving balloon loans qualified mortgage 
status.
    According to the definition used in the final rule, approximately 
10 percent of the U.S. population lives in areas that the Bureau 
defines as rural or underserved: the Bureau estimates that 2,707 small 
creditors, currently issuing first-lien mortgages and operating 
predominantly in rural or underserved areas, will be able to originate 
balloon qualified mortgages as a result of the provision. Given the low 
population density of the areas currently defined as rural, the 
corresponding limits on the number of creditors, and the challenges of 
making loans that could be sold in the secondary market, keeping this 
source of credit in the community with the safeguards added by the rule 
is likely more important to consumers than the consumer protections 
associated with not allowing balloon loans to be qualified mortgages. 
In somewhat less rural areas, for example the micropolitan counties not 
covered by the definition in the final rule, there are more creditors 
that can provide alternative forms of credit, such as ARM loans, and 
more creditors in general.
d. Qualified Mortgages and Appraisals
    One impact of the current definition of qualified mortgage is 
related to higher-risk mortgages as defined in the Act. The Act 
contains special appraisal requirements with respect to higher-risk 
mortgages; those requirements are the subject of an interagency 
rulemaking process which resulted in a proposed rule in August which 
the agencies expect to finalize shortly. The Act generally defines a 
higher-risk mortgage as a closed-end consumer credit transaction 
secured by a principal dwelling with an APR exceeding rate thresholds 
substantially similar to rate triggers currently in Regulation Z for 
higher-priced mortgage loans, but excluding qualified mortgages. In 
general, as the number of loans defined as qualified mortgages 
increases, the number of loans that would be covered by the proposed 
appraisal requirements decreases. Based on the general definition of 
qualified mortgage in the final rule, those higher priced mortgage 
loans with a debt-to-income ratio of 43 or less would be exempt from 
the new requirements for interior appraisals. The temporary provision 
allowing additional loans (e.g. loans with a higher debt to income 
ratio and that are purchasable by the GSEs or insurable by FHA), to be 
qualified mortgages could further remove mortgages from that 
requirement. The impact of this reduction in the scope of appraisal 
requirements is relatively muted for first lien mortgages because of 
the small number of high-risk mortgages to begin

[[Page 6573]]

with and the fact that most lenders already do a full interior 
appraisal and share the results with the consumer.

E. Potential Specific Impacts of the Final Rule

1. Depository Institutions and Credit Unions With $10 Billion or Less 
in Total Assets, as Described in Section 1026
    Some depository institutions and credit unions with $10 billion or 
less in total assets as described in Section 1026 may see different 
impacts from the final rule than larger institutions. These differences 
are driven by the lending practices and portfolios at smaller 
depository institutions and credit unions, notably those below roughly 
$2 billion in assets, and by the nature of these institutions' 
relationship to the secondary market.
    The Bureau understands that lending practices at many smaller 
institutions (according to comment letters and outreach) are based on a 
more personal relationship-based model, and less on automated systems, 
at least when the lender plans to keep the loan on portfolio rather 
than sell it. To the extent that the documentation and verification 
requirements in the final rule differ from current practice at these 
institutions, the final rule may impose some new compliance costs. 
However, unless these institutions keep all of the loans they originate 
on portfolio, which seems unlikely, they are already subject to 
documentation requirements from the secondary market so that any 
incremental costs are likely to be small. In addition, data from HMDA 
indicate that, on average, a larger proportion of loan originations at 
smaller institutions are higher-priced mortgage loans and will 
therefore have the rebuttable presumption of compliance rather than the 
safe harbor. These loans already are subject to an obligation to assess 
repayment ability and a rebuttable presumption under the Board's 2009 
rule, so any new effects on these loans from the final rule, at least 
the loans these institutions keep on portfolio, are expected to be 
limited. Historically, delinquency rates on mortgages at smaller 
institutions are lower than the average in the industry and as such, 
the expected litigation costs for these loans are also probably quite 
low. Nevertheless, the proposal posted elsewhere in today's Federal 
Register asks for comment on whether the safe harbor should be extended 
to additional loans at particular smaller institutions.
    The establishment of assignee liability for violation of the 
ability-to-repay provisions may also differentially impact smaller 
institutions by increasing counterparty risk for entities purchasing 
mortgages from these institutions. As described above, creditors and 
secondary market purchasers are expected to contract around the new 
ability-to-repay liability. For example, both Fannie Mae and Freddie 
Mac require lenders to represent and warrant that loans sold to the 
enterprises meet the current ability-to-repay requirements and to 
repurchase loans in cases where violations are found. Under such an 
arrangement,\235\ should a consumer bring a claim, the purchaser will 
look to the originator to repurchase the loan; if the originator is no 
longer in business or does not have the financial means to do so, the 
purchaser will have to bear the risk. This places greater incentive on 
purchasers to vet potential counterparties and may impact some smaller 
institutions' ability to sell loans. The impact is likely greatest for 
loans made under the general ability-to-repay standard rather than for 
qualified mortgages. In the near term, the temporary provisions 
expanding the number of qualified mortgages, will greatly mitigate 
costs for these institutions.
---------------------------------------------------------------------------

    \235\ It is also possible that other contracting arrangements 
will develop. The industry is currently working on various changes 
to the traditional pooling and servicing agreements, for example.
---------------------------------------------------------------------------

2. Impact of the Provisions on Consumers in Rural Areas
    The final rule should have minimal differential impacts on 
consumers in rural areas. In these areas, a greater fraction of loans 
are made by smaller institutions and carried on portfolio. The 
availability or pricing for fixed rate or adjustable-rate loans that 
are qualified mortgages is likely to be unaffected. Notably, the 
liability for these loans is nearly unchanged; those below the 
threshold will be subject to the safe harbor while those above the 
threshold have a rebuttable presumption similar to the one in place 
under existing regulation. Only the very small number of loans made by 
these institutions and then sold may be impacted by the changes in 
counterparty risk. Consumers constrained to borrow from these lenders 
may see a small increase in the price of credit, either from the 
lenders now having to fund the loan on the balance sheet or facing 
reduced prices in the secondary market. The possible increases in 
compliance costs just described may also lead to very small increases 
in rates.
    An important difference between the rural and the non-rural 
consumers is the availability of balloon loans following the rule. 
While the balloon loans in the non-rural areas that are not underserved 
cannot be qualified mortgages, small lenders operating predominantly in 
the rural or underserved areas can, under certain conditions, originate 
balloons loans that are qualified mortgages. Thus, rural consumers will 
preserve access to credit, while potentially experiencing the lack of 
protection associated with prohibiting balloon transactions from being 
qualified mortgages. Despite the fact that excluding a small creditor 
from the balloon loan market generally does not significantly disrupt 
the price-setting process, this might not be true for rural markets. In 
particular, there are 567 counties that have three creditors or fewer 
(that originate five or more covered transactions per year), according 
to HMDA 2011. Going from three creditors to two could significantly 
increase prices for consumers.
    Data regarding the specific mortgages originated and held on bank 
and credit union portfolios is very limited; the exception is the data 
on the credit union call report showing the total number and amount of 
balloon loans together with hybrid adjustable-rate mortgages. According 
to these data, there appear to be few institutions, and therefore very 
few consumers affected in this way. In counties where the problem 
should be worst, namely micropolitan counties not covered by the rural 
or underserved definition, there are just under 50 credit unions that 
extend balloon loans and not ARMs; in total they originate 1,200 
balloon loans. Consumers seeking credit at these institutions, or 
similarly situated banks or thrifts, may face some costs in taking a 
different product or in switching institutions depending on the product 
offerings and prices in the market. The Bureau believes any price 
increase is likely not significant as these areas are served by 
multiple lenders. On average, according to the 2011 HMDA data, 16 
lenders on average made higher-priced mortgage loans in these counties, 
a proxy for what could be balloon loans.

F. Alternatives Considered

    Two factors are most relevant when comparing the benefits, costs 
and impacts of the final rule to alternative regulatory 
implementations: the requirements for underwriting each loan and the 
eventual legal liability attached to that loan. The current rule 
differs from the Board's proposal along both dimensions, particularly 
in regard to qualified mortgages, as it uses a slightly different 
structure overall, such as incorporating a specific debt-to-income

[[Page 6574]]

ratio requirement. It also varies in structure from some other 
proposals offered by commenters. However, even within the structure 
developed in the final rule, the parameters within the rule (e.g. the 
DTI ratio threshold) could have been different. In order to more fully 
illuminate the impacts of the final rule, this section first considers 
the final rule in comparison to the proposals and then to other 
reasonable alternatives.
    In the 2011 ATR Proposal, the Board proposed two alternative 
definitions for a qualified mortgage. The Board's Alternative 1 
proposed to define a qualified mortgage using only the statutory 
provisions (except for the discretionary requirement to consider the 
consumer's debt-to-income ratio or residual income). That is, the 
definition of a qualified mortgage would be based on product features, 
cost limitations (points and fees limit) and income verification but 
would not require the creditor to follow any other specific 
underwriting procedures. Alternative 1 would have operated as a legal 
safe harbor with the conclusive presumption of compliance.
    The final rule maintains a minimum standard for documenting and 
verifying loans and varies the legal liability with the perceived 
consumer risk. Alternative 1, on the other hand, placed more emphasis 
on the restrictions on product features to protect consumers. Loans 
without interest-only, negative amortization or balloon features, or 
where total points and fees do not exceed three points were assumed 
safe and therefore had limited requirements for documenting income and 
debt (relative to other loans) and were afforded the conclusive 
presumption of compliance.
    Compared to this alternative, the final rule with the temporary 
provisions likely offers qualified mortgage status to a similar number 
of loans: without the effects of the temporary provisions, fewer loans 
would qualify as qualified mortgages. The final rule also mandates 
stricter documentation and verification of qualified mortgages and 
limits the presumption of compliance in the case of higher-priced 
covered transactions. Compared to Alternative 1, only those loans that 
meet the product, features and point-and-fee limitations and that have 
a DTI ratio less than or equal to 43 percent are qualified mortgages. 
This approach limits the reliance on compensating factors when 
underwriting high DTI ratio loans and recognizes that while such loans 
may be in the creditor's interest, there is a greater possibility that 
the consumer may not have the ability to repay the loan. This change 
likely increases costs slightly in order to provide this consumer 
protection. Requiring the additional verification of debts for 
qualified mortgages also provides additional consumer protection. Since 
this is current practice in the market today, this likely adds very 
little cost for the time being; however, it does impose costs as credit 
expands to the point that the market would otherwise relax verification 
requirements--as well as benefits to consumers and society at large 
from preventing loans based on unverified (or no) data. Compared to 
Alternative 1, the only difference in the strength of the liability 
protection for qualified mortgages is for those loans above the higher-
priced threshold. In the final rule, these loans have a rebuttable 
presumption of compliance rather than a conclusive presumption. 
However, given that the legal standard today is a rebuttable 
presumption, the final rule nearly maintains the status quo for 
borrowers with HPMLs; adopting Alternative 1 would have been a slight 
diminution of these borrower's legal rights.
    The Board's Alternative 2 would have provided the lender with a 
rebuttable presumption of compliance and would have defined a 
``qualified mortgage'' as including the statutory criteria as well the 
additional underwriting requirements from the general ability-to-repay 
standard. The Board proposed to permit, but not require, creditors to 
comply with the underwriting requirements by looking to ``widely 
accepted governmental and non-governmental underwriting standards'' 
(such as the FHA's standards). The important difference between this 
aspect of Alternative 2 and Alternative 1 is that, under Alternative 2, 
the relative weights for such tradeoffs had to be derived from widely 
accepted standards.
    Compared to Alternative 2, the final rule with the temporary 
provisions likely offers qualified mortgage status to a similar number 
of loans; without the effects of the temporary provisions, fewer loans 
would be eligible to be qualified mortgages. Under the final rule, 
there is little difference in the documentation and verification 
requirements; however, the presumption of compliance is strengthened 
for the majority of qualified mortgages. Compared to Alternative 2 (and 
to Alternative 1), only those loans that meet the product, features and 
cost limitations and that have a DTI ratio less than or equal to 43 
percent are qualified mortgages. This limits the use of compensating 
factors for high DTI loans and recognizes that while such loans may be 
in the creditor's interest, there is a greater possibility that the 
consumer may not have the ability to repay the loan. This change likely 
increases costs slightly in order to provide this consumer protection. 
Both Alternative 2 and the final rule have very similar documentation 
and verification standards so there is little difference in the 
benefits and costs along that dimension. Relative to Alternative 2, the 
difference in the liability standard is for those qualified mortgages 
below the higher-priced threshold. In the final rule, these loans have 
a conclusive presumption of compliance rather than just a rebuttable 
presumption.
    As noted in the preamble, a coalition of industry and consumer 
advocates presented another alternative proposal to the Bureau that 
would have provided a tiered approach to defining a qualified mortgage. 
Under the first tier, if the consumer's total debt-to-income ratio is 
43 percent or less, the loan would be a qualified mortgage, and no 
other tests would be required. Under the second tier, if the consumer's 
total debt-to-income ratio is more than 43 percent, the creditor would 
apply a series of tests related to the consumer's front-end debt-to-
income ratio (housing debt to income), stability of income and past 
payment history, availability of reserves, and residual income to 
determine if a loan is a qualified mortgage. This would have allowed 
some loans with up to 50 percent DTI ratios to meet the qualified 
mortgage definition. To the extent that it relies on additional factors 
beyond the DTI ratio, this alternative is similar to the Board's 
approach. However, the coalition's proposal generally restricted the 
factors considered to be factors related to ability to repay, rather 
than other factors related to credit or collateral in its 
determination. These commenters also supported a rebuttable presumption 
standard for qualified mortgages.
    Relative to this alternative, the final rule will likely include 
fewer loans as qualified mortgages. The loans that will not be 
qualified mortgages are those that would qualify only under one or more 
of the additional factors besides DTI ratio that the alternative 
included: housing expenses, stability of income, reserves etc. As a 
result, these loans will have to meet the ability-to-repay standard of 
the final rule, providing additional consumer protections with the 
minor added costs described above. Relative to a rule including these 
factors, the final rule is simpler and easier to implement for 
industry, lowering costs overall. In addition, creditors are free to 
include such factors in their own credit decisions and to

[[Page 6575]]

develop the best models for their inclusion. The Bureau views this more 
dynamic outcome as a benefit relative to a more prescriptive rule 
detailing how such factors should be traded off against each other. 
This alternative did include a rebuttable presumption of compliance for 
all qualified mortgages; as such, the final rule's safe harbor limits 
liability costs and consumer benefits, as already discussed, for those 
qualified mortgages that are not higher priced covered transactions.
    As noted, the Bureau also considered certain alternatives to its 
own version of the final rule. One such alternative would have used a 
threshold of a 36 percent DTI ratio to define qualified mortgages. This 
would have left roughly an additional 15 percent of loans, both during 
the 1997-2003 period and during 2011, without a presumption of 
compliance. As noted however, the Bureau believes that 43 percent is a 
more efficient threshold: it is an accepted market standard, rates of 
delinquency and default for borrowers between 36 and 43 percent are 
still modest, and many borrowers--particularly in higher cost housing 
markets--borrow at these levels.
    The Bureau also considered whether all qualified mortgages should 
have the same degree of presumption with the qualified mortgage 
standard--either all being afforded a conclusive presumption of 
compliance or all being afforded a rebuttable presumption. As discussed 
in the section-by-section analysis, the Bureau determined that the 
bifurcated approach in which only higher-priced covered transactions 
provide the consumer with the opportunity to rebut the presumption of 
compliance best balances the concerns of costs, certainty, and consumer 
protection.

VIII. Final Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) generally requires an agency 
to conduct an initial regulatory flexibility analysis (IRFA) and a 
final regulatory flexibility analysis (FRFA) of any rule subject to 
notice-and-comment rulemaking requirements, unless the agency certifies 
that the rule will not have a significant economic impact on a 
substantial number of small entities.\236\ The Bureau also is subject 
to certain additional procedures under the RFA involving the convening 
of a panel to consult with small business representatives prior to 
proposing a rule for which an IRFA is required.\237\
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    \236\ For purposes of assessing the impacts of the final rule on 
small entities, ``small entities'' is defined in the RFA to include 
small businesses, small not-for-profit organizations, and small 
government jurisdictions. 5 U.S.C. 601(6). A ``small business'' is 
determined by application of Small Business Administration 
regulations and reference to the North American Industry 
Classification System (NAICS) classifications and size standards. 5 
U.S.C. 601(3). A ``small organization'' is any ``not-for-profit 
enterprise which is independently owned and operated and is not 
dominant in its field.'' 5 U.S.C. 601(4). A ``small governmental 
jurisdiction'' is the government of a city, county, town, township, 
village, school district, or special district with a population of 
less than 50,000. 5 U.S.C. 601(5).
    \237\ 5 U.S.C. 609.
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    In the 2011 ATR Proposal, the Board did not certify that the rule 
would not have a significant economic impact on a substantial number of 
small entities and therefore prepared an IRFA.\238\ In this IRFA the 
Board solicited comment on any costs, compliance requirements, or 
changes in operating procedures arising from the application of the 
proposed rule to small businesses, comment regarding any state or local 
statutes or regulations that would duplicate, overlap, or conflict with 
the proposed rule, and comment on alternative means of compliance for 
small entities with the ability-to-repay requirements and restrictions 
on prepayment penalties. Comments addressing the ability-to-repay 
requirements and restrictions on prepayment penalties are addressed in 
the section-by-section analysis above. Comments addressing the impact 
on the cost of credit are discussed below.
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    \238\ 76 FR 27479-27480.
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1. A Statement of the Need for, and Objectives of, the Rule
    The Bureau is publishing a final rule to establish new ability-to-
repay requirements related to mortgage origination. As discussed in the 
preamble, the final rule's amendments to Regulation Z implement certain 
amendments to TILA that were added by sections 1411, 1412, 1413, and 
1414 of the Dodd-Frank Act in response to the recent foreclosure crisis 
to address certain lending practices (such as low- or no-documentation 
loans or underwriting mortgages without including any principal 
repayments in the underwriting determination) that led to consumers 
having mortgages they could not afford, thereby contributing to high 
default and foreclosure rates.
    A full discussion of the market failures motivating these 
provisions of the Dodd-Frank Act and the final rule is included in the 
preamble and in the Bureau's section 1022 analysis above. Those 
discussions also describe the specific ways the final rule addresses 
these issues. However, in general, the purpose of the Dodd-Frank Act 
ability-to-repay requirements is to assure that consumers are offered 
and receive residential mortgage loans on terms that reasonably reflect 
their ability to repay the loans and that are understandable and not 
unfair, deceptive or abusive. Prior to the Dodd-Frank Act, existing 
Regulation Z provided ability-to-repay requirements for high-cost and 
higher-priced mortgages. Accordingly, new TILA section 129C generally 
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 according to its terms, including any 
mortgage-related obligations (such as property taxes and mortgage 
insurance). Consistent with the statute, the final rule applies the 
ability-to-repay requirements of TILA section 129C to any consumer 
credit transaction secured by a dwelling, except an open-end credit 
plan, timeshare plan, reverse mortgage, or temporary loan.
    Congress also recognized the importance of maintaining access to 
responsible, affordable mortgage credit. To provide creditors more 
certainty about their potential liability under the ability-to-repay 
standards while protecting consumers from unaffordable loans, the Dodd-
Frank Act creates a presumption of compliance with the ability-to-repay 
requirement when creditors make ``qualified mortgages.'' Qualified 
mortgages do not contain certain features that Congress deemed to 
create a risk to consumers' ability to repay, and must be underwritten 
using standards set forth in the statute that are designed to assure 
that consumers will have the ability to repay these loans. The final 
rule establishes standards for complying with the ability-to-repay 
requirements, including defining ``qualified mortgage.'' The final rule 
provides three options for originating a qualified mortgage: under the 
general definition in Sec.  1026.43(e)(2), for loans where the 
consumer's monthly debt-to-income ratio would not exceed 43 percent; 
under the definition Sec.  1026.43(e)(4), for a maximum of seven years, 
for loans that are eligible for purchase by the GSEs while in 
conservatorship or certain other Federal agencies, and under Sec.  
1026.43(f), for loans that have balloon-payment features if the 
creditor operates predominantly in rural or underserved areas and meets 
certain asset-size and transaction volume limits.
    Congress did not explicitly define the nature of the presumption of 
compliance that attaches to a qualified mortgage. Congress also left 
some contours of a qualified mortgage

[[Page 6576]]

undefined, such as whether there should be a minimum debt-to-income 
ratio. Congress left these decisions to the Bureau and granted broad 
authority to revise, add to, or subtract from the qualified mortgage 
criteria upon a finding that doing so is ``necessary or proper'' or 
``necessary and appropriate'' to achieve certain specified standards, 
such as ensuring that responsible, affordable mortgage credit remains 
available to consumers.
    As discussed above, the final rule recognizes both the need to 
assure that consumers are offered and receive loans based on a 
reasonable and good faith determination of their repayment ability and 
the need to ensure that responsible, affordable mortgage credit remains 
available to consumers. The Bureau believes, based upon its analysis of 
the data available to it, that, under the final rule, the vast majority 
of loans originated today can meet the standards for a qualified 
mortgage so long as creditors follow the required procedures, such as 
verifying income or assets, and current debt obligations, alimony and 
child support. The Bureau also believes, based upon its analysis of the 
historical performance of loans meeting the rule's definition of 
``qualified mortgages,'' that consumers will be able to repay these 
loans. The Bureau believes that the final rule will not restrict 
creditors' ability to make responsible loans, both within and outside 
the qualified mortgage space.
    The final rule provides special rules for complying with the 
ability-to-repay requirements for a creditor refinancing a ``non-
standard mortgage'' into a ``standard mortgage.'' The purpose of this 
provision is to provide flexibility for creditors to refinance a 
consumer out of a risky mortgage into a more stable one without 
undertaking a full underwriting process.
    In addition to the ability-to-repay and qualified mortgage 
provisions, the final rule implements the Dodd-Frank Act limits on 
prepayment penalties and lengthens the time creditors must retain 
records that evidence compliance with the ability-to-repay and 
prepayment penalty provisions.
2. Summary of Significant Issues Raised by Comments in Response to the 
Initial Regulatory Flexibility Analysis, Statement of the Assessment of 
the Bureau of Such Issues, and a Statement of Any Changes Made as a 
Result of Such Comments
    The Board's IRFA estimated the possible compliance costs for small 
entities from each major component of the rule against a pre-statute 
baseline. The Board requested comments on the IRFA.
    The Board did not receive any comments in its IRFA. Industry 
commenters generally expressed concern with respect to the costs they 
anticipated from the 2011 ATR Proposal. The Bureau received numerous 
comments describing in general terms the impact of the proposed rule on 
small creditors and the need for the qualified mortgage definition to 
be structured as a safe harbor with clear, well-defined standards to 
ensure that the largest number of consumers possible can access credit. 
Small creditors are particularly concerned about the litigation risk 
associated with the requirement to make a reasonable and good faith 
determination of consumers' ability to repay based on verified and 
documented information. Because of their size, small creditors note 
that they are particularly unsuited to bear the burden and cost of 
litigation and would find it particularly difficult to absorb the cost 
of an adverse judgment. Indeed, small creditors insist that they will 
not continue to make mortgage loans unless they are protected from 
liability for violations of the ability-to-repay rules by a conclusive 
presumption of compliance or ``safe harbor.'' These small creditors' 
concerns about compliance with the ability-to-repay rule and associated 
litigation risk have been repeatedly expressed to the Bureau by their 
trade associations and prudential regulators.
    Several commenters on the proposal urged the Bureau to adopt less 
stringent regulatory requirements for small creditors or for loans held 
in portfolio by small creditors. For example, at least two commenters 
on the proposal, a credit union and a state trade group for small 
banks, urged the Bureau to exempt small portfolio creditors from the 
ability-to-repay and qualified mortgage rule. Two other trade group 
commenters urged the Bureau to adopt less stringent regulatory 
requirements for small creditors than for larger creditors at least in 
part because mortgage loans made by small creditors often are held in 
portfolio and therefore historically have been conservatively 
underwritten.
    Some industry commenters supported not including quantitative 
standards for such variables as debt-to-income ratios and residual 
income because they argued that underwriting a loan involves weighing a 
variety of factors, and creditors and investors should be allowed to 
exercise discretion and weigh risks for each individual loan. To that 
point, one industry trade group commenter argued that community banks, 
for example, generally have conservative requirements for a consumer's 
debt-to-income ratio, especially for loans that are held in portfolio 
by the bank, and consider many factors when underwriting for mortgage 
loans, such as payment history, liquid reserves, and other assets. 
Because several factors are considered and evaluated in the 
underwriting process, this commenter asserted that community banks can 
be flexible when underwriting for mortgage loans and provide 
arrangements for certain consumers that fall outside of the normal 
debt-to-income ratio for a certain loan. This commenter contended that 
strict quantitative standards would inhibit community banks' 
relationship lending and ability to use their sound judgment in the 
lending process. Some commenters contended that requiring specific 
quantitative standards could restrict credit access and availability 
for consumers.
    A number of other commenters expressed concerns that the 
availability of portfolio mortgage loans from small creditors would be 
severely limited because the proposed exception for rural balloon loans 
was too restrictive. Some industry commenters urged the Bureau to allow 
balloon mortgage loans held in portfolio by the originating banks for 
the life of the loan to be included under this safe harbor so that 
small creditors could continue to meet the specific needs of their 
customers.
    These comments, and the responses, are discussed in the section-by-
section analysis and element 6-1 of this FRFA.
3. Response to the Small Business Administration Chief Counsel for 
Advocacy
    The SBA Office of Advocacy (Advocacy) provided a formal comment 
letter to the Bureau in response to the Bureau's reopening of the 
comment period for certain issues relating to the ability-to-repay/
qualified mortgage rulemaking. Among other things, this letter 
expressed concern about the following issues: the qualified mortgage 
definition and the use of data as a means for measuring a consumer's 
ability to repay.
    First, Advocacy expressed concern that the qualified mortgage 
definition will have major implications on the viability of community 
banks. Advocacy pointed to the assertion made by small banks that they 
will no longer originate mortgage loans if they are only provided with 
a rebuttable presumption of compliance. In addition, according to 
Advocacy, small banks contend that establishing the qualified mortgage 
as a

[[Page 6577]]

rebuttable presumption of compliance will reduce the availability and 
affordability of mortgages to consumers due to increased litigation and 
compliance costs, and the exit by certain small lenders unable to 
manage the risk. According to Advocacy, small banks assert that one way 
to enable them to compete effectively (and to ensure consumers can 
obtain affordable loans) is to establish the qualified mortgage as a 
safe harbor and allow for non-traditional loans such as mortgages with 
balloon payments to continue to be made.
    The Bureau carefully considered the arguments for establishing the 
qualified mortgage as a safe harbor or rebuttable presumption of 
compliance in light of the proposed rule, and a complete discussion of 
the consideration of the Bureau's final rule can be found in the 
respective section of the section-by-section analysis, the Bureau's 
section 1022(b)(2) discussion, and in element 6-1 of this FRFA.
    As discussed in more detail elsewhere, the final rule provides a 
safe harbor under the ability-to-repay requirements for mortgage loans 
that satisfy the definition of a qualified mortgage and are not higher-
priced covered transactions (i.e., APR does not exceed Average Prime 
Offer Rate (APOR) \239\ + 1.5 percentage points for first liens or 3.5 
percentage points for subordinate liens). The final rule provides a 
rebuttable presumption for all other qualified mortgage loans, meaning 
qualified mortgage loans that are higher-priced covered transactions 
(i.e., APR exceeds APOR + 1.5 percentage points for first lien or 3.5 
percentage points for subordinate lien). The Bureau believes that a 
bifurcated approach to the presumption of compliance provides the best 
way of balancing consumer protection and access to credit 
considerations and is consistent with the purposes of the statute, 
while calibrating consumer protections and risk levels to match the 
historical record of loan performance. To reduce uncertainty in 
potential litigation, the final rule defines the standard by which a 
consumer may rebut the presumption of compliance afforded to higher-
priced qualified mortgages.
---------------------------------------------------------------------------

    \239\ The Average Prime Offer Rate means ``the average prime 
offer rate for a comparable transaction as of the date on which the 
interest rate for the transaction is set, as published by the 
Bureau.'' TILA section 129C(b)(2)B).
---------------------------------------------------------------------------

    The Bureau notes that the Board's proposed Sec.  1026.43 did not 
include special provisions for portfolio loans made by small creditors 
and the Board's proposal did not address such an accommodation. 
However, this final rule is related to a proposed rule published 
elsewhere in today's Federal Register. As discussed in more detail 
below, in that proposal, the Bureau is proposing certain amendments to 
this final rule, including a proposal to define as a qualified mortgage 
a larger category of loans made and held in portfolio by small 
creditors than this final rule defines as a qualified mortgage.
    Second, Advocacy expressed concern about using loan performance, as 
measured by the delinquency rate, as an appropriate metric to evaluate 
whether consumers had the ability to repay at the time their loans were 
consummated. Advocacy noted that a consumer's circumstances might 
change after the loan was made due to unemployment or illness. The 
Bureau agrees that consumers' circumstances can change and lead to 
delinquency or default. However, the Bureau also believes that DTI is 
an indicator of the consumer's ability to repay. All things being 
equal, consumers carrying loans with higher DTI ratios will be less 
able to absorb any such shocks and are more likely to default.
4. A Description of and an Estimate of the Number of Small Entities to 
Which the Rule Will Apply
    The final rule will apply to creditors that engage in originating 
or extending certain dwelling-secured credit. 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 1026.1(c)(1).\240\ Small entities that originate or extend 
closed-end loans secured by a dwelling are potentially subject to at 
least some aspects of the final rule.
---------------------------------------------------------------------------

    \240\ 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 1026.1(c)(1). 
Regulation Z provides, in general, that a person regularly extends 
consumer credit only if the person extended credit more than 5 times 
for transactions secured by a dwelling in the preceding year.
---------------------------------------------------------------------------

    For purposes of assessing the impacts of the final rule on small 
entities, ``small entities'' is defined in the RFA to include small 
businesses, small nonprofit organizations, and small government 
jurisdictions. 5 U.S.C. 601(6). A ``small business'' is determined by 
application of SBA regulations and reference to the North American 
Industry Classification System (NAICS) classifications and size 
standards.\241\ 5 U.S.C. 601(3). Under such standards, banks and other 
depository institutions are considered ``small'' if they have $175 
million or less in assets, and for other financial businesses, the 
threshold is average annual receipts (i.e., annual revenues) that do 
not exceed $7 million.\242\
---------------------------------------------------------------------------

    \241\ The current SBA size standards are found on SBA's Web site 
at http://www.sba.gov/content/table-small-business-size-standards.
    \242\ See id.
---------------------------------------------------------------------------

    The Bureau can identify through data under the Home Mortgage 
Disclosure Act, Reports of Condition and Income (Call Reports), and 
data from the National Mortgage Licensing System (NMLS) the approximate 
numbers of small depository institutions that will be subject to the 
final rule. Origination data is available for entities that report in 
HMDA, NMLS or the credit union call reports; for other entities, the 
Bureau has estimated their origination activities using statistical 
projection methods.
    The following table provides the Bureau's estimate of the number 
and types of entities to which the rule will apply:

[[Page 6578]]

[GRAPHIC] [TIFF OMITTED] TR30JA13.000

5. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements
    The final rule does not impose new reporting requirements. The 
final rule does, however, impose new recordkeeping and other compliance 
requirements on certain small entities. The requirements on small 
entities from each major component of the rule are presented below.
    The Bureau discusses impacts against a pre-statute baseline. This 
baseline assumes compliance with the Federal rules that overlap with 
the final rule. The impact of the rule relative to the pre-statute 
baseline will be smaller than the impact would be if not for compliance 
with the existing Federal rules. In particular, creditors have already 
incurred some of the one-time costs necessary to comply with the final 
rule when they came into compliance with the 2008 HOEPA Final Rule on 
higher-priced mortgage loans. And creditors already have budgeted for 
some of the ongoing costs of the final rule to the extent those are 
costs necessary to remaining in compliance with the 2008 HOEPA Final 
Rule. These expenses attributable to the 2008 HOEPA Final Rule will 
facilitate and thereby reduce the cost of compliance with this final 
rule.
Recordkeeping Requirements
    The final rule imposes new record retention requirements on covered 
persons. As discussed above, the final rule requires creditors to 
retain evidence of compliance with Sec.  1026.43 (containing the 
ability-to-repay/qualified mortgage provisions and prepayment penalty 
restrictions) for three years after consummation. The final rule 
clarifies that creditors need not maintain actual paper copies of the 
documentation used to underwrite a transaction. For most covered 
persons, the required records will be kept in electronic form and 
creditors need retain only enough information to reconstruct the 
required records. This should limit any burden associated with the 
record retention requirement for creditors.
Other Compliance Requirements
    As discussed in detail in the section-by-section analysis and the 
Bureau's section 1022(b)(2) discussion above, the final rule imposes 
new compliance requirements on creditors. In general, creditors will 
have to update their policies and procedures; additionally, creditors 
may have to update their systems, for example, to store flags 
identifying qualified mortgages, and to ensure compliance. The Bureau 
believes that small creditors' major one-time costs will be to learn 
about the final rule, consider whether they need to modify their 
underwriting practices and procedures to comply with the rule and, if 
necessary, modify their practices and procedures. The precise costs to 
small entities of modifying their underwriting practices, should they 
need to do so, are difficult to predict. These costs will depend on a 
number of factors, including, among other things, the current practices 
and systems 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. To the extent that most small creditors' processes already 
align with the rule, any additional compliance costs should be minimal.
    When originating mortgages, the creditor must calculate the monthly 
mortgage payment based on the greater of the fully indexed rate or any 
introductory rate, assuming monthly, fully amortizing payments that are 
substantially equal. The final rule provides special payment 
calculation rules for loans with balloon payments, interest-only loans, 
and negative amortization loans. The final 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 presumption of compliance or safe harbor 
for qualified mortgages.
    The Final Rule also includes requirements for documentation and 
verification of certain information that the creditor must consider in 
assessing a consumer's repayment ability. The final rule provides 
special rules for verification of a consumer's income or assets, and 
provides examples of records that can be used. Different verification

[[Page 6579]]

requirements apply to qualified mortgages. Creditors that originate 
qualified mortgages under the general definition must verify a 
consumer's income or assets, current debt obligations, alimony, and 
child support, and must also verify a consumer's monthly debt-to-income 
ratio. The final rule does not contain specific verification 
requirements for creditors originating qualified mortgages under the 
temporary provisions; however, such loans must comply with eligibility 
requirements (including underwriting requirements) of the GSEs or the 
Federal agency program applicable to the loan.
    The final rule also provides special rules for complying with the 
ability-to-repay requirements for a creditor refinancing a ``non-
standard mortgage'' into a ``standard mortgage.'' This provision is 
based on TILA section 129C(a)(6)(E), which contains special rules for 
the refinance of a ``hybrid loan'' into a ``standard loan.'' The 
purpose of this provision is to provide flexibility for creditors to 
refinance a consumer out of a risky mortgage into a more stable one 
without undertaking a full underwriting process. Under the final rule, 
a non-standard mortgage is defined as an adjustable-rate mortgage with 
an introductory fixed interest rate for a period of one year or longer, 
an interest-only loan, or a negative amortization loan. Under this 
option, a creditor refinancing a non-standard mortgage into a standard 
mortgage does not have to consider the eight specific underwriting 
criteria under the general ability-to-repay option, if certain 
conditions are met, thus reducing compliance costs for small entities.
    Prepayment limitations, as discussed in detail in the section-by-
section analysis and the Bureau's section 1022 analysis, are also 
included in the final rule.
Estimate of the Classes of Small Entities Which Will Be Subject to the 
Requirement
    Section 603(b)(4) of the RFA requires an estimate of the classes of 
small entities which will be subject to the requirement. The classes of 
small entities which will be subject to the reporting, recordkeeping, 
and compliance requirements of the final rule are the same classes of 
small entities that are identified above in part VIII.B.4.
    Section 604(a)(5) of the RFA also requires an estimate of the type 
of professional skills necessary for the preparation of the reports or 
records. The Bureau anticipates that the professional skills required 
for compliance with the final rule are the same or similar to those 
required in the ordinary course of business of the small entities 
affected by the final rule. Compliance by the small entities that will 
be affected by the final rule will require continued performance of the 
basic functions that they perform today: Managing information about 
consumers and conducting sound underwriting practices for mortgage 
originations.
6-1. Description of the Steps the Agency has Taken To Minimize the 
Significant Economic Impact on Small Entities
    The Bureau understands the new provisions will impose a cost on 
small entities, and has attempted to mitigate the burden consistent 
with statutory objectives. The Bureau has also taken numerous 
additional steps that are likely to reduce the overall cost of the 
rule. Nevertheless, the rule will certainly create new one-time and 
ongoing costs for creditors. The section-by-section analysis of each 
provision and the Bureau's section 1022 analysis contain a complete 
discussion of the following steps taken to mitigate the burden.
    The final rule provides small creditors with the option of offering 
only qualified mortgages, which will enjoy either a presumption of 
compliance with respect to the repayment ability requirement (for 
higher-priced covered transactions) or a safe harbor from the repayment 
ability requirement, thus reducing litigation risks and costs for small 
creditors.
    The Bureau believes that a variety of underwriting standards can 
yield reasonable, good faith ability-to-repay determinations. The 
Bureau is permitting creditors to develop and apply their own 
underwriting standards (and to make changes to those standards over 
time in response to empirical information and changing economic and 
other conditions) as long as those standards lead to ability-to-repay 
determinations that are reasonable and in good faith. In addition, the 
Bureau will permit creditors to use their own definitions and other 
technical underwriting criteria and notes that underwriting guidelines 
issued by governmental entities such as the FHA are a source to which 
creditors may refer for guidance on definitions and technical 
underwriting criteria. The Bureau believes this flexibility is 
necessary given the wide range of creditors, consumers, and mortgage 
products to which this rule applies. The Bureau believes this increased 
flexibility will reduce the burden on small creditors by allowing them 
to determine the practices that fit best with their business model.
Qualified Mortgage Provisions
    The general definition of the qualified mortgage includes a very 
clear standard of 43 percent for the debt-to-income threshold and clear 
methods to compute that figure. The clarity of this provision, and 
others, should make implementation of and compliance with these 
provisions of the rule. The Bureau carefully considered the arguments 
for establishing the qualified mortgage as a safe harbor or rebuttable 
presumption of compliance in light of the proposed rule, and a complete 
discussion of the consideration of the Bureau's final rule can be found 
in the respective section of the section-by-section analysis. The final 
rule establishes standards for complying with the ability-to-repay 
requirements, including defining ``qualified mortgage.'' The final rule 
provides three options for originating a qualified mortgage: under the 
general definition in Sec.  1026.43(e)(2), for loans where the 
consumer's monthly debt-to-income ratio would not exceed 43 percent; 
under the definition Sec.  1026.43(e)(4), for a maximum of seven years, 
for loans that are eligible for purchase by the GSEs while in 
conservatorship or certain other Federal agencies, and under Sec.  
1026.43(f), for loans that have balloon-payment features if the 
creditor operates predominantly in rural or underserved areas and meets 
certain asset-size and transaction volume limits. The final rule 
provides a safe harbor under the ability-to-repay requirements for 
mortgage loans that satisfy the definition of a qualified mortgage and 
are not higher-priced covered transactions (i.e., APR does not exceed 
Average Prime Offer Rate (APOR) \243\ + 1.5 percentage points for first 
liens or 3.5 percentage points for subordinate liens). The final rule 
provides a rebuttable presumption for all other qualified mortgage 
loans, meaning qualified mortgage loans that are higher-priced covered 
transactions (i.e., APR exceeds APOR + 1.5 percentage points for first 
lien or 3.5 percentage points for subordinate lien).
---------------------------------------------------------------------------

    \243\ The Average Prime Offer Rate means ``the average prime 
offer rate for a comparable transaction as of the date on which the 
interest rate for the transaction is set, as published by the 
Bureau.'' TILA section 129C(b)(2)B).
---------------------------------------------------------------------------

    The Bureau believes that a bifurcated approach to the presumption 
of compliance provides the best way of balancing consumer protection 
and access to credit considerations and is consistent with the purposes 
of the statute, while calibrating consumer protections and risk levels 
to match the historical record of loan performance. To reduce 
uncertainty in potential

[[Page 6580]]

litigation, the final rule defines the standard by which a consumer may 
rebut the presumption of compliance afforded to higher-priced qualified 
mortgages. The Bureau's approach to the standards with which a consumer 
can rebut the presumption that applies to higher-priced transactions is 
further designed to ensure careful calibration.
    The Bureau considered several alternatives, including only the safe 
harbor standard and only the rebuttable presumption standard. In its 
rulemaking, the Bureau tried to balance consumers' access to credit 
concerns with the consumer protection associated with reducing 
consumers' cost of litigation. Compared to the final rule, only the 
safe harbor standard marginally increased consumers' access to credit, 
but significantly reduced consumer protection. Conversely, only the 
rebuttable presumption standard marginally increased consumer 
protection, but significantly decreased consumers' access to credit.
Balloon-Payment Qualified Mortgage Provisions
    The Bureau has also 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. The Bureau 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. Under the final rule, the Bureau is permitting small creditors 
operating predominantly in rural or underserved areas to originate a 
balloon-payment qualified mortgage.
    Unlike loans that are qualified mortgages under the general 
definition, there is no specific debt-to-income ratio requirement for 
balloon-payment qualified mortgages. However, creditors must consider 
and verify a consumer's monthly debt-to-income ratio. Like the other 
qualified mortgage definitions, a loan that satisfies the criteria for 
a balloon-payment qualified mortgage and is not a higher-priced covered 
transaction receives a legal safe harbor under the ability-to-repay 
requirements. A loan that satisfies those criteria and is a higher-
priced covered transaction receives a rebuttable presumption of 
compliance with the ability-to-repay requirements. The Bureau believes 
that this exception will decrease the economic impact of the final rule 
on small entities. In response to concerns regarding the proposed 
provisions for holding balloon-payment loans in portfolio, the final 
rule provides more flexible portfolio requirements which permit certain 
transfers.
Concurrent Proposal for Portfolio Loans Made by Small Creditors
    The Bureau notes that the Board's proposal did not include special 
provisions for portfolio loans made by small creditors and the Board's 
proposal did not address such an accommodation.
    The Bureau understands that creditors generally have in place 
underwriting policies, procedures, and internal controls that require 
verification of the consumer's reasonably expected income or assets, 
employment status, debt obligations and simultaneous loans, and debt-
to-income or residual income. Notably, in response to the proposal, 
commenters stated that most creditors today are already complying with 
the full ability-to-repay underwriting standards. For these 
institutions, there would be no additional burden as a result of the 
verification requirements in the final rule, since those institutions 
collect the required information in the normal course of business. To 
the extent small creditors do not verify and document some or all of 
the information required by the proposed rule in the normal course of 
business, they will need to engage in certain one-time implementation 
efforts and system adjustments. These one-time costs might include 
expenses related to creditors needing to reanalyze their product lines, 
retrain staff, and reorganize the processing and administrative 
elements of their mortgage operations.
    In a related proposed rule published elsewhere in today's Federal 
Register, the Bureau is proposing certain amendments to this final 
rule, including an additional definition of a qualified mortgage for 
certain loans made and held in portfolio by small creditors. The 
proposed new category would include certain loans originated by small 
creditors that: (1) Have total assets less than $2 billion at the end 
of the previous calendar year; and (2) together with all affiliates, 
originated 500 or fewer covered transactions, secured by first-liens 
during the previous calendar year. These loans generally conform the 
requirements under the general definition of a qualified mortgage 
except the 43 percent limit on monthly debt-to-income ratio. Under the 
proposed additional definition, a creditor would not have to use the 
instructions in the appendix to the final rule to calculate debt-to-
income ratio, and a loan with a consumer debt-to-income ratio higher 
than 43 percent could be a qualified mortgage if all other criteria are 
met.
    The Bureau also is proposing to allow small creditors to charge a 
higher annual percentage rate for first-lien qualified mortgages in the 
proposed new category and still benefit from a conclusive presumption 
of compliance or ``safe harbor.'' In addition, the Bureau also is 
proposing to allow small creditors operating predominantly in rural or 
underserved areas to offer first-lien balloon loans with a higher 
annual percentage rate and still benefit from a conclusive presumption 
of compliance with the ability to repay rules or ``safe harbor.'' The 
Bureau is proposing these changes because it believes they may be 
necessary to preserve access to credit for some consumers. The 
regulatory requirement to make a reasonable and good faith 
determination based on verified and documented evidence that a consumer 
has a reasonable ability to repay may entail significant litigation 
risk for small creditors. The Bureau believes that small creditors have 
historically engaged in responsible mortgage underwriting that includes 
thorough and thoughtful determinations of consumers' ability to repay, 
at least in part because they bear the risk of default associated with 
loans held in their portfolios. The Bureau also believes that because 
small creditors' lending model is based on maintaining ongoing, 
mutually beneficial relationships with their customers, they therefore 
have a more comprehensive understanding of their customers' financial 
circumstances and are better able to assess ability to repay than 
larger creditors.
    Further, the Bureau understands that the only sources of mortgage 
credit available to consumers in rural and underserved areas may be 
small creditors because larger creditors may be unable or unwilling to 
lend in these areas. For these reasons, the Bureau is proposing a new 
category of qualified mortgages that would include small creditor 
portfolio loans and is also proposing to raise the annual percentage 
rate threshold for the safe harbor to accommodate small creditors' 
higher costs. The Bureau believes these steps may be necessary to 
preserve some rural and underserved consumers' access to non-conforming 
credit.
6-2. Description of the Steps the Agency Has Taken To Minimize Any 
Additional Cost of Credit for Small Entities
    Section 603(d) of the RFA requires the Bureau to consult with small 
entities regarding the potential impact of the proposed rule on the 
cost of credit for small entities and related matters. 5

[[Page 6581]]

U.S.C. 603(d). The Bureau notes that the Board was not subject to this 
requirement when it issued its IRFA.
    The Bureau does not believe that the final rule will result in an 
increase in the cost of business credit for small entities. Instead, 
the final rule will apply only to mortgage loans obtained by consumers 
primarily for personal, family, or household purposes and the final 
rule will not apply to loans obtained primarily for business purposes. 
Given that the final rule does not increase the cost of credit for 
small entities, the Bureau has not taken additional steps to minimize 
the cost of credit for small entities.

IX. Paperwork Reduction Act Analysis

    Certain provisions of this final rule contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (44 U.S.C. 3501 et seq.) (Paperwork Reduction Act 
or PRA).
    This final rule amends 12 CFR part 1026 (Regulation Z). Regulation 
Z currently contains collections of information approved by the Office 
of Management and Budget (OMB). The Bureau's OMB control number for 
Regulation Z is 3170-0015. The PRA (44 U.S.C 3507(a), (a)(2) and 
(a)(3)) requires that a Federal agency may not conduct or sponsor a 
collection of information unless OMB approved the collection under the 
PRA and the OMB control number obtained is displayed. Further, 
notwithstanding any other provision of law, no person is required to 
comply with, or is subject to any penalty for failure to comply with, a 
collection of information that does not display a currently valid OMB 
control number (44 U.S.C. 3512).
    This final rule contains information collection requirements that 
have not been approved by the OMB and, therefore, are not effective 
until OMB approval is obtained. The unapproved information collection 
requirements are contained in sections 1026.25(c)(3) and 1026.43(c)-(f) 
of these regulations. The Bureau will publish a separate notice in the 
Federal Register announcing the submission of these information 
collection requirements to OMB as well as OMB's action on these 
submissions; including, the OMB control number and expiration date.
    On May 11, 2011, the Board of Governors of the Federal Reserve 
System (Board) published notice of the proposed rule in the Federal 
Register (76 FR 27390). The information collection requirements in 
Sec. Sec.  1026.25(c)(3) and 1026.43(c)-(f) were contained in the 
Board's proposal; however, these requirements were not separately 
discussed in the proposal's PRA section. For full public transparency, 
the Bureau now claims these requirements as information collections. 
The Bureau received no PRA-related comments to the Board's proposal on 
the information collections in Sec. Sec.  1026.25(c)(3) and 1026.43(c).

A. Overview

    As described below, the final rule amends the collections of 
information currently in Regulation Z to implement amendments to TILA 
made by the Dodd-Frank Act. The Dodd-Frank 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). 
TILA section 129C(a); 15 U.S.C. 1639c(a). The Dodd-Frank Act provides 
special protection from liability for creditors who make ``qualified 
mortgages.'' TILA section 129C(b); 15 U.S.C. 1639c(b). The purpose of 
the Dodd-Frank Act ability-to-repay requirement is to assure that 
consumers are offered and receive residential mortgage loans on terms 
that reasonably reflect their ability to repay the loans and that are 
understandable and not unfair, deceptive or abusive. TILA section 
129B(a)(2); 15 U.S.C. 1639b(a)(2). Prior to the Dodd-Frank Act, 
existing Regulation Z provided ability-to-repay requirements for high-
cost and higher-priced mortgage loans. The Dodd-Frank Act expanded the 
scope of the ability-to-repay requirement to cover all residential 
mortgage loans.
    The final rule establishes standards for complying with the 
ability-to-repay requirement, including defining ``qualified 
mortgage.'' The final rule provides three options for originating a 
qualified mortgage: under the general definition in Sec.  
1026.43(e)(2), for loans where the consumer's monthly debt-to-income 
ratio do not exceed 43 percent; under the definition Sec.  
1026.43(e)(4), for a maximum of seven years, for loans that are 
eligible for purchase by the GSEs while in conservatorship or certain 
other Federal agencies, and under Sec.  1026.43(f), for loans that have 
a balloon-payment if the creditor operates predominantly in rural or 
underserved areas and meets certain underwriting requirements, and 
asset-size and transaction volume limits.
    In addition to the ability-to-repay and qualified mortgage 
provisions, the final rule implements the Dodd-Frank Act limits on 
prepayment penalties and lengthens the time creditors must retain 
records that evidence compliance with the ability-to-repay and 
prepayment penalty provisions. Currently, Regulation Z requires 
creditors to retain evidence of compliance for two years after 
disclosures must be made or action must be taken. The final rule amends 
Regulation Z to require creditors to retain evidence of compliance with 
the ability-to-repay/qualified mortgage provisions and prepayment 
penalty restrictions in Sec.  1026.43 for three years after 
consummation for consistency with statute of limitations on claims 
under TILA section 129C. See generally the section-by-section analysis 
of Sec. Sec.  1026.25 and 1026.43, above.
    The information collection in the final rule is required to provide 
benefits for consumers and would be mandatory. See 15 U.S.C. 1601 et 
seq.; 12 U.S.C. 2601 et seq. Because the Bureau does not collect any 
information under the final rule, no issue of confidentiality arises. 
The likely respondents would be depository institutions (i.e., 
commercial banks/savings institutions and credit unions) and non-
depository institutions (i.e., mortgage companies or other non-bank 
lenders) subject to Regulation Z.\244\
---------------------------------------------------------------------------

    \244\ For purposes of this PRA analysis, references to 
``creditors'' or ``lenders'' shall be deemed to refer collectively 
to commercial banks, savings institutions, credit unions, and 
mortgage companies (i.e., non-depository lenders), unless otherwise 
stated. Moreover, reference to ``respondents'' shall generally mean 
all categories of entities identified in the sentence to which this 
footnote is appended, except as otherwise stated or if the context 
indicates otherwise.
---------------------------------------------------------------------------

    Under the final rule, the Bureau generally accounts for the 
paperwork burden associated with Regulation Z for the following 
respondents pursuant to its administrative enforcement authority: 
insured depository institutions with more than $10 billion in total 
assets, their depository institution affiliates, and certain 
nondepository lenders. The Bureau and the FTC generally both have 
enforcement authority over non-depository institutions for Regulation 
Z. Accordingly, the Bureau has allocated to itself half of the 
estimated burden to non-depository institutions. Other Federal agencies 
are responsible for estimating and reporting to OMB the total paperwork 
burden for the institutions for which they have administrative 
enforcement authority. They may, but are not required to, use the 
Bureau's burden estimation methodology.
    Using the Bureau's burden estimation methodology, the total 
estimated burden under the changes to Regulation Z for all of the 
nearly 14,300 institutions subject to the final rule, including

[[Page 6582]]

Bureau respondents,\245\ would be approximately 14,300 hours for one-
time changes. The aggregate estimates of total burdens presented in 
this part VIII are based on estimated costs that are weighted averages 
across respondents. The Bureau expects that the amount of time required 
to implement each of the changes for a given institution may vary based 
on the size, complexity, and practices of the respondent.
---------------------------------------------------------------------------

    \245\ There are 153 depository institutions (and their 
depository affiliates) that are subject to the Bureau's 
administrative enforcement authority. In addition there are 146 
privately insured credit unions that are subject to the Bureau's 
administrative enforcement authority. For purposes of this PRA 
analysis, the Bureau's respondents under Regulation Z are 135 
depository institutions that originate either open or closed-end 
mortgages; 77 privately insured credit unions that originate either 
open or closed-end mortgages; and an estimated 2,787 non-depository 
institutions that are subject to the Bureau's administrative 
enforcement authority. Unless otherwise specified, all references to 
burden hours and costs for the Bureau respondents for the collection 
under Regulation Z are based on a calculation that includes one half 
of burden for the estimated 2,787 nondepository institutions and 77 
privately insured credit unions.
---------------------------------------------------------------------------

B. Information Collection Requirements

    The Bureau believes the following aspects of the final rule would 
be information collection requirements under the PRA.
1. Ability-To-Repay Verification and Documentation Requirements
    Section 1026.43(c)(2) of the final rule contains eight specific 
criteria that a creditor must consider in assessing a consumer's 
repayment ability. Section 1026.43(c)(3) of the final rule requires 
creditors originating residential mortgage loans to verify the 
information that the creditor relies on in determining a consumer's 
repayment ability under Sec.  1026.43(c)(2) using reasonably reliable 
third-party records. Section 1026.43(c)(4) of the final rule provides 
special rules for verification of a consumer's income or assets, and 
provides examples of records that can be used to verify the consumer's 
income or assets (for example, tax-return and payroll transcripts).
    If a creditor chooses to make a qualified mortgage, different 
verification requirements apply to qualified mortgages. Creditors that 
originate qualified mortgages under Sec.  1026.43(e)(2) or (f) must 
verify a consumer's income or assets, and current debt obligations, 
alimony and child support and must also verify a consumer's monthly 
debt-to-income ratio (or, in the case of qualified mortgages under 
Sec.  1026.43(f), residual income). The final rule does not contain 
specific verification requirements for creditors originating qualified 
mortgages under Sec.  1026.43(e)(4); however, such loans must comply 
with eligibility requirements (including underwriting requirements) of 
the GSEs or the Federal agency program applicable to the loan.
    The Bureau estimates one-time and ongoing costs to respondents of 
complying with the requirements in Sec.  1026.43 as follows.
    One-time costs. The Bureau estimates that covered persons will 
incur one-time costs associated with reviewing the final rule. 
Specifically, the Bureau estimates that, for each covered person, one 
attorney and one compliance officer will each take 21 minutes (42 
minutes in total) to read and review the sections of the Federal 
Register that describe the verification and documentation requirements, 
based on the length of the sections.
    The Bureau estimates the one-time costs to the 135 depository 
institutions (including their depository affiliates) that are mortgage 
originator respondents of the Bureau under Regulation Z would be 
$7,700, or 94 hours. For the estimated 2,787 nondepository institutions 
and 77 privately insured credit unions that are subject to the Bureau's 
administrative enforcement authority, the Bureau is taking the half the 
burden for purposes of this PRA analysis. Accordingly, the Bureau 
estimates the total one-time costs across all relevant providers of 
reviewing the relevant sections of the Federal Register to be about 
1000 hours or roughly $81,000.
    Ongoing costs. The Bureau does not believe that the verification 
and documentation requirements of the final rule will result in 
additional ongoing costs for most covered persons. The Bureau 
understands that creditors generally have in place underwriting 
policies, procedures, and internal controls that require verification 
of the consumer's reasonably expected income or assets, employment 
status, debt obligations and simultaneous loans, credit history, and 
debt-to-income or residual income. Notably, in response to the 2011 ATR 
Proposal, commenters stated that most creditors today are already 
complying with the full ability-to-repay underwriting standards. For 
these institutions, there would be no additional burden as a result of 
the verification requirements in the final rule, since those 
institutions collect the required information in the normal course of 
business.
2. Record Retention Requirement
    The final rule imposes new record retention requirements on covered 
persons. As discussed above in part V, the final rule requires 
creditors to retain evidence of compliance with Sec.  1026.43 
(containing the ability-to-repay/qualified mortgage provisions and 
prepayment penalty restrictions) for three years after consummation. 
See part V above, section-by-section analysis of Sec.  1026.25.
    The Bureau estimates one-time and ongoing costs to respondents of 
complying with the record retention requirement in Sec.  1026.25 as 
follows.
    One-time costs. The Bureau estimates that covered persons will 
incur one-time costs associated with reviewing the final rule. 
Specifically, the Bureau estimates that, for each covered person, one 
attorney and one compliance officer will each take 9 minutes (18 
minutes in total) to read and review the sections of the final rule 
that describe the record retention requirements, based on the length of 
the sections.
    The Bureau estimates the one-time costs to the 135 depository 
institutions (including their depository affiliates) that are mortgage 
originator respondents of the Bureau under Regulation Z would be 
$3,300, or 40 hours. For the estimated 2,787 nondepository institutions 
and 77 privately insured credit unions that are subject to the Bureau's 
administrative enforcement authority, the Bureau is taking the half the 
burden for purposes of this PRA analysis. Accordingly, the Bureau 
estimates the total one-time costs across all relevant providers of 
reviewing the relevant sections of the Federal Register to be about 430 
hours or roughly $35,000.
    Ongoing costs. The Bureau believes that any burden associated with 
the final rule's record keeping requirement will be minimal or de 
minimis. Under current rules, creditors must retain evidence of 
compliance with Regulation Z for two years after consummation; the 
final rule extends that period to three years after consummation for 
evidence of compliance with the ability-to-repay/qualified mortgage 
provisions and the prepayment penalty limitations in this final rule. 
The final rule clarifies that creditors need retain only enough 
information to reconstruct the required records.
    The final rule clarifies that creditors need not maintain actual 
paper copies of the documentation used to underwrite a transaction. See 
comments 25(a)(2) and 25(c)(3)-1. For most covered persons, the 
required records will be kept in electronic form. This further reduces 
any burden associated with the final rule's record retention 
requirement for creditors that keep the required records in electronic 
form, as the only additional requirement will be to store data for an 
additional year, to

[[Page 6583]]

the extent such creditors are currently storing such data for the 
minimum period required by Regulation Z.
    Furthermore, the Bureau believes that many creditors will retain 
such records for at least three years in the ordinary course of 
business, even in the absence of a change to record retention 
requirements, due to the Dodd-Frank Act's extension of the statute of 
limitations for civil liability for violations of the prepayment 
penalty provisions or ability-to-repay provisions (including the 
qualified mortgage provisions) to three years after the date of a 
violation. Even absent the rule, the Bureau believes that most 
creditors will retain records of compliance with Sec.  1026.43 for the 
life of the loan, given that the statute allows borrowers to bring a 
defensive claim for recoupment or setoff in the event that a creditor 
or assignee initiates foreclosure proceedings.

C. Summary of Burden Hours

    The below table summarizes the one time and annual burdens under 
Regulation Z associated with information collections affected by the 
final rule for Bureau respondents under the PRA. For the two 
collections, the one-time burden for Bureau respondents is 
approximately 1,570 hours.
    The Consumer Financial Protection Bureau has a continuing interest 
in the public's opinions of our collections of information. At any 
time, comments regarding the burden estimate, or any other aspect of 
this collection of information, including suggestions for reducing the 
burden, may be sent to:
    The Consumer Financial Protection Bureau (Attention: PRA Office), 
1700 G Street NW., Washington, DC, 20552, or by the internet to [email protected].

List of Subjects in 12 CFR Part 1026

    Advertising, Consumer protection, Mortgages, Reporting and 
recordkeeping requirements, Truth in Lending.

Authority and Issuance

    For the reasons set forth in the preamble, the Bureau amends 
Regulation Z, 12 CFR part 1026, as set forth below:

PART 1026--TRUTH IN LENDING (REGULATION Z)

0
1. The authority citation for part 1026 continues to read as follows:

    Authority: 12 U.S.C. 2601; 2603-2605, 2607, 2609, 2617, 5511, 
5512, 5532, 5581; 15 U.S.C. 1601 et seq.

Subpart D--Miscellaneous

0
2. Section 1026.25 is amended by:
0
A. Revising paragraph (a); and
0
B. Adding and reserving paragraphs (c)(1) and (c)(2).
0
C. Adding paragraph (c)(3).
    The additions and revisions read as follows:


Sec.  1026.25  Record retention.

    (a) General rule. A creditor shall retain evidence of compliance 
with this regulation, other than advertising requirements under 
Sec. Sec.  1026.16 and 1026.24 and certain requirements for mortgage 
loans under paragraph (c) of this section, for two 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 a creditor under their jurisdictions to retain records for 
a longer period if necessary to carry out their enforcement 
responsibilities under section 108 of the Act.
* * * * *
    (c) Records related to certain requirements for mortgage loans. (1) 
[Reserved]
    (2) [Reserved]
    (3) Records related to minimum standards for transactions secured 
by a dwelling. Notwithstanding paragraph (a) of this section, a 
creditor shall retain evidence of compliance with Sec.  1026.43 of this 
regulation for three years after consummation of a transaction covered 
by that section.

Subpart E--Special Rules for Certain Home Mortgage Transactions

0
3. Section 1026.32 is amended by:
0
A. Revising the section heading;
0
B. Revising paragraph (b)(1);
0
C. Removing and reserving paragraph (b)(2);
0
D. Adding paragraph (b)(3) through (6)
    The additions and revisions read as follows:


Sec.  1026.32  Requirements for high-cost mortgages.

* * * * *
    (b) Definitions. For purposes of this subpart, the following 
definitions apply:
    (1) In connection with a closed-end credit transaction, points and 
fees means the following fees or charges that are known at or before 
consummation:
    (i) All items included in the finance charge under Sec.  1026.4(a) 
and (b), except that the following items are excluded:
    (A) Interest or the time-price differential;
    (B) Any premium or other charge imposed in connection with any 
Federal or State agency program for any guaranty or insurance that 
protects the creditor against the consumer's default or other credit 
loss;
    (C) For any guaranty or insurance that protects the creditor 
against the consumer's default or other credit loss and that is not in 
connection with any Federal or State agency program:
    (1) If the premium or other charge is payable after consummation, 
the entire amount of such premium or other charge; or
    (2) If the premium or other charge is payable at or before 
consummation, the portion of any such premium or other charge that is 
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;
    (D) 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 paragraph 
(b)(1)(i)(C), (iii), or (iv) of this section;
    (E) Up to two bona fide discount points paid by the consumer in 
connection with the transaction, if the interest rate without any 
discount does not exceed:
    (1) The average prime offer rate, as defined in Sec.  
1026.35(a)(2), by more than one percentage point; or
    (2) For purposes of paragraph (a)(1)(ii) of this section, for 
transactions that are secured by personal property, the average rate 
for a loan insured under Title I of the National Housing Act (12 U.S.C. 
1702 et seq.) by more than one percentage point; and
    (F) If no discount points have been excluded under paragraph 
(b)(1)(i)(E) of this section, then up to one bona fide discount point 
paid by the consumer in connection with the transaction, if the 
interest rate without any discount does not exceed:
    (1) The average prime offer rate, as defined in Sec.  
1026.35(a)(2), by more than two percentage points; or
    (2) For purposes of paragraph (a)(1)(ii) of this section, for 
transactions that are secured by personal property, the average rate 
for a loan insured under Title I of the National Housing Act (12 U.S.C. 
1702 et seq.) by more than two percentage points;
    (ii) All compensation paid directly or indirectly by a consumer or 
creditor to a loan originator, as defined in Sec.  1026.36(a)(1), that 
can be attributed to

[[Page 6584]]

that transaction at the time the interest rate is set;
    (iii) All items listed in Sec.  1026.4(c)(7) (other than amounts 
held for future payment of taxes), unless:
    (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;
    (iv) Premiums or other charges payable at or before consummation 
for any credit life, credit disability, credit unemployment, or credit 
property insurance, or any other life, accident, health, or loss-of-
income insurance for which the creditor is a beneficiary, or any 
payments directly or indirectly for any debt cancellation or suspension 
agreement or contract;
    (v) The maximum prepayment penalty, as defined in paragraph 
(b)(6)(i) of this section, that may be charged or collected under the 
terms of the mortgage loan; and
    (vi) The total prepayment penalty, as defined in paragraph 
(b)(6)(i) of this section, incurred by the consumer if the consumer 
refinances the existing mortgage loan with the current holder of the 
existing loan, a servicer acting on behalf of the current holder, or an 
affiliate of either.
    (2) [Reserved]
    (3) Bona fide discount point--(i) Closed-end credit. The term bona 
fide discount point means an amount equal to 1 percent of the loan 
amount paid by the consumer that reduces the interest rate or time-
price differential applicable to the transaction 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.
    (ii) [Reserved]
    (4) Total loan amount--(i) Closed-end credit. The total loan amount 
for a closed-end credit transaction is calculated by taking the amount 
financed, as determined according to Sec.  1026.18(b), and deducting 
any cost listed in Sec.  1026.32(b)(1)(iii), (iv), or (vi) that is both 
included as points and fees under Sec.  1026.32(b)(1) and financed by 
the creditor.
    (ii) [Reserved]
    (5) 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.).
    (6) Prepayment penalty--(i) Closed-end credit transactions. For a 
closed-end credit transaction, prepayment penalty means a charge 
imposed for paying all or part of the transaction's principal before 
the date on which the principal is due, other than a waived, bona fide 
third-party charge that the creditor imposes if the consumer prepays 
all of the transaction's principal sooner than 36 months after 
consummation, provided, however, that interest charged consistent with 
the monthly interest accrual amortization method is not a prepayment 
penalty for extensions of credit insured by the Federal Housing 
Administration that are consummated before January 21, 2015.
    (ii) [Reserved]
* * * * *
0
4. Add Sec.  1026.43 to read as follows:


Sec.  1026.43  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.  1026.2(a)(19), 
including any real property attached to a dwelling, other than:
    (1) A home equity line of credit subject to Sec.  1026.40;
    (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.  1026.33;
    (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; or
    (iii) A construction phase of 12 months or less of a construction-
to-permanent loan.
    (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.  1026.2(a)(19), including any 
real property attached to a dwelling, 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 that will apply after recast, as determined 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.  1026.18(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; premiums and 
similar charges identified in Sec.  1026.4(b)(5), (7), (8), and (10) 
that are required by the creditor; fees and special assessments imposed 
by a condominium, cooperative, or homeowners association; ground rent; 
and leasehold payments.
    (9) Points and fees has the same meaning as in Sec.  1026.32(b)(1).
    (10) Prepayment penalty has the same meaning as in Sec.  
1026.32(b)(6).
    (11) Recast means:
    (i) For an adjustable-rate mortgage, as defined in Sec.  
1026.18(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.  
1026.18(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.  
1026.18(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.  1026.40 that will be secured by 
the same dwelling and made to the same consumer at or before 
consummation of the covered transaction or, if to be made after 
consummation, will cover closing costs of the first covered 
transaction.
    (13) Third-party record means:

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    (i) A document or other record prepared or reviewed by an 
appropriate person other than the consumer, the creditor, or the 
mortgage broker, as defined in Sec.  1026.36(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.
    (c) Repayment ability--(1) General requirement. A creditor shall 
not make a loan that is 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 to repay the loan 
according to its terms.
    (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, including any real property 
attached to 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, alimony, and child 
support;
    (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 
the information that the creditor relies on in determining a consumer's 
repayment ability under Sec.  1026.43(c)(2) using reasonably reliable 
third-party records, except that:
    (i) For purposes of paragraph (c)(2)(i) of this section, a creditor 
must verify a consumer's income or assets that the creditor relies on 
in accordance with Sec.  1026.43(c)(4);
    (ii) 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
    (iii) 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 an obligation.
    (4) Verification of income or assets. A creditor must verify the 
amounts of income or assets that the creditor relies on under Sec.  
1026.43(c)(2)(i) 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 IRS 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 
consideration required under paragraph (c)(2)(iii) of this section 
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 
consideration required under paragraph (c)(2)(iii) of this section for:
    (A) A loan with a balloon payment, as defined in Sec.  
1026.18(s)(5)(i), using:
    (1) The maximum payment scheduled during the first five years after 
the date on which the first regular periodic payment will be due 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.  1026.18(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.  
1026.18(s)(7)(v), 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 evaluation required under paragraph (c)(2)(iv) of this 
section, a creditor must consider, taking into account any mortgage-
related obligations, a consumer's payment on a simultaneous loan that 
is:
    (i) A covered transaction, by following paragraph (c)(5)of this 
section; or
    (ii) A home equity line of credit subject to Sec.  1026.40, by 
using the periodic payment required under the terms of the plan and the 
amount of credit to be drawn at or before consummation of the covered 
transaction.
    (7) Monthly debt-to-income ratio or residual income--(i) 
Definitions. For purposes of this paragraph (c)(7), 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, 
alimony, and child support, 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

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expected income, including any income from assets, as required by 
paragraphs (c)(2)(i) and (c)(4) of this section.
    (ii) Calculations-- (A) Monthly debt-to-income ratio. If a creditor 
considers 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 the consumer's total 
monthly income.
    (B) Monthly residual income. If a creditor considers 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 
consumer's total monthly income.
    (d) Refinancing of non-standard mortgages--(1) 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.  
1026.18(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.  1026.18(s)(7)(iv); 
or
    (C) A negative amortization loan, as defined in Sec.  
1026.18(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.  
1026.18(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.  1026.20(a).
    (2) 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;
    (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 no later than two months after the non-standard 
mortgage has recast.
    (iv) The consumer has made no more than one payment more than 30 
days late on the non-standard mortgage during the 12 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; and
    (vi) If the non-standard mortgage was consummated on or after 
January 10, 2014, the non-standard mortgage was made in accordance with 
paragraph (c) or (e) of this section, as applicable.
    (3) Exemption from repayment ability requirements. A creditor is 
not required to comply with the requirements of paragraph (c) of this 
section if:
    (i) The conditions in paragraph (d)(2) of this section are met; and
    (ii) The creditor has considered whether the standard mortgage 
likely will prevent a default by the consumer on the non-standard 
mortgage once the loan is recast.
    (4) Offer of rate discounts and other favorable terms. A creditor 
making a covered transaction under this paragraph (d) may offer to the 
consumer rate discounts and terms that are the same as, or better than, 
the 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. For purposes of the comparison conducted 
pursuant to paragraph (d)(2)(ii) of this section, the creditor must 
calculate the monthly payment for a non-standard mortgage 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)(1)(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)(1)(i)(B) 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; or
    (3) For a negative amortization loan under paragraph (d)(1)(i)(C) 
of this section, the maximum loan amount, determined after adjusting 
for the outstanding principal balance.
    (ii) Standard mortgage. For purposes of the comparison conducted 
pursuant to paragraph (d)(2)(ii) of this section, 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--(1) Safe harbor and presumption of 
compliance--(i) Safe harbor for transactions that are not higher-priced 
covered transactions. A creditor or assignee of a qualified mortgage, 
as defined in paragraphs (e)(2), (e)(4), or (f) of this section, that 
is not a higher-priced covered transaction, as defined in paragraph 
(b)(4) of this section, complies with the repayment ability 
requirements of paragraph (c) of this section.
    (ii) Presumption of compliance for higher-priced covered 
transactions. (A) A creditor or assignee of a qualified mortgage, as 
defined in paragraphs (e)(2), (e)(4), or (f) of this section, that is a 
higher-priced covered transaction, as

[[Page 6587]]

defined in paragraph (b)(4) of this section, is presumed to comply with 
the repayment ability requirements of paragraph (c) of this section.
    (B) To rebut the presumption of compliance described in paragraph 
(e)(1)(ii)(A) of this section, it must be proven that, despite meeting 
the requirements of paragraphs (e)(2), (e)(4), or (f) of this section, 
the creditor did not make a reasonable and good faith determination of 
the consumer's repayment ability at the time of consummation, by 
showing that the consumer's income, debt obligations, alimony, child 
support, and the consumer's monthly payment (including mortgage-related 
obligations) on the covered transaction and on any simultaneous loans 
of which the creditor was aware at consummation would leave the 
consumer with insufficient residual income or assets other than the 
value of the dwelling (including any real property attached to the 
dwelling) that secures the loan with which to meet living expenses, 
including any recurring and material non-debt obligations of which the 
creditor was aware at the time of consummation.
    (2) Qualified mortgage defined--general. Except as provided in 
paragraphs (e)(4) or (f) of this section, a qualified mortgage is a 
covered transaction:
    (i) That provides for regular periodic payments that are 
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, 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.  
1026.18(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 the monthly payment for mortgage-related obligations, using:
    (A) The maximum interest rate that may apply during the first five 
years after the date on which the first regular periodic payment will 
be due; 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, 
assuming the consumer will have made all required payments as due prior 
to that date; or
    (2) The loan amount over the loan term;
    (v) For which the creditor considers and verifies at or before 
consummation the following:
    (A) The consumer's current or reasonably expected income or assets 
other than the value of the dwelling (including any real property 
attached to the dwelling) that secures the loan, in accordance with 
appendix Q and paragraphs (c)(2)(i) and (c)(4) of this section; and
    (B) The consumer's current debt obligations, alimony, and child 
support in accordance with appendix Q and paragraphs (c)(2)(vi) and 
(c)(3) of this section; and
    (vi) For which the ratio of the consumer's total monthly debt to 
total monthly income at the time of consummation does not exceed 43 
percent. For purposes of this paragraph (e)(2)(vi), the ratio of the 
consumer's total monthly debt to total monthly income is determined:
    (A) Except as provided in paragraph (e)(2)(vi)(B) of this section, 
in accordance with the standards in appendix Q;
    (B) Using the consumer's monthly payment on:
    (1) The covered transaction, including the monthly payment for 
mortgage-related obligations, in accordance with paragraph (e)(2)(iv) 
of this section; and
    (2) 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.
    (3) Limits on points and fees for qualified mortgages. (i) A 
covered transaction is not a qualified mortgage unless the 
transaction's total points and fees, as defined in Sec.  1026.32(b)(1), 
do not exceed:
    (A) For a loan amount greater than or equal to $100,000 (indexed 
for inflation): 3 percent of the total loan amount;
    (B) For a loan amount greater than or equal to $60,000 (indexed for 
inflation) but less than $100,000 (indexed for inflation): $3,000 
(indexed for inflation);
    (C) For a loan amount greater than or equal to $20,000 (indexed for 
inflation) but less than $60,000 (indexed for inflation): 5 percent of 
the total loan amount;
    (D) For a loan amount greater than or equal to $12,500 (indexed for 
inflation) but less than $20,000 (indexed for inflation): $1,000 
(indexed for inflation);
    (E) For a loan amount less than $12,500 (indexed for inflation): 8 
percent of the total loan amount.
    (ii) The dollar amounts, including the loan amounts, in paragraph 
(e)(3)(i) of this section shall be adjusted annually on January 1 by 
the annual percentage change in the Consumer Price Index for All Urban 
Consumers (CPI-U) that was reported on the preceding June 1. See the 
official commentary to this paragraph (e)(3)(ii) for the current dollar 
amounts.
    (4) Qualified mortgage defined--special rules--(i) General. 
Notwithstanding paragraph (e)(2) of this section, a qualified mortgage 
is a covered transaction that satisfies:
    (A) The requirements of paragraphs (e)(2)(i) through (iii) of this 
section; and
    (B) One or more of the criteria in paragraph (e)(4)(ii) of this 
section.
    (ii) Eligible loans. A qualified mortgage under this paragraph 
(e)(4) must be one of the following at consummation:
    (A) A loan that is eligible:
    (1) To be purchased or guaranteed by the Federal National Mortgage 
Association or the Federal Home Loan Mortgage Corporation operating 
under the conservatorship or receivership of the Federal Housing 
Finance Agency pursuant to section 1367(a) of the Federal Housing 
Enterprises Financial Safety and Soundness Act of 1992 (12 U.S.C. 
4617(a)); or
    (2) To be purchased or guaranteed by any limited-life regulatory 
entity succeeding the charter of either the Federal National Mortgage 
Association or the Federal Home Loan Mortgage Corporation pursuant to 
section 1367(i) of the Federal Housing Enterprises Financial Safety and 
Soundness Act of 1992 (12 U.S.C. 4617(i));
    (B) A loan that is eligible to be insured by the U.S. Department of 
Housing and Urban Development under the National Housing Act (12 U.S.C. 
1707 et seq.);
    (C) A loan that is eligible to be guaranteed the U.S. Department of 
Veterans Affairs;
    (D) A loan that is eligible to be guaranteed by the U.S. Department 
of Agriculture pursuant to 42 U.S.C. 1472(h); or
    (E) A loan that is eligible to be insured by the Rural Housing 
Service.
    (iii) Sunset of special rules. (A) Each respective special rule 
described in paragraph (e)(4)(ii)(B), (C), (D), or (E) of this section 
shall expire on the effective date of a rule issued by each respective

[[Page 6588]]

agency pursuant to its authority under TILA section 129C(b)(3)(ii) to 
define a qualified mortgage.
    (B) Unless otherwise expired under paragraph (e)(4)(iii)(A) of this 
section, the special rules in this paragraph (e)(4) are available only 
for covered transactions consummated on or before January 10, 2021.
    (f) Balloon-payment qualified mortgages made by certain creditors--
(1) Exemption. Notwithstanding paragraph (e)(2) of this section, a 
qualified mortgage may provide for a balloon payment, provided:
    (i) The loan satisfies the requirements for a qualified mortgage in 
paragraphs (e)(2)(i)(A), (e)(2)(ii), (e)(2)(iii), and (e)(2)(v) of this 
section, but without regard to the standards in appendix Q;
    (ii) The creditor determines at or before consummation that the 
consumer can make all of the scheduled payments under the terms of the 
legal obligation, as described in paragraph (f)(1)(iv) of this section, 
together with the consumer's monthly payments for all mortgage-related 
obligations and excluding the balloon payment, from the consumer's 
current or reasonably expected income or assets other than the dwelling 
that secures the loan;
    (iii) The creditor considers at or before consummation the 
consumer's monthly debt-to-income ratio or residual income and verifies 
the debt obligations and income used to determine that ratio in 
accordance with paragraph (c)(7) of this section, except that the 
calculation of the payment on the covered transaction for purposes of 
determining the consumer's total monthly debt obligations in 
(c)(7)(i)(A) shall be determined in accordance with paragraph 
(f)(iv)(A) of this section, together with the consumer's monthly 
payments for all mortgage-related obligations and excluding the balloon 
payment;
    (iv) The legal obligation provides for:
    (A) Scheduled payments that are substantially equal, calculated 
using an amortization period that does not exceed 30 years;
    (B) An interest rate that does not increase over the term of the 
loan; and
    (C) A loan term of five years or longer.
    (v) The loan is not subject, at consummation, to a commitment to be 
acquired by another person, other than a person that satisfies the 
requirements of paragraph (f)(1)(vi) of this section; and
    (vi) The creditor satisfies the requirements stated in Sec.  
1026.35(b)(2)(iii)(A), (B), and (C).
    (2) Post-consummation transfer of balloon-payment qualified 
mortgage. A balloon-payment qualified mortgage, extended pursuant to 
paragraph (f)(1), immediately loses its status as a qualified mortgage 
under paragraph (f)(1) if legal title to the balloon-payment qualified 
mortgage is sold, assigned, or otherwise transferred to another person 
except when:
    (i) The balloon-payment qualified mortgage is sold, assigned, or 
otherwise transferred to another person three years or more after 
consummation of the balloon-payment qualified mortgage;
    (ii) The balloon-payment qualified mortgage is sold, assigned, or 
otherwise transferred to a creditor that satisfies the requirements of 
paragraph (f)(1)(vi) of this section;
    (iii) The balloon-payment qualified mortgage is sold, assigned, or 
otherwise transferred to another person pursuant to a capital 
restoration plan or other action under 12 U.S.C. 1831o, actions or 
instructions of any person acting as conservator, receiver or 
bankruptcy trustee, an order of a State or Federal governmental agency 
with jurisdiction to examine the creditor pursuant to State or Federal 
law, or an agreement between the creditor and such an agency; or
    (iv) The balloon-payment qualified mortgage is sold, assigned, or 
otherwise transferred pursuant to a merger of the creditor with another 
person or acquisition of the creditor by another person or of another 
person by the creditor.
    (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), (e)(4), or (f) 
of this section; and
    (C) Is not a higher-priced mortgage loan, as defined in Sec.  
1026.35(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) 2 percent, if incurred during the first two years following 
consummation; and
    (B) 1 percent, if incurred during the third year following 
consummation.
    (3) Alternative offer required. 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.  
1026.18(s)(7)(iii); or
    (B) Is a step-rate mortgage, as defined in Sec.  1026.18(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.  1026.36(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 
discount points and origination points or fees.
    (5) Creditor that is a loan originator. If the creditor is a loan 
originator, as defined in Sec.  1026.36(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

[[Page 6589]]

    (ii) Another person, if the transaction offered by the other person 
has a lower interest rate or a lower total dollar amount of origination 
discount points and points or fees.
    (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.  1026.2(a)(20), a creditor shall not structure the loan 
as an open-end plan to evade the requirements of this section.
    5. Reserved appendices N, O, and P are added, and appendix Q is 
added to read as follows:

Appendix N to Part 1026--[Reserved]

Appendix O to Part 1026--[Reserved]

Appendix P to Part 1026--[Reserved]

Appendix Q to Part 1026--Standards for Determining Monthly Debt and 
Income

    Section 1026.43(e)(2)(vi) provides that, to satisfy the 
requirements for a qualified mortgage under Sec.  1026.43(e)(2), the 
ratio of the consumer's total monthly debt to total monthly income 
at the time of consummation cannot exceed 43 percent. Section 
1026.43(e)(2)(vi)(A) requires the creditor to calculate the ratio of 
the consumer's total monthly debt to total monthly income using the 
following standards, with additional requirements for calculating 
debt and income appearing in Sec.  1026.43(e)(2)(vi)(B).

I. Consumer Eligibility

    A. Stability of Income.
    1. Effective Income. Income may not be used in calculating the 
consumer's income ratios if it comes from any source that cannot be 
verified, is not stable, or will not continue.
    2. Verifying Employment History.
    a. The creditor must verify the consumer's employment for the 
most recent two full years, and the consumer must:
    i. Explain any gaps in employment that span one or more months, 
and
    ii. Indicate if he/she was in school or the military for the 
recent two full years, providing evidence supporting this claim, 
such as college transcripts, or discharge papers.
    b. Allowances can be made for seasonal employment, typical for 
the building trades and agriculture, if documented by the creditor.

    Note: A consumer with a 25 percent or greater ownership interest 
in a business is considered self-employed and will be evaluated as a 
self-employed consumer for underwriting purposes.

    3. Analyzing a Consumer's Employment Record.
    a. When analyzing the probability of continued employment, 
creditors must examine:
    i. The consumer's past employment record;
    ii. Qualifications for the position;
    iii. Previous training and education; and
    iv. The employer's confirmation of continued employment.
    b. Favorably consider a consumer for a mortgage if he/she 
changes jobs frequently within the same line of work, but continues 
to advance in income or benefits. In this analysis, income stability 
takes precedence over job stability.
    4. Consumers Returning to Work After an Extended Absence. A 
consumer's income may be considered effective and stable when 
recently returning to work after an extended absence if he/she:
    a. Is employed in the current job for six months or longer; and
    b. Can document a two-year work history prior to an absence from 
employment using:
    i. Traditional employment verifications; and/or
    ii. Copies of IRS Form W-2s or pay stubs.

    Note: An acceptable employment situation includes individuals 
who took several years off from employment to raise children, then 
returned to the workforce.

    c. Important: Situations not meeting the criteria listed above 
may not be used in qualifying. Extended absence is defined as six 
months.
    B. Salary, Wage and Other Forms of Income.
    1. General Policy on Consumer Income Analysis.
    a. The income of each consumer who will be obligated for the 
mortgage debt must be analyzed to determine whether his/her income 
level can be reasonably expected to continue through at least the 
first three years of the mortgage loan.
    b. In most cases, a consumer's income is limited to salaries or 
wages. Income from other sources can be considered as effective, 
when properly verified and documented by the creditor.
    Notes:
    i. Effective income for consumers planning to retire during the 
first three-year period must include the amount of:
    a. Documented retirement benefits;
    b. Social Security payments; or
    c. Other payments expected to be received in retirement.
    ii. Creditors must not ask the consumer about possible, future 
maternity leave.
    2. Overtime and Bonus Income.
    a. Overtime and bonus income can be used to qualify the consumer 
if he/she has received this income for the past two years, and it 
will likely continue. If the employment verification states that the 
overtime and bonus income is unlikely to continue, it may not be 
used in qualifying.
    b. The creditor must develop an average of bonus or overtime 
income for the past two years. Periods of overtime and bonus income 
less than two years may be acceptable, provided the creditor can 
justify and document in writing the reason for using the income for 
qualifying purposes.
    3. Establishing an Overtime and Bonus Income Earning Trend.
    a. The creditor must establish and document an earnings trend 
for overtime and bonus income. If either type of income shows a 
continual decline, the creditor must document in writing a sound 
rationalization for including the income when qualifying the 
consumer.
    b. A period of more than two years must be used in calculating 
the average overtime and bonus income if the income varies 
significantly from year to year.
    4. Qualifying Part-Time Income.
    a. Part-time and seasonal income can be used to qualify the 
consumer if the creditor documents that the consumer has worked the 
part-time job uninterrupted for the past two years, and plans to 
continue. Many low and moderate income families rely on part-time 
and seasonal income for day to day needs, and creditors should not 
restrict consideration of such income when qualifying these 
consumers.
    b. Part-time income received for less than two years may be 
included as effective income, provided that the creditor justifies 
and documents that the income is likely to continue.
    c. Part-time income not meeting the qualifying requirements may 
not be used in qualifying.
    Note: For qualifying purposes, ``part-time'' income refers to 
employment taken to supplement the consumer's income from regular 
employment; part-time employment is not a primary job and it is 
worked less than 40 hours.
    5. Income from Seasonal Employment.
    a. Seasonal income is considered uninterrupted, and may be used 
to qualify the consumer, if the creditor documents that the 
consumer:
    i. Has worked the same job for the past two years, and
    ii. Expects to be rehired the next season.
    b. Seasonal employment includes:
    i. Umpiring baseball games in the summer; or
    ii. Working at a department store during the holiday shopping 
season.
    6. Primary Employment Less Than 40 Hour Work Week.
    a. When a consumer's primary employment is less than a typical 
40-hour work week, the creditor should evaluate the stability of 
that income as regular, on-going primary employment.
    b. Example: A registered nurse may have worked 24 hours per week 
for the last year. Although this job is less than the 40-hour work 
week, it is the consumer's primary employment, and should be 
considered effective income.
    7. Commission Income.
    a. Commission income must be averaged over the previous two 
years. To qualify commission income, the consumer must provide:
    i. Copies of signed tax returns for the last two years; and
    ii. The most recent pay stub.
    b. Consumers whose commission income was received for more than 
one year, but less than two years may be considered favorably if the 
underwriter can:

[[Page 6590]]

    i. Document the likelihood that the income will continue, and
    ii. Soundly rationalize accepting the commission income.
    Notes:
    i. Unreimbursed business expenses must be subtracted from gross 
income.
    ii. A commissioned consumer is one who receives more than 25 
percent of his/her annual income from commissions.
    iii. A tax transcript obtained directly from the IRS may be used 
in lieu of signed tax returns, and the cost of the transcript may be 
charged to the consumer.
    8. Qualifying Commission Income Earned for Less Than One Year.
    a. Commission income earned for less than one year is not 
considered effective income. Exceptions may be made for situations 
in which the consumer's compensation was changed from salary to 
commission within a similar position with the same employer.
    b. A consumer may also qualify when the portion of earnings not 
attributed to commissions would be sufficient to qualify the 
consumer for the mortgage.
    9. Employer Differential Payments. If the employer subsidizes a 
consumer's mortgage payment through direct payments, the amount of 
the payments:
    a. Is considered gross income, and
    b. Cannot be used to offset the mortgage payment directly, even 
if the employer pays the servicing creditor directly.
    10. Retirement Income. Retirement income must be verified from 
the former employer, or from Federal tax returns. If any retirement 
income, such as employer pensions or 401(k)'s, will cease within the 
first full three years of the mortgage loan, such income may not be 
used in qualifying.
    11. Social Security Income. Social Security income must be 
verified by the Social Security Administration or on Federal tax 
returns. If any benefits expire within the first full three years of 
the loan, the income source may not be used in qualifying.
    Notes:
    i. The creditor must obtain a complete copy of the current 
awards letter.
    ii. Not all Social Security income is for retirement-aged 
recipients; therefore, documented continuation is required.
    iii. Some portion of Social Security income may be ``grossed 
up'' if deemed nontaxable by the IRS.
    12. Automobile Allowances and Expense Account Payments.
    a. Only the amount by which the consumer's automobile allowance 
or expense account payments exceed actual expenditures may be 
considered income.
    b. To establish the amount to add to gross income, the consumer 
must provide the following:
    i. IRS Form 2106, Employee Business Expenses, for the previous 
two years; and
    ii. Employer verification that the payments will continue.
    c. If the consumer uses the standard per-mile rate in 
calculating automobile expenses, as opposed to the actual cost 
method, the portion that the IRS considers depreciation may be added 
back to income.
    d. Expenses that must be treated as recurring debt include:
    i. The consumer's monthly car payment; and
    ii. Any loss resulting from the calculation of the difference 
between the actual expenditures and the expense account allowance.
    C. Consumers Employed by a Family Owned Business.
    1. Income Documentation Requirement.
    In addition to normal employment verification, a consumer 
employed by a family owned business is required to provide evidence 
that he/she is not an owner of the business, which may include:
    a. Copies of signed personal tax returns, or
    b. A signed copy of the corporate tax return showing ownership 
percentage.
    Note: A tax transcript obtained directly from the IRS may be 
used in lieu of signed tax returns, and the cost of the transcript 
may be charged to the consumer.
    D. General Information on Self-Employed Consumers and Income 
Analysis.
    1. Definition: Self Employed Consumer. A consumer with a 25 
percent or greater ownership interest in a business is considered 
self-employed.
    2. Types of Business Structures. There are four basic types of 
business structures. They include:
    a. Sole proprietorships;
    b. Corporations;
    c. Limited liability or ``S'' corporations; and
    d. Partnerships.
    3. Minimum Length of Self Employment.
    a. Income from self-employment is considered stable, and 
effective, if the consumer has been self-employed for two or more 
years.
    b. Due to the high probability of failure during the first few 
years of a business, the requirements described in the table below 
are necessary for consumers who have been self-employed for less 
than two years.
[GRAPHIC] [TIFF OMITTED] TR30JA13.001

    4. General Documentation Requirements for Self Employed 
Consumers. Self-employed consumers must provide the following 
documentation:
    a. Signed, dated individual tax returns, with all applicable tax 
schedules for the most recent two years;
    b. For a corporation, ``S'' corporation, or partnership, signed 
copies of Federal business income tax returns for the last two 
years, with all applicable tax schedules;
    c. Year to date profit and loss (P&L) statement and balance 
sheet; and
    d. Business credit report for corporations and ``S'' 
corporations.
    5. Establishing a Consumer's Earnings Trend.
    a. When qualifying a consumer for a mortgage loan, the creditor 
must establish the consumer's earnings trend from the previous two 
years using the consumer's tax returns.
    b. If a consumer:
    i. Provides quarterly tax returns, the income analysis may 
include income through the period covered by the tax filings, or
    ii. Is not subject to quarterly tax returns, or does not file 
them, then the income shown on the P&L statement may be included in 
the analysis, provided the income stream based on the P&L is 
consistent with the previous years' earnings.
    c. If the P&L statements submitted for the current year show an 
income stream considerably greater than what is supported by the 
previous year's tax returns, the creditor must base the income 
analysis solely on the income verified through the tax returns.

[[Page 6591]]

    d. If the consumer's earnings trend for the previous two years 
is downward and the most recent tax return or P&L is less than the 
prior year's tax return, the consumer's most recent year's tax 
return or P&L must be used to calculate his/her income.
    6. Analyzing the Business's Financial Strength:
    a. To determine if the business is expected to generate 
sufficient income for the consumer's needs, the creditor must 
carefully analyze the business's financial strength, including the:
    i. Source of the business's income;
    ii. General economic outlook for similar businesses in the area.
    b. Annual earnings that are stable or increasing are acceptable, 
while businesses that show a significant decline in income over the 
analysis period are not acceptable.
    E. Income Analysis: Individual Tax Returns (IRS Form 1040).
    1. General Policy on Adjusting Income Based on a Review of IRS 
Form 1040. The amount shown on a consumer's IRS Form 1040 as 
adjusted gross income must either be increased or decreased based on 
the creditor's analysis of the individual tax return and any related 
tax schedules.
    2. Guidelines for Analyzing IRS Form 1040. The table below 
contains guidelines for analyzing IRS Form 1040:

[[Page 6592]]

[GRAPHIC] [TIFF OMITTED] TR30JA13.002

    F. Income Analysis: Corporate Tax Returns (IRS Form 1120).
    1. Description: Corporation. A corporation is a State-chartered 
business owned by its stockholders.
    2. Need To Obtain Consumer Percentage of Ownership Information.
    a. Corporate compensation to the officers, generally in 
proportion to the percentage of ownership, is shown on the:
    i. Corporate tax return IRS Form 1120; and
    ii. Individual tax returns.
    b. When a consumer's percentage of ownership does not appear on 
the tax returns, the creditor must obtain the

[[Page 6593]]

information from the corporation's accountant, along with evidence 
that the consumer has the right to any compensation.
    3. Analyzing Corporate Tax Returns.
    a. In order to determine a consumer's self-employed income from 
a corporation the adjusted business income must:
    i. Be determined; and
    ii. Multiplied by the consumer's percentage of ownership in the 
business.
    b. The table below describes the items found on IRS Form 1120 
for which an adjustment must be made in order to determine adjusted 
business income.
[GRAPHIC] [TIFF OMITTED] TR30JA13.003

    G. Income Analysis: ``S'' Corporation Tax Returns (IRS Form 
1120S).
    1. Description: ``S'' Corporation.
    a. An ``S'' corporation is generally a small, start-up business, 
with gains and losses passed to stockholders in proportion to each 
stockholder's percentage of business ownership.
    b. Income for owners of ``S'' corporations comes from IRS Form 
W-2 wages, and is taxed at the individual rate. The IRS Form 1120S, 
Compensation of Officers line item is transferred to the consumer's 
individual IRS Form 1040.
    2. Analyzing ``S'' Corporation Tax Returns.
    a. ``S'' corporation depreciation and depletion may be added 
back to income in proportion to the consumer's share of the 
corporation's income.
    b. In addition, the income must also be reduced proportionately 
by the total obligations payable by the corporation in less than one 
year.
    c. Important: The consumer's withdrawal of cash from the 
corporation may have a severe negative impact on the corporation's 
ability to continue operating, and must be considered in the income 
analysis.
    H. Income Analysis: Partnership Tax Returns (IRS Form 1065).
    1. Description: Partnership.
    a. A partnership is formed when two or more individuals form a 
business, and share in profits, losses, and responsibility for 
running the company.
    b. Each partner pays taxes on his/her proportionate share of the 
partnership's net income.
    2. Analyzing Partnership Tax Returns.
    a. Both general and limited partnerships report income on IRS 
Form 1065, and the partners' share of income is carried over to 
Schedule E of IRS Form 1040.
    b. The creditor must review IRS Form 1065 to assess the 
viability of the business. Both depreciation and depletion may be 
added back to the income in proportion to the consumer's share of 
income.
    c. Income must also be reduced proportionately by the total 
obligations payable by the partnership in less than one year.
    d. Important: Cash withdrawals from the partnership may have a 
severe negative impact on the partnership's ability to continue 
operating, and must be considered in the income analysis.

II. Non-Employment Related Consumer Income

    A. Alimony, Child Support, and Maintenance Income Criteria. 
Alimony, child support, or maintenance income may be considered 
effective, if:
    1. Payments are likely to be received consistently for the first 
three years of the mortgage;
    2. The consumer provides the required documentation, which 
includes a copy of the:
    i. Final divorce decree;
    ii. Legal separation agreement;
    iii. Court order; or
    iv. Voluntary payment agreement; and
    3. The consumer can provide acceptable evidence that payments 
have been received during the last 12 months, such as:
    i. Cancelled checks;
    ii. Deposit slips;
    iii. Tax returns; or
    iv. Court records.
    Notes:
    i. Periods less than 12 months may be acceptable, provided the 
creditor can adequately document the payer's ability and willingness 
to make timely payments.
    ii. Child support may be ``grossed up'' under the same 
provisions as non-taxable income sources.
    B. Investment and Trust Income.
    1. Analyzing Interest and Dividends.
    a. Interest and dividend income may be used as long as tax 
returns or account statements support a two-year receipt history. 
This income must be averaged over the two years.
    b. Subtract any funds that are derived from these sources, and 
are required for the cash investment, before calculating the 
projected interest or dividend income.
    2. Trust Income.
    a. Income from trusts may be used if guaranteed, constant 
payments will continue for at least the first three years of the 
mortgage term.
    b. Required trust income documentation includes a copy of the 
Trust Agreement or other trustee statement, confirming the:
    i. Amount of the trust;
    ii. Frequency of distribution; and
    iii. Duration of payments.
    c. Trust account funds may be used for the required cash 
investment if the consumer provides adequate documentation that the 
withdrawal of funds will not negatively affect income. The consumer 
may use funds from the trust account for the required cash 
investment, but the trust income used to determine repayment ability 
cannot be affected negatively by its use.
    3. Notes Receivable Income.
    a. In order to include notes receivable income to qualify a 
consumer, he/she must provide:
    i. A copy of the note to establish the amount and length of 
payment, and
    ii. Evidence that these payments have been consistently received 
for the last 12 months through deposit slips, cancelled checks, or 
tax returns.
    b. If the consumer is not the original payee on the note, the 
creditor must establish that the consumer is now a holder in due 
course, and able to enforce the note.
    4. Eligible Investment Properties.
    Follow the steps in the table below to calculate an investment 
property's income or loss if the property to be subject to a 
mortgage is an eligible investment property.

[[Page 6594]]

[GRAPHIC] [TIFF OMITTED] TR30JA13.004

    C. Military, Government Agency, and Assistance Program Income.
    1. Military Income.
    a. Military personnel not only receive base pay, but oftentimes 
are entitled to additional forms of pay, such as:
    i. Income from variable housing allowances;
    ii. Clothing allowances;
    iii. Flight or hazard pay;
    iv. Rations; and
    v. Proficiency pay.
    b. These types of additional pay are acceptable when analyzing a 
consumer's income as long as the probability of such pay to continue 
is verified in writing.
    Note: The tax-exempt nature of some of the above payments should 
also be considered.
    2. VA Benefits.
    a. Direct compensation for service-related disabilities from the 
Department of Veterans Affairs (VA) is acceptable, provided the 
creditor receives documentation from the VA.
    b. Education benefits used to offset education expenses are not 
acceptable.
    3. Government Assistance Programs.
    a. Income received from government assistance programs is 
acceptable as long as the paying agency provides documentation 
indicating that the income is expected to continue for at least 
three years.
    b. If the income from government assistance programs will not be 
received for at least three years, it may not be used in qualifying.
    c. Unemployment income must be documented for two years, and 
there must be reasonable assurance that this income will continue. 
This requirement may apply to seasonal employment.
    4. Mortgage Credit Certificates.
    a. If a government entity subsidizes the mortgage payments 
either through direct payments or tax rebates, these payments may be 
considered as acceptable income.
    b. Either type of subsidy may be added to gross income, or used 
directly to offset the mortgage payment, before calculating the 
qualifying ratios.
    5. Homeownership Subsidies.
    a. A monthly subsidy may be treated as income, if a consumer is 
receiving subsidies under the housing choice voucher home ownership 
option from a public housing agency (PHA). Although continuation of 
the homeownership voucher subsidy beyond the first year is subject 
to Congressional appropriation, for the purposes of underwriting, 
the subsidy will be assumed to continue for at least three years.
    b. If the consumer is receiving the subsidy directly, the amount 
received is treated as income. The amount received may also be 
treated as nontaxable income and be ``grossed up'' by 25 percent, 
which means that the amount of the subsidy, plus 25 percent of that 
subsidy may be added to the consumer's income from employment and/or 
other sources.
    c. Creditors may treat this subsidy as an ``offset'' to the 
monthly mortgage payment (that is, reduce the monthly mortgage 
payment by the amount of the home ownership assistance payment 
before dividing by the monthly income to determine the payment-to-
income and debt-to-income ratios). The subsidy payment must not pass 
through the consumer's hands.
    d. The assistance payment must be:
    i. Paid directly to the servicing creditor; or
    ii. Placed in an account that only the servicing creditor may 
access.
    Note: Assistance payments made directly to the consumer must be 
treated as income.
    D. Rental Income.
    1. Analyzing the Stability of Rental Income.
    a. Rent received for properties owned by the consumer is 
acceptable as long as the creditor can document the stability of the 
rental income through:
    i. A current lease;
    ii. An agreement to lease, or
    iii. A rental history over the previous 24 months that is free 
of unexplained gaps greater than three months (such gaps could be 
explained by student, seasonal, or military renters, or property 
rehabilitation).
    b. A separate schedule of real estate is not required for rental 
properties as long as all properties are documented on the Uniform 
Residential Loan Application.
    Note: The underwriting analysis may not consider rental income 
from any property being vacated by the consumer, except under the 
circumstances described below.
    2. Rental Income From Consumer Occupied Property.
    a. The rent for multiple unit property where the consumer 
resides in one or more units and charges rent to tenants of other 
units may be used for qualifying purposes.
    b. Projected rent for the tenant-occupied units only may:
    i. Be considered gross income, only after deducting vacancy and 
maintenance factors, and
    ii. Not be used as a direct offset to the mortgage payment.
    3. Income from Roommates in a Single Family Property.
    a. Income from roommates in a single family property occupied as 
the consumer's primary residence is not acceptable. Rental income 
from boarders however, is acceptable, if the boarders are related by 
blood, marriage, or law.
    b. The rental income may be considered effective, if shown on 
the consumer's tax return. If not on the tax return, rental income 
paid by the boarder may not be used in qualifying.
    4. Documentation Required To Verify Rental Income. Analysis of 
the following required documentation is necessary to verify all 
consumer rental income:
    a. IRS Form 1040 Schedule E; and
    b. Current leases/rental agreements.
    5. Analyzing IRS Form 1040 Schedule E.
    a. The IRS Form 1040 Schedule E is required to verify all rental 
income. Depreciation shown on Schedule E may be added back to the 
net income or loss.
    b. Positive rental income is considered gross income for 
qualifying purposes, while negative income must be treated as a 
recurring liability.
    c. The creditor must confirm that the consumer still owns each 
property listed, by comparing Schedule E with the real estate owned 
section of the URLA.
    6. Using Current Leases To Analyze Rental Income.
    a. The consumer can provide a current signed lease or other 
rental agreement for a property that was acquired since the last 
income tax filing, and is not shown on Schedule E.
    b. In order to calculate the rental income:
    i. Reduce the gross rental amount by 25 percent for vacancies 
and maintenance;
    ii. Subtract PITI and any homeowners association dues; and
    iii. Apply the resulting amount to income, if positive, or 
recurring debts, if negative.
    7. Exclusion of Rental Income From Property Being Vacated by the 
Consumer. Underwriters may not consider any rental income from a 
consumer's principal residence that is being vacated in favor of 
another principal residence, except under the conditions described 
below:
    Notes:
    i. This policy assures that a consumer either has sufficient 
income to make both mortgage payments without any rental

[[Page 6595]]

income, or has an equity position not likely to result in defaulting 
on the mortgage on the property being vacated.
    ii. This applies solely to a principal residence being vacated 
in favor of another principal residence. It does not apply to 
existing rental properties disclosed on the loan application and 
confirmed by tax returns (Schedule E of form IRS 1040).
    8. Policy Exceptions Regarding the Exclusion of Rental Income 
From a Principal Residence Being Vacated by a Consumer.
    When a consumer vacates a principal residence in favor of 
another principal residence, the rental income, reduced by the 
appropriate vacancy factor, may be considered in the underwriting 
analysis under the circumstances listed in the table below.
[GRAPHIC] [TIFF OMITTED] TR30JA13.005

    E. Non Taxable and Projected Income.
    1. Types of Non Taxable Income.
    Certain types of regular income may not be subject to Federal 
tax. Such types of nontaxable income include:
    a. Some portion of Social Security, some Federal government 
employee retirement income, Railroad Retirement Benefits, and some 
State government retirement income:
    b. Certain types of disability and public assistance payments;
    c. Child support;
    d. Military allowances; and
    e. Other income that is documented as being exempt from Federal 
income taxes.
    2. Adding Non Taxable Income to a Consumer's Gross Income.
    a. The amount of continuing tax savings attributed to regular 
income not subject to Federal taxes may be added to the consumer's 
gross income.
    b. The percentage of non-taxable income that may be added cannot 
exceed the appropriate tax rate for the income amount. Additional 
allowances for dependents are not acceptable.
    c. The creditor:
    i. Must document and support the amount of income grossed up for 
any non-taxable income source, and
    ii. Should use the tax rate used to calculate the consumer's 
last year's income tax.
    Note: If the consumer is not required to file a Federal tax 
return, the tax rate to use is 25 percent.
    3. Analyzing Projected Income.
    a. Projected or hypothetical income is not acceptable for 
qualifying purposes. However, exceptions are permitted for income 
from the following sources:
    i. Cost-of-living adjustments;
    ii. Performance raises; and
    iii. Bonuses.
    b. For the above exceptions to apply, the income must be:
    i. Verified in writing by the employer; and
    ii. Scheduled to begin within 60 days of loan closing.
    4. Project Income for New Job.
    a. Projected income is acceptable for qualifying purposes for a 
consumer scheduled to start a new job within 60 days of loan closing 
if there is a guaranteed, non-revocable contract for employment.
    b. The creditor must verify that the consumer will have 
sufficient income or cash reserves to support the mortgage payment 
and any other obligations between loan closing and the start of 
employment. Examples of this type of scenario are teachers whose 
contracts begin with the new school year, or physicians beginning a 
residency after the loan closes fall under this category.
    c. The loan is not eligible for endorsement if the loan closes 
more than 60 days before the consumer starts the new job. To be 
eligible for endorsement, the creditor must obtain from the consumer 
a pay stub or other acceptable evidence indicating that he/she has 
started the new job.

III. Consumer Liabilities: Recurring Obligations

    1. Types of Recurring Obligation. Recurring obligations include:
    a. All installment loans;
    b. Revolving charge accounts;
    c. Real estate loans;
    d. Alimony;
    e. Child support; and
    f. Other continuing obligations.
    2. Debt to Income Ratio Computation for Recurring Obligations.
    a. The creditor must include the following when computing the 
debt to income ratios for recurring obligations:
    i. Monthly housing expense; and
    ii. Additional recurring charges extending ten months or more, 
such as
    a. Payments on installment accounts;
    b. Child support or separate maintenance payments;
    c. Revolving accounts; and
    d. Alimony.
    b. Debts lasting less than ten months must be included if the 
amount of the debt affects the consumer's ability to pay the 
mortgage during the months immediately after loan closing, 
especially if the consumer will have limited or no cash assets after 
loan closing.

[[Page 6596]]

    Note: Monthly payments on revolving or open-ended accounts, 
regardless of the balance, are counted as a liability for qualifying 
purposes even if the account appears likely to be paid off within 10 
months or less.
    3. Revolving Account Monthly Payment Calculation. If the credit 
report shows any revolving accounts with an outstanding balance but 
no specific minimum monthly payment, the payment must be calculated 
as the greater of:
    a. 5 percent of the balance; or
    b. $10.
    Note: If the actual monthly payment is documented from the 
creditor or the creditor obtains a copy of the current statement 
reflecting the monthly payment, that amount may be used for 
qualifying purposes.
    4. Reduction of Alimony Payment for Qualifying Ratio 
Calculation. Since there are tax consequences of alimony payments, 
the creditor may choose to treat the monthly alimony obligation as a 
reduction from the consumer's gross income when calculating 
qualifying ratios, rather than treating it as a monthly obligation.

IV. Consumer Liabilities: Contingent Liability

    1. Definition: Contingent Liability. A contingent liability 
exists when an individual is held responsible for payment of a debt 
if another party, jointly or severally obligated, defaults on the 
payment.
    2. Application of Contingent Liability Policies. The contingent 
liability policies described in this topic apply unless the consumer 
can provide conclusive evidence from the debt holder that there is 
no possibility that the debt holder will pursue debt collection 
against him/her should the other party default.
    3. Contingent Liability on Mortgage Assumptions. Contingent 
liability must be considered when the consumer remains obligated on 
an outstanding FHA-insured, VA-guaranteed, or conventional mortgage 
secured by property that:
    a. Has been sold or traded within the last 12 months without a 
release of liability, or
    b. Is to be sold on assumption without a release of liability 
being obtained.
    4. Exemption From Contingent Liability Policy on Mortgage 
Assumptions. When a mortgage is assumed, contingent liabilities need 
not be considered if the:
    a. Originating creditor of the mortgage being underwritten 
obtains, from the servicer of the assumed loan, a payment history 
showing that the mortgage has been current during the previous 12 
months, or
    b. Value of the property, as established by an appraisal or the 
sales price on the HUD-1 Settlement Statement from the sale of the 
property, results in a loan-to-value (LTV) ratio of 75 percent or 
less.
    5. Contingent Liability on Cosigned Obligations.
    a. Contingent liability applies, and the debt must be included 
in the underwriting analysis, if an individual applying for a 
mortgage is a cosigner/co-obligor on:
    i. A car loan;
    ii. A student loan;
    iii. A mortgage; or
    iv. Any other obligation.
    b. If the creditor obtains documented proof that the primary 
obligor has been making regular payments during the previous 12 
months, and does not have a history of delinquent payments on the 
loan during that time, the payment does not have to be included in 
the consumer's monthly obligations.

V. Consumer Liabilities: Projected Obligations and Obligations Not 
Considered Debt

    1. Projected Obligations.
    a. Debt payments, such as a student loan or balloon-payment note 
scheduled to begin or come due within 12 months of the mortgage loan 
closing, must be included by the creditor as anticipated monthly 
obligations during the underwriting analysis.
    b. Debt payments do not have to be classified as projected 
obligations if the consumer provides written evidence that the debt 
will be deferred to a period outside the 12-month timeframe.
    c. Balloon-payment notes that come due within one year of loan 
closing must be considered in the underwriting analysis.
    2. Obligations Not Considered Debt. Obligations not considered 
debt, and therefore not subtracted from gross income, include:
    a. Federal, State, and local taxes;
    b. Federal Insurance Contributions Act (FICA) or other 
retirement contributions, such as 401(k) accounts (including 
repayment of debt secured by these funds):
    c. Commuting costs;
    d. Union dues;
    e. Open accounts with zero balances;
    f. Automatic deductions to savings accounts;
    g. Child care; and
    h. Voluntary deductions.
    6. In Supplement I to Part 1026--Official Interpretations:
    A. Under Section 1026.25--Record Retention:
    i. Under 25(a) General rule, paragraph 2 is revised.
    ii. Section 25(c) Records related to certain requirements for 
mortgage loans, 25(c)(3) Records related to minimum standards for 
transactions secured by a dwelling, and paragraphs 1 and 2 are 
added.
    B. The heading for Section 1026.32 is revised.
    C. Under revised Section 1026.32:
    i. Under 32(b) Definitions:
    a. Paragraph 32(b)(1) and paragraph 1 are added.
    b. Under Paragraph 32(b)(1)(i), paragraph 1 is revised.
    c. Paragraph 32(b)(1)(i)(B) and paragraph 1 are added.
    d. Paragraph 32(b)(1)(i)(C) and paragraphs 1 and 2 are added.
    e. Paragraph 32(b)(1)(i)(D) and paragraphs 1, 2, 3, and 4 are 
added.
    f. Paragraph 32(b)(1)(i)(E) and paragraphs 1, 2, and 3 are 
added.
    g. Paragraph 32(b)(1)(i)(F) and paragraphs 1 and 2 are added.
    h. Under Paragraph 32(b)(1)(ii), paragraphs 1 and 2 are revised 
and paragraphs 3 and 4 are added.
    i. Paragraph 32(b)(1)(iii) and paragraph 1 are added.
    j. Under Paragraph 32(b)(1)(iv), paragraph 1 is revised and 
paragraphs 2 and 3 are added.
    k. 32(b)(3) Bona fide discount point, 32(b)(3)(i) Closed-end 
credit, and paragraph 1 are added.
    l. 32(b)(4) Total loan amount, 32(b)(4)(i) Closed-end credit, 
and paragraph 1 are added.
    m. 32(b)(6) Prepayment penalty and paragraphs 1 and 2 are added.
    D. Section 1026.43--Minimum Standards for Transactions Secured 
by a Dwelling is added.
    The revisions and additions read as follows:

Supplement I to Part 1026--Official Interpretations

* * * * *

Subpart D--Miscellaneous

* * * * *

Section 1026.25--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 by any method that reproduces records accurately (including 
computer programs). Unless otherwise required, 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.
* * * * *
    25(c) Records related to certain requirements for mortgage 
loans.
    25(c)(3) Records related to minimum standards for transactions 
secured by a dwelling.
    1. Evidence of compliance with repayment ability provisions. A 
creditor must retain evidence of compliance with Sec.  1026.43 for 
three years after the date of consummation of a consumer credit 
transaction covered by that section. (See comment 25(c)-2 for 
guidance on the retention of evidence of compliance with the 
requirement to offer a consumer a loan without a prepayment penalty 
under Sec.  1026.43(g)(3).) If a creditor must verify and document 
information used in underwriting a transaction subject to Sec.  
1026.43, the creditor shall retain evidence sufficient to 
demonstrate compliance with the documentation requirements of the 
rule. Although a creditor need not retain actual paper copies of the 
documentation used in underwriting a transaction subject to Sec.  
1026.43, to comply with Sec.  1026.25(c)(3), the creditor must 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 must be able to 
reproduce the IRS Form W-2 itself, and

[[Page 6597]]

not merely the income information that was contained in the form.
    2. Dwelling-secured transactions and prepayment penalties. If a 
transaction covered by Sec.  1026.43 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.  
1026.43(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. If a 
creditor offers a transaction with a prepayment penalty to a 
consumer through a mortgage broker, to evidence compliance with 
Sec.  1026.43(g)(4) the creditor should retain evidence 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.  1026.43(g)(4)(ii).
* * * * *

Subpart E--Special Rules for Certain Home Mortgage Transactions

* * * * *

Section 1026.32--Requirements for High-Cost Mortgages

* * * * *
    32(b) Definitions.
    Paragraph 32(b)(1).
    1. Known at or before consummation. Section 1026.32(b)(1) 
includes in points and fees for closed-end credit transactions those 
items listed in Sec.  1026.32(b)(1)(i) through (vi) that are known 
at or before consummation. The following examples clarify how to 
determine whether a charge or fee is known at or before 
consummation.
    i. General. In general, a charge or fee is ``known at or before 
consummation'' if the creditor knows at or before consummation that 
the charge or fee will be imposed in connection with the 
transaction, even if the charge or fee is scheduled to be paid after 
consummation. Thus, for example, if the creditor charges the 
consumer $400 for an appraisal conducted by an affiliate of the 
creditor, the $400 is included in points and fees, even if the 
consumer finances it and repays it over the loan term, because the 
creditor knows at or before consummation that the charge or fee is 
imposed in connection with the transaction. By contrast, if a 
creditor does not know whether a charge or fee will be imposed, it 
is not included in points and fees. For example, charges or fees 
that the creditor may impose if the consumer seeks to modify a loan 
after consummation are not included in points and fees, because the 
creditor does not know at or before consummation whether the 
consumer will seek to modify the loan and therefore incur the fees 
or charges.
    ii. Prepayment penalties. Notwithstanding the guidance in 
comment 32(b)(1)-1.i, under Sec.  1026.32(b)(1)(v) the maximum 
prepayment penalty that may be charged or collected under the terms 
of the mortgage loan is included in points and fees because the 
amount of the maximum prepayment penalty that may be charged or 
collected is known at or before consummation.
    iii. Certain mortgage and credit insurance premiums. 
Notwithstanding the guidance in comment 32(b)(1)-1.i, under Sec.  
1026.32(b)(1)(i)(C)(1) and (iii) premiums and charges for private 
mortgage insurance and credit insurance that are payable after 
consummation are not included in points and fees, even if the 
amounts of such premiums and charges are known at or before 
consummation.
    Paragraph 32(b)(1)(i).
    1. General. Section 1026.32(b)(1)(i) includes in the total 
``points and fees'' items included in the finance charge under Sec.  
1026.4(a) and (b). However, certain items that may be included in 
the finance charge are excluded from points and fees under Sec.  
1026.32(b)(1)(i)(A) through (F). Items excluded from the finance 
charge under other provisions of Sec.  1026.4 are not included in 
the total points and fees under Sec.  1026.32(b)(1)(i), but may be 
included in points and fees under Sec.  1026.32(b)(1)(ii) through 
(vi). 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.  1026.4(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.  1026.4(c)(7) specifies that 
appraisal fees are not included in the finance charge. A fee imposed 
by the creditor for an appraisal performed by an employee of the 
creditor therefore would not be included in the finance charge and 
would not be counted in points and fees under Sec.  
1026.32(b)(1)(i). Section 1026.32(b)(1)(iii), however, expressly 
includes in points and fees items listed in Sec.  1026.4(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.
    Paragraph 32(b)(1)(i)(B).
    1. Federal and State mortgage insurance premiums and guaranty 
fees. Under Sec.  1026.32(b)(1)(i)(B), mortgage insurance premiums 
or guaranty fees in connection with a Federal or State agency 
program are excluded from points and fees, even though they are 
included in the finance charge under Sec.  1026.4(a) and (b). For 
example, if a consumer is required to pay a $2,000 mortgage 
insurance premium for a loan insured by the Federal Housing 
Administration, the $2,000 must be included in the finance charge 
but is not counted in points and fees. Similarly, if a consumer pays 
a 2 percent funding fee for a loan guaranteed by the U.S. Department 
of Veterans Affairs or through the U.S Department of Agriculture's 
Rural Development Single Family Housing Guaranteed Loan Program, the 
fee is included in the finance charge but is not included in points 
and fees.
    Paragraph 32(b)(1)(i)(C).
    1. Private mortgage insurance premiums. i. Payable after 
consummation. Under Sec.  1026.32(b)(1)(i)(C)(1), private mortgage 
insurance premiums payable after consummation are excluded from 
points and fees.
    ii. Payable at or before consummation. A. General. Under Sec.  
1026.32(b)(1)(i)(C)(2), private mortgage insurance premiums payable 
at or before consummation (i.e., single or up-front premiums) may be 
excluded from points and fees, even though they are included in the 
finance charge under Sec.  1026.4(a) and (b). However, the portion 
of the premium that 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)) is included in points 
and fees. To determine whether any portion of the premium exceeds 
the amount payable under policies in effect at the time of 
origination under section 203(c)(2)(A) of the National Housing Act, 
a creditor references the premium amount that would be payable for 
the transaction under that Act, as implemented by applicable 
regulations and other written authorities issued by the Federal 
Housing Administration (such as Mortgagee Letters), even if the 
transaction would not qualify to be insured under that Act 
(including, for example, because the principal amount exceeds the 
maximum insurable under that Act).
    B. Non-refundable premiums. To qualify for the exclusion from 
points and fees, private mortgage insurance premiums payable at or 
before consummation 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.
    C. Example. Assume that a $3,000 private mortgage insurance 
premium charged on a closed-end mortgage loan is payable at or 
before closing and is required to be refunded on a pro rata basis 
and that the refund is automatically issued upon notification of the 
satisfaction of the underlying mortgage loan. Assume also that the 
maximum 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 
private mortgage insurance premium were not required to be refunded 
on a pro rata basis or if the refund were not automatically issued 
upon notification of the satisfaction of the underlying mortgage 
loan, the entire $3,000 premium would be included in points and 
fees.
    2. Method of paying private mortgage insurance premiums. The 
portion of any private mortgage insurance premiums payable at or 
before consummation that does not qualify for an exclusion from 
points and fees under Sec.  1026.32(b)(1)(i)(C)(2) must be included 
in points and fees for purposes of Sec.  1026.32(b)(1)(i) whether 
paid in cash or financed and whether the insurance is optional or 
required.
    Paragraph 32(b)(1)(i)(D).
    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 any bona fide third-party charge not retained by 
the creditor, loan

[[Page 6598]]

originator, or an affiliate of either. For example, if bona fide 
charges are imposed by a third-party settlement agent and are not 
retained by the creditor, loan originator, or an affiliate of 
either, those charges are not included in points and fees, even if 
those charges are included in the finance charge under Sec.  
1026.4(a)(2). The term loan originator has the same meaning as in 
Sec.  1026.36(a)(1).
    2. Private mortgage insurance. The exclusion for bona fide 
third-party charges not retained by the creditor, loan originator, 
or an affiliate of either is limited by Sec.  1026.32(b)(1)(i)(C) in 
the general definition of ``points and fees.'' Section 
1026.32(b)(1)(i)(C) requires inclusion in points and fees of 
premiums or other charges payable at or before consummation 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)(c)-1 and -2 for 
further discussion of including private mortgage insurance premiums 
payable at or before consummation in the points and fees 
calculation.
    3. Real estate-related fees. The exclusion for bona fide third-
party charges not retained by the creditor, loan originator, or an 
affiliate of either is limited by Sec.  1026.32(b)(1)(iii) in the 
general definition of points and fees. Section 1026.32(b)(1)(iii) 
requires inclusion in points and fees of items listed in Sec.  
1026.4(c)(7) 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. If a 
charge is required to be included in points and fees under Sec.  
1026.32(b)(1)(iii), it may not be excluded under Sec.  
1026.32(b)(1)(i)(D), even if the criteria for exclusion in Sec.  
1026.32(b)(1)(i)(D) are satisfied.
    4. Credit insurance. The exclusion for bona fide third-party 
charges not retained by the creditor, loan originator, or an 
affiliate of either is limited by Sec.  1026.32(b)(1)(iv) in the 
general definition of points and fees. Section 1026.32(b)(1)(iv) 
requires inclusion in points and fees of premiums and other charges 
for credit insurance and certain other types of insurance. If a 
charge is required to be included in points and fees under Sec.  
1026.32(b)(1)(iv), it may not be excluded under Sec.  
1026.32(b)(1)(i)(D), even if the criteria for exclusion in Sec.  
1026.32(b)(1)(i)(D) are satisfied.
    Paragraph 32(b)(1)(i)(E).
    1. Bona fide discount point. The term bona fide discount point 
is defined in Sec.  1026.32(b)(3).
    2. Average prime offer rate. The average prime offer rate for 
purposes of paragraph (b)(1)(i)(E) of this section is the average 
prime offer rate that applies to a comparable transaction as of the 
date the discounted interest rate for the transaction is set. For 
the meaning of ``comparable transaction,'' refer to comment 
35(a)(2)-2. The table of average prime offer rates published by the 
Bureau indicates how to identify the comparable transaction. See 
comment 35(a)(2)-2.
    3. Example. Assume a 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 percent 
on May 1, 2014 that was discounted from a rate of 6.5 percent 
because the consumer paid two discount points. Finally, assume that 
the average prime offer rate as of May 1, 2014 for home mortgages 
with a fixed interest rate and a 30-year term is 5.5 percent. The 
creditor may exclude two bona fide discount points from the points 
and fees calculation because the rate from which the discounted rate 
was derived (6.5 percent) exceeded the average prime offer rate for 
a comparable transaction as of the date the rate on the transaction 
was set (5.5 percent) by only 1 percentage point.
    Paragraph 32(b)(1)(i)(F).
    1. Bona fide discount point and average prime offer rate. 
Comments 32(b)(1)(i)(E)-1 and -2 provide guidance concerning the 
definition of bona fide discount point and average prime offer rate, 
respectively.
    2. Example. Assume a 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 percent 
on May 1, 2014, that was discounted from a rate of 7 percent because 
the consumer paid four discount points. Finally, assume that the 
average prime offer rate as of May 1, 2014, for home mortgages with 
a fixed interest rate and a 30-year term is 5 percent. The creditor 
may exclude one discount point from the points and fees calculation 
because the rate from which the discounted rate was derived (7 
percent) exceeded the average prime offer rate for a comparable 
transaction as of the date the rate on the transaction was set (5 
percent) by only 2 percentage points.
    Paragraph 32(b)(1)(ii).
    1. Loan originator compensation--general. Compensation paid by a 
consumer or creditor to a loan originator is included in the 
calculation of points and fees for a transaction, provided that such 
compensation can be attributed to that particular transaction at the 
time the interest rate is set. 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.
    2. Loan originator compensation--attributable to a particular 
transaction. i. Loan originator compensation includes the dollar 
value of compensation, such as a bonus, commission, or award of 
merchandise, services, trips, or similar prizes, that is paid by a 
consumer or creditor to a loan originator and can be attributed to 
that particular transaction. The amount of compensation that can be 
attributed to a particular transaction is the dollar value of 
compensation that the loan originator will receive if the 
transaction is consummated. As explained in comment 32(b)(1)(ii)-3, 
the amount of compensation that a loan originator will receive is 
calculated as of the date the interest rate is set and includes 
compensation that is paid before, at, or after consummation.
    ii. Loan originator compensation excludes compensation that 
cannot be attributed to that transaction, 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. However, any 
compensation in addition to the base salary that can be attributed 
to the transaction at the time the interest rate is set must be 
included in loan originator compensation for the purpose of 
calculating points and fees.
    3. Loan originator compensation--timing. Compensation paid to a 
loan originator that can be attributed to a transaction must be 
included in the points and fees calculation for that loan regardless 
of whether the compensation is paid before, at, or after 
consummation. The amount of loan originator compensation that can be 
attributed to a transaction is determined as of the date the 
interest rate is set. Thus, loan originator compensation for a 
transaction includes the portion of a bonus, commission, or award of 
merchandise, services, trips, or similar prizes that can be 
attributed to that transaction at the time the creditor sets the 
interest rate for the transaction, even if that bonus, commission, 
or award of merchandise, services, trips, or similar prizes is not 
paid until after consummation. For example, assume a $100,000 
transaction and that, as of the date the interest rate is set, the 
loan originator is entitled to receive a commission equal to 1 
percent of the loan amount at consummation, i.e., $1,000, payable at 
the end of the month. In addition, assume that after the date the 
interest rate is set but before consummation of the transaction, the 
loan originator originates other transactions that enable the loan 
originator to meet a loan volume threshold, which increases the loan 
originator's commission to 1.25 percent of the loan amount, i.e., 
$1,250. In this case, the creditor need include only $1,000 as loan 
originator compensation in points and fees because, as of the date 
the interest rate was set, the loan originator would have been 
entitled to receive $1,000 upon consummation of the transaction.
    4. Loan originator compensation--examples. The following 
examples illustrate the rule:
    i. 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 year-end bonus by $100. In 
this case, $100 of the bonus is loan originator compensation that 
must be included in points and fees for the transaction.

[[Page 6599]]

    ii. 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 finalized at the end 
of the year, according to a predetermined schedule that provides for 
a specific per-transaction dollar amount based on the total dollar 
value of consummated transactions originated by the loan officer. If 
on the date the interest rate for a transaction is set, the loan 
officer has originated total volume that qualifies the loan officer 
to receive a $300 bonus per transaction under the predetermined 
schedule, then $300 of the year-end bonus can be attributed to that 
particular transaction and therefore is loan originator compensation 
that must be included in points and fees for that transaction.
    iii. Assume that, according to a creditor's compensation 
policies, the creditor awards its loan officers a bonus at the end 
of the 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, if, on the date the interest rate for the transaction is set, 
the loan officer has originated 10 or fewer transactions that year, 
then none of the year-end bonus is attributable to the transaction 
and therefore none of the bonus is included in points and fees for 
that transaction. If, on the date the interest rate for the 
transaction is set, the loan officer has originated at more than 10 
but no more than 20 transactions, $100 of the bonus is attributable 
to the transaction and is included in points and fees for that 
transaction. If, on the date the interest rate for the transaction 
is set, the loan officer has originated more than 20 transactions, 
$200 of the bonus is attributable to the transaction and is included 
in points and fees for the transaction.
    iv. Assume that, according to a creditor's compensation 
policies, the creditor pays its loan officers a base salary of $500 
per week and awards its loan officers a bonus of $250 for each 
consummated transaction. For each transaction, none of the $500 base 
salary is counted in points and fees as loan originator compensation 
under Sec.  1026.32(b)(1)(ii) because no precise portion of the base 
salary can be attributed to a particular transaction, but the $250 
bonus is counted as loan originator compensation that is included in 
points and fees.
    Paragraph 32(b)(1)(iii).
    1. Other charges. Section 1026.32(b)(1)(iii) defines points and 
fees to include all items listed in Sec.  1026.4(c)(7), other than 
amounts held for the future payment of taxes, unless certain 
exclusions apply. An item listed in Sec.  1026.4(c)(7) may be 
excluded from the points and fees calculation if the charge is 
reasonable; the creditor receives no direct or indirect compensation 
from the charge; 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 or its affiliate and no charge is paid to an affiliate). By 
contrast, 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. Credit insurance and debt cancellation or suspension 
coverage. In determining points and fees for purposes of Sec.  
1026.32(b)(1), premiums paid at or before consummation for credit 
insurance or any debt cancellation or suspension agreement or 
contract are included in points and fees whether they are paid in 
cash or, if permitted by applicable law, financed and whether the 
insurance or coverage is optional or required. Such charges are also 
included whether the amount represents the entire premium or payment 
for the coverage or an initial payment.
    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 protects the consumer's interest in the 
property.
    3. Life, accident, health, or loss-of-income insurance. Premiums 
or other charges for these types of insurance are included in points 
and fees only if the creditor is a beneficiary. If the consumer or 
another person designated by the consumer is the sole beneficiary, 
then the premiums or other charges are not included in points and 
fees.
    32(b)(3) Bona fide discount point.
    32(b)(3)(i) Closed-end credit.
    1. Definition of bona fide discount point. Section 1026.32(b)(3) 
provides that, to be bona fide, a discount point must reduce the 
interest rate 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. 
To satisfy this standard, a creditor may show that the reduction is 
reasonably consistent with established industry norms and practices 
for secondary mortgage market transactions. For example, a creditor 
may rely on pricing in the to-be-announced (TBA) market for 
mortgage-backed securities (MBS) to establish that the interest rate 
reduction is consistent with the compensation that the creditor 
could reasonably expect to receive in the secondary market. The 
creditor may also establish that its interest rate reduction is 
consistent with established industry practices by showing that its 
calculation complies with requirements prescribed in Fannie Mae or 
Freddie Mac guidelines for interest rate reductions from bona fide 
discount points. For example, assume that the Fannie Mae Single-
Family Selling Guide or the Freddie Mac Single Family Seller/
Servicer Guide imposes a cap on points and fees but excludes from 
the cap discount points that result in a bona fide reduction in the 
interest rate. Assume the guidelines require that, for a discount 
point to be bona fide so that it would not count against the cap, a 
discount point must result in at least a 25 basis point reduction in 
the interest rate. Accordingly, if the creditor offers a 25 basis 
point interest rate reduction for a discount point and the 
requirements of Sec.  1026.32(b)(1)(i)(E) or (F) are satisfied, the 
discount point is bona fide and is excluded from the calculation of 
points and fees.
    32(b)(4) Total loan amount.
    32(b)(4)(i) Closed-end credit.
    1. Total loan amount; examples. Below are several examples 
showing how to calculate the total loan amount for closed-end 
mortgage loans, each using a $10,000 amount borrowed, a $300 
appraisal fee, and $400 in prepaid finance charges. A $500 single 
premium for optional credit unemployment insurance is used in one 
example.
    i. If the consumer finances a $300 fee for a creditor-conducted 
appraisal and pays $400 in prepaid finance charges at closing, the 
amount financed under Sec.  1026.18(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.  
1026.32(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.  1026.18(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.  
1026.32(b)(1)(iii). In this case, the amount financed is the same as 
the total loan amount: $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 unemployment 
insurance, and pays $400 in prepaid finance charges at closing, the 
amount financed under Sec.  1026.18(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.  
1026.32(b)(1)(ii), and the $500 insurance premium is added under 
1026.32(b)(1)(iv). The $300 and $500 costs are deducted from the 
amount financed

[[Page 6600]]

($10,400) to derive a total loan amount of $9,600.
    32(b)(6) Prepayment penalty.
    1. Examples of prepayment penalties; closed-end credit 
transactions. For purposes of Sec.  1026.32(b)(6)(i), the following 
are examples of prepayment penalties:
    i. 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 interest accrual amortization used for other payments 
in the transaction under the terms of the loan contract. ``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 any grace period). Thus, under the terms of a loan 
contract providing for monthly interest accrual amortization, if the 
amount of interest due on May 1 for the preceding month of April is 
$3,000, the loan contract will require payment of $3,000 in interest 
for the month of April whether the payment is made on April 20, on 
May 1, or on May 10. In this example, if the consumer prepays the 
loan in full on April 20 and if the accrued interest as of that date 
is $2,000, then assessment of a charge of $3,000 constitutes a 
prepayment penalty of $1,000 because the amount of interest actually 
earned through April 20 is only $2,000.
    ii. A fee, such as an origination or other loan closing cost, 
that is waived by the creditor on the condition that the consumer 
does not prepay the loan. However, the term prepayment penalty does 
not include a waived bona fide third-party charge imposed by the 
creditor if the consumer pays all of a covered transaction's 
principal before the date on which the principal is due sooner than 
36 months after consummation. For example, assume that at 
consummation, the creditor waives $3,000 in closing costs to cover 
bona fide third-party charges but the terms of the loan agreement 
provide that the creditor may recoup the $3,000 in waived charges if 
the consumer repays the entire loan balance sooner than 36 months 
after consummation. The $3,000 charge is not a prepayment penalty. 
In contrast, for example, assume that at consummation, the creditor 
waives $3,000 in closing costs to cover bona fide third-party 
charges but the terms of the loan agreement provide that the 
creditor may recoup $4,500, in part to recoup waived charges, if the 
consumer repays the entire loan balance sooner than 36 months after 
consummation. The $3,000 that the creditor may impose to cover the 
waived bona fide third-party charges is not a prepayment penalty, 
but the additional $1,500 charge is a prepayment penalty and subject 
to the restrictions under Sec.  1026.43(g).
    iii. A minimum finance charge in a simple interest transaction.
    iv. Computing a refund of unearned interest by a method that is 
less favorable to the consumer than the actuarial method, as defined 
by section 933(d) of the Housing and Community Development Act of 
1992, 15 U.S.C. 1615(d). For purposes of computing a refund of 
unearned interest, if using the actuarial method defined by 
applicable State law results in a refund that is greater than the 
refund calculated by using the method described in section 933(d) of 
the Housing and Community Development Act of 1992, creditors should 
use the State law definition in determining if a refund is a 
prepayment penalty.
    2. Fees that are not prepayment penalties; closed-end credit 
transactions. For purposes of Sec.  1026.32(b)(6)(i), fees that are 
not prepayment penalties include, for example:
    i. Fees imposed for preparing and providing documents when a 
loan is paid in full if such fees are imposed whether or not the 
loan is prepaid. Examples include a loan payoff statement, a 
reconveyance document, or another document releasing the creditor's 
security interest in the dwelling that secures the loan.
    ii. Loan guarantee fees.
* * * * *

Section 1026.43--Minimum Standards for Transactions Secured by a 
Dwelling

    1. Record retention. See Sec.  1026.25(c)(3) and comments 
25(c)(3)-1 and -2 for guidance on the required retention of records 
as evidence of compliance with Sec.  1026.43.
    43(a) Scope.
    1. Consumer credit. In general, Sec.  1026.43 applies to 
consumer credit transactions secured by a dwelling, but certain 
dwelling-secured consumer credit transactions are exempt or 
partially exempt from coverage under Sec.  1026.43(a)(1) through 
(3). (See Sec.  1026.2(a)(12) for the definition of ``consumer 
credit.'') Section 1026.43 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.  1026.3 and associated 
commentary for guidance in determining the primary purpose of an 
extension of credit. In addition, Sec.  1026.43 does not apply to 
any change to an existing loan that is not treated as a refinancing 
under Sec.  1026.20(a).
    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.  1026.2(a)(19). For purposes of 
Sec.  1026.43, 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.  
1026.43(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.
    Paragraph 43(a)(3).
    1. Renewable temporary or ``bridge'' loan. Under Sec.  
1026.43(a)(3)(ii), a temporary or ``bridge'' loan with a term of 12 
months or less is exempt from Sec.  1026.43(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 provided that any renewal possible under the loan 
contract is for one year or less. 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 exempt from Sec.  1026.43(c) 
through (f) because the initial loan term is 12 months.
    2. Construction phase of a construction-to-permanent loan. Under 
Sec.  1026.43(a)(3)(iii), a construction phase of 12 months or less 
of a construction-to-permanent loan is exempt from Sec.  1026.43(c) 
through (f). A construction-to-permanent loan is a potentially 
multiple-advance loan to finance the construction, rehabilitation, 
or improvement of a dwelling that may be permanently financed by the 
same creditor. For such a loan, the construction phase and the 
permanent phase may be treated as separate transactions for the 
purpose of compliance with Sec.  1026.43(c) through (f), and the 
construction phase of the loan is exempt from Sec.  1026.43(c) 
through (f), provided the initial term is 12 months or less. See 
Sec.  1026.17(c)(6)(ii), allowing similar treatment for disclosures. 
Where the construction phase of a construction-to-permanent loan is 
renewable for a period of one year or less, the term of that 
construction phase does not include any additional period of time 
that could result from a renewal provision. For example, if the 
construction phase of a construction-to-permanent loan has an 
initial term of 12 months but is renewable for another 12-month term 
before permanent financing begins, the construction phase is exempt 
from Sec.  1026.43(c) through (f) because the initial term is 12 
months. Any renewal of one year or less also qualifies for the 
exemption. The permanent phase of the loan is treated as a separate 
transaction and is not exempt under Sec.  1026.43(a)(3)(iii). It may 
be a qualified mortgage if it satisfies the appropriate 
requirements.
    43(b) Definitions.
    43(b)(1) Covered transaction.
    1. The definition of covered transaction restates the scope of 
the rule as described at Sec.  1026.43(a).
    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. In some cases, the initial rate 
charged to consumers is lower than the rate would be if it were 
calculated using the index or formula that will apply after recast, 
as determined at consummation (i.e., a ``discounted rate''). In 
other cases, the 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, or is based on an index or 
formula that will not apply after recast, and is set at 5 percent 
for the first

[[Page 6601]]

five years. The loan agreement provides that future interest rate 
adjustments will be calculated based on a specific index plus a 3 
percent margin. If the value of the index at consummation is 5 
percent, the interest rate that would have been applied at 
consummation had the creditor based the initial rate on this index 
is 8 percent (5 percent plus 3 percent margin). For purposes of 
Sec.  1026.43(b)(3), the fully indexed rate is 8 percent. 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.  1026.43(c), see Sec.  1026.43(c)(5)(i) and 
comment 43(c)(5)(i)-2.
    2. Index or formula value at consummation. The value at 
consummation of the index or formula 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 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 
value 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 percent for the first three years of 
the loan, after which the rate will adjust annually to a specified 
index plus a margin of 3 percent. The loan agreement provides for a 
2 percent annual interest rate adjustment cap, and a lifetime 
maximum interest rate of 10 percent. The index value in effect at 
consummation is 4.5 percent; the fully indexed rate is 7.5 percent 
(4.5 percent plus 3 percent), regardless of the 2 percent 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. To illustrate, assume an 
adjustable-rate mortgage has an initial fixed rate of 5 percent for 
the first three years of the loan, after which the rate will adjust 
annually to a specified index plus a margin of 3 percent. The loan 
agreement provides for a 2 percent annual interest rate adjustment 
cap and a lifetime maximum interest rate of 7 percent. The index 
value in effect at consummation is 4.5 percent; under the generally 
applicable rule, the fully indexed rate is 7.5 percent (4.5 percent 
plus 3 percent). Nevertheless, the creditor may choose to use the 
lifetime maximum interest rate of 7 percent as the fully indexed 
rate, rather than 7.5 percent, for purposes of Sec.  1026.43(b)(3). 
Furthermore, 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 complies by using the 
highest rate in that range as the maximum interest rate for purposes 
of Sec.  1026.43(b)(3).
    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 percent for the first two years of the loan, 7 percent for the 
next three years, and 7.5 percent thereafter for the remainder of 
loan term. For purposes of this section, the creditor must use 7.5 
percent, which is the maximum rate that may apply during the loan 
term. ``Step-rate mortgage'' is defined in Sec.  1026.18(s)(7)(ii).
    ii. Assume a fixed-rate mortgage with an interest rate at 
consummation of 7 percent 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 percent, which is the interest rate 
that is fixed at consummation. ``Fixed-rate mortgage'' is defined in 
Sec.  1026.18(s)(7)(iii).
    43(b)(4) Higher-priced covered transaction.
    1. Average prime offer rate. The average prime offer rate is 
defined in Sec.  1026.35(a)(2). For further explanation of the 
meaning of ``average prime offer rate,'' and additional guidance on 
determining the average prime offer rate, see comments 35(a)(2)-1 
through -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 by the 
specified amount the average prime offer rate for a comparable 
transaction as of the date the interest rate is set. The published 
tables of average prime offer rates indicate how to identify a 
comparable transaction. See comment 35(a)(2)-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.  
1026.17(c)(6) and associated commentary regarding treatment of 
multiple-advance and construction-to-permanent loans as single or 
multiple transactions. See also comment 43(a)(3)-2.
    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.  
1026.43(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 can 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.  1026.43(b)(5); ``negative amortization 
loan'' is defined in Sec.  1026.18(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.
    3. Examples. The following are examples of how to determine the 
maximum loan amount for a negative amortization loan (all amounts 
shown are rounded, and all amounts are calculated using non-rounded 
values):
    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 percent 
of its original balance (i.e., a negative

[[Page 6602]]

amortization cap of 115 percent) or for the first five years of the 
loan (60 monthly payments), whichever occurs first. The introductory 
interest rate at consummation is 1.5 percent. One month after the 
first day of the first full calendar month following consummation, 
the interest rate adjusts and will adjust monthly thereafter based 
on the specified index plus a margin of 3.5 percent. The maximum 
lifetime interest rate is 10.5 percent; 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 percent. 
After that, the minimum monthly payment adjusts annually, but may 
increase by no more than 7.5 percent over the previous year's 
payment. The minimum monthly payment is $690 in the first year, $742 
in the second year, and $797 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 percent at the first adjustment (i.e., the due date of the 
first periodic monthly payment) 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 percent 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 percent is reached at the first rate 
adjustment (i.e., the due date of the first periodic monthly 
payment), the negative amortization cap of 115 percent 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 $229,251.
    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 
percent, and requires the consumer to make minimum monthly payments 
during the first year, with payments increasing 12.5 percent over 
the previous year every year for four years. The payment schedule 
provides for payments of $943 in the first year, $1,061 in the 
second year, $1,193 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 $207,662, 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. Section 1026.43(b)(8) defines mortgage-related 
obligations, which must be considered in determining a consumer's 
ability to repay pursuant to Sec.  1026.43(c). Section 1026.43(b)(8) 
includes, in the evaluation of mortgage-related obligations, fees 
and special assessments owed to a condominium, cooperative, or 
homeowners association. Section 1026.43(b)(8) includes ground rent 
and leasehold payments in the definition of mortgage-related 
obligations. See commentary to Sec.  1026.43(c)(2)(v) regarding the 
requirement to take into account any mortgage-related obligations 
for purposes of determining a consumer's ability to repay.
    2. Property taxes. Section 1026.43(b)(8) includes property taxes 
in the evaluation of mortgage-related obligations. Obligations that 
are related to the ownership or use of real property and paid to a 
taxing authority, whether on a monthly, quarterly, annual, or other 
basis, are property taxes for purposes of Sec.  1026.43(b)(8). 
Section 1026.43(b)(8) includes obligations that are equivalent to 
property taxes, even if such obligations are not denominated as 
``taxes.'' For example, governments may establish or allow 
independent districts with the authority to impose levies on 
properties within the district to fund a special purpose, such as a 
local development bond district, water district, or other public 
purpose. These levies may be referred to as taxes, assessments, 
surcharges, or by some other name. For purposes of Sec.  
1026.43(b)(8), these are property taxes and are included in the 
determination of mortgage-related obligations.
    3. Insurance premiums and similar charges. Section 1026.43(b)(8) 
includes in the evaluation of mortgage-related obligations premiums 
and similar charges identified in Sec.  1026.4(b)(5), (7), (8), or 
(10) that are required by the creditor. This includes all premiums 
or charges related to coverage protecting the creditor against a 
consumer's default, credit loss, collateral loss, or similar loss, 
if the consumer is required to pay the premium or charge. For 
example, if Federal law requires flood insurance to be obtained in 
connection with the mortgage loan, the flood insurance premium is a 
mortgage-related obligation for purposes of Sec.  1026.43(b)(8). 
Section 1026.43(b)(8) does not include premiums or similar charges 
identified in Sec.  1026.4(b)(5), (7), (8), or (10) that are not 
required by the creditor and that the consumer purchases 
voluntarily. For example:
    i. If a creditor does not require earthquake insurance to be 
obtained in connection with the mortgage loan, but the consumer 
voluntarily chooses to purchase such insurance, the earthquake 
insurance premium is not a mortgage-related obligation for purposes 
of Sec.  1026.43(b)(8).
    ii. If a creditor requires a minimum amount of coverage for 
homeowners' insurance and the consumer voluntarily chooses to 
purchase a more comprehensive amount of coverage, the portion of the 
premium allocated to the required minimum coverage is a mortgage-
related obligation for purposes of Sec.  1026.43(b)(8), while the 
portion of the premium allocated to the more comprehensive coverage 
voluntarily purchased by the consumer is not a mortgage-related 
obligation for purposes of Sec.  1026.43(b)(8).
    iii. If the consumer purchases insurance or similar coverage not 
required by the creditor at consummation without having requested 
the specific non-required insurance or similar coverage and without 
having agreed to the premium or charge for the specific non-required 
insurance or similar coverage prior to consummation, the premium or 
charge is not voluntary for purposes of Sec.  1026.43(b)(8) and is a 
mortgage-related obligation.
    4. Mortgage insurance, guarantee, or similar charges. Section 
1026.43(b)(8) includes in the evaluation of mortgage-related 
obligations premiums or charges protecting the creditor against the 
consumer's default or other credit loss. This includes all premiums 
or similar charges, whether denominated as mortgage insurance, 
guarantee insurance, or otherwise, as determined according to 
applicable State or Federal law. For example, monthly ``private 
mortgage insurance'' payments paid to a non-governmental entity, 
annual ``guarantee fee'' payments required by a Federal housing 
program, and a quarterly ``mortgage insurance'' payment paid to a 
State agency administering a housing program are all mortgage-
related obligations for purposes of Sec.  1026.43(b)(8). Section 
1026.43(b)(8) includes these charges in the definition of mortgage-
related obligations if the creditor requires the consumer to pay 
them, even if the consumer is not legally obligated to pay the 
charges under the terms of the insurance program. For example, if a 
mortgage insurance program obligates the creditor to make recurring 
mortgage insurance payments, and the creditor requires the consumer 
to reimburse the creditor for such recurring payments, the 
consumer's payments are mortgage-related obligations for purposes of 
Sec.  1026.43(b)(8). However, if a mortgage insurance program 
obligates the creditor to make recurring mortgage insurance 
payments, and the creditor does not require the consumer to 
reimburse the creditor for the cost of the mortgage insurance 
payments, the recurring mortgage insurance payments are not 
mortgage-related obligations for purposes of Sec.  1026.43(b)(8).
    5. Relation to the finance charge. Section 1026.43(b)(8) 
includes in the evaluation of mortgage-related obligations premiums 
and similar charges identified in Sec.  1026.4(b)(5), (7), (8), or 
(10) that are required by the creditor. These premiums and similar 
charges are mortgage-related obligations regardless of whether the 
premium or similar charge is excluded from the finance charge 
pursuant to Sec.  1026.4(d). For example, a premium for insurance 
against loss or damage to the property written in connection with 
the credit transaction is a premium identified in Sec.  
1026.4(b)(8). If this premium is required by the creditor, the 
premium is a mortgage-related obligation pursuant to Sec.  
1026.43(b)(8), regardless of whether the premium is excluded from 
the finance charge pursuant to Sec.  1026.4(d)(2).
    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

[[Page 6603]]

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 1026.43(b)(12) defines a simultaneous loan 
as another covered transaction or a home equity line of credit 
(HELOC) subject to Sec.  1026.40 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. (As with all of Sec.  1026.43, the term 
``dwelling'' includes any real property attached to a dwelling.) 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 Sec.  
1026.43(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.  1026.2(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.  
1026.43(c)(2)(viii) and 1026.43(c)(3), a creditor may use a credit 
report prepared by a consumer reporting agency that is transmitted 
electronically.
    2. Forms. A record prepared by a third party includes a form a 
creditor gives to a third party to provide 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.  1026.43(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 an appropriate 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.  1026.43(b)(13)(i). In contrast, a 
profit-and-loss statement prepared by a self-employed consumer and 
reviewed by the consumer's non-accountant spouse is not a third-
party record under Sec.  1026.43(b)(13)(i).
    Paragraph 43(b)(13)(iii).
    1. Creditor's records. Section 1026.43(b)(13)(iii) provides that 
a 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.
    43(c)(1) General requirement.
    1. Reasonable and good faith determination. i. General. 
Creditors generally are required by Sec.  1026.43(c)(1) to make 
reasonable and good faith determinations of consumers' ability to 
repay. Section 1026.43(c) and the accompanying commentary describe 
certain requirements for making this ability-to-repay determination, 
but do not provide comprehensive underwriting standards to which 
creditors must adhere. For example, the rule and commentary do not 
specify how much income is needed to support a particular level of 
debt or how credit history should be weighed against other factors. 
So long as creditors consider the factors set forth in Sec.  
1026.43(c)(2) according to the requirements of Sec.  1026.43(c), 
creditors are permitted to develop their own underwriting standards 
and make changes to those standards over time in response to 
empirical information and changing economic and other conditions. 
Whether a particular ability-to-repay determination is reasonable 
and in good faith will depend not only on the underwriting standards 
adopted by the creditor, but on the facts and circumstances of an 
individual extension of credit and how a creditor's underwriting 
standards were applied to those facts and circumstances. A 
consumer's statement or attestation that the consumer has the 
ability to repay the loan is not indicative of whether the 
creditor's determination was reasonable and in good faith.
    ii. Considerations. A. The following may be evidence that a 
creditor's ability-to-repay determination was reasonable and in good 
faith:
    1. The consumer demonstrated actual ability to repay the loan by 
making timely payments, without modification or accommodation, for a 
significant period of time after consummation or, for an adjustable-
rate, interest-only, or negative-amortization mortgage, for a 
significant period of time after recast;
    2. The creditor used underwriting standards that have 
historically resulted in comparatively low rates of delinquency and 
default during adverse economic conditions; or
    3. The creditor used underwriting standards based on empirically 
derived, demonstrably and statistically sound models.
    B. In contrast, the following may be evidence that a creditor's 
ability-to-repay determination was not reasonable or in good faith:
    1. The consumer defaulted on the loan a short time after 
consummation or, for an adjustable-rate, interest-only, or negative-
amortization mortgage, a short time after recast;
    2. The creditor used underwriting standards that have 
historically resulted in comparatively high levels of delinquency 
and default during adverse economic conditions;
    3. The creditor applied underwriting standards inconsistently or 
used underwriting standards different from those used for similar 
loans without reasonable justification;
    4. The creditor disregarded evidence that the underwriting 
standards it used are not effective at determining consumers' 
repayment ability;
    5. The creditor disregarded evidence that the consumer may have 
insufficient residual income to cover other recurring obligations 
and expenses, taking into account the consumer's assets other than 
the property securing the loan, after paying his or her monthly 
payments for the covered transaction, any simultaneous loans, 
mortgage-related obligations, and any current debt obligations; or
    6. The creditor disregarded evidence that the consumer would 
have the ability to repay only if the consumer subsequently 
refinanced the loan or sold the property securing the loan.
    C. All of the considerations listed in paragraphs (A) and (B) 
above may be relevant to whether a creditor's ability-to-repay 
determination was reasonable and in good faith. However, these 
considerations are not requirements or prohibitions with which 
creditors must comply, nor are they elements of a claim that a 
consumer must prove to

[[Page 6604]]

establish a violation of the ability-to-repay requirements. For 
example, creditors are not required to validate their underwriting 
criteria using mathematical models. These considerations also are 
not absolute in their application; instead they exist on a continuum 
and may apply to varying degrees. For example, the longer a consumer 
successfully makes timely payments after consummation or recast the 
less likely it is that the creditor's determination of ability to 
repay was unreasonable or not in good faith. Finally, each of these 
considerations must be viewed in the context of all facts and 
circumstances relevant to a particular extension of credit. For 
example, in some cases inconsistent application of underwriting 
standards may indicate that a creditor is manipulating those 
standards to approve a loan despite a consumer's inability to repay. 
The creditor's ability-to-repay determination therefore may be 
unreasonable or in bad faith. However, in other cases inconsistently 
applied underwriting standards may be the result of, for example, 
inadequate training and may nonetheless yield a reasonable and good 
faith ability-to-repay determination in a particular case. 
Similarly, although an early payment default on a mortgage will 
often be persuasive evidence that the creditor did not have a 
reasonable and good faith belief in the consumer's ability to repay 
(and such evidence may even be sufficient to establish a prima facie 
case of an ability-to-repay violation), a particular ability-to-
repay determination may be reasonable and in good faith even though 
the consumer defaulted shortly after consummation if, for example, 
the consumer experienced a sudden and unexpected loss of income. In 
contrast, an ability-to-repay determination may be unreasonable or 
not in good faith even though the consumer made timely payments for 
a significant period of time if, for example, the consumer was able 
to make those payments only by foregoing necessities such as food 
and heat.
    2. Repayment ability at consummation. Section 1026.43(c)(1) 
requires the creditor to determine, at or before the time the loan 
is consummated, that a consumer will have a reasonable ability 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 cannot be reasonably anticipated from 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 considered at or before 
consummation indicate 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 under the rule.
    3. Interaction with Regulation B. Section 1026.43(c)(1) does not 
require or permit the creditor to make inquiries or verifications 
prohibited by Regulation B, 12 CFR part 1002.
    43(c)(2) Basis for determination.
    1. General. Section 1026.43(c)(2) sets forth factors creditors 
must consider when making the ability-to-repay determination 
required under Sec.  1026.43(c)(1) and the accompanying commentary 
provides guidance regarding these factors. Creditors must conform to 
these requirements and may rely on guidance provided in the 
commentary. However, Sec.  1026.43(c) and the accompanying 
commentary do not provide comprehensive guidance on definitions and 
other technical underwriting criteria necessary for evaluating these 
factors in practice. So long as a creditor complies with the 
provisions of Sec.  1026.43(c), the creditor is permitted to use its 
own definitions and other technical underwriting criteria. A 
creditor may, but is not required to, look to guidance issued by 
entities such as the Federal Housing Administration, the U.S. 
Department of Veterans Affairs, the U.S. Department of Agriculture, 
or Fannie Mae or Freddie Mac while operating under the 
conservatorship of the Federal Housing Finance Agency. For example, 
a creditor may refer to such guidance to classify particular 
inflows, obligations, or property as ``income,'' ``debt,'' or 
``assets.'' Similarly, a creditor may refer to such guidance to 
determine what information to use when evaluating the income of a 
self-employed or seasonally employed consumer or what information to 
use when evaluating the credit history of a consumer who has 
obtained few or no extensions of traditional ``credit'' as defined 
in Sec.  1026.2(a)(14). These examples are illustrative, and 
creditors are not required to conform to guidance issued by these or 
other such entities. However, as required by Sec.  1026.43(c)(1), a 
creditor must ensure that its underwriting criteria, as applied to 
the facts and circumstances of a particular extension of credit, 
result in a reasonable, good faith determination of a consumer's 
ability to repay. For example, a definition used in underwriting 
that is reasonable in isolation may lead to ability-to-repay 
determinations that are unreasonable or not in good faith when 
considered in the context of a creditor's underwriting standards or 
when adopted or applied in bad faith. Similarly, an ability-to-repay 
determination is not unreasonable or in bad faith merely because the 
underwriting criteria used included a definition that was by itself 
unreasonable.
    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. (As stated in 
Sec.  1026.43(a), the value of the dwelling includes the value of 
the real property to which the residential structure is attached, if 
the real property also secures the covered transaction.)
    2. Income or assets relied on. A creditor need consider only the 
income or assets 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 (or assets) relied on to 
determine the consumer's repayment ability. See comment 43(c)(4)-1.
    3. Reasonably expected income. If a creditor relies on expected 
income in excess of the consumer's 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 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 seasonal 
income from the sale of crops or from agricultural employment. Each 
year, the consumer's income arrives during only a few months. 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.
    5. Multiple applicants. When two or more consumers apply for an 
extension of credit as joint obligors with primary liability on an 
obligation, Sec.  1026.43(c)(2)(i) does not require the creditor to 
consider income or assets that are not needed to support the 
creditor's repayment ability determination. If the income or assets 
of one applicant are

[[Page 6605]]

sufficient to support the creditor's repayment ability 
determination, the creditor is not required to consider the income 
or assets of the other applicant. For example, if a husband and wife 
jointly apply for a loan and the creditor reasonably determines that 
the wife's income is sufficient to repay the loan, the creditor is 
not required to consider the husband's income.
    Paragraph 43(c)(2)(ii).
    1. Employment status and income. Employment status need not be 
full-time, and employment need not occur at regular intervals. If, 
in determining the consumer's repayment ability, the creditor relies 
on income from the consumer's employment, then that employment may 
be, for example, full-time, part-time, seasonal, irregular, 
military, or self-employment, so long as the creditor considers 
those characteristics of the employment. Under Sec.  
1026.43(c)(2)(ii), a creditor must 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 comments 43(c)(2)(i)-5 and 
43(c)(4)-2 for guidance on which income to consider when multiple 
consumers apply jointly for a loan.
    Paragraph 43(c)(2)(iii).
    1. General. For purposes of the repayment ability determination 
required under Sec.  1026.43(c)(2), a creditor must consider the 
consumer's monthly payment on a covered transaction that is 
calculated as required under Sec.  1026.43(c)(5).
    Paragraph 43(c)(2)(iv).
    1. Home equity lines of credit. For purposes of Sec.  
1026.43(c)(2)(iv), a simultaneous loan includes any covered 
transaction or home equity line of credit (HELOC) subject to Sec.  
1026.40 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.  1026.43. See 
Sec.  1026.43(a) discussing the scope of this section. 
``Simultaneous loan'' is defined in Sec.  1026.43(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.  
1026.43(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 or has been 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 are designed to determine whether at or 
before consummation 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 must require the consumer to 
state the source of the down payment and provide verification. If 
the creditor determines the source of the down payment 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 down payment source is the consumer's 
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. The creditor is not 
obligated to investigate beyond reasonable underwriting policies and 
procedures 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.  1026.43(c)(2)(iv), a 
simultaneous loan includes a loan that comes into existence 
concurrently with the covered transaction subject to Sec.  
1026.43(c). A simultaneous loan does not include a credit 
transaction that occurs after consummation of the covered 
transaction that is subject to this section. However, any 
simultaneous loan that specifically covers closing costs of the 
covered transaction, but is scheduled to be extended after 
consummation must be considered for the purposes of Sec.  
1026.43(c)(2)(iv).
    Paragraph 43(c)(2)(v).
    1. General. A creditor must include in its repayment ability 
assessment the consumer's monthly payment for mortgage-related 
obligations, such as the expected property taxes and premiums or 
similar charges identified in Sec.  1026.4(b)(5), (7), (8), or (10) 
that are required by the creditor. See Sec.  1026.43(b)(8) defining 
the term ``mortgage-related obligations.'' 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. Section 1026.43(c)(2)(v) includes only payments that 
occur on an ongoing or recurring basis in the evaluation of the 
consumer's monthly payment for mortgage-related obligations. One-
time charges, or obligations satisfied at or before consummation, 
are not ongoing or recurring, and are therefore not part of the 
consumer's monthly payment for purposes of Sec.  1026.43(c)(2)(v). 
For example:
    i. Assume that a consumer will be required to pay property 
taxes, as described in comment 43(b)(8)-2, on a quarterly, annual, 
or other basis after consummation. Section 1026.43(c)(2)(v) includes 
these recurring property taxes in the evaluation of the consumer's 
monthly payment for mortgage-related obligations. However, if the 
consumer will incur a one-time charge to satisfy property taxes that 
are past due, Sec.  1026.43(c)(2)(v) does not include this one-time 
charge in the evaluation of the consumer's monthly payment for 
mortgage-related obligations.
    ii. Assume that a consumer will be required to pay mortgage 
insurance premiums, as described in comment 43(b)(8)-2, on a 
monthly, annual, or other basis after consummation. Section 
1026.43(c)(2)(v) includes these recurring mortgage insurance 
payments in the evaluation of the consumer's monthly payment for 
mortgage-related obligations. However, if the consumer will incur a 
one-time fee or charge for mortgage insurance or similar purposes, 
such as an up-front mortgage insurance premium imposed at 
consummation, Sec.  1026.43(c)(2)(v) does not include this up-front 
mortgage insurance premium in the evaluation of the consumer's 
monthly payment for mortgage-related obligations.
    2. Obligations to an association, other than special 
assessments. Section 1026.43(b)(8) defines mortgage-related 
obligations to include obligations owed to a condominium, 
cooperative, or homeowners association. However, Sec.  
1026.43(c)(2)(v) does not require a creditor to include in the 
evaluation of the consumer's monthly payment for mortgage-related 
obligations payments to such associations imposed in connection with 
the extension of credit, or imposed as an incident to the transfer 
of ownership, if such obligations are fully satisfied at or before 
consummation. For example, if a homeowners association imposes a 
one-time transfer fee on the transaction, and the consumer will pay 
the fee at or before consummation, Sec.  1026.43(c)(2)(v) does not 
require the creditor to include this one-time transfer fee in the 
evaluation of the consumer's monthly payment for mortgage-related 
obligations. Section 1026.43(c)(2)(v) also does not require the 
creditor to include this fee in the evaluation of the consumer's 
monthly payment for mortgage-related obligations if the consumer 
finances the fee in the loan amount. However, if the consumer incurs 
the obligation and will satisfy the obligation with recurring 
payments after consummation, regardless of whether the obligation is 
escrowed, Sec.  1026.43(c)(2)(v) requires the creditor to include 
the transfer fee in the evaluation of the consumer's monthly payment 
for mortgage-related obligations.
    3. Special assessments imposed by an association. Section 
1026.43(b)(8) defines mortgage-related obligations to include 
special assessments imposed by a condominium, cooperative, or 
homeowners association. Section 1026.43(c)(2)(v) does not require a 
creditor to include special assessments in the evaluation of the 
consumer's monthly payment for mortgage-related obligations if the 
special assessments are fully satisfied at or before consummation. 
For example, if a homeowners association imposes a special 
assessment that the consumer will have to pay in full at or before 
consummation, Sec.  1026.43(c)(2)(v) does not include the special 
assessment in the

[[Page 6606]]

evaluation of the consumer's monthly payment for mortgage-related 
obligations. Section 1026.43(c)(2)(v) does not require a creditor to 
include special assessments in the evaluation of the consumer's 
monthly payment for mortgage-related obligations if the special 
assessments are imposed as a one-time charge. For example, if a 
homeowners association imposes a special assessment that the 
consumer will have to satisfy in one payment, Sec.  1026.43(c)(2)(v) 
does not include this one-time special assessment in the evaluation 
of the consumer's monthly payment for mortgage-related obligations. 
However, if the consumer will pay the special assessment on a 
recurring basis after consummation, regardless of whether the 
consumer's payments for the special assessment are escrowed, Sec.  
1026.43(c)(2)(v) requires the creditor to include this recurring 
special assessment in the evaluation of the consumer's monthly 
payment for mortgage-related obligations.
    4. Pro rata amount. For purposes of Sec.  1026.43(c)(2)(v), the 
creditor may divide the recurring payments for mortgage-related 
obligations into monthly, pro rata amounts. In considering a 
mortgage-related obligation that is not paid monthly, if the 
mortgage loan is originated pursuant to a government program the 
creditor may determine the pro rata monthly amount of the mortgage-
related obligation in accordance with the specific requirements of 
that program. If the mortgage loan is originated pursuant to a 
government program that does not contain specific standards for 
determining the pro rata monthly amount of the mortgage-related 
obligation, or if the mortgage loan is not originated pursuant to a 
government program, the creditor complies with Sec.  
1026.43(c)(2)(v) by dividing the total amount of a particular non-
monthly mortgage-related obligation by no more than the number of 
months from the month that the non-monthly mortgage-related 
obligation was due prior to consummation until the month that the 
non-monthly mortgage-related obligation will be due after 
consummation. When determining the pro rata monthly payment amount, 
the creditor may also consider comment 43(c)(2)(v)-5, which explains 
that the creditor need not project potential changes. The following 
examples further illustrate how a creditor may determine the pro 
rata monthly amount of mortgage-related obligations, pursuant to 
Sec.  1026.43(c)(2)(v):
    i. Assume that a consumer applies for a mortgage loan on 
February 1st. Assume further that the subject property is located in 
a jurisdiction where property taxes are paid in arrears on the first 
day of October. The creditor complies with Sec.  1026.43(c)(2)(v) by 
determining the annual property tax amount owed in the prior 
October, dividing the amount by 12, and using the resulting amount 
as the pro rata monthly property tax payment amount for the 
determination of the consumer's monthly payment for mortgage-related 
obligations. The creditor complies even if the consumer will likely 
owe more in the next year than the amount owed the prior October 
because the jurisdiction normally increases the property tax rate 
annually, provided that the creditor does not have knowledge of an 
increase in the property tax rate at the time of underwriting. See 
also comment 43(c)(2)(v)-5 regarding estimates of mortgage-related 
obligations.
    ii. Assume that a subject property is located in a special water 
district, the assessments for which are billed separately from local 
property taxes. The creditor complies with Sec.  1026.43(c)(2)(v) by 
dividing the full amount that will be owed by the number of months 
in the assessment period, and including the resulting amount in the 
calculation of monthly mortgage-related obligations. However, Sec.  
1026.43(c)(2)(v) does not require a creditor to adjust the monthly 
amount to account for potential deviations from the average monthly 
amount. For example, assume in this example that the special water 
assessment is billed every eight months, that the consumer will have 
to pay the first water district bill four months after consummation, 
and that the seller will not provide the consumer with any funds to 
pay for the seller's obligation (i.e., the four months prior to 
consummation). Although the consumer will be required to budget 
twice the average monthly amount to pay the first water district 
bill, Sec.  1026.43(c)(2)(v) does not require the creditor to use 
the increased amount; the creditor complies with Sec.  
1026.43(c)(2)(v) by using the average monthly amount.
    iii. Assume that the subject property is located in an area 
where flood insurance is required by Federal law, and assume further 
that the flood insurance policy premium is paid every three years 
following consummation. The creditor complies with Sec.  
1026.43(c)(2)(v) by dividing the three-year premium by 36 months and 
including the resulting amount in the determination of the 
consumer's monthly payment for mortgage-related obligations. The 
creditor complies even if the consumer will not establish a monthly 
escrow for flood insurance.
    iv. Assume that the subject property is part of a homeowners 
association that has imposed upon the seller a special assessment of 
$1,200. Assume further that this special assessment will become the 
consumer's obligation upon consummation of the transaction, that the 
consumer is permitted to pay the special assessment in twelve $100 
installments after consummation, and that the mortgage loan will not 
be originated pursuant to a government program that contains 
specific requirements for prorating special assessments. The 
creditor complies with Sec.  1026.43(c)(2)(v) by dividing the $1,200 
special assessment by 12 months and including the resulting $100 
monthly amount in the determination of the consumer's monthly 
payment for mortgage-related obligations. The creditor complies by 
using this calculation even if the consumer intends to pay the 
special assessment in a manner other than that used by the creditor 
in determining the monthly pro rata amount, such as where the 
consumer intends to pay six $200 installments.
    5. 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. Information is 
known if it is reasonably available to the creditor at the time of 
underwriting the loan. Creditors may rely on guidance provided under 
comment 17(c)(2)(i)-1 in determining if information is reasonably 
available. For purposes of this section, the creditor need not 
project potential changes, such as by estimating possible increases 
in taxes and insurance. See comment 43(c)(2)(v)-4 for additional 
examples discussing the projection of potential changes. The 
following examples further illustrate the requirements of Sec.  
1026.43(c)(2)(v):
    i. Assume that the property is subject to a community governance 
association, such as a homeowners association. The creditor complies 
with Sec.  1026.43(c)(2)(v) by relying on an estimate of mortgage-
related obligations prepared by the homeowners association. In 
accordance with the guidance provided under comment 17(c)(2)(i)-1, 
the creditor need only exercise due diligence in determining 
mortgage-related obligations, and complies with Sec.  
1026.43(c)(2)(v) by relying on the representations of other reliable 
parties in preparing estimates.
    ii. Assume that the homeowners association has imposed a special 
assessment on the seller, but the seller does not inform the 
creditor of the special assessment, the homeowners association does 
not include the special assessment in the estimate of expenses 
prepared for the creditor, and the creditor is unaware of the 
special assessment. The creditor complies with Sec.  
1026.43(c)(2)(v) if it does not include the special assessment in 
the determination of mortgage-related obligations. The creditor may 
rely on the representations of other reliable parties, in accordance 
with the guidance provided under comment 17(c)(2)(i)-1.
    iii. Assume that the homeowners association imposes a special 
assessment after the creditor has completed underwriting, but prior 
to consummation. The creditor does not violate Sec.  
1026.43(c)(2)(v) if the creditor does not include the special 
assessment in the determination of the consumer's monthly payment 
for mortgage-related obligations, provided the homeowners 
association does not inform the creditor about the special 
assessment during underwriting. Section 1026.43(c)(2)(v) does not 
require the creditor to re-underwrite the loan. The creditor has 
complied with Sec.  1026.43(c)(2)(v) by including the obligations 
known to the creditor at the time the loan is underwritten, even if 
the creditor learns of new mortgage-related obligations before the 
transaction is consummated.
    Paragraph 43(c)(2)(vi).
    1. Consideration of current debt obligations. Section 
1026.43(c)(2)(vi) requires creditors to consider a consumer's 
current debt obligations and any alimony or child support the 
consumer is required to pay. Examples of current debt obligations 
include student loans, automobile loans, revolving debt, and 
existing mortgages that will not be paid off at or before 
consummation. Creditors have significant flexibility to consider 
current debt obligations in light of attendant facts and 
circumstances, including that an obligation is likely to be paid off 
soon after consummation. For example, a creditor may take into 
account that an existing mortgage is

[[Page 6607]]

likely to be paid off soon after consummation because there is an 
existing contract for sale of the property that secures that 
mortgage. Similarly, creditors should consider whether debt 
obligations in forbearance or deferral at the time of underwriting 
are likely to affect the consumer's ability to repay based on the 
payment for which the consumer will be liable upon expiration of the 
forbearance or deferral period and other relevant facts and 
circumstances, such as when the forbearance or deferral period will 
expire.
    2. Multiple applicants. When two or more consumers apply for an 
extension of credit as joint obligors with primary liability on an 
obligation, Sec.  1026.43(c)(2)(vi) requires a creditor to consider 
the debt obligations of all such joint applicants. For example, if a 
co-applicant is repaying a student loan at the time of underwriting, 
the creditor complies with Sec.  1026.43(c)(2)(vi) by considering 
the co-applicant's student loan obligation. If one consumer is 
merely a surety or guarantor, Sec.  1026.43(c)(2)(vi) does not 
require a creditor to consider the debt obligations of such surety 
or guarantor. The requirements of Sec.  1026.43(c)(2)(vi) do not 
affect the disclosure requirements of this part, such as, for 
example, Sec. Sec.  1026.17(d), 1026.23(b), 1026.31(e), 
1026.39(b)(3), and 1026.46(f).
    Paragraph 43(c)(2)(vii).
    1. Monthly debt-to-income ratio and residual income. See Sec.  
1026.43(c)(7) and its associated commentary regarding the 
definitions and calculations for the monthly debt-to-income ratio 
and residual income.
    Paragraph 43(c)(2)(viii).
    1. Consideration of credit history. ``Credit history'' may 
include factors such as the number and age of credit lines, payment 
history, and any judgments, collections, or bankruptcies. Section 
1026.43(c)(2)(viii) does not require creditors to obtain or consider 
a consolidated credit score or prescribe a minimum credit score that 
creditors must apply. The rule also does not specify which aspects 
of credit history a creditor must consider or how various aspects of 
credit history should be weighed against each other or against other 
underwriting factors. Some aspects of a consumer's credit history, 
whether positive or negative, may not be directly indicative of the 
consumer's ability to repay. A creditor therefore may give various 
aspects of a consumer's credit history as much or as little weight 
as is appropriate to reach a reasonable, good faith determination of 
ability to repay. Where a consumer has obtained few or no extensions 
of traditional ``credit,'' as defined in Sec.  1026.2(a)(14), a 
creditor may, but is not required to, look to nontraditional credit 
references, such as rental payment history or utility payments.
    2. Multiple applicants. When two or more consumers apply for an 
extension of credit as joint obligors with primary liability on an 
obligation, Sec.  1026.43(c)(2)(viii) requires a creditor to 
consider the credit history of all such joint applicants. If a 
consumer is merely a surety or guarantor, Sec.  1026.43(c)(2)(viii) 
does not require a creditor to consider the credit history of such 
surety or guarantor. The requirements of Sec.  1026.43(c)(2)(viii) 
do not affect the disclosure requirements of this part, such as, for 
example, Sec. Sec.  1026.17(d), 1026.23(b), 1026.31(e), 
1026.39(b)(3), and 1026.46(f).
    43(c)(3) Verification using third-party records.
    1. Records specific to the individual consumer. Records a 
creditor uses for verification under Sec.  1026.43(c)(3) and (4) 
must be specific to the individual consumer. Records regarding 
average incomes in the consumer's geographic location or average 
wages paid by the consumer's employer, for example, are not specific 
to the individual consumer and are not sufficient for verification.
    2. Obtaining records. To conduct verification under Sec.  
1026.43(c)(3) and (4), a creditor 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. A 
creditor also may obtain third-party records directly from the 
consumer, likewise as long as the records are reasonably reliable 
and specific to the individual consumer. For example, a creditor 
using payroll statements to verify the consumer's income, as allowed 
under Sec.  1026.43(c)(4)(iii), may obtain the payroll statements 
from the consumer.
    3. Credit report as a reasonably reliable third-party record. A 
credit report generally is considered a reasonably reliable third-
party record under Sec.  1026.43(c)(3) for purposes of verifying 
items customarily found on a credit report, such as the consumer's 
current debt obligations, monthly debts, and credit history. Section 
1026.43(c)(3) generally does not require creditors to obtain 
additional reasonably reliable third-party records to verify 
information contained in a credit report. For example, if a credit 
report states the existence and amount of a consumer's debt 
obligation, the creditor is not required to obtain additional 
verification of the existence or amount of that obligation. In 
contrast, a credit report does not serve as a reasonably reliably 
third-party record for purposes of verifying items that do not 
appear on the credit report. For example, certain monthly debt 
obligations, such as legal obligations like alimony or child 
support, may not be reflected on a credit report. Thus, a credit 
report that does not list a consumer's monthly alimony obligation 
does not serve as a reasonably reliable third-party record for 
purposes of verifying that obligation. If a credit report reflects a 
current debt obligation that a consumer has not listed on the 
application, the creditor complies with Sec.  1026.43(c)(3) if the 
creditor considers the existence and amount of the debt obligation 
as it is reflected in the credit report. However, in some cases a 
creditor may know or have reason to know that a credit report may be 
inaccurate in whole or in part. For example, a creditor may have 
information indicating that a credit report is subject to a fraud 
alert, extended alert, active duty alert, or similar alert 
identified in 15 U.S.C. 1681c-1 or that a debt obligation listed on 
a credit report is subject to a statement of dispute pursuant to 15 
U.S.C. 1681i(b). A creditor may also have other reasonably reliable 
third-party records or other information or evidence that the 
creditor reasonably finds to be reliable that contradict the credit 
report or otherwise indicate that the credit report is inaccurate. 
If a creditor knows or has reason to know that a credit report may 
be inaccurate in whole or in part, the creditor complies with Sec.  
1026.43(c)(3) by disregarding an inaccurate or disputed item, items, 
or credit report, but does not have to obtain additional third-party 
records. The creditor may also, but is not required, to obtain other 
reasonably reliable third-party records to verify information with 
respect to which the credit report, or item therein, may be 
inaccurate. For example, the creditor might obtain statements or 
bank records regarding a particular debt obligation subject to a 
statement of dispute. See also comment 43(c)(3)-6, which describes a 
situation in which a consumer reports a debt obligation that is not 
listed on a credit report.
    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 and may not 
reflect a loan that 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. For 
further guidance, see comments 43(c)(3)-1 and -2 discussing 
verification using third-party records.
    5. Verification of mortgage-related obligations. Creditors must 
make the repayment ability determination required under Sec.  
1026.43(c)(2) based on information verified from reasonably reliable 
records. For general guidance regarding verification see comments 
43(c)(3)-1 and -2, which discuss verification using third-party 
records. With respect to the verification of mortgage-related 
obligations that are property taxes required to be considered under 
Sec.  1026.43(c)(2)(v), a record is reasonably reliable if the 
information in the record was provided by a governmental 
organization, such as a taxing authority or local government. The 
creditor complies with Sec.  1026.43(c)(2)(v) by relying on property 
taxes referenced in the title report if the source of the property 
tax information was a local taxing authority. With respect to other 
information in a record provided by an entity assessing charges, 
such as a homeowners association, the creditor complies with Sec.  
1026.43(c)(2)(v) if it relies on homeowners association billing 
statements provided by the seller. Records are also reasonably 
reliable if the information in the record was obtained from a valid 
and legally executed contract. For example, the creditor complies 
with Sec.  1026.43(c)(2)(v) by relying on the amount of monthly 
ground rent referenced in the ground rent agreement currently in 
effect and applicable to the subject property. Records, other than 
those discussed above, may be reasonably reliable for purposes of 
Sec.  1026.43(c)(2)(v) if the source provided the information 
objectively.
    6. Verification of current debt obligations. Section 
1026.43(c)(3) does not require

[[Page 6608]]

creditors to obtain additional records to verify the existence or 
amount of obligations shown on a consumer's credit report or listed 
on the consumer's application, absent circumstances described in 
comment 43(c)(3)-3. Under Sec.  1026.43(c)(3)(iii), if a creditor 
relies on a consumer's credit report to verify a consumer's current 
debt obligations and the consumer's application lists a debt 
obligation not shown on the credit report, the creditor may consider 
the existence and amount of the obligation as it is stated on the 
consumer's application. The creditor is not required to further 
verify of the existence or amount of the obligation, absent 
circumstances described in comment 43(c)(3)-3.
    7. Verification of credit history. To verify credit history, a 
creditor may, for example, look to credit reports from credit 
bureaus or to reasonably reliable third-party records that evidence 
nontraditional credit references, such as evidence of rental payment 
history or public utility payments.
    8. Verification of military employment. A creditor may verify 
the employment status of military personnel by using a military 
Leave and Earnings Statement or by 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.
    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. See also comments 43(c)(3)-1 and -2.
    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. See comment 43(c)(2)(i)-5.
    3. Tax-return transcript. Under Sec.  1026.43(c)(4), a creditor 
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. A creditor may 
obtain a copy of a tax-return transcript or a filed tax return 
directly from the consumer or from a service provider. A creditor 
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, a 
creditor 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.  1026.43(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.  
1026.43(c)(5). The payment calculation methods differ depending on 
the type of credit extended. The payment calculation method set 
forth in Sec.  1026.43(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 such covered transaction 
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.  1026.18(s)(7)(iii), (i), (ii), (iv) and 
(v), respectively. For the meaning of the term ``balloon payment,'' 
see Sec.  1026.18(s)(5)(i). The payment calculation methods set 
forth in Sec.  1026.43(c)(5)(ii) apply to any covered transaction 
that is a loan with a balloon payment, interest-only loan, or 
negative amortization loan. See comment 43(c)(5)(i)-5 and the 
commentary to Sec.  1026.43(c)(5)(ii), which provide examples for 
calculating the monthly payment for purposes of the repayment 
ability determination required under Sec.  1026.43(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. Sometimes, 
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., fully indexed rate). However, an initial rate that is a 
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.  1026.43(b)(3).
    3. Monthly, fully amortizing payments. Section 1026.43(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.  
1026.43(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 under Sec.  1026.43(c)(5)(i), 
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 percent (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.  1026.17(c)(3) (discussing minor 
variations), and Sec.  1026.17(c)(4)(i) through (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.  1026.43(c)(5)(i) 
(all amounts shown are rounded, and all amounts are calculated using 
non-rounded values):
    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 percent. For 
purposes of Sec.  1026.43(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 percent.
    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 percent 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 percent, subject to a 2 percent annual periodic interest 
rate adjustment cap. The index value in effect at consummation is 
4.5 percent; the fully indexed rate is 7.5 percent (4.5 percent plus 
3 percent). Even though the scheduled monthly payment required for 
the first five years is $1199, for purposes of Sec.  
1026.43(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 
percent.
    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 percent for the first two years of the loan, 7 
percent for the next three years of the loan, and 7.5 percent 
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

[[Page 6609]]

purposes of Sec.  1026.43(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 percent.
    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.  1026.43(b)(4), or is not a 
higher-priced covered transaction because the annual percentage rate 
does not exceed the applicable threshold calculated using the 
applicable average prime offer rate (APOR) for a comparable 
transaction. ``Average prime offer rate'' is defined in Sec.  
1026.35(a)(2); ``higher-priced covered transaction'' is defined in 
Sec.  1026.43(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 the date on which 
the first regular periodic payment will be due. ``Balloon payment'' 
is defined in Sec.  1026.18(s)(5)(i).
    2. First five years after the date on which the first regular 
periodic payment will be due. Under Sec.  1026.43(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 the date on which the first regular 
periodic payment will be due. To illustrate:
    i. Assume a loan that provides for regular monthly payments and 
a balloon payment due at the end of a six-year loan term. The loan 
is consummated on August 15, 2014, and the first monthly payment is 
due on October 1, 2014. The first five years after the first monthly 
payment end on October 1, 2019. The balloon payment must be made on 
the due date of the 72nd monthly payment, which is September 1, 
2020. For purposes of determining the consumer's ability to repay 
the loan under Sec.  1026.43(c)(2)(iii), the creditor need not 
consider the balloon payment that is due on September 1, 2020.
    ii. Assume a loan that provides for regular monthly payments and 
a balloon payment due at the end of a five-year loan term. The loan 
is consummated on August 15, 2014, and the first monthly payment is 
due on October 1, 2014. The first five years after the first monthly 
payment end on October 1, 2019. The balloon payment must be made on 
the due date of the 60th monthly payment, which is September 1, 
2019. For purposes of determining the consumer's ability to repay 
the loan under Sec.  1026.43(c)(2)(iii), the creditor must consider 
the balloon payment that is due on September 1, 2019.
    3. Renewable balloon-payment mortgage; loan term. A balloon-
payment mortgage that is not a higher-priced covered transaction 
could provide that a creditor is unconditionally obligated to renew 
a balloon-payment mortgage 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-payment mortgages. 
For purposes of this section, the loan term does not include any 
period of time that could result from a renewal provision. To 
illustrate, assume a three-year balloon-payment mortgage 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-payment 
mortgage is three years, and not the potential six 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 three-year loan term. See 
comment 43(c)(5)(ii)(A)-4.ii, which provides an example of how to 
determine the consumer's repayment ability for a three-year 
renewable balloon-payment mortgage that is not a higher-priced 
covered transaction.
    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 the date on which the first regular periodic payment will be 
due (all amounts shown are rounded, and all amounts are calculated 
using non-rounded values):
    i. Balloon-payment mortgage with a three-year loan term; fixed 
interest rate. A loan agreement provides for a fixed interest rate 
of 6 percent, which is below the APOR-calculated 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.  1026.43(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 mortgage with a three-year loan 
term. Assume the same facts above in comment 43(c)(5)(ii)(A)-4.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. In determining the maximum payment scheduled during the 
first five years after the date on which the first regular periodic 
payment will be due, the creditor must use a loan term of three 
years. Accordingly, for purposes of Sec.  1026.43(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 mortgage with a six-year loan term; fixed 
interest rate. A loan provides for a fixed interest rate of 6 
percent, 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 six-
year loan term but is amortized over 30 years. The loan is 
consummated on March 15, 2014, and the monthly payment scheduled for 
the first six years following consummation is $1,199, with the first 
monthly payment due on May 1, 2014. The first five years after the 
date on which the first regular periodic payment will be due end on 
May 1, 2019. The balloon payment of $183,995 is required on the due 
date of the 72nd monthly payment, which is April 1, 2020 (more than 
five years after the date on which the first regular periodic 
payment will be due). For purposes of Sec.  1026.43(c)(2)(iii), the 
creditor may 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 $183,995 due on April 1, 2020.
    5. Higher-priced covered transaction with a balloon payment. 
Where a loan with a balloon payment is a higher-priced covered 
transaction, the creditor must determine the consumer's repayment 
ability based on the loan's payment schedule, including any balloon 
payment. For example (all amounts are rounded): Assume a higher-
priced covered transaction with a fixed interest rate of 7 percent. 
The loan amount is $200,000 and the loan has a ten 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 $172,955. 
For purposes of Sec.  1026.43(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 $172,955.
    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.  
1026.43(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.  1026.43(b)(5) and (b)(11), 
respectively. ``Interest-only'' and ``Interest-only loan'' are 
defined in Sec.  1026.18(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.  1026.43(c)(5)(ii)(B) 
(all amounts shown are rounded, and all amounts are calculated using 
non-rounded values):
    i. Fixed-rate mortgage with interest-only payments for five 
years. A loan in an amount

[[Page 6610]]

of $200,000 has a 30-year loan term. The loan agreement provides for 
a fixed interest rate of 7 percent, and permits interest-only 
payments for the first five years. The monthly payment of $1,167 
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 $1,414, 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.  1026.43(c)(2)(iii), the creditor must determine 
the consumer's ability to repay the loan based on a payment of 
$1,414, 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 
percent.
    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 percent 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 percent, 
subject to an annual interest rate adjustment cap of 2 percent. The 
index value in effect at consummation is 4.5 percent; the fully 
indexed rate is 7.5 percent (4.5 percent plus 3 percent). The 
monthly payments for the first three years are $833. For the fourth 
year, the payments are $1,167, based on an interest rate of 7 
percent, calculated by adding the 2 percent annual adjustment cap to 
the initial rate of 5 percent. For the fifth year, the payments are 
$1,250, applying the fully indexed rate of 7.5 percent. These first 
five years of payments will 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 $1,478, 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.  
1026.43(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 
percent.
    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 the loan term after the loan 
is recast. ``Recast'' is defined in Sec.  1026.43(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.  1026.43(c)(5)(ii)(C), see Sec.  
1026.43(b)(7) and associated commentary. ``Negative amortization 
loan'' is defined in Sec.  1026.18(s)(7)(v).
    2. Term of loan. Under Sec.  1026.43(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.  
1026.43(c)(5)(ii)(C) (all amounts shown are rounded, and all amounts 
are calculated using non-rounded values):
    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 percent of its original balance (i.e., a negative 
amortization cap of 115 percent) or for the first five years of the 
loan (60 monthly payments), whichever occurs first. The introductory 
interest rate at consummation is 1.5 percent. One month after 
consummation, the interest rate adjusts and will adjust monthly 
thereafter based on the specified index plus a margin of 3.5 
percent. The index value in effect at consummation is 4.5 percent; 
the fully indexed rate is 8 percent (4.5 percent plus 3.5 percent). 
The maximum lifetime interest rate is 10.5 percent; 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 percent. After that, the minimum monthly payment adjusts 
annually, but may increase by no more than 7.5 percent over the 
previous year's payment. The minimum monthly payment is $690 in the 
first year, $742 in the second year, and $797 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 percent at the first adjustment (i.e., the due date of the 
first periodic monthly payment), 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 percent 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 percent is reached at the 
first rate adjustment (i.e., the due date of the first periodic 
monthly payment), the negative amortization cap of 115 percent 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 $229,251, and the remaining term of 
the loan is 27 years and nine months (333 months).
    C. For purposes of Sec.  1026.43(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 $229,251 over the remaining loan term of 333 months using 
the fully indexed rate of 8 percent. See comments 43(b)(7)-1 and -2 
discussing the calculation of the maximum loan amount, and Sec.  
1026.43(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 percent, and requires the consumer to 
make minimum monthly payments during the first year, with payments 
increasing 12.5 percent over the previous year every year for four 
years (the annual payment cap). The payment schedule provides for 
payments of $943 in the first year, $1,061 in the second year, 
$1,193 in the third year, $1,343 in the fourth year, and then 
requires $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 the 
minimum payments increase year-to-year up to the 12.5 percent 
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 $207,662, and the 
remaining loan term is 27 years (324 months). For purposes of Sec.  
1026.43(c)(2)(iii), the creditor must determine the consumer's 
ability to repay the loan based on a monthly payment of $1,497, 
which is the substantially equal, monthly payment of principal and 
interest that will repay the maximum loan amount of $207,662 over 
the remaining loan term of 27 years using the fixed interest rate of 
7.5 percent.
    43(c)(6) Payment calculation for simultaneous loans.
    1. Scope. In determining the consumer's repayment ability for a 
covered transaction under Sec.  1026.43(c)(2)(iii), a creditor must 
include consideration of any simultaneous loan which it knows, or 
has reason to know, will be made at or before consummation of

[[Page 6611]]

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.  1026.43(b)(12).
    2. Payment calculation--covered transaction. For a simultaneous 
loan that is a covered transaction, as that term is defined under 
Sec.  1026.43(b)(1), a creditor must determine a consumer's ability 
to repay the monthly payment obligation for a simultaneous loan as 
set forth in Sec.  1026.43(c)(5), taking into account any mortgage-
related obligations required to be considered under Sec.  
1026.43(c)(2)(v). For the meaning of the term ``mortgage-related 
obligations,'' see Sec.  1026.43(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.  1026.40, 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.  1026.43(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. Any additional draw against the line of credit 
that the creditor of the covered transaction does not know or have 
reason to know about before or during underwriting need not be 
considered in relation to ability to repay. For example, where the 
creditor's policies and procedures require the source of down 
payment to be verified, and the creditor verifies that a 
simultaneous loan that is a HELOC will provide the source of down 
payment for the first-lien covered transaction, the creditor must 
consider the periodic payment on the HELOC by assuming the amount 
drawn is at least the down payment amount. In general, a creditor 
should determine the periodic payment based on guidance in the 
commentary to Sec.  1026.40(d)(5) (discussing payment terms).
    43(c)(7) Monthly debt-to-income ratio or residual income.
    1. Monthly debt-to-income ratio or monthly residual income. 
Under Sec.  1026.43(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.  
1026.43(c)(7). In contrast to the qualified mortgage provisions in 
Sec.  1026.43(e), Sec.  1026.43(c) does not prescribe a specific 
monthly debt-to-income ratio with which creditors must comply. 
Instead, an appropriate threshold for a consumer's monthly debt-to-
income ratio or monthly residual income is for the creditor to 
determine in making a reasonable and good faith determination of a 
consumer's ability to repay.
    2. Use of both monthly debt-to-income ratio and monthly residual 
income. If a creditor considers the consumer's monthly debt-to-
income ratio, the creditor may also consider the consumer's residual 
income as further validation of the assessment made using the 
consumer's monthly debt-to-income ratio.
    3. Compensating factors. The creditor may consider factors in 
addition to the monthly debt-to-income ratio or residual income in 
assessing a consumer's repayment ability. For example, the creditor 
may reasonably and in good faith determine that a consumer has the 
ability to repay despite a higher debt-to-income ratio or lower 
residual income in light of the consumer's assets other than the 
dwelling, including any real property attached to the dwelling, 
securing the covered transaction, such as a savings account. The 
creditor may also reasonably and in good faith determine that a 
consumer has the ability to repay despite a higher debt-to-income 
ratio in light of the consumer's residual income.
    43(d) Refinancing of non-standard mortgages.
    43(d)(1) Definitions.
    43(d)(1)(i) Non-standard mortgage.
    Paragraph 43(d)(1)(i)(A).
    1. Adjustable-rate mortgage with an introductory fixed rate. 
Under Sec.  1026.43(d)(1)(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 one-half years is not a ``non-standard mortgage.''
    43(d)(1)(ii) Standard mortgage.
    Paragraph 43(d)(1)(ii)(A).
    1. Regular periodic payments. Under Sec.  1026.43(d)(1)(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)(1)(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 
adjustable-rate mortgage that applies the same fixed interest rate 
to determine the first 60 payments of principal and interest due. 
The loan is consummated on August 15, 2013, and the first monthly 
payment is due on October 1, 2013. The date that is five years after 
consummation is August 15, 2018. The first interest rate adjustment 
occurs on September 1, 2018. This loan meets the criterion for a 
``standard mortgage'' under Sec.  1026.43(d)(1)(ii)(D) because the 
interest rate is fixed until September 1, 2018, 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)(1)(ii)(E).
    1. Permissible use of proceeds. To qualify as a ``standard 
mortgage,'' the loan's 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)(2) Scope.
    1. Written application. For an explanation of the requirements 
for a ``written application'' in Sec.  1026.43(d)(2)(iii), 
(d)(2)(iv), and (d)(2)(v), see comment 19(a)(1)(i)-3.
    Paragraph 43(d)(2)(ii).
    1. Materially lower. The exemptions afforded under Sec.  
1026.43(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.  1026.43(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)(2)(iv).
    1. Late payment--12 months prior to application. Under Sec.  
1026.43(d)(2)(iv), the exemptions in Sec.  1026.43(d)(3) apply to a 
covered transaction only if, during the 12 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)(2)-1.) For example, assume a consumer applies for a 
refinancing on May 1, 2014. Assume also that the consumer made a 
non-standard mortgage payment on August 15, 2013, that was 45 days 
late. The consumer made no other late payments on the non-standard 
mortgage between May 1, 2013, and May 1, 2014. In this example, the 
requirement under Sec.  1026.43(d)(2)(iv) is met because the 
consumer made only one payment that was over 30 days late within the 
12 months prior to applying for the refinancing (i.e., eight 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

[[Page 6612]]

by the 16th of the month, the payment due date for purposes of Sec.  
1026.43(d)(2)(iv) and (v) is the first day of the month, not the 
16th day of the month. Thus, a payment due under the contract on 
October 1st that is paid on November 1st is made more than 30 days 
after the payment due date.
    Paragraph 43(d)(2)(v).
    1. Late payment--six months prior to application. Under Sec.  
1026.43(d)(2)(v), the exemptions in Sec.  1026.43(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)(2)-1 and 43(d)(2)(iv)-2.) For 
example, assume a consumer with a non-standard mortgage applies for 
a refinancing on May 1, 2014. If the consumer made a payment on 
March 15, 2014, that was 45 days late, the requirement under Sec.  
1026.43(d)(2)(v) is not met because the consumer made a payment more 
than 30 days late 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.
    Paragraph 43(d)(2)(vi).
    1. Non-standard mortgage loan made in accordance with ability-
to-repay or qualified mortgage requirements. For non-standard 
mortgages that are consummated on or after January 10, 2014, Sec.  
1026.43(d)(2)(vi) provides that the refinancing provisions set forth 
in Sec.  1026.43(d) apply only if the non-standard mortgage was made 
in accordance with the requirements of Sec.  1026.43(c) or (e), as 
applicable. For example, if a creditor originated a non-standard 
mortgage on or after January 10, 2014 that did not comply with the 
requirements of Sec.  1026.43(c) and was not a qualified mortgage 
pursuant to Sec.  1026.43(e), Sec.  1026.43(d) would not apply to 
the refinancing of the non-standard mortgage loan into a standard 
mortgage loan. However, Sec.  1026.43(d) applies to the refinancing 
of a non-standard mortgage loan into a standard mortgage loan, 
regardless of whether the non-standard mortgage loan was made in 
compliance with Sec.  1026.43(c) or (e), if the non-standard 
mortgage loan was consummated prior to January 10, 2014.
    43(d)(3) Exemption from repayment ability requirements.
    1. Two-part determination. To qualify for the exemptions in 
Sec.  1026.43(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 likely would 
prevent the consumer's default.
    43(d)(4) Offer of rate discounts and other favorable terms.
    1. Documented underwriting practices. In connection with a 
refinancing made pursuant to Sec.  1026.43(d), Sec.  1026.43(d)(4) 
requires a creditor offering a consumer rate discounts and terms 
that are the same as, or better than, the rate discounts and terms 
offered to new consumers to make such an offer consistent with the 
creditor's documented underwriting practices. Section 1026.43(d)(4) 
does not require a creditor making a refinancing pursuant to Sec.  
1026.43(d) to comply with the underwriting requirements of Sec.  
1026.43(c). Rather, Sec.  1026.43(d)(4) requires creditors providing 
such discounts to do so consistent with documented policies related 
to loan pricing, loan term qualifications, or other similar 
underwriting practices. For example, assume that a creditor is 
providing a consumer with a refinancing made pursuant to Sec.  
1026.43(d) and that this creditor has a documented practice of 
offering rate discounts to consumers with credit scores above a 
certain threshold. Assume further that the consumer receiving the 
refinancing has a credit score below this threshold, and therefore 
would not normally qualify for the rate discount available to 
consumers with high credit scores. This creditor complies with Sec.  
1026.43(d)(4) by offering the consumer the discounted rate in 
connection with the refinancing made pursuant to Sec.  1026.43(d), 
even if the consumer would not normally qualify for that discounted 
rate, provided that the offer of the discounted rate is not 
prohibited by applicable State or Federal law. However, Sec.  
1026.43(d)(4) does not require a creditor to offer a consumer such a 
discounted rate.
    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.  1026.43(d)(2)(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.  1026.43(b)(11) and associated commentary.
    2. Fully indexed rate. The term ``fully indexed rate'' in Sec.  
1026.43(d)(5)(i)(A) for calculating the payment for a non-standard 
mortgage is generally defined in Sec.  1026.43(b)(3) and associated 
commentary. Under Sec.  1026.43(b)(3) the fully indexed rate is 
calculated at the time of consummation. For purposes of Sec.  
1026.43(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.  1026.43(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.  1026.43(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, 2014, the creditor must calculate the 
outstanding principal balance as of September 1, 2014, 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 
monthly payments).
    iii. Third, the payment must be based on the fully indexed rate, 
as described in Sec.  1026.43(d)(5)(i)(A).
    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 percent 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 is consummated on February 15, 
2014, and the first monthly payment is due on April 1, 2014. The 
loan is recast on the due date of the 24th monthly payment, which is 
March 1, 2016.
    iii. On March 15, 2015, 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 
percent.
    iv. To calculate the non-standard mortgage payment that must be 
compared to the standard mortgage payment under Sec.  
1026.43(d)(2)(ii), the creditor must use:
    A. The outstanding principal balance as of March 1, 2016, 
assuming all scheduled payments have been made up to March 1, 2016, 
and the last payment due under the fixed rate terms is made and 
credited on March 1, 2016. In this example, the outstanding 
principal balance is $193,948.
    B. The fully indexed rate of 7.5 percent, which is the index 
value of 4.5 percent as of March 15, 2015 (the date on which the 
application for a refinancing is received) plus the margin of 3 
percent.
    C. The remaining loan term as of March 1, 2016, the date of the 
recast, which is 28 years (336 monthly payments).
    v. Based on these assumptions, the monthly payment for the non-
standard mortgage for purposes of determining

[[Page 6613]]

whether the standard mortgage monthly payment is lower than the non-
standard mortgage monthly payment (see Sec.  1026.43(d)(2)(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.  
1026.43(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 outstanding principal 
balance as of the date of the recast, assuming all scheduled 
payments are made under the terms of the legal obligation in effect 
before the mortgage is recast. For a loan on which only interest and 
no principal has been paid, the outstanding principal balance at the 
time of recast will be the loan amount, as defined in Sec.  
1026.43(b)(5), 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, 2015, the creditor must 
calculate the outstanding principal balance as of September 1, 2015, 
assuming that all 24 payments under the interest-only payment terms 
have been made and credited timely and that no payments of principal 
have been made.
    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 monthly payments).
    iii. Third, the payment must be based on the fully indexed rate, 
as described in Sec.  1026.43(d)(5)(i)(A).
    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 percent, 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 is consummated on February 15, 
2014, and the first monthly payment is due on April 1, 2014. The 
loan is recast on the due date of the 24th monthly payment, which is 
March 1, 2016.
    iii. On March 15, 2015, the creditor receives the consumer's 
written application for a refinancing, after the consumer has made 
12 monthly on-time payments. The consumer has made no additional 
payments of principal.
    iv. To calculate the non-standard mortgage payment that must be 
compared to the standard mortgage payment under Sec.  
1026.43(d)(2)(ii), the creditor must use:
    A. The loan amount, which is the outstanding principal balance 
as of March 1, 2016, 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 percent, 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, 2016, the date of the 
recast, which is 28 years (336 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.  1026.43(d)(2)(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.  1026.43(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, determined after adjusting for the outstanding principal 
balance. If the consumer makes only the minimum periodic payments 
for the maximum possible time, until the consumer must begin making 
fully amortizing payments, the outstanding principal balance will be 
the maximum loan amount, as defined in Sec.  1026.43(b)(7). In this 
event, the creditor complies with Sec.  1026.43(d)(5)(i)(C)(3) by 
relying on the examples of how to calculate the maximum loan amount, 
see comment 43(b)(7)-3. If the consumer makes payments above the 
minimum periodic payments for the maximum possible time, the 
creditor must calculate the maximum loan amount based on the 
outstanding principal balance. In this event, the creditor complies 
with Sec.  1026.43(d)(5)(i)(C)(3) by relying on the examples of how 
to calculate the maximum loan amount in comment 43(d)(5)(i)-10.
    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 remaining loan term of 25 years (300 
monthly 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 if only minimum payments made. 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 percent 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 percent.
    ii. The non-standard mortgage is consummated on February 15, 
2014, and the first monthly payment is due on April 1, 2014. Assume 
that the consumer has made only the minimum periodic payments. 
Assume further that, based on the calculation of the maximum loan 
amount required under Sec.  1026.43(b)(7) and associated commentary, 
the negative amortization cap of 115 percent would be reached on 
June 1, 2016, the due date of the 27th monthly payment.
    iii. On March 15, 2015, 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 
percent.
    iv. To calculate the non-standard mortgage payment that must be 
compared to the standard mortgage payment under Sec.  
1026.43(d)(2)(ii), the creditor must use:
    A. The maximum loan amount of $229,251 as of June 1, 2016;
    B. The fully indexed rate of 8 percent, which is the index value 
of 4.5 percent as of March 15, 2015 (the date on which the creditor 
receives the application for a refinancing) plus the margin of 3.5 
percent; and
    C. The remaining loan term as of June 1, 2016, the date of the 
recast, which is 27 years and nine months (333 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.  1026.43(d)(2)(ii)) is $1,716. 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.
    10. Example of payment calculation for a negative amortization 
loan if payments above minimum amount made. 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 percent 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 percent. 
The introductory interest rate at consummation is 1.5 percent. One 
month after consummation, the interest rate adjusts and will adjust 
monthly thereafter based on the specified index plus a margin of 3.5 
percent. The maximum lifetime interest rate is 10.5 percent; 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

[[Page 6614]]

on the initial interest rate of 1.5 percent. After that, the minimum 
monthly payment adjusts annually, but may increase by no more than 
7.5 percent over the previous year's payment. The minimum monthly 
payment is $690 in the first year, $742 in the second year, $798 in 
the third year, $857 in the fourth year, and $922 in the fifth year.
    ii. The non-standard mortgage is consummated on February 15, 
2014, and the first monthly payment is due on April 1, 2014. Assume 
that the consumer has made more than the minimum periodic payments, 
and that after the consumer's 12th monthly on-time payment the 
outstanding principal balance is $195,000. Based on the calculation 
of the maximum loan amount after adjusting for this outstanding 
principal balance, the negative amortization cap of 115 percent 
would be reached on March 1, 2019, the due date of the 60th monthly 
payment.
    iii. On March 15, 2015, 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 
percent.
    iv. To calculate the non-standard mortgage payment that must be 
compared to the standard mortgage payment under Sec.  
1026.43(d)(2)(ii), the creditor must use:
    A. The maximum loan amount of $229,219 as of March 1, 2019.
    B. The fully indexed rate of 8 percent, which is the index value 
of 4.5 percent as of March 15, 2015 (the date on which the creditor 
receives the application for a refinancing) plus the margin of 3.5 
percent.
    C. The remaining loan term as of March 1, 2019, the date of the 
recast, which is exactly 25 years (300 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.  1026.43(d)(2)(ii)) is $1,769. 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 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.  
1026.43(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 after consummation, 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, 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 after the date on which the first regular 
periodic payment will be due is 4 percent, the rate for the 
following two years is 5 percent, and the rate for the next two 
years is 6 percent, the rate that must be used is 6 percent.
    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 an interest rate of 6 percent 
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 percent, subject to a 2 percent 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.  1026.43(d)(2)(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 
percent.
    43(e) Qualified mortgages.
    43(e)(1) Safe harbor and presumption of compliance.
    1. General. Section 1026.43(c) requires a creditor to make a 
reasonable and good faith determination at or before consummation 
that a consumer will be able to repay a covered transaction. Section 
1026.43(e)(1)(i) and (ii) provide a safe harbor and presumption of 
compliance, respectively, with the repayment ability requirements of 
Sec.  1026.43(c) for creditors and assignees of covered transactions 
that satisfy the requirements of a qualified mortgage under Sec.  
1026.43(e)(2), (e)(4), or (f). See Sec.  1026.43(e)(1)(i) and (ii) 
and associated commentary.
    43(e)(1)(i) Safe harbor for transactions that are not higher-
priced covered transactions.
    1. Safe harbor. To qualify for the safe harbor in Sec.  
1026.43(e)(1)(i), a covered transaction must meet the requirements 
of a qualified mortgage under Sec.  1026.43(e)(2), (e)(4), or (f) 
and must not be a higher-priced covered transaction, as defined in 
Sec.  1026.43(b)(4). For guidance on determining whether a loan is a 
higher-priced covered transaction, see comment 43(b)(4)-1.
    43(e)(1)(ii) Presumption of compliance for higher-priced covered 
transactions.
    1. General. Under Sec.  1026.43(e)(1)(ii), a creditor or 
assignee of a qualified mortgage under Sec.  1026.43(e)(2), (e)(4), 
or (f) that is a higher-priced covered transaction is presumed to 
comply with the repayment ability requirements of Sec.  1026.43(c). 
To rebut the presumption, it must be proven that, despite meeting 
the standards for a qualified mortgage (including either the debt-
to-income standard in Sec.  1026.43(e)(2)(vi) or the standards of 
one of the entities specified in Sec.  1026.43(e)(4)(ii)), the 
creditor did not have a reasonable and good faith belief in the 
consumer's repayment ability. Specifically, it must be proven that, 
at the time of consummation, based on the information available to 
the creditor, the consumer's income, debt obligations, alimony, 
child support, and the consumer's monthly payment (including 
mortgage-related obligations) on the covered transaction and on any 
simultaneous loans of which the creditor was aware at consummation 
would leave the consumer with insufficient residual income or assets 
other than the value of the dwelling (including any real property 
attached to the dwelling) that secures the loan with which to meet 
living expenses, including any recurring and material non-debt 
obligations of which the creditor was aware at the time of 
consummation, and that the creditor thereby did not make a 
reasonable and good faith determination of the consumer's repayment 
ability. For example, a consumer may rebut the presumption with 
evidence demonstrating that the consumer's residual income was 
insufficient to meet living expenses, such as food, clothing, 
gasoline, and health care, including the payment of recurring 
medical expenses of which the creditor was aware at the time of 
consummation, and after taking into account the consumer's assets 
other than the value of the dwelling securing the loan, such as a 
savings account. In addition, the longer the period of time that the 
consumer has demonstrated actual ability to repay the loan by making 
timely payments, without modification or accommodation, after 
consummation or, for an adjustable-rate mortgage, after recast, the 
less likely the consumer will be able to rebut the presumption based 
on insufficient residual income and prove that, at the time the loan 
was made, the creditor failed to make a reasonable and good faith 
determination that the consumer had the reasonable ability to repay 
the loan.
    43(e)(2) Qualified mortgage defined--general.
    Paragraph 43(e)(2)(i).
    1. Regular periodic payments. Under Sec.  1026.43(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.  1026.43(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.  
1026.43(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.  1026.43(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

[[Page 6615]]

example, allow deferral of principal repayment in this manner and 
therefore may not be qualified mortgages.
    Paragraph 43(e)(2)(ii).
    1. General. The 30-year term limitation in Sec.  
1026.43(e)(2)(ii) is applied without regard to any interim period 
between consummation and the beginning of the first full unit period 
of the repayment schedule. For example, assume a covered transaction 
is consummated on March 20, 2014 and the due date of the first 
regular periodic payment is April 30, 2014. The beginning of the 
first full unit period of the repayment schedule is April 1, 2014 
and the loan term therefore ends on April 1, 2044. The transaction 
would comply with the 30-year term limitation in Sec.  
1026.43(e)(2)(ii).
    Paragraph 43(e)(2)(iv).
    1. Maximum interest rate during the first five years. 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 the 
date on which the first regular periodic payment will be due. 
Creditors must use the maximum rate that could apply at any time 
during the first five years after the date on which the first 
regular periodic payment will be due, 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.  1026.18(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 Sec.  1026.43(e)(2)(iv). 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 the date on which the first 
regular periodic payment will be due. To illustrate:
    i. Adjustable-rate mortgage with discount for three years. 
Assume an adjustable-rate mortgage has an initial discounted rate of 
5 percent that is fixed for the first three years, measured from the 
first day of the first full calendar month following consummation, 
after which the rate will adjust annually based on a specified index 
plus a margin of 3 percent. The index value in effect at 
consummation is 4.5 percent. The loan agreement provides for an 
annual interest rate adjustment cap of 2 percent, and a lifetime 
maximum interest rate of 12 percent. The first rate adjustment 
occurs on the due date of the 36th monthly payment; the rate can 
adjust to no more than 7 percent (5 percent initial discounted rate 
plus 2 percent 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 percent (7 percent rate plus 2 
percent annual interest rate adjustment cap). The third rate 
adjustment occurs on the due date of the 60th monthly payment; the 
rate can adjust to no more than 11 percent (9 percent rate plus 2 
percent annual interest rate cap adjustment). The maximum interest 
rate during the first five years after the date on which the first 
regular periodic payment will be due is 11 percent (the rate on the 
due date of the 60th monthly payment). For further discussion of how 
to determine whether a rate adjustment occurs during the first five 
years after the date on which the first regular periodic payment 
will be due, see comment 43(e)(2)(iv)-7.
    ii. Adjustable-rate mortgage with discount for three years. 
Assume the same facts as in paragraph 3.i except that the lifetime 
maximum interest rate is 10 percent, which is less than the maximum 
interest rate in the first five years after the date on which the 
first regular periodic payment will be due of 11 percent that would 
apply but for the lifetime maximum interest rate. The maximum 
interest rate during the first five years after the date on which 
the first regular periodic payment will be due is 10 percent.
    iii. Step-rate mortgage. Assume a step-rate mortgage with an 
interest rate fixed at 6.5 percent for the first two years, measured 
from the first day of the first full calendar month following 
consummation, 7 percent for the next three years, and then 7.5 
percent for the remainder of the loan term. The maximum interest 
rate during the first five years after the date on which the first 
regular periodic payment will be due is 7.5 percent.
    4. First five years after the date on which the first regular 
periodic payment will be due. Under Sec.  1026.43(e)(2)(iv)(A), the 
creditor must underwrite the loan using the maximum interest rate 
that may apply during the first five years after the date on which 
the first regular periodic payment will be due. To illustrate, 
assume an adjustable-rate mortgage with an initial fixed interest 
rate of 5 percent for the first five years, measured from the first 
day of the first full calendar month following consummation, after 
which the interest rate will adjust annually to the specified index 
plus a margin of 6 percent, subject to a 2 percent annual interest 
rate adjustment cap. The index value in effect at consummation is 
5.5 percent. The loan consummates on September 15, 2014, and the 
first monthly payment is due on November 1, 2014. The first rate 
adjustment to no more than 7 percent (5 percent plus 2 percent 
annual interest rate adjustment cap) occurs on the due date of the 
60th monthly payment, which is October 1, 2019, and therefore, the 
rate adjustment occurs during the first five years after the date on 
which the first regular periodic payment will be due. To meet the 
definition of qualified mortgage under Sec.  1026.43(e)(2), the 
creditor must underwrite the loan using a monthly payment of 
principal and interest based on an interest rate of 7 percent.
    5. Loan amount. To meet the definition of qualified mortgage 
under Sec.  1026.43(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 the date on which the 
first regular periodic payment will be due that repays either:
    i. The outstanding principal balance as of the earliest date the 
maximum interest rate during the first five years after the date on 
which the first regular periodic payment will be due 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 percent that is fixed for an initial period of 
three years, measured from the first day of the first full calendar 
month following consummation, after which the interest rate will 
adjust annually based on a specified index plus a margin of 3 
percent, subject to a 2 percent annual interest rate adjustment cap 
and a lifetime maximum interest rate of 9 percent. The index value 
in effect at consummation equals 4.5 percent. Assuming the interest 
rate increases after consummation as quickly as possible, the rate 
adjustment to the lifetime maximum interest rate of 9 percent 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 
percent; or
    ii. The loan amount, as that term is defined in Sec.  
1026.43(b)(5), over the entire loan term, as that term is defined in 
Sec.  1026.43(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 percent.
    6. Mortgage-related obligations. Section 1026.43(e)(2)(iv) 
requires creditors to take the consumer's monthly payment for 
mortgage-related obligations into account when underwriting the 
loan. For the meaning of the term ``mortgage-related obligations,'' 
see Sec.  1026.43(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 the date on which 
the first regular periodic payment will be due for purposes of 
meeting the definition of qualified mortgage under Sec.  1026.43(e) 
(all payment amounts shown are rounded, and all amounts are 
calculated using non-rounded values; all initial fixed interest rate 
periods are measured from the first day of the first full calendar 
month following consummation):
    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 percent. The 
maximum interest rate during the first five years after the date on 
which the first regular

[[Page 6616]]

periodic payment will be due for a fixed-rate mortgage is the 
interest rate in effect at consummation, which is 7 percent 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 percent 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 percent, subject to a 2 percent annual interest rate 
adjustment cap and a lifetime maximum interest rate of 9 percent. 
The index value in effect at consummation is 4.5 percent. The loan 
is consummated on March 15, 2014, and the first regular periodic 
payment is due May 1, 2014. The loan agreement provides that the 
first rate adjustment occurs on April 1, 2017 (the due date of the 
36th monthly payment); the second rate adjustment occurs on April 1, 
2018 (the due date of the 48th monthly payment); and the third rate 
adjustment occurs on April 1, 2019 (the due date of the 60th monthly 
payment). Under this example, the maximum interest rate during the 
first five years after the date on which the first regular periodic 
payment due is 9 percent (the lifetime interest rate cap), which 
applies beginning on April 1, 2018 (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 transaction will meet the definition of a qualified 
mortgage if the creditor 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 rate during the first five years after the date on which 
the first regular periodic payment will be due of 9 percent. 
Alternatively, the transaction will meet the definition of a 
qualified mortgage if the creditor 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 the date on 
which the first regular periodic payment will be due of 9 percent.
    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 percent 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 percent, subject to a 2 percent annual interest rate 
adjustment cap. The index value in effect at consummation is 4.5 
percent. The loan consummates on March 15, 2014 and the first 
regular periodic payment is due May 1, 2014. Under the terms of the 
loan agreement, the first rate adjustment to no more than 8 percent 
(6 percent plus 2 percent annual interest rate adjustment cap) is on 
April 1, 2019 (the due date of the 60th monthly payment), which 
occurs less than five years after the date on which the first 
regular periodic payment will be due. Thus, the maximum interest 
rate under the terms of the loan during the first five years after 
the date on which the first regular periodic payment will be due is 
8 percent.
    B. The transaction will meet the definition of a qualified 
mortgage if the creditor underwrites the loan using the monthly 
payment of principal and interest of $1,436 to repay the outstanding 
principal balance at the end of the fifth year of $186,109 over the 
remaining 25 years of the loan term (300 months), using the maximum 
interest rate during the first five years after the date on which 
the first regular periodic payment will be due of 8 percent. 
Alternatively, the transaction will meet the definition of a 
qualified mortgage if the creditor underwrites the loan using the 
monthly payment of principal and interest of $1,468 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 the date on 
which the first regular periodic payment will be due of 8 percent.
    iv. Adjustable-rate mortgage with discount for seven 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 percent that 
is fixed for an initial period of seven years, after which the 
interest rate will adjust annually based on a specified index plus a 
margin of 3 percent, subject to a 2 percent annual interest rate 
adjustment cap. The index value in effect at consummation is 4.5 
percent. The loan is consummated on March 15, 2014, and the first 
regular periodic payment is due May 1, 2014. Under the terms of the 
loan agreement, the first rate adjustment is on April 1, 2021 (the 
due date of the 84th monthly payment), which occurs more than five 
years after the date on which the first regular periodic payment 
will be due. Thus, the maximum interest rate under the terms of the 
loan during the first five years after the date on which the first 
regular periodic payment will be due is 6 percent.
    B. The transaction will meet the definition of a qualified 
mortgage if the creditor 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 after the date on which the first 
regular periodic payment will be due of 6 percent.
    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 percent for the first two years of the loan, 7 percent 
for the next three years, and then 7.5 percent for remainder of the 
loan term. The maximum interest rate during the first five years 
after the date on which the first regular periodic payment will be 
due is 7.5 percent, which occurs on the due date of the 60th monthly 
payment. The outstanding principal balance at the end of the fifth 
year (after the 60th payment is credited) is $187,868.
    B. The transaction will meet the definition of a qualified 
mortgage if the creditor underwrites the loan using a monthly 
payment of principal and interest of $1,388 to repay the outstanding 
principal balance of $187,868 over the remaining 25 years of the 
loan term (300 months), using the maximum interest rate during the 
first five years after the date on which the first regular periodic 
payment will be due of 7.5 percent. Alternatively, the transaction 
will meet the definition of a qualified mortgage if the creditor 
underwrites the loan using a monthly payment of principal and 
interest of $1,398 to repay $200,000 over the 30-year loan term 
using the maximum interest rate during the first five years after 
the date on which the first regular periodic payment will be due of 
7.5 percent.
    Paragraph 43(e)(2)(v).
    1. General. For guidance on satisfying Sec.  1026.43(e)(2)(v), a 
creditor may rely on commentary to Sec.  1026.43(c)(2)(i) and (vi), 
(c)(3), and (c)(4).
    2. Income or assets. Section 1026.43(e)(2)(v)(A) requires 
creditors to consider and verify the consumer's current or 
reasonably expected income or assets. For purposes of this 
requirement, the creditor must consider and verify, at a minimum, 
any income specified in appendix Q. A creditor may also consider and 
verify any other income in accordance with Sec.  1026.43(c)(2)(i) 
and (c)(4); however, such income would not be included in the total 
monthly debt-to-income ratio determination required by Sec.  
1026.43(e)(2)(vi).
    3. Debts. Section 1026.43(e)(2)(v)(B) requires creditors to 
consider and verify the consumer's current debt obligations, 
alimony, and child support. For purposes of this requirement, the 
creditor must consider and verify, at a minimum, any debt or 
liability specified in appendix Q. A creditor may also consider and 
verify other debt in accordance with Sec.  1026.43(c)(2)(vi) and 
(c)(3); however, such debt would not be included in the total 
monthly debt-to-income ratio determination required by Sec.  
1026.43(e)(2)(vi).
    Paragraph 43(e)(2)(vi).
    1. Calculation of monthly payment on the covered transaction and 
simultaneous loans. As provided in appendix Q, for purposes of Sec.  
1026.43(e)(2)(vi), creditors must include in the definition of 
``debt'' a consumer's monthly housing expense. This includes, for 
example, the consumer's monthly payment on the covered transaction 
(including mortgage-related obligations) and on simultaneous loans. 
Accordingly, Sec.  1026.43(e)(2)(vi)(B) provides the method by which 
a creditor calculates the consumer's monthly payment on the covered 
transaction and on any simultaneous loan that the creditor knows or 
has reason to know will be made.
    43(e)(3) Limits on points and fees for qualified mortgages.
    Paragraph 43(e)(3)(i).
    1. Total loan amount. The term ``total loan amount'' is defined 
in Sec.  1026.32(b)(4)(i). For an explanation of how to calculate 
the ``total loan amount'' under Sec.  1026.43(e)(3)(i), see comment 
32(b)(4)(i)-1.
    2. Calculation of allowable points and fees. A creditor must 
determine which category the loan falls into based on the face 
amount

[[Page 6617]]

of the note (the ``loan amount'' as defined in Sec.  1026.43(b)(5)). 
For categories with a percentage limit, the creditor must apply the 
allowable points and fees percentage to the ``total loan amount,'' 
which may be different than the loan amount. 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.  1026.43(b)(5). For 
example, if the loan amount is $55,000, the loan falls into the tier 
for loans greater than or equal to $20,000 but less than $60,000, to 
which a 5 percent cap on points and fees applies. For tiers with a 
prescribed dollar limit on points and fees (e.g., for loans from 
$60,000 up to $100,000, the limit is $3,000), the creditor does not 
need to do any further calculations.
    ii. Second, for tiers with a percentage limit, the creditor must 
determine the total loan amount based on the calculation for the 
total loan amount under comment 32(b)(4)(i)-1. If the loan amount is 
$55,000, for example, the total loan amount may be a different 
amount, such as $52,000.
    iii. Third, the creditor must apply the percentage cap on points 
and fees to the total loan amount. For example, for a loan of 
$55,000 where the total loan amount is $52,000, the allowable points 
and fees are 5 percent of $52,000, or $2,600.
    3. Sample determination of allowable points and fees.
    i. A covered transaction with a loan amount of $105,000 falls 
into the first points and fees tier, to which a points and fees cap 
of 3 percent of the total loan amount applies. See Sec.  
1026.43(e)(3)(i)(A). Therefore, if the calculation under comment 
32(b)(4)(i)-1 results in a total loan amount of $102,000, then the 
allowable total points and fees for this loan are 3 percent of 
$102,000, or $3,060.
    ii. A covered transaction with a loan amount of $75,000 falls 
into the second points and fees tier, to which a points and fees cap 
of $3,000 applies. See Sec.  1026.43(e)(3)(i)(B). The allowable 
total points and fees for this loan are $3,000, regardless of the 
total loan amount.
    iii. 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 5 percent of the total loan amount applies. See Sec.  
1026.43(e)(3)(i)(C). Therefore, if the calculation under comment 
32(b)(4)(i)-1 results in a total loan amount of $48,000, then the 
allowable total points and fees for this loan are 5 percent of 
$48,000, or $2,400.
    iv. A covered transaction with a loan amount of $15,000 falls 
into the fourth points and fees tier, to which a points and fees cap 
of $1,000 applies. See Sec.  1026.43(e)(3)(i)(D). The allowable 
total points and fees for this loan are $1,000, regardless of the 
total loan amount.
    v. A covered transaction with a loan amount of $10,000 falls 
into the fifth points and fees tier, to which a points and fees cap 
of 8 percent of the total loan amount applies. See Sec.  
1026.43(e)(3)(i)(E). Therefore, if the calculation under comment 
32(b)(4)(i)-1 results in a total loan amount of $7,000, then the 
allowable total points and fees for this loan are 8 percent of 
$7,000, or $560.
    Paragraph 43(e)(3)(ii).
    1. Annual adjustment for inflation. The dollar amounts, 
including the loan amounts, in Sec.  1026.43(e)(3)(i) will be 
adjusted annually on January 1 by the annual percentage change in 
the CPI-U that was in effect on the preceding June 1. The Bureau 
will publish adjustments after the June figures become available 
each year.
    43(e)(4) Qualified mortgage defined--special rules.
    1. Alternative definition. Subject to the sunset provided under 
Sec.  1026.43(e)(4)(iii), Sec.  1026.43(e)(4) provides an 
alternative definition of qualified mortgage to the definition 
provided in Sec.  1026.43(e)(2). To be a qualified mortgage under 
Sec.  1026.43(e)(4), the creditor must satisfy the requirements 
under Sec.  1026.43(e)(2)(i) through (iii), in addition to being one 
of the types of loans specified in Sec.  1026.43(e)(4)(ii)(A) 
through (E).
    2. Termination of conservatorship. Section 1026.43(e)(4)(ii)(A) 
requires that a covered transaction be eligible for purchase or 
guarantee by the Federal National Mortgage Association (``Fannie 
Mae'') or the Federal Home Loan Mortgage Corporation (``Freddie 
Mac'') (or any limited-life regulatory entity succeeding the charter 
of either) operating under the conservatorship or receivership of 
the Federal Housing Finance Agency pursuant to section 1367 of the 
Federal Housing Enterprises Financial Safety and Soundness Act of 
1992 (12 U.S.C. 4617). The special rule under Sec.  
1026.43(e)(4)(ii)(A) does not apply if Fannie Mae or Freddie Mac (or 
any limited-life regulatory entity succeeding the charter of either) 
has ceased operating under the conservatorship or receivership of 
the Federal Housing Finance Agency. For example, if either Fannie 
Mae or Freddie Mac (or succeeding limited-life regulatory entity) 
ceases to operate under the conservatorship or receivership of the 
Federal Housing Finance Agency, Sec.  1026.43(e)(4)(ii)(A) would no 
longer apply to loans eligible for purchase or guarantee by that 
entity; however, the special rule would be available for a loan that 
is eligible for purchase or guarantee by the other entity still 
operating under conservatorship or receivership.
    3. Timing. Under Sec.  1026.43(e)(4)(iii), the definition of 
qualified mortgage under paragraph (e)(4) applies only to loans 
consummated on or before January 10, 2021, regardless of whether 
Fannie Mae or Freddie Mac (or any limited-life regulatory entity 
succeeding the charter of either) continues to operate under the 
conservatorship or receivership of the Federal Housing Finance 
Agency. Accordingly, Sec.  1026.43(e)(4) is available only for 
covered transactions consummated on or before the earlier of either:
    i. The date Fannie Mae or Freddie Mac (or any limited-life 
regulatory entity succeeding the charter of either), respectively, 
cease to operate under the conservatorship or receivership of the 
Federal Housing Finance Agency pursuant to section 1367 of the 
Federal Housing Enterprises Financial Safety and Soundness Act of 
1992 (12 U.S.C. 4617); or
    ii. January 10, 2021, as provided by Sec.  1026.43(e)(4)(iii).
    4. Eligible for purchase, guarantee, or insurance. To satisfy 
Sec.  1026.43(e)(4)(ii), a loan need not be actually purchased or 
guaranteed by Fannie Mae or Freddie Mac or insured or guaranteed by 
the U.S. Department of Housing and Urban Development, U.S. 
Department of Veterans Affairs, U.S. Department of Agriculture, or 
Rural Housing Service. Rather, Sec.  1026.43(e)(4)(ii) requires only 
that the loan be eligible (i.e., meet the criteria) for such 
purchase, guarantee, or insurance. For example, for purposes of 
Sec.  1026.43(e)(4), a creditor is not required to sell a loan to 
Fannie Mae or Freddie Mac (or any limited-life regulatory entity 
succeeding the charter of either) to be a qualified mortgage; 
however, the loan must be eligible for purchase or guarantee by 
Fannie Mae or Freddie Mac (or any limited-life regulatory entity 
succeeding the charter of either), including satisfying any 
requirements regarding consideration and verification of a 
consumer's income or assets, credit history, and debt-to-income 
ratio or residual income. To determine eligibility, a creditor may 
rely on an underwriting recommendation provided by Fannie Mae or 
Freddie Mac's Automated Underwriting Systems (AUSs) or written guide 
in effect at the time. Accordingly, a covered transaction is 
eligible for purchase or guarantee by Fannie Mae or Freddie Mac if:
    i. The loan conforms to the standards set forth in the Fannie 
Mae Single-Family Selling Guide or the Freddie Mac Single-Family 
Seller/Servicer Guide; or
    ii. The loan receives one of the following recommendations from 
the corresponding automated underwriting system:
    A. An ``Approve/Eligible'' recommendation from Desktop 
Underwriter (DU); or
    B. An ``Accept and Eligible to Purchase'' recommendation from 
Loan Prospector (LP).
    43(f) Balloon-Payment qualified mortgages made by certain 
creditors.
    43(f)(1) Exemption.
    Paragraph 43(f)(1)(i).
    1. Satisfaction of qualified mortgage requirements. Under Sec.  
1026.43(f)(1)(i), for a mortgage that provides for a balloon payment 
to be a qualified mortgage, the mortgage must satisfy the 
requirements for a qualified mortgage in paragraphs (e)(2)(i)(A), 
(e)(2)(ii), (iii), and (v). Therefore, 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.  1026.43(e)(2)(i)(A); must have a loan term that does not 
exceed 30 years, pursuant to Sec.  1026.43(e)(2)(ii); must have 
total points and fees that do not exceed specified thresholds 
pursuant to Sec.  1026.43(e)(2)(iii); and must satisfy the 
consideration and verification requirements in Sec.  
1026.43(e)(2)(v).
    Paragraph 43(f)(1)(ii).
    1. Example. Under Sec.  1026.43(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

[[Page 6618]]

over 30 years. The loan agreement provides for a fixed interest rate 
of 6 percent. The loan consummates on March 3, 2014, and the monthly 
payment of principal and interest scheduled for the first five years 
is $1,199, with the first monthly payment due on April 1, 2014. The 
balloon payment of $187,308 is required on the due date of the 60th 
monthly payment, which is April 1, 2019. The loan can be a qualified 
mortgage if the creditor underwrites the loan using the scheduled 
principal and interest payment of $1,199, plus the consumer's 
monthly payment for all mortgage-related obligations, and satisfies 
the other criteria set forth in Sec.  1026.43(f).
    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.  1026.43(f)(1)(ii), in accordance 
with the legal obligation, together with the consumer's monthly 
payments for all mortgage-related obligations and excluding the 
balloon payment, to meet the repayment ability requirements of Sec.  
1026.43(f)(1)(ii). A creditor satisfies Sec.  1026.43(f)(1)(ii) if 
it uses the maximum payment in the payment schedule, excluding any 
balloon payment, to determine if the consumer has the ability to 
make the scheduled payments.
    Paragraph 43(f)(1)(iii).
    1. Debt-to-income or residual income. A creditor must consider 
and verify the consumer's monthly debt-to-income ratio or residual 
income to meet the requirements of Sec.  1026.43(f)(1)(iii). To 
calculate the consumer's monthly debt-to-income or residual income 
for purposes of Sec.  1026.43(f)(1)(iii), the creditor may rely on 
the definitions and calculation rules in Sec.  1026.43(c)(7) and its 
accompanying commentary, except for the calculation rules for a 
consumer's total monthly debt obligations (which is a component of 
debt-to-income and residual income under Sec.  1026.43(c)(7)). For 
purposes of calculating the consumer's total monthly debt 
obligations under Sec.  1026.43(f)(1)(iii), the creditor must 
calculate the monthly payment on the covered transaction using the 
payment calculation rules in Sec.  1026.43(f)(1)(iv)(A), together 
with all mortgage-related obligations and excluding the balloon 
payment.
    Paragraph 43(f)(1)(iv).
    1. Scheduled payments. Under Sec.  1026.43(f)(1)(iv)(A), the 
legal obligation must provide that scheduled payments must be 
substantially equal and determined using an amortization period that 
does not exceed 30 years. 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.
    2. Substantially equal. The calculation of payments scheduled by 
the legal obligation under Sec.  1026.43(f)(1)(iv)(A) are required 
to result in substantially equal amounts. This means that the 
scheduled payments need to be similar, but need not be equal. For 
further guidance on substantially equal payments, see comment 
43(c)(5)(i)-4.
    3. Interest-only payments. A mortgage that only requires the 
payment of accrued interest each month does not meet the 
requirements of Sec.  1026.43(f)(1)(iv)(A).
    Paragraph 43(f)(1)(v).
    1. Forward commitments. A creditor may make a mortgage loan that 
will be transferred or sold to a purchaser pursuant to an agreement 
that has been entered into at or before the time the transaction is 
consummated. Such an agreement is sometimes known as a ``forward 
commitment.'' A balloon-payment mortgage that will be acquired by a 
purchaser pursuant to a forward commitment does not satisfy the 
requirements of Sec.  1026.43(f)(1)(v), whether the forward 
commitment provides for the purchase and sale of the specific 
transaction or for the purchase and sale of transactions with 
certain prescribed criteria that the transaction meets. However, a 
purchase and sale of a balloon-payment qualified mortgage to another 
person that separately meets the requirements of Sec.  
1026.43(f)(1)(vi) is permitted. For example: assume a creditor that 
meets the requirements of Sec.  1026.43(f)(1)(vi) makes a balloon-
payment mortgage that meets the requirements of Sec.  
1026.43(f)(1)(i) through (iv); if the balloon-payment mortgage meets 
the purchase criteria of an investor with which the creditor has an 
agreement to sell such loans after consummation, then the balloon-
payment mortgage does not meet the definition of a qualified 
mortgage in accordance with Sec.  1026.43(f)(1)(v). However, if the 
investor meets the requirement of Sec.  1026.43(f)(1)(vi), the 
balloon-payment qualified mortgage retains its qualified mortgage 
status.
    Paragraph 43(f)(1)(vi).
    1. Creditor qualifications. Under Sec.  1026.43(f)(1)(vi), to 
make a qualified mortgage that provides for a balloon payment, the 
creditor must satisfy three criteria that are also required under 
Sec.  1026.35(b)(2)(iii)(A), (B) and (C), which require:
    i. During the preceding calendar year, the creditor extended 
over 50 percent of its total first-lien covered transactions, as 
defined in Sec.  1026.43(b)(1), on properties that are located in 
counties that are designated either ``rural'' or ``underserved,'' as 
defined in Sec.  1026.35(b)(2)(iv), to satisfy the requirement of 
Sec.  1026.35(b)(2)(iii)(A). Pursuant to Sec.  1026.35(b)(2)(iv), a 
county is considered to be rural if it is neither in a metropolitan 
statistical area, nor a micropolitan statistical area adjacent to a 
metropolitan statistical area, as those terms are defined by the 
U.S. Office of Management and Budget. A county is considered to be 
underserved if no more than two creditors extend covered 
transactions secured by a first lien five or more times in that 
county during a calendar year. The Bureau determines annually which 
counties in the United States are rural or underserved and publishes 
on its public Web site lists of those counties to enable creditors 
to determine whether they meet this criterion. Thus, for example, if 
a creditor originated 90 first-lien covered transactions during 
2013, the creditor meets this element of the exception in 2014 if at 
least 46 of those transactions are secured by first liens on 
properties located in one or more counties that are on the Bureau's 
lists for 2013.
    ii. During the preceding calendar year, the creditor together 
with its affiliates originated 500 or fewer first-lien covered 
transactions, as defined by Sec.  1026.43(b)(1), to satisfy the 
requirement of Sec.  1026.35(b)(2)(iii)(B).
    iii. 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 Bureau, to satisfy the requirement of Sec.  
1026.35(b)(2)(iii)(C). For calendar year 2013, the asset threshold 
was $2,000,000,000.
    43(f)(2) Post-consummation transfer of balloon-payment qualified 
mortgage.
    1. Requirement to hold in portfolio. Creditors generally must 
hold a balloon-payment qualified mortgage in portfolio to maintain 
the transaction's status as a qualified mortgage under Sec.  
1026.43(f)(1), subject to four exceptions. Unless one of these 
exceptions applies, a balloon-payment qualified mortgage is no 
longer a qualified mortgage under Sec.  1026.43(f)(1) once legal 
title to the debt obligation is sold, assigned, or otherwise 
transferred to another person. Accordingly, unless one of the 
exceptions applies, the transferee could not benefit from the 
presumption of compliance for qualified mortgages under Sec.  
1026.43(f)(1) unless the loan also met the requirements of another 
qualified mortgage definition.
    2. Application to subsequent transferees. The exceptions 
contained in Sec.  1026.43(f)(2) apply not only to an initial sale, 
assignment, or other transfer by the originating creditor but to 
subsequent sales, assignments, and other transfers as well. For 
example, assume Creditor A originates a qualified mortgage under 
Sec.  1026.43(f)(1). Six months after consummation, Creditor A sells 
the qualified mortgage to Creditor B pursuant to Sec.  
1026.43(f)(2)(ii) and the loan retains its qualified mortgage status 
because Creditor B complies with the limits on operating 
predominantly in rural or underserved areas, asset size, and number 
of transactions. If Creditor B sells the qualified mortgage, it will 
lose its qualified mortgage status under Sec.  1026.43(f)(1) unless 
the sale qualifies for one of the Sec.  1026.43(f)(2) exceptions for 
sales three or more years after consummation, to another qualifying 
institution, as required by supervisory action, or pursuant to a 
merger or acquisition.
    Paragraph 43(f)(2)(i).
    1. Transfer three years after consummation. Under Sec.  
1026.43(f)(2)(i), if a balloon-payment qualified mortgage under 
Sec.  1026.43(f)(1) is sold, assigned, or otherwise transferred 
three years or more after consummation, the balloon-payment 
qualified mortgage retains its status as a qualified mortgage under 
Sec.  1026.43(f)(1) following the sale. The transferee need not be 
eligible to originate qualified mortgages under Sec.  
1026.43(f)(1)(vi). The balloon-payment qualified mortgage will 
continue to be a qualified mortgage throughout its life, and the 
transferee, and any subsequent transferees, may invoke the 
presumption of compliance for qualified mortgages under Sec.  
1026.43(f)(1).

[[Page 6619]]

    Paragraph 43(f)(2)(ii).
    1. Transfer to another qualifying creditor. Under Sec.  
1026.43(f)(2)(ii), a balloon-payment qualified mortgage under Sec.  
1026.43(f)(1) may be sold, assigned, or otherwise transferred at any 
time to another creditor that meets the requirements of Sec.  
1026.43(f)(1)(vi). That section requires that a creditor: (1) 
Operate predominantly in a rural or underserved area during the 
preceding calendar year; (2) during the preceding calendar year, 
together with all affiliates, originated 500 or fewer first-lien 
covered transactions; and (3) had total assets less than $2 billion 
(as adjusted for inflation) at the end of the preceding calendar 
year. A balloon-payment qualified mortgage under Sec.  1026.43(f)(1) 
transferred to a creditor that meets these criteria would retain its 
qualified mortgage status even if it is transferred less than three 
years after consummation.
    Paragraph 43(f)(2)(iii).
    1. Supervisory sales. Section 1026.43(f)(2)(iii) facilitates 
sales that are deemed necessary by supervisory agencies to revive 
troubled creditors and resolve failed creditors. A balloon-payment 
qualified mortgage under Sec.  1026.43(f)(1) retains its qualified 
mortgage status if it is sold, assigned, or otherwise transferred to 
another person pursuant to: (1) A capital restoration plan or other 
action under 12 U.S.C. 1831o; (2) the actions or instructions of any 
person acting as conservator, receiver, or bankruptcy trustee; (3) 
an order of a State or Federal government agency with jurisdiction 
to examine the creditor pursuant to State or Federal law; or (4) an 
agreement between the creditor and such an agency. A balloon-payment 
qualified mortgage under Sec.  1026.43(f)(1) that is sold, assigned, 
or otherwise transferred under these circumstances retains its 
qualified mortgage status regardless of how long after consummation 
it is sold and regardless of the size or other characteristics of 
the transferee. Section 1026.43(f)(2)(iii) does not apply to 
transfers done to comply with a generally applicable regulation with 
future effect designed to implement, interpret, or prescribe law or 
policy in the absence of a specific order by or a specific agreement 
with a governmental agency described in Sec.  1026.43(f)(2)(iii) 
directing the sale of one or more qualified mortgages under Sec.  
1026.43(f)(1) held by the creditor or one of the other circumstances 
listed in Sec.  1026.43(f)(2)(iii). For example, a balloon-payment 
qualified mortgage under Sec.  1026.43(f)(1) that is sold pursuant 
to a capital restoration plan under 12 U.S.C. 1831o would retain its 
status as a qualified mortgage following the sale. However, if the 
creditor simply chose to sell the same qualified mortgage as one way 
to comply with general regulatory capital requirements in the 
absence of supervisory action or agreement it would lose its status 
as a qualified mortgage following the sale unless it qualifies under 
another definition of qualified mortgage.
    Paragraph 43(f)(2)(iv).
    1. Mergers and acquisitions. A qualified mortgage under Sec.  
1026.43(f)(1) retains its qualified mortgage status if a creditor 
merges with, is acquired by another person, or acquires another 
person regardless of whether the creditor or its successor is 
eligible to originate new balloon-payment qualified mortgages under 
Sec.  1026.43(f)(1) after the merger or acquisition. However, the 
creditor or its successor can originate new balloon-payment 
qualified mortgages under Sec.  1026.43(f)(1) only if it complies 
with all of the requirements of Sec.  1026.43(f)(1) after the merger 
or acquisition. For example, assume a small creditor that originates 
250 first-lien covered transactions each year and originates 
balloon-payment qualified mortgages under Sec.  1026.43(f)(1) is 
acquired by a larger creditor that originates 10,000 first-lien 
covered transactions each year. Following the acquisition, the small 
creditor would no longer be able to originate balloon-payment 
qualified mortgages because, together with its affiliates, it would 
originate more than 500 first-lien covered transactions each year. 
However, the balloon-payment qualified mortgages originated by the 
small creditor before the acquisition would retain their qualified 
mortgage status.
    43(g) Prepayment penalties.
    43(g)(2) Limits on prepayment penalties.
    1. Maximum period and amount. Section 1026.43(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.  1026.43(g)(2). For example, a covered transaction may include 
a prepayment penalty that may be imposed for two years after 
consummation and that equals 1 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.  1026.43(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. Under Sec.  
1026.43(g)(3)(i), if the covered transaction with a prepayment 
penalty is a fixed-rate mortgage, as defined in Sec.  
1026.18(s)(7)(iii), then the alternative covered transaction without 
a prepayment penalty must also be a fixed-rate mortgage. Likewise, 
if the covered transaction with a prepayment penalty is a step-rate 
mortgage, as defined in Sec.  1026.18(s)(7)(ii), then the 
alternative covered transaction without a prepayment penalty must 
also be a step-rate mortgage.
    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.  1026.43(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.  
1026.43(g)(3)(iv) 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.  1026.43(e)(2)(iii).
    Paragraph 43(g)(3)(v).
    1. Transactions for which the consumer likely qualifies. Under 
Sec.  1026.43(g)(3)(v), the alternative covered transaction without 
a prepayment penalty the creditor must offer under Sec.  
1026.43(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.  1026.43(g)(3)(v) are not met. The creditor's belief that the 
consumer likely qualifies for the 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.  1026.43(g)(4), where the creditor 
offers covered transactions with a prepayment penalty to consumers 
through a mortgage broker, as defined in Sec.  1026.36(a)(2), the 
creditor must present the mortgage broker an alternative covered 
transaction that satisfies the requirements of Sec.  1026.43(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 1026.43(g)(4)(ii) 
requires that the creditor provide, by agreement, for the mortgage 
broker to present the consumer an alternative covered transaction 
that satisfies the requirements of Sec.  1026.43(g)(3) offered by 
either the creditor or by another creditor, if the other creditor 
offers a covered transaction with a lower interest rate or a lower 
total dollar amount of discount points and origination points or 
fees. The agreement may provide for the mortgage broker to present 
both the creditor's covered transaction and an alternative covered 
transaction offered by another creditor with a lower interest rate 
or a lower total dollar amount of origination discount points and 
points or fees. 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

[[Page 6620]]

Sec.  1026.43(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.  1026.36(a)(1) applies for purposes of Sec.  1026.43(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 and ii.
    2. Lower interest rate. Under Sec.  1026.43(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.  1026.43(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 creditor 
documents a loan as open-end credit but the features and terms, or 
other circumstances, demonstrate that the loan does not meet the 
definition of open-end credit in Sec.  1026.2(a)(20), the loan is 
subject to the rules for closed-end credit, including Sec.  1026.43.

    Dated: January 10, 2013.
Richard Cordray,
Director, Bureau of Consumer Financial Protection.
[FR Doc. 2013-00736 Filed 1-16-13; 11:15 am]
BILLING CODE 4810-AM-P