[Federal Register Volume 73, Number 6 (Wednesday, January 9, 2008)]
[Proposed Rules]
[Pages 1672-1735]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-25058]
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Part II
Federal Reserve System
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12 CFR Part 226
Truth in Lending; Proposed Rule
Federal Register / Vol. 73 , No. 6 / Wednesday, January 9, 2008 /
Proposed Rules
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FEDERAL RESERVE SYSTEM
12 CFR Part 226
[Regulation Z; Docket No. R-1305]
Truth in Lending
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Proposed rule; request for public comment.
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SUMMARY: The Board proposes to amend Regulation Z, which implements the
Truth in Lending Act and Home Ownership and Equity Protection Act. The
goals of the amendments are to protect consumers in the mortgage market
from unfair, abusive, or deceptive lending and servicing practices
while preserving responsible lending and sustainable homeownership;
ensure that advertisements for mortgage loans provide accurate and
balanced information and do not contain misleading or deceptive
representations; and provide consumers transaction-specific disclosures
early enough to use while shopping for a mortgage. The proposed
revisions would apply four protections to a newly-defined category of
higher-priced mortgage loans secured by a consumer's principal
dwelling, including a prohibition on a pattern or practice of lending
based on the collateral without regard to consumers' ability to repay
their obligations from income, or from other sources besides the
collateral. The proposed revisions would apply three new protections to
mortgage loans secured by a consumer's principal dwelling regardless of
loan price, including a prohibition on a creditor paying a mortgage
broker more than the consumer had agreed the broker would receive. The
Board also proposes to require that advertisements provide accurate and
balanced information, in a clear and conspicuous manner, about rates,
monthly payments, and other loan features; and to ban several deceptive
or misleading advertising practices, including representations that a
rate or payment is ``fixed'' when it can change. Finally, the proposal
would require creditors to provide consumers with transaction-specific
mortgage loan disclosures before they pay any fee except a reasonable
fee for reviewing credit history.
DATES: Comments must be received on or before April 8, 2008.
ADDRESSES: You may submit comments, identified by Docket No. R-1305, by
any of the following methods:
Agency Web site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
E-mail: [email protected]. Include the
docket number in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Address to Jennifer J. Johnson, Secretary, Board of
Governors of the Federal Reserve System, 20th Street and Constitution
Avenue, NW., Washington, DC 20551.
All public comments will be made available on the Board's Web site
at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, unless modified for technical reasons. Accordingly, comments
will not be edited to remove any identifying or contact information.
Public comments may also be viewed electronically or in paper in Room
MP-500 of the Board's Martin Building (20th and C Streets, NW.) between
9 a.m. and 5 p.m. on weekdays.
FOR FURTHER INFORMATION CONTACT: Kathleen C. Ryan, Dan S. Sokolov, or
David Stein, Counsels; Jamie Z. Goodson, Brent Lattin, Jelena
McWilliams, or Paul Mondor, Attorneys; Division of Consumer and
Community Affairs, Board of Governors of the Federal Reserve System,
Washington, DC 20551, at (202) 452-2412 or (202) 452-3667. For users of
Telecommunications Device for the Deaf (TDD) only, contact (202) 263-
4869.
SUPPLEMENTARY INFORMATION:
I. Summary of Proposal
A. Proposals To Prevent Unfairness, Deception, and Abuse
B. Proposals To Improve Mortgage Advertising
C. Proposals To Give Consumers Disclosures Early
II. Consumer Protection Concerns in the Subprime Market
A. Recent Problems in the Mortgage Market
B. The Loosening of Underwriting Standards
C. Market Imperfections That Can Facilitate Abusive and
Unaffordable Loans
III. The Board's Hoepa Hearings
A. Home Ownership and Equity Protection Act (HOEPA)
B. Summary of 2006 Hearings
C. Summary of June 2007 Hearing
D. Congressional Hearings
IV. Inter-Agency Supervisory Guidance
V. Legal Authority
A. The Board's Authority Under TILA Section 129(l)(2)
B. The Board's Authority Under TILA Section 105(a)
VI. Proposed Definition of ``Higher-Priced Mortgage Loan''
A. Overview
B. Public Comment on the Scope of New HOEPA Rules
C. General Principles Governing the Board's Determination of
Coverage
D. Types of Loans Proposed To Be Covered Under Sec. 226.35
E. Proposed APR Trigger for Sec. 226.35
F. Mechanics of the Proposed APR Trigger
VII. Proposed Rules for Higher-Priced Mortgage Loans--Sec. 226.35
A. Overview
B. Disregard of Consumers' Ability To Repay--Sec. Sec.
226.34(a)(4) and 226.35(b)(1)
C. Verification of Income and Assets Relied On--Sec.
226.35(b)(2)
D. Prepayment Penalties--Sec. 226.32(d)(6) and (7); Sec.
226.35(b)(3)
E. Requirement to Escrow--Sec. 226.35(b)(4)
F. Evasion Through Spurious Open-end Credit--Sec. 226.35(b)(5)
VIII. Proposed Rules for Mortgage Loans--Sec. 226.36
A. Creditor Payments to Mortgage Brokers--Sec. 226.36(a)
B. Coercion of Appraisers--Sec. 226.36(b)
C. Servicing Abuses--Sec. 226.36(c)
D. Coverage--Sec. 226.36(d)
IX. Other Potential Concerns
A. Other HOEPA Prohibitions
B. Steering
X. Advertising
A. Advertising Rules for Open-end Home-equity Plans--Sec.
226.16
B. Advertising Rules for Closed-end Credit--Sec. 226.24
XI. Mortgage Loan Disclosures
A. Early Mortgage Loan Disclosures--Sec. 226.19
B. Future Plans To Improve Disclosure
XII. Civil Liability and Remedies; Administrative Enforcement
XIII. Effective Date
XIV. Paperwork Reduction Act
XV. Initial Regulatory Flexibility Analysis
I. Summary of Proposal
The Board is proposing to establish new regulatory protections for
consumers in the residential mortgage market through amendments to
Regulation Z, which implements the Truth in Lending Act (TILA) and the
Home Ownership and Equity Protection Act (HOEPA). The goals of the
amendments are to protect consumers in the mortgage market from unfair,
abusive, or deceptive lending and servicing practices while preserving
responsible lending and sustainable homeownership; ensure that
advertisements for mortgage loans provide accurate and balanced
information and do not contain misleading or deceptive representations;
and provide consumers transaction-specific disclosures early enough to
use while shopping.
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A. Proposals To Prevent Unfairness, Deception, and Abuse
The Board is proposing seven new restrictions or requirements for
mortgage lending and servicing intended to protect consumers against
unfairness, deception, and abuse while preserving responsible lending
and sustainable homeownership. The restrictions would be adopted under
TILA Section 129(l)(2), which authorizes the Board to prohibit unfair
or deceptive practices in connection with mortgage loans, as well as to
prohibit abusive practices or practices not in the interest of the
borrower in connection with refinancings. 15 U.S.C. 1639(l)(2). Some of
the restrictions would apply only to higher-priced mortgage loans,
while others would apply to all mortgage loans secured by a consumer's
principal dwelling.
Protections Covering Higher-Priced Mortgage Loans
The Board is proposing four protections for consumers receiving
higher-priced mortgage loans. These loans would be defined as consumer-
purpose, closed-end loans secured by a consumer's principal dwelling
and having an annual percentage rate (APR) that exceeds the comparable
Treasury security by three or more percentage points for first-lien
loans, or five or more percentage points for subordinate-lien loans.
For higher-priced mortgage loans, the Board proposes to:
[cir] Prohibit creditors from engaging in a pattern or practice of
extending credit without regard to borrowers' ability to repay from
sources other than the collateral itself;
[cir] Require creditors to verify income and assets they rely upon
in making loans;
[cir] Prohibit prepayment penalties unless certain conditions are
met; and
[cir] Require creditors to establish escrow accounts for taxes and
insurance, but permit creditors to allow borrowers to opt out of
escrows 12 months after loan consummation.
In addition, the proposal would prohibit creditors from structuring
closed-end mortgage loans as open-end lines of credit for the purpose
of evading these rules, which do not apply to lines of credit.
Protections Covering Closed-End Loans Secured by Consumer's Principal
Dwelling
In addition, in connection with all consumer-purpose, closed-end
loans secured by a consumer's principal dwelling, the Board is
proposing to:
[cir] Prohibit creditors from paying a mortgage broker more than
the consumer had agreed in advance that the broker would receive;
[cir] Prohibit any creditor or mortgage broker from coercing,
influencing, or otherwise encouraging an appraiser to provide a
misstated appraisal in connection with a mortgage loan; and
[cir] Prohibit mortgage servicers from ``pyramiding'' late fees,
failing to credit payments as of the date of receipt, failing to
provide loan payoff statements upon request within a reasonable time,
or failing to deliver a fee schedule to a consumer upon request.
B. Proposals To Improve Mortgage Advertising
Another goal of this proposal is to ensure that mortgage loan
advertisements provide accurate and balanced information and do not
contain misleading or deceptive representations. Thus the Board is
proposing to require that advertisements for both open-end and closed-
end mortgage loans provide accurate and balanced information, in a
clear and conspicuous manner, about rates, monthly payments, and other
loan features. This proposal is made under the Board's general
authority to adopt regulations to ensure consumers are informed about
and can shop for credit. TILA Section 105(a), 15 U.S.C. 1604(a).
The Board is also proposing, under TILA Section 129(l)(2), 15
U.S.C. 1639(l)(2), to prohibit the following seven deceptive or
misleading practices in advertisements for closed-end mortgage loans:
[cir] Advertising ``fixed'' rates or payments for loans whose rates
or payments can vary without adequately disclosing that the interest
rate or payment amounts are ``fixed'' only for a limited period of
time, rather than for the full term of the loan;
[cir] Comparing an actual or hypothetical consumer's current rate
or payment obligations and the rates or payments that would apply if
the consumer obtains the advertised product unless the advertisement
states the rates or payments that will apply over the full term of the
loan;
[cir] Advertisements that characterize the products offered as
``government loan programs,'' ``government-supported loans,'' or
otherwise endorsed or sponsored by a federal or state government entity
even though the advertised products are not government-supported or -
sponsored loans;
[cir] Advertisements, such as solicitation letters, that display
the name of the consumer's current mortgage lender, unless the
advertisement also prominently discloses that the advertisement is from
a mortgage lender not affiliated with the consumer's current lender;
[cir] Advertising claims of debt elimination if the product
advertised would merely replace one debt obligation with another;
[cir] Advertisements that create a false impression that the
mortgage broker or lender has a fiduciary relationship with the
consumer; and
[cir] Foreign-language advertisements in which certain information,
such as a low introductory ``teaser'' rate, is provided in a foreign
language, while required disclosures are provided only in English.
C. Proposal To Give Consumers Disclosures Early
A third goal of this proposal is to provide consumers transaction-
specific disclosures early enough to use while shopping for a mortgage
loan. The Board proposes to require creditors to provide transaction-
specific mortgage loan disclosures such as the APR and payment schedule
for all home-secured, closed-end loans no later than three days after
application, and before the consumer pays any fee except a reasonable
fee for the originator's review of the consumer's credit history.
The Board recognizes that these disclosures need to be updated to
reflect the increased complexity of mortgage products. In early 2008,
the Board will begin testing current TILA mortgage disclosures and
potential revisions to these disclosures through one-on-one interviews
with consumers. The Board expects that this testing will identify
potential improvements for the Board to propose for public comment in a
separate rulemaking.
II. Consumer Protection Concerns in the Subprime Market
A. Recent Problems in the Mortgage Market
Subprime mortgage loans are made to borrowers who are perceived to
have high credit risk. These loans' share of total consumer
originations, according to one estimate, reached about nine percent in
2001 and doubled to 20 percent by 2005, where it stayed in 2006.\1\ The
resulting increase in the supply of mortgage credit likely contributed
to the rise in the homeownership rate from 64 percent in 1994 to a high
of 69 percent in 2006--though about 68 percent now--and expanded
consumers' access to the equity in their homes. Recently, however, some
of this benefit has
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eroded. In the last two years, delinquencies and foreclosure starts
among subprime mortgages have increased dramatically and reached
exceptionally high levels as house price growth has slowed or prices
have declined in some areas. The proportion of all subprime mortgages
past-due ninety days or more (``serious delinquency'') was about 13
percent in October 2007, more than double the mid-2005 level.\2\
Adjustable-rate subprime mortgages have performed the worst, reaching a
serious delinquency rate of nearly 19 percent in October 2007, triple
the mid-2005 level. These mortgages have seen unusually high levels of
early payment default, or default after only one or two payments or
even no payment at all.
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\1\ Inside Mortgage Finance Publications, Inc., The 2007
Mortgage Market Statistical Annual vol. I (IMF 2007 Mortgage
Market), at 4.
\2\ Delinquency rates calculated from data from First American
LoanPerformance on mortgages in subprime securitized pools. Figures
include loans on non-owner-occupied properties.
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The serious delinquency rate has also risen for loans in alt-A
(near prime) securitized pools. According to one source, originations
of these loans were 13 percent of consumer mortgage originations in
2006.\3\ Alt-A loans are made to borrowers who typically have higher
credit scores than subprime borrowers, but the loans pose more risk
than prime loans because they involve small down payments or reduced
income documentation, or the terms of the loan are nontraditional and
may increase risk. The rate of serious delinquency for these loans has
risen to over 3 percent (as of September 2007) from 1 percent only a
year ago. In contrast, 1 percent of loans in the prime-mortgage sector
were seriously delinquent as of October.
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\3\ IMF 2007 Mortgage Market, at 4.
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The consequences of default are severe for homeowners, who face the
possibility of foreclosure, the loss of accumulated home equity, higher
rates for other credit transactions, and reduced access to credit. When
foreclosures are clustered, they can injure entire communities by
reducing property values in surrounding areas. Higher delinquencies are
in fact showing through to foreclosures. Lenders initiated 430,000
foreclosures in the third quarter of 2007, about half of them on
subrpime mortgages. This was significantly higher than the quarterly
average of 325,000 in the first half of the year, and nearly twice the
quarterly average of 225,000 for the past six years.\4\
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\4\ Estimates are based on data from Mortgage Bankers'
Association's National Delinquency Survey (2007).
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B. The Loosening of Underwriting Standards
Rising delinquencies have been caused largely by a combination of a
decline in house price appreciation--and in some areas slower economic
growth--and a loosening of underwriting standards. Underwriting
standards loosened in large parts of the mortgage market in recent
years as lenders--particularly nondepository institutions, many of
which have since ceased to exist--competed more aggressively for market
share. This loosening was particularly pronounced in the subprime
sector, where the frequent combination of several riskier loan
attributes--high loan-to-value ratio, payment shock on adjustable-rate
mortgages, no verification of borrower income, and no escrow for taxes
and insurance--increased the risk of serious delinquency and
foreclosure for subprime loans originated in 2005 through early 2007.
Payment shock from rate adjustments within two or three years of
origination could make these loans unaffordable to many of the
consumers who hold them. Approximately three-fourths of originations in
securitized subprime ``pools'' from 2004 to 2006 were adjustable-rate
mortgages (ARMs) with two-or three-year ``teaser'' rates followed by
substantial increases in the rate and payment (so-called ``2-28'' and
``3-27'' mortgages).\5\ The burden of these payment increases on the
borrower would likely be heavier than expected if the borrower's stated
income was inflated, as appears to have happened in some cases, and the
inflated figure was used to determine repayment ability. In addition,
affordability problems with subprime loans can be compounded by
unexpected property tax and homeowners insurance obligations. In the
prime market, lenders typically establish escrows for these
obligations, but in the subprime market escrows have been the exception
rather than the rule.
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\5\ Figure calculated from First American Loan Performance data.
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Delinquencies and foreclosure initiations in subprime ARMs are
expected to rise further as more of these mortgages see their rates and
payments reset at significantly higher levels. On average in 2008,
374,000 subprime mortgages per quarter are scheduled to undergo their
first interest rate and payment reset. Relative to past years, avoiding
the payment shock of an interest rate reset by refinancing the mortgage
will be much more difficult. Not only have home prices flattened out or
declined, thereby reducing homeowners' equity, but borrowers often had
little equity to start with because of very high initial cumulative
loan-to-value ratios. Moreover, prepayment penalty clauses, which are
found in a substantial majority of subprime loans, place an added
demand on the limited equity or other resources available to many
borrowers and make it harder still for them to refinance. Borrowers who
cannot refinance will have to make sacrifices to stay in their homes or
could lose their homes altogether.\6\
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\6\ These effects may be mitigated for some borrowers by a
recently-announced agreement among major loan servicers and
investors to ``freeze'' many subprime ARMs at their initial interest
rates for five years.
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Relaxed underwriting was not limited to the subprime market.
According to one estimate, interest-only mortgages (most of them with
adjustable rates) and ``option ARMs''--which permit borrowers to defer
both principal and interest for a time in exchange for higher payments
later--rose from 7 percent of total consumer mortgage originations in
2004 to 26 percent in 2006.\7\ By one estimate these mortgages reached
78 percent of alt-A originations in 2006.\8\ These types of mortgages
hold the potential for payment shock and increasingly contained
additional layers of risk such as loan amounts near the full appraised
value of the home, and partial or no documentation of income. For
example, the share of interest-only mortgages with low or no
documentation in alt-A securitized pools increased from around 60
percent in 2003 to nearly 80 percent in 2006.\9\ Most of these
mortgages have not yet reset so their full implications are not yet
apparent. The risks to consumers and to creditors were serious enough,
however, to cause the federal banking agencies to issue supervisory
guidance, which many state agencies later adopted.\10\
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\7\ IMF 2007 Mortgage Market, at 6.
\8\ David Liu & Shumin Li, Alt-A Credit--The Other Shoe Drops?,
The MarketPulse (First American LoanPerformance, Inc., San
Francisco, Cal.), Dec. 2006.
\9\ Figures calculated from First American LoanPerformance data.
\10\ Interagency Guidance on Nontraditional Mortgage Product
Risks, 71 FR 58609, Oct. 4, 2006.
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A decline in underwriting standards does not just increase the risk
that consumers will be provided loans they cannot repay. It also
increases the risk that originators will engage in an abusive strategy
of ``flipping'' borrowers in a succession of refinancings, ostensibly
to lower borrowers' burdensome payments, that strip borrowers' equity
and provide them no
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benefit. Moreover, an atmosphere of relaxed standards may increase the
incidence of abusive lending practices by attracting less scrupulous
originators into the market, while at the same time bringing more
vulnerable borrowers into the market. These abuses can lead consumers
to pay more for their loans than their risk profiles warrant.
The market has responded to the current problems with increasing
attention to loan quality. Structural factors, or market imperfections,
however, make it necessary to consider regulations to help prevent a
recurrence of these problems. New regulation can also provide the
market clear ``rules of the road'' at a time of uncertainty, so that
responsible higher-priced lending, which serves a critical need, may
continue.
C. Market Imperfections That Can Facilitate Abusive and Unaffordable
Loans
The recent sharp increase in serious delinquencies has highlighted
the roles that structural elements of the subprime mortgage market may
play in increasing the likelihood of injury to consumers who find
themselves in that market. Limitations on price and product
transparency in the subprime market--often compounded by misleading or
inaccurate advertising--may make it harder for consumers to protect
themselves from abusive or unaffordable loans, even with the best
disclosures. The injuries consumers in the subprime market may suffer
as a result are magnified when originators' incentives to carefully
assess consumers' repayment ability grow weaker, as can happen when
originators sell off their loans to be securitized. The fragmentation
of the originator market can further exacerbate the problem by making
it more difficult for investors to monitor originators and for lenders
to monitor brokers. The multiplicity of originators and their
regulators can also inhibit the ability of regulators to protect
consumers from abusive and unaffordable loans.
Limited Transparency and Limits of Disclosure
Limited transparency in the subprime market increases the risk that
borrowers in that market will receive unaffordable or abusive loans.
The transparency of the subprime market to consumers is limited in
several respects. First, price information for the subprime market is
not widely and readily available to consumers. A consumer searching in
the prime market can buy a newspaper or access the Internet and easily
find current interest rates from a wide variety of lenders without
paying a fee. In contrast, subprime rates, which can vary significantly
based on the individual borrower's risk profile, are not broadly
advertised. Advertising in the subprime market focuses on easy approval
and low payments. Moreover, a borrower shopping in the subprime market
generally cannot obtain a useful rate quote from a particular lender
without submitting an application and paying a fee. The quote may not
even be reliable, as loan originators sometimes use ``bait and switch''
strategies.
Second, products in the subprime market tend to be complex, both
relative to the prime market and in absolute terms, as well as less
standardized than in the prime market.\11\ As discussed earlier,
subprime originations have much more often had adjustable rates than
more easily understood fixed rates. Adjustable-rate mortgages require
consumers to make judgments about the future direction of interest
rates and translate expected rate changes into changes in their payment
amounts. Subprime loans are also far more likely to have prepayment
penalties. The price of the penalty is not reflected in the annual
percentage rate (APR); to calculate that price, the consumer must both
calculate the size of the penalty according to a formula such as six
months of interest, and assess the likelihood the consumer will move or
refinance during the penalty period. In these and other ways subprime
products tend to be complex for consumers.
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\11\ U.S. Dep't of Hous. & Urban Dev. & U.S. Dep't of Treasury,
Recommendations to Curb Predatory Home Mortgage Lending 17 (2000)
(``While predatory lending can occur in the prime market, such
practices are for the most part effectively deterred by competition
among lenders, greater homogeneity in loan terms and the prime
borrowers' greater familiarity with complex financial
transactions.''); Howard Lax, Michael Manti, Paul Raca & Peter Zorn,
Subprime Lending: An Investigation of Economic Efficiency (Subprime
Lending Investigation), 15 Housing Policy Debate 3, 570 (2004)
(stating that the subprime market lacks the ``overall
standardization of products, underwriting, and delivery systems''
that is found in the prime market).
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Third, the roles and incentives of originators are not transparent.
One source estimates that 60 percent or more of mortgages originated in
the last several years were originated through a mortgage broker, often
an independent entity, who takes loan applications from consumers and
shops them to depository institutions or other lenders.\12\ Anecdotal
evidence indicates that consumers in both the prime and subprime
markets often believe, in error, that a mortgage broker is obligated to
find the consumer the best and most suitable loan terms available. For
example, in a 2003 survey of older borrowers who had obtained prime or
subprime refinancings, seventy percent of respondents with broker-
originated refinance loans reported that they had relied ``a lot'' on
their brokers to find the best mortgage for them.\13\ Consumers who
rely on brokers often are unaware, however, that a broker's interests
may diverge from, and conflict with, their own interests. In
particular, consumers are often unaware that a creditor pays a broker
more to originate a loan with a rate higher than the rate the consumer
qualifies for based on the creditor's underwriting criteria.
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\12\ Data reported by Wholesale Access Mortgage Research and
Consulting, Inc., available at http://www.wholesaleaccess.com/8-17-07-prs.shtml; http://www.wholesaleaccess.com/7_28_mbkr.shtml.
\13\ Kellie K. Kim-Sung & Sharon Hermanson, Experiences of Older
Refinance Mortgage Loan Borrowers: Broker- and Lender-Originated
Loans, Data Digest No. 83 (AARP Public Policy Inst., Washington,
DC), Jan. 2003, at 3, available at http://www.aarp.org/research/credit-debt/mortgages/experiences_of_older_refinance_mortgage_loan_borro.html.
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Limited shopping. In this environment of limited transparency,
consumers--particularly those in the subprime market--who have been
told by an originator that they will receive a loan from that
originator may reasonably decide not to shop further among originators
or among loan options. The costs of further shopping may be
significant, including completing another application form and paying
yet another application fee. Delaying receipt of funds is another cost
of continuing to shop, a potentially significant one for the many
borrowers in the subprime market who are seeking to refinance their
obligations to lower their debt payments at least temporarily, to
extract equity in the form of cash, or both.\14\ Nearly 90 percent of
subprime ARMs used for refinancing in recent years were ``cash out.''
\15\
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\14\ See Anthony Pennington-Cross & Souphala Chomsisengphet,
Subprime Refinancing: Equity Extraction and Mortgage Termination, 35
Real Estate Economics 2, 233 (2007) (reporting that 49% of subprime
refinance loans involve equity extraction, compared with 26% of
prime refinance loans); Marsha J. Courchane, Brian J. Surette, and
Peter M. Zorn, Subprime Borrowers: Mortgage Transitions and Outcomes
(Subprime Outcomes), 29 J. of Real Estate Economics 4, 368-371
(2004) (discussing survey evidence that borrowers with subprime
loans are more likely to have experienced major adverse life events
(marital disruption; major medical problem; major spell of
unemployment; major decrease of income) and often use refinancing
for debt consolidation or home equity extraction); Subprime Lending
Investigation, at 551-552 (citing survey evidence that borrowers
with subprime loans have increased incidence of major medical
expenses, major unemployment spells, and major drops in income).
\15\ Figure calculated from First American LoanPerformance data.
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While the cost of continuing to shop is likely obvious, the benefit
may not be
[[Page 1676]]
clear or may appear quite small. Without easy access to subprime
product prices, a consumer who has been offered a loan by one
originator may have only a limited idea whether further shopping is
likely to produce a better deal. Moreover, consumers in the subprime
market have reported in studies that they were turned down by several
lenders before being approved.\16\ Once approved, these consumers may
see little advantage to continuing to shop if they expect, based on
their experience, that many of their applications to other originators
would be turned down. Furthermore, if a consumer uses a broker and
believes that the broker is shopping for the consumer, the consumer may
believe the chance of finding a better deal than the broker is small.
An unscrupulous originator may also seek to discourage a consumer from
shopping by intentionally understating the cost of an offered loan. For
all of these reasons, borrowers in the subprime market may not shop
beyond the first approval and may be willing to accept unfavorable
terms.\17\
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\16\ James M. Lacko & Janis K. Pappalardo, Fed. Trade Comm'n,
Improving Consumer Mortgage Disclosures: An Empirical Assessment of
Current and Prototype Disclosure Forms (Improving Mortgage
Disclosures), 24-26 (2007) (reporting evidence based on qualitative
consumer interviews); Subprime Lending Investigation, at 550
(finding based on survey data that ``[p]robably the most significant
hurdle overcome by subprime borrowers * * * is just getting approved
for a loan for the first time. This impact might well make subprime
borrowers more willing to accept less favorable terms as they become
uncertain about the possibility of qualifying for a loan at all.'').
\17\ Subprime Outcomes, at 371-372 (reporting survey evidence
that relative to prime borrowers, subprime borrowers are less
knowledgeable about the mortgage process, search less for the best
rates, and feel they have less choice about mortgage terms and
conditions); Subprime Mortgage Investigation, at 554 (``Our focus
groups suggested that prime and subprime borrowers use quite
different search criteria in looking for a loan. Subprime borrowers
search primarily for loan approval and low monthly payments, while
prime borrowers focus on getting the lowest available interest rate.
These distinctions are quantitatively confirmed by our survey.'').
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Limited focus. Consumers considering obtaining a typically complex
subprime mortgage loan may simplify their decision by focusing on a few
attributes of the product or service that seem most important.\18\ A
consumer may focus on loan attributes that have the most obvious and
immediate consequence such as loan amount, down payment, initial
monthly payment, initial interest rate, and up-front fees (though up-
front fees may be more obscure when added to the loan amount, and
``discount points'' in particular may be difficult for consumers to
understand). These consumers, therefore, may not focus on terms that
may seem less immediately important to them such as future increases in
payment amounts or interest rates, prepayment penalties, and negative
amortization. They are also not likely to focus on underwriting
practices such as income verification, and on features such as escrows
for future tax and insurance obligations.\19\ Consumers who do not
fully understand such terms and features, however, are less able to
appreciate their risks, which can be significant. For example, the
payment may increase sharply and a prepayment penalty may hinder the
consumer from refinancing to avoid the payment increase. Thus,
consumers may unwittingly accept loans that they will have difficulty
repaying.
---------------------------------------------------------------------------
\18\ Jinkook Lee & Jeanne M. Hogarth, Consumer Information
Search for Home Mortgages: Who, What, How Much, and What Else?
(Consumer Information Search), Financial Services Review 291 (2000)
(``In all, there are dozens of features and costs disclosed per
loan, far in excess of the combination of terms, lenders, and
information sources consumers report using when shopping.'').
\19\ Consumer Information Search, at 285 (reporting survey
evidence that most consumers compared interest rate or APR, loan
type (fixed-rate or ARM), and mandatory up-front fees, but only a
quarter considered the costs of optional products such as credit
insurance and back-end costs such as late fees). There is evidence
that borrowers are not aware of, or do not understand, terms of this
nature even after they have obtained a loan. See Improving Mortgage
Disclosures, at 27-30 (discussing anecdotal evidence based on
consumer interviews that borrowers were not aware of, did not
understand, or misunderstood an important cost or feature of their
loans that had substantial impact on the overall cost, the future
payments, or the ability to refinance with other lenders); Brian
Bucks & Karen Pence, Do Homeowners Know Their House Values and
Mortgage Terms? 18-22 (Fed. Reserve Bd. of Governors Fin. and Econ.
Discussion Series Working Paper No. 2006-3, 2006) (discussing
statistical evidence that borrowers with ARMs underestimate annual
as well as life-time caps on the interest rate; the rate of
underestimation increases for lower-income and less-educated
borrowers), available at http://www.federalreserve.gov/pubs/feds/2006/200603/200603pap.pdf.
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Limits of disclosure. Disclosures describing the multiplicity of
features of a complex loan could help some consumers in the subprime
market, but disclosures may not be sufficient to protect them against
unfair loan terms or lending practices. Obtaining widespread consumer
understanding of the many potentially significant features of a typical
subprime product is a major challenge.\20\ Moreover, even if all of a
loan's features are disclosed clearly to consumers, they may continue
to focus on a few features that appear most significant. Alternatively,
disclosing all features may ``overload'' consumers and make it more
difficult for them to discern which features are most important.
---------------------------------------------------------------------------
\20\ Improving Mortgage Disclosures, at 74-76 (finding that
borrowers in the subprime market may have more difficulty
understanding their loan terms because their loans are more complex
than loans in the prime market).
---------------------------------------------------------------------------
Furthermore, a consumer cannot make effective use of disclosures
without having a certain minimum level of understanding of the market
and products. Disclosures themselves, likely cannot provide this
minimum understanding for transactions that are complex and that
consumers engage in infrequently. Moreover, consumers may rely more on
their originators to explain the disclosures when the transaction is
complex; some originators may have incentives to misrepresent the
disclosures so as to obscure the transaction's risks to the consumer;
and such misrepresentations may be particularly effective if the
originator is face-to-face with the consumer.\21\ Therefore, while the
Board anticipates proposing changes to Regulation Z to improve mortgage
loan disclosures, it appears unlikely that better disclosures, alone,
will address adequately the risk of abusive or unaffordable loans in
the subprime market.
---------------------------------------------------------------------------
\21\ U.S. Gen. Accounting Office, GAO 04-280, Consumer
Protection: Federal and State Agencies Face Challenges in Combating
Predatory Lending 97-98 (2004) (stating that the inherent complexity
of mortgage loans, some borrowers' lack of financial sophistication,
education, or infirmities, and misleading statements and actions by
lenders and brokers limit the effectiveness of even clear and
transparent disclosures).
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Misaligned Incentives and Obstacles to Monitoring
Not only are consumers in the subprime market often unable to
protect themselves from abusive or unaffordable loans, originators may
at certain times be more likely to extend unaffordable loans. The
recent sharp rise in serious delinquencies on subprime mortgages has
made clear that originators may not give adequate attention to
repayment ability if they sell the mortgages they originate and bear
little loss if the mortgages default. The growth of the secondary
market gave lenders--and, thus, mortgage borrowers--greater access to
capital markets, lowered transaction costs, and allowed risk to be
shared more widely. This ``originate-to-distribute'' model, however,
may also tend to contribute to the loosening of underwriting standards,
particularly during periods of rapid house price appreciation, which
may mask problems by keeping default and delinquency rates low until
price appreciation slows or reverses.
This potential tendency has several related causes. First, when an
originator sells a mortgage and its servicing rights, depending on the
terms of the sale, most or all of the risks typically are passed on
[[Page 1677]]
to the loan purchaser. Thus, originators who sell loans may have less
of an incentive to undertake careful underwriting than if they kept the
loans. Second, warranties by sellers to purchasers and other
``repurchase'' contractual provisions have little meaningful benefit if
originators have limited assets. Third, fees for some loan originators
have been tied to loan volume, making loan sales--sometimes
accomplished through aggressive ``push marketing''--a higher priority
than loan quality for some originators. Fourth, investors may not
exercise adequate due diligence on mortgages in the pools in which they
are invested, and may instead rely heavily on credit-ratings firms to
determine the quality of the investment.
The fragmentation of the originator market can further exacerbate
the problem. Data reported under HMDA show that independent mortgage
companies--those not related to depository institutions or their
subsidiaries or affiliates--made nearly one-half of higher-priced
first-lien mortgages in 2005 and 2006 but only one-fourth of loans that
were not higher-priced. Nor was lending by independent mortgage
companies particularly concentrated: In each of 2005 and 2006 around
150 independent mortgage companies made 500 or more higher-priced
first-lien mortgage loans on owner-occupied dwellings. In addition, one
source suggests that 60 percent or more of mortgages originated in the
last several years were originated through a mortgage broker.\22\ This
same source estimates the number of brokerage companies at over 50,000
in recent years.
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\22\ Data reported by Wholesale Access Mortgage Research and
Consulting, Inc. Available at http://www.wholesaleaccess.com/8-17-07-prs.shtml; http://www.wholesaleaccess.com/7_28_mbkr.shtml.
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Thus, a securitized pool of mortgages may have been sourced by tens
of lenders and thousands of brokers. Investors have limited ability to
directly monitor these originators' activities. Similarly, a lender may
receive a handful of loans from each of hundreds or thousands of small
brokers every year. A lender has limited ability or incentive to
monitor every small brokerage's operations and performance.
Government oversight of such a fragmented originator market faces
significant challenges. The various lending institutions and brokers
operate in fifty different states and the District of Columbia with
different regulatory and supervisory regimes, varying resources for
supervision and enforcement, and different practices in sharing
information among regulators. State regulatory regimes come under
particular pressure when a booming market brings new lenders and
brokers into the marketplace more rapidly than regulators can increase
their oversight resources. These circumstances may inhibit the ability
of regulators to protect consumers from abusive and unaffordable loans.
A Role for New HOEPA Rules
As explained above, consumers in the subprime market face serious
constraints on their ability to protect themselves from abusive or
unaffordable loans, even with the best disclosures; originators
themselves may at times lack sufficient market incentives to ensure
loans they sell are affordable; and regulators face limits on their
ability to oversee a fragmented subprime origination market. These
circumstances appear to warrant imposing a new national legal standard
on subprime lenders to help ensure that consumers receive mortgage
loans they can afford to repay, and help prevent the equity-stripping
abuses that unaffordable loans facilitate. Adopting this standard under
authority of HOEPA would ensure that it applied uniformly to all
originators and provide consumers an opportunity to redress wrongs
through civil actions to the extent authorized by TILA. As explained in
the next part, substantial information supplied to the Board through
several public hearings confirms the need for new HOEPA rules.
III. The Board's HOEPA Hearings
A. Home Ownership and Equity Protection Act (HOEPA)
The Board has recently held extensive public hearings on consumer
protection issues in the mortgage market, including the subprime
sector. These hearings were held pursuant to the Home Ownership and
Equity Protection Act (HOEPA), which directs the Board to hold public
hearings periodically on the home equity lending market and the
adequacy of existing law for protecting the interests of consumers,
particularly low income consumers. HOEPA imposes substantive
restrictions, and special pre-closing disclosures, on particularly
high-cost refinancings and home equity loans (``HOEPA loans'').\23\
These restrictions include limitations on prepayment penalties and
``balloon payment'' loans, and prohibitions of negative amortization
and of engaging in a pattern or practice of lending based on the
collateral without regard to repayment ability.
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\23\ HOEPA loans are closed-end, non-purchase money mortgages
secured by a consumer's principal dwelling (other than a reverse
mortgage) where either: (a) The APR at consummation will exceed the
yield on Treasury securities of comparable maturity by more than 8
percentage points for first-lien loans, or 10 percentage points for
subordinate-lien loans; or (b) the total points and fees payable by
the consumer at or before closing exceed the greater of 8 percent of
the total loan amount, or $547 for 2007 (adjusted annually).
---------------------------------------------------------------------------
When it enacted HOEPA, Congress granted the Board authority,
codified in TILA Section 129(l), to create exemptions to HOEPA's
restrictions and to expand its protections. 15 U.S.C. 1639(l). Under
TILA Section 129(l)(1), the Board may create exemptions to HOEPA's
restrictions as needed to keep responsible credit available; and under
TILA Section 129(l)(2), the Board may adopt new or expanded
restrictions as needed to protect consumers from unfairness, deception,
or evasion of HOEPA. In HOEPA Section 158, Congress directed the Board
to monitor changes in the home equity market through regular public
hearings.
Hearings the Board held in 2000 led the Board to expand HOEPA's
protections in December 2001.\24\ Those rules, which took effect in
2002, lowered HOEPA's rate trigger, expanded its fee trigger to include
single-premium credit insurance, added an anti-``flipping''
restriction, and improved the special pre-closing disclosure.
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\24\ Truth in Lending, 66 FR 65604, 65608, Dec. 20, 2001.
---------------------------------------------------------------------------
B. Summary of 2006 Hearings
In the summer of 2006, the Board held four hearings in four cities
on three broad topics: (1) The impact of the 2002 HOEPA rule changes on
predatory lending practices, as well as the effects on consumers of
state and local predatory lending laws; (2) nontraditional mortgage
products and reverse mortgages; and (3) informed consumer choice in the
subprime market. Hearing panelists included mortgage lenders and
brokers, credit ratings agencies, real estate agents, consumer
advocates, community development groups, housing counselors,
academicians, researchers, and state and federal government officials.
In addition, consumers, housing counselors, brokers, and other
individuals made brief statements at the hearings during an ``open
mike'' period. In all, 67 individuals testified on panels and 54
comment letters were submitted to the Board.
Consumer advocates and some state officials stated that HOEPA is
generally effective in preventing abusive terms in loans subject to the
HOEPA price triggers. They noted, however, that very
[[Page 1678]]
few loans are made with rates or fees at or above the HOEPA triggers,
and some advocated that Congress lower them. Consumer advocates and
state officials also urged regulators and Congress to curb abusive
practices in the origination of loans that do not meet HOEPA's price
triggers.
Consumer advocates identified several particular areas of concern.
They urged the Board to prohibit or restrict certain loan features or
terms, such as prepayment penalties, and underwriting practices such as
``stated income'' or ``low documentation'' (``low doc'') loans for
which the borrower's income is not documented or verified. They also
expressed concern about aggressive marketing practices such as steering
borrowers to higher-cost loans by emphasizing initial low monthly
payments based on an introductory rate without adequately explaining
that the consumer will owe considerably higher monthly payments after
the introductory rate expires.
Some consumer advocates stated that brokers and lenders should be
held to a higher duty such as a duty of good faith and fair dealing or
a duty to make only loans suitable for the borrower. These advocates
also urged the Board to ban ``yield spread premiums,'' payments that
brokers receive from the lender at closing for delivering a loan with
an interest rate that is higher than the lender's ``buy rate,'' because
they provide brokers an incentive to increase consumers' interest
rates. They argued that such steps would align reality with consumers'
perceptions that brokers serve their best interests. Consumer advocates
also expressed concerns that brokers, lenders, and others may coerce
appraisers to misrepresent the value of a dwelling; and that servicers
may charge consumers unwarranted fees and in some cases make it
difficult for consumers who are in default to avoid foreclosure.
Industry panelists and commenters, on the other hand, expressed
concern that state predatory lending laws may reduce the availability
of credit for some subprime borrowers. Most industry commenters opposed
prohibiting stated income loans, prepayment penalties, or other loan
terms, asserting that this approach would harm borrowers more than help
them. They urged the Board and other regulators to focus instead on
enforcing existing laws to remove ``bad actors'' from the market. Some
lenders indicated, however, that restrictions on certain features or
practices might be appropriate if the restrictions were clear and
narrow. Industry commenters also stated that subjective suitability
standards would create uncertainties for brokers and lenders and
subject them to excessive litigation risk.
C. Summary of June 2007 Hearing
In light of the information received at the 2006 hearings and the
rise in defaults that began soon after, the Board held an additional
hearing in June 2007 to explore how it could use its authority under
HOEPA to prevent abusive lending practices in the subprime market while
still preserving responsible subprime lending. The Board focused the
hearing on four specific areas: Lenders' determination of borrowers'
repayment ability; ``stated income'' and ``low doc'' lending; the lack
of escrows in the subprime market relative to the prime market; and the
high frequency of prepayment penalties in the subprime market.
At the hearing, the Board heard from 16 panelists representing
consumers, mortgage lenders, mortgage brokers, and state government
officials, as well as from academicians. The Board also received almost
100 written comments after the hearing from an equally diverse group.
Industry representatives acknowledged concerns with recent lending
practices but urged the Board to address most of these concerns through
supervisory guidance rather than regulations under HOEPA. They
maintained that supervisory guidance, unlike regulation, is flexible
enough to preserve access to responsible credit. They also suggested
that supervisory guidance issued recently regarding nontraditional
mortgages and subprime lending, as well as market self-correction, have
reduced the need for new regulations. Industry representatives support
improving mortgage disclosures to help consumers avoid abusive loans.
They urged that any substantive rules adopted by the Board be clearly
drawn to limit uncertainty and narrowly drawn to avoid unduly
restricting credit.
In contrast, consumer advocates, state and local officials, and
Members of Congress urged the Board to adopt regulations under HOEPA.
They acknowledged a proper place for guidance but contended that recent
problems indicate the need for requirements enforceable by borrowers
through civil actions, which HOEPA enables and guidance does not. They
also expressed concern that less responsible, less closely supervised
lenders are not subject to the guidance and that there is limited
enforcement of existing laws for these entities. Consumer advocates and
others welcomed improved disclosures but insisted they would not
prevent abusive lending. More detailed accounts of the testimony and
letters are provided below in the context of specific issues the Board
is proposing to address.
D. Congressional Hearings
Congress has also held a number of hearings in the past year about
consumer protection concerns in the mortgage market.\25\ In these
hearings, Congress has heard testimony from individual consumers,
representatives of consumer and community groups, representatives of
financial and mortgage industry groups and federal and state officials.
These hearings have focused on rising subprime foreclosure rates and
the extent to which lending practices have contributed to them.
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\25\ 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).
---------------------------------------------------------------------------
Consumer and community group representatives testified that certain
lending terms or practices, such as hybrid adjustable-rate mortgages,
prepayment penalties, low or no documentation loans, lack of escrows
for taxes and insurance, and failure to consider the consumer's ability
to repay have contributed to foreclosures. In addition, these witnesses
testified that consumers often believe that mortgage brokers represent
their interests and shop on their behalf for the best loan terms. As a
result, they argue that consumers do not shop independently to ensure
that they are getting the best terms for which they qualify. They also
[[Page 1679]]
testified that, because originators sell most loans into the secondary
market and do not share the risk of default, brokers and lenders have
less incentive to ensure consumers can afford their loans.
Financial services and mortgage industry representatives testified
that consumers need better disclosures of their loan terms, but that
substantive restrictions on subprime loan terms would risk reducing
access to credit for some borrowers. In addition, these witnesses
testified that applying a fiduciary duty to the subprime market, such
as requiring that a loan be in the borrower's best interest, would
introduce subjective standards that would significantly increase
compliance and litigation risk. According to these witnesses, some
lenders would be less willing to offer loans in the subprime market,
making it harder for some consumers to get loans.
IV. Inter-Agency Supervisory Guidance
In December 2005, the Board and the other federal banking agencies
responded to concerns about the rapid growth of nontraditional
mortgages in the previous two years by proposing supervisory guidance.
Nontraditional mortgages are mortgages that allow the borrower to defer
repayment of principal and sometimes interest. The guidance advised
institutions of the need to reduce ``risk layering'' practices with
respect to these products, such as failing to document income or
lending nearly the full appraised value of the home. The proposal, and
the final guidance issued in September 2006, specifically advised
lenders that layering risks in nontraditional mortgage loans to
subprime borrowers may significantly increase risks to borrowers as
well as institutions.\26\
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\26\ Interagency Guidance on Nontraditional Mortgage Product
Risks, 71 FR 58609, Oct. 4, 2006.
---------------------------------------------------------------------------
The Board and the other federal banking agencies addressed concerns
about the subprime market more broadly in March 2007 with a proposal
addressing the heightened risks to consumers and institutions of ARMs
with two or three-year ``teaser'' rates followed by substantial
increases in the rate and payment. The guidance, finalized in June,
sets out the standards institutions should follow to ensure borrowers
in the subprime market obtain loans they can afford to repay.\27\ Among
other steps, the guidance advises lenders to (1) use the fully-indexed
rate and fully-amortizing payment when qualifying borrowers for loans
with adjustable rates and potentially non-amortizing payments; (2)
limit stated income and reduced documentation loans to cases where
mitigating factors clearly minimize the need for full documentation of
income; (3) provide that prepayment penalty clauses expire a reasonable
period before reset, typically at least 60 days.
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\27\ Statement on Subprime Mortgage Lending, 72 FR 37569, Jul.
10, 2007.
---------------------------------------------------------------------------
The Conference of State Bank Supervisors (CSBS) and American
Association of Residential Mortgage Regulators (AARMR) issued parallel
statements for state supervisors to use with state-supervised entities,
and many states have adopted the statements.
The guidance issued by the federal banking agencies has helped to
promote safety and soundness and protect consumers in the subprime
market. Guidance, however, is not necessarily implemented uniformly by
all originators. Originators who are not subject to routine examination
and supervision may not adhere to guidance as closely as originators
who are. Guidance also does not provide individual consumers who have
suffered harm because of abusive lending practices an opportunity for
redress. The new and expanded consumer protections that the Board is
proposing would apply uniformly to all creditors and be enforceable by
federal and state supervisory and enforcement agencies and in many
cases by borrowers.
V. Legal Authority
A. The Board's Authority Under TILA Section 129(l)(2)
The substantive limitations in new proposed Sec. Sec. 226.35 and
226.36 and corresponding revisions proposed for existing Sec. 226.32,
as well as proposed restrictions on misleading and deceptive
advertisements, would be based on the Board's authority under TILA
Section 129(l)(2), 15 U.S.C. 1639(l)(2). That provision gives the Board
authority to prohibit acts or practices in connection with:
Mortgage loans that the Board finds to be unfair,
deceptive, or designed to evade the provisions of HOEPA; and
Refinancing of mortgage loans that the Board finds to be
associated with abusive lending practices or that are otherwise not in
the interest of the borrower.
The authority granted to the Board under Section 129(l)(2), 15
U.S.C. 1639(l)(2), is broad both in absolute terms and relative to
HOEPA's statutory prohibitions. For example, this authority reaches
mortgage loans with rates and fees that do not meet HOEPA's rate or fee
trigger in TILA Section 103(aa), 15 U.S.C. 1602(aa), as well as types
of mortgage loans not covered under that section, such as home purchase
loans. Nor is the Board's authority limited to regulating specific
contractual terms of mortgage loan agreements; it extends to regulating
loan-related practices generally, within the standards set forth in the
statute. Moreover, while HOEPA's current restrictions apply only to
creditors and only to loan terms or lending practices, TILA Section
129(l)(2) is not limited to creditors, nor is it limited to loan terms
or lending practices. See 15 U.S.C. 1639(l)(2). It authorizes
protections against unfair or deceptive practices when such practices
are ``in connection with mortgage loans,'' and it authorizes
protections against abusive practices ``in connection with refinancing
of mortgage loans.''
HOEPA does not set forth a standard for what is unfair or
deceptive, but the Conference Report for HOEPA indicates that, in
determining whether a practice in connection with mortgage loans is
unfair or deceptive, the Board should look to the standards employed
for interpreting state unfair and deceptive trade practices acts and
the Federal Trade Commission Act, Section 5(a), 15 U.S.C. 45(a).\28\
---------------------------------------------------------------------------
\28\ H.R. Rep. 103-652, at 162 (1994) (Conf. Rep.).
---------------------------------------------------------------------------
Congress has codified standards developed by the Federal Trade
Commission for determining whether acts or practices are unfair under
Section 5(a), 15 U.S.C. 45(a).\29\ Under the Act, an act or practice is
unfair when it causes or is likely to cause substantial injury to
consumers which is not reasonably avoidable by consumers themselves and
not outweighed by countervailing benefits to consumers or to
competition. In addition, in determining whether an act or practice is
unfair, the FTC is permitted to consider established public policies,
but public policy considerations may not serve as the primary basis for
an unfairness determination.\30\
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\29\ See 15 U.S.C. 45(n); Letter from FTC to the Hon. Wendell H.
Ford and the Hon. John C. Danforth (Dec. 17, 1980).
\30\ 15 U.S.C. 45(n).
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The FTC has interpreted these standards to mean that consumer
injury is the central focus of any inquiry regarding unfairness.\31\
Consumer injury may be substantial if it imposes a small harm on a
large number of consumers, or if it raises a significant risk of
[[Page 1680]]
concrete harm.\32\ The FTC looks to whether an act or practice is
injurious in its net effects.\33\ The agency has also observed that an
unfair act or practice will almost always reflect a market failure or
market imperfection that prevents the forces of supply and demand from
maximizing benefits and minimizing costs.\34\ In evaluating unfairness,
the FTC looks to whether consumers' free market decisions are
unjustifiably hindered.\35\
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\31\ Statement of Basis and Purpose and Regulatory Analysis,
Credit Practices Rule (Credit Practices Rule), 42 FR 7740, 7743
March 1, 1984.
\32\ Letter from Commissioners of the FTC to the Hon. Wendell H.
Ford, Chairman, and the Hon. John C. Danforth, Ranking Minority
Member, Consumer Subcomm. of the H. Comm. on Commerce, Science, and
Transp., n.12 (Dec. 17, 1980).
\33\ Credit Practices Rule, 42 FR at 7744.
\34\ Credit Practices Rule at 7744.
\35\ Credit Practices Rule at 7744.
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The FTC has also adopted standards for determining whether an act
or practice is deceptive (though these standards, unlike unfairness
standards, have not been incorporated into the FTC Act).\36\ First,
there must be a representation, omission or practice that is likely to
mislead the consumer. Second, the act or practice is examined from the
perspective of a consumer acting reasonably in the circumstances.
Third, the representation, omission, or practice must be material. That
is, it must be likely to affect the consumer's conduct or decision with
regard to a product or service.\37\
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\36\ Letter from James C. Miller III, Chairman, FTC to the Hon.
John D. Dingell, Chairman, H. Comm. on Energy and Commerce (Dingell
Letter) (Oct. 14, 1983).
\37\ Dingell Letter at 1-2.
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Many states also have adopted statutes prohibiting unfair or
deceptive acts or practices, and these statutes employ a variety of
standards, many of them different from the standards currently applied
to the FTC Act. A number of states follow an unfairness standard
formerly used by the FTC. Under this standard, an act or practice is
unfair where it offends public policy; or is immoral, unethical,
oppressive, or unscrupulous; and causes substantial injury to
consumers.\38\ Some states require that a finding of deception be
supported by a showing of intent to deceive, while other states only
require showing that an act or practice is capable of being interpreted
in a misleading way.\39\
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\38\ See, e.g., Kenai Chrysler Ctr., Inc. v. Denison, 167 P.3d
1240, 1255 (2007) (quoting FTC v. Sperry & Hutchinson Co., 405 U.S.
233, 244-45 n.5 (1972)); State v. Moran, 151 N.H. 450, 452, 861 A.2d
763, 755-56 (2004) (concurrently applying the FTC's former test and
a test under which an act or practice is unfair or deceptive if
``the objectionable conduct * * * attain[s] a level of rascality
that would raise an eyebrow of someone inured to the rough and
tumble of the world of commerce.'') (citation omitted); Robinson v.
Toyota Motor Credit Corp., 201 Ill. 2d 403, 417-418, 775 N.E.2d 951,
961-62 (2002) (quoting 405 U.S. at 244-45 n.5).
\39\ Compare Robinson, 201 Ill. 2d at 417 (showing of intent to
deceive required under Illinois Consumer Fraud Act) with Kenai
Chrysler Ctr., 167 P.3d at 1255 (no showing of intent to deceive
required under Alaska Unfair Trade Practices Act).
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In proposing rules under TILA Section 129(l)(2)(A), 15 U.S.C.
1639(l)(2)(A), the Board has considered the standards currently applied
to the FTC Act's prohibition against unfair or deceptive acts or
practices, as well as the standards applied to similar state statutes.
B. The Board's Authority Under TILA Section 105(a)
Other aspects of this proposal are based on the Board's general
authority under TILA Section 105(a) to prescribe regulations necessary
or proper to carry out TILA's purposes. 15 U.S.C. 1604(a). This section
is the basis for the proposal to require early disclosures for
residential mortgage transactions as well as many of the proposals to
improve advertising disclosures. These proposals are intended to carry
out TILA's purposes of informing consumers about their credit terms and
helping them shop for credit. See TILA Section 102, 15 U.S.C. 1603.
VI. Proposed Definition of ``Higher-Priced Mortgage Loan''
A. Overview
The Board proposes to extend certain consumer protections to a
subset of consumer residential mortgage loans referred to as ``higher-
priced mortgage loans.'' A creditor would be prohibited from engaging
in a pattern or practice of making higher-priced mortgage loans based
on the collateral without regard to repayment ability. A creditor would
also be prohibited from making an individual higher-priced mortgage
loan without: Verifying the consumer income and assets the creditor
relied upon to make the loan; and establishing an escrow account for
taxes and insurance. In addition, a higher-priced mortgage loan would
not be permitted to have a prepayment penalty except under certain
conditions. Finally, a creditor would be prohibited from structuring a
closed-end mortgage loan as an open-end line of credit for the purpose
of evading the restrictions on higher-priced mortgage loans, which
would not apply to open-end lines of credit.
This part VI discusses the proposed definition of a ``higher priced
mortgage loan'' and a discussion of the specific protections that would
apply to these loans follows in part VII. The Board is proposing to
apply certain other restrictions to closed-end consumer mortgage loans
secured by the consumer's principal dwelling without regard to loan
price. These restrictions are discussed separately in part VIII.
Higher-priced mortgage loans would be defined as consumer credit
transactions secured by the consumer's principal dwelling for which the
APR on the loan exceeds the yield on comparable Treasury securities by
at least three percentage points for first-lien loans, or five
percentage points for subordinate lien loans. The proposed definition
would include home purchase loans, refinancings of loans, and home
equity loans. The definition would exclude home equity lines of credit
(``HELOCs''). In addition, there would be exclusions for reverse
mortgages, construction-only loans, and bridge loans.
The definition of ``higher-priced mortgage loans'' would appear in
proposed Sec. 226.35(a). Such loans would be subject to the
restrictions and requirements in Sec. 226.35(b) concerning repayment
ability, income verification, prepayment penalties, escrows, and
evasion, except that subordinate-lien higher-priced mortgage loans
would not be subject to the escrow requirement.
B. Public Comment on the Scope of New HOEPA Rules
The June 14, 2007 hearing notice solicited comment on the following
questions concerning coverage:
Whether terms or practices discussed in the hearing notice
should be prohibited or restricted for all mortgage loans, or only for
loans offered to subprime borrowers?
Whether terms or practices should be prohibited or
restricted for loans to first-time homebuyers, home purchase loans, or
refinancings and home equity loans?
Whether terms or practices should be prohibited or
restricted only for certain products, such as adjustable-rate mortgages
or nontraditional mortgages?
Many commenters addressed the scope of any rules the Board might
propose. Some consumer and community groups favored applying some or
all prohibitions to the entire mortgage market, though other groups
recommended that certain protections (e.g., for repayment ability) be
applied to the entire market and others (e.g., for escrows) only to
subprime and nontraditional loans. In general, financial institutions
and financial services groups maintained that new rules should not be
applied to the entire market.
Most commenters suggested that, to the extent the Board targets
subprime
[[Page 1681]]
loans, it do so based on loan characteristics rather than borrower
characteristics such as credit score. Some commenters proposed that
coverage be determined by a loan's annual percentage rate (APR) and
suggested various approaches based on lender reporting of ``higher-
priced loans'' under Regulation C, which implements the Home Mortgage
Disclosure Act (HMDA). Several industry commenters, however, pointed
out drawbacks of using an approach based on HMDA reporting and
advocated instead that the Board cover only loans with ``payment
shock.''
C. General Principles Governing the Board's Determination of Coverage
Four main principles will guide the Board's determination of
appropriate coverage. First, new regulations should be applied as
broadly as needed to protect consumers from actual or potential injury,
but not so broadly that the costs, including the always-present risk of
unintended consequences, would clearly outweigh the benefits. Evidence
that consumers have actually been injured by a particular practice in a
particular market segment is important to determining proper coverage.
Protection may also be needed in a particular segment, however, to
prevent potential future injury in that segment or to limit adverse
effects should lenders circumvent protections applied to another
segment.
Second, the most practical and effective way to protect borrowers
is to apply protections based on loan characteristics, rather than
borrower characteristics. Identifying a class of protected borrowers
would present operational difficulties and other problems. For example,
it is common to distinguish borrowers by credit score, with lower-
scoring borrowers generally considered to be at higher risk of injury
in the mortgage market. Defining the protected field as lower-scoring
consumers would fail to protect higher-scoring consumers ``steered'' to
loans meant for lower-scoring consumers. Moreover, the market uses
different commercial scores, and choosing a particular score as the
benchmark for a regulation could give unfair advantage to the company
that provides that score.
Third, the rule identifying higher-priced loans should be as simple
as reasonably possible, consistent with protecting consumers and
minimizing costs. For the sake of simplicity, the same coverage rule
should apply to all new protections except where the benefit of
tailoring coverage criteria to specific protections outweighs the
increased complexity.
Fourth, the rule should give lenders a reasonable degree of
certainty during the application process regarding whether a
transaction, when completed, will be covered by a particular
protection. For some protections, reasonable certainty may be needed
early in the application process; for other protections, it may not be
needed until later. Reasonable certainty does not mean complete
certainty. A rule that would provide lenders complete certainty about
coverage early in the application process is likely not achievable.
D. Types of Loans Proposed To Be Covered Under Sec. 226.35
The Board's proposed definition of ``higher-priced mortgage loan''
has two main aspects. The first aspect is loan type--the definition
includes certain types of loans (such as home purchase loans) and
excludes others (such as HELOCs). The second aspect is loan price--the
definition includes only loans with APRs exceeding specified
thresholds. The first aspect of the definition, loan type, is discussed
immediately below, and the second is discussed thereafter.
The Board proposes to apply the protections of Sec. 226.35 to
first-lien, as well as subordinate-lien, closed-end mortgage loans
secured by the consumer's principal dwelling, including home purchase
loans, refinancings of loans, and home equity loans. The proposed
definition would not cover loans that do not have primarily a consumer
purpose, such as loans for real estate investment. The proposed
definition also would not cover HELOCs, reverse mortgages,
construction-only loans, or bridge loans.
Coverage of Home Purchase Loans, Refinancings, and Home Equity Loans
The statutory protections for HOEPA loans are generally limited to
closed-end refinancings and home equity loans. See TILA Section
103(aa), 15 U.S.C. 1602(aa). The Board proposes to apply the
protections of Sec. 226.35 to loans of these types, which have
historically presented the greatest risk to consumers. These loans are
often made to consumers who have home equity and, therefore, have an
existing asset at risk. These loans also can be marketed aggressively
by originators to homeowners who may not benefit from them and who, if
responding to the marketing and not shopping independently, may have
limited information about their options.
The Board proposes to use its authority under TILA Section
129(l)(2), 15 U.S.C. 1639(l)(2), to cover home purchase loans as well.
Covering only refinancings of home purchase loans would fail to protect
consumers adequately. From 2003 to 2006, 44 percent of the higher-risk
ARMs that came to dominate the subprime market in recent years were
extended to consumers to purchase a home.\40\ Delinquencies on subprime
ARMs used for home purchase have risen sharply just as they have for
refinancings. Moreover, comments and testimony at the Board's hearings
indicate that the problems with abusive lending practices are not
confined to refinancings and home equity loans.
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\40\ Figure calculated from First American LoanPerformance data.
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Furthermore, consumers who are seeking home purchase loans can face
unique constraints on their ability to make decisions. First-time
homebuyers are likely unfamiliar with the mortgage market. Homebuyers
generally are primarily focused on acquiring a new home, arranging to
move into it, and making other life plans related to the move, such as
placing their children in new schools. These matters can occupy much of
the time and attention consumers might otherwise devote to shopping for
a loan and deciding what loan to accept. Moreover, even if the consumer
comes to understand later in the application process that an offered
loan may not be appropriate, the consumer may not be able to reject the
loan without risk of abrogating the sales agreement and losing a
substantial deposit, as well as disrupting moving plans.
Coverage of Subordinate-Lien Loans
The Board is proposing to apply the proposed new protections--with
the exception of the requirement to establish escrows--to subordinate-
lien loans. (The reasons for this exception are discussed below under
part VII.D.) The Board seeks comment on whether other exceptions would
be appropriate. For example, should the Board limit coverage of all or
some of the proposed restrictions to certain kinds of subordinate-lien
loans such as ``piggy backs'' to first-lien loans, or subordinate-lien
loans that are larger than the first-lien loan?
Limitation to Loans Secured by Principal Dwelling; Exclusion of Loans
for Investment
The Board is proposing to limit the protections in proposed Sec.
226.35 to loans secured by the consumer's principal dwelling. The
Board's primary concern is to ensure that consumers not lose the homes
they principally occupy
[[Page 1682]]
because of unfair, abusive, or deceptive lending practices. The
inevitable costs of new regulation, including potential unintended
consequences, can most clearly be justified when people's principal
homes are at stake.
Limiting the proposed protections to loans secured by the principal
dwelling would have the effect of excluding many, but not all, loans to
purchase second homes. A loan to a consumer to purchase a second home,
for example, would not be covered by these protections if the loan was
secured only by the second home or by another dwelling (such as an
investment property) other than the consumer's principal dwelling. Such
a loan would, however, be covered if it was instead secured by the
consumer's principal dwelling.
Limiting the proposed protections to loans secured by the principal
dwelling--and to loans having primarily a consumer purpose--would also
have the effect of excluding loans primarily for a real estate
investment purpose. This exclusion is consistent with TILA's focus on
consumer concerns and its exclusion in Section 104 of credit primarily
for business, commercial, or agricultural purposes. See 15 U.S.C.
1603(1). Real estate investors are expected to be more sophisticated
than ordinary consumers about the real estate financing process and to
have more experience with it, especially if they invest in several
properties. Accordingly, the need to protect investors is not clear,
and in any event is likely not sufficient to justify the potential
unintended consequences of imposing restrictions, with civil liability
if they are violated, on the financing of real estate investment
transactions.
The Board shares concerns that individuals who invest in
residential real estate and do not pay their mortgage obligations put
tenants at risk of eviction in the event of foreclosure. Regulating the
rights of landlords and tenants, however, is traditionally a matter for
state and local law. The Board believes that state and local law could
better address this particular tenant protection concern than a Board
regulation.
Exclusion of HELOCs
The Board proposes to exclude HELOCs from the proposed protections.
These transactions do not appear to present as clear a need for new
regulations as closed-end transactions. Most originators of HELOCs hold
them in portfolio rather than sell them, which aligns these
originators' interests in loan performance more closely with their
borrowers' interests. In addition, TILA and Regulation Z provide
borrowers special protections for HELOCs such as restrictions on
changing plan terms. And, unlike originations of higher-priced closed-
end mortgage loans, HELOC originations are concentrated in the banking
and thrift industries, where the federal banking agencies can use
supervisory authorities to protect borrowers. For example, when
inadequate underwriting of HELOCs unduly increased risks to originators
and consumers several years ago, the agencies responded with
guidance.\41\ For these reasons, the Board is not proposing to cover
HELOCs.
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\41\ Interagency Credit Risk Guidance for Home Equity Lending,
May 16, 2005.
Available at http://www.federalreserve.gov/boarddocs/srletters/2005/sr0511a1.pdf.
Addendum to Credit Risk Guidance for Home Equity Lending, Sept.
29, 2006. Available at http://www.federalreserve.gov/BoardDocs/SRLetters/2006/SR0615a3.pdf.
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The Board recognizes, however, that HELOCs may represent a risk of
circumvention. Creditors may seek to evade limitations on closed-end
transactions by structuring such transactions as open-end transactions.
In proposed Sec. 226.35(b)(5), discussed below in part VII.F., the
Board proposes to prohibit structuring a closed-end loan as an open-end
transaction for the purpose of evading the new rules in Sec. 226.35.
To the extent it may instead be appropriate to apply those rules
directly to HELOCs, the Board seeks comment on how an APR threshold for
HELOCs could be set to achieve the objectives, discussed further in
subpart E., of covering the subprime market and generally excluding the
prime market.
Exclusion of Reverse Mortgages and Construction-Only Loans
The Board proposes to exclude reverse mortgages and construction-
only loans from the new protections in Sec. 226.35(b). A reverse
mortgage is defined in current Sec. 226.33(a), and the proposal would
retain this definition. The Board heard from panelists about reverse
mortgages at its 2006 HOEPA hearings and has not identified significant
abuses in the reverse mortgage market. Moreover, reverse mortgages are
unique transactions that present unique risks that are currently
addressed by Regulation Z Sec. 226.33. At an appropriate time, the
Board will review Sec. 226.33 and consider whether new or different
protections are needed for reverse mortgages.
The Board would also exclude from Sec. 226.35's protections a
construction-only loan, defined as a loan solely for the purpose of
financing the initial construction of a dwelling, consistent with the
definition of a ``residential mortgage transaction'' in Sec.
226.2(a)(24). A construction-only loan would not include the permanent
financing that replaces a construction loan. Construction-only loans do
not appear to present the same risk of consumer abuse as other loans
the proposal would cover. The permanent financing, or a new home-
secured loan following construction, would be covered by proposed Sec.
226.35. Applying Sec. 226.35 to construction-only loans, which
generally have higher interest rates than the permanent financing,
could hinder some borrowers' access to construction financing without
meaningfully enhancing consumer protection.
Exclusion of Bridge Loans
Proposed Sec. 226.35(a)(5) would exempt from Sec. 226.35
temporary or ``bridge loans'' with a term of no more than twelve
months. The regulation would give as an example a loan that a consumer
takes to ``bridge'' between the purchase of a new dwelling and the sale
of the consumer's existing dwelling. HOEPA now covers certain bridge
loans with rates or fees high enough to make them HOEPA loans. TILA
Section 129(l)(1) provides the Board authority to exempt classes of
mortgage transactions from HOEPA if the Board finds that the exemption
is in the interest of the borrowing public and will apply only to
products that maintain and strengthen homeownership and equity
protection. 15 U.S.C. 1639(l)(2). The Board believes a narrow exemption
from HOEPA for bridge loans would be in borrowers' interest and support
homeownership. The Board seeks comment on the proposed exemption.
E. Proposed APR Trigger for Sec. 226.35
Overview
The Board proposes to use an APR trigger to define the range of
transactions that would be covered by the protections of proposed Sec.
226.35. The Board seeks to set the trigger at a level that would
capture the subprime market but generally exclude the prime market.
There is, however, inherent uncertainty as to what level would achieve
these objectives. The Board believes that it may be appropriate, in the
face of this uncertainty, to err on the side of covering somewhat more
than the subprime market. Based on this approach, the Board proposes a
threshold of three percentage points above the comparable Treasury
security for first-lien loans, or five percentage points for
subordinate-lien loans. Based on available data, it appears that this
threshold would capture at least the
[[Page 1683]]
higher-priced end of the alt-A market. The Board seeks comment, and
solicits data, on the extent to which the threshold would cover the
alt-A market, and on the benefits and costs, including any potential
unintended consequences for consumers, of applying any or all of the
protections in Sec. 226.35 to the alt-A market to the extent it would
be covered. The Board also seeks comment on whether a different
threshold, such as four percentage points for first-lien loans (and six
percentage points for subordinate-lien loans), would better satisfy the
objectives of covering the subprime market, excluding the prime market,
and avoiding unintended consequences for consumers in the alt-A market.
Reasons To Use APR
The APR corresponds closely to credit risk, that is, the risk of
default as well as the closely related risks of serious delinquency and
foreclosure. Loans with higher APRs generally have higher credit risks,
whatever the source of the risk might be--weaker borrower credit
histories, higher borrower debt-to-income ratios, higher loan-to-value
ratios, less complete income or asset documentation, less traditional
loan terms or payment schedules, or combinations of these or other risk
factors. Since disclosing an APR has long been required by TILA, the
figure is also very familiar and readily available to creditors and
consumers. Therefore, the Board believes it appropriate to use a loan's
APR to identify loans having a high enough credit risk to warrant the
protections of proposed Sec. 226.35.
The APR for two loans with identical risk characteristics can be
different at different times solely because of market changes in
mortgage rates. The Board proposes to control for such market changes
by comparing a loan's APR to the yield on the comparable Treasury
security. This would be similar, but not identical, to the approach
HOEPA uses currently to identify HOEPA-covered loans, see TILA Section
103(aa), 15 U.S.C. 1602(aa), and Sec. 226.32(a), and Regulation C uses
to identify higher-priced loans reportable under HMDA, see 12 CFR
203.4(a)(12). The Board is aware of concerns that the method that these
regulations use to match mortgage loans to Treasuries leads to some
inaccuracy in coverage and makes coverage vary with changes in the
yield curve (the relationship between short-term and long-term interest
rates). As discussed in more detail below, the Board is proposing to
address these concerns in the context of Sec. 226.35.
Coverage Objectives
The Board set forth above a general principle that new regulations
should be applied as broadly as needed to protect consumers from actual
or potential injury, but not so broadly that the costs, including the
always-present risk of unintended consequences, would clearly outweigh
the benefits. Consistent with this principle, the Board believes that
the APR threshold should satisfy two objectives. It should ensure that
subprime loans are covered. Second, it should also generally exclude
prime loans.
The subprime market should be covered because it is, by definition,
the market with the highest credit risk. There are of course variations
in risk within the subprime market. For example, delinquencies on
fixed-rate subprime mortgages have been lower in recent years than on
adjustable-rate subprime mortgages. It may not be practical or
effective, however, to target certain loans in the subprime market for
coverage while excluding others. Such a rule would be more complex and
possibly require frequent updating as products evolved. Moreover,
market imperfections discussed in part II.C.--the subprime market's
lack of transparency and potentially inadequate creditor incentives to
make only loans that consumers can repay--affect the subprime market as
a whole.
There are two principal reasons why the Board seeks to exclude the
prime market from Sec. 226.35. First, there is limited evidence that
the problems addressed in Sec. 226.35, such as lending without regard
to repayment ability, have been significant in the prime market or gone
unaddressed when they have on occasion arisen. By nature, loans in the
prime market have a lower credit risk, as seen in the relatively low
default and delinquency rates for prime loans compared to sharply
increasing rates for subprime loans since 2005. Moreover, the prime
market is more transparent and competitive, characteristics that make
it less likely a creditor can sustain an unfair, abusive, or deceptive
practice. In addition, borrowers in the prime market are less likely to
be under the degree of financial stress that tends to weaken the
ability of many borrowers in the subprime market to protect themselves
against unfair, abusive, or deceptive practices. To be sure, there have
been concerns about the prime market, and this proposal would address
some of them. For example, the proposal addresses concerns about
coercion of appraisers, untransparent creditor payments to mortgage
brokers, and abusive servicing practices.
Second, any undue risks to consumers in the prime market from
particular loan terms or lending practices can be adequately addressed
through means other than new regulations under HOEPA. Supervisory
guidance from the federal agencies influences a large majority of the
prime market which, unlike the subprime market, has been dominated by
federally supervised institutions.\42\ Such guidance affords regulators
and institutions alike more flexibility than a regulation, with
potentially fewer unintended consequences. In addition, the Government
Sponsored Enterprises continue to play a major role in the prime
market, and they are accountable to regulators and policy makers for
the standards they set for loans they will purchase.\43\
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\42\ According to HMDA data from 2005 and 2006, more than three-
quarters of prime, conventional first-lien mortgage loans on owner-
occupied properties were made by depository institutions or their
affiliates. For this purpose, a loan for which price information was
not reported is treated as a prime loan.
\43\ According to HMDA data from 2005 and 2006, nearly 30
percent of prime, conventional first-lien mortgage loans on owner-
occupied properties were purchased by Fannie Mae or Freddie Mac.
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For these reasons, the Board does not believe that substantive
restrictions on loan terms or lending practices are warranted in the
prime market at this time. The need for such restrictions is not clear
and their potential unintended consequences could be significant.
Inherent Uncertainty of Meeting Coverage Objectives
There are three major reasons why it is inherently uncertain which
APR threshold would achieve the twin objectives of covering the
subprime market and generally excluding the prime market. First, there
is no single, precise, and uniform definition of the prime or subprime
market, or of a prime or subprime loan. Moreover, the markets are
separated by a somewhat loosely defined segment known as the alt-A
market, the precise boundaries of which are not clear.
Second, available data sets enable only estimation, not precise
calculation, of the empirical relationship between APR and credit risk.
A proprietary dataset such as First American LoanPerformance may
contain detailed information on loan characteristics, including the
contract rate, but lack the APR or sufficient data to derive the APR.
Other data must be consulted to estimate APRs based on contract rates.
HMDA data contain the APR for higher-priced loans (as adjusted by
comparable Treasury securities), but they have little information about
credit risk.
[[Page 1684]]
Third, data sets can of course show only the existing or past
distribution of loans across market segments, which may change in ways
that are difficult to predict. In particular, the distribution could
change in response to the Board's imposition of the restrictions in
Sec. 226.35, but the likely direction of the change is not clear. A
loan's APR is typically not known to a certainty until after the
underwriting has been completed, and not until closing if the consumer
has not locked the interest rate. Creditors might build in a
``cushion'' against this uncertainty by voluntarily setting their
internal thresholds lower than the threshold in the regulation.
Creditors would have a competing incentive to avoid the
restrictions, however, by restructuring the prices of potential loans
that would have APRs just above the threshold to cause the loans' APRs
to come under the threshold. Different combinations of interest rate
and points that are economically identical for an originator produce
different APRs. If proposed Sec. 226.35 were adopted, an originator
would have an incentive to achieve a rate-point combination that would
bring a loan's APR below the threshold (if the borrower had the
resources or equity to pay the points). Moreover, some fees, such as
late fees and prepayment penalties, are not included in the APR.
Creditors could increase the number or amounts of such fees to maintain
a loan's effective price while lowering its APR below the threshold. It
is not clear whether the net effect of these competing forces of over-
compliance and circumvention would be to capture more, or fewer, loans.
For all of the above reasons, there is inherent uncertainty as to
what APR threshold would achieve the objectives of covering the
subprime market and generally excluding the prime market.
The Alt-A Market
In the face of this uncertainty, deciding on an APR threshold calls
for judgment. The Board believes it may be appropriate to err on the
side of covering somewhat more than the subprime market. In effect,
this could mean covering part of the alt-A market, a possibility that
merits special consideration.
The alt-A market is generally understood to be for borrowers who
typically have higher credit scores than subprime borrowers but still
pose more risk than prime borrowers because they make small down
payments or do not document their incomes, or for other reasons. The
definition of this market is not precise, however. Moreover, the size
and character of this market segment have changed markedly in a
relatively short period. According to one source, it was 2 percent of
residential mortgage originations in 2003 and 13 percent in 2006.\44\
At least part of this growth was due to increasing flexibility of
underwriting standards. For example, in 2006, 80 percent of loans
originated for alt-A securitized pools were underwritten without full
documentation of income, compared to about 60 percent from 2000 to
2004.\45\ At the same time, nontraditional mortgages allowing borrowers
to defer principal, or both principal and interest, also expanded,
reaching 78 percent of alt-A originations in 2006.\46\
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\44\ IMF 2007 Mortgage Market, at 4.
\45\ Figures calculated from First American LoanPerformance
data.
\46\ David Liu & Shumin Li, Alt A Credit--The Other Shoe Drops?,
The MarketPulse The MarketPulse (First American LoanPerformance,
Inc., San Francisco, Cal.), Dec. 2006.
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The Board recognizes that risks to consumers in the alt-A market
are lower than risks in the subprime market. The Board believes,
however, that it may be appropriate to cover at least part of the alt-A
market with the protections of Sec. 226.35. Because of the inherent
uncertainties in setting an APR threshold discussed above, covering
part of the alt-A market may be necessary to ensure consistent coverage
of the subprime market. Moreover, to the extent Sec. 226.35 were to
cover the higher-priced end of the alt-A market, where several risks
may be layered, the regulation may benefit consumers more than it would
cost them. For example, applying an income verification requirement to
the riskier part of the alt-A market could ameliorate injuries to
consumers from lending based on inflated incomes without necessarily
depriving consumers of access to credit, if they are able to document
their incomes as Sec. 226.35(b)(2) would require. Prohibiting lending
without regard to repayment ability in this market slice could reduce
the risk to consumers from ``payment shock'' on nontraditional loans.
At the same time, the Board recognizes the potential for unintended
consequences if Sec. 226.35 restrictions were to cover part of the
alt-A market and seeks to minimize those consequences.
The Proposed Thresholds of 3 and 5 Percentage Points
Based on the foregoing considerations, the Board is proposing to
set the APR threshold for a loan at three percentage points above the
comparable Treasury security, or five percentage points in the case of
a subordinate-lien loan. Available data indicate that this threshold
would capture the subprime market but generally exclude the prime
market. In each of the last two years, the percentage of the first-lien
mortgage market Regulation C has captured as higher-priced using a
threshold of three percentage points has been greater than the
percentage of the total market originations that one industry source
has estimated to be subprime (25 percent vs. 20 percent in 2005; 28
percent vs. 20 percent in 2006).\47\ Regulation C is not thought,
however, to have reached the prime market. Rather, in both years it
reached into the alt-A market, which the same source estimated to be 12
percent in 2005 and 13 percent in 2006. In 2004, Regulation C captured
a significantly smaller part of the market than an industry estimate of
the subprime market (11 percent vs. 19 percent), but that year's HMDA
data were somewhat anomalous.\48\
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\47\ For industry estimates see IMF 2007 Mortgage Market, at 4.
\48\ The principal cause of the reporting deficit was the
unusually steep yield curve that characterized 2004. For purposes of
proposed Sec. 226.35(a), the Board is proposing to adjust the
method that Regulation C uses to calculate the higher-priced loan
threshold to reduce, though not eliminate, the effects of yield
curve changes on Sec. 226.35's coverage. This proposal is discussed
below.
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The Board does not have data indicating how closely the proposed
threshold of five percentage points for subordinate-lien loans would
correspond to the subprime home equity market. It is the Board's
understanding, however, that this threshold, which has prevailed in
Regulation C since 2004, has been at least roughly accurate.
Requests for Comment
The Board seeks comment, and supporting data, on whether different
thresholds would better satisfy the objectives of covering the subprime
market and generally excluding the prime market. The Board seeks
comment and data both as to first-lien loans and as to subordinate-lien
loans; and both as to home purchase loans and as to refinancings. The
Board also seeks comment and supporting data on the extent to which the
proposed threshold would cover the alt-A market and, as discussed
above, on the costs and benefits of such coverage. Moreover, the Board
seeks comment on whether a different threshold than that proposed, such
as four percentage points for first-lien loans (and six percentage
points for subordinate-lien loans), would better satisfy the objectives
of covering the subprime market, excluding the prime market, and
avoiding unintended
[[Page 1685]]
consequences for consumers in the alt-A market.
The Board also seeks comment on the extent to which lenders may set
an internal threshold lower than that set forth in the regulation to
ensure compliance, and the consequences that could have for consumers.
Conversely, the Board seeks comment on the extent of the risk creditors
would circumvent the proposed restrictions by charging more fees and
lower interest rates to reduce their loans' APRs, and the consequences
that could have for consumers. Is this risk significant enough to
warrant addressing separately. For example, should the Board adopt a
separate fee trigger? What fees would such a trigger include and at
what level would it be set? Alternatively, would a general prohibition
on manipulating the APR to circumvent the protections of Sec. 226.35
be practicable?
F. Mechanics of the Proposed APR Trigger
Under Regulation C, price information on a closed-end, first-lien
loan is reported if the loan's APR exceeds by three or more percentage
points (five if the loan is secured by a subordinate lien) the yield on
Treasury securities having a comparable period of maturity. A lender
uses the yield on Treasury securities as of the 15th day of the
preceding month if the rate is set between the 1st and the 14th day of
the month, and as of the 15th of the current month if the rate is set
on or after the 15th day. Although the Board proposes to use the same
numerical thresholds, the Board proposes to use somewhat different
rules for matching mortgage loans to Treasury securities.
Matching Loans to Treasury Securities
For purposes of this rulemaking, the Board proposes to use a
different approach than Regulation C uses to match loans to Treasury
securities, with the intent of reducing effects solely from changes in
the interest rate environment. Following the model of HOEPA (TILA
Section 103(aa), 15 U.S.C. 1603(aa)), Regulation C compares the APR on
a loan to the yield on Treasury securities having a period of maturity
comparable to the maturity of the loan. 12 CFR 203.4(a)(12). For
example, the APR on a fixed-rate, 30-year loan--the most common loan
term in the market--is compared to the yield on a 30-year Treasury
security. In actuality, mortgage loans are usually paid off long before
they mature, typically in five to ten years. Rates on fixed-rate 30-
year mortgage loans, therefore, more closely track yields on Treasury
securities having maturities in the range of five to ten years rather
than yields on 30-year Treasury securities. Rates on adjustable-rate
mortgages more closely track yields on Treasury securities that mature
in one to five years, depending in part on the duration of any initial
fixed-rate period. As a result, changes in the relationship of short-
term rates to long-term rates, known as the yield curve, have affected
reporting of higher-priced mortgage loans.
For purposes of the rules proposed here, the Board's goal is to
reduce this ``yield curve effect.'' Ideally, each loan would be matched
to a Treasury security that corresponds to that loan's expected
maturity, which would be determined based on empirical data about
prepayment speeds for loans with the same features. It is not
practicable, however, to match loans to Treasuries on the basis of the
full range of features that may influence prepayment speeds. For the
sake of simplicity and predictability, the Board proposes to prescribe
rules based on three features: whether the loan is adjustable-rate or
fixed-rate; the term of the loan; and the length of any initial fixed-
rate period, if the loan is adjustable-rate.
Proposed Sec. 226.35(a) that would match closed-end loans to
Treasury securities as follows. First, variable rate transactions with
an initial fixed-rate period of more than one year would be matched to
Treasuries having a maturity closest to the length of the fixed-rate
period (unless the fixed-rate period exceeds seven years, in which case
the creditor would use the rules applied to non-variable rate loans).
For example, a 30-year ARM having an initial fixed-rate period of five
years would be matched to a 5-year Treasury security. Second, variable-
rate transactions with an initial fixed-rate period of one year or less
would be matched to Treasury security having a maturity of one year.
Third, fixed-rate loans would be matched on the basis of loan term in
the following way: A fixed-rate loan with a term of 20 years or more
would be matched to a 10-year Treasury security; a fixed-rate loan with
a term of more than 7 years but less than twenty years would be matched
to a 7-year Treasury security; and a fixed-rate loan with a term of
seven years or less would be matched to the Treasury security with a
maturity closest to the term.
Timing of the Match
The proposal also would differ from Regulation C as to timing. The
Treasury security yield that would be used is the yield as of the 15th
of the month preceding the month in which the application is received,
rather than the 15th of the month before the rate is locked. This would
introduce more certainty, earlier in the application process, to the
determination as to whether a potential transaction would be a higher-
priced mortgage loan when consummated. The actual APR, however, would
not be known to a certainty early in the application process, leaving
some uncertainty as to whether a potential loan will be a higher-priced
loan if it is actually originated. The APR disclosed within three days
of application could change before closing for legitimate reasons such
as changes in the interest rate or in the borrower's decision as to how
many points to pay, if any. It is not expected, however, that an APR
would change substantially in many cases for legitimate reasons.
Using two different trigger dates in Regulation C and Regulation Z
Sec. 226.35(a)--the rate lock date in the first and the application
date in the second--could increase regulatory burden. Using the rate
lock date in Sec. 226.35(a), however, could increase uncertainty,
relative to using the application date, as to whether a loan would be
higher-priced when consummated. The Board believes the potentially
somewhat higher regulatory burden from inconsistency may be justified
by the increase in certainty.
Requests for Comment
The Board seeks data with which to evaluate the proposed approach
to matching mortgage loans to Treasury securities and the proposal to
select the appropriate Treasury security based on the application date.
The Board also solicits suggestions for alternative approaches that
would better meet the objectives of relative simplicity and reasonably
accurate coverage.
VII. Proposed Rules for Higher-Priced Mortgage Loans--Sec. 226.35
A. Overview
This part discusses the new consumer protections the Board proposes
to apply to ``higher-priced mortgage loans.'' A creditor would be
prohibited from engaging in a pattern or practice of making higher-
priced mortgage loans based on the collateral without regard to
repayment ability. A creditor would also be prohibited from making an
individual higher-priced mortgage loan without: Verifying the income
and assets the creditor relied upon to make the loan; and establishing
an escrow account for taxes and insurance. In addition, a higher-priced
mortgage loan
[[Page 1686]]
could not have a prepayment penalty except under certain conditions.
The Board believes that the practices that would be prohibited,
when conducted in connection with higher-priced mortgage loans, are
unfair, deceptive, associated with abusive lending practices, and
otherwise not in the interest of the borrower. See TILA Section
129(l)(2), 15 U.S.C. 1639(l)(2), and the discussion of this statute in
part V above. Making higher-priced mortgage loans without adequately
considering repayment ability, verifying income or assets, or
establishing an escrow account for taxes and insurance significantly
increases the risk that consumers will not be able to repay their
loans. When consumers cannot repay their loans and must choose between
losing their homes and refinancing in an effort to stay in their homes,
they are more vulnerable to such abuses as loan flipping and equity
stripping. Prepayment penalties in certain circumstances can exacerbate
these injuries by making it more costly to exit unaffordable loans.
The Board has considered that some of the practices that would be
prohibited may benefit some consumers in some circumstances. As
discussed more fully below with respect to each prohibited practice,
however, the Board believes that in connection with higher-priced
mortgage loans these practices are likely to cause more injury to
consumers than any benefit the practices may provide them. The Board
has also considered that the proposed rules may reduce the access of
some consumers in some circumstances to legitimate and beneficial
credit arrangements, either directly as a result of a prohibition or
indirectly because creditors may incur, and pass on, increased
compliance and litigation costs. The Board believes the benefits of the
proposal outweigh these costs.
The Board has also considered other, potentially less burdensome,
approaches such as requiring more, or better, disclosures. For reasons
discussed in part II.C., the Board believes that disclosures alone may
not provide consumers in the subprime market adequate protection from
unfair, deceptive, and abusive lending practices. The discussion below
sets forth additional reasons why disclosures and other possible
alternatives to the proposed prohibitions may not give adequate
protection.
In addition to proposing new protections for consumers with higher-
priced mortgage loans, the Board is also proposing to prohibit a
creditor from structuring a closed-end mortgage loan as an open-end
line of credit for the purpose of evading the restrictions on higher-
priced mortgage loans, which do not apply to open-end lines of credit.
This proposal is based on the authority of the Board under TILA Section
129(l)(2) to prohibit practices that would evade Board regulations
adopted under authority of that statute. 15 U.S.C. 1639(l)(2).
B. Disregard of Consumers' Ability to Repay--Sec. Sec. 226.34(a)(4)
and 226.35(b)(1)
TILA Section 129(h), 15 U.S.C. 1639(h), and Regulation Z Sec.
226.34(a)(4) currently prohibit a pattern or practice of extending
HOEPA loans based on consumers' collateral without regard to their
repayment ability. HOEPA loans are, however, a very small portion of
the subprime market. The Board is proposing to extend the prohibition
against a pattern or practice of lending based on consumers' collateral
without regard to their repayment ability to higher-priced mortgage
loans as defined in Sec. 226.35(a). The prohibition in Sec.
226.34(a)(4) would be revised somewhat, and this revised prohibition
would be incorporated as proposed new Sec. 226.35(b)(1).
Public Comment on Determining Ability To Repay
In the Board's June 14, 2007 hearing notice, the Board solicited
comment on the following alternatives to ensure borrowers' repayment
ability:
Should lenders be required to underwrite all loans based
on the fully-indexed rate and fully amortizing payments?
Should there be a rebuttable presumption that a loan is
unaffordable if the borrower's debt-to-income (DTI) ratio exceeds 50
percent?
Are there specific consumer disclosures that would help
address concerns about unaffordable loans?
Few commenters offered specific disclosure suggestions but many
commenters and hearing witnesses addressed the first two questions.
Most consumer and community groups who commented support a requirement
to underwrite ARMs using the fully-indexed, fully-amortizing rate.
Several recommended, however, that the Board require underwriting to
the maximum rate possible or, at least, to a rate higher than the
fully-indexed rate. These commenters are concerned that using the
fully-indexed rate would not adequately assure repayment ability
because indexes can increase.
All of the financial institutions and financial services trade
groups who responded to the question agree that underwriting a loan
based on its fully-indexed interest rate and fully-amortizing payment
is generally prudent. With few exceptions, however, most of these
commenters oppose codifying such a standard in a regulation, arguing
that a regulation would be too rigid, constrain lenders from relying on
their own experience and judgment, and make ARMs unavailable to many
subprime borrowers. Several financial institutions and trade groups
asked that any fully-indexed rate requirement the Board adopts be
limited to ARMs with introductory fixed-rate periods of less than five
years. They maintained that most borrowers having ARMs with longer
fixed-rate periods refinance before the rate adjusts.
Consumer and community groups argue that a requirement to
underwrite to the fully-indexed rate would not assure that loans would
be affordable unless the Board also specified a maximum debt-to-income
(DTI) ratio. Most groups stated that a maximum 50 percent DTI ratio
would be an appropriate threshold to identify presumptively
unaffordable loans. On the other hand, the vast majority of the
financial institution and industry trade group commenters oppose
adoption of a maximum DTI ratio. Some stated the DTI ratio is not one
of the most important predictors of loan performance. Others noted the
difficulties of clearly defining ``debt'' and ``income'' for purposes
of such a rule, or of clearly defining mitigating factors such as high
credit scores. Some identified categories of borrowers for whom high
DTIs are not inappropriate, such as high-income borrowers; borrowers
with substantial assets; and borrowers refinancing or consolidating
loans with even higher payment burdens.
Discussion
Recent evidence of disregard for repayment ability. Subprime loans
are expected to default at higher rates than prime loans because they
generally are made to higher-risk borrowers. But the high frequency of
so-called 2-28 and 3-27 ARMs in subprime originations in recent years--
and the recent rapid and significant increase in serious delinquencies
and foreclosures among such loans originated from 2005 to early 2007,
including within several months of closing--have raised serious
questions as to whether originators have paid adequate attention to
repayment ability. Approximately three-quarters of securitized
originations in subprime pools from 2004 to 2006 were of 2-28 or 3-27
ARMs, or ARMs with interest rates discounted for two or three years and
fully-indexed afterwards. In a
[[Page 1687]]
typical case of a 2-28 discounted ARM, a $200,000 loan with a
discounted rate of 7 percent for two years (compared to a fully-indexed
rate of 11.5 percent) and a 10 percent maximum rate in the third year
would start at a payment of $1,531 and jump to a payment of $1,939 in
the third year, even if the index value did not increase. The rate
would reach the fully-indexed rate in the fourth year (if the index
value still did not change), and the payment would increase to
$2,152.\49\
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\49\ This example is taken from the federal agencies' proposed
subprime illustrations. Proposed Illustrations of Consumer
Information for Subprime Mortgage Lending, 72 FR 45495, 45497 n.2 &
45499, Aug. 14, 2007. The example assumes an initial index of 5.5
percent and a margin of 6 percent; assumes annual payment
adjustments after the initial discount period; a 3 percent cap on
the interest rate increase at the end of year 2; and a 2 percent
annual payment adjustment cap on interest rate increases thereafter,
with a lifetime payment adjustment cap of 6 percent (or a maximum
rate of 13 percent).
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In recent years many subprime lenders did not consider adequately
whether borrowers would be able to afford the higher payment, and
appeared instead to assume that borrowers would be able to refinance
notwithstanding their very limited equity. Originators extended some 2-
28 ARMs from 2005 to early 2007 without having reason to believe the
borrower would be able to afford the payment after reset. Originators
may have assumed that these borrowers would refinance before reset, an
assumption that proved unrealistic, at least under newly tightened
lending standards, when house prices fell and the borrowers could not
accumulate enough equity to refinance. In fact, some 2-28 ARMs
originated in 2005 and 2006 appear to have been made to borrowers who
could not afford even the initial payment. Over 10 percent of the 2-28
ARMs originated in 2005 appear to have become seriously delinquent
before their first reset.\50\ While some borrowers may have been able
to make their payments--they stopped making payment because the values
of their houses declined and they lost what little equity they had--
others may not have been able to afford even their initial payments.
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\50\ Figure calculated from First American LoanPerformance data.
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Potential reasons for unaffordable loans. There are several reasons
why borrowers, especially in the subprime market, would accept loans
they would not be able to repay. In some cases, less scrupulous
originators may mislead borrowers into entering into unaffordable loans
by understating the payment before closing and disclosing the true
payment only at closing. At the closing table, many borrowers may not
notice the disclosure of the payment or have time to consider it; or
they may consider it but feel constrained to close the loan. This
constraint may arise from a variety of circumstances. For example, the
borrower may have signed agreements to purchase a new house and to sell
the current house. Or the borrower may need to escape an overly
burdensome payment on a current loan, or urgently need the cash that
the loan will provide for a household emergency.
In the subprime market in particular, consumers may accept loans
knowing they may have difficulty affording the payments because they do
not have reason to believe a more affordable loan would be available to
them. Possible sources of this behavior, including the limited
transparency of prices, products, and broker incentives in the subprime
market, are discussed in part II.C. Borrowers who do not expect any
benefit from shopping further, which can be costly, make a reasoned
decision not to shop and to accept the terms they believe are the best
they can get.
Furthermore, borrowers' own assessment of their repayment ability
may be influenced by their belief that a lender would not provide
credit to a consumer who did not have the capacity to repay. Borrowers
could reasonably infer from a lender's approval of their applications
that the lender had appropriately determined that they would be able to
repay their loans. Borrowers operating under this impression may not
independently assess their repayment ability to the extent necessary to
protect themselves from taking on obligations they cannot repay.
Borrowers are likely unaware of market imperfections that may reduce
lenders' incentives to fully assess repayment ability. See part II.C.
In addition, lenders and brokers may sometimes encourage borrowers to
be excessively optimistic about their ability to refinance should they
be unable to sustain repayment. For example, they sometimes offer
reassurances that interest rates will remain low and house prices will
increase; borrowers may be swayed by such reassurances because they
believe the sources are experts.
Injuries from unaffordable loans. When borrowers cannot afford to
meet their payment obligations, they and their communities suffer
significant injury. Such borrowers are forced to use up home equity or
other assets to cover the costs of refinancing. If refinancing is not
an option, then borrowers must make sacrifices to keep their homes. If
they cannot keep their homes, then they must sell before they had
planned or endure foreclosure and eviction; in either case they may owe
the lender more than the house is worth. If a neighborhood has a
concentration of unaffordable loans, then the entire neighborhood may
endure a decline in homeowner equity. Moreover, if disregard for
repayment ability contributes to a rise in delinquencies and
foreclosures, as appears to have happened recently, then the credit
tightening that may follow can injure all consumers who are potentially
in the market for a mortgage loan.
Potential benefits. There does not appear to be any benefit to
consumers from loans that are clearly unaffordable at origination or
immediately thereafter. The Board recognizes, however, that some
consumers may in some circumstances benefit from loans whose payments
would increase significantly after an initial period of reduced
payments. For example, some consumers may expect to be relocated by
their employers and therefore intend to sell their homes before their
payment would increase significantly. Moreover, a planned increase in
the payment that would not be affordable at consumers' current incomes
(as of consummation) may be affordable at the incomes consumers can
document that they reasonably expect to earn when the payment
increases. The proposal described below is intended to provide
sufficient flexibility to creditors to ensure that credit would be
available under such circumstances.
Consumers may also benefit from loans with payments that could
increase after an initial period of reduced payments if they have a
realistic chance of refinancing, before the payment burden increases
substantially, into lower-rate loans that were more affordable on a
longer-term basis. This benefit is, however, quite uncertain, and it is
accompanied by substantial risk. Consumers would have to both improve
their credit scores sufficiently and accumulate enough equity to
qualify for lower-rate loans. Concerns about the affordability after
reset of 2-28 and 3-27 ARMs originated from 2005 to early 2007
illustrate the hazards of counting on both developments occurring
before payments become burdensome. Marketed as ``affordability
products,'' these loans often were made with high loan-to-value ratios
on the assumption that house prices would appreciate. In areas where
house price appreciation slowed or prices declined outright, the
assumption proved unreliable. Moreover, the Board is not aware of
evidence on the proportion of such borrowers who were actually able to
raise their credit scores enough to
[[Page 1688]]
qualify for lower-rate loans had they accumulated sufficient equity. In
short, evidence from recent events is consistent with a conclusion that
a widespread practice of making subprime loans with built-in payment
shock after a relatively short period on the basis of assuming
consumers will accumulate sufficient equity and improve their credit
scores enough to refinance before the shock sets in can cause consumers
more injury than benefit.
The Proposed Prohibition
HOEPA and Sec. 226.34 prohibit a lender from engaging in a pattern
or practice of extending credit subject to Sec. 226.32 (HOEPA loans)
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. Under the
proposal, the prohibition in Sec. 226.34(a)(4) would be revised to
clarify and strengthen it. The revised Sec. 226.34(a)(4) would be
incorporated into Sec. 226.35(b) as one of the restrictions that apply
to higher-priced mortgage loans. Higher-priced mortgage loans would be
defined in Sec. 226.35(a) as explained above.
As proposed, Regulation Z would prohibit a lender from engaging in
a pattern or practice of making higher-priced mortgage loans based on
the value of consumers' collateral without regard to consumers'
repayment ability as of consummation, including consumers' current and
reasonably expected income, current and reasonably expected
obligations, employment, and assets other than the collateral. Each of
the elements of this proposed standard is discussed below.
Collateral-based lending. The proposal would prohibit a pattern or
practice of collateral-based lending with higher-priced mortgage loans.
The Board recognizes that this proposal may reduce the availability of
credit for consumers whose current and expected income and non-
collateral assets are not sufficient to demonstrate repayment ability.
For example, unemployed borrowers with limited assets apart from their
homes may have more difficulty obtaining mortgage credit under this
proposal if their combined risk factors are high enough that the APR of
their potential loan would exceed the proposed threshold in Sec.
226.35(a).
``Pattern or practice.'' The Board is not proposing to prohibit
making an individual loan without regard to repayment ability, either
for HOEPA loans or for higher-priced mortgage loans. Instead, the Board
is proposing to retain the pattern or practice element in the
prohibition, and to include that element in the proposed new
prohibition for higher-priced mortgage loans. The ``pattern or
practice'' element of the prohibition is intended to balance potential
costs and benefits of the rule. Creating civil liability for an
originator that fails to assess repayment ability on any individual
loan could inadvertently cause an unwarranted reduction in the
availability of mortgage credit to consumers. The ``pattern or
practice'' element is intended to reduce that risk while helping
prevent originators from making unaffordable loans on a scale that
could cause consumers substantial injury.
Whether a creditor had engaged in the prohibited pattern or
practice would depend on the totality of the circumstances in the
particular case, as explained in an existing comment to Sec.
226.34(a)(4). The comment further indicates that while a pattern or
practice is not established by isolated, random, or accidental acts, it
can be established without the use of a statistical process. It also
notes that a creditor might act under a lending policy (whether written
or unwritten) and that action alone could establish a pattern or
practice of making loans in violation of the prohibition.
The Board is not proposing to adopt a quantitative standard for
determining the existence of a pattern or practice. Nor does it appear
feasible for the Board to give examples, as the inquiry depends on the
totality of the circumstances. Comment is sought, however, on whether
further guidance would be appropriate and specific suggestions are
solicited.
``Current and expected income.'' The statute and regulation both
prohibit a creditor from disregarding a consumer's repayment ability,
including current and expected income. The Board proposes to retain the
references to expected and current income, and to clarify that
expectations of income must be reasonable. The Board believes consumers
may benefit if a creditor is permitted to take into account reasonably
expected increases in income. For example, a consumer seeking a
professional degree or certificate may, depending on the job market and
other relevant circumstances, reasonably anticipate an increase in
income after obtaining the degree or certificate. Under the proposal, a
creditor could consider such an increase. For consumers who do not have
a current income and cannot demonstrate a reasonable expectation of
income, creditors may consider assets other than the collateral.
Other proposed clarifications. Several other revisions are proposed
for clarity. The phrase ``as of consummation'' would be added to make
clear that the prohibition is based on the facts and circumstances that
existed as of consummation. Under proposed comment 34(a)(4)-2, events
after consummation, such as an unusually high default rate, may be
relevant to determining whether a creditor has violated Sec.
226.34(a)(4), but events after consummation do not, by themselves,
establish a violation. The comment would provide the following example:
a violation is not established if borrowers default after consummation
because of serious illness or job loss.
In addition, to clarify the basis for determining repayment ability
the regulation and existing comments would be revised, and new comments
would be added. First, comment 34(a)(4)-1 (renumbered as 34(a)(4)-3)
would be revised to clarify the regulation's reference to employment as
a factor in determining repayment ability. The comment would indicate
that in some circumstances it may be appropriate or necessary to take
into account expected changes in employment. For example, depending on
all of the facts and circumstances, it may be reasonable to assume that
students obtaining professional degrees or certificates will obtain
employment upon receiving the degree or certificate.
Second, the regulation would be revised to refer not just to
current obligations but also to expected obligations. This would make
the reference to obligations parallel to the statute and regulation's
references to current and expected income. Proposed comment
34(a)(4)(i)(A)-2 would clarify that, where two different creditors are
extending loans simultaneously to the same consumer, one a first-lien
loan and the other a subordinate-lien loan, each creditor would
generally be expected to verify the obligation the consumer is
undertaking with the other creditor. A pattern or practice of failing
to do so would create a presumption of a violation.
Third, the revised regulation would make clear that creditors may
rely on assets other than the collateral to determine repayment
ability. An existing comment would be revised to give these examples: A
savings accounts or investments that can be used by the consumer. The
Board believes it is appropriate for lenders to consider non-collateral
assets such as these in determining repayment ability, and for
consumers to be free to substitute assets for income in meeting their
obligations.
[[Page 1689]]
Fourth, minor revisions would be made to Sec. 226.34(a)(4) solely
for clarity. The term ``consumer'' in the regulation would be put in
the plural, ``consumers,'' to reflect that the prohibition concerns a
pattern or practice. The phrase ``based on consumers' collateral''
would be revised to read ``based on the value of consumers'
collateral.'' No change in meaning is intended.
Proposed Presumptions
Section 226.34(a)(4) contains a provision creating a rebuttable
presumption of a violation where a lender engages in a pattern or
practice of failing to verify and document repayment ability. The
proposed regulation would retain this presumption, which would be
incorporated in proposed Sec. 226.35(b)(1). The Board is also
proposing to add new, rebuttable presumptions to Sec. 226.34(a)(4)
and, by incorporation, Sec. 226.35(b)(1). These would be presumptions
of a violation for engaging in a pattern or practice of failing to
consider: consumers' ability to pay the loan based on the interest rate
specified in the regulation (Sec. 226.34(a)(4)(i)(B)); consumers'
ability to make fully-amortizing loan payments that include expected
property taxes and homeowners insurance (Sec. 226.34(a)(4)(i)(C)); the
ratio of borrowers' total debt obligations to income as of consummation
(Sec. 226.34(a)(4)(i)(D)); and borrowers' residual income (Sec.
226.34(a)(4)(i)(E)).
A new comment 34(a)(4)(i)-1 would clarify that the presumption for
failing to verify income as well as the proposed new presumptions would
be rebuttable by the lender with evidence that the lender did not
disregard repayment ability. The comment would also clarify that the
presumptions are not exhaustive. That is, a creditor may violate Sec.
226.34(a)(4) (or Sec. 226.35(b)(1)) by patterns or practices other
than those specified in paragraph 34(a)(4)(i).
Each of the proposed presumptions is discussed in turn below.
Comment is sought generally on the appropriateness of the proposed
presumptions, and on whether additional presumptions should be adopted.
Failure to verify. Section 226.34(a)(4) contains a provision
creating a rebuttable presumption of a violation where a lender engages
in a pattern or practice of failing to verify and document repayment
ability. The proposed regulation would retain this presumption, though
it would be placed, along with other proposed new presumptions, in new
sub-paragraph (i) of Sec. 226.34(a)(4). It would also be revised to
refer explicitly to the aspects of repayment ability identified in
Sec. 226.34(a)(4), namely, borrower's current and reasonably expected
income and assets, current and reasonably expected obligations, and
employment. It would also refer to the verification requirements stated
in Sec. 226.35(b)(2)(i). Under Sec. 226.35(b)(2), a lender would be
required to verify amounts the lender relies on by the consumer's
Internal Revenue Service Form W-2, tax returns, payroll receipts,
financial institution records, or other third-party documents that
provide reasonably reliable evidence of the consumer's income and
assets. See part VII.C. A new comment would clarify that a pattern or
practice of failing to verify obligations would also trigger a
presumption of a violation. It would indicate, however, that a credit
report generally may be used to verify obligations.
Ability to make fully-indexed, fully-amortizing payments. Variable
rate mortgages with discounted initial rates have become common in the
subprime market. In a typical example, a loan would have an index and
margin at consummation of 11.5 percent but a discounted initial rate
for the first two years of 7 percent. Determining repayment ability on
the basis of the initial rate would not give a realistic picture of the
borrower's ability to afford the loan once the rate began adjusting
according to the agreed index and margin.\51\ The Board is proposing in
Sec. 226.34(a)(4)(i)(B) that a pattern or practice of failing to
consider a borrower's repayment ability at the fully-indexed rate would
create a presumption of a violation of Sec. 226.34(a)(4) (or Sec.
226.35(b)(1)).
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\51\ As discussed in part IV above, concerns about underwriting
practices for products with introductory rates or payments led the
Board and the other federal supervisory agencies to issue guidance
advising institutions to qualify borrowers using the fully-indexed
rate and fully amortizing payments.
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Section 226.34(a)(4)(i)(B) would also address the case of a step-
rate loan, a loan in which specific interest rate changes are agreed to
in advance. For example, the parties could agree that the interest rate
on the loan would be 5 percent for two years, 6 percent for two years,
and 7 percent thereafter. The regulation would provide that, for such
loans, a failure to consider the borrower's repayment ability at the
highest interest rate possible within the first seven years of the
loan's term (seven percent in the example) would create a presumption
of a violation. The Board seeks comment on whether a shorter period,
such as five years, would be appropriate.
The Board also seeks comment on whether this presumption should be
modified to accommodate loans with balloon payments and, if so, how it
should be modified.
Borrower debt-to-income ratio and residual income. The proposed
presumptions of a violation for failure to consider the debt-to-income
ratio (Sec. 226.34(a)(4)(i)(D)) or residual income ((Sec.
226.34(a)(4)(i)(E)) reflect the fact that this information generally is
part of a responsible determination of repayment ability. Comment
34(a)(4)(i)(D)-1 would clarify, however, that the Board is not
proposing a specific debt-to-income ratio that would create a
presumption of a violation; nor is the Board proposing a specific ratio
that would be a safe harbor. Similarly, comment 34(a)(4)(i)(E)-1 would
indicate that the regulation does not require a specific level of
residual income.
The Board is concerned that making a specific debt-to-income ratio
or residual income level either a presumptive violation or a safe
harbor could limit credit availability without providing adequate off-
setting benefits. These are but two of many factors that determine
repayment ability. For example, depending on the circumstances, the
repayment risk implied by a high debt-to-income ratio could be offset
by other factors that reduce the risk, such as a high credit score and
a substantial down payment. The Board is reluctant to adopt a
quantitative standard for one or two underwriting factors when
repayment ability depends on the totality of many inter-relating
factors.
It is possible, however, that adopting a quantitative standard for
the debt-to-income ratio or other underwriting factors would provide at
least some benefit to creditors and, by extension, consumers, by
providing bright lines. The Board seeks comment on whether it should
adopt a presumption of a violation, or a safe harbor, at a 50 percent
debt-to-income ratio, or at a lower or higher ratio. What exceptions
would be necessary for borrowers with high incomes or substantial
assets, or for other cases? Comment is also sought on whether the Board
should in addition, or instead, adopt quantitative standards for
presumptive violations, or safe harbors, based on other underwriting
factors.
Property taxes and insurance. Section 226.34(a)(4)(i)(C) would
create a separate presumption of a violation of Sec. 226.34(a)(4) (or
Sec. 226.35(b)(1)) for a pattern or practice of failing to consider
the borrower's repayment ability based on a fully-amortizing payment
that includes expected property taxes,
[[Page 1690]]
homeowners insurance, and other specified housing expenses. This is
intended to address concerns that some creditors would determine a
borrower's ability to repay a nontraditional loan that offered an
option to defer principal or interest for several years on the basis of
a payment that was non-amortizing (interest only) or negatively
amortizing (less than interest). Negative amortization also can arise
on variable-rate transactions with annual payment caps. The proposed
presumption would encourage lenders to consider the fully-amortizing
payment, as the Subprime Guidance advises lenders to do. See part V.
The fully-amortizing payment would be based on the term of the loan.
For example, the amortizing payment for a 2-28 ARM would be calculated
based on a 30-year amortization schedule.
Proposed Time Horizon
The Board recognizes that it may not be reasonable, or to
consumers' benefit, to hold creditors responsible for assuring
repayment ability for the life of a loan. Most mortgage loans have
terms of thirty years but prepay long before that. The Board seeks to
ensure that consumers retain the ability to exchange lower initial
payments for higher payments later, or for a balloon payment at the end
of the loan. Accordingly, a safe harbor for creditors may be
appropriate so long as it assures payments will be affordable for a
reasonable time. Proposed Sec. 226.34(a)(4)(ii) would provide that a
creditor does not violate Sec. 226.34(a)(4) if the creditor has a
reasonable basis to believe that consumers will be able to make loan
payments for at least seven years, considering each of the factors
identified in Sec. 226.34(a)(4)(i) (such as the fully-indexed rate and
the fully-amortizing payment schedule) and any other factors relevant
to determining repayment ability.
This proposal is not intended to preclude creditors from offering
loans with substantial payment increases before seven years. If such
loans fell outside of the safe harbor, they could nonetheless be
justified in appropriate circumstances. For example, a consumer with a
documented intent to sell the home within three years may reasonably
choose a loan with a substantial payment increase in the third year.
The Board seeks comment, however, on whether specifying a shorter time
horizon, such as five years, would be appropriate.
General Request for Comment
In addition to the specific requests for comment stated above, the
Board seeks comment on whether proposed Sec. Sec. 226.34(a)(4) and
226.35(b)(1) would ensure that creditors adequately consider repayment
ability without unduly constraining credit availability. The Board
seeks data and information that could help the Board evaluate the costs
and benefits of the proposal as it would affect the subprime market and
any portion of the alt-A market to which the proposal may apply.
C. Verification of Income and Assets Relied on--Sec. 226.35(b)(2)
Proposed Sec. 226.35(b)(2) would prohibit creditors in a
transaction subject to Sec. 226.35(a) from relying on amounts of
assets or income, including expected income, in extending credit unless
the creditor verifies such amounts. Creditors who fail to verify income
or assets before extending credit are given a safe harbor if they can
show that the amounts of the consumer's income or assets relied on were
not materially greater than what the creditor could have documented at
consummation.
Public Comment on Stated Income Lending
In the hearing notice, the Board solicited comment on the following
questions:
Whether stated income or low-documentation loans should be
prohibited for certain loans, such as loans to subprime borrowers?
Whether stated income or low-documentation loans should be
prohibited for higher-risk loans, for example, for loans with high
loan-to-value ratios?
How a restriction on stated income or low-documentation
loans would affect consumers and the type and terms of credit offered?
Whether lenders should be required to disclose to the
consumer that a stated income loan is being offered and allow the
consumer the option to document income?
Consumer and community groups, individuals, and political
officials, and some financial institutions and groups, favored greater
restrictions on stated income loans for two reasons. First, some
borrowers who could easily document their income have been harmed by
receiving stated income loans that cost them more than a full
documentation loan. According to commenters, these borrowers did not
realize that they could have received a less costly loan by documenting
their incomes. Second, other borrowers have been harmed when
originators inflated their incomes--often without consumers'
knowledge--to assure the originator would be able to make the loan or
to enable the originator to make a larger loan, which might have higher
payments that were less affordable to the consumer. To address these
concerns, these commenters favored requiring creditors to obtain some
documentation to support a consumer's statement of income or assets.
Some suggested that documentation be required only for subprime loans,
while others suggested it be required for all loans.
In contrast, most financial institution and financial services
trade group commenters opposed prohibiting stated income loans. These
commenters argued that financial institutions should retain flexibility
to accommodate borrowers who may have difficulty fully documenting
their income, or whose credit risk profile is strong enough that their
income is not used as an underwriting factor. Some of these commenters
did, however, support the banking agencies' use of guidance, such as
the Subprime Statement, to address any risks of stated income loans.
One major mortgage lender supported limiting stated income lending in
subprime loans by a new regulation, if the regulation allowed for
mitigating circumstances.
Discussion
Until recently, large and increasing numbers of home-secured loans
in the subprime market were underwritten without fully verifying the
borrower's income and assets.\52\ The share of ``low doc'' and ``no
doc'' loan originations in the securitized subprime market rose from 20
percent in 2000, to 30 percent in 2004, to 40 percent in 2006.\53\ Low
and no documentation loans are more prevalent in the Alt-A market,
where originations of such loans in securitized pools rose from about
60 percent in 2000-2004 to 80 percent in 2006. Not all low doc or no
doc loans are stated income loans (because in some cases originators
did not rely on income or assets as the source of repayment), but many
are.
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\52\ See U.S. Gov't Accountability Office, GAO-08-78R,
Information on Recent Default and Foreclosure Trends for Home
Mortgages and Associated Economic and Market Developments 5 (2007);
Fannie Mae, Weekly Economic Commentary (Mar. 26, 2007).
\53\ Figures calculated from First American Loan Performance
data.
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Lending based on unverified, or minimally verified, incomes or
assets can be appropriate for consumers whose risk profiles justify the
potential increased risk and who might otherwise have to incur a
significant cost to document their incomes or assets. The practice,
however, increases the risk
[[Page 1691]]
that credit is extended on the basis of inflated incomes and assets,
which, in turn, can injure not just the particular borrowers whose
incomes or assets were inflated but their neighbors, as well. The
practice also presents an opportunity for originators to mislead
consumers who could easily document their incomes and assets into
paying a premium for a stated income or stated asset loan. These
concerns are addressed in turn below.
Risk of inflated incomes and assets. There is anecdotal evidence
that the incomes used in stated income loans were often inflated.\54\
There is also evidence in the form of a higher rate of default for low
doc and no doc loans (many of which are stated income loans) than for
full documentation loans, and in the increase in the rate of default
for low/no doc loans originated when underwriting standards were
declining.\55\
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\54\ See Mortgage Asset Research Inst., Inc., Eighth Periodic
Mortgage Fraud Case Report to the Mortgage Bankers Association
(2006) (reporting that 90 of 100 stated income loans sampled used
inflated income when compared to tax return data); Fitch Ratings,
Drivers of 2006 Subprime Vintage Performance (Fitch 2006 Subprime
Performance) (November 13, 2007) (reporting that stated income loans
with high combined loan to value ratios appear to have become
vehicles for fraud).
\55\ Michelle A. Danis and Anthony Pennington-Cross, The
Delinquency of Subprime Mortgages, Journal of Economics and Business
(forthcoming 2007); see also Fitch 2006 Subprime Performance
(stating that lack of income verification, as opposed to lack of
employment or down payment verification, caused 2006 low
documentation loans delinquencies to be higher than earlier
vintages' low documentation loans).
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Stated income lending programs give originators incentives as well
as opportunities to inflate an applicant's income or assets, or to
encourage applicants to do so. Compensating the originator based on
loan size and origination volume, common practices, may give the
originator incentives to maximize loan size and origination volume at
the expense of loan quality. Inflating income or assets can increase
both loan size and origination volume, because it can cause a creditor
to accept an application that would otherwise have been rejected or met
with an offer of a smaller loan.
The nature of the application process makes it possible that an
applicant would not learn that the originator had inflated the
applicant's income or assets. In many cases, applicants may not even
know that they are obtaining stated income loans. They may have given
the originator documents verifying their income and assets that the
originator kept from the loan file so that the loan could be classified
as ``stated income, stated assets.'' If an applicant has applied
knowingly for a stated income or stated assets loan, the originator may
fill out the financial statement on the standard application form based
on information the applicant provides orally. The applicant may not
review the form closely enough to detect errors in the stated income or
assets, especially if seeing the form for the first time at the closing
table. A consumer who detects errors at the closing table may not
realize their importance or may face constraints that make it
particularly difficult to walk away from the table without the loan.
While some originators may inflate income without consumers'
knowledge, other originators may tacitly encourage applicants to
knowingly state inflated incomes and assets by making it clear that
their actual incomes and assets are not high enough to qualify them for
the loans they seek. Such originators may reassure applicants that this
is a benign and common practice. In addition, applicants may inflate
their incomes and assets on their own initiative in circumstances where
the originator does not have reason to know.
Injuries from inflated income and assets. The injuries to consumers
from extending credit based on inflated incomes and assets are
apparent. Borrowers whose loans are underwritten based on inflated
income may receive larger loans with payments larger than they can
comfortably afford and, therefore, face a higher risk of default as
well as a higher risk of serious delinquency leading to foreclosure or
distress sale. These risks are particularly pronounced for borrowers in
the subprime market because their financial situations often are more
precarious. The injuries caused by income inflation are not limited
either to the particular borrowers whose incomes were inflated by the
originator, nor to particular borrowers who inflated their incomes on
their own. The practice can injure many other consumers, too. Inflating
applicant incomes raises the risk of distress sales and foreclosures,
concentrations of which can depress an entire community. Moreover, a
widespread practice of inflating applicant incomes in an area with
rapid house price appreciation--the kind of area where the practice may
be most likely to arise--may fuel this appreciation and contribute to a
``bubble.''
Undisclosed premiums. Stated income lending also potentially
injures consumers by leading them to pay more for their loans than they
otherwise would. There is generally a premium for a stated income loan.
An originator may not have sufficient incentive to disclose the premium
on its own initiative because collecting and reviewing documents could
slow down the origination process, reduce the number of loans an
originator produces in a period, and, therefore, reduce the
originator's compensation for the period. The risk that a consumer
would not be aware of the premium may be particularly acute where
products are complex, as is often true in the subprime market and was,
at least until recently, true in the alt-A market due to the rapid
growth of interest-only loans and option ARMs. Thus, consumers who can
document income with little effort may choose not to because they are
unaware of the cost of a stated income loan. Such consumers are
effectively deprived of an opportunity to shop for a potentially lower-
rate loan requiring full documentation.
The Board recognizes that stated income lending in the subprime
market may have potential benefits. It may speed credit access by
several days for consumers who need credit on an emergency basis. It
may save some consumers from expending significant effort to document
their income, and it may provide access to credit for consumers who
otherwise would not have access because they actually cannot document
their income, for whatever reason. For the reasons discussed above,
however, the Board believes that, within the subprime market, where
risks to consumers are already elevated, the potential benefits to
consumers of stated income/stated asset lending may be outweighed by
the potential injury to consumers and competition. Stated-income
lending is a significant part of the neighboring alt-A market, but,
there too, it can raise concerns. Until the recent tightening of
underwriting standards in the alt-A market, stated-income lending was
increasingly layered on top of other risks, such as loan terms that
permit the borrower to defer payment of interest or principal.
The Board's Proposal
To address the injuries to consumers from stated income loans in
the higher-priced market, the Board proposes to require creditors to
verify the income and assets they rely on with third-party documents
that provide reasonably reliable evidence such as W-2 forms, tax
returns, payroll receipts, or financial institution records. The rule
is intended to be flexible and appropriately balance costs with
benefits.
The benefits of the proposal would appear to be significant. The
rule should make it more difficult for any party to inflate incomes or
assets on higher-priced mortgage loans and, therefore,
[[Page 1692]]
reduce the frequency of the practice and the injuries to consumers the
practice can cause. The rule also should eliminate the risk that
consumers with higher-priced mortgage loans who could document income
would unknowingly pay more for a loan that did not require
documentation.
The proposal could have costs as well. In general, the time from
application to closing could be longer if an applicant were required to
produce, and the creditor required to review, third party documents
verifying income. Also, consumers who did not have documents verifying
their income readily at hand would face the inconvenience of obtaining
such documents. Another cost could be reduced access to credit for
consumers who would have difficulty documenting their income. As
explained further below, the Board believes the regulation is
sufficiently flexible to keep these costs to reasonable levels relative
to the expected benefits of the proposed rule.
Five elements of the proposal are intended to reduce the costs to
consumers and creditors that income verification may entail. First, the
proposed rule requires that only the income or assets the creditor
relies upon in approving the extension of credit be verified. For
example, if a creditor does not rely on a part of the consumer's
income, such as an annual bonus, in approving the extension of credit,
the creditor would not need to verify the consumer's bonus.\56\
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\56\ Creditors would, however, still be prohibited from engaging
in a pattern or practice of extending higher-priced mortgage loans
to consumers based on the collateral without regard to repayment
ability. See proposed Sec. 226.35(b)(1). Consequently, creditors
would not be able to evade the proposed income verification rule by
consistently declining to consider income or assets.
---------------------------------------------------------------------------
Second, the proposed rule specifically authorizes a creditor to
rely on W-2 forms, tax returns, payroll receipts, and financial
institution records. These kinds of documents generally have proven to
be reliable sources of information about borrowers' income and assets.
Moreover, most consumers can, or should be able to, produce one of
these kinds of documents with little difficulty. Thus, the proposed
safe harbor for relying on one of these kinds of documents should
protect consumers while minimizing costs.
Third, creditors may use any other third-party documents that
provide reasonably reliable evidence of the borrower's income and
assets. Examples of other third-party documents that provide reasonably
reliable evidence of the borrower's income include check-cashing
receipts or a written statement from the consumer's employer. See
proposed comment 35(b)(2)-4. These are but examples, and a creditor may
rely on third-party documents of any kind so long as they are
reasonably reliable. The one kind of document that is categorically
excluded is a statement only from the consumer.
Fourth, the proposal is not intended to limit creditors' ability to
adjust their underwriting standards for consumers who for legitimate
reasons have difficulty documenting income, such as self-employed
borrowers, or employed borrowers with irregular income.\57\ For
example, the rule would not dictate that a creditor must have at least
two year's tax returns to approve an extension of credit to a self-
employed borrower. As another example, if a creditor relied on a
statement by an employed applicant that the applicant was likely to
receive an annual bonus from the employer, the creditor could verify
the statement with third-party documents showing a consumer's past
annual bonuses. See proposed comment 35(b)(4)(i)-1. The same would hold
for credit extended to employees who work on commission.
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\57\ For depository institutions and their affiliates, safety
and soundness considerations would continue to govern underwriting,
as always.
---------------------------------------------------------------------------
Fifth, creditors who have extended credit to a consumer and wish to
extend new credit to the same consumer need not re-collect documents
that the creditor previously collected from the consumer if the
documents would not have changed since they were initially verified.
See proposed comment 35(b)(2)(i)-4. For example, if the creditor has
collected the consumer's 2006 tax return for a loan in May 2007, and
the creditor makes another loan to that consumer in August 2007, the
creditor may rely on the 2006 tax return.
Proposed safe harbor. The proposed rule would contain a safe harbor
for creditors who fail to verify income before extending credit if the
amounts of income or assets relied on were not materially greater than
the creditor could have verified when the extension of credit was
consummated. See proposed Sec. 226.35(b)(2)(ii) and comment
35(b)(2)(ii)-1. The proposed safe harbor would cover cases where the
creditor's failure to verify income would not have altered the decision
to extend credit to the consumer or the terms of the credit.
Requests for Comment
The Board seeks comment on whether, and in what specific
circumstance, the proposed rule would reduce access to credit for
certain borrowers, such as the self-employed, who may have difficulty
documenting income and assets. The Board also requests comment on
whether the rule could be made more flexible without undermining
consumer protection. Comment on these questions is solicited both with
respect to the subprime market and any part of the alt-A market that
the proposed definition of ``higher-priced mortgage loan'' would tend
to cover. Comment is also sought on the appropriateness of the proposed
safe harbor, and on whether other safe harbors would be appropriate.
Potential alternatives. The Board believes the proposed rule would
provide consumers a significant new protection against lending based on
income or asset inflation. It is also expected that creditors,
regulators, and courts would find it relatively easy to determine
compliance with the proposed rule. The Board recognizes, however, that
the rule is broad in that it imposes a blanket requirement on all
creditors to verify, for every higher-priced mortgage loan they
originate, the income and assets they rely on, without consideration of
the extent to which the risks of inflating income or assets may vary
from case to case. This rule could increase costs for creditors as well
as consumers. The rule is also broad in another respect: It imposes a
blanket verification requirement on creditors even though consumers,
themselves, may inflate their stated incomes without the creditor's
knowledge. Such consumers might in some instances seek to enforce the
proposed rule through civil actions.
For these reasons, the Board seeks suggestions of narrower
alternatives that would impose fewer costs on creditors and consumers
while providing sufficient protection to consumers who may be injured,
directly or indirectly, by stated income lending. For example, should
the Board, instead of adopting the proposed rule, prohibit creditors
and mortgage brokers from inflating incomes, influencing consumers to
inflate incomes, or extending credit while having reason to believe
that a consumer inflated income or was influenced to inflate income?
Would a rule attempting to distinguish cases where creditors or brokers
were not complicit in applicants' inflating incomes be cost-effective
and practicable? If such a rule were adopted, should it provide a safe
harbor for verifying income?
Subordinate-lien loans. The Board's proposal covers both first-lien
and subordinate-lien loans, but the Board requests comment on whether
the proposed rule should make an exception for all subordinate-lien
loans, or for subordinate-lien loans in amounts
[[Page 1693]]
less than a specified dollar amount, or less than a specified
percentage of the home's value. Requiring income and asset verification
for subordinate-lien loans could in some cases increase costs without
providing meaningful protection to consumers. For example, if a
consumer has a record of making timely payments on a first-lien loan,
then verifying income or assets for a small subordinate-lien loan--
assuming the creditor relied on income or assets to make the credit
decision--may not provide sufficient additional information about the
borrower's ability to repay the debt to justify the cost of
verification. Thus, the Board seeks suggestions for potential
exemptions for subordinate-lien loans that would not undermine consumer
protection.
D. Prepayment Penalties--Sec. 226.32(d)(6) and (7); Sec. 226.35(b)(3)
Pursuant to TILA Section 129(c), a HOEPA-covered loan may not
provide for a prepayment penalty unless: the borrower's debt-to-income
(DTI) ratio at consummation does not exceed 50 percent (and debt and
income are verified); prepayment is not made using funds from a
refinancing by the same creditor or its affiliate; the penalty term
does not exceed five years from loan consummation; and the penalty is
not prohibited under other applicable law. 15 U.S.C. 1639(c); see also
12 CFR 226.32(d)(6) and (7). The Board proposes to apply these
restrictions to higher-priced mortgage loans. In addition, the Board
proposes to require that the period during which a creditor may impose
a prepayment penalty expire at least sixty days before the first date,
if any, on which the periodic payment amount may increase under the
terms of the loan.
Public Comments on Prepayment Penalties
In connection with its June 14, 2007 HOEPA hearing, the Board
requested public comment on the following questions:
Should prepayment penalties be restricted? For example,
should prepayment penalties that extend beyond the first adjustment
period on an ARM be prohibited?
Would enhanced disclosure of prepayment penalties help
address concerns about abuses?
How would a prohibition or restriction on prepayment
penalties affect consumers and the type and terms of credit offered?
Consumer and community groups generally commented that prepayment
penalties are linked to higher loan costs for some borrowers. Many
brokers and loan officers have at least some discretion to decide what
interest rate to offer borrowers. In general, the higher the rate, the
greater the compensation the lender pays the originator. Because the
lender seeks to recover this compensation from the borrower, the lender
prefers loans with prepayment payment penalties in case the borrower
refinances the loan. Consumer and community group commenters stated
that consumers shopping for home loans do not consider back-end costs
such as prepayment penalties but rather focus on monthly payments or
``teaser'' interest rates on ARMs. In addition, they maintained that
prepayment penalties discourage borrowers from refinancing unaffordable
loans or cause them to lose home equity when the penalty amount is
included in the principal amount of a refinance loan.
Accordingly, most consumer and community groups recommended that
the Board ban prepayment penalties on subprime home loans, a
recommendation also made by state and local government officials and a
trade group representing community development financial institutions.
Consumer and community groups suggested that, at a minimum, if the
Board permits prepayment penalties, it should require prepayment
penalties for fixed-rate loans to expire two years after loan
origination and prepayment penalties on subprime hybrid ARMs to
terminate between sixty days and six months prior to the first rate
adjustment on the loan. These groups stated that, although disclosures
could be improved, doing so would not solve the problems associated
with prepayment penalties in the subprime market.
Most financial institutions and financial services trade groups
recommended that the Board concentrate on improving disclosures and
limit any regulation to requiring that the penalty term on a subprime
hybrid ARM end before the first rate adjustment. A majority of these
commenters recommended that borrowers be allowed to refinance without
penalty starting sixty days prior the first reset; a few commenters
recommended thirty days. These commenters stated that additional
restrictions on prepayment penalties would reduce the amount of credit
lenders and investors make available in the affected market. With
respect to fixed-rate loans, some financial institutions and industry
trade groups stated that a three-year limit on the term of a prepayment
penalty would be appropriate. Some credit union trade groups
recommended a maximum term, such as one or two years, for a prepayment
penalty, including a penalty on a fixed-rate loan.
Discussion
Prepayment risk measures the possibility that a loan will be repaid
before the end of the loan term.\58\ Because a prepayment results in
payment of the principal ahead of schedule, the lender (or secondary-
market investor) must reinvest the funds at the new market rate, which
may be lower than the old rate, particularly in the case of a
refinancing. A lender also may incur certain fixed costs, such as
payments to a mortgage broker, that the lender seeks to recover even if
the loan is repaid early. Lenders generally account for the risk of
prepayment in setting the interest rate on the loan, and usually in the
subprime market (but only occasionally in the prime market) also
account for the risk by including a prepayment penalty clause in the
loan agreement.
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\58\ Robert B. Avery, Glenn B. Canner & Robert E. Cook, New Data
Reported under HMDA and Its Application in Fair Lending Enforcement,
2005 Fed. Reserve Bulletin 344, 368.
---------------------------------------------------------------------------
In principle, a lender may offer a consumer a choice between a loan
with a prepayment penalty and a loan that does not have a penalty but
has a higher interest rate. Consumers in the subprime market who
understood the potential trade-off between the interest rate and
prepayment penalty might be willing to accept a contract with a
prepayment penalty in exchange for a lower interest rate. For example,
they may expect that they will refinance their loans after taking some
time to improve their credit scores enough to qualify for a lower rate.
Such consumers may be willing to accept a penalty with a term roughly
equivalent to the time they expect it will take them to improve their
scores. Accordingly, prepayment penalties may benefit individual
borrowers in the subprime market who in certain circumstances would
voluntarily choose them.
Prepayment penalties may also benefit borrowers in the subprime
market overall. Investors may find prepayment patterns more difficult
to predict for subprime loans than for prime loans because prepayment
of subprime loans depends not only on interest rate changes (as does
prepayment of prime loans) but also on changes to borrowers' credit
profiles that affect their chances of qualifying for a lower-rate loan.
To the extent that penalties make the cash flow from investments backed
by subprime mortgage more predictable, the secondary market may become
more
[[Page 1694]]
liquid. A more liquid secondary market may benefit borrowers by
lowering interest rates and increasing credit availability.
Prepayment penalties, however, also impose substantial costs on
borrowers that may not be clear to them. These penalties can prevent
borrowers who cannot afford to pay the penalty, either in cash or from
home equity, from exiting unaffordable or high-cost loans. Moreover,
borrowers who refinance and pay a penalty decrease their home equity
and increase their loan balance if they finance the penalty into the
new loan--as is likely if they are refinancing because of financial
distress. The loss of home equity and the payment of interest on the
financed penalty amount are particularly concerning if the refinance
loan represents a loan ``flipping'' abuse.
The injuries prepayment penalties may cause consumers are
particularly concerning because of serious questions as to whether
borrowers knowingly accept the risk of such injuries. Current
disclosures of prepayment penalties, including the disclosure of
penalties in Regulation Z Sec. 226.18(k), do not appear adequate to
ensure transparency. Moreover, a Federal Trade Commission report
concluded, based on consumer testing, that even an improved disclosure
of the prepayment penalty left a substantial portion of the prime and
subprime consumers interviewed without a basic understanding of the
penalty.\59\ It is questionable whether consumers can accurately factor
a contingent cost such as a prepayment penalty into the price of a
loan; unlike the interest rate and points, a prepayment penalty is not
included in the APR.
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\59\ Improving Mortgage Disclosures, at 110.
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The lack of transparency is particularly troubling when originators
have incentives to impose prepayment penalty clauses on consumers
without giving them a genuine choice. Individual originators may be
able to earn larger commissions or yield spread premiums on subprime
loans by securing loan agreements with penalties, which increase a
lender's certainty of recouping from the consumer its payment to the
originator. Originators may seek to impose prepayment penalty clauses
on consumers simply to increase their own compensation. This risk
appears particularly high in the subprime market, where most loans have
had prepayment penalties and borrowers may not have had a realistic
opportunity to negotiate for a loan without a penalty.
The Board plans to use consumer testing to improve the disclosure
of prepayment penalties as part of its ongoing review of closed-end
TILA rules, but the Board recognizes that disclosure has its limits.
The prepayment penalty may be a term that highlights those limits. It
is complicated for borrowers to process and of secondary importance to
them compared to other loan terms. Accordingly, the Board is proposing
to restrict prepayment penalties on higher-priced mortgage loans.
The Board's Proposal--In General
The Board proposes to apply HOEPA's prepayment penalty restrictions
to a broader segment of the market, higher-priced mortgage loans, and
to add a new restriction for mortgages whose payments may increase,
such as ARMs. A HOEPA--covered loan may not provide for a prepayment
penalty unless: the borrower's DTI ratio at consummation does not
exceed 50 percent (and debt and income are verified); prepayment is not
made using funds from a refinancing by the same creditor or its
affiliate; the penalty term does not exceed five years from loan
consummation; and the penalty is not prohibited under other applicable
law. 15 U.S.C. 1639(c); Sec. 226.32(d)(6) and (7). The Board proposes
to apply these restrictions to higher-priced mortgage loans. In
addition, the Board proposes to require that the period during which a
creditor may impose a prepayment penalty expire at least sixty days
before the first date, if any, on which the periodic payment amount may
increase under the terms of the loan.\60\
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\60\ The interagency Statement on Subprime Lending provides that
borrowers with certain ARMs should be given a reasonable period of
time (typically, at least sixty days) prior to the first rate reset
to refinance without penalty. 72 FR 37569, 37574, July 10, 2007.
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The proposal is intended to prohibit prepayment penalties in cases
where they may pose the greatest risk of injury to consumers. The 50
percent DTI cap, while not a perfect measure of affordability, may tend
to reduce the likelihood that an unaffordable loan will have a
prepayment penalty, which would hinder a consumer's ability to exit the
loan by refinancing the loan or selling the house. The same-creditor
restriction may reduce the likelihood that a creditor could ``pack'' a
prepayment penalty into a loan as part of a strategy to strip the
borrower's equity by flipping the loan in a short time. The five-year
restriction would prevent creditors from ``trapping'' consumers in a
loan for an exceedingly long period. The mandatory expiration of the
penalty before a possible payment increase would help prevent consumers
who had been enticed by a discounted initial payment from being trapped
when the payment increased. Thus, the proposal would prohibit
prepayment penalties in circumstances indicating a higher risk of
injury.
The proposal is also intended to preserve the potential benefits of
penalties to consumers in cases where the penalties may present less
risk to them. Apart from the riskier penalty clauses that would be
prohibited, individual consumers would retain a potential option to
choose between a penalty clause and a higher interest rate. There are
legitimate concerns that consumers are not frequently offered a clear
and genuine choice. The Board will be seeking to determine through
consumer testing whether it can develop a clear and effective
disclosure of a consumer's options. There are also legitimate concerns
that, no matter how clearly the choice is disclosed, product complexity
and other constraints will tend to undermine individual consumer
decision making. See part II.C. In this proposal, however, the Board is
weighing against such concerns the potential benefit to all consumers
in the subprime market from the increased liquidity that prepayment
penalties may provide.
Specific Restrictions
Debt-to-income ratio. TILA and Regulation Z prohibit a prepayment
penalty on a HOEPA loan if the borrower's DTI ratio at consummation
exceeds 50 percent. 15 U.S.C. 1639(c)(2)(A)(i); Sec.
226.32(d)(7)(iii). The Board proposes to apply this rule to higher-
priced mortgage loans. Proposed staff comments would give examples of
funds and obligations that creditors commonly classify as ``debt'' or
``income.'' Further, the proposal specifies that creditors may, but
need not, look to widely accepted governmental and non-governmental
underwriting standards to determine how to classify particular funds or
obligations as ``debt'' or ``income.'' The Board does not propose to
require creditors to use any particular standard for calculating debt
or income. A creditor would not violate the prepayment penalty rule if
its particular calculation method deviated from those in widely-used
underwriting handbooks or manuals, so long as the creditor's method was
reasonable.
The 50 percent DTI cap, while not a perfect measure of
affordability, may tend to reduce the likelihood that an unaffordable
loan will have a prepayment penalty, which would hinder a consumer's
ability to exit the
[[Page 1695]]
loan by refinancing the loan or selling the house. Loans with high
borrower DTI ratios can be affordable, depending on the borrower's
circumstances. A borrower whose DTI ratio exceeds 50 percent at
consummation, however, will likely have greater difficulty repaying a
particular loan, all other things being equal, than a borrower with a
lower DTI ratio.
TILA Section 129(c)(2)(A)(ii) states that the consumer's income and
expenses are to be verified by a financial statement signed by the
consumer, by a credit report, and in the case of employment income, by
payment records or by verification from the employer of the consumer
(which verification may be in the form of a copy of a pay stub or other
payment record supplied by the consumer). 15 U.S.C. 1639(c)(2)(A)(ii).
The Board's proposal, however, does not permit verification of income,
whether from employment by another person or self-employment, by a
signed statement of the borrower alone. The proposed rule cross-
references proposed Sec. 226.35(b)(2)(i), which requires that income
relied upon be verified by reasonably reliable third party documents.
There are three bases for the proposal to strengthen the statute's
verification requirement. First, under TILA Section 129(l)(2), the
Board has a broad authority to update HOEPA's protections as needed to
prevent unfair practices. 15 U.S.C. 1639(l)(2)(A). For the reasons
discussed in part VII.C., the Board believes that relying on a
borrower's statement alone is unfair to consumers, regardless of
whether the consumer is employed by another person, self-employed, or
unemployed. Second, the Board has a broad authority under Section
129(l)(2) to update HOEPA's protections as needed to prevent their
evasion. 15 U.S.C. 1639(l)(2)(A). A signed financial statement
declaring all or most of a consumer's income to be self-employment
income or income from sources other than employment could be used to
evade the statute. Third, adopting a single income verification
standard throughout proposed Sec. 226.35(b) would facilitate
compliance.
Same creditor. HOEPA does not permit a prepayment penalty on a
HOEPA loan if a prepayment is made with amounts obtained by the
consumer through a refinancing with the creditor or an affiliate of the
creditor. 15 U.S.C. 1639(c)(2)(B). A prohibition on charging a
prepayment penalty in the event of a same-lender refinance discourages
originators from seeking to ``flip'' the loan. To foreclose evasion by
creditors who might direct borrowers to refinance with an affiliated
creditor, the same-lender refinance rule covers loans by a creditor's
affiliate. The Board requests comment on the effect of imposing the
same-creditor restriction on a market where loans are frequently sold.
Five-year limit. HOEPA limits the term of a prepayment penalty on a
HOEPA loan to five years after loan origination. 15 U.S.C.
1639(c)(2)(C). The Board believes it would be appropriate to apply the
same limitation to prepayment penalties on higher-priced mortgage
loans. The Board seeks comment, however, on whether five years is the
appropriate limit considering both the need to protect consumers from
abuse and the potential benefits of prepayment penalties for consumers.
As discussed below, under the proposal a prepayment penalty would have
to expire earlier than five years if the payment may increase before
then.
Payment increase. In addition to extending the coverage of HOEPA's
prepayment penalty restrictions to a broader segment of the market, the
Board proposes to require that, for higher-priced mortgage loans, the
period during which a penalty may be imposed expire at least sixty days
prior to the first date, if any, on which the periodic payment amount
may increase. Mandatory expiration of the penalty before a possible
payment increase would help prevent consumers who had been enticed by a
discounted initial payment from being trapped when the payment
increased.
The proposed rule would depend on when the rate may increase under
the loan agreement, and not on when the rate actually does increase.
Although a periodic payment may not actually increase on a rate
adjustment date, a creditor may not know whether a borrower's payment
will increase in enough time for the creditor to give the borrower a
long enough pre-adjustment window in which to refinance without
penalty. The proposed bright-line rule would enable creditors and
borrowers to know with certainty, at or before loan consummation, the
date after which creditors may no longer require a borrower to pay a
prepayment penalty.
Periodic payments may increase for a variety of reasons, including
a scheduled shift from a discounted interest rate to a fully indexed
rate, a change in index value on a non-discounted ARM, or mandatory
amortization of principal when deferred principal or interest exceeds a
certain threshold. For the sake of simplicity, the proposal would set a
single standard for all higher-priced mortgage loans for which periodic
payments may increase. For example, if a payment-option ARM allows
minimum monthly payments for one year and the first adjustment to the
monthly payment is scheduled for one year after origination, a
prepayment penalty term would have to end at least sixty days before
the end of the first year.
Furthermore, if monthly payments may change before the first
scheduled payment adjustment, a prepayment penalty term would have to
end at least sixty days before the first date on which such an
unscheduled payment change could occur. For instance, the first
adjustment on a loan may be scheduled for three years after loan
origination, but the creditor may have the right to make an unscheduled
payment change if negative amortization causes the loan's principal
amount to exceed a certain threshold. In this case, a prepayment
penalty could not be charged fewer than sixty days before the first
date on which negative amortization possibly could lead to an increase
in the borrower's monthly payments.
The mandatory expiration would apply only when required payments
may increase, not when consumers may opt to pay more than their
agreement requires. Moreover, it would not apply to a payment increase
due to a borrower's late payment, default, or delinquency.
HMDA data for 2004 through 2006 suggest that a sixty-day period
before a payment change would be enough time for a significant majority
of subprime borrowers to shop for a new loan to refinance the existing
obligation. Creditors report price data on first-lien loans if the
difference between a loan's APR and the yield on the comparable
Treasury security is equal to or greater than 3 percentage points. For
90 percent of the first-lien higher-priced loans, the period between
loan application and origination was less than fifty days. For 75
percent of the first-lien higher-priced loans, the period was less than
forty-two days.
Requests for Comment
The Board asks for comment on whether the proposal appropriately
balances the potential benefits and potential costs of prepayment
penalties to consumers who have higher-priced mortgage loans. The Board
asks for specific comment on whether the term allowed for a prepayment
penalty should be shorter than five years. Specific comment is also
sought on the proposal to strengthen the statute's income verification
requirement, and on the potential effects of the same-creditor
restriction in a market where creditors sell many of their loans.
[[Page 1696]]
The Board also requests comment on the proposal to require that a
prepayment penalty period on a higher-priced loan expire at least sixty
days prior to the first date on which a periodic payment may increase.
In particular, the Board asks for comment on the number of days before
a possible payment increase that a prepayment penalty should expire. In
addition, the Board solicits comments on whether this provision should
apply only to loans whose periodic payment may change within a certain
number of years (for example, three or five years) after loan
consummation. The Board also seeks comment on whether particular loan
types (for example, graduated payment, step-rate, or growth equity
transactions) should be exempted from a rule on prepayment penalty
expiration.
Comment on these matters is sought both with respect to the
subprime market and any part of the alt-A market the proposal may
cover. Comment is also sought both with respect to higher-priced
mortgage loans and with respect to the sub-category of HOEPA loans.
Notice of Change to Interest Rate and Payment
Under Regulation Z Sec. 226.20(c), an adjustment to the interest
rate with or without a corresponding adjustment to the payment in a
variable-rate transaction requires new disclosures to the consumer. At
least 25, but no more than 120, calendar days before a payment at a new
level is due, disclosures must be delivered or placed in the mail that
state, among other things, the new rate and payment amount, if any. A
notice that combined information about a new payment and interest rate
with information about the impending expiration of a prepayment penalty
period could potentially benefit consumers.
Reconciling the current notice with the proposed prepayment penalty
period could, however, be difficult. For example, some creditors set a
consumer's new payment or rate 30 or 45 days before the first possible
change in the monthly payment--after the proposal would require a
prepayment penalty period to end. Also, notice of expiration might be
more clear and conspicuous to a borrower if provided separately from
the Sec. 226.20(c) disclosures. Allowing a combined notice might
distort borrower decision making. For example, consumers might mistake
a notice of their ability to refinance without penalty as a
recommendation that they refinance, though their loan may remain
affordable and otherwise favorable compared to available alternatives.
An argument can be made that no separate notice of the upcoming
expiration of a prepayment penalty period is necessary. Unlike a
payment change, the amount of which may remain uncertain until
relatively close to the date of any such change, both the creditor and
the borrower will have information at loan consummation needed to
determine when the prepayment penalty period will expire. On the other
hand, consumers may benefit from being reminded when they may prepay
without penalty.
The Board proposes to defer revising Sec. 226.20(c) or drafting of
new disclosure requirements connected with the proposed prepayment
penalty period expiration regulation until the Board proposes
comprehensive amendments to Regulation Z's closed-end disclosure
provisions. Deferral would enable consumer testing of different
disclosure options. In the interim, however, consumers might lack
adequate information about when they may prepay without penalty.
Accordingly, the Board requests comment on whether, if it adopts the
proposed prepayment penalty expiration requirement, the Board should
specifically address the requirement's interaction with Sec.
226.20(c).
E. Requirement to Escrow--Sec. 226.35(b)(4)
The Board proposes to prohibit a creditor from making higher-priced
loans secured by a first lien without establishing an escrow account
for property taxes and homeowners insurance. Under the proposal,
creditors may allow a borrower to ``opt out'' of the escrow, but not at
or before consummation, only twelve months after. The proposed rule
would appear in Sec. 226.35(b)(4).
Public Comment on Escrows
The June 14, 2007 hearing notice solicited comment on the following
questions:
Should escrows for taxes and insurance be required for
subprime mortgage loans?
If escrows were required, should consumers be permitted to
``opt out'' of escrows?
Should lenders be required to disclose the absence of
escrows to consumers and if so, at what point during a transaction?
Should lenders be required to disclose an estimate of the consumer's
tax and insurance obligations?
How would escrow requirements affect consumers and the
type of and terms of credit offered?
Consumer and community groups that commented or testified urged the
Board to require escrows on subprime loans. They cited the infrequency
of escrows in the subprime market--one group cited a statistic in a
servicing trade publication indicating that as few as one-quarter of
subprime loans have escrow accounts. Commenters stated that escrows
have long been a staple of the prime lending market and suggested that
borrowers in the subprime market would benefit as much or more if
escrows were available or required. They argued that lack of escrows in
the subprime market enables originators to advertise and quote low
monthly payments that do not include tax and insurance obligations,
misleading borrowers, especially first-time homebuyers. Current
homeowners whose monthly payments include contributions to an escrow
account may believe that the originator who quotes them a payment
without escrow contributions can lower the homeowner's mortgage
payment. In reality, the payment on the new loan could be as high, or
higher, when property taxes and homeowners insurance are taken into
account. Commenters also stated that first-time homebuyers as well as
current homeowners with escrow accounts may not be aware of the need to
save on their own for tax and insurance payments if they are provided
loans without escrows. These borrowers may struggle to meet those
obligations when they come due, leaving them vulnerable to loan
flipping and equity stripping.
Many lenders and financial services trade groups that testified or
commented agree that escrowing taxes and insurance is generally
beneficial to subprime borrowers as well as lenders, servicers, and
investors. Some of these commenters favor a regulation to mandate
escrows, assuming it provides them ample time to come into compliance.
Some of these commenters, however, would prefer that the Board adopt
guidance rather than a regulation to allow flexibility. Other
commenters believe that consumers are generally well-enough informed
about tax and insurance obligations to save on their own for these
payments. These commenters contend that, if escrows were mandated, some
potential borrowers would not be able to fund the escrow account at
closing.
Discussion
The Board is concerned that the subprime market does not appear to
[[Page 1697]]
offer borrowers a genuine opportunity to escrow. Subprime servicers may
not set up an escrow infrastructure at all, and subprime originators
have disincentives to require or encourage borrowers to take advantage
of escrows when they are available. A collective action problem
prevails if each individual originator fears that offering escrows
would put it at a disadvantage relative to competitors, even if
originators collectively would benefit from escrows.\61\ Each
originator may fear losing business if it escrows. An originator that
escrowed would have to quote a monthly payment that included taxes and
insurance. Competitors that did not escrow could poach potential or
actual customers of the originator by not including taxes and insurance
in their quotes. So an originator may be unwilling to escrow without
assurance that its competitors also would escrow, though if all
originators escrowed then all would likely benefit.
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\61\ An industry representative at the Board's 2007 hearing
indicated that her company's internal analysis showed that escrows
clearly improved loan performance. Transcript of HOEPA Hearing at 66
(Jun. 14, 2007), available at http://www.federalreserve.gov/events/publichearings/hoepa/2007/20070614/transcript.pdf.
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This market failure causes consumers substantial injury. A lack of
escrows in the subprime market may make it more likely that borrowers
inadvertently take on mortgages they cannot afford because they focus
only on the payment of principal and interest. A lack of escrows may
also facilitate misleading payment quotes, which distort competition.
Lack of escrows also may make it more likely that borrowers who have
trouble saving on their own initiative and would prefer a forced saving
plan such as an escrow will not have the resources to pay tax and
insurance bills when they come due. This problem may be particularly
acute in the subprime market, where borrowers are more likely to be
cash-strapped. Failure to pay taxes and insurance is generally an act
of default which may subject the property to a public auction or an
acquisition by a public agency. Borrowers who face a tax or insurance
bill they cannot pay are particularly vulnerable to predatory home
equity loans because their situation is urgent.
While failure to escrow can cause consumers substantial injury,
escrows can also impose costs on consumers. Some borrowers may not be
able to afford the cost of funding an escrow at closing. Escrowing also
creates an opportunity cost for borrowers who could use the funds for a
more productive purpose and still meet their tax and insurance
obligations. Some states address this cost at least in part by
requiring that an escrow earn interest, but others do not impose such
requirements. Moreover, the cost of setting up and administering
escrows is passed on at least in part to consumers. The Board has
considered these costs in formulating the following proposal.
The Board's Proposal
The Board is proposing to make escrow accounts mandatory on first-
lien higher-priced mortgage loans and permit, but not require,
creditors to offer borrowers an option to cancel escrows twelve months
after consummation. The Board proposes to define ``escrow account'' by
reference to the definition of ``escrow account'' in the U.S.
Department of Housing and Urban Development's Regulation X (Real Estate
Settlement Procedures Act (RESPA)).
The Board believes the proposed remedy for the injuries caused by
the subprime market's failure to offer escrow accounts appropriately
balances the benefits and costs of escrows. Creditors would have an
option to allow consumers to limit the opportunity cost of escrow
accounts by opting out after one year. The Board is proposing an ``opt
out'' rather than an ``opt in'' regime because ``opt in'' would allow
some originators to discourage borrowers from escrowing, creating
pressure on other originators to follow suit and leaving the collective
action problem unresolved. Moreover, an ``opt out'' available at
closing or immediately thereafter would be subject to manipulation. If
a consumer could opt out at, or soon after, closing, then some
originators might still quote payments without taxes and insurance and
tell consumers that they could keep their payments from going up by
signing a piece of paper at or shortly after closing. A fairly long
period may be required to prevent such circumvention, and to educate
borrowers to the benefits of escrowing; the Board proposes twelve
months.
Requests for Comment
The Board seeks comment on whether the benefits of the proposed
regulation outweigh the costs. Comment is sought both with respect to
the subprime market and with respect to any part of the alt-A market
this proposal may cover.
The Board also seeks comment on whether creditors should be
required, rather than permitted, to allow borrowers to opt out. Comment
is also sought on whether a mandatory escrow period different from
twelve months would be appropriate, and on whether consumers could
effectively be protected from manipulation if the rule permitted them
to opt out before closing or soon thereafter.
State Escrow Laws
The Board recognizes that some state laws limit creditors' ability
to require escrows. In addition, certain state laws provide consumers a
right to cancel an escrow that the consumer may exercise sooner than
twelve months after closing. The Board's proposal would not be
consistent with such laws and, if adopted, would preempt them to the
extent of the inconsistency. The Board seeks information about which
state laws would be inconsistent with this proposal.
Other Proposals on Escrows
Other parts of this proposal address other issues with escrows.
Proposed Sec. 226.35(b)(1) would require creditors to take into
account taxes and insurance when determining whether a borrower can
repay a loan. Proposed Sec. 226.24(f)(3)(i)(C) would require
advertisements that state a payment amount that does not include taxes
and insurance to disclose that in close proximity to the payment
amount.
F. Evasion Through Spurious Open-end Credit--Sec. 226.35(b)(5)
The Board's proposal to exclude HELOCs from the new rules in Sec.
226.35 is discussed in subpart A. above. As noted, the Board recognizes
this could lead some creditors to attempt to evade the requirements in
Sec. 226.35 by structuring credit as open-end instead of closed-end.
Regulation Z Sec. 226.34(b) addresses this risk as to HOEPA coverage
by prohibiting structuring a transaction that does not meet the
definition of ``open-end credit'' as a HELOC to evade HOEPA. The Board
proposes to extend this approach to new Sec. 226.35. Proposed Sec.
226.35(b)(5) would prohibit a creditor from structuring a closed-end
transaction--that is, a transaction that does not meet the definition
of ``open-end credit''--as a HELOC to evade the limitations in Sec.
226.35.
The Board recognizes that consumers may prefer HELOCs to closed-end
home equity loans because of the added flexibility HELOCs provide them.
It is not the Board's intention to limit consumers' ability to choose
between these two ways of structuring home equity credit. An overly
broad anti-evasion rule could potentially limit consumer choices by
casting doubt on the validity of legitimate open-end plans. The Board
seeks comment on the extent to which the proposed anti-evasion rule
could have this consequence, and solicits suggestions
[[Page 1698]]
for a more narrowly tailored rule. For example, the primary concern
would appear to be with HELOCs that are substituted for closed-end home
purchase loans and refinancings, which are usually first-lien loans,
rather than with HELOCs taken for home improvement or other consumer
purposes. The Board seeks comment on whether it should limit an anti-
evasion rule to HELOCs secured by first liens where the consumer draws
down all or most of the entire line of credit immediately after the
account is opened. Would such a rule be effective in preventing evasion
or would it be easily evaded itself?
VIII. Proposed Rules for Mortgage Loans--Sec. 226.36
Proposed Sec. 226.35, discussed above, would apply certain new
protections to higher-priced mortgage loans. In contrast, proposed
Sec. 226.36 would apply other new protections to mortgage loans
generally, though only if secured by the consumer's principal dwelling.
The proposal would prohibit: (1) Creditors from paying mortgage brokers
more than an amount the broker disclosed to the consumer in advance as
its total compensation; (2) creditors or mortgage brokers from coercing
or influencing appraisers to misrepresent the value of a dwelling; and
(3) servicers from engaging in unfair fee and billing practices. As
with proposed Sec. 226.35, however, proposed Sec. 226.36 would not
apply to HELOCs.
A. Creditor Payments to Mortgage Brokers--Sec. 226.36(a)
The Board proposes to prohibit a creditor from paying a mortgage
broker in connection with a covered transaction unless the payment does
not exceed an amount the broker has agreed in advance with the consumer
will be the broker's total compensation. The agreement must also
disclose that the consumer will pay the entire compensation even if all
or part is paid directly by the creditor, and that a creditor's payment
to a broker can influence the broker to offer the consumer loan terms
or products that are not in the consumer's interest or are not the most
favorable the consumer could obtain. Creditors could demonstrate
compliance with the provision by obtaining a copy of the broker-
consumer agreement and ensuring their payment to the broker does not
exceed the amount stated in the agreement. The proposal would provide
creditors two alternative means to comply, one where the creditor
complies with a state law that provides consumers equivalent
protection, a second where a creditor can demonstrate that its payments
to a mortgage broker are not determined by reference to the
transaction's interest rate.
Public Comment on Creditor Payments to Mortgage Brokers
Although the Board did not solicit comment on mortgage broker
compensation in its notice of the June 2007 hearing, a number of
commenters and some panelists raised the topic. In addition, the Board
received information about broker compensation from panelists in the
2006 hearings.
Consumer and creditor representatives alike have raised concerns
about the fairness and transparency of creditor payments to brokers,
known as yield spread premiums. Several commenters and panelists stated
that consumers are not aware of the payments creditors make to brokers,
or that such payments increase consumers' interest rates. They also
stated that consumers may mistakenly believe that a broker seeks to
obtain the best interest rate available. Consumer groups have expressed
particular concern about increased payments to brokers for delivering
loans both with higher interest rates and prepayment penalties.
Consumer groups suggested, variously, prohibiting creditors paying
brokers yield spread premiums, imposing on brokers that accept yield
spread premiums a fiduciary duty to consumers, imposing on creditors
that pay yield spread premiums liability for broker misconduct, or
including yield spread premiums in the points and fees test for HOEPA
coverage. Several creditors and creditor trade associations advocated
requiring brokers to disclose whether the broker represents the
consumer's interests, and how and by whom the broker is to be
compensated. Some of these commenters recommended requiring brokers to
disclose their total compensation to the consumer and prohibiting
creditors from paying brokers more than the disclosed amount.
Discussion
A yield spread premium is the present dollar value of the
difference between the lowest interest rate the wholesale lender would
have accepted on a particular transaction and the interest rate the
broker actually obtained for the lender. This dollar amount is usually
paid to the mortgage broker, though it may also be applied to other
closing costs. (This proposal would restrict only amounts paid to and
retained by the broker, however, and not amounts the broker is
obligated to pass on to other settlement service providers.) The
creditor's payment to the broker based on the interest rate is an
alternative to the consumer's paying the broker directly from the
consumer's preexisting resources or from the loan proceeds. Preexisting
resources or loan proceeds may not be sufficient to cover the broker's
total fee, or may appear to the consumer to be a more costly way to
finance those costs if the consumer expects to prepay the loan in a
relatively short period. Thus, consumers potentially benefit from
having an option to pay brokers for their services indirectly by
accepting a higher interest rate.
The Board shares concerns, however, that creditor payments to
mortgage brokers are not transparent to consumers and are potentially
unfair to them. Creditor payments to brokers based on the interest rate
give brokers an incentive to provide consumers loans with higher
interest rates. Some brokers may refrain from acting on this incentive
out of legal, business, or ethical considerations. Moreover,
competition in the mortgage loan market may often limit brokers'
ability to act on the incentive. The market often leaves brokers room
to act on the incentive should they choose, however, especially as to
consumers who are less sophisticated and less likely to shop among
either loans or brokers.
Large numbers of consumers are simply not aware the incentive
exists. Many consumers do not know that creditors pay brokers based on
the interest rate, and current legally required disclosures seem to
have only limited effect.\62\ Some consumers may not even know that
creditors pay brokers: a common broker practice of charging a small
part of its compensation directly to the consumer, to be paid from the
consumer's existing resources or loan proceeds, may lead consumers to
believe, incorrectly, that this amount is all the consumer will pay or
the broker will receive. Consumers who do understand that the creditor
pays the broker based on the interest rate may not fully understand the
implications of the practice. They may not appreciate the full extent
of the incentive this gives the broker to increase the rate because
they do not
[[Page 1699]]
know the dollar amount of the creditor's payment.
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\62\ This is true not only of state-mandated disclosures but
also of the early federal disclosure currently in place under the
Real Estate Settlement Procedures Act (RESPA), the good faith
estimate of settlement costs (GFE). As the Department of Housing and
Urban Development (HUD) has noted, the current GFE does not convey
to consumers an adequate understanding of how mortgage brokers are
paid. RESPA Simplification, 67 FR 49134, 49140-41, Jul. 29, 2002
(proposed rule under RESPA).
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Moreover, consumers often wrongly believe that brokers agree, or
are required, to obtain the best interest rate available. Several
commenters in connection with the 2006 hearings suggested that mortgage
broker marketing cultivates an image of the broker as a ``trusted
advisor'' to the consumer. Consumers who have this perception may rely
heavily on a broker's advice, and there is some evidence that such
reliance is common. In a 2003 survey of older borrowers who had
obtained prime or subprime refinancings, seventy percent of respondents
with broker-originated refinance loans reported that they had relied
``a lot'' on their brokers to find the best mortgage for them.\63\
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\63\ Kellie K. Kim-Sung & Sharon Hermanson, Experiences of Older
Refinance Mortgage Loan Borrowers: Broker- and Lender-Originated
Loans, Data Digest No. 83 (AARP Public Policy Inst., Washington,
D.C.), Jan. 2003, at 3, available at http://www.aarp.org/research/credit-debt/mortgages/experiences_of_older_refinance_mortgage_loan_borro.html.
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If consumers believe that brokers protect consumers' interests by
shopping for the lowest rates available, then consumers will be less
likely to take steps to protect their own interests when dealing with a
broker. For example, they may be less likely to shop rates across
retail and wholesale channels simultaneously to assure themselves the
broker is providing a competitive rate. They may also be less likely to
shop and negotiate brokers' services, obligations, or compensation up-
front, or at all. For example, they may be less likely to seek out
brokers who will promise in writing to obtain the lowest rate
available.
The Board's Proposal
The Board proposes to prohibit a creditor from paying a mortgage
broker in connection with a covered transaction unless the payment does
not exceed an amount the broker has agreed with the consumer in advance
will be the broker's total compensation. The proposal would restrict
only amounts the broker retains, not amounts the broker distributes to
other settlement service providers. The agreement must also disclose
that the consumer will pay the entire compensation even if all or part
is paid directly by the creditor, and that a creditor's payment to a
broker can influence the broker to offer the consumer loan terms or
products that are not in the consumer's interest or are not the most
favorable the consumer could obtain. The commentary would provide model
language for each of these disclosures, which the Board anticipates
testing with consumers. The broker and consumer must have entered into
the agreement before the consumer had paid a fee to any person or
submitted a written application to the broker, whichever occurred
earlier.
The proposal is intended to limit the potential for unfairness,
deception, and abuse in creditor payments to brokers in exchange for
higher interest rates while preserving this option for consumers to
finance their obligations to brokers. Conditioning such payments on a
broker's advance commitment to the consumer to limit its compensation
to a specified dollar amount may increase transparency and improve
competition in the market for brokerage services. Improved competition
could lower the price of brokerage services, improve the quality of
those services, or both. When consumers are aware how much they will
pay for a broker's services, they may be more likely to shop and
negotiate among brokers based on broker fees, broker services, and
other terms of broker contracts.
Disclosing that the consumer ultimately pays the broker's
compensation would help ensure that the disclosure of a compensation
figure was meaningful and not undermined by a consumer's perception
that the creditor, not the consumer, shoulders the broker fee.
Disclosing that the creditor's payment may influence the broker not to
serve the best interests of the consumer would help ensure that
consumers were on notice of the need to protect their own interests
when dealing with a mortgage broker rather than assume that the broker
would fully protect their interests.
The rule is intended to impose a fairly minimal compliance burden.
A creditor would demonstrate compliance by obtaining a copy of a timely
executed broker-consumer agreement and ensuring that it did not pay the
broker more than the amount stated in the agreement, reduced by any
amount paid directly by the consumer. The amount paid directly by the
consumer, if any, would appear on the HUD-1 Settlement Statement
prepared in accordance with the Real Estate Settlement Procedures Act.
The Board considered imposing a disclosure obligation directly on
brokers. It does not appear, however, that a disclosure alone would
provide consumers adequate protection. More protection is provided
where creditors are prohibited from paying more than the amount
disclosed.
Compensation amount. The proposal would require that the
compensation be disclosed as a flat dollar amount. The proposal would
not permit disclosing a range of fees or a percentage figure. The Board
recognizes that disclosure in these or other forms has been common. The
Board is concerned, however, that disclosure in a form other than a
flat dollar amount, however, would not be meaningful to consumers.
Timing. The proposal would require that the broker-consumer
agreement have been entered into before the consumer pays a fee to any
person in connection with the transaction or submits an application.
This is intended to ensure the consumer has not already become ``locked
in'' to a relationship with the broker by paying a fee or submitting an
application. The early timing requirement may also tend to limit the
risk that a broker would price discriminate on the basis of the
sophistication and market options of the borrower.
The Board recognizes that requiring a broker who seeks to be paid
by the creditor to commit to its fee this early in its relationship
with the consumer may lead brokers to price their services on the basis
of the average cost of a transaction rather than separately for each
transaction. Average cost pricing can potentially create some
inefficiency. The Board believes, however, that this cost may be
outweighed by the increased efficiency from improved transparency.
Loans covered. The proposed rule would apply to the prime market as
well as the subprime market. The Board recognizes that injury to
consumers in the prime market is likely more limited than injury in the
subprime market because loans in the prime market have a much narrower
range of interest rates, which limits the rents that can be extracted
from consumers. The Board is concerned, however, that the lack of
transparency discussed above may injure borrowers in the prime market,
too, even if not to the same degree.
Originators covered. The proposal is limited to creditor payments
to brokers. A broker would be defined as a person, other than a
creditor's employee, who for monetary gain arranges, negotiates, or
otherwise obtains an extension of credit for a consumer. See proposed
Sec. 226.36(c). A person who met this definition would be considered a
mortgage broker even if the credit obligation was initially payable to
the person, unless the person funded the transaction from its own
resources, from deposits, or from a bona fide warehouse line of credit.
The Board is aware of concerns that a rule restricting, and
encouraging disclosure of, lender payments to brokers but not lender
payments to their
[[Page 1700]]
employees could create an ``uneven playing field'' between brokers and
lenders. Creditors sometimes pay their employed loan officers on a
basis similar to their payment of yield spread premiums to independent
brokers. To the extent a loan originated through an employee exceeds
the creditor's ``par'' rate, the creditor may realize a gain from
selling the loan on the secondary market and it may share some of this
gain with the employee. Such payments give employees an incentive to
increase the interest rate.
The Board does not propose, however, to restrict creditor payments
to their own employees. The Board is not aware of significant evidence
that consumers perceive lenders' employees the way they often perceive
independent brokers--as trusted advisors who shop for the best loan for
a consumer among a wide variety of sources. Accordingly, it is not
clear that a key premise of the proposal to restrict creditor payments
to brokers--that consumers expect a broker has a legal or professional
obligation to give disinterested advice and find the consumer the best
loan available--holds true for creditor payments to their own
employees. In addition, extending the proposal to creditor payments to
their employees could present difficult practical problems. For
example, a creditor may not know even as of consummation whether it
will sell a particular loan in the secondary market. If the creditor is
nonetheless certain to sell the loan, it may not know until near or at
consummation what its gain will be or, therefore, how much it will pay
its employee.
Compliance alternatives. The proposal would provide creditors two
alternative ways to comply, one where the creditor complies with a
state law that provides consumers equivalent protection, a second where
a creditor can demonstrate that its payments to a mortgage broker are
not determined by reference to the transaction's interest rate. The
first safe harbor is for a creditor payment to a broker for a
transaction in connection with a state statute or regulation that (a)
expressly prohibits the broker from being compensated in a manner that
would influence a broker to offer loan products or terms not in the
consumer's interest or not the most favorable the consumer could
obtain; and (b) requires that a mortgage broker provide consumers with
a written agreement that includes a description of the mortgage
broker's role in the transaction and the broker's relationship to the
consumer, as defined by such statute or regulation. An example would be
a state statute or regulation that imposed a fiduciary obligation on a
mortgage broker not to puts its own interests ahead of the consumer's
and required the broker to disclose this obligation in an agreement
with the consumer.
The second alternative is for a creditor that can demonstrate that
the compensation it pays to a mortgage broker in connection with a
transaction is not determined, in whole or in part, by reference to the
transaction's interest rate. For instance, if a creditor can show that
it pays brokers the same flat fee for all transactions regardless of
the interest rate, the creditor would not be subject to the restriction
on payments to brokers under Sec. 226.36(a)(1).
Requests for Comment
The Board seeks comment generally on the costs and benefits of the
proposal, including the proposed alternatives means of compliance. The
Board seeks specific comment on whether it would be appropriate to
apply the proposed rule, or a similar rule, to lender payments to loan
originators in their employ and, if so, how the rule would address
practical difficulties such as those discussed above. Further, the
Board seeks comment on whether the benefits of applying the proposed
rule to the prime market would outweigh the costs, including potential
unintended consequences. The Board seeks specific comment on whether
the proposed rule should be limited to higher-priced mortgage loans as
defined in proposed Sec. 226.35(a).
The Board also seeks comment on the proposed condition that the
broker-consumer agreement have been entered into before the consumer
pays a fee to any person in connection with the transaction or submits
an application. Would brokers have a reduced incentive to shop actively
among potential sources of financing for the lowest possible rate?
Would a broker potentially terminate its relationship with a consumer
without obtaining a loan for the consumer because the consumer's
particular needs would be more difficult to meet than the broker
anticipated when it set its compensation? If these are concerns, would
it be appropriate for the Board to provide a narrow allowance for
renegotiation of the broker's compensation later in the application
process? How should such a permission be crafted to ensure transparency
and protect consumers from unfair practices such as ``bait and
switch''?
The Proposed Rule's Relationship to Other Laws
The Board recognizes that HUD has issued policy statements
regarding creditor payments to mortgage brokers under RESPA and
guidance as to disclosure of such payments on the Good Faith Estimate
and HUD-1 Settlement Statement. The Board is also aware that HUD has
announced its intention to propose improved disclosures for broker
compensation under RESPA in the near future. The Board intends that its
proposal would complement any proposal by HUD and operate in
combination with that proposal to meet the agencies' shared objectives
of fair and transparent markets for mortgage loans and for mortgage
brokerage services. The Board and HUD have discussed their mutual
desire and intention to work together to achieve these objectives while
minimizing any duplication between their regulations. Accordingly, the
proposed restriction of creditor payments to mortgage brokers is
intended to be consistent with HUD's existing guidance regarding
creditor compensation to brokers under Section 8 of RESPA, 12 U.S.C.
2607.
The Board is also aware that many states regulate brokers and their
compensation in various respects. Under TILA Section 111, the proposed
rule would not preempt such state laws except to the extent they are
inconsistent with the proposal's requirements. 15 U.S.C. 1610. The
Board seeks comment on the relationship of this proposal to state laws.
B. Coercion of Appraisers--Sec. 226.36(b)
The Board proposes to prohibit creditors and mortgage brokers from
coercing appraisers to misrepresent the value of a consumer's principal
dwelling. The Board also proposes to prohibit creditors from extending
credit when creditors know or have reason to know, at or before loan
consummation, that an appraiser has misstated a dwelling's value. The
regulation would apply to all consumer credit transactions secured by a
consumer's principal dwelling.
Discussion
Some responses to the Board's request for public comment urged the
Board to address coercion of appraisers, even though the Board did not
specifically request comment on that issue. For example, the National
Association of Attorneys General and many consumer and community groups
cited inflated appraisals as a problem in the home
[[Page 1701]]
mortgage market. A lender trade association suggested that the Board
require appraisers to report instances of improper pressure and ban
inflation of appraisals. Appraiser trade associations and several
consumer and community groups urged the Board to prohibit coercion of
appraisers as an unfair or deceptive act or practice. Also, testimony
before Congress has cited data that suggests that appraisers frequently
are subject to coercion.\64\
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\64\ For example, on June 26, 2007, at a hearing of the U.S.
Senate Committee on Banking, the President of the Appraisal
Institute testified for several appraiser trade organizations about
threats to appraiser independence. He cited a 2007 survey by the
October Research Corporation that found that 90 percent of
appraisers reported having been pressured to report higher property
values, a percentage almost twice as high as reported in a 2003
survey. Ending Mortgage Abuse: Safeguarding Homebuyers: Hearing
before the Subcomm. on Hous., Transp., & Comm'y Dev. of the S. Comm.
on Banking, Hous., and Urban Affairs 4, 110th Cong. (2007)
(statement of Alan Hummel, Chair, Government Relations Committee,
Appraisal Institute).
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Pressuring an appraiser to overstate, or understate, the value of a
consumer's dwelling distorts the lending process and harms consumers.
If the appraisal is inflated on a home purchase loan, a consumer may
pay more for the house than the consumer otherwise would have. Inflated
appraisals also may lead consumers to think they have more equity in
their homes than they really have, and consumers may borrow or make
other financial decisions based on this incorrect information. For
example, a consumer who purchases a home based on an inflated appraisal
may overestimate her ability to refinance and may take on a riskier
loan than she otherwise would have. Moreover, the consumer would not
necessarily be aware that an appraisal had been inflated or appreciate
the risk that appraisal inflation entailed. Understated appraisals,
though perhaps less common, can cause consumers to be denied access to
credit for which they were qualified.
Inflated appraisals of homes concentrated in a neighborhood may
affect other appraisals, since appraisers factor the value of
comparable properties into their property valuation. For the same
reason, understated appraisals may affect appraisals of neighboring
properties. Thus, inflated or understated appraisals can harm consumers
other than those who are party to the transaction with the inflated
appraisal. Moreover, these consumers are not in a position to know of
the practice or avoid it.
State legislatures and enforcement agencies have addressed concerns
about parties who exert undue influence over appraisers' property
valuations.\65\ Several states have banned coercion of appraisers or
enacted general laws against mortgage fraud that may be used to combat
appraiser coercion.\66\ In 2006, forty-nine states and the District of
Columbia (collectively, the Settling States) entered into a settlement
agreement with ACC Capital Holdings Corporation and several of its
subsidiaries, including Ameriquest Mortgage Company (collectively, the
Ameriquest Parties). The Settling States alleged that the Ameriquest
Parties had engaged in deceptive or misleading acts that resulted in
the Ameriquest Parties' obtaining inflated appraisals of homes'
value.\67\ To settle the complaints, the Ameriquest Parties agreed to
abide by policies designed to ensure appraiser independence and
accurate valuations. Also, the Attorneys General of New York and Ohio
recently have filed actions that allege, among other violations, the
exertion of improper influence over appraisers.
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\65\ The federal financial institution regulatory agencies have
issued regulations to the institutions they supervise that explain,
among other things, how those institutions should promote appraiser
independence. The Board's proposal is not intended to alter those
regulations or any other federal or state statutes, regulations, or
agency guidance related to appraisals.
\66\ See, e.g., Colo. Rev. Stat. Sec. 6-1-717; Iowa Code Sec.
543D.18A; Ohio Rev. Code Ann. Sec. Sec. 1322.07(G),
1345.031(B)(10), 4763.12(E).
\67\ See, e.g., Iowa ex rel. Miller v. Ameriquest Mortgage Co.,
No. 05771 EQCE-053090 (Iowa D. Ct. 2006) (Pls. Pet. 5).
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The Board's Proposal
To address the harm from improper influencing of appraisers, the
Board proposes to prohibit creditors and mortgage brokers and their
affiliates from pressuring an appraiser to misrepresent a dwelling's
value, for all closed-end consumer credit transactions secured by a
consumer's principal dwelling. The proposed regulation defines the term
``appraiser'' as a person who engages in the business of providing, or
offering to provide, assessments of the value of dwellings.
Further, the Board's proposed regulation prohibits a creditor from
extending credit if the creditor knew or had reason to know that a
broker had coerced an appraiser to misstate a dwelling's value, unless
the creditor acted with reasonable diligence to determine that the
appraisal was accurate. For example, an appraiser might notify a
creditor that a mortgage broker had tried--and failed--to get the
appraiser to inflate a dwelling's value. If, after reasonable,
documented investigation, the creditor found that the appraiser had not
misstated the dwelling's value, the creditor could extend credit based
on the appraiser's valuation. The proposed commentary states that,
alternatively, the creditor could extend credit based on another
appraisal untainted by improper influence.
The commentary to the proposed regulation gives examples of acts
that would violate the regulation: implying to an appraiser that
retention of the appraiser depends on the amount at which the appraiser
values a consumer's principal dwelling; failing to compensate an
appraiser or to retain the appraiser in the future because the
appraiser does not value a consumer's principal dwelling at or above a
certain amount; and conditioning an appraiser's compensation on loan
consummation. The commentary also lists examples of acts that would not
violate the regulation: requesting that an appraiser consider
additional information for, provide additional information about, or
correct factual errors in a valuation; obtaining multiple appraisals of
a dwelling (provided that the creditor or mortgage broker selects
appraisals based on reliability rather than on the value stated);
withholding compensation from an appraiser for breach of contract or
substandard performance of services or terminating a relationship for
violation of legal or ethical standards; and taking action permitted or
required by applicable federal or state statute, regulation, or agency
guidance.
A regulation under HOEPA that expressly prohibits creditors and
brokers from pressuring appraisers to misstate or misrepresent the
value of a consumer's dwelling would provide enforcement agencies in
every state with a specific legal basis for an action alleging
appraiser coercion. The Board requests comments on the potential costs
and benefits of its proposed appraiser influence regulation. The Board
seeks specific comment on the appropriateness of proposed examples of
actions that would or would not violate the proposed regulation.
C. Servicing Abuses--Sec. 226.36(d)
The Board proposes to prohibit certain practices on the part of
servicers of closed-end consumer credit transactions secured by a
consumer's principal dwelling. Proposed Sec. 226.36(d) would provide
that no servicer shall: (1) Fail to credit a consumer's periodic
payment as of the date received; (2) impose a late fee or delinquency
charge where the only late fee or delinquency charge is due to a
consumer's failure to include in a current payment a delinquency charge
imposed on earlier payments; (3) fail to
[[Page 1702]]
provide a current schedule of servicing fees and charges within a
reasonable time of request; or (4) fail to provide an accurate payoff
statement within a reasonable time of request.
Discussion
Although the Board did not solicit comment on whether certain
mortgage servicer practices should be prohibited or restricted in its
notices of the 2006 or 2007 hearings, some commenters raised the topic
in that context. The issue has also been presented in recent
congressional testimony. Consumer advocates have raised concerns that
some servicers may be charging consumers unwarranted or excessive fees,
such as late fees and other ``service'' fees, in the normal course of
mortgage servicing, as well as in foreclosure scenarios. There is
anecdotal evidence that significant numbers of consumers have
complained about servicing practices, and instances of unfair practices
have been cited in court cases.\68\ In 2003, the FTC announced a $40
million settlement with a large mortgage servicer and its affiliates to
address allegations of abusive behavior.\69\ Consumer advocates have
also raised concerns that consumers are sometimes unable to understand
the basis upon which fees are charged, in part because disclosure and
other forms of notice to consumers of servicer fees are limited.
---------------------------------------------------------------------------
\68\ See, e.g., Islam v. Option One Mortgage Corp., 432 F. Supp.
2d 181 (D. Mass 2006); In Re Coates, 292 B.R. 894 (D. Ill. 2003); In
Re Gorshstein, 285 B.R. 118 (S.D.N.Y. 2002); In re Tate, 253 B.R.
653 (2000); Rawlings v. Dovenmuehle Mortgage Inc., 64 F. Supp. 2d
1156 (M.D. Ala. 1999); Ronemus v. FTB Mortgage Servs., 201 B.R. 458
(1996).
\69\ Consent Order, United States v. Fairbanks Capital Corp.,
Civ. No. 03-12219-DPW (D. Mass Nov. 21, 2003, as modified Sept. 4,
2007). See also Ocwen Federal Bank FSB, Supervisory Agreement, OTS
Docket No. 04592 (Apr. 19, 2004) (settlement resolving mortgage
servicing issues).
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The Board shares concerns about abusive servicing practices. Before
securitization became commonplace, a lending institution would often
act as both originator and collector--that is, it would service its own
loans. Today, however, separate servicing companies play a key role:
they are chiefly responsible for account maintenance activities,
including collecting payments (and remitting amounts due to investors),
handling interest rate adjustments, and managing delinquencies or
foreclosures. Servicers also act as the primary point of contact for
consumers. In exchange for performing these services, servicers
generally receive a fixed per-loan or monthly fee, float income, and
ancillary fees--including default charges--that the consumer must pay.
A potential consequence of the ``originate-to-distribute'' model
discussed in part II.C. above is the misalignment of incentives between
consumers, servicers, and investors. Servicers contract directly with
investors, and consumers are not a party to the contract. The investor
is principally concerned with maximizing returns on the mortgage loans.
So long as returns are maximized, the investor may be indifferent to
the fees the servicer charges the borrower. Consumers do not have the
ability to shop for servicers and have no ability to change servicers
(without refinancing). As a result, servicers do not compete in any
direct sense for consumers. Thus, there may not be sufficient market
pressure on servicers to ensure competitive practices.
As a result, as described above, substantial anecdotal evidence of
servicer abuse exists. For example, servicers may not timely credit, or
may misapply, payments, resulting in improper late fees. Even where the
first late fee is properly assessed, servicers may apply future
payments to the late fee first, making it appear future payments are
delinquent even though they are, in fact, paid in full within the
required time period, and permitting the servicer to charge additional
late fees--a practice commonly referred to as ``pyramiding'' of late
fees. The Board is also concerned about the transparency of servicer
fees and charges, especially because consumers may have no notices of
such charges prior to their assessment. Consumers may be faced with
charges that are confusing, excessive, or cannot easily be linked to a
particular service. In addition, servicers may fail to provide payoff
statements in a timely fashion, thus impeding consumers from
refinancing existing loans.
The Board's Proposal
The Board is proposing to restrict certain servicing practices and
to provide more transparency in the servicing market. Proposed Sec.
226.36(d) would prohibit four servicing practices that are likely to
harm consumers. First, the proposal would prohibit a servicer from
failing to credit a payment to a consumer's account as of the same date
it is received. Second, the proposal would prohibit ``pyramiding'' of
late fees, by prohibiting a servicer from imposing a late fee on a
consumer for making an otherwise timely payment that would be the full
amount currently due but for its failure to include a previously
assessed late fee. Third, the proposal would prohibit a servicer from
failing to provide to a consumer, within a reasonable time after
receiving a request, a schedule of all specific fees and charges it
imposes in connection with mortgage loans it services, including the
dollar amount and an explanation of each fee and the circumstances
under which it will be imposed. Fourth, the proposal would prohibit a
servicer from failing to provide, within a reasonable time after
receiving a request, an accurate statement of the amount currently
required to pay the obligation it services in full, often referred to
as a payoff statement. Under proposed Sec. 226.36(d)(3), the term
``servicer'' and ``servicing'' are given the same meanings as provided
in Regulation X, 24 CFR 3500.2.
As described in part V above, TILA Section 129(l)(2) authorizes
protections against unfair practices by non-creditors and against
unfair or deceptive practices outside of the origination process, when
such practices are ``in connection with mortgage loans.'' 15 U.S.C.
1639(l)(2). The Board believes that unfair or deceptive servicing
practices fall squarely within the purview of Section 129(l)(2) because
servicing is an integral part of the life of a mortgage loan and,
therefore, has a close and direct ``connection with mortgage loans.''
Accordingly, the Board bases its proposal to prohibit certain unfair or
deceptive servicing practices on its authority under Section 129(l)(2),
15 U.S.C. 1639(l)(2).
Late Payments
The proposed rule prohibiting the failure to credit payments as of
the date received would be substantially similar to the existing
provision requiring prompt crediting of payment on open-end
transactions in Sec. 226.10. Accordingly, proposed Sec.
226.36(d)(1)(i) would require a servicer to credit a payment to the
consumer's loan account as of the date of receipt, except when a delay
in crediting does not result in a finance or other charge or in the
reporting of negative information to a consumer reporting agency except
as provided in Sec. 226.36(d)(2). As the proposed commentary would
make clear, the proposal would not require that a servicer physically
enter the payment on the date received, but would require only that it
be credited as of the date received. Thus, a servicer that receives a
payment on or before its due date and does not enter the payment on its
books until after the due date does not violate the requirement as long
as the entry does not result in the imposition of a late charge,
interest, or
[[Page 1703]]
other charge to the consumer. The Board seeks comment on whether (and
if so, how) partial payments should be addressed in this provision.
Similar to Sec. 226.10(b), proposed Sec. 226.36(d)(2) would
require a servicer that specifies payment requirements in writing, but
that accepts a non-conforming payment, to credit the payment within
five days of receipt. The proposed commentary is also similar to the
commentary accompanying Sec. 226.10(b); for example, it explains that
the servicer may specify in writing reasonable requirements for making
payments, such as setting a cut-off hour for payment to be received.
The Board seeks comment on whether the commentary should include a safe
harbor as to what constitutes a reasonable payment requirement, for
example, a cut-off time of 5 p.m. for receipt of a mailed check.
Pyramiding Late Fees
The prohibition on pyramiding late fees parallels the existing
prohibition in the ``credit practices rule,'' under section 5 of the
FTC Act, 15 U.S.C. 45. See, e.g., 12 CFR 227.15 (Board's Regulation
AA). Proposed Sec. 226.36(d)(1)(ii) would prohibit servicers from
imposing any late fee or delinquency charge on the consumer in
connection with a payment, when the only delinquency is attributable to
late fees or delinquency charges assessed on an earlier payment, and
the payment is otherwise a full payment for the applicable period and
is paid on its due date or within an applicable grace period. The
proposed commentary provides that the prohibition should be construed
consistently with the credit practices rule. Servicers are currently
subject to this rule, whether they are banks (Regulation AA), thrifts
(12 CFR 535.4), or other kinds of institutions (16 CFR 444.4).
Consumers may nevertheless benefit if the Board adopted the same
requirement under TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2). This
would permit state attorneys general to enforce the rule uniformly,
where currently they may be limited to enforcing the rule through state
statutes that may vary. Accordingly, violations of the anti-pyramiding
rule by servicers would provide state attorneys general an additional
means of enforcement.
Schedule of Fees and Charges
The third proposed rule would require a servicer to provide to a
consumer upon request a schedule of all specific fees and charges that
may be imposed in connection with the servicing of the consumer's
account, including a dollar amount and an explanation of each and the
circumstances under which it may be imposed. The Board believes that
making the fee schedule available to consumers upon request will bring
transparency to the market and will make it more difficult for
unscrupulous servicers to camouflage or inflate fees. Therefore, the
proposal would require the servicer to provide, upon request, a fee
schedule that is specific both as to the amount and reason for each
charge, to prevent servicers from disguising fees by lumping them
together or giving them generic names.
The proposed commentary would also explain that a dollar amount may
be expressed as a flat fee or, if a flat fee is not feasible, as an
hourly rate or percentage. Thus, if the services of a foreclosure
attorney are required, the servicer might list the attorney's hourly
rate because it would be difficult for a servicer to determine a flat
dollar amount. However, it might not be difficult for a servicer to
determine a flat delivery service fee. The Board believes that
disclosure of a dollar figure for each fee will discourage abusive
servicing practices by enhancing the consumer's understanding of
servicing charges. The Board seeks comment on the effectiveness of this
approach, and on any alternative methods to achieve the same objective.
Further, the proposed commentary would clarify that ``fees
imposed'' by the servicer include third party fees or charges passed on
by the servicer to the consumer. The Board recognizes that servicers
may have difficulty identifying third party charges with complete
certainty, because third party fees may vary depending on the
circumstances (for example, fees may vary by geography). The Board
seeks comment on whether the benefit of increasing the transparency of
third party charges would outweigh the costs associated with a
servicer's uncertainty as to such charges.
The proposed commentary would clarify that a servicer who receives
a request for the schedule of fees may either mail the schedule to the
consumer or direct the consumer to a specific Web site where the
schedule is located. The Board believes that having the option to post
the schedule on a Web site will greatly reduce the burden on servicers
to provide schedules. However, the proposed commentary provides that
any such Web site address reference must be specific enough to inform
the consumer where the schedule is located, rather than solely
referring to the servicer's home page.
Loan Payoff Statement
Proposed Sec. 226.36(d)(1)(iv) would prohibit a servicer from
failing to provide, within a reasonable time after receiving a request
from the consumer or any person acting on behalf of the consumer, an
accurate statement of the full amount required to pay the obligation in
full as of a specified date, often referred to as a payoff statement.
Servicers' delay in providing payoff statements has impeded consumers
from refinancing existing loans or otherwise clearing title. Such
delays increase transaction costs and may discourage consumers from
pursuing a refinance opportunity. The proposed commentary states that
under normal market conditions, three business days would be a
reasonable time to provide the payoff statements; however, the
commentary states that a reasonable time might be longer than three
business days when servicers are experiencing an unusually high volume
of refinancing requests.
Under this provision, the servicer would be required to respond to
the request of a person acting on behalf of the consumer; this is to
ensure that the creditor with whom the consumer is refinancing receives
the payoff statement in a timely manner. It also ensures that others
who act on the consumer's behalf, such as a non-profit homeownership
counselor, can obtain a payoff statement for the consumer within a
reasonable time.
D. Coverage--Sec. 226.36(e)
Proposed Sec. 226.36 would apply new protections to mortgage loans
generally, if primarily for a consumer purpose and secured by the
consumer's principal dwelling, because the Board believes that the
concerns addressed by proposed Sec. 226.36 also apply to the prime
market. However, the Board proposes to exclude HELOCs from coverage of
Sec. 226.36 because the risks to consumers addressed by the proposal
may be lower in connection with HELOCs than with closed-end
transactions. Most originators of HELOCs hold them in portfolio rather
than sell them, which aligns these originators' interests in loan
performance more closely with their borrowers' interests. Further,
consumers with HELOCs can be protected in other ways besides regulation
under HOEPA. Unlike closed-end transactions, HELOCs are concentrated in
the banking and thrift industries, where the federal banking agencies
can use their supervisory authority to protect
[[Page 1704]]
consumers.\70\ Similarly, TILA and Regulation Z already contain a
prompt crediting rule for HELOCs, 12 CFR 226.10, of the kind the Board
is proposing in Sec. 226.36(d).
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\70\ See, e.g., Interagency Credit Risk Management Guidance for
Home Equity Lending, Fed. Reserve Bd. SR Letter 05-11 (May 16,
2005); Addendum to Credit Risk Management Guidance for Home Equity
Lending, Fed. Reserve Bd. SR Letter 06-15 app. 3 (Nov. 26, 2006).
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The Board seeks comment on whether there is a need to apply any or
all of the proposed prohibitions in Sec. 226.36 to HELOCs. For
example, one source reports that the proportion of HELOCs originated
through mortgage brokers is quite small.\71\ This may suggest that the
risks of improper creditor payments to brokers or broker coercion of
appraisers in connection with HELOCs is limited. Are mortgage brokers
growing as a channel for HELOC origination such that regulation under
Sec. Sec. 226.36(a) through 226.36(c) is necessary? Do originators
contract out HELOC servicing often enough to necessitate the proposed
protections of Sec. 226.36(d)? If coverage should be extended to
HELOCs, the Board also solicits comment as to whether such coverage
should be limited to specific types of HELOCs. For example, do purchase
money HELOCs, which are often used in combination with first-lien
closed-end loans to purchase a home, mirror the risks associated with
first-lien loans?
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\71\ Consumer Bankers Ass'n, 2006 Home Equity Loan Study (June
30, 2006) (reporting that about 10 percent of HELOCs were originated
through a broker channel recently).
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IX. Other Potential Concerns
A. Other HOEPA Prohibitions
As discussed in part VII, the Board is proposing to extend to
higher-priced mortgage loans two of the restrictions HOEPA currently
applies only to HOEPA loans, concerning determinations of repayment
ability and prepayment penalties. See TILA Section 129(c) and (h), 15
U.S.C. 1639(c) and (h). HOEPA also prohibits negative amortization,
interest rate increases after default, balloon payments on loans with a
term of less than five years, and prepaid payments. TILA Section
129(d)-(g), 15 U.S.C. 1639(d)-(g). In addition, the statute prohibits
creditors from paying home improvement contractors directly unless the
consumer consents in writing. TILA Section 129(j), 15 U.S.C. 1639(j).
In 2002, the Board added to these limitations on HOEPA loans a
regulatory prohibition on due-on-demand clauses and on refinancings by
the same creditor (or assignee) within one year unless the refinancing
is in the borrower's interest. 12 CFR 226.32(d)(8) and 226.34(a)(3).
The Board seeks comment on whether any of these restrictions should
be applied to higher-priced mortgage loans. Is there evidence that any
of these practices has caused consumers in the subprime market
substantial injury or has the potential to do so? Would the benefits of
applying the restriction to higher-priced mortgage loans outweigh the
costs, considering both the subprime market and the part of the alt-A
market that may be covered by the proposal?
Negative amortization has been a particular concern in recent years
because of the rapid spread of nontraditional mortgages that permit
consumers to defer for a time paying any principal and to pay less than
the interest due. What are the costs and benefits for consumers of
negative amortization in the part of the market that would be covered
under the definition of higher-priced mortgage loans? Would proposed
Sec. 226.35(b)(1), which would generally prohibit a pattern or
practice of extending higher-priced mortgage loans without regard to
consumers' repayment ability--taking into account a fully-amortizing
payment--adequately address concerns about negative amortization on
such loans?
Historically, loans with balloon payments also have been of concern
in the subprime market. What are the costs and benefits for consumers
of balloon loans in the part of the market that would be covered under
the definition of higher-priced mortgage loans? Should the Board
prohibit balloon payments with such loans and, if so, should balloon
payments be permitted on loans with terms of more than five years, as
HOEPA now permits? Proposed Sec. 226.35(b)(1) would provide creditors
a safe harbor from the prohibition against a pattern or practice of
lending without regard to repayment ability if the creditor has a
reasonable basis to believe consumers will be able to make loan
payments for at least seven years after consummation of the
transaction. Would this safe harbor tend to encourage creditors to
restrict balloon payments to the eighth year, or later? If so, would
the proposal provide consumers adequate protections from balloon loans
without a regulation specifically addressing them?
B. Steering
Consumer advocates and others have expressed concern that borrowers
are sometimes steered into loans with prices higher than the borrowers'
risk profiles warrant or terms and features not suitable to the
borrower. Existing law also restricts steering. If a creditor steered
borrowers to higher-rate loans or to certain loan products on the basis
of borrowers' race, ethnicity, or other prohibited factors, the
creditor would violate the Equal Credit Opportunity Act, 15 U.S.C. 1601
et seq., and Regulation B, 12 CFR 202, as well as the Fair Housing Act,
42 U.S.C. 3601 et seq.
Moreover, two parts of this proposal would help to address steering
regardless whether the steering had a racial basis or other prohibited
basis. First, proposed Sec. 226.36(a) would limit creditor payments to
mortgage brokers to an amount the broker had agreed with the consumer
in advance--before the broker could know what rate the consumer would
qualify for--would be the broker's total compensation. This provision
also would prohibit the payment unless the broker had given the
consumer a written notice that a broker that receives payments from a
creditor may have incentives not to provide the consumer the best or
most suitable rates or terms. These restrictions are intended to reduce
the incentive and ability of a mortgage broker to offer a consumer a
higher rate simply so that the broker, without the consumer's
knowledge, could receive a larger payment from the creditor. Second,
proposed Sec. 226.35(b)(1) would prohibit a creditor from engaging in
a pattern or practice of extending higher-priced mortgage loans based
on the collateral without regard to repayment ability. Thus, if a
creditor steered borrowers into higher-priced mortgage loans that the
borrower may not have the ability to repay--or accepted loans from
brokers that had done so--the creditor would risk violating proposed
Sec. 226.35(b)(1).
X. Advertising
The Board proposes to amend the advertising rules for open-end
home-equity plans under Sec. 226.16, and for closed-end credit under
Sec. 226.24 to address advertisements for home-secured loans. For
open-end home-equity plan advertisements, the two most significant
changes relate to the clear and conspicuous standard and the
advertisement of introductory terms. For advertisements for closed-end
credit secured by a dwelling, the three most significant changes relate
to strengthening the clear and conspicuous standard for advertising
disclosures, regulating the disclosure of rates and payments in
advertisements to ensure that low introductory or ``teaser'' rates or
payments are not given undue emphasis, and prohibiting certain acts or
practices in advertisements as provided under Section 129(l)(2) of
TILA.
[[Page 1705]]
A. Advertising Rules for Open-end Home-equity Plans--Sec. 226.16
Overview
The Board is proposing to amend the open-end home-equity plan
advertising rules in Sec. 226.16. The two most significant changes
relate to the clear and conspicuous standard and the advertisement of
introductory terms in home-equity plans. Each of these proposed changes
is summarized below.
First, the Board is proposing to revise the clear and conspicuous
standard for home-equity plan advertisements, consistent with the
approach taken in the advertising rules for consumer leases under
Regulation M. See 12 CFR 213.7(b). New commentary provisions would
clarify how the clear and conspicuous standard applies to
advertisements of home-equity plans with introductory rates or
payments, and to Internet, television, and oral advertisements of home-
equity plans. The proposal would also allow alternative disclosures for
television and radio advertisements for home-equity plans by revising
the Board's earlier proposal for open-end plans that are not home-
secured to apply to home-equity plans as well. See 12 CFR 226.16(f) and
72 FR 32948, 33064 (June 14, 2007).
Second, the Board is proposing to amend the regulation and
commentary to ensure that advertisements adequately disclose not only
introductory plan terms, but also the rates and payments that will
apply over the term of the loan. The proposed changes are modeled after
proposed amendments to the advertising rules for open-end plans that
are not home-secured. See 72 FR 32948, 33064 (June 14, 2007).
The Board is also proposing changes to implement provisions of the
Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 which
requires disclosure of the tax implications of certain home-equity
plans. See Pub. L. No. 109-8, 119 Stat. 23. Other technical and
conforming changes are also proposed.
The Board is not proposing to extend to home-equity plan
advertisements the prohibitions it proposes to apply to advertisements
for closed-end credit secured by a dwelling. As discussed below in
connection with its proposed changes to Sec. 226.24, the Board is
proposing to prohibit certain acts or practices connected with
advertisements for closed-end mortgage credit under TILA Sec.
129(l)(2). See discussion of Sec. 226.24(i) below. Based on its review
of advertising copy and outreach efforts, the Board has not identified
similar misleading acts or practices in advertisements for home-equity
plans. The Board seeks comment, however, on whether it should extend
any or all of the prohibitions contained in the proposed Sec.
226.24(i) to home-equity plans, or whether there are other acts or
practices associated with advertisements for home-equity plans that
should be prohibited.
Current Statute and Regulation
TILA Section 147, implemented by the Board in Sec. 226.16(d),
governs advertisements of open-end home-equity plans secured by the
consumer's principal dwelling. 15 U.S.C. 1665b. The statute applies to
the advertisement itself, and therefore, the statutory and regulatory
requirements apply to any person advertising an open-end credit plan,
whether or not they meet the definition of creditor. See comment
2(a)(2)-2. Under the statute, if an open-end credit advertisement sets
forth, affirmatively or negatively, any of the specific terms of the
plan, including any required periodic payment amount, then the
advertisement must also clearly and conspicuously state: (1) Any loan
fee the amount of which is determined as a percentage of the credit
limit and an estimate of the aggregate amount of other fees for opening
the account; (2) in any case in which periodic rates may be used to
compute the finance charge, the periodic rates expressed as an annual
percentage rate; (3) the highest annual percentage rate which may be
imposed under the plan; and (4) any other information the Board may by
regulation require.
The specific terms of an open-end plan that ``trigger'' additional
disclosures, which are commonly known as ``triggering terms,'' are the
payment terms of the plan, or finance charges and other charges
required to be disclosed under Sec. Sec. 226.6(a) and 226.6(b). If an
advertisement for a home-equity plan states a triggering term, the
regulation requires that the advertisement also state the terms
required by the statute. See 12 CFR 226.16(d)(1); see also comments
16(d)-1, and 16(d)-2.
Discussion
Clear and conspicuous standard. The Board is proposing to add
comments 16-4 to 16-7 to clarify how the clear and conspicuous standard
applies to advertisements for home-equity plans.
Currently, comment 16-1 explains that advertisements for open-end
credit are subject to a clear and conspicuous standard set out in Sec.
226.5(a)(1). The Board is not prescribing specific rules regarding the
format of advertisements. However, proposed comment 16-4 would
elaborate on the requirement that certain disclosures about
introductory rates or payments in advertisements for home-equity plans
be prominent and in close proximity to the triggering terms in order to
satisfy the clear and conspicuous standard when introductory rates or
payments are advertised and the disclosure requirements of proposed
Sec. 226.16(d)(6) apply. The disclosures would be deemed to meet this
requirement if they appear immediately next to or directly above or
below the trigger terms, without any intervening text or graphical
displays. Terms required to be disclosed with equal prominence to the
introductory rate or payment would be deemed to meet this requirement
if they appear in the same type size as the trigger terms. A more
detailed discussion of the proposed requirements for introductory rates
or payments is found below.
The equal prominence and close proximity requirements of proposed
Sec. 226.16(d)(6) would apply to all visual text advertisements.
However, comment 16-4 states that electronic advertisements that
disclose introductory rates or payments in a manner that complies with
the Board's recently amended rule for electronic advertisements under
Sec. 226.16(c) would be deemed to satisfy the clear and conspicuous
standard. See 72 FR 63462 (Nov. 9, 2007). Under the rule, if an
electronic advertisement provides the required disclosures in a table
or schedule, any statement of triggering terms elsewhere in the
advertisement must clearly direct the consumer to the location of the
table or schedule. For example, a triggering term in an advertisement
on an Internet Web site may be accompanied by a link that directly
takes the consumer to the additional information. See comment 16(c)(1)-
2.
An electronic advertisement may require consumers to scroll down a
page, or click a link, to access important rate or payment information
under the current rule. For example, an electronic advertisement may
state a low introductory payment and require the consumer to click a
link to find out that the payment applies for only two years and the
payments that will apply after that. Using links in this manner may
permit Internet advertisements to continue to emphasize low,
introductory ``teaser'' rates or payments, while de-emphasizing rates
or payments that apply for the term of a plan, as sometimes occurs with
the use of footnotes. However, the Board recognizes that electronic
advertisements may be displayed on
[[Page 1706]]
devices with small screens, such as on Internet-enabled cellphones or
personal digital assistants, that might necessitate scrolling in order
to view additional information. The Board seeks comment on whether it
should amend the rules for electronic advertisements for home-equity
plans to require that all information about rates or payments that
apply for the term of the plan be stated in close proximity to
introductory rates or payments in a manner that does not require the
consumer to click a link to access the information. The Board also
solicits comment on the costs and practical limitations, if any, of
imposing this close proximity requirement on electronic advertisements.
The Board is also proposing to interpret the clear and conspicuous
standards for Internet, television, and oral advertisements of home-
equity plans. Proposed comment 16-5 explains that disclosures in the
context of visual text advertisements on the Internet must not be
obscured by techniques such as graphical displays, shading, coloration,
or other devices, and must comply with all other requirements for clear
and conspicuous disclosures under Sec. 226.16(d). Proposed comment 16-
6 likewise explains that textual disclosures in television
advertisements must not be obscured by techniques such as graphical
displays, shading, coloration, or other devices, must be displayed in a
manner that allows the consumer to read the information, and must
comply with all other requirements for clear and conspicuous
disclosures under Sec. 226.16(d). Proposed comment 16-7 would explain
that oral advertisements, such as by radio or television, must provide
disclosures at a speed and volume sufficient for a consumer to hear and
comprehend them. In this context, the word ``comprehend'' means that
the disclosures must be intelligible to consumers, not that advertisers
must ensure that consumers understand the meaning of the disclosures.
The Board is also proposing to allow the use of a toll-free telephone
number as an alternative to certain oral disclosures in television or
radio advertisements.
226.16(d)(2)--Discounted and Premium Rates
If an advertisement for a variable-rate home-equity plan states an
initial annual percentage rate that is not based on the index and
margin used to make later rate adjustments, the advertisement must also
state the period of time the initial rate will be in effect, and a
reasonably current annual percentage rate that would have been in
effect using the index and margin. See 12 CFR 226.16(d)(2). The Board
proposes to revise this section to require that the triggered
disclosures be stated with equal prominence and in close proximity to
the statement of the initial APR. The Board believes that this will
enhance consumers' understanding of the cost of credit for the home-
equity plan being advertised.
Proposed comment 16(d)-6 would provide safe harbors for what
constitutes a ``reasonably current index and margin'' as used in Sec.
226.16(d)(2) as well as Sec. 226.16(d)(6). Under the proposed comment,
the time period during which an index and margin would be considered
reasonably current would depend on the medium in which the
advertisement was distributed. For direct mail advertisements, a
reasonably current index and margin would be one that was in effect
within 60 days before mailing. For advertisements in electronic form, a
reasonably current index and margin would be one that was in effect
within 30 days before the advertisement was sent to a consumer's e-mail
address, or for advertisements made on an Internet Web site, when
viewed by the public. For printed advertisements made available to the
general public, a reasonably current index and margin would be one that
was in effect within 30 days before printing.
226.16(d)(3)--Balloon Payment
If an advertisement for a home-equity plan contains a statement
about any minimum periodic payment, the advertisement must also state,
if applicable, that a balloon payment may result. See 12 CFR
226.16(d)(3). The Board proposes to revise this section to clarify that
only statements about the amount of any minimum periodic payment
trigger the required disclosure, and to require that the disclosure of
a balloon payment be equally prominent and in close proximity to the
statement of a minimum periodic payment. Consistent with comment
5b(d)(5)(ii)-3, the Board proposes to clarify that the disclosure is
triggered when an advertisement contains a statement of any minimum
periodic payment and a balloon payment may result if only minimum
periodic payments are made, even if a balloon payment is uncertain or
unlikely. Additionally, the Board proposes to clarify that a balloon
payment results if paying the minimum periodic payments would not fully
amortize the outstanding balance by a specified date or time, and the
consumer must repay the entire outstanding balance at such time.
Current comment 16(d)-7 states that an advertisement for a plan
where a balloon payment will occur when only minimum payments are made
must also state the fact that a balloon payment will result (not merely
that a balloon payment ``may'' result). The Board proposes to
incorporate the language from comment 16(d)-7 into the text of Sec.
226.16(d)(3) with technical revisions. The comment would be revised and
renumbered as comment 16(d)-9. The required disclosures regarding
balloon payments must be stated with equal prominence and in close
proximity to the minimum periodic payment. The Board believes that this
will enhance consumers' ability to notice and understand the potential
financial impact of making only minimum payments.
226.16(d)(4)--Tax Implications
Section 1302 of the Bankruptcy Act amends TILA Section 147(b) to
require additional disclosures for advertisements that are disseminated
in paper form to the public or through the Internet, relating to an
extension of credit secured by a consumer's principal dwelling that may
exceed the fair market value of the dwelling. Such advertisements must
include a statement that the interest on the portion of the credit
extension that is greater than the fair market value of the dwelling is
not tax deductible for Federal income tax purposes. 15 U.S.C. 1665b(b).
The statute also requires a statement that the consumer should consult
a tax adviser for further information on the deductibility of the
interest.
The Bankruptcy Act also requires that disclosures be provided at
the time of application in cases where the extension of credit may
exceed the fair market value of the dwelling. See 15 U.S.C.
1637a(a)(13). The Board intends to implement the application disclosure
portion of the Bankruptcy Act during its forthcoming review of closed-
end and HELOC disclosures under TILA. However, the Board requested
comment on the implementation of both the advertising and application
disclosures under this provision of the Bankruptcy Act for open-end
credit in its October 17, 2005, ANPR. 70 FR 60235, 60244 (Oct. 17,
2005). A majority of comments on this issue addressed only the
application disclosure requirement, but some commenters specifically
addressed the advertising disclosure requirement. One industry
commenter suggested that the advertising disclosure requirement apply
only in cases where the advertised product allows for the credit to
exceed the fair market value of the dwelling. Other industry commenters
suggested that the
[[Page 1707]]
requirement apply only to advertisements for products that are intended
to exceed the fair market value of the dwelling.
The Board proposes to revise Sec. 226.16(d)(4) and comment 16(d)-3
to implement TILA Section 147(b). The Board's proposal clarifies that
the new requirements apply to advertisements for home-equity plans
where the advertised extension of credit may, by its terms, exceed the
fair market value of the dwelling. The Board seeks comment on whether
the new requirements should only apply to advertisements that state or
imply that the creditor provides extensions of credit greater than the
fair market value of the dwelling.
226.16(d)(6)--Introductory Rates and Payments
The Board is proposing to add Sec. 226.16(d)(6) to address the
advertisement of introductory rates and payments in advertisements for
home-equity plans. The proposed rule provides that if an advertisement
for a home-equity plan states an introductory rate or payment, the
advertisement must use the term ``introductory'' or ``intro'' in
immediate proximity to each mention of the introductory rate or
payment. The proposed rule also provides that such advertisements must
disclose the following information in a clear and conspicuous manner
with each listing of the introductory rate or payment: the period of
time during which the introductory rate or introductory payment will
apply; in the case of an introductory rate, any annual percentage rate
that will apply under the plan; and, in the case of an introductory
payment, the amount and time periods of any payments that will apply
under the plan. In variable-rate transactions, payments that will be
determined based on application of an index and margin to an assumed
balance shall be disclosed based on a reasonably current index and
margin. Although introductory rates are addressed, in part, by Sec.
226.16(d)(2), which deals with the advertisement of discounted and
premium rates, Sec. 226.16(d)(6) is broader because it is not limited
to initial rates, but applies to any advertised rate that applies for a
limited period of time.
Proposed Sec. 226.16(d)(6) is similar to the approach taken by the
Board with regard to the advertisement of introductory rates for open-
end (not home-secured) plans in the June 2007 proposal to amend the
Regulation Z open-end advertising rules. See 72 FR 32948, 33064 (June
14, 2007). However, the June 2007 proposal would only apply to the
advertisement of introductory rates, while this proposal would apply to
the advertisement of both introductory rates and payments.
226.16(d)(6)(i)--Definitions
The Board proposes to define the terms ``introductory rate,''
``introductory payment,'' and ``introductory period'' in Sec.
226.16(d)(6)(i). In a variable-rate plan, the term ``introductory
rate'' means any annual percentage rate applicable to a home-equity
plan that is not based on the index and margin that will be used to
make rate adjustments under the plan, if that rate is less than a
reasonably current annual percentage rate that would be in effect based
on the index and margin that will be used to make rate adjustments
under the plan. The term ``introductory payment'' means, in the case of
a variable-rate plan, the amount of any payment applicable to a home-
equity plan for an introductory period that is not derived from the
index and margin that will be used to determine the amount of any other
payments under the plan and, given an assumed balance, is less than any
other payment that will be in effect under the plan based on a
reasonably current application of the index and margin that will be
used to determine the amount of such payments. For a non-variable-rate
plan, the term ``introductory payment'' means the amount of any payment
applicable to a home-equity plan for an introductory period if that
payment is less than the amount of any other payments that will be in
effect under the plan given an assumed balance. The term ``introductory
period'' means a period of time, less than the full term of the loan,
that the introductory rate or payment may be applicable.
Proposed comment 16(d)-5.i clarifies how the concepts of
introductory rates and introductory payments apply in the context of
advertisements for variable-rate plans. Specifically, the proposed
comment provides that if the advertised annual percentage rate or the
advertised payment is based on the index and margin that will be used
to make rate or payment adjustments over the term of the loan, then
there is no introductory rate or introductory payment. On the other
hand, if the advertised annual percentage rate, or the advertised
payment, is not based on the index and margin that will be used to make
rate or payment adjustments, and a reasonably current application of
the index and margin would result in a higher annual percentage rate
or, given an assumed balance, a higher payment, then there is an
introductory rate or introductory payment. The proposed revisions
generally assume that a single index and margin will be used to make
rate or payment adjustments under the plan. The Board solicits comment
on whether and to what extent multiple indexes and margins are used in
home-equity plans and whether additional or different rules are needed
for such products.
Proposed comment 16(d)-5.v clarifies how the concept of
introductory payments applies in the context of advertisements for non-
variable-rate plans. Specifically, the proposed comment provides that
if the advertised payment is calculated in the same way as other
payments under the plan based on an assumed balance, the fact that the
payment could increase solely if the consumer made an additional draw
does not make the payment an introductory payment. For example, if a
payment of $500 results from an assumed $10,000 draw, and the payment
would increase to $1000 if the consumer made an additional $10,000
draw, the payment is not an introductory payment.
226.16(d)(6)(ii)--Stating the Term ``Introductory''
Proposed Sec. 226.16(d)(6)(ii) would require creditors to state
either the term ''introductory'' or its commonly-understood
abbreviation ''intro'' in immediate proximity to each listing of the
introductory rate or payment in an advertisement for a home-equity
plan. Proposed comment 16(d)-5.ii clarifies that placing the word
``introductory'' or ``intro'' within the same sentence as the
introductory rate or introductory payment satisfies the immediately
proximate standard.
226.16(d)(6)(iii)--Stating the Introductory Period and Post-
Introductory Rate or Payments
Proposed Sec. 226.16(d)(6)(iii) provides that if an advertisement
states an introductory rate or introductory payment, it must also
clearly and conspicuously disclose, with equal prominence and in close
proximity to the introductory rate or payment, the following, as
applicable: the period of time during which the introductory rate or
introductory payment will apply; in the case of an introductory rate,
any annual percentage rate that will apply under the plan; and, in the
case of an introductory payment, the amount and time periods of any
payments that will apply under the plan. In variable-rate transactions,
payments that will be determined based on application of an index and
margin to an assumed balance shall be disclosed based on a reasonably
current index and margin.
Proposed comment 16(d)-5.iii provides safe harbors for satisfying
the closely proximate or equally prominent
[[Page 1708]]
requirements of proposed Sec. 226.16(d)(6)(iii). Specifically, the
required disclosures will be deemed to be closely proximate to the
introductory rate or payment if they are in the same paragraph as the
introductory rate or payment. Information disclosed in a footnote will
not be deemed to be closely proximate to the introductory rate or
payment. Consumer testing of account-opening and other disclosures
undertaken in conjunction with the Board's open-end Regulation Z
proposal suggests that placing information in a footnote makes it much
less likely that the consumer will notice it. The required disclosures
will be deemed equally prominent with the introductory rate or payment
if they are in the same type size as the introductory rate or payment.
Proposed comment 16(d)-5.iv clarifies that the requirement to
disclose the amount and time periods of any payments that will apply
under the plan may require the disclosure of several payment amounts,
including any balloon payments. The comment provides an example of a
home-equity plan with several payment amounts over the repayment period
to illustrate the disclosure requirements. Proposed comment 16(d)-6,
which is discussed above, would provide safe harbor definitions for the
phrase ``reasonably current index and margin.''
226.16(d)(6)(iv)--Envelope Excluded
Proposed Sec. 226.16(d)(6)(iv) provides that the requirements of
Sec. 226.16(d)(6)(iii) do not apply to envelopes, or to banner
advertisements and pop-up advertisements that are linked to an
electronic application or solicitation provided electronically. In the
Board's view, because banner advertisements and pop-up advertisements
are used to direct consumers to more detailed advertisements, they are
similar to envelopes in the direct mail context.
226.16(f)--Alternative Disclosures--Television or Radio Advertisements
The Board is proposing to expand Sec. 226.16(f) to allow for
alternative disclosures of the information required for home-equity
plans under Sec. 226.16(d)(1), where applicable, consistent with its
proposal for credit cards and other open-end plans. See proposed Sec.
226.16(f) and 72 FR 32948, 33064 (June 14, 2007).
The Board's proposed revision follows the general format of the
Board's earlier proposal for alternative disclosures for oral
television and radio advertisements. If a triggering term is stated in
the advertisement, one option would be to state each of the disclosures
required by current Sec. Sec. 226.16(b)(1) and (d)(1) at a speed and
volume sufficient for a consumer to hear and comprehend them. Another
option would be for the advertisement to state orally the APR
applicable to the home-equity plan, and the fact that the rate may be
increased after consummation, and provide a toll-free telephone number
that the consumer may call to receive more information. Given the space
and time constraints on television and radio advertisements, the
required disclosures may go unnoticed by consumers or be difficult for
them to retain. Thus, providing an alternative means of disclosure may
be more effective in many cases given the nature of the media.
This approach is also similar to the approach taken in the
advertising rules for consumer leases under Regulation M, which also
allows the use of toll-free numbers in television and radio
advertisements. See 12 CFR 213.7(f)(1)(ii).
B. Advertising Rules for Closed-end Credit--Sec. 226.24
Overview
The Board is proposing to amend the closed-end credit advertising
rules in Sec. 226.24 to address advertisements for home-secured loans.
The three most significant changes relate to strengthening the clear
and conspicuous standard for advertising disclosures, regulating the
disclosure of rates and payments in advertisements to ensure that low
introductory or ``teaser'' rates or payments are not given undue
emphasis, and prohibiting certain acts or practices in advertisements
as provided under Section 129(l)(2) of TILA, 15 U.S.C. 1639(l)(2). Each
of these proposed changes is summarized below.
First, the Board is proposing to add a provision setting forth the
clear and conspicuous standard for all closed-end advertisements and a
number of new commentary provisions applicable to advertisements for
home-secured loans. The regulation would be revised to include a clear
and conspicuous standard for advertising disclosures, consistent with
the approach taken in the advertising rules for Regulation M. See 12
CFR 213.7(b). New commentary provisions would be added to clarify how
the clear and conspicuous standard applies to rates or payments in
advertisements for home-secured loans, and to Internet, television, and
oral advertisements of home-secured loans. The proposal would also add
a provision to allow alternative disclosures for television and radio
advertisements that is modeled after a proposed revision to the
advertising rules for open-end (not home-secured) plans. See 72 FR
32948, 33064 (June 14, 2007).
Second, the Board is proposing to amend the regulation and
commentary to address the advertisement of rates and payments for home-
secured loans. The proposed revisions are designed to ensure that
advertisements adequately disclose all rates or payments that will
apply over the term of the loan and the time periods for which those
rates or payments will apply. Many advertisements for home-secured
loans place undue emphasis on low, introductory ``teaser'' rates or
payments that will apply for a limited period of time. Such
advertisements do not give consumers accurate or balanced information
about the costs or terms of the products offered.
The proposed revisions would also prohibit advertisements from
disclosing an interest rate lower than the rate at which interest is
accruing. Instead, the only rates that could be included in
advertisements for home-secured loans are the APR and one or more
simple annual rates of interest. Many advertisements for home-secured
loans promote very low rates that do not appear to be the rates at
which interest is accruing. The advertisement of interest rates lower
than the rate at which interest is accruing is likely confusing for
consumers. Taken together, the Board believes that the proposed changes
regarding the disclosure of rates and payments in advertisements for
home-secured loans will enhance the accuracy of advertising disclosures
and benefit consumers.
Third, pursuant to TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2),
the Board is proposing to prohibit seven specific acts or practices in
connection with advertisements for home-secured loans that the Board
finds to be unfair, deceptive, associated with abusive lending
practices, or otherwise not in the interest of the borrower.
Bankruptcy Act changes. The Board is also proposing several changes
to clarify certain provisions of the closed-end advertising rules,
including the scope of the certain triggering terms, and to implement
provisions of the Bankruptcy Abuse Prevention and Consumer Protection
Act of 2005 requiring disclosure of the tax implications of home-
secured loans. See Pub. L. No. 109-8, 119 Stat. 23. Technical and
conforming changes to the closed-end advertising rules are also
proposed.
Outreach. The Board's staff conducted extensive research and
outreach in connection with developing the
[[Page 1709]]
proposed revisions to the closed-end advertising rules. Board staff
collected and reviewed numerous examples of advertising copy for home-
secured loans. Board staff also consulted with representatives of
consumer and community groups and Federal Trade Commission staff to
identify areas where the advertising disclosures could be improved, as
well as to identify acts or practices connected with advertisements for
home-secured loans that should be prohibited. This research and
outreach indicated that many advertisements prominently disclose terms
that apply to home-secured loans for a limited period of time, such as
low introductory ``teaser'' rates or payments, while disclosing with
much less prominence, often in a footnote, the rates or payments that
apply over the full term of the loan. Board staff also identified
through this research and outreach effort particular advertising acts
or practices that can mislead consumers.
Current Statute and Regulation
TILA Section 144, implemented by the Board in Sec. 226.24, governs
advertisements of credit other than open-end plans. 15 U.S.C. 1664.
TILA Section 144 thus applies to advertisements of closed-end credit,
including advertisements for closed-end credit secured by a dwelling
(also referred to as ``home-secured loans''). The statute applies to
the advertisement itself, and therefore, the statutory and regulatory
requirements apply to any person advertising closed-end credit, whether
or not such person meets the definition of creditor. See comment
2(a)(2)-2. Under the statute, if an advertisement states the rate of a
finance charge, the advertisement must state the rate of that charge as
an APR. In addition, closed-end credit advertisements that contain
certain terms must also include additional disclosures. The specific
terms of closed-end credit that ``trigger'' additional disclosures,
which are commonly known as ``triggering terms,'' are (1) the amount of
the downpayment, if any, (2) the amount of any installment payment, (3)
the dollar amount of any finance charge, and (4) the number of
installments or the period of repayment. If an advertisement for
closed-end credit states a triggering term, then the advertisement must
also state any downpayment, the terms of repayment, and the rate of the
finance charged expressed as an APR. See 12 CFR 226.24(b)-(c); see also
comments 24(b)-(c) (as redesignated to proposed Sec. Sec. 226.24(c)-
(d) and comments 24(c)-(d)).
TILA Section 105(a) authorizes the Board to adopt regulations to
ensure meaningful disclosure of credit terms so that consumers will be
able to compare available credit terms and avoid the uninformed use of
credit. 15 U.S.C. 1604(a). TILA Section 122 authorizes the Board to
require that information, including the information required under
Section 144, be disclosed in a clear and conspicuous manner. 15 U.S.C.
1632. TILA Section 129(l)(2) authorizes the Board to prohibit acts or
practices in connection with mortgage loans that the Board finds to be
unfair or deceptive. TILA Section 129(l)(2) also authorizes the Board
to prohibit acts or practices in connection with the refinancing of
mortgage loans that the Board finds to be associated with abusive
lending practices, or that are otherwise not in the interest of the
borrower. 15 U.S.C. 1639(l)(2).
226.24(b)--Clear and Conspicuous Standard
The Board is proposing to add a clear and conspicuous standard in
Sec. 226.24(b) that would apply to all closed-end advertising. This
provision would supplement, rather than replace, the clear and
conspicuous standard that applies to all closed-end credit disclosures
under Subpart C of Regulation Z and that requires all disclosures be in
a reasonably understandable form. See 12 CFR 226.17(a)(1); comment
17(a)(1)-1. The new provision provides a framework for clarifying how
the clear and conspicuous standard applies to advertisements that are
not in writing or in a form that the consumer may keep, or that
emphasize introductory rates or payments.
Currently, comment 24-1 explains that advertisements for closed-end
credit are subject to a clear and conspicuous standard based on Sec.
226.17(a)(1). The existing comment would be renumbered as comment
24(b)-1 and revised to reference the proposed format requirements for
advertisements of rates or payments for home-secured loans. The Board
is not prescribing specific rules regarding the format of advertising
disclosures generally. However, proposed comment 24(b)-2 would
elaborate on the requirement that certain disclosures about rates or
payments in advertisements for home-secured loans be prominent and in
close proximity to other information about rates or payments in the
advertisement in order to satisfy the clear and conspicuous standard
and the disclosure requirements of proposed Sec. 226.24(f). Terms
required to be disclosed in close proximity to other rate or payment
information would be deemed to meet this requirement if they appear
immediately next to or directly above or below the trigger terms,
without any intervening text or graphical displays. Terms required to
be disclosed with equal prominence to other rate or payment information
would be deemed to meet this requirement if they appear in the same
type size as other rates or payments. A more detailed discussion of the
proposed requirements for disclosing rates or payments is found below.
The equal prominence and close proximity requirements of proposed
Sec. 226.24(f) would apply to all visual text advertisements. However,
comment 24(b)-2 states that electronic advertisements that disclose
rates or payments in a manner that complies with the Board's recently
amended rule for electronic advertisements under current Sec.
226.24(d) would be deemed to satisfy the clear and conspicuous
standard. See 72 FR 63462 (Nov. 9, 2007). Under the rule, if an
electronic advertisement provides the required disclosures in a table
or schedule, any statement of triggering terms elsewhere in the
advertisement must clearly direct the consumer to the location of the
table or schedule. For example, a triggering term in an advertisement
on an Internet Web site may be accompanied by a link that directly
takes the consumer to the additional information. See comment 24(d)-4.
The Board recognizes that electronic advertisements may be
displayed on devices with small screens that might necessitate
scrolling to view additional information. The Board seeks comment,
however, on whether it should amend the rules for electronic
advertisements for home-secured loans to require that all information
about rates or payments that apply for the term of the loan be stated
in close proximity to other rates or payments in a manner that does not
require the consumer to click a link to access the information. The
Board also solicits comment on the costs and practical limitations, if
any, of imposing this close proximity requirement on electronic
advertisements.
The Board is also proposing to interpret the clear and conspicuous
standards for Internet, television, and oral advertisements of home-
secured loans. Proposed comment 24(b)-3 explains that disclosures in
the context of visual text advertisements on the Internet must not be
obscured by techniques such as graphical displays, shading, coloration,
or other devices, and must comply with all other requirements for clear
and conspicuous
[[Page 1710]]
disclosures under Sec. 226.24. Proposed comment 24(b)-4 likewise
explains that visual text advertisements on television must not be
obscured by techniques such as graphical displays, shading, coloration,
or other devices, must be displayed in a manner that allows a consumer
to read the information required to be disclosed, and must comply with
all other requirements for clear and conspicuous disclosures under
Sec. 226.24. Proposed comment 24(b)-5 would explain that oral
advertisements, such as by radio or television, must provide the
disclosures at a speed and volume sufficient for a consumer to hear and
comprehend them. In this context, the word ``comprehend'' means that
the disclosures be intelligible to consumers, not that advertisers must
ensure that consumers understand the meaning of all of the disclosures.
Proposed Sec. 226.24(g) provides an alternative method of disclosure
for television or radio advertisements when trigger terms are stated
orally and is discussed more fully below.
226.24(c)--Advertisement of Rate of Finance Charge
Disclosure of simple annual rate or periodic rate. If an
advertisement states a rate of finance charge, it shall state the rate
as an APR. See 12 CFR 226.24(b) (as redesignated to proposed Sec.
226.24(c)). An advertisement may also state, in conjunction with and
not more conspicuously than the APR, a simple annual rate or periodic
rate that is applied to an unpaid balance.
The Board proposes to renumber Sec. 226.24(b) as Sec. 226.24(c),
and revise it. The revised rule would provide that advertisements for
home-secured loans shall not state any rate other than an APR, except
that a simple annual rate that is applied to an unpaid balance may be
stated in conjunction with, but not more conspicuously than, the APR.
Advertisement of a periodic rate, other than the simple annual rate, or
any other rates would no longer be permitted in connection with home-
secured loans.
Comment 24(b)-2 would be renumbered as comment 24(c)-2 and revised
to clarify that a simple annual rate or periodic rate is the rate at
which interest is accruing. A rate lower than the rate at which
interest is accruing, such as an effective rate, payment rate, or
qualifying rate, is not a simple annual rate or periodic rate. The
example in renumbered comment 24(c)-2 also would be revised to
reference proposed Sec. 226.24(f), which contains requirements
regarding the disclosure of rates and payments in advertisements for
home-secured loans.
Buydowns. Comment 24(b)-3, which addresses ``buydowns,'' would be
renumbered as comment 24(c)-3 and revised. A buydown is where a seller
or creditor offers a reduced interest rate and reduced payments to a
consumer for a limited period of time. Comment 24(c)-3 allows the
seller or creditor, in the case of a buydown, to advertise the reduced
simple interest rate, the limited term to which the reduced rate
applies, and the simple interest rate applicable to the balance of the
term. The advertisement may show the effect of the buydown agreement on
the payment schedule for the buydown period. The Board proposes to
revise the comment to explain that additional disclosures would be
required when an advertisement includes information showing the effect
of the buydown agreement on the payment schedule. Such advertisements
would have to provide the disclosures required by current Sec.
226.24(c)(2) because showing the effect of the buydown agreement on the
payment schedule is a statement about the amount of any payment, and
thus is a triggering term. See 12 CFR 226.24(c)(1)(iii). In these
circumstances, the additional disclosures are necessary for consumers
to understand the costs of the loan and the terms of repayment.
Consistent with these changes, the examples of statements about
buydowns that an advertisement may make without triggering additional
disclosures would be removed.
Effective rates. The Board is proposing to delete current comment
24(b)-4. The current comment allows the advertisement of three rates:
the APR; the rate at which interest is accruing; and an interest rate
lower than the rate at which interest is accruing, which may be
referred to as an effective rate, payment rate, or qualifying rate. The
comment also contains an example of how to disclose the three rates.
The Board is proposing to delete this comment for the reasons
stated below. First, the disclosure of three rates is unnecessarily
confusing for consumers and the disclosure of an interest rate lower
than the rate at which interest is accruing does not provide meaningful
information to consumers about the cost of credit. Second, when the
effective rates comment was adopted in 1982, the Board noted that the
comment was designed ``to address the advertisement of special
financing involving `effective rates,' `payment rates,' or `qualifying
rates.'' ' See 47 FR 41338, 41342 (Sept. 20, 1982). At that time, when
interest rates were quite high, these terms were used in connection
with graduated-payment mortgages. Today, however, some advertisers
appear to rely on this comment when advertising rates for a variety of
home-secured loans, such as negative amortization loans and option
ARMs. In these circumstances, the advertisement of rates lower than the
rate at which interest is accruing for these products is not helpful to
consumers, particularly consumers who may not fully understand how
these non-traditional home-secured loans work.
Discounted variable-rate transactions. Comment 24(b)-5 would be
renumbered as comment 24(c)-4 and revised to explain that an
advertisement for a discounted variable-rate transaction which
advertises a reduced or discounted simple annual rate must show with
equal prominence and in close proximity to that rate, the limited term
to which the simple annual rate applies and the annual percentage rate
that will apply after the term of the initial rate expires.
The comment would also be revised to explain that additional
disclosures would be required when an advertisement includes
information showing the effect of the discount on the payment schedule.
Such advertisements would have to provide the disclosures required by
current Sec. 226.24(c)(2). Showing the effect of the discount on the
payment schedule is a statement about the number of payments or the
period of repayment, and thus is a triggering term. See 12 CFR
226.24(c)(1)(ii). In these circumstances, the additional disclosures
are necessary for consumers to understand the costs of the loan and the
terms of repayment. Consistent with these changes, the examples of
statements about discounted variable-rate transactions that an
advertisement may make without triggering additional disclosures would
be removed.
226.24(d)--Advertisement of Terms That Require Additional Disclosures
Required disclosures. The Board proposes to renumber Sec.
226.24(c) as Sec. 226.24(d) and revise it. The proposed rule would
clarify the meaning of the ``terms of repayment'' required to be
disclosed. Specifically, the terms of repayment must reflect ``the
repayment obligations over the full term of the loan, including any
balloon payment,'' not just the repayment terms that will apply for a
limited period of time. This proposed revision is consistent with other
proposed changes and is designed to ensure that advertisements for
closed-end credit, especially home-secured loans, adequately disclose
the terms that
[[Page 1711]]
will apply over the full term of the loan, not just for a limited
period of time.
Consistent with these proposed changes, comment 24(c)(2)-2 would be
renumbered as comment 24(d)(2)-2 and revised. Commentary regarding
advertisement of loans that have a graduated-payment feature would be
removed from comment 24(d)(2)-2.
In advertisements for home-secured loans where payments may vary
because of the inclusion of mortgage insurance premiums, the comment
would explain that the advertisement may state the number and timing of
payments, the amounts of the largest and smallest of those payments,
and the fact that other payments will vary between those amounts.
In advertisements for home-secured loans with one series of low
monthly payments followed by another series of higher monthly payments,
the comment would explain that the advertisement may state the number
and time period of each series of payments and the amounts of each of
those payments. However, the amount of the series of higher payments
would have to be based on the assumption that the consumer makes the
lower series of payments for the maximum allowable period of time. For
example, if a consumer has the option of making interest-only payments
for two years and an advertisement states the amount of the interest-
only payment, the advertisement must state the amount of the series of
higher payments based on the assumption that the consumer makes the
interest-only payments for the full two years. The Board believes that
without these disclosures consumers may not fully understand the cost
of the loan or the payment terms that may result once the higher
payments take effect.
The proposed revisions to renumbered comment 24(d)(2)-2 would apply
to all closed-end advertisements. The Board believes that the terms of
repayment for any closed-end credit product should be disclosed for the
full term of the loan, not just for a limited period of time. The Board
also does not believe that this proposed change will significantly
impact advertising practices for closed-end credit products such as
auto loans and installment loans that ordinarily have shorter terms
than home-secured loans.
New comment 24(d)(2)-3 would be added to address the disclosure of
balloon payments as part of the repayment terms. The proposed comment
notes that in some transactions, a balloon payment will occur when the
consumer only makes the minimum payments specified in an advertisement.
A balloon payment results if paying the minimum payments does not fully
amortize the outstanding balance by a specified date or time, usually
the end of the term of the loan, and the consumer must repay the entire
outstanding balance at such time. The proposed comment explains that if
a balloon payment will occur if the consumer only makes the minimum
payments specified in an advertisement, the advertisement must state
with equal prominence and in close proximity to the minimum payment
statement the amount and timing of the balloon payment that will result
if the consumer makes only the minimum payments for the maximum period
of time that the consumer is permitted to make such minimum payments.
The Board believes that disclosure of the balloon payment in
advertisements that promote such minimum payments is necessary to
inform consumers about the repayment terms that will apply over the
full term of the loan.
Current comments 24(c)(2)-3 and 24(c)(2)-4 would be renumbered as
comments 24(d)(2)-4 and 24(d)(2)-5 without substantive change.
226.24(e)--Catalogs or Other Multiple-Page Advertisements; Electronic
Advertisements
The Board is proposing to renumber Sec. 226.24(d) as Sec.
226.24(e) and make technical changes to reflect the renumbering of
certain sections of the regulation and commentary.
226.24(f)--Disclosure of Rates and Payments in Advertisements for
Credit Secured by a Dwelling
The Board is proposing to add a new subsection (f) to Sec. 226.24
to address the disclosure of rates and payments in advertisements for
home-secured loans. The primary purpose of these provisions is to
ensure that advertisements do not place undue emphasis on low
introductory ``teaser'' rates or payments, but adequately disclose the
rates and payments that will apply over the term of the loan. The
specific provisions of proposed subsection (f) are discussed below.
226.24(f)(1)--Scope
Proposed Sec. 226.24(f)(1) provides that the new section applies
to any advertisement for credit secured by a dwelling, other than
television or radio advertisements, including promotional materials
accompanying applications. The Board does not believe it is feasible to
apply the requirements of this section, notably the close proximity and
prominence requirements, to oral advertisements. However, the Board
requests comment on whether these or different standards should be
applied to oral advertisements for home-secured loans.
226.24(f)(2)--Disclosure of Rates
Proposed Sec. 226.24(f)(2) addresses the disclosure of rates.
Under the proposed rule, if an advertisement for credit secured by a
dwelling states a simple annual rate of interest and more than one
simple annual rate of interest will apply over the term of the
advertised loan, the advertisement must disclose the following
information in a clear and conspicuous manner: (a) Each simple annual
rate of interest that will apply. In variable-rate transactions, a rate
determined by an index and margin must be disclosed based on a
reasonably current index and margin; (b) the period of time during
which each simple annual rate of interest will apply; and (c) the
annual percentage rate for the loan. If the rate is variable, the
annual percentage rate must comply with the accuracy standards in
Sec. Sec. 226.17(c) and 226.22.
Proposed comment 24(f)-4 would specifically address how this
requirement applies in the context of advertisements for variable-rate
transactions. For such transactions, if the simple annual rate that
applies at consummation is based on the index and margin that will be
used to make subsequent rate adjustments over the term of the loan,
then there is only one simple annual rate and the requirements of Sec.
226.24(f)(2) do not apply. If, however, the simple annual rate that
applies at consummation is not based on the index and margin that will
be used to make subsequent rate adjustments over the term of the loan,
then there is more than one simple annual rate and the requirements of
Sec. 226.24(f)(2) apply. The proposed revisions generally assume that
a single index and margin will be used to make rate or payment
adjustments under the loan. The Board solicits comment on whether and
to what extent multiple indexes and margins are used in home-secured
loans and whether additional or different rules are needed for such
products.
Finally, the proposed rule establishes a clear and conspicuous
standard for the disclosure of rates in advertisements for home-secured
loans. Under this standard, the information required to be disclosed by
Sec. 226.24(f)(2) must be disclosed with equal prominence and in close
proximity to any advertised rate that triggered the required
disclosures, except that the annual percentage rate may be disclosed
with greater prominence than the other information.
[[Page 1712]]
Proposed comment 24(f)-1 would provide safe harbors for compliance with
the equal prominence and close proximity standards. Proposed comment
24(f)-2 provides a cross-reference to comment 24(b)-2, which provides
further guidance on the clear and conspicuous standard in this context.
226.24(f)(3)--Disclosure of Payments
Proposed Sec. 226.24(f)(3) addresses the disclosure of payments.
Under the proposed rule, if an advertisement for credit secured by a
dwelling states the amount of any payment, the advertisement must
disclose the following information in a clear and conspicuous manner:
(a) The amount of each payment that will apply over the term of the
loan, including any balloon payment. In variable-rate transactions,
payments that will be determined based on application of an index and
margin must be disclosed based on a reasonably current index and
margin; (b) the period of time during which each payment will apply;
and (c) in an advertisement for credit secured by a first lien on a
dwelling, the fact that the payments do not include amounts for taxes
and insurance premiums, if applicable, and that the actual payment
obligation will be greater. These requirements are in addition to the
disclosure requirements of current Sec. 226.24(c).
Proposed comment 24(f)(3)-2 would specifically address how this
requirement applies in the context of advertisements for variable-rate
transactions. For such transactions, if the payment that applies at
consummation is based on the index and margin that will be used to make
subsequent payment adjustments over the term of the loan, then there is
only one payment that must be disclosed and the requirements of Sec.
226.24(f)(3) do not apply. If, however, the payment that applies at
consummation is not based on the index and margin that will be used to
make subsequent payment adjustments over the term of the loan, then
there is more than one payment that must be disclosed and the
requirements of Sec. 226.24(f)(3) apply.
The proposed rule establishes a clear and conspicuous standard for
the disclosure of payments in advertisements for home-secured loans.
Under this standard, the information required to be disclosed under
Sec. 226.24(f)(3) regarding the amounts and time periods of payments
must be disclosed with equal prominence and in close proximity to any
advertised payment that triggered the required disclosures. The
information required to be disclosed under Sec. 226.24(f)(3) regarding
the fact that taxes and insurance premiums are not included in the
payment must be prominently disclosed and in close proximity to the
advertised payments. The Board believes that requiring the disclosure
about taxes and insurance premiums to be equally prominent could
distract consumers from the key payment and time period information. As
noted above, proposed comment 24(f)-1 would provide safe harbors for
compliance with the equal prominence and close proximity standards.
Proposed comment 24(f)-2 provides a cross-reference to the comment
24(b)-2, which provides further guidance regarding the application of
the clear and conspicuous standard in this context.
Proposed comment 24(f)-3 clarifies how the rules on disclosures of
rates and payments in advertisements apply to the use of comparisons in
advertisements. This comment covers both rate and payment comparisons,
but in practice, comparisons in advertisements usually focus on
payments.
Proposed comment 24(f)(3)-1 clarifies that the requirement to
disclose the amounts and time periods of all payments that will apply
over the term of the loan may require the disclosure of several payment
amounts, including any balloon payment. The comment provides an
illustrative example.
Proposed comment 24(f)-5 would provide safe harbors for what
constitutes a ``reasonably current index and margin'' as used in Sec.
226.24(f). Under the proposed comment, the time period during which an
index and margin would be considered reasonably current would depend on
the medium in which the advertisement was distributed. For direct mail
advertisements, a reasonably current index and margin would be one that
was in effect within 60 days before mailing. For advertisements in
electronic form, a reasonably current index and margin would be one
that was in effect within 30 days before the advertisement was sent to
a consumer's e-mail address, or for advertisements made on an Internet
Web site, when viewed by the public. For printed advertisements made
available to the general public, a reasonably current index and margin
would be one that was in effect within 30 days before printing.
226.24(f)(4)--Envelope Excluded
Proposed Sec. 226.24(f)(4) provides that the requirements of
Sec. Sec. 226.24(f)(2) and (3) do not apply to envelopes or to banner
advertisements and pop-up advertisements that are linked to an
electronic application or solicitation provided electronically. In the
Board's view, banner advertisements and pop-up advertisements are
similar to envelopes in the direct mail context.
226.24(g)--Alternative Disclosures--Television or Radio Advertisements
The Board is proposing to add a new Sec. 226.24(g) to allow
alternative disclosures to be provided in oral television and radio
advertisements pursuant to its authority under TILA Sec. Sec. 105(a),
122, and 144. One option would be to state each of the disclosures
required by current Sec. 226.24(c)(2) at a speed and volume sufficient
for a consumer to hear and comprehend them if a triggering term is
stated in the advertisement. Another option would be for the
advertisement to state orally the APR applicable to the loan, and the
fact that the rate may be increased after consummation, if applicable,
at a speed and volume sufficient for a consumer to hear and comprehend
them. However, instead of orally disclosing the required information
about the amount or percentage of the downpayment and the terms of
repayment, the advertisement could provide a toll-free telephone number
that the consumer may call to receive more information. Given the space
and time constraints on television and radio advertisements, the
required disclosures may go unnoticed by consumers or be difficult for
them to retain. Thus, providing an alternative means of disclosure may
be more effective in many cases given the nature of television and
radio media.
This approach is consistent with the approach taken in the proposed
revisions to the advertising rules for open-end plans (other than home-
secured plans). See 72 FR 32948, 33064 (June 14, 2007). This approach
is also similar, but not identical, to the approach taken in the
advertising rules under Regulation M. See 12 CFR 213.7(f). Section
213.7(f)(1)(ii) of Regulation M permits a leasing advertisement made
through television or radio to direct the consumer to a written
advertisement in a publication of general circulation in a community
served by the media station. The Board has not proposed this option
because it may not provide sufficient, readily-accessible information
to consumers who are shopping for a home-secured loan and because
advertisers, particularly those advertising on a regional or national
scale, are not likely to use this option.
226.24(h)--Tax Implications
Section 1302 of the Bankruptcy Act amends TILA Section 144(e) to
address
[[Page 1713]]
advertisements that are disseminated in paper form to the public or
through the Internet, as opposed to by radio or television, and that
relate to an extension of credit secured by a consumer's principal
dwelling that may exceed the fair market value of the dwelling. Such
advertisements must include a statement that the interest on the
portion of the credit extension that is greater than the fair market
value of the dwelling is not tax deductible for Federal income tax
purposes. 15 U.S.C. 1664(e). For such advertisements, the statute also
requires inclusion of a statement that the consumer should consult a
tax adviser for further information on the deductibility of the
interest.
The Bankruptcy Act also requires that disclosures be provided at
the time of application in cases where the extension of credit may
exceed the fair market value of the dwelling. See 15 U.S.C.
1638(a)(15). The Board intends to implement the application disclosure
portion of the Bankruptcy Act during its forthcoming review of closed-
end and HELOC disclosures under TILA. However, the Board requested
comment on the implementation of both the advertising and application
disclosures under this provision of the Bankruptcy Act for open-end
credit in its October 17, 2005, ANPR. 70 FR 60235, 60244 (Oct. 17,
2005). A majority of comments on this issue addressed only the
application disclosure requirement, but some commenters specifically
addressed the advertising disclosure requirement. One industry
commenter suggested that the advertising disclosure requirement apply
only in cases where the advertised product allows for the credit to
exceed the fair market value of the dwelling. Other industry commenters
suggested that the requirement apply only to advertisements for
products that are intended to exceed the fair market value of the
dwelling.
The Board proposes to add Sec. 226.24(h) and comment 24(h)-1 to
implement TILA Section 144(e). The Board's proposal clarifies that the
new requirements apply to advertisements for home-secured loans where
the advertised extension of credit may, by its terms, exceed the fair
market value of the dwelling. The Board seeks comment on whether the
new requirements should only apply to advertisements that state or
imply that the creditor provides extensions of credit greater than the
fair market value of the dwelling.
226.24(i)--Prohibited Acts or Practices in Mortgage Advertisements
Section 129(l)(2) of TILA gives the Board the authority to prohibit
acts or practices in connection with mortgage loans that it finds to be
unfair or deceptive. Section 129(l)(2) of TILA also gives the Board the
authority to prohibit acts or practices in connection with the
refinancing of mortgage loans that the Board finds to be associated
with abusive lending practices, or that are otherwise not in the
interest of the borrower. 15 U.S.C. 1639(l)(2). Through an extensive
review of advertising copy and other outreach efforts described above,
Board staff identified a number of acts or practices connected with
mortgage and mortgage refinancing advertising that appear to be
inconsistent with the standards set forth in Section 129(l)(2) of TILA.
Accordingly, the Board is proposing to add Sec. 226.24(i) to prohibit
seven acts or practices connected with advertisements of home-secured
loans. The Board solicits comment on the appropriateness of the seven
proposed prohibitions and whether any additional acts or practices
should be prohibited by the regulation.
226.24(i)(1)--Misleading Advertising for ``Fixed'' Rates, Payments or
Loans
Advertisements for home-secured loans often refer to a rate or
payment, or to the credit transaction, as ``fixed.'' Such a reference
is appropriate when used to denote a fixed-rate mortgage in which the
rate or payment amounts do not change over the full term of the loan.
Indeed, some credit counselors often encourage consumers to shop only
for fixed-rate mortgages.
The Board has found that some advertisements also use the term
``fixed'' in connection adjustable-rate mortgages, or with fixed-rate
mortgages that include low initial payments that will increase. Some of
these advertisements make clear that the rate or payment is only
``fixed'' for a defined period of time, but after that the rate or
payment may increase. For example, one advertisement reviewed
prominently discloses that the product is an ``Adjustable-Rate
Mortgage'' in large type, and clearly discloses in standard type that
the rate is ``fixed'' for the first three, five, or seven years
depending upon the product selected and may increase after that.
However, other advertisements do not adequately disclose that the
interest rate or payment amounts are ``fixed'' only for a limited
period of time, rather than for the full term of the loan. For example,
some advertisements reviewed prominently refer to a ``30-Year Fixed
Rate Loan'' or ``Fixed Pay Rate Loan'' on the first page. A footnote on
the last page of the advertisements discloses in small type that the
loan product is a payment option ARM in which the fully indexed rate
and fully amortizing payment will be applied after the first five
years. The Board finds that the use of the word ``fixed'' in this
manner can mislead consumers into believing that the advertised product
is a fixed-rate mortgage with rates and payments that will not change
during the term of the loan.
Proposed Sec. 226.24(i)(1) would prohibit the use of the term
``fixed'' in advertisements for credit secured by a dwelling, unless
certain conditions are satisfied. The proposal would prohibit the use
of the term ``fixed'' in advertisements for variable-rate transactions,
unless two conditions are satisfied. First, the phrase ``Adjustable-
Rate Mortgage'' or ``Variable-Rate Mortgage'' must appear in the
advertisement before the first use of the word ``fixed'' and be at
least as conspicuous as every use of the word ``fixed.'' Second, each
use of the word ``fixed'' must be accompanied by an equally prominent
and closely proximate statement of the time period for which the rate
or payment is fixed and the fact that the rate may vary or the payment
may increase after that period. Based on the advertising copy reviewed,
particularly the first example described above, the Board believes
there are legitimate and appropriate circumstances for using the term
``fixed,'' even in advertisements for variable-rate transactions.
Therefore, the Board is not proposing an absolute ban on use of the
term ``fixed'' in advertisements for variable-rate transactions. The
Board believes that this more targeted approach will curb deceptive
advertising practices.
The proposal would also prohibit the use of the term ``fixed'' to
refer to the advertised payment in advertisements solely for
transactions other than variable-rate transactions where the advertised
payment may increase (i.e., fixed-rate mortgage transactions with an
initial lower payment that will increase), unless each use of the word
``fixed'' to refer to the advertised payment is accompanied by an
equally prominent and closely proximate statement of the time period
for which the payment is fixed and the fact that the payment may
increase after that period.
Finally, the proposal would prohibit the use of the term ``fixed''
in advertisements for both variable-rate transactions and non-variable-
rate
[[Page 1714]]
transactions, unless certain conditions are satisfied. First, the
phrase ``Adjustable-Rate Mortgage,'' ``Variable-Rate Mortgage,'' or
``ARM'' must appear in the advertisement with equal prominence as any
use of the word ``fixed.'' Second, each use of the term ``fixed'' to
refer to a rate, payment, or to the credit transaction, must clearly
refer solely to transactions for which rates are fixed and, if used to
refer to an advertised payment, be accompanied by an equally prominent
and closely proximate statement of the time period for which the
advertised payment is fixed and the fact that the payment will increase
after that period. Third, if the term ``fixed'' refers to the variable-
rate transactions, it must be accompanied by an equally prominent and
closely proximate statement of a time period for which the rate or
payment is fixed, and the fact that the rate may vary or the payment
may increase after that period.
The Board believes that this approach balances the need to protect
consumers from misleading advertisements about the terms that are
``fixed,'' while ensuring that advertisers can continue to use the term
``fixed'' for legitimate, non-deceptive purposes in advertisements for
home-secured loans, including variable-rate transactions.
226.24(i)(2)--Misleading Comparisons in Advertisements
Some advertisements for home-secured loans make comparisons between
an actual or hypothetical consumer's current rate or payment
obligations and the rates or payments that would apply if the consumer
obtains the advertised product. The advertised rates or payments used
in these comparisons frequently are low introductory ``teaser'' rates
or payments that will not apply over the full term of the loan, and do
not include amounts for taxes or insurance premiums. In addition, the
current rate or payment obligations used in these comparisons
frequently include not only the consumer's mortgage payment, but also
possible payments for short-term, non-home secured, or revolving credit
obligations, such as auto loans, installment loans, or credit card
debts.
The Board finds that making comparisons in advertisements can be
misleading if the advertisement compares the consumer's current
payments or rates to payments or rates available for the advertised
product that will only be in effect for a limited period of time,
rather than for the term of the loan. Similarly, the Board finds that
such comparisons can be misleading if the consumer's current payments
include amounts for taxes and insurance premiums, but the payments for
the advertised product do not include those amounts. These practices
make comparison between the consumer's current obligations and the
lower advertised rates or payments misleading.
Proposed Sec. 226.24(i)(2) would prohibit any advertisement for
credit secured by a dwelling from making any comparison between an
actual or hypothetical consumer's current payments or rates and the
payment or simple annual rate that will be available under the
advertised product for less than the term of the loan, unless two
conditions are satisfied. First, the comparison must include with equal
prominence and in close proximity to the ``teaser'' payment or rate,
all applicable payments or rates for the advertised product that will
apply over the term of the loan and the period of time for which each
applicable payment or simple annual rate will apply. Second, the
advertisement must include a prominent statement in close proximity to
the advertised payments that such payments do not include amounts for
taxes and insurance premiums, if applicable. In the case of
advertisements for variable-rate transactions where the advertised
payment or simple annual rate is based on the index and margin that
will be used to make subsequent rate or payment adjustments over the
term of the loan, the comparison must include: (a) An equally prominent
statement in close proximity to the advertised payment or rate that the
payment or rate is subject to adjustment and the time period when the
first adjustment will occur; and (b) a prominent statement in close
proximity to the advertised payment that the payment does not include
amounts for taxes and insurance premiums, if applicable.
Proposed comment 24(i)-1 would clarify that a misleading comparison
includes a claim about the amount that a consumer may save under the
advertised product. For example, a statement such as ``save $600 per
month on a $500,000 loan'' constitutes an implied comparison between
the advertised product's payment and a consumer's current payment.
The Board is not proposing to prohibit comparisons that take into
account the consolidation of non-mortgage credit, such as auto loans,
installment loans, or revolving credit card debt, into a single, home-
secured loan. Debt consolidation can be beneficial for some consumers.
Prohibiting the use of comparisons in advertisements that are based
solely on low introductory ``teaser'' rates or payments should address
abusive practices in advertisements focused on debt consolidation. The
Board solicits comment on whether comparisons based on the assumed
refinancing of non-mortgage debt into a new home-secured loan are
associated with abusive lending practices or otherwise not in the
interest of the borrower and should therefore be prohibited as well.
226.24(i)(3)--Misrepresentations About Government Endorsement
Some advertisements for home-secured loans characterize the
products offered as ``government loan programs,'' ``government-
supported loans,'' or otherwise endorsed or sponsored by a federal or
state government entity, even though the advertised products are not
government-supported loans, such as FHA or VA loans, or otherwise
endorsed or sponsored by any federal, state, or local government
entity. The Board finds that such advertisements can mislead consumers
into believing that the government is guaranteeing, endorsing, or
supporting the advertised loan product. Proposed Sec. 226.24(i)(3)
would prohibit such statements unless the advertisement is for an FHA
loan, VA loan, or similar loan program that is, in fact, endorsed or
sponsored by a federal, state, or local government entity. Proposed
comment 24(i)-2 illustrates that a misrepresentation about government
endorsement includes a statement that the federal Community
Reinvestment Act entitles the consumer to refinance his or her mortgage
at the new low rate offered in the advertisement is prohibited because
it conveys to the consumer a misleading impression that the advertised
product is endorsed or sponsored by the federal government.
226.24(i)(4)--Misleading Use of the Current Mortgage Lender's Name
Some advertisements for home-secured loans prominently display the
name of the consumer's current mortgage lender, while failing to
disclose or to disclose adequately the fact that the advertisement is
by a mortgage lender that is not associated with the consumer's current
lender. The Board finds that such advertisements may mislead consumers
into believing that their current lender is offering the loan
advertised or that the loan terms stated in the advertisement
constitute a reduction in the consumer's payment amount or rate, rather
than an offer to refinance the current loan with a different creditor.
Proposed Sec. 226.24(i)(4) would prohibit any advertisement for a
home-secured loan, such as a letter, that is not sent by or on behalf
of the consumer's current
[[Page 1715]]
lender from using the name of the consumer's current lender, unless the
advertisement also discloses with equal prominence: (a) The name of the
person or creditor making the advertisement; and (b) a clear and
conspicuous statement that the person making the advertisement is not
associated with, or acting on behalf of, the consumer's current lender.
226.24(i)(5)--Misleading Claims of Debt Elimination
Some advertisements for home-secured loans include statements that
promise to eliminate, cancel, wipe-out, waive, or forgive debt. The
Board finds that such advertisements can mislead consumers into
believing that they are entering into a debt forgiveness program rather
than merely replacing one debt obligation with another. Proposed Sec.
226.24(i)(5) would prohibit advertisements for credit secured by a
dwelling that offer to eliminate debt, or waive or forgive a consumer's
existing loan terms or obligations to another creditor. Proposed
comment 24(i)-3 provides examples of claims that would be prohibited.
These include the following claims: ``Wipe-Out Personal Debts!'', ``New
DEBT-FREE Payment'', ``Set yourself free; get out of debt today'',
``Refinance today and wipe your debt clean!'', ``Get yourself out of
debt * * * Forever!'', and, in the context of an advertisement
referring to a consumer's existing obligations to another creditor,
``Pre-payment Penalty Waiver.'' The proposed comment would also clarify
that this provision does not prohibit an advertisement for a home-
secured loan from claiming that the advertised product may reduce debt
payments, consolidate debts, or shorten the term of the debt.
226.24(i)(6)--Misleading Claims Suggesting a Fiduciary or Other
Relationship
Some advertisements for home-secured loans attempt to create the
impression that the mortgage broker or lender, its employees, or its
subcontractors, have a fiduciary relationship with the consumer. The
Board finds that such advertisements may mislead consumers into
believing that the broker or lender will consider only the consumer's
best interest in offering a mortgage loan to the consumer, when, in
fact, the broker or lender may be considering its own interests.
Proposed Sec. 226.24(i)(6) would prohibit advertisements for credit
secured by a dwelling from using the terms ``counselor'' or ``financial
advisor'' to refer to a for-profit mortgage broker or lender, its
employees, or persons working for the broker or lender that are
involved in offering, originating or selling mortgages. The Board
recognizes that counselors and financial advisors do play a legitimate
role in assisting consumers in selecting appropriate home-secured
loans. Nothing in this rule would prohibit advertisements for bona fide
consumer credit counseling services, such as counseling services
provided by non-profit organizations, or bona fide financial advisory
services, such as services provided by certified financial planners.
226.24(i)(7)--Misleading Foreign-Language Advertisements
Some advertisements for home-secured loans are targeted to non-
English speaking consumers. In general, this is an appropriate means of
promoting home ownership or offering loans to under-served, immigrant
communities. In some of these advertisements, however, information
about some of the trigger terms or required disclosures, such as a low
introductory ``teaser'' rate or payment, is provided in a foreign
language, while information about other trigger terms or required
disclosures, such as the fully-indexed rate or fully amortizing
payment, is provided only in English. The Board finds that this
practice can mislead non-English speaking consumers who may not be able
to comprehend the important English-language disclosures. Proposed
Sec. 226.24(i)(7) would prohibit advertisements for home-secured loans
from providing information about some trigger terms or required
disclosures, such as an initial rate or payment, only in a foreign
language, but providing information about other trigger terms or
required disclosures, such as information about the fully-indexed rate
or fully amortizing payment, only in English. Advertisements that
provide all disclosures in both English and a foreign language or
advertisements that are entirely in English or entirely in a foreign
language would not be affected by this prohibition.
XI. Mortgage Loan Disclosures
A. Early Mortgage Loan Disclosures--Sec. 226.19
TILA Section 128(b)(1) provides that the primary closed-end
disclosure (referred to in this subpart as the ``mortgage loan
disclosure''), which includes the annual percentage rate (APR) and
other material disclosures, must be delivered ``before the credit is
extended.'' 15 U.S.C. 1638(b)(1). A separate rule applies to
residential mortgage transactions subject to the Real Estate Settlement
Procedures Act (RESPA) and requires that ``good faith estimates'' of
the mortgage loan disclosure be made ``before the credit is extended,
or shall be delivered or placed in the mail not later than three
business days after the creditor receives the consumer's written
application, whichever is earlier.'' 15 U.S.C. 1638(b)(2).
The Board proposes to amend Regulation Z to extend the early
mortgage loan disclosure requirement for residential mortgage
transactions to other types of closed-end mortgage transactions,
including mortgage refinancings, home equity loans, and reverse
mortgages. Consistent with the existing requirement for residential
mortgage transactions, this requirement would be limited to
transactions secured by a consumer's principal dwelling. The Board also
proposes to require that the early mortgage loan disclosure be
delivered before the consumer pays a fee to any person for these
transactions. The Board is proposing an exception to the fee
restriction, however, for obtaining information on the consumer's
credit history.
This proposal is made pursuant to TILA Section 105(a), which
mandates that the Board prescribe regulations to carry out TILA's
purposes, and authorizes the Board to create such classifications,
differentiations, or other provisions, and to provide for such
adjustments and exceptions for any class of transactions, as in the
judgment of the Board are necessary or proper to effectuate the
purposes of TILA, to prevent circumvention or evasion thereof, or to
facilitate compliance therewith. 15 U.S.C. 1604(a). TILA Section 102(a)
provides, in pertinent part, that the Act's purposes are 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. 15 U.S.C. 1601(a). The proposal is
intended to help consumers make informed use of credit and shop among
available credit alternatives.
Under the current rule, creditors need not deliver mortgage loan
disclosures on non-purchase money mortgage transactions until
consummation. By that time, consumers may not be in a position to make
meaningful use of the disclosure. Once consumers have reached the
settlement table, it is likely too late for them to use the disclosure
to shop among mortgages or to inform themselves adequately of the terms
of the loan. Consumers are presented at
[[Page 1716]]
settlement with a large, often overwhelming, number of documents, and
they may not reasonably be able to focus adequate attention on the
mortgage loan disclosure. Moreover, by the time of loan consummation,
consumers may feel committed to the loan because they are accessing
their equity for an urgent need, or they have already paid substantial
application fees.
The mortgage loan disclosure that consumers would receive early in
the application process under this proposal includes a payment
schedule, which would illustrate any increases in payments over time.
The disclosure also would include an APR that reflects the fully
indexed rate in cases of hybrid and payment-option ARMs, which
sometimes are marketed on the basis of only an initial, discounted rate
or a temporary, minimum payment. Providing this information within
three days of application, before the consumer has paid a fee, would
help ensure that consumers would have a genuine opportunity to review
the credit terms being offered; ensure that the terms are consistent
with their understanding of the transaction; assess whether the terms
meet their needs and are affordable; and decide whether to go through
with the transaction or continue to shop among alternatives.
Disclosure Before Fee Paid
The Board proposes to require that all of the early mortgage loan
disclosures be delivered before the consumer pays a fee to any person
in connection with the consumer's application for a mortgage
transaction. Consumers typically pay fees to apply for a mortgage loan,
such as fees for a credit report and property appraisal, as well as
nonspecific ``application'' fees. If the fee is significant, a consumer
may feel constrained from shopping for alternatives. This risk is
particularly high in the subprime market, where consumers often are
cash-strapped and where limited price transparency may obscure the
benefits of continuing to shop. See part II.C for a discussion of these
points. The risk also applies to the prime market, where many consumers
would find significant a fee of several hundred dollars such as the fee
often imposed for an appraisal and other services.
The proposed early disclosure obligation would be limited to fees
paid in connection with an application for a mortgage transaction. This
limitation is necessary because the obligation is triggered by a fee
paid to any person, not just to the creditor. The Board seeks comment
on whether further guidance is necessary to clarify what fees would be
deemed in connection with an application.
The Board is proposing an exception to the fee restriction,
however, for obtaining information on the consumer's credit history.
The proposed exception to the fee restriction recognizes that creditors
generally cannot make accurate transaction-specific estimates without
having considered the consumer's credit history. To require creditors
to bear the cost of reviewing credit history with little assurance the
customer will apply for a loan may be unduly burdensome and could
undermine the utility of the disclosures. The proposed exception would
allow creditors to recoup the bona fide and reasonable amount necessary
to obtain a credit report or other, similar form of information on the
consumer's credit history.
The Board expects this proposal would impose additional costs on
creditors, some of which may be passed on in part to consumers. Some
creditors already deliver early mortgage loan disclosures on non-
purchase money mortgages. Not all creditors, however, follow this
practice, and those that do not would face increased costs, both one-
time costs to modify their systems and ongoing costs to originate
loans. The Board seeks comment on whether the benefits of this proposal
outweigh these costs or other costs commenters identify.
Corresponding changes also would be made to the staff commentary,
and certain other conforming amendments to Regulation Z and the staff
commentary also are proposed.
B. Future Plans To Improve Disclosure
The Board remains committed to its longstanding belief that better
information in the mortgage market can improve competition and help
consumers make better decisions. This proposal contains new rules to
prevent incomplete or misleading mortgage loan advertisements and
solicitations, and to require lenders to provide mortgage disclosures
more quickly so that consumers can get the information they need when
it is most useful to them. The Board recognizes that these disclosures
need to be updated to reflect the increased complexity of mortgage
products. In early 2008, the Board will begin testing current TILA
mortgage disclosures and potential revisions to these disclosures
through one-on-one interviews with consumers. The Board expects that
this testing will identify potential improvements for the Board to
propose for public comment in a separate rulemaking.
XII. Civil Liability and Remedies; Administrative Enforcement
Consumer Remedies for Unfair, Deceptive, or Abusive Practices
The restrictions on loan terms and lending practices in proposed
Sec. Sec. 226.35 and 226.36, as well as the advertising restrictions
in proposed Sec. 226.24(i), are based on the Board's authority under
TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2). Consumers who bring
timely actions against creditors for violations of these restrictions
may be able to recover: (i) Actual damages; (ii) statutory damages in
an individual action of up to $2,000 or, in a class action, total
statutory damages for the class of up to $500,000 or one percent of the
creditor's net worth, whichever is less; (iii) special statutory
damages equal to the sum of all finance charges and fees paid by the
consumer; and (iv) court costs and attorney fees. TILA Section 130(a),
15 U.S.C. 1640(a).\72\
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\72\ Section 130(a), 15 U.S.C. 1640(a), authorizes recovery of
amounts of types (i), (ii), and (iv) from a creditor for a failure
to comply with any requirement imposed under Chapter 2, which
includes Section 129, 15 U.S.C. 1639. Section 130(a)(4), 15 U.S.C.
1640(a)(4), further authorizes recovery of amounts of type (iii) for
a failure to comply with any requirement under Section 129, 15
U.S.C. 1639, unless the creditor demonstrates that the failure to
comply is not material. Under TILA Section 103(y), 15 U.S.C.
1602(y), a reference to a requirement imposed under TILA or any
provision thereof also includes a reference to the regulations of
the Board under TILA or the provision in question. Therefore,
Section 130(a), 15 U.S.C. 1640(a), authorizes recovery from a
creditor of amounts of all four types if the creditor fails to
comply with a Board regulation adopted under authority of Section
129(l)(2), 15 U.S.C. 1639(l)(2).
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If a loan is a HOEPA loan--that is, its APR or fees exceed the
triggers in Sec. 226.32(a)--and the creditor has assigned it to
another person, consumers may be able to obtain from the assignee all
of the foregoing damages, including the finance charges and fees paid
by the consumer. TILA Section 131(d), 15 U.S.C. 1641(d). For all other
loans, TILA Section 131(e), 15 U.S.C. 1641(e), limits the liability of
assignees for violations of Regulation Z to disclosure violations that
are apparent on the face of the disclosure statement required by TILA.
TILA does not authorize private civil actions against parties other
than creditors and assignees. A creditor is the party to whom the debt
is initially payable. TILA Section 103(f), 15 U.S.C. 1602(f). A
mortgage broker is not a creditor unless the debt is initially payable
to the broker. Loan servicers may be creditors, but often they are not.
Neither is a servicer treated as an assignee under TILA if the servicer
is or was the owner of the obligation only for
[[Page 1717]]
purposes of administrative convenience in servicing the obligation.
TILA Section 131(f), 15 U.S.C. 1641(f).
A Consumer's Right to Rescind
A consumer has a right to rescind a transaction for up to three
years after consummation when the mortgage contains a provision
prohibited by a rule adopted under authority of TILA Section 129(l)(2).
See TILA Sections 125 and 129(j), 15 U.S.C. 1636 and 1639(j). Moreover,
any consumer who has the right to rescind a transaction may rescind the
transaction as against any assignee. TILA Section 131(c), 15 U.S.C.
1641(c). The right of rescission does not extend, however, to home
purchase loans, construction loans, or certain refinancings with the
same creditor. TILA Section 125(e), 15 U.S.C. 1636.
Under current Regulation Z, 12 CFR 226.23(a)(3), footnote 48, a
HOEPA loan having a prepayment penalty that does not conform to the
requirements of Sec. 226.32(d)(7) is a mortgage containing a provision
prohibited by TILA Section 129, 15 U.S.C. 1639, and, therefore, is
subject to the three-year right of the consumer to rescind. Proposed
Sec. 226.35(b)(3), which would be adopted under authority of Section
129(l)(2), 15 U.S.C. 1639(l)(2), would apply the restrictions on
prepayment penalties in Sec. 226.32(d)(6) and (7) to higher-priced
mortgage loans, as defined in proposed Sec. 226.35(a). Accordingly,
the Board is proposing to revise footnote 48 to clarify that a higher-
priced mortgage loan (whether or not it is a HOEPA loan) having a
prepayment penalty that does not conform to the requirements of Sec.
226.32(d)(7), as incorporated in Sec. 226.35(b)(3), is also subject to
a three-year right of rescission. (As mentioned, however, the right of
rescission does not extend to home purchase loans, construction loans,
or certain refinancings with the same creditor.) Other rules the Board
is proposing would not be prohibitions of particular provisions of
mortgages, and violations of those rules therefore would not trigger
the extended right of rescission.
Advertising Rules and Civil Liability
The Board's proposal in connection with advertising practices
presents a unique case with respect to civil liability under TILA. TILA
Section 130 provides for civil liability of creditors for violations
only of chapters 2, 4, and 5 of the act, 15 U.S.C. 1640(a), whereas the
advertising provisions of TILA are found in chapter 3. Accordingly, the
Board's proposed rules relating to advertising disclosures, such as the
disclosures about rates or payments, would not create civil liability
for creditors, assignees, or other persons, because those rules would
be promulgated under the Board's general rulemaking authority in TILA
Section 105(a), 15 U.S.C. 1604(a). These proposed rules would, however,
be subject to administrative enforcement by appropriate agencies.
Proposed Sec. 226.24(i), which would prohibit certain acts or
practices in connection with closed-end advertisements for credit
secured by a dwelling, would be promulgated under the Board's authority
in TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2). Section 130(a), 15
U.S.C. 1640(a), authorizes a civil action by any person against a
creditor who fails to comply with respect to that person with a rule
adopted under authority of Section 129(l)(2), 15 U.S.C. 1639(l)(2). It
is not clear, however, whether a consumer may bring an action against a
creditor under Section 130(a), 15 U.S.C. 1640(a), for violating an
advertising restriction in proposed Sec. 226.24(i) if the consumer has
not obtained a mortgage loan from the creditor.
Administrative Enforcement
In addition to providing consumers remedies against creditors and
assignees, the statute authorizes various agencies to enforce
Regulation Z administratively against various parties. The federal
banking agencies may enforce the regulation against banks and thrifts.
TILA Section 108(a), 15 U.S.C. 1607(a). The Federal Trade Commission
(FTC) is generally authorized to enforce violations of Regulation Z as
to any other entity or individual. TILA Section 108(c), 15 U.S.C.
1607(c). State attorneys general may enforce violations of regulations
adopted under authority of TILA Section 129(l)(2). See TILA Section
130(e), 15 U.S.C. 1640(e).
XIII. Effective Date
Under TILA, the Board's disclosure regulations are to have an
effective date of that October 1 which follows by at least six months
the date of promulgation. TILA Section 105(d), 15 U.S.C. 1604(d).
However, the Board may, at its discretion, lengthen the implementation
period for creditors to adjust their forms to accommodate new
requirements, or shorten the period where the Board makes a specific
finding that such action is necessary to prevent unfair or deceptive
disclosure practices. Id. The Board requests comment on whether six
months would be an appropriate implementation period for the proposed
rules. Specifically, the Board requests comment on the length of time
creditors may need to implement the proposed rules, as well as on
whether the Board should specify a shorter implementation period for
certain provisions in order to prevent unfair or deceptive practices.
XIV. Paperwork Reduction Act
In accordance with the Paperwork Reduction Act (PRA) of 1995 (44
U.S.C. 3506; 5 CFR Part 1320 Appendix A.1), the Board reviewed the
proposed rule under the authority delegated to the Board by the Office
of Management and Budget (OMB). The collection of information that is
required by this proposed rule is found in 12 CFR part 226. The Federal
Reserve may not conduct or sponsor, and an organization is not required
to respond to, this information collection unless the information
collection displays a currently valid OMB control number. The OMB
control number is 7100-0199.
This information collection is required to provide benefits for
consumers and is mandatory (15 U.S.C. 1601 et seq.). The respondents/
recordkeepers are creditors and other entities subject to Regulation Z,
including for-profit financial institutions and small businesses.
TILA and Regulation Z are intended to ensure effective disclosure
of the costs and terms of credit to consumers. For open-end credit,
creditors are required, among other things, to disclose information
about the initial costs and terms and to provide periodic statements of
account activity, notices of changes in terms, and statements of rights
concerning billing error procedures. Regulation Z requires specific
types of disclosures for credit and charge card accounts and home-
equity plans. For closed-end loans, such as mortgage and installment
loans, cost disclosures are required to be provided prior to
consummation. Special disclosures are required in connection with
certain products, such as reverse mortgages, certain variable-rate
loans, and certain mortgages with rates and fees above specified
thresholds. TILA and Regulation Z also contain rules concerning credit
advertising. Creditors are required to retain evidence of compliance
for twenty-four months (12 CFR 226.25), but Regulation Z does not
specify the types of records that must be retained.
Under the PRA, the Federal Reserve accounts for the paperwork
burden associated with Regulation Z for the state member banks and
other creditors supervised by the Federal Reserve that engage in
lending covered by Regulation Z and, therefore, are respondents under
the PRA. Appendix I of Regulation Z defines the Federal Reserve-
regulated institutions as: state member banks,
[[Page 1718]]
branches and agencies of foreign banks (other than federal branches,
federal agencies, and insured state branches of foreign banks),
commercial lending companies owned or controlled by foreign banks, and
organizations operating under section 25 or 25A of the Federal Reserve
Act. Other federal agencies account for the paperwork burden on other
creditors. Paperwork burden associated with entities that are not
creditors will be accounted for by other federal agencies. The current
total annual burden to comply with the provisions of Regulation Z is
estimated to be 552,398 hours for the 1,172 Federal Reserve-regulated
institutions that are deemed to be respondents for the purposes of the
PRA. To ease the burden and cost of complying with Regulation Z
(particularly for small entities), the Federal Reserve provides model
forms, which are appended to the regulation.
The proposed rule would impose a one-time increase in the total
annual burden under Regulation Z for all respondents regulated by the
Federal Reserve by 46,880 hours, from 552,398 to 599,278 hours.
The total estimated burden increase, as well as the estimates of
the burden increase associated with each major section of the proposed
rule as set forth below, represents averages for all respondents
regulated by the Federal Reserve. The Federal Reserve expects that the
amount of time required to implement each of the proposed changes for a
given institution may vary based on the size and complexity of the
respondent. Furthermore, the burden estimate for this rulemaking does
not include the burden addressing changes to format, timing, and
content requirements for the five main types of open-end credit
disclosures governed by Regulation Z as announced in a separate
proposed rulemaking (Docket No. R-1286).
The Federal Reserve proposes revisions to Sec. Sec. 226.16 and
226.24 to require that advertisements provide accurate and balanced
information, in a clear and conspicuous manner. Additional proposed
revisions to Sec. 226.24 would prohibit advertisements that are
deceptive.
The proposed changes to the advertising provisions would amend the
open-end home-equity plan advertising rules in Sec. 226.16 and amend
the closed-end credit advertising rules in Sec. 226.24. The two most
significant changes in Sec. 226.16 relate to the clear and conspicuous
standard and the advertisement of introductory terms in home-equity
plans. The three most significant changes in Sec. 226.24 relate to
strengthening the clear and conspicuous standard for advertising
disclosures, regulating the disclosure of rates and payments in
advertisements to ensure that low introductory or ``teaser'' rates or
payments are not given undue emphasis, and prohibiting certain acts or
practices in advertisements that the Federal Reserve finds inconsistent
with the standards set forth in TILA Section 129(l)(2). The Federal
Reserve estimates that 1,172 respondents regulated by the Federal
Reserve would take, on average, 40 hours (one business week) to revise
and update their advertising materials to comply with the proposed
disclosure requirements in Sec. Sec. 226.16 and 226.24. These one-time
revisions would increase the burden by 46,880 hours.
The 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 Federal Reserve's burden estimates. Using the
Federal Reserve's method, the total current estimated annual burden for
all financial institutions subject to Regulation Z, including Federal
Reserve-supervised institutions, would be approximately 61,656,695
hours. The proposed rule would increase the estimated annual burden for
all institutions subject to Regulation Z by 772,000 hours to 62,428,695
hours. The above estimates represent an average across all respondents
and reflect variations between institutions based on their size,
complexity, and practices. All covered institutions, of which there are
approximately 19,300, potentially are affected by this collection of
information, and thus are respondents for purposes of the PRA.
Comments are invited on: (1) Whether the proposed collection of
information is necessary for the proper performance of the Federal
Reserve's functions; including whether the information has practical
utility; (2) the accuracy of the Federal Reserve's estimate of the
burden of the proposed information collection, including the cost of
compliance; (3) ways to enhance the quality, utility, and clarity of
the information to be collected; and (4) ways to minimize the burden of
information collection on respondents, including through the use of
automated collection techniques or other forms of information
technology. Comments on the collection of information should be sent to
Michelle Shore, Federal Reserve Board Clearance Officer, Division of
Research and Statistics, Mail Stop 151-A, Board of Governors of the
Federal Reserve System, Washington, DC 20551, with copies of such
comments sent to the Office of Management and Budget, Paperwork
Reduction Project (7100-0199), Washington, DC 20503.
XV. Initial Regulatory Flexibility Analysis
In accordance with section 3(a) of the Regulatory Flexibility Act
(RFA), 5 U.S.C. Sec. Sec. 601-612, the Board is publishing an initial
regulatory flexibility analysis for the proposed amendments to
Regulation Z. The RFA requires an agency either to provide an initial
regulatory flexibility analysis with a proposed rule or certify that
the proposed rule will not have a significant economic impact on a
substantial number of small entities. An entity is considered ``small''
if it has $165 million or less in assets for banks and other depository
institutions; and $6.5 million or less in revenues for non-bank
mortgage lenders, mortgage brokers, and loan servicers.\73\
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\73\ U.S. Small Business Administration, Table of Small Business
Size Standards Matched to North American Industry Classification
System Codes; available at http://www.sba.gov/idc/groups/public/documents/sba_homepage/serv_sstd_tablepdf.pdf.
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Based on its analysis and for the reasons stated below, the Board
believes that this proposed rule will have a significant economic
impact on a substantial number of small entities. A final regulatory
flexibility analysis will be conducted after consideration of comments
received during the public comment period. The Board requests public
comment in the following areas.
Reasons for the Proposed Rule
Congress enacted TILA based on findings that economic stability
would be enhanced and competition among consumer credit providers would
be strengthened by the informed use of credit resulting from consumers'
awareness of the cost of credit. One of the stated purposes of TILA is
to provide a meaningful disclosure of credit terms to enable consumers
to compare credit terms available in the marketplace more readily and
avoid the uninformed use of credit. TILA's disclosure requirements
differ depending on whether consumer credit is an open-end (revolving)
plan or a closed-end (installment) loan. TILA also contains procedural
and substantive protections for consumers. TILA directs the Board to
prescribe regulations to carry out the purposes of the statute.
Congress enacted HOEPA in 1994 as an amendment to TILA. TILA is
implemented by the Board's Regulation Z. HOEPA imposed additional
substantive protections on certain high-cost mortgage transactions.
HOEPA also authorized the Board to prohibit acts or
[[Page 1719]]
practices in connection with mortgage loans that are unfair, deceptive,
or designed to evade the purposes of HOEPA, and acts or practices in
connection with refinancing of mortgage loans that are associated with
abusive lending or are otherwise not in the interest of borrowers.
The proposed regulations would prohibit certain acts or practices
in connection with closed-end mortgage loans to address problems that
have been observed in the mortgage market, particularly the subprime
market. Some of the proposed prohibitions or restrictions would apply
only to higher-priced closed-end mortgage loans secured by the
consumer's principal dwelling. These include: (1) Prohibiting a pattern
or practice of extending credit based on the collateral without
considering the borrower's ability to repay; (2) requiring creditors to
establish escrow accounts for taxes and insurance for first-lien loans;
(3) requiring creditors to verify income and assets they rely upon in
making loans; and (4) prohibiting prepayment penalties except under
certain conditions.
Other proposed prohibitions or restrictions would apply generally
to closed-end mortgage loans secured by the consumer's principal
dwelling. These include restrictions on certain creditor payments to
brokers, a prohibition on coercion of appraisers, and a prohibition on
certain mortgage loan servicing practices. Finally, the proposal would
prohibit certain advertising practices in connection with closed-end
mortgage loans secured by a consumer's dwelling.
The Board's proposal also would require certain TILA disclosures
for closed-end mortgages to be provided to the consumer earlier in the
loan process. The proposal would revise the Regulation Z advertising
rules to ensure that advertisements for open-end and closed-end
mortgage loans provide accurate and balanced information about rates
and payments.
Statement of Objectives and Legal Basis
The SUPPLEMENTARY INFORMATION contains this information. In
summary, the proposed amendments to Regulation Z are designed to
achieve three goals: (1) Prohibit certain acts or practices for higher-
priced mortgage loans secured by a consumer's principal dwelling and
prohibit other acts or practices for closed-end mortgage loans secured
by a consumer's principal dwelling; (2) revise the disclosures required
in advertisements for credit secured by a consumer's dwelling and
prohibit certain practices in connection with closed-end mortgage
advertising; and (3) require disclosures for closed-end mortgages to be
provided earlier in the transaction.
The legal basis for the proposed rule is in Sections 105(a),
122(a), and 129(l)(2) of TILA. A more detailed discussion of the
Board's rulemaking authority is set forth in part V of the
SUPPLEMENTARY INFORMATION.
Description of Small Entities to Which the Proposed Rule Would Apply
The proposed regulations would apply to all institutions and
entities that engage in closed-end home-secured lending and servicing.
The Board is not aware of a reliable source for the total number of
small entities likely to be affected by the proposal, and the credit
provisions of TILA and Regulation Z have broad applicability to
individuals and businesses that originate, extend and service even
small numbers of home-secured credit. See Sec. 226.1(c)(1).\74\ All
small entities that originate, extend, or service closed-end loans
secured by a consumer's dwelling potentially could be subject to the
proposed rule.
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\74\ 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.'' Sec. 226.1(c)(1).
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The Board can, however, identify through data from Reports of
Condition and Income (``call reports'') approximate numbers of small
depository institutions that would be subject to the proposed rules.
Based on December 2006 call report data, approximately 6,932 small
institutions would be subject to the proposed rule. Approximately
17,618 depository institutions in the United States filed call report
data, approximately 13,018 of which had total domestic assets of $165
million or less and thus were considered small entities for purposes of
the Regulatory Flexibility Act. Of 4,558 banks, 615 thrifts and 7,691
credit unions that filed call report data and were considered small
entities, 4,389 banks, 574 thrifts, and 5,104 credit unions, totaling
10,067 institutions, extended mortgage credit. For purposes of this
analysis, thrifts include savings banks, savings and loan entities, co-
operative banks and industrial banks.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Filed call
Filed call report data and
Filed call Filed call report data and originated or
Filed call report data and report data and originated or extended
report data had assets <= originated or extended mortgage credit
$165M extended mortgage credit with assets <=
mortgage credit with assets <= $165M and did
$165M not file HMDA
--------------------------------------------------------------------------------------------------------------------------------------------------------
Commercial banks.............................................. 7,423 4,558 7,210 4,389 2,808
Thrifts \75\.................................................. 1,344 615 1,280 574 254
Credit unions................................................. 8,535 7,691 5,948 5,104 3,870
Other......................................................... 316 154 0 0 0
-----------------------------------------------------------------------------------------
Total..................................................... 17,618 13,018 14,438 10,067 6,932
--------------------------------------------------------------------------------------------------------------------------------------------------------
The Board cannot identify with certainty the number of small non-
depository institutions that would be subject to the proposed rule.
Home Mortgage Disclosure Act (HMDA) \76\ data
[[Page 1720]]
indicate that 2,004 non-depository institutions filed HMDA reports in
2006.\77\ Based on the small volume of lending activity reported by
these institutions, most are likely to be small.
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\75\ Thrifts include savings banks, savings and loan
associations, co-operative and industrial banks.
\76\ The 8,886 lenders (both depository institutions and
mortgage companies) covered by HMDA in 2006 accounted for an
estimated 80% of all home lending in the United States. Under HMDA,
lenders use a ''loan/application register'' (HMDA/LAR) to report
information annually to their federal supervisory agencies for each
application and loan acted on during the calendar year. Lenders must
make their HMDA/LARs available to the public by March 31 following
the year to which the data relate, and they must remove the two
date-related fields to help preserve applicants' privacy. Only
lenders that have offices (or, for non-depository institutions, are
deemed to have offices) in metropolitan areas are required to report
under HMDA. However, if a lender is required to report, it must
report information on all of its home loan applications and loans in
all locations, including non-metropolitan areas.
\77\ The 2006 HMDA Data, http://www.federalreserve.gov/pubs/bulletin/2007/pdf/hmda06draft.pdf.
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Certain parts of the proposal would apply to mortgage brokers and
mortgage servicers. According to the National Association of Mortgage
Brokers, in 2004 there were 53,000 mortgage brokerage companies that
employed an estimated 418,700 people.\78\ The Board believes that most
of these companies are small entities.\79\
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\78\ http://www.namb.org/namb/Industry_Facts.asp?SnID=719224934
\79\ In the first quarter of 2007, 77% of brokers (NAICS 522310)
had fewer than five employees; only 0.4% had 100 or more employees,
thus it seems likely that most have revenues below the threshold.
(Bureau of Labor Statistics' Quarterly Census of Employment and
Wages).
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The proposal would prohibit certain unfair mortgage servicing
practices. The Board is not aware, however, of a source of data for the
number of small mortgage servicers. The available data are not
sufficient for the Board to realistically estimate the number of
mortgage servicers that would be subject to the proposed rule and that
are small as defined by the Small Business Administration. The Board
invites comment and information on the number and type of small
entities affected by the proposed rule.
Projected Reporting, Recordkeeping, and Other Compliance Requirements
The compliance requirements of the proposed rules are described in
parts VI through VIII and in parts X and XI of the SUPPLEMENTARY
INFORMATION. The effect of the proposed revisions to Regulation Z on
small entities is unknown. Some small entities would be required, among
other things, to modify their underwriting practices and home-secured
credit disclosures to comply with the revised rules. The precise costs
to small entities of updating their systems, disclosures, and
underwriting practices are difficult to predict. These costs will
depend on a number of unknown factors, including, among other things,
the specifications of the current systems used by such entities to
prepare and provide disclosures and/or solicitations and to administer
and maintain accounts, the complexity of the terms of credit products
that they offer, and the range of such product offerings. Additionally,
the proposed rules could affect how mortgage brokers are compensated.
The precise costs that the proposed rule would impose on mortgage
brokers are also difficult to ascertain. Nevertheless, the Board
believes that these costs will have a significant economic effect on
small entities, including mortgage brokers. The Board seeks information
and comment on any costs, compliance requirements, or changes in
operating procedures arising from the application of the proposed rule
to small institutions.
Identification of Duplicative, Overlapping, or Conflicting Federal
Rules
Other federal rules. The Board has not identified any federal rules
that conflict with the proposed revisions to Regulation Z.
Overlap with RESPA. Certain terms defined in the proposed rule,
such as ``escrow account,'' ``servicer'' and ``servicing,'' cross-
reference existing definitions under the U.S. Department of Housing and
Urban Development's (HUD) Regulation X (Real Estate Settlement
Procedures Act (RESPA).
Overlap with HUD's guidance. The Board recognizes that HUD has
issued policy statements regarding creditor payments to mortgage
brokers under RESPA and guidance as to disclosure of such payments on
the Good Faith Estimate and HUD-1 Settlement Statement. The Board is
also aware that HUD has announced its intention to propose improved
disclosures for broker compensation under RESPA in the near future. The
Board intends that its proposal would complement any proposal by HUD.
The proposed provision regarding creditor payments to brokers is
intended to be consistent with HUD's existing guidance regarding broker
compensation under Section 8 of RESPA.
Identification of Duplicative, Overlapping, or Conflicting State Laws
Certain sections of the proposed rules may result in inconsistency
with certain state laws.
Escrows. Certain states have laws regulating escrows for taxes and
insurance. Section 226.35(b)(4) would require creditors to establish
escrow accounts for taxes and insurance for first-lien higher-priced
loans, but allow creditors to allow borrowers to opt out of escrows 12
months after loan consummation. These provisions may be inconsistent
with certain state laws that limit creditors' ability to require
escrows or provide consumers with a right to opt out of an escrow
sooner than 12 months after loan consummation.
Creditor payments to brokers. The Board is aware that many states
regulate brokers and their compensation in various respects. Under TILA
Section 111, the proposed rule would not preempt such state laws except
to the extent they are inconsistent with the proposal's requirements.
15 U.S.C. 1610.
The Board seeks comment regarding any state or local statutes or
regulations, that would duplicate, overlap, or conflict with the
proposed rule.
Discussion of Significant Alternatives
The Board considered whether improved disclosures could protect
consumers against unfair acts or practices in connection with closed-
end mortgage loans secured by a consumer's principal dwelling as well
as the proposed rule. While the Board anticipates proposing
improvements to mortgage loan disclosures, it does not appear that
better disclosures alone will address unfair, abusive, or deceptive
practices in the mortgage market, including the subprime market.
The Board welcomes comments on any significant alternatives,
consistent with the requirements of TILA, that would minimize the
impact of the proposed rule on small entities.
List of Subjects in 12 CFR Part 226
Advertising, Consumer protection, Federal Reserve System,
Mortgages, Reporting and recordkeeping requirements, Truth in lending.
Text of Proposed Revisions
Certain conventions have been used to highlight the proposed
revisions. New language is shown inside bold arrows, and language that
would be deleted is set off with bold brackets.
Authority and Issuance
For the reasons set forth in the preamble, the Board proposes to
amend Regulation Z, 12 CFR part 226, as set forth below:
PART 226--TRUTH IN LENDING (REGULATION Z)
1. The authority citation for part 226 is amended to read as
follows:
Authority: 12 U.S.C. 3806; 15 U.S.C. 1604[rtrif],[ltrif] [and]
1637(c)(5)[rtrif], and 1639(l)[ltrif].
Subpart A--General
2. Section 226.1 is amended by revising paragraph (d)(5) to read as
follows:
Sec. 226.1 Authority, purpose, coverage, organization, enforcement
and liability.
* * * * *
(d) * * *
[[Page 1721]]
(5) Subpart E contains special rules for mortgage transactions.
Section 226.32 requires certain disclosures and provides limitations
for loans that have rates and fees above specified amounts. Section
226.33 requires disclosures, including the total annual loan cost rate,
for reverse mortgage transactions. Section 226.34 prohibits specific
acts and practices in connection with mortgage transactions [rtrif]
that are subject to Sec. 226.32. Section 226.35 prohibits specific
acts and practices in connection with higher-priced mortgage loans, as
defined in Sec. 226.35(a). Section 226.36 prohibits specific acts and
practices in connection with credit secured by a consumer's principal
dwelling[ltrif].
* * * * *
Subpart B--Open-End Credit
3. Section 226.16 is amended by revising paragraphs (d)(1) through
(d)(4), removing and reserving footnote 36e, and adding new paragraphs
(d)(6) and (f) to read as follows:
Sec. 226.16 Advertising.
* * * * *
(d) Additional requirements for home-equity plans--(1)
Advertisement of terms that require additional disclosures. If any of
the terms required to be disclosed under Sec. [rtrif]226.6(a)(1) or
(2)[ltrif] [226.6(a) or (b)] or the payment terms of the plan are set
forth, affirmatively or negatively, in an advertisement for a home-
equity plan subject to the requirements of Sec. 226.5b, the
advertisement also shall clearly and conspicuously set forth the
following:
(i) Any loan fee that is a percentage of the credit limit under the
plan and an estimate of any other fees imposed for opening the plan,
stated as a single dollar amount or a reasonable range.
(ii) Any periodic rate used to compute the finance charge,
expressed as an annual percentage rate as determined under Sec.
226.14(b).
(iii) The maximum annual percentage rate that may be imposed in a
variable-rate plan.
(2) Discounted and premium rates. If an advertisement states an
initial annual percentage rate that is not based on the index and
margin used to make later rate adjustments in a variable-rate plan, the
advertisement also shall state [rtrif]with equal prominence and in
close proximity to the initial rate:
(i) T[ltrif][t]he period of time such [rtrif]initial[ltrif] rate
will be in effect[rtrif];[ltrif] and[, with equal prominence to the
initial rate,]
[rtrif](ii) A[ltrif][a] reasonably current annual percentage rate
that would have been in effect using the index and margin.
(3) Balloon payment. If an advertisement contains a statement
[about] [rtrif]of[ltrif] any minimum periodic payment [rtrif]and a
balloon payment may result if only the minimum periodic payments are
made, even if such a payment is uncertain or unlikely[ltrif], the
advertisement also shall state[, if applicable,] [rtrif]with equal
prominence and in close proximity to the minimum periodic payment
statement[ltrif] that a balloon payment may result[rtrif], if
applicable[ltrif].36e [rtrif]A balloon payment results if
paying the minimum periodic payments does not fully amortize the
outstanding balance by a specified date or time, and the consumer is
required to repay the entire outstanding balance at such time. If a
balloon payment will occur when the consumer makes only the minimum
payments required under the plan, an advertisement for such a program
which contains any statement of any minimum periodic payment shall also
state with equal prominence and in close proximity to the minimum
periodic payment statement:
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\36e\ [rtrif][Reserved.][ltrif] [See footnote 10b.]
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(i) That a balloon payment will result; and
(ii) The amount and timing of the balloon payment that will result
if the consumer makes only the minimum payments for the maximum period
of time that the consumer is permitted to make such payments.[ltrif]
(4) Tax implications. An advertisement that states that any
interest expense incurred under the home-equity plan is or may be tax
deductible may not be misleading in this regard. [rtrif]If an
advertisement distributed in paper form or through the Internet (rather
than by radio or television) is for a home-equity plan secured by the
consumer's principal dwelling, and the advertised extension of credit
may, by its terms, exceed the fair market value of the dwelling, the
advertisement shall clearly and conspicuously state that:
(i) The interest on the portion of the credit extension that is
greater than the fair market value of the dwelling is not tax
deductible for Federal income tax purposes; and
(ii) The consumer should consult a tax adviser for further
information regarding the deductibility of interest and charges.[ltrif]
* * * * *
[rtrif](6) Introductory rates and payments.
(i) Definitions. The following definitions apply for purposes if
paragraph (d)(6) of this section.
(A) Introductory rate. The term ``introductory rate'' means, in a
variable-rate plan, any annual percentage rate that is not based on the
index and margin that will be used to make rate adjustments under the
plan, if that rate is less than a reasonably current annual percentage
rate that would be in effect under the index and margin that will be
used to make rate adjustments under the plan.
(B) Introductory payment. The term ``introductory payment'' means--
(1) For a variable-rate plan, any payment applicable for an
introductory period that:
(i) Is not derived by applying the index and margin to the
outstanding balance when such index and margin will be used to
determine other payments under the plan; and
(ii) Is less than other payments under the plan derived by applying
a reasonably current index and margin that will be used to determine
the amount of such payments, given an assumed balance.
(2) For a plan other than a variable-rate plan, any payment
applicable for an introductory period if that payment is less than
other payments that will be in effect under the plan given an assumed
balance.
(C) Introductory period. An ``introductory period'' means a period
of time, less than the full term of the loan, that the introductory
rate or introductory payment may be applicable.
(ii) Stating the term ``introductory''. If any annual percentage
rate is an introductory rate, or if any payment is an introductory
payment, the term ``introductory'' or ``intro'' must be stated in
immediate proximity to each listing of the introductory rate or
payment.
(iii) Stating the introductory period and post-introductory rate or
payments. If any annual percentage rate that may be applied to a plan
is an introductory rate, or if any payment applicable to a plan is an
introductory payment, the following must be disclosed in a clear and
conspicuous manner with equal prominence and in close proximity to each
listing of the introductory rate or payment:
(A) The period of time during which the introductory rate or
introductory payment will apply;
(B) In the case of an introductory rate, any annual percentage rate
that will apply under the plan. If such rate is variable, the annual
percentage rate must be disclosed in accordance with the accuracy
standards in Sec. Sec. 226.5b, or 226.16(b)(1)(ii) as applicable; and
(C) In the case of an introductory payment, the amounts and time
periods of any payments that will apply under the plan. In variable-
rate transactions,
[[Page 1722]]
payments that will be determined based on application of an index and
margin shall be disclosed based on a reasonably current index and
margin.
(iv) Envelope excluded. The requirements in paragraph (d)(6)(iii)
of this section do not apply to an envelope in which an application or
solicitation is mailed, or to a banner advertisement or pop-up
advertisement linked to an application or solicitation provided
electronically.[ltrif]
* * * * *
[rtrif](f) Alternative disclosures--television or radio
advertisements. An advertisement made through television or radio
stating any of the terms requiring additional disclosures under
paragraph (b)(1) or (d)(1) of this section may alternatively comply
with paragraph (b)(1) or (d)(1) of this section by stating the
information required by paragraph (b)(1)(ii) of this section or
paragraph (d)(1)(ii) of this section, as applicable, and listing a
toll-free telephone number along with a reference that such number may
be used by consumers to obtain additional cost information.[ltrif]
Subpart C--Closed-End Credit
4. Section 226.17 is amended by revising paragraph (b) and the
introductory text of paragraph (f), and removing and reserving footnote
39 to read as follows:
Sec. 226.17 General disclosure requirements.
* * * * *
(b) Time of disclosures. The creditor shall make disclosures before
consummation of the transaction. In certain [residential] mortgage
transactions, special timing requirements are set forth in Sec.
226.19(a). In certain variable-rate transactions, special timing
requirements for variable-rate disclosures are set forth in Sec.
226.19(b) and Sec. 226.20(c). In certain transactions involving mail
or telephone orders or a series of sales, the timing of the disclosures
may be delayed in accordance with paragraphs (g) and (h) of this
section.
* * * * *
(f) Early disclosures. If disclosures required by this subpart are
given before the date of consummation of a transaction and a subsequent
event makes them inaccurate, the creditor shall disclose before
consummation [rtrif](except that, for certain mortgage transactions,
Sec. 226.19(a)(2) permits redisclosure no later than consummation or
settlement, whichever is later).[ltrif] \39\--
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\39\ [rtrif][Reserved.][ltrif] [For certain residential mortgage
transactions, section 226.19(a)(2) permits redisclosure no later
than consummation or settlement, whichever is later.]
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* * * * *
5. Section 226.19 is amended by revising the heading and paragraph
(a)(1) to read as follows:
Sec. 226.19 Certain [residential] mortgage and variable-rate
transactions.
(a) [Residential m] [rtrif]M[ltrif]ortgage transactions subject to
RESPA--(1)[rtrif](i)[ltrif] Time of disclosures. In a [residential]
mortgage transaction subject to the Real Estate Settlement Procedures
Act (12 U.S.C. 2601 et seq.) [rtrif]that is secured by the consumer's
principal dwelling, other than a home equity line of credit subject to
Sec. 226.5b,[ltrif] the creditor shall make good faith estimates of
the disclosures required by Sec. 226.18 before consummation, or shall
deliver or place them in the mail not later than three business days
after the creditor receives the consumer's written application,
whichever is earlier.
[rtrif](ii) Imposition of fees. Except as provided in paragraph
(a)(1)(iii) of this section, neither a creditor nor any other person
may impose a fee on the consumer in connection with the consumer's
application for a mortgage transaction subject to paragraph (a)(1)(i)
of this section before the consumer has received the disclosures
required by paragraph (a)(1)(i) of this section. If the disclosures are
mailed to the consumer, the consumer is considered to have received
them three business days after they are mailed.
(iii) Exception to fee restriction. A creditor or other person may
impose a fee for obtaining the consumer's credit report before the
consumer has received the disclosure required by paragraph (a)(1)(i) of
this section, provided the fee is bona fide and reasonable in
amount.[ltrif]
* * * * *
6. Section 226.24 is revised to read as follows:
Sec. 226.24 Advertising.
(a) Actually available terms. If an advertisement for credit states
specific credit terms, it shall state only those terms that actually
are or will be arranged or offered by the creditor.
[rtrif](b) Clear and conspicuous standard. Disclosures required by
this section shall be made clearly and conspicuously.[ltrif]
[rtrif](c)[ltrif][(b)] Advertisement of rate of finance charge. If
an advertisement states a rate of finance charge, it shall state the
rate as an ``annual percentage rate,'' using that term. If the annual
percentage rate may be increased after consummation, the advertisement
shall state that fact.[rtrif] If an advertisement is for credit not
secured by a dwelling, t[ltrif][T]he advertisement shall not state any
other rate, except that a simple annual rate or periodic rate that is
applied to an unpaid balance may be stated in conjunction with, but not
more conspicuously than, the annual percentage rate.[rtrif] If an
advertisement is for credit secured by a dwelling, the advertisement
shall not state any other rate, except that a simple annual rate that
is applied to an unpaid balance may be stated in conjunction with, but
not more conspicuously than, the annual percentage rate.[ltrif]
[rtrif](d)[ltrif][(c)] Advertisement of terms that require
additional disclosures--(1) [rtrif]Triggering terms.[ltrif] If any of
the following terms is set forth in an advertisement, the advertisement
shall meet the requirements of paragraph [rtrif](d)[ltrif][(c)](2) of
this section:
(i) The amount or percentage of any downpayment.
(ii) The number of payments or period of repayment.
(iii) The amount of any payment.
(iv) The amount of any finance charge.
(2) [rtrif]Additional terms.[ltrif] An advertisement stating any of
the terms in paragraph [rtrif](d)[ltrif][(c)](1) of this section shall
state the following terms,\49\ as applicable (an example of one or more
typical extensions of credit with a statement of all the terms
applicable to each may be used):
---------------------------------------------------------------------------
\49\ [rtrif][Reserved.][ltrif][An example of one or more typical
extensions of credit with a statement of all the terms applicable to
each may be used.]
---------------------------------------------------------------------------
(i) The amount or percentage of the downpayment.
(ii) The terms of repayment [rtrif], which reflect the repayment
obligations over the full term of the loan, including any balloon
payment[ltrif].
(iii) The ``annual percentage rate,'' using that term, and, if the
rate may be increased after consummation, that fact.
[rtrif](e)[ltrif][(d)] Catalogs or other multiple-page
advertisements; electronic advertisements.
(1) If a catalog or other multiple-page advertisement, or an
electronic advertisement (such as an advertisement appearing on an
Internet Web site), gives information in a table or schedule in
sufficient detail to permit determination of the disclosures required
by paragraph [rtrif](d)[ltrif][(c)](2) of this section, it shall be
considered a single advertisement if--
[[Page 1723]]
(i) The table or schedule is clearly and conspicuously set forth;
and
(ii) Any statement of the credit terms in paragraph
[rtrif](d)[ltrif][(c)](1) of this section appearing anywhere else in
the catalog or advertisement clearly refers to the page or location
where the table or schedule begins.
(2) A catalog or other multiple-page advertisement or an electronic
advertisement (such as an advertisement appearing on an Internet Web
site) complies with paragraph [rtrif](d)[ltrif][(c)](2) of this section
if the table or schedule of terms includes all appropriate disclosures
for a representative scale of amounts up to the level of the more
commonly sold higher-priced property or services offered.
[rtrif](f) Disclosure of Rates and Payments in Advertisements for
Credit Secured by a Dwelling.
(1) Scope. The requirements of this paragraph apply to any
advertisement for credit secured by a dwelling, other than television
or radio advertisements, including promotional materials accompanying
applications.
(2) Disclosure of rates--(i) In general. If an advertisement for
credit secured by a dwelling states a simple annual rate of interest
and more than one simple annual rate of interest will apply over the
term of the advertised loan, the advertisement shall disclose in a
clear and conspicuous manner:
(A) Each simple annual rate of interest that will apply. In
variable-rate transactions, a rate determined by adding an index and
margin shall be disclosed based on a reasonably current index and
margin;
(B) The period of time during which each simple annual rate of
interest will apply; and
(C) The annual percentage rate for the loan. If such rate is
variable, the annual percentage rate shall comply with the accuracy
standards in Sec. Sec. 226.17(c) and 226.22.
(ii) Clear and conspicuous requirement. For purposes of paragraph
(f)(2)(i) of this section, clearly and conspicuously disclosed means
that the required information in paragraphs (f)(2)(i)(A) through (C)
shall be disclosed with equal prominence and in close proximity to any
advertised rate that triggered the required disclosures. The required
information in paragraph (f)(2)(i)(C) may be disclosed with greater
prominence than the other information.
(3) Disclosure of payments--(i) In general. In addition to the
requirements of paragraph (c) of this section, if an advertisement for
credit secured by a dwelling states the amount of any payment, the
advertisement shall disclose in a clear and conspicuous manner:
(A) The amount of each payment that will apply over the term of the
loan, including any balloon payment. In variable-rate transactions,
payments that will be determined based on the application of the sum of
an index and margin shall be disclosed based on a reasonably current
index and margin;
(B) The period of time during which each payment will apply; and
(C) In an advertisement for credit secured by a first lien on a
dwelling, the fact that the payments do not include amounts for taxes
and insurance premiums, if applicable, and that the actual payment
obligation will be greater.
(ii) Clear and conspicuous requirement. For purposes of paragraph
(f)(3)(i) of this section, a clear and conspicuous disclosure means
that the required information in paragraphs (f)(3)(i)(A) and (B) shall
be disclosed with equal prominence and in close proximity to any
advertised payment that triggered the required disclosures, and that
the required information in paragraph (f)(3)(i)(C) shall be disclosed
with prominence and in close proximity to the advertised payments.
(4) Envelope excluded. The requirements in paragraphs (f)(2) and
(f)(3) of this section do not apply to an envelope in which an
application or solicitation is mailed, or to a banner advertisement or
pop-up advertisement linked to an application or solicitation provided
electronically.
(g) Alternative disclosures--television or radio advertisements. An
advertisement made through television or radio stating orally any of
the terms requiring additional disclosures under paragraph (d)(2) of
this section may comply with paragraph (d)(2) of this section either
by:
(1) Stating orally each of the additional disclosures required
under paragraph (d)(2) of this section at a speed and volume sufficient
for a consumer to hear and comprehend them; or
(2) Stating orally the information required by paragraph
(d)(2)(iii) of this section at a speed and volume sufficient for a
consumer to hear and comprehend them, and listing a toll-free telephone
number along with a reference that such number may be used by consumers
to obtain additional cost information.
(h) Tax implications. If an advertisement distributed in paper form
or through the Internet (rather than by radio or television) is for a
loan secured by the consumer's principal dwelling, and the advertised
extension of credit may, by its terms, exceed the fair market value of
the dwelling, the advertisement shall clearly and conspicuously state
that:
(1) The interest on the portion of the credit extension that is
greater than the fair market value of the dwelling is not tax
deductible for Federal income tax purposes; and
(2) The consumer should consult a tax adviser for further
information regarding the deductibility of interest and charges.
(i) Prohibited acts or practices in advertisements for credit
secured by a dwelling. The following acts or practices are prohibited
in advertisements for credit secured by a dwelling:
(1) Misleading advertising of ``fixed'' rates and payments. Using
the word ``fixed'' to refer to rates, payments, or the credit
transaction in an advertisement for variable-rate transactions or other
transactions where the advertised payment may increase, unless:
(i) In the case of an advertisement solely for one or more
variable-rate transactions,
(A) The phrase ``Adjustable-Rate Mortgage'' or ``Variable-Rate
Mortgage'' appears in the advertisement before the first use of the
word ``fixed'' and is at least as conspicuous as every use of the word
``fixed'' in the advertisement; and
(B) Each use of the word ``fixed'' to refer to a rate or payment is
accompanied by an equally prominent and closely proximate statement of
the time period for which the rate or payment is fixed, and the fact
that the rate may vary or the payment may increase after that period;
(ii) In the case of an advertisement solely for transactions other
than variable-rate transactions where the advertised payment may
increase (e.g., a fixed-rate mortgage transaction with an initial lower
payment), each use of the word ``fixed'' to refer to the advertised
payment is accompanied by an equally prominent and closely proximate
statement of the time period for which the payment is fixed, and the
fact that the payment may increase after that period; or
(iii) In the case of an advertisement for both variable-rate
transactions and non-variable-rate transactions,
(A) The phrase ``Adjustable-Rate Mortgage,'' ``Variable-Rate
Mortgage,'' or ``ARM'' appears in the advertisement with equal
prominence as any use of the term ``fixed,'' ``Fixed-Rate Mortgage,''
or similar terms; and
(B) Each use of the word ``fixed'' to refer to a rate, payment, or
the credit transaction either refers solely to the transactions for
which rates are fixed and complies with paragraph (i)(1)(ii) of this
section, if applicable, or, if it refers
[[Page 1724]]
to the variable-rate transactions, is accompanied by an equally
prominent and closely proximate statement of the time period for which
the rate or payment is fixed, and the fact that the rate may vary or
the payment may increase after that period.
(2) Misleading comparisons in advertisements. Making any comparison
in an advertisement between an actual or hypothetical consumer's
current credit payments or rates and any payment or simple annual rate
that will be available under the advertised product for less than the
term of the loan, unless:
(i) In general. The advertisement includes:
(A) An equally prominent, closely proximate comparison to all
applicable payments or rates for the advertised product that will apply
over the term of the loan and an equally prominent, closely proximate
statement of the period of time for which each applicable payment or
rate applies; and
(B) A prominent statement in close proximity to the payments
described in paragraph (i)(2)(i)(A) of this section that the advertised
payments do not include amounts for taxes and insurance premiums, if
applicable; or
(ii) Application to variable-rate transactions. If the
advertisement is for a variable-rate transaction, and the advertised
payment or simple annual rate is based on the index and margin that
will be used to make subsequent rate or payment adjustments over the
term of the loan, the advertisement includes:
(A) An equally prominent statement in close proximity to the
payment or rate that the payment or rate is subject to adjustment and
the time period when the first adjustment will occur; and
(B) A prominent statement in close proximity to the advertised
payment that the payment does not include amounts for taxes and
insurance premiums, if applicable.
(3) Misrepresentations about government endorsement. Making any
statement in an advertisement that the product offered is a
``government loan program'', ``government-supported loan'', or is
otherwise endorsed or sponsored by any federal, state, or local
government entity, unless the advertisement is for an FHA loan, VA
loan, or similar loan program that is, in fact, endorsed or sponsored
by a federal, state, or local government entity.
(4) Misleading use of the current lender's name. Using the name of
the consumer's current lender in an advertisement that is not sent by
or on behalf of the consumer's current lender, unless the
advertisement:
(i) Discloses with equal prominence the name of the person or
creditor making the advertisement; and
(ii) Includes a clear and conspicuous statement that the person
making the advertisement is not associated with, or acting on behalf
of, the consumer's current lender.
(5) Misleading claims of debt elimination. Making any claim in an
advertisement that the mortgage product offered will eliminate debt or
result in a waiver or forgiveness of a consumer's existing loan terms
with, or obligations to, another creditor.
(6) Misleading claims suggesting a fiduciary or other relationship.
Using the terms ``counselor'' or ``financial advisor'' in an
advertisement to refer to a for-profit mortgage broker or mortgage
lender, its employees, or persons working for the broker or lender that
are involved in offering, originating or selling mortgages.
(7) Misleading foreign-language advertisements. Providing
information about some trigger terms or required disclosures, such as
an initial rate or payment, only in a foreign language in an
advertisement, but providing information about other trigger terms or
required disclosures, such as information about the fully-indexed rate
or fully amortizing payment, only in English in the same
advertisement.[ltrif]
Subpart E--Special Rules for Certain Home Mortgage Transactions
7. Section 226.32 is amended by revising paragraph (d)(7) to read
as follows:
Sec. 226.32 Requirements for certain closed-end home mortgages.
* * * * *
(d) * * *
(7) Prepayment penalty exception. A mortgage transaction subject to
this section may provide for a prepayment penalty otherwise permitted
by law (including a refund calculated according to the rule of 78s) if:
(i) The penalty can be exercised only for the first five years
following consummation;
(ii) The source of the prepayment funds is not a refinancing by the
creditor or an affiliate of the creditor; [and]
(iii) At consummation, the consumer's total monthly [rtrif]debt
payments[ltrif] [debts] (including amounts owed under the mortgage) do
not exceed 50 percent of the consumer's monthly gross income, as
verified [rtrif]in accordance with Sec. 226.35(b)(2)(i); and[ltrif]
[by the consumer's signed financial statement, a credit report, and
payment records for employment income.]
[rtrif](iv) The penalty period ends at least sixty days prior to
the first date, if any, on which the principal or interest payment
amount may increase under the terms of the loan.[ltrif]
* * * * *
8. Section 226.34 is amended by revising the heading and paragraph
(a)(4) to read as follows:
Sec. 226.34 Prohibited acts or practices in connection with credit
[secured by a consumer's dwelling] [rtrif]subject to Sec.
226.32[ltrif].
(a) * * *
[(4) Repayment ability. Engage in a pattern or practice of
extending credit subject to Sec. 226.32 to a consumer based on the
consumer's collateral without regard to the consumer's repayment
ability, including the consumer's current income, current obligations,
and employment. There is a presumption that a creditor has violated
this paragraph (a)(4) if the creditor engages in a pattern or practice
of making loans subject toSec. 226.32 without verifying and
documenting consumers' repayment ability.]
[rtrif](4) Repayment ability. Engage in a pattern or practice of
extending credit subject to Sec. 226.32 to consumers based on the
value of consumers' collateral without regard to consumers' repayment
ability as of consummation, including consumers' current and reasonably
expected income, current and reasonably expected obligations,
employment, and assets other than the collateral.
(i) There is a presumption that a creditor has violated this
paragraph (a)(4) if the creditor engages in a pattern or practice of
failing to--
(A) Verify and document consumers' repayment ability in accordance
with Sec. 226.35(b)(2)(i);
(B) Consider consumers' ability to make loan payments based on the
interest rate, determined as follows in the case of a loan in which the
interest rate may increase after consummation--
(1) For a variable rate loan, the interest rate as determined by
adding the margin and the index value as of consummation, or the
initial rate if that rate is greater than the sum of the index value
and margin as of consummation; and
(2) For a step-rate loan, the highest interest rate possible within
the first seven years of the loan's term;
(C) Consider consumers' ability to make loan payments based on a
fully-amortizing payment that includes, as applicable: expected
property taxes; homeowners' association dues; premiums for insurance
against loss of or damage to property, or against
[[Page 1725]]
liability arising out of the ownership or use of the property; premiums
for any guarantee or insurance protecting the creditor against
consumers' default or other credit loss; and premiums for other
mortgage related insurance;
(D) Consider the ratio of consumers' total debt obligations to
consumers' income; or
(E) Consider the income consumers will have after paying debt
obligations.
(ii) A creditor does not violate this paragraph (a)(4) if it has a
reasonable basis to believe consumers will be able to make loan
payments for at least seven years after consummation of the
transaction, considering the factors identified in paragraph (a)(4)(i)
of this section and any other factors relevant to determining repayment
ability.
(iii) This paragraph (a)(4) does not apply to temporary or
``bridge'' loans with terms of twelve months or less, such as a loan to
purchase a new dwelling where the consumer plans to sell a current
dwelling within twelve months.[ltrif]
* * * * *
9. New Sec. 226.35 is added to read as follows:
[rtrif]Sec. 226.35 Prohibited acts or practices in connection with
higher-priced mortgage loans.
(a) Higher-priced mortgage loans. (1) For purposes of this section,
a higher-priced mortgage loan is a consumer credit transaction that is
secured by the consumer's principal dwelling in which the annual
percentage rate at consummation will exceed the yield on comparable
Treasury securities by three or more percentage points for loans
secured by a first lien on a dwelling, or by five or more percentage
points for loans secured by a subordinate lien on a dwelling.
(2) Comparable Treasury securities are determined as follows for
variable rate loans:
(i) For a loan with an initial rate that is fixed for more than one
year, securities with a maturity matching the duration of the fixed-
rate period, unless the fixed-rate period exceeds seven years, in which
case the creditor should use the rules applied to non-variable rate
loans; and
(ii) For all other loans, securities with a maturity of one year.
(3) Comparable Treasury securities are determined as follows for
non-variable rate loans:
(i) For a loan with a term of twenty years or more, securities with
a maturity of ten years;
(ii) For a loan with a term of more than seven years but less than
twenty years, securities with a maturity of seven years; and
(iii) For a loan with a term of seven years or less, securities
with a maturity matching the term of the transaction.
(4) The creditor shall use the yield on Treasury securities as of
the 15th day of the preceding month if the creditor receives the
application between the 1st and the 14th day of the month and as of the
15th day of the current month if the creditor receives the application
on or after the 15th day.
(5) Notwithstanding paragraph (a)(1) of this section, a higher-
priced mortgage loan excludes a transaction to finance the initial
construction of a dwelling, a temporary or ``bridge'' loan with a term
of twelve months or less, such as a loan to purchase a new dwelling
where the consumer plans to sell a current dwelling within twelve
months, a reverse-mortgage transaction subject to Sec. 226.33, or a
home equity line of credit subject to Sec. 226.5b.
(b) Rules for higher-priced mortgage loans. Higher-priced mortgage
loans are subject to the following restrictions:
(1) Repayment ability. A creditor shall not engage in a pattern or
practice of extending credit as provided in Sec. 226.34(a)(4).
(2) Verification of income and assets relied on. (i) A creditor
shall not rely on amounts of income, including expected income, or
assets in approving an extension of credit unless the creditor verifies
such amounts by the consumer's Internal Revenue Service Form W-2, tax
returns, payroll receipts, financial institution records, or other
third-party documents that provide reasonably reliable evidence of the
consumer's income or assets.
(ii) A creditor has not violated paragraph (b)(2)(i) of this
section if the amounts of income and assets that the creditor relied
upon in approving the transaction are not materially greater than the
amounts of the consumer's income or assets that the creditor could have
verified pursuant to paragraph (b)(2)(i) of this section at the time
the loan was consummated.
(3) Prepayment penalties. A loan shall not include a prepayment
penalty provision except under the conditions provided in Sec.
226.32(d)(7).
(4) Failure to escrow for property taxes and insurance. Prior to or
at consummation of a loan secured by a first lien on a dwelling, an
escrow account must be established for payment of property taxes;
premiums for insurance against loss of or damage to property, or
against liability arising out of the ownership or use of the property;
premiums for any guarantee or insurance protecting the creditor against
the consumer's default or other credit loss; and premiums for other
mortgage-related insurance.
(i) A creditor may permit a consumer to cancel the escrow account
required in paragraph (b)(4) only in response to a consumer's dated
written request to cancel the escrow account that is received no
earlier than twelve months after consummation.
(ii) For purposes of this section, ``escrow account'' shall have
the same meaning as in 24 CFR 3500.17(b) as amended.
(5) Evasion; open-end credit. In connection with credit secured by
a consumer's principal dwelling that does not meet the definition of
open-end credit in Sec. 226.2(a)(20), a creditor shall not structure a
home-secured loan as an open-end plan to evade the requirements of this
section.[ltrif]
10. New Sec. 226.36 is added to read as follows:
[rtrif]Sec. 226.36 Prohibited acts or practices in connection with
credit secured by a consumer's principal dwelling.
(a) Creditor payments to mortgage brokers. (1) In connection with a
consumer credit transaction secured by a consumer's principal dwelling,
except as provided in paragraph (a)(2) of this section, a creditor
shall not make any payment, directly or indirectly, to a mortgage
broker unless the broker enters into a written agreement with the
consumer that satisfies the conditions set forth in this paragraph
(a)(1). A creditor payment to a mortgage broker subject to this
paragraph (a)(1) shall not exceed the total compensation amount stated
in the written agreement, reduced by any amounts paid directly by the
consumer or by any other source. The written agreement must be entered
into before the consumer pays a fee to any person in connection with
the mortgage transaction or submits a written application to the broker
for the transaction, whichever is earlier. The written agreement must
include a clear and conspicuous statement--
(i) Of the total amount of compensation the mortgage broker will
receive and retain from all sources, as a dollar amount;
(ii) That the consumer will pay the entire amount of compensation
that the mortgage broker will receive and retain, even if all or part
is paid directly by the creditor, because the creditor recovers such
payments through a higher interest rate; and
(iii) That creditor payments to a mortgage broker can influence the
broker to offer certain loan products or terms to the consumer that are
not in the consumer's interest or are not the most
[[Page 1726]]
favorable the consumer otherwise could obtain.
(2) Paragraph (a)(1) of this section does not apply to a
transaction--
(i) That is subject to a state statute or regulation that expressly
imposes a duty on mortgage brokers, under which a mortgage broker may
not offer to consumers loan products or terms that are not in
consumers' interest or are less favorable than consumers otherwise
could obtain, and that requires that a mortgage broker provide
consumers with a written agreement that includes a description of the
mortgage broker's role in the transaction and the mortgage broker's
relationship to the consumer, as defined by such statute or regulation;
or
(ii) Where the creditor can demonstrate that the compensation it
pays to a mortgage broker in connection with a transaction is not
determined, in whole or in part, by reference to the transaction's
interest rate.
(b) Misrepresentation of value of consumer's dwelling--(1) Coercion
of appraiser. In connection with a consumer credit transaction secured
by a consumer's principal dwelling, no creditor or mortgage broker, and
no affiliate of a creditor or mortgage broker shall directly or
indirectly coerce, influence, or otherwise encourage an appraiser to
misstate or misrepresent the value of such dwelling.
(i) Examples of actions that violate paragraph (b)(1) of this
section include:
(A) Implying to an appraiser that current or future retention of
the appraiser depends on the amount at which the appraiser values a
consumer's principal dwelling;
(B) Failing to compensate an appraiser because the appraiser does
not value a consumer's principal dwelling at or above a certain amount;
and
(C) Conditioning an appraiser's compensation on loan consummation.
(ii) Examples of actions that do not violate this subsection
include:
(A) Asking an appraiser to consider additional information about a
consumer's principal dwelling or about comparable properties;
(B) Requesting that an appraiser provide additional information
about the basis for a valuation;
(C) Requesting that an appraiser correct factual errors in a
valuation;
(D) Obtaining multiple appraisals of a consumer's principal
dwelling, so long as the creditor adheres to a policy of selecting the
most reliable appraisal, rather than the appraisal that states the
highest value;
(E) Withholding compensation from an appraiser for breach of
contract or substandard performance of services as provided by
contract;
(F) Terminating a relationship with an appraiser for violations of
applicable federal or state law or breaches of ethical or professional
standards; and
(G) Taking action permitted or required by applicable federal or
state statute, regulation, or agency guidance.
(2) When extension of credit prohibited. In connection with a
consumer credit transaction secured by a consumer's principal dwelling,
a creditor who knows or has reason to know, at or before loan
consummation, of a violation of Sec. 226.36(b)(1) in connection with
an appraisal shall not extend credit based on such appraisal unless the
creditor documents that it has acted with reasonable diligence to
determine that the appraisal does not materially misstate or
misrepresent the value of such dwelling.
(3) Appraiser defined. As used in this paragraph (b), an appraiser
is a person who engages in the business of providing assessments of the
value of dwellings. The term ``appraiser'' includes persons that
employ, refer, or manage appraisers and affiliates of such persons.
(c) Mortgage broker defined. For purposes of this section, the term
``mortgage broker'' means a person, other than an employee of a
creditor, who for compensation or other monetary gain, or in
expectation of compensation or other monetary gain, arranges,
negotiates, or otherwise obtains an extension of consumer credit. The
term includes a person meeting this definition, even if the consumer
credit obligation is initially payable to such person, unless the
person provides the funds for the transaction at consummation out of
the person's own resources, out of deposits held by the person, or by
drawing on a bona fide warehouse line of credit.
(d) Servicing practices. (1) In connection with a consumer credit
transaction secured by a consumer's principal dwelling, no servicer
shall--
(i) Fail to credit a payment to the consumer's loan account as of
the date of receipt, except when a delay in crediting does not result
in any charge to the consumer or in the reporting of negative
information to a consumer reporting agency, or except as provided in
paragraph (d)(2) of this section;
(ii) Impose on the consumer any late fee or delinquency charge in
connection with a payment, when the only delinquency is attributable to
late fees or delinquency charges assessed on an earlier payment, and
the payment is otherwise a full payment for the applicable period and
is paid on its due date or within an applicable grace period;
(iii) Fail to provide to the consumer within a reasonable time
after receiving a consumer's request a schedule of all specific fees
and charges that the servicer may impose on the consumer in connection
with servicing the consumer's account, including a dollar amount and an
explanation of each such fee and the circumstances under which it is
imposed; or
(iv) Fail to provide, within a reasonable time after receiving a
request from the consumer or any person acting on behalf of the
consumer, an accurate statement of the total outstanding balance of the
consumer's obligation that would be required to satisfy the obligation
in full as of a specified date.
(2) If a servicer specifies in writing requirements for the
consumer to follow in making payments, but accepts a payment that does
not conform to the requirements, the servicer shall credit the payment
within 5 days of receipt.
(3) For purposes of this paragraph (d), the terms ``servicer'' and
``servicing'' have the same meanings as provided in 24 CFR 3500.2(b),
as amended.
(e) This section does not apply to a home equity line of credit
subject to Sec. 226.5b.[ltrif]
11. In Supplement I to Part 226:
a. Under Section 226.2--Definitions and Rules of Construction, 2(a)
Definitions, 2(a)(24) Residential Mortgage Transaction, paragraphs
2(a)(24)-1 and 2(a)(24)-5 are revised.
b. Under Section 226.16--Advertising:
i. Paragraph 16-1 is revised, paragraph 16-2 is redesignated as
paragraph 16-6, and new paragraphs 16-2 through 16-5 are added.
ii. Under 16(d) Additional requirements for home equity plans,
paragraph 16(d)-3 is revised, paragraphs 16(d)-5, 16(d)-6, and 16(d)-7
are redesignated as paragraphs 16(d)-7, 16(d)-8, and 16(d)-9
respectively, newly designated paragraphs 16(d)-7 and 16(d)-9 and the
heading of newly designated paragraph 16(d)-8 are revised, and new
paragraphs 16(d)-5 and 16(d)-6 are added.
c. Under Section 226.17--General Disclosure Requirements, 17(c)
Basis of disclosures and use of estimates, Paragraph 17(c)(1),
paragraph 17(c)(1)-8 is revised, and under 17(f) Early disclosures,
paragraph 17(f)-4 is revised.
d. Under Section 226.19--Certain Residential Mortgage and Variable-
Rate Transactions, the heading is revised, heading 19(a)(1) Time of
disclosure is redesignated as heading 19(a)(1)(i) Time of disclosure,
paragraphs 19(a)(1)(i)-1 and 19(a)(1)(i)-5 are revised, new headings
19(a)(1)(ii) Imposition of fees and 19(a)(1)(iii) Exception to fee
[[Page 1727]]
restriction are added, and new paragraphs 19(a)(1)(ii)-1, 19(a)(1)(ii)-
2, and 19(a)(1)(iii)-1 are added.
e. Under Section 226.24--Advertising:
i. Paragraph 24-1 is removed;
ii. Heading 24(d) Catalogues or other multiple-page advertisements;
electronic advertisements is redesignated as 24(e) Catalogues or other
multiple-page advertisements; electronic advertisements, and newly
designated paragraphs 24(e)-1, 24(e)-2, and 24(e)-4 are revised;
iii. Headings 24(c) Advertisement of terms that require additional
disclosures, Paragraph 24(c)(1), and Paragraph 24(c)(2), are
redesignated as 24(d) Advertisement of terms that require additional
disclosures, Paragraph 24(d)(1), and Paragraph 24(d)(2) respectively,
newly designated paragraphs 24(d)-1, 24(d)(1)-3, and 24(d)(2)-2 are
revised, newly designated paragraphs 24(d)(2)-3 and 24(d)(2)-4 are
further redesignated as paragraphs 24(d)(2)-4 and 24(d)(2)-5
respectively, new paragraph 24(d)(2)-3 is added, and newly designated
paragraph 24(d)(2)-5 is revised;
iv. Heading 24(b) Advertisement of rate of finance charge is
redesignated as 24(c) Advertisement of rate of finance charge, and
newly designated paragraphs 24(c)-2 and 24(c)-3 are revised, newly
designated paragraph 24(c)-4 is removed, newly designated paragraph
24(c)-5 is redesignated as paragraph 24(c)-4 and revised, and newly
designated paragraph 24(c)-6 is further redesignated as paragraph
24(c)-5.
v. New heading 24(b) Clear and conspicuous standard is added, and
new paragraphs 24(b)-1 through 24(b)-5 are added; and
vi. New headings 24(f) Disclosure of rates or payments in
advertisements for credit secured by a dwelling, 24(f)(3) Disclosure of
payments, 24(g) Alternative disclosures--television or radio
advertisements, 24(h) Statements of tax deductibility, and 24(i)
Prohibited acts or practices in advertisements for credit secured by a
dwelling, and new paragraphs 24(f)-1 through 24(f)-5, 24(f)(3)-1 and
24(f)(3)-2, 24(g)-1 through 24(g)-3, 24(h)-1, and 24(i)-1 through
24(i)-3 are added.
f. Under Section 226.32--Requirements for Certain Closed-End Home
Mortgages, 32(a) Coverage:
i. New heading Paragraph 32(a)(2) and new paragraph 32(a)(2)-1 are
added.
ii. Under 32(d) Limitations, new paragraph 32(d)-1 is added.
iii. Under 32(d)(7) Prepayment penalty exception, new paragraph
32(d)(7)-1 is added.
iv. Under Paragraph 32(d)(7)(iii), paragraphs 32(d)(7)(iii)-1 and
32(d)(7)(iii)-2 are removed, and new paragraphs 32(d)(7)(iii)-1 through
32(d)(7)(iii)-4 are added.
v. New heading Paragraph 32(d)(7)(iv) and new paragraphs
32(d)(7)(iv)-1 and 32(d)(7)(iv)-2 are added.
g. Under Section 226.34--Prohibited Acts or Practices in Connection
with Credit Secured by a Consumer's Dwelling; Open-end Credit:
i. The heading is revised.
ii. Under 34(a) Prohibited acts or practices for loans subject to
Sec. 226.32, 34(a)(4) Repayment ability, paragraphs 34(a)(4)-3 and
34(a)(4)-4 are removed, paragraphs 34(a)(4)-1 and 34(a)(4)-2 are
redesignated as paragraphs 34(a)(4)-3 and 34(a)(4)-4 respectively and
revised, new paragraphs 34(a)(4)-1 and 34(a)(4)-2 are added, and new
headings Paragraph 34(a)(4)(i), Paragraph 34(a)(4)(i)(A), Paragraph
34(a)(4)(i)(B), Paragraph 34(a)(4)(i)(D), and Paragraph 34(a)(4)(i)(E)
and new paragraphs 34(a)(4)(i)-1, 34(a)(4)(i)(A)-1 and 34(a)(4)(i)(A)-
2, 34(a)(4)(i)(B)-1, 34(a)(4)(i)(D)-1, and 34(a)(4)(i)(E)-1 are added.
h. A new Section 226.35--Prohibited Acts or Practices in Connection
with Higher-priced Mortgage Loans is added.
i. A new Section 226.36--Prohibited Acts or Practices in Connection
with Credit Secured by a Consumer's Principal Dwelling is added.
Supplement I to Part 226--Official Staff Interpretations
* * * * *
Subpart A--General
* * * * *
Section 226.2--Definitions and Rules of Construction
2(a) Definitions.
* * * * *
2(a)(24) Residential mortgage transaction.
1. Relation to other sections. This term is important in
[lsqbb]six[rsqbb] [rtrif]five[ltrif] provisions in the regulation:
[lsqbb][rsqbb] [rtrif]i.[ltrif] Sec. 226.4(c)(7)--
exclusions from the finance charge.
[lsqbb][rsqbb] [rtrif]ii.[ltrif] Sec. 226.15(f)--
exemption from the right of rescission.
[lsqbb][rsqbb] [rtrif]iii.[ltrif] Sec. 226.18(q)--
whether or not the obligation is assumable.
[lsqbb] Section 226.19--special timing rules.[rsqbb]
[lsqbb][rsqbb] [rtrif]iv.[ltrif] Sec. 226.20(b)--
disclosure requirements for assumptions.
[lsqbb][rsqbb] [rtrif]v.[ltrif] Sec. 226.23(f)--
exemption from the right of rescission.
* * * * *
5. Acquisition. i. A residential mortgage transaction finances
the acquisition of a consumer's principal dwelling. The term does
not include a transaction involving a consumer's principal dwelling
if the consumer had previously purchased and acquired some interest
to the dwelling, even though the consumer had not acquired full
legal title.
ii. Examples of new transactions involving a previously acquired
dwelling include the financing of a balloon payment due under a land
sale contract and an extension of credit made to a joint owner of
property to buy out the other joint owner's interest. In these
instances, disclosures are not required under Sec. 226.18(q)
[lsqbb]or section 226.19(a)[rsqbb] (assumability policies [lsqbb]and
early disclosures for residential mortgage transactions[rsqbb]).
However, the rescission rules of Sec. Sec. 226.15 and 226.23 do
apply to these new transactions.
iii. In other cases, the disclosure and rescission rules do not
apply. For example, where a buyer enters into a written agreement
with the creditor holding the seller's mortgage, allowing the buyer
to assume the mortgage, if the buyer had previously purchased the
property and agreed with the seller to make the mortgage payments,
Sec. 226.20(b) does not apply (assumptions involving residential
mortgages).
* * * * *
Subpart B--Open-End Credit
* * * * *
Section 226.16--Advertising
1. Clear and conspicuous standard[rtrif]--general[ltrif].
Section 226.16 is subject to the general ``clear and conspicuous''
standard for subpart B (see Sec. 226.5(a)(1)) but prescribes no
specific rules for the format of the necessary
disclosures[lsqbb].[rsqbb][rtrif], aside from the format
requirements related to the disclosure of an introductory rate under
Sec. Sec. 226.16(d)(6) and 226.16(e). Aside from the terms
described in Sec. Sec. 226.16(d)(6) and 226.16(e), the[ltrif]
[lsqbb]The[rsqbb] credit terms need not be printed in a certain type
size nor need they appear in any particular place in the
advertisement.
[rtrif]2. Clear and conspicuous standard-introductory rates or
payments for home--equity plans. For purposes of Sec. 226.16(d)(6),
a clear and conspicuous disclosure means that the required
information in Sec. 226.16(d)(6)(iii)(A)-(C) is disclosed with
equal prominence and in close proximity to the introductory rate or
payment to which it applies. If the information in Sec.
226.16(d)(6)(iii)(A)-(C) is the same type size and is located
immediately next to or directly above or below the introductory rate
or payment to which it applies, without any intervening text or
graphical displays, the disclosures would be deemed to be equally
prominent and in close proximity. Notwithstanding the above, for
electronic advertisements that disclose introductory rates or
payments, compliance with the requirements of Sec. 226.16(c) is
deemed to satisfy the clear and conspicuous standard.
3. Clear and conspicuous standard--Internet advertisements for
home-equity plans. For purposes of this section, a clear and
conspicuous disclosure for visual text advertisements on the
Internet for home-equity plans subject to the requirements of Sec.
226.5b means that the required disclosures are not obscured by
techniques such as graphical displays, shading, coloration, or
[[Page 1728]]
other devices and comply with all other requirements for clear and
conspicuous disclosures under Sec. 226.16(d). See also comment
16(c)(1)-2.
4. Clear and conspicuous standard--televised advertisements for
home-equity plans. For purposes of this section, and except as
otherwise provided by Sec. 226.16(f) for alternative disclosures, a
clear and conspicuous disclosure in the context of visual text
advertisements on television for home-equity plans subject to the
requirements of Sec. 226.5b means that the required disclosures are
not obscured by techniques such as graphical displays, shading,
coloration, or other devices, are displayed in a manner that allows
for a consumer to read the information required to be disclosed, and
comply with all other requirements for clear and conspicuous
disclosures under Sec. 226.16(d). For example, very fine print in a
television advertisement would not meet the clear and conspicuous
standard if consumers cannot see and read the information required
to be disclosed.
5. Clear and conspicuous standard--oral advertisements for home-
equity plans. For purposes of this section, and except as otherwise
provided by Sec. 226.16(f) for alternative disclosures, a clear and
conspicuous disclosure in the context of an oral advertisement for
home-equity plans subject to the requirements of Sec. 226.5b,
whether by radio, television, the Internet, or other medium, means
that the required disclosures are given at a speed and volume
sufficient for a consumer to hear and comprehend them. For example,
information stated very rapidly at a low volume in a radio or
television advertisement would not meet the clear and conspicuous
standard if consumers cannot hear and comprehend the information
required to be disclosed.[ltrif]
[rtrif]6.[ltrif] [lsqbb]2.[rsqbb] Expressing the annual
percentage rate in abbreviated form. * * *
* * * * *
16(d) Additional requirements for home-equity plans.
* * * * *
3. Statements of tax deductibility. An advertisement referring
to deductibility for tax purposes is not misleading if it includes a
statement such as ``consult a tax advisor regarding the
deductibility of interest.'' [rtrif]An advertisement for a home-
equity plan where the plan's terms do not allow for extensions of
credit greater than the fair market value of the consumer's dwelling
need not give the disclosures regarding which portion of the
interest is tax deductible. An advertisement for such a plan is not
required to refer to deductibility for tax purposes; however, if it
does so, it must not be misleading in this regard.[ltrif]
* * * * *
[rtrif]5. Introductory rates and payments in advertisements for
home-equity plans. Section 226.16(d)(6) requires additional
disclosures for introductory rates or payments.
i. Variable-rate plans. In advertisements for variable-rate
plans, if the advertised annual percentage rate is based on (or the
advertised payment is derived from) the index and margin that will
be used to make rate (or payment) adjustments over the term of the
loan, then there is no introductory rate or introductory payment.
If, however, the advertised annual percentage rate is not based on
(or the advertised payment is not derived from) the index and margin
that will be used to make rate (or payment) adjustments, and a
reasonably current application of the index and margin would result
in a higher annual percentage rate (or, given an assumed balance, a
higher payment) then there is an introductory rate or introductory
payment.
ii. Immediate proximity. Including the term ``introductory'' or
``intro'' in the same sentence as the listing of the introductory
rate or payment is deemed to be in immediate proximity of the
listing.
iii. Equal prominence, close proximity. Information required to
be disclosed in Sec. 226.16(d)(6)(iii) that is in the same
paragraph as the introductory rate or payment (not in a footnote to
that paragraph) is deemed to be closely proximate to the listing.
Information required to be disclosed in Sec. 226.16(d)(6)(iii) that
is in the same type size as the introductory rate or payment is
deemed to be equally prominent.
iv. Amounts and time periods of payments. Section
226.16(d)(6)(iii)(C) requires disclosure of the amount and time
periods of any payments that will apply under the plan. This section
may require disclosure of several payment amounts, including any
balloon payment. For example, if an advertisement for a home-equity
plan offers a $100,000 five-year line of credit and assumes that the
entire line is drawn resulting in a payment of $800 per month for
the first six months, increasing to $1,000 per month after month
six, followed by a $50,000 balloon payment after five years, the
advertisement must disclose the amount and time period of each of
the two monthly payment streams, as well as the amount and timing of
the balloon payment, with equal prominence and in close proximity to
the introductory payment.
v. Plans other than variable-rate plans. For a plan other than a
variable-rate plan, if an advertised payment is calculated in the
same way as other payments based on an assumed balance, the fact
that the payment could increase solely if the consumer made an
additional draw does not make the payment an introductory payment.
For example, if a payment of $500 results from an assumed $10,000
draw, and the payment would increase to $1000 if the consumer made
an additional $10,000 draw, the payment is not an introductory
payment.
6. Reasonably current index and margin. For the purposes of this
section, an index and margin is considered reasonably current if:
i. For direct mail advertisements, it was in effect within 60
days before mailing;
ii. For advertisements in electronic form, it was in effect
within 30 days before the advertisement is sent to a consumer's e-
mail address, or in the case of an advertisement made on an Internet
Web site, when viewed by the public; or
iii. For printed advertisements made available to the general
public, including ones contained in a catalog, magazine, or other
generally available publication, it was in effect within 30 days
before printing.
7.[ltrif][lsqbb]5.[rsqbb] Relation to other sections.
Advertisements for home-equity plans must comply with all provisions
in Sec. 226.16, [rtrif]except for Sec. 226.16(e),[ltrif] not
solely the rules in Sec. 226.16(d). If an advertisement contains
information (such as the payment terms) that triggers the duty under
Sec. 226.16(d) to state the annual percentage rate, the additional
disclosures in Sec. 226.16(b) must be provided in the
advertisement. While Sec. 226.16(d) does not require a statement of
fees to use or maintain the plan (such as membership fees and
transaction charges), such fees must be disclosed under Sec.
226.16(b)(1) and (3).
[rtrif]8.[ltrif][lsqbb]6.[rsqbb] Inapplicability of closed-end
rules. * * *
[rtrif]9.[ltrif][lsqbb]7.[rsqbb] Balloon payment. [lsqbb]In some
programs, a balloon payment will occur if only the minimum payments
under the plan are made. If an advertisement for such a program
contains any statement about a minimum periodic payment, the
advertisement must also state that a balloon payment will result
(not merely that a balloon payment ``may'' result). ([rsqbb]See
comment 5b(d)(5)(ii)-3 for [lsqbb]guidance on items[rsqbb]
[rtrif]information[ltrif] not required to be stated in
[lsqbb]the[rsqbb] advertisement[rtrif]s[ltrif], and on situations in
which the balloon payment requirement does not apply.[lsqbb])[rsqbb]
* * * * *
Subpart C--Closed-End Credit
Section 226.17--General Disclosure Requirements
* * * * *
17(c) Basis of disclosures and use of estimates.
* * * * *
Paragraph 17(c)(1).
* * * * *
8. Basis of disclosures in variable-rate transactions. The
disclosures for a variable-rate transaction must be given for the
full term of the transaction and must be based on the terms in
effect at the time of consummation. Creditors should base the
disclosures only on the initial rate and should not assume that this
rate will increase. For example, in a loan with an initial rate of
10 percent and a 5 percentage points rate cap, creditors should base
the disclosures on the initial rate and should not assume that this
rate will increase 5 percentage points. However, in a variable-rate
transaction with a seller buydown that is reflected in the credit
contract, a consumer buydown, or a discounted or premium rate,
disclosures should not be based solely on the initial terms. In
those transactions, the disclosed annual percentage rate should be a
composite rate based on the rate in effect during the initial period
and the rate that is the basis of the variable-rate feature for the
remainder of the term. (See the commentary to Sec. 226.17(c) for a
discussion of buydown, discounted, and premium transactions and the
commentary to Sec. 226.19(a)(2) for a discussion of the
redisclosure in certain [lsqbb]residential[rsqbb] mortgage
transactions with a variable-rate feature).
* * * * *
17(f) Early disclosures.
* * * * *
[[Page 1729]]
4. Special rules. In [lsqbb]residential[rsqbb] mortgage
transactions subject to Sec. 226.19, the creditor must redisclose
if, between the delivery of the required early disclosures and
consummation, the annual percentage rate changes by more than a
stated tolerance. When subsequent events occur after consummation,
new disclosures are required only if there is a refinancing or an
assumption within the meaning of Sec. 226.20.
* * * * *
Section 226.19--Certain [lsqbb]Residential[rsqbb] Mortgage and
Variable-Rate Transactions
19(a)(1)[rtrif](i)[ltrif] Time of disclosure.
1. Coverage. This section requires early disclosure of credit
terms in [lsqbb]residential[rsqbb] mortgage transactions that are
[rtrif]secured by a consumer's principal dwelling and[ltrif] also
subject to the Real Estate Settlement Procedures Act (RESPA) and its
implementing Regulation X, administered by the Department of Housing
and Urban Development (HUD). To be covered by Sec. 226.19, a
transaction must be [lsqbb]both a residential mortgage transaction
under section 226.2(a) and[rsqbb] a federally related mortgage loan
under RESPA. ``Federally related mortgage loan'' is defined under
RESPA (12 U.S.C. 2602) and Regulation X (24 CFR
3500.[lsqbb]5(b)[rsqbb][rtrif]2[ltrif]), and is subject to any
interpretations by HUD.[rtrif] RESPA coverage includes such
transactions as loans to purchase dwellings, refinancings of loans
secured by dwellings, and subordinate-lien home-equity loans, among
others. Although RESPA coverage relates to any dwelling, Sec.
226.19(a) applies to such transactions only if they are secured by a
consumer's principal dwelling. Also, home equity lines of credit
subject to Sec. 226.5b are not covered by Sec. 226.19(a).[ltrif]
* * * * *
5. Itemization of amount financed. In many
[lsqbb]residential[rsqbb] mortgage transactions, the itemization of
the amount financed required by Sec. 226.18(c) will contain items,
such as origination fees or points, that also must be disclosed as
part of the good faith estimates of settlement costs required under
RESPA. Creditors furnishing the RESPA good faith estimates need not
give consumers any itemization of the amount financed, either with
the disclosures provided within three days after application or with
the disclosures given at consummation or settlement.
[rtrif]19(a)(1)(ii) Imposition of fees.
1. Timing of fees. The consumer must receive the disclosures
required by this section before paying any fee to a creditor or
other person in connection with the consumer's application for a
mortgage transaction that is subject to Sec. 226.19(a)(1)(i),
except as provided in Sec. 226.19(a)(1)(iii). If the creditor
delivers the disclosures to the consumer in person, a fee may be
imposed anytime after delivery. If the creditor places the
disclosures in the mail, the creditor may impose a fee after the
consumer receives the disclosures or, in all cases, on or after the
fourth business day after mailing the disclosure.
2. Fees restricted. A creditor or other person may not charge
any fee other than to obtain a consumer's credit history, such as
for a credit report(s), until the consumer has received the
disclosures required by Sec. 226.19(a)(1)(i). For example, until
the consumer has received the disclosures, the creditor may not
impose a fee on the consumer for an appraisal or for underwriting.
19(a)(1)(iii) Exception to fee restriction.
1. Requirements for exception. A creditor or other person may
impose a fee before the consumer receives the required disclosures
if it is for obtaining information on the consumer's credit history,
such as by purchasing a credit report(s) on the consumer. The fee
also must be bona fide and reasonable in amount. For example, a
creditor may collect a fee for obtaining a credit report(s) if it is
the creditor's ordinary practice to obtain such credit history
information. The creditor may refer to this fee as an ``application
fee.''[ltrif]
* * * * *
Section 226.24--Advertising
[lsqbb]1. Clear and conspicuous standard. This section is
subject to the general ``clear and conspicuous'' standard for this
subpart but prescribes no specific rules for the format of the
necessary disclosures. The credit terms need not be printed in a
certain type size nor need they appear in any particular place in
the advertisement. For example, a merchandise tag that is an
advertisement under the regulation complies with this section if the
necessary credit terms are on both sides of the tag, so long as each
side is accessible.[rsqbb]
* * * * *
[rtrif]24(b) Clear and conspicuous standard.
1. Clear and conspicuous standard--general. This section is
subject to the general ``clear and conspicuous'' standard for this
subpart, see Sec. 226.17(a)(1), but prescribes no specific rules
for the format of the necessary disclosures, other than the format
requirements related to the advertisement of rates and payments as
described in comment 24(b)-2 below. The credit terms need not be
printed in a certain type size nor need they appear in any
particular place in the advertisement. For example, a merchandise
tag that is an advertisement under the regulation complies with this
section if the necessary credit terms are on both sides of the tag,
so long as each side is accessible.
2. Clear and conspicuous standard--rates and payments in
advertisements for credit secured by a dwelling. For purposes of
Sec. 226.24(f), a clear and conspicuous disclosure means that the
required information in Sec. Sec. 226.24(f)(2)(i) and
226.24(f)(3)(i)(A) and (B) is disclosed with equal prominence and in
close proximity to the advertised rates or payments triggering the
required disclosures, and that the required information in Sec.
226.24(f)(3)(i)(C) is disclosed with prominence and in close
proximity to the advertised rates or payments triggering the
required disclosures. If the required information in Sec. Sec.
226.24(f)(2)(i) and 226.24(f)(3)(i)(A) and (B) is the same type size
as the advertised rates or payments triggering the required
disclosures, the disclosures are deemed to be equally prominent. The
information in Sec. 226.24(f)(3)(i)(C) must be disclosed with
prominence, but need not be disclosed with equal prominence or be
the same type size as the payments triggering the required
disclosures. If the required information in Sec. Sec.
226.24(f)(2)(i) and 226.24(f)(3)(i) is located immediately next to
or directly above or below the advertised rates or payments
triggering the required disclosures, without any intervening text or
graphical displays, the disclosures are deemed to be in close
proximity. Notwithstanding the above, for electronic advertisements
that disclose rates or payments, compliance with the requirements of
Sec. 226.24(e) is deemed to satisfy the clear and conspicuous
standard.
3. Clear and conspicuous standard--Internet advertisements for
credit secured by a dwelling. For purposes of this section, a clear
and conspicuous disclosure for visual text advertisements on the
Internet for credit secured by a dwelling means that the required
disclosures are not obscured by techniques such as graphical
displays, shading, coloration, or other devices and comply with all
other requirements for clear and conspicuous disclosures under Sec.
226.24. See also comment 24(e)-4.
4. Clear and conspicuous standard--televised advertisements for
credit secured by a dwelling. For purposes of this section, and
except as otherwise provided by Sec. 226.24(g) for alternative
disclosures, a clear and conspicuous disclosure in the context of
visual text advertisements on television for credit secured by a
dwelling means that the required disclosures are not obscured by
techniques such as graphical displays, shading, coloration, or other
devices, are displayed in a manner that allows a consumer to read
the information required to be disclosed, and comply with all other
requirements for clear and conspicuous disclosures under Sec.
226.24. For example, very fine print in a television advertisement
would not meet the clear and conspicuous standard if consumers
cannot see and read the information required to be disclosed.
5. Clear and conspicuous standard--oral advertisements for
credit secured by a dwelling. For purposes of this section, and
except as otherwise provided by Sec. 226.24(g) for alternative
disclosures, a clear and conspicuous disclosure in the context of an
oral advertisement for credit secured by a dwelling, whether by
radio, television, or other medium, means that the required
disclosures are given at a speed and volume sufficient for a
consumer to hear and comprehend them. For example, information
stated very rapidly at a low volume in a radio or television
advertisement would not meet the clear and conspicuous standard if
consumers cannot hear and comprehend the information required to be
disclosed.[ltrif]
24[rtrif](c)[ltrif][lsqbb](b)[rsqbb] Advertisement of rate of
finance charge.
* * * * *
2. Simple or periodic rates. The advertisement may not
simultaneously state any other rate, except that a simple annual
rate or periodic rate applicable to an unpaid balance may appear
along with (but not more conspicuously than) the annual percentage
rate. [rtrif]An advertisement for credit secured by a dwelling may
not state a periodic rate, other than a simple annual rate, that is
applied to an unpaid balance.[ltrif] For
example[rtrif],[ltrif][lsqbb]:[rsqbb]
[[Page 1730]]
[lsqbb] I[rsqbb][rtrif]i[ltrif]n an advertisement for
[lsqbb]real estate[rsqbb] [rtrif]credit secured by a
dwelling[ltrif], a simple [rtrif]annual[ltrif] interest rate may be
shown in the same type size as the annual percentage rate for the
advertised credit[rtrif], subject to the requirements of section
226.24(f)[ltrif]. [rtrif]A simple annual rate or periodic rate that
is applied to an unpaid balance is the rate at which interest is
accruing; those terms do not include a rate lower than the rate at
which interest is accruing, such as an effective rate, payment rate,
or qualifying rate.[ltrif]
3. Buydowns. When a third party (such as a seller) or a creditor
wishes to promote the availability of reduced interest rates
(consumer or seller buydowns), the advertised annual percentage rate
must be determined in accordance with [lsqbb]the rules in[rsqbb] the
commentary to Sec. 226.17(c) regarding the basis of transactional
disclosures for buydowns. The seller or creditor may advertise the
reduced simple interest rate, provided the advertisement shows the
limited term to which the reduced rate applies and states the simple
interest rate applicable to the balance of the term. The
advertisement may also show the effect of the buydown agreement on
the payment schedule for the buydown period[rtrif], but this
will[ltrif] [lsqbb]without[rsqbb] trigger[lsqbb]ing[rsqbb] the
additional disclosures under Sec.
226.24[rtrif](d)[ltrif][lsqbb](c)[rsqbb](2). [lsqbb]For example, the
advertisement may state that ``with this buydown arrangement, your
monthly payments for the first three years of the mortgage term will
be only $350'' or ``this buydown arrangement will reduce your
monthly payments for the first three years of the mortgage term by
$150.''[rsqbb]
[lsqbb]4. Effective rates. In some transactions the consumer's
payments may be based upon an interest rate lower than the rate at
which interest is accruing. The lower rate may be referred to as the
effective rate, payment rate, or qualifying rate. A creditor or
seller may advertise such rates by stating the term of the reduced
payment schedule, the interest rate upon which the reduced payments
are calculated, the rate at which the interest is in fact accruing,
and the annual percentage rate. The advertised annual percentage
rate that must accompany this rate must take into account the
interest that will accrue but will not be paid during this period.
For example, an advertisement may state, ``An effective first-year
interest rate of 10 percent. Interest being earned at 14 percent.
Annual percentage rate 15 percent.''[rsqbb]
[rtrif]4[ltrif][lsqbb]5[rsqbb]. Discounted variable-rate
transactions. The advertised annual percentage rate for discounted
variable-rate transactions must be determined in accordance with
comment 17(c)(1)-10 regarding the basis of transactional disclosures
for such financing.
[rtrif]i.[ltrif] A creditor or seller may promote the
availability of the initial rate reduction in such transactions by
advertising the reduced [lsqbb]initial[rsqbb] [rtrif]simple
annual[ltrif] rate, provided the advertisement shows [rtrif]with
equal prominence and in close proximity[ltrif] the limited term to
which the reduced rate applies [rtrif]and the annual percentage rate
that will apply after the term of the initial rate reduction
expires. See Sec. 226.24(f)[ltrif].
[rtrif]ii.[ltrif][lsqbb][rsqbb] Limits or caps on
periodic rate or payment adjustments need not be stated. To
illustrate using the second example in comment 17(c)(1)-10, the fact
that the rate is presumed to be 11 percent in the second year and 12
percent for the remaining 28 years need not be included in the
advertisement.
[rtrif]iii.[ltrif][lsqbb][rsqbb] The advertisement may
also show the effect of the discount on the payment schedule for the
discount period[rtrif], but this will[ltrif] [lsqbb]without[rsqbb]
trigger[lsqbb]ing[rsqbb] the additional disclosures under Sec.
226.24(d). [lsqbb]For example, the advertisement may state that
``with this discount, your monthly payments for the first year of
the mortgage term will be only $577'' or ``this discount will reduce
your monthly payments for the first year of mortgage term by
$223.''[rsqbb]
24[rtrif](d)[ltrif][lsqbb](c)[rsqbb] Advertisement of terms that
require additional disclosures.
1. General rule. Under Sec.
226.24[rtrif](d)[ltrif][lsqbb](c)[rsqbb](1), whenever certain
triggering terms appear in credit advertisements, the additional
credit terms enumerated in Sec.
226.24[rtrif](d)[ltrif][lsqbb](c)[rsqbb](2) must also appear. These
provisions apply even if the triggering term is not stated
explicitly but may be readily determined from the advertisement. For
example, an advertisement may state ``80 percent financing
available,'' which is in fact indicating that a 20 percent
downpayment is required.
Paragraph 24[rtrif](d)[ltrif][lsqbb](c)[rsqbb](1).
* * * * *
3. Payment amount. The dollar amount of any payment includes
statements such as:
``Payable in installments of $103''
``$25 weekly''
[rtrif] ``$500,000 loan for just $1,650 per
month''[ltrif]
``$1,200 balance payable in 10 equal installments''
In the last example, the amount of each payment is readily
determinable, even though not explicitly stated. But statements such
as ``monthly payments to suit your needs'' or ``regular monthly
payments'' are not covered.
* * * * *
Paragraph 24[rtrif](d)[ltrif][lsqbb](c)[rsqbb](2).
* * * * *
2. Disclosure of repayment terms. [lsqbb]While
t[rsqbb][rtrif]T[ltrif]he phrase ``terms of repayment'' generally
has the same meaning as the ``payment schedule'' required to be
disclosed under Sec. 226.18(g)[rtrif].[ltrif][lsqbb],[rsqbb]
[lsqbb]s[rsqbb][rtrif]S[ltrif]ection
226.24[rtrif](d)[ltrif][lsqbb](c)[rsqbb](2)(ii) provides
[lsqbb]greater[rsqbb] flexibility to creditors in making this
disclosure for advertising purposes. Repayment terms may be
expressed in a variety of ways in addition to an exact repayment
schedule; this is particularly true for advertisements that do not
contemplate a single specific transaction. [rtrif]Repayment terms,
however, must reflect the consumer's repayment obligations over the
full term of the loan, including any balloon payment, see comment
24(d)(2)(iii), not just the repayment terms that will apply for a
limited period of time.[ltrif] For example:
[rtrif]i.[ltrif][lsqbb][rsqbb] A creditor may use a
unit-cost approach in making the required disclosure, such as ``48
monthly payments of $27.83 per $1,000 borrowed.''
[lsqbb] In an advertisement for credit secured by a
dwelling, when any series of payments varies because of a graduated-
payment feature or because of the inclusion of mortgage insurance
premiums, a creditor may state the number and timing of payments,
and the amounts of the largest and smallest of those payments, and
the fact that other payments will vary between those amounts.[rsqbb]
[rtrif]ii. In an advertisement for credit secured by a dwelling,
when any series of payments varies because of the inclusion of
mortgage insurance premiums, a creditor may state the number and
timing of payments, the amounts of the largest and smallest of those
payments, and the fact that other payments will vary between those
amounts.
iii. In an advertisement for credit secured by a dwelling, when
one series of monthly payments will apply for a limited period of
time followed by a series of higher monthly payments for the
remaining term of the loan, the advertisement must state the number
and time period of each series of payments, and the amounts of each
of those payments. For this purpose, the creditor must assume that
the consumer makes the lower series of payments for the maximum
allowable period of time.
3. Balloon payment; disclosure of repayment terms. In some
transactions, a balloon payment will occur when the consumer only
makes the minimum payments specified in an advertisement. A balloon
payment results if paying the minimum payments does not fully
amortize the outstanding balance by a specified date or time,
usually the end of the term of the loan, and the consumer must repay
the entire outstanding balance at such time. If a balloon payment
will occur when the consumer only makes the minimum payments
specified in an advertisement, the advertisement must state with
equal prominence and in close proximity to the minimum payment
statement the amount and timing of the balloon payment that will
result if the consumer makes only the minimum payments for the
maximum period of time that the consumer is permitted to make such
payments.
4.[ltrif][lsqbb]3.[rsqbb] Annual percentage rate. The advertised
annual percentage rate may be expressed using the abbreviation APR.
The advertisement must also state, if applicable, that the annual
percentage rate is subject to increase after consummation.
[rtrif]5.[ltrif][lsqbb]4.[rsqbb] Use of examples. [rtrif]A
creditor may use[ltrif] [lsqbb]Footnote 49 authorizes the use
of[rsqbb] illustrative credit transactions to make the necessary
disclosures under Sec. 226.24[rtrif](d)[ltrif][lsqbb](c)[rsqbb](2).
That is, where a range of possible combinations of credit terms is
offered, the advertisement may use examples of typical transactions,
so long as each example contains all of the applicable terms
required by Sec. 226.24[rtrif](d)[ltrif][lsqbb](c)[rsqbb]. The
examples must be labeled as such and must reflect representative
credit terms [lsqbb]that are[rsqbb] made available by the creditor
to present and prospective customers.
24[rtrif](e)[ltrif][lsqbb](d)[rsqbb] Catalogs or other multiple-
page advertisements; electronic advertisements.
1. Definition. The multiple-page advertisements to which this
section refers are advertisements consisting of a series of
[[Page 1731]]
sequentially numbered pages--for example, a supplement to a
newspaper. A mailing consisting of several separate flyers or pieces
of promotional material in a single envelope does not constitute a
single multiple-page advertisement for purposes of Sec.
226.24[rtrif](e)[ltrif][lsqbb](d)[rsqbb].
2. General. Section 226.24[rtrif](e)[ltrif][lsqbb](d)[rsqbb]
permits creditors to put credit information together in one place in
a catalog or other multiple-page advertisement or in an electronic
advertisement (such as an advertisement appearing on an Internet Web
site). The rule applies only if the advertisement contains one or
more of the triggering terms from Sec.
226.24[rtrif](d)[ltrif][lsqbb](c)[rsqbb](1). A list of different
annual percentage rates applicable to different balances, for
example, does not trigger further disclosures under Sec.
226.24[rtrif](d)[ltrif][lsqbb](c)[rsqbb](2) and so is not covered by
Sec. 226.24[rtrif](e)[ltrif][lsqbb](d)[rsqbb].
* * * * *
4. Electronic advertisement. If an electronic advertisement
(such as an advertisement appearing on an Internet Web site)
contains the table or schedule permitted under Sec.
226.24[rtrif](e)[ltrif][lsqbb](d)[rsqbb](1), any statement of terms
set forth in Sec. 226.24[rtrif](d)[ltrif][lsqbb](c)[rsqbb](1)
appearing anywhere else in the advertisement must clearly direct the
consumer to the location where the table or schedule begins. For
example, a term triggering additional disclosures may be accompanied
by a link that directly takes the consumer to the additional
information.
[rtrif]24(f) Disclosure of rates and payments in advertisements
for credit secured by a dwelling.
1. Equal prominence, close proximity. Information required to be
disclosed under Sec. Sec. 226.24(f)(2)(i) and 226.24(f)(3)(i) that
is in the same paragraph as the simple annual rate or payment amount
(not in a footnote to that paragraph) is deemed to be closely
proximate to the listing. Information required to be disclosed under
Sec. Sec. 226.24(f)(2)(i) and 226.24(f)(3)(i)(A) and (B) that is in
the same type size as the simple annual rate or payment amount is
deemed to be equally prominent.
2. Clear and conspicuous standard. For more information about
the applicable clear and conspicuous standard, see comment 24(b)-2.
3. Comparisons in advertisements. When making any comparison in
an advertisement between an actual or hypothetical consumer's
current credit payments or rates and the payments or rates available
under the advertised product, the advertisement must state all
applicable payments or rates for the advertised product and the time
periods for which those payments or rates will apply, as required by
this section.
4. Application to variable-rate transactions--disclosure of
rates. In advertisements for variable-rate transactions, if a simple
annual rate that applies at consummation is not based on the index
and margin that will be used to make subsequent rate adjustments
over the term of the loan, the requirements of Sec. 226.24(f)(2)(i)
apply.
5. Reasonably current index and margin. For the purposes of this
section, an index and margin is considered reasonably current if:
i. For direct mail advertisements, it was in effect within 60
days before mailing;
ii. For advertisements in electronic form, it was in effect
within 30 days before the advertisement is sent to a consumer's e-
mail address, or in the case of an advertisement made on an Internet
Web site, when viewed by the public; or
iii. For printed advertisements made available to the general
public, including ones contained in a catalog, magazine, or other
generally available publication, it was in effect within 30 days
before printing.
24(f)(3) Disclosure of payments.
1. Amounts and time periods of payments. Section 226.24(f)(3)(i)
requires disclosure of the amounts and time periods of all payments
that will apply over the term of the loan. This section may require
disclosure of several payment amounts, including any balloon
payment. For example, if an advertisement for credit secured by a
dwelling offers $300,000 of credit with a 30-year loan term for a
payment of $600 per month for the first six months, increasing to
$1,500 per month after month six, followed by a balloon payment of
$30,000 at the end of the loan term, the advertisement must disclose
the amount and time periods of each of the two monthly payment
streams, as well as the amount and timing of the balloon payment,
with equal prominence and in close proximity to each other.
2. Application to variable-rate transactions--disclosure of
payments. In advertisements for variable-rate transactions, if the
payment that applies at consummation is not based on the index and
margin that will be used to make subsequent payment adjustments over
the term of the loan, the requirements of Sec. 226.24(f)(3)(i)
apply.
24(g) Alternative disclosures--television or radio
advertisements.
1. Toll-free number, local or collect calls. In complying with
the disclosure requirements of Sec. 226.24(g), an advertisement
must provide a toll-free telephone number. Alternatively, an
advertisement may provide any telephone number that allows a
consumer to reverse the phone charges when calling for information.
2. Multi-purpose number. When an advertised toll-free telephone
number provides a recording, disclosures should be provided early in
the sequence to ensure that the consumer receives the required
disclosures. For example, in providing several options--such as
providing directions to the advertiser's place of business--the
option allowing the consumer to request disclosures should be
provided early in the telephone message to ensure that the option to
request disclosures is not obscured by other information.
3. Statement accompanying toll free number. Language must
accompany a telephone number indicating that disclosures are
available by calling the toll-free number, such as ``call 1-800-000-
0000 for details about credit costs and terms.''
24(h) Statements of tax deductibility.
1. When disclosures not required. An advertisement for a home-
secured loan where the loan's terms do not allow for extensions of
credit greater than the fair market value of the consumer's dwelling
need not give the disclosures regarding which portions of the
interest are tax deductible.
24(i) Prohibited acts or practices in advertisements for credit
secured by a dwelling.
1. Misleading comparisons in advertisements--savings claims. A
misleading comparison includes a claim about the amount a consumer
may save under the advertised product. For example, a statement such
as ``save $300 per month on a $300,000 loan'' constitutes an implied
comparison between the advertised product's payment and a consumer's
current payment.
2. Misrepresentations about government endorsement. A statement
that the federal Community Reinvestment Act entitles the consumer to
refinance his or her mortgage at the low rate offered in the
advertisement is prohibited because it conveys a misleading
impression that the advertised product is endorsed or sponsored by
the federal government.
3. Misleading claims of debt elimination. The prohibition
against misleading claims of debt elimination or waiver or
forgiveness does not apply to claims that the advertised product may
reduce debt payments, consolidate debts, or shorten the term of the
debt. Examples of misleading claims of debt elimination or waiver or
forgiveness of loan terms with, or obligations to, another creditor
of debt include: ``Wipe-Out Personal Debts!'', ``New DEBT-FREE
Payment'', ``Set yourself free; get out of debt today'', ``Refinance
today and wipe your debt clean!'', ``Get yourself out of debt * * *
Forever!'', and ``Pre-payment Penalty Waiver.''[ltrif]
Subpart E--Special Rules for Certain Home Mortgage Transactions
Section 226.32--Requirements for Certain Closed-End Home Mortgages
32(a) Coverage.
* * * * *
[rtrif]Paragraph 32(a)(2)
1. Exemption limited. Section 226.32(a)(2) lists certain
transactions as being exempt from the provisions of Sec. 226.32.
Nevertheless, those transactions may be subject to the provisions of
Sec. 226.35, including any provisions of Sec. 226.32 to which
Sec. 226.35 refers. See 12 CFR 226.35(a).[ltrif]
* * * * *
32(d) Limitations.
[rtrif]1. Additional prohibitions applicable under other
sections. Section 226.34 sets forth certain prohibitions in
connection with mortgage credit subject to Sec. 226.32, in addition
to the limitations in Sec. 226.32(d). Further, Sec. 226.35(b)
prohibits certain practices in connection with transactions that
meet the coverage test in Sec. 226.35(a). Because the coverage test
in Sec. 226.35(a) is generally broader than the coverage test in
Sec. 226.32(a), most Sec. 226.32 mortgage loans are also subject
to the prohibitions set forth in Sec. 226.35(b), in addition to the
limitations in Sec. 226.32(d).[ltrif]
* * * * *
32(d)(7) Prepayment penalty exception.
[rtrif]1. Other application of section. The conditions in Sec.
226.32(d)(7) apply to prepayment penalties on mortgage transactions
described in Sec. 226.32(a). In
[[Page 1732]]
addition, these conditions apply to mortgage transactions covered by
Sec. 226.35(a).[ltrif]
Paragraph 32(d)(7)(iii).
[lsqbb]1. Calculating debt-to-income ratio. ``Debt'' does not
include amounts paid by the borrower in cash at closing or amounts
from the loan proceeds that directly repay an existing debt.
Creditors may consider combined debt-to-income ratios for
transactions involving joint applicants.
2. Verification. Verification of employment satisfies the
requirement for payment records for employment income.[rsqbb]
[rtrif]1. Classifying debt and income. To determine whether to
classify particular funds or obligations as ``debt'' or ``income''
under the prepayment penalty exception in Sec. 226.32(d)(7)(iii),
creditors may look to widely accepted governmental and non-
governmental underwriting standards, including, for example, those
set forth in the Federal Housing Administration's handbook on
Mortgage Credit Analysis for Mortgage Insurance on One-to Four-Unit
Mortgage Loans.
2. Debt described. i. For purposes of Sec. 226.32(d)(7)(iii),
``debt'' includes, but is not limited to, the consumer's liabilities
and obligations for:
A. Housing expenses;
B. Loans such as installment and real estate loans;
C. Open-end credit plans; and
D. Alimony, child support, and separate maintenance.
ii. ``Debt'' does not include amounts paid by a borrower in cash
at closing or amounts from the loan proceeds that directly repay an
existing debt.
3. Income described. For purposes of Sec. 226.32(d)(7)(iii),
``income'' includes, but is not limited to, funds a consumer
receives:
i. From employment (whether full-time, part-time, seasonal,
military, or self-employment), including without limitation salary,
wages, base pay, overtime pay, bonus pay, tips, and commissions;
ii. As interest or dividends;
iii. As retirement benefits or public assistance; and
iv. As alimony, child support, or separate maintenance payments,
to the extent permitted under Regulation B, 12 CFR 202.5(d)(2),
202.6(b)(5).
4. Verification. Creditors shall verify income in the manner
described in Sec. 226.35(b)(2)(i) and the related comments.
Creditors may verify debt with a credit report.
Paragraph 32(d)(7)(iv).
1. Changes in payment amounts. Section 226.32(d)(7)(iv) permits
a prepayment penalty only if the period during which the penalty may
be imposed ends at least sixty days prior to the first date, if any,
on which the principal or interest payment amount may increase under
the terms of the loan. This permits a consumer to refinance or
otherwise pay off all or part of the loan, without a penalty, sixty
days before there is an increase in the payment of interest or
principal. For example, the principal or interest payment amount may
increase because--
i. The loan's interest rate increases;
ii. Scheduled payments of principal or interest increase
independently of interest rate changes, for example with a graduated
or step-rate transaction; or
iii. Negative amortization occurs and, under the loan terms,
triggers an increase in principal or interest payment amounts.
2. Payment increases excluded from Sec. 226.32(d)(7)(iv).
Payment increases due to the following circumstances are not
considered payment increases for purposes of Sec. 226.32(d)(7)(iv):
i. Actual unanticipated late payment, the borrower's
delinquency, or default; and
ii. Increased payments made solely at the consumer's option,
such as when a consumer chooses to make a payment of interest and
principal on a loan that only requires the consumer to pay
interest.[ltrif]
* * * * *
Section 226.34--Prohibited Acts or Practices in Connection with
Credit [lsqbb]Secured by a Consumer's Dwelling; Open-end
Credit[rsqbb] [rtrif]Subject to Sec. 226.32[ltrif]
34(a) Prohibited acts or practices for loans subject to Sec.
226.32.
* * * * *
34(a)(4) Repayment ability.
[rtrif]1. Application of repayment ability rule to Sec.
226.35(a) higher-cost mortgage loans. The Sec. 226.34(a)(4)
prohibition against a pattern or practice of making loans without
regard to consumers' repayment ability applies to creditors making
mortgage loans described in Sec. 226.32(a). In addition, the Sec.
226.34(a)(4) prohibition applies to creditors making higher-cost
mortgage transactions, including residential mortgage transactions,
described in Sec. 226.35(a). See 12 CFR 226.35(b)(1).
2. Determination as of consummation. Section 226.34(a)(4)
prohibits a creditor from engaging in a pattern or practice of
extending credit subject to Sec. 226.32 to consumers based on the
value of consumers' collateral without regard to consumers'
repayment ability as of consummation. This prohibition is based on
the facts and circumstances that existed as of consummation. Events
after consummation may be relevant to determining whether a creditor
has violated Sec. 226.34(a)(4), but events after consummation do
not, by themselves, establish a violation. For example, a violation
is not established if borrowers default after consummation because
of serious illness or job loss.[ltrif]
[lsqbb]1.[rsqbb][rtrif]3.[ltrif] Income[rtrif], assets, and
employment[ltrif]. Any [rtrif]current or reasonably expected assets
or current or reasonably[ltrif] expected income [lsqbb]can[rsqbb]
[rtrif]may[ltrif] be considered by the creditor, except [rtrif]the
collateral itself[ltrif] [lsqbb]equity income that would be realized
from collateral[rsqbb]. For example, a creditor may use information
about [rtrif]current or expected[ltrif] income other than regular
salary or wages, such as income described in paragraph
226.32(d)(7)(iii)-(3) [lsqbb]such as gifts, expected retirement
payments, or income from self-employment, such as housecleaning or
childcare[rsqbb]. [rtrif]Employment should also be considered. In
some circumstances, it may be appropriate or necessary to take into
account expected changes in employment. For example, depending on
all of the facts and circumstances, it may be reasonable to assume
that students obtaining professional degrees or certificates will
obtain employment upon receiving the degree or certificate. In other
circumstances, a creditor may have information indicating that an
employed person will become unemployed. A creditor may also take
into account assets such as savings accounts or investments that can
be used by the consumer.[ltrif]
[lsqbb]2.[rsqbb][rtrif]4.[ltrif] Pattern or practice of
extending credit--repayment ability. Whether a creditor [lsqbb]is
engaging in or[rsqbb] has engaged in a pattern or practice of
violations of this section depends on the totality of the
circumstances in the particular case. While a pattern or practice is
not established by isolated, random, or accidental acts, it can be
established without the use of a statistical process. In addition, a
creditor might act under a lending policy (whether written or
unwritten) and that action alone could establish a pattern or
practice of making loans in violation of this section.
[lsqbb]3. Discounted introductory rates. In transactions where
the creditor sets an initial interest rate to be adjusted later
(whether fixed or to be determined by an index or formula), in
determining repayment ability the creditor must consider the
consumer's ability to make loan payments based on the non-discounted
or fully-indexed rate at the time of consummation.[rsqbb]
[lsqbb]4. Verifying and documenting income and obligations.
Creditors may verify and document a consumer's repayment ability in
various ways. A creditor may verify and document a consumer's income
and current obligations through any reliable source that provides
the creditor with a reasonable basis for believing that there are
sufficient funds to support the loan. Reliable sources include, but
are not limited to, a credit report, tax returns, pension
statements, and payment records for employment income.[rsqbb]
[rtrif]Paragraph 34(a)(4)(i).
1. Presumptions. Section 226.34(a)(4)(i) sets forth particular
patterns or practices that would create a presumption that a
creditor has violated Sec. 226.34(a)(4). These presumptions may be
rebutted with sufficient evidence that a creditor did not engage in
a pattern or practice of disregarding repayment ability. These
presumptions are also not exhaustive. That is, a creditor may
violate Sec. 226.34(a)(4) by patterns or practices other than those
specified in Sec. 226.34(a)(4)(i).
Paragraph 34(a)(4)(i)(A).
1. Failure to verify income and assets relied on. A creditor is
presumed to have violated the prohibition on lending without regard
to repayment ability if the creditor has engaged in a pattern or
practice of failing to verify and document repayment ability. A
pattern or practice of failing to document and verify income and
assets relied on to make the credit decision as required by Sec.
226.35(b)(2)(i) would trigger this presumption.
2. Failure to verify obligations. A pattern or practice of
failing to verify obligations would also trigger this presumption.
In general, a credit report may be used to verify obligations. Where
two different creditors are extending loans simultaneously, one a
first-lien loan and the other a subordinate-lien loan, each creditor
is expected to verify the obligation the consumer is undertaking
with the other creditor. A pattern or practice of
[[Page 1733]]
failing to do so would create a presumption of a violation.
Paragraph 34(a)(4)(i)(B).
1. Variable rate loans. For some variable rate loans, the
initial interest rate is not based on the index and margin or
formula used for later adjustments. In such cases, a pattern or
practice of failing to consider the consumer's ability to make loan
payments based on the index and margin or formula used for later
adjustments, or the initial interest rate, if greater than the sum
of the index and margin at consummation, would lead to a presumption
that the creditor has violated Sec. 226.34(a)(4)(i)(B). For
examples of these and other variable rate loans, see comment
17(c)(1)-10.
Paragraph 34(a)(4)(i)(D).
1. Failure to consider debt-to-income ratio. A creditor is
presumed to have violated the prohibition against lending without
regard to repayment ability if the creditor has engaged in a pattern
or practice of failing to consider the ratio of consumers' total
debt obligations to consumers' income. For this purpose, a creditor
may rely on the commentary to Sec. 226.32(d)(7)(iii) to determine
the components of debt and income. Unlike Sec. 226.32(d)(7)(iii),
however, Sec. 226.34(a)(4)(i)(D) does not identify a specific debt
to income ratio. Although a pattern of unusually high ratios may be
evidence that a creditor has violated Sec. 226.34(a)(4), compliance
is determined on the basis of all the facts and circumstances
relevant to repayment ability.
Paragraph 34(a)(4)(i)(E).
1. Failure to consider residual income. A creditor is presumed
to have violated the prohibition against lending without regard to
repayment ability if the creditor has engaged in a pattern or
practice of failing to consider consumers' residual income.
Paragraph (a)(4)(i)(E) requires a creditor to consider whether
consumers will have sufficient income, after paying the new
obligation and existing obligations, to cover ordinary living
expenses.[ltrif]
* * * * *
[rtrif]Section 226.35--Acts or Practices in Connection With Higher-
priced Mortgage Loans
35(a) Coverage.
1. In general. To determine whether a loan is a higher-priced
mortgage loan for purposes of the limitations set forth in this
section, a creditor must use the rules for determining the
applicable Treasury security set forth in Sec. 226.35(a). (Note:
these rules are different from the rules in Sec. 226.32(a).)
2. Treasury securities. To determine the yield on comparable
Treasury securities, creditors may use the yield on actively traded
issues adjusted to constant maturities published in the Board's
``Selected Interest Rates'' (statistical release H-15). Further
guidance can be found in comments 35(a)(2)-1 and 35(a)(3)-1.
Paragraph 35(a)(2).
1. In general. Section 226.35(a)(2) sets forth the rules for
identifying comparable Treasury securities for variable rate
transactions. A variable rate transaction is one in which the annual
percentage rate may increase after consummation. (See comment
226.18(f)-1. See also comments 226.17(c)(1)-8 and -10 for guidance
on calculating the annual percentage rate for a variable rate
transaction.) The rules in Sec. 226.35(a)(2) apply to all variable
rate transactions, regardless of whether the initial rate is a
discounted or premium rate, or is determined by the index and margin
used to make later adjustments. If the initial interest rate is
fixed for more than one year, Sec. 226.35(a)(2) requires the
creditor to use the yield on the Treasury security matching the
duration of the initial interest rate. For example--
i. In the case of a variable rate loan with an initial interest
rate fixed for the first five years based on the value of the index
at consummation plus the margin, and adjusting thereafter, a
creditor would use the yield on the constant maturity of five years,
such as published in the statistical release H-15;
ii. In the case of a variable rate loan with an initial interest
rate that is a discounted or premium rate for the first five years
and adjusts thereafter based on an index and margin, a creditor
would use the yield on the constant maturity of five years published
in the statistical release H-15;
iii. In the case of a variable rate loan, if the initial
interest rate is fixed for the first four years (either at the value
of the index at consummation plus margin or at a discounted or
premium rate), and the statistical release H-15 does not report a
constant maturity of four years but reports a maturity of three
years and a maturity of five years, the creditor may use the yield
from either maturity; and
iv. In the case of a variable rate loan, if the interest rate
will adjust within the first year, the creditor would use the yield
on the constant maturity of one year regardless of the length of any
initial rate. For example, if the initial interest rate is fixed for
one month and adjusts monthly thereafter, the creditor would use the
yield on the constant maturity of one year.
Paragraph 35(a)(3).
1. In general. Section 226.35(a)(3) sets forth the rules for
identifying yields on comparable Treasury securities for
transactions other than variable rate transactions. Under these
rules, for a transaction with a term of 30 years, the creditor would
compare the APR to the yield on the constant Treasury maturity of
ten years on statistical release H-15. For a transaction with a term
of 15 years, the creditor would use the yield on the constant
Treasury maturity of seven years. For a transaction with a term of
five years, the creditor would use the yield on the constant
Treasury maturity of five years.
2. Balloon loans. A creditor must look to the term of the loan
regardless of the amortization period of the loan. For example, if a
creditor extends a five-year ``balloon'' loan with payments based on
a 30-year amortization, the creditor should use the yield on the
constant Treasury maturity of five years.
Paragraph 35(a)(4).
1. Application date. An application is deemed received when it
reaches the creditor in any of the ways applications are normally
transmitted. See comment 226.19(a)(1)-3. An application transmitted
through an intermediary agent or broker is received when it reaches
the creditor, rather than when it reaches the agent or broker. See
comment 19(b)-3 to determine whether a transaction involves an
intermediary agent or broker.
2. When 15th of the month is not a business day. If the most
recent 15th of the month is not a business day, the creditor must
use the yield on the constant Treasury maturity as of the business
day immediately preceding the 15th.
Paragraph 35(b)(2).
1. Income and assets relied on. A creditor must comply with
Sec. 226.35(b)(2)(i) with respect to the income and assets relied
on in evaluating the creditworthiness of consumers. For example, if
a consumer earns both a salary and an annual bonus, but the creditor
only relies on the applicant's salary to evaluate creditworthiness,
the creditor need only comply with Sec. 226.35(b)(2)(i) with
respect to the salary.
2. Income and assets--co-applicant. If two persons jointly apply
for credit and both list income or assets on the application, the
creditor must comply with Sec. 226.35(b)(2) with respect to both
applicants unless the creditor only relies on the income or assets
of one of the applicants.
3. Income and assets--guarantors. A creditor does not need to
comply with Sec. 226.35(b)(2) with respect to the income or assets
of a person who is not primarily liable on the obligation, such as a
guarantor.
4. Expected income. A creditor may rely on a consumer's expected
income, except equity income that would be realized from collateral,
so long as the creditor verifies the basis for that expectation
using documents listed under Sec. 226.35(b)(2)(i), including third-
party documents that provide reasonably reliable evidence of the
borrower's expected income. For example, if, based on a consumer's
statement, the creditor relies on an expectation that a consumer
will receive an annual bonus, the creditor may verify the basis for
that expectation with documents that show the consumer's past annual
bonuses. Similarly, if the creditor relies on a consumer's expected
salary following the consumer's receipt of an educational degree,
the creditor may verify that expectation with a written statement
from an employer indicating that the consumer will be employed upon
graduation and the salary.
Paragraph 35(b)(2)(i).
1. Internal Revenue Service (IRS) Form W-2. A creditor may
verify a consumer's income using an IRS Form W-2 (or any subsequent
revisions or similar IRS Forms used for reporting wages and tax
withholding). The lender may also use an electronic retrieval
service for obtaining the consumer's W-2 information.
2. Tax returns. A creditor may verify a consumer's income or
assets using the consumer's tax return. A creditor may also use IRS
Form 4506 ``Request for Copy of Tax Return,'' Form 4506-T ``Request
for Transcript of Tax Return,'' or Form 8821 ``Tax Information
Authorization'' (or any subsequent revisions or similar IRS Forms
appropriate for obtaining tax return information directly from the
IRS) to verify the consumer's income or assets. The lender
[[Page 1734]]
may also use an electronic retrieval service for obtaining tax
return information.
3. Other third-party documents that provide reasonably reliable
evidence of consumer's income or assets. Creditors may verify income
and assets using other documents produced by third parties that
provide reasonably reliable evidence of the consumer's income or
assets. For example, creditors may verify the consumer's income
using receipts from a check-cashing service, or by obtaining a
written statement from the consumer's employer that states the
consumer's income.
4. Duplicative collection of documentation. A creditor that has
made a loan to a consumer and is refinancing or extending new credit
to the same consumer need not collect from the consumer a document
the creditor previously examined if that document presumably will
not have changed since it was initially collected. For example, if
the creditor has collected the consumer's 2006 tax return to make a
loan in May 2007, the creditor may rely on the 2006 tax return if
the creditor makes another loan to the same consumer in August 2007.
Using the same example, if the creditor has collected the consumer's
bank statement for May 2007 in making the first loan, the creditor
may rely on that bank statement for that month in making the
subsequent loan in August.
Paragraph 35(b)(2)(ii).
1. No violation if income or assets relied on were not
materially greater than verifiable amounts. A creditor must verify
amounts of income or assets relied upon in extending credit for a
higher-priced mortgage loan. However, the creditor does not violate
Sec. 226.35(b)(2) if it demonstrates that the income or assets
relied upon were not materially greater than the amounts that the
creditor would have been able to verify pursuant to Sec.
226.35(b)(2)(i) at consummation. For example, if a creditor approves
an extension of credit relying on a consumer's annual income of
$40,000 but fails to obtain documentation of that amount before
extending the credit, the creditor will not have violated this
section if the creditor later obtains evidence that would satisfy
Sec. 226.35(b)(2)(i), such as tax return information, showing that
the consumer had an annual income of at least $40,000 at the time
the loan was consummated.[ltrif]
[rtrif]Section 226.36--Prohibited Acts or Practices in Connection
with Credit Secured by a Consumer's Principal Dwelling
36(a) Creditor payments to mortgage brokers.
Paragraph 36(a)(1).
1. Timing of agreement. The agreement under Sec. 226.36(a)(1)
must be entered into by the consumer and mortgage broker before the
consumer pays a fee to any person or submits a written application
for the credit transaction to the broker, whichever occurs first.
The agreement must be entered into before the consumer's payment of
any fee, regardless of whether the fee is received or retained by
the broker. The agreement also must be entered into before the
consumer submits a written application for the credit transaction to
the broker.
2. Written agreement. The agreement under Sec. 226.36(a)(1)
must be in writing and must be a legally enforceable contract under
applicable law. As evidence of compliance with this section, a
creditor may rely on a written agreement that meets the criteria set
forth in Sec. 226.36(a)(1)(i)-(iii) and is signed and
contemporaneously dated by the consumer and the broker, together
with documentation (such as the HUD-1 Settlement Statement prepared
in accordance with RESPA) that the creditor's payment to a broker
does not exceed the amount provided for in the written agreement,
taking into account any portion of that amount received by the
broker directly from the consumer or out of loan proceeds.
3. Clear and conspicuous. The three statements required by Sec.
226.36(a)(1)(i)-(iii) are clear and conspicuous if they are
noticeable, grouped together, and prominently placed on the first
page of the written agreement. They are noticeable if they are at
least as large as the largest type size used in the rest of the
agreement's text. This standard also requires that the statements be
reasonably understandable. The following example would be considered
reasonably understandable: ``The total fee I/we will receive for
your loan is $ ------. You will pay this entire amount. The lender
will increase your interest rate if the lender pays any part of this
amount. A lender payment to a mortgage broker can influence which
loan products and terms the broker offers you, which may not be in
your best interest or may be less favorable than you otherwise could
obtain.''
Paragraph 36(a)(1)(i).
1. Total amount of broker's compensation. The agreement must set
forth the total compensation the mortgage broker will receive and
retain as a dollar amount. The broker's total compensation stated in
the agreement is limited to amounts that the broker both receives
and retains. It does not include amounts received by the broker and
paid to third parties for other services obtained in connection with
the transaction, such as a fee for an appraisal or inspection,
provided such amounts actually are paid to and retained by third
parties.
Paragraph 36(a)(2).
1. Effect of section. Section 226.36(a)(2) provides two
exceptions to the general rule in Sec. 226.36(a)(1). Creditor
payments to mortgage brokers that qualify for either exception are
not subject to the prohibition on creditor payments to mortgage
brokers. Accordingly, in such cases, the agreement prescribed by
Sec. 226.36(a)(1) is not required.
Paragraph 36(a)(2)(i).
1. State statute or regulation. A state statute or regulation
may impose a specific duty on mortgage brokers, under which a broker
may not offer loan products or terms that are less favorable than
the consumer otherwise could obtain through the same broker,
assuming the same loan terms and conditions. For example, such a law
may impose a duty on brokers to act solely in the consumer's best
interests. Where brokers are subject by law to such a duty, and the
applicable statute or regulation requires brokers to provide
consumers with a written agreement that describes the broker's role
and relationship to the consumer, Sec. 226.36(a)(1) does not apply.
Paragraph 36(a)(2)(ii).
1. Compensation not determined by reference to interest rate.
Where a creditor can demonstrate that the compensation it pays to a
mortgage broker is not based on the interest rate for the
transaction, Sec. 226.36(a)(1) does not apply. This exception would
be available, for example, if a creditor can show that it pays
brokers the same flat fee for all transactions, regardless of the
interest rate. Under this exception, unlike the general rule of
Sec. 226.36(a)(1), no part of the broker's compensation may be
based on the interest rate, even if the consumer is aware of the
relationship and agrees to it. Creditor payments to brokers may
vary, however, based on factors other than the interest rate (such
as loan principal amount) without losing this exception.
36(b) Misrepresentation of value of consumer's principal
dwelling.
36(b)(2) When extension of credit prohibited.
1. Reasonable diligence. A creditor will be deemed to have acted
with reasonable diligence under Sec. 226.36(b)(2) if the creditor
extends credit based on an appraisal other than the one subject to
the restriction in Sec. 226.36(b)(2).
36(c) Mortgage broker defined.
1. Meaning of mortgage broker. Section 226.36(c) provides that a
mortgage broker is any person who for compensation or other monetary
gain arranges, negotiates, or otherwise obtains an extension of
consumer credit, but is not an employee of a creditor. In addition,
this definition expressly includes any person that satisfies this
definition but makes use of ``table funding.'' Table funding occurs
when a transaction is consummated with the debt obligation initially
payable by its terms to one person, but another person provides the
funds for the transaction at consummation and receives an immediate
assignment of the note, loan contract, or other evidence of the debt
obligation. Although Sec. 226.2(a)(17)(1)(B) provides that a person
to whom a debt obligation is initially payable on its face generally
is a creditor, Sec. 226.36(c) provides that, solely for the
purposes of Sec. 226.36, such a person is considered a mortgage
broker. In addition, although consumers themselves often arrange,
negotiate, or otherwise obtain extensions of consumer credit on
their own behalf, they do not do so for compensation or other
monetary gain and, therefore, are not mortgage brokers under this
section.
36(d) Servicing practices.
Paragraph 36(d)(1)(i).
1. Crediting of payments. Under Sec. 226.36(d)(1)(i), a
mortgage servicer must credit a payment to a consumer's loan account
as of the date of receipt. This does not require that a mortgage
servicer post the payment to the consumer's loan account on a
particular date; the servicer is only required to credit the payment
as of the date of receipt. Accordingly, a servicer that receives a
payment on or before its due date and does not enter the payment on
its books or in its system until after the payment's due date does
not violate this requirement as long as the entry does not result in
the imposition of a late charge, additional interest, or similar
penalty to the consumer, or in the reporting
[[Page 1735]]
of negative information to a consumer reporting agency.
2. Date of receipt. The ``date of receipt'' is the date that the
payment instrument or other means of payment reaches the mortgage
servicer. For example, payment by check is received when the
mortgage servicer receives it, not when the funds are collected. If
the consumer elects to have payment made by a third-party payor such
as a financial institution, through a preauthorized payment or
telephone bill-payment arrangement, payment is received when the
mortgage servicer receives the third-party payor's check or other
transfer medium, such as an electronic fund transfer.
Paragraph 36(d)(1)(ii).
1. Pyramiding of late fees. The prohibition on pyramiding of
late fees in this subsection should be construed consistently with
the ``credit practices rule'' of Regulation AA, 12 CFR 227.15.
Paragraph 36(d)(1)(iii).
1. Fees and charges imposed by the servicer. The schedule of
fees and charges must include any third-party fees or charges
assessed on the consumer by the servicer.
2. Provision of schedule to consumer. The servicer may provide
the schedule to the consumer in writing or it may direct the
consumer to a specific website address where the schedule is
located. Any such website address reference must be specific enough
to inform the consumer where the schedule is located, rather than
solely referring to the servicer's home page.
3. Dollar amount of fees and charges. The dollar amount of a fee
or charge may be expressed as a flat fee or, if a flat fee is not
feasible, an hourly rate or percentage.
Paragraph 36(d)(1)(iv).
1. Reasonable time. The payoff statement must be provided to the
consumer, or person acting on behalf of the consumer, within a
reasonable time after the request. For example, it would be
reasonable under normal market conditions to provide the statement
within three business days of a consumer's request. This timeframe
might be extended, for example, when the market is experiencing an
unusually high volume of refinancing requests.
2. Person acting on behalf of the consumer. For purposes of
Sec. 226.36(d)(1)(iv), a person acting on behalf of the consumer
may include the consumer's representative, such as an attorney
representing the individual in pre-foreclosure or bankruptcy
proceedings, a non-profit consumer counseling or similar
organization, or a lender with which the consumer is refinancing and
which requires the payoff statement to complete the refinancing.
Paragraph 36(d)(2).
1. Payment requirements. The servicer may specify reasonable
requirements for making payments in writing, such as requiring that
payments be accompanied by the account number; setting a cut-off
hour for payment to be received, or setting different hours for
payment by mail and payments made in person; specifying that only
checks or money orders should be sent by mail; specifying that
payment is to be made in U.S. dollars; or specifying one particular
address for receiving payments, such as a post office box. The
servicer may be prohibited, however, from specifying payment by
preauthorized electronic fund transfer. (See section 913 of the
Electronic Fund Transfer Act.)
2. Implied guidelines for payments. In the absence of specified
requirements for making payments, payments may be made at any
location where the servicer conducts business; any time during the
servicer's normal business hours; and by cash, money order, draft,
or other similar instrument in properly negotiable form, or by
electronic fund transfer if the servicer and consumer have so
agreed.[rtrif]
By order of the Board of Governors of the Federal Reserve
System, December 20, 2007.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. E7-25058 Filed 1-8-08; 8:45 am]
BILLING CODE 6210-01-P