Lenders made millions of mortgages during the decade of the 2000s, some of which were not rigorously underwritten, and for some of which the borrowers had no hope of repaying. As the loans went into default, lenders’ losses mounted and borrowers’ woes increased. The mortgage market’s collapse led to the second greatest economic recession in the last 100 years and nearly brought the United States’ economy to its knees.

To remedy this situation, Congress and various federal agencies required lenders to assess a consumer’s ability to repay a home loan before the creditor could extend the consumer the credit. To encourage responsible lending, Congress provided for penalties where a loan was made to a borrower who did not have the ability to repay it fully. Congress also permitted the regulators to create a “safe harbor” for creditors, where it would be presumed that the borrower had the ability to repay a mortgage loan.

On January 10, 2013, the Consumer Financial Protection Bureau (Bureau) released its final Ability-to-Repay and Qualified Mortgage Rule, effective January 10, 2014. This article will look at that rule by first exploring the background and financial situation that led to the release of the rule, Congress’ statutory enactments permitting the rule, and the final rule itself.

Background

In the early part of the last decade, as housing prices rocketed skyward, lenders began introducing products that permitted borrowers to take advantage of their increasing equity. Lenders moved away from the fully-amortizing, fixed-rate, 30-year loan, and offered hybrid adjustable-rate mortgages where the initial interest rate was set at a below-market rate for a fixed period, such as two, three, five, or seven years. Lenders offered fully adjustable rate loans, where the interest rate was adjusted on a monthly or yearly basis. As the demand for loans increased, both by borrowers and investors, lenders offered loans with an interest-only payment, deferring the repayment of principal for a period of years. This permitted borrowers to obtain larger loans than could be afforded if the loans had to be repaid in equal payments of principal and interest over 30 years. Finally, the industry offered option ARM loans, where a borrower could choose to repay a portion of the interest owed, adding the remainder to an increasing principal balance.

To facilitate these loans, lenders relaxed their underwriting standards. Low-document and no-document loans proliferated. Borrowers could state their income, without offering any verification of it, and lenders would rely on the representations. Lenders would check borrowers’ credit and the value of the property, and little else. As long as the property value elevator rode upward, lenders made the loans, borrowers obtained loans, and investors bought loans.

Many borrowers took advantage of these loans, obtaining cash-out refinances. The cash-out portion may not have been used to improve the value of the property, and was often lost to repayment of other (overextended) debts, or to fund new purchases of vacations, impermanent assets, or consumables. In addition, with the advent of easier-to-obtain loans, new borrowers entered the housing market and became first-time homeowners for a small or no down payment. These borrowers often obtained loans with adjustable rate features or limited principal repayment that exposed the market to risk as payments adjusted or property values declined.

In the middle to late 2000s, the housing market slowed and reversed, and many borrowers were unable to repay their loans. As loans went into default and foreclosures increased, lenders and servicers were overwhelmed, and investors began to take losses. With the collapse of the housing market, America, and the world, entered the most serious recession since the Great Depression.

Reaction to the Housing Crisis – Ability to Repay Consideration

In 2008, the Federal Reserve Board (Board) adopted a rule under the Truth in Lending Act which prohibited creditors from making “higher-price” mortgage loans without assessing consumers’ ability to repay the loans. Under the Board’s rule, a creditor is presumed to have complied with the ability-to-repay requirement if the creditor followed specified underwriting practices.

In 2010, when Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), Sections 1411 and 1412 required lenders to assess consumers’ ability to repay all home loans before extending credit and provided that the regulators could create a safe harbor and presumption of compliance with the ability-to-repay requirement for “qualified mortgages.” Congress set forth the requirements in a new section of the Truth in Lending Act, Section 129C (link here), and permitted rulemaking to interpret the act and provide guidance to the industry and consumers.

The Bureau conducted extensive research and analysis on this issue. It sought public comment on new data and information, and the Bureau met with stakeholders on all sides in formulating the rule. On January 10, 2013, the Bureau released the final rule. (See “Ability to Repay and Qualified Mortgage Standards Under the Truth in Lending Act (Regulation Z)” at www.consumerfinance.gov. See also Ability-to-Repay and Qualified Mortgage Standards under the Truth in Lending Act, Final Rule, 78 Fed. Reg. 6408 (January 30, 2013), to be codified at 12 C.F.R. § 1026.) The Bureau stated that the rule protects consumers from risky practices that helped cause the mortgage crisis. It helps ensure that responsible consumers obtain responsible loans and that creditors can extend credit responsibly, without worrying about competition from unscrupulous lenders.

Under the statute, the ability-to-repay requirements are effective as of January 21, 2013. The final rule delays the implementation of the ability-to-repay requirements until January 10, 2014. If a successful challenge is mounted to the recess appointment of Richard Cordray as director of the Bureau, the ability-to-repay provisions are effective immediately. It is unknown whether they will have a retroactive effect.

Ability-to-Repay Rule

The Ability-to-Repay Rule, Regulation Z Section 1026.43, requires that a creditor make a “reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan according to its terms.” The creditor must follow underwriting requirements and verify the information by using reasonably relied upon third-party records. The rule applies to all residential mortgages including purchase loans, refinances, home equity loans, first liens, and subordinate liens. In short, if the creditor is making a loan secured by a principal residence, second or vacation home, condominium, or mobile or manufactured home, the creditor must verify the borrowers’ ability to repay the loan. The section does not apply to commercial or business loans, even if secured by a personal dwelling. It also does not apply to loans for timeshares, reverse mortgages, loan modifications, and temporary bridge loans.

The creditor must consider and evaluate at least the following eight factors:

Current or reasonably expected income or assets. The creditor may consider borrowers’ assets and income that borrowers will use to repay the loan. The creditor may not consider the value of the secured property, including any equity in the dwelling. Because of seasonal work, or other factors that result in variable income, the creditor may consider current income and “reasonably” expected income. A creditor may also consider a joint applicant’s income and assets.

Current employment status. The creditor must consider borrowers’ current employment status to the extent that the creditor relies on the employment income to repay the loan. If borrowers’ intend to repay the loan with investment income, employment need not be considered.

Monthly payments on the covered transaction. The monthly payment obligation is based on the “full” payment. The payment must be considered on a monthly basis, and be at the fully adjusted indexed rate or the introductory rate, whichever is higher. In short, teaser rates and other “low” starting rates are not to be considered in the ability-to-repay analysis.

Monthly payments on a simultaneous loan. The creditor must consider the “full” monthly payments on any simultaneous loan that the creditor knows or has reason to know will be made on or before consummation when secured by the same dwelling. This includes piggy-back loans, concurrent loans, and open-ended home equity loans, even if made by another creditor. The rule applies to purchases and refinances.

Monthly payments for mortgage-related obligations. The creditor must consider payments for mortgage-related obligations, according to the loan’s terms, and all applicable taxes, hazard insurance, mortgage guarantee insurance, assessments, ground lease payments, and special assessments (if known). The creditor must consider these amounts whether or not an escrow is established. Where these charges are paid on an annual or periodic basis, they are to be calculated as if paid monthly. However, where the charge is a onetime, up-front fee, it need not be considered in the ability-to-repay calculation.

Current debt obligations, alimony, and child support. The creditor must consider borrowers’ other debt obligations that are actually owed. Each applicant’s obligations are to be evaluated, but the creditor does not need to consider other obligations of sureties or guarantors. Creditors are given significant flexibility in this area and may use reasonable means to consider other debt obligations.

Monthly debt-to-income ratio or residual income. The rule gives the creditor flexibility in defining “income” and “debt” based on governmental and non-governmental underwriting standards. The rule also gives the creditor flexibility in evaluating the appropriate debt-to-income ratio in light of residual income. For example, where the debt-to-income ratio is high and the borrowers have a large income, the borrowers should have sufficient remaining income to satisfy living expenses and therefore justify the loan. The determination is subject to a reasonable and good faith standard.

Credit history. A creditor must consider borrowers’ credit histories, but does not have to review a specific credit report or minimum credit score. Creditors may consider factors such as the number and age of credit lines, payment history, and any judgments, collections, or bankruptcies. The creditors must review borrowers’ credit histories and give various aspects as much or little weight as is appropriate to reach a reasonable, good faith determination of borrowers’ ability to repay the loan.

Creditors will typically use third-party records (not prepared by the consumer, creditor, mortgage broker, or any of their agents) to make a reasonable and good faith determination, based on verified and documented information, that a consumer has a reasonable ability to repay the mortgage loan. The rule requires that the creditor retain evidence of the ability to repay for three years. However, because of possible challenges by borrowers to the ability-to-repay determination, it is recommended that creditors and their successors maintain these records for the life of the loan.

The Ability-to-Repay Rule does not apply to every loan. Principally, the rule does not apply where a
non-standard mortgage (such as an adjustable rate loan, interest-only loan, or negative amortization loan) is refinanced into a standard mortgage, where the current creditor provides the refinance, the new payment will be materially (10 percent) lower, and most of the previous payments were timely. However, the ability-to-repay analysis implicitly applies to the new loan.

Qualified Mortgages

The Dodd Frank Act provided that “qualified mortgages” are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. The Bureau’s rule establishes a safe harbor and creates a conclusive presumption for loans that meet certain criteria and are not high-priced loans that the creditor made a good faith and reasonable determination of the consumer’s ability to repay. Where the loan satisfies the requirements of a qualified mortgage and is a high-priced loan, there is a rebuttable presumption that the creditor complied with the ability-to-repay requirement. Borrowers may overcome the presumption when they can show that after making all mortgage related payments there is insufficient income left over to meet living expenses. The longer it takes for borrowers to default, the more difficult it is to overcome the presumption.

A qualified mortgage includes the following criteria:

Regular substantially equal periodic payments. This does not include negative amortization loans, interest only payments, and balloon payments. If the loan does not require monthly payments, the payments are to be calculated as if paid monthly.

Term is 30 years or less.

Total points and fees to not exceed 3 percent of the loan amount. Points and fees are broadly interpreted. The 3 percent cap is adjusted as the loan balance falls below $100,000. Points and fees include all items in the finance charge as defined in the Truth in Lending Act, other than interest. The points and fees include loan originator compensation paid by the consumer or creditor, as known at the time the interest rate is set, if attributable to the transaction, whether paid to the individual loan officer or a broker. The points and fees include charges paid to the creditor, originator, or affiliate, even if the same fees would not be included if charged by an independent third party. For example, title charges by an affiliated title company are included in the 3 percent calculation, but similar charges by an independent title company are not. The points and fees included other charges as detailed by the rule. The loan amount is the amount stated in the promissory note.

Monthly payment calculated based on the highest expected payment in the first five years. The creditor must underwrite the loan based on a fully amortized payment schedule taking into account the highest adjustment of any loan payment, and all other mortgage-related payments, including taxes and insurance, whether or not impounded by the creditor.

Consider current and reasonably expected income and expenses. This includes debt obligations, alimony, and child support. The income and expenses must be verified and documented, as discussed above. This eliminates low-document and no-document loans from being qualified mortgages.

Debt-to-income ratio does not exceed 43 percent. The debt includes all mortgage-related expenses, and simultaneous mortgage-related expenses that the creditor knows or has reason to know.

If these criteria are met and the loan is underwritten with good faith and reasonable reliance on verified third-party provided documentation, then the loan is a qualified mortgage entitled to a conclusive presumption that the loan meets the ability-to-pay requirements.

Alternative Qualified Mortgages

The Bureau established a second, temporary class of qualified mortgages based on the belief that certain consumers can afford loans with a higher debt-to-income ratio of 43 percent based on their particular circumstances. In addition, the temporary class of qualified mortgages may help overcome any initial reluctance of creditors to make loans that might not be qualified mortgages. These loans may be underwritten with more flexibility, but still require a reasonable and good faith belief in borrowers’ ability to repay the loans.

These alternative qualified mortgage loans must satisfy the general product feature prerequisites for a qualified mortgage and also satisfy the underwriting requirements of, and are eligible to be purchased, guaranteed or insured by (1) the GSEs while they operate under federal conservatorship or receivership or (2) the U.S. Department of Housing and Urban Development, Department of Veterans Affairs, or Department of Agriculture or Rural Housing Service. This temporary class will phase out as each agency issues its own qualified mortgage rules, or the GSE conservatorship ends, or seven years elapse.

Note that the rule does not define how the eligibility determination is made if the GSEs or federal agency does not actually purchase, guarantee, or insure the loan. Similarly, in light of the current state of repurchase litigation, even if the loan is purchased, guaranteed, or insured, it is unknown if that determination creates a qualified mortgage “presumption” that is conclusive or rebuttable.

Failure to Comply with Ability-to-Repay

A creditor must properly determine whether borrowers have the ability to repay their loans. Where a creditor does not act properly, the Bureau retains the ability to issue cease and desist orders, or impose civil monetary penalties.

The rule provides a private right of action to borrowers. They may seek actual damages, statutory damages, costs, and attorneys’ fees, and special damages equal to the finance charges and fees incurred. In short, where the creditor does not properly assess borrowers’ ability to repay loans, borrowers must repay the principal amount of the loan, less damages, and could end up with a “free” loan. Borrowers may also seek damages in class action litigation and individual cases. While current law provides for a one-year statute of limitation on damage actions, borrowers have three years to bring their ability-to-repay damage claims.

Borrowers may also assert the ability-to-repay defense in response to a foreclosure action and seek recoupment or set-off. The three-year statute of limitation does not apply, but borrowers are limited to three years of finance charges and fees as special damages. Assignees are liable for the errors of the original creditor.

Conclusion

Creditors must assess borrowers’ ability to repay a loan based on verifiable information. Creditors must act in a good faith and reasonable manner to determine whether borrowers can afford the loan(s) offered. To avoid liability under a faulty ability-to-pay determination, creditors may rely on the safe harbor of the qualified mortgage conclusive presumption. Qualified mortgages must be fully underwritten, at the maximum adjusted payment, based on verifiable information provided by third parties, to a high level of specification, even though the rule provides the creditor with discretion to make its determination. It is unknown what types of loans will be offered to borrowers and whether the loans will be purchased in the secondary market. However, it is expected that in the initial term, most residential mortgages will be low cost, fixed-rate loans, issued to very credit-worthy borrowers who meet all lending criteria. As GSEs and other agencies agree to purchase, guarantee or insure loans, the pool of available loans will expand, helping the Bureau meet its goal of ensuring that responsible consumers obtain responsible loans and that creditors extend credit responsibly, without worrying about competition from unscrupulous lenders.

On January 20, 2013, the Consumer Financial Protection Bureau (Bureau) released its final rule regarding the loan originator compensation requirements under the Truth in Lending Act (Rule). It followed up by publishing the Rule in the Federal Register on February 15, 2013. Despite the Bureau’s labeling of the Rule, it does more than implement statutorily required loan originator compensation changes. It also clarifies existing loan origination compensation requirements, including those based on prior informal interpretations rather than the plain language of Regulation Z or its commentary. Less obvious from the name of the Rule, it includes loan originator qualification requirements, requires the use of unique identifiers on certain loan documents, prohibits mandatory arbitration provisions and the financing of single-premium credit insurance for covered loans, and extends record keeping requirements. It also addresses the statutory prohibition on upfront points and fees in certain loans. The provisions regarding mandatory arbitration and the financing of single premium credit insurance have a stated effective date of June 1, 2013. The remainder of the Rule has a stated effective date of January 10, 2014.

The Rule revises the definition of the term “loan originator.” The term generally will mean a person, who in the expectation of compensation, does any of the following in connection with a residential mortgage loan: offers, arranges, negotiates, takes an application for, assists a consumer in obtaining or applying for, or otherwise obtains or makes a residential mortgage loan for another person. It will also include a person that advertises that the person can or will perform any of these activities. The Bureau will interpret this definition broadly and, consistent with prior informal interpretations, will include referral activity within the scope of covered loan origination activities. However, the Rule and related commentary provide some clarifications regarding the scope of covered referral activity. For example, covered referral activity will not include, among other things, providing general information in response to inquiries or, if the person is an employee of a creditor or mortgage broker, providing contact information for a loan originator in response to a request, unless the employee does so based on the inquiring person’s financial characteristics or discusses particular loan terms. Additionally, the Rule lists several categories of persons that will not be loan originators, including certain bona fide third-party advisors, certain licensed or registered real estate brokers, certain seller financers, and loan servicers and their employees when modifying or offering to modify an existing loan that is in default or is likely to go into default. It also clarifies when administrative and clerical staff members are not acting as loan originators.

The Rule continues the prohibition on basing loan originator compensation on any of the residential mortgage loan transaction’s terms or conditions, including any factor that is a proxy for a loan term or condition. The terms and conditions will include any right or obligation of the parties to a residential mortgage loan, except the amount of credit extended if the compensation is based on a fixed percentage. The Rule provides clarification regarding what constitutes a proxy. A factor will be a proxy if it consistently varies a term or terms over a significant number of loans and the loan originator has the ability to add, drop, or change the factor.

Consistent with prior informal interpretations of Regulation Z, the Rule clarifies that the prohibition includes not only compensation based on the terms or conditions of a single transaction, but also compensation based on the terms of multiple transactions by a single loan originator or multiple loan originators. Because the prohibition includes the terms or conditions of multiple loans by multiple originators, loan originator compensation cannot be based on the profits of a residential mortgage loan-related business. The Rule adopts this interpretation, but creates two exceptions. First, contributions to or benefits paid from designated tax-advantaged plans are permissible if they are not based on the terms of the individual loan originator’s transactions. Second, payments pursuant to certain non-deferred profits based compensation plans, as set forth in the Rule, could be permissible if they meet additional requirements, such as being limited to 10 percent or less of the loan originator’s total compensation or if the individual was the loan originator for 10 or fewer residential mortgage loans during the 12 months preceding the compensation determination date.

The Rule, similar to current Regulation Z, will generally prohibit reductions to loan originator compensation to offset costs if the terms of a transaction change. The reductions are prohibited because they are based on a term or condition of the transaction. However, the Commentary to the Rule states that reductions to compensation to offset unanticipated increases in certain settlement charges are permitted.

The Rule creates an exception to the Regulation Z prohibition on dual compensation. The Rule will allow a mortgage broker that receives compensation from the consumer to pay its employees or contractors commissions under certain circumstances.

For some, what is not in the Rule may be as important as what is in it. The Dodd-Frank Act would have prohibited certain loan originator compensation if the borrower paid upfront points and fees. For example, the Dodd-Frank Act would have generally prohibited a lender from paying individual loan originators certain commissions and other compensation in connection with a mortgage loan if the borrower paid up front points and fees. The Bureau had proposed creating a partial exemption. The proposal would have allowed a lender to charge up front points and fees and pay commissions and other compensation if the lender offered the borrower an alternative loan that did not include upfront points and fees. Rather than adopt this partial exemption, the Bureau decided to adopt a complete exemption to the statutory ban on upfront points and fees. The Bureau intends to assess the effects of the complete exemption and may take future action, including narrowing the exemption.

The Rule imposes obligations on creditors and mortgage brokers to ensure that the individual loan originators who work for them (i.e., employees, agents, contractors) are licensed or registered under other applicable laws, such as the Secure and Fair Enforcement for Mortgage Licensing Act of 2008. The Rule requires creditors and mortgage brokers that employ individual loan originators who are not required to be licensed or registered to ensure that these loan originator employees meet character, fitness, and background standards and receive training similar to licensed and registered loan originators. The Rule also requires that creditors and mortgage brokers include their unique identifiers and names on certain loan documents. The creditor or broker also must list the name and identifier of the individual loan originator primarily responsible for the origination of the loan.

The Rule prohibits loan terms that require the borrower to submit a dispute about a residential mortgage loan or certain home equity lines of credit (HELOCs) to binding arbitration. Additionally, under the Rule, no agreement relating to a residential mortgage loan or certain HELOCs could be applied to bar a borrower from bringing a court claim regarding an alleged violation of federal law. However, the parties could agree to arbitrate or otherwise settle a claim after a dispute arises.

The Rule prohibits the financing of any premiums for credit insurance in connection with a residential mortgage loan or certain HELOCs, but will permit premiums that are calculated and paid in full on a monthly basis.

The Rule expands recordkeeping requirements regarding loan originator compensation. The recordkeeping requirements apply to loan originator organizations, including both creditors and mortgage brokers. They will be required to keep evidence of compliance for three years. The increased time period will match the longer statute of limitations that will apply to claims for violations of the loan originator compensation requirements.

In conclusion, the Rule could affect several different aspects of a mortgage lender’s or broker’s operations, including hiring, employee training, compensation structures, referral activities, loan forms, litigation budgets, record retention schedules, and other policies and procedures. Going forward, lenders and brokers may be able to revise compensation structures. If they do so, they may need to consider other recently published rules that could affect loan originator compensation (e.g., Ability-to-Repay Rule). Depository institutions will have to provide additional training and background screening. Lenders and brokers will likely need to revise loan documents to provide identification information and revise their record retention schedules and other policies and procedures so that they are able to demonstrate compliance. The Rule is an example of the importance of reviewing not only the regulation but also the commentary and supplementary information. In this case, the Rule does not cover everything that one must know about upcoming loan originator compensation issues, but the commentary and supplementary information as well as the regulation clarify several important points from current Regulation Z’s requirements and cover several other issues on which mortgage lenders and brokers will need to be advised.

On January 10, 2013, the Bureau of Consumer Financial Protection (Bureau) issued a final rule amending Regulation Z by expanding the types of transactions subject to the Home Ownership and Equity Protection Act of 1994 (HOEPA), revising and expanding HOEPA thresholds, and imposing additional requirements on HOEPA loans. The final rule also amends Regulation Z and Regulation X (RESPA) by imposing homeownership counseling requirements. These changes are effective for all loans applied for on and after January 10, 2014.

This article focuses on the final rule’s expanded coverage, thresholds, requirements, and its impact on creditors, brokers, purchasers, and consumers.

Expanded Coverage

Transactions eligible for HOEPA coverage now include purchase-money loans and home-equity lines of credit (HELOCs). Transactions excluded from coverage include: reverse mortgage loans, loans to finance the initial construction of a dwelling, loans originated by a Housing Finance Agency, and loans under USDA’s Section 502 Direct Loan Program. While this expanded coverage may improve consumers’ understanding of the terms and features of a high-cost mortgage, it also may limit their access to credit, since most lenders are reluctant to make high-cost mortgages. Further, creditors will incur additional costs in identifying these types of loans, including, but not limited to, those costs related to changing or upgrading automated systems and disclosures, legal and compliance review, and staff training. Creditors also may lose revenue as a greater number of their loans are subject to HOEPA, and there is limited secondary market demand for high-cost mortgages.

What is a High-Cost Mortgage?

A “High-Cost Mortgage” is a consumer credit transaction secured by a consumer’s 1-4 unit principal dwelling, including purchase and non-purchase money closed-end credit transactions and HELOCs, in which

1. The annual percentage rate (APR) exceeds the average prime offer rate (APOR) for a comparable transaction by more than:
   1. 6.5 percentage points for first liens;
   2. 8.5 percentage points for first liens less than $50,000 secured by a dwelling that is personal property (e.g., manufactured home); or
   3. 8.5 percentage points for junior liens;
2. The total points and fees exceed:
   1. 5 percent of the total loan amount if the loan amount is $20,000 or more; or
   2. The lesser of 8 percent of the total loan amount or $1,000 for a loan amount less than $20,000 (the $1,000 and $20,000 figures are adjusted annually); or
3. A prepayment penalty may be charged more than 36 months after consummation or account opening, or may exceed, in total, more than 2 percent of the amount prepaid.

Although the thresholds seem straight-forward, the devil is in the details. Let’s dive into those details.

New High-Cost APR and Index

Creditors may use one of three methods to determine the interest rate for the APR calculation. For a fixed-rate transaction, a creditor must use the interest rate in effect as of the date the interest rate for the transaction was set. For a variable-rate transaction which varies according to an index, a creditor must use the higher of the index plus margin or the introductory interest rate in effect as of the date the interest rate for the transaction is set. For a variable-rate transaction which does not vary according to an index (e.g., step-rate mortgage), a creditor must use the maximum interest rate that may be imposed during the term of the transaction.

In order to determine the applicable rate threshold, a creditor must now use the APOR index for a comparable transaction. APOR tables and guidance are available at www.ffiec.gov/ratespread/aportables.htm and www.ffiec.gov/ratespread. There are three factors to consider when determining a “comparable transaction”: (1) whether the transaction is a fixed-rate or variable-rate, (2) the date the interest rate for the transaction was set, and (3) the term of the transaction. The “date the interest rate was set” means the date on which the loan’s interest rate is set for the final time before closing. If there is a rate lock agreement, it is the lock date specified in the agreement. If a rate is reset after execution of a rate lock agreement (e.g., float-down option exercise date), then the relevant date is the date the rate is re-set for the final time before closing. If there is no rate lock agreement, the relevant date is the date on which the rate is set for the final time before closing. In the case of a fixed-rate transaction, the “term of the transaction” is the transaction’s term to maturity. In the case of a variable-rate transaction, the “term of the transaction” is the initial fixed-rate period, rounded to the nearest number of whole years (or, if the initial fixed-rate period is less than one year, one year). A creditor originating a fixed-rate, evergreen HELOC should use a term of 30 years.

What is the potential impact of the revised APR threshold? First, the Bureau estimates a 20 percent increase in refinance and home improvement loans that will be High-Cost Mortgages. Second, FHA recently extended its monthly mortgage insurance premium requirement. This will cause the APR for FHA loans to be higher, since the APR reflects costs other than interest on closed-end transactions, which in turn could make more FHA loans High-Cost Mortgages. Third, the APR calculated from a fully-indexed rate will be higher than the composite APR calculated according to Regulation Z Section 1026.17.

New High-Cost Points and Fees Threshold and Definition

Which points and fees threshold applies depends on whether the face amount of the note, in a closed-end transaction, or the credit limit, in an open-end transaction, is $20,000 or more. In contrast, for the points and fees threshold calculation, the final rule uses a “total loan amount.” In a closed-end transaction the “total loan amount” is calculated by starting with the amount financed and subtracting (1) any financed item listed in 1026.4(c)(7) which is unreasonable or is paid to the creditor or an affiliate; (2) any upfront financed credit insurance premium; and (3) the prior loan’s prepayment penalty if it is financed, subject to certain limitations. The HELOC “total loan amount” is the credit limit.

The final rule also amends the definition of points and fees to remove certain items previously included (e.g., certain upfront mortgage insurance premiums and bona fide discount points) and to add other items (e.g., the maximum prepayment penalty). Under the final rule, “points and fees” mean the following fees or charges that are known at or before consummation:

1. All items included in the finance charge under 1026.4(a) and (b).
2. All compensation paid directly or indirectly by a consumer or creditor to a loan originator that can be attributed to the transaction at the time the interest rate is set. This requirement, as currently drafted, would double-count loan originator compensation under certain circumstances. There is a Concurrent Proposal that would address this issue. Stay tuned.
3. All items listed in 1026.4(c)(7) if unreasonable, or the creditor or its affiliate receives compensation, direct or indirect, in connection with the charge.
4. Upfront credit life, disability, unemployment insurance premiums.
5. The maximum prepayment penalty. (Note: The following state high cost points and fees calculations also may include some or all of the prepayment penalty amount: Arkansas, Georgia, Massachusetts, New Jersey, New Mexico, North Carolina, and South Carolina.)
6. The prior loan’s prepayment penalty, subject to certain limitations. (Note: Georgia, Massachusetts, New Jersey, and New Mexico have a similar requirement.)
7. For HELOCs only, any participation fee payable at or before account opening and any minimum or per-transaction fee (assume at least one draw).

The following items known at or before consummation are excluded from the calculation of “points and fees”:

1. Interest or time-price differential
2. Any premium or similar charge imposed in connection with a federal or state agency program (i.e., FHA Mortgage Insurance, VA Funding Fee, or USDA RHS Upfront Guarantee Fee).
3. Any premium or similar charge that protects the creditor against the consumer’s default or other credit loss (e.g., private mortgage insurance), but only to the extent the upfront amount does not exceed the FHA upfront mortgage insurance premium for a comparable loan and the upfront guarantee or premium is automatically refundable on a pro rata basis upon satisfaction of the mortgage.
4. Any bona fide third-party charge not retained by the creditor, loan originator, or an affiliate of either, unless the charge is required to be included;
5. Up to 2 bona fide discount points, if the undiscounted interest rate does not exceed the comparable APOR by more than 1 percentage point, or up to 1 bona fide discount point if the undiscounted interest rate does not exceed the APOR by more than 2 percentage points. For transactions secured by personal property, a creditor would use the average rate for a loan insured under Title I of NHA. A discount point is considered bona fide if it reduces the undiscounted rate by at least .25 basis points. (The following states have some form of bona fide discount point exclusion in their high cost thresholds: Indiana, New Jersey, New Mexico, North Carolina, South Carolina, and Tennessee.)

Based upon the lower points and fees threshold, smaller loan amounts may easily exceed the 5 percent threshold. If this occurs, access to small loan credit may be limited, as creditors and the secondary market have little appetite for High-Cost Mortgages.

New Prepayment Penalty Threshold

The new threshold limits when a penalty may be imposed to the first 36 months of the transaction, and limits the penalty amount to 2 percent of the amount prepaid. For purposes of this threshold, a prepayment penalty does not include (1) certain conditionally-waived upfront bona fide third-party closing costs; and (2) until January 21, 2015, interest charged consistent with the monthly interest accrual amortization method for FHA insured transactions.

The Bureau believes the number of transactions affected by the prepayment threshold will be small, since the maximum prepayment penalty is included in the points and fees calculation, and a creditor would have to forgo some or all of the other charges included in the points and fees calculation, in order to originate a “qualified mortgage” which caps points and fees at 3 percent. In addition, limiting the penalty to the first 36 months will impact lenders in California, Louisiana, Minnesota, New Hampshire, and Ohio, all of which allow prepayment penalties to be charged for a longer period (60/84, 60, 42, 60, and 60 months respectively). This threshold also impacts the allowable prepayment penalty amount in Illinois, 3 percent, and Louisiana, which allows a 5 percent penalty in the first year.

New High-Cost Mortgage Restrictions

Sections 1026.32 and 1026.34 provide that once a transaction is a High-Cost Mortgage:

• Balloon payments are generally prohibited.
• Prepayment penalties are prohibited.
• Financing points and fees are prohibited.
• Late fees cannot exceed 4 percent of the past due payment or be imposed until after 15 days past due.
• Payoff statement must be provided within 5 days of request and fees are restricted.
• Modification and Deferral Fees are prohibited.
• Ability-to-Repay assessment is required for HELOCs. Closed-end loans must meet the 2013 Ability-to-Repay Final Rule requirements.
• No default may be recommended or encouraged.

Revised High-Cost Mortgage Disclosures

Section 1026.32(c) revises the High-Cost Mortgage disclosure and distinguishes closed-end and HELOC requirements. A creditor must provide the disclosure to the consumer not less than 3 business days prior to consummation or account opening. “Business day” has the same meaning as the Regulation Z rescission rule. If the disclosure becomes inaccurate, a creditor must provide new disclosures and begin a new 3-day waiting period. A consumer may waive the waiting period to meet a bona fide personal emergency. A creditor may provide new disclosures by telephone if the consumer initiates the change and if, prior to or at consummation or account opening (1) the creditor provides new disclosures, and (2) the consumer and creditor sign a statement concerning the delivery and timing of telephone disclosures.

Corrections of Unintentional Violations

New Section 1026.32(h) allows a creditor or assignee, who, when acting in good faith, fails to comply with any Section 1026.32 requirement, to take steps to cure the “violation” by providing written notice of available choices. For notice to be adequate, the consumer should have at least 60 days to consider the options and communicate a choice. The creditor or assignee must satisfy either of the following sets of conditions:

1. Within 30 days of consummation or account opening and prior to the institution of any action, the consumer discovers the violation or the creditor or assignee notifies the consumer, and the creditor or assignee (a) provides appropriate restitution within 30 days; (b) adjusts the transaction’s terms, within 30 days, by either, at the choice of the consumer (i) making the transaction satisfy Section 1026.32 requirements; or (ii) Changing the transaction’s terms so it will no longer be a High-Cost Mortgage.
2. Within 60 days of the creditor’s discovery or receipt of notification of an unintentional violation or bona fide error and prior to the institution of any action, the creditor (a) notifies the consumer of the compliance failure; (b) provides appropriate restitution within 30 days; and (c) adjusts the transaction’s terms, within 30 days, by either, at the choice of the consumer (i) making the transaction satisfy Section 1026.32 requirements; or (ii) changing the transaction’s terms so it will no longer be a High-Cost Mortgage.

Regulation X (RESPA) Homeownership Counseling Organization List

12 CFR 1026.20 requires a lender to provide a written list of homeownership counseling organizations (the List) to the applicant of a federally related mortgage loan, which includes a loan (other than temporary financing, e.g., construction loan) secured by a 1-4 unit dwelling, including purchase and non-purchase money closed-end credit and HELOCs. The creditor must retrieve the List information from the Bureau’s website or from data made available by the Bureau or HUD no more than 30 days prior to delivery.

A lender must provide the List no later than 3 business days after the lender or mortgage broker receives an application. If there is more than one applicant, the lender may provide the List to the applicant with primary liability. If the lender does not provide the List in person, the lender must mail or deliver it by other means, including electronically, subject to the E-Sign Act. Although the lender is ultimately responsible for compliance, a mortgage broker or dealer also may provide the List. If there is more than one lender, only one List is required. Unless otherwise prohibited, the lender may provide the List with other required disclosures. For a HELOC subject to Regulation Z, a lender that provides the applicant with the List may comply with the timing and delivery requirements of either 1024.20(a) or 1026.40(b).

A lender does not need to provide the List if before the end of the 3 business days, the application is denied or withdrawn, or the application is for a reverse mortgage or loan secured by a timeshare.

High-Cost Mortgage Counseling Requirements

Section 1026.34(a)(5) requires a creditor, prior to making a High-Cost Mortgage, to receive written certification from an unaffiliated HUD-certified or -approved or state housing finance authority-certified or -approved counselor that the consumer received counseling on the advisability of the transaction. The certification must contain the elements specified in 1026.34(a)(5). The creditor may receive the certification by mail, e-mail, or facsimile. A creditor may process the application, order the appraisal or title search, prior to receiving the certification.

A consumer may not obtain counseling until after receiving the initial good faith estimate on a closed-end transaction or the initial HELOC disclosures required by Regulation Z. A creditor cannot direct a consumer to a particular counselor or organization. A consumer may pay a bona fide third-party counseling fee and it may be financed. A creditor may pay the fee, but cannot condition payment on loan consummation or account opening. A creditor may confirm counseling prior to paying the fee; however, if the consumer withdraws the application, a creditor may not condition the payment on receipt of the certification.

Negative Amortization Counseling Requirements

Section 1026.36(k) requires a creditor, prior to making a closed-end loan secured by a 1-4 unit dwelling which may result in negative amortization, to obtain confirmation that a first-time borrower received counseling on the risks of negative amortization from a HUD-certified or -approved counselor or counseling organization. Acceptable confirmation includes a certificate, letter, or e-mail. This requirement does not apply to reverse mortgages or loans secured by a timeshare. A creditor cannot direct a consumer to choose a particular counselor or organization. Although a creditor cannot make the loan prior to receiving this confirmation, a creditor may engage in other activities, such as processing the application or ordering the appraisal or title search.

Conclusion

Although originations of High-Cost Mortgages are a small percentage of the market as a result of special disclosure requirements, restrictions, enhanced borrower remedies, and assignee liability, the expansion of HOEPA coverage will increase the number of loans subject to HOEPA and the new and lower thresholds will increase the number of loans classified as High-Cost Mortgages. What percentage of loans this will include is difficult to determine.

This article just begins to scratch the surface of the issues this final rule raises for lenders, brokers, and their compliance or legal experts. Lenders will want to review 30 state and local high cost coverage and threshold requirements to determine any necessary changes. Lenders will want to review rates and fees on smaller loans, in order to determine how to price these loans appropriately to avoid a High-Cost Mortgage designation. Lenders and brokers will want to review their loan originator compensation policies. Lenders will want to review state prepayment penalty riders to ensure compliance with federal and state law. Lenders will want to consider creating new procedures to handle unintentional Section 32 violations, to meet the timing and other cure requirements. Finally, lenders will need to plan for the additional costs they will incur in updating automated systems, disclosures and documents, employee training, and outside legal advice. Will these HOEPA changes ultimately help consumers or reduce access to credit? Only time will tell.