Recent Updates to Regulation Z and the New HOEPA Rule

Recently, amendments to Regulation Z, the implementing regulation for the Truth-in-Lending Act (“TILA”) and the Home Ownership and Equity Protection Act (“HOEPA”), became effective. Congress enacted HOEPA in 1994 to respond to allegations of abusive lending practices in the home equity lending market. HOEPA applies to closed-end loans on owner-occupied primary residences and non-purchase money transactions, and requires creditors to disclose and comply with limitations in home-equity loan rates and fees.

The Federal Reserve System issued significant new mortgage rules that took effect on October 1, 2009. For a newly defined category of higher-priced mortgage loans, the new rule adds protections and enhances existing protections for HOEPA loans, the strongest of which are aimed at curbing questionable lending practices in the subprime mortgage market.

These loans have annual percentage rates (“APR”) above the average prime offer rate for a comparable transaction by at least 1.5 percentage points for first mortgages or 3.5 percentage points for second mortgages.

Under HOEPA, a mortgage is defined as a “High Cost Loan” if it includes certain fees and interest rates that exceed a defined threshold. Covered loans include:

1: A first lien loan where the annual percentage rate (“APR”) exceeds the rates on comparable Treasury securities by more than eight percentage points;

2: A junior lien loan were the APR exceeds the rates on comparable Treasury securities by more than ten percentage points;

3: The total fees and points paid by the borrower exceed eight percent of the total loan amount.

The definition of a “High Cost Loan”, however, excludes home equity lines of credit (“HELOCs”), reverse mortgages, construction-only loans and bridge loans. As the definition excludes HELOCs, lenders are prohibited from structuring closed-end transactions as a HELOC where there is no reasonable expectation that repeat transactions will occur.

Further , the Regulation provides on higher-priced mortgage loans, secured by a consumer’s principal dwelling, the following restrictions:

> The Lender has an affirmative duty to assess the borrower’s ability to repay the loan. The Lender should consider the factors such as the loan-to-value ratio and the borrower’s debt-to-income ratio or residual income at the time the loan is originated.

> Require creditors to verify the income and assets they rely upon to determine repayment ability.

> Ban any prepayment penalty if the payment can change in the initial four years. For other higher-priced loans, a prepayment penalty period cannot last for more than two years.

> Require creditors to establish escrow accounts for property taxes and homeowners insurance for all first-lien mortgage loans.

The APR and fee-based triggers include amounts paid at closing for optional credit life, accident, health or loss of income insurance and other credit protection products purchased in connection with the loan transaction.

The rule expands the initial or early disclosure requirements to apply to lenders when their customers purchase a loan for “any extension of credit secured by the dwelling of a consumer.” The disclosure requirements now include home refinance loans, home equity loans and loans to finance the purchase or construction of the consumer’s principal dwelling. The previous rule did not require an initial disclosure to be provided to borrowers on home refinanced loans.

The amendments will affect how a lender does business. Due to the fact that lenders are also prohibited from collecting any fees before the consumer receives the disclosures, except for a fee for obtaining a consumer’s credit report, lenders must deliver or mail the early disclosures at least seven business days before consummation. If the APR contained in the early disclosures becomes inaccurate, lenders must provide revised disclosures reflecting the APR and other disclosures that change so that the consumer receives the revised disclosures at least three business days before consummation. The disclosures must inform consumers that they are not obligated to complete the transaction merely because disclosures were provided or because the consumer has applied for a loan. In addition to the disclosure requirements, the new rules prohibit the following practices:

> Balloon payments on loans having a term of less than five years;

> Negative amortization payments and capitalized unpaid interest;

> Pre-paid payments. Loan terms may not include more than two payments that are consolidated and paid in advance from the loan proceeds provided to the borrower;

> Due-on-demand clauses. Exceptions include fraud by the borrower in connection with the loan or other defined default;

> Default interest rates that exceeds the rate in effect prior to default.

The rule does include lender safe harbor practices, permitting lenders to use reasonably reliable evidence of employment, such as information on a W-2 Form, tax returns, payroll receipts and other information from the borrower or borrower’s employer.

In addition to the rules governing higher-priced mortgage loans, the rules adopt the following protections for loans secured by a consumer’s principal dwelling, regardless of whether the loan is higher-priced:

> Bans creditors and mortgage brokers from coercing a real estate appraiser to overestimate a home’s value.

> Bans “abusive” servicing practices. Companies that service mortgage loans are prohibited from certain practices, such as pyramiding late fees (taking late fees from regular payments leaving a part of the scheduled payment overdue). Also, Servicers are required to credit consumers’ loan payments as of the date of receipt and provide a payoff statement within a reasonable time of request.

> Creditors must provide a good faith estimate of the loan costs, including a schedule of payments, within three days after a consumer applies for any mortgage loan secured by a consumer’s principal dwelling, such as a home improvement loan or a loan to refinance an existing loan. Currently, early cost estimates are only required for home purchase loans.

HOEPA coverage is based not only on the loan interest rate, but also on points and fees charged by the lender. The effect of these changes may be that more loans exceed the HOEPA thresholds, subjecting many to additional disclosure requirements and restrictions. Additionally, more loans will be covered under state- specific predatory lending laws.

Because of the significant changes to the regulations, Lenders should review the regulations and must ensure that their TILA disclosures and their policies and procedures are revised to comply with these changes.