The Federal Reserve is inviting public comment on a rule that would provide four options for complying with new amendments to the Truth in Lending Act (TILA). In an attempt to limit confusion we've written this story using as much content from the Fed's Proposed Rule as possible. Our recap is long but we feel that is a necessary evil. HERE is the 474 page document if you'd like to read it yourself. It wasn't an enjoyable experience.....
BACKGROUND INFO
In 2006 and 2007, the Federal Reserve Board held a series of national hearings on consumer protection issues in the mortgage market. In response to these hearings, in July of 2008, the Board adopted HOEPA's Final Rule which defined a new class of “higher-priced mortgage loans,” .
DEFINITION: Under the 2008 HOEPA Final Rule, a higher-priced mortgage loan is a consumer credit transaction secured by the consumer’s principal dwelling with an APR that exceeds the average prime offer rate (APOR) for a comparable transaction, as of the date the interest rate is set, by 1.5 or more percentage points for loans secured by a first lien on the dwelling, or by 3.5 or more percentage points for loans secured by a subordinate lien on the dwelling. The definition of a “higher-priced mortgage loan” includes those loans that are defined as “high-cost mortgages.”
The Board’s 2008 HOEPA Final Rule also revised the "ability to repay" requirements for high-cost mortgages, and extended these requirements to higher-priced mortgage loans. Specifically, the rule:
- Prohibits a creditor from extending a higher-priced mortgage loan based on the collateral and without regard to the consumer’s repayment ability.
- Prohibits a creditor from relying on income or assets to assess repayment ability unless the creditor verifies such amounts using third-party documents that provide reasonably reliable evidence of the consumer’s income and assets
WHY ARE NEW AMENDMENT PROPOSALS NECESSARY?
Over the years, concerns have been raised about creditors originating mortgage loans without regard to the consumer's ability to repay the loan. Beginning in about 2006, these concerns were heightened as mortgage delinquencies and foreclosures rates increased dramatically, caused in part by the loosening of underwriting standards. One of the purposes of TILA is to promote the informed use of consumer credit by requiring disclosures about its costs and terms. TILA requires additional disclosures for loans secured by consumers’ homes and permits consumers to rescind certain transactions that involve their principal dwelling.
Well, the Dodd-Frank Wall Street Reform and Consumer Protection Act amended the Truth in Lending Act (TILA) to prohibit creditors from making mortgage loans without regard to the consumer’s repayment ability. The Act’s underwriting requirements are substantially similar but not identical to the ability-to-repay requirements adopted by the Board for higher-priced mortgage loans in July 2008 under the Home Ownership and Equity Protection Act.
Unlike the Board’s 2008 HOEPA Final Rule, the new "ability to repay" proposal as dictated by Dodd-Frank is not limited to higher-priced mortgage loans or loans secured by the consumer’s principal dwelling only. The Fed's newly proposed rule applies the "ability-to-repay" requirements to all high-cost mortgage transactions and any consumer credit transaction secured by a primary residence, second home, or investment property. not just a primary residence. The proposed rule would apply to all consumer mortgages including closed-end 2nd mortgages. (The proposal does not apply to home equity lines, open-end credit plans, timeshare plans, reverse mortgages, or temporary loans with terms of 12 months or less)
Plain and Simple: Regulation Z currently prohibits a credit or from making a higher-priced mortgage loan without regard to the consumer’s ability to repay the loan. This new proposal would implement statutory changes made by the Dodd-Frank Act that expand the scope of the ability-to-repay requirement to cover any consumer credit transaction secured by all dwellings (excluding an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan). The Dodd-Frank Act essentially codifies the ability-to- repay requirements of the Board’s 2008 HOEPA Final Rule and expands the scope to the covered transactions. More importantly, the proposal would establish standards for complying with the ability-to-repay requirement, including by making a “qualified mortgage.” Do not confuse the use of "Qualified Mortgages" in these TILA reforms with the debate surrounding "Qualified Residential Mortgages" which are part of Risk Retention Regs. They are however related in the sense that Dodd-Frank requires that the definition of "Qualified Residential Mortgage" be no broader than the definition of "Qualified Mortgage" in the ability-to-repay rules.
Glen Corso, Managing Director of the Community Mortgage Banking Project clarified the relevance of each proposal in this statement, “Today’s issuance by the Fed of proposed regulations on the ability-to-repay provisions of the Dodd-Frank Act is important for consumers and the mortgage industry because it will allow for a side-by-side comparison with the proposed Qualified Residential Mortgage exemption and the Risk Retention regulations. These two regulations will be influential in determining the future shape of the mortgage market of the future, thus it is vital that we achieve the goal of harmonizing those two sets of regulations to the greatest extent possible.
WHAT IS BEING PROPOSED BY THE FED?
The expansion of "high-cost" regs to include vacation and investment properties is fairly straightforward. The introduction of "Qualified Mortgages" ...not as straightforward. Consistent with the Dodd-Frank Act, the proposal provides four options for lenders to comply with new "ability-to-repay" requirements.
First, a creditor can meet the general ability-to-repay standard by originating a mortgage loan for which:
- The creditor considers and verifies the following eight underwriting factors in determining repayment ability: (1) current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment on the mortgage; (4) the monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations; (6) current debt obligations; (7) the monthly debt-to- income ratio, or residual income; and (8) credit history; and
- The mortgage payment calculation is based on the fully indexed rate.
Second, a creditor can refinance a “non-standard mortgage” into a “standard mortgage.” This is based on a statutory provision that is meant to provide flexibility for streamlined refinancings, which are no- or low-documentation transactions designed to quickly refinance a consumer out of a risky mortgage into a more stable product. Under this option, the creditor does not have to verify the consumer’s income or assets. The proposal defines a “standard mortgage” as a mortgage loan that, among other things, does not contain negative amortization, interest-only payments, or balloon payments; and has limited points and fees. “Non-standard mortgage” is defined as (1) an adjustable-rate mortgage with an introductory fixed interest rate for a period of years, (2) an interest-only loan, and (3) a negative amortization loan.
Plain and Simple: The Dodd-Frank Act provides an exception to the ability-to-repay standard’s underwriting requirements if: (1) the same creditor is refinancing a “hybrid mortgage” into a “standard mortgage,” (2) the consumer’s monthly payment is reduced through the refinancing, and (3) the consumer has not been delinquent on any payment on the existing hybrid mortgage. This provision appears to be intended to provide flexibility for streamlined refinancings, which are no- or low-documentation loans designed to quickly refinance a consumer in a risky mortgage into a more stable product. Streamlined refinancings have substantially increased in recent years to accommodate consumers at risk of default. Basically this leaves the door open for a "Rapid Refinance" program.
Third, a creditor can originate a “qualified mortgage,” which provides special protection from liability for creditors who make “qualified mortgages.” It is unclear whether that protection is intended to be a safe harbor or a rebuttable presumption of compliance with the repayment ability requirement. Therefore, the Board is proposing two alternative definitions of a “qualified mortgage.”
Alternative # 1: operates as a legal safe harbor and defines a “qualified mortgage” as a mortgage for which:
(a)
The loan does not contain negative amortization, interest-only
payments, or balloon payments, or a loan term exceeding 30 years;
(b) The total points and fees do not exceed 3% of the total loan amount;
(c) The borrower’s income or assets are verified and documented; and
(d)
The underwriting of the mortgage (1) is based on the maximum interest
rate in the first five years, (2) uses a payment scheduled that fully
amortizes the loan over the loan term, and (3) takes into account any
mortgage-related obligations.
Alternative #2: provides a rebuttable presumption of compliance and defines a “qualified mortgage” as including the criteria listed under Alternative 1 as well as the following additional underwriting requirements from the ability-to-repay standard:
(1) the consumer’s employment status,
(2) the monthly payment for any simultaneous loan,
(3) the consumer’s current debt obligations,
(4) the total debt-to-income ratio or residual income, and
(5) the consumer’s credit history.
YES. That does say a "Qualified Mortgage" would require that total points and fees not exceed 3% of the total loan amount. Definition of “points and fees”: Consistent with the Act, the proposal revises Regulation Z to define “points and fees” to now include: (1) certain mortgage insurance premiums in excess of the amount payable under Federal Housing Administration provisions; (2) all compensation paid directly or indirectly by a consumer or creditor to a loan originator; and (3) the prepayment penalty on the covered transaction, or on the existing loan if it is refinanced by the same creditor. The proposal also provides exceptions to the calculation of points and fees for: (1) any bona fide third party charge not retained by the creditor, loan originator, or an affiliate of either, and (2) certain bona fide discount points
The Board is proposing two alternatives for implementing the limits on points and fees for qualified mortgages. Alternative A is based on certain tiers of loan amounts (e.g., a points and fees threshold of 3.5 percent of the total loan amount for a loan amount greater than or equal to $60,000 but less than $75,000). Alternative A is designed to be an easier calculation for creditors, but may result in some anomalies (e.g., a points and fees threshold of $2,250 for a $75,000 loan, but a points and fees threshold of $2,450 for a $70,000 loan). Alternative B is designed to remedy these anomalies by providing amore precise sliding scale, but may be cumbersome for some creditors.
SEE PAGE 28 OF THE PROPOSAL FOR MORE ON THAT TOPIC. We know it's going to be a hot-button issue as it will make the big banks even bigger, just like the "QRM" proposal.
Finally, a small creditor operating predominantly in rural or underserved areas can originate a balloon-payment qualified mortgage. This standard is evidently meant to accommodate community banks that originate balloon loans to hedge against interest rate risk. Under this option, a small creditor can make a balloon-payment qualified mortgage if the loan term is five years or more, and the payment calculation is based on the scheduled periodic payments, excluding the balloon payment.
Plain and Simple: Consistent with the Dodd-Frank Act, the proposal provides four options for lenders to comply with the "ability-to-repay" requirement. Specifically, a creditor can either:
- Originate a covered transaction under the general ability-to-repay standard;
- Refinance a “non-standard mortgage” into a “standard mortgage
- Originate a “qualified mortgage,” which provides a presumption of compliance with the rule; or
- Originate a balloon-payment qualified mortgage, which provides a presumption of compliance with the rule.
WHAT LIABILITIES WOULD BANKS BE PROTECTED FROM BY WRITING "QUALIFIED MORTGAGES"?
HOEPA created three special remedies for a violation of its provisions.
First,
a consumer who brings a timely action against a creditor for a
violation of rules issued under TILA may be able to recover special
statutory damages equal to the sum of all finance charges and fees paid
by the consumer (often referred to as “HOEPA damages”), unless the
creditor demonstrates that the failure to comply is not material. This
recovery is in addition to actual damages; statutory damages in an
individual action or class action, up to a prescribed threshold; and
court costs and attorney fees that would be available for violations of
other TILA provisions.
Second, if a creditor assigns a high-cost
mortgage to another person, the consumer may be able to obtain from the
assignee all of the foregoing damages. For all other loans, TILA limits
the liability of assignees for violations of Regulation Z to disclosure
violations that are apparent on the face of the disclosure statement
required by TILA
Finally, a consumer has a right to rescind a
transaction for up to three years after consummation when the mortgage
contains a provision prohibited by a rule adopted under the authority of
TILA. Any consumer who has the right to rescind a transaction may
rescind the transaction as against any assignee. The right of rescission
does not extend, however, to home purchase loans, construction loans,
or certain refinancings with the same creditor
The
Dodd-Frank Act creates special remedies for violations of TILA. The
Dodd-Frank Act provides that a consumer who brings a timely action
against a creditor for a violation of TILA Section 129C(a) (the
ability-to-repay requirements) may be able to recover special statutory
damages equal to the sum of all finance charges and fees paid by the
consumer (often referred to as “HOEPA damages”), unless the creditor
demonstrates that the failure to comply is not material. This recovery
is in addition to actual damages; statutory damages in an individual
action or class action, up to a prescribed threshold; and court costs
and attorney fees that would be available for violations of other TILA
provisions.
The Dodd-Frank Act also provides that a consumer may
assert a violation of TILA Section 129C(a) as a defense to foreclosure
by recoupment or set off. There is no time limit on the use of this
defense.
Plain and Simple: “The proposed ability-to-repay regulations present two options for the Qualified Mortgage. One option reportedly offers lenders and investors in mortgages a true safe harbor from the significant liability under the Truth in Lending Act that results from failure to meet the ability-to-repay rules. If this option does offer a true legal Safe Harbor, lenders and investors will have the legal certainty necessary to provide low cost mortgage credit without the added expense of excessive defensive measures undertaken strictly to ward off class action attorneys.” -Glen Corso.
The proposal also implements the Dodd-Frank Act’s limits on prepayment penalties, lengthens the time creditors must retain records that evidence compliance with the ability-to-repay and prepayment penalty provisions, and prohibits evasion of the rule by structuring a closed-end extension of credit as an open-end plan. The Dodd-Frank Act contains other consumer protections for mortgages, which will be implemented in subsequent rulemakings.
If you have a problem with the proposal you must speak your mind. This is not the final rule. Comments on this proposed rule must be received on or before July 22, 2011. All comment letters will be transferred to the Consumer Financial Protection Bureau at that time. You may submit comments, identified by Docket No. R- 1417 and RIN No. AD 7100 AD 75, 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: regs.comments@federalreserve.gov. Include the docket number in the subject line of the message.
- Fax: (202) 452-3819 or (202) 452-3102.
- Snail Mail: Address to Jennifer J. Johnson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, N.W., Washington, DC 20551.
All public comments will be made available on the Board’s web site
