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.
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
- The annual percentage rate (APR) exceeds the average prime offer rate (APOR) for a comparable transaction by more than:
- 6.5 percentage points for first liens;
- 8.5 percentage points for first liens less than $50,000 secured by a dwelling that is personal property (e.g., manufactured home); or
- 8.5 percentage points for junior liens;
- The total points and fees exceed:
- 5 percent of the total loan amount if the loan amount is $20,000 or more; or
- 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
- 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:
- All items included in the finance charge under 1026.4(a) and (b).
- 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.
- 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.
- Upfront credit life, disability, unemployment insurance premiums.
- 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.)
- The prior loan's prepayment penalty, subject to certain limitations. (Note: Georgia, Massachusetts, New Jersey, and New Mexico have a similar requirement.)
- 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":
- Interest or time-price differential
- 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).
- 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.
- 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;
- 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:
- 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.
- 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.
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.