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High Cost Mortgages: Points And Fees Are More Than Finance Charge

Editor's Note: Subsequent to the writing of the article below, Section 226.32 of Regulation Z was amended to change the test for what constitutes a "high cost mortgage". The mandatory compliance date for the changes was October 1, 2002. See the reg for full details. Reg Z - Section 226.32.

Regulation Z's new Subpart E - Special Rules for Certain Home Mortgage Transactions contains a definition of "points and fees." 226.32(a)(1) This definition is different from the finance charge for a loan. It differs by including fees that are generally excluded from the finance charge for most real estate secured transactions. If the loan in question is not a high cost mortgage, this difference is not relevant. However, if the loan could be a high cost loan, then it is important to calculate the points and fees to determine whether the loan exceeds the regulatory benchmarks and becomes a high cost or "Section 32" loan.

Loans secured by consumer's principal dwelling
The special high cost mortgage rule applies to loans that are secured by the consumer's principal dwelling. The rule exempts home equity loans, reverse mortgage loans, and purchase money mortgages. All other loans secured by the consumer's principal dwelling could be high cost mortgages if the points and fees exceed the measurements stated in the regulation. The first step in determining whether you have loans subject to Section 32 is to eliminate loans of the three exempted types. Then calculate the points and fees.

Points and Fees
This is the heart of the new rule's compliance challenge. Finance charge calculations are difficult enough and remain the most common source of violations of Truth in Lending. Calculation of total points and fees may quickly multiply problems with Truth in Lending compliance.

Points and fees include charges that are generally excluded for real estate secured loans under 226.4(c)(7). However, the calculation is not simple. First, the creditor must identify all charges that are excluded from the finance charge under 226.4(c)(7). Then the bank must determine whether the charges are "reasonable." If the charge is reasonable, it may be excluded from the total points and fees if the bank is not compensated by the charge and the charge is not paid to an affiliate of the creditor. (This last condition has echoes of RESPA.)

The total points and fees also includes any compensation paid to brokers by the consumer. All broker fees paid by the consumer must be included in this calculation without regard to when and to whom they were paid. You must include fees collected by the bank for payment to the broker and fees paid directly by the consumer to the broker, even if this occurred before closing.

Broker fees can only be excluded from the total points and fees under two circumstances. First, fees that are not paid by the consumer may be excluded. Second, fees that are included in the finance charge calculated under 226.4(a)&(b) do not need to be included a second time. Note that when the regulatory amendments take effect, on October 1, 1996, these fees will be included in the finance charge calculation. Hopefully, that will make this step simpler.

This inclusion of broker fees in the total points and fees, taken together with the coming change to include broker fees in the finance charge, indicate Congress' concern that the cost of credit should include the cost of shopping or arranging for credit.

Total Loan Amount
When dealing with high cost or "Section 32" mortgages, it is important to distinguish between the "amount financed" and the "total loan amount." Neither amount is simply the face amount of the note. Both are calculated beginning with the note amount and taking into account the amount and treatment of finance charges and other fees.

Section 32 calculations are based on the total loan amount. This is arrived at by calculating the amount financed (as directed in 226.18(b) and then deducting any cost from 226.32(b)(1)(iii), fees usually excluded from the finance charge for real estate secured loans, that is both included as points and fees and financed in the loan transaction. The effect is to produce a total loan amount that is either the same as or less than the amount financed.

  • Identify all types of loans that may be secured by the borrower's principal dwelling but are not exempt from the rule. This may include home improvement loans, refinancings, balloon loans, and second trusts.
  • Audit a sample of each non-exempt loan type you have identified to determine whether they were subject to fees or charges that meet (or come close to meeting) the 226.32(a) thresholds.
  • Establish a procedure that requires a compliance review for the high cost test of any new loan product - including pricing - before it is offered to customers.
Copyright © 1996 Compliance Action. Originally appeared in Compliance Action, Vol. 1, No. 10, 6/96

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