My question: If prepaid interest is a credit to the borrower on the HUD because of the time between the closing date and 1st payment date, should the negative amount still be included as a finance charge (which will reduce the total prepaid finance charges)?

Example-Close a mortgage loan on 4/2 with a first due date of 5/1. Since the first due date is on 5/1 instead of 6/1, the borrower will receive a "prepaid interest credit" equal to 2 days of interest. This interest credit shows as a negative amount of page 2 of our HUD on the prepaid interest line. Since our system has that line hard-coded to be included as a finance charge, the total finance charge will be reduced by the interest credit on these loans. I think that if prepaid interest is positive (i.e. a cost to the borrower), it should be a FC, if it's negative (i.e. a credit to the borrower), it should be excluded so it does not reduce the total finance charges. Any thoughts?

There is no such thing as a negative prepaid finance charge. You do not net out the "credit" against the prepaid finance charges.

I'd either ignore this amount or call it additional proceeds. (See Comment #2 on Sec. 226.18(b).) If you call it additional proceeds, it produces exactly the same APR as if you call it a negative PFC.

I reviewed the TIL commentary, which states the following regarding rebates and loan premiums, "If the creditor chooses to reflect them in the §226.18 disclosures, rather than disregard them, they may be taken into account in any manner as part of those disclosures." Since the interest credit I referred to does not offset a HUD charge (unlike an application fee credit which offsets appraisal and credit report charges), this credit reduces the total prepaid finance charges and the APR. Do you think this scenario would be ok under this section?

I disagree here. I think that the interest credit should be used as an offset against the other prepaid finance charges. Prepaid interest is not a loan rebate as covered in comment #2.

Bottom line is that you are charging the customer a regular payment amount (which includes a full month's interest) less than one month after the closing. You are issuing a credit to the borrower for the interest that would accrue between during the amount of time the period is short. I don't see what this wouldn't be counted as a negative prepaid finance charge.

I agree that a short day interest credit is not exactly a "rebate," but that's the closest Reg. Z gets to an answer to this problem.

As Howard indicated above, there is no such thing as a negative FC. Moveover, it's not accurate to say that the credit offsets a PFC, because the unearned portion of the first payment period's interest is not "prepaid" in the first place. It is paid on the first payment due date, not at closing.

You can't call it a FC, because it is not a charge to the borrower.

Another possibility is to call the credit a lender-paid buydown fee. Because the consumer doesn't pay it, that type of fee would be left out of the disclosures all together.

The only things that ARE clear are:

1. You face civil liability and possible reimbursement if you understate the FC by more than $100. Because neither Reg Z nor the OSC address this question squarely, you have no clear authority to reduce the FC by the amount of the short day credit.

2. There is no restriction on the number or amounts of disbursements of funds to the borrower. If you want to give the borrower an extra $100+ because your loan servicing system is not capable of servicing odd payment periods, that's perfectly OK.

By calling the short day credit additional proceeds, you effectively wash out the unearned interest amount and also neutralize its effect on the APR.

So everyone in the mortgage industry that has used it as a credit toward other prepaid finance charges has it wrong? I deal with literally hundreds of mortgage lenders that do it this way. I find it really hard to believe that such consensus is incorrect.

Sorry, but I have to go with Richard on this one. Apparently, you might not know Richard's credentials when it comes to Regulation Z and proper APR calculation. He founded and has run APR Systems, Inc. since 1984 and has assisted hundreds of banks and worked with all the regulators on situations that require restitution and interpretation of Regulation Z.

You may find it hard to believe, but I personally would go with Richard's interpretation over, not only hundreds, but a thousand mortgage lenders any day.

I've been working compliance and writing software systems that deal with lending and APRs since 1982. I have contacts at all of the regulatory agencies and in fact was a beta-tester of the system written by Alan Dombrow (now Winapr). While I'm not questioning Richard's experience or expertise, I do disagree with his assessment here. The mortgage lenders that I am speaking of number among the biggest in the world. Their compliance officers and counsel have been through these issues with a fine tooth comb and they are all in agreement. Also, they have been doing it this way for as long as I remember. In that number of years, I would think that someone would have said something, regulators or investors, if there was any violation from the way they are doing it.

I think there is a lot of room for interpretation on this specific issue, as it is not directly addressed and therefore not spelled out in black and white. In fact, this is not the first time this has been discussed within these forums.

Don't take this wrong, because while I do not doubt your credentials, it's easy to claim a lot of things as an anonymous poster. Richard at least puts his name behind his opinions.

Well, I'm sorry but I am not allowed to post my name nor my company affiliation. Believe what you want to believe.

I hit the Continue button too quickly.

Yeah, I get my jollies by hanging around a lending compliance thread posting false information.....puhleeeeze!

Apparently, you took it wrong after all and I apologize. I didn't mean that as a personal affront. We however have some anonymous posters that speak with authority and are sometimes way off base (and not that it hasn't even gone for me on more than one occasion ). It was just an attempt to remind all readers that they need to read and then verify everything that crosses these forums.

I just got back from instructing at the TBA Compliance School and I had a young compliance professional that came up to me after the session and say - I don't agree with this or that. When asked what they based this on, the answer would be they got it from the BOL forums. I inquired about which poster said it and they replied - oh, it was anonymous.

Read and then verify is really only the point I was trying to make. Again, except my apologies as my original attempt at making the point that I had in my head didn't translate well to words.

Not to worry. I'm a little over-sensitive when the old "anonymous" poster barbs start. Too many out here criticize anonymous posting and I have been the victim of that before. Even if the post is valid you get the old "if you can't put your name on it" stuff. And no one gives any consideration to the possibility that posters may be bound by company policy to not post with any identifying information. Also, if anonymous posting is allowed, it shouldn't be criticized.

I agree whole-heartedly with you that any and all information gleened out here be given the utmost scrutiny and in cases such as above submitted to counsel or the proper authorities before following said information. I was merely attempting to share my "real world" experience with this specific issue.

Easy folks.....I didn't mean to start a brawl and leave the scene.

Randy is correct to report that I've had a lot of experience with Reg. Z - almost 35 years. During that time I've developed a healthy fear of a law and regulation that can destroy the economy of the free world without warning.

"Everyone's doing it" is never good enough for me. Everyone was also excluding courier fees from the Finance Charge until 'Rodash v. AIB Mortgage Co., 16 F.3d 1142 (11th Cir. 1994)' hit the fan. In this case, it took a retroactive emergency act of Congress to save the entire mortgage industry from total meltdown due to a $22 FedEx charge that was not disclosed to Martha Rodash as a Finance Charge.

It's good to maintain contacts with all the regulatory agencies and Alan is probably the single most knowledgeable Reg Z expert on the planet. Nevertheless, the fact that no one's been impaled on this particular technicality yet doesn't mean this practice is legal--only that no one has taken it to court and won. (Don't forget that Alan was blindsided by Rodash just like lenders big and small.)

Actually, Alan and I have debated this issue over the years. His experience has been that Fed staffers (the only non-judges whose opinions acutally have any legal effect) do not like to discuss this issue. Consequently, there is no commentary on point. Comment #2 is as close as you get. Years ago, Alan's preference was to treat short day interest credits as an addition to the Amount Financed. At the time, he was willing to accept short day interest credits as an offset to total PFCs, but ONLY if the result was still a positive number because, as Howard said, there's no such thing as a negative PFC. From a programmer's viewpoint, this means different processing rules for interest-only or low-fee disclosures than for deals with enough PFCs to mask the credit. This type of program design confirms your lack of conviction in the legality of "negative PFCs." I'd hate to be in court trying to defend a practice that I only followed when no one could tell the difference.

When there's no reg, commentary, or case law on point, multiple disclosure options, and degrees of risk ranging up to class action liability, I still vote for taking the safe way out--call the short day credit additional proceeds and skip the risk.

Its actually either:

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