[Federal Register: July 30, 2008 (Volume 73, Number 147)]
[Rules and Regulations]
[Page 44521-44614]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr30jy08-24]
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Part III
Federal Reserve System
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12 CFR Part 226
Truth in Lending; Final Rule
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FEDERAL RESERVE SYSTEM
12 CFR Part 226
[Regulation Z; Docket No. R-1305]
Truth in Lending
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Final rule; official staff commentary.
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SUMMARY: The Board is publishing final rules amending Regulation Z,
which implements the Truth in Lending Act and Home Ownership and Equity
Protection Act. The goals of the amendments are to protect consumers in
the mortgage market from unfair, abusive, or deceptive lending and
servicing practices while preserving responsible lending and
sustainable homeownership; ensure that advertisements for mortgage
loans provide accurate and balanced information and do not contain
misleading or deceptive representations; and provide consumers
transaction-specific disclosures early enough to use while shopping for
a mortgage. The final rule applies four protections to a newly-defined
category of higher-priced mortgage loans secured by a consumer's
principal dwelling, including a prohibition on lending based on the
collateral without regard to consumers' ability to repay their
obligations from income, or from other sources besides the collateral.
The revisions apply two new protections to mortgage loans secured by a
consumer's principal dwelling regardless of loan price, including a
prohibition on abusive servicing practices. The Board is also
finalizing rules requiring that advertisements provide accurate and
balanced information, in a clear and conspicuous manner, about rates,
monthly payments, and other loan features. The advertising rules ban
several deceptive or misleading advertising practices, including
representations that a rate or payment is ``fixed'' when it can change.
Finally, the revisions require creditors to provide consumers with
transaction-specific mortgage loan disclosures within three business
days after application and before they pay any fee except a reasonable
fee for reviewing credit history.
DATES: This final rule is effective on October 1, 2009, except for
Sec. 226.35(b)(3)) which is effective on April 1, 2010. See part XIII,
below, regarding mandatory compliance with Sec. 226.35(b)(3) on
mortgages secured by manufactured housing.
FOR FURTHER INFORMATION CONTACT: Kathleen C. Ryan or Dan S. Sokolov,
Counsels; Paul Mondor, Senior Attorney; Jamie Z. Goodson, Brent Lattin,
Jelena McWilliams, Dana E. Miller, or Nikita M. Pastor, Attorneys;
Division of Consumer and Community Affairs, Board of Governors of the
Federal Reserve System, Washington, DC 20551, at (202) 452-2412 or
(202) 452-3667. For users of Telecommunications Device for the Deaf
(TDD) only, contact (202) 263-4869.
SUPPLEMENTARY INFORMATION:
I. Summary of Final Rules
A. Rules To Prevent Unfairness, Deception, and Abuse
B. Revisions To Improve Mortgage Advertising
C. Requirement To Give Consumers Disclosures Early
II. Consumer Protection Concerns in the Subprime Market
A. Recent Problems in the Mortgage Market
B. Market Imperfections That Can Facilitate Abusive and
Unaffordable Loans
III. The Board's HOEPA Hearings
A. Home Ownership and Equity Protection Act (HOEPA)
B. Summary of 2006 Hearings
C. Summary of June 2007 Hearing
D. Congressional Hearings
IV. Interagency Supervisory Guidance
V. Legal Authority
A. The Board's Authority Under TILA Section 129(l)(2)
B. The Board's Authority Under TILA Section 105(a)
VI. The Board's Proposal
A. Proposals To Prevent Unfairness, Deception, and Abuse
B. Proposals To Improve Mortgage Advertising
C. Proposal To Give Consumers Disclosures Early
VII. Overview of Comments Received
VIII. Definition of ``Higher-Priced Mortgage Loan''--Sec. 226.35(a)
A. Overview
B. Public Comment on the Proposal
C. General Approach
D. Index for Higher-Priced Mortgage Loans
E. Threshold for Higher-Priced Mortgage Loans
F. The Timing of Setting the Threshold
G. Proposal To Conform Regulation C (HMDA)
H. Types of Loans Covered Under Sec. 226.35
IX. Final Rules for Higher-Priced Mortgage Loans and HOEPA Loans
A. Overview
B. Disregard of Consumer's Ability To Repay--Sec. Sec.
226.34(a)(4) and 226.35(b)(1)
C. Prepayment Penalties--Sec. 226.32(d)(6) and (7); Sec.
226.35(b)(2)
D. Escrows for Taxes and Insurance--Sec. 226.35(b)(3)
E. Evasion Through Spurious Open-End Credit--Sec. 226.35(b)(4)
X. Final Rules for Mortgage Loans--Sec. 226.36
A. Creditor Payments to Mortgage Brokers--Sec. 226.36(a)
B. Coercion of Appraisers--Sec. 226.36(b)
C. Servicing Abuses--Sec. 226.36(c)
D. Coverage--Sec. 226.36(d)
XI. Advertising
A. Advertising Rules for Open-End Home-Equity Plans--Sec.
226.16
B. Advertising Rules for Closed-End Credit)--Sec. 226.24
XII. Mortgage Loan Disclosures
A. Early Mortgage Loan Disclosures--Sec. 226.19
B. Plans To Improve Disclosure
XIII. Mandatory Compliance Dates
XIV. Paperwork Reduction Act
XV. Regulatory Flexibility Analysis
I. Summary of Final Rules
On January 9, 2008, the Board published proposed rules that would
amend Regulation Z, which implements the Truth in Lending Act (TILA)
and the Home Ownership and Equity Protection Act (HOEPA). 73 FR 1672.
The Board is publishing final amendments to Regulation Z to establish
new regulatory protections for consumers in the residential mortgage
market. The goals of the amendments are to protect consumers in the
mortgage market from unfair, abusive, or deceptive lending and
servicing practices while preserving responsible lending and
sustainable homeownership; ensure that advertisements for mortgage
loans provide accurate and balanced information and do not contain
misleading or deceptive representations; and provide consumers
transaction-specific disclosures early enough to use while shopping for
mortgage loans.
A. Rules To Prevent Unfairness, Deception, and Abuse
The Board is publishing seven new restrictions or requirements for
mortgage lending and servicing intended to protect consumers against
unfairness, deception, and abuse while preserving responsible lending
and sustainable homeownership. The restrictions are adopted under TILA
Section 129(l)(2), which authorizes the Board to prohibit unfair or
deceptive practices in connection with mortgage loans, as well as to
prohibit abusive practices or practices not in the interest of the
borrower in connection with refinancings. 15 U.S.C. 1639(l)(2). Some of
the restrictions apply only to higher-priced mortgage loans, while
others apply to all mortgage loans secured by a consumer's principal
dwelling.
Protections Covering Higher-Priced Mortgage Loans
The Board is finalizing four protections for consumers receiving
higher-priced mortgage loans. These loans are defined as consumer-
purpose, closed-end loans secured by a consumer's principal dwelling
and
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having an annual percentage rate (APR) that exceeds the average prime
offer rates for a comparable transaction published by the Board by at
least 1.5 percentage points for first-lien loans, or 3.5 percentage
points for subordinate-lien loans. For higher-priced mortgage loans,
the final rules:
[cir] Prohibit creditors from extending credit without regard to a
consumer's ability to repay from sources other than the collateral
itself;
[cir] Require creditors to verify income and assets they rely upon
to determine repayment ability;
[cir] Prohibit prepayment penalties except under certain
conditions; and
[cir] Require creditors to establish escrow accounts for taxes and
insurance, but permit creditors to allow borrowers to cancel escrows 12
months after loan consummation.
In addition, the final rules prohibit creditors from structuring
closed-end mortgage loans as open-end lines of credit for the purpose
of evading these rules, which do not apply to open-end lines of credit.
Protections Covering Closed-End Loans Secured by Consumer's Principal
Dwelling
In addition, in connection with all consumer-purpose, closed-end
loans secured by a consumer's principal dwelling, the Board's rules:
[cir] Prohibit any creditor or mortgage broker from coercing,
influencing, or otherwise encouraging an appraiser to provide a
misstated appraisal in connection with a mortgage loan; and
[cir] Prohibit mortgage servicers from ``pyramiding'' late fees,
failing to credit payments as of the date of receipt, or failing to
provide loan payoff statements upon request within a reasonable time.
The Board is withdrawing its proposal to require servicers to deliver a
fee schedule to consumers upon request; and its proposal to prohibit
creditors from paying a mortgage broker more than the consumer had
agreed in advance that the broker would receive. The reasons for the
withdrawal of these two proposals are discussed in parts X.A and X.C
below.
Prospective Application of Final Rule
The final rule is effective on October 1, 2009, or later for the
requirement to establish an escrow account for taxes and insurance for
higher-priced mortgage loans. Compliance with the rules is not required
before the effective dates. Accordingly, nothing in this rule should be
construed or interpreted to be a determination that acts or practices
restricted or prohibited under this rule are, or are not, unfair or
deceptive before the effective date of this rule.
Unfair acts or practices can be addressed through case-by-case
enforcement actions against specific institutions, through regulations
applying to all institutions, or both. A regulation is prospective and
applies to the market as a whole, drawing bright lines that distinguish
broad categories of conduct. By contrast, an enforcement action
concerns a specific institution's conduct and is based on all of the
facts and circumstances surrounding that conduct.\1\
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\1\ See Board and FDIC, CA 04-2, Unfair Acts or Practices by
State-Chartered Banks (March 11, 2004), available at http://
www.federalreserve.gov/boarddocs/press/bcreg/2004/20040311/
attachment.pdf.
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Because broad regulations, such as the rules adopted here, can
require large numbers of institutions to make major adjustments to
their practices, there could be more harm to consumers than benefit if
the rules were effective immediately. If institutions were not provided
a reasonable time to make changes to their operations and systems to
comply with this rule, they would either incur excessively large
expenses, which would be passed on to consumers, or cease engaging in
the regulated activity altogether, to the detriment of consumers. And
because the Board finds an act or practice unfair only when the harm
outweighs the benefits to consumers or to competition, the
implementation period preceding the effective date set forth in the
final rule is integral to the Board's decision to restrict or prohibit
certain acts or practices.
For these reasons, acts or practices occurring before the effective
dates of these rules will be judged on the totality of the
circumstances under other applicable laws or regulations. Similarly,
acts or practices occurring after the rule's effective dates that are
not governed by these rules will continue to be judged on the totality
of the circumstances under other applicable laws or regulations.
B. Revisions To Improve Mortgage Advertising
Another goal of the final rules is to ensure that mortgage loan
advertisements provide accurate and balanced information and do not
contain misleading or deceptive representations. Thus the Board's rules
require that advertisements for both open-end and closed-end mortgage
loans provide accurate and balanced information, in a clear and
conspicuous manner, about rates, monthly payments, and other loan
features. These rules are adopted under the Board's authorities to:
adopt regulations to ensure consumers are informed about and can shop
for credit; require that information, including the information
required for advertisements for closed-end credit, be disclosed in a
clear and conspicuous manner; and regulate advertisements of open-end
home-equity plans secured by the consumer's principal dwelling. See
TILA Section 105(a), 15 U.S.C. 1604(a); TILA Section 122, 15 U.S.C.
1632; TILA Section 144, 15 U.S.C. 1664; TILA Section 147, 15 U.S.C.
1665b.
The Board is also adopting, under TILA Section 129(l)(2), 15 U.S.C.
1639(l)(2), rules to prohibit the following seven deceptive or
misleading practices in advertisements for closed-end mortgage loans:
[cir] Advertisements that state ``fixed'' rates or payments for
loans whose rates or payments can vary without adequately disclosing
that the interest rate or payment amounts are ``fixed'' only for a
limited period of time, rather than for the full term of the loan;
[cir] Advertisements that compare an actual or hypothetical rate or
payment obligation to the rates or payments that would apply if the
consumer obtains the advertised product unless the advertisement states
the rates or payments that will apply over the full term of the loan;
[cir] Advertisements that characterize the products offered as
``government loan programs,'' ``government-supported loans,'' or
otherwise endorsed or sponsored by a federal or state government entity
even though the advertised products are not government-supported or -
sponsored loans;
[cir] Advertisements, such as solicitation letters, that display
the name of the consumer's current mortgage lender, unless the
advertisement also prominently discloses that the advertisement is from
a mortgage lender not affiliated with the consumer's current lender;
[cir] Advertisements that make claims of debt elimination if the
product advertised would merely replace one debt obligation with
another;
[cir] Advertisements that create a false impression that the
mortgage broker or lender is a ``counselor'' for the consumer; and
[cir] Foreign-language advertisements in which certain information,
such as a low introductory ``teaser'' rate, is provided in a foreign
language, while required disclosures are provided only in English.
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C. Requirement To Give Consumers Disclosures Early
A third goal of these rules is to provide consumers transaction-
specific disclosures early enough to use while shopping for a mortgage
loan. The final rule requires creditors to provide transaction-specific
mortgage loan disclosures such as the APR and payment schedule for all
home-secured, closed-end loans no later than three business days after
application, and before the consumer pays any fee except a reasonable
fee for the review of the consumer's credit history.
The Board recognizes that these disclosures need to be updated to
reflect the increased complexity of mortgage products. In early 2008,
the Board began testing current TILA mortgage disclosures and potential
revisions to these disclosures through one-on-one interviews with
consumers. The Board expects that this testing will identify potential
improvements for the Board to propose for public comment in a separate
rulemaking.
II. Consumer Protection Concerns in the Subprime Market
A. Recent Problems in the Mortgage Market
Subprime mortgage loans are made to borrowers who are perceived to
have high credit risk. These loans' share of total consumer
originations, according to one estimate, reached about nine percent in
2001 and doubled to 20 percent by 2005, where it stayed in 2006.\2\ The
resulting increase in the supply of mortgage credit likely contributed
to the rise in the homeownership rate from 64 percent in 1994 to a high
of 69 percent in 2005--though about 68 percent now--and expanded
consumers' access to the equity in their homes.
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\2\ Inside Mortgage Finance Publications, Inc., The 2007
Mortgage Market Statistical Annual vol. I (IMF 2007 Mortgage
Market), at 4.
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Recently, however, some of these benefits have eroded. In the last
two years, delinquencies and foreclosure starts among subprime
mortgages have increased dramatically and reached exceptionally high
levels as house price growth has slowed or prices have declined in some
areas. The proportion of all subprime mortgages past-due ninety days or
more (``serious delinquency'') was about 18 percent in May 2008, more
than triple the mid-2005 level.\3\ Adjustable-rate subprime mortgages
have performed the worst, reaching a serious delinquency rate of 27
percent in May 2008, five times the mid-2005 level. These mortgages
have seen unusually high levels of early payment default, or default
after only one or two payments or even no payment at all.
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\3\ Delinquency rates calculated from data from First American
LoanPerformance.
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The serious delinquency rate has also risen for loans in alt-A
(near prime) securitized pools. According to one source, originations
of these loans were 13 percent of consumer mortgage originations in
2006.\4\ Alt-A loans are made to borrowers who typically have higher
credit scores than subprime borrowers, but the loans pose more risk
than prime loans because they involve small down payments or reduced
income documentation, or the terms of the loan are nontraditional and
may increase risk. The rate of serious delinquency for these loans has
risen to over 8 percent (as of April 2008) from less than 2 percent
only a year earlier. In contrast, 1.5 percent of loans in the prime-
mortgage sector were seriously delinquent as of April 2008.
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\4\ IMF 2007 Mortgage Market at 4.
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The consequences of default are severe for homeowners, who face the
possibility of foreclosure, the loss of accumulated home equity, higher
rates for other credit transactions, and reduced access to credit. When
foreclosures are clustered, they can injure entire communities by
reducing property values in surrounding areas. Higher delinquencies are
in fact showing through to foreclosures. Lenders initiated over 550,000
foreclosures in the first quarter of 2008, about half of them on
subprime mortgages. This was significantly higher than the quarterly
average of 325,000 in the first half of the year, and nearly twice the
quarterly average of 225,000 for the past six years.\5\
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\5\ Estimates are based on data from Mortgage Bankers'
Association's National Delinquency Survey (2007) (MBA Nat'l
Delinquency Survey).
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Rising delinquencies have been caused largely by a combination of a
decline in house price appreciation--and in some areas slower economic
growth--and a loosening of underwriting standards, particularly in the
subprime sector. The loosening of underwriting standards is discussed
in more detail in part II.B. The next section discusses underlying
market imperfections that facilitated this loosening and made it
difficult for consumers to avoid injury.
B. Market Imperfections That Can Facilitate Abusive and Unaffordable
Loans
The recent sharp increase in serious delinquencies has highlighted
the roles that structural elements of the subprime mortgage market may
play in increasing the likelihood of injury to consumers who find
themselves in that market. Limitations on price and product
transparency in the subprime market--often compounded by misleading or
inaccurate advertising--may make it harder for consumers to protect
themselves from abusive or unaffordable loans, even with the best
disclosures. The injuries consumers in the subprime market may suffer
as a result are magnified when originators' incentives to carefully
assess consumers' repayment ability grow weaker, as can happen when
originators sell their loans to be securitized.\6\ The fragmentation of
the originator market can further exacerbate the problem by making it
more difficult for investors to monitor originators and for regulators
to protect consumers.
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\6\ Benjamin J. Keys, Tanmoy K. Mukherjee, Amit Seru and Vikram
Vig, Did Securitization Lead to Lax Screening? Evidence from Suprime
Loans at 22, available at: http://ssrn.com/abstract=1093137.
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Limited Transparency and Limits of Disclosure
Limited transparency in the subprime market increases the risk that
borrowers in that market will receive unaffordable or abusive loans.
The transparency of the subprime market to consumers is limited in
several respects. First, price information for the subprime market is
not widely and readily available to consumers. A consumer reading a
newspaper, telephoning brokers or lenders, or searching the Internet
can easily obtain current prime interest rate quotes for free. In
contrast, subprime rates, which can vary significantly based on the
individual borrower's risk profile, are not broadly advertised and are
usually obtainable only after application and paying a fee. Subprime
rate quotes may not even be reliable if the originator engages in a
``bait and switch'' strategy. Price opacity is exacerbated because the
subprime consumer often does not know her own credit score. Even if she
knows her score, the prevailing interest rate for someone with that
score and other credit risk characteristics is not generally publicly
available.
Second, products in the subprime market tend to be complex, both
relative to the prime market and in absolute terms, as well as less
standardized than in the prime market.\7\ As discussed
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earlier, subprime originations have much more often been ARMs than
fixed rate mortgages. ARMs require consumers to make judgments about
the future direction of interest rates and translate expected rate
changes into changes in their payment amounts. Subprime loans are also
far more likely to have prepayment penalties. Because the annual
percentage rate (APR) does not reflect the price of the penalty, the
consumer must both calculate the size of the penalty from a formula and
assess the likelihood of moving or refinancing during the penalty
period. In these and other ways, subprime products tend to be complex
for consumers.
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\7\ U.S. Dep't of Housing & Urban Development and U.S. Dep't of
Treasury, Recommendations to Curb Predatory Home Mortgage Lending 17
(2000) (``While predatory lending can occur in the prime market,
such practices are for the most part effectively deterred by
competition among lenders, greater homogeneity in loan terms and the
prime borrowers' greater familiarity with complex financial
transactions.''); Howard Lax, Michael Manti, Paul Raca and Peter
Zorn, Subprime Lending: An Investigation of Economic Efficiency, 15
Housing Policy Debate 533, 570 (2004) (Subprime Lending
Investigation) (stating that the subprime market lacks the ``overall
standardization of products, underwriting, and delivery systems''
that is found in the prime market).
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Third, the roles and incentives of originators are not transparent.
One source estimates that 60 percent or more of mortgages originated in
the last several years were originated through a mortgage broker, often
an independent entity, who takes loan applications from consumers and
shops them to depository institutions or other lenders.\8\ Anecdotal
evidence indicates that consumers in both the prime and subprime
markets often believe, in error, that a mortgage broker is obligated to
find the consumer the best and most suitable loan terms available.
Consumers who rely on brokers often are unaware, however, that a
broker's interests may diverge from, and conflict with, their own
interests. In particular, consumers are often unaware that a creditor
pays a broker more to originate a loan with a rate higher than the rate
the consumer qualifies for based on the creditor's underwriting
criteria.
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\8\ Data reported by Wholesale Access Mortgage Research and
Consulting, Inc., available at http://www.wholesaleaccess.com/.
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Limited shopping. In this environment of limited transparency,
consumers--particularly those in the subprime market--may reasonably
decide not to shop further among originators or among loan options once
an originator has told them they will receive a loan, because further
shopping can be very costly. Shopping may require additional
applications and application fees, and may delay the consumer's receipt
of funds. This delay creates a potentially significant cost for the
many subprime borrowers seeking to refinance their obligations to lower
their debt payments at least temporarily, to extract equity in the form
of cash, or both.\9\ In recent years, nearly 90 percent of subprime
ARMs used for refinancings were ``cash out.'' \10\
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\9\ See Anthony Pennington-Cross & Souphala Chomsisengphet,
Subprime Refinancing: Equity Extraction and Mortgage Termination, 35
Real Estate Economics 2, 233 (2007) (reporting that 49% of subprime
refinance loans involve equity extraction, compared with 26% of
prime refinance loans); Marsha J. Courchane, Brian J. Surette, and
Peter M. Zorn, Subprime Borrowers: Mortgage Transitions and Outcomes
(Subprime Outcomes), 29 J. of Real Estate Economics 4, 368-371
(2004) (discussing survey evidence that borrowers with subprime
loans are more likely to have experienced major adverse life events
(marital disruption; major medical problem; major spell of
unemployment; major decrease of income) and often use refinancing
for debt consolidation or home equity extraction); Subprime Lending
Investigation, at 551-552 (citing survey evidence that borrowers
with subprime loans have increased incidence of major medical
expenses, major unemployment spells, and major drops in income).
\10\ A ``cash out'' transaction is one in which the borrower
refinances an existing mortgage, and the new mortgage amount is
greater than the existing mortgage amount, to allow the borrower to
extract from the home. Figure calculated from First American
LoanPerformance data.
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While shopping costs are likely clear, the benefits may not be
obvious or may appear minimal. Without easy access to subprime product
prices, a consumer may have only a limited idea after working with one
originator whether further shopping is likely to produce a better deal.
Moreover, consumers in the subprime market have reported in studies
that they were turned down by several lenders before being
approved.\11\ Once approved, these consumers may see little advantage
to continuing to shop for better terms if they expect to be turned down
by other originators. Further, if a consumer uses a broker believing
that the broker is shopping for the consumer for the best deal, the
consumer may believe a better deal is not obtainable. An unscrupulous
originator may also seek to discourage a consumer from shopping by
intentionally understating the cost of an offered loan. For all of
these reasons, borrowers in the subprime market may not shop beyond the
first approval and may be willing to accept unfavorable terms.\12\
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\11\ James M. Lacko and Janis K. Pappalardo, Federal Trade
Commission, Improving Consumer Mortgage Disclosures: An Empirical
Assessment of Current and Prototype Disclosure Forms at 24-26
(2007), available at: http://www.ftc.gov/os/2007/06/
P025505MortgageDisclosureReport.pdf (Improving Mortgage Disclosures)
(reporting evidence based on qualitative consumer interviews);
Subprime Lending Investigation at 550 (finding based on survey data
that ``[p]robably the most significant hurdle overcome by subprime
borrowers * * * is just getting approved for a loan for the first
time. This impact might well make subprime borrowers more willing to
accept less favorable terms as they become uncertain about the
possibility of qualifying for a loan at all.'').
\12\ Subprime Outcomes at 371-372 (reporting survey evidence
that relative to prime borrowers, subprime borrowers are less
knowledgeable about the mortgage process, search less for the best
rates, and feel they have less choice about mortgage terms and
conditions); Subprime Mortgage Investigation at 554 (``Our focus
groups suggested that prime and subprime borrowers use quite
different search criteria in looking for a loan. Subprime borrowers
search primarily for loan approval and low monthly payments, while
prime borrowers focus on getting the lowest available interest rate.
These distinctions are quantitatively confirmed by our survey.'').
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Limited focus. Consumers considering obtaining a typically complex
subprime mortgage loan may simplify their decision by focusing on a few
attributes of the product or service that seem most important.\13\ A
consumer may focus on loan attributes that have the most obvious and
immediate consequence such as loan amount, down payment, initial
monthly payment, initial interest rate, and up-front fees (though up-
front fees may be more obscure when added to the loan amount, and
``discount points'' in particular may be difficult for consumers to
understand). These consumers, therefore, may not focus on terms that
may seem less immediately important to them such as future increases in
payment amounts or interest rates, prepayment penalties, and negative
amortization. They are also not likely to focus on underwriting
practices such as income verification, and on features such as escrows
for future tax and insurance obligations.\14\ Consumers who do not
fully understand such terms and features, however, are less able to
appreciate their risks, which can be significant. For example, the
payment may increase sharply and a prepayment penalty may hinder the
consumer from
[[Page 44526]]
refinancing to avoid the payment increase. Thus, consumers may
unwittingly accept loans that they will have difficulty repaying.
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\13\ Jinkook Lee and Jeanne M. Hogarth, Consumer Information
Search for Home Mortgages: Who, What, How Much, and What Else?,
Financial Services Review 291 (2000) (Consumer Information Search)
(``In all, there are dozens of features and costs disclosed per
loan, far in excess of the combination of terms, lenders, and
information sources consumers report using when shopping.'').
\14\ Consumer Information Search at 285 (reporting survey
evidence that most consumers compared interest rate or APR, loan
type (fixed-rate or ARM), and mandatory up-front fees, but only a
quarter considered the costs of optional products such as credit
insurance and back-end costs such as late fees). There is evidence
that borrowers are not aware of, or do not understand, terms of this
nature even after they have obtained a loan. See Improving Mortgage
Disclosures at 27-30 (discussing anecdotal evidence based on
consumer interviews that borrowers were not aware of, did not
understand, or misunderstood an important cost or feature of their
loans that had substantial impact on the overall cost, the future
payments, or the ability to refinance with other lenders); Brian
Bucks and Karen Pence, Do Homeowners Know Their House Values and
Mortgage Terms? 18-22 (Board Fin. and Econ. Discussion Series
Working Paper No. 2006-3, 2006) (discussing statistical evidence
that borrowers with ARMs underestimate annual as well as life-time
caps on the interest rate; the rate of underestimation increases for
lower-income and less-educated borrowers), available at http://
www.federalreserve.gov/pubs/feds/2006/200603/200603pap.pdf.
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Limits of disclosure. Disclosures describing the multiplicity of
features of a complex loan could help some consumers in the subprime
market, but may not be sufficient to protect them against unfair loan
terms or lending practices. Obtaining widespread consumer understanding
of the many potentially significant features of a typical subprime
product is a major challenge.\15\ If consumers do not have a certain
minimum level understanding of the market and products, disclosures for
complex and infrequent transactions may not effectively provide that
minimum understanding. Moreover, even if all of a loan's features are
disclosed clearly to consumers, they may continue to focus on a few
features that appear most significant. Alternatively, disclosing all
features may ``overload'' consumers and make it more difficult for them
to discern which features are most important.
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\15\ Improving Mortgage Disclosures at 74-76 (finding that
borrowers in the subprime market may have more difficulty
understanding their loan terms because their loans are more complex
than loans in the prime market).
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Moreover, consumers may rely more on their originators to explain
the disclosures when the transaction is complex; some originators may
have incentives to misrepresent the disclosures so as to obscure the
transaction's risks to the consumer; and such misrepresentations may be
particularly effective if the originator is face-to-face with the
consumer.\16\ Therefore, while the Board anticipates proposing changes
to Regulation Z to improve mortgage loan disclosures, it is unlikely
that better disclosures, alone, will address adequately the risk of
abusive or unaffordable loans in the subprime market.
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\16\ U.S. Gen. Accounting Office, GAO 04-280, Consumer
Protection: Federal and State Agencies Face Challenges in Combating
Predatory Lending 97-98 (2004) (stating that the inherent complexity
of mortgage loans, some borrowers' lack of financial sophistication,
education, or infirmities, and misleading statements and actions by
lenders and brokers limit the effectiveness of even clear and
transparent disclosures).
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Misaligned Incentives and Obstacles to Monitoring
Not only are consumers in the subprime market often unable to
protect themselves from abusive or unaffordable loans, originators may
at certain times be more likely to extend unaffordable loans. The
recent sharp rise in serious delinquencies on subprime mortgages has
made clear that originators were not adequately assessing repayment
ability, particularly where mortgages were sold to the secondary market
and the originator retained little of the risk. The growth of the
secondary market gave lenders--and, thus, mortgage borrowers--greater
access to capital markets, lowered transaction costs, and allowed risk
to be shared more widely. This ``originate-to-distribute'' model,
however, has also contributed to the loosening of underwriting
standards, particularly during periods of rapid house price
appreciation, which may mask problems by keeping default and
delinquency rates low until price appreciation slows or reverses.\17\
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\17\ Atif Mian and Amir Sufi, The Consequences of Mortgage
Credit Expansion: Evidence from the 2007 Mortgage Default Crisis
(May 2008), available at: http://ssrn.com/abstract=1072304.
---------------------------------------------------------------------------
This potential tendency has several related causes. First, when an
originator sells a mortgage and its servicing rights, depending on the
terms of the sale, most or all of the risks typically are passed on to
the loan purchaser. Thus, originators that sell loans may have less of
an incentive to undertake careful underwriting than if they kept the
loans. Second, warranties by sellers to purchasers and other
``repurchase'' contractual provisions have little meaningful benefit if
originators have limited assets. Third, fees for some loan originators
have been tied to loan volume, making loan sales--sometimes
accomplished through aggressive ``push marketing''--a higher priority
than loan quality for some originators. Fourth, investors may not
exercise adequate due diligence on mortgages in the pools in which they
are invested, and may instead rely heavily on credit-ratings firms to
determine the quality of the investment.\18\
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\18\ Benjamin J. Keys, Tanmoy K. Mukherjee, Amit Seru and Vikram
Vig, Did Securitization Lead to Lax Screening? Evidence from Suprime
Loans at 22, available at: http://ssrn.com/abstract=1093137.
---------------------------------------------------------------------------
Fragmentation in the originator market can further exacerbate the
problem. Data reported under the Home Mortgage Disclosure Act (HMDA)
show that independent mortgage companies--those not related to
depository institutions or their subsidiaries or affiliates--in 2005
and 2006 made nearly one-half of first-lien mortgage loans reportable
as being higher-priced but only one-fourth of loans that were not
reportable as higher-priced. Nor was lending by independent mortgage
companies particularly concentrated: In each of 2005 and 2006 around
150 independent mortgage companies made 500 or more first-lien mortgage
loans on owner-occupied dwellings that were reportable as higher-
priced. In addition, as noted earlier, one source suggests that 60
percent or more of mortgages originated in the last several years were
originated through mortgage brokers.\19\ This same source estimates the
number of brokerage companies at over 50,000 in recent years.
---------------------------------------------------------------------------
\19\ Data reported by Wholesale Access Mortgage Research and
Consulting, Inc., available at http://www.wholesaleaccess.com.
---------------------------------------------------------------------------
Thus, a securitized pool of mortgages may have been sourced by tens
of lenders and thousands of brokers. Investors have limited ability to
directly monitor these originators' activities. Further, government
oversight of such a fragmented market faces significant challenges
because originators operate in different states and under different
regulatory and supervisory regimes and different practices in sharing
information among regulators. These circumstances may inhibit the
ability of regulators to protect consumers from abusive and
unaffordable loans.
A Role for New HOEPA Rules
As explained above, consumers in the subprime market face serious
constraints on their ability to protect themselves from abusive or
unaffordable loans, even with the best disclosures; originators
themselves may at times lack sufficient market incentives to ensure
loans they originate are affordable; and regulators face limits on
their ability to oversee a fragmented subprime origination market.
These circumstances warrant imposing a new national legal standard on
subprime lenders to help ensure that consumers receive mortgage loans
they can afford to repay, and help prevent the equity-stripping abuses
that unaffordable loans facilitate. Adopting this standard under
authority of HOEPA ensures that it is applied uniformly to all
originators and provides consumers an opportunity to redress wrongs
through civil actions to the extent authorized by TILA. As explained in
the next part, substantial information supplied to the Board through
several public hearings confirms the need for new HOEPA rules.
III. The Board's HOEPA Hearings
A. Home Ownership and Equity Protection Act (HOEPA)
The Board has recently held extensive public hearings on consumer
protection issues in the mortgage market, including the subprime
sector. These hearings were held pursuant to the Home Ownership and
Equity Protection Act (HOEPA), which directs the Board to hold public
hearings periodically on the home equity lending market and the
adequacy of existing law for protecting
[[Page 44527]]
the interests of consumers, particularly low income consumers. HOEPA
imposes substantive restrictions, and special pre-closing disclosures,
on particularly high-cost refinancings and home equity loans (``HOEPA
loans'').\20\ These restrictions include limitations on prepayment
penalties and ``balloon payment'' loans, and prohibitions of negative
amortization and of engaging in a pattern or practice of lending based
on the collateral without regard to repayment ability.
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\20\ HOEPA loans are closed-end, non-purchase money mortgages
secured by a consumer's principal dwelling (other than a reverse
mortgage) where either: (a) The APR at consummation will exceed the
yield on Treasury securities of comparable maturity by more than 8
percentage points for first-lien loans, or 10 percentage points for
subordinate-lien loans; or (b) the total points and fees payable by
the consumer at or before closing exceed the greater of 8 percent of
the total loan amount, or $547 for 2007 (adjusted annually).
---------------------------------------------------------------------------
When it enacted HOEPA, Congress granted the Board authority,
codified in TILA Section 129(l), to create exemptions to HOEPA's
restrictions and to expand its protections. 15 U.S.C. 1639(l). Under
TILA Section 129(l)(1), the Board may create exemptions to HOEPA's
restrictions as needed to keep responsible credit available; and under
TILA Section 129(l)(2), the Board may adopt new or expanded
restrictions as needed to protect consumers from unfairness, deception,
or evasion of HOEPA. In HOEPA Section 158, Congress directed the Board
to monitor changes in the home equity market through regular public
hearings.
Hearings the Board held in 2000 led the Board to expand HOEPA's
protections in December 2001.\21\ Those rules, which took effect in
2002, lowered HOEPA's rate trigger, expanded its fee trigger to include
single-premium credit insurance, added an anti-``flipping''
restriction, and improved the special pre-closing disclosure.
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\21\ Truth in Lending, 66 FR 65604, 65608, Dec. 20, 2001.
---------------------------------------------------------------------------
B. Summary of 2006 Hearings
In the summer of 2006, the Board held four hearings in four cities
on three broad topics: (1) The impact of the 2002 HOEPA rule changes on
predatory lending practices, as well as the effects on consumers of
state and local predatory lending laws; (2) nontraditional mortgage
products and reverse mortgages; and (3) informed consumer choice in the
subprime market. Hearing panelists included mortgage lenders and
brokers, credit ratings agencies, real estate agents, consumer
advocates, community development groups, housing counselors,
academicians, researchers, and state and federal government officials.
In addition, consumers, housing counselors, brokers, and other
individuals made brief statements at the hearings during an ``open
mike'' period. In all, 67 individuals testified on panels and 54
comment letters were submitted to the Board.
Consumer advocates and some state officials stated that HOEPA is
generally effective in preventing abusive terms in loans subject to the
HOEPA price triggers. They noted, however, that very few loans are made
with rates or fees at or above the HOEPA triggers, and some advocated
that Congress lower them. Consumer advocates and state officials also
urged regulators and Congress to curb abusive practices in the
origination of loans that do not meet HOEPA's price triggers.
Consumer advocates identified several particular areas of concern.
They urged the Board to prohibit or restrict certain loan features or
terms, such as prepayment penalties, and underwriting practices such as
``stated income'' or ``low documentation'' (``low doc'') loans for
which the borrower's income is not documented or verified. They also
expressed concern about aggressive marketing practices such as steering
borrowers to higher-cost loans by emphasizing initial low monthly
payments based on an introductory rate without adequately explaining
that the consumer will owe considerably higher monthly payments after
the introductory rate expires.
Some consumer advocates stated that brokers and lenders should be
held to a duty of care such as a duty of good faith and fair dealing or
a duty to make only loans suitable for the borrower. These advocates
also urged the Board to ban ``yield spread premiums,'' payments that
brokers receive from the lender at closing for delivering a loan with
an interest rate that is higher than the lender's ``buy rate,'' because
they provide brokers an incentive to increase consumers' interest
rates. They argued that such steps would align reality with consumers'
perceptions that brokers serve their best interests. Consumer advocates
also expressed concerns that brokers, lenders, and others may coerce
appraisers to misrepresent the value of a dwelling; and that servicers
may charge consumers unwarranted fees and in some cases make it
difficult for consumers who are in default to avoid foreclosure.
Industry panelists and commenters, on the other hand, expressed
concern that state predatory lending laws may reduce the availability
of credit for some subprime borrowers. Most industry commenters opposed
prohibiting stated income loans, prepayment penalties, or other loan
terms, asserting that this approach would harm borrowers more than help
them. They urged the Board and other regulators to focus instead on
enforcing existing laws to remove ``bad actors'' from the market. Some
lenders indicated, however, that restrictions on certain features or
practices might be appropriate if the restrictions were clear and
narrow. Industry commenters also stated that subjective suitability
standards would create uncertainties for brokers and lenders and
subject them to excessive litigation risk.
C. Summary of June 2007 Hearing
In light of the information received at the 2006 hearings and the
rise in defaults that began soon after, the Board held an additional
hearing in June 2007 to explore how it could use its authority under
HOEPA to prevent abusive lending practices in the subprime market while
still preserving responsible subprime lending. The Board focused the
hearing on four specific areas: Lenders' determination of borrowers'
repayment ability; ``stated income'' and ``low doc'' lending; the lack
of escrows in the subprime market relative to the prime market; and the
high frequency of prepayment penalties in the subprime market.
At the hearing, the Board heard from 16 panelists representing
consumers, mortgage lenders, mortgage brokers, and state government
officials, as well as from academicians. The Board also received almost
100 written comments after the hearing from an equally diverse group.
Industry representatives acknowledged concerns with recent lending
practices but urged the Board to address most of these concerns through
supervisory guidance rather than regulations under HOEPA. They
maintained that supervisory guidance, unlike regulation, is flexible
enough to preserve access to responsible credit. They also suggested
that supervisory guidance issued recently regarding nontraditional
mortgages and subprime lending, as well as market self-correction, have
reduced the need for new regulations. Industry representatives support
improving mortgage disclosures to help consumers avoid abusive loans.
They urged that any substantive rules adopted by the Board be clearly
drawn to limit uncertainty and narrowly drawn to avoid unduly
restricting credit.
In contrast, consumer advocates, state and local officials, and
Members of Congress urged the Board to adopt regulations under HOEPA.
They acknowledged a proper place for
[[Page 44528]]
guidance but contended that recent problems indicate the need for
requirements enforceable by borrowers through civil actions, which
HOEPA enables and guidance does not. They also expressed concern that
less responsible, less closely supervised lenders are not subject to
the guidance and that there is limited enforcement of existing laws for
these entities. Consumer advocates and others welcomed improved
disclosures but insisted they would not prevent abusive lending. More
detailed accounts of the testimony and letters are provided below in
the context of specific issues the Board is addressing in these final
rules.
D. Congressional Hearings
Congress has also held a number of hearings in the past year about
consumer protection concerns in the mortgage market.\22\ In these
hearings, Congress has heard testimony from individual consumers,
representatives of consumer and community groups, representatives of
financial and mortgage industry groups and federal and state officials.
These hearings have focused on rising subprime foreclosure rates and
the extent to which lending practices have contributed to them.
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\22\ E.g., Foreclosure Problems and Solutions: Federal, State,
and Local Efforts to Address the Foreclosure Crisis in Ohio: Hearing
before the Subcomm. on Housing and Comm. Oppty. of the H. Comm. on
Fin. Servs., 110th Cong. (2008); Targeting Federal Aid to
Neighborhoods Distressed by the Subprime Mortgage Crisis: Hearing
before the Subcomm. on Housing and Comm. Oppty. of the H. Comm. on
Fin. Servs., 110th Cong. (2008); Improving Consumer Protections in
Subprime Lending: Hearing before the Subcomm. on Int. Comm., Trade,
and Tourism of the S. Comm. on Comm., Sci., and Trans., 110th Cong.
(2008); H.R. 5679, The Foreclosure Prevention and Sound Mortgage
Servicing Act of 2008: Hearing before the Subcomm. on Housing and
Comm. Oppty. of the H. Comm. on Fin. Servs., 110th Cong. (2008);
Restoring the American Dream: Solutions to Predatory Lending and the
Foreclosure Crisis: S. Comm. on Banking, Hsg., and Urban Affairs,
110th Cong. (2008); Consumer Protection in Financial Services:
Subprime Lending and Other Financial Activities: Hearing before the
Subcomm. on Fin. Svcs. and Gen. Gov't of the H. Approp. Comm., 110th
Cong. (2008); Progress in Administration and Other Efforts to
Coordinate and Enhance Mortgage Foreclosure Prevention: Hearing
before the H. Comm. on Fin. Servs., 110th Cong. (2007); Legislative
Proposals on Reforming Mortgage Practices: Hearing before the H.
Comm. on Fin. Servs., 110th Cong. (2007); Legislative and Regulatory
Options for Minimizing and Mitigating Mortgage Foreclosures: Hearing
before the H. Comm. on Fin. Servs., 110th Cong. (2007); Ending
Mortgage Abuse: Safeguarding Homebuyers: Hearing before the S.
Subcomm. on Hous., Transp., and Cmty. Dev. of the S. Comm. on
Banking, Hous., and Urban Affairs, 110th Cong. (2007); Improving
Federal Consumer Protection in Financial Services: Hearing before
the H. Comm. on Fin. Servs., 110th Cong. (2007).
---------------------------------------------------------------------------
Consumer and community group representatives testified that certain
lending terms or practices, such as hybrid adjustable-rate mortgages,
prepayment penalties, low or no documentation loans, lack of escrows
for taxes and insurance, and failure to consider the consumer's ability
to repay have contributed to foreclosures. In addition, these witnesses
testified that consumers often believe that mortgage brokers represent
their interests and shop on their behalf for the best loan terms. As a
result, they argue that consumers do not shop independently to ensure
that they are getting the best terms for which they qualify. They also
testified that, because originators sell most loans into the secondary
market and do not share the risk of default, brokers and lenders have
less incentive to ensure consumers can afford their loans.
Financial services and mortgage industry representatives testified
that consumers need better disclosures of their loan terms, but that
substantive restrictions on subprime loan terms would risk reducing
access to credit for some borrowers. In addition, these witnesses
testified that applying a fiduciary duty to the subprime market, such
as requiring that a loan be in the borrower's best interest, would
introduce subjective standards that would significantly increase
compliance and litigation risk. According to these witnesses, some
lenders would be less willing to offer loans in the subprime market,
making it harder for some consumers to get loans.
IV. Interagency Supervisory Guidance
In December 2005, the Board and the other federal banking agencies
responded to concerns about the rapid growth of nontraditional
mortgages in the previous two years by proposing supervisory guidance.
Nontraditional mortgages are mortgages that allow the borrower to defer
repayment of principal and sometimes interest. The guidance advised
institutions of the need to reduce ``risk layering'' practices with
respect to these products, such as failing to document income or
lending nearly the full appraised value of the home. The proposal, and
the final guidance issued in September 2006, specifically advised
lenders that layering risks in nontraditional mortgage loans to
subprime borrowers may significantly increase risks to borrowers as
well as institutions.\23\
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\23\ Interagency Guidance on Nontraditional Mortgage Product
Risks, 71 FR 58609, Oct. 4, 2006 (Nontraditional Mortgage Guidance).
---------------------------------------------------------------------------
The Board and the other federal banking agencies addressed concerns
about the subprime market more broadly in March 2007 with a proposal
addressing the heightened risks to consumers and institutions of ARMs
with two or three-year ``teaser'' rates followed by substantial
increases in the rate and payment. The guidance, finalized in June
2007, sets out the standards institutions should follow to ensure
borrowers in the subprime market obtain loans they can afford to
repay.\24\ Among other steps, the guidance advises lenders to (1) use
the fully-indexed rate and fully-amortizing payment when qualifying
borrowers for loans with adjustable rates and potentially non-
amortizing payments; (2) limit stated income and reduced documentation
loans to cases where mitigating factors clearly minimize the need for
full documentation of income; (3) provide that prepayment penalty
clauses expire a reasonable period before reset, typically at least 60
days.
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\24\ Statement on Subprime Mortgage Lending, 72 FR 37569, Jul.
10, 2007 (Subprime Statement).
---------------------------------------------------------------------------
The Conference of State Bank Supervisors (CSBS) and American
Association of Residential Mortgage Regulators (AARMR) issued parallel
statements for state supervisors to use with state-supervised entities,
and many states have adopted the statements.
The guidance issued by the federal banking agencies has helped to
promote safety and soundness and protect consumers in the subprime
market. Guidance, however, is not necessarily implemented uniformly by
all originators. Originators who are not subject to routine examination
and supervision may not adhere to guidance as closely as originators
who are. Guidance also does not provide individual consumers who have
suffered harm because of abusive lending practices an opportunity for
redress. The new and expanded consumer protections that the Board is
adopting apply uniformly to all creditors and are enforceable by
federal and state supervisory and enforcement agencies and in many
cases by borrowers.
V. Legal Authority
A. The Board's Authority Under TILA Section 129(l)(2)
The substantive limitations in new Sec. Sec. 226.35 and 226.36 and
corresponding revisions to Sec. Sec. 226.32 and 226.34, as well as
restrictions on misleading and deceptive advertisements, are based on
the Board's authority under TILA Section 129(l)(2), 15 U.S.C.
1639(l)(2). That provision gives the Board authority to prohibit acts
or practices in connection with:
[[Page 44529]]
Mortgage loans that the Board finds to be unfair,
deceptive, or designed to evade the provisions of HOEPA; and
Refinancing of mortgage loans that the Board finds to be
associated with abusive lending practices or that are otherwise not in
the interest of the borrower.
The authority granted to the Board under TILA Section 129(l)(2), 15
U.S.C. 1639(l)(2), is broad. It reaches mortgage loans with rates and
fees that do not meet HOEPA's rate or fee trigger in TILA Section
103(aa), 15 U.S.C. 1602(aa), as well as types of mortgage loans not
covered under that section, such as home purchase loans. Section
129(l)(2) also authorizes the Board to strengthen the protections in
Section 129 (c)-(i) for the loans to which Section 103(aa) applies
these protections (HOEPA loans). In TILA Section 129 (c)-(i), Congress
set minimum standards for HOEPA loans. The Board is authorized to
strengthen those standards for HOEPA loans when the Board finds
practices unfair, deceptive, or abusive. The Board is also authorized
by Section 129(l)(2) to apply those strengthened standards to loans
that are not HOEPA loans. Moreover, while HOEPA's statutory
restrictions apply only to creditors and only to loan terms or lending
practices, Section 129(l)(2) is not limited to acts or practices by
creditors, nor is it limited to loan terms or lending practices. See 15
U.S.C. 1639(l)(2). It authorizes protections against unfair or
deceptive practices when such practices are ``in connection with
mortgage loans,'' and it authorizes protections against abusive
practices ``in connection with refinancing of mortgage loans.'' Thus,
the Board's authority is not limited to regulating specific contractual
terms of mortgage loan agreements; it extends to regulating loan-
related practices generally, within the standards set forth in the
statute.
HOEPA does not set forth a standard for what is unfair or
deceptive, but the Conference Report for HOEPA indicates that, in
determining whether a practice in connection with mortgage loans is
unfair or deceptive, the Board should look to the standards employed
for interpreting state unfair and deceptive trade practices statutes
and the Federal Trade Commission Act (FTC Act), Section 5(a), 15 U.S.C.
45(a).\25\
---------------------------------------------------------------------------
\25\ H.R. Rep. 103-652, at 162 (1994) (Conf. Rep.).
---------------------------------------------------------------------------
Congress has codified standards developed by the Federal Trade
Commission (FTC) for determining whether acts or practices are unfair
under Section 5(a), 15 U.S.C. 45(a).\26\ Under the FTC Act, an act or
practice is unfair when it causes or is likely to cause substantial
injury to consumers which is not reasonably avoidable by consumers
themselves and not outweighed by countervailing benefits to consumers
or to competition. In addition, in determining whether an act or
practice is unfair, the FTC is permitted to consider established public
policies, but public policy considerations may not serve as the primary
basis for an unfairness determination.\27\
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\26\ See 15 U.S.C. 45(n); Letter from FTC to the Hon. Wendell H.
Ford and the Hon. John C. Danforth (Dec. 17, 1980).
\27\ 15 U.S.C. 45(n).
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The FTC has interpreted these standards to mean that consumer
injury is the central focus of any inquiry regarding unfairness.\28\
Consumer injury may be substantial if it imposes a small harm on a
large number of consumers, or if it raises a significant risk of
concrete harm.\29\ The FTC looks to whether an act or practice is
injurious in its net effects.\30\ The agency has also observed that an
unfair act or practice will almost always reflect a market failure or
market imperfection that prevents the forces of supply and demand from
maximizing benefits and minimizing costs.\31\ In evaluating unfairness,
the FTC looks to whether consumers' free market decisions are
unjustifiably hindered.\32\
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\28\ Statement of Basis and Purpose and Regulatory Analysis,
Credit Practices Rule, 42 FR 7740, 7743, March 1, 1984 (Credit
Practices Rule).
\29\ Letter from Commissioners of the FTC to the Hon. Wendell H.
Ford, Chairman, and the Hon. John C. Danforth, Ranking Minority
Member, Consumer Subcomm. of the H. Comm. on Commerce, Science, and
Transp., n.12 (Dec. 17, 1980).
\30\ Credit Practices Rule, 42 FR at 7744.
\31\ Id.
\32\ Id.
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The FTC has also adopted standards for determining whether an act
or practice is deceptive (though these standards, unlike unfairness
standards, have not been incorporated into the FTC Act).\33\ First,
there must be a representation, omission or practice that is likely to
mislead the consumer. Second, the act or practice is examined from the
perspective of a consumer acting reasonably in the circumstances.
Third, the representation, omission, or practice must be material. That
is, it must be likely to affect the consumer's conduct or decision with
regard to a product or service.\34\
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\33\ Letter from James C. Miller III, Chairman, FTC to the Hon.
John D. Dingell, Chairman, H. Comm. on Energy and Commerce (Oct. 14,
1983) (Dingell Letter).
\34\ Dingell Letter at 1-2.
---------------------------------------------------------------------------
Many states also have adopted statutes prohibiting unfair or
deceptive acts or practices, and these statutes employ a variety of
standards, many of them different from the standards currently applied
to the FTC Act. A number of states follow an unfairness standard
formerly used by the FTC. Under this standard, an act or practice is
unfair where it offends public policy; or is immoral, unethical,
oppressive, or unscrupulous; and causes substantial injury to
consumers.\35\
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\35\ See, e.g., Kenai Chrysler Ctr., Inc. v. Denison, 167 P.3d
1240, 1255 (Alaska 2007) (quoting FTC v. Sperry & Hutchinson Co.,
405 U.S. 233, 244-45 n.5 (1972)); State v. Moran, 151 N.H. 450, 452,
861 A.2d 763, 755-56 (N.H. 2004) (concurrently applying the FTC's
former test and a test under which an act or practice is unfair or
deceptive if ``the objectionable conduct * * * attain[s] a level of
rascality that would raise an eyebrow of someone inured to the rough
and tumble of the world of commerce.'') (citation omitted); Robinson
v. Toyota Motor Credit Corp., 201 Ill. 2d 403, 417-418, 775 N.E.2d
951, 961-62 (2002) (quoting 405 U.S. at 244-45 n.5).
---------------------------------------------------------------------------
In adopting final rules under TILA Section 129(l)(2)(A), 15 U.S.C.
1639(l)(2)(A), the Board has considered the standards currently applied
to the FTC Act's prohibition against unfair or deceptive acts or
practices, as well as the standards applied to similar state statutes.
B. The Board's Authority Under TILA Section 105(a)
Other aspects of these rules are based on the Board's general
authority under TILA Section 105(a) to prescribe regulations necessary
or proper to carry out TILA's purposes 15 U.S.C. 1604(a). This section
is the basis for the requirement to provide early disclosures for
residential mortgage transactions as well as many of the revisions to
improve advertising disclosures. These rules are intended to carry out
TILA's purposes of informing consumers about their credit terms and
helping them shop for credit. See TILA Section 102, 15 U.S.C. 1603.
VI. The Board's Proposal
On January 9, 2008, the Board published a notice of proposed
rulemaking in the Federal Register (73 FR 1672) proposing to amend
Regulation Z.
A. Proposals To Prevent Unfairness, Deception, and Abuse
The Board proposed new restrictions and requirements for mortgage
lending and servicing intended to protect consumers against unfairness,
deception, and abuse while preserving responsible lending and
sustainable homeownership. Some of the proposed restrictions would
apply only to higher-priced mortgage loans, while others
[[Page 44530]]
would apply to all mortgage loans secured by a consumer's principal
dwelling.
Protections Covering Higher-Priced Mortgage Loans
The Board proposed certain protections for consumers receiving
higher-priced mortgage loans. Higher-priced mortgage loans would have
been loans with an annual percentage rate (APR) that exceeds the
comparable Treasury security by three or more percentage points for
first-lien loans, or five or more percentage points for subordinate-
lien loans. For such loans, the Board proposed to:
[cir] Prohibit creditors from engaging in a pattern or practice of
extending credit without regard to borrowers' ability to repay from
sources other than the collateral itself;
[cir] Require creditors to verify income and assets they rely upon
in making loans;
[cir] Prohibit prepayment penalties unless certain conditions are
met; and
[cir] Require creditors to establish escrow accounts for taxes and
insurance, but permit creditors to allow borrowers to opt out of
escrows 12 months after loan consummation.
In addition, the proposal would have prohibited creditors from
structuring closed-end mortgage loans as open-end lines of credit for
the purpose of evading these rules, which do not apply to lines of
credit.
Proposed Protections Covering Closed-End Loans Secured by Consumer's
Principal Dwelling
In addition, in connection with all consumer-purpose, closed-end
loans secured by a consumer's principal dwelling, the Board proposed
to:
[cir] Prohibit creditors from paying a mortgage broker more than
the consumer had agreed in advance that the broker would receive;
[cir] Prohibit any creditor or mortgage broker from coercing,
influencing, or otherwise encouraging an appraiser to provide a
misstated appraisal in connection with a mortgage loan; and
[cir] Prohibit mortgage servicers from ``pyramiding'' late fees,
failing to credit payments as of the date of receipt, failing to
provide loan payoff statements upon request within a reasonable time,
or failing to deliver a fee schedule to a consumer upon request.
B. Proposals To Improve Mortgage Advertising
Another goal of the Board's proposal was to ensure that mortgage
loan advertisements provide accurate and balanced information and do
not contain misleading or deceptive representations. The Board proposed
to require that advertisements for both open-end and closed-end
mortgage loans provide accurate and balanced information, in a clear
and conspicuous manner, about rates, monthly payments, and other loan
features. The proposal was issued under the Board's authorities to:
Adopt regulations to ensure consumers are informed about and can shop
for credit; require that information, including the information
required for advertisements for closed-end credit, be disclosed in a
clear and conspicuous manner; and regulate advertisements of open-end
home-equity plans secured by the consumer's principal dwelling. See
TILA Section 105(a), 15 U.S.C. 1604(a); Section 122, 15 U.S.C. 1632;
Section 144, 15 U.S.C. 1664; Section 147, 15 U.S.C. 1665b.
The Board also proposed, under TILA Section 129(l)(2), 15 U.S.C.
1639(l)(2), to prohibit the following seven deceptive or misleading
practices in advertisements for closed-end mortgage loans:
[cir] Advertising ``fixed'' rates or payments for loans whose rates
or payments can vary without adequately disclosing that the interest
rate or payment amounts are ``fixed'' only for a limited period of
time, rather than for the full term of the loan;
[cir] Comparing an actual or hypothetical consumer's rate or
payment obligations and the rates or payments that would apply if the
consumer obtains the advertised product unless the advertisement states
the rates or payments that will apply over the full term of the loan;
[cir] Advertisements that characterize the products offered as
``government loan programs,'' ``government-supported loans,'' or
otherwise endorsed or sponsored by a federal or state government entity
even though the advertised products are not government-supported or -
sponsored loans;
[cir] Advertisements, such as solicitation letters, that display
the name of the consumer's current mortgage lender, unless the
advertisement also prominently discloses that the advertisement is from
a mortgage lender not affiliated with the consumer's current lender;
[cir] Advertising claims of debt elimination if the product
advertised would merely replace one debt obligation with another;
[cir] Advertisements that create a false impression that the
mortgage broker or lender has a fiduciary relationship with the
consumer; and
[cir] Foreign-language advertisements in which certain information,
such as a low introductory ``teaser'' rate, is provided in a foreign
language, while required disclosures are provided only in English.
C. Proposal To Give Consumers Disclosures Early
A third goal of the proposal was to provide consumers transaction-
specific disclosures early enough to use while shopping for a mortgage
loan. The Board proposed to require creditors to provide transaction-
specific mortgage loan disclosures such as the APR and payment schedule
for all home-secured, closed-end loans no later than three business
days after application, and before the consumer pays any fee except a
reasonable fee for the originator's review of the consumer's credit
history.
VII. Overview of Comments Received
The Board received approximately 4700 comments on the proposal. The
comments came from community banks, independent mortgage companies,
large bank holding companies, secondary market participants, credit
unions, state and national trade associations for financial
institutions in the mortgage business, mortgage brokers and mortgage
broker trade associations, realtors and realtor trade associations,
individual consumers, local and national community groups, federal and
state regulators and elected officials, appraisers, academics, and
other interested parties.
Commenters generally supported the Board's effort to protect
consumers from unfair practices, particularly in the subprime market,
while preserving responsible lending and sustainable homeownership.
However, industry commenters generally opposed the breadth of the
proposal; favoring narrower and more flexible rules. They also
expressed concerns about the costs of certain proposals, such as the
requirement to establish escrows for all first-lien higher-priced
mortgage loans. Consumer advocates, federal and state regulators
(including the Federal Deposit Insurance Corporation (FDIC)), and
elected officials (including members of Congress and some state
attorneys general) supported the proposal as addressing some of the
abuses in the subprime market, but argued that additional consumer
protections are needed.
Many commenters supported the approach of using loan price to
identify ``higher-priced'' loans. Financial institution commenters and
their trade associations were concerned, however, that the proposed
price thresholds were too low, and could capture many prime loans. They
contended that broad
[[Page 44531]]
coverage would reduce credit availability because creditors would
refrain from making covered loans or would pass on compliance costs.
Many industry commenters urged the Board to use a different index to
define higher-priced mortgage loans than the proposed index of Treasury
security yields, because the spread between Treasury yields and
mortgage rates can change. Consumer advocate commenters generally, but
not uniformly, favored applying the Board's proposed protections to all
loans secured by a principal dwelling regardless of loan price. In the
alternative, they favored the proposed price thresholds but urged the
Board also to apply the protections to nontraditional mortgage loans.
Industry commenters generally, but not uniformly, supported or did
not oppose a rule prohibiting lenders from engaging in a pattern or
practice of unaffordable lending. They urged the Board, however, to
provide a clear and specific ``safe harbor'' and remove the
presumptions of violations in order to avoid unduly constraining
credit. In contrast, consumer advocate commenters and others urged the
Board to revise the ability to repay rule so that it applies on a loan-
by-loan basis and not only to a pattern or practice of disregarding
borrowers' ability to repay. These commenters argued that a requirement
to prove a ``pattern or practice'' would prevent consumers from
bringing claims and would weaken the rule's power to deter abuse.
Consumer advocate commenters and some federal and state regulators
and elected officials also maintained that a complete ban on prepayment
penalties is necessary to protect consumers. In particular, many of
these commenters argued that prepayment penalties' harms to subprime
consumers outweigh the benefits of any reductions in interest rate
consumers receive, and that the Board's proposed restrictions on
prepayment penalties would not adequately address the harms. However,
most banks and their trade associations stated that the interest rate
benefit afforded to consumers with loans having prepayment penalty
provisions lowers credit costs and increases credit availability.
Many community banks and mortgage brokers as well as several
industry trade associations opposed the proposed escrow requirement,
contending that escrow infrastructures would be costly and that
creditors would either refrain from making higher-priced loans or would
pass costs on to consumers. Consumers also expressed concern that they
would lose interest on their escrowed funds and that servicers would
fail to properly pay tax and insurance obligations. Several industry
trade associations, several large creditors and some mortgage brokers,
consumer and community development groups, and state and federal
officials, however, supported the proposed escrow requirement as
protecting consumers from expensive force-placed insurance or default,
and possibly foreclosure.
For their part, mortgage brokers and their trade associations
principally addressed the yield spread premium proposal, which they
strongly opposed. They, as well as FTC staff, argued that prohibiting
creditors from paying brokers more than the consumer agreed to in
writing would put brokers at a competitive disadvantage relative to
retail lenders. They also argued that consumers would be confused and
misled by a broker compensation disclosure. Consumer advocates, several
members of Congress, several state attorneys general, and the FDIC
contended that the proposal would do little to protect consumers and
urged the Board to ban yield spread premiums outright.
Most commenters generally supported the Board's proposed
advertising rules, although some commenters requested clarifications
and modifications. Commenters were divided about the proposal to
require early mortgage loan disclosures. Many creditors and their trade
associations opposed the proposal because of perceived operational cost
and compliance difficulties, and concerns about the scope of the fee
restriction and its application to third party originators. Consumer
groups, state regulators and enforcement generally supported the
proposed rule, however, because it would make more information
available to consumers when they are shopping for loans. Some of the
commenters requested that the Board require lenders to redisclose
before loan consummation to enhance the accuracy of information.
Industry commenters urged the Board to adopt all of the proposed
restrictions in Sec. Sec. 226.35 and 226.36 under its TILA Section
105(a) authority rather than its Section 129(l)(2) authority. They
argued that using Section 129(l)(2) authority would impose
disproportionately heavy penalties on lenders for violations and
unnecessary costs on consumers. Consumer advocates, on the other hand,
supported using Section 129(l)(2) authority and urged the Board use it
more broadly to adopt the other proposed rules concerning early
disclosures and advertising.
Public comments with respect to these and other provisions of the
rule are described and discussed in more detail below.
VIII. Definition of ``Higher-Priced Mortgage Loan''--Sec. 226.35(a)
A. Overview
The Board proposed to extend certain consumer protections to a
subset of consumer residential mortgage loans referred to as ``higher-
priced mortgage loans.'' This part VIII discusses the definition of
``higher-priced mortgage loan'' the Board is adopting. A discussion of
the specific protections that apply to these loans follows in part IX.
The Board is also finalizing the proposal to apply certain other
restrictions to closed-end consumer mortgage loans secured by the
consumer's principal dwelling without regard to loan price. These
restrictions are discussed separately in part X.
Under the proposal, higher-priced mortgage loans would be defined
as consumer credit transactions secured by the consumer's principal
dwelling for which the APR on the loan exceeds the yield on comparable
Treasury securities by at least three percentage points for first-lien
loans, or five percentage points for subordinate-lien loans. The
proposed definition would include home purchase loans, refinancings,
and home equity loans. The definition would exclude home equity lines
of credit (``HELOCs''). There would also be exclusions for reverse
mortgages, construction-only loans, and bridge loans.
The Board is adopting a definition of ``higher-priced mortgage
loan'' that is substantially similar to that proposed but different in
the particulars. The changes to the final rule are being made in
response to commenters' concerns. The final definition, like the
proposed definition, sets a threshold above a measure of market rates
to distinguish higher-priced mortgage loans from the rest of the
mortgage market. But the measure the Board is adopting is different,
and therefore so is the threshold. Instead of yields on Treasury
securities, the definition uses average offer rates for the lowest-risk
prime mortgages, termed ``average prime offer rates.'' For the
foreseeable future, the Board will obtain or, as applicable, derive
average prime offer rates from the Freddie Mac Primary Mortgage Market
Survey[reg]. The threshold is set at 1.5 percentage points above the
average prime offer rate on a comparable transaction for first-lien
loans, and 3.5 percentage points for subordinate-lien loans. The
exclusions from ``higher-priced mortgage loans'' for HELOCs and
[[Page 44532]]
certain other types of transactions are adopted as proposed.
The definition of ``higher-priced mortgage loans'' appears in Sec.
226.35(a). Such loans are subject to the restrictions and requirements
in Sec. 226.35(b) concerning repayment ability, income verification,
prepayment penalties, escrows, and evasion, except that only first-lien
higher-priced mortgage loans are subject to the escrow requirement.
B. Public Comment on the Proposal
Most industry commenters, a national consumer advocacy and research
organization, and others supported the approach of using loan price to
identify loans subject to stricter regulations. A large number and wide
variety of these commenters, however, urged the Board to use a prime
mortgage market rate instead of, or in addition to, Treasury yields to
avoid arbitrary changes in coverage due to changes in the premium for
mortgages over Treasuries or in the relationship between short-term and
long-term Treasury yields. The precise recommendations are discussed in
more detail in subpart D below. Industry commenters were particularly
concerned that the threshold over the chosen index be set high enough
to exclude the prime market. They maintained that the proposed
thresholds of 300 and 500 basis points over Treasury yields would cover
a significant part of the prime market and reduce credit availability.
Consumer and civil rights group commenters generally, but not
uniformly, opposed limiting protections to higher-priced mortgage loans
and recommended applying these protections to all loans secured by a
principal dwelling. They recommended in the alternative that the
thresholds be adopted at the levels proposed, or even lower, and that
nontraditional mortgage loans, which permit non-amortizing payments or
negatively amortizing payments, be covered regardless of loan price.
They believe the Nontraditional Mortgage Guidance is not adequate to
protect consumers.
The proposed exclusion of HELOCs drew criticism from several
consumer and civil rights groups but strong support from industry
commenters. The other proposed exclusions drew limited comment. Some
industry commenters proposed additional exclusions for loans with
federal guaranties such as FHA, VA, and Rural Housing Service. A few
commenters also proposed excluding ``jumbo'' loans, that is, loans in
an amount that exceeds the threshold of eligibility for purchase by
Fannie Mae or Freddie Mac. Other proposed exclusions are discussed
below.
C. General Approach
Cover Subprime, Exclude Prime
The Board stated in connection with the proposal a general
principle that new regulations should be applied as broadly as needed
to protect consumers from actual or potential injury, but not so
broadly that the costs, including the always-present risk of unintended
consequences, would clearly outweigh the benefits. Consistent with this
principle, the Board believes, as it stated in connection with the
proposal, that the stricter regulations of Sec. 226.35 should cover
the subprime market and generally exclude the prime market.
The Board believes that the practices that Sec. 226.35 would
prohibit--lending without regard to ability to pay from verified income
and non-collateral assets, failure to establish an escrow for taxes and
insurance, and prepayment penalties outside of prescribed limits--are
so clearly injurious on balance to consumers within the subprime market
that they should be categorically barred in that market. The reasons
for this conclusion are detailed below in part IX with respect to each
practice. Moreover, the Board has concluded that, to be effective,
these prohibitions must cover the entire subprime market and not just
subprime products with particular terms or features. Market
imperfections discussed in part II--the subprime market's lack of
transparency and potentially inadequate incentives for creditors to
make only loans that consumers can repay--affect consumers throughout
the subprime market. To be sure, risk within the subprime market has
varied by loan type. For example, delinquencies on fixed-rate subprime
mortgages have been lower in recent years than on adjustable-rate
subprime mortgages. It is not likely to be practical or effective,
however, to target certain types of loans in the subprime market for
coverage while excluding others. Such a rule would be unduly complex,
likely fail to adapt quickly enough to ever-changing products, and
encourage creditors to steer borrowers to uncovered products.
In the prime market, however, the Board believes that a case-by-
case approach to determining whether the Sec. 226.35 practices are
unfair or deceptive is more appropriate. By nature, loans in the prime
market have a lower credit risk. Moreover, the prime market is more
transparent and competitive, characteristics that make it less likely a
creditor can sustain an unfair, abusive, or deceptive practice. In
addition, borrowers in the prime market are less likely to be under the
degree of financial stress that tends to weaken the ability of many
borrowers in the subprime market to protect themselves against unfair,
abusive, or deceptive practices. The final rule applies protections
against coercion of appraisers and unfair servicing practices to the
prime market because, with respect to these particular practices, the
prime market, too, suffers a lack of transparency and these practices
do not appear to be limited to the subprime market.
With these limited exceptions, at present the Board believes that
any undue risks to consumers in the prime market from particular loan
terms or lending practices are better addressed through means other
than new regulations under HOEPA. Supervisory guidance from the federal
agencies influences a large majority of the prime market which, unlike
the subprime market, has been dominated by federally supervised
institutions.\36\ Such guidance affords regulators and institutions
alike more flexibility than a regulation, with potentially fewer
unintended consequences. In addition, the standards the Government
Sponsored Enterprises set for the loans they will purchase continue to
have significant influence within the prime market, and these entities
are accountable for those standards to regulators and Congress.\37\
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\36\ According to HMDA data from 2005 and 2006, more than three-
quarters of prime, conventional first-lien mortgage loans on owner-
occupied properties were made by depository institutions or their
affiliates. For this purpose, a loan for which price information was
not reported is treated as a prime loan.
\37\ According to HMDA data from 2005 and 2006, nearly 30
percent of prime, conventional first-lien mortgage loans on owner-
occupied properties were purchased by Fannie Mae or Freddie Mac.
This figure understates the GSEs' influence on the prime market
because it excludes the many loans that were underwritten using the
GSEs' standards but were not sold to the GSEs.
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Use the APR
The Board also continues to believe--and few, if any, commenters
disagreed--that the best way to identify the subprime market is by loan
price rather than by borrower characteristics. Identifying a class of
protected borrowers would present operational difficulties and other
problems. For example, it is common to distinguish borrowers by credit
score, with lower-scoring borrowers generally considered to be at
higher risk of injury in the mortgage market. Defining the protected
field as lower-scoring consumers would fail to protect higher-scoring
consumers ``steered'' to loans meant for lower-scoring consumers.
Moreover, the market uses different commercial scores, and choosing a
particular score
[[Page 44533]]
as the benchmark for a regulation could give unfair advantage to the
company that provides that score.
The most appropriate measure of loan price for this regulation is
the APR; few, if any, commenters disagreed with this point either. The
APR corresponds closely to credit risk, that is, the risk of default as
well as the closely related risks of serious delinquency and
foreclosure. Loans with higher APRs generally have higher credit risks,
whatever the source of the risk might be--weaker borrower credit
histories, higher borrower debt-to-income ratios, higher loan-to-value
ratios, less complete income or asset documentation, less traditional
loan terms or payment schedules, or combinations of these or other risk
factors. Because disclosing an APR has long been required by TILA, the
figure is also very familiar and readily available to creditors and
consumers. Therefore, the Board believes it appropriate to use a loan's
APR to identify loans having a high enough credit risk to warrant the
protections of Sec. 226.35.
Two loans with identical risk characteristics will likely have
different APRs if they were originated when market rates were
different. It is important to normalize the APR by an index that moves
with mortgage market rates so that loans with the same risk
characteristics will be treated the same regardless of when the loans
were originated. The Board proposed to use as this index the yields on
comparable Treasury securities, which HOEPA uses currently to identify
HOEPA-covered loans, see TILA Section 103(aa), 15 U.S.C. 1602(aa), and
Sec. 226.32(a), and Regulation C uses to identify mortgage loans
reportable under HMDA as being higher-priced, see 12 CFR 203.4(a)(12).
For reasons discussed in more detail below, the final rule uses instead
an index that more closely tracks movements in mortgage rates than do
Treasury yields.
Uncertainty
As the Board stated in connection with the proposal, there are
three major reasons why it is inherently uncertain which APR threshold
would achieve the twin objectives of covering the subprime market and
generally excluding the prime market. First, there is not a uniform
definition of the prime or subprime market, or of a prime or subprime
loan. Moreover, the markets are separated by a somewhat loosely defined
segment known as the alt-A market, the precise boundaries of which are
not clear.
Second, available data sets provide only a rough measure of the
empirical relationship between APR and credit risk. A proprietary
dataset such as the loan-level data on subprime securitized mortgages
published by First American LoanPerformance may contain detailed
information on loan characteristics, including the contract rate, but
lack the APR or sufficient data to derive the APR. Other data must be
consulted to estimate APRs based on contract rates. HMDA data contain
the APR for mortgage loans reportable as being higher-priced (as
adjusted by comparable Treasury securities), but they have little
information about credit risk.
Third, data sets can of course show only the existing or past
distribution of loans across market segments, which may change in ways
that are difficult to predict. In particular, the distribution could
change in response to the Board's imposition of the restrictions in
Sec. 226.35, but the likely direction of the change is not clear.
``Over compliance'' could effectively lower the threshold. While a
loan's APR can be estimated early in the application process, it is
typically not known to a certainty until after the underwriting has
been completed and the interest rate has been locked. Creditors might
build in a ``cushion'' against this uncertainty by voluntarily setting
their internal thresholds lower than the threshold in the regulation.
Creditors would have a competing incentive to avoid the
restrictions, however, by restructuring the prices of potential loans
that would have APRs just above the threshold to cause the loans' APRs
to come under the threshold. Different combinations of contract rates
and points that are economically identical for an originator produce
different APRs. With the adoption of Sec. 226.35, an originator may
have an incentive to achieve a rate-point combination that would bring
a loan's APR below the threshold (if the borrower had the resources or
equity to pay the points). Moreover, some fees, such as late fees and
prepayment penalties, are not included in the APR. Creditors could
increase the number or amounts of such fees to maintain a loan's
effective price while lowering its APR below the threshold. It is not
clear whether the net effect of these competing forces of over-
compliance and circumvention would be to capture more, or fewer, loans.
For all of the above reasons, there is inherent uncertainty as to
what APR threshold would perfectly achieve the objectives of covering
the subprime market and generally excluding the prime market. In the
face of this uncertainty, deciding on an APR threshold calls for
judgment. As the Board stated with the proposal, the Board believes it
is appropriate to err on the side of covering somewhat more than the
subprime market.
The Alt-A Market
If the selected thresholds cover more than the subprime market,
then they likely extend into what has been known as the alt-A market.
The alt-A market is generally understood to be for borrowers who
typically have higher credit scores than subprime borrowers but still
pose more risk than prime borrowers because they make small down
payments or do not document their incomes, or for other reasons. The
definition of this market is not precise, however.
The Board judges that the benefits of extending Sec. 226.35's
restrictions into some part of the alt-A market to ensure coverage of
the entire subprime market outweigh the costs. This market segment also
saw undue relaxation of underwriting standards, one reason that its
share of residential mortgage originations grew sixfold from 2003 to
2006 (from two percent of originations to 13 percent). \38\ See part
VIII.C for further discussion of the relaxation of underwriting
standards in the alt-A market.
---------------------------------------------------------------------------
\38\ IMF 2007 Mortgage Market at 4.
---------------------------------------------------------------------------
To the extent Sec. 226.35 covers the higher-priced end of the alt-
A market, where risks in that segment are highest, the regulation will
likely benefit consumers more than it would cost them. Prohibiting
lending without regard to repayment ability in this market slice would
likely reduce the risk to consumers from ``payment shock'' on
nontraditional loans. Applying the income verification requirement of
Sec. Sec. 226.32(a)(4)(ii) and 226.35(b)(1) to the riskier part of the
alt-A market could ameliorate injuries to consumers from lending based
on inflated incomes without necessarily depriving consumers of access
to credit.
D. Index for Higher-Priced Mortgage Loans
Under the proposal, higher-priced mortgage loans would be defined
as consumer credit transactions secured by the consumer's principal
dwelling for which the APR on the loan exceeds the yield on comparable
Treasury securities by at least three percentage points for first-lien
loans, or five percentage points for subordinate-lien loans. The
proposed definition would include home purchase loans, refinancings of
home purchase loans, and home equity
[[Page 44534]]
loans. The definition would exclude home equity lines of credit
(``HELOCs''), reverse mortgages, construction-only loans, and bridge
loans.
The Board is adopting a definition of ``higher-priced mortgage
loan'' that is substantially similar to that proposed but different in
the particulars. The final definition, like the proposed definition,
sets a threshold above a measure of market rates to distinguish higher-
priced mortgage loans from the rest of the mortgage market. But the
measure the Board is adopting is different, and therefore so is the
threshold. Instead of yields on Treasury securities, the final
definition uses average offer rates for the lowest-risk prime
mortgages, termed ``average prime offer rates.'' For the foreseeable
future, the Board will obtain or, as applicable, derive average prime
offer rates for a wide variety of types of transactions from the
Primary Mortgage Market Survey[reg] (PMMS) conducted by Freddie Mac,
and publish these rates on at least a weekly basis. The Board will
conduct its own survey if it becomes appropriate or necessary to do so.
The threshold is set at 1.5 percentage points above the average prime
offer rate on a comparable transaction for first-lien loans, and 3.5
percentage points for subordinate-lien loans. The exclusions from
``higher-priced mortgage loans'' for HELOCs and certain other types of
transactions are adopted as proposed.
Public Comment
A large number and wide variety of industry commenters, as well as
a consumer research and advocacy group, urged the Board to use a prime
mortgage market rate instead of, or in addition to, Treasury yields.
First, they argued the tendency of prime mortgage rates at certain
times to deviate significantly from Treasury yields--such as during the
``flight to quality'' seen in recent months--would lead to unwarranted
coverage of the prime market and arbitrary swings in coverage. Many of
these commenters also pointed out that changes in the Treasury yield
curve (the relationship of short-term to long-term Treasury yields) can
increase or decrease coverage even though neither borrower risk
profiles nor creditor practices or products have changed. The Board's
proposal to address this second problem by matching Treasuries to
mortgages on the basis of the loan's expected life span drew limited,
but mostly negative, comment. Although one large lender specifically
agreed with the proposed matching rules, a few others stated the rules
were too complicated.
The precise recommendations for a measure of mortgage market rates
varied. Several commenters specifically recommended using the PMMS.
They recommended that a threshold be added to the PMMS figure because
it is, by design, at the low end of the range of rates that can be
found in the prime market. Recommendations for thresholds for first-
lien loans ranged from 150 to 300 basis points over the PMMS. Some
commenters recommended approaches that would rely on both Treasuries
and the PMMS. A few recommended the approach of a recent North Carolina
law, which covers a first-lien loan only if its APR exceeds two
thresholds: 300 basis points over the comparable Treasury yield and 175
basis points over the PMMS rate for the 30-year fixed-rate loan. A few
recommended a different way to integrate Treasuries and the PMMS. Under
this approach, the threshold would be set at the comparable Treasury
yield (determined as proposed) plus 200 basis points (400 for
subordinate-lien loans), plus the spread between the PMMS 30-year FRM
rate and the seven-year Treasury.
Some commenters offered alternatives to the PMMS. A consumer
research and advocacy group and Freddie Mac suggested that the Board
could use the higher of the Freddie Mac Required Net Yield (the yield
Freddie Mac expects from purchasing a conforming mortgage) and the
equivalent Fannie Mae yield. Fannie Mae offered a similar, but not
identical, recommendation to use the higher of the current coupon yield
for Fannie Mae Mortgage Backed Securities and Freddie Mac participation
certifications (PC). These yields reflect the price at which a
government-sponsored entity (GSE) security can be sold in the market.
At least one commenter suggested that the Board could conduct its own
survey of mortgage market rates.
Discussion
Based on these comments and the analysis below, the final rule does
not use Treasury yields as the index for higher-priced mortgage loans.
Instead, the rule uses average offer rates on the lowest-risk prime
mortgage loans, termed ``average prime offer rates.'' For the
foreseeable future, the Board will obtain or, as applicable, derive
these rates for a wide variety of types of transactions from the PMMS
and publish them on a weekly basis.
Drawbacks of using Treasury security yields. There are significant
advantages to using Treasury yields to set the APR thresholds.
Treasuries are traded in a highly liquid market; Treasury yield data
are published for many different maturities and can easily be
calculated for other maturities; and the integrity of published yields
is not subject to question. For these reasons, Treasuries are also
commonly used in federal statutes, such as HOEPA, for benchmarking
purposes.
As recent events have highlighted, however, using Treasury yields
to set the APR threshold in a law regulating mortgage loans has two
major disadvantages. The most significant disadvantage is that the
spread between Treasuries and mortgage rates, even prime mortgage
rates, changes in the short term and in the long term. Moreover, the
comparable Treasury security for a given mortgage loan is quite
difficult to determine accurately.
The Treasury-mortgage spread can change for at least three
different reasons. First, credit risk may change on mortgages, even for
the highest-quality borrowers. For example, credit risk increases when
house prices fall. Second, competition for prime borrowers can
increase, tightening spreads, or decrease, allowing lenders to charge
wider spreads. Third, movements in financial markets can affect
Treasury yields but have no effect on lenders' cost of funds or,
therefore, on mortgage rates. For example, Treasury yields fall
disproportionately more than mortgage rates during a ``flight to
quality.''
Recent events illustrate how much the Treasury-mortgage spread can
swing. The spread averaged about 170 basis points in 2007, but
increased to an average of about 220 basis points in the first half of
2008. In addition, the spread was highly volatile in this period,
shifting as much as 25 basis points in a week. The spread may decrease,
but predictions of long-term spreads are highly uncertain.
Changes in the Treasury-mortgage spread can undermine key
objectives of the regulation. These changes mean that loans with
identical credit risk are covered in some periods but not in others,
contrary to the objective of consistent and predictable coverage over
time. Moreover, lenders' uncertainty as to when such changes will occur
can cause them to set an internal threshold below the regulatory
threshold. This may reduce credit availability directly (if a lender's
policy is not to make higher-priced mortgage loans) or indirectly, by
increasing regulatory burden. The recent volatility might lead lenders
to set relatively conservative cushions.
Adverse consequences of volatility in the spread between mortgages
rates and Treasuries could be reduced simply by setting the regulatory
threshold at a high enough level to ensure it excludes all
[[Page 44535]]
prime loans. But a threshold high enough to accomplish this objective
would likely fail to meet another, equally important objective of
covering essentially all of the subprime market. Instead, the Board is
adopting a rate that closely follows mortgage market rates, which
should mute the effects on coverage of changes in the spread between
mortgage rates and Treasury yields.
The second major disadvantage of using Treasury yields to set the
threshold is that the comparable Treasury security for a given mortgage
loan is quite difficult to determine accurately. Regulation C
determines the comparable Treasury security on the basis of contractual
maturity: A loan is matched to a Treasury with the same contract term.
For example, the regulation matches a 30-year mortgage loan to a 30-
year Treasury security. This method does not, however, account for the
fact that very few loans reach their full maturity, and it causes
significant distortions when the yield curve changes shape.\39\ These
distortions can bias coverage, sometimes in unpredictable ways, and
consequently might influence the preferences of lenders to offer
certain loan products in certain environments. For example, a steep
yield curve will create two regulatory forces pushing the subprime
market toward ARMs: A lender could avoid coverage on the margins by
selling ARMs rather than fixed-rate mortgages, and the consumer would
receive an APR that understates the interest rate risk from an ARM
relative to that from a fixed-rate mortgage. (Regulation Z requires the
APR be calculated as if the index does not change; a steep yield curve
indicates that the index will likely rise.) Artificial regulatory
incentives to increase ARMs production in the subprime market could
undermine consumer protection.
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\39\ Robert B. Avery, Kenneth P. Brevoort, and Glenn B. Canner,
Higher-Priced Home Lending and the 2005 HMDA Data, 92 Fed. Res.
Bulletin A123-66 (Sept. 8, 2006).
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The Board proposed to reduce distortions in coverage resulting from
changes in the yield curve by matching loans to Treasury securities on
the basis of the loan's expected life span rather than its legal term
to maturity. For example, the Board proposed to match a 30-year fixed-
rate mortgage loan to a 10-year Treasury security on the supposition
that the mortgage loan will prepay (or default) in ten years or less. A
limitation of this approach is that loan life spans change as rates of
house price appreciation, mortgage rates, and macroeconomic factors
such as unemployment rates change. Loan life spans also change as
specific loan features that influence default or prepayment rates
change, such as prepayment penalties. The challenge of adjusting the
regulation's matching rules on a timely basis would be substantial, and
too-frequent adjustments would complicate creditors' compliance.
Indeed, many commenters judged the proposed matching rules to be too
complicated. This matching problem can be reduced, if not necessarily
eliminated, by using mortgage market rates instead of Treasury security
yields to set the threshold.
A rate from the prime mortgage market. To address the principal
drawbacks of Treasury security yields, the Board is adopting a final
rule that relies instead on a rate that more closely tracks rates in
the prime mortgage market. Section 226.35(a)(2) defines an ``average
prime offer rate'' as an annual percentage rate derived from average
interest rates, points, and other pricing terms offered by a
representative sample of creditors for mortgage transactions that have
low-risk pricing characteristics. Comparing a transaction's annual
percentage rate to this average offered annual percentage rate, rather
than to an average offered contract interest rate, should make the
rule's coverage more accurate and consistent. A transaction is a
higher-priced mortgage loan if its APR exceeds the average prime offer
rate for a comparable transaction by 1.5 percentage points, or 3.5
percentage points in the case of a subordinate-lien transaction. (The
basis for selecting these thresholds is explained further in part
VIII.E) The creditor uses the most recently available average prime
offer rate as of the date the creditor sets the transaction's interest
rate for the final time before consummation.
To facilitate compliance, the final rule and commentary provide
that the Board will derive average prime offer rates from survey data
according to a methodology it will make publicly available, and publish
these rates in a table on the Internet on at least a weekly basis. This
table will indicate how to identify a comparable transaction.
As noted above, the survey the Board intends to use for the
foreseeable future is the PMMS, which contains weekly average rates and
points offered by a representative sample of creditors to prime
borrowers seeking a first-lien, conventional, conforming mortgage and
who would have at least 20 percent equity. The PMMS contains pricing
data for four types of transactions: ``1-year ARM,'' ``5/1-year ARM,''
``30-year fixed,'' and ``15-year fixed.'' For the two types of ARMs,
PMMS pricing data are based on ARMs that adjust according to the yield
on one-year Treasury securities; the pricing data include the margin
and the initial rate (if it differs from the sum of the index and
margin). These data are updated every week and are published on Freddie
Mac's Web site.\40\
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\40\ See http://www.freddiemac.com/dlink/html/PMMS/display/
PMMSOutputYr.jsp.
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The Freddie Mac PMMS is the most viable option for obtaining
average prime offer rates. This is the only publicly available data
source that has rates for more than one kind of fixed-rate mortgage
(the 15-year and the 30-year) and more than one kind of variable-rate
mortgage (the 1-year ARM and the 5/1 ARM). Having rates on at least two
fixed-rate products and at least two variable-rate products supplies a
firmer basis for estimating rates for other fixed-rate and variable-
rate products (such as a 20-year fixed or a 3/1 ARM).
Other publicly available surveys the Board considered are less
suitable for the purposes of this rule. Only one ARM rate is collected
by the Mortgage Bankers Association's Weekly Mortgage Applications
Survey and the Federal Housing Finance Board's Monthly Survey of
Interest Rates and Terms on Conventional Single-Family Non-Farm
Mortgage Loans. Moreover, the FHFB Survey has a substantial lag because
it is monthly and reports rates on closed loans. The Board also
evaluated two non-survey options involving Fannie Mae and Freddie Mac.
One is the Required Net Yield, the prices these institutions will pay
to purchase loans directly. The other is the yield on mortgage-backed
securities issued by Fannie Mae and Freddie Mac. With either option,
data for ARM yields would be difficult to obtain.
These other data sources, however, provide useful benchmarks to
evaluate the accuracy of the PMMS. The PMMS has closely tracked these
other indices, according to a Board staff analysis. The Board will
continue to use them periodically to help it determine whether the PMMS
remains an appropriate data source for Regulation Z. If the PMMS ceases
to be available, or if circumstances arise that render it unsuitable
for this rule, the Board will consider other alternatives including
conducting its own survey.
The Board will use the pricing terms from the PMMS, such as
interest rate and points, to calculate an annual percentage rate
(consistent with Regulation Z, Sec. 226.22) for each of the four types
of transactions that the
[[Page 44536]]
PMMS reports. These annual percentage rates are the average prime offer
rates for transactions of that type. The Board will derive annual
percentage rates for other types of transactions from the loan pricing
terms available in the survey. The method of derivation the Board
expects to use is being published for comment in connection with the
simultaneously proposed revisions to Regulation C. When finalized, the
method will be published on the Internet along with the table of annual
percentage rates.
E. Threshold for Higher-Priced Mortgage Loans
The Board proposed a threshold of three percentage points above the
comparable Treasury security for first-lien loans, or five percentage
points for subordinate-lien loans. Since the final rule uses a
different index, it must also use a different threshold. The Board is
adopting a threshold for first-lien loans of 1.5 percentage points
above the average prime offer rate for a comparable transaction, and
3.5 percentage points for second-lien loans.
Public Comment
Industry commenters consistently contended that, should the Board
use Treasury yields as proposed, thresholds of 300 and 500 basis points
would be too low to meet the Board's stated objective of excluding the
prime market.\41\ These commenters recommended thresholds of 400 basis
points (600 for subordinate-lien loans) or higher, but a few trade
associations recommended 500 (700) or 600 (800). These commenters
contended that covering any part of the prime market would harm
consumers because the secondary market would not purchase loans with
rates over the threshold. They also stated that many originators would
seek to avoid originating such loans because of a stigma these
commenters expect will attach to such loans, the increased compliance
cost associated with the proposed regulations, and the substantial
monetary recovery TILA Section 130 would provide plaintiffs for
violations of the regulations.
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\41\ One trade association reported that some of its members
found the proposal would have covered up to one-third of prime loans
originated between November 2007 and January 2008. This and other
commenters said the effect was particularly pronounced with ARMs.
Several members of this association were reported to have found that
more than one-half of prime 7/1, 5/1, and 3/1 ARMs originated
between November 2007 and January 2008 would have been covered. A
different association of mortgage lenders indicated that some of its
members had found that almost 20 percent of prime and alt-A loans
would be covered under the proposal, though the time frame its
members used was not specified. A major lender reported that the
proposal would have captured 8-10 percent of its portfolio in 2006
and 2007, about twice the portion of its portfolio that it was
required to report as higher-priced under HMDA. The lender
represents that it did not make subprime loans in this period and
asserts that its figures are predictive of the impact the proposal
would have on the prime market overall. Another large lender that
stated it does not make subprime loans believes that about 10
percent of its current originations would fall above the proposed
thresholds. One lender, however, expressed satisfaction with the
proposed 300 basis points for first-lien loans and said an internal
analysis of historical data found it would not have captured
significant numbers of its prime loans. But this lender's analysis
found that significant numbers of prime subordinate-lien loans would
have been captured, leading the lender to recommend raising the
threshold for subordinate-lien loans to 600 basis points.
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A trade association for the manufactured housing industry submitted
that the proposed thresholds would cover a substantial majority of
personal property loans used to purchase manufactured homes. This
commenter contended that the reasons these loans are priced higher than
loans secured by real estate (such as the smaller loan amounts and the
lack of real property securing the loan) do not support a rule that
would cover personal property loans disproportionately.
Consumer and civil rights group commenters generally, but not
uniformly, opposed limiting protections to higher-rate loans and
recommended applying these protections to all loans secured by a
principal dwelling. They recommended in the alternative that the
thresholds be adopted at the levels proposed or even lower. They argued
it was critical to cover all of the subprime market and much if not all
of the alt-A market.
Discussion
As discussed above, the Board has concluded that the stricter
regulations of Sec. 226.35 should cover the subprime market and
generally exclude the prime market; and in the face of uncertainty it
is appropriate to err on the side of covering somewhat more than the
subprime market. Based on available data, it appeared that the
thresholds the Board proposed would capture all of the subprime market
and a portion of the alt-A market.\42\ Based also on available data,
the Board believes that the thresholds it is adopting would cover all,
or virtually all, of the subprime market and a portion of the alt-A
market. The Board considered loan-level origination data for the period
2004 to 2007 for subprime and alt-A securitized pools. The proprietary
source of these data is FirstAmerican Loan Performance.\43\ The Board
also ascertained from a proprietary database of mostly prime loans
(McDash Analytics) that coverage of the prime market during the first
three quarters of 2007 at these thresholds would have been very
limited. The Board recognizes that the recent mortgage market
disruption began at the end of this period, but it is the latest period
for which data were available.
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\42\ The Board noted in the proposal that the percentage of the
first-lien mortgage market Regulation C has captured as higher-
priced using a threshold of three percentage points has been greater
than the percentage of the total market originations that one
industry source has estimated to be subprime (25 percent vs. 20
percent in 2005; 28 percent vs. 20 percent in 2006). For industry
estimates see IMF 2007 Mortgage Market at 4. Regulation C's coverage
of higher-priced loans is not thought, however, to have reached the
prime market in those years. Rather, in both 2005 and 2006 it
reached into the alt-A market, which the same source estimated to be
12 percent in 2005 and 13 percent in 2006. In 2004, Regulation C
captured a significantly smaller part of the market than an industry
estimate of the subprime market (11 percent vs. 19 percent), but
that year's HMDA data were somewhat anomalous because of a steep
yield curve.
\43\ Annual percentage rates were estimated from the contract
rates in these data using formulas derived from a separate
proprietary database of subprime loans that collects contract rates,
points, and annual percentage rates. This separate database, which
contains data on the loan originations of eight subprime mortgage
lenders, is maintained by the Financial Services Research Program at
George Washington University.
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The Board is adopting a threshold for subordinate-lien loans of 3.5
percentage points. This is consistent with the Board's proposal to set
the threshold over Treasury yields for these loans two percentage
points above the threshold for first-lien loans. With rare exceptions,
commenters explicitly endorsed, or at least did not raise any objection
to, this approach. The Board recognizes that it would be preferable to
set a threshold for second-lien loans above a measure of market rates
for second-lien loans, but it does not appear that a suitable measure
of this kind exists. Although data are very limited, the Board believes
it is appropriate to apply the same difference of two percentage points
to the thresholds above average prime offer rates.
As discussed earlier, the Board recognizes that there are
limitations to making judgments about the future scope of the rule
based on past data. For example, when the final rule takes effect, the
risk premiums for alt-A loans compared to the conforming loans in the
PMMS may be higher than the risk premiums for the period 2004-2007. In
that case, coverage of alt-A loans would be higher than an estimate for
that period would indicate.
Another important example is prime ``jumbo'' loans, or loans
extended to borrowers with low-risk mortgage
[[Page 44537]]
pricing characteristics, but in amounts that exceed the threshold for
loans eligible for purchase by Freddie Mac or Fannie Mae. The PMMS
collects pricing data only on loans eligible for purchase by one of
these entities (``conforming loans''). Prime jumbo loans have always
had somewhat higher rates than prime conforming loans, but the spread
has widened significantly and become much more volatile since August
2007. If this spread remains wider and more volatile when the final
rule takes effect, the rule will cover a significant share of
transactions that would be prime jumbo loans. While covering prime
jumbo loans is not the Board's objective, the Board does not believe
that it should set the threshold at a higher level to avoid what may be
only temporary coverage of these loans relative to the long time
horizon for this rule.
A third example is a request from a trade association for the
manufactured housing industry, including lenders specializing in this
industry, that the thresholds be set higher for loans secured by
dwellings deemed to be personal property. This association pointed to
the higher risk creditors bear on these loans compared to loans secured
by real property, which makes their rates systematically higher for
reasons apart from the risks they pose to consumers. It also maintained
that such loans have not been associated with the abusive practices of
the subprime market.\44\
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\44\ The specific concern of the commenter is with the
requirement to escrow, not, apparently, with the other requirements
for higher-priced loans. As discussed in part IX.D, the Board is
providing creditors two years to comply with the escrow requirement
for manufactured home loans.
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Credit risk and liquidity risk can vary by many factors, including
geography, property type, and type of loan. This may suggest to some
that different thresholds should be applied to different classes of
transactions. This approach would make the regulation inordinately
complicated and subject it to frequent revision, which would not be in
the interest of creditors, investors, or consumers. Although the
simpler approach the Board is adopting--just two thresholds, one for
first-lien loans and another for subordinate-lien loans--has its
disadvantages, the Board believes they are outweighed by its benefits
of simplicity and stability.
F. The Timing of Setting the Threshold
The Board proposed to set the threshold for a dwelling-secured
mortgage loan as of the application date. Specifically, a creditor
would use the Treasury yield as of the 15th of the month preceding the
month in which the application is received. The Board noted that
inconsistency with Regulation C, which sets the threshold as of the
15th of the month before the rate is locked, could increase regulatory
burden. The Board suggested, however, that setting the threshold as of
the application date might introduce more certainty, earlier in the
application process, to the determination as to whether a potential
transaction would be a higher-priced mortgage loan when consummated.
Very few commenters addressed the precise issue. A couple of them
specifically advocated using the rate lock date to select the Treasury
yield, as in Regulation C, rather than the application date. Subsequent
outreach by the Board indicated that there are different views as to
which date to use. Some parties prefer the rate lock date because it is
more accurate and therefore would minimize coverage of loans that are
not intended to be covered and maximize coverage of loans that are
intended to be covered. Other parties prefer the application date
because they believe it increases the creditor's ability to predict,
when underwriting the loan, that the loan is, or is not, covered by
Sec. 226.35.
As noted above, the final rule requires the creditor to use the
rate lock date, the date the rate is set for the final time before
consummation, rather than the application date. Using the application
date might increase the predictability of coverage at the time of
underwriting. Using the rate lock date would increase the accuracy of
coverage at least somewhat. On balance, the Board believes it is more
important to maximize coverage accuracy.
G. Proposal To Conform Regulation C (HMDA)
Regulation C, which implements HMDA, requires creditors to report
price data on higher-priced mortgage loans. A creditor reports the
difference between a loan's annual percentage rate and the yield on
Treasury securities having comparable periods of maturity, if that
difference is at least three percentage points for first-lien loans or
at least five percentage points for subordinate-lien loans. 12 CFR
203.4(a)(12). Many commenters suggested that the Board establish a
uniform definition of ``higher-priced mortgage loan'' for purposes of
Regulation C and Regulation Z. Having a single definition would reduce
regulatory burden and make the HMDA data a more useful tool to evaluate
effects of Regulation Z. Moreover, the Board adopted Regulation C's
requirement to report certain mortgage loans as being higher-priced
with an objective of covering the subprime market and exclude the prime
market, and the definition of ``higher-priced mortgage loan'' adopted
in this rule better achieves this objective than the definition in
Regulation C for the reasons discussed in part VIII.D. Accordingly, in
a separate notice published simultaneously with this final rule the
Board is proposing to amend Regulation C to apply the same index and
threshold adopted in Sec. 226.35(a).
H. Types of Loans Covered Under Sec. 226.35
The Board proposed to apply the protections of Sec. 226.35 to
first-lien, as well as subordinate-lien, closed-end mortgage loans
secured by the consumer's principal dwelling. This would include home
purchase loans, refinancings, and home equity loans. The proposed
definition would not cover loans that do not have primarily a consumer
purpose, such as loans for real estate investment. The proposed
definition also would not cover HELOCs, reverse mortgages,
construction-only loans, or bridge loans. In these respects, the rule
is adopted as proposed.
Coverage of Home Purchase Loans, Refinancings, and Home Equity Loans
The statutory protections for HOEPA loans are generally limited to
closed-end refinancings and home equity loans. See TILA Section
103(aa), 15 U.S.C. 1602(aa). The final rule applies the protections of
Sec. 226.35 to loans of these types, which have historically presented
the greatest risk to consumers. These loans are often made to consumers
who have home equity and, therefore, have an existing asset at risk.
These loans also can be marketed aggressively by originators to
homeowners who may not benefit from them and who, if responding to the
marketing and not shopping independently, may have limited information
about their options.
The Board proposed to use its authority under TILA Section
129(l)(2), 15