[Federal Register: August 26, 2009 (Volume 74, Number 164)]
[Proposed Rules]
[Page 43231-43425]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr26au09-18]
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Part II
Federal Reserve System
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12 CFR Part 226
Truth in Lending; Proposed Rule
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FEDERAL RESERVE SYSTEM
12 CFR Part 226
[Regulation Z; Docket No. R-1366]
Truth in Lending
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Proposed rule; request for public comment.
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SUMMARY: The Board proposes to amend Regulation Z, which implements the
Truth in Lending Act (TILA), and the staff commentary to the
regulation, as part of a comprehensive review of TILA's rules for
closed-end credit. This proposal would revise the rules for disclosures
of closed-end credit secured by real property or a consumer's dwelling,
except for rules regarding rescission and reverse mortgages, which the
Board anticipates will be reviewed at a later date. Published elsewhere
in today's Federal Register is the Board's proposal regarding rules for
disclosures of open-end credit secured by a consumer's dwelling.
Disclosures provided at application would include a Board-published
one-page ``Key Questions to Ask About Your Mortgage'' document that
explains potentially risky loan features, and a Board-published one-
page ``Fixed vs. Adjustable Rate Mortgages'' document. Transaction-
specific disclosures required within three business days of application
would summarize key loan terms. The calculation of the annual
percentage rate and the finance charge would be revised to be more
comprehensive, and their disclosures improved. Consumers would receive
a ``final'' TILA disclosure at least three business days before
consummation. Certain new post-consummation disclosures would be
required. In addition, the proposed revisions would prohibit certain
payments to mortgage brokers and loan officers that are based on the
loan's terms or conditions, and prohibit steering consumers to
transactions that are not in their interest to increase compensation
received.
Rules regarding eligibility restrictions and disclosures for credit
insurance and debt cancellation or debt suspension coverage would apply
to all closed-end and open-end credit transactions.
DATES: Comments must be received on or before December 24, 2009.
ADDRESSES: You may submit comments, identified by Docket No. R-1366, by
any of the following methods:
Agency Web Site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/
generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
E-mail: regs.comments@federalreserve.gov. Include the
docket number in the subject line of the message.
FAX: (202) 452-3819 or (202) 452-3102.
Mail: Jennifer J. Johnson, Secretary, Board of Governors
of the Federal Reserve System, 20th Street and Constitution Avenue,
NW., Washington, DC 20551.
All public comments are available from the Board's Web site at
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, unless modified for technical reasons. Accordingly, your
comments will not be edited to remove any identifying or contact
information. Public comments may also be viewed electronically or in
paper in Room MP-500 of the Board's Martin Building (20th and C
Streets, NW.) between 9 a.m. and 5 p.m. on weekdays.
FOR FURTHER INFORMATION CONTACT: Jamie Z. Goodson, Jelena McWilliams,
Nikita M. Pastor, or Maureen C. Yap, Attorneys; Paul Mondor, Senior
Attorney; or Kathleen C. Ryan, Senior Counsel. Division of Consumer and
Community Affairs, Board of Governors of the Federal Reserve System, at
(202) 452-3667 or 452-2412; for users of Telecommunications Device for
the Deaf (TDD) only, contact (202) 263-4869.
SUPPLEMENTARY INFORMATION:
I. Background on TILA and Regulation Z
Congress enacted the Truth in Lending Act (TILA) based on findings
that economic stability would be enhanced and competition among
consumer credit providers would be strengthened by the informed use of
credit resulting from consumers' awareness of the cost of credit. One
of the purposes of TILA is to provide meaningful disclosure of credit
terms to enable consumers to compare credit terms available in the
marketplace more readily and avoid the uninformed use of credit.
TILA's disclosures differ depending on whether credit is an open-
end (revolving) plan or a closed-end (installment) loan. TILA also
contains procedural and substantive protections for consumers. TILA is
implemented by the Board's Regulation Z. An Official Staff Commentary
interprets the requirements of Regulation Z. By statute, creditors that
follow in good faith Board or official staff interpretations are
insulated from civil liability, criminal penalties, or administrative
sanction.
II. Summary of Major Proposed Changes
The goal of the proposed amendments to Regulation Z is to improve
the effectiveness of disclosures that creditors provide to consumers in
connection with an application and throughout the life of a mortgage.
The proposed changes are the result of the Board's review of the
provisions that apply to closed-end mortgage transactions. The proposal
would apply to all closed-end credit transactions secured by real
property or a dwelling, and would not be limited to credit secured by
the consumer's principal dwelling. The Board is proposing changes to
the format, timing, and content of disclosures for the four main types
of closed-end credit information governed by Regulation Z: (1)
disclosures at application; (2) disclosures within three days after
application; (3) disclosures three days before consummation; and (4)
disclosures after consummation. In addition, the Board is proposing
additional protections related to limits on loan originator
compensation.
Disclosures at Application. The proposal contains new requirements
and changes to the format and content of disclosures given at
application, to make them more meaningful and easier for consumers to
use. The proposed changes include:
Providing a new one-page Board publication, entitled ``Key
Questions to Ask About Your Mortgage,'' which would explain the
potentially risky features of a loan.
Providing a new one-page Board publication, entitled
``Fixed vs. Adjustable Rate Mortgages,'' which would explain the basic
differences between such loans and would replace the lengthy Consumer
Handbook on Adjustable-Rate Mortgages (CHARM booklet) currently
required under Regulation Z.
Revising the format and content of the current adjustable-
rate mortgage (ARM) loan program disclosure, including: a requirement
that the disclosure be in a tabular question and answer format, a
streamlined plain-language disclosure of interest rate and payment
information, and a new disclosure of potentially risky features, such
as prepayment penalties.
Disclosures within Three Days after Application. The proposal also
contains revisions to the TILA disclosures provided within three days
after
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application (the ``early TILA disclosure'') to make the information
clearer and more conspicuous. The proposed changes include:
Revising the calculation of the finance charge and annual
percentage rate (APR) so that they capture most fees and costs paid by
consumers in connection with the credit transaction.
Providing a graph that would show consumers how their APR
compares to the APRs for borrowers with excellent credit and for
borrowers with impaired credit.
Summarizing key loan features, such as the loan term,
amount, and type, and disclosing total settlement charges, as is
currently required for the good faith estimate of settlement costs
(GFE) under the Real Estate Settlement Procedures Act (RESPA) and
Regulation X.
Requiring disclosure of potential changes to the interest
rate and monthly payment.
Adopting new format requirements, including rules
regarding: type size and use of boldface for certain terms, placement
of information, and highlighting certain information in a tabular
format.
Disclosures Three Days before Consummation. The proposal would
require creditors to provide a ``final'' TILA disclosure that the
consumer must receive at least three business days before consummation.
In addition, two proposed alternatives regarding redisclosure of the
``final'' TILA disclosure include:
Alternative 1: If any terms change after the ``final''
TILA disclosures are provided, then another final TILA disclosure would
need to be provided so that the consumer receives it at least three
business days before consummation.
Alternative 2: If the APR exceeds a certain tolerance or
an adjustable-rate feature is added after the ``final'' TILA
disclosures are provided, then another final TILA disclosure would need
to be provided so that the consumer receives it at least three business
days before consummation. All other changes could be disclosed at
consummation.
Disclosures after Consummation. The proposal would change the
timing, content and types of notices provided after consummation. The
proposed changes include:
For ARMs, increasing advance notice of a payment change
from 25 to 60 days, and revising the format and content of the ARM
adjustment notice.
For payment option loans with negative amortization,
requiring a monthly statement to provide information about payment
options that include the costs and effects of negatively-amortizing
payments.
For creditor-placed property insurance, requiring notice
of the cost and coverage at least 45 days before imposing a charge for
such insurance.
Loan Originator Compensation. The proposal contains new limits on
originator compensation for all closed-end mortgages. The proposed
changes include:
Prohibiting certain payments to a mortgage broker or a
loan officer that are based on the loan's terms and conditions.
Prohibiting a mortgage broker or loan officer from
``steering'' consumers to transactions that are not in their interest
in order to increase the mortgage broker's or loan officer's
compensation.
III. The Board's Review of Closed-End Credit Rules
The Board has amended Regulation Z numerous times since TILA
simplification in 1980. In 1987, the Board revised Regulation Z to
require special disclosures for closed-end ARMs secured by the
borrower's principal dwelling. 52 FR 48665; Dec. 24, 1987. In 1995, the
Board revised Regulation Z to implement changes to TILA by the Home
Ownership and Equity Protection Act (HOEPA). 60 FR 15463; Mar. 24,
1995. HOEPA requires special disclosures and substantive protections
for home-equity loans and refinancings with APRs or points and fees
above certain statutory thresholds. Numerous other amendments have been
made over the years to address new mortgage products and other matters,
such as abusive lending practices in the mortgage and home-equity
markets.
The Board's current review of Regulation Z was initiated in
December 2004 with an advance notice of proposed rulemaking.\1\ 69 FR
70925; Dec. 8, 2004. At that time, the Board announced its intent to
conduct its review of Regulation Z in stages, focusing first on the
rules for open-end (revolving) credit accounts that are not home-
secured, chiefly general-purpose credit cards and retailer credit card
plans. In December 2008, the Board approved final rules for open-end
credit that is not home-secured. 74 FR 5244; Jan. 29, 2009.
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\1\ The review was initiated pursuant to requirements of section
303 of the Riegle Community Development and Regulatory Improvement
Act of 1994, section 610(c) of the Regulatory Flexibility Act of
1980, and section 2222 of the Economic Growth and Regulatory
Paperwork Reduction Act of 1996. An advance notice of proposed
rulemaking is published to obtain preliminary information prior to
issuing a proposed rule or, in some cases, deciding whether to issue
a proposed rule.
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Beginning in 2007, the Board proposed revisions to the rules for
closed-end credit in several phases:
HOEPA. In 2007, the Board proposed rules under HOEPA for
higher-priced mortgage loans (2007 HOEPA Proposed Rule). The final
rules, approved in July 2008 (2008 HOEPA Final Rule), prohibited
certain unfair or deceptive lending and servicing practices in
connection with closed-end mortgages. The Board also approved revisions
to advertising rules for both closed-end and open-end home-secured
loans to ensure that advertisements contain accurate and balanced
information and do not contain misleading or deceptive representations.
The final rules also required creditors to provide consumers with
transaction-specific disclosures early enough to use while shopping for
a mortgage. 73 FR 44522; July 30, 2008.
Timing of Disclosures for Closed-End Mortgages. On May 7,
2009, the Board approved final rules implementing the Mortgage
Disclosure Improvement Act of 2008 (the MDIA).\2\ The MDIA adds to the
requirements of the 2008 HOEPA Final Rule regarding transaction-
specific disclosures. Among other things, the MDIA and the final rules
require early, transaction-specific disclosures for mortgage loans
secured by dwellings even when the dwelling is not the consumer's
principal dwelling, and requires waiting periods between the time when
disclosures are given and consummation of the transaction. 74 FR 23289;
May 19, 2009.
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\2\ The MDIA is contained in Sections 2501 through 2503 of the
Housing and Economic Recovery Act of 2008, Public Law 110-289,
enacted on July 30, 2008. The MDIA was later amended by the
Emergency Economic Stabilization Act of 2008, Public Law 110-343,
enacted on October 3, 2008.
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This proposal would revise the rules for disclosures for closed-end
credit secured by real property or a consumer's dwelling. The Board
anticipates reviewing the rules for rescission and reverse mortgages in
the next phase of the Regulation Z review.
A. Coordination With Disclosures Required Under the Real Estate
Settlement Procedures Act
The Board anticipates working with the Department of Housing and
Urban Development (HUD) to ensure that TILA and Real Estate Settlement
Procedures Act of 1974 (RESPA) disclosures are compatible and
complementary, including potentially developing a single disclosure
form that creditors could use to combine the initial disclosures
required under TILA and
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RESPA. The two statutes have different purposes but have considerable
overlap. Harmonizing the two disclosure schemes would ensure that
consumers receive consistent information under both laws. It may also
help reduce information overload by eliminating some duplicative
disclosures. Consumer testing would be used to ensure consumers could
understand and use the combined disclosures. In the meantime, the Board
is proposing a revised model TILA form so that commenters can see how
the Board's proposed revisions to Regulation Z might be applied in
practice.
RESPA, which is implemented by HUD's Regulation X, seeks to ensure
that consumers are provided with timely information about the nature
and costs of the settlement process and are protected from
unnecessarily high real estate settlement charges. To this end, RESPA
mandates that consumers receive information about the costs associated
with a mortgage loan transaction, and prohibits certain business
practices. Under RESPA, creditors must provide a GFE within three
business days after a consumer submits a written application for a
mortgage loan, which is the same time creditors must provide the early
TILA disclosure. RESPA also requires a statement of the actual costs
imposed at loan settlement (HUD-1 settlement statement). In November
2008, HUD published revised RESPA rules, including new GFE and HUD-1
settlement statement forms, which lenders, mortgage brokers, and
settlement agents must use beginning on January 1, 2010. 73 FR 68204;
Nov. 17, 2008. In addition to revised disclosures of settlement costs,
the revised GFE now includes loan terms, some of which would also
appear on the TILA disclosure, such as whether there is a prepayment
penalty and the borrower's interest rate and monthly payment. The
revised GFE form was developed through HUD's consumer testing.
TILA, which is implemented by the Board's Regulation Z, governs the
disclosure of the APR and certain loan terms. This proposal contains a
revised model TILA form that was developed through consumer testing. In
addition to a revised disclosure of the APR and loan terms, the revised
TILA disclosure would include the total settlement charges that appear
on the GFE required under RESPA. Total settlement charges would be
added to the TILA form because consumer testing conducted by the Board
found that consumers wanted to have settlement charges disclosed on the
TILA form.
The proposed revised TILA form and HUD's revised GFE would
represent significant improvements, but overlap between the two forms
could be eliminated to reduce information overload and consistency
issues. There have been previous efforts to develop a combined TILA and
RESPA disclosure form, which were fueled by the amount, complexity, and
overlap of information in the disclosures. Under a 1996 congressional
directive, the Board and HUD studied ways to simplify and improve the
disclosures. In July 1998, the Board and HUD submitted a joint report
to Congress that provided a broad outline intended to be a starting
point for consideration of legislative reform of the mortgage
disclosure requirements (the 1998 Joint Report).\3\ The 1998 Joint
Report included a recommendation for combining and simplifying the
RESPA and TILA disclosure forms to satisfy the requirements of both
laws. In addition, The 1998 Joint Report recommended that the timing of
the TILA and RESPA disclosures be coordinated. Recent regulatory
changes addressed the timing issues so that initial disclosures
required under TILA and RESPA would be delivered at the same time.
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\3\ Bd. of Governors of the Fed. Reserve Sys. and U.S. Dep't of
Hous. and Urban Dev., Joint Report to the Congress Concerning Reform
to the Truth in Lending Act and the Real Estate Settlement
Procedures Act (1998), available at http://www.federalreserve.gov/
boarddocs/rptcongress/tila.pdf.
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B. The Bankruptcy Act's Amendment to TILA
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
(Bankruptcy Act) primarily amended the federal bankruptcy code, but
also contained several provisions amending TILA. With respect to open-
end and closed-end dwelling-secured credit, the Bankruptcy Act requires
that the credit application disclosure contain a statement warning
consumers that if the loan exceeds the fair market value of the
dwelling, then the interest on that portion of the loan is not tax
deductible, and the consumer should consult a tax advisor for further
information on tax deductibility. This proposal would implement this
Bankruptcy Act provision.
C. The MDIA's Amendments to TILA
On July 30, 2008, Congress enacted the MDIA.\4\ The MDIA codified
some of the requirements of the Board's 2008 HOEPA Final Rule, which
required transaction-specific disclosures to be provided within three
business days after an application is received and before the consumer
has paid a fee, other than a fee for obtaining the consumer's credit
history.\5\ The MDIA also expanded coverage of the early disclosure
requirement to include loans secured by a dwelling even when it is not
the consumer's principal dwelling. In addition, the MDIA required
creditors to mail or deliver early TILA disclosures at least seven
business days before consummation and provide corrected disclosures if
the disclosed APR changes in excess of a specified tolerance. The
consumer must receive the corrected disclosures no later than three
business days before consummation. The Board implemented these MDIA
requirements in final rules published May 19, 2009, and effective July
30, 2009. 74 FR 23289; May 19, 2009.
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\4\ As noted, Congress subsequently amended the MDIA with the
Emergency Economic Stabilization Act of 2008.
\5\ To ease discussion, the description of the closed-end
mortgage disclosure scheme includes MDIA's recent amendments to TILA
and the disclosure timing requirements of the 2008 HOEPA Final Rule
that will be effective July 30, 2009.
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The MDIA also requires payment examples if the interest rate or
payments can change. Such disclosures are to be formatted in accordance
with the results of consumer testing conducted by the Board. Those
provisions of the MDIA will not become effective until January 30,
2011, or any earlier compliance date established by the Board. This
proposal would implement those MDIA provisions.
D. Consumer Testing
A principal goal for the Regulation Z review is to produce revised
and improved mortgage disclosures that consumers will be more likely to
understand and use in their decisions, while at the same time not
creating undue burdens for creditors. Currently, Regulation Z requires
creditors to provide at application an ARM loan program disclosure and
the CHARM booklet. An early TILA disclosure is required within three
business days of application and at least seven business days before
consummation for closed-end mortgages.
In 2007, the Board retained a research and consulting firm (ICF
Macro) that specializes in designing and testing documents to conduct
consumer testing to help the Board's review of mortgage rules under
Regulation Z. Working closely with the Board, ICF Macro conducted
several tests in different cities throughout the United States. The
testing consisted of four focus groups and eleven rounds of one-on-one
cognitive interviews. The goals of these focus groups and interviews
were to learn how consumers shop for
[[Page 43235]]
mortgages and what information consumers read when they receive
mortgage disclosures, and to assess their understanding of such
disclosures.
The consumer testing groups contained participants with a range of
ethnicities, ages, educational levels, and mortgage behaviors,
including first-time mortgage shoppers, prime and subprime borrowers,
and consumers who had obtained one or more closed-end mortgages. For
each round of testing, ICF Macro developed a set of model disclosure
forms to be tested. Interview participants were asked to review model
forms and provide their reactions, and were then asked a series of
questions designed to test their understanding of the content. Data
were collected on which elements and features of each form were most
successful in providing information clearly and effectively. The
findings from each round of interviews were incorporated in revisions
to the model forms for the following round of testing.
Specifically, the Board worked with ICF Macro to develop and test
several types of closed-end disclosures, including:
Two Board publications to be provided at application,
entitled ``Key Questions To Ask About Your Mortgage'' and ``Fixed vs.
Adjustable Rate Mortgages'';
An ARM loan program disclosure to be provided at
application;
An early TILA disclosure to be provided within three
business days of application, and again so that the consumer receives
it at least three business days before consummation;
An ARM adjustment notice to be provided after
consummation; and
A payment option monthly statement to be provided after
consummation.
Exploratory focus groups. In February and March 2008 the Board
worked with ICF Macro to conduct four focus groups with consumers who
had obtained a mortgage in the previous two years. Two of the groups
consisted of subprime borrowers and two consisted of prime borrowers,
with creditworthiness determined by their answers to questions about
prior financial hardship, difficulties encountered in shopping for
credit, and the rate on their current mortgage. Each focus group
consisted of between seven and nine people that discussed issues
identified by the Board and raised by a moderator from ICF Macro.
Through these focus groups, the Board gathered information on how
consumers shop for mortgages, what information consumers currently use
in making decisions about mortgages, and what perceptions consumers had
of TILA disclosures currently provided in the shopping and application
process.
Cognitive interviews on existing disclosures. In 2008, the Board
worked with ICF Macro to conduct five rounds of cognitive interviews
with mortgage customers (seven to eleven participants per round). These
cognitive interviews consisted of one-on-one discussions with
consumers, during which consumers described their recent mortgage
shopping experience and reviewed existing sample mortgage disclosures.
In addition to learning about shopping behavior, the goals of these
interviews were: (1) To learn more about what information consumers
read when they receive current mortgage disclosures; (2) to research
how easily consumers can find various pieces of information in these
disclosures; and (3) to test consumers' understanding of certain
mortgage related words and phrases.
1. Initial design of disclosures for testing. In the fall of 2008,
the Board worked with ICF Macro to develop sample mortgage disclosures
to be used in later rounds of testing, taking into account information
learned through the focus groups and the cognitive interviews.
2. Additional cognitive interviews and revisions to disclosures. In
late 2008 and early 2009, the Board worked with ICF Macro to conduct
six additional rounds of cognitive interviews (nine or ten participants
per round), where consumers were asked to view new sample mortgage
disclosures developed by the Board and ICF Macro. The rounds of
interviews were conducted sequentially to allow for revisions to the
testing materials based on what was learned from the testing during
each previous round.
Results of testing. Several of the model forms were developed
through the testing. A report summarizing the results of the testing is
available on the Board's public Web site: http://
www.federalreserve.gov.
Many consumer testing participants reported that they did not shop
for a lender or a mortgage. Several stated that they were referred to a
lender by a realtor, family member or friend, and that they relied on
that lender to get them a loan. Participants who reported shopping for
a mortgage relied on originators' oral quotes for interest rates,
monthly payments, and closing costs. Most participants stated that once
they had applied for a particular loan and received a TILA disclosure
they ceased shopping. Some cited the time involved, and the amount of
documentation required, as factors for limiting their shopping. These
findings suggest that consumers need information early in the process
and that information should not be limited to information about ARMs.
Therefore, the proposal would require creditors to provide key
information about evaluating loan terms at the time an application form
is provided, as discussed below.
1. Disclosures provided to consumers before application. Currently,
creditors must provide the CHARM booklet before a consumer applies or
pays a nonrefundable fee, whichever is earlier. The booklet explains
how ARMs generally work. Testing showed that participants found the
CHARM booklet too lengthy to be useful, although some liked specific
elements such as the glossary. In addition, creditors must provide an
ARM loan program disclosure for each ARM loan program in which the
consumer expresses an interest, before the consumer applies or has paid
a nonrefundable fee. The ARM loan program disclosure currently must
include either a 15-year historical example of rates and payments for a
$10,000 loan, or the maximum interest rate and payment for a $10,000
loan originated at the interest rate in effect for the disclosure's
identified month and year. Many testing participants found the
narrative form of the current ARM loan program disclosure difficult to
read and understand. Some participants mistook the historical examples
to be their actual loan rate and payments. Participants also found the
content of the disclosure too general to be useful to them when
comparing between lenders or products, and noted the absence of key
loan information, such as the interest rate.
Thus, the proposal would require creditors to provide, for all
closed-end mortgages, a one-page document that explains the basic
differences between fixed-rate mortgages and ARMs, and a one-page
document that would explain potentially risky features of a mortgage in
a plain-English question and answer format. In addition, the proposal
would streamline the content of the ARM loan program disclosure to
highlight in a table form information that participants found most
useful, such as interest rate and payment adjustments, and to provide
information about program-specific loan features that could pose
greater risk, such as prepayment penalties. Consumer testing suggested
that highlighting such information in a table form improved
participants' ability to identify and understand the information
provided about key loan features.
2. Disclosures provided to consumers after application. Currently,
creditors
[[Page 43236]]
must provide an early TILA disclosure within three business days after
application and at least seven business days before consummation, and
before the consumer has paid a fee other than a fee for obtaining the
consumer's credit history. If the APR on the early TILA disclosure
exceeds a certain tolerance before consummation, the creditor must
provide corrected disclosures that the consumer must receive at least
three days before consummation. If any term other than the APR becomes
inaccurate, the creditor must give the corrected disclosure no later
than at consummation.
The early TILA disclosure--and any corrected disclosure--must
provide certain information, such as the loan's annual percentage rate
(APR), finance charge, amount financed, and total of payments.
Participants in consumer testing indicated that much of the information
in the current TILA disclosure was of secondary importance to them when
considering a loan. Participants consistently looked for the contract
rate of interest, monthly payment, and in some cases, closing costs.
Most participants assumed that the APR was the contract rate of
interest, and that the finance charge was the total of all interest
they would pay if they kept the loan to maturity. Most identified the
amount financed as the loan amount. When asked to compare two loan
offers using redesigned model forms that contained these disclosures,
few participants used the APR and finance charge to compare the loans.
In addition, some participants had difficulty determining whether the
loan tested had a variable or fixed rate and understanding the payment
schedule's relationship to the changing interest rate. Many did not
understand what circumstances would trigger a prepayment penalty.
Thus, the proposal contains a number of revisions to the format and
content of TILA disclosures to make them clearer and more conspicuous.
To enhance the effectiveness of the finance charge as a disclosure of
the true cost of credit, the proposal would require a simpler, more
inclusive approach. The disclosure of the APR would be enhanced to
improve consumers' comprehension of the cost of credit. In addition, to
help consumers determine whether the loan offered is affordable for
them, creditors would be required to summarize key loan terms and
highlight interest rate and payment information in a table. Consumer
testing showed that using special formatting requirements, consistent
terminology and a minimum 10-point font, would ensure that consumers
are better able to identify and review key loan terms.
3. Disclosures required after consummation. Currently, creditors
must provide advance notice to a consumer before the interest rate and
monthly payment adjust on an ARM. The ARM adjustment notice must
provide certain information, including current and prior interest
rates, the index values upon which the current and prior interest rates
are based, and the payment that would be required to amortize the loan
fully at the new interest rate. The Board worked with ICF Macro to
develop a revised ARM adjustment notice that would enhance consumers'
ability to identify and understand changes being made to their loan
terms. Consumer testing of the revised ARM adjustment notice indicated
that consumers understood the content and were able correctly to
identify the amount and due date of the new payment. Thus, under the
proposal, creditors would be required to provide the ARM adjustment
notice in a revised format that would highlight changes being made to
the interest rate and the monthly payment, and provide other important
information, such as the due date of the new payment and the loan
balance.
Currently, creditors are not required to provide disclosures after
consummation for negatively-amortizing loans. The Board worked with ICF
Macro to develop a monthly statement that compares the amount and the
impact on the loan balance of a fully-amortizing payment, interest-only
payment, and minimum payment. Consumer testing of the proposed monthly
statement indicated that consumers understood the content, easily
recognized the payment options highlighted in the table, and understood
that by making only the minimum payment they would be borrowing more
money and increasing their loan balance. Thus, to improve consumer
understanding of the risks associated with payment option loans, the
Board proposes to require, not later than 15 days before a periodic
payment is due, a monthly statement of payment options that explains
the impact of payment choice on the loan balance.
Additional testing during and after the comment period. During the
comment period, the Board will work with ICF Macro to conduct
additional testing of model disclosures. After receiving comments from
the public on the proposal and the proposed disclosure forms, the Board
will work with ICF Macro to further revise model disclosures based on
comments received, and to conduct additional rounds of cognitive
interviews to test the revised disclosures. After the cognitive
interviews, quantitative testing will be conducted. The goal of the
quantitative testing is to measure consumers' comprehension of the
newly-developed disclosures with a larger and more statistically
representative group of consumers.
E. Other Outreach and Research
The Board also solicited input from members of the Board's Consumer
Advisory Council on various issues presented by the review of
Regulation Z. During 2009, for example, the Council discussed ways to
improve disclosures for home-secured credit. In addition, Board staff
met or conducted conference calls with various industry and consumer
group representatives throughout the review process leading to this
proposal. Board staff also reviewed disclosures currently provided by
creditors, the Federal Trade Commission's (FTC) report on consumer
testing of mortgage disclosures,\6\ HUD's report on consumer testing of
the GFE,\7\ and other information.
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\6\ James M. Lacko and Janis K. Pappalardo, Fed. Trade Comm'n,
Improving Consumer Mortgage Disclosures: An Empirical Assessment of
Current and Protoype Disclosure Forms (2007), (``Improving Consumer
Mortgage Disclosures'') available at http://www2.ftc.gov/os/2007/06/
P025505MortgageDisclosureReport.pdf.
\7\ U.S. Dep't. of Hous. and Urban Dev., Summary Report:
Consumer Testing of the Good Faith Estimate Form (GFE) (2008),
available at http://www.huduser.org/publications/pdf/Summary_
Report_GFE.pdf.
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F. Reviewing Regulation Z in Stages
The Board is proceeding with a review of Regulation Z in stages.
This proposal largely contains revisions to rules affecting closed-end
credit transactions secured by real property or a dwelling. Published
elsewhere in today's Federal Register is the Board's proposal regarding
disclosures for open-end credit secured by a consumer's dwelling.
Closed-end mortgages are distinct from other TILA-covered products, and
conducting a review in stages allows for a manageable process. To
minimize compliance burden for creditors offering other closed-end
credit, as well as home-secured credit, the proposed rules that would
apply only to closed-end home-secured credit are organized in sections
separate from the general disclosure requirements for closed-end rules.
Although this reorganization would increase the size of the regulation
and commentary, the Board believes a clear delineation of rules for
closed-end, home-secured loans pending the review of the remaining
closed-end rules provides a clear compliance benefit to creditors.
[[Page 43237]]
G. Implementation Period
The Board contemplates providing creditors sufficient time to
implement any revisions that may be adopted. The Board seeks comment on
an appropriate implementation period.
IV. The Board's Rulemaking Authority
TILA Section 105. TILA mandates that the Board prescribe
regulations to carry out the purposes of the act. TILA also
specifically authorizes the Board, among other things, to:
Issue regulations that contain such classifications,
differentiations, or other provisions, or that provide for such
adjustments and exceptions for any class of transactions, that in the
Board's judgment are necessary or proper to effectuate the purposes of
TILA, facilitate compliance with the act, or prevent circumvention or
evasion. 15 U.S.C. 1604(a).
Exempt from all or part of TILA any class of transactions
if the Board determines that TILA coverage does not provide a
meaningful benefit to consumers in the form of useful information or
protection. The Board must consider factors identified in the act and
publish its rationale at the time it proposes an exemption for comment.
15 U.S.C. 1604(f).
In the course of developing the proposal, the Board has considered
the views of interested parties, its experience in implementing and
enforcing Regulation Z, and the results obtained from testing various
disclosure options in controlled consumer tests. For the reasons
discussed in this notice, the Board believes this proposal is
appropriate pursuant to the authority under TILA Section 105(a).
Also, as explained in this notice, the Board believes that the
specific exemptions proposed are appropriate because the existing
requirements do not provide a meaningful benefit to consumers in the
form of useful information or protection. In reaching this conclusion
with each proposed exemption, the Board considered (1) the amount of
the loan and whether the disclosure provides a benefit to consumers who
are parties to the transaction involving a loan of such amount; (2) the
extent to which the requirement complicates, hinders, or makes more
expensive the credit process; (3) the status of the borrower, including
any related financial arrangements of the borrower, the financial
sophistication of the borrower relative to the type of transaction, and
the importance to the borrower of the credit, related supporting
property, and coverage under TILA; (4) whether the loan is secured by
the principal residence of the borrower; and (5) whether the exemption
would undermine the goal of consumer protection. The rationales for
these proposed exemptions are explained in part VI below.
TILA Section 129(l)(2). TILA also authorizes the Board to prohibit
acts or practices in connection with:
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 mortgage loans not covered
under that section, such as home purchase 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 ``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).\8\
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\8\ H.R. Rep. 103-652, at 162 (1994) (Conf. Rep.).
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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).\9\ 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.\10\
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\9\ See 15 U.S.C. 45(n); 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. (Dec. 17, 1980).
\10\ 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.\11\
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.\12\ The FTC looks to whether an act or practice is
injurious in its net effects.\13\ The FTC 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.\14\ In evaluating unfairness,
the FTC looks to whether consumers' free market decisions are
unjustifiably hindered.\15\
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\11\ Statement of Basis and Purpose and Regulatory Analysis,
Credit Practices Rule, 42 FR 7740, 7743; Mar. 1, 1984 (Credit
Practices Rule).
\12\ 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).
\13\ Credit Practices Rule, 42 FR at 7744.
\14\ Id.
\15\ 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).\16\ 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.\17\
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\16\ 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).
\17\ Dingell Letter at 1-2.
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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
[[Page 43238]]
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.\18\
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\18\ 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 developing proposed 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.
V. Discussion of Major Proposed Revisions
The goal of the proposed revisions is to improve the effectiveness
of the Regulation Z disclosures that must be provided to consumers for
closed-end credit transactions secured by real property or a dwelling.
To shop for and understand the cost of home-secured credit, consumers
must be able to identify and comprehend the key terms of mortgages. But
the terms and conditions for mortgage transactions can be very complex.
The proposed revisions to Regulation Z are intended to provide the most
essential information to consumers when the information would be most
useful to them, with content and formats that are clear and
conspicuous. The proposed revisions are expected to improve consumers'
ability to make informed credit decisions and enhance competition among
creditors. Many of the changes are based on the consumer testing that
was conducted in connection with the review of Regulation Z.
In considering the proposed revisions, the Board sought to ensure
that the proposal would not reduce access to credit, and sought to
balance the potential benefits for consumers with the compliance
burdens imposed on creditors. For example, the proposed revisions seek
to provide greater certainty to creditors in identifying what costs
must be disclosed for mortgages, and how those costs must be disclosed.
More effective disclosures may also reduce confusion and
misunderstanding, which may also ease creditors' costs relating to
consumer complaints and inquiries.
A. Disclosures at Application
Currently, Regulation Z requires pre-application disclosures only
for variable-rate transactions. For these transactions, creditors are
required to provide the CHARM booklet and a loan program disclosure
that provides twelve items of information at the time an application
form is provided or before the consumer pays a nonrefundable fee,
whichever is earlier.
``Key Questions to Ask about Your Mortgage'' publication. Since
1987, the number of loan products and product features has grown,
providing consumers with more choices. However, the growth in loan
features and products has also made the decision-making process more
complex for consumers. The proposal would require creditors to provide
to consumers a one-page Board publication entitled, ``Key Questions to
Ask about Your Mortgage.'' Creditors would be required to provide this
document for all closed-end loans secured by real property or a
dwelling, not just variable-rate loans, before the consumer applies for
a loan or pays a nonrefundable fee, whichever is earlier. The
publication would inform consumers in a plain-English question and
answer format about potentially risky features, such as interest-only,
negative amortization, and prepayment penalties. To enable consumers to
track the presence or absence of potentially risky features throughout
the mortgage transaction process, the key questions and answers
provided in this one-page document would also be included in the ARM
loan program disclosure and the early and final TILA disclosures.
``Fixed vs. Adjustable Rate Mortgages'' publication. Instead of the
CHARM booklet, the proposal would require creditors to provide a one-
page Board publication entitled, ``Fixed vs. Adjustable Rate
Mortgages'' for all closed-end loans secured by real property or a
dwelling, not just variable-rate loans. The publication would contain
an explanation of the basic differences between fixed-rate mortgages
and ARMs. Although the requirement to provide a CHARM booklet would be
eliminated, the Board would continue to publish the CHARM booklet as a
consumer-education publication.
ARM loan program disclosure. Currently, for each variable-rate loan
program in which a consumer expresses an interest, creditors must
provide certain information, including the index and margin to be used
to calculate interest rates and payments, and either a 15-year
historical example of rates and payments for a $10,000 loan, or the
maximum interest rate and payment for a $10,000 loan originated at the
interest rate in effect for the disclosure's identified month and year.
Based on consumer testing, the proposal would simplify the ARM loan
program disclosure to focus on the interest rate and payment and the
potential risks associated with ARMs. Information on how to calculate
payments, and the effect of rising interest rates on monthly payments
would be moved to the early TILA disclosure provided after application.
Placing the information there will allow the creditor to customize the
information to the consumer's potential loan, making the information
more useful to consumers. The proposed ARM loan program disclosure
would be provided in a tabular question and answer format to enable
consumers to easily locate the most important information.
B. Disclosures Within Three Days After Application
TILA and Regulation Z currently require creditors to provide an
early TILA disclosure within three business days after application and
at least seven business days before consummation, and before the
consumer has paid a fee other than a fee for obtaining the consumer's
credit history. If the APR on the early TILA disclosure exceeds a
certain tolerance before consummation, the creditor must provide
corrected disclosures that the consumer must receive at least three
days before consummation. If any term other than the APR becomes
inaccurate, the creditor must give the corrected disclosure no later
than at consummation.
The early TILA disclosure, and any corrected disclosure, must
include certain loan information, including the amount financed, the
finance charge, the APR, the total of payments, and the amount and
timing of payments. The finance charge is the sum of all credit-related
charges, but excludes a variety of fees and charges. TILA requires that
the finance charge and the APR be disclosed more conspicuously than
other information. The APR is calculated based on the finance charge
and is meant to be a single, unified number to help consumers
understand the total cost of credit.
Calculation of the finance charge. The proposal contains a number
of revisions to the calculation of the finance charge and the
disclosure of the finance charge and the APR to improve consumers'
[[Page 43239]]
understanding of the cost of credit. Currently, TILA and Regulation Z
permit creditors to exclude several fees or charges from the finance
charge, including certain fees or charges imposed by third party
closing agents; certain premiums for credit or property insurance or
fees for debt cancellation or debt suspension coverage, if the creditor
meets certain conditions; security interest charges; and real-estate
related fees, such as title examination or document preparation fees.
Consumer groups, creditors, and government agencies have long been
dissatisfied with the ``some fees in, some fees out'' approach to the
finance charge. Consumer groups and others believe that the current
approach obscures the true cost of credit. They contend that this
approach creates incentives for creditors to shift the cost of credit
from the interest rate to ancillary fees excluded from the finance
charge. They further contend that this approach undermines the purpose
of the APR, which is to express in a single figure the total cost of
credit. Creditors maintain that consumers are confused by the APR and
that the current approach creates significant regulatory burdens. They
contend that determining which fees are or are not included in the
finance charge is overly complex and creates litigation risk.
The Board proposes to use its exception and exemption authority to
revise the finance charge calculation for closed-end mortgages,
including HOEPA loans. The proposal would maintain TILA's definition of
a ``finance charge'' as a fee or charge payable directly or indirectly
by the consumer and imposed directly or indirectly by the creditor as
an incident to the extension of credit. However, the proposal would
require the finance charge to include charges by third parties if the
creditor requires the use of a third party as a condition of or
incident to the extension of credit (even if the consumer chooses the
third party), or if the creditor retains a portion of the third-party
charge (to the extent of the portion retained). Charges that would be
incurred in a comparable cash transaction, such as transfer taxes,
would continue to be excluded from the finance charge. Under this
approach, consumers would benefit from having a finance charge and APR
disclosure that better represent the cost of credit, undiluted by
myriad exclusions for various fees and charges. This approach would
cause more loans to be subject to the special protections of the
Board's 2008 HOEPA Final Rule, special disclosures and restrictions for
HOEPA loans, and certain State anti-predatory lending laws. However,
the proposal could also reduce compliance burdens, regulatory
uncertainty, and litigation risks for creditors.
Disclosure of the finance charge and the APR. Currently, creditors
are required to disclose the loan's ``finance charge'' and ``annual
percentage rate,'' using those terms, more conspicuously than the other
required disclosures. Consumer testing indicated that consumers do not
understand the term ``finance charge.'' Most consumers believe the term
refers to the total of all interest they would pay if they keep the
loan to maturity, but do not realize that it includes the fees and
costs associated with the loan. For these reasons, the proposal
replaces the term ``finance charge'' with ``interest and settlement
charges'' to make clear it is more than interest, and the disclosure
would no longer be more conspicuous than the other required
disclosures.
In addition, the disclosure of the APR would be enhanced to improve
consumers' comprehension of the cost of credit. Under the proposal,
creditors would be required to disclose the APR in 16-point font in
close proximity to a graph that compares the consumer's APR to the
HOEPA average prime offer rate for borrowers with excellent credit and
the HOEPA threshold for higher-priced loans. This disclosure would put
the APR in context and help consumers understand whether they are being
offered a loan that comports with their creditworthiness.
Interest rate and payment summary. Currently, creditors are
required to disclose the number, amount, and timing of payments
scheduled to repay the loan. Under the MDIA's amendments to TILA,
creditors will be required to provide examples of adjustments to the
regularly required payment based on the change in interest rates
specified in the contract. Consumer testing consistently indicated that
consumers shop for and evaluate a mortgage based on the contract
interest rate and the monthly payment, but consumers have difficulty
understanding such terms using the current TILA disclosure. Under the
proposal, creditors would be required to disclose in a tabular format
the contract interest rate together with the corresponding monthly
payment, including escrows for taxes and property and/or mortgage
insurance. Special disclosure requirements would be imposed for
adjustable-rate or step-rate loans to show the interest rate and
payment at consummation, the maximum interest rate and payment at first
adjustment, and the highest possible maximum interest rate and payment.
Additional special disclosures would be required for loans with
negatively-amortizing payment options, introductory interest rates,
interest-only payments, and balloon payments.
Disclosure of other terms. In addition to the interest rate and
monthly payment, consumer testing indicated that consumers benefit from
the disclosure of other key terms in a clear format. Thus, the proposal
would require creditors to provide in a tabular format information
about the loan amount, the loan term, the loan type (such as fixed-
rate), the total settlement charges, and the maximum amount of any
prepayment penalty. In addition, creditors would be required to
disclose in a tabular question and answer format the ``Key Questions
about Risk,'' which would include information about potentially risky
loan features such as prepayment penalties, interest-only payments, and
negative amortization.
C. Disclosures Three Days Before Consummation
As noted above, the creditor is required to provide the early TILA
disclosure to the consumer within three business days after receiving
the consumer's written application and at least seven business days
before consummation, and before the consumer has paid a fee other than
a fee for obtaining the consumer's credit history. If the APR on the
early TILA disclosure exceeds a certain tolerance before consummation,
the creditor must provide corrected disclosures that the consumer must
receive at least three days before consummation. If any term other than
the APR becomes inaccurate, the creditor must give the corrected
disclosure no later than at consummation. The consumer may waive the
seven- and three-day waiting periods for a bona fide personal financial
emergency.
There are, however, long-standing concerns about consumers facing
different loan terms or increased settlement costs at closing. Members
of the Board's Consumer Advisory Council, participants in public
hearings, and commenters on prior Board rulemakings have expressed
concern about consumers not learning of changes to credit terms or
settlement charges until consummation. In addition, consumer testing
indicated that consumers are often surprised at closing by changes in
important loan terms, such as the addition of an adjustable-rate
feature. Despite these changes, consumers report that they have
proceeded with closing because they lacked alternatives (especially in
the case of a home purchase loan), or
[[Page 43240]]
were told that they could easily refinance with better terms in the
near future.
For these reasons, the proposal would require the creditor to
provide a final TILA disclosure that the consumer must receive at least
three business days before consummation, even if no terms have changed
since the early TILA disclosure was provided. In addition, the Board is
proposing two alternative approaches to address changes to loan terms
and settlement charges during the three-business-day waiting period.
Under the first approach, if any terms change during the three-
business-day waiting period, the creditor would be required to provide
another final TILA disclosure and wait an additional three business
days before consummation could occur. Under the second approach,
creditors would be required to provide another final TILA disclosure,
but would have to wait an additional three business days before
consummation only if the APR exceeds a designated tolerance or the
creditor adds an adjustable-rate feature. Otherwise, the creditor would
be permitted to provide the new final TILA disclosure at consummation.
D. Disclosures After Consummation
Regulation Z requires certain notices to be provided after
consummation. Currently, for variable-rate transactions, creditors are
required to provide advance notice of an interest rate adjustment.
There are no disclosure requirements for other post-consummation
events.
ARM adjustment notice. Currently, for variable-rate transactions,
creditors are required to provide a notice of interest rate adjustment
at least 25, but no more than 120, calendar days before a payment at a
new level is due. In addition, creditors must provide an adjustment
notice at least once each year during which an interest rate adjustment
is implemented without an accompanying payment change. These
disclosures must include certain information, including the current and
prior interest rates and the index values upon which the current and
prior interest rates are based.
Under the proposal, creditors would be required to provide the ARM
adjustment notice at least 60 days before payment at a new level is
due. This proposal seeks to address concerns that consumers need more
than 25 days to seek out a refinancing in the event of a payment
adjustment. This notice is particularly critical for subprime borrowers
who may be more vulnerable to payment shock and may have a more
difficult time refinancing a loan.
Payment option statement. Currently, creditors are not required to
provide disclosures after consummation for negatively amortizing loans,
such as payment option loans. To ensure consumers receive information
about the risks associated with payment option loans (e.g., payment
shock), the proposal would require creditors to provide a periodic
statement for payment option loans that have negative amortization. The
disclosure would contain a table with a comparison of the amount and
impact on the loan balance and property equity of a fully-amortizing
payment, interest-only payment, and minimum negatively-amortizing
payment. This disclosure would be provided not later than 15 days
before a periodic payment is due.
Creditor-placed property insurance notice. Creditors are not
currently required under Regulation Z to provide notice before charging
for creditor-placed property insurance. Industry reports indicate that
the volume of creditor-placed property insurance has increased
significantly. Consumers struggling financially may fail to pay
required property insurance premiums unaware that creditors have the
right to obtain such insurance on their behalf and add the premiums to
their outstanding loan balance. Such premiums are often considerably
more expensive than premiums for insurance obtained by the consumer.
Thus, under the proposal, creditors would be required to provide notice
to consumers of the cost and coverage of creditor-placed property
insurance at least 45 days before a charge is imposed for such
insurance. In addition, creditors would be required to provide
consumers with evidence of such insurance within 15 days of imposing a
charge for the insurance.
E. Prohibitions on Payments to Loan Originators and Steering
Currently, creditors pay commissions to loan originators in the
form of ``yield spread premiums.'' A yield spread premium is the
present dollar value of the difference between the lowest interest rate
a lender would have accepted on a particular transaction and the
interest rate a loan originator actually obtained for the lender. Some
or all of this dollar value is usually paid to the loan originator by
the creditor as a form of compensation, though it may also be applied
to other closing costs.
Yield spread premiums can create financial incentives to steer
consumers to riskier loans for which loan originators will receive
greater compensation. Consumers generally are not aware of loan
originators' conflict of interest and cannot reasonably protect
themselves against it. Yield spread premiums may provide some benefit
to consumers because consumers do not have to pay loan originators'
compensation in cash or through financing. However, the Board believes
that this benefit may be outweighed by costs to consumers, such as when
consumers pay a higher interest rate or obtain a loan with terms the
consumer may not otherwise have chosen, such as a prepayment penalty or
an adjustable rate.
In response to these concerns, the 2007 HOEPA Proposed Rule
attempted to address the potential unfairness through disclosure. The
proposal would have prohibited a creditor from paying a mortgage broker
more than the consumer had previously agreed in writing that the
mortgage broker would receive. A mortgage broker would have had to
enter into the written agreement with the consumer, before accepting
the consumer's loan application and before the consumer paid any fee in
connection with the transaction (other than a fee for obtaining a
credit report). The agreement also would have disclosed (1) that the
consumer ultimately would bear the cost of the entire compensation even
if the creditor paid part of it directly; and (2) that a creditor's
payment to a broker could influence the broker to offer the consumer
loan terms or products that would not be in the consumer's interest or
the most favorable the consumer could obtain.
Based on analysis of comments received on the 2007 HOEPA Proposed
Rule, the results of consumer testing, and other information, the Board
withdrew the proposed provisions relating to broker compensation in the
2008 HOEPA Final Rule. In particular, the Board's consumer testing
raised concerns that the proposed agreement and disclosures would
confuse consumers and undermine their decisionmaking rather than
improve it. Participants often concluded, not necessarily correctly,
that brokers are more expensive than creditors. Many also believed that
brokers would serve their best interests notwithstanding the conflict
resulting from the relationship between interest rates and brokers'
compensation.\19\ The proposed disclosures presented a significant risk
of misleading consumers regarding both the relative costs of brokers
and lenders and the role of brokers in their
[[Page 43241]]
transactions. In withdrawing the broker compensation provisions of the
HOEPA proposal, the Board stated it would continue to explore options
to address potential unfairness associated with loan originator
compensation arrangements.
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\19\ See Macro International, Inc., Consumer Testing of Mortgage
Broker Disclosures (July 10, 2008), available at http://
www.federalreserve.gov/newsevents/press/bcreg/
20080714regzconstest.pdf.
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To address the concerns related to loan originator compensation,
the Board proposes to prohibit payments to loan originators that are
based on the loan's terms and conditions. This prohibition would not
apply to payments that consumers make directly to loan originators. The
Board solicits comment on an alternative that would allow loan
originators to receive payments that are based on the principal loan
amount, which is a common practice today. If a consumer directly pays
the loan originator, the proposal would prohibit the loan originator
from also receiving compensation from any other party in connection
with that transaction. These rules would be proposed under the Board's
HOEPA authority to prohibit unfair or deceptive acts or practices in
connection with mortgage loans.
Under the proposal, a ``loan originator'' would include both
mortgage brokers and employees of creditors who perform loan
origination functions. The 2007 HOEPA Proposed Rule covered only
mortgage brokers. However, a creditor's loan officers frequently have
the same discretion as mortgage brokers to modify loans' terms to
increase their compensation, and there is evidence that creditors' loan
officers engage in such practices.
The Board also seeks comment on an optional proposal that would
prohibit loan originators from directing or ``steering'' consumers to a
particular creditor's loan products based on the fact that the loan
originator will receive additional compensation even when that loan may
not be in the consumer's best interest. The Board solicits comment on
whether the proposed rule would be effective in achieving the stated
purpose. In addition, the Board solicits comment on the feasibility and
practicality of such a rule, its enforceability, and any unintended
adverse effects the rule might have.
F. Additional Protections
Credit insurance or debt cancellation or debt suspension coverage
eligibility for all loan transactions. Currently, creditors may exclude
from the finance charge a premium or charge for credit insurance or
debt cancellation or debt suspension coverage if the creditor discloses
the voluntary nature and cost of the product, and the consumer signs or
initials an affirmative request for the product. Concerns have been
raised about creditors who sometimes offer products that contain
eligibility restrictions, specifically age or employment restrictions,
but do not evaluate whether applicants for the products actually meet
the eligibility restrictions at the time of enrollment. Subsequently,
consumers' claims for benefits may be denied because they did not meet
the eligibility restrictions at the time of enrollment. Consumers are
presumably unaware that they are paying for a product for which they
will derive no benefit. Under the proposal, creditors would be required
to determine whether the consumer meets the age and/or employment
eligibility criteria at the time of enrollment in the product and
provide a disclosure that such a determination has been made. The
proposal is not limited to mortgage transactions and would apply to all
closed-end and open-end transactions.
VI. Section-by-Section Analysis
Section 226.1 Authority, Purpose, Coverage, Organization, Enforcement,
and Liability
1(b) Purpose
Section 226.1(b) would be revised to reflect the fact that Sec.
226.35 prohibits certain acts or practices for transactions secured by
the consumer's principal dwelling. In addition, Sec. 226.1(b) would be
revised to reflect the proposal to broaden the scope of Sec. 226.36
(from transactions secured by the consumer's principal dwelling to all
transactions secured by real property or a dwelling).
1(d) Organization
1(d)(5)
The Board proposes to revise Sec. 226.1(d)(5) to reflect the scope
of Sec. Sec. 226.32, 226.34, and 226.35. The Board would also revise
Sec. 226.1(d)(5) to reflect the proposed change in the scope of Sec.
226.36, and the addition of new Sec. Sec. 226.37 and 226.38.
Section 226.2 Definitions and Rules
2(a) Definitions
2(a)(24) Residential Mortgage Transaction
Regulation Z, Sec. 226.2(a)(24), defines a ``residential mortgage
transaction'' as ``a transaction in which a mortgage, deed of trust,
purchase money security interest arising under an installment sales
contract, or equivalent consensual security interest is created or
retained in the consumer's principal dwelling to finance the
acquisition or initial construction of that dwelling.'' Currently,
comment 2(a)(24)-1 states that the term is important in five provisions
in Regulation Z, including assumption under Sec. Sec. 226.18(q) and
226.20(b). However, the proposed rule would expand coverage of the
assumption rules to cover any closed-end credit transaction secured by
real property or a dwelling. Thus, the Board proposes to revise
comments 2(a)(24)-1, -2, and -5 to reflect this change.
Section 226.3 Exempt Transactions
3(b) Credit Over $25,000 Not Secured by Real Property or a Dwelling
TILA and Regulation Z cover all credit transactions that are
secured by real property or a principal dwelling in which the amount
financed exceeds $25,000. 15 U.S.C. 1603(3). Section 226.3(b), which
implements TILA Section 104(3), provides that credit transactions over
$25,000 not secured by real property, or by personal property used or
expected to be used as the principal dwelling of the consumer, are
exempt from Regulation Z. 15 U.S.C. 1603(3).
As noted in the discussion under Sec. Sec. 226.19 and 226.38, the
Board proposes to require creditors to provide certain disclosures for
all closed-end transactions secured by real property or a dwelling, not
just principal dwellings. However, the Board recognizes that, if
personal property that is a dwelling but not the borrower's principal
dwelling secures a loan of over $25,000, it is not covered by TILA in
the first instance. For example, Regulation Z does not apply to a
$26,000 loan that is secured by a manufactured home that is not the
consumer's second or vacation home. Notwithstanding this exemption, the
Board solicits comment on whether consumers in these transactions
receive adequate information regarding their loan terms and are
afforded sufficient protections. The Board also seeks comment on the
relative benefits and costs of applying Regulation Z to these
transactions.
Section 226.4 Finance Charge
Background
Section 106(a) of TILA provides that the finance charge in a
consumer credit transaction is ``the sum of all charges, payable
directly or indirectly by the person to whom the credit is extended,
and imposed directly or indirectly by the creditor as an incident to
the extension of credit.'' 15 U.S.C. 1605(a). The finance charge does
not include charges of a type payable in a comparable cash transaction.
Id. The finance charge does not include fees or charges imposed by
third party closing agents, such as settlement agents, attorneys, and
title companies, if the creditor does not require the imposition
[[Page 43242]]
of those charges or the services provided, and the creditor does not
retain the charges. Id. Examples of finance charges include, among
other things, interest, points, service or carrying charges, credit
report fees, and credit insurance premiums. Id.
The finance charge is significant for two reasons. First, it is
meant to represent, in dollar terms, the ``cost of credit'' in whatever
form imposed by the creditor or paid by the borrower. Second, the
finance charge is used in calculating the annual percentage rate (APR)
for the loan, 15 U.S.C. 1606, which represents the ``cost of credit,
expressed as a yearly rate.'' Sec. 226.22(a)(1). Together, these two
interrelated terms are among the most important terms disclosed to
consumers under TILA.
While the test for determining what is included in a finance charge
is very broad, TILA Section 106 excludes from the definition of the
finance charge various fees or charges. The statute excludes from the
finance charge: Premiums for credit insurance if coverage is not
required to obtain credit, certain disclosures are provided to the
consumer, and the consumer affirmatively requests the insurance in
writing; and premiums for property and liability insurance written in
connection with a consumer credit transaction if the insurance may be
obtained from a person of the consumer's choice and certain disclosures
are provided to the consumer. 15 U.S.C. 1605(b) and (c). Statutory
exclusions also apply to certain security interest charges, including:
(1) Fees or charges required by law and paid to public officials for
determining the existence of, or for perfecting, releasing, or
satisfying, any security related to the credit transaction; (2)
premiums for insurance purchased instead of perfecting any security
interest otherwise required by the creditor; and (3) taxes levied on
security instruments or the documents evidencing indebtedness if
payment of those taxes is required to record the instrument securing
the evidence of indebtedness. 15 U.S.C. 1605(d). Finally, the statute
excludes from the finance charge various fees in connection with loans
secured by real property, such as title examination fees, title
insurance premiums, fees for preparation of loan-related documents,
escrows for future payment of taxes and insurance, notary fees,
appraisal fees, pest and flood-hazard inspection fees, and credit
report fees. 15 U.S.C. 1605(e).
Through the exclusions described above, the Congress has adopted a
``some fees in, some fees out'' approach to the finance charge with
some fees automatically excluded from the finance charge and other fees
excluded from the finance charge provided certain conditions are met.
The regulation tracks this approach with a three-tiered approach to the
classification of fees or charges: (1) Some fees or charges are finance
charges; (2) some fees and charges are not finance charges; and (3)
some fees and charges are not finance charges, but only if certain
conditions are met. As a result, neither the finance charge nor the
corresponding APR disclosed to the consumer reflect the consumer's
total cost of credit.
Section 226.4(a) defines the finance charge as ``the cost of
consumer credit as a dollar amount.'' Consistent with TILA Section
106(a), the finance charge includes ``any charge payable directly or
indirectly by the consumer and imposed directly or indirectly by the
creditor as an incident to or a condition of the extension of credit''
and does not include ``any charge of a type payable in a comparable
cash transaction.'' Sec. 226.4(a). The finance charge also includes
fees and amounts charged by someone other than the creditor if the
creditor requires the use of a third party as a condition of or
incident to the extension of credit, even if the consumer can choose
the third party, or if the creditor retains a portion of the third
party charge (to the extent of the portion retained). Sec.
226.4(a)(1).
The Board has adopted provisions in the regulation to give effect
to each of the statutory exclusions and conditional exclusions from the
finance charge. Closing agent charges are not included in the finance
charge unless the creditor requires the particular services for which
the consumer is charged, requires imposition of the charge, or retains
a portion of the charge (to the extent of the portion retained). Sec.
226.4(a)(2). Premiums for credit insurance may be excluded from the
finance charge if insurance coverage is not required by the creditor,
certain disclosures are provided to the consumer, and the consumer
affirmatively requests the insurance coverage in a writing signed or
initialed by the consumer. Sec. 226.4(d)(1). Premiums for property and
liability insurance may also be excluded from the finance charge if the
insurance may be obtained from a person of the consumer's choice and
certain disclosures are provided to the consumer. Sec. 226.4(d)(2).
Certain security interest charges enumerated in the statute, such as
taxes and fees prescribed by law and paid to public officials for
determining the existence of, or for perfecting, releasing, or
satisfying, a security interest, are excluded from the finance charge.
Sec. 226.4(e). The regulation also excludes from the finance charge
the real estate related fees enumerated in Section 106(e) of TILA.
Sec. 226.4(c)(7).
Over time, the Board, by regulation, has contributed to the ``some
fees in, some fees out'' approach to the finance charge by determining
that certain other charges not specifically excluded by the statute are
not finance charges. These regulatory exclusions often sought to bring
logical consistency to the treatment of fees that are similar to fees
the statute excludes or conditionally excludes from the finance charge.
Charges excluded from the finance charge by regulation include: Charges
for debt cancellation or debt suspension coverage if the coverage is
not required by the creditor, certain disclosures are provided to the
consumer, and the consumer affirmatively requests the coverage in a
writing signed or initialed by the consumer; and fees for verifying the
information in a credit report. See Sec. 226.4(d)(3) and comment
4(c)(7)-1. The additional fees the Board has excluded from the finance
charge generally are closely analogous or related to fees that the
statute excludes or conditionally excludes from the finance charge. For
example, premiums for voluntary debt cancellation coverage are closely
analogous to premiums for voluntary credit insurance, which TILA
excludes from the finance charge. Likewise, charges for verifying a
credit report are related to the credit report itself.
Concerns With the Current Approach to Finance Charges
The ``some fees in, some fees out'' approach to the finance charge
has been problematic both for consumers and for creditors since TILA's
inception. Many of these problems were described in the 1998 Joint
Report.\20\
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\20\ The 1998 Joint Report at 8-16.
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One fundamental problem is that there are two views of what is
meant by the ``cost of credit.'' From the creditor's perspective, the
cost of credit means the interest and fee income that the creditor
receives or requires in exchange for providing credit to the consumer.
From the consumer's perspective, however, the cost of credit means what
the consumer pays for the credit, regardless of the persons to whom
such amounts are paid.\21\ The statute uses both of these approaches in
designating which fees are and are not included in the finance charge.
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\21\ See The 1998 Joint Report at 10.
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The influence of the creditor's perspective on the cost of credit
is evident in how the ``some fees in, some
[[Page 43243]]
fees out'' approach to the finance charge has evolved and been applied
to loans secured by real property. Many services provided in connection
with real estate loans are performed by third parties, such as
appraisers, closing agents, inspectors, public officials, attorneys,
and title companies. Some of these services are required by the
creditor, while others are not. In either case, the fees for these
services generally are remitted in whole or in part to the third party.
In some cases, the creditor may have little control over the fees
imposed by these third parties. From the creditor's perspective, the
creditor generally does not receive and retain these charges in
connection with providing credit to the consumer. From the consumer's
perspective, however, these third-party charges are part of what the
consumer pays to obtain credit.\22\
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\22\ See The 1998 Joint Report at 11.
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Another problem with the ``some fees in, some fees out'' approach
is that it undermines the effectiveness of the APR as an accurate
measure of the cost of credit expressed as a yearly rate. The APR is
designed to be a benchmark for consumer shopping. In consumer testing
conducted for the Board, however, the APR appeared not to be fulfilling
that objective in connection with mortgage loans.
A single figure such as the APR is simple to use, particularly if
consumers can use it to evaluate and compare competing products, rather
than having to evaluate multiple figures.\23\ This is especially true
for a figure such as the APR, which has a forty-year history in
consumer disclosures, and thus is familiar to consumers. Nevertheless,
if that single figure is not understood by consumers or does not fully
represent what it purports to represent, the usefulness of that figure
is undermined. Consumer testing shows that most consumers do not
understand the APR, and many believe that the APR is the interest rate.
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\23\ See The 1998 Joint Report at 9.
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Under the current ``some fees in, some fees out'' approach to the
finance charge, mortgage lenders also have an incentive to unbundle the
cost of credit and shift some of the costs from the interest rate into
ancillary fees that are excluded from the finance charge and not
considered when calculating the APR, resulting in a lower APR than
otherwise would have been disclosed. This further undermines the
usefulness of the APR and has resulted in the proliferation of ``junk
fees,'' such as fees for preparing loan-related documents. Such
unbundling of the cost of credit, and the resulting pricing complexity,
can have a detrimental impact on consumers. For example, research
undertaken by HUD suggests that borrowers experience great difficulty
when deciding whether the tradeoff between paying higher up-front costs
or paying a higher interest rate is in their best interest, and that
borrowers who do not pay up-front loan origination fees generally pay
less than borrowers who do pay such fees.\24\ To the extent that the
APR calculation includes most or all fees, the APR can reduce the
incentive for lenders to include junk fees in credit agreements.\25\
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\24\ U.S. Department of Housing and Urban Development, A Study
of Closing Costs for FHA Mortgages at x-xi and 2-4 (May 2008).
\25\ See The 1998 Joint Report at 9.
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Based on extensive outreach conducted by Board staff, there appears
to be a broad consensus that the ``some fees in, some fees out''
approach to the finance charge and corresponding APR calculation and
disclosure is seriously flawed. Many industry representatives consider
the finance charge definition overly complex. For creditors, this
complexity creates significant regulatory burden and litigation risk.
While some industry representatives generally favor a more inclusive
measure, they have not advocated a specific test for determining the
finance charge.
Consumer advocates believe that the exclusions from the finance
charge undermine the purpose of the finance charge and the APR, which
is to measure the cost of credit. Some consumer advocates have
recommended a ``but for'' test that would include in the finance charge
all fees except those that the consumer would pay if he or she were not
``obtaining, accessing, or repaying the extension of credit,'' such as
fees paid in comparable cash transactions.\26\
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\26\ Renuart, Elizabeth and Diane E. Thomson, The Truth, the
Whole Truth, and Nothing but the Truth: Fulfilling the Promise of
Truth in Lending, 25 Yale J. on Reg. 181, 230 (2008).
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In the 1998 Joint Report, the Board and HUD recommended that the
Congress adopt a more comprehensive definition of the finance
charge.\27\ The Board and HUD recommended adopting a ``required-cost of
credit'' test that would include in the finance charge ``the costs the
consumer is required to pay to get the credit.'' \28\ Under this
approach, the finance charge would include (and the APR would reflect)
costs required to be paid by the consumer to obtain the credit,
including many fees currently excluded from the finance charge, such as
application fees, appraisal fees, document preparation fees, fees for
title services, and fees paid to public officials to record security
interests.\29\ Under the ``required-cost of credit'' test, fees for
optional services, such as premiums for voluntary credit insurance,
would be excluded from the finance charge.\30\
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\27\ The 1998 Joint Report at 15-16.
\28\ The 1998 Joint Report at 13, 16.
\29\ The 1998 Joint Report at 13.
\30\ The 1998 Joint Report at 13.
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The Board's Proposal
A simpler, more inclusive test for determining the finance charge.
The Board believes consumers would benefit from having a disclosure
that includes fees or charges that better represent the full cost of
credit undiluted by myriad exclusions, the basis for which consumers
cannot be expected to understand. In addition, having a single
benchmark figure--the APR--that is simple to use should allow consumers
to evaluate competing mortgage products by reviewing one variable. The
Board also believes that such a disclosure would reduce compliance
burdens, regulatory uncertainty, and litigation risks for creditors who
must provide accurate TILA disclosures.
Thus, the Board would retain the APR as a benchmark for closed-end
transactions secured by real property or a dwelling but is proposing
certain revisions designed to make the APR more useful to consumers.
First, as discussed below, the Board is proposing to provide consumers
with more helpful explanation of the APR and what it represents.
Second, the Board is proposing to require disclosure of the APR
together with a new disclosure of the interest rate, as discussed
below. Third, the Board is proposing to replace the ``some fees in,
some fees out'' approach for determining the finance charge with a
simpler, more inclusive approach for determining the finance charge
that is based on TILA Section 106(a), 15 U.S.C. 1605(a). This approach
is designed to ensure that the finance charge and the corresponding APR
disclosed to consumers fulfills the basic purpose of TILA by providing
a more complete and useful measure of the cost of credit.
Pursuant to its authority under TILA Sections 105(a) and (f) of
TILA, 15 U.S.C. 1604(a) and (f), the Board is proposing to amend Sec.
226.4 to make most of the current exclusions from the finance charge
inapplicable to closed-end credit transactions secured by real property
or a dwelling. For such loans, the Board is proposing to replace the
``some fees in, some fees out'' approach with a simpler, more inclusive
test based on the definition of finance
[[Page 43244]]
charge in TILA Section 106(a), 15 U.S.C. 1605(a), for determining what
fees or charges are included in the finance charge. The Board believes
that the current patchwork of fee exclusions from the definition of the
finance charge is not consistent with TILA's purpose of disclosing the
cost of credit to the consumer. The Board believes that a more
inclusive approach to determining the finance charge would be more
consistent with TILA's purpose, enhance consumer understanding and use
of the finance charge and APR disclosures, and reduce compliance costs.
The Board also believes that the proposed revisions to the finance
charge may enhance competition for third-party services since creditors
would likely be more mindful of fees or charges that must be included
in the finance charge and APR.
The proposed test for determining the finance charge tracks the
language of current Sec. 226.4 but excluding Sec. 226.4(a)(2).
Specifically, under this test, a fee or charge is included in the
finance charge for closed-end credit transactions secured by real
property or a dwelling if it is (1) ``payable directly or indirectly by
the consumer'' to whom credit is extended, and (2) ``imposed directly
or indirectly by the creditor as an incident to or a condition of the
extension of credit.'' The finance charge would continue to exclude
fees or charges paid in comparable cash transactions. See Sec.
226.4(a). The finance charge also includes charges by third parties if
the creditor: (1) Requires use of a third party as a condition of or
incident to the extension of credit, even if the consumer can choose
the third party; or (2) retains a portion of the third-party charge, to
the extent of the portion retained. See Sec. 226.4(a)(1). Other
exclusions from the finance charge for closed-end credit transactions
secured by real property or a dwelling would be limited to late fees
and similar default or delinquency charges, seller's points, and
premiums for property and liability insurance.
As new services are added, and new fees are charged, in connection
with closed-end credit transactions secured by real property or a
dwelling, creditors would have to apply the basic test in making
judgments about whether or not new fees must be included in the finance
charge. The Board requests comment on whether further guidance is
needed to assist creditors in making these determinations, and, if so,
what specific guidance would be helpful.
Loans covered. Section 226.4 is part of Subpart A, General, as
opposed to Subpart C, Closed-End Credit. Nevertheless, the proposed
amendments to Sec. 226.4 would apply only to closed-end credit
transactions secured by real property or a dwelling, consistent with
the general scope of this proposed rule. The Board seeks comment on
whether the same amendments should be made applicable to other closed-
end credit and may consider such amendments under a future review of
Regulation Z. Contemporaneous with this proposal, the Board is
publishing separately proposed rules regarding home equity lines of
credit (HELOCs). Accordingly, the Board is not proposing to apply the
changes to the finance charge determination to HELOCs in this
rulemaking. As discussed in the HELOC proposal, the Board believes that
changing the definition of finance charge for HELOC accounts would not
have a material effect on the HELOC disclosures and accordingly is
unnecessary.
Impact on coverage of other rules. One potential consequence of
adopting a more inclusive test for determining the finance charge is
that more loans may qualify as ``HOEPA loans,'' as described in TILA
Section 103(aa), and therefore be subject to the additional disclosures
and prohibitions applicable to such loans under TILA Section 129.
Similarly, more loans may be subject to the Board's recently adopted
protections for higher-priced mortgage loans under Sec. 226.35, which
become effective on October 1, 2009. 73 FR 44522; Jul. 30, 2008.
Finally, more loans may qualify as covered loans under certain State
anti-predatory lending laws that use the APR as a coverage test. The
Board has conducted some analysis to quantify these impacts.
To estimate representative charges, the Board obtained information
from a 2008 survey conducted by Bankrate.com on closing costs for each
state, based on a $200,000 hypothetical mortgage loan.\31\ Using these
estimates, and scaling those that are calculated as a percentage of
loan amount as necessary, the Board estimated the effect on the APRs of
first-lien loans in two databases: HMDA records, which include most
closed-end home loans, and data obtained from Lender Processing
Services, Inc. (LPS), which include mostly prime and near-prime home
loans serviced by several large mortgage servicers.
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\31\ To supplement the Bankrate.com survey with estimated
recording fees and taxes, which the survey did not include, the
Board used the Martindale-Hubbell service's digest of State laws. As
discussed below, the Board is not proposing to revise comment 4(a)-
5, which provides principles for determining the treatment of taxes
based on the party on whom the law imposes the tax. For the sake of
simplicity, the Board did not attempt to distinguish such laws on
this basis and, instead, included all recording taxes in the finance
charge under the proposal. The analysis thus may have included some
recording taxes in the finance charge under the proposal that could
have been excluded under comment 4(a)-5.
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On the basis of this analysis, the Board estimates that proposed
Sec. 226.4 would increase the share of first-lien refinance and home
improvement loans covered by HOEPA, under Sec. 226.32, by about 0.6
percent. While this increase is small, the Board also notes that,
because very few HOEPA loans are originated overall, the absolute
number of loans covered would increase markedly--more than 350 percent.
Because the HMDA data do not include APRs for loans below the rate
spread reporting thresholds, see 12 CFR 203.4(a)(12), 2006 LPS data
were used to estimate the impact on coverage of Sec. 226.35. Based on
this analysis, the Board estimates that about 3 percent of the first-
lien loans in the loan amount range of the typical home purchase or
refinance loan ($175,000 to $225,000) that were below the Sec. 226.35
APR threshold would have been above the threshold if proposed Sec.
226.4 had been in effect at the time.
The Board also examined HMDA data for the impact of the proposed,
more inclusive finance charge definition on APRs in certain states.
Specifically, the Board considered the APR tests for coverage of first-
lien mortgages under the anti-predatory lending laws in the District of
Columbia (DC), Illinois, and Maryland. These laws are the only three
State anti-predatory lending laws with APR coverage thresholds that are
lower than the federal HOEPA APR threshold, for first-lien loans, of
800 basis points over the U.S. Treasury yield on securities with
comparable maturities. DC and Illinois use a threshold of 600 basis
points, and Maryland uses a threshold of 700 basis points, over the
comparable Treasury yield.\32\ Freddie Mac and Fannie Mae have policies
under which they will not purchase loans that exceed the Illinois
thresholds,\33\ but they have no such policies with regard to DC or
Maryland. The Board estimates that proposed Sec. 226.4 would convert
the following percentages of first-lien loans that are under the
applicable APR threshold into loans that exceed that threshold and thus
would become covered by the applicable State anti-predatory lending
law: DC, 2.5%; Illinois, 4.0%; Maryland, 0.0%.
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\32\ DC Code Ann. 26-1151.01(7)(A)(i); Ill. Comp. Stat. ch. 815,
137/10; Md. Code Ann. Com. Law 12-1029(a)(2).
\33\ http://www.freddiemac.com/learn/pdfs/uw/Pred_
requirements.pdf; https://www.efanniemae.com/sf/guides/ssg/annltrs/
pdf/2003/03-12.pdf.
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[[Page 43245]]
The Board notes that the impact of the proposed finance charge
definition on APRs varies among loans based on two significant factors.
First, because many of the affected charges are fixed dollar amounts,
the impact is significantly greater for smaller loans. Second, the
impact likely would vary geographically because some charges, notably
title insurance premiums and recording fees and taxes, vary
considerably by state. The Board believes the proposal, on balance,
would be in consumers' interests but seeks comment on these
consequences of the proposal and the impact it may have on loans that
could become subject to these various laws.
Legal authority. The Board is proposing to adopt the simpler, more
inclusive test for determining the finance charge and corresponding APR
pursuant to its general rulemaking, exception, and exemption
authorities under TILA Section 105. Section 105(a) directs the Board to
prescribe regulations to carry out the purposes of this title, which
include facilitating consumers' ability to compare credit terms and
helping consumers avoid the uninformed use of credit. 15 U.S.C.
1601(a), 1604(a). Section 105(a) generally authorizes the Board to make
adjustments and exceptions to TILA to effectuate the statute's
purposes, to prevent circumvention or evasion of the statute, or to
facilitate compliance with the statute. 15 U.S.C. 1601(a), 1604(a).
The Board has considered the purposes for which it may exercise its
authority under TILA Section 105(a) carefully and, based on that
review, believes that the proposed adjustments and exceptions are
appropriate. The proposal has the potential to effectuate the statute's
purpose by better informing consumers of the total cost of credit and
to prevent circumvention or evasion of the statute through the
unbundling or shifting of the cost of credit from finance charges to
fees or charges that are currently excluded from the finance charge.
The Board believes that Congress did not anticipate how such unbundling
would undermine the purposes of TILA, when it enacted the exceptions.
For example, fees for preparation of loan-related documents are
excluded from the finance charge by TILA Section 106(e), 15 U.S.C.
1605(e); in practice, document preparation fees have become a common
vehicle used by creditors to enhance their revenue without having any
impact on the finance charge or APR. A simpler, more inclusive approach
to determining the finance charge also would facilitate compliance with
the statute.
TILA Section 105(f) generally authorizes the Board to exempt any
class of transactions from coverage under any part of TILA if the Board
determines that coverage under that part does not provide a meaningful
benefit to consumers in the form of useful information or protection.
15 U.S.C. 1604(f)(1). The Board is proposing to exempt closed-end
transactions secured by real property or a dwelling from the complex
exclusions in TILA Section 106(b) through (e), 15 U.S.C. 1605(b)
through (e). TILA Section 105(f) directs the Board to make the
determination of whether coverage of such transactions under those
exclusions provides a meaningful benefit to consumers in light of
specific factors. 15 U.S.C. 1604(f)(2). These factors are (1) the
amount of the loan and whether the disclosure provides a benefit to
consumers who are parties to the transaction involving a loan of such
amount; (2) the extent to which the requirement complicates, hinders,
or makes more expensive the credit process; (3) the status of the
borrower, including any related financial arrangements of the borrower,
the financial sophistication of the borrower relative to the type of
transaction, and the importance to the borrower of the credit, related
supporting property, and coverage under TILA; (4) whether the loan is
secured by the principal residence of the borrower; and (5) whether the
exemption would undermine the goal of consumer protection.
The Board has considered each of these factors carefully and, based
on that review, believes that the proposed exemptions are appropriate.
Mortgage loans generally are the largest credit obligation that most
consumers assume. Most of these loans are secured by the consumer's
principal residence. For many consumers, their mortgage loan is the
most important credit obligation that they have. Consumer testing
suggests that consumers find the finance charge and APR disclosures
confusing and unhelpful when shopping for a mortgage. Along with other
changes, replacing the patchwork ``some fees in, some fees out''
approach to determining the finance charge with a more inclusive
approach that reflects the consumer's total cost of credit has the
potential to further the goals of consumer protection and promote the
informed use of credit for mortgage loans. Adoption of a more inclusive
finance charge also would simplify compliance, reduce regulatory
burden, and reduce litigation risk for creditors.
The Board's exception and exemption authority under Sections 105(a)
and (f) does not apply in the case of a mortgage referred to in Section
103(aa), which are high-cost mortgages generally referred to as ``HOEPA
loans.'' The Board does not believe that this limitation restricts its
ability to apply the revised provisions regarding finance charges to
all mortgage loans, including HOEPA loans. This limitation on the
Board's general exception and exemption authority is a necessary
corollary to the decision of the Congress, as reflected in TILA Section
129(l)(1), to grant the Board more limited authority to exempt HOEPA
loans from the prohibitions applicable only to HOEPA loans in Section
129(c) through (i) of TILA. See 15 U.S.C. 1639(l)(1). Here, the Board
is not proposing any exemptions from the HOEPA prohibitions. This
limitation does raise a question as to whether the Board could use its
exception and exemption authority under Sections 105(a) and (f) to
except or exempt HOEPA loans, but not other types of mortgage loans,
from other, generally applicable TILA provisions. That question,
however, is not implicated by this proposal.
Here, the Board is proposing to apply its general exception and
exemption authority to enhance the finance charge disclosure for all
loans secured by real property or a dwelling, including both HOEPA and
non-HOEPA loans, in order to fulfill the statute's purpose of having
the finance charge and APR disclosures reflect the total cost of
credit. It would not be consistent with the statute or with
Congressional intent to interpret the Board's authority under Sections
105(a) and (f) in such a way that the proposed revisions could apply
only to mortgage loans that are not subject to HOEPA. Reading the
statute in a way that would deprive HOEPA borrowers of improved finance
charge and APR disclosures is not a reasonable construction of the
statute and contravenes the Congress's goal of ensuring ``that enhanced
protections are provided to consumers who are most vulnerable to
abuse.'' \34\
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\34\ H.R. Conf. Rept. 103-652 at 159 (Aug. 2, 1994).
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The Board solicits comment on all aspects of this proposal,
including the cost, burden, and benefits to consumers and to industry
regarding the proposed revisions to the determination of the finance
charge. The Board also requests comment on any alternatives to the
proposal that would further the purposes of TILA and provide consumers
with more useful disclosures.
4(a) Definition
Comment 4(a)-5 contains guidance for determining whether taxes
should be treated as finance charges. Generally, a tax imposed on the
creditor is a finance
[[Page 43246]]
charge if the creditor passes it through to the consumer. If applicable
law imposes a tax solely on the consumer, on the creditor and consumer
jointly, on the credit transaction itself without specifying a liable
party, or on the creditor with direction or authorization to pass it
through to the consumer, the tax is not a finance charge. Consequently,
an examination of the law imposing each tax that is paid by the
consumer is required to determine whether such taxes are finance
charges. This examination of laws creates burden for creditors and may
result in inconsistent treatment of similar taxes. The resulting
disclosures likely are not as useful to consumers as they might be if
all taxes were treated consistently. The Board seeks comment on whether
the rules for determining the finance charge treatment of taxes imposed
by State and local governments should be simplified and, if so, how.
The Board also seeks comment on whether any such simplification should
be for purposes of closed-end transactions secured by real property or
a dwelling only or should have more general applicability.
Proposed new comment 4(a)-6 would clarify that there is no
comparable cash transaction in a transaction where there is no seller,
such as a refinancing, and thus the comparable cash transaction
exclusion from the finance charge does not apply to such transactions.
4(a)(2) Special Rule; Closing Agent Charges
The Board is proposing to amend Sec. 226.4(a)(2), which set out
special rules for closing agent charges, in light of the proposed new
Sec. 226.4(g), discussed below. As a result, this provision would no
longer apply to closed-end credit transactions secured by real property
or a dwelling because the fees excluded by Sec. 226.4(a)(2) meet the
general definition of the finance charge in TILA Section 106(a). The
Board also proposes certain conforming amendments to the staff
commentary under this provision.
Under the general definition of ``finance charge'' in TILA Section
106(a), a charge is a finance charge if it is (1) ``payable directly or
indirectly by the person to whom the credit is extended,'' and (2)
``imposed directly or indirectly by the creditor as an incident to the
extension of credit.'' 15 U.S.C. 1605(a). Application of the basic
statutory definition as the test for determining which charges are
finance charges would result in many third-party charges being treated
as finance charges because such third-party charges often are payable
directly or indirectly by the consumer and imposed indirectly by the
creditor. For instance, because real estate settlements are complex
financial and legal transactions, creditors generally require a
licensed closing agent (often an attorney) to conduct closings to
ensure that the transaction is handled with professional skill and
care. These closing agents typically impose fees on the consumer in the
course of ensuring that the loan is consummated appropriately. In some
cases, the creditor clearly requires the particular third-party service
for which a fee is charged, such as where the creditor instructs the
closing agent to send documents by overnight courier. In other cases,
however, whether the creditor requires the particular service is not
clear.
A rule that requires case-by-case factual determinations as to
whether a particular third-party fee must be included in the finance
charge results in complexity and inconsistent treatment of such fees.
Such inconsistent treatment in turn undermines the utility of the
finance charge and APR as comparison shopping tools and introduces
uncertainty and litigation risk for creditors. For these reasons, the
Board believes that fees charged by closing agents, both their own and
those of other third parties they hire to perform particular services,
should be treated uniformly as finance charges. The Board seeks comment
on whether any such third-party charges do not fall within the basic
test for determining the finance charge and could be excluded from the
finance charge without requiring factual determination in each case.
Requiring third-party charges to be included in the finance charge
creates some risk that a creditor may understate the finance charge if
the creditor does not know that a particular charge was imposed by a
third party. This risk is mitigated to some extent by TILA Section
106(f), which provides that a disclosed finance charge is treated as
accurate if it does not vary from the actual finance charge by more
than $100 or is greater than the amount required to be disclosed. 15
U.S.C. 1605(f). This tolerance has been incorporated into Regulation Z.
See Sec. 226.18(d)(1). The Board requests comment on whether it should
increase the finance charge tolerance, for example to $200, in light of
its proposal to require more third-party charges to be included in the
finance charge. The Board also requests comment on whether the existing
or any increased tolerance should be linked to an inflation index, such
as the Consumer Price Index.
Excluding fees from the finance charge because they are voluntary
or optional also is not consistent with the statutory purpose of
disclosing the ``cost of credit,'' which includes charges imposed ``as
an incident to the extension of credit.'' \35\ 15 U.S.C. 1605(a). One
basis for the current exclusions for voluntary or optional charges is
an implicit assumption that they are not ``imposed directly or
indirectly by the creditor'' on the consumer. However, charges may be
imposed by a creditor even if the services for which the fee is imposed
are not specifically required by the creditor. Moreover, a test that
depends upon whether a service is ``voluntary'' inherently requires a
factual determination. In the current provisions addressing credit
insurance, the Board has identified certain objective criteria for
determining when the consumer's purchase of such insurance is deemed to
be voluntary. However, as discussed below, this approach has many
problems and has not proven satisfactory. The Board believes that
drawing a bright-line to include in the finance charge both voluntary
and required charges that are imposed by the creditor would eliminate
the difficulties posed by this type of fact-based analysis and provide
a more consistent measure of the cost of credit.
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\35\ The Board has consistently interpreted the definition of
finance charge as not dependent on whether a charge is voluntary or
required. As a practical matter, most voluntary fees are excluded
because they coincidentally are payable in a comparable cash
transaction, not specifically because they are voluntary. See, e.g.,
61 FR 49237, 49239; Sept. 19, 1996 (charges for voluntary debt
cancellation agreements).
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Another basis for the current exclusions for voluntary or optional
charges in connection with the credit transaction is an assumption that
creditors cannot know the amounts of such charges at the time the
disclosure must be provided to the consumer. The Board presumes that
creditors know the amounts of their own voluntary charges, if any. The
Board believes that creditors generally know or can readily determine
voluntary third-party charges when providing TILA disclosures three
business days before consummation, as proposed Sec. 226.19(a)(2)(ii)
would require. As a practical matter, the primary voluntary third-party
charge in connection with a mortgage transaction of which the Board is
aware (and that is not otherwise excluded from the finance charge) is
the premium for voluntary credit insurance, and creditors generally
solicit consumers for such insurance. In fact, under existing Sec.
226.4(d)(1)(ii), creditors historically
[[Page 43247]]
have had to disclose the premium for voluntary credit insurance to
exclude it from the finance charge. The Board nevertheless solicits
comment on whether there are voluntary third-party charges the amounts
of which cannot be determined three business days before consummation.
The Board recognizes that creditors may not know what voluntary or
optional charges the consumer will incur when providing early TILA
disclosures. When providing early TILA disclosures, creditors may rely
on reasonable assumptions regarding voluntary or optional charges and
label those amounts as estimates. The Board invites comment on whether
further guidance is required regarding reasonable assumptions that may
be made regarding voluntary or optional charges in early TILA
disclosures.
4(b) Examples of Finance Charges
The Board is proposing technical amendments to comment 4(b)-1 to
reflect the fact that the exclusions from the finance charge under
Sec. 226.4(c) through (e), other than Sec. Sec. 226.4(c)(2),
226.4(c)(5) and 226.4(d)(2), would not apply to closed-end credit
transactions secured by real property or a dwelling.
4(c) Charges Excluded From the Finance Charge
The Board proposes to amend Sec. 226.4(c), which lists
miscellaneous exclusions from the finance charge, to provide that Sec.
226.4(c) is limited by proposed new Sec. 226.4(g). Thus, except for
late fees and similar default or delinquency charges and seller's
points, the exclusions in Sec. 226.4(c) would not apply to closed-end
credit transactions secured by real property or a dwelling. The Board
also proposes certain conforming amendments to the staff commentary
under those provisions.
4(c)(2)
The exclusion of fees for actual unanticipated late payment,
exceeding a credit limit, or for delinquency, default, or a similar
occurrence in Sec. 226.4(c)(2) would be retained for closed-end credit
transactions secured by real property or a dwelling. The Board believes
these charges should be excluded because they necessarily occur only
after the finance charge is disclosed to consumers. At the time the
TILA disclosures must be provided to consumers, a creditor cannot know
whether it will impose such charges or their amounts.
4(c)(5)
The exclusion of seller's points from the finance charge in Sec.
226.4(c)(5) would be retained for closed-end credit transactions
secured by real property or a dwelling. Seller's points are not payable
by the consumer. Comment 226.4(c)(5)-1 notes that seller's points may
be passed on to the buyer in the form of a higher sales price for the
property or dwelling. Even then, seller's points are excluded from the
finance charge. A different rule would require a fact-specific
determination in every transaction involving seller's points regarding
whether and to what extent the seller shifted those costs to the
borrower. The Board does not believe that such a rule is feasible. The
Board seeks comment on the retention of the seller's points exclusion.
4(c)(7) Real-Estate Related Fees
The Board is proposing to amend Sec. 226.4(c)(7), which currently
excludes from the finance charge a number of fees charged in
transactions secured by real property or in residential mortgage
transactions if those fees are bona fide and reasonable. Under the
proposal, the following fees currently excluded would be included in
the finance charge for closed-end credit transactions secured by real
property or a dwelling: fees for title examination, abstract of title,
title insurance, property survey, and similar purposes; fees for
preparing loan-related documents, such as deeds, mortgages, and
reconveyance or settlement documents; notary and credit-report fees;
property appraisal fees or fees for inspections to assess the value or
condition of the property if the service is performed prior to closing,
including fees related to pest-infestation or flood-hazard
determinations; and amounts required to be paid into escrow or trustee
accounts if the amounts would not otherwise be included in the finance
charge. The commentary provisions under Sec. 226.4(c)(7) would also be
amended accordingly.
As amended, Sec. 226.4(c)(7) and the commentary provisions under
Sec. 226.4(c)(7) would apply only to open-end credit plans secured by
real property and open-end residential mortgage transactions. Thus, for
HELOCs, the fees specified in Sec. 226.4(c)(7) would continue to be
excluded from the finance charge. The Board requests comment on whether
it should retain Sec. 226.4(c)(7), as proposed to be amended, or
delete Sec. 226.4(c)(7) altogether, in light of the proposed changes
to the Regulation Z HELOC rules, published today in a separate Federal
Register notice. See the discussion under Sec. 226.4 in that notice.
4(d) Insurance and Debt Cancellation and Debt Suspension Coverage
The Board is proposing technical amendments to comment 4(d)-12 to
reflect the fact that the exclusions from the finance charge under
Sec. 226.4(e) would not apply to closed-end transactions secured by
real property or a dwelling.
4(d)(1) and (3) Voluntary Credit Insurance Premiums; Voluntary Debt
Cancellation and Debt Suspension Fees
The Board is proposing to amend Sec. Sec. 226.4(d)(1), exclusion
for voluntary credit insurance premiums, and 226.4(d)(3), exclusion for
voluntary debt cancellation and debt suspension fees, to limit their
application consistently with proposed Sec. 226.4(g). Thus, these
exclusions would not apply to closed-end transactions secured by real
property or a dwelling.
Age or employment eligibility criteria. Under TILA Section
106(a)(5), 15 U.S.C. 1605(a)(5), a premium or other charge for any
guarantee or insurance protecting the creditor against the obligor's
default or other credit loss is a finance charge. Under Sec. Sec.
226.4(b)(7) and 226.4(b)(10), a premium or charge for credit life,
accident, health, or loss-of-income insurance, or debt cancellation or
debt suspension coverage is a finance charge if the insurance or
coverage is written in connection with a credit transaction. TILA
Section 106(b), 15 U.S.C. 1605(b), allows the creditor to exclude from
the finance charge any charge or premium for credit life, accident, or
health insurance written in connection with any consumer credit
transaction if (1) the coverage is not a factor in the approval by the
creditor of the extension of credit, and this fact is clearly disclosed
in writing to the consumer; and (2) in order to obtain the insurance,
the consumer specifically requests the insurance after getting the
disclosures. Under Sec. Sec. 226.4(d)(1) and 226.4(d)(3), the creditor
may exclude from the finance charge any premium for credit life,
accident, health or loss-of-income insurance; any charge or premium
paid for debt cancellation coverage for amounts exceeding the value of
the collateral securing the obligation; or any charge or premium for
debt cancellation or debt suspension coverage in the event of loss of
life, health, or income or in case of accident, whether or not the
coverage is insurance, if (1) the insurance or coverage is not required
by the creditor and the creditor discloses this fact in writing; (2)
the creditor discloses the premium or charge for the initial term of
the insurance or coverage,
[[Page 43248]]
(3) the creditor discloses the term of insurance or coverage, if the
term is less than the term of the credit transaction, and (4) the
consumer signs or initials an affirmative written request for the
insurance or coverage after receiving the required disclosures. In
addition, under Sec. 226.4(d)(3)(iii), the creditor must disclose for
debt suspension coverage the fact that the obligation to pay loan
principal and interest is only suspended, and that interest will
continue to accrue during the period of suspension.\36\ Under proposed
Sec. 226.4(g), these provisions would not apply to closed-end credit
transactions secured by real property or a dwelling.
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\36\ The provisions regarding debt suspension coverage were in
the December 2008 Open-End Final Rule. See 74 FR 5244, 5400; Jan.
29, 2009. These provisions will take effect on July 1, 2010.
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Some creditors offer credit insurance or debt cancellation or debt
suspension products with eligibility restrictions, but may not evaluate
whether applicants for the products actually meet the eligibility
criteria at the time the applicants request the product.\37\ For
instance, a consumer who is 70 at the time of enrollment could never
receive the benefits of a product with a 65-year-old age limit.\38\
Similarly, a consumer who is self-employed at the time of enrollment
would not receive benefits if the product requires the consumer to be
employed as a W-2 wage employee.\39\
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\37\ See, e.g., Parker et al. v. Protective Life Ins. Co. of
Ohio et al., Nos. 2004-T-0127 and 2004-T-0128, 2006 Ohio App. LEXIS
3983, at *28 (Ohio Ct. App. Aug. 4, 2006) (reversing summary
judgment for defendants automobile dealership and insurer because
the automobile dealership employee did not evaluate whether the
plaintiffs were eligible for credit disability insurance and the
plaintiffs were later denied benefits based on eligibility
restrictions); Stewart v. Gulf Guaranty Life Ins. Co., No. 2000-CA-
01511-SCT, 2002 Miss. LEXIS 254, at *4 (Miss. Aug. 15, 2002)
(affirming the jury award where the insurer did not require the bank
employee to have the consumer fill out a credit life and disability
insurance application regarding pre-existing conditions and the
insurer later denied coverage based on a pre-existing condition).
\38\ See, e.g., Fed. Trade Comm'n v. Stewart Finance Holdings,
Inc. et al., Civ. Action No. 103CV-2648, Final Judgment and Order at
13 (N.D. Ga. Nov. 9, 2005) (alleging that the finance company sold
accidental death and dismemberment insurance to borrowers who were
not eligible for the product due to age restrictions).
\39\ See, e.g., In the Matter of Providian Nat'l Bank, OCC
Docket No. 2000-53, Consent Order (June 28, 2000) (alleging that the
bank marketed an involuntary unemployment credit protection program
but failed to adequately disclose that such protection was
unavailable to consumers who were self-employed).
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Although age and employment eligibility criteria may be set forth
in the product marketing materials and/or enrollment forms, the Board
believes few consumers notice this information when they obtain credit
and choose to purchase the voluntary credit insurance or debt
cancellation or debt suspension coverage. Because the product is sold
in connection with a credit transaction that is underwritten by the
creditor, the consumer may reasonably believe that the creditor has
determined that the consumer is eligible for the product. This may be
especially true for age restrictions because that information is
typically requested by the creditor on the credit application form. As
a result, many consumers may not discover until they file a claim that
they were paying for a product for which they were not eligible when
they initially purchased it. Consumers that do not submit claims may
never discover that they are paying for products that hold no value for
them.
To address this problem, the Board proposes to add Sec. Sec.
226.4(d)(1)(iv) and 226.4(d)(3)(v) to permit creditors to exclude a
premium or charge from the finance charge only if the creditor
determines at the time of enrollment that the consumer meets any
applicable age or employment eligibility criteria for the credit
insurance or the debt suspension or debt cancellation coverage. These
provisions would apply to open-end as well as closed-end (non-real
property) credit transactions. Proposed comment 4(d)-14 would state
that a premium or charge for credit life, accident, health, or loss-of-
income insurance, or debt cancellation or debt suspension coverage is
voluntary and can be excluded from the finance charge only if the
consumer meets the product's age or employment eligibility criteria at
the time of enrollment. The proposed comment would further clarify that
to exclude such a premium or charge from the finance charge, the
creditor would have to determine at the time of enrollment that the
consumer is eligible for the product under the product's age or
employment eligibility restrictions.
Proposed comment 4(d)-14 would provide that the creditor could use
reasonably reliable evidence of the consumer's age or employment status
to satisfy the condition. Reasonably reliable evidence of a consumer's
age would include using the date of birth on the consumer's credit
application, on the driver's license or other government-issued
identification, or on the credit report. Reasonably reliable evidence
of a consumer's employment status would include the consumer's
information on a credit application, Internal Revenue Service Form W-2,
tax returns, payroll receipts, or other evidence such as a letter or e-
mail from the consumer or the consumer's employer. A determination of
age or employment eligibility at the time of enrollment should not be
unduly burdensome because in most cases the creditor would already have
information about the consumer's age and employment status as part of
the credit underwriting process. The Board seeks comment on whether
other examples of reasonably reliable evidence of the consumer's age or
employment status should be included.
Proposed comment 4(d)-14 would clarify that, if the consumer does
not meet the product's age or employment eligibility criteria, then the
premium or charge is not voluntary and must be included in the finance
charge. If the creditor offers a bundled product (such as credit life
insurance combined with credit involuntary unemployment insurance) and
the consumer does not meet the age and/or employment eligibility
criteria for all of the bundled products, the proposed commentary would
clarify that the creditor must either: (1) treat the entire premium or
charge for the bundled product as a finance charge, or (2) offer the
consumer the option of selecting only the products for which the
consumer is eligible and exclude the premium or charge from the finance
charge if the consumer chooses an optional product for which the
consumer meets the age and/or employment eligibility criteria at the
time of enrollment.
The Board proposes this rule and commentary to address concerns
about the voluntary nature of this product. TILA Section 106(b), 15
U.S.C. 1605(b), states that ``[c]harges or premiums for credit life,
accident, or health insurance written in connection with any consumer
credit transaction shall be included in the finance charge unless (1)
the coverage of the debtor by the insurance is not a factor in the
approval by the creditor of the extension of credit, and this fact is
clearly disclosed in writing to the person applying for or obtaining
the extension of credit; and (2) in order to obtain the insurance in
connection with the extension of credit, the person to whom the credit
is extended must give specific affirmative written indication of his
desire to do so after written disclosure to him of the cost thereof.''
Historically, Sec. 226.4(d) has implemented this provision as a
``voluntariness'' standard. For example, in 1981, comment 4(d)-5 was
adopted as part of the TILA simplification process. The comment stated
that the credit insurance ``must be voluntary in order for the premium
to be excluded from the finance charge.'' 46 FR 50288, 50301; Oct. 9,
1981 (emphasis added). In 1996, the Board amended Regulation Z to apply
the rules for credit insurance to debt cancellation coverage. In
adopting this provision, the Board
[[Page 43249]]
stated: ``The new rule allows creditors to exclude fees for voluntary
debt cancellation coverage from the finance charge when specified
disclosures are made.'' 61 FR 49237, 49240; Sept. 19, 1996 (emphasis
added). In the December 2008 Open-End Final Rule, the Board applied the
rules for credit insurance and debt cancellation coverage to debt
suspension coverage. In adopting this provision, the Board referred to
the May 2007 Open-End Proposed Rule, which stated that the Board
``proposed to revise Sec. 226.4(d)(3) to expressly permit creditors to
exclude charges for voluntary debt suspension coverage from the finance
charge when, after receiving certain disclosures, the consumer
affirmatively requests such as product.'' 74 FR 5244, 5266; Jan. 29,
2009 (emphasis in original). Finally, the model forms currently contain
the following statement emphasizing the voluntary nature of the
product: ``Credit life insurance and credit disability insurance are
not required to obtain credit, and will not be provided unless you sign
and agree to pay the additional cost.'' See Appendix H-1 (Credit Sale
Model Form) and Appendix H-2 (Loan Model Form). The Board believes that
if the consumer was ineligible for the benefits of credit insurance or
debt cancellation or debt suspension coverage at the time of
enrollment, then the purchase cannot be voluntary because a reasonable
consumer would not knowingly purchase a policy for which he or she can
derive no benefit. For these reasons, the Board believes that the
requirements of proposed Sec. Sec. 226.4(d)(1)(iv) and 226.4(d)(3)(v)
would help ensure that the purchase of credit insurance or debt
cancellation or debt suspension coverage would, in fact, be voluntary.
The Board notes that although the proposed rule would require
creditors to determine the consumer's age and/or employment eligibility
for the product at the time of enrollment, the proposed rule would not
affect the creditor's ability to deny coverage if the consumer
misrepresented his or her age or employment status at the time of
enrollment. Finally, the proposed rule does not require a creditor to
determine if a consumer ceases to meet the age or employment
eligibility criteria after enrollment. For example, the creditor has
complied with the proposal if the consumer becomes ineligible for the
policy or coverage after enrollment. State or other law may address
these issues. However, the Board solicits comment on whether creditors
should be required to determine whether the consumer meets the
product's age or employment eligibility criteria after the product is
sold (e.g., before renewing an annual premium), or whether creditors
should be required to provide notice when the consumer exceeds the age
limit of the product after enrollment.
Revised disclosures. As discussed above, TILA Section 106(b), 15
U.S.C. 1605(b), and Sec. Sec. 226.4(d)(1) and 226.4(d)(3) allow a
creditor to exclude from the finance charge a credit insurance premium
or debt cancellation or debt suspension fee if the creditor provides
disclosures that inform the consumer of the voluntary nature and cost
of the product. Currently, Regulation Z does not specifically mandate
the format of these disclosures, but provides sample language in the
model forms. For example, Appendix H-2 (Loan Model Form) contains the
following language: ``Credit life insurance and credit disability
insurance are not required to obtain credit, and will not be provided
unless you sign and agree to pay the additional cost.'' The model form
also shows the type of product (e.g., credit life or credit
disability); the cost of the premium; and a signature line. The
signature area is accompanied by the following language: ``I want
credit life insurance.''
Concerns have been raised about whether the current disclosures
sufficiently inform consumers of the voluntary nature and costs of the
product. To address these concerns, a disclosure was tested that
included a charge for credit life insurance and listed the product
under the title ``Optional Features.'' Only about half of the
participants understood that accepting credit insurance was voluntary
and that they could decline the product. Subsequently, a disclosure was
tested that stated, ``STOP. You do not have to buy this insurance to
get this loan.'' After reading this disclosure, all participants
understood the voluntary nature of the product.
In addition, concerns have been raised about the product's cost.
The product may be more costly than, for example, traditional life
insurance, but may not provide additional benefits. To address this
concern, the Board tested the following language: ``If you have
insurance already, this policy may not provide you with any additional
benefits. Other types of insurance can give you similar benefits and
are often less expensive.'' Participant comprehension of the costs and
benefits of the product was significantly increased by these plain-
language disclosures.
Concerns have also been raised about eligibility restrictions.
Consumers might not be aware that they may incur a cost for a product
that provides no benefit to them if the eligibility criteria are not
met at the time of enrollment. Accordingly, the Board tested the
following language: ``Even if you pay for this insurance, you may not
qualify to receive any benefits in the future.'' Participants were
greatly surprised to learn that they might purchase the insurance only
to later discover that they were not eligible for benefits. A few
participants indicated that they did not understand how they could pay
for the coverage and then receive no benefits. To address this issue
and to conform to the requirements of proposed Sec. Sec.
226.4(d)(1)(iv) and 226.4(d)(3)(v), the following statement was added
to the disclosure: ``Based on our review of your age and/or employment
status at this time, you would be eligible to receive benefits.''
However, if there are other eligibility restrictions, such as pre-
existing health conditions, the creditor would be required to disclose
the following statements: ``Based on our review of your age and/or
employment status at this time, you may be eligible to receive
benefits. However, you may not qualify to receive any benefits because
of other eligibility restrictions.''
Finally, a sentence was added to the disclosure to refer consumers
to the Board's Web site to learn more about the product, and the cost
disclosure was streamlined to display more clearly the exact cost of
the product. Most consumer testing participants indicated they would
visit the Board's Web site to learn more about a credit insurance or
debt cancellation or debt suspension product.
Based on this consumer testing, the Board proposes to add model
clauses and samples that provide clearer information to consumers about
the voluntary nature and costs of credit insurance or debt cancellation
or debt suspension coverage. These model clauses and samples would
apply in open-end or closed-end (not secured by real property)
transactions, if the product is voluntary and the consumer qualifies
for benefits based on age or employment. For closed-end transactions
secured by real property or a dwelling, the model clause or sample
would be required whether or not the product is voluntary. Model
Clauses and Samples are proposed at Appendix G-16(C) and G-16(D) and H-
17(C) and H-17(D). These Model Clauses and Samples would be in addition
to the Debt Suspension Model Clauses and Samples found at Appendix G-
16(A) and G-16(B) and H-17(A) and H-17(B).
Timing of disclosures. Currently, comment 4(d)-2 states that ``[i]f
disclosures are given early, for example
[[Page 43250]]
under Sec. 226.17(f) or Sec. 226.19(a), the creditor need not
redisclose if the actual premium is different at the time of
consummation. If insurance disclosures are not given at the time of
early disclosure and insurance is in fact written in connection with
the transaction, the disclosures under Sec. 226.4(d) must be made in
order to exclude the premiums from the finance charge.'' The Board
proposes to delete the reference to Sec. 226.19(a) to conform to the
new timing and redisclosure requirements under proposed Sec.
226.19(a).
4(d)(2) Property Insurance Premiums
The proposal would retain the exclusion from the finance charge of
premiums for insurance against loss or damage to property or against
liability arising out of the ownership or use of property under TILA
Section 106(c) and Sec. 226.4(d)(2). Consumers typically purchase
property and liability insurance to protect against a variety of risks,
including loss of or damage to the property, such as damage caused by
fire, loss of or damage to personal property kept on the property, such
as furniture, and owner liability for injuries incurred by visitors to
the property. Although creditors generally require such insurance as a
condition of extending closed-end credit secured by real property or a
dwelling in order to protect the value of the collateral that is
securing the loan, consumers who do not have mortgages regularly
purchase this type of insurance to protect themselves from the risks
described above. This type of insurance is best viewed as a hybrid
product that protects not only the value of the creditor's collateral,
but also protects the consumer from loss or impairment of the
consumer's equity in the property, loss or impairment of the consumer's
personal property, and personal liability if anyone is injured on the
property. Consequently, it is impossible to segregate that portion of
the insurance (and that portion of the premium) which protects the
creditor from that portion which protects only the consumer.
In addition, the Board has not identified significant abuses in
connection with the sale or marketing of insurance against loss or
damage to property or against liability arising out of the ownership or
use of property. The market for these products appears to be
competitive. Consumers can purchase this type of insurance from many
insurance companies, including companies not associated with mortgage
lenders. In addition, policies generally are tailored to the particular
risks faced by the consumer. Thus, consumers have choices with regard
to how much insurance to purchase to cover various risks and, as a
result, have some control over the premiums they pay.
The Board requests comment on the appropriateness of retaining the
current exclusion from the finance charge of premiums for insurance
against loss or damage to property or against liability arising out of
the ownership or use of property. The Board notes that, under current
Sec. 226.4(d)(2), the category of property and liability insurance has
been interpreted to include coverage against flood risks; the Board
seeks comment on whether the reasons for retaining the exclusion
discussed above are applicable to flood insurance specifically and, if
not, whether it should be subject to separate treatment under
Regulation Z. In addition, the Board requests comment on whether
including such premiums in the finance charge could have adverse or
unintended consequences for consumers and for creditors.
TILA Section 106(c) states that charges or premiums for property
insurance must be included in the finance charge unless ``a clear and
specific statement in writing is furnished by the creditor to the
person to whom the credit is extended, setting forth the cost of the
insurance if obtained from or through the creditor, and stating that
the person to whom the credit is extended may choose the person through
which the insurance is to be obtained.'' 15 U.S.C. 1605(c) (emphasis
added). Section 226.4(d)(2) permits property insurance premiums to be
excluded from the finance charge under the following conditions, among
others: ``If the coverage is obtained from or through the creditor, the
premium for the initial term of insurance coverage shall be disclosed.
If the term of insurance is less than the term of the transaction, the
term of insurance shall also be disclosed.'' (Emphasis added). Comment
4(d)-8 states, in relevant part, that ``[t]he premium or charge must be
disclosed only if the consumer elects to purchase the insurance from
the creditor; in such a case, the creditor must also disclose the term
of the property insurance coverage if it is less than the term of the
obligation.'' (Emphasis added.) Currently, the comment does not use the
statutory language ``from or through the creditor'' and does not define
the phrase. To conform to the statutory and regulatory language, the
Board proposes to amend comment 4(d)-8 to clarify that the premium or
charge and term (if less than the term of the obligation) must be
disclosed if the consumer elects to purchase the insurance ``from or
through the creditor.'' In addition, the proposed comment would clarify
that insurance is available ``from or through a creditor'' if it is
available from the creditor's ``affiliate,'' as that term is defined
under the Bank Holding Company Act, 12 U.S.C. 1841(k). The Bank Holding
Company Act defines an ``affiliate'' as ``any company that controls, is
controlled by, or is under common control with another company.'' Thus,
if the consumer elects to purchase property insurance from a company
that controls, is controlled by, or is under common control with the
creditor, then the creditor would be required to disclose the cost of
the insurance, and the term, if it is less than the term of the
obligation. The Board believes that this proposed rule would clarify
for creditors the meaning of ``through the creditor'' and provide
consumers with a clearer disclosure of the cost of property insurance.
4(d)(4) Telephone Purchases
Under Sec. Sec. 226.4(d)(1) and 226.4(d)(3), creditors may exclude
from the finance charge premiums for credit insurance or fees for debt
cancellation or debt suspension coverage, if the creditor provides
certain disclosures in writing and the consumer signs or initials an
affirmative written request for the insurance or coverage. Over the
years, the Board has received industry requests to permit creditors to
provide the disclosures and obtain the affirmative consumer request
orally in order to facilitate telephone purchases of these products. In
addition, the OCC has issued telephone sales guidelines for national
banks that sell debt cancellation and debt suspension coverage. 12 CFR
37.6(c)(3), 37.7(b).
In the December 2008 Open-End Final Rule, the Board created an
exception to the requirement to provide prior written disclosures and
obtain written signatures or initials for telephone purchases of credit
insurance and debt cancellation or debt suspension coverage in
connection with open-end (not home-secured) plans. 74 FR 5244, 5267;
Jan. 29, 2009. This rule will take effect on July 1, 2010. Under new
Sec. 226.4(d)(4), for telephone purchases a creditor may make the
disclosures orally and the consumer may affirmatively request the
insurance or coverage orally, provided that the creditor (1) maintains
evidence that the consumer, after being provided the disclosures
orally, affirmatively elected to purchase the insurance or coverage,
and (2) mails the required disclosures within three business days after
the telephone purchase. New comment 226.4(d)(4)-1 provides that a
creditor does not satisfy
[[Page 43251]]
the requirement to obtain a consumer's affirmative request if the
``request'' was a response to a leading question or negative consent.
The comment also provides an example of an acceptable enrollment
question (``Do you want to enroll in this optional debt cancellation
plan?'').
The Board promulgated this rule pursuant to its exception and
exemption authorities under TILA Section 105. Section 105(a) authorizes
the Board to make exceptions to TILA to effectuate the statute's
purposes, which include facilitating consumers' ability to compare
credit terms and helping consumers avoid the uninformed use of credit.
15 U.S.C. 1601(a), 1604(a). In addition, the Board considered the
exemption factors set forth in TILA Section 105(f)(2), 15 U.S.C.
1604(f)(2), and determined that an exemption for telephone purchases
for open-end (not home-secured) plans was appropriate because the rule
contained adequate safeguards to ensure that oral purchases are
voluntary. 74 FR 5268. The Board emphasized that consumers in open-end
(not home-secured) plans receive monthly statements that clearly
disclose fees, including credit insurance and debt cancellation or debt
suspension coverage charges. Id. Consumers who are billed for insurance
or coverage they did not request can dispute the charge as a billing
error. Id. The Board stated that as part of the closed-end review, it
would consider whether to expand the telephone purchase rule to this
type of credit. 74 FR 5267.
The Board believes that a telephone purchase rule for closed-end
credit is not appropriate. Monthly statements are not required for
closed-end credit, and it would be difficult for consumers who do not
receive monthly statements to detect charges for unwanted coverage.
Moreover, there is no billing error resolution process for closed-end
loans.
Finally, the Board noted in the December 2008 Open-End Final Rule
that an exception or exemption for the telephone purchase of credit
insurance or debt cancellation or debt suspension coverage in
connection with closed-end loans may be ``less necessary.'' 74 FR 5267.
For open-end (not home-secured) credit, new comments 4(b)(7) and (8)-2
and 4(b)(10)-2 in the December 2008 Open-End Final Rule clarify that
credit insurance and debt cancellation or debt suspension coverage is
``written in connection with a credit transaction'' if the consumer
purchases it after the opening of an open-end (not home-secured) plan
because the consumer retains the ability to obtain advances of funds.
74 FR 5265. Therefore, in such a transaction, the creditor must comply
with the disclosure and consumer request requirements even if the
credit insurance and debt cancellation or debt suspension coverage is
sold after the opening of the plan. A creditor in an open-end (not
home-secured) transaction may be more likely to market the product by
telephone after the opening of the plan, and new Sec. 226.4(d)(4)
facilitates the telephone purchase. By contrast, a creditor in a
closed-end transaction is more likely to have the opportunity to meet
the consumer face-to-face at or before consummation to market the
product, provide the disclosure, and obtain the consumer request. For
these reasons, this proposal does not contain a telephone purchase rule
for credit insurance or debt cancellation or debt suspension coverage
sold in connection with a closed-end credit transaction. The Board
seeks comment on this issue. For a discussion of the application of the
telephone purchase rule to HELOCs, see the Board's proposal for such
transactions published simultaneously with this proposal.
4(e) Certain Security Interest Charges
The Board proposes to amend Sec. 226.4(e), which provides
exclusions from the finance charge for certain government recording and
related charges and insurance premiums incurred in lieu of such
charges, as limited by proposed Sec. 226.4(g). Thus, the exclusions
listed in Sec. 226.4(e) would not apply to closed-end credit
transactions secured by real property or a dwelling. The Board also
proposes certain conforming amendments to the staff commentary under
this provision.
4(g) Special Rule; Closed-End Mortgage Transactions
The Board is proposing to add a new Sec. 226.4(g) as a special
rule for closed-end credit transactions secured by real property or a
dwelling. Proposed Sec. 226.4(g) would provide that the exclusions
from the finance charge enumerated in Sec. Sec. 226.4(a)(2) (closing
agent charges), (c) (miscellaneous charges), (d) (premiums for certain
insurance and debt cancellation coverage), and (e) (certain security-
interest charges) do not apply to closed-end credit transactions
secured by real property or a dwelling, except that the exclusions in
Sec. 226.4(c)(2) for late, over-limit, delinquency, default, and
similar fees, Sec. 226.4(c)(5) for seller's points, and Sec.
226.4(d)(2) for property and liability insurance would continue to
apply to such transactions. As noted above, a cross-reference to the
special rule in Sec. 226.4(g) would be added to each of the enumerated
sections. With these changes, the following fees that currently are
excluded from the finance charge would be included in the finance
charge for closed-end mortgage transactions (unless otherwise
excluded): Closing agent charges, application fees charged to all
applicants for credit (whether or not credit is extended), voluntary
credit insurance premiums, voluntary debt-cancellation charges or
premiums, taxes or fees required by law and paid to public officials
relating to security interests, premiums for insurance obtained in lieu
of perfecting a security interest, taxes imposed as a condition of
recording the instruments securing the evidence of indebtedness, and
various real-estate related fees.
Proposed commentary to Sec. 226.4(g) is included to clarify the
rule for mortgage transactions. Proposed comment 4(g)-1 clarifies that
the commentary for the exclusions identified above no longer applies to
closed-end credit transactions secured by real property or a dwelling.
Proposed comment 4(g)-2 clarifies that third-party charges that meet
the definition under Sec. 226.4(a) and are not otherwise excluded
generally are finance charges, whether or not the creditor requires the
services for which they are imposed. Proposed comment 4(g)-3 clarifies
that charges payable in a comparable cash transaction, such as property
taxes and fees or taxes imposed to record the deed evidencing transfer
of title to the property from the seller to the buyer, are not finance
charges because they would have to be paid even if no credit were
extended to finance the purchase.
Request for Comment
The Board solicits comment on the benefits and costs of the
proposed changes for determining the finance charge for closed-end
credit transactions secured by real property or a dwelling. The Board
requests comment specifically on whether this approach adequately or
appropriately addresses the concerns raised by the ``some fees in, some
fees out'' approach in light of the statute's purposes, the need for
consumer protection and meaningful disclosures, and industry concerns
regarding complexity and burden. The Board also seeks comment on the
benefits and costs of the rules for insurance and related products
under the proposed amendments to Sec. 226.4(d).
Section 226.17 General Disclosure Requirements
The Board is proposing new rules governing format and content of
disclosures for transactions secured by real property or a dwelling
under new
[[Page 43252]]
Sec. Sec. 226.37 and 226.38. Accordingly, the Board proposes
conforming and technical amendments to current Sec. Sec. 226.17 and
226.18, as discussed more fully below. In addition, in reviewing the
rules for closed-end credit, regulatory text and associated commentary
have been redesignated, and footnotes moved to the text of the
regulation or commentary, as appropriate, to facilitate compliance with
the regulation.
17(a) Form of Disclosures
17(a)(1)
The Board proposes special rules in new Sec. 226.37 and associated
commentary to govern the format of disclosures required under proposed
Sec. Sec. 226.38 and 226.20(d), and existing Sec. Sec. 226.19(b) and
226.20(c). These new format rules would be in addition to the rules
contained in current Sec. 226.17(a)(1). Current Sec. 226.17(a)(1)
requires that closed-end credit disclosures be grouped together,
segregated from everything else, and not contain any information not
directly related to the disclosures. The Board proposes to revise Sec.
226.17(a)(1) to clarify that the general disclosure standards continue
to apply to transactions secured by real property or a dwelling, but
under the proposal, creditors would also be required to meet the higher
standards under proposed Sec. 226.37. In addition, Sec. 226.17(a)(1)
would be revised to reflect the requirement of electronic disclosures
in certain circumstances, as discussed under Sec. 226.19(d). Under the
proposal, the substance of footnotes 37 and 38 would be moved to the
regulatory text of Sec. 226.17(a)(1).
Footnotes 37 and 38 currently provide exceptions to the grouped and
segregated requirement under Sec. 226.17(a)(1). Footnote 37 allows
creditors to include certain information not directly related to the
required disclosures, such as the consumer's name, address, and account
number. Footnote 38, which implements TILA Section 128(b)(1) in part,
allows creditors to exclude certain required disclosures from the
grouped and segregated requirement, such as the creditor's identity
under Sec. 226.18(a). 15 U.S.C. 1638(b)(1). The Board proposes to
revise the substance of footnote 38 to require that the creditor's
identity under Sec. 226.18(a) be subject to the grouped together and
segregated requirement for all closed-end credit disclosures. (See
proposed Sec. 226.37(a)(2), which parallels this approach for
transactions secured by real property or a dwelling). The Board
proposes to make this adjustment pursuant to its authority under TILA
Section 105(a). 15 U.S.C. 1604(a). Section 105(a) authorizes the Board
to make exceptions and adjustments to TILA to effectuate the statute's
purposes, which include facilitating consumers' ability to compare
credit terms, and avoiding the uninformed use of credit. 15 U.S.C.
1601(a).
The Board believes requiring the creditor's identity to be grouped
together with required disclosures could assist consumers. The Board
believes it is important for the disclosures to bear the creditor's
identity so that consumers can more easily identify the appropriate
entity. As a result, the Board believes the proposal would help serve
TILA's purpose to provide meaningful disclosure of terms.
Commentary to Sec. 226.17(a)(1) provides guidance to creditors
regarding the general disclosures standards contained in Sec.
226.17(a)(1). The Board proposes to clarify the applicability of
comments 17(a)(1)-2, -5, -6, and -7 to transactions secured by real
property or a dwelling.
Current comment 17(a)(1)-2 provides an exception to the grouped and
segregated requirement for disclosures on variable rate transactions
required under existing Sec. Sec. 226.19(b) and 226.20(c). For the
reasons discussed under proposed Sec. 226.37(a)(2), the Board proposes
to require that ARM loan program disclosures under proposed Sec.
226.19(b), and ARMs adjustment notices under proposed Sec. 226.20(c),
be subject to the grouped and segregated requirement. As a result, the
reference made to Sec. Sec. 226.19(b) and 226.20(c) would be removed
from comment 17(a)(1)-2.
Current comment 17(a)(1)-5, which addresses information considered
directly related to the segregated disclosures, would be revised to
clarify that it does not apply to transactions secured by real property
or a dwelling, and to cross-reference proposed Sec. 226.37(a)(2).
Under the proposal, cross-references in comments 17(a)(1)-5(viii),
(xi), (xii), and (xvi) would be updated; no substantive change is
intended. In addition, as noted below, proposed revisions to Sec.
226.18(f) regarding variable rate transactions, and proposed Sec.
226.38(j)(6) regarding assumption disclosure for transactions secured
by real property or a dwelling, render comments 17(a)(1)-5(xiii) and
(xiv) unnecessary and therefore those comments would be deleted.
Finally, comment 17(a)(1)-5(xvi) would be revised to update cross-
references.
As discussed under proposed Sec. Sec. 226.37(a)(2) and 226.38, the
Board proposes to require that creditors make disclosures for
transactions secured by real property or a dwelling only as applicable.
Current comment 17(a)(1)-6, which permits creditors to design multi-
purpose forms for closed-end credit disclosures as long as they are
clear and conspicuous, would be revised to clarify that it does not
apply to transactions secured by real property or a dwelling, as
discussed more fully below under proposed Sec. 226.37(a)(2).
Finally, the Board proposes to clarify in current comment 17(a)(1)-
7 that transactions secured by real property or a dwelling and that
have balloon payment financing with leasing characteristics are treated
as closed-end credit under TILA and subject to its disclosure
requirements.
17(a)(2)
Section 226.17(a)(2), which implements TILA Section 122(a),
requires the terms finance charge and annual percentage rate, together
with a corresponding amount or percentage rate, to be more conspicuous
than any other disclosure, except the creditor's identity under Sec.
226.18(a). The Board proposes new disclosure requirements under
proposed Sec. 226.38(e)(5)(ii) for the finance charge (renamed
``interest and settlement charges''), and under proposed Sec. Sec.
226.37(a)(2) and 226.38(b) for the APR. As a result, the Board would
revise Sec. 226.17(a)(2) to be inapplicable to transactions secured by
real property or a dwelling.
17(b) Time of Disclosures
Section 227.17(b) and comment 17(b)-1 require creditors to make
closed-end credit disclosures before consummation of the transaction;
special timing requirements apply to dwelling-secured transactions and
variable-rate transactions. As discussed more fully under Sec. 226.19,
the Board is proposing to require creditors to make pre-consummation
disclosures for transactions secured by real property or a dwelling in
accordance with special timing requirements. As a result, the Board
proposes to revise Sec. 226.17(b) and comment 17(b)-1 to clarify that
more specific timing rules would apply to transactions secured by real
property or a dwelling. Current comment 17(b)-2, which addresses
disclosure requirements for transactions converted from open-end to
closed-end, would be revised to clarify that the special timing
requirements under Sec. 226.19(b) would apply for adjustable rate
transactions secured by real property or a dwelling.
[[Page 43253]]
17(c) Basis of Disclosures and Use of Estimates
17(c)(1) Legal Obligation
Section 226.17(c)(1) requires that disclosures under subpart C
reflect the terms of the legal obligation between the parties.
Commentary to Sec. 226.17(c)(1) provides guidance regarding disclosure
of specific transaction types and loan features. The Board proposes to
add new provisions in Sec. 226.17(c)(1)(i) through (vi) to move
certain content from commentary to the regulation, as discussed below.
In addition, the Board would revise certain commentary to Sec.
226.17(c)(1) to reflect the new disclosure regime for mortgages, and
redesignate comments as appropriate. Each of these proposed
subsections, and accompanying commentary, is discussed below.
Comments 17(c)(1)-1 and 17(c)(1)-2 generally address disclosure of
the legal obligation and modification of such obligation. Comment
17(c)(1)-1 would be revised to include the general principle that the
consumer is presumed to abide by the terms of the legal obligation. For
example, proposed comment 17(c)(1)-1 states that creditors should
assume that a consumer will make payments on time and in full. This
proposed revision is consistent with existing comment 17(c)(2)(i)-3,
which states that creditors may base all disclosures on the assumption
that payments will be made on time, disregarding any possible
inaccuracies resulting from consumers' payment patterns. Comment
17(c)(2)(i)-3 specifically addresses disclosures for simple-interest
transactions that potentially may be affected by late payments. The
proposed revisions to comment 17(c)(1)-1 would clarify that disclosures
for all transactions subject to Sec. 226.17 should be based on the
assumption that the consumer will adhere to the terms of the legal
obligation.
Comment 17(c)(1)-2 would be revised to clarify that transactions
secured by real property or a dwelling are subject to the special
disclosure rules under proposed Sec. 226.38(a)(3) and (c). Under the
proposal, preferred-rate loans with a fixed interest rate would not be
considered ARMs, and therefore, comment 17(c)(1)-2 also would be
revised to remove the cross-reference to Sec. 226.19(b). Comment
17(c)(1)-2 would be redesignated as 17(c)(1)-2(i) through (iii).
Comment 17(c)(1)-16, which addresses disclosure for credit extensions
that may be treated as multiple transactions, would be moved and
redesignated as comment 17(c)(1)-3; no substantive change is intended.
Comment 17(c)(1)-15 states that where a deposit account is created
for the sole purpose of accumulating payments that are applied to
satisfy the consumer's credit obligation--a practice used in Morris
Plan transactions--payments to that account are treated the same as
loan payments. Under the proposal, comment 17(c)(1)-15 would be
removed. As discussed below, Morris Plan transactions are rare. In
addition, the Board believes that such deposits clearly constitute loan
payments and therefore comment 17(c)(1)-15 is unnecessary.
The remaining commentary to Sec. 226.17(c)(1) would be revised and
redesignated as discussed below under proposed subsections 17(c)(1)(i)
through (vi).
17(c)(1)(i) Buydowns
Comments 17(c)(1)-3 through 17(c)(1)-5 address third-party
buydowns, consumer buydowns, and split buydowns, respectively. The
proposed rule would add a new provision in Sec. 226.17(c)(1)(i) that
reflects that existing commentary about buydowns. Proposed Sec.
226.17(c)(1)(i) requires creditors to disclose an APR that is a
composite rate, based on the rate in effect during the initial period
and the rate in effect for the remainder of the loan's term, if the
consumer's interest rate or payments are reduced for all or part of the
loan term. Proposed Sec. 226.17(c)(1)(i) applies to seller or third-
party buydowns if they are reflected in the legal obligation, and to
all consumer buydowns.
Comments 17(c)(1)-3 through 17(c)(1)-5 would be redesignated as
comments 17(c)(1)(i)-1 through -4 and revised to reflect changes in the
terminology used under the proposed rule to describe the finance
charge, for transactions secured by real property or a dwelling.
17(c)(1)(ii) Wrap-Around Financing
Comment 17(c)(1)-6 provides guidance on disclosures for
transactions that involve wrap-around financing; comment 17(c)(1)-7
provides guidance on disclosures for wrap-around transactions that
include a balloon payment. Both comments state that, in transactions
that involve wrap-around financing, the amount financed equals the sum
of the new funds advanced by the wrap creditor and the remaining
principal owed to the original creditor on the pre-existing loan. The
proposed rule would incorporate this guidance into proposed Sec.
226.17(c)(1)(ii). Comments 17(c)(1)-6 and 17(c)(1)-7 would be
redesignated as comments 17(c)(1)(ii)-1 and 17(c)(1)(ii)-2,
respectively; no substantive change is intended.
17(c)(1)(iii) Variable- or Adjustable-Rate Transactions
Comment 17(c)(1)-8 currently provides that creditors should base
disclosures for variable- or adjustable-rate transactions on the full
term of the transaction and the terms in effect at the time of
consummation and should not assume that the rate will increase. The
proposed rule would incorporate that guidance into proposed Sec.
226.17(c)(1)(iii). Proposed Sec. 226.17(c)(1)(iii) would require
creditors to base disclosures for variable- or adjustable-rate
transactions on the full loan term, and on the terms in effect at the
time of consummation, except as otherwise provided under proposed
Sec. Sec. 226.17(c)(1)(iii) or 226.38(a)(3) and (c) for transactions
secured by real property or a dwelling.
As discussed below under proposed Sec. 226.38(c), creditors would
be required to disclose specified rate and payment adjustments for
adjustable-rate loans secured by real property or a dwelling. As a
result, comment 17(c)(1)-8 would be revised to clarify that creditors
must disclose specified rate and payment adjustments for adjustable-
rate loans secured by real property or a dwelling in accordance with
the requirements under proposed Sec. 226.38(c). Current comment
17(c)(1)-8 would be redesignated as comment 17(c)(1)(iii)-1.
Current comment 17(c)(1)-9, which states that a variable-rate
feature does not, by itself, make the disclosures estimates, would be
redesignated as comment 17(c)(1)(iii)-2. No substantive change is
intended.
17(c)(1)(iii)(A) and (B) Discounted and Premium Rates
Comment 17(c)(1)-10 provides that if the initial interest for a
variable-rate transaction is not determined by the index or formula
used to make later interest-rate adjustments, disclosures should
reflect a composite APR based on the initial interest rate for as long
as it is charged and, for the remainder of the term, the rate that
would have been applied using the index or formula at the time of
consummation. The proposed rule would incorporate that commentary into
proposed Sec. 226.17(c)(1)(iii)(B).
Proposed Sec. 226.17(c)(1)(iii) contains two separate disclosure
rules; which disclosure rule applies depends on whether or not the
initial rate is determined using the same index or formula used to make
subsequent rate adjustments. If the initial rate is determined using
the same index or
[[Page 43254]]
formula used for subsequent rate adjustments, then the general rule
that disclosures must reflect the terms in effect at the time of
consummation applies under proposed Sec. 226.17(c)(1)(iii)(A). If the
initial rate is set using a different index or formula, however,
disclosures must reflect a composite APR under proposed Sec.
226.17(c)(1)(iii)(B). The composite APR would be based on the initial
rate for as long as it is charged and, for the remainder of the loan
term, the rate that would have applied if such index or formula had
been used at the time of consummation. Comments 17(c)(1)-10(i) through
(vi) would be revised to reflect that, under the proposed rule, for
transactions secured by real property or a dwelling, new terminology
would be used for specified disclosures (for example, the term
``interest and settlement charges'' would be used in place of ``finance
charge''), as discussed below. Comments 17(c)(1)-10(i) through (vi)
also would be redesignated as comments 17(c)(1)(iii)-3(i) through (vi);
no substantive change is intended. Finally, a cross-reference in
comment 24(c)-4 would be updated to reflect the redesignation of
comment 17(c)(1)-10.
Comment 17(c)(1)-11 provides that variable rate transactions
include the following transaction types, even if initially they feature
a fixed interest rate: balloon-payment loans where the creditor is
unconditionally obligated to renew, but can increase the interest rate
at the time of renewal; preferred-rate loans where the interest rate
may increase upon some future event; and price-level adjusted mortgages
that provide for periodic payment and loan balance adjustments. (But
see the discussion under proposed Sec. 226.19(b) on comment 19(b)-5,
which clarifies that creditors need not provide the disclosures
required by Sec. 226.19(b) for specified balloon-payment, preferred-
rate, and price-level adjusted mortgages.) As discussed below, proposed
Sec. 226.38(a)(3), which address disclosure of loan type for
transactions secured by real property or a dwelling, would treat each
of these transaction types as fixed-rate loans. As a result, comment
17(c)(1)-11 would be revised to clarify that balloon-payment,
preferred-rate, and price-level adjusted mortgages secured by real
property or a dwelling are considered fixed-rate transactions for the
purposes of the loan type disclosure required under proposed Sec.
226.38(a)(3). (See also the discussion under proposed Sec. 226.38(c),
which clarifies that the loan type attributed to transactions under
proposed Sec. 226.38(a)(3) applies for purposes of interest rate and
payment summary disclosures under proposed Sec. 226.38(c).)
Further, certain shared-equity or shared-appreciation mortgages are
considered variable-rate transactions under comment 17(c)(1)-11.
However, under the proposal, if a mortgage is secured by real property
or a dwelling, the mortgage would not be considered an adjustable-rate
loan solely because of a shared-equity or shared-appreciation feature.
As discussed under proposed Sec. Sec. 226.19(b)(2)(ii)(F) and
226.38(d)(2)(vi), the Board would require creditors to disclose shared-
equity or shared-appreciation as a loan feature for transactions
secured by real property or a dwelling. As a result, guidance in
comment 17(c)(1)-11 relating to shared-equity and shared-appreciation
mortgages would be deleted.
Comment 17(c)(1)-11 would be redesignated as comment 17(c)(1)(iii)-
4(i) through (iii), except that guidance under current comment
17(c)(1)-11 regarding graduated payment mortgages and step-rate
transactions without a variable-rate feature would be redesignated as
comment 17(c)(1)(iii)-5. A cross-reference to comment 17(c)(1)-11 in
comment 30-1 would be updated accordingly. Comment 17(c)(1)-12, which
addresses graduated-payment ARMs, would be redesignated as comment
17(c)(1)(iii)-6(i) through (iii); no substantive change is intended.
Current comment 17(c)(1)-13 states that creditors may base
disclosures for growth-equity mortgages (also referred to as ``payment-
escalated mortgages'') on estimated payment increases, using the best
information reasonably available, or may disclose by analogy to the
variable-rate disclosures in Sec. 226.18(f)(1). As discussed below,
current Sec. 226.18(f) contains disclosure requirements for variable-
rate transactions that differ based on a loan's security interest and
term. Under the proposed rule, Sec. 226.18(f) would be revised so that
a loan's security interest, not its term, would determine whether the
creditor would provide variable- or adjustable-rate disclosures.
Accordingly, under the proposal, the reference made in comment
17(c)(1)-13 to providing disclosures analogous to those under current
Sec. 226.18(f)(1) would be deleted, and comment 17(c)(1)-13 would be
revised to require creditors to base disclosures for growth-equity
mortgages using estimated payment increases. The reference to
graduated-payment mortgages would be removed for clarity. Comment
17(c)(1)-13 would be redesignated as comment 17(c)(1)(iii)-7.
17(c)(1)(iv) Reverse Mortgages
Comment 17(c)(1)-14 provides that if a reverse mortgage has a
specified period for disbursements but repayment is due only upon the
occurrence of a future event such as the death of the consumer, the
creditor must assume that repayment will occur when disbursements end.
The proposed rule would incorporate this commentary into the regulation
as proposed Sec. 226.17(c)(1)(vi). Comment 17(c)(1)-14 would be
revised to clarify that the disclosure requirements for reverse
mortgage under Sec. 226.33 apply only if the consumer's death is one
of the conditions of repayment, as provided under Sec. 226.33(a).
Comment 17(c)(1)-14 also would be revised by removing the discussion of
shared-equity and shared-appreciation features because under the
proposed rule transactions with such features would not be deemed
adjustable-rate loans solely because of such features, as discussed
above. Further, comment 17(c)(1)-14 would be revised to state that, if
a reverse mortgage has an adjustable interest rate and is secured by
real property or a dwelling, the creditor must disclose the shared-
equity or shared-appreciation feature as required under Sec. Sec.
226.19(b)(2)(ii)(F) and 226.38(d)(2)(vi). Finally, under the proposed
rule comment 17(c)(1)-14 would be redesignated as comment 17(c)(1)(iv)-
1(i) through (iii).
17(c)(1)(v) Tax Refund-Anticipation Loans
Comment 17(c)(1)-17 clarifies that if a consumer is required to
repay a tax refund-anticipation loan when the consumer receives a tax
refund, disclosures are to be based on the creditor's estimate of the
time the refund will be delivered. Comment 17(c)(1)-17 further
clarifies that the finance charge includes any repayment amount that
exceeds the loan amount that is not excluded from the finance charge
under Sec. 226.4. The proposed rule would incorporate this guidance
into the regulation as proposed Sec. 226.17(c)(1)(v). Comment
17(c)(1)-17 which would be redesignated as comments 17(c)(1)(v)-1(i)
and -1(ii) under the proposed rule. No substantive change is intended.
17(c)(1)(vi) Pawn Transactions
For pawn transactions, proposed Sec. 226.17(c)(1)(vi) would
require creditors to: (1) Disclose the initial sum provided to the
consumer as the amount financed; (2) include the difference between the
initial sum provided to the consumer and the price at which the
[[Page 43255]]
item is pledged or sold in the finance charge; and (3) determine the
APR using the redemption date as the end of the loan term. Proposed
Sec. 226.17(c)(1)(vi) is consistent with comment 17(c)(1)-18, which
would be redesignated as comment 17(c)(1)(vi)-1. No substantive change
is intended.
17(c)(2) Estimates
Under the proposal, Sec. 226.17(c)(2) would be revised to clarify
that proposed Sec. 226.19(a) would limit creditors' ability to provide
estimated disclosures for transactions secured by real property or a
dwelling. As discussed below, proposed Sec. 226.19(a) requires
creditors to provide disclosures that consumers must receive no later
than three business days before consummation and which may not be
estimated disclosures. Comments 17(c)(2)(i)-1 and 17(c)(2)(i)-2, which
address the basis and labeling of estimates, respectively, also would
be revised to reflect this limitation. In addition, comment
17(c)(2)(i)-3, which states that creditors may base all disclosures on
the assumption that consumers will make timely payments, would be
revised to clarify that creditors may also assume that consumers would
make payments in the amounts required by the terms of the legal
obligation. In technical revisions, a heading would be added to Sec.
226.17(c)(2) for clarity; no substantive change is intended.
17(c)(3) Disregarded Effects
In technical revisions, a heading would be added to Sec.
226.17(c)(3) for clarity, and guidance under current comment 17(c)(3)-1
would be redesignated as 17(c)(3)-1(i) and (ii). No substantive change
is intended.
17(c)(4) Disregarded Irregularities
Under the proposal, Sec. 226.17(c)(4) would be revised to clarify
that creditors may disregard period irregularities when disclosing the
payment summary table, as required under proposed Sec. 226.38(c), for
transactions secured by real property or a dwelling. No substantive
change to the treatment of period irregularities is intended.
In technical revisions, a heading would be added to Sec.
226.17(c)(4) for clarity. Also, comment 17(c)(4)-1 would be
redesignated as comment 17(c)(4)-1(i) and (ii), and comment 17(c)(4)-2
would be redesignated as comment 17(c)(4)-2(i) through (iii). No
substantive change is intended.
17(c)(5) Demand Obligations
Under the proposal, comment 17(c)(5)-1, which addresses demand
obligation disclosures, would be revised to reflect that proposed
Sec. Sec. 226.19(b)(2)(ii)(D) and 226.38(d)(2)(iv) contain
requirements for disclosing a demand feature in transactions secured by
real property or a dwelling. Comment 17(c)(5)-2, which addresses future
events such as the maturity date, would be revised to clarify that
certain disclosures for transactions not secured by real property or a
dwelling may not contain estimated disclosures, as discussed below
under proposed Sec. 226.19(a)(2). Comment 17(c)(5)-3, which addresses
demand after a stated period, would be revised to delete obsolete
references to specific loan programs and update cross-references.
Comment 17(c)(5)-4, which addresses balloon payment mortgages, would be
revised to reflect that creditors must disclose a payment summary table
for transactions secured by real property or a dwelling under proposed
Sec. 226.38(c) (rather than a payment schedule, as required for
transactions not secured by real property or a dwelling under Sec.
226.18(g)) and to update a cross-reference. In technical revisions, a
heading would be added to Sec. 226.17(c)(5) for clarity; no
substantive change is intended.
17(c)(6) Multiple Advance Loans
In technical revisions, a heading would be added to Sec.
226.17(c)(6) for clarity; no substantive change is intended.
17(d) Multiple Creditors; Multiple Consumers
Section 226.17(d) addresses transactions that involve multiple
creditors and consumers. The Board does not propose any changes to
these provisions, except that the guidance contained in current comment
17(d)-1 would be redesignated as comment 17(d)-1(i) through (iii); no
substantive change is intended.
17(e) Effect of Subsequent Events
Section 226.17(e) addresses whether a subsequent event makes a
disclosure inaccurate or requires a new disclosure. Under proposed
Sec. 226.20(e), if a creditor obtains insurance on behalf of the
consumer subsequent to consummation, the creditor would be required to
provide notice before charging for such insurance. The Board proposes
to revise comment 17(e)-1 to reflect this new requirement.
17(f) Early Disclosures
Under the proposal, in addition to providing early disclosures,
creditors would be required to provide additional disclosures that a
consumer must receive no later than three business days before
consummation for transactions secured by real property or a dwelling.
Accordingly, comments 17(f)-1 through -4 would be revised to clarify
that the special disclosure timing requirements under Sec.
226.19(a)(2) would apply to transactions secured by real property or a
dwelling. In technical revisions, guidance in current comment 17(f)-1
would be renumbered and headings revised to clarify that some of the
current guidance would not apply to transactions secured by real
property or a dwelling under the proposed rule.
17(g) Mail or Telephone Orders--Delay in Disclosures
Section 226.17(g) and comment 17(g)-1 permit creditors to delay
disclosures for transactions involving mail or telephone orders until
the first payment is due if certain information, such as the APR or
finance charge, is provided to the consumer in advance of any request.
As discussed under Sec. 226.19(a) and 226.20(c), the Board proposes
special timing requirements for disclosures for transactions secured by
real property or a dwelling and for adjustable rate transactions. As a
result, the Board proposes to revise Sec. 226.17(g) and comment 17(g)-
1 to clarify that they do not apply to transactions secured by real
property or a dwelling.
17(h) and 17(i) Series of Sales--Delay in Disclosures; Interim Student
Credit Extensions
Sections 226.17(h) and (i) address delay in disclosures in
transactions involving a series of sales and interim student credit
extensions. The Board does not propose any substantive changes to these
provisions. In technical revisions, a cross-reference is corrected.
Section 226.18 Content of Disclosures
As noted, the Board proposes to require creditors to provide new
disclosures for transactions secured by real property or a dwelling
under proposed Sec. 226.38. Accordingly, the Board would clarify under
Sec. 226.18 that creditors must provide the new disclosures under
Sec. 226.38 for transactions secured by real property or a dwelling.
In addition, the Board proposes conforming amendments to Sec. 226.18
and associated commentary to reflect the new disclosure regime for
mortgages, and would redesignate comments as appropriate.
18(a) Creditor
Currently, Sec. 226.18(a), which implements TILA Section
128(a)(1), requires disclosure of the identity of the creditor making
the disclosures. 15
[[Page 43256]]
U.S.C. 1638(a)(1). Comment 18(a)-1 states, in part, that this
disclosure may, at the creditor's option, appear apart from the other
required disclosures. As discussed above, currently, Sec. 226.17(a)(1)
footnote 38, which implements TILA Section 128(b)(1), allows creditors
to exclude from the grouped and segregated requirement certain required
disclosures, such as the creditor's identity. 15 U.S.C. 1638(b)(1).
However, the Board proposes to revise the substance of footnote 38 to
require the creditor's identity under Sec. 226.18(a) to be subject to
the grouped together and segregated requirement for all closed-end
credit disclosures. Thus, the Board proposes to revise comment 18(a)-1
to reflect this change.
18(b) Amount Financed
Section 226.18(b) addresses the disclosure and calculation of the
amount financed. The Board proposes to revise comment 18(b)-2, which
provides guidance regarding treatment of rebates and loan premiums for
the amount financed calculation required under Sec. 226.18(b). Comment
18(b)-2 primarily addresses credit sales, such as automobile financing,
and provides that creditors may choose whether to reflect creditor-paid
premiums and seller- or manufacturer-paid rebates in the disclosures
required under Sec. 226.18. The Board believes that creditor-paid
premiums and seller- or manufacturer-paid rebates are analogous to
buydowns. Like buydowns, such premiums and rebates may or may not be
funded by the creditor and reduce costs that otherwise would be borne
by the consumer. Accordingly, their impact on the amount financed, like
that of buydowns, properly depends on whether they are part of the
legal obligation. See comments 17(c)(1)-1 through -5. The Board is
proposing to revise comment 18(b)-2 to clarify that the disclosures,
including the amount financed, must reflect loan premiums and rebates
regardless of their source, but only if they are part of the terms of
the legal obligation between the creditor and the consumer. As
discussed below, proposed comment 38(e)(5)(iii)-2 would parallel this
approach for transactions secured by real property or a dwelling.
In addition, the Board proposes to revise comment 18(b)(2)-1, which
addresses amounts included in the amount financed calculation that are
not otherwise included in the finance charge, to remove reference to
real estate settlement charges for the reasons discussed more fully
under Sec. 226.4.
18(c) Itemization of Amount Financed
Section 226.18(c) requires a separate disclosure of the itemization
of amount financed and provides guidance on the amounts that must be
included in such itemization. As discussed below, the Board proposes
new Sec. 226.38(e)(5)(iii) to address the calculation and disclosure
requirements of the amount financed for transactions secured by real
property or a dwelling. Under the proposal, the substance of footnote
40, which permits creditors to substitute good faith estimates required
under RESPA for the itemization of the amount financed for dwelling-
secured transactions, would be moved to new Sec. 226.38(j)(1)(iii).
Comment 18(c)-2 affords creditors flexibility in the information
that may be included in the itemization of amount financed. Under the
proposal, the Board would revise comment 18(c)-2(i) to remove
references made to escrow items and to the commentary under Sec.
226.18(g) because the proposal renders them unnecessary, and 18(c)-
2(vi) to reflect a technical revision with no intended change in
substance or meaning. The Board also proposes to move comment 18(c)-4
regarding the exemption afforded to RESPA transactions, and
18(c)(1)(iv)-2 regarding prepaid mortgage insurance premiums to
proposed comments 38(j)(1)(iii)-1 and 38(j)(1)(i)(D)-2, respectively,
because they apply only to dwelling-secured transactions.
18(d) Finance Charge
Section 226.18(d) requires disclosure of the finance charge for
closed-end credit. As discussed below, the Board proposes new Sec.
226.38(e)(5)(ii) to address disclosure of the finance charge (renamed
``interest and settlement charges'') for transactions secured by real
property or a dwelling. As a result, reference to the finance charge
tolerances for mortgage loans would be moved from Sec. 226.18(d) to
proposed Sec. 226.38(e)(5)(ii); no substantive change is intended.
Technical amendments to comment 18(d)(2) would reflect this revision.
18(e) Annual Percentage Rate
Section 226.18(e) requires disclosure of the annual percentage
rate, using that term. The substance of footnote 42 would be moved to
the regulatory text of Sec. 226.18(e). Technical amendments to comment
18(e)-2 would reflect this revision; no substantive change is intended.
18(f) Variable Rate
Section 226.18(f)(1) contains disclosure requirements for variable-
rate transactions not secured by a consumer's principal dwelling and
variable-rate transactions secured by a consumer's principal dwelling
if the loan term is one year or less. Section 226.18(f)(1) requires
creditors to make the following disclosures within three business days
after receiving the consumer's application: (1) Circumstances under
which the APR may increase; (2) any limitations on the increase; (3)
the effect of an increase; and (4) an example of the payment terms that
would result from an increase. Section 226.18(f)(2) applies to
variable-rate transactions secured by a consumer's principal dwelling
with a loan term greater than one year, and requires creditors to
disclose that the loan has a variable-rate feature together with a
statement that variable-rate program disclosures (required by current
Sec. 226.19(b)) have been provided earlier.
The Board adopted Sec. 226.18(f)(2) in 1987, at the same time that
it adopted Sec. 226.19(b) (disclosures for variable-rate mortgages
with terms greater than one year). The Board adopted those provisions
based on recommendations by the Federal Financial Institutions
Examination Council (FFIEC). 52 FR 48665; Dec. 24, 1987. However, the
Board applied the requirements of those provisions only to loans
secured by a principal dwelling with a term greater than one year.
Loans secured by a principal dwelling with a term of one year or less,
and loans not secured by a principal dwelling remained subject to rules
in Sec. 226.18(f)(1). The Board did not apply the new variable-rate
loan disclosure requirements to such loans because public comments
expressed concern about potential compliance problems for creditors
making short-term loans. 52 FR at 48666.
Proposed Sec. Sec. 226.19(b) and 226.38(c) contain disclosure
requirements for closed-end adjustable-rate loans secured by real
property or a dwelling, and would apply the same rules to loans with a
term of one year or less as for loans with a term greater than one
year. Disclosures required by those provisions are discussed below. As
a result, Sec. 226.18(f)(2) and comment 18(f)(2)-1, which address
requirements and guidance for closed-end adjustable-rate loans secured
by real property or a dwelling, are unnecessary and would be deleted.
The substance of footnote 43, which permits creditors to substitute
information required under Sec. 226.18(f)(2) and 226.19(b) for the
disclosures required by Sec. 226.18(f)(1), would also be deleted.
Section 226.18(f)(1)(i) through (iv) would be redesignated as Sec.
226.18(f)(1) through
[[Page 43257]]
(4), and references in comment 18(f)-1 would be updated.
As discussed below, proposed Sec. Sec. 226.19(b)(3)(iii) and
226.38(d)(2)(iii) regarding disclosure of shared-equity or shared-
appreciation loan features would render guidance about shared-equity or
shared-appreciation mortgages in comment 18(f)-1 unnecessary, and
therefore that comment would be deleted. Comment 18(f)(1)-1 regarding
terms used in disclosures, and comment 18(f)(1)(i)-2 regarding
conversion features would be redesignated as comments 18(f)-2 and -3,
respectively. Finally, comments 18(f)(1)(i)-1, 18(f)(1)(ii)-1,
18(f)(1)(iii)-1, and 18(f)(1)(iv)-1 would be redesignated as comments
18(f)(1)-1, 18(f)(2)-1, 18(f)(3)-1, and 18(f)(4)-1, respectively.
18(g) Payment Schedule
Section 226.18(g) and associated commentary address the disclosure
of the payment schedule for all closed-end credit. As discussed under
proposed Sec. 226.38(c), the Board would require creditors to provide
disclosures regarding interest rates and monthly payments in a tabular
format for transactions secured by real property or a dwelling. As a
result, creditors would not need to comply with the disclosure
requirements of Sec. 226.18(g) for such transactions. However, as
discussed under proposed Sec. 226.38(e)(5)(i), creditors would be
required to disclose the number and total amount of payments that the
consumer would make over the full term of the loan for transactions
secured by real property or a dwelling. Proposed comment 18(e)(5)(i)-1
would require creditors to calculate the total payments following the
rules under Sec. 226.18(g) and associated commentary. As a result, the
Board proposes to revise comment 18(g)-3 to require creditors to
disclose the total number of payments for all payment levels as a
single figure for transactions secured by real property or a dwelling,
and to cross-reference proposed Sec. 226.38(e)(5)(i).
18(h) Total of Payments
In a technical revision, the substance of footnote 44 would be
moved to the regulation text of Sec. 226.18(e); technical amendments
to comment 18(h)-3 would reflect this revision.
18(i) Demand Feature
Section 226.18(i) and associated commentary address the following
for all closed-end credit: disclosure of a demand feature; the type of
demand features covered; and the relationship to payment schedule
disclosures. The Board does not propose any change to this provision,
except that comments 18(i)-2 and -3 would be updated to cross-reference
proposed Sec. Sec. 226.38(d)(2)(iv) and 226.38(c), which address the
disclosure requirements for a demand feature and payment schedule,
respectively, for transactions secured by real property or a dwelling.
No substantive change is intended.
18(k) Prepayment
Section 226.18(k)(1) provides that, when an obligation includes a
finance charge computed from time to time by application of a rate to
the unpaid principal balance, the creditor must disclose a statement
that indicates whether or not a penalty may be imposed if the
obligation is prepaid in full. Comment 18(k)(1)-1 provides examples of
charges considered penalties under Sec. 226.18(k)(1). One such example
is ``interest charges for any period after prepayment in full is
made.'' When the loan is prepaid in full, there is no balance to which
the creditor may apply the interest rate. Accordingly, the proposed
rule would revise this example for clarity; no substantive change is
intended. Proposed Sec. 226.38(a)(5) contains requirements for
disclosing prepayment penalties for transactions secured by real
property or a dwelling. As discussed below, commentary on proposed
Sec. 226.38(a)(5) is consistent with the commentary on Sec.
226.18(k), as proposed to be revised.
18(j) Through 18(m) Total Sale Price; Prepayment; Late Payment;
Security Interest
Sections 226.18(j), (k), (l), and (m) address, respectively,
disclosures regarding: total sale price; prepayment; late payment; and
security interest. The Board does not propose any changes to these
provisions, except for a minor technical amendment to comment 18(k)(1)-
1, as discussed above. However, as noted below, the Board proposes new
disclosure requirements under Sec. Sec. 226.38(a)(5) and
226.38(d)(1)(iii) regarding prepayment penalties, Sec. 226.38(j)(3)
regarding late payment, and Sec. 226.38(f)(2) regarding security
interest, for transactions secured by real property or a dwelling.
18(n) Insurance and Debt Cancellation
Section 226.18(n) requires disclosure of insurance and debt
cancellation in accordance with the requirements under Sec. 226.4(d)
to exclude such fees from the finance charge. For the reasons discussed
under Sec. 226.4(d), the Board proposes to revise Sec. 226.18(n) and
comment 18(n)-2 to clarify that this disclosure requirement also
applies to debt suspension policies.
18(o) and 18(p) Certain Security-Interest Charges; Contract Reference
Sections 226.18(o) and (p) address, respectively, disclosures
regarding certain security-interest charges and contract reference. The
Board does not propose any changes to these provisions. However, as
noted below, the Board would require creditors to provide parallel
contract references for transactions secured by real property or a
dwelling under proposed Sec. 226.38(j)(5). No parallel disclosure for
security-interest charges is proposed for transactions secured by real
property or a dwelling because such disclosures would not apply to
those transactions under the Board's proposed revisions to Sec. 226.4,
discussed above.
18(q) Assumption Policy
Section 226.18(q) and associated commentary require disclosure of
assumption policies for residential mortgage transactions. Under the
proposal, the Board proposes to move Sec. 226.18(q) and comments
18(q)-1 and -2 to proposed Sec. 226.38(j)(6) and comments 38(j)(6)-1
and -2, respectively, because assumption policies apply only to
transactions secured by real property or a dwelling. No substantive
change is intended.
18(r) Required Deposit
Section 226.18(r) addresses disclosure requirements when creditors
require consumers to maintain deposits as a condition to the specific
transaction. Footnote 45 provides additional guidance on such required
deposits and includes a reference to payments made under Morris Plans.
Although at least one Morris Plan bank remains active, Morris Plans
essentially are obsolete today. Accordingly, the Board proposes to move
the substance of footnote 45 to the regulation text but delete the
reference to Morris Plans. Comments 18(r)-1, -3, and -5 would also be
similarly revised. In addition, under the proposal, comment 18(r)-2 on
pledged-account mortgages would be moved to comment 38(i)-2 because it
applies only to transactions secured by real property. (See also
comment 17(c)(1)-15 on Morris Plans, which the Board proposes to delete
as unnecessary.) Comment 18(r)-6 would be redesignated as comment
18(r)-6(i) through (vii).
[[Page 43258]]
Section 226.19 Early Disclosures and Adjustable-Rate Disclosures for
Transactions Secured by Real Property or a Dwelling
Section 226.19(a) currently contains timing requirements for
providing disclosures for closed-end transactions secured by a dwelling
and subject to RESPA. Section 226.19(b) contains disclosure timing and
content requirements for variable-rate loans secured by a consumer's
principal dwelling. The Board proposes to revise Sec. 226.19(a) and
(b) to apply the disclosures to any closed-end transaction secured by
real property or a dwelling, for reasons discussed below. Section
226.19(a) also would be revised to require creditors to provide new
disclosures that a consumer must receive at least three business days
before consummation, in addition to the existing requirement to provide
early disclosures within three business days of application. The Board
also proposes to revise the content of disclosures for ARMs required
under Sec. 226.19(b), require new disclosures about risky loan
features in proposed Sec. 226.19(c), and to include existing rules
about disclosures provided through an intermediary agent or broker, or
by telephone or electronic communication, in proposed Sec. 226.19(d).
19(a) Good Faith Estimates of Mortgage Transaction Terms and New
Disclosures
TILA Section 128(b)(2), 15 U.S.C. 1638(b)(2), requires creditors to
mail or deliver to consumers good faith estimates of disclosures
required by TILA Section 128(a), 15 U.S.C. 1638(a) (early disclosures),
for a transaction secured by a dwelling and subject to RESPA. As
amended by the MDIA, TILA Section 128(b)(2) requires creditors to
deliver or mail the early disclosures at least seven business days
before consummation. Further, TILA Section 128(b)(2), as amended by the
MDIA, requires that the creditor provide corrected disclosures if the
disclosed APR changes in excess of a specified tolerance. The consumer
must receive the corrected disclosures no later than three business
days before consummation. The Board implemented these MDIA requirements
in Sec. 226.19(a) through a final rule effective July 30, 2009 (MDIA
Final Rule). 74 FR 23289; May 19, 2009.
The Board proposes to expand the coverage of Sec. 226.19(a) so
that the timing provisions would apply to closed-end mortgage
transactions secured by real property or a dwelling, and would not be
limited to RESPA-covered transactions. Thus, proposed Sec. 226.19(a)
would apply to transactions secured by real property that does not
include a dwelling, such as vacant land, and transactions that are not
subject to RESPA, such as construction loans.
The Board also proposes to revise Sec. 226.19(a) so that, in
addition to the early disclosures, the creditor must provide final
disclosures that the consumer must receive no later than three business
days before consummation. Under existing Sec. 226.19(a), by contrast,
a consumer must receive new disclosures at least three business days
before consummation only if changes to the previously disclosed APR
exceed a specified tolerance. The Board is proposing two alternative
provisions to address circumstances where terms change after the
consumer has received the final disclosures.
19(a)(1)(i) Time of Good Faith Estimates of Disclosures
TILA Section 128(b)(2), 15 U.S.C. 1638(b)(2), as amended by the
MDIA, requires creditors to provide early disclosures if a transaction
is secured by a dwelling and subject to RESPA. However, TILA's early
disclosure requirements do not apply to mortgage transactions for
personal, family, or household purposes if they are secured by real
property that is not a dwelling, for example a consumer's business
property. Creditors need not provide early disclosures for transactions
secured by property of 25 acres or more, temporary financing (such as a
construction loan), or transactions secured by vacant land because
RESPA does not apply to such transactions. 24 CFR 3500.5(b)(1), (3),
and (4).
The Board proposes to expand Sec. 226.19(a) to cover transactions
secured by real property, even if the property is not a dwelling and
even if the transaction is not subject to RESPA. (Transactions secured
by a consumer's interest in a timeshare plan would be treated
differently, as discussed under Sec. 226.19(a)(5) below.) Under TILA
Section 128(b)(2), 15 U.S.C. 1638(b)(2), if the transaction is not
secured by a dwelling, or is not covered by RESPA, the creditor is only
required to provide disclosures before consummation. The Board proposes
to require creditors to provide early disclosures under TILA for all
closed-end transactions secured by real property or a dwelling to
facilitate compliance.
Section 226.18 currently contains requirements for the content of
transaction-specific disclosures secured by real property or a
dwelling, whether or not creditors are required to provide that content
in early disclosures. Although under the proposed rule Sec. 226.38
rather than Sec. 226.18 would contain requirements for disclosure
content for transactions secured by real property or a dwelling, the
content required in early disclosures is the same as the content of
disclosures provided in cases where early disclosures are not required.
Applying the requirement to provide early disclosures to all
transactions secured by real property or a dwelling would simplify
creditors' determination of the time by which creditors must make the
disclosures required by Sec. 226.38. The Board requests comment about
operational or other issues involved in providing early disclosures for
temporary loans, however. The Board also solicits comment on whether
there are other types of loans exempt from RESPA to which it is not
appropriate to apply proposed Sec. 226.19(a).
Proposed new comment 19-1 states that proposed Sec. 226.19 applies
to transactions secured by real property or a dwelling even if such
transactions are not subject to RESPA. The proposed comment clarifies
that TILA does not apply to transactions that are primarily for
business, commercial, or agricultural purposes, however. (Proposed
comment 19-1 addresses the introductory text to proposed Sec. 226.19,
which provides that all of Sec. 226.19, not only Sec. 226.19(a),
applies to closed-end transactions secured by real property or a
dwelling.)
Comment 19(a)(1)(i)-1, which discusses the coverage of Sec.
226.19(a), would be removed because proposed comment 19-1 would discuss
the coverage of all of proposed Sec. 226.19. Comment 19(a)(1)(i)-2
would be revised to clarify that under the proposed rule disclosures
required by proposed Sec. 226.19(a)(2) may not contain estimated
disclosures, with limited exceptions. The comment also would be revised
to reflect that proposed Sec. 226.37 contains requirements for
disclosure of estimates and contingencies, as discussed below. Comment
19(a)(1)(i)-3 would be revised to reflect that creditors may rely on
RESPA and Regulation X to determine when an application is received,
even for transactions not subject to RESPA. Comment 19(a)(1)(i)-5 would
be revised to refer to the itemization of the amount financed
disclosures in proposed Sec. 226.38(j) rather than in Sec. 226.18(c),
as currently referenced. Finally, comments 19(a)(1)(i)-2 through -5
would be redesignated as comments 19(a)(1)(i)-1 through -4.
19(a)(1)(ii) Imposition of Fees
On July 30, 2008, the Board published the 2008 HOEPA Final Rule
amending Regulation Z, which implements TILA
[[Page 43259]]
and HOEPA. The July 2008 final rule requires creditors to give
transaction-specific cost disclosures no later than three business days
after receiving a consumer's application, for closed-end mortgage
transactions secured by a consumer's principal dwelling, under Sec.
226.19(a)(1)(i). Further, the 2008 HOEPA Final Rule prohibits creditors
and other persons from imposing a fee on the consumer, other than a fee
for obtaining the consumer's credit history, before the consumer
receives the early disclosures, under Sec. 226.19(a)(1)(ii) and (iii).
Section 226.19(a)(1)(ii) provides that if the early disclosures are
mailed to the consumer, the consumer is considered to have received
them three business days after they are mailed. 73 FR 44522, 44600-
44601.
The proposed rule would revise Sec. 226.19(a)(1)(ii) to conform to
the presumption of receipt provision the Board subsequently adopted in
the MDIA Final Rule in Sec. 226.19(a)(2)(ii).\40\ Under the proposed
rule Sec. 226.19(a)(1)(ii) would be revised to provide that if the
early disclosures are mailed to the consumer or delivered to the
consumer by means other than delivery in person, the consumer is deemed
to have received the corrected disclosures three business days after
they are mailed or delivered. This is consistent with comment
19(a)(1)(ii)-1, which provides that creditors may impose a fee any time
after midnight following the third business day after the creditor
delivers or mails the early disclosures in all cases, regardless of the
method the creditor uses to provide the early disclosures. The Board
does not intend to make substantive changes by conforming the
presumption of receipt provisions under Sec. Sec. 226.19(a)(1)(ii) and
226.19(a)(2)(ii).
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\40\ On the same day the July 2008 final rule was published, the
Congress passed the MDIA. Under the MDIA, if the APR stated in the
early disclosures changes in excess of a specified tolerance, the
creditor must provide corrected disclosures that the consumer must
receive no later than three business days before consummation. The
MDIA provides that if the creditor mails the corrected disclosures,
the consumer is considered to have received them three business days
after they are mailed. These early disclosure rules are contained in
TILA Section 128(b)(2)(E) (to be codified at 15 U.S.C.
1638(b)(2)(E)). Section 226.19(a)(2)(ii) implements these rules.
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The Board also proposes to revise comment 19(a)(1)(ii)-1 to clarify
that the three-business-day presumption of receipt applies in all
cases, including where a creditor uses electronic mail or a courier to
provide the early disclosures. Proposed comment 19(a)(1)(ii)-1 provides
that creditors that use electronic mail or a courier other than the
postal service may use the three-business-day presumption of receipt.
This comment is consistent with existing comment 19(a)(2)(ii)-3 adopted
through the MDIA Final Rule. (Comment 19(a)(2)(ii)-3 would be
redesignated as comment 19(a)(2)(v)-1 and conforming edits would be
made in connection with the proposed requirement that creditors provide
final disclosures that the consumer must receive no later than three
business days before consummation, as discussed below.)
An additional change would be made to comment 19(a)(1)(ii)-1 under
the proposed rule. Currently, comment 19(a)(1)(ii)-1 provides that if
the creditor places the early disclosures in the mail, the creditor may
impose a fee in all cases ``after midnight on the third business day
following mailing of the disclosures.'' The Board recognizes that the
phrase ``after midnight on the third business day'' may be construed to
mean either that the creditor may impose a fee at the beginning of the
third business day after the creditor receives the consumer's
application, or at the beginning of the fourth business day after the
creditor receives the consumer's application. Thus, the Board proposes
to revise comment 19(a)(1)(ii)-1 to provide that the creditor may
impose a fee after the consumer receives the early disclosures or, in
all cases, after midnight following the third business day after
mailing the early disclosures. For example, proposed comment
19(a)(1)(ii)-1 provides that (assuming that there are no intervening
legal public holidays) a creditor that receives the consumer's written
application on Monday and mails the early mortgage loan disclosure on
Tuesday may impose a fee on the consumer on Saturday.
19(a)(2)(ii) Three-Business-Day Waiting Period
Under Sec. 226.19(a), as revised by the MDIA Final Rule, if
changes to the APR disclosed for a closed-end transaction secured by a
dwelling and subject to RESPA exceed a specified tolerance, creditors
must provide corrected disclosures. The consumer must receive the
corrected disclosures no later than three business days before
consummation. The tolerance specified for closed-end ``regular
transactions'' (those that do not involve multiple advances, irregular
payment periods, or irregular payment amounts) is \1/8\ of 1 percentage
point and for closed-end ``irregular transactions'' (those that involve
multiple advances, irregular payment periods, or irregular payment
amounts, such as an ARM with a discounted initial interest rate) is \1/
4\ of 1 percentage point. See Sec. 226.22(a) and footnote 46; comment
17(c)(1)-10(iv).
Currently, if an APR stated in early disclosures for a closed-end
transaction not subject to Sec. 226.19(a) remains accurate but other
terms that were not labeled as estimates change, the creditor must
disclose those changed terms before consummation under Sec. 226.17(f).
Creditors also must provide corrected disclosures if a variable-rate
feature is added to a closed-end transaction under Sec. 226.17(f),
whether or not the transaction is subject to Sec. 226.19(a). See
comment 17(f)-2. In practice, most creditors provide ``final''
disclosures to a consumer on the day of consummation, whether or not
the loan terms stated in the early disclosures have changed.
Under the proposed rule, after providing early disclosures for a
closed-end transaction secured by real property or a dwelling,
creditors would provide a second set of disclosures in all cases, under
Sec. 226.19(a)(2)(ii). The consumer would have to receive these final
disclosures no later than three business days before consummation.
Proposed Sec. 226.19(a)(2)(ii) is designed to address long-standing
concerns that consumers may find out about different loan terms or
increased settlement costs only at consummation. Members of the Board's
Consumer Advisory Council and commenters on prior Board rulemakings
have expressed concern about consumers not learning of changes to
credit terms until consummation. Further, several participants in the
Board's consumer testing stated that they had been surprised at closing
by important changes in loan terms. For example, some participants said
that they had been told at closing that a loan would have an adjustable
rate even though previously they had been told they would receive a
fixed-rate loan. Participants said that they closed despite unfavorable
changes in loan terms because they lacked alternatives, especially in
the case of a loan financing a home purchase. Some participants stated
that they accepted changed terms because the loan originator advised
them that they could easily obtain a refinance loan with better terms
in the near future.
Terms or costs may change after early disclosures are given for a
variety of reasons, including that the consumer did not lock the
interest rate at application or an appraisal report developed after
early disclosures are provided shows a different property value than
the creditor assumed when providing the early disclosure. Regardless of
the reason for the changed terms, a consumer who receives notice
[[Page 43260]]
of changed loan terms at consummation that differ from those originally
disclosed does not have a meaningful opportunity to make an informed
credit decision.
To address concerns about changes to loan terms, proposed Sec.
226.19(a)(2)(ii) requires creditors to provide final disclosures that a
consumer would have to receive no later than the third business day
before consummation. Under proposed Sec. 226.38(a)(4), the early
disclosures and final disclosures would contain total estimated
settlement costs disclosed under RESPA and HUD's Regulation X, which
implements RESPA. Regulation X permits final settlement charges to be
disclosed at consummation; the consumer may request that final
settlement charges be disclosed twenty-four hours in advance, however.
24 CFR 3500.10(a) and (b). Thus, under RESPA, creditors, settlement
agents, and settlement service providers have until the day of
consummation to determine the amounts of the various settlement costs.
Effective January 1, 2010, Regulation X provides that the sum of most
lender-required third party settlement costs may vary no more than 10
percent from the same costs disclosed on the good faith estimate (GFE)
delivered earlier. Certain other changes, such as the lender's
origination fee, cannot vary, unless the consumer did not lock the
interest rate.
The Board believes that proposed Sec. 226.19(a)(2) would not
conflict with tolerance and timing rules under Regulation X--that is,
creditors could comply with both Regulation Z and Regulation X.
However, the Board's proposal would require creditors to finalize
settlement costs earlier than RESPA does: At least three business days
before consummation, and as much as a week before consummation if the
creditor mails the disclosures to the consumer.\41\ The Board
recognizes that requiring that loan terms and costs be finalized
several days before consummation would require significant changes to
current settlement practices. These changes would generate costs that
creditors and third-party service providers would pass on to consumers.
The Board solicits comment on the operational and other practical
effects of requiring that consumers receive final TILA disclosures for
closed-end loans secured by real property or a dwelling no later than
three business days before consummation.
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\41\ Under existing and proposed Sec. 226.19(a)(2), a consumer
is deemed to receive corrected disclosures three business days after
a creditor mails them. Under existing and proposed Sec.
226.19(a)(2), creditors may but need not rely on the presumption of
receipt to determine when the three-business-day waiting period
begins, whether creditors mail TILA disclosures using the postal
service, use a courier other than the postal service, or provide
disclosures electronically. Alternatively, creditors may rely on
evidence of receipt. 74 FR at 23293; 73 FR 44522, 44593; July 30,
2008.
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Proposed comment 19(a)(2)(ii)-1 provides that creditors must
provide final disclosures even if the terms disclosed have not changed
since the creditor provided the early disclosures. Proposed comment
19(a)(2)(ii)-2 provides that disclosures made under Sec.
226.19(a)(2)(ii) must contain each of the applicable disclosures
required by Sec. 226.38.
If escrows for taxes and insurance will be required, creditors may
disclose periodic payments of taxes and insurance as estimates under
Sec. 226.38(c). If the creditor includes escrowed amounts when
calculating the total of payments under Sec. 226.38(e)(5)(i), then the
total of payments also would be disclosed as estimated disclosures, as
discussed in comment 38(e)(5)-1. Periodic payment disclosures that
include escrowed amounts must be estimated disclosures because the
creditor cannot know with certainty the amounts for property taxes and
insurance after the first year of the loan. Proposed comment
19(a)(2)(ii)-3 clarifies that other disclosures may not be estimated
under proposed Sec. 226.19(a)(2)(ii). Finally, comment 19(a)(2)(ii)-4
provides an example that illustrates when consummation may occur after
the consumer receives the final disclosures.
19(a)(2)(iii) Additional Three-Business-Day Waiting Period
The Board is proposing two alternative requirements for creditors
to provide corrected disclosures after making the final disclosures
required by Sec. 226.19(a)(2)(ii), to be designated as Sec.
226.19(a)(2)(iii). Consumers would have to receive the corrected
disclosures required by proposed Sec. 226.19(a)(2)(iii) no later than
the third business day before consummation. Under both Alternative 1
and Alternative 2, comment 19(a)(2)-2 would be revised to reflect that
there is more than one three-business-day waiting period under Sec.
226.19(a).
Alternative 1. The first alternative would require that a creditor
provide corrected disclosures if any terms stated in the final
disclosures required by proposed Sec. 226.19(a)(2)(ii) change. This
would ensure that consumers are aware of the final loan terms and costs
at least three business days before consummation. The consumer would
have to receive the corrected disclosures no later than the third
business day before consummation.
Under Alternative 1, proposed comment 19(a)(2)(iii)-1 clarifies
that a disclosed APR is accurate for purposes of Sec.
226.19(a)(2)(iii) if the disclosure is accurate under proposed Sec.
226.19(a)(2)(iv). (Under proposed Sec. 226.19(a)(2)(iv), an APR
disclosed under proposed Sec. 226.19(a)(2)(ii) or (iii) is considered
accurate as provided by Sec. 226.22, except that in certain
circumstances the APR is considered accurate if the APR decreases from
the APR disclosed previously, as discussed below.) Proposed comment
19(a)(2)(iii)-2 states that disclosures made under Sec.
226.19(a)(2)(ii) must contain each of the disclosures required by Sec.
226.38. Proposed comment 19(a)(2)(iii)-3 clarifies that creditors may
rely on proposed comment 19(a)(2)(ii)-3 in determining which of the
disclosures required by Sec. 226.19(a)(2)(iii) may be estimated
disclosures. Proposed comment 19(a)(2)(iii)-4 provides an example that
shows when consummation may occur after the consumer receives corrected
disclosures. Existing comments 19(a)(2)(ii)-1 through -4 would be
removed under Alternative 1.
Alternative 2. It is not clear that it is always in a consumer's
interest to delay consummation until three business days after the
consumer receives corrected disclosures if any terms or costs change.
Thus, the Board proposes an alternative Sec. 226.19(a)(2)(iii) that
incorporates the existing tolerance for APR changes under Sec. 226.22
and incorporates an additional tolerance discussed under Sec.
226.19(a)(iv). If the APR changes beyond the specified tolerances,
creditors would be required to provide corrected disclosures that the
consumer must receive no later than three business days before
consummation.
Under the second alternative, after the creditor provides the final
disclosures, only APR changes beyond the specified tolerances or the
addition of a variable-rate feature to the loan would trigger a
requirement that consumers receive corrected disclosures no later than
three business days before consummation. In other cases, the creditor
would have to disclose changed terms no later than the day of
consummation, under existing Sec. 226.17(f). Under this alternative, a
consumer would be alerted to significant increases in loan costs and
would have three business days to investigate the reason for the change
or to consider other options. Smaller APR increases or other changes to
loan terms would not trigger a three-day delay in consummation,
however. This alternative is designed to prevent
[[Page 43261]]
relatively minor changes in loan terms from repeatedly delaying
consummation.
Under Alternative 2, comment 19(a)(2)(ii)-1 would be redesignated
as comment 19(a)(2)(iii)-1 and revised to clarify that creditors must
provide corrected disclosures if the APR disclosed pursuant to Sec.
226.19(a)(ii) becomes inaccurate under proposed Sec. 226.19(a)(2)(iv),
which incorporates existing tolerances under Sec. 226.22, or an
adjustable-rate feature is added. Comment 19(a)(2)(ii)-2 would be
redesignated as comment 19(a)(2)(iii)-2 and revised to: (1) Reflect
that corrected disclosures must comply with the format requirements of
proposed Sec. 226.37 as well as those of Sec. 226.17(a); (2) reflect
that a different APR will almost always result in changes in ``interest
and settlement charges'' and the ``payment summary'' (currently
designated as the finance charge and payment schedule, respectively);
(3) clarify that the addition of an adjustable-rate feature triggers
the requirement to provide corrected disclosures, by moving a cross-
reference to comment 17(f)-2; and (4) remove guidance on the timing and
conditions of new disclosures from guidance on disclosure content, for
clarity. Proposed comment 19(a)(2)(iii)-3 clarifies that creditors may
rely on proposed comment 19(a)(2)(ii)-3 in determining which of the
disclosures required by Sec. 226.19(a)(2)(iii) creditors may estimate.
Under the proposed rule, comment 19(a)(2)(iii)-4 would be revised to
update a cross-reference consistent with the proposed rule and reflect
that consumers must receive disclosures under Sec. 226.19(a)(2)(ii)
whether or not the disclosures correct the early disclosures.
The Board solicits comment on whether, under Alternative 2, changes
other than APR changes in excess of the specified tolerance or the
addition of an adjustable-rate feature after the creditor makes the new
disclosures should trigger an additional three-business-day waiting
period. For example, should the addition of a prepayment penalty,
negative amortization, interest-only, or balloon payment feature
trigger a waiting period requirement?
Proposed Sec. 226.19(a)(2)(iii) (under Alternative 2) would
require corrected disclosures and a new three-business-day waiting
period if the previously disclosed APR has become inaccurate. Under
current rules, a disclosed APR is considered accurate and does not
trigger corrected disclosures if it results from a disclosed finance
charge that is greater than the finance charge required to be disclosed
(i.e., the finance charge is ``overstated''). See Sec. Sec.
226.22(a)(4) and 226.18(d)(1)(ii). In some transactions, the finance
charge at consummation might be lower than the amount previously
disclosed, for example, if the parties agree to a smaller principal
loan amount after early disclosures were made. In the same transaction,
the APR might increase because of an increase in the interest rate
after the early disclosures were made. In this transaction, at
consummation the previously disclosed finance charge would be
overstated and the previously disclosed APR understated. In such a
case, the question has been raised as to whether the previously
disclosed APR, which was derived from the overstated finance charge,
should be deemed accurate even though it is understated at
consummation. The Board believes the APR in this case is not accurate.
The Board believes an APR ``results from'' an overstated finance charge
only if the APR also is overstated. The Board solicits comment on
whether, should Alternative 2 be adopted, the Board also should adopt
commentary under Sec. 226.22(a)(4) to clarify this interpretation.
Proposed Sec. 226.19(a)(2)(iv) contains APR tolerances, and
proposed Sec. 226.38(e)(5)(ii) contains tolerances for interest and
settlement charges (as the finance charge would be referred to under
the proposed rule), for transactions secured by real property or a
dwelling. The Board solicits comment on whether, under Sec.
226.38(e)(5)(ii), tolerances would be appropriate for numerical
disclosures other than the APR and interest and settlement charges. For
example, would dollar tolerances for overstatements of periodic payment
disclosures required by Sec. 226.38(c) be appropriate? What standards
should be used to prevent overstated disclosures from undermining the
integrity of the early disclosures and their usefulness as a shopping
tool?
19(a)(2)(iv) Annual Percentage Rate Accuracy
Under proposed Sec. 226.19(a)(2)(iv), an APR disclosed under
proposed Sec. 226.19(a)(2)(ii) or (iii) is considered accurate as
provided by Sec. 226.22, except that the APR also is considered
accurate if the APR decreases due to a discount (1) the creditor gives
the consumer to induce periodic payments by automated debit from a
consumer's deposit account or (2) the title insurer gives the consumer
on owner's title insurance. Thus, such APR changes would not trigger a
new three-business-day waiting period. Comment 19(a)(2)(iv)-1 clarifies
that if a change occurs that does not render the APR inaccurate under
Sec. 226.19(a)(iv), the creditor must disclose the changed terms
before consummation, consistent with Sec. 226.17(f). The Board
solicits comment on whether a disclosed APR that is higher than the
actual APR at consummation should be considered accurate in other
circumstances.
19(a)(2)(v) Timing of Receipt
As adopted by the MDIA Final Rule, Sec. 226.19(a)(2)(ii) provides
that consumers must receive corrected disclosures, if required, no
later than three business days before consummation. Further, Sec.
226.19(a)(2)(ii) provides that if the corrected disclosures are mailed
to the consumer or delivered to the consumer by means other than
delivery in person, the consumer is deemed to have received the
disclosures three business days after they are mailed or delivered. The
proposed rule applies this presumption for purposes of both the waiting
period under proposed Sec. 226.19(a)(2)(ii) and the waiting period
under proposed Sec. 226.19(a)(2)(iii). The presumption would be moved
to Sec. 226.19(a)(2)(v) under the proposed rule.
Proposed comment 19(a)(2)(v)-1 states that whether the creditor
provides disclosures by delivery, postal service, electronic mail, or
courier other than the postal service, consumers are deemed to receive
the disclosures three business days after the creditor so provides
them, for purposes of determining when a three-business-day waiting
period required by Sec. 226.19(a)(2)(ii) or (iii) begins. Further,
proposed comment 19(a)(2)(v)-1 clarifies that creditors may rely on
evidence of earlier receipt, regardless of how the creditor provides
disclosures to the consumer. This commentary is consistent with the
Board's discussion of delivery and mailing under the MDIA Final Rule
and the 2008 HOEPA Final Rule. See 74 FR at 23292-23293; 73 FR at
44593.
19(a)(3) Consumer's Waiver of Waiting Period
Section 226.19(a)(3) and comment 19(a)(3)-1 would be revised to
reflect that under the proposed rule the disclosures required for
transactions secured by real property or a dwelling are contained in
Sec. 226.38 rather than in Sec. 226.18. Section 226.19(a)(3) also
would be revised to reflect that there is more than one three-business-
day waiting period under proposed Sec. 226.19(a)(2); comment 19(a)(3)-
1 would be revised to clarify that a separate waiver is required for
each waiting period to be waived.
[[Page 43262]]
Section 226.19(a)(2)(ii) currently requires creditors to provide
corrected disclosures to a consumer if changes to the disclosed APR
exceed the specified tolerance (APR correction disclosures). The
consumer must receive APR correction disclosures no later than three
business days before consummation. Comment 19(a)(3)-2 provides examples
that show whether or not the three-business-day waiting period would
need to be waived to allow consummation to occur during the seven-
business-day waiting period required by Sec. 226.19(a)(2)(i), in the
event of a bona fide personal financial emergency. This example would
be removed because proposed Sec. 226.19(a)(2)(ii) provides that, after
the creditor provides the early disclosures, consumers must receive
final disclosures no later than three business days before consummation
in all cases. Comment 19(a)(3)-3 provides examples illustrating whether
or not, after the seven-business-day waiting period required by Sec.
226.19(a)(2)(i), the three-business-day waiting period triggered by APR
correction disclosures would need to be waived to allow consummation to
occur, in the event of a bona fide personal financial emergency.
Comment 19(a)(3)-3 would be revised to reflect that in all cases
consumers would have to receive final disclosures after the creditor
provides the early disclosures under the proposed rule and that under
proposed Sec. 226.19(a)(2)(iv) a disclosed APR that is overstated is
considered accurate in specified circumstances. Comment 19(a)(3)-3
would be redesignated as comment 19(a)(3)-2 under the proposed rule.
19(a)(4) Notice
Section 226.19(a)(4) currently requires creditors to disclose that
a consumer need not enter into a loan agreement because the consumer
has received disclosures or signed a loan application. This requirement
would be moved to Sec. 226.38(f)(1) under the proposed rule. Proposed
Sec. 226.38 contains all content requirements for disclosures for
transactions secured by real property or a dwelling.
19(a)(5) Timeshare Transactions
Section 226.19(a)(5) excludes transactions secured by a consumer's
interest in a timeshare plan described in 11 U.S.C. 101(53(D))
(timeshare transactions) from Sec. 226.19(a)(1) through (a)(4), which
address the following: (1) The period within which the creditor must
provide the early disclosures and the fact that creditors and other
persons cannot collect fees from the consumer before the consumer
receives the early disclosures; (2) waiting periods after the creditor
provides the early disclosures and after the consumer receives
corrected disclosures (if any) and before consummation; (3) waiver of
waiting periods; and (4) the requirement to disclose a statement that
the consumer is not required to consummate a transaction merely because
the consumer has received disclosures or signed a loan application.
Section 226.19(a)(5)(ii) contains timing requirements for early
disclosures, and Sec. 226.19(a)(5)(iii) contains timing requirements
for corrected disclosures, for timeshare transactions. Waiting periods
are not required for timeshare transactions, so Sec. 226.19(a)(5) does
not contain requirements similar to the requirements in Sec.
226.19(a)(3) for waiving waiting periods for non-timeshare
transactions. Section 226.19(a)(5) also does not contain a requirement
similar to that in Sec. 226.19(a)(4) that disclosures contain a
statement that a consumer need not consummate a transaction simply
because the consumer receives disclosures or signs a loan application.
Section 226.19(a)(4) would be removed under the proposed rule, and a
substantially similar requirement would apply under proposed Sec.
226.38(f)(1). Proposed Sec. 226.38(f)(1) requires creditors to
disclose a statement that a consumer is not obligated to consummate a
loan and that the consumer's signature only confirms receipt of a
disclosure statement.
Proposed Sec. 226.38(f)(1) applies to timeshare transactions. The
MDIA exempts timeshare transactions from the requirements of TILA
Section 128(b)(2)(C), which existing Sec. 226.19(a)(4) implements.
However, the Board does not believe that the Congress intended to
exempt timeshare transactions from any requirement to disclose to a
consumer that the consumer is not obligated to consummate a loan. Thus,
the proposed rule does not exempt timeshare transactions from Sec.
226.38(f)(1).
Section 226.19(a)(5) would be redesignated as Sec. 226.19(a)(4)
and cross-references adjusted accordingly under the proposed rule
because Sec. 226.19(a)(4) would be removed, as discussed above.
Comment 19(a)(5)(ii)-1 would be revised to reflect that the coverage of
Sec. 226.19 has been expanded to include transactions not subject to
RESPA, as discussed above. Comment 19(a)(5)(iii)-1 would be revised to
clarify that timeshare transactions are subject to the general
requirement to disclose changed terms under Sec. 226.17(f). Further,
comment 19(a)(5)(iii)-1 would be revised to reflect that cross-
referenced commentary on variable- or adjustable- rate transactions
would be incorporated into proposed Sec. 226.17(c)(1)(iii). Finally,
commentary on Sec. 226.19(a)(5)(ii) and (iii) would be redesignated as
commentary on Sec. 226.19(a)(4)(ii) and (iii), respectively.
19(b) Adjustable-Rate Loan Program Disclosures
Section 226.19(b) currently requires creditors to provide detailed
disclosures about adjustable-rate loan programs and a CHARM booklet if
a consumer expresses an interest in ARMs. Section 226.19(b) applies to
closed-end transactions secured by a consumer's principal dwelling with
a term greater than one year. Creditors must provide these disclosures
at the time an application form is provided or before the consumer pays
a non-refundable fee, whichever is earlier. Creditors need not provide
these disclosures, however, if a loan is secured by a dwelling other
than a principal dwelling (such as a second home) or real property that
is not a dwelling (such as vacant land) or with a term of one year or
less. For such transactions, creditors instead must provide the less
detailed variable-rate disclosures required by Sec. 226.18(f)(1)
within three business days after receiving the consumer's application,
as discussed above.
The Board proposes to require creditors to provide ARM loan program
disclosures, and additional disclosures discussed below, at the time an
application form is provided, for all closed-end transactions secured
by real property or a dwelling, regardless of the length of the loan's
term. The ARM disclosures and the new disclosures are intended to alert
consumers to certain risks before they apply for a loan. The Board
believes that consumers should receive this information, even where the
loan would be secured by a second home or unimproved real property, and
where the loan term is one year or less. In these circumstances, the
transaction likely involves a significant asset and consumers should
receive information about risks, so that they can decide whether the
program or loan feature is appropriate. The Board solicits comment on
whether loan program disclosures should be given at the time an
application form is provided to a consumer or before the consumer pays
a non-refundable fee, whichever is earlier, for transactions other than
ARMs.
The Board proposes to require creditors to provide the following
disclosures at the time an application is provided:
[[Page 43263]]
The ARM loan program disclosure, for each program in which
the consumer expresses an interest (proposed Sec. 226.19(b));
The ``Key Questions about Risk'' document published by the
Board (proposed Sec. 226.19(c)); and
The ``Fixed vs. Adjustable-Rate Mortgages'' document
published by the Board (proposed Sec. 226.19(c)).
Creditors no longer would be required to provide the CHARM booklet,
as discussed under Sec. 226.19(c).
Current content of ARM loan program disclosures. For adjustable-
rate mortgage transactions secured by a consumer's principal dwelling
with a term greater than one year, Sec. 226.19(b)(2) requires the
creditor to provide disclosures to consumers at the time an application
form is provided or before the consumer pays a nonrefundable fee,
whichever is earlier. Section 226.19(b)(2) requires creditors to
provide the following disclosures, as applicable, for each adjustable-
rate loan program in which the consumer expresses an interest: (1) The
fact that interest rate, payment, or term of the loan can change, (2)
the index or formula used in making adjustments, and a source of
information about the index or formula, (3) an explanation of how the
interest rate and payment will be determined, including an explanation
of how the index is adjusted, such as by the addition of a margin, (4)
a statement that the consumer should ask about the current margin value
and current interest rate, (5) the fact that the interest rate will be
discounted, and a statement that the consumer should ask about the
amount of the interest rate discount, (6) the frequency of interest
rate and payment changes, (7) any rules relating to changes in the
index, interest rate, payment amount, and outstanding loan balance, (8)
pursuant to TILA Section 128(a)(14), 15 U.S.C. 1638(a)(14), either (a)
an historical example based on a $10,000 loan amount that illustrates
how interest rate changes implemented according to the terms of the
loan program would have affected payments and the loan balance over the
past fifteen years or (b) the maximum interest rate and payment for a
$10,000 loan originated at an initial interest rate in effect as of an
identified month and year and a statement that the periodic payments
may increase or decrease substantially, (9) an explanation of how the
consumer may calculate the payments for the loan, (10) the fact that
the loan program contains a demand feature, (11) the type of
information that will be provided in notices of adjustments and the
timing of such notices, and (12) a statement that the disclosure forms
are available for the creditor's other variable-rate loan programs.
Amendments to maximum rate and historical example disclosures. TILA
Section 128(a)(14), 15 U.S.C. 1638(a)(14), requires creditors to
disclose at application (a) a statement that the periodic payments may
increase or decrease substantially and the maximum interest rate and
payment for a $10,000 loan originated at a recent interest rate,
assuming the maximum periodic increases in rates and payments under the
program or (b) an historical example illustrating the effects of
interest rate changes implemented according to the loan program.
Section 226.19(b)(2)(viii) implements TILA Section 128(a)(14). For the
reasons discussed below, the Board proposes not to require creditors to
provide either the historical example or the maximum interest rate and
payment based on a $10,000 loan.
The Board proposes to eliminate the disclosure of the historical
example or the maximum interest rate and payment based on a $10,000
loan pursuant to the Board's exception and exemption authorities in
TILA Section 105. Section 105(a) authorizes the Board to make
exceptions to TILA to effectuate the statute's purposes, which include
facilitating consumers' ability to compare credit terms and helping
consumers avoid the uniformed use of credit. See 15 U.S.C. 1601(a),
1604(a). Section 105(f) authorizes the Board to exempt any class of
transactions from coverage under any part of TILA if the Board
determines that coverage under that part does not provide a meaningful
benefit to consumers in the form of useful information or protection.
See 15 U.S.C. 1604(f)(1). The Board must make this determination in
light of specific factors. See 15 U.S.C. 1604(f)(2). These factors are
(1) the amount of the loan and whether the disclosure provides a
benefit to consumers who are parties to the transaction involving a
loan of such amount; (2) the extent to which the requirement
complicates, hinders, or makes more expensive the credit process; (3)
the status of the borrower, including any related financial
arrangements of the borrower, the financial sophistication of the
borrower relative to the type of transaction, and the importance to the
borrower of the credit, related supporting property, and coverage under
TILA; (4) whether the loan is secured by the principal residence of the
borrower; and (5) whether the exemption would undermine the goal of
consumer protection.
The Board has considered each of these factors carefully and based
on that review believes that the proposed exemption is appropriate.
Consumer testing conducted by the Board showed that examples based on
hypothetical loan amounts and interest rates may be confusing to
consumers and may not provide meaningful benefit. Several participants
thought the historical example showed payments and rates that actually
would apply if the participant chose the loan program described in the
disclosure. Some participants mistakenly thought that the disclosures
described an ARM with a fifteen-year term because the disclosure showed
fifteen years' worth of index changes under an ARM program. Some
consumer testing participants said that disclosures based on a
hypothetical $10,000 loan amount are not useful to them; these
consumers said they wanted to see information about rates and terms
that would actually apply in the context of their own loan amount.
The Board's exception and exemption authority under Sections 105(a)
and (f) does not apply in the case of a mortgage referred to in Section
103(aa), which are high-cost mortgages generally referred to as ``HOEPA
loans.'' The Board does not believe that this limitation restricts its
ability to apply the proposed changes to all mortgage loans, including
HOEPA loans. This limitation on the Board's general exception and
exemption authority is a necessary corollary to the decision of the
Congress, as reflected in TILA Section 129(l)(1), to grant the Board
more limited authority to exempt HOEPA loans from the prohibitions
applicable only to HOEPA loans in Section 129(c) through (i) of TILA.
See 15 U.S.C. 1639(l)(1). Here, the Board is not proposing any
exemptions from the HOEPA prohibitions. This limitation does raise a
question as to whether the Board could use its exception and exemption
authority under Sections 105(a) and (f) to except or exempt HOEPA
loans, but not other types of mortgage loans, from other, generally
applicable TILA provisions. That question, however, is not implicated
by this proposal.
Here, the Board is proposing to apply its general exception and
exemption authority to eliminate information from the ARM loan program
disclosure that consumers find confusing or not useful, for all loans
secured by real property or a dwelling, including both HOEPA and non-
HOEPA loans, in order to fulfill the statute's purpose of facilitating
consumers' ability to compare credit terms and helping consumers avoid
the uninformed use of credit. It would not be consistent with the
statute or with
[[Page 43264]]
Congressional intent to interpret the Board's authority under Sections
105(a) and (f) in such a way that the proposed revisions could apply
only to mortgage loans that are not subject to HOEPA. Reading the
statute in a way that would deprive HOEPA borrowers of improved ARM
loan program disclosures is not a reasonable construction of the
statute and contravenes the Congress's goal of ensuring ``that enhanced
protections are provided to consumers who are most vulnerable to
abuse.'' \42\
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\42\ H.R. Conf. Rept. 103-652 at 159 (Aug. 2, 1994).
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The Board notes that proposed Sec. 226.38(c) would require
creditors to provide consumers with the maximum possible interest rate
and payment within three business days after the consumer applies for
an ARM or a loan in which payments may vary. See discussion of Sec.
226.38(c). Consumer testing indicated that consumers find this
information very useful when provided in the context of an actual loan
offer, in contrast to the information for a hypothetical loan amount in
relation to an historical interest rate or the interest rate or for a
recently originated loan, as required by TILA Section 128(a)(14).
In addition to removing Sec. 226.19(b)(2)(viii), the proposed rule
would remove the related requirement under Sec. 226.19(b)(2)(ix) that
creditors explain how a consumer may calculate payments for the
consumer's loan amount based on either the initial interest rate used
to calculate the maximum interest rate and payment disclosure or the
most recent payment shown in the historical example. The proposed rule
also would eliminate commentary on Sec. 226.19(b)(2)(viii) and (ix).
Further, the proposed rule would eliminate comment 19(b)(2)-2(i)(I),
which provides that if a loan feature must be taken into account in
preparing the historical example of payment and loan balance movements
required by Sec. 226.19(b)(2)(viii), variable-rate loans that differ
as to that feature constitute separate loan programs under Sec.
226.19(b)(2).
Amendments to other regulations and comments. Comment 19(b)-1
currently provides that in an assumption of an adjustable-rate mortgage
transaction secured by the consumer's principal dwelling with a term
greater than one year, disclosures need not be provided under
Sec. Sec. 226.18(f)(2)(ii) or 226.19(b). Comment 19(b)-2(iv) currently
provides that in cases where an open-end credit account will convert to
a closed-end transaction subject to Sec. 226.19(b), the creditor must
provide the disclosures required by Sec. 226.19(b). The proposed rule
would integrate the foregoing commentary into Sec. 226.19(b). Proposed
Sec. 226.19(b) would apply to all closed-end mortgage transactions
secured by real property or a dwelling regardless of loan security or
term, however, as discussed above.
The proposed rule would not require program disclosures to contain
an explanation of how payments will be determined, a disclosure that
creditors must make under existing Sec. 226.19(b)(2)(iii). In general,
consumer testing participants preferred to receive specific information
about the amount of the payments they would have to make, which
generally is not available at the time the consumer submits a loan
application. Most participants found model loan program disclosures
based on current requirements to be confusing because they contained
complex terminology. Participants responded much more positively to
revised model disclosures, which did not discuss technical issues about
how payments are determined. If a creditor chooses to include an
explanation of how payments will be determined, the explanation must be
disclosed apart from the segregated disclosures that proposed Sec.
226.19(b) requires, as a general rule under proposed Sec.
226.37(a)(2), discussed below.
Footnote 45a to Sec. 226.19(b) currently states that creditors may
substitute information provided in accordance with variable-rate
regulations of other federal agencies for the disclosures required by
Sec. 226.19(b). The proposed rule would remove and reserve that
footnote and comment 19(b)-4. The footnote was designed to account for
the fact that disclosure rules for variable-rate loans issued by HUD,
the Federal Home Loan Bank Board, and the Office of the Comptroller of
the Currency (OCC) were in effect when the Board adopted Sec.
226.19(b). No comprehensive disclosure requirements for variable-rate
loans currently are in effect under the rules of HUD, the OCC, or the
Office of Thrift Supervision (OTS), the successor agency to the FHLBB.
No such requirements are in effect under the rules of the Federal
Deposit Insurance Corporation (FDIC) or the National Credit Union
Administration (NCUA) either. Moreover, HUD and the OTS have
incorporated the disclosure requirements for variable-rate loans under
TILA and Regulation Z into their own regulations by cross-
reference.\43\ Accordingly, footnote 45a no longer appears to be
necessary. The Board requests comment, however, on whether there are
potential inconsistencies between any ARM loan disclosures required by
other federal financial institution supervisory agencies that
Regulation Z should specifically address.
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\43\ See 24 CFR 203.49(g) (HUD); 12 CFR 560.210 (OTS). Some of
those agencies have issued regulations that apply to adjustable rate
mortgages. See, e.g., 12 CFR 34.22 (OCC) (requiring that an index
specified in a national bank's loan documents for an ARM subject to
Sec. 226.19(b) be readily available to and verifiable by a borrower
and beyond the bank's control). Those requirements do not establish
comprehensive disclosure requirements, however.
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Comment 19(b)-5 currently states that creditors must provide
disclosures under Sec. 226.19(b) for certain renewable balloon-
payment, preferred-rate, and price-level adjusted mortgages with a
fixed interest rate, if they are secured by a dwelling and have a term
greater than one year. However, such mortgages lack most of the
adjustable interest rate and payment features required to be disclosed
under proposed Sec. 226.19(b)(1). For example, the frequency of rate
and payment changes for a preferred-rate loan with a fixed interest
rate likely cannot be known because the loss of the preferred rate is
based on factors other than a formula or a change in the value of an
index. Accordingly, under the proposed rule creditors would not be
required to provide ARM loan program disclosures under Sec. 226.19(b)
for such mortgages. Creditors would be required to provide ARM loan
program disclosures for such mortgages if their interest rate is
adjustable, however. Cross-references in comment 19(b)-5 would be
updated and the comment would be redesignated as comment 19(b)-3 under
the proposed rule.
Existing comment 19(b)(2)-2(i) provides examples of particular loan
features that distinguish separate loan programs. That commentary would
be redesignated as comment 19(b)-5(i) but generally would be unchanged
under the proposal, with one exception. Differences among rules
relating to loan balance changes would be removed as an example of a
particular loan feature that distinguishes separate loan programs.
However, differences in the possibility of negative amortization would
continue to distinguish separate loan programs, as discussed above.
Also, existing comment 19(b)(2)(vii)-2(i) on disclosing a negative
amortization feature would be redesignated as comment 19(b)-5 under the
proposal.
The requirement to provide loan program disclosures for each loan
program in which a consumer expresses an interest generally would
remain unchanged. However, comment 19(b)(2)-4 would be revised to state
that a creditor ``must describe''--rather than
[[Page 43265]]
``must fully describe''--an ARM loan program. The proposal would reduce
some of the material that creditors must disclose about ARM loan
programs to highlight information that is most important to consumers,
as discussed above.
Use of term ``Adjustable-Rate Mortgage'' or ``ARM.'' Proposed Sec.
226.19(b) requires the creditor to disclose the heading ``Adjustable-
Rate Mortgage'' or ``ARM.'' Participants in the Board's consumer
testing showed greater familiarity with the term ``adjustable-rate
mortgage'' than with ``variable-rate mortgage.'' Format requirements in
proposed Sec. 226.19(b)(4)(iii) state that the statement must be more
conspicuous than, and must precede, the other disclosures required by
Sec. 226.19(b) and must be located outside of the tables required by
proposed Sec. 226.19(b)(4)(iv). Finally, proposed Sec.
226.19(b)(4)(iii) states that creditors may make the ``Adjustable-Rate
Mortgage'' or ``ARM'' disclosure in a heading that states the name of
the creditor and the name of the loan program, such as ``ABC Bank 3/1
Adjustable Rate Mortgage.''
19(b)(1) Interest Rate and Payment Disclosures
Proposed Sec. 226.19(b)(1) requires the creditor to disclose the
following information, as applicable, grouped together under the
heading ``Interest Rate and Payment,'' using that term: (1) The
introductory period, (2) the frequency of the rate and payment change,
(3) the index, (4) the limit on rate changes, (5) the conversion
feature, and (6) the preferred rate.
Introductory period. Proposed Sec. 226.19(b)(1)(i) requires the
creditor to disclose the period during which the interest rate or
payment remains fixed and a statement that the interest rate may vary
or the payment may increase after that period. This disclosure is
similar to that required under existing Sec. 226.19(b)(2)(i). Proposed
Sec. 226.19(b)(1)(i) also requires the creditor to provide an
explanation of the effect on the interest rate of having an initial
interest rate that is not determined using the index or formula that
applies for interest rate adjustments, that is, of having a discounted
or premium interest rate. This disclosure requirement is similar to
that required under existing Sec. 226.19(b)(2)(v). However, the
proposed rule would eliminate the requirement that ARM loan program
disclosures state that the consumer should ask about the amount of the
interest rate discount.
Frequency of rate and payment change. Proposed Sec.
226.19(b)(1)(ii) requires the creditor to disclose the frequency of
interest rate and payment changes, as currently is required under Sec.
226.19(b)(2)(vi).
Index. Proposed Sec. 226.19(b)(1)(iii) requires the creditor to
disclose the index or formula used in making adjustments and a source
of information about the index or formula. Proposed Sec.
226.19(b)(1)(iii) also requires the creditor to provide an explanation
of how the interest rate will be determined, including an explanation
of how the index is adjusted, such as by the addition of a margin.
Those requirements are contained in existing Sec. 226.19(b)(2)(ii) and
(iii). However, the proposed rule eliminates Sec. 226.19(b)(2)(iv),
which requires the creditor to disclose that the consumer should ask
about the current margin value and current interest rate.
Limit on rate changes. Currently, requirements for disclosing
interest rate or payment limitations and carryover are contained in
existing Sec. 226.19(b)(2)(vii). The proposed rule would retain these
requirements, under proposed Sec. 226.19(b)(1)(iv). (Existing Sec.
226.19(b)(2)(vii) also contains a requirement to disclose negative
amortization. The proposed rule would retain that requirement as
proposed Sec. 226.19(b)(2)(ii)(B), as discussed below.)
Conversion feature. Existing comment 19(b)(2)(vii)-3 provides that
if a loan program permits consumers to convert a variable-rate loan to
a fixed-rate loan, the creditor must disclose that the fixed interest
rate after conversion may be higher than the adjustable interest rate
before conversion. Comment 19(b)(2)(vii)-3 further provides that the
creditor must disclose any limitations on the period during which the
loan may be converted, a statement that conversion fees may be charged,
and any interest rate and payment limitations that apply if the
consumer exercises the conversion option. The proposed rule would
integrate this commentary into proposed Sec. 226.19(b)(1)(v).
Preferred rate. Currently, if the variable-rate mortgage
transaction is a preferred-rate loan, the creditor must disclose any
event that would allow the creditor to increase the interest rate, for
example, upon the termination of the consumer's employment with the
creditor, whether voluntary or involuntary. See comment 19(b)(2)(vii)-
4. The creditor also must disclose that fees may be charged when the
preferred rate no longer is in effect, if applicable. The Board
proposes to retain these requirements in proposed Sec.
226.19(b)(1)(vi).
19(b)(2) Key Questions About Risk
Currently, TILA Section 128(a)(14), 15 U.S.C. 1638(a)(14), and
Sec. 226.19(b)(2), require the creditor to disclose only certain
information about certain adjustable-rate mortgage features early in
the mortgage application process. The Board believes, however, that the
consumer should be aware early in the process of other risky features,
in addition to adjustable-rate features. For this reason, the Board
proposes to require ``Key Question'' disclosures several times during
the process to allow consumers to become aware of and track potentially
risky features of their loan. Consumer testing and document design
principles suggest that keeping language and design elements consistent
between forms improves consumers' ability to identify and track any
changes in the information being disclosed. As discussed more fully
below, proposed Sec. 226.19(c)(1) would require the creditor to
provide a Board publication entitled ``Key Questions to Ask about Your
Mortgage'' at the time an application form is provided to the consumer
or before the consumer pays a non-refundable fee, whichever is earlier.
The content of this disclosure would be published by the Board and
would address important terms related to any type of mortgage, whether
fixed-rate or adjustable-rate. At the same time, if the consumer
expresses an interest in an ARM loan program, proposed Sec.
226.19(b)(2) would require the creditor to disclose the ``Key Questions
about Risk'' as part of the ARM loan program disclosure. These ``Key
Questions'' would be tailored to the specific ARM loan program in which
the consumer has expressed an interest. Subsequently, within three days
of the creditor receiving the consumer's application for a specific
loan program, proposed Sec. 226.38(d) would require the creditor to
make a similar disclosure of ``Key Questions about Risk'' in the
transaction-specific TILA disclosure. The list of the ``Key Questions
about Risk'' for the transaction-specific TILA disclosure required
under proposed Sec. 226.38(d) would be the same as that required for
the ARM loan program disclosure under proposed Sec. 226.19(b)(2), but
the information in the TILA disclosure would be specific to the loan
program for which the consumer applied and would apply to fixed-rate or
adjustable-rate loan programs. The Board believes that consistently
using the ``Key Questions'' terminology would enhance consumers'
ability to identify, review, and understand the disclosed terms across
all disclosures, and,
[[Page 43266]]
therefore, avoid the uninformed use of credit.
Key questions about risk. As discussed above, current Sec.
226.19(b)(2) requires the creditor to disclose over 12 loan features.
Consumer testing showed that the current format for these disclosures
was very difficult for participants to understand. In addition, because
the content was so general, participants felt the current disclosure
would not help them shop for a mortgage. Therefore, the Board proposes
to replace existing Sec. 226.19(b)(2) with a new streamlined ARM loan
program disclosure that would contain key information specific to that
loan program. The proposed rule would require creditors to disclose
certain information grouped together under the heading ``Key Questions
about Risk,'' using that term, to draw the consumer's attention to
information about the potential adverse impact that certain loan
features could have on the consumer's ability to repay the loan.
Proposed Sec. 226.19(b)(2)(i) requires the creditor to always disclose
information about the following three terms: (1) Rate increases, (2)
payment increases, and (3) prepayment penalties. Proposed Sec.
226.19(b)(2)(ii) would require the creditor to disclose information
about the following six terms, but only if they are applicable to the
loan program: (1) Interest-only payments, (2) negative amortization,
(3) balloon payment, (4) demand feature, (5) no-documentation or low-
documentation loans, and (6) shared-equity or shared-appreciation. The
``Key Questions about Risk'' disclosure would be subject to special
format requirements, including a tabular format and a question and
answer format, as described under proposed Sec. 226.19(b)(4). The
Board believes it is critical that consumers be alerted to certain risk
factors before they have applied for an ARM, so that they can decide
whether they want a loan with those terms. The Board solicits comment
on whether there are other risk factors that loan program disclosures
or publications should identify.
Required disclosures. As noted above, proposed Sec.
226.19(b)(2)(i) requires the creditor to disclose information about the
following three terms: (1) Rate increases, (2) payment increases, and
(3) prepayment penalties. The Board believes that these three factors
should always be disclosed. Rate and payment increases pose the most
direct risk of payment shock. In addition, consumer testing showed that
interest rate and monthly payment were by far the two most common terms
that participants used to shop for a mortgage. The Board also believes
that the prepayment penalty is a key risk factor because it is critical
to the consumer's ability sell the home or to refinance the loan to
obtain a lower rate and payments. While the other risk factors are
important, those factors are only required to be disclosed as
applicable to avoid information overload.
Rate and payment increases. With respect to rate increases,
proposed Sec. 226.19(b)(2)(i)(A) would require the creditor to
disclose a statement that the interest rate on the loan may increase,
along with a statement indicating when the first rate increase may
occur and the frequency with which the interest rate may increase. With
respect to payment increases, proposed Sec. 226.19(b)(2)(i)(B) would
require the creditor to disclose a statement indicating whether or not
the periodic payment on the loan may increase. If the periodic payment
on the loan may increase, then the creditor would disclose a statement
indicating when the first payment may increase. For payment option
loans, if the periodic payment may increase, the creditor would
disclose a statement indicating when the first minimum payment would
increase. Proposed comment 19(b)(2)(i)-1 would clarify that the
requirement to disclose when the first rate or payment increase may
occur refers to the time period in which the increase may occur, not
the exact calendar date. For example, the disclosure may state, ``Your
interest rate may increase at the end of the 3-year introductory
period.''
Prepayment penalties. If the obligation includes a finance charge
computed from time to time by application of a rate to the unpaid
principal balance, proposed Sec. 226.19(b)(2)(i)(C) would require the
creditor to disclose a statement indicating whether or not a penalty
could be imposed if the obligation is prepaid in full. If the creditor
could impose a prepayment penalty, the creditor would disclose the
circumstances under which and the period in which the creditor could
impose the penalty. Because of the importance of prepayment penalties,
the proposed rule would also require disclosure of this feature under
proposed Sec. 226.38(a)(5). To avoid duplication, proposed comments
19(b)(2)(i)(C)-1 to -3 cross-reference proposed comments 38(a)(5)-1 to
-3 for information about whether there is a prepayment penalty and
examples of charges that are or are not prepayment penalties.
Some consumers take out ARM loans planning to refinance or sell the
home securing the loan before the rate or payment increases. Consumer
testing showed that while most participants understood the general
meaning of the phrase ``prepayment penalty,'' they did not realize that
the penalty would apply if they refinanced their loan or sold their
home. The Board believes it is important for consumers to understand
that a prepayment penalty may be imposed in various circumstances,
including paying off the loan, refinancing, or selling the home early.
Additional disclosures. As noted above, proposed Sec.
226.19(b)(2)(ii) requires the creditor to disclose information about
the following six terms, as applicable: (1) Interest-only payments, (2)
negative amortization, (3) balloon payment, (4) demand feature, (5) no-
documentation or low-documentation loans, and (6) shared-equity or
shared-appreciation. The Board proposes to require these disclosures
only when the feature is present, in contrast to the required
disclosures of proposed Sec. 226.19(b)(2)(i). Proposed comment
19(b)(2)(ii)-1 would clarify that ``as applicable'' means that any
disclosure not relevant to a particular ARM loan program may be
omitted. Although consumer testing showed that some participants felt
reassured by seeing all of the risk factors whether they were a feature
of the loan or not, the Board is concerned about the potential for
information overload if the entire list is included on every ARM loan
program disclosure.
Interest-only payments. Proposed Sec. 226.19(b)(2)(ii)(A) requires
the creditor to disclose a statement that periodic payments will be
applied only toward interest on the loan. The creditor would also
disclose a statement of any limitation on the number of periodic
payments that will be applied only toward interest on the loan and not
towards the principal, that such payments will cover the interest owed
each month, but none of the principal, and that making these periodic
payments means the loan amount will stay the same and the consumer will
not have paid any of the loan amount. For payment option loans, the
creditor would disclose a statement that the loan gives the consumer
the choice to make periodic payments that cover the interest owed each
month, but none of the principal, and that making these periodic
payments means the loan amount will stay the same and the consumer will
not have paid any of the loan amount. Consumer testing showed that many
participants did not understand that there are loans where the periodic
payments do not pay down the mortgage principal. The Board believes it
is important to alert
[[Page 43267]]
consumers to this feature in order to avoid payment shock when the
principal becomes due or the periodic payment increases.
Negative amortization. Proposed Sec. 226.19(b)(2)(ii)(B) would
require the creditor to disclose a statement that the loan balance may
increase even if the consumer makes the required periodic payments. In
addition, the creditor would disclose a statement that the minimum
payment covers only a part of the interest the consumer owes each
period and none of the principal, that the unpaid interest will be
added to the consumer's loan amount, and that over time this will
increase the total amount the consumer is borrowing and cause the
consumer to lose equity in the home. The proposed requirement would
replace existing Sec. 226.19(b)(2)(vii), which requires the creditor
to disclose any rules relating to changes in the outstanding loan
balance, including an explanation of negative amortization. The Board
believes that information regarding negative amortization should be
disclosed because it is a complicated feature that significantly
impacts a consumer's ability to repay the loan. Consumer testing showed
that participants were generally unfamiliar with the term or concept.
However, participants generally understood the revised transaction-
specific plain-language explanation of negative amortization's causes
and effects when disclosed in the ``Key Questions'' format.
Balloon payment. Proposed Sec. 226.19(b)(2)(ii)(C) requires the
creditor to disclose a statement that the consumer will owe a balloon
payment, along with a statement of when it will be due. Proposed
comment 19(b)(2)(ii)(C)-1 would clarify that the creditor must make
this disclosure if the loan program includes a payment schedule with
regular periodic payments that when aggregated do not fully amortize
the outstanding principal balance. Proposed comment 19(b)(2)(ii)(C)-2
would clarify that the requirement to disclose when the balloon payment
is due refers to the time period when it is due, not the exact calendar
date. For example, the disclosure may state, ``You would owe a balloon
payment due in seven years.'' The Board believes it is important for
the consumer to be aware early in the process of any potential payment
shock.
Demand feature. Proposed Sec. 226.19(b)(2)(ii)(D) would require
the creditor to disclose a statement that the creditor may demand full
repayment of the loan, along with a statement of the timing of any
advance notice the creditor will give the consumer before the creditor
exercises such right. Proposed comment Sec. 226.19(b)(2)(ii)(D)-1
would clarify that this requirement would apply not only to
transactions payable on demand from the outset, but also to
transactions that convert to a demand status after a stated period.
Proposed comments Sec. 226.19(b)(2)(ii)(D)-2 and -3 cross-reference
comment 18(i)-2 regarding covered demand features and comment 18(i)-3
regarding the relationship to the payment schedule disclosures. The
proposed rule replaces existing Sec. 226.19(b)(2)(x). The Board
believes that demand features are rare in consumer mortgage
transactions, but pose a considerable risk when present and, therefore,
should be brought to the consumer's attention. Consumer testing showed
that participants understood the revised language regarding a demand
feature and thought it was important information.
No-documentation or low-documentation loans. Proposed Sec.
226.19(b)(2)(ii)(E) would require the creditor to disclose a statement
that the consumer's loan could have a higher rate or fees if the
consumer does not document employment, income, or other assets. In
addition, the creditor would disclose a statement that if the consumer
provides more documentation, the consumer could decrease the interest
rate or fees. The Board is concerned that consumers who obtain loans
with such features may not understand that they may pay a higher price
for this feature.
Shared-equity or shared-appreciation. Proposed Sec.
226.19(b)(2)(ii)(F) requires the creditor to disclose a statement that
any future equity or appreciation in the real property or dwelling that
secures the loan must be shared, along with a statement of the
percentage of future equity or appreciation to which the creditor is
entitled, and the events that may trigger such an obligation. The Board
is aware that a number of shared-equity and shared-appreciation
programs are being offered to consumers, including low- and moderate-
income borrowers, on various terms. Consumer testing showed that
participants were generally unfamiliar with the concept of shared-
equity or shared-appreciation. However, to the extent that a shared-
equity or a shared-appreciation feature is being offered as one of the
loan terms, participants stated that they would want it disclosed
clearly and prominently.
19(b)(3) Additional Information and Web Site
Currently, Sec. 226.19(b)(2)(iv) and (v) require the creditor to
disclose a statement that consumers should ask the creditor about the
current margin value and current interest rate or the amount of any
interest rate discount. Existing Sec. 226.19(b)(2)(xii) requires a
notice that disclosure forms are available for the creditor's other
variable-rate programs. Consumer testing indicated that many consumers
skim disclosures quickly and become frustrated if they cannot quickly
locate the key information they seek. Reducing the number of non-
specific notices in the loan program disclosures would increase the
likelihood that consumers will read and understand specific
disclosures. Under proposed Sec. 226.19(b)(3), the creditor would be
required to disclose that the consumer may visit the Web site of the
Federal Reserve Board for more information about adjustable-rate
mortgages and for a list of licensed housing counselors in the
consumer's area that can help the consumer understand the risks and
benefits of the loan. The Board believes that streamlining the notice
will reduce information overload.
19(b)(4) Format Requirements
Proposed Sec. 226.19(b)(4) contains format requirements for ARM
loan program disclosures. As discussed more fully in proposed Sec.
226.37, consumer testing showed that the location and order in which
information was presented affected consumers' ability to locate and
comprehend the information disclosed. Based on these findings, the
Board proposes, under Sec. 226.19(b)(4)(i), to require that creditors
disclose the ``Key Questions about Risk'' using the format requirements
for similar disclosures required by Sec. 226.38, except as otherwise
provided in proposed Sec. 226.19(b)(4). Proposed Sec.
226.19(b)(4)(ii) would require that the disclosures required by
paragraphs (b)(1) through (b)(3) be grouped together and placed in a
prominent location. Proposed Sec. 226.19(b)(4)(iii) would require that
the heading ``Adjustable Rate Mortgage'' or ``ARM'' required under
Sec. 226.19(b) be more conspicuous than and precede the other
disclosures. The heading would be required to be outside the tables
required under this paragraph. The creditor would be permitted to use a
heading with the name of the loan program and the name of the creditor,
such as ``XXX Bank 3/1 ARM.'' Proposed Sec. 226.19(b)(4)(viii) would
require the disclosure of the Board's Web site and list of licensed
housing counselors to be disclosed outside of the required tables
described below.
Proposed Sec. 226.19(b)(4)(iv) to (vii) would require the
following special formats for the ARM loan program
[[Page 43268]]
disclosure: tabular format, question and answer format, highlighted
answers, and special order of disclosures. Proposed Sec.
226.19(b)(4)(iv) would require the creditor to provide the interest
rate disclosure required under Sec. 226.19(b)(1) and the ``Key
Questions about Risk'' disclosure required under Sec. 226.19(b)(2) in
the form of two tables with headings, content and format substantially
similar to Model Form H-4(B) in Appendix H. Consumer testing showed
that using a tabular format improved participants' ability to readily
identify and understand key information. Only the information required
or permitted by paragraphs (b)(1) and (b)(2) would be in this table. In
addition, under Sec. 226.19(b)(4)(v), the ``Key Questions about Risk''
disclosures would be required to be grouped together and presented in
the format of a question and answer in a manner substantially similar
to Model Form H-4(B) in Appendix H. The table with interest rate
information would precede the table with the ``Key Questions about
Risk.'' Consumer testing showed that using a question and answer format
improved participants' ability to recognize and understand potentially
risky or costly features of a loan. Proposed Sec. 226.19(b)(4)(vi)
would require the creditor to disclose each affirmative answer in bold
text and in all capitalized letters to highlight the fact that a risky
feature is present in the loan. Negative answers (required under
proposed Sec. 226.19(b)(2)(i) but not under proposed Sec.
226.(b)(2)(ii)) would be disclosed in non-bold text. Finally, proposed
Sec. 226.19(b)(4)(vii) would require the creditor to make the
disclosures, as applicable, in the following order: Rate increases
under Sec. 226.19(b)(2)(i)(A), payment increases under Sec.
226.19(b)(2)(i)(B), interest-only payments under Sec.
226.19(b)(2)(ii)(A), negative amortization under Sec.
226.19(b)(2)(ii)(B), balloon payments under Sec. 226.19(b)(2)(ii)(C),
prepayment penalties under Sec. 226.19(b)(2)(i)(C), demand feature
under Sec. 226.19(b)(2)(ii)(D), no-documentation or low-documentation
loans under Sec. 226.19(b)(2)(ii)(E), and shared-equity or shared-
appreciation under Sec. 226.19(b)(2)(ii)(F). This order would ensure
that consumers receive critical information about their payments first.
Model Clauses and Samples are proposed at Appendix H-4(C) through H-
4(F).
19(c) Publications for Transactions Secured by Real Property or a
Dwelling
Based on the results of consumer testing, under the proposal
creditors would be required to provide to consumers two Board
publications for closed-end transactions secured by real property or a
dwelling. The first publication, entitled ``Key Questions to Ask about
Your Mortgage,'' discusses loan terms and conditions that are important
for consumers to consider when selecting a closed-end mortgage loan.
The second publication, entitled ``Fixed vs. Adjustable Rate
Mortgages,'' discusses the respective costs and benefits of fixed-rate
mortgages and ARMs.
Under existing Sec. 226.19(b)(1), the creditor must provide to the
consumer a copy of the CHARM booklet published by the Board, or a
suitable substitute. The Board consumer tested the CHARM booklet and a
sample current loan program disclosure. Few of the consumer testing
participants who had obtained an ARM recalled having seen the CHARM
booklet. Although many participants thought that the information in the
CHARM booklet is useful, particularly the descriptions of ``payment
shock,'' prepayment penalties, and negative amortization, most
participants thought that the CHARM booklet is too long and that they
likely would not read it.
The proposed rule would eliminate the requirement under Sec.
226.19(b)(1) for creditors to provide the CHARM booklet to consumers
who express interest in an ARM transaction, and instead, under proposed
Sec. 226.38(c)(2) require a brief Board publication showing the
principal differences between a fixed-rate loan and an ARM. Comment
19(b)(1)- and -2 on the CHARM booklet would be removed accordingly.
Also, proposed Sec. 226.38(c)(1) would require creditors to provide to
all consumers--regardless of whether they express interest in an ARM--
two new single-page Board publications. These new disclosure forms
would contain a notice stating where consumers may obtain additional
information about ARMs. The Board believes that requiring that
creditors provide the ``Key Questions to Ask about Your Mortgage''
publication and the ``Fixed versus Adjustable Rate Mortgages''
publication without modifications would promote consistency in the
information consumers receive about ARMs. Accordingly, proposed Sec.
226.19(c) would require creditors to provide this information ``as
published.''
The Board proposes to require creditors to provide these
publications at the time a consumer is given an application form or
pays a non-refundable fee, whichever is earlier, for fixed-rate
mortgage loans as well as variable-rate mortgage loans. Special rules
for when a consumer accesses an application form electronically and
when the creditor receives a consumer's application from an
intermediary agent or broker are discussed below. The Board solicits
comment on whether there are other loan types for which loan program
publications should be given at the time an application form is
provided to a consumer or before the consumer pays a non-refundable
fee, whichever is earlier.
19(d) Timing of Disclosures
Proposed comment 19(c)-1 states that creditors are not required to
provide disclosures under proposed Sec. 226.19(c) in cases where an
open-end credit account will convert to a closed-end transaction. The
``Key Questions to Ask About Your Mortgage'' disclosure and the ``Fixed
vs. Adjustable Rate Mortgages'' disclosure would not be helpful at that
time, because the creditor and consumer already will have entered into
a written agreement. By contrast, transaction-specific disclosures are
required in such cases under Sec. 226.19(b), both as in effect (see
comment 19(b)-2(iv)) and as proposed (see proposed Sec. 226.19(b) and
comment 19(b)-2).
Existing Sec. 226.19(b) requires that creditors provide variable-
rate loan program disclosures at the time an application form is
provided to a consumer or before the consumer pays a non-refundable
fee, whichever is earlier. Comment 19(b)-2 currently discusses when a
creditor should provide such disclosures in cases where the creditor
receives a consumer's application through an intermediary agent or
broker or a consumer requests an application by telephone. The comment
also clarifies that if the creditor solicits applications by mailing
application forms, the creditor must send the ARM loan program
disclosures with the application form. Existing Sec. 226.19(c)
contains requirements for providing variable-rate loan program
disclosures when a consumer accesses an application form
electronically. (Section 226.17(a)(1) currently permits creditors to
provide the ARM loan program disclosures electronically, without regard
to the consumer-consent or other provisions of the Electronic
Signatures in Global and National Commerce Act, 15 U.S.C. 7001 et seq.
(E-Sign Act)).
Under the Board's proposal, timing requirements for ARM loan
program disclosures would be consolidated in proposed Sec. 226.19(d).
These timing requirements also would apply to the provision of the
proposed new ``Key Questions to Ask About Your Mortgage'' and ``Fixed
vs. Adjustable Rate
[[Page 43269]]
Mortgages'' disclosures. Proposed Sec. 226.19(d)(1) contains the
general requirement to provide ARM loan program disclosures (if a
consumer expresses interest in ARMs) at the time an application form is
provided or before the consumer pays a non-refundable fee, whichever is
earlier. Proposed Sec. 226.19(d)(1) also specifies that creditors must
provide ARM loan program disclosures before charging a fee for
obtaining a consumer's credit report.
Proposed Sec. 226.19(d)(2) states that if a consumer accesses an
ARM loan application electronically, a creditor must provide the
disclosures in electronic form, except as provided in Sec.
226.19(d)(2). Proposed Sec. 226.19(d)(2), in turn, states that if a
consumer who is physically present in a creditor's office accesses an
ARM loan application electronically, the creditor may provide
disclosures in either electronic or paper form. These provisions are
consistent with existing comment 19(c)-1(i) and (ii). Comment 19(c)-1
on the form of electronic disclosures would be redesignated as comment
19(d)(2)(i)-1. Commentary on the timing of electronic disclosures,
currently contained in comment 19(b)-2(v), would be redesignated as
comments 19(d)(2)(i)-2 and 19(d)(2)(ii)-1. Further, under the proposed
rule existing Sec. 226.17(a) would be revised to include the proposed
new Key Questions to Ask About Your Mortgage'' and ``Fixed vs.
Adjustable Rate Mortgages'' disclosures among the disclosures creditors
may provide without regard to the consumer-consent or other provisions
of the E-Sign Act.
Proposed Sec. 226.19(d)(3) contains rules for applications made by
telephone or through an intermediary. These rules are consistent with
existing comment 19(b)-2. Existing comments 19(b)-2(i) through -2(iii)
are redesignated as comments 19(d)(3)-1 through 19(d)(3)-3. Existing
comment 19(b)-2(iii) states that the creditor must include the
disclosures required by Sec. 226.19(b) with any application form the
creditor sends by mail to solicit consumers. This comment is
redesignated as proposed comment 19(d)(3)-3 and revised to cover the
Key Questions and Fixed versus Adjustable Rate Mortgages disclosures
required by proposed Sec. 226.19(c).
Proposed Sec. 226.19(d)(4) provides that, where a consumer does
not express interest in an ARM until after receiving or accessing an
application form or paying a non-refundable fee, the creditor must
provide an ARM loan program disclosure(s) within three business days
after the consumer expresses such interest to the creditor or the
creditor receives notice from an intermediary broker or agent that the
consumer has expressed interest in an ARM. This is consistent with
existing footnote 45b. Existing comment 19(b)-3 is redesignated as
comments 19(d)(3)-1 through 19(d)(3)-3 under the proposed rule.
Proposed Sec. 226.19(d)(5) provides that if the consumer expresses
an interest in negotiating loan terms that are not generally offered,
the creditor need not provide the disclosures required by Sec.
226.19(b) before an application form is provided. Proposed Sec.
226.19(d)(5) requires that the creditor provide such disclosures as
soon as reasonably possible after the terms to be disclosed have been
determined and not later than the time the consumer pays a non-
refundable fee. Further, proposed Sec. 226.19(d)(5) provides that in
all cases the creditor must provide the disclosures required by Sec.
226.19(c) of this section at the time an application form is provided
or before the consumer pays a non-refundable fee, including a fee for
obtaining a consumer's credit history, whichever is earlier.
Comment 19(b)(2)-1 currently provides that, if ARM loan program
disclosures cannot be provided because a consumer expresses an interest
in individually negotiating loan terms that the creditor generally does
not offer, the creditor may provide disclosures reflecting those terms
as soon as reasonably possible after the terms have been decided upon,
but not later than the time the consumer pays a non-refundable fee.
Proposed Sec. 226.19(d)(5) incorporates that guidance into the
regulation. Further, comment 19(b)(2)-1 provides that if, after an
application form is provided or the consumer pays a non-refundable fee,
a consumer expresses an interest in an adjustable-mortgage loan program
for which the creditor has not provided the ARM loan program
disclosures, the creditor must provide such disclosures as soon as
reasonably possible. Proposed Sec. 226.19(d)(6) incorporates that
guidance into the regulation. The foregoing guidance is removed from
comment 19(b)(2)-1 (which the proposed rule would redesignate as
comment 19(b)-4) because under the proposed rule timing rules for ARM
loan program disclosures are contained in Sec. 226.19(d) rather than
Sec. 226.19(b).
Section 226.20 Subsequent Disclosure Requirements
20(b) Assumptions
Section 226.20(b) currently requires post-consummation disclosures
if the creditor expressly agrees in writing with a subsequent consumer
to accept that consumer as a primary obligator on an existing
residential mortgage transaction. The Board proposes technical changes
to Sec. 226.20(b) and associated commentary to reflect the new format
and content disclosure requirements for transactions secured by real
property or a dwelling under Sec. Sec. 226.37 and 226.38.
20(c) Rate Adjustments
For ARM transactions subject to Sec. 226.19(b), Sec. 226.20(c)
currently requires creditors to mail or deliver to consumers a notice
of interest rate adjustment at least 25, but no more than 120, calendar
days before a payment at a new level is due. Section 226.20(c) also
requires creditors to mail or deliver to consumers an adjustment notice
at least once each year during which an interest rate adjustment is
implemented without an accompanying payment change.
Those adjustment notices must state: (1) The current and prior
interest rates for the loan; (2) the index values upon which the
current and prior interest rates are based; (3) the extent to which the
creditor has foregone any increase in the interest rate; (4) the
contractual effects of the adjustment, including the payment due after
the adjustment is made, and a statement of the loan balance; and (5)
the payment, if different from the payment due after adjustment, that
would be required to fully amortize the loan at the new interest rate
over the remainder of the loan term. Model clauses in Appendix H-4(H)
illustrate how creditors may comply with the requirements of Sec.
226.20(c).
Discussion
The Board adopted the requirements for post-consummation
disclosures (subsequent disclosures) in 1987. The minimum advance
notice of a rate adjustment was set at 25 days to track the rules of
the Office of the Comptroller of the Currency (OCC) and to provide
creditors with flexibility in giving adjustment notices for a variety
of ARMs. See 52 FR 48665, 48668; Dec. 24, 1987. Since 1987, ARMs have
grown in popularity, especially from 2003 to 2007. Beginning in 2007,
ARM growth began to slow as consumers experienced difficulty repaying
such loans and concerns grew about the risk of payment shock ARMs pose.
Because ARMs pose the risk of payment shock, it is critical that
consumers receive notice of ARM payment changes so they can prepare to
make higher payments if necessary. If
[[Page 43270]]
the new payments are unaffordable, borrowers need time to seek a
refinance loan with lower payments or make other arrangements. Even if
a consumer can afford a higher payment, the consumer may want to
refinance into a fixed-rate loan for payment certainty or into another
ARM loan with lower payments. It is particularly important that
consumers with subprime loans receive adequate notice before a payment
increase, as these borrowers tend to be more vulnerable to payment
shock.
The Board believes the current 25-day notice is insufficient to
allow many consumers to refinance into a loan with affordable payments
or to make other arrangements. In the ``Subprime Mortgage Guidance''
issued in 2007, the Board, the OCC, FDIC, OTS, and NCUA stated that
consumers should be given at least 60 days before an ARM adjustment in
which to refinance without paying a prepayment penalty. Several
consumer advocates who commented on the Board's 2008 HOEPA Final Rule
stated that consumers with subprime ARMs may need significant time in
which to seek out a refinancing, in some cases as much as 6 months.
The Board's Proposal
The Board proposes to require creditors to mail or deliver a notice
of an interest rate adjustment at least 60 days before payment at a new
level is due, instead of the current 25-day provision. Creditors would
provide notice annually where interest rate changes are made without
accompanying payment changes under the proposed. Proposed Sec.
226.20(c)(1)(i) contains timing requirements for circumstances where a
payment change accompanies an interest rate adjustment, and proposed
Sec. 226.20(c)(ii) contains timing requirements for circumstances
where no payment change accompanies interest rate changes made during a
year.
Proposed Sec. 226.20(c)(2) contains content requirements for
disclosures required where a payment change accompanies an interest
rate adjustment. Proposed Sec. 226.20(c)(3) contains content
requirements for disclosures required once each year where no payment
change accompanies an interest rate change. Whether or not a payment
change is made, under proposed Sec. 226.20(c)(4) creditors would
disclose the following information: (1) The date until which the
creditor may impose a prepayment penalty if the consumer prepays the
obligation in full, if applicable; (2) a phone number the consumer may
call to obtain additional information about the loan; and (3) a
telephone number and Internet Web site for HUD-licensed housing
counselors. Proposed Sec. 226.20(c)(5) contains formatting
requirements for discloses required by proposed Sec. 226.20(c).
Section 226.20(c) currently provides that an adjustment to the
interest rate with or without a corresponding adjustment to the payment
in an adjustable-rate mortgage subject to Sec. 226.19(b) is an event
requiring new disclosures to the consumer. The proposed rule would
retain this provision. Comment 20(c)-1 provides that the requirements
of Sec. 226.20(c) apply where the interest rate and payment change due
to the conversion of an adjustable-rate mortgage subject to Sec.
226.19(b) to a fixed-rate mortgage. The proposed rule would incorporate
this guidance into proposed Sec. 226.20(c). Further, the proposed rule
would revise comment 20(c)-1 for clarity and to remove commentary on
timing requirements, because timing requirements are contained in
proposed Sec. 226.20(c)(1).
The proposed rule would revise comment 20(c)-2 to clarify that
price-level adjusted mortgages and similar mortgages are not subject to
the disclosure requirements of Sec. 226.20(c) because they are not
subject to the disclosure timing requirements of Sec. 226.19(b), as
discussed above. The proposed rule would remove the commentary stating
that ``shared-equity'' and ``shared-appreciation'' mortgages are not
subject to the disclosure requirements of Sec. 226.20(c) to conform
with the removal of reference to such mortgages as examples of
variable-rate transactions from comment 17(c)(1)-11 (redesignated as
proposed comment 17(c)(1)(iii)-4), as discussed above. Under the
proposed rule, whether or not creditors must provide ARM adjustment
notices for a shared-equity or shared-appreciation mortgage depends on
whether such mortgage has an adjustable rate or a fixed rate. Shared-
equity and shared-appreciation mortgages with a fixed rate would not be
considered adjustable-rate mortgages under the proposed rule.
20(c)(1) Timing of Disclosures
The Board proposes to require creditors to mail or deliver a notice
of an interest rate adjustment for a closed-end ARM at least 60, but no
more than 120, days before payment at a new level is due. This proposal
is designed to provide borrowers with enough advance notice about an
impending rate and payment change to enable them to refinance the loan
if they cannot afford the adjusted payment. Even if consumers do not
need or want to refinance a loan, they may need time to adjust other
spending in order to afford higher mortgage loan payments.
The Board issued the current rule requiring 25 days' notice before
a payment at a new level is due in 1987. Home Mortgage Disclosure Act
(HMDA) data for the years 2004 through 2007 suggest that a requirement
to provide ARM adjustment 60, rather than 25, days before payment at a
new level is due more closely reflects the time needed for consumers to
refinance a loan.\44\ In each of those years, for first-lien refinance
loans, the period between loan application and origination was 25 days
or less for 50 percent of the loans originated, 45 days or less for 75
percent of the loans originated, and 65 days or less for 90 percent of
the loans originated. (These data do not include time needed to compare
available refinance loans.) Requiring creditors to provide an ARM
adjustment notice at least 60 days before payment at a new level is due
would better enable consumers to arrange to make a higher payment (if
applicable) without missing a payment or paying less than the amount
due.
---------------------------------------------------------------------------
\44\ HMDA data consist of information reported by about 8,600
home lenders, including all of the nation's largest mortgage
originators. Reported loans are estimated to represent about 80
percent of all home lending nationwide. Accordingly, HMDA data
likely provide a broadly representative view of U.S. home lending.
Robert B. Avery, Kenneth P. Brevoort, and Glenn B. Canner, The 2007
HMDA Data, 94 Fed. Reserve Bulletin A107 (Dec. 23, 2008).
---------------------------------------------------------------------------
The Board believes that a 60-day minimum notice requirement is
consistent with many existing ARM agreements. For most ARMs, creditors
base the calculation of interest rate changes on the value of an index
30 or 45 days prior to the effective date of a rate change (calculation
date). Creditors generally refer to the period from the calculation
date to the effective date of the interest rate change as the ``look-
back period.'' (Interest rate change dates tend to be the first of a
month to correspond with payment due dates.) In turn, payment in the
new amount is due on the first day of the month following the month in
which interest accrued at the new rate.
Thus, for most ARM loans creditors know what the new interest rate
and payment will be well before payment at a new level is due, even
assuming a week-long lag between publication of an index's level and
the creditor's verification of that level. In fact, many creditors mail
or deliver notice of an interest rate and payment change 60 or more
days before payment at a new level is due.
[[Page 43271]]
However, some ARM agreements may provide for shorter look-back
periods. For example, the calculation date for some ARM products is the
first business day of the month that precedes the effective date of the
interest rate change. The first day of that month may not be a business
day, in which case the look-back period would be fewer than 30 days. In
addition, it takes time for index levels to be reported and for
creditors to confirm the index level and prepare disclosures for
delivery or mailing.
Proposed Sec. 226.20(c)(1) requires creditors to provide advance
notice of an adjustment at least 60, but no more than 120, days before
payment at a new level is due, not before the interest rate changes.
Comment 20(c)-1 would be revised to reflect the increase in the
required advance notice of a payment adjustment. Proposed comment
20(c)(1)-1 provides that if an adjustable-rate feature is added when an
open-end credit account is converted to an adjustable-rate transaction,
creditors must provide disclosures under Sec. 226.20(c)(1) where
payments change due to conversion of a transaction subject to Sec.
226.19(b) to a fixed-rate transaction. Because relevant payment changes
under existing and proposed Sec. 226.20(c) are those due to interest
changes, proposed comment 20(c)(1)-2 clarifies that payment changes due
to adjustments in property tax obligations or premiums for mortgage-
related insurance do not trigger requirements to disclose interest rate
and payment adjustments.
The Board solicits comment on the operational changes creditors and
servicers would need to make to provide disclosures at least 60 days
before payment at a new level is due. Are there indices that are
published at times that would make compliance with such a rule
difficult? Are reported levels for particular indices difficult to
confirm within a few days? The Board requests comment on whether
requiring creditors to provide 45, rather than 60, days' advance notice
of a payment change better balance concerns about providing sufficient
notice to consumers and sufficient time for creditors to verify
reported indices and prepare disclosures.
A look-back period of 45 days likely provides ample time for a
creditor to determine a loan's new interest rate and provide
disclosures at least 60 days before payment at a new level is due, as
discussed above. Are there reasons why a look-back period of forty-five
days is not feasible for certain loan types for which a shorter look-
back period is common, for example, subordinate-lien loans? Also, where
an interest rate and payment adjustment is due to the conversion of an
adjustable-rate mortgage to a fixed-rate mortgage under a written
agreement, should creditors continue to be required to provide an
adjustment notice at least 25, rather than at least 60, days before
payment at a new level is due?
Coverage. Section 226.20(c) currently applies to transactions
subject to Sec. 226.19(b), which applies to closed-end ARMs secured by
a consumer's principal dwelling with a term greater than one year. The
Board is proposing to apply Sec. 226.19(b) to all closed-end ARMs
secured by real property or a dwelling, as discussed above. Proposed
Sec. 226.20(c) would apply to the same category of transactions.
The Board recognizes that currently creditors need not provide ARM
adjustment notices under existing Sec. 226.20(c) for a short-term
transaction, such as a construction loan, with an adjustable rate. The
Board solicits comment on whether a 60-day notice period is appropriate
for such loans and if not, what period would be appropriate and still
provide consumers sufficient notice of a payment change.
Existing ARM loan agreements. The Board is aware that some ARM loan
agreements may provide for a look-back period that is too short for the
creditor to be able to provide an adjustment notice at least 60 days
before payment at a new level is due. The Board seeks comment on the
number or proportion of existing ARM loan agreements under which
creditors or servicers could not comply with a minimum 60-day advance
notice requirement.
20(c)(2)(i)
Where a payment change accompanies an interest rate change,
proposed Sec. 226.20(c)(2)(i) requires creditors to disclose a
statement that changes are being made to the interest rate and the date
such change is effective. Proposed Sec. 226.20(c)(2)(i) also requires
creditors to state that more detailed information is available in the
loan agreements. Proposed Sec. 226.20(c)(5)(ii) requires that these
disclosures appear before the other required disclosures, as discussed
below.
20(c)(2)(ii)
Proposed Sec. 226.20(c)(2)(ii) requires creditors to provide the
following disclosures for covered loans in the form of a table: (1) The
current and new interest rates; (2) if payments are interest-only or
negatively amortizing, the amount of the current and new payment
allocated to pay interest, principal, and property taxes and mortgage-
related insurance, as applicable; and (3) the current and new periodic
payment amounts and the due date for the first new payment. This
content is substantially similar to the content of the ``Payment
Summary'' table in the TILA disclosures provided before consummation
for most types of ARMs. (Under proposed Sec. 226.38, the ``Payment
Summary'' table for negatively amortizing ARMs differs from the
``Payment Summary'' table for other ARMs, as discussed below.) Under
proposed Sec. 226.20(c)(5)(iii), this table would have to contain
headings, content, and format substantially similar to those in
Appendix H-4(G), as discussed below.
Currently, ARM adjustment notices need not state how payments are
allocated among principal, interest, and escrow accounts. The Board
believes that a table showing payment allocations would benefit
consumers with interest-only or negatively amortizing loans.
Participants in the Board's consumer testing generally understood a
sample form with a table showing the transition from interest-only
payments to payments of both principal and interest. Further, all
participants correctly identified the new payment and the due date of
the first payment at the new level shown in the table. Almost all
participants recognized the increase in the interest rate and amounts
escrowed for taxes and property-related insurance and that part of the
new payment would be allocated to pay principal.
Comment 20(c)(1)-1 on disclosing ``current'' and ``prior'' interest
rates would be revised for clarity to refer instead to ``current'' and
``new'' interest rates. Under the proposed rule, Sec. 226.20(c)(3)
contains content requirements for annual notice disclosures and Sec.
226.20(c)(2) contains content requirements for payment change notices.
Accordingly, commentary on disclosure where no payment change has
occurred during a year would be removed from comment 20(c)(1)-1.
20(c)(2)(iii)
Creditors currently must disclose the index values upon which the
prior and new interest rates are based, under existing Sec.
226.19(c)(2). Some consumer testing participants had difficulty
understanding the relationship among an index, a margin, and an
interest rate. Accordingly, proposed Sec. 226.20(c)(2)(iii)
substitutes a requirement that disclosures contain a description of the
change in the index or formula for the disclosure required under
existing Sec. 226.20(c)(2). For example, rather than
[[Page 43272]]
disclose that payments previously were based on a 1-year LIBOR rate of
3.75 and now would be based on a new rate of 5.75, a creditor might
disclose the following: ``Your interest rate will change due to an
increase in the 1-year LIBOR index.'' Further, proposed Sec.
226.20(c)(2)(iii) requires creditors to disclose any application of
previously foregone increases together with the description of the
change in the index or formula.
A simple statement of the occurrence that caused the interest rate
and payment to change likely conveys a level of information suitable
for most consumers' needs. In consumer testing conducted for the Board,
participants indicated that they found explanations of interest rates
difficult to follow. Thus, providing more information would likely
result in information overload. Consumers who prefer more information
can review the loan agreement to determine the interaction between the
interest rate and the index and margin or to learn more about the
formula used to determine the interest rate. The loan agreement also
will contain information about how the creditor may apply previously
foregone interest. For these reasons, proposed Sec. 226.20(c)(2)(ii)
does not require creditors to disclose the current and prior index
values. Comment 20(c)(2)-1 would be removed accordingly.
Comment 20(c)(4)-1, which discusses the types of contractual
effects Sec. 226.20(c) requires creditors to disclose--for example,
effects on the loan term and balance--also would be removed under the
proposed rule. Proposed comments 20(c)(2)(vi)-2, 20(c)(2)(vii)-1, and
20(c)(3)(v)-1 reflect the removed commentary, however.
20(c)(2)(iv)
Existing Sec. 226.20(c)(3) requires that a creditor disclose the
extent to which the creditor has foregone any increase in the interest
rate. This requirement would be redesignated as proposed Sec.
226.20(c)(2)(iv). Further, proposed Sec. 226.20(c)(iv) would require
creditors to disclose the earliest date a creditor may apply foregone
interest to future adjustments, subject to any rate caps. Proposed
comment 20(c)(3)(iv)-1 states that creditors may rely on proposed
comment 20(c)(2)(iv)-1 in determining to which transactions the
requirement to disclose foregone interest applies and how to disclose
such increases. Proposed comment 20(c)(3)(iv)-1 clarifies that
creditors need not disclose the earliest date the creditor may apply
foregone interest in notices provided annually when no payment change
occurs during a year.
20(c)(2)(v)
Proposed Sec. 226.20(c)(2)(v) would require creditors to disclose
limits on interest rate or payment increases at each adjustment, if
any, and the maximum interest rate or payment over the life of the
loan. This is consistent with the disclosure of rate change limits in
the ``More Information about Your Payments'' section of the disclosures
provided within three business days of application. See proposed Sec.
226.38(e).
20(c)(2)(vi)
Currently, where the required loan payment is different from the
payment disclosed under Sec. 226.20(c)(4), Sec. 226.20(c)(5) requires
a creditor to disclose the payment required to fully amortize the loan
over the remainder of the loan term. This requirement would be
redesignated as proposed Sec. 226.20(c)(2)(vi). Further, in all cases
creditors would disclose a statement regarding whether or not part of
the new payment will be allocated to pay the loan principal. This is
consistent with the focus on the impact of loan payments on loan
principal in the proposed new ``Key Questions'' disclosure in Sec.
226.19(c) and the ``Key Questions about Risk'' section of the
disclosure creditors provide within three business days of application
in proposed Sec. 226.38(d).
Existing comment 20(c)(5)-1, on fully amortizing payments, would be
redesignated as comment 20(c)(2)(vi)-1. The comment also would be
revised for clarity and to update cross-references. Consistent with
existing comment 20(c)(4)-1, proposed comment 20(c)(2)(vi)-2 clarifies
that the creditor must disclose any change in the term or maturity of
the loan if the change resulted from the rate adjustment.
20(c)(2)(vii)
Existing Sec. 226.20(c)(4) requires creditors to disclose the loan
balance. This requirement would be redesignated as proposed Sec.
226.20(c)(2)(vii) and would require creditors to disclose the loan
balance as of the effective date of the interest rate adjustment.
Proposed comment 20(c)(2)(vii)-1 clarifies that the balance required to
be disclosed is the balance on which the new adjusted payment is based.
This is consistent with existing comment 20(c)(4)-1.
20(c)(3) Content of Annual Interest Rate Notice
Existing Sec. 226.20(c) requires creditors to provide ARM
adjustment notices at least once each year during which an interest
rate adjustment is implemented without an accompanying payment change.
This requirement would be redesignated as proposed Sec. 226.20(c)(3).
Currently, Sec. 226.20(c) contains a single list of required
disclosures creditors must provide as applicable, in a payment change
notice and an annual notice of interest rate changes without payment
changes. Proposed Sec. 226.20(c)(3) specifies the disclosures that are
applicable for purposes of annual notices.
20(c)(3)(i)
Under proposed Sec. 226.20(c)(3)(i), where no payment adjustment
has been made during a year, the creditor must disclose that the
interest rate on the loan has changed without changing the payments the
consumer must make. Further, proposed Sec. 226.20(c)(3)(i) requires
creditors to disclose the specific time period for which the annual
notice discloses interest rates that were not accompanied by payment
changes. Proposed Sec. 226.20(c)(5)(ii) requires that this disclosure
appear before the other required disclosures, as discussed below.
20(c)(3)(ii)
Under proposed Sec. 226.20(c)(3)(ii), a creditor must disclose the
highest and lowest interest rates applied during the year in which no
payment change has accompanied interest rate changes. Creditors would
not disclose all interest rates applied to a transaction if the payment
has not changed. By contrast, existing comment 20(c)-1 provides that
creditors either may disclose all interest rates that applied or the
highest and lowest rates. The Board believes that a simple and clear
disclosure of the highest and lowest interest rates applied better
conveys to consumers the impact of interest rate changes than does a
list of all of the interest rates applied. This is especially true
where interest rates change more frequently than monthly.
20(c)(3)(iii)
Creditors disclose the extent to which the creditor has foregone
any increase in the interest rate under existing Sec. 226.20(c)(3).
This requirement would be contained in proposed Sec. 226.20(c)(3)(iii)
for notices where payment changes do not accompany interest rate
changes made during a year.
20(c)(3)(iv)
Proposed Sec. 226.20(c)(3)(iv) requires creditors to disclose the
maximum interest rate that may apply over the life of the loan. This is
consistent with the disclosure of rate change limits in the ``More
Information about Your Payments'' section of the disclosures
[[Page 43273]]
provided within three business days of application in proposed Sec.
226.38(e).
20(c)(3)(v)
Existing Sec. 226.20(c)(4) requires creditors to disclose the loan
balance. Under the proposal, this requirement would be contained in
proposed Sec. 226.20(c)(3)(v) for purposes of annual notices where
payment changes do not accompany interest rate changes. Creditors would
disclose the loan balance as of the last date of the year covered by
the disclosure. Proposed comment 20(c)(3)(v)-1 clarifies that the
balance required to be disclosed is the balance on which the new
adjusted payment is based. This is consistent with existing comment
20(c)(4)-1.
20(c)(4) Additional Information
Proposed Sec. 226.20(c)(4) requires that ARM adjustment notices
creditors provide information about prepayment penalties, contacting
the creditor, and locating housing counseling resources. Proposed Sec.
226.20(c)(5)(ii) requires that these additional disclosures be located
directly below the required interest rate disclosures, as discussed
below.
20(c)(4)(i)
Proposed Sec. 226.20(c)(4)(i) requires creditors to disclose the
last date the creditor may impose a penalty if the consumer prepays the
obligation in full and the amount of the maximum penalty possible
before that date, if applicable. Under proposed Sec. 226.20(c)(4)(i),
if an ARM has a prepayment penalty, the creditor must disclose the
required information whether or not a payment change accompanies the
interest rate change. The Board believes that disclosures regarding a
prepayment penalty would assist consumers in determining when to seek a
refinance loan. When presented with a sample ARM adjustment notice for
a loan with a prepayment penalty, almost all consumer testing
participants recognized that a prepayment penalty would apply if they
obtained a refinance loan before a specified date.
Proposed Sec. 226.20(c)(4)(i) provides that the creditor shall
disclose the maximum prepayment penalty possible if the consumer
prepays in full between the date the creditor delivers or mails the ARM
adjustment notice and the last day the creditor may impose the penalty.
The Board requests comment on whether creditors should determine the
maximum prepayment penalty during some other period, for example
between the date the creditor prepares the ARM adjustment notice and
the last day the creditor may impose the penalty.
20(c)(4)(ii)
Proposed Sec. 226.20(c)(4)(ii) requires creditors to disclose a
phone number to call for additional information about the consumer's
loan. Creditors must provide this information whether or not a payment
change accompanies an interest rate change, under the proposed rule.
Most consumer testing participants responded positively to tested
disclosures stating how to contact their lender with questions and
stated that they would call their lender if they realized they were
unable to afford higher payments on an ARM.
20(c)(4)(iii)
Proposed Sec. 226.20(c)(4)(iii) requires creditors to disclose a
phone number and an Internet Web site consumers may use to obtain a
list of HUD-licensed housing counselors. The proposed rule requires
creditors to provide this disclosure whether or not a payment change
accompanies an interest rate change. Most consumer testing participants
thought that information about how to locate a HUD-licensed housing
counselor would be useful to consumers. Some said that they would use
the information themselves if they had difficulty affording payments.
20(c)(5) Format of Disclosures
20(c)(5)(i)
Proposed Sec. 226.20(c)(5)(i) requires that the heading, content,
and format of the disclosures required by Sec. 226.20(c) be
substantially similar to the heading, content, and format of the model
form in Appendix H-4(G), where an interest rate adjustment is
accompanied by a payment change, or the model form in Appendix H-4(K),
where a creditor provides an annual notice of interest rate adjustments
without an accompanying payment change. Proposed Sec. 226.20(c)(5)(i)
also requires that the disclosures required by Sec. 226.20(c) be
placed in a prominent location. (Comment 37(d)-1 states that
disclosures meet the prominent location standard if they are located on
the first page and on the front side of the disclosure statement.)
Further, under proposed Sec. 226.20(c)(5)(i) the interest rate
disclosures required by Sec. 226.20(c)(2) (where a payment change
accompanies an interest rate change) or Sec. 226.20(c)(3) (where no
payment change occurs during a year) must be grouped together with the
additional disclosures on prepayment penalties, contacting the creditor
or servicer for loan information, and locating housing counseling
resources required by proposed Sec. 226.20(c)(4). These grouped
disclosures must be segregated from everything else.
20(c)(5)(ii)
Under proposed Sec. 226.20(c)(5)(ii), the statement that changes
are being made to the interest rate and payments (under proposed Sec.
226.20(c)(2)(i)) or that the interest rate has changed without
accompanying payments changes (under proposed Sec. 226.20(c)(3)(i))
must precede the other required disclosures. The additional disclosures
on information on prepayment penalties, contacting the creditor, and
housing counseling resources required by proposed Sec. 226.20(c)(4)
must follow the interest rate disclosures, under proposed Sec.
226.20(c)(5)(ii).
20(c)(5)(iii)
Under proposed Sec. 226.20(c)(5)(iii), where a payment change
accompanies an interest rate adjustment, the interest rate and payment
change disclosures required by proposed Sec. 226.20(c)(2)(ii) must
contain headings, content, and format substantially similar to those in
the table contained in Appendix H-4(G). The textual disclosures
required by proposed Sec. 226.20(c)(2)(iii) through (vii) must be
located directly below the table. Further, the format requirements in
Sec. 226.37 apply to ARM adjustment notices, as discussed below.
Regulations of other agencies. Footnote 45c to Sec. 226.20(c)
currently states that creditors may substitute information provided in
accordance with variable-rate subsequent disclosure regulations of
other federal agencies for the disclosure required by Sec. 226.20(c).
The Board adopted footnote 45c in 1987, a time when OCC, FHLBB, and HUD
regulations contained subsequent disclosure requirements for ARMs. See
52 FR 48665, 48671; Dec. 24, 1987. The proposed rule would remove
footnote 45c. No comprehensive disclosure requirements for variable-
rate mortgage transactions presently are in effect under the
regulations of the other Federal financial institution supervisory
agencies, as discussed above.
20(d) Periodic Statement for Negative Amortization Loans
The Board proposes to require creditors to provide periodic
statements for payment option ARMs with a negative amortization feature
that are secured by real property or a dwelling. Such ARMs permit
consumers to choose the amount paid (above a specified minimum) each
period. In 2006, the Board, the OCC, the OTS, the FDIC, and the NCUA
expressed concerns about
[[Page 43274]]
consumer understanding of how such loans function and of the effect of
negative amortization on a loan's balance in the Interagency Guidance
on Nontraditional Mortgage Product Risks issued in 2006. 71 FR 58609;
October 4, 2006. The agencies issued related sample illustrations that
include a payment summary table showing the impact of various payment
options on the loan balance that creditors may include with periodic
statements for payment option ARMs. 72 FR 31825, 31831; Jun. 8, 2007.
The illustrations were not consumer-tested. The Board's proposed model
table showing payment options is similar to the summary table the
agencies issued but has been revised based on consumer testing.
Payment option ARMs are complex products. Most participants in the
Board's consumer testing were unfamiliar with such loans and with
negative amortization generally. These loans present consumers with
choices each month, and how the consumer exercises his or her choice
may result in negative amortization and much higher payments when the
consumer must begin to make fully amortizing payments or a balloon
payment. The Board believes that consumers should be informed of the
consequences of making minimum payments on such a loan. Thus, the Board
proposes to require creditors to provide a periodic statement that
describes a consumer's payment options and the effects of making
payments in those amounts.\45\
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\45\ The Federal financial institution supervisory agencies (the
Board, the OCC, the OTS, the FDIC, and the NCUA (collectively, the
agencies)) expressed concerns about consumer understanding of how
such loans function and of the effect of negative amortization on a
loan's balance in the Interagency Guidance on Nontraditional
Mortgage Product Risks issued in 2006. 71 FR 58609; October 4, 2006.
The agencies issued related sample illustrations that include a
payment summary table showing the impact of various payment options
on the loan balance that creditors may include with periodic
statements for payment option ARMs. 72 FR 31825, 31831; Jun. 8,
2007. Proposed Sec. 226.20(d) requires creditors to provide
periodic statements that disclose payment options in the form of a
table. The proposed model table is similar to the summary table the
agencies issued but has been revised based on consumer testing.
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20(d)(1) Timing and Content of Disclosures
For closed-end transactions secured by real property or a dwelling
that permit the consumer to select among multiple payment options that
include an option that results in negative amortization, proposed Sec.
226.20(d) requires creditors to provide a periodic statement that
discloses payment options not later than fifteen business days before a
payment is due. Where payment at a new level is due, however, proposed
Sec. 226.20(c) requires creditors to provide an ARM adjustment notice
no later than 60 days beforehand, as discussed above.
20(d)(1)(i) Payment
Proposed Sec. 226.20(d)(1)(i) would require creditors to disclose,
based on the interest rate in effect at the time the disclosure is
made, the payment amount required to: (1) Pay off the loan balance in
full by the end of the term through regular periodic payments, without
a balloon payment; (2) prevent negative amortization, if the legal
obligation explicitly permits the consumer to elect to pay interest
only without paying principal; and (3) pay the minimum payment required
under the legal obligation. Under the proposed rule, creditors would
provide each disclosure as applicable. For example, if the terms of the
loan obligation did not provide the option for consumers to make
interest-only payments, creditors would disclose only the required
minimum payment and the fully amortizing payment.
In consumer testing conducted for the Board, participants generally
understood the options presented in the table. Most were able to
understand that making the minimum required payment would cause their
loan balance to grow. They also understood that making a fully
amortizing payment would be a safe choice and would pay their loan
balance off over time.
Proposed comment 20(d)(1)-1 clarifies that creditors must provide a
summary table under Sec. 226.20(d) for covered loans that allow a
consumer to choose to make a payment that results in negative
amortization even if the initial payments required do not negatively
amortize the loan. Proposed comment 20(d)(1)-1 states that a payment
summary table need only contain those disclosures that apply to payment
options available to a consumer, however. For example, the proposed
comment states that if a negatively amortizing loan recasts and a
consumer must begin to make fully amortizing payments, the payment
summary table need not disclose payments other than the fully
amortizing payment.
Proposed comment 20(d)(1)-2 states that creditors may base all
disclosures on the assumption that payments will be made on time and in
the amounts required by the terms of the legal obligation, disregarding
any possible inaccuracies resulting from consumers' payment patterns.
This is consistent with existing comment 17(c)(2)(i)-3 and proposed
revisions to comment 17(c)(1)-1, discussed above. Proposed comment
20(d)(1)-2 clarifies, however, that creditors may not base disclosures
for loans with a negatively amortizing feature on the fully amortizing,
interest-only, or other payment unless that payment is the amount the
consumer is required to pay under the legal obligation. Finally,
proposed comment 20(d)(1)(i)-1 states that creditors may rely on
comment 38(c)(5)-1 to determine whether a payment is a regular periodic
payment or a balloon payment.
20(d)(1)(ii) Effects
Proposed Sec. 226.20(d)(1)(ii) requires creditors to disclose the
effects of making payments in the amounts required to be disclosed
under proposed Sec. 226.20(d). Appendix H-4(L) contains a proposed
model form with accessible language on fully amortizing payments,
interest-only payments, and negatively amortizing minimum payments.
First, the model form states that a fully amortizing payment will cover
all the interest owed in a particular payment plus some principal and
decrease the loan balance and that if the consumer regularly makes the
fully amortizing payment the consumer will pay off the loan on
schedule. Second, the model form states that an interest-only payment
will cover all the interest owed in a particular payment but none of
the principal, that the consumer's balance will remain the same, and
that if the consumer regularly makes interest-only payments the
consumer will have to make larger payments as early as a specified
date. Third, the model form states that a minimum payment will cover
only part of the interest owed in a particular payment and result in a
specified amount of unpaid interest being added to the loan balance and
that if the consumer makes a minimum payment the consumer in effect
will be borrowing more money and will lose home equity. Further, the
model form states that if a consumer regularly makes minimum payments
the consumer will have to make significantly larger payments as early
as a specified date.
Proposed comment 20(d)(1)(ii)-1 states that the disclosures
required by Sec. 226.20(d) must be consistent with the terms of the
legal obligation. For example, the proposed comment clarifies that
disclosures may not state that making fully amortizing payments on an
interest-only loan will reduce a consumer's loan balance if the
creditor will not apply payments that exceed the interest-only payment
to principal.
[[Page 43275]]
20(d)(1)(iii) Unpaid Interest
Proposed Sec. 226.20(d)(1)(iii) requires creditors to disclose the
amount that will be added to the loan balance due to unpaid interest,
if the consumer elects to make a payment that results in negative
amortization.
20(d)(2) Format of Disclosures
Proposed Sec. 226.20(d)(2)(i) requires that periodic statements
for loans with a negative amortization feature contain payment
disclosures with content substantially similar to the content of Form
H-4(L) in Appendix H. Further, the proposed provision requires
creditors to make payment disclosures in a payment summary table with
headings, content, and format substantially similar to Form H-4(L).
Proposed Sec. 226.20(d)(2)(ii) requires that disclosures be placed in
a prominent location (that is, located on the first page and on the
front side of the disclosure statement, as clarified by proposed
comment 37(d)(1)-1), with one exception. Under proposed Sec.
226.20(d)(2)(ii), if the payment disclosures required by Sec.
226.20(d) are made together with the ARM adjustment disclosures
required by Sec. 226.20(c), the payment disclosures must be located
directly below the ARM adjustment disclosures.
Proposed Sec. 226.20(d)(2)(iii) requires that the table required
by Sec. 226.20(d)(2)(i) contain only the information required by Sec.
226.20(d)(1). Other information may be presented with the table under
the proposed rule, provided that such information appears outside of
the required table.
Alternatives not proposed. The Board is proposing to apply the
requirement to provide periodic statements that contain a payment
summary table, for payment option ARMs with a negative amortization
feature that are secured by real property or a dwelling. The Board
considered requiring periodic statements for all loans secured by real
property or a dwelling. The Board is not proposing such a requirement,
however. It is not clear that a monthly statement on a fixed-rate
mortgage or an ARM without payment options would provide sufficient
benefits to consumers to offset the costs of providing statements. For
these loans, the consumer cannot exercise any choice in payments.
Moreover, creditors must give borrowers advance notice each time the
required payment for a variable-rate transaction adjusts, under Sec.
226.20(c), as discussed above. Servicers send borrowers with escrow
accounts annual statements under RESPA. Some servicers send additional
escrow notices more frequently, for example quarterly. Those statements
assist consumers in monitoring account changes related to changes in
taxes or property insurance costs.
20(e) Creditor-Placed Property Insurance
Creditor-placed property insurance requirements. The security
instrument or promissory note typically contains a requirement that the
consumer maintain insurance on the property securing the loan, such as
the consumer's dwelling or automobile. If the consumer fails to
maintain the insurance or the insurance is cancelled, the credit
agreement typically authorizes the creditor to obtain such insurance at
the consumer's expense. The premium becomes additional debt of the
consumer. This practice is known as ``creditor-placed property
insurance.''
Industry reports indicate that the volume of creditor-placed
property insurance premiums has increased significantly in the past few
years.\46\ Consumers struggling financially may fail to pay required
property insurance premiums unaware that the creditor has the right to
obtain such insurance on their behalf and add the premiums to the
outstanding loan balance.\47\ In some instances, creditors have
improperly obtained property insurance when they arguably knew or
should have known that the consumer already had insurance.\48\
Generally, creditor-placed insurance is more costly and provides less
coverage than insurance that a consumer purchases through an insurance
agent.\49\
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\46\ See, e.g., Consumer Credit Industry Association, Fact Book
of Credit-Related Insurance at 1 (2007) (finding that the 2007
volume of creditor-placed property insurance premiums was over twice
the 2002 amount).
\47\ See State of Wisconsin, Office of the Commissioner of
Insurance, ``Force-Placed'' Insurance Surprises Those Who Let
Policies Lapse (May 30, 2002) available at http://oci.wi.gov/
pressrel/0502home.htm (``Many people don't realize that if they let
that [homeowner's] insurance lapse, banks and other lenders can
legally re-insure their home loan by buying insurance to replace it
and making the homebuyer pay for it.'').
\48\ See, e.g., United States of America v. Fairbanks Capital
Corp., Civ. Action No. 03-12219-DPW, Complaint at ] 17 (D. Mass.
Nov. 12, 2003) (finding that Fairbanks improperly obtained property
insurance when it knew or should have known that borrowers already
had insurance); Ocwen Federal Bank FSB, OTS Docket No. 04592,
Supervisory Agreement, OTS Docket No. 04592 (Apr. 19, 2004)
(requiring the bank to take reasonable actions to determine whether
appropriate hazard insurance is already in place before it obtained
creditor-placed property insurance).
\49\ See, e.g., Webb, et al. v. Chase Manhattan Mortgage Corp.,
No. 2:05-CV-0548, 2008 U.S. Dist. LEXIS 42559, at *15 (S.D. Ohio May
28, 2008) (finding that the creditor-placed property insurance
premium was four times higher than the plaintiff's original premium
and did not cover personal property or provide coverage for personal
liability or medical payments to others).
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Currently, there is no provision in Regulation Z or federal law
that requires the creditor to provide notice of the cost to the
consumer before charging the consumer for creditor-placed property
insurance. It appears that only a few states require creditors to
provide notice, and these requirements differ. Under Michigan law, for
example, a creditor may not impose charges on a debtor for creditor-
placed property insurance unless the creditor provides two notices and
allows the borrower a total of 30 days to provide evidence of
insurance.\50\ New Mexico law, on the other hand, simply requires the
insurer to provide notice to the debtor within 15 days after the
placement or renewal of creditor-placed property insurance.\51\ The
majority of states have no notice requirement. The servicing guidelines
of Fannie Mae and Freddie Mac also vary greatly. Fannie Mae's
guidelines state that the servicer ``should'' provide the borrower with
at least one written notice and a total of at least 60 days to provide
evidence of insurance before charging for creditor-placed property
insurance.\52\ Freddie Mac's guidelines do not require the servicer to
provide notice to the borrower.\53\
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\50\ Mich. Comp. Laws Sec. 500.1625 (2009).
\51\ N.M. Admin. Code Sec. 13.18.3.17 (2009).
\52\ Fannie Mae Single-Family Servicing Guide, Part II, Ch. 6
Lender-Placed Property Insurance (2005).
\53\ Freddie Mac Single-Family Seller/Servicer Guide, Vol. 2,
Sec. 58.9 Special Insurance Requirements and Changes in Insurance
Requirements (2007).
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In order to ensure that consumers are informed of the cost of
creditor-placed property insurance, the Board proposes to use its
authority under TILA Section 105(a), 15 U.S.C. 1604(a), to add Sec.
226.20(e) to require the creditor to provide notice of the cost and
coverage of creditor-placed property insurance before charging the
consumer for such insurance. In addition, proposed Sec. 226.20(e)(4)
would require the creditor to provide the consumer with evidence of
creditor-placed property insurance within 15 days of imposing a charge
for such insurance. Proposed Sec. 226.20(e)(1) would define
``creditor-placed property insurance'' as ``property insurance coverage
obtained by the creditor when the property insurance required by the
credit agreement has lapsed.'' Section 226.20(e) would apply to secured
closed-end loans, including mortgage and automobile loans. The Board
solicits comment as to whether this rule should also apply to HELOCs.
Proposed Sec. 226.20(e)(2) contains three conditions for charging
for creditor-
[[Page 43276]]
placed property insurance. First, proposed Sec. 226.20(e)(2)(i) would
require the creditor to make a reasonable determination that the
required property insurance had lapsed. Second, proposed Sec.
226.20(e)(2)(ii) would require the creditor to mail or deliver to the
consumer a written notice containing the information required by the
proposed rule at least 45 days before a charge is imposed on the
consumer for the creditor-placed property insurance. Finally, proposed
Sec. 226.20(e)(2)(iii) would permit the creditor to charge the
consumer if, during the 45-day notice period, the consumer did not
provide the creditor with evidence of adequate property insurance.
Notice period timing and charges. Under the proposed rule, the
creditor would have to mail or deliver to the consumer the required
written notice at least 45 days before charging the consumer for the
cost of creditor-placed property insurance. This 45-day notice period
is consistent with the 45-day notice period required by the Flood
Disaster Protection Act of 1973 Section 102(e), 42 U.S.C. 4012a(e), and
represents the midpoint between State law 30-day notice periods \54\
and the 60-day Fannie Mae Servicing Guide recommendation.\55\ The Board
notes that the provision in the Fannie Mae Servicing Guide is stated as
a recommendation, but not a requirement. The Board believes that a 45-
day notice period would allow the consumer reasonable time to shop for
and provide evidence of insurance. The Board recognizes that it may
take several days for the consumer to receive a notice sent by mail,
but the consumer would still have at least one calendar month in which
to shop for and purchase property insurance. Comment is solicited,
however, on whether a different time period would better serve the
needs of consumers and creditors.
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\54\ See Ark. Code Ann. Sec. 23-101-113 (2008); Mich. Comp.
Laws Sec. 500.1625 (2009); Miss. Code Ann. Sec. 83-54-25 (2008);
Tenn. Code Ann. Sec. 56-49-113 (2009).
\55\ Fannie Mae Single-Family Servicing Guide, Part II, Ch. 6
Lender-Placed Property Insurance (2005).
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Proposed comment 20(e)-1 would make clear that if the creditor
complies with Sec. 226.20(e), the creditor could charge the consumer
for creditor-placed insurance as of the 46th day after sending the
notice to the consumer. For example, a creditor that mails the required
notice on January 2, 2011, may begin to charge the consumer for the
cost of the creditor-placed property insurance on February 18, 2011.
Proposed comment 20(e)-1 would also clarify that the creditor may
charge the consumer for the cost of any required property insurance
obtained during the 45-day notice period if such charge is not
prohibited by applicable State or other law.
Content and format of notice. Proposed Sec. 226.20(e)(3) would
require the creditor to provide the written notice clearly and
conspicuously. Proposed Sec. 226.20(e)(3)(i) would require that the
notice contain the creditor's name and contact information, the loan
number, and the address or description of the property securing the
credit transaction. The Board solicits comment as to whether the
creditor should be required to establish a local or toll-free telephone
number for the consumer to contact the creditor.
Under proposed Sec. 226.20(e)(ii)-(viii), the notice would also
need to contain the following statements: (1) That the consumer is
obligated to maintain insurance on the property securing the credit
transaction; (2) that the required property insurance has lapsed; (3)
that the creditor is authorized to obtain the property insurance on the
consumer's behalf; (4) the date the creditor can charge the consumer
for the cost of the creditor-placed property insurance; (5) how the
consumer may provide evidence of property insurance; (6) the cost of
the creditor-placed property insurance stated as an annual premium, and
that this premium is likely significantly higher than a premium for
property insurance purchased by the consumer; and (7) that the
creditor-placed insurance may not provide as much coverage as
homeowner's insurance. The Board solicits comment on whether the notice
should also contain statements, if applicable, that the creditor will
receive compensation for obtaining creditor-placed property insurance
and that the creditor will establish an escrow account to pay for the
creditor-placed insurance premium. Although such statements would be
informative, the Board is concerned that providing these additional
disclosures could result in information overload for the consumer. A
Model Clause is proposed at Appendix H-18.
The Board proposes to use its authority under TILA Section 105(a),
15 U.S.C. 1604(a), to add Sec. 226.20(e) to require the creditor to
provide notice before charging the consumer for the cost of creditor-
placed property insurance. TILA Section 105(a), 15 U.S.C. 1604(a),
authorizes the Board to prescribe regulations to carry out the purposes
of the act. TILA's purpose includes promoting ``the informed use of
credit,'' which ``results from an awareness of the cost thereof by
consumers.'' TILA Section 102(a), 15 U.S.C. 1601(a). Currently, few
consumers are aware of the cost or coverage of creditor-placed property
insurance, or that the premiums become additional debt of the consumer.
The Board believes that this proposed rule would inform consumers of
the cost and coverage of the creditor-placed property insurance and
avoid the uninformed use of credit. In addition, this proposed rule
would not prohibit the creditor from charging for creditor-placed
property insurance, but would simply delay the charge until the
consumer has been provided sufficient notice of the cost and sufficient
time to shop for his or her own homeowner's insurance.
Section 226.25 Record Retention
25(a) General Rule
Section 226.25(a) provides that creditors must retain records to
evidence compliance with Regulation Z for two years. As discussed in
detail below, the Board is proposing to add a new comment to Sec.
226.25(a) to provide guidance on record retention requirements relating
to proposed Sec. 226.36(d)(1), which would prohibit any person from
paying compensation to a loan originator based on any of the terms or
conditions of the transaction. Proposed comment 25(a)-5 would provide
that, to evidence compliance with proposed Sec. 226.36(d)(1), a
creditor must retain for each covered transaction a record of the
agreement between it and the loan originator that governs the
originator's compensation and a record of the amount of compensation
actually paid to the originator in connection with the transaction.
Section 226.27 Language of Disclosures
Currently, Sec. 226.27, permits TILA disclosures in a language
other than English as long as the disclosures are provided in English
upon the consumer's request. Many consumers do not speak English or
speak English as a second language. According to the 2000 Census, at
least 18% of the population (47 million people) speak a language other
than English at home.\56\ To protect non-native English speakers from
fraud and discrimination in credit transactions, recent enforcement
actions have required that creditors or mortgage brokers provide
translations of presentations, disclosures, or documents.\57\ Moreover,
several states
[[Page 43277]]
have enacted laws to require credit disclosures or documents in Spanish
or other foreign languages.\58\ In 2006, Fannie Mae and Freddie Mac
announced the availability of non-executable Spanish translations of
the Fannie Mae/Freddie Mac Uniform Instrument to help the residential
mortgage industry better serve Spanish-speaking consumers.\59\ Finally,
Congress recently asked the General Accounting Office to conduct a
study examining the relationship between fluency in English and
financial literacy, and the extent, if any, to which individuals whose
native language is not English are impeded in the conduct of their
financial affairs.\60\
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\56\ U.S. Census Bureau, Language Use and English-Speaking
Ability: 2000 at 2 (Oct. 2003), available at http://www.census.gov/
prod/2003pubs/c2kbr-29.pdf.
\57\ See, e.g., In the Matter of First Mariner Bank, Baltimore,
Maryland, FDIC-07-285b, FDIC-08-358k, Consent Agreement at 5 (April
22, 2009) (alleging that the bank discriminated against Hispanics,
African-Americans, and women by charging them higher prices for
residential mortgage loans and requiring the bank to provide
financial literacy courses in English and Spanish); Fed. Trade
Comm'n v. MortgagesParaHispanos.com and Daniel Moises Goldberg, Civ.
Action No. 4:06cv19, Final Judgment and Order at 5 (E.D. Tex. Sept.
27, 2006) (alleging that the mortgage broker misrepresented the
mortgage terms to Spanish-speaking consumers and requiring the
broker to provide a disclosure and consumer education brochure in
Spanish to any consumer if they have reason to believe that the
consumer's primary language is Spanish); In re Ameriquest Mortgage
Co., et al., Settlement Agreement at 17-18 (Jan. 23, 2006)
(requiring documents and disclosures to be translated to Spanish or
to any language in which Ameriquest advertises).
\58\ Ariz. Rev. Stat. Sec. 6-631 (requiring a consumer loan
lender to provide a notice in English and Spanish that the consumer
may request the TILA disclosure in Spanish); Cal. Civ. Code Sec.
1632 (requiring any person engaged in a trade or business who
negotiates certain transactions primarily in Spanish, Chinese,
Tagalog, Vietnamese, or Korean to deliver a translation of the
contract in the language in which the contract was negotiated); DC
Code Ann. Sec. 26-1113 (requiring a post-application mortgage
disclosure to be provided in the language of the mortgage lender's
presentation to the borrower); 815 Ill. Comp. Stat. Ann. 122/2-20
(requiring payday lenders to provide consumers with a written
disclosure in English and in the language in which the loan was
negotiated); Tex. Fin. Code Ann. Sec. 341.502 (requiring that the
TILA disclosure be provided in Spanish if the terms for the consumer
loan, retail installment transaction, or home equity loan were
negotiated in Spanish).
\59\ News Release, Fannie Mae and Freddie Mac Offer Mortgage
Documents in Spanish to Aid Lenders and Industry Partners with
Helping More Hispanics Become Homeowners; Collaborative Effort Aimed
at Helping Close the Hispanic and Overall Minority Homeownership
Gaps (Sept. 25, 2006), available at http://www.fanniemae.com/
newsreleases/2006/3803.jhtml?p=Media&s=News+Releases.
\60\ Credit CARD Act of 2009, Public Law 111-24, Sec. 513, 123
Stat. 1734, 1765 (2009).
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Consumer advocates are concerned that consumers who do not speak
English or speak English as a second language may be more susceptible
to abusive credit practices or offered less favorable credit terms or
products because they are not provided with disclosures they can
understand. Industry representatives, on the other hand, raise concerns
about the cost and burden of translating documents into multiple
foreign languages and the potential liability for inaccurate
translations. Both consumer advocates and industry representatives
question whether consumers who speak minority languages will still have
access to credit if creditors have to bear the cost and liability for
translating documents into little-known languages. Creditors may be
reluctant to engage in outreach to consumers who speak those languages.
The Board solicits comment on whether it should use its rulemaking
authority to require creditors to provide translations of credit
disclosures. Comment is requested on whether the failure to provide
credit disclosure translations is unfair or deceptive, or impedes the
informed use of credit. Comment is also requested on potential
litigation issues, such as whether a translation would be admissible
into evidence or whether an inaccurate translation would toll TILA's
statute of limitations or extend the right of rescission. Finally,
comment is requested on the effectiveness of State laws that require
translations of disclosures or documents and whether the Board should
adopt similar regulations.
The Board requests comment on the following translation issues:
What is the scope of the problem? That is, approximately
how many consumers do not understand TILA disclosures because of
language barriers?
Should creditors be required to provide consumers with
translations of required TILA disclosures? If such translations were
required, what should be the trigger for such disclosures (e.g., the
language of the negotiation, the language of the creditor's
presentation, the language of the creditor's advertisement, a consumer
request)?
Should there be an exception for consumers who are
accompanied by an interpreter?
Would a translation requirement negatively affect
consumers and the type and terms of credit offered because creditors
would be reluctant to risk liability for engaging in transactions in a
language other than English?
Finally, the Board solicits comment on the following coverage
issues:
Should a translation requirement apply only to mortgages
loans, or also to other types of credit products, such as auto loans or
credit cards?
Should a translation requirement apply only to the TILA
disclosures provided before or at consummation, or to any credit
disclosures or documents provided before, at, or subsequent to
consummation?
Should a translation requirement apply to Web sites that
provide early TILA disclosures?
Should a translation requirement apply only to one or a
few languages, or should it apply to any foreign language?
Section 226.32 Requirements for Certain Closed-End Mortgages
32(b) Definitions
32(b)(1)
Section 226.32(b)(1) defines the ``point and fees'' used to
determine whether a loan is a HOEPA loan. That definition consists of
four elements: (i) All items required to be disclosed under Sec.
226.4(a) and 226.4(b), except interest or the time-price differential;
(ii) All compensation paid to mortgage brokers; (iii) All items listed
in Sec. 226.4(c)(7) (other than amounts held for future payment of
taxes) unless the charge is reasonable, the creditor receives no direct
or indirect compensation in connection with the charge, and the charge
is not paid to an affiliate of the creditor; and (iv) Premiums or other
charges for credit life, accident, health, or loss-of-income insurance,
or debt-cancellation coverage (whether or not the debt-cancellation
coverage is insurance under applicable law) that provides for
cancellation of all or part of the consumer's liability in the event of
the loss of life, health, or income or in the case of accident, written
in connection with the credit transaction. In light of the changes to
the finance charge under proposed Sec. 226.4, discussed above, the
Board is proposing technical amendments to this provision.
The reference to ``items required to be disclosed under Sec.
226.4(a) and 226.4(b), except interest or the time-price differential''
in Sec. 226.32(b)(1)(i) implements TILA Section 103(aa)(4)(A). That
provision includes in points and fees ``all items included in the
finance charge, except interest or the time-price differential.'' 15
U.S.C. 1602(aa)(4)(A). Thus, ``items required to be disclosed under
Sec. 226.4(a) and 226.4(b)'' is intended to capture the finance
charge. Section 226.32(b)(1)(ii) and (iii) parallel the additional
elements in TILA Section 103(aa)(4)(B) and (C). See 15 U.S.C.
1602(aa)(4)(B) and (C). Finally, TILA Section 103(aa)(4)(D) provides
for the inclusion of such other charges as the Board determines to be
appropriate. 15 U.S.C. 1602(aa)(4)(D). Pursuant to that authority, in
Sec. 226.32(b)(1)(iv), the Board included credit insurance premiums
and debt cancellation coverage fees. Thus, the statutory definition
reflects Congress's intent to
[[Page 43278]]
include in points and fees mortgage broker compensation, certain real-
estate related fees, and the insurance charges added by the Board, even
if those items would be excluded from the finance charge under other
applicable rules.
Under TILA Section 103(aa)(1), HOEPA applies to certain
transactions that are secured by a consumer's principal dwelling. 15
U.S.C. 1602(aa)(1). Proposed Sec. 226.4(g), and therefore the more
inclusive definition of finance charge it would create, would apply to
any transaction secured by real property or a dwelling. Consequently,
all loans that are potentially subject to HOEPA would be subject to the
proposed ``but for'' finance charge definition. Under that definition,
the items included under the points and fees definition in addition to
the finance charge (other than interest or the time-price differential)
would never be excluded from the finance charge for transactions
secured by real property or a dwelling.
The Board believes that proposed Sec. 226.4 would render Sec.
226.32(b)(1)(ii) through (iv) unnecessary because all items included in
points and fees under those provisions already would be included as
part of the finance charge. To eliminate unnecessary complexity, the
Board proposes to streamline Sec. 226.32(b)(1) by deleting those
additional elements. The Board also proposes to revise Sec.
226.32(b)(1) to provide that points and fees means all items included
in the finance charge pursuant to Sec. 226.4, except interest or the
time-price differential, instead of Sec. 226.32(b)(1)(i)'s reference
to ``items required to be disclosed under Sec. 226.4(a) and
226.4(b).'' This change would reflect the language of TILA more closely
and is not meant to effect any substantive change to HOEPA's coverage.
32(c) Disclosures
32(c)(1) Notices
For HOEPA loans, TILA Sections 129(a)(1)(A) and (B), 15 U.S.C.
1639(a)(1)(A) and (B), and Sec. 226.32(c)(1), require the creditor to
provide the following disclosures in conspicuous type size: ``You are
not required to complete this agreement merely because you have
received these disclosures or have signed a loan application. If you
obtain this loan, the lender will have a mortgage on your home. You
could lose your home, and any money you have put into it, if you do not
meet your obligations under the loan.'' The first sentence is a ``no
obligation'' statement to inform the consumer that the space for the
consumer's signature that may be on the credit application does not
obligate the consumer to accept the terms of the loan. The next two
sentences are ``security interest'' disclosures to inform the consumer
of the potential consequences when the creditor takes a security
interest in the consumer's home. Comment 32(c)(1)-1 states that these
disclosures need not be in a particular format or part of the note or
mortgage document. A Model Clause is currently provided at Appendix H-
16.
As discussed more fully in Sec. 226.38(f)(1), the MDIA amended
TILA Section 128(b)(2), 15 U.S.C. 1638(b)(2), to require the creditor
to provide the following ``no obligation'' statement on the TILA
disclosure: ``You are not required to complete this agreement merely
because you have received these disclosures or signed a loan
application.'' Based on consumer testing, the Board proposes to use its
adjustments and exception authority under TILA Section 105(a), 15
U.S.C. 1604(a), to modify the specific wording on the disclosure.
Proposed Sec. 226.38(f)(1) would require the creditor to provide a
statement that the consumer has no obligation to accept the loan, and,
if the creditor provides space for a consumer's signature, a statement
that a signature by the consumer only confirms receipt of the
disclosure statement. During consumer testing, participants'
comprehension improved when they reviewed the plain-language version of
the clause.
Similarly, based on consumer testing, the Board proposes to use its
adjustments and exception authority under TILA Section 105(a), 15
U.S.C. 1604(a), to require the creditor under proposed Sec.
226.32(c)(1) to provide the following ``no obligation'' statement in
connection with a HOEPA loan: ``You have no obligation to accept this
loan. Your signature below only confirms that you have received this
form.'' TILA Section 105(a), 15 U.S.C. 1604(a), states that the Board
``may provide for such adjustments * * * as in the judgment of the
Board are necessary or proper to effectuate the purposes of [TILA]''.
One of the purposes of TILA is to promote the informed use of credit.
TILA Section 102(a), 15 U.S.C. 1601(a). Consumer testing showed that
the ``no obligation'' language improved participants' understanding of
the key point that signing or accepting a disclosure did not obligate
the consumer to accept the terms of the loan.
In addition, the Board proposes to use its adjustments and
exception authority under TILA Section 105(a), 15 U.S.C. 1604(a), to
require the creditor under proposed Sec. 226.32(c)(1) to provide the
following ``security interest'' statement in connection with a HOEPA
loan: ``If you are unable to make the payments on this loan, you could
lose your home.'' As discussed more fully in Sec. 226.38(f)(2),
consumer testing showed that participant comprehension of this
disclosure improved when the plain-language version of the ``security
interest'' disclosure was used. The Board believes that the plain-
language versions of the ``no obligation'' and ``security interest''
disclosures will better inform consumers who are considering obtaining
HOEPA loans.
The proposal would delete comment 32(c)(1)-1 and require these
statements to be in bold text and a minimum 10-point font, consistent
with proposed Sec. Sec. 226.37 and 226.38. A revised Model Clause is
proposed at Appendix H-16.
32(c)(5) Amount Borrowed
For HOEPA mortgage refinancing loans, Sec. 226.32(c)(5) requires
the creditor to disclose the amount borrowed, and states that ``where
the amount borrowed includes premiums or other charges for optional
credit insurance or debt-cancellation coverage, that fact shall be
stated, grouped together with the disclosure of the amount borrowed.''
In the December 2008 Open-End Final Rule, the existing rules for credit
insurance and debt cancellation coverage were applied to debt
suspension coverage for purposes of excluding a charge for debt
suspension coverage from the finance charge. See 74 FR 5244, 5255; Jan.
29, 2009. In the final rule, the Board stated that ``[d]ebt
cancellation coverage and debt suspension coverage are fundamentally
similar to the extent they offer a consumer the ability to pay in
advance for the right to reduce the consumer's obligations under the
plan on the occurrence of specified events that could impair the
consumer's ability to satisfy those obligations.'' 74 FR 5266. The
Board also noted that the two products are different because debt
cancellation coverage cancels the debt while debt suspension merely
suspends payment of the debt. Id. Despite this difference, the Board
adopted a final rule treating the two products the same for purposes of
the finance charge, but adding a special disclosure warning consumers
of the risks of debt suspension coverage. Id. Consistent with this
approach, the Board proposes to treat debt suspension coverage in the
same manner as debt cancellation coverage for purposes of the
disclosing the amount borrowed for a HOEPA mortgage refinancing loan.
The Board proposes to revise Sec. 226.32(c)(5) to clarify that where
the amount borrowed
[[Page 43279]]
includes charges for debt suspension coverage, that fact should be
stated, grouped together with the disclosure of the amount borrowed.
Proposed comment 32(c)(5)-1 would also be revised to include a
reference to debt suspension coverage. Comment is solicited on this
approach.
Section 226.35 Prohibited Acts or Practices in Connection With Higher-
Priced Mortgage Loans
35(a) Higher-Priced Mortgage Loans
35(a)(2)
In its final rule implementing new requirements for higher-priced
mortgage loans, 73 FR 44522; July 30, 2008, the Board adopted the
``average prime offer rate'' as the benchmark for coverage of new Sec.
226.35. In so doing, the Board adopted commentary under new Sec.
226.35(a)(2) regarding the calculation of the average prime offer rate
and related guidance. Comment 35(a)(2)-4 indicated that the Board
publishes average prime offer rates and the methodology for their
calculation on the Internet. The Board is proposing to amend comment
35(a)(2)-4 to specify where on the Internet the table and methodology
may be found (http://www.ffiec.gov/hmda).
The Board also is proposing new comment 35(a)(2)-5 to provide
additional guidance on determination of applicable average prime offer
rates for purposes of Sec. 226.35. The comment would clarify that the
average prime offer rate is defined identically under Sec. 226.35 and
under Regulation C (HMDA), 12 CFR 203.4(a)(12)(ii). Thus, for purposes
of both coverage of Sec. 226.35 and coverage of the rate spread
reporting requirement under Regulation C, 12 CFR 203.4(a)(12)(i), the
applicable average prime offer rate is identical. The comment would
clarify further that guidance on the applicable average prime offer
rate is provided in the staff commentary under Regulation C, the
Board's A Guide to HMDA Reporting: Getting it Right!, and the relevant
``Frequently Asked Questions'' on HMDA compliance posted on the FFIEC's
Web site referenced above.
Section 226.36 Prohibited Acts or Practices in Connection With Credit
Secured by Real Property or a Consumer's Dwelling
The Board proposes to amend Sec. 226.36 to extend the scope of the
section's coverage to all closed-end transactions secured by real
property or a dwelling. Currently, this section applies to closed-end
credit transactions secured by a consumer's principal dwelling. As
revised, Sec. 226.36 would apply to closed-end transactions secured by
any dwelling, not just a consumer's principal dwelling. This approach
would be consistent with recent amendments to the TILA effected by the
MDIA.
36(a) Loan Originator and Mortgage Broker Defined
As discussed below in more detail, the Board proposes to prohibit
certain payments to loan originators that are based on a transaction's
terms and conditions, and also proposes to prohibit loan originators
from ``steering'' consumers to transactions that are not in their
interest in order to increase the originator's compensation.
Accordingly, the Board proposes to amend the regulation to provide a
definition of ``loan originator'' in Sec. 226.36(a)(1), which would
include persons who are covered by the current definition of mortgage
broker but also would include employees of the creditor, who are not
considered ``mortgage brokers.'' Existing Sec. 226.36(a) defines the
term ``mortgage broker'' because mortgage brokers are subject to the
prohibition on coercion of appraisers in Sec. 226.36(b). A revised
definition of mortgage broker would be designated as Sec.
226.36(a)(2). The provision of existing Sec. 226.36(a) stating that a
creditor making a ``table funded'' transaction is considered a mortgage
broker would be revised for clarity; no substantive change is intended
other than the expansion of the definition from mortgage broker to loan
originator. Thus, under proposed Sec. 226.36(a)(1), a creditor that
does not provide the funds for the transaction at consummation out of
its own resources, out of deposits held by it, or by drawing on a bona
fide warehouse line of credit would be considered a loan originator for
purposes of Sec. 226.36.
36(b) and (c) Misrepresentation of Value of Consumer's Dwelling;
Servicing Practices
The Board proposes to amend Sec. 226.36(b) and (c) to reflect the
expanded scope of coverage of Sec. 226.36, as noted above. Existing
Sec. 226.36(b) prohibits creditors and mortgage brokers and their
affiliates from coercing, influencing, or otherwise encouraging
appraisers to misstate or misrepresent the value of the consumer's
principal dwelling in connection with a closed-end mortgage
transaction. Section 226.36(c) currently prohibits certain practices of
servicers of closed-end consumer credit transactions secured by a
consumer's principal dwelling. Under this proposal, the rules relating
to appraiser coercion and loan servicing would apply to all closed-end
transactions secured by real property or a dwelling, for the reasons
discussed above.
36(d) Prohibited Payments to Loan Originators
The Board is proposing to use its authority in HOEPA to prohibit
unfair or deceptive acts or practices in mortgage lending to restrict
certain practices related to the payment of loan originators. See TILA
Section 129(l)(2)(A), 15 U.S.C. 1639(l)(2)(A). For this purpose, a
``loan originator'' includes both mortgage brokers and employees of
creditors who perform loan origination functions.
Specifically, to address the potential unfairness that can arise
with certain loan originator compensation practices, the proposed rule
would prohibit a creditor or other party from paying compensation to a
loan originator based on the credit transaction's terms or conditions.
This prohibition would not apply to payments that consumers make
directly to a loan originator. However, if a consumer directly pays the
loan originator, the proposed rule would prohibit the originator from
also receiving compensation from any other party in connection with
that transaction.
The Board is soliciting comment on an alternative that would allow
loan originators to receive payments that are based on the principal
loan amount, which is a common practice today. The Board is also
soliciting comment on whether it should adopt a rule that seeks to
prohibit loan originators from directing or ``steering'' consumers to
loans based on the fact that the originator will receive additional
compensation, unless that loan is in the consumer's interest. The Board
is expressly soliciting comment on whether the rule would be effective
in achieving the stated purpose. Comment is also solicited on the
feasibility and practicality of such a rule, its enforceability, and
any unintended adverse effects the rule might have. These proposals and
alternatives are discussed more fully below.
Background
In the summer of 2006, the Board held public hearings on home
equity lending in four cities. During the hearings, consumer advocates
urged the Board to ban ``yield spread premiums,'' payments that
mortgage brokers receive from the creditor at closing for delivering a
loan with an interest rate that is higher than the creditor's ``buy
rate.'' The consumer advocates asserted that yield spread premiums
provide brokers an incentive to increase consumers' interest rates
[[Page 43280]]
unnecessarily. They argued that a prohibition would align reality with
consumers' perception that brokers serve consumers' best interests.
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 of 2007 to explore how it could use its authority under
HOEPA to prevent abusive lending practices in the subprime mortgage
market while still preserving responsible lending. Although the Board
did not expressly solicit comment on mortgage broker compensation in
its notice of the June 2007 hearing, a number of commenters and some
hearing panelists raised the topic. Consumer and creditor
representatives alike raised concerns about the fairness and
transparency of creditors' payment of yield spread premiums to brokers.
Several commenters and panelists stated that consumers are not aware of
the payments creditors make to brokers, or that such payments increase
consumers' interest rates. They also stated that consumers may
mistakenly believe that a broker seeks to obtain the best interest rate
available. Consumer groups have expressed particular concern about
increased payments to brokers for delivering loans both with higher
interest rates and prepayment penalties. Consumer groups suggested a
variety of solutions, such as prohibiting creditors paying brokers
yield spread premiums, imposing on brokers that accept yield spread
premiums a fiduciary duty to consumers, imposing on creditors that pay
yield spread premiums liability for broker misconduct, or including
yield spread premiums in the points and fees test for loans subject to
HOEPA. Several creditors and creditor trade associations advocated
requiring brokers to disclose whether the broker represents the
consumer's interests, and how and by whom the broker is to be
compensated. Some of these commenters recommended that brokers be
required to disclose their total compensation to the consumer and that
creditors be prohibited from paying brokers more than the disclosed
amount.
To address these concerns, the Board's January 2008 proposed rule
would have prohibited a creditor from paying a mortgage broker any
compensation greater than the amount the consumer had previously agreed
in writing that the broker would receive. 73 FR 1672, 1698-1700; Jan.
9, 2008 (HOEPA proposal). In support of the rule, the Board explained
its concerns about yield spread premiums, which are summarized below.
A yield spread premium is the present dollar value of the
difference between the lowest interest rate the wholesale lender would
have accepted on a particular transaction and the interest rate the
broker actually obtained for the lender. This dollar amount is usually
paid to the mortgage broker, though it may also be applied to reduce
the consumer's upfront closing costs. The creditor's payment to the
broker based on the interest rate is an alternative to the consumer
paying the broker directly from the consumer's preexisting resources or
from loan proceeds. Preexisting resources or loan proceeds may not be
sufficient to cover the broker's total fee, or may appear to the
consumer to be a more costly way to finance those costs if the consumer
expects to prepay the loan in a relatively short period. Thus,
consumers potentially benefit from having an option to pay brokers for
their services indirectly by accepting a higher interest rate.
The Board shares concerns, however, that creditors' payments to
mortgage brokers are not transparent to consumers and are potentially
unfair to them. Creditor payments to brokers based on the interest rate
give brokers an incentive to provide consumers loans with higher
interest rates. Some brokers may refrain from acting on this incentive
out of legal, business, or ethical considerations. Moreover,
competition in the mortgage loan market may often limit brokers'
ability to act on the incentive. The market often leaves brokers room
to act on the incentive should they choose, however, especially as to
consumers who are less sophisticated and less likely to shop among
either loans or brokers.
Large numbers of consumers are simply not aware the incentive
exists. Many consumers do not know that creditors pay brokers based on
the interest rate, and the current legally required disclosures seem to
have only limited effect. Some consumers may not even know that
creditors pay brokers: A common broker practice of charging a small
part of its compensation directly to the consumer, to be paid from the
consumer's existing resources or loan proceeds, may lead consumers to
believe, incorrectly, that this amount is all the consumer will pay or
that the broker will receive. Consumers who do understand that the
creditor pays the broker based on the interest rate may not fully
understand the implications of the practice. They may not appreciate
the full extent of the incentive the practice gives the broker to
increase the rate because they do not know the dollar amount of the
creditor's payment.
Moreover, consumers often wrongly believe that brokers have agreed,
or are required, to obtain the best interest rate available. Several
commenters in connection with the 2006 hearings suggested that mortgage
broker marketing cultivates an image of the broker as a ``trusted
advisor'' to the consumer. Consumers who have this perception may rely
heavily on a broker's advice, and there is some evidence that such
reliance is common. In a 2003 survey of older borrowers who had
obtained prime or subprime refinancings, majorities of respondents with
refinance loans obtained through both brokers and creditors' employees
reported that they had relied ``a lot'' on their loan originators to
find the best mortgage for them.\61\ The Board's recent consumer
testing also suggests that many consumers shop little for mortgages and
often rely on one broker or lender because of their trust in the
relationship.
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\61\ See Kellie K. Kim-Sung & Sharon Hermanson, Experiences of
Older Refinance Mortgage Loan Borrowers: Broker- and Lender-
Originated Loans, Data Digest No. 83 (AARP Public Policy Inst.,
Washington, DC, Jan. 2003, at 3, available at http://
assets.aarp.org/rgcenter/post-import/dd83_loans.pdf.
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If consumers believe that brokers protect consumers' interests by
shopping for the lowest rates available, then consumers will be less
likely to take steps to protect their interests when dealing with
brokers. For example, they may be less likely to shop rates across
retail and wholesale channels simultaneously to assure themselves the
broker is providing a competitive rate. They may also be less likely to
shop and negotiate brokers' services, obligations, or compensation
upfront, or at all. For example, they may be less likely to seek out
brokers who will promise in writing to obtain the lowest rate
available.
In response to these concerns, the 2008 HOEPA proposal would have
prohibited a creditor from paying a broker more than the consumer
agreed in writing to pay. Under the proposal, the consumer and mortgage
broker would have had to enter into a written agreement before the
broker accepted the consumer's loan application and before the consumer
paid any fee in connection with the transaction (other than a fee for
obtaining a credit report). The agreement also would have disclosed (i)
that the consumer ultimately would bear the cost of the entire
compensation even if the creditor paid part of it directly; and (ii)
that a creditor's payment to a broker could influence the broker to
offer the consumer loan terms or products that would not be in the
consumer's interest
[[Continued on page 43281]]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
]
[[pp. 43281-43330]] Truth in Lending
[[Continued from page 43280]]
[[Page 43281]]
or the most favorable the consumer could obtain.
Based on the Board's analysis of comments received on the HOEPA
proposal, the results of consumer testing, and other information, the
Board withdrew the proposed provisions relating to broker compensation.
73 FR 44522, 44563-65; July 30, 2008. The Board's withdrawal of those
provisions was based on its concern that the proposed agreement and
disclosures could confuse consumers and undermine their decision-making
rather than improve it. The risks of consumer confusion arose from two
sources. First, an institution can act as either creditor or broker
depending on the transaction. At the time the agreement and disclosures
would have been required, such an institution could be uncertain as to
which role it ultimately would play. This could render the proposed
disclosures inaccurate and misleading in some, and possibly many,
cases. Second, the Board was concerned by the reactions of consumers
who participated in one-on-one interviews about the proposed agreement
and disclosures as part of the Board's consumer testing. These
consumers often concluded, not necessarily correctly, that brokers are
more expensive than creditors. Many also believed that brokers would
serve their best interests notwithstanding the conflict resulting from
the relationship between interest rates and brokers' compensation.\62\
The proposed disclosures presented a significant risk of misleading
consumers regarding both the relative costs of brokers and lenders and
the role of brokers in their transactions.
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\62\ For more details on the consumer testing, see the report of
the Board's contractor, Macro International, Inc., Consumer Testing
of Mortgage Broker Disclosures (July 10, 2008), available at http://
www.federalreserve.gov/newsevents/press/bcreg/
20080714regzconstest.pdf.
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In withdrawing the broker compensation provisions of the HOEPA
proposal, the Board stated it would continue to explore options to
address potential unfairness associated with loan originator
compensation arrangements, such as yield spread premiums. The Board
indicated it would consider whether disclosures or other approaches
could effectively remedy this potential unfairness without imposing
unintended consequences.
Potential for Unfairness in Loan Originator Compensation Practices
As noted above, the Board is now proposing rules to prohibit
certain practices relating to payments made to compensate mortgage
brokers and other loan originators. These rules would be adopted
pursuant to the Board's authority under HOEPA, as contained in TILA
Section 129(l), which authorizes the Board to prohibit acts or practice
in connection with mortgage loans that the Board finds to be unfair or
deceptive. As discussed in part IV above, in considering whether a
practice is unfair or deceptive under TILA Section 129(l), the Board
has generally relied on the standards that have been adopted for
purposes of Section 5(a) of the FTC Act, 15 U.S.C. 45(a), which also
prohibits unfair and deceptive acts and practices.
For purposes of the FTC Act, an act or practice is considered
unfair when it causes or is likely to cause substantial injury to
consumers that is not reasonably avoidable by consumers themselves and
not outweighed by countervailing benefits to consumers or to
competition. As explained below, the practice of basing a loan
originator's compensation on the credit transaction's terms or
conditions appears to meet these standards and constitute an unfair
practice. Furthermore, based on its experience with consumer testing,
particularly in connection with the HOEPA proposal, the Board believes
that disclosure alone would be insufficient for most consumers to avoid
the harm caused by this practice. Thus, the Board is proposing a rule
that would remedy the practice through substantive regulations that
prohibit particular practices.
Specifically, under proposed Sec. 226.36(d)(1), compensation
payments made to a mortgage broker or any other loan originator based
on a mortgage transaction's terms or conditions would be prohibited.
Unlike the 2008 HOEPA proposal, the rule would also apply to creditors'
employees who originate loans. As noted above, such payments when made
to a mortgage broker are commonly referred to as yield spread premiums.
There are analogous payments made by creditors to their employees who
originate loans at a higher interest rate than the minimum rate
required by the creditor. This arrangement is frequently referred to as
an ``overage.'' For convenience, the discussion below uses the term
``yield spread premium'' also to refer to these types of payments,
which would be covered by the proposed rule as well.
Substantial injury. When loan originators receive compensation
based on a transaction's terms and conditions, they have an incentive
to provide consumers loans with higher interest rates or other less
favorable terms. Yield spread premiums, therefore, present a
significant risk of economic injury to consumers. Currently, such
injury is common because consumers typically are not aware of the
practice or do not understand its implications and cannot effectively
negotiate its use.
Creditors' payments to mortgage brokers or their own employees that
originate loans (``loan officers'') generally are not transparent to
consumers. Brokers may impose a direct fee on the consumer which may
lead consumers to believe that this is the sole source of the broker's
compensation. While consumers expect the creditor to compensate its own
loan officers, they do not necessarily understand that the loan
originator may have the ability to increase the creditor's interest
rate or include certain loan terms for the originator's own gain.
To guard effectively against this practice, a consumer would have
to know the lowest interest rate the creditor would have accepted to
ascertain that the offered interest rate represents a rate increase by
the loan originator. Most consumers will not know the lowest rate the
creditor would be willing to accept. The consumer also would need to
understand the dollar amount of the yield spread premium that is
generated by the rate increase to determine what portion, if any, is
being applied to reduce the consumer's upfront loan charges. Although
HUD recently adopted disclosures in Regulation X, implementing RESPA,
that could enhance some consumers' understanding of mortgage broker
compensation, the details of the compensation arrangements are complex
and the disclosures are limited. A creditor may show the yield spread
premium as a credit to the borrower that is applied to cover upfront
costs, but is also permitted to add the amount of the yield spread to
the total origination charges being disclosed. This would not
necessarily inform the consumer that the rate has been increased by the
originator and that a lower rate with a smaller origination charge was
also available. In addition, the Regulation X disclosure concerning
yield spread premiums would not apply to overages occurring when the
loan originator is employed by the creditor. Thus, the Regulation X
disclosure, while perhaps an improvement over previous rules, is not
likely by itself to prevent consumers from incurring substantial injury
from the practice.
Because consumers generally do not understand the yield spread
premium mechanism, they are unable to engage in effective negotiation.
Instead they are more likely to rely on the loan originator's advice
and frequently obtain a higher rate or other unfavorable terms
[[Page 43282]]
solely because of greater originator compensation. These consumers
suffer substantial injury by incurring greater costs for mortgage
credit than they would otherwise be required to pay.
Injury not reasonably avoidable. Yield spread premiums create a
conflict of interest between the loan originator and consumer. As noted
above, many consumers are not aware of creditor payments to loan
originators, especially in the case of mortgage brokers, because these
arrangements lack transparency. Although consumers may reasonably
expect creditors to compensate their own employees, consumers do not
know how the loan officer's compensation is structured or that the loan
officer can increase the creditor's interest rate or offer certain loan
terms to increase their own compensation. Without this understanding,
consumers cannot reasonably be expected to appreciate or avoid the risk
of financial harm these arrangements represent.
Yield spread premiums are complex and may be counter-intuitive even
to well-informed consumers. Based on the Board's experience with
consumer testing, the Board believes that disclosures are insufficient
to overcome the gap in consumer comprehension regarding this critical
aspect of the transaction. Currently, the required disclosures of
originator compensation under federal and State laws seem to have
little, if any, effect on originators' incentive to provide consumers
with increased interest rates or other unfavorable loan terms, such as
a prepayment penalty, that can increase the originator's
compensation.\63\ The Board's consumer testing, discussed above,
supported the finding that disclosures about yield spread premiums are
ineffective; consumers in these tests did not understand yield spread
premiums and did not grasp how they create an incentive for loan
originators to increase consumers' costs.
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\63\ Creditors may be willing to offer a loan with a lower
interest rate in return for including a prepayment penalty. A loan
originator that offers a loan with a prepayment penalty might not
offer the lower rate, resulting in a premium interest rate and the
payment of a yield spread premium.
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Consumers' lack of comprehension of yield spread premiums is
compounded where the originator also imposes a direct charge on the
consumer. A mortgage broker might charge the consumer a direct fee, for
example $500, for arranging the consumer's mortgage loan. This charge
encourages consumers to infer that the broker accepts the consumer-paid
fee to represent the consumer's financial interests. Consumers may
believe that the fee they pay is the originator's sole compensation.
This may lead reasonable consumers to believe, erroneously, that loan
originators are working on their behalf and are under a legal or
ethical obligation to help consumers obtain the most favorable loan
terms and conditions. There is evidence that consumers often regard
loan originators as ``trusted advisors'' or ``hired experts'' and
consequently rely on originators' advice. Consumers who regard loan
originators in this manner are far less likely to shop or negotiate to
assure themselves that they are being offered competitive mortgage
terms. Even for consumers who shop, the lack of transparency in
originator compensation arrangements makes it unlikely consumers will
avoid yield spread premiums that unnecessarily increase the cost of
their loan.
Consumers generally lack expertise in complex mortgage transactions
because they engage in such mortgage transactions infrequently. Their
reliance on the loan originator is reasonable in light of the
originator's greater experience and professional training in the area,
the belief that originators are working on their behalf, and the
apparent ineffectiveness of disclosures to dispel that belief.
Injury not outweighed by benefits to consumers or to competition.
Yield spread premiums can represent a potential consumer benefit in
cases where the amount is applied to reduce consumers' upfront closing
costs, including originator compensation. A creditor's increase in the
interest rate (or the addition of other loan terms) may be used to
generate additional income that the creditor uses to compensate the
originator, in lieu of adding origination points or fees that the
consumer would be required to pay directly from the consumer's
preexisting funds or the loan proceeds. This can benefit a consumer who
lacks the resources to pay closing costs in cash, or who might have
insufficient equity in the property to increase the loan amount to
cover these costs. Further, some consumers prefer to fund closing
costs, including origination fees, through a higher rate if the
consumer expects to own the property or have the loan for a relatively
short period, for example, less than five years. For those consumers
who understand this trade-off there could be potential benefits. In
such cases, however, the yield spread premium does not increase the
amount of compensation paid by the creditor to the originator, who
would receive the same amount whether the loan has a higher rate or a
lower rate accompanied by higher upfront fees.
Nevertheless, without a clear understanding of yield spread
premiums or effective disclosure, the majority of consumers are not
equipped to police the market to ensure that yield spread premiums are
in fact applied to reduce their closing costs, especially in the case
of loan originator compensation. This would be particularly difficult
because consumers are not likely to have any basis for determining a
``typical'' or ``reasonable'' amount for originator compensation.
Accordingly, the Board is proposing a rule that prohibits any person
from basing a loan originator's compensation on the loan's rate or
terms but still affords creditors the flexibility to structure loan
pricing to preserve the potential consumer benefit of compensating an
originator through the interest rate.
The Board's Proposal
Under Sec. 226.36(d)(1), the Board proposes to prohibit any person
from compensating a loan originator, directly or indirectly, based on
the terms or conditions of a loan transaction secured by real property
or a dwelling. This prohibition would apply to any person, rather than
only a creditor, to prevent evasion by structuring loan originator
payments through non-creditors. For example, secondary market investors
that purchase closed loans from creditors would not be permitted to pay
compensation to loan originators that is based on the terms or
conditions of their transactions.
Under the proposal, compensation that is based on the loan amount
would be considered a payment that is based on a term or condition of
the loan. The prohibition would not apply to consumers' direct payments
to loan originators. Under Sec. 226.36(d)(2), however, if the consumer
compensates the loan originator directly, the originator would be
prohibited from receiving compensation from the creditor or any other
person.
Because the loan originator could not receive compensation based on
the interest rate or other terms, the originator would have no
incentive to alter the terms made available by the creditor to deliver
a more expensive loan. For example, a company acting as a mortgage
broker could not provide greater compensation to its employee acting as
the loan originator for a transaction with a 7 percent interest rate
than for a transaction with a 6 percent interest rate. A creditor would
be under the same restriction in compensating its loan officer. For
this purpose, the term ``compensation'' would not be limited to
commissions, but would include
[[Page 43283]]
salaries or any financial incentive that is tied to the transaction's
terms or conditions, including annual or periodic bonuses or awards of
merchandise or other prizes. See proposed comment 36(d)(1)-1.
Proposed comment 36(d)(1)-2 provides examples of compensation that
is based on the transaction's terms or conditions, such as payments
that are based on the interest rate, annual percentage rate, or the
existence of a prepayment penalty. Examples of loan originator
compensation that is not based on the transaction's terms or conditions
are listed in proposed comment 36(d)(1)-3. These include compensation
based on the originator's loan volume, the performance of loans
delivered by the originator, or hourly wages.
The Board recognizes that loans originators may need to expend more
time and resources in originating loans for consumers with limited or
blemished credit histories. Because such loans are likely to carry
higher rates, originators currently rely on higher yield spread
premiums to compensate them for the additional time and efforts. Paying
an originator based on the time expended would be permissible under the
proposed rule.
Although the proposed rule would not prohibit a creditor from
basing compensation on the originator's loan volume, such arrangements
may raise concerns about whether it creates incentives for originators
to deliver loans without proper regard for the credit risks involved.
The Board expects creditors to exercise due diligence to monitor and
manage such risks. Financial institution regulators generally will
examine creditors they supervise to ensure they have systems in place
to exercise such due diligence.
The proposed rule also would not prohibit compensation that differs
by geographical area, but any such arrangements must comply with other
applicable laws such as the Equal Credit Opportunity Act (15 U.S.C.
1691-1691f) and Fair Housing Act (42 U.S.C. 3601-3619). See proposed
comment 36(d)(1)-4. Creditors that use geography as a criterion for
setting originator compensation would need to be able to demonstrate
that this reflects legitimate differences in the costs of origination
and in the levels of competition for originators' services.
Under the proposed rule, creditors also may compensate their own
loan officers differently than mortgage brokers. For instance, in light
of the fact that mortgage brokers relieve creditors of certain overhead
costs of loan originations, a creditor might pay brokers more than its
own loan officers. Likewise, a creditor might pay one loan originator
of either type more than it pays another, as long as each originator
receives compensation that is not based on the terms of the
transactions they deliver to the creditor.
Scope of coverage. The Board believes that the proposed rule should
apply to creditors' employees who originate loans in addition to
mortgage brokers. A creditor's loan officers frequently have the same
discretion over loan pricing that mortgage brokers have to modify a
loan's terms to increase their compensation, and there is evidence
suggesting that loan officers engage in such practices.\64\
Accordingly, the coverage of Sec. 226.36(d)(1) is broader than the
2008 HOEPA proposal, which covered only mortgage brokers. Some
commenters on the HOEPA proposal expressed concern that it would create
an ``unlevel playing field'' by creating an unfair advantage for
creditors that would not have to comply with the same requirements as
brokers.
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\64\ For example, the Federal Trade Commission's settlement with
Gateway Funding, Inc. in December 2008 illustrates a case where a
creditor's loan officers created ``overages,'' although the primary
legal theory concerned disparate treatment by race in the imposition
of overages. The FTC's complaint and the court's final judgment and
order can be found on the FTC's web-site at http://www.ftc.gov/os/
caselist/0623063/index.shtm. The FTC has since filed a complaint
alleging similar patterns of overages in violation of fair lending
laws, against Golden Empire Mortgage, Inc. The May 2009 complaint
can be found at http://www.ftc.gov/os/caselist/0623061/
090511gemcmpt.pdf. A similar pattern of overages was alleged in
legal actions brought by the Department of Justice (DOJ), which
resulted in settlement agreements with Huntington Mortgage Company
(1995) and Fleet Mortgage Corp. (1996).
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The proposed rule would apply to covered transactions whether or
not they are higher-priced mortgage loans. A loan originator's
financial incentive to deliver less favorable loan terms to a consumer
could result in consumer injury whether or not the loan has a rate
above the coverage threshold in Sec. 226.35. The risks of harm could
be reduced in the lower-priced segment of the market, however, where
consumers historically have more choices. Comment is solicited on the
relative costs and benefits of applying the rule to all segments of the
market, and whether the costs would outweigh the benefits for loans
below the higher-priced mortgage loan threshold.
Creditors' pricing flexibility. The proposed rule would not affect
creditors' flexibility in setting rates or other loan terms. The rule
does not limit the creditor's ability to adjust the loan terms it
offers to consumers as a means of financing costs the consumer would
otherwise be obligated to pay directly (in cash or out of the loan
proceeds), including the originator's compensation, provided this does
not affect the amount the originator receives for the transaction.
Thus, a creditor could recoup costs by adding to the loan pricing terms
an origination point (calculated as one percentage point of the loan
amount) even though the creditor could not pay the originator's
compensation on that basis. Similarly, a creditor could add a constant
premium of, for instance, \1/4\ of one percent to the interest rates on
all transactions for which the creditor will pay compensation to the
loan originator, as a means of recouping the cost of the originator's
compensation. The creditor would not recoup the same dollar amount in
each transaction, however, because the present value of the premium in
dollars would vary with the loan amount. Consequently, even though loan
pricing could be set in this manner, this method could not be used to
set the loan originator's compensation. See proposed comment 36(d)(1)-
5.
Effect of modification of loan terms. The proposed rule is designed
to prevent consumers from being harmed by loan originators making
unfavorable modifications to loan terms, such as increasing the
interest rate, to increase the originator's compensation. Currently,
loan originators might also exercise discretion to make modifications
in the consumer's favor. For example, to retain the consumer's
business, today a loan originator might agree with the consumer to
reduce the amount the consumer must pay in origination points on the
loan, which would be funded by a reduction in the amount the originator
receives from the creditor as compensation for delivering the loan.
Under the proposed rule, however, a creditor would not be permitted to
reduce the amount it pays to the loan originator based on such a change
in loan terms. As a result, the reduction in origination points would
be a cost borne by the creditor.
Thus, when the creditor offers to extend a loan with specified
terms and conditions (such as the rate and points), the amount of the
originator's compensation for that transaction is not subject to
change, through either an increase or a decrease, even if different
loan terms are negotiated. If this were not the case, a creditor
generally could agree to compensate originators at a high level and
then subsequently lower the compensation only in selective cases, such
as when the consumer obtains a competing offer with a lower interest
rate. This would have the same
[[Page 43284]]
effect as increasing the originator's compensation for higher rate
loans. Proposed comment 36(d)(1)-6 would address this issue.
Periodic changes in loan originator compensation. Under proposed
Sec. 226.36(d)(1) a creditor would not be prevented from periodically
revising the compensation it agrees to pay a loan originator. However,
a creditor may not revise a loan originator's compensation arrangement
in connection with each transaction. This guidance is reflected in
proposed comment 36(d)(1)-7. The revised compensation arrangement must
result in payments to the loan originator that are not based on the
terms or conditions of a credit transaction. A creditor might
periodically review factors such as loan performance, transaction
volume, as well as current market conditions for originator
compensation, and prospectively revise the compensation it agrees to
pay to a loan originator. For example, assume that during the first six
months of the year, a creditor pays $3,000 to a particular loan
originator for each loan delivered, regardless of the loan terms. After
considering the volume of business produced by that originator, the
creditor could decide that as of July 1, it will pay $3,250 for each
loan delivered by that originator, regardless of the loan terms. The
change in compensation would not be a violation even if the loans made
by the creditor after July 1 generally carry higher interest rates than
loans made before that date.
Alternative to permit compensation based on loan amount. The Board
is also publishing for comment a proposed alternative that would allow
loan originator compensation to be based on the loan amount, which
would not be considered a transaction term or condition for purposes of
the prohibition in Sec. 226.36(d)(1). Currently, the compensation
received by many mortgage originators is structured as a percentage of
the loan amount. Other participants in the mortgage market, such as
creditors, mortgage insurers, and other service providers, also receive
compensation based on the loan amount. The Board is therefore seeking
comment on whether prohibiting originator compensation on this basis
might be unduly restrictive and unnecessary to achieve the purposes of
the proposed rule.
On the other hand, prohibiting compensation based on the loan
amount would eliminate an incentive for the originator to steer
consumers to a larger loan amount. Such steering maximizes the
originator's compensation but also increases the transaction's loan-to-
value ratio and decreases the consumer's equity in the property. If the
loan-to-value ratio increases sufficiently, the consumer may incur
additional costs in the form of a higher interest rate or additional
points and fees, including the cost of mortgage insurance premiums.
Because the consumer's monthly payment would also be larger, the
originator might direct the consumer to riskier loan products that have
discounted initial rates but are subject to significant payment
increases after the introductory period expires.
Because of the foregoing concerns, the Board is publishing two
alternative versions of proposed Sec. 226.36(d)(1). The first
alternative would consider the loan amount as a term or condition of
the loan, thereby prohibiting the payment of originator compensation as
a percentage of the loan amount. The second alternative provides that
the loan amount is not a term or condition of the loan, and would
permit such payments. The second alternative would be accompanied by
proposed comment 36(d)(1)-10 to provide further guidance. Under
proposed comment 36(d)(1)-10, a loan originator could be paid a fixed
percentage of the loan amount even though the dollar amount paid by a
particular creditor would vary from transaction to transaction and
would increase as the loan amount increases. Comment 36(d)(1)-10 also
permits compensation paid as a fixed percentage of the loan amount to
be subject to a specified minimum or maximum dollar amount. For
example, a loan originator's compensation could be set at one percent
of the principal loan amount but not less than $1,000 or greater than
$5,000.
The Board seeks comment on the two alternatives. Further, if the
final rule permits compensation based on the loan amount, should
creditors be permitted to apply different percentages to loans of
different amounts? Should creditors be allowed to pay a larger
percentage for smaller loan amounts, which could be an incentive to
originate loans in lower- priced neighborhoods that ensures that the
originator receives an amount that is comparable to loans originated in
high-priced neighborhoods? If so, should creditors also be permitted to
pay originators a higher percentage for larger loan amounts?
Prohibition of compensation from both the consumer and another
source. Proposed Sec. 226.36(d)(2) would provide that, if a loan
originator is compensated directly by the consumer for a transaction
secured by real property or a dwelling, no other person may pay any
compensation to the originator for that transaction. Direct
compensation paid by a consumer to a loan originator would not be
limited to ``origination fees,'' ``broker fees,'' or similarly labeled
charges. Rather, compensation for this purpose includes any payment by
the consumer that is retained by the loan originator. Thus, a creditor
that is a loan originator by virtue of making a table funded
transaction, as discussed above, would be subject to this prohibition
if it imposes and retains any direct charge on the consumer for the
transaction.
Consumers reasonably may believe that when they pay a loan
originator directly, that amount is the only compensation the
originator will receive. As discussed above, consumers generally are
not aware of creditor payments to originators. If the consumer were
aware of such payments, the consumer might reasonably expect that
making a direct payment to an originator would reduce or eliminate the
need for the creditor to fund the originator's compensation through the
consumer's interest rate. Because the consumer is unaware of yield
spread premiums, however, the consumer cannot effectively negotiate the
originator's compensation. In fact, if consumers pay loan originators
directly and creditors also pay originators through higher rates,
consumers may be injured by unwittingly paying originators more in
total compensation (directly and through the rate) than consumers
believe they agreed to pay.
The Board believes that simply disclosing the yield spread premium
would not address this injury to consumers. Consumer testing in
connection with the Board's 2008 HOEPA Final Rule shows that, even with
a disclosure, consumers do not understand how a creditor payment to a
loan originator can result in a higher interest rate for the consumer.
A disclosure therefore cannot inform consumers that they effectively
are paying the loan originator more than they believe they agreed to
pay. Without that knowledge, consumers cannot take steps to protect
their own interests, such as by negotiating for a smaller direct
payment, a lower rate, or both.
The Board also believes that this prohibition would increase
transparency for consumers by requiring that all originator
compensation come from the creditor or from the consumer, but not both.
This additional consequence of proposed Sec. 226.36(d)(2) would reduce
the total number of loan pricing variables with which the consumer must
contend. There is evidence that such simplification is consistent with
TILA's purpose of promoting the informed use of
[[Page 43285]]
consumer credit.\65\ See TILA Section 102(a), 15 U.S.C. 1601(a).
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\65\ See, e.g., Woodward, Susan E., A Study of Closing Costs for
FHA Mortgages at 70-73 (Urban Institute and U.S. Department of
Housing and Urban Development 2008), available at http://
www.urban.org/UploadedPDF/411682_fha_mortgages.pdf.
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Proposed Sec. 226.36(d)(2) would prohibit only payments to an
originator that are made in connection with the particular credit
transaction, such as a commission for delivering the loan. The rule is
not intended to prohibit payment of a salary to a loan originator who
also receives direct compensation from a consumer in connection with
that consumer's transaction. This guidance is contained in proposed
comment 36(d)(2)-1.
Record retention requirements. Creditors are required by Sec.
226.25(a) to retain evidence of compliance with Regulation Z for two
years. Proposed staff comment 25(a)-5 would be added to clarify that,
to demonstrate compliance with Sec. 226.36(d)(1), a creditor must
retain at least two types of records.
First, a creditor must have a record of the compensation agreement
with the loan originator that was in effect on the date the
transaction's rate was set. The Board believes this date is most likely
when a loan originator's compensation was determined for a given
transaction. The Board seeks comment, however, on whether some other
time would be more appropriate, in light of the purposes of the
proposed rule. Proposed comment 25(a)-5 would clarify that the rules in
Sec. 226.35(a) would govern in determining when a transaction's rate
is set.
Second, proposed comment 25(a)-5 would state that a creditor must
retain a record of the actual amount of compensation it paid to a loan
originator in connection with each covered transaction. The proposed
comment would clarify that, in the case of mortgage brokers, the HUD-1
settlement statement required under RESPA would be an example of such a
record because it itemizes the compensation received by a mortgage
broker. The Board solicits comment on whether any comparable record
exists for loan officer compensation that should be referenced in
proposed comment 25(a)-5. To facilitate compliance, a cross reference
to the record retention requirement would be included in proposed
comment 36(d)(1)-9.
The Board solicits comment on whether there are other records that
should be subject to the retention requirements. The Board also seeks
comment on whether the existing two-year record retention period is
adequate for purposes of the rules governing loan originator
compensation.
The current record retention requirements in Sec. 226.25 apply
only to creditors. Although loan originator compensation has
historically been paid by creditors, the prohibitions in Sec.
226.36(d) apply more broadly to any person to prevent evasion by
restructuring of payments through non-creditors. Accordingly, the Board
expects that payments to loan originators will continue to be made
largely by creditors. The Board seeks comment on whether there is a
need to adopt requirements for retaining records concerning originator
compensation that would apply to persons other than creditors,
including the relative costs and benefits of that approach.
36(e) Prohibition on Steering
Optional Proposal on Steering by Loan Originators
The Board is also soliciting comment on whether it should adopt a
rule that seeks to prohibit loan originators from directing or
``steering'' consumers to loans based on the fact that the originator
will receive additional compensation, when that loan may not be in the
consumer's best interest. Under proposed Sec. 226.36(d)(1), a loan
originator would receive the same compensation from a particular
creditor regardless of the transaction's rate or terms. That provision,
however, would not prohibit a loan originator from directing a consumer
to transactions from a single creditor that offers greater compensation
to the originator, while ignoring possible transactions having lower
interest rates that are available from other creditors.
Attempting to address this issue presents difficulties. Determining
whether a loan originator was warranted in directing a consumer to a
loan that resulted in greater compensation for the originator also
involves a determination of whether that loan was in the consumer's
best interest compared to other available loan products. There is,
however, no uniform method for making that evaluation. Consumers and
loan originators may choose from among possible loan offers for a
variety of reasons. The annual percentage rate (APR) is a tool that
facilitates comparison shopping among different loans, but it is
imperfect for reasons that are well documented, including the fact that
the APR is calculated by amortizing origination fees over the full loan
term rather than the expected life of the loan. See the 1998 Joint
Report to the Congress by the Board and HUD, cited above. In
considering interest rates, consumers may view the economic trade-off
between rates and points differently depending on their individual
financial circumstances or the amount of time they expect to hold the
loan. Moreover, consumers evaluate other factors in deciding whether a
loan is in their best interest even if it is not represented as the
lowest cost option among the possible loan offers available through the
originator. Thus, some consumers may reasonably determine that the
financial risk created by a loan's prepayment penalty is acceptable in
light of the loan's lower interest rate, while other consumers may
prefer to accept a higher rate to avoid the risk. Consumers and loan
originators also may consider factors other than loan cost, such as the
creditor's rate lock-in policies, or the creditor's reputation for
delivering loans within the promised time-frame, especially for home-
purchase loans.
The Board believes, however, that there is benefit in attempting to
craft a rule that prohibits and deters the most egregious practices,
even if such a rule cannot ensure that consumers always obtain the
lowest cost loan. Under the proposal, a loan originator would have a
duty not to steer a consumer to higher cost loans that pay more to the
originator when the loan is not in the consumer's interest. Originators
would violate the rule, for example, if they directed the consumer to a
fixed-rate loan option from a creditor that maximizes the originator's
compensation without providing the consumer with an opportunity to
choose from other available loans that have lower fixed interest rates
with the equivalent amount in origination and discount points.
The Board is publishing a proposal, designated as proposed Sec.
226.36(e)(1), to reflect this optional approach. Specifically, the rule
would prohibit loan originators from directing or ``steering'' a
consumer to consummate a transaction secured by real property or a
dwelling that is not in the consumer's interest, based on the fact that
the originator will receive greater compensation from the creditor in
that transaction than in other transactions the originator offered or
could have offered to the consumer. The proposed rule seeks to preserve
consumer choice by ensuring that consumers have appropriate loan
options that reflect considerations other than the maximum amount of
compensation that will be paid to the originator. Proposed comments
36(e)(1)-1 through -3 would provide additional guidance on the rule.
[[Page 43286]]
Proposed Sec. 226.36(e) would not require a loan originator to
direct a consumer to the transaction that will result in the least
amount of compensation being paid to the originator by the creditor.
However, if the loan originator reviews possible loan offers available
from a significant number of the creditors with which the originator
regularly does business and the originator directs the consumer to the
transaction that will result in the least amount of creditor-paid
compensation, the requirements of Sec. 226.36(e) would be deemed to be
satisfied. See proposed comment 36(e)(1)-2(ii).
Loan originators employed by the creditor in a transaction would be
prohibited under Sec. 226.36(d)(1) from receiving compensation based
on the terms or conditions of the loan. Thus, when originating loans
for the employer, the originator could not steer the consumer to a
particular loan to increase compensation. Accordingly, in those cases,
their compliance with Sec. 226.36(d)(1) would be deemed to satisfy the
requirements of proposed Sec. 226.36(e). See proposed comment
36(e)(1)-2(ii). A creditor's employee, however, occasionally might act
as a broker in forwarding a consumer's application to a creditor other
than the originator's employer, such as when the employer does not
offer any loan products for which the consumer would qualify. If the
originator is compensated for arranging the loan with the other
creditor, the originator would not be an employee of the creditor in
that transaction and would be subject to proposed Sec. 226.36(e).
The Board is also publishing provisions that would facilitate
compliance with the prohibition in proposed Sec. 226.36(e)(1). Under
proposed Sec. 226.36(e)(2) and (3), a safe harbor would be created,
and there would be no violation if the loan was chosen by the consumer
from at least three loan options for each type of transaction (fixed-
rate or adjustable-rate loan) in which the consumer expressed an
interest, provided the following conditions are met. The loan
originator must obtain loan options from a significant number of
creditors with which the originator regularly does business. For each
type of transaction in which the consumer expressed an interest, the
originator must present and permit the consumer to choose from at least
three loans that include: the loan with the lowest interest rate, the
loan with the second lowest interest rate, and the loan with the lowest
total dollar amount for origination points or fees and discount points.
The loan originator must have a good faith belief that these are loans
for which the consumer likely qualifies. If the originator presents
more than three loans to the consumer, the originator must highlight
the three loans that satisfy the lowest rate and points criteria in the
rule. Proposed comments 36(e)(2)-1 and 36(e)(3)-1 though -4 would
provide guidance on the application of the rule.
Comment is expressly solicited on whether the proposed rule in
Sec. 226.36(e) and the accompanying commentary would be effective in
achieving the stated purpose. Comment is also solicited on the
feasibility and practicality of such a rule, its enforceability, and
any unintended adverse effects the rule might have.
36(f)
The Board proposes to redesignate existing Sec. 226.36(d) as Sec.
226.36(f). Existing Sec. 226.36(d) provides that Sec. 226.36 does not
apply to home-equity lines of credit (HELOCs). The redesignation would
accommodate proposed new Sec. 226.36(d) and (e), discussed above.
The Board proposed as part of the 2008 HOEPA proposal to exclude
HELOCs from the coverage of Sec. 226.36 because of two considerations,
which suggested that the protections may be unnecessary for such
transactions. First, the Board understood that most originators of
HELOCs hold them in portfolio rather than sell them, which aligns these
originators' interests in loan performance more closely with their
borrowers' interests. Second, the Board understood that HELOCs are
concentrated in the banking and thrift industries, where the federal
banking agencies can use their supervisory authority to protect
consumers. The Board sought comment on whether these considerations
were valid or whether any or all of the protections in Sec. 226.36
should apply to HELOCs. Although mortgage lenders and other industry
representatives commented in support of the proposed exclusion and
consumer advocates commented in opposition, neither group provided the
Board with substantial evidence as to whether the kinds of problems
Sec. 226.36 addresses exist in the HELOC market.
In the July 2008 HOEPA Final Rule, the Board limited the scope of
Sec. 226.36 to closed-end mortgages. In the absence of clear evidence
of abuse, the Board continued to believe the protections may be
unnecessary for the reasons discussed above. Nevertheless, the Board
remains aware of concerns that creditors may structure transactions as
HELOCs solely to evade the protections of Sec. 226.36. The Board also
is aware that many of the same opportunities and incentives that
underlie the abuses addressed by Sec. 226.36 for closed-end mortgages
may well exist for HELOCs. Reasons therefore exist for positing that
such unfair practices either may or may not occur with HELOCs, but the
Board lacks concrete evidence as to which is the case.
The Board requests comment on whether any or all of the protections
in Sec. 226.36 should apply to HELOCs. Specifically, what evidence
exists that shows whether loan originators unfairly manipulate HELOC
terms and conditions to receive greater compensation, injuring
consumers as a result? What evidence is there as to whether appraisals
obtained for HELOCs have been influenced toward misstating property
values? To what extent do creditors contract out HELOC servicing to
third parties, thus undermining the Board's premise regarding aligned
interests between servicers and consumers? Whether third parties or the
original creditors primarily service HELOCs, what evidence shows
whether they engage in the abusive servicing practices addressed by
Sec. 226.36(c)?
Section 226.37 Special Disclosure Requirements for Closed-End Mortgages
Section 226.17(a), which implements Sections 122(a) and 128(b)(1)
of TILA, addresses format and other disclosure standards for all
closed-end credit. 15 U.S.C. 1632(a), 1638(b)(1). For closed-end
credit, creditors must provide disclosures in writing in a form that
the consumer may keep, grouped together and segregated from other
information. In addition, the loan's ``finance charge'' and ``annual
percentage rate,'' using those terms, must be more conspicuous than
other required disclosures.
The Board proposes special rules in new Sec. 226.37 to govern the
format of required disclosures under TILA for transactions secured by
real property or a dwelling. These new rules would be in addition to
the rules in Sec. 226.17. The proposed format rules are intended to
(1) improve consumers' ability to identify disclosed loan terms more
readily; (2) emphasize information that is most important to the
consumer in the decision-making process; and (3) simplify the
organization and structure of required disclosures to reduce complexity
and ``information overload.'' Proposed Sec. 226.37 would establish
special format rules for disclosures required by proposed Sec. Sec.
226.38 and 226.20(d), and existing Sec. Sec. 226.19(b) and 226.20(c).
The Board is proposing Sec. 226.37 and associated commentary to
address the
[[Page 43287]]
duty to provide ``clear and conspicuous'' disclosures that are grouped
together and segregated from other information, and to require that
certain information be highlighted in table form or in a graph.
Proposed Sec. 226.37 would also require creditors to use consistent
terminology for all disclosures. The Board is proposing to revise the
requirement that certain terms be used or disclosed more conspicuously,
for transactions secured by real property or a dwelling. The general
disclosure standards under Sec. 226.17(a)(1) and associated commentary
continue to apply transactions secured by real property or a dwelling
but, under the proposal creditors would also be required to meet the
higher standards under proposed Sec. 226.37.
37(a) Form of Disclosures
37(a)(1) Clear and Conspicuous
Section 122(a) of TILA and Sec. 226.17(a)(1) require that all
closed-end credit disclosures be made clearly and conspicuously. 15
U.S.C. 1632(a). Currently, under comment 17(a)(1)-1, the Board
interprets the clear and conspicuous standard to mean that disclosures
must be in a ``reasonably understandable'' form. This standard does not
require any mathematical progression or format, or that disclosures be
provided in a particular type size, although disclosures must be
legible whether typewritten, handwritten, or printed by computer.
Comment 17(a)(1)-3 provides that the standard does not require
disclosures to be located in a particular place.
Consumer testing conducted by the Board showed that information
presented without any highlighting or other emphasis, and the use of
small print led many participants to miss or disregard key information
about the loan transaction. As discussed more fully under the following
sections, consumer testing indicates that when certain information is
presented and highlighted in a specific way consumers are able to
identify and use key terms more easily: proposed Sec. 226.38 for
disclosures required on transactions secured by real property or a
dwelling, Sec. 226.19(b) for ARM loan program disclosures, Sec.
226.20(c) for ARM adjustment notices, and Sec. 226.20(d) for periodic
statements on loans that are negatively amortizing.\66\ For example,
consumer testing of the current TILA model form indicated that
participants viewed both the interest rate and monthly payment as
important. Although participants generally understood that the interest
rate on their loan could change, several arrived at this conclusion
because of the payment schedule disclosure, which showed different
monthly payment amounts, not because they understood the loan had a
variable rate feature that would affect their monthly payments. In
addition to testing the current TILA model form, the Board also tested
variations of that form, including a form it developed in 1998 with HUD
(``Joint Form'') that was submitted to Congress in the 1998 Joint
Report.\67\ Participants who reviewed the Joint Form also generally
understood the loan had an adjustable rate, but less than half
understood the rate was fixed only for the first three years and could
vary only after that time period. However, when the Board consumer
tested information about interest rates and monthly payments in a
tabular form, participants could identify more readily that the loan
had an adjustable rate feature, and comprehension of when interest
rates would adjust and the impact that rate adjustments had on their
monthly payments improved.
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\66\ See also Improving Consumer Mortgage Disclosures (finding
that incorporating white space, using clear headings, and using
certain formatting and organization create a ``less intimidating
appearance than many consumer financial disclosures, making it more
likely that consumers will both want to read the form and be able to
use it productively in their decisions.'').
\67\ See the 1998 Joint Report, App.A-6.
---------------------------------------------------------------------------
For these reasons, the Board proposes to require that creditors
make disclosures for transactions secured by real property or a
dwelling clearly and conspicuously, by highlighting certain information
in accordance with the requirements in proposed Sec. Sec. 226.38,
226.19(b), Sec. 226.20(c), and Sec. 226.20(d). Proposed comment
37(a)(1)-1 would clarify that to meet the clear and conspicuous
standard, disclosures must be in a reasonably understandable form and
readily noticeable to the consumer. Proposed comment 37(a)(1)-2
provides that to meet the readily noticeable standard, the disclosures
under proposed Sec. Sec. 226.38, 226.19(b), 226.20(c), and 226.20(d)
generally must be provided in a minimum 10-point font. The approach of
requiring a minimum of 10-point font for certain disclosures is
consistent with the approach taken by the Board in revising disclosures
required under TILA for certain open-end credit. 74 FR 5244; Jan. 29,
2009.
New comment 37(a)(1)-3 would clarify that disclosures under
proposed Sec. Sec. 226.38 and 226.19(b) must be provided on a document
separate from other information, although these disclosures, as well as
disclosures under proposed Sec. Sec. 226.20(c) and 226.20(d), may be
made on more than one page, on the front or back side of a page, and
continued from one page to the next. Consumer testing suggests that
consumers may not read information carefully if it is excessive in
length, and if unable to identify relevant information quickly are
likely to become frustrated and not read the disclosures. The Board
believes that allowing creditors to combine disclosures with other
information may increase the likelihood that consumers will not read
the disclosures.
37(a)(2) Grouped Together and Segregated
Section 128(b)(1) of TILA and Sec. 226.17(a)(1) currently require
that, except for certain information, the disclosures required for
closed-end credit must be grouped together, segregated from everything
else, and not contain any information not directly related to the
required disclosures. 15 U.S.C. 1638(b)(1). Comment 17(a)(1)-2 states
that creditors can satisfy the grouped together and segregation
requirement in a variety of ways, including combining segregated
disclosures with other information as long as they are set off by a
certain format type. Comment 17(a)(1)-2 further provides that the
segregation requirement does not apply to disclosures for variable rate
transactions required under current Sec. Sec. 226.19(b) and 226.20(c).
Comment 17(a)(1)-7 clarifies that balloon-payment financing with
leasing characteristics is subject to the grouped together and
segregation requirement.
Consumer testing conducted by the Board indicated that participants
generally are overwhelmed by the amount of information presented for
loan transactions, and as a result, do not read their mortgage
disclosures carefully. Consumer testing showed that emphasizing terms
and costs consumers find important, and separating out less useful
information, is critical to improving consumers' ability to identify
and use key information in their decision-making process.\68\ Consumer
testing also demonstrated that grouping related concepts and figures
together, and presenting them in a particular format or structure can
improve
[[Page 43288]]
consumers' ability to identify, comprehend, or use disclosed terms.
---------------------------------------------------------------------------
\68\ See also Improving Consumer Mortgage Disclosure at 69
(consumer testing results showed that current mortgage disclosure
forms failed to convey key cost disclosures, but that prototype
disclosures, which removed less useful information, significantly
improved consumers' recognition of key mortgage costs).
---------------------------------------------------------------------------
For these reasons, the Board proposes to require that certain
disclosures be grouped together and segregated in the manner discussed
below, pursuant to its authority under TILA Section 105(a). 15 U.S.C.
1604(a). Section 105(a) authorizes the Board to make exceptions and
adjustments to TILA to effectuate the statute's purposes, which include
facilitating consumers' ability to compare credit terms and helping
consumers avoid the uninformed use of credit. 15 U.S.C. 1601(a),
1604(a). Grouping and segregating information which is most useful and
relevant to the loan transaction would facilitate consumers' ability to
evaluate a loan offer.
Segregation of disclosures. Proposed Sec. 226.37(a)(2) would
implement TILA Section 128(b)(1) of TILA, in part, for transactions
secured by real property or a dwelling. 15 U.S.C. 1604(a), 1638(b)(1).
Proposed Sec. 226.37(a)(2) would require that disclosures for such
transactions be grouped together in accordance with the requirements
under proposed Sec. 226.38(a) through (j), segregated from other
information, and not contain any information not directly related to
the segregated disclosures. Based on consumer testing, the Board also
is proposing to require that ARM loan program disclosures under
proposed Sec. 226.19(b), ARM adjustment notices under proposed Sec.
226.20(c), and periodic notices for payment option loans that are
negatively amortizing under proposed Sec. 226.20(d), be subject to a
grouped-together and segregation requirement. Thus, the reference to
Sec. Sec. 226.19(b) and 226.20(c) would be deleted from comment
17(a)(1)-2.
Proposed comment 37(a)(2)-1 would clarify that to be segregated,
disclosures must be set off from other information. Based on consumer
testing, the Board is concerned that allowing creditors to combine
disclosures with other information, in any format, will diminish the
clarity of key disclosures, potentially cause ``information overload,''
and increase the likelihood that consumers may not read the
disclosures. Proposed comment 37(a)(2)-1 also would provide guidance on
how creditors can group together and segregate the disclosures in
accordance with proposed Sec. 226.38(a)-(j), such as by using bold
print dividing lines.
Content of segregated disclosures; directly related information.
Footnotes 37 and 38 currently provide exceptions to the grouped-
together and segregation requirement under Sec. 226.17(a)(1). Footnote
37 allows creditors to include information not directly related to the
required disclosures, such as the consumer's name, address, and account
number. Footnote 38, which implements TILA Section 128(b)(1), 15 U.S.C.
1638(b)(1), allows creditors to exclude certain required disclosures
from the grouped-together and segregation requirement, such as the
creditor's identity under Sec. 226.18(a), the variable-rate example
under Sec. 226.18(f)(1)(iv), insurance or debt cancellation
disclosures under Sec. 226.18(n), or certain security-interest charges
under Sec. 226.18(o). Comment 17(a)(1)-4 clarifies that creditors have
flexibility in grouping the disclosures listed in footnotes 37 and 38
either together with or separately from segregated disclosures, and
comment 17(a)(1)-5 addresses what is considered directly related to the
segregated disclosures.
Proposed Sec. 226.37(a)(2)(i) and (ii) would provide exceptions to
the grouped-together and segregation requirement, and implement TILA
Section 128(b)(1) for transactions secured by real property or a
dwelling. 15 U.S.C. 1638(b)(1). Proposed Sec. 226.37(a)(2)(i)
replicates the content in current footnote 37 and would allow the
following disclosures to be made together with the segregated
disclosures: the date of the transaction, and the consumer's name,
address and account number. Proposed Sec. 226.37(a)(2)(ii) generally
replicates the substance in current footnote 38, except that the Board
proposes to remove the reference to the variable-rate example under
Sec. 226.18(f)(iv), which would be eliminated for mortgage loans as
discussed under proposed Sec. 226.19(b). Under proposed Sec.
226.37(a)(2)(ii), creditors also would have flexibility to make the tax
deductibility disclosure, as discussed under proposed Sec.
226.38(f)(4), together with or separately from other required
disclosures.
Proposed comment 37(a)(2)-2 clarifies that creditors may add or
delete the disclosures listed in proposed Sec. 226.37(a)(2)(i) and
(ii) in any combination together with or separate from the segregated
disclosures. Proposed comment 37(a)(2)-3 provides guidance on the type
of information that would be considered directly related and that may
be included with the segregated disclosures for transactions secured by
real property or a dwelling. Information described in comments
17(a)(1)-5(i) through (xv) are not included in proposed comment
37(a)(2)-3 because they are not applicable to transactions secured by
real property or a dwelling, or are unnecessary as a result of other
proposed disclosures: grace periods for late fees; unsecured interest;
demand features; instructions on multi-purpose forms; minimum finance
charge statement; negative amortization; due-on-sale clauses;
prepayment of interest statement; the hypothetical example disclosure
required by current Sec. 226.18(f)(1)(iv); the variable rate
transaction disclosure required by current Sec. 226.18(f)(1);
assumption; and the late-payment fee disclosure for single-payment
loans.
The Board also proposes to require that the disclosure of the
creditor's identity be grouped together and segregated from other
information, for all closed-end credit. The Board proposes to make this
change pursuant to its authority under TILA Section 105(a). 15 U.S.C.
1604(a). Section 105(a) authorizes the Board to make exceptions and
adjustments to TILA to effectuate the statute's purposes, which include
facilitating consumers' ability to compare credit terms, and avoiding
the uninformed use of credit. 15 U.S.C. 1601(a). The Board believes
that the creditor's identity should be included with the grouped-
together and segregated disclosures so that consumers can more easily
identify the appropriate entity. Thus, current footnote 38 would be
revised, and proposed Sec. 226.37(a)(2) would implement this aspect of
the proposal for transactions secured by real property or a dwelling.
In technical revisions, the Board proposes to move the substance of
footnotes 37 and 38 to the regulatory text of Sec. 226.17(a)(1).
Current comment 17(a)(1)-7 would be revised to address disclosures for
transactions secured by real property or a dwelling that have balloon
payment financing with leasing characteristics; a cross-reference to
comment 17(a)(1)-7 is proposed in new comment 37(a)(2)-4.
The Board seeks comment on whether it should continue to permit
creditors to make the insurance or debt cancellation disclosures under
proposed Sec. 226.4(d) together with or separately from other required
disclosures. Consumer testing showed that many participants found these
disclosures too long and complex, and as a result they do not read or
only skim the disclosures. The Board is concerned that adding the
insurance information to the information about loan terms required by
proposed Sec. 226.38 will result in ``information overload.''
Multi-purpose forms. Comment 17(a)(1)-6 currently permits creditors
to design multi-purpose forms for TILA-required closed-end credit
disclosures as long as the clear and conspicuous requirement is met.
The Board proposes
[[Page 43289]]
to require that disclosures for transactions secured by real property
or a dwelling be made only as applicable, as discussed more fully under
proposed Sec. 226.38. As noted, consumer testing indicates that
consumers may not read information if it is excessive in length, and if
unable to identify relevant information quickly are likely to become
frustrated and not read the disclosures. The Board believes that
allowing creditors to combine disclosures with other information that
is not applicable to the transaction may contribute to ``information
overload,'' and increase the likelihood that consumers will not read
the disclosures.
For these reasons, under the proposal creditors would not be
permitted to use forms for more than one type of mortgage transaction
(i.e., multi-purpose forms). The Board believes technology and form
design software will allow creditors to prepare transaction-specific,
customized disclosure forms at minimal cost. The Board seeks comment,
however, on whether creditors already provide consumers with customized
disclosures forms for mortgage loans in the regular course of business,
or the extent to which creditors rely on multi-purpose forms. The Board
seeks comment on potential operational changes, difficulties, or costs
that would be incurred to implement the requirement to have
transaction-specific disclosures for transactions secured by real
property or a dwelling.
37(b) Separate Disclosures
Existing Sec. 226.17(a)(1) requires certain disclosures to be
provided separately from the segregated information, such as the
itemization of amount financed required by Sec. 226.18(c)(1) and TILA
Section 128(a)(2)(A). 15 U.S.C. 1638(a)(2)(A). The Board is proposing
to expand the list of disclosures that must be provided separately from
the segregated information, based on consumer testing.
Consumer testing showed that certain disclosures, such as
disclosures about assumption or property insurance, were confusing to
participants, or were generally not as useful in the participants'
decision-making process as other information. For example, with respect
to assumption, few participants understood the current assumption
policy model clause in Model Clause H-6 in Appendix H to Regulation Z;
almost no one stated that the assumption was important information when
applying for and obtaining a loan. With respect to property insurance,
most participants understood that the borrower can obtain property
insurance from anyone that is acceptable to the lender, but
participants stated they were already aware of this fact and therefore
this information was not useful. Regarding rebates, consumers
understood that early payoff of the loan could result in a refund of
interest and fees, and generally expressed interest in knowing this
information. However, most also indicated that information about
rebates would not have an impact on whether they accepted a loan and
therefore, it was not as important or useful to the decision-making
process as other information, such as interest rate or closing costs.
With respect to the contract reference, almost all participants
understood already that they could read their contract to learn what
could happen if they stopped making payments, defaulted, paid off or
refinanced their loan early. In addition, other proposed disclosures,
such as the prepayment penalty under proposed Sec. 226.38(a)(5) or
demand feature under proposed Sec. 226.38(d)(2)(iv), would make the
contract reference disclosure less important because such information
would already be disclosed directly on the disclosure statement itself.
Moreover, because creditors must provide disclosures within three
business days after application for transactions secured by real
property or a consumer's dwelling, consumers will not have a contract
to reference at this point in time.
For these reasons, the Board proposes to require that certain
information be disclosed separately from the grouped together and
segregation information, to improve consumers' ability to focus on the
terms that are most important for shopping and decision-making.\69\ New
Sec. 226.37(b) would require that creditors provide the following
disclosures separately from other information for transactions secured
by real-property or a dwelling: Itemization of amount financed under
proposed Sec. 226.38(j)(1); rebates under proposed Sec. 226.38(j)(2);
late payment under proposed Sec. 226.38(j)(3); property insurance
under proposed Sec. 226.38(j)(4); contract reference under proposed
Sec. 226.38(j)(5); and assumption under proposed Sec. 226.38(j)(6).
---------------------------------------------------------------------------
\69\ See also Improving Consumer Mortgage Disclosures at 37-38,
59-60 (finding that streamlining disclosures improved consumer
ability to identify and understand key terms of the loan transaction
disclosed).
---------------------------------------------------------------------------
The Board proposes this approach pursuant to its authority under
TILA Section 105(a). 15 U.S.C. 1604(a). Section 105(a) authorizes the
Board to make exceptions and adjustments to TILA for any class of
transactions to effectuate the statute's purposes, which include
facilitating consumers' ability to compare credit terms and helping
consumers avoid the uninformed use of credit. 15 U.S.C. 1601(a),
1604(a). In this case, the Board believes an exception from TILA's
grouped together and segregation requirement is necessary to effectuate
the Act's purposes for transactions secured by real property or a
dwelling. As noted above, many consumers may not read information if it
is excessive in length, and if unable to identify relevant information
quickly are likely to become frustrated and not read the disclosures.
The Board is concerned that allowing creditors to combine the
information in proposed Sec. 226.38(j) with other required information
could contribute to ``information overload,'' distract from other
important disclosures, such as the APR or monthly payments, and may
increase the likelihood that consumers will not read the disclosures.
Thus, the Board believes that requiring these disclosures to be
separate from the other required disclosures will serve TILA's purpose
to avoid the uninformed use of credit. 15 U.S.C. 1601(a).
37(c) Terminology
37(c)(1) Consistent Terminology
Currently, there is no requirement that TILA disclosures for
closed-end credit use consistent terminology. Consumer testing showed
that some participants were confused when different terms are used for
the same information. For example, when the terms loan amount,
principal, and loan balance were used, some participants attributed
different meaning to each term used. Based on these findings, the Board
proposes Sec. 226.37(c)(1) to require the use of consistent
terminology for the disclosures under proposed Sec. Sec. 226.38,
226.19(b), 226.20(c) and 226.20(d). The Board believes that using
consistent terminology will enhance a consumers' ability to identify,
review, and comprehend disclosed terms across all disclosures and
therefore, avoid the uninformed use of credit. Proposed comment
37(c)(1)-1 clarifies that terms do not need to be identical, unless
otherwise specified, but must be close enough in meaning to enable the
consumer to relate the disclosures to one another. Proposed comment
37(c)(1)-2 provides guidance on combining terms for transactions
secured by real property or a dwelling when more than one numerical
disclosure would be the same, and provides an example relating to the
total payments and amount financed disclosures required under proposed
[[Page 43290]]
Sec. Sec. 226.38(e)(5)(i) and 226.38(e)(5)(iii), respectively.
37(c)(2) Terms Required To Be More Conspicuous
Currently TILA Section 122(a) and Sec. 226.17(a)(2) require
creditors to disclose the terms ``finance charge'' and ``annual
percentage rate,'' together with a corresponding dollar amount and
percentage rate, more conspicuously than any other disclosure, except
the creditor's identity under Sec. 226.18(a). 15 U.S.C. 1632(a). Under
TILA Section 103(u), the finance charge and the annual percentage rate
are material disclosures; failure to disclose either term extends the
right of rescission under TILA Section 125, and can result in actual
and statutory damages under TILA Section 130(a). 15 U.S.C. 1602(u); 15
U.S.C. 1635, 1640(a).
Finance charge: interest and settlement charges. Section 226.18(d),
which implements TILA Sections 128(a)(3) and (a)(8), requires creditors
to disclose the ``finance charge,'' using that term, and a brief
description such as ``the dollar amount the credit will cost you'' for
closed-end credit. 15 U.S.C. 1638(a)(3), (a)(8). Consumer testing
showed that participants could not correctly explain what the finance
charge represented. Many consumers recognized that the finance charge
included all of the interest they would pay over the loan's term, but
did not know that it also included fees. Most participants did not find
the finance charge to be useful in evaluating a loan offer. However,
some participants expressed a general interest in knowing the
information.
Based on these results, the Board tested a form with the finance
charge disclosed as ``interest and settlement charges,'' to more
closely represent the components of the finance charge. Participants
generally understood the term, but still stated that they did not find
the term very useful, particularly when compared to other information
such as the interest rate or monthly payments. Consumer testing
suggests that highlighting terms that are not useful in the decision-
making process may generally diminish consumers' ability to understand
other key terms.
For these reasons, and as discussed more fully in the discussion of
proposed Sec. 226.38(e)(5)(ii), the Board proposes to exercise its
authority under TILA Section 105(a) to make certain exceptions to the
disclosure of the finance charge under TILA Section 128(a)(3) and TILA
Section 122(a). 15 U.S.C. 1604(a); 1632(a); 1638(a)(3). First,
creditors would be required to disclose the finance charge as
``interest and settlement charges,'' not as the ``finance charge'' as
required by TILA Section 128(a)(3). 15 U.S.C. 1638(a)(3). Second, the
disclosure of interest and settlement charges would not have to be more
conspicuous than other terms, as required by TILA Section 122(a). 15
U.S.C. 1632(a).
The exception to TILA's requirements that the finance charge be
disclosed as the ``finance charge'' and that it be more conspicuous
than other information is proposed pursuant to TILA Section 105(a). 15
U.S.C. 1604(a). The Board has authority under TILA Section 105(a) to
adopt ``such adjustments and exceptions for any class of transactions
as in the judgment of the Board are necessary or proper to effectuate
the purposes of this title, to prevent circumvention or evasion
thereof, or to facilitate compliance therewith.'' 15 U.S.C. 1601(a),
1604(a). The class of transactions that would be affected is closed-end
transactions secured by real property or a dwelling. The Board believes
an exception from TILA's requirements is necessary and proper to
effectuate TILA's purposes to assure meaningful disclosure and informed
credit use. Consumer testing showed that disclosing the finance charge
as ``interest and settlement charges'' improved participants'
understanding of the information, even though the figure may not
include all interest and settlement charges applicable to the
transaction. (See discussion under proposed Sec. 226.4 regarding
content and calculation of the interest and settlement charges.)
Moreover, consumer testing showed that participants did not find the
interest and settlement charges as useful, when choosing or evaluating
a loan product, as other information, such as whether the loan has an
adjustable rate or the monthly payment amount.
In addition, and for the reasons discussed more fully under
proposed Sec. 226.38(e)(5)(ii) regarding interest and settlement
charges, the proposal would group the interest and settlement charges
disclosure with other disclosures relating to the total cost of the
loan offered, such as the total of payments and the amount financed.
Consumer testing conducted by the Board, as well as basic document
design principles, shows that grouping related concepts and figures
makes it easier for consumers to identify, comprehend, or use disclosed
terms.
Annual percentage rate. TILA Section 122(a) and Sec. 226.17(a)(1)
require that the term ``annual percentage rate,'' when disclosed with
the corresponding percentage rate, be disclosed more conspicuously than
any other required disclosure. 15 U.S.C. 1632(a). The Board is
proposing to revise the description of the APR and require that
creditors provide context for the APR by disclosing it on a scaled
graph with explanatory text, as discussed more fully under proposed
Sec. Sec. 226.38(b). In addition, the Board is proposing Sec.
226.37(c)(2) to implement TILA Section 122(a) for transactions secured
by real property or a dwelling. 15 U.S.C. 1632(a). Section 226.37(c)(2)
would require that creditors disclose the APR in a 16-point font, in a
prominent location, and in close proximity to the scaled graph and
explanations proposed under Sec. 226.38(b)(2) through (4).
As discussed under proposed Sec. 226.38(b), the APR is one of the
most important terms disclosed about the loan; it is the only single,
unified number available to help consumers understand the overall cost
of a loan. To this end, the Board believes it is essential that
consumers be able to identify the APR easily. Consumer testing and
basic document design principles show that participants generally pay
greater attention to figures, such as numbers, percentages and dollar
signs, than to terminology that may accompany, describe or label any
disclosed figure. However, the TILA disclosure contains many numerical
figures that consumers must identify and review. Given that the Board
is proposing to require a minimum 10-point font for disclosure of other
terms on the TILA (see discussion under proposed comment 37(a)(1)-2),
and based on document design principles, the Board consumer tested
disclosing the APR figure in a larger font and in bold text to make it
more readily noticeable as compared to other disclosed terms. When
tested in this manner, participants were able to easily identify the
APR. Based on consumer testing, the Board believes that a 16-point font
requirement for the APR is sufficient to highlight the APR. The Board
also notes that the approach of requiring at least a 16-point font for
the APR disclosure is consistent with the approach taken by the Board
in revising the purchase APR disclosure required under TILA for open-
end credit. 74 FR 5244; Jan. 29, 2009.
Proposed comment 37(c)-3(i) through (iii) would provide further
guidance on the more conspicuous requirement and would clarify that the
APR must be more conspicuous only in relation to other required
disclosures under proposed Sec. 226.38, and only as required under
proposed Sec. 226.37(c)(2) and Sec. 226.38(b). Proposed comment
37(c)-4 would provide guidance on how creditors can comply with the
more
[[Page 43291]]
conspicuous requirement for transactions secured by real property or a
dwelling.
The Board seeks comment on whether the APR should be made more or
less prominent using a larger or smaller font-size, and whether
different graphs or visuals could be used to provide better context for
the APR. The Board also seeks comment on the relative advantages and
disadvantages of a graphic-based versus text-based approach to
disclosing the APR, and the potential operational changes,
difficulties, or costs that would be incurred to implement the graphic-
based APR disclosure requirement for transactions secured by real
property or a dwelling.
37(d) Specific Formats
Currently, Sec. 226.17(a)(1) does not impose special format design
or location requirements on disclosures for closed-end credit. However,
as discussed more fully under proposed Sec. 226.38, consumer testing
showed that the current TILA form did not present key loan information
in a manner that was noticeable and easy for consumers to understand.
For example, the payment schedule required under current Sec.
226.18(g) did not effectively demonstrate to participants the
relationship between monthly payments and an adjustable interest rate
feature. Consumer testing also showed that the current TILA form
highlighted terms that confused many participants. For example, most
participants incorrectly assumed the amount financed was the same as
the loan amount, a term not required on the current TILA form. In other
instances, the current TILA form emphasized information that
participants generally understood, but did not find useful or
important, such as the total of payments. Many participants also noted
that the current TILA form failed to include information they would
find useful when shopping or evaluating a loan offer, such as the
contract interest rate and settlement charges.
As discussed under proposed Sec. 226.19, consumer testing of the
current ARM loan program disclosure and the CHARM booklet also revealed
ineffective presentation of information relating to adjustable rate
loan programs. Many participants found the narrative format and
terminology used in the current ARM loan program disclosure
complicated, dense, and difficult to read and understand. With respect
to the CHARM booklet, many participants generally indicated that the
information it contained was informative and educational, but they
would be unlikely to read it because it was too long.
In addition, as noted previously, consumer testing suggests that
consumers may not read information carefully if it is excessive in
length, and if unable to identify relevant information quickly are
likely to become frustrated and not read the disclosures. As discussed
more fully under proposed Sec. 226.37(a) through (c), this suggests
highlighting and structuring disclosures in a particular manner to
improve clarity, identification and comprehension of disclosed terms.
To address the problems with the current TILA form and ARM loan
program disclosures, the Board used various formats to present key loan
information, such as tabular forms and question and answer format.
Consumer testing suggests that using tabular forms improved
participants' ability to readily identify and understand key
information, as discussed under proposed Sec. Sec. 226.19(b) and
226.38(c). For example, current ARM loan program disclosures provide
information in narrative form, which participants found difficult to
read and understand. However, consumer testing showed that when
information about interest rate, monthly payment and loan features was
presented in tabular format, participants found the information easier
to locate and their comprehension of the disclosed terms improved. The
benefits of disclosing important information in a tabular format are
consistent with the results of consumer testing conducted by the Board
in revising credit card disclosures. 74 FR 5244; Jan. 29, 2009.
Consumer testing also showed that using question and answer format
improved participants' ability to recognize and understand potentially
risky or costly features of a loan, as discussed under proposed
Sec. Sec. 226.19 and 226.38(d). Consumer testing and basic document
design principles suggest that keeping language and design elements
consistent between forms improves consumers' ability to identify and
track changes in the information being disclosed. As a result, the
Board also integrated the question and answer format used on the
revised TILA model form into ARM loan program disclosures required
under proposed Sec. 226.19(b).
To present key loan terms more effectively, the Board also used
specific location and structure requirements. Consumer testing suggests
that the location and order in which information is presented impacts
consumers' ability to find and comprehend the information disclosed.
For example, as discussed under proposed Sec. 226.38(a), disclosing
key information, such as the loan term, amount, type, and settlement
charges, before other required disclosures and in a tabular format
improved participants' ability to quickly and accurately identify key
loan terms. In another example, participants' ability to identify the
frequency of rate adjustments after an introductory period expired also
improved when this information was included both in the loan summary
section at the top of the revised TILA model form, and then again below
in the interest rate and payment summary section.
Based on consumer testing results, basic document design
principles, and for the reasons discussed more fully under each of the
following subsections, the Board is proposing to establish special
format rules for: disclosures under proposed Sec. 226.38 for
transactions secured by real property or a dwelling; ARM loan program
disclosures under proposed Sec. 226.19(b) for adjustable rate
transactions; ARM adjustment notices under proposed Sec. 226.20(c);
and periodic statements required for payment option loans that are
negatively amortizing under proposed Sec. 226.20(d). The special rules
regarding format, structure and location of disclosures are noted in
proposed Sec. 226.37(d)(1) through (10). Proposed comments 37(d)-1 and
-2 would provide guidance to creditors on how to comply with the
special format rules noted in proposed Sec. 226.37(d)(1) through (10)
regarding prominence and close proximity of disclosed terms.
37(e) Electronic Disclosures
Currently, under Sec. 226.17(a)(1) creditors are permitted to
provide in electronic form any TILA disclosure for closed-end credit
that is required to be provided or made available to consumers in
writing if the consumer affirmatively consents to receipt of electronic
disclosures in a prescribed manner. Electronic Signatures in Global and
National Commerce Act (the E-Sign Act), 15 U.S.C. 7001 et seq. The
Board proposes Sec. 226.37(e) to allow creditors to provide required
disclosures for transactions covered by proposed Sec. 226.38 in
electronic form in accordance with the requirements under Sec.
226.17(a)(1).
Section 226.38 Content of Disclosures for Credit Secured by Real
Property or a Dwelling
38(a) Loan Summary
To shop for and understand the cost of credit, consumers must be
able to identify and understand the key credit terms offered to them.
As discussed
[[Page 43292]]
below, the Board's consumer testing suggested that loan amount, loan
term and loan type are key terms that consumers are familiar with and
expect to see on closed-end mortgage disclosures, together with
settlement charges and whether a prepayment penalty would apply to
their loan.
The Board's Proposal
The Board proposes to require creditors to provide the following
key loan features in a loan summary section: loan amount, loan term,
loan type, the total settlement charges, whether a prepayment penalty
applies and, the maximum amount of the penalty. The purpose of the
proposed disclosures is to improve their effectiveness and consumer
comprehension. A concise loan summary would help consumers compare loan
offers; a summary may also help consumers determine whether they can
afford the loan they are offered, and whether the disclosure presents
the same loan terms they discussed with their mortgage broker or
lender.
The Board conducted consumer testing of loan summary disclosures.
Participants were able to identify the exact loan amount, what type of
a loan they were being offered, how long they would have to pay off
their loan, how much they would have to pay in settlement charges, and
whether a prepayment penalty would apply. A discussion of the items
that would be included in the loan summary follows.
38(a)(1) Loan Amount
Currently creditors are not required to disclose the loan amount
for closed-end mortgages, except for loans subject to HOEPA. Under
Sec. 226.32(c)(5), creditors are required to disclose the total amount
borrowed. The Board is proposing to require a similar disclosure of the
loan amount for all transactions secured by a real property or a
dwelling. Proposed Sec. 226.38(a)(1) would require creditors to
disclose ``loan amount,'' which would be defined as the principal
amount the consumer will borrow reflected in the note or loan contract.
The loan amount is a core loan term that the consumer should be able to
verify readily on the disclosure. Disclosing the loan amount may also
alert the consumer to fees that are financed in addition to the
principal balance.
38(a)(2) Loan Term
Currently, Regulation Z requires creditors to disclose the number
of payments but not the term of the loan. The Board believes that the
loan term is an important fact about the loan that consumers should
know when evaluating a loan offer. Consumer testing of current model
forms conducted by the Board indicated that some consumers are not able
to readily identify the loan term from the number of payments disclosed
in the current disclosures. Although some participants could determine
the loan term by dividing by 12 the number of months shown in the
payment schedule disclosed under Sec. 226.18(g), other participants
could not readily figure the term of the loan offered, particularly for
loans that have multiple payment levels, such as discounted adjustable-
rate mortgages. For these reasons, the Board is proposing to require
disclosure of the loan term in the summary section for loans covered by
Sec. 226.38, and to define ``loan term'' for these purposes as the
time to repay the obligation in full. For instance, instead of
disclosing the number of months for each payment amount for variable
interest rate loans and requiring the consumer to add up those months
to determine the loan term, the proposed disclosure would state ``Loan
term: 30 years.'' Likewise, for a 10-year loan with a balloon payment
due in year 10 and an amortization schedule of 30 years, the proposed
disclosure would state ``Loan term: 10 years.''
38(a)(3) Loan Type and Features
Regulation Z does not require the creditor to disclose the type of
the loan, except in the case of loans with variable interest rates.
Current Sec. 226.18(f) requires a disclosure of a variable rate if the
annual percentage rate may increase after consummation. The Board's
consumer testing indicates that the current variable rate disclosures
may not clearly convey whether the loan has a fixed or a variable
interest rate. The Board believes that a specific disclosure of a loan
type offered will assist consumers in better understanding whether a
loan features a rate that may increase after consummation, so that the
consumer may evaluate whether they want a loan in which the rate and
payments can increase.
The Board is proposing to require a disclosure of the loan type in
the loan summary section for loans covered by Sec. 226.38. Proposed
Sec. 226.38(a)(3)(i) would require that a loan be classified as one of
three types: an ``adjustable-rate mortgage (ARM),'' a ``step-rate
mortgage,'' or a ``fixed-rate mortgage'' using those terms. The
categories proposed in Sec. 226.38(a)(3)(i) apply only to disclosures
requires for closed-end transaction secured by real property or a
dwelling, and are different from the categories in Sec. 226.18(f) and
commentary to Sec. 226.17(c)(1). Proposed Sec. 226.38(a)(3)(ii) would
require an additional disclosure if the loan has one or more of the
following three features: ``negative amortization,'' ``interest-only
payments,'' or ``step-payments,'' using those terms. The related
commentary would provide examples for each loan type and feature.
38(a)(3)(i) Loan Type
As discussed above, consumer testing indicated that the current
variable rate disclosure is not sufficiently clear for many consumers.
When presented with a current closed-end model form for an adjustable-
rate mortgage, over half of the participants understood that the
interest rate would change. However, several participants inferred this
from the different monthly payments in the payment schedule, not
because the check box on the form indicated that the loan had a
``variable rate.'' A few participants indicated that they did not know
whether the rate would change. Some participants commented that
although the current model form used the term ``variable rate,'' they
were more familiar with the term ``adjustable rate.'' As a result, the
Board tested revised disclosures using the term ``adjustable rate
mortgage'' in the loan summary section. All participants who were shown
a revised disclosure for a variable rate transaction using the term
``adjustable-rate mortgage'' understood that the interest rate and
payments could change during the loan's term.
Proposed Sec. 226.38(a)(3)(i) would define an adjustable-rate
mortgage as a transaction in which the annual percentage rate may
increase after consummation; a step-rate mortgage as a transaction in
which the interest rate will change after consummation as specified in
the legal obligation between the parties; and a fixed-rate mortgage as
a transaction that is neither an adjustable-rate mortgage nor a step-
rate mortgage. Proposed comment 38(a)(3)(i)(A)-2 would offer examples
of adjustable-rate mortgages and clarify that some variable-rate
transactions described in comment 17(c)(1)(iii)-4, such as certain
renewable balloon-payment, preferred-rate and price-level-adjusted
loans, would be considered fixed-rate mortgages for the purposes of the
``loan type'' disclosure in the loan summary required by Sec.
226.38(a). This follows the current approach in comment 17(c)(1)-11
which provide that disclosures for certain variable-rate transactions
should be based on the interest rate that applies at consummation.
Proposed Sec. 226.38(a)(3)(i)(B) would require the creditor to
disclose a loan as a ``step-rate mortgage'' if the interest rate will
change after consummation,
[[Page 43293]]
provided all such interest rates are specified in the legal obligation
between the parties. Under existing guidance, such a loan would not be
considered a variable rate loan. The Board believes that for the
purposes of the loan summary, which is to alert the consumer to the
possibility that their interest rate and payment could increase after
consummation, step-rate loans should not be identified as fixed or
variable rate loans, even though they share certain features with both
loan types. Proposed comment 38(a)(3)(i)(B)-2 would clarify that
certain preferred-rate loans would not be considered step-rate
mortgages for the purposes of the ``loan type'' disclosures. Proposed
comment 38(a)(3)(i)(C)-1 would offer examples of fixed-rate mortgages
and explain which variable-rate transactions described in comment
17(c)(1)(iii)-4 would be considered fixed-rate mortgages for the
purposes of the ``loan type'' disclosure.
38(a)(3)(ii) Loan Features
The general classification of loans as fixed rate, adjustable rate
and step rate would enable consumers to understand what loan type they
are being offered and to shop for loan products according to consumers'
needs and preferences. However, these broad categories of loan types
are not sufficient to warn consumers about the potential risks that a
specific loan may carry. As discussed previously, nontraditional
mortgage products with negatively amortizing or interest-only payments
grew in popularity in recent years, subjecting consumers to the risk of
payment shock. Disclosures should clearly alert consumers to these
features before the consumer becomes obligated on the loan. To alert
consumers to potentially risky loan features, the Board is proposing to
require an additional disclosure for each loan type in the loan summary
if the loan has step-payments, payment option or negative amortization
features, or interest-only payments.
Proposed Sec. 226.38(a)(3)(ii) would require creditors to disclose
whether a loan would have one or more of the following features: Step-
payments if the legal obligation permits the periodic monthly payment
to increase by a set amount for a specified amount of time; a payment
option feature if the legal obligation permits the consumer to make
payments that result in negative amortization and other types of
payments; a negative amortization feature if the legal obligation
requires the consumer to make payments that result in negative
amortization--that is, the legal obligation does not permit the
consumer to make payments that would cover all interest accrued or all
interest accrued and principal; or an interest-only feature if the
legal obligation permits or requires the consumer to make one or more
regular periodic payments of interest accrued and no principal, and the
legal obligation does not require or permit any payments that would
result in negative amortization.
Proposed comment 38(a)(3)(ii)(A)-1 would offer an example of a
step-payment feature. For example, if the consumer is offered a fixed-
rate mortgage with 24 monthly payments at $1,000 that will later
increase to $1,200 and remain at that level for a specified period of
time, and the loan amortizes fully over the loan term, the creditor
would disclose ``Fixed-Rate Mortgage, step-payments'' for the loan type
in the loan summary. Proposed comment 38(a)(3)(ii)(B) and (C)-1 would
clarify that a creditor should disclose the loan feature as either
``payment option'' or ``negative amortization'' but not both, whereas a
loan may have both a ``step-payment'' feature and either a ``payment
option'' or a ``negative amortization'' feature. Moreover, for a loan
to have a ``payment option'' feature, all periodic payment choices must
be specified in the legal obligation and must include a choice to make
payments that may result in negative amortization. Proposed comment
38(a)(3)(ii)(D)-1 would provide that a creditor should not disclose
both an ``interest-only'' feature and a ``payment option'' feature or
``negative amortization'' feature in a single transaction, whereas a
loan may have both an ``interest-only'' feature and a ``step-payment''
feature.
38(a)(4) Total Settlement Charges
Currently, TILA and Regulation Z disclose settlement charges
through the finance charge. TILA Section 128(a)(3) and Sec. 226.18(d)
require the creditor to disclose the finance charge. 15 U.S.C.
1638(a)(3). TILA Section 106(a) defines the ``finance charge'' as the
``sum of all charges, payable directly or indirectly by the person to
whom the credit is extended, and imposed directly or indirectly by the
credit or as an incident to the extension of credit.'' 15 U.S.C.
1605(a). Section 226.4(a) further defines the ``finance charge'' as
``the cost of consumer credit as a dollar amount.'' The finance charge
includes any interest due under the loan terms as well as other charges
incurred in connection with the credit transaction. See Sec. 226.4(a)
and (b).
Consumer testing indicated that participants did not understand the
term ``finance charge.'' Most participants believed the term referred
only to the total amount of interest they would pay if they kept the
loan to maturity, but did not always realize that it also includes the
fees and costs incurred as part of the credit transaction. Most
participants did not find the finance charge useful in evaluating a
loan offer.
The disclosure of settlement charges is governed by RESPA, 12
U.S.C. 2601-2617, and implemented by HUD under Regulation X, 24 CFR
part 3500. Under RESPA and Regulation X, creditors must provide a GFE
of settlement costs within three business days of application for a
mortgage, which is the same time creditors must provide the early TILA
disclosure. RESPA and Regulation X also require a statement of the
final settlement costs at loan closing (``HUD-1 or HUD-1A settlement
statement''). Under the new final rule for Regulation X, effective
January 1, 2010, the GFE is subject to certain accuracy requirements,
absent changed circumstances. RESPA and Regulation X do not, however,
provide any remedies for a violation of the accuracy requirements.
Consumer testing consistently demonstrated that participants wanted
to see settlement charges on the revised TILA disclosure. Participants
stated that including such a disclosure would help them confirm
information that the loan originator told them about the cost of the
loan during the mortgage application process. During consumer testing,
participants indicated that they were often surprised at the closing
table by substantial increases in the settlement charges. Despite these
changes, consumers reported that they proceeded with closing because
they lacked alternatives (especially in the case of a home purchase
loan), or were told that they could easily refinance with better terms
in the near future. Participants indicated that they would like an
estimate of their settlement charges as early as possible in the loan
process, and that it would be helpful to have the settlement charges
displayed in the context of the other loan terms, rather than on a
separate GFE or HUD-1 or HUD-1A settlement statement.
For these reasons, the Board proposes Sec. 226.38(a)(4) to require
creditors to disclose the ``total settlement charges,'' using that
term, as those charges are disclosed under Regulation X, 12 CFR part
3500. The proposed rule would further require, as applicable, a
statement of the amount of the charges already included in the loan
amount. Finally, the proposed rule would require disclosure of a
statement, as applicable, that the total amount does not include a down
payment, along with
[[Page 43294]]
a reference to the GFE or HUD-1 for more details.
Proposed comment 38(a)(4)-1 would clarify that on the early TILA
disclosure required by Sec. 226.19(a)(1)(i), the creditor must
disclose the amount of the ``Total Estimated Settlement Charges'' as
disclosed on the GFE under Regulation X, 12 CFR part 3500, Appendix C.
For the final TILA disclosure required by proposed Sec.
226.19(a)(2)(ii), the creditor would be required to disclose the sum of
the final settlement charges. The creditor would be permitted to use
the sum of the ``Charges That Cannot Increase,'' ``Charges That In
Total Cannot Increase By More Than 10%,'' and ``Charges That Can
Change'' as would be disclosed in the column entitled ``HUD-1'' on page
three of the HUD-1 or on page two of the HUD-1A settlement statement
under Regulation X, 12 CFR part 3500, Appendix A. Alternatively, the
creditor would be permitted to provide the consumer with the final HUD-
1 or HUD-1A settlement statement. For transactions in which a GFE, HUD-
1 or HUD-1A are not required, the proposed comment would clarify that
the creditor may look to such documents for guidance on how to comply
with the requirements of this section.
The Board recognizes that creditors are not currently required to
provide the final settlement charges before consummation. Regulation X,
24 CFR 3500.10(b), permits the settlement agent to provide the
completed HUD-1 or HUD-1A at settlement. However, proposed Sec.
226.19(a)(2)(ii) would require the creditor to provide the TILA
disclosure required by proposed Sec. 226.38, including the total
settlement charges disclosed under proposed Sec. 226.38(a)(4), so that
the consumer receives it at least three business days before
consummation. In addition, under proposed Sec. 226.19(a)(2)(iii)-
Alternative 1, if anything changes during the three-business-day
waiting period, including total settlement charges, the creditor would
be required to supply another final TILA disclosure and three-business-
day waiting period before consummation could occur. Consumers could
waive the three-day waiting periods for bona fide personal financial
emergencies.
The Board recognizes that proposed Sec. Sec. 226.19(a)(2)(ii),
226.19(a)(2)(iii)-Alternative 1, and 226.38(a)(4) would require the
creditor to disclose final settlement charge information several days
in advance of consummation. These requirements would impose a cost on
creditors, which may be passed on to consumers. Operational procedures
and systems would need to be changed significantly to determine several
days before closing the precise total amount of settlement charges that
the consumer would pay at settlement. The Board believes, however, that
the cost would be outweighed by the benefit to consumers of knowing
their final total settlement charges three business days before
consummation. This proposal would enable consumers to review and verify
cost information in advance of consummation, and contact the creditor
with questions or take other action, as appropriate.
38(a)(5) Prepayment Penalty
Current Disclosure Requirements
Under TILA Section 128(a)(11) and existing Sec. 226.18(k)(1), if
an obligation includes a finance charge computed by applying a rate to
the unpaid principal balance (a ``simple-interest obligation''),
creditors must disclose whether or not a penalty may be imposed if the
consumer prepays the obligation in full. Comment 18(k)(1)-1 states that
the term ``penalty'' refers only to charges that are assessed because
of the prepayment in full of a simple-interest obligation, in addition
to other amounts.
The existing model form in Appendix H-2 contains checkboxes for
creditors to indicate whether a consumer ``may'' or ``will not'' have
to pay a penalty if the consumer prepays the obligation in full. The
Board adopted these checkbox options in 1980, in response to concerns
that a statement that a prepayment penalty ``will be imposed'' would be
misleading. The Board noted that many credit contracts allow a penalty
to be imposed only if the loan is paid off within a certain time period
after consummation or under other specific circumstances. See 45 FR
80648, 80682; Dec. 5, 1980.
Discussion
Consumer testing of the current disclosure showed that participants
had difficulty identifying whether a loan would have a prepayment
penalty and in what circumstances it would apply. For example, in the
Board's consumer testing, participants did not understand that
refinancing a loan or paying off the loan with proceeds from the sale
of the home securing the loan could trigger a prepayment penalty.
Similarly, consumer testing conducted by FTC staff found that two-
thirds of participants who looked at a sample of the existing TILA
disclosure showing a loan with a two-year prepayment penalty did not
understand that a prepayment penalty would be charged if the consumer
refinanced the loan two years after origination.\70\ Some participants
thought that a prepayment penalty could be charged only if they paid
off their entire loan from their own funds, such as with money obtained
through a sudden financial windfall.\71\
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\70\ Improving Consumer Mortgage Disclosures at 78.
\71\ Id.
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The Board developed and tested a revised prepayment penalty
disclosure. Participants in the Board's consumer testing generally
understood that if they prepaid the loan within the time specified in
the disclosure, a penalty could be imposed. Participants also
understood that the penalty could be imposed if they refinanced or sold
the home during the time the penalty was in effect.
The Board's Proposal
Under proposed Sec. 226.38(a)(5), if the legal obligation permits
a creditor to impose a prepayment penalty the creditor must disclose in
the ``Loan Summary'' section the period during which the penalty
provision applies, the maximum possible penalty, and the circumstances
in which the creditor may impose the penalty. If the legal obligation
does not allow the creditor to impose a prepayment penalty, the
creditor would make no disclosure regarding prepayment penalties in the
``Loan Summary'' section. (However, proposed Sec. 226.38(d)(1)(iii)
requires the creditor to disclose whether or not the legal obligation
permits the creditor to charge a prepayment penalty in the ``Key
Questions about Risk'' section.)
Maximum penalty amount. The Board is proposing to require creditors
to disclose the maximum penalty possible under the legal obligation.
Prepayment penalties may be substantial. The existence of a prepayment
penalty may make it difficult to refinance a loan or sell a home. This
may be particularly difficult for consumers who have adjustable rate
loans or other loans that pose the risk of payment shock, as these
consumers may believe that they can refinance or sell the home to avoid
the increased payments. Thus, it is important for consumers to know the
maximum penalty amount before they are obligated on a loan.
Under proposed Sec. 226.38(a)(5) and (d)(1)(iii), creditors could
not disclose the method or formula they use to determine the penalty
with the disclosures required by Sec. 226.38. Although some consumers
might benefit from knowing how a prepayment penalty will be determined,
the Board is concerned that consumers may be overloaded with
information if the
[[Page 43295]]
calculation method is included with the segregated information. Many
consumers would not read the prepayment penalty disclosure at all if it
contains mathematical procedures and terms. Creditors may, of course,
disclose how a prepayment penalty will be determined, as long as the
disclosure is not disclosed together with the segregated disclosures.
Creditors also could not disclose a range of possible prepayment
penalties or give examples of penalty amounts assuming the consumer
prepaid at a hypothetical point in time under proposed Sec.
226.38(a)(5) or (d)(1)(iii). The Board believes that it is important
that prepayment penalty disclosures simply and clearly convey to
consumers the potential magnitude of the prepayment penalty.
Disclosures based on assumptions or averages could undermine the impact
of the maximum penalty disclosure.
Additional penalty disclosures. Consumer testing indicated that
some consumers do not understand that paying off the loan with the
proceeds of a refinance loan or a home sale can trigger a prepayment
penalty provision, as discussed above. Therefore, the proposed rule
would require creditors to disclose the conditions upon which and the
period during which they may impose a prepayment penalty.
It is important for a consumer to know what actions will trigger a
prepayment penalty provision before obtaining a loan with such a
provision. Consumers likely will not receive the loan agreement
containing the prepayment penalty provision until consummation and may
have little opportunity to review the agreement before becoming
obligated. Moreover, a prepayment penalty is but one of many loan terms
for consumers to consider at closing. The Board believes that including
key information about a prepayment penalty provision in transaction-
specific disclosures would help consumers avoid the uninformed use of
credit.
Coverage. Comment 226.18(k)(1)-1 clarifies that Sec. 226.18(k)(1)
applies to transactions in which interest calculations take into
account all scheduled reductions in principal, whether interest
calculations are made daily or at some other interval. Proposed comment
38(a)(5)-1 is consistent with comment 18(k)(1)-1. Proposed Sec.
38(j)(2) reflects existing Sec. 226.18(k)(2) on rebate disclosures, as
discussed below. Existing comment 18(k)-2 discusses cases where a
single transaction involves both a rebate and a penalty. Proposed
comment 38(a)(5)-8 reflects this existing commentary.
Definition of prepayment penalty. Comment 18(k)(1)-1 states that
under Sec. 226.18(k)(1) the term ``penalty'' refers only to those
charges that are assessed because of the prepayment in full of a
simple-interest obligation, in addition to other amounts. Comment
18(k)(1)-1 clarifies that interest charges for any period after
prepayment in full is made and minimum finance charges are examples of
prepayment penalties. The Board is proposing to revise comment
18(k)(1)-1 for clarity by substituting ``charges determined by treating
the loan balance as outstanding for a period after prepayment in full
and applying the interest rate to such `balance' '' for ``interest
charges for any period after prepayment,'' as discussed above. Proposed
comments 38(a)(5)-2(i) and (ii) are consistent with comment 18(k)(1)-1,
as it is proposed to be amended.
Proposed comment 38(a)(5)-2(iii) states that origination or other
charges that a creditor waives on the condition that the consumer does
not prepay the loan are prepayment penalties, for transactions secured
by real property or a dwelling. Fees imposed for a preparing a payoff
statement and performing other services when a consumer prepays the
obligation would not be considered a prepayment penalty under the
proposed rule, however. Such fees are not strictly linked to a
consumer's prepaying the obligation, as they are charged at the end of
a loan's term as well. The Board solicits comment on this distinction.
For purposes of some State laws, a minimum finance charge is not
considered a prepayment penalty. For purposes of disclosure under TILA,
a minimum finance charge is considered a prepayment penalty. Existing
comment 18(k)(1)-1 and proposed comment 38(a)(5)-2 are designed to
promote clear, consistent disclosure of charges creditors may impose
when a consumer prepays the obligation in full. The proposed rule would
not preempt State laws unless State law disclosure requirements are
inconsistent with the rule, and then only to the extent of any
inconsistency.
Existing comment 17(a)(1)-5(vii) allows creditors to disclose that
the borrower may pay a minimum finance charge as information directly
related to the penalty disclosure. Further, if a State or federal law
prohibits creditors from charging a prepayment penalty but permits the
charging of interest for some period after the consumer prepays from
that prohibition, existing comment 17(a)(1)-5(xi) permits creditors to
disclose that a consumer may have to pay interest for some period after
prepayment as information directly related to the prepayment penalty
disclosure. Comments 17(a)(1)-5(vii) and (xi), together with other
commentary in comment 17(a)(1)-5, would not apply to transactions
secured by real property or a dwelling, as discussed above.
Existing comment 18(k)(1)-1 states that loan guarantee fees are
examples of charges that are not penalties. The Board proposes to
retain this example in comment 38(a)(5)-2. (In a separate rulemaking,
the Board proposed to remove the example of interim interest on a
student loan as an example of charges that are not penalties. See 74 FR
12464, 12469; Mar. 29, 2009.)
Disclosed as applicable; disclosure content. Proposed comment
38(a)(5)-4 clarifies that if no prepayment penalty applies, creditors
need not disclose that fact in the ``Loan Summary'' section of
transaction-specific disclosures. Proposed Sec. 226.38(d)(1)(iii)
requires creditors to disclose whether or not the legal obligation
permits the creditor to charge a prepayment penalty in the ``Key
Questions about Risk'' section, however. Proposed comment 38(a)(5)-5
clarifies that creditors must disclose the maximum penalty as a
numerical amount. This is consistent with the general rule of
construction of the word ``amount'' required by Sec. 226.2(b)(5).
Basis of disclosure. Proposed comment 38(a)(5)-6 explains how
creditors determine the maximum penalty amount and contains examples
that illustrate how those principles are applied. (Proposed comment
38(d)(1)(iii) states that creditors may rely on proposed comment
38(a)(5)-6 in determining the maximum prepayment penalty to be
disclosed as one of the ``Key Questions about Risk'' disclosures.)
Proposed comment 38(a)(5)-6 states that in all cases, the creditor
should assume that the consumer prepays at a time when the prepayment
penalty may be charged. The comment also states that if more than one
type of prepayment penalty applies (for example, if the loan includes a
minimum finance charge and the creditor may collect interest after
prepayment), the creditor should include the maximum amount of each
type of prepayment penalty in determining the maximum penalty possible.
Existing comment 18(k)(1)-1 clarifies that interest charges for any
period after a consumer prepays in full and a minimum finance charge in
a simple interest transaction are deemed to be prepayment penalties.
Proposed comment 38(a)(5)-6(i) and (ii) clarifies that the amount of
such charges must be
[[Page 43296]]
counted in determining the maximum penalty.
Proposed comment 38(a)(5)-6(iii) provides examples of how creditors
may calculate a maximum prepayment penalty where the creditor
determines the penalty by applying a constant rate to the loan balance
at the time of prepayment. In such cases, the prepayment penalty amount
is largest when the balance is as high as possible. Proposed comment
38(a)(5)-6(iv) illustrates a method creditors could use to approximate
the maximum penalty where the penalty amount depends on both the loan
balance and the time at which the consumer prepays (for example, where
a prepayment penalty on an adjustable-rate loan equals six months'
interest payments). If the penalty amount depends on both the loan
balance and the time at which the consumer prepays, under the proposed
rule creditors would disclose the greater of (1) the penalty charged
when the balance is the highest possible and (2) the penalty charged
when the penalty rate is the highest possible (two-stage penalty
calculation).
The two-stage penalty calculation produces an amount that
approximates, but does not necessarily equal, the maximum prepayment
penalty. The Board believes, however, that the amount determined using
the two-stage penalty calculation ordinarily will be sufficiently close
to the actual maximum prepayment penalty that it would be appropriate
for creditors to use the method in complying with Sec. 226.38(a)(5)
and (d)(1)(iii). The Board solicits comment on whether the Board should
permit creditors to use the two-stage penalty calculation where the
penalty rate increases. Will this ``two-stage penalty calculation''
method produce a prepayment penalty amount that sufficiently
approximates the maximum prepayment penalty possible for a loan? Are
there cases where there will be a significant disparity between the
maximum penalty determined using the two-stage penalty calculation and
the actual maximum penalty?
Neither the simple penalty calculation nor the two-stage penalty
calculation will enable the creditor to determine the maximum penalty
where the penalty rate on a negatively amortizing loan declines. In
such a case, the creditor must determine the maximum prepayment penalty
by determining what the penalty would be at each point during the loan
term while the penalty is in effect.
Requiring all creditors to base maximum penalty disclosures on the
foregoing rules ensures standardization of disclosures. Allowing
creditors to select their own assumptions about when consumers are
likely to prepay would result in inconsistencies among the disclosures
given by different creditors. The Board considered other approaches,
such as requiring creditors to disclose the maximum prepayment penalty
based on a single hypothetical point in time (for example, one year
after origination). However, this approach would understate the amount
consumers who prepay earlier would have to pay.
Timely payment assumed. Proposed comment 38(a)(5)-7 states that
creditors may assume that the consumer makes payments on time and may
disregard any possible inaccuracies resulting from consumers' payment
patterns. This is consistent with existing comment 17(c)(2)(i)-3 and
proposed clarifications in comment 17(c)(1)-1. Proposed comment
38(a)(5)-7 further clarifies that where the payment required by a legal
obligation's terms is not a fully amortizing payment, the creditor must
base disclosures on the required periodic payment and may not assume
that the consumer will make payments that exceed the required payment.
38(b) Annual Percentage Rate
The Board proposes to improve the APR's utility to consumers by
making it a more inclusive measure of the cost of credit, as discussed
under Sec. 226.4, and also by improving the manner in which the APR is
disclosed on the TILA statement. Proposed Sec. 226.38(b)(1) would
require the APR to be disclosed, using the term ``annual percentage
rate'' and with the description, ``overall cost of this loan including
interest and settlement charges.'' Proposed Sec. 226.38(b)(2) would
require creditors to show the APR plotted on a graph, relative to (1)
the ``average prime offer rate'' (APOR) for borrowers with excellent
credit for a comparable loan type, in the week in which the disclosure
is provided, and (2) the higher-priced loan threshold under Sec.
226.35(a).\72\ Proposed Sec. 226.38(b)(3) would require an explanation
of the APOR and higher-priced threshold. Proposed Sec. 226.38(b)(4)
would require creditors to disclose the average per-period savings from
a 1 percentage-point reduction in the disclosed APR. Certain loans,
including construction loans, would be excluded from proposed Sec.
226.38(b)(2) and (b)(3).
---------------------------------------------------------------------------
\72\ The Board issued Sec. 226.35(a) in its 2008 HOEPA Final
Rule; compliance with Sec. 226.35(a) is mandatory beginning on
October 1, 2009.
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Current Rules
For closed-end credit, TILA Section 128(a)(4) and (a)(8) require
creditors to disclose the ``annual percentage rate,'' using that term,
together with a brief description such as ``the cost of your credit as
a yearly rate.'' 15 U.S.C. 1638(a)(4), (a)(8). Section 226.18(e)
implements these requirements. As discussed in proposed Sec. 226.37,
TILA Section 122 and Sec. 226.17(a) require the APR, with the finance
charge, to be more conspicuous than other disclosures except the
disclosure of the creditor's identity. Changes to the requirements of
Sec. 226.17(a) are discussed under Sec. 226.37.
Discussion
The APR is the only single, unified number available to help
consumers understand the overall cost of a loan.\73\ 15 U.S.C.
1638(a)(4). Before enactment of TILA in 1968, creditors could advertise
a 6 percent loan rate, but were allowed to calculate the interest
charged to the consumer by using a simple interest, an add-on, or a
discount rate method.\74\ Although the advertised loan rate would
appear the same, the amount of interest consumers actually would pay
over the loan term would differ greatly under each of these calculation
methods.\75\ In addition, consumers were forced to evaluate different
components of a loan's costs, such as interest rate, points, and
closing costs, when comparing competing loan offers. The APR
standardizes the interest rate calculation and seeks to capture the
overall cost of the credit offered so that consumers can compare
competing loan more easily than if they had to evaluate the
relationship and impact of different loan costs themselves.\76\
---------------------------------------------------------------------------
\73\ The 1998 Joint Report at 8; see also Bd. Of Governors of
Fed. Res. Sys., 1996 Report to Congress: Finance Charges for
Consumer Credit under the Truth in Lending Act at (April 1996).
\74\ The 1998 Joint Report at 8.
\75\ Id.
\76\ Id.
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Participants in the Board's consumer testing generally did not
understand the APR and often mistook it for the loan's interest
rate.\77\ The Board tested alternative descriptive statements and
formats for the APR, but consumers continued to be confused by the APR.
For example, some participants thought the APR reflected future
adjustments to the interest rate, or the maximum possible interest rate
for a variable rate loan. A few participants recognized that
[[Page 43297]]
the APR differed from the interest rate, but were unable to articulate
the reason. In addition, when presented with two hypothetical loan
offers, participants did not use the APR to compare and choose between
the offers. Instead, participants chose a loan based on one or more of
the following pieces of information: the interest rate, monthly
payment, and settlement costs.
---------------------------------------------------------------------------
\77\ See also Improving Consumer Mortgage Disclosures at 35
(finding that most respondents in consumer testing did not
understand or were confused by the APR and generally mistook it for
the contract interest rate).
---------------------------------------------------------------------------
The Board's Proposal
The Board proposes to retain the APR disclosure, with several
changes designed to improve the APR's utility for consumers. These
proposed changes would apply only to closed-end transactions secured by
real property or a dwelling. First, the Board proposes to revise the
description to use simpler terminology. Proposed Sec. 226.38(b)(1)
would require creditors to disclose the APR, expressed as a percentage,
together with a statement that it represents the overall cost of the
loan, including interest and settlement charges. As discussed under
Sec. 226.4, the Board also proposes to make the APR more inclusive of
the cost of credit. Moreover, under Sec. 226.38(c), the interest rate
would be disclosed on the form, which would help some consumers
understand that the APR does not represent the interest rate.
Second, the proposed rule also would require creditors to disclose
the APR using a graph that shows the consumer how the APR for the loan
offered would compare to the average prime offer rate and the threshold
for higher-priced loans under Sec. 226.35(a). This disclosure would
help consumers understand how the APR on the loan offered to them
compares to APRs offered to borrowers with excellent credit for a
similar loan type, and higher-priced loans which generally are made to
borrowers who present higher risk. Such borrowers include those with
blemished credit histories, or with high loan-to-value ratios.
The Board's consumer testing shows that consumers do not understand
the APR's utility. Testing the APR with different names and
descriptions did not measurably increase consumers' understanding of
the APR. Although the APR was designed in part to facilitate comparison
of competing loan products, testing suggests that most consumers do not
compare competing loans by APR, probably because they receive only one
TILA disclosure before they consummate a loan. If consumers comparison
shop for a loan, they do so before they apply for a loan and likely
shop based on oral quotes of interest rates and points.
The Board's testing suggests that with little understanding of the
APR and no ready and appropriate basis for comparison, many consumers
ignore the APR in favor of information they find more accessible, such
as the loan's monthly payment or settlement costs. Therefore, the Board
is taking two steps to improve the disclosure of the APR. The first
step is designed to draw consumers' attention to the APR. To do so, the
Board proposes to require disclosure of the consumer's APR on a graph
to highlight the APR and distinguish it from other numerical
disclosures, including the interest rate. Consumers would be more
likely to notice the APR plotted on the graph, in a prominent location
on the disclosure statement. Principles of consumer design provide that
a graphic device accommodates different learning styles. And, consumer
research has shown that use of graphics or similar visual devices help
consumers attend to or notice important information.\78\
---------------------------------------------------------------------------
\78\ Kozup, John, Elizabeth Howlett, and Michael Pagano. 2008.
``The Effects of Summary Information on Consumer Perception of
Mutual Fund Characteristics.'' The Journal of Consumer Affairs, vol.
42. See also Testimony of John Kozup, Assistant Professor,
Department of Marketing, and Director, Center for Marketing and
Public Policy, Villanova University; http://www.federalreserve.gov/
events/publichearings/hoepa/2006/20060711/transcript.pdf.
---------------------------------------------------------------------------
The Board's next proposed step is to present the APR in a context
that is designed to facilitate understanding of the APR. The Board
believes that consumers would be more likely to use the APR if it is
shown to them in context of other rates, rather than in isolation as is
presently often the case. Research on consumer behavior suggests that
consumer choice is affected by whether a consumer is presented with a
single option for a product or multiple options. Consumers making a
choice in the presence of more than one option are more likely to make
a selection based on the relative merits of the options presented,
rather than on their own existing ``references'' for the value of the
product.\79\ Here, the Board believes that presenting consumers with
information about other rates, current as of the week of the consumer's
application, would help consumers make more informed decisions about
the loan offered.
---------------------------------------------------------------------------
\79\ See, e.g., Hsee, Christopher K. and France Leclerc. 1988.
``Will Products Look More Attractive When Presented Separately or
Together?'' Journal of Consumer Research, vol. 25.
---------------------------------------------------------------------------
Testing suggests that showing the consumer the APR in context of
information about other APRs would result in consumer benefits. For
example, the APR graph would cause consumers to ask the creditor
questions about the rate offered to them and when applicable, why it
differs from the average APR offered to borrowers with excellent credit
histories. The proposed APR disclosure would enable consumers to
determine whether they are being offered a loan that comports with
their creditworthiness. A borrower who knows his or her credit history
is excellent or very good would be informed that the loan offered is
higher-priced. Participants in the Board's testing stated that if they
knew they had excellent credit, they would ask the lender why they were
being offered a higher-priced loan and what they would need to do to
get a better offer. The Board notes that some participants indicated
that the disclosed APR, even if higher-priced, was lower than the
interest rate on their current loan and thus was attractive to them.
Nevertheless, while some consumers may not be prompted by the APR graph
to seek information about improved loan terms, testing suggests others
may do so and benefit as a result.
The Board recognizes that not all consumers are aware of their
credit history, and thus may not be able to assess whether the loan
offered is consistent with their credit standing. The Board anticipates
that the APR graph would cause some consumers to investigate their
credit reports. If there are errors, these consumers could take steps
to resolve the errors. If consumers in fact have impaired credit, some
consumers might consider whether to delay seeking a loan until they
could repair their credit standing.
In some instances the APR graph may be potentially confusing. That
is, a loan may be a higher-priced loan for reasons other than the
borrower's credit history. For example, a consumer might have little
home equity, resulting in a high loan-to-value ratio and a higher APR.
The Board believes that even in such cases, the APR graph nonetheless
would be beneficial to consumers. It would prompt the consumer to ask
questions, and creditors should be able to explain to consumers why the
APR on a loan is higher-priced. In many cases the explanation may help
the consumer determine whether they could take steps to get a lower
APR. For example, if the creditor explains that the offered loan is a
higher-priced loan because of a low down-payment, the borrower would be
alerted that providing a larger down payment would result in a reduced
APR and cost savings.
The Board also notes that certain loans may be higher-priced loans
simply because of the loan type. For example, loans that exceed the
threshold amount for eligibility for purchase by Fannie
[[Page 43298]]
Mae and Freddie Mac, known as ``nonconforming'' or ``jumbo loans,'' may
tend to be higher-priced loans because of the method for calculating
the APOR. The APOR is the average APR for conforming loans offered to
borrowers with excellent credit. In the case of such loans, creditors
would have to explain to consumers why the loan's APR is higher-priced.
Third, the proposal would require the creditor to disclose the
average per-period savings from a 1 percentage-point reduction in the
disclosed APR. The Board believes that showing consumers the
relationship between the APR and a concrete dollar figure would help
make the possible benefits of obtaining better loan terms more concrete
for consumers. Showing potential savings that could result from a lower
APR would help encourage consumers to shop and negotiate for better
loan terms, or as discussed, to increase their downpayment, resolve
errors in their credit report, or seek to improve their credit
standing.
38(b)(2)
Proposed Sec. 226.38(b)(2) would require a graph indicating the
consumer's APR within a range of APRs beginning with the average prime
offer rate (``APOR''), as defined in Sec. 226.35(a)(2), including the
higher-priced mortgage loan threshold, as defined in Sec.
226.35(a)(1), and terminating four percentage points greater than the
higher-priced mortgage loan threshold. Proposed Sec. 226.38(b)(3)
would require a statement of the APOR as defined in Sec. 226.35(a)(2),
and the higher-priced mortgage loan threshold, as defined in Sec.
226.35(a)(1), current as of the week the disclosure is produced. The
graphic would contain different shaded areas using different scales for
the range between the APOR and the higher-priced mortgage loan
threshold, and for the range above the higher-priced mortgage loan
threshold. The graphic would also label the range above the higher-
priced mortgage loan threshold as the ``high-cost zone.''
Creditors would use the Board's table of average prime offer rates
to find the APOR for the loan type that matches the loan being
disclosed, for the week in which the creditor provides the disclosure.
Creditors would follow the Board's guidance in commentary to Sec.
226.35(a) in determining how to select the appropriate APOR. In the
text explaining the APOR, creditors may include a statement clarifying
that the APOR is for conforming loans only.
The Board requests comment on any potential operational difficulty
in producing the graph proposed in Sec. 226.38(b)(2) in an accurate
and timely manner. Comment is also sought on whether a different
graphical device would better draw consumers' attention to the APR and
illustrate the APR's utility to consumers.
38(b)(3)
To help consumers navigate the information provided by the graph,
proposed Sec. 226.38(b)(3) would require an explanation of the average
prime offer rate as defined in Sec. 226.35(a)(2), and the higher-
priced mortgage loan threshold, as defined in Sec. 226.35(a)(1).
Participants in the Board's consumer testing found this statement
helpful in understanding the information in the graph.
38(b)(4)
Proposed Sec. 226.38(b)(4) would provide how creditors must
calculate the average per-period savings that would result from a 1
percentage-point reduction in the APR. (This discussion refers to
monthly savings because most mortgage loans require monthly payments.)
Creditors would calculate the average per-month savings by reducing the
interest rate (or rates in the case of an ARM, as discussed in comment
34(b)(4)-1) by 1 percentage point, computing a hypothetical total of
payments reflecting the payment schedule at the lower rate or rates.
The creditor would divide the difference between (1) the total of
payments disclosed under proposed Sec. 226.38(e)(5)(i), and (2) the
hypothetical total of payments by the number of payment periods
required under the terms of the legal obligation. The creditor would
report the results of this calculation as the average savings each
month from a 1 percentage-point reduction in the APR. Proposed comment
38(b)(4)-1 would provide guidance on this method, and would include
examples for fixed- and adjustable-rate mortgages.
The Board notes that the proposed method does not result in an
exact 1 percentage-point reduction in APR, but is likely to be within a
few basis points of a 1 percentage-point reduction. The results would
be sufficiently accurate to show consumers that a lower APR will yield
savings. Methods that might result in an actual 1 percentage-point
reduction in the APR would likely be more complicated and would vary
depending on the terms of the loan, such as whether the rate is
variable and whether the payments amortize the loan. The Board believes
that any additional consumer benefit from disclosing the precise 1
percentage-point APR reduction would not be sufficient to offset the
costs of a more complex calculation method. The Board seeks comment,
however, on its proposed method and whether another method would
achieve the objectives of the disclosure without imposing undue
compliance burdens.
38(b)(5) Exemptions
Proposed section 226.38(b)(5) would exempt construction loans,
bridge loans, and reverse mortgages from the requirement to show the
APR plotted on a graph (Sec. 226.38(b)(2)) and the statement of the
APOR and the higher-priced loan threshold (Sec. 226.38(b)(3)). The
exempted transactions are also exempt from the definition of a higher-
priced mortgage, under Sec. 226.35(a)(3) in the Board's 2008 HOEPA
Final Rule. The Board does not publish an average prime offer rate for
construction, bridge, or reverse mortgage loans. Thus, an exemption
seems appropriate. The Board seeks comment, however, on whether these
transactions should nevertheless be subject to Sec. 226.38(b)(2) and
(3).
38(c) Interest Rate and Payment Summary
Proposed Sec. 226.38(c) provides requirements for disclosure of
the contract interest rate and the periodic payment for transactions
secured by real property or a dwelling. The information proposed to be
required by this paragraph must be in the form of a table, as provided
in Sec. 226.38(c)(1), substantially similar to Model Forms H-19(A), H-
19(B), or H-19(C) in Appendix H. Additional formatting requirements
would be provided in Sec. 226.37. The rules for disclosing the
interest rate and periodic payments for an amortizing loan are provided
in proposed Sec. Sec. 226.38(c)(2)(i) and 226.38(c)(3). Rules for
disclosing the interest rate and periodic payments for a loan with
negative amortization are in proposed Sec. Sec. 226.38(c)(2)(ii) and
226.38(c)(4). Special rules for disclosing balloon payments are found
in proposed Sec. 226.38(c)(5). Additional explanations of introductory
rates and negative amortization are contained in proposed Sec. Sec.
226.38(c)(2)(iii) and 226.38(c)(6), respectively. Proposed Sec.
226.38(c)(7) provides definitions for certain terms used in Sec.
226.38(c).
Existing Requirements for Periodic Payments
TILA Section 128(a)(6) requires the creditor to disclose the
number, amount, and due dates or period of payments scheduled to repay
the total of payments, for closed-end credit. 15 U.S.C. 1648(a)(6).
Currently, Sec. 226.18(g) implements TILA 128(a)(6). Under
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Sec. 226.18(g), creditors must show the number, amounts, and timing of
payments scheduled to repay the obligation, except as provided in Sec.
226.18(g)(2) for certain loans with varying payments.\80\ The creditor
must provide these disclosures on the TILA statement within three
business days of receiving th