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Truth in Lending: Refinancing or Not?

In a volatile rate environment, many mortgage borrowers come in to the bank asking for a better deal - or they say they will refinance their loan somewhere else. They are giving your bank the first chance to keep their loan and their business - and they are also hoping to save a bundle in refinancing costs. You will often find that it makes the best business sense to take steps to keep the customer by reducing the rate rather than requiring the customer to reapply.

Truth in Lending allows the lender to make some modifications to the loan without refinancing the loan and going through the whole - expensive - drill of processing a new application and generating new disclosures. This technique saves the bank a lot of work and the customer a lot of closing costs. The trick is knowing when you are modifying an existing loan and when you are doing a true refinancing with a new loan.

If loan officers know the tricks under Truth in Lending and RESPA, they can make suggestions to customers that will keep the customer, spare the bank from preparing a whole new set of disclosures, and stay within the compliance boundaries.

Knowing how to modify the loan without triggering disclosures is not an evasion of the regulations. The permission to modify a loan without triggering new disclosures is based on the assumption that the change is in the customer's interest. There may be several reasons for this, such as the examples listed below. In the current environment of concern for fair and non-deceptive trade practices, banks should be particularly careful to assess the customer's benefit and be sure that the customer does in fact benefit from the change.

With that principle in mind, the bank can offer to modify the customer's loan agreement and save both the customer and the bank the costs of re-application, new underwriting, and new disclosures. Train loan officers to understand and follow the rules set out below so that they can provide better service to their customers and stay in compliance.

Note: If the bank is making changes to the note because the consumer is in default, no disclosure requirements are triggered. You would not need to go through this form of analysis. You should, however, carefully document the default before changing the terms of the agreement.

Be sure to check with compliance and/or legal before doing anything that isn't clearly within these boundaries.

  1. When deciding to modify a loan without making new disclosures, be sure that there is clear customer benefit. If there is any question, get advice from your compliance manager or counsel.

  2. Changes that benefits the customer:

  • Lowering the interest rate.
  • Providing a smaller margin over the index, thus lowing the interest rate.
  • Converting a variable rate loan to a fixed rate loan.
  • Extending the amortization period to lower the payments.
  • Allowing the customer to skip a payment.
  • Before making the change for the customer, consider whether the change is also in the bank's interest.

  • Changes that benefit the bank:

    • Keeping the customer and the loan.
    • Providing valuable customer service, thus keeping the customer and eventually cross-selling other products.
    • Using a simple technique to adjust the loan.
    • As long as the change benefits the customer, the lender may be able to make changes to the loan without triggering new disclosures - both early and final. Both Truth in Lending and RESPA allow the bank to charge a reasonable fee to make this loan modification, even though no new disclosures are given.
  • Make sure the transaction passes the two tests.

  • A. Is the modification in the customer's favor? Does the customer walk away with a loan that is in some way better for them? Check this against the customer benefits listed above. At least several of the benefits should exist to establish that the change is in the customer's interest.

    B. Does the transaction modify - but not extinguish and replace - the existing note?

    • If you rewrite the loan, you have a new loan and all of the disclosure requirements would kick in.
    • Keep the existing loan document and prepare a "modification" - a brief agreement that refers to the existing note and simply changes one or several of the terms in that note.
    • You can file the modification without replacing the existing note. Take whatever steps are necessary under state law to ensure that the modified transaction is enforceable and that the bank is secured.
    • Do it!

    Copyright © 2001 Compliance Action. Originally appeared in Compliance Action, Vol. 6, No. 4, 4/01

    First published on 04/01/2001

    Filed under: 

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