Proposal To Update Regulation Z Commentary

In keeping with its annual schedule for updating the Regulation Z commentary, the Federal Reserve Board has proposed revisions to the commentary. Most of the proposals clarify the recent changes to Regulation Z, including those that affect the finance charge such as charges by third parties, mortgage broker fees, and per diem interest. The proposal also provides guidance on how to resolve discrepancies between the disclosure rules of Truth in Lending and RESPA.

Third Party Charges
A standard rule of thumb in determining what fees are part of the finance charge is to determine whether the creditor required the service or fee as a condition of granting credit. Recent amendments to Regulation Z provide that charges imposed by third parties, or fees for services arranged by third parties, are finance charges if the creditor requires the service or the third party. The commentary proposals provide an indication of how broadly these third party charge requirements will be construed. As an example, the proposal provides that required mortgage insurance is a finance charge even if the applicant may choose the insurer. Proposed Section 226.4(a)(1)-1.

When the third party is a closing agent, a special rule applies. The commentary proposal would clarify the circumstances when a charge imposed by a closing agent becomes a finance charge, when the creditor requires a service or the imposition of the charge, or the creditor retains a portion of the charge. Proposed Section 226.4(a)(2)-1.

The proposal would also clarify that charges exempt under Section 226.4(c)(7) with respect to loans secured by real estate do not become finance charges when imposed by or through a third party. Thus, fees for appraisals or other exempted services would be exempted from the finance charge regardless of whether the service was arranged by the lender or by a third party. The simple rule of thumb would be that the exemptions listed in Section 226.4(c)(7) over-ride any other part of Section 226.4 that would appear to include the charge. Proposed Section 226.4(a)(3)-1.

The proposal would allow certain fee arrangements between creditor and broker without making them finance charges. When the creditor and mortgage broker provide for compensation such as yield spreads or back points, the compensation paid by the creditor to the broker would not be a finance charge. Any fees paid by the consumer, such as points, are finance charges. It is only the arrangement between the creditor and the broker that would be covered by this provision. Proposed Section 226.4(a)(3)-2. This proposal to the Regulation Z Commentary comes at a time when HUD is considering whether such fees should be disclosed or taken into account in RESPA disclosures.

Sellers Points
Sellers points have long been excluded from the finance charge. However, questions have arisen about certain fees that may be paid by the seller as an inducement to the borrower. The proposal provides more guidance on how to determine whether the fees can be exempted from the finance charge. Proposed Section 226.4(c)(5)-2 would bring in the concept of legal obligation from Section 226.17(c)(1) so that the determination of whether to include the fee as a finance charge or consider it exempt as sellers points would be determined by whether the consumer has a legal obligation to pay the fee.

Per Diem Interest
The new commentary proposal elaborates on the protection for per diem interest provided in the regulation revisions issued in September, 1996. The proposal explains that this protection would be available, regardless of the number of days involved in the per diem interest discrepancy, as long as the early disclosure was accurate when provided. This would include a situation for which no per diem interest was disclosed because the transaction was expected to take place at the end of a month.The commentary also explains that the protection for per diem interest operates independently of the tolerances. It includes an example showing that an understatement of the finance charge by $200 because of per diem interest would not affect the tolerance for a fee of $90 that was omitted from the finance charge. Proposed Section 226.17(c)(2)(ii)-1.

The proposal contains related changes to the early disclosure requirements. Proposed Section 226.17(f)-1 would revise that paragraph to illustrate the operation of tolerances and to take into account the rule protecting per diem interest changes. If adopted as proposed, this paragraph would clarify that, if correct when provided and if labeled as estimates, early disclosures may be relied on as long as changes to the annual percentage rate do not exceed the applicable tolerance even if per diem interest changes because of changes in scheduling the settlement date. This protection is only available if the disclosures were accurate when provided and if they were labeled as estimates.

Itemization of Amount Financed
The regulation and commentary provide that the good faith estimate required by RESPA is a substitute for the itemization for the amount financed. The commentary proposal would clarify that the settlement sheet (HUD-1 or HUD-1A) required by RESPA also serves as an itemization for the amount financed. In order for the settlement sheet to serve as the itemization, it must be provided to the customer within the timing requirements of Regulation Z before consummation. Section 226.18(c)-4.

Because there are differences in how costs are disclosed on the HUD-1 and which costs or what portion of them is a finance charge, there have been questions about correct calculations and disclosures. The proposed commentary would provide guidance for these questions, particularly those that result from the present rules on escrow accounting. The proposal would clarify that a fee that is a finance charge under Truth in Lending is not changed because of changes to escrow accounting. Creditors must be able to identify those fees that are finance charges.

The commentary would further clarify that the lender should use the itemized amount and not the amount that is adjusted for aggregate accounting purposes to be the amount paid in to the escrow account. Proposed Section 226.18(c)(1)(iv)-2.

Also Noteworthy
Other proposals would adjust the existing commentary to reflect the new tolerances for finance charges and APRs throughout the commentary and provide additional guidance on how these provisions interact. A new paragraph Section 226.32(b)(1)(i)-1 explains that per diem interest is interest, not "points and fees." It therefore is not included in the points and fees calculation in determining whether a loan is a high cost mortgage.

Finally, the proposal would revise Section 226.5(b)(2)(ii)-3 to accommodate periodic statements provided electronically. This represents an early step in the FRB's effort to modernize regulations and disclosure requirements to reflect and accommodate electronic communications.

ACTION STEPS

Review a sample of loan files to assess the impact of the per diem interest rule. Particularly look at settlements conducted by third parties.
Review the early disclosures provided in the loan files. Check to see whether the early disclosures are labeled as estimates. If not, loan closing procedures should require automatic redisclosure at closing.
Review written procedures for loan closings to identify what should be revised to provide accurate instructions for per diem interest.
While you are reviewing files, look for any third party charges and review how those were disclosed. If you find any omissions, provide information about these charges to lending staff. Include examples to make your point clear.
Review the HUD-1 disclosures in the files you have sampled. Note how the closing costs and any other fees are entered on the HUD-1. Identify which are finance charges and check how these numbers are carried into the Truth in Lending calculations. Determine whether your bank will need to revise its procedures.
Write a comment letter and send it to the Federal Reserve Board by January 6, 1997.