Okay, we have an investor that is telling us they don't "recongize" the .25% tolerance on ARM loans, and they quote the following:

1. Irregular transactions. The annual percentage rate for an irregular transaction is considered accurate if it varies in either direction by not more than1/4of 1 percentage point from the actual annual percentage rate. This tolerance is intended for more complex transactions that do not call for a single advance and a regular series of equal payments at equal intervals. The1/4of 1 percentage point tolerance may be used, for example, in a construction loan where advances are made as construction progresses, or in a transaction where payments vary to reflect the consumer's seasonal income. It may also be used in transactions with graduated payment schedules where the contract commits the consumer to several series of payments in different amounts. It does not apply, however, to loans with variable rate features where the initial disclosures are based on a regular amortization schedule over the life of the loan, even though payments may later change because of the variable rate feature.

I take this to mean that if the initial rate on an ARM loan is the SAME as the current index plus margin, this would not be considered irregular because the payment schedule would show as 359 pmts of $XX and 1 pmt of $XXX, even though the payment may change over the term of the loan.

However, an ARM loan that reflects, for example, 60 pmts of $XX, 299 pmts of $XXX, and 1 pmt of $X would still be considered irregular, correct??

Yes, you are right. Par-priced ARMs can also become "irregular" if you add PMI renewal premiums to the payment schedule or otherwise alter the terms of repayment so the disclosed payment schedule becomes more complex than:
1 @ $$$
nnn @ $$$
1 @ $$$

See "Volume I" for illustration of the rationale for this rule.

THANK YOU!! I'm so glad you added the part about PMI premiums in the schedule, because this same investor is also telling us that FHA loans are not considered irregular even though the one we are having an issue with has TWELVE different payment schedules and amounts due to the monthly MI. They said that since the P&I stays the same it is not irregular. I'm seriously going to lose it, but first I will check out Volume I (if I can find it!)

Thanks again!

The concept of an "irregular transaction" is not controlled by product types, rate options, or anything else that is normally included in a loan product's features. Instead, "irregular transaction" is introduced and defined in Footnote 46:

For purposes of paragraph (a)(3) of this section, an irregular transaction is one that includes one or more of the following features: multiple advances, irregular payment periods, or irregular payment amounts (other than an irregular first period or an irregular first or final payment).

At the dawn of Regulation Z the Fed produced table books (Volumes I and II) to facilitate APR calculations. The agency also published the mathematical equations, but they could only be solved using computers - and most lenders in the 1960s did not have computers. Volume I supported "regular" transactions and a few of the most common "irregular" transactions. Volume II handled loans that were more complex.

If you skim through the instructions in Volume I, you will find that its limited functionality matches the language in Footnote 46. Volume I can only be used for loans with a single advance and a more-or-less "regular" payment schedule. In order to cover the widest possible range of loans that were common in the real world, the Fed "beefed up" Volume I with special procedures that could account for:
1. "odd days" in the first payment period,
2. one odd payment amount at the beginning of the loan, and
3. one odd payment amount at the end of the loan.

Although Volume I was awkward to use, it was fairly accurate. Volume II was very complicated and lenders were likely to make mistakes when using it. Even though Volumes I and II are rarely, if ever, used these days, Regulation Z still recognizes them and Footnote 46 still provides a sliding-scale tolerance based on their capabilities.

Yep, that's exactly what I sent their compliance/legal department and the response I got was "An FHA loan is not considered an irregular transaction. The payment differences are due to the FHA monthly insurance amount. So we do have a consistent set of P&I payments."

That's it. No regulatory support (because there isn't any) or further explanation. Now we're trying to contact someone at the Fed to see what the chances are that we can get something in writing to show them. It's now become a matter of principle

Thank you again for taking the time to assure me that at least sometimes, I DO know what I'm talking about!

The investor is wrong. Your position tracks the OSC to Section 226.18(g):

18(g) Payment schedule.

1. Amounts included in repayment schedule. The repayment schedule should reflect all components of the finance charge, not merely the portion attributable to interest....

5. Mortgage insurance. The payment schedule should reflect the consumer's mortgage insurance payments until the date on which the creditor must automatically terminate coverage under applicable law....

It can't be any clearer than that.