We discovered yesterday that we closed two HPML's with balloon mortgages of less than 7 years. Obviously, we are severely out of compliance with regard to Ability to Repay and proper disclosures. While we are addressing our policy and procedures and retraining our people immediately, we are wondering what (if anything) we can do to cure this. (Or make the best of it with regard to the examiners). The CFO wants to change (lower) the rate by sending the customer a letter. I'm not sure that this will be sufficient. Has anyone else had to cure a HPML after consummation? What items should we be thinking about?

We make HPML balloons of less than 7 years every week. It might help that we're regulated by the FRB; not sure how the other regulators look at it.

Frequently Asked Questions and Answers

1. Question: Does the rule prohibit short-term balloon loans that are higher-priced mortgage loans?

Answer: No. However, the creditor must use prudent underwriting standards and, after considering consumers’ income, employment, obligations and assets other than the collateral, the creditor should determine that the value of the collateral (the home) is not the basis for repaying the obligation (including the balloon payment).

2. Question: Does that mean the creditor must verify that the consumer has assets and/or income at the time of consummation that would be sufficient to pay the balloon payment when it comes due?

Answer: No, such a requirement would effectively ban short-term balloon loans. If the Board had intended to ban these products it would have done so explicitly.

3. Question: What must the creditor do, then, to verify the borrower’s ability to repay a short-term balloon loan?

Answer: In addition to verifying the consumer’s ability to make regular monthly payments, a creditor should verify that the consumer would likely be able to satisfy the balloon payment obligation by refinancing the loan or through income or assets other than the collateral.

4. Question: How does the creditor verify, when it originates a short-term balloon loan, whether the consumer could qualify for a refinancing before the balloon payment is due?

Answer: The creditor has an affirmative duty to engage in prudent underwriting. 5 Thus, the creditor should consider factors such as the loan-to-value ratio and the borrower’s debt-to-income ratio or residual income—all as of the time of consummation. A borrower with a high debt-to-income ratio, and/or with little or no equity in the property, will be less likely to be able to refinance the loan before the balloon payment comes due than a borrower with lower debt-to-income and loan-to-value ratios. The creditor is not required to predict the consumer’s future financial circumstances, interest rate environment, and home value.

Please distribute copies of this letter to your examination staff for their immediate use. If you have any questions, please contact Kathleen Ryan, Senior Counsel, Regulations Section at 202-452-3667.

It has never been our intention to do this. We are not giving the customer an unconditional guarantee to renew for 7 years and the borrower cannot pay the entire balloon payment. We also don't have an ARM program disclosure. These two slipped through some VERY big cracks!

This is also an ARM?

Thanks for you in depth answer!!! It helps!

Just for clarification and to reiterate: (because i had this conversation with Jack Holzknecht once if i remember, so i don't want to mislead you)--we take a lot of stock in this letter because it comes from the FRB and we're regulated by the FRB. If you're regulated by somebody else, you might want to get their take on this.

We are regulated by the FDIC. Does anyone have their take on this?

They appear to follow the same guidance.

At the time the letter was written, Regulation Z belonged to the Fed. Their interpretation is the only official interpretation that there is. It doesn't matter what an individual examiner from another agency may think. The CFPB nor the FRB has rescinded that guidance.

Your biggest issue is whether or not you escrowed. As far as the ability to repay goes, if you didn't meet the requirements, you need to seriously look at your underwriting processes as it is just following industry standard credit underwriting processes from a safety and soundness perspective.

Once you create a HPML violation, there really is nothing that you can do to un-ring the bell.

Thanks for the info! Yes we are escrowing. I was concerned with our preclosing actions. My comfort level is much better with the guidance info. Do you know where on the FRB website I can print this from?

click here

I got it...Thanks for your help!

We are regulated by the FDIC and we have made two loans that are HPML and are under 7 years. The field office that examined us were ok with it.

I agree with what Randy said earlier, at least that it shouldn't matter who the regulator in question is. Reg. Z is (or was) the FRB's regulation and what they say on the issue of what the regulation means should be (or should have been, prior to transfer to the CFPB) the last word. I've just spoken to people who have said that the FDIC and perhaps the OCC were more of a stickler on this issue than the FRB.

For futures balloon loans, what about the new Qualified Mortgage Rules the CFPB want to put in place in January 2014? It states "the loan may not contain features that provide for interest-only payments, negative-amortization payments where the principal amount increases, or balloon payments (subject to limited exceptions)."

Right....of course, there is the exemption in section (f) for rural/underserved banks. But 3 year balloons even there will be a no-go is you want QM status. Has to be 5 years (from the first payment date).

I'm keeping a close eye on the QM issue. I asked a FDIC examiner if he had any news on the "rural and underserved" definition because of the impact it will have on our ability to offer these loans and he said that they still have not come up with who it will affect. We are in a farming/fishing community but the part of our state "officially" considered rural enough is NOT here. Thanks for everyone responding so quickly this morning!

The list has already been published, so you either fall into the slot on the two-prong tests, or you don't.

The subsequent proposal won't affect whether or not you can do a balloon. It affects other pieces.