# Regulation Z; Truth in Lending > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2011-9766 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** May 11, 2011 - **Citation:** 76 FR 27390 ## Text FEDERAL RESERVE SYSTEM 12 CFR Part 226 [Regulation Z; Docket No. R-1417] RIN 7100-AD75 Regulation Z; Truth in Lending AGENCY: Board of Governors of the Federal Reserve System. ACTION: Proposed rule; request for public comment. SUMMARY: The Board is publishing for public comment a proposed rule amending Regulation Z (Truth in Lending) to implement amendments to the Truth in Lending Act (TILA) made by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act or Act). Regulation Z currently prohibits a creditor from making a higher-priced mortgage loan without regard to the consumer's ability to repay the loan. The proposal would implement statutory changes made by the Dodd-Frank Act that expand the scope of the ability-to-repay requirement to cover any consumer credit transaction secured by a dwelling (excluding an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan). In addition, the proposal would establish standards for complying with the ability-to-repay requirement, including by making a “qualified mortgage.” The proposal also implements the Act's limits on prepayment penalties. Finally, the proposal would require creditors to retain evidence of compliance with this rule for three years after a loan is consummated. General rulemaking authority for TILA is scheduled to transfer to the Consumer Financial Protection Bureau (CFPB) on July 21, 2011. Accordingly, this rulemaking will become a proposal of the CFPB and will not be finalized by the Board. DATES: Comments on this proposed rule must be received on or before July 22, 2011. All comment letters will be transferred to the Consumer Financial Protection Bureau. ADDRESSES: You may submit comments, identified by Docket No. R-1417 and RIN No. 7100-AD75, 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: Address to Jennifer J. Johnson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, NW., Washington, DC 20551. All public comments will be made available on the Board's Web site at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as submitted, unless modified for technical reasons. Accordingly, 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, Catherine Henderson, or Priscilla Walton-Fein, Attorneys; Paul Mondor, Lorna Neill, Nikita M. Pastor, or Maureen C. Yap, Senior Attorneys; or Brent Lattin, Counsel; Division of Consumer and Community Affairs, Board of Governors of the Federal Reserve System, Washington, DC 20551, at (202) 452-2412 or (202) 452-3667. For users of Telecommunications Device for the Deaf (TDD) only, contact (202) 263-4869. SUPPLEMENTARY INFORMATION: I. Summary of the Proposed Rule The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act or Act) amends the Truth in Lending Act (TILA) to prohibit creditors from making mortgage loans without regard to the consumer's repayment ability. Public Law 111-203 § 1411, 124 Stat. 1376, 2142 (to be codified at 15 U.S.C. 1639c). The Act's underwriting requirements are substantially similar but not identical to the ability-to-repay requirements adopted by the Board for higher-priced mortgage loans in July 2008 under the Home Ownership and Equity Protection Act. 73 FR 44522, Jul. 30, 2008 (“2008 HOEPA Final Rule”). General rulemaking authority for TILA is scheduled to transfer to the Consumer Financial Protection Bureau (CFPB) in July 2011. Accordingly, this rulemaking will become a proposal of the CFPB and will not be finalized by the Board. Consistent with the Act, the proposal applies the ability-to-repay requirements to any consumer credit transaction secured by a dwelling, except an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan. Thus, unlike the Board's 2008 HOEPA Final Rule, the proposal is not limited to higher-priced mortgage loans or loans secured by the consumer's principal dwelling. The Act prohibits a creditor from making a mortgage loan unless the creditor makes a reasonable and good faith determination, based on verified and documented information, that the consumer will have a reasonable ability to repay the loan, including any mortgage-related obligations (such as property taxes). Consistent with the Act, the proposal provides four options for complying with the ability-to-repay requirement. First, a creditor can meet the general ability-to-repay standard by originating a mortgage loan for which: • The creditor considers and verifies the following eight underwriting factors in determining repayment ability: (1) Current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment on the mortgage; (4) the monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations; (6) current debt obligations; (7) the monthly debt-to-income ratio, or residual income; and (8) credit history; and • The mortgage payment calculation is based on the fully indexed rate. Second, a creditor can refinance a “non-standard mortgage” into a “standard mortgage.” This is based on a statutory provision that is meant to provide flexibility for streamlined refinancings, which are no- or low-documentation transactions designed to quickly refinance a consumer out of a risky mortgage into a more stable product. Under this option, the creditor does not have to verify the consumer's income or assets. The proposal defines a “standard mortgage” as a mortgage loan that, among other things, does not contain negative amortization, interest-only payments, or balloon payments; and has limited points and fees. Third, a creditor can originate a “qualified mortgage,” which provides special protection from liability for creditors who make “qualified mortgages.” It is unclear whether that protection is intended to be a safe harbor or a rebuttable presumption of compliance with the repayment ability requirement. Therefore, the Board is proposing two alternative definitions of a “qualified mortgage.” Alternative 1 operates as a legal safe harbor and defines a “qualified mortgage” as a mortgage for which: (a) The loan does not contain negative amortization, interest-only payments, or balloon payments, or a loan term exceeding 30 years; (b) The total points and fees do not exceed 3% of the total loan amount; (c) The borrower's income or assets are verified and documented; and (d) The underwriting of the mortgage (1) is based on the maximum interest rate in the first five years, (2) uses a payment schedule that fully amortizes the loan over the loan term, and (3) takes into account any mortgage-related obligations. Alternative 2 provides a rebuttable presumption of compliance and defines a “qualified mortgage” as including the criteria listed under Alternative 1 as well as the following additional underwriting requirements from the ability-to-repay standard: (1) The consumer's employment status, (2) the monthly payment for any simultaneous loan, (3) the consumer's current debt obligations, (4) the total debt-to-income ratio or residual income, and (5) the consumer's credit history. Finally, a small creditor operating predominantly in rural or underserved areas can originate a balloon-payment qualified mortgage. This standard is evidently meant to accommodate community banks that originate balloon loans to hedge against interest rate risk. Under this option, a small creditor can make a balloon-payment qualified mortgage if the loan term is five years or more, and the payment calculation is based on the scheduled periodic payments, excluding the balloon payment. The proposal also implements the Dodd-Frank Act's limits on prepayment penalties, lengthens the time creditors must retain records that evidence compliance with the ability-to-repay and prepayment penalty provisions, and prohibits evasion of the rule by structuring a closed-end extension of credit as an open-end plan. The Dodd-Frank Act contains other consumer protections for mortgages, which will be implemented in subsequent rulemakings. II. Background Over the years, concerns have been raised about creditors originating mortgage loans without regard to the consumer's ability to repay the loan. Beginning in about 2006, these concerns were heightened as mortgage delinquencies and foreclosures rates increased dramatically, caused in part by the loosening of underwriting standards. See 73 FR 44524, Jul. 30, 2008. Following is background information, including a brief summary of the legislative and regulatory responses to this issue, which culminated in the enactment of the Dodd-Frank Act on July 21, 2010. A. TILA and Regulation Z In 1968, Congress enacted TILA, 15 U.S.C. 1601 et seq., 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 promote the informed use of consumer credit by requiring disclosures about its costs and terms. TILA requires additional disclosures for loans secured by consumers' homes and permits consumers to rescind certain transactions that involve their principal dwelling. TILA directs the Board to prescribe regulations to carry out the purposes of the law, and specifically authorizes the Board, among other things, to issue regulations that contain such additional requirements, classifications, differentiations, or other provisions, or that provide for such adjustments and exceptions for all or any class of transactions, that in the Board's judgment are necessary or proper to effectuate the purposes of TILA, facilitate compliance with TILA, or prevent circumvention or evasion. 15 U.S.C. 1604(a). TILA is implemented by the Board's Regulation Z, 12 CFR part 226. An Official Staff Commentary interprets the requirements of the regulation and provides guidance to creditors in applying the rules to specific transactions. See 12 CFR part 226, Supp. I. B. The Home Ownership and Equity Protection Act (HOEPA) and HOEPA Rules In response to evidence of abusive practices in the home-equity lending market, Congress amended TILA by enacting the Home Ownership and Equity Protection Act (HOEPA) in 1994. Public Law 103-325, 108 Stat. 2160. HOEPA defines a class of “high-cost mortgages,” which are generally closed-end home-equity loans (excluding home-purchase loans) with annual percentage rates (APRs) or total points and fees exceeding prescribed thresholds. 1 HOEPA created special substantive protections for high-cost mortgages, including prohibiting a creditor from engaging in a pattern or practice of extending a high-cost mortgage to a consumer based on the consumer's collateral without regard to the consumer's repayment ability, including the consumer's current and expected income, current obligations, and employment. TILA Section 129(h); 15 U.S.C. 1639(h). In addition to the disclosures and limitations specified in the statute, TILA Section 129, as added by HOEPA, expanded the Board's rulemaking authority. TILA Section 129( l )(2)(A) authorizes the Board to prohibit acts or practices the Board finds to be unfair and deceptive in connection with mortgage loans. 15 U.S.C. 1639( l )(2)(A). TILA Section 129( l )(2)(B) authorizes the Board to prohibit acts or practices in connection with the 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. 15 U.S.C. 1639( l )(2)(B). 1 Mortgages covered by the HOEPA amendments have been referred to as “HOEPA loans,” “Section 32 loans,” or “high-cost mortgages.” The Dodd-Frank Act now refers to these loans as “high-cost mortgages.” See the Dodd-Frank Act § 1431; TILA Section 103(aa). For simplicity and consistency, this proposal will use the term “high-cost mortgages” to refer to mortgages covered by the HOEPA amendments. In addition, HOEPA created three special remedies for a violation of its provisions. First, a consumer who brings a timely action against a creditor for a violation of rules issued under TILA Section 129 may be able to recover special statutory damages equal to the sum of all finance charges and fees paid by the consumer (often referred to as “HOEPA damages”), unless the creditor demonstrates that the failure to comply is not material. TILA Section 130(a); 15 U.S.C. 1640(a). This recovery is in addition to actual damages; statutory damages in an individual action or class action, up to a prescribed threshold; and court costs and attorney fees that would be available for violations of other TILA provisions. Second, if a creditor assigns a high-cost mortgage to another person, the consumer may be able to obtain from the assignee all of the foregoing damages. TILA Section 131(d); 15 U.S.C. 1641(d). For all other loans, TILA Section 131(e), 15 U.S.C. 1641(e), limits the liability of assignees for violations of Regulation Z to disclosure violations that are apparent on the face of the disclosure statement required by TILA. Finally, a consumer has a right to rescind a transaction for up to three years after consummation when the mortgage contains a provision prohibited by a rule adopted under the authority of TILA Section 129( l )(2). TILA Section 125 and 129(j); 15 U.S.C. 1635 and 1639(j). Any consumer who has the right to rescind a transaction may rescind the transaction as against any assignee. TILA Section 131(c); 15 U.S.C. 1641(c). The right of rescission does not extend, however, to home purchase loans, construction loans, or certain refinancings with the same creditor. TILA Section 125(e); 15 U.S.C. 1635(e). In 1995, the Board implemented the HOEPA amendments at § 226.31, 226.32, and 226.33 of Regulation Z. 60 FR 15463, March 24, 1995. In particular, § 226.32(e)(1) implemented TILA Section 129(h) to prohibit a creditor from extending a high-cost mortgage based on the consumer's collateral if, considering the consumer's current and expected income, current obligations, and employment status, the consumer would be unable to make the scheduled payments. In 2001, the Board amended these regulations to expand HOEPA's protections to more loans by revising the APR threshold, and points and fees definition. 66 FR 65604, Dec. 20, 2001. In addition, the ability-to-repay provisions in the regulation were revised to provide for a presumption of a violation of the rule if the creditor engages in a pattern or practice of making high-cost mortgages without verifying and documenting the consumers' repayment ability. C. 2006 and 2007 Interagency Supervisory Guidance In December 2005, the Board and the other Federal banking agencies responded to concerns about the rapid growth of nontraditional mortgages in the previous two years by proposing supervisory guidance. Nontraditional mortgages are mortgages that allow the borrower to defer repayment of principal and sometimes interest. The guidance advised institutions of the need to reduce “risk layering” practices with respect to these products, such as failing to document income or lending nearly the full appraised value of the home. The final guidance issued in September 2006 specifically advised lenders that layering risks in nontraditional mortgage loans to subprime borrowers may significantly increase risks to borrowers as well as institutions. Interagency Guidance on Nontraditional Mortgage Product Risks, 71 FR 58609, Oct. 4, 2006 (“2006 Nontraditional Mortgage Guidance”). The Board and the other Federal banking agencies addressed concerns about the subprime market in March 2007 with proposed supervisory guidance addressing the heightened risks to consumers and institutions of adjustable-rate mortgages with two- or three-year “teaser” rates followed by substantial increases in the rate and payment. The guidance, finalized in June of 2007, set out the standards institutions should follow to ensure borrowers in the subprime market obtain loans they can afford to repay. Among other steps, the guidance advised lenders to (1) use the fully-indexed rate and fully-amortizing payment when qualifying borrowers for loans with adjustable rates and potentially non-amortizing payments; (2) limit stated income and reduced documentation loans to cases where mitigating factors clearly minimize the need for full documentation of income; and (3) provide that prepayment penalty clauses expire a reasonable period before reset, typically at least 60 days. Statement on Subprime Mortgage Lending, 72 FR 37569, Jul. 10, 2007 (“2007 Subprime Mortgage Statement”). 2 The Conference of State Bank Supervisors (“CSBS”) and the American Association of Residential Mortgage Regulators (“AARMR”) issued parallel statements for state supervisors to use with state-supervised entities, and many states adopted the statements. 2 The 2006 Nontraditional Mortgage Guidance and the 2007 Subprime Mortgage Statement will hereinafter collectively be referred to as the “Interagency Supervisory Guidance.” D. 2008 HOEPA Final Rule In 2006 and 2007, the Board held a series of national hearings on consumer protection issues in the mortgage market. During those hearings, consumer advocates and government officials expressed a number of concerns, and urged the Board to prohibit or restrict certain underwriting practices, such as “stated income” or “low documentation” loans, and certain product features, such as prepayment penalties. See 73 FR 44527, Jul. 30, 2008. The Board was also urged to adopt regulations under HOEPA, because, unlike the Interagency Supervisory Guidance, the regulations would apply to all creditors and would be enforceable by consumers through civil actions. In response to these hearings, in July of 2008, the Board adopted final rules pursuant to the Board's authority in TILA Section 129( l )(2)(A). 73 FR 44522, Jul. 30, 2008 (“2008 HOEPA Final Rule”). The Board's 2008 HOEPA Final Rule defined a new class of “higher-priced mortgage loans,” . Under the 2008 HOEPA Final Rule, a higher-priced mortgage loan is a consumer credit transaction secured by the consumer's principal dwelling with an APR that exceeds the average prime offer rate (APOR) for a comparable transaction, as of the date the interest rate is set, by 1.5 or more percentage points for loans secured by a first lien on the dwelling, or by 3.5 or more percentage points for loans secured by a subordinate lien on the dwelling. Section 226.35(a)(1). The definition of a “higher-priced mortgage loan” includes those loans that are defined as “high-cost mortgages.” Among other things, the Board's 2008 HOEPA Final Rule revised the ability-to-repay requirements for high-cost mortgages, and extended these requirements to higher-priced mortgage loans. Sections 226.34(a)(4), 226.35(b)(1). Specifically, the rule: • Prohibits a creditor from extending a higher-priced mortgage loan based on the collateral and without regard to the consumer's repayment ability. • Prohibits a creditor from relying on income or assets to assess repayment ability unless the creditor verifies such amounts using third-party documents that provide reasonably reliable evidence of the consumer's income and assets. In addition, the Board's 2008 Final Rule provides certain restrictions on prepayment penalties for high-cost mortgages and higher-priced mortgage loans. Sections 226.32(d), 226.35(b)(2). E. The Dodd-Frank Act In 2007, Congress held hearings focused on rising subprime foreclosure rates and the extent to which lending practices contributed to them. See 73 FR 44528, Jul. 30, 2008. Consumer advocates testified that certain lending terms or practices contributed to the foreclosures, including a failure to consider the consumer's ability to repay, low- or no-documentation loans, hybrid adjustable-rate mortgages, and prepayment penalties. Industry representatives, on the other hand, testified that adopting substantive restrictions on subprime loan terms would risk reducing access to credit for some borrowers. In response to these hearings, the House of Representatives passed the Mortgage Reform and Anti-Predatory Lending Act in 2007 and 2009. H.R. 3915, 110th Cong. (2007); H.R. 1728, 111th Cong. (2009). Both bills would have amended TILA to provide consumer protections for mortgages, including ability-to-repay requirements, but neither bill was passed by the Senate. Then, on July 21, 2010, the Dodd-Frank Act was signed into law. Public Law 111-203, 124 Stat. 1376 (2010). Title XIV of the Dodd-Frank Act contains the Mortgage Reform and Anti-Predatory Lending Act. 3 Sections 1411, 1412, and 1414 of the Dodd-Frank Act create new TILA Section 129C, which, among other things, establishes new ability-to-repay requirements and new limits on prepayment penalties. Public Law 111-203, § 1411, 1412, 1414, 124 Stat. 1376, 2142-53 (to be codified at 15 U.S.C. 1639c). The Dodd-Frank Act states that Congress created new TILA Section 129C upon a finding that “economic stabilization would be enhanced by the protection, limitation, and regulation of the terms of residential mortgage credit and the practices related to such credit, while ensuring that responsible, affordable mortgage credit remains available to consumers.” Dodd-Frank Act Section 1402; TILA Section 129B(a)(1). The Dodd-Frank Act further states that the purpose of TILA Section 129C is to “assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans.” Dodd-Frank Act Section 1402; TILA Section 129B(a)(2). 3 Although S. Rpt. No. 111-176 generally contains the legislative history for the Dodd-Frank Act, it does not contain the legislative history for the Mortgage Reform and Anti-Predatory Lending Act. Therefore, the Board has relied on the legislative history for the 2007 and 2009 House bills for guidance in interpreting the statute. See H. Rpt. No. 110-441 for H.R. 3915 (2007), and H. Rpt. No. 111-194 for H.R. 1728 (2009). Specifically, TILA Section 129C: • Expands coverage of the ability-to-repay requirements to any consumer credit transaction secured by a dwelling, except an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan. • Prohibits a creditor from making a mortgage loan unless the creditor makes a reasonable and good faith determination, based on verified and documented information, that the consumer has a reasonable ability to repay the loan according to its terms, and all applicable taxes, insurance, and assessments. • Provides a presumption of compliance with the ability-to-repay requirements if the mortgage loan is a “qualified mortgage,” which does not contain certain risky features and limits points and fees on the loan. • Prohibits prepayment penalties unless the mortgage is a prime, fixed-rate qualified mortgage, and the amount of the prepayment penalty is limited. The Dodd-Frank Act creates special remedies for violations of TILA Section 129C. Section 1416 of the Dodd-Frank Act provides that a consumer who brings a timely action against a creditor for a violation of TILA Section 129C(a) (the ability-to-repay requirements) may be able to recover special statutory damages equal to the sum of all finance charges and fees paid by the consumer (often referred to as “HOEPA damages”), unless the creditor demonstrates that the failure to comply is not material. TILA Section 130(a). This recovery is in addition to actual damages; statutory damages in an individual action or class action, up to a prescribed threshold; and court costs and attorney fees that would be available for violations of other TILA provisions. In addition, the statute of limitations for an action for a violation of TILA Section 129C is three years from the date of the occurrence of the violation (as compared to one year for other TILA violations). TILA Section 130(e). Moreover, Section 1413 of the Dodd-Frank Act provides that a consumer may assert a violation of TILA Section 129C(a) as a defense to foreclosure by recoupment or set off. TILA Section 130(k). There is no time limit on the use of this defense. F. Other Recent Board Actions In addition to the 2008 HOEPA Final Rule, the Board has recently published several proposed or final rules for mortgages that are referenced in or relevant to this proposal. 2009 Closed-End Mortgage Proposal. In August 2009, the Board issued two proposals to amend Regulation Z: One for closed-end mortgages and one for home equity lines of credit (“HELOCs”). For closed-end mortgages, the August 2009 proposal would revise the disclosure requirements to highlight potentially risky features, such as adjustable rates and negative amortization, and address other issues, such as the timing of disclosures. See 74 FR 43232, Aug. 26, 2009 (“2009 Closed-End Mortgage Proposal”). For HELOCs, the August 2009 proposal would revise the disclosure requirements and address other issues, such as account terminations. 74 FR 43428, Aug. 26, 2009 (“2009 HELOC Proposal”). Public comments for both proposals were due by December 24, 2009. 2010 Mortgage Proposal. In September 2010, the Board issued a proposal that would revise Regulation Z with respect to rescission, refinancing, reverse mortgages, and the refund of certain fees. See 75 FR 58539, Sept. 24, 2010 (“2010 Mortgage Proposal”). Public comments for this proposal were due by December 23, 2010. On February 1, 2011, the Board issued a press release stating that it does not expect to finalize the 2009 Closed-End Mortgage Proposal, 2009 HELOC Proposal, or the 2010 Mortgage Proposal prior to the transfer of authority for such rulemakings to the Consumer Financial Protection Bureau in July 2011. 2010 Loan Originator Compensation Rule. In September 2010, the Board adopted a final rule on loan originator compensation to prohibit compensation to mortgage brokers and loan officers (collectively, “loan originators”) that is based on a loan's interest rate or other terms. The final rule also prohibits loan originators from steering consumers to loans that are not in the consumers' interest to increase the loan originator's compensation. 75 FR 58509, Sept. 24, 2010 (“2010 Loan Originator Compensation Rule”). This rule became effective April 6, 2011. 2010 MDIA Interim Final Rule. In May 2009, the Board adopted final rules implementing the amendments to TILA under the Mortgage Disclosure Improvement Act of 2008 (“MDIA”). 4 Among other things, the MDIA and the final rules require early, transaction-specific disclosures for mortgage loans secured by a dwelling, and requires waiting periods between the time when disclosures are given and consummation of the transaction. These rules became effective July 30, 2009, as required by the statute. See 74 FR 23289, May 19, 2009. The MDIA also requires disclosure of payment examples if the loan's interest rate or payments can change, along with a statement that there is no guarantee that the consumer will be able to refinance the transaction in the future. Under the statute, these provisions of the MDIA became effective on January 30, 2011. On September 24, 2010, the Board published an interim rule to implement these requirements. See 75 FR 58470, Sept. 24, 2010. In particular, the rule provided definitions for a “balloon payment,” “adjustable-rate mortgage,” “step-rate mortgage,” “fixed-rate mortgage,” “interest-only loan,” “negative amortization loan,” and the “fully indexed rate.” See § 226.18(s)(5) and (s)(7). Subsequently, the Board issued an interim rule to make certain clarifying changes. See 75 FR 81836, Dec. 29, 2010. The term “2010 MDIA Interim Final Rule” is used to refer to the September 2010 final rule as revised by the December 2010 final rule. 4 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. 2011 Escrow Proposal and Final Rule. In March 2011, the Board issued a proposal to implement Sections 1461 and 1462 of the Dodd-Frank Act, which create new TILA Section 129D and provide certain escrow requirements for higher-priced mortgage loans. See 76 FR 11599, March 2, 2011 (“2011 Escrow Proposal”). In particular, the proposal would revise the definition of a “higher-priced mortgage loan,” and create an exemption from the escrow requirement for any loan extended by a creditor that makes most of its first-lien higher-priced mortgage loans in counties designated by the Board as “rural or underserved,” has annual originations of 100 or fewer first-lien mortgage loans, and does not escrow for any mortgage transaction it services. In March 2011, the Board also issued a final rule that implements a provision of the Dodd-Frank Act that increases the APR threshold used to determine whether a mortgage lender is required to establish an escrow account for property taxes and insurance for first-lien, “jumbo” mortgage loans. See 76 FR 11319, March 2, 2011 (“2011 Jumbo Loan Escrow Final Rule”). Jumbo loans are loans exceeding the conforming loan-size limit for purchase by Freddie Mac, as specified by the legislation. 2011 Risk Retention Proposal. On March 31, 2011, the Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, the U.S. Department of Housing and Urban Development, and the Federal Housing Finance Agency (“Agencies”) issued a proposal to implement Section 941 of the Dodd-Frank Act, which adds a new Section 15G to the Securities Exchange Act of 1934. 15 U.S.C. 78o-11. As required by the Act, the proposal generally requires the sponsor of an asset-backed security to retain not less than five percent of the credit risk of the assets collateralizing the security. The Act and the proposal include a variety of exemptions, including an exemption for an asset-backed security that is collateralized exclusively by “qualified residential mortgages.” The Act requires the Agencies to define the term “qualified residential mortgage” taking into consideration underwriting and product features that historical loan performance data indicate result in a lower risk of default. The Act further provides that the definition of a “qualified residential mortgage” can be “no broader than” the definition of a “qualified mortgage” under TILA Section 129C(b)(2). The 2011 Risk Retention Proposal implements these provisions of the Act. Public comments for this proposal are due by June 10, 2011. G. Development of This Proposal In developing this proposal, the Board reviewed the laws, regulations, proposals, and legislative history described above as well as state ability-to-repay laws. The Board also conducted extensive outreach with consumer advocates, industry representatives, and Federal and state regulators, and examined underwriting rules and guidelines for the Federal Housing Administration, the U.S. Department of Veterans' Affairs, Fannie Mae, Freddie Mac, the Home Affordable Modification Program, and private creditors. Finally, the Board conducted independent analyses regarding the effect of various underwriting procedures and loan features on loan performance. III. Legal Authority TILA Section 105(a) mandates that the Board prescribe regulations to carry out the purposes of the Act. 15 U.S.C. 1604(a). In addition, TILA, as amended by the Dodd-Frank Act, specifically authorizes the Board to: • Issue regulations that contain such additional requirements, classifications, differentiations, or other provisions, or that provide for such adjustments and exceptions for all or 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. TILA Section 105(a); 15 U.S.C. 1604(a). • By regulation, prohibit or condition terms, acts or practices relating to residential mortgage loans that the Board finds to be abusive, unfair, deceptive, or predatory; necessary or proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of the ability-to-repay requirements; necessary or proper to effectuate the purposes of the ability-to-repay requirements, to prevent circumvention or evasion thereof, or to facilitate compliance; or are not in the interest of the borrower. TILA Section 129B(e); 15 U.S.C. 1639b(e). • Prescribe regulations that revise, add to, or subtract from the criteria that define a qualified mortgage upon a finding that such regulations are necessary or proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of the ability-to-repay requirements; or necessary and appropriate to effectuate the purposes of the ability-to-repay requirements, to prevent circumvention or evasion thereof, or to facilitate compliance. TILA Section 129C(b)(3)(B)(i); 15 U.S.C. 1639c(b)(3)(B)(i). TILA, as amended by the Dodd-Frank Act, states that it is the purpose of the ability-to-repay requirements to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans. TILA Section 129B(a)(2); 15 U.S.C. 1639b(a)(2). IV. Discussion of the Proposed Rule A. Scope of Coverage Consistent with the Dodd-Frank Act, the proposal applies to any dwelling-secured consumer credit transaction, including vacation homes and home equity loans. The proposal does not apply to open-end credit plans, timeshare plans, reverse mortgages, or temporary loans with terms of 12 months or less. The Act essentially codifies the ability-to-repay requirements of the Board's 2008 HOEPA Final Rule and expands the scope to the covered transactions described above. B. Ability-to-Repay Requirements Consistent with the Dodd-Frank Act, the proposal provides that a creditor may not make a covered mortgage loan unless the creditor makes a reasonable and good faith determination, based on verified and documented information, that the consumer will have a reasonable ability to repay the loan, including any mortgage-related obligations (such as property taxes). TILA Section 129C; 15 U.S.C. 1639C. The Act and the proposal provide four options for complying with the ability-to-repay requirement. Specifically, a creditor can: • Originate a covered transaction under the general ability-to-repay standard; • Refinance a “non-standard mortgage” into a “standard mortgage”; • Originate a “qualified mortgage,” which provides a presumption of compliance with the rule; or • Originate a balloon-payment qualified mortgage, which provides a presumption of compliance with the rule. Each of these methods is discussed below, with a description of: (1) Limits on the loan features or term, (2) limits on points and fees, (3) underwriting requirements, and (4) payment calculations. General Ability-to-Repay Standard Limits on loan features, term, and points and fees. Under the general ability-to-repay standards, there are no limits on the loan's features, term, or points and fees, but the creditor must follow certain underwriting requirements and payment calculations. Underwriting requirements. Consistent with the Dodd-Frank Act, the proposal requires the creditor to consider and verify the following eight underwriting factors: • Current or reasonably expected income or assets; • Current employment status; • The monthly payment on the covered transaction; • The monthly payment on any simultaneous loan; • The monthly payment for mortgage-related obligations; • Current debt obligations; • The monthly debt-to-income ratio, or residual income; and • Credit history. The proposal permits the creditor to consider and verify these underwriting factors based on widely accepted underwriting standards. The proposal is generally consistent with the Act except in one respect. The Act does not require the creditor to consider simultaneous loans that are home equity lines of credit (“HELOCs”), but the Board is using its adjustment and exception authority and discretionary regulatory authority to include HELOCs within the definition of simultaneous loans. The Board believes that such inclusion would help ensure the consumer's ability to repay the loan. Data and outreach indicated that the origination of a simultaneous HELOC markedly increases the rate of default. In addition, this approach is consistent with the Board's 2008 HOEPA Final Rule. Payment calculations. Under the general ability-to-repay standard, the Dodd-Frank Act does not ban mortgage features, but instead requires the creditor to underwrite the mortgage payment according to certain assumptions and calculations. Specifically, consistent with the Act, the proposal requires creditors to calculate the mortgage payment using: (1) The fully indexed rate; and (2) monthly, substantially equal payments that amortize the loan amount over the loan term. In addition, the Board is using its adjustment and exception authority and discretionary regulatory authority to require the creditor to underwrite the payment based on the introductory interest rate if it is greater than the fully indexed rate. Some transactions use a premium initial rate that is higher than the fully indexed rate. The Board believes this approach would help ensure the consumer's ability to repay the loan and prevent circumvention or evasion. The Act and proposal also provide special payment calculations for interest-only loans, negative amortization loans, and balloon loans. In particular, the requirements for balloon loans depend on whether the loan is “higher-priced” 5 or not. Consistent with the Act, the proposal requires a creditor to underwrite a higher-priced loan with a balloon payment by considering the consumer's ability to make the balloon payment (without refinancing). As a practical matter, this would mean that a creditor would not be able to make a higher-priced balloon loan unless the consumer had substantial documented assets or income. 5 The Act provides separate underwriting requirements for balloon loans depending on whether the loan's APR exceeds the APOR by 1.5 percent for a first-lien loan or by 3.5 percent for a subordinate-lien loan. The Act permits a creditor to underwrite a balloon loan that is not higher-priced in accordance with regulations prescribed by the Board. The proposal requires creditors to underwrite a balloon loan using the maximum payment scheduled during the first five years after consummation. This approach would not capture the balloon payment for a balloon loan with a term of five years or more. The Board believes five years is the appropriate time horizon in order to ensure consumers have a reasonable ability to repay the loan, and to preserve credit choice and availability. Moreover, the five year time horizon is consistent with other provisions in the Act and the proposal, which require underwriting based on the first five years after consummation (for qualified mortgages and the refinancing of a non-standard mortgage) or which require a minimum term of five years (for balloon-payment qualified mortgages made by certain creditors). Refinancing of a Non-Standard Mortgage The Dodd-Frank Act provides an exception to the ability-to-repay standard's underwriting requirements if: (1) The same creditor is refinancing a “hybrid mortgage” into a “standard mortgage,” (2) the consumer's monthly payment is reduced through the refinancing, and (3) the consumer has not been delinquent on any payment on the existing hybrid mortgage. This provision appears to be intended to provide flexibility for streamlined refinancings, which are no- or low-documentation loans designed to quickly refinance a consumer in a risky mortgage into a more stable product. Streamlined refinancings have substantially increased in recent years to accommodate consumers at risk of default. Definitions—loan features, term, and points and fees. Although the Act uses the term “hybrid mortgage,” the proposal uses the term “non-standard mortgage,” defined as (1) an adjustable-rate mortgage with an introductory fixed interest rate for a period of years, (2) an interest-only loan, and (3) a negative amortization loan. The Board believes that this definition is consistent with the legislative history, which indicates that Congress was generally concerned with loans that provide for “payment shock” through significantly higher payments over the life of the loan. The proposal defines the term “standard mortgage” as a covered transaction which, among other things, does not contain negative amortization, interest-only payments, or balloon payments; and limits the points and fees. Underwriting requirements. If the conditions described above are met, the Act states that the creditor may give concerns about preventing a likely default a “higher priority as an acceptable underwriting practice.” The Board interprets this provision to provide an exception from the general ability-to-repay requirements for income and asset verification. The Board believes that this approach is consistent with the statute and would preserve access to streamlined refinancings. Payment calculations. The proposal provides specific payment calculations for purposes of determining whether the refinancing reduces the consumer's monthly mortgage payment, and for determining whether the consumer has the ability to repay the standard mortgage. The calculation for the non-standard mortgage would reflect the highest payment that would occur as of the date of the expiration of the period during which introductory-rate payments, interest-only payments, or negatively amortizing payments are permitted. For a standard mortgage, the calculation would be based on: (1) The maximum interest rate that may apply during the first five years after consummation, and (2) monthly, substantially equal payments that amortize the loan amount over the loan term. Safe Harbor or Presumption of Compliance for a Qualified Mortgage Under the Board's 2008 HOEPA Final Rule, a creditor may obtain a presumption of compliance with the repayment ability requirement if it follows the required procedures, such as verifying the consumer's income or assets, and additional optional procedures, such as assessing the consumer's debt-to-income ratio. However, the 2008 HOEPA Final Rule makes clear that even if the creditor follows the required and optional criteria, the creditor has only obtained a presumption of compliance with the repayment ability requirement. The consumer can still rebut or overcome that presumption by showing that, despite following the required and optional procedures, the creditor nonetheless disregarded the consumer's ability to repay the loan. For example, the consumer could present evidence that although the creditor assessed the consumer's debt-to-income ratio, that ratio was very high with little residual income. This evidence may be sufficient to overcome the presumption of compliance and demonstrate that the creditor extended credit without regard to the consumer's ability to repay the loan. The Dodd-Frank Act provides special protection from liability for creditors who make “qualified mortgages,” but it is unclear whether that protection is intended to be a safe harbor or a rebuttable presumption of compliance with the repayment ability requirement. The Act states that a creditor or assignee “may presume” that a loan has met the repayment ability requirement if the loan is a “qualified mortgage.” This might suggest that originating a qualified mortgage only provides a presumption of compliance, which the consumer can rebut by providing evidence that the creditor did not, in fact, make a good faith and reasonable determination of the consumer's ability to repay the loan. However, the Act does not state that a creditor that makes a “qualified mortgage” must comply with all of the underwriting criteria of the general ability-to-repay standard. Specifically, the Act defines a “qualified mortgage” as a covered transaction for which: • The loan does not contain negative amortization, interest-only payments, or balloon payments; • The term does not exceed 30 years; • The points and fees generally do not exceed three percent of the total loan amount; • The income or assets are considered and verified; • The total debt-to-income ratio or residual income complies with any guideline or regulation prescribed by the Board; and • The underwriting: (1) Is based on the maximum rate during the first five years, (2) uses a payment schedule that fully amortizes the loan over the loan term, and (3) takes into account all mortgage-related obligations. The definition of a “qualified mortgage” does not require the creditor to consider and verify the following underwriting requirements that are part of the general ability-to-repay standard: (1) The consumer's employment status, (2) the payment of any simultaneous loans of which the creditor knows or has reason to know, (3) the consumer's current obligations, and (4) the consumer's credit history. Thus, if the “qualified mortgage” definition is deemed to be a safe harbor, the consumer could not allege the creditor violated the repayment ability requirement by failing to consider and verify employment status, simultaneous loans, current obligations, or credit history. Under this approach, originating a “qualified mortgage” would be an alternative to complying with the general ability-to-repay standard and would operate as a safe harbor. Thus, if a creditor satisfied the qualified mortgage criteria, the consumer could not assert that the creditor had violated the ability-to-repay provisions. The consumer could only show that the creditor did not comply with one of the qualified mortgage safe harbor criteria. There are sound policy reasons for interpreting a “qualified mortgage” as providing either a safe harbor or a presumption of compliance. Interpreting a “qualified mortgage” as a safe harbor would provide creditors with an incentive to make qualified mortgages. That is, in exchange for limiting loan fees and features, the creditor's regulatory burden and exposure to liability would be reduced. Consumers may benefit by being provided with mortgage loans that do not have certain risky features or high costs. However, the drawback to this approach is that a creditor could not be challenged for failing to underwrite a loan based on the consumer's employment status, simultaneous loans, current debt obligations, or credit history, or for generally not making a reasonable and good faith determination of the consumer's ability to repay the loan. Interpreting a “qualified mortgage” as providing a rebuttable presumption of compliance would better ensure that creditors consider a consumer's ability to repay the loan. Creditors would have to make individualized determinations that the consumer had the ability to repay the loan based on all of the underwriting factors listed in the general ability-to-repay standard. This approach would require the creditor to comply with all of the ability-to-repay standards, and preserve the consumer's ability to use these standards in a defense to foreclosure or other legal action. In addition, a consumer could assert that, despite complying with the criteria for a qualified mortgage and the ability-to-repay standard, the creditor did not make a reasonable and good faith determination of the consumer's ability to repay the loan. However, the drawback of this approach is that it provides little legal certainty for the creditor, and thus, little incentive to make a “qualified mortgage,” which limits loan fees and features. Because of the statutory ambiguity and these competing concerns, the Board is proposing two alternative definitions of a “qualified mortgage.” Alternative 1 defines a “qualified mortgage” based on the criteria listed in the Act, and the definition operates as a legal safe harbor and alternative to complying with the general ability-to-repay standard. Alternative 1 does not define a “qualified mortgage” to include a requirement to consider the consumer's debt-to-income ratio or residual income. Because of the discretion inherent in making these calculations, such a requirement would not provide certainty that the loan is a qualified mortgage. Alternative 2 defines a “qualified mortgage” to include the requirements listed in the Act as well as the other underwriting requirements that are in the general ability-to-repay standard ( i.e., employment status, simultaneous loans, current debt obligations, debt-to-income ratio, and credit history). The definition provides a presumption of compliance that could be rebutted by the consumer. Limits on points and fees. The Dodd-Frank Act defines a “qualified mortgage” as a loan for which, among other things, the total points and fees do not exceed three percent of the total loan amount. In addition, the Act requires the Board to prescribe rules adjusting this threshold for “smaller loans” and to “consider the potential impact of such rules on rural areas and other areas where home values are lower.” If the threshold were not adjusted for smaller loans, then creditors might not be able to recover their fixed costs for originating the loan. This could deter some creditors from originating smaller loans, thus reducing access to credit. The Board is proposing two alternatives for implementing the limits on points and fees for qualified mortgages. Alternative A is based on certain tiers of loan amounts ( e.g., a points and fees threshold of 3.5 percent of the total loan amount for a loan amount greater than or equal to $60,000 but less than $75,000). Alternative A is designed to be an easier calculation for creditors, but may result in some anomalies ( e.g., a points and fees threshold of $2,250 for a $75,000 loan, but a points and fees threshold of $2,450 for a $70,000 loan). Alternative B is designed to remedy these anomalies by providing a more precise sliding scale, but may be cumbersome for some creditors. The proposal solicits comment on these approaches. Definition of “points and fees.” Generally, a qualified mortgage cannot have points and fees that exceed three percent of the total loan amount. Consistent with the Act, the proposal revises Regulation Z to define “points and fees” to now include: (1) Certain mortgage insurance premiums in excess of the amount payable under Federal Housing Administration provisions; (2) all compensation paid directly or indirectly by a consumer or creditor to a loan originator; and (3) the prepayment penalty on the covered transaction, or on the existing loan if it is refinanced by the same creditor. The proposal also provides exceptions to the calculation of points and fees for: (1) Any bona fide third party charge not retained by the creditor, loan originator, or an affiliate of either, and (2) certain bona fide discount points. Underwriting requirements. As discussed above, it is not clear whether the Act intends the definition of a “qualified mortgage” to be a somewhat narrowly-defined safe harbor or a more broadly-defined presumption of compliance. For this reason, the Board is proposing two alternative definitions with respect to the underwriting requirements. Under Alternative 1, the underwriting requirements for a qualified mortgage are limited to requiring a creditor to consider and verify the consumer's current or reasonably expected income or assets. Under Alternative 2, the definition of a qualified mortgage requires a creditor to consider and verify all of the underwriting factors required under the general ability-to-repay standard, namely: (1) The currently or reasonably expected income, (2) the employment status, (3) the monthly payment on any simultaneous loan, (4) the current debt obligations, (5) the monthly debt-to-income ratio or residual income, and (6) the credit history. Payment calculations. Consistent with the Dodd-Frank Act, the proposal defines a qualified mortgage to require the creditor to calculate the mortgage payment using the periodic payment of principal and interest based on the maximum interest rate that may apply during the first five years after consummation. Balloon-Payment Qualified Mortgages Made by Certain Creditors The Board is exercising the authority provided under the Dodd-Frank Act to provide an exception to the definition of a “qualified mortgage” for a balloon-payment loan made by a creditor that meets the criteria set forth in the Act. Based on outreach, it appears that some community banks make short-term balloon loans as a means of hedging against interest rate risk, and that the community banks typically hold these loans in portfolio. The Board believes Congress enacted this exception to ensure access to credit in rural and underserved areas where consumers may be able to obtain credit only from such community banks offering these balloon-payment loans. This exception is similar to the exemption from the escrow requirements provided in another section of the Dodd-Frank Act. The proposal provides an exception for a creditor that meets the following four criteria, with some alternatives: (1) Operates in predominantly rural or underserved areas. The creditor, during the preceding calendar year, must have extended more than 50% of its total covered transactions that provide for balloon payments in one or more counties designated by the Board as “rural” or “underserved.” (2) Total annual covered transactions. Under Alternative 1, the creditor, together with all affiliates, extended covered transactions of some dollar amount or less during the preceding calendar year. Under Alternative 2, the creditor, together with all affiliates, extended some number of covered transactions or fewer during the preceding calendar year. The proposal solicits comment on an appropriate dollar amount or number of transactions. (3) Balloon loans in portfolio. Under Alternative 1, the creditor must not sell any balloon-payment loans on or after the effective date of the final rule. Under Alternative 2, the creditor must not have sold any balloon-payment loans during the preceding and current calendar year. (4) Asset size. The creditor must meet an asset size threshold set annually by the Board, which for calendar year 2011 would be $2 billion. Limits on loan features. The Dodd-Frank Act generally provides that a balloon-payment qualified mortgage contains the same limits on loan features and the loan term as a qualified mortgage, except for allowing the balloon payment. In addition, the Board is using its adjustment and exception authority and discretionary regulatory authority to add a requirement that the loan term be five years or longer. The Board believes that this requirement would help ensure the consumer's ability to repay the loan by providing more time for the consumer to build equity. Points and fees and underwriting requirements. Consistent with the Dodd-Frank Act, the proposal requires that a balloon-payment qualified mortgage provide for the same limits on points and fees and underwriting requirements as a qualified mortgage. Payment calculations. Consistent with the Dodd-Frank Act, the proposal provides that a creditor may underwrite a balloon-payment qualified mortgage using all of the scheduled payments, except the balloon payment. Other Protections Limits on prepayment penalties. Consistent with the Dodd-Frank Act, the proposal provides that a covered transaction may not include a prepayment penalty unless the transaction: (1) Has an APR that cannot increase after consummation ( i.e., a fixed-rate or step-rate mortgage), (2) is a qualified mortgage, and (3) is not a higher-priced mortgage loan. The proposal further provides, consistent with the Act, that the prepayment penalty may not exceed three percent of the outstanding loan balance during the first year after consummation, two percent during the second year after consummation, and one percent during the third year after consummation. Prepayment penalties are not permitted after the end of the third year after consummation. Finally, pursuant to the Act, the proposal requires a creditor offering a consumer a loan with a prepayment penalty to also offer that consumer a loan without a prepayment penalty. Expansion of record retention rules. Currently, Regulation Z requires creditors to retain evidence of compliance for two years after disclosures must be made or action must be taken. The Dodd-Frank Act extends the statute of limitations for civil liability for a violation of the prepayment penalty provisions or ability-to-repay provisions (including the qualified mortgage provisions) to three years after the date of a violation. The proposal revises Regulation Z to lengthen the record retention requirement to three years after consummation for consistency with the Dodd-Frank Act. Prohibition on evasion through open-end credit. Currently, Regulation Z prohibits a creditor from structuring a closed-end loan as an open-end plan to evade the requirements for higher-priced mortgage loans. The Board is using its adjustment and exception authority and discretionary regulatory authority to include a similar provision in this proposal in order to prevent circumvention or evasion. V. Section-by-Section Analysis Section 226.25 Record Retention 25(a) General Rule Currently, § 226.25(a) requires that creditors retain evidence of compliance with Regulation Z for two years after disclosures must be made or action must be taken. Section 226.25(a) also clarifies that administrative agencies responsible for enforcing Regulation Z may require creditors under their jurisdictions to retain records for a longer period, if necessary to carry out their enforcement responsibilities under TILA Section 108. 15 U.S.C. 1607. Under TILA Section 130(e), the statute of limitations for civil liability for a violation of TILA is one year after the date a violation occurs. 15 U.S.C. 1640. The proposal would implement the requirement to consider a consumer's repayment ability under TILA Section 129C(a), alternative requirements for “qualified mortgages” under TILA Section 129C(b), and prepayment penalty requirements under TILA Section 129C(c) in proposed § 226.43, as discussed in detail below. Section 1416 of the Dodd-Frank Act extends the statute of limitations for civil liability for a violation of TILA Section 129C, among other provisions, to three years after the date a violation occurs. Accordingly, the Board proposes to revise § 226.25(a) to require that creditors retain records that evidence compliance with proposed § 226.43 for at least three years after consummation. Although creditors will take action required under proposed § 226.43 (underwriting covered transactions and offering consumers the option of a covered transaction without a prepayment penalty) before a transaction is consummated, the Board believes calculating the record retention period from the time of consummation would facilitate compliance by establishing a clear time period for record retention. The proposal to extend the required period for retention of evidence of compliance with § 226.43 would not affect the record retention period for other requirements under Regulation Z. Increasing the period creditors must retain records evidencing compliance with § 226.43 from two to three years would increase creditors' compliance burden. The Board believes many creditors will retain such records for at least three years, even in the absence of a change to record retention requirements, due to the extension of the statute of limitations for civil liability. Currently, comment 25(a)-2 clarifies that in general creditors need retain only enough information to reconstruct the required disclosures or other records. The Board proposes a new comment 25(a)-6 that clarifies that if a creditor must verify and document information used in underwriting a transaction subject to proposed § 226.43, the creditor should retain evidence sufficient to demonstrate compliance with the documentation requirements of § 226.25(a). Proposed comment 25(a)-6 also clarifies that creditors need not retain actual paper copies of the documentation used to underwrite a transaction, but they should be able to reproduce those records accurately, for example, by retaining a reproduction of a consumer's Internal Revenue Service Form W-2 rather than merely the income information on the form. The Board also proposes to revise comment 25(a)-2 to remove obsolete references to particular documentation methods and to reflect that in some cases creditors must be able to reproduce (not merely reconstruct) records. Proposed comment 25(a)-7 provides guidance regarding retention of records evidencing compliance with the requirement to offer a consumer an alternative covered transaction without a prepayment penalty, discussed below in the section-by-section analyses of proposed § 226.43(g)(3) through (5). Proposed comment 25(a)-7 clarifies that creditors must retain records that document compliance with that requirement if a transaction subject to proposed § 226.43 is consummated with a prepayment penalty, but need not retain such records if a covered transaction is consummated without a prepayment penalty or a covered transaction is not consummated. See proposed § 226.43(g)(6). The Board believes the requirement to offer a transaction without a prepayment penalty under TILA Section 129C(c)(4) is intended to ensure that consumers can voluntarily choose an alternative covered transaction with a prepayment penalty. The Board therefore believes it is unnecessary for creditors to document compliance with the offer requirement when a consumer does not choose a transaction with a prepayment penalty, or if the covered transaction is not consummated. As discussed in detail below in the section-by-section analysis of proposed § 226.43(g)(4), if the creditor offers a covered transaction with a prepayment penalty through a mortgage broker, the creditor must present the mortgage broker an alternative covered transaction without a prepayment penalty. Also, the creditor must provide, by agreement, for the mortgage broker to present the consumer that transaction or an alternative covered transaction without a prepayment penalty offered by another creditor that has a lower interest rate or a lower total dollar amount of origination points or fees and discount points. Proposed comment 25(a)-7 clarifies that, to evidence compliance with proposed § 226.43(g)(4), the creditor should retain a record of (1) the alternative covered transaction without a prepayment penalty presented to the mortgage broker pursuant to proposed § 226.43(g)(4)(i), such as a rate sheet, and (2) the agreement with the mortgage broker required by proposed § 226.34(g)(4)(ii). Section 226.32 Requirements for Certain Closed-End Home Mortgages Introduction The Board proposes to revise the definition of “points and fees” in § 226.32(b)(1) to incorporate amendments to this definition under the Dodd-Frank Act. 6 Formerly, the definition of “points and fees” in both TILA and Regulation Z applied only for determining whether a home mortgage is a “high-cost mortgage” under TILA. See TILA Section 103(aa)(4), 15 U.S.C. 1602(aa)(4); § 226.32. As discussed earlier, however, the Dodd-Frank Act amended TILA to create a new type of mortgage—a “qualified mortgage”—to which certain limits on the points and fees that may be charged apply. 7 Under the new TILA amendments, the term “points and fees” for qualified mortgages has the same meaning as “points and fees” for high-cost mortgages. 6 Public Law 111-203, 124 Stat. 1376, Title XIV, § 1431. 7 Id. § 1412; TILA Section 129C(b)(2)(A)(vii), (b)(2)(C)(i); 15 U.S.C. 1639c(b)(2)(A)(vii), (b)(2)(C)(i). The Board proposes amendments to the definition of “points and fees” to implement the limitation on points and fees for qualified mortgages. The Board is not currently proposing regulations to implement the Dodd-Frank Act's amendments to TILA's high-cost mortgage rules generally. 8 For example, the Board is not proposing at this time to implement revisions to the points and fees thresholds for high-cost mortgages that exclude from the threshold calculation “bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or mortgage originator” and that permit creditors to exclude certain “bona fide discount points.” 9 By contrast, identical provisions in the Dodd-Frank Act defining the points and fees threshold for qualified mortgages are proposed to be implemented in new § 226.43(e)(3), discussed below. 10 8 Id. § 1431-1433. The Dodd-Frank Act defines a high-cost mortgage to include a mortgage for which “the total points and fees payable in connection with the transaction, other than bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or mortgage originator, exceed—(I) in the case of a transaction for $20,000 or more, 5 percent of the total transaction amount; or (II) in the case of a transaction for less than $20,000, the lesser of 8 percent of the total transaction amount or $1,000 (or such other dollar amount as the Board shall prescribe by regulation.” Id. § 1431(a); TILA Section 103(aa)(1)(A)(ii); 15 U.S.C. 1602(aa)(1)(A)(ii). 9 Public Law 111-203, 124 Stat. 1376, Title XIV, § 1431(a) and (d); TILA Section 103(aa)(1) and (dd); 15 U.S.C. 1602(aa)(1) and (dd). 10 Public Law 111-203, 124 Stat. 1376, Title XIV, § 1412; TILA Section 129C(b)(2)(C); 15 U.S.C. 1639c(b)(2)(C). Thus, if the rule on qualified mortgages is finalized prior to the rule on high-cost mortgages, the calculation of the points and fees threshold for each type of mortgage would be different, but the baseline definition of “points and fees” would be the same. 32(a) Coverage 32(a)(1) Calculation of the “Total Loan Amount” TILA Section 129C(b)(2)(A)(vii) defines a “qualified mortgage” as a mortgage for which, among other things, “the total points and fees [] payable in connection with the loan do not exceed 3 percent of the total loan amount” (emphasis added). 11 Therefore, for purposes of implementing the qualified mortgage provisions, the Board proposes to retain existing comment 32(a)(1)(ii)-1 explaining the meaning of the term “total loan amount,” with the minor revisions discussed below. 11 Similarly, prior to being revised by the Dodd-Frank Act, TILA Section 103(aa)(1)(B) defined a high-cost mortgage to include a mortgage for which “the total points and fees payable by the consumer at or before closing will exceed the greater of (i) eight percent of the total loan amount; or (ii) $400” (emphasis added). Regulation Z currently defines a high-cost mortgage to include a loan for which the total points and fees payable by the consumer at or before closing exceed a certain percentage of the “total loan amount” or a dollar amount adjusted annually for inflation. See § 226.32(a)(1)(ii). Commentary to § 226.32(a)(1)(ii) explains the term “total loan amount.” See comment 32(a)(1)(ii)-1. Section 1431 of the Dodd-Frank Act now defines a high-cost mortgage to include a mortgage for which the points and fees do not exceed a certain percentage of the “total transaction amount,” rather than using the term “total loan amount.” TILA Section 103(aa)(1)(A)(ii). The Dodd-Frank Act does not define the term “total transaction amount.” However, as discussed above, the Board is not at this time proposing to revise the definition of high-cost mortgage in § 226.32 to implement Dodd-Frank Act amendments to TILA's high-cost mortgage provisions. First, the proposal revises the “total loan amount” calculation under current comment 32(a)(1)(ii)-1 to account for charges added to TILA's definition of points and fees by the Dodd-Frank Act (proposed to be implemented under revisions to § 226.32(b)(1), discussed below). Under Regulation Z, the “total loan amount” is calculated to ensure that the allowable points and fees is a percentage of the amount of credit extended to the consumer, without taking into account the financed points and fees themselves. Specifically, under current comment 32(a)(1)(ii)-1, the “total loan amount” is calculated by “taking the amount financed, as determined according to § 226.18(b), and deducting any cost listed in § 226.32(b)(1)(iii) and § 226.32(b)(1)(iv) that is both included as points and fees under § 226.32(b)(1) and financed by the creditor.” Section 226.32(b)(1)(iii) and (b)(1)(iv) pertain to “real estate-related fees” listed in § 226.4(c)(7) and premiums or other charges for credit insurance or debt cancellation coverage, respectively. The Board proposes to revise this comment to cross-reference additional financed points and fees described in proposed § 226.32(b)(1)(vi) as well. This addition would require a creditor also to deduct from the amount financed any prepayment penalties that are “incurred by the consumer if the mortgage loan refinances a previous loan made or currently held by the creditor refinancing the loan or an affiliate of the creditor”—to the extent that the prepayment penalties are financed by the creditor into the new loan. See proposed § 226.32(b)(1)(vi), implementing TILA Section 103(aa)(4)(F). In this way, the three percent limit on points and fees for qualified mortgages will be based on the amount of credit extended to the borrower without taking into account the financed points and fees themselves. The proposal also revises one of the commentary's examples of the “total loan amount” calculation. Specifically, the Board proposes to revise the example of a $500 single premium for optional “credit life insurance” used in comment 32(b)(1)(i)-1.iv to be a $500 single premium for optional “credit unemployment insurance.” This change is proposed because, under the Dodd-Frank Act, single-premium credit insurance—including credit life insurance—is prohibited in covered transactions except for certain limited types of credit unemployment insurance. 12 See TILA Section 129C(d); 15 U.S.C. 1639c(d). 12 Public Law 111-203, 124 Stat. 1376, Title XIV, § 1414. The Board is not at this time proposing to implement the restrictions on single-premium credit insurance under the Dodd-Frank Act. Alternative calculation of “total loan amount” based on the “principal loan amount.” As noted, currently the “total loan amount” is calculated by taking the “amount financed” (as determined under § 226.18(b)) and deducting any cost listed in § 226.32(b)(1)(iii) and § 226.32(b)(1)(iv) that is both included as points and fees under § 226.32(b)(1) and financed by the creditor. The Board requests comment on whether to streamline the calculation to better ensure that the “total loan amount” includes all credit extended other than financed points and fees. Specifically, the Board solicits comment on whether to revise the calculation of “total loan amount” to be the following: “principal loan amount” (as defined in § 226.18(b) and accompanying commentary), minus charges that are points and fees under § 226.32(b)(1) and are financed by the creditor. The purpose of using the “principal loan amount” instead of the “amount financed” would be to streamline the calculation to facilitate compliance and to ensure that no charges other than financed points and fees are excluded from the “total loan amount.” In general, the revised calculation would yield a larger “total loan amount” to which the percentage points and fees thresholds would have to be applied than would the proposed (and existing) “total loan amount” calculation, because only financed points and fees and no other financed amounts would be excluded. Thus, creditors in some cases would be able to charge more points and fees on the same loan than under the proposed (and existing) rule. To illustrate, under the proposed (and current) rule, the “total loan amount” for a loan with a “principal loan amount” of $100,000 and a $3,000 upfront mortgage insurance premium is $97,000. This is because the “amount financed,” from which the “total loan amount” is derived, excludes prepaid finance charges. The $3,000 upfront mortgage origination charge meets the definition of a prepaid finance charge ( see § 226.2(a)(23)) and thus would be excluded from the “principal loan amount” to derive the “amount financed.” The “total loan amount” is the “amount financed” ($97,000) minus any points and fees listed in § 226.32(b)(1)(iii) or (b)(1)(iv) that are financed. In this example, there are no charges under § 226.32(b)(1)(iii) or (b)(1)(iv), so the “total loan amount” is $97,000. The allowable points and fees under the qualified mortgage test in this example is three percent of $97,000 or $2,910. If the “total loan amount” is derived simply by subtracting from the “principal loan amount” all points and fees that are financed, however, a different result occurs. In the example above, assume that the allowable upfront mortgage insurance premium for FHA loans is $2,000. Under proposed § 226.32(b)(1)(i)(B) (discussed in detail below), only the $1,000 difference between the $3,000 upfront private mortgage insurance premium and the $2,000 amount that would be allowable for an FHA loan must be counted as points and fees. To determine the “total loan amount,” the creditor would subtract $1,000 from the “principal loan amount” ($100,000), resulting in $99,000. The allowable points and fees under the qualified mortgage test in this example is three percent of $99,000 or $2,970. The Board requests comment on the proposed revisions to the comment explaining how to calculate the “total loan amount,” including whether additional guidance is needed. 32(b) Definitions 32(b)(1) The proposed rule would revise existing elements of Regulation Z's definition of “points and fees” (see proposed § 226.32(b)(1)(i)-(iv)) and add certain items not previously included in “points and fees” but now mandated by statute to be included (see proposed § 226.32(b)(1)(v) and (vi)). These changes are discussed in turn below. 32(b)(1)(i) Finance Charge Current § 226.32(b)(1)(i) requires that “points and fees” include “all items required to be disclosed under § 226.4(a) and 226.4(b)”—the provisions that define the term “finance charge” —“except interest or the time-price differential.” Proposed § 226.32(b)(1)(i) would revise the current provision to include in points and fees “all items considered to be a finance charge under § 226.4(a) and 226.4(b), except — • Interest or the time-price differential; and • Any premium or charge for any guarantee or insurance protecting the creditor against the consumer's default or other credit loss to the extent that the premium or charge is assessed— ○ in connection with any Federal or state agency program; ○ not in excess of the amount payable under policies in effect at the time of origination under Section 203(c)(2)(A) of the National Housing Act (12 U.S.C. 1709(c)(2)(A)) ( i.e., for Federal Housing Administration (FHA) loans), provided that the premium or charge is required to be refundable on a pro-rated basis and the refund is automatically issued upon notification of the satisfaction of the underlying mortgage loan; or ○ payable after the loan closing. See proposed § 226.32(b)(1)(i)(A)-(C). The Board proposes to revise the existing phrase, “all items required to be disclosed under § 226.4(a) and 226.4(b)” to read, “all items considered to be a finance charge under § 226.4(a) and 226.4(b)” in part because § 226.4 itself does not require disclosure of the finance charge (see instead, for example, § 226.18(d)). The Board also proposes to revise comment 32(b)(1)(i)-1. Existing comment 32(b)(1)(i)-1 states that § 226.32(b)(1)(i) includes in the total “points and fees” items defined as finance charges under § 226.4(a) and 226.4(b). The comment explains that items excluded from the finance charge under other provisions of § 226.4 are not included in the total “points and fees” under § 226.32(b)(1)(i), but may be included in “points and fees” under § 226.32(b)(1)(ii) and 226.32(b)(1)(iii). The Board proposes to revise this comment to state that items excluded from the finance charge under other provision of § 226.4 may be included in “points and fee” under § 226.32(b)(1)(ii) through 226.32(b)(1)(vi). This change is proposed to reflect the additional items added to the definition of “points and fees” by the Dodd-Frank Act and to correct the previous omission of § 226.32(b)(1)(iv). In addition, the Board proposes to incorporate into this comment an example of how this rule operates. Thus, the proposed comment notes that a fee imposed by the creditor for an appraisal performed by an employee of the creditor meets the definition of “finance charge” under § 226.4(a) as “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.” However, § 226.4(c)(7) expressly provides that appraisal fees are not finance charges. Therefore, under the general rule regarding the finance charges that must be counted as points and fees, a fee imposed by the creditor for an appraisal performed by an employee of the creditor would not be counted in points and fees. Section 226.32(b)(1)(iii), however, expressly includes in points and fees items listed in § 226.4(c)(7) (including appraisal fees) if the creditor receives compensation in connection with the charge. A creditor would receive compensation for an appraisal performed by its own employee. Thus, the appraisal fee in this example must be included in the calculation of points and fees. Comment 32(b)(1)(i)-1 is also proposed to be updated to include cross-references that correspond to provisions added to the definition of “points and fees” by the Dodd-Frank Act ( see proposed § 226.32(b)(1)(v) and (b)(1)(vi)). 32(b)(1)(i)(B) Mortgage Insurance Proposed § 226.32(b)(1)(i)(B) adds a new provision to the current definition of “points and fees” regarding charges for mortgage insurance and similar products. As stated above, under this provision, points and fees would include all items considered to be a finance charge under § 226.4(a) and 226.4(b) except mortgage insurance premiums or mortgage guarantee charges or fees to the extent that the premium or charge is— • assessed in connection with any Federal or state agency program; • not in excess of the amount payable under FHA mortgage insurance policies (provided that the premium or charge is required to be refundable on a pro-rated basis and the refund is automatically issued upon notification of the satisfaction of the underlying mortgage loan); or • payable after the loan closing. This provision implements TILA Section 103(aa)(1)(C), which specifies how “mortgage insurance” should be treated in the statutory definition of points and fees under TILA Section 103(aa)(4). Exclusion of government insurance premiums and guaranty fees. The Board proposes to incorporate the new statutory exclusion from points and fees of “any premium provided by an agency of the Federal Government or an agency of a State,” with revisions. TILA Section 103(aa)(1)(C)(i). Specifically, the proposal excludes “any premium or charge for any guaranty or insurance” under a Federal or state government program. See proposed § 226.32(b)(1)(i)(B)( 1 ). Proposed comment 32(b)(1)(i)-2 explains that, under § 226.32(b)(1)(i)(B)( 1 ) and ( 3 ), upfront mortgage insurance premiums or guaranty fees in connection with a Federal or state agency program are not “points and fees,” even though they are finance charges under § 226.4(a) and (b). The comment provides the following example: If a consumer is required to pay a $2,000 mortgage insurance premium before or at closing for a loan insured by the U.S. Federal Housing Administration, the $2,000 must be treated as a finance charge but need not be counted in “points and fees.” The Board interprets the statute to exclude from points and fees not only upfront mortgage insurance premiums under government programs but also charges for mortgage guaranties under government programs, which typically are assessed upfront as well. The proposed exclusion from points and fees of both mortgage insurance premiums and guaranty fees under government programs is also supported by the Board's authority under TILA Section 105(a) to make adjustments to facilitate compliance with TILA and to effectuate the purposes of TILA. 15 U.S.C. 1604(a). The exclusion is further supported by the Board's authority under TILA Section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Board finds necessary or proper to effectuate the purposes of TILA. 15 U.S.C. 1639b(e). The purposes of TILA include “assur[ing] that consumers are offered and receive residential mortgage loan on terms that reasonably reflect their ability to repay the loans.” TILA Section 129B(a)(2); 15 U.S.C. 1629b(a)(2). Representatives of both the U.S. Department of Veterans Affairs (VA) and the U.S. Department of Agriculture (USDA) expressed concerns to Board staff that the statute, which excludes only “premiums” under government programs, could be read to mean that upfront charges for guaranties offered under loan programs of these agencies and any state agencies must be counted in “points and fees.” The Board understands that this interpretation of the statute could disrupt these loan guaranty programs, jeopardizing an important home mortgage credit resource for many consumers. According to VA representatives, for example, if VA “funding fees” for the VA mortgage loan guaranty are included in points and fees, for example, VA loans might exceed high-cost mortgage thresholds and likely would exceed the points and fees cap for a qualified mortgage. 13 In sum, the Board believes that the proposal is necessary to ensure consumer's access to credit through state and Federal government programs. 13 The statute authorizes certain agencies, including the VA and USDA, to prescribe rules defining the loans under their programs that are qualified mortgages; until those rules take effect, however, it appears that even loans under government programs will be subject to the general ability-to-repay requirements and the criteria for qualified mortgages. See TILA Section 129C(b)(3)(ii). The Board requests comment on the proposal to exclude from “points and fees” upfront premiums as well as charges for any insurance or guaranty under a Federal or state government program. Inclusion of upfront private mortgage insurance. Proposed § 226.32(b)(1)(i)(B)( 2 ) excludes from points and fees any premium or charge for any guaranty or insurance protecting the creditor against the consumer's default or other credit loss to the extent the premium or charge does not exceed the amount payable under policies in effect at the time of origination under Section 203(c)(2)(A) of the National Housing Act (12 U.S.C. 1709(c)(2)(A)) ( i.e., for Federal Housing Administration (FHA) loans). Upfront private mortgage insurance charges may only be excluded from points and fees, however, if the premium or charge is required to be refundable on a pro-rated basis and the refund is automatically issued upon notification of the satisfaction of the underlying mortgage loan. Proposed § 226.32(b)(1)(i)(B)( 3 ) excludes from points and fees any premium or charge for any guarantee or insurance protecting the creditor against the consumer's default or other credit loss to the extent that the premium or charge is payable after the loan closing. Comment 32(b)(1)(i)-3 explains that, under proposed § 226.32(b)(1)(i)(B)( 2 ) and ( 3 ), upfront private mortgage insurance premiums are not “points and fees,” even though they are finance charges under § 226.4(a) and (b)—but only to the extent that the premium amount does not exceed the amount payable under policies in effect at the time of origination under Section 203(c)(2)(A) of the National Housing Act (12 U.S.C. 1709(c)(2)(A)). In addition, upfront private mortgage insurance premiums are excluded from “points and fees” only if they are required to be refunded on a pro rata basis and the refund is automatically issued upon notification of the satisfaction of the underlying mortgage loan. This comment provides the following example: Assume that a $3,000 upfront private mortgage insurance premium charged on a covered transaction is required to be refunded on a pro rata basis and automatically issued upon notification of the satisfaction of the underlying mortgage loan. Assume also that the maximum upfront premium allowable under the National Housing Act is $2,000. In this case, the creditor could exclude $2,000 from “points and fees” but would have to include in points and fees the remaining $1,000, because this is the amount that exceeds the allowable premium under the National Housing Act. However, if the $3,000 upfront private mortgage insurance premium were not required to be refunded on a pro rata basis and automatically issued upon notification of the satisfaction of the underlying mortgage loan, the entire $3,000 premium must be included in “points and fees.” Proposed comment 32(b)(1)(i)-4 explains that upfront private mortgage insurance premiums that do not qualify for an exclusion from “points and fees” under § 226.32(b)(1)(i)(B)( 2 ) must be included in “points and fees” whether paid before or at closing, in cash or financed, and whether the insurance is optional or required. This comment further explains that these charges are also included whether the amount represents the entire premium or an initial payment. This proposed comment is consistent with existing comment 32(b)(1)(iv)-1 regarding the treatment of credit insurance premiums. TILA's new mortgage insurance provision could plausibly be interpreted to apply to the definition of points and fees solely for purposes of high-cost mortgages and not for qualified mortgages. In this regard, the Board notes that the statutory provision mandating a three percent cap on points and fees for qualified mortgages specifically cross-references TILA Section 103(aa)(4) for the definition of “points and fees” applicable to qualified mortgages. The provision on mortgage insurance, however, does not appear in TILA Section 103(aa)(4), but appears rather as part of the general definition of a high-cost mortgage. See TILA Section 103(aa)(1). The Board also notes that certain provisions in the Dodd-Frank Act's high-cost mortgage section regarding points and fees are repeated in the qualified mortgage section on points and fees. For example, both the high-cost mortgage provisions and the qualified mortgage provisions expressly exclude from points and fees “bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or mortgage originator.” TILA Sections 103(aa)(1)(A)(ii) (for high-cost mortgages), 129C(b)(2)(C)(i) (for qualified mortgages). The mortgage insurance provision, however, does not separately appear in the qualified mortgage section. Nonetheless, the Board believes that the better interpretation of the statute is that the mortgage insurance provision in TILA Section 103(aa)(1)(C) applies to the meaning of points and fees for both high-cost mortgages and qualified mortgages. The statute's structure reasonably supports this view: By its plain language, the mortgage insurance provision prescribes how points and fees should be computed “for purposes of paragraph (4)”—namely, for purposes of TILA Section 103(aa)(4). The mortgage insurance provision contains no caveat limiting its application solely to the points and fees calculation for high-cost mortgages. The cross-reference in the qualified mortgage provisions to TILA Section 103(aa)(4) appropriately can be read to include provisions that expressly prescribe how points and fees should be calculated under TILA Section 103(aa)(4), wherever located. Applying the mortgage insurance provision to the meaning of points and fees for both high-cost mortgages and qualified mortgages is also supported by the Board's authority under TILA Section 105(a) to make adjustments to facilitate compliance with TILA 15 U.S.C. 1604(a). The exclusion is further supported by the Board's authority under TILA Section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Board finds necessary or proper to effectuate the purposes of TILA. 15 U.S.C. 1639b(e). The purposes of TILA include “assur[ing] that consumers are offered and receive residential mortgage loan on terms that reasonably reflect their ability to repay the loans.” TILA Section 129B(a)(2); 15 U.S.C. 1629b(a)(2). From a practical standpoint, the Board is concerned about the increased risk of confusion and compliance error if points and fees has two separate meanings in TILA—one for determining whether a loan is a high-cost mortgage and another for determining whether a loan is a qualified mortgage. The proposal is intended to facilitate compliance by applying the mortgage insurance provision to the meaning of points and fees for both high-cost mortgages and qualified mortgages. In addition, the Board is concerned that market distortions could result due to different treatment of mortgage insurance in calculating points and fees for high-cost mortgages and qualified mortgages. As noted, “points and fees” for both high-cost mortgages and qualified mortgages generally excludes “bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or mortgage originator.” TILA Sections 103(aa)(1)(A)(ii), 129C(b)(2)(C)(i). Under this general provision standing alone, premiums for upfront private mortgage insurance would be excluded from points and fees. However, as noted, the statute's specific provision on mortgage insurance (TILA Section 103(aa)(1)(C)) requires that any portion of upfront premiums for private mortgage insurance that exceeds amounts allowable for upfront insurance premiums in FHA mortgage loan transactions be counted in points and fees. It further provides that upfront private mortgage insurance premiums must be included in points and fees if they are not required to be refunded on a pro rata basis and the refund is not automatically issued upon notification of the satisfaction of the underlying mortgage loan. Narrowly applying the mortgage insurance provision to the definition of points and fees only for high-cost mortgages would mean that any premium amount for upfront private mortgage insurance could be charged on qualified mortgages; in most cases, none of that amount would be subject to the cap on points and fees for qualified mortgages because it would be excluded as a “bona fide third party fee” that is not retained by the creditor, loan originator, or an affiliate of either. As a result, consumers of qualified mortgages could be vulnerable to paying excessive upfront private mortgage insurance costs. In the Board's view, this outcome would undercut Congress's clear intent to ensure that qualified mortgages are products with limited fees and more safe features. 32(b)(1)(ii) Loan Originator Compensation The Board proposes revisions to § 226.32(b)(ii) to reflect statutory amendments under the Dodd-Frank Act. Current § 226.32(b)(ii) requires inclusion in points and fees of “all compensation paid to a mortgage broker.” Proposed § 226.32(b)(ii) would implement a new statutory provision that requires inclusion in points and fees of “all compensation paid directly or indirectly by a consumer or creditor to a mortgage originator from any source, including a mortgage originator that is also the creditor in a table-funded transaction.” See TILA Section 103(aa)(4)(B), 15 U.S.C. 1602(aa)(4)(B). Consistent with the statute, the Board also proposes to exclude from points and fees compensation paid to certain persons. See proposed § 226.32(b)(2), discussed below. Proposed § 226.32(b)(1)(ii) mirrors the statutory language, with two exceptions. First, the statute requires inclusion of “compensation paid directly or indirectly by a consumer or creditor to a mortgage originator from any source. * * *” The proposed rule does not include the phrase “from any source” because the provision expressly covers compensation paid “directly or indirectly” to the loan originator, which would have the same effect. The Board requests comment on whether any reason exists to include the phrase “from any source” to describe loan originator compensation for purposes of implementing TILA Section 103(aa)(4)(B). Second, the proposal uses the term “loan originator” as defined in § 226.36(a)(1), 14 not the term “mortgage originator” under Section 1401 of the Dodd-Frank Act. 15 See TILA Section 103(cc)(2); 15 U.S.C. 1602(cc)(2). The term “loan originator” is used for consistency with existing Regulation Z provisions under § 226.36. The Board believes that the term “loan originator,” as defined in § 226.36(a)(1), is appropriately used in proposed § 226.32(b)(1)(ii) because the meaning of “loan originator” under § 226.36(a)(1) and the statutory definition of “mortgage originator” are consistent in several key respects, discussed below. 14 Section 226.36(a)(1) defines the term “loan originator” to mean, “with respect to a particular transaction, a person who for compensation or other monetary gain, or in expectation of compensation or other monetary gain, arranges, negotiates, or otherwise obtains an extension of credit for another person. The term `loan originator' includes an employee of the creditor if the employee meets this definition. The term `loan originator' includes the creditor only if the creditor does not provide the funds for the transaction at consummation out of the creditor's own resources, including drawing on a bona fide warehouse line of credit, or out of deposits held by the creditor.” Section 226.36(a)(1). 15 Public Law 111-203, 124 Stat. 1376, Title XIV, § 1401. In addition, new § 226.32(b)(2) would account for the distinctions between the Dodd-Frank Act's definition of “mortgage originator” and the definition of “loan originator” under § 226.36(a)(1). Proposed § 226.32(b)(2) exempts from points and fees compensation paid to certain persons expressly excluded from the statutory definition of “mortgage originator.” See section-by-section analysis of § 226.32(b)(2), below. Use of the term “loan originator” in proposed § 226.32(b)(1)(ii). Loan originator functions. The Dodd-Frank Act defines the term “mortgage originator” to mean “any person who, for direct or indirect compensation or gain, or in the expectation of direct or indirect compensation or gain—(i) takes a residential mortgage loan application; (ii) assists a consumer in obtaining or applying to obtain a residential mortgage loan; or (iii) offers or negotiates terms of a residential mortgage loan . * * *” TILA Section 103(cc)(2)(A). The statute further defines “assists a consumer in obtaining or applying to obtain a residential mortgage loan” to mean, “among other things, advising on residential mortgage loan terms (including rates, fees, and other costs), preparing residential mortgage loan packages, or collecting information on behalf of the consumer with regard to a residential mortgage loan.” The definition of “loan originator” in § 226.36 includes all of the activities listed in the statute as part of the definition of “mortgage originator,” with one exception. Unlike the statutory definition of “mortgage originator,” however, Regulation Z's definition of “loan originator” does not include “any person who represents to the public, through advertising or other means of communicating or providing information (including the use of business cards, stationery, brochures, signs, rate lists, or other promotional items), that such person can or will provide any of the activities” described above. TILA Section 103(cc)(2)(B); 15 U.S.C. 1602(cc)(2)(B). The Board does not believe that adding this element of the definition of “mortgage originator” to Regulation Z's definition of “loan originator” is necessary at this time because § 226.36 and the proposed definition of “points and fees” are concerned solely with loan originators that receive compensation for performing defined origination functions. A person who solely represents to the public that he is able to offer or negotiate mortgage terms for a consumer has not yet received compensation for that function; thus, there is no compensation to account for in calculating “points and fees” for a particular transaction. The Board solicits comment on the proposal not to include in the definition of “loan originator” a “person who represents to the public, through advertising or other means of communicating or providing information (including the use of business cards, stationery, brochures, signs, rate lists, or other promotional items), that such person can or will provide” the services of a loan originator. Administrative tasks. The Board also believes that the definition of “loan originator” in § 226.32(a)(1) is consistent with the Dodd-Frank Act's definition of “mortgage originator” in that both exclude persons that perform solely administrative or clerical tasks. Specifically, the statute excludes any person who does not perform the tasks in the paragraph above and “who performs purely administrative or clerical tasks on behalf of a person who [performs those tasks].” TILA Section 103(cc)(2)(B); 15 U.S.C. 1602(cc)(2)(B). Similarly, Regulation Z's current definition of “loan originator” excludes “managers, administrative staff, and similar individuals who are employed by a creditor or loan originator but do not arrange, negotiate, or otherwise obtain an extension of credit for a consumer, and whose compensation is not based on whether any particular loan is originated.” Comment 36(a)(1)-4. Seller financing. In addition, the existing definition of “loan originator” in § 226.36(a)(1) is consistent with the statutory definition of “mortgage originator” in that both exclude persons and entities that provide seller financing for properties that they own. See TILA Section 103(cc)(2)(E); 15 U.S.C. 1602(cc)(2)(E). Under the definition of “loan originator” in § 226.36(a)(1), these persons would be “creditors”—but they are not “creditors” that use table funding. As noted below, creditors that use table funding are “loan originators” under § 226.36. However, all other “creditors” are not “loan originators.” See 75 FR 58509, 58510 (Sept. 24, 2010). Creditors in table-funded transactions. Both the existing definition of “loan originator” in § 226.36(a)(1) and the statutory definition of “mortgage originator” exclude the creditor, except for the creditor in a table-funded transaction. See TILA Section 103(cc)(2)(F); 15 U.S.C. 1602(cc)(2)(F); see also comment 36(a)-1.i. Both also include employees of a creditor, individual brokers and mortgage brokerage firms, including entities that close loans in their own names that are table funded by a third party. Secondary market transactions. Finally, neither the definition of “loan originator” in § 226.36(a)(1) nor the statutory definition of “mortgage originator” includes entities that earn compensation on the sale of loans by creditors to secondary market purchasers—transactions to which consumers are not a direct party. See generally TILA Section 103(cc)(2); 15 U.S.C. 1602(cc)(2). Comments 32(b)(1)(ii)-1, -2, and -3. Proposed comments 32(b)(1)(ii)-1, -2, and -3 provide guidance on the types of loan originator compensation 16 included in “points and fees.” Existing comment 32(b)(1)(ii)-1 would be revised to clarify that compensation paid by either a consumer or a creditor to a loan originator, as defined in § 226.32(a)(1), is included in “points and fees.” No other substantive changes are intended. 16 Loan originator compensation would, of course, need to be consistent with the Interagency Guidance on Sound Incentive Compensation Policies. 75 FR 36395, June 25, 2010. New comment 32(b)(1)(ii)-2.i would clarify that, in determining “points and fees,” loan originator compensation includes the dollar value of compensation paid to a loan originator for a covered transaction, such as a bonus, commission, yield spread premium, award of merchandise, services, trips, or similar prizes, or hourly pay for the actual number of hours worked on a particular transaction. The proposed comment would further clarify that compensation paid to a loan originator for a covered transaction must be included in the “points and fees” calculation for that transaction whenever paid, whether at or before closing or anytime after closing, as long as that compensation amount can be determined at the time of closing. Thus, loan originator compensation for a covered transaction includes compensation that will be paid as part of a periodic bonus, commission, or gift if a portion of the dollar value of the bonus, commission, or gift can be attributed to that transaction. Proposed comment 32(b)(1)(ii)-2.i then provides three examples of compensation paid to a loan originator that must be included in the points and fees calculation. The first example assumes that, according to a creditor's compensation policies, the creditor awards its loan officers a bonus every year based on the number of loan applications taken by the loan officer that result in consummated transactions during that year, and that each consummated transaction increases the bonus by $100. In this case, the $100 bonus must be counted in the amount of loan originator compensation that the creditor includes in “points and fees.” The second example assumes that, according to a creditor's compensation policies, the creditor awards its loan officers a bonus every year based on the dollar value of consummated transactions originated by the loan officer during that year. Also assumed is that, for each transaction of up to $100,000, the creditor awards its loan officers a bonus of $100; for each transaction of more than $100,000 up to $250,000, the creditor awards its loan officers $200; and for each transaction of more than $250,000, the creditor awards its loan officers $300. In this case, for a mortgage transaction of $300,000, the $300 bonus is loan originator compensation that must be included in “points and fees.” The third example assumes that, according to a creditor's compensation policies, the creditor awards its loan officers a bonus every year based on the number of consummated transactions originated by the loan officer during that year. Also assumed is that for the first 10 transactions originated by the loan officer in a given year, no bonus is awarded; for the next 10 transactions originated by the loan officer up to 20, a bonus of $100 per transaction is awarded; and for each transaction originated after the first 20, a bonus of $200 per transaction is awarded. In this case, for the first 10 transactions originated by a loan officer during a given year, no amount of loan originator compensation need be included in “points and fees.” For any mortgage transaction made after the first 10, up to the 20th transaction, $100 must be included in “points and fees.” For any mortgage transaction made after the first 20, $200 must be included in “points and fees.” Proposed comment 32(b)(1)(ii)-2.ii clarifies that, in determining “points and fees,” loan originator compensation excludes compensation that cannot be attributed to a transaction at the time of origination, including, for example: • Compensation based on the performance of the loan originator's loans. • Compensation based on the overall quality of a loan originator's loan files. • The base salary of a loan originator who is also the employee of the creditor, not accounting for any bonuses, commissions, pay raises, or other financial awards based solely on a particular transaction or the number or amount of covered transactions originated by the loan originator. Proposed comment 32(b)(1)(ii)-3 explains that loan originator compensation includes amounts the loan originator retains and is not dependent on the label or name of any fee imposed in connection with the transaction. For example, if a loan originator imposes a “processing fee” and retains the fee, the fee is loan originator compensation under paragraph 32(b)(1)(ii) whether the originator expends the fee to process the consumer's application or uses it for other expenses, such as overhead. The proposed comment is consistent with comment 36(d)(1)-1.ii for loan originator compensation. The Board requests comment on the proposal regarding the types of loan originator compensation that must be included in points and fees, including the appropriateness of specific examples given in the commentary. 32(b)(1)(iii) Real Estate-Related Fees Consistent with the statute, the Board proposes no changes to existing § 226.32(b)(1)(iii), which includes in points and fees “all items listed in § 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.” During outreach, creditor representatives raised concerns about the inclusion in points and fees of real estate-related fees paid to an affiliate of the creditor, such as an affiliated title company. These fees have historically been included in points and fees for high-cost mortgages under both TILA and Regulation Z, but the points and fees threshold for qualified mortgages is much lower than for the high-cost mortgage threshold. Thus, creditors that use affiliated settlement service providers such as title companies are concerned that they will have difficulty making loans that meet the qualified mortgage points and fees threshold. The Board is not proposing an exemption for fees paid to creditor-affiliated settlement services providers. The Board notes that Congress appears to have rejected excluding from points and fees real estate-related fees where a creditor would receive indirect compensation as a result of obtaining distributions of profits from an affiliated entity based on the creditor's ownership interest in compliance with RESPA. 17 The Board requests comment on the proposal not to exclude from the points and fees calculation for qualified mortgages fees paid to creditor-affiliated settlement services providers. The Board invites commenters favoring this exclusion to explain why excluding these fees from the points and fees calculation would be consistent with the purposes of the statute. 17 See Mortgage Reform and Anti-Predatory Lending Act, H. Rep. 111-94, p. 121 (May 4, 2009). An earlier version of the Dodd-Frank Act would have amended the statutory provision implemented by § 226.32(b)(1)(iii) to read as follows (added language italicized): * * * [P]oints and fees shall include— * * * (C) each of the charges listed in section 106(e) (except an escrow for future payment of taxes), unless— (i) the charge is reasonable; (ii) the creditor receives no direct or indirect compensation , except where applied to the charges set forth in section 106(e)(1) where a creditor may receive indirect compensation solely as a result of obtaining distributions of profits from an affiliated entity based on its ownership interest in compliance with section 8(c)(4) of the Real Estate Settlement Procedures Act of 1974; and (iii) the charge is paid to a third party unaffiliated with the creditor. See id. Payable at or before closing. The Dodd-Frank Act removed the phrase “payable at or before closing” from the high-cost mortgage points and fees test in TILA Section 103(aa)(1)(B). See TILA Section 103(aa)(1)(A)(ii). The phrase “payable at or before closing” is also not in TILA's provisions on the points and fees cap for qualified mortgages. See TILA Section 129C(b)(2)(A)(vii), (b)(2)(C). Thus, with a few exceptions, any item listed in the “points and fees” definition under § 226.32(b)(1) must be counted toward the limits on points and fees for both high-cost mortgages and qualified mortgages, even if it is payable after loan closing. The exceptions are mortgage insurance premiums and charges for credit insurance and debt cancellation and suspension coverage. The statute expressly states that these premiums and charges are included in points and fees only if payable at or before closing. See TILA Section 103(aa)(1)(C) (for mortgage insurance) and TILA Section 103(aa)(4)(D) (for credit insurance and debt cancellation and suspension coverage). The statute does not so limit § 226.4(c)(7) charges, possibly because these charges could reasonably be viewed as charges that by definition are only payable at or before closing. 18 18 Section 226.4(c)(7) implements TILA Section 106(e), which states: “The following items, when charged in connection with any extension of credit secured by an interest in real property, shall not be included in the computation of the finance charge with respect to that transaction: (1) Fees or premiums for title examination, title insurance, or similar purposes. (2) Fees for preparation of loan-related documents. (3) Escrows for future payments of taxes and insurance. (4) Fees for notarizing deeds and other documents. (5) Appraisal fees, including fees related to any pest infestation or flood hazard inspections conducted prior to closing. (6) Credit reports” (emphasis added). 15 U.S.C. 1605(e). Nonetheless, regarding the mortgage loan transaction costs that are deemed points and fees, the Board requests comment on whether any other types of fees should be included in points and fees only if they are “payable at or before closing.” The Board is concerned that some fees that occur after closing, such as fees to modify a loan, might be deemed to be points and fees. If so, calculating the points and fees to determine whether a transaction is a qualified mortgage may be difficult because the amount of future fees ( e.g., loan modification fees) cannot be known prior to closing. Creditors might be exposed to excessive litigation risk if consumers were able at any point during the life of a mortgage to argue that the points and fees for the loan exceed the qualified mortgage limits due to fees imposed after loan closing. Creditors therefore might be discouraged from making qualified mortgages, which would thwart Congress's goal of increasing incentives for creditors to make more stable, affordable loans. 32(b)(1)(iv) Credit Insurance and Debt Cancellation or Suspension Coverage The Board proposes to revise § 226.32(b)(1)(iv) to reflect statutory changes under the Dodd-Frank Act. See TILA Section 103(aa)(4)(D). Specifically, proposed § 226.32(b)(1)(iv) includes in points and fees “[p]remiums or other charges payable at or before closing of the mortgage loan for any credit life, credit disability, credit unemployment, or credit property insurance, or any other life, accident, health, or loss-of- income insurance, or any payments directly or indirectly for any debt cancellation or suspension agreement or contract.” Except for non-substantive changes in the ordering of the items listed, this provision mirrors the statutory language. TILA's new points and fees provision regarding charges for credit insurance and debt cancellation and suspension coverage adds certain types of credit insurance-related products to the existing list of credit insurance products for which payments at or before closing must be considered points and fees in existing § 226.32(b)(1)(iv). Accordingly, proposed revisions to § 226.32(b)(1)(iv) add to the list of products the following new items: Credit disability, credit unemployment, or credit property insurance and debt suspension coverage. (Other life, accident, health, or loss-of-income insurance, or any payments directly or indirectly for any debt cancellation or suspension agreement or contract are included in the existing provision.) In a separate provision, however, the Dodd-Frank Act bans single-premium credit insurance and debt protection products of all the types listed above, except for credit unemployment insurance meeting certain conditions. See TILA Section 129C(d); 15 U.S.C. 1639c(d). The Board notes that the practical result of these combined amendments is that only single-premium credit unemployment insurance meeting certain conditions is permitted; therefore only single-premium credit unemployment insurance will be included in points and fees. 19 19 Public Law 111-203, 124 Stat. 1376, Title XIV, § 1414. The Board is not at this time proposing to implement the restrictions on single-premium credit insurance under the Dodd-Frank Act. The proposal revises current comment 32(b)(1)(iv)-1 to clarify that upfront charges for debt cancellation or suspension agreements or contracts are expressly included in points and fees. Another proposed revision clarifies that upfront credit insurance premiums and debt cancellation or suspension charges must be included in “points and fees” regardless of whether the insurance or coverage is optional or voluntary. The proposal adds new comment 32(b)(1)(iv)-2 to clarify that “credit property insurance” includes insurance against loss of or damage to personal property, such as a houseboat or manufactured home. The comment states that “credit property insurance” as used in § 226.32(b)(1)(iv) covers the creditor's security interest in the property. The comment explains that “credit property insurance” does not include homeowners insurance, which, unlike “credit property insurance,” typically covers not only the dwelling but its contents, and designates the consumer, not the creditor, as the beneficiary. The Board requests comment on the proposal to implement the statutory provision that includes upfront premiums and charges for credit insurance and debt cancellation and suspension coverage in the definition of “points and fees.” 32(b)(1)(v) Prepayment Penalties That May be Charged on the Loan Proposed § 226.32(b)(1)(v) includes in points and fees “the maximum prepayment penalty, as defined in § 226.43(b)(10), that may be charged or collected under the terms of the mortgage loan.” This provision implements TILA Section 103(aa)(4)(E) and incorporates the statutory language, with the exception of minor non-substantive changes, such as that the proposed regulatory provision cross-references proposed § 226.43(b)(10) for the definition of “prepayment penalty.” See section-by-section analysis of § 226.43(b)(10), below. 32(b)(1)(vi) Total Prepayment Penalties Incurred in a Refinance Proposed § 226.32(b)(1)(vi) includes in points and fees “the total prepayment penalty, as defined in § 226.43(b)(10), incurred by the consumer if the mortgage loan is refinanced by the current holder of the existing mortgage loan, a servicer acting on behalf of the current holder, or an affiliate of either.” This provision implements TILA Section 103(aa)(4)(F), which includes in points and fees prepayment penalties incurred by a consumer “if the mortgage loan refinances a previous loan made or currently held by the creditor refinancing the loan or an affiliate of the creditor.” See 15 U.S.C. 1602(aa)(4)(F). The Board believes that this statutory provision is intended in part to curtail the practice of “loan flipping,” which involves a creditor refinancing an existing loan for financial gain due to prepayment penalties and other fees that a consumer must pay to refinance the loan—regardless of whether the refinance is beneficial to the consumer. The Board uses the phrases “current holder of the existing mortgage loan” and “servicer acting on behalf of the current holder” to describe the parties that refinance a loan subject to this provision because, as a practical matter, these are the entities that would refinance the loan and directly or indirectly gain from associated prepayment penalties. The Board also uses the phrase “an affiliate of the current holder” to describe a third party that refinances a loan subject to this provision to be consistent with the statute, which, as noted, applies to prepayment penalties incurred in connection with refinances by “the creditor * * * or an affiliate of the creditor.” The proposed regulatory provision also cross-references proposed § 226.43(b)(10) for the definition of “prepayment penalty.” See section-by-section analysis of § 226.43(b)(10), below. The Board requests comment on the proposal to incorporate into the definition of “points and fees” the prepayment penalty provisions of TILA Section 103(aa)(4)(E) and (F) and solicits comment in particular on whether additional guidance is needed to facilitate compliance with these provisions. 32(b)(2) Exclusion From “Points and Fees” of Compensation Paid to Certain Persons The Board proposes new § 226.32(b)(2) to reflect statutory amendments under the Dodd-Frank Act. Current § 226.32(b)(2), defining “affiliate,” is proposed to be re-numbered as § 226.32(b)(3). Proposed § 226.32(b)(2) is intended to exempt from “points and fees” compensation paid to certain persons expressly excluded from the meaning of “mortgage originator” under the Dodd-Frank Act. Employees of retailers of manufactured homes. Specifically, proposed § 226.32(b)(2)(i) excludes from “points and fees” compensation paid to “an employee of a retailer of manufactured homes who does not take a residential mortgage loan application, offer or negotiate terms of a residential mortgage loan, or advise a consumer on loan terms (including rates, fees, and other costs) but who, for compensation or other monetary gain, or in expectation of compensation or other monetary gain, assists a consumer in obtaining or applying to obtain a residential mortgage loan.” This proposed exemption is necessary to implement the revised definition of “points and fees” under TILA Section 103(aa)(4)(B) (quoted above), because the statutory definition of “mortgage originator” excludes “an employee of a retailer of manufactured homes” who, for compensation or other monetary gain, or in expectation of compensation or other monetary gain, prepares residential mortgage loan packages or collects information on behalf of a consumer with regard to a residential mortgage loan. 20 20 Specifically, the statute excludes from the definition of “mortgage originator” “any person who is * * * (ii) an employee of a retailer of manufactured homes who is not described in clause (i) [takes a residential mortgage loan application] or (iii) [offers or negotiates terms of a residential mortgage loan] of subparagraph (A) and who does not advise a consumer on loan terms (including rates, fees, and other costs).” TILA Section 103(cc)(2)(A)(i), (cc)(2)(A)(iii) and (cc)(2) [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2011-9766. Public record. Not legal advice.