HPML: The New Category of Higher-Priced Mortgages

Are you compliant with the final rule amendments to Reg Z that took effect October 1, 2009? Attached you will find 1) highlights of the new rule and 2) a letter from the Federal Reserve Board of Governors to HUD clarifying how FHA loans are deemed to comply with the new rule. The index to be used in the determination of a High Priced Mortgage Loan, the “average prime offer rate” (APOR) can be found at www.ffiec.gov/ratespread/YieldTableFixed.CSV Be sure to check ALLREGS or another reliable source for more information and to determine if your loans are in compliance.

Highlights of Final Rule Amending Home Mortgage Provisions of Regulation Z (Truth in Lending)

The rule establishes a new category of "higher-priced mortgages" that includes virtually all closed-end subprime loans secured by a consumer's principal dwelling. Which loans qualify as "higher-priced" will be determined by a new index that will be published by the Federal Reserve Board.(1)

The rule, for these higher-priced loans:

Prohibits a lender from making a loan without regard to borrowers' ability to repay the loan from income and assets other than the home's value. A lender complies, in part, by assessing repayment ability based on the highest scheduled payment in the first seven years of the loan. To show that a lender violated this prohibition, a borrower does not need to demonstrate that it is part of a "pattern or practice."
Prohibits a lender from relying on income or assets that it does not verify to determine repayment ability.
Bans any prepayment penalty if the payment can change during the initial four years. For other higher-priced loans, a prepayment penalty period cannot last for more than two years.
Requires that the lender establish an escrow account for the payment of property taxes and homeowners' insurance for first-lien loans. The lender may offer the borrower the opportunity to cancel the escrow account after one year.

The rule, for all closed-end mortgages secured by a consumer's principal dwelling:

Prohibits certain servicing practices: failing to credit a payment to a consumer’s account as of the date the payment is received, failing to provide a payoff statement within a reasonable period of time, and "pyramiding" late fees.
Prohibits a creditor or broker from coercing or encouraging an appraiser to misrepresent the value of a home.
Creditors must provide a good faith estimate of the loan costs, including a schedule of payments, within three days after a consumer applies for any mortgage loan secured by a consumer's principal dwelling, such as a home improvement loan or a loan to refinance an existing loan.

The rule, for all mortgages:

Requires advertising to contain additional information about rates, monthly payments, and other loan features. The rule also bans seven deceptive or misleading advertising practices, including representing that a rate or payment is "fixed" when it can change.

Based on compelling evidence from consumer testing, the Board is withdrawing the proposed rule regarding yield-spread premiums. The Board, however, intends to analyze alternative approaches to this issue as part of its ongoing review of the rules for closed-end loan rules under Regulation Z.
Compliance with the new rules, other than the escrow requirement, is mandatory for all applications received on or after October 1, 2009. The escrow requirement has an effective date of April 1, 2010 for site-built homes, and October 1, 2010 for manufactured homes.

Footnotes
1. The rule's definition of "higher-priced mortgage loans" will capture virtually all loans in the subprime market, but generally exclude loans in the prime market. To provide an index, the Federal Reserve Board will publish the "average prime offer rate," based on a survey currently published by Freddie Mac. A loan is higher-priced if it is a first-lien mortgage and has an annual percentage rate that is 1.5 percentage points or more above this index, or 3.5 percentage points if it is a subordinate-lien mortgage. This definition overcomes certain technical problems with the original proposal, but the expected market coverage is similar. Return to text

BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
WASHINGTON, D.C. 20551

Shaun Donovan
Secretary, U.S. Department of Housing
And Urban Development
451 Seventh Street, SW
Washington, DC 20410

Dear Secretary Donovan:

In July 2008, the Federal Reserve Board ("Board") issued final rules amending Regulation Z, which implements the Truth in Lending Act (TILA). The July 2008 final rules adopted new protections for consumer mortgage loans, including several provisions that address recent problems in the subprime mortgage market. (73 FR 44522, July 30, 2008). Among other things, the July 2008 final rules define a class of higher-priced mortgage loans that are subject to certain protections. One protection involves prepayment penalties. Higher-priced mortgage loans may not have a prepayment penalty for longer than two years and, for some higher-priced loans, prepayment penalties of any duration are prohibited. The provisions concerning prepayment penalties are applicable to higher-priced loans for which a creditor receives an application on or after October 1, 2009.

You have asked whether the provisions limiting prepayment penalties would apply to certain FHA loans beginning on the October 1, 2009 effective date. In particular, you have asked whether FHA loans are covered by the Board's staff commentary to Regulation Z that provides that prepayment penalties include any "interest charges for any period after prepayment in full is made." See 12 CFR part 226, comment 226.18(k)(I)-1. You note that under FHA programs, for purposes of allocating a consumer's payment to accrued interest and principal, all loan payments are treated as being made on the scheduled due date so long as the payment is made prior to the expiration of the payment grace period ("monthly interest accrual amortization"). For example, if the consumer's installment payment of principal and accrued interest is due on the first day of each month, the portion of the payment that will be allocated to accrued interest is the same, whether the creditor receives the payment on the due date, an earlier date (such as the 20th ofthe previous mo nth), or shortly after the due date. Under this arrangement, we understand that consumers would not be penalized for making payments during the grace period because all timely payments are considered to be received on the payment due date for purposes of calculating the accrual and payment of interest. At the same time, we understand that consumers that make early payments are treated as having paid on the payment due date and do not receive any reduction in interest due.

We understand that the same monthly interest accrual amortization method is also used when the consumer prepays the loan in full. Thus, if the consumer's prepayment occurs 10 days before the payment due date, the consumer owes the same amount of interest as if the prepayment occurs on the payment due date. You have advised the Board that, for federally-insured loans, due to the monthly interest accrual amortization method, HUD has not considered the payment of interest after the prepayment date as a prepayment penalty and has advised lenders that they need not disclose this practice as a prepayment penalty for these loans.

The Board's staff commentary noted above provides guidance about prepayment penalties but does not address the specific situation involving loans that generally use the monthly interest accrual amortization method. In light of the guidance given by HUD regarding the payment of interest after the prepayment date, and the fact that the Board staff commentary on this issue does not expressly address this issue in the context of monthly interest accrual amortization, Board staff believes that lenders that use such an interest accrual method discussed above may continue to follow that practice. Lenders that engage in this practice would not be required to treat the interest charged from the date of prepayment until the next installment due date as a prepayment penalty for any purpose under Regulation Z. Staff also believes that lenders who have followed this practice in the past have acted reasonably and have complied in good faith with the prepayment penalty provisions of Regulation Z in this circumstance, whether or not the additional interest was treat ed or disclosed as a prepayment penalty under Regulation Z.

We understand that HUD is considering revising this portion of its rules and FHA loan agreements. In addition, over the coming months, staff expects to review the staff commentary and consider whether the commentary should be changed to address specifically this aspect of FHA and other lending programs, including whether the commentary should be changed to treat this feature as a prepayment penalty.

Creditors may rely on this letter as an official interpretation of Regulation Z and, under TILA, liability will not apply to actions taken in good faith reliance on the guidance set forth in this letter, to the same extent as if this guidance were set forth in the commentary to Regulation Z.

Sincerely,

Sandra Braunstein
Director, Division of Consumer & Community Affairs