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New “Higher-Priced Mortgage Loan” Rules Go Into Effect October 1
By Chuck Dodge

Given the pace of recent regulatory changes on the state and federal level, it is easy to get wound up about what is happening now as you try to keep up with the developments. Because October 1 is so close now, it seems timely to review some fairly significant changes enacted in 2008 that will be going into effect in a few days. The changes are courtesy of the Federal Reserve Board’s 2008 efforts in connection with Regulations C and Z, and both pertain to “higher-priced mortgage loans.” Through amendments to Regulation C back in 2002, mortgage lenders have been collecting and reporting the rate spread on “higher-priced mortgage loans” as part of their loan origination data. The triggers have changed under Regulation C, but the data collection and reporting requirement remains the same. The concept of a “higher-priced mortgage loan” is new to Regulation Z. The Board amended Regulation Z last summer just before it finalized its amendments to Regulation C, creating the new category of mortgage loans that fall somewhere between prime and subprime, and applying certain new consumer protections to those loans. To ease the compliance burden involved with these rulemakings, the Board defined “higher-priced mortgage loan” the same way under Regulations C and Z.

Higher-Priced Mortgage Loans Under Regulation C

The FRB introduced the concept of a “higher-priced mortgage loan” through its rulemaking under the Home Mortgage Disclosure Act (HMDA) in 2002. In connection with the new requirements to collect and report loan pricing data under HMDA, the Board wanted lenders to report pricing on loans that were not HOEPA loans, but that were priced higher than the “prime” market rate. Regulation C currently requires lenders to collect and report the spread between the annual percentage rate (APR) on a mortgage loan and the yield on a Treasury security of comparable maturity if the spread exceeds 3.0 percentage points for a first lien loan or 5.0 percentage points for a subordinate lien loan. The difference is known as a rate spread, and mortgage lenders have been reporting rate spreads in connection with mortgage loans since those rules went into effect.

In its 2008 rulemaking, the FRB approved amendments to Regulation C that revise the rules for reporting price information - in the form of a rate spread - on these “higher-priced mortgage loans.” The FRB described the changes as aiming to improve the accuracy and usefulness of data reported under HMDA. Under the final rule, a lender will report the spread between the loan’s APR and a survey-based estimate of APRs currently offered on prime mortgages of a comparable type (“average prime offer rate”) if the spread is equal to or greater than 1.5 percentage points for a first lien loan or equal to or greater than 3.5 percentage points for a subordinate-lien loan. The Board will publish average prime offer rates based on the Primary Mortgage Market Survey® currently published by Freddie Mac. The Board will conduct its own survey if it becomes appropriate or necessary to do so.

The changes to Regulation C conform the threshold for rate spread reporting to the definition of “higher-priced mortgage loans” adopted by the Board under Regulation Z in July of 2008, shortly before the Board undertook to finalize these changes to Regulation C. In setting the new rate spread reporting threshold lower and attaching the trigger to a different market barometer, the Board sought to continue to cover subprime mortgages and generally avoid covering prime mortgages, but to collect data “more consistent with prevailing mortgage market pricing over time.” While the lower rate spread triggers for reporting will likely require reporting on Alt-A loans not covered before, the Board considers that largely unintended consequence of the new rules worthwhile in light of the benefit to consumers in general, but also to a group of borrowers and potential borrowers that the Board considers to have been the object of lenders’ unscrupulous lending policies that led to the recent unpleasantness in the mortgage market. The Board furthered its consumer protection agenda aimed at that group of borrowers through its amendments to Regulation Z.

Higher-Priced Mortgage Loans Under Regulation Z

On July 14, 2008, the Board issued a final rule effecting changes to Regulation Z under the Home Ownership and Equity Protection Act (HOEPA). The new rules restrict certain practices and require lenders and brokers to provide certain mortgage disclosures earlier in the home loan transaction. As noted earlier in this article, the rule creates a category of “higher-priced mortgage loans” that is new to Regulation Z and HOEPA and imposes certain protections on those types of loans.

In this rulemaking, the Board defined “higher-priced mortgage loan” to be consumer credit transactions secured by the consumer’s principal dwelling for which APR exceeds the average prime offer rate (as published by Freddie Mac) for comparable transactions by 1.5 percentage points for first lien loans and 3.5 percentage points for subordinate-lien loans. Noticeably and intentionally, these are the same triggers that apply under the revised Regulation C for rate spread reporting. In the Supplemental materials to the final rule, the Board acknowledges that these thresholds will capture not only the subprime market, but also a portion of the Alt-A market. The Board adopted exclusions from the definition of “higher-priced mortgage loan” for HELOCs, reverse mortgages, construction-only loans, and bridge loans.

The new consumer protections that apply to “higher-priced mortgage loans” under Regulation Z focus on the borrower’s ability to pay and prepayment penalties. Specifically, the new rules prohibit a creditor from extending credit without regard to the borrower’s ability to repay from sources other than the collateral itself, both in connection with “higher-priced mortgage loans” and HOEPA loans. Regulation Z already included a prohibition on engaging in a “pattern or practice” of extending HOEPA loans without regard to repayment ability, but the new rule removes the “pattern or practice” reference for HOEPA loans and does not apply it in the context of “higher-priced mortgage loans.” In this rule the Board creates a presumption of compliance with the new requirement if the creditor satisfies each of three requirements: (1) verifying repayment ability; (2) determining the consumer’s repayment ability using the largest scheduled payment of principal and interest in the first seven years following consummation (and taking into account property tax and insurance obligations and similar mortgage-related expenses); and (3) assessing the consumer’s repayment ability using at least one of the following measures: a ratio of total debt obligations to income, or the income the consumer will have after paying debt obligations.

The rule includes new Official Staff Commentary provisions that also clarify that repayment ability must be assessed at consummation and that a violation of the requirement to verify the ability to repay is not established merely because a borrower defaults because of significant expenses or income losses that occur after consummation. The rule allows creditors to rely on expected income and employment, not just current income and employment, though expectations for improvement in income and employment must be reasonable and verified by third party documents.

The rule also prohibits prepayment penalties on “higher-priced mortgage loans” or HOEPA loans if payments can change within the first four years. For all other “higher-priced mortgage loans” and HOEPA loans (loans where the payment is fixed for the first four years), the rule permits the assessment of prepayment penalties only during the first two years of the loan and only if other applicable law permits the penalty and if the penalty is not assessed on a refinancing by the same creditor or an affiliate.

By imposing an October 1 effective date, the Board was responsive in each rulemaking to lenders’ comments that it would take some time to make the necessary system and training adjustments to comply with the new rules. But the adjustment period is over, and the rules go into effect shortly.

Chuck Dodge is a partner in the Maryland office of Hudson Cook, LLP. Basis Points readers can reach Chuck at 410-865-5427 or by email at cdodge@hudco.com.

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