Insights

The Dodd-Frank Act will amend Section 32 of the federal Truth in Lending Act, otherwise known as the Home Ownership and Equity Protection Act or HOEPA. These amendments will significantly expand the number of loans captured by HOEPA. The Act accomplishes this in several ways: it includes loans that were previously exempted, it amends both the points and fees trigger and the APR trigger, and it adds a prepayment penalty trigger. In addition to expanding the number of loans captured under HOEPA, the Act imposes additional substantive restrictions on HOEPA loans. As a practical matter, these new restrictions will have limited impact, as virtually all lenders avoid making HOEPA loans. For that reason, this article will focus primarily on the new definition of a HOEPA loan.

Eliminated Exemptions: HOEPA still applies only to loans secured by a consumer’s principal dwelling, and still exempts reverse mortgage from coverage. However, the Act will expand HOEPA’s reach to now cover purchase money transactions and home equity lines of credit.

New Points and Fees Test: The Act generally provides that a loan will be subject to HOEPA if the total points and fees, other than bona fide third party charges not retained by the mortgage originator, creditor or an affiliate of either, do not exceed:

• For transactions of $20,000 or more, 5% of the total transaction amount
• For transactions of less than $20,000, the lesser of $1,000 or 8% of the total transaction amount. The $1,000 amount may be adjusted by the Federal Reserve Board.
  
  “Total transaction amount” is not defined. This term likely means the principal amount of the loan, as opposed to the “total loan amount,” which under the current version of HOEPA can mean something less than the amount financed.
  
  Points and fees are generally defined to mean all fees other than third party fees not retained by the mortgage originator, creditor or an affiliate of either. The following are expressly included in the points and fees test if they are retained by the mortgage originator, creditor or an affiliate of either:

• Finance charges, except interest or time-price differential
• Compensation paid directly or indirectly by either the consumer or creditor to the mortgage originator (including a creditor in a table-funded transaction). This provision represents an expansion of the current HOEPA definition to include indirect payments by creditors to brokers.
• Non-finance charge closing costs (226.4(c)(7) fees)
• Single premium insurance premiums or debt cancellation fees. This includes other accident, loss-of-income, life or health insurance premiums, as well as credit property insurance premiums.
• Maximum prepayment penalties that can be charged on the new loan
• In a refinancing, the prepayment penalties that the consumer must pay if the original loan was made or is held by the same creditor or an affiliate

Mortgage insurance premiums and bona fide discount points are expressly excluded from the points and fees calculation. Mortgage insurance premiums include premiums paid after closing, government premiums such as VA or FHA, and private mortgage insurance that does not exceed the maximum FHA rate and that is refunded on an automatic and pro-rated basis upon satisfaction of the mortgage.

Bona fide discount points include:

• Up to two “bona fide” discount points, provided that the non-discounted rate cannot exceed the prime offer rate (or the average FHA rate in the case of a personal property secured loan), PLUS one point
• If the above discount point test fails, one point, provided that the non-discounted rate cannot exceed the prime offer rate (or average FHA rate in the case of a personal property secured loan), PLUS two points
• Discount points must be knowingly paid by the consumer to reduce the rate and the rate reduction must be consistent with established industry norms and practices for secondary market practices.

For HELOCs, the points and fees test is based on the total minimum fees a consumer would have to pay in order to draw down the entire line of credit.

New APR Test: The Act amends the APR test so that it will now be based on the comparable average prime offer rate. The average prime offer rate is the rate that is currently used to identify HMDA reportable transactions and higher-priced mortgage loans. The Act is silent as to the date of the average prime offer rate to be used in this test.

Under the new APR test, a loan will be subject to HOEPA if:

• For first mortgage loans either not secured by personal property or in amounts of $50,000 or greater, the APR at consummation exceeds the average prime offer rate by 6.5 percentage points
• For first mortgage loans of less than $50,000 secured by personal property (e.g., mobile homes), the APR at consummation exceeds the average prime offer rate by 8.5 percentage points
• For subordinate mortgage loans, the APR at consummation exceeds the average prime offer rate by 8.5 percentage points.

For loans where the rate varies only in accordance with an index, the APR is determined by the index value at consummation plus the highest margin provided in the contract. If the rate can vary at any time for any reason, the APR is determined assuming the maximum highest rate is charged for the term of the loan. The Act does not explain how to apply the APR test to HELOCs. Additionally, the Federal Reserve Board (or the CFPB after the transfer of powers to the new agency) will have authority to adjust the percentage points added to the prime offer rate from between 6 and 10 percentage points for first liens (or between 8 and 12 percentage points for subordinate liens).

Consider the following comparisons of the current HOEPA APR triggers for fixed rate loans (as of June 30, 2010) against the new HOEPA APR triggers that would take effect under the Bill:

• First mortgage loans either not secured by personal property or in amounts of $50,000 or greater:
  • Old Test: APR must exceed 12.01%
  • New Test: APR must exceed 11.25%
• First mortgage loans of less than $50,000 secured by personal property:
  • Old Test: APR must exceed 12.01%
  • New Test: APR must exceed 13.25%
• Subordinate mortgage loans:
  • Old Test: APR must exceed 13.82%
  • New Test: APR must exceed 12.72%

The following is a comparison of the current and future APR triggers for one-year ARMs (as of June 30, 2010):

• First mortgage loans either not secured by personal property or in amounts of $50,000 or greater:
  • Old Test: APR must exceed 12.01%
  • New Test: APR must exceed 9.67%

New Prepayment Penalty Test: The Act introduces an entirely new trigger to HOEPA in the form of a prepayment penalty test. A loan will be subject to HOEPA if the loan agreement permits a creditor to charge a prepayment penalty 36 or more months after consummation OR if the total of the prepayment penalty charges that may be imposed exceed more than 2% of the amount prepaid.

Effect on State High Cost Mortgage Laws: Some state high cost mortgage laws incorporate by reference one or more of the HOEPA triggers in order to determine what loans are subject to the state high cost mortgage law. It is unclear how the Act will affect these state law triggers.

Substantive Restrictions: The Act would enact additional substantive provisions on HOEPA loans. As noted above, the vast majority of lenders attempt to avoid making HOEPA loans at all cost, so these new restrictions will likely have limited practical effect. However, the following is a brief overview of the new restrictions applicable to all HOEPA loans:

• Prepayment penalties prohibited.
• Balloon payments prohibited except when the payment schedule is adjusted due to the seasonal or irregular income of the consumer.
• Creditors may not recommend default on an existing loan.
• Late fees are subject to restrictions, including that they are limited to 4% of the past due payment with a 15-day grace period, they must be specifically authorized in the loan documents and pyramiding is prohibited.
• Loan agreement may not authorize the creditor to accelerate except in the case of a payment default, pursuant to a due-on-sale clause, or pursuant to a material violation of another provision of the loan document unrelated to the payment schedule.
• Creditors may not finance (1) prepayment penalties in a refinance transaction if the creditor or an affiliate is the holder of the refinanced note, or (2) points and fees.
• Creditors may not structure a loan as an open-end transaction or other form of loan or divide a loan into separate parts in order to evade the HOEPA restrictions.
• Modification, amendment, extension, and deferral fees are prohibited.
• Borrowers are entitled to four free payoff statements each year, creditors can charge a fax or courier fee if the payoff statement is also available for free (i.e., by mail), and payoff statements must be provided within five business days after receiving a consumer’s request.
• Pre-loan counseling is required.

Cure for Mistakes: The Act would amend HOEPA to allow for cure of certain mistakes.

Creditors or assignees will not be liable for HOEPA violations made in good faith if the customer is notified of the error (or discovers it), appropriate restitution is made, and adjustments are made to the loan to either (at the election of the consumer) make the loan satisfy HOEPA or change the terms of the loan so that it is no longer a high cost mortgage loan. Any such corrective action must be made within 30 days of loan closing and prior to the institution of any action.

If a HOEPA violation is made in good faith and is unintentional or the result of a bona fide error, the creditor or assignee will not be liable if the consumer is notified of the error, appropriate restitution is made, and adjustments are made to the loan to either (at the election of the consumer) make the loan satisfy HOEPA or change the terms of the loan so that it is no longer a high cost mortgage loan. Any such corrective action must be made within 60 days of the creditor discovering or receiving notification of the error and prior to the institution of any action.

The cure provisions do not address what happens if the consumer does not make an election within the timeframe required to correct the error. The cure provisions also do not define “appropriate restitution.”

Effective Date: Regulations implementing these changes must be issued in final form within 18 months of the designated transfer date. The designated transfer date is the date on which the CFPB accepts functions from the other federal agencies. The designated transfer date is to be established within 12 months after the passage of the Act; although the date can be delayed for up to another six months. Any regulations must take effect within 12 months after date of issuance.

The statutory provisions take effect when the regulations become effective; however, if a regulation to implement a provision has not been issued (presumably in proposed form) within 18 months after enactment, then the relevant provision becomes effective 18 months after enactment, even though there are no regulations interpreting the provision. Finally, although the CFPB is ultimately given rulemaking authority for most of the regulations that implement Title XIV, the Federal Reserve Board could issue regulations implementing these provisions prior to the designated transfer date.

Conclusion: Creditors will have to adjust all of their procedures for testing for high cost mortgage loans to ensure that they will not accidentally make such loans. In addition, lenders will have to institute new procedures to test all purchase money loans and home equity lines of credit.And, ultimately some loans simply will not be made because creditors will determine that the loans cannot be offered profitably without imposing rates or fees that would make them high cost mortgage loans.

Robert A. Cook is a partner in the Maryland office of Hudson Cook, LLP. Basis Points readers can reach Robert at 410-865-5401 or by email at rcook@hudco.com.

Meghan S. Musselman is an associate in the Maryland office of Hudson Cook, LLP. Basis Points readers can reach Meghan at 410-865-5403 or by email at mmusselman@hudco.com.