The following is an article reprinted with permission from the upcoming Spring 2009 edition of The WWR Letter:
By: Gail C. Hersh, Jr., Partner
On October 1, 2009, the “final rule” amending Regulation Z (“Reg Z”) (the Truth in Lending Act) goes into effect, except for some escrow requirements that will be phased in during 2010. The changes were made as part of the Home Ownership and Equity Protection Act, and revise and expand the protections to consumers in mortgage lending transactions, as well as other transactions. The new requirements will not just apply to those institutions under the watch of the Federal Reserve Board, but to all mortgage lenders.
Addressing Public Concern
The impetus for the changes to Reg Z was to address the public’s concern about perceived abuses in the sub-prime mortgage market, with that sector’s products receiving a new moniker of “average prime offer rate” derived from Freddie Mac’s Primary Mortgage Market Survey. A loan will be deemed “higher-priced” when the annual percentage rate is more than 1.5% above the index when it is secured by a first mortgage and 3.5% when it is secured by a junior mortgage. When this type of loan is secured by a borrower’s primary residence, four principal requirements are triggered:
- Lenders must assess the borrower’s ability to repay the loan;
- Lenders must verify income and assets of the borrower;
- Lenders are banned from imposing most prepayment penalties (PLEASE NOTE: Federal credit unions are not permitted to charge prepayment penalties); and
- Lenders are mandated to establish escrow of taxes and insurance.
Borrower’s Ability to Pay
Assessing a borrower’s ability to repay will likely be the area creating the most risk exposure for lenders. To establish liability of a lender, a borrower no longer needs to show a lender’s pattern of conduct in failing to assess a borrower’s ability to repay. To comply, a lender will need to assess the borrower’s ability to pay by examining the total debt to income ratio or the available income after paying of debt obligations. The lender must also confirm the borrower’s ability to pay the largest possible amount of principal and interest in all change periods in the first seven years of the loan in light of the borrower’s current obligations. Section 226.34 requires not only the verification of income but requires verification of the borrower’s obligations under subpart (a)(4)(ii)(C), and offers no guidance on what would constitute compliance.
Verification of income and assets must be done through IRS records, payroll receipts, financial institution/credit union records and other third-party documents. This is required for even self-employed applicants. Similarly reliable information should be sought for verification of the borrower’s obligations.
The revision prohibits any prepayment penalty for more than two years and any penalty if the payment can change in the first four years of the loan. So what loans can have a prepayment penalty? Fixed rate loans and loans with a first adjustment period of greater than four years may include a pre-payment penalty only in the first two years.
Escrow of taxes and insurance is mandated in all “higher-priced” first mortgage transactions. Optional insurance chosen by the borrower need not be escrowed. The escrow requirements are effective for applications received on or after April 1, 2010, with an additional delayed effective date of October 1, 2010 for applications for loans secured by manufactured housing.
One of the additional effects of the “final rule” is to trigger the required disclosures for refinances in many instances where a loan is a modification. For those modifications where the new balance exceeds the original balance, as would often be the case for either early or long-standing defaults, §226.20(a)(4) would characterize this as a refinance. As a refinance, the disclosure requirements and rescission rights under the Real Estate Sales Practices Act and the Truth in Lending Act are applicable. Raising the interest rate, adjusting a variable rate or changing the rate from fixed to variable will also trigger the disclosure requirements. Where the old note is kept in place, and only the amount (not to exceed the original amount) and payment schedule are modified, the disclosures are not required. A review of the need for disclosures should be standard practice as part of any modification, and the rule of thumb to keep in mind is “when in doubt, disclose.”
Timing of Disclosures
The timing for disclosure in nearly all residential mortgage transactions was also modified by §226.19(a)(1) to require the Good Faith Estimate be made within three days of application.
The amendments to Reg Z also include provisions restricting advertising of closed-end mortgage transactions, prohibiting collusion of lenders and appraisers, mandating that servicers apply borrower’s payments on the date received and banning servicers from pyramiding late fees.
As the October date approaches, credit unions should begin adopting procedures to ensure present and on-going compliance. Credit unions must evaluate their products for those that will be identified as “higher-priced” and make sure systems are in place to handle the new requirements. They should also review the additional requirements regarding advertising, appraisals and servicer issues thoroughly.
Gail C. Hersh, Jr. is an Associate in the Foreclosure/Evictions department of WWR’s Cincinnati office. He can be reached at (513) 333-4020 or firstname.lastname@example.org.