Partners (Number 3, 2008)

Rule Changes Fine-Tune Consumer Protection

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In July of this year the Federal Reserve Board finalized new mortgage rules under the Truth in Lending Act and Regulation Z resulting in changes that will affect three classes of mortgage loan products. Mortgage products reflecting the new rules include HOEPA loans (Homeownership Equity Protection Act), Higher-Priced Mortgage loans (HPM), and Consumer Principal Dwelling loans (CPD). Most of the new provisions will go into effect on October 1, 2009.

HOEPA rules
Although HOEPA rules are largely unchanged from the current provisions in Regulation Z, the Board did amend two HOEPA sections of Regulation Z related to loan limitations for prepayment penalties as well as a borrower's ability to repay a loan.

Prepayment penalties. The prepayment penalty provision originally allowed a penalty during the first five years following consummation of the loan. The final rule will allow prepayment penalties only in the first two years of a HOEPA loan transaction. This section also allows a prepayment penalty for adjustable rate transactions if the periodic payment of principal, interest or both do not change during the first four years of the transaction. The prepayment penalty rules also apply to high-priced mortgage loan transactions.

Repayment ability. Repayment ability provisions prevent a lender from making a HOEPA loan without considering and verifying a consumer's repayment ability at closing as indicated by expected income, employment, assets other than collateral, current obligations and mortgage-related obligations.

Higher-Priced mortgage rules
The HPM rules identify a new class of mortgage loans—those secured by a consumer's principal dwelling that have higher-priced rates based on a formula defined in the regulation. The final rule represents significant changes from the rules proposed in 2007.

Rate spread. The Board changed the Annual Percentage Rate (APR) spread in the final rule for first lien and subordinate lien loans to 1.5 and 3.5 percentage points, respectively, above the "average prime offer rate" (APOR).

APOR. The new APOR will be based on the APR derived for the average interest rates, points and other loan-pricing terms currently offered to consumers by a representative sample of creditors for mortgage transactions that have low-risk pricing characteristics. The Board expects to publish a rate table weekly on the Internet and will initially use the rates from the "Freddie Mac Primary Mortgage Market Survey." Current Freddie Mac rates are found on its website and include rates for two fixed and two ARM products.

New restrictions. The new HPM rules also include specific restrictions for prepayment penalties and repayment ability assessments based on the HOEPA rules and restrictions for escrow accounts and open-ended credit. The escrow account rules require lenders making HPM loans secured by a first lien on a consumer's principal dwelling to establish, prior to closing the transaction, escrow accounts for property taxes and mortgage-related insurance required by the lender. Because of the operational changes required for some lenders, the Board has delayed the effective dates for escrow accounts until April 1, 2010 for HPM loans, except for those secured by manufactured housing, which are delayed until October 1, 2010.

Consumer principal dwelling rules
The final rules also include a new section for loans secured by a consumer's principal dwelling. Affecting the broadest category of loans, these regulations stipulate prohibited acts or practices for any consumer credit secured by the consumer's primary home, including purchase and non-purchase money transactions, prime and subprime loans.

The prohibited acts or practices cover rules related to: the definition of a mortgage broker, misrepresentation of the value of a consumer's dwelling through coercion of an appraiser, servicing practices prohibitions and exemption for home equity lines of credit (HELOCs).

Mortgage broker. The regulation proposal issued in 2007 included rules for mortgage brokers that prohibited payments beyond those specifically agreed to and disclosed in writing before closing the transaction. The proposed rules particularly sought to reduce broker incentives to increase consumer rates and thus to limit the potential unfairness, deception and abuse in the use of yield spread premiums (YSP).

While the Board remains concerned about the yield spread premium issue, they withdrew the broker rule on the basis it may confuse consumers and undermine the loan decision-making process rather than improve it. The Board's decision was informed by an analysis of comments, consumer testing and other data. The final rule includes only a definition of the term "mortgage broker."

It is important to note that while the Federal Reserve Board did not add new rules for mortgage brokers about YSPs under the Truth in Lending Act as originally proposed, YSPs are considered in the finance charge and APR disclosures. YSPs must also be itemized and disclosed to consumers on the HUD-1 loan closing document, required by Real Estate Settlement Procedures Act (RESPA).

Other prohibitions. The other prohibitions specifically relating to coercion of appraisers and servicing practices are similar to those in rules as initially proposed.

Advertising rules
The final rules also include changes to the advertising provisions for both open-ended and closed-end credit. The changes require additional information about rates, monthly payments and other loan features. The final rule also bans seven deceptive or misleading advertising practices.

Housing and Economic Recovery Act
In addition to the Truth in Lending/Regulation Z final rule changes, Congress recently passed the comprehensive Housing and Economic Recovery Act of 2008, which included changes to the Truth in Lending Act similar to the regulatory requirements discussed above. In particular, early Truth in Lending Act disclosures are required on a broader range of mortgage products, at least seven days prior to closing. The Act would also expand civil liability provisions for transactions secured by a dwelling from the current amount—not less than $200 or greater than $2,000—to not less than $400 or greater than $4,000.

For more information:
For access to all regulations and regulatory amendments go to

This article was written by Jeff Paul, manager for Industry Outreach and E-Banking/Privacy Act Compliance in the Consumer Affairs Section at the Atlanta Fed.