Amendments to Federal Reserve Board Regulation Z Become Effective October 1, 2009 By: Fran Sponsler, CRCM Date: 09/24/09 On October 1, 2009, most of the final rules amending Regulation Z (Truth in Lending Act) go into effect (except for the escrow requirements that will be phased in during April and October of 2010).  The changes were made as part of the Home Ownership and Equity Protection Act, which revises and expands the protections to consumers in mortgage lending transactions, as well as other transactions.  The new requirements apply to all financial institutions, as well as all mortgage lenders. The motivation behind the changes to Reg Z was to address the public’s concern about the perceived (and actual) abuses in the mortgage lending industry.  A sample of the abusive practices include: the offering of alternative financing solutions, such as “nontraditional” loans (i.e. interest-only and payment-option loans) and “subprime” loans (i.e. hybrid adjustable-rate mortgages) which often contain terms and features that result in unsustainable home ownership. Therefore, the Federal Reserve, through the authority of Congress, implemented new restrictions and provisions for loans originated as ‘high priced mortgages.’ In order to determine if a loan is a high priced mortgage, the Federal Reserve provided an index which publishes the average prime offer rate (APOR) based on a survey currently published by Freddie Mac.  A high priced mortgage loan is any mortgage (purchase-money or non-purchase-money) secured by a consumer’s principal dwelling, where the annual percentage rate (APR) is more than 1.5 percentage points above the index on a first mortgage and 3.5 percentage points on a second mortgage.   Mortgage lenders originating high priced mortgage loans must consider the additional four provisions: 1. Lenders must assess the borrower’s ability to repay the loan; 2. Lenders must verify the income and assets of the borrower; 3. Lenders are banned from imposing most prepayment penalties; and 4. Lenders are mandated to establish escrow of taxes and insurance. Borrower’s Ability to Repay To comply, lenders will need to assess the borrower’s ability to pay by examining the total debt-to-income or the available income after paying all of the borrower’s debt obligations. Where a higher-priced mortgage loan has a fixed monthly payment for the first seven years concluding with a balloon payment, a lender may, for purposes of the presumption, determine the consumer’s repayment ability by considering the amount of the borrower’s fixed monthly loan payment.  However, where a balloon payment comes due before the end of seven years, the balloon payment must be considered in determining the repayment ability.  This, in effect, prohibits higher priced mortgage loans with balloon payments due in less than seven years in almost all cases.     Verifying Income Creditors are required to verify the income and assets they rely upon to determine repayment ability. Verification of income and assets can be done through tax returns, payroll stubs or W-2 forms, financial institution records, and other third-party documents. This requirement also applies to self-employed applicants.  Similarly reliable information should be sought for verification of a self-employed borrower’s obligations. Prepayment Penalties This revision prohibits any prepayment penalty after the first two years of the loan.  In addition, no prepayment penalties are allowed if the loan payment can change during the first four years of the loan (e.g. adjustable rate mortgages). Escrow Requirements Escrow of taxes and insurance is mandated in all “high priced” first mortgage transactions.  However, 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 a delayed effective date of October 1, 2010 for applications for loans secured by manufactured housing. Other Changes In addition to the above mentioned changes, other amendments to Regulation Z include provisions regarding home loan advertising, requiring loan servicers to post payments as of the date of receipt and providing pay off statements within a reasonable amount of time of request.  Loan servicers are also prohibited from ‘pyramiding’ late fees (i.e. assessing late charges on unpaid late charges).  Lastly, the amendments include the prohibition of mortgage lenders from coercing, influencing, or encouraging an appraiser to misrepresent the value of the property.  We will address these changes in further detail in a future newsletter article.  For more information please visit the following website: http://www.fdic.gov/regulations/examinations/supervisory/insights/sisum09/examiners_desk.html