Regulation Z; Truth in Lending, 27390-27506 [2011-9766]

Agencies

• FEDERAL RESERVE SYSTEM

[Federal Register Volume 76, Number 91 (Wednesday, May 11, 2011)]
[Proposed Rules]
[Pages 27390-27506]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-9766]



[[Page 27389]]

Vol. 76

Wednesday,

No. 91

May 11, 2011

Part II





Federal Reserve System





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12 CFR Part 226



Regulation Z; Truth in Lending; Proposed Rule

Federal Register / Vol. 76 , No. 91 / Wednesday, May 11, 2011 / 
Proposed Rules

[[Page 27390]]


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FEDERAL RESERVE SYSTEM

12 CFR Part 226

[Regulation Z; Docket No. R-1417]
RIN 7100-AD75


Regulation Z; Truth in Lending

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Proposed rule; request for public comment.

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SUMMARY: The Board is publishing for public comment a proposed rule 
amending Regulation Z (Truth in Lending) to implement amendments to the 
Truth in Lending Act (TILA) made by the Dodd-Frank Wall Street Reform 
and Consumer Protection Act (Dodd-Frank Act or Act). Regulation Z 
currently prohibits a creditor from making a higher-priced mortgage 
loan without regard to the consumer's ability to repay the loan. The 
proposal would implement statutory changes made by the Dodd-Frank Act 
that expand the scope of the ability-to-repay requirement to cover any 
consumer credit transaction secured by a dwelling (excluding an open-
end credit plan, timeshare plan, reverse mortgage, or temporary loan). 
In addition, the proposal would establish standards for complying with 
the ability-to-repay requirement, including by making a ``qualified 
mortgage.'' The proposal also implements the Act's limits on prepayment 
penalties. Finally, the proposal would require creditors to retain 
evidence of compliance with this rule for three years after a loan is 
consummated. General rulemaking authority for TILA is scheduled to 
transfer to the Consumer Financial Protection Bureau (CFPB) on July 21, 
2011. Accordingly, this rulemaking will become a proposal of the CFPB 
and will not be finalized by the Board.

DATES: Comments on this proposed rule must be received on or before 
July 22, 2011. All comment letters will be transferred to the Consumer 
Financial Protection Bureau.

ADDRESSES: You may submit comments, identified by Docket No. R-1417 and 
RIN No. 7100-AD75, by any of the following methods:
     Agency Web Site: https://www.federalreserve.gov. Follow the 
instructions for submitting comments at https://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
     Federal eRulemaking Portal: https://www.regulations.gov. 
Follow the instructions for submitting comments.
     E-mail: regs.comments@federalreserve.gov. Include the 
docket number in the subject line of the message.
     Fax: (202) 452-3819 or (202) 452-3102.
     Mail: Address to Jennifer J. Johnson, Secretary, Board of 
Governors of the Federal Reserve System, 20th Street and Constitution 
Avenue, NW., Washington, DC 20551.
    All public comments will be made available on the Board's Web site 
at https://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as 
submitted, unless modified for technical reasons. Accordingly, comments 
will not be edited to remove any identifying or contact information. 
Public comments may also be viewed electronically or in paper in Room 
MP-500 of the Board's Martin Building (20th and C Streets, NW.) between 
9 a.m. and 5 p.m. on weekdays.

FOR FURTHER INFORMATION CONTACT: Jamie Z. Goodson, Catherine Henderson, 
or Priscilla Walton-Fein, Attorneys; Paul Mondor, Lorna Neill, Nikita 
M. Pastor, or Maureen C. Yap, Senior Attorneys; or Brent Lattin, 
Counsel; Division of Consumer and Community Affairs, Board of Governors 
of the Federal Reserve System, Washington, DC 20551, at (202) 452-2412 
or (202) 452-3667. For users of Telecommunications Device for the Deaf 
(TDD) only, contact (202) 263-4869.

SUPPLEMENTARY INFORMATION: 

I. Summary of the Proposed Rule

    The Dodd-Frank Wall Street Reform and Consumer Protection Act 
(Dodd-Frank Act or Act) amends the Truth in Lending Act (TILA) to 
prohibit creditors from making mortgage loans without regard to the 
consumer's repayment ability. Public Law 111-203 Sec.  1411, 124 Stat. 
1376, 2142 (to be codified at 15 U.S.C. 1639c). The Act's underwriting 
requirements are substantially similar but not identical to the 
ability-to-repay requirements adopted by the Board for higher-priced 
mortgage loans in July 2008 under the Home Ownership and Equity 
Protection Act. 73 FR 44522, Jul. 30, 2008 (``2008 HOEPA Final Rule''). 
General rulemaking authority for TILA is scheduled to transfer to the 
Consumer Financial Protection Bureau (CFPB) in July 2011. Accordingly, 
this rulemaking will become a proposal of the CFPB and will not be 
finalized by the Board.
    Consistent with the Act, the proposal applies the ability-to-repay 
requirements to any consumer credit transaction secured by a dwelling, 
except an open-end credit plan, timeshare plan, reverse mortgage, or 
temporary loan. Thus, unlike the Board's 2008 HOEPA Final Rule, the 
proposal is not limited to higher-priced mortgage loans or loans 
secured by the consumer's principal dwelling. The Act prohibits a 
creditor from making a mortgage loan unless the creditor makes a 
reasonable and good faith determination, based on verified and 
documented information, that the consumer will have a reasonable 
ability to repay the loan, including any mortgage-related obligations 
(such as property taxes).
    Consistent with the Act, the proposal provides four options for 
complying with the ability-to-repay requirement. First, a creditor can 
meet the general ability-to-repay standard by originating a mortgage 
loan for which:
     The creditor considers and verifies the following eight 
underwriting factors in determining repayment ability: (1) Current or 
reasonably expected income or assets; (2) current employment status; 
(3) the monthly payment on the mortgage; (4) the monthly payment on any 
simultaneous loan; (5) the monthly payment for mortgage-related 
obligations; (6) current debt obligations; (7) the monthly debt-to-
income ratio, or residual income; and (8) credit history; and
     The mortgage payment calculation is based on the fully 
indexed rate.
    Second, a creditor can refinance a ``non-standard mortgage'' into a 
``standard mortgage.'' This is based on a statutory provision that is 
meant to provide flexibility for streamlined refinancings, which are 
no- or low-documentation transactions designed to quickly refinance a 
consumer out of a risky mortgage into a more stable product. Under this 
option, the creditor does not have to verify the consumer's income or 
assets. The proposal defines a ``standard mortgage'' as a mortgage loan 
that, among other things, does not contain negative amortization, 
interest-only payments, or balloon payments; and has limited points and 
fees.
    Third, a creditor can originate a ``qualified mortgage,'' which 
provides special protection from liability for creditors who make 
``qualified mortgages.'' It is unclear whether that protection is 
intended to be a safe harbor or a rebuttable presumption of compliance 
with the repayment ability requirement. Therefore, the Board is 
proposing two alternative definitions of a ``qualified mortgage.''
    Alternative 1 operates as a legal safe harbor and defines a 
``qualified mortgage'' as a mortgage for which:
    (a) The loan does not contain negative amortization, interest-only 
payments, or balloon payments, or a loan term exceeding 30 years;

[[Page 27391]]

    (b) The total points and fees do not exceed 3% of the total loan 
amount;
    (c) The borrower's income or assets are verified and documented; 
and
    (d) The underwriting of the mortgage (1) is based on the maximum 
interest rate in the first five years, (2) uses a payment schedule that 
fully amortizes the loan over the loan term, and (3) takes into account 
any mortgage-related obligations.
    Alternative 2 provides a rebuttable presumption of compliance and 
defines a ``qualified mortgage'' as including the criteria listed under 
Alternative 1 as well as the following additional underwriting 
requirements from the ability-to-repay standard: (1) The consumer's 
employment status, (2) the monthly payment for any simultaneous loan, 
(3) the consumer's current debt obligations, (4) the total debt-to-
income ratio or residual income, and (5) the consumer's credit history.
    Finally, a small creditor operating predominantly in rural or 
underserved areas can originate a balloon-payment qualified mortgage. 
This standard is evidently meant to accommodate community banks that 
originate balloon loans to hedge against interest rate risk. Under this 
option, a small creditor can make a balloon-payment qualified mortgage 
if the loan term is five years or more, and the payment calculation is 
based on the scheduled periodic payments, excluding the balloon 
payment.
    The proposal also implements the Dodd-Frank Act's limits on 
prepayment penalties, lengthens the time creditors must retain records 
that evidence compliance with the ability-to-repay and prepayment 
penalty provisions, and prohibits evasion of the rule by structuring a 
closed-end extension of credit as an open-end plan. The Dodd-Frank Act 
contains other consumer protections for mortgages, which will be 
implemented in subsequent rulemakings.

II. Background

    Over the years, concerns have been raised about creditors 
originating mortgage loans without regard to the consumer's ability to 
repay the loan. Beginning in about 2006, these concerns were heightened 
as mortgage delinquencies and foreclosures rates increased 
dramatically, caused in part by the loosening of underwriting 
standards. See 73 FR 44524, Jul. 30, 2008. Following is background 
information, including a brief summary of the legislative and 
regulatory responses to this issue, which culminated in the enactment 
of the Dodd-Frank Act on July 21, 2010.

A. TILA and Regulation Z

    In 1968, Congress enacted TILA, 15 U.S.C. 1601 et seq., based on 
findings that economic stability would be enhanced and competition 
among consumer credit providers would be strengthened by the informed 
use of credit resulting from consumers' awareness of the cost of 
credit. One of the purposes of TILA is to promote the informed use of 
consumer credit by requiring disclosures about its costs and terms. 
TILA requires additional disclosures for loans secured by consumers' 
homes and permits consumers to rescind certain transactions that 
involve their principal dwelling. TILA directs the Board to prescribe 
regulations to carry out the purposes of the law, and specifically 
authorizes the Board, among other things, to issue regulations that 
contain such additional requirements, classifications, 
differentiations, or other provisions, or that provide for such 
adjustments and exceptions for all or any class of transactions, that 
in the Board's judgment are necessary or proper to effectuate the 
purposes of TILA, facilitate compliance with TILA, or prevent 
circumvention or evasion. 15 U.S.C. 1604(a). TILA is implemented by the 
Board's Regulation Z, 12 CFR part 226. An Official Staff Commentary 
interprets the requirements of the regulation and provides guidance to 
creditors in applying the rules to specific transactions. See 12 CFR 
part 226, Supp. I.

B. The Home Ownership and Equity Protection Act (HOEPA) and HOEPA Rules

    In response to evidence of abusive practices in the home-equity 
lending market, Congress amended TILA by enacting the Home Ownership 
and Equity Protection Act (HOEPA) in 1994. Public Law 103-325, 108 
Stat. 2160. HOEPA defines a class of ``high-cost mortgages,'' which are 
generally closed-end home-equity loans (excluding home-purchase loans) 
with annual percentage rates (APRs) or total points and fees exceeding 
prescribed thresholds.\1\ HOEPA created special substantive protections 
for high-cost mortgages, including prohibiting a creditor from engaging 
in a pattern or practice of extending a high-cost mortgage to a 
consumer based on the consumer's collateral without regard to the 
consumer's repayment ability, including the consumer's current and 
expected income, current obligations, and employment. TILA Section 
129(h); 15 U.S.C. 1639(h). In addition to the disclosures and 
limitations specified in the statute, TILA Section 129, as added by 
HOEPA, expanded the Board's rulemaking authority. TILA Section 
129(l)(2)(A) authorizes the Board to prohibit acts or practices the 
Board finds to be unfair and deceptive in connection with mortgage 
loans. 15 U.S.C. 1639(l)(2)(A). TILA Section 129(l)(2)(B) authorizes 
the Board to prohibit acts or practices in connection with the 
refinancing of mortgage loans that the board finds to be associated 
with abusive lending practices, or that are otherwise not in the 
interest of the borrower. 15 U.S.C. 1639(l)(2)(B).
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    \1\ Mortgages covered by the HOEPA amendments have been referred 
to as ``HOEPA loans,'' ``Section 32 loans,'' or ``high-cost 
mortgages.'' The Dodd-Frank Act now refers to these loans as ``high-
cost mortgages.'' See the Dodd-Frank Act Sec.  1431; TILA Section 
103(aa). For simplicity and consistency, this proposal will use the 
term ``high-cost mortgages'' to refer to mortgages covered by the 
HOEPA amendments.
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    In addition, HOEPA created three special remedies for a violation 
of its provisions. First, a consumer who brings a timely action against 
a creditor for a violation of rules issued under TILA Section 129 may 
be able to recover special statutory damages equal to the sum of all 
finance charges and fees paid by the consumer (often referred to as 
``HOEPA damages''), unless the creditor demonstrates that the failure 
to comply is not material. TILA Section 130(a); 15 U.S.C. 1640(a). This 
recovery is in addition to actual damages; statutory damages in an 
individual action or class action, up to a prescribed threshold; and 
court costs and attorney fees that would be available for violations of 
other TILA provisions. Second, if a creditor assigns a high-cost 
mortgage to another person, the consumer may be able to obtain from the 
assignee all of the foregoing damages. TILA Section 131(d); 15 U.S.C. 
1641(d). For all other loans, TILA Section 131(e), 15 U.S.C. 1641(e), 
limits the liability of assignees for violations of Regulation Z to 
disclosure violations that are apparent on the face of the disclosure 
statement required by TILA. Finally, a consumer has a right to rescind 
a transaction for up to three years after consummation when the 
mortgage contains a provision prohibited by a rule adopted under the 
authority of TILA Section 129(l)(2). TILA Section 125 and 129(j); 15 
U.S.C. 1635 and 1639(j). Any consumer who has the right to rescind a 
transaction may rescind the transaction as against any assignee. TILA 
Section 131(c); 15 U.S.C. 1641(c). The right of rescission does not 
extend, however, to home purchase loans, construction loans, or certain 
refinancings with the same

[[Page 27392]]

creditor. TILA Section 125(e); 15 U.S.C. 1635(e).
    In 1995, the Board implemented the HOEPA amendments at Sec.  
226.31, 226.32, and 226.33 of Regulation Z. 60 FR 15463, March 24, 
1995. In particular, Sec.  226.32(e)(1) implemented TILA Section 129(h) 
to prohibit a creditor from extending a high-cost mortgage based on the 
consumer's collateral if, considering the consumer's current and 
expected income, current obligations, and employment status, the 
consumer would be unable to make the scheduled payments. In 2001, the 
Board amended these regulations to expand HOEPA's protections to more 
loans by revising the APR threshold, and points and fees definition. 66 
FR 65604, Dec. 20, 2001. In addition, the ability-to-repay provisions 
in the regulation were revised to provide for a presumption of a 
violation of the rule if the creditor engages in a pattern or practice 
of making high-cost mortgages without verifying and documenting the 
consumers' repayment ability.

C. 2006 and 2007 Interagency Supervisory Guidance

    In December 2005, the Board and the other Federal banking agencies 
responded to concerns about the rapid growth of nontraditional 
mortgages in the previous two years by proposing supervisory guidance. 
Nontraditional mortgages are mortgages that allow the borrower to defer 
repayment of principal and sometimes interest. The guidance advised 
institutions of the need to reduce ``risk layering'' practices with 
respect to these products, such as failing to document income or 
lending nearly the full appraised value of the home. The final guidance 
issued in September 2006 specifically advised lenders that layering 
risks in nontraditional mortgage loans to subprime borrowers may 
significantly increase risks to borrowers as well as institutions. 
Interagency Guidance on Nontraditional Mortgage Product Risks, 71 FR 
58609, Oct. 4, 2006 (``2006 Nontraditional Mortgage Guidance'').
    The Board and the other Federal banking agencies addressed concerns 
about the subprime market in March 2007 with proposed supervisory 
guidance addressing the heightened risks to consumers and institutions 
of adjustable-rate mortgages with two- or three-year ``teaser'' rates 
followed by substantial increases in the rate and payment. The 
guidance, finalized in June of 2007, set out the standards institutions 
should follow to ensure borrowers in the subprime market obtain loans 
they can afford to repay. Among other steps, the guidance advised 
lenders to (1) use the fully-indexed rate and fully-amortizing payment 
when qualifying borrowers for loans with adjustable rates and 
potentially non-amortizing payments; (2) limit stated income and 
reduced documentation loans to cases where mitigating factors clearly 
minimize the need for full documentation of income; and (3) provide 
that prepayment penalty clauses expire a reasonable period before 
reset, typically at least 60 days. Statement on Subprime Mortgage 
Lending, 72 FR 37569, Jul. 10, 2007 (``2007 Subprime Mortgage 
Statement'').\2\ The Conference of State Bank Supervisors (``CSBS'') 
and the American Association of Residential Mortgage Regulators 
(``AARMR'') issued parallel statements for state supervisors to use 
with state-supervised entities, and many states adopted the statements.
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    \2\ The 2006 Nontraditional Mortgage Guidance and the 2007 
Subprime Mortgage Statement will hereinafter collectively be 
referred to as the ``Interagency Supervisory Guidance.''
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D. 2008 HOEPA Final Rule

    In 2006 and 2007, the Board held a series of national hearings on 
consumer protection issues in the mortgage market. During those 
hearings, consumer advocates and government officials expressed a 
number of concerns, and urged the Board to prohibit or restrict certain 
underwriting practices, such as ``stated income'' or ``low 
documentation'' loans, and certain product features, such as prepayment 
penalties. See 73 FR 44527, Jul. 30, 2008. The Board was also urged to 
adopt regulations under HOEPA, because, unlike the Interagency 
Supervisory Guidance, the regulations would apply to all creditors and 
would be enforceable by consumers through civil actions.
    In response to these hearings, in July of 2008, the Board adopted 
final rules pursuant to the Board's authority in TILA Section 
129(l)(2)(A). 73 FR 44522, Jul. 30, 2008 (``2008 HOEPA Final Rule''). 
The Board's 2008 HOEPA Final Rule defined a new class of ``higher-
priced mortgage loans,'' . Under the 2008 HOEPA Final Rule, a higher-
priced mortgage loan is a consumer credit transaction secured by the 
consumer's principal dwelling with an APR that exceeds the average 
prime offer rate (APOR) for a comparable transaction, as of the date 
the interest rate is set, by 1.5 or more percentage points for loans 
secured by a first lien on the dwelling, or by 3.5 or more percentage 
points for loans secured by a subordinate lien on the dwelling. Section 
226.35(a)(1). The definition of a ``higher-priced mortgage loan'' 
includes those loans that are defined as ``high-cost mortgages.''
    Among other things, the Board's 2008 HOEPA Final Rule revised the 
ability-to-repay requirements for high-cost mortgages, and extended 
these requirements to higher-priced mortgage loans. Sections 
226.34(a)(4), 226.35(b)(1). Specifically, the rule:
     Prohibits a creditor from extending a higher-priced 
mortgage loan based on the collateral and without regard to the 
consumer's repayment ability.
     Prohibits a creditor from relying on income or assets to 
assess repayment ability unless the creditor verifies such amounts 
using third-party documents that provide reasonably reliable evidence 
of the consumer's income and assets.

In addition, the Board's 2008 Final Rule provides certain restrictions 
on prepayment penalties for high-cost mortgages and higher-priced 
mortgage loans. Sections 226.32(d), 226.35(b)(2).

E. The Dodd-Frank Act

    In 2007, Congress held hearings focused on rising subprime 
foreclosure rates and the extent to which lending practices contributed 
to them. See 73 FR 44528, Jul. 30, 2008. Consumer advocates testified 
that certain lending terms or practices contributed to the 
foreclosures, including a failure to consider the consumer's ability to 
repay, low- or no-documentation loans, hybrid adjustable-rate 
mortgages, and prepayment penalties. Industry representatives, on the 
other hand, testified that adopting substantive restrictions on 
subprime loan terms would risk reducing access to credit for some 
borrowers. In response to these hearings, the House of Representatives 
passed the Mortgage Reform and Anti-Predatory Lending Act in 2007 and 
2009. H.R. 3915, 110th Cong. (2007); H.R. 1728, 111th Cong. (2009). 
Both bills would have amended TILA to provide consumer protections for 
mortgages, including ability-to-repay requirements, but neither bill 
was passed by the Senate.
    Then, on July 21, 2010, the Dodd-Frank Act was signed into law. 
Public Law 111-203, 124 Stat. 1376 (2010). Title XIV of the Dodd-Frank 
Act contains the Mortgage Reform and Anti-Predatory Lending Act.\3\ 
Sections 1411,

[[Page 27393]]

1412, and 1414 of the Dodd-Frank Act create new TILA Section 129C, 
which, among other things, establishes new ability-to-repay 
requirements and new limits on prepayment penalties. Public Law 111-
203, Sec.  1411, 1412, 1414, 124 Stat. 1376, 2142-53 (to be codified at 
15 U.S.C. 1639c). The Dodd-Frank Act states that Congress created new 
TILA Section 129C upon a finding that ``economic stabilization would be 
enhanced by the protection, limitation, and regulation of the terms of 
residential mortgage credit and the practices related to such credit, 
while ensuring that responsible, affordable mortgage credit remains 
available to consumers.'' Dodd-Frank Act Section 1402; TILA Section 
129B(a)(1). The Dodd-Frank Act further states that the purpose of TILA 
Section 129C is to ``assure that consumers are offered and receive 
residential mortgage loans on terms that reasonably reflect their 
ability to repay the loans.'' Dodd-Frank Act Section 1402; TILA Section 
129B(a)(2).
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    \3\ Although S. Rpt. No. 111-176 generally contains the 
legislative history for the Dodd-Frank Act, it does not contain the 
legislative history for the Mortgage Reform and Anti-Predatory 
Lending Act. Therefore, the Board has relied on the legislative 
history for the 2007 and 2009 House bills for guidance in 
interpreting the statute. See H. Rpt. No. 110-441 for H.R. 3915 
(2007), and H. Rpt. No. 111-194 for H.R. 1728 (2009).
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    Specifically, TILA Section 129C:
     Expands coverage of the ability-to-repay requirements to 
any consumer credit transaction secured by a dwelling, except an open-
end credit plan, timeshare plan, reverse mortgage, or temporary loan.
     Prohibits a creditor from making a mortgage loan unless 
the creditor makes a reasonable and good faith determination, based on 
verified and documented information, that the consumer has a reasonable 
ability to repay the loan according to its terms, and all applicable 
taxes, insurance, and assessments.
     Provides a presumption of compliance with the ability-to-
repay requirements if the mortgage loan is a ``qualified mortgage,'' 
which does not contain certain risky features and limits points and 
fees on the loan.
     Prohibits prepayment penalties unless the mortgage is a 
prime, fixed-rate qualified mortgage, and the amount of the prepayment 
penalty is limited.
    The Dodd-Frank Act creates special remedies for violations of TILA 
Section 129C. Section 1416 of the Dodd-Frank Act provides that a 
consumer who brings a timely action against a creditor for a violation 
of TILA Section 129C(a) (the ability-to-repay requirements) may be able 
to recover special statutory damages equal to the sum of all finance 
charges and fees paid by the consumer (often referred to as ``HOEPA 
damages''), unless the creditor demonstrates that the failure to comply 
is not material. TILA Section 130(a). This recovery is in addition to 
actual damages; statutory damages in an individual action or class 
action, up to a prescribed threshold; and court costs and attorney fees 
that would be available for violations of other TILA provisions. In 
addition, the statute of limitations for an action for a violation of 
TILA Section 129C is three years from the date of the occurrence of the 
violation (as compared to one year for other TILA violations). TILA 
Section 130(e). Moreover, Section 1413 of the Dodd-Frank Act provides 
that a consumer may assert a violation of TILA Section 129C(a) as a 
defense to foreclosure by recoupment or set off. TILA Section 130(k). 
There is no time limit on the use of this defense.

F. Other Recent Board Actions

    In addition to the 2008 HOEPA Final Rule, the Board has recently 
published several proposed or final rules for mortgages that are 
referenced in or relevant to this proposal.
    2009 Closed-End Mortgage Proposal. In August 2009, the Board issued 
two proposals to amend Regulation Z: One for closed-end mortgages and 
one for home equity lines of credit (``HELOCs''). For closed-end 
mortgages, the August 2009 proposal would revise the disclosure 
requirements to highlight potentially risky features, such as 
adjustable rates and negative amortization, and address other issues, 
such as the timing of disclosures. See 74 FR 43232, Aug. 26, 2009 
(``2009 Closed-End Mortgage Proposal''). For HELOCs, the August 2009 
proposal would revise the disclosure requirements and address other 
issues, such as account terminations. 74 FR 43428, Aug. 26, 2009 
(``2009 HELOC Proposal''). Public comments for both proposals were due 
by December 24, 2009.
    2010 Mortgage Proposal. In September 2010, the Board issued a 
proposal that would revise Regulation Z with respect to rescission, 
refinancing, reverse mortgages, and the refund of certain fees. See 75 
FR 58539, Sept. 24, 2010 (``2010 Mortgage Proposal''). Public comments 
for this proposal were due by December 23, 2010. On February 1, 2011, 
the Board issued a press release stating that it does not expect to 
finalize the 2009 Closed-End Mortgage Proposal, 2009 HELOC Proposal, or 
the 2010 Mortgage Proposal prior to the transfer of authority for such 
rulemakings to the Consumer Financial Protection Bureau in July 2011.
    2010 Loan Originator Compensation Rule. In September 2010, the 
Board adopted a final rule on loan originator compensation to prohibit 
compensation to mortgage brokers and loan officers (collectively, 
``loan originators'') that is based on a loan's interest rate or other 
terms. The final rule also prohibits loan originators from steering 
consumers to loans that are not in the consumers' interest to increase 
the loan originator's compensation. 75 FR 58509, Sept. 24, 2010 (``2010 
Loan Originator Compensation Rule''). This rule became effective April 
6, 2011.
    2010 MDIA Interim Final Rule. In May 2009, the Board adopted final 
rules implementing the amendments to TILA under the Mortgage Disclosure 
Improvement Act of 2008 (``MDIA'').\4\ Among other things, the MDIA and 
the final rules require early, transaction-specific disclosures for 
mortgage loans secured by a dwelling, and requires waiting periods 
between the time when disclosures are given and consummation of the 
transaction. These rules became effective July 30, 2009, as required by 
the statute. See 74 FR 23289, May 19, 2009. The MDIA also requires 
disclosure of payment examples if the loan's interest rate or payments 
can change, along with a statement that there is no guarantee that the 
consumer will be able to refinance the transaction in the future. Under 
the statute, these provisions of the MDIA became effective on January 
30, 2011. On September 24, 2010, the Board published an interim rule to 
implement these requirements. See 75 FR 58470, Sept. 24, 2010. In 
particular, the rule provided definitions for a ``balloon payment,'' 
``adjustable-rate mortgage,'' ``step-rate mortgage,'' ``fixed-rate 
mortgage,'' ``interest-only loan,'' ``negative amortization loan,'' and 
the ``fully indexed rate.'' See Sec.  226.18(s)(5) and (s)(7). 
Subsequently, the Board issued an interim rule to make certain 
clarifying changes. See 75 FR 81836, Dec. 29, 2010. The term ``2010 
MDIA Interim Final Rule'' is used to refer to the September 2010 final 
rule as revised by the December 2010 final rule.
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    \4\ The MDIA is contained in Sections 2501 through 2503 of the 
Housing and Economic Recovery Act of 2008, Public Law 110-289, 
enacted on July 30, 2008. The MDIA was later amended by the 
Emergency Economic Stabilization Act of 2008, Public Law 110-343, 
enacted on October 3, 2008.
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    2011 Escrow Proposal and Final Rule. In March 2011, the Board 
issued a proposal to implement Sections 1461 and 1462 of the Dodd-Frank 
Act, which create new TILA Section 129D and provide certain escrow 
requirements for higher-priced mortgage loans. See 76 FR 11599, March 
2, 2011 (``2011 Escrow Proposal''). In particular, the proposal would 
revise the definition of a ``higher-priced mortgage loan,'' and create 
an exemption from the escrow requirement for any loan extended by a 
creditor that makes most of its first-lien higher-priced mortgage loans 
in counties designated by the Board as ``rural or underserved,'' has 
annual originations of 100 or fewer

[[Page 27394]]

first-lien mortgage loans, and does not escrow for any mortgage 
transaction it services.
    In March 2011, the Board also issued a final rule that implements a 
provision of the Dodd-Frank Act that increases the APR threshold used 
to determine whether a mortgage lender is required to establish an 
escrow account for property taxes and insurance for first-lien, 
``jumbo'' mortgage loans. See 76 FR 11319, March 2, 2011 (``2011 Jumbo 
Loan Escrow Final Rule''). Jumbo loans are loans exceeding the 
conforming loan-size limit for purchase by Freddie Mac, as specified by 
the legislation.
    2011 Risk Retention Proposal. On March 31, 2011, the Board, the 
Office of the Comptroller of the Currency, the Federal Deposit 
Insurance Corporation, the Securities and Exchange Commission, the U.S. 
Department of Housing and Urban Development, and the Federal Housing 
Finance Agency (``Agencies'') issued a proposal to implement Section 
941 of the Dodd-Frank Act, which adds a new Section 15G to the 
Securities Exchange Act of 1934. 15 U.S.C. 78o-11. As required by the 
Act, the proposal generally requires the sponsor of an asset-backed 
security to retain not less than five percent of the credit risk of the 
assets collateralizing the security. The Act and the proposal include a 
variety of exemptions, including an exemption for an asset-backed 
security that is collateralized exclusively by ``qualified residential 
mortgages.'' The Act requires the Agencies to define the term 
``qualified residential mortgage'' taking into consideration 
underwriting and product features that historical loan performance data 
indicate result in a lower risk of default. The Act further provides 
that the definition of a ``qualified residential mortgage'' can be ``no 
broader than'' the definition of a ``qualified mortgage'' under TILA 
Section 129C(b)(2). The 2011 Risk Retention Proposal implements these 
provisions of the Act. Public comments for this proposal are due by 
June 10, 2011.

G. Development of This Proposal

    In developing this proposal, the Board reviewed the laws, 
regulations, proposals, and legislative history described above as well 
as state ability-to-repay laws. The Board also conducted extensive 
outreach with consumer advocates, industry representatives, and Federal 
and state regulators, and examined underwriting rules and guidelines 
for the Federal Housing Administration, the U.S. Department of 
Veterans' Affairs, Fannie Mae, Freddie Mac, the Home Affordable 
Modification Program, and private creditors. Finally, the Board 
conducted independent analyses regarding the effect of various 
underwriting procedures and loan features on loan performance.

III. Legal Authority

    TILA Section 105(a) mandates that the Board prescribe regulations 
to carry out the purposes of the Act. 15 U.S.C. 1604(a). In addition, 
TILA, as amended by the Dodd-Frank Act, specifically authorizes the 
Board to:
     Issue regulations that contain such additional 
requirements, classifications, differentiations, or other provisions, 
or that provide for such adjustments and exceptions for all or any 
class of transactions, that in the Board's judgment are necessary or 
proper to effectuate the purposes of TILA, facilitate compliance with 
the Act, or prevent circumvention or evasion. TILA Section 105(a); 15 
U.S.C. 1604(a).
     By regulation, prohibit or condition terms, acts or 
practices relating to residential mortgage loans that the Board finds 
to be abusive, unfair, deceptive, or predatory; necessary or proper to 
ensure that responsible, affordable mortgage credit remains available 
to consumers in a manner consistent with the purposes of the ability-
to-repay requirements; necessary or proper to effectuate the purposes 
of the ability-to-repay requirements, to prevent circumvention or 
evasion thereof, or to facilitate compliance; or are not in the 
interest of the borrower. TILA Section 129B(e); 15 U.S.C. 1639b(e).
     Prescribe regulations that revise, add to, or subtract 
from the criteria that define a qualified mortgage upon a finding that 
such regulations are necessary or proper to ensure that responsible, 
affordable mortgage credit remains available to consumers in a manner 
consistent with the purposes of the ability-to-repay requirements; or 
necessary and appropriate to effectuate the purposes of the ability-to-
repay requirements, to prevent circumvention or evasion thereof, or to 
facilitate compliance. TILA Section 129C(b)(3)(B)(i); 15 U.S.C. 
1639c(b)(3)(B)(i).

TILA, as amended by the Dodd-Frank Act, states that it is the purpose 
of the ability-to-repay requirements to assure that consumers are 
offered and receive residential mortgage loans on terms that reasonably 
reflect their ability to repay the loans. TILA Section 129B(a)(2); 15 
U.S.C. 1639b(a)(2).

IV. Discussion of the Proposed Rule

A. Scope of Coverage

    Consistent with the Dodd-Frank Act, the proposal applies to any 
dwelling-secured consumer credit transaction, including vacation homes 
and home equity loans. The proposal does not apply to open-end credit 
plans, timeshare plans, reverse mortgages, or temporary loans with 
terms of 12 months or less. The Act essentially codifies the ability-
to-repay requirements of the Board's 2008 HOEPA Final Rule and expands 
the scope to the covered transactions described above.

B. Ability-to-Repay Requirements

    Consistent with the Dodd-Frank Act, the proposal provides that a 
creditor may not make a covered mortgage loan unless the creditor makes 
a reasonable and good faith determination, based on verified and 
documented information, that the consumer will have a reasonable 
ability to repay the loan, including any mortgage-related obligations 
(such as property taxes). TILA Section 129C; 15 U.S.C. 1639C. The Act 
and the proposal provide four options for complying with the ability-
to-repay requirement. Specifically, a creditor can:
     Originate a covered transaction under the general ability-
to-repay standard;
     Refinance a ``non-standard mortgage'' into a ``standard 
mortgage'';
     Originate a ``qualified mortgage,'' which provides a 
presumption of compliance with the rule; or
     Originate a balloon-payment qualified mortgage, which 
provides a presumption of compliance with the rule.
    Each of these methods is discussed below, with a description of: 
(1) Limits on the loan features or term, (2) limits on points and fees, 
(3) underwriting requirements, and (4) payment calculations.
General Ability-to-Repay Standard
    Limits on loan features, term, and points and fees. Under the 
general ability-to-repay standards, there are no limits on the loan's 
features, term, or points and fees, but the creditor must follow 
certain underwriting requirements and payment calculations.
    Underwriting requirements. Consistent with the Dodd-Frank Act, the 
proposal requires the creditor to consider and verify the following 
eight underwriting factors:
     Current or reasonably expected income or assets;
     Current employment status;

[[Page 27395]]

     The monthly payment on the covered transaction;
     The monthly payment on any simultaneous loan;
     The monthly payment for mortgage-related obligations;
     Current debt obligations;
     The monthly debt-to-income ratio, or residual income; and
     Credit history.

The proposal permits the creditor to consider and verify these 
underwriting factors based on widely accepted underwriting standards.

    The proposal is generally consistent with the Act except in one 
respect. The Act does not require the creditor to consider simultaneous 
loans that are home equity lines of credit (``HELOCs''), but the Board 
is using its adjustment and exception authority and discretionary 
regulatory authority to include HELOCs within the definition of 
simultaneous loans. The Board believes that such inclusion would help 
ensure the consumer's ability to repay the loan. Data and outreach 
indicated that the origination of a simultaneous HELOC markedly 
increases the rate of default. In addition, this approach is consistent 
with the Board's 2008 HOEPA Final Rule.
    Payment calculations. Under the general ability-to-repay standard, 
the Dodd-Frank Act does not ban mortgage features, but instead requires 
the creditor to underwrite the mortgage payment according to certain 
assumptions and calculations. Specifically, consistent with the Act, 
the proposal requires creditors to calculate the mortgage payment 
using: (1) The fully indexed rate; and (2) monthly, substantially equal 
payments that amortize the loan amount over the loan term. In addition, 
the Board is using its adjustment and exception authority and 
discretionary regulatory authority to require the creditor to 
underwrite the payment based on the introductory interest rate if it is 
greater than the fully indexed rate. Some transactions use a premium 
initial rate that is higher than the fully indexed rate. The Board 
believes this approach would help ensure the consumer's ability to 
repay the loan and prevent circumvention or evasion.
    The Act and proposal also provide special payment calculations for 
interest-only loans, negative amortization loans, and balloon loans. In 
particular, the requirements for balloon loans depend on whether the 
loan is ``higher-priced'' \5\ or not. Consistent with the Act, the 
proposal requires a creditor to underwrite a higher-priced loan with a 
balloon payment by considering the consumer's ability to make the 
balloon payment (without refinancing). As a practical matter, this 
would mean that a creditor would not be able to make a higher-priced 
balloon loan unless the consumer had substantial documented assets or 
income.
---------------------------------------------------------------------------

    \5\ The Act provides separate underwriting requirements for 
balloon loans depending on whether the loan's APR exceeds the APOR 
by 1.5 percent for a first-lien loan or by 3.5 percent for a 
subordinate-lien loan.
---------------------------------------------------------------------------

    The Act permits a creditor to underwrite a balloon loan that is not 
higher-priced in accordance with regulations prescribed by the Board. 
The proposal requires creditors to underwrite a balloon loan using the 
maximum payment scheduled during the first five years after 
consummation. This approach would not capture the balloon payment for a 
balloon loan with a term of five years or more. The Board believes five 
years is the appropriate time horizon in order to ensure consumers have 
a reasonable ability to repay the loan, and to preserve credit choice 
and availability. Moreover, the five year time horizon is consistent 
with other provisions in the Act and the proposal, which require 
underwriting based on the first five years after consummation (for 
qualified mortgages and the refinancing of a non-standard mortgage) or 
which require a minimum term of five years (for balloon-payment 
qualified mortgages made by certain creditors).
Refinancing of a Non-Standard Mortgage
    The Dodd-Frank Act provides an exception to the ability-to-repay 
standard's underwriting requirements if: (1) The same creditor is 
refinancing a ``hybrid mortgage'' into a ``standard mortgage,'' (2) the 
consumer's monthly payment is reduced through the refinancing, and (3) 
the consumer has not been delinquent on any payment on the existing 
hybrid mortgage. This provision appears to be intended to provide 
flexibility for streamlined refinancings, which are no- or low-
documentation loans designed to quickly refinance a consumer in a risky 
mortgage into a more stable product. Streamlined refinancings have 
substantially increased in recent years to accommodate consumers at 
risk of default.
    Definitions--loan features, term, and points and fees. Although the 
Act uses the term ``hybrid mortgage,'' the proposal uses the term 
``non-standard mortgage,'' defined as (1) an adjustable-rate mortgage 
with an introductory fixed interest rate for a period of years, (2) an 
interest-only loan, and (3) a negative amortization loan. The Board 
believes that this definition is consistent with the legislative 
history, which indicates that Congress was generally concerned with 
loans that provide for ``payment shock'' through significantly higher 
payments over the life of the loan.
    The proposal defines the term ``standard mortgage'' as a covered 
transaction which, among other things, does not contain negative 
amortization, interest-only payments, or balloon payments; and limits 
the points and fees.
    Underwriting requirements. If the conditions described above are 
met, the Act states that the creditor may give concerns about 
preventing a likely default a ``higher priority as an acceptable 
underwriting practice.'' The Board interprets this provision to provide 
an exception from the general ability-to-repay requirements for income 
and asset verification. The Board believes that this approach is 
consistent with the statute and would preserve access to streamlined 
refinancings.
    Payment calculations. The proposal provides specific payment 
calculations for purposes of determining whether the refinancing 
reduces the consumer's monthly mortgage payment, and for determining 
whether the consumer has the ability to repay the standard mortgage. 
The calculation for the non-standard mortgage would reflect the highest 
payment that would occur as of the date of the expiration of the period 
during which introductory-rate payments, interest-only payments, or 
negatively amortizing payments are permitted. For a standard mortgage, 
the calculation would be based on: (1) The maximum interest rate that 
may apply during the first five years after consummation, and (2) 
monthly, substantially equal payments that amortize the loan amount 
over the loan term.
Safe Harbor or Presumption of Compliance for a Qualified Mortgage
    Under the Board's 2008 HOEPA Final Rule, a creditor may obtain a 
presumption of compliance with the repayment ability requirement if it 
follows the required procedures, such as verifying the consumer's 
income or assets, and additional optional procedures, such as assessing 
the consumer's debt-to-income ratio. However, the 2008 HOEPA Final Rule 
makes clear that even if the creditor follows the required and optional 
criteria, the creditor has only obtained a presumption of compliance 
with the repayment ability requirement. The consumer can still rebut or 
overcome

[[Page 27396]]

that presumption by showing that, despite following the required and 
optional procedures, the creditor nonetheless disregarded the 
consumer's ability to repay the loan. For example, the consumer could 
present evidence that although the creditor assessed the consumer's 
debt-to-income ratio, that ratio was very high with little residual 
income. This evidence may be sufficient to overcome the presumption of 
compliance and demonstrate that the creditor extended credit without 
regard to the consumer's ability to repay the loan.
    The Dodd-Frank Act provides special protection from liability for 
creditors who make ``qualified mortgages,'' but it is unclear whether 
that protection is intended to be a safe harbor or a rebuttable 
presumption of compliance with the repayment ability requirement. The 
Act states that a creditor or assignee ``may presume'' that a loan has 
met the repayment ability requirement if the loan is a ``qualified 
mortgage.'' This might suggest that originating a qualified mortgage 
only provides a presumption of compliance, which the consumer can rebut 
by providing evidence that the creditor did not, in fact, make a good 
faith and reasonable determination of the consumer's ability to repay 
the loan.
    However, the Act does not state that a creditor that makes a 
``qualified mortgage'' must comply with all of the underwriting 
criteria of the general ability-to-repay standard. Specifically, the 
Act defines a ``qualified mortgage'' as a covered transaction for 
which:
     The loan does not contain negative amortization, interest-
only payments, or balloon payments;
     The term does not exceed 30 years;
     The points and fees generally do not exceed three percent 
of the total loan amount;
     The income or assets are considered and verified;
     The total debt-to-income ratio or residual income complies 
with any guideline or regulation prescribed by the Board; and
     The underwriting: (1) Is based on the maximum rate during 
the first five years, (2) uses a payment schedule that fully amortizes 
the loan over the loan term, and (3) takes into account all mortgage-
related obligations.

The definition of a ``qualified mortgage'' does not require the 
creditor to consider and verify the following underwriting requirements 
that are part of the general ability-to-repay standard: (1) The 
consumer's employment status, (2) the payment of any simultaneous loans 
of which the creditor knows or has reason to know, (3) the consumer's 
current obligations, and (4) the consumer's credit history. Thus, if 
the ``qualified mortgage'' definition is deemed to be a safe harbor, 
the consumer could not allege the creditor violated the repayment 
ability requirement by failing to consider and verify employment 
status, simultaneous loans, current obligations, or credit history. 
Under this approach, originating a ``qualified mortgage'' would be an 
alternative to complying with the general ability-to-repay standard and 
would operate as a safe harbor. Thus, if a creditor satisfied the 
qualified mortgage criteria, the consumer could not assert that the 
creditor had violated the ability-to-repay provisions. The consumer 
could only show that the creditor did not comply with one of the 
qualified mortgage safe harbor criteria.
    There are sound policy reasons for interpreting a ``qualified 
mortgage'' as providing either a safe harbor or a presumption of 
compliance. Interpreting a ``qualified mortgage'' as a safe harbor 
would provide creditors with an incentive to make qualified mortgages. 
That is, in exchange for limiting loan fees and features, the 
creditor's regulatory burden and exposure to liability would be 
reduced. Consumers may benefit by being provided with mortgage loans 
that do not have certain risky features or high costs. However, the 
drawback to this approach is that a creditor could not be challenged 
for failing to underwrite a loan based on the consumer's employment 
status, simultaneous loans, current debt obligations, or credit 
history, or for generally not making a reasonable and good faith 
determination of the consumer's ability to repay the loan.
    Interpreting a ``qualified mortgage'' as providing a rebuttable 
presumption of compliance would better ensure that creditors consider a 
consumer's ability to repay the loan. Creditors would have to make 
individualized determinations that the consumer had the ability to 
repay the loan based on all of the underwriting factors listed in the 
general ability-to-repay standard. This approach would require the 
creditor to comply with all of the ability-to-repay standards, and 
preserve the consumer's ability to use these standards in a defense to 
foreclosure or other legal action. In addition, a consumer could assert 
that, despite complying with the criteria for a qualified mortgage and 
the ability-to-repay standard, the creditor did not make a reasonable 
and good faith determination of the consumer's ability to repay the 
loan. However, the drawback of this approach is that it provides little 
legal certainty for the creditor, and thus, little incentive to make a 
``qualified mortgage,'' which limits loan fees and features.
    Because of the statutory ambiguity and these competing concerns, 
the Board is proposing two alternative definitions of a ``qualified 
mortgage.'' Alternative 1 defines a ``qualified mortgage'' based on the 
criteria listed in the Act, and the definition operates as a legal safe 
harbor and alternative to complying with the general ability-to-repay 
standard. Alternative 1 does not define a ``qualified mortgage'' to 
include a requirement to consider the consumer's debt-to-income ratio 
or residual income. Because of the discretion inherent in making these 
calculations, such a requirement would not provide certainty that the 
loan is a qualified mortgage.
    Alternative 2 defines a ``qualified mortgage'' to include the 
requirements listed in the Act as well as the other underwriting 
requirements that are in the general ability-to-repay standard (i.e., 
employment status, simultaneous loans, current debt obligations, debt-
to-income ratio, and credit history). The definition provides a 
presumption of compliance that could be rebutted by the consumer.
    Limits on points and fees. The Dodd-Frank Act defines a ``qualified 
mortgage'' as a loan for which, among other things, the total points 
and fees do not exceed three percent of the total loan amount. In 
addition, the Act requires the Board to prescribe rules adjusting this 
threshold for ``smaller loans'' and to ``consider the potential impact 
of such rules on rural areas and other areas where home values are 
lower.'' If the threshold were not adjusted for smaller loans, then 
creditors might not be able to recover their fixed costs for 
originating the loan. This could deter some creditors from originating 
smaller loans, thus reducing access to credit.
    The Board is proposing two alternatives for implementing the limits 
on points and fees for qualified mortgages. Alternative A is based on 
certain tiers of loan amounts (e.g., a points and fees threshold of 3.5 
percent of the total loan amount for a loan amount greater than or 
equal to $60,000 but less than $75,000). Alternative A is designed to 
be an easier calculation for creditors, but may result in some 
anomalies (e.g., a points and fees threshold of $2,250 for a $75,000 
loan, but a points and fees threshold of $2,450 for a $70,000 loan). 
Alternative B is designed to remedy these anomalies by providing a more 
precise sliding scale, but may be cumbersome for some creditors. The 
proposal solicits comment on these approaches.

[[Page 27397]]

    Definition of ``points and fees.'' Generally, a qualified mortgage 
cannot have points and fees that exceed three percent of the total loan 
amount. Consistent with the Act, the proposal revises Regulation Z to 
define ``points and fees'' to now include: (1) Certain mortgage 
insurance premiums in excess of the amount payable under Federal 
Housing Administration provisions; (2) all compensation paid directly 
or indirectly by a consumer or creditor to a loan originator; and (3) 
the prepayment penalty on the covered transaction, or on the existing 
loan if it is refinanced by the same creditor. The proposal also 
provides exceptions to the calculation of points and fees for: (1) Any 
bona fide third party charge not retained by the creditor, loan 
originator, or an affiliate of either, and (2) certain bona fide 
discount points.
    Underwriting requirements. As discussed above, it is not clear 
whether the Act intends the definition of a ``qualified mortgage'' to 
be a somewhat narrowly-defined safe harbor or a more broadly-defined 
presumption of compliance. For this reason, the Board is proposing two 
alternative definitions with respect to the underwriting requirements. 
Under Alternative 1, the underwriting requirements for a qualified 
mortgage are limited to requiring a creditor to consider and verify the 
consumer's current or reasonably expected income or assets. Under 
Alternative 2, the definition of a qualified mortgage requires a 
creditor to consider and verify all of the underwriting factors 
required under the general ability-to-repay standard, namely: (1) The 
currently or reasonably expected income, (2) the employment status, (3) 
the monthly payment on any simultaneous loan, (4) the current debt 
obligations, (5) the monthly debt-to-income ratio or residual income, 
and (6) the credit history.
    Payment calculations. Consistent with the Dodd-Frank Act, the 
proposal defines a qualified mortgage to require the creditor to 
calculate the mortgage payment using the periodic payment of principal 
and interest based on the maximum interest rate that may apply during 
the first five years after consummation.
Balloon-Payment Qualified Mortgages Made by Certain Creditors
    The Board is exercising the authority provided under the Dodd-Frank 
Act to provide an exception to the definition of a ``qualified 
mortgage'' for a balloon-payment loan made by a creditor that meets the 
criteria set forth in the Act. Based on outreach, it appears that some 
community banks make short-term balloon loans as a means of hedging 
against interest rate risk, and that the community banks typically hold 
these loans in portfolio. The Board believes Congress enacted this 
exception to ensure access to credit in rural and underserved areas 
where consumers may be able to obtain credit only from such community 
banks offering these balloon-payment loans. This exception is similar 
to the exemption from the escrow requirements provided in another 
section of the Dodd-Frank Act.
    The proposal provides an exception for a creditor that meets the 
following four criteria, with some alternatives:
    (1) Operates in predominantly rural or underserved areas. The 
creditor, during the preceding calendar year, must have extended more 
than 50% of its total covered transactions that provide for balloon 
payments in one or more counties designated by the Board as ``rural'' 
or ``underserved.''
    (2) Total annual covered transactions. Under Alternative 1, the 
creditor, together with all affiliates, extended covered transactions 
of some dollar amount or less during the preceding calendar year. Under 
Alternative 2, the creditor, together with all affiliates, extended 
some number of covered transactions or fewer during the preceding 
calendar year. The proposal solicits comment on an appropriate dollar 
amount or number of transactions.
    (3) Balloon loans in portfolio. Under Alternative 1, the creditor 
must not sell any balloon-payment loans on or after the effective date 
of the final rule. Under Alternative 2, the creditor must not have sold 
any balloon-payment loans during the preceding and current calendar 
year.
    (4) Asset size. The creditor must meet an asset size threshold set 
annually by the Board, which for calendar year 2011 would be $2 
billion.
    Limits on loan features. The Dodd-Frank Act generally provides that 
a balloon-payment qualified mortgage contains the same limits on loan 
features and the loan term as a qualified mortgage, except for allowing 
the balloon payment. In addition, the Board is using its adjustment and 
exception authority and discretionary regulatory authority to add a 
requirement that the loan term be five years or longer. The Board 
believes that this requirement would help ensure the consumer's ability 
to repay the loan by providing more time for the consumer to build 
equity.
    Points and fees and underwriting requirements. Consistent with the 
Dodd-Frank Act, the proposal requires that a balloon-payment qualified 
mortgage provide for the same limits on points and fees and 
underwriting requirements as a qualified mortgage.
    Payment calculations. Consistent with the Dodd-Frank Act, the 
proposal provides that a creditor may underwrite a balloon-payment 
qualified mortgage using all of the scheduled payments, except the 
balloon payment.
Other Protections
    Limits on prepayment penalties. Consistent with the Dodd-Frank Act, 
the proposal provides that a covered transaction may not include a 
prepayment penalty unless the transaction: (1) Has an APR that cannot 
increase after consummation (i.e., a fixed-rate or step-rate mortgage), 
(2) is a qualified mortgage, and (3) is not a higher-priced mortgage 
loan. The proposal further provides, consistent with the Act, that the 
prepayment penalty may not exceed three percent of the outstanding loan 
balance during the first year after consummation, two percent during 
the second year after consummation, and one percent during the third 
year after consummation. Prepayment penalties are not permitted after 
the end of the third year after consummation. Finally, pursuant to the 
Act, the proposal requires a creditor offering a consumer a loan with a 
prepayment penalty to also offer that consumer a loan without a 
prepayment penalty.
    Expansion of record retention rules. Currently, Regulation Z 
requires creditors to retain evidence of compliance for two years after 
disclosures must be made or action must be taken. The Dodd-Frank Act 
extends the statute of limitations for civil liability for a violation 
of the prepayment penalty provisions or ability-to-repay provisions 
(including the qualified mortgage provisions) to three years after the 
date of a violation. The proposal revises Regulation Z to lengthen the 
record retention requirement to three years after consummation for 
consistency with the Dodd-Frank Act.
    Prohibition on evasion through open-end credit. Currently, 
Regulation Z prohibits a creditor from structuring a closed-end loan as 
an open-end plan to evade the requirements for higher-priced mortgage 
loans. The Board is using its adjustment and exception authority and 
discretionary regulatory authority to include a similar provision in 
this proposal in order to prevent circumvention or evasion.

[[Page 27398]]

V. Section-by-Section Analysis

Section 226.25 Record Retention

25(a) General Rule
    Currently, Sec.  226.25(a) requires that creditors retain evidence 
of compliance with Regulation Z for two years after disclosures must be 
made or action must be taken. Section 226.25(a) also clarifies that 
administrative agencies responsible for enforcing Regulation Z may 
require creditors under their jurisdictions to retain records for a 
longer period, if necessary to carry out their enforcement 
responsibilities under TILA Section 108. 15 U.S.C. 1607. Under TILA 
Section 130(e), the statute of limitations for civil liability for a 
violation of TILA is one year after the date a violation occurs. 15 
U.S.C. 1640.
    The proposal would implement the requirement to consider a 
consumer's repayment ability under TILA Section 129C(a), alternative 
requirements for ``qualified mortgages'' under TILA Section 129C(b), 
and prepayment penalty requirements under TILA Section 129C(c) in 
proposed Sec.  226.43, as discussed in detail below. Section 1416 of 
the Dodd-Frank Act extends the statute of limitations for civil 
liability for a violation of TILA Section 129C, among other provisions, 
to three years after the date a violation occurs. Accordingly, the 
Board proposes to revise Sec.  226.25(a) to require that creditors 
retain records that evidence compliance with proposed Sec.  226.43 for 
at least three years after consummation. Although creditors will take 
action required under proposed Sec.  226.43 (underwriting covered 
transactions and offering consumers the option of a covered transaction 
without a prepayment penalty) before a transaction is consummated, the 
Board believes calculating the record retention period from the time of 
consummation would facilitate compliance by establishing a clear time 
period for record retention. The proposal to extend the required period 
for retention of evidence of compliance with Sec.  226.43 would not 
affect the record retention period for other requirements under 
Regulation Z. Increasing the period creditors must retain records 
evidencing compliance with Sec.  226.43 from two to three years would 
increase creditors' compliance burden. The Board believes many 
creditors will retain such records for at least three years, even in 
the absence of a change to record retention requirements, due to the 
extension of the statute of limitations for civil liability.
    Currently, comment 25(a)-2 clarifies that in general creditors need 
retain only enough information to reconstruct the required disclosures 
or other records. The Board proposes a new comment 25(a)-6 that 
clarifies that if a creditor must verify and document information used 
in underwriting a transaction subject to proposed Sec.  226.43, the 
creditor should retain evidence sufficient to demonstrate compliance 
with the documentation requirements of Sec.  226.25(a). Proposed 
comment 25(a)-6 also clarifies that creditors need not retain actual 
paper copies of the documentation used to underwrite a transaction, but 
they should be able to reproduce those records accurately, for example, 
by retaining a reproduction of a consumer's Internal Revenue Service 
Form W-2 rather than merely the income information on the form. The 
Board also proposes to revise comment 25(a)-2 to remove obsolete 
references to particular documentation methods and to reflect that in 
some cases creditors must be able to reproduce (not merely reconstruct) 
records.
    Proposed comment 25(a)-7 provides guidance regarding retention of 
records evidencing compliance with the requirement to offer a consumer 
an alte