Ability-to-Repay and Qualified Mortgage Standards Under the Truth in Lending Act (Regulation Z), 6407-6620 [2013-00736]

Download as PDF Vol. 78 Wednesday, No. 20 January 30, 2013 Part II Bureau of Consumer Financial Protection sroberts on DSK5SPTVN1PROD with 12 CFR Part 1026 Ability-to-Repay and Qualified Mortgage Standards under the Truth in Lending Act (Regulation Z); Final Rule VerDate Mar<15>2010 21:02 Jan 29, 2013 Jkt 229001 PO 00000 Frm 00001 Fmt 4717 Sfmt 4717 E:\FR\FM\30JAR2.SGM 30JAR2 6408 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations BUREAU OF CONSUMER FINANCIAL PROTECTION 12 CFR Part 1026 [CFPB–2011–0008; CFPB–2012–0022] RIN 3170–AA17 Ability-to-Repay and Qualified Mortgage Standards Under the Truth in Lending Act (Regulation Z) Bureau of Consumer Financial Protection. ACTION: Final rule; official interpretations. AGENCY: The Bureau of Consumer Financial Protection (Bureau) is amending Regulation Z, which implements the Truth in Lending Act (TILA). 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 final rule implements sections 1411 and 1412 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which generally require creditors to make a reasonable, good faith determination of a consumer’s ability to repay any consumer credit transaction secured by a dwelling (excluding an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan) and establishes certain protections from liability under this requirement for ‘‘qualified mortgages.’’ The final rule also implements section 1414 of the Dodd-Frank Act, which limits prepayment penalties. Finally, the final rule requires creditors to retain evidence of compliance with the rule for three years after a covered loan is consummated. DATES: The rule is effective January 10, 2014. FOR FURTHER INFORMATION CONTACT: Joseph Devlin, Gregory Evans, David Friend, Jennifer Kozma, Eamonn K. Moran, or Priscilla Walton-Fein, Counsels; Thomas J. Kearney or Mark Morelli, Senior Counsels; or Stephen Shin, Managing Counsel, Office of Regulations, at (202) 435–7700. SUPPLEMENTARY INFORMATION: sroberts on DSK5SPTVN1PROD with SUMMARY: I. Summary of the Final Rule The Consumer Financial Protection Bureau (Bureau) is issuing a final rule to implement laws requiring mortgage lenders to consider consumers’ ability to repay home loans before extending them credit. The rule will take effect on January 10, 2014. The Bureau is also releasing a proposal to seek comment on whether to adjust the final rule for certain VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 community-based lenders, housing stabilization programs, certain refinancing programs of the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac) (collectively, the GSEs) and Federal agencies, and small portfolio creditors. The Bureau expects to finalize the concurrent proposal this spring so that affected creditors can prepare for the January 2014 effective date. Background During the years preceding the mortgage crisis, too many mortgages were made to consumers without regard to the consumer’s ability to repay the loans. Loose underwriting practices by some creditors—including failure to verify the consumer’s income or debts and qualifying consumers for mortgages based on ‘‘teaser’’ interest rates that would cause monthly payments to jump to unaffordable levels after the first few years—contributed to a mortgage crisis that led to the nation’s most serious recession since the Great Depression. In response to this crisis, in 2008 the Federal Reserve Board (Board) adopted a rule under the Truth in Lending Act which prohibits creditors from making ‘‘higher-price mortgage loans’’ without assessing consumers’ ability to repay the loans. Under the Board’s rule, a creditor is presumed to have complied with the ability-to-repay requirements if the creditor follows certain specified underwriting practices. This rule has been in effect since October 2009. In the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress required that for residential mortgages, creditors must make 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. Congress also established a presumption of compliance for a certain category of mortgages, called ‘‘qualified mortgages.’’ These provisions are similar, but not identical to, the Board’s 2008 rule and cover the entire mortgage market rather than simply higher-priced mortgages. The Board proposed a rule to implement the new statutory requirements before authority passed to the Bureau to finalize the rule. Summary of Final Rule The final rule contains the following key elements: Ability-to-Repay Determinations. The final rule describes certain minimum requirements for creditors making ability-to-repay determinations, but does not dictate that they follow PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 particular underwriting models. At a minimum, creditors generally must consider eight underwriting factors: (1) Current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment on the covered transaction; (4) the monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations; (6) current debt obligations, alimony, and child support; (7) the monthly debt-to-income ratio or residual income; and (8) credit history. Creditors must generally use reasonably reliable third-party records to verify the information they use to evaluate the factors. The rule provides guidance as to the application of these factors under the statute. For example, monthly payments must generally be calculated by assuming that the loan is repaid in substantially equal monthly payments during its term. For adjustable-rate mortgages, the monthly payment must be calculated using the fully indexed rate or an introductory rate, whichever is higher. Special payment calculation rules apply for loans with balloon payments, interest-only payments, or negative amortization. The final rule also provides special rules to encourage creditors to refinance ‘‘non-standard mortgages’’—which include various types of mortgages which can lead to payment shock that can result in default—into ‘‘standard mortgages’’ with fixed rates for at least five years that reduce consumers’ monthly payments. Presumption for Qualified Mortgages. The Dodd-Frank Act provides that ‘‘qualified mortgages’’ are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. However, the Act did not specify whether the presumption of compliance is conclusive (i.e., creates a safe harbor) or is rebuttable. The final rule provides a safe harbor for loans that satisfy the definition of a qualified mortgage and are not ‘‘higher-priced,’’ as generally defined by the Board’s 2008 rule. The final rule provides a rebuttable presumption for higher-priced mortgage loans, as described further below. The line the Bureau is drawing is one that has long been recognized as a rule of thumb to separate prime loans from subprime loans. Indeed, under the existing regulations that were adopted by the Board in 2008, only higher-priced mortgage loans are subject to an abilityto-repay requirement and a rebuttable presumption of compliance if creditors follow certain requirements. The new rule strengthens the requirements needed to qualify for a rebuttable presumption for subprime loans and E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations defines with more particularity the grounds for rebutting the presumption. Specifically, the final rule provides that consumers may show a violation with regard to a subprime qualified mortgage by showing that, at the time the loan was originated, the consumer’s income and debt obligations left insufficient residual income or assets to meet living expenses. The analysis would consider the consumer’s monthly payments on the loan, loan-related obligations, and any simultaneous loans of which the creditor was aware, as well as any recurring, material living expenses of which the creditor was aware. Guidance accompanying the rule notes that the longer the period of time that the consumer has demonstrated actual ability to repay the loan by making timely payments, without modification or accommodation, after consummation or, for an adjustable-rate mortgage, after recast, the less likely the consumer will be able to rebut the presumption based on insufficient residual income. With respect to prime loans—which are not currently covered by the Board’s ability-to-repay rule—the final rule applies the new ability-to-repay requirements but creates a strong presumption for those prime loans that constitute qualified mortgages. Thus, if a prime loan satisfies the qualified mortgage criteria described below, it will be conclusively presumed that the creditor made a good faith and reasonable determination of the consumer’s ability to repay. General Requirements for Qualified Mortgages. The Dodd-Frank Act sets certain product-feature prerequisites and affordability underwriting requirements for qualified mortgages and vests discretion in the Bureau to decide whether additional underwriting or other requirements should apply. The final rule implements the statutory criteria, which generally prohibit loans with negative amortization, interestonly payments, balloon payments, or terms exceeding 30 years from being qualified mortgages. So-called ‘‘no-doc’’ loans where the creditor does not verify income or assets also cannot be qualified mortgages. Finally, a loan generally cannot be a qualified mortgage if the points and fees paid by the consumer exceed three percent of the total loan amount, although certain ‘‘bona fide discount points’’ are excluded for prime loans. The rule provides guidance on the calculation of points and fees and thresholds for smaller loans. The final rule also establishes general underwriting criteria for qualified mortgages. Most importantly, the general rule requires that monthly VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 payments be calculated based on the highest payment that will apply in the first five years of the loan and that the consumer have a total (or ‘‘back-end’’) debt-to-income ratio that is less than or equal to 43 percent. The appendix to the rule details the calculation of debt-toincome for these purposes, drawing upon Federal Housing Administration guidelines for such calculations. The Bureau believes that these criteria will protect consumers by ensuring that creditors use a set of underwriting requirements that generally safeguard affordability. At the same time, these criteria provide bright lines for creditors who want to make qualified mortgages. The Bureau also believes that there are many instances in which individual consumers can afford a debt-to-income ratio above 43 percent based on their particular circumstances, but that such loans are better evaluated on an individual basis under the ability-torepay criteria rather than with a blanket presumption. In light of the fragile state of the mortgage market as a result of the recent mortgage crisis, however, the Bureau is concerned that creditors may initially be reluctant to make loans that are not qualified mortgages, even though they are responsibly underwritten. The final rule therefore provides for a second, temporary category of qualified mortgages that have more flexible underwriting requirements so long as they satisfy the general product feature prerequisites for a qualified mortgage and also satisfy the underwriting requirements of, and are therefore eligible to be purchased, guaranteed or insured by either (1) the GSEs while they operate under Federal conservatorship or receivership; or (2) the U.S. Department of Housing and Urban Development, Department of Veterans Affairs, or Department of Agriculture or Rural Housing Service. This temporary provision will phase out over time as the various Federal agencies issue their own qualified mortgage rules and if GSE conservatorship ends, and in any event after seven years. Rural Balloon-Payment Qualified Mortgages. The final rule also implements a special provision in the Dodd-Frank Act that would treat certain balloon-payment mortgages as qualified mortgages if they are originated and held in portfolio by small creditors operating predominantly in rural or underserved areas. This provision is designed to assure credit availability in rural areas, where some creditors may only offer balloon-payment mortgages. Loans are only eligible if they have a term of at least five years, a fixedinterest rate, and meet certain basic PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 6409 underwriting standards; debt-to-income ratios must be considered but are not subject to the 43 percent general requirement. Creditors are only eligible to make rural balloon-payment qualified mortgages if they originate at least 50 percent of their first-lien mortgages in counties that are rural or underserved, have less than $2 billion in assets, and (along with their affiliates) originate no more than 500 first-lien mortgages per year. The Bureau will designate a list of ‘‘rural’’ and ‘‘underserved’’ counties each year, and has defined coverage more broadly than originally had been proposed. Creditors must generally hold the loans on their portfolios for three years in order to maintain their ‘‘qualified mortgage’’ status. Other Final Rule Provisions. The final rule also implements Dodd-Frank Act provisions that generally prohibit prepayment penalties except for certain fixed-rate, qualified mortgages where the penalties satisfy certain restrictions and the creditor has offered the consumer an alternative loan without such penalties. To match with certain statutory changes, the final rule also lengthens to three years the time creditors must retain records that evidence compliance with the ability-torepay and prepayment penalty provisions and prohibits evasion of the rule by structuring a closed-end extension of credit that does not meet the definition of open-end credit as an open-end plan. Summary of Concurrent Proposal The concurrent proposal seeks comment on whether the general abilityto-repay and qualified mortgage rule should be modified to address potential adverse consequences on certain narrowly-defined categories of lending programs. Because those measures were not proposed by the Board originally, the Bureau believes additional public input would be helpful. Specifically, the proposal seeks comment on whether it would be appropriate to exempt designated non-profit lenders, homeownership stabilization programs, and certain Federal agency and GSE refinancing programs from the abilityto-repay requirements because they are subject to their own specialized underwriting criteria. The proposal also seeks comment on whether to create a new category of qualified mortgages, similar to the one for rural balloon-payment mortgages, for loans without balloon-payment features that are originated and held on portfolio by small creditors. The new category would not be limited to lenders that operate predominantly in rural or E:\FR\FM\30JAR2.SGM 30JAR2 6410 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations underserved areas, but would use the same general size thresholds and other criteria as the rural balloon-payment rules. The proposal also seeks comment on whether to increase the threshold separating safe harbor and rebuttable presumption qualified mortgages for both rural balloon-payment qualified mortgages and the new small portfolio qualified mortgages, in light of the fact that small creditors often have higher costs of funds than larger creditors. Specifically, the Bureau is proposing a threshold of 3.5 percentage points above APOR for first-lien loans. II. Background For over 20 years, consumer advocates, legislators, and regulators have raised concerns 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 foreclosure rates increased dramatically, caused in part by the loosening of underwriting standards. See 73 FR 44524 (July 30, 2008). The following discussion provides background information, including a brief summary of the legislative and regulatory responses to the foregoing concerns, which culminated in the enactment of the Dodd-Frank Act on July 21, 2010, the Board’s May 11, 2011, proposed rule to implement certain amendments to TILA made by the Dodd-Frank Act, and now the Bureau’s issuance of this final rule to implement sections 1411, 1412, and 1414 of that act. A. The Mortgage Market sroberts on DSK5SPTVN1PROD with Overview of the Market and the Mortgage Crisis The mortgage market is the single largest market for consumer financial products and services in the United States, with approximately $9.9 trillion in mortgage loans outstanding.1 During the last decade, the market went through an unprecedented cycle of expansion and contraction that was fueled in part by the securitization of mortgages and creation of increasingly sophisticated derivative products. So many other parts of the American financial system were drawn into mortgage-related activities that, when the housing market collapsed in 2008, it sparked the most severe recession in the 1 Fed. Reserve Sys., Flow of Funds Accounts of the United States, at 67 tbl.L.10 (2012), available at https://www.federalreserve.gov/releases/z1/Current/ z1.pdf (as of the end of the third quarter of 2012). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 United States since the Great Depression.2 The expansion in this market is commonly attributed to both particular economic conditions (including an era of low interest rates and rising housing prices) and to changes within the industry. Interest rates dropped significantly—by more than 20 percent—from 2000 through 2003.3 Housing prices increased dramatically— about 152 percent—between 1997 and 2006.4 Driven by the decrease in interest rates and the increase in housing prices, the volume of refinancings increased rapidly, from about 2.5 million loans in 2000 to more than 15 million in 2003.5 In the mid-2000s, the market experienced a steady deterioration of credit standards in mortgage lending, with evidence that loans were made solely against collateral, or even against expected increases in the value of collateral, and without consideration of ability to repay. This deterioration of credit standards was particularly evidenced by the growth of ‘‘subprime’’ and ‘‘Alt-A’’ products, which consumers were often unable to repay.6 Subprime products were sold primarily to consumers with poor or no credit history, although there is evidence that 2 See Thomas F. Siems, Branding the Great Recession, Fin. Insights (Fed. Reserve Bank of Dall.) May 13, 2012, at 3, available at https:// www.dallasfed.org/assets/documents/banking/firm/ fi/fi1201.pdf (stating that the [great recession] ‘‘was the longest and deepest economic contraction, as measured by the drop in real GDP, since the Great Depression.’’). 3 See U.S. Dep’t of Hous. & Urban Dev., An Analysis of Mortgage Refinancing, 2001–2003, at 2 (2004) (‘‘An Analysis of Mortgage Refinancing, 2001–2003’’), available at www.huduser.org/ Publications/pdf/MortgageRefinance03.pdf; Souphala Chomsisengphet & Anthony PenningtonCross, The Evolution of the Subprime Mortgage Market, 88 Fed. Res. Bank of St. Louis Rev. 31, 48 (2006), available at https://research.stlouisfed.org/ publications/review/article/5019. 4 U.S. Fin. Crisis Inquiry Comm’n, The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States 156 (Official Gov’t ed. 2011) (‘‘FCIC Report’’), available at https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPOFCIC.pdf. 5 An Analysis of Mortgage Refinancing, 2001– 2003, at 1. 6 FCIC Report at 88. These products included most notably 2/28 and 3/27 hybrid adjustable rate mortgages (ARMs) and option ARM products. Id. at 106. A hybrid ARM is an adjustable rate mortgage loan that has a low fixed introductory rate for a certain period of time. An option ARM is an adjustable rate mortgage loan that has a scheduled loan payment that may result in negative amortization for a certain period of time, but that expressly permits specified larger payments in the contract or servicing documents, such as an interest-only payment or a fully amortizing payment. For these loans, the scheduled negatively amortizing payment was typically described in marketing and servicing materials as the ‘‘optional payment.’’ These products were often marketed to subprime customers. PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 some consumers who would have qualified for ‘‘prime’’ loans were steered into subprime loans as well.7 The AltA category of loans permitted consumers to take out mortgage loans while providing little or no documentation of income or other evidence of repayment ability. Because these loans involved additional risk, they were typically more expensive to consumers than ‘‘prime’’ mortgages, although many of them had very low introductory interest rates. In 2003, subprime and Alt-A origination volume was about $400 billion; in 2006, it had reached $830 billion.8 So long as housing prices were continuing to increase, it was relatively easy for consumers to refinance their existing loans into more affordable products to avoid interest rate resets and other adjustments. When housing prices began to decline in 2005, however, refinancing became more difficult and delinquency rates on subprime and AltA products increased dramatically.9 More and more consumers, especially those with subprime and Alt-A loans, were unable or unwilling to make their mortgage payments. An early sign of the mortgage crisis was an upswing in early payment defaults—generally defined as borrowers being 60 or more days delinquent within the first year. Prior to 2006, 1.1 percent of mortgages would end up 60 or more days delinquent within the first two years.10 Taking a more expansive definition of early payment default to include 60 days delinquent within the first two years, this figure was double the historic average during 2006, 2007 and 2008.11 In 2006, 2007, and 2008, 2.3 percent, 2.1 percent, and 2.3 percent of mortgages ended up 60 or more days delinquent within the first two years, respectively. By the summer of 2006, 1.5 percent of loans less than a year old were in 7 For example, the Federal Reserve Board on July 18, 2011, issued a consent cease and desist order and assessed an $85 million civil money penalty against Wells Fargo & Company of San Francisco, a registered bank holding company, and Wells Fargo Financial, Inc., of Des Moines. The order addresses allegations that Wells Fargo Financial employees steered potential prime-eligible consumers into more costly subprime loans and separately falsified income information in mortgage applications. In addition to the civil money penalty, the order requires that Wells Fargo compensate affected consumers. See Press Release, Fed. Reserve Bd. (July 20, 2011), available at https:// www.federalreserve.gov/newsevents/press/ enforcement/20110720a.htm. 8 Inside Mortg. Fin., Mortgage Originations by Product, in 1. The 2011 Mortgage Market Statistical Annual 20 (2011). 9 FCIC Report at 215–217. 10 CoreLogic’s TrueStandings Servicing (reflects first-lien mortgage loans) (data service accessible only through paid subscription). 11 Id. E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with default, and this figure peaked at 2.5 percent in late 2007, well above the 1.0 percent peak in the 2000 recession.12 First payment defaults—mortgages taken out by consumers who never made a single payment—exceeded 1.5 percent of loans in early 2007.13 In addition, as the economy worsened, the rates of serious delinquency (90 or more days past due or in foreclosure) for the subprime and Alt-A products began a steep increase from approximately 10 percent in 2006, to 20 percent in 2007, to more than 40 percent in 2010.14 The impact of this level of delinquencies was severe on creditors who held loans on their books and on private investors who purchased loans directly or through securitized vehicles. Prior to and during the bubble, the evolution of the securitization of mortgages attracted increasing involvement from financial institutions that were not directly involved in the extension of credit to consumers and from investors worldwide. Securitization of mortgages allows originating creditors to sell off their loans (and reinvest the funds earned in making new ones) to investors who want an income stream over time. Securitization had been pioneered by what are now called governmentsponsored enterprises (GSEs), including the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). But by the early 2000s, large numbers of private financial institutions were deeply involved in creating increasingly complex mortgage-related investment vehicles through securities and derivative products. The private securitization-backed subprime and AltA mortgage market ground to a halt in 2007 in the face of the rising delinquencies on subprime and Alt-A products.15 Six years later, the United States continues to grapple with the fallout. The fall in housing prices is estimated to have resulted in about $7 trillion in household wealth losses.16 In addition, distressed homeownership and 12 Id. at 215. (CoreLogic Chief Economist Mark Fleming told the FCIC that the early payment default rate ‘‘certainly correlates with the increase in the Alt-A and subprime shares and the turn of the housing market and the sensitivity of those loan products.’’). 13 Id. 14 Id. at 217. 15 Id. at 124. 16 The U.S. Housing Market: Current Conditions and Policy Considerations, at 3 (Fed. Reserve Bd., White Paper, 2012), available at https:// www.federalreserve.gov/publications/other-reports/ files/housing-white-paper-20120104.pdf. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 foreclosure rates remain at unprecedented levels.17 Response and Government Programs In light of these conditions, the Federal government began providing support to the mortgage markets in 2008 and continues to do so at extraordinary levels today. The Housing and Economic Recovery Act of 2008, which became effective on October 1, 2008, provided both new safeguards and increased regulation for Fannie Mae and Freddie Mac, as well as provisions to assist troubled borrowers and to the hardest hit communities. Fannie Mae and Freddie Mac, which supported the mainstream mortgage market, experienced heavy losses and were placed in conservatorship by the Federal government in 2008 to support the collapsing mortgage market.18 Because private investors have withdrawn from the mortgage securitization market and there are no other effective secondary market mechanisms in place, the GSEs’ continued operations help ensure that the secondary mortgage market continues to function and to assist consumers in obtaining new mortgages or refinancing existing mortgages. The Troubled Asset Relief Program (TARP), created to implement programs to stabilize the financial system during the financial crisis, was authorized through the Emergency Economic Stabilization Act of 2008 (EESA), as amended by the American Recovery and Reinvestment Act of 2009, and includes programs to help struggling homeowners avoid 17 Lender Processing Servs., PowerPoint Presentation, LPS Mortgage Monitor: May 2012 Mortgage Performance Observations, Data as of April 2012 Month End, 3, 11 (May 2012), available at https://www.lpsvcs.com/ LPSCorporateInformation/CommunicationCenter/ DataReports/Pages/Mortgage-Monitor.aspx. 18 The Housing and Economic Recovery Act of 2008 (HERA), which created the Federal Housing Finance Agency (FHFA), granted the Director of FHFA discretionary authority to appoint FHFA conservator or receiver of the Enterprises ‘‘for the purpose of reorganizing, rehabilitating, or winding up the affairs of a regulated entity.’’ Housing and Economic Recovery Act of 2008, section 1367 (a)(2), amending the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, 12 U.S.C. 4617(a)(2). On September 6, 2008, FHFA exercised that authority, placing the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) into conservatorships. The two GSEs have since received more than $180 billion in support from the Treasury Department. Through the second quarter of 2012, Fannie Mae has drawn $116.1 billion and Freddie Mac has drawn $71.3 billion, for an aggregate draw of $187.5 billion from the Treasury Department. Fed. Hous. Fin. Agency, Conservator’s Report on the Enterprises’ Financial Performance, at 17 (Second Quarter 2012), available at https://www.fhfa.gov/webfiles/24549/ ConservatorsReport2Q2012.pdf. PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 6411 foreclosure.19 Since 2008, several other Federal government efforts have endeavored to keep the country’s housing finance system functioning, including the Treasury Department’s and the Federal Reserve System’s mortgage-backed securities (MBS) purchase programs to help keep interest rates low and the Federal Housing Administration’s (FHA’s) increased market presence. As a result, mortgage credit has remained available, albeit with more restrictive underwriting terms that limit or preclude some consumers’ access to credit. These same government agencies together with the GSEs and other market participants have also undertaken a series of efforts to help families avoid foreclosure through loan-modification programs, loan-refinance programs and foreclosure alternatives.20 Size and Volume of the Current Mortgage Origination Market Even with the economic downturn and tightening of credit standards, approximately $1.28 trillion in mortgage loans were originated in 2011.21 In exchange for an extension of mortgage credit, consumers promise to make regular mortgage payments and provide their home or real property as collateral. The overwhelming majority of homebuyers continue to use mortgage loans to finance at least some of the 19 The Making Home Affordable Program (MHA) is the umbrella program for Treasury’s homeowner assistance and foreclosure mitigation efforts. The main MHA components are the Home Affordable Modification Program (HAMP), a Treasury program that uses TARP funds to provide incentives for mortgage servicers to modify eligible first-lien mortgages, and two initiatives at the GSEs that use non-TARP funds. Incentive payments for modifications to loans owned or guaranteed by the GSEs are paid by the GSEs, not TARP. Treasury over time expanded MHA to include sub-programs designed to overcome obstacles to sustainable HAMP modifications. Treasury also allocated TARP funds to support two additional housing support efforts: An FHA refinancing program and TARP funding for 19 state housing finance agencies, called the Housing Finance Agency Hardest Hit Fund. In the first half of 2012, Treasury extended the application period for HAMP by a year to December 31, 2013, and opened HAMP to nonowner-occupied rental properties and to consumers with a wider range of debt-to-income ratios under ‘‘HAMP Tier 2.’’ 20 The Home Affordable Refinance Program (HARP) is designed to help eligible homeowners refinance their mortgage. HARP is designed for those homeowners who are current on their mortgage payments but have been unable to get traditional refinancing because the value of their homes has declined. For a mortgage to be considered for a HARP refinance, it must be owned or guaranteed by the GSEs. HARP ends on December 31, 2013. 21 Moody’s Analytics, Credit Forecast 2012 (2012) (‘‘Credit Forecast 2012’’), available at https:// www.economy.com/default.asp (reflects first-lien mortgage loans) (data service accessibly only through paid subscription). E:\FR\FM\30JAR2.SGM 30JAR2 6412 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with purchase price of their property. In 2011, 93 percent of all home purchases were financed with a mortgage credit transaction.22 Consumers may obtain mortgage credit to purchase a home, to refinance an existing mortgage, to access home equity, or to finance home improvement. Purchase loans and refinancings together produced 6.3 million new first-lien mortgage loan originations in 2011.23 The proportion of loans that are for purchases as opposed to refinances varies with the interest rate environment and other market factors. In 2011, 65 percent of the market was refinance transactions and 35 percent was purchase loans, by volume.24 Historically the distribution has been more even. In 2000, refinances accounted for 44 percent of the market while purchase loans comprised 56 percent; in 2005, the two products were split evenly.25 With a home equity transaction, a homeowner uses his or her equity as collateral to secure consumer credit. The credit proceeds can be used, for example, to pay for home improvements. Home equity credit transactions and home equity lines of credit resulted in an additional 1.3 million mortgage loan originations in 2011.26 The market for higher-priced mortgage loans remains significant. Data reported under the Home Mortgage Disclosure Act (HMDA) show that in 2011 approximately 332,000 transactions, including subordinate liens, were reportable as higher-priced mortgage loans. Of these transactions, refinancings accounted for approximately 44 percent of the higherpriced mortgage loan market, and 90 percent of the overall higher-priced mortgage loan market involved first-lien transactions. The median first-lien higher-priced mortgage loan was for $81,000, while the interquartile range (quarter of the transactions are below, quarter of the transactions are above) was $47,000 to $142,000. GSE-eligible loans, together with the other federally insured or guaranteed loans, cover the majority of the current mortgage market. Since entering conservatorship in September 2008, the 22 Inside Mortg. Fin., New Homes Sold by Financing, in 1 The 2012 Mortgage Market Statistical Annual 12 (2012). 23 Credit Forecast 2012. 24 Inside Mortg. Fin., Mortgage Originations by Product, in The 2012 Mortgage Market Statistical Annual 17 (2012). 25 Id. These percentages are based on the dollar amount of the loans. 26 Credit Forecast (2012) (reflects open-end and closed-end home equity loans). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 GSEs have bought or guaranteed roughly three of every four mortgages originated in the country. Mortgages guaranteed by FHA make up most of the rest.27 Outside of the securitization available through the Government National Mortgage Association (Ginnie Mae) for loans primarily backed by FHA, there are very few alternatives in place today to assume the secondary market functions served by the GSEs.28 Continued Fragility of the Mortgage Market The current mortgage market is especially fragile as a result of the recent mortgage crisis. Tight credit remains an important factor in the contraction in mortgage lending seen over the past few years. Mortgage loan terms and credit standards have tightened most for consumers with lower credit scores and with less money available for a down payment. According to CoreLogic’s TrueStandings Servicing, a proprietary data service that covers about two-thirds of the mortgage market, average underwriting standards have tightened considerably since 2007. Through the first nine months of 2012, for consumers that have received closed-end first-lien mortgages, the weighted average FICO 29 score was 750, the loan-to-value (LTV) ratio was 78 percent, and the debt-toincome (DTI) ratio was 34.5 percent.30 In comparison, in the peak of the housing bubble in 2007, the weighted average FICO score was 706, the LTV was 80 percent, and the DTI was 39.8 percent.31 In this tight credit environment, the data suggest that creditors are not willing to take significant risks. In terms of the distribution of origination characteristics, for 90 percent of all the Fannie Mae and Freddie Mac mortgage 27 Fed. Hous. Fin. Agency, A Strategic Plan for Enterprise Conservatorships: The Next Chapter in a Story that Needs an Ending, at 14 (2012) (‘‘FHFA Report’’), available at https://www.fhfa.gov/webfiles/ 23344/StrategicPlanConservatorshipsFINAL.pdf. 28 FHFA Report at 8–9. Secondary market issuance remains heavily reliant upon the explicitly government guaranteed securities of FNMA, FHLMC, and GNMA. Through the first three quarters of 2012, approximately $1.2 trillion of the $1.33 trillion in mortgage originations have been securitized, less than $10 billion of the $1.2 trillion were non-agency mortgage backed securities. Inside Mortgage Finance (Nov. 2, 2012), at 4. 29 FICO is a type of credit score that makes up a substantial portion of the credit report that lenders use to assess an applicant’s credit risk and whether to extend a loan 30 CoreLogic, TrueStandings Servicing Database, available at https://www.truestandings.com (data reflects first-lien mortgage loans) (data service accessible only through paid subscription). According to CoreLogic’s TrueStandings Servicing, FICO reports that in 2011, approximately 38 percent of consumers receiving first-lien mortgage credit had a FICO score of 750 or greater. 31 Id. PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 loans originated in 2011, consumers had a FICO score over 700 and a DTI less than 44 percent.32 According to the Federal Reserve’s Senior Loan Officer Opinion Survey on Bank Lending Practices, in April 2012 nearly 60 percent of creditors reported that they would be much less likely, relative to 2006, to originate a conforming homepurchase mortgage 33 to a consumer with a 10 percent down payment and a credit score of 620—a traditional marker for those consumers with weaker credit histories.34 The Federal Reserve Board calculates that the share of mortgage borrowers with credit scores below 620 has fallen from about 17 percent of consumers at the end of 2006 to about 5 percent more recently.35 Creditors also appear to have pulled back on offering these consumers loans insured by the FHA, which provides mortgage insurance on loans made by FHAapproved creditors throughout the United States and its territories and is especially structured to help promote affordability.36 The Bureau is acutely aware of the high levels of anxiety in the mortgage market today. These concerns include the continued slow pace of recovery, the confluence of multiple major regulatory and capital initiatives, and the compliance burdens of the various Dodd-Frank Act rulemakings (including uncertainty on what constitutes a qualified residential mortgage (QRM), which, as discussed below, relates to the Dodd-Frank Act’s credit risk retention requirements and mortgage securitizations). These concerns are causing discussion about whether creditors will consider exiting the business. The Bureau acknowledges that it will likely take some time for the mortgage market to stabilize and that creditors will need to adjust their operations to account for several major regulatory and capital regimes. B. TILA and Regulation Z In 1968, Congress enacted the Truth in Lending Act (TILA), 15 U.S.C. 1601 32 Id. 33 A conforming mortgage is one that is eligible for purchase or credit guarantee by Fannie Mae or Freddie Mac. 34 Fed. Reserve Bd., Senior Loan Officer Opinion Survey on Bank Lending Practices, available at https://www.federalreserve.gov/boarddocs/ SnLoanSurvey/default.htm. 35 Federal Reserve Board staff calculations based on the Federal Reserve Bank of New York Consumer Credit Panel. The 10th percentile of credit scores on mortgage originations rose from 585 in 2006 to 635 at the end of 2011. 36 FHA insures mortgages on single family and multifamily homes including manufactured homes and hospitals. It is the largest insurer of mortgages in the world, insuring over 34 million properties since its inception in 1934. E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with et seq., based on findings that the informed use of credit resulting from consumers’ awareness of the cost of credit would enhance economic stability and competition among consumer credit providers. One of the purposes of TILA is to promote the informed use of consumer credit by requiring disclosures about its costs and terms. See 15 U.S.C. 1601. TILA requires additional disclosures for loans secured by consumers’ homes and permits consumers to rescind certain transactions secured by their principal dwellings when the required disclosures are not provided. 15 U.S.C. 1635, 1637a. Section 105(a) of TILA directs the Bureau (formerly directed the Board of Governors of the Federal Reserve System) to prescribe regulations to carry out TILA’s purposes and specifically authorizes the Bureau, 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 Bureau’s judgment are necessary or proper to effectuate the purposes of TILA, facilitate compliance thereof, or prevent circumvention or evasion therewith. See 15 U.S.C. 1604(a). General rulemaking authority for TILA transferred to the Bureau in July 2011, other than for certain motor vehicle dealers in accordance with the Dodd-Frank Act section 1029, 12 U.S.C. 5519. Pursuant to the Dodd-Frank Act and TILA, as amended, the Bureau published for public comment an interim final rule establishing a new Regulation Z, 12 CFR part 1026, implementing TILA (except with respect to persons excluded from the Bureau’s rulemaking authority by section 1029 of the Dodd-Frank Act). 76 FR 79768 (Dec. 22, 2011). This rule did not impose any new substantive obligations but did make technical and conforming changes to reflect the transfer of authority and certain other changes made by the Dodd-Frank Act. The Bureau’s Regulation Z took effect on December 30, 2011. The Official Staff Interpretations interpret the requirements of the regulation and provides guidance to creditors in applying the rules to specific transactions. See 12 CFR part 1026, Supp. I. C. The Home Ownership and Equity Protection Act (HOEPA) and HOEPA Rules In response to evidence of abusive practices in the home-equity lending market, in 1994 Congress amended TILA by enacting the Home Ownership VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 and Equity Protection Act (HOEPA) as part of the Riegle Community Development and Regulatory Improvement Act of 1994. Public Law 103–325, 108 Stat. 2160. HOEPA was enacted as an amendment to TILA to address abusive practices in refinancing and home-equity mortgage loans with high interest rates or high fees.37 Loans that meet HOEPA’s high-cost triggers are subject to special disclosure requirements and restrictions on loan terms, and consumers with high-cost mortgages have enhanced remedies for violations of the law.38 The statute applied generally to closed-end mortgage credit, but excluded purchase money mortgage loans and reverse mortgages. Coverage was triggered where a loan’s annual percentage rate (APR) exceeded comparable Treasury securities by specified thresholds for particular loan types, or where points and fees exceeded eight percent of the total loan amount or a dollar threshold.39 For high-cost loans meeting either of those thresholds, HOEPA required creditors to provide special pre-closing disclosures, restricted prepayment penalties and certain other loan terms, and regulated various creditor practices, such as extending credit without regard to a consumer’s ability to repay the loan. HOEPA also provided a mechanism for consumers to rescind covered loans that included certain prohibited terms and to obtain higher damages than are allowed for other types of TILA violations. Finally, HOEPA amended TILA section 131, 15 U.S.C. 1641, to provide that purchasers of high-cost loans generally are subject to all claims and defenses against the original creditor with respect to the mortgage, including a creditor’s failure to make an ability-to-repay determination before making the loan. HOEPA created special substantive protections for high-cost mortgages, such as prohibiting a creditor from engaging in a pattern or practice of extending a high-cost mortgage to a 37 HOEPA amended TILA by adding new sections 103(aa) and 129, 15 U.S.C. 1602(aa) and 1639. 38 HOEPA defines a class of ‘‘high-cost mortgages,’’ which are generally closed-end homeequity loans (excluding home-purchase loans) with annual percentage rates (APRs) or total points and fees exceeding prescribed thresholds. 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 Dodd-Frank Act section 1431; TILA section 103(aa). For simplicity and consistency, this final rule uses the term ‘‘high-cost mortgages’’ to refer to mortgages covered by the HOEPA amendments. 39 The Dodd-Frank Act adjusted the baseline for the APR comparison, lowered the points and fees threshold, and added a prepayment trigger. PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 6413 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, HOEPA expanded the Board’s rulemaking authority, among other things, to prohibit acts or practices the Board found to be unfair and deceptive in connection with mortgage loans.40 In 1995, the Board implemented the HOEPA amendments at §§ 226.31, 226.32, and 226.33 41 of Regulation Z. See 60 FR 15463 (Mar. 24, 1995). In particular, § 226.32(e)(1) 42 implemented TILA section 129(h)’s ability-to-repay requirements to prohibit a creditor from engaging in a pattern or practice of extending a high-cost mortgage based on the consumer’s collateral without regard to the consumer’s repayment ability, including the consumer’s current income, current obligations, and employment status. In 2001, the Board published additional significant changes to expand both HOEPA’s protections to more loans by revising the annual percentage rate (APR) threshold for first-lien mortgage loans, expanded the definition of points and fees to include the cost of optional credit insurance and debt cancellation premiums, and enhanced the restrictions associated with high-cost loans. See 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 consumer’s repayment ability. 40 As discussed above, with the enactment of the Dodd-Frank Act, general rulemaking authority for TILA, including HOEPA, transferred from the Board to the Bureau on July 21, 2011. 41 Subsequently renumbered as sections 1026.31, 1026.32, and 1026.33 of Regulation Z. As discussed above, pursuant to the Dodd-Frank Act and TILA, as amended, the Bureau published for public comment an interim final rule establishing a new Regulation Z, 12 CFR part 1026, implementing TILA (except with respect to persons excluded from the Bureau’s rulemaking authority by section 1029 of the Dodd-Frank Act). 76 FR 79768 (Dec. 22, 2011). The Bureau’s Regulation Z took effect on December 30, 2011. 42 Subsequently renumbered as section 1026.32(e)(1) of Regulation Z. 43 Along with the Board, the other Federal banking agencies included the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), Office of Thrift Supervision (OTS), and the National Credit Union Administration (NCUA). E:\FR\FM\30JAR2.SGM 30JAR2 6414 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with D. 2006 and 2007 Interagency Supervisory Guidance In December 2005, the Federal banking agencies 43 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 consumer to defer repayment of principal and sometimes interest. The guidance advised institutions of the need to reduce ‘‘risk layering’’ with respect to these products, such as by failing to document income or lending nearly the full appraised value of the home. The final guidance issued in September 2006 specifically advised creditors that layering risks in nontraditional mortgage loans to consumers receiving subprime credit may significantly increase risks to consumers as well as institutions. See Interagency Guidance on Nontraditional Mortgage Product Risks, 71 FR 58609 (Oct. 4, 2006) (2006 Nontraditional Mortgage Guidance). The 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’’ interest 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 consumers in the subprime market obtain loans they can afford to repay. Among other steps, the guidance advised creditors: (1) To use the fully indexed rate and fully-amortizing payment when qualifying consumers for loans with adjustable rates and potentially non-amortizing payments; (2) to limit stated income and reduced documentation loans to cases where mitigating factors clearly minimize the need for full documentation of income; and (3) to provide that prepayment penalty clauses expire a reasonable period before reset, typically at least 60 days. See Statement on Subprime Mortgage Lending, 72 FR 37569 (July 10, 2007) (2007 Subprime Mortgage Statement).44 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. 44 The 2006 Nontraditional Mortgage Guidance and the 2007 Subprime Mortgage Statement will hereinafter be referred to collectively as the ‘‘Interagency Supervisory Guidance.’’ VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 E. 2008 HOEPA Final Rule After the Board finalized the 2001 HOEPA rules, new consumer protection issues arose in the mortgage market. 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 (July 30, 2008). The Board was also urged to adopt additional 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. As discussed above, in 1995 the Board implemented TILA section 129(h)’s ability-to-repay requirements for high-cost mortgage loans. In 2008, the Board exercised its authority under HOEPA to extend certain consumer protections concerning a consumer’s ability to repay and prepayment penalties to a new category of ‘‘higher-priced mortgage loans’’ (HPMLs) 45 with APRs that are lower than those prescribed for highcost loans but that nevertheless exceed the average prime offer rate by prescribed amounts. This new category of loans was designed to include subprime credit. Specifically, the Board exercised its authority to revise HOEPA’s restrictions on high-cost loans based on a conclusion that the revisions were necessary to prevent unfair and deceptive acts or practices in connection with mortgage loans. 73 FR 44522 (July 30, 2008) (2008 HOEPA Final Rule). The Board determined that imposing the burden to prove ‘‘pattern or practice’’ on an individual consumer would leave many consumers with a lesser remedy, such as those provided under some State laws, or without any remedy for loans made without regard to repayment ability. In particular, the 45 Under the Board’s 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. The definition of a ‘‘higher-priced mortgage loan’’ includes practically all ‘‘high-cost mortgages’’ because the latter transactions are determined by higher loan pricing threshold tests. See 12 CFR 226.35(a)(1), since codified in parallel by the Bureau at 12 CFR 1026.35(a)(1). PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 Board concluded that a prohibition on making individual loans without regard for repayment ability was necessary to ensure a remedy for consumers who are given unaffordable loans and to deter irresponsible lending, which injures individual consumers. The 2008 HOEPA Final Rule provides a presumption of compliance with the higher-priced mortgage ability-to-repay requirements if the creditor follows certain procedures regarding underwriting the loan payment, assessing the debt-to-income ratio or residual income, and limiting the features of the loan, in addition to following certain procedures mandated for all creditors. See § 1026.34(a)(4)(iii) and (iv). However, the 2008 HOEPA Final Rule makes clear that even if the creditor follows the required and optional criteria, the creditor has merely obtained a presumption of compliance with the repayment ability requirement. The consumer can still rebut or overcome that presumption by showing that, despite following the required and optional procedures, the creditor nonetheless disregarded the consumer’s ability the loan. F. The Dodd-Frank Act In 2007, Congress held numerous hearings focused on rising subprime foreclosure rates and the extent to which lending practices contributed to them.46 Consumer advocates testified 46 E.g., Progress in Administration and Other Efforts to Coordinate and Enhance Mortgage Foreclosure Prevention: Hearing before the H. Comm. on Fin. Servs., 110th Cong. (2007); Legislative Proposals on Reforming Mortgage Practices: Hearing before the H. Comm. on Fin. Servs., 110th Cong. (2007); Legislative and Regulatory Options for Minimizing and Mitigating Mortgage Foreclosures: Hearing before the H. Comm. on Fin. Servs., 110th Cong. (2007); Ending Mortgage Abuse: Safeguarding Homebuyers: Hearing before the S. Subcomm. on Hous., Transp., and Cmty. Dev. of the S. Comm. on Banking, Hous., and Urban Affairs, 110th Cong. (2007); Improving Federal Consumer Protection in Financial Services: Hearing before the H. Comm. on Fin. Servs., 110th Cong. (2007); The Role of the Secondary Market in Subprime Mortgage Lending: Hearing before the Subcomm. on Fin. Insts. and Consumer Credit of the H. Comm. on Fin. Servs., 110th Cong. (2007); Possible Responses to Rising Mortgage Foreclosures: Hearing before the H. Comm. on Fin. Servs., 110th Cong. (2007); Subprime Mortgage Market Turmoil: Examining the Role of Securitization: Hearing before the Subcomm. on Secs., Ins., and Inv. of the S. Comm. on Banking, Hous., and Urban Affairs, 110th Cong. (2007); Subprime and Predatory Lending: New Regulatory Guidance, Current Market Conditions, and Effects on Regulated Financial Institutions: Hearing before the Subcomm. on Fin. Insts. and Consumer Credit of the H. Comm. on Fin. Servs., 110th Cong. (2007); Mortgage Market Turmoil: Causes and Consequences, Hearing before the S. Comm. on Banking, Hous., and Urban Affairs, 110th Cong. (2007); Preserving the American Dream: Predatory Lending Practices and Home Foreclosures, Hearing before the S. Comm. on Banking, Hous., and Urban Affairs, 110th Cong. (2007). E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with that certain lending terms or practices contributed to the foreclosures, including a failure to consider the consumer’s ability to repay, low- or nodocumentation loans, hybrid adjustablerate 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 consumers. In response to these hearings, the House of Representatives passed the Mortgage Reform and Anti-Predatory Lending Act, both in 2007 and again in 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. Instead, both houses shifted their focus to enacting comprehensive financial reform legislation. In December 2009, the House passed the Wall Street Reform and Consumer Protection Act of 2009, its version of comprehensive financial reform legislation, which included an abilityto-repay and qualified mortgage provision. H.R. 4173, 111th Cong. (2009). In May 2010, the Senate passed its own version of ability-to-repay requirements in its own version of comprehensive financial reform legislation, called the Restoring American Financial Stability Act of 2010. S. 3217, 111th Cong. (2010). After conference committee negotiations, the Dodd-Frank Act was passed by both houses of Congress and was signed into law on July 21, 2010. Public Law 111– 203, 124 Stat. 1376 (2010). In the Dodd-Frank Act, Congress established the Bureau and, under sections 1061 and 1100A, generally consolidated the rulemaking authority for Federal consumer financial laws, including TILA and RESPA, in the Bureau.47 Congress also provided the Bureau, among other things, with supervision authority for Federal consumer financial laws over certain entities, including insured depository institutions and credit unions with total assets over $10 billion and their affiliates, and mortgage-related nondepository financial services 47 Sections 1011 and 1021 of the Dodd-Frank Act, in title X, the ‘‘Consumer Financial Protection Act,’’ Public Law 111–203, secs. 1001–1100H, codified at 12 U.S.C. 5491, 5511. The Consumer Financial Protection Act is substantially codified at 12 U.S.C. 5481–5603. Section 1029 of the Dodd-Frank Act excludes from this transfer of authority, subject to certain exceptions, any rulemaking authority over a motor vehicle dealer that is predominantly engaged in the sale and servicing of motor vehicles, the leasing and servicing of motor vehicles, or both. 12 U.S.C. 5519. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 providers.48 In addition, Congress provided the Bureau with authority, subject to certain limitations, to enforce the Federal consumer financial laws, including the 18 enumerated consumer laws. Title X of the Dodd-Frank Act, and rules thereunder. The Bureau can bring civil actions in court and administrative enforcement proceedings to obtain remedies such as civil penalties and cease-and-desist orders. At the same time, Congress significantly amended the statutory requirements governing mortgage practices with the intent to restrict the practices that contributed to the crisis. Title XIV of the Dodd-Frank Act contains a modified version of the Mortgage Reform and Anti-Predatory Lending Act.49 The Dodd-Frank Act requires the Bureau to propose consolidation of the major federal mortgage disclosures, imposes new requirements and limitations to address a wide range of consumer mortgage issues, and imposes credit risk retention requirements in connection with mortgage securitization. Through the Dodd-Frank Act, Congress expanded HOEPA to apply to more types of mortgage transactions, including purchase money mortgage loans and home-equity lines of credit. Congress also amended HOEPA’s existing high-cost triggers, added a prepayment penalty trigger, and expanded the protections associated with high-cost mortgages.50 In addition, sections 1411, 1412, and 1414 of the Dodd-Frank Act created new TILA section 129C, which establishes, among other things, new ability-to-repay requirements and new limits on prepayment penalties. Section 1402 of 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 48 Sections 1024 through 1026 of the Dodd-Frank Act, codified at 12 U.S.C. 5514 through 5516. 49 Although S. Rept. No. 111–176 contains general legislative history concerning the DoddFrank Act and the Senate ability-to-repay provisions, it does not address the House Mortgage Reform and Anti-Predatory Lending Act. Separate legislative history for the predecessor House bills is available in H. Rept. No. 110–441 for H.R. 3915 (2007), and H. Rept. No. 111–194 for H.R. 1728 (2009). 50 Under the Dodd-Frank Act, HOEPA protections would be triggered where: (1) A loan’s annual percentage rate (APR) exceeds the average prime offer rate by 6.5 percentage points for most first-lien mortgages and 8.5 percentage points for subordinate lien mortgages; (2) a loan’s points and fees exceed 5 percent of the total transaction amount, or a higher threshold for loans below $20,000; or (3) the creditor may charge a prepayment penalty more than 36 months after loan consummation or account opening, or penalties that exceed more than 2 percent of the amount prepaid. PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 6415 residential mortgage credit and the practices related to such credit, while ensuring that responsible, affordable mortgage credit remains available to consumers.’’ TILA section 129B(a)(1), 15 U.S.C. 1639b(a)(1). Section 1402 of 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.’’ TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2). Specifically, TILA section 129C: • Expands coverage of the ability-torepay requirements to any consumer credit transaction secured by a dwelling, except an open-end credit plan, credit secured by an interest in a 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 does not exceed certain thresholds for points and fees on the loan and which meets such other criteria as the Bureau may prescribe. • Prohibits prepayment penalties unless the mortgage is a fixed-rate qualified mortgage that is not a higherpriced mortgage loan, and the amount and duration of the prepayment penalty are limited. The statutory ability-to-repay standards reflect Congress’s belief that certain lending practices (such as lowor no-documentation loans or underwriting loans without regard to principal repayment) led to consumers having mortgages they could not afford, resulting in high default and foreclosure rates. Accordingly, new TILA section 129C generally prohibits a creditor from making a residential 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. To provide more certainty to creditors while protecting consumers from unaffordable loans, the Dodd-Frank Act provides a presumption of compliance with the ability-to-repay requirements for certain ‘‘qualified mortgages.’’ TILA section 129C(b)(1) states that a creditor E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6416 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations or assignee may presume that a loan has met the repayment ability requirement if the loan is a qualified mortgage. Qualified mortgages are prohibited from containing certain features that Congress considered to increase risks to consumers and must comply with certain limits on points and fees. The Dodd-Frank Act creates special remedies for violations of TILA section 129C. As amended by section 1416 of the Dodd-Frank Act, TILA 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, unless the creditor demonstrates that the failure to comply is not material. TILA section 130(a). This recovery is in addition to: (1) Actual damages; (2) statutory damages in an individual action or class action, up to a prescribed threshold; and (3) court costs and attorney fees that would be available for violations of other TILA provisions. In addition, the statute of limitations 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 most other TILA violations, except for actions brought under section 129 or 129B, or actions brought by a State attorney general to enforce a violation of section 129, 129B, 129C, 129D, 129E, 129F, 129G, or 129H, which may be brought not later than 3 years after the date on which the violation occurs, and private education loans under 15 U.S.C. 1650(a), which may be brought not later than one year from the due date of first regular payment of principal). TILA section 130(e). Moreover, as amended by section 1413 of the Dodd-Frank Act, TILA provides that when a creditor, or an assignee, other holder or their agent initiates a foreclosure action, a consumer may assert a violation of TILA section 129C(a) ‘‘as a matter of defense by recoupment or setoff.’’ TILA section 130(k). There is no time limit on the use of this defense and the amount of recoupment or setoff is limited, with respect to the special statutory damages, to no more than three years of finance charges and fees. For high-cost loans an assignee generally continues to be subject to all claims and defenses, not only in foreclosure, with respect to that mortgage that the consumer could assert against the creditor of the mortgage, unless the assignee demonstrates, by a preponderance of evidence, that a reasonable person exercising ordinary due diligence, could not determine that VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 the mortgage was a high-cost mortgage. TILA section 131(d). In addition to the foregoing ability-torepay provisions, the Dodd-Frank Act established other new standards concerning a wide range of mortgage lending practices, including compensation of mortgage originators,51 Federal mortgage disclosures,52 and mortgage servicing.53 Those and other Dodd-Frank Act provisions are the subjects of other rulemakings by the Bureau. For additional information on those other rulemakings, see the discussion below in part III.C. G. Qualified Residential Mortgage Rulemaking Section 15G of the Securities Exchange Act of 1934, added by section 941(b) of the Dodd-Frank Act, generally requires the securitizer of asset-backed securities (ABS) to retain not less than five percent of the credit risk of the assets collateralizing the ABS. 15 U.S.C. 78o–11. The Dodd-Frank Act’s credit risk retention requirements are aimed at addressing weaknesses and failures in the securitization process and the securitization markets.54 By requiring that the securitizer retain a portion of the credit risk of the assets being securitized, the Dodd-Frank Act provides securitizers an incentive to monitor and ensure the quality of the assets underlying a securitization transaction. Six Federal agencies (not including the Bureau) are tasked with implementing this requirement. Those agencies are the Board, Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), Securities and Exchange Commission (SEC), Federal Housing Finance Agency (FHFA), and Department of Housing and Urban Development (HUD) (collectively, the QRM agencies). Section 15G of the Securities Exchange Act of 1934 provides that the credit risk retention requirements shall not apply to an issuance of ABS if all of the assets that collateralize the ABS are ‘‘qualified residential mortgages’’ (QRMs). See 15 U.S.C. 78o– 11(c)(1)(C)(iii), (4)(A) and (B). Section 51 Sections 1402 through 1405 of the Dodd-Frank Act, codified at 15 U.S.C. 1639b. 52 Section 1032(f) of the Dodd-Frank Act, codified at 12 U.S.C. 5532(f). 53 Sections 1418, 1420, 1463, and 1464 of the Dodd-Frank Act, codified at 12 U.S.C. 2605; 15 U.S.C. 1638, 1638a, 1639f, and 1639g. 54 As noted in the legislative history of section 15G of the Securities Exchange Act of 1934, ‘‘[w]hen securitizers retain a material amount of risk, they have ‘skin in the game,’ aligning their economic interest with those of investors in assetbacked securities.’’ See S. Rept. 176, 111th Cong., at 129 (2010). PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 15G requires the QRM agencies to jointly define what constitutes a QRM, taking into consideration underwriting and product features that historical loan performance data indicate result in a lower risk of default. See 15 U.S.C. 78o– 11(e)(4). Notably, section 15G also provides that the definition of a QRM shall be ‘‘no broader than’’ the definition of a ‘‘qualified mortgage,’’ as the term is defined under TILA section 129C(b)(2), as amended by the DoddFrank Act, and regulations adopted thereunder. 15 U.S.C. 78o–11(e)(4)(C). On April 29, 2011, the QRM agencies issued joint proposed risk retention rules, including a proposed QRM definition (2011 QRM Proposed Rule). See 76 FR 24090 (Apr. 29, 2011). The proposed rule has not been finalized. Among other requirements, the 2011 QRM Proposed Rule incorporates the qualified mortgage restrictions on negative amortization, interest-only, and balloon payments, limits points and fees to three percent of the loan amount, and prohibits prepayment penalties. The proposed rule also establishes underwriting standards designed to ensure that QRMs have high credit quality, including: • A maximum ‘‘front-end’’ monthly debt-to-income ratio (which looks at only the consumer’s mortgage payment relative to income, but not at other debts) of 28 percent; • A maximum ‘‘back-end’’ monthly debt-to-income ratio (which includes all of the consumer’s debt, not just the mortgage payment) of 36 percent; • A maximum loan-to-value (LTV) ratio of 80 percent in the case of a purchase transaction (with a lesser combined LTV permitted for refinance transactions); • A 20 percent down payment requirement in the case of a purchase transaction; and • Credit history verification and documentation requirements. The proposed rule also includes appraisal requirements, restrictions on the assumability of the mortgage, and requires the creditor to commit to certain servicing policies and procedures regarding loss mitigation. See 76 FR at 24166–67. To provide clarity on the definitions, calculations, and verification requirements for the QRM standards, the 2011 QRM Proposed Rule incorporates certain definitions and key terms established by HUD and required to be used by creditors originating FHAinsured residential mortgages. See 76 FR at 24119. Specifically, the 2011 QRM Proposed Rule incorporates the definitions and standards set out in the HUD Handbook 4155.1 (New Version), E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with Mortgage Credit Analysis for Mortgage Insurance, as in effect on December 31, 2010, for determining and verifying the consumer’s funds and the consumer’s monthly housing debt, total monthly debt, and monthly gross income.55 The qualified mortgage and QRM definitions are distinct and relate to different parts of the Dodd-Frank Act with different purposes, but both are designed to address problems that had arisen in the mortgage origination process. The qualified mortgage standard provides creditors with a presumption of compliance with the requirement in TILA section 129C(a) to assess a consumer’s ability to repay a residential mortgage loan. The purpose of these provisions is to ensure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans. See TILA section 129B(a)(2). The Dodd-Frank Act’s credit risk retention requirements are intended to address problems in the securitization markets and in mortgage markets by requiring that securitizers, as a general matter, retain an economic interest in the credit risk of the assets they securitize. The QRM credit risk retention requirement was meant to incentivize creditors to make more responsible loans because they will need to keep some skin in the game.56 Nevertheless, as discussed above, the Dodd-Frank Act requires that the QRM definition be ‘‘no broader than’’ the qualified mortgage definition. Therefore, in issuing the 2011 QRM Proposed Rule, the QRM agencies sought to incorporate the statutory qualified mortgage standards, in addition to other requirements, into the QRM definition. 76 FR at 24118. This approach was designed to minimize the potential for conflicts between the QRM standards in the proposed rule and the qualified mortgage definition that the Bureau would ultimately adopt in a final rule. In the 2011 QRM Proposed Rule, the QRM agencies stated their expectation to monitor the rules adopted by the Bureau under TILA to define a qualified mortgage and to review those rules to ensure that the definition of QRM in the final rule is ‘‘no broader’’ than the definition of a qualified mortgage and to appropriately implement the DoddFrank Act’s credit risk retention requirement. See 76 FR at 24118. In 55 See U.S. Dep’t of Hous. & Urban Dev., Housing Handbook 4155.1, Mortgage Credit Analysis for Mortgage Insurance (rev. Mar. 2011) (‘‘HUD Handbook 4155.1’’), available at https:// portal.hud.gov/hudportal/HUD?src=/ program_offices/administration/hudclips/ handbooks/hsgh/4155.1. 56 See S. Rept. 176, 111th Cong., at 129 (2010). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 preparing this final rule, the Bureau has consulted regularly with the QRM agencies to coordinate the qualified mortgage and qualified residential mortgage definitions. However, while the Bureau’s qualified mortgage definition will set the outer boundary of a QRM, the QRM agencies have discretion under the Dodd-Frank Act to define QRMs in a way that is stricter than the qualified mortgage definition. III. Summary of the Rulemaking Process A. The Board’s Proposal In 2011, the Board published for public comment a proposed rule amending Regulation Z to implement the foregoing ability-to-repay amendments to TILA made by the Dodd-Frank Act. See 76 FR 27390 (May 11, 2011) (2011 ATR Proposal, the Board’s proposal or the proposal). Consistent with the Dodd-Frank Act, the Board’s proposal applied the ability-torepay requirements to any consumer credit transaction secured by a dwelling (including vacation home loans and home equity loans), except an open-end credit plan, extension of credit secured by a consumer’s interest in a timeshare plan, reverse mortgage, or temporary loan with a term of 12 months or less. The Board’s proposal provided four options for complying with the abilityto-repay requirement, including by making a ‘‘qualified mortgage.’’ First, the proposal would have allowed a creditor to meet the general ability-torepay standard by originating a covered mortgage loan for which the creditor considered and verified eight underwriting factors in determining repayment ability, and, for adjustable rate loans, the mortgage payment calculation is based on the fully indexed rate.57 Second, the proposal would have allowed a creditor to refinance a ‘‘nonstandard mortgage’’ into a ‘‘standard mortgage.’’ 58 Under this option, the 57 The eight factors are: (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. 58 This alternative is based on a Dodd-Frank Act provision that is meant to provide flexibility for certain streamlined refinancings, which are no- or low-documentation transactions designed to refinance a consumer quickly under certain circumstances, when such refinancings would move consumers out of risky mortgages and into more stable mortgage products—what the proposal defined as mortgage loans that, among other things, do not contain negative amortization, interest-only payments, or balloon payments, and have limited points and fees. TILA section 129C(a)(6)(E); 15 U.S.C. 1639c(a)(6)(E). PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 6417 proposal would not have required the creditor to verify the consumer’s income or assets. Third, the proposal would have allowed a creditor to originate a qualified mortgage, which provides special protection from liability for creditors. Because the Board determined that it was unclear whether that protection is intended to be a safe harbor or a rebuttable presumption of compliance with the repayment ability requirement, the Board proposed two alternative definitions of a qualified mortgage.59 Finally, the proposal would have allowed a small creditor operating predominantly in rural or underserved areas to originate 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.60 The Board’s proposal also would have implemented the Dodd-Frank Act’s limits on prepayment penalties, lengthened the time creditors must retain evidence of compliance with the ability-to-repay and prepayment penalty provisions, and prohibited evasion of the rule by structuring a closed-end extension of credit that does not meet the definition of an open-end plan. As discussed above, rulemaking authority under TILA generally transferred from the Board to the Bureau in July 2011, including the authority under Dodd-Frank Act section 1412 to prescribe regulations to carry out the purposes of the qualified mortgage rules. 12 U.S.C. 5512; 12 U.S.C. 5581; 15 U.S.C. 1639c. As discussed above, TILA section 105(a) directs the Bureau to prescribe regulations to carry out the purposes of 59 The Board’s proposed first alternative would have operated as a legal safe harbor and define 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; (b) the total points and fees do not exceed 3 percent of the total loan amount; (c) the consumer’s income or assets are verified and documented; and (d) the underwriting of the mortgage is based on the maximum interest rate in the first five years, uses a payment schedule that fully amortizes the loan over the loan term, and takes into account any mortgage-related obligations. The Board’s proposed second alternative would have provided a rebuttable presumption of compliance and defined a ‘‘qualified mortgage’’ as including the criteria listed above in the first alternative as well as considering and verifying the following additional underwriting requirements from the ability-to-repay standard: The consumer’s employment status, the monthly payment for any simultaneous loan, the consumer’s current debt obligations, the total debt-to-income ratio or residual income, and the consumer’s credit history. 60 This alternative is based on statutory provision. TILA section 129C(b)(2)(E); 15 U.S.C. 1639c. As the Board’s proposal noted, this standard is evidently meant to accommodate community banks that originate balloon-payment mortgages in lieu of adjustable-rate mortgages to hedge against interest rate risk. E:\FR\FM\30JAR2.SGM 30JAR2 6418 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with TILA. Except with respect to the substantive restrictions on high-cost mortgages provided in TILA section 129, TILA section 105(a) authorizes the Bureau to prescribe regulations that may contain additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions that the Bureau determines are necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith. B. Comments and Post-Proposal Outreach The Board received numerous comments on the proposal, including comments regarding the criteria for a ‘‘qualified mortgage’’ and whether a qualified mortgage provides a safe harbor or a presumption of compliance with the repayment ability requirements. As noted above, in response to the proposed rule, the Board received approximately 1,800 letters from commenters, including members of Congress, creditors, consumer groups, trade associations, mortgage and real estate market participants, and individual consumers. As of July 21, 2011, the Dodd-Frank Act generally transferred the Board’s rulemaking authority for TILA, among other Federal consumer financial laws, to the Bureau. Accordingly, all comment letters on the proposed rule were also transferred to the Bureau. Materials submitted were filed in the record and are publicly available at https://www.regulations.gov. Through various comment letters and the Bureau’s own collection of data, the Bureau received additional information and new data pertaining to the proposed rule. Accordingly, in May 2012, the Bureau reopened the comment period in order to solicit further comment on data and new information, including data that may assist the Bureau in defining loans with characteristics that make it appropriate to presume that the creditor complied with the ability-to-repay requirements or assist the Bureau in assessing the benefits and costs to consumers, including access to credit, and covered persons, as well as the market share covered by, alternative definitions of a ‘‘qualified mortgage.’’ The Bureau received approximately 160 comments in response to the reopened comment period from a variety of commenters, including creditors, consumer groups, trade associations, mortgage and real estate market participants, individuals, small entities, the SBA’s Office of Advocacy, and FHA. As discussed in more detail below, the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 Bureau has considered these comments in adopting this final rule. C. Other Rulemakings In addition to this final rule, the Bureau is adopting several other final rules and issuing one proposal, all relating to mortgage credit to implement requirements of title XIV of the DoddFrank Act. The Bureau is also issuing a final rule jointly with other Federal agencies to implement requirements for mortgage appraisals in title XIV. Each of the final rules follows a proposal issued in 2011 by the Board or in 2012 by the Bureau alone or jointly with other Federal agencies. Collectively, these proposed and final rules are referred to as the Title XIV Rulemakings. • Ability to Repay: Simultaneously with this final rule (the 2013 ATR Final Rule), the Bureau is issuing a proposal to amend certain provisions of the final rule, including by the addition of exemptions for certain nonprofit creditors and certain homeownership stabilization programs and a definition of a ‘‘qualified mortgage’’ for certain loans made and held in portfolio by small creditors (the 2013 ATR Concurrent Proposal). The Bureau expects to act on the 2013 ATR Concurrent Proposal on an expedited basis, so that any exceptions or adjustments can take effect simultaneously with this final rule. • Escrows: The Bureau is finalizing a rule, following a March 2011 proposal issued by the Board (the Board’s 2011 Escrows Proposal),61 to implement certain provisions of the Dodd-Frank Act expanding on existing rules that require escrow accounts to be established for higher-priced mortgage loans and creating an exemption for certain loans held by creditors operating predominantly in rural or underserved areas, pursuant to TILA section 129D as established by Dodd-Frank Act sections 1461. 15 U.S.C. 1639d. The Bureau’s final rule is referred to as the 2013 Escrows Final Rule. • HOEPA: Following its July 2012 proposal (the 2012 HOEPA Proposal),62 the Bureau is issuing a final rule to implement Dodd-Frank Act requirements expanding protections for ‘‘high-cost mortgages’’ under the Homeownership and Equity Protection Act (HOEPA), pursuant to TILA sections 103(bb) and 129, as amended by DoddFrank Act sections 1431 through 1433. 15 U.S.C. 1602(bb) and 1639. The Bureau also is finalizing rules to implement certain title XIV requirements concerning 61 76 FR 11598 (Mar. 2, 2011). 62 77 FR 49090 (Aug. 15,2012). PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 homeownership counseling, including a requirement that creditors provide lists of homeownership counselors to applicants for federally related mortgage loans, pursuant to RESPA section 5(c), as amended by Dodd-Frank Act section 1450. 12 U.S.C. 2604(c). The Bureau’s final rule is referred to as the 2013 HOEPA Final Rule. • Servicing: Following its August 2012 proposals (the 2012 RESPA Servicing Proposal and 2012 TILA Servicing Proposal),63 the Bureau is adopting final rules to implement DoddFrank Act requirements regarding forceplaced insurance, error resolution, information requests, and payment crediting, as well as requirements for mortgage loan periodic statements and adjustable-rate mortgage reset disclosures, pursuant to section 6 of RESPA and sections 128, 128A, 129F, and 129G of TILA, as amended or established by Dodd-Frank Act sections 1418, 1420, 1463, and 1464. 12 U.S.C. 2605; 15 U.S.C. 1638, 1638a, 1639f, and 1639g. The Bureau also is finalizing rules on early intervention for troubled and delinquent consumers, and loss mitigation procedures, pursuant to the Bureau’s authority under section 6 of RESPA, as amended by Dodd-Frank Act section 1463, to establish obligations for mortgage servicers that it finds to be appropriate to carry out the consumer protection purposes of RESPA, and its authority under section 19(a) of RESPA to prescribe rules necessary to achieve the purposes of RESPA. The Bureau’s final rule under RESPA with respect to mortgage servicing also establishes requirements for general servicing standards policies and procedures and continuity of contact pursuant to its authority under section 19(a) of RESPA. The Bureau’s final rules are referred to as the 2013 RESPA Servicing Final Rule and the 2013 TILA Servicing Final Rule, respectively. • Loan Originator Compensation: Following its August 2012 proposal (the 2012 Loan Originator Proposal),64 the Bureau is issuing a final rule to implement provisions of the DoddFrank Act requiring certain creditors and loan originators to meet certain duties of care, including qualification requirements; requiring the establishment of certain compliance procedures by depository institutions; prohibiting loan originators, creditors, and the affiliates of both from receiving compensation in various forms (including based on the terms of the transaction) and from sources other than 63 77 FR 57200 (Sept. 17, 2012) (RESPA); 77 FR 57318 (Sept. 17, 2012) (TILA). 64 77 FR 55272 (Sept. 7, 2012). E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with the consumer, with specified exceptions; and establishing restrictions on mandatory arbitration and financing of single premium credit insurance, pursuant to TILA sections 129B and 129C as established by Dodd-Frank Act sections 1402, 1403, and 1414(a). 15 U.S.C. 1639b, 1639c. The Bureau’s final rule is referred to as the 2013 Loan Originator Final Rule. • Appraisals: The Bureau, jointly with other Federal agencies,65 is issuing a final rule implementing Dodd-Frank Act requirements concerning appraisals for higher-risk mortgages, pursuant to TILA section 129H as established by Dodd-Frank Act section 1471. 15 U.S.C. 1639h. This rule follows the agencies’ August 2012 joint proposal (the 2012 Interagency Appraisals Proposal).66 The agencies’ joint final rule is referred to as the 2013 Interagency Appraisals Final Rule. In addition, following its August 2012 proposal (the 2012 ECOA Appraisals Proposal),67 the Bureau is issuing a final rule to implement provisions of the Dodd-Frank Act requiring that creditors provide applicants with a free copy of written appraisals and valuations developed in connection with applications for loans secured by a first lien on a dwelling, pursuant to section 701(e) of the Equal Credit Opportunity Act (ECOA) as amended by Dodd-Frank Act section 1474. 15 U.S.C. 1691(e). The Bureau’s final rule is referred to as the 2013 ECOA Appraisals Final Rule. The Bureau is not at this time finalizing proposals concerning various disclosure requirements that were added by title XIV of the Dodd-Frank Act, integration of mortgage disclosures under TILA and RESPA, or a simpler, more inclusive definition of the finance charge for purposes of disclosures for closed-end mortgage transactions under Regulation Z. The Bureau expects to finalize these proposals and to consider whether to adjust regulatory thresholds under the Title XIV Rulemakings in connection with any change in the calculation of the finance charge later in 2013, after it has completed quantitative testing, and any additional qualitative testing deemed appropriate, of the forms that it proposed in July 2012 to combine TILA mortgage disclosures with the good faith estimate (RESPA GFE) and settlement statement (RESPA settlement statement) required under the Real 65 Specifically, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Federal Housing Finance Agency. 66 77 FR 54722 (Sept. 5, 2012). 67 77 FR 50390 (Aug. 21, 2012). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 Estate Settlement Procedures Act, pursuant to Dodd-Frank Act section 1032(f) and sections 4(a) of RESPA and 105(b) of TILA, as amended by DoddFrank Act sections 1098 and 1100A, respectively (the 2012 TILA–RESPA Proposal).68 Accordingly, the Bureau already has issued a final rule delaying implementation of various affected title XIV disclosure provisions.69 The Bureau’s approaches to coordinating the implementation of the Title XIV Rulemakings and to the finance charge proposal are discussed in turn below. Coordinated Implementation of Title XIV Rulemakings As noted in all of its foregoing proposals, the Bureau regards each of the Title XIV Rulemakings as affecting aspects of the mortgage industry and its regulations. Accordingly, as noted in its proposals, the Bureau is coordinating carefully the Title XIV Rulemakings, particularly with respect to their effective dates. The Dodd-Frank Act requirements to be implemented by the Title XIV Rulemakings generally will take effect on January 21, 2013, unless final rules implementing those requirements are issued on or before that date and provide for a different effective date. See Dodd-Frank Act section 1400(c), 15 U.S.C. 1601 note. In addition, some of the Title XIV Rulemakings are to take effect no later than one year after they are issued. Id. The comments on the appropriate effective date for this final rule are discussed in detail below in part VI of this notice. In general, however, consumer advocates requested that the Bureau put the protections in the Title XIV Rulemakings into effect as soon as practicable. In contrast, the Bureau received some industry comments indicating that implementing so many new requirements at the same time would create a significant cumulative burden for creditors. In addition, many commenters also acknowledged the advantages of implementing multiple revisions to the regulations in a coordinated fashion.70 Thus, a tension 68 77 FR 51116 (Aug. 23, 2012). FR 70105 (Nov. 23, 2012). 70 Of the several final rules being adopted under the Title XIV Rulemakings, six entail amendments to Regulation Z, with the only exceptions being the 2013 RESPA Servicing Final Rule (Regulation X) and the 2013 ECOA Appraisals Final Rule (Regulation B); the 2013 HOEPA Final Rule also amends Regulation X, in addition to Regulation Z. The six Regulation Z final rules involve numerous instances of intersecting provisions, either by crossreferences to each other’s provisions or by adopting parallel provisions. Thus, adopting some of those amendments without also adopting certain other, closely related provisions would create significant technical issues, e.g., new provisions containing cross-references to other provisions that do not yet 69 77 PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 6419 exists between coordinating the adoption of the Title XIV Rulemakings and facilitating industry’s implementation of such a large set of new requirements. Some have suggested that the Bureau resolve this tension by adopting a sequenced implementation, while others have requested that the Bureau simply provide a longer implementation period for all of the final rules. The Bureau recognizes that many of the new provisions will require creditors to make changes to automated systems and, further, that most administrators of large systems are reluctant to make too many changes to their systems at once. At the same time, however, the Bureau notes that the Dodd-Frank Act established virtually all of these changes to institutions’ compliance responsibilities, and contemplated that they be implemented in a relatively short period of time. And, as already noted, the extent of interaction among many of the Title XIV Rulemakings necessitates that many of their provisions take effect together. Finally, notwithstanding commenters’ expressed concerns for cumulative burden, the Bureau expects that creditors actually may realize some efficiencies from adapting their systems for compliance with multiple new, closely related requirements at once, especially if given sufficient overall time to do so. Accordingly, the Bureau is requiring that, as a general matter, creditors and other affected persons begin complying with the final rules on January 10, 2014. As noted above, section 1400(c) of the Dodd-Frank Act requires that some provisions of the Title XIV Rulemakings take effect no later than one year after the Bureau issues them. Accordingly, the Bureau is establishing January 10, 2014, one year after issuance of this final rule and the Bureau’s 2013 Escrows and HOEPA Final Rules (i.e., the earliest of the title XIV final rules), as the baseline effective date for most of the Title XIV Rulemakings. The Bureau believes that, on balance, this approach will facilitate the implementation of the rules’ overlapping provisions, while also affording creditors sufficient time to implement the more complex or resource-intensive new requirements. The Bureau has identified certain rulemakings or selected aspects thereof, however, that do not present significant implementation burdens for industry. Accordingly, the Bureau is setting exist, which could undermine the ability of creditors and other parties subject to the rules to understand their obligations and implement appropriate systems changes in an integrated and efficient manner. E:\FR\FM\30JAR2.SGM 30JAR2 6420 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with earlier effective dates for those final rules or certain aspects thereof, as applicable. Those effective dates are set forth and explained in the Federal Registers notices for those final rules. More Inclusive Finance Charge Proposal As noted above, the Bureau proposed in the 2012 TILA–RESPA Proposal to make the definition of finance charge more inclusive, thus rendering the finance charge and annual percentage rate a more useful tool for consumers to compare the cost of credit across different alternatives. 77 FR 51116, 51143 (Aug. 23, 2012). Because the new definition would include additional costs that are not currently counted, it would cause the finance charges and APRs on many affected transactions to increase. This in turn could cause more such transactions to become subject to various compliance regimes under Regulation Z. Specifically, the finance charge is central to the calculation of a transaction’s ‘‘points and fees,’’ which in turn has been (and remains) a coverage threshold for the special protections afforded ‘‘high-cost mortgages’’ under HOEPA. Points and fees also will be subject to a 3-percent limit for purposes of determining whether a transaction is a ‘‘qualified mortgage’’ under this final rule. Meanwhile, the APR serves as a coverage threshold for HOEPA protections as well as for certain protections afforded ‘‘higher-priced mortgage loans’’ under § 1026.35, including the mandatory escrow account requirements being amended by the 2013 Escrows Final Rule. Finally, because the 2013 Interagency Appraisals Final Rule uses the same APR-based coverage test as is used for identifying higher-priced mortgage loans, the APR affects that rulemaking as well. Thus, the proposed more inclusive finance charge would have had the indirect effect of increasing coverage under HOEPA and the escrow and appraisal requirements for higher-priced mortgage loans, as well as decreasing the number of transactions that may be qualified mortgages—even holding actual loan terms constant—simply because of the increase in calculated finance charges, and consequently APRs, for closed-end mortgage transactions generally. As noted above, these expanded coverage consequences were not the intent of the more inclusive finance charge proposal. Accordingly, as discussed more extensively in the Escrows Proposal, the HOEPA Proposal, the ATR Proposal, and the Interagency Appraisals Proposal, the Board and subsequently the Bureau (and other agencies) sought comment on certain VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 adjustments to the affected regulatory thresholds to counteract this unintended effect. First, the Board and then the Bureau proposed to adopt a ‘‘transaction coverage rate’’ for use as the metric to determine coverage of these regimes in place of the APR. The transaction coverage rate would have been calculated solely for coverage determination purposes and would not have been disclosed to consumers, who still would have received only a disclosure of the expanded APR. The transaction coverage rate calculation would exclude from the prepaid finance charge all costs otherwise included for purposes of the APR calculation except charges retained by the creditor, any mortgage broker, or any affiliate of either. Similarly, the Board and Bureau proposed to reverse the effects of the more inclusive finance charge on the calculation of points and fees; the points and fees figure is calculated only as a HOEPA and qualified mortgage coverage metric and is not disclosed to consumers. The Bureau also sought comment on other potential mitigation measures, such as adjusting the numeric thresholds for particular compliance regimes to account for the general shift in affected transactions’ APRs. The Bureau’s 2012 TILA–RESPA Proposal sought comment on whether to finalize the more inclusive finance charge proposal in conjunction with the Title XIV Rulemakings or with the rest of the TILA–RESPA Proposal concerning the integration of mortgage disclosure forms. 77 FR 51116, 51125 (Aug. 23, 2012). Upon additional consideration and review of comments received, the Bureau decided to defer a decision whether to adopt the more inclusive finance charge proposal and any related adjustments to regulatory thresholds until it later finalizes the TILA–RESPA Proposal. 77 FR 54843 (Sept. 6, 2012); 77 FR 54844 (Sept. 6, 2012).71 Accordingly, this final rule and the 2013 Escrows, HOEPA, and Interagency Appraisals Final Rules all are deferring any action on their respective proposed adjustments to regulatory thresholds. IV. Legal Authority The final rule was issued on January 10, 2013, in accordance with 12 CFR 1074.1. The Bureau issued this final rule pursuant to its authority under TILA and the Dodd-Frank Act. See TILA section 105(a), 15 U.S.C. 1604(a). On July 21, 2011, section 1061 of the DoddFrank Act transferred to the Bureau the ‘‘consumer financial protection functions’’ previously vested in certain other Federal agencies, including the Board. The term ‘‘consumer financial protection function’’ is defined to include ‘‘all authority to prescribe rules or issue orders or guidelines pursuant to any Federal consumer financial law, including performing appropriate functions to promulgate and review such rules, orders, and guidelines.’’ 72 TILA is defined as a Federal consumer financial law.73 Accordingly, the Bureau has authority to issue regulations pursuant to TILA. A. TILA Ability-to-Repay and Qualified Mortgage Provisions As discussed above, the Dodd-Frank Act amended TILA to generally prohibit a creditor from making a residential mortgage loan without a reasonable and good faith determination that, at the time the loan is consummated, the consumer has a reasonable ability to repay the loan, along with taxes, insurance, and assessments. TILA section 129C(a), 15 U.S.C. 1639c(a). As described below in part IV.B, the Bureau has authority to prescribe regulations to carry out the purposes of TILA pursuant to TILA section 105(a). 15 U.S.C. 1604(a). In particular, it is the purpose of TILA section 129C, as amended by the Dodd-Frank Act, to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans and that are understandable and not unfair, deceptive, and abusive. TILA section 129B(a)(2); 15 U.S.C. 1639b(a)(2). The Dodd-Frank Act also provides creditors originating ‘‘qualified mortgages’’ special protection from liability under the ability-to-repay requirements. TILA section 129C(b), 15 U.S.C. 1639c(b). TILA generally defines a ‘‘qualified mortgage’’ as a residential mortgage loan 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 loan amount; the income or assets are considered and verified; and the underwriting is based on the maximum rate during the first five years, uses a 72 12 U.S.C. 5581(a)(1). Act section 1002(14), 12 U.S.C. 5481(14) (defining ‘‘Federal consumer financial law’’ to include the ‘‘enumerated consumer laws’’ and the provisions of title X of the Dodd-Frank Act), Dodd-Frank Act section 1002(12), 12 U.S.C. 5481(12) (defining ‘‘enumerated consumer laws’’ to include TILA). 73 Dodd-Frank 71 These notices extended the comment period on the more inclusive finance charge and corresponding regulatory threshold adjustments under the 2012 TILA–RESPA and HOEPA Proposals. It did not change any other aspect of either proposal. PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations payment schedule that fully amortizes the loan over the loan term, and takes into account all mortgage-related obligations. TILA section 129C(b)(2), 15 U.S.C. 1639c(b)(2). In addition, to constitute a qualified mortgage a loan must meet ‘‘any guidelines or regulations established by the Bureau relating to ratios of total monthly debt to monthly income or alternative measures of ability to pay regular expenses after payment of total monthly debt, taking into account the income levels of the borrower and such other factors as the Bureau may determine are relevant and consistent with the purposes described in [TILA section 129C(b)(3)(B)(i)].’’ The Dodd-Frank Act also provides the Bureau with authority to 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 are necessary and appropriate to effectuate the purposes of the ability-to-repay requirements, to prevent circumvention or evasion thereof, or to facilitate compliance with TILA sections 129B and 129C. TILA section 129C(b)(3)(B)(i), 15 U.S.C. 1639c(b)(3)(B)(i). In addition, TILA section 129C(b)(3)(A) provides the Bureau with authority to prescribe regulations to carry out the purposes of the qualified mortgage provisions, such as to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of TILA section 129C. TILA section 129C(b)(3)(A), 15 U.S.C. 1939c(b)(3)(A). As discussed in the section-by-section analysis below, the Bureau is issuing certain provisions of this rule pursuant to its authority under TILA section 129C(b)(3)(B)(i). The Dodd-Frank Act provides the Bureau with other specific grants of rulewriting authority with respect to the ability-to-repay and qualified mortgage provisions. With respect to the abilityto-repay provisions, TILA section 129C(a)(6)(D)(i) through (iii) provides that when calculating the payment obligation that will be used to determine whether the consumer can repay a covered transaction, the creditor must use a fully amortizing payment schedule and assume that: (1) The loan proceeds are fully disbursed on the date the loan is consummated; (2) the loan is repaid in substantially equal, monthly amortizing payments for principal and interest over the entire term of the loan with no balloon payment; and (3) the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 interest rate over the entire term of the loan is a fixed rate equal to the fully indexed rate at the time of the loan closing, without considering the introductory rate. 15 U.S.C. 1639c(a)(6)(D)(i) through (iii). However, TILA section 129C(a)(6)(D) authorizes the Bureau to prescribe regulations for calculating the payment obligation for loans that require more rapid repayment (including balloon payments), and which have an annual percentage rate that does not exceed a certain rate threshold. 15 U.S.C. 1639c(a)(6)(D). With respect to the qualified mortgage provisions, the Dodd-Frank Act contains several specific grants of rulewriting authority. First, as described above, for purposes of defining ‘‘qualified mortgage,’’ TILA section 129C(b)(2)(A)(vi) provides the Bureau with authority to establish guidelines or regulations relating to monthly debt-toincome ratios or alternative measures of ability to pay. Second, TILA section 129C(b)(2)(D) provides that the Bureau shall prescribe rules adjusting the qualified mortgage points and fees limits described above to permit creditors that extend smaller loans to meet the requirements of the qualified mortgage provisions. 15 U.S.C. 1639c(b)(2)(D)(ii). In prescribing such rules, the Bureau must consider their potential impact on rural areas and other areas where home values are lower. Id. Third, TILA section 129C(b)(2)(E) provides the Bureau with authority to include in the definition of ‘‘qualified mortgage’’ loans with balloon payment features, if those loans meet certain underwriting criteria and are originated by creditors that operate predominantly in rural or underserved areas, have total annual residential mortgage originations that do not exceed a limit set by the Bureau, and meet any asset size threshold and any other criteria as the Bureau may establish, consistent with the purposes of TILA. 15 U.S.C. 1639c(b)(2)(E). As discussed in the section-by-section analysis below, the Bureau is issuing certain provisions of this rule pursuant to its authority under TILA sections 129C(a)(6)(D), (b)(2)(A)(vi), (b)(2)(D), and (b)(2)(E). B. Other Rulemaking and Exception Authorities This final rule also relies on other rulemaking and exception authorities specifically granted to the Bureau by TILA and the Dodd-Frank Act, including the authorities discussed below. TILA TILA section 105(a). As amended by the Dodd-Frank Act, TILA section PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 6421 105(a), 15 U.S.C. 1604(a), directs the Bureau to prescribe regulations to carry out the purposes of TILA, and provides that such regulations may contain additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions that the Bureau judges are necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith. A purpose of TILA is ‘‘to assure a meaningful disclosure of credit terms so that the consumer will be able to compare more readily the various credit terms available to him and avoid the uninformed use of credit.’’ TILA section 102(a), 15 U.S.C. 1601(a). This stated purpose is informed by Congress’s finding that ‘‘economic stabilization would be enhanced and the competition among the various financial institutions and other firms engaged in the extension of consumer credit would be strengthened by the informed use of credit[.]’’ TILA section 102(a). Thus, strengthened competition among financial institutions is a goal of TILA, achieved through the effectuation of TILA’s purposes. Historically, TILA section 105(a) has served as a broad source of authority for rules that promote the informed use of credit through required disclosures and substantive regulation of certain practices. However, Dodd-Frank Act section 1100A clarified the Bureau’s section 105(a) authority by amending that section to provide express authority to prescribe regulations that contain ‘‘additional requirements’’ that the Bureau finds are necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith. This amendment clarified the authority to exercise TILA section 105(a) to prescribe requirements beyond those specifically listed in the statute that meet the standards outlined in section 105(a). The Dodd-Frank Act also clarified the Bureau’s rulemaking authority over high-cost mortgages under HOEPA pursuant to section 105(a). As amended by the Dodd-Frank Act, TILA section 105(a) authority to make adjustments and exceptions to the requirements of TILA applies to all transactions subject to TILA, except with respect to the substantive provisions of TILA section 129, 15 U.S.C. 1639, that apply to the high-cost mortgages defined in TILA section 103(bb), 15 U.S.C. 1602(bb). TILA, as amended by the Dodd-Frank Act, states that it is the purpose of the ability-to-repay requirements of TILA E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6422 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations section 129C to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans and that are understandable and not unfair, deceptive, or abusive. TILA section 129B(a)(2). The Bureau interprets this addition as a new purpose of TILA. Therefore, the Bureau believes that its authority under TILA section 105(a) to make exceptions, adjustments, and additional provisions, among other things, that the Bureau finds are necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith applies with respect to the purpose of section 129C as well as the purpose described in section TILA section 129B(a)(2). The purpose of TILA section 129C is informed by the findings articulated in section 129B(a) 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 and affordable mortgage credit remains available to consumers. As discussed in the section-by-section analysis below, the Bureau is issuing regulations to carry out TILA’s purposes, including such additional requirements, adjustments, and exceptions as, in the Bureau’s judgment, are necessary and proper to carry out the purposes of TILA, prevent circumvention or evasion thereof, or to facilitate compliance therewith. In developing these aspects of the final rule pursuant to its authority under TILA section 105(a), the Bureau has considered the purposes of TILA, including the purposes of TILA section 129C, and the findings of TILA, including strengthening competition among financial institutions and promoting economic stabilization, and the findings of TILA section 129B(a)(1), 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. The Bureau believes that ensuring that mortgage credit is offered and received on terms consumers can afford ensures the availability of responsible, affordable mortgage credit. TILA section 129B(e). Dodd-Frank Act section 1405(a) amended TILA to add new section 129B(e), 15 U.S.C. 1639B(e). That section authorizes the Bureau to prohibit or condition terms, acts, or practices relating to residential VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 mortgage loans that the Bureau finds to be abusive, unfair, deceptive, predatory, necessary or proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of TILA section 129C, necessary or proper to effectuate the purposes of sections 129B and 129C, to prevent circumvention or evasion thereof, or to facilitate compliance with such sections, or are not in the interest of the consumer. In developing rules under TILA section 129B(e), the Bureau has considered whether the rules are in the interest of the consumer, as required by the statute. As discussed in the sectionby-section analysis below, the Bureau is issuing portions of this rule pursuant to its authority under TILA section 129B(e). The Dodd-Frank Act Dodd-Frank Act section 1022(b). Section 1022(b)(1) of the Dodd-Frank Act authorizes the Bureau to prescribe rules ‘‘as may be necessary or appropriate to enable the Bureau to administer and carry out the purposes and objectives of the Federal consumer financial laws, and to prevent evasions thereof.’’ 12 U.S.C. 5512(b)(1). TILA and title X of the Dodd-Frank Act are Federal consumer financial laws. Accordingly, the Bureau is exercising its authority under Dodd-Frank Act section 1022(b) to prescribe rules that carry out the purposes and objectives of TILA and title X and prevent evasion of those laws. V. Section-by-Section Analysis Section 1026.25 Record Retention 25(a) General Rule Section 1416 of the Dodd-Frank Act revised TILA section 130(e) to extend the statute of limitations for civil liability for a violation of TILA section 129C, as well as sections 129 and 129B, to three years after the date a violation occurs. Existing § 1026.25(a) requires that creditors retain evidence of compliance with Regulation Z for two years after disclosures must be made or action must be taken. Accordingly, the Board proposed to revise § 226.25(a) 74 to require that creditors retain records that show compliance with proposed § 226.43, which would implement TILA section 129C, for at least three years after consummation. The Board did not propose to alter the regulation’s existing 74 This section-by-section analysis discusses the Board’s proposal by reference to the Board’s Regulation Z, 12 CFR part 226, which the Board proposed to amend, and discusses the Bureau’s final rule by reference to the Bureau’s Regulation Z, 12 CFR part 1026, which this final rule amends. PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 clarification that administrative agencies responsible for enforcing Regulation Z may require creditors under the agency’s jurisdiction to retain records for a longer period, if necessary to carry out the agency’s enforcement responsibilities under TILA section 108, 15 U.S.C. 1607. Under TILA section 130(e), as amended by Dodd-Frank, the statute of limitations for civil liability for a violation of other sections of TILA remains one year after the date a violation occurs, except for private education loans under 15 U.S.C. 1650(a), actions brought under section 129 or 129B, or actions brought by a State attorney general to enforce a violation of section 129, 129B, 129C, 129D, 129E, 129F, 129G, or 129H. 15 U.S.C. 1640(e). Moreover, as amended by section 1413 of the Dodd-Frank Act, TILA provides that when a creditor, an assignee, other holder or their agent initiates a foreclosure action, a consumer may assert a violation of TILA section 129C(a) ‘‘as a matter of defense by recoupment or setoff.’’ TILA section 130(k). There is no time limit on the use of this defense. As discussed below, the Bureau is adopting minor modifications to § 1026.25(a) and adding in new § 1026.25(c) to reflect section 1416 of the Dodd-Frank Act, in § 1026.25(c)(3) as well as other exceptional record retention requirements related to mortgage loans. 25(c) Records Related to Certain Requirements for Mortgage Loans The Bureau is adopting the revision proposed in § 226.25(a) to require a creditor to retain records demonstrating compliance with § 1026.43 consistent with the extended statute of limitations for violations of that section, though the Bureau is adopting this requirement in § 1026.25(c)(3) to provide additional clarity. As the 2012 TILA–RESPA Proposal proposed new § 1026.25(c)(1) and the 2012 Loan Originator Proposal proposed new § 1026.25(c)(2), the Bureau concludes that adding new § 1026.25(c)(3) eases compliance burden by placing all record retention requirements that are related to mortgage loans and which differ from the general record retention in one section, § 1026.25(c). Likewise, the Bureau is amending § 1026.25(a) to reflect that certain record retention requirements, such as records related to minimum standards for transactions secured by a dwelling, are governed by § 1026.43(c). Commenters did not provide the Bureau with significant, specific feedback with respect to proposed § 226.25(a), although industry E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations commenters generally expressed concern with respect to the compliance burden of the 2011 ATR Proposal. Increasing the period a creditor must retain records from two to three years may impose some marginal increase in the creditor’s compliance burden in the form of incremental cost of storage. However, the Bureau believes that even absent the rule, responsible creditors will likely elect to retain records of compliance with § 1026.43 for a period of time well beyond three years, given that the statute allows consumers to bring a defensive claim for recoupment or setoff in the event that a creditor or assignee initiates foreclosure proceedings. Indeed, at least one commenter noted this tension and requested that the Bureau provide further regulatory instruction, although the Bureau does not deem it necessary to mandate recordkeeping burdens beyond what is required by section 1416 of the Dodd-Frank Act. Furthermore, the record-keeping burden imposed by the rule is tailored only to show compliance with § 1026.43, and the Bureau believes is justified to protect the interests of both creditors and consumers in the event that an affirmative claim is brought during the first three years after consummation. The Bureau believes that calculating the record retention period under § 1026.43 from loan consummation facilitates compliance by establishing a single, clear start to the period, even though a creditor will take action (e.g., underwriting the covered transaction and offering a consumer the option of a covered transaction without a prepayment penalty) over several days or weeks prior to consummation. The Bureau is thus adopting the timeframe as proposed to reduce compliance burden. Existing comment 25(a)–2 clarifies that, in general, a creditor need retain only enough information to reconstruct the required disclosures or other records. The Board proposed, and the Bureau is adopting, amendments to comment 25(a)–2 and a new comment 25(c)(3)–1 to clarify that, if a creditor must verify and document information used in underwriting a transaction subject to § 1026.43, the creditor must retain evidence sufficient to demonstrate having done so, in compliance with § 1026.25(a) and § 1026.25(c)(3). In an effort to reduce compliance burden, comment 25(c)(3)– 1 also clarifies that creditors need not retain actual paper copies of the documentation used to underwrite a transaction but that creditors must be able to reproduce those records accurately. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 The Board proposed comment 25(a)– 7 to provide guidance on retaining records evidencing compliance with the requirement to offer a consumer an alternative covered transaction without a prepayment penalty, as discussed below in the section-by-section analysis of § 1026.43(g)(3) through (5). The Bureau believes the requirement to offer a transaction without a prepayment penalty under TILA section 129C(c)(4) is intended to ensure that consumers who choose an alternative covered transaction with a prepayment penalty do so voluntarily. The Bureau further believes it is unnecessary, and contrary to the Bureau’s efforts to streamline its regulations, facilitate regulatory compliance, and minimize compliance burden, for a creditor to document compliance with the requirement to offer an alternative covered transaction without a prepayment penalty when a consumer does not choose a transaction with a prepayment penalty or if the covered transaction is not consummated. Accordingly, the Bureau is adopting as proposed comment 25(a)– 7 as comment 25(c)(3)–2, to clarify that a creditor must retain records that document compliance with that requirement if a transaction subject to § 1026.43 is consummated with a prepayment penalty, but need not retain such records if a covered transaction is consummated without a prepayment penalty or a covered transaction is not consummated. See § 1026.43(g)(6). The Board proposed comment 25(a)– 7 also to provide specific guidance on retaining records evidencing compliance with the requirement to offer a consumer an alternative covered transaction without a prepayment penalty when a creditor offers a transaction through a mortgage broker. As discussed in detail below in the section-by-section analysis of § 1026.43(g)(4), the Board proposed that if the creditor offers a covered transaction with a prepayment penalty through a mortgage broker, the creditor must present the mortgage broker an alternative covered transaction without a prepayment penalty. Also, the creditor must provide, by agreement, for the mortgage broker to present to the consumer that transaction or an alternative covered transaction without a prepayment penalty offered by another creditor that has a lower interest rate or a lower total dollar amount of origination points or fees and discount points than the creditor’s presented alternative covered transaction. The Bureau did not receive significant comment on this clarification, and is adopting the comment largely as PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 6423 proposed, renumbered as comment 25(c)(3)–2. Comment 25(c)(3)–2 also clarifies that, to demonstrate compliance with § 1026.43(g)(4), the creditor must retain a record of (1) the alternative covered transaction without a prepayment penalty presented to the mortgage broker pursuant to § 1026.43(g)(4)(i), such as a rate sheet, and (2) the agreement with the mortgage broker required by § 1026.34(g)(4)(ii). Section 1026.32 Requirements for High-Cost Mortgages 32(b) Definitions 32(b)(1) Points and Fees—General Section 1412 of the Dodd-Frank Act added TILA section 129C(b)(2)(A)(vii), which defines a ‘‘qualified mortgage’’ as a loan for which, among other things, the total ‘‘points and fees’’ do not exceed 3 percent of the total loan amount. The limits on points and fees for qualified mortgages are implemented in new § 1026.43(e)(3). TILA section 129C(b)(2)(C) generally defines ‘‘points and fees’’ for qualified mortgages to have the same meaning as in TILA section 103(aa)(4) (renumbered as section 103(bb)(4)), which defines ‘‘points and fees’’ for the purpose of determining whether a transaction qualifies as a high-cost mortgage under HOEPA.75 TILA section 103(aa)(4) is implemented in current § 1026.32(b)(1). Accordingly, the Board proposed in § 226.43(b)(9) that, for a qualified mortgage, ‘‘points and fees’’ has the same meaning as in § 226.32(b)(1). The Board also proposed in the 2011 ATR Proposal to amend § 226.32(b)(1) to implement revisions to the definition of ‘‘points and fees’’ under section 1431 of the Dodd-Frank Act. Among other things, the Dodd-Frank Act excluded certain private mortgage insurance premiums from, and added loan originator compensation and prepayment penalties to, the definition of ‘‘points and fees’’ that had previously 75 The Dodd-Frank Act renumbered existing TILA section 103(aa), which contains the definition of ‘‘points and fees,’’ for the high-cost mortgage points and fees threshold, as section 103(bb). See § 1100A(1)(A) of the Dodd-Frank Act. However, in defining points and fees for the qualified mortgage points and fees limits, TILA section 129C(b)(2)(C) refers to TILA section 103(aa)(4) rather than TILA section 103(bb)(4). To give meaning to this provision, the Bureau concludes that the reference to TILA section in 103(aa)(4) in TILA section 129C(b)(2)(C) is mistaken and therefore interprets TILA section 129C(b)(2)(C) as referring to the points and fees definition in renumbered TILA section 103(bb)(4). This proposal generally references TILA section 103(aa) to refer to the pre-Dodd-Frank provision, which is in effect until the Dodd-Frank Act’s amendments take effect, and TILA section 103(bb) to refer to the provision as amended. E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6424 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations applied to high-cost mortgage loans under HOEPA. In the Bureau’s 2012 HOEPA Proposal, the Bureau republished the Board’s proposed revisions to § 226.32(b)(1), with only minor changes, in renumbered § 1026.32(b)(1). The Bureau noted in its 2012 HOEPA Proposal that it was particularly interested in receiving comments concerning any newly-proposed language and the application of the definition in the high-cost mortgage context. The Bureau received numerous comments from both industry and consumer advocacy groups, the majority of which were neither specific to newlyproposed language nor to the application of the definition to high-cost mortgages. These comments largely reiterated comments that the Board and the Bureau had received in the ATR rulemaking docket. The Bureau is addressing comments received in response to 2012 HOEPA Proposal in the 2013 HOEPA Final Rule. Similarly, comments received in response to the Board’s 2011 ATR Proposal are discussed in this final rule. The Bureau is carefully coordinating the 2013 HOEPA and ATR Final Rules to ensure a consistent and cohesive regulatory framework. The Bureau is now finalizing § 1026.32(b)(1), (b)(3), (b)(4)(i), (b)(5), and (b)(6)(i) in this rule in response to the comments received on both proposals. The Bureau is finalizing § 1026.32(b)(2), (b)(4)(ii), and (b)(6)(ii) in the 2013 HOEPA Final Rule. Existing § 1026.32(b)(1) defines ‘‘points and fees’’ by listing included charges in § 1026.32(b)(1)(i) through (iv). As discussed below, the Board proposed revisions to § 226.32(b)(1)(i) through (iv) and proposed to add new § 226.32(b)(1)(v) and (vi). In the 2012 HOEPA Proposal, the Bureau proposed to add the phrase ‘‘in connection with a closed-end mortgage loan’’ to § 1026.32(b)(1) to clarify that its definition of ‘‘points and fees’’ would have applied only for closed-end mortgages. The Bureau also proposed to define ‘‘points and fees’’ in § 1026.32(b)(3) for purposes of defining which open-end credit plans qualify as ‘‘high-cost mortgages’’ under HOEPA. However, that section is not relevant to this rulemaking because the ability-torepay requirement in TILA section 129C does not apply to open-end credit. Accordingly, the Bureau is adopting § 1026.32(b)(1) with the clarification that its definition of ‘‘points and fees’’ is ‘‘in connection with a closed-end mortgage loan.’’ Payable at or before consummation. In the 2011 ATR Proposal, the Board noted that the Dodd-Frank Act removed VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 the phrase ‘‘payable at or before closing’’ from the high-cost mortgage points and fees test in TILA section 103(aa)(1)(B). See TILA section 103(bb)(1)(A)(ii). Prior to the DoddFrank Act, fees and charges were included in points and fees for the highcost mortgage points and fees test only if they were payable at or before closing. The phrase ‘‘payable at or before closing’’ is also not in TILA’s provisions on the points and fees cap for qualified mortgages. See TILA section 129C(b)(2)(A)(vii), (b)(2)(C). Thus, the Board stated that, with a few exceptions, the statute provides that any charge that falls within the ‘‘points and fees’’ definition must be counted toward the limits on points and fees for both highcost mortgages and qualified mortgages, even if it is payable after loan closing. The Board noted that the exceptions are mortgage insurance premiums and charges for credit insurance and debt cancellation and suspension coverage. The statute expressly states that these premiums and charges are included in points and fees only if payable at or before closing. See TILA section 103(bb)(1)(C) (for mortgage insurance) and TILA section 103(bb)(4)(D) (for credit insurance and debt cancellation and suspension coverage). The Board expressed concern that some fees that occur after closing, such as fees to modify a loan, might be deemed to be points and fees. If so, the Board cautioned that calculating the points and fees to determine whether a transaction is a qualified mortgage may be difficult because the amount of future fees (e.g., loan modification fees) cannot be known prior to closing. The Board noted that creditors might be exposed to excessive litigation risk if consumers were able at any point during the life of a mortgage to argue that the points and fees for the loan exceed the qualified mortgage limits due to fees imposed after loan closing. The Board expressed concern that creditors therefore might be discouraged from making qualified mortgages, which would undermine Congress’s goal of increasing incentives for creditors to make more stable, affordable loans. The Board requested comment on whether any other types of fees should be included in points and fees only if they are ‘‘payable at or before closing.’’ Several industry commenters stated that charges paid after closing should not be included in points and fees and requested that the Bureau clarify whether such charges are included. For example, some industry commenters sought confirmation that charges for a subsequent loan modification would not be included in points and fees. More PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 generally, industry commenters argued that they would have difficulty calculating charges that would be paid after closing and that including such charges in points and fees would create uncertainty and litigation risk. In response to the Bureau’s 2012 HOEPA Proposal, one consumer advocate noted that there are inconsistent and confusing standards for when charges must be payable to be included in points and fees. This commenter recommended that the Bureau adopt a ‘‘known at or before closing’’ standard, arguing that this standard would clarify that financed points are included, would prevent creditors from evading the points and fees test by requiring consumers to pay charges after consummation, and would provide certainty to creditors that must know the amount of points and fees at or before closing. The Bureau appreciates that creditors need certainty in calculating points and fees so they can ensure that they are originating qualified mortgages (or are not exceeding the points and fees thresholds for high-cost mortgages). The Dodd-Frank Act provides that for the points and fees tests for both qualified mortgages and high-cost mortgages, only charges ‘‘payable in connection with’’ the transaction are included in points and fees. See TILA sections 103(bb)(1)(A)(ii) (high-cost mortgages) and 129C(b)(2)(A)(vii) (qualified mortgages). The Bureau interprets this ‘‘in connection with’’ requirement as limiting the universe of charges that need to be included in points and fees. To clarify when charges or fees are ‘‘in connection with’’ a transaction, the Bureau is specifying in § 1026.32(b)(1) that fees or charges are included in points and fees only if they are ‘‘known at or before consummation.’’ The Bureau is also adding new comment 32(b)(1)–1, which provides examples of fees and charges that are and are not known at or before consummation. The comment explains that charges for a subsequent loan modification generally would not be included in points and fees because, at consummation, the creditor would not know whether a consumer would seek to modify the loan and therefore would not know whether charges in connection with a modification would ever be imposed. Indeed, loan modification fees likely would not be included in the finance charge under § 1026.4, as they would not be charges imposed by creditor as an incident to or a condition of the extension of credit. Thus, this clarification is consistent with the definition of the finance charge. Comment 32(b)(1)–1 also E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations clarifies that the maximum prepayment penalties that may be charged or collected under the terms of a mortgage loan are included in points and fees under § 1026.32(b)(1)(v). In addition, comment 32(b)(1)–1 notes that, under § 1026.32(b)(1)(i)(C)(1) and (iv), premiums or other charges for private mortgage insurance and credit insurance payable after consummation are not included in points and fees. This means that such charges may be included in points and fees only if they are payable at or before consummation. Thus, even if the amounts of such premiums or other charges are known at or before consummation, they are included in points and fees only if they are payable at or before consummation. 32(b)(1)(i) sroberts on DSK5SPTVN1PROD with Points and Fees—Included in the Finance Charge TILA section 103(aa)(4)(A) specifies that ‘‘points and fees’’ includes all items included in the finance charge, except interest or the time-price differential. This provision is implemented in current § 1026.32(b)(1)(i). Section 1431 of the Dodd-Frank Act added TILA section 103(bb)(1)(C), which excludes from points and fees certain types and amounts of mortgage insurance premiums. The Board proposed to revise § 226.32(b)(1)(i) to implement these provisions. The Board proposed to move the exclusion of interest or the timeprice differential to new § 226.32(b)(1)(i)(A). The Board also proposed to add § 226.32(b)(1)(i)(B) to implement the new exclusion for certain mortgage insurance. In § 226.32(b)(1)(i), the Board proposed to revise the phrase ‘‘all items required to be disclosed under § 226.4(a) and 226.4(b)’’ to read ‘‘all items considered to be a finance charge under § 226.4(a) and 226.4(b)’’ because § 226.4 does not itself require disclosure of the finance charge. One industry commenter argued that the definition of points and fees was overbroad because it included all items considered to be a finance charge. The commenter asserted that several items that are included in the finance charge under § 1026.4(b) are vague or inapplicable in the context of mortgage transactions or duplicate items specifically addressed in other provisions. Several industry commenters also requested clarification about whether certain types of fees and charges are included in points and fees. At least two commenters asked that the Bureau clarify that closing agent costs are not included in points and fees. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 The Bureau is adopting renumbered § 1026.32(b)(1)(i) and (i)(A) substantially as proposed, with certain clarifications in the commentary and in other parts of the rule as discussed below to address commenters’ requests for clarification. For consistency with the language in § 1026.4, the Bureau is revising § 1026.32(b)(1)(i) to refer to ‘‘items included in the finance charge’’ rather than ‘‘items considered to be a finance charge.’’ As noted above, several commenters requested clarification regarding whether certain types of charges would be included in points and fees. With respect to closing agent charges, § 1026.4(a)(2) provides a specific rule for when such charges must be included in the finance charge. If they are not included in the finance charge, they would not be included in points and fees. Moreover, as discussed below and in new comment 32(b)(1)(i)(D)–1, certain closing agent charges may also be excluded from points and fees as bona fide third-party charges that are not retained by the creditor, loan originator, or an affiliate of either. The Board also proposed to revise comment 32(b)(1)(i)–1, which states that § 226.32(b)(1)(i) includes in the total ‘‘points and fees’’ items defined as finance charges under § 226.4(a) and 226.4(b). The comment explains that items excluded from the finance charge under other provisions of § 226.4 are not included in the total ‘‘points and fees’’ under § 226.32(b)(1)(i), but may be included in ‘‘points and fees’’ under § 226.32(b)(1)(ii) and (iii). The Board proposed to revise this comment to state that items excluded from the finance charge under other provisions of § 226.4 may be included in ‘‘points and fees’’ under § 226.32(b)(1)(ii) through (vi).76 The proposed revision was intended to reflect the additional items added to the definition of ‘‘points and fees’’ by the Dodd-Frank Act and corrected the previous omission of § 226.32(b)(1)(iv). See proposed § 226.32(b)(1)(v) and (vi). The proposed comment also would have added an example of how this rule would operate. Under that example, a fee imposed by the creditor for an appraisal performed by an employee of the creditor meets the general definition of ‘‘finance charge’’ under § 226.4(a) as 76 Proposed comment 32(b)(1)(i)–1 contained a typographical error. It stated that ‘‘[i]tems excluded from the finance charge under other provisions of § 226.4 are not excluded in the total ‘‘points and fees’’ under § 226.32(b)(1)(i), but may be included in ‘‘points and fees’’ under § 226.32(b)(1)(ii) through § 226.32(b)(1)(vi).’’ (emphasis added). It should have read that such items ‘‘are not included in the total ‘‘points and fees’’ under § 226.32(b)(1)(i), but may be included in ‘‘points and fees’’ under § 226.32(b)(1)(ii) through § 226.32(b)(1)(vi).’’ PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 6425 ‘‘any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit.’’ However, § 226.4(c)(7) expressly provides that appraisal fees are not finance charges. Therefore, under the general rule in proposed § 226.32(b)(1)(i) providing that finance charges must be counted as points and fees, a fee imposed by the creditor for an appraisal performed by an employee of the creditor would not have been counted in points and fees. Proposed § 226.32(b)(1)(iii), however, would have expressly included in points and fees items listed in § 226.4(c)(7) (including appraisal fees) if the creditor receives compensation in connection with the charge. A creditor would receive compensation for an appraisal performed by its own employee. Thus, the appraisal fee in this example would have been included in the calculation of points and fees. The Bureau did not receive substantial comment on this proposed guidance. The Bureau is adopting comment 32(b)(1)(i)–1, with certain revisions for clarity. As revised, comment 32(b)(1)(i)–1 explains that certain items that may be included in the finance charge under § 1026.32(b)(1)(i) are excluded under § 1026.32(b)(1)(i)(A) through (F). Mortgage Insurance Under existing § 1026.32(b)(1)(i), mortgage insurance premiums are included in the finance charge and therefore are included in points and fees if payable at or before closing. As noted above, the Board proposed new § 226.32(b)(1)(i)(B) to implement TILA section 103(bb)(1)(C), which provides that points and fees shall exclude certain charges for mortgage insurance premiums. Specifically, the statute excludes: (1) Any premium charged for insurance provided by an agency of the Federal Government or an agency of a State; (2) any amount that is not in excess of the amount payable under policies in effect at the time of origination under section 203(c)(2)(A) of the National Housing Act, provided that the premium, charge, or fee is required to be refundable on a pro-rated basis and the refund is automatically issued upon notification of the satisfaction of the underlying mortgage loan; and (3) any premium paid by the consumer after closing. The Board noted that the exclusions for certain premiums could plausibly be interpreted to apply to the definition of points and fees solely for purposes of high-cost mortgages and not for qualified mortgages. TILA section E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6426 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations 129C(b)(2)(C)(i) cross-references TILA section 103(aa)(4) (renumbered as 103(bb)(4)) for the definition of ‘‘points and fees,’’ but the provision on mortgage insurance appears in TILA section 103(bb)(1)(C) and not in section 103(bb)(4). The Board also noted that certain provisions in the Dodd-Frank Act’s high-cost mortgage section regarding points and fees are repeated in the qualified mortgage section on points and fees. For example, both the highcost mortgage provisions and the qualified mortgage provisions expressly exclude from points and fees ‘‘bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or mortgage originator.’’ TILA sections 103(bb)(1)(A)(ii) (for high-cost mortgages), 129C(b)(2)(C)(i) (for qualified mortgages). The mortgage insurance provision, however, does not separately appear in the qualified mortgage section. Nonetheless, the Board concluded that the better interpretation of the statute is that the mortgage insurance provision in TILA section 103(bb)(1)(C) applies to the meaning of points and fees for both high-cost mortgages and qualified mortgages. The Board noted that the statute’s structure reasonably supports this view: by its plain language, the mortgage insurance provision prescribes how points and fees should be computed ‘‘for purposes of paragraph (4),’’ i.e., for purposes of TILA section 103(bb)(4). The mortgage insurance provision contains no caveat limiting its application solely to the points and fees calculation for high-cost mortgages. Thus, the Board determined that the cross-reference in the qualified mortgage provisions to TILA section 103(bb)(4) should be read to include provisions that expressly prescribe how points and fees should be calculated under TILA section 103(bb)(4), wherever located. The Board noted that its proposal to apply the mortgage insurance provision to the meaning of points and fees for both high-cost mortgages and qualified mortgages is also supported by the Board’s authority under TILA section 105(a) to make adjustments to facilitate compliance with TILA. The Board also cited its authority under TILA section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Board finds necessary or proper to effectuate the purposes of TILA. The purposes of TILA include ‘‘assur[ing] that consumers are offered and receive residential mortgage loan on terms that reasonably reflect their ability to repay the loans.’’ TILA section 129B(a)(2). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 The Board also expressed concern about the increased risk of confusion and compliance error if points and fees were to have two separate meanings in TILA—one for determining whether a loan is a high-cost mortgage and another for determining whether a loan is a qualified mortgage. The Board stated that the proposal is intended to facilitate compliance by applying the mortgage insurance provision to the meaning of points and fees for both high-cost mortgages and qualified mortgages. In addition, the Board expressed concern that market distortions could result due to different treatment of mortgage insurance in calculating points and fees for high-cost mortgages and qualified mortgages. ‘‘Points and fees’’ for both high-cost mortgages and qualified mortgages generally excludes ‘‘bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or mortgage originator.’’ TILA sections 103(bb)(1)(A)(ii), 129C(b)(2)(C)(i). Under this general provision standing alone, premiums for up-front private mortgage insurance would be excluded from points and fees. However, as noted, the statute’s specific provision on mortgage insurance (TILA section 103(bb)(1)(C)) imposes certain limitations on the amount and conditions under which upfront premiums for private mortgage insurance are excluded from points and fees. Applying the mortgage insurance provision to the definition of points and fees only for high-cost mortgages would mean that any premium amount for upfront private mortgage insurance could be charged on qualified mortgages; in most cases, none of that amount would be subject to the cap on points and fees for qualified mortgages because it would be excluded as a ‘‘bona fide third party fee’’ that is not retained by the creditor, loan originator, or an affiliate of either. The Board noted that, as a result, consumers who obtain qualified mortgages could be vulnerable to paying excessive up-front private mortgage insurance costs. The Board concluded that this outcome would undercut Congress’s clear intent to ensure that qualified mortgages are products with limited fees and more safe features. For the reasons noted by the Board, the Bureau interprets the mortgage insurance provision in TILA section 103(bb)(1)(C) as applying to the meaning of points and fees for both high-cost mortgages and qualified mortgages. The Bureau is also adopting this approach pursuant to its authority under TILA sections 105(a) and 129C(b)(3)(B)(i). Applying the mortgage insurance provision to the meaning of points and fees for qualified mortgages is necessary PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 and proper to effectuate the purposes of, and facilitate compliance with the purposes of, the ability-to-repay requirements in TILA section 129C. Similarly, the Bureau finds that it is necessary and proper to use its authority under TILA section 129C(b)(3)(B)(i) to revise, add to, or subtract from the criteria that define a qualified mortgage. As noted above, construing the mortgage insurance provision as applying to qualified mortgages will reduce the likelihood that consumers who obtain qualified mortgages will pay excessive private mortgage insurance premiums, and therefore will help ensure that responsible, affordable credit remains available to consumers in a manner consistent with the purposes of TILA section 129C. Proposed § 226.32(b)(1)(i)(B) tracked the substance of the statute with one exception. The Board interpreted the statute as excluding from points and fees not only up-front mortgage insurance premiums under government programs but also charges for mortgage guaranties under government programs. The Board noted that it was proposing the exclusion from points and fees of both mortgage insurance premiums and guaranty fees under government programs pursuant to its authority under TILA section 105(a) to make adjustments to facilitate compliance with TILA and its purposes and to effectuate the purposes of TILA. The Board also found that the exclusion is further supported by the Board’s authority under TILA section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Board finds necessary or proper to effectuate the purposes of TILA. The purposes of TILA include ‘‘assur[ing] that consumers are offered and receive residential mortgage loan on terms that reasonably reflect their ability to repay the loans.’’ TILA section 129B(a)(2). The Board noted that both the U.S. Department of Veterans Affairs (VA) and the U.S. Department of Agriculture (USDA) expressed concerns that, if upfront charges for guaranties provided by those agencies and State agencies were included in points and fees, their loans might exceed high-cost thresholds and exceed the cap for qualified mortgages, thereby disrupting these programs and jeopardizing an important source of credit for many consumers. The Board requested comment on its proposal to exclude up-front charges for any guaranty under a Federal or State government program, as well as any upfront mortgage insurance premiums under government programs. Several industry commenters argued that premiums for private mortgage E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations insurance should be excluded altogether, even if the premiums do not satisfy the statutory standard for exclusion. These commenters noted that private mortgage insurance provides substantial benefits, allowing consumers who cannot afford a down payment an alternative for obtaining credit. Another commenter noted that the refundability requirement of the rule would make private mortgage insurance more expensive. One industry commenter asserted that the language in proposed § 226.32(b)(1)(i)(B)(2) was inconsistent with the statutory language and the example in the commentary. The commenter suggested that a literal reading of proposed § 226.32(b)(1)(i)(B)(2) would require exclusion of the entire premium if it exceeded the FHA insurance premium, rather than merely exclusion of that portion of the premium in excess of the FHA premium. Another industry commenter maintained that the term ‘‘upfront’’ is vague and that the Bureau instead should use the phrase ‘‘payable at or before closing.’’ The Bureau is adopting proposed § 226.32(b)(1)(i)(B) as reunumbered § 1026.32(b)(1)(i)(B) with no substantive changes but with revisions for clarity. The Bureau is dividing proposed § 226.32(b)(1)(i)(B) into two parts. The first part, § 1026.32(b)(1)(i)(B), addresses insurance premiums and guaranty charges under government programs. The second part, § 1026.32(b)(1)(i)(C), addresses premiums for private mortgage insurance. Consistent with the Board’s proposal, § 1026.32(b)(1)(i)(B) excludes from points and fees charges for mortgage guaranties under government programs, as well as premiums for mortgage insurance under government programs. The Bureau concurs with the Board’s interpretation that, in addition to mortgage insurance premiums under government programs, the statute also excludes from points and fees charges for mortgage guaranties under government programs. Like the Board, the Bureau believes that this conclusion is further supported by TILA sections 105(a) and 129C(b)(3)(B)(i) and that it is necessary and proper to invoke this authority. The exclusion from points and fees of charges for mortgage guaranties under government programs is necessary and proper to effectuate the purposes of TILA. The Bureau is concerned that including such charges in points and fees could cause loans offered through government programs to exceed high-cost mortgage thresholds and qualified mortgage points and fees limits, potentially disrupting an VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 important source of affordable financing for many consumers. This exclusion helps ensure that loans do not unnecessarily exceed the points and fees limits for qualified mortgages, which is consistent with the purpose, stated in TILA section 129B(a)(2), of assuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans and with the purpose stated in TILA section 129C(b)(3)(B)(i) of ensuring that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of TILA section 129C. Proposed comment 32(b)(1)(i)–2 provided an example of a mortgage insurance premium that is not counted in points and fees because the loan was insured by the FHA. The Bureau is renumbering this comment as 32(b)(1)(i)(B)–1 and revising it to add an additional example to clarify that mortgage guaranty fees under government programs, such as VA and USDA funding fees, are excluded from points and fees. The Bureau is also deleting the reference to ‘‘up-front’’ premiums and charges. Under the statute, premiums for mortgage insurance or guaranty fees in connection with a Federal or State government program are excluded from points and fees whenever paid. The statutory provision excluding premiums or charges paid after consummation applies only to private mortgage insurance. The Bureau is addressing exclusions for private mortgage insurance in § 1026.32(b)(1)(i)(C). For private mortgage insurance premiums payable after consummation, § 1026.32(b)(1)(i)(C)(1) provides that the entire amount of the premium is excluded from points and fees. For private mortgage insurance premiums payable at or before consummation, § 1026.32(b)(1)(i)(C)(1) provides that the portion of the premium not in excess of the amount payable under policies in effect at the time of origination under section 203(c)(2)(A) of the National Housing Act is excluded from points and fees, provided that the premium is required to be refundable on a pro-rated basis and the refund is automatically issued upon notification of the satisfaction of the underlying mortgage loan. As noted by one commenter, the language in proposed § 226.32(b)(1)(i)(B) could be read to conflict with the statute and the commentary because it suggested that, if a private mortgage insurance premium payable at or before consummation exceeded the FHA insurance premium, then the entire PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 6427 private mortgage insurance premium would be included in points and fees. The Bureau is clarifying in § 1026.32(b)(1)(i)(C)(2) that only the portion of the private mortgage insurance premium that exceeds the FHA premium must be included in points and fees. With respect to the comments requesting that all private mortgage insurance premiums be excluded from points and fees, the Bureau notes that TILA section 103(bb)(1)(C) prescribes specific and detailed conditions for excluding private mortgage insurance premiums. Under these circumstances, the Bureau does not believe it would be appropriate to exercise its exception authority to reverse Congress’s decision. Proposed comment 32(b)(1)(i)–3 explained that private mortgage insurance premiums payable at or before consummation need not be included in points and fees to the extent that the premium does not exceed the amount payable under policies in effect at the time of origination under section 203(c)(2)(A) of the National Housing Act and the premiums are required to be refunded on a pro-rated basis and the refund is automatically issued upon notification of satisfaction of the underlying mortgage loan. Proposed comment 32(b)(1)(i)–3 also provided an example of this exclusion. Proposed comment 32(b)(1)(i)–4 explained that private mortgage insurance premiums that do not qualify for an exclusion must be included in points and fees whether paid at or before consummation, in cash or financed, whether optional or required, and whether the amount represents the entire premium or an initial payment. The Bureau did not receive substantial comments on these proposed interpretations. The Bureau is adopting comments 32(b)(1)(i)–3, and –4 with certain revisions for clarity and renumbered as comments 32(b)(1)(i)(C)– 1 and –2. Comment 32(b)(1)(i)(C)–1.i is revised to specify that private mortgage insurance premiums paid after consummation are excluded from points and fees. The Bureau also adopts clarifying changes that specify that creditors originating conventional loans—even such loans that are not eligible to be FHA loans (i.e., because their principal balance is too high)— should look to the permissible up-front premium amount for FHA loans, as implemented by applicable regulations and other written authorities issued by the FHA (such as Mortgagee Letters). For example, pursuant to HUD’s Mortgagee Letter 12–4 (published March 6, 2012), the allowable up-front FHA premium for single-family homes is 1.75 E:\FR\FM\30JAR2.SGM 30JAR2 6428 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations percent of the base loan amount.77 Finally, the Bureau clarifies that only the portion of the single or up-front PMI premium in excess of the allowable FHA premium (i.e., rather than any monthly premium or portion thereof) must be included in points and fees. Comments 32(b)(1)(i)(C)–1 and –2 also have both been revised for clarity and consistency. For example, the comments as adopted refer to premiums ‘‘payable at or before consummation’’ rather than ‘‘up-front’’ premiums and to ‘‘consummation’’ rather than ‘‘closing.’’ The Bureau notes that the statute refers to ‘‘closing’’ rather than ‘‘consummation.’’ However, for consistency with the terminology in Regulation Z, the Bureau is using the term ‘‘consummation.’’ sroberts on DSK5SPTVN1PROD with Bona Fide Third-Party Charges and Bona Fide Discount Points The Dodd-Frank Act amended TILA to add nearly identical provisions excluding certain bona fide third-party charges and bona fide discount points from the calculation of points and fees for both qualified mortgages and highcost mortgages.78 Specifically, section 1412 of the Dodd-Frank Act added new TILA section 129C(b)(2)(C), which excludes certain bona fide third-party charges and bona fide discount points from the calculation of points and fees for the qualified mortgage points and fees threshold. Similarly, section 1431 of the Dodd-Frank Act amended TILA section 103(bb)(1)(A)(ii) and added TILA section 103(dd) to provide for nearly identical exclusions in calculating points and fees for the highcost mortgage threshold. In the 2011 ATR Proposal, the Board proposed to implement in § 226.43(e)(3)(ii)(A) through (C) the exclusion of certain bona fide thirdparty charges and bona fide discount points only for the calculation of points and fees for the qualified mortgage points and fees threshold. In the 2012 HOEPA Proposal, the Bureau proposed to implement these exclusions in 77 See Department of Housing and Urban Development, Mortgagee Letter 12–4 (Mar. 6, 2012), available at https://portal.hud.gov/hudportal/ documents/huddoc?id=12-04ml.pdf. 78 The exclusions differ in only one respect. To exclude two or one bona fide discount points from the points and fees test for determining whether a loan is a high-cost mortgage, TILA section 103(dd)(1)(B) and (C) specified that the interest rate for personal property loans before the discount must be within 1 or 2 percentage points, respectively, of the average rate on a loan in connection with which insurance is provided under title I of the National Housing Act. TILA section 129C(b)(2)(C), which prescribes conditions for excluding bona fide discount points from points and fees for qualified mortgages, does not contain analogous provisions. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 proposed § 1026.32(b)(5) for the points and fees threshold for high-cost mortgages. The Bureau noted that proposed § 1026.32(b)(5) was generally consistent with the Board’s proposed § 226.43(e)(3)(ii)(A) through (C). The Bureau believes that it is appropriate to consolidate these exclusions in a single provision. The Bureau is now finalizing both rules, and the exclusions are nearly identical for both the qualified mortgage and highcost mortgage contexts. Moreover, under the Board’s ATR Proposal, the points and fees calculation for the qualified mortgage points and fees threshold already would have cross-referenced the definition of points and fees for highcost mortgages in § 226.32(b)(1). Given that the points and fees calculations for both the qualified mortgage and highcost mortgage points and fees thresholds will use the same points and fees definition in § 1026.32(b)(1), the Bureau believes it is unnecessary to implement nearly identical exclusions from points and fees in separate provisions for qualified mortgages and high-cost mortgages. Accordingly, the Bureau is consolidating the exclusions for certain bona fide third-party charges and bona fide discount points for both qualified mortgages and high-cost mortgages in new § 1026.32(b)(1)(i)(D) through (F). In addition, the definition of ‘‘bona fide discount points’’ for the purposes of § 1026.32(b)(1)(i)(E) and (F), which the 2011 ATR Proposal would have implemented in § 226.43(e)(3)(iv), is instead being implemented in § 1026.32(b)(3). Bona fide third-party charges. TILA Section 129C(b)(2)(C)(i) excludes from points and fees ‘‘bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or mortgage originator.’’ Tracking the statute, proposed § 226.43(e)(3)(ii)(A) would have excluded from ‘‘points and fees’’ for qualified mortgages any bona fide third party charge not retained by the creditor, loan originator, or an affiliate of either. Proposed § 226.43(e)(3)(iii) would have specified that the term ‘‘loan originator’’ has the same meaning as in § 226.36(a)(1). Proposed § 226.43(e)(3)(ii)(A) would also have implemented TILA section 103(bb)(1)(C), which requires that premiums for private mortgage insurance be included in ‘‘points and fees’’ as defined in TILA section 103(bb)(4) under certain circumstances. Applying general rules of statutory construction, the Board concluded that the more specific provision on private mortgage insurance supersedes the more general provision permitting any bona PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 fide third party charge not retained by the creditor, mortgage originator, or an affiliate of either to be excluded from ‘‘points and fees.’’ Thus, proposed § 226.43(e)(3)(ii)(A) would have excluded from points and fees any bona fide third party charge not retained by the creditor, loan originator, or an affiliate of either unless the charges were premiums for private mortgage insurance that were included in points and fees under § 226.32(b)(1)(i)(B). The Board noted that, in setting the purchase price for specific loans, Fannie Mae and Freddie Mac make loan-level price adjustments (LLPAs) to compensate offset added risks, such as a high LTV or low credit score, among many other risk factors. Creditors may, but are not required to, increase the interest rate charged to the consumer so as to offset the impact of the LLPAs or increase the costs to the consumer in the form of points to offset the lost revenue resulting from the LLPAs. The Board noted that, during outreach, some creditors argued that these points should not be counted in points and fees for qualified mortgages under the exclusion for ‘‘bona fide third party charges not retained by the loan originator, creditor, or an affiliate of either’’ in TILA section 129C(b)(2)(C). The Board acknowledged creditors’ concerns about exceeding the qualified mortgage points and fees thresholds due to LLPAs required by the GSEs. However, the Board questioned whether an exemption for LLPAs would be consistent with congressional intent in limiting points and fees for qualified mortgages. The Board noted that points charged to meet GSE risk-based price adjustment requirements are arguably no different than other points charged on loans sold to any secondary market purchaser to compensate that purchaser for added loan-level risks. Congress clearly contemplated that discount points generally should be included in points and fees for qualified mortgages. The Board noted that an exclusion for points charged by creditors in response to secondary market LLPAs also would raise questions about the appropriate treatment of points charged by creditors to offset loan-level risks on mortgage loans that they hold in portfolio. The Board reasoned that, under normal circumstances, these points are retained by the creditor, so it would not be appropriate to exclude them from points and fees under the ‘‘bona fide third party charge’’ exclusion. However, the Board cautioned that requiring that these points be included in points and fees, when similar charges on loans sold into the secondary market are excluded, may create undesirable market E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations imbalances between loans sold to the secondary market and loans held in portfolio. The Board also noted that creditors may offset risks on their portfolio loans (or on loans sold into the secondary market) by charging a higher rate rather than additional points and fees; however, the Board recognized the limits of this approach to loan-level risk mitigation due to concerns such as exceeding high-cost mortgage rate thresholds. Nonetheless, the Board noted that in practice, an exclusion from the qualified mortgage points and fees calculation for all points charged to offset loan-level risks may create compliance and enforcement difficulties. The Board questioned whether meaningful distinctions between points charged to offset loanlevel risks and other points and fees charged on a loan could be made clearly and consistently. In addition, the Board observed that such an exclusion could be overbroad and inconsistent with Congress’s intent that points generally be counted toward the points and fees threshold for qualified mortgages. The Board requested comment on whether and on what basis the final rule should exclude from points and fees for qualified mortgages points charged to meet risk-based price adjustment requirements of secondary market purchasers and points charged to offset loan-level risks on mortgages held in portfolio. Consumer advocates did not comment on this issue. Many industry commenters argued that LLPAs should be excluded from points and fees as bona fide third party charges. The GSE commenters agreed that LLPAs should be excluded as bona fide third party charges, noting that they are not retained by the creditor. One GSE commenter noted that LLPAs are set fees that are transparent and accessible via the GSEs’ Web sites. Some industry commenters contended that including LLPAs in points and fees would cause many loans to exceed the points and fees cap for qualified mortgages. Other industry commenters argued that requiring LLPAs to be included in points and fees would force creditors to recover the costs through increases in the interest rate. One of the GSE commenters acknowledged the concern that creditors holding loans in portfolio could be at a disadvantage if LLPAs were excluded from points and fees and suggested that the Bureau consider allowing such creditors to exclude published loan level risk adjustment fees. One industry commenter urged the Bureau to coordinate with the agencies VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 responsible for finalizing the 2011 QRM Proposed Rule to avoid unintended consequences. The 2011 ARM Proposed Rule, if adopted, would require, in certain circumstances, that sponsors of MBS create premium capture cash reserve accounts to limit sponsors’ ability to monetize the excess spread between the proceeds from the sale of the interests and the par value of those interests. See 76 FR 24113. The commenter stated that this would result in any premium in the price of a securitization backed by residential mortgage loans being placed in a firstloss position in the securitization. The commenter argued that this would make premium loans too expensive to originate and that creditors would not be able to recover LLPAs through interest rate adjustments. The commenter maintained that if the LLPAs were included in the calculation for the qualified mortgage points and fees limit, creditors would also be severely constrained in recovering LLPAs through points. The commenter argued that LLPAs therefore should be excluded from the points and fees calculation for qualified mortgages. The Bureau is adopting § 226.43(e)(3)(ii)(A), with certain revisions, as renumbered § 1026.32(b)(1)(i)(D). As revised, § 1026.32(b)(1)(i)(D) provides that a bona fide third party charge not retained by the creditor, loan originator, or an affiliate of either the general is excluded from points and fees unless the charge is required to be included under § 1026.32(b)(1)(i)(C) (for mortgage insurance premiums), (iii) (for real estate related fees), or (iv) (for credit insurance premiums). As noted above, the Board proposed that the specific provision regarding mortgage insurance, TILA section 103(bb)(1)(C), should govern the exclusion of private mortgage insurance premiums of points and fees, rather than TILA section 129C(b)(2)(C), which provides generally for the exclusion of certain bona fide thirdparty charges. The Bureau likewise believes that the specific statutory provisions regarding real estate related fees and credit insurance premiums in TILA section 103(bb)(4)(C) and (D) should govern whether these charges are included in points and fees rather than the more general provisions regarding exclusion of bona fide third-party charges, TILA sections 103(bb)(1)(A)(ii) (for high-cost mortgages) or 129C(b)(2)(C) (for qualified mortgages). Thus, § 1026.32(b)(1)(i)(D) provides that the general exclusion for bona fide third-party charges applies unless the PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 6429 charges are required to be included under § 1026.32(b)(1)(i)(C), (iii), or (iv). The Bureau acknowledges that TILA sections 103(bb)(1)(A)(ii) and 129C(b)(2)(C) could plausibly be read to provide for a two-step calculation of points and fees: first, the creditor would calculate points and fees as defined in TILA section 103(bb)(4); and, second, the creditor would exclude all bona fide third-party charges not retained by the mortgage originator, creditor, or an affiliate of either, as provided in TILA sections 103(bb)(1)(A)(ii) (for high-cost mortgages) and 129C(b)(2)(C) (for qualified mortgages). Under this reading, charges for, e.g., private mortgage insurance could initially, in step one, be included in points and fees but then, in step two, be excluded as bona fide third-party charges under TILA sections 103(bb)(1)(A)(ii) or 129C(b)(2)(C). To give meaning to the specific statutory provisions regarding mortgage insurance, real estate related fees, and credit insurance, the Bureau believes that the better reading is that these specific provisions should govern whether such charges are included in points and fees, rather than the general provisions excluding certain bona fide third-party charges. For example, Congress added TILA section 103(bb)(1)(C), which prescribes certain conditions under which private mortgage insurance premiums would be included in points and fees. The Bureau believes that the purpose of this provision is to help ensure that consumers with a qualified mortgage are not charged excessive private mortgage insurance premiums. If such premiums could be excluded as bona fide thirdparty charges under TILA sections 103(bb)(1)(A)(ii) or 129C(b)(2)(C), then the purpose of this provision would be undermined. In further support of its interpretation, the Bureau is invoking its authority under TILA section 105(a) to make such adjustments and exceptions as are necessary and proper to effectuate the purposes of TILA, including that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans. Similarly, the Bureau finds that it is necessary, proper and appropriate to use its authority under TILA section 129C(b)(3)(B)(i) to revise and subtract from the statutory language. This use of authority ensures that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purpose of TILA section 129C, referenced above, as well as effectuating that purpose. As noted above, several industry commenters argued that points charged E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6430 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations by creditors to offset LLPAs should be excluded from points and fees under § 1026.32(b)(1)(i)(D). In setting the purchase price for loans, the GSEs impose LLPAs to offset certain credit risks, and creditors may but are not required to recoup the revenue lost as a result of the LLPAs by increasing the costs to consumers in the form of points. The Bureau believes that the manner in which creditors respond to LLPAs is better viewed as a fundamental component of how the pricing of a mortgage loan is determined rather than as a third party charge. As the Board noted, allowing creditors to exclude points charged to offset LLPAs could create market imbalances between loans sold on the secondary market and loans held in portfolio. While such imbalances could be addressed by excluding risk adjustment fees more broadly, including fees charged by creditors for loans held in portfolio, the Bureau agrees with the Board that this could create compliance and enforcement difficulties. Thus, the Bureau concludes that points charged to offset LLPAs may not be excluded from points and fees under § 1026.32(b)(1)(i)(D). To the extent that creditors offer consumers the opportunity to pay points to lower the interest rate that the creditor would otherwise charge to recover the lost revenue from the LLPAs, such points may, if they satisfy the requirements of § 1026.32(b)(1)(i)(E) or (F), be excluded from points and fees as bona fide discount points. As noted above, one commenter expressed concern that if the requirements for premium capture cash reserve accounts proposed in the 2011 QRM Proposed Rule were adopted, creditors would have difficulty in recovering the costs of LLPAs through rate and that, because of the points and fees limits for qualified mortgages, creditors would also have trouble recovering the costs of LLPAs through up-front charges to consumers. The Bureau notes that, as proposed, the premium capture cash reserve account requirement would not apply to securities sponsored by the GSEs and would not apply to securities comprised solely of QRMs. See 76 FR 24112, 24120. Thus, it is not clear, that even if it were adopted, the requirement would have as substantial an impact as suggested by the commenter. In any event, the requirement has merely been proposed, not finalized. The Bureau will continue to coordinate with the agencies responsible for finalizing the 2011 QRM Proposed Rule to consider the combined effects of that rule and the instant rule. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 The Board proposed comment 43(e)(3)(ii)–1 to clarify the meaning in proposed § 226.43(e)(3)(ii)(A) of ‘‘retained by’’ the loan originator, creditor, or an affiliate of either. Proposed comment 43(e)(3)(ii)–1 provided that if a creditor charges a consumer $400 for an appraisal conducted by a third party not affiliated with the creditor, pays the third party appraiser $300 for the appraisal, and retains $100, the creditor may exclude $300 of this fee from ‘‘points and fees’’ but must count the $100 it retains in ‘‘points and fees.’’ As noted above, several commenters expressed confusion about the relationship between proposed § 226.43(e)(3)(ii)(A), which would have excluded bona fide third party charges not retained by the loan originator, creditor, or an affiliate of either, and proposed § 226.32(b)(1)(iii), which would have excluded certain real estate related charges if they are reasonable, if the creditor receives no direct or indirect compensation in connection with the charges, and the charges are not paid to an affiliate of the creditor. As explained above, the Bureau interprets the more specific provision governing the inclusion in points and fees of real estate related charges (implemented in § 1026.32(b)(1)(iii)) as taking precedence over the more general exclusion for bona fide third party charges in renumbered § 1026.32(b)(1)(i)(D). Accordingly, the Bureau does not believe that the example in proposed comment 43(e)(3)(ii)–1 is appropriate for illustrating the exclusion for bona fide third party charges because the subject of the example, appraisals, is specifically addressed in § 1026.32(b)(1)(iii). The Bureau therefore is revising renumbered comment 32(b)(1)(i)(D)–1 by using a settlement agent charge to illustrate the exclusion for bona fide third party charges. By altering this example to address closing agent charges, the Bureau is also responding to requests from commenters that the Bureau provide more guidance on whether closing agent charges are included in points and fees. As noted above, proposed § 226.43(e)(3)(iii) would have specified that the term ‘‘loan originator,’’ as used in proposed § 226.43(e)(3)(ii)(A), has the same meaning as in § 226.36(a)(1). The Bureau is moving the cross-reference to the definition of ‘‘loan originator’’ in § 226.36(a)(1) to comment 32(b)(1)(i)(D)– 1. The Board proposed comment 43(e)(3)(ii)–2 to explain that, under § 226.32(b)(1)(i)(B), creditors would PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 have to include in ‘‘points and fees’’ premiums or charges payable at or before consummation for any private guaranty or insurance protecting the creditor against the consumer’s default or other credit loss to the extent that the premium or charge exceeds the amount payable under policies in effect at the time of origination under section 203(c)(2)(A) of the National Housing Act (12 U.S.C. 1709(c)(2)(A)). The proposed comment also would have explained that these premiums or charges would be included if the premiums or charges were not required to be refundable on a pro-rated basis, or the refund is not automatically issued upon notification of the satisfaction of the underlying mortgage loan. The comment would have clarified that, under these circumstances, even if the premiums and charges were not retained by the creditor, loan originator, or an affiliate of either, they would be included in the ‘‘points and fees’’ calculation for qualified mortgages. The comment also would have cross-referenced proposed comments 32(b)(1)(i)–3 and –4 for further discussion of including private mortgage insurance premiums in the points and fees calculation. The Bureau is adopting proposed comment 43(e)(3)(ii)–2 substantially as proposed, renumbered as comment 32(b)(i)(D)–2. In addition, the Bureau also is adopting new comments 32(b)(i)(D)–3 and –4 to explain that the exclusion of bona fide third party charges under § 1026.32(b)(1)(i)(D) does not apply to real estate-related charges and credit insurance premiums. The inclusion of these items in points and fees is specifically addressed in § 1026.32(b)(iii) and (iv), respectively. Bona fide discount points. TILA section 129C(b)(2)(C)(ii) excludes up to two bona fide discount points from points and fees under certain circumstances. Specifically, it excludes up to two bona fide discount points if the interest rate before the discount does not exceed the average prime offer rate by more than two percentage points. Alternatively, it excludes up to one discount point if the interest rate before the discount does not exceed the average prime offer rate by more than one percentage point. The Board proposed to implement this provision in proposed § 226.43(e)(3)(ii)(B) and (C). Proposed § 226.43(e)(3)(ii)(B) would have permitted a creditor to exclude from points and fees for a qualified mortgage up to two bona fide discount points paid by the consumer in connection with the covered transaction, provided that: (1) The interest rate before the rate is discounted does not exceed the average E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations prime offer rate, as defined in § 226.45(a)(2)(ii), by more than one percent; and (2) the average prime offer rate used for purposes of paragraph 43(e)(3)(ii)(B)(1) is the same average prime offer rate that applies to a comparable transaction as of the date the discounted interest rate for the covered transaction is set. Proposed § 226.43(e)(3)(ii)(C) would have permitted a creditor to exclude from points and fees for a qualified mortgage up to one bona fide discount point paid by the consumer in connection with the covered transaction, provided that: (1) The interest rate before the discount does not exceed the average prime offer rate, as defined in § 226.45(a)(2)(ii), by more than two percent; (2) the average prime offer rate used for purposes of § 226.43(e)(3)(ii)(C)(1) is the same average prime offer rate that applies to a comparable transaction as of the date the discounted interest rate for the covered transaction is set; and (3) two bona fide discount points have not been excluded under § 226.43(e)(3)(ii)(B). Several industry commenters argued that creditors should be permitted to exclude from points and fees more than two discount points. Some industry commenters maintained that creditors should be permitted to exclude as many discount points as consumers choose to pay. Another commenter contended that creditors should be able to exclude as many as three discount points. A few industry commenters requested eliminating the requirement that, for the discount points to be bona fide, the interest rate before the discount must be within one or two percentage points of the average prime offer rate. One industry commenter argued that this requirement is too inflexible. Several commenters recommended that this requirement be adjusted for jumbo loans and for second homes. Another commenter claimed that this requirement would limit the options for consumers paying higher interest rates and that these are the consumers for whom it would be most beneficial to pay down their interest rates. Several commenters argued that the effect of these two limitations for excluding discount points from points and fees—the limit on the number of discount points that could be excluded and the requirement that the prediscount rate be within one or two points of the average prime offer rate— would have a negative impact on consumers. They maintained that these limitations would prevent consumers from choosing their optimal combination of interest rate and points for their financial circumstances. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 One commenter noted that proposed § 226.43(e)(3)(ii)(B) and (C) would require that, for the discount points or point to be excluded from points and fees, the interest rate before the discount must not exceed the average prime offer rate by more than one or two ‘‘percent,’’ respectively. The commenter recommended that, for clarity and consistency with the statute, the requirement should instead require that the interest rate before the discount be within one or two ‘‘percentage points’’ of the average prime offer rate. The Bureau is adopting proposed § 226.43(e)(3)(ii)(B) and (C), renumbered as § 1026.32(b)(1)(i)(E) and (F), with certain revisions. As suggested by a commenter, the Bureau is revising both § 1026.32(b)(1)(i)(E)(1) and (F)(1) to require that, to exclude the discount points or point, the interest rate must be within one or two ‘‘percentage points’’ (rather than ‘‘percent’’) of the average prime offer rate. This formulation is clearer and consistent with the statutory language. The Bureau is also adding § 1026.32(b)(1)(i)(E)(2) and (F)(2) to implement TILA section 103(dd)(1)(B) and (C), which specify that, to exclude discount points from points and fees for purposes of determining whether a loan is a high-cost mortgage, the interest rate for personal property loans before the discount must be within one or two percentage points, respectively, of the average rate on a loan in connection with which insurance is provided under title I of the National Housing Act. This provision does not apply to the points and fees limit for qualified mortgages, regardless of whether a loan is a highcost mortgage. The provision is included in the final rule for completeness. Finally, in § 1026.32(b)(1)(i)(F), the Bureau is clarifying that bona fide discount points cannot be excluded under § 1026.32(b)(1)(i)(F) if any bona fide discount points already have been excluded under § 1026.32(b)(1)(i)(E). As noted above, several commenters urged the Bureau to alter or eliminate the limitations on how many discount points may be excluded and the requirement that the pre-discount interest rate must be within one or two points of the average prime offer rate. A few industry commenters also requested that the Bureau adjust the limitation on the pre-discount interest rate specifically for jumbo loans and loans for vacation homes. These commenters noted that interest rates for such loans otherwise would often be too high to qualify for the exclusion for bona fide discount points. The Bureau recognizes that these limitations may circumscribe the ability of consumers to purchase PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 6431 discount points to lower their interest rates. Nevertheless, the Bureau does not believe it would be appropriate to exercise its exception authority. Congress apparently concluded that there was a greater probability of consumer injury when consumers purchased more than two discount points or when the consumers were using discount points to buy down higher interest rates. The Bureau also notes that, in other sections of the DoddFrank Act, Congress prescribed different thresholds above the average prime offer rate for jumbo loans. See TILA sections 129C(c)(1)(B) (prepayment penalties) and 129H(f)(2) (appraisals). Congress did not do so in the provision regarding exclusion of bona fide discount points. The Bureau is adding new comment 32(b)(1)(i)(E)–2 to note that the term ‘‘bona fide discount point’’ is defined in § 1026.32(b)(3). To streamline the rule, the Bureau is moving into new comment 32(b)(1)(i)(E)–2 the explanation that the average prime offer rate used for purposes of for both § 1026.32(b)(1)(i)(E) and (F) is the average prime offer rate that applies to a comparable transaction as of the date the discounted interest rate for the covered transaction is set. The Board proposed comment 43(e)(3)(ii)–5 to clarify that the average prime offer rate table indicates how to identify the comparable transaction. The Bureau is adding the language from proposed comment 43(e)(3)(ii)–5 to new comment 32(b)(1)(i)(E)–2, with a revision to the cross-reference for the comment addressing ‘‘comparable transaction.’’ Proposed comment 43(e)(3)(ii)–3 would have included an example to illustrate the rule permitting exclusion of two bona fide discount points. The example would have assumed a covered transaction that is a first-lien, purchase money home mortgage with a fixed interest rate and a 30-year term. It would also have assumed that the consumer locks in an interest rate of 6 percent on May 1, 2011, that was discounted from a rate of 6.5 percent because the consumer paid two discount points. Finally, assume that the average prime offer rate as of May 1, 2011 for first-lien, purchase money home mortgages with a fixed interest rate and a 30-year term is 5.5 percent. In this example, the creditor would have been able to exclude two discount points from the ‘‘points and fees’’ calculation because the rate from which the discounted rate was derived exceeded the average prime offer rate for a comparable transaction as of the date the rate on the covered transaction was set by only 1 percent. E:\FR\FM\30JAR2.SGM 30JAR2 6432 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations The Bureau is adopting proposed comment 43(e)(3)(ii)–3 substantially as proposed but renumbered as comment 32(b)(1)(i)(E)–3. The Bureau is also adding new comment 32(b)(1)(i)(F)–1 to explain that comments 32(b)(1)(i)(E)–1 and –2 provide guidance concerning the definitions of ‘‘bona fide discount point’’ and ‘‘average prime offer rate,’’ respectively. Proposed comment 43(e)(3)(ii)–4 would have provided an example to illustrate the rule permitting exclusion of one bona fide discount point. The example assumed a covered transaction that is a first-lien, purchase money home mortgage with a fixed interest rate and a 30-year term. The example also would have assumed that the consumer locks in an interest rate of 6 percent on May 1, 2011, that was discounted from a rate of 7 percent because the consumer paid four discount points. Finally, the example would have assumed that the average prime offer rate as of May 1, 2011, for first-lien, purchase money home mortgages with a fixed interest rate and a 30-year term is 5 percent. In this example, the creditor would have been able to exclude one discount point from the ‘‘points and fees’’ calculation because the rate from which the discounted rate was derived (7 percent) exceeded the average prime offer rate for a comparable transaction as of the date the rate on the covered transaction was set (5 percent) by only 2 percent. The Bureau is adopting proposed comment 43(e)(3)(ii)–4 substantially as proposed but renumbered as comment 32(b)(1)(i)(F)– 2. 32(b)(1)(ii) sroberts on DSK5SPTVN1PROD with When HOEPA was enacted in 1994, it required that ‘‘all compensation paid to mortgage brokers’’ be counted toward the threshold for points and fees that triggers special consumer protections under the statute. Specifically, TILA section 103(aa)(4) provided that charges are included in points and fees only if they are payable at or before consummation and did not expressly address whether ‘‘backend’’ payments from creditors to mortgage brokers funded out of the interest rate (commonly referred to as yield spread premiums) are included in points and fees.79 This requirement is implemented 79 Some commenters use the term ‘‘yield spread premium’’ to refer to any payment from a creditor to a mortgage broker that is funded by increasing the interest rate that would otherwise be charged to the consumer in the absence of that payment. These commenters generally assume that any payment to the brokerage firm by the creditor is funded out of the interest rate, reasoning that had the consumer paid the brokerage firm directly, the creditor would VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 in existing § 1026.32(b)(1)(ii), which requires that all compensation paid by consumers directly to mortgage brokers be included in points and fees, but does not address compensation paid by creditors to mortgage brokers or compensation paid by any company to individual employees (such as loan officers who are employed by a creditor or mortgage broker). The Dodd-Frank Act substantially expanded the scope of compensation included in points and fees for both the high-cost mortgage threshold in HOEPA and the qualified mortgage points and fees limits.80 Section 1431 of the DoddFrank Act amended TILA to require that ‘‘all compensation paid directly or indirectly by a consumer or creditor to a mortgage originator from any source, including a mortgage originator that is also the creditor in a table-funded transaction,’’ be included in points and fees. TILA section 103(bb)(4)(B) (emphasis added). Under amended TILA section 103(bb)(4)(B), compensation paid to anyone that qualifies as a ‘‘mortgage originator’’ is to be included in points and fees.81 Thus, in addition to compensation paid to mortgage brokerage firms and individual brokers, points and fees also includes compensation paid to other mortgage originators, including employees of a creditor (i.e., loan officers). In addition, as noted above, the Dodd-Frank Act removed the phrase ‘‘payable at or have had lower expenses and would have been able to charge a lower rate. Other commenters use the term ‘‘yield spread premium’’ more narrowly to refer only to a payment from a creditor to a mortgage broker that is based on the interest rate, i.e., the mortgage broker receives a larger payment if the consumer agrees to a higher interest rate. To avoid confusion, the Bureau is limiting its use of the term and is instead more specifically describing the payment at issue. 80 Currently, the points and fees threshold for determining whether a loan is a high-cost mortgage is the greater of 8 percent of the total loan amount or $400 (adjusted for inflation). Section 1431 of the Dodd-Frank Act lowered the points and fees threshold for determining whether a loan is a highcost mortgage to 5 percent of the total transaction amount for loans of $20,000 or more and to the lesser of 8 percent of the total transaction amount or $1,000 for loans less than $20,000. 81 ‘‘Mortgage originator’’ is generally defined to include ‘‘any person who, for direct or indirect compensation or gain, or in the expectation of direct or indirect compensation or gain—(i) takes a residential mortgage loan application; (ii) assists a consumer in obtaining or applying to obtain a residential mortgage loan; or (iii) offers or negotiates terms of a residential mortgage loan.’’ TILA section 103(dd)(2). The statute excludes certain persons from the definition, including a person who performs purely administrative or clerical tasks; an employee of a retailer of manufactured homes who does not take a residential mortgage application or offer or negotiate terms of a residential mortgage loan; and, subject to certain conditions, real estate brokers, sellers who finance three or fewer properties in a 12-month period, and servicers. TILA section 103(dd)(2)(C) through (F). PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 before closing’’ from the high-cost mortgage points and fees test and did not apply the ‘‘payable at or before closing’’ limitation to the points and fees cap for qualified mortgages. See TILA sections 103(bb)(1)(A)(ii) and 129C(b)(2)(A)(vii), (b)(2)(C). Thus, the statute appears to contemplate that even compensation paid to mortgage brokers and other loan originators after consummation should be counted toward the points and fees thresholds. This change is one of several provisions in the Dodd-Frank Act that focus on loan originator compensation and regulation, in apparent response to concerns that industry compensation practices contributed to the mortgage market crisis by creating strong incentives for brokers and retail loan officers to steer consumers into higherpriced loans. Specifically, loan originators were often paid a commission by creditors that increased with the interest rate on a transaction. These commissions were funded by creditors through the increased revenue received by the creditor as a result of the higher rate paid by the consumer and were closely tied to the price the creditor expected to receive for the loan on the secondary market as a result of that higher rate.82 In addition, many mortgage brokers charged consumers up-front fees to cover some of their costs at the same time that they accepted backend payments from creditors out of the rate. This may have contributed to consumer confusion about where the brokers’ loyalties lay. The Dodd-Frank Act took a number of steps to address loan originator compensation issues, including: (1) Adopting requirements that loan originators be ‘‘qualified’’ as defined by Bureau regulations; (2) generally prohibiting compensation based on rate and other terms (except for loan amount) and prohibiting a loan originator from receiving compensation from both consumers and other parties in a single transaction; (3) requiring the promulgation of additional rules to prohibit steering consumers to less advantageous transactions; (4) requiring the disclosure of loan originator compensation; and (5) restricting loan originator compensation under HOEPA and the qualified mortgage provisions by including such compensation within the points and fees calculations. See TILA sections 103(bb)(4)(A)(ii), (B); 82 For more detailed discussions, see the Bureau’s 2012 Loan Originator Proposal and the final rule issued by the Board in 2010. 77 FR 55272, 55276, 55290 (Sept. 7, 2012); 75 FR 58509, 5815–16, 58519–20 (Sept. 24, 2010) (2010 Loan Originator Final Rule). E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations 128(a)(18); 129B(b), (c); 129C(b)(2)(A)(vii), (C)(i). The Board proposed revisions to § 226.32(b)(1)(ii) to implement the inclusion of more forms of loan originator compensation into the points and fees thresholds. Those proposed revisions tracked the statutory language, with two exceptions. First, proposed § 226.32(b)(1)(ii) did not include the phrase ‘‘from any source.’’ The Board noted that the statute covers compensation paid ‘‘directly or indirectly’’ to the loan originator, and concluded that it would be redundant to cover compensation ‘‘from any source.’’ Second, for consistency with Regulation Z, the proposal used the term ‘‘loan originator’’ as defined in § 226.36(a)(1), rather than the term ‘‘mortgage originator’’ that appears in section 1401 of the Dodd-Frank Act. See TILA section 103(cc)(2). The Board explained that it interpreted the definitions of mortgage originator under the statute and loan originator under existing Regulation Z to be generally consistent, with one exception that the Board concluded was not relevant for purposes of the points and fees thresholds. Specifically, the statutory definition refers to ‘‘any person who represents to the public, through advertising or other means of communicating or providing information (including the use of business cards, stationery, brochures, signs, rate lists, or other promotional items), that such person can or will provide’’ the services listed in the definition (such as offering or negotiating loan terms), while the existing Regulation Z definition does not include persons solely on this basis. The Board concluded that it was not necessary to add this element of the definition to implement the points and fees calculations anyway, reasoning that the calculation of points and fees is concerned only with loan originators that receive compensation for performing defined origination functions in connection with a consummated loan. The Board noted that a person who merely represents to the public that such person can offer or negotiate mortgage terms for a consumer has not yet received compensation for that function, so there is no compensation to include in the calculation of points and fees for a particular transaction. In the proposed commentary, the Board explained what compensation would and would not have been included in points and fees under proposed § 226.32(b)(1)(ii). The Board proposed to revise existing comment 32(b)(1)(ii)–1 to clarify that compensation paid by either a consumer VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 or a creditor to a loan originator, as defined in § 1026.36(a)(1), would be included in points and fees. Proposed comment 32(b)(1)(ii)–1 also stated that loan originator compensation already included in points and fees because it is included in the finance charge under § 226.32(b)(1)(i) would not be counted again under § 226.32(b)(1)(ii). Proposed comment 32(b)(1)(ii)–2.i stated that, in determining points and fees, loan originator compensation includes the dollar value of compensation paid to a loan originator for a specific transaction, such as a bonus, commission, yield spread premium, award of merchandise, services, trips, or similar prizes, or hourly pay for the actual number of hours worked on a particular transaction. Proposed comment 32(b)(1)(ii)–2.ii clarified that loan originator compensation excludes compensation that cannot be attributed to a transaction at the time of origination, including, for example, the base salary of a loan originator that is also the employee of the creditor, or compensation based on the performance of the loan originator’s loans or on the overall quality of a loan originator’s loan files. Proposed comment 32(b)(1)(ii)–2.i also explained that compensation paid to a loan originator for a covered transaction must be included in the points and fees calculation for that transaction whenever paid, whether at or before closing or any time after closing, as long as the compensation amount can be determined at the time of closing. In addition, proposed comment 32(b)(1)(ii)–2.i provided three examples of compensation paid to a loan originator that would have been included in the points and fees calculation. Proposed comment 32(b)(1)(ii)–3 stated that loan originator compensation includes amounts the loan originator retains and is not dependent on the label or name of any fee imposed in connection with the transaction. Proposed comment 32(b)(1)(ii)–3 offered an example of a loan originator imposing and retaining a ‘‘processing fee’’ and stated that such a fee is loan originator compensation, regardless of whether the loan originator expends the fee to process the consumer’s application or uses it for other expenses, such as overhead. The Board requested comment on the types of loan originator compensation that must be included in points and fees. The Board also sought comment on the appropriateness of specific examples given in the commentary. Many industry commenters objected to the basic concept of including loan PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 6433 originator compensation in points and fees, urging the Bureau to use its exception authority to exclude loan originator compensation from points and fees altogether. Several industry commenters contended that other statutory provisions and rules, including the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (SAFE Act), the Board’s 2010 Loan Originator Final Rule, and certain Dodd-Frank Act provisions (including those proposed to be implemented in the Bureau’s 2012 Loan Originator Proposal), adequately regulate loan originator compensation and prohibit or restrict problematic loan originator compensation practices. Accordingly, they argued it is therefore unnecessary to include loan originator compensation in points and fees. Many industry commenters also asserted that the amount of compensation paid to loan originators has little or no bearing on a consumer’s ability to repay a mortgage, and thus that including loan originator compensation in points and fees under this rulemaking is unnecessary. They further asserted that including loan originator compensation in points and fees would greatly increase compliance burdens on creditors, discourage creditors from making qualified mortgages, and ultimately reduce access to credit and increase the cost of credit. Several industry commenters argued that, if the Bureau does not exclude all loan originator compensation from points and fees, then the Bureau should at least exclude compensation paid to individual loan originators (i.e., loan officers who are employed by creditors or mortgage brokerage firms). They argued that compensation paid to individual loan originators is already included in the cost of the loan, either in the interest rate or in origination fees. They maintained that including compensation paid to individual loan originators in points and fees would therefore constitute double counting. Several industry commenters also claimed that they would face significant challenges in determining the amount of compensation for individual loan originators. They noted that creditors need clear, objective standards for determining whether loans satisfy the qualified mortgage standard, and that the complexity of apportioning compensation to individual loans at the time of each closing to determine the amount of loan originator compensation to count toward the points and fees cap would create uncertainty. They also noted that having to track individual loan originators’ compensation and allocate that compensation to individual E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6434 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations loans would create additional compliance burdens, particularly for compensation paid after closing. Several industry commenters also stated that estimating loan originator compensation in table-funded transactions would prove difficult because the funding assignee may not know the amount paid by the table-funded creditor to the individual loan originator. Several industry commenters also asserted that including compensation paid to individual loan originators would lead to anomalous results: Otherwise identical loans could have significant differences in points and fees depending on the timing of the mortgage loan or the identity of the loan officer. They noted, for example, that a loan that qualifies a loan officer for a substantial bonus because it enables a loan officer to satisfy a long-term (e.g., annual) origination-volume target or a loan that is originated by a high-performing loan officer could have substantially higher loan originator compensation, and thus substantially higher points and fees, than an otherwise identical loan. Because the consumers would not be paying higher fees or interest rates because of such circumstances, the commenters argued that the result would not further the goals of the statute. Some industry commenters made a separate argument that the proposed method for including loan originator compensation in points and fees would create an unfair playing field for mortgage brokers. These commenters noted that, since a brokerage firm can be paid by only one source under the Board’s 2010 Loan Originator Final Rule and related provisions of the DoddFrank Act, a payment by a creditor to a mortgage broker must cover both the broker’s overhead costs and the cost of compensating the individual that worked on the transaction. The creditor’s entire payment to the mortgage broker is loan originator compensation that is included in points and fees, so that loan originator compensation in a wholesale transaction includes both the compensation received from the creditor to cover the overhead costs of the mortgage broker and the compensation that the broker passes through to the individual employee who worked on the transaction. By contrast, in a loan obtained directly from a creditor, the creditor would have to include in points and fees the compensation paid to the loan officer, but could choose to recover its overhead costs through the interest rate rather than an up-front charge that would count toward the points and fees thresholds. One industry commenter VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 provided examples illustrating that, as a result of this difference, loans obtained through a mortgage broker could have interest rates and fees identical to those in a loan obtained directly through a creditor but could have significantly higher loan originator compensation included in points and fees. Thus, particularly for smaller loan amounts, commenters expressed concern that it would be difficult for loans originated through mortgage brokers to remain under the points and fees limits for qualified mortgages. A nonprofit loan originator commenter also argued that including loan originator compensation in points and fees could undercut programs that help low and moderate income consumers obtain affordable mortgages. This commenter noted that it relies on payments from creditors to help it provide services to consumers and that counting such payments as loan originator compensation and including them in points and fees could jeopardize its programs. The commenter requested that this problem be addressed by excluding nonprofit organizations from the definition of loan originator or by excluding payments by creditors to nonprofit organizations from points and fees. Consumer advocates approved of including loan originator compensation in points and fees, regardless of when and by whom the compensation is paid. They asserted that including loan originator compensation would promote more consistent treatment by ensuring that all payments that loan originators receive count toward the points and fees thresholds, regardless of whether the payment is made by the consumer or the creditor and whether it is paid through the rate or through up-front fees. They maintained that the provision was intended to help prevent consumers from paying excessive amounts for loan origination services. More specifically, some consumer advocates argued that the Dodd-Frank Act provision requiring inclusion of loan originator compensation in points and fees is an important part of a multi-pronged approach to address widespread steering of consumers into more expensive mortgage transactions, and in particular, to address the role of commissions funded through the interest rate in such steering. The consumer advocates noted that separate prohibitions on compensation based on terms and on a loan originator’s receiving compensation from both the consumer and another party do not limit the amount of compensation a loan originator can receive or prevent a loan originator from inducing consumers to PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 agree to above-market interest rates. They expressed concern that, particularly in the subprime market, loan originators could specialize in originating transactions with abovemarket interest rates, with the expectation they could arrange to receive above-market compensation for all of their transactions. Consumer advocates argued that counting all methods of loan originator compensation toward the points and fees thresholds was intended to deter such conduct. Consumer advocates also pointed out that in the wholesale context, the consumer has the option of paying the brokerage firm directly for its services. Such payments have always been included within the calculation of points and fees for HOEPA purposes. The advocates argued that when a consumer elects not to make the upfront payment but instead elects to fund the same amount of money for the brokerage through an increased rate, there is no justification for treating the money received by the brokerage as a result of the consumer’s decision any differently. The Bureau has carefully considered the comments received in light of the concerns about various issues with regard to loan originator compensation practices, the general concerns about the impacts of the ability-to-repay/qualified mortgage rule and revised HOEPA thresholds on a market in which access to mortgage credit is already extremely tight, differences between the retail and wholesale origination channels, and practical considerations regarding both the burdens of day-to-day implementation and the opportunities for evasion by parties who wish to engage in rent-seeking. As discussed further below, the Bureau is concerned about implementation burdens and anomalies created by the requirement to include loan originator compensation in points and fees, the impacts that it could have on pricing and access to credit, and the risks that rent-seekers will continue to find ways to evade the statutory scheme. Nevertheless, the Bureau believes that, in light of the historical record and of Congress’s evident concern with loan originator compensation practices, it would not be appropriate to waive the statutory requirement that loan originator compensation be included in points and fees. The Bureau has, however, worked to craft the rule that implements Congress’s judgment in a way that is practicable and that reduces potential negative impacts of the statutory requirement, as discussed below. The Bureau is also seeking comment in the E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations concurrent proposal being published elsewhere in today’s Federal Register on whether additional measures would better protect consumers and reduce implementation burdens and unintended consequences. Accordingly, the Bureau in adopting § 1026.32(b)(1)(ii) has generally tracked the statutory language and the Board’s proposal in the regulation text, but has expanded the commentary to provide more detailed guidance to clarify what compensation must be included in points and fees. The Dodd-Frank Act requires inclusion in points and fees of ‘‘all compensation paid directly or indirectly by a consumer or creditor to a mortgage originator from any source, including a mortgage originator that is also the creditor in a table-funded transaction.’’ See TILA section 103(bb)(4)(B). Consistent with the Board’s proposal, revised § 1026.32(b)(ii) does not include the phrase ‘‘from any source.’’ The Bureau agrees that the phrase is unnecessary because the provision expressly covers compensation paid ‘‘directly or indirectly’’ to the loan originator. Like the Board’s proposal, the final rule also uses the term ‘‘loan originator’’ as defined in § 1026.36(a)(1), not the term ‘‘mortgage originator’’ under section 1401 of the Dodd-Frank Act. See TILA section 103(cc)(2). The Bureau agrees that the definitions are consistent in relevant respects and notes that it is in the process of amending the regulatory definition to harmonize it even more closely with the Dodd-Frank Act definition of ‘‘mortgage originator.’’ 83 Accordingly, the Bureau believes use of consistent terminology in Regulation Z will facilitate compliance. Finally, as revised, § 1026.32(b)(1)(ii) also does not include the language in proposed § 226.32(b)(1)(ii) that specified that the provision also applies to a loan originator that is the creditor in a tablefunded transaction. The Bureau has concluded that that clarification is unnecessary because a creditor in a table-funded transaction is already included in the definition of loan originator in § 1026.36(a)(1). To clarify what compensation must be included in points and fees, revised § 1026.32(b)(1)(ii) specifies that compensation must be included if it can be attributed to the particular transaction at the time the interest rate is set. These limitations are discussed in more detail below. In adopting the general rule, the Bureau carefully considered arguments by industry commenters that loan 83 See 2012 Loan Originator Proposal, 77 FR 55283–88. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 originator compensation should not be included in points and fees because other statutory provisions and rules already regulate loan originator compensation, because loan originator compensation is already included in the costs of mortgage loans, and because including loan originator compensation in points and fees would push many loans over the 3 percent cap on points and fees for qualified mortgages (or even over the points and fees limits for determining whether a loan is a highcost mortgage under HOEPA), which would increase costs and impair access to credit. The Bureau views the fact that other provisions within the Dodd-Frank Act address other aspects of loan originator compensation and activity as evidence of the high priority that Congress placed on regulating such compensation. The other provisions pointed to by the commenters address specific compensation practices that created particularly strong incentives for loan originators to ‘‘upcharge’’ consumers on a loan-by-loan basis and particular confusion about loan originators’ loyalties. The Bureau believes that the inclusion of loan originator compensation in points and fees has distinct purposes. In addition to discouraging more generalized rentseeking and excessive loan originator compensation, the Bureau believes that Congress may have been focused on particular risks to consumers. Thus, with respect to qualified mortgages, including loan originator compensation in points and fees helps to ensure that, in cases in which high up-front compensation might otherwise cause the creditor and/or loan originator to be less concerned about long-term sustainability, the creditor is not able to invoke a presumption of compliance if challenged to demonstrate that it made a reasonable and good faith determination of the consumer’s ability to repay the loan. Similarly in HOEPA, the threshold triggers additional consumer protections, such as enhanced disclosures and housing counseling, for the loans with the highest up-front pricing. The Bureau recognizes that the method that Congress chose to effectuate these goals does not ensure entirely consistent results as to whether a loan is a qualified mortgage or a highcost transaction. For instance, loans that are identical to consumers in terms of up-front costs and interest rate may nevertheless have different points and fees based on the identity of the loan originator who handled the transaction for the consumer, since different individual loan originators in a retail PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 6435 environment or different brokerage firms in a wholesale environment may earn different commissions from the creditor without that translating in differences in costs to the consumer. In addition, there are anomalies introduced by the fact that ‘‘loan originator’’ is defined to include mortgage broker firms and individual employees hired by either brokers or creditors, but not creditors themselves. As a result, counting the total compensation paid to a mortgage broker firm will capture both the firm’s overhead costs and the compensation that the firm passes on to its individual loan officer. By contrast, in a retail transaction, the creditor would have to include in points and fees the compensation that it paid to its loan officer, but would continue to have the option of recovering its overhead costs through the interest rate, instead of an up-front charge, to avoid counting them toward the points and fees thresholds. Indeed, the Bureau expects that the new requirement may prompt creditors to shift certain other expenses into rate to stay under the thresholds. Nevertheless, to the extent there are anomalies from including loan originator compensation in points and fees, these anomalies appear to be the result of deliberate policy choices by Congress to expand the historical definition of points and fees to include all methods of loan originator compensation, whether derived from up-front charges or from the rate, without attempting to capture all overhead expenses by creditors or the gain on sale that the creditor can realize upon closing a mortgage. The Bureau agrees that counting loan originator compensation that is structured through rate toward the points and fees thresholds could cause some loans not to be classified as qualified mortgages and to trigger HOEPA protections, compared to existing treatment under HOEPA and its implementing regulation. However, the Bureau views this to be exactly the result that Congress intended. In light of the express statutory language and Congress’s evident concern with increasing consumer protections in connection with high levels of loan originator compensation, the Bureau does not believe that it is appropriate to use its exception or adjustment authority in TILA section 105(a) or in TILA section 129C(b)(3)(B)(i) to exclude loan originator compensation entirely from points and fees for qualified mortgages and HOEPA. As discussed below, however, the Bureau is attempting to implement the points and fees E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6436 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations requirements with as much sensitivity as practicable to potential impacts on the pricing of and availability of credit, anomalies and unintended consequences, and compliance burdens. The Bureau also carefully considered comments urging it to exclude compensation paid to individual loan originators from points and fees, but ultimately concluded that such a result would be inconsistent with the plain language of the statute and could exacerbate the potential inconsistent effects of the rule on different mortgage origination channels. As noted above, many industry commenters argued that, even if loan originator compensation were not excluded altogether, at least compensation paid to individual loan originators should be excluded from points and fees. Under this approach, only payments to mortgage brokers would be included in points and fees. The commenters contended that it would be difficult to track compensation paid to individual loan originators, particularly when that compensation may be paid after consummation of the loan and that it would create substantial compliance problems. They also argued that including compensation paid to individual loan originators in points and fees would create anomalies, in which identical transactions from the consumer’s perspective (i.e., the same interest rate and up-front costs) could nevertheless have different points and fees because of loan originator compensation. As explained above, the Bureau does not believe it is appropriate to use its exception authority to exclude loan originator compensation from points and fees, and even using that exception authority more narrowly to exclude compensation paid to individual loan originators could undermine Congress’s apparent goal of providing stronger consumer protections in cases of high loan originator compensation. Although earlier versions of legislation focused specifically on compensation to ‘‘mortgage brokers,’’ which is consistent with existing HOEPA, the Dodd-Frank Act refers to compensation to ‘‘mortgage originators,’’ a term that is defined in detail elsewhere in the statute to include individual loan officers employed by both creditors and brokers, in addition to the brokers themselves. To the extent that Congress believed that high levels of loan originator compensation evidenced additional risk to consumers, excluding individual loan originators from consideration appears inconsistent with this policy judgment. Moreover, the Bureau notes that using exception authority to exclude VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 compensation paid to individual loan originators would exacerbate the differential treatment between the retail and wholesale channels concerning overhead costs. As noted above, compensation paid by the consumer or creditor to the mortgage broker necessarily will include amounts for both the mortgage broker’s overhead and profit and for the compensation the mortgage broker passes on to its loan officer. Excluding individual loan officer compensation on the retail side, however, would effectively exempt creditors from counting any loan originator compensation at all toward points and fees. Thus, for transactions that would be identical from the consumer’s perspective in terms of interest rate and up-front costs, the wholesale transaction could have significantly higher points and fees (because the entire payment from the creditor to the mortgage broker would be captured in points and fees), while the retail transaction might include no loan origination compensation at all in points and fees. Such a result would put brokerage firms at a disadvantage in their ability to originate qualified mortgages and put them at significantly greater risk of originating HOEPA loans. This in turn could constrict the supply of loan originators and the origination channels available to consumers to their detriment. The Bureau recognizes that including compensation paid to individual loan originators, such as loan officers, with respect to individual transactions may impose additional burdens. For example, creditors will have to track employee compensation for purposes of complying with the rule, and the calculation of points and fees will be more complicated. However, the Bureau notes that creditors and brokers already have to monitor compensation more carefully as a result of the 2010 Loan Originator Final Rule and the related Dodd-Frank Act restrictions on compensation based on terms and on dual compensation. The Bureau also believes that these concerns can be reduced by providing clear guidance on issues such as what types of compensation are covered, when compensation is determined, and how to avoid ‘‘double-counting’’ payments that are already included in points and fees calculations. The Bureau has therefore revised the Board’s proposed regulation and commentary to provide more detailed guidance, and is seeking comment in the proposal published elsewhere in the Federal Register today on additional guidance and potential PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 implementation issues among other matters. As noted above, the Bureau is revising § 1026.32(b)(1)(ii) to clarify that compensation must be counted toward the points and fees thresholds if it can be attributed to the particular transaction at the time the interest rate is set. The Bureau is also revising comment 32(b)(1)(ii)–1 to explain in general terms when compensation qualifies as loan originator compensation that must be included in points and fees. In particular, compensation paid by a consumer or creditor to a loan originator is included in the calculation of points and fees, provided that such compensation can be attributed to that particular transaction at the time the interest rate is set. The Bureau also incorporates part of proposed comment 32(b)(1)(ii)–3 into revised comment 32(b)(1)(ii)–1, explaining that loan originator compensation includes amounts the loan originator retains, and is not dependent on the label or name of any fee imposed in connection with the transaction. However, revised comment 32(b)(1)(ii)–1 does not include the example from proposed comment 32(b)(1)(ii)–3, which stated that, if a loan originator imposes a processing fee and retains the fee, the fee is loan originator compensation under § 1026.32(b)(1)(ii) whether the originator expends the fee to process the consumer’s application or uses it for other expenses, such as overhead. That example may be confusing in this context because a processing fee paid to a loan originator likely would be a finance charge under § 1026.4 and would therefore already be included in points and fees under § 1026.32(b)(1)(i). Revised comment 32(b)(1)(ii)–2.i explains that compensation, such as a bonus, commission, or an award of merchandise, services, trips or similar prizes, must be included only if it can be attributed to a particular transaction. The requirement that compensation is included in points and fees only if it can be attributed to a particular transaction is consistent with the statutory language. The Dodd-Frank Act provides that, for the points and fees tests for both qualified mortgages and high-cost mortgages, only charges that are ‘‘in connection with’’ the transaction are included in points and fees. See TILA sections 103(bb)(1)(A)(ii) (high-cost mortgages) and 129C(b)(2)(A)(vii) (qualified mortgages). Limiting loan originator compensation to compensation that is attributable to the transaction implements the statutory requirement that points and fees are ‘‘in connection’’ with the transaction. This E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with limitation also makes the rule more workable. Compensation is included in points and fees only if it can be attributed to a specific transaction to facilitate compliance with the rule and avoid over-burdening creditors with complex calculations to determine, for example, the portion of a loan officer’s salary that should be counted in points and fees.84 For clarity, the Bureau has moved the discussion of the timing of loan originator compensation into new comment 32(b)(1)(ii)–3, and has added additional examples to 32(b)(1)(ii)–4, to illustrate the types and amount of compensation that should be included in points and fees. Revised comment 32(b)(1)(ii)–2.ii explains that loan originator compensation excludes compensation that cannot be attributed to a particular transaction at the time the interest rate is set, including, for example, compensation based on the long-term performance of the loan originator’s loans or on the overall quality of the loan originator’s loan files. The base salary of a loan originator is also excluded, although additional compensation that is attributable to a particular transaction must be included in points and fees. The Bureau has decided to seek further comment in the concurrent proposal regarding treatment of hourly wages for the actual number of hours worked on a particular transaction. The Board’s proposal would have included hourly pay for the actual number of hours worked on a particular transaction in loan originator compensation for purposes of the points and fees thresholds, and the Bureau agrees that such wages are attributable to the particular transaction. However, the Bureau is unclear as to whether industry actually tracks compensation this way in light of the administrative burdens. Moreover, while the general rule provides for calculation of loan originator compensation at the time the interest rate is set for the reasons discussed above, the actual hours of hours worked on a transaction would not be known at that time. The Bureau 84 In contrast, the existing restrictions on particular loan originator compensation structures in § 1026.36 apply to all compensation such as salaries, hourly wages, and contingent bonuses because those restrictions apply only at the time such compensation is paid, and therefore they can be applied with certainty. Moreover, those rules also provide for different treatment of compensation that is not ‘‘specific to, and paid solely in connection with, the transaction,’’ where such a distinction is necessary for reasons of practical application of the rule. See comment 36(d)(2)–1 (prohibition of loan originator receiving compensation directly from consumer and also from any other person does not prohibit consumer payments where loan originator also receives salary or hourly wage). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 is therefore seeking comment on issues relating to hourly wages, including whether to require estimates of the hours to be worked between rate set and consummation. New comment 32(b)(1)(ii)–3 explains that loan originator compensation must be included in the points and fees calculation for a transaction whenever the compensation is paid, whether before, at or after closing, as long as that compensation amount can be attributed to the particular transaction at the time the interest rate is set. Some industry commenters expressed concern that it would be difficult to determine the amount of compensation that would be paid after consummation and that creditors might have to recalculate loan originator compensation (and thus points and fees) after underwriting if, for example, a loan officer became eligible for higher compensation because other transactions had been consummated. The Bureau appreciates that industry participants need certainty at the time of underwriting as to whether transactions will exceed the points and fees limits for qualified mortgages (and for high-cost mortgages). To address this concern, the comment 32(b)(1)(ii)–3 explains that loan originator compensation should be calculated at the time the interest rate is set. The Bureau believes that the date the interest rate is set is an appropriate standard for calculating loan originator compensation. It would allow creditors to be able to calculate points and fees with sufficient certainty so that they know early in the process whether a transaction will be a qualified mortgage or a high-cost mortgage. As noted above, several industry commenters argued that including loan originator compensation in points and fees would result in double counting. They stated that creditors often will recover loan originator compensation costs through origination charges, and these charges are already included in points and fees under § 1026.32(b)(1)(i). However, the underlying statutory provisions as amended by the DoddFrank Act do not express any limitation on its requirement to count loan originator compensation toward the points and fees test. Rather, the literal language of TILA section 103(bb)(4) as amended by the Dodd-Frank Act defines points and fees to include all items included in the finance charge (except interest rate), all compensation paid directly or indirectly by a consumer or creditor to a loan originator, ‘‘and’’ various other enumerated items. The use of ‘‘and’’ and the references to ‘‘all’’ compensation paid ‘‘directly or indirectly’’ and ‘‘from any source’’ PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 6437 suggest that compensation should be counted as it flows downstream from one party to another so that it is counted each time that it reaches a loan originator, whatever the previous source. The Bureau believes the statute would be read to require that loan originator compensation be treated as additive to the other elements of points and fees. The Bureau believes that an automatic literal reading of the statute in all cases, however, would not be in the best interest of either consumers or industry. For instance, the Bureau does not believe that it is necessary or appropriate to count the same payment made by a consumer to a mortgage broker firm twice, simply because it is both part of the finance charge and loan originator compensation. Similarly, the Bureau does not believe that, where a payment from either a consumer or a creditor to a mortgage broker is counted toward points and fees, it is necessary or appropriate to count separately funds that the broker then passes on to its individual employees. In each case, any costs and risks to the consumer from high loan originator compensation are adequately captured by counting the funds a single time against the points and fees cap; thus, the Bureau does not believe the purposes of the statute would be served by counting some or all of the funds a second time, and is concerned that doing so could have negative impacts on the price and availability of credit. Determining the appropriate accounting rule is significantly more complicated, however, in situations in which a consumer pays some up-front charges to the creditor and the creditor pays loan originator compensation to either its own employee or to a mortgage broker firm. Because money is fungible, tracking how a creditor spends money it collects in up-front charges versus amounts collected through the rate to cover both loan originator compensation and its other overhead expenses would be extraordinarily complex and cumbersome. To facilitate compliance, the Bureau believes it is appropriate and necessary to adopt one or more generalized rules regarding the accounting of various payments. However, the Bureau does not believe it yet has sufficient information with which to choose definitively between the additive approach provided for in the statutory language and other potential methods of accounting for payments in light of the multiple practical and complex policy considerations involved. The potential downstream effects of different accounting methods are E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6438 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations significant. Under the additive approach where no offsetting consumer payments against creditor-paid loan originator compensation is allowed, creditors whose combined loan originator compensation and up-front charges would otherwise exceed the points and fees limits would have strong incentives to cap their up-front charges for other overhead expenses under the threshold and instead recover those expenses by increasing interest rates to generate higher gains on sale. This would adversely affect consumers who prefer a lower interest rate and higher up-front costs and, at the margins, could result in some consumers being unable to qualify for credit. Additionally, to the extent creditors responded to a ‘‘no offsetting’’ rule by increasing interest rates, this could increase the number of qualified mortgages that receive a rebuttable rather than conclusive presumption of compliance. One alternative would be to allow all consumer payments to offset creditorpaid loan originator compensation. However, a ‘‘full offsetting’’ approach would allow creditors to offset much higher levels of up-front points and fees against expenses paid through rate before the heightened consumer protections required by the Dodd-Frank Act would apply. Particularly under HOEPA, this may raise tensions with Congress’s apparent intent. Other alternatives might use a hybrid approach depending on the type of expense, type of loan, or other factors, but would involve more compliance complexity. In light of the complex considerations, the Bureau believes it is necessary to seek additional notice and comment. The Bureau therefore is finalizing this rule without qualifying the statutory result and is proposing two alternative comments in the concurrent proposal, one of which would explicitly preclude offsetting, and the other of which would allow full offsetting of any consumer-paid charges against creditorpaid loan originator compensation. The Bureau is also proposing comments to clarify treatment of compensation paid by consumers to mortgage brokers and by mortgage brokers to their individual employees. The Bureau is seeking comment on all aspects of this issue, including the market impacts and whether adjustments to the final rule would be appropriate. In addition, the Bureau is seeking comment on whether it would be helpful to provide for additional adjustment of the rules or additional commentary to clarify any overlaps in definitions between the points and fees provisions in this rulemaking and the HOEPA rulemaking VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 and the provisions that the Bureau is separately finalizing in connection with the Bureau’s 2012 Loan Originator Compensation Proposal. Finally, comment 32(b)(1)(ii)–4 includes revised versions of examples in proposed comment 32(b)(1)(ii)–2, as well as additional examples to provide additional guidance regarding what compensation qualifies as loan originator compensation that must be included in points and fees. These examples illustrate when compensation can be attributed to a particular transaction at the time the interest rate is set. New comment 32(b)(1)(ii)–5 adds an example explaining how salary is treated for purposes of loan originator compensation for calculating points and fees. 32(b)(1)(iii) TILA section 103(aa)(4)(C) provides that points and fees include certain real estate-related charges listed in TILA section 106(e) and is implemented in § 1026.32(b)(1)(iii). The Dodd-Frank Act did not amend TILA section 103(aa)(4)(C) (but did renumber it as section 103(bb)(4)(C)). Although the Board indicated in the Supplementary Information that it was not proposing any changes, proposed § 226.32(b)(1)(iii) would have added the phrase ‘‘payable at or before closing of the mortgage’’ loan and would have separated the elements into three new paragraphs (A) through (C). Thus, proposed § 226.32(b)(1)(iii) would have included in points and fees ‘‘all items listed in § 226.4(c)(7) (other than amounts held for future payment of taxes) payable at or before closing of the mortgage loan, unless: (A) The charge is reasonable; (B) the creditor receives no direct or indirect compensation in connection with the charge; and (C) the charge is not paid to an affiliate of the creditor.’’ The Board noted that the statute did not exclude these charges if they were payable after closing and questioned whether such a limitation was necessary because these charges could reasonably be viewed as charges that by definition are payable only at or before closing. As noted in the section-by-section analysis of § 1026.32(b)(1), the Board requested comment on whether there are any other types of fees that should be included in points and fees only if they are payable at or before closing. The Board noted that during outreach creditors had raised concerns about including in points and fees real-estate related fees paid to an affiliate of the creditor, such as an affiliated title company. Although these fees always have been included in points and fees for high-cost loans, creditors using PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 affiliated title companies were concerned they would have difficulty meeting the lower threshold for points and fees for qualified mortgages. The Board, however, did not propose to exempt fees paid to creditor-affiliated settlement service providers, noting that Congress appeared to have rejected excluding such fees from points and fees. Industry commenters criticized the Board’s proposed treatment of fees paid to affiliates as overbroad. Industry commenters argued that a creditor’s affiliation with a service provider, such as a title insurance agency, does not have any impact on the consumer’s ability to repay a loan. They maintained that studies over the past two decades have shown that title services provided by affiliated businesses are competitive in cost compared to services provided by unaffiliated businesses. They contended that the rule should instead focus solely on whether the fee is bona fide. These commenters also argued that the largest real estate-related charge, title insurance fees, are often either mandated by State law or required to be filed with the relevant state authority and do not vary. Regardless of whether the State sets the rate or requires that the rate be filed, these commenters argued that there are so few insurers that rates tend to be nearly identical among providers. These commenters also argued that including fees to affiliates would negatively affect consumers. They claimed that the inclusion of fees paid to affiliates would cause loans that would otherwise be qualified mortgages to exceed the points and fees cap, resulting in more expense to the creditor, which would be passed through to consumers in the form of higher interest rates or fees, or in more denials of credit. They also claimed that the proposal would harm consumers by reducing competition among settlement service providers and by eliminating operational efficiencies. One industry trade association reported that some of its members with affiliates would discontinue offering mortgages, which would reduce competition among creditors, especially for creditors offering smaller loans, since these loans would be most affected by the points and fees cap. They claimed that treating affiliated and unaffiliated providers differently would incentivize creditors to use unaffiliated third-party service providers to stay within the qualified mortgage points and fees cap. Several industry commenters noted that RESPA permits affiliated business arrangements and provides protections E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations for consumers, including a prohibition against requiring that consumers use affiliates, a requirement to disclose affiliation to consumers, and a limitation that compensation include only return on ownership interest. These commenters argued that charges paid to affiliates should be excluded from points and fees as long the RESPA requirements are satisfied. Several industry commenters objected to the requirement that charges be ‘‘reasonable’’ to be excluded from points and fees. They argued that the requirement was vague and that it would be difficult for a creditor to judge whether a third-party charge met the standard. Several commenters also argued that the Dodd-Frank Act provision permitting exclusion of certain bona fide third-party charges should apply rather than the three-part test for items listed in § 1026.4(c)(7). See TILA section 129C(b)(2)(C)(i). Two consumer advocates commented on this aspect of the proposal. They supported including in points and fees all fees paid to any settlement service provider affiliated with the creditor. The Bureau is adopting § 226.32(b)(1)(iii) as proposed but renumbered as § 1026.32(b)(1)(iii). TILA section 103(bb)(4) specifically mandates that fees paid to and retained by affiliates of the creditor be included in points and fees. The Bureau acknowledges that including fees paid to affiliates in points and fees could make it more difficult for creditors using affiliated service providers to stay under the points and fees cap for qualified mortgages and that, as a result, creditors could be disincented from using affiliated service providers. This is especially true with respect to affiliated title insurers because of the cost of title insurance. On the other hand, despite RESPA’s regulation of fees charged by affiliates, concerns have nonetheless been raised that fees paid to an affiliate pose greater risks to the consumer, since affiliates of a creditor may not have to compete in the market with other providers of a service and thus may charge higher prices that get passed on to the consumer. The Bureau believes that Congress weighed these competing considerations and made a deliberate decision not to exclude fees paid to affiliates. This approach is further reflected throughout title XIV, which repeatedly amended TILA to treat fees paid to affiliates as the equivalent to fees paid to a creditor or loan originator. See, e.g., Dodd-Frank Act sections 1403, 1411, 1412, 1414, and 1431. For example, as noted above, TILA section 129C(b)(2)(C)(i), as added by section 1412 of the Dodd-Frank Act, provides VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 that for purposes of the qualified mortgage points and fees test, bona fide third-party charges are excluded other than charges ‘‘retained by * * * an affiliate of the creditor or mortgage originator.’’ Similarly, TILA section 129B(c)(2)(B)(ii), added by section 1403 of the Dodd-Frank Act, restricts the payment of points and fees but permits the payment of bona fide third-party charges unless those charges are ‘‘retained by * * * an affiliate of the creditor or originator.’’ In light of these considerations, the Bureau does not believe there is sufficient justification to use its exception authority in this instance as the Bureau cannot find, given Congress’s clear determination, that excluding affiliate fees from the calculation of points and fees is necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith. As noted above, some commenters objected to the requirement that charges be ‘‘reasonable.’’ The Bureau notes that a ‘‘reasonable’’ requirement has been in place for many years before the DoddFrank Act. TILA section 103(aa)(4)(C) specifically provides that charges listed in TILA section 106(e) are included in points and fees for high-cost mortgages unless, among other things, the charge is reasonable. This requirement is implemented in existing § 1026.32(b)(1)(iii). Similarly, a charge may be excluded from the finance charge under § 1026.4(c)(7) only if it is reasonable. In the absence of any evidence that this requirement has been unworkable, the Bureau declines to alter it. The fact that a transaction for such services is conducted at arms-length ordinarily should be sufficient to make the charge reasonable. The reasonableness requirement is not intended to invite an inquiry into whether a particular appraiser or title insurance company is imposing excessive charges. Some commenters also maintained that the provision permitting exclusion of certain bona fide third-party charges should apply rather than the three-part test for items listed in § 1026.4(c)(7). See TILA section 129C(b)(2)(C)(i). As discussed in more detail in the sectionby-section analysis of § 1026.32(b)(1)(i)(D), the Bureau concludes that § 1026.32(b)(1)(iii), which specifically addresses exclusion of items listed in § 1026.4(c)(7), takes precedence over the more general exclusion in § 1026.32(b)(1)(i)(D). The Board’s proposed comment 32(b)(1)(iii)–1 was substantially the same as existing comment 32(b)(1)(ii)–2. It would have provided an example of PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 6439 the inclusion or exclusion of real-estate related charges. The Bureau did not receive substantial comment on the proposed comment. The Bureau is therefore adopting comment 32(b)(1)(ii)–1 substantially as proposed, with revisions for clarity. 32(b)(1)(iv) As amended by section 1431 of the Dodd-Frank Act, TILA section 103(bb)(4)(D) includes in points and fees premiums for various forms of credit insurance and charges for debt cancellation or suspension coverage. The Board proposed § 226.32(b)(1)(iv) to implement this provision. The Board also proposed to revise comment 32(b)(1)(iv)–1 to reflect the revised statutory language and to add new comment 32(b)(1)(iv)–2 to clarify that ‘‘credit property insurance’’ includes insurance against loss or damage to personal property such as a houseboat or manufactured home. Several commenters argued that proposed § 226.32(b)(1)(iv) did not accurately implement the provision in Dodd-Frank Act section 1431 that specifies that ‘‘insurance premiums or debt cancellation or suspension fees calculated and paid in full on a monthly basis shall not be considered financed by the creditor.’’ They argued that comment 32(b)(1)(iv)–1 should be revised so that it expressly excludes monthly premiums for credit insurance from points and fees, including such premiums payable in the first month. At least one industry commenter also argued that voluntary credit insurance premiums should not be included in points and fees. Consumer advocates supported inclusion of credit insurance premiums in points and fees, noting that these services can add significant costs to mortgages. The Bureau is adopting § 226.32(b)(1)(iv) substantially as proposed, with revisions for clarity, as renumbered § 1026.32(b)(1)(iv). As revised, § 1026.32(b)(1)(iv) states that premiums or other charges for ‘‘any other life, accident, health, or loss-ofincome insurance’’ are included in points and fees only if the insurance is for the benefit of the creditor. The Bureau is also adopting proposed comments 32(b)(1)(iv)–1 and –2 substantially as proposed, with revisions for clarity and consistency with terminology in Regulation Z. The Bureau is also adopting new comment 32(b)(1)(iv)–3 to clarify that premiums or other charges for ‘‘any other life, accident, health, or loss-of-income insurance’’ are included in points and fees only if the creditor is a beneficiary of the insurance. E:\FR\FM\30JAR2.SGM 30JAR2 6440 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with As noted above, several commenters argued that premiums paid monthly, including the first such premium, should not be included in points and fees. The statute requires that premiums ‘‘payable at or before closing’’ be included in points and fees; it provides only that premiums ‘‘calculated and paid in full on a monthly basis shall not be considered financed by the creditor.’’ TILA section 103(bb)(4)(D). Thus, if the first premium is payable at or before closing, that payment is included in points and fees even though the subsequent monthly payments are not. Another commenter argued that voluntary credit insurance premiums should be excluded from points and fees. However, under the current rule, voluntary credit insurance premiums are included in points and fees. In light of the fact that the Dodd-Frank Act expanded the types of credit insurance that must be included in points and fees, the Bureau does not believe it would be appropriate to reconsider whether voluntary credit insurance premiums should be included in points and fees. 32(b)(1)(v) As added by the Dodd-Frank Act, new TILA section 103(bb)(4)(E) includes in points and fees ‘‘the maximum prepayment penalties which may be charged or collected under the terms of the credit transaction.’’ The Board’s proposed § 226.32(b)(1)(v) closely tracked the statutory language, but it cross-referenced proposed § 226.43(b)(10) for the definition of ‘‘prepayment penalty.’’ Few commenters addressed this provision. One industry commenter argued that the maximum prepayment penalty should not be included in points and fees because a prepayment that triggers the penalty may never occur and thus the fee may never be assessed. The Bureau is adopting § 226.32(b)(1)(v) substantially as proposed but renumbered as § 1026.32(b)(1)(v), with a revision to its definitional cross-reference. As revised, § 1026.32(b)(1)(v) refers to the definition of prepayment penalty in § 1026.32(b)(6)(i). With respect to the comment arguing that prepayment penalties should not be included in points and fees, the statute requires inclusion in points and fees of the maximum prepayment penalties that ‘‘may be charged or collected.’’ Thus, under the statutory language, the imposition of the charge need not be certain for the prepayment penalty to be included in points and fees. In this provision (and other provisions added VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 by the Dodd-Frank Act, such as TILA section 129C(c)), Congress sought to limit and deter the use of prepayment penalties, and the Bureau does not believe that it would be appropriate to exercise its exception authority in a manner that could undermine that goal. 32(b)(1)(vi) New TILA section 103(bb)(4)(F) requires that points and fees include ‘‘all prepayment fees or penalties that are incurred by the consumer if the loan refinances a previous loan made or currently held by the same creditor or an affiliate of the creditor.’’ The Board’s proposed § 226.32(b)(1)(vi) would have implemented this provision by including in points and fees the total prepayment penalty, as defined in § 226.43(b)(10), incurred by the consumer if the mortgage loan is refinanced by the current holder of the existing mortgage loan, a servicer acting on behalf of the current holder, or an affiliate of either. The Board stated its belief that this provision is intended in part to curtail the practice of ‘‘loan flipping,’’ which involves a creditor refinancing an existing loan for financial gain resulting from prepayment penalties and other fees that a consumer must pay to refinance the loan— regardless of whether the refinancing is beneficial to the consumer. The Board noted that it departed from the statutory language to use the phrases ‘‘current holder of the existing mortgage loan’’ and ‘‘servicer acting on behalf of the current holder’’ in proposed § 226.32(b)(1)(vi) because, as a practical matter, these are the entities that would refinance the loan and directly or indirectly gain from associated prepayment penalties. Few commenters addressed this provision. Two consumer groups expressed support for including these prepayment penalties in points and fees, arguing that many consumers were victimized by loan flipping and the resulting fees and charges. The Bureau is adopting § 226.32(b)(1)(vi) substantially as proposed but renumbered as § 1026.32(b)(1)(vi). In addition to revising for clarity, the Bureau has also revised § 1026.32(b)(1)(vi) to refer to the definition of prepayment penalty in § 1026.32(b)(6)(i). Like the Board, the Bureau believes that it is appropriate for § 1026.32(b)(1)(vi) to apply to the current holder of the existing mortgage loan, the servicer acting on behalf of the current holder, or an affiliate of either. These are the entities that would refinance the loan and gain from the prepayment penalties on the previous loan. Accordingly, the Bureau is PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 invoking its exception and adjustment authority under TILA sections 105(a) and 129C(b)(3)(B)(i). The Bureau believes that adjusting the statutory language to more precisely target the entities that would benefit from refinancing loans with prepayment penalties will more effectively deter loan flipping to collect prepayment penalties and help preserve consumers’ access to safe, affordable credit. It also will lessen the compliance burden on other entities that lack the incentive for loan flipping, such as a creditor that originated the existing loan but no longer holds the loan. For these reasons, the Bureau believes that use of its exception and adjustment authority is necessary and proper under TILA section 105(a) to effectuate the purposes of TILA and to facilitate compliance with TILA and its purposes, including the purpose of assuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans. Similarly, the Bureau finds that it is necessary, proper, and appropriate to use its authority under TILA section 129C(b)(3)(B)(i) to revise and subtract from statutory language. This use of authority ensures that responsible, affordable mortgage credit remains available to consumers in a manner consistent with and effectuates the purpose of TILA section 129C, referenced above, and facilitates compliance with section 129C of TILA. 32(b)(2) Proposed Provisions Not Adopted As noted in the section-by-section analysis of § 1026.32(b)(1)(ii) above, section 1431(c) of the Dodd-Frank Act amended TILA to require that all compensation paid directly or indirectly by a consumer or a creditor to a ‘‘mortgage originator’’ be included in points and fees for high-cost mortgages and qualified mortgages. As also noted above, the Board’s 2011 ATR Proposal proposed to implement this statutory change in proposed § 226.32(b)(1)(ii) using the term ‘‘loan originator,’’ as defined in existing § 1026.36(a)(1), rather than the statutory term ‘‘mortgage originator.’’ In turn, the Board proposed new § 226.32(b)(2) to exclude from points and fees compensation paid to certain categories of persons specifically excluded from the definition of ‘‘mortgage originator’’ in amended TILA section 103, namely employees of a retailer of manufactured homes under certain circumstances, certain real estate brokers, and servicers. The Bureau is not adopting proposed § 226.32(b)(2). The Bureau is amending E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations the definition of ‘‘loan originator’’ § 1026.36(a)(1) and the associated commentary to incorporate the statutory exclusion of these persons from the definition. Accordingly, to the extent these persons are excluded from the definition of loan originator compensation, their compensation is not loan originator compensation that must be counted in points and fees, and the exclusions in proposed § 226.32(b)(2) are no longer necessary. Instead, in the 2013 HOEPA Final Rule, the Bureau is finalizing the definition of points and fees for HELOCs in § 1026.32(b)(2). Current § 1026.32(b)(2), which contains the definition of ‘‘affiliate,’’ is being renumbered as § 1026.32(b)(5). 32(b)(3) Bona Fide Discount Point sroberts on DSK5SPTVN1PROD with 32(b)(3)(i) Closed-End Credit The Dodd-Frank Act defines the term ‘‘bona fide discount points’’ as used in § 1026.32(b)(1)(i)(E) and (F), which, as discussed above, permit exclusion of ‘‘bona fide discount points’’ from points and fees for qualified mortgages. TILA section 129C(b)(2)(C)(iii) defines the term ‘‘bona fide discount points’’ as ‘‘loan discount points which are knowingly paid by the consumer for the purpose of reducing, and which in fact result in a bona fide reduction of, the interest rate or time-price differential applicable to the mortgage.’’ TILA section 129C(b)(2)(C)(iv) limits the types of discount points that may be excluded from ‘‘points and fees’’ to those for which ‘‘the amount of the interest rate reduction purchased is reasonably consistent with established industry norms and practices for secondary market transactions.’’ Proposed § 226.43(e)(3)(iv) would have implemented these provisions by defining the term ‘‘bona fide discount point’’ as ‘‘any percent of the loan amount’’ paid by the consumer that reduces the interest rate or time-price differential applicable to the mortgage loan by an amount based on a calculation that: (1) Is consistent with established industry practices for determining the amount of reduction in the interest rate or time-price differential appropriate for the amount of discount points paid by the consumer; and (2) accounts for the amount of compensation that the creditor can reasonably expect to receive from secondary market investors in return for the mortgage loan. The Board’s proposal would have required that the creditor be able to show a relationship between the amount of interest rate reduction purchased by a discount point and the value of the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 transaction in the secondary market. The Board observed that, based on outreach with representatives of creditors and GSEs, the value of a rate reduction in a particular mortgage transaction on the secondary market is based on many complex factors, which interact in a variety of complex ways. The Board noted that these factors may include, among others: • The product type, such as whether the loan is a fixed-rate or adjustable-rate mortgage, or has a 30-year term or a 15year term. • How much the MBS market is willing to pay for a loan at that interest rate and the liquidity of an MBS with loans at that rate. • How much the secondary market is willing to pay for excess interest on the loan that is available for capitalization outside of the MBS market. • The amount of the guaranty fee required to be paid by the creditor to the investor. The Board indicated that it was offering a flexible proposal because of its concern that a more prescriptive interpretation would be operationally unworkable for most creditors and would lead to excessive legal and regulatory risk. In addition, the Board also noted that, due to the variation in inputs described above, a more prescriptive rule likely would require continual updating, creating additional compliance burden and potential confusion. The Board also noted a concern that small creditors such as community banks that often hold loans in portfolio rather than sell them on the secondary market may have difficulty complying with this requirement. The Board therefore requested comment on whether it would be appropriate to provide any exemptions from the requirement that the interest rate reduction purchased by a ‘‘bona fide discount point’’ be tied to secondary market factors. Many industry commenters criticized the second prong of the Board’s proposal, which would have required that the interest rate reduction account for the amount of compensation that the creditor can reasonably expect to receive from secondary market investors in return for the mortgage loan. Several industry commenters argued that this test would be complex and difficult to apply and that, if challenged, it would be difficult for creditors to prove that the calculation was done properly. Two industry commenters noted that creditors do not always sell or plan to sell loans in the secondary market at the time of origination and so would not know what compensation they would PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 6441 receive on the secondary market. Several industry commenters emphasized that the secondary market test would be impracticable for creditors holding loans in portfolio. Consumer groups did not comment on this issue. As noted above, the Bureau is consolidating the exclusions for certain bona fide third-party charges and bona fide discount points in § 1026.32(b)(1)(i)(D) through (F). As a result, the Bureau is adopting proposed § 226.43(e)(3)(iv), with the revision discussed below, as renumbered § 1026.32(b)(3)(i). In the 2013 HOEPA Final Rule, the Bureau is adopting a definition of bona fide discount point for open-end credit in § 1026.32(b)(3)(ii). After carefully considering the comments, the Bureau is modifying the definition of ‘‘bona fide discount point.’’ Specifically, the Bureau believes it would be difficult, if not impossible, for many creditors to account for the secondary market compensation in calculating interest rate reductions. This is particularly true for loans held in portfolio. Therefore, the Board is removing from § 1026.32(b)(3)(i) the requirement that interest rate reductions take into account secondary market compensation. Instead, as revised, § 1026.32(b)(3)(i) requires only that the calculation of the interest rate reduction be consistent with established industry practices for determining the amount of reduction in the interest rate or timeprice differential appropriate for the amount of discount points paid by the consumer. The Bureau finds that removing the secondary market component of the ‘‘bona fide’’ discount point definition is necessary and proper under TILA section 105(a) to effectuate the purposes of and facilitate compliance with TILA. Similarly, the Bureau finds that it is necessary and proper to use its authority under TILA section 129C(b)(3)(B)(i) to revise and subtract from the criteria that define a qualified mortgage by removing the secondary market component from the bona fide discount point definition. It will provide creditors sufficient flexibility to demonstrate that they are in compliance with the requirement that, to be excluded from points and fees, discount points must be bona fide. In clarifying the definition, it also will facilitate the use of bona fide discount points by consumers to help create the appropriate combination of points and rate for their financial situation, thereby helping ensure that consumers are offered and receive residential mortgage loan on terms that reasonably reflect their ability to repay the loans and that responsible, affordable mortgage credit E:\FR\FM\30JAR2.SGM 30JAR2 6442 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations remains available to consumers in a manner consistent with the purposes of TILA as provided in TILA section 129C. To provide some guidance on how creditors may comply with this requirement, the Bureau is adding new comment 32(b)(3)(i)–1. This comment explains how creditors can comply with ‘‘established industry practices’’ for calculating interest rate reductions. Specifically, comment 32(b)(3)(i)–1 notes that one way creditors can satisfy this requirement is by complying with established industry norms and practices for secondary mortgage market transactions. Comment 32(b)(3)(i)–1 then provides two examples. First a creditor may rely on pricing in the tobe-announced (TBA) market for MBS to establish that the interest rate reduction is consistent with the compensation that the creditor could reasonably expect to receive in the secondary market. Second, a creditor could comply with established industry practices, such as guidelines from Fannie Mae or Freddie Mac that prescribe when an interest rate reduction from a discount point is considered bona fide. However, because these examples from the secondary market are merely illustrations of how a creditor could comply with the ‘‘established industry practices’’ requirement for bona fide interest rate reduction, creditors, and in particular creditors that retain loans in portfolio, will have flexibility to use other approaches for complying with this requirement. 32(b)(4) Total Loan Amount sroberts on DSK5SPTVN1PROD with 32(b)(4)(i) Closed-End Credit As added by section 1412 of the Dodd-Frank Act, TILA section 129C(b)(2)(A)(vii) defines a ‘‘qualified mortgage’’ as a mortgage for which, among other things, ‘‘the total points and fees * * * payable in connection with the loan do not exceed 3 percent of the total loan amount.’’ For purposes of implementing the qualified mortgage provisions, the Board proposed to retain existing comment 32(a)(1)(ii)–1 explaining the meaning of the term ‘‘total loan amount,’’ with certain minor revisions discussed below, while also seeking comment on an alternative approach. The proposal would have revised the ‘‘total loan amount’’ calculation under current comment 32(a)(1)(ii)–1 to account for charges added to TILA’s definition of points and fees by the Dodd-Frank Act. Under Regulation Z for purposes of applying the existing points and fees trigger for high-cost loans, the ‘‘total loan amount’’ is calculated as the amount of credit extended to or on VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 behalf of the consumer, minus any financed points and fees. Specifically, under current comment 32(a)(1)(ii)–1, the ‘‘total loan amount’’ is calculated by ‘‘taking the amount financed, as determined according to § 1026.18(b), and deducting any cost listed in § 1026.32(b)(1)(iii) and § 1026.32(b)(1)(iv) that is both included as points and fees under § 1026.32(b)(1) and financed by the creditor.’’ Section 1026.32(b)(1)(iii) and (b)(1)(iv) pertain to ‘‘real estate-related fees’’ listed in § 1026.4(c)(7) and premiums or other charges for credit insurance or debt cancellation coverage, respectively. The Board proposed to revise this comment to cross-reference additional financed points and fees described in proposed § 226.32(b)(1)(vi) as well. This addition would have required a creditor also to deduct from the amount financed any prepayment penalties that are incurred by the consumer if the mortgage loan refinances a previous loan made or currently held by the creditor refinancing the loan or an affiliate of the creditor—to the extent that the prepayment penalties are financed by the creditor. As a result, the 3 percent limit on points and fees for qualified mortgages would have been based on the amount of credit extended to the consumer without taking into account any financed points and fees. The Board’s proposal also would have revised one of the commentary’s examples of the ‘‘total loan amount’’ calculation. Specifically, the Board proposed to revise the example of a $500 single premium for optional ‘‘credit life insurance’’ used in comment 32(b)(1)(i)–1.iv to be a $500 single premium for optional ‘‘credit unemployment insurance.’’ The Board stated that this change was proposed because, under the Dodd-Frank Act, single-premium credit insurance— including credit life insurance—is prohibited in covered transactions except for certain limited types of credit unemployment insurance. See TILA section 129C(d). The Board requested comment on the proposed revisions to the comment explaining how to calculate the ‘‘total loan amount,’’ including whether additional guidance is needed. The Board also requested comment on whether to streamline the calculation to ensure that the ‘‘total loan amount’’ would include all credit extended other than financed points and fees. Specifically, the Board solicited comment on whether to revise the calculation of ‘‘total loan amount’’ to be the ‘‘principal loan amount’’ (as defined in § 226.18(b) and accompanying commentary), minus charges that are PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 points and fees under § 226.32(b)(1) and are financed by the creditor. The Board explained that the purpose of using the ‘‘principal loan amount’’ instead of the ‘‘amount financed’’ would be to streamline the calculation to facilitate compliance and to ensure that no charges other than financed points and fees are excluded from the ‘‘total loan amount.’’ 85 In general, the revised calculation would have yielded a larger ‘‘total loan amount’’ to which the percentage points and fees thresholds would have to be applied than would the proposed (and existing) ‘‘total loan amount’’ calculation, because only financed points and fees and no other financed amounts would be excluded. Thus, creditors in some cases would be able to charge more points and fees on the same loan under the alternative outlined by the Board than under either the proposed or existing rule. In the 2012 HOEPA Proposal, the Bureau proposed the following for organizational purposes: (1) To move the existing definition of ‘‘total loan amount’’ for closed-end mortgage loans from comment 32(a)(1)(ii)–1 to proposed § 1026.32(b)(6)(i); and (2) to move the examples showing how to calculate the total loan amount for closed-end mortgage loans from existing comment 32(a)(1)(ii)–1 to proposed comment 32(b)(6)(i)–1. The Bureau proposed to specify that the calculation applies to closed-end mortgage loans because the Bureau also proposed to define ‘‘total loan amount’’ separately for open-end credit plans. The Bureau also proposed to amend the definition of ‘‘total loan amount’’ in a manner similar to the Board’s alternative proposal described above. The Bureau indicated this proposed revision would streamline the total loan amount calculation to facilitate compliance and would be sensible in light of the more inclusive definition of the finance charge proposed in the Bureau’s 2012 TILA– RESPA Integration Proposal. Few commenters addressed the Board’s proposal regarding total loan amount. Several industry commenters recommended that the alternative method of calculating total loan amount be used because it would be easier to calculate. At least two industry commenters recommended that, for simplicity, the amount recited in the note be used for calculating the permitted points and fees. After reviewing the comments, the Bureau is following the 2012 HOEPA 85 Specifically, under the alternative approach, prepaid finance charges would not be deducted from the principal loan amount. Only financed points and fees would be deducted. E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations Proposal and moving the definition of total loan amount into the text of the rule in § 1026.32(b)(4)(i). In 2013 HOEPA Final Rule, the Bureau is adopting a definition of total loan amount for open-end credit in § 1026.32(b)(4)(ii). The examples showing how to calculate the total loan amount are moved to comment 32(b)(4)(i)–1. However, the Bureau has concluded that, at this point, the current approach to calculating the total loan amount should remain in place. Creditors are familiar with the method from using it for HOEPA points and fees calculations. Moreover, as noted above, the Bureau is deferring action on the more inclusive definition of the finance charge proposed in the Bureau’s 2012 TILA–RESPA Integration Proposal. If the Bureau expands the definition of the finance charge, the Bureau will at the same time consider the effect on coverage thresholds that rely on the finance charge or the APR. 32(b)(5) The final rule renumbers existing § 1026.32(b)(2) defining the term ‘‘affiliate’’ as § 1026.32(b)(5) for organizational purposes. 32(b)(6) Prepayment Penalty sroberts on DSK5SPTVN1PROD with The Dodd-Frank Act’s Amendments to TILA Relating to Prepayment Penalties Sections 1431 and 1432 of the DoddFrank Act (relating to high-cost mortgages) and section 1414 of the Dodd-Frank Act (relating to qualified mortgages) amended TILA to restrict and, in many cases, prohibit a creditor from imposing prepayment penalties in dwelling-secured credit transactions. The Dodd-Frank Act restricted prepayment penalties in three main ways. First, as the Board discussed in its 2011 ATR Proposal, the Dodd-Frank Act added new TILA section 129C(c)(1) relating to qualified mortgages, which generally provides that a covered transaction (i.e., in general, a closedend, dwelling-secured credit transaction) may include a prepayment penalty only if it; (1) Is a qualified mortgage, to be defined by the Board, (2) has an APR that cannot increase after consummation, and (3) is not a higherpriced mortgage loan. The Board proposed to implement TILA section 129C(c)(1) in § 226.43(g)(1) and to define the term prepayment penalty in § 226.43(b)(10). Under new TILA section 129C(c)(3), moreover, even loans that meet the statutorily prescribed criteria (i.e., fixed-rate, non-higher-priced qualified mortgages) are capped in the amount of prepayment penalties that VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 may be charged, starting at three percent in the first year after consummation and decreasing annually by increments of one percentage point thereafter so that no penalties may be charged after the third year. The Board proposed to implement TILA section 129C(c)(3) in § 226.43(g)(2). Second, section 1431(a) of the DoddFrank Act amended TILA section 103(bb)(1)(A)(iii) to provide that a credit transaction is a high-cost mortgage if the credit transaction documents permit the creditor to charge or collect prepayment fees or penalties more than 36 months after the transaction closing or if such fees or penalties exceed, in the aggregate, more than two percent of the amount prepaid. Moreover, under amended TILA section 129(c)(1), highcost mortgages are prohibited from having a prepayment penalty. Accordingly, any prepayment penalty in excess of two percent of the amount prepaid on any closed end mortgage would both trigger and violate the rule’s high-cost mortgage provisions. The Bureau’s 2012 HOEPA Proposal proposed to implement these requirements with several minor clarifications in § 1026.32(a)(1)(iii). See 77 FR 49090, 49150 (Aug. 15, 2012). Third, both qualified mortgages and most closed-end mortgage loans and open-end credit plans secured by a consumer’s principal dwelling are subject to additional limitations on prepayment penalties through the inclusion of prepayment penalties in the definition of points and fees for qualified mortgages and high-cost mortgages. See the section-by-section analysis of proposed § 226.32(b)(1)(v) and (vi); 77 FR 49090, 49109–10 (Aug. 15, 2012). Taken together, the Dodd-Frank Act’s amendments to TILA relating to prepayment penalties mean that most closed-end, dwelling-secured transactions: (1) May provide for a prepayment penalty only if the transaction is a fixed-rate, qualified mortgage that is neither high-cost nor higher-priced under §§ 1026.32 and 1026.35; (2) may not, even if permitted to provide for a prepayment penalty, charge the penalty more than three years following consummation or in an amount that exceeds two percent of the amount prepaid; and (3) may be required to limit any penalty even further to comply with the points and fees limitations for qualified mortgages or to stay below the points and fees trigger for high-cost mortgages. In the interest of lowering compliance burden and to provide additional clarity for creditors, the Bureau has elected to define prepayment penalty in a PO 00000 Frm 00037 Fmt 4701 Sfmt 4700 6443 consistent manner for purposes of all of the Dodd-Frank Act’s amendments. This definition is located in § 1026.32(b)(6). New § 1026.43(b)(10) cross-references this prepayment definition to provide consistency. TILA establishes certain disclosure requirements for transactions for which a penalty is imposed upon prepayment, but TILA does not define the term ‘‘prepayment penalty.’’ The Dodd-Frank Act also does not define the term. TILA section 128(a)(11) requires that the transaction-specific disclosures for closed-end consumer credit transactions disclose a ‘‘penalty’’ imposed upon prepayment in full of a closed-end transaction, without using the term ‘‘prepayment penalty.’’ 15 U.S.C. 1638(a)(11).86 Comment 18(k)(1)–1 clarifies that a ‘‘penalty’’ imposed upon prepayment in full is a charge assessed solely because of the prepayment of an obligation and includes, for example, ‘‘interest’’ charges for any period after prepayment in full is made and a minimum finance charge. The Board’s 2011 ATR Proposal proposed to implement the Dodd-Frank Act’s prepayment penalty-related amendments to TILA for qualified mortgages by defining ‘‘prepayment penalty’’ for most closed-end, dwellingsecured transactions in new § 226.43(b)(10), and by cross-referencing proposed § 226.43(b)(10) in the proposed joint definition of points and fees for qualified and high-cost mortgages in § 226.32(b)(1)(v) and (vi). The definition of prepayment penalty proposed in the Board’s 2011 ATR Proposal differed from the Board’s prior proposals and existing guidance in the following respects: (1) Proposed § 226.43(b)(10) defined prepayment penalty with reference to a payment of ‘‘all or part of’’ the principal in a transaction covered by the provision, while § 1026.18(k) and associated commentary and the Board’s 2009 Closed-End Proposal and 2010 Mortgage Proposal referred to payment ‘‘in full;’’ (2) the examples provided omitted reference to a minimum finance charge and loan guarantee fees; and (3) proposed § 226.43(b)(10) did not incorporate, and the Board’s 2011 ATR Proposal did not otherwise address, the language in § 1026.18(k)(2) and associated commentary regarding 86 Also, TILA section 128(a)(12) requires that the transaction-specific disclosures state that the consumer should refer to the appropriate contract document for information regarding certain loan terms or features, including ‘‘prepayment * * * penalties.’’ 15 U.S.C. 1638(a)(12). In addition, TILA section 129(c) limits the circumstances in which a high-cost mortgage may include a ‘‘prepayment penalty.’’ 15 U.S.C. 1639(c). E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6444 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations disclosure of a rebate of a precomputed finance charge, or the language in § 1026.32(b)(6) and associated commentary concerning prepayment penalties for high-cost mortgages. The Board proposal generally received support from industry commenters and consumer advocates for accurately implementing section 129C(c) by using a plain language definition of prepayment penalty. Many commenters, particularly consumer groups, supported a rule that eliminates or tightly restricts the availability of prepayment penalties. Some industry commenters, however, cautioned the Bureau against implementing an overbroad definition of prepayment penalty, citing primarily a concern over consumers’ access to credit. At least one commenter argued that a prepayment penalty ban should be more narrowly focused on the subprime loan market, noting that the proposal affected prepayment penalties on a wider variety of products. Other industry commenters expressed a concern about the Board’s approach to the monthly interest accrual amortization method, as discussed in more detail below as part of the discussion of comment 32(b)(6)–1. The Bureau adopts the definition of prepayment penalty under § 1026.32(b)(6) largely as proposed by the Board in order to create a clear application of the term prepayment penalty that is consistent with the definitions proposed in the Bureau’s 2012 TILA–RESPA Proposal (which itself draws from the definition adopted in the Bureau’s 2013 HOEPA Final Rule). However, the Bureau adds to § 1026.32(b)(6) an explicit exclusion from the definition of prepayment penalty for a waived bona fide thirdparty charge that the creditor imposes if the consumer, sooner than 36 months after consummation, pays all of a covered transaction’s principal before the date on which the principal is due. This addition is discussed in detail below. Consistent with TILA section 129(c)(1), existing § 1026.32(d)(6), and the Board’s proposed § 226.43(b)(10) for qualified mortgages, § 1026.32(b)(6)(i) provides that, for a closed-end mortgage loan, a ‘‘prepayment penalty’’ means a charge imposed for paying all or part of the transaction’s principal before the date on which the principal is due, though the Bureau has added a carveout from this definition to accommodate the repayment of certain conditionally waived closing costs when the consumer prepays in full. The Bureau adopts this definition of prepayment penalty under § 1026.32(b)(6), rather than under § 1026.43(b)(10), to facilitate compliance for creditors across VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 rulemakings. The definition of ‘‘prepayment penalty’’ under § 1026.32(b)(6) thus will apply to prepayment penalty restrictions, as applied under § 1026.43(g). Section 1026.32(b)(6) also contains requirements and guidance related to the Bureau’s 2013 HOEPA Final Rule, such as a definition of prepayment penalty that applies to open-end credit. The Board’s 2011 ATR Proposal included as an example of a prepayment penalty a fee that the creditor waives unless the consumer prepays the covered transaction. Some industry commenters contended that such conditional fee waivers should be excluded from the definition of prepayment penalties. The commenters argued that creditors imposed conditional fee waivers not to increase profit, but to ensure compensation for fixed costs associated with originating the loan. At least one commenter directed the Bureau to a 1996 National Credit Union Administration opinion letter that concluded that a conditional waiver of closing costs by a credit union was a benefit to the consumer. Other comments characterized the conditional fee waiver as a ‘‘reimbursement,’’ rather than compensation. The Bureau finds such comments persuasive, particularly with respect to a situation in which the creditor waives a bona fide third-party charge (or charges) on condition that the consumer reimburse the creditor for the cost of that charge if the consumer prepays the loan. In such situations, the Bureau recognizes that the creditor receives no profit from imposing or collecting such charges and the Bureau believes that treating such charges as a prepayment penalty might very well have the effect of reducing consumer choice without providing any commensurate consumer benefit. In an effort to provide a sensible way to permit a creditor to protect itself from losing money paid at closing to third parties on the consumer’s behalf, prior to such time as the creditor can otherwise recoup such costs through the interest rate on the mortgage loan, while balancing consumer protection interests, the Bureau has concluded that such fees should be permissible for a limited time after consummation. The Bureau thus adopts § 1032(b)(6)(i) to clarify that the term prepayment penalty does not include a waived bona fide third-party charge imposed by the creditor if the consumer pays all of a covered transaction’s principal before the date on which the principal is due sooner than 36 months after consummation. The Bureau concludes that limiting the duration of the possible charge to 36 months after consummation is PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 consistent with TILA 129C(c)(3)(D), which prohibits any prepayment penalty three years after loan consummation, while accommodating the concerns discussed above. Moreover, § 1032(b)(6)(i) excludes from the definition of prepayment penalty only those charges that a creditor imposes to recoup waived bona-fide third party charges in such cases where the consumer prepays in full. Thus, for example, if one month after loan consummation, the consumer prepays $100 of principal earlier than it is due, where the total principal is $100,000, then any fee that the creditor imposes for such prepayment is a prepayment penalty under § 1032(b)(6)(i) and such a fee is restricted in accordance with § 1026.43(g). The Bureau believes that § 1026.32(b)(6) accurately implements TILA section 129C(c), which significantly limits the applicability and duration of prepayment penalties. Some commenters argued that restrictions on prepayment penalties should be more narrowly focused on specific products or consumers, because not all consumers need protection from the pitfalls of prepayment penalties. The Bureau agrees that prepayment penalties are not always harmful to consumers and that, in some cases, allowing a creditor to charge a prepayment penalty may lead to increased consumer choice and access to credit. Congress recognized this balance by allowing a creditor to charge a prepayment penalty only in certain circumstances, such as requiring the loan to be a qualified mortgage, under TILA section 129C(c)(1)(A), and by limiting a creditor to charging a prepayment penalty to no more than three years following consummation, under TILA section 129C(c)(3)(D). Section 1026.32(b)(6) remains faithful to that balance, with the Bureau’s minor clarification with respect to waived bona fide third party charges, as described above. The Board’s 2011 ATR Proposal included several other examples of a prepayment penalty under proposed § 226.43(b)(10)(i). For clarity, the Bureau incorporates these examples as comment 32(b)(6)–1.i and ii, and the Bureau is adding comment 32(b)(6)–1.iii and iv to provide additional clarity. Likewise, the Bureau is largely adopting the Board’s proposed § 226.43(b)(10)(ii), an example of what is not a prepayment penalty, as comment 32(b)(6)–3.i, as well as adding comment 32(b)(6)–3.ii. Comment 32(b)(6)–1.i through iv gives the following examples of prepayment penalties: (1) A charge determined by treating the loan balance as outstanding for a period of time after prepayment in E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations full and applying the interest rate to such ‘‘balance,’’ even if the charge results from interest accrual amortization used for other payments in the transaction under the terms of the loan contract; (2) a fee, such as an origination or other loan closing cost, that is waived by the creditor on the condition that the consumer does not prepay the loan; (3) a minimum finance charge in a simple interest transaction; and (4) computing a refund of unearned interest by a method that is less favorable to the consumer than the actuarial method, as defined by section 933(d) of the Housing and Community Development Act of 1992, 15 U.S.C. 1615(d). Post-payoff interest charges. The Board proposal included as an example of a prepayment penalty in proposed § 226.43(b)(10)(i)(A) a charge determined by the creditor or servicer treating the loan balance as outstanding for a period of time after prepayment in full. Some industry commenters expressed reservations about treating this monthly interest accrual amortization method as a prepayment penalty, arguing that such a rule might cause higher resale prices in the secondary mortgage market to account for cash flow uncertainty. Other commenters noted that this calculation method is currently used by FHA to compute interest on its loans (including loans currently in Ginnie Mae pools), or that such charges were not customarily considered a prepayment penalty. Some commenters expressed concern that the rule would disrupt FHA lending. After careful consideration of the comments received, the Bureau concludes that going forward (e.g., for loans a creditor originates after the effective date), it is appropriate to designate higher interest charges for consumers based on accrual methods that treat a loan balance as outstanding for a period of time after prepayment in full as prepayment penalties under § 1026.32(b)(6) and comment 32(b)(6)– 1.i. In such instances, the consumer submits a payment before it is due, but the creditor nonetheless charges interest on the portion of the principal that the creditor has already received. The Bureau believes that charging a consumer interest after the consumer has repaid the principal is the functional equivalent of a prepayment penalty. Comment 32(b)(6)–1.i further clarifies that ‘‘interest accrual amortization’’ refers to the method by which the amount of interest due for each period (e.g., month) in a transaction’s term is determined and notes, for example, that ‘‘monthly interest accrual amortization’’ treats VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 each payment as made on the scheduled, monthly due date even if it is actually paid early or late (until the expiration of any grace period). The proposed comment also provides an example where a prepayment penalty of $1,000 is imposed because a full month’s interest of $3,000 is charged even though only $2,000 in interest was earned in the month during which the consumer prepaid. With respect to FHA practices relating to monthly interest accrual amortization, the Bureau has consulted extensively with HUD in issuing this final rule as well as the 2013 HOEPA Final Rule. Based on these consultations, the Bureau understands that HUD must engage in rulemaking to end its practice of imposing interest charges on consumers for the balance of the month in which consumers prepay in full. The Bureau further understands that HUD requires approximately 24 months to complete its rulemaking process. Accordingly, in recognition of the important role that FHA-insured credit plays in the current mortgage market and to facilitate FHA creditors’ ability to comply with this aspect of the 2013 ATR and HOEPA Final Rules, the Bureau is using its authority under TILA section 105(a) to provide for optional compliance until January 15, 2015 with § 1026.32(b)(6)(i) and the official interpretation of that provision in comment 32(b)(6)–1.i regarding monthly interest accrual amortization. Specifically, § 1026.32(b)(6)(i) provides that interest charged consistent with the monthly interest accrual amortization method is not a prepayment penalty for FHA loans consummated before January 21, 2015. FHA loans consummated on or after January 21, 2015 must comply with all aspects of the final rule. The Bureau is making this adjustment pursuant to its authority under TILA section 105(a), which provides that the Bureau’s regulations may contain such additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions as in the Bureau’s judgment are necessary or proper to effectuate the purposes of TILA, prevent circumvention or evasion thereof, or facilitate compliance therewith. 15 U.S.C. 1604(a). The purposes of TILA include the purposes that apply to 129C, to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loan. See 15 U.S.C. 1639b(a)(2). The Bureau believes it is necessary and proper to make this adjustment to ensure that consumers PO 00000 Frm 00039 Fmt 4701 Sfmt 4700 6445 receive loans on affordable terms and to facilitate compliance with TILA and its purposes while mitigating the risk of disruption to the market. For purposes of this rulemaking, the Bureau specifically notes that the inclusion of interest charged consistent with the monthly interest accrual amortization method in the definition of prepayment penalty for purposes of determining whether a transaction is in compliance with the requirements of § 1026.43(g) applies only to transactions consummated on or after January 10, 2014; for FHA loans, compliance with this aspect of the definition of prepayment penalties is optional for transactions consummated prior to January 21, 2015. With regard to general concerns that loans subject to these interest accrual methods may be subject to higher prices on the secondary market, the Bureau is confident that the secondary market will be able to price the increased risk of prepayment, if any, that may occur as a result of the limits that will apply to monthly interest accrual amortizationrelated prepayment penalties. The secondary market already does so for various other types of prepayment risk on investor pools, such as the risk of refinancing or sale of the property. Comment 32(b)(6)–1.ii further explains the 36 month carve-out for a waived bona fide third-party charge imposed by the creditor if the consumer pays all of a covered transaction’s principal before the date on which the principal is due sooner than 36 months after consummation, as included in § 1026.32(b)(6)(i). The comment explains that if a creditor waives $3,000 in closing costs to cover bona fide third party charges but the terms of the loan agreement provide that the creditor may recoup $4,500, in part to recoup waived charges, then only $3,000 that the creditor may impose to cover the waived bona fide third party charges is considered not to be a prepayment penalty, while any additional $1,500 charge for prepayment is a prepayment penalty and subject to the restrictions under § 1026.43(g). This comment also demonstrates that the only amount excepted from the definition of prepayment penalty under § 1026.32(b)(6)(i) is the actual amount that the creditor pays to a third party for a waived, bona fide charge. Minimum finance charges; unearned interest refunds. Although longstanding Regulation Z commentary has listed a minimum finance charge in a simple interest transaction as an example of a prepayment penalty, the Board proposed to omit that example from proposed § 226.43(b)(10) because the E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6446 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations Board reasoned that such a charge typically is imposed with open-end, rather than closed-end, transactions. The Bureau did not receive substantial comment on this omission, but the Bureau has elected to continue using this example in comment 32(b)(6)–1.iii for consistency. Likewise, the Board did not propose to include the example of computing a refund of unearned interest by a method that is less favorable to the consumer than the actuarial method, but the Bureau is nonetheless using this example in comment 32(b)(6)–1.iv because similar language is found in longstanding Regulation Z commentary. Examples of fees that are not prepayment penalties. The Board included in proposed § 226.43(b)(10)(ii) an example of a fee not considered a prepayment penalty. For the sake of clarity, the Bureau is moving this example into comment 32(b)(6)–2.i, rather than keep the example in the text of the regulation. The Bureau also is adding a second example in comment 32(b)(6)–2.ii. Comment 32(b)(6)–2.i explains that fees imposed for preparing and providing documents when a loan is paid in full are not prepayment penalties when such fees are imposed whether or not the loan is prepaid or the consumer terminates the plan prior to the end of its term. Commenters did not provide substantial feedback on this example, which the Bureau has reworded slightly from the Board proposal to provide conformity and clarity. The Board proposed omitting text from preexisting commentary on Regulation Z stating that a prepayment penalty did not include loan guarantee fees, noting that loan guarantee fees are not charges imposed for paying all or part of a loan’s principal before the date on which the principal is due. The Bureau did not receive substantial comment on this omission. While the Bureau agrees with the Board’s analysis, the Bureau nonetheless elects to include this example in comment 43(b)(6)–2.ii to clarify that loan guarantee fees continue to fall outside the definition of a prepayment penalty. Moreover, including this example of a fee that is not a prepayment penalty is consistent with the Bureau’s efforts to streamline definitions and ease regulatory burden. Construction-to-permanent financing. Some industry commenters advocated that, for construction-to-permanent loans, the Bureau should exclude from the definition of prepayment penalty charges levied by a creditor if a consumer does not convert the construction loan into a permanent loan with the same creditor within a VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 specified time period. The Bureau believes that the concern expressed by these commenters that the cost of credit for these construction-to-permanent loans would increase if such charges were treated as prepayment penalties is misplaced primarily because in many cases, such charges are not, in fact, a prepayment penalty. A prepayment penalty is ‘‘a charge imposed for paying all or part of a covered transaction’s principal before the date on which the principal is due.’’ First, the case where the creditor charges the consumer a fee for failing to convert a loan within a specified period after completing the repayment of a construction loan as scheduled is not a prepayment penalty; the fee is not assessed for an early payment of principal, but rather for the consumer’s failure to take an action upon scheduled repayment of principal. Second, the case where a consumer does convert the construction loan to a permanent loan in a timely manner, but incurs a fee for converting the loan with another creditor, is also likely not prepayment penalty. While such cases depend highly on contractual wording, in the example above, the consumer is charged a fee not for his early payment of principal, but rather for his use of another creditor. Third, the case where the creditor charges the consumer a fee for converting the construction loan to a permanent loan earlier than specified by agreement, even with the same creditor, likely is a prepayment penalty. While this example is not the same as the hypothetical described by most commenters, who expressed concern if a consumer does not convert the construction loan into a permanent loan with the same creditor within a specified time period, this is an example of a prepayment penalty, as the creditor has imposed a charge for paying all or part of a covered transaction’s principal before the date on which the principal was due. As the above examples demonstrate, whether a construction-topermanent loan contains a prepayment penalty is fact-specific, and the Bureau has decided that adding a comment specifically addressing such loans would not be instructive. The Bureau sees no policy reason to generally exclude fees specific to construction-topermanent loan from the definition of prepayment penalty and its statutory limits. The Bureau was not presented with any evidence that the risks inherent in construction-to-permanent loans could not be priced by creditors through alternative means, such as the examples described above, via interest rate, or charging closing costs. The Bureau also notes that, because of the PO 00000 Frm 00040 Fmt 4701 Sfmt 4700 scope of the rule, described in the section-by-section analysis of § 1026.43(a), as well as the prepayment penalty restrictions, described in the section-by-section analysis of § 1026.43(g), construction-to-permanent loans cannot be qualified mortgages, and thus under § 1026.43(g)(1)(ii)(B) cannot include a prepayment penalty. Construction-to-permanent loans are discussed in more detail in the sectionby-section analysis of § 1026.43(a). Open-end credit. The Bureau is concurrently adopting comments 32(b)(6)–3 and –4 to clarify its approach to prepayment penalties with respect to open-end credit. As the Board’s 2011 ATR Proposal did not address open-end credit plans, the Bureau is not clarifying prepayment penalties with respect to open-end credit plans in this final rule. Instead, guidance is provided in comments 32(b)(6)–3 and –4, which the Bureau is adopting in the concurrent 2013 HOEPA Final Rule. Section 1026.43 Minimum Standards for Transactions Secured by a Dwelling 43(a) Scope Sections 1411, 1412 and 1414 of the Dodd-Frank Act add new TILA section 129C, which requires creditors to determine a consumer’s ability to repay a ‘‘residential mortgage loan’’ and establishes new rules and prohibitions on prepayment penalties. Section 1401 of the Dodd-Frank Act adds new TILA section 103(cc),87 which defines ‘‘residential mortgage loan’’ to mean, with some exceptions, any consumer credit transaction secured by a mortgage, deed of trust, or other equivalent consensual security interest on ‘‘a dwelling or on residential real property that includes a dwelling.’’ TILA section 103(v) defines ‘‘dwelling’’ to mean a residential structure or mobile home which contains one- to fourfamily housing units, or individual units of condominiums or cooperatives. Thus, a ‘‘residential mortgage loan’’ is a dwelling-secured consumer credit transaction, regardless of whether the consumer credit transaction involves a home purchase, refinancing, home equity loan, first lien or subordinate lien, and regardless of whether the dwelling is a principal residence, second home, vacation home (other than a timeshare residence), a one- to fourunit residence, condominium, cooperative, mobile home, or manufactured home. 87 Two TILA subsections designated 103(cc) exist due to a discrepancy in the instructions given by the Dodd-Frank Act. See Dodd-Frank Act sections 1100A and 1401. E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations However, the Dodd-Frank Act specifically excludes from the term ‘‘residential mortgage loan’’ an openend credit plan or an extension of credit secured by an interest in a timeshare plan, for purposes of the repayment ability and prepayment penalty provisions under TILA section 129C, among other provisions. See TILA section 103(cc)(5); see also TILA section 129C(i) (providing that timeshare transactions are not subject to TILA section 129C). Further, the repayment ability provisions of TILA section 129C(a) do not apply to reverse mortgages or temporary or ‘‘bridge’’ loans with a term of 12 months or less, including a loan to purchase a new dwelling where the consumer plans to sell another dwelling within 12 months. See TILA section 129C(a)(8). The repayment ability provisions of TILA section 129C(a) also do not apply to consumer credit transactions secured by vacant land. See TILA section 103(cc)(5) and 129C(a)(1). TILA Section 103(cc) defines ‘‘residential mortgage loan’’ to mean a consumer credit transaction secured by a mortgage or equivalent consensual security interest ‘‘on a dwelling or on residential real property that includes a dwelling.’’ Under TILA and Regulation Z, the term ‘‘dwelling’’ means a residential structure with one to four units, whether or not the structure is attached to real property, and includes a condominium or cooperative unit, mobile home, and trailer, if used as a residence. See 15 U.S.C. 1602(v), § 1026.2(a)(19). To facilitate compliance by using consistent terminology throughout Regulation Z, the proposal used the term ‘‘dwelling,’’ as defined in § 1026.2(a)(19), and not the phrase ‘‘residential real property that includes a dwelling.’’ Proposed comment 43(a)– 2 clarified that, for purposes of proposed § 226.43, the term ‘‘dwelling’’ would include any real property to which the residential structure is attached that also secures the covered transaction. Proposed § 226.43(a) generally defined the scope of the ability-to-repay provisions to include any consumer credit transaction that is secured by a dwelling, other than home equity lines of credit, mortgage transactions secured by an interest in a timeshare plan, or for certain provisions reverse mortgages or temporary loans with a term of 12 months or less. Proposed comment 43(a)–1 clarified that proposed § 226.43 would not apply to an extension of credit primarily for a business, commercial, or agricultural purpose and cross-referenced the existing guidance on determining the primary purpose of VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 an extension of credit in commentary on § 1026.3. Numerous commenters requested additional exemptions from coverage beyond the statutory exemptions listed at proposed § 226.43(a)(1) through (3). The Bureau received requests for exemptions from the rule for sellerfinanced transactions, loans secured by non-primary residences, community development loans, downpayment assistance loans, loans eligible for purchase by GSEs, and housing stabilization refinances. The requested exemptions related to community development loans, downpayment assistance loans, and housing stabilization refinances are not being included in this final rule, but are addressed in the Bureau’s proposed rule regarding amendments to the ability-torepay requirements, published elsewhere in today’s Federal Register. The requested exemptions that are not being included in the rule and are not being addressed in today’s concurrent proposal are discussed immediately below. The Bureau received numerous letters from individuals concerned that the rule would cover individual home sellers who finance the buyer’s purchase, either through a loan or an installment sale. However, because the definition of ‘‘creditor’’ for mortgages generally covers only persons who extend credit secured by a dwelling more than five times in a calendar year, the overwhelming majority of individual seller-financed transactions will not be covered by the rule. Those creditors who self-finance six or more transactions in a calendar year, whether through loans or installment sales, will need to comply with the ability-to-repay provisions of § 1026.43, just as they must comply with other relevant provisions of Regulation Z. An association of State bank regulators suggested that the scope of the ability-to-repay requirements be limited to owner-occupied primary residences, stating that ability to repay on vacation homes and investment properties should be left to an institution’s business judgment. The Bureau believes it is not appropriate or necessary to exercise its exception authority to change the scope of the provision in this way for several reasons. First, as discussed in proposed comment 43(a)–1, loans that have a business purpose 88 are not covered by TILA, and so would not be covered by the ability-to-repay provisions as proposed and adopted. Investment purpose loans are considered to be 88 12 PO 00000 Fmt 4701 business purpose loans. Second, vacation home loans are consumer credit transactions that can have marked effects on a consumer’s finances. If a consumer is unable to repay a mortgage on a vacation home, the consumer will likely suffer severe financial consequences and the spillover effects on property values and other consumers in the affected area can be substantial as well. Third, the Bureau understands that default rates on vacation homes are generally higher than those on primary residences, and an exemption could increase this disparity. For the reasons discussed below, the general scope provision and the statutory exemptions in § 1026.43(a)(1) through (3)(ii) are adopted substantially as proposed, with minor changes as discussed in the relevant sections below, and the addition of § 1026.43(a)(3)(iii) to provide an exemption for the construction phase of a construction-to-permanent loan. The general scope provision at § 1026.43(a) now includes language making clear that real property attached to a dwelling will be considered a part of the dwelling for purposes of compliance with § 1026.43. Although as discussed above similar language was included in the official commentary in the proposed rule, the Bureau believes this important legal requirement should be part of the regulatory text. Comment 43(a)–1 now includes a reference to § 1026.20(a), which describes different types of changes to an existing loan that will not be treated as refinancings, to make clear that creditors may rely on that section in determining whether or not § 1026.43 will apply to a particular change to an existing loan. 43(a)(1) The Board’s proposal included an exemption from the scope of section 226.43 for ‘‘[a] home equity line of credit subject to § 226.5b,’’ 89 which implemented the exclusion of HELOCs from coverage in the statutory definition of ‘‘residential mortgage loan.’’ DoddFrank Act section 1401. The Bureau received two comments asking that the HELOC exemption be reconsidered. The commenters stated that HELOCs had contributed to the crisis in the mortgage market and that failure to include them in the ability-to-repay rule’s coverage would likely lead to more consumer abuse and systemic problems. The Bureau notes that Congress specifically exempted open-end lines of credit from the ability-to-repay 89 The Regulation Z section on HELOCs has been relocated and is now at 12 CFR 1026.40. CFR 1026.3(a). Frm 00041 6447 Sfmt 4700 E:\FR\FM\30JAR2.SGM 30JAR2 6448 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations requirements, even though the DoddFrank Act extends other consumer protections to such loans, including the requirements for high-cost mortgages under HOEPA. The Bureau also notes that home equity lines of credit have consistently had lower delinquency rates than other forms of consumer credit.90 Furthermore, the requirements contained in the Dodd-Frank Act with respect to assessing a consumer’s ability to repay a residential mortgage, and the regulations the Bureau is adopting thereunder, were crafted to apply to the underwriting of closed-end loans and are not necessarily transferrable to underwriting for an open-end line of credit secured by real estate. In light of these considerations, the Bureau does not believe there is sufficient justification to find it necessary or proper to use its adjustment and exception authority to expand the ability-to-repay provisions to HELOCs at this time. However, as discussed in detail below, the Bureau is adopting the Board’s proposal to require creditors to consider and verify contemporaneous HELOCs in addition to other types of simultaneous loans for the purpose of complying with the ability-to-repay provisions. See the section-by-section analysis of § 1026.43(b)(12) below. In addition, the final rule includes the Board’s proposed anti-evasion provision, which forbids the structuring of credit that does not meet the definition of open-end credit as an open-end plan in order to evade the requirements of this rule. See § 1026.43(h). Accordingly, § 1026.43(a)(1) is adopted as proposed, with the embedded citation updated. However, the Bureau intends to monitor the HELOC exemption through its supervision function and may revisit the issue as part of its broader review of the ability-to-repay rule under section 1022(d) of the Dodd-Frank Act, which requires the Bureau to publish an assessment of a significant rule or order not later than five years after its effective date. 43(a)(2) sroberts on DSK5SPTVN1PROD with The Bureau did not receive comments on the statutory timeshare exemption included in proposed § 226.43(a)(2). Accordingly, the Bureau is adopting § 1026.43(a)(2) as proposed. 90 See Fed. Reserve Bank of N.Y., Quarterly Report on Household Debt and Credit, at 9 (Nov. 2012), available at https://www.newyorkfed.org/ research/national_economy/householdcredit/ DistrictReport_Q32012.pdf. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 43(a)(3) 43(a)(3)(i) Proposed § 226.43(a)(3)(i) created an exemption from the ability-to-repay requirements in § 226.43(c) through (f) for reverse mortgages, as provided in the statute. The Bureau did not receive comments on this exemption.91 Accordingly, the Bureau is adopting § 1026.43(a)(3)(i) as proposed. 43(a)(3)(ii) Proposed § 226.43(a)(3)(ii) provided an exemption from the ability-to-repay requirements in § 226.43(c) through (f) for ‘‘[a] temporary or ‘bridge’ loan with a term of 12 months or less, such as a loan to finance the purchase of a new dwelling where the consumer plans to sell a current dwelling within 12 months or a loan to finance the initial construction of a dwelling.’’ Furthermore, proposed comment 43(a)– 3 provided that, ‘‘[w]here a temporary or bridge loan is renewable, the loan term does not include any additional period of time that could result from a renewal provision.’’ The Board solicited comment on whether a decision to treat renewals in this manner would lead to evasion of the rule. The statute includes the one-year exemption implemented in the proposed rule but does not specifically address renewals. TILA section 129C(a)(8), 15 U.S.C. 1639c(a)(8). Generally, commenters did not specifically address the proposal’s request for comment on renewals of short-term financing; however, one industry commenter stated that the statutory one-year limitation would interfere with construction loans, which often require more than a year to complete. The Bureau understands that construction loans often go beyond a single year. Although the comment did not specify that disregarding potential renewals would alleviate this concern, the Bureau believes that disregarding renewals would facilitate compliance and prevent unwarranted restrictions on access to construction loans. Commenters did not respond to the Board’s query about whether or not disregarding renewals of transactions with one-year terms would lead to evasion of the rule. Upon further analysis, the Bureau believes that this concern does not warrant changing the proposed commentary. However, the Bureau intends to monitor the issue through its supervision function and to 91 Comments were received regarding the possible description of a reverse mortgage qualified mortgage, and they are discussed below. These commenters did not discuss or question the general exemption from the ability-to-repay rule. PO 00000 Frm 00042 Fmt 4701 Sfmt 4700 revisit the issue as part of its broader review of the ability-to-repay rule under section 1022(d) of the Dodd-Frank Act, which requires the Bureau to conduct an assessment of significant rules five years after they are adopted. One industry trade association commented on the wording of the temporary financing exemption, suggesting that the inclusion of the two examples, bridge loans and construction loans, would create uncertainty as to whether the exemption would apply to temporary financing of other types. However, the Bureau believes further clarification is not required because the exemption applies to any temporary loan with a term of 12 months or less, and the examples are merely illustrative. The Bureau is aware of and provides clarifying examples of certain common loan products that are temporary or ‘‘bridge’’ loans. The commenter did not note other common types of temporary loan products. The Bureau further believes that the rule permits other types of temporary financing as long as the loan satisfies the requirements of the exemption. Accordingly, § 1026.43(a)(3)(ii) and associated commentary are adopted substantially as proposed. 43(a)(3)(iii) The Bureau also received comments requesting clarification on how the temporary financing exemption would apply to construction-to-permanent loans, i.e., construction financing that will be permanently financed by the same creditor. Typically, such loans have a short construction period, during which payments are made of interest only, followed by a fully amortizing permanent period, often an additional 30 years. Because of this hybrid form, the loans do not appear to qualify for the temporary financing exemption, nor would they be qualified mortgages because of the interest-only period and the fact that the entire loan term will often slightly exceed 30 years. However, such loans may have significant consumer benefits because they avoid the inconvenience and expense of a second closing, and also avoid the risk that permanent financing will be unavailable when the construction loan is due. The Bureau notes that existing § 1026.17(c)(6)(ii) provides that construction-to-permanent loans may be disclosed as either a single transaction or as multiple transactions at the creditor’s option. Consistent with that provision, the Bureau is using its adjustment and exception authority to allow the construction phase of a construction-to-permanent loan to be E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations exempt from the ability-to-repay requirements as a temporary loan; however, the permanent phase of the loan is subject to § 1026.43. Because the permanent phase is subject to § 1026.43, it may be a qualified mortgage if it satisfies the appropriate requirements. As amended by the Dodd-Frank Act, TILA section 105(a), 15 U.S.C. 1604(a), directs the Bureau to prescribe regulations to carry out the purposes of TILA, and provides that such regulations may contain additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions that the Bureau judges are necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith. The main purpose of section 129C is articulated in section 129B(a)(2)—‘‘to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans and that are not unfair, deceptive or abusive.’’ Creditors’ ability to continue originating construction-to-permanent loans in a cost effective manner will help to ensure that consumers are offered and receive loans on terms that reasonably reflect their ability to repay. The construction-to-permanent product avoids the possibility of a consumer being unable to repay a construction loan, because the permanent financing is already part of the contract. Without the ability to treat the permanent financing as a qualified mortgage, and the construction phase as exempt, it is not clear how many creditors would continue to offer such loans, especially in the short term. In addition, consumers will benefit from the potentially lower costs associated with qualified mortgages. In addition to effectuating the purpose of ensuring ability to repay, this exemption will greatly facilitate compliance for creditors providing this product. Proposed comment 43(a)(3)–1 provided that, where a temporary or ‘‘bridge’’ loan is renewable, the loan term does not include any additional period of time that could result from a renewal provision. The Bureau is adding comment 43(a)(3)–2 to make clear that if a construction-to-permanent loan is treated as multiple transactions in regard to compliance with the abilityto-repay requirements, and the initial one-year construction phase is renewable, the loan term of the construction phase does not include any additional period of time that could result from a renewal of that VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 construction phase that is one year or less in duration. Comment 43(a)(3)–2 also makes clear that if the construction phase of a construction-to-permanent loan is treated as exempt, the permanent financing phase may be a qualified mortgage if it meets the appropriate requirements. Accordingly, § 1026.43(a)(3)(iii) and comment 43(a)(3)–2 are added to this final rule. 43(b) Definitions 43(b)(1) The definition of ‘‘covered transaction’’ restates the scope of the rule, discussed above, which implements the statutory term ‘‘residential mortgage loan’’ defined at TILA § 103(cc)(5). The Bureau did not receive any comments specifically on this provision and is adopting it as proposed in § 1026.43(b)(1). For clarity, the Bureau has added comment 43(b)(1)–1 explaining that the term ‘‘covered transaction’’ restates the scope of the rule as described in § 1026.43(a). 43(b)(2) TILA section 129C(a)(3) requires that ‘‘[a] creditor shall determine the ability of the consumer to repay using a payment schedule that fully amortizes the loan over the term of the loan.’’ In implementing this provision, the proposed rule defined a ‘‘fully amortizing payment’’ as ‘‘a periodic payment of principal and interest that will fully repay the loan amount over the loan term.’’ The term ‘‘fully amortizing payment’’ is used in the general ‘‘payment calculation’’ provision in § 1026.43(c)(5)(i)(B), which requires the use of ‘‘[m]onthly, fully amortizing payments that are substantially equal.’’ The Bureau has determined that the definition of ‘‘fully amortizing payment’’ enables accurate implementation of the payment calculation process envisioned by the statute, and no comments focused on or questioned this definition. Accordingly, § 1026.43(b)(2) is adopted as proposed. 43(b)(3) TILA section 129C(a)(6)(D) provides that, for purposes of making the repayment ability determination required under TILA section 129C(a), the creditor must calculate the monthly payment on the mortgage obligation based on several assumptions, including that the monthly payment be calculated using the fully indexed rate at the time of loan closing, without considering the introductory rate. See TILA section 129C(a)(6)(D)(iii). TILA section 129C(a)(7) defines the term ‘‘fully indexed rate’’ as ‘‘the index rate PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 6449 prevailing on a residential mortgage loan at the time the loan is made plus the margin that will apply after the expiration of any introductory interest rates.’’ The term ‘‘fully indexed rate’’ appeared in proposed § 226.43(c)(5), which implemented TILA section 129C(a)(6)(D)(iii) and provided the payment calculation rules for covered transactions. The term also appeared in proposed § 226.43(d)(5), which provided special rules for creditors that refinance a consumer from a nonstandard mortgage to a standard mortgage. Proposed § 226.43(b)(3) defined the term ‘‘fully indexed rate’’ as ‘‘the interest rate calculated using the index or formula at the time of consummation and the maximum margin that can apply at any time during the loan term.’’ This proposed definition was consistent with the statutory language of TILA sections 129C(a)(6)(D)(iii) and 129C(a)(7), but revised certain text to provide clarity. First, for consistency with current Regulation Z and to facilitate compliance, the proposal replaced the phrases ‘‘at the time of the loan closing’’ in TILA section 129C(a)(6)(D)(iii) and ‘‘at the time the loan is made’’ in TILA section 129C(a)(7) with the phrase ‘‘at the time of consummation’’ for purposes of identifying the fully indexed rate. The Board interpreted these statutory phrases to have the same meaning as the phrase ‘‘at the time of consummation.’’ See current § 1026.2(a)(7), defining the term ‘‘consummation’’ for purposes of Regulation Z requirements as ‘‘the time that a consumer becomes contractually obligated on a credit transaction.’’ In requiring that the fully indexed rate be determined using the specified index at consummation, the Board was concerned that the possible existence of loans that use more than one index could complicate this determination. Given the increasing relevance of market indices, the Board solicited comment on whether loan products currently exist that base the interest rate on a specific index at consummation, but then base subsequent rate adjustments on a different index, and whether further guidance addressing how to calculate the fully indexed rate for such loan products would be needed. The proposed rule interpreted the statutory reference to the margin that will apply ‘‘after the expiration of any introductory interest rates’’ as a reference to the maximum margin that can apply ‘‘at any time during the loan term.’’ The Bureau agrees with this interpretation, because the statutory use E:\FR\FM\30JAR2.SGM 30JAR2 6450 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with of the plural ‘‘rates’’ modified by the allinclusive term ‘‘any’’ clearly indicates not only that something more than the initial introductory rate is meant, but that ‘‘any’’ preliminary rate should be disregarded. In addition, the statutory term itself, ‘‘fully indexed rate,’’ appears to require such a reading. Referencing the entire loan term as the relevant period of time during which the creditor must identify the maximum margin that can occur under the loan makes the phrase ‘‘after the expiration of any introductory interest rates’’ unnecessary and allows for simplicity and consistency with new TILA section 103(bb), the high cost mortgage provision. Because the proposal required that the creditor use the ‘‘maximum’’ margin that can apply when determining the fully indexed rate, the creditor would be required to take into account the largest margin that could apply under the terms of the legal obligation. The approach of using the maximum margin that can apply at any time during the loan term is consistent with the statutory language contained in TILA section 103(bb), as amended by section 1431 of the DoddFrank Act, which defines a high-cost mortgage. This statutory provision provides that, for purposes of the definition of a ‘‘high-cost mortgage’’ under HOEPA, for a mortgage with an interest rate that varies solely in accordance with an index, the annual percentage rate must be based on ‘‘the interest rate determined by adding the index rate in effect on the date of consummation of the transaction to the maximum margin permitted at any time during the loan agreement.’’ 92 Furthermore, although the Board was not aware of any current loan products that possess more than one margin that may apply over the loan term, the Board proposed this clarification to address the possibility that creditors may create products that permit different margins to take effect at different points throughout the loan term. The proposal solicited comment on this approach. The proposed definition of ‘‘fully indexed rate’’ was also generally consistent with the definition of ‘‘fully indexed rate’’ as used in the MDIA Interim Final Rule,93 and with the Federal banking agencies’ use of the 92 Previous to the passage of the Dodd-Frank Act, the annual percentage rate used for this determination was calculated the same way as for the rest of the Truth in Lending Act, pursuant to § 1026.14. 93 See 2010 MDIA Interim Final Rule, 75 FR 58470, 58484 (Sept. 24, 2010) (defines fully indexed rate as ‘‘the interest rate calculated using the index value and margin’’); see also 75 FR 81836 (Dec. 29, 2010) (revising the MDIA Interim Final Rule). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 term ‘‘fully indexed rate’’ in the 2006 Nontraditional Mortgage Guidance and 2007 Subprime Mortgage Statement. Proposed comment 43(b)(3)–1 noted that in some adjustable-rate transactions, creditors may set an initial interest rate that is not determined by the index or formula used to make later interest rate adjustments. This proposed comment explained that this initial rate charged to consumers will sometimes be lower than the rate would be if it were calculated using the index or formula at consummation (i.e., a ‘‘discounted rate’’); in some cases, this initial rate may be higher (i.e., a ‘‘premium rate’’). The proposed comment clarified that when determining the fully indexed rate where the initial interest rate is not determined using the index or formula for subsequent interest rate adjustments, the creditor must use the interest rate that would have applied had the creditor used such index or formula plus margin at the time of consummation. The proposed comment further clarified that this means, in determining the fully indexed rate, the creditor must not take into account any discounted or premium rate. (In addition, to facilitate compliance, this comment directed creditors to commentary that addresses payment calculations based on the greater of the fully indexed rate or ‘‘premium rate’’ for purposes of the repayment ability determination under proposed § 226.43(c)). See final rule § 1026.43(c)(5)(i)(A) and comment 43(c)(5)(i)–2.) Proposed comment 43(b)(3)–1 differed from guidance on disclosure requirements in current comment 17(c)(1)–10.i, which provides that in cases where the initial interest rate is not calculated using the index or formula for later rate adjustments, the creditor should disclose a composite annual percentage rate that reflects both the initial rate and the fully indexed rate. The Board believed the different approach taken in proposed comment 43(b)(3)–1 was required by the statutory language and was appropriate in the present case where the purpose of the statute is to determine whether the consumer can repay the loan according to its terms, including any potential increases in required payments. TILA section 129B(a)(2), 15 U.S.C 1639b(a)(2). Proposed comment 43(b)(3)–2 further clarified that if the contract provides for a delay in the implementation of changes in an index value or formula, the creditor need not use the index or formula in effect at consummation, and provides an illustrative example. This proposed comment was consistent with current guidance in Regulation Z PO 00000 Frm 00044 Fmt 4701 Sfmt 4700 regarding the use of the index value at the time of consummation where the contract provides for a delay. See comments 17(c)(1)–10.i and 18(s)(2)(iii)(C)–1, which address the fully indexed rate for purposes of disclosure requirements. Proposed comment 43(b)(3)–3 explained that the creditor must determine the fully indexed rate without taking into account any periodic interest rate adjustment caps that may limit how quickly the fully indexed rate may be reached at any time during the loan term under the terms of the legal obligation. As the proposal noted, the guidance contained in proposed comment 43(b)(3)–3 differed from guidance contained in current comment 17(c)(1)–10.iii, which states that, when disclosing the annual percentage rate, creditors should give effect to periodic interest rate adjustment caps. Nonetheless, the Board believed the approach in proposed comment 43(b)(3)–3 was consistent with, and required by, the statutory language that states that the fully indexed rate must be determined without considering any introductory rate and by using the margin that will apply after expiration of any introductory interest rates. See TILA section 129C(a)(6)(D)(iii) and (7). In addition, the Board noted that the proposed definition of fully indexed rate, and its use in the proposed payment calculation rules, was designed to assess whether the consumer has the ability to repay the loan according to its terms. TILA section 129B(a)(2), 15 U.S.C 1639b(a)(2). This purpose differs from the principal purpose of disclosure requirements, which is to help ensure that consumers avoid the uninformed use of credit. TILA section 102(a), 15 U.S.C. 1601(a). Furthermore, the guidance contained in proposed comment 43(b)(3)–3 was consistent with the Federal banking agencies’ use of the term fully indexed rate in the 2006 Nontraditional Mortgage Guidance and 2007 Subprime Mortgage Statement. Proposed comment 43(b)(3)–4 clarified that when determining the fully indexed rate, a creditor may choose, in its sole discretion, to take into account the lifetime maximum interest rate provided under the terms of the legal obligation. This comment explained, however, that where the creditor chooses to use the lifetime maximum interest rate, and the loan agreement provides a range for the maximum interest rate, the creditor must use the highest rate in that range as the maximum interest rate. In allowing creditors to use the lifetime maximum interest rate provided under E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations the terms of the obligation, the Board was apparently interested in simplifying compliance and benefiting consumers by encouraging reasonable lifetime interest rate caps. In doing so, the Board was apparently reading its proposed definition of fully indexed rate to allow the maximum margin that can apply at any time during the loan term to refer to the maximum margin as determined at consummation. In other words, when the index value is determined at consummation, the maximum margin that can apply at any time during the loan term will be the difference between the lifetime interest rate cap and that index value. Consequently, adding the index value at consummation to that maximum margin, as required by the fully indexed rate definition, will yield the lifetime interest rate cap as the fully indexed rate. Commenters generally did not focus specifically on the definition of ‘‘fully indexed rate’’ and associated commentary proposed by the Board, or provide examples of loans with more than one index or more than one margin. An organization representing state bank regulators supported the use of the maximum margin that can apply at any time during the loan term, suggesting that it would prevent evasion. (Some commenter groups did urge the Bureau to use its adjustment authority to require creditors to use a rate higher than the fully indexed rate in assessing a consumer’s ability to repay; these comments are discussed below in the section-by-section analysis of § 1026.43(c)(5)(i)). The Bureau is adopting the rule and commentary largely as proposed, with some modifications for clarity. Specifically, the Bureau decided to include language in the definition that will make clear that the index used in determining the fully indexed rate is the index that will apply after the loan is recast, so that any index that might be used earlier in determining an initial or intermediate rate would not be used. This new language is included for clarification only, and does not change the intended meaning of the proposed definition. In the proposed rule, the Board noted that the statutory construct of the payment calculation rules, and the requirement to calculate payments based on the fully indexed rate, apply to all loans that are subject to the ability-to-repay provisions, including loans that do not base the interest rate on an index and therefore, do not have a fully indexed rate. Specifically, the statute states that ‘‘[f]or purposes of making any determination under this subsection, a creditor shall calculate the monthly payment amount for principal VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 and interest on any residential mortgage loan by assuming’’ several factors, including the fully indexed rate, as defined in the statute (emphasis added). See TILA section 129C(a)(6)(D). The statutory definition of ‘‘residential mortgage loan’’ includes loans with variable-rate features that are not based on an index or formula, such as steprate mortgages. See TILA section 103(cc); see also proposed § 226.43(a), which addressed the proposal’s scope, and proposed § 226.43(b)(1), which defined ‘‘covered transaction.’’ However, because step-rate mortgages do not have a fully indexed rate, it was unclear what interest rate the creditor should assume when calculating payment amounts for the purpose of determining the consumer’s ability to repay the covered transaction. As discussed above, the proposal interpreted the statutory requirement to use the ‘‘margin that can apply at any time after the expiration of any introductory interest rates’’ to mean that the creditor must use the ‘‘maximum margin that can apply at any time during the loan term’’ when determining the fully indexed rate. Accordingly, consistent with this approach, the proposal clarified in proposed comment 43(b)(3)–5 that where there is no fully indexed rate because the interest rate offered in the loan is not based on, and does not vary with, an index or formula, the creditor must use the maximum interest rate that may apply at any time during the loan term. Proposed comment 43(b)(3)–5 provided illustrative examples of how to determine the maximum interest rate for a step-rate and a fixed-rate mortgage. The Board believed this approach was appropriate because the purpose of TILA section 129C is to require creditors to assess whether the consumer can repay the loan according to its terms, including any potential increases in required payments. TILA section 129B(a)(2), 15 U.S.C 1639b(a)(2). Requiring creditors to use the maximum interest rate would help to ensure that consumers could repay their loans. However, the Board was also concerned that by requiring creditors to use the maximum interest rate in a step-rate mortgage, the monthly payments used to determine the consumer’s repayment ability might be overstated and potentially restrict credit availability. Therefore, the Board solicited comment on this approach, and whether authority under TILA sections 105(a) and 129B(e) should be used to provide an exception for step-rate mortgages, possibly requiring creditors to use the maximum interest rate that occurs in only the first PO 00000 Frm 00045 Fmt 4701 Sfmt 4700 6451 5 or 10 years, or some other appropriate time horizon. The Bureau received few comments on the use of the maximum interest rate that may apply at any time during the loan term for step-rate mortgages. A consumer group and a regulatory reform group stated that this method was better and more protective of consumers than using a seven- or ten-year horizon. An organization representing state bank regulators suggested that the Bureau use a five-year horizon, provided that the loan has limits on later rate increases. An industry trade association suggested that the maximum rate only be applied to the balance remaining when that maximum rate is reached. The Bureau believes that the proposal’s method of using the maximum interest rate that may apply at any time during the loan term for steprate mortgages is appropriate. This approach most closely approximates the statutorily required fully indexed rate because it employs the highest rate ascertainable at consummation, as does the fully indexed rate, and it applies that rate to the entire original principal of the loan, as the calculation in § 1026.43(c)(5)(i) does with the fully indexed rate. In addition, this method most effectively ensures the consumer’s ability to repay the loan. For the reasons stated above, § 1026.43(b)(3) is adopted substantially as proposed, with the clarification discussed above specifying that the index used in determining the fully indexed rate is the index that will apply after the loan is recast. Issues regarding the use of the fully indexed rate in the payment calculations required by § 1026.43(c)(5) are discussed in the section-by-section analysis of that section below. 43(b)(4) The Dodd-Frank Act added TILA section 129C(a)(6)(D)(ii)(II), which provides that a creditor making a balloon-payment loan with an APR at or above certain thresholds must determine ability to repay ‘‘using the contract’s repayment schedule.’’ The thresholds required by the statute are 1.5 or more percentage points above the average prime offer rate (APOR) for a comparable transaction for a first lien, and 3.5 or more percentage points above APOR for a subordinate lien. These thresholds are the same as those used in the Board’s 2008 HOEPA Final Rule 94 to designate a new category of ‘‘higherpriced mortgage loans’’ (HPMLs), which was amended by the Board’s 2011 Jumbo Loans Escrows Final Rule to 94 73 E:\FR\FM\30JAR2.SGM FR 44522 (July 30, 2008). 30JAR2 sroberts on DSK5SPTVN1PROD with 6452 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations include a separate threshold for jumbo loans for purposes of certain escrows requirements.95 Implementing these thresholds for use with the payment underwriting determination for balloonpayment mortgages, the proposed rule defined a ‘‘higher-priced covered transaction’’ as one in which the annual percentage rate (APR) ‘‘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 a first-lien covered transaction, or by 3.5 or more percentage points for a subordinate-lien covered transaction.’’ As explained further below and provided for in the statute, the designation of certain covered transactions as higher-priced affects the ability-to-repay determination for balloon-payment mortgages, and requires that those higher-priced transactions be analyzed using the loan contract’s full repayment schedule, including the balloon payment. § 1026.43(c)(5)(ii)(A)(2). Proposed comment 43(b)(4)–1 provided guidance on the term ‘‘average prime offer rate.’’ Proposed comment 43(b)(4)–2 stated that the table of average prime offer rates published by the Board would indicate how to identify the comparable transaction for a higher-priced covered transaction. Proposed comment 43(b)(4)–3 clarified that a transaction’s annual percentage rate is compared to the average prime offer rate as of the date the transaction’s interest rate is set (or ‘‘locked’’) before consummation. This proposed comment also explained that sometimes a creditor sets the interest rate initially and then resets it at a different level before consummation, and clarified that in these cases, the creditor should use the last date the interest rate is set before consummation. The Board explained in its proposed rule that it believed the ability-to-repay requirements for higher-priced balloonpayment loans was meant to apply to the subprime market, but that use of the annual percentage rate could lead to prime loans being exposed to this test. For this reason, the Board was concerned that the statutory formula for a higher-priced covered transaction might be over-inclusive. Accordingly, the Board solicited comment on whether the ‘‘transaction coverage rate’’ (TCR) should be used for this determination, instead of the annual percentage rate. 76 FR 27412. The TCR had previously been proposed in conjunction with a more inclusive version of the APR, in order to avoid having the more inclusive, hence 95 See 76 FR 11319 (Mar. 2, 2011). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 higher, APRs trigger certain requirements unnecessarily. The TCR includes fewer charges, and the Board’s 2011 Escrows Proposal proposed to use it in the threshold test for determining application of those requirements. 76 FR 11598, 11626–11627 (Mar. 2, 2011). The only comment substantively discussing the possible substitution of the TCR for the APR was strongly opposed to the idea, stating that it would create unnecessary compliance difficulty and costs. The Bureau has determined that possible transition to a TCR standard will implicate several rules and is not appropriate at the present time. However, the issue will be considered further as part of the Bureau’s TILA/RESPA rulemaking. See 77 FR 51116, 51126 (Aug. 23, 2012). The Board also solicited comment on whether or not to provide a higher threshold for jumbo balloon-payment mortgages or for balloon-payment mortgages secured by a residence that is not the consumer’s principal dwelling, e.g., a vacation home. 76 FR 27412. The Board requested this information due to its belief that higher interest rates charged for these loans might render them unavailable without the adjustment. The margin above APOR suggested for first-lien jumbo balloonpayment mortgages was 2.5 percentage points. Two industry commenters supported the higher threshold for jumbo loans, arguing that the current thresholds would interfere with credit accessibility. One of these commenters also stated that the higher threshold should be available for all balloon-payment mortgages. No commenters discussed the non-principal-dwelling threshold. Many other commenters objected strongly to the statutory requirement, implemented in the proposed rule, that the balloon payment be considered in applying the ability-to-repay requirements to higher-priced covered transaction balloon-payment mortgages. These industry commenters felt that the percentage point thresholds were too low, and that many loans currently being made would become unavailable. They did not, however, submit sufficient data to help the Bureau assess these claims. Other commenters, including several consumer protection advocacy organizations, argued that the higher-priced rule would be helpful in ensuring consumers’ ability to repay their loans. The Bureau has evaluated the proposed definition of ‘‘higher-priced covered transaction’’ not only in relation to its use in the payment determination for balloon-payment mortgages, but also in the light of its PO 00000 Frm 00046 Fmt 4701 Sfmt 4700 application in other provisions of the final rule. For example, as discussed below, the final rule varies the strength of the presumption of compliance for qualified mortgages. A qualified mortgage designated as a higher-priced covered transaction will be presumed to comply with the ability-to repayprovision at § 1026.43(c)(1), but will not qualify for the safe harbor provision. See § 1026.43(e)(1)(ii) and (i). Specifically, the Bureau has considered whether to adopt a different threshold to define high price mortgage loans for jumbo loans than for other loans. The Bureau notes that the Board expressly addressed this issue in its 2008 HOEPA Final Rule and concluded not to do so. The Board explained that although prime jumbo loans have always had somewhat higher rates than prime conforming loans, the spread has been quite volatile.96 The Board concluded that it was sounder to err on the side of being over-inclusive than to set a higher threshold for jumbo loans and potentially fail to include subprime jumbo loans.97 The Bureau is persuaded by the Board’s reasoning. The Bureau recognizes that in the Dodd-Frank Act Congress, in requiring creditors to establish escrows accounts for certain transactions and in requiring appraisals for certain transactions based upon the interest rate of the transactions, did establish a separate threshold for jumbo loans. The Bureau is implementing that separate threshold in its 2013 Escrows Final Rule which is being issued contemporaneously with this final rule. However, the Bureau also notes that in the ability-to-repay provision of the Dodd-Frank Act, Congress mandated underwriting rules for balloon-payment mortgages which vary based upon the pricing of the loan, and in doing so Congress followed the thresholds adopted by the Board in its 2008 HOEPA Final Rule and did not add a separate threshold for jumbo loans. The fact that the Act uses the Board’s criteria in the ability to repay context lends further support to the Bureau’s decision to use those criteria as well in defining higher-priced loans under the final rule. Accordingly, the Bureau is not providing for a higher threshold for jumbo or non-principal dwelling balloon-payment mortgages at this time. In regard to the possibility of a higher threshold for non-principal dwellings such as vacation homes, the Bureau understands that such products have historically been considered to be at higher risk of default than loans on 96 See 73 FR 44537 (July 30, 2008) 97 Id. E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with principal dwellings. Therefore, any difference in rates is likely driven by the repayment risk associated with the product, and a rule meant to ensure a consumer’s ability to repay the loan should not provide an exemption under these circumstances. And further, the Bureau did not receive and is not aware of any data supporting such an exemption. The Bureau does not believe that these decisions regarding jumbo and non-principal-dwelling balloonpayment mortgages are likely to create any credit accessibility problems. In this final rule at § 1026.43(f), the Bureau is adopting a much wider area in which institutions that provide credit in rural or underserved areas may originate qualified mortgages that are balloonpayment loans than did the proposed rule. Because these are the areas in which balloon-payment loans are considered necessary to preserve access to credit, and higher-priced balloonpayment mortgages in these areas can meet the criteria for a qualified mortgage and thus will not have to include the balloon payment in the ability-to-repay evaluation, access to necessary balloonpayment mortgages will not be reduced. Accordingly, § 1026.43(b)(4) is adopted as proposed. The associated commentary is amended with revisions to update information and citations. 43(b)(5) The proposed rule defined ‘‘loan amount’’ as ‘‘the principal amount the consumer will borrow as reflected in the promissory note or loan contract.’’ This definition implemented the statutory language requiring that the monthly payment be calculated assuming that ‘‘the loan proceeds are fully disbursed on the date of consummation of the loan.’’ Dodd-Frank Act section 1411(a)(2), TILA section 129C(a)(6)(D)(i). The term ‘‘loan amount’’ was used in the proposed definition of ‘‘fully amortizing payment’’ in § 226.43(b)(2), which was then used in the general ‘‘payment calculation’’ at § 226.43(c)(5)(i)(B). The payment calculation required the use of payments that pay off the loan amount over the actual term of the loan. The statute further requires that creditors assume that the loan amount is ‘‘fully disbursed on the date of consummation of the loan.’’ See TILA Section 129C(a)(6)(D)(i). The Board recognized that some loans do not disburse the entire loan amount to the consumer at consummation, but may, for example, provide for multiple disbursements up to an amount stated in the loan agreement. See current § 1026.17(c)(6), discussing multiple- VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 advance loans and comment 17(c)(6)–2 and –3. In these cases, the loan amount, as reflected in the promissory note or loan contract, does not accurately reflect the amount disbursed at consummation. Thus, to reflect the statutory requirement that the creditor assume the loan amount is fully disbursed at consummation, the Board clarified that creditors must use the entire loan amount as reflected in the loan contract or promissory note, even where the loan amount is not fully disbursed at consummation. Proposed comment 43(b)(5)–1 provided an illustrative example and stated that generally, creditors should rely on § 1026.17(c)(6) and associated commentary regarding treatment of multiple-advance and construction loans that would be covered by the ability-to-repay requirements (i.e., loans with a term greater than 12 months). See § 1026.43(a)(3) discussing scope of coverage and term length. The Board specifically solicited comment on whether further guidance was needed regarding determination of the loan amount for loans with multiple disbursements. The Bureau did not receive comments on the definition of ‘‘loan amount’’ or its application to loans with multiple disbursements. The Bureau believes that the loan amount for multiple disbursement loans that are covered transactions must be determined assuming that ‘‘the loan proceeds are fully disbursed on the date of consummation of the loan’’ 98 as required by the statute and the rule, and explained in comment 43(b)(5)–1. Accordingly, the Bureau is adopting § 1026.43(b)(5) and associated commentary as proposed. 43(b)(6) The interchangeable phrases ‘‘loan term’’ and ‘‘term of the loan’’ appear in the ability-to-repay and qualified mortgage provisions of TILA, with no definition. See TILA section 129C(c)(3), 129C(a)(6)(D)(ii), 129C(b)(2)(A)(iv) and (v); 15 U.S.C. 1639c(c)(3), 1639c(a)(6)(D)(ii), 1639c(b)(2)(A)(iv) and (v). The proposed rule defined ‘‘loan term’’ as ‘‘the period of time to repay the obligation in full.’’ Proposed comment 43(b)(6)–1 clarified that the loan term is the period of time it takes to repay the loan amount in full, and provided an example. The term is used in § 1026.43(b)(2), the ‘‘fully amortizing payment’’ definition, which is then used in § 1026.43(c)(5)(i), the payment calculation general rule. It is also used in the qualified mortgage payment 98 Dodd-Frank Act section 1411(a)(2), TILA section 129C(a)(6)(D)(i). PO 00000 Frm 00047 Fmt 4701 Sfmt 4700 6453 calculation at § 1026.43(e)(2)(iv). The Bureau did not receive any comments on this definition, and considers it to be an accurate and appropriate implementation of the statutory language. Accordingly, proposed § 1026.43(b)(6) is adopted as proposed. 43(b)(7) The definition of ‘‘maximum loan amount’’ and the calculation for which it is used implement the requirements regarding negative amortization loans in new TILA section 129C(a)(6)(C) and (D). The statute requires that a creditor ‘‘take into consideration any balance increase that may accrue from any negative amortization provision.’’ The ‘‘maximum loan amount’’ is defined in the proposed rule as including the loan balance and any amount that will be added to the balance as a result of negative amortization assuming the consumer makes only minimum payments and the maximum interest rate is reached at the earliest possible time. The ‘‘maximum loan amount’’ is used to determine a consumer’s ability to repay for negative amortization loans under § 1026.43(c)(5)(ii)(C) by taking into account any loan balance increase that may occur as a result of negative amortization. The term ‘‘maximum loan amount’’ is also used for negative amortization loans in the ‘‘refinancing of non-standard mortgages’’ provision, at § 1026.43(d)(5)(i)(C)(3). The proposed rule included commentary on how to calculate the maximum loan amount, with examples. See comment 43(b)(7)– 1 through –3. The Bureau did not receive any comments on this definition and considers it to be an accurate and appropriate implementation of the statute. Accordingly, § 1026.43(b)(7) and associated commentary are adopted as proposed. 43(b)(8) TILA section 129C(a)(1) and (3), as added by section 1411 of the DoddFrank Act, requires creditors to consider and verify mortgage-related obligations as part of the ability-to-repay determination ‘‘according to [the loan’s] terms, and all applicable taxes, insurance (including mortgage guarantee insurance), and assessments.’’ TILA section 129C(a)(2) provides that consumers must have ‘‘a reasonable ability to repay the combined payments of all loans on the same dwelling according to the terms of those loans and all applicable taxes, insurance (including mortgage guarantee insurance), and assessments.’’ Although the Dodd-Frank Act did not establish or E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6454 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations define a single, collective term, the foregoing requirements recite ongoing obligations that are substantially similar to the definition of ‘‘mortgage-related obligation’’ used elsewhere in Regulation Z. Section 1026.34(a)(4)(i), which was added by the 2008 HOEPA Final Rule, defines mortgage-related obligations as expected property taxes, premiums for mortgage-related insurance required by the creditor as set forth in the relevant escrow provisions of Regulation Z, and similar expenses. Comment 34(a)(4)(i)–1 clarifies that, for purposes of § 1026.34(a)(4)(i), similar expenses include homeowners association dues and condominium or cooperative fees. Section 1026.35(b)(3)(i), which addresses escrows, states that ‘‘premiums for mortgage-related insurance required by the creditor, [include] insurance against loss of or damage to property, or against liability arising out of the ownership or use of the property, or insurance protecting the creditor against the consumer’s default or other credit loss.’’ Under the Board’s proposed § 226.43(b)(8), ‘‘mortgage-related obligations’’ was defined to mean property taxes; mortgage related insurance premiums required by the creditor as set forth in proposed § 226.45(b)(1); homeowners association, condominium, and cooperative fees; ground rent or leasehold payments; and special assessments. The Board’s proposed definition was substantially similar to the definition under § 1026.34(a)(4)(i), with three clarifications. First, the proposed definition of mortgage-related obligations would have included a reference to ground rent or leasehold payments, which are payments made to the real property owner or leaseholder for use of the real property. Second, the proposed definition would have included a reference to ‘‘special assessments.’’ Proposed comment 43(b)(8)–1 would have clarified that special assessments include, for example, assessments that are imposed on the consumer at or before consummation, such as a one-time homeowners association fee that will not be paid by the consumer in full at or before consummation. Third, mortgage-related obligations would have referenced proposed § 226.45(b)(1), where the Board proposed to recodify the existing escrow requirement for higher-priced mortgage loans, to include mortgage-related insurance premiums required by the creditor, such as insurance against loss of or damage to property, or against liability arising out of the ownership or use of the property, VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 or insurance protecting the creditor against the consumer’s default or other credit loss. The Board solicited comment on how to address any issues that may arise in connection with homeowners association transfer fees and costs associated with loans for energy efficient improvements. Proposed comment 43(b)(8)–1 would have clarified further that mortgagerelated obligations include mortgagerelated insurance premiums only if required by the creditor. This comment would have explained that the creditor need not include premiums for mortgage-related insurance that the creditor does not require, such as earthquake insurance or credit insurance, or fees for optional debt suspension and debt cancellation agreements. To facilitate compliance, this comment would have referred to commentary associated with proposed § 226.43(c)(2)(v), which sets forth the requirement to take into account any mortgage-related obligations for purposes of the repayment ability determination required under proposed § 226.43(c). Industry commenters and consumer advocates generally supported the Board’s proposed definition of mortgage-related obligations. One industry commenter opposed including community transfer fees, which are deed-based fees imposed upon the transfer of the property. This commenter was concerned that subjecting these fees to Federal law might affect existing contracts, deeds, and covenants related to these fees, which are subject to State and local regulation, as well as common law regarding the transfer of real property. The commenter also asked that special assessments not fall under the definition of mortgage-related obligations. The commenter recommended that, if special assessments are included, creditors be required to consider only current special assessments, not future special assessments. The commenter noted that, while common assessments should be included in the definition of mortgagerelated obligations, the Bureau should provide guidance to creditors on the substance of questionnaires seeking information from third parties about mortgage-related obligations. Certain consumer advocates suggested that voluntary insurance premiums be included in the definition of mortgagerelated obligations. One consumer advocate explained that premiums such as these are technically voluntary, but many consumers believe them to be required, or have difficulty cancelling them if they choose to cancel them. Community advocates and several PO 00000 Frm 00048 Fmt 4701 Sfmt 4700 industry commenters also recommended that homeowners association dues, and similar charges, be included in the definition of mortgagerelated obligations. They argued that such a requirement would further transparency in the mortgage loan origination process and would help ensure that consumers receive only credit they can reasonably expect to repay. For the reasons discussed below, the Bureau concludes that property taxes, certain insurance premiums required by the creditor, obligations to community governance associations, such as cooperative, condominium, and homeowners associations, ground rent, and lease payments should be included in the definition of mortgage-related obligations. These obligations are incurred in connection with the mortgage loan transaction but are in addition to the obligation to repay principal and interest. Thus, the cost of these obligations should be considered with the obligation to repay principal and interest for purposes of determining a consumer’s ability to repay. Further, the Bureau believes that the word ‘assessments’ in TILA section 129C is most appropriately interpreted to refer to all obligations imposed on consumers in connection with ownership of the dwelling or real property, such as ground rent, lease payments, and, as discussed in detail below, obligations to community governance associations, whether denominated as association dues, special assessments, or otherwise. While the provision adopted by the Bureau is substantially similar to the provision proposed, the Bureau was persuaded by the comment letters that additional clarity and guidance is required. The Bureau is especially sensitive to the fact that many of the loans that will be subject to the abilityto-repay rules may be made by small institutions, which are often unable to devote substantial resources to analysis of regulatory compliance. To address the concerns and feedback raised in the comment letters, the Bureau has revised § 1026.43(b)(8) and related commentary in two ways. First, the language of § 1026.43(b)(8) is being modified to add additional clarity. As adopted, § 1026.43(b)(8) refers to premiums and similar charges identified in § 1026.4(b)(5), (7), (8), or (10), if required by the creditor, instead of the proposed language, which referred to ‘‘mortgage-related insurance.’’ Second, the commentary is being significantly expanded to provide additional clarification and guidance. As adopted, § 1026.43(b)(8) defines ‘‘mortgage-related obligations’’ to mean E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations property taxes; premiums and similar charges identified in § 1026.4(b)(5), (7), (8), or (10) that are required by the creditor; fees and special assessments imposed by a condominium, cooperative, or homeowners association; ground rent; and leasehold payments. As proposed, comment 43(b)(8)–1 discussed all components of the proposed definition. To provide further clarity, the final rule splits the content of proposed comment 43(b)(8)–1 into four separate comments, each of which provides additional guidance. As adopted by the Bureau, comment 43(b)(8)–1 contains general guidance and a cross-reference to § 1026.43(c)(2)(v), which contains the requirement to take into account any mortgage-related obligations for purposes of determining a consumer’s ability to repay. The multitude of requests for additional guidance and clarification suggests that additional clarification of the meaning of ‘‘property tax’’ is needed. Comment 43(b)(8)–2 further clarifies that § 1026.43(b)(8) includes obligations that are functionally equivalent to property taxes, even if such obligations follow a different naming convention. For example, governments may establish independent districts with the authority to impose recurring levies on properties within the district to fund a special purpose, such as a local development bond district, water district, or other public purpose. These recurring levies may have a variety of names, such as taxes, assessments, or surcharges. Comment 43(b)(8)–2 clarifies that obligations such as these are property taxes based on the character of the obligation, as opposed to the name of the obligation, and therefore are mortgage-related obligations. Most comments supported the inclusion of insurance premiums in the ability-to-repay determination. However, the Bureau believes that some modifications to the proposed ‘‘mortgage-related insurance premium’’ language are appropriate. The Bureau is persuaded that additional clarification and guidance is important, and the Bureau is especially sensitive to concerns related to regulatory complexity. The Bureau has determined that the proposed language should be clarified by revising the text to refer to the current definition of finance charge under § 1026.4. The components of the finance charge are long-standing parts of Regulation Z. Explicitly referring to existing language should facilitate compliance. Therefore, § 1026.43(b)(8) defines mortgage-related obligations to include all premiums or other charges VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 related to protection against a consumer’s default, credit loss, collateral loss, or similar loss as identified in § 1026.4(b)(5), (7), (8), or (10) except, as explained above, those premiums or charges that that are not required by the creditor. Comment 43(b)(8)–3 also contains illustrative examples of this definition. For example, if Federal law requires flood insurance to be obtained in connection with the mortgage loan, the flood insurance premium is a mortgagerelated obligation for purposes of § 1026.43(b)(8). Several commenters stated that insurance premiums and similar charges should be included in the determination even if the creditor does not require them in connection with the loan transaction. The Bureau has carefully considered these arguments, but has determined that insurance premiums and similar charges should not be considered mortgage-related obligations if such premiums and charges are not required by the creditor and instead have been voluntarily purchased by the consumer. The Bureau acknowledges that obligations such as these are usually paid from a consumer’s monthly income and, in a sense, affect a consumer’s ability to repay. But the consumer is free to cancel recurring obligations such as these at any time, provided they are truly voluntary. Thus, they are not ‘‘obligations’’ in the sense required by section 129C(a)(3) of TILA. The Bureau shares the concern raised by several commenters that unscrupulous creditors may mislead consumers into believing that these charges are not optional or cannot be cancelled. However, the Bureau does not believe that altering the ability-to-repay calculation for all is the appropriate method for combatting the harmful actions of a few. The Bureau believes that the better course of action is to exclude such premiums and charges from the definition of mortgage-related obligations only if they are truly voluntary, and is confident that violations of this requirement will be apparent in specific cases from the facts. Also, in the scenarios described by commenters where consumers are misled into believing that such charges are required, the premium or charge would not be voluntary for purposes of the definition of finance charge under § 1026.4(d), and would therefore be a mortgage-related obligation for the purposes of § 1026.43(b)(8). Therefore, comment 43(b)(8)–3 clarifies that insurance premiums and similar charges identified in § 1026.4(b)(5), (7), (8), or (10) that are not required by the creditor PO 00000 Frm 00049 Fmt 4701 Sfmt 4700 6455 and that the consumer purchases voluntarily are not mortgage-related obligations for purposes of § 1026.43(b)(8). For example, if a creditor does not require earthquake insurance to be obtained in connection with the mortgage loan, but the consumer voluntarily chooses to purchase such insurance, the earthquake insurance premium is not a mortgage-related obligation for purposes of § 1026.43(b)(8). Or, if a creditor requires a minimum amount of coverage for homeowners’ insurance and the consumer voluntarily chooses to purchase a more comprehensive amount of coverage, the portion of the premium allocated to the minimum coverage is a mortgage-related obligation for the purposes of § 1026.43(b)(8), while the portion of the premium allocated to the more comprehensive coverage voluntarily purchased by the consumer is not a mortgage-related obligation for the purposes of § 1026.43(b)(8). However, if the consumer purchases non-required insurance or similar coverage at consummation without having requested the specific nonrequired insurance or similar coverage and without having agreed to the premium or charge for the specific nonrequired insurance or similar coverage prior to consummation, the premium or charge is not voluntary for purposes of § 1026.43(b)(8) and is a mortgage-related obligation. Several commenters supported the inclusion of mortgage insurance in the definition of mortgage-related obligations. The Bureau also has received several informal requests for guidance regarding the meaning of the term ‘‘mortgage insurance’’ in the context of certain disclosures required by Regulation Z. The Bureau has decided to clarify this issue with respect to the requirements of § 1026.43. Thus, comment 43(b)(8)–4 clarifies that § 1026.43(b)(8) includes all premiums or similar charges for coverage protecting the creditor against the consumer’s default or other credit loss in the determination of mortgage-related obligations, whether denominated as mortgage insurance, guarantee insurance, or otherwise, as determined according to applicable State or Federal law. For example, monthly ‘‘private mortgage insurance’’ payments paid to a non-governmental entity, annual ‘‘guarantee fee’’ payments required by a Federal housing program, and a quarterly ‘‘mortgage insurance’’ payment paid to a State agency administering a housing program are all mortgage-related obligations for purposes of § 1026.43(b)(8). Comment E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6456 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations 43(b)(8)–4 also clarifies that § 1026.43(b)(8) includes these charges in the definition of mortgage-related obligations if the creditor requires the consumer to pay them, even if the consumer is not legally obligated to pay the charges under the terms of the insurance program. Comment 43(b)(8)–4 also contains several other illustrative examples. Several comment letters stressed the importance of including homeowners association dues and similar obligations in the determination of ability to repay. These letters noted that, during the subprime crisis, the failure to account for these obligations led to many consumers qualifying for mortgage loans that they could not actually afford. The Bureau agrees with these assessments. Recurring financial obligations payable to community governance associations, such as homeowners association dues, should be taken into consideration in determining whether a consumer has the ability to repay the obligation. While several comment letters identified practical problems with including obligations such as these in the calculation, these issues stemmed from difficulties that may arise in calculating, estimating, or verifying these obligations, rather than whether the obligations should be included in the ability-to-repay calculation. Based on this feedback, § 1026.43(b)(8) includes obligations to a homeowners association, condominium association, or condominium association in the determination of mortgage-related obligations. The Bureau has addressed the concerns related to difficulties in calculating, estimating, or verifying such obligations in the commentary to § 1026.43(c)(2)(v) and (c)(3). One comment letter focused extensively on community transfer fees, which are deed-based fees imposed upon the transfer of the property. The Bureau recognizes that this topic is complex and is often the subject of special requirements imposed at the State and local level. However, the Bureau does not believe that the requirements of § 1026.43 implicate these complex issues. The narrow question is whether such obligations should be considered mortgage-related obligations for purposes of determining the consumer’s ability to repay. The Bureau agrees with the argument, advanced by several commenters, that the entirety of the consumer’s ongoing obligations should be included in the determination. A responsible determination of the consumer’s ability to repay requires an accounting of such obligations, whether the purpose of the obligation is to satisfy the payment of a VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 community transfer fee or traditional homeowners association dues. As with other obligations owed to condominium, cooperative, or homeowners associations discussed above, the Bureau believes that the practical problems with these obligations relate to when such obligations should be included in the determination of the consumer’s ability to repay, rather than whether the obligations should be considered mortgage-related obligations. Therefore, the Bureau has addressed the concerns related to these obligations in the commentary to § 1026.43(c)(2)(v) and (c)(3). In response to the request for feedback in the 2011 ATR Proposal, several commenters addressed the proposed treatment of special assessments. Unlike community transfer fees, which are generally identified in the deed or master community plan, creditors may encounter difficulty determining whether special assessments exist. However, as with similar charges discussed above, these concerns relate to determining the consumer’s monthly payment for mortgage-related obligations, rather than whether these charges should be considered mortgagerelated obligations. Special assessments may be significant and may affect the consumer’s ability to repay a mortgage loan. Thus, the Bureau has concluded that special assessments should be included in the definition of mortgagerelated obligations under § 1026.43(b)(8) and has addressed the concerns raised by commenters related to calculating, estimating, or verifying these obligations in the commentary to § 1026.43(c)(2)(v) and (c)(3). New comment 43(b)(8)–5 explains that § 1026.43(b)(8) includes in the evaluation of mortgage-related obligations premiums and similar charges identified in § 1026.4(b)(5), (7), (8), or (10) that are required by the creditor. These premiums and similar charges are mortgage-related obligations regardless of whether the premium or similar charge is excluded from the finance charge pursuant to § 1026.4(d). For example, a premium for insurance against loss or damage to the property written in connection with the credit transaction is a premium identified in § 1026.4(b)(8). If this premium is required by the creditor, the premium is a mortgage-related obligation pursuant to § 1026.43(b)(8), regardless of whether the premium is excluded from the finance charge pursuant to § 1026.4(d)(2). Commenters did not request this guidance specifically, but the Bureau believes that this comment is needed to provide additional clarity. PO 00000 Frm 00050 Fmt 4701 Sfmt 4700 43(b)(9) TILA section 129C(b)(2)(C) generally defines ‘‘points and fees’’ for a qualified mortgage to have the same meaning as in TILA section 103(bb)(4), which defines points and fees for the purpose of determining whether a transaction exceeds the HOEPA points and fees threshold. Proposed § 226.43(b)(9) would have provided that ‘‘points and fees’’ has the same meaning as in § 226.32(b)(1). The Bureau adopts this provision as renumbered § 1026.43(b)(9). 43(b)(10) Sections 1414, 1431, and 1432 of the Dodd-Frank Act amended TILA to restrict, and in many cases, prohibit a creditor from imposing prepayment penalties in dwelling-secured credit transactions. TILA does not, however, define the term ‘‘prepayment penalty.’’ In an effort to address comprehensively prepayment penalties in a fashion that eases compliance burden, as discussed above, the Bureau is defining prepayment penalty in § 1026.43(b)(10) by cross-referencing § 1026.32(b)(6). For a full discussion of the Bureau’s approach to defining prepayment penalties, see § 1026.32(b)(6), its commentary, and the section-by-section analysis of those provisions above. 43(b)(11) TILA in several instances uses the term ‘‘reset’’ to refer to the time at which the terms of a mortgage loan are adjusted, usually resulting in higher required payments. For example, TILA section 129C(a)(6)(E)(ii) states that a creditor that refinances a loan may, under certain conditions, ‘‘consider if the extension of new credit would prevent a likely default should the original mortgage reset and give such concerns a higher priority as an acceptable underwriting practice.’’ 15 U.S.C. 1639c(a)(6)(E)(ii). The legislative history further indicates that, for adjustable-rate mortgages with low, fixed introductory rates, Congress understood the term ‘‘reset’’ to mean the time at which low introductory rates convert to indexed rates, resulting in ‘‘significantly higher monthly payments for homeowners.’’ 99 Outreach conducted prior to issuance of the proposed rule indicated that the term ‘‘recast’’ is typically used in reference to the time at which fully amortizing payments are required for interest-only and negative amortization loans and that the term ‘‘reset’’ is more 99 See Comm. on Fin. Servs., Report on H.R. 1728, Mortgage Reform and Anti-Predatory Lending Act, H. Rept. 94, 111th Cong., at 52 (2009). E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with frequently used to indicate the time at which adjustable-rate mortgages with an introductory fixed rate convert to a variable rate. For simplicity and clarity, however, the Board proposed to use the term ‘‘recast’’ to cover the conversion to generally less favorable terms and higher payments not only for interestonly loans and negative amortization loans, but also for adjustable-rate mortgages. Proposed § 226.43(b)(11) defined the term ‘‘recast,’’ which was used in two provisions of proposed § 226.43: (1) Proposed § 226.43(c)(5)(ii) regarding certain required payment calculations that creditors must consider in determining a consumer’s ability to repay a covered transaction; and (2) proposed § 226.43(d) regarding payment calculations required for refinancings that are exempt from the ability-to-repay requirements in § 226.43(c). Specifically, proposed § 226.43(b)(11) defined the term ‘‘recast’’ as follows: (1) For an adjustable-rate mortgage, as defined in § 1026.18(s)(7)(i),100 the expiration of the period during which payments based on the introductory interest rate are permitted under the terms of the legal obligation; (2) for an interest-only loan, as defined in § 1026.18(s)(7)(iv),101 the expiration of the period during which interest-only payments are permitted under the terms of the legal obligation; and (3) for a negative amortization loan, as defined in § 1026.18(s)(7)(v),102 the expiration of the period during which negatively amortizing payments are permitted under the terms of the legal obligation. Proposed comment 43(b)(11)–1 explained that the date on which the ‘‘recast’’ occurs is the due date of the last monthly payment based on the introductory fixed rate, the last interestonly payment, or the last negatively amortizing payment, as applicable. Proposed comment 43(b)(11)–1 also provided an illustration showing how to determine the date of the recast. 100 ‘‘The term ‘‘adjustable-rate mortgage’’ means a transaction secured by real property or a dwelling for which the annual percentage rate may increase after consummation.’’ 12 CFR 1026.18(s)(7)(i). 101 ‘‘The term ‘‘interest-only’’ means that, under the terms of the legal obligation, one or more of the periodic payments may be applied solely to accrued interest and not to loan principal; an ‘‘interest-only loan’’ is a loan that permits interest-only payments.’’ 12 CFR 1026.18(s)(7)(iv). 102 ‘‘[T]he term ‘‘negative amortization’’ means payment of periodic payments that will result in an increase in the principal balance under the terms of the legal obligation; the term ‘‘negative amortization loan’’ means a loan, other than a reverse mortgage subject to section 1026.33, that provides for a minimum periodic payment that covers only a portion of the accrued interest, resulting in negative amortization.’’ 12 CFR 1026.18(s)(7)(v). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 Commenters did not focus specifically on the definition of ‘‘recast,’’ except that an association of State bank regulators agreed with the benefit of using a single term for the shift to higher payments for adjustable-rate, interest-only, and negative amortization loans. The Bureau considers the proposed provision to be an accurate and appropriate implementation of the statute. Accordingly, the Bureau is adopting proposed § 226.43(b)(11) as proposed, in renumbered § 1026.43(b)(11). 43(b)(12) New TILA section 129C(a)(2) provides that ‘‘if a creditor knows, or has reason to know, that 1 or more residential mortgage loans secured by the same dwelling will be made to the same consumer,’’ that creditor must make the ability-to-repay determination for ‘‘the combined payments of all loans on the same dwelling according to the terms of those loans and all applicable taxes, insurance (including mortgage guarantee insurance), and assessments.’’ This section, entitled ‘‘multiple loans,’’ follows the basic ability-to-repay requirements for a single loan, in new TILA section 129C(a)(1). The proposed rule implemented the main requirement of the ‘‘multiple loans’’ provision by mandating in proposed § 226.43(c)(2)(iv) that a creditor, in making its ability-to-repay determination on the primary loan, take into account the payments on any ‘‘simultaneous loan’’ about which the creditor knows or has reason to know. ‘‘Simultaneous loan’’ was defined in proposed § 226.43(b)(12) as ‘‘another covered transaction or home equity line of credit subject to § 226.5b 103 that will be secured by the same dwelling and made to the same consumer at or before consummation of the covered transaction.’’ Thus, although the statute referred only to closed-end ‘‘residential mortgage loans,’’ the Board proposed to expand the requirement to include consideration of simultaneous HELOCs. The proposed definition did not include pre-existing mortgage obligations, which would be considered as ‘‘current debt obligations’’ under § 1026.43(c)(2)(vi). The Board chose to include HELOCs in the definition of ‘‘simultaneous loan’’ because it believed that new TILA section 129C(a)(2) was meant to help ensure that creditors account for the increased risk of consumer delinquency or default on the covered transaction where more than one loan secured by the same dwelling is originated concurrently. The Board believed that 103 The Board’s § 226.5b was recodified in the Bureau’s Regulation Z as § 1026.40. PO 00000 Frm 00051 Fmt 4701 Sfmt 4700 6457 this increased risk would be present whether the other mortgage obligation was a closed-end credit obligation or a HELOC. For these reasons, and several others explained in detail below, the Board proposed to use its exception and adjustment authority under TILA section 105(a) to include HELOCs within the scope of new TILA section 129C(a)(2). 76 FR 27417–27418. Because one of the main reasons for including HELOCs was the likelihood of a consumer drawing on the credit line to provide the down payment in a purchase transaction, the Board solicited comment on whether this exception should be limited to purchase transactions. TILA section 105(a), as amended by section 1100A of the Dodd-Frank Act, authorized the Board, and now the Bureau, to prescribe regulations to carry out the purposes of TILA and Regulation Z, to prevent circumvention or evasion, or to facilitate compliance. 15 U.S.C. 1604(a). The inclusion of HELOCs was further supported by the Board’s authority under TILA section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Board found necessary or proper to effectuate the purposes of TILA. 15 U.S.C. 1639b(e). One purpose of the statute is set forth in TILA section 129B(a)(2), which states that ‘‘[i]t is the purpose[] of * * * [S]ection 129C to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans.’’ 15 U.S.C. 1639b. For the reasons stated below, the Board believed that requiring creditors to consider simultaneous loans that are HELOCs for purposes of TILA section 129C(a)(2) would help to ensure that consumers are offered, and receive, loans on terms that reasonably reflect their ability to repay. First, the Board proposed in § 226.43(c)(2)(vi) that the creditor must consider current debt obligations in determining a consumer’s ability to repay a covered transaction. Consistent with current § 1026.34(a)(4), proposed § 226.43(c)(2)(vi) would not have distinguished between pre-existing closed-end and open-end mortgage obligations. The Board believed consistency required that it take the same approach when determining how to consider mortgage obligations that come into existence concurrently with a first-lien loan as would be taken for preexisting mortgage obligations, whether the first-lien is a purchase or nonpurchase transaction (i.e., refinancing). Including HELOCs in the proposed definition of ‘‘simultaneous loan’’ for purposes of TILA section 129C(a)(2) was E:\FR\FM\30JAR2.SGM 30JAR2 6458 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with also considered generally consistent with current comment 34(a)(4)–3, and the 2006 Nontraditional Mortgage Guidance regarding simultaneous second-lien loans.104 Second, data indicate that where a subordinate loan is originated concurrently with a first-lien loan to provide some or all of the down payment (i.e., a ‘‘piggyback loan’’), the default rate on the first-lien loan increases significantly, and in direct correlation to increasing combined loanto-value ratios.105 The data does not distinguish between ‘‘piggyback loans’’ that are closed-end or open-end credit transactions, or between purchase and non-purchase transactions. However, empirical evidence demonstrates that approximately 60 percent of consumers who open a HELOC concurrently with a first-lien loan borrow against the line of credit at the time of origination,106 suggesting that in many cases the HELOC may be used to provide some, or all, of the down payment on the firstlien loan. The Board recognized that consumers have varied reasons for originating a HELOC concurrently with the first-lien loan, for example, to reduce overall closing costs or for the convenience of having access to an available credit line in the future. However, the Board believed concerns relating to HELOCs originated concurrently for savings or convenience, and not to provide payment towards the first-lien home purchase loan, might be mitigated by the Board’s proposal to require that a creditor consider the periodic payment on the simultaneous loan based on the actual amount drawn from the credit line by the consumer. See proposed § 226.43(c)(6)(ii), discussing payment calculation requirements for simultaneous loans that are HELOCs. Still, the Board recognized that in the case of a non-purchase transaction (e.g., a refinancing) a simultaneous loan that is a HELOC might be unlikely to be originated and drawn upon to provide payment towards the first-lien loan, 104 See 2006 Nontraditional Mortgage Guidance, 71 FR 58609, 58614 (Oct. 4, 2006). 105 Kristopher Gerardi et al., Making Sense of the Subprime Crisis, Brookings Papers on Econ. Activity (Fall 2008), at 40 tbl.3. 106 The Board conducted independent analysis using data obtained from the FRBNY Consumer Credit Panel to determine the proportion of piggyback HELOCs taken out in the same month as the first-lien loan that have a draw at the time of origination. Data used was extracted from credit record data in years 2003 through 2010. See Donghoon Lee and Wilbert van der Klaauw, An Introduction to the FRBNY Consumer Credit Panel (Fed. Reserve Bd. Of N.Y.C., Staff Rept. No. 479, 2010), available at https://data.newyorkfed.org/ research/staff_reports/sr479.pdf (providing further description of the database). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 except perhaps towards closing costs. Thus, the Board solicited comment on whether it should narrow the requirement to consider simultaneous loans that are HELOCs to apply only to purchase transactions. Third, in developing this proposal Board staff conducted outreach with a variety of participants that consistently expressed the view that second-lien loans significantly impact a consumer’s performance on the first-lien loan, and that many second-lien loans are HELOCs. One industry participant explained that the vast majority of ‘‘piggyback loans’’ it originated were HELOCs that were fully drawn at the time of origination and used to assist in the first-lien purchase transaction. Another outreach participant stated that HELOCs make up approximately 90 percent of its simultaneous loan bookof-business. Industry outreach participants generally indicated that it is a currently accepted underwriting practice to include HELOCs in the repayment ability assessment on the first-lien loan, and generally confirmed that the majority of simultaneous liens considered during the underwriting process are HELOCs. For these reasons, the Board proposed to use its authority under TILA sections 105(a) and 129B(e) to broaden the scope of TILA section 129C(a)(2), and accordingly proposed to define the term ‘‘simultaneous loan’’ to include HELOCs. Proposed comment 43(b)(12)–1 clarified that the definition of ‘‘simultaneous loan’’ includes any loan that meets the definition, whether made by the same creditor or a third-party creditor, and provides an illustrative example of this principle. Proposed comment 43(b)(12)–2 further clarified the meaning of the term ‘‘same consumer,’’ and explained that for purposes of the definition of ‘‘simultaneous loan,’’ the term ‘‘same consumer’’ would include any consumer, as that term is defined in § 1026.2(a)(11), that enters into a loan that is a covered transaction and also enters into another loan (e.g., a secondlien covered transaction or HELOC) secured by the same dwelling. This comment further explained that where two or more consumers enter into a legal obligation that is a covered transaction, but only one of them enters into another loan secured by the same dwelling, the ‘‘same consumer’’ includes the person that has entered into both legal obligations. The Board believed this comment would reflect statutory intent to include any loan that could impact the consumer’s ability to repay the covered transaction according to its terms (i.e., to require the creditor PO 00000 Frm 00052 Fmt 4701 Sfmt 4700 to consider the combined payment obligations of the consumer(s) obligated to repay the covered transaction). See TILA § 129C(a)(2). Both industry and consumer advocate commenters overwhelmingly supported inclusion of HELOCs as simultaneous loans, with only one industry commenter objecting. The objecting commenter stated that there was no persuasive policy argument for deviating from the statute, but did not provide any reason to believe that concurrent HELOCs are less relevant to an assessment of a consumer’s ability to repay than concurrent closed-end second liens. As explained in the proposed rule, most industry participants are already considering HELOCs in the underwriting of seniorlien loans on the same property. 76 FR 27418. For the reasons set forth by the Board and discussed above, the Bureau has determined that inclusion of HELOCs in the definition of simultaneous loans is an appropriate use of its TILA authority to make adjustments and additional requirements. TILA section 105(a), as amended by section 1100A of the Dodd-Frank Act, authorizes the Bureau to prescribe regulations that may contain such additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions, as in the judgment of the Bureau are necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion of TILA, or to facilitate compliance with TILA. 15 U.S.C. 1604(a). The Bureau finds that the inclusion of HELOCs is necessary and proper to effectuate the purposes of TILA. The inclusion of HELOCs is further supported by the Bureau’s authority under TILA section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Bureau finds necessary or proper to effectuate the purposes of TILA. 15 U.S.C. 1639b(e). TILA section 129B(a)(2) states that ‘‘[i]t is the purpose[] of * * * [S]ection 129C to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans.’’ 15 U.S.C. 1639b. Inclusion of HELOCs as simultaneous loans will help to carry out this purpose of TILA by helping to ensure that consumers receive loans on affordable terms, as further explained above. Accordingly, the Bureau is adopting § 1026.43(b)(12) and associated commentary as proposed, with clarifying edits to ensure that simultaneous loans scheduled after E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with consummation will be considered in determining ability to repay. 43(b)(13) TILA section 129C(a)(1) requires that a creditor determine a consumer’s repayment ability using ‘‘verified and documented information,’’ and TILA section 129C(a)(4) specifically requires the creditor to verify a consumer’s income or assets relied on to determine repayment ability using a consumer’s tax return or ‘‘third-party documents’’ that provide reasonably reliable evidence of the consumer’s income or assets, as discussed in detail below in the section-by-section analysis of § 1026.43(c)(3) and (4). The Board proposed to define the term ‘‘third-party record’’ to mean: (1) A document or other record prepared or reviewed by a person other than the consumer, the creditor, any mortgage broker, as defined in § 1026.36(a)(2), or any agent of the creditor or mortgage broker; (2) a copy of a tax return filed with the Internal Revenue Service or a state taxing authority; (3) a record the creditor maintains for an account of the consumer held by the creditor; or (4) if the consumer is an employee of the creditor or the mortgage broker, a document or other record regarding the consumer’s employment status or income. The Board explained that, in general, a creditor should refer to reasonably reliable records prepared by or reviewed by a third party to verify repayment ability under TILA section 129C(a), a principle consistent with verification requirements previously outlined under the Board’s 2008 HOEPA Final Rule. See § 1026.34(a)(4)(ii). Commenters generally supported the Board’s broad definition of a third-party record as a reasonable definition that allows a creditor to use a wide variety of documents and sources, while ensuring that the consumer does not remain the sole source of information. Some consumer advocates, however, cautioned the Bureau against relying upon tax records to provide a basis for verifying income history, pursuant to amended TILA section 129C(a)(4)(A), to avoid penalizing consumers who may not have access to accurate tax records. The Bureau does not address comments with respect to consumers who may not maintain accurate tax records because the definition provided in 1026.43(b)(13) of third-party record merely ensures that a creditor may use any of a wide variety of documents, including tax records, as a method of income verification without mandating their use. Rather than rely solely on tax records, for example, a creditor might look to other third-party records for VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 verification purposes, including the creditor’s records regarding a consumer’s savings account held by the creditor, which qualifies as a third-party record under § 1026.43(b)(13)(iii), or employment records for a consumer employed by the creditor, which qualifies as a third-party record under § 1026.43(b)(13)(iv). The Board proposed comment 43(b)(13)–1 to clarify that third-party records would include records transmitted or viewed electronically, for example, a credit report prepared by a consumer reporting agency and transmitted or viewed electronically. The Bureau did not receive significant feedback on the proposed comment and is adopting the comment largely as proposed. The Bureau is clarifying that an electronic third-party record should be transmitted electronically, such as via email or if the creditor is able to click on a secure hyperlink to access a consumer’s credit report. The Bureau is making this slight clarification to convey that mere viewing of a record, without the ability to capture or maintain the record, would likely be problematic with respect to record retention under § 1026.25(a) and (c). While it seems unlikely that an electronic record could be viewed without being transmitted as well, the Bureau is making this alteration to avoid any confusion. The Bureau is adopting the remaining comments to 43(b)(13) largely as proposed by the Board. These comments did not elicit significant public feedback. Comment 43(b)(13)–1 assures creditors that a third-party record may be transmitted electronically. Comment 43(b)(13)–2 explains that a third-party record includes a form a creditor provides to a third party for providing information, even if the creditor completes parts of the form unrelated to the information sought. Thus, for example, a creditor may send a Webform, or mail a paper form, created by the creditor, to a consumer’s current employer, on which the employer could check a box that indicates that the consumer works for the employer. The creditor may even elect to fill in the creditor’s name, or other portions of the form, so long as those portions are unrelated to the information that the creditor seeks to verify, such as income or employment status. Comment 43(b)(13)(i)–1 clarifies that a third-party record includes a document or other record prepared by the consumer, the creditor, the mortgage broker, or an agent of the creditor or mortgage broker, if the record is reviewed by a third party. For example, a profit-and-loss statement prepared by PO 00000 Frm 00053 Fmt 4701 Sfmt 4700 6459 a self-employed consumer and reviewed by a third-party accountant is a thirdparty record under § 1026.43(b)(13)(i). The Bureau is including comment 43(b)(13)(i)–1 to explain how some firstparty records, e.g., documents originally prepared by the consumer, may become third-party records by virtue of an appropriate, disinterested third-party’s review or audit. It is the third party review, the Bureau believes, that provides reasonably reliable evidence of the underlying information in the document, just as if the document were originally prepared by the third party. Moreover, this clarification allows the creditor to consult a wider variety of documents in its determination of a consumer’s ability to repay. Creditors should be cautioned not to assume, however, that merely because a document is a third-party record as defined by § 1026.43(b)(13), and the creditor uses the information provided by that document to make a determination as to whether the consumer will have a reasonable ability to repay the loan according to its terms, that the creditor has satisfied the requirements of this rule. The creditor also must make a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability, at the time of consummation, to repay the loan according to its terms. For a full discussion of the Bureau’s approach to this determination, see § 1026.43(c)(1), its commentary, and the section-bysection analysis of those provisions below. Finally, comment 43(b)(13)(iii)–1 clarifies that a third-party record includes a record that the creditor maintains for the consumer’s account. Such examples might include records of a checking account, savings account, and retirement account that the consumer holds, or has held, with the creditor. Comment 43(b)(13)(iii)–1 also provides the example of a creditor’s records for an account related to a consumer’s outstanding obligations to the creditor, such as the creditor’s records for a first-lien mortgage to a consumer who applies for a subordinate-lien home equity loan. This comment helps assure industry that such records are a legitimate basis for determining a consumer’s ability to repay, and/or for verifying income and assets because it is unlikely to be in a creditor’s interest to falsify such records for purposes of satisfying § 1026.43(b)(13), as falsifying records would violate the good faith requirement of § 1026.43(c)(1). In addition, this comment should help E:\FR\FM\30JAR2.SGM 30JAR2 6460 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with assure creditors that the rule does not inhibit a creditor’s ability to ‘‘cross-sell’’ products to consumers, by avoiding placing the creditor at a disadvantage with respect to verifying a consumer’s information by virtue of the creditor’s existing relationship with the consumer. 43(c) Repayment Ability As enacted by the Dodd-Frank Act, TILA section 129C(a)(1) provides that no creditor may make a residential mortgage loan unless the creditor makes a reasonable and good faith determination, based on verified and documented information, that, at the time the loan is consummated, the consumer has a reasonable ability to repay the loan according to its terms and all applicable taxes, insurance, and assessments. TILA section 129C(a)(2) extends the same requirement to a combination of multiple residential mortgage loans secured by the same dwelling where the creditor knows or has reason to know that such loans will be made to the same consumer. TILA sections 129C(a)(3) and (a)(4) specify factors that must be considered in determining a consumer’s ability to repay and verification requirements for income and assets considered as part of that determination. Proposed § 226.43(c) would have implemented TILA section 129C(a)(1) through (4) in a manner substantially similar to the statute. Proposed § 226.43(c)(1) would have implemented the requirement in TILA section 129C(a)(1) that creditors make a reasonable and good faith determination that a consumer will have a reasonable ability to repay the loan according to its terms. Proposed § 226.43(c)(2) would have required creditors to consider the following factors in making a determination of repayment ability, as required by TILA section 129C(a)(1) through (3): the consumer’s current or reasonably expected income or assets (other than the property that secures the loan); the consumer’s employment status, if the creditor relies on employment income; the consumer’s monthly payment on the loan; the consumer’s monthly payment on any simultaneous loan that the creditor knows or has reason to know will be made; the consumer’s monthly payment for mortgage-related obligations; the consumer’s current debt obligations; and the consumer’s monthly debt-toincome ratio or residual income. Proposed § 226.43(c)(3) would have required that creditors verify the information they use in making an ability-to-repay determination using third-party records, as required by TILA section 129C(a)(1). Proposed § 226.43(c)(4) would have specified VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 methods for verifying income and assets as required by TILA section 129C(a)(1) and (4). Proposed § 226.43(c)(5) and (6) would have specified how to calculate the monthly mortgage and simultaneous loan payments required to be considered under proposed § 226.43(c)(2). Proposed § 226.43(c)(7) would have specified how to calculate the monthly debt-to-income ratio or monthly residual income required to be considered under proposed § 226.43(c)(2). As discussed in detail below, the Bureau is adopting § 1026.43(c) substantially as proposed, with various modifications and clarifications. Proposed comment 43(c)–1 would have indicated that creditors may look to widely accepted governmental or nongovernmental underwriting standards, such as the handbook on Mortgagee Credit Analysis for Mortgage Insurance on One- to Four-Unit Mortgage Loans issued by FHA, to evaluate a consumer’s ability to repay. The proposed comment would have stated that creditors may look to such standards in determining, for example, whether to classify particular inflows, obligations, or property as ‘‘income,’’ ‘‘debt,’’ or ‘‘assets’’; factors to consider in evaluating the income of a selfemployed or seasonally employed consumer; or factors to consider in evaluating the credit history of a consumer who has obtained few or no extensions of traditional ‘‘credit’’ as defined in § 1026.2(a)(14). In the Supplemental Information regarding proposed comment 43(c)–1, the Board stated that the proposed rule and commentary were intended to provide flexibility in underwriting standards so that creditors could adapt their underwriting processes to a consumer’s particular circumstances. The Board stated its belief that such flexibility is necessary because the rule covers such a wide variety of consumers and mortgage products. Commenters generally supported giving creditors significant flexibility to develop and apply their own underwriting standards. However, commenters had concerns regarding the specific approach taken in proposed comment 43(c)–1. Commenters raised a number of questions about what kinds of underwriting standards might be considered widely accepted, such as whether a creditor’s proprietary underwriting standards could ever be considered widely accepted. Commenters also were uncertain whether the proposed comment required creditors to adopt particular governmental underwriting standards in their entirety and requested clarification PO 00000 Frm 00054 Fmt 4701 Sfmt 4700 on that point. At least one commenter, an industry trade group, noted that FHA-insured loans constitute a small percentage of the mortgage market and questioned whether FHA underwriting standards therefore are widely accepted. This commenter also questioned whether it is appropriate to encourage creditors to apply FHA underwriting standards other than with respect to FHA-insured loans, as FHA programs are generally designed to make mortgage credit available in circumstances where private creditors are unwilling to extend such credit without a government guarantee. Finally, consumer group commenters asserted that underwriting standards do not accurately determine ability to repay merely because they are widely accepted and pointed to the widespread proliferation of lax underwriting standards that predated the recent financial crisis. The Bureau believes that the Board did not intend to require creditors to use any particular governmental underwriting standards, including FHA standards, in their entirety or to prohibit creditors from using proprietary underwriting standards. The Bureau also does not believe that the Board intended to endorse lax underwriting standards on the basis that those standards may be prevalent in the mortgage market at a particular time. The Bureau therefore is adopting two new comments to provide greater clarity regarding the role of underwriting standards in ability-to-repay determinations and is not adopting proposed comment 43(c)–1. The Bureau is concerned based on the comments received that referring creditors to widely accepted governmental and nongovernmental underwriting standards could lead to undesirable misinterpretations and confusion. The discussion of widely accepted standards in proposed comment 43(c)–1 could be misinterpreted to suggest that the underwriting standards of any single market participant with a large market share are widely accepted and therefore to be emulated. The widely accepted standard also could be misinterpreted to indicate that proprietary underwriting standards cannot yield reasonable, good faith determinations of a consumer’s ability to repay because they are unique to a particular creditor and not employed throughout the mortgage market. Similarly, the widely accepted standard could be misinterpreted to encourage a creditor that lends in a limited geographic area or in a particular market niche to apply widely accepted underwriting standards that E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with are inappropriate for that particular creditor’s loans. The Bureau also is concerned that evaluating underwriting standards based on whether they are widely accepted could have other undesirable consequences. In a market bubble or economic crisis, many creditors may change their underwriting standards in similar ways, leading to widely accepted underwriting standards becoming unreasonably lax or unreasonably tight. A regulatory directive to use underwriting standards that are widely accepted could exacerbate those effects. Also, referring creditors to widely accepted governmental and nongovernmental underwriting standards could hinder creditors’ ability to respond to changing market and economic conditions and stifle market growth and positive innovation. Finally, the Bureau is concerned that focusing on whether underwriting standards are widely accepted could distract creditors from focusing on their obligation under TILA section 129C and § 1026.43(c) to make ability-to-repay determinations that are reasonable and in good faith. The Bureau believes that a creditor’s underwriting standards are an important factor in making reasonable and good faith ability-torepay determinations. However, how those standards are applied to the individual facts and circumstances of a particular extension of credit is equally or more important. In light of these issues, the Bureau is not adopting proposed comment 43(c)– 1. Instead, the Bureau is adopting two new comments, comment 43(c)(1)–1 and comment 43(c)(2)–1. New comment 43(c)(1)–1 clarifies that creditors are permitted to develop and apply their own underwriting standards as long as those standards lead to ability-to-repay determinations that are reasonable and in good faith. New comment 43(c)(2)–1 clarifies that creditors are permitted to use their own definitions and other technical underwriting criteria and notes that underwriting guidelines issued by governmental entities such as the FHA are a source to which creditors may refer for guidance on definitions and technical underwriting criteria. These comments are discussed below in the section-by-section of § 1026.43(c)(1) and (2). 43(c)(1) General Requirement Proposed § 226.43(c)(1) would have implemented TILA section 129C(a)(1) by providing that a creditor shall not make a loan that is a covered transaction unless the creditor makes a reasonable and good faith determination at or VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 before consummation that the consumer will have a reasonable ability, at the time of consummation, to repay the loan according to its terms, including any mortgage-related obligations. Commenters generally agreed that creditors should not make loans to consumers unable to repay them and supported the requirement to consider ability to repay. Accordingly, § 1026.43(c)(1) is adopted substantially as proposed, with two technical and conforming changes. As adopted, § 1026.43(c)(1) requires creditors to make a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan according to its terms. Section 1026.43(c)(1) as adopted omits the reference in the proposed rule to determining that a consumer has a reasonable ability ‘‘at the time of consummation’’ to repay the loan according to its terms. The Bureau believes this phrase is potentially misleading and does not accurately reflect the intent of either the Board or the Bureau. Mortgage loans are not required to be repaid at the time of consummation; instead, they are required to be repaid over months or years after consummation. Creditors are required to make a predictive judgment at the time of consummation that a consumer is likely to have the ability to repay a loan in the future. The Bureau believes that the rule more clearly reflects this requirement without the reference to ability ‘‘at the time of consummation’’ to repay the loan. The creditor’s determination will necessarily be based on the consumer’s circumstances at or before consummation and evidence, if any, that those circumstances are likely to change in the future. Section 1026.43(c)(1) as adopted also omits the reference in the proposed rule to mortgage-related obligations. The Bureau believes this reference is unnecessary because § 1026.43(c)(2) requires creditors to consider consumers’ monthly payments for mortgage-related obligations and could create confusion because § 1026.43(c)(1) does not include references to other factors creditors must consider under § 1026.43(c)(2). As noted above, the Bureau is adopting new comment 43(c)(1)–1, which provides guidance regarding, among other things, how the requirement to make a reasonable and good faith determination of ability to repay relates to a creditor’s underwriting standards. New comment 43(c)(1)–1 replaces in part and responds PO 00000 Frm 00055 Fmt 4701 Sfmt 4700 6461 to comments regarding proposed comment 43(c)–1, discussed above. New comment 43(c)(1)–1 emphasizes that creditors are to be evaluated on whether they make a reasonable and good faith determination that a consumer will have a reasonable ability to repay as required by § 1026.43(c)(1). The comment acknowledges that § 1026.43(c) and the accompanying commentary describe certain requirements for making ability-to-repay determinations, but do not provide comprehensive underwriting standards to which creditors must adhere. As an example, new comment 43(c)(1)–1 notes that the rule and commentary do not specify how much income is needed to support a particular level of debt or how to weigh credit history against other factors. The Bureau believes that a variety of underwriting standards can yield reasonable, good faith ability-to-repay determinations. New comment 43(c)(1)– 1 explains that, so long as creditors consider the factors set forth in § 1026.43(c)(2) according to the requirements of § 1026.43(c), creditors are permitted to develop and apply their own proprietary underwriting standards and to make changes to those standards over time in response to empirical information and changing economic and other conditions. The Bureau believes this flexibility is necessary given the wide range of creditors, consumers, and mortgage products to which this rule applies. The Bureau also believes that there are no indicators in the statutory text or legislative history of the DoddFrank Act that Congress intended to replace proprietary underwriting standards with underwriting standards dictated by governmental or government-sponsored entities as part of the ability-to-repay requirements. The Bureau therefore believes that preserving this flexibility here is consistent with Congressional intent. The comment emphasizes that whether a particular ability-to-repay determination is reasonable and in good faith will depend not only on the underwriting standards adopted by the creditor, but on the facts and circumstances of an individual extension of credit and how the creditor’s underwriting standards were applied to those facts and circumstances. The comment also states that a consumer’s statement or attestation that the consumer has the ability to repay the loan is not indicative of whether the creditor’s determination was reasonable and in good faith. Concerns have been raised that creditors and others will have difficulty evaluating whether a particular ability- E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6462 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations to-repay determination is reasonable and in good faith. Although the statute and the rule specifies certain factors that a creditor must consider in making such a determination, the Bureau does not believe that there is any litmus test that can be prescribed to determine whether a creditor, in considering those factors, arrived at a belief in the consumer’s ability to repay which was both objectively reasonable and in subjective good faith. Nevertheless, new comment 43(c)(1)–1 lists considerations that may be relevant to whether a creditor who considered and verified the required factors in accordance with the rule arrived at an ability-to-repay determination that was reasonable and in good faith. The comment states that the following may be evidence that a creditor’s ability-to-repay determination was reasonable and in good faith: (1) The consumer demonstrated actual ability to repay the loan by making timely payments, without modification or accommodation, for a significant period of time after consummation or, for an adjustable-rate, interest-only, or negative-amortization mortgage, for a significant period of time after recast; (2) the creditor used underwriting standards that have historically resulted in comparatively low rates of delinquency and default during adverse economic conditions; or (3) the creditor used underwriting standards based on empirically derived, demonstrably and statistically sound models. In contrast, new comment 43(c)(1)–1 states that the following may be evidence that a creditor’s ability-torepay determination was not reasonable or in good faith: (1) The consumer defaulted on the loan a short time after consummation or, for an adjustable-rate, interest-only, or negative-amortization mortgage, a short time after recast; (2) the creditor used underwriting standards that have historically resulted in comparatively high levels of delinquency and default during adverse economic conditions; (3) the creditor applied underwriting standards inconsistently or used underwriting standards different from those used for similar loans without reasonable justification; (4) the creditor disregarded evidence that the underwriting standards it used are not effective at determining consumers’ repayment ability; (5) the creditor consciously disregarded evidence that the consumer may have insufficient residual income to cover other recurring obligations and expenses, taking into account the consumer’s assets other than the property securing the covered transaction, after paying his or her VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 monthly payments for the covered transaction, any simultaneous loan, mortgage-related obligations and any current debt obligations; or (6) the creditor disregarded evidence that the consumer would have the ability to repay only if the consumer subsequently refinanced the loan or sold the property securing the loan. New comment 43(c)(1)–1 states the Bureau’s belief that all of these considerations may be relevant to whether a creditor’s ability-to-repay determination was reasonable and in good faith. However, the comment also clarifies that these considerations are not requirements or prohibitions with which creditors must comply, nor are they elements of a claim that a consumer must prove to establish a violation of the ability-to-repay requirements. As an example, the comment clarifies that creditors are not required to validate their underwriting criteria using mathematical models. New comment 43(c)(1)–1 also clarifies that these considerations are not absolute in their application; instead they exist on a continuum and may apply to varying degrees. As an example, the comment states that the longer a consumer successfully makes timely payments after consummation or recast the less likely it is that the creditor’s determination of ability to repay was unreasonable or not in good faith. Finally, new comment 43(c)(1)–1 clarifies that each of these considerations must be viewed in the context of all facts and circumstances relevant to a particular extension of credit. As an example, the comment states that in some cases inconsistent application of underwriting standards may indicate that a creditor is manipulating those standards to approve a loan despite a consumer’s inability to repay. The creditor’s abilityto-repay determination therefore may be unreasonable or in bad faith. However, in other cases inconsistently applied underwriting standards may be the result of, for example, inadequate training and may nonetheless yield a reasonable and good faith ability-torepay determination in a particular case. Similarly, the comment states that although an early payment default on a mortgage will often be persuasive evidence that the creditor did not have a reasonable and good faith belief in the consumer’s ability to repay (and such evidence may even be sufficient to establish a prima facie case of an abilityto-repay violation), a particular abilityto-repay determination may be reasonable and in good faith even though the consumer defaulted shortly PO 00000 Frm 00056 Fmt 4701 Sfmt 4700 after consummation if, for example, the consumer experienced a sudden and unexpected loss of income. In contrast, the comment states that an ability-torepay determination may be unreasonable or not in good faith even though the consumer made timely payments for a significant period of time if, for example, the consumer was able to make those payments only by foregoing necessities such as food and heat. The Board proposed comment 43(c)(1)–1 to clarify that a change in a consumer’s circumstances after consummation of a loan, such as a significant reduction in income due to a job loss or a significant obligation arising from a major medical expense, that cannot reasonably be anticipated from the consumer’s application or the records used to determine repayment ability, is not relevant to determining a creditor’s compliance with the rule. The proposed comment would have further clarified that, if the application or records considered by the creditor at or before consummation indicate that there will be a change in the consumer’s repayment ability after consummation, such as if a consumer’s application states that the consumer plans to retire within 12 months without obtaining new employment or that the consumer will transition from full-time to parttime employment, the creditor must consider that information. Commenters generally supported proposed comment 43(c)(1)–1. Proposed comment 43(c)(1)– 1 is adopted substantially as proposed and redesignated as comment 43(c)(1)– 2. The Board also proposed comment 43(c)(1)–2 to clarify that § 226.43(c)(1) does not require or permit the creditor to make inquiries or verifications prohibited by Regulation B, 12 CFR part 1002. Commenters generally supported proposed comment 43(c)(1)–2. Proposed comment 43(c)(1)–2 is adopted substantially as proposed and redesignated as comment 43(c)(1)–3. 43(c)(2) Basis for Determination As discussed above, TILA section 129C(a)(1) generally requires a creditor to make a reasonable and good faith determination that a consumer has a reasonable ability to repay a loan and all applicable taxes, insurance, and assessments. TILA section 129C(a)(2) requires a creditor to include in that determination the cost of any other residential mortgage loans made to the same consumer and secured by the same dwelling. TILA section 129C(a)(3) enumerates several factors a creditor must consider in determining a consumer’s ability to repay: credit E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations history; current income; expected income; current obligations; debt-toincome ratio or residual income; employment status; and other financial resources other than equity in the property securing the loan. Proposed § 226.43(c)(2) would have implemented the requirements under these sections of TILA that a creditor consider specified factors as part of a determination of a consumer’s ability to repay. Proposed § 226.43(c)(2) would have required creditors to consider the following factors in making a determination of repayment ability, as required by TILA section 129C(a)(1) through (3): the consumer’s current or reasonably expected income or assets, other than the dwelling that secures the loan; the consumer’s employment status, if the creditor relies on employment income; the consumer’s monthly payment on the loan; the consumer’s monthly payment on any simultaneous loan that the creditor knows or has reason to know will be made; the consumer’s monthly payment for mortgage-related obligations; the consumer’s current debt obligations; the consumer’s monthly debt-to-income ratio or residual income; and the consumer’s credit history. As discussed in detail below, the Bureau is adopting § 1026.43(c)(2) substantially as proposed, with technical and conforming changes. As indicated above, the Bureau also is adopting new comment 43(c)(2)–1. New comment 43(c)(2)–1 provides guidance regarding definitional and other technical underwriting issues related to the factors enumerated in § 1026.43(c)(2). New comment 43(c)(2)– 1 replaces in part and responds to comments received regarding proposed comment 43(c)–1, as discussed above. New comment 43(c)(2)–1 notes that § 1026.43(c)(2) sets forth factors creditors must consider when making the ability-to-repay determination required under § 1026.43(c)(1) and the accompanying commentary provides guidance regarding these factors. New comment 43(c)(2)–1 also notes that creditors must conform to these requirements and may rely on guidance provided in the commentary. New comment 43(c)(2)–1 also acknowledges that the rule and commentary do not provide comprehensive guidance on definitions and other technical underwriting criteria necessary for evaluating these factors in practice. The comment clarifies that, so long as a creditor complies with the provisions of § 1026.43(c), the creditor is permitted to use its own definitions and other technical underwriting criteria. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 New comment 43(c)(2)–1 further provides that a creditor may, but is not required to, look to guidance issued by entities such as the FHA, VA, USDA, or Fannie Mae or Freddie Mac while operating under the conservatorship of the Federal Housing Finance Administration. New comment 43(c)(2)– 1 gives several examples of instances where a creditor could refer to such guidance, such as: classifying particular inflows, obligations, and property as ‘‘income,’’ ‘‘debt,’’ or ‘‘assets’’; determining what information to use when evaluating the income of a selfemployed or seasonally employed consumer; or determining what information to use when evaluating the credit history of a consumer who has few or no extensions of traditional credit. The comment emphasizes that these examples are illustrative, and creditors are not required to conform to guidance issued by these or other such entities. The Bureau is aware that many creditors have, for example, existing underwriting definitions of ‘‘income’’ and ‘‘debt.’’ Creditors are not required to modify their existing definitions and other technical underwriting criteria to conform to guidance issued by such entities, and creditors’ existing definitions and other technical underwriting criteria are not noncompliant merely because they differ from those used in such guidance. Finally, new comment 43(c)(2)–1 emphasizes that a creditor must ensure that its underwriting criteria, as applied to the facts and circumstances of a particular extension of credit, result in a reasonable, good faith determination of a consumer’s ability to repay. As an example, new comment 43(c)(2)–1 states that a definition used in underwriting that is reasonable in isolation may lead to ability-to-repay determinations that are unreasonable or not in good faith when considered in the context of a creditor’s underwriting standards or when adopted or applied in bad faith. Similarly, an ability-to-repay determination is not unreasonable or in bad faith merely because the underwriting criteria used included a definition that was by itself unreasonable. 43(c)(2)(i) TILA section 129C(a)(3) provides that, in making the repayment ability determination, a creditor must consider, among other factors, a consumer’s current income, reasonably expected income, and ‘‘financial resources’’ other than the consumer’s equity in the dwelling or real property that secures loan repayment. Furthermore, under TILA section 129C(a)(9), a creditor may PO 00000 Frm 00057 Fmt 4701 Sfmt 4700 6463 consider the seasonality or irregularity of a consumer’s income in determining repayment ability. The Board’s proposal generally mirrored TILA section 129C(a)(3), but differed in two respects. First, proposed § 226.43(c)(2)(i) used the term ‘‘assets’’ rather than ‘‘financial resources,’’ to conform with terminology used in other provisions under TILA section 129C(a) and Regulation Z. See, e.g., TILA section 129C(a)(4) (requiring that creditors consider a consumer’s assets in determining repayment ability); § 1026.51(a) (requiring consideration of a consumer’s assets in determining a consumer’s ability to pay a credit extension under a credit card account). The Board explained that the terms ‘‘financial resources’’ and ‘‘assets’’ are synonymous as used in TILA section 129C(a), and elected to use the term ‘‘assets’’ throughout the proposal for consistency. The Bureau is adopting this interpretation as well, as part of its effort to streamline regulations and reduce compliance burden, and uses the term ‘‘assets’’ throughout Regulation Z. Second, the Board’s proposal provided that a creditor may not look to the value of the dwelling that secures the covered transaction, instead of providing that a creditor may not look to the consumer’s equity in the dwelling, as provided in TILA section 129C(a). The Bureau received comments expressing concern that the Board had proposed dispensing with the term ‘‘equity.’’ These comments protested that the Board had assumed that congressional concern was over the foreclosure value of the home, rather than protecting all homeowners, including those who may have low home values. The commenters’ concerns are likely misplaced, however, as the Board’s language provides, if anything, broader protection for homeowners. TILA section 129C(a)(3) is intended to address the risk that a creditor will consider the amount that could be obtained through a foreclosure sale of the dwelling, which may exceed the amount of the consumer’s equity in the dwelling. For example, the rule addresses the situation in which, several years after consummation, the value of a consumer’s home has decreased significantly. The rule prohibits a creditor from considering, at or before consummation, any value associated with this home, even in the event that the ‘‘underwater’’ home is sold at foreclosure. The rule thus avoids the situation in which the creditor might assume that rising home values might make up the difference should the consumer be unable to make full mortgage payments, and therefore the rule is more protective of consumers E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6464 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations because the rule forbids the creditor from considering any value associated with the dwelling whether the consumer’s equity stake in the dwelling is large or small. The Bureau is adopting the Board’s proposal, providing that a creditor may not look to the value of the dwelling that secures the covered transaction, instead of providing that a creditor may not look to the consumer’s equity in the dwelling, as provided in TILA section 129C(a). The Bureau is making this adjustment pursuant to its authority under TILA section 105(a), which provides that the Bureau’s regulations may contain such additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions as in the Bureau’s judgment are necessary or proper to effectuate the purposes of TILA, prevent circumvention or evasion thereof, or facilitate compliance therewith. 15 U.S.C. 1604(a). The purposes of TILA include the purposes that apply to 129C, to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loan. See 15 U.S.C. 1639b(a)(2). As further explained above, the Bureau believes it is necessary and proper to make this adjustment to ensure that consumers receive loans on affordable terms and to facilitate compliance with TILA and its purposes. The Board proposed comment 43(c)(2)(i)–1 to clarify that a creditor may base a determination of repayment ability on current or reasonably expected income from employment or other sources, assets other than the dwelling that secures the covered transaction, or both. The Bureau did not receive significant comment on the proposal and has adopted the Board’s proposed comment. In congruence with the Bureau’s adoption of the phrase ‘‘value of the dwelling’’ in § 1026.43(c)(2)(i), instead of the consumer’s equity in the dwelling, as originally provided in TILA section 129C(a), comment 43(c)(2)(i)–1 likewise notes that the creditor may not consider the dwelling that secures the transaction as an asset in any respect. This comment is also consistent with comment 43(a)–2, which further clarifies that the term ‘‘dwelling’’ includes the value of the real property to which the dwelling is attached, if the real property also secures the covered transaction. Comment 43(c)(2)(i)–1 also provides examples of types of income the creditor may consider, including salary, wages, self-employment income, military or reserve duty income, tips, VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 commissions, and retirement benefits; and examples of assets the creditor may consider, including funds in a savings or checking account, amounts vested in a retirement account, stocks, and bonds. The Bureau did not receive significant comment on the proposal and has adopted the Board’s proposed comment. The Bureau notes that there may be assets other than those listed in comment 43(c)(2)(i)–1 that a creditor may consider; the Bureau does not intend for the list to be exhaustive, but merely illustrative. The Board proposed comment 43(c)(2)(i)–2 to explain that, if a creditor bases its determination of repayment ability entirely or in part on a consumer’s income, the creditor need consider only the income necessary to support a determination that the consumer can repay the covered transaction. The Bureau did not receive significant comment and has adopted the Board’s comment largely as proposed. This comment clarifies that a creditor need not document and verify every aspect of the consumer’s income, merely enough income to support the creditor’s good faith determination. For example, if a consumer earns income from a full-time job and a part-time job and the creditor reasonably determines that the consumer’s income from the full-time job is sufficient to repay the covered transaction, the creditor need not consider the consumer’s income from the part-time job. Comment 43(c)(2)(i)–2 also cross-references comment 43(c)(4)–1 for clarity. The Board proposed comment 43(c)(2)(i)–3 to clarify that the creditor may rely on the consumer’s reasonably expected income either in addition to or instead of current income. This comment is similar to existing comment 34(a)(4)(ii)–2, which describes a similar income test for high-cost mortgages under § 1026.34(a)(4).107 This consistency should serve to reduce compliance burden for creditors. The Bureau did not receive significant comment on the proposal and is adopting the Board’s comment as proposed. Comment 43(c)(2)(i)–3 further explains that, if a creditor relies on expected income, the expectation that the income will be available for repayment must be reasonable and verified with third-party records that provide reasonably reliable evidence of the consumer’s expected income. Comment 43(c)(2)(i)–3 also gives 107 The Bureau has proposed revising comment 34(a)(4)(ii)–2, though not in a manner that would affect the ‘‘reasonably expected income’’ aspect of the comment. See 77 FR 49090, 49153 (Aug. 15, 2012). The Bureau is concurrently finalizing the 2012 HOEPA Proposal. PO 00000 Frm 00058 Fmt 4701 Sfmt 4700 examples of reasonably expected income, such as expected bonuses verified with documents demonstrating past bonuses or expected salary from a job verified with a written statement from an employer stating a specified salary. As the Board has previously stated, in some cases a covered transaction may have a likely payment increase that would not be affordable at the consumer’s income at the time of consummation. A creditor may be able to verify a reasonable expectation of an increase in the consumer’s income that will make the higher payment affordable to the consumer. See 73 FR 44522, 44544 (July 30, 2008). TILA section 129C(a)(9) provides that a creditor may consider the seasonality or irregularity of a consumer’s income in determining repayment ability. Accordingly, the Board proposed comment 43(c)(2)(i)–4 to clarify that a creditor reasonably may determine that a consumer can make periodic loan payments even if the consumer’s income, such as self-employment or agricultural employment income, is seasonal or irregular. The Bureau received little comment on this proposal, although at least one consumer advocate expressed concern that creditors might interpret the rule to allow for a creditor to differentiate among types of income. Specifically, the commenter expressed concern that some creditors might differentiate types of income, for example salaried income as opposed to disability payments, and that these creditors might require the consumer to produce a letter stating that the disability income was guaranteed for a specified period. The Bureau understands these concerns, and cautions creditors not to overlook the requirements imposed by the Equal Credit Opportunity Act, implemented by the Bureau under Regulation B. See 15 U.S.C. 1601 et seq.; 12 CFR 1002.1 et seq. For example, 12 CFR 1002.6(b)(2) prohibits a creditor from taking into account whether an applicant’s income derives from any public assistance program. The distinction here is that 43(c)(2)(i)–4 permits the creditor to consider the regularity of the consumer’s income, but such consideration must be based on the consumer’s income history, not based on the source of the income, as both a consumer’s wages or a consumer’s receipt of public assistance may or may not be irregular. The Bureau is adopting this comment largely as proposed, as the concerns discussed above are largely covered by Regulation B. Comment 43(c)(2)(i)–4 states that, for example, if the creditor determines that the income E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with a consumer receives a few months each year from, for example, selling crops or from agricultural employment is sufficient to make monthly loan payments when divided equally across 12 months, then the creditor reasonably may determine that the consumer can repay the loan, even though the consumer may not receive income during certain months. Finally, the Bureau is adding new comment 43(c)(2)(i)–5 to further clarify, in the case of joint applicants, the consumer’s current or reasonably expected income or assets basis of the creditor’s ability-to-repay determination. This comment is similar in approach to the Board’s proposed comment 43(c)(4)–2, discussed below, however, proposed comment 43(c)(4)–2 discussed the verification of income in the case of joint applicants. The Bureau is adding comment 43(c)(2)(i)–5 to clarify the creditor’s basis for making an ability-to-repay determination for joint applicants. Comment 43(c)(2)(i)–5 explains that when two or more consumers apply for an extension of credit as joint obligors with primary liability on an obligation, § 1026.43(c)(i) does not require the creditor to consider income or assets that are not needed to support the creditor’s repayment ability determination. Thus, the comment explains that if the income or assets of one applicant are sufficient to support the creditor’s repayment ability determination, then the creditor is not required to consider the income or assets of the other applicant. 43(c)(2)(ii) TILA section 129C(a)(3) requires that a creditor consider a consumer’s employment status in determining the consumer’s repayment ability, among other requirements. The Board proposal implemented this requirement in proposed § 226.43(c)(2)(ii) and clarified that a creditor need consider a consumer’s employment status only if the creditor relies on income from the consumer’s employment in determining repayment ability. The Bureau did not receive significant comment on the Board’s proposal and is adopting § 1026.43(c)(2)(ii) as proposed. The Bureau sees no purpose in requiring a creditor to consider a consumer’s employment status in the case where the creditor need not consider the income from that employment in the creditor’s reasonable and good faith determination that the consumer will have a reasonable ability to repay the loan according to its terms. The Board proposed, and the Bureau is adopting, comment 43(c)(2)(ii)–1 to illustrate this point further. The VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 comment states, for example, that if a creditor relies wholly on a consumer’s investment income to determine the consumer’s repayment ability, the creditor need not consider or verify the consumer’s employment status. The proposed comment further clarifies that employment may be full-time, part-time, seasonal, irregular, military, or selfemployment. Comment 43(c)(2)(ii)–1 is similar to comment 34(a)(4)–6, which discusses income, assets, and employment in determining repayment ability for high-cost mortgages. In its proposal, the Board explained that a creditor generally must verify information relied on to determine repayment ability using reasonably reliable third-party records, but may verify employment status orally as long as the creditor prepares a record of the oral information. The Board proposed comment 43(c)(2)(ii)–2 to add that a creditor also may verify the employment status of military personnel using the electronic database maintained by the Department of Defense (DoD) to facilitate identification of consumers covered by credit protections provided pursuant to 10 U.S.C. 987, also known as the ‘‘Talent Amendment.’’ 108 The Board solicited comment on whether creditors needed additional flexibility in verifying the employment status of military personnel, such as by verifying the employment status of a member of the military using a Leave and Earnings Statement. As this proposed comment was designed to provide clarification for creditors with respect to verifying a consumer’s employment, this proposed comment is discussed in the section-bysection analysis of § 1026.43(c)(3) below. 43(c)(2)(iii) Proposed § 226.43(c)(2)(iii) implemented the requirements under new TILA section 129C(a)(1) and (3), in part, by requiring that the creditor consider the consumer’s monthly payment on the covered transaction, calculated in accordance with proposed § 226.43(c)(5), for purposes of determining the consumer’s repayment ability. Proposed comment 43(c)(2)(iii)– 1 clarified the regulatory language and made clear that mortgage-related obligations must also be considered. The Bureau did not receive comments on this provision. Accordingly, the 108 The Talent Amendment is contained in the John Warner National Defense Authorization Act. See Public Law 109–364, 120 Stat. 2083, 2266 (2006); 72 FR 50580, 5088 (Aug. 31, 2007) (discussing the DoD database in a final rule implementing the Talent Amendment). Currently, the DoD database is available at https:// www.dmdc.osd.mil/appj/mla/. PO 00000 Frm 00059 Fmt 4701 Sfmt 4700 6465 Bureau is adopting § 1026.43(c)(2)(iii) as proposed. Comment 43(c)(2)(iii)–1 has been edited to remove the reference to mortgage-related obligations as potentially confusing. The monthly payment for mortgage-related obligations must be considered under § 1026.43(c)(2)(v). 43(c)(2)(iv) Proposed § 226.43(c)(2)(iv) implemented the requirements under new TILA section 129C(a)(2), in part, by requiring that the creditor consider ‘‘the consumer’s monthly payment on any simultaneous loan that the creditor knows or has reason to know will be made, calculated in accordance with’’ proposed § 226.43(c)(6), for purposes of determining the consumer’s repayment ability. As explained above in the section-by-section analysis of § 1026.43(b)(12), ‘‘simultaneous loan’’ is defined, in the proposed and final rules, to include HELOCs. Proposed comment 43(c)(2)(iv)–1 clarified that for purposes of the repayment ability determination, a simultaneous loan includes any covered transaction or HELOC that will be made to the same consumer at or before consummation of the covered transaction and secured by the same dwelling that secures the covered transaction. This comment explained that a HELOC that is a simultaneous loan that the creditor knows or has reason to know about must be considered in determining a consumer’s ability to repay the covered transaction, even though the HELOC is not a covered transaction subject to § 1026.43. Proposed comment 43(c)(2)(iv)–3 clarified the scope of timing and the meaning of the phrase ‘‘at or before consummation’’ with respect to simultaneous loans that the creditor must consider for purposes of proposed § 226.43(c)(2)(iv). Proposed comment 43(c)(2)(iv)–4 provided guidance on the verification of simultaneous loans. The Bureau received several industry comments on the requirement, in the regulation and the statute, that the creditor consider any simultaneous loan it ‘‘knows or has reason to know’’ will be made. The commenters felt that the standard was vague, and that it would be difficult for a creditor to understand when it ‘‘has reason to know’’ a simultaneous loan will be made. The Board provided guidance on the ‘‘knows or has reason to know’’ standard in proposed comment 43(c)(2)(iv)–2. This comment provided that, in regard to ‘‘piggyback’’ secondlien loans, the creditor complies with the standard if it follows policies and procedures that are designed to E:\FR\FM\30JAR2.SGM 30JAR2 6466 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with determine whether at or before consummation that the same consumer has applied for another credit transaction secured by the same dwelling. The proposed comment provided an example in which the requested loan amount is less than the home purchase price, indicating that there is a down payment coming from a different funding source. The creditor’s policies and procedures must require the consumer to state the source of the down payment, which must be verified. If the creditor determines that the source of the down payment is another extension of credit that will be made to the same consumer and secured by the same dwelling, the creditor knows or has reason to know of the simultaneous loan. Alternatively, if the creditor has verified information that the down payment source is the consumer’s existing assets, the creditor would be under no further obligation to determine whether a simultaneous loan will be extended at or before consummation. The Bureau believes that comment 43(c)(2)(iv)–2 provides clear guidance on the ‘‘knows or has reason to know’’ standard, with the addition of language clarifying that the creditor is not obligated to investigate beyond reasonable underwriting policies and procedures to determine whether a simultaneous loan will be extended at or before consummation of the covered transaction. The Bureau considers the provision to be an accurate and appropriate implementation of the statute. Proposed § 226.43(c)(2)(iv) and associated commentary are adopted substantially as proposed, in renumbered § 1026.43(c)(2)(iv), with the addition of the language discussed above to comment 43(c)(2)(iv)–2 and other minor clarifying changes. Comment 43(c)(2)(iv)–3 now includes language making clear that if the consummation of the loan transaction is extended past the traditional closing, any simultaneous loan originated after that traditional closing may still be interpreted as having occurred ‘‘at’’ consummation. In addition, as discussed below, comment 43(c)(2)(iv)– 4, Verification of simultaneous loans, has been grouped with other verification comments, in comment 43(c)(3)–4. 43(c)(2)(v) As discussed above, TILA section 129C(a)(1) and (3) requires creditors to consider and verify mortgage-related obligations as part of the ability-to-repay determination ‘‘according to [the loan’s] terms, and all applicable taxes, insurance (including mortgage VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 guarantee insurance), and assessments.’’ Section 1026.34(a)(4), which was added by the 2008 HOEPA Final Rule, also requires creditors to consider mortgagerelated obligations in assessing repayment ability. See the section-bysection analysis of § 1026.43(b)(8) for a discussion of the Bureau’s interpretation of ‘‘mortgage-related obligations’’ and the definition adopted in the final rule. The Board proposed to require creditors to consider the consumer’s monthly payment for mortgage-related obligations as part of the repayment ability determination. Proposed comment 43(c)(2)(v)–1 explained that mortgage-related obligations must be included in the creditor’s determination of repayment ability regardless of whether the amounts are included in the monthly payment or whether there is an escrow account established. Proposed comment 43(c)(2)(v)–2 clarified that, in considering mortgagerelated obligations that are not paid monthly, the creditor may look to widely accepted governmental or nongovernmental standards to determine the pro rata monthly payment amount. The Board solicited comment on operational difficulties creditors may encounter when complying with this monthly requirement, and whether additional guidance was necessary. Proposed comment 43(c)(2)(v)–3 explained that estimates of mortgagerelated obligations should be based upon information known to the creditor at the time the creditor underwrites the mortgage obligation. This comment explained that information is known if it is ‘‘reasonably available’’ to the creditor at the time of underwriting the loan, and cross-referenced current comment 17(c)(2)(i)–1 for guidance regarding ‘‘reasonably available.’’ Proposed comment 43(c)(2)(v)–3 further clarified that, for purposes of determining repayment ability under proposed § 226.43(c), the creditor would not need to project potential changes. Proposed comment 43(c)(2)(v)–4 stated that creditors must make the repayment ability determination required under proposed § 226.43(c) based on information verified from reasonably reliable records. This comment explained that guidance regarding verification of mortgagerelated obligations could be found in proposed comments 43(c)(3)–1 and –2, which discuss verification using thirdparty records. The Board solicited comment on any special concerns regarding the requirement to document certain mortgage-related obligations, for example, ground rent or leasehold payments, or special assessments. The PO 00000 Frm 00060 Fmt 4701 Sfmt 4700 Board also solicited comment on whether it should provide that the HUD–1 or –1A or a successor form could serve as verification of mortgagerelated obligations reflected by the form, where a legal obligation exists to complete the form accurately. Industry commenters and consumer advocates generally supported including consideration and verification of mortgage-related obligations in the ability-to-repay determination. Several industry commenters asked that the Bureau provide creditors more flexibility in considering and verifying mortgage-related obligations. They suggested that a reasonable and good faith determination be deemed sufficient, rather than use of all underwriting standards in any particular government or nongovernment handbook. Community banks asserted that flexible standards were necessary to meet their customers’ needs. Some consumer advocates suggested that creditors be permitted to draw on only widely accepted standards that have been validated by experience or sanctioned by a government agency. Some industry commenters asked for more guidance on how to calculate pro rata monthly payment amounts and estimated property taxes. One industry commenter asked that creditors be permitted to use pro rata monthly payment amounts for special assessments, not quarterly or yearly amounts. The commenter requested that estimates of common assessments be permitted. This commenter also recommended that creditors be permitted to verify the amount of common assessments with information provided by the consumer. One commenter noted that verification using HUD–1 forms should be permitted because there is a legal obligation to complete the HUD–1 accurately. The Bureau is adopting the rule as proposed. For the reasons discussed below, the Bureau concludes that a creditor should consider the consumer’s monthly payment for mortgage-related obligations in determining the consumer’s ability to repay, pursuant to § 1026.43(c)(1). As commenters confirmed, obligations related to the mortgage may affect the consumer’s ability to satisfy the obligation to make recurring payments of principal and interest. The Bureau also agrees with the argument raised by many commenters that the failure to account consistently for these obligations during the subprime crisis harmed many consumers. Thus, the Bureau has determined that it is appropriate to adopt § 1026.43(c)(2)(v) as proposed. However, the Bureau believes that E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations additional guidance will facilitate compliance. As explained below, the Bureau has expanded on the proposed commentary language to provide additional clarity and illustrative examples. The final version of comment 43(c)(2)(v)–1 is substantially similar to the language as proposed. As discussed under § 1026.43(b)(8) above, the Bureau is revising the language related to insurance premiums to provide additional clarity. The modifications to the language in proposed comment 43(c)(2)(v)–1 conform to the language adopted under § 1026.43(b)(8) and the related commentary. Furthermore, the final version of comment 43(c)(2)(v)-1 contains additional explanation regarding the determination of the consumer’s monthly payment, and provides additional illustrative examples to clarify further the requirements of § 1026.43(c)(2)(v). For example, assume that a consumer will be required to pay mortgage insurance premiums, as defined by § 1026.43(b)(8), on a monthly, annual, or other basis after consummation. Section 1026.43(c)(2)(v) includes these recurring mortgage insurance payments in the evaluation of the consumer’s monthly payment for mortgage-related obligations. However, if the consumer will incur a one-time fee or charge for mortgage insurance or similar purposes, such as an up-front mortgage insurance premium imposed at consummation, § 1026.43(c)(2)(v) does not include this up-front mortgage insurance premium in the evaluation of the consumer’s monthly payment for mortgage-related obligations. As discussed under § 1026.43(b)(8) above, several commenters discussed the importance of including homeowners association dues and similar obligations in the determination of ability to repay. These commenters argued, and the Bureau agrees, that recurring financial obligations payable to community governance associations, such as homeowners association dues, should be taken into consideration in determining whether a consumer has the ability to repay the obligation. The Bureau recognizes the practical problems that may arise with including obligations such as these in the evaluation of the consumer’s monthly payment for mortgage-related obligations. Commenters identified issues stemming from difficulties which may arise in calculating, estimating, and verifying these obligations. Based on this feedback, the Bureau has determined that additional clarification is necessary. As adopted, comment 43(c)(2)(v)–2 clarifies that creditors need VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 not include payments to community governance associations if such obligations are fully satisfied at or before consummation by the consumer. This comment further clarifies that § 1026.43(c)(2)(v) does not require the creditor to include these payments in the evaluation of the consumer’s monthly payment for mortgage-related obligations if the consumer does not pay the fee directly at or before consummation, and instead finances the obligation. In these cases, the financed obligation will be included in the loan amount, and is therefore already included in the determination of ability to repay pursuant to § 1026.43(c)(2)(iii). However, if the consumer incurs the obligation and will satisfy the obligation with recurring payments after consummation, regardless of whether the obligation is escrowed, § 1026.43(c)(2)(v) requires the creditor to include the obligation in the evaluation of the consumer’s monthly payment for mortgage-related obligations. The Bureau has also addressed the concerns raised by commenters related to calculating, estimating, and verifying these obligations in comments 43(c)(2)(v)–4 and –5 and 43(c)(3)–5, respectively. As discussed under § 1026.43(b)(8) above, one comment letter focused extensively on community transfer fees. The Bureau agrees with the argument, advanced by several commenters, that the entirety of the consumer’s ongoing obligations should be included in the determination. A responsible determination of the consumer’s ability to repay requires an accounting of such obligations, whether the purpose of the obligation is to satisfy the payment of a community transfer fee or traditional homeowners association dues. An obligation that is not paid in full at or before consummation must be paid after consummation, which may affect the consumer’s ability to repay ongoing obligations. Thus, comment 43(c)(2)(v)– 2 clarifies that community transfer fees are included in the determination of the consumer’s monthly payment for mortgage-related obligations if such fees are paid on a recurring basis after consummation. Additionally, the Bureau believes that a creditor is not required to include community transfer fees that are imposed on the seller, as many community transfer fees are, in the ability-to-repay calculation. In response to the request for feedback in the proposed rule, several commenters addressed the proposed treatment of special assessments. Unlike community transfer fees, which are generally identified in the deed or master community plan, creditors may PO 00000 Frm 00061 Fmt 4701 Sfmt 4700 6467 encounter difficulty determining whether special assessments exist. Special assessments are often imposed in response to some urgent or unexpected need. Consequently, neither the creditor nor the community governance association may be able to predict the frequency and magnitude of special assessments. However, this difficulty does not exist for special assessments that are known at the time of underwriting. Known special assessments, which the buyer must pay and which may be significant, may affect the consumer’s ability to repay the obligation. Thus, comment 43(c)(2)(v)–3 clarifies that the creditor must include special assessments in the evaluation of the consumer’s monthly payment for mortgage-related obligations if such fees are paid by the consumer on a recurring basis after consummation, regardless of whether an escrow is established for these fees. For example, if a homeowners association imposes a special assessment that the consumer will have to pay in full at or before consummation, § 1026.43(c)(2)(v) does not include the special assessment in the evaluation of the consumer’s monthly payment for mortgage-related obligations. Section 1026.43(c)(2)(v) does not require a creditor to include special assessments in the evaluation of the consumer’s monthly payment for mortgage-related obligations if the special assessments are imposed as a one-time charge. For example, if a homeowners association imposes a special assessment that the consumer will have to satisfy in one payment, § 1026.43(c)(2)(v) does not include this one-time special assessment in the evaluation of the consumer’s monthly payment for mortgage-related obligations. However, if the consumer will pay the special assessment on a recurring basis after consummation, regardless of whether the consumer’s payments for the special assessment are escrowed, § 1026.43(c)(2)(v) requires the creditor to include this recurring special assessment in the evaluation of the consumer’s monthly payment for mortgage-related obligations. Comment 43(c)(2)(v)–3 also includes several other examples illustrating this requirement. The Bureau agrees that clear and detailed guidance regarding determining pro rata monthly payments of mortgagerelated obligations should be provided. However, the Bureau believes that it is important to strike a balance between providing clear guidance and providing creditors with the flexibility to serve the evolving mortgage market. The comments identified significant concerns with the use of ‘‘widely E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6468 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations accepted governmental and nongovernmental standards’’ for purposes of determining the pro rata monthly payment amount for mortgage-related obligations. While commenters generally stated that ‘‘widely accepted governmental standards’’ was an appropriate standard, others commented that ‘‘non-governmental standards’’ may not be sufficiently clear. The Bureau believes that ‘‘governmental standards’’ could be relied on to perform pro rata calculations of monthly mortgage related obligations because such standards provide detailed and comprehensive guidance and are frequently revised to adapt to the needs of the evolving residential finance market. However, the comments noted that ‘‘non-governmental standards’’ is not sufficiently descriptive to illustrate clearly how to calculate pro rata monthly payments. Additionally, the Bureau believes that clear guidance is also needed to address the possibility that a particular government program may not specifically describe how to calculate pro rata monthly payment amounts for mortgage-related obligations. Thus, the Bureau believes that it is appropriate to revise and further develop the concept of ‘‘widely accepted governmental and nongovernmental standards.’’ Based on this feedback, the Bureau has revised and expanded the comment clarifying how to calculate pro rata monthly mortgage obligations. As adopted, comment 43(c)(2)(v)–4 provides that, if the mortgage loan is originated pursuant to a governmental program, the creditor may determine the pro rata monthly amount of the mortgage-related obligation in accordance with the specific requirements of that program. If the mortgage loan is originated pursuant to a government program that does not contain specific standards for determining the pro rata monthly amount of the mortgage-related obligation, or if the mortgage loan is not originated pursuant to a government program, the creditor complies with § 1026.43(c)(2)(v) by dividing the total amount of a particular non-monthly mortgage-related obligation by no more than the number of months from the month that the non-monthly mortgagerelated obligation last was due prior to consummation until the month that the non-monthly mortgage-related obligation next will be due after consummation. Comment 43(c)(2)(v)–4 also includes several examples which illustrate the conversion of non-monthly obligations into monthly, pro rata payments. For example, assume that a VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 consumer applies for a mortgage loan on February 1st. Assume further that the subject property is located in a jurisdiction where property taxes are paid in arrears annually on the first day of October. The creditor complies with § 1026.43(c)(2)(v) by determining the annual property tax amount owed in the prior October, dividing the amount by 12, and using the resulting amount as the pro rata monthly property tax payment amount for the determination of the consumer’s monthly payment for mortgage-related obligations. The creditor complies even if the consumer will likely owe more in the next year than the amount owed the prior October because the jurisdiction normally increases the property tax rate annually, provided that the creditor does not have knowledge of an increase in the property tax rate at the time of underwriting. The Bureau is adopting comment 43(c)(2)(v)–5 in a form that is substantially similar to the version proposed. One industry commenter was especially concerned about estimating costs for community governance organizations, such as cooperative, condominium, or homeowners associations. This commenter noted that, because of industry concerns about TILA liability, many community governance organizations refuse to provide estimates of association expenses absent agreements disclaiming association liability. This commenter expressed concern that the ability-torepay requirements would make community governance organizations less likely to provide estimates of association expenses, which would result in mortgage loan processing delays. The Bureau does not believe that the ability-to-repay requirements will lead to difficulties in exchanging information between creditors and associations because the ability-to-repay requirements generally apply only to creditors, as defined under § 1026.2(a)(17). However, the Bureau recognizes that consumers may be harmed if mortgage loan transactions are needlessly delayed by concerns arising from the ability-to-repay requirements. Thus, the Bureau has decided to address these concerns by adding several examples to comment 43(c)(2)(v)–5 illustrating the requirements of § 1026.43(c)(2)(v). For example, the creditor complies with § 1026.43(c)(2)(v) by relying on an estimate of mortgagerelated obligations prepared by the homeowners association. In accordance with the guidance provided under comment 17(c)(2)(i)–1, the creditor need only exercise due diligence in PO 00000 Frm 00062 Fmt 4701 Sfmt 4700 determining mortgage-related obligations, and complies with § 1026.43(c)(2)(v) by relying on the representations of other reliable parties in preparing estimates. Or, assume that the homeowners association has imposed a special assessment on the seller, but the seller does not inform the creditor of the special assessment, the homeowners association does not include the special assessment in the estimate of expenses prepared for the creditor, and the creditor is unaware of the special assessment. The creditor complies with § 1026.43(c)(2)(v) if it does not include the special assessment in the determination of mortgage-related obligations. The creditor may rely on the representations of other reliable parties, in accordance with the guidance provided under comment 17(c)(2)(i)–1. 43(c)(2)(vi) TILA section 129C(a)(1) and (3) requires creditors to consider ‘‘current obligations’’ as part of an ability-torepay determination. Proposed § 226.43(c)(2)(vi) would have implemented the requirement under TILA section 129C(a)(1) and (3) by requiring creditors to consider current debt obligations. Proposed comment 43(c)(2)(vi)–1 would have specified that current debt obligations creditors must consider include, among other things, alimony and child support. The Bureau believes that it is reasonable to consider child support and alimony as ‘‘debts’’ given that the term ‘‘debt’’ is not defined in the statute. However, the Bureau understands that while alimony and child support are obligations, they may not be considered debt obligations unless and until they are not paid in a timely manner. Therefore, § 1026.43(c)(2)(vi) specifies that creditors must consider current debt obligations, alimony, and child support to clarify that alimony and child support are included whether or not they are paid in a timely manner. Proposed comment 43(c)(2)(vi)–1 would have referred creditors to widely accepted governmental and nongovernmental underwriting standards in determining how to define ‘‘current debt obligations.’’ The proposed comment would have given examples of current debt obligations, such as student loans, automobile loans, revolving debt, alimony, child support, and existing mortgages. The Board solicited comment on proposed comment 43(c)(2)(vi)–1 and on whether more specific guidance should be provided to creditors. Commenters generally supported giving creditors significant flexibility and did not encourage the Bureau to adopt more specific guidance. E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations Because the Bureau believes that a wide range of criteria and guidelines for considering current debt obligations will contribute to reasonable, good faith ability-to-repay determinations, comment 43(c)(2)(vi)–1 as adopted preserves the flexible approach of the Board’s proposed comment. The comment gives examples of current debt obligations but does not provide an exhaustive list. The comment therefore preserves substantial flexibility for creditors to develop their own underwriting guidelines regarding consideration of current debt obligations. Reference to widely accepted governmental and nongovernmental underwriting standards has been omitted, as discussed above in the section-by-section analysis of § 1026.43(c). The Board also solicited comment on whether additional guidance should be provided regarding consideration of debt obligations that are almost paid off. Commenters generally stated that creditors should be required to consider obligations that are almost paid off only if they affect repayment ability. The Bureau agrees that many different standards for considering obligations that are almost paid off could lead to reasonable, good faith ability-to-repay determinations. As adopted, comment 43(c)(2)(vi)–1 includes additional language clarifying that creditors have significant flexibility to consider current debt obligations in light of attendant facts and circumstances, including that an obligation is likely to be paid off soon after consummation. As an example, comment 43(c)(2)(vi)–1 states that a creditor may take into account that an existing mortgage is likely to be paid off soon after consummation because there is an existing contract for sale of the property that secures that mortgage. The Board also solicited comment on whether additional guidance should be provided regarding consideration of debt obligations in forbearance or deferral. Several commenters, including both creditors and consumer advocates, supported requiring creditors to consider obligations in forbearance or deferral. At least one large creditor objected to requiring creditors to consider such obligations in all cases. The Bureau believes that many different standards for considering obligations in forbearance or deferral could lead to reasonable, good faith determinations of ability to repay. As adopted, comment 43(c)(2)(vi)–1 therefore includes additional language clarifying that creditors should consider whether debt obligations in forbearance or deferral at the time of underwriting are likely to VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 affect a consumer’s ability to repay based on the payment for which the consumer will be liable upon expiration of the forbearance or deferral period and other relevant facts and circumstances, such as when the forbearance or deferral period will expire. Parts of proposed comment 43(c)(2)(vi)–1 and proposed comment 43(c)(2)(vi)–2 would have provided guidance on verification of current debt obligations. All guidance regarding verification has been moved to the commentary to § 1026.43(c)(3) and is discussed below in the section-bysection analysis of that provision. The Board solicited comment on whether it should provide guidance on consideration of current debt obligations for joint applicants. Commenters generally did not comment on consideration of current debt obligations for joint applicants. One trade association commenter stated that joint applicants should be subject to the same standards as individual applicants. Because the Bureau believes that the current debt obligations of all joint applicants must be considered to reach a reasonable, good faith determination of ability to repay, the Bureau is adopting new comment 43(c)(2)(vi)–2. New comment 43(c)(2)(vi)–2 clarifies that when two or more consumers apply for credit as joint obligors, a creditor must consider the debt obligations of all such joint applicants. The comment also explains that creditors are not required to consider the debt obligations of a consumer acting merely as surety or guarantor. Finally, the comment clarifies that the requirements of § 1026.43(c)(2)(vi) do not affect various disclosure requirements. 43(c)(2)(vii) TILA section 129C(a)(3) requires creditors to consider the consumer’s monthly debt-to-income ratio or residual income the consumer will have after paying non-mortgage debt and mortgage-related obligations, as part of the ability-to-repay determination under TILA section 129C(a)(1). This provision is consistent with the 2008 HOEPA Final Rule, which grants a creditor in a high-cost or higher-priced mortgage loan a presumption of compliance with the requirement that the creditor assess repayment ability if, among other things, the creditor considers the consumer’s debt-to-income ratio or residual income. See § 1026.34(a)(4)(iii)(C), (b)(1). Existing comment 34(a)(4)(iii)(C)–1 provides that creditors may look to widely accepted governmental and non-governmental underwriting standards in defining ‘‘income’’ and ‘‘debt’’ including, for PO 00000 Frm 00063 Fmt 4701 Sfmt 4700 6469 example, those set forth in the FHA Handbook on Mortgage Credit Analysis for Mortgage Insurance on One-to-Four Unit Mortgage Loans. Proposed § 226.43(c)(2)(vii) would have implemented TILA section 129C(a)(3) by requiring creditors, as part of the repayment ability determination, to consider the consumer’s monthly debt-to-income ratio or residual income. Proposed comment 43(c)(2)(vii)–1 would have cross-referenced § 226.43(c)(7), regarding the definitions and calculations for the monthly debtto-income and residual income. Consistent with the 2008 HOEPA Final Rule, the proposed rule would have provided creditors flexibility to determine whether to use a debt-toincome ratio or residual income metric in assessing the consumer’s repayment ability. As the Board noted, if one of these metrics alone holds as much predictive power as the two together, then requiring creditors to use both metrics could reduce credit access without an offsetting increase in consumer protection. 76 FR 27390, 27424–25 (May 11, 2011), citing 73 FR 44550 (July 30, 2008). The proposed rule did not specifically address creditors’ use of both metrics if such an approach would provide incremental predictive power of assessing a consumer’s repayment ability. However, as discussed above in the section-bysection analysis of § 1026.43(c), the Board’s proposed comment 43(c)–1 would have provided that, in evaluating the consumer’s repayment ability under § 226.43(c), creditors may look to widely accepted governmental or nongovernmental underwriting standards, such as the FHA Handbook on Mortgage Credit Analysis for Mortgage Insurance on One-to-Four Unit Mortgage Loans, consistent with existing comment 34(a)(4)(iii)(C)–1. In response to the proposed rule, industry commenters and consumer advocates generally supported including consideration of the debt-to-income ratio or residual income in the abilityto-repay determination. Several industry commenters asked that the Bureau provide creditors more flexibility in considering and verifying the debt-toincome ratio or residual income. They suggested that a reasonable and good faith determination be deemed sufficient, rather than use of all underwriting standards in any particular government or nongovernment handbook. Community banks asserted that flexible standards are necessary to meet their customers’ needs. Some consumer advocates suggested that creditors be permitted only to draw on widely accepted E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6470 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations standards that have been validated by experience or sanctioned by a government agency. They argued that more specific standards would help ensure safe and sound underwriting criteria, higher compliance rates, and a larger number of performing loans. Section 1026.43(c)(2)(vii) adopts the Board’s proposal by requiring a creditor making the repayment determination under § 1026.43(c)(1) to consider the consumer’s monthly debt-to-income ratio or residual income, in accordance with § 1026.43(c)(7). The Bureau believes that a flexible approach to evaluating a consumer’s debt-to-income ratio or residual income is appropriate because stricter guidelines may limit access to credit and create fair lending problems. Broad guidelines will provide creditors necessary flexibility to serve the whole of the mortgage market effectively and responsibly. Accordingly, the final rule sets minimum underwriting standards while providing creditors with flexibility to use their own reasonable guidelines in making the repayment ability determination required by § 1026.43(c)(1). Moreover, and as in the 2008 HOEPA Final Rule, the approach would provide creditors flexibility to determine whether to use a debt-toincome ratio or residual income, or both, in assessing a consumer’s repayment ability. As discussed above in the section-bysection analysis of § 1026.43(c), the Bureau is not finalizing the Board’s proposed comment 43(c)–1 regarding the use of widely accepted governmental or non-governmental underwriting standards in evaluating the consumer’s repayment ability. Instead, for the reasons discussed above, comment 43(c)(2)–1 provides that the rule and commentary permit creditors to adopt reasonable standards for evaluating factors in underwriting a loan, such as whether to classify particular inflows or obligations as ‘‘income’’ or ‘‘debt,’’ and that, in evaluating a consumer’s repayment ability, a creditor may look to governmental underwriting standards. See section-by-section analysis of § 1026.43(c)(2). The Bureau believes a flexible approach to evaluating debt and income is appropriate in making the repayment ability determination under § 1026.43(c). However, for the reasons discussed below, the Bureau believes a quantitative standard for evaluating a consumer’s debt-to-income ratio should apply to loans that are ‘‘qualified mortgages’’ that receive a safe harbor or presumption of compliance with the repayment ability determination under VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 § 1026.43(c). For a discussion of the quantitative debt-to-income standard that applies to qualified mortgages pursuant to § 1026.43(e)(2) and the rationale for applying a quantitative standard in the qualified mortgage space, see the section-by-section analysis of § 1026.43(e)(2). 43(c)(2)(viii) TILA section 129C(a)(1) and (3) requires creditors to consider credit history as part of the ability-to-repay determination. Proposed § 226.43(c)(2)(viii) would have implemented the requirement under TILA section 129C(a)(1) and (3) by adopting the statutory requirement that creditors consider credit history as part of an ability-to-repay determination. Proposed comment 43(c)(2)(viii)–1 would have referred creditors to widely accepted governmental and nongovernmental underwriting standards to define credit history. The proposed comment would have given examples of factors creditors could consider, such as the number and age of credit lines, payment history, and any judgments, collections, or bankruptcies. The proposed comment also would have referred creditors to credit bureau reports or to nontraditional credit references such as rental payment history or public utility payments. Commenters generally did not object to the proposed adoption of the statutory requirement to consider credit history as part of ability-to-repay determinations. Commenters generally supported giving creditors significant flexibility in how to consider credit history. Creditors also generally supported clarifying that creditors may look to nontraditional credit references such as rental payment history or public utility payments. Section 1026.43(c)(2)(viii) is adopted as proposed. Comment 43(c)(2)(viii)–1 as adopted substantially maintains the proposed comment’s flexible approach to consideration of credit history. Comment 43(c)(2)(viii)–1 notes that ‘‘credit history’’ may include factors such as the number and age of credit lines, payment history, and any judgments, collections, or bankruptcies. The comment clarifies that the rule does not require creditors to obtain or consider a consolidated credit score or prescribe a minimum credit score that creditors must apply. The comment further clarifies that the rule does not specify which aspects of credit history a creditor must consider or how various aspects of credit history could be weighed against each other or against other underwriting factors. The comment explains that some aspects of PO 00000 Frm 00064 Fmt 4701 Sfmt 4700 a consumer’s credit history, whether positive or negative, may not be directly indicative of the consumer’s ability to repay and that a creditor therefore may give various aspects of a consumer’s credit history as much or as little weight as is appropriate to reach a reasonable, good faith determination of ability to repay. The Bureau believes that this flexible approach is appropriate because of the wide range of creditors, consumers, and loans to which the rule will apply. The Bureau believes that a wide range of approaches to considering credit history will contribute to reasonable, good faith ability-to-repay determinations. As in the proposal, the comment, as adopted, clarifies that creditors may look to non-traditional credit references such as rental payment history or public utility payments, but are not required to do so. Reference to widely accepted governmental and nongovernmental underwriting standards has been omitted, as discussed in the section-by-section analysis of § 1026.43(c), above. Portions of proposed comment 43(c)(2)(viii)–1 discussed verification of credit history. All guidance regarding verification has been moved to the commentary to § 1026.43(c)(3) and is discussed below in the section-bysection analysis of that provision. Because the Bureau believes that the credit history of all joint applicants must be considered to reach a reasonable, good faith determination of joint applicants’ ability to repay, and for conformity with the commentary to § 1026.43(c)(2)(vi) regarding consideration of current debt obligations for multiple applicants, the Bureau is adopting new comment 43(c)(2)(viii)–2 regarding multiple applicants. The comment clarifies that, when two or more consumers apply jointly for credit, the creditor is required by § 1026.43(c)(2)(viii) to consider the credit history of all joint applicants. New comment 43(c)(2)(viii)–2 also clarifies that creditors are not required to consider the credit history of a consumer who acts merely as a surety or guarantor. Finally, the comment clarifies that the requirements of § 1026.43(c)(2)(viii) do not affect various disclosure requirements. 43(c)(3) Verification Using Third-Party Records TILA section 129C(a)(1) requires that a creditor make a reasonable and good faith determination, based on ‘‘verified and documented information,’’ that a consumer has a reasonable ability to repay the covered transaction. The Board’s 2008 HOEPA Final Rule required that a creditor verify the E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations consumer’s income or assets relied on to determine repayment ability and the consumer’s current obligations under § 1026.34(a)(4)(ii)(A) and (C). Thus, TILA section 129C(a)(1) differs from existing repayment ability rules by requiring a creditor to verify information relied on in considering the consumer’s ability to repay according to the considerations required under TILA section 129C(a)(3), which are discussed above in the section-by-section analysis of § 1026.43(c)(2). The Board’s proposal would have implemented TILA section 129C(a)(1)’s general requirement to verify a consumer’s repayment ability in proposed § 226.43(c)(3), which required that a creditor verify a consumer’s repayment ability using reasonably reliable third-party records, with two exceptions. Under the first exception, proposed § 226.43(c)(3)(i) provided that a creditor may orally verify a consumer’s employment status, if the creditor subsequently prepares a record of the oral employment status verification. Under the second exception, proposed § 226.43(c)(3)(ii) provided that, in cases where a creditor relies on a consumer’s credit report to verify a consumer’s current debt obligations and the consumer’s application states a current debt obligation not shown in the consumer’s credit report, the creditor need not independently verify the additional debt obligation, as reported. Proposed comment 43(c)(3)–1 clarified that records a creditor uses to verify a consumer’s repayment ability under proposed § 226.43(c)(3) must be specific to the individual consumer. Records regarding, for example, average incomes in the consumer’s geographic location or average incomes paid by the consumer’s employer would not be specific to the individual consumer and are not sufficient. Proposed comment 43(c)(3)–2 provided that a creditor may obtain third-party records from a third-party service provider, as long as the records are reasonably reliable and specific to the individual consumer. As stated in § 1026.43(c)(3), the standard for verification is that the creditor must use ‘‘reasonably reliable third-party records,’’ which is fulfilled for reasonably reliable documents, specific to the consumer, provided by a thirdparty service provider. Also, proposed comment 43(c)(3)–2 clarified that a creditor may obtain third-party records, for example, payroll statements, directly from the consumer, again as long as the records are reasonably reliable. The Board also solicited comment on whether any documents or records VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 prepared by the consumer and not reviewed by a third party appropriately could be considered in determining repayment ability, for example, because a particular record provides information not obtainable using third-party records. In particular, the Board solicited comment on methods currently used to ensure that documents prepared by selfemployed consumers (such as a year-todate profit and loss statement for the period after the period covered by the consumer’s latest income tax return, or an operating income statement prepared by a consumer whose income includes rental income) are reasonably reliable for use in determining repayment ability. Commenters generally supported the Board’s proposal to implement the Dodd-Frank Act’s verification requirements. Consumer groups generally found the proposal to be an accurate implementation of the statute and posited that the proposal would provide much-needed protection for consumers. Industry commenters generally also supported the proposal, noting that most underwriters already engaged in similarly sound underwriting practices. Some industry commenters noted that verifying a consumer’s employment status imposes a burden upon the consumer’s employer as well, however the Bureau has concluded that the oral verification provision provided by § 1026.43(c)(3)(ii), discussed below, alleviates such concerns. The Bureau is adopting § 1026.43(c)(3) substantially as proposed, with certain clarifying changes which are described below. The final rule also adds new comment 43(c)(3)–3. In addition, for organizational purposes, the final rule generally adopts proposed comments 43(c)(2)(iv)–4, 43(c)(2)(v)–4, 43(c)(2)(vi)–1, 43(c)(2)(viii)–1, and 43(c)(2)(ii)–2 in renumbered comments 43(c)(3)–4 through –8 with revisions as discussed below. These changes and additions to § 1026.43(c)(3) and its commentary are discussed below. First, the final rule adds a new § 1026.43(c)(3)(i), which provides that, for purposes of § 1026.43(c)(2)(i), a creditor must verify a consumer’s income or assets in accordance with § 1026.43(c)(4). This is an exception to the general rule in § 1026.43(c)(3) that a creditor must verify the information that the creditor relies on in determining a consumer’s repayment ability under § 1026.43(c)(2) using reasonably reliable third-party records. Because of this new provision, proposed § 226.43(c)(3)(i) and (ii) are adopted as proposed in § 1026.43(c)(3)(ii) and (iii), with minor PO 00000 Frm 00065 Fmt 4701 Sfmt 4700 6471 technical revisions. In addition, the Bureau is adopting proposed comments 43(c)(3)–1 and –2 substantially as proposed with revisions to clarify that the guidance applies to both § 1026.43(c)(3) and (c)(4). The Bureau is adding new comment 43(c)(3)–3 to clarify that a credit report generally is considered a reasonably reliable third-party record. The Board’s proposed comment 43(c)(2)(vi)–2 stated, among other things, that a credit report is deemed a reasonably reliable thirdparty record under proposed § 226.43(c)(3). Commenters did not address that aspect of proposed comment 43(c)(2)(vi)–2. The Bureau believes credit reports are generally reasonably reliable third-party records for verification purposes. Comment 43(c)(3)–3 also explains that a creditor is not generally required to obtain additional reasonably reliable thirdparty records to verify information contained in a credit report, as the report itself is the means of verification. Likewise, comment 43(c)(3)–3 explains that if information is not included in the credit report, then the credit report cannot serve as a means of verifying that information. The comment further explains, however, that if the creditor may know or have reason to know that a credit report is not reasonably reliable, in whole or in part, then the creditor complies with § 1026.43(c)(3) by disregarding such inaccurate or disputed items or reports. The creditor may also, but is not required, to obtain other reasonably reliable third-party records to verify information with respect to which the credit report, or item therein, may be inaccurate. The Bureau believes that this guidance strikes the appropriate balance between acknowledging that in many cases, a credit report is a reasonably reliable third-party record for verification and documentation for many creditors, but also that a credit report may be subject to a fraud alert, extended alert, active duty alert, or similar alert identified in 15 U.S.C. 1681c–1, or may contain debt obligations listed on a credit report is subject to a statement of dispute pursuant to 15 U.S.C. 1681i(b). Accordingly, for the reasons discussed above, the Bureau is adopting new comment 43(c)(3)–3. As noted above, the Bureau is adopting proposed comment 43(c)(2)(iv)–4 as comment 43(c)(3)–4 for organizational purposes. The Board proposed comment 43(c)(2)(iv)–4 to explain that although a creditor could use a credit report to verify current obligations, the report would not reflect a simultaneous loan that has not yet been consummated or has just recently E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6472 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations been consummated. Proposed comment 43(c)(2)(iv)–2 clarified that if the creditor knows or has reason to know that there will be a simultaneous loan extended at or before consummation, then the creditor may verify the simultaneous loan by obtaining thirdparty verification from the third-party creditor of the simultaneous loan. The proposed comment provided, as an example, that the creditor may obtain a copy of the promissory note or other written verification from the third-party creditor in accordance with widely accepted governmental or nongovernmental standards. In addition, proposed comment 43(c)(2)(iv)–2 crossreferenced comments 43(c)(3)–1 and –2, which discuss verification using thirdparty records. The Bureau generally did not receive comment with respect to this proposed comment; however, at least one commenter supported the example that a promissory note would serve as appropriate documentation for verifying a simultaneous loan. The Bureau is adopting proposed comment 43(c)(2)(iv)–4 as comment 43(c)(3)–4 with the following amendment. For consistency with other aspects of the rule, comment 43(c)(3)–4 does not include the Board’s proposed reference to widely accepted governmental or non-governmental standards. The Board proposed comment 43(c)(2)(v)–4, which stated that creditors must make the repayment ability determination required under proposed § 226.43(c) based on information verified from reasonably reliable records. The Board solicited comment on any special concerns regarding the requirement to document certain mortgage-related obligations, for example, ground rent or leasehold payments, or special assessments. The Board also solicited comment on whether it should provide that the HUD–1 or –1A or a successor form could serve as verification of mortgagerelated obligations reflected by the form, where a legal obligation exists to complete the HUD–1 or –1A accurately. To provide additional clarity, the Bureau is moving guidance that discusses verification, including proposed comment 43(c)(2)(v)–4, as part of the section-by-section analysis of, and commentary to, § 1026.43(c)(3). Additional comments from the Board’s proposal with respect to mortgagerelated obligations are in the section-bysection analysis of § 1026.43(c)(2)(v), above. Industry commenters and consumer advocates generally supported including consideration and verification of mortgage-related obligations in the ability-to-repay determination. Several VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 industry commenters asked that the Bureau provide creditors more flexibility in considering and verifying mortgage-related obligations. Several consumer advocate commenters discussed the importance of verifying mortgage-related obligations based on reliable records, noting that inadequate, or non-existent, verification measures played a significant part in the subprime crisis. Industry commenters agreed that verification was appropriate, but these commenters also stressed the importance of clear and detailed guidance. Several commenters were concerned about the meaning of ‘‘reasonably reliable records’’ in the context of mortgage-related obligations. Some commenters asked the Bureau to designate certain items as reasonably reliable, such as taxes referenced in a title report, statements of common expenses provided by community associations, or items identified in the HUD–1 or HUD–1A. The Bureau is adopting proposed comment 43(c)(2)(v)–4 as comment 43(c)(3)–5 with revision to provide further explanation of its approach to verifying mortgage-related obligations. While the reasonably reliable standard contains an element of subjectivity, the Bureau concludes that this flexibility is necessary. The Bureau believes that it is important to craft a regulation with the flexibility to accommodate an evolving mortgage market. The Bureau determines that the reasonably reliable standard is appropriate in this context given the nature of the items that are defined as mortgage-related obligations. Thus, comment 43(c)(3)–5 incorporates by reference comments 43(c)(3)–1 and –2. Mortgage-related obligations refer to a limited set of charges, such as property taxes and lease payments, which a creditor can generally verify from an independent or objective source. Thus, in the context of mortgage-related obligations this standard provides certainty while being sufficiently flexible to adapt as underwriting practices develop over time. To address the concerns raised by several commenters, the Bureau is providing further clarification in 43(c)(3)–5 to provide detailed guidance and several examples illustrating these requirements. For example, comment 43(c)(3)–5 clarifies that records are reasonably reliable for purposes § 1026.43(c)(2)(v) if the information in the record was provided by a governmental organization, such as a taxing authority or local government. Comment 43(c)(3)–5 also explains that a creditor complies with § 1026.43(c)(2)(v) if it relies on, for example, homeowners PO 00000 Frm 00066 Fmt 4701 Sfmt 4700 association billing statements provided by the seller to verify other information in a record provided by an entity assessing charges, such as a homeowners association. Comment 43(c)(3)–5 further illustrates that records are reasonably reliable if the information in the record was obtained from a valid and legally executed contract, such as a ground rent agreement. Comment 43(c)(3)–5 also clarifies that other records may be reasonably reliable if the creditor can demonstrate that the source provided the information objectively. The Board’s proposal solicited comment regarding whether the HUD–1, or similar successor document, should be considered a reasonably reliable record. The Board noted, and commenters confirmed, that the HUD–1, HUD–1A, or successor form might be a reasonably reliable record because a legal obligation exists to complete the form accurately. Although the Bureau agrees with these considerations, the Bureau does not believe that a document provided in final form at consummation, such as the HUD–1, should be used for the purposes of determining ability to repay pursuant to § 1026.43(c)(2)(v). The Bureau expects the ability-to-repay determination to be conducted in advance of consummation. It therefore may be impractical for a creditor to rely on a document that is produced in final form at, or shortly before, consummation for verification purposes. The Bureau is also concerned that real estate transactions may be needlessly disrupted or delayed if creditors delay determining the consumer’s ability to repay until the HUD–1, or similar successor document, is prepared. Given these concerns, and strictly as a matter of policy, the Bureau does not wish to encourage the use of the HUD–1, or similar successor document, for the purposes of determining a consumer’s ability to repay, and the Bureau is not specifically designating the HUD–1 as a reasonably reliable record in either § 1026.43(c)(2)(v) or related commentary, such as comment 43(c)(3)– 5. However, the Bureau acknowledges that the HUD–1, HUD–1A, or similar successor document may comply with § 1026.43(c)(3). The Board proposed comment 43(c)(2)(vi)–1, which discussed both consideration and verification of current debt obligations. The Bureau discusses portions of proposed comment 43(c)(2)(vi)–1, regarding consideration of current debt obligations, in the section-by-section analysis of § 1026.43(c)(2)(vi). As noted above, for organizational purposes and to provide E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations additional clarity, however, the Bureau is moving guidance that discusses verification, including portions of proposed comment 43(c)(2)(vi)–1, as part of the commentary to § 1026.43(c)(3). With respect to verification, proposed comment 43(c)(2)(vi)–1 stated that: (1) In determining how to verify current debt obligations, a creditor may look to widely accepted governmental and nongovernmental underwriting standards; and (2) a creditor may, for example, look to credit reports, student loan statements, automobile loan statements, credit card statements, alimony or child support court orders and existing mortgage statements. Commenters did not provide the Bureau with significant comment with respect to this proposal, although at least one large bank commenter specifically urged the Bureau to allow creditors to verify current debt obligations using a credit report. For the reasons discussed below, the Bureau is adopting, in relevant part, proposed comment 43(c)(2)(vi)–1 as comment 43(c)(3)–6. The Bureau believes that the proposed guidance regarding verification using statements and orders related to individual obligations could be misinterpreted as implying that credit reports are not sufficient verification of current debt obligations and that creditors must obtain statements and other documentation pertaining to each individual obligation. Comment 43(c)(3)–6 therefore explains that a creditor is not required to further verify the existence or amount of the obligation listed in a credit report, absent circumstances described in comment 43(c)(3)–3. The Bureau believes that a credit report is a reasonably reliable third-party record and is sufficient verification of current debt obligations in most cases. The Bureau also believes that this approach is reflected in the Board’s proposal. For example, proposed comment 43(c)(2)(vi)–2 stated that a credit report is a reasonably reliable third-party record; and proposed § 1026.43(c)(3)(ii) indicated that a creditor could rely on a consumer’s credit report to verify a consumer’s current debt obligations. Unlike proposed comment 43(c)(2)(vi)– 1, comment 43(c)(3)–6 does not include reference to widely accepted governmental and nongovernmental underwriting standards for consistency with the amendments in other parts of the rule. To understand the Bureau’s approach to verification standards, see the section-by-section analysis, commentary, and regulation text of § 1026.43(c) and § 1026.43(c)(1) above. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 The Board proposed comment 43(c)(2)(viii)–1, which discussed both the consideration and verification of credit history. The Bureau discusses portions of proposed comment 43(c)(2)(viii)–1, those regarding consideration of credit history, in the section-by-section analysis of § 1026.43(c)(2)(viii). However, the Bureau is moving guidance on verification, including portions of proposed comment 43(c)(2)(viii)–1, to § 1026.43(c)(3) and its commentary. Regarding verification, proposed comment 43(c)(2)(viii)–1 stated that: (1) Creditors may look to widely accepted governmental and nongovernmental underwriting standards to determine how to verify credit history; and (2) a creditor may, for example, look to credit reports from credit bureaus, or other nontraditional credit references contained in third-party documents, such as rental payment history or public utility payments to verify credit history. Commenters did not object to the Board’s proposed approach to verification of credit history. The Bureau is adopting this approach under comment 43(c)(3)–7 with the following exception. References to widely accepted governmental and nongovernmental underwriting standards have been removed, as discussed above in the section-bysection analysis of § 1026.43(c). Portions of proposed comment 43(c)(2)(viii)–1 regarding verification are otherwise adopted substantially as proposed in new comment 43(c)(3)–7. The Board proposed comment 43(c)(2)(ii)–2 to clarify that a creditor also may verify the employment status of military personnel using the electronic database maintained by the DoD to facilitate identification of consumers covered by credit protections provided pursuant to 10 U.S.C. 987, also known as the ‘‘Talent Amendment.’’ 109 The Board also sought additional comment as to whether creditors needed additional flexibility in verifying the employment status of military personnel, such as by verifying the employment status of a member of the military using a Leave and Earnings Statement. Industry commenters requested that the Bureau provide additional flexibility for creditors to verify military employment. For example, some industry commenters noted that a Leave and Earnings Statement was concrete evidence of employment status and income for military personnel and other industry commenters stated that institutions that frequently work with 109 See PO 00000 supra note 105. Frm 00067 Fmt 4701 Sfmt 4700 6473 military personnel have built their own expertise in determining the reliability of using the Leave and Earnings Statement. These commenters argued that using a Leave and Earnings Statement is as reliable a means of verifying the employment status of military personnel as using a payroll statement to verify that employment status of a civilian. Accordingly, the Bureau is adopting proposed comment 43(c)(2)(ii)–2 as comment 43(c)(3)–8, for organizational purposes, with the following additional clarification. Comment 43(c)(3)–8 clarifies that a creditor may verify military employment by means of a military Leave and Earnings Statement. Therefore, comment 43(c)(3)–8 provides that a creditor may verify the employment status of military personnel by using either a military Leave and Earnings Statement or by using the electronic database maintained by the DoD. The Board solicited comment on whether a creditor might appropriately verify a consumer’s repayment ability using any documents or records prepared by the consumer and not reviewed by a third party, perhaps because a particular record might provide information not obtainable using third-party records. The Bureau did not receive sufficient indication that such records would qualify as reasonably reliable and has thus not added additional regulatory text or commentary to allow for the use of such records. However, a creditor using reasonable judgment nevertheless may determine that such information is useful in verifying a consumer’s ability to repay. For example, the creditor may consider and verify a self-employed consumer’s income from the consumer’s 2013 income tax return, and the consumer then may offer an unaudited year-to-date profit and loss statement that reflects significantly lower expected income in 2014. The creditor might reasonably use the lower 2014 income figure as a more conservative method of underwriting. However, should the unverified 2014 income reflect significantly greater income than the income tax return showed for 2013, a creditor instead would verify this information in accordance with § 1026.43(c)(4). 43(c)(4) Verification of Income or Assets TILA section 129C(a)(4) requires that a creditor verify amounts of income or assets that a creditor relied upon to determine repayment ability by reviewing the consumer’s Internal Revenue Service (IRS) Form W–2, tax returns, payroll statements, financial E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6474 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations institution records, or other third-party documents that provide reasonably reliable evidence of the consumer’s income or assets. TILA section 129C(a)(4) further provides that, in order to safeguard against fraudulent reporting, any consideration of a consumer’s income history must include the verification of income using either (1) IRS transcripts of tax returns; or (2) an alternative method that quickly and effectively verifies income documentation by a third-party, subject to rules prescribed by the Board, and now the Bureau. TILA section 129C(a)(4) is similar to existing § 1026.34(a)(4)(ii)(A), adopted by the Board’s 2008 HOEPA Final Rule, although TILA section 129C(a)(4)(B) provides for the alternative methods of third-party income documentation (other than use of an IRS tax-return transcript) to be both ‘‘reasonably reliable’’ and to ‘‘quickly and effectively’’ verify a consumer’s income. The Board proposed to implement TILA section 129C(a)(4)(B), adjusting the requirement to (1) require the creditor to use reasonably reliable third-party records, consistent with TILA section 129C(a)(4), rather than the ‘‘quickly and effectively’’ standard of TILA section 129C(a)(4)(B); and (2) provide examples of reasonably reliable records that a creditor can use to efficiently verify income, as well as assets. As discussed in the Board’s proposal, the Board proposed these adjustments pursuant to its authority under TILA sections 105(a) and 129B(e). The Board believed that considering reasonably reliable records effectuates the purposes of TILA section 129C(a)(4), is an effective means of verifying a consumer’s income, and helps ensure that consumers are offered and receive loans on terms that reasonably reflect their repayment ability. Industry and consumer group commenters generally supported proposed § 226.43(c)(4) because the proposal would permit a creditor to use a wide variety of documented income and/or asset verification methods, while maintaining the appropriate goal of ensuring accurate verification procedures. Some commenters requested that the Bureau allow a creditor to underwrite a mortgage based on records maintained by a financial institution that show an ability to repay. Specifically, commenters raised concerns with respect to customers who may not have certain documents, such as IRS Form W–2, because of their employment or immigration status. The Bureau expects that § 1026.43(c)(4) provides that the answer to such VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 concerns is self-explanatory; a creditor need not, by virtue of the requirements of § 1026.43(c)(4), require a consumer to produce an IRS Form W–2 in order to verify income. Some industry commenters argued that the Bureau should also permit creditors to verify information for certain applicants, such as the self-employed, by using non-third party reviewed documents, arguing it would reduce costs for consumers. The Bureau does not find such justification to be persuasive, as other widely available documents, such as financial institution records or tax records, could easily serve as means of verification without imposing significant cost to the consumer or creditor. See also the discussion of comment 43(b)(13)(i)–1, addressing third-party records. Some industry commenters advocated, in addition, that creditors be allowed to employ broader, faster sources of income verification, such as internet-based tools that employ aggregate employer data, or be allowed to rely on statistically qualified models to estimate income or assets. The Bureau, however, believes that permitting creditors to use statistical models or aggregate data to verify income or assets would be contrary to the purposes of TILA section 129C(a)(4). Although the statute uses the words ‘‘quickly and effectively,’’ these words cannot be read in isolation, but should instead be read in context of the entirety of TILA section 129C(a)(4). As noted above, the Bureau believes that TILA section 129C(a)(4) is primarily intended to safeguard against fraudulent reporting and inaccurate underwriting, rather than accelerate the process of verifying a consumer’s income, as the statute specifically notes that a creditor must verify a consumer’s income history ‘‘[i]n order to safeguard against fraudulent reporting.’’ The Bureau further believes that permitting the use of aggregate data or non-individualized estimates would undermine the requirements to verify a consumer’s income and to determine a consumer’s ability to repay. Rather, the Bureau believes that the statute requires verification of the amount of income or assets relied upon using evidence of an individual’s income or assets. For substantially the same reasons stated in the Board’s proposal, the Bureau is adopting proposed § 226.43(c)(4) and its accompanying commentary substantially as proposed in renumbered § 1026.43(c)(4), with revisions for clarity. Accordingly, the Bureau is implementing TILA section 129C(a)(4) in § 1026.43(c)(4), which provides that a creditor must verify the amounts of income or assets it relies on to determine a consumer’s ability to PO 00000 Frm 00068 Fmt 4701 Sfmt 4700 repay a covered transaction using thirdparty records that provide reasonably reliable evidence of the consumer’s income or assets. Section 1026.43(c)(4) further provides a list of illustrative examples of methods of verifying a consumer’s income or asserts using reasonably reliable third-party records. Such examples include: (1) Copies of tax returns the consumer filed with the IRS or a State taxing authority; (2) IRS Form W–2s or similar IRS forms for reporting wages or tax withholding; (3) payroll statements, including military Leave and Earnings Statements; (4) financial institution records; (5) records from the consumer’s employer or a third party that obtained consumer-specific income information from the consumer’s employer; (6) records from a government agency stating the consumer’s income from benefits or entitlements, such as a ‘‘proof of income’’ letter issued by the Social Security Administration; (7) check cashing receipts; and (8) receipts from a consumer’s use of funds transfer services. The Bureau also believes that by providing such examples of acceptable records, the Bureau enables creditors to quickly and effectively verify a consumer’s income, as provided in TILA section 129C(a)(4)(B). Comment 43(c)(4)–1 clarifies that under § 1026.43(c)(4), a creditor need verify only the income or assets relied upon to determine the consumer’s repayment ability. Comment 43(c)(4)–1 also provides an example where the creditor need not verify a consumer’s annual bonus because the creditor relies on only the consumer’s salary to determine the consumer’s repayment ability. This comment also clarifies that comments 43(c)(3)–1 and –2, discussed above, are instructive with respect to income and asset verification. Comment 43(c)(4)–2 clarifies that, if consumers jointly apply for a loan and each consumer lists his or her income or assets on the application, the creditor need verify only the income or assets the creditor relies on to determine repayment ability. Comment 43(c)(2)(i)– 5, discussed above, may also be instructive in cases of multiple applicants. Comment 43(c)(4)–3 provides that a creditor may verify a consumer’s income using an IRS tax-return transcript that summarizes the information in the consumer’s filed tax return, another record that provides reasonably reliable evidence of the consumer’s income, or both. Comment 43(c)(4)–3 also clarifies that a creditor may obtain a copy of an IRS tax-return transcript or filed tax return from a service provider or from the consumer, E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations and the creditor need not obtain the copy directly from the IRS or other taxing authority. For additional guidance, Comment 43(c)(4)–3 crossreferences guidance on obtaining records in comment 43(c)(3)–2. Finally, comment 43(c)(4)(vi)–1 states that an example of a record from a Federal, State, or local government agency stating the consumer’s income from benefits or entitlements is a ‘‘proof of income letter’’ (also known as a ‘‘budget letter,’’ ‘‘benefits letter,’’ or ‘‘proof of award letter’’) from the Social Security Administration. As discussed above, the Bureau is adopting § 1026.43(c)(4) as enabling creditors to quickly and effectively verify a consumer’s income, as provided in TILA section 129C(a)(4)(B). In addition, for substantially the same rationale as discussed in the Board’s proposal, the Bureau is adopting § 1026.43(c)(4) using its authority under TILA section 105(a) to prescribe regulations to carry out the purposes of TILA. One of the purposes of TILA section 129C is to assure that consumers are offered and receive covered transactions on terms that reasonably reflect their ability to repay the loan. See TILA section 129B(a)(2). The Bureau believes that a creditor consulting reasonably reliable records is an effective means of verifying a consumer’s income and helps ensure that consumers are offered and receive loans on terms that reasonably reflect their repayment ability. The Bureau further believes that TILA section 129C(a)(4) is intended to safeguard against fraudulent or inaccurate reporting, rather than to accelerate the creditor’s ability to verify a consumer’s income. Indeed, the Bureau believes that there is a risk that requiring a creditor to use quick methods to verify the consumer’s income would undermine the effectiveness of the ability-to-repay requirements by sacrificing thoroughness for speed. The Bureau believes instead that requiring the use of reasonably reliable records effectuates the purposes of TILA section 129C(a)(4) without suggesting that creditors must obtain records or complete income verification within a specific period of time. The Bureau is adopting the examples of reasonably reliable records, proposed by the Board, that a creditor may use to efficiently verify income or assets, because the Bureau believes that it will facilitate compliance by providing clear guidance to creditors. The Bureau notes that the Board proposal solicited comment on whether it should provide an affirmative defense for a creditor that can show that the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 amounts of the consumer’s income or assets that the creditor relied upon in determining the consumer’s repayment ability were not materially greater than the amounts the creditor could have verified using third-party records at or before consummation. Such an affirmative defense, while not specified under TILA, would be consistent with the Board’s 2008 HOEPA Final Rule. See § 1026.34(a)(4)(ii)(B).110 Consumer group commenters generally opposed an affirmative defense, arguing that such an allowance would essentially gut the income and asset verification requirement provided by the rule. Other commenters noted that providing an affirmative defense might result in confusion, and possible litigation, over what the term ‘‘material’’ may mean, and that a rule permitting an affirmative defense would need to define materiality specifically, including from whose perspective materiality should be measured (i.e., the creditor’s or the consumer’s). Based on the comments received, the Bureau believes that an affirmative defense is not warranted. The Bureau believes that permitting an affirmative defense could result in circumvention of the § 1026.43(c)(4) verification requirement. For the reasons stated, the Bureau is not adopting an affirmative defense for a creditor that can show that the amounts of the consumer’s income or assets that the creditor relied upon in determining the consumer’s repayment ability were not materially greater than the amounts the creditor could have verified using third-party records at or before consummation. 43(c)(5) Payment Calculation The Board proposed § 226.43(c)(5) to implement the payment calculation requirements of TILA section 129C(a), as enacted by section 1411 of the DoddFrank Act. TILA section 129C(a) contains the general requirement that a creditor determine the consumer’s ‘‘ability to repay the loan, according to its terms, and all applicable taxes, insurance (including mortgage guarantee insurance), and assessments,’’ based on several considerations, including ‘‘a payment schedule that fully amortizes the loan over the term of the loan.’’ TILA section 129C(a)(1) and (3). The statutory requirement to consider mortgage-related obligations, as defined in § 1026.43(b)(8), is discussed above in the section-bysection analysis of § 1026.43(c)(2)(v). 110 The Bureau’s 2012 HOEPA Proposal proposed to amend this subsection, though not in a manner that affected the overall effect of an affirmative defense. See 77 FR 49090, 49153 (Aug. 15, 2012). PO 00000 Frm 00069 Fmt 4701 Sfmt 4700 6475 TILA section 129C(a) requires, among other things, that a creditor make a determination that a consumer ‘‘has a reasonable ability to repay’’ a residential mortgage loan. TILA section 129C(a)(6)(D) provides the process for calculating the monthly payment amount ‘‘[f]or purposes of making any determination under this subsection,’’ i.e., subsection (a), for ‘‘any residential mortgage loan.’’ TILA section 129C(a)(6)(A) through (D) requires creditors to make uniform assumptions when calculating the payment obligation for purposes of determining the consumer’s repayment ability for the covered transaction. Specifically, TILA section 129C(a)(6)(D)(i) through (iii) provides that, when calculating the payment obligation that will be used to determine whether the consumer can repay the covered transaction, the creditor must use a fully amortizing payment schedule and assume that: (1) The loan proceeds are fully disbursed on the date the loan is consummated; (2) the loan is repaid in substantially equal, monthly amortizing payments for principal and interest over the entire term of the loan with no balloon payment; and (3) the interest rate over the entire term of the loan is a fixed rate equal to the fully indexed rate at the time of the loan closing, without considering the introductory rate. The term ‘‘fully indexed rate’’ is defined in TILA section 129C(a)(7). TILA section 129C(a)(6)(D)(ii)(I) and (II), however, provides two exceptions to the second assumption regarding ‘‘substantially equal, monthly payments over the entire term of the loan with no balloon payment’’ for loans that require ‘‘more rapid repayment (including balloon payment).’’ First, this statutory provision authorizes the Bureau to prescribe regulations for calculating the payment obligation for loans that require more rapid repayment (including balloon payment), and which have an annual percentage rate that does not exceed the threshold for higherpriced mortgage loans. TILA section 129C(a)(6)(D)(ii)(I). Second, for loans that ‘‘require more rapid repayment (including balloon payment),’’ and which exceed the higher-priced mortgage loan threshold, the statute requires that the creditor use the loan contract’s repayment schedule. TILA section 129C(a)(6)(D)(ii)(II). The statute does not define the term ‘‘rapid repayment.’’ The statute also provides three additional clarifications to the assumptions stated above for loans that contain certain features. First, for variable-rate loans that defer repayment of any principal or interest, TILA E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6476 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations section 129C(a)(6)(A) states that for purposes of the repayment ability determination a creditor must use ‘‘a fully amortizing repayment schedule.’’ This provision generally reiterates the requirement provided under TILA section 129C(a)(3) to use a payment schedule that fully amortizes the loan. Second, for covered transactions that permit or require interest-only payments, the statute requires that the creditor determine the consumers’ repayment ability using ‘‘the payment amount required to amortize the loan by its final maturity.’’ TILA section 129C(a)(6)(B). Third, for covered transactions with negative amortization, the statute requires the creditor to also take into account ‘‘any balance increase that may accrue from any negative amortization provision’’ when making the repayment ability determination. TILA section 129C(a)(6)(C). The statute does not define the terms ‘‘variablerate,’’ ‘‘fully amortizing,’’ ‘‘interestonly,’’ or ‘‘negative amortization.’’ Proposed § 226.43(c)(5)(i) and (ii) implemented these statutory provisions, as discussed in further detail below. TILA section 129C(a), as enacted by section 1411 of the Dodd-Frank Act, largely codifies many aspects of the repayment ability rule under § 1026.34(a)(4) from the Board’s 2008 HOEPA Final Rule and extends such requirements to the entire mortgage market regardless of the loan’s interest rate. Similarly to § 1026.34(a)(4), the statutory framework of TILA section 129C(a) focuses on prescribing the requirements that govern the underwriting process and extension of credit to consumers, rather than dictating which credit terms may or may not be permissible. However, there are differences between TILA section 129C(a) and the 2008 HOEPA Final Rule with respect to payment calculation requirements. Current § 1026.34(a)(4) does not address how a creditor must calculate the payment obligation for a loan that cannot meet the presumption of compliance under § 1026.34(a)(4)(iii)(B). For example, § 1026.34(a)(4) does not specify how to calculate the periodic payment required for a negative amortization loan or balloon-payment mortgage with a term of less than seven years. In contrast, the Dodd-Frank Act lays out a specific framework for underwriting any loan subject to TILA section 129C(a). In taking this approach, the statutory requirements in TILA section 129C(a)(6)(D) addressing payment calculation requirements differ from § 1026.34(a)(4)(iii) in the following manner: (1) The statute generally premises repayment ability on monthly VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 payment obligations calculated using the fully indexed rate, with no limit on the term of the loan that should be considered for such purpose; (2) the statute permits underwriting loans with balloon payments to differ depending on whether the loan’s annual percentage rate exceeds the applicable loan pricing benchmark, or meets or falls below the applicable loan pricing benchmark; and (3) the statute expressly addresses underwriting requirements for loans with interest-only payments or negative amortization. In 2006 and 2007 the Board and other Federal banking agencies addressed concerns regarding the increased risk to creditors and consumers presented by loans that permit consumers to defer repayment of principal and sometimes interest, and by adjustable-rate mortgages in the subprime market. The Interagency Supervisory Guidance stated that creditors should determine a consumer’s repayment ability using a payment amount based on the fully indexed rate, assuming a fully amortizing schedule. In addition, the 2006 Nontraditional Mortgage Guidance addressed specific considerations for negative amortization and interest-only loans. State supervisors issued parallel statements to this guidance, which most states have adopted. TILA section 129C(a)(3) and (6) is generally consistent with this longstanding Interagency Supervisory Guidance and largely extends the guidance regarding payment calculation assumptions to all loan types covered under TILA section 129C(a), regardless of a loan’s interest rate. The Board proposed § 226.43(c)(5) to implement the payment calculation requirements of TILA section 129C(a)(1), (3) and (6) for purposes of the repayment ability determination required under proposed § 226.43(c). Consistent with these statutory provisions, proposed § 226.43(c)(5) did not prohibit the creditor from offering certain credit terms or loan features, but rather focused on the calculation process the creditor would be required to use to determine whether the consumer could repay the loan according to its terms. Under the proposal, creditors generally would have been required to determine a consumer’s ability to repay a covered transaction using the fully indexed rate or the introductory rate, whichever is greater, to calculate monthly, fully amortizing payments that are substantially equal, unless a special rule applies. See proposed § 226.43(c)(5)(i). For clarity and simplicity, proposed § 226.43(c)(5)(i) used the terms ‘‘fully amortizing payment’’ and ‘‘fully PO 00000 Frm 00070 Fmt 4701 Sfmt 4700 indexed rate,’’ which were defined separately under proposed § 226.43(b)(2) and (3), respectively, as discussed above. Proposed comment 43(c)(5)(i)–1 clarified that the general rule would apply whether the covered transaction is an adjustable-, step-, or fixed-rate mortgage, as those terms are defined in § 1026.18(s)(7)(i), (ii), and (iii), respectively. Proposed § 226.43(c)(5)(ii)(A) through (C) created exceptions to the general rule and provided special rules for calculating the payment obligation for balloon-payment mortgages, interestonly loans or negative amortization loans, as follows: Balloon-payment mortgages. Consistent with TILA section 129C(a)(6)(D)(ii)(I) and (II), for covered transactions with a balloon payment, proposed § 226.43(c)(5)(ii)(A) provided special rules that differed depending on the loan’s rate. Proposed § 226.43(c)(5)(ii)(A)(1) stated that for covered transactions with a balloon payment that are not higher-priced covered transactions, the creditor must determine a consumer’s ability to repay the loan using the maximum payment scheduled in the first five years after consummation. Proposed § 226.43(c)(5)(ii)(A)(2) further stated that for covered transactions with balloon payments that are higher priced covered transactions, the creditor must determine the consumer’s ability to repay according to the loan’s payment schedule, including any balloon payment. For clarity, proposed § 226.43(c)(5)(ii)(A) used the term ‘‘higher-priced covered transaction’’ to refer to a covered transaction that exceeds the applicable higher-priced mortgage loan coverage threshold. ‘‘Higher-priced covered transaction’’ is defined in § 1026.43(b)(4), discussed above. The term ‘‘balloon payment’’ has the same meaning as in current § 1026.18(s)(5)(i). Interest-only loans. Consistent with TILA section 129C(a)(6)(B) and (D), proposed § 226.43(c)(5)(ii)(B) provided special rules for interest-only loans. Proposed § 226.43(c)(5)(ii)(B) required that the creditor determine the consumer’s ability to repay the interestonly loan using (1) the fully indexed rate or the introductory rate, whichever is greater; and (2) substantially equal, monthly payments of principal and interest that will repay the loan amount over the term of the loan remaining as of the date the loan is recast. For clarity, proposed § 226.43(c)(5)(ii)(B) used the terms ‘‘loan amount’’ and ‘‘recast,’’ which are defined and discussed under § 1026.43(b)(5) and (11), respectively. The term ‘‘interest-only loan’’ has the E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with same meaning as in current § 1026.18(s)(7)(iv). Negative amortization loans. Consistent with TILA section 129C(a)(6)(C) and (D), proposed § 226.43(c)(5)(ii)(C) provided special rules for negative amortization loans. Proposed § 226.43(c)(5)(ii)(C) required that the creditor determine the consumer’s ability to repay the negative amortization loan using (1) the fully indexed rate or the introductory rate, whichever is greater; and (2) substantially equal, monthly payments of principal and interest that will repay the maximum loan amount over the term of the loan remaining as of the date the loan is recast. Proposed comment 43(c)(5)(ii)(C)–1 clarified that for purposes of the rule, the creditor would first have to determine the maximum loan amount and the period of time that remains in the loan term after the loan is recast. For clarity, proposed § 226.43(c)(5)(ii)(C) used the terms ‘‘maximum loan amount’’ and ‘‘recast,’’ which are defined and discussed under § 1026.43(b)(7) and (11), respectively. The term ‘‘negative amortization loan’’ has the same meaning as in current § 1026.18(s)(7)(v) and comment 18(s)(7)–1. 43(c)(5)(i) General Rule Proposed § 226.43(c)(5)(i) implemented the payment calculation requirements in TILA section 129C(a)(3), 129C(6)(D)(i) through (iii), and stated the general rule for calculating the payment obligation on a covered transaction for purposes of the ability-to-repay provisions. Consistent with the statute, proposed § 226.43(c)(5)(i) provided that unless an exception applies under proposed § 226.43(c)(5)(ii), a creditor must make the repayment ability determination required under proposed § 226.43(c)(2)(iii) by using the greater of the fully indexed rate or any introductory interest rate, and monthly, fully amortizing payments that are substantially equal. That is, under the proposed general rule the creditor would calculate the consumer’s monthly payment amount based on the loan amount, and amortize that loan amount in substantially equal payments over the loan term, using the fully indexed rate. Proposed comment 43(c)(5)(i)–1 explained that the payment calculation method set forth in proposed § 226.43(c)(5)(i) applied to any covered transaction that does not have a balloon payment or that is not an interest-only loan or negative amortization loan, whether it is a fixed-rate, adjustable-rate or step-rate mortgage. This comment VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 further explained that the payment calculation method set forth in proposed § 226.43(c)(5)(ii) applied to any covered transaction that is a loan with a balloon payment, interest-only loan, or negative amortization loan. To facilitate compliance, this comment listed the defined terms used in proposed § 226.43(c)(5) and provided cross-references to their definitions. The fully indexed rate or introductory rate, whichever is greater. Proposed § 226.43(c)(5)(i)(A) implemented the requirement in TILA section 129C(a)(6)(D)(iii) to use the fully indexed rate when calculating the monthly, fully amortizing payment for purposes of the repayment ability determination. Proposed § 226.43(c)(5)(i)(A) also provided that when creditors calculate the monthly, fully amortizing payment for adjustablerate mortgages, they would have to use the introductory interest rate if it were greater than the fully indexed rate (i.e., a premium rate). In some adjustable-rate transactions, creditors may set an initial interest rate that is not determined by the index or formula used to make later interest rate adjustments. Sometimes this initial rate charged to consumers is lower than the rate would be if it were determined by using the index plus margin, or formula (i.e., the fully indexed rate). However, an initial rate that is a premium rate is higher than the rate based on the index or formula. Thus, requiring creditors to use only the fully indexed rate would result in creditors underwriting loans that have a ‘‘premium’’ introductory rate at a rate lower than the rate on which the consumer’s initial payments would be based. The Board believed that requiring creditors to assess the consumer’s ability to repay on the initial higher payments would better effectuate the statutory intent and purpose. Proposed comment 43(c)(5)(i)–2 provided guidance on using the greater of the premium or fully indexed rate. Monthly, fully amortizing payments. For simplicity, proposed § 226.43(c)(5)(i) used the term ‘‘fully amortizing payment’’ to refer to the statutory requirements that a creditor use a payment schedule that repays the loan assuming that (1) the loan proceeds are fully disbursed on the date of consummation of the loan; and (2) the loan is repaid in amortizing payments for principal and interest over the entire term of the loan. See TILA sections 129C(a)(3) and (6)(D)(i) and (ii). As discussed above, § 1026.43(b)(2) defines ‘‘fully amortizing payment’’ to mean a periodic payment of principal and interest that will fully repay the loan amount over the loan term. The terms PO 00000 Frm 00071 Fmt 4701 Sfmt 4700 6477 ‘‘loan amount’’ and ‘‘loan term’’ are defined in § 1026.43(b)(5) and (b)(6), respectively, and discussed above. The statute also expressly requires that a creditor use ‘‘monthly amortizing payments’’ for purposes of the repayment ability determination. TILA section 129C(6)(D)(ii). The Board recognized that some loan agreements require consumers to make periodic payments with less frequency, for example quarterly or semi-annually. Proposed § 226.43(c)(5)(i)(B) did not dictate the frequency of payment under the terms of the loan agreement, but did require creditors to convert the payment schedule to monthly payments to determine the consumer’s repayment ability. Proposed comment 43(c)(5)(i)–3 clarified that the general payment calculation rules do not prescribe the terms or loan features that a creditor may choose to offer or extend to a consumer, but establish the calculation method a creditor must use to determine the consumer’s repayment ability for a covered transaction. This comment explained, by way of example, that the terms of the loan agreement may require that the consumer repay the loan in quarterly or bi-weekly scheduled payments, but for purposes of the repayment ability determination, the creditor must convert these scheduled payments to monthly payments in accordance with proposed § 226.43(c)(5)(i)(B). This comment also explained that the loan agreement may not require the consumer to make fully amortizing payments, but for purposes of the repayment ability determination the creditor must convert any nonamortizing payments to fully amortizing payments. Substantially equal. Proposed comment 43(c)(5)(i)–4 provided additional guidance to creditors for determining whether monthly, fully amortizing payments are ‘‘substantially equal.’’ See TILA section 129C(a)(6)(D)(ii). This comment stated that creditors should disregard minor variations due to payment-schedule irregularities and odd periods, such as a long or short first or last payment period. The comment explained that monthly payments of principal and interest that repay the loan amount over the loan term need not be equal, but that the monthly payments should be substantially the same without significant variation in the monthly combined payments of both principal and interest. Proposed comment 43(c)(5)(i)–4 further explained that where, for example, no two monthly payments vary from each other by more than 1 percent (excluding odd periods, such as a long or short first or last E:\FR\FM\30JAR2.SGM 30JAR2 6478 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with payment period), such monthly payments would be considered substantially equal for purposes of the rule. The comment further provided that, in general, creditors should determine whether the monthly, fully amortizing payments are substantially equal based on guidance provided in current § 1026.17(c)(3) (discussing minor variations), and § 1026.17(c)(4)(i) through (iii) (discussing paymentschedule irregularities and measuring odd periods due to a long or short first period) and associated commentary. The proposal solicited comment on operational difficulties that arise by ensuring payment amounts meet the ‘‘substantially equal’’ condition. The proposal also solicited comment on whether a 1 percent variance is an appropriate tolerance threshold. Examples of payment calculations. Proposed comment § 226.43(c)(5)(i)–5 provided illustrative examples of how to determine the consumer’s repayment ability based on substantially equal, monthly, fully amortizing payments as required under proposed § 226.43(c)(5)(i) for a fixed-rate, adjustable-rate and step-rate mortgage. The Board recognized that, although consistent with the statute, the proposed framework would require creditors to underwrite certain loans, such as hybrid ARMs with a discounted rate period of five or more years (e.g., 5/1, 7/1, and 10/ 1 ARMs) to a more stringent standard as compared to the underwriting standard set forth in proposed § 226.43(e)(2)(v) for qualified mortgages.111 The Board believed this approach was consistent with the statute’s intent to ensure consumers can reasonably repay their loans, and that in both cases consumers’ interests are properly protected. See TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2). To meet the definition of a qualified mortgage, a loan cannot have certain risky terms or features, such as provisions that permit deferral of principal or a term that exceeds 30 years; no similar restrictions apply to loans subject to the ability-to-repay standard. See proposed § 226.43(e)(2)(i) and (ii). As a result, the risk of potential payment shock is diminished significantly for qualified mortgages. For this reason, the Board believed that maintaining the potentially more lenient statutory underwriting standard for loans that satisfy the qualified mortgage criteria would help to ensure that responsible and affordable credit 111 The Bureau has also determined that in many instances the fully indexed rate would result in a more lenient underwriting standard than the qualified mortgage calculation. See the discussion of non-qualified mortgage ARM underwriting below. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 remains available to consumers. See TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2). Loan amount or outstanding principal balance. As noted above, proposed § 226.43(c)(5)(i) was consistent with the statutory requirements regarding payment calculations for purposes of the repayment ability determination. The Board believed that the intent of these statutory requirements was to prevent creditors from assessing the consumer’s repayment ability based on understated payment obligations, especially when risky features can be present on the loan. However, the Board was concerned that the statute, as implemented in proposed § 226.43(c)(5)(i), would require creditors to determine, in some cases, a consumer’s repayment ability using overstated payment amounts because the creditor would have to assume that the consumer repays the loan amount in substantially equal payments based on the fully indexed rate, regardless of when the fully indexed rate could take effect under the terms of the loan. The Board was concerned that this approach might restrict credit availability, even where consumers were able to demonstrate that they can repay the payment obligation once the fully indexed rate takes effect. For this reason, the proposal solicited comment on whether authority should be exercised under TILA sections 105(a) and 129B(e) to provide that the creditor may calculate the monthly payment using the fully indexed rate based on the outstanding principal balance as of the date the fully indexed rate takes effect under the loan’s terms, instead of the loan amount at consummation. Step-rate and adjustable-rate calculations. Due to concerns regarding credit availability, the proposal also solicited comment on alternative means to calculate monthly payments for steprate and adjustable-rate mortgages. The proposal asked for comment on whether or not the rule should require that creditors underwrite a step-rate or an adjustable-rate mortgage using the maximum interest rate in the first seven or ten years or some other appropriate time horizon that would reflect a significant introductory rate period. The section-by-section analysis of the ‘‘fully indexed rate’’ definition, at § 1026.43(b)(3) above, discusses this issue in regard to step-rate mortgages. For discussion of payment calculation methods for adjustable-rate mortgages, see below. Safe harbor to facilitate compliance. The Board recognized that under its proposal, creditors would have to comply with multiple assumptions PO 00000 Frm 00072 Fmt 4701 Sfmt 4700 when calculating the particular payment for purposes of the repayment ability determination. The Board was concerned that the complexity of the proposed payment calculation requirements might increase the potential for unintentional errors to occur, making compliance difficult, especially for small creditors that might be unable to invest in advanced technology or software needed to ensure payment calculations are compliant. At the same time, the Board noted that the intent of the statutory framework and the proposal was to ensure consumers are offered and receive loans on terms that they can reasonably repay. Thus, the Board solicited comment on whether authority under TILA sections 105(a) and 129B(e) should be exercised to provide a safe harbor for creditors that use the largest scheduled payment that can occur during the loan term to determine the consumer’s ability to repay, to facilitate compliance with the requirements under proposed § 226.43(c)(5)(i) and (ii). Final Rule The final rule requires creditors to underwrite the loan at the premium rate if greater than the fully indexed rate for purposes of the repayment ability determination using the authority under TILA section 105(a). 15 U.S.C. 1604(a). TILA section 105(a), as amended by section 1100A of the Dodd-Frank Act, provides that the Bureau’s regulations may contain such additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions as in the Bureau’s judgment are necessary or proper to effectuate the purposes of TILA, prevent circumvention or evasion thereof, or facilitate compliance therewith. 15 U.S.C. 1604(a). This approach is further supported by the authority under TILA section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Bureau finds necessary and proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with and which effectuates the purposes of sections 129B and 129C, and which are in the interest of the consumer. 15 U.S.C. 1639b(e). The purposes of TILA include the purpose of TILA sections 129B and 129C, to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loan, among other things. TILA section 129B(b), 15 U.S.C. 1639b. For the reasons discussed above, the Bureau believes that E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations requiring creditors to underwrite the loan to the premium rate for purposes of the repayment ability determination is necessary and proper to ensure that consumers are offered, and receive, loans on terms that reasonably reflect their ability to repay, and to prevent circumvention or evasion. Without a requirement to consider payments based on a premium rate, a creditor could originate loans with introductory-period payments that consumers do not have the ability to repay. Therefore, this provision is also in the interest of consumers. As discussed above, the Board solicited comment on whether payments for non-qualified mortgage ARMs should be calculated similarly to qualified mortgage ARMs, by using the maximum rate that will apply during a certain period, such as the first seven years or some other appropriate time horizon. Consumer and community groups were divided on this issue. Some supported use of the fully indexed rate, but one stated that underwriting ARMs based on the initial period of at least five years may be appropriate. Another suggested that for non-qualified mortgage ARMs the rule should require use of the maximum interest rate or interest rate cap, whichever is greater, to better protect against payment shock. A civil rights organization also advocated that ARMs that are not qualified mortgages should be underwritten to several points above the fully indexed rate. A combined comment from consumer advocacy organizations also supported non-qualified mortgage ARMs being underwritten more strictly, suggesting that because this is the market segment that will have the fewest controls, the predatory practices will migrate here, and there is significant danger of payment shock when using the fully indexed rate in a low-rate environment such as today’s market. They suggested that the rule follow Fannie Mae’s method, which requires underwriting that uses the fully indexed rate or the note rate plus 2 percent, whichever is greater, for ARMs with initial fixed periods of up to five years. In addition, one joint industry and consumer advocacy comment suggested adding 2 percent to the fully indexed rate in order to calculate the monthly payment amount. Industry groups were strongly in favor of using a specific time period for underwriting, generally suggesting five years. One credit union association stated that use of the fully indexed rate is excessive and unnecessary, and will increase the cost of credit. Industry commenters stated that creditors generally consider only the fixed-rate VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 period, and ARMs with fixed periods of at least five years are considered safe. One large bank stated that the calculation for ARMs, whether or not they are qualified mortgages, should be uniform to ease compliance. The Bureau has determined that it will not use its exception and adjustment authority to change the statutory underwriting scheme for nonqualified mortgage ARMs. The statutory scheme clearly differentiates between the qualified mortgage and nonqualified mortgage underwriting strategies. The qualified mortgage underwriting rules ignore any adjustment in interest rate that may occur after the first five years; thus, for example, for an ARM with an initial adjustment period of seven years, the interest rate used for the qualified mortgage calculation will be the initial interest rate. In addition, the qualified mortgage rules, by using the ‘‘maximum interest rate,’’ take into account any adjustment in interest rate that can occur during the first five years, including adjustments attributable to changes in the index rate. In contrast, the non-qualified mortgage rules have an unlimited time horizon but do not take into account adjustments attributable to changes in the index rate. Based on the its research and analysis, the Bureau notes that the data indicate that neither the fully indexed rate nor the maximum rate during a defined underwriting period produces consistent results with regard to abilityto-repay calculations. The Bureau finds that the underwriting outcomes under the two methods vary depending on a number of complex variables, such as the terms of the loan (e.g., the length of the initial adjustment period and interest rate caps) and the interest rate environment. In other words, for a particular loan, whether the monthly payment may be higher under a calculation that uses the fully indexed rate, as opposed to the maximum rate in the first five years, depends on a number of factors. Given the factspecific nature of the payment calculation outcomes, the Bureau believes that overriding the statutory scheme would be inappropriate. The Bureau also believes that adjusting the interest rate to be used for non-qualified mortgage ability-to-repay calculations to somewhere between the fully indexed rate specified in the statute and the maximum interest rate mandated for qualified mortgage underwriting; for example through an adjustment to the fully indexed rate of an additional 2 percent, would be inappropriate. The fully indexed rate had been in use since it was adopted by PO 00000 Frm 00073 Fmt 4701 Sfmt 4700 6479 the Interagency Supervisory Guidance in 2006, and Congress was likely relying on that experience in crafting the statutory scheme. Adding to the fully indexed rate would potentially reduce the availability of credit. Such an adjustment also could result in a calculated interest rate and monthly payment that are higher than the interest rate and payment calculated for qualified mortgage underwriting, given that the qualified mortgage rules look only to potential adjustments during the first five years. The Bureau recognizes that underwriting practices today often take into account potential adjustments in an ARM that can result from increases in the index rate. For example, Fannie Mae requires underwriting that uses the fully indexed rate or the note rate plus 2 percent, whichever is greater, for ARMs with initial fixed periods of up to five years. The Bureau notes that underwriters have the flexibility to adjust their practices in response to changing interest rate environments whereas the process an administrative agency like the Bureau must follow to amend a rule is more time consuming. The Bureau also notes that the creditor must make a reasonable determination that the consumer has the ability to repay the loan according to its terms. Therefore, in situations where there is a significant likelihood that the consumer will face an adjustment that will take the interest rate above the fully indexed rate, a creditor whose debt-to-income or residual income calculation indicates that a consumer cannot afford to absorb any such increase may not have a reasonable belief in the consumer’s ability to repay the loan according to its terms. See comment 43(c)(1)–1. Although the Bureau has determined to implement the statutory scheme as written and require use of the fully indexed rate for non-qualified mortgage ARMs, it will monitor this issue through its mandatory five-year review, and may make adjustments as necessary. As discussed above, the Board also solicited comment on whether or not to allow the fully indexed rate to be applied to the balance projected to be remaining when the fully indexed rate goes into effect, instead of the full loan amount, and thus give a potentially more accurate figure for the maximum payment that would be required for purposes of determining ability to repay. A consumer group and a group advocating for financial reform supported this possibility, saying that allowing lenders to apply the fully indexed rate to the balance remaining when the rate changes, rather than the full loan amount, will encourage longer E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6480 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations fixed-rate periods and safer lending, as well as preserve access to credit. An association representing credit unions also agreed with the possible amendment, stating that the new method would yield a more accurate measure of the maximum payment that could be owed. The Bureau believes it is appropriate for the final rule to remain consistent with the statutory scheme. The Bureau believes that changing the calculation method, required by the statute,112 would not be an appropriate use of its exception and adjustment authority. The Bureau believes the potentially stricter underwriting method of calculating the monthly payment by applying the imputed (i.e., fully indexed) interest rate to the full loan amount for non-qualified mortgage ARMs, provides greater assurance of the ability to repay. In addition, payment calculation using the fully indexed rate can only approximate the consumer’s payments after recast, since the index may have increased significantly by then. Accordingly, the Bureau believes that requiring the use of the full loan amount will reduce the potential inaccuracy of the ability-to-repay determination in such a situation. In addition, the Board solicited comment on whether to provide a safe harbor for any creditor that underwrites using the ‘‘largest scheduled payment that can occur during the loan term.’’ To provide such a safe harbor the Bureau would have to employ its exception and adjustment authority because the use of the fully indexed rate calculation is required by TILA section 129C(a)(6)(D)(iii). Two industry commenters and an association of state bank regulators supported this exemption, but none of them provided a developed rationale for their support or included information useful in assessing the possible exemption. The Bureau does not believe that it would be appropriate at this time to alter the statutory scheme in this manner. As discussed above, the Board also solicited comment on how to lessen any operational difficulties of ensuring that payment amounts meet the ‘‘substantially equal’’ condition, and whether or not allowing a one percent variance between payments provided an appropriate threshold. Only two commenters mentioned this issue. One industry commenter stated that the 1 percent threshold was appropriate, but an association of state bank regulators 112 ‘‘A creditor shall determine the ability of the consumer to repay using a payment schedule that fully amortizes the loan over the loan term.’’ TILA § 129C(a)(3). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 believed that a 5 percent threshold would work better. Because the 1 percent threshold appears to be sufficient to allow for payment variance and industry commenters did not express a need for a higher threshold, the Bureau does not believe that the provision should be amended. For the reasons stated above, the Bureau is adopting § 1026.43(c)(5)(i) and associated commentary substantially as proposed, with minor clarifying revisions. 43(c)(5)(ii) Special Rules for Loans With a Balloon Payment, Interest-Only Loans, and Negative Amortization Loans Proposed § 226.43(c)(5)(ii) created exceptions to the general rule under proposed § 226.43(c)(5)(i), and provided special rules in proposed § 226.43(c)(5)(ii)(A) through (C) for loans with a balloon payment, interestonly loans, and negative amortization loans, respectively, for purposes of the repayment ability determination required under proposed § 226.43(c)(2)(iii). In addition to TILA section 129C(a)(6)(D)(i) through (iii), proposed § 226.43(c)(5)(ii)(A) through (C) implemented TILA sections 129C(a)(6)(B) and (C), and TILA section 129C(a)(6)(D)(ii)(I) and (II). Each of these proposed special rules is discussed below. 43(c)(5)(ii)(A) Implementing the different payment calculation methods in TILA section 129C(a)(6)(D)(ii), the Board proposed different rules for balloon-payment mortgages that are higher-priced covered transactions and those that are not, in § 1026.43(c)(5)(ii)(A)(1) and (2). Proposed comment 43(c)(5)(ii)(A)–1 provided guidance on applying these two methods. This guidance is adopted as proposed with minor changes for clarity and to update a citation. The language describing the calculation method for balloon-payment mortgages that are not higher-priced covered transactions has been changed to reflect the use of the first regular payment due date as the start of the relevant five-year period. Pursuant to the Bureau’s rulewriting authority under TILA section 129C(a)(6)(D)(ii)(I), this change has been made to facilitate compliance through consistency with the amended underwriting method for qualified mortgages. See the section-by-section analysis of § 1026.43(e)(2)(iv)(A). As with the recast on five-year adjustablerate qualified mortgages, the Bureau believes that consumers will benefit from having a balloon payment moved to at least five years after the first PO 00000 Frm 00074 Fmt 4701 Sfmt 4700 regular payment due date, rather than five years after consummation. 43(c)(5)(ii)(A)(1) The statute provides an exception from the general payment calculation discussed above for loans that require ‘‘more rapid repayment (including balloon payment).’’ See TILA section 129C(a)(6)(D)(ii)(I) and (II). For balloonpayment loans that are not higherpriced covered transactions (as determined by using the margins above APOR in TILA section 129C(a)(6)(D)(ii)(I) and implemented at § 1026.43(b)(4)), the statute provides that the payment calculation will be determined by regulation. The Board proposed that a creditor be required to make the repayment determination under proposed § 226.43(c)(2)(iii) for ‘‘[t]he maximum payment scheduled during the first five years after consummation * * *’’ The Board chose a five-year period in order to preserve access to affordable short-term credit, and because five years was considered an adequate period for a consumer’s finances to improve sufficiently to afford a fully amortizing loan. The Board believed that balloonpayment loans of less than five years presented more risk of inability to repay. The Board also believed that the five-year period would facilitate compliance and create a level playing field because of its uniformity with the general qualified mortgage provision (see § 1026.43(e)), and balloon-payment qualified mortgage provision (see § 1026.43(f)). The Board solicited comment on whether the five-year horizon was appropriate. Proposed comment § 226.43(c)(5)(ii)(A)–2 provided further guidance to creditors on determining whether a balloon payment occurs in the first five years after consummation. Proposed comment 43(c)(5)(ii)(A)–3 addressed renewable balloon-payment loans. This comment discussed balloon-payment loans that are not higher-priced covered transactions which provide an unconditional obligation to renew a balloon-payment loan at the consumer’s option or obligation to renew subject to conditions within the consumer’s control. This comment clarified that for purposes of the repayment ability determination, the loan term does not include the period of time that could result from a renewal provision. The Board recognized that proposed comment 43(c)(5)(ii)(A)–3 did not take the same approach as guidance contained in comment 17(c)(1)–11 regarding treatment of renewable balloon-payment loans for disclosure purposes, or with guidance contained in E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations current comment 34(a)(4)(iv)–2 of the Board’s 2008 HOEPA Final Rule. Although the proposal differed from current guidance in Regulation Z, the Board believed this approach was appropriate for several reasons. First, the ability-to-repay provisions in the Dodd-Frank Act do not address extending the term of a balloon-payment loan with an unconditional obligation to renew provision. Second, permitting short-term ‘‘prime’’ balloon-payment loans to benefit from the special payment calculation rule when a creditor includes an unconditional obligation to renew, but retains the right to increase the interest rate at the time of renewal, would create a significant loophole in the balloon payment rules. Such an approach could frustrate the objective to ensure consumers obtain mortgages on affordable terms for a reasonable period of time because the interest rate could escalate within a short period of time, increasing the potential risk of payment shock to the consumer. This is particularly the case where no limits exist on the interest rate that the creditor can choose to offer to the consumer at the time of renewal. See TILA Section 129B(a)(2), 15 U.S.C. 1639b(a)(2), and TILA Section 129C(b)(2)(A)(v). Moreover, the Board believed it would be speculative to posit the interest rate at the time of renewal for purposes of the repayment ability determination. Third, the guidance contained in comment 17(c)(1)–11 regarding treatment of renewable balloon-payment loans is meant to help ensure consumers are aware of their loan terms and avoid the uninformed use of credit, which differs from the stated purpose of this proposed provision, which was to help ensure that consumers receive loans on terms that reasonably reflect their repayment ability. TILA section 102(a), 15 U.S.C. 1601(a)(2), and TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2). Proposed comment 43(c)(5)(ii)(A)–4 provided several illustrative examples of how to determine the maximum payment scheduled during the first five years after consummation for loans with a balloon payment that are not higherpriced covered transactions. In regard to the proposed five-year underwriting period, some commenters suggested that the payment period considered should be increased to ten years, stating that balloon-payment loans were repeatedly used in an abusive manner during the years of heavy subprime lending. The combined consumer advocacy organizations’ comment stated that the five-year underwriting might lead to an increase in five-year balloon-payment loans, VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 which would be bad for sustainable lending. On the other hand, a trade association representing credit unions supported the five-year rule. One industry commenter objected to the whole balloon underwriting scheme, including the five-year rule, apparently preferring something less. For the reasons discussed by the Board in the proposal, and described above, the Bureau has determined that five years is an appropriate time frame for determining the ability to repay on balloon-payment mortgages that are not higher-priced covered transactions. However, for the sake of uniformity and ease of compliance with the qualified mortgage calculation and ability-torepay calculation for non-qualified mortgage adjustable-rate mortgages, the proposed provision has been changed to state that the five years will be measured from the date of the first regularly scheduled payment, rather than the date of consummation. The Bureau has made this determination pursuant to the authority granted by TILA section 129C(a)(6)(D)(ii)(I) to prescribe regulations for calculating payments to determine consumers’ ability to repay balloon-payment mortgages that are not higher-cost covered transactions. TILA section 129C(a)(6)(D)(ii)) refers to loans requiring ‘‘more rapid repayment (including balloon payment).’’ The Board solicited comment about whether this statutory language should be read as referring to loan types other than balloon-payment loans. The Bureau did not receive comments on this matter, and has determined that the rule language does not need to be amended to include other types of ‘‘rapid repayment’’ loans at this time. The Board also solicited comment about balloon-payment loans that have an unconditional obligation to renew. The Board asked whether or not such loans should be allowed to comply with the ability-to-repay requirements using the total of the mandatory renewal terms, instead of just the first term. As discussed above, proposed comment 43(c)(5)(ii)(A)–3 made clear that this would not be allowed under the rule as proposed. The Board also solicited comment on any required conditions that the renewal obligation should have, if such an amendment were made. However, the Bureau did not receive comments on this matter, and the provision and staff comment are adopted as proposed. A creditor making any non-higher-priced balloon-payment mortgage of less than five years with a clear obligation to renew can avoid having the ability-to-repay PO 00000 Frm 00075 Fmt 4701 Sfmt 4700 6481 determination applied to the balloon payment by including the renewal period in the loan term so that the balloon payment occurs after five years. Accordingly, the Bureau is adopting § 1026.43(c)(5)(ii)(A)(1) and associated commentary substantially as proposed, with minor changes for clarification, as well as new language to reflect that the five-year underwriting period begins with the due date of the first payment, as discussed above. In addition, the Bureau has added a second example to comment 43(c)(5)(ii)(A)–2 to demonstrate the effect of the change to the beginning of the underwriting period. 43(c)(5)(ii)(A)(2) Proposed § 226.43(c)(5)(ii)(A)(2) implemented TILA section 129C(a)(6)(D)(ii)(II) and provided that for a higher-priced covered transaction, the creditor must determine the consumer’s ability to repay a loan with a balloon payment using the scheduled payments required under the terms of the loan, including any balloon payment. TILA section 129C(a)(6)(D)(ii)(II) states that for loans that require ‘‘more rapid repayment 113 (including balloon payment),’’ and which exceed the loan pricing threshold set forth, the creditor must underwrite the loan using the ‘‘[loan] contract’s repayment schedule.’’ For purposes of proposed § 226.43(c)(5)(i)(A), ‘‘higherpriced covered transaction’’ means a covered transaction with an annual percentage rate that exceeds the average prime offer rate for a comparable transaction as of the date the interest rate is set by 1.5 or more percentage points for a first-lien covered transaction, or by 3.5 or more percentage points for a subordinate-lien covered transaction. See § 1026.43(b)(4). The proposed rule interpreted the statutory requirement that the creditor use the loan contract’s payment schedule to mean that the creditor must use all scheduled payments under the terms of the loan needed to fully amortize the loan, consistent with the requirement under TILA section 129C(a)(3). Payment of the balloon, either at maturity or during any intermittent period, is necessary to fully amortize the loan, and so a consumer’s ability to pay the balloon payment would need to be considered. Proposed comment 43(c)(5)(ii)(A)–5 provided an illustrative example of how to determine the consumer’s repayment ability based on the loan contract’s payment schedule, including any 113 See the previous section, .43(c)(5)(ii)(A)(1), for discussion of this statutory language. E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6482 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations balloon payment. The proposed rule applied to ‘‘non-prime’’ loans with a balloon payment regardless of the length of the term or any contract provision that provides for an unconditional guarantee to renew. In making this proposal, the Board expressed concern that this approach could lessen credit choice for non-prime consumers and solicited comment, with supporting data, on the impact of this approach for low-to-moderate income consumers. In addition, the Board asked for comment on whether or not a consumer’s ability to refinance out of a balloon-payment loan should be considered in determining ability to repay. Industry commenters who focused on this provision opposed applying the ability-to-repay determination to the entire payment schedule. Two trade associations representing small and mid-size banks strongly objected to including the balloon payment in the underwriting, and one stated that many of the loans its members currently make would fall into the higher-priced category, making these loans unavailable. However, the statutory scheme for including the balloon payment was supported by a state housing agency and the combined consumer protection advocacy organizations submitting joint comments. None of the commenters submitted data supporting the importance of higher-priced balloon-payment mortgages for credit availability, or whether consideration of a consumer’s ability to obtain refinancing would make the ability-to-repay determination less significant in this context. The Bureau notes that under § 1026.43(f) a balloon-payment mortgage that is a higher-priced covered transaction made by certain creditors in rural or underserved areas may also be a qualified mortgage and thus the creditor would not have to consider the consumer’s ability to repay the balloon payment. Because this final rule adopts a wider definition of ‘‘rural or underserved area’’ than the Board proposed, potential credit accessibility concerns have been lessened. See the section-by-section analysis of § 1026.43(f), below. The statute requires the consideration of the balloon payment for higher-priced covered transactions, and the Bureau does not believe that using its exception and adjustment authority would be appropriate for this issue. Accordingly, § 1026.43(c)(5)(ii)(A)(2) and associated commentary are adopted substantially as proposed, with minor changes for clarification. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 43(c)(5)(ii)(B) The Board’s proposed § 226.43(c)(5)(ii)(B) implemented TILA section 129C(a)(6)(B), which requires that the creditor determine the consumer’s repayment ability using ‘‘the payment amount required to amortize the loan by its final maturity.’’ For clarity, the proposed rule used the term ‘‘recast,’’ which is defined for interestonly loans as the expiration of the period during which interest-only payments are permitted under the terms of the legal obligation. See § 1026.43(b)(11). The statute does not define the term ‘‘interest-only.’’ For purposes of this rule, the terms ‘‘interest-only loan’’ and ‘‘interest-only’’ have the same meaning as in § 1026.18(s)(7)(iv). For interest-only loans (i.e., loans that permit interest only payments for any part of the loan term), proposed § 226.43(c)(5)(ii)(B) provided that the creditor must determine the consumer’s ability to repay the interest-only loan using (1) the fully indexed rate or any introductory rate, whichever is greater; and (2) substantially equal, monthly payments of principal and interest that will repay the loan amount over the term of the loan remaining as of the date the loan is recast. The proposed payment calculation rule for interestonly loans paralleled the general rule proposed in § 226.43(c)(5)(i), except that proposed § 226.43(c)(5)(ii)(B)(2) required a creditor to determine the consumer’s ability to repay the loan amount over the term that remains after the loan is recast, rather than requiring the creditor to use fully amortizing payments, as defined under proposed § 226.43(b)(2). The Board interpreted the statutory text in TILA section 129C(a)(6)(B) as requiring the creditor to determine the consumer’s ability to repay an interestonly loan using the monthly principal and interest payment amount needed to repay the loan amount once the interestonly payment period expires, rather than using, for example, an understated monthly principal and interest payment that would amortize the loan over its entire term, similar to a 30-year fixed mortgage. The proposed rule would apply to all interest-only loans, regardless of the length of the interestonly period. The Board believed this approach most accurately assessed the consumer’s ability to repay the loan once it begins to amortize; this is consistent with the approach taken for interest-only loans in the 2006 Nontraditional Mortgage Guidance. Proposed comment 43(c)(5)(ii)(B)–1 provided guidance on the monthly PO 00000 Frm 00076 Fmt 4701 Sfmt 4700 payment calculation for interest-only loans, and clarified that the relevant term of the loan for calculating these payments is the period of time that remains after the loan is recast. This comment also explained that for a loan on which only interest and no principal has been paid, the loan amount will be the outstanding principal balance at the time of the recast. Proposed comment 43(c)(5)(ii)(B)–2 provided illustrative examples for how to determine the consumer’s repayment ability based on substantially equal monthly payments of principal and interest for interest-only loans. Commenters did not focus on the calculation for interest-only loans. The Bureau considers the Board’s interpretation and implementation of the statute to be accurate and appropriate. Accordingly, § 1026.43(c)(5)(ii)(B) and associated commentary are adopted as proposed. 43(c)(5)(ii)(C) Proposed § 226.43(c)(5)(ii)(C) implemented the statutory requirement in TILA section 129C(a)(6)(C) that the creditor consider ‘‘any balance increase that may accrue from any negative amortization provision when making the repayment ability determination.’’ The statute does not define the term ‘‘negative amortization.’’ For such loans, proposed § 226.43(c)(5)(ii)(C) provided that a creditor must determine the consumer’s repayment ability using (1) the fully indexed rate or any introductory interest rate, whichever is greater; and (2) substantially equal, monthly payments of principal and interest that will repay the maximum loan amount over the term of the loan remaining as of the date the loan is recast. The proposed payment calculation rule for negative amortization loans paralleled the general rule in proposed § 226.43(c)(5)(i), except that proposed § 226.43(c)(5)(ii)(C)(2) required the creditor to use the monthly payment amount that repays the maximum loan amount over the term of the loan that remains after the loan is recast, rather than requiring the creditor to use fully amortizing payments, as defined under § 1026.43(b)(2). The proposed rule used the terms ‘‘maximum loan amount’’ and ‘‘recast,’’ which are defined and discussed at § 1026.43(b)(7) and (b)(11), respectively. The Board proposed that the term ‘‘negative amortization loan’’ have the same meaning as set forth in § 226.18(s)(7)(v), which provided that the term ‘‘negative amortization loan’’ means a loan, other than a reverse mortgage subject to § 226.33, that E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with provides for a minimum periodic payment that covers only a portion of the accrued interest, resulting in negative amortization. As defined, the term ‘‘negative amortization loan’’ does not cover other loan types that may have a negative amortization feature, but which do not permit the consumer multiple payment options, such as seasonal income loans. Accordingly, proposed § 226.43(c)(5)(ii)(C) covered only loan products that permit or require minimum periodic payments, such as payment-option loans and graduated payment mortgages with negative amortization.114 The Board believed that covering these types of loans in proposed § 226.43(c)(5)(ii)(C) was consistent with statutory intent to account for the negative equity that can occur when a consumer makes payments that defer some or all principal or interest for a period of time, and to address the impact that any potential payment shock might have on the consumer’s ability to repay the loan. See TILA section 129C(a)(6)(C). In contrast, in a transaction such as a seasonal loan that has a negative amortization feature, but which does not provide for minimum periodic payments that permit deferral of some or all principal, the consumer repays the loan with fully amortizing payments in accordance with the payment schedule. Accordingly, the same potential for payment shock due to accumulating negative amortization does not exist. These loans with a negative amortization feature are therefore not covered by the proposed term ‘‘negative amortization loan,’’ and would not be subject to the special payment calculation requirements for negative amortization loans at proposed § 226.43(c)(5)(ii)(C). For purposes of determining the consumer’s ability to repay a negative amortization loan under proposed § 226.43(c)(5)(ii)(C), creditors would be required to make a two-step payment calculation. Step one: maximum loan amount. Proposed § 226.43(c)(5)(ii)(C) would have required that the creditor first determine the maximum loan amount and period of time that remains in the loan term after the loan is recast before determining the consumer’s repayment ability on the loan. See comment 43(c)(5)(ii)(C)–1; see also proposed § 226.43(b)(11), which defined the term ‘‘recast’’ to mean the expiration of the 114 Graduated payment mortgages that have negative amortization and fall within the definition of ‘‘negative amortization loans’’ provide for step payments that may be less than the interest accrued for a fixed period of time. The unpaid interest is added to the principal balance of the loan. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 period during which negatively amortizing payments are permitted under the terms of the legal obligation. Proposed comment 43(c)(5)(ii)(C)–2 further clarified that recast for a negative amortization loan occurs after the maximum loan amount is reached (i.e., the negative amortization cap) or the introductory minimum periodic payment period expires. As discussed above, § 1026.43(b)(7) defines ‘‘maximum loan amount’’ as the loan amount plus any increase in principal balance that results from negative amortization, as defined in § 1026.18(s)(7)(v), based on the terms of the legal obligation. Under the proposal, creditors would make the following two assumptions when determining the maximum loan amount: (1) The consumer makes only the minimum periodic payments for the maximum possible time, until the consumer must begin making fully amortizing payments; and (2) the maximum interest rate is reached at the earliest possible time. As discussed above under the proposed definition of ‘‘maximum loan amount,’’ the Board interpreted the statutory language in TILA section 129C(a)(6)(C) as requiring creditors to fully account for any potential increase in the loan amount that might result under the loan’s terms where the consumer makes only the minimum periodic payments required. The Board believed the intent of this statutory provision was to help ensure that the creditor consider the consumer’s capacity to absorb the increased payment amounts that would be needed to amortize the larger loan amount once the loan is recast. The Board recognized that the approach taken towards calculating the maximum loan amount requires creditors to assume a ‘‘worstcase scenario,’’ but believed this approach was consistent with statutory intent to take into account the greatest potential increase in the principal balance. Moreover, the Board noted that calculating the maximum loan amount based on these assumptions is consistent with the approach in the 2010 MDIA Interim Final Rule,115 which addresses disclosure requirements for negative amortization loans, and also the 2006 Nontraditional Mortgage Guidance, which provides guidance to creditors regarding underwriting negative amortization loans.116 115 See 12 CFR 1026.18(s)(2)(ii) and comment 18(s)(2)(ii)–2. 116 See 2006 Nontraditional Mortgage Guidance, at 58614, n.7. PO 00000 Frm 00077 Fmt 4701 Sfmt 4700 6483 Step two: payment calculation. Once the creditor knows the maximum loan amount and period of time that remains after the loan is recast, the proposed payment calculation rule for negative amortization loans would require the creditor to use the fully indexed rate or introductory rate, whichever is greater, to calculate the substantially equal, monthly payment amount that will repay the maximum loan amount over the term of the loan that remains as of the date the loan is recast. See proposed § 226.43(c)(5)(ii)(C)(1) and (2). Proposed comment 43(c)(5)(ii)(C)–1 clarified that creditors must follow this two-step approach when determining the consumer’s repayment ability on a negative amortization loan, and also provided cross-references to aid compliance. Proposed comment 43(c)(5)(ii)(C)–2 provided further guidance to creditors regarding the relevant term of the loan that must be used for purposes of the repayment ability determination. Proposed comment 43(c)(5)(ii)(C)–3 provided illustrative examples of how to determine the consumer’s repayment ability based on substantially equal monthly payments of principal and interest as required under proposed § 226.43(c)(5)(ii)(C) for a negative amortization loan. In discussing the ability-to-repay requirements for negative amortization loans, the Board noted the anomaly that a graduated payment mortgage may have a largest scheduled payment that is larger than the payment calculated under proposed § 226.43(c)(5)(ii)(C). The Board solicited comment on whether or not the largest scheduled payment should be used in determining ability to repay. The Bureau received one comment on this issue, from an association of State bank regulators, arguing that the rule should use the largest payment scheduled. However, the Bureau does not believe that a special rule for graduated payment mortgages, which would require an exception from the statute, is necessary to ensure ability to repay these loans. It is unlikely that the calculated payment will be very different from the largest scheduled payment, and introducing this added complexity to the rule is unnecessary. Also, the one comment favoring such a choice did not include sufficient data to support use of the exception and adjustment authority under TILA, and the Bureau is not aware any such data. Final Rule The Bureau did not receive comments on the proposed method for calculating payments for negative amortization E:\FR\FM\30JAR2.SGM 30JAR2 6484 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations loans. The Bureau believes that the method proposed by the Board implements the statutory provision accurately and appropriately. Accordingly, § 1026.43(c)(5)(ii)(C) and associated commentary are adopted substantially as proposed, with minor changes for clarification. 43(c)(6) Payment Calculation for Simultaneous Loans 43(c)(6)(i) The Board’s proposed rule provided that for purposes of determining a consumer’s ability to repay a loan, ‘‘a creditor must consider a consumer’s payment on a simultaneous loan that is—(i) a covered transaction, by following paragraphs (c)(5)(i) and (ii) of this section’’ (i.e., the payment calculation rules for the covered transaction itself). Proposed comment 43(c)(6)–1 stated that in determining the consumer’s repayment ability for a covered transaction, the creditor must include consideration of any simultaneous loan which it knows or has reason to know will be made at or before consummation of the covered transaction. Proposed comment 43(c)(6)–2 explained that for a simultaneous loan that is a covered transaction, as that term was defined in proposed § 226.43(b)(1), the creditor must determine a consumer’s ability to repay the monthly payment obligation for a simultaneous loan as set forth in proposed § 226.43(c)(5), taking into account any mortgage-related obligations. The Bureau did not receive comments on this specific language or the use of the covered transaction payment calculation for simultaneous loans. For discussion of other issues regarding simultaneous loans, see the section-bysection analysis of § 1026.43(b)(12), .43(c)(2)(iv) and .43(c)(6)(ii). The Bureau considers the language of proposed§ 226.43(c)(6)(i) to be an accurate and appropriate implementation of the statute. Accordingly, the Bureau is adopting § 1026.43(c)(6)(i) and associated commentary substantially as proposed, with minor changes for clarity. The requirement to consider any mortgagerelated obligations, presented in comment 43(c)(6)–2, is now also part of the regulatory text, at § 1026.43(c)(6). sroberts on DSK5SPTVN1PROD with 43(c)(6)(ii) For a simultaneous loan that is a HELOC, the consumer is generally not committed to using the entire credit line at consummation. The amount of funds drawn on a simultaneous HELOC may differ greatly depending, for example, VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 on whether the HELOC is used as a ‘‘piggyback loan’’ to help towards payment on a home purchase transaction or if the HELOC is opened for convenience to be drawn down at a future time. In the proposed rule, the Board was concerned that requiring the creditor to underwrite a simultaneous HELOC assuming a full draw on the credit line might unduly restrict credit access, especially in connection with non-purchase transactions, because it would require creditors to assess the consumer’s repayment ability using potentially overstated payment amounts. For this reason, the Board proposed under § 226.43(c)(6)(ii) that the creditor calculate the payment for the simultaneous HELOC based on the amount of funds to be drawn by the consumer at consummation of the covered transaction. The Board solicited comment on whether this approach was appropriate. Proposed comment 43(c)(6)–3 clarified that for a simultaneous loan that is a HELOC, the creditor must consider the periodic payment required under the terms of the plan when assessing the consumer’s ability to repay the covered transaction secured by the same dwelling as the simultaneous loan. This comment explained that under proposed § 226.43(c)(6)(ii), the creditor must determine the periodic payment required under the terms of the plan by considering the actual amount of credit to be drawn by the consumer at or before consummation of the covered transaction. This comment clarified that the amount to be drawn is the amount requested by the consumer; when the amount requested will be disbursed, or actual receipt of funds, is not determinative. Several industry commenters objected that it is difficult to know the actual amount drawn on a HELOC if it is held by another lender. One commenter suggested finding another way to do this calculation, such as by adding 1 percent of the full HELOC line to the overall monthly payment. Two banking trade associations said that the full line of credit should be considered, and if the consumer does not qualify, the line of credit can be reduced in order to qualify safely. One bank stated that creditors regulated by Federal banking agencies are bound by the interagency ‘‘Credit Risk Guidance for Home Equity Lending’’ (2005) to consider the full line of credit, and this will create an uneven playing field. Other industry commenters supported use of the actual amount drawn at consummation. Both Freddie Mac and Fannie Mae stated that the Board’s proposal for considering the actual PO 00000 Frm 00078 Fmt 4701 Sfmt 4700 amount drawn at closing was consistent with their underwriting standards. In addition, an association representing one state’s credit unions stated that requiring consideration of a 100 percent draw would be onerous and inaccurate. It also asked that we make clear that the creditor does not have to recalculate a consumer’s ability to repay if the amount drawn changes at consummation. The Bureau believes that requiring consideration of 100 percent of a home equity line of credit would unnecessarily restrict credit availability for consumers. Available but unaccessed credit is not considered in determining ability to repay a mortgage when the consumer has other types of credit lines, such as credit cards. Although HELOCs are secured by the consumer’s dwelling, and thus differ from other types of available but unaccessed credit, this difference does not seem determinative. Any potential dwelling-secured home equity line of credit that a creditor might grant to a consumer could simply be requested by the consumer immediately following consummation of the covered transaction. The fact that the potential credit line has been identified and enumerated prior to the transaction, rather than after, does not seem significant compared to the fact that the consumer has chosen not to access that credit, and will not be making payments on it. As with the rest of the ability-torepay requirements, creditors should apply appropriate underwriting procedures, and are not restricted to the legally mandated minimum required by this rule, as long as they satisfy that minimum. The requirements of the 2005 ‘‘Credit Risk Guidance for Home Equity Lending’’ do not change the Bureau’s view of this issue. The Guidance covers home equity lending itself, not consideration of HELOCs as simultaneous loans when determining ability to repay for senior non-HELOCs. The requirement to consider the entire home equity line of credit controls only a bank’s granting of that line of credit. For this reason, the Bureau does not believe that banks following this guidance will be disadvantaged. In addition, the Bureau will not be implementing the suggested alternative of adding 1 percent to the calculated monthly payment on the covered transaction. The Bureau is not aware of any data supporting the accuracy of such an approach. In regard to the comments concerning difficulty in determining the amount of the draw and the monthly HELOC payment, the Bureau as discussed above E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations in the section-by-section analysis of § 1026.43(c)(2)(iv) has added language to comment 43(c)(2)(iv)–4 providing more specific guidance in applying the knows or has reason to know standard. In addition, language has been added to comment 43(c)(6)–3, regarding payment calculations for simultaneous HELOCs, making clear that a creditor does not need to reconsider ability to repay if the consumer unexpectedly draws more money than planned at closing from a HELOC issued by a different creditor. In addition, the regulation language has been clarified to state that the creditor must use the amount of credit ‘‘to be’’ drawn at consummation, making clear that a violation does not occur if the creditor did not know or have reason to know that a different amount would be drawn. The Board also solicited comment on whether or not a safe harbor should be given to those creditors who consider the full HELOC credit line. However, commenters did not focus on this possibility. The Bureau believes that although a creditor may choose to underwrite using the full credit line as a means of considering ability to repay in relation to the actual draw, a safe harbor is not warranted. Because the full credit line should always be equal to or greater than the actual draw, appropriate use of the full credit line in underwriting will constitute appropriate compliance without a safe harbor. In addition to the amount of a HELOC that needs to be considered in determining ability to repay, the Board also solicited comment on whether the treatment of HELOCs as simultaneous loans should be limited to purchase transactions. The Board suggested that concerns regarding ‘‘piggyback loans’’ were not as acute with non-purchase transactions. Consumer and public interest groups opposed limiting the consideration of HELOCs to purchase transactions. Several consumer advocacy groups suggested that if only purchase transactions were covered, the abuses would migrate to the unregulated space. Some commenters said they did not see a reason to exclude the cost of a simultaneous loan when it is extended as part of a refinance. Industry commenters did not focus much on this issue, but an association representing credit unions supported limiting consideration to purchase transactions in order to reduce regulatory burden on credit unions and streamline the refinancing process. The Bureau believes that requiring consideration of HELOCs as simultaneous loans is appropriate in both purchase and non-purchase VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 transactions. In both situations the HELOC is a lien on the consumer’s dwelling with a cost that affects the viability of the covered transaction loan. The Bureau recognizes that a simultaneous HELOC in connection with a refinancing is more likely to be a convenience than one issued simultaneously with a purchase transaction, which will often cover down payment, transaction costs or other major expenses. However, the final rule accommodates this difference by allowing the creditor to base its ability-to-repay determination on the actual draw. The Bureau did not receive and is not aware of any information or data that justifies excluding actual draws on simultaneous HELOCs in connection with refinances from this rule. For the reasons stated above, the Bureau considers the language of proposed§ 226.43(c)(6)(ii) to be an accurate and appropriate implementation of the statute. Accordingly, the Bureau is adopting § 1026.43(c)(6)(ii) and associated commentary as proposed, with minor changes for clarity. 43(c)(7) Monthly Debt-to-Income Ratio or Residual Income As discussed above, TILA section 129C(a)(3) requires creditors to consider the debt-to-income ratio or residual income the consumer will have after paying non-mortgage debt and mortgage-related obligations, as part of the ability-to-repay determination under TILA section 129C(a)(1). The Board’s proposal would have implemented this requirement in § 226.43(c)(2)(vii). The Board proposed definitions and calculations for the monthly debt-toincome ratio and residual income in § 226.43(c)(7). With respect to the definitions, proposed § 226.43(c)(7)(i)(A) would have defined the total monthly debt obligations as the sum of: the payment on the covered transaction, as required to be calculated by proposed § 226.43(c)(2)(iii) and (c)(5); the monthly payment on any simultaneous loans, as required to be calculated by proposed § 226.43(c)(2)(iv) and (c)(6); the monthly payment amount of any mortgagerelated obligations, as required to be considered by proposed § 226.43(c)(2)(v); and the monthly payment amount of any current debt obligations, as required to be considered by proposed § 226.43(c)(2)(vi). Proposed § 1026.43(c)(7)(i)(B) would have defined the total monthly income as the sum of the consumer’s current or reasonably expected income, including any income PO 00000 Frm 00079 Fmt 4701 Sfmt 4700 6485 from assets, as required to be considered by proposed § 226.43(c)(2)(i) and (c)(4). With respect to the calculations, proposed § 226.43(c)(7)(ii)(A) would have required the creditor to consider the consumer’s monthly debt-to-income ratio by taking the ratio of the consumer’s total monthly debt obligations to total monthly income. Proposed § 226.43(c)(7)(ii)(B) would have required the creditor to consider the consumer’s residual income by subtracting the consumer’s total monthly debt obligations from the total monthly income. The Board solicited comment on whether consideration of residual income should account for loan amount, region of the country, and family size, and on whether creditors should be required to include Federal and State taxes in the consumer’s obligations to calculate the residual income. Proposed comment 43(c)(7)–1 would have stated that a creditor must calculate the consumer’s total monthly debt obligations and total monthly income in accordance with the requirements in proposed § 226.43(c)(7). The proposed comment would have explained that creditors may look to widely accepted governmental and nongovernmental underwriting standards to determine the appropriate thresholds for the debt-to-income ratio or residual income. Proposed comment 43(c)(7)–2 would have clarified that if a creditor considers both the consumer’s debt-to-income ratio and residual income, the creditor may base its determination of ability to repay on either the consumer’s debt-toincome ratio or residual income, even if the determination would differ with the basis used. In the section-by-section analysis of proposed § 226.43(c)(7), the Board explained that it did not wish to create an incentive for creditors to consider and verify as few factors as possible in the repayment ability determination. Proposed comment 43(c)(7)–3 would have provided that creditors may consider compensating factors to mitigate a higher debt-to-income ratio or lower residual income. The proposed comment would have provided that the creditor may, for example, consider the consumer’s assets other than the dwelling securing the covered transaction or the consumer’s residual income as a compensating factor for a higher debt-to-income ratio. The proposed comment also would have provided that, in determining whether and in what manner to consider compensating factors, creditors may look to widely accepted governmental and non-governmental underwriting E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6486 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations standards. The Board solicited comment on whether it should provide more guidance on what factors creditors may consider, and on how creditors may include compensating factors in the repayment ability determination. In addition, the Board solicited comment on two issues related to the use of automated underwriting systems. The Board solicited comment on providing a safe harbor for creditors relying on automated underwriting systems that use monthly debt-toincome ratios, if the system developer certifies that the system’s use of monthly debt-to-income ratios in determining repayment ability is empirically derived and statistically sound. The Board also solicited comment on other methods to facilitate creditor reliance on automated underwriting systems, while ensuring that creditors can demonstrate compliance with the rule. As discussed above in the section-bysection analysis of § 1026.43(c)(2)(vii), industry commenters and consumer advocates largely supported including consideration of the monthly debt-toincome ratio or residual income in the ability-to-repay determination and generally favored a flexible approach to consideration of those factors. In response to the Board’s proposal, some consumer advocates asked that the Bureau conduct research on the debt-toincome ratio and residual income. They requested a standard that reflects the relationship between the debt-to-income ratio and residual income. One industry commenter recommended that the Bureau adopt the VA calculation of residual income. Another industry commenter suggested that the Bureau adopt the same definitions of the debtto-income ratio and residual income as for qualified residential mortgages, to reduce compliance burdens and the possibility of errors. One industry commenter asked that consideration of residual income be permitted to vary with family size and geographic location. The commenter suggested that the residual income calculation account for Federal and State taxes. Several consumer advocates suggested that the Bureau review the VA residual income guidelines and update the cost of living tiers. They affirmed that all regularly scheduled debt payments should be included in the residual income calculation. They noted that residual income should be sufficient to cover basic living necessities, including food, utilities, clothing, transportation, and known health care expenses. One industry commenter asked that the Bureau provide guidance on and additional examples of compensating VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 factors, for example, situations where a consumer has many assets but a low income or high debt-to-income ratio. The commenter suggested that the Bureau clarify that the list of examples was not exclusive. Consumer advocates recommended that the Bureau not permit extensions of credit based on a good credit history or involving a high loan-to-value ratio if the debt-to-income ratio or residual income does not reflect an ability to repay. These commenters argued that credit scores and down payments reflect past behavior and incentives to make down payments, not ability to repay. The Bureau is largely adopting § 1026.43(c)(7) as proposed, with certain clarifying changes to the commentary. Specifically, comment 43(c)(7)–1 clarifies that § 1026.43(c) does not prescribe a specific debt-to-income ratio with which creditors must comply. For the reasons discussed above in the section-by-section analysis of § 1026.43(c), the Bureau is not finalizing the portion of proposed comment 43(c)(7)–1 which would have provided that the creditor may look to widely accepted governmental and nongovernmental underwriting standards to determine the appropriate threshold for the monthly debt-to-income ratio or the monthly residual income. Instead, comment 43(c)(7)–1 provides that an appropriate threshold for a consumer’s monthly debt-to-income ratio or monthly residual income is for the creditor to determine in making a reasonable and good faith determination of a consumer’s repayment ability. Comment 43(c)(7)–2 clarifies guidance regarding use of both monthly debt-to-income and monthly residual income by providing that if a creditor considers the consumer’s monthly debtto-income ratio, the creditor may also consider the consumer’s residual income as further validation of the assessment made using the consumer’s monthly debt-to-income ratio. The Bureau is not finalizing proposed comment 43(c)(7)–2, which would have provided that if a creditor considers both the consumer’s monthly debt-toincome ratio and residual income, the creditor may base the ability-to-repay determination on either metric, even if the ability-to-repay determination would differ with the basis used. The Bureau believes the final guidance better reflects how the two standards work together in practice, but the change is not intended to alter the rule. Comment 43(c)(7)–3 also clarifies guidance regarding the use of compensating factors in assessing a consumer’s ability to repay by providing that, for example, the creditor may PO 00000 Frm 00080 Fmt 4701 Sfmt 4700 reasonably and in good faith determine that an individual consumer has the ability to repay despite a higher monthly debt-to-income ratio or lower residual income in light of the consumer’s assets other than the dwelling securing the covered transaction, such as a savings account. The creditor may also reasonably and in good faith determine that a consumer has the ability to repay despite a higher debt-to-income ratio in light of the consumer’s residual income. The Bureau believes that not permitting use of compensating factors may reduce access to credit in some cases, even if the consumer could afford the mortgage. The Bureau does not believe, however, that the rule should provide an extensive list of compensating factors that the creditor may consider in assessing repayment ability. Instead, creditors should make reasonable and good faith determinations of the consumer’s repayment ability in light of the facts and circumstances. This approach to compensating factors is consistent with the final rule’s flexible approach to the requirement that creditors make a reasonable and good faith of a consumer’s repayment ability throughout § 1026.43(c). The Bureau will consider conducting a future study on the debt-to-income ratio and residual income. Except for one small creditor and the VA, the Bureau is not aware of any creditors that routinely use residual income in underwriting, other than as a compensating factor.117 The VA underwrites its loans to veterans based on a residual income table developed in 1997. The Bureau understands that the table shows the residual income desired for the consumer based on the loan amount, region of the country, and family size, but does not account for differences in housing or living costs within regions (for instance rural Vermont versus New York City). The Bureau also understands that the residual income is calculated by deducting obligations, including Federal and State taxes, from effective income. However, at this time, the Bureau is unable to conduct a detailed review of the VA residual income guidelines, which would include an analysis of whether those guidelines are predictive of repayment ability, to determine if those standards should be incorporated, in whole or in part, into the ability-to117 See also Michael E. Stone, What is Housing Affordability? The Case for the Residual Income Approach, 17 Housing Pol’y Debate 179 (2006) (advocating use of a residual income approach but acknowledging that it ‘‘is neither well known, particularly in this country, nor widely understood, let alone accepted’’). E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations repay analysis that applies to the entire residential mortgage market. Further, the Bureau believes that providing broad standards for the definition and calculation of residual income will help preserve flexibility if creditors wish to develop and refine more nuanced residual income standards in the future. The Bureau accordingly does not find it necessary or appropriate to specify a detailed methodology in the final rule for consideration of residual income. The final rule also does not provide a safe harbor for creditors relying on automated underwriting systems that use monthly debt-to-income ratios. The Bureau understands that creditors routinely rely on automated underwriting systems, many of which are proprietary and thus lack transparency to the individual creditors using the systems. Such systems may decide, for example, whether the debtto-income ratio and compensating factors are appropriate, but may not disclose to the individual creditors using such systems which compensating factors were used for loan approval. However, the Bureau does not believe a safe harbor is necessary in light of the flexibility the final rule provides to creditors in assessing a consumer’s repayment ability, including consideration of monthly debt-toincome ratios. See comments 43(c)(1)–1 and 43(c)(2)–1. Finally, the Bureau notes the contrast between the flexible approach to considering and calculating debt-toincome in § 1026.43(c)(2)(vii) and (7) and the specific standards for evaluating debt-to-income for purposes of determining whether a covered transaction is a qualified mortgage under § 1026.43(e)(2). For the reasons discussed below in the section-bysection analysis of § 1026.43(e)(2), the Bureau believes a specific, quantitative standard for evaluating a consumer’s debt-to-income ratio is appropriate in determining whether a loan receives either a safe harbor or presumption of compliance with the repayment ability requirements of § 1026.43(c)(1) pursuant to § 1026.43(e)(2). However, the abilityto-repay requirements in § 1026.43(c) will apply to the whole of the mortgage market and therefore require flexibility to permit creditors to assess repayment ability while ensuring continued access to responsible, affordable mortgage credit. Accordingly, the final rule sets minimum underwriting standards while providing creditors with flexibility to use their own quantitative standards in making the repayment ability determination required by § 1026.43(c)(1). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 43(d) Refinancing of Non-Standard Mortgages Two provisions of section 1411 of the Dodd-Frank Act address the refinancing of existing mortgage loans under the ability-to-repay requirements. As provided in the Dodd-Frank Act, TILA section 129C(a)(5) provides that certain Federal agencies may create an exemption from the income verification requirements in TILA section 129C(a)(4) if certain conditions are met. 15 U.S.C. 1639c(a)(5). In addition, TILA section 129C(a)(6)(E) provides certain special ability-to-repay requirements to encourage applications to refinance existing ‘‘hybrid loans’’ into a ‘‘standard loans’’ with the same creditor, where the consumer has not been delinquent on any payments on the existing loan and the monthly payments would be reduced under the refinanced loan. The statute allows creditors to give special weight to the consumer’s good standing and to consider whether the refinancing would prevent a likely default, as well as other potentially favorable treatment to the consumer. However, it does not expressly exempt applications for such ‘‘payment shock refinancings’’ from TILA’s general ability-to-repay requirements or define ‘‘hybrid’’ or ‘‘standard loans.’’ 118 15 U.S.C. 1639c(a)(6)(E). The Board noted in its proposal that it reviewed the Dodd-Frank Act’s legislative history, consulted with consumer advocates and representatives of both industry and the GSEs, and examined underwriting rules and guidelines for the refinance programs of private creditors, GSEs and Federal agencies, as well as for the Home Affordable Modification Program (HAMP). The Board noted that it also considered TILA section 129C(a)(5), which permits Federal agencies to adopt rules exempting refinancings from certain of the ability-to-repay requirements in TILA section 129C(a). In proposing § 226.43(d) to implement TILA section 129C(a)(6)(E), the Board interpreted the statute as being intended to afford greater flexibility to creditors of certain home mortgage refinancings when complying with the general ability-to-repay provisions in TILA section 129C(a). Consistent with this reading of the statute, the proposal would have provided an exemption from certain criteria required to be considered as part of the general 118 Section 128A of TILA, as added by Section 1418 of the Dodd-Frank Act, includes a definition of ‘‘hybrid adjustable rate mortgage.’’ However, that definition applies to the adjustable rate mortgage disclosure requirements under TILA section 128A, not the ability-to-repay requirements under TILA section 129C. PO 00000 Frm 00081 Fmt 4701 Sfmt 4700 6487 repayment ability determination under TILA section 129C(a). Specifically, the Board’s proposal would have permitted creditors to evaluate qualifying applications without having to verify the consumer’s income and assets as prescribed in the general ability-torepay requirements, provided that a number of additional conditions were met. In addition, the proposal would have permitted a creditor to calculate the monthly payment used for determining the consumer’s ability to repay the new loan based on assumptions that would typically result in a lower monthly payment than those required to be used under the general ability-to-repay requirements. The proposal also clarified the conditions that must be met in a home mortgage refinancing in order for this greater flexibility to apply. The Board noted that TILA section 129C(a)(6)(E)(ii) permits creditors to give prevention of a ‘‘likely default should the original mortgage reset a higher priority as an acceptable underwriting practice.’’ 15 U.S.C. 1639c(a)(6)(E)(ii). The Board interpreted this provision to mean that certain ability-to-repay criteria under TILA section 129C(a) should not apply to refinances that meet the requisite conditions. TILA section 129C(a) specifically prescribes the requirements that creditors must meet to satisfy the obligation to determine a consumer’s ability to repay a mortgage loan. The Board concluded that the term ‘‘underwriting practice’’ could reasonably be interpreted to refer to the underwriting rules prescribed in earlier portions of TILA section 129C(a); namely, those concerning the general ability-to-repay underwriting requirements. The Board also structured its proposal to provide for flexibility in underwriting that is characteristic of so-called ‘‘streamlined refinances,’’ which are offered by creditors to existing customers without having to go through a full underwriting process appropriate for a new origination. The Board noted that section 1411 of the Dodd-Frank Act specifically authorizes streamlined refinancings of loans made, guaranteed, or insured by Federal agencies, and concluded that TILA section 129C(a)(6)(E) is most reasonably interpreted as being designed to address the remaining market for streamlined refinancings; namely, those offered under programs of private creditors and the GSEs. The Board stated that in its understanding typical streamlined refinance programs do not require documentation of income and assets, although a verbal verification of E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6488 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations employment may be required. The Board further noted that TILA section 129C(a)(6)(E) includes three central elements of typical streamlined refinance programs, in that it requires that the creditor be the same for the existing and new mortgage loan obligation, that the consumer have a positive payment history on the existing mortgage loan obligation, and that the payment on the new refinancing be lower than on the existing mortgage loan obligation. One difference the Board noted between the statute and typical streamlined refinance programs is that the statute targets consumers facing ‘‘likely default’’ if the existing mortgage ‘‘reset[s].’’ The Board indicated that, by contrast, streamlined refinance programs may not be limited to consumers at risk in this way. For example, streamlined refinancing programs may assist consumers who are not facing potential default but who simply wish to take advantage of lower rates despite a drop in their home value or wish to switch from a less stable variable-rate product to a fixed-rate product. The Board noted parallels between TILA’s new refinancing provisions and the focus of HAMP, a government program specifically aimed at providing modifications for consumers at risk of ‘‘imminent default,’’ or in default or foreclosure.119 However, the Board noted that underwriting criteria for a HAMP modification are considerably more stringent than for a typical streamlined refinance. On balance, the Board interpreted the statutory language as being modeled on the underwriting standards of typical streamlined refinance programs rather than the tighter standards of HAMP. The Board concluded that Congress intended to facilitate opportunities to refinance loans on which payments could become significantly higher and thus unaffordable. The Board cautioned that applying underwriting standards that are too stringent could impede refinances that Congress intended to encourage. In particular, the statutory language permitting creditors to give ‘‘likely default’’ a ‘‘higher priority as an acceptable underwriting practice’’ indicates that flexibility in these special refinances should be permitted. In addition, underwriting standards that go significantly beyond those used in existing streamlined refinance programs could create a risk that these programs would be unable to meet the TILA ability-to-repay requirements; thus, an 119 See, e.g., Fannie Mae, FM 0509, Home Affordable Modification Program, at 1 (2009). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 important refinancing resource for atrisk consumers would be compromised and the overall mortgage market potentially disrupted at a vulnerable time. The Board noted, however, that consumers at risk of default when higher payments are required might present greater credit risks to the institutions holding their loans when those loans are refinanced without verifying the consumer’s income and assets. Accordingly, the Board’s proposal would have imposed some requirements that are more stringent than those of typical streamlined refinance programs as a prerequisite to the refinancing provision under proposed § 226.43(d). For example, the proposal would have permitted a consumer to have had only one delinquency of more than 30 days in the 24 months immediately preceding the consumer’s application for a refinance. By contrast, the Board indicated that streamlined refinance programs of which it is aware tend to consider the consumer’s payment history for only the last 12 months.120 In addition, the proposal would have defined the type of loan into which a consumer may refinance under TILA’s new refinancing provisions to include several characteristics designed to ensure that those loans are stable and affordable. These include a requirement that the interest rate be fixed for the first five years after consummation and that the points and fees be capped at three percent of the total loan amount, subject to a limited exemption for smaller loans. 43(d)(1) Definitions In the Board’s proposal, § 226.43(d)(1) established the scope of paragraph (d) and set forth the conditions under which the special refinancing provisions applied, while proposed § 226.43(d)(2) addressed the definitions for ‘‘non-standard mortgage,’’ ‘‘standard mortgage,’’ and ‘‘refinancing.’’ The Bureau believes that paragraph (d) should begin with the relevant definitions, before proceeding to the scope and conditions of the special refinancing provisions. The rule finalized by the Bureau is accordingly reordered. The following discussion details the definitions adopted in § 1026.43(d)(1), which were proposed by the Board under § 226.43(d)(2). Proposed § 226.43(d)(2) defined the terms ‘‘non-standard mortgage’’ and ‘‘standard mortgage.’’ As noted earlier, 120 See, e.g., Fannie Mae, Home Affordable Refinance Refi Plus Options, at 2 (Mar. 29, 2010); Freddie Mac, Pub. No. 387, Freddie Mac-owned Streamlined Refinance Mortgage, at 2 (2010). PO 00000 Frm 00082 Fmt 4701 Sfmt 4700 the statute does not define the terms ‘‘hybrid loan’’ and ‘‘standard loan’’ used in the special refinancing provisions of TILA section 129C(a)(6)(E). Therefore, the Board proposed definitions it believed to be consistent with the policy objective underlying these special provisions: Facilitating the refinancing of home mortgages on which consumers risk a likely default due to impending payment shock into more stable and affordable products. 43(d)(1)(i) Non-Standard Mortgage As noted above, the statute does not define the terms ‘‘hybrid loan’’ and ‘‘standard loan’’ used in TILA section 129C(a)(6)(E). The Board proposed definitions it believed to be consistent with Congress’s objectives. Proposed § 226.43(d)(2)(i) substituted the term ‘‘non-standard mortgage’’ for the statutory term ‘‘hybrid loan’’ and would have defined non-standard mortgage as any ‘‘covered transaction,’’ as defined in proposed § 226.43(b)(1), that is: • An adjustable-rate mortgage, as defined in § 226.18(s)(7)(i), with an introductory fixed interest rate for a period of one year or longer; 121 • An interest-only loan, as defined in § 226.18(s)(7)(iv); 122 or • A negative amortization loan, as defined in § 226.18(s)(7)(v).123 Proposed comment 43(d)(2)(i)(A)–1 explained the application of the definition of non-standard mortgage to an adjustable-rate mortgage with an introductory fixed interest rate for one or more years. This proposed comment clarified that, for example, a covered transaction with a fixed introductory rate for the first two, three or five years that then converts to a variable rate for the remaining 28, 27 or 25 years, respectively, is a non-standard mortgage. By contrast, a covered transaction with an introductory rate for six months that then converts to a variable rate for the remaining 29 and 1⁄2 years is not a non-standard mortgage. The Board articulated several rationales for its proposed definition of 121 ‘‘The term ‘adjustable-rate mortgage’ means a transaction secured by real property or a dwelling for which the annual percentage rate may increase after consummation.’’ 12 CFR 1026.18(s)(7)(i). 122 ‘‘The term ‘interest-only’ means that, under the terms of the legal obligation, one or more of the periodic payments may be applied solely to accrued interest and not to loan principal; an ‘interest-only loan’ is a loan that permits interest-only payments.’’ 12 CFR 1026.18(s)(7)(iv). 123 ‘‘[T]he term ‘negative amortization’ means payment of periodic payments that will result in an increase in the principal balance under the terms of the legal obligation; the term ‘negative amortization loan’ means a loan that permits payments resulting in negative amortization, other than a reverse mortgage subject to section 226.33.’’ 12 CFR 1026.18(s)(7)(v). E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations a non-standard mortgage. First, the Board noted that the legislative history of the Dodd-Frank Act describes ‘‘hybrid’’ mortgages as mortgages with a ‘‘blend’’ of fixed-rate and adjustable-rate characteristics—generally loans with an initial fixed period and adjustment periods, such as ‘‘2/23s and 3/27s.’’ 124 The Board also stated that the legislative history indicates that Congress was concerned about consumers being trapped in mortgages likely to result in payments that would suddenly become significantly higher—often referred to as ‘‘payment shock’’—because their home values had dropped, thereby ‘‘making refinancing difficult.’’ 125 The Board interpreted Congress’ concern about consumers being at risk due to payment shock as supporting an interpretation of the term ‘‘hybrid loan’’ to encompass both loans that are ‘‘hybrid’’ in that they start with a fixed interest rate and convert to a variable rate, but also loans that are ‘‘hybrid’’ in that consumers can make payments that do not pay down principal for a period of time that then convert to higher payments covering all or a portion of principal. By defining ‘‘non-standard mortgage’’ in this way, the proposal was intended to increase refinancing options for a wide range of at-risk consumers while conforming to the statutory language and legislative intent. The proposed definition of ‘‘nonstandard mortgage’’ would not have included adjustable-rate mortgages whose rate is fixed for an initial period of less than one year. In those instances, the Board posited that a consumer may not face ‘‘payment shock’’ because the consumer has paid the fixed rate for such a short period of time. The Board also expressed concern that allowing streamlined refinancings under this provision where the interest rate is fixed for less than one year could result in ‘‘loan flipping.’’ A creditor, for example, could make a covered transaction and then only a few months later refinance that loan under proposed § 226.43(d) to take advantage of the exemption from certain ability-to-repay requirements while still profiting from the refinancing fees. The Board expressed concern that under its proposed definition, a consumer could refinance out of a relatively stable product, such as an adjustable-rate mortgage with a fixed interest rate for a period of 10 years, which then adjusts to a variable rate for the remaining loan term, and that it was 124 See Comm. on Fin. Servs., Report on H.R. 1728, Mortgage Reform and Anti-Predatory Lending Act, H. Rept. 94, 110th Cong., at 5 (2009). 125 Id. at 51–52. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 unclear whether TILA section 129C(a)(6)(E) was intended to cover this type of product. The Board solicited comment on whether adjustable-rate mortgages with an initial fixed rate should be considered non-standard mortgages regardless of how long the initial fixed rate applies, or if the proposed initial fixed-rate period of at least one year should otherwise be revised. The proposed definition of nonstandard mortgage also did not include balloon-payment mortgages. The Board noted that balloon-payment mortgages are not clearly ‘‘hybrid’’ products, given that the monthly payments on a balloonpayment mortgage do not necessarily increase or change from the time of consummation; rather, the entire outstanding principal balance becomes due on a particular, predetermined date. The Board stated that consumers of balloon-payment mortgages typically expect that the entire loan balance will be due at once at a certain point in time and are generally aware well in advance that they will need to repay the loan or refinance. The Board solicited comment on whether to use its legal authority to include balloon-payment mortgages in the definition of non-standard mortgage for purposes of the special refinancing provisions of TILA section 129C(a)(6)(E). The Board also requested comment generally on the appropriateness of the proposed definition of non-standard mortgage. Commenters on this aspect of the proposal generally urged the Bureau to expand in various ways the proposed definition of non-standard mortgage and either supported or did not address the proposed definition’s inclusion of adjustable-rate mortgages, interest-only loans, or negative amortization loans. One consumer group commented that it supported the Board’s proposed definition of non-standard mortgage. Other consumer group commenters stated that the Bureau should use its exemption and adjustment authority under TILA to include balloon-payment loans within the scope of proposed § 226.43(d). In addition, one industry commenter stated that creditors should have flexibility to refinance a performing balloon-payment loan within the six months preceding, or three months following, a balloon payment date without regard to the ability-to-pay requirements. In contrast, one industry commenter stated that balloon-payment loans should not be included in the definition of nonstandard mortgage, because consumers are generally well aware of the balloon payment feature in a loan, which is PO 00000 Frm 00083 Fmt 4701 Sfmt 4700 6489 clearly explained to customers. This industry commenter further stated that during the life of a balloon-payment loan, its customers often make regular payments that reduce the principal balance and that balloon-payment loans do not make it more likely that a consumer will default. While the Bureau agrees that many consumers may need to seek a refinancing when a balloon loan payment comes due, given the approach that the Bureau has taken to implementing the payment shock refinancing provision in § 1026.43(d), the Bureau is declining to expand the definition of non-standard mortgage to include balloon-payment mortgages. As discussed in more detail in the supplementary information to § 1026.43(d)(3), as adopted § 1026.43(d) provides a broad exemption to all of the general ability-to-repay requirements set forth in § 1026.43(c) when a nonstandard mortgage is refinanced into a standard mortgage provided that certain conditions are met. The point of this exemption is to enable creditors, without going through full underwriting, to offer consumers who are facing increased monthly payments due to the recast of a loan a new loan with lower monthly payments. Thus, a key element of the exemption is that the monthly payment on the standard mortgage be materially lower than the monthly payment for the non-standard mortgage. As discussed in the sectionby-section analysis of § 1026.43(d)(1) below, the Bureau is adopting a safe harbor for reductions of 10 percent. Balloon payments pose a different kind of risk to consumers, one that arises not from the monthly payments (which often tend to be low) but from the balloon payment due when the entire remaining balance becomes due. The provisions of § 1026.43(d)(1) are not meant to address this type of risk. Accordingly, the Bureau declines to expand the definition of non-standard mortgage to include balloon-payment loans. The Bureau believes, however, that where a consumer is performing under a balloon-payment mortgage and is offered a new loan of a type that would qualify as a standard loan with monthly payments at or below the payments of the balloon-payment mortgage, creditors will have little difficulty in satisfying the ability-torepay requirements. Consumer group commenters and one GSE commenter argued that the definition of non-standard mortgage should accommodate GSE-held loans. These commenters stated that these loans should receive the same income verification exemption as Federal E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6490 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations agency streamlined refinancing programs. These commenters noted that while the GSEs are held in conservatorship by the Federal government, GSE-held loans should be treated the same as FHA for purposes of streamlined refinance programs, which are ultimately about reducing the risk to the taxpayer by avoiding default by consumers who could receive lowercost mortgage loans. Consumer group commenters further urged that GSE streamlined refinance programs should be subject to standards at least as stringent as those for the FHA streamlined refinance program. In addition, one of the GSEs questioned the policy justification for the differences between sections 129C(a)(5) and 129C(a)(6)(E) of TILA. TILA section 129C(a)(5), which applies to certain government loans, permits Federal agencies to exempt certain refinancings from the income and asset verification requirement without regard to the original mortgage product, in contrast to TILA section 129C(a)(6)(E), which as discussed above applies only when the original loan is a ‘‘hybrid’’ loan. This commenter noted that consumers with certain types of mortgage loans, such as fixed-rate and balloon-payment loans, may have to go through a more costly and cumbersome process to refinance their mortgages than consumers with government loans. The Bureau declines to adopt regulations implementing TILA section 129C(a)(5). The Bureau notes that TILA section 129C(a)(5) expressly confers authority on certain Federal agencies (i.e., HUD, VA, USDA, and RHS) to exempt from the income verification requirement refinancings of certain loans made, guaranteed, or insured by such Federal agencies. The scope of TILA section 129C(a)(5) is limited to such Federal agencies or governmentguaranteed or -insured loans. The Bureau also declines to expand the scope of § 1026.43(d) to include GSE refinancings that do not otherwise fall within the scope of § 1026.43(d). While accommodation for GSE-held mortgage loans that are not non-standard mortgages under § 1026.43(d) may be appropriate, the Bureau wishes to obtain additional information in connection with GSE refinancings and has requested feedback in a proposed rule published elsewhere in today’s Federal Register. However, the Bureau notes that to the extent a loan held by the GSEs (or a loan made, guaranteed or insured by the Federal agencies above) qualifies as a non-standard mortgage under § 1026.43(d)(1)(i) and the other conditions in § 1026.43(d) are met, the refinancing provisions of general VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 applicability in § 1026.43(d) would be available for refinancing a GSE-held loan. Industry commenters and one industry trade association commented that special ability-to-repay requirements should be available for all rate-and-term refinancings, regardless of whether the refinancings are insured or guaranteed by the Federal government or involve a non-standard mortgage. One industry trade association stated that such special ability-to-repay requirements should incorporate similar standards to those established for certain government loans in TILA section 129C(a)(5), including a requirement that the consumer not be 30 or more days delinquent. For such loans, this trade association stated that other requirements under TILA section 129C(a)(6)(E) regarding payment history should not be imposed, because the consumer is already obligated to pay the debt and the note holder in many cases will already bear the credit risk. Other commenters stated that because a rateand-term refinancing would offer the consumer a better rate (except in the case of adjustable rate mortgages), there is no reason to deny the creditor the ability to improve its credit risk and to offer the consumer better financing. Several industry commenters and one GSE noted that streamlined refinancing programs are an important resource for consumers seeking to refinance into a lower monthly payment mortgage even when the underlying mortgage loan is not a non-standard mortgage, and urged the Bureau to considering modifying proposed § 226.43(d) to include conventional loans where the party making or purchasing the new loan already owns the credit risk. The Bureau declines to expand the scope of § 1026.43(d) to include rateand-term refinancings when the underlying mortgage is not a nonstandard mortgage, as defined in § 1026.43(d)(1)(i). The Bureau believes that the statute clearly limits the refinancing provision in TILA section 129(C)(6)(E) to circumstances where the loan being refinanced is a ‘‘hybrid loan’’ and where the refinancing could ‘‘prevent a likely default.’’ The Bureau agrees with the Board that TILA section 129C(a)(6)(E) is intended to address concerns about loans involving possible payment shock. Where a consumer has proven capable of making payments, is about to experience payment shock, is at risk of default, and is refinancing to a mortgage with a lower monthly payment and with product terms that do not pose any increased risk, the Bureau believes that the benefits of the refinancing outweigh the consumer protections PO 00000 Frm 00084 Fmt 4701 Sfmt 4700 afforded by the ability-to-repay requirements. Absent these exigent circumstances, the Bureau believes that creditors should determine that the consumer has the ability to repay the mortgage loan. The Bureau does not believe that a consumer who receives an initial lower monthly payment from a rate-and-term refinancing actually receives a benefit if the consumer cannot reasonably be expected to repay the loan. Also, the Bureau notes that some of the scenarios identified by commenters, such as offering a consumer a better rate with a rate-andterm refinancing where the creditor bears the credit risk, would be exempt from the ability-to-repay requirements. A refinancing that results in a reduction in the APR with a corresponding change in the payment schedule and meets the other conditions in § 1026.20(a) is not a ‘‘refinancing’’ for purposes of § 1026.43, and therefore is not subject to the ability-to-repay requirements. As with other terms used in TILA section 129C, the Bureau believes that this interpretation is necessary to achieve Congress’s intent. Several other industry commenters urged the Bureau to broaden the definition of non-standard mortgage to include refinancings extended pursuant to the Home Affordable Refinance Program (HARP) and similar programs. One such commenter indicated that under HARP, a loan can only be refinanced if the consumer is not in default, the new payment is fully amortizing, and both the original and new loans comply with agency requirements. This commenter stated that HARP permits consumers who would not otherwise be able to refinance due to a high loan-to-value ratio or other reasons to refinance into another loan, providing a consumer benefit. The commenter indicated that HARP loans do not meet all of the proposed ability-to-repay requirements and that the Bureau should use its authority to provide that HARP and other similar programs are exempt from the ability-to-repay requirements, as they promote credit availability and increasing stability in the housing market. The Bureau acknowledges that HARP refinancings and the payment shock refinancings addressed under TILA section 129C(a)(6)(E) are both intended to assist consumers harmed by the financial crisis. Although both types of refinancings are motivated by similar goals, the Bureau does not believe that expanding § 1026.43(d) to include all HARP refinancings is consistent with TILA section 129C(a)(6)(E) because HARP refinancings are not predicated E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with on the occurrence of payment shock and a consumer’s likely default. For example, a consumer with a mortgage loan that will not recast and who is not at risk of default may qualify for a HARP refinancing if the consumer’s loan-tovalue ratio exceeds 80 percent. The Bureau strongly believes that § 1026.43(d) should be limited to instances where a consumer is facing payment shock and likely default. While not limited to the prevention of payment shock and default, the Bureau acknowledges that extensions of credit made pursuant to programs such as HARP are intended to assist consumers harmed by the financial crisis. Furthermore, these programs employ complex underwriting requirements to determine a consumer’s ability to repay. Thus, it may be appropriate to modify the ability-to-repay requirements to accommodate such programs. However, an appropriate balance between helping affected consumers and ensuring that these consumers are offered and receive residential mortgage loans on terms that reasonably reflect consumers’ ability to repay must be found. To determine how to strike this balance, the Bureau wishes to obtain additional information in connection with these programs and has requested feedback in a proposed rule published elsewhere in today’s Federal Register. Accordingly, the definition of ‘‘nonstandard mortgage’’ is adopted as proposed, renumbered as § 1026.43(d)(1)(i). In addition, comment 43(d)(2)(i)(A)–1 also is adopted as proposed, renumbered as 43(d)(1)(i)(A)–1. 43(d)(1)(ii) Standard Mortgage Proposed § 226.43(d)(2)(ii) would have substituted the term ‘‘standard mortgage’’ for the statutory term ‘‘standard loan’’ and defined this term to mean a covered transaction that has the following five characteristics: • First, the regular periodic payments may not: (1) Cause the principal balance to increase; (2) allow the consumer to defer repayment of principal; or (3) result in a balloon payment. • Second, the total points and fees payable in connection with the transaction may not exceed three percent of the total loan amount, with exceptions for smaller loans specified in proposed § 226.43(e)(3). • Third, the loan term may not exceed 40 years. • Fourth, the interest rate must be fixed for the first five years after consummation. • Fifth, the proceeds from the loan may be used solely to pay—(1) the outstanding principal balance on the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 non-standard mortgage; and (2) closing or settlement charges required to be disclosed under RESPA. Proposed limitations on regular periodic payments. Proposed § 226.43(d)(2)(ii)(A) would have required that a standard mortgage provide for regular periodic payments that do not result in negative amortization, deferral of principal repayment, or a balloon payment. Proposed comment 43(d)(2)(ii)(A)–1 clarified that ‘‘regular periodic payments’’ are payments that do not result in an increase of the principal balance (negative amortization) or allow the consumer to defer repayment of principal. The proposed comment explained that the requirement for ‘‘regular periodic payments’’ means that the contractual terms of the standard mortgage must obligate the consumer to make payments of principal and interest on a monthly or other periodic basis that will repay the loan amount over the loan term. Proposed comment 43(d)(2)(ii)(A)–1 further explained that, with the exception of payments resulting from any interest rate changes after consummation in an adjustablerate or step-rate mortgage, the periodic payments must be substantially equal, with a cross-reference to proposed comment 43(c)(5)(i)–3 regarding the meaning of ‘‘substantially equal.’’ In addition, the comment clarified that ‘‘regular periodic payments’’ do not include a single-payment transaction and cross-referenced similar commentary on the meaning of ‘‘regular periodic payments’’ under proposed comment 43(e)(2)(i)–1. Proposed comment 43(d)(2)(ii)(A)–1 also crossreferenced proposed comment 43(e)(2)(i)–2 to explain the prohibition on payments that ‘‘allow the consumer to defer repayment of principal.’’ One consumer group commenter stated that it supported the exclusion of negative amortization, interest-only payments, and balloon payments from the definition of standard mortgage. In addition, several other consumer groups commented in support of the Board’s proposal to exclude balloon-payment loans from the definition of standard mortgage. These commenters stated that balloon-payment products, even with self-executing renewal, should not be permitted to take advantage of an exemption from the general underwriting standards in § 1026.43(c). Consumer groups expressed concern that, in cases where the consumer does not have assets sufficient to make the balloon payment, balloon-payment loans will necessarily require another refinance or will lead to a default. The Bureau agrees with the concerns PO 00000 Frm 00085 Fmt 4701 Sfmt 4700 6491 expressed by such commenters and believes that it is appropriate to require that balloon-payment loans be underwritten in accordance with the general ability-to-repay standard, rather than under the payment shock refinancing provision in § 1026.43(d). Accordingly, the Bureau is not expanding the definition of standard mortgage to include balloon-payment mortgages. The Bureau received no other comment on this proposed definition. Accordingly, the Bureau is adopting the definition of standard mortgage as proposed, renumbered as § 1026.43(d)(1)(ii)(A). Similarly, the Bureau received no comment on proposed comment 43(d)(2)(ii)(A)–1, which is adopted as proposed and renumbered as 43(d)(1)(ii)(A)–1. Proposed three percent cap on points and fees. Proposed § 226.43(d)(2)(ii)(B) would have prohibited creditors from charging points and fees on the mortgage loan of more than three percent of the total loan amount, with certain exceptions for small loans. Specifically, proposed § 226.43(d)(2)(ii)(B) cross-referenced the points and fees provisions under proposed § 226.43(e)(3), thereby applying the points and fees limitations for a ‘‘qualified mortgage’’ to a standard mortgage. The points and fees limitation for a ‘‘qualified mortgage’’ and the relevant exception for small loans are discussed in detail in the section-bysection analysis of § 1026.43(e)(3) below. The Board noted several reasons for the proposed limitation on the points and fees that may be charged on a standard mortgage. First, the limitation was intended to prevent creditors from undermining the provision’s purpose— placing at-risk consumers into more affordable loans—by charging excessive points and fees for the refinance. Second, the points and fees limitation was intended to ensure that consumers attain a net benefit in refinancing their non-standard mortgage. The higher a consumer’s up-front costs to refinance a home mortgage, the longer it will take for the consumer to recoup those costs through lower payments on the new mortgage. By limiting the amount of points and fees that can be charged in a refinance covered by proposed § 226.43(d), the provision increases the likelihood that the consumer will hold the loan long enough to recoup those costs. Third, the proposed limitation was intended to be consistent with the provisions set forth in TILA section 129C(a)(5) regarding certain refinancings under Federal agency programs. E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6492 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations The Board requested comment on the proposal to apply the same limit on the points and fees that may be charged for a ‘‘qualified mortgage’’ under § 226.43(e) to the points and fees that may be charged on a ‘‘standard mortgage’’ under § 226.43(d). The Bureau received no comments on this proposed points and fees threshold, which is adopted as proposed, renumbered as § 1026.43(d)(1)(ii)(B). See the sectionby-section analysis of § 1026.43(e)(3) below for more specific information regarding the limitations applicable to ‘‘points and fees’’ for qualified mortgages and refinancings under § 1026.43(d). Proposed loan term of no more than 40 years. Proposed § 226.43(d)(2)(ii)(C) would have provided that, to qualify as a standard mortgage under proposed § 226.43(d), a covered transaction may not have a loan term of more than 40 years. The Board stated that this condition was intended to ensure that creditors and consumers have sufficient options to refinance a 30-year loan, for example, which is unaffordable for the consumer in the near term, into a loan with lower, more affordable payments over a longer term. This flexibility may be especially important in higher cost areas where loan amounts on average exceed loan amounts in other areas. The Board noted that loans with longer terms may cost more over time, but indicated that it was reluctant to foreclose options for consumers for whom the lower payment of a 40-year loan might make the difference between defaulting and not defaulting. The Board also noted that prevalent streamlined refinance programs permit loan terms of up to 40 years and expressed concern about disrupting the current mortgage market at a vulnerable time. The Board specifically requested comment on the proposed condition to allow a standard mortgage to have a loan term of up to 40 years. The Bureau received no comment on this proposed condition, which is adopted as proposed, renumbered as § 1026.43(d)(1)(ii)(C). Proposed requirement that the interest rate be fixed for the first five years. Proposed § 226.43(d)(2)(ii)(D) would have required that a standard mortgage have a fixed interest rate for the first five years after consummation. Proposed comment 43(d)(2)(ii)(D)–1 provided an illustrative example. The proposed comment also cross-referenced proposed comment 43(e)(2)(iv)–3.iii for guidance regarding step-rate mortgages. The Board articulated several reasons for requiring a minimum five-year fixedrate period for standard mortgages. First, the Board noted that a fixed rate for five VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 years is consistent with TILA section 129C(b)(2)(A)(v), which requires the creditor to underwrite a qualified mortgage based on the maximum interest rate that may apply during the first five years. The Board indicated that Congress intended both qualified mortgages and standard mortgages to be stable loan products, and therefore that the required five-year fixed-rate period for qualified mortgages would also be an appropriate benchmark for standard mortgages. The Board further stated that the safeguard of a fixed rate for five years after consummation would help to ensure that consumers refinance into products that are stable for a substantial period of time. In particular, a fixed payment for five years after consummation would constitute a significant improvement in the circumstances of a consumer who may have defaulted absent the refinance. The Board specifically noted that the proposal would permit so-called ‘‘5/1 ARMs,’’ where the interest rate is fixed for the first five years, after which time the rate becomes variable, to be standard mortgages. The Board requested comment on the proposal defining a standard mortgage as a mortgage loan with an interest rate that is fixed for at least the first five years after consummation, including on whether the rate should be required to be fixed for a shorter or longer period and data to support any alternative time period. One consumer group commenter stated that the use of adjustable-rate mortgages should be limited in the definition of standard mortgage. This commenter stated that adjustable-rate mortgage loans contributed to the subprime lending expansion and the financial crisis that followed. In particular, this commenter expressed concern that adjustable-rate mortgage loans were utilized in loan-flipping schemes that trapped consumers in unaffordable loans, forcing such consumers to refinance into less affordable mortgage loans. This commenter indicated that standard mortgages should be limited to fixed and step-rate loans and, in low or moderate interest rate environments, adjustable-rate mortgages with a 5-year or longer-term fixed period. However, this commenter urged the Bureau to consider permitting shorter-term adjustable-rate mortgages to be standard mortgages in high interest rate environments because in such circumstance, an adjustable-rate mortgage could potentially reduce the consumer’s monthly payments at recast, which may outweigh the risks of PO 00000 Frm 00086 Fmt 4701 Sfmt 4700 increased payments for some consumers. The Bureau is adopting the requirement that a standard mortgage have a fixed interest rate for the first five years after consummation as proposed, renumbered as § 1026.43(d)(1)(ii)(D). The Bureau agrees with the Board that the intent of TILA section 129C(a)(6)(E) appears to be to facilitate refinances of riskier mortgages into more stable loan products, and accordingly, believes that a standard mortgage should provide for a significant period of time during which payments will be predictable, based on a fixed rate or step rates that are set at the time of consummation. The Bureau believes that five years is an appropriate standard in part because it is consistent with the statutory requirement for a qualified mortgage under section 129C(b)(2)(A)(v). The Bureau believes that predictability for consumers is best effectuated by a single rule that applies in all interest rate environments, rather than a rule that depends on the interest rate environment in effect at the time of the refinancing. Further, given that § 1026.43(d) provides an exemption from the general ability-to-repay requirements in § 1026.43(c), the Bureau believes that it is important that a refinancing conducted in accordance with § 1026.43(d) result in a stable loan product and predictable payments for a significant period of time. In addition, the Board solicited comment on whether a balloon-payment mortgage of at least five years should be considered a standard mortgage under the refinancing provisions of proposed § 226.43(d). The Board noted that in some circumstances, a balloon-payment mortgage with a fixed, monthly payment for five years might benefit a consumer who otherwise would have defaulted. The Board further noted that a five-year balloon-payment mortgage may not be appreciably less risky for the consumer than a ‘‘5/1 ARM,’’ which is permitted under the proposal, depending on the terms of the rate adjustment scheduled to occur in year five. As discussed above, several consumer groups stated that balloon products, even with self-executing renewal, should not be permitted to take advantage of an exemption from the general underwriting standards in § 1026.43(c). Consumer groups expressed concern that, in cases where the consumer does not have assets sufficient to make the balloon payment, balloon-payment mortgages will necessarily require another refinance or will lead to a default. For the reasons discussed in the supplementary information to § 1026.43(d)(1)(ii)(A) E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations above, the Bureau is not expanding the definition of ‘‘standard mortgage’’ to include balloon-payment mortgages. Proposed requirement that loan proceeds be used for limited purposes. Proposed § 226.43(d)(2)(ii)(E) would have restricted the use of the proceeds of a standard mortgage to two purposes: • To pay off the outstanding principal balance on the non-standard mortgage; and • To pay closing or settlement charges required to be disclosed under the Real Estate Settlement Procedures Act, 12 U.S.C. 2601 et seq., which includes amounts required to be deposited in an escrow account at or before consummation. Proposed comment 43(d)(2)(ii)(E)–1 clarified that if the proceeds of a covered transaction are used for other purposes, such as to pay off other liens or to provide additional cash to the consumer for discretionary spending, the transaction does not meet the definition of a ‘‘standard mortgage.’’ The Board expressed concern that permitting the consumers to lose additional equity in their homes under the proposed refinancing provisions could undermine the financial stability of those consumers, thus contravening the purposes of TILA section 129C(a)(6)(E). The Board requested comment, however, on whether some de minimis amount of cash to the consumer should be permitted, either because this allowance would be operationally necessary to cover transaction costs or for other reasons, such as to reimburse a consumer for closing costs that were over-estimated but financed. The Bureau received only one comment on this aspect of the proposal. An association of State bank regulators agreed that the rule should generally restrict the use of the proceeds of the standard mortgage to paying off the outstanding balance on the nonstandard mortgage or to pay closing or settlement costs. However, they urged the Bureau to provide an exemption that would permit loan proceeds to be used to pay for known home repair needs and suggested that any such exemption require the consumer to provide verified estimates in advance in order to ensure that loan proceeds are used only for required home repairs. The Bureau is adopting the limitation on the use of loan proceeds as proposed, renumbered as § 1026.43(d)(1)(ii)(E). The Bureau declines to permit the proceeds of a refinancing conducted in accordance with § 1026.43(d) to be used for home repair purposes, for several reasons. First, the Bureau believes that such an exemption would be VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 inconsistent with the statutory purposes of TILA section 129C(a)(6)(E), which is intended to permit refinancings on the basis of less stringent underwriting in the narrow circumstances where a consumer’s non-standard mortgage is about to recast and lead to a likely default by the consumer. The Bureau believes that permitting a consumer to utilize home equity for home repairs in connection with a refinancing conducted pursuant to § 1026.43(d) could further compromise the financial position of consumers who are already in a risky financial position. The Bureau believes that it would be more appropriate, where home repairs are needed, for a creditor to perform the underwriting required to advance any credit required in connection with those repairs. In addition, the Bureau believes that such an exemption could be subject to manipulation by fraudulent home contractors, by the creditor, and even by a consumer. It would be difficult, even with a requirement that the consumer provide verified estimates, to ensure that amounts being disbursed for home repairs actually are needed, and in fact used, for that purpose. 43(d)(1)(iii) Proposed § 226.43(d)(2)(iii) would have defined the term ‘‘refinancing’’ to have the same meaning as in § 1026.20(a).126 Section 1026.20(a) defines the term ‘‘refinancing’’ generally to mean a transaction in which an existing obligation is ‘‘satisfied and replaced by a new obligation undertaken by the same consumer.’’ Official commentary explains that ‘‘[w]hether a refinancing has occurred is determined by reference to whether the original obligation has been satisfied or extinguished and replaced by a new obligation, based on the parties’ contract and applicable law.’’ See comment 20(a)–1. However, the following are not considered ‘‘refinancings’’ for purposes of § 1026.20(a): (1) A renewal of a payment obligation with no change in the original terms; and (2) a reduction in the annual percentage rate with a corresponding change in the payment schedule. See § 1026.20(a)(1) and (a)(2), and comment 20(a)–2. The Board requested comment on whether the proposed meaning of ‘‘refinancing’’ should be expanded to include a broader range of transactions or otherwise should be defined differently or explained more fully than proposed. The Bureau received no comments on this proposed definition. 126 The Board’s proposal originally referred to 226.20(a), which was subsequently renumbered as 12 CFR 1026.20(a). PO 00000 Frm 00087 Fmt 4701 Sfmt 4700 6493 Accordingly, the Bureau is adopting the definition of refinancing as proposed, renumbered as § 1026.43(d)(1)(iii). 43(d)(2) Scope In the Board’s proposal, § 226.43(d)(2) addressed the definitions for ‘‘nonstandard mortgage,’’ ‘‘standard mortgage,’’ and ‘‘refinancing,’’ while proposed § 226.43(d)(1) established the scope of paragraph (d) and set forth the conditions under which the special refinancing provisions applied. The Bureau believes that paragraph (d) should begin with the relevant definitions, before proceeding to the scope and conditions of the special refinancing provisions. The rule finalized by the Bureau is accordingly reordered. The following discussion details the provisions adopted in § 1026.43(d)(2), which were proposed by the Board under § 226.43(d)(1). Proposed § 226.43(d)(1) would have defined the scope of the refinancing provisions under proposed § 226.43(d). Specifically, proposed § 226.43(d) applied when a non-standard mortgage is refinanced into a standard mortgage and the following conditions are met— • The creditor of the standard mortgage is the current holder of the existing non-standard mortgage or the servicer acting on behalf of the current holder. • The monthly payment for the standard mortgage is significantly lower than the monthly payment for the nonstandard mortgage, as calculated under proposed § 226.43(d)(5). • The creditor receives the consumer’s written application for the standard mortgage before the nonstandard mortgage is ‘‘recast.’’ • The consumer has made no more than one payment more than 30 days late on the non-standard mortgage during the 24 months immediately preceding the creditor’s receipt of the consumer’s written application for the standard mortgage. • The consumer has made no payments more than 30 days late during the six months immediately preceding the creditor’s receipt of the consumer’s written application for the standard mortgage. Proposed comment 43(d)(1)–1 clarified that the requirements for a ‘‘written application,’’ a term that appears in § 226.43(d)(1)(iii), (d)(1)(iv) and (d)(1)(v), discussed in detail below, are found in comment 19(a)(1)(i)–3. Comment 19(a)(1)(i)–3 states that creditors may rely on the Real Estate Settlement Procedures Act (RESPA) and Regulation X (including any interpretations issued by HUD) in E:\FR\FM\30JAR2.SGM 30JAR2 6494 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with deciding whether a ‘‘written application’’ has been received. This comment further states that, in general, Regulation X defines ‘‘application’’ to mean the submission of a borrower’s financial information in anticipation of a credit decision relating to a federally related mortgage loan. See 12 CFR 1024.2(b). Comment 19(a)(1)(i)–3 clarifies that an application is received when it reaches the creditor in any of the ways applications are normally transmitted, such as by mail, hand delivery, or through an intermediary agent or broker. The comment further clarifies that, if an application reaches the creditor through an intermediary agent or broker, the application is received when it reaches the creditor, rather than when it reaches the agent or broker. Comment 19(a)(1)(i)–3 also cross-references comment 19(b)–3 for guidance in determining whether or not the transaction involves an intermediary agent or broker. The Bureau received no comments on this proposed comment, which is adopted as proposed, renumbered as 43(d)(2)–1. 43(d)(2)(i) Proposed § 226.43(d)(1)(i) would have required that the creditor for the new mortgage loan also be either the current holder of the existing non-standard mortgage or the servicer acting on behalf of the current holder. This provision was intended to implement the requirement in TILA section 129C(a)(6)(E) that the existing loan must be refinanced by ‘‘the creditor into a standard loan to be made by the same creditor.’’ The Board interpreted the statutory phrase ‘‘same creditor’’ to mean that the creditor refinancing the loan must have an existing relationship with the consumer. The Board explained that the existing relationship is important because the creditor must be able to easily access the consumer’s payment history and potentially other information about the consumer in lieu of documenting the consumer’s income and assets. The Board also noted that this statutory provision is intended to ensure that the creditor of the refinancing has an interest in placing the consumer into a new loan that is affordable and beneficial. The proposal would have permitted the creditor of the refinanced loan to be the holder, or servicer acting on behalf of the holder, of the existing mortgage. The Board further explained that the existing servicer may be the entity conducting the refinance, particularly for refinances held by GSEs. By also permitting the creditor on the refinanced loan to be the servicer acting on behalf of the holder VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 of the existing mortgage, the proposal was intended to apply to a loan that has been sold to a GSE, refinanced by the existing servicer, and continues to be held by the same GSE. The Board solicited comment on whether the proposed rule could be structured differently to better ensure that the creditor retains an interest in the performance of the new loan and whether additional guidance is needed. Several commenters urged the Bureau to impose a specific period following a refinancing under § 226.43(d) during which the creditor must remain the current holder of the loan. Consumer group commenters suggested that to be eligible for the non-standard mortgage refinancing the creditor should be required to maintain full interest in the refinanced loan for a minimum of 12 months. These commenters expressed concern that the lack of such a retention requirement would permit creditors to refinance loans that are likely to fail without performing the robust underwriting that would otherwise be required for a new loan. If such loans were to be immediately sold to a third party, consumer groups indicated that it could invite abuse by creditors with an incentive to sell riskier loans without providing full value to the consumer. An association of State bank regulators urged the Bureau to adopt a two-year holding period during which the creditor must remain the current holder of the loan. One industry commenter indicated that the Bureau should broaden the scope to permit a subservicer of the loan to be the creditor with respect to the standard loan. Another industry commenter stated that the scope should be expanded to allow a creditor to refinance a non-standard mortgage that it did not originate or is not servicing. This commenter indicated that due to the volume of requests for refinancing received by some creditors, consumers may benefit from more timely refinancing if a third-party creditor is eligible to use non-standard refinancing provisions. The Bureau is adopting this requirement as proposed, renumbered as § 1026.43(d)(2)(i). As discussed in more detail below, as adopted § 1026.43(d) provides a broad exemption to all of the ability-to-repay requirements set forth in § 1026.43(c) when a non-standard mortgage is refinanced into a standard mortgage provided that certain conditions are met. Section 1026.43(d)(2)(i) is adopted pursuant to the Bureau’s authority under section 105(a) of TILA. The Bureau finds that this adjustment is necessary to effectuate the purposes of PO 00000 Frm 00088 Fmt 4701 Sfmt 4700 TILA by ensuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay, while ensuring that consumers at risk of default due to payment shock are able to obtain responsible, affordable refinancing credit from the current holder of the consumer’s mortgage loan, or the servicer acting on behalf of the current holder. To prevent unscrupulous creditors from using § 1026.43(d) to engage in loan-flipping, and to ensure that this exemption is available only in those cases where consumer benefit is the most likely, the Bureau believes that it is important that the creditor of the standard loan be the holder of, or the servicer acting on behalf of the holder of, the non-standard loan. In such cases, the Bureau agrees with the Board that the creditor has a better incentive to refinance the consumer into a more stable and affordable loan. Therefore, the Bureau declines to extend the scope of § 1026.43(d) to cover cases in which the creditor of the non-standard loan is not the current holder of the nonstandard loan or servicer acting on behalf of that holder. The Bureau believes that the combination of this restriction and the other protections contained in § 1026.43(d) is sufficient to prevent unscrupulous creditors from engaging in loan-flipping. Therefore, the Bureau does not believe that it is necessary to impose a specified period during which the creditor of the standard mortgage must remain the holder of the loan. As discussed in the section-by-section analysis of § 1026.43(d)(2)(vi) below, the Bureau has conditioned use of § 1026.43(d), for non-standard loans consummated after the effective date of this final rule, on the non-standard loan having been made in accordance with the ability-to-repay requirements in § 1026.43(c), including consideration of the eight factors listed in § 1026.43(c)(2). The Bureau believes that this will help to ensure that creditors cannot use the refinancing provisions of § 1026.43(d) to systematically make and divest riskier mortgages, or to cure substandard underwriting on a non-standard mortgage by refinancing the consumer into a loan with a lower, but still unaffordable, payment. TILA section 130(k)(1) provides that consumers may assert as a defense to foreclosure by way of recoupment or setoff violations of TILA section 129C(a) (of which TILA section 129C(a)(6)(E) comprises a subpart). 15 U.S.C. 1640(k)(1). This defense to foreclosure applies against assignees of the loan in addition to the original creditor. Therefore, given that E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with the non-standard loan having been originated in accordance with § 1026.43(c) is a condition for using the refinancing provision in § 1026.43(d), a consumer may assert violations of § 1026.43(c) on the original nonstandard loan as a defense to foreclosure for the standard loan made under § 1026.43(d), even if that standard loan is subsequently sold by the creditor. In addition to believing that imposition of a holding period is unnecessary, the Bureau has concerns that imposition of a holding period also could create adverse consequences for the safety and soundness of financial institutions. In some circumstances, a creditor may need for safety and soundness reasons to sell a portion of its portfolio, which may include a residential mortgage loan that was made in accordance with § 1026.43(d). However, such a creditor may not know at the time of the refinancing that it ultimately will need to sell the loan, and may even intend to remain the holder the loan for a longer period of time at the time of consummation. The Bureau has concerns about the burden imposed on issuers by a holding period in such circumstances where the creditor does not or cannot know at the time of the refinance under § 1026.43(d) that the loan will need to be sold within the next 12 months. 43(d)(2)(ii) Proposed § 226.43(d)(1)(ii) would have required that the monthly payment on the new mortgage loan be ‘‘materially lower’’ than the monthly payment for the existing mortgage loan. This proposed provision would have implemented the requirement in TILA section 129C(a)(6)(E) that there be ‘‘a reduction in monthly payment on the existing hybrid loan’’ in order for the special provisions to apply to a refinancing. Proposed comment 43(d)(1)(ii)–1 provided that the monthly payment for the new loan must be ‘‘materially lower’’ than the monthly payment for an existing non-standard mortgage and clarifies that the payments that must be compared must be calculated according to proposed § 226.43(d)(5). The proposed comment also clarified that whether the new loan payment is ‘‘materially lower’’ than the non-standard mortgage payment depends on the facts and circumstances, but that, in all cases, a payment reduction of 10 percent or greater would meet the ‘‘materially lower’’ standard. Consumer groups and an association of State bank regulators supported the adoption of a 10 percent safe harbor for the ‘‘materially lower’’ standard. In contrast, industry commenters opposed VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 the requirement that payment on the standard mortgage be ‘‘materially lower’’ than the payment on the nonstandard mortgage. These commenters urged the Bureau not to adopt the 10 percent safe harbor proposed by the Board and stated that the 10 percent safe harbor would become the de facto rule if adopted. These commenters expressed concerns that the ‘‘materially lower’’ standard would unduly restrict access to credit for many consumers and suggested that the Bureau instead adopt a standard that would permit more consumers to qualify for the nonstandard refinancing provisions. Several commenters indicated that the Bureau should adopt a five percent safe harbor rather than the proposed ten percent. One industry commenter recommended that the Bureau permit reductions of a minimum dollar amount to satisfy the rule, particularly in cases where the monthly payment is already low. Finally, one industry commenter asked the Bureau to provide guidance regarding the meaning of ‘‘materially lower’’ when the reduction in payment is less than 10 percent. The Bureau is adopting as proposed the requirement that the payment on the standard mortgage be ‘‘materially lower’’ than the non-standard mortgage and the safe harbor for a 10 percent or greater reduction, renumbered as § 1026.43(d)(2)(ii) and comment 43(d)(2)(ii)–1. The Bureau agrees with the Board that it would be inconsistent with the statutory purpose to permit the required reduction to be merely de minimis. In such cases, the consumer likely would not obtain a meaningful benefit that would help to prevent default. As discussed in the section-bysection analysis below, § 1026.43(d)(3) exempts refinancings from the abilityto-repay requirements in § 1026.43(c), provided that certain conditions are met. Given that § 1026.43(d) provides a broad exemption to the ability-to-repay requirements, the Bureau believes that it is important that the reduction in payment provide significant value to the consumer and increase the likelihood that the refinancing will improve the consumer’s ability to repay the loan. Accordingly, the Bureau is adopting the 10 percent safe harbor as proposed. The Bureau declines to adopt a dollar amount safe harbor because the appropriate dollar amount would depend on a number of factors, including the amount of the loan and monthly payment, but notes that reductions of less than 10 percent could nonetheless meet the ‘‘materially lower’’ standard depending on the relevant facts and circumstances. PO 00000 Frm 00089 Fmt 4701 Sfmt 4700 6495 43(d)(2)(iii) Proposed § 226.43(d)(1)(iii) would have required that the creditor for the refinancing receive the consumer’s written application for the refinancing before the existing non-standard mortgage is ‘‘recast.’’ As discussed in the section-by-section analysis of § 1026.43(b)(11) above, the proposal defined the term ‘‘recast’’ to mean, for an adjustable-rate mortgage, the expiration of the period during which payments based on the introductory fixed rate are permitted; for an interestonly loan, the expiration of the period during which the interest-only payments are permitted; and, for a negative amortization loan, the expiration of the period during which negatively amortizing payments are permitted. The Board explained that the proposal was intended to implement TILA section 129C(a)(6)(E)(ii), which permits creditors of certain refinances to ‘‘consider if the extension of new credit would prevent a likely default should the original mortgage reset.’’ This statutory language implies that the special refinancing provisions apply only where the original mortgage has not yet ‘‘reset.’’ Accordingly, the Board concluded that Congress’s concern likely was prevention of default in the event of a ‘‘reset,’’ not loss mitigation on a mortgage for which a default on the ‘‘reset’’ payment has already occurred. However, in recognition of the fact that a consumer may not realize that a loan will be recast until the recast occurs and that the consumer could not refinance the loan under proposed § 226.43(d), the Board also requested comment on whether it would be appropriate to use legal authority to make adjustments to TILA to permit refinancings after a loan is recast. Consumer groups urged the Bureau to expand the scope of the non-standard refinancing provisions to apply to applications filed after the initial recast of a non-standard loan has occurred. These commenters stated that the intent of the proposal is to avoid ‘‘likely default’’ and indicated that for some consumers, notification that the consumer’s interest rate has adjusted and their payment has increased may be their first notice that their payment has gone up and increased their likelihood of default. One consumer group commenter stated that these consumers may be better credit risks than those consumers whose loans have not yet recast and they would clearly benefit from a materially lower monthly payment. E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6496 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations Several industry commenters similarly urged the Bureau to modify the provisions to apply to applications for refinancings received after recast of the non-standard loan. One of these commenters stated that the timing of the application is irrelevant to the consumer’s ability to repay or the consumer’s need to refinance. One industry commenter stated that processing an application and assessing a consumer’s ability to repay a new loan may require additional time well before the recast date. This commenter urged the Bureau to expand the scope of the non-standard refinancing provisions to include refinancings after a loan is recast that are in the best interests of consumers. For the reasons discussed below, the Bureau is adopting § 1026.43(d)(2)(iii), which provides that § 1026.43(d) applies to the refinancing of a nonstandard mortgage into a standard mortgage when the creditor receives the consumer’s written application for the standard mortgage no later than two months after the non-standard mortgage has recast, provided certain other conditions are met. The Bureau believes that the best reading of TILA section 129C(a)(6)(E) is that it is intended to facilitate refinancings for consumers at risk of default due to the ‘‘payment shock’’ that may occur upon the recast of the consumer’s loan to a higher rate or fully amortizing payments. The Bureau acknowledges that the statutory language contemplates that such recast has not yet occurred. However, the Bureau does not believe that Congress intended to provide relief for consumers facing imminent ‘‘payment shock’’ based on how promptly the consumer filed, or how quickly the creditor processed, an application for a refinancing. For example, the periodic rate on a mortgage loan may recast on July 1st, but the higher payment reflecting the recast interest rate would not be due until August 1st. In this example, a consumer may not experience payment shock until a month after the consumer’s rate recasts. Additionally, it may take a significant amount of time for a consumer to provide the creditor with all of the information required by the creditor, thereby triggering the receipt of an application for purposes of the abilityto-repay requirements. The Bureau does not believe that Congress intended the special treatment afforded by TILA section 129C(a)(6)(E) to hinge on paperwork delays such as these. The Bureau agrees with the arguments raised by commenters and believes that the purposes of TILA are best effectuated by VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 permitting consumers to submit applications for refinancings for a short period of time after recast occurs. The Bureau has determined that permitting a consumer to apply for a refinancing within two months of the date of recast strikes the appropriate balance between the language of the statute and the practical considerations involved with submitting an application for a refinancing in response to payment shock. Pursuant to its authority under TILA section 105(a), the Bureau finds that modifying § 1026.43(d) to apply to extensions of credit where the creditor receives the consumer’s written application for the standard mortgage no later than two months after the nonstandard mortgage has recast ensures that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay while ensuring that responsible, affordable mortgage credit remains available to consumers at risk of default due to higher payments resulting from the recast. 43(d)(2)(iv) Proposed § 226.43(d)(1)(iv) would have required that, during the 24 months immediately preceding the creditor’s receipt of the consumer’s written application for the standard mortgage, the consumer has made no more than one payment on the nonstandard mortgage more than 30 days late. Proposed comment 43(d)(1)(iv)–1 provided an illustrative example. Together with proposed § 226.43(d)(1)(v), proposed § 226.43(d)(1)(iv) would have implemented the portion of TILA section 129C(a)(6)(E) that requires that the consumer not have been ‘‘delinquent on any payment on the existing hybrid loan.’’ Although TILA section 129C(a)(6)(E) contains a statutory prohibition on ‘‘any’’ delinquencies on the existing non-standard (‘‘hybrid’’) mortgage, the Board interpreted its proposal as consistent with the statute in addition to being consistent with the consumer protection purpose of TILA and current industry practices. In addition, the Board noted its authority under TILA sections 105(a) and 129B(e)—which has since transferred to the Bureau—to adjust provisions of TILA and condition practices ‘‘to assure that consumers are offered and receive residential mortgage loan on terms that reasonably reflect their ability to repay the loans and that are understandable and not unfair, deceptive, or abusive.’’ 15 U.S.C. 1604(a); 15 U.S.C. 1639b(e); TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2). PO 00000 Frm 00090 Fmt 4701 Sfmt 4700 The Board provided several reasons for proposing to require a look-back period for payment history of 24 months, rather than a 12-month period. First, the Board noted that consumers at risk of default when higher payments are required might present greater credit risks to the institutions holding their loans, even if the institutions refinance those loans. Second, the Board noted views expressed during outreach by GSE and creditor representatives that consumers with positive payment histories tend to be less likely than other consumers to become obligated on a new loan for which they cannot afford the monthly payments. The Board solicited comment on the proposal to require that the consumer have only one delinquency during the 24 months prior to applying for a refinancing, particularly on whether a longer or shorter look-back period should be required. In addition, under the proposal, late payments of 30 days or fewer on the existing, non-standard mortgage would not disqualify a consumer from refinancing the non-standard mortgage under the streamlined refinance provisions of proposed § 226.43(d). The Board stated that allowing delinquencies of 30 or fewer days is consistent with the statutory prohibition on ‘‘any’’ delinquency for several reasons. First, the Board noted that delinquencies of this length may occur for many reasons outside of the consumer’s control, such as mailing delays, miscommunication about where the payment should be sent, or payment crediting errors. Second, many creditors incorporate a late fee ‘‘grace period’’ into their payment arrangements, which permits consumers to make their monthly payments for a certain number of days after the contractual due date without incurring a late fee. Accordingly, the Board noted that the statute should not be read to prohibit consumers from obtaining needed refinances due to payments that are late but within a late fee grace period. Finally, the Board indicated that the predominant streamlined refinance programs of which it is aware uniformly measure whether a consumer has a positive payment history based on whether the consumer has made any payments late by 30 days (or, as in the proposal, more than 30 days). Proposed comment 43(d)(1)(iv)–2 would have clarified that whether a payment is more than 30 days late depends on the contractual due date not accounting for any grace period and provided an illustrative example. The Board indicated that using the contractual due date for determining E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations whether a payment has been made more than 30 days after the due date would facilitate compliance and enforcement by providing clarity. Whereas late fee ‘‘grace periods’’ are often not stated in writing, the contractual due date is unambiguous. Finally, the Board stated that using the contractual due date for determining whether a loan payment is made on time is consistent with standard home mortgage loan contracts. The Board requested comment on whether the delinquencies that creditors are required to consider under § 226.43(d)(1) should be late payments of more than 30 days as proposed, 30 days or more, or some other time period. Consumer groups supported the Board’s proposal to identify late payments as late payments of more than 30 days. However, they stated that the requirement that consumers not have more than one delinquency in the past 24 months to qualify for a refinance under § 1026.43(d) was overly stringent and that the appropriate standard would be no delinquencies in the past 12 months. Several industry commenters similarly urged the Bureau to adopt a 12-month period rather than the proposed 24-month period in which a consumer may have one late payment. These commenters stated that permitting only one 30-day late payment in the past 24 months is too restrictive and would require a creditor to overlook a recent history of timely payments. In addition, one industry commenter stated that the standard for defining a late payment should be late payments of more than 60 days. The Bureau is adopting this provision generally as proposed, renumbered as § 1026.43(d)(2)(iv), with one substantive change. The Bureau is adopting a 12month look-back period rather than the 24-month period proposed by the Board. The Bureau believes that reviewing a consumer’s payment history over the last 12 months would be more appropriate than a 24-month period, and agrees that a 24-month period may unduly restrict consumer access to the § 1026.43(d) refinancing provisions. The Bureau believes that the requirement that a consumer’s account have no more than one 30-day late payment in the past 12 months will best effectuate the purposes of TILA by ensuring that only those consumers with positive payment histories are eligible for the nonstandard refinancing provisions under § 1026.43(d). Section 1026.43(d)(2)(iv) is adopted pursuant to the Bureau’s authority under section 105(a) of TILA. The Bureau finds that this adjustment is necessary and proper to effectuate the purposes of TILA by ensuring that VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay, while ensuring that consumers at risk of default due to payment shock are able to obtain responsible, affordable refinancing credit. The Bureau also is adopting comments 43(d)(1)(iv)–1 and 43(d)(1)(iv)–2 generally as proposed, with conforming amendments to reflect the 12-month look-back period in § 1026.43(d)(2)(iv), and renumbered as 43(d)(2)(iv)–1 and 43(d)(2)(iv)–2. The Bureau has made several technical amendments to the example in comment 43(d)(2)(iv)–1 for clarity. As proposed, the examples in the comment referred to dates prior to the effective date of this rule; the Bureau has updated the dates in the examples so that they will occur after this rule becomes effective. 43(d)(2)(v) Proposed § 226.43(d)(1)(v) would have required that the consumer have made no payments on the non-standard mortgage more than 30 days late during the six months immediately preceding the creditor’s receipt of the consumer’s written application for the standard mortgage. This provision complemented proposed § 226.43(d)(1)(iv), discussed above, in implementing the portion of TILA section 129C(a)(6)(E) that requires that the consumer not have been ‘‘delinquent on any payment on the existing hybrid loan.’’ Taken together with proposed § 226.43(d)(1)(iv), the Board believed that this is a reasonable interpretation of the prohibition on ‘‘any’’ delinquencies on the nonstandard mortgage and is supported by the Board’s authority under TILA sections 105(a) and 129B(e)—which has transferred to the Bureau—to adjust provisions of TILA and condition practices ‘‘to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans and that are understandable and not unfair, deceptive, or abusive.’’ 15 U.S.C. 1604(a); TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2). The Board stated that a six-month ‘‘clean’’ payment record indicates a reasonable level of financial stability on the part of the consumer applying for a refinancing. In addition, the Board noted that participants in its outreach indicated that a prohibition on delinquencies of more than 30 days for the six months prior to application for the refinancing was generally consistent with common industry practice and would not be unduly disruptive to PO 00000 Frm 00091 Fmt 4701 Sfmt 4700 6497 existing streamlined refinance programs with well-performing loans. Proposed comment 43(d)(1)(v)–1 provided an illustrative example of the proposed rule and clarified that if the number of months between consummation of the non-standard mortgage and the consumer’s application for the standard mortgage is six or fewer, the consumer may not have made any payment more than 30 days late on the non-standard mortgage. The comment cross-referenced proposed comments 43(d)(1)–2 and 43(d)(1)(iv)–2 for an explanation of ‘‘written application’’ and how to determine the payment due date, respectively. One industry commenter stated that the prohibition on late payments in the past six months should be amended to provide flexibility when the late payment was due to extenuating circumstances. The Bureau declines to adopt a rule providing an adjustment for extenuating circumstances, for several reasons. First, the existence or absence of extenuating circumstances is a factspecific question and it would be difficult to distinguish by regulation between extenuating circumstances that reflect an ongoing risk with regard to the consumer’s ability to repay the loan versus extenuating circumstances that present less risk. In addition, an adjustment for extenuating circumstances appears to be inconsistent with the purposes of TILA section 129C(a)(6)(E), which contemplates that the consumer ‘‘has not been delinquent on any payment on the existing hybrid loan,’’ without distinguishing between payments that are delinquent due to extenuating circumstances or otherwise. Furthermore, by defining a late payment as more than 30 days late, the Bureau believes that many extenuating circumstances, for example a payment made three weeks late due to mail delivery issues, will not preclude use of § 1026.43(d). Accordingly, the Bureau is adopting this provision as proposed, renumbered as § 1026.43(d)(2)(v). Similarly, the Bureau is adopting comment 43(d)(1)(v)–1 generally as proposed, with several technical amendments for clarity and renumbered as 43(d)(2)(v)–1. As proposed, the examples in the comment referred to dates prior to the effective date of this rule; the Bureau has updated the dates in the examples so that they will occur after this rule becomes effective. Pursuant to its authority under TILA section 105(a), the Bureau finds that requiring that the consumer have made no payments on the non-standard mortgage more than 30 days late during the six months E:\FR\FM\30JAR2.SGM 30JAR2 6498 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations immediately preceding the creditor’s receipt of the consumer’s written application for the standard mortgage ensures that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay while ensuring that responsible, affordable mortgage credit remains available to consumers at risk of default due to higher payments resulting from the recast. 43(d)(2)(vi) For the reasons discussed in the section-by-section analysis of § 1026.43(d)(3), the Bureau is adopting a new § 1026.43(d)(2)(vi) that generally conditions use of § 1026.43(d) on the existing non-standard mortgage having been made in accordance with § 1026.43(c), provided that the existing non-standard mortgage loan was consummated on or after January 10, 2014. For the reasons discussed in the section-by-section analysis of § 1026.43(d)(3), the Bureau believes that this provision is necessary and proper to prevent use of § 1026.43(d)’s streamlined refinance provision to circumvent or ‘‘cure’’ violations of the ability-to-repay requirements in § 1026.43(c). Section 1026.43(d)(2)(vi) is adopted pursuant to the Bureau’s authority under TILA section 105(a). The Bureau finds that this adjustment is necessary to effectuate the purposes of TILA by ensuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay, while ensuring that consumers at risk of default due to payment shock are able to obtain responsible and affordable refinancing credit. Furthermore, the Bureau believes that this adjustment is necessary to prevent unscrupulous creditors from using § 1026.43(d) to engage in loanflipping or other practices that are harmful to consumers, thereby circumventing the requirements of TILA. sroberts on DSK5SPTVN1PROD with 43(d)(3) Exemption From Repayment Ability Requirements Under specific conditions, proposed § 226.43(d)(3) would have exempted a creditor in a refinancing from two of the ability-to-repay requirements under proposed § 226.43(c). First, the proposal provided that a creditor is not required to comply with the income and asset verification requirements of proposed § 226.43(c)(2)(i) and (c)(4). Second, the proposal provided that the creditor is not required to comply with the payment calculation requirements of proposed § 226.43(c)(2)(iii) and (c)(5); the creditor may instead use payment VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 calculations prescribed in proposed § 226.43(d)(5)(ii). For these exemptions to apply, proposed § 226.43(d)(3)(i)(A) would have required that all of the conditions in proposed § 226.43(d)(1)(i) through (v) be met. In addition, proposed § 226.43(d)(3)(i)(B) would have required that the creditor consider whether the standard mortgage will prevent a likely default by the consumer on the nonstandard mortgage when the nonstandard mortgage is recast. This proposed provision implemented TILA section 129C(a)(6)(E)(ii), which permits a creditor to ‘‘consider if the extension of new credit would prevent a likely default should the original mortgage reset and give such concerns a higher priority as an acceptable underwriting practice.’’ As clarified in proposed comment 43(d)(3)(i)–1, the Board interpreted TILA section 129(a)(6)(E)(ii) to require a creditor to consider whether: (1) The consumer is likely to default on the existing mortgage once new, higher payments are required; and (2) the new mortgage will prevent the consumer’s default. The Board solicited comment regarding whether these proposed provisions were appropriate, and also specifically solicited comment on whether exemptions from the abilityto-repay requirements, other than those proposed, were appropriate. Several commenters expressly supported this proposed provision. An association of State bank supervisors stated that refinancing designed to put a consumer in a higher-quality standard mortgage before the existing lowerquality mortgage recasts should be given greater deference and further stated that it is sound policy to encourage refinancing where it protects both the economic interest of the creditor and the financial health of the consumer. Consumer groups commented that limited and careful exemption from income verification, provided that protections are in place, can help consumers and communities, while preventing reckless and abusive lending on the basis of little or no documentation. Civil rights organizations also stated that the streamlined refinance option would provide much-needed relief for consumers with loans that are not sustainable in the long term but who are not yet in default. These commenters also stated that minority consumers have been targeted in the past for unsustainable loans and that this provision could help to prevent further foreclosures and economic loss in minority communities, as well as for homeowners in general. PO 00000 Frm 00092 Fmt 4701 Sfmt 4700 Other consumer group commenters stated that an exemption to the income verification requirement for refinancing into standard mortgages is problematic. One commenter stated that, because the refinance would be executed by the same creditor that made the original hybrid loan, income verification would not be difficult. This commenter urged the Bureau to encourage income documentation when implementing the Dodd-Frank Act. Several industry commenters urged the Bureau to provide additional relief for refinancings made in accordance with proposed § 226.43(d), either by permitting the standard loan to be classified as a qualified mortgage or by providing exemptions from other of the proposed ability-to-repay requirements. One industry commenter stated that in addition to the proposed exemption for the verification of income and assets, refinancings conducted in accordance with § 226.43(d) also should be exempt from the requirements to consider the consumer’s debt-to-income ratio or residual income, if the consumer is still employed and has not incurred significant additional debt obligations prior to the refinance. This commenter stated that overly rigid standards could significantly reduce the number of consumers who qualify for this exemption. Similarly, one industry trade association urged the Bureau to exempt refinancings from the requirement to consider the consumer’s debt obligations, debt-to-income ratio, and employment. This commenter stated that the proposed requirement to consider these additional underwriting factors was seemingly in conflict with the purpose of proposed § 226.43(d) and would preclude consumers from taking advantage of beneficial and less costly refinancing opportunities. In addition, several industry commenters and one industry trade association commented that standard mortgages made in accordance with § 226.43(d) should be treated as qualified mortgages. The Bureau agrees with the concerns raised by commenters that the proposed exemptions were drawn too narrowly. The Bureau believes that TILA section 129C(a)(6)(E) is intended to create incentives for creditors to refinance loans in circumstances where consumers have non-standard loans on which they are currently able to make payments but on which they are likely to be unable to make the payments after recast and therefore default on the loan. Accordingly, the Bureau believes that in order to create incentives for creditors to use the non-standard refinancing provision, TILA section 129C(a)(6)(E) must be intended to provide at least a E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations limited exemption from the general ability-to-repay determination as adopted in § 1026.43(c). Otherwise, creditors may have little incentive to provide consumers at risk of default with refinancings that result in ‘‘materially lower’’ payments. The Bureau believes, however, that in implementing TILA section 129C(a)(6)(E) it is important to balance the creation of additional flexibility and incentives for creditors to refinance non-standard mortgages into standard mortgages against the likelihood of benefit to the consumer. The Bureau notes that under the final rule as adopted, the availability of the non-standard refinancing provision contains several conditions that are intended to benefit the consumer. First, the special ability-to-repay requirements in § 1026.43(d) are available only if the conditions in § 1026.43(d)(2) are met. These conditions include limiting the scope of § 1026.43(d) to refinancings of non-standard mortgages into standard mortgages, which generally are more stable products with reduced risk of payment shock. The definition of standard mortgage in § 1026.43(d)(1)(ii) includes a number of limitations that are intended to ensure that creditors may only use the provisions in § 1026.43(d) to offer a consumer a product with safer features. For example, as discussed in the section-bysection analysis of § 1026.43(d)(1)(ii) a standard mortgage may not include negative amortization, an interest-only feature, or a balloon payment; in addition, the term of the standard mortgage may not exceed 40 years, the interest rate must be fixed for at least the first five years, the loan is subject to a limitation on the points and fees that may be charged, and there are limitations on the use of proceeds from the refinancing. Furthermore, § 1026.43(d)(2)(ii) requires that the monthly payment on the standard mortgage be materially lower than the monthly payment for the non-standard mortgage and, as discussed above, the Bureau is adopting a 10 percent safe harbor for what constitutes a ‘‘material’’ reduction. The Bureau has concerns that, as proposed by the Board, an exemption only from the requirement to consider and verify the consumer’s income or assets may create insufficient incentives for creditors to make refinancings to assist consumers at risk of default. For example, the proposal would have required creditors to comply with the requirement in § 1026.43(c)(2)(vii) to consider the consumer’s debt-to-income ratio or residual income. Accordingly, notwithstanding an exemption from VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 income or asset verification, the proposal would have required consideration of income, as well as consideration of all of the other underwriting criteria set forth in § 1026.43(c)(2). The Bureau believes that in light of the safeguards imposed by other portions of § 1026.43(d), as discussed above, it is appropriate to provide an exemption to all of the ability-to-repay requirements under § 1026.43(c) for a refinance conducted in accordance with § 1026.43(d). The Bureau believes that a broad exemption from the general ability-to-repay determination is appropriate in order to create incentives for creditors to quickly and efficiently refinance consumers whose nonstandard mortgages are about to recast, thus rendering them likely to default, into more affordable, more stable mortgage loans. The Bureau is aware that some consumers may nonetheless default on a standard mortgage made in accordance with § 1026.43(d), but those consumers likely would have defaulted had the non-standard mortgage remained in place. For others, the material reduction in payment required under § 1026.43(d)(2) and the more stable product type following refinancing may be sufficient to enable consumers to avoid default. The Bureau believes that a refinancing conducted in accordance with § 1026.43(d) will generally improve a consumer’s chances of avoiding default. Section 1026.43(d)(3) is adopted pursuant to the Bureau’s authority under TILA section 105(a). The Bureau finds that this adjustment is necessary to effectuate the purposes of TILA by ensuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay, while ensuring that consumers at risk of default due to payment shock are able to obtain responsible and affordable refinancing credit. However, to prevent evasion or circumvention of the ability-to-repay requirements in § 1026.43(c), the Bureau is imposing one additional condition on the use of § 1026.43(d). Specifically, new § 1026.43(d)(2)(vi) conditions the use of § 1026.43(d), for non-standard mortgages consummated on or after the effective date of this rule, on the nonstandard mortgage having been made in accordance with § 1026.43(c). The Bureau has concerns that absent § 1026.43(d)(2)(vi), a creditor might attempt to use a refinancing conducted in accordance with § 1026.43(d) to ‘‘cure’’ substandard underwriting of the prior non-standard mortgage. For example, without § 1026.43(d)(2)(vi), if a creditor discovered that it had made PO 00000 Frm 00093 Fmt 4701 Sfmt 4700 6499 an error in consideration of the underwriting factors under § 1026.43(c)(2) for a non-standard mortgage, the creditor might consider conducting a refinancing under § 1026.43(d), in order to argue that the consumer may no longer raise as a defense to foreclosure the underwriting of the original non-standard mortgage. The Bureau believes that conditioning the use of § 1026.43(d) on the earlier loan having been made in accordance with § 1026.43(c) will better effectuate the purposes of TILA by ensuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay while preventing unscrupulous creditors from evading the ability-torepay requirements. New § 1026.43(d)(2)(vi) applies only to non-standard mortgages consummated on or after the effective date of this rule. For non-standard loans consummated before the effective date of this final rule, a refinancing under § 1026.43(d) would not be subject to this condition. The Bureau believes that non-standard mortgages made prior to the effective date, to which the abilityto-repay requirements in § 1026.43(c) did not apply, may present an increased risk of default when they are about to recast, so that facilitating refinancing into more stable mortgages may be particularly important even if the consumer could not qualify for a new loan under traditional ability-to-repay requirements. The Bureau believes that, on balance, given the conditions that apply to refinances under § 1026.43(d), refinances of these loans are more likely to benefit consumers than to harm consumers, notwithstanding the inapplicability of § 1026.43(d)(2)(vi). In addition, the concern about a creditor using § 1026.43(d) to ‘‘cure’’ prior violations of § 1026.43(c) does not apply to loans made before the effective date of this rule, as such loans were not required to be made in accordance with § 1026.43. Proposed condition that the consumer will likely default. Proposed comment 43(d)(3)(i)–2 would have clarified that, in considering whether the consumer’s default on the non-standard mortgage is ‘‘likely,’’ the creditor may look to widely accepted governmental and nongovernmental standards for analyzing a consumer’s likelihood of default. The proposal was not intended, however, to constrain servicers and other relevant parties from using other methods to determine a consumer’s likelihood of default, including those tailored specifically to that servicer. As discussed in the supplementary information to the proposal, the Board E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6500 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations considered certain government refinancing programs as well as feedback from outreach participants, each of which suggested that there may be legitimate differences in servicer assessments of a consumer’s likelihood of default. The Board noted that it considered an ‘‘imminent default’’ standard but heard from consumer advocates that ‘‘imminent default’’ may be a standard that is too high for the refinancing provisions in TILA section 129C(a)(6)(E) and could prevent many consumers from obtaining a refinancing to avoid payment shock. Accordingly, the Board’s proposal used the exact statutory wording—‘‘likely default’’—in implementing the provision permitting a creditor to prioritize prevention of default in underwriting a refinancing. The Board solicited comment on the proposal to use the term ‘‘likely default’’ in implementing TILA section 129C(a)(6)(E)(ii) and on whether additional guidance is needed on how to meet the requirement that a creditor must reasonably and in good faith determine that a standard mortgage will prevent a likely default should the nonstandard mortgage be recast. Two industry trade associations urged the Bureau to remove proposed § 226.43(d)(3)(i)(B) as a condition to the availability of the non-standard refinancing provisions. One of these commenters noted that a creditor would have to underwrite a consumer’s income and assets to determine whether the consumer would likely default, which would defeat the purpose of the proposed provision. Several industry commenters also indicated that the ‘‘likelihood of default’’ standard is vague and accordingly subjects creditors to potential liability for waiving certain ability-to-repay requirements, and questioned the extent to which creditors would utilize the streamline refinance option in light of this potential liability. One such commenter urged the Bureau to eliminate this requirement or, in the alternative, to provide additional guidance regarding when a consumer is ‘‘likely to go into default.’’ An association of State bank supervisors stated that there can be no quantifiable standard for the definition of ‘‘likely default.’’ These commenters further stated that institutions must use sound judgment and regulators must provide responsible oversight to ensure that abuses are not occurring through the refinancing exemption set forth in § 1026.43(d). The Bureau is adopting the provision as proposed, renumbered as § 1026.43(d)(3)(i)(B), and is also adopting comments 43(d)(3)(i)–1 and 43(d)(3)(i)–2 as proposed. The Bureau VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 believes that eliminating the requirement that a creditor consider whether the extension of new credit would prevent a likely default would be inconsistent with TILA section 129C(a)(6)(E), which expressly includes language regarding consideration by the creditor of ‘‘[whether] the extension of new credit would prevent a likely default should the original mortgage reset.’’ At the same time, the Bureau agrees with the association of State bank supervisors that it would be difficult to impose by regulation a single standard for what constitutes a likely default. Accordingly, the Bureau is adopting the flexible approach proposed by the Board, which would permit but not require creditors to look to widelyaccepted standards for analyzing a consumer’s likelihood of default. The Bureau does not believe that this flexible approach requires a creditor to consider the consumer’s income and assets if, for example, statistical evidence indicates that consumers who experience a payment shock of the type that the consumer is about to experience have a high incidence of defaulting following the payment shock. Proposed payment calculation for repayment ability determination. Proposed comment 43(d)(3)(ii)–1 would have explained that, if the conditions in proposed § 226.43(d)(1) are met, the creditor may satisfy the payment calculation requirements for determining a consumer’s ability to repay the new loan by applying the calculation prescribed under proposed § 226.43(d)(5)(ii), rather than the calculation prescribed under proposed § 226.43(c)(2)(iii) and (c)(5). As discussed in the section-by-section analysis above, as adopted § 1026.43(d)(3) provides an exemption from the requirements of § 1026.43(c) if certain conditions are met. Accordingly, while the creditor is required to determine whether there is a material reduction in payment consistent with § 1026.43(d)(2)(ii) by using the payment calculations prescribed in § 1026.43(d)(5), the creditor is not required to use these same payment calculations for purposes of § 1026.43(c). Accordingly, the Bureau is withdrawing proposed comment 43(d)(3)(ii)–1 as unnecessary. 43(d)(4) Offer of Rate Discounts and Other Favorable Terms Proposed § 226.43(d)(4) would have provided that a creditor making a loan under the special refinancing provisions of § 226.43(d) may offer to the consumer the same or better rate discounts and other terms that the creditor offers to any new consumer, consistent with the PO 00000 Frm 00094 Fmt 4701 Sfmt 4700 creditor’s documented underwriting practices and to the extent not prohibited by applicable State or Federal law. This aspect of the proposal was intended to implement TILA section 129C(a)(6)(E)(iii), which permits creditors of refinancings subject to special ability-to-repay requirements in TILA section 129C(a)(6)(E) to ‘‘offer rate discounts and other favorable terms’’ to the consumer ‘‘that would be available to new customers with high credit ratings based on such underwriting practice.’’ The Bureau received no comments on this provision, which is adopted as proposed and renumbered as § 1026.43(d)(4). The Bureau is concerned that the phrase ‘‘consistent with the creditor’s underwriting practice’’ could be misinterpreted to refer to the underwriting requirements in § 1026.43(c). As this final rule provides an exemption under § 1026.43(d) for all of the requirements in § 1026.43(c), subject to the other conditions discussed above, the Bureau believes that additional clarification is needed to address this potential misinterpretation. Thus, the Bureau is adopting comment 43(d)(4)–1, which clarifies that in connection with a refinancing made pursuant to § 1026.43(d), § 1026.43(d)(4) requires a creditor offering a consumer rate discounts and terms that are the same as, or better than, the rate discounts and terms offered to new consumers to make such an offer consistent with the creditor’s documented underwriting practices. Section 1026.43(d)(4) does not require a creditor making a refinancing pursuant to § 1026.43(d) to comply with the underwriting requirements of § 1026.43(c). Rather, § 1026.43(d)(4) requires creditors providing such discounts to do so consistent with documented policies related to loan pricing, loan term qualifications, or other similar underwriting practices. For example, assume that a creditor is providing a consumer with a refinancing made pursuant to § 1026.43(d) and that this creditor has a documented practice of offering rate discounts to consumers with credit scores above a certain threshold. Assume further that the consumer receiving the refinancing has a credit score below this threshold, and therefore would not normally qualify for the rate discount available to consumers with high credit scores. This creditor complies with § 1026.43(d)(4) by offering the consumer the discounted rate in connection with the refinancing made pursuant to § 1026.43(d), even if the consumer would not normally E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations qualify for that discounted rate, provided that the offer of the discounted rate is not prohibited by applicable State or Federal law. However, § 1026.43(d)(4) does not require a creditor to offer a consumer such a discounted rate. sroberts on DSK5SPTVN1PROD with 43(d)(5) Payment Calculations Proposed § 226.43(d)(5) would have prescribed the payment calculations for determining whether the consumer’s monthly payment for a standard mortgage will be ‘‘materially lower’’ than the monthly payment for the nonstandard mortgage. Proposed § 226.43(d)(5) thus was intended to complement proposed § 226.43(d)(1)(ii) in implementing TILA section 129C(a)(6)(E), which requires a ‘‘reduction’’ in the monthly payment for the existing non-standard (‘‘hybrid’’) mortgage when refinanced into a standard mortgage. 43(d)(5)(i) Non-Standard mortgage Proposed § 226.43(d)(5)(i) would have required that the monthly payment for a non-standard mortgage be based on substantially equal, monthly, fully amortizing payments of principal and interest that would result once the mortgage is recast. The Board stated that comparing the payment on the standard mortgage to the payment amount on which the consumer likely would have defaulted (i.e., the payment resulting on the existing non-standard mortgage once the introductory terms cease and a higher payment results) would promote needed refinances consistent with Congress’s intent. The Board noted that the payment that the consumer is currently making on the existing non-standard mortgage may be an inappropriately low payment to compare to the standard mortgage payment. The existing payments may be interest-only or negatively amortizing; these temporarily lower payment amounts would be difficult for creditors to ‘‘reduce’’ with a refinanced loan that has a comparable term length and principal amount. Indeed, the payment on a new loan with a fixed-rate rate and fully-amortizing payment, as is required for the payment calculation of a standard mortgage under the proposal, for example, is likely to be higher than the interest-only or negative amortization payment. As a result, few refinancings would yield a lower monthly payment, so many consumers could not receive the benefits of refinancing into a more stable loan product. Accordingly, the proposal would have required a creditor to calculate the monthly payment for a non-standard mortgage using— VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 • The fully indexed rate as of a reasonable period of time before or after the date on which the creditor receives the consumer’s written application for the standard mortgage; • The term of the loan remaining as of the date of the recast, assuming all scheduled payments have been made up to the recast date and the payment due on the recast date is made and credited as of that date; and • A remaining loan amount that is— Æ For an adjustable-rate mortgage, the outstanding principal balance as of the date the mortgage is recast, assuming all scheduled payments have been made up to the recast date and the payment due on the recast date is made and credited as of that date; Æ For an interest-only loan, the loan amount, assuming all scheduled payments have been made up to the recast date and the payment due on the recast date is made and credited as of that date; Æ For a negative amortization loan, the maximum loan amount. Proposed comment 43(d)(5)(i)–1 would have explained that, to determine whether the monthly periodic payment for a standard mortgage is materially lower than the monthly periodic payment for the non-standard mortgage under proposed § 226.43(d)(1)(ii), the creditor must consider the monthly payment for the non-standard mortgage that will result after the loan is recast, assuming substantially equal payments of principal and interest that amortize the remaining loan amount over the remaining term as of the date the mortgage is recast. The proposed comment noted that guidance regarding the meaning of ‘‘substantially equal’’ and ‘‘recast’’ is provided in comment 43(c)(5)(i)–4 and § 226.43(b)(11), respectively. Proposed comment 43(d)(5)(i)–2 would have explained that the term ‘‘fully indexed rate’’ used for calculating the payment for a non-standard mortgage is generally defined in proposed § 226.43(b)(3) and associated commentary. The proposed comment explained an important difference between the ‘‘fully indexed rate’’ as defined in proposed § 226.43(b)(3), however, and the meaning of ‘‘fully indexed rate’’ in § 226.43(d)(5)(i). Specifically, under proposed § 226.43(b)(3), the fully indexed rate is calculated at the time of consummation. Under proposed § 226.43(d)(5)(i), the fully indexed rate would be calculated within a reasonable period of time before or after the date on which the creditor receives the consumer’s written application for the standard mortgage. Comment 43(d)(5)(i)–2 clarified that 30 PO 00000 Frm 00095 Fmt 4701 Sfmt 4700 6501 days would generally be considered a ‘‘reasonable period of time.’’ Proposed comment 43(d)(5)(i)–3 would have clarified that the term ‘‘written application’’ is explained in comment 19(a)(1)(i)–3. Comment 19(a)(1)(i)–3 states that creditors may rely on RESPA and Regulation X (including any interpretations issued by HUD) in deciding whether a ‘‘written application’’ has been received. In general, Regulation X defines ‘‘application’’ to mean the submission of a borrower’s financial information in anticipation of a credit decision relating to a federally related mortgage loan. See 12 CFR 1024.2(b). As explained in comment 19(a)(1)(i)–3, an application is received when it reaches the creditor in any of the ways applications are normally transmitted, such as by mail, hand delivery, or through an intermediary agent or broker. If an application reaches the creditor through an intermediary agent or broker, the application is received when it reaches the creditor, rather than when it reaches the agent or broker. This proposed comment also cross-referenced comment 19(b)–3 for guidance in determining whether the transaction involves an intermediary agent or broker. Proposed payment calculation for an adjustable-rate mortgage with an introductory fixed rate. Proposed comments 43(d)(5)(i)–4 and –5 would have clarified the payment calculation for an adjustable-rate mortgage with an introductory fixed rate under proposed § 226.43(d)(5)(i). Proposed comment 43(d)(5)(i)–4 clarified that the monthly periodic payment for an adjustable-rate mortgage with an introductory fixed interest rate for a period of one or more years must be calculated based on several assumptions. First, the payment must be based on the outstanding principal balance as of the date on which the mortgage is recast, assuming all scheduled payments have been made up to that date and the last payment due under those terms is made and credited on that date. Second, the payment calculation must be based on substantially equal monthly payments of principal and interest that will fully repay the outstanding principal balance over the term of the loan remaining as of the date the loan is recast. Third, the payment must be based on the fully indexed rate, as defined in § 226.43(b)(3), as of the date of the written application for the standard mortgage. The proposed comment set forth an illustrative example. Proposed comment 43(d)(5)(i)–5 would have provided a second illustrative example of the payment calculation for an E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6502 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations adjustable-rate mortgage with an introductory fixed rate. Proposed payment calculation for an interest-only loan. Proposed comments 43(d)(5)(i)–6 and –7 would have explained the payment calculation for an interest-only loan under proposed § 226.43(d)(5)(i). Proposed comment 43(d)(5)(i)–6 would have clarified that the monthly periodic payment for an interest-only loan must be calculated based on several assumptions. First, the payment must be based on the loan amount, as defined in § 226.43(b)(5), assuming all scheduled payments are made under the terms of the legal obligation in effect before the mortgage is recast. The comment provides an example of a mortgage with a 30-year loan term for which the first 24 months of payments are interest-only. The comment then explains that, if the 24th payment is due on September 1, 2013, the creditor must calculate the outstanding principal balance as of September 1, 2013, assuming that all 24 payments under the interest-only payment terms have been made and credited. Second, the payment calculation must be based on substantially equal monthly payments of principal and interest that will fully repay the loan amount over the term of the loan remaining as of the date the loan is recast. Thus, in the example above, the creditor must assume a loan term of 28 years (336 payments). Third, the payment must be based on the fully indexed rate as of the date of the written application for the standard mortgage. Proposed comment 43(d)(5)(i)–7 would have provided an illustration of the payment calculation for an interestonly loan. The example assumes a loan in an amount of $200,000 that has a 30year loan term. The loan agreement provides for a fixed interest rate of 7 percent, and permits interest-only payments for the first two years, after which time amortizing payments of principal and interest are required. Second, the example states that the nonstandard mortgage is consummated on February 15, 2011, and the first monthly payment is due on April 1, 2011. The loan is recast on the due date of the 24th monthly payment, which is March 1, 2013. Finally, the example assumes that on March 15, 2012, the creditor receives the consumer’s written application for a refinancing, after the consumer has made 12 monthly on-time payments. Proposed comment 43(d)(5)(i)–7 would have further explained that, to calculate the non-standard mortgage payment that must be compared to the standard mortgage payment, the creditor must use— VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 • The loan amount, which is the outstanding principal balance as of March 1, 2013, assuming all scheduled interest-only payments have been made and credited up to that date. In this example, the loan amount is $200,000. • An interest rate of 7 percent, which is the interest rate in effect at the time of consummation of this fixed-rate nonstandard mortgage. • The remaining loan term as of March 1, 2013, the date of the recast, which is 28 years. The comment concluded by stating that, based on the assumptions above, the monthly payment for the nonstandard mortgage for purposes of determining whether the standard mortgage monthly payment is lower than the non-standard mortgage monthly payment is $1,359. This is the substantially equal, monthly payment of principal and interest required to repay the loan amount at the fully indexed rate over the remaining term. Proposed payment calculation for a negative amortization loan. Proposed comments 43(d)(5)(i)–8 and –9 would have explained the payment calculation for a negative amortization loan under proposed § 226.43(d)(5)(i)(C). Proposed comment 43(d)(5)(i)–8 would have clarified that the monthly periodic payment for a negative amortization loan must be calculated based on several assumptions. First, the calculation must be based on the maximum loan amount. The comment further stated that examples of how to calculate the maximum loan amount are provided in proposed comment 43(b)(7)–3. Second, the payment calculation must be based on substantially equal monthly payments of principal and interest that will fully repay the maximum loan amount over the term of the loan remaining as of the date the loan is recast. For example, the comment states, if the loan term is 30 years and the loan is recast on the due date of the 60th monthly payment, the creditor must assume a loan term of 25 years. Third, the payment must be based on the fully indexed rate as of the date of the written application for the standard mortgage. Proposed comment 43(d)(5)(i)–9 would have provided an illustration of the payment calculation for a negative amortization loan. The example assumes a loan in an amount of $200,000 that has a 30-year loan term. The loan agreement provides that the consumer can make minimum monthly payments that cover only part of the interest accrued each month until the date on which the principal balance increases to the negative amortization cap of 115 percent of the loan amount, PO 00000 Frm 00096 Fmt 4701 Sfmt 4700 or for the first five years of monthly payments, whichever occurs first. The loan is an adjustable-rate mortgage that adjusts monthly according to a specified index plus a margin of 3.5 percent. The example also assumed that the non-standard mortgage is consummated on February 15, 2011, and the first monthly payment is due on April 1, 2011. Further, the example assumes that, based on the calculation of the maximum loan amount required under § 226.43(b)(7) and associated commentary, the negative amortization cap of 115 percent is reached on July 1, 2013, the due date of the 28th monthly payment. Finally, the example assumes that on March 15, 2012, the creditor receives the consumer’s written application for a refinancing, after the consumer has made 12 monthly on-time payments. On this date, the index value is 4.5 percent. Proposed comment 43(d)(5)(i)–9 then stated that, to calculate the nonstandard mortgage payment that must be compared to the standard mortgage payment under proposed § 226.43(d)(1)(ii), the creditor must use— • The maximum loan amount of $229,243 as of July 1, 2013. • The fully indexed rate of 8 percent, which is the index value of 4.5 percent as of March 15, 2012 (the date on which the creditor receives the application for a refinancing) plus the margin of 3.5 percent. • The remaining loan term as of July 1, 2013, the date of the recast, which is 27 years and 8 months (332 monthly payments). The comment concluded by stating that, based on the assumptions above, the monthly payment for the nonstandard mortgage for purposes of determining whether the standard mortgage monthly payment is lower than the non-standard mortgage monthly payment is $1,717. This is the substantially equal, monthly payment of principal and interest required to repay the maximum loan amount at the fully indexed rate over the remaining term. The Board requested comment on the proposed payment calculation for a nonstandard mortgage and on the appropriateness and usefulness of the proposed payment calculation examples. The Bureau received no specific comment on the payment calculations for non-standard mortgages set forth in proposed § 226.43(d)(5)(i) and its associated commentary. Accordingly, the provision that is being adopted is substantially similar to the version proposed, renumbered as § 1026.43(d)(5)(i). The Bureau also is E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations adopting the associated commentary generally as proposed. The Bureau has made several technical amendments to the examples in comments 43(d)(5)(i)–4, –5, –6, –7, and –9 for clarity. As proposed, the examples in the comment referred to dates prior to the effective date of this rule; the Bureau has updated the dates in the examples so that they will occur after this rule becomes effective. The Bureau believes that it is necessary to clarify the provisions related to payment calculations for interest-only loans and negative amortization loans. The provisions adopted clarify that the payment calculation required by § 1026.43(d)(5)(i) must be based on the outstanding principal balance, rather than the original amount of credit extended. Accordingly, as adopted § 1026.43(d)(5)(i)(C)(2) requires the remaining loan amount for an interestonly loan to be based on the outstanding principal balance as of the date of the recast, assuming all scheduled payments have been made up to the recast date and the payment due on the recast date is made and credited as of that date. Similarly, § 1026.43(d)(5)(i)(C)(3) requires the remaining loan amount for a negative amortization loan to be based on the maximum loan amount, determined after adjusting for the outstanding principal balance. The Bureau has made technical amendments to the example in comments 43(d)(5)(i)–6, –7, –8, and –9 to conform to this clarification. Additionally, the Bureau has added new comment 43(d)(5)(i)–10 to add an additional illustration of the payment calculation for a negative amortization loan. As adopted, comment 43(d)(5)(i)– 10 provides an illustrative example, clarifying that, pursuant to the example and assumptions included in the example, to calculate the non-standard mortgage payment on a negative amortization loan for which the consumer has made more than the minimum required payment that must be compared to the standard mortgage payment under § 1026.43(d)(1)(i), the creditor must use the maximum loan amount of $229,219 as of March 1, 2019, the fully indexed rate of 8 percent, which is the index value of 4.5 percent as of March 15, 2012 (the date on which the creditor receives the application for a refinancing) plus the margin of 3.5 percent, and the remaining loan term as of March 1, 2019, the date of the recast, which is 25 years (300 monthly payments). The comment further explains that, based on these assumptions, the monthly payment for the non-standard mortgage for purposes VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 of determining whether the standard mortgage monthly payment is lower than the non-standard mortgage monthly payment is $1,769. This is the substantially equal, monthly payment of principal and interest required to repay the maximum loan amount at the fully indexed rate over the remaining term. The Bureau finds that comment 43(d)(5)(i)–10, which is adopted pursuant to the Bureau’s authority under section 105(a) of TILA, is necessary to facilitate compliance with TILA. 43(d)(5)(ii) Standard Mortgage Proposed § 226.43(d)(5)(ii) would have prescribed the required calculation for the monthly payment on a standard mortgage that must be compared to the monthly payment on a non-standard mortgage under proposed § 226.43(d)(1)(ii). The same payment calculation must also be used by creditors of refinances under proposed § 226.43(d) in determining whether the consumer has a reasonable ability to repay the standard mortgage, as would have been required under proposed § 226.43(c)(2)(ii). Specifically, the monthly payment for a standard mortgage must be based on substantially equal, monthly, fully amortizing payments using the maximum interest rate that may apply to the standard mortgage within the first five years after consummation. Proposed comment 43(d)(5)(ii)–1 would have clarified that the meaning of ‘‘fully amortizing payment’’ is defined in § 226.43(b)(2), and that guidance regarding the meaning of ‘‘substantially equal’’ may be found in proposed comment 43(c)(5)(i)–4. Proposed comment 43(d)(5)(ii)–1 also explained that, for a mortgage with a single, fixed rate for the first five years, the maximum rate that will apply during the first five years after consummation will be the rate at consummation. For a step-rate mortgage, however, which is a type of fixed-rate mortgage, the rate that must be used is the highest rate that will apply during the first five years after consummation. For example, if the rate for the first two years is 4 percent, the rate for the second two years is 5 percent, and the rate for the next two years is 6 percent, the rate that must be used is 6 percent. Proposed comment 43(d)(5)(ii)–2 would have provided an illustration of the payment calculation for a standard mortgage. The example assumes a loan in an amount of $200,000 with a 30-year loan term. The loan agreement provides for an interest rate of 6 percent that is fixed for an initial period of five years, after which time the interest rate will PO 00000 Frm 00097 Fmt 4701 Sfmt 4700 6503 adjust annually based on a specified index plus a margin of 3 percent, subject to a 2 percent annual interest rate adjustment cap. The comment states that, based on the above assumptions, the creditor must determine whether the standard mortgage payment is materially lower than the non-standard mortgage payment based on a standard mortgage payment of $1,199. This is the substantially equal, monthly payment of principal and interest required to repay $200,000 over 30 years at an interest rate of 6 percent. The Bureau received no specific comment on the payment calculations for standard mortgages set forth in proposed § 226.43(d)(5)(ii) and its associated commentary. Accordingly, this provisions is adopted as proposed, renumbered as § 1026.43(d)(5)(ii). The Bureau also is adopting the associated commentary generally as proposed, with several technical amendments for clarity. 43(e) Qualified Mortgages Background As discussed above, TILA section 129C(a)(1) prohibits a creditor from making a residential mortgage loan unless the creditor makes a reasonable and good faith determination, at or before consummation, based on verified and documented information, that at the time of consummation the consumer has a reasonable ability to repay the loan. TILA section 129C(a)(1) through (4) and (6) through (9) requires creditors specifically to consider and verify various factors relating to the consumer’s income and other assets, debts and other obligations, and credit history. However, the ability-to-repay provisions do not directly restrict features, term, or costs of the loan. TILA section 129C(b), in contrast, provides that loans that meet certain requirements shall be deemed ‘‘qualified mortgages,’’ which are entitled to a presumption of compliance with the ability-to-repay requirements. The section sets forth a number of qualified mortgage requirements which focus mainly on prohibiting certain risky features and practices (such as negative amortization and interest-only periods or underwriting a loan without verifying the consumer’s income) and on generally limiting points and fees in excess of 3 percent of the total loan amount. The only underwriting provisions in the statutory definition of qualified mortgage are a requirement that ‘‘income and financial resources relied upon to qualify the [borrowers] be verified and documented’’ and a further requirement that underwriting be based E:\FR\FM\30JAR2.SGM 30JAR2 6504 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with upon a fully amortizing schedule using the maximum rate permitted during the first five years of the loan. TILA section 129C(b)(2)(A)(iii) through (v). However, TILA section 129C(b)(2)(A)(vi) authorizes the Bureau to adopt ‘‘guidelines or regulations * * * relating to ratios of total monthly debt to monthly income or alternative measures of ability to pay * * * .’’ And TILA section 129C(b)(3)(B)(i) further authorizes the Bureau to revise, add to, or subtract from the criteria that define a qualified mortgage upon a finding that the changes are necessary or proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of TILA section 129C, necessary and appropriate to effectuate the purposes of TILA sections 129C and 129B, to prevent circumvention or evasion thereof, or to facilitate compliance with TILA sections 129C and 129B.127 The qualified mortgage requirements are critical to implementation of various parts of the Dodd-Frank Act. For example, several consumer protection requirements in title XIV of the DoddFrank Act treat qualified mortgages differently than non-qualified mortgages or key off elements of the qualified mortgage definition.128 In addition, the requirements concerning retention of risk by parties involved in the securitization process under title IX of the Dodd-Frank Act provide special treatment for ‘‘qualified residential mortgages,’’ which under section 15G of the Securities Exchange Act of 1934, as amended by section 941(b) of the DoddFrank Act, ‘‘shall be no broader than the 127 TILA section 129B contains requirements and restrictions relating to mortgage originators. TILA section 129B(b) requires a loan originator to be qualified and, when required, registered and licensed as a mortgage originator under the Secure and Fair Enforcement of Mortgage Licensing Act of 2008 (SAFE Act), and to include on all loan documents any unique identifier of the mortgage originator provided by the Nationwide Mortgage Licensing System and Registry. That section also requires the Bureau to prescribe regulations requiring depository institutions to establish and maintain procedures designed to ensure and monitor compliance of such institutions, including their subsidiaries and employees, with the SAFE Act. TILA section 129B(c) contains certain prohibitions on loan originator steering, including restrictions on various compensation practices, and requires the Bureau to prescribe regulations to prohibit certain specific steering activities. 128 For example, as described in the section-bysection analysis of § 1026.43(g), TILA section 129C(c), added by section 1414(a) of the DoddFrank Act, provides that a residential mortgage loan that is not a ‘‘qualified mortgage’’ may not contain a prepayment penalty. In addition, section 1471 of the Dodd-Frank Act establishes a new TILA section 129H, which sets forth appraisal requirements applicable to higher-risk mortgages. The definition of ‘‘higher-risk mortgage’’ expressly excludes qualified mortgages. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 term ‘qualified mortgage,’’’ as defined by TILA section 129C(b) and the Bureau’s implementing regulations. 15 U.S.C. 780–11(e)(4).129 For present purposes, however, the definition of a qualified mortgage is perhaps most significant because of its implications for ability-to-repay claims. TILA section 129C(b)(1) provides that ‘‘[a]ny creditor with respect to any residential mortgage loan, and any assignee of such loan subject to liability under this title, may presume that the loan has met the [ability-to-repay] requirements of subsection (a), if the loan is a qualified mortgage.’’ But the statute does not describe the strength of the presumption or what if anything could be used to rebut it. As discussed further below, there are legal and policy arguments that support interpreting the presumption as either rebuttable or conclusive. Determining the definition and scope of protection afforded to qualified mortgages is the area of this rulemaking which has engendered perhaps the greatest interest and comment. Although TILA section 129C(a)(1) requires only that a creditor make a ‘‘reasonable and good faith determination’’ of the consumer’s ‘‘reasonable ability to repay’’ a residential mortgage, considerable concern has arisen about the actual and perceived litigation and liability risk to creditors and assignees under the statute. Commenters tended to focus heavily on the choice between a presumption that is rebuttable and one that is conclusive as a means of mitigating that risk, although the criteria that define a qualified mortgage are also important because a creditor would have to prove status as a qualified mortgage in order to invoke any (rebuttable or conclusive) presumption of compliance. In assessing the potential impacts of the statute, it is important to note that regulations issued after the mortgage crisis but prior to the enactment of the Dodd-Frank Act have already imposed ability-to-repay requirements for highcost and higher-priced mortgages and created a presumption of compliance for such mortgages if the creditor satisfied certain underwriting and verification requirements. Specifically, under provisions of the Board’s 2008 HOEPA Final Rule that took effect in October 2009, creditors are prohibited from extending high-cost or higher-priced mortgage loans without regard to the consumer’s ability to repay. See § 1026.34(a)(4). The rules provide a presumption of compliance with those 129 See part II.G for a discussion of the 2011 QRM Proposed Rule. PO 00000 Frm 00098 Fmt 4701 Sfmt 4700 ability-to-repay requirements if the creditor follows certain optional procedures regarding underwriting the loan payment, assessing the debt-toincome (DTI) ratio or residual income, and limiting the features of the loan, in addition to following certain procedures mandated for all creditors. See § 1026.34(a)(4)(iii) and (iv) and comment 34(a)(4)(iii)–1. However, the 2008 HOEPA Final Rule makes clear that even if the creditor follows these criteria, the presumption of compliance is rebuttable. See comment 34(a)(4)(iii)– 1. The consumer can still overcome 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 or residual income, the debt-to-income ratio was very high or the residual income was very low. 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 extends a requirement to assess consumers’ ability to repay to the full mortgage market, and establishes a presumption using a different set of criteria that focus more on product features than underwriting practices. Further, the statute establishes similar but slightly different remedies than are available under the existing requirements. Section 1416 of the Dodd-Frank Act amended TILA section 130(a) to provide that a consumer who brings a timely action against a creditor for a violation 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. The statute of limitations is three years from the date of the occurrence of the violation. Moreover, as amended by section 1413 of the Dodd-Frank Act, TILA section 130(k) provides that when a creditor, assignee, or other holder initiates a foreclosure action, a consumer may assert a violation of the ability-to-repay requirements as a matter of defense by recoupment or setoff. There is no time limit on the use of this defense, but the amount of recoupment or setoff is limited with respect to the special statutory damages to no more than three years of finance charges and fees. This limit on setoff is more restrictive than under the existing regulations, but also expressly applies to assignees. E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with In light of the statutory ambiguities, complex policy considerations, and concerns about litigation risk, the Board’s proposal mapped out two alternatives at the opposite ends of a spectrum for defining a qualified mortgage and the protection afforded to such mortgages. At one end, the Board’s Alternative 1 would have defined qualified mortgage only to include the mandated statutory elements listed in TILA section 129C(b)(2), most of which, as noted above, relate to product features and not to the underwriting decision or process itself. This alternative would have provided creditors with a safe harbor to establish compliance with the general repayment ability requirement in proposed § 226.43(c)(1). As the Board recognized, this would provide strong incentives for creditors to make qualified mortgages in order to minimize litigation risk and compliance burden under general ability-to-repay requirements, but might prevent consumers from seeking redress for failure to assess their ability to repay. In Alternative 2, the Board proposed a definition of qualified mortgage which incorporated both the statutory product feature restrictions and additional underwriting elements drawn from the general ability-to-repay requirements, as well as seeking comment on whether to establish a specific debt-to-income requirement. Alternative 2 also specified that consumers could rebut the presumption of compliance by demonstrating that a creditor did not adequately determine the consumers’ ability to repay the loan. As the Board recognized, this would better ensure that creditors fully evaluate consumers’ ability to repay qualified mortgages and preserve consumers’ rights to seek redress. However, the Board expressed concern that Alternative 2 would provide little incentive to make qualified mortgages in the first place, given that the requirements may be challenging to satisfy and the strength of protection afforded would be minimal. Overview of Final Rule As noted above and discussed in greater detail in the section-by-section analysis below, the Dodd-Frank Act accords the Bureau significant discretion in defining the scope of, and legal protections afforded to, a qualified mortgage. In developing the rules for qualified mortgages, the Bureau has carefully considered numerous factors, including the Board’s proposal to implement TILA section 129C(b), comments and ex parte communications, current regulations and the current state of the mortgage VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 market, and the implications of the qualified mortgage rule on other parts of the Dodd-Frank Act. The Bureau is acutely aware of the problematic practices that gave rise to the financial crisis and sees the ability-to-pay requirement as an important bulwark to prevent a recurrence of those practices by establishing a floor for safe underwriting. At the same time, the Bureau is equally aware of the anxiety in the mortgage market today concerning the continued slow pace of recovery and the confluence of multiple major regulatory and capital initiatives. Although every industry representative that has communicated with the Bureau acknowledges the importance of assessing a consumer’s ability to repay before extending a mortgage to the consumer—and no creditor claims to do otherwise—there is nonetheless a widespread fear about the litigation risks associated with the Dodd-Frank Act ability-to-repay requirements. Even community banks, deeply ingrained within their local communities and committed to a relationship lending model, have expressed to the Bureau their fear of litigation. In crafting the rules to implement the qualified mortgage provision, the Bureau has sought to balance creating new protections for consumers and new responsibilities for creditors with preserving consumers’ access to credit and allowing for appropriate lending and innovation. The Bureau recognizes both the need for certainty in the short term and the risk that actions taken by the Bureau in order to provide such certainty could, over time, defeat the prophylactic aims of the statute or impede recovery in various parts of the market. For instance, in defining the criteria for a qualified mortgage, the Bureau is called upon to identify a class of mortgages which can be presumed to be affordable. The boundaries must be clearly drawn so that consumers, creditors, and secondary market investors can all proceed with reasonable assurance as to whether a particular loan constitutes a qualified mortgage. Yet the Bureau believes that it is not possible by rule to define every instance in which a mortgage is affordable, and the Bureau fears that an overly broad definition of qualified mortgage could stigmatize non-qualified mortgages or leave insufficient liquidity for such loans. If the definition of qualified mortgage is so broad as to deter creditors from making non-qualified mortgages altogether, the regulation would curtail access to responsible credit for consumers and turn the Bureau’s definition of a PO 00000 Frm 00099 Fmt 4701 Sfmt 4700 6505 qualified mortgage into a straitjacket setting the outer boundary of credit availability. The Bureau does not believe such a result would be consistent with congressional intent or in the best interests of consumers or the market. The Bureau is thus attuned to the problems of the past, the pressures that exist today, and the ways in which the market might return in the future. As a result, the Bureau has worked to establish guideposts in the final rule to make sure that the market’s return is healthy and sustainable for the longterm. Within that framework, the Bureau is defining qualified mortgages to strike a clear and calibrated balance as follows: First, the final rule provides meaningful protections for consumers while providing clarity to creditors about what they must do if they seek to invoke the qualified mortgage presumption of compliance. Accordingly, the qualified mortgage criteria include not only the minimum elements required by the statute— including prohibitions on risky loan features, a cap on points and fees, and special underwriting rules for adjustable-rate mortgages—but additional underwriting features to ensure that creditors do in fact evaluate individual consumers’ ability to repay the qualified mortgages. The qualified mortgage criteria thus incorporate key elements of the verification requirements under the ability-to-repay standard and strengthen the consumer protections established by the ability-torepay requirements. In particular, the final rule provides a bright-line threshold for the consumer’s total debt-to-income ratio, so that under a qualified mortgage, the consumer’s total monthly debt payments cannot exceed 43 percent of the consumer’s total monthly income. The bright-line threshold for debt-to-income serves multiple purposes. First, it protects consumer interests because debt-toincome ratios are a common and important tool for evaluating consumers’ ability to repay their loans over time, and the 43 percent threshold has been utilized by the Federal Housing Administration (FHA) for many years as its general boundary for defining affordability. Relative to other benchmarks that are used in the market (such as GSE guidelines) that have a benchmark of 36 percent, before consideration of compensating factors, this threshold is a relatively liberal one which allows ample room for consumers to qualify for an affordable mortgage. Second, it provides a wellestablished and well-understood rule E:\FR\FM\30JAR2.SGM 30JAR2 6506 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with that will provide certainty for creditors and help to minimize the potential for disputes and costly litigation over whether a mortgage is a qualified mortgage. Third, it allows room for a vibrant market for non-qualified mortgages over time. The Bureau recognizes that there will be many instances in which individual consumers can afford an even higher debt-to-income ratio based on their particular circumstances, although the Bureau believes that such loans are better evaluated on an individual basis under the ability-to-repay criteria rather than with a blanket presumption. The Bureau also believes that there are a sufficient number of potential borrowers who can afford a mortgage that would bring their debt-to-income ratio above 43 percent that responsible creditors will continue to make such loans as they become more comfortable with the new regulatory framework. To preserve access to credit during the transition period, the Bureau has also adopted temporary measures as discussed further below. The second major feature of the final rule is the provision of carefully calibrated presumptions of compliance afforded to different types of qualified mortgages. Following the approach developed by the Board in the existing ability-to-repay rules to distinguish between prime and subprime loans, the final rule distinguishes between two types of qualified mortgages based on the mortgage’s Annual Percentage Rate (APR) relative to the Average Prime Offer Rate (APOR).130 For loans that exceed APOR by a specified amount— loans denominated as ‘‘higher-priced mortgage loans’’—the final rule provides a rebuttable presumption. In other words, the creditor is presumed to have satisfied the ability-to-repay requirements, but a consumer may rebut that presumption under carefully defined circumstances.131 For all other loans, i.e., loans that are not ‘‘higherpriced,’’ the final rule provides a conclusive presumption that the creditor has satisfied the ability-to-repay requirements once the creditor proves that it has in fact made a qualified mortgage. In other words, the final rule provides a safe harbor from ability-torepay challenges for the least risky type of qualified mortgages, while providing room to rebut the presumption for qualified mortgages whose pricing is indicative of a higher level of risk.132 The Bureau believes that this calibration will further encourage creditors to extend credit responsibly and provide certainty that promotes access to credit. The Bureau believes that loans that fall within the rebuttable presumption category will be loans made to consumers who are more likely to be vulnerable 133 so that, even if the loans satisfy the criteria for a qualified mortgage, those consumers should be provided the opportunity to prove that, in an individual case, the creditor did not have a reasonable belief that the loan would be affordable for that consumer. Under a qualified mortgage with a safe harbor, most of the loans within this category will be the loans made to prime borrowers who pose fewer risks. Furthermore, considering the difference in historical performance levels between prime and subprime loans, the Bureau believes that it is reasonable to presume conclusively that a creditor who has verified a consumer’s debt and income, determined in accordance with specified standards that the consumer has a debt-to-income ratio that does not exceed 43 percent, and made a prime mortgage with the product features required for a qualified mortgage has satisfied its obligation to assess the consumer’s ability to repay. This approach will provide significant certainty to creditors operating in the prime market. The approach will also create lesser but still important protection for creditors in the subprime market who follow the qualified mortgage rules, while preserving consumer remedies and creating strong incentives for more responsible lending in the part of the market in which the most abuses occurred prior to the financial crisis. Third, the final rule provides a temporary special rule for certain qualified mortgages to provide a transition period to help ensure that 130 APOR means ‘‘the average prime offer rate for a comparable transaction as of the date on which the interest rate for the transaction is set, as published by the Bureau.’’ TILA section 129C(b)(2)(B). 131 As described further below, under a qualified mortgage with a rebuttable presumption, a consumer can rebut that presumption by showing that, in fact, at the time the loan was made the consumer did not have sufficient income or assets (other than the value of the dwelling that secures the transaction), after paying his or her mortgage and other debts, to be able to meet his or her other living expenses of which the creditor was aware. 132 The threshold for determining which treatment applies generally matches the threshold for ‘‘higher-priced mortgage loans’’ under existing Regulation Z, except that the rule does not provide a separate, higher threshold for jumbo loans. The Dodd-Frank Act itself codified the same thresholds for other purposes. See Dodd-Frank Act section 1411, enacting TILA section 129C(6)(d)(ii). In adopting the ‘‘higher-priced mortgage loans’’ threshold in 2008, the Board explained that the aim was to ‘‘cover the subprime market and generally exclude the prime market.’’ 73 FR 44522, 44532 (July 30, 2008). 133 See generally, id. at 44533. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 PO 00000 Frm 00100 Fmt 4701 Sfmt 4700 sustainable credit will return in all parts of the market over time. The temporary special rule expands the definition of a qualified mortgage to include any loan that is eligible to be purchased, guaranteed, or insured by various Federal agencies or by the GSEs while they are operating under conservatorship. This temporary provision preserves access to credit in today’s market by permitting a loan that does not satisfy the 43 percent debt-toincome ratio threshold to nonetheless be a qualified mortgage based upon an underwriting determination made pursuant to guidelines created by the GSEs while in conservatorship or one of the Federal agencies. This temporary provision will sunset in a maximum of seven years. As with loans that satisfy the 43 percent debt-to-income ratio threshold, qualified mortgages under this temporary rule will receive either a rebuttable or conclusive presumption of compliance depending upon the pricing of the loan relative to APOR. The Bureau believes this provision will provide sufficient consumer protection while providing adequate time for creditors to adjust to the new requirements of the final rule as well as to changes in other regulatory, capital, and economic conditions. A detailed description of the qualified mortgage definition is set forth below. Section 1026.43(e)(1) provides the presumption of compliance provided to qualified mortgages. Section 1026.43(e)(2) provides the criteria for a qualified mortgage under the general definition, including the restrictions on certain product features, verification requirements, and a specified debt-toincome ratio threshold. Section 1026.43(e)(3) provides the limits on points and fees for qualified mortgages, including the limits for smaller loan amounts. Section 1026.43(e)(4) provides the temporary special rule for qualified mortgages. Lastly, § 1026.43(f) implements a statutory exemption permitting certain balloon-payment loans by creditors operating predominantly in rural or underserved areas to be qualified mortgages. 43(e)(1) Safe Harbor and Presumption of Compliance As discussed above, the Dodd-Frank Act provides a presumption of compliance with the ability-to-repay requirements for qualified mortgages, but the statute is not clear as to whether that presumption is intended to be conclusive so as to create a safe harbor that cuts off litigation or a rebuttable presumption of compliance with the ability-to-repay requirements. The title of section 1412 refers to both a ‘‘safe E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations harbor and rebuttable presumption,’’ and as discussed below there are references to both safe harbors and presumptions in other provisions of the statute. As the Board’s proposal discussed, an analysis of the statutory construction and policy implications demonstrates that there are sound reasons for adopting either interpretation. See 76 FR 27390, 27452– 55 (May 11, 2011). Several aspects of the statutory structure favor a safe harbor interpretation. First, TILA section 129C(b)(1) states that a creditor or assignee may presume that a loan has ‘‘met the requirements of subsection (a), if the loan is a qualified mortgage.’’ TILA section 129C(a) contains the general ability-to repay requirement, and also a set of specific underwriting criteria that must be considered by a creditor in assessing the consumer’s repayment ability. Rather than stating that the presumption of compliance applies only to TILA section 129C(a)(1) for the general ability-to-repay requirements, it appears Congress intended creditors who make qualified mortgages to be presumed to comply with both the ability-to-repay requirements and all of the specific underwriting criteria. Second, TILA section 129C(b)(2) does not define a qualified mortgage as requiring compliance with all of the underwriting criteria of the general ability-to-repay standard. Therefore, unlike the approach found in the 2008 HOEPA Final Rule, it appears that meeting the criteria for a qualified mortgage is an alternative way of establishing compliance with all of the ability-torepay requirements, which could suggest that meeting the qualified mortgage criteria conclusively satisfies these requirements. In other words, given that a qualified mortgage satisfies the ability-to-repay requirements, one could assume that meeting the qualified mortgage definition conclusively establishes compliance with those requirements. In addition, TILA section 129C(b)(3)(B), which provides the Bureau authority to revise, add to, or subtract from the qualified mortgage criteria upon making certain findings, is titled ‘‘Revision of Safe Harbor Criteria.’’ Further, in section 1421 of the DoddFrank Act, Congress instructed the Government Accountability Office to issue a study on the effect ‘‘on the mortgage market for mortgages that are not within the safe harbor provided in the amendments made by this subtitle.’’ Certain policy considerations also favor a safe harbor. Treating a qualified mortgage as a safe harbor provides VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 greater legal certainty for creditors and secondary market participants than a rebuttable presumption of compliance. Increased legal certainty may benefit consumers if as a result creditors are encouraged to make loans that satisfy the qualified mortgage criteria, as such loans cannot have certain risky features and have a cap on upfront costs. Furthermore, increased certainty may result in loans with a lower cost than would be charged in a world of legal uncertainty. Thus, a safe harbor may also allow creditors to provide consumers additional or more affordable access to credit by reducing their expected total litigation costs. On the other hand, there are also several aspects of the statutory structure that favor interpreting qualified mortgage as creating a rebuttable presumption of compliance. With respect to statutory construction, TILA section 129C(b)(1) states that a creditor or assignee ‘‘may presume’’ that a loan has met the repayment ability requirement if the loan is a qualified mortgage. As the Board’s proposal notes, this could suggest that originating a qualified mortgage provides a presumption of compliance with the repayment ability requirements, which the consumer can rebut with evidence that the creditor did not, in fact, make a good faith and reasonable determination of the consumer’s ability to repay the loan. Similarly, in the smaller loans provisions in TILA section 129C(b)(2)(D), Congress instructed the Bureau to adjust the points and fees cap for qualified mortgages ‘‘to permit lenders that extend smaller loans to meet the requirements of the presumption of compliance’’ in TILA section 129C(b)(1).134 As noted above, the 2008 HOEPA Final Rule also contains a rebuttable presumption of compliance with respect to the abilityto-repay requirements that currently apply to high-cost and higher-priced mortgages. The legislative history of the DoddFrank Act may also favor interpreting ‘‘qualified mortgage’’ as a rebuttable presumption of compliance. As described in a joint comment letter from several consumer advocacy groups, a prior version of Dodd-Frank Act title XIV from 2007 contemplated a dual track for liability in litigation: a rebuttable presumption for creditors and a safe harbor for secondary market 134 In prescribing such rules, the Bureau is to consider the potential impact of such rules on rural areas and other areas where home values are lower. This provision did not appear in earlier versions of title XIV of the Dodd-Frank Act, so there is no legislative history to explain the use of the word ‘‘presumption’’ in this context. PO 00000 Frm 00101 Fmt 4701 Sfmt 4700 6507 participants.135 That draft legislation would have provided that creditors, assignees, and securitizers could presume compliance with the ability-torepay provision if the loan met certain requirements.136 However, the presumption of compliance would have been rebuttable only against the creditor, effectively creating a safe harbor for assignees and securitizers.137 The caption ‘‘safe harbor and rebuttable presumption’’ appears to have originated from the 2007 version of the legislation. The 2009 version of the legislation did not contain this dual track approach.138 Instead, the language simply stated that creditors, assignees, and securitizers ‘‘may presume’’ that qualified mortgages satisfied ability-torepay requirements, without specifying the nature of the presumption.139 The committee report of the 2009 bill described the provision as establishing a ‘‘limited safe harbor’’ for qualified mortgages, while also stating that ‘‘the presumption can be rebutted.’’ 140 This suggests that Congress contemplated that qualified mortgages would receive a rebuttable presumption of compliance with the ability-to-repay provisions, notwithstanding Congress’s use of the term ‘‘safe harbor’’ in the heading of section 129C(b) and elsewhere in the statute and legislative history. There are also policy reasons that favor interpreting ‘‘qualified mortgage’’ as a rebuttable presumption of compliance. The ultimate aim of the statutory provisions is to assure that, before making a mortgage loan, the creditor makes a determination of the consumer’s ability to repay. No matter how many elements the Bureau might add to the definition of qualified mortgage, it still would not be possible to define a class of loans which ensured that every consumer within the class could necessarily afford a particular loan. In light of this, interpreting the statute to provide a safe harbor that precludes a consumer from challenging the creditor’s determination of repayment ability seems to raise 135 See Mortgage Reform and Anti-Predatory Lending Act of 2007, H.R. 3915, 110th Cong. (2007). 136 See H.R. 3915 § 203. Specifically, that prior version of title XIV would have created two types of qualified mortgages: (1) a ‘‘qualified mortgage,’’ which included loans with prime interest rates or government insured VA or FHA loans, and (2) a ‘‘qualified safe harbor mortgage,’’ which met underwriting standards and loan term restrictions similar to the definition of qualified mortgage eventually codified at TILA section 129C(b)(2). 137 Id. 138 See Mortgage Reform and Anti-Predatory Lending Act of 2009, H.R. 1728. 139 See H.R. 1728 § 203. 140 Mortgage Reform and Anti-Predatory Lending Act of 2009, H. Rept. No. 94, 111th Cong., at 48 (2009). E:\FR\FM\30JAR2.SGM 30JAR2 6508 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations tensions with the requirement to determine repayment ability. In contrast, interpreting a qualified mortgage as providing a rebuttable presumption of compliance would better ensure that creditors consider each consumer’s ability to repay the loan rather than only satisfying the qualified mortgage criteria. sroberts on DSK5SPTVN1PROD with The Board’s Proposal As described above, in light of the statutory ambiguity and competing policy considerations, the Board proposed two alternative definitions for a qualified mortgage, which generally represent two ends of the spectrum of possible definitions. Alternative 1 would have applied only the specific requirements listed for qualified mortgages in TILA section 129C(b)(2), and would have provided creditors with a safe harbor to establish compliance with the general repayment ability requirement in proposed § 226.43(c)(1). Alternative 2 would have required a qualified mortgage to satisfy the specific requirements listed in the TILA section 129C(b)(2), as well as additional requirements taken from the general ability-to-repay standard in proposed § 226.43(c)(2) through (7). Alternative 2 would have provided a rebuttable presumption of compliance with the ability-to-repay requirements. Although the Board specifically proposed two alternative qualified mortgage definitions, it also sought comment on other approaches by soliciting comment on other alternative definitions. The Board also specifically solicited comment on what criteria should be included in the definition of a qualified mortgage to ensure that the definition provides an incentive to creditors to make qualified mortgages, while also ensuring that consumers have the ability to repay those loans. In particular, the Board sought comment on whether the qualified mortgage definition should require consideration of a consumer’s debt-to-income ratio or residual income, including whether and how to include a quantitative standard for the debt-toincome ratio or residual income for the qualified mortgage definition. Comments Generally, numerous industry and other commenters, including some members of Congress, supported a legal safe harbor while consumer groups and other commenters, including an association of State bank regulators, supported a rebuttable presumption. However, as described below, commenters did not necessarily support the two alternative proposals specifically as drafted by the Board. For VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 instance, a significant number of industry commenters advocated incorporating the general ability-torepay requirements into the qualified mortgage definition, while providing a safe harbor for those loans that met the enhanced standards. And a coalition of industry and consumer advocates presented a proposal to the Bureau that would have provided a tiered approach to defining a qualified mortgage. Under the first tier, if the consumer’s back-end debt-to-income (total debt-to-income) ratio is 43 percent or less, the loan would be a qualified mortgage, and no other tests would be required. Under the second tier, if the consumer’s total debtto-income ratio is more than 43 percent, the creditor would apply a series of tests related to the consumer’s front-end debt-to-income ratio (housing debt-toincome), stability of income and past payment history, availability of reserves, and residual income to determine if a loan is a qualified mortgage. Comments in favor of safe harbor. Industry commenters strongly supported a legal safe harbor from liability for qualified mortgages. These commenters believe that a broad safe harbor with clear, bright lines would provide certainty and clarity for creditors and assignees. Generally, industry commenters argued that a safe harbor is needed in order: (i) To ensure creditors make loans, (ii) to ensure the availability of and access to affordable credit without increasing the costs of borrowing; (iii) to promote certainty and saleability in the secondary market, and (iv) to contain litigation risk and costs for creditors and assignees. Generally, although acknowledging ambiguities in the statutory language, industry commenters argued that the statute’s intent and legislative history indicate that qualified mortgages are meant to be a legal safe harbor, in lieu of the ability-to-repay standards. Industry commenters argued that a safe harbor would best ensure safe, welldocumented, and properly underwritten loans without limiting the availability of credit or increasing the costs of credit to consumers. Many industry commenters asserted that a legal safe harbor from liability would ensure access to affordable credit. Other industry commenters argued that a safe harbor ultimately benefits consumers with increased access to credit, reduced loan fees and interest rates, and less-risky loan features. In contrast, various industry commenters contended that a rebuttable presumption would not provide enough certainty for creditors and the secondary market. Commenters argued that if creditors cannot easily ascertain whether a loan satisfies the PO 00000 Frm 00102 Fmt 4701 Sfmt 4700 ability-to-repay requirements, creditors will either not make loans or will pass the cost of uncertain legal risk to consumers, which in turn would increase the cost of borrowing. Numerous industry commenters argued for a legal safe harbor because of the liabilities of an ability-to-repay violation and the costs associated with ability-to-repay litigation. Generally, commenters argued that a rebuttable presumption for qualified mortgages would invite more extensive litigation than necessary that will result in greater costs being borne by all consumers. Commenters emphasized the relatively severe penalties for ability-to-repay violations under the Dodd-Frank Act, including enhanced damages, an extended three-year statute of limitations, a recoupment or set-off provision as a defense to foreclosure, and new enforcement authorities by State attorneys general. In addition, assignee liabilities are amplified because of the recoupment and set-off provision in TILA section 130(k). Commenters asserted that the increased costs associated with litigation could make compliance too costly for smaller creditors, which would reduce competition and credit availability from the market. In particular, community bank trade association commenters argued that the Bureau should adopt a safe harbor for qualified mortgage loans and include bright-line requirements to protect community banks from litigation and ease the compliance burden. Ultimately, community bank trade association commenters stated that few, if any, banks would risk providing a mortgage that only has a rebuttable presumption attached. Industry commenters generally believed that a rebuttable presumption would increase the incidence of litigation because any consumer who defaults on a loan would be likely to sue for recoupment in foreclosure. Commenters were also concerned about frivolous challenges in court as well as heightened scrutiny by regulators. In particular, a credit union association commenter supported a safe harbor because of concerns that a rebuttable presumption would cause credit unions to be faced with significant amounts of frivolous foreclosure defense litigation in the future. In addition to increased incidence of litigation, industry commenters and other interested parties argued that the estimated costs of litigation under a rebuttable presumption would be overly burdensome for creditors and assignees. Some commenters and interested parties presented estimates of the litigation costs associated with claims alleging a E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations violation of the ability-to-repay requirements. For example, one industry trade association commenter estimated that the attorney’s fees for a claim involving a qualified mortgage under a safe harbor would cost $30,000, compared to $50,000 for a claim under a rebuttable presumption. That commenter provided a separate estimation from a law firm that the attorneys’ fees to the creditor will be approximately $26,000 in cases where the matter is disposed of on a motion to dismiss, whereas the fees for the cost of a full trial could reach $155,000. That commenter asserted that safe harbor claims are more likely to be dismissed on a motion to dismiss than the rebuttable presumption. An industry commenter and other interested parties argued that the estimated costs to creditors associated with litigation and penalties for an ability-to-repay violation could be substantial and provided illustrations of costs under the proposal, noting potential cost estimates of the possible statutory damages and attorney’s fees. For example, the total estimated costs and damages ranged between approximately $70,000 and $110,000 depending on various assumptions, such as the interest rate on a loan or whether the presumption of compliance is conclusive or rebuttable. Industry commenters also generally argued that a safe harbor would promote access to credit because creditors would be more willing to extend credit where they receive protections under the statutory scheme. One industry trade association commenter cited the 2008 HOEPA Final Rule, which provided a rebuttable presumption of compliance with the requirement to consider a consumer’s repayment ability upon meeting certain criteria, as causing a significant drop in higher-priced mortgage loan originations, and suggested that access to general mortgage credit would be similarly restricted if the final rule adopts a rebuttable presumption for the market as a whole. A large bank commenter similarly noted the lack of lending in the higher-priced mortgage space since the 2008 HOEPA Final Rule took effect. In addition to the liquidity constraints for non-qualified mortgages, commenters argued that the liability and damages from a potential ability-torepay TILA violation would be a disincentive for a majority of creditors to make non-qualified mortgage loans. Further, some commenters suggested that creditors could face reputational risk from making non-qualified mortgage loans because consumers would view them as ‘‘inferior’’ to VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 qualified mortgages. Other commenters argued that reducing the protections afforded to qualified mortgages could cause creditors to act more conservatively and restrict credit or result in the denial of credit at a higher rate and increase the cost of credit. Many commenters argued that the most serious effects and impacts on the availability and cost of credit would be for minority, low- to moderate-income, and first-time borrowers. Therefore, industry commenters believed that a bright-line safe harbor would provide the strongest incentive for creditors to provide sustainable mortgage credit to the widest array of qualified consumers. Furthermore, one industry trade association commenter argued that not providing strong incentives for creditors would diminish the possibility of recovery of the housing market and the nation’s economy. Industry commenters also expressed concerns regarding secondary market considerations and assignee liability. Commenters urged the Bureau to consider commercial litigation costs associated with the contractually required repurchase (‘‘put-back’’) of loans sold on the secondary market where there is litigation over those loans, as well as the risk of extended foreclosure timelines because of ongoing ability-to-repay litigation. Industry commenters asserted that a safe harbor is critical to promote saleability of loans in the secondary market. In particular, they stated that clarity and certainty provided by a safe harbor would promote efficiencies in the secondary market because investors in securitized residential mortgage loans (mortgage backed securities, or MBS) could be more certain that they are not purchasing compliance risk along with their investments. Commenters asserted that without a safe harbor, the resulting uncertainty would eliminate the efficiencies provided by secondary sale or securitization of loans. By extension, commenters claimed that the cost of borrowing for consumers would ultimately increase. Large bank commenters stated that although they might originate non-qualified mortgage loans, the number would be relatively small and held in portfolio because they believe it is unlikely that non-qualified mortgage loans will be saleable in the secondary market. Generally, industry commenters asserted that creditors, regardless of size, would be unwilling to risk exposure outside the qualified mortgage space. One large bank commenter stated that the 2008 HOEPA Final Rule did not create a defense to foreclosure against assignees for the life PO 00000 Frm 00103 Fmt 4701 Sfmt 4700 6509 of the loan, as does the Dodd-Frank Act’s ability-to-repay provisions. Accordingly, industry commenters strongly supported broad coverage of qualified mortgages, as noted above. Commenters asserted that the secondary market will demand a ‘‘safe harbor’’ for quality assurance and risk avoidance. If the regulatory framework does not provide a safe harbor, commenters asserted that investors would require creditors to agree to additional, strict representations and warranties when assigning loans. Contracts between loan originators and secondary market purchasers often require originators to repurchase loans should a loan perform poorly, and these commenters expect that future contracts will include provisions related to the ability-to-repay rule. Commenters assert that the risks and costs associated with additional potential put-backs to the creditor would increase liability and risk to creditors, which would ultimately increase the cost of credit to consumers. Furthermore, commenters contended that if the rule is too onerous in its application to the secondary market, then the secondary market participants may purchase fewer loans or increase pricing to account for the additional risk, such as is now the case for high-cost mortgages. Commenters noted that the risks associated with assignee liability are heightened by any vagueness in standards in the rule. One secondary market purchaser commenter argued that a rebuttable presumption would present challenges because purchasers (or assignees) are not part of the origination process. It is not feasible for purchasers to evaluate all of the considerations that went into an underwriting decision, so they must rely on the creditor’s representations that the loan was originated in compliance with applicable laws and the purchaser’s requirements. However, assignees may have to defend a creditor’s underwriting decision at any time during the life of the loan because there is no statute of limitations on raising the failure to make an ability-to-repay determination as a defense to foreclosure. The commenters argued that defending these cases would be difficult and costly, and that such burdens would be reduced by safe harbor protections. Comments in favor of rebuttable presumption of compliance. Consumer group commenters generally urged the Bureau to adopt a rebuttable presumption for qualified mortgages. Commenters argued that Congress intended a rebuttable presumption, not a safe harbor. In particular, commenters contended that the Dodd-Frank Act’s E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6510 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations legislative history and statutory text strongly support a rebuttable presumption. Commenters noted that the statute is designed to strike a fair balance between market incentives and market discipline, as well as a balance between consumers’ legal rights and excessive exposure to litigation risk for creditors. Commenters asserted that the purpose of the qualified mortgage designation is to foster sustainable lending products and practices built upon sound product design and sensible underwriting. To that end, a rebuttable presumption would accomplish the goal of encouraging creditors to originate loans that meet the qualified mortgage definition while assuring consumers of significantly greater protection from abusive or ineffective underwriting than if a safe harbor were adopted. Consumer group commenters contended that qualified mortgages can earn and deserve the trust of both consumers and investors only if they carry the assurance that they are soundly designed and properly underwritten. Many consumer group commenters asserted that a rebuttable presumption would provide better protections for consumers as well as improving safeguards against widespread risky lending while helping ensure that there would be no shortcuts on common sense underwriting. They argued that a legal safe harbor could invite abusive lending because consumers will have no legal recourse. Several commenters also asserted that no qualified mortgage definition could cover all contingencies in which such abuses could occur. Some commenters argued that a legal safe harbor would leave consumers unprotected against abuses, such as those associated with simultaneous liens or from inadequate consideration of employment and income. An association of State bank regulators favored a rebuttable presumption because, although a rebuttable presumption provides less legal protection than a safe harbor, a rebuttable presumption encourages institutions to consider repayment factors that are part of a sound underwriting process. That commenter contended that a creditor should not be granted blanket protection from a foreclosure defense of an ability-torepay violation if the creditor failed to consider and verify such crucial information as a consumer’s employment status and credit history, for example. On this point, the rebuttable presumption proposed by the Board would require creditors to make individualized determinations that the consumer has the ability to repay the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 loan based on all of the underwriting factors listed in the general ability-torepay standard. Consumer group commenters observed that a rebuttable presumption would better ensure that creditors actually consider a consumer’s ability to repay the loan. Consumer group commenters also asserted that the goals of safe, sound, sustainable mortgage lending and a balanced system of accountability are best served by a rebuttable presumption because consumers should be able to put evidence before a court that the creditor’s consideration and verification of the consumer’s ability to repay the loan was unreasonable or in bad faith. To that end, a rebuttable presumption would allow the consumer to assert that, despite complying with the criteria for a qualified mortgage and the ability-torepay standard, the creditor did not make a reasonable and good faith determination of the consumer’s ability to repay the loan. Without this accountability, commenters argued that the Dodd-Frank Act’s effectiveness would be undermined. Ultimately, consumer group commenters believed that a rebuttable presumption would not exacerbate current issues with credit access and availability, but would instead allow room for honest, efficient competition and affordable credit. Consumer group commenters generally contended that the fear of litigation and estimated costs and risks associated with ability-torepay violations are overstated and based on misunderstanding of the extent of exposure to TILA liability. Consumer group commenters and some ex parte communications asserted that the potential incidence of litigation is relatively small, and therefore liability cost and risk are minimal for any given mortgage creditor. For example, consumer group commenters asserted that there are significant practical limitations to consumers bringing an ability-to-repay claim, suggesting that few distressed homeowners would be able to obtain legal representation often necessary to mount a successful rebuttal in litigation. Consumer groups provided percentages of borrowers in foreclosure who are represented by lawyers, noting the difficulty of bringing a TILA violation claim, and addressed estimates of litigation costs, such as attorneys’ fees. Consumer groups provided estimates of the number of cases in foreclosure and the percentage of cases that involve TILA claims, such as a claim of rescission. Furthermore, consumer group commenters argued that the three-year cap on enhanced damages (equal to the PO 00000 Frm 00104 Fmt 4701 Sfmt 4700 sum if all finance charges and fees paid by the consumer within three years of consummation) for violation of the ability-to-repay requirements limits litigation risk significantly. Commenters contended that, as a general rule, a court is more likely to find that the ability-torepay determination at consummation was not reasonable and in good faith the earlier in the process a default occurs, and at that point the amount of interest paid by a consumer (a component of enhanced damages) will be relatively small. Commenters argued that the longer it takes a consumer to default, the harder the burden it will be for the consumer to show that the default was reasonably predictable at consummation and was caused by improper underwriting rather than a subsequent income or expense shock; moreover, even if the consumer can surmount that burden, the amount of damages is still capped at three years’ worth of paid interest. In addition, consumer group commenters contended that the penalties to which creditors could be subject on a finding of failure to meet the ability-to-repay requirements would not be so injurious or even so likely to be applied in all but the most egregious situations as to impose any meaningful risk upon creditors. Moreover, many consumer group commenters observed that creditors that comply with the rules and ensure that their loan originators are using sound, well documented and verified underwriting will be adequately protected by a rebuttable presumption. Final Rule As described above, the presumption afforded to qualified mortgages in the final rule balances consumers’ ability to invoke the protections of the DoddFrank Act scheme with the need to create sufficient certainty to promote access to credit in all parts of the market. Specifically, the final rule provides a safe harbor with the abilityto-repay requirements for loans that meet the qualified mortgage criteria and pose the least risk, while providing a rebuttable presumption for ‘‘higherpriced’’ mortgage loans, defined as having an APR that exceeds APOR by 1.5 percentage points for first liens and 3.5 percentage points for second liens.141 The final rule also specifically defines the grounds on which the presumption accorded to more expensive qualified mortgages can be rebutted. In issuing this final rule, the 141 For the reasons discussed above in the sectionby-section analysis of § 1026.43(b)(4), the Bureau does not adopt a separate threshold for jumbo loans in the higher-priced covered transaction definition for purposes of § 1026.43(e)(1). E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations Bureau has drawn on the experiences from the current ability-to-repay provisions that apply to higher-priced mortgages, described above. Based on the difference in historical performance levels between prime and subprime loans, the Bureau believes that this approach will provide significant certainty to creditors while preserving consumer remedies and creating strong incentives for more responsible lending in the part of the market in which the most abuses occurred prior to the financial crisis. In issuing this final rule, the Bureau carefully considered the comments received and the interpretive and policy considerations for providing qualified mortgages either a safe harbor or rebuttable presumption of compliance with the repayment ability requirements. For the reasons set forth by the Board and discussed above, the Bureau finds that the statutory language is ambiguous and does not mandate a particular approach. In adopting the final rule, the Bureau accordingly focused on which interpretation would best promote the various policy goals of the statute, taking into account the Bureau’s authority, among other things, to make adjustments and exceptions necessary or proper to effectuate the purposes of TILA, as amended by the Dodd-Frank Act. Discouraging unsafe underwriting. As described in part II above, the ability-torepay provisions of the Dodd-Frank Act were codified in response to lax lending terms and practices in the mid-2000’s, which led to increased foreclosures, particularly for subprime borrowers. The statutory underwriting requirements for a qualified mortgage— for example, the requirement that loans be underwritten on a fully amortized basis using the maximum interest rate during the first five years and not a teaser rate, and the requirement to consider and verify a consumer’s income or assets—will help prevent a return to such lax lending. So, too, will the requirement that a consumer’s debtto-income ratio (including mortgagerelated obligations and obligations on simultaneous second liens) not exceed 43 percent, as discussed further below. Notwithstanding these requirements, however, the Bureau recognizes that it is not possible to define by a bright-line rule a class of mortgages as to which it will always be the case that each individual consumer has the ability to repay his or her loan. That is especially true with respect to subprime loans. In many cases, the pricing of a subprime loan is the result of loan level price adjustments established by the secondary market and calibrated to VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 default risk. Furthermore, the subprime segment of the market is comprised of borrowers who tend to be less sophisticated and who have fewer options available to them, and thus are more susceptible to being victimized by predatory lending practices. The historical performance of subprime loans bears all this out.142 The Bureau concludes, therefore, that for subprime loans there is reason to impose heightened standards to protect consumers and otherwise promote the policies of the statute. Accordingly, the Bureau believes that it is important to afford consumers the opportunity to rebut the presumption of compliance that applies to qualified mortgages with regard to higher-priced mortgages by showing that, in fact, the creditor did not have a good faith and reasonable belief in the consumer’s reasonable ability to repay the loan at the time the loan was made. These same considerations lead to the opposite result with respect to prime loans which satisfy the requirements for a qualified mortgage. The fact that a consumer receives a prime rate is itself indicative of the absence of any indicia that would warrant a loan level price adjustment, and thus is suggestive of the consumer’s ability to repay. Historically, prime rate loans have performed significantly better than subprime rate loans and the prime segment of the market has been subject to fewer abuses.143 Moreover, requiring creditors to prove that they have satisfied the qualified mortgage requirements in order to invoke the presumption of compliance will itself ensure that the loans in question do not contain certain risky features and are underwritten with careful attention to consumers’ debt-toincome ratios. Accordingly, the Bureau believes that where a loan is not a higher-priced covered transaction and meets both the product and underwriting requirements for a qualified mortgage, there are sufficient grounds for concluding that the creditor had a reasonable and good faith belief in the consumer’s ability to repay to warrant a safe harbor. This approach carefully balances the likelihood of consumers needing redress 142 For example, data from the MBA delinquency survey show that serious delinquency rates for conventional prime mortgages averaged roughly 2 percent from 1998 through 2011 and peaked at 7 percent following the recent housing collapse. In contrast, the serious delinquency rates averaged 13 percent over the same period. In late 2009, it peaked at over 30 percent.’’ Mortgage Bankers Association, National Delinquency Survey. For a discussion of the historical performance of subprime loans, see 2008 HOEPA Final Rule, 73 FR 44522, 44524–26 (July 30, 2008). 143 See id. PO 00000 Frm 00105 Fmt 4701 Sfmt 4700 6511 with the potential benefits to both consumers and industry of reducing uncertainty concerning the new regime. To the extent that the rule reduces litigation risk concerns for prime qualified mortgages, consumers in the prime market may benefit from enhanced competition (although, as discussed below, the Bureau believes litigation costs will be small and manageable for almost all creditors). In particular, the Bureau believes that larger creditors may expand correspondent lending relationships with smaller banks with respect to prime qualified mortgages. Larger creditors may also relax currently restrictive credit overlays (creditorcreated underwriting requirements that go beyond GSE or agency guidelines), thereby increasing access to credit. Scope of rebuttable presumption. In light of the heightened protections for subprime loans, the final rule also carefully defines the grounds on which the presumption that applies to higherpriced qualified mortgages can be rebutted. The Bureau believes that this feature is critical to ensuring that creditors have sufficient incentives to provide higher-priced qualified mortgages to consumers. Given the historical record of abuses in the subprime market, the Bureau believes it is particularly important to ensure that consumers are able to access qualified mortgages in light of their product feature restrictions and other protections. Specifically, the final rule defines the standard by which a consumer may rebut the presumption of compliance afforded to higher-priced qualified mortgages, and provides an example of how a consumer may rebut the presumption. As described below, the final rule provides that consumers may rebut the presumption with regard to a higher-priced covered transaction by showing that, at the time the loan was originated, the consumer’s income and debt obligations left insufficient residual income or assets to meet living expenses. The analysis would consider the consumer’s monthly payments on the loan, mortgage-related obligations, and any simultaneous loans of which the creditor was aware, as well as any recurring, material living expenses of which the creditor was aware. The Bureau believes the rebuttal standard in the final rule appropriately balances the consumer protection and access to credit considerations described above. This standard is consistent with the standard in the 2008 HOEPA Final Rule, and is specified as the exclusive means of rebutting the presumption. Commentary to the E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6512 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations existing rule provides as an example of how its presumption may be rebutted that the consumer could show ‘‘a very high debt-to-income ratio and a very limited residual income.’’ Under the definition of qualified mortgage that the Bureau is adopting, however, the creditor generally is not entitled to a presumption if the debt-to-income ratio is ‘‘very high.’’ As a result, the Bureau is focusing the standard for rebutting the presumption in the final rule on whether, despite meeting a debt-toincome test, the consumer nonetheless had insufficient residual income to cover the consumer’s living expenses. The Bureau believes this standard is sufficiently broad to provide consumers a reasonable opportunity to demonstrate that the creditor did not have a good faith and reasonable belief in the consumer’s repayment ability, despite meeting the prerequisites of a qualified mortgage. At the same time, the Bureau believes the rebuttal standard in the final rule is sufficiently clear to provide certainty to creditors, investors, and regulators about the standards by which the presumption can successfully be challenged in cases where creditors have correctly followed the qualified mortgage requirements. Several commenters raised concerns about the use of oral evidence to impeach the information contained in the loan file. For example, a consumer may seek to show that a loan does not meet the requirements of a qualified mortgage by relying on information provided orally to the creditor or loan originator to establish that the debt-toincome ratio was miscalculated. Alternatively, a consumer may seek to show that the creditor should have known, based upon facts disclosed orally to the creditor or loan originator, that the consumer had insufficient residual income to be able to afford the mortgage. The final rule does not preclude the use of such oral evidence in ability-to-repay cases. The Bureau believes that courts will determine the weight to be given to such evidence on a case-by-case basis. To exclude such evidence across the board would invite abuses in which consumers could be misled or coerced by an unscrupulous loan originator into keeping certain facts out of the written record. Litigation risks and access to credit. In light of the continuing and widespread concern about litigation risk under the Dodd-Frank Act regime, the Bureau, in the course of developing the framework described above, carefully analyzed the impacts of potential litigation on nonqualified mortgages, any qualified mortgages with a rebuttable presumption, and any qualified VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 mortgages with a safe harbor. The Bureau also considered secondary market dynamics, including the potential impacts on creditors from loans that the secondary market ‘‘puts back’’ on the originators because of ability-to-repay litigation. The Bureau’s analysis is described in detail in the section 1022(b)(2) analysis under part VII; the results of that analysis helped to shape the calibrated approach that the Bureau is adopting in the final rule and suggest that the mortgage market will be able to absorb litigation risks under the rule without jeopardizing access to credit. Specifically, as discussed in the section 1022(b)(2) analysis under part VII, the Bureau believes that even without the benefit of any presumption of compliance, the actual increase in costs from the litigation risk associated with ability-to-pay requirements would be quite modest. This is a function of the relatively small number of potential claims, the relatively small size of those claims, and the relatively low likelihood of claims being filed and successfully prosecuted. The Bureau notes that litigation likely would arise only when a consumer in fact was unable to repay the loan (i.e. was seriously delinquent or had defaulted), and even then only if the consumer elects to assert a claim and is able to secure a lawyer to provide representation; the consumer can prevail only upon proving that the creditor lacked a reasonable and good faith belief in the consumer’s ability to repay at consummation or failed to consider the statutory factors in arriving at that belief. The rebuttable presumption of compliance being afforded to qualified mortgages that are higher-priced reduces the litigation risk, and hence the potential transaction costs, still further. As described above, the Bureau has crafted the presumption of compliance being afforded to subprime loans so that it is not materially different than the presumption that exists today under the 2008 HOEPA Final Rule. Indeed, the Bureau is defining with more particularity the requirements for rebutting this presumption. No evidence has been presented to the Bureau to suggest that the presumption under the 2008 HOEPA Final Rule has led to significant litigation or to any distortions in the market for higherpriced mortgages. As noted above, commenters noted the lack of lending in the higher-priced mortgage space since the 2008 HOEPA Final Rule took effect, but the Bureau is unaware of evidence suggesting the low lending levels are the result of the Board’s rule, as compared to the general state of the economy, PO 00000 Frm 00106 Fmt 4701 Sfmt 4700 uncertainty over multiple regulatory and capital initiatives, and other factors. Relative to the Dodd-Frank Act, the Bureau notes that the existing regime already provides for attorneys’ fees and the same remedies against creditors in affirmative cases, and actually provides for greater remedies against creditors in foreclosure defense situations. Nevertheless, the incidence of claims under the existing ability-to-repay rules for high-cost and higher-priced loans and analogous State laws is relatively low. The Bureau’s analysis shows that cost estimates remain modest for both loans that are not qualified mortgages and loans that are qualified mortgages with a rebuttable presumption of compliance, and even more so for qualified mortgages with a safe harbor. The Bureau recognizes, of course, that under the Dodd-Frank Act ability-torepay provisions, a consumer can assert a claim against an assignee as a ‘‘defense by recoupment or set off’’ in a foreclosure action. There is no time limit on the use of this defense, but the consumer cannot recover as special statutory damages more than three years of finance charges and fees. To the extent this leads to increased litigation potential with respect to qualified mortgages as to which the presumption of compliance is rebuttable, this may cause creditors to take greater care when underwriting these riskier products to avoid potential put-back risk from investors. The Bureau believes that this is precisely what Congress intended—to create incentives for creditors to engage in sound underwriting and for secondary market investors to monitor the quality of the loans they buy—and that these incentives are particularly warranted with respect to the subprime market. At the same time, the Bureau does not believe that the potential assignee liability with respect to higher-priced qualified mortgages will preclude such loans from being sold on the secondary market. Specifically, in analyzing impacts on the secondary market the Bureau notes that investors are purchasing higher-priced mortgage loans that are subject to the existing ability-to-repay requirements and presumption of compliance and that the GSEs have already incorporated into their contracts with creditors a representation and warranty designed to provide investor protection in the event of an ability-to-repay violation. The Bureau agrees with industry and secondary market participant commenters that investors will likely require creditors to agree to similar representations and warranties when assigning or selling loans under the new E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations rule because secondary market participants will not want to be held accountable for ability-to-repay compliance which investors will view as the responsibility of the creditor. For prime loans, this may represent an incremental risk of put-back to creditors, given that such loans are not subject to the current regime, but those loans are being provided a safe harbor if they are qualified mortgages. For subprime (higher risk) loans it is not clear that there is any incremental risk beyond that which exists today under the Board’s rule. There are also some administrative costs associated with such ‘‘put-backs’’ (e.g., costs associated with the process of putting back loans from the issuer or insurer or servicer on behalf of the securitization trust to the creditor as a result of the ability-torepay claims), but those costs are unlikely to be material for qualified mortgages subject to the rebuttable presumption and will not affect either the pricing of the loans or the availability of a secondary market for these loans. In sum, the Bureau has crafted the calibrated presumptions to ensure that these litigation and secondary market impacts do not jeopardize access to credit. With regard to subprime loans, there is some possibility that creditors who are less sophisticated or less able to bear any litigation risk may elect to refrain from engaging in subprime lending, but as discussed below, the Bureau believes that there are sufficient creditors with the capabilities of making responsible subprime loans so as to avoid significant adverse impact on credit availability in that market. Specific provisions. For the reasons discussed above, in § 1026.43(e)(1), the Bureau is providing a safe harbor and rebuttable presumption with the abilityto-repay requirements for loans that meet the definition of a qualified mortgage. As explained in comment 43(e)(1)–1, § 1026.43(c) requires a creditor to make a reasonable and good faith determination at or before consummation that a consumer will be able to repay a covered transaction. Section 1026.43(e)(1)(i) and (ii) provide a safe harbor and rebuttable presumption of compliance, respectively, with the repayment ability requirements of § 1026.43(c) for creditors and assignees of covered transactions that satisfy the requirements of a qualified mortgage under § 1026.43(e)(2), (e)(4), or (f). Section 1026.43(e)(1)(i) provides a safe harbor for qualified mortgages that are not higher-priced covered transactions, by stating that a creditor or assignee of a qualified mortgage as VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 defined in § 1026.43(e)(2), (e)(4), or (f) that is not a higher-priced covered transaction, as defined in § 1026.43(b)(4), complies with the repayment ability requirements of § 1026.43(c). Comment 43(e)(1)(i)–1 clarifies that, to qualify for the safe harbor in § 1026.43(e)(1)(i), a covered transaction must meet the requirements of a qualified mortgage in § 1026.43(e)(2), (e)(4), or (f) and must not be a higher-priced covered transaction, as defined in § 1026.43(b)(4). For qualified mortgages that are higher-priced covered transactions, § 1026.43(e)(1)(ii)(A) provides a rebuttable presumption of compliance with the repayment ability requirements. That section provides that a creditor or assignee of a qualified mortgage as defined in § 1026.43(e)(2), (e)(4), or (f) that is a higher-priced covered transaction, as defined § 1026.43(b)(4), is presumed to comply with the repayment ability requirements of § 1026.43(c). Section 1026.43(e)(1)(ii)(B) provides that to rebut the presumption of compliance, it must be proven that, despite meeting the requirements of § 1026.43(e)(2), (e)(4), or (f), the creditor did not make a reasonable and good faith determination of the consumer’s repayment ability at the time of consummation, by showing that the consumer’s income, debt obligations, alimony, child support, and the consumer’s monthly payment (including mortgage-related obligations) on the covered transaction and on any simultaneous loans of which the creditor was aware at consummation would leave the consumer with insufficient residual income or assets other than the value of the dwelling (including any real property attached to the dwelling) that secures the loan with which to meet living expenses, including any recurring and material non-debt obligations of which the creditor was aware at the time of consummation. Comment 43(e)(1)(ii)–1 clarifies that a creditor or assignee of a qualified mortgage under § 1026.43(e)(2), (e)(4), or (f) that is a higher-priced covered transaction is presumed to comply with the repayment ability requirements of § 1026.43(c). To rebut the presumption, it must be proven that, despite meeting the standards for a qualified mortgage (including either the debt-to-income standard in § 1026.43(e)(2)(vi) or the standards of one of the entities specified in § 1026.43(e)(4)(ii)), the creditor did not have a reasonable and good faith belief in the consumer’s repayment ability. To rebut the presumption, it PO 00000 Frm 00107 Fmt 4701 Sfmt 4700 6513 must be proven that, despite meeting the standards for a qualified mortgage (including either the debt-to-income standard in § 1026.43(e)(2)(vi) or the standards of one of the entities specified in § 1026.43(e)(4)(ii)), the creditor did not have a reasonable and good faith belief in the consumer’s repayment ability. Specifically, it must be proven that, at the time of consummation, based on the information available to the creditor, the consumer’s income, debt obligations, alimony, child support, and the consumer’s monthly payment (including mortgage-related obligations) on the covered transaction and on any simultaneous loans of which the creditor was aware at consummation would leave the consumer with insufficient residual income or assets other than the value of the dwelling (including any real property attached to the dwelling) that secures the loan with which to meet living expenses, including any recurring and material non-debt obligations of which the creditor was aware at the time of consummation, and that the creditor thereby did not make a reasonable and good faith determination of the consumer’s repayment ability. The comment also provides, by way of example, that a consumer may rebut the presumption with evidence demonstrating that the consumer’s residual income was insufficient to meet living expenses, such as food, clothing, gasoline, and health care, including the payment of recurring medical expenses of which the creditor was aware at the time of consummation, and after taking into account the consumer’s assets other than the value of the dwelling securing the loan, such as a savings account. In addition, the longer the period of time that the consumer has demonstrated actual ability to repay the loan by making timely payments, without modification or accommodation, after consummation or, for an adjustable-rate mortgage, after recast, the less likely the consumer will be able to rebut the presumption based on insufficient residual income and prove that, at the time the loan was made, the creditor failed to make a reasonable and good faith determination that the consumer had the reasonable ability to repay the loan. As noted above, the Bureau believes that the statutory language regarding whether qualified mortgages receive either a safe harbor or rebuttable presumption of compliance is ambiguous, and does not plainly mandate one approach over the other. Furthermore, the Bureau has the authority to tailor the strength of the E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6514 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations presumption of compliance based on the characteristics associated with the different types of qualified mortgages. Accordingly, the Bureau interprets TILA section 129C(b)(1) to create a rebuttable presumption, but exercises its adjustment authority under TILA section 105(a) to limit the ability to rebut the presumption in two ways, because an open-ended rebuttable presumption would unduly restrict access to credit without a corresponding benefit to consumers. First, the Bureau uses its adjustment authority under section 105(a) to limit the ability to rebut the presumption to insufficient residual income or assets other than the dwelling that secures the transaction because the Bureau believes exercise of this authority is necessary and proper to facilitate compliance with and to effectuate a purpose of section 129 and TILA. The Bureau believes this approach, while preserving consumer remedies, provides clear standards to creditors and courts regarding the basis upon which the presumption of compliance that applies to higher-priced covered transactions may be rebutted, thereby enhancing creditor certainty and encouraging lending in the higherpriced mortgage market. The Bureau finds this approach is necessary and proper to ensure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans, a purpose of section 129 and TILA. Second, with respect to prime loans (loans with an APR that does not exceed APOR by 1.5 percentage points for first liens and 3.5 percentage points for second liens), the Bureau also uses its adjustment authority under TILA section 105(a) to provide a conclusive presumption (e.g., a safe harbor). Under the conclusive presumption, if a prime loan satisfies the criteria for being a qualified mortgage, the loan will be deemed to satisfy section 129C’s abilityto-repay criteria and will not be subject to rebuttal based on residual income or otherwise. The Bureau finds that this approach balances the competing consumer protection and access to credit considerations described above. As discussed above, the Bureau will not extend the safe harbor to higher-priced loans because that approach would provide insufficient protection to consumers in loans with higher interest rates who may require greater protection than consumers in prime rate loans. On the other hand, an approach that provided a rebuttable presumption of compliance for all qualified mortgages (including prime loans which historically have a low default rate) could lead creditors to make fewer VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 mortgage loans to certain consumers, which could restrict access to credit (or unduly raise the cost of credit) without a corresponding benefit to consumers. The Bureau finds that this adjustment providing a safe harbor for prime loans is necessary and proper to facilitate compliance with and to effectuate the purposes of section 129C and TILA, including to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans.144 43(e)(2) Qualified Mortgage Defined— General As discussed above, TILA section 129C(b)(2) defines the requirements for qualified mortgages to limit certain loan terms and features. The statute generally prohibits a qualified mortgage from permitting an increase of the principal balance on the loan (negative amortization), interest-only payments, balloon payments (except for certain balloon-payment qualified mortgages pursuant to TILA section 129C(b)(2)(E)), a term greater than 30 years, or points and fees that exceed a specified threshold. In addition, the statute incorporates limited underwriting criteria that overlap with some elements of the general ability-to-repay standard. Specifically, the statutory definition of qualified mortgage requires the creditor to (1) verify and document the income and financial resources relied upon to qualify the obligors on the loan; and (2) underwrite the loan based on a fully amortizing payment schedule and the maximum interest rate during the first five years, taking into account all applicable taxes, insurance, and assessments. As noted above, these requirements appear to be focused primarily on ensuring that certain mortgage products—no-documentation loans and loans underwritten based only on a consumer’s ability to make payments during short introductory periods with low ‘‘teaser’’ interest rates—are not eligible to be qualified mortgages. In addition to these limited underwriting criteria, the statute also authorizes the Bureau to establish 144 These adjustments are consistent with the Bureau’s authority under TILA section 129C(b)(3)(B)(i) to 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 this section, necessary and appropriate to effectuate the purposes of TILA section 129B and section 129C, to prevent circumvention or evasion thereof, or to facilitate compliance with such sections. PO 00000 Frm 00108 Fmt 4701 Sfmt 4700 additional criteria relating to ratios of total monthly debt to monthly income or alternative measures of ability to pay regular expenses after payment of total monthly debt, taking into account the income levels of the consumer and other factors the Bureau determines relevant and consistent with the purposes described in TILA section 129C(b)(3)(B)(i). To the extent the Bureau incorporates a debt-to-income or residual income requirement into the qualified mortgage definition, several additional elements of the general ability-to-repay standard would effectively also be incorporated into the qualified mortgage definition, since debt-to-income and residual income analyses by their nature require assessment of income, debt (including simultaneous loans), and mortgagerelated obligations. As discussed above, the Board proposed two alternatives to implement the qualified mortgage elements. Both alternatives under the Board’s proposal would have incorporated the statutory elements of a qualified mortgage (e.g., product feature and loan term restrictions, limits on points and fees, payment calculation requirements, and the requirement to consider and verify the consumer’s income or assets). However, Alternative 2 also included the additional factors in the general ability-to-repay standard. Comments Qualified mortgage definition. As an initial matter, the majority of commenters generally favored defining qualified mortgages to reach a broad portion of the overall market and to provide clarity with regard to the required elements. Commenters agreed that clarity promotes the benefits of creditors lending with confidence and consumers receiving loans that comply with the basic requirements of an affordable loan. In addition, commenters generally agreed that a qualified mortgage should be broad, encompassing the vast majority of the existing mortgage market. Numerous commenters indicated that creditors believed that the difference between the legal protections afforded (or risks associated with) qualified mortgages and non-qualified mortgages would result in very little lending outside of qualified mortgages. Commenters asserted that a narrowly defined qualified mortgage would leave loans outside the legal protections of qualified mortgages and would result in constrained credit or increased cost of credit. As discussed in the section-by-section analysis of § 1026.43(e)(1), commenters did not necessarily support the two E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations alternatives specifically as proposed by the Board, but suggested variations on the definition of qualified mortgage that contain some or all of the Board’s proposed criteria, or additional criteria not specifically included in either of the Board’s proposed alternatives. For example, as described below, a coalition of industry and consumer advocates suggested a tiered approach to defining qualified mortgage, based primarily on meeting a specific back-end debt-toincome requirement, with alternative means of satisfying the qualified mortgage definition (such as housing debt-to-income, reserves, and residual income) if the back-end debt-to-income test is not satisfied. Similarly, one industry commenter suggested using a weighted approach to defining qualified mortgage, which would weight some underwriting factors more heavily than others and permit a significant factor in one area to compensate for a weak or missing factor in another area. Consumer group commenters and some industry commenters generally supported excluding from the definition of qualified mortgage certain risky loan features which result in ‘‘payment shock,’’ such as negative amortization or interest-only features. Consumer group commenters also supported limiting qualified mortgages to a 30-year term, as required by statute. Consumer group commenters and one industry trade association strongly supported requiring creditors to consider and verify the all the ability-to-repay requirements. These commenters contended that the abilityto-repay requirements represent prudent mortgage underwriting techniques and are essential to sustainable lending. To that point, these commenters argued that qualified mortgage loans should represent the best underwritten and most fully documented loans, which would justify some form of protection from future liability. In addition, several consumer group commenters suggested adding a further requirement that when assessing the consumer’s income and determining whether the consumer will be able to meet the monthly payments, a creditor must also take into account other recurring but non-debt related expenses. These commenters argued that many consumers, and especially low- and moderate-income consumers, face significant monthly recurring expenses, such as medical care or prescriptions and child care expense needed to enable the borrower or coborrower to work outside the home. These commenters further argued that even where the percentage of disposable income in such situations seems reasonable, the nominal amounts left to VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 low- and moderate-income consumers may be insufficient to enable such households to reasonably meet all their obligations. While one consumer group commenter specifically supported the inclusion of a consumer’s credit history as an appropriate factor for a creditor to consider and verify when underwriting a loan, several commenters argued that the consumer’s credit history should be not included in the ability-to-repay requirements because, although credit history may be relevant in prudent underwriting, it involves a multitude of factors that need to be taken into consideration. In addition, one association of State bank regulators also favored consideration of the repayment factors that are part of a sound underwriting process. As noted above, some industry commenters also generally supported including the underwriting requirements as proposed in Alternative 2, with some adjustments, so long as the resulting qualified mortgage was entitled to a safe harbor. These commenters stated that most creditors today are already complying with the full ability-to-repay underwriting standards, and strong standards will help them resist competitive forces to lower underwriting standards in the future. Other industry commenters argued that the qualified mortgage criteria should not exclude specific loan products because the result will be that such products will be unavailable in the market. Some commenters generally supported aligning the definition of qualified mortgage with the definition proposed by several Federal agencies to define ‘‘qualified residential mortgages’’ (QRM) for purposes of the risk retention requirements in title IX of the DoddFrank Act. For example, one commenter suggested that the required payment calculation for qualified mortgages be consistent with the QRM proposed requirement that the payment calculation be based on the maximum rate in the first five years after the first full payment required. An association of reverse mortgage lenders requested that a ‘‘qualified’’ reverse mortgage be defined to ensure that the Federal agencies finalizing the QRM rule are able to make a proprietary reverse mortgage a QRM, which would be exempt from the risk retention requirements. Lastly, numerous consumer group commenters argued that high-cost mortgages be excluded from being a qualified mortgage. Quantitative standards. Some industry commenters supported including quantitative standards for such variables as debt-to-income ratios PO 00000 Frm 00109 Fmt 4701 Sfmt 4700 6515 and credit score with compensating factors in the qualified mortgage definition. These commenters contended that quantitative standards provide certainty and would help ensure creditworthy consumers have access to qualified mortgage loans. One consumer group commenter argued that, without specific quantitative standards, bank examiners and assignees would have no benchmarks against which to measure a creditor’s compliance or safety and soundness. One industry commenter favored quantitative standards such as a maximum back-end debt-to-income ratio because that would provide sufficient certainty to creditors and investors. One consumer group commenter supported including quantitative standards for the debt-toincome ratio because, without this, every loan would be open to debate as to whether the consumer had the ability to repay at the time of loan consummation. As described further below, certain commenters and interested parties requested that the Bureau adopt a specific debt-to-income ratio requirement for qualified mortgages. For example, some suggested that if a consumer’s total debt-to-income ratio is below a specified threshold, the mortgage loan should satisfy the qualified mortgage requirements, assuming other relevant conditions are met. In addition to a debt-to-income requirement, some commenters and interested parties suggested that the Bureau should include within the definition of a ‘‘qualified mortgage’’ loans with a debt-to-income ratio above a certain threshold if the consumer has a certain amount of assets, such as money in a savings or similar account, or a certain amount of residual income. Some industry commenters advocated against including quantitative standards for such variables as debt-to-income ratios and residual income. Those commenters argued that underwriting a loan involves weighing a variety of factors, and creditors and investors should be allowed to exercise discretion and weigh risks for each individual loan. To that point, one industry trade group commenter argued that community banks, for example, generally have conservative requirements for a consumer’s debt-toincome ratio, especially for loans that are held in portfolio by the bank, and consider many factors when underwriting mortgage loans, such as payment history, liquid reserves, and other assets. Because several factors are considered and evaluated in the underwriting process, this commenter asserted that community banks can be E:\FR\FM\30JAR2.SGM 30JAR2 6516 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with flexible when underwriting mortgage loans and provide arrangements for certain consumers that fall outside of the normal debt-to-income ratio for a certain loan. This commenter contended that strict quantitative standards would inhibit community banks’ relationship lending and ability to use their sound judgment in the lending process. Some commenters contended that requiring specific quantitative standards could restrict credit access and availability for consumers. Generally, industry commenters and some consumer group commenters believed compensating factors are beneficial in underwriting and should be permitted. These commenters generally believe compensating factors should be incorporated into the qualified mortgage criteria, such as in circumstances when a specified debt-toincome ratio threshold was exceeded. In their view, lending is an individualized decision and compensating factors can, for example, mitigate a consumer’s high debt-to-income ratio or low residual income. One industry trade group commenter argued that the inclusion of compensating factors would allow for a broader underwriting approach and should include family history, repayment history, potential income growth, and inter-family transactions. One association of State bank regulators suggested that the rule provide guidance on mitigating factors for creditors to consider when operating outside of standard parameters. For example, creditors lending outside of typical debt-to-income standards can rely upon other assets or the fact that a consumer has a high income. Other industry commenters argued that the rule should provide for enough flexibility to allow for common-sense underwriting and avoid rigid limits or formulas that would exclude consumers on the basis of one or a few underwriting factors. Another commenter stated that the rule should not set thresholds or limits on repayment ability factors. Instead, the rule should allow the creditor to consider the required factors and be held to a good faith standard. Such a rule permits individualized determinations to be made based on each consumer, local markets, and the risk tolerance of each creditor. Final Rule Section 1026.43(e)(2) of the final rule contains the general qualified mortgage definition. As set forth below, the final rule defines qualified mortgages under § 1026.43(e)(2) as loans that satisfy all of the qualified mortgage criteria required by the statute (including underwriting to the maximum interest rate during the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 first five years of the loan and consideration and verification of the consumer’s income or assets), for which the creditor considers and verifies the consumer’s current debt obligations, alimony, and child support, and that have a total (‘‘back-end’’) monthly debtto-income ratio of no greater than 43 percent, following the standards for ‘‘debt’’ and ‘‘income’’ set forth in appendix Q. While the general definition of qualified mortgage in § 1026.43(e)(2) contains all of the statutory qualified mortgage elements, it does not separately incorporate all of the general ability-to-repay underwriting requirements that would have been part of the qualified mortgage definition under the Board’s proposed Alternative 2. In particular, the definition of qualified mortgage in § 1026.43(e)(2) does not specifically require consideration of the consumer’s employment status, monthly payment on the covered transaction (other than the requirement to underwrite the loan to the maximum rate in the first five years), monthly payment on any simultaneous loans, or the consumer’s credit history, which are part of the general ability-to-repay analysis under § 1026.43(c)(2). Instead, most of these requirements are incorporated into the standards for determining ‘‘debt’’ and ‘‘income’’ pursuant to § 1026.43(e)(2)(vi)(A) and (B), to which the creditor must look to determine if the loan meets the 43 percent debt-toincome ratio threshold as required in § 1026.43(e)(2)(vi). In particular, that calculation will require the creditor to verify, among other things, the consumer’s employment status (to determine current or expected income) and the monthly payment on the covered transaction (including mortgage-related obligations) and on any simultaneous loans that the creditor knows or has reason to know will be made. In addition, although consideration and verification of a consumer’s credit history is not specifically incorporated into the qualified mortgage definition, creditors must verify a consumer’s debt obligations using reasonably reliable third-party records, which may include use of a credit report or records that evidence nontraditional credit references. See section-by-section analysis of § 1026.43(e)(2)(v) and (c)(3). The final rule adopts this approach because the Bureau believes that the statute is fundamentally about assuring that the mortgage credit consumers receive is affordable. Qualified mortgages are intended to be mortgages as to which it can be presumed that the PO 00000 Frm 00110 Fmt 4701 Sfmt 4700 creditor made a reasonable determination of the consumer’s ability to repay. Such a presumption would not be reasonable—indeed would be imprudent—if a creditor made a mortgage loan without considering and verifying core aspects of the consumer’s individual financial picture, such as income or assets and debt. Incorporating these ability-to-repay underwriting requirements into the qualified mortgage definition thus ensures that creditors assess the consumer’s repayment ability for a qualified mortgage using robust and appropriate underwriting procedures. The specific requirements for a qualified mortgage under § 1026.43(e)(2) are described below. The Bureau notes that the final rule does not define a ‘‘qualified’’ reverse mortgage. As described above, TILA section 129C(a)(8) excludes reverse mortgages from the repayment ability requirements. See section-by-section analysis of § 1026.43(a)(3)(i). However, TILA section 129C(b)(2)(ix) provides that the term ‘‘qualified mortgage’’ may include a ‘‘residential mortgage loan’’ that is ‘‘a reverse mortgage which meets the standards for a qualified mortgage, as set by the Bureau in rules that are consistent with the purposes of this subsection.’’ The Board’s proposal did not include reverse mortgages in the definition of a ‘‘qualified mortgage.’’ Because reverse mortgages are exempt from the ability-to-repay requirements, the effects of defining a reverse mortgage as a ‘‘qualified mortgage’’ would be, for example, to allow for certain otherwise banned prepayment penalties and permit reverse mortgages to be QRMs under the Dodd-Frank Act’s risk retention rules. The Bureau believes that the first effect is contrary to the purposes of the statute. With respect to the QRM rulemaking, the Bureau will continue to coordinate with the Federal agencies finalizing the QRM rulemaking to determine the appropriate treatment of reverse mortgages. 43(e)(2)(i) TILA section 129C(b)(2)(A)(i) states that the regular periodic payments of a qualified mortgage may not result in an increase of the principal balance or allow the consumer to defer repayment of principal (except for certain balloonpayment loans made by creditors operating predominantly in rural or underserved areas, discussed below in the section-by-section analysis of § 1026.43(f)). TILA section 129C(b)(2)(A)(ii) states that the terms of a qualified mortgage may not include a balloon payment (subject to an exception for creditors operating E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations predominantly in rural or underserved areas). The statute defines ‘‘balloon payment’’ as ‘‘a scheduled payment that is more than twice as large as the average of earlier scheduled payments.’’ TILA section 129C(b)(2)(A)(ii). The Board’s proposed § 226.43(e)(2)(i) would have implemented TILA sections 129C(b)(2)(A)(i) and (ii). First, the proposed provision would have required that a qualified mortgage provide for regular periodic payments. Second, proposed § 226.43(e)(2)(i) would have provided that the regular periodic payments may not (1) result in an increase of the principal balance; (2) allow the consumer to defer repayment of principal, except as provided in proposed § 226.43(f); or (3) result in a balloon payment, as defined in proposed § 226.18(s)(5)(i), except as provided in proposed § 226.43(f). Proposed comment 43(e)(2)(i)–1 would have explained that, as a consequence of the foregoing requirements, a qualified mortgage must require the consumer to make payments of principal and interest, on a monthly or other periodic basis, that will fully repay the loan amount over the loan term. These periodic payments must be substantially equal except for the effect that any interest rate change after consummation has on the payment amount in the case of an adjustable-rate or step-rate mortgage. The proposed comment would have also provided that, because proposed § 226.43(e)(2)(i) would have required that a qualified mortgage provide for regular, periodic payments, a single-payment transaction may not be a qualified mortgage. This comment would have clarified a potential evasion of the regulation, as a creditor otherwise could structure a transaction with a single payment due at maturity that technically would not be a balloon payment as defined in proposed § 226.18(s)(5)(i) because it is not more than two times a regular periodic payment. Proposed comment 43(e)(2)(i)–2 would have provided additional guidance on the requirement in proposed § 226.43(e)(2)(i)(B) that a qualified mortgage may not allow the consumer to defer repayment of principal. The comment would have clarified that, in addition to interestonly terms, deferred principal repayment also occurs if the payment is applied to both accrued interest and principal but the consumer makes periodic payments that are less than the amount that would be required under a payment schedule that has substantially equal payments that fully repay the loan amount over the loan term. Graduated payment mortgages, for example, allow VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 deferral of principal repayment in this manner and therefore may not be qualified mortgages. As noted above, the Dodd-Frank Act defines ‘‘balloon payment’’ as ‘‘a scheduled payment that is more than twice as large as the average of earlier scheduled payments.’’ However, proposed § 226.43(e)(2)(i)(C) would have cross-referenced Regulation Z’s existing definition of ‘‘balloon payment’’ in § 226.18(s)(5)(i), which provides that a balloon payment is ‘‘a payment that is more than two times a regular periodic payment.’’ The Board noted that this definition is substantially similar to the statutory one, except that it uses as its benchmark any regular periodic payment rather than the average of earlier scheduled payments. The Board explained that the difference in wording between the statutory definition and the existing regulatory definition does not yield a significant difference in what constitutes a ‘‘balloon payment’’ in the qualified mortgage context. Specifically, the Board stated its belief that because a qualified mortgage generally must provide for substantially equal, fully amortizing payments of principal and interest, a payment that is greater than twice any one of a loan’s regular periodic payments also generally will be greater than twice the average of its earlier scheduled payments. Accordingly, to facilitate compliance, the Board proposed to cross-reference the existing definition of ‘‘balloon payment.’’ The Board proposed this adjustment to the statutory definition pursuant to its authority under TILA section 105(a) to make such adjustments for all or any class of transactions as in the judgment of the Board are necessary or proper to facilitate compliance with TILA. The Board stated that this approach is further supported by its authority under TILA section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Board finds necessary or proper to facilitate compliance. Finally, in the preamble to the Board’s proposal, the Board noted that some balloon-payment loans are renewable at maturity and that such loans might appropriately be eligible to be qualified mortgages, provided the terms for renewal eliminate the risk of the consumer facing a large, unaffordable payment obligation, which underlies the rationale for generally excluding balloon-payment loans from the definition of qualified mortgages. If the consumer is protected by the terms of the transaction from that risk, the Board stated that such a transaction might appropriately be treated as though it PO 00000 Frm 00111 Fmt 4701 Sfmt 4700 6517 effectively is not a balloon-payment loan even if it is technically structured as one. The Board solicited comment on whether it should include an exception providing that, notwithstanding proposed § 226.43(e)(2)(i)(C), a qualified mortgage may provide for a balloon payment if the creditor is unconditionally obligated to renew the loan at the consumer’s option (or is obligated to renew subject to conditions within the consumer’s control). The Board sought comment on how such an exception should be structured to ensure that the large-payment risk ordinarily accompanying a balloonpayment loan is fully eliminated by the renewal terms and on how such an exception might be structured to avoid the potential for circumvention. As discussed above, commenters generally supported excluding from the definition of qualified mortgage certain risky loan features which result in ‘‘payment shock,’’ such as negative amortization or interest-only features. Commenters generally recognized such features as significant contributors to the recent housing crisis. Industry commenters noted that such restrictions are objective criteria which creditors can conclusively demonstrate were met at the time of origination. However, one mortgage company asserted that such limitations should not apply in loss mitigation transactions, such as loan modifications and extensions, or to loan assumptions. That commenter noted that while negative amortization is not common in most loan modification programs, the feature can be used at times to help consumers work through default situations. The commenter also noted that deferral of payments, including principal payments, and balloon payment structures are commonly used to relieve payment default burdens. One bank commenter argued that the rule should permit qualified mortgages to have balloon payment features if the creditor is unconditionally obligated to renew the loan at the consumer’s option, or is obligated to renew subject to conditions within the consumer’s control. For the reasons discussed in the proposed rule, the Bureau is adopting § 226.43(e)(2)(i) as proposed in renumbered § 1026.43(e)(2)(i), with certain clarifying changes. In particular, in addition to the proposed language, section 1026.43(e)(2)(i) specifies that a qualified mortgage is a covered transaction that provides for regular periodic payments that are substantially equal, ‘‘except for the effect that any interest rate change after consummation has on the payment in the case of an adjustable-rate or step-rate mortgage.’’ E:\FR\FM\30JAR2.SGM 30JAR2 6518 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with This language appeared in the commentary to § 226.43(e)(2)(i) in the proposed rule, but to provide clarity, the Bureau is adopting this language in the text of § 1026.43(e)(2)(i) in the final rule. Notably, the Bureau is adopting in § 1026.43(e)(2)(i) the proposed crossreference to the existing Regulation Z definition of balloon payment. Like the Board, the Bureau finds that the statutory definition and the existing regulatory definition do not yield a significant difference in what constitutes a ‘‘balloon payment’’ in the qualified mortgage context. Accordingly, the Bureau makes this adjustment pursuant to its authority under TILA section 105(a) because the Bureau believes that affording creditors a single definition of balloon payment within Regulation Z is necessary and proper to facilitate compliance with and effectuate the purposes of TILA. In addition, like the proposal, the final rule does not provide exceptions from the prohibition on qualified mortgages providing for balloon payments, other than the exception for creditors operating predominantly in rural or underserved areas, described below in the section-by-section analysis of § 1026.43(f). The Bureau believes that it is appropriate to implement the rule consistent with statutory intent, which specifies only a narrow exception from this general rule for creditors operating predominantly in rural or underserved areas rather than a broader exception to the general prohibition on qualified mortgages containing balloon payment features. With respect to renewable balloon-payment loans, the Bureau does not believe that the risk that a consumer will face a significant payment shock from the balloon feature can be fully eliminated, and that a rule that attempts to provide such special treatment for renewable balloon-payment loans would be subject to abuse. 43(e)(2)(ii) TILA section 129C(b)(2)(A)(viii) requires that a qualified mortgage must not provide for a loan term that exceeds 30 years, ‘‘except as such term may be extended under paragraph (3), such as in high-cost areas.’’ As discussed above, TILA section 129C(b)(3)(B)(i) authorizes the Bureau to revise, add to, or subtract from the qualified mortgage criteria if the Bureau makes certain findings, including that such revision is necessary or proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of TILA section 129C(b) or necessary and appropriate to effectuate the purposes of section 129C. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 Proposed § 226.43(e)(2)(ii) would have implemented the 30-year maximum loan term requirement in the statute without exception. The preamble to the proposed rule explains that, based on available information, the Board believed that mortgage loans with terms greater than 30 years are rare and, when made, generally are for the convenience of consumers who could qualify for a loan with a 30-year term but prefer to spread out their payments further. Therefore, the Board believed such an exception is generally unnecessary. The Board solicited comment on whether there are any ‘‘high-cost areas’’ in which loan terms in excess of 30 years are necessary to ensure that responsible, affordable credit is available and, if so, how they should be identified for purposes of such an exception. The Board also sought comment on whether any other exceptions would be appropriate, consistent with the Board’s authority in TILA section 129C(b)(3)(B)(i). As noted above, commenters generally supported the 30-year term limitation. One commenter suggested the final rule should clarify that a loan term that is slightly longer than 30 years because of the due date of the first regular payment nevertheless meets the 30-year term requirement. One trade association commenter suggested that creditors be provided flexibility to originate 40-year loans in order to accommodate consumers in regions of the country where housing prices are especially high, but did not provide any information regarding the historic performance of 40-year loans or discuss how the Bureau should define high-cost areas in a way that avoids abuse. An association of State bank regulators also suggested that the rule permit loan terms beyond 30 years in high-cost areas and suggested that those areas could be determined based on housing price indices. That commenter, two large industry trade associations, and one mortgage company commenter argued that the 30-year term limitation should not apply to loan modifications that provide a consumer with a loan with a lower monthly payment than he or she may otherwise face. One such commenter noted that, as a general matter, the rule should clarify that modifications of existing loans should not be subject to the same ability-torepay requirements to avoid depriving consumers of beneficial modifications. For the reasons discussed in the proposed rule, the Bureau is generally adopting § 226.43(e)(2)(ii) as proposed in renumbered § 1026.43(e)(2)(ii). In response to commenter concern, the final rule clarifies in comment PO 00000 Frm 00112 Fmt 4701 Sfmt 4700 43(e)(2)(ii)–1 that the 30-year term limitation in § 1026.43(e)(2)(ii) is applied without regard to any interim period between consummation and the beginning of the first full unit period of the repayment schedule. Consistent with the Board’s analysis, the final rule does not provide exceptions to the 30year loan limitation. Like the Board, the Bureau is unaware of a basis upon which to conclude that an exception to the 30-year loan term limitation for qualified mortgages in high-cost areas is appropriate. In particular, the Bureau believes that loans with terms greater than 30 years are rare and that, when made, generally are for the convenience of consumers who could qualify for a loan with a 30-year term. The final rule also does not provide additional guidance on the 30-year loan term limitation in the context of loan modifications. The Bureau understands that private creditors may offer loan modifications to consumers at risk of default or foreclosure, and that such modifications may extend the duration of the loan beyond the initial term. If such modification results in the satisfaction and replacement of the original obligation, the loan would be a refinance under current § 1026.20(a), and therefore the new transaction must comply with the ability-to-repay requirements of § 1026.43(c) or satisfy the criteria for a qualified mortgage, independent of any ability-to-repay analysis or the qualified mortgage status of the initial transaction. However, if the transaction does not meet the criteria in 1026.20(a), which determines a refinancing—generally resulting in the satisfaction and replacement of the original obligation—the loan would not be a refinance under § 1026.20(a), and would instead be an extension of the original loan. In such a case, compliance with the ability-to-repay provision, including a loan’s qualified mortgage status, would be determined as of the date of consummation of the initial transaction, regardless of a later modification. 43(e)(2)(iii) TILA section 129C(b)(2)(A)(vii) defines a qualified mortgage as a loan for which, among other things, the total points and fees payable in connection with the loan do not exceed three percent of the total loan amount. TILA section 129C(b)(2)(D) requires the Bureau to prescribe rules adjusting this threshold to ‘‘permit lenders that extend smaller loans to meet the requirements of the presumption of compliance.’’ The statute further requires the Bureau, in prescribing such rules, to ‘‘consider the potential impact of such rules on rural E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations areas and other areas where home values are lower.’’ Proposed § 226.43(e)(2)(iii) would have implemented these provisions by providing that a qualified mortgage is a loan for which the total points and fees payable in connection with the loan do not exceed the amounts specified under proposed § 226.43(e)(3). As discussed in detail in the section-by-section analysis of § 1026.43(e)(3), the Board proposed two alternatives for calculating the allowable points and fees for a qualified mortgage: One approach would have consisted of five ‘‘tiers’’ of loan sizes and corresponding limits on points and fees, while the other approach would have consisted of three ‘‘tiers’’ of points and fees based on a formula yielding a greater allowable percentage of the total loan amount to be charged in points and fees for each dollar increase in loan size. Additionally, proposed § 226.43(b)(9) would have defined ‘‘points and fees’’ to have the same meaning as in proposed § 226.32(b)(1). For the reasons discussed in the proposed rule, the Bureau is generally adopting § 226.43(e)(2)(iii) as proposed in renumbered § 1026.43(e)(2)(iii). For a discussion of the final rule’s approach to calculating allowable points and fees for a qualified mortgage, see the sectionby-section analysis of § 1026.43(e)(3). For a discussion of the definition of points and fees, see the section-bysection analysis of § 1026.32(b)(1). As noted above, several consumer group commenters requested that highcost mortgages be prohibited from receiving qualified mortgage status. Those commenters noted that high-cost mortgages have been singled out by Congress as deserving of special regulatory treatment because of their potential to be abusive to consumers. They argue that it would seem incongruous for any high-cost mortgage to be given a presumption of compliance with the ability-to-repay rule. However, the final rule does not prohibit a high-cost mortgage from being a qualified mortgage. Under the DoddFrank Act, a mortgage loan is a high-cost mortgage when (1) the annual percentage rate exceeds APOR by more than 6.5 percentage points for first-liens or 8.5 percentage points for subordinateliens; (2) points and fees exceed 5 percent, generally; or (3) when prepayment penalties may be imposed more than three years after consummation or exceed 2 percent of the amount prepaid. Neither the Board’s 2011 ATR–QM Proposal nor the Bureau’s 2012 HOEPA Proposal would have prohibited loans that are high-cost mortgages as a result of a high interest VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 rate from receiving qualified mortgage status. As a general matter, the ability-torepay requirements in this final rule apply to most closed-end mortgage loans, including closed-end high-cost mortgages. Notwithstanding the DoddFrank Act’s creation of a new ability-torepay regime for mortgage loans, Congress did not modify an existing prohibition in TILA section 129(h) against originating a high-cost mortgage without regard to a consumer’s repayment ability (HOEPA ability-torepay). Thus, under TILA (as amended by the Dodd-Frank Act), closed-end high-cost mortgages are subject both to the general ability-to-repay provisions and to HOEPA’s ability-to-repay requirement.145 As implemented in existing § 1026.34(a)(4), the HOEPA ability-to-repay rules contain a rebuttable presumption of compliance if the creditor takes certain steps that are generally less rigorous than the DoddFrank Act’s ability-to-repay requirements, as implemented in this rule. For this reason, and as explained further in that rulemaking, the Bureau’s 2013 HOEPA Final Rule provides that a creditor complies with the high-cost mortgage ability-to-repay requirement by complying with the general abilityto-repay provision, as implemented by this final rule.146 The final rule does not prohibit highcost mortgages from being qualified mortgages for several reasons. First, the Dodd-Frank Act does not prohibit highcost mortgages from receiving qualified mortgage status. While the statute imposes a points and fees limit on qualified mortgages (3 percent, generally) that effectively prohibits loans that trigger the high-cost mortgage points and fee threshold from receiving qualified mortgage status, it does not impose an annual percentage rate limit 145 The statutory HOEPA ability-to-repay provisions prohibit creditors from engaging in a pattern or practice of making loans without regard to the consumer’s repayment ability. In the 2008 HOEPA Final Rule, the Board eliminated the ‘‘pattern or practice’’ requirement under the HOEPA ability-to-repay provision and also applied the repayment ability requirement to higher-priced mortgage loans. 146 The Bureau notes that, among other restrictions, the 2013 HOEPA Final Rule also includes in § 1026.32(d)(1) a prohibition on balloon payment features for most high-cost mortgages, and retains the current restrictions on high-cost mortgages permitting negative amortization. As noted, high-cost mortgages will be subject to these restrictions in addition to the requirements imposed in this final rule. With respect to prepayment penalty revisions, the Dodd-Frank Act deleted the statutory restrictions applicable to high-cost mortgages. The new Dodd-Frank Act prepayment penalty restrictions of section 1414 are implemented as discussed below. PO 00000 Frm 00113 Fmt 4701 Sfmt 4700 6519 on qualified mortgages.147 Therefore, nothing in the statute prohibits a creditor from making a loan with a very high interest rate such that the loan is a high-cost mortgage while still meeting the criteria for a qualified mortgage. In addition, the final rule does not prohibit high-cost mortgages from being qualified mortgages because the Bureau believes that, for loans that meet the qualified mortgage definition, there is reason to presume, subject to rebuttal, that the creditor had a reasonable and good faith belief in the consumer’s ability to repay notwithstanding the high interest rate. High-cost mortgages will be less likely to meet qualified mortgage criteria because the higher interest rate will generate higher monthly payments and thus require higher income to satisfy the debt-toincome test for a qualified mortgage. But where that test is satisfied—that is, where the consumer has an acceptable debt-to-income ratio calculated in accordance with qualified mortgage underwriting rules—there is no logical reason to exclude the loan from the definition of a qualified mortgage. Allowing a high-cost mortgage to be a qualified mortgage can benefit consumers. The Bureau anticipates that, in the small loan market, creditors may sometimes exceed high-cost mortgage thresholds due to the unique structure of their business. The Bureau believes it would be in the interest of consumers to afford qualified mortgage status to loans meeting the qualified mortgage criteria so as to remove any incremental impediment that the general ability-torepay provisions would impose on making such loans. The Bureau also believes this approach could provide an incentive to creditors making high-cost mortgages to satisfy the qualified mortgage requirements, which would provide additional consumer protections, such as restricting interestonly payments and limiting loan terms to 30 years, which are not requirements under HOEPA. 147 The points and fees limit for qualified mortgages set forth in the Dodd-Frank Act, as implemented in § 1026.43(e) of this final rule (including separate points and fees limits for smaller loans), is lower than the high-cost mortgage points and fees threshold. Thus, any loan that triggers the high-cost mortgage provisions through the points and fees criteria could not satisfy the qualified mortgage definition. Likewise, § 1026.43(g) of this final rule provides that, where qualified mortgages are permitted to have prepayment penalties, such penalties may not be imposed more than three years after consummation or in an amount that exceeds 2 percent of the amount prepaid. This limitation aligns with the prepayment penalty trigger for the high-cost mortgage provisions, such that a loan that satisfies the qualified mortgage requirements would never trigger the high-cost mortgage provisions as a result of a prepayment penalty. E:\FR\FM\30JAR2.SGM 30JAR2 6520 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations Furthermore, allowing high-cost mortgage loans to be qualified mortgages would not impact the various impediments to making high-cost mortgage loans, including enhanced disclosure and counseling requirements and the enhanced liability for HOEPA violations. Thus, there would remain strong disincentives to making high-cost mortgages. The Bureau does not believe that allowing high-cost mortgages to be qualified mortgages would incent creditors who would not otherwise make high-cost mortgages to start making them. sroberts on DSK5SPTVN1PROD with 43(e)(2)(iv) TILA section 129C(b)(2)(A)(iv) and (v) provides as a condition to meeting the definition of a qualified mortgage, in addition to other criteria, that the underwriting process for a fixed-rate or adjustable-rate loan be based on ‘‘a payment schedule that fully amortizes the loan over the loan term and takes into account all applicable taxes, insurance, and assessments.’’ The statute further states that for an adjustable-rate loan, the underwriting must be based on ‘‘the maximum rate permitted under the loan during the first 5 years.’’ See TILA section 129C(b)(2)(A)(v). The statute does not define the terms ‘‘fixed rate,’’ ‘‘adjustable-rate,’’ or ‘‘loan term,’’ and provides no additional assumptions regarding how to calculate the payment obligation. These statutory requirements differ from the payment calculation requirements set forth in existing § 1026.34(a)(4)(iii), which provides a presumption of compliance with the repayment ability requirements for higher-priced mortgage loans, where the creditor underwrites the loan using the largest payment of principal and interest scheduled in the first seven years following consummation. The existing presumption of compliance under § 1026.34(a)(4)(iii) is available for all high-cost and higher-priced mortgage loans, except for loans with negative amortization or balloon-payment mortgages with a term less than seven years. In contrast, TILA section 129C(b)(2)(A) requires the creditor to underwrite the loan based on the maximum payment during the first five years, and does not extend the scope of qualified mortgages to any loan that contains certain risky features or a loan term exceeding 30 years. Loans with a balloon-payment feature would not meet the definition of a qualified mortgage regardless of term length, unless made by a creditor that satisfies the conditions in § 1026.43(f). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 The Board proposed to implement the underwriting requirements of TILA section 129C(b)(2)(A)(iv) and (v), for purposes of determining whether a loan meets the definition of a qualified mortgage, in proposed § 226.43(e)(2)(iv). Under the proposal, creditors would have been required to underwrite a loan that is a fixed-, adjustable-, or step-rate mortgage using a periodic payment of principal and interest based on the maximum interest rate permitted during the first five years after consummation. The terms ‘‘adjustable-rate mortgage,’’ ‘‘step-rate mortgage,’’ and ‘‘fixed-rate mortgage’’ would have had the meaning as in current § 1026.18(s)(7)(i) through (iii), respectively. Specifically, proposed § 226.43(e)(2)(iv) would have provided that meeting the definition of a qualified mortgage is contingent, in part, on creditors meeting the following underwriting requirements: (1) Proposed § 226.43(e)(2)(iv) would have required that the creditor take into account any mortgage-related obligations when underwriting the consumer’s loan; (2) Proposed § 226.43(e)(2)(iv)(A) would have required the creditor to use the maximum interest rate that may apply during the first five years after consummation; and (3) Proposed § 226.43(e)(2)(iv)(B) would have required that the periodic payments of principal and interest repay either the outstanding principal balance over the remaining term of the loan as of the date the interest rate adjusts to the maximum interest rate that can occur during the first five years after consummation, or the loan amount over the loan term. These three underwriting conditions under proposed § 226.43(e)(2)(iv), and the approach to these criteria adopted in the final rule, are discussed below. Proposed § 226.43(e)(2)(iv) would have implemented TILA section 129C(b)(2)(A)(iv) and (v), in part, and provided that, to be a qualified mortgage under proposed § 1026.43(e)(2), the creditor must underwrite the loan taking into account any mortgage-related obligations. Proposed comment 43(e)(2)(iv)–6 would have provided cross-references to proposed § 226.43(b)(8) and associated commentary. The Board proposed to use the term ‘‘mortgage-related obligations’’ in place of ‘‘all applicable taxes, insurance (including mortgage guarantee insurance), and assessments.’’ Proposed § 226.43(b)(8) would have defined the term ‘‘mortgage-related obligations’’ to mean property taxes; mortgage-related insurance premiums required by the creditor as set forth in PO 00000 Frm 00114 Fmt 4701 Sfmt 4700 proposed § 226.45(b)(1); homeowners association, condominium, and cooperative fees; ground rent or leasehold payments; and special assessments. Commenters generally supported the inclusion of mortgage-related obligations in the underwriting requirement in proposed § 226.43(e)(2)(iv). Several industry trade associations, banks, civil rights organizations, and consumer advocacy groups specifically supported the requirement. Several commenters requested clear guidance on the amounts to be included in the monthly payment amount, including mortgagerelated obligations. In addition, a civil rights organization and several consumer advocacy groups argued that the creditor should also be required to consider recurring, non-debt expenses, such as medical supplies and child care. As discussed above in the section-bysection analysis of § 1026.43(b)(8), the Bureau is adopting the proposed definition of mortgage-related obligations in renumbered § 1026.43(b)(8), with certain clarifying changes and additional examples. For the reasons discussed above, the Bureau is adopting the mortgage-related obligations portion of § 226.43(e)(2)(vi) as proposed in renumbered § 1026.43(e)(2)(vi). The final rule does not contain a specific requirement that the creditor consider, when underwriting the consumer’s monthly payment, recurring non-debt expenses, such as medical supplies and child care. However, such expenses, if known to the creditor at the time of consummation, may be relevant to a consumer’s ability to rebut the presumption of compliance that applies to qualified mortgages that are higherpriced covered transactions. See section-by-section analysis of § 1026.43(e)(1)(ii)(B). 43(e)(2)(iv)(A) Proposed § 226.43(e)(2)(iv)(A) would have implemented TILA section 129C(b)(2)(A)(iv) and (v), in part, and provided that, to be a qualified mortgage under proposed § 1026.43(e)(2), the creditor must underwrite the loan using the maximum interest rate that may apply during the first five years after consummation. However, the statute does not define the term ‘‘maximum rate,’’ nor does the statute clarify whether the phrase ‘‘the maximum rate permitted under the loan during the first 5 years’’ means the creditor should use the maximum interest rate that occurs during the first five years of the loan beginning with the first periodic payment due under the loan, or during E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations the first five years after consummation of the loan. The former approach would capture the rate recast for a 5/1 hybrid adjustable-rate mortgage that occurs on the due date of the 60th monthly payment, and the latter would not. The Board interpreted the phrase ‘‘maximum rate permitted’’ as requiring creditors to underwrite the loan based on the maximum interest rate that could occur under the terms of the loan during the first five years after consummation, assuming a rising index value. See proposed comment 43(e)(2)(iv)–1. The Board noted that this interpretation is consistent with current guidance contained in Regulation Z regarding disclosure of the maximum interest rate. See MDIA Interim Rule, 75 FR 58471 (Sept. 24, 2010). The Board further stated that this interpretation is consistent with congressional intent to encourage creditors to make loans to consumers that are less risky and that afford the consumer a reasonable period of time to repay (i.e., 5 years) on less risky terms. For the reasons described in the proposed rule, the Bureau is adopting the ‘‘maximum interest rate’’ provision in § 1026.43(e)(2)(iv) as proposed in renumbered § 1026.43(e)(2)(iv). The Board proposed to interpret the phrase ‘‘during the first 5 years’’ as requiring creditors to underwrite the loan based on the maximum interest rate that may apply during the first five years after consummation. TILA section 129C(b)(2)(A)(v). The preamble to the proposed rule explains several reasons for this interpretation. First, the Board noted that a plain reading of the statutory language conveys that the ‘‘first five years’’ is the first five years of the loan once it comes into existence (i.e., once it is consummated). The Board believed that interpreting the phrase to mean the first five years beginning with the first periodic payment due under the loan would require an expansive reading of the statutory text. Second, the Board noted that the intent of this underwriting condition is to ensure that the consumer can afford the loan’s payments for a reasonable amount of time and that Congress intended for a reasonable amount of time to be the first five years after consummation. Third, the Board proposed this approach because it is consistent with prior iterations of this statutory text and the Board’s 2008 HOEPA Final Rule. As noted above, the Dodd-Frank Act codifies many aspects of the repayment ability requirements contained in existing § 1026.34(a)(4) of the Board’s 2008 HOEPA Final Rule. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 Fourth, the Board believed that interpreting the phrase ‘‘during the first five years’’ as including the rate adjustment at the end of the fifth year would be of limited benefit to consumers because creditors could easily structure their product offerings to avoid application of the rule. For example, a creditor could move a rate adjustment that typically occurs on the due date of the 60th monthly payment to due date of the first month that falls outside the specified time horizon, making any proposal to extend the time period in order to include the rate adjustment of diminished value. Finally, the Board believed that the proposed timing of the five-year period could appropriately differ from the approach used under the 2010 MDIA Interim Final Rule, given the different purposes of the rules. The Board amended the 2010 MDIA Interim Final Rule to require that creditors base their interest rate and payment disclosures on the first five years after the due date of the first regular periodic payment rather than the first five years after consummation. See 75 FR 81836, 81839 (Dec. 29, 2010). The revision clarified that the disclosure requirements for 5⁄1 hybrid adjustable-rate mortgages must include the rate adjustment that occurs on the due date of the 60th monthly payment, which typically occurs more than five years after consummation. The disclosure requirements under the 2010 MDIA Interim Final Rule, as revised, are intended to help make consumers aware of changes to their loan terms that may occur if they choose to stay in the loan beyond five years and therefore, helps to ensure consumers avoid the uninformed use of credit. The Board believed a different approach is appropriate under proposed § 226.43(e)(2)(iv) because that requirement seeks to ensure that the loan’s payments are affordable for a reasonable period of time. For the reasons stated above, the Board believed that Congress intended the first five years after consummation to be a reasonable period of time to ensure that the consumer has the ability to repay the loan according to its terms. For all the above-listed reasons, the Board interpreted the statutory text as requiring that the creditor underwrite the loan using the maximum interest rate during the first five years after consummation. The Board solicited comment on its interpretation of the phrase ‘‘first five years’’ and the appropriateness of this approach. The Board also proposed clarifying commentary and examples, which are described below. As described above, commenters generally supported the payment PO 00000 Frm 00115 Fmt 4701 Sfmt 4700 6521 calculation requirements in the proposed rule, including the five-year payment calculation. A comment from a coalition of consumer advocates suggested that the period may not be long enough to assure a consumer’s ability to repay given that the average homeowner holds their mortgage for approximately seven years, and suggested that the five-year payment calculation requirement be extended to reflect the average mortgage duration of the first ten years of the loan. Two industry commenters suggested that the time horizon in the required payment calculation for qualified mortgages be consistent with the proposed requirement in the 2011 QRM Proposed Rule that the payment calculation be based on the maximum rate in the first five years after the date on which the first regular periodic payment will be due. One such commenter noted that the payment calculation approach in the 2011 QRM Proposed Rule is more protective of consumers. Another industry commenter suggested that the final rule should measure the first five years from the first regularly scheduled payment, for consistency with the 2010 MDIA Interim Final Rule. An association of State bank regulators agreed with the Board’s reasoning, noting that creditors could structure loans to recast outside any parameter set by the rule and that an effective way to prevent purposeful evasion of the payment calculation provision would require legislation. Notwithstanding the Board’s proposed approach, the Bureau interprets the phrase ‘‘during the first 5 years’’ as requiring creditors to underwrite the loan based on the maximum interest rate that may apply during the first five years after the first regular periodic payment will be due. Like the Board, the Bureau finds the statutory language to be ambiguous. However, the Bureau believes that the statutory phrase ‘‘during the first 5 years’’ could be given either meaning, and that this approach provides greater protections to consumers by requiring creditors to underwrite qualified mortgages using the rate that would apply after the recast of a five-year adjustable rate mortgage. Further, as noted, this approach is consistent with the payment calculation in the 2011 QRM Proposed Rule and in existing Regulation Z with respect to the disclosure requirements for interest rates on adjustable-rate amortizing loans. Accordingly, § 1026.43(e)(2)(iv)(A) provides that a qualified mortgage under § 1026.43(e)(2) must be underwritten, taking into account any mortgage- E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6522 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations related obligations, using the maximum interest rate that may apply during the first five years after the date on which the first regular periodic payment will be due. Although the Bureau is finalizing the commentary and examples to § 226.43(e)(2)(iv) as proposed in the commentary to renumbered § 1026.43(e)(2)(iv), the final rule makes conforming changes to the proposed commentary to reflect the adjusted time horizon. The proposed commentary and the changes to the proposed commentary as implemented in the final rule are described below. The Bureau is finalizing comment 43(e)(2)(iv)–1 as proposed, but with conforming changes to reflect the new time horizon. In the final rule, the comment provides guidance to creditors on how to determine the maximum interest rate during the first five years after the date on which the first regular periodic payment will be due. This comment explains that creditors must use the maximum rate that could apply at any time during the first five years after the date on which the first regular periodic payment will be due, regardless of whether the maximum rate is reached at the first or subsequent adjustment during such five year period. The Bureau is finalizing comment 43(e)(2)(iv)(A)–2 as proposed. That comment clarifies that for a fixed-rate mortgage, creditors should use the interest rate in effect at consummation, and provides a cross-reference to § 1026.18(s)(7)(iii) for the meaning of the term ‘‘fixed-rate mortgage.’’ The Bureau is finalizing comment 43(e)(2)(iv)–3 as proposed, but with conforming changes to reflect the new time horizon. That comment provides guidance to creditors regarding treatment of periodic interest rate adjustment caps, and explains that, for an adjustable-rate mortgage, creditors should assume the interest rate increases after consummation as rapidly as possible, taking into account the terms of the legal obligation. The comment further explains that creditors should account for any periodic interest rate adjustment cap that may limit how quickly the interest rate can increase under the terms of the legal obligation. The comment states that where a range for the maximum interest rate during the first five years is provided, the highest rate in that range is the maximum interest rate for purposes of this section. Finally, the comment clarifies that where the terms of the legal obligation are not based on an index plus a margin, or formula, the creditor must use the maximum interest rate that occurs during the first five VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 years after the date on which the first regular periodic payment will be due. The Bureau is also adopting comment 43(e)(2)(iv)–3.i through .iii as proposed, but with conforming changes to the comment to reflect the new time horizon. Those comments provide examples of how to determine the maximum interest rate. For example, comment 43(e)(2)(iv)–3.1 illustrates how to determine the maximum interest rate in the first five years after the date on which the first regular periodic payment will be due for an adjustable-rate mortgage with a discounted rate for three years. The Bureau is also finalizing comment 43(e)(2)(iv)–4 as proposed, but with conforming changes to reflect the new time horizon. Comment 43(e)(2)(iv)–4 clarifies the meaning of the phrase ‘‘first five years after the date on which the first regular periodic payment will be due.’’ This comment provides that under § 1026.43(e)(2)(iv)(A), the creditor must underwrite the loan using the maximum interest rate that may apply during the first five years after the date on which the first regular periodic payment will be due, and provides an illustrative example. 43(e)(2)(iv)(B) Proposed § 226.43(e)(2)(iv)(B) would have implemented TILA section 129C(b)(2)(A)(iv) and (v), in part, by providing, as part of meeting the definition of a qualified mortgage under proposed § 1026.43(e)(2), that the creditor underwrite the loan using periodic payments of principal and interest that will repay either (1) the outstanding principal balance over the remaining term of the loan as of the date the interest rate adjusts to the maximum interest rate that occurs during the first five years after consummation; or (2) the loan amount over the loan term. See proposed § 226.43(e)(2)(iv)(B)(1) and (2). TILA section 129C(b)(2)(A)(iv) and (v) states that underwriting should be based ‘‘on a payment schedule that fully amortizes the loan over the loan term.’’ The Board noted that unlike the payment calculation assumptions set forth for purposes of the general abilityto-repay rule, under TILA section 129C(a)(6), the underwriting conditions for purposes of meeting the definition of a qualified mortgage do not specify the loan amount that should be repaid, and do not define ‘‘loan term.’’ For consistency and to facilitate compliance, the Board proposed to use the terms ‘‘loan amount’’ and ‘‘loan term’’ in proposed § 226.43(b)(5) and (b), respectively, for purposes of this underwriting condition. PO 00000 Frm 00116 Fmt 4701 Sfmt 4700 However, the Board also believed that a loan that meets the definition of a qualified mortgage and which has the benefit of other safeguards, such as limits on loan features and fees, merits flexibility in the underwriting process. Accordingly, the Board proposed to permit creditors to underwrite the loan using periodic payments of principal and interest that will repay either the outstanding principal balance as of the date the maximum interest rate during the first five years after consummation takes effect under the terms of the loan, or the loan amount as of the date of consummation. The Board believed the former approach more accurately reflects the largest payment amount that the consumer would need to make under the terms of the loan during the first five years after consummation, whereas the latter approach would actually overstate the payment amounts required. This approach would have set a minimum standard for qualified mortgages, while affording creditors latitude to choose either approach to facilitate compliance. For the reasons described in the proposed rule, the Bureau is finalizing § 226.43(e)(2)(iv)(A) as proposed in renumbered § 1026.43(e)(2)(iv)(A). However, the final rule makes conforming changes to the proposed commentary to reflect the adjusted timehorizon to the first five years after the due date of the first regular periodic payment. The proposed commentary and the changes to the proposed commentary in the final rule are described below. The Bureau is finalizing comment 43(e)(2)(iv)–5 as proposed, but with conforming changes to reflect the new time horizon. Comment 43(e)(2)(iv)–5 provides further clarification to creditors regarding the loan amount to be used for purposes of this second condition in § 1026.43(e)(2)(iv). The comment explains that for a creditor to meet the definition of a qualified mortgage under § 1026.43(e)(2), the creditor must determine the periodic payment of principal and interest using the maximum interest rate permitted during the first five years after the date on which the first regular periodic payment will be due that repays either (1) the outstanding principal balance as of the earliest date the maximum interest rate can take effect under the terms of the legal obligation, over the remaining term of the loan, or (2) the loan amount, as that term is defined in § 1026.43(b)(5), over the entire loan term, as that term is defined in § 1026.43(b)(6). This comment provides illustrative examples for both approaches. E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations The Bureau is finalizing comment 43(c)(2)(iv)–6 as proposed. That comment reiterates that § 1026.43(e)(2)(iv) requires creditors to take mortgage-related obligations into account when underwriting the loan and refers to § 1026.43(b)(8) and its associated commentary for the meaning of mortgage-related obligations. The Bureau is also finalizing comment 43(e)(2)(iv)–7 as proposed, but with conforming changes to reflect the new time horizon. Comment 43(e)(2)(iv)–7 provides examples of how to determine the periodic payment of principal and interest based on the maximum interest rate during the first five years after the date on which the first regular periodic payment will be due under § 1026.43(e)(2)(iv). The final rule provides an additional example of how to determine the periodic payment of principal and interest based on the maximum interest rate during the first five years after the date on which the first regular periodic payment will be due under § 1026.43(e)(2)(iv) for an adjustable-rate mortgage with a discount of seven years, to illustrate how the payment calculation applies in a loan that adjusts after the five-year time horizon. Comment 43(e)(2)(iv)–7.iv provides an example of a loan in an amount of $200,000 with a 30-year loan term, that provides for a discounted interest rate of 6 percent that is fixed for an initial period of seven years, after which the interest rate will adjust annually based on a specified index plus a margin of 3 percent, subject to a 2 percent annual interest rate adjustment cap. The index value in effect at consummation is 4.5 percent. The loan is consummated on March 15, 2014, and the first regular periodic payment is due May 1, 2014. Under the terms of the loan agreement, the first rate adjustment is on April 1, 2021 (the due date of the 84th monthly payment), which occurs more than five years after the date on which the first regular periodic payment will be due. Thus, the maximum interest rate under the terms of the loan during the first five years after the date on which the first regular periodic payment will be due is 6 percent. Under this example, the transaction will meet the definition of a qualified mortgage if the creditor underwrites the loan using the monthly payment of principal and interest of $1,199 to repay the loan amount of $200,000 over the 30-year loan term using the maximum interest rate during the first five years after the date on which the first regular periodic payment will be due of 6 percent. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 43(e)(2)(v) 43(e)(2)(v)(A) TILA section 129C(b)(2)(A)(iii) provides that a condition for meeting the requirements of a qualified mortgage is that the income and financial resources relied upon to qualify the obligors on the residential mortgage loan are verified and documented. This requirement is consistent with requirement under the general abilityto-repay standard to consider and verify a consumer’s income or assets using third-party records, pursuant to TILA section 129C(a)(1) and (3), as discussed above in the section-by-section analysis of § 1026.43(c)(2)(i) and (c)(4). Proposed § 226.43(e)(2)(v) would have implemented TILA section 129C(b)(2)(A)(iii) by providing that for a covered transaction to be a qualified mortgage, the creditor must consider and verify the consumer’s current or reasonably expected income or assets to determine the consumer’s repayment ability, as required by proposed § 226.43(c)(2)(i) and (c)(4). The proposal used the term ‘‘assets’’ instead of ‘‘financial resources’’ for consistency with other provisions in Regulation Z and, as noted above, the Bureau believes that the terms have the same meaning. Proposed comment 43(e)(2)(v)–1 would have clarified that creditors may rely on commentary to proposed § 226.43(c)(2)(i), (c)(3) and (c)(4) for guidance regarding considering and verifying the consumer’s income or assets to satisfy the conditions for a qualified mortgage under proposed § 226.43(e)(2)(v). For the reasons discussed in the proposal, the Bureau is finalizing § 226.43(e)(2)(v)(A) as proposed in renumbered § 1026.43(e)(2)(v)(A), with additional clarification that the value of the dwelling includes any real property to which the dwelling is attached. Renumbered § 1026.43(e)(2)(v)(A) also provides that the creditor must consider and verify the consumer’s current or reasonably expected income or assets other than the value of the dwelling (including any real property attached to the dwelling) that secures the loan, in accordance with appendix Q, in addition to § 1026.43(c)(2)(i) and (c)(4). Comment 43(e)(2)(v)–2 clarifies this provision, by explaining that, for purposes of this requirement, the creditor must consider and verify, at a minimum, any income specified in appendix Q. A creditor may also consider and verify any other income in accordance with § 1026.43(c)(2)(i) and (c)(4); however, such income would not be included in the total monthly debtto-income ratio determination by PO 00000 Frm 00117 Fmt 4701 Sfmt 4700 6523 § 1026.43(e)(2)(vi). As described below, appendix Q contains specific standards for defining ‘‘income,’’ to provide certainty to creditors as to whether a loan meets the requirements for a qualified mortgage. The final rule includes this reference to appendix Q and additional comment to clarify the relationship between the requirement to consider a consumer’s current or reasonably expected income in § 1026.43(e)(2)(v)(A) and the definition of ‘‘income’’ in appendix Q. In other words, a creditor who considers ‘‘income’’ as defined in appendix Q meets the income requirement in § 1026.43(e)(2)(v)(A), so long as that income is verified pursuant to § 1026.43(c)(4). In addition, comment 43(e)(2)(v)–1 provides that for guidance on satisfying § 1026.43(e)(2)(v), a creditor may rely on commentary to § 1026.43(c)(2)(i) and (vi), (c)(3), and (c)(4). 43(e)(2)(v)(B) The Board’s proposed Alternative 2 would have required that creditors consider and verify the following additional underwriting requirements, which are also required under the general ability-to-repay standard: the consumer’s employment status, the consumer’s monthly payment on any simultaneous loans, the consumer’s current debt obligations, the consumer’s monthly debt-to-income ratio or residual income, and the consumer’s credit history. The commentary would have provided that creditors could look to commentary on the general repayment ability provisions under proposed § 226.43(c)(2)(i), (ii), (iv), and (vi) through (viii), and (c)(3), (c)(4), (c)(6), and (c)(7) for guidance regarding considering and verifying the consumer’s repayment ability to satisfy the conditions under § 226.43(e)(2)(v) for a qualified mortgage. See proposed comment 43(e)(2)(v)–1 under Alternative 2. The Board proposed these additions pursuant to its legal authority under TILA section 129C(b)(3)(B)(i). The Board believed that adding these requirements may be necessary to better ensure that the consumers are offered and receive loans on terms that reasonably reflect their ability to repay the loan. In the final rule, § 1026.43(e)(2)(v)(B) provides that, to meet the requirements for a qualified mortgage under § 1026.43(e)(2), the creditor must consider and verify the consumer’s current debt obligations, alimony, and child support, in accordance with appendix Q and § 1026.43(c)(2)(vi) and (c)(3). In addition, new comment 43(e)(2)(v)–3 clarifies that, for purposes E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6524 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations of considering and verifying the consumer’s current debt obligations, alimony, and child support pursuant to § 1026.43(e)(2)(v)(B), the creditor must consider and verify, at a minimum, any debt or liability specified in appendix Q. A creditor may also consider and verify other debt in accordance with § 1026.43(c)(2)(vi) and (c)(3); however, such debt would not be included in the total monthly debt-to-income ratio determination required by § 1026.43(e)(2)(vi). As described below, appendix Q contains specific standards for defining ‘‘debt,’’ to provide certainty to creditors as to whether a loan meets the requirements for a qualified mortgage. The final rule includes this reference to appendix Q and additional comment to clarify the relationship between the requirement to consider a consumer’s current debt obligations, alimony, and child support in § 1026.43(e)(2)(v)(B) and the definition of ‘‘debt’’ in appendix Q. In other words, a creditor who considers ‘‘debt’’ as defined in appendix Q meets the requirement in § 1026.43(e)(2)(v)(B), so long as that income is verified pursuant to § 1026.43(c)(3). The Bureau is incorporating the requirement that the creditor consider and verify the consumer’s current debt obligations, alimony, and child support into the definition of a qualified mortgage in § 1026.43(e)(2) pursuant to its authority under TILA section 129C(b)(3)(B)(i). The Bureau finds that this addition to the qualified mortgage criteria is necessary and proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner that is consistent with the purposes of TILA section 129C and necessary and appropriate to effectuate the purposes of TILA section 129C, which includes assuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loan. The Bureau also incorporates this requirement pursuant to its authority under TILA section 105(a) to issue regulations that, among other things, contain such additional requirements, other provisions, or that provide for such adjustments for all or any class of transactions, that in the Bureau’s judgment are necessary or proper to effectuate the purposes of TILA, which include the above purpose of section 129C, among other things. The Bureau believes that this addition to the qualified mortgage criteria is necessary and proper to achieve this purpose. In particular, as discussed above, the Bureau finds that incorporating the requirement that a VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 creditor consider and verify a consumer’s current debt obligations, alimony, and child support into the qualified mortgage criteria ensures that creditors consider, on an individual basis, and verify whether a consumer has the ability to repay a qualified mortgage. Furthermore, together with the requirement to consider and verify income, the Bureau believes this requirement to consider and verify debt obligations, alimony, and child support strengthens consumer protection and is fundamental to the underlying components of the requirement in § 1026.43(e)(2)(vi), which provides a specific debt-to-income ratio threshold. Ultimately, the Bureau believes that the statute is fundamentally about establishing standards for determining a consumer’s reasonable ability to repay and therefore believes it is appropriate to incorporate the ability-to-repay underwriting requirements into the qualified mortgage definition to ensure consistent consumer protections for repayment ability for a qualified mortgage. However, as described above, most of the ability-to-repay requirements must be considered and verified to satisfy the specific debt-toincome ratio requirement in § 1026.43(e)(2)(vi), which requires the creditor to follow the standards for ‘‘debt’’ and ‘‘income’’ in appendix Q, including the consumer’s employment status, monthly payment on the covered transaction, monthly payment on simultaneous loans of which the creditor is aware, and monthly payment on mortgage-related obligations. For this reason, unlike the Board’s proposed Alternative 2, the final rule does not separately require consideration and verification of these factors that are part of the general ability-to-repay analysis. 43(e)(2)(vi) TILA section 129C(b)(2)(vi) states that the term qualified mortgage includes any mortgage loan ‘‘that complies with any guidelines or regulations established by the Bureau relating to ratios of total monthly debt to monthly income or alternative measure of ability to pay regular expenses after payment of total monthly debt, taking into account the income levels of the consumer and such other factors as the Bureau may determine relevant and consistent with the purposes described in paragraph (3)(B)(i).’’ Board’s Proposal Under proposed § 226.43(e)(2)(v) under Alternative 1, creditors would not have been required to consider the consumer’s debt-to-income ratio or residual income to make a qualified PO 00000 Frm 00118 Fmt 4701 Sfmt 4700 mortgage. The Board noted several reasons for proposing this approach. First, the Board noted that the debt-toincome ratio and residual income are based on widely accepted standards which, although flexible, do not provide certainty that a loan is a qualified mortgage. The Board believed this approach is contrary to Congress’ apparent intent to provide incentives to creditors to make qualified mortgages, since they have less risky features and terms. Second, the Board noted that because the definition of a qualified mortgage under Alternative 1 would not require consideration of current debt obligations or simultaneous loans, it would be impossible for a creditor to calculate the debt-to-income ratio or residual income without adding those requirements as well. Third, the Board stated that data shows that the debt-toincome ratio generally does not have a significant predictive power of loan performance once the effects of credit history, loan type, and loan-to-value ratio are considered.148 Fourth, the Board noted that although consideration of the mortgage debt-to-income ratio (or ‘‘front-end’’ debt-to-income) might help consumers receive loans on terms that reasonably reflect their ability to repay the loans, the Board’s outreach indicated that creditors often do not find that ‘‘front-end’’ debt-to-income ratio is a strong predictor of ability to repay. Finally, the Board stated its concern that the benefit of including the debt-to-income ratio or residual income in the definition of qualified mortgage may not outweigh the cost to certain consumers who may not meet widely accepted debt-to-income ratio standards, but may have other compensating factors, such as sufficient residual income or other resources to be able to reasonably afford the mortgage. A definition of qualified mortgage that required consideration of the consumer’s debt-to-income or residual income could limit the availability of credit to those consumers. However, under proposed § 226.43(e)(2)(v) under Alternative 2, a qualified mortgage would have been defined as a loan which, among other things, the creditor considers the consumer’s monthly debt-to-income ratio or residual income, pursuant to proposed § 226.43(c)(2)(vii) and (c)(7). The Board noted that, without determining the consumer’s debt-toincome ratio, a creditor could originate 148 The proposal cited Yuliya Demyanyk & Otto Van Hemert, Understanding the Subprime Mortgage Crisis, 24 Rev. Fin. Stud. 1848 (2011); James A. Berkovec et al., Race, Redlining, and Residential Mortgage Loan Performance, 9 J. Real Est. Fin. & Econs. 263 (1994). E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations a qualified mortgage without any requirement to consider the effect of the new loan payment on the consumer’s overall financial picture. The consumer could have a very high total debt-toincome ratio under reasonable underwriting standards, and be predicted to default soon after the first scheduled mortgage payment. Accordingly, the Board believed that including the debt-to-income ratio or residual income in the definition of qualified mortgage might ensure that the consumer has a reasonable ability to repay the loan. The Board did not propose a quantitative standard for the debt-toincome ratio in the qualified mortgage definition, but solicited comment on the appropriateness of such an approach. The Board’s proposal noted several reasons for declining to introduce a specific debt-to-income ratio for qualified mortgages. First, as explained in the 2008 HOEPA Final Rule, the Board was concerned that setting a specific debt-to-income ratio could limit credit availability without providing adequate off-setting benefits. 73 FR 4455 (July 30, 2008). The Board sought comment on what exceptions may be necessary for low-income consumers or consumers living in high-cost areas, or for other cases, if the Board were to adopt a quantitative debt-to-income standard. Second, outreach conducted by the Board revealed a range of underwriting guidelines for debt-to-income ratios based on product type, whether creditors used manual or automated underwriting, and special considerations for high- and low-income consumers. The Board believed that setting a quantitative standard would require it to address the operational issues related to the calculation of the debt-to-income ratio. For example, the Board would need clearly to define income and current debt obligations, as well as compensating factors and the situations in which creditors may use compensating factors. In addition, the debt-to-income ratio is often a floating metric, since the percentage changes as new information about income or current debt obligations becomes available. A quantitative standard would require guidelines on the timing of the debt-to-income ratio calculation, and what circumstances would necessitate a re-calculation of the debtto-income ratio. Furthermore, a quantitative standard may also need to provide tolerances for mistakes made in calculating the debt-to-income ratio. The rule would also need to address the use of automated underwriting systems in determining the debt-to-income. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 For all these reasons, the Board did not propose a quantitative standard for the debt-to-income ratio. The Board recognized, however, that creditors, and ultimately consumers, may benefit from a higher degree of certainty surrounding the qualified mortgage definition that a quantitative standard could provide. Therefore, the Board solicited comment on whether and how it should prescribe a quantitative standard for the debt-toincome ratio or residual income for the qualified mortgage definition. Comments As noted above, the Bureau received comments in response to the Board’s 2011 ATR Proposal and in response to the Bureau’s May 2012 notice to reopen the comment period. The reopened comment period solicited comment specifically on new data and information obtained from the Federal Housing Finance Agency (FHFA) after the close of the original comment period. In the notice to reopen the comment period, the Bureau, among other things, solicited comment on data and information as well as sought comment specifically on certain underwriting factors, such as a debt-toincome ratio, and their relationship to measures of delinquency or their impact on the number or percentage of mortgage loans that would be a qualified mortgage. In addition, the Bureau sought comment and data on estimates of litigation costs and liability risks associated with claims alleging a violation of ability-to-repay requirements. Comments on general debt-to-income ratio or residual income requirement. In response to the proposed rule, some industry commenters argued that the final rule should not require consideration and verification of a consumer’s monthly debt-to-income ratio or residual income for a qualified mortgage. They argued that such an approach would create a vague, subjective definition of qualified mortgage. Certain industry commenters requested that if the Bureau added consideration and verification of the debt-to-income ratio or residual income to the definition of a qualified mortgage, the Bureau establish flexible standards. These commenters argued that imposing low debt-to-income ratio requirements would be devastating to many potential creditworthy homebuyers. Other industry commenters suggested that if the Bureau added consideration and verification of the debt-to-income ratio or residual income to the definition of a qualified mortgage, the Bureau provide clear and objective standards. For example, one industry PO 00000 Frm 00119 Fmt 4701 Sfmt 4700 6525 trade group commenter noted that, historically, the debt-to-income ratio has been a key metric used to assess a consumer’s ability to repay a mortgage loan, and has been incorporated into both manual and automated underwriting systems used in the industry. Some industry commenters asked that the final rule adopt the VA calculation of residual income. See also the section-by-section analysis of section 1026.43(c)(7). Another industry commenter suggested that any mortgage with a residual income of at least $600 be sufficient for a qualified mortgage. Another industry commenter suggested that, at a minimum, residual income considerations would require a workable standard with clear, specific, and objective criteria and be explicitly limited to specific expense items. An industry trade group commenter recommended that if the Bureau requires the use of residual income, creditors be allowed flexibility in considering residual income along with other factors in loan underwriting. Comments that addressed a specific debt-to-income ratio are discussed below. Several industry commenters recommended that if the Bureau required consideration and verification of the debt-to-income ratio or residual income for a qualified mortgage, creditors be permitted to take compensating factors into account. They suggested that the Bureau provide examples of compensating factors, such as: (1) The property being an energyefficient home; (2) the consumer having probability for increased earnings based on education, job training, or length of time in a profession; (3) the consumer having demonstrated ability to carry a higher total debt-load while maintaining a good credit history for at least 12 months; (4) future expenses being lower, such as child-support payments to cease for child soon to reach age of majority; or (5) the consumer having substantial verified liquid assets. Consumer advocates generally supported adding consideration and verification of the debt-to-income ratio or residual income to the definition of a qualified mortgage. They noted that such inclusion would help ensure that consumers receive mortgages they can afford and that such factors are basic, core features of common-sense underwriting that are clearly related to the risk of consumer default. To that point, these commenters contended that residual income is an essential component, especially for lower-income families. One consumer group commenter stressed that residual income standards should be E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6526 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations incorporated, and pointed to the FHFA data in the Bureau’s notice to reopen the comment period to demonstrate that relying solely on debt-to-income ratios is insufficient to ensure sound lending based on a consumer’s ability to repay. Many industry and consumer group commenters and interested parties supported use of a specific debt-toincome ratio threshold. For example, some suggested that if a consumer’s total debt-to-income ratio is below a specified threshold, the mortgage loan should satisfy the qualified mortgage requirements, assuming other relevant conditions are met. At least one industry commenter supported allowing the use of FHA underwriting guidelines to define ‘‘debt’’ and ‘‘income.’’ Although many commenters supported the use of a specific debt-toincome ratio threshold, both industry and consumer group commenters noted that relying on debt-to-income is only one element of underwriting, and that creditors have used other compensating factors and underwriting criteria. Some commenters acknowledged that a consumer’s debt-to-income ratio is a useful measure of loan performance; however, they asserted that the year of origination (i.e., vintage) has more bearing on loan performance. In addition, some commenters argued that measures of consumer credit history and loan-to-value are more predictive, and that broader economic factors largely determine loan performance. Several industry commenters recommended a debt-to-income ratio cutoff that is at the upper end of today’s relatively conservative lending standards, while permitting creditors to consider loans that exceed that debt-to-income ratio threshold if the consumer satisfies other objective criteria (such as reserves, housing payment history, and residual income), that help creditors assess the consumer’s ability to repay the loan. These commenters argued that the FHFA data in the Bureau’s notice to reopen the comment period demonstrate that when loans are properly underwritten, debt-to-income ratios can be relatively high without significantly affecting loan performance. Numerous commenters argued that the Bureau should consider the costs and benefits of selecting a maximum debt-to-income ratio for qualified mortgages. Many industry and consumer group commenters argued that a debt-to-income threshold that is too low would unnecessarily exclude a large percentage of consumers from qualified mortgages. One joint industry and consumer group comment letter suggested a 43 percent total debt-toincome ratio. In addition to a debt-to- VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 income requirement, some commenters and interested parties suggested that the Bureau should include within the definition of a ‘‘qualified mortgage’’ loans with a debt-to-income ratio above a certain threshold if the consumer has a certain amount of assets, such as money in a savings or similar account, or a certain amount of residual income. For example, an industry commenter suggested a 45 percent total debt-toincome ratio, with an allowance for higher total debt-to-income ratios of up to 50 percent for consumers with significant assets (e.g., at least one year’s worth of reserves). This commenter asked that the Bureau carve out consumers who have shown ability to maintain a high debt-to-income ratio or who have a nontraditional credit history. This commenter explained that the higher the debt-to-income ratio, the more likely a brief interruption in income or unexpected large expense could compromise repayment ability. The commenter noted that only a numerical standard would provide sufficient certainty for creditors and investors, since they may otherwise end up litigating what is a reasonable debtto-income ratio. Another industry commenter asked that a 50 percent back-end debt-to-income ratio be sufficient. This commenter noted that without clear and objective standards, creditors trying to make a qualified mortgage would fall back on the qualified residential mortgage standards. Another industry trade association commenter argued that a total debt-toincome ratio threshold of 43 percent is problematic because according to the FHFA data in the Bureau’s notice to reopen the comment period, there is no appreciable difference in performance for loans with a 43 percent debt-toincome ratio and loans with 46 percent debt-to-income ratio. In other words, commenters argued that the FHFA data supports a higher debt-to-income ratio threshold, such as 46 percent. Another commenter noted that the FHFA data does not include data on portfolio loans. Some consumer group commenters suggested that the Bureau conduct further research into the role of debt-toincome ratios and the relationship between a consumer’s debt-to-income ratio and residual income. One commenter noted that the Bureau should consider a tiered-approach for higher-income consumers who can support a higher debt-to-income ratio. Another consumer group commenter argued that residual income should be incorporated into the definition of qualified mortgage. Several commenters suggested that the Bureau use the PO 00000 Frm 00120 Fmt 4701 Sfmt 4700 general residual income standards of the VA as a model for a residual income test, and one of these commenters recommended that the Bureau coordinate with FHFA to evaluate the experiences of the GSEs in using residual income in determining a consumer’s ability to repay. Some commenters opposed including a specific debt-to-income ratio threshold into the qualified mortgage criteria. For example, one commenter argued that though the qualified mortgage criteria should be as objective as possible, a specific debt-to-income threshold should not be imposed because the criteria should be flexible to account for changing markets. Another commenter argued that creditors should be able to consider debt-to-income and residual income ratios, but creditors should not be restricted to using prescribed debt-toincome or residual income ratios. One industry commenter contended that if the Bureau were to impose a 45 percent total debt-to-income ratio, for example, most larger secondary market investors/ servicers would impose a total debt-toincome ratio that is much lower (such as 43 percent or 41 percent) as a general rule of risk management. Final Rule The Bureau believes, based upon its review of the data it has obtained and the comments received, that the use of total debt-to-income as a qualified mortgage criterion provides a widespread and useful measure of a consumer’s ability to repay, and that the Bureau should exercise its authority to adopt a specific debt-to-income ratio that must be met in order for a loan to meet the requirements of a qualified mortgage. The Bureau believes that the qualified mortgage criteria should include a standard for evaluating whether consumers have the ability to repay their mortgage loans, in addition to the product feature requirements specified in the statute. At the same time, the Bureau recognizes concerns that creditors should readily be able to determine whether individual mortgage transactions will be deemed qualified mortgages. The Bureau addresses these concerns by adopting a bright-line debtto-income ratio threshold of 43 percent, as well as clear and specific standards, based on FHA guidelines, set forth in appendix Q for calculating the debt-toincome ratio in individual cases. The Bureau believes that a consumer’s debt-to-income ratio is generally predictive of the likelihood of default, and is a useful indicator of such. At a basic level, the lower the debt-to-income ratio, the greater the consumer’s ability to pay back a mortgage loan would be E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with under existing conditions as well as changed circumstances, such as an increase in an adjustable rate, a drop in future income, or unanticipated expenses or new debts. The Bureau’s analysis of FHFA’s Historical Loan Performance (HLP) dataset, data provided by the FHA,149 and data provided by commenters all bear this out. These data indicate that debt-toincome ratio correlates with loan performance, as measured by delinquency rate (where delinquency is defined as being over 60 days late), in any credit cycle. Within a typical range of debt-to-income ratios for prudent underwriting (e.g., under 32 percent debt-to-income to 46 percent debt-toincome), the Bureau notes that generally, there is a gradual increase in delinquency with higher debt-to-income ratio.150 The record also shows that debt-to-income ratios are widely used as an important part of the underwriting processes of both governmental programs and private lenders. The Bureau recognizes the Board’s initial assessment that debt-to-income ratios may not have significant predictive power once the effects of credit history, loan type, and loan-tovalue are considered. In the same vein, the Bureau notes that some commenters suggested that the Bureau include compensating factors in addition to a specific debt-to-income ratio threshold. Even if a standard that takes into account multiple factors produces more accurate ability-to-pay determinations in specific cases, incorporating a multifactor test or compensating factors into the definition of a qualified mortgage would undermine the goal of ensuring that creditors and the secondary market can readily determine whether a particular loan is a qualified mortgage. Further, the Bureau believes that compensating factors would be too complex to calibrate into a bright-line rule and that some compensating factors suggested by commenters as appropriate, such as loan-to-value ratios, do not speak to a consumer’s repayment ability. Therefore, as permitted by the statute, the Bureau is adopting a specific debtto-income ratio threshold because this approach provides a clear, bright line criterion for a qualified mortgage that ensures that creditors in fact evaluate 149 The FHA’s comment letter provided in response to the 2012 notice to reopen the comment period describes this data. 150 See, e.g., 77 F.R. 33120, 33122–23 (June 5, 2012) (Table 2: Ever 60+ Delinquency Rates, summarizing the HLP dataset by volume of loans and percentage that were ever 60 days or more delinquent, tabulated by the total DTI on the loans and year of origination). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 consumers’ ability to repay qualified mortgages and provides certainty for creditors to know that a loan satisfies the definition of a qualified mortgage. A specific debt-to-income ratio threshold also provides additional certainty to assignees and investors in the secondary market, which should help reduce possible concerns regarding legal risk and potentially promote credit availability. As numerous commenters have urged, there is significant value to providing objective requirements that can be determined based on loan files. As described below, the final rule generally requires creditors to use the standards for defining ‘‘debt’’ and ‘‘income’’ in appendix Q, which are adapted from current FHA guidelines, to minimize burden and provide consistent standards. The standards set forth in appendix Q provide sufficient detail and clarity to address concerns that creditors may not have adequate certainty about whether a particular loan satisfies the requirements for being a qualified mortgage, and therefore will not deter creditors from providing qualified mortgages to consumers. The Bureau anticipates that the standards will facilitate compliance with the Dodd-Frank Act risk retention requirements, as the 2011 QRM Proposed Rule relied on FHA standards for defining ‘‘debt’’ and ‘‘income.’’ The Bureau has consulted with the Federal agencies responsible for the QRM rulemaking in developing this rule, and will continue to do so going forward. Based on analysis of available data and comments received, the Bureau believes that 43 percent is an appropriate ratio for a specific debt-toincome threshold, and that this approach advances the goals of consumer protection and preserving access to credit. The Bureau acknowledges, based on its analysis of the data, that there is no ‘‘magic number’’ which separates affordable from unaffordable mortgages; rather, as noted above, there is a gradual increase in delinquency rates as debt-to-income ratios increase. That being said, the Bureau understands that 43 percent is within the range of debt-to-income ratios used by many creditors and generally comports with industry standards and practices for prudent underwriting. As noted above, 43 percent is the threshold used by the FHA as its general boundary. Although the Bureau notes that Fannie Mae’s and Freddie Mac’s guidelines generally require a 36 percent debt-to-income ratio, without compensating factors, the Bureau believes that a 43 percent debtto-income threshold represents an PO 00000 Frm 00121 Fmt 4701 Sfmt 4700 6527 appropriate method to define which loans merit treatment as qualified mortgages. In particular, the Bureau believes that 43 percent represents a prudent outer boundary for a categorical presumption of a consumer’s ability to repay. As discussed above, there was significant debate among the commenters about the precise debt-toincome ratio threshold to establish. Although a lower debt-to-income threshold would provide greater assurance of a consumer’s ability to repay a loan, many commenters argued, and the Bureau agrees, that establishing a debt-to-income ratio threshold significantly below 43 percent would curtail many consumers’ access to qualified mortgages. One commenter estimated that roughly half of conventional borrowers would not be eligible for qualified mortgage loans if the debt-to-income ratio was set at 32 percent, while 85 percent of borrowers would be eligible with a ratio set at 45 percent. At the same time, the Bureau declines to establish a debt-to-income ratio threshold higher than 43 percent. The Bureau recognizes that some commenters suggested that debt-toincome ratios above 43 percent would not significantly increase the likelihood of default (depending to some extent on the presence of compensating factors), and that some consumers may face greater difficulty obtaining qualified mortgages absent a higher threshold. However, as the debt-to-income ratio increases, the presence of compensating factors becomes more important to the underwriting process and in ensuring that consumers have the ability to repay the loan. The general ability-to-repay procedures, rather than the qualified mortgage framework, is better suited for consideration of all relevant factors that go to a consumer’s ability to repay a mortgage loan. Thus, the Bureau emphasizes that it does not believe that a 43 percent debtto-income ratio represents the outer boundary of responsible lending. The Bureau notes that even in today’s creditconstrained market, approximately 22 percent of mortgage loans are made with a debt-to-income ratio that exceeds 43 percent and that prior to the mortgage boom approximately 20 percent of mortgage loans were made above that threshold. Various governmental agencies, GSEs, and creditors have developed a range of compensating factors that are applied on a case by case basis to assess a consumer’s ability to repay when the consumer’s debt-toincome ratio exceeds a specified ratio. Many community banks and credit E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6528 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations unions have found that they can prudently lend to consumers with a higher debt-to-income ratio based upon their firsthand knowledge of the individual consumer. As discussed below, many of those loans will fall within the temporary exception that the Bureau is recognizing for qualified mortgages. Over the long term, as the market recovers from the mortgage crisis and adjusts to the ability-to-repay rules, the Bureau expects that there will be a robust and sizable market for prudent loans beyond the 43 percent threshold even without the benefit of the presumption of compliance that applies to qualified mortgages. In short, the Bureau does not believe that consumers who do not receive a qualified mortgage because of the 43 percent debt-toincome ratio threshold should be cut off from responsible credit, and has structured the rule to try to ensure that a robust and affordable ability-to-repay market develops over time. The Bureau also believes that there would be significant negative consequences to the market from setting a higher threshold. For instance, if the qualified mortgage debt-to-income ratio threshold were set above 43 percent, it might sweep in many mortgages in which there is not a sound reason to presume that the creditor had a reasonable belief in the consumer’s ability to repay. At a minimum, adopting a higher debt-to-income threshold to define qualified mortgages would require a corresponding weakening of the strength of the presumption of compliance—which would largely defeat the point of adopting a higher debt-to-income threshold. Additionally, the Bureau also fears that if the qualified mortgage boundary were to cover substantially all of the mortgage market, creditors might be unwilling to make non-qualified mortgage loans, with the result that the qualified mortgage rule would define the limit of credit availability. The Bureau believes that lending in the nonqualified mortgage market can and should be robust and competitive over time. The Bureau expects that, as credit conditions ease, creditors will continue making prudent, profitable loans in nontraditional segments, such as to consumers who have sufficient total assets or future earning potential to be able to afford a loan with a higher debtto-income ratio or consumers who have a demonstrated ability to pay housing expenses at or above the level of a contemplated mortgage. Finally, the Bureau acknowledges arguments that residual income may be a better measure of repayment ability in the long run. A consumer with a VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 relatively low household income may not be able to afford a 43 percent debtto-income ratio because the remaining income, in absolute dollar terms, is too small to enable the consumer to cover his or her living expenses. Conversely, a consumer with a relatively high household income may be able to afford a higher debt ratio and still live comfortably on what is left over. Unfortunately, however, the Bureau lacks sufficient data, among other considerations, to mandate a bright-line rule based on residual income at this time. The Bureau expects to study residual income further in preparation for the five-year review of this rule required by the Dodd-Frank Act. See also section-by-section analysis of § 1026.43(c)(7). The Bureau believes that it is important that the final rule provide clear standards by which creditors calculate a consumer’s monthly debt-toincome ratio for purposes of the specific debt-to-income threshold in § 1026.43(e)(2)(vi). For this reason, the final rule provides specific standards for defining ‘‘debt’’ and ‘‘income’’ in appendix Q. These standards are based on the definitions of debt and income used by creditors originating residential mortgages that are insured by the FHA. In particular, appendix Q incorporates the definitions and standards in the HUD Handbook 4155.1, Mortgage Credit Analysis for Mortgage Insurance on One-to-Four-Unit Mortgage Loans, to determine and verify a consumer’s total monthly debt and monthly income, with limited modifications to remove portions unique to the FHA underwriting process, such as references to the TOTAL Scorecard Instructions. The use of FHA guidelines for this purpose provides clear, well-established standards for determining whether a loan is a qualified mortgage under § 1026.43(e)(2). This approach is also consistent with the proposed approach to defining debt and income in the 2011 QRM Proposed Rule, and therefore could facilitate compliance for creditors. The Bureau has consulted with the Federal agencies responsible for the QRM rulemaking and will continue to do so going forward as that rulemaking is completed, as well as to discuss changes to FHA guidelines that may occur over time. Accordingly, § 1026.43(e)(2)(vi) provides that, as a condition to being a qualified mortgage under § 1026.43(e)(2), the consumer’s total monthly debt-to-income ratio does not exceed 43 percent. For purposes of § 1026.43(e)(2)(vi), the consumer’s monthly debt-to-income ratio is calculated in accordance with appendix PO 00000 Frm 00122 Fmt 4701 Sfmt 4700 Q, except as provided in § 1026.43(e)(2)(vi)(B). Section 1026.43(e)(2)(vi)(B) contains additional requirements regarding the calculation of ‘‘debt,’’ for consistency with other parts of the qualified mortgage definition and § 1026.43. Specifically, that section provides that the consumer’s monthly debt-to-income ratio must be calculated using the consumer’s monthly payment on the covered transaction, including mortgage-related obligations, in accordance with § 1026.43(e)(2)(iv), and any simultaneous loan that the creditor knows or has reason to know will be made, in accordance with § 1026.43(c)(2)(iv) and (c)(6). Comment 43(e)(2)(vi)–1 clarifies the relationship between the definition of ‘‘debt’’ in appendix Q and the requirements of § 1026.43(e)(2)(vi)(B). Specifically, the comment states that, as provided in appendix Q, for purposes of § 1026.43(e)(2)(vi), creditors must include in the definition of ‘‘debt’’ a consumer’s monthly housing expense. This includes, for example, the consumer’s monthly payment on the covered transaction (including mortgage-related obligations) and simultaneous loans. Accordingly, § 1026.43(e)(2)(vi)(B) provides the method by which a creditor calculates the consumer’s monthly payment on the covered transaction and on any simultaneous loan that the creditor knows or has reason to know will be made. The Bureau notes that the specific 43 percent debt-to-income requirement applies only to qualified mortgages under § 1026.43(e)(2). For the reasons discussed below, the specific debt-toincome ratio requirement does not apply to loans that meet the qualified mortgage definitions in § 1026.43(e)(4) or (f). 43(e)(3) Limits on Points and Fees for Qualified Mortgages 43(e)(3)(i) TILA section 129C(b)(2)(A)(vii) defines a ‘‘qualified mortgage’’ as a loan for which, among other things, the total points and fees payable in connection with the loan do not exceed 3 percent of the total loan amount. TILA section 129C(b)(2)(D) requires the Bureau to prescribe rules adjusting this limit to ‘‘permit lenders that extend smaller loans to meet the requirements of the presumption of compliance.’’ The statute further requires the Bureau to ‘‘consider the potential impact of such rules on rural areas and other areas where home values are lower.’’ The statute does not define and the E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations legislative history does not provide guidance on the term ‘‘smaller loan’’ or the phrase ‘‘rural areas and other areas where home values are lower.’’ The Board proposed two alternative versions of § 226.43(e)(3)(i) to implement the 3 percent points and fees cap for qualified mortgages and the adjustment to the cap for smaller loans. For both alternatives, the Board proposed a threshold of $75,000, indexed to inflation, for smaller loans. For loans above the $75,000 threshold, the 3 percent points and fees cap for qualified mortgages would have applied. For loans below $75,000, different limits would have applied, depending on the amount of the loan. The Board explained that it set the smaller loan threshold at $75,000 because it believed that Congress intended the exception to the 3 percent points and fees cap to apply to more than a minimal, but still limited, proportion of home-secured loans. The Board noted that HMDA data show that 8.4 percent of first-lien, home-purchase (site-built) mortgages in 2008 and 9.7 percent of such mortgages in 2009 had a loan amount of $74,000 or less. The Board also stated that outreach and research indicated that $2,250—3 percent of $75,000—is within range of average costs to originate a first-lien home mortgage. Thus, the Board concluded that $75,000 appears to be an appropriate benchmark for applying the 3 percent limit on points and fees, with higher limits below that threshold offering creditors a reasonable opportunity to recover their origination costs. Both of the Board’s proposed alternatives would have separated loans into tiers based on loan size, with each tier subject to different limits on points and fees. The Board’s proposed Alternative 1 would have consisted of five tiers of loan sizes and corresponding limits on points and fees: • For a loan amount of $75,000 or more, 3 percent of the total loan amount; • For a loan amount greater than or equal to $60,000 but less than $75,000, 3.5 percent of the total loan amount; • For a loan amount greater than or equal to $40,000 but less than $60,000, 4 percent of the total loan amount; • For a loan amount greater than or equal to $20,000 but less than $40,000, 4.5 percent of the total loan amount; and • For a loan amount less than $20,000, 5 percent of the total loan amount. Alternative 2 would have consisted of three tiers of loan sizes and corresponding limits on points and fees. The first and third tiers were consistent VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 with Alternative 1. The middle tier was a sliding scale that reduced the points and fees cap (as a percentage of the loan amount) with each dollar increase in loan size. The three tiers of Alternative 2 would have consisted of: • For a loan amount of $75,000 or more, 3 percent of the total loan amount; • For a loan amount greater than or equal to $20,000 but less than $75,000, a percentage of the total loan amount yielded by the following formula: Æ Total loan amount¥$20,000 = $Z Æ $Z × 0.0036 basis points = Y basis points Æ 500 basis points¥Y basis points = X basis points Æ X basis points × 0.01 = Allowable points and fees as a percentage of the total loan amount. • For a loan amount less than $20,000, 5 percent of the total loan amount. The approach in Alternative 2 would have smoothed the transition from one tier to another and fixed an anomaly of Alternative 1. Under Alternative 1, for loans just above and below the dividing line between tiers, a greater dollar amount of points and fees would have been allowed on the smaller loans than on the larger loans. For example, the allowable points and fees on a total loan amount of $76,000 would have been $2,280 (3 percent of $76,000), but the permissible points and fees on a total loan amount of $70,000 would have been $2,450 (3.5 percent of $70,000). The Board noted that its proposal was designed to ensure that if a loan is a qualified mortgage it would not also be a high-cost mortgage based on the points and fees. The Board stated its belief that the statute is designed to reduce the compliance burden on creditors when they make qualified mortgages, in order to encourage creditors to make loans with stable, understandable loan features. The Board expressed concern that creating points and fees thresholds for small loans that might result in qualified mortgages also being high-cost mortgages would discourage creditors from making qualified mortgages because the requirements and limitations of high-cost loans are generally more stringent than for other loans. The Board requested comment on the proposed alternative loan size ranges and corresponding points and fees limits for qualified mortgages. The Board also requested comment on whether the loan size ranges should be indexed for inflation. The Board stated that, instead of using a smaller loan threshold with different tiers, it had considered adjusting the PO 00000 Frm 00123 Fmt 4701 Sfmt 4700 6529 criteria for smaller loans by narrowing the types of charges that would be included in points and fees for smaller loans. The Board indicated that outreach participants disfavored this approach because it would have required different ways of calculating points and fees, depending on loan size, and thus likely would have increased the burden of complying with the rules and the risk of error. The Board also stated that it had considered proposing an alternative points and fees threshold for certain geographical areas. As the Board noted, however, property values shift over time, and there is substantial variation in property values and loan amounts within geographical areas. Thus, adjusting the limits on points and fees based solely on geographic areas would have been a less straightforward and less precise method of addressing the statute’s concern with smaller loans. No commenters supported these approaches. Several industry commenters argued that points and fees have little, if any, relationship to consumers’ ability to repay their mortgage loans and that qualified mortgages should therefore not be subject to limits on points and fees. Although they acknowledged that the Dodd-Frank Act generally prescribed a 3 percent limit on points and fees for qualified mortgages, they urged the Bureau to use its authority to eliminate this requirement. Several industry commenters contended that the 3 percent limit on points and fees for qualified mortgages is too low. They maintained that the 3 percent cap would require creditors to increase interest rates to recover their costs and would limit consumers’ flexibility to arrange their optimal combination of interest rates and points and fees. Industry commenters also claimed that the 3 percent limit would have a negative impact on consumers’ access to affordable credit. Some industry commenters noted that the GSEs’ seller/servicer guides contain standards that limit points and fees for loans that the GSEs purchase or securitize, with the current standards limiting points and fees to the greater of 5 percent of the mortgage amount or $1,000. The commenters argued that Bureau should use its authority adopt the GSEs’ standards instead of the requirements prescribed by the DoddFrank Act. One commenter argued that, because of the complexity of the points and fees test, the Bureau should adopt a tolerance of one-quarter of 1 percent or $250 for the 3 percent limit so that de minimis errors in calculating points and fees would not prevent a loan from E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6530 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations retaining the legal protection of a qualified mortgage. With respect to the two proposed alternative versions of section 43(e)(3)(i), industry commenters generally preferred Alternative 1. They explained that Alternative 2 was too complex, would be difficult to implement, and would increase compliance and litigation costs. Some consumer advocates preferred Alternative 2, stating that it would be more beneficial to consumers. Other consumer advocates preferred Alternative 1, asserting that its simplicity would minimize miscalculations that could harm consumers. They stated that the difference to the consumer between Alternative 1 and Alternative 2 was marginal. Some of these consumer advocates argued that the benefit afforded by simplicity would outweigh the small pricing distortions. Commenters did not object to the Board’s general approach of setting a threshold amount for smaller loans and adjusting the points and fees cap for loans below the threshold. Instead, the comments discussed what the threshold loan amount should be for smaller loans and what limits should be imposed on points and fees for loans below the threshold. Industry commenters contended that the Board’s proposed limits on points and fees for smaller loans would be too low and would not permit creditors to recover their costs. They stated that many origination costs are fixed regardless of loan size. They asserted that if a creditor could not cover those costs through points and fees, the creditor would either not make the mortgage or increase the interest rate to cover the costs. Industry commenters expressed concern that, for smaller loans, a rate increase might result in the loan becoming a high-cost mortgage or in some consumers no longer being eligible for the loan. They contended that creditors would be reluctant to make these loans and credit availability would be compromised, in particular for low-income, minority, and rural consumers, and first-time home buyers. One commenter reported that if a consumer were offered a high interest rate to cover costs and the rate were increased to offset the costs of a smaller loan, the consumer would pay thousands of dollars more over the life of the loan. Industry commenters asserted that the proposed alternatives did not capture the congressional intent of providing creditors sufficient incentives to make smaller loans. Industry commenters urged the Bureau to revise the proposal to allow creditors VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 to recover more of their costs through points and fees, either by increasing the threshold for smaller loans or raising the limits for loans below the threshold or by doing both. Many industry commenters recommended raising the threshold for smaller loans from the $75,000 threshold proposed by the Board. One industry commenter suggested setting the threshold at $100,000, indexed to inflation. Relying on loan balances for median home prices, another industry commenter asked that the Bureau raise the threshold to $125,000. Many other industry commenters recommended raising the threshold to $150,000. One commenter noted that the average loan size in the United States at the end of the second quarter of 2010 was $193,800 and suggested using 80 percent of the average loan size, rounding off to the nearest $10,000. In addition to urging the Bureau to raise the smaller loan threshold, many industry commenters recommended that the Bureau revise the proposal to permit creditors to charge higher points and fees for loans below the smaller loan threshold for qualified mortgages. Several industry commenters asked that the Bureau set the cap between 3.5 and 5 percent, indexed to inflation, for all loans under the smaller loans threshold. One industry commenter noted that Fannie Mae and Freddie Mac permit points and fees up to 5 percent. An industry commenter suggested a cap equal to the greater of 3 percent or $2,000, indexed to inflation. A combination of industry commenters and consumer advocates recommended a cap equal to the greater of 3 percent or $3,000. One industry commenter advocated a 4 percent cap for all loans below $125,000. Several industry commenters recommended that the cap be set at a fixed amount plus a percentage to lessen the impact of moving from one tier to the next. In support of their arguments to raise the smaller loan threshold and to raise the limits on points and fees for loans below the threshold, several industry commenters provided data showing that many smaller loans would have exceeded the proposed points and fees caps. For example, a trade association commenter drew on data submitted by a member bank that showed that the majority of loans under $100,000 would exceed the points and fees cap, assuming fees paid to an affiliate title company were included, and that many loans between $100,000 and $150,000 would also exceed the cap. A trade association industry commenter shared data from one of its members, a financial services provider. The member PO 00000 Frm 00124 Fmt 4701 Sfmt 4700 reviewed over 250,000 of its recent loans and found that none of the loans under $75,000 would meet the proposed cap and that 50 percent of the loans under $125,000 would meet the cap. Several industry commenters reported that if the Bureau raised the smaller loan threshold to $150,000, a significantly smaller percentage of loans would exceed the points and fees cap. A trade association representing the manufactured housing industry noted the Board’s concern about setting the points and fees cap so high that some qualified mortgages would be deemed high-cost mortgages under HOEPA. The commenter argued, however, that the Bureau has authority to change highcost mortgage thresholds and urged the Bureau to exercise this authority. The commenter cited section 1431 of the Dodd-Frank Act for the proposition that the Board may increase the amount of origination costs above $1,000 for loans less than $20,000. The commenter also said that section 1022 of the Dodd-Frank Act may grant the Board authority to exempt certain smaller sized manufactured home loans from the 5 percent points and fees caps on highcost mortgages for loans above $20,000, based on asset class, transaction volume, and existing consumer protections. Consumer advocates generally endorsed the $75,000 threshold for smaller loans. They questioned industry concerns that the 3 percent threshold would limit the availability of credit for consumers with comparatively low loan amounts. Instead, the commenters emphasized the importance of ensuring that qualified mortgages are affordable. In their view, the 3 percent points and fees cap is a key factor in ensuring affordability, so the exception for smaller loans should apply to only a limited proportion of loans. Consumer advocates argued that the points and fees cap should not exceed the 5 percent HOEPA trigger. They asserted that points and fees should be reasonable, reflect actual origination costs, and not result in disparate pricing schemes disadvantaging consumers with smaller loans. One consumer advocate recommended analyzing the impact of a 3 percent points and fees cap on access to credit for low- and moderate-income consumers, in particular for Community Reinvestment Act loans. The commenter asked that the Bureau describe in preamble the results of any analysis of points and fees by loan amount, and for Community Reinvestment Act and nonCommunity Reinvestment Act loans. In light of these comments, the Bureau is adopting revised E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations § 1026.43(e)(3)(i) to implement the limits on points and fees for qualified mortgages. As noted above, several industry commenters argued that points and fees have little if any bearing on consumers’ ability to repay their mortgage loans and that the points and fees limits would result in higher interest rates and reduced access to credit. They urged the Bureau to use its authority to eliminate the limits on points and fees for qualified mortgages. As an alternative to eliminating the points and fees limits entirely, some industry commenters requested that the Bureau adopt the GSEs’ standards limiting points and fees for loans that they purchase or securitize. Those standards currently limit points and fees to the greater of 5 percent of the loan amount or $1,000. The Bureau does not believe it would be appropriate to eliminate the limits on points and fees for qualified mortgages. The Bureau also declines to adopt the GSEs’ current standards and raise the general 3 percent limit on points and fees. The goal of TILA section 129C is to assure that consumers are able to repay their mortgages over the term of the loans. Originators that make large sums up front may be less careful in assuring the consumers’ ability to repay over time. Moreover, Congress may have believed that the points and fees limits may deter originators from imposing unnecessary or excessive up-front charges. In the absence of persuasive evidence that the points and fees limits will undermine consumers’ access to affordable credit, the Bureau does not believe it would be appropriate to eliminate the points and fees limits or to raise the general 3 percent limit. As discussed in more detail below, however, the Bureau is implementing revised points and fees limits for smaller loans. The Bureau also notes that the Dodd-Frank Act did not adopt a tolerance that would allow creditors to exceed the points and fees limits by small amounts and declines to adopt such a tolerance. As noted above, a consumer advocate requested that the Bureau conduct an analysis of the 3 percent points and fees cap on access to credit for low- and moderate-income consumers, in particular for Community Reinvestment Act loans. Given the lack of available data, it has not been practicable for the Bureau to perform such an analysis while finalizing this and other title XIV rules. The Bureau will consider whether it is possible and valuable to conduct such an analysis in the future. Revised § 1026.43(e)(3)(i) employs an approach similar to that proposed by the Board to implement the 3 percent cap VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 on points and fees and the adjustment to the cap for smaller loans. Like the Board’s proposal, § 1026.43(e)(3)(i) sets a threshold for smaller loans, establishes tiers based on loan size, and sets limits on points and fees within each tier. However, § 1026.43(e)(3)(i) uses a mix of percentage and flat dollar limits to avoid anomalous results at tier margins and also adjusts the definition of smaller loan to include more transactions. Although most commenters favored this tiering methodology, as noted above, some commenters suggested that the Bureau reject the Board’s tiered approach and instead adopt a simpler mechanism, with all loan amounts below the threshold subject to a single percentage cap or dollar amount cap on points and fees. Like the Board, the Bureau believes the tiered approach provides a more flexible and calibrated mechanism for implementing the limits on points and fees for smaller loans. A single percentage cap that would apply to all smaller loans may not allow creditors a reasonable opportunity to recover costs for very small loans. It also may create a distortion in which loans just below the smaller loan threshold would be permitted to have significantly higher points and fees than loans just above the smaller loan threshold. A single dollar amount cap (e.g., $3,000) could result in points and fees that are a very high percentage of the very smallest loans and, as a result, could result in qualified mortgages also triggering the obligations of high-cost mortgages. Thus, as in the Board’s proposal, the final rule sets a threshold for smaller loans and establishes tiers, based on loan size, with different limits on points and fees. Specifically, § 1026.43(e)(3)(i) provides that a transaction is not a qualified mortgage unless the total points and fees payable in connection with the loan do not exceed: • For a loan amount greater than or equal to $100,000, 3 percent of the total loan amount; • For a loan amount greater than or equal to $60,000 but less than $100,000, $3,000; • For a loan amount greater than or equal to $20,000 but less than $60,000, 5 percent of the total loan amount; • For a loan amount greater than or equal to $12,500 but less than $20,000, $1,000 of the total loan amount; • For a loan amount of less than $12,500, 8 percent of the total loan amount. The Bureau’s final rule departs from the proposal in two ways. First, § 1026.43(e)(3)(i) raises the threshold for smaller loans to $100,000. Second, for loans below the $100,000 threshold, PO 00000 Frm 00125 Fmt 4701 Sfmt 4700 6531 § 1026.43(e)(3)(i) revises the points and fees caps for smaller loans within the various tiers. The general effect of these revisions will be to increase the points and fees that creditors can charge for smaller loans while still permitting those loans to meet the standard for a qualified mortgage. These two changes are discussed at greater length below. $100,000 Threshold for Smaller Loans To fulfill the stated purpose of the adjustment for smaller loans, the threshold should be set at a level that is sufficient to permit creditors making smaller loans a reasonable opportunity to recoup their origination costs and still offer qualified mortgages but not so high as to cause loans to exceed the HOEPA threshold to become high-cost mortgages. As noted above, the Board proposed to set the smaller loan threshold so that three percent of that amount would have provided creditors with a reasonable opportunity to recover their costs, with loans below that threshold subject to higher caps on points and fees. Thus, the Board’s proposed $75,000 threshold would have created a benchmark of $2,250. The Board stated that its outreach and research indicated that $2,250 would be within the range of average costs to originate a first-lien home mortgage. However, as noted above, several industry commenters reported, based on recent loan data, that creditors’ points and fees often exceed $2,250 for smaller loans and that a significant number of loans above $75,000 would exceed the three percent cap.151 This evidence suggests that the $2,250 benchmark (and the corresponding $75,000 smaller loan threshold) in the proposal could have been insufficient to permit creditors to recoup all or even most of their origination costs. The Bureau is aware that the commenters’ loan data reflects creditors’ points and fees, and not the underlying costs. Nevertheless, the evidence that substantial proportions of smaller loans would have exceeded the points and fees limits raises concerns that the creditors would not be able to recover their costs through points and fees and still originate qualified mortgages. Creditors that are unable to recover their origination costs through points and fees would have to attempt to recover those costs through higher rates. If the higher rates would trigger the additional 151 As the Board noted, resources that provide data on origination costs tend to use different methodologies to calculate points and fees and do not use the methodology prescribed under TILA as amended by the Dodd-Frank Act. The same concerns apply to commenters’ data on points and fees. E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6532 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations regulatory requirements applicable to high-cost loans under HOEPA or would render some potential consumers ineligible, then access to credit for at least some consumers could be compromised. Moreover, for consumers who plan to remain in their homes (and their loans) for a long time, a higher interest rate would result in higher payments over the life of the loan. Some commenters claimed that a substantial portion of loans up to $125,000 or $150,000 would exceed the 3 percent points and fees cap and that the Bureau should raise the threshold accordingly. The Bureau disagrees for two reasons. First, this would stretch the meaning of ‘‘smaller loans.’’ In 2011, slightly under 21 percent of first-lien home mortgages were below $100,000 and another 22 percent were between $100,000 and $150,000. Thus, increasing the threshold to $150,000 would more than double the number of loans entitled to an exception to the congressionally-established points and fees cap and would capture over 40 percent of the market. The Bureau believes that this would be an overly expansive construction of the term ‘‘smaller loans’’ for the purpose of the exception to the general rule capping points and fees for qualified mortgages at 3 percent. Such a broad definition of ‘‘smaller loans’’ could allow the exception to undermine the cap on points and fees and frustrate congressional intent that qualified mortgages include limited points and fees. The function of the smaller loan exception to the points and fees cap is to make it possible for creditors making smaller loans to originate qualified mortgages. The smaller loan exception should provide creditors a reasonable opportunity to recover most, if not all, of their origination costs for smaller loans and still originate qualified mortgages. It should not be transformed into a mechanism that ensures that creditors can continue to charge the same points and fees they have in the past and still have their loans meet the qualified mortgage standard. The Bureau concludes that a $100,000 small loan threshold strikes an appropriate balance between congressional goals of allowing creditors offering smaller loans to meet the standard for qualified mortgages and ensuring that qualified mortgages include limited points and fees. The $100,000 threshold (and, as discussed below, the corresponding adjustments to the points and fees limits for loans under that threshold) should provide creditors with a reasonable opportunity to recover most, if not all, of their origination costs through points and VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 fees, reducing the likelihood that any increase in rates would trigger obligations of high-cost loans or would cause loans to be higher-priced covered transactions under § 1026.43(b)(4). At the same time, the $100,000 threshold would not render the smaller loan exception so broad that it undermines the general 3 percent cap on points and fees. It would cover a significant but still limited proportion of mortgages. According to the 2011 Home Mortgage Disclosure Act 152 (HMDA) data, 20.4 percent of first-lien home purchase mortgages and 20.9 percent of first-lien refinances were less than $100,000.153 Limits on Points and Fees for Smaller Loans In addition to raising the smaller loan threshold to $100,000, § 1026.43(e)(3)(i) also differs from the Board’s proposal by setting higher limits on points and fees for smaller loans. As noted above, the Bureau is concerned that the Board’s proposal would not have provided creditors with a reasonable opportunity to recover their origination costs. Thus, § 1026.43(e)(3)(i) allows creditors higher limits on points and fees for smaller loans. Specifically, for loans of $60,000 up to $100,000, § 1026.43(e)(3)(i) allows points and fees of no more than $3,000. For loans of $20,000 up to $60,000, § 1026.43(e)(3)(i) allows points and fees of no more than 5 percent of the total loan amount. For loans of $12,500 up to $20,000, § 1026.43(e)(3)(i) allows points and fees of no more than $1,000. For loan amounts less than $12,500, § 1026.43(e)(3)(i) allows points and fees of no more than 8 percent of the total loan amount. In contrast with the Board’s proposed Alternative 1, § 1026.43(e)(3)(i) creates smooth transitions between the tiers. As noted above, under Alternative 1, the one-half percent changes in the points and fees cap between tiers would have produced the anomalous result that some smaller loans would have been permitted to include a higher dollar amount of points and fees than larger loans. While proposed Alternative 2 would have avoided this problem, it 152 12 U.S.C. 2801 et seq. proportion of loans under the $100,000 threshold would of course be larger than under a $75,000 threshold. As indicated in the Board’s proposal, in 2008, 8.3 percent of first-lien home purchase mortgages and 7.6 percent of refinances were under $75,000 for owner-occupied, one- to four-family, site-built properties. According to 2011 HMDA data, 10.6 percent of first-lien home purchases and 11 percent of first-lien refinances were under $75,000. Nevertheless, the Bureau believes that the $100,000 threshold is sufficiently limited that it remains faithful to the statute’s framework, with the smaller loan exception not undermining the general 3 percent limit on points and fees. 153 The PO 00000 Frm 00126 Fmt 4701 Sfmt 4700 would also have been somewhat more complex, thereby increasing the risk of errors. The tiers in § 1026.43(e)(3)(i) all feature easy-to-calculate limits, making compliance easier. Finally, the three lower tiers are tied to the comparable thresholds for highcost loans to ensure that the points and fees on loans that satisfy the qualified mortgage standard do not trigger the additional obligations of high-cost mortgages. Under TILA as amended, a high-cost mortgage has points and fees equal to 5 percent of the total transaction amount if the transaction is $20,000 or more, and points and fees equal to the lesser of 8 percent of the total transaction amount or $1,000, if the transaction is less than $20,000. See TILA section 103(bb)(1)(A)(ii)(I) and (II). Setting the maximum points and fees caps based on the HOEPA triggers will help ensure that a qualified mortgage is not a high-cost mortgage because of the points and fees. Proposed comment 43(e)(3)(i)–1 would have cross-referenced comment 32(a)(ii)–1 for an explanation of how to calculate the ‘‘total loan amount.’’ The Bureau adopts comment 43(e)(3)(i)–1 substantially as proposed, but it adds an explanation for tiers in which the prescribed points and fees limit is a fixed dollar amount rather than a percentage and revises the crossreference because the explanation of calculating ‘‘total loan amount’’ is moved to comment 32(b)(5)(i)–1. Proposed comment 43(e)(3)(i)–2 would have explained that a creditor must determine which category the loan falls into based on the face amount of the note (the ‘‘loan amount’’), but must apply the allowable points and fees percentage to the ‘‘total loan amount,’’ which may be an amount that is different than the face amount of the note. The Bureau adopts comment 43(e)(3)(i)–2 substantially as proposed, but it revises some of the limits to reflect the changes described above. Proposed comment 43(e)(3)(i)–3 would have provided examples of calculations for different loan amounts. The Bureau adopts comment 43(e)(3)(i)– 3 with revisions to reflect the changes to some of the limits described above. Impact on Rural Areas and Other Areas Where Home Values Are Lower TILA section 129C(b)(2)(D) requires the Bureau to consider the rules’ potential impact on ‘‘rural areas and other areas where home values are lower.’’ The Bureau considered the concerns raised by industry commenters that if the limits on points and fees for smaller loans were set too low, access to credit could be impaired, in particular E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations for low income, minority, and rural consumers, and first-time home buyers. Setting the threshold for smaller loans too low may also negatively affect access to credit for manufactured housing, which disproportionately serves lower-income consumers and rural areas. The higher threshold and higher limits on points and fees for smaller loans should help to ensure that creditors are able to offer qualified mortgages in rural areas and other areas where home values are lower. The Bureau declines to adopt the recommendation of one commenter that it exempt smaller loans for manufactured homes from the points and fees triggers for high-cost mortgages. Section 1431 of the Dodd Frank Act provides that a loan of $20,000 or more is deemed a high-cost mortgage if total points and fees exceed 5 percent of the total transaction amount and that a loan of less than $20,000 is deemed a highcost mortgage if total points and fees exceed the lesser of 8 percent of the total transaction amount or $1,000, or other such dollar amount as the Bureau may prescribe by regulations. Such a change is beyond the scope of this rulemaking and is more appropriately addressed in the parallel HOEPA rulemaking. 43(e)(3)(ii) Bona Fide Third-party Charges and Bona Fide Discount Points As discussed in the section-by-section analysis of § 1026.32(b)(1)(i), the Bureau is moving the provisions excluding certain bona fide third-party charges and bona fide discount points to § 1026.32(b)(1)(i)(D) through (F). The Board had proposed to implement these provisions in proposed § 226.43(e)(3)(ii) through (iv). sroberts on DSK5SPTVN1PROD with Indexing Points and Fees Limits for Inflation The Board requested comment on whether the loan size ranges for the qualified mortgage points and fees limits should be indexed for inflation. A few industry commenters recommended that the loan size ranges or the permitted dollar amounts of points and fees be adjusted for inflation. The Bureau believes that it is appropriate to adjust the points and fees limits to reflect inflation. In addition, the Bureau notes that, as prescribed by TILA section 103(aa)(3), what was originally a $400 points and fees limit for high-cost loans has been adjusted annually for inflation, and that the dollar amounts of the new high-cost points and fees thresholds in TILA section 103(bb)(1)(A)(ii)(II) will also be adjusted VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 annually for inflation. The Bureau believes the points and fees thresholds for high-cost loans and qualified mortgages should be treated consistently with respect to inflation adjustments. Accordingly, in new § 1026.43(e)(3)(ii), the Bureau provides that the dollar amounts, including the loan amounts, shall be adjusted annually to reflect changes in the Consumer Price Index for All Urban Consumers (CPI–U). The adjusted amounts will be published in new comment 43(e)(3)(ii)–1. 43(e)(4) Qualified Mortgage Defined— Special Rules As discussed above, the Bureau is finalizing the general qualified mortgage definition in § 1026.43(e)(2). Under that definition, qualified mortgages would be limited to loans that satisfy the qualified mortgage product feature criteria in the statute (including prohibitions on certain risky loan features, limitations on points and fees, and the requirement to underwrite to the maximum rate in the first five years of the loan), for which the creditor considers and verifies the consumer’s income and assets and current debt obligations, alimony, and child support, and for which the consumer’s total (or ‘‘backend’’) debt-to-income ratio is less than or equal to 43 percent.154 The Bureau believes this approach establishes an appropriate benchmark over the long term for distinguishing which loans should be presumed to meet the ability-to-repay requirements under the Dodd-Frank Act, while also leaving room for the provision of responsible mortgage credit over time to consumers with higher debt-to-income ratios under the general ability-to-repay 154 As noted above, the Board proposed two alternative definitions of qualified mortgage, but also solicited comment on other alternative definitions. The Board specifically requested comment on what criteria should be included in the definition of a qualified mortgage to ensure that the definition provides an incentive to creditors to make qualified mortgages, while also ensuring that consumers have the ability to repay those loans. In addition, as described above, the Board’s proposed comment 43(c)-1 would have provided that creditors may look to widely accepted governmental or non-governmental underwriting standards when assessing a consumer’s repayment ability under the general ability-to-repay standard, including assessing the eight specific underwriting criteria under proposed §§ 226.43(c)(2) and (e)(2)(v)-Alternative 2. Similarly, proposed comment 43(c)(7)–1 would have provided that, to determine the appropriate threshold for monthly debt-to-income ratio or residual income, the creditor may look to widely accepted governmental and non-governmental underwriting standards. As noted, various commenters suggested that the final rule should look to certain Federal agency underwriting standards for purposes of determining whether a loan has met certain aspects of the qualified mortgage definition (for example, debt-toincome ratios and residual income). PO 00000 Frm 00127 Fmt 4701 Sfmt 4700 6533 requirements. However, the Bureau acknowledges it may take some time for the non-qualified mortgage market to establish itself in light of the market anxiety regarding litigation risk under the ability-to-repay rules, the general slow recovery of the mortgage market, and the need for creditors to adjust their operations to account for several other major regulatory and capital regimes. In light of these factors, the Bureau has concluded that it is appropriate to provide a temporary alternative definition of qualified mortgage. This will help ensure access to responsible, affordable credit is available for consumers with debt-to-income ratios above 43 percent and facilitate compliance by creditors by promoting the use of widely recognized, federallyrelated underwriting standards. Under this temporary provision, as a substitute for the general qualified mortgage definition in § 1026.43(e)(2), which contains a 43 percent debt-toincome ratio threshold, the final rule provides a second definition of qualified mortgage in § 1026.43(e)(4) for loans that meet the prohibitions on certain risky loan features (e.g., negative amortization and interest only features) and the limitations on points and fees under § 1026.43(e)(2) and are eligible for purchase or guarantee by the GSEs, while under the conservatorship of the FHFA, or eligible to be insured or guaranteed by the U.S. Department of Housing and Urban Development under the National Housing Act (12 U.S.C. 1707 et seq.) (FHA), the VA, the USDA, or the Rural Housing Service (RHS).155 The FHA, VA, USDA, and RHS have authority under the statute to define qualified mortgage standards for their own loans, so coverage under § 1026.43(e)(4), will sunset once each agency promulgates its own qualified mortgage standards, and such rules take effect. See TILA section 129C(b)(3)(ii). Coverage of GSE-eligible loans will sunset when conservatorship ends. Even if the Federal agencies do not issue additional rules or conservatorship does not end, the temporary qualified mortgage definition in § 1026.43(e)(4) will expire seven 155 Eligibility standards for the GSEs and Federal agencies are available at: Fannie Mae, Single Family Selling Guide, https://www.fanniemae.com/ content/guide/sel111312.pdf; Freddie Mac, SingleFamily Seller/Servicer Guide, https:// www.freddiemac.com/sell/guide/; HUD Handbook 4155.1, https://www.hud.gov/offices/adm/hudclips/ handbooks/hsgh/4155.1/41551HSGH.pdf; Lenders Handbook—VA Pamphlet 26–7, Web Automated Reference Material System (WARMS), https:// www.benefits.va.gov/warms/pam26_7.asp; Underwriting Guidelines: USDA Rural Development Guaranteed Rural Housing Loan Program, https:// www.rurdev.usda.gov/SupportDocuments/CA-SFHGRHUnderwritingGuide.pdf. E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6534 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations years after the effective date of the rule. The Bureau believes that this will provide an adequate period for economic, market, and regulatory conditions to stabilize. Because the Bureau is obligated by statute to analyze the impact and status of the ability-torepay rule five years after its effective date, the Bureau will have an opportunity to confirm that it is appropriate to allow the temporary provision to expire prior to the sunset. Covered transactions that satisfy the requirements of § 1026.43(e)(4) that are consummated before the sunset of § 1026.43(e)(4) will retain their qualified mortgage status after the temporary definition expires. However, a loan consummated after the sunset of § 1026.43(e)(4) may only be a qualified mortgage if it satisfies the requirements of § 1026.43(e)(2) or (f). The alternative definition of qualified mortgage recognizes that the current mortgage market is especially fragile as a result of the recent mortgage crisis. It also recognizes the government’s extraordinary efforts to address the crisis; GSE-eligible loans, together with the other federally insured or guaranteed loans, cover roughly 80 percent of the current mortgage market. In light of this significant Federal role and the government’s focus on affordability in the wake of the mortgage crisis, the Bureau believes it is appropriate, for the time being, to presume that loans that are eligible for purchase, guarantee, or insurance by the designated Federal agencies and the GSEs while under conservatorship have been originated with appropriate consideration of consumers’ ability to repay, where those loans also satisfy the requirements of § 1026.43(e)(2) concerning restrictions on product features and total points and fees limitations. The temporary definition is carefully calibrated to provide a reasonable transition period to the general qualified mortgage definition, including the 43 percent debt-to-income ratio requirement. While this temporary definition is in effect, the Bureau will monitor the market to ensure it remains appropriate to presume that the loans falling within those programs have been originated with appropriate consideration of the consumer’s repayment ability. The Bureau believes this temporary approach will ultimately benefit consumers by minimizing any increases in the cost of credit as a result of this rule while the markets adjust to the new regulations. The Bureau believes this temporary alternative definition will provide an orderly transition period, while preserving access to credit and VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 effectuating the broader purposes of the ability-to-repay statute during the interim period. The Bureau believes that responsible loans can be made above a 43 percent debt-to-income ratio threshold, and has consciously structured the qualified mortgage requirements in a way that leaves room for responsible lending on both sides of the qualified mortgage line. The temporary exception has been carefully structured to cover loans that are eligible to be purchased, guaranteed, or insured by the GSEs (while in conservatorship) or Federal agencies regardless of whether the loans are actually so purchased, guaranteed, or insured; this will leave room for private investors to return to the market and secure the same legal protection as the GSEs and Federal agencies. At the same time, as the market recovers and the GSEs and FHA are able to reduce their presence in the market, the percentage of loans that are granted qualified mortgage status under the temporary definition will shrink towards the longterm structure. In addition to being a loan that is eligible to be made, guaranteed, or insured by the above-described Federal agencies or the GSEs while in conservatorship, to meet the definition of qualified mortgage under § 1026.43(e)(4), the loan must satisfy the statutory qualified mortgage criteria regarding prohibitions on certain risky loan features and limitations on points and fees. Specifically, § 1026.43(e)(4)(i) provides that, notwithstanding § 1026.43(e)(2), a qualified mortgage is a covered transaction that satisfies the requirements of § 1026.43(e)(2)(i) through (iii). As discussed above, those provisions require: that the loan provide for regular periodic payments that do not result in an increase of the principal balance, allow the consumer to defer repayment of principal, or result in a balloon payments; that the loan term does not exceed 30 years; and that the total points and fees payable in connection with the loan do not exceed the threshold set forth in § 1026.43(e)(3). As described further below, the temporary definition does not include requirements to (1) verify and document the consumer’s income or assets relied upon in qualifying the consumer; (2) underwrite a fixed rate loan based on a payment schedule that fully amortizes the loan over the term and takes into account all applicable taxes, insurance, and assessments; or (3) underwrite an adjustable-rate loan using the maximum interest rate permitted in the first five years. The Bureau highlights that a loan need not be actually purchased or PO 00000 Frm 00128 Fmt 4701 Sfmt 4700 guaranteed by the GSEs or insured or guaranteed by the above-listed Federal agencies to qualify for the temporary definition in § 1026.43(e)(4). Rather, the loan need only be eligible for such purchase, guarantee, or insurance. Notably, the temporary qualified mortgage definition does not include ‘‘jumbo loans.’’ The Bureau does not believe that creditors making jumbo loans need the benefit of the temporary exception, as the Bureau views the jumbo market as already robust and stable. Jumbo loans can still be qualified mortgages if they meet the general rule (i.e. are within the 43 percent debt-toincome ratio and underwritten in accordance with the general qualified mortgage requirements). Section 1026.43(e)(4)(iii) contains the sunset provisions for the special qualified mortgage definition in § 1026.43(e)(4). Specifically, § 1026.43(e)(4)(iii)(A) provides that each respective special rule in § 1026.43(e)(4)(ii)(B) (FHA loans), (e)(4)(ii)(C) (VA loans), (e)(4)(ii)(D) (USDA loans); and (e)(4)(ii)(E) (RHS loans) shall expire on the effective date of a rule issued by each respective agency pursuant to its authority under TILA section 129C(b)(3)(ii) to define a qualified mortgage. Section 1026.43(e)(4)(iii)(B) provides that, unless otherwise expired under § 1026.43(e)(4)(iii)(A), the special rules in § 1026.43(e)(4) are available only for covered transactions consummated on or before a date that is seven years after the effective date of this rule. Comment 43(e)(4)–1 provides additional clarification regarding the special qualified mortgage definition. Specifically, the comment provides that, subject to the sunset provided under § 1026.43(e)(4)(iii), § 1026.43(e)(4) provides an alternative definition of qualified mortgage to the definition provided in § 1026.43(e)(2). To be a qualified mortgage under § 1026.43(e)(4), the creditor must satisfy the requirements under §§ 1026.43(e)(2)(i) through (iii), in addition to being one of the types of loans specified in §§ 1026.43(e)(4)(ii)(A) through (E). Comment 43(e)(4)–2 clarifies the effect that a termination of conservatorship would have on loans that satisfy the qualified mortgage definition under § 1026.43(e)(4) because of their eligibility for purchase or guarantee by Fannie Mae or Freddie Mac. The comment provides that § 1026.43(e)(4)(ii)(A) requires that a covered transaction be eligible for purchase or guarantee by Fannie Mae or Freddie Mac (or any limited-life regulatory entity succeeding the charter E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations of either) operating under the conservatorship or receivership of the FHFA pursuant to section 1367 of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (12 U.S.C. 4617), as amended by the Housing and Economic Recovery Act of 2008). The special rule under § 1026.43(e)(4)(ii)(A) does not apply if Fannie Mae or Freddie Mac (or any limited-life regulatory entity succeeding the charter of either) has ceased operating under the conservatorship or receivership of the FHFA. For example, if either Fannie Mae or Freddie Mac (or succeeding limited-life regulatory entity) ceases to operate under the conservatorship or receivership of the FHFA, § 1026.43(e)(4)(ii)(A) would no longer apply to loans eligible for purchase or guarantee by that entity; however, the special rule would be available for a loan that is eligible for purchase or guarantee by the other entity still operating under conservatorship or receivership. Comment 43(e)(4)(iii)–3 clarifies that the definition of qualified mortgage under § 1026.43(e)(4) applies only to loans consummated on or before a date that is seven years after the effective date of the rule, regardless of whether Fannie Mae or Freddie Mac (or any limited-life regulatory entity succeeding the charter of either) continues to operate under the conservatorship or receivership of the FHFA. Accordingly, § 1026.43(e)(4) is available only for covered transactions consummated on or before the earlier of either: (i) The date Fannie Mae or Freddie Mac (or any limited-life regulatory entity succeeding the charter of either), respectively, cease to operate under the conservatorship or receivership of the FHFA pursuant to section 1367 of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (12 U.S.C. 4617), as amended by the Housing and Economic Recovery Act of 2008; or (ii) a date that is seven years after the effective date of the rule, as provided by § 1026.43(e)(4)(iii). Finally, comment 43(e)(4)(iii)–4 clarifies that, to satisfy § 1026.43(e)(4)(ii), a loan need not be actually purchased or guaranteed by the GSEs or insured or guaranteed by the FHA, VA, USFA, or RHS. Rather, § 1026.43(e)(4)(ii) requires only that the loan be eligible for such purchase, guarantee, or insurance. Rather, § 1026.43(e)(4)(ii) requires only that the loan be eligible for such purchase, guarantee, or insurance. For example, for purposes of § 1026.43(e)(4), a creditor is not required to sell a loan to Fannie Mae or Freddie Mac (or any limited-life regulatory entity succeeding VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 the charter of either) to be a qualified mortgage. Rather, the loan must be eligible for purchase or guarantee by Fannie Mae or Freddie Mac (or any limited-life regulatory entity succeeding the charter of either), including satisfying any requirements regarding consideration and verification of a consumer’s income or assets, current debt obligations, and debt-to-income ratio or residual income. To determine eligibility, a creditor may rely on an underwriting recommendation provided by Fannie Mae and Freddie Mac’s Automated Underwriting Systems (AUSs) or written guide. Accordingly, a covered transaction is eligible for purchase or guarantee by Fannie Mae or Freddie Mac if: (i) The loan conforms to the standards set forth in the Fannie Mae Single-Family Selling Guide or the Freddie Mac Single-Family Seller/ Servicer Guide; or (ii) the loan receives an ‘‘Approve/Eligible’’ recommendation from Desktop Underwriter (DU); or an ‘‘Accept and Eligible to Purchase’’ recommendation from Loan Prospector (LP). The Bureau is finalizing § 1026.43(e)(4) pursuant to its authority under TILA section 129C(b)(3)(B)(i) to prescribe regulations that revise, add to, or subtract from the criteria that define a qualified mortgage upon the findings described above. The Bureau believes the temporary qualified mortgage definition is necessary and proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of TILA section 129C and necessary and appropriate to effectuate the purposes of TILA section 129C, which includes assuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loan. As described above, the Bureau believes that the provision of qualified mortgage status to loans that are eligible for purchase, guarantee, or to be insured by the Federal entities described above will provide a smooth transition to a more normal mortgage market. Similarly, the Bureau believes that including all loans that are eligible to be made, guaranteed, or insured by agencies of the Federal government and the GSEs while under conservatorship, will minimize the risk of disruption as the market adjusts to the ability-to-repay requirements of this rule. This adjustment to the qualified mortgage definition will also facilitate compliance with the ability-to-repay requirements. The Bureau is also finalizing § 1026.43(e)(4) pursuant to its authority under TILA section 105(a) to issue regulations with such requirements, PO 00000 Frm 00129 Fmt 4701 Sfmt 4700 6535 classifications, differentiations, or other provisions, and that provide for such adjustments and exceptions for all or any class of transactions, as in the judgment of the Bureau are necessary and proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith. For the reasons described above, the Bureau believes the adjustments to the definition of qualified mortgage are necessary to effectuate the purposes of TILA, which include the above-described purpose of TILA section 129C, among other things, and to facilitate compliance therewith. The Bureau is exercising this authority to remove certain qualified mortgage statutory criteria, as discussed further below, and to add criteria related to eligibility for Federal agency programs and GSEs while conservatorship, as outlined above, in order to create this qualified mortgage definition. As noted above, § 1026.43(e)(4) applies to loans that are eligible for guarantee or insurance by the Federal agencies listed above. The provisions of section 1412 apply to all residential mortgage loans, including loans that are eligible for and are guaranteed or insured by the Federal agencies listed above. However, TILA section 129C(b)(3)(B)(ii) provides the Federal agencies listed above with authority, in consultation with the Bureau, to prescribe rules defining the types of loans they insure, guarantee or administer, as the case may be, that are qualified mortgages and such rules may revise, add to, or subtract from the criteria used to define a qualified mortgage upon certain findings. Consistent with this authority, the Bureau leaves to these agencies, in consultation with the Bureau, further prescribing qualified mortgage rules defining the types of loans they respectively insure, guarantee or administer, and their rules may further revise the qualified mortgage criteria finalized in this rule with respect to these loans. In light of the Federal agencies’ authority in TILA section 129C(b)(3)(B)(ii), § 1026.43(e)(4) will sunset once each agency has exercised its authority to promulgate their own qualified mortgage standards. As noted above, the final rule does not specifically include in the temporary definition the statutory requirements to (1) verify and document the consumer’s income or assets relied upon in qualifying the consumer; (2) underwrite a fixed rate loan based on a payment schedule that fully amortizes the loan over the term and takes into account all applicable taxes, insurance, E:\FR\FM\30JAR2.SGM 30JAR2 6536 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with and assessments; or (3) underwrite an adjustable-rate loan using the maximum interest rate permitted in the first five years. As discussed above, the Bureau believes it is appropriate, for the time being, to presume that loans that are eligible for purchase, guarantee, or insurance by the designated Federal agencies and the GSEs while under conservatorship have been originated with appropriate consideration of consumers’ ability to repay where the loans satisfy the requirements of § 1026.43(e)(2) concerning restrictions on product features and total points and fees limitations. Layering additional and different underwriting requirements on top of the requirements that are unique to each loan program would undermine the purpose of the temporary definition, namely, to preserve access to credit during a transition period while the mortgage industry adjusts to this final rule and during a time when the market is especially fragile. Accordingly, as noted above, the Bureau is using its authority under TILA section 129C(b)(3)(B)(i) to remove these statutory requirements from the qualified mortgage definition in § 1026.43(e)(4). For similar reasons the Bureau is not requiring that loans that meet this qualified mortgage definition meet the 43 percent debt-to-income ratio requirement in § 1026.43(e)(2). The eligibility requirements of the GSEs and Federal agencies incorporate debt-toincome ratio thresholds. However, the GSEs and Federal agencies also permit consideration of certain compensating factors that are unique to each loan program. The Bureau declines to layer an additional debt-to-income ratio requirement to avoid undermining the purpose of the temporary qualified mortgage definition. 43(f) Balloon-Payment Qualified Mortgages Made by Certain Creditors TILA section 129C(b)(2)(E) authorizes the Bureau to permit qualified mortgages with balloon payments, provided the loans meet four conditions. Specifically, those conditions are that: (1) The loan meets certain of the criteria for a qualified mortgage; (2) the creditor makes a determination that the consumer is able to make all scheduled payments, except the balloon payment, out of income or assets other than the collateral; (3) the loan is underwritten based on a payment schedule that fully amortizes the loan over a period of not more than 30 years and takes into account all applicable taxes, insurance, and assessments; and (4) the creditor meets four prescribed qualifications. Those four qualifications are that the creditor: VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 (1) Operates predominantly in rural or underserved areas; (2) together with all affiliates, has total annual residential mortgage loan originations that do not exceed a limit set by the Bureau; (3) retains the balloon-payment loans in portfolio; and (4) meets any asset-size threshold and any other criteria the Bureau may establish, consistent with the purposes of this subtitle. The four creditor qualifications are nearly identical to provisions in section 1461 of the Dodd-Frank Act, which authorizes the Bureau under TILA section 129D(c) to exempt small creditors that operate predominantly in rural or underserved areas from a requirement to establish escrow accounts for certain first-lien, higherpriced mortgage loans. Specifically, the statute authorizes creation of an exemption for any creditor that (1) operates predominantly in rural or underserved areas; (2) together with all affiliates has total annual residential mortgage transaction originations that do not exceed a limit set by the Bureau; (3) retains its mortgage debt obligations in portfolio; and (4) meets any asset-size thresholds and any other criteria that the Bureau may establish. The Board interpreted the two provisions as serving similar but not identical purposes, and thus varied certain aspects of the proposals to implement the balloon-payment qualified mortgage and escrow provisions. Specifically, the Board interpreted the qualified mortgage provision as being designed to ensure access to credit in rural and underserved areas where consumers may be able to obtain credit only from community banks offering balloonpayment mortgages, and the escrow provision to exempt creditors that do not possess economies of scale to costeffectively offset the burden of establishing escrow accounts by maintaining a certain minimum portfolio size from being required to establish escrow accounts on higherpriced mortgage loans. Accordingly, the two Board proposals would have used common definitions of ‘‘rural’’ and ‘‘underserved,’’ but did not provide uniformity in calculating and defining various other elements. For the balloon balloon-payment qualified mortgage provisions, for instance, the Board’s proposed § 226.43(f) would have required that the creditor (1) in the preceding calendar year, have made more than 50 percent of its balloonpayment mortgages in rural or underserved areas; and (2) have assets that did not exceed $2 billion. The Board proposed two alternatives each for qualifications relating to (1) the total PO 00000 Frm 00130 Fmt 4701 Sfmt 4700 annual originations limit; and (2) the retention of balloon-payment mortgages in portfolio. The proposal also would have implemented the four conditions for balloon-payment qualified mortgages under TILA section 129C(b)(2)(E) and used its adjustment and exception authority to add a requirement that the loan term be five years or longer. In contrast, the Board’s proposal for the escrows exemption under proposed § 226.45(b)(2)(iii) would have required that the creditor have (1) in the preceding calendar year, have made more than 50 percent of its first-lien mortgages in rural or underserved areas; (2) together with all affiliates, originated and retained servicing rights to no more than 100 first-lien mortgage debt obligations in either the current or prior calendar year; and (3) together with all affiliates, not maintained an escrow account on any consumer credit secured by real property. The Board also sought comment on whether to add a requirement for the creditor to meet an asset-size limit and what that size should be. In both cases, the Board proposed to use a narrow definition of rural based on the Economic Research Service (ERS) of the USDA’s ‘‘urban influence codes’’ (UICs). The UICs are based on the definitions of ‘‘metropolitan statistical areas’’ of at least one million residents and ‘‘micropolitan statistical areas’’ with a town of at least 2,500 residents, as developed by the Office of Management and Budget, along with other factors reviewed by the ERS that place counties into twelve separately defined UICs depending on the size of the largest city and town in the county. The Board’s proposal would have limited the definition of rural to certain ‘‘non-core’’ counties that are not located in or adjacent to any metropolitan or micropolitan area. This definition corresponded with UICs of 7, 10, 11, and 12, which would have covered areas in which only 2.3 percent of the nation’s population lives. In light of the overlap in criteria between the balloon-payment qualified mortgage and escrow exemption provisions, the Bureau considered comments responding to both proposals in determining how to finalize the particular elements of each rule as discussed further below. With regard to permitting qualified mortgages with balloon payments generally, consumer group commenters stated that the balloon-payment qualified mortgage exemption is a discretionary provision, as TILA section 129C(b)(2)(E) states that the Bureau ‘‘may’’ provide an exemption for balloon-payment mortgages to be qualified mortgages, and E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations stated that such an exemption should not be provided in the final rule because such exemption would have a negative effect on consumers’ access to responsible and affordable credit. Trade association and industry commenters generally supported the balloonpayment qualified mortgage exemption, with some comments related to the specific provisions that are discussed below. One trade association commented that the exemption should extend to all balloon-payment mortgages held in portfolio by financial institutions; as such a broader exemption would achieve Congress’s intent as well as reduce the difficulty that creditors would have in complying with the requirements in the proposal. Three trade associations and several industry commenters commented that the balloon-payment qualified mortgage exemption was needed to ensure access to credit for consumers in rural areas because smaller institutions in those areas use balloon-payment mortgages to control interest rate risk. The Bureau believes Congress enacted the exemption in TILA section 129C(b)(2)(E) because it was concerned that the restrictions on balloon-payment mortgages under the ability to repay and general qualified mortgage provisions might unduly constrain access to credit in rural and underserved areas, where consumers may be able to obtain credit only from a limited number of creditors, including some community banks that may offer only balloon-payment mortgages. Because Congress explicitly set out detailed criteria, indicating that it did not intend to exclude balloonpayment mortgages from treatment as qualified mortgages that meet those criteria, and the Bureau is implementing the statutory exemption for balloonpayment mortgages to be qualified mortgages provided they meet the conditions described below. The Bureau believes those criteria reflect a careful judgment by Congress concerning the circumstances in which the potential negative impact from restricting consumers’ access to responsible and affordable credit would outweigh any benefit of prohibiting qualified mortgages from providing for balloon payments. The Bureau therefore believes that the scope of the exemption provided in this final rule implements Congress’s judgment as to the proper balance between those two imperatives. The Bureau believes that there are compelling reasons underlying Congress’s decision not to allow balloon-payment mortgages to enjoy qualified-mortgage status except in carefully limited circumstances. It is the rare consumer who can afford to make VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 a balloon payment when due. Thus, ordinarily a consumer facing a balloon payment must obtain new financing. Depending on market conditions at the time and also the consumer’s own economic circumstances, consumers may find it difficult to obtain affordable credit. Some consumers may be forced to sell their homes to pay off the balloon-payment mortgage. Others may find it necessary to take on a new loan on terms that create hardships for the consumers. Unscrupulous lenders may seek to take advantage of consumers faced with the necessity of making a balloon payment by offering loans on predatory terms. On the other hand, in rural and other underserved areas, it is not uncommon for consumers to seek a mortgage loan of a type that cannot be sold on the secondary market, because of special characteristics of either the property in question or the consumer. Many community banks make mortgages that are held in portfolio in these circumstances. To manage interest rate risk and avoid complexities in originating and servicing adjustable rate mortgages, these banks generally make balloon-payment mortgage loans which the banks roll over, at then current market interest rate, when the balloonpayment mortgage comes due. For example, data available through the National Credit Union Administration indicates that among credit unions which make mortgages in rural areas (using the definition of rural described below), 25 percent make only balloonpayment or hybrid mortgages. There are also substantial data suggesting that the small portfolio creditors that are most likely to rely on balloon-payment mortgages to manage their interest rate risks (or to have difficulty maintaining escrow accounts) have a significantly better track record than larger creditors with regard to loan performance. As discussed in more depth in the 2013 ATR Concurrent Proposal, because small portfolio lenders retain a higher percentage of their loans on their own books, they have strong incentives to engage in thorough underwriting. To minimize performance risk, small community lenders have developed underwriting standards that are different than those employed by larger institutions. Small lenders generally engage in ‘‘relationship banking,’’ in which underwriting decisions rely at least in part on qualitative information gained from personal relationships between lenders and consumers. This qualitative information focuses on subjective factors such as consumer character and reliability which ‘‘may be difficult to PO 00000 Frm 00131 Fmt 4701 Sfmt 4700 6537 quantify, verify, and communicate through the normal transmission channels of banking organization.’’ 156 While it is not possible to disaggregate the impact of each of the elements of the community banking model, the combined effect is highly beneficial. Moreover, where consumers have trouble paying their mortgage debt obligations, small portfolio creditors have strong incentives to work with the consumers to get them back on track, both to protect the creditors’ balance sheets and their reputations in their local communities. Market-wide data demonstrate that loan delinquency and charge-off rates are significantly lower at smaller banks than larger ones.157 The Bureau believes that these kinds of considerations underlay Congress’s decision to authorize the Bureau to establish an exemption under TILA section 129C(b)(2)(E) 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 mortgages. Thus, the Bureau concludes that exercising its authority is appropriate, but also that the exemption should implement the statutory criteria to ensure it effectuates Congress’s intent. Accordingly, as discussed in more detail below, the Bureau adopts § 1026.43(f) largely as proposed but with certain changes described below to implement TILA section 129C(b)(2)(E). In particular, the Bureau has concluded that it is appropriate to make the specific creditor qualifications much more consistent between the balloonpayment qualified mortgage and escrow exemptions than originally proposed by the Board.158 The Bureau believes that this approach is justified by several considerations, including the largely identical statutory language, the similar congressional intents underlying the two provisions, and the fact that requiring small creditors operating predominantly in rural or underserved 156 See Allen N. Berger & Gregory F. Udell, Small Business Credit Availability and Relationship Lending: The Importance of Bank Organizational Structure, 112 Econ. J. F32 (2002). 157 See 2013 ATR Concurrent Proposal; Fed. Deposit Ins. Corp., FDIC Community Banking Study, (Dec. 2012), available at https://fdic.gov/ regulations/resources/cbi/study.html. 158 The Bureau has similarly attempted to maintain consistency between the asset size, annual originations threshold, and requirements concerning portfolio loans as between the final rules that it is adopting with regard to balloon qualified mortgages and the escrow exemption and its separate proposal to create a new type of qualified mortgages originated and held by small portfolio creditors. The Bureau is seeking comment in that proposal on these elements and on whether other adjustments are appropriate to the existing rules to maintain continuity and reduce compliance burden. See 2013 ATR Concurrent Proposal. E:\FR\FM\30JAR2.SGM 30JAR2 6538 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with areas to track overlapping but not identical sets of technical criteria for each separate provision could create unwarranted compliance burden that itself would frustrate the intent of the statutes. Although the Bureau has recast and loosened some of the criteria in order to promote consistency, the Bureau has carefully calibrated the changes to further the purposes of each rulemaking and in light of the evidence suggesting that small portfolio lenders’ relationship banking model provides significant consumer protections in its own right. For the foregoing reasons, the Bureau is adopting § 1026.43(f)(1)(vi) to implement TILA section 129C(b)(2)(E)(iv) by providing that a balloon loan that meets the other criteria specified in the regulation is a qualified mortgage if the creditor: (1) In the preceding calendar year made more than 50 percent of its covered transactions secured by a first lien in counties designated by the Bureau as ‘‘rural’’ or ‘‘underserved’’; (2) together with all affiliates extended 500 or fewer first-lien covered transactions in the preceding calendar year; and (3) has total assets that are less than $2 billion, adjusted annually for inflation. The final rule also creates greater parallelism with the escrow provision with regard to the requirement that the affected loans be held in portfolio by requiring in both rules that the transactions not be subject to a ‘‘forward commitment’’ agreement to sell the loan at the time of consummation. These qualifications and the other requirements under the final rule are discussed in more detail below. 43(f)(1) Exemption The Bureau believes that the provisions of TILA section 129C(b)(2)(E) are designed to require that balloonpayment qualified mortgages meet the same criteria for qualified mortgages as described in TILA section 129C(b)(2)(A), except where the nature of the balloonpayment mortgage itself requires adjustment to the general rules. In TILA section 129C(b)(2)(A), a qualified mortgage cannot allow the consumer to defer repayment of principal. Deferred principal repayment may occur if the payment is applied to both accrued interest and principal but the consumer makes periodic payments that are less than the amount that would be required under a payment schedule that has substantially equal payments that fully repay the loan amount over the loan term. The scheduled payments that fully repay a balloon-payment mortgage over the loan term include the balloon payment itself and, therefore, are not substantially equal. Thus, balloon- VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 payment mortgages permit the consumer to defer repayment of principal. Additionally, a qualified mortgage must explicitly fully amortize the loan amount over the loan term and explicitly cannot result in a balloon payment under TILA section 129C(b)(2)(A). Since TILA section 129C(b)(2)(A) contains these provisions, TILA section 129C(b)(2)(E) exempts balloon-payment qualified mortgages from meeting those requirements. TILA section 129C(b)(2)(E) has additional requirements that a creditor consider the consumer’s ability to repay the scheduled payments using a calculation methodology appropriate for a balloonpayment mortgage. Accordingly, the Bureau is adjusting the ability-to-repay requirements generally applicable to qualified mortgages under § 1026.43(e)(2) for the balloon-payment qualified mortgage exemption. Requirements that are the same in both the generally applicable qualified mortgage requirements and the balloon-payment qualified mortgage exemption are specifically described in paragraph (f)(1)(i). The requirements in the generally applicable qualified mortgage requirements that are inapplicable, for the reasons described below, to the balloon-payment qualified mortgage exemption are replaced by requirements in paragraph (f)(1)(ii), (iii) and (iv) that specifically address the provisions inherent in balloon-payment mortgages. and (e)(2)(v). These requirements are similar to the requirements in the Board’s proposal, except that they are stated as affirmative requirements instead of excluding qualified mortgage requirements that are not required to be considered for balloon-payment qualified mortgages. Section 1026.43(f)(1)(i), by exclusion, exempts balloon-payment qualified mortgages from the requirements in § 1026.43(e)(2)(i)(B), (e)(2)(i)(C), (e)(2)(iv), and (e)(2)(vi), which use calculation methodologies that would make the origination of balloonpayment qualified mortgages difficult, if not impossible. The requirements in subsequent provisions of § 1026.43(f)(1) are adopted below to require the consideration of scheduled payments and the debt-to-income ratio made in conjunction with alternative calculation methodologies that are appropriate for balloon-payment qualified mortgages. Comment 43(f)(1)(i)–1 clarifies that a balloon-payment qualified mortgage under this exemption must provide for regular periodic payments that do not result in an increase of the principal balance as required by § 1026.43(e)(2)(i)(A), must have a loan term that does not exceed 30 years as required by § 1026.43(e)(2)(ii), must have total points and fees that do not exceed specified thresholds pursuant to § 1026.43(e)(2)(iii), and must satisfy the consideration and verification requirements in § 1026.43(e)(2)(v). 43(f)(1)(i) TILA section 129C(b)(2)(E)(i) requires that a balloon-payment qualified mortgage meet all of the criteria for a qualified mortgage, except for the provisions that require the loan to have: (1) Regular periodic payments that provide for the complete repayment of principal over the loan term, (2) terms that do not result in a balloon payment, and (3) a payment schedule that fully amortizes the mortgage over the loan term taking into account all applicable taxes, insurance and assessments. The Board’s proposed § 226.43(f)(1)(i) would have implemented this provision by requiring that balloon-payment qualified mortgages meet the same requirements for other qualified mortgages, except for specific provisions of § 226.43(e)(2) that would not have to be considered. Commenters did not address these requirements specifically. The Bureau is adopting § 1026.43(f)(1)(i) to implement TILA section 129C(b)(2)(E)(i) by providing that a balloon-payment qualified mortgage must meet the criteria for a qualified mortgage as required by § 1026.43(e)(2)(i)(A), (e)(2)(ii), (e)(2)(iii), 43(f)(1)(ii) TILA section 129C(b)(2)(E)(ii) requires a creditor making a balloon-payment qualified mortgage to determine that the consumer is able to make all scheduled payments, except the balloon payment, out of income and assets other than the collateral. TILA section 129C(b)(2)(E)(iii) requires a creditor making a balloon-payment qualified mortgage to determine, among other things, that the scheduled payments include mortgage-related obligations. Proposed § 226.43(f)(1)(ii) would have required that the creditor determine that the consumer can make all of the scheduled payments, except for the balloon payment, from the consumer’s current or reasonably expected income or assets other than the dwelling that secures the loan. Commenters did not address this requirement specifically. The Bureau is adopting § 1026.43(f)(1)(ii) to implement TILA section 129C(b)(2)(E)(ii) and a portion of TILA section 129C(b)(2)(E)(iii) by requiring a creditor to determine that the consumer can make all of the payments under the terms of the legal obligation, as described in PO 00000 Frm 00132 Fmt 4701 Sfmt 4700 E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with § 1026.43(f)(1)(iv)(A), together with all mortgage-related obligations and excluding the balloon payment, from the consumer’s income or assets other than the dwelling that secures the loan. Comment 43(f)(1)(ii)–1 provides an example to illustrate the calculation of the monthly payment on which this determination must be based. Comment 43(f)(1)(ii)–2 provides additional clarification on how a creditor may make the required determination that the consumer is able to make all scheduled payments other than the balloon payment. 43(f)(1)(iii) TILA section 129C(b)(3)(B)(i) permits the addition of additional requirements or revision of the criteria that define a qualified mortgage upon the finds discussed below. The Board’s proposal did not include an explicit requirement to consider the consumer’s debt-toincome ratio in relation to a balloonpayment qualified mortgage. The Board, however, sought comment on what criteria should be included in the definition of a qualified mortgage to ensure that the definition provides an incentive to creditors to make qualified mortgages, while also ensuring that consumers have the ability to repay qualified mortgages. One commenter advocated eliminating the balloonpayment qualified mortgage exemption completely as they recommended that balloon-payment mortgages should not be permitted at all, but rather suggested that the Board and Bureau take steps to make the balloon-payment qualified mortgage exemption rare. As discussed above with regard to other categories of qualified mortgages, the Bureau believes consideration of debt-to-income ratio or residual income is fundamental to any determination of ability to repay. A consumer is able to repay a loan if he or she has sufficient funds to pay his or her other obligations and expenses and still make the payments required by the terms of the loan. Thus, debt-to-income comparisons provide a valuable predictive metric in assessing the consumer’s repayment ability. The Bureau believes that it would be inconsistent with congressional intent to have balloonpayment qualified mortgages not meet those same requirements, as modified to the particular nature of a balloonpayment mortgage. Accordingly, the Bureau is adopting § 1026.43(f)(1)(iii) to provide that, to make a balloon-payment qualified mortgage, a creditor must consider and verify the consumer’s monthly debt-toincome ratio or residual income in accordance with § 1026.43(c)(7) by VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 using the calculation methodology described in § 1026.43(f)(iv)(A), together with all mortgage-related obligations and excluding the balloon payment. Comment 43(f)(1)(iii)–1 clarifies that the calculation required under § 1026.43(c)(7)(i)(A) should be made using the payment calculation methodology under § 1026.43(f)(1)(iv)(A), together with all mortgage-related obligations and excluding the balloon payment, in order to comply with § 1026.43(f)(1)(iii). At the same time, however, the Bureau declines to impose a specific debt-to-income or residual threshold for this category of qualified mortgages because, as discussed above, the Bureau believes that small creditors excel at making highly individualized determinations of ability to repay that take into consideration the unique characteristics and financial circumstances of the particular consumer. While the Bureau believes that many creditors can make mortgage loans with consumer debt-to-income ratios above 43 percent that consumers are able to repay, the Bureau believes that portfolio loans made by small creditors are particularly likely to be made responsibly and to be affordable for the consumer even if such loans exceed the 43 percent threshold. The Bureau therefore believes that it is appropriate to presume compliance even above the 43 percent threshold for small creditors who meet the other criteria in § 1026.43(f). The Bureau believes that the discipline imposed when small creditors make loans that they will hold in their portfolio is sufficient to protect consumers’ interests in this regard. Because the Bureau is not proposing a specific limit on consumer debt-to-income ratio, the Bureau does not believe it is necessary to require creditors to calculate debt-to-income ratio in accordance with a particular standard such as that set forth in appendix Q. In adopting this requirement, the Bureau is adding a condition for a balloon-payment qualified mortgage that is not established by TILA section 129C(b)(2)(E). The Bureau adds this condition pursuant to TILA section 129C(b)(3)(B)(i), which authorizes the Bureau ‘‘to 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 this section, necessary and appropriate to effectuate the purposes of this section and Section 129B, to prevent circumvention or PO 00000 Frm 00133 Fmt 4701 Sfmt 4700 6539 evasion thereof, or to facilitate compliance with such sections.’’ A purpose of TILA section 129C, among other things, is to ensure that consumers are offered and receive loans on terms that they are reasonably able to repay. See TILA section 129B(a)(2). The Bureau believes that a creditor considering and verifying the consumer’s monthly debt-to-income ratio or residual income in order for the balloon-payment mortgage to qualify as a balloon-payment qualified mortgage is necessary, proper, and appropriate both to effectuate the purposes of TILA section 129C to prevent circumvention or evasion thereof and to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of this section. For these reasons, the Bureau believes that § 1026.43(f)(1)(iii), in requiring a creditor considering and verifying the consumer’s monthly debtto-income ratio or residual income in order for the balloon-payment mortgage to qualify as a balloon-payment qualified mortgage, effectuates the purposes of TILA section 129C and prevents circumvention or evasion thereof. In addition the Bureau invokes its authority under section 105(a) in order to add the above qualification for a balloon-payment qualified mortgage. Section 105(a) authorizes the Bureau to issue regulations that, among other things, contain such additional requirements, other provisions, or that provide for such adjustments for all or any class of transactions, that in the Bureau’s judgment are necessary or proper to effectuate the purposes of TILA, which include the above purpose of section 129C, among other things. See 15 U.S.C. 1604(a). The Bureau believes that this addition to the qualified mortgage criteria is necessary and proper to achieve this purpose. 43(f)(1)(iv) TILA section 126C(b)(2)(E)(iii) and the Board proposal require that the loan be underwritten with specific payment calculation methodologies to qualify as a balloon-payment qualified mortgage. The underwriting of a loan is based on the terms of the legal obligation. The general requirements of a qualified mortgage in § 1026.43(e)(2) govern loans secured by real property or a dwelling with multiple methods of payment calculations, terms, and conditions. However, unlike other the types of qualified mortgage, the balloon-payment qualified mortgage deals with a specific type of transaction, a balloon-payment mortgage, with specific characteristics that are described in the legal E:\FR\FM\30JAR2.SGM 30JAR2 6540 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with obligation. Therefore, the Bureau considers the requirement of TILA section 129C(b)(2)(E)(iii) to be requirements relating to the terms of the legal obligation of the loan. Accordingly, the Bureau is adopting § 1026.43(f)(1)(iv), requiring the legal obligation of a balloon-payment qualified mortgage to have the following terms: (1) Scheduled payments that are substantially equal and calculated on an amortization period that does not exceed 30 years; (2) the interest rate does not vary during the loan term, and (3) the loan term is for five years or longer. Scheduled Payments TILA section 129C(b)(2)(E)(iii) requires that a balloon-payment qualified mortgage must be underwritten based on a payment schedule that fully amortizes the loan over a period of not more than 30 years and takes into account all applicable taxes, insurance, and assessments. The Board’s proposed § 226.43(f)(1)(iii) incorporated this statutory requirement. Commenters did not address this requirement specifically. The Bureau is adopting the Board’s proposal and implements § 1026.43(f)(1)(iv) to require that the scheduled payments, on which the determinations required by § 1026.43(f)(1)(ii) and (f)(1)(iii) are based, are calculated using an amortization period that does not exceed 30 years. The requirement that the payments include all mortgagerelated obligations is required as part of § 1026.43(f)(1)(ii), above. The Bureau believes that the underwriting referenced in TILA section 129C(b)(2)(E)(iii) corresponds to the determination of the consumer’s repayment ability referenced in TILA section 129C(b)(2)(E)(ii). Comment 43(f)(1)(iv)–1 clarifies that the amortization period used to determine the scheduled periodic payments that the consumer must pay under the terms of the legal obligation may not exceed 30 years. In its proposal, the Board sought comment on whether a balloon-payment mortgage with interest-only payments should qualify for the balloon-payment exemption. One association of State bank regulators commented that loans with interest-only payments would be properly excluded from the exemption in order to permit the exemption to be available only to those institutions that appropriately utilize the balloonpayment mortgages to mitigate interest rate risk. The Bureau agrees with this assessment and believes that permitting interest-only payments would be contrary to the intent of Congress requiring amortizing payments as a requirement of a qualified mortgage, as interest-only payments do not provide any reduction in principal. Accordingly, the Bureau is adding comment 43(f)(1)(iv)–2 which clarifies that a loan that provides for interest-only payments cannot qualify for the balloon-payment qualified mortgage exemption, because it would not require the consumer to make any payments towards the principal balance of the loan contrary to the requirement that the scheduled payments result in amortization of the loan for a period that does not exceed 30 years. Fixed Interest Rate TILA section 129C(b)(3)(B)(i) permits the addition of additional requirements upon the finding that such regulations are necessary or proper to ensure that responsible, affordable mortgage credit remains available to consumers. The Board’s proposal did not include any restrictions on the interest rate terms of the loan, but did observe that community banks appear to originate balloon-payment mortgages to hedge against interest-rate risk. The Board sought comment on what criteria should be included in the definition of a qualified mortgage to ensure that the definition provides an incentive to creditors to make qualified mortgages, while also ensuring that consumers have the ability to repay qualified mortgages. The Bureau believes that the purpose of the exemption was to permit balloonpayment mortgages to be originated for those consumers that still need or want them, and to permit competition between creditors that address interest rate risk through the use of adjustable rate mortgages and those creditors that address interest rate risk through the use of balloon-payment mortgages. The Bureau believes that creditors that have the infrastructure and resources to originate adjustable rate mortgages do not need to resort to the use of balloonpayment mortgages to address interest rate risk. Accordingly, the Bureau is adopting § 1026.43(f)(1)(iv)(B), which requires that the legal obligation of a balloon-payment qualified mortgage must include an interest rate that will not increase during the term of the loan. In adopting this requirement, the Bureau is adding a condition for a balloon-payment qualified mortgage that is not established by TILA section 129C(b)(2)(E). The Bureau adds this condition pursuant to TILA section 129C(b)(3)(B)(i), which authorizes the Bureau ‘‘to revise, add to, or subtract from the criteria that define a qualified VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 PO 00000 Frm 00134 Fmt 4701 Sfmt 4700 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 this section, necessary and appropriate to effectuate the purposes of this section and Section 129B, to prevent circumvention or evasion thereof, or to facilitate compliance with such sections.’’ A purpose of TILA section 129C is to ensure that consumers are offered and receive loans on terms that they are reasonably able to repay. See TILA section 129B(a)(2). The Bureau believes that requiring the legal obligation of a balloon-payment qualified mortgage to contain an interest rate that does not increase during the loan term is necessary, proper, and appropriate both to effectuate the purposes of TILA section 129C and to prevent circumvention or evasion thereof and to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of this section. For these reasons, the Bureau believes that § 1026.43(f)(1)(iv)(B), in requiring the legal obligation of a balloon-payment qualified mortgage to contain an interest rate that does not increase during the loan term, effectuates the purposes of TILA section 129C and prevents circumvention or evasion thereof. In addition the Bureau invokes its authority under section 105(a) in order to add the above qualification for a balloon-payment qualified mortgage. Section 105(a) authorizes the Bureau to issue regulations that, among other things, contain such additional requirements, other provisions, or that provide for such adjustments for all or any class of transactions, that in the Bureau’s judgment are necessary or proper to effectuate the purposes of TILA, which include the above purpose of Section 129C, among other things. See 15 U.S.C. 1604(a). The Bureau believes that this addition to the qualified mortgage criteria is necessary and proper to achieve this purpose. Loan Term of Five Years or Longer TILA section 129C(b)(3)(B)(i) permits the adoption of additional requirements upon the finding that such regulations are necessary or proper to ensure that responsible, affordable mortgage credit remains available to consumers. The Board’s proposed § 226.43(f)(1)(iv) would have included the addition of a requirement that a balloon-payment qualified mortgage must have a loan term of five years or longer. One association of State bank regulators and an industry trade group commented that E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations the five-year term requirement was appropriate, as the time period is consistent with other provisions of the proposed rule. One industry trade group and one industry commenter commented that three years would be a more appropriate term because some of the creditors that would qualify under proposed § 226.43(f)(1)(v) utilize threeyear terms. The Bureau is not persuaded that the exemption was meant by Congress to permit any current business practice of creditors that would satisfy the requirements of proposed § 226.43(f)(1)(v), rather the exemption was meant to provide a reasonable exemption for some balloon-payment mortgages that still meet other requirements of a qualified mortgage. The Bureau notes that the statute requires underwriting for an adjustablerate qualified mortgage to be based on the maximum interest rate permitted during the first five years. See TILA Section 129C(b)(2)(A)(v). Therefore, the Bureau is adopting the Board’s proposal by implementing § 1026.43(f)(1)(iv)(C) requiring a loan term of five years or longer because it reflects the statutory intent that five years is a reasonable period to repay a loan. Since other requirements of a qualified mortgage include a review of the mortgage over a five-year term, it would be more consistent with the intent of the exemption for the balloon-payment mortgage to have at least a five-year term. The Bureau believes that it is appropriate to structure the exemption to prevent balloon-payment mortgages with very short loan terms from being qualified mortgages because such loans would present certain risks to consumers. A consumer with a loan term of less than five years, particularly where the amortization period is especially long, would face a balloon payment soon after consummation, in an amount virtually equal to the original loan amount. The consumer would establish little equity in the property under such terms, and if the pattern is repeated the consumer may never make any significant progress toward owning the home unencumbered. Thus, the greater the difference between a balloonpayment mortgage’s amortization period and its loan term, the more likely the consumer would face this problem. The Bureau’s requirement of a minimum term therefore complements the 30-year maximum amortization period prescribed by TILA section 129C(b)(2)(E)(iii). In adopting this requirement, the Bureau is adding a condition for a balloon-payment qualified mortgage that is not established by TILA section VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 129C(b)(2)(E). The Bureau adds this condition pursuant to TILA section 129C(b)(3)(B)(i), which authorizes the Bureau ‘‘to 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 this section, necessary and appropriate to effectuate the purposes of this section and Section 129B, to prevent circumvention or evasion thereof, or to facilitate compliance with such sections.’’ A purpose of TILA section 129C is to ensure that consumers are offered and receive loans on terms that they are reasonably able to repay. See TILA section 129B(a)(2). For the reasons discussed above, the Bureau believes that a minimum loan term for balloonpayment mortgages is necessary and appropriate both to effectuate the purposes of TILA section 129C and to prevent circumvention or evasion thereof. For these reasons, the Bureau believes that § 1026.43(f)(1)(iv)(C), in limiting the exemption for balloonpayment qualified mortgages to covered transactions with loan terms of at least five years and thus ensuring that such products truly support mortgage affordability, effectuates the purposes of TILA section 129C and prevents circumvention or evasion thereof. The Bureau also believes this minimum loan term for balloon-payment qualified mortgages is necessary, proper, and appropriate to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of Section 129C. In addition the Bureau invokes its authority under section 105(a) in order to add the above qualification for a balloon-payment qualified mortgage. Section 105(a) authorizes the Bureau to issue regulations that, among other things, contain such additional requirements, other provisions, or that provide for such adjustments for all or any class of transactions, that in the Bureau’s judgment are necessary or proper to effectuate the purposes of TILA, which include the above purpose of Section 129C, among other things. See 15 U.S.C. 1604(a). The Bureau believes that this addition to the qualified mortgage criteria is necessary and proper to achieve this purpose. 43(f)(1)(v) and (vi) TILA section 129C(b)(2)(E)(iv) includes among the conditions for a balloon-payment qualified mortgage that the creditor (1) operates predominantly PO 00000 Frm 00135 Fmt 4701 Sfmt 4700 6541 in rural or underserved areas; (2) together with all affiliates, has total annual residential mortgage loan originations that do not exceed a limit set by the Bureau; (3) retains the balloon-payment loans in portfolio; and (4) meets any asset-size threshold and any other criteria as the Bureau may establish. The Board proposed § 226.43(f)(1)(v) to impose specific requirements to implement some of these elements and sought comment on alternatives to implement others. Specifically, the Board: (1) Proposed a requirement that the creditor in the preceding year made more than 50 percent of its balloon-payment mortgages in rural or underserved areas; (2) sought comment on whether to adopt an annual originations limit based on either the total volume of mortgages or the total number of mortgages made in the last year by the creditor, together with affiliates, without proposing a specific threshold; (3) sought comment on two alternatives to implement the portfolio requirement by revoking a creditor’s ability to make balloonpayment qualified mortgages if the creditor sold any balloon-payment mortgages either in the last year or at any time after the final rule was adopted; and alternatives, and (4) did not have assets that exceeded $2 billion, adjusted annually for inflation. In contrast, the Board’s escrows proposal would have implemented nearly identical statutory requirements under TILA 129D(c) by requiring that the creditor (1) in the preceding calendar year, have made more than 50 percent of its first-lien mortgages in rural or underserved areas; (2) together with all affiliates, originated and retained servicing rights to no more than 100 first-lien mortgage debt obligations in either the current or prior calendar year; and (3) not be permitted to invoke the exception for any first-lien higherpriced mortgage loan that was subject to a ‘‘forward commitment’’ to sell the loan at the time of consummation. The Board also sought comment on whether to impose an asset limit without proposing a specific threshold, and proposed to impose a further requirement that the creditor and its affiliates not maintain escrow accounts for any other loans in order to be eligible for the exception. As stated above, the Bureau has considered the comments received under both proposals regarding implementation of the largely identical statutory criteria, and has concluded that it is appropriate to create a much higher degree of consistency between the elements in the two individual rules. Implementation of each of the E:\FR\FM\30JAR2.SGM 30JAR2 6542 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations statutory elements is discussed further below. sroberts on DSK5SPTVN1PROD with Holding of Balloon-Payment Mortgages in Portfolio TILA section 129C(b)(E)(iv) requires that the lender keep balloon-payment mortgages in portfolio. The Board proposed to implement this requirement by removing a creditor’s eligibility for the exemption under proposed § 226.43(f)(1)(v)(C) if it sold a balloonpayment mortgage during two alternative periods, one that would cover any time after the adoption of the final rule and another that would look only to sales during the preceding or current calendar year. The Board concluded that this was the best approach to implement the statutory requirement in the qualified mortgage context because it would allow a creditor to determine at consummation whether a particular balloon-payment loan was eligible to be a qualified mortgage and allow the loan to maintain such status even if it were sold, while creating strong safeguards against gaming of the exception by revoking the creditor’s ability to invoke the provisions if they began selling such loans to other holders. In contrast, the Board’s 2011 Escrows Proposal would have implemented a parallel statutory requirement under TILA section 129D(c)(3) by looking to whether the particular first-lien, higherpriced mortgage loan was subject to sale under a ‘‘forward commitment.’’ Forward commitments are agreements entered into at or before consummation of a transaction under which a purchaser is committed to acquire the specific loan or loans meeting specified criteria from the creditor after consummation. The Board believed that the proposal was a reasonable way to implement the statutory requirement because it would allow the creditor and consumer to determine at consummation whether an escrow requirement was required to be established; the Board reasoned that fashioning the rule in a way that would require that an escrow account be established sometime after consummation if the particular loan was transferred to a non-eligible holder would be potentially burdensome to consumers, since the consumer may not have the funds available to make a large lump-sum payment at that time. At the same time, the Board believed the rule would prevent gaming of the escrows exception because it thought that small creditors would be reluctant to make a loan that they did not intend to keep in their portfolios unless they had the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 assurance of a committed buyer before extending the credit. Comments received on the escrows proposal had a divergence of opinion on how the forward commitment requirement would work in practice. One trade association commenter stated that the forward commitment requirement would prevent creditors from selling portfolio mortgage debt obligations in the future. This appears to be a misreading of the Board’s 2011 Escrows Proposal, as it would not have restricted the sale of higher-priced mortgage loans. Instead, the proposed forward commitment requirement provided that, so long as the higherpriced mortgage loan was not subject to a forward commitment at the time of consummation, the higher-priced mortgage loan could be sold on the secondary market without requiring an escrow account to be established at that time. One consumer advocacy group, concerned about the possibility that creditors would use the provision to skirt the escrow requirements, suggested a blanket rule that higher-priced mortgage loans that are exempt must be maintained in the portfolio of the creditor or, alternatively, that upon sale secondary market purchasers must be required to establish escrow accounts for such mortgage debt obligations. After consideration of these comments and further analysis of parallels between the two rulemakings, the Bureau believes that it is useful and appropriate to implement the noforward-commitment requirement in both rules. Accordingly, the Bureau is adding § 1026.43(f)(1)(v) to provide that a loan is not eligible to be a balloonpayment qualified mortgage if it is subject, at consummation, to a commitment to be acquired by another person, other than a person that separately meets the requirements of § 1026.43(f)(1)(vi). Comment 43(f)(1)(v)– 1 clarifies that a balloon-payment mortgage that will be acquired by a purchaser pursuant to a forward commitment does not satisfy the requirements of § 1026.43(f)(1)(v), whether the forward commitment refers to the specific transaction or the balloon-payment mortgage meets prescribed criteria of the forward commitment, along with an example. The Bureau believes the rationale for the balloon-payment qualified mortgage exemption is not present when a loan will be or is eligible to be acquired pursuant to a forward commitment, even if the creditor is exempt, as the creditor does not intend to retain the balloon-payment mortgage in its portfolio. PO 00000 Frm 00136 Fmt 4701 Sfmt 4700 In adopting this requirement, the Bureau is adding a condition for a balloon-payment qualified mortgage that is not established by TILA section 129C(b)(2)(E). The Bureau is adopting § 1026.43(f)(1)(vi) pursuant to TILA section 129C(b)(3)(B)(i), which authorizes the Bureau ‘‘to 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 this section, necessary and appropriate to effectuate the purposes of this section and Section 129B, to prevent circumvention or evasion thereof, or to facilitate compliance with such sections.’’ A purpose of TILA section 129C is to ensure that consumers are offered and receive loans on terms that they are reasonably able to repay. See TILA section 129B(a)(2). The Bureau believes that the prohibition on mortgages originated in conjunction with a forward commitment from qualifying as a balloon-payment qualified mortgage is necessary, proper, and appropriate both to effectuate the purposes of TILA section 129C and to prevent circumvention or evasion thereof. For these reasons, the Bureau believes that § 1026.43(f)(1)(v), in limiting the exemption for balloon-payment qualified mortgages to mortgages that are not originated in conjunction with a forward commitment, effectuates the purposes of TILA section 129C and prevents circumvention or evasion thereof and is necessary, proper, and appropriate to do so. Limiting balloonpayment qualified mortgages to those that are not originated in conjunction with a forward commitment effectively facilitates compliance with the statutory requirement that a balloon-payment qualified mortgage is extended by a creditor that retains the balloonpayment qualified mortgages in portfolio. In addition the Bureau invokes its authority under section 105(a) in order to add the above qualification for a balloon-payment qualified mortgage. Section 105(a) authorizes the Bureau to issue regulations that, among other things, contain such additional requirements, other provisions, or that provide for such adjustments for all or any class of transactions, that in the Bureau’s judgment are necessary or proper to effectuate the purposes of TILA, which include the above purpose of Section 129C, among other things. See 15 U.S.C. 1604(a). The Bureau believes that this addition to the E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with qualified mortgage criteria is necessary and proper to achieve this purpose. ‘‘Operates Predominantly in Rural or Underserved Areas’’ Under TILA section 129C(b)(2)(E)(iv)(I), to qualify for the exemption, a creditor must ‘‘operate predominantly in rural or underserved areas.’’ The Board’s proposed § 226.43(f)(1)(v)(A) would have required a creditor to have made during the preceding calendar year more than 50 percent of its total balloon-payment mortgages in ‘‘rural or underserved’’ areas. The Board sought comment generally on the appropriateness of the proposed approach to implement the phrase ‘‘operate predominantly.’’ Two trade group commenters commented that the balloon exemption should extend to all creditors that retain balloon-payment mortgages in their portfolio, and to eliminate this proposed requirement, which would have the same effect as the extension of the exemption proposed generally, discussed above. Overall, the Bureau believes Congress enacted the exemption in TILA section 129C(b)(2)(E) to ensure access to credit in rural and underserved areas where consumers may be able to obtain credit only from such community banks or credit unions offering balloon-payment mortgages. The ‘‘operates predominantly in’’ requirement serves to limit the exemption to these institutions. To remove this portion of the qualifications of the creditor would be to circumvent Congress’s stated requirement that the exemption was intended for creditors operating predominantly in rural and underserved areas and would potentially extend the exemption to, for example, a national bank that makes loans in rural areas and that is fully capable of putting on its balance sheet fixed rate 30-year mortgage loans or adjustable rate mortgage loans. The Bureau believes that ‘‘predominantly’’ indicates a portion greater than half, hence the regulatory requirement of more than 50 percent. The Board also proposed § 226.43(f)(2) to implement this provision by defining the terms ‘‘rural’’ and ‘‘underserved,’’ which are not defined in the statute. The Board’s proposed § 226.43(f)(2) established separate criteria for both rural and underserved areas. Commenters addressing the creditor qualifications under § 226.43(f)(2) discussed the definitions themselves, and did not comment on the necessity of creating definitions for the terms rural and underserved. The Bureau is adopting VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 the Board’s approach by implementing section 1026.43(f)(2) which establishes separate criteria for both ‘‘rural’’ and ‘‘underserved.’’ This means that a property could qualify for designation by the Bureau under either definition, and that covered transactions made by a creditor in either a rural or underserved area will be included in determining whether the creditor operates predominantly in such areas. ‘‘Rural’’ As described above, the Board’s proposed definition of rural for purposes of both the balloon-payment qualified mortgage and escrows exception relied upon the USDA ERS ‘‘urban influence codes’’ (UICs). The UICs are based on the definitions of ‘‘metropolitan’’ and ‘‘micropolitan’’ as developed by the Office of Management and Budget, along with other factors reviewed by the ERS, which place counties into twelve separately defined UICs depending on the size of the largest city and town in the county. The Board’s proposal would have limited the definition of rural to certain ‘‘noncore’’ counties that are not located in or adjacent to any metropolitan or micropolitan area. This definition corresponded with UICs of 7, 10, 11, or 12. The population that would have been covered under the Board’s proposed definition was 2.3 percent of the United States population under the 2000 census. The Board believed this limited the definition of ‘‘rural’’ to those properties most likely to have only limited sources of mortgage credit because of their remoteness from urban centers and their resources. The Board sought comment on all aspects of this approach to defining rural, including whether the definition should be broader or narrower. Many commenters in both rulemakings, including more than a dozen trade group commenters, several individual industry commenters, one association of State banking regulators, and a United States Senator, suggested that this definition of a rural area was too narrow and would exclude too many creditors from qualifying for the balloon-payment qualified mortgage exemption and constrain the availability of credit to rural properties. The comment from a United States Senator suggested using the eligibility of a property to secure a single-family loan under the USDA’s Rural Housing Loan program as the definition of a rural property. A trade association argued that because community banks use balloon-payment mortgages to hedge against interest rate risk, the exemption should not be confined to rural areas. PO 00000 Frm 00137 Fmt 4701 Sfmt 4700 6543 The Bureau agrees that a broader definition of ‘‘rural’’ is appropriate to ensure access to credit with regard to both the escrows and balloon-payment qualified mortgage exemptions. In particular, the Bureau believes that all ‘‘non-core’’ counties should be encompassed in the definition of rural, including counties adjacent to a metropolitan area or a county with a town of at least 2,500 residents (i.e., counties with a UIC of 4, 6, and 9 in addition to the counties with the UICs included in the Board’s definition). The Bureau also believes that micropolitan areas which are not adjacent to a metropolitan area should be included within the definition of rural, (i.e., counties with a UIC of 8). These counties have significantly fewer creditors originating higher-priced mortgage loans and balloon-payment mortgages than other counties.159 Including these counties within the definition of rural would result in 9.7 percent of the population being included within rural areas. Under this definition, only counties in metropolitan areas or in micropolitan areas adjacent to metropolitan areas would be excluded from the definition of rural. The Bureau also considered adopting the definition of rural used to determine the eligibility of a property to secure a single family loan under the USDA’s Rural Housing Loan program. For purposes of the Rural Housing Loan program, USDA subdivides counties into rural and non-rural areas. As a result, use of this definition would bring within the definition of rural certain portions of metropolitan and micropolitan counties. Given the size of some counties, particularly in western States, this approach may provide a more nuanced measure of access to credit in some areas than a county-by159 A review of data from HMDA reporting entities indicates that there were 700 creditors in 2011 that otherwise meet the requirements of § 1026.35(b)(2)(iii), of which 391 originate higherpriced mortgage loans in counties that meet the definition of rural, compared to 2,110 creditors that otherwise meet the requirements of § 1026.35(b)(2)(iii) that originate balloon-payment mortgages in counties that would not be rural. The 391 creditors originated 12,921 higher-priced mortgage loans, representing 30 percent of their 43,359 total mortgage loan originations. A review of data from credit unions indicates that there were 830 creditors in 2011 that otherwise meet the requirements of § 1026.35(b)(2)(iii), of which 415 originate balloon-payment and hybrid mortgages in counties that meet the definition of rural, compared to 3,551 creditors that otherwise meet the requirements of § 1026.35(b)(2)(iii) that originate balloon-payment mortgages in counties that would not be rural. The 415 creditors originated 4,980 balloon-payment mortgage originations, representing 20 percent of their 24,968 total mortgage loan originations. E:\FR\FM\30JAR2.SGM 30JAR2 6544 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with county metric. However, use of the Rural Housing Loan metrics would incorporate such significant portions of metropolitan and micropolitan counties that 37 percent of the United States population would be within areas defined as rural. Based on a review of HMDA data and the location of mortgage transactions originated by HMDA reporting entities, the average number of creditors in the areas that would meet the USDA’s Rural Housing Loan program definition of rural is ten. The Bureau believes that a wholesale adoption of the Rural Housing Loan definitions would therefore expand the definition of rural beyond the intent of the escrow and balloon-payment qualified mortgage exemptions under sections 1412 and 1461 of the DoddFrank Act by incorporating areas in which there is robust access to credit. Accordingly, the final rule incorporates the provisions of the escrow final rule providing that a county is rural if it is neither in a metropolitan statistical area, nor in a micropolitan statistical area that is adjacent to a metropolitan statistical area. The Bureau intends to continue studying over time the possible selective use of the Rural Housing Loan program definitions and tools provided on the USDA Web site to determine whether a particular property is located within a ‘‘rural’’ area. For purposes of initial implementation, however, the Bureau believes that defining ‘‘rural’’ to include more UIC categories creates an appropriate balance to preserve access to credit and create a system that is easy for creditors to implement. ‘‘Underserved’’ The Board’s proposed § 226.43(f)(2)(ii) would have defined a county as ‘‘underserved’’ during a calendar year if no more than two creditors extend consumer credit five or more times in that county. The definition was based on the Board’s judgment that, where no more than two creditors are significantly active, the inability of one creditor to offer a balloon-payment mortgage would be detrimental to consumers who would have limited credit options because only one creditor would be left to provide the balloon-payment mortgage. Essentially, a consumer who could only qualify for a balloon-payment mortgage would be required to obtain credit from the remaining creditor in that area. Most of the same commenters that stated that the definition of rural was too narrow, as discussed above, also stated that the definition of underserved was too narrow, as well. The commenters proposed various different standards, including standards that considered the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 extent to which the property was in a rural area, as an alternate definition. The Bureau believes the purpose of the exemption is to permit creditors that rely on certain balloon-payment mortgage products to continue to offer credit to consumers, rather than leave the mortgage loan market, if such creditors’ withdrawal would significantly limit consumers’ ability to obtain mortgage credit. In light of this rationale, the Bureau believes that ‘‘underserved’’ should be implemented in a way that protects consumers from losing meaningful access to mortgage credit. The Bureau is proposing to do so by designating as underserved only those areas where the withdrawal of a creditor from the market could leave no meaningful competition for consumers’ mortgage business. The Bureau believes that the expanded definition of rural, as discussed above, and the purposes of the balloon-payment qualified mortgage exemption enable continued consumer ability to obtain mortgage credit. Scope of Mortgage Operations The Bureau has made one other change to the final rule to make the standards more consistent as between the balloon qualified mortgage and escrows exemption with regard to what type of mortgage loan operations are tracked for purposes of determining whether a creditor operates predominantly in rural or underserved areas. As noted above, the Board’s proposed rule for balloon-payment qualified mortgages would have based a creditor’s eligibility on the geographic distribution of its balloon-payment mortgages, while the escrows proposal focused on the distribution of first-lien mortgages. Given that the underlying statutory language regarding ‘‘operates predominantly’’ is the same in each instance and that tracking each type of mortgage separately would increase administrative burden, the Bureau believes it is appropriate to base the threshold for both rules on the distribution of all first-lien ‘‘covered transactions’’ as defined in § 1026.43(b)(1).160 The Bureau believes that counting all transactions will facilitate compliance, promote consistency in applying the two exemptions under both rulemakings, and be more useful in identifying which institutions truly specialize in serving rural and underserved areas. The Bureau also believes that it is appropriate to measure first-lien 160 As discussed above, § 1026.43(b)(1) defines covered transactions as closed-end consumer credit transactions that are secured by a dwelling, other than certain tractions that are exempt from coverage under § 1026.43(a). PO 00000 Frm 00138 Fmt 4701 Sfmt 4700 covered transactions because the balloon-payment mortgages that will meet the requirements of the balloonpayment qualified mortgage exemption will be first-lien covered transactions, as having subordinate financing along with the balloon-payment mortgage would be rare since it further constrains a consumer’s ability to build equity in the property and able to refinance the balloon-payment mortgage when it becomes due. Accordingly, a creditor must have made during the preceding calendar year more than 50 percent of its total covered transactions secured by a first lien on property in a rural or underserved area, which is the same as the requirement of § 1026.35(b)(2)(iii)(A) in the 2013 Escrows Final Rule. Total Annual Residential Mortgage Loan Origination TILA section 129C(b)(2)(E)(iv)(II) requires the Bureau to establish a limitation on the ‘‘total annual residential mortgage loan originations’’ for a creditor seeking to fall within the balloon-payment qualified mortgage exemption. The Board’s proposed § 226.43(f)(1)(v)(B) provided two alternatives to meet the statutory requirement that the creditor ‘‘together with all affiliates, has total annual residential mortgage originations that do not exceed a limit set by the Board.’’ TILA section 129C(b)(2)(E)(iv)(II). The first alternative was a volume based limit, and the second alternative was a total annual number of covered transactions limit. The Board’s proposal did not propose any specific numeric thresholds for either alternative, but rather sought comment on the appropriate volume or number of loans originated based on the alternatives described in the proposal. In contrast, the Board’s escrow proposal would have restricted eligibility to creditors that, along with their affiliates, originate and service no more than 100 new first-lien loans per calendar year. Although the Dodd-Frank Act requirement to establish escrow accounts applies only to higher-priced mortgage loans that are secured by first liens, the Board reasoned that it was appropriate to base the threshold on all first-lien originations because creditors are free to establish escrow accounts for all of their first-lien mortgages voluntarily in order to achieve the scale necessary to escrow cost effectively. The Board estimated that a minimum servicing portfolio size of 500 is necessary to escrow cost effectively, and assumed that the average life expectancy of a mortgage loan is about five years. Based on this reasoning, the Board reasoned that creditors would no E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations longer need the benefit of the exemption if they originated and serviced more than 100 new first-lien loans per year. In response to the balloon-payment qualified mortgage loan proposal, two trade groups and one association of State bank regulators argued that other criteria, such as the asset-size limit or portfolio requirement, were sufficient and neither a volume nor a total annual number of covered transactions limit would be necessary. One trade group commenter suggested combining the proposed alternatives and permit creditors to pick which limit they would operate under. Other trade group and industry commenters indicated that it would be preferable to base the annual originations limit on the number of transactions rather than volume because of the varying dollar amount of loans originated, which would constrain the number of consumers with limited credit options which could obtain balloon-payment mortgages in rural or underserved areas. Four trade group and industry commenters suggested increasing the threshold for the total annual number of covered transactions by various amounts ranging from 250 to 1,000 transactions. The commenters did not articulate any particular reason or data to support the suggested limits, other than one commenter who indicated its suggestion was intended to be higher than its own amount of total annual covered transactions. Similarly in the escrows rulemaking, commenters asserted that the 100-loan threshold was not in fact sufficient to make escrowing cost-effective. Suggestions for higher thresholds ranged from 200 to 1,000 mortgage debt obligations per year originated and serviced, though no commenters provided data to support their suggestions for alternative thresholds or to refute the Board’s cost analysis. One consumer advocacy commenter suggested the proposed threshold was too high because it counted only firstlien mortgage transactions, instead of all mortgage debt obligations, but offered no specific alternative amount. Two industry commenters also suggested that the origination limit should measure only the number of higher-priced mortgage loans originated and serviced by the creditor and its affiliates. The Bureau believes that the requirement of TILA section 129C(b)(2)(E)(iv)(II) reflects Congress’s recognition that larger creditors who operate in rural or underserved areas should be able to make credit available without resorting to balloon-payment mortgages. Similarly, the requirement of TILA section 129C(d) reflects a recognition that larger creditors have the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 systems capability and operational scale to establish cost-efficient escrow accounts. In light of the strong concerns expressed in both rulemakings about the potential negative impacts on small creditors in rural and underserved areas, the Bureau conducted further analysis to try to determine the most appropriate thresholds, although it was significantly constrained by the fact that data is limited with regard to mortgage originations in rural areas generally and in particular with regard to originations of balloon-payment mortgages. The Bureau started with the premise that it would be preferable to use the same annual originations threshold in both rules in order to reflect the consistent language in both statutory provisions focusing on ‘‘total annual mortgage loan originations,’’ to facilitate compliance avoiding requiring institutions to track multiple metrics, and to promote consistent application of the two exemptions. This requires significant reconciliation between the two proposals, however, because the escrows proposal focused specifically on loans originated and serviced in order to best gauge creditors’ ability to maintain escrow accounts over time, while servicing arrangements are not directly relevant to the balloon-payment qualified mortgage. However, to the extent that creditors chose to offer balloon-payment mortgages to manage their interest rate risk without having to undertake the compliance burdens involved in administering adjustable rate mortgages over time, the Bureau believes that both provisions are focused in a broad sense on accommodating creditors whose systems constraints might otherwise cause them to exit the market. With this in mind, the Bureau ultimately has decided to adopt a threshold of 500 or fewer annual originations of first-lien loans for both rules. The Bureau believes that this threshold will provide greater flexibility and reduce concerns that the specific threshold that had been proposed in the escrows rulemaking (100 loans originated and serviced annually) would reduce access to credit by excluding creditors who need special accommodations in light of their capacity constraints. At the same time, the increase is not as dramatic as it may first appear because the Bureau’s analysis of HMDA data suggests that even small creditors are likely to sell off a significant number of loans to the secondary market. Assuming that most loans that are retained in portfolio are also serviced in house, the Bureau estimates that a creditor originating no more than 500 first-lien loans per year PO 00000 Frm 00139 Fmt 4701 Sfmt 4700 6545 would maintain and service a portfolio of about 670 mortgage debt obligations over time, assuming a life expectancy of five years per mortgage debt obligation.161 Thus, the higher threshold will help to assure that creditors who are subject to the escrow requirements do in fact maintain portfolios of sufficient size to maintain the accounts on a cost efficient basis over time, in the event that the Board’s estimate of a minimum portfolio of 500 loans was too low.162 However, the Bureau believes that the 500 annual originations threshold in combination with the other requirements will still assure that the balloon-payment qualified mortgage and escrow exceptions are available only to small creditors that focus primarily on a relationship-lending model and face significant systems constraints. Asset-Size Threshold Under TILA section 129C(b)(2)(E)(iv)(IV), to qualify for the exemption, a creditor must meet any asset-size threshold established by the Bureau. The Board’s proposed § 226.43(f)(1)(v)(D) would have established the threshold for calendar year 2013 at $2 billion, with annual adjustments for inflation thereafter. Thus, a creditor would satisfy this element of the test for 2013 if it had total assets of $2 billion or less on December 31, 2012. This number was based on the limited data available to the Board at the time of the proposal. Based on that limited information, the Board reasoned that none of the entities it identified as operating predominantly in rural or underserved areas had total assets as of the end of 2009 greater than $2 billion, and therefore, the limitation should be set at $2 billion. The Board expressly proposed setting the asset-size threshold 161 A review of 2011 HMDA data shows creditors that otherwise meet the criteria of § 1026.43(f)(1)(vi) and originate between 200 and 500 or fewer firstlien covered transactions per year average 134 transactions per year retained in portfolio. Over a five year period, the total portfolio for these creditors would average 670 mortgage debt obligations. 162 Given that escrow accounts are typically not maintained for loans secured by subordinate liens, the Bureau does not believe that it makes sense to count such loans toward the threshold because they would not contribute to a creditor’s ability to achieve cost-efficiency. At the same time, the Bureau believes it is appropriate to count all firstlien loans toward the threshold, since creditors can voluntarily establish escrow accounts for such loans in order to increase the cost-effectiveness of their program even though the mandatory account requirements under the Dodd-Frank Act apply only to first-lien, higher-priced mortgage loans. Focusing on all first-lien originations also provides a metric that is useful for gauging the relative scale of creditors’ operations for purposes of the balloonpayment qualified mortgages, while focusing solely on the number of higher-priced mortgage loan originations would not. E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6546 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations at the highest level currently held by any of the institutions that appear to be smaller institutions that served areas with otherwise limited credit options. The Board sought comment on what threshold would be appropriate and whether the asset-size test is necessary at all. Conversely, in the escrows proposal the Board did not propose an asset threshold, but rather simply requested comment on whether a threshold should be established and, if so, what it should be. In response to the Board’s 2011 ATR Proposal, one association of State bank regulators suggested that the asset-size threshold be included and be the only requirement for a creditor to qualify for the balloon-mortgage qualified mortgage exemption. Two trade group commenters suggested that a $2 billion asset-size threshold was appropriate, with one also suggesting that the assetsize threshold be the only requirement for a creditor to qualify for the balloonmortgage qualified mortgage exemption. One industry commenter suggested that the asset-size threshold be $10 billion. In response to the Board’s 2011 Escrows Proposal, the association of State bank regulators again suggested that an asset-size threshold be the only requirement to qualify for the escrow exception, but did not propose a specific dollar threshold. A trade association suggested a threshold of $1 billion, but did not provide a rational for that amount. For reasons discussed above, the Bureau is adopting a mortgage origination limit as contemplated by the statute. Given that limitation, restricting the asset size of institutions that can claim the exemption is of limited importance. Nonetheless, the Bureau believes that an asset limitation is still helpful because very large institutions should have sufficient resources to adapt their systems to provide mortgages without balloon payments and with escrow accounts even if the scale of their mortgage operations is relatively modest. A very large institution with a relatively modest mortgage operation also does not have the same type of reputational and balance-sheet incentives to maintain the same kind of relationship-lending model as a smaller community-based lender. Accordingly, the Bureau believes that the $2 billion asset limitation by the Board remains an appropriate limitation and should be applied in both rulemakings. Accordingly, the creditor must have total assets of less than $2 billion 163 as 163 The $2 billion threshold reflects the purposes of the balloon-payment qualified mortgage VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 of December 31, 2012, which is the same as the requirement of § 1026.35(b)(2)(iii)(C) in the 2013 Escrows Final Rule. Criteria Creditor Also Must Satisfy in the Final Rule Adopted From the Board’s 2011 Escrows Proposal The Bureau notes that the three criteria discussed above are the same in both TILA 129C(b)(2)(E)(iv) and 129D(c). Commenters in both the Board’s 2011 ATR Proposal and the Board’s 2011 Escrows Proposal also made a note of the need to have consistent application of requirements and definitions across the Title XIV Rulemakings. The comments received in both of the Board’s proposals identified the same concerns and made similar suggestions for each of the criteria in both the Board’s 2011 ATR Proposal and 2011 Escrows Proposal. The Bureau believes the balloon-payment qualified mortgage exemption is designed to ensure access to credit in rural and underserved areas where consumers may be able to obtain credit only from a limited number of creditors. One way to ensure continued access to credit for these consumers is to reduce and streamline regulatory requirements for creditors so that creditors maintain participation in or enter these markets. One method by which this can be accomplished is by having one set of requirements that are consistent between differing regulatory purposes. These criteria, since they are identical in TILA, can be adopted once in one section of Regulation Z and referenced by the other section. Accordingly, the Bureau is adopting § 1026.43(f)(1)(vi) to require the creditor to meet the satisfy the requirements stated in § 1026.35(b)(iii)(A), (B), and (C), adopted in the 2013 Escrows Final Rule, in order to originate a balloonpayment qualified mortgage under § 1026.43(f)(1). Comment 43(f)(1)(vi)–1.i clarifies that the Bureau publishes annually a list of counties that qualify as rural or underserved in accordance with § 1026.35(b)(2)(iii)(A). The comment further clarifies that the Bureau’s annual determination of rural or underserved counties are based on the definitions set forth in § 1026.35(b)(2)(iv). Comment 43(f)(1)(vi)–1.ii clarifies that the creditor along with all affiliates must not originate more than 500 first lien exemption and the structure of the mortgage lending industry. The choice of $2 billion in assets as a threshold for purposes of TILA section 129C(b)(2)(E) does not imply that a threshold of that type or of that magnitude would be an appropriate way to distinguish small firms for other purposes or in other industries. PO 00000 Frm 00140 Fmt 4701 Sfmt 4700 transactions during the preceding calendar year in accordance with § 1026.35(b)(2)(iii)(B). Comment 43(f)(1)(vi)–1.iii clarifies that the initial asset-size threshold for a creditor is $2 billion for calendar year 2013 and will be updated each December to publish the applicable threshold for the following calendar year in accordance with§ 1026.35(b)(2)(iii)(C). The comment further clarifies that a creditor that had total assets below the threshold on December 31 of the preceding year satisfies this criterion for purposes of the exemption during the current calendar year. 43(f)(2) Post-Consummation Transfer of Balloon-Payment Qualified Mortgage As noted in the discussion related to paragraph (f)(1)(v) above, TILA section 129C(b)(E)(iv) requires that the lender keep balloon-payment mortgages in portfolio, which addressed in both the Board’s 2011 ATR Proposal and 2011 Escrows Proposal in different ways. In light of the differences between the two rulemakings and in particular the important ramifications of qualified mortgage status over the life of the loan, however, the Bureau believes that it is also appropriate for this final rule to contain additional safeguards concerning post-consummation sales that are not pursuant to a forward commitment in order to prevent gaming of the balloon-payment qualified mortgage exception. As noted above, the Board had proposed an approach under which the creditor would lose its eligibility to originate balloon-payment qualified mortgages once it sold any balloon-payment mortgages. Under one alternative, a single sale after the effective date of the rule would have permanently disqualified the creditor from invoking the exception, while the other alternative would have disqualified the creditor from invoking the exception for two calendar years. In addition to the comments received on the Board’s 2011 Escrows Proposal related to the forward commitment requirement discussed in paragraph (f)(1)(v), above, two trade group commenters and one industry commenter indicated that the second alternative was preferable, but urged the Bureau only to look at the last calendar year, instead of the current or prior years. Of these commenters, one trade group and the industry commenter suggested adding a de minimis number of permitted transfers of balloonpayment qualified mortgages. One trade group commenter noted that the statute requires that only balloon-payment qualified mortgages be kept in portfolio. Another trade group commenter E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations questioned the impact that either of the Board’s alternatives would have on a rural creditors’ ability to sell a balloonpayment mortgage if the creditor was directed to do pursuant to action requirements of prudential regulators, such as a prompt corrective action notice. The Bureau agrees with commenters that the first alternative would work against the stated purpose of the balloon-payment qualified mortgage exemption, as creditors that would not qualify would forever be excluded from this exemption in the future. Over time, this would further reduce the creditors originating balloon-payment qualified mortgages and thereby reduce the availability of credit to those markets. In addition, the Bureau believes the Board’s second alternative mitigates but does not eliminate these difficulties. Under the second alternative the disqualification from originating balloon-payment qualified mortgages would be temporary rather than permanent, but even so creditors who found it necessary to sell off a balloonpayment mortgage would pay a steep price in terms of their ability to originate loans in the future, and credit availability would be negatively impacted. Commenters that supported the second alternative did so with the stated preference for the second alternative to the first, instead of the requirements of the second alternative itself. The Bureau believes these concerns can be eliminated or reduced by providing, as a general rule, that if a balloon-payment qualified mortgage is sold, that mortgage loses its status as a qualified mortgage, but the creditor does not lose its ability to originate balloonpayment qualified mortgages in the future. The rule would be subject to four exceptions to permit a balloon-payment qualified mortgage to be sold in narrowly defined circumstances without losing its qualified mortgage status. The first exception would allow for a sale to any person three years after consummation; this would require the creditor to keep the balloon-payment qualified mortgage for the same period of time that a consumer could bring a claim for violation of § 1026.43 under TILA section 130(e). This facilitates managing interest rate risk by selling seasoned balloon-payment qualified mortgages, but encourages responsible underwriting because the originating creditor would keep all risk of affirmative claims while those claims could be asserted. The second exemption would permit creditors to sell to other qualifying creditors, which would provide flexibility and VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 consistency with the portfolio requirement. The third exception would address the need of creditors to sell loans to comply with requirements of prudential regulators, conservators, receivers and others who have the responsibility to ensure creditors are operating within the bounds of the law. The fourth exemption addresses changes in the ownership of the creditor itself, so that the balloon-payment qualified mortgages held by the creditor do not lose their qualified mortgage status solely because of the change in ownership of the creditor. Accordingly, the Bureau is adopting § 1026.43(f)(2) to require a creditor to retain a balloon-payment qualified mortgage in its portfolio, otherwise the balloon-payment qualified mortgage will no longer be a qualified mortgage, with four exceptions as set forth above. Comment 43(f)(2)–1 clarifies that creditors must generally hold a balloonpayment qualified mortgage in portfolio, subject to four exceptions. Comment 43(f)(2)–2 clarifies that the four exceptions apply to all subsequent transfers, and not just the initial transfer of the balloon-payment qualified mortgage, and provides an example. Comment 43(f)(2)(i)–1 clarifies the application of the exception relating to transfers of the balloon-payment qualified mortgage three years or more after consummation. Comment 43(f)(2)(ii)–1 clarifies the application of the exemption relating to the transfer of a balloon-payment qualified mortgage to a creditor that meets the requirements of § 1026.43(f)(1)(vi). Comment 43(f)(2)(iii)–1 clarifies the application of the exemption related to the transfer of a balloon-payment qualified mortgage pursuant to the requirements of a supervisory regulator and provides an example. Comment 43(f)(2)(iv)–1 clarifies the application of the exemption related to the transfer of a balloon-payment qualified mortgage as a result or the merger or sale of the creditor and provides an example. 43(g) Prepayment Penalties As discussed above regarding treatment of prepayment penalties under the points and fees test for qualified mortgages and for high-cost loans under HOEPA in § 1026.32(b)(1) and the definition of prepayment penalty under § 1026.32(b)(6), the DoddFrank Act restricts prepayment penalties in a number of ways. Section 1026.43(g) implements TILA section 129C(c), which establishes general limits on prepayment penalties for all residential mortgage loans. Specifically, TILA section 129C(c) provides that: PO 00000 Frm 00141 Fmt 4701 Sfmt 4700 6547 • Only a qualified mortgage may contain a prepayment penalty; • A qualified mortgage with a prepayment penalty may not have an adjustable rate and may not have an annual percentage rate that exceeds the threshold for a higher-priced mortgage loan; • The prepayment penalty may not exceed three percent of the outstanding balance during the first year after consummation, two percent during the second year after consummation, and one percent during the third year after consummation; • There can be no prepayment penalty after the end of the third year after consummation; and • A creditor may not offer a consumer a loan with a prepayment penalty without offering the consumer a loan that does not include a prepayment penalty. Taken together, the Dodd-Frank Act’s amendments to TILA relating to prepayment penalties mean that most closed-end, dwelling-secured transactions: (1) May provide for a prepayment penalty only if the transaction is a fixed-rate, qualified mortgage that is neither high-cost nor higher-priced under §§ 1026.32 and 1026.35; (2) may not, even if permitted to provide for a prepayment penalty, charge the penalty more than three years following consummation or in an amount that exceeds two percent of the amount prepaid; and (3) may be required to limit any penalty even further to comply with the points and fees limitations for qualified mortgages, or to stay below the points and fees trigger for high-cost mortgages. Section 1026.43(g) now reflects these principles. The Board proposal implemented TILA section 129C(c) in § 226.43(g) without significant alteration, except that under proposed § 226.43(g)(2)(ii), the Board proposed to apply the percentage tests outlined in the statute to the amount of the outstanding loan balance prepaid, rather than to the entire outstanding loan balance, to provide tighter restrictions on the penalties allowed on partial prepayments. Commenters generally supported the Board’s proposal, though some industry commenters expressed concern that limitations on prepayment penalties would reduce prices on the sale of mortgages in the secondary market due to increased prepayment risk. Consumer advocates generally supported limiting prepayment penalties, as described by amended TILA section 129C(c), as an important element in ensuring affordability. Other industry commenters expressed concern that E:\FR\FM\30JAR2.SGM 30JAR2 6548 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with such a limitation on the imposition of prepayment penalties would lead to fewer creditors conditionally waiving closing costs, noting that this implication might limit access to credit. At least one industry commenter argued that the Board’s proposal to limit prepayment penalties was too broad in scope, stating the legislative history demonstrated that the true target of the prepayment penalty prohibition of TILA section 129C(c) was limited to mortgages with teaser rates and/or balloon payments and to protect subprime consumers, not those consumers who chose a product with a lower interest rate in exchange for a prepayment penalty provision. The Bureau does not find this argument persuasive, given the plain language of amended TILA section 129C(c). After review, the Bureau is adopting most of the Board’s proposal, although as discussed below the Bureau is altering the prepayment limitation in the first year after consummation to reflect the separate limitations enacted in sections 1431 and 1432 of the DoddFrank Act, regarding high-cost mortgages. Scope; Reverse Mortgages and Temporary Loans Section 1026.43(g) implements TILA section 129C(c), which applies to a ‘‘residential mortgage loan,’’ that is, to a consumer credit transaction secured by a dwelling, including any real property attached to the dwelling, other than an open-end credit plan or a transaction secured by a consumer’s interest in a timeshare plan. See TILA section 103(cc)(5). Consequently, the regulation refers to ‘‘covered transaction,’’ which as defined in § 1026.43(b)(1) and discussed further in the section-bysection analysis of § 1026.43(a) excludes open-end credit plans and transactions secured by timeshares from coverage consistent with statutory exclusions. However, neither the definition of ‘‘residential mortgage loan’’ nor the TILA section 129C(c)(1) prepayment penalty prohibition excludes reverse mortgages or temporary or ‘‘bridge’’ loans with a term of 12 months or less, such as a loan to finance the purchase of a new dwelling where the consumer plans to sell a current dwelling. See TILA sections 103(cc)(5), 129C(a)(8), 129C(c). Moreover, because under TILA section 129C(c)(1)(A), only a qualified mortgage may have a prepayment penalty and reverse mortgages and temporary loans are excluded from the ability-to-repay and qualified mortgage requirements of the Dodd-Frank Act (and thus may not be qualified mortgages), prepayment penalties would VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 not be permitted on either product absent further accommodation. The Board proposal sought comment on whether further provisions addressing the treatment of reverse mortgages were warranted. Because reverse mortgages are not subject to the ability-to-repay requirements, the Board did not propose to define a category of closed-end reverse mortgages as qualified mortgages, though it sought comment on the possibility of using its authority to do so, given that qualified mortgage status affects both application of the Dodd-Frank Act prepayment penalty provisions and certain provisions concerning securitization and ‘‘qualified residential mortgages.’’ See TILA section 129C(b)(2)(A)(ix) and (b)(3)(B).164 The Board specifically requested comment on whether special rules should be created to permit certain reverse mortgages to have prepayment penalties. In particular, the Board sought comment on how it might create criteria for a ‘‘qualified mortgage’’ reverse mortgage that would be consistent with the purposes of qualified mortgages under TILA section 129C(b), and requested any supporting data on the prepayment rates for reverse mortgages. Consumer advocates generally supported the Board’s proposal to apply the prepayment penalty requirements to reverse mortgages, and industry commenters did not object. Moreover, commenters did not provide data or other advocacy to refute the Board’s reasoning for including reverse mortgages within the scope of § 1026.43(g): (1) That the overwhelming majority of reverse mortgages being originated in the current market are insured by the FHA, which does not allow reverse mortgages to contain prepayment penalties; and (2) excluding ‘‘qualified’’ reverse mortgages from coverage of the prepayment penalty prohibition would not be necessary or appropriate to effectuate the purposes of TILA section 129C, absent an articulated reason why such exclusion would ‘‘assure that consumers are offered and receive residential mortgage loans on terms that reasonably affect their ability to repay the loans and that are understandable and not unfair, deceptive, or abusive.’’ See TILA section 129B(a)(2). While the Board did not specifically seek comment with respect to whether further provisions addressing the treatment of bridge loans under 164 Open-end credit plans are excluded from the definition of ‘‘residential mortgage loan,’’ and thus open-end reverse mortgages are not subject to the prepayment penalty requirements under TILA section 129C(c). TILA section 103(cc)(5). PO 00000 Frm 00142 Fmt 4701 Sfmt 4700 § 1026.43(g) were warranted, commenters nevertheless discussed the intersection of bridge loans and prepayment penalties. As discussed in the section-by-section analysis of § 1026.32(b)(6), some industry commenters expressed concern that the availability of, or cost of, constructionto-permanent loans might suffer, should the rule restrict the permissible prepayment penalty charges levied by a creditor if a consumer does not convert the construction loan into a permanent loan with the same creditor within a specified time period. As discussed in the section-by-section analysis of § 1026.32(b)(6), some commenters may have been mistaken with respect to whether certain fees were, in fact, a prepayment penalty. To the extent fees charged by a bridge loan are a prepayment penalty, however, they are prohibited as of the effective date. According to § 1026.43(a)(3)(iii), the construction phase of a construction-topermanent loan cannot be a qualified mortgage, and thus under § 1026.43(g)(1)(ii)(B) such a loan cannot include a prepayment penalty. Construction-to-permanent loans are discussed in more detail in the sectionby-section analysis of § 1026.43(a). Accordingly, the Bureau is finalizing the rule at this time without special provisions to otherwise alter the general scope of this rule, as discussed in the section-by-section analysis of § 1026.43(a), such as by allowing the application of prepayment penalties for either reverse mortgages or temporary loans. The Bureau may revisit the issue in subsequent years, either as part of a future rulemaking to evaluate application of all title XIV requirements to reverse mortgages or as part of the five-year review of significant rules required under section 1022(d) of the Dodd-Frank Act. 43(g)(1) When Permitted TILA section 129C(c)(1)(A) provides that a covered transaction must not include a penalty for paying all or part of the principal balance before it is due unless the transaction is a qualified mortgage as defined in TILA section 129C(b)(2). TILA section 129C(c)(1)(B) further restricts the range of qualified mortgages on which prepayment penalties are permitted by excluding qualified mortgages that have an adjustable rate or that meet the thresholds for ‘‘higher-priced mortgage loans’’ because their APRs exceed the average prime offer rate for a E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with comparable transaction by a specified number of percentage points.165 To implement TILA section 129C(c)(1), the Board proposed § 226.43(g)(1), which provided that a covered transaction may not include a prepayment penalty unless the prepayment penalty is otherwise permitted by law, and the transaction: (1) Has an APR that cannot increase after consummation; (2) is a qualified mortgage, as defined in § 226.43(e) or (f); and (3) is not a higher-priced mortgage loan, as defined in § 226.45(a). The Board proposed under § 226.43(g)(1)(i) that a prepayment penalty must be otherwise permitted by applicable law. The Board reasoned that TILA section 129C(c) limits, but does not specifically authorize, including a prepayment penalty with a covered transaction. Thus, TILA section 129C(c) does not override other applicable laws, such as State laws, that may be more restrictive with respect to prepayment penalties, so a prepayment penalty would not be permitted if otherwise prohibited by applicable law. This approach is consistent with prepayment penalty requirements for high-cost mortgages under § 1026.32(d)(7)(i) and higherpriced mortgage loans under § 1026.35(b)(2)(i). The Board proposed § 226.43(g)(1)(ii)(A) to interpret the statutory language to apply to covered transactions for which the APR may increase after consummation. This regulatory language is consistent with other uses of ‘‘variable-rate’’ within Regulation Z, such as comment 17(c)(1)–11, which provides examples of variable-rate transactions. Some consumer advocates did not support the Board’s proposal, arguing that for certain mortgages (specifically step-rate mortgages) the interest rate can increase after consummation without affecting the APR. These commenters argued that the purpose of TILA section 129C(c)(1)(B)(i) is to avoid allowing a creditor to lock a consumer into a risingcost mortgage via a prepayment penalty and a rising interest rate. Consumer groups expressed concern that a consumer might become ‘‘trapped’’ by a prepayment penalty on the one hand, 165 The applicable APR threshold depends on whether a first lien or subordinate lien secures the transaction and whether or not the transaction’s original principal obligation exceeds the maximum principal obligation for a loan eligible for purchase by Freddie Mac, that is, whether or not the covered transaction is a ‘‘jumbo’’ loan. Specifically, the APR threshold is: (1) 1.5 percentage points above the average prime offer rate, for a first-lien, non‘‘jumbo’’ loan; (2) 2.5 percentage points above the average prime offer rate, for a first-lien ‘‘jumbo’’ loan; and (3) 3.5 percentage points above the average prime offer rate, for a subordinate-lien loan. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 and a rising interest rate on the other. The Bureau does not find this argument persuasive. TILA section 129C(1)(B)(i) prohibits a transaction with ‘‘an adjustable rate’’ from including a prepayment penalty. Longstanding rules under Regulation Z for closed-end transactions generally categorize transactions based on the possibility of APR changes, rather than interest rate changes.166 This distinction is relevant because covered transactions may have an APR that cannot increase after consummation even though a specific interest rate, or payments, may increase after consummation. For example, the APR for a ‘‘step-rate mortgage’’ without a variable-rate feature does not change after consummation, because the rates that will apply and the periods for which they will apply are known at consummation. See § 1026.18(s)(7)(ii) (defining ‘‘step-rate mortgage’’ for purposes of transaction-specific interest rate and payment disclosures). Thus, the danger of an interest rate/prepayment penalty ‘‘trap’’ is mitigated in a step-rate loan because the consumer knowledge of the exact payments to expect each month for the 36 months following consummation during which a prepayment penalty might apply. The Bureau therefore is adopting § 1026.43(g)(1)(ii)(A) as proposed. A fixed-rate mortgage or a step-rate mortgage therefore may have a prepayment penalty, but an adjustablerate mortgage may not have a prepayment penalty. See § 1026.18(s)(7)(i) through (iii) (defining ‘‘fixed-rate mortgage,’’ ‘‘step-rate mortgage,’’ and ‘‘adjustable-rate mortgage’’). Balloon-Payment Mortgages Under TILA section 129C(c)(1)(A), a covered transaction may not include a prepayment penalty unless the transaction is a qualified mortgage under TILA section 129C(b)(2). The Board proposed to implement TILA section 129C(c)(1)(A) in § 226.43(g)(1)(ii)(B) and noted that, under section 129C(b)(2)(e), a covered transaction with a balloon payment may be a qualified mortgage if the creditor originates covered transactions primarily in ‘‘rural’’ or ‘‘underserved’’ areas, as discussed in detail above in the section-by-section analysis of § 1026.43(f); thus, a consumer could face a prepayment penalty if the 166 See, e.g., § 1026.18(f) (requiring disclosures regarding APR increases), § 1026.18(s)(7)(i) through (iii) (categorizing disclosures for purposes of interest rate and payment disclosures), § 1026.36(e)(2)(i) and (ii) (categorizing transactions for purposes of the safe harbor for the anti-steering requirement under § 1026.36(e)(1)). PO 00000 Frm 00143 Fmt 4701 Sfmt 4700 6549 consumer attempts to refinance out of a balloon-payment qualified mortgage before the balloon payment is due. The Board solicited comment on whether it would be appropriate to use its legal authority under TILA sections 105(a) and 129B(e) to provide that a balloonpayment qualified mortgage may not have a prepayment penalty in any case. Most commenters generally supported the Board’s decision not to extend the prepayment penalty ban to all balloonpayment loans, noting the need for such financial products in rural and underserved areas. In light of the access concerns, the Bureau declines to exercise its exception authority under TILA sections 105(a) and 129B(e) to add a blanket prohibition of prepayment penalties for all balloon-payment loans. Accordingly, the Bureau is adopting § 1026.43(g)(1)(ii)(B) as proposed. The Bureau will continue to monitor the use of balloon-payment qualified mortgages and their use of prepayment penalties. Threshold for a Higher-Priced Mortgage Loan Under TILA section 129C(c)(1)(B), a covered transaction may not include a prepayment penalty unless the transaction’s APR is below the specified threshold for ‘‘higher-priced mortgage loans.’’ As discussed above, those thresholds are determined by reference to the applicable average prime offer rate. The Board proposed under § 226.43(g)(1)(ii)(C) that a creditor would determine whether a transaction is a higher-priced mortgage loan based on the transaction coverage rate rather than the APR, for purposes of the prepayment penalty restriction, because APRs are based on a broader set of charges, including some third-party charges such as mortgage insurance premiums, than average prime offer rates. The Board expressed a concern that using the APR metric posed a risk of over-inclusive coverage beyond the subprime market and instead proposed using the transaction coverage rate. In August 2012, the Bureau extended the notice-and-comment period for comments relating to the proposed adoption of the more inclusive finance charge, including the transaction coverage rate. At that time, the Bureau noted that it would not be finalizing the more inclusive finance charge in January 2013. See 77 FR 54843 (Sept. 6, 2012). The Bureau therefore does not address in this rulemaking the numerous public comments that it received concerning the proposed alternatives for the APR coverage test. The Bureau instead will address such comments in connection with its finalization of the 2012 TILA–RESPA E:\FR\FM\30JAR2.SGM 30JAR2 6550 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with Integration Proposal, thus resolving that issue together with the Bureau’s determination whether to adopt the more inclusive finance charge. The Bureau is thus adopting the definition of a higher-priced loan as defined in § 1026.35(a), which corresponds to the thresholds specified in TILA section 129C(1)(B)(ii). 43(g)(2) Limits on Prepayment Penalties TILA section 129C(c)(3) provides that a prepayment penalty may not be imposed more than three years after the covered transaction is consummated and limits the maximum amount of the prepayment penalty. Specifically, TILA section 129C(c)(3) limits the prepayment penalty to (1) three percent of the outstanding principal balance during the first year following consummation; (2) two percent during the second year following consummation; and (3) one percent during the third year following consummation. The Board’s proposed § 226.43(g)(2) was substantially similar to TILA section 129C(c)(3) except that the Board proposed to determine the maximum penalty amount by applying the percentages established in the statute to the amount of the outstanding loan balance prepaid, rather than to the entire outstanding loan balance. The Board reasoned that calculating the maximum prepayment penalty based on the amount of the outstanding loan balance that is prepaid, rather than the entire outstanding loan balance, would effectuate the purposes of TILA section 129C(c) to facilitate partial (and full) prepayment by more strictly limiting the amounts of prepayment penalties imposed. The Board noted in its proposal that under HOEPA as amended by the DoddFrank Act, TILA section 103(bb)(1)(A)(iii) now defines a ‘‘highcost mortgage’’ as any loan secured by the consumer’s principal dwelling in which the creditor may charge prepayment fees or penalties more than 36 months after the closing of the transaction, or in which the fees or penalties exceed, in the aggregate, more than two percent of the amount prepaid. Moreover, under amended TILA section 129(c)(1), high-cost mortgages are prohibited from having prepayment penalties. Accordingly, any prepayment penalty in excess of two percent of the amount prepaid on any closed-end mortgage would both trigger and violate HOEPA’s high-cost mortgage protections. The Board did not propose to implement these limitations on prepayment penalties in § 226.43(g)(2), but did solicit comment on whether the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 proposed text should be modified to incorporate the limitation of prepayment penalty amounts to two percent of the amount prepaid, as provided under TILA sections 103(bb)(1)(A)(iii) and 129(c)(1). The Board also solicited comment on whether to adopt some other threshold to account for the limitations on points and fees, including prepayment penalties, to satisfy the requirements for ‘‘qualified mortgages,’’ under TILA section 129C(b)(2)(A)(vii) and proposed § 226.43(e)(2)(iii). The Bureau did not receive significant comment on the proposed adjustment of determining the maximum penalty amount by applying the percentages established in the statute to the amount of the outstanding loan balance prepaid, rather than to the entire outstanding loan balance, and therefore is adopting § 1026.43(g)(2) to measure prepayment penalties using the outstanding loan balance prepaid, as proposed. The Bureau is making this adjustment pursuant to its authority under TILA section 105(a) to issue regulations with such requirements, classifications, differentiations, or other provisions, and that provide for such adjustments and exceptions for all or any class of transactions, as in the judgment of the Bureau are necessary and proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith. For instance, the Bureau believes that it would be inconsistent with congressional intent to strong disfavor and limit prepayment penalties for the Bureau to allow creditors to charge one or two percent of the entire outstanding loan balance every time that a consumer pays even a slightly greater amount than the required monthly payment due. The Bureau did not receive significant comment on how to resolve the differing prepayment thresholds for high-cost mortgages and qualified mortgages, as described by the Board. But the Bureau believes that it is imperative to provide clear guidance to creditors with respect to all new limitations on prepayment penalties in dwelling-secured credit transactions, as imposed by the DoddFrank Act. As noted by the Board, new TILA section 129C(c)(3) limits prepayment penalties for fixed-rate, non-higher-priced qualified mortgages to three percent, two percent, and one percent of the outstanding loan balance prepaid during the first, second, and third years following consummation, respectively. However, amended TILA sections 103(bb)(1)(A)(iii) and 129(c)(1) for high-cost mortgages effectively prohibit prepayment penalties in excess PO 00000 Frm 00144 Fmt 4701 Sfmt 4700 of two percent of the amount prepaid at any time following consummation for most credit transactions secured by a consumer’s principal dwelling by providing that HOEPA protections (including a ban on prepayment penalties) apply to mortgage loans with prepayment penalties that exceed two percent of the outstanding loan balance prepaid. The Bureau concludes that, to comply with both the high-cost mortgage provisions and the qualified mortgage provisions, creditors originating most closed-end mortgage loans secured by a consumer’s principal dwelling would need to limit the prepayment penalty on the transaction to: (1) No more than two percent of the amount prepaid during the first and second years following consummation, (2) no more than one percent of the amount prepaid during the third year following consummation, and (3) zero thereafter. Accordingly, the Bureau is modifying the final rule to reflect the two percent cap imposed by the Dodd-Frank Act amendments to HOEPA. As adopted in final form, § 1026.43(g)(2) amends the maximum prepayment penalty threshold for qualified mortgages during the first year following consummation, specified as three percent in TILA section 129C(c), to two percent, to reflect the interaction of the qualified mortgage and HOEPA revisions. In addition to finalizing this provision as a matter of reasonable interpretation of how the statutory provisions work together, the Bureau is making this adjustment pursuant to its authority under TILA section 105(a) to issue regulations with such requirements, classifications, differentiations, or other provisions, and that provide for such adjustments and exceptions for all or any class of transactions, as in the judgment of the Bureau are necessary and proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith. The Bureau is exercising this adjustment to prevent creditor uncertainty regarding the interaction of qualified mortgages and high-cost mortgage rules, thus facilitating compliance. For example, assume a creditor issues a loan that meets the specifications of a § 1026.43(e) qualified mortgage. The loan terms specify that this creditor may charge up to three percent of any prepaid amount in the year following consummation. If the Bureau implements TILA section 129C(c) and sections 103(bb)(1)(A)(iii) and 129(c)(1) for high-cost mortgages, which effectively prohibit prepayment E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with penalties in excess of two percent of the amount prepaid at any time following consummation, then the creditor will have complied with certain provisions of TILA while violating others. Thus, to avoid this complex interaction, the Bureau is eliminating the possibility of simultaneous compliance with and violation of TILA by reducing the maximum prepayment penalty allowed in the year following consummation to two percent under § 1026.43(g)(2)(ii)(A). Comment 43(g)(2)–1 clarifies that a covered transaction may include a prepayment penalty that may be imposed only during a shorter period or in a lower amount than provided in § 1026.43(g)(2). Comment 43(g)(2)–1 provides the example of a prepayment penalty that a creditor may impose for two years after consummation that is limited to one percent of the amount prepaid. The Bureau is changing the prepayment example in comment 43(g)(2)–1 to reflect the Bureau’s adjustment in § 1026.43(g)(2)(ii)(A) of the maximum prepayment penalty in the first year after consummation from three percent to two percent. The Bureau recognizes that TILA section 129C(b)(2)(A)(vii) indirectly limits the amount of a prepayment penalty for a qualified mortgage, by limiting the maximum ‘‘points and fees’’ for a qualified mortgage to three percent of the total loan amount. See § 1026.43(e)(2)(iii), discussed above. The definition of ‘‘points and fees’’ includes the maximum prepayment penalty that may be charged, as well as any prepayment penalty incurred by the consumer if the loan refinances a previous loan made or currently held by the same creditor or an affiliate of the creditor. See TILA section 103(bb)(4)(E), § 1026.32(b)(1), and accompanying section-by-section analysis. Thus, if a creditor wants to include the maximum two percent prepayment penalty as a term of a qualified mortgage, it generally would have to forego any other charges that are included in the definition of points and fees. See the section-bysection analysis of § 1026.32(b)(1). 43(g)(3) Alternative Offer Required Under TILA section 129C(c)(4), if a creditor offers a consumer a covered transaction with a prepayment penalty, the creditor also must offer the consumer a covered transaction without a prepayment penalty. The Board proposed § 226.43(g)(3), which contained language to implement TILA section 129C(c)(4) and added provisions to ensure comparability between the two alternative offers. Specifically, the proposed rule would mandate that the alternative covered transaction without VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 a prepayment penalty must: (1) Have an APR that cannot increase after consummation and the same type of interest rate as the covered transaction with a prepayment penalty (that is, both must be fixed-rate mortgages or both must be step-rate mortgages); (2) have the same loan term as the covered transaction with a prepayment penalty; (3) satisfy the periodic payment conditions for qualified mortgages; and (4) satisfy the points and fees conditions for qualified mortgages. Proposed § 226.43(g)(3) also provided that the alternative covered transaction must be a transaction for which the consumer likely qualifies. The Bureau did not receive significant comment on the proposal and is adopting § 1026.43(g)(3) as proposed. The Bureau is adding the additional conditions proposed by the Board to those specified in TILA section 129C(c)(4) to ensure that the alternative covered transactions is a realistic alternative for the consumer: A loan under substantially similar terms as the loan with a prepayment penalty for which the consumer likely qualifies. The Bureau is including these additional requirements pursuant to the Bureau’s authority under TILA section 105(a) to prescribe regulations that contain such additional requirements, classifications, differentiations, or other provisions, or provide for such adjustments or exceptions for all or any class of transactions, as in the judgment of the Bureau are necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith. The Bureau believes that requirements designed to ensure that the alternative covered transactions effectuate the purposes of TILA section 129C(c)(4) by enabling the consumer to focus on a prepayment penalty’s risks and benefits without having to consider or evaluate other differences between the alternative covered transactions. For example, under final § 1026.43(g)(3), a consumer is able to compare a fixed-rate mortgage with a prepayment penalty with a fixed-rate mortgage without a prepayment penalty, rather than with a step-rate mortgage without a prepayment penalty. Also, the Bureau believes requiring that the alternative covered transaction without a prepayment penalty be one for which the consumer likely qualifies effectuates the purposes of and prevents circumvention of TILA section 129C(c)(4), by providing for consumers to be able to choose between options that likely are available. PO 00000 Frm 00145 Fmt 4701 Sfmt 4700 6551 Under § 1026.43(g)(1)(i), a covered transaction with an APR that may increase after consummation may not have a prepayment penalty. The Board proposed in § 226.43(g)(3)(i) that, if a creditor offers a covered transaction with a prepayment penalty, the creditor must offer an alternative covered transaction without a prepayment penalty and with an APR that may not increase after consummation. The Board also proposed that the covered transaction with a prepayment penalty and the alternative covered transaction without a prepayment penalty must have the same type of interest rate. The Board offered these proposals to ensure that a consumer is able to choose between substantially similar alternative transactions. The Bureau did not receive significant comment on the proposal and is adopting the Board’s proposal regarding the APR and the type of interest rate for the alternative transaction. Higher-priced mortgage loans. The Board proposed that, under § 226.43(g)(3), if a creditor offers a covered transaction with a prepayment penalty, which may not be a higherpriced mortgage loan, the creditor may offer the consumer an alternative covered transaction without a prepayment penalty that is a higherpriced mortgage loan. The Board reasoned that TILA section 129C(c)(4) is intended to ensure that a consumer has a choice whether to obtain a covered transaction with a prepayment penalty, not to limit the pricing of the alternative covered transaction without a prepayment penalty that the creditor must offer. In fact, all things being equal, one would expect a creditor to cover the increased risk of prepayment by increasing the rate, thereby increasing the likelihood that the transaction might be a higher-priced mortgage loan. Furthermore, the Board noted that restricting the pricing of the required alternative covered transaction without a prepayment penalty might result in some creditors choosing to offer fewer loans. The Board thus did not propose to limit rate increases for the alternative covered transaction. The Bureau did not receive significant comment on this aspect of the proposal and is adopting the rule as proposed. Timing of offer. The Board proposal concerning the alternative offer without a prepayment penalty that a creditor is required to offer under TILA section 129C(c)(4) did not specify that the creditor makes this alternative offer at or by a particular time. The Board proposal was consistent with § 1026.36(e)(2) and (3), which provide a safe harbor for the anti-steering requirement if a loan E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6552 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations originator presents certain loan options to the consumer. These rules also do not contain a timing requirement. The Board solicited comment on whether it would be appropriate to require that creditors offer the alternative covered transaction without a prepayment penalty during a specified time period, such as before the consumer pays a nonrefundable fee or at least fifteen calendar days before consummation. The Board also solicited comment on whether, if a timing requirement were included for the required alternative offer, whether a timing requirement should also be included under the safe harbor for the anti-steering requirement, for consistency. The Bureau did not receive significant comment on the proposal and is not including a specific timing requirement. The Bureau will continue to study required alternative offers to ensure that creditors offer consumers a meaningful alternative transaction that does not contain a prepayment penalty, in accordance with the purposes of TILA section 129C(c)(4). In the course of its review, if the Bureau determines that more specific timing requirements would provide more consumer choice, the Bureau may propose to revise § 1026.43(g)(3) accordingly. The Board proposed comment 43(g)(3)(i)–1 to clarify that the covered transaction with a prepayment penalty and the alternative covered transaction without a prepayment penalty both must be either fixed-rate mortgages or step-rate mortgages. The Bureau did not receive significant comment on the proposal and is adopting the comment with some revisions for clarification only. For purposes of § 1026.43(g)(3)(i), the term ‘‘type of interest rate’’ means whether the covered transaction is a fixed-rate mortgage, as defined in § 1026.18(s)(7)(iii), or a step-rate mortgage, as defined in § 1026.18(s)(7)(ii). Substance of offer. As discussed above, § 1026.43(g)(1)(ii)(B) provides that a covered transaction with a prepayment penalty must be a qualified mortgage, as defined in § 1026.43(e)(2), (e)(4), or (f). The Board proposal concerning the alternative offer without a prepayment penalty that a creditor is required to offer under TILA section 129C(c)(4) did not mandate that the alternative covered transaction offered without a prepayment penalty must also be a qualified mortgage. But under proposed § 226.43(g)(3)(ii) through (iv), the Board proposed to incorporate three conditions of qualified mortgages on the alternative offer, so that consumers may choose between alternative covered transactions that are substantially VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 similar. Accordingly, the Board proposed that the alternative covered transaction without a prepayment penalty must: (1) Have the same loan term as the covered transaction with a prepayment penalty; (2) satisfy the periodic payment conditions in § 1026.43(e)(2)(i); and (3) satisfy the points and fees condition under § 1026.43(e)(2)(iii), based on the information known to the creditor at the time the transaction is offered. The Bureau did not receive significant comment on the proposal and is adopting the Board’s proposal. The Bureau is including this provision both as part of its interpretation of TILA section 129C(c)(4) and using its authority under TILA sections 105(a), which provides that the Bureau’s regulations may contain such additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions as in the Bureau’s judgment are necessary or proper to effectuate the purposes of TILA, prevent circumvention or evasion thereof, or facilitate compliance therewith. 15 U.S.C. 1604(a), 1639b(e). This approach is further supported by the authority under TILA section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Bureau finds necessary and proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes and to effectuate the purposes of section 129B and 129C, and that are in the interest of the consumer, among other things. 15 U.S.C. 1639b(e). The purposes of TILA include the purposes that apply to 129B and 129C, to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loan. See 15 U.S.C. 1639b(a)(2). The Bureau believes that requiring the creditor that offers the consumer a loan with a prepayment penalty to also offer the consumer the ability to choose an alternative covered transaction that is otherwise substantially similar, besides not including a prepayment penalty, is necessary and proper to fulfill such purposes by ensuring that the consumer is offered a reasonable alternative product that the consumer can repay and which does not include a prepayment penalty. For this reason, this provision is also in the interest of the consumer. The Board proposed comment 43(g)(3)(iv)–1 to provide guidance for cases where a creditor offers a consumer PO 00000 Frm 00146 Fmt 4701 Sfmt 4700 an alternative covered transaction without a prepayment penalty under § 1026.43(g)(3) and knows only some of the points and fees that will be charged for the loan. For example, a creditor may not know that a consumer intends to buy single-premium credit unemployment insurance, which would be included in the points and fees for the covered transaction. Proposed comment 43(g)(3)(iv)–1 clarified that the points and fees condition is satisfied if the creditor reasonably believes, based on the information known to the creditor at the time the offer is made, that the amount of points and fees to be charged for an alternative covered transaction without a prepayment penalty will be less than or equal to the amount of points and fees allowed for a qualified mortgage under § 1026.43(e)(2)(iii). The Bureau did not receive significant comment on the proposal and is adopting the comment largely as proposed. The Board proposed comment 43(g)(3)(v)–1 to clarify what is meant by an alternative transaction for which the consumer likely qualifies. In this example, the creditor has a good faith belief the consumer can afford monthly payments of up to $800. If the creditor offers the consumer a fixed-rate mortgage with a prepayment penalty for which monthly payments are $700 and an alternative covered transaction without a prepayment penalty for which monthly payments are $900, the requirements of § 1026.43(g)(3)(v) are not met. Proposed comment 43(g)(3)(v)– 1 also clarified that, in making the determination the consumer likely qualifies for the alternative covered transaction, the creditor may rely on information provided by the consumer, even if the information subsequently is determined to be inaccurate. The Bureau did not receive significant comment on the proposal and is adopting the Board’s comment as proposed. Comment 43(g)(3)(v)–1 is substantially similar to comment 36(e)(3)–4, which provides clarification under the rules providing a safe harbor for the anti-steering requirements if, among other things, a loan originator presents the consumer with loan options for which the consumer likely qualifies.167 In addition to agreeing with 167 Section 1026.36(e) generally prohibits, in a consumer credit transaction, a loan originator from ‘‘steering’’ a consumer to consummate a transaction based on the fact that the originator will receive greater compensation from the creditor in that transaction than in other transactions the originator offered or could have offered to the consumer, unless the consummated transaction is in the consumer’s interest. Section 1026.36(e)(3) explains that there is a safe harbor for this anti-steering requirement when the loan originator presents the E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations the Board’s reasoning, the Bureau is adopting this rule and comment to promote consistency and further the Bureau’s initiative to provide streamlined regulatory guidance. sroberts on DSK5SPTVN1PROD with 43(g)(4) Offer Through a Mortgage Broker The requirement to offer an alternative covered transaction without a prepayment penalty applies to a ‘‘creditor.’’ See TILA section 129C(c)(4). TILA section 103(f), in relevant part, defines ‘‘creditor’’ to mean a person who both: (1) Regularly extends consumer credit which is payable by agreement in more than four installments or for which the payment of a finance charge is or may be required, and (2) is the person to whom the debt arising from the consumer credit transaction is initially payable on the face of the evidence of indebtedness (or, if there is no such evidence of indebtedness, by agreement). 15 U.S.C. 1602(f). The Board proposed § 226.43(g)(4), which would apply when a creditor offers a covered transaction with a prepayment penalty through a mortgage broker, as defined in § 1026.36(a)(2), to account for operational differences in offering a covered transaction through the wholesale channel versus through the retail channel.168 The Board proposed under § 226.43(g)(4) that, if a creditor offers a covered transaction to a consumer through a mortgage broker, as defined in § 1026.36(a)(2), the creditor must present to the mortgage broker an alternative covered transaction without a prepayment penalty that meets the conditions in § 1026.43(g)(3). The Board reasoned that the requirement to offer an alternative covered transaction without a prepayment penalty properly is applied to creditors and not to mortgage brokers, because creditors ‘‘offer’’ covered transactions, even if mortgage brokers present those offers to consumers. Further, the Board noted that, if Congress had intended to apply TILA section 129C(c)(4) to mortgage brokers, Congress would have explicitly applied that provision to ‘‘mortgage originators’’ in addition to creditors.169 The Board’s consumer with: (1) The loan option with the lowest interest rate overall, (2) the loan option with the lowest interest rate without certain risky features, including a prepayment penalty, and (3) the loan option with the lowest total origination points or fees and discount points. See § 1026.36(e)(3)(i). 168 For ease of discussion, the terms ‘‘mortgage broker’’ and ‘‘loan originator’’ as used in this discussion have the same meaning as under the Bureau’s requirements for loan originator compensation. See § 1026.36(a)(1), (2). 169 TILA section 103(cc), as added by section 1401 of the Dodd-Frank Act, defines ‘‘mortgage VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 proposal also provided under proposed § 226.43(g)(4)(ii) that the creditor must establish, by agreement, that the mortgage broker must present the consumer an alternative covered transaction without a prepayment penalty that meets the conditions in § 1026.43(g)(3) offered by (1) the creditor, or (2) another creditor, if the transaction has a lower interest rate or a lower total dollar amount of origination points or fees and discount points. The Bureau did not receive significant comment on proposed § 226.43(g)(4) and is adopting § 1026.43(g)(4) largely as proposed. By providing for the presentation of a loan option with a lower interest rate or a lower total dollar amount of origination points or fees and discount points than the loan option offered by the creditor, § 1026.43(g)(4) facilitates compliance with § 1026.43(g)(3) and with the safe harbor for the anti-steering requirement in connection with a single covered transaction, as governed by § 1026.36(e)(3)(i). Section 1026.43(g)(4) does not affect the conditions that a loan originator must meet to take advantage of the safe harbor for the anti-steering requirement, however. Thus, if a loan originator chooses to use the safe harbor, the originator must present the consumer with: (1) The loan option with the lowest interest rate overall, (2) the loan option with the lowest interest rate without certain risky features, including a prepayment penalty, and (3) the loan option with the lowest total origination points or fees and discount points. See § 1026.36(e)(3)(i). The Bureau believes that requiring a mortgage broker to present to a consumer the creditor’s alternative covered transaction without a prepayment penalty could confuse the consumer if he or she is presented with numerous other loan options under § 1026.36(e). Presenting a consumer with four or more loan options for each type of transaction in which the consumer expresses an interest may not help the consumer to make a meaningful choice. When compared with other loan options a mortgage broker presents to a consumer, a creditor’s covered transaction without a prepayment penalty might not have the lowest interest rate (among transactions originator’’ to mean any person who, for direct or indirect compensation or gain, or in the expectation of direct or indirect compensation or gain, takes a residential mortgage loan application, assists a consumer in obtaining or applying to obtain a residential mortgage loan, or offers or negotiates terms of a residential mortgage loan. 15 U.S.C. 1602(cc). The term ‘‘mortgage originator’’ is used, for example, for purposes of the anti-steering requirement added to TILA by section 1403 of the Dodd-Frank Act. See TILA section 129B(c). PO 00000 Frm 00147 Fmt 4701 Sfmt 4700 6553 either with or without risky features, such as a prepayment penalty) or the lowest total dollar amount of origination points or fees and discount points, and thus might not be among the loan options most important for consumers to evaluate. Also, the creditor may have operational difficulties in confirming whether or not a mortgage broker has presented to the consumer the alternative covered transaction without a prepayment penalty. The Board proposed comment 43(g)(4)–1 to clarify that the creditor may satisfy the requirement to present the mortgage broker such alternative covered transaction without a prepayment penalty by providing the mortgage broker a rate sheet that states the terms of such an alternative covered transaction without a prepayment penalty. The Board proposed comment 43(g)(4)–2 to clarify that the creditor’s agreement with the mortgage broker may provide for the mortgage broker to present both the creditor’s covered transaction and a covered transaction offered by another creditor with a lower interest rate or a lower total dollar amount of origination points or fees and discount points. Comment 43(g)(4)–2 also cross-references comment 36(e)(3)– 3 for guidance in determining which step-rate mortgage has a lower interest rate. The Board proposed comment 43(g)(4)–3 to clarify that a creditor’s agreement with a mortgage broker for purposes of § 1026.43(g)(4) may be part of another agreement with the mortgage broker, for example, a compensation agreement. The comment clarifies that the creditor thus need not enter into a separate agreement with the mortgage broker with respect to each covered transaction with a prepayment penalty. The Bureau did not receive significant comment on proposed comments 43(g)(4)–1 through –3 and is adopting these comments largely as proposed. Provisions Not Adopted As explained in the preamble to the Board’s proposal, the Board did not propose specific rules under proposed § 226.43(g)(4) to apply in the case where the loan originator is the creditor’s employee. The Bureau did not receive significant comment on that omission and likewise is not adopting special provisions under § 1026.43(g)(4) to apply where the loan originator is the creditor’s employee. The Bureau believes that, in such cases, the employee likely can present alternative covered transactions with and without a prepayment penalty to the consumer without significant operational difficulties. E:\FR\FM\30JAR2.SGM 30JAR2 6554 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations The Board solicited comment on whether additional guidance was needed regarding offers of covered transactions through mortgage brokers that use the safe harbor for the antisteering requirement, under § 226.36(e)(2) and (3). The Bureau did not receive significant comment on the proposal and concludes that additional guidance is not currently required. The Bureau will continue to study the interaction between prepayment penalty restrictions, as applied to mortgage brokers under § 1026.43(g)(4) and the safe harbor for the anti-steering requirement, under § 1026.36(e)(2) and (3) to ensure that brokers are operating with sufficient guidance. In the course of its review, if the Bureau determines that more guidance would provide clarity or otherwise reduce compliance burden, then the Bureau may propose to add additional guidance. sroberts on DSK5SPTVN1PROD with 43(g)(5) Creditor That Is a Loan Originator The Board proposed § 226.43(g)(5) to address table funding situations, where a creditor does not provide the funds for a covered transaction out of its own resources but rather obtains funds from another person and, immediately after consummation, assigns the note, loan contract, or other evidence of the debt obligation to the other person. Such a creditor generally presents to a consumer loan options offered by other creditors, and this creditor is a loan originator subject to the anti-steering requirements in § 1026.36(e). See § 1026.36(a)(1); comment 36(a)(1)–1. Like other loan originators, such a creditor may use the safe harbor for the anti-steering requirements under § 1026.36(e)(2) and (3). The Board proposed that, if the creditor is a loan originator, as defined in § 1026.36(a)(1), and the creditor presents a consumer a covered transaction with a prepayment penalty offered by a person to which the creditor would assign the covered transaction after consummation, the creditor must present the consumer an alternative covered transaction without a prepayment penalty offered by (1) the prospective assignee, or (2) another person, if the transaction offered by the other person has a lower interest rate or a lower total dollar amount of origination points or fees and discount points. The Board reasoned that its proposal provided flexibility with respect to the presentation of loan options, which facilitates compliance with § 1026.43(g)(3) and with the safe harbor for the anti-steering requirement in connection with the same covered transaction. See § 1026.36(e)(3)(i). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 The Bureau did not receive significant comment on the proposal and is adopting the Board’s proposal. Like § 1026.43(g)(4), § 1026.43(g)(5) does not affect the conditions that a creditor that is a loan originator must meet to take advantage of the safe harbor for the antisteering requirement. Accordingly, if a creditor that is a loan originator chooses to use the safe harbor, the creditor must present the consumer (1) the loan option with the lowest interest rate overall, (2) the loan option with the lowest interest rate without certain risky features, including a prepayment penalty, and (3) the loan option with the lowest total origination points or fees and discount points. See § 1026.36(e)(3)(i). The Board proposed comment 43(g)(5)–1 to clarify that a loan originator includes any creditor that satisfies the definition of the term but makes use of ‘‘table-funding’’ by a third party. The Bureau did not receive significant comment on the proposed comment and is adopting it as proposed. The Board proposed comment 43(g)(5)– 2 to cross-reference guidance in comment 36(e)(3)–3 on determining which step-rate mortgage has a lower interest rate. The Bureau did not receive significant comment on the proposal and is adopting the Board’s proposed comment. 43(g)(6) Applicability TILA section 129C(c)(1)(A) provides that only a qualified mortgage may contain a prepayment penalty and TILA section 129C(c)(4) further requires the creditor to offer the consumer an alternative offer that does not contain a prepayment penalty. The Board proposed § 226.43(g)(6) to provide that § 226.43(g) would apply only if a transaction is consummated with a prepayment penalty and would not be violated if (1) a covered transaction is consummated without a prepayment penalty or (2) the creditor and consumer do not consummate a covered transaction. The Bureau did not receive significant comment on the proposal and is adopting the Board’s proposal under § 1026.43(g)(6). Section 1026.43(g)(2) limits the period during which a prepayment penalty may be imposed and the amount of any prepayment penalty. As provided in § 1026(g)(6), those prepayment penalty limitations apply only if a covered transaction with a prepayment penalty is consummated. Similarly, § 1026.43(g)(3) requires a creditor that offers a consumer a covered transaction with a prepayment penalty to offer the consumer an alternative covered transaction without a prepayment penalty. Where a consumer PO 00000 Frm 00148 Fmt 4701 Sfmt 4700 consummates a covered transaction without a prepayment penalty, § 1026(g)(6) states that it is unnecessary to require that the creditor offer the consumer an alternative covered transaction without a prepayment penalty. Thus § 1026.43(g) applies only if the consumer consummates a covered transaction with a prepayment penalty. 43(h) Evasion; Open-End Credit TILA section 129C, which addresses the ability-to-repay requirements and qualified mortgages, applies to residential mortgage loans. TILA section 103(cc)(5) defines ‘‘residential mortgage loans’’ as excluding open-end credit plans, such as HELOCs. In its proposal, the Board recognized that the exclusion of open-end credit plans could lead some creditors to attempt to evade the requirements of TILA section 129C by structuring credit that otherwise would have been structured as closed-end as open-end instead. The Board proposed § 226.43(h) to prohibit a creditor from evading the requirements of § 226.43 by structuring a transaction that does not meet the definition of open-end credit in § 226.2(a)(20) as open-end credit, such as a HELOC. The Board proposed comment 43(h)–1 to explain that where a loan is documented as open-end credit but the features and terms, or other circumstances, demonstrate that the loan does not meet the definition of open-end credit, then the loan is subject to the rules for closed-end credit, including § 226.43. The Board proposed these provisions using its authority under TILA sections 105(a) and 129B(e) to prevent circumvention or evasion. The Board noted that an overly broad anti-evasion rule could limit consumer choice by casting doubt on the validity of legitimate open-end plans, and the Board thus solicited comment on whether to limit the anti-evasion rule’s application, for example, to HELOCs secured by first liens where the consumer draws down all or most of the entire line of credit immediately after the account is opened. Consumer groups generally supported the proposed anti-evasion provision; some consumer groups suggested that the provision should be expanded to require all HELOCs to comply with all Dodd-Frank Act requirements, expressing concern over the potential for consumer abuse. Industry commenters generally sought clarification on the anti-evasion rule, noting that ambiguity with respect to the provision might limit creditors’ ability, or willingness, to offer HELOCs or other open-end credit products. E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with The Bureau is adopting the Board’s proposal largely as proposed. Section 1026.43(h) is also consistent with the Board’s 2008 HOEPA Final Rule, § 1026.35(b)(4), which provides a similar anti-evasion provision with respect to higher-priced mortgage loans. The Bureau is including this provision both as part of its interpretation of TILA section 129C and using its authority under TILA section 105(a), which provides that the Bureau’s regulations may contain such additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions as in the Bureau’s judgment are necessary or proper to effectuate the purposes of TILA, prevent circumvention or evasion thereof, or facilitate compliance therewith, and TILA section 129B(e) to prevent circumvention or evasion. 15 U.S.C. 1604(a), 1639b(e). The purposes of TILA include the purposes that apply to section 129C, to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loan. See 15 U.S.C. 1639b(a)(2). While some industry commenters requested further clarification on this provision, so as to avoid limiting consumer choice, the Bureau believes that no further commentary is required. A creditor that offers a consumer an open-end line of credit in the ordinary course of business need not be concerned with running afoul of the anti-evasion requirement, and a creditor need not undertake any additional compliance or reporting steps to do so. A creditor only violates § 1026.43(h) when the creditor structures credit secured by a consumer’s dwelling that does not meet the definition of open-end credit in § 1026.2(a)(20) as an open-end plan in order to evade the ability-to-repay requirements. The Bureau’s approach should allow creditors acting in good faith to continue to provide credit to consumers in the manner best fit for business needs and consumer demand, without concern of accidentally running afoul of the anti-evasion requirement. VI. Effective Date This final rule is effective on January 10, 2014. The rule applies to transactions for which the creditor received an application on or after that date. As discussed above in part III.C, the Bureau believes that this approach is consistent with the timeframes established in section 1400(c) of the Dodd-Frank Act and, on balance, will facilitate the implementation of the rules’ overlapping provisions, while VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 6555 also affording creditors sufficient time to implement the more complex or resource-intensive new requirements. As noted above, in response to the proposal, some industry commenters requested that the Bureau provide additional time for compliance because the Bureau is finalizing several mortgage rules at the same time. These commenters expressed concern over both the breadth and complexity of new rules expected from the Bureau and from other regulators. Some commenters stated that small institutions, in particular, might face a higher cost of compliance under the timeframes established in section 1400(c) of the Dodd-Frank Act. One industry commenter explained that the new rules would require creditors to alter financial products, modify compliance systems, and train staff. Another industry commenter noted that some credit unions and other institutions that rely on third-party providers, such as software vendors, to assist with compliance might face particular challenges with implementing necessary changes over a short time period since such third parties will need time to incorporate necessary updates and conduct testing, and include the changes in their scheduled releases. Some commenters urged the Bureau to coordinate publishing and effective dates among the title XIV rules and the QRM rulemaking, in order to assist creditors in minimizing compliance burden. For the reasons already discussed above, the Bureau believes that an effective date of January 10, 2014 for this final rule and most provisions of the other title XIV final rules will ensure that consumers receive the protections in these rules as soon as reasonably practicable, taking into account the timeframes established by the DoddFrank Act, the need for a coordinated approach to facilitate implementation of the rules’ overlapping provisions, and the need to afford creditors and other affected entities sufficient time to implement the more complex or resource-intensive new requirements. addition, the Bureau has consulted, or offered to consult with, the prudential regulators, SEC, HUD, FHFA, the Federal Trade Commission, and the Department of the Treasury, including regarding consistency with any prudential, market, or systemic objectives administered by such agencies. The Bureau also held discussions with or solicited feedback from the United States. Department of Agriculture, Rural Housing Service, the Federal Housing Administration, and the Department of Veterans Affairs regarding the potential impacts of the final rule on those entities’ loan programs. The Board issued the 2011 ATR Proposal prior to the transfer of rulemaking authority to the Bureau. As the Board was not subject to DoddFrank Act section 1022(b)(2), the 2011 ATR Proposal did not contain a proposed Dodd-Frank Act section 1022 analysis. The Dodd-Frank Act and the final rule establish minimum standards for consideration of a consumer’s repayment ability for creditors originating certain closed-end, residential mortgage loans. These underwriting requirements are similar, but not identical, to the ability-to-repay requirements that apply to high-cost and higher-priced mortgage loans under current regulations.171 In general, the Act and the final rule prohibit a creditor from making a covered transaction 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. These documentation and verification requirements effectively prohibit no documentation and limited documentation loans that were common in the later years of the housing bubble. The final rule generally requires the creditor to verify the information relied on in considering a consumer’s debts relative to income or residual income after paying debts, using reasonably reliable third-party records, with special VII. Dodd-Frank Act Section 1022(b)(2) Analysis on depository institutions and credit unions with $10 billion or less in total assets as described in section 1026 of the Dodd-Frank Act; and the impact on consumers in rural areas. 171 The Bureau notes that under the final rule, ‘‘higher-priced covered transaction’’ is defined in § 1026.43(b)(4). ‘‘Higher-priced mortgage loan’’ (HPML) is defined in § 1026.35. ‘‘High-cost mortgage’’ is defined in § 1026.32. The Bureau further notes that interest rate thresholds specified in the ‘‘higher-priced covered transaction’’ definition (higher-priced threshold) are similar to the HPML thresholds, except the final rule’s higherpriced threshold does not include a specified rate threshold for ‘‘jumbo’’ loans, as provided in § 1026.35. A. Overview In developing the final rule, the Bureau has considered potential benefits, costs, and impacts.170 In 170 Specifically, section 1022(b)(2)(A) of the Dodd-Frank Act calls for the Bureau to consider the potential benefits and costs of a regulation to consumers and covered persons, including the potential reduction of access by consumers to consumer financial products or services; the impact PO 00000 Frm 00149 Fmt 4701 Sfmt 4700 E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6556 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations rules for verifying a consumer’s income or assets. The creditor must calculate the monthly mortgage payment based on the greater of the fully-indexed rate or any introductory rate, assuming monthly, fully amortizing payments that are substantially equal. The final rule provides special payment calculation rules for loans with balloon payments, interest-only loans, and negative amortization loans. The final rule provides special rules for complying with the ability-to-repay requirements for a creditor refinancing a ‘‘non-standard mortgage’’ into a ‘‘standard mortgage.’’ Under the final rule, a non-standard mortgage is defined as an adjustable-rate mortgage with an introductory fixed interest rate for a period of one year or longer, an interestonly loan, or a negative amortization loan. Under this provision, a creditor refinancing a non-standard mortgage into a standard mortgage does not have to consider the specific underwriting criteria a lender must otherwise consider under the general ability-torepay option, if certain conditions are met. To provide creditors more certainty about their potential liability under the ability-to-pay standards while protecting consumers from unaffordable loans, the Dodd-Frank Act creates a presumption of compliance with the ability-to-pay requirement when creditors make ‘‘qualified mortgages.’’ According to the statute, covered transactions, in general, are qualified mortgages where: the loan does not contain negative amortization, interestonly payments, or balloon payments (except in certain limited circumstances); the term does not exceed 30 years; points and fees (excluding up to two bona fide discount points) do not exceed three percent of the total loan amount; the income or assets and debt obligations are considered and verified; the underwriting is based on the maximum rate during the first five years, uses a payment schedule that fully amortizes the loan over the loan term, and takes into account all mortgage-related obligations. Under the final rule creditors have three options for originating a qualified mortgage. Under the first option, the loan must satisfy basic documentation and verification requirements for income or assets and debt, and the consumer must have a total (or ‘‘backend’’) debt-to-income ratio that is less than or equal to 43 percent. With respect to a loan that satisfies these criteria and is not a higher-priced covered transaction, there is a conclusive presumption that the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 creditor satisfied the ability-to-pay requirements so that the loan qualifies for a legal safe harbor under the abilityto-repay requirements. A loan that satisfies these criteria and is a higherpriced covered transaction receives a rebuttable presumption of compliance with the ability-to-repay requirements. The second option for originating a qualified mortgage provides a temporary expansion of the general definition. Through this option, a loan is a qualified mortgage if it meets the prohibitions on certain loan features, the limitations on points and fees and loan terms that apply under the general definition and also meets one of the following requirements: is eligible for purchase or guarantee by the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac) (collectively, the GSEs), while operating under the conservatorship or receivership of the FHFA; is eligible to be purchased or guaranteed by any limited-life regulatory entity succeeding the charter of either the GSEs; or is eligible to be insured by the FHA, VA or USDA or USDA RHS. This temporary provision expires with respect to GSEeligible loans when conservatorship of the GSEs ends and expires with respect to each other category of loans on the effective date of a rule issued by each respective Federal agency pursuant to its authority under TILA section 129C(b)(3)(ii) to define a qualified mortgage. Alternatively, if GSE conservatorship continues or the Federal agencies do not issue rules defining qualified mortgage pursuant to TILA section 129C(b)(3)(ii), the temporary qualified mortgage definition expires seven years after the effective date of the rule. Unlike loans that are qualified mortgages under the general definition, there is no specific monthly debt-toincome ratio threshold to be a qualified mortgage under this temporary provision, except as may be required to be eligible for purchase or guarantee or to be insured by the GSEs or Federal agencies. The temporary qualified mortgage definition does not specifically include documentation and verification requirements or a specific payment calculation requirement. The Bureau understands that, to be eligible for purchase or guarantee by the GSE’s or to be eligible to be guaranteed or insured by the Federal agencies, a loan must first satisfy certain payment calculation requirements and repayment ability analyses (which include consideration of a consumer’s total monthly debt-to-income ratio) and the information on which the calculation is PO 00000 Frm 00150 Fmt 4701 Sfmt 4700 based must be documented and verified. As is true with respect to the first category of qualified mortgages described above, a loan that satisfies these criteria and is not a higher-priced covered transaction receives a legal safe harbor under the ability-to-repay requirements. A loan that satisfies these criteria and is a higher-priced covered transaction receives a rebuttable presumption of compliance with the ability-to-repay requirements. The third option for qualified mortgages exists only for small creditors operating predominantly in rural or underserved areas, who are allowed under the rule to originate a balloonpayment qualified mortgage. Specifically, this option exists for lenders originating 500 or fewer covered transactions, secured by a first lien, in the preceding calendar year, with assets equal to or under $2 billion (to be adjusted annually), and who made more than 50 percent of their total covered transactions secured by first liens on properties in counties that are ‘‘rural’’ or ‘‘underserved.’’ These creditors are allowed to offer loans with balloon payments assuming the loan also meets certain loan-specific criteria: the creditor must satisfy the requirements under the general qualified mortgage definition regarding consideration and verification of income or assets and debt obligations; the loan cannot permit negative amortization; the creditor must determine that the consumer can make all of the scheduled payments (other than the final balloon payment) under the terms of the legal obligation from the consumer’s current or reasonably expected income or assets other than the dwelling that secures the transaction; the loan must have a term of least five years and no more than 30 years; the interest rate is fixed during the term of the loan; the creditor must base the payment calculation on the scheduled periodic payments, excluding the balloon payment; and the loan must not be subject to a forward commitment at the time of consummation. Unlike loans that are qualified mortgages under the general definition, there is no specific debt-to-income ratio requirement for balloon-payment qualified mortgages. However, creditors must generally consider and verify a consumer’s monthly debt-to-income ratio. Like the other qualified mortgage definitions, a loan that satisfies the criteria for a balloon-payment qualified mortgage and is not a higher-priced covered transaction receives a legal safe harbor under the ability-to-repay requirements for as long as the loan is held in portfolio by the creditor who originated the loan. The safe harbor also E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations applies to balloon-payment qualified mortgages which are sold three years or more after consummation. A loan that satisfies the balloon payment qualified mortgage criteria and is a higher-priced covered transaction receives a rebuttable presumption of compliance with the ability-to-repay requirements. As discussed above, the final rule provides a conclusive presumption of compliance with the ability-to-repay requirements for loans that satisfy the definition of a qualified mortgage and are not higher-priced covered transactions (i.e., APR does not exceed Average Prime Offer Rate (APOR) + 1.5 percentage points for first liens or 3.5 percentage points for subordinate liens).172 The final rule provides a rebuttable presumption of compliance with ability-to-repay requirements for all other qualified mortgage loans, meaning qualified mortgage loans that are higher-priced covered transactions. A consumer who seeks to rebut the presumption must prove that, at the time of consummation, in light of the consumer’s income and debt obligations, the consumer’s monthly payment (including mortgage-related obligations) on the covered transaction and any simultaneous loans of which the creditor was aware, would leave the consumer with insufficient residual income to pay living expenses, including recurring and material obligations or expenses of which the creditor was aware. Finally, the final rule implements the Dodd-Frank Act 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 this rule, in connection with credit that does not meet the definition of open-end credit, by structuring a closed-end extension of credit as an open-end plan. A consumer who brings an action against a creditor for a violation of the ability-to-repay requirements within three years from when the violation occurs may be able to recover special statutory damages equal to the sum of all finance charges and fees paid by the consumer, unless the creditor demonstrates that the failure to comply is not material; 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. 172 The Average Prime Offer Rate means ‘‘the average prime offer rate for a comparable transaction as of the date on which the interest rate for the transaction is set, as published by the Bureau.’’ TILA section 129C(b)(2)B). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 After the expiration of the three-year time period, the consumer is precluded from bringing an affirmative claim against the creditor. At any time, when a creditor or an assignee initiates a foreclosure action, a consumer may assert a violation of these provisions ‘‘as a matter of defense by recoupment or setoff.’’ There is no time limit on the use of this defense, although the recoupment or setoff of finance charge and fees is limited to the first three years of finance charges and fees paid by the consumer under the mortgage. B. Data and Quantification of Benefits, Costs and Impacts Section 1022 of the Dodd-Frank Act requires that the Bureau, in adopting the rule, consider potential benefits and costs to consumers and covered persons resulting from the rule, including the potential reduction of access by consumers to consumer financial products or services resulting from the rule, as noted above; it also requires the Bureau to consider the impact of proposed rules on covered persons and the impact on consumers in rural areas. These potential benefits and costs, and these impacts, however, are not generally susceptible to particularized or definitive calculation in connection with this rule. The incidence and scope of such potential benefits and costs, and such impacts, will be influenced very substantially by economic cycles, market developments, and business and consumer choices, that are substantially independent from adoption of the rule. No commenter has advanced data or methodology that it claims would enable precise calculation of these benefits, costs, or impacts. Moreover, the potential benefits of the rule on consumers and covered persons in creating market changes anticipated to address market failures are especially hard to quantify. In considering the relevant potential benefits, costs, and impacts, the Bureau has utilized the available data discussed in this preamble, where the Bureau has found it informative, and applied its knowledge and expertise concerning consumer financial markets, potential business and consumer choices, and economic analyses that it regards as most reliable and helpful, to consider the relevant potential benefits and costs, and relevant impacts. The data relied upon by the Bureau includes the public comment record established by the proposed rule, as well as the data described in the Bureau’s Federal Register notice reopening the comment PO 00000 Frm 00151 Fmt 4701 Sfmt 4700 6557 for this rule,173 and the public comments thereon. However, the Bureau notes that for some aspects of this analysis, there are limited data available with which to quantify the potential costs, benefits, and impacts of the final rule. For example, data on the number and volume of various loan products originated for the portfolios of bank and non-bank lenders exists only in certain circumstances. Data regarding many of the benefits of the rule such as the benefits from prevented defaults or from prevented injuries to the financial system are also limited. In light of these data limitations, the analysis below generally provides a qualitative discussion of the benefits, costs, and impacts of the final rule. General economic principles, together with the limited data that are available, provide insight into these benefits, costs, and impacts. Where possible, the Bureau has made quantitative estimates based on these principles and the data that are available. For the reasons stated in this preamble, the Bureau considers that the rule as adopted faithfully implements the purposes and objectives of Congress in the statute. Based on each and all of these considerations, the Bureau has concluded that the rule is appropriate as an implementation of the Act. C. Baseline for Analysis The provisions of Dodd Frank concerning minimum loan standards and the ability-to-repay requirement are self-effectuating, and the Dodd-Frank Act does not require the Bureau to adopt a regulation to implement these amendments. The Act does require the Bureau to issue regulations to ‘‘carry out the purposes of’’ the subsection governing qualified mortgages, which includes the ‘‘presumption of compliance’’ accorded those mortgages. In the absence of such regulations, the statutory provisions would take effect on January 21, 2013, and there would be no clarification beyond the statute as to the meaning of the ability-to-repay requirement, which mortgages meet the statutory criteria for a qualified mortgage, and the nature of the presumption of compliance with respect to such mortgages. Thus, many costs and benefits of the final rule considered below would arise largely or entirely from the statute, not from the final rule. The final rule would provide substantial benefits compared to allowing these provisions to take effect alone by clarifying parts of the statute that are ambiguous. Greater clarity on these 173 See E:\FR\FM\30JAR2.SGM 77 FR 33120 (June 5, 2012) 30JAR2 6558 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with issues should reduce the compliance burdens on covered persons by reducing costs for attorneys and compliance officers as well as potential costs of over-compliance and unnecessary litigation. Section 1022 of the Dodd-Frank Act permits the Bureau to consider the benefits and costs of the rule solely compared to the state of the world in which the statute takes effect without an implementing regulation. To provide the public better information about the benefits and costs of the statute, however, the Bureau has nonetheless chosen to evaluate the benefits, costs, and impacts of the major provisions of the final rule against a pre-statutory baseline. That is, the Bureau’s analysis below considers the benefits, costs, and impacts of the relevant provisions of the Dodd-Frank Act combined with the final rule implementing those provisions relative to the regulatory regime that pre-dates the Act and remains in effect until the final rule takes effect. As noted, current regulations have parallel but not identical ability-to-repay rules applied to higher-price and high-cost mortgage loans.174 In the analysis, in addition to referring to present market conditions, the Bureau refers at times to data from other historical periods—the market as it existed from 1997 to 2003 and the years of the bubble and the collapse— to provide the public a fuller sense of the potential impacts of the rule in other market conditions.175 Considering the current state of the market makes clear the near term benefits and costs of the provisions. However, at this point in the credit cycle, the market is highly restrictive and operating under very tight credit conditions.176 Against this background, the benefits and the costs of the rule may appear smaller than otherwise. The Bureau considers the mortgage market as it existed from 1997 through 174 The Bureau has chosen, as a matter of discretion, to consider the benefits and costs of those provisions that are required by the DoddFrank Act in order to better inform the rulemaking. The Bureau has discretion in future rulemakings to choose the relevant provisions to discuss and to choose the most appropriate baseline for that particular rulemaking. 175 The statute and final rule are designed to ensure a minimal level of underwriting across various states of the housing market and credit cycle. As a result, the Bureau determined, as a matter of discretion, that it was beneficial to compare certain aspects of the rule against different scenarios, using different historical data. 176 See Board of Governors of the Federal Reserve System, ‘‘Monetary Policy Report to the Congress,’’ (July 17, 2012), available at https:// www.federalreserve.gov/monetarypolicy/files/ 20120717_mprfullreport.pdf. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 2003 useful to assess some of the rule’s possible effects when credit conditions, and the economy more generally, return to normal. During this period, home prices were generally rising and the housing market was in a positive phase. Notably, interest rates were falling in 2002 and 2003, which created a very large surge in refinancing activity. This period may not be perfectly representative of an ‘‘average’’ market, but these years span almost a full business cycle, capturing the end of 1990’s expansion, the early 2000’s recession and the beginning of the next expansion.177 The analysis also uses data from the period 2004 through 2009. Beginning in 2004, the mortgage market in the United States was in the height of the housing bubble. In 2007 home prices, mortgage lending, and the economy more generally collapsed. The period that covers the ‘‘bubble’’ years and the crash that followed is also useful to gauge the impacts of the final rule. It is exactly the lending conditions during those years, and the damage they caused, that the statute and the final rule are primarily designed to prevent. Examining the performance and effects of the mortgages offered during this period, loans that were largely originated based on the perceived value of collateral, offers insights into the potential benefits and costs of the rule. D. Coverage of the Final Rule The provisions of the final rule require creditors to determine a consumer’s ability to repay a ‘‘residential mortgage loan, ’’ excluding reverse mortgages and temporary bridge loans of 12 months or less, (referred to as ‘‘covered transactions’’) ’’and establish new rules and prohibitions on prepayment penalties. For these purposes, this rule covers with some exceptions, any dwelling-secured consumer credit transaction, regardless of whether the consumer credit transaction involves a home purchase, refinancing, home equity loan, first lien or subordinate lien, and regardless of whether the dwelling is a principal residence, second home, vacation home (other than a timeshare residence), a one- to four-unit residence, condominium, cooperative, mobile home, or manufactured home. However, the Dodd-Frank Act specifically excludes from these provisions openend credit plans or extensions of credit secured by an interest in a timeshare plan. The final rule generally also excludes reverse mortgages, residential 177 Reliable loan level data from earlier time periods is generally unavailable. PO 00000 Frm 00152 Fmt 4701 Sfmt 4700 construction loans, and bridge loans with a term of 12 months or less. E. Potential Benefits and Costs to Consumers and Covered Persons In the analysis of benefits, costs and impacts, the Bureau has chosen to consider the ability-to-repay provisions together with the various qualified mortgage provisions. The discussion below first addresses the economics of an ability-to-repay standard, and considers the specific market failures that the statute and the rule aim to address. In general, market failures may include incomplete markets, externalities, imperfect competition, imperfect information, or imperfect information processing by consumers and several of those are discussed here.178 The benefits and costs of the requirement to assess ability to repay based upon documented and verified information are then discussed along with the impacts of the new liabilities, and the presumption of compliance that mitigates those liabilities established under the Dodd-Frank Act. Additional provisions of the rule are considered including the impacts of the provisions related to points and fees, prepayment penalties and the definition of ‘‘rural or underserved’’. The relationship between these provisions and other mortgage related rulemakings is discussed. The benefits, costs and impacts of the final rule in relation to several major alternatives are then discussed. 1. Economics of Ability To Repay The basic requirement of Section 1411 of the Dodd-Frank Act is that a covered transaction may only be made when the creditor has made a ‘‘reasonable and good faith’’ determination that the consumer will be able to repay the loan. In the absence of any market imperfections, when negotiating a loan, both the lender and borrower would understand and consider the probability of default and the related costs should such a default occur. Creditors would extend credit if, and only if, the ‘‘price’’ of the loan, i.e., the risk-adjusted return (the return taking into account the expected loss from default) is high enough to justify the investment. Informed consumers would accept the loan if, and only if, the benefits of financing the property are worth the costs, including any expected costs in the likelihood that they default and 178 For a general discussion of market failures, including incomplete markets, see Chapter 4 (‘‘Market Failure’’) in Joseph E. Stiglitz. Economics of the Public Sector, 3d edition. New York: W. W. Norton & Company, Inc. (2000). E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations cannot maintain access to the specific property. The primary benefits or costs from an ability-to-repay requirement therefore derive from situations, where, absent such a requirement, these conditions are not met or where certain externalities may exist. These may include situations where the originator or creditor is not fully informed or has incorrect information about the transaction. More likely, a fully informed originator or creditor may not fully internalize all of the relevant costs, and is willing to extend credit even though the consumer may lack the ability to repay. Since the consumer willingly enters into the transaction, he or she must also be uninformed of either the true likelihood or true costs of default, or must not fully internalize all of the relevant costs. As discussed below, some of these situations arise when the lender or the borrower, fully understanding the risks of the loan and the inherent costs to themselves, do not factor costs borne by parties outside the transactions into their decisions. Collateral based or ‘‘hard money’’ lending is one possible case where such lending could occur. If the lender is assured (or believes he is assured) of recovering the value of the loan by gaining possession of the asset, the lender may not pay sufficient attention to the ability of the borrower to repay the loan or to the impact of default on third parties. For very low loan-to-value (LTV) mortgages, i.e., those where the value of the property more than covers the value of the loan, the lender may not care at all if the borrower can afford the payments. Even for higher LTV mortgages, if prices are rising sharply, borrowers with even limited equity in the home may be able to gain financing since lenders can expect a profitable sale or refinancing of the property as long as prices continue to rise. Other cases may involve loan originators who do not bear the credit risk of the loan, and therefore do not bear the ultimate costs of default. The common case is lenders who sell their loans: these lenders earn upfront origination fees from consumers and gains on sale but (absent complete contracts that provide otherwise) may not generally bear the costs of a later borrower default. As the relative size of the upfront fees increase, the potential agency problems do as well. The market recognizes the informational issues in these transactions and has developed mechanisms to mitigate adverse selection and moral hazard. For example, purchasers of loans engage in due diligence, either directly or by hiring third parties, validating the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 information provided about the loans and ensuring that the seller has provided only loans that meet agreed upon criteria. In addition, contracts provide that ex-post, should a loan perform poorly, the originator may have to repurchase the loan. This contracting feature is also designed to ensure that the initial creditor of the loan has the proper incentives to verify the borrower’s ability to repay or the collateral value. Still, not all information about the loan may be captured and passed among sequential owners of the loan; some tacit information, not passed on, may give the creditor an informational advantage over others and diminishes the creditors’ incentives to verify the consumer’s ability to repay.179 However, even lenders who maintain loans in portfolio may pay insufficient attention to the borrower’s ability to repay. Cases where the loan creditor can earn sufficiently high up-front compensation, or where incentives of the individual loan originators and the creditor differ, may lead to lending that does not include a realistic assessment of the borrower’s ability to repay. For example, a retail loan originator who earns commission may not have the same incentives as the owners of the bank that employs the loan originator and who will bear the ultimate cost of the loan once on portfolio. Even if such loan originators do not have final decision-making authority as to whether the creditor will make the loan, the loan originator controls the information that the underwriter receives and may have an information advantage that could systematically bias underwriting decisions.180 This information problem, and therefore the risk of poorly underwritten portfolio loans, may be even greater where the originator is not an employee of the creditor as is true in the brokerage and correspondent lending contexts. In all these cases, the common problem is the failure of the originator 179 Some consumers may also benefit from informational asymmetries that lead to the secondary market purchasing their mortgages without full information about the characteristics of the loan. 180 Examples of empirical evidence of the persistence of moral hazard among employees in commercial and retail lending, include originators of residential mortgages, appears in Sumit Agarwal and and Itzhak Ben-David, ‘‘Do Loan Officers’ Incentives Lead to Lax Lending Standards?’’ Federal Reserve Bank of Chicago working paper (2012); Aritje Berndt; and Burton Hollifield, and Patrik Sandas, 2010, The Role of Mortgage Brokers in the Subprime Crisis, Working paper, Carnegie Mellon University. Cole, Shawn, Martin Kanz, and Leora Klapper (2010), Rewarding Calculated Risk-Taking: Evidence from a Series of Experiments with Commercial Bank Loan Officers, Working paper, Harvard Business School. PO 00000 Frm 00153 Fmt 4701 Sfmt 4700 6559 or creditor to internalize particular costs, often magnified by information failures and systematic biases that lead to underestimation of the risks involved. The first such costs are simply the pecuniary costs from a defaulted loan— if the loan originator or the creditor does not bear the ultimate credit risk, he or she will not invest sufficiently in verifying the consumer’s ability to repay. Even in cases where the lender does bear those costs, he or she will usually not fully internalize the private costs that a defaulting borrower will incur should default occur. Further, there are social costs from default that creditors may not internalize, as discussed below.181 As noted earlier, the borrower also must decide whether to enter into the mortgage, and fully informed, perfectly rational consumers should consider their own risk of default and private costs in the event of default. However, as with lenders, borrowers may not fully anticipate the future probability or costs of default, either because they are uninformed or for other reasons. Consumers may underestimate the true costs of homeownership or be overly optimistic about their own future (or even current) financial condition. This can be exacerbated in the case of less sophisticated consumers negotiating with more informed mortgage professionals who have an interest in closing the loan and who may falsely reassure consumers about the consumers’ ability to repay. Consumers (and as noted above, creditors) may also misjudge the current or future value of the property securing the loan.182 This latter phenomenon was very much in evidence during the later years of the housing bubble as many consumers simply assumed that in times of financial stress, they could always sell or refinance. Further, consumers may not understand or may underestimate the costs they will incur in the event of default, such as the loss of the borrower’s own home, costs of relocation, and the borrower’s loss of future credit, employment and other 181 With these market failures, even if regulation limits opportunities for lenders to extend credit without retaining a portion of the risk, there may be cases where lenders will not pay enough attention to a borrower’s ability to repay. 182 See Foote, Christopher L., Kristopher S. Gerardi, and Paul S. Willen, ‘‘Why Did So Many People Make So Many Ex Post Bad Decisions? The Causes of the Foreclosure Crisis,’’ Public Policy Discussions Papers, Federal Reserve Bank of Boston (2012), available at https://www.bostonfed.org/ economic/ppdp/2012/ppdp1202.pdf. E:\FR\FM\30JAR2.SGM 30JAR2 6560 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with opportunities for which credit reports or credit scores weigh in the decision.183 As noted above, neither party to the transaction is likely to internalize costs to third parties. Even among very informed consumers and creditors, most will not internalize the social costs that delinquency or foreclosure can have.184 Research has consistently shown that a foreclosure will have a negative effect on the other homeowners in the vicinity either through the displacement of demand that otherwise would have increased the neighborhood prices, reduced valuations of future sales if the buyers and/or the appraisers are using the sold foreclosed property as a comparable, vandalism, and disinvestment.185 While the estimated magnitudes and the breadth of the impact differ, researchers seem to agree that there is a negative impact on houses in the vicinity of the foreclosure, and this impact is the highest for the houses that are the closest to the foreclosed house and for the houses that get sold 183 See for example, Kenneth P. Brevoort and Cheryl R. Cooper, Foreclosure’s Wake: The Credit Experiences of Individuals Following Foreclosure, Working Paper, 2010 available at https:// works.bepress.com/kbrevoort/2. 184 Section 1022 requires consideration of benefits and costs to consumers and covered persons. The ability to pay rule also has important potential benefits and costs for other individuals and firms, and for society at large. The Bureau discusses these benefits and costs here because they are particularly important to the Bureau’s development, and public understanding of, the final rule. The rule implements statutory provisions, enacted in the wake of the financial crisis, that seem clearly intended to help prevent the potential negative social externalities of poor underwriting while preserving the potential positive social externalities of mortgage lending. The Bureau reserves discretion in the case of each rule whether to discuss benefits and costs other than to consumers and covered persons. 185 There are several papers documenting various magnitudes of the negative effect on the nearby properties. Data in Massachusetts from 1987 to 2009 indicate that aside from a 27% reduction in the value of a house (possibly due to losses associated with abandonment), foreclosures lead to a 1% reduction in the value of every other house within 5 tenths of a mile. See John Y. Campbell, Stefano Giglio, and Parag Pathak, Forced Sales and House Prices, American Economic Review 101(5) (2011), abstract available at: https://www.aeaweb.org/ articles.php?doi=10.1257/aer.101.5.2108. Data from Fannie Mae for the Chicago MSA, show that a foreclosure within 0.9 kilometers can decrease the price of a house by as much as 8.7%, however the magnitude decreases to under 2% within five years of the foreclosure. See Zhenguo Lin, Eric Rosenblatt, and Vincent W. Yao. ‘‘Spillover Effects of Foreclosures on Neighborhood Property Values,’’ The Journal of Real Estate Finance and Economics, 2009, 38(4), 387–407. Similarly, data from a Maryland dataset for 2006–2009 show that a foreclosure results in a 28% increase in the default risk to its nearest neighbors. See Charles Towe and Chad Lawley, 2011, ‘‘The Contagion Effect of Neighboring Foreclosures,’’ SSRN Working Paper 1834805. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 within a short period of time of the foreclosed sale.186 Research is also beginning to examine other spillover effects from foreclosures including increases in neighborhood crime 187 and social effects on family members such as hampered school performance.188 Social policy has long favored homeownership for the societal benefits that may ensue; the negative spillovers from foreclosures can be seen as the inverse of this dynamic.189 The Dodd-Frank Act and the final rule address these potential market failures through minimum underwriting requirements at origination and new liability for originators and assignees in cases where the standards are found not to be met. For qualified mortgages that have earned the conclusive presumption, meeting the qualified mortgage product criteria and underwriting requirements and pricing of the loan at a prime rate are judged in the rule to be enough to ensure that the lender made a reasonable and good faith determination that the borrower will be able to repay the loan. For loans where the final rule creates a presumption of compliance but leaves room for the borrower to rebut the presumption of compliance, or loans for which there is no presumption (i.e., loans that are not qualified mortgages) the lender may exert greater care in underwriting the loan than would be true in the absence of any liability for extending a loan which the consumer cannot afford to repay. Lenders therefore face an initial market tradeoff when choosing the optimal level of costs to bear in documenting and underwriting the loan and assessing the ability to repay (subject to the minimum standards all loans must meet): some increased effort (and therefore increased cost) at the time of origination may lower costs resulting from possible liability should the borrower become delinquent or default. Since assignees now share this 186 Frame, W. Scott (2010): Estimating the effect of mortgage foreclosures on nearby property values: A critical review of the literature, Economic Review, Federal Reserve Bank of Atlanta, ISSN 0732–1813, Vol. 95, https://hdl.handle.net/10419/ 57661. 187 See for example, Ingrid Gould Ellen, Johanna Lacoe, and Claudia Sharygin, Do Foreclosures Cause Crime?, Working Paper 2011. 188 A summary of recent and ongoing research is presented in Julia B. Isaacs, The Ongoing Impact of Foreclosures on Children, First Focus/The Brookings Institution, April 2012. See also Samuel R. Dastrup and Julian R. Betts, Elementary Education Outcomes and Stress at Home: Evidence from Mortgage Default in San Diego. 189 See for example, the literature summarized in Dwight Jaffee and John M. Quigley, The future of the government sponsored enterprises: the role for government in the U.S. mortgage market, NBER Working Paper Series, Working Paper 17685, available at https://www.nber.org/papers/w17685. PO 00000 Frm 00154 Fmt 4701 Sfmt 4700 liability, they have an additional incentive to monitor the behavior of the original creditor. The ex-post liability to the consumer mitigates the incentives for the creditor to shirk on the ex-ante investments in the underwriting. Even creditors making the optimal choice of effort when documenting, verifying and underwriting the loan may still face some legal challenges from consumers ex-post. This will occur when a consumer proves unable to repay a loan and wrongly believes (or chooses to assert) that the creditor failed to properly assess the consumer’s ability to repay before making the loan. This will likely result in some litigation expense, although the Bureau believes that over time, that expense will likely diminish as experience with litigation resolves more precise guidelines regarding what level of compliance is considered complete. After some experience, litigation expense will most likely result where compliance is insufficient or from limited novel sets of facts and circumstances where some ambiguity remains.190 Regardless of which party incurs the costs, the economic costs of these actions are the resources used to litigate these cases, thereby helping to ensure compliance and limiting the incidence of loosely documented originations. The reimbursement of interest and fees, along with the statutory damages, paid to the borrower, constitute, in economic terms, a transfer—a cost to the originator or assignee and a benefit to the compensated borrower.191 2. Potential Benefits of the Ability-ToRepay Provisions for Consumers and Covered Persons The final rule will help to ensure that loans are not made without regard for the borrower’s ability to repay and thereby protect consumers and as noted above, others affected by defaults and foreclosures. (These others are themselves consumers and the adverse spillover effect from defaults and foreclosures very much impacts their economic well being.) Historically, the conditions under which credit is extended have been cyclical in nature. Periods of tight credit, such as the 190 The Bureau recognizes that there may always be some frivolous lawsuits for which lenders will pay legal expenses. In addition, uncertainty inherent in the legal system also implies a base level of litigation. 191 In a cost benefit accounting, the ex-post realization of the contingent payment from the creditor to the borrower is a transfer, a cost on one side and a benefit on the other. For risk-averse consumers, the ex-ante insurance value of the contingent payment is also a benefit. In other words, consumers are better off knowing that if they are harmed, they will recover some damages. E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations conditions that exist in the current mortgage market, are marked by reduced loan activity, very stringent lending standards, and extreme care in underwriting. In such periods, the benefits of a regime designed to require prudent underwriting, may be less apparent, and, in the near term, adopting such a regime, as the final rule does, will likely have little direct and immediate effect either on consumers or covered persons. As explained further in the discussion of costs to consumers and covered persons, lenders generally are already doing what the rule requires and a large majority of their loans will qualify for the conclusive presumption of compliance. However, as credit expands, as it almost inevitably will, the final rule will help to ensure that loans are made properly and with regard for the borrower’s ability to repay. To assess the benefits of the final rule, therefore, it is useful to examine the provisions of the final rule in the context of the recent housing bubble and its collapse in 2007. There is growing evidence that many of the market failures in the previous discussion were in play in the years leading up to the housing collapse. In some cases, lenders and borrowers entered into loan contracts on the misplaced belief that the home’s value would provide sufficient protection. These cases included subprime borrowers who were offered loans because the lender believed that the house value either at the time of origination or in the near future could cover any default. Some of these borrowers were also counting on increased housing values and a future opportunity to refinance; others likely understood less about the transaction and were at an informational disadvantage relative to the lender. These cases also included Alt-A loans taken by borrowers hoping to speculate on housing values. In both of these situations, these loans frequently involved less traditional products, loans structured with minimal monthly payments in order to allow the borrower to qualify and to carry the loan for a period of time with minimal expense. Many of these loans were sold into the secondary market, limiting the lenders’ credit risk, but many lenders also retained these loans on their own portfolios either with the intent of earning the full anticipated profits from such loans over time or with the intent to hold the loans for a period of time before selling them. And throughout the housing boom, most lenders and borrowers entering into such agreements failed to consider the costs that default would inflict on other properties (and VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 the consumers who inhabited them) and on the financial system and economy writ large. The benefits from the ability-to-repay requirements therefore come from further limiting and deterring unaffordable lending, above and beyond the current ability-to-pay requirements for higher-priced mortgage loans, and thereby reducing the ensuing private and social costs of excess delinquency and default. For example, the basic requirement that all loans be underwritten based on documented income and debt would have eliminated many of the loans made later in the bubble that led to crisis. Described as ‘‘stated-income’’ loans or ‘‘liar-loans,’’ these mortgages became very prevalent in the later years of the expansion and had very poor, and worse than expected, performance when the markets collapsed.192 There is also growing evidence that incomes on many mortgage applications were overstated in the years before the crash.193 Importantly, while limited and reduced documentation loans were a large segment of the subprime market, many of these loans were also made to prime, higher credit score borrowers and on properties with lower loan-to-value ratios.194 This suggests a substantial benefit to the documentation and verification requirements across all 192 From 2000 to 2009, reduced documentation loans grew from 2 percent of outstandings to 9 percent. See FCIC Report pgs 110–111 for discussion of these loans. Other research documents the poor performance of these loans and that the increased risk was not properly priced. See, for example, Michael LaCour-Little and Jing Yang, Taking the Lie Out of Liar Loans: The Effect of Reduced Documentation on the Performance and Pricing of Alt-A and Subprime Mortgages, 2012, Working Paper and Wei Jiang, Ashlyn Aiko Nelson, and Edward Vytlacil, Liar’s Loan? Effects of Origination Channel and Information Falsification on Mortgage Delinquency, 2011, Working Paper. Some authors have tried to understand the differences between cases where lenders offered these loans as a benefit to certain customers and cases where customers simply chose a higherpriced limited doc alternative. See Irina Paley and Konstantinos Tzioumis, Rethinking Stated-income Loans: Separating the Wheat from The Chaff, Working Paper, 2011. For evidence that the risk on these loans was not fully priced, see Cost of Freddie Mac’s Affordable Housing Mission, presentation to Board of Directors, 2009 at https://fcicstatic.law.stanford.edu/cdn_media/fcic-docs/200906-04FreddieMacCostofAffordableHousingMission.pdf p.12 analyzing the ‘‘unexpectedly poor performance of * * * Alt-A purchases’’ 193 For example, see Robert B. Avery, Neil Bhutta, Kenneth P. Brevoort, and Glenn B. Canner, The Mortgage Market in 2011: Highlights from the Data Reported under the Home Mortgage Disclosure Act, FEDS Working Paper Series, 2012. See also FCIC Report, pgs. 110–111; LaCour-Little and Yang, 2012; Jiang, Nelson, and Vytlacil, 2011; Paley and Tzioumis, 2011. 194 See FCIC Report, pgs. 110–111; LaCour-Little and Yang, 2012; Jiang, Nelson, and Vytlacil, 2011; Paley and Tzioumis, 2011. PO 00000 Frm 00155 Fmt 4701 Sfmt 4700 6561 segments of the market, particularly the substantial majority of covered transactions that current ability-to-pay requirements do not cover now and are not expected to cover in the future. As prices rose, aspiring homeowners borrowed money by misstating their income; many loan originators were at least indifferent to or even complicit or proactive in these endeavors. The systemic effects were evident: the extension of credit against inflated incomes expanded the supply of credit, which in turn continued the rapid rise of house prices in the later years of the housing boom and exacerbated the eventual crash.195 The statute and the final rule also require that creditors must underwrite based on an amortizing payment using the fully indexed rate (or the maximum rate in five years for qualified mortgages) and including, with limited exceptions, any balloon payments in the first five years. This effectively bans the practice of underwriting loans based upon low upfront payments, either the lower interest-only payments on interest-only loans or negatively amortizing option ARMs or the teaser rates on hybrid ARMs. In their later incarnations, interestonly and negatively amortizing loans (along with loans with terms greater than 30 years) were often sold on the basis of the consumer’s ability to afford the initial payments and without regard to the consumer’s ability to afford subsequent payments once the rate was recast. At the peak of the market, between 2004 and 2006, the percentage of loans that were interest-only, option ARMs or 40-year mortgages rose from just 7 percent of originations to 29 percent. The lower payment possibility for these loans allows borrowers to qualify for loans that they otherwise may not have been able to afford; but this comes with the same risks just described. The performance of many of these loans was also very poor, and worse than expected, with the onset of the downturn.196 The final rule does not 195 See Financial Stability Oversight Council, Macroeconomic Effects of Risk Retention Requirements, January 2011, at 12. (‘‘[T]here is some evidence that the increased supply in subprime mortgage credit was in part responsible for greater home price appreciation * * * [and] increases in home prices may have reinforced expectations for future appreciation, which may have fueled more lending. Increases in loan volume, in turn, may have precipitated further increases in home prices.’’); Mian, Atif and Amir Sufi, ‘‘The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis,’’ Quarterly Journal of Economics, vol. 124, no. 4 (2009). 196 See Amromin, Gene, Jennifer Huang, Clemens Sialm, and Edward Zhong, ‘‘Complex Mortgages,’’ E:\FR\FM\30JAR2.SGM Continued 30JAR2 6562 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with ban such products outright, but rather requires that lenders that make such loans have a ‘‘reasonable and good faith’’ belief in the borrower’s ability to repay and that in formulating such a belief the lender must calculate the monthly payment based on the fully indexed rate and fully amortizing payments, and does not allow these loans to enjoy the presumption of compliance associated with qualified mortgage status. The new underwriting requirements, coupled with the liability for violating these rules, should deter improper loans and ensure proper underwriting and diligence when making such loans; again limiting cases of personal or social harm. Underwriting hybrid ARMs to the teaser rate was also a very common practice, in particular among subprime loans of the early 2000’s. So called ‘‘2/ 28’’ and ‘‘3/27’’ loans were often underwritten based on the low initial payment,197 and exposed the borrower to potential payment shocks, and a need to refinance, two or three years into the mortgage.198 For example, in 2005, the teaser rate on subprime ARMs with an initial fixed-rate period of two or three years was 3.5 percentage points below the fully indexed rate.199 As a result, mortgages originated in that year faced a potentially large change in the interest rate and payment, or ‘‘payment shock,’’ at the first adjustment even absent any change in the index. The evidence is mixed on whether payment shock at the initial interest rate adjustment causes default.200 And Federal Reserve Bank of Chicago Working Paper 2010–17 (2010), available at https:// www.chicagofed.org/digital_assets/publications/ working_papers/2010/wp2010_17.pdf. 197 See for example, Christopher Mayer, Karen Pence, and Shane M. Sherlund, ‘‘The Rise in Mortgage Defaults,’’ Journal of Economic Perspectives 23, no. 1 (Winter 2009): Table 2, Attributes for Mortgages in Subprime and Alt-A Pools, p. 31. (showing that from 2003 to mid-2007, about 70 percent of subprime loans in securitized pools were hybrid adjustable rate mortgage loans.) 198 Brent W. Ambrose & Michael LaCour-Little, Prepayment Risk in Adjustable Rate Mortgages Subject to Initial Year Discounts: Some New Evidence, 29 Real Est. Econs. 305 (2001) (showing that the expiration of teaser rates causes more ARM prepayments, using data from the 1990s). The same result, using data from the 2000s and focusing on subprime mortgages, is reported in Shane Sherland, The Past, Present and Future of Subprime Mortgages, (Div. of Research & Statistics and Div. of Monetary Affairs, Fed. Reserve Bd., Washington, DC 2008); The result that larger payment increases generally cause more ARM prepayments, using data from the 1980s, appears in James Vanderhoff, Adjustable and Fixed Rate Mortgage Termination, Option Values and Local Market Conditions, 24 Real Est. Econs. 379 (1996). 199 See Christopher Mayer, Karen Pence, & Shane Sherlund, The Rise in Mortgage Defaults, 23 J. Econ. Persps. 27, 37 (2009). 200 Mayer, Pence, & Sherlund, supra note 125, at 37 provide data from the 2000s that does not find VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 indeed, for some borrowers, these loans can be efficient contracts that allow for the extension of credit (see discussion below).201 However, the widespread use of the product put many borrowers in precarious financial positions and may also have fueled the systemic rise in home prices.202 The elimination of these products should limit both the individual and the systemic harms which ultimately translate, in the largest part, into harms to individual consumers. The final rule reduces the likelihood that these products will reemerge on a broad scale and thus should limit the potential for individual and the systemic harms. The final rule bans nodoc and the old low-doc loans since the level of documentation is lower than that required by the rule). * * * The rule reduces the incentive to offer these other alternative mortgage products by requiring that underwriting be done assuming a fully amortizing payment at the fully indexed rate. The final rule also does not provide any legal protection for the lender that makes these loans (or the investor that acquires or guarantees them) as the loans are categorically disqualified from being qualified mortgage. These nonamortizing products will likely persist only in narrow niches for more sophisticated borrowers who want to match their mortgage payment to changes in their expected income stream and who have the resources to qualify for the products under the stringent underwriting assumptions the statute and regulation require. But these products will not likely be marketed as broadly as they were during the bubble. In addition to the products just described, loans with points and fees (except for bona fide discount points) that exceed three percent of the total amount cannot be qualified mortgages, except as applicable for smaller loans as defined. Creditors may take more care in originating a loan when more of the return derives from performance over time (interest payments) rather from upfront payments (points and fees). As a causal relationship between payment shock at the initial interest rate adjustment and default. In contrast, see Anthony Pennington-Cross & Giang Ho, The Termination of Subprime Hybrid and Fixed-Rate Mortgages, 38 Real Est. Econs. 399, 420 (2010), for evidence that among consumers with certain hybrid ARMs originated in the 2000s, a substantial number experienced an increase in monthly payment of at least 5% at the initial interest rate adjustment, and that the default rate for these loans was three times higher than it would have been if the payment had not changed. 201 See for example, Gary Gorton, The Panic of 2007, paper presented at the Federal Reserve Bank of Kansas City’s Jackson Hole Conference, August 2008, p. 12–18. 202 .See for example, Mian and Sufi, 2009. PO 00000 Frm 00156 Fmt 4701 Sfmt 4700 such, this provision may offer lenders more incentive to underwrite these loans carefully. As loans with higher points and fees are usually assumed to be offered to borrowers in weaker financial circumstances, this provision offers protection to that class of borrowers.203 As discussed above, the various liability provisions provide the incentives for lenders to take proper care judging the borrower’s ability to repay. This incentive is strongest for loans that are not qualified mortgages. Within the qualified mortgage space, higher priced mortgage loans (HPMLs) are still subject to ability-to-repay liability but afforded a rebuttable presumption of compliance. This liability already exists under rules that took effect in October 2009 for HPMLs, so that relative to existing rules, there are few benefits (or costs) associated with the liability provisions for such loans. However, there are some material differences in the underwriting requirements and smaller differences in the scope of the presumption where the liability now applies where it did not in the past. The new assignee liability may also strengthen the incentives relative to the existing rules. Comparing the rebuttable presumption for higher priced qualified mortgages to the conclusive presumption (safe harbor) provision for qualified mortgages below the higherpriced threshold highlights the benefit of leaving the possibility of rebuttal in place. Borrowers paying higher rates on mortgage loans that meet the qualified mortgage product features are most likely to have lower credit scores, lower incomes and/or other risk factors; as such, it is among these subprime borrowers that a greater possibility exists for lenders to place the borrower into a loan that he or she may not have the ability to repay. The ability of the borrower to rebut the presumption of compliance leaves lenders with the additional incentive to ‘‘double check’’ the loan to examine further the borrower’s financial condition and residual income, and to ensure that these higher risk borrowers have the means to live in the home they just purchased or refinanced. Where a consumer is unable to afford his or her mortgage—and proves that the lender lacked a reasonable and good faith belief in the consumer’s repayment ability at the time the loan was made— the damages the borrower recovers are a benefit to that party. The same damages should also be considered a 203 In general, smaller dollar loans are more likely to be impacted by the points and fees provisions. E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations cost to the lender and as such, estimates regarding the frequency of such actions and the dollar amounts involved are in the next section discussing costs. Another impact of the differentiated structure of the final rule, where certain loans enjoy a conclusive presumption, others are given a rebuttable presumption and still others are subject to ability to repay scrutiny without the benefit of a presumption, is that some borrowers may gain ‘‘better’’ loans as lenders choose to make loans that qualify for the highest level of legal protection. Lenders in less competitive environments who have some flexibility over product offerings and/or pricing power may find it more profitable to offer a borrower a qualified mortgage rather than a non-qualified mortgage if, for such lenders, the expected value of the heightened legal protection is enough of an expected cost savings to offset any revenue reduction from making the qualified mortgage. For example, a creditor may restructure the price of a transaction with points and fees otherwise just above the points and fees limit for a qualified mortgage to have fewer upfront costs, and a higher interest rate, so that the loan is then under the limit and a qualified mortgage. Similarly, situations could exist where lowering the price on a loan would make the loan eligible for the safe harbor rather than the rebuttable presumption. The prevalence of these situations, or others similar situations, is hard to predict and depends on the future prices for mortgages in each of these segments, the competitive nature of the segments, and the individual lender’s and borrower’s situation. The benefits of the rule, as discussed above, will be widely shared among individual borrowers, creditors, investors, and the public (consumers) generally. As discussed above, the loss that occurs when a consumer is unable to repay a loan is felt by the consumer, the holder(s) of that loan, and other parties outside the transaction including other consumers and would-beconsumers. Ensuring that lenders make a reasonable and good faith determination of the borrower’s ability to repay should prevent a widespread deterioration of underwriting standards, the extension of excess credit and the broader negative effects that can have on these parties. To the extent lenders are deterred from making unaffordable loans, or encouraged to make more affordable loans, all of these parties will benefit. VerDate Mar<15>2010 21:02 Jan 29, 2013 Jkt 229001 3. Potential Costs of the Ability-ToRepay Provisions to Consumers and Covered Persons In this part the Bureau considers costs to consumers and covered persons of the ability to repay provisions of the statute and final rule, including any potential cost in the form of reduced access to credit for consumers. The primary ongoing costs of the requirements of the final rule rest in the underwriting costs, including costs at origination to verify information on which the lender relies in the underwriting decision and the increased liability on lenders and assignees. As previously noted, in the current environment, lenders are already largely complying with these requirements and thus the rule should impose minimal, if any, ex ante costs. But in other credit environments, when creditors may wish to lower their underwriting criteria and require less documentation and perform less verification, the rule would require them to make a good faith and reasonable determination of ability to repay and to require them to incur exante costs to document, verify and consider income and debt (and credit history). This should increase the quality of underwriting of mortgages at origination and thereby limit the prevalence of future delinquency and default, and the level of ex-post costs. (Of course, exogenous or unanticipated events and borrower behavior will still result in some delinquent and defaulting loans and some possible legal actions.) In this scheme, the possibility of legal recourse by the borrower serves as an incentive for better lender assessment of repayment ability as well as offering borrowers redress for wrongdoing. Lenders will determine the optimal combination of upfront underwriting cost and ex-post liability costs; to the extent these costs increase and competitive conditions allow lenders to pass this cost onto borrowers, some borrowers will pay more for their loans. At the margin, certain loans that were made in the past, namely those where the borrower has limited ability to repay, will not be made. a. Costs of the Documentation and Underwriting Requirements Two distinct requirements of the final rule—the requirement to verify income or assets, debt, and credit history, and the requirement to underwrite a mortgage based on an assessment of debt load using the fully indexed rate and fully amortizing payment—create costs for certain creditors and consumers. The final rule follows the statute in requiring that all creditors PO 00000 Frm 00157 Fmt 4701 Sfmt 4700 6563 verify borrowers’ income, debt and credit history. Reduced documentation loans were originally offered to high credit quality borrowers with substantial incomes. However, in the 2000’s, the prevalence of these loans increased substantially and the borrowers to whom they were offered changed. Anecdotally, some of these loans could have been made with full documentation; however, for that subset of loans, it was precisely the reduced processing times and paperwork costs of originating these loans that made them popular among mortgage brokers and originators during the boom. From this perspective, for certain consumers and creditors, requiring full documentation and verification may result in the loan being made with a less efficient contractual form, or possibly in the loan not being made. In these latter cases, consumers would lose the benefits they get from the mortgage (the benefits of owning a home, for example, or the benefits of obtaining better terms on a loan through a refinancing) and creditors would lose any profits on the loan. However, for most other originators, and consumers, reduced documentation loans were a way to grant credit to unqualified borrowers who did not have the means to afford the mortgage. As discussed in the benefits section, the elimination of these loans in these circumstances is a principal benefit of the rule.204 For borrowers for whom the most efficient outcome (from a societal perspective) is, in fact, a reduced documentation mortgage, the requirements in the final rule have two possible costs. The time and material to verify the required underwriting elements with documents are true resource costs; depending on competitive conditions, the lender or the borrower may bear the actual costs. Precise estimates of these costs from time and motion studies or cost function analyses are not available, but the required pay stubs or tax records should not be a large burden. The final rule allows income to be verified utilizing copies of tax returns which the consumer can provide the creditor and permits debts to be verified utilizing a credit report. For those with more idiosyncratic income sources that would somehow not be reflected on a tax return, the costs may be slightly higher. However, it is also possible that certain loans that would be made absent the documentation requirements would not be made under the rule. This could happen, for example, in cases where the 204 In these cases, the requirements of the final rule are the benefits that were described earlier. E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6564 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations cost of documenting the required factors is sufficiently high or where the borrower pays an exorbitant ‘‘privacy’’ cost in disclosing the documents. The final rule only requires that income or assets be verified to the extent they are relied upon by the creditor in assessing the consumer’s ability to repay; thus the consumer is not required to disclose or document income or assets except if the consumer prefers to have her ability to repay assessed without regard to the undisclosed information. In the event that there are cases in which, despite these rules, a consumer who could qualify for a mortgage is unwilling to incur the privacy cost in documenting income or assets, the transaction will not occur: and the benefit to consumers and lenders from these ‘lost’ transactions is the relevant cost. Relative to industry practice today, these requirements are likely to impose only a very limited burden for creditors. With the exception of the two situations discussed below, most loans today are made under very stringent, and perhaps inefficiently high, documentation requirements.205 The Bureau understands that full documentation is required for all purchase loans and many refinance loans being supported by government programs such as FHA. In addition, both Fannie Mae and Freddie Mac currently require full documentation. The Bureau believe that only a small subset of loans that creditors intend to hold on portfolio are underwritten today without the documentation that meets or is very close to the documentation required by the final rule. For this limited set of loans, the rule imposes the costs already described: The direct compliance costs to collect the required documentation in order to verify the information provided by the consumer and any costs from forgone transactions. One exception to the stringent documentation requirements now prevailing in the market (and exceeding the requirements of the rule) are certain streamlined refinance programs aimed at aiding the housing market recovery and certain targeted housing support programs offered to low and moderate income borrowers. The Bureau recognizes that the requirements of the final rule could greatly increase costs for these programs and hinder their success. It also recognizes that the possibility of consumer harm is likely limited in these contexts. As a result, elsewhere in today’s Federal Register the Bureau is proposing certain 205 To the extent that these requirements are inefficiently high, the cost is due to current practice and not to the final rule discussed here. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 exemptions from these requirements and seeking comment on the scope of such exemptions. There may also be some situations where lenders may have systems to document and verify the required information, but who do so in a manner that varies slightly from the provisions of the rule. These lenders may have to bear some costs to modify their systems or practices, but as noted above the Bureau understands there to be few such cases. Lenders who do collect information as required by the final rule, but who may use it differently may also incur some costs. For example, certain lenders may have systems or procedures in which the calculation of the DTI ratio does not conform to the requirements in appendix Q. Such a creditor could continue its current practices, which should they satisfy the ability-to-repay requirements, albeit without the benefit of a presumption of compliance. Lenders that prefer to make qualified mortgages with a presumption of compliance would have to bear the costs to modify systems or make other changes in order to calculate the required figures according to the rule. Modifications to information technology systems may also be necessary to enable lenders to label and track qualified mortgages. More broadly, the Bureau also recognizes that the establishment of the ability-to-pay requirements and the related distinction for qualified mortgages under the Act, will require modifications to existing compliance systems and to creditors’ other management policies and procedures. For example, review and monitoring procedures may have to be altered to ensure compliance with the new requirements. Again, given the current state of the mortgage market, it is likely that many of these procedures are largely already in place. If measured relative to the benchmark of the earlier periods, either the period from 1997 to 2003 or the later years of the bubble, the requirements of the final rule could be seen to impose more substantial costs. Over the former period, there were more limited documentation loans than today, however it appears that many of these arose in the situations described where such lending is efficient. By the latter period, there were even more such loans and the balance appears to have shifted to one where many if not most of the limited documentation loans had misstated income and other deficiencies. During those periods there were likely some lenders, as evidenced by the existence of no-income, no-asset (NINA) PO 00000 Frm 00158 Fmt 4701 Sfmt 4700 loans, that used underwriting systems that did not look at or verify income, debts, or assets, but rather relied primarily on credit score and LTV. Under the final rule, these lenders would be impacted in two ways: They would have to collect and verify income, assets and debts; and more importantly, they would have to change much of their underlying business model to consider the required factors. As noted, the Bureau does not believe such lending is currently being practiced, and the benefits of preventing such lending may be substantial (as discussed above). The requirements that all loans be underwritten assuming a fully amortizing payment and the fully indexed rate (or to obtain qualified mortgage status the maximum rate within 5 years of origination) have costs similar in nature to the documentation requirements. There are some individuals or households with projected increases in income that will match the projected increased housing costs; the final rule allows the creditor to factor expected future income into the denominator of the debt-to-income calculation but does require that the numerator be calculated on the fullyindexed payment. There also may be individuals with constant income but a housing need that is shorter than the introductory period. In at least these latter cases, there may be some loans where it is efficient to qualify the borrower only on the current payment or some other amount. It is difficult to quantify the set of borrowers affected in this way, however to the extent that those loans are not made, both the lender and borrower will incur the costs of lost profits and lost consumer benefits, respectively. The provisions of the rule requiring extended retention times for documentation sufficient to show compliance with the rule (from two years to three years) will also impose some very limited costs on creditors. Electronic storage, communication and backup are very inexpensive and are likely to decrease in costs further. b. Liability Costs Creditor may trade off the ex-ante underwriting cost just discussed with ex-post liability costs that stem from TILA’s liability provisions and their interaction with the rule’s qualified mortgage and presumption of compliance provisions.206 Qualified 206 The Bureau’s regulations are accompanied by some form of liability for non-compliance, and the Bureau generally does not address litigation costs and liability as part of its analysis under Section E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with mortgages with interest rates below the threshold for higher-priced covered transactions enjoy a conclusive presumption of compliance (although disputes may arise as to whether a particular loan meets the qualified mortgage test); qualified mortgages above the specified interest rate threshold enjoy a rebuttable presumption of compliance with the ability-to-repay requirements; and, loans that are not qualified mortgages are subject to general ability-to-repay provisions, under which the borrower will bear the burden of proof for establishing a violation. Within each segment, lenders and borrowers (or their attorneys in contingency arrangements) must pay for the costs of litigation, whether such litigation arises in the context of a private right of action brought by the borrower, or a defense raised by the borrower to a foreclosure. Originators and assignees also face various contingencies that may arise if such a claim is raised or succeeds. Within each segment, the additional costs increase proportionally with borrowers’ probability of delinquency or default. For example, the additional cost for qualified mortgages with a rebuttable presumption of compliance is smallest for lower debt-to-income (DTI) ratio loans (since these borrowers are less likely to be in a position to need or want to bring claims) and increases as the DTI ratio (keeping other factors constant) rises. The same is true as the interest rate of a loan increases, assuming that interest rate is accurately calibrated to risk. In estimating empirically the long-run additional liability costs from alleged or actual violations of the final rule, the Bureau examines the mortgage market as it existed from 1997 to 2003. The Bureau applies that market data and the pre-statute baseline to compare the liability for creditors under the final 1022 because the considerations are self-evident and the analysis is simplified by assuming full compliance. In general, to the extent regulated entities under-comply with a consumer protection regulation, they will experience less compliance costs, consumers will experience less benefits, and the entities will be at a higher risk of litigation costs and liability, including from private suits to the extent the relevant statute, such as TILA, provides for private liability. In addition, even if there is full compliance, there will always be some residual risk of non-meritorious litigation. The Bureau, however, has chosen to discuss litigation costs and liability in this analysis because these considerations are particularly important in the context of this final rule. The meaning and effect of the presumption of compliance that attaches to qualified mortgages is a key issue in this rulemaking and has been a major focus for commenters and interested parties. As such, the Bureau is addressing these considerations in this analysis. In other rulemakings, the Bureau notes that consideration of litigation costs is not always necessary and remains at its discretion. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 rule to the liability they would have incurred under the legal regime that existed under federal law just before passage of the Act. i. Size of the Market Segments The data used in estimating liability costs comes from several sources. Data regarding the loans guaranteed or purchased by Fannie Mae and Freddie Mac are from the Historical Loan Performance (HLP) dataset maintained by FHFA. The FHFA shared a one percent random sample of these loans with the Bureau, along with information about their characteristics and performance. In the notice to reopen the comment period for this rulemaking, the Bureau detailed these data and requested comment. Commenters were generally supportive of using these data, but suggested looking at other sources as well including proprietary industry datasets available for sale. These data cover a large but select portion of GSE loans. In contrast, the HLP data cover the entire universe of GSE loans and even the one percent sample is more representative. As such, the Bureau believes the HLP data are the better data for the GSE segment of the market and has consulted with the suggested sources in other parts of the analysis. Over the 1997–2003 period loans guaranteed or purchased by the GSEs comprised roughly 47 percent of the mortgage market. Similarly, information on loans insured by the FHA was provided by the FHA in response to the June 5, 2012 notice. The data cover the years from 1997 to 2011 and exclude Home Equity Conversion Mortgages (HECM) as well as mortgages with seller-funded downpayment.207 Combined with loan insured by the Veterans Administration or the Rural Housing Service, these loans comprised an estimated 9 percent of the market during this period. The Bureau did not get loan-level data from the VA or RHS.208 Data on mortgages in non-agency securitizations were taken from proprietary industry sources that the Bureau has licensed. While less complete than the HLP files, these data 207 As described in the comment letter, ‘‘the data conform generally to the type and kind of FHA data featured in a recent Discussion Paper published by the Philadelphia Federal Reserve in December 2011, FHA Lending: Recent Trends and Their Implication for the Future.’’ The letter contains charts and data from that paper. 208 In sizing the mortgage market and various components, the Bureau relied on aggregate market data from the Mortgage Market Annual, published by Inside Mortgage Finance and on data provided by the Market Data section of the FHA Web site which can be found at https://www.fhfa.gov/ Default.aspx?Page=70. PO 00000 Frm 00159 Fmt 4701 Sfmt 4700 6565 also include data on the characteristics and performance of individual loans. Over the 1997 to 2003 period, this segment comprised roughly 13 percent of originations. The remaining loans are those held on the balance sheets of banks, thrifts and credit unions. While aggregate data regarding the performance of these portfolios is available, comprehensive loan level data similar to the enterprise, FHA and private-label loans is not.209 As a result, the actual characteristics of individual loans are not available. Without the temporary provisions granting qualified mortgage status to certain loans that are eligible to be purchased by the GSEs or insured by FHA, VA and RHS, of the mortgages originated during the 1997 to 2003 period, the Bureau estimates that roughly 70 percent of would have been qualified mortgages. Most of these loans would qualify for the safe harbor, and perhaps one to four percent points of these loans would have been qualified mortgages subject to the rebuttable presumption. Another 22 percent of loans would have been non-qualified mortgages subject to the ability-to-repay requirements. The remaining 8 percent of loans made over that period were appear to have been made without sufficient documentation to be permitted under TILA section 129C documentation or were subprime hybrid adjustable rate mortgages underwritten to teaser rates in a way that is no longer allowed under the final rule. An important caveat is that these estimates are not adjusted to account for: (1) Loans with total points and fees above the thresholds and therefore not eligible to be qualified mortgages; (2) the exception of rural balloon loans to qualified mortgages; or the exception for streamlined refinancings of nontraditional loans.210 Based on data from 2011, the Bureau estimates that without the temporary provisions granting qualified mortgage status to certain loans purchasable by the GSEs or insurable by FHA, VA and RHS, 76 percent of mortgages would have been qualified mortgages inside 209 The proprietary industry data available for sale only contains loan level information for portfolio loans that are serviced by the largest servicers in the country. 210 Estimates for the GSE loans and the FHA loans are derived from the datasets provided to the CFPB and described above. For loans in private label securities, estimates are made based upon reported average characteristics of loans in subprime and Alt-A securitizations. The aggregate value of loans originated and held on balance sheet are estimated using data from Inside Mortgage Finance and the distribution of DTI is assumed to mirror the distribution at the GSEs. Statistical projections described below support such an assumption. E:\FR\FM\30JAR2.SGM 30JAR2 6566 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations the safe harbor, 2 percent of mortgages would have been qualified mortgages with a rebuttable presumption, and 22 percent of mortgages would have been subject to the ability-to-repay requirements. These estimates are subject to the same limitation stated above.211 sroberts on DSK5SPTVN1PROD with ii. Liability Costs for Qualified Mortgages For qualified mortgages claimed to be within the safe harbor, borrowers will have no claim against the lender for ability-to-repay violations unless the loan does not in fact meet the requirements for safe harbor treatment. Based on the experience of loans originated during the 1997–2003 period, the Bureau estimates that roughly four percent of qualified mortgages loans will ever be 60 days delinquent and less than one percent are expected to result in foreclosure.212 The performance of the qualified mortgages that have a conclusive presumption of compliance is expected to be slightly better than these averages. The Bureau believes that only a very small fraction of these delinquent or foreclosed-upon borrowers would seek to raise an ability-to-repay claim. The conclusive presumption precludes liability for loans which meet the eligbility criteria for a safe haror, i.e. loans whose product features make 211 The estimates in this analysis are based upon data and statistical analyses performed by the Bureau. To estimate counts and properties of mortgages for entities that do not report under HMDA, the Bureau has matched HMDA data to Call Report data and MCR data and has statistically projected estimated loan counts for those depository institutions that do not report these data either under HMDA or on the NCUA call report. The Bureau has projected originations of higherpriced mortgage loans for depositories that do not report HMDA in a similar fashion. These projections use Poisson regressions that estimate loan volumes as a function of an institution’s total assets, employment, mortgage holdings and geographic presence. Neither HMDA nor the Call Report data have loan level estimates of the DTI. To estimate these figures, the Bureau has matched the HMDA data to data on the HLP dataset provided by the FHFA. This allows estimation of coefficients in a probit model to predict DTI using loan amount, income and other variables. This model is then used to estimate DTI for loans in HMDA. 212 In the HLP data, under four percent of loans originated from 1997 to 2003 that satisfy most of the requirements of the first definition of a qualified mortgage (i.e.,not no-doc or low-doc, not IO, not neg-am and with DTI ratio equal to or below 43%) were ever 60 days delinquent. Among all FHA insured loans over the same years, just under 6 percent of loans with a DTI ratio equal to or below 43 percent were ever 60 days delinquent. Some of these loans would have a conclusive presumption of compliance with the ability-to-pay requirements and others would have the rebuttable presumption. The four percent and one percent figures are likely to slightly overestimate the rates for loans in the safe harbor and may be underestimates for loans with the rebuttable presumption. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 them eligible; for which the lender verified income, assets, and debts and properly calculated the DTI ratio to be 43 percent or less; and which are not higher priced. And even if a loan is erroneously categorized as a qualified mortgage with a safe harbor, a borrower still cannot recover unless the lender has violated the general ability-to-repay requirements, including the requirement that the lender make a ‘‘reasonable and good faith’’ determination that the consumer had the ability to repay. Generally, only a small percentage of borrowers contest foreclosure and even smaller percentage do so with the benefit of legal representation. This fact, and the limited chance of success for borrowers to raise successful claims, makes it very unlikely that many claims will arise from borrowers with these qualified mortgages. For qualified mortgage loans above the higher-priced threshold, costs (as well as benefits) of the final rule derive from the differences, including differences with respect to the originator and assignee liability, between the existing liability rules and the final rule. Under existing rules, creditors that make a higher-priced mortgage loan (HPML) are not allowed to extend credit without regard to ‘‘the consumer’s repayment ability as of consummation, including the consumer’s current and reasonably expected income, employment, assets other than the collateral, current obligations, and mortgage-related obligations.’’ Further, a creditor is presumed to have complied if the creditor properly verifies and documents income and assets, made the determination using the largest payment of principal and interest scheduled in the first seven years following consummation, and took into account the ratio of total debt obligations to income, or the income the consumer had after paying debt obligations. As noted, 1 to 4 percent of loans, based on data from the 1997- 2003 period, are estimated to be qualified mortgages with a rebuttable presumption. As just described, the delinquency rates and default rates are expected to be just around 4 percent and 1 percent respectively. Nearly all of the mortgages that will be qualified mortgages above the higherpriced threshold are currently covered by the existing HPML presumption of compliance,213 because the 213 There may be some loans that are currently made with a rebuttable presumption that will no longer have that presumption but instead will be covered the general ability to repay standards. For example, higher priced covered transactions with more than three points and fees will not qualify for the presumption under the final rule. PO 00000 Frm 00160 Fmt 4701 Sfmt 4700 requirements in the final rule that qualified mortgage loans be fully documented, have verified income and be underwritten to the maximum payment in the first five years of the loan (with the exception for rural balloon loans) will in most cases also satisfy the requirements for obtaining the presumption under the 2008 HOEPA Final Rule. The final rule’s requirements for obtaining the status of a qualified mortgage (and thus the rebuttable presumption) are slightly more prescriptive than the existing rules for gaining that presumption and this difference in the criteria for qualification may leave borrowers with slightly less opportunity to rebut the presumption of compliance.214 For the subset of these borrowers that are in default more than three years into the mortgage, that seek to and are able to successfully rebut the lender’s presumption of compliance (when seeking an offset during foreclosure), and that are therefore entitled to compensation, the returns from this action are in fact reduced relative to the existing rules which do not limit the recovery period in a claim for offset in a foreclosure proceeding brought by the creditor. As such, the probability that lenders will have to defend such an action is reduced relative to current rules although the subset described above is likely to be so small that the impact will be immaterial. As discussed below, relative to the existing rules lenders may face increased putback risk from investors although that, too, is small. For the set of borrowers that are in default within the first three years, potential damages are not reduced; however, the increased requirements at origination to qualify for qualified mortgage status, and the correspondingly more limited grounds on which to rebut the presumption reduce the probability of a successful challenge. So here too, the probability that lenders will have to defend such an action may be reduced or at least held constant relative to current rules. Overall, therefore the ex-post liabilities 214 Under the Board’s rule, the presumption of compliance attaches if the creditor ‘‘tak[es] into account’’ either the ‘‘ratio of total debt obligations to income or the income the consumer will have after paying debt obligations.’’ The consumer may rebut the presumption ‘‘with evidence that the creditor nonetheless disregarded repayment’’ such as by offering ‘‘evidence of a very high debt-toincome ratio and very limited residual income.’’ Under the final rule, however, a creditor cannot claim the benefit of the presumption of compliance if the debt to income is very high, since the final rule contains specific debt-to-income criteria for qualified mortgages. Thus, under the final rule, to rebut the presumption the consumer must prove insufficient residual income. E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with for lenders are likely reduced for these loans. Relative to current rules for HPMLs, the current rule extends liability to assignees.215 The establishment of assignee liability does not increase the amount that a borrower can obtain from a successful legal action; however, it does increase the number of parties from whom the borrower can seek redress. Borrowers in a foreclosure action in a judicial state can now assert their claim against the assignee bringing the foreclosure action, rather than having to initiate an affirmative lawsuit against the originator that no longer holds the loan. The effect is to reduce the costs of bringing these defensive actions and therefore increasing their likely number. For loans that are not sold, or for borrowers wishing to bring affirmative actions, the establishment of assignee liability has little or no effect. The extension of liability to assignees may also increase the cost of contracting between the two parties. Under the final rule, the borrower now has a contingent claim against two parties. As a result, the two parties will want to contract exante about the extent of each party’s liability under the various contingencies. This increase in contracting costs should be small for two reasons. First, even in the absence of assignee liability, the market has already included these contingencies in standard contracts. For example, following the Board’s 2008 rule, the Fannie Mae seller servicer guide was amended to include provisions that HPMLs are ‘‘eligible for delivery to Fannie Mae provided [that] * * * lenders represent and warrant when they sell an HPML to Fannie Mae that the mortgage complies in all respects with Regulation Z requirements for HPMLs, including the underwriting and consumer protection requirements.216’’ 215 As amended by section 1413 of the DoddFrank Act, TILA provides that when a creditor, an assignee, other holder or their agent initiates a foreclosure action, a consumer may assert a violation of TILA section 129C(a) ‘‘as a matter of defense by recoupment or setoff.’’ TILA section 130(k). There is no time limit on the use of this defense and the amount of recoupment or setoff is limited, with respect to the special statutory damages, to no more than three years of finance charges and fees. In contrast, for high cost loans as under existing law, an assignee generally continues to be subject to all claims and defenses, not only in foreclosure, with respect to that mortgage that the consumer could assert against the creditor of the mortgage, unless the assignee demonstrates, by a preponderance of evidence, that a reasonable person exercising ordinary due diligence, could not determine that the mortgage was a high cost mortgage. TILA 131(d). 216 See Fannie Mae, ‘‘Delivery of Higher-Priced Mortgage Loans, Revised Qualifying Rate Requirements, Assessment of Late Charges, Clarifications to Points and Fees Limitation, and VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 The Freddie Mac seller servicer guide has similar provisions.217 With contracts like these already in place, it appears that amending contracts for the particulars of the final rule should be small. Second, underwriting guidelines, pooling and servicing agreements and other contracts in the mortgage market are currently being reworked and refined.218 Among the myriad of changes, addenda to manage the abilityto-repay liabilities of the current rule should be only a small cost. iii. Non-Qualified Mortgages and Estimation of Costs The remaining loans are not qualified mortgages. These include for example, mortgage loans with a back-end DTI ratio over 43 percent, loans with points and fees above three percent of the loan balance, mortgages with a term over 30 years, or balloon loans that do not qualify for qualified mortgage balloon definition.219 For loans in this segment priced below the higher-priced threshold, the obligation to assess the consumer’s ability to repay and the liability where the lender fails to do so is a new liability for both the originator and any assignees. For loans in this segment above the higher-priced threshold, lenders cannot invoke a rebuttable presumption of compliance and for those loans that are not highcost loans, assignees are subject to expanded liability as compared to current rules.220 The Bureau has estimated litigation costs under the new ability to pay standards for non-qualified mortgages. Estimating costs for non-qualified mortgages should reasonably serve an upper bound for the costs for qualified Updates to Reporting under the Home Mortgage Disclosure Act,’’ Announcement 09–24 (July 10, 2009), available at https://www.fanniemae.com/ content/announcement/0924.pdf. 217 See Freddie Mac, ‘‘Higher-Priced Mortgages Loans and Rate Spread Data,’’ Bulletin 2009–17 (July 8, 2009), available at https:// www.freddiemac.com/sell/guide/bulletins/pdf/ bll0917.pdf. 218 See Federal Housing Finance Agency, ‘‘Strategic Plan for Enterprise Conservatorships,’’ (Feb. 21, 2012), available at https://www.fhfa.gov/ webfiles/23344/ StrategicPlanConservatorshipsFINAL.pdf. Also see Federal Housing Finance Agency, ‘‘Building a New Infrastucture for the Secondary Mortgage Market,’’ available at https://www.fhfa.gov/webfiles/24572/ FHFASecuritizationWhitePaper100412FINAL.pdf. 219 The Bureau believes that the requirements for higher-priced balloon loans made by lenders who do not meet the rural or underserved test effectively ban these products. 220 Note that several state laws have ability-torepay requirements applicable to conforming loans and/or higher priced loans, and there are variations in their applicability, requirements, and liability provisions. The benefits and costs of the final rule will be attenuated to the extent that certain states already provide similar requirements. PO 00000 Frm 00161 Fmt 4701 Sfmt 4700 6567 mortgages. Costs for putbacks, or loans the buyers of which force the sellers to take back on their books because they do not satisfy the final rule are also estimated. Estimating the increased liability costs involves a series of assumptions about the performance of these loans, the probability that borrowers will bring particular actions, and the subsequent behavior of lenders and courts. Some assumptions about costs are also necessary. Under the ability-to-repay provisions, consumers can bring an action against the lender at any point during the first three years of the loan or as an offset to foreclosure at any time. In the latter cases, the recovery of interest and finance charges is capped at the amount paid during the first three years. The Bureau has estimated these costs as follows. To begin, assume an average loan balance of $210,000 (just below the mean balance for first lien loans reported in HMDA in 2011), an average interest rate of 7 percent (the average mortgage rate for 30 yr. mortgages from 1997 to 2003) 221, and an average of $3,150 (1.5 points) paid up front in fees. Further, assume that, on average, affirmative cases and contested early foreclosures happen at the midpoint of the period, 18 months after consummation. This implies that for the affirmative cases, and the early foreclosures borrowers contest, successful borrowers are reimbursed for fees and interest an average of roughly $29,200.222 (The Bureau assumes in this calculation that all prevailing borrowers receive $4,000 in statutory TILA damages.) For the later foreclosures, defined here as foreclosure that occur three or more years after loan consummation, borrowers who contest foreclosure are reimbursed for 36 months of interest or roughly $51,250. Based on data from the FHFA for 1997–2003 for loans with DTI ratios above 43 percent, it is reasonable to assume, 3.5 percent of loans reach 60 day delinquency during the first three years of the loan but do not start a foreclosure process, an additional 1.5 percent of loans start the foreclosure process within the first three years, and an additional 1.5 percent of loans start the foreclosure process after three 221 H.15 monthly series from Federal Reserve Board of Governors downloaded from St, Louis Fred at https://research.stlouisfed.org/fred2/series/ MORTG/downloaddata?cid=114. 222 Because some of the costs are independent of loan size, one has to make assumptions about the underlying loan value; otherwise, all calculations could simply be done as percentages of loan balances. The figures used here are consistent with those used by commenters that provided similar calculations. E:\FR\FM\30JAR2.SGM 30JAR2 6568 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with years.223 The Bureau believes that consumers who have fallen behind on their mortgage payments are unlikely to initiate an ability to repay claim in court prior to foreclosure. Rather, they will likely seek to work with their servicer and the owner of the loan to cure the delinquency through, e.g., forbearance or some form of loan modification, or where that is not possible, to reach an agreement to enable the consumer to walk away from the property and the loan (i.e., deed in lieu or short sale). Once a foreclosure proceeding is commenced, however, it will then be in the interest of consumers to assert ability-to-repay claims where there is a plausible basis to do so; this is especially true in judicial foreclosure states because an ability-to-repay claim can be asserted as a defense by way of offset against whoever holds the loan at the time of the foreclosure (i.e., the originator or assignee). The ability of consumers to assert such claims either defensively or, in non-judicial foreclosure states, in affirmative actions will depend to some extent upon their ability to obtain legal representation. In its notice reopening the comment period for the rule, the Bureau specifically requested information and data regarding the frequency of such actions. In general, industry commenters asserted, that even under the rebuttable presumption standard, future legal actions under the rule would be very common. In contrast, consumer and community groups pointed to the available evidence and experience to suggest that only a very small minority of consumers in foreclosure are represented and that very few claims are brought. Consumer group commenters pointed out the practical limitations of consumers to bring an ability-to-repay claim, noting that few distressed homeowners would be able to afford and obtain legal representation often necessary to mount a successful rebuttal in litigation. Consumer groups also provided percentages of borrowers in foreclosure who are represented by lawyers, noting the difficulty of bringing a TILA violation claim, and addressed estimates of litigation costs, such as attorney’s fees. The data provided however are quite limited: two commenters (both 223 These values are derived from GSE loans with at DTI ratio above 43% originated during the 1997– 2003 period. For these loans, roughly 7 percent ever reached 60 days late, one-half of those in the first three years. Roughly 3 percent ever reached 180 days delinquent which is a rough proxy for foreclosure. One could also assume that some additional borrowers simply stop paying their loans strategically in order to extract funds from the originator or assignee, however that possibility seems unreasonable. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 representing industry) suggest that during the recent years there were roughly 900 mortgage-related TILA cases filed each year in Federal court while data regarding the number of TILA claims brought in state courts were not provided.224 More specifically the Bureau has considered the available evidence with respect to the extent of litigation under laws potentially analogous to this one, such as the 2008 HOEPA Final Rule (which does not provide assignee liability, except as applicable to high cost mortgages) and under HOEPA and state anti-predatory lending laws (which generally do provide for assignee liability). So far as the Bureau is aware, claims under these rules have been very infrequent. Industry participants likely have access to the most complete information about litigation activity, much of which activity is not reported in legal databases such as Lexis and Westlaw. Industry commenters, however, did not bring forth any evidence to suggest that claims have been anything but rare. Thus, relative to the one to two million annual foreclosure starts from 2009 through 2011,225 the record supports a conclusion that litigation under TILA generally and under the most directly analogous federal and state laws has been very limited. Industry commenters maintained that past experience is not a guide because new liability under the Dodd-Frank Act will increase incentives for litigation. The Bureau recognizes that the availability of new ability-to-repay remedies may make it easier for consumers to obtain representation (by providing those consumers whose loans are not currently covered by the Board rule with new rights; and those consumers whose loans are covered, with more easily asserted, and to that extent more valuable claims). Thus, the analysis below of litigation costs relies on very conservative (likely unrealistic) assumptions about the extent to which the Dodd-Frank liability provisions will increase litigation levels above levels under current laws. Among the three percent of borrowers that are in foreclosure, the Bureau assumes that 20 percent will bring an action against the lender for failing to meet the ability-to-repay requirements; that implies that 0.6 percent of borrowers will bring claims. As noted, this value is many times higher than 224 See Mortgage Bankers Association comment letter, docket CFPB–2012–0029, submitted Sep. 7, 2012. See also National Consumer Law Center comment letter, docket CFPB–2012–0029, submitted Sep. 7, 2012. 225 MBA National Delinquency Survey. PO 00000 Frm 00162 Fmt 4701 Sfmt 4700 recent experience with the 2008 HOEPA Final Rule or analogous state laws would suggest and is a very conservative upper bound. One half of these borrowers, should they prevail, are assumed to be entitled to 18 months of interest and the other half to 36 months of interest. Based on our assumed loan size ($210,000), interest rate (7%), and origination fees ($3,150) as discussed above, on average a successful borrower will have a claim of $40,225 (including the statutory TILA damages, before legal costs). To estimate legal costs, assume that in each case, the lender will move for summary judgment based upon what they are likely to claim to be undisputed evidence documenting their consideration of borrowers’ ability to pay. The consumer would likely claim that he or she was unable to pay the mortgage from its inception, and would have to present evidence from which it could be inferred that the creditor did not make a ‘‘reasonable and good faith determination’’ of the consumer’s ability to repay. To estimate legal costs, assume that in each case, following any discovery permitted, the lender will move for summary judgment, which is a written request for a judgment in the moving party’s favor (along with a written legal brief in support of the motion with supporting documents and affidavits) before a lawsuit goes to trial, claiming that all factual and legal issues can be decided in the moving party’s favor, as a means to avoid trial altogether. The opposing party (i.e., the consumer) would need to show that there are triable issues of fact. The analysis assumes that, in these motions, the lender will succeed four-fifths of the time. In the remaining one fifth of cases, the lender settles prior to summary judgment and pays the full value of the claim. This assumption is also conservative. In evidence provided by industry commenters which the commenters suggested were analogous, lenders prevailed in nearly all of the cases cited. To litigate these cases, the borrower is assumed to spend 60 hours of attorney time up to and including responding to the motion for summary judgment while the lender, given its resources, is assumed to spend 170 hours up to and including filing the relevant motions.226 In 2011, the average wage for lawyers in the legal services industry was $68.75/ hr; adjusting that figure to reflect benefits and other forms of 226 Comment letters submitted to the Board suggest roughly this number of hours when assessing the cost of a rebuttable presumption. See MBA Comment Letter dated July 22, 2011. E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations compensation, and a 50 percent markup for firm yields an hourly rate for legal services of $150/hr. With these assumptions, borrowers are willing to bring cases, and lenders will defend them, since on average both sides are ahead relative to simply dropping the claim or paying it in full.227 To reflect the expected value of these costs, the costs of non-qualified mortgages would increase by 10 basis points (0.1 percent of the loan amount, or roughly $212 for the $210,000 loan).228 Assuming loans with a weighted average life of four years, this could add roughly 2.5 basis points (0.025 percentage points) to the rate of each loan. Were the whole cost passed on to the consumer, increasing the rate from 7.0 percent to 7.025 percent, the monthly payment would rise by roughly $3.50. The resource cost to litigate this case is also roughly 10 basis points since it includes the lenders’ and the borrowers’ legal expenses of $25,500 and $9,000, respectively, and excludes the transfer of $40,225 that occurs in successful cases. iv. Sensitivity Analysis sroberts on DSK5SPTVN1PROD with As part of a sensitivity analysis, the Bureau has estimated these costs under different assumptions. Notably, industry commenters provided estimates of the costs for various types of cases related to mortgage actions. These comments suggest a much higher cost for legal expenses of $300 per hour and closer to 300 hours to litigate cases that involve motions for summary judgment. Using these figures (and the assumption that borrowers’ legal expenses include a proportionally higher 150 hours at $300/hr), the increased cost of each loan is approximately 31 basis points or an increase in the interest rate of just under 8 basis points (0.08 percentage points). Importantly, in this scenario, using the assumptions set forth previously about loan size and other factors, lenders would spend $107,000 to defend claims worth substantially less than the legal costs ($40,225).229 It is possible, however, that lenders would be willing to litigate such cases in order to discourage future litigation but, if so, 227 For illustration purposes, the Bureau assumes that 20 percent of the potential litigants have private costs of litigation of less than $1,000. Under the assumptions above, the creditor prefers to incur the legal costs to file for summary judgment as opposed to settling outright (the creditor’s expected payoff is roughly $5,000 dollars more in this case). 228 This is calculated as 0.6 percent of borrowers bringing cases multiplied by $35,345 in expected lender costs per case divided by the $210,000 loan amount. 229 At the same time, higher litigation costs may deter certain consumers from bringing suit. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 one would expect a corresponding diminution of litigation over time. As a second sensitivity test, going back to the original legal cost estimates, one can assume that of the 3.5 percent of borrowers who find themselves behind on their payments during the first three years, 84 percent (or 3 percent of total borrowers) chose to bring affirmative claims. This would quintuple the original estimates on a per loan basis to fifty basis points spread over a four-year average life. Similarly, one could assume that a larger percentage of borrowers in default bring claims. Raising that assumption from 20 percent to 40 percent results in estimated costs of 20 basis points per loan. Originators and assignees share the liability for ability-to-repay violations. Depending on the contract in place, lenders will bear some repurchase risk for those loans that are sold into the secondary market. For example, sellers of loans to the GSEs already bear this risk for HPMLs since the enterprises have the right to put the loan back in case of ability-to-repay violations. In cases where the lender is defunct or there are other issues affecting the lender’s capacity to reassume the risk, the purchaser of the loan may be unable to exercise that right and will bear the additional liability costs. The need of both the seller and the buyer to budget for expected capital and liquidity charges in these situations, and to negotiate the specific transactions, will also add some costs. However, in recent work, some economists have estimated that even for loans from the 2005 to 2008 vintage repurchase risk added conservatively about 19 basis points (or 0.19 percent of the loan amount) to the cost of a loan. Given the much lower default rates in the coming years (based on the default rates during the 1997– 2003 period), and the increased underwriting requirements mandated by the final rule even for non-qualified mortgages, these costs are likely to be closer to 1–3 basis points at most.230 v. Summary of Litigation Costs Combining liability costs and repurchase costs, estimated costs for non-qualified mortgage loans (loans 230 Securitized loans performed very poorly just following the bubble, with delinquency rates many times that of loans in more typical times. Adjusting the figures to reflect this better performance and the increased origination standards in the final rule, yields the 1–3 basis points. See Andreas Fuster, Laurie Goodman, David Lucca and Laurel Madar, Linsey Molloy, Paul Willen, The Rising Gap Between Primary and Seconadary Mortgage Rates, November 2012 available at: https:// www.newyorkfed.org/research/conference/2012/ mortgage/primsecsprd_frbny.pdf. PO 00000 Frm 00163 Fmt 4701 Sfmt 4700 6569 made under the ability-to-repay standard without any presumption of compliance) are estimated to increase by approximately twelve basis points (or 3 basis points (0.03 percentage points) on the rate); under very conservative estimates, this figure could be as high as forty basis points (or ten basis points (0.01 percentage points) on the rate). Depending on the competitive conditions in the relevant product and geographic markets, some of this increase will be passed on to borrowers and the rest will be absorbed by lenders. Certain borrowers may be priced out of the market as a result of the price increase. However, the number of such borrowers is likely to be very small given the values above since an increase of even ten basis points on the rate on an average mortgage would increase the monthly payment by less than $10. vi. Temporary Provisions for Qualified Mortgages As described in the preamble, the final rule recognizes the fragility of the current mortgage market and therefore includes temporary measures extending qualified mortgage status to loans that in the long run may not be qualified mortgages. These include loans with a DTI above 43 percent and that nonetheless can be purchased or guaranteed by the GSEs, insured by the FHA, VA or RHS. Based on the data as of year-end 2011, such loans are approximately 18 percent of the market. Without fuller data on the points and fees and product features associated with most loans, it is hard to estimate precisely the size of this segment or predict how large it would be several years from now with, or without, the statute taking effect. Ignoring those features, based on information about the rates and fees on these loans we believe roughly 97 percent of these loans should qualify for the legal safe harbor with the conclusive presumption of compliance (i.e., they are not higher-priced covered transactions) and 3 percent are estimated to qualify for the rebuttable presumption (i.e., they are higher-priced covered transactions). The temporary expansion of the definition of a qualified mortgage results in over 95 percent of the market being granted qualified mortgage status. Extending qualified mortgage status to these loans reduces costs to lenders as described above and limits some of the consumer protections that an increased possibility of liability would create if a creditor were able to satisfy the GSE or federal agency underwriting standards without having a reasonable and good faith believe in the consumer’s ability to repay. However, the added certainty E:\FR\FM\30JAR2.SGM 30JAR2 6570 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with from this reduced liability should benefit both consumers and covered persons. The mortgage market is still fragile, even four plus years past the most turbulent portions of the financial crisis. With lenders and the markets in general adjusting to new regulations designed to counter the forces behind the crisis, extending qualified mortgage status to these segments of loans should limit any disruption to the supply of mortgage credit with only limited effects on consumers. The extension of qualified mortgage status to these loans should allow the market time to digest the rules and for any increase in premia associated with uncertainty about litigation and putback costs to diminish. c. Access to Credit Overall, the Bureau believes that the final rule will not lead to a significant reduction in consumers’ access to consumer financial products and services, namely mortgage credit. The Bureau notes the potential for the ability to repay requirements, including increased documentation and amortization requirements, to prevent some consumers from qualifying for a loan. First, the final rule generally bans no-doc and low-doc loans to the extent the level of documentation is lower than that required by the rule. The final rule would by definition prevent borrowers who would only qualify for these types of loans from receiving a mortgage; as discussed, that is one of the benefits of the rule. Second, the final rule generally increases documentation requirements for mortgage loans and requires underwriting to be done based on an assumed fully amortizing loan at the fully indexed rate. As noted above, when measured against the current marketplace, the Bureau anticipates the effect of these requirements on access to credit to be very small. The Bureau anticipates that, as the economy recovers, the currently restrictive credit environment will loosen. Indeed, if anything, the Bureau anticipates that the immediate effect of the rule may be to contribute to the recovery of the mortgage market by reducing legal uncertainty which may be affecting lending. This is especially true if the impact of the rule were compared to a post-statutory baseline (i.e. to the implementation of the DoddFrank ability to pay and qualified mortage provisions without implementing regulations.) Measured against the years leading up to the financial crisis, when lending standards were quite loose, the effects of the final rule on access to credit would of course have been significantly larger. The final rule will set a floor to the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 loosening of credit in order to prevent the deterioration of lending standards to dangerous levels. A primary goal of the statute was to prevent a repeat of the deterioration of lending standards that contributed to the financial crisis, which harmed consumers in various ways and significantly curtailed their access to credit. Such a goal will, by definition, entail some potential diminution of access to credit as market standards change over time. The Bureau believes that, to the extent the final rule reduces credit access, it will primarily reduce inefficient lending that ignores or inappropriately discounts a consumer’s ability to repay the loan, thereby preventing consumer harm, rather than impeding access to credit for borrowers that do have an ability to repay. The Bureau notes that the rule may have a disproportionate impact on access to credit for consumers with atypical financial characteristics, such as income streams that are inconsistent over time or particularly difficult to document. There also exists the potential for both increased documentation requirements and increased liability to increase the price of mortgage loans for some consumers. As discussed above, price increases from both increased documentation requirements and increased liability should be small. The documentation requirements, such as providing a pay stub or tax return, will impose relatively little additional cost to most consumers. Similarly, the increased documentation costs for creditors should not be significant, or result in more than relatively small increases in the cost of mortgage loans. With respect to liability costs, the Bureau notes that over 95 percent of the current market is estimated to satisfy one of the definitions of a qualified mortgage, greatly reducing the expected cost of litigation. The Bureau also notes that the clear standards established for determining whether a loan is a qualified mortgage should reduce uncertainty regarding litigation costs, which will mitigate any resulting impact on access to credit. In light of the foregoing considerations, the Bureau believes that the ability to repay requirements and the accompanying potential litigation costs will create, at most, relatively small price increases for mortgage loans. These small price increases, in turn, are not likely to result in the denial of credit to more than a relatively small number of borrowers, some of whom commenters pointed out could be low income, at the margin. The Bureau notes that concerns have been raised concerning the application of increased documentation and PO 00000 Frm 00164 Fmt 4701 Sfmt 4700 amortization requirements to such entities as certain nonprofits and state housing finance agencies, as well as certain refinancing programs. As applied to such entities and programs, the final rule may restrict access to mortgage credit, including for consumers who may otherwise have limited credit options, while doing little to further the consumer protection purposes of the statute. To address these concerns, the Bureau has proposed separately to exempt some such entities and programs from these documentation and amortization requirements. The Bureau also notes that concerns have been raised regarding the application of the qualified mortgage criteria and the general ability to repay requirements to certain small creditors. These concerns arise from the observation that for many community banks and credit unions, for example, compliance resources are scarce and compliance costs as a percentage of revenue can be high. At the same time, these institutions employ a traditional model of relationship lending that did not succumb to the general deterioration in lending standards that contributed to the financial crisis. Moreover, because this business model may be based on particularized knowledge of customers and the development of durable customer relationships, the resulting loans may be beneficial to customers even when they do not conform to the general standards set forth in the final rule. Further, these institutions have particularly strong incentives not only to maintain positive reputations in their communities, but also, because they often keep the loans they make in their own portfolios, to pay appropriate attention to the borrower’s ability to repay the loan. Accordingly, the Bureau has proposed separately to provide additional criteria by which certain small portfolio lenders may make qualified mortgages. Greater access to credit can be associated with higher home prices and higher homeownership rates, and as discussed in the section on costs, there is some evidence of positive social effects from home ownership. As such, were the rule to overly restrict credit, it is important to note that these positive spillovers would also be limited. However, the Bureau does not believe that the rule will result in an inappropriate reduction in access to credit; rather, over time, the final rule should ensure that lending standards do not deteriorate to dangerous levels, while at the same time ensuring that lending not be too restrictive. E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations 4. Potential impacts of other provisions Below, the Bureau discusses the impacts of several other provisions of the final rule and notes their interaction with other rulemakings. These include the points and fees provisions (which interact with the HOEPA rulemaking), the provisions of the statute regarding prepayment penalties, and the definition of rural or underserved areas (which interacts with the current rulemaking regarding escrow account requirements for certain higher-priced mortgage loans and with the 2013 HOEPA final rule). The interagency rule on appraisal requirements for high-risk mortgage loans also interacts with the QM definition. sroberts on DSK5SPTVN1PROD with a. Points and Fees Provisions To be a ‘‘qualified mortgage,’’ the statute requires (among the other requirements already discussed) that the total points and fees payable in connection with the loan do not exceed 3 percent of the total loan amount and requires the Bureau to prescribe rules adjusting this limit to ‘‘permit lenders that extend smaller loans to meet the requirements of the presumption of compliance.’’ As noted earlier, such a restriction may have the effect of limiting cases where creditors, having received more funds up front, are less concerned about the long-term performance of the loan. In the final rule, that limit is amended to a tiered approach with the following limits: for a loan amount greater than or equal to $100,000, three percent of the total loan amount; for a loan amount greater than or equal to $60,000 but less than $100,000, $3,000; for a loan amount greater than or equal to $20,000 but less than $60,000, five percent of the total loan amount; for a loan amount greater than or equal to $12,500 but less than $20,000, $1,000 of the total loan amount; and, for a loan amount of less than $12,500, eight percent of the total loan amount. The higher limits for smaller dollar loans should allow more loans to be made as qualified mortgages. Data on the points and fees associated with a representative set of loans is not currently available. As a result, the Bureau cannot estimate precisely how many loans are impacted by this change. Under TILA as amended, a high-cost mortgage has points and fees equal to five percent of the total transaction amount if the transaction is $20,000 or more, and points and fees equal to the lesser of eight percent of the total transaction amount or $1,000, if the transaction is less than $20,000. Setting the maximum points and fees caps VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 based on the HOEPA triggers will help ensure that a qualified mortgage is not a high-cost mortgage because of the points and fees. The Dodd-Frank Act substantially expanded the scope of compensation included in points and fees for both the qualified mortgage and high-cost mortgage points and fees limits. In addition to compensation paid to mortgage brokerage firms and individual brokers, points and fees also includes compensation paid to other mortgage originators, including employees of a creditor (i.e., loan officers). Under the existing rule, only consumer payments to mortgage brokers are included in points and fees for the high-cost mortgage threshold. Also under the Act, any fees paid to and retained by affiliates of the creditor must be included in points and fees (except for any bona fide third-party charge not retained by the creditor, loan originator, or an affiliate of either, unless otherwise required under the rule). The final rule restates these provisions. In a concurrent proposal published elsewhere in today’s Federal Register, the Bureau proposed one alternative which would permit loan originator compensation to be netted against other upfront charges paid by the consumer and one that would not. Still, the inclusion of loan originator compensation in points and fees under the Final Rule (together with the statutory provisions implementing in the Final Rule regarding the treatment of charges due to third parties affiliated with the creditor) could have the effect of limiting the number of loans eligible to be qualified mortgages. For most prime loans, the Bureau believes that this change will not have a major impact: current industry pricing practices and the exemption for bona fide discount points suggest that few of these loans will be constrained by the points and fees limits. For loans near the border of higherpriced loans (i.e. loans one percentage point above APOR), the exemption for bona-fide discount points is reduced and for loans priced at two percentage points or more above APOR the exemption is eliminated. For these loans, the inclusion of loan originator compensation and affiliate fees could limit qualified mortgage status for certain loans. Loans that will qualify for the safe harbor, but where the borrower pays for these charges through a higher interest rate, may lose the conclusive presumption of compliance and instead have only the rebuttable presumption. This impact is most likely greater for lenders with affiliated companies whose PO 00000 Frm 00165 Fmt 4701 Sfmt 4700 6571 charges must be included in the points and fees calculations. b. Prepayment Penalties The Final Rule implements the provisions of Dodd-Frank with respect to prepayment penalties. Specifically, in accordance with the statute, the rule prohibits prepayment penalties for any mortgage other than a fixed-rate mortgage that is a qualified mortgage and not a higher-priced mortgage.231 Where the Final Rule permits prepayment penalties, it limits these penalties to 2 percent of the outstanding balance on the loan during the first year after consummation and 1 percent of the outstanding balance during the second year after consummation. Available information from the sources described above suggests that loans originated today do not contain prepayment penalties, and this is likely to be true for the foreseeable future. Neither loans originated for sale to Fannie Mae and Freddie Mac, nor loans insured by FHA generally contain prepayment penalties.232 Moreover, the Bureau understands that prime loans, which make up the vast majority of originations today, have in recent years rarely had prepayment penalties.233 Some originators may make subprime loans they hold on portfolio for which they charge prepayment penalties, but data on terms of loans on portfolio are not available and at least in the current market, this is likely to be a very small number of loans. With the low interest rates that prevail today, lenders see little reason to limit prepayment risk by charging prepayment penalties. Prepayment penalties by design impose costs on consumers to switch from their current loans to loans with lower interest rates. This cost can be particularly high for consumers with potentially increasing payments and who seek to refinance to avoid the increases. Moreover, these penalties are complex and often not transparent to consumers. Consumers may not focus on prepayment penalty terms because they are more focused on the terms they 231 For purposes of this provision of the rule, a higher priced mortgage is defined in the Act as a first lien, non-jumbo mortgage with an APR that is more than 150 basis points above APOR; a first lien, jumbo mortgage with an APR that is more than 250 basis points above APOR; and a second lien mortgage with an APR that is 350 basis points above APOR. 232 As explained in the final rule, FHA loans used a method of interest calculaton which results in consumers who pay off loans during the course of a month being obligated to pay interest until the end of the month. The Final Rule treats that as a prepayment penalty and provides an extended compliance period to allow time for FHA to change this feature of its loans. 233 See 73 FR 44522 (July 30, 2008). E:\FR\FM\30JAR2.SGM 30JAR2 6572 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations find more salient, such as interest rate and payment amount. Leading up to the mortgage crisis, some loan originators sometimes took advantage of consumers’ lack of awareness or understanding of prepayment penalties.234 Originators could sell unsuspecting consumers loans with substantial expected payment increases as well as substantial prepayment penalties that would prevent the consumer from refinancing. By limiting prepayment penalties to prime, fixed-rate qualified mortgages, the Final Rule benefits consumers by limiting these cases and lowering the cost of exiting a mortgage. Consumers will be able to refinance at lower cost, either when market rates drop or when the consumer’s risk profile improves. In other cases, consumers who are sold mortgages with rates higher than their risk profile warrants will be able to refinance their mortgages to a market rate at lower cost. In still other cases, consumers will be able to sell their homes and move at lower cost. This cost reduction from restriction of prepayment penalties is particularly important to consumers who incur drops in income or increases in expenses that cause them to struggle to make their mortgage payments. However, to the extent prepayment penalties compensate investors for legitimate prepayment risk, restricting penalties will reduce the value of certain mortgages and limit the returns to creditors and investors (which includes entities that are covered persons as well as entities that are not covered persons). In these cases, the cost of credit for some consumers will rise as creditors raise prices to compensate for increased prepayment risk. Currently, the number of loans that would have prepayment penalties but for the Final Rule appears to be very small, however, so costs to consumers and covered persons are expected to be de minimis. sroberts on DSK5SPTVN1PROD with c. Definition of Small Lenders, Rural and Underserved The final rule allows certain small creditors operating predominantly in rural or underserved areas to originate balloon-payment qualified mortgages. Specifically, this option exists for lenders originating 500 or fewer covered transactions (including their affiliates), secured by a first lien, in the preceding calendar year, with assets under $2 billion (to be adjusted annually), and 234 Over 70 percent of subprime loans from 2001 through 2007 had prepayment penalties. See Demyank and Hemert, Review of Financial Studies, 24,6, 2011. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 who made more than 50 percent of their total covered transactions secured by first liens on properties in counties that are ‘‘rural’’ or ‘‘underserved.’’ For the purposes of the final rule, and the 2013 Escrow rule published elsewhere in today’s Federal Register, the Bureau has defined rural to include noncore counties and those micropolitan counties that are not adjacent to metropolitan statistical areas using the Department of Agriculture’s urban influence codes. Relative to the proposed rule that only included a subset of rural counties, the final rule expands the exemption. The Bureau has not altered the definition of underserved from that contained in the proposed rule. Although there is no comprehensive evidence with respect to the prevalence of balloon loans, the Bureau understands anecdotally from outreach that in these rural areas, creditors sometimes have difficulty selling certain loans on the secondary market either because of unique features of the rural property or of the rural borrower. In these instances, the creditors will make a portfolio loan. Because of their small size, some of these creditors eschew ARMs and manage interest rate risk by making balloon payment loans which the creditors then roll-over based on then-current interest rate when the balloon payment comes due. Relative to a pre-statutory baseline, the rural balloon provisions of the rule have minimal effect. Relative to a poststatutory baseline in which the statute was implemented without the exception for rural lenders, the provisions of the rule have the following impacts on consumers and covered persons. Creditors covered by the rule’s definition are permitted to make balloon loans which are qualified mortgages, potentially mitigating consumer access to credit issues that might arise if balloon payment mortgages were restricted. The rule creates certain minimum, consumer-protective requirements with respect to such balloon loans, such as a minimum term of five years and a requirement that the interest rate be fixed for that period of time. The rule also requires that creditors verify and consider income and debts before making such loans (albeit without a fixed debt-to-income requirement). However, to the extent these creditors rely on this permission to make balloon loans rather than other types of qualified mortgages, the rule also denies these consumers the consumer protections associated with not giving balloon loans qualified mortgage status. PO 00000 Frm 00166 Fmt 4701 Sfmt 4700 According to the definition used in the final rule, approximately 10 percent of the U.S. population lives in areas that the Bureau defines as rural or underserved: the Bureau estimates that 2,707 small creditors, currently issuing first-lien mortgages and operating predominantly in rural or underserved areas, will be able to originate balloon qualified mortgages as a result of the provision. Given the low population density of the areas currently defined as rural, the corresponding limits on the number of creditors, and the challenges of making loans that could be sold in the secondary market, keeping this source of credit in the community with the safeguards added by the rule is likely more important to consumers than the consumer protections associated with not allowing balloon loans to be qualified mortgages. In somewhat less rural areas, for example the micropolitan counties not covered by the definition in the final rule, there are more creditors that can provide alternative forms of credit, such as ARM loans, and more creditors in general. d. Qualified Mortgages and Appraisals One impact of the current definition of qualified mortgage is related to higher-risk mortgages as defined in the Act. The Act contains special appraisal requirements with respect to higher-risk mortgages; those requirements are the subject of an interagency rulemaking process which resulted in a proposed rule in August which the agencies expect to finalize shortly. The Act generally defines a higher-risk mortgage as a closed-end consumer credit transaction secured by a principal dwelling with an APR exceeding rate thresholds substantially similar to rate triggers currently in Regulation Z for higher-priced mortgage loans, but excluding qualified mortgages. In general, as the number of loans defined as qualified mortgages increases, the number of loans that would be covered by the proposed appraisal requirements decreases. Based on the general definition of qualified mortgage in the final rule, those higher priced mortgage loans with a debt-to-income ratio of 43 or less would be exempt from the new requirements for interior appraisals. The temporary provision allowing additional loans (e.g. loans with a higher debt to income ratio and that are purchasable by the GSEs or insurable by FHA), to be qualified mortgages could further remove mortgages from that requirement. The impact of this reduction in the scope of appraisal requirements is relatively muted for first lien mortgages because of the small number of high-risk mortgages to begin E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations with and the fact that most lenders already do a full interior appraisal and share the results with the consumer. sroberts on DSK5SPTVN1PROD with E. Potential Specific Impacts of the Final Rule 1. Depository Institutions and Credit Unions With $10 Billion or Less in Total Assets, as Described in Section 1026 Some depository institutions and credit unions with $10 billion or less in total assets as described in Section 1026 may see different impacts from the final rule than larger institutions. These differences are driven by the lending practices and portfolios at smaller depository institutions and credit unions, notably those below roughly $2 billion in assets, and by the nature of these institutions’ relationship to the secondary market. The Bureau understands that lending practices at many smaller institutions (according to comment letters and outreach) are based on a more personal relationship-based model, and less on automated systems, at least when the lender plans to keep the loan on portfolio rather than sell it. To the extent that the documentation and verification requirements in the final rule differ from current practice at these institutions, the final rule may impose some new compliance costs. However, unless these institutions keep all of the loans they originate on portfolio, which seems unlikely, they are already subject to documentation requirements from the secondary market so that any incremental costs are likely to be small. In addition, data from HMDA indicate that, on average, a larger proportion of loan originations at smaller institutions are higher-priced mortgage loans and will therefore have the rebuttable presumption of compliance rather than the safe harbor. These loans already are subject to an obligation to assess repayment ability and a rebuttable presumption under the Board’s 2009 rule, so any new effects on these loans from the final rule, at least the loans these institutions keep on portfolio, are expected to be limited. Historically, delinquency rates on mortgages at smaller institutions are lower than the average in the industry and as such, the expected litigation costs for these loans are also probably quite low. Nevertheless, the proposal posted elsewhere in today’s Federal Register asks for comment on whether the safe harbor should be extended to additional loans at particular smaller institutions. The establishment of assignee liability for violation of the ability-to-repay provisions may also differentially impact smaller institutions by VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 increasing counterparty risk for entities purchasing mortgages from these institutions. As described above, creditors and secondary market purchasers are expected to contract around the new ability-to-repay liability. For example, both Fannie Mae and Freddie Mac require lenders to represent and warrant that loans sold to the enterprises meet the current abilityto-repay requirements and to repurchase loans in cases where violations are found. Under such an arrangement,235 should a consumer bring a claim, the purchaser will look to the originator to repurchase the loan; if the originator is no longer in business or does not have the financial means to do so, the purchaser will have to bear the risk. This places greater incentive on purchasers to vet potential counterparties and may impact some smaller institutions’ ability to sell loans. The impact is likely greatest for loans made under the general ability-to-repay standard rather than for qualified mortgages. In the near term, the temporary provisions expanding the number of qualified mortgages, will greatly mitigate costs for these institutions. 2. Impact of the Provisions on Consumers in Rural Areas The final rule should have minimal differential impacts on consumers in rural areas. In these areas, a greater fraction of loans are made by smaller institutions and carried on portfolio. The availability or pricing for fixed rate or adjustable-rate loans that are qualified mortgages is likely to be unaffected. Notably, the liability for these loans is nearly unchanged; those below the threshold will be subject to the safe harbor while those above the threshold have a rebuttable presumption similar to the one in place under existing regulation. Only the very small number of loans made by these institutions and then sold may be impacted by the changes in counterparty risk. Consumers constrained to borrow from these lenders may see a small increase in the price of credit, either from the lenders now having to fund the loan on the balance sheet or facing reduced prices in the secondary market. The possible increases in compliance costs just described may also lead to very small increases in rates. An important difference between the rural and the non-rural consumers is the 235 It is also possible that other contracting arrangements will develop. The industry is currently working on various changes to the traditional pooling and servicing agreements, for example. PO 00000 Frm 00167 Fmt 4701 Sfmt 4700 6573 availability of balloon loans following the rule. While the balloon loans in the non-rural areas that are not underserved cannot be qualified mortgages, small lenders operating predominantly in the rural or underserved areas can, under certain conditions, originate balloons loans that are qualified mortgages. Thus, rural consumers will preserve access to credit, while potentially experiencing the lack of protection associated with prohibiting balloon transactions from being qualified mortgages. Despite the fact that excluding a small creditor from the balloon loan market generally does not significantly disrupt the pricesetting process, this might not be true for rural markets. In particular, there are 567 counties that have three creditors or fewer (that originate five or more covered transactions per year), according to HMDA 2011. Going from three creditors to two could significantly increase prices for consumers. Data regarding the specific mortgages originated and held on bank and credit union portfolios is very limited; the exception is the data on the credit union call report showing the total number and amount of balloon loans together with hybrid adjustable-rate mortgages. According to these data, there appear to be few institutions, and therefore very few consumers affected in this way. In counties where the problem should be worst, namely micropolitan counties not covered by the rural or underserved definition, there are just under 50 credit unions that extend balloon loans and not ARMs; in total they originate 1,200 balloon loans. Consumers seeking credit at these institutions, or similarly situated banks or thrifts, may face some costs in taking a different product or in switching institutions depending on the product offerings and prices in the market. The Bureau believes any price increase is likely not significant as these areas are served by multiple lenders. On average, according to the 2011 HMDA data, 16 lenders on average made higher-priced mortgage loans in these counties, a proxy for what could be balloon loans. F. Alternatives Considered Two factors are most relevant when comparing the benefits, costs and impacts of the final rule to alternative regulatory implementations: the requirements for underwriting each loan and the eventual legal liability attached to that loan. The current rule differs from the Board’s proposal along both dimensions, particularly in regard to qualified mortgages, as it uses a slightly different structure overall, such as incorporating a specific debt-to-income E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6574 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations ratio requirement. It also varies in structure from some other proposals offered by commenters. However, even within the structure developed in the final rule, the parameters within the rule (e.g. the DTI ratio threshold) could have been different. In order to more fully illuminate the impacts of the final rule, this section first considers the final rule in comparison to the proposals and then to other reasonable alternatives. In the 2011 ATR Proposal, the Board proposed two alternative definitions for a qualified mortgage. The Board’s Alternative 1 proposed to define a qualified mortgage using only the statutory provisions (except for the discretionary requirement to consider the consumer’s debt-to-income ratio or residual income). That is, the definition of a qualified mortgage would be based on product features, cost limitations (points and fees limit) and income verification but would not require the creditor to follow any other specific underwriting procedures. Alternative 1 would have operated as a legal safe harbor with the conclusive presumption of compliance. The final rule maintains a minimum standard for documenting and verifying loans and varies the legal liability with the perceived consumer risk. Alternative 1, on the other hand, placed more emphasis on the restrictions on product features to protect consumers. Loans without interest-only, negative amortization or balloon features, or where total points and fees do not exceed three points were assumed safe and therefore had limited requirements for documenting income and debt (relative to other loans) and were afforded the conclusive presumption of compliance. Compared to this alternative, the final rule with the temporary provisions likely offers qualified mortgage status to a similar number of loans: without the effects of the temporary provisions, fewer loans would qualify as qualified mortgages. The final rule also mandates stricter documentation and verification of qualified mortgages and limits the presumption of compliance in the case of higher-priced covered transactions. Compared to Alternative 1, only those loans that meet the product, features and point-and-fee limitations and that have a DTI ratio less than or equal to 43 percent are qualified mortgages. This approach limits the reliance on compensating factors when underwriting high DTI ratio loans and recognizes that while such loans may be in the creditor’s interest, there is a greater possibility that the consumer may not have the ability to repay the loan. This change likely increases costs VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 slightly in order to provide this consumer protection. Requiring the additional verification of debts for qualified mortgages also provides additional consumer protection. Since this is current practice in the market today, this likely adds very little cost for the time being; however, it does impose costs as credit expands to the point that the market would otherwise relax verification requirements—as well as benefits to consumers and society at large from preventing loans based on unverified (or no) data. Compared to Alternative 1, the only difference in the strength of the liability protection for qualified mortgages is for those loans above the higher-priced threshold. In the final rule, these loans have a rebuttable presumption of compliance rather than a conclusive presumption. However, given that the legal standard today is a rebuttable presumption, the final rule nearly maintains the status quo for borrowers with HPMLs; adopting Alternative 1 would have been a slight diminution of these borrower’s legal rights. The Board’s Alternative 2 would have provided the lender with a rebuttable presumption of compliance and would have defined a ‘‘qualified mortgage’’ as including the statutory criteria as well the additional underwriting requirements from the general ability-torepay standard. The Board proposed to permit, but not require, creditors to comply with the underwriting requirements by looking to ‘‘widely accepted governmental and nongovernmental underwriting standards’’ (such as the FHA’s standards). The important difference between this aspect of Alternative 2 and Alternative 1 is that, under Alternative 2, the relative weights for such tradeoffs had to be derived from widely accepted standards. Compared to Alternative 2, the final rule with the temporary provisions likely offers qualified mortgage status to a similar number of loans; without the effects of the temporary provisions, fewer loans would be eligible to be qualified mortgages. Under the final rule, there is little difference in the documentation and verification requirements; however, the presumption of compliance is strengthened for the majority of qualified mortgages. Compared to Alternative 2 (and to Alternative 1), only those loans that meet the product, features and cost limitations and that have a DTI ratio less than or equal to 43 percent are qualified mortgages. This limits the use of compensating factors for high DTI loans and recognizes that while such loans may be in the PO 00000 Frm 00168 Fmt 4701 Sfmt 4700 creditor’s interest, there is a greater possibility that the consumer may not have the ability to repay the loan. This change likely increases costs slightly in order to provide this consumer protection. Both Alternative 2 and the final rule have very similar documentation and verification standards so there is little difference in the benefits and costs along that dimension. Relative to Alternative 2, the difference in the liability standard is for those qualified mortgages below the higher-priced threshold. In the final rule, these loans have a conclusive presumption of compliance rather than just a rebuttable presumption. As noted in the preamble, a coalition of industry and consumer advocates presented another alternative proposal to the Bureau that would have provided a tiered approach to defining a qualified mortgage. Under the first tier, if the consumer’s total debt-to-income ratio is 43 percent or less, the loan would be a qualified mortgage, and no other tests would be required. Under the second tier, if the consumer’s total debt-toincome ratio is more than 43 percent, the creditor would apply a series of tests related to the consumer’s front-end debt-to-income ratio (housing debt to income), stability of income and past payment history, availability of reserves, and residual income to determine if a loan is a qualified mortgage. This would have allowed some loans with up to 50 percent DTI ratios to meet the qualified mortgage definition. To the extent that it relies on additional factors beyond the DTI ratio, this alternative is similar to the Board’s approach. However, the coalition’s proposal generally restricted the factors considered to be factors related to ability to repay, rather than other factors related to credit or collateral in its determination. These commenters also supported a rebuttable presumption standard for qualified mortgages. Relative to this alternative, the final rule will likely include fewer loans as qualified mortgages. The loans that will not be qualified mortgages are those that would qualify only under one or more of the additional factors besides DTI ratio that the alternative included: housing expenses, stability of income, reserves etc. As a result, these loans will have to meet the ability-to-repay standard of the final rule, providing additional consumer protections with the minor added costs described above. Relative to a rule including these factors, the final rule is simpler and easier to implement for industry, lowering costs overall. In addition, creditors are free to include such factors in their own credit decisions and to E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations develop the best models for their inclusion. The Bureau views this more dynamic outcome as a benefit relative to a more prescriptive rule detailing how such factors should be traded off against each other. This alternative did include a rebuttable presumption of compliance for all qualified mortgages; as such, the final rule’s safe harbor limits liability costs and consumer benefits, as already discussed, for those qualified mortgages that are not higher priced covered transactions. As noted, the Bureau also considered certain alternatives to its own version of the final rule. One such alternative would have used a threshold of a 36 percent DTI ratio to define qualified mortgages. This would have left roughly an additional 15 percent of loans, both during the 1997–2003 period and during 2011, without a presumption of compliance. As noted however, the Bureau believes that 43 percent is a more efficient threshold: it is an accepted market standard, rates of delinquency and default for borrowers between 36 and 43 percent are still modest, and many borrowers— particularly in higher cost housing markets—borrow at these levels. The Bureau also considered whether all qualified mortgages should have the same degree of presumption with the qualified mortgage standard—either all being afforded a conclusive presumption of compliance or all being afforded a rebuttable presumption. As discussed in the section-by-section analysis, the Bureau determined that the bifurcated approach in which only higher-priced covered transactions provide the consumer with the opportunity to rebut the presumption of compliance best balances the concerns of costs, certainty, and consumer protection. sroberts on DSK5SPTVN1PROD with VIII. Final Regulatory Flexibility Act The Regulatory Flexibility Act (RFA) generally requires an agency to conduct an initial regulatory flexibility analysis (IRFA) and a final regulatory flexibility analysis (FRFA) of any rule subject to notice-and-comment rulemaking requirements, unless the agency certifies that the rule will not have a significant economic impact on a substantial number of small entities.236 The Bureau 236 For purposes of assessing the impacts of the final rule on small entities, ‘‘small entities’’ is defined in the RFA to include small businesses, small not-for-profit organizations, and small government jurisdictions. 5 U.S.C. 601(6). A ‘‘small business’’ is determined by application of Small Business Administration regulations and reference to the North American Industry Classification System (NAICS) classifications and size standards. 5 U.S.C. 601(3). A ‘‘small organization’’ is any ‘‘notfor-profit enterprise which is independently owned VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 also is subject to certain additional procedures under the RFA involving the convening of a panel to consult with small business representatives prior to proposing a rule for which an IRFA is required.237 In the 2011 ATR Proposal, the Board did not certify that the rule would not have a significant economic impact on a substantial number of small entities and therefore prepared an IRFA.238 In this IRFA the Board solicited comment on any costs, compliance requirements, or changes in operating procedures arising from the application of the proposed rule to small businesses, comment regarding any state or local statutes or regulations that would duplicate, overlap, or conflict with the proposed rule, and comment on alternative means of compliance for small entities with the ability-to-repay requirements and restrictions on prepayment penalties. Comments addressing the ability-to-repay requirements and restrictions on prepayment penalties are addressed in the section-by-section analysis above. Comments addressing the impact on the cost of credit are discussed below. 1. A Statement of the Need for, and Objectives of, the Rule The Bureau is publishing a final rule to establish new ability-to-repay requirements related to mortgage origination. As discussed in the preamble, the final rule’s amendments to Regulation Z implement certain amendments to TILA that were added by sections 1411, 1412, 1413, and 1414 of the Dodd-Frank Act in response to the recent foreclosure crisis to address certain lending practices (such as lowor no-documentation loans or underwriting mortgages without including any principal repayments in the underwriting determination) that led to consumers having mortgages they could not afford, thereby contributing to high default and foreclosure rates. A full discussion of the market failures motivating these provisions of the Dodd-Frank Act and the final rule is included in the preamble and in the Bureau’s section 1022 analysis above. Those discussions also describe the specific ways the final rule addresses these issues. However, in general, the purpose of the Dodd-Frank Act abilityto-repay requirements is to assure that consumers are offered and receive and operated and is not dominant in its field.’’ 5 U.S.C. 601(4). A ‘‘small governmental jurisdiction’’ is the government of a city, county, town, township, village, school district, or special district with a population of less than 50,000. 5 U.S.C. 601(5). 237 5 U.S.C. 609. 238 76 FR 27479–27480. PO 00000 Frm 00169 Fmt 4701 Sfmt 4700 6575 residential mortgage loans on terms that reasonably reflect their ability to repay the loans and that are understandable and not unfair, deceptive or abusive. Prior to the Dodd-Frank Act, existing Regulation Z provided ability-to-repay requirements for high-cost and higherpriced mortgages. Accordingly, new TILA section 129C generally prohibits a creditor from making a residential 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, including any mortgage-related obligations (such as property taxes and mortgage insurance). Consistent with the statute, the final rule applies the ability-to-repay requirements of TILA section 129C to any consumer credit transaction secured by a dwelling, except an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan. Congress also recognized the importance of maintaining access to responsible, affordable mortgage credit. To provide creditors more certainty about their potential liability under the ability-to-repay standards while protecting consumers from unaffordable loans, the Dodd-Frank Act creates a presumption of compliance with the ability-to-repay requirement when creditors make ‘‘qualified mortgages.’’ Qualified mortgages do not contain certain features that Congress deemed to create a risk to consumers’ ability to repay, and must be underwritten using standards set forth in the statute that are designed to assure that consumers will have the ability to repay these loans. The final rule establishes standards for complying with the ability-to-repay requirements, including defining ‘‘qualified mortgage.’’ The final rule provides three options for originating a qualified mortgage: under the general definition in § 1026.43(e)(2), for loans where the consumer’s monthly debt-toincome ratio would not exceed 43 percent; under the definition § 1026.43(e)(4), for a maximum of seven years, for loans that are eligible for purchase by the GSEs while in conservatorship or certain other Federal agencies, and under § 1026.43(f), for loans that have balloon-payment features if the creditor operates predominantly in rural or underserved areas and meets certain asset-size and transaction volume limits. Congress did not explicitly define the nature of the presumption of compliance that attaches to a qualified mortgage. Congress also left some contours of a qualified mortgage E:\FR\FM\30JAR2.SGM 30JAR2 6576 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with undefined, such as whether there should be a minimum debt-to-income ratio. Congress left these decisions to the Bureau and granted broad authority to revise, add to, or subtract from the qualified mortgage criteria upon a finding that doing so is ‘‘necessary or proper’’ or ‘‘necessary and appropriate’’ to achieve certain specified standards, such as ensuring that responsible, affordable mortgage credit remains available to consumers. As discussed above, the final rule recognizes both the need to assure that consumers are offered and receive loans based on a reasonable and good faith determination of their repayment ability and the need to ensure that responsible, affordable mortgage credit remains available to consumers. The Bureau believes, based upon its analysis of the data available to it, that, under the final rule, the vast majority of loans originated today can meet the standards for a qualified mortgage so long as creditors follow the required procedures, such as verifying income or assets, and current debt obligations, alimony and child support. The Bureau also believes, based upon its analysis of the historical performance of loans meeting the rule’s definition of ‘‘qualified mortgages,’’ that consumers will be able to repay these loans. The Bureau believes that the final rule will not restrict creditors’ ability to make responsible loans, both within and outside the qualified mortgage space. The final rule provides special rules for complying with the ability-to-repay requirements for a creditor refinancing a ‘‘non-standard mortgage’’ into a ‘‘standard mortgage.’’ The purpose of this provision is to provide flexibility for creditors to refinance a consumer out of a risky mortgage into a more stable one without undertaking a full underwriting process. In addition to the ability-to-repay and qualified mortgage provisions, the final rule implements the Dodd-Frank Act limits on prepayment penalties and lengthens the time creditors must retain records that evidence compliance with the ability-to-repay and prepayment penalty provisions. 2. Summary of Significant Issues Raised by Comments in Response to the Initial Regulatory Flexibility Analysis, Statement of the Assessment of the Bureau of Such Issues, and a Statement of Any Changes Made as a Result of Such Comments The Board’s IRFA estimated the possible compliance costs for small entities from each major component of the rule against a pre-statute baseline. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 The Board requested comments on the IRFA. The Board did not receive any comments in its IRFA. Industry commenters generally expressed concern with respect to the costs they anticipated from the 2011 ATR Proposal. The Bureau received numerous comments describing in general terms the impact of the proposed rule on small creditors and the need for the qualified mortgage definition to be structured as a safe harbor with clear, well-defined standards to ensure that the largest number of consumers possible can access credit. Small creditors are particularly concerned about the litigation risk associated with the requirement to make a reasonable and good faith determination of consumers’ ability to repay based on verified and documented information. Because of their size, small creditors note that they are particularly unsuited to bear the burden and cost of litigation and would find it particularly difficult to absorb the cost of an adverse judgment. Indeed, small creditors insist that they will not continue to make mortgage loans unless they are protected from liability for violations of the ability-to-repay rules by a conclusive presumption of compliance or ‘‘safe harbor.’’ These small creditors’ concerns about compliance with the ability-to-repay rule and associated litigation risk have been repeatedly expressed to the Bureau by their trade associations and prudential regulators. Several commenters on the proposal urged the Bureau to adopt less stringent regulatory requirements for small creditors or for loans held in portfolio by small creditors. For example, at least two commenters on the proposal, a credit union and a state trade group for small banks, urged the Bureau to exempt small portfolio creditors from the ability-to-repay and qualified mortgage rule. Two other trade group commenters urged the Bureau to adopt less stringent regulatory requirements for small creditors than for larger creditors at least in part because mortgage loans made by small creditors often are held in portfolio and therefore historically have been conservatively underwritten. Some industry commenters supported not including quantitative standards for such variables as debt-to-income ratios and residual income because they argued that underwriting a loan involves weighing a variety of factors, and creditors and investors should be allowed to exercise discretion and weigh risks for each individual loan. To that point, one industry trade group PO 00000 Frm 00170 Fmt 4701 Sfmt 4700 commenter argued that community banks, for example, generally have conservative requirements for a consumer’s debt-to-income ratio, especially for loans that are held in portfolio by the bank, and consider many factors when underwriting for mortgage loans, such as payment history, liquid reserves, and other assets. Because several factors are considered and evaluated in the underwriting process, this commenter asserted that community banks can be flexible when underwriting for mortgage loans and provide arrangements for certain consumers that fall outside of the normal debt-to-income ratio for a certain loan. This commenter contended that strict quantitative standards would inhibit community banks’ relationship lending and ability to use their sound judgment in the lending process. Some commenters contended that requiring specific quantitative standards could restrict credit access and availability for consumers. A number of other commenters expressed concerns that the availability of portfolio mortgage loans from small creditors would be severely limited because the proposed exception for rural balloon loans was too restrictive. Some industry commenters urged the Bureau to allow balloon mortgage loans held in portfolio by the originating banks for the life of the loan to be included under this safe harbor so that small creditors could continue to meet the specific needs of their customers. These comments, and the responses, are discussed in the section-by-section analysis and element 6–1 of this FRFA. 3. Response to the Small Business Administration Chief Counsel for Advocacy The SBA Office of Advocacy (Advocacy) provided a formal comment letter to the Bureau in response to the Bureau’s reopening of the comment period for certain issues relating to the ability-to-repay/qualified mortgage rulemaking. Among other things, this letter expressed concern about the following issues: the qualified mortgage definition and the use of data as a means for measuring a consumer’s ability to repay. First, Advocacy expressed concern that the qualified mortgage definition will have major implications on the viability of community banks. Advocacy pointed to the assertion made by small banks that they will no longer originate mortgage loans if they are only provided with a rebuttable presumption of compliance. In addition, according to Advocacy, small banks contend that establishing the qualified mortgage as a E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations rebuttable presumption of compliance will reduce the availability and affordability of mortgages to consumers due to increased litigation and compliance costs, and the exit by certain small lenders unable to manage the risk. According to Advocacy, small banks assert that one way to enable them to compete effectively (and to ensure consumers can obtain affordable loans) is to establish the qualified mortgage as a safe harbor and allow for non-traditional loans such as mortgages with balloon payments to continue to be made. The Bureau carefully considered the arguments for establishing the qualified mortgage as a safe harbor or rebuttable presumption of compliance in light of the proposed rule, and a complete discussion of the consideration of the Bureau’s final rule can be found in the respective section of the section-bysection analysis, the Bureau’s section 1022(b)(2) discussion, and in element 6– 1 of this FRFA. As discussed in more detail elsewhere, the final rule provides a safe harbor under the ability-to-repay requirements for mortgage loans that satisfy the definition of a qualified mortgage and are not higher-priced covered transactions (i.e., APR does not exceed Average Prime Offer Rate (APOR) 239 + 1.5 percentage points for first liens or 3.5 percentage points for subordinate liens). The final rule provides a rebuttable presumption for all other qualified mortgage loans, meaning qualified mortgage loans that are higher-priced covered transactions (i.e., APR exceeds APOR + 1.5 percentage points for first lien or 3.5 percentage points for subordinate lien). The Bureau believes that a bifurcated approach to the presumption of compliance provides the best way of balancing consumer protection and access to credit considerations and is consistent with the purposes of the statute, while calibrating consumer protections and risk levels to match the sroberts on DSK5SPTVN1PROD with 239 The Average Prime Offer Rate means ‘‘the average prime offer rate for a comparable transaction as of the date on which the interest rate for the transaction is set, as published by the Bureau.’’ TILA section 129C(b)(2)B). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 historical record of loan performance. To reduce uncertainty in potential litigation, the final rule defines the standard by which a consumer may rebut the presumption of compliance afforded to higher-priced qualified mortgages. The Bureau notes that the Board’s proposed § 1026.43 did not include special provisions for portfolio loans made by small creditors and the Board’s proposal did not address such an accommodation. However, this final rule is related to a proposed rule published elsewhere in today’s Federal Register. As discussed in more detail below, in that proposal, the Bureau is proposing certain amendments to this final rule, including a proposal to define as a qualified mortgage a larger category of loans made and held in portfolio by small creditors than this final rule defines as a qualified mortgage. Second, Advocacy expressed concern about using loan performance, as measured by the delinquency rate, as an appropriate metric to evaluate whether consumers had the ability to repay at the time their loans were consummated. Advocacy noted that a consumer’s circumstances might change after the loan was made due to unemployment or illness. The Bureau agrees that consumers’ circumstances can change and lead to delinquency or default. However, the Bureau also believes that DTI is an indicator of the consumer’s ability to repay. All things being equal, consumers carrying loans with higher DTI ratios will be less able to absorb any such shocks and are more likely to default. 4. A Description of and an Estimate of the Number of Small Entities to Which the Rule Will Apply The final rule will apply to creditors that engage in originating or extending certain dwelling-secured credit. The credit provisions of TILA and Regulation Z have broad applicability to individuals and businesses that originate and extend even small numbers of home-secured credit. See 1026.1(c)(1).240 Small entities that 240 Regulation Z generally applies to ‘‘each individual or business that offers or extends credit PO 00000 Frm 00171 Fmt 4701 Sfmt 4700 6577 originate or extend closed-end loans secured by a dwelling are potentially subject to at least some aspects of the final rule. For purposes of assessing the impacts of the final rule on small entities, ‘‘small entities’’ is defined in the RFA to include small businesses, small nonprofit organizations, and small government jurisdictions. 5 U.S.C. 601(6). A ‘‘small business’’ is determined by application of SBA regulations and reference to the North American Industry Classification System (NAICS) classifications and size standards.241 5 U.S.C. 601(3). Under such standards, banks and other depository institutions are considered ‘‘small’’ if they have $175 million or less in assets, and for other financial businesses, the threshold is average annual receipts (i.e., annual revenues) that do not exceed $7 million.242 The Bureau can identify through data under the Home Mortgage Disclosure Act, Reports of Condition and Income (Call Reports), and data from the National Mortgage Licensing System (NMLS) the approximate numbers of small depository institutions that will be subject to the final rule. Origination data is available for entities that report in HMDA, NMLS or the credit union call reports; for other entities, the Bureau has estimated their origination activities using statistical projection methods. The following table provides the Bureau’s estimate of the number and types of entities to which the rule will apply: when four conditions are met: (i) The credit is offered or extended to consumers; (ii) the offering or extension of credit is done regularly; (iii) the credit is subject to a finance charge or is payable by a written agreement in more than four installments, and (iv) the credit is primarily for personal, family, or household purposes.’’ Section 1026.1(c)(1). Regulation Z provides, in general, that a person regularly extends consumer credit only if the person extended credit more than 5 times for transactions secured by a dwelling in the preceding year. 241 The current SBA size standards are found on SBA’s Web site at https://www.sba.gov/content/ table-small-business-size-standards. 242 See id. E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations 5. Projected Reporting, Recordkeeping, and Other Compliance Requirements The final rule does not impose new reporting requirements. The final rule does, however, impose new recordkeeping and other compliance requirements on certain small entities. The requirements on small entities from each major component of the rule are presented below. The Bureau discusses impacts against a pre-statute baseline. This baseline assumes compliance with the Federal rules that overlap with the final rule. The impact of the rule relative to the pre-statute baseline will be smaller than the impact would be if not for compliance with the existing Federal rules. In particular, creditors have already incurred some of the one-time costs necessary to comply with the final rule when they came into compliance with the 2008 HOEPA Final Rule on higher-priced mortgage loans. And creditors already have budgeted for some of the ongoing costs of the final rule to the extent those are costs necessary to remaining in compliance with the 2008 HOEPA Final Rule. These expenses attributable to the 2008 HOEPA Final Rule will facilitate and thereby reduce the cost of compliance with this final rule. sroberts on DSK5SPTVN1PROD with Recordkeeping Requirements The final rule imposes new record retention requirements on covered persons. As discussed above, the final rule requires creditors to retain evidence of compliance with § 1026.43 VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 (containing the ability-to-repay/ qualified mortgage provisions and prepayment penalty restrictions) for three years after consummation. The final rule clarifies that creditors need not maintain actual paper copies of the documentation used to underwrite a transaction. For most covered persons, the required records will be kept in electronic form and creditors need retain only enough information to reconstruct the required records. This should limit any burden associated with the record retention requirement for creditors. Other Compliance Requirements As discussed in detail in the sectionby-section analysis and the Bureau’s section 1022(b)(2) discussion above, the final rule imposes new compliance requirements on creditors. In general, creditors will have to update their policies and procedures; additionally, creditors may have to update their systems, for example, to store flags identifying qualified mortgages, and to ensure compliance. The Bureau believes that small creditors’ major one-time costs will be to learn about the final rule, consider whether they need to modify their underwriting practices and procedures to comply with the rule and, if necessary, modify their practices and procedures. The precise costs to small entities of modifying their underwriting practices, should they need to do so, are difficult to predict. These costs will depend on a number of factors, including, among other things, the current practices and systems used by PO 00000 Frm 00172 Fmt 4701 Sfmt 4700 such entities to collect and analyze consumer income, asset, and liability information, the complexity of the terms of credit products that they offer, and the range of such product offerings. To the extent that most small creditors’ processes already align with the rule, any additional compliance costs should be minimal. When originating mortgages, the creditor must calculate the monthly mortgage payment based on the greater of the fully indexed rate or any introductory rate, assuming monthly, fully amortizing payments that are substantially equal. The final rule provides special payment calculation rules for loans with balloon payments, interest-only loans, and negative amortization loans. The final rule may therefore increase compliance costs for small entities, particularly for creditors that offer products that contain balloon payments, interest-only loans, and negative amortization loans. The precise costs to small entities of updating their processes and systems to account for these additional calculations are difficult to predict, but these costs are mitigated, in some circumstances, by the presumption of compliance or safe harbor for qualified mortgages. The Final Rule also includes requirements for documentation and verification of certain information that the creditor must consider in assessing a consumer’s repayment ability. The final rule provides special rules for verification of a consumer’s income or assets, and provides examples of records that can be used. Different verification E:\FR\FM\30JAR2.SGM 30JAR2 ER30JA13.000</GPH> 6578 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with requirements apply to qualified mortgages. Creditors that originate qualified mortgages under the general definition must verify a consumer’s income or assets, current debt obligations, alimony, and child support, and must also verify a consumer’s monthly debt-to-income ratio. The final rule does not contain specific verification requirements for creditors originating qualified mortgages under the temporary provisions; however, such loans must comply with eligibility requirements (including underwriting requirements) of the GSEs or the Federal agency program applicable to the loan. The final rule also provides special rules for complying with the ability-torepay requirements for a creditor refinancing a ‘‘non-standard mortgage’’ into a ‘‘standard mortgage.’’ This provision is based on TILA section 129C(a)(6)(E), which contains special rules for the refinance of a ‘‘hybrid loan’’ into a ‘‘standard loan.’’ The purpose of this provision is to provide flexibility for creditors to refinance a consumer out of a risky mortgage into a more stable one without undertaking a full underwriting process. Under the final rule, a non-standard mortgage is defined as an adjustable-rate mortgage with an introductory fixed interest rate for a period of one year or longer, an interest-only loan, or a negative amortization loan. Under this option, a creditor refinancing a non-standard mortgage into a standard mortgage does not have to consider the eight specific underwriting criteria under the general ability-to-repay option, if certain conditions are met, thus reducing compliance costs for small entities. Prepayment limitations, as discussed in detail in the section-by-section analysis and the Bureau’s section 1022 analysis, are also included in the final rule. Estimate of the Classes of Small Entities Which Will Be Subject to the Requirement Section 603(b)(4) of the RFA requires an estimate of the classes of small entities which will be subject to the requirement. The classes of small entities which will be subject to the reporting, recordkeeping, and compliance requirements of the final rule are the same classes of small entities that are identified above in part VIII.B.4. Section 604(a)(5) of the RFA also requires an estimate of the type of professional skills necessary for the preparation of the reports or records. The Bureau anticipates that the professional skills required for compliance with the final rule are the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 same or similar to those required in the ordinary course of business of the small entities affected by the final rule. Compliance by the small entities that will be affected by the final rule will require continued performance of the basic functions that they perform today: Managing information about consumers and conducting sound underwriting practices for mortgage originations. 6–1. Description of the Steps the Agency has Taken To Minimize the Significant Economic Impact on Small Entities The Bureau understands the new provisions will impose a cost on small entities, and has attempted to mitigate the burden consistent with statutory objectives. The Bureau has also taken numerous additional steps that are likely to reduce the overall cost of the rule. Nevertheless, the rule will certainly create new one-time and ongoing costs for creditors. The sectionby-section analysis of each provision and the Bureau’s section 1022 analysis contain a complete discussion of the following steps taken to mitigate the burden. The final rule provides small creditors with the option of offering only qualified mortgages, which will enjoy either a presumption of compliance with respect to the repayment ability requirement (for higher-priced covered transactions) or a safe harbor from the repayment ability requirement, thus reducing litigation risks and costs for small creditors. The Bureau believes that a variety of underwriting standards can yield reasonable, good faith ability-to-repay determinations. The Bureau is permitting creditors to develop and apply their own underwriting standards (and to make changes to those standards over time in response to empirical information and changing economic and other conditions) as long as those standards lead to ability-to-repay determinations that are reasonable and in good faith. In addition, the Bureau will permit creditors to use their own definitions and other technical underwriting criteria and notes that underwriting guidelines issued by governmental entities such as the FHA are a source to which creditors may refer for guidance on definitions and technical underwriting criteria. The Bureau believes this flexibility is necessary given the wide range of creditors, consumers, and mortgage products to which this rule applies. The Bureau believes this increased flexibility will reduce the burden on small creditors by allowing them to determine the practices that fit best with their business model. PO 00000 Frm 00173 Fmt 4701 Sfmt 4700 6579 Qualified Mortgage Provisions The general definition of the qualified mortgage includes a very clear standard of 43 percent for the debt-to-income threshold and clear methods to compute that figure. The clarity of this provision, and others, should make implementation of and compliance with these provisions of the rule. The Bureau carefully considered the arguments for establishing the qualified mortgage as a safe harbor or rebuttable presumption of compliance in light of the proposed rule, and a complete discussion of the consideration of the Bureau’s final rule can be found in the respective section of the section-by-section analysis. The final rule establishes standards for complying with the ability-to-repay requirements, including defining ‘‘qualified mortgage.’’ The final rule provides three options for originating a qualified mortgage: under the general definition in § 1026.43(e)(2), for loans where the consumer’s monthly debt-toincome ratio would not exceed 43 percent; under the definition § 1026.43(e)(4), for a maximum of seven years, for loans that are eligible for purchase by the GSEs while in conservatorship or certain other Federal agencies, and under § 1026.43(f), for loans that have balloon-payment features if the creditor operates predominantly in rural or underserved areas and meets certain asset-size and transaction volume limits. The final rule provides a safe harbor under the abilityto-repay requirements for mortgage loans that satisfy the definition of a qualified mortgage and are not higherpriced covered transactions (i.e., APR does not exceed Average Prime Offer Rate (APOR) 243 + 1.5 percentage points for first liens or 3.5 percentage points for subordinate liens). The final rule provides a rebuttable presumption for all other qualified mortgage loans, meaning qualified mortgage loans that are higher-priced covered transactions (i.e., APR exceeds APOR + 1.5 percentage points for first lien or 3.5 percentage points for subordinate lien). The Bureau believes that a bifurcated approach to the presumption of compliance provides the best way of balancing consumer protection and access to credit considerations and is consistent with the purposes of the statute, while calibrating consumer protections and risk levels to match the historical record of loan performance. To reduce uncertainty in potential 243 The Average Prime Offer Rate means ‘‘the average prime offer rate for a comparable transaction as of the date on which the interest rate for the transaction is set, as published by the Bureau.’’ TILA section 129C(b)(2)B). E:\FR\FM\30JAR2.SGM 30JAR2 6580 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with litigation, the final rule defines the standard by which a consumer may rebut the presumption of compliance afforded to higher-priced qualified mortgages. The Bureau’s approach to the standards with which a consumer can rebut the presumption that applies to higher-priced transactions is further designed to ensure careful calibration. The Bureau considered several alternatives, including only the safe harbor standard and only the rebuttable presumption standard. In its rulemaking, the Bureau tried to balance consumers’ access to credit concerns with the consumer protection associated with reducing consumers’ cost of litigation. Compared to the final rule, only the safe harbor standard marginally increased consumers’ access to credit, but significantly reduced consumer protection. Conversely, only the rebuttable presumption standard marginally increased consumer protection, but significantly decreased consumers’ access to credit. Balloon-Payment Qualified Mortgage Provisions The Bureau has also provided an exception to the general provision that a qualified mortgage may not provide for a balloon payment for loans that are originated by certain small creditors and that meet specified criteria. The Bureau understands that community banks originate balloon-payment loans to hedge against interest rate risk, rather than making adjustable-rate mortgages, and that community banks hold these balloon-payment loans in portfolio virtually without exception because they are not eligible for sale in the secondary market. Under the final rule, the Bureau is permitting small creditors operating predominantly in rural or underserved areas to originate a balloonpayment qualified mortgage. Unlike loans that are qualified mortgages under the general definition, there is no specific debt-to-income ratio requirement for balloon-payment qualified mortgages. However, creditors must consider and verify a consumer’s monthly debt-to-income ratio. Like the other qualified mortgage definitions, a loan that satisfies the criteria for a balloon-payment qualified mortgage and is not a higher-priced covered transaction receives a legal safe harbor under the ability-to-repay requirements. A loan that satisfies those criteria and is a higher-priced covered transaction receives a rebuttable presumption of compliance with the ability-to-repay requirements. The Bureau believes that this exception will decrease the economic impact of the final rule on small entities. In response to concerns VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 regarding the proposed provisions for holding balloon-payment loans in portfolio, the final rule provides more flexible portfolio requirements which permit certain transfers. Concurrent Proposal for Portfolio Loans Made by Small Creditors The Bureau notes that the Board’s proposal did not include special provisions for portfolio loans made by small creditors and the Board’s proposal did not address such an accommodation. The Bureau understands that creditors generally have in place underwriting policies, procedures, and internal controls that require verification of the consumer’s reasonably expected income or assets, employment status, debt obligations and simultaneous loans, and debt-to-income or residual income. Notably, in response to the proposal, commenters stated that most creditors today are already complying with the full ability-to-repay underwriting standards. For these institutions, there would be no additional burden as a result of the verification requirements in the final rule, since those institutions collect the required information in the normal course of business. To the extent small creditors do not verify and document some or all of the information required by the proposed rule in the normal course of business, they will need to engage in certain one-time implementation efforts and system adjustments. These one-time costs might include expenses related to creditors needing to reanalyze their product lines, retrain staff, and reorganize the processing and administrative elements of their mortgage operations. In a related proposed rule published elsewhere in today’s Federal Register, the Bureau is proposing certain amendments to this final rule, including an additional definition of a qualified mortgage for certain loans made and held in portfolio by small creditors. The proposed new category would include certain loans originated by small creditors that: (1) Have total assets less than $2 billion at the end of the previous calendar year; and (2) together with all affiliates, originated 500 or fewer covered transactions, secured by first-liens during the previous calendar year. These loans generally conform the requirements under the general definition of a qualified mortgage except the 43 percent limit on monthly debt-toincome ratio. Under the proposed additional definition, a creditor would not have to use the instructions in the appendix to the final rule to calculate debt-to-income ratio, and a loan with a consumer debt-to-income ratio higher PO 00000 Frm 00174 Fmt 4701 Sfmt 4700 than 43 percent could be a qualified mortgage if all other criteria are met. The Bureau also is proposing to allow small creditors to charge a higher annual percentage rate for first-lien qualified mortgages in the proposed new category and still benefit from a conclusive presumption of compliance or ‘‘safe harbor.’’ In addition, the Bureau also is proposing to allow small creditors operating predominantly in rural or underserved areas to offer firstlien balloon loans with a higher annual percentage rate and still benefit from a conclusive presumption of compliance with the ability to repay rules or ‘‘safe harbor.’’ The Bureau is proposing these changes because it believes they may be necessary to preserve access to credit for some consumers. The regulatory requirement to make a reasonable and good faith determination based on verified and documented evidence that a consumer has a reasonable ability to repay may entail significant litigation risk for small creditors. The Bureau believes that small creditors have historically engaged in responsible mortgage underwriting that includes thorough and thoughtful determinations of consumers’ ability to repay, at least in part because they bear the risk of default associated with loans held in their portfolios. The Bureau also believes that because small creditors’ lending model is based on maintaining ongoing, mutually beneficial relationships with their customers, they therefore have a more comprehensive understanding of their customers’ financial circumstances and are better able to assess ability to repay than larger creditors. Further, the Bureau understands that the only sources of mortgage credit available to consumers in rural and underserved areas may be small creditors because larger creditors may be unable or unwilling to lend in these areas. For these reasons, the Bureau is proposing a new category of qualified mortgages that would include small creditor portfolio loans and is also proposing to raise the annual percentage rate threshold for the safe harbor to accommodate small creditors’ higher costs. The Bureau believes these steps may be necessary to preserve some rural and underserved consumers’ access to non-conforming credit. 6–2. Description of the Steps the Agency Has Taken To Minimize Any Additional Cost of Credit for Small Entities Section 603(d) of the RFA requires the Bureau to consult with small entities regarding the potential impact of the proposed rule on the cost of credit for small entities and related matters. 5 E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with U.S.C. 603(d). The Bureau notes that the Board was not subject to this requirement when it issued its IRFA. The Bureau does not believe that the final rule will result in an increase in the cost of business credit for small entities. Instead, the final rule will apply only to mortgage loans obtained by consumers primarily for personal, family, or household purposes and the final rule will not apply to loans obtained primarily for business purposes. Given that the final rule does not increase the cost of credit for small entities, the Bureau has not taken additional steps to minimize the cost of credit for small entities. IX. Paperwork Reduction Act Analysis Certain provisions of this final rule contain ‘‘collection of information’’ requirements within the meaning of the Paperwork Reduction Act of 1995 (44 U.S.C. 3501 et seq.) (Paperwork Reduction Act or PRA). This final rule amends 12 CFR part 1026 (Regulation Z). Regulation Z currently contains collections of information approved by the Office of Management and Budget (OMB). The Bureau’s OMB control number for Regulation Z is 3170–0015. The PRA (44 U.S.C 3507(a), (a)(2) and (a)(3)) requires that a Federal agency may not conduct or sponsor a collection of information unless OMB approved the collection under the PRA and the OMB control number obtained is displayed. Further, notwithstanding any other provision of law, no person is required to comply with, or is subject to any penalty for failure to comply with, a collection of information that does not display a currently valid OMB control number (44 U.S.C. 3512). This final rule contains information collection requirements that have not been approved by the OMB and, therefore, are not effective until OMB approval is obtained. The unapproved information collection requirements are contained in sections 1026.25(c)(3) and 1026.43(c)–(f) of these regulations. The Bureau will publish a separate notice in the Federal Register announcing the submission of these information collection requirements to OMB as well as OMB’s action on these submissions; including, the OMB control number and expiration date. On May 11, 2011, the Board of Governors of the Federal Reserve System (Board) published notice of the proposed rule in the Federal Register (76 FR 27390). The information collection requirements in §§ 1026.25(c)(3) and 1026.43(c)–(f) were contained in the Board’s proposal; however, these requirements were not VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 separately discussed in the proposal’s PRA section. For full public transparency, the Bureau now claims these requirements as information collections. The Bureau received no PRA-related comments to the Board’s proposal on the information collections in §§ 1026.25(c)(3) and 1026.43(c). A. Overview As described below, the final rule amends the collections of information currently in Regulation Z to implement amendments to TILA made by the Dodd-Frank Act. The Dodd-Frank 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). TILA section 129C(a); 15 U.S.C. 1639c(a). The Dodd-Frank Act provides special protection from liability for creditors who make ‘‘qualified mortgages.’’ TILA section 129C(b); 15 U.S.C. 1639c(b). The purpose of the Dodd-Frank Act abilityto-repay requirement is to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans and that are understandable and not unfair, deceptive or abusive. TILA section 129B(a)(2); 15 U.S.C. 1639b(a)(2). Prior to the Dodd-Frank Act, existing Regulation Z provided ability-to-repay requirements for highcost and higher-priced mortgage loans. The Dodd-Frank Act expanded the scope of the ability-to-repay requirement to cover all residential mortgage loans. The final rule establishes standards for complying with the ability-to-repay requirement, including defining ‘‘qualified mortgage.’’ The final rule provides three options for originating a qualified mortgage: under the general definition in § 1026.43(e)(2), for loans where the consumer’s monthly debt-toincome ratio do not exceed 43 percent; under the definition § 1026.43(e)(4), for a maximum of seven years, for loans that are eligible for purchase by the GSEs while in conservatorship or certain other Federal agencies, and under § 1026.43(f), for loans that have a balloon-payment if the creditor operates predominantly in rural or underserved areas and meets certain underwriting requirements, and asset-size and transaction volume limits. In addition to the ability-to-repay and qualified mortgage provisions, the final rule implements the Dodd-Frank Act limits on prepayment penalties and PO 00000 Frm 00175 Fmt 4701 Sfmt 4700 6581 lengthens the time creditors must retain records that evidence compliance with the ability-to-repay and prepayment penalty provisions. Currently, Regulation Z requires creditors to retain evidence of compliance for two years after disclosures must be made or action must be taken. The final rule amends Regulation Z to require creditors to retain evidence of compliance with the ability-to-repay/qualified mortgage provisions and prepayment penalty restrictions in § 1026.43 for three years after consummation for consistency with statute of limitations on claims under TILA section 129C. See generally the section-by-section analysis of §§ 1026.25 and 1026.43, above. The information collection in the final rule is required to provide benefits for consumers and would be mandatory. See 15 U.S.C. 1601 et seq.; 12 U.S.C. 2601 et seq. Because the Bureau does not collect any information under the final rule, no issue of confidentiality arises. The likely respondents would be depository institutions (i.e., commercial banks/savings institutions and credit unions) and non-depository institutions (i.e., mortgage companies or other nonbank lenders) subject to Regulation Z.244 Under the final rule, the Bureau generally accounts for the paperwork burden associated with Regulation Z for the following respondents pursuant to its administrative enforcement authority: insured depository institutions with more than $10 billion in total assets, their depository institution affiliates, and certain nondepository lenders. The Bureau and the FTC generally both have enforcement authority over nondepository institutions for Regulation Z. Accordingly, the Bureau has allocated to itself half of the estimated burden to non-depository institutions. Other Federal agencies are responsible for estimating and reporting to OMB the total paperwork burden for the institutions for which they have administrative enforcement authority. They may, but are not required to, use the Bureau’s burden estimation methodology. Using the Bureau’s burden estimation methodology, the total estimated burden under the changes to Regulation Z for all of the nearly 14,300 institutions subject to the final rule, including 244 For purposes of this PRA analysis, references to ‘‘creditors’’ or ‘‘lenders’’ shall be deemed to refer collectively to commercial banks, savings institutions, credit unions, and mortgage companies (i.e., non-depository lenders), unless otherwise stated. Moreover, reference to ‘‘respondents’’ shall generally mean all categories of entities identified in the sentence to which this footnote is appended, except as otherwise stated or if the context indicates otherwise. E:\FR\FM\30JAR2.SGM 30JAR2 6582 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations Bureau respondents,245 would be approximately 14,300 hours for onetime changes. The aggregate estimates of total burdens presented in this part VIII are based on estimated costs that are weighted averages across respondents. The Bureau expects that the amount of time required to implement each of the changes for a given institution may vary based on the size, complexity, and practices of the respondent. B. Information Collection Requirements The Bureau believes the following aspects of the final rule would be information collection requirements under the PRA. sroberts on DSK5SPTVN1PROD with 1. Ability-To-Repay Verification and Documentation Requirements Section 1026.43(c)(2) of the final rule contains eight specific criteria that a creditor must consider in assessing a consumer’s repayment ability. Section 1026.43(c)(3) of the final rule requires creditors originating residential mortgage loans to verify the information that the creditor relies on in determining a consumer’s repayment ability under § 1026.43(c)(2) using reasonably reliable third-party records. Section 1026.43(c)(4) of the final rule provides special rules for verification of a consumer’s income or assets, and provides examples of records that can be used to verify the consumer’s income or assets (for example, tax-return and payroll transcripts). If a creditor chooses to make a qualified mortgage, different verification requirements apply to qualified mortgages. Creditors that originate qualified mortgages under § 1026.43(e)(2) or (f) must verify a consumer’s income or assets, and current debt obligations, alimony and child support and must also verify a consumer’s monthly debt-to-income ratio (or, in the case of qualified mortgages under § 1026.43(f), residual income). The final rule does not contain specific verification requirements for creditors originating qualified mortgages 245 There are 153 depository institutions (and their depository affiliates) that are subject to the Bureau’s administrative enforcement authority. In addition there are 146 privately insured credit unions that are subject to the Bureau’s administrative enforcement authority. For purposes of this PRA analysis, the Bureau’s respondents under Regulation Z are 135 depository institutions that originate either open or closed-end mortgages; 77 privately insured credit unions that originate either open or closed-end mortgages; and an estimated 2,787 non-depository institutions that are subject to the Bureau’s administrative enforcement authority. Unless otherwise specified, all references to burden hours and costs for the Bureau respondents for the collection under Regulation Z are based on a calculation that includes one half of burden for the estimated 2,787 nondepository institutions and 77 privately insured credit unions. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 under § 1026.43(e)(4); however, such loans must comply with eligibility requirements (including underwriting requirements) of the GSEs or the Federal agency program applicable to the loan. The Bureau estimates one-time and ongoing costs to respondents of complying with the requirements in § 1026.43 as follows. One-time costs. The Bureau estimates that covered persons will incur one-time costs associated with reviewing the final rule. Specifically, the Bureau estimates that, for each covered person, one attorney and one compliance officer will each take 21 minutes (42 minutes in total) to read and review the sections of the Federal Register that describe the verification and documentation requirements, based on the length of the sections. The Bureau estimates the one-time costs to the 135 depository institutions (including their depository affiliates) that are mortgage originator respondents of the Bureau under Regulation Z would be $7,700, or 94 hours. For the estimated 2,787 nondepository institutions and 77 privately insured credit unions that are subject to the Bureau’s administrative enforcement authority, the Bureau is taking the half the burden for purposes of this PRA analysis. Accordingly, the Bureau estimates the total one-time costs across all relevant providers of reviewing the relevant sections of the Federal Register to be about 1000 hours or roughly $81,000. Ongoing costs. The Bureau does not believe that the verification and documentation requirements of the final rule will result in additional ongoing costs for most covered persons. The Bureau understands that creditors generally have in place underwriting policies, procedures, and internal controls that require verification of the consumer’s reasonably expected income or assets, employment status, debt obligations and simultaneous loans, credit history, and debt-to-income or residual income. Notably, in response to the 2011 ATR Proposal, commenters stated that most creditors today are already complying with the full abilityto-repay underwriting standards. For these institutions, there would be no additional burden as a result of the verification requirements in the final rule, since those institutions collect the required information in the normal course of business. 2. Record Retention Requirement The final rule imposes new record retention requirements on covered persons. As discussed above in part V, the final rule requires creditors to retain PO 00000 Frm 00176 Fmt 4701 Sfmt 4700 evidence of compliance with § 1026.43 (containing the ability-to-repay/ qualified mortgage provisions and prepayment penalty restrictions) for three years after consummation. See part V above, section-by-section analysis of § 1026.25. The Bureau estimates one-time and ongoing costs to respondents of complying with the record retention requirement in § 1026.25 as follows. One-time costs. The Bureau estimates that covered persons will incur one-time costs associated with reviewing the final rule. Specifically, the Bureau estimates that, for each covered person, one attorney and one compliance officer will each take 9 minutes (18 minutes in total) to read and review the sections of the final rule that describe the record retention requirements, based on the length of the sections. The Bureau estimates the one-time costs to the 135 depository institutions (including their depository affiliates) that are mortgage originator respondents of the Bureau under Regulation Z would be $3,300, or 40 hours. For the estimated 2,787 nondepository institutions and 77 privately insured credit unions that are subject to the Bureau’s administrative enforcement authority, the Bureau is taking the half the burden for purposes of this PRA analysis. Accordingly, the Bureau estimates the total one-time costs across all relevant providers of reviewing the relevant sections of the Federal Register to be about 430 hours or roughly $35,000. Ongoing costs. The Bureau believes that any burden associated with the final rule’s record keeping requirement will be minimal or de minimis. Under current rules, creditors must retain evidence of compliance with Regulation Z for two years after consummation; the final rule extends that period to three years after consummation for evidence of compliance with the ability-to-repay/ qualified mortgage provisions and the prepayment penalty limitations in this final rule. The final rule clarifies that creditors need retain only enough information to reconstruct the required records. The final rule clarifies that creditors need not maintain actual paper copies of the documentation used to underwrite a transaction. See comments 25(a)(2) and 25(c)(3)–1. For most covered persons, the required records will be kept in electronic form. This further reduces any burden associated with the final rule’s record retention requirement for creditors that keep the required records in electronic form, as the only additional requirement will be to store data for an additional year, to E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations the extent such creditors are currently storing such data for the minimum period required by Regulation Z. Furthermore, the Bureau believes that many creditors will retain such records for at least three years in the ordinary course of business, even in the absence of a change to record retention requirements, due to the Dodd-Frank Act’s extension of the statute of limitations for civil liability for violations of the prepayment penalty provisions or ability-to-repay provisions (including the qualified mortgage provisions) to three years after the date of a violation. Even absent the rule, the Bureau believes that most creditors will retain records of compliance with § 1026.43 for the life of the loan, given that the statute allows borrowers to bring a defensive claim for recoupment or setoff in the event that a creditor or assignee initiates foreclosure proceedings. C. Summary of Burden Hours The below table summarizes the one time and annual burdens under Regulation Z associated with information collections affected by the final rule for Bureau respondents under the PRA. For the two collections, the one-time burden for Bureau respondents is approximately 1,570 hours. The Consumer Financial Protection Bureau has a continuing interest in the public’s opinions of our collections of information. At any time, comments regarding the burden estimate, or any other aspect of this collection of information, including suggestions for reducing the burden, may be sent to: The Consumer Financial Protection Bureau (Attention: PRA Office), 1700 G Street NW., Washington, DC, 20552, or by the internet to CFPB_Public_PRA@cfpb.gov. List of Subjects in 12 CFR Part 1026 Advertising, Consumer protection, Mortgages, Reporting and recordkeeping requirements, Truth in Lending. Authority and Issuance sroberts on DSK5SPTVN1PROD with PART 1026—TRUTH IN LENDING (REGULATION Z) 1. The authority citation for part 1026 continues to read as follows: ■ Authority: 12 U.S.C. 2601; 2603–2605, 2607, 2609, 2617, 5511, 5512, 5532, 5581; 15 U.S.C. 1601 et seq. 20:04 Jan 29, 2013 2. Section 1026.25 is amended by: A. Revising paragraph (a); and B. Adding and reserving paragraphs (c)(1) and (c)(2). ■ C. Adding paragraph (c)(3). The additions and revisions read as follows: ■ ■ ■ § 1026.25 Record retention. (a) General rule. A creditor shall retain evidence of compliance with this regulation, other than advertising requirements under §§ 1026.16 and 1026.24 and certain requirements for mortgage loans under paragraph (c) of this section, for two years after the date disclosures are required to be made or action is required to be taken. The administrative agencies responsible for enforcing the regulation may require a creditor under their jurisdictions to retain records for a longer period if necessary to carry out their enforcement responsibilities under section 108 of the Act. * * * * * (c) Records related to certain requirements for mortgage loans. (1) [Reserved] (2) [Reserved] (3) Records related to minimum standards for transactions secured by a dwelling. Notwithstanding paragraph (a) of this section, a creditor shall retain evidence of compliance with § 1026.43 of this regulation for three years after consummation of a transaction covered by that section. Subpart E—Special Rules for Certain Home Mortgage Transactions 3. Section 1026.32 is amended by: A. Revising the section heading; B. Revising paragraph (b)(1); C. Removing and reserving paragraph (b)(2); ■ D. Adding paragraph (b)(3) through (6) The additions and revisions read as follows: ■ ■ ■ ■ § 1026.32 Requirements for high-cost mortgages. * For the reasons set forth in the preamble, the Bureau amends Regulation Z, 12 CFR part 1026, as set forth below: VerDate Mar<15>2010 Subpart D—Miscellaneous Jkt 229001 * * * * (b) Definitions. For purposes of this subpart, the following definitions apply: (1) In connection with a closed-end credit transaction, points and fees means the following fees or charges that are known at or before consummation: (i) All items included in the finance charge under § 1026.4(a) and (b), except that the following items are excluded: (A) Interest or the time-price differential; (B) Any premium or other charge imposed in connection with any Federal PO 00000 Frm 00177 Fmt 4701 Sfmt 4700 6583 or State agency program for any guaranty or insurance that protects the creditor against the consumer’s default or other credit loss; (C) For any guaranty or insurance that protects the creditor against the consumer’s default or other credit loss and that is not in connection with any Federal or State agency program: (1) If the premium or other charge is payable after consummation, the entire amount of such premium or other charge; or (2) If the premium or other charge is payable at or before consummation, the portion of any such premium or other charge that is not in excess of the amount payable under policies in effect at the time of origination under section 203(c)(2)(A) of the National Housing Act (12 U.S.C. 1709(c)(2)(A)), provided that the premium or charge is required to be refundable on a pro rata basis and the refund is automatically issued upon notification of the satisfaction of the underlying mortgage loan; (D) Any bona fide third-party charge not retained by the creditor, loan originator, or an affiliate of either, unless the charge is required to be included in points and fees under paragraph (b)(1)(i)(C), (iii), or (iv) of this section; (E) Up to two bona fide discount points paid by the consumer in connection with the transaction, if the interest rate without any discount does not exceed: (1) The average prime offer rate, as defined in § 1026.35(a)(2), by more than one percentage point; or (2) For purposes of paragraph (a)(1)(ii) of this section, for transactions that are secured by personal property, the average rate for a loan insured under Title I of the National Housing Act (12 U.S.C. 1702 et seq.) by more than one percentage point; and (F) If no discount points have been excluded under paragraph (b)(1)(i)(E) of this section, then up to one bona fide discount point paid by the consumer in connection with the transaction, if the interest rate without any discount does not exceed: (1) The average prime offer rate, as defined in § 1026.35(a)(2), by more than two percentage points; or (2) For purposes of paragraph (a)(1)(ii) of this section, for transactions that are secured by personal property, the average rate for a loan insured under Title I of the National Housing Act (12 U.S.C. 1702 et seq.) by more than two percentage points; (ii) All compensation paid directly or indirectly by a consumer or creditor to a loan originator, as defined in § 1026.36(a)(1), that can be attributed to E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6584 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations that transaction at the time the interest rate is set; (iii) All items listed in § 1026.4(c)(7) (other than amounts held for future payment of taxes), unless: (A) The charge is reasonable; (B) The creditor receives no direct or indirect compensation in connection with the charge; and (C) The charge is not paid to an affiliate of the creditor; (iv) Premiums or other charges payable at or before consummation for any credit life, credit disability, credit unemployment, or credit property insurance, or any other life, accident, health, or loss-of-income insurance for which the creditor is a beneficiary, or any payments directly or indirectly for any debt cancellation or suspension agreement or contract; (v) The maximum prepayment penalty, as defined in paragraph (b)(6)(i) of this section, that may be charged or collected under the terms of the mortgage loan; and (vi) The total prepayment penalty, as defined in paragraph (b)(6)(i) of this section, incurred by the consumer if the consumer refinances the existing mortgage loan with the current holder of the existing loan, a servicer acting on behalf of the current holder, or an affiliate of either. (2) [Reserved] (3) Bona fide discount point—(i) Closed-end credit. The term bona fide discount point means an amount equal to 1 percent of the loan amount paid by the consumer that reduces the interest rate or time-price differential applicable to the transaction based on a calculation that is consistent with established industry practices for determining the amount of reduction in the interest rate or time-price differential appropriate for the amount of discount points paid by the consumer. (ii) [Reserved] (4) Total loan amount—(i) Closed-end credit. The total loan amount for a closed-end credit transaction is calculated by taking the amount financed, as determined according to § 1026.18(b), and deducting any cost listed in § 1026.32(b)(1)(iii), (iv), or (vi) that is both included as points and fees under § 1026.32(b)(1) and financed by the creditor. (ii) [Reserved] (5) Affiliate means any company that controls, is controlled by, or is under common control with another company, as set forth in the Bank Holding Company Act of 1956 (12 U.S.C. 1841 et seq.). (6) Prepayment penalty—(i) Closedend credit transactions. For a closedend credit transaction, prepayment VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 penalty means a charge imposed for paying all or part of the transaction’s principal before the date on which the principal is due, other than a waived, bona fide third-party charge that the creditor imposes if the consumer prepays all of the transaction’s principal sooner than 36 months after consummation, provided, however, that interest charged consistent with the monthly interest accrual amortization method is not a prepayment penalty for extensions of credit insured by the Federal Housing Administration that are consummated before January 21, 2015. (ii) [Reserved] * * * * * ■ 4. Add § 1026.43 to read as follows: § 1026.43 Minimum standards for transactions secured by a dwelling. (a) Scope. This section applies to any consumer credit transaction that is secured by a dwelling, as defined in § 1026.2(a)(19), including any real property attached to a dwelling, other than: (1) A home equity line of credit subject to § 1026.40; (2) A mortgage transaction secured by a consumer’s interest in a timeshare plan, as defined in 11 U.S.C. 101(53(D)); or (3) For purposes of paragraphs (c) through (f) of this section: (i) A reverse mortgage subject to § 1026.33; (ii) A temporary or ‘‘bridge’’ loan with a term of 12 months or less, such as a loan to finance the purchase of a new dwelling where the consumer plans to sell a current dwelling within 12 months or a loan to finance the initial construction of a dwelling; or (iii) A construction phase of 12 months or less of a construction-topermanent loan. (b) Definitions. For purposes of this section: (1) Covered transaction means a consumer credit transaction that is secured by a dwelling, as defined in § 1026.2(a)(19), including any real property attached to a dwelling, other than a transaction exempt from coverage under paragraph (a) of this section. (2) Fully amortizing payment means a periodic payment of principal and interest that will fully repay the loan amount over the loan term. (3) Fully indexed rate means the interest rate calculated using the index or formula that will apply after recast, as determined at the time of consummation, and the maximum margin that can apply at any time during the loan term. (4) Higher-priced covered transaction means a covered transaction with an PO 00000 Frm 00178 Fmt 4701 Sfmt 4700 annual percentage rate that exceeds the average prime offer rate for a comparable transaction as of the date the interest rate is set by 1.5 or more percentage points for a first-lien covered transaction, or by 3.5 or more percentage points for a subordinate-lien covered transaction. (5) Loan amount means the principal amount the consumer will borrow as reflected in the promissory note or loan contract. (6) Loan term means the period of time to repay the obligation in full. (7) Maximum loan amount means the loan amount plus any increase in principal balance that results from negative amortization, as defined in § 1026.18(s)(7)(v), based on the terms of the legal obligation assuming: (i) The consumer makes only the minimum periodic payments for the maximum possible time, until the consumer must begin making fully amortizing payments; and (ii) The maximum interest rate is reached at the earliest possible time. (8) Mortgage-related obligations mean property taxes; premiums and similar charges identified in § 1026.4(b)(5), (7), (8), and (10) that are required by the creditor; fees and special assessments imposed by a condominium, cooperative, or homeowners association; ground rent; and leasehold payments. (9) Points and fees has the same meaning as in § 1026.32(b)(1). (10) Prepayment penalty has the same meaning as in § 1026.32(b)(6). (11) Recast means: (i) For an adjustable-rate mortgage, as defined in § 1026.18(s)(7)(i), the expiration of the period during which payments based on the introductory fixed interest rate are permitted under the terms of the legal obligation; (ii) For an interest-only loan, as defined in § 1026.18(s)(7)(iv), the expiration of the period during which interest-only payments are permitted under the terms of the legal obligation; and (iii) For a negative amortization loan, as defined in § 1026.18(s)(7)(v), the expiration of the period during which negatively amortizing payments are permitted under the terms of the legal obligation. (12) Simultaneous loan means another covered transaction or home equity line of credit subject to § 1026.40 that will be secured by the same dwelling and made to the same consumer at or before consummation of the covered transaction or, if to be made after consummation, will cover closing costs of the first covered transaction. (13) Third-party record means: E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations (i) A document or other record prepared or reviewed by an appropriate person other than the consumer, the creditor, or the mortgage broker, as defined in § 1026.36(a)(2), or an agent of the creditor or mortgage broker; (ii) A copy of a tax return filed with the Internal Revenue Service or a State taxing authority; (iii) A record the creditor maintains for an account of the consumer held by the creditor; or (iv) If the consumer is an employee of the creditor or the mortgage broker, a document or other record maintained by the creditor or mortgage broker regarding the consumer’s employment status or employment income. (c) Repayment ability—(1) General requirement. A creditor shall not make a loan that is a covered transaction unless the creditor makes a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan according to its terms. (2) Basis for determination. Except as provided otherwise in paragraphs (d), (e), and (f) of this section, in making the repayment ability determination required under paragraph (c)(1) of this section, a creditor must consider the following: (i) The consumer’s current or reasonably expected income or assets, other than the value of the dwelling, including any real property attached to the dwelling, that secures the loan; (ii) If the creditor relies on income from the consumer’s employment in determining repayment ability, the consumer’s current employment status; (iii) The consumer’s monthly payment on the covered transaction, calculated in accordance with paragraph (c)(5) of this section; (iv) The consumer’s monthly payment on any simultaneous loan that the creditor knows or has reason to know will be made, calculated in accordance with paragraph (c)(6) of this section; (v) The consumer’s monthly payment for mortgage-related obligations; (vi) The consumer’s current debt obligations, alimony, and child support; (vii) The consumer’s monthly debt-toincome ratio or residual income in accordance with paragraph (c)(7) of this section; and (viii) The consumer’s credit history. (3) Verification using third-party records. A creditor must verify the information that the creditor relies on in determining a consumer’s repayment ability under § 1026.43(c)(2) using reasonably reliable third-party records, except that: (i) For purposes of paragraph (c)(2)(i) of this section, a creditor must verify a VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 consumer’s income or assets that the creditor relies on in accordance with § 1026.43(c)(4); (ii) For purposes of paragraph (c)(2)(ii) of this section, a creditor may verify a consumer’s employment status orally if the creditor prepares a record of the information obtained orally; and (iii) For purposes of paragraph (c)(2)(vi) of this section, if a creditor relies on a consumer’s credit report to verify a consumer’s current debt obligations and a consumer’s application states a current debt obligation not shown in the consumer’s credit report, the creditor need not independently verify such an obligation. (4) Verification of income or assets. A creditor must verify the amounts of income or assets that the creditor relies on under § 1026.43(c)(2)(i) to determine a consumer’s ability to repay a covered transaction using third-party records that provide reasonably reliable evidence of the consumer’s income or assets. A creditor may verify the consumer’s income using a tax-return transcript issued by the Internal Revenue Service (IRS). Examples of other records the creditor may use to verify the consumer’s income or assets include: (i) Copies of tax returns the consumer filed with the IRS or a State taxing authority; (ii) IRS Form W–2s or similar IRS forms used for reporting wages or tax withholding; (iii) Payroll statements, including military Leave and Earnings Statements; (iv) Financial institution records; (v) Records from the consumer’s employer or a third party that obtained information from the employer; (vi) Records from a Federal, State, or local government agency stating the consumer’s income from benefits or entitlements; (vii) Receipts from the consumer’s use of check cashing services; and (viii) Receipts from the consumer’s use of a funds transfer service. (5) Payment calculation—(i) General rule. Except as provided in paragraph (c)(5)(ii) of this section, a creditor must make the consideration required under paragraph (c)(2)(iii) of this section using: (A) The fully indexed rate or any introductory interest rate, whichever is greater; and (B) Monthly, fully amortizing payments that are substantially equal. (ii) Special rules for loans with a balloon payment, interest-only loans, and negative amortization loans. A creditor must make the consideration required under paragraph (c)(2)(iii) of this section for: PO 00000 Frm 00179 Fmt 4701 Sfmt 4700 6585 (A) A loan with a balloon payment, as defined in § 1026.18(s)(5)(i), using: (1) The maximum payment scheduled during the first five years after the date on which the first regular periodic payment will be due for a loan that is not a higher-priced covered transaction; or (2) The maximum payment in the payment schedule, including any balloon payment, for a higher-priced covered transaction; (B) An interest-only loan, as defined in § 1026.18(s)(7)(iv), using: (1) The fully indexed rate or any introductory interest rate, whichever is greater; and (2) Substantially equal, monthly payments of principal and interest that will repay the loan amount over the term of the loan remaining as of the date the loan is recast. (C) A negative amortization loan, as defined in § 1026.18(s)(7)(v), using: (1) The fully indexed rate or any introductory interest rate, whichever is greater; and (2) Substantially equal, monthly payments of principal and interest that will repay the maximum loan amount over the term of the loan remaining as of the date the loan is recast. (6) Payment calculation for simultaneous loans. For purposes of making the evaluation required under paragraph (c)(2)(iv) of this section, a creditor must consider, taking into account any mortgage-related obligations, a consumer’s payment on a simultaneous loan that is: (i) A covered transaction, by following paragraph (c)(5)of this section; or (ii) A home equity line of credit subject to § 1026.40, by using the periodic payment required under the terms of the plan and the amount of credit to be drawn at or before consummation of the covered transaction. (7) Monthly debt-to-income ratio or residual income—(i) Definitions. For purposes of this paragraph (c)(7), the following definitions apply: (A) Total monthly debt obligations. The term total monthly debt obligations means the sum of: the payment on the covered transaction, as required to be calculated by paragraphs (c)(2)(iii) and (c)(5) of this section; simultaneous loans, as required by paragraphs (c)(2)(iv) and (c)(6) of this section; mortgage-related obligations, as required by paragraph (c)(2)(v) of this section; and current debt obligations, alimony, and child support, as required by paragraph (c)(2)(vi) of this section. (B) Total monthly income. The term total monthly income means the sum of the consumer’s current or reasonably E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6586 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations expected income, including any income from assets, as required by paragraphs (c)(2)(i) and (c)(4) of this section. (ii) Calculations— (A) Monthly debtto-income ratio. If a creditor considers the consumer’s monthly debt-to-income ratio under paragraph (c)(2)(vii) of this section, the creditor must consider the ratio of the consumer’s total monthly debt obligations to the consumer’s total monthly income. (B) Monthly residual income. If a creditor considers the consumer’s monthly residual income under paragraph (c)(2)(vii) of this section, the creditor must consider the consumer’s remaining income after subtracting the consumer’s total monthly debt obligations from the consumer’s total monthly income. (d) Refinancing of non-standard mortgages—(1) Definitions. For purposes of this paragraph (d), the following definitions apply: (i) Non-standard mortgage. The term non-standard mortgage means a covered transaction that is: (A) An adjustable-rate mortgage, as defined in § 1026.18(s)(7)(i), with an introductory fixed interest rate for a period of one year or longer; (B) An interest-only loan, as defined in § 1026.18(s)(7)(iv); or (C) A negative amortization loan, as defined in § 1026.18(s)(7)(v). (ii) Standard mortgage. The term standard mortgage means a covered transaction: (A) That provides for regular periodic payments that do not: (1) Cause the principal balance to increase; (2) Allow the consumer to defer repayment of principal; or (3) Result in a balloon payment, as defined in § 1026.18(s)(5)(i); (B) For which the total points and fees payable in connection with the transaction do not exceed the amounts specified in paragraph (e)(3) of this section; (C) For which the term does not exceed 40 years; (D) For which the interest rate is fixed for at least the first five years after consummation; and (E) For which the proceeds from the loan are used solely for the following purposes: (1) To pay off the outstanding principal balance on the non-standard mortgage; and (2) To pay closing or settlement charges required to be disclosed under the Real Estate Settlement Procedures Act, 12 U.S.C. 2601 et seq. (iii) Refinancing. The term refinancing has the same meaning as in § 1026.20(a). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 (2) Scope. The provisions of this paragraph (d) apply to the refinancing of a non-standard mortgage into a standard mortgage when the following conditions are met: (i) The creditor for the standard mortgage is the current holder of the existing non-standard mortgage or the servicer acting on behalf of the current holder; (ii) The monthly payment for the standard mortgage is materially lower than the monthly payment for the nonstandard mortgage, as calculated under paragraph (d)(5) of this section. (iii) The creditor receives the consumer’s written application for the standard mortgage no later than two months after the non-standard mortgage has recast. (iv) The consumer has made no more than one payment more than 30 days late on the non-standard mortgage during the 12 months immediately preceding the creditor’s receipt of the consumer’s written application for the standard mortgage. (v) The consumer has made no payments more than 30 days late during the six months immediately preceding the creditor’s receipt of the consumer’s written application for the standard mortgage; and (vi) If the non-standard mortgage was consummated on or after January 10, 2014, the non-standard mortgage was made in accordance with paragraph (c) or (e) of this section, as applicable. (3) Exemption from repayment ability requirements. A creditor is not required to comply with the requirements of paragraph (c) of this section if: (i) The conditions in paragraph (d)(2) of this section are met; and (ii) The creditor has considered whether the standard mortgage likely will prevent a default by the consumer on the non-standard mortgage once the loan is recast. (4) Offer of rate discounts and other favorable terms. A creditor making a covered transaction under this paragraph (d) may offer to the consumer rate discounts and terms that are the same as, or better than, the rate discounts and terms that the creditor offers to new consumers, consistent with the creditor’s documented underwriting practices and to the extent not prohibited by applicable State or Federal law. (5) Payment calculations. For purposes of determining whether the consumer’s monthly payment for a standard mortgage will be materially lower than the monthly payment for the non-standard mortgage, the following provisions shall be used: PO 00000 Frm 00180 Fmt 4701 Sfmt 4700 (i) Non-standard mortgage. For purposes of the comparison conducted pursuant to paragraph (d)(2)(ii) of this section, the creditor must calculate the monthly payment for a non-standard mortgage based on substantially equal, monthly, fully amortizing payments of principal and interest using: (A) The fully indexed rate as of a reasonable period of time before or after the date on which the creditor receives the consumer’s written application for the standard mortgage; (B) The term of the loan remaining as of the date on which the recast occurs, assuming all scheduled payments have been made up to the recast date and the payment due on the recast date is made and credited as of that date; and (C) A remaining loan amount that is: (1) For an adjustable-rate mortgage under paragraph (d)(1)(i)(A) of this section, the outstanding principal balance as of the date of the recast, assuming all scheduled payments have been made up to the recast date and the payment due on the recast date is made and credited as of that date; (2) For an interest-only loan under paragraph (d)(1)(i)(B) of this section, the outstanding principal balance as of the date of the recast, assuming all scheduled payments have been made up to the recast date and the payment due on the recast date is made and credited as of that date; or (3) For a negative amortization loan under paragraph (d)(1)(i)(C) of this section, the maximum loan amount, determined after adjusting for the outstanding principal balance. (ii) Standard mortgage. For purposes of the comparison conducted pursuant to paragraph (d)(2)(ii) of this section, the monthly payment for a standard mortgage must be based on substantially equal, monthly, fully amortizing payments based on the maximum interest rate that may apply during the first five years after consummation. (e) Qualified mortgages—(1) Safe harbor and presumption of compliance—(i) Safe harbor for transactions that are not higher-priced covered transactions. A creditor or assignee of a qualified mortgage, as defined in paragraphs (e)(2), (e)(4), or (f) of this section, that is not a higherpriced covered transaction, as defined in paragraph (b)(4) of this section, complies with the repayment ability requirements of paragraph (c) of this section. (ii) Presumption of compliance for higher-priced covered transactions. (A) A creditor or assignee of a qualified mortgage, as defined in paragraphs (e)(2), (e)(4), or (f) of this section, that is a higher-priced covered transaction, as E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations defined in paragraph (b)(4) of this section, is presumed to comply with the repayment ability requirements of paragraph (c) of this section. (B) To rebut the presumption of compliance described in paragraph (e)(1)(ii)(A) of this section, it must be proven that, despite meeting the requirements of paragraphs (e)(2), (e)(4), or (f) of this section, the creditor did not make a reasonable and good faith determination of the consumer’s repayment ability at the time of consummation, by showing that the consumer’s income, debt obligations, alimony, child support, and the consumer’s monthly payment (including mortgage-related obligations) on the covered transaction and on any simultaneous loans of which the creditor was aware at consummation would leave the consumer with insufficient residual income or assets other than the value of the dwelling (including any real property attached to the dwelling) that secures the loan with which to meet living expenses, including any recurring and material non-debt obligations of which the creditor was aware at the time of consummation. (2) Qualified mortgage defined— general. Except as provided in paragraphs (e)(4) or (f) of this section, a qualified mortgage is a covered transaction: (i) That provides for regular periodic payments that are substantially equal, except for the effect that any interest rate change after consummation has on the payment in the case of an adjustable-rate or step-rate mortgage, that do not: (A) Result in an increase of the principal balance; (B) Allow the consumer to defer repayment of principal, except as provided in paragraph (f) of this section; or (C) Result in a balloon payment, as defined in § 1026.18(s)(5)(i), except as provided in paragraph (f) of this section; (ii) For which the loan term does not exceed 30 years; (iii) For which the total points and fees payable in connection with the loan do not exceed the amounts specified in paragraph (e)(3) of this section; (iv) For which the creditor underwrites the loan, taking into account the monthly payment for mortgage-related obligations, using: (A) The maximum interest rate that may apply during the first five years after the date on which the first regular periodic payment will be due; and (B) Periodic payments of principal and interest that will repay either: VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 (1) The outstanding principal balance over the remaining term of the loan as of the date the interest rate adjusts to the maximum interest rate set forth in paragraph (e)(2)(iv)(A) of this section, assuming the consumer will have made all required payments as due prior to that date; or (2) The loan amount over the loan term; (v) For which the creditor considers and verifies at or before consummation the following: (A) The consumer’s current or reasonably expected income or assets other than the value of the dwelling (including any real property attached to the dwelling) that secures the loan, in accordance with appendix Q and paragraphs (c)(2)(i) and (c)(4) of this section; and (B) The consumer’s current debt obligations, alimony, and child support in accordance with appendix Q and paragraphs (c)(2)(vi) and (c)(3) of this section; and (vi) For which the ratio of the consumer’s total monthly debt to total monthly income at the time of consummation does not exceed 43 percent. For purposes of this paragraph (e)(2)(vi), the ratio of the consumer’s total monthly debt to total monthly income is determined: (A) Except as provided in paragraph (e)(2)(vi)(B) of this section, in accordance with the standards in appendix Q; (B) Using the consumer’s monthly payment on: (1) The covered transaction, including the monthly payment for mortgagerelated obligations, in accordance with paragraph (e)(2)(iv) of this section; and (2) Any simultaneous loan that the creditor knows or has reason to know will be made, in accordance with paragraphs (c)(2)(iv) and (c)(6) of this section. (3) Limits on points and fees for qualified mortgages. (i) A covered transaction is not a qualified mortgage unless the transaction’s total points and fees, as defined in § 1026.32(b)(1), do not exceed: (A) For a loan amount greater than or equal to $100,000 (indexed for inflation): 3 percent of the total loan amount; (B) For a loan amount greater than or equal to $60,000 (indexed for inflation) but less than $100,000 (indexed for inflation): $3,000 (indexed for inflation); (C) For a loan amount greater than or equal to $20,000 (indexed for inflation) but less than $60,000 (indexed for inflation): 5 percent of the total loan amount; PO 00000 Frm 00181 Fmt 4701 Sfmt 4700 6587 (D) For a loan amount greater than or equal to $12,500 (indexed for inflation) but less than $20,000 (indexed for inflation): $1,000 (indexed for inflation); (E) For a loan amount less than $12,500 (indexed for inflation): 8 percent of the total loan amount. (ii) The dollar amounts, including the loan amounts, in paragraph (e)(3)(i) of this section shall be adjusted annually on January 1 by the annual percentage change in the Consumer Price Index for All Urban Consumers (CPI–U) that was reported on the preceding June 1. See the official commentary to this paragraph (e)(3)(ii) for the current dollar amounts. (4) Qualified mortgage defined— special rules—(i) General. Notwithstanding paragraph (e)(2) of this section, a qualified mortgage is a covered transaction that satisfies: (A) The requirements of paragraphs (e)(2)(i) through (iii) of this section; and (B) One or more of the criteria in paragraph (e)(4)(ii) of this section. (ii) Eligible loans. A qualified mortgage under this paragraph (e)(4) must be one of the following at consummation: (A) A loan that is eligible: (1) To be purchased or guaranteed by the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation operating under the conservatorship or receivership of the Federal Housing Finance Agency pursuant to section 1367(a) of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (12 U.S.C. 4617(a)); or (2) To be purchased or guaranteed by any limited-life regulatory entity succeeding the charter of either the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation pursuant to section 1367(i) of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (12 U.S.C. 4617(i)); (B) A loan that is eligible to be insured by the U.S. Department of Housing and Urban Development under the National Housing Act (12 U.S.C. 1707 et seq.); (C) A loan that is eligible to be guaranteed the U.S. Department of Veterans Affairs; (D) A loan that is eligible to be guaranteed by the U.S. Department of Agriculture pursuant to 42 U.S.C. 1472(h); or (E) A loan that is eligible to be insured by the Rural Housing Service. (iii) Sunset of special rules. (A) Each respective special rule described in paragraph (e)(4)(ii)(B), (C), (D), or (E) of this section shall expire on the effective date of a rule issued by each respective E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6588 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations agency pursuant to its authority under TILA section 129C(b)(3)(ii) to define a qualified mortgage. (B) Unless otherwise expired under paragraph (e)(4)(iii)(A) of this section, the special rules in this paragraph (e)(4) are available only for covered transactions consummated on or before January 10, 2021. (f) Balloon-payment qualified mortgages made by certain creditors— (1) Exemption. Notwithstanding paragraph (e)(2) of this section, a qualified mortgage may provide for a balloon payment, provided: (i) The loan satisfies the requirements for a qualified mortgage in paragraphs (e)(2)(i)(A), (e)(2)(ii), (e)(2)(iii), and (e)(2)(v) of this section, but without regard to the standards in appendix Q; (ii) The creditor determines at or before consummation that the consumer can make all of the scheduled payments under the terms of the legal obligation, as described in paragraph (f)(1)(iv) of this section, together with the consumer’s monthly payments for all mortgage-related obligations and excluding the balloon payment, from the consumer’s current or reasonably expected income or assets other than the dwelling that secures the loan; (iii) The creditor considers at or before consummation the consumer’s monthly debt-to-income ratio or residual income and verifies the debt obligations and income used to determine that ratio in accordance with paragraph (c)(7) of this section, except that the calculation of the payment on the covered transaction for purposes of determining the consumer’s total monthly debt obligations in (c)(7)(i)(A) shall be determined in accordance with paragraph (f)(iv)(A) of this section, together with the consumer’s monthly payments for all mortgage-related obligations and excluding the balloon payment; (iv) The legal obligation provides for: (A) Scheduled payments that are substantially equal, calculated using an amortization period that does not exceed 30 years; (B) An interest rate that does not increase over the term of the loan; and (C) A loan term of five years or longer. (v) The loan is not subject, at consummation, to a commitment to be acquired by another person, other than a person that satisfies the requirements of paragraph (f)(1)(vi) of this section; and (vi) The creditor satisfies the requirements stated in § 1026.35(b)(2)(iii)(A), (B), and (C). (2) Post-consummation transfer of balloon-payment qualified mortgage. A balloon-payment qualified mortgage, VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 extended pursuant to paragraph (f)(1), immediately loses its status as a qualified mortgage under paragraph (f)(1) if legal title to the balloon-payment qualified mortgage is sold, assigned, or otherwise transferred to another person except when: (i) The balloon-payment qualified mortgage is sold, assigned, or otherwise transferred to another person three years or more after consummation of the balloon-payment qualified mortgage; (ii) The balloon-payment qualified mortgage is sold, assigned, or otherwise transferred to a creditor that satisfies the requirements of paragraph (f)(1)(vi) of this section; (iii) The balloon-payment qualified mortgage is sold, assigned, or otherwise transferred to another person pursuant to a capital restoration plan or other action under 12 U.S.C. 1831o, actions or instructions of any person acting as conservator, receiver or bankruptcy trustee, an order of a State or Federal governmental agency with jurisdiction to examine the creditor pursuant to State or Federal law, or an agreement between the creditor and such an agency; or (iv) The balloon-payment qualified mortgage is sold, assigned, or otherwise transferred pursuant to a merger of the creditor with another person or acquisition of the creditor by another person or of another person by the creditor. (g) Prepayment penalties—(1) When permitted. A covered transaction must not include a prepayment penalty unless: (i) The prepayment penalty is otherwise permitted by law; and (ii) The transaction: (A) Has an annual percentage rate that cannot increase after consummation; (B) Is a qualified mortgage under paragraph (e)(2), (e)(4), or (f) of this section; and (C) Is not a higher-priced mortgage loan, as defined in § 1026.35(a). (2) Limits on prepayment penalties. A prepayment penalty: (i) Must not apply after the three-year period following consummation; and (ii) Must not exceed the following percentages of the amount of the outstanding loan balance prepaid: (A) 2 percent, if incurred during the first two years following consummation; and (B) 1 percent, if incurred during the third year following consummation. (3) Alternative offer required. A creditor must not offer a consumer a covered transaction with a prepayment penalty unless the creditor also offers the consumer an alternative covered transaction without a prepayment PO 00000 Frm 00182 Fmt 4701 Sfmt 4700 penalty and the alternative covered transaction: (i) Has an annual percentage rate that cannot increase after consummation and has the same type of interest rate as the covered transaction with a prepayment penalty; for purposes of this paragraph (g), the term ‘‘type of interest rate’’ refers to whether a transaction: (A) Is a fixed-rate mortgage, as defined in § 1026.18(s)(7)(iii); or (B) Is a step-rate mortgage, as defined in § 1026.18(s)(7)(ii); (ii) Has the same loan term as the loan term for the covered transaction with a prepayment penalty; (iii) Satisfies the periodic payment conditions under paragraph (e)(2)(i) of this section; (iv) Satisfies the points and fees conditions under paragraph (e)(2)(iii) of this section, based on the information known to the creditor at the time the transaction is offered; and (v) Is a transaction for which the creditor has a good faith belief that the consumer likely qualifies, based on the information known to the creditor at the time the creditor offers the covered transaction without a prepayment penalty. (4) Offer through a mortgage broker. If the creditor offers a covered transaction with a prepayment penalty to the consumer through a mortgage broker, as defined in § 1026.36(a)(2), the creditor must: (i) Present the mortgage broker an alternative covered transaction without a prepayment penalty that satisfies the requirements of paragraph (g)(3) of this section; and (ii) Establish by agreement that the mortgage broker must present the consumer an alternative covered transaction without a prepayment penalty that satisfies the requirements of paragraph (g)(3) of this section, offered by: (A) The creditor; or (B) Another creditor, if the transaction offered by the other creditor has a lower interest rate or a lower total dollar amount of discount points and origination points or fees. (5) Creditor that is a loan originator. If the creditor is a loan originator, as defined in § 1026.36(a)(1), and the creditor presents the consumer a covered transaction offered by a person to which the creditor would assign the covered transaction after consummation, the creditor must present the consumer an alternative covered transaction without a prepayment penalty that satisfies the requirements of paragraph (g)(3) of this section, offered by: (i) The assignee; or E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations (ii) Another person, if the transaction offered by the other person has a lower interest rate or a lower total dollar amount of origination discount points and points or fees. (6) Applicability. This paragraph (g) applies only if a covered transaction is consummated with a prepayment penalty and is not violated if: (i) A covered transaction is consummated without a prepayment penalty; or (ii) The creditor and consumer do not consummate a covered transaction. (h) Evasion; open-end credit. In connection with credit secured by a consumer’s dwelling that does not meet the definition of open-end credit in § 1026.2(a)(20), a creditor shall not structure the loan as an open-end plan to evade the requirements of this section. 5. Reserved appendices N, O, and P are added, and appendix Q is added to read as follows: Appendix N to Part 1026—[Reserved] Appendix O to Part 1026—[Reserved] Appendix P to Part 1026—[Reserved] Appendix Q to Part 1026—Standards for Determining Monthly Debt and Income sroberts on DSK5SPTVN1PROD with Section 1026.43(e)(2)(vi) provides that, to satisfy the requirements for a qualified mortgage under § 1026.43(e)(2), the ratio of the consumer’s total monthly debt to total monthly income at the time of consummation cannot exceed 43 percent. Section 1026.43(e)(2)(vi)(A) requires the creditor to calculate the ratio of the consumer’s total monthly debt to total monthly income using the following standards, with additional requirements for calculating debt and income appearing in § 1026.43(e)(2)(vi)(B). I. Consumer Eligibility A. Stability of Income. 1. Effective Income. Income may not be used in calculating the consumer’s income ratios if it comes from any source that cannot be verified, is not stable, or will not continue. 2. Verifying Employment History. a. The creditor must verify the consumer’s employment for the most recent two full years, and the consumer must: i. Explain any gaps in employment that span one or more months, and ii. Indicate if he/she was in school or the military for the recent two full years, providing evidence supporting this claim, such as college transcripts, or discharge papers. b. Allowances can be made for seasonal employment, typical for the building trades and agriculture, if documented by the creditor. Note: A consumer with a 25 percent or greater ownership interest in a business is considered self-employed and will be evaluated as a self-employed consumer for underwriting purposes. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 3. Analyzing a Consumer’s Employment Record. a. When analyzing the probability of continued employment, creditors must examine: i. The consumer’s past employment record; ii. Qualifications for the position; iii. Previous training and education; and iv. The employer’s confirmation of continued employment. b. Favorably consider a consumer for a mortgage if he/she changes jobs frequently within the same line of work, but continues to advance in income or benefits. In this analysis, income stability takes precedence over job stability. 4. Consumers Returning to Work After an Extended Absence. A consumer’s income may be considered effective and stable when recently returning to work after an extended absence if he/she: a. Is employed in the current job for six months or longer; and b. Can document a two-year work history prior to an absence from employment using: i. Traditional employment verifications; and/or ii. Copies of IRS Form W–2s or pay stubs. Note: An acceptable employment situation includes individuals who took several years off from employment to raise children, then returned to the workforce. c. Important: Situations not meeting the criteria listed above may not be used in qualifying. Extended absence is defined as six months. B. Salary, Wage and Other Forms of Income. 1. General Policy on Consumer Income Analysis. a. The income of each consumer who will be obligated for the mortgage debt must be analyzed to determine whether his/her income level can be reasonably expected to continue through at least the first three years of the mortgage loan. b. In most cases, a consumer’s income is limited to salaries or wages. Income from other sources can be considered as effective, when properly verified and documented by the creditor. Notes: i. Effective income for consumers planning to retire during the first three-year period must include the amount of: a. Documented retirement benefits; b. Social Security payments; or c. Other payments expected to be received in retirement. ii. Creditors must not ask the consumer about possible, future maternity leave. 2. Overtime and Bonus Income. a. Overtime and bonus income can be used to qualify the consumer if he/she has received this income for the past two years, and it will likely continue. If the employment verification states that the overtime and bonus income is unlikely to continue, it may not be used in qualifying. b. The creditor must develop an average of bonus or overtime income for the past two years. Periods of overtime and bonus income less than two years may be acceptable, provided the creditor can justify and document in writing the reason for using the income for qualifying purposes. PO 00000 Frm 00183 Fmt 4701 Sfmt 4700 6589 3. Establishing an Overtime and Bonus Income Earning Trend. a. The creditor must establish and document an earnings trend for overtime and bonus income. If either type of income shows a continual decline, the creditor must document in writing a sound rationalization for including the income when qualifying the consumer. b. A period of more than two years must be used in calculating the average overtime and bonus income if the income varies significantly from year to year. 4. Qualifying Part-Time Income. a. Part-time and seasonal income can be used to qualify the consumer if the creditor documents that the consumer has worked the part-time job uninterrupted for the past two years, and plans to continue. Many low and moderate income families rely on part-time and seasonal income for day to day needs, and creditors should not restrict consideration of such income when qualifying these consumers. b. Part-time income received for less than two years may be included as effective income, provided that the creditor justifies and documents that the income is likely to continue. c. Part-time income not meeting the qualifying requirements may not be used in qualifying. Note: For qualifying purposes, ‘‘part-time’’ income refers to employment taken to supplement the consumer’s income from regular employment; part-time employment is not a primary job and it is worked less than 40 hours. 5. Income from Seasonal Employment. a. Seasonal income is considered uninterrupted, and may be used to qualify the consumer, if the creditor documents that the consumer: i. Has worked the same job for the past two years, and ii. Expects to be rehired the next season. b. Seasonal employment includes: i. Umpiring baseball games in the summer; or ii. Working at a department store during the holiday shopping season. 6. Primary Employment Less Than 40 Hour Work Week. a. When a consumer’s primary employment is less than a typical 40-hour work week, the creditor should evaluate the stability of that income as regular, on-going primary employment. b. Example: A registered nurse may have worked 24 hours per week for the last year. Although this job is less than the 40-hour work week, it is the consumer’s primary employment, and should be considered effective income. 7. Commission Income. a. Commission income must be averaged over the previous two years. To qualify commission income, the consumer must provide: i. Copies of signed tax returns for the last two years; and ii. The most recent pay stub. b. Consumers whose commission income was received for more than one year, but less than two years may be considered favorably if the underwriter can: E:\FR\FM\30JAR2.SGM 30JAR2 6590 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations 11. Social Security Income. Social Security income must be verified by the Social Security Administration or on Federal tax returns. If any benefits expire within the first full three years of the loan, the income source may not be used in qualifying. Notes: i. The creditor must obtain a complete copy of the current awards letter. ii. Not all Social Security income is for retirement-aged recipients; therefore, documented continuation is required. iii. Some portion of Social Security income may be ‘‘grossed up’’ if deemed nontaxable by the IRS. 12. Automobile Allowances and Expense Account Payments. a. Only the amount by which the consumer’s automobile allowance or expense account payments exceed actual expenditures may be considered income. b. To establish the amount to add to gross income, the consumer must provide the following: i. IRS Form 2106, Employee Business Expenses, for the previous two years; and ii. Employer verification that the payments will continue. c. If the consumer uses the standard permile rate in calculating automobile expenses, as opposed to the actual cost method, the portion that the IRS considers depreciation may be added back to income. d. Expenses that must be treated as recurring debt include: i. The consumer’s monthly car payment; and ii. Any loss resulting from the calculation of the difference between the actual expenditures and the expense account allowance. C. Consumers Employed by a Family Owned Business. 1. Income Documentation Requirement. In addition to normal employment verification, a consumer employed by a family owned business is required to provide evidence that he/she is not an owner of the business, which may include: a. Copies of signed personal tax returns, or b. A signed copy of the corporate tax return showing ownership percentage. Note: A tax transcript obtained directly from the IRS may be used in lieu of signed tax returns, and the cost of the transcript may be charged to the consumer. D. General Information on Self-Employed Consumers and Income Analysis. 1. Definition: Self Employed Consumer. A consumer with a 25 percent or greater ownership interest in a business is considered self-employed. 2. Types of Business Structures. There are four basic types of business structures. They include: a. Sole proprietorships; b. Corporations; c. Limited liability or ‘‘S’’ corporations; and d. Partnerships. 3. Minimum Length of Self Employment. a. Income from self-employment is considered stable, and effective, if the consumer has been self-employed for two or more years. b. Due to the high probability of failure during the first few years of a business, the requirements described in the table below are necessary for consumers who have been selfemployed for less than two years. 4. General Documentation Requirements for Self Employed Consumers. Self-employed consumers must provide the following documentation: a. Signed, dated individual tax returns, with all applicable tax schedules for the most recent two years; b. For a corporation, ‘‘S’’ corporation, or partnership, signed copies of Federal business income tax returns for the last two years, with all applicable tax schedules; c. Year to date profit and loss (P&L) statement and balance sheet; and d. Business credit report for corporations and ‘‘S’’ corporations. 5. Establishing a Consumer’s Earnings Trend. a. When qualifying a consumer for a mortgage loan, the creditor must establish the consumer’s earnings trend from the previous two years using the consumer’s tax returns. b. If a consumer: i. Provides quarterly tax returns, the income analysis may include income through the period covered by the tax filings, or ii. Is not subject to quarterly tax returns, or does not file them, then the income shown on the P&L statement may be included in the analysis, provided the income stream based on the P&L is consistent with the previous years’ earnings. c. If the P&L statements submitted for the current year show an income stream considerably greater than what is supported by the previous year’s tax returns, the creditor must base the income analysis solely on the income verified through the tax returns. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 PO 00000 Frm 00184 Fmt 4701 Sfmt 4700 E:\FR\FM\30JAR2.SGM 30JAR2 ER30JA13.001</GPH> sroberts on DSK5SPTVN1PROD with i. Document the likelihood that the income will continue, and ii. Soundly rationalize accepting the commission income. Notes: i. Unreimbursed business expenses must be subtracted from gross income. ii. A commissioned consumer is one who receives more than 25 percent of his/her annual income from commissions. iii. A tax transcript obtained directly from the IRS may be used in lieu of signed tax returns, and the cost of the transcript may be charged to the consumer. 8. Qualifying Commission Income Earned for Less Than One Year. a. Commission income earned for less than one year is not considered effective income. Exceptions may be made for situations in which the consumer’s compensation was changed from salary to commission within a similar position with the same employer. b. A consumer may also qualify when the portion of earnings not attributed to commissions would be sufficient to qualify the consumer for the mortgage. 9. Employer Differential Payments. If the employer subsidizes a consumer’s mortgage payment through direct payments, the amount of the payments: a. Is considered gross income, and b. Cannot be used to offset the mortgage payment directly, even if the employer pays the servicing creditor directly. 10. Retirement Income. Retirement income must be verified from the former employer, or from Federal tax returns. If any retirement income, such as employer pensions or 401(k)’s, will cease within the first full three years of the mortgage loan, such income may not be used in qualifying. Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with d. If the consumer’s earnings trend for the previous two years is downward and the most recent tax return or P&L is less than the prior year’s tax return, the consumer’s most recent year’s tax return or P&L must be used to calculate his/her income. 6. Analyzing the Business’s Financial Strength: a. To determine if the business is expected to generate sufficient income for the consumer’s needs, the creditor must carefully VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 analyze the business’s financial strength, including the: i. Source of the business’s income; ii. General economic outlook for similar businesses in the area. b. Annual earnings that are stable or increasing are acceptable, while businesses that show a significant decline in income over the analysis period are not acceptable. E. Income Analysis: Individual Tax Returns (IRS Form 1040). PO 00000 Frm 00185 Fmt 4701 Sfmt 4700 6591 1. General Policy on Adjusting Income Based on a Review of IRS Form 1040. The amount shown on a consumer’s IRS Form 1040 as adjusted gross income must either be increased or decreased based on the creditor’s analysis of the individual tax return and any related tax schedules. 2. Guidelines for Analyzing IRS Form 1040. The table below contains guidelines for analyzing IRS Form 1040: E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations F. Income Analysis: Corporate Tax Returns (IRS Form 1120). 1. Description: Corporation. A corporation is a State-chartered business owned by its stockholders. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 2. Need To Obtain Consumer Percentage of Ownership Information. a. Corporate compensation to the officers, generally in proportion to the percentage of ownership, is shown on the: PO 00000 Frm 00186 Fmt 4701 Sfmt 4700 i. Corporate tax return IRS Form 1120; and ii. Individual tax returns. b. When a consumer’s percentage of ownership does not appear on the tax returns, the creditor must obtain the E:\FR\FM\30JAR2.SGM 30JAR2 ER30JA13.002</GPH> sroberts on DSK5SPTVN1PROD with 6592 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations 6593 a. In order to determine a consumer’s selfemployed income from a corporation the adjusted business income must: i. Be determined; and ii. Multiplied by the consumer’s percentage of ownership in the business. b. The table below describes the items found on IRS Form 1120 for which an adjustment must be made in order to determine adjusted business income. G. Income Analysis: ‘‘S’’ Corporation Tax Returns (IRS Form 1120S). 1. Description: ‘‘S’’ Corporation. a. An ‘‘S’’ corporation is generally a small, start-up business, with gains and losses passed to stockholders in proportion to each stockholder’s percentage of business ownership. b. Income for owners of ‘‘S’’ corporations comes from IRS Form W–2 wages, and is taxed at the individual rate. The IRS Form 1120S, Compensation of Officers line item is transferred to the consumer’s individual IRS Form 1040. 2. Analyzing ‘‘S’’ Corporation Tax Returns. a. ‘‘S’’ corporation depreciation and depletion may be added back to income in proportion to the consumer’s share of the corporation’s income. b. In addition, the income must also be reduced proportionately by the total obligations payable by the corporation in less than one year. c. Important: The consumer’s withdrawal of cash from the corporation may have a severe negative impact on the corporation’s ability to continue operating, and must be considered in the income analysis. H. Income Analysis: Partnership Tax Returns (IRS Form 1065). 1. Description: Partnership. a. A partnership is formed when two or more individuals form a business, and share in profits, losses, and responsibility for running the company. b. Each partner pays taxes on his/her proportionate share of the partnership’s net income. 2. Analyzing Partnership Tax Returns. a. Both general and limited partnerships report income on IRS Form 1065, and the partners’ share of income is carried over to Schedule E of IRS Form 1040. b. The creditor must review IRS Form 1065 to assess the viability of the business. Both depreciation and depletion may be added back to the income in proportion to the consumer’s share of income. c. Income must also be reduced proportionately by the total obligations payable by the partnership in less than one year. d. Important: Cash withdrawals from the partnership may have a severe negative impact on the partnership’s ability to continue operating, and must be considered in the income analysis. statements support a two-year receipt history. This income must be averaged over the two years. b. Subtract any funds that are derived from these sources, and are required for the cash investment, before calculating the projected interest or dividend income. 2. Trust Income. a. Income from trusts may be used if guaranteed, constant payments will continue for at least the first three years of the mortgage term. b. Required trust income documentation includes a copy of the Trust Agreement or other trustee statement, confirming the: i. Amount of the trust; ii. Frequency of distribution; and iii. Duration of payments. c. Trust account funds may be used for the required cash investment if the consumer provides adequate documentation that the withdrawal of funds will not negatively affect income. The consumer may use funds from the trust account for the required cash investment, but the trust income used to determine repayment ability cannot be affected negatively by its use. 3. Notes Receivable Income. a. In order to include notes receivable income to qualify a consumer, he/she must provide: i. A copy of the note to establish the amount and length of payment, and ii. Evidence that these payments have been consistently received for the last 12 months through deposit slips, cancelled checks, or tax returns. b. If the consumer is not the original payee on the note, the creditor must establish that the consumer is now a holder in due course, and able to enforce the note. 4. Eligible Investment Properties. Follow the steps in the table below to calculate an investment property’s income or loss if the property to be subject to a mortgage is an eligible investment property. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 II. Non-Employment Related Consumer Income A. Alimony, Child Support, and Maintenance Income Criteria. Alimony, child support, or maintenance income may be considered effective, if: 1. Payments are likely to be received consistently for the first three years of the mortgage; 2. The consumer provides the required documentation, which includes a copy of the: i. Final divorce decree; ii. Legal separation agreement; iii. Court order; or iv. Voluntary payment agreement; and 3. The consumer can provide acceptable evidence that payments have been received during the last 12 months, such as: i. Cancelled checks; ii. Deposit slips; iii. Tax returns; or iv. Court records. Notes: i. Periods less than 12 months may be acceptable, provided the creditor can adequately document the payer’s ability and willingness to make timely payments. ii. Child support may be ‘‘grossed up’’ under the same provisions as non-taxable income sources. B. Investment and Trust Income. 1. Analyzing Interest and Dividends. a. Interest and dividend income may be used as long as tax returns or account PO 00000 Frm 00187 Fmt 4701 Sfmt 4700 E:\FR\FM\30JAR2.SGM 30JAR2 ER30JA13.003</GPH> sroberts on DSK5SPTVN1PROD with information from the corporation’s accountant, along with evidence that the consumer has the right to any compensation. 3. Analyzing Corporate Tax Returns. Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations C. Military, Government Agency, and Assistance Program Income. 1. Military Income. a. Military personnel not only receive base pay, but oftentimes are entitled to additional forms of pay, such as: i. Income from variable housing allowances; ii. Clothing allowances; iii. Flight or hazard pay; iv. Rations; and v. Proficiency pay. b. These types of additional pay are acceptable when analyzing a consumer’s income as long as the probability of such pay to continue is verified in writing. Note: The tax-exempt nature of some of the above payments should also be considered. 2. VA Benefits. a. Direct compensation for service-related disabilities from the Department of Veterans Affairs (VA) is acceptable, provided the creditor receives documentation from the VA. b. Education benefits used to offset education expenses are not acceptable. 3. Government Assistance Programs. a. Income received from government assistance programs is acceptable as long as the paying agency provides documentation indicating that the income is expected to continue for at least three years. b. If the income from government assistance programs will not be received for at least three years, it may not be used in qualifying. c. Unemployment income must be documented for two years, and there must be reasonable assurance that this income will continue. This requirement may apply to seasonal employment. 4. Mortgage Credit Certificates. a. If a government entity subsidizes the mortgage payments either through direct payments or tax rebates, these payments may be considered as acceptable income. b. Either type of subsidy may be added to gross income, or used directly to offset the mortgage payment, before calculating the qualifying ratios. 5. Homeownership Subsidies. a. A monthly subsidy may be treated as income, if a consumer is receiving subsidies under the housing choice voucher home ownership option from a public housing agency (PHA). Although continuation of the homeownership voucher subsidy beyond the first year is subject to Congressional appropriation, for the purposes of VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 underwriting, the subsidy will be assumed to continue for at least three years. b. If the consumer is receiving the subsidy directly, the amount received is treated as income. The amount received may also be treated as nontaxable income and be ‘‘grossed up’’ by 25 percent, which means that the amount of the subsidy, plus 25 percent of that subsidy may be added to the consumer’s income from employment and/or other sources. c. Creditors may treat this subsidy as an ‘‘offset’’ to the monthly mortgage payment (that is, reduce the monthly mortgage payment by the amount of the home ownership assistance payment before dividing by the monthly income to determine the payment-to-income and debt-to-income ratios). The subsidy payment must not pass through the consumer’s hands. d. The assistance payment must be: i. Paid directly to the servicing creditor; or ii. Placed in an account that only the servicing creditor may access. Note: Assistance payments made directly to the consumer must be treated as income. D. Rental Income. 1. Analyzing the Stability of Rental Income. a. Rent received for properties owned by the consumer is acceptable as long as the creditor can document the stability of the rental income through: i. A current lease; ii. An agreement to lease, or iii. A rental history over the previous 24 months that is free of unexplained gaps greater than three months (such gaps could be explained by student, seasonal, or military renters, or property rehabilitation). b. A separate schedule of real estate is not required for rental properties as long as all properties are documented on the Uniform Residential Loan Application. Note: The underwriting analysis may not consider rental income from any property being vacated by the consumer, except under the circumstances described below. 2. Rental Income From Consumer Occupied Property. a. The rent for multiple unit property where the consumer resides in one or more units and charges rent to tenants of other units may be used for qualifying purposes. b. Projected rent for the tenant-occupied units only may: i. Be considered gross income, only after deducting vacancy and maintenance factors, and PO 00000 Frm 00188 Fmt 4701 Sfmt 4700 ii. Not be used as a direct offset to the mortgage payment. 3. Income from Roommates in a Single Family Property. a. Income from roommates in a single family property occupied as the consumer’s primary residence is not acceptable. Rental income from boarders however, is acceptable, if the boarders are related by blood, marriage, or law. b. The rental income may be considered effective, if shown on the consumer’s tax return. If not on the tax return, rental income paid by the boarder may not be used in qualifying. 4. Documentation Required To Verify Rental Income. Analysis of the following required documentation is necessary to verify all consumer rental income: a. IRS Form 1040 Schedule E; and b. Current leases/rental agreements. 5. Analyzing IRS Form 1040 Schedule E. a. The IRS Form 1040 Schedule E is required to verify all rental income. Depreciation shown on Schedule E may be added back to the net income or loss. b. Positive rental income is considered gross income for qualifying purposes, while negative income must be treated as a recurring liability. c. The creditor must confirm that the consumer still owns each property listed, by comparing Schedule E with the real estate owned section of the URLA. 6. Using Current Leases To Analyze Rental Income. a. The consumer can provide a current signed lease or other rental agreement for a property that was acquired since the last income tax filing, and is not shown on Schedule E. b. In order to calculate the rental income: i. Reduce the gross rental amount by 25 percent for vacancies and maintenance; ii. Subtract PITI and any homeowners association dues; and iii. Apply the resulting amount to income, if positive, or recurring debts, if negative. 7. Exclusion of Rental Income From Property Being Vacated by the Consumer. Underwriters may not consider any rental income from a consumer’s principal residence that is being vacated in favor of another principal residence, except under the conditions described below: Notes: i. This policy assures that a consumer either has sufficient income to make both mortgage payments without any rental E:\FR\FM\30JAR2.SGM 30JAR2 ER30JA13.004</GPH> sroberts on DSK5SPTVN1PROD with 6594 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations 6595 loan application and confirmed by tax returns (Schedule E of form IRS 1040). 8. Policy Exceptions Regarding the Exclusion of Rental Income From a Principal Residence Being Vacated by a Consumer. When a consumer vacates a principal residence in favor of another principal residence, the rental income, reduced by the appropriate vacancy factor, may be considered in the underwriting analysis under the circumstances listed in the table below. E. Non Taxable and Projected Income. 1. Types of Non Taxable Income. Certain types of regular income may not be subject to Federal tax. Such types of nontaxable income include: a. Some portion of Social Security, some Federal government employee retirement income, Railroad Retirement Benefits, and some State government retirement income: b. Certain types of disability and public assistance payments; c. Child support; d. Military allowances; and e. Other income that is documented as being exempt from Federal income taxes. 2. Adding Non Taxable Income to a Consumer’s Gross Income. a. The amount of continuing tax savings attributed to regular income not subject to Federal taxes may be added to the consumer’s gross income. b. The percentage of non-taxable income that may be added cannot exceed the appropriate tax rate for the income amount. Additional allowances for dependents are not acceptable. c. The creditor: i. Must document and support the amount of income grossed up for any non-taxable income source, and ii. Should use the tax rate used to calculate the consumer’s last year’s income tax. Note: If the consumer is not required to file a Federal tax return, the tax rate to use is 25 percent. 3. Analyzing Projected Income. a. Projected or hypothetical income is not acceptable for qualifying purposes. However, exceptions are permitted for income from the following sources: i. Cost-of-living adjustments; ii. Performance raises; and iii. Bonuses. b. For the above exceptions to apply, the income must be: i. Verified in writing by the employer; and ii. Scheduled to begin within 60 days of loan closing. 4. Project Income for New Job. a. Projected income is acceptable for qualifying purposes for a consumer scheduled to start a new job within 60 days of loan closing if there is a guaranteed, nonrevocable contract for employment. b. The creditor must verify that the consumer will have sufficient income or cash reserves to support the mortgage payment and any other obligations between loan closing and the start of employment. Examples of this type of scenario are teachers whose contracts begin with the new school year, or physicians beginning a residency after the loan closes fall under this category. c. The loan is not eligible for endorsement if the loan closes more than 60 days before the consumer starts the new job. To be eligible for endorsement, the creditor must obtain from the consumer a pay stub or other acceptable evidence indicating that he/she has started the new job. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 PO 00000 Frm 00189 Fmt 4701 Sfmt 4700 III. Consumer Liabilities: Recurring Obligations 1. Types of Recurring Obligation. Recurring obligations include: a. All installment loans; b. Revolving charge accounts; c. Real estate loans; d. Alimony; e. Child support; and f. Other continuing obligations. 2. Debt to Income Ratio Computation for Recurring Obligations. a. The creditor must include the following when computing the debt to income ratios for recurring obligations: i. Monthly housing expense; and ii. Additional recurring charges extending ten months or more, such as a. Payments on installment accounts; b. Child support or separate maintenance payments; c. Revolving accounts; and d. Alimony. b. Debts lasting less than ten months must be included if the amount of the debt affects the consumer’s ability to pay the mortgage during the months immediately after loan closing, especially if the consumer will have limited or no cash assets after loan closing. E:\FR\FM\30JAR2.SGM 30JAR2 ER30JA13.005</GPH> sroberts on DSK5SPTVN1PROD with income, or has an equity position not likely to result in defaulting on the mortgage on the property being vacated. ii. This applies solely to a principal residence being vacated in favor of another principal residence. It does not apply to existing rental properties disclosed on the 6596 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with Note: Monthly payments on revolving or open-ended accounts, regardless of the balance, are counted as a liability for qualifying purposes even if the account appears likely to be paid off within 10 months or less. 3. Revolving Account Monthly Payment Calculation. If the credit report shows any revolving accounts with an outstanding balance but no specific minimum monthly payment, the payment must be calculated as the greater of: a. 5 percent of the balance; or b. $10. Note: If the actual monthly payment is documented from the creditor or the creditor obtains a copy of the current statement reflecting the monthly payment, that amount may be used for qualifying purposes. 4. Reduction of Alimony Payment for Qualifying Ratio Calculation. Since there are tax consequences of alimony payments, the creditor may choose to treat the monthly alimony obligation as a reduction from the consumer’s gross income when calculating qualifying ratios, rather than treating it as a monthly obligation. IV. Consumer Liabilities: Contingent Liability 1. Definition: Contingent Liability. A contingent liability exists when an individual is held responsible for payment of a debt if another party, jointly or severally obligated, defaults on the payment. 2. Application of Contingent Liability Policies. The contingent liability policies described in this topic apply unless the consumer can provide conclusive evidence from the debt holder that there is no possibility that the debt holder will pursue debt collection against him/her should the other party default. 3. Contingent Liability on Mortgage Assumptions. Contingent liability must be considered when the consumer remains obligated on an outstanding FHA-insured, VA-guaranteed, or conventional mortgage secured by property that: a. Has been sold or traded within the last 12 months without a release of liability, or b. Is to be sold on assumption without a release of liability being obtained. 4. Exemption From Contingent Liability Policy on Mortgage Assumptions. When a mortgage is assumed, contingent liabilities need not be considered if the: a. Originating creditor of the mortgage being underwritten obtains, from the servicer of the assumed loan, a payment history showing that the mortgage has been current during the previous 12 months, or b. Value of the property, as established by an appraisal or the sales price on the HUD– 1 Settlement Statement from the sale of the property, results in a loan-to-value (LTV) ratio of 75 percent or less. 5. Contingent Liability on Cosigned Obligations. a. Contingent liability applies, and the debt must be included in the underwriting analysis, if an individual applying for a mortgage is a cosigner/co-obligor on: i. A car loan; ii. A student loan; iii. A mortgage; or VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 iv. Any other obligation. b. If the creditor obtains documented proof that the primary obligor has been making regular payments during the previous 12 months, and does not have a history of delinquent payments on the loan during that time, the payment does not have to be included in the consumer’s monthly obligations. V. Consumer Liabilities: Projected Obligations and Obligations Not Considered Debt 1. Projected Obligations. a. Debt payments, such as a student loan or balloon-payment note scheduled to begin or come due within 12 months of the mortgage loan closing, must be included by the creditor as anticipated monthly obligations during the underwriting analysis. b. Debt payments do not have to be classified as projected obligations if the consumer provides written evidence that the debt will be deferred to a period outside the 12-month timeframe. c. Balloon-payment notes that come due within one year of loan closing must be considered in the underwriting analysis. 2. Obligations Not Considered Debt. Obligations not considered debt, and therefore not subtracted from gross income, include: a. Federal, State, and local taxes; b. Federal Insurance Contributions Act (FICA) or other retirement contributions, such as 401(k) accounts (including repayment of debt secured by these funds): c. Commuting costs; d. Union dues; e. Open accounts with zero balances; f. Automatic deductions to savings accounts; g. Child care; and h. Voluntary deductions. 6. In Supplement I to Part 1026—Official Interpretations: A. Under Section 1026.25—Record Retention: i. Under 25(a) General rule, paragraph 2 is revised. ii. Section 25(c) Records related to certain requirements for mortgage loans, 25(c)(3) Records related to minimum standards for transactions secured by a dwelling, and paragraphs 1 and 2 are added. B. The heading for Section 1026.32 is revised. C. Under revised Section 1026.32: i. Under 32(b) Definitions: a. Paragraph 32(b)(1) and paragraph 1 are added. b. Under Paragraph 32(b)(1)(i), paragraph 1 is revised. c. Paragraph 32(b)(1)(i)(B) and paragraph 1 are added. d. Paragraph 32(b)(1)(i)(C) and paragraphs 1 and 2 are added. e. Paragraph 32(b)(1)(i)(D) and paragraphs 1, 2, 3, and 4 are added. f. Paragraph 32(b)(1)(i)(E) and paragraphs 1, 2, and 3 are added. g. Paragraph 32(b)(1)(i)(F) and paragraphs 1 and 2 are added. h. Under Paragraph 32(b)(1)(ii), paragraphs 1 and 2 are revised and paragraphs 3 and 4 are added. PO 00000 Frm 00190 Fmt 4701 Sfmt 4700 i. Paragraph 32(b)(1)(iii) and paragraph 1 are added. j. Under Paragraph 32(b)(1)(iv), paragraph 1 is revised and paragraphs 2 and 3 are added. k. 32(b)(3) Bona fide discount point, 32(b)(3)(i) Closed-end credit, and paragraph 1 are added. l. 32(b)(4) Total loan amount, 32(b)(4)(i) Closed-end credit, and paragraph 1 are added. m. 32(b)(6) Prepayment penalty and paragraphs 1 and 2 are added. D. Section 1026.43—Minimum Standards for Transactions Secured by a Dwelling is added. The revisions and additions read as follows: Supplement I to Part 1026—Official Interpretations * * * * * Subpart D—Miscellaneous * * * * * Section 1026.25—Record Retention 25(a) General rule. * * * * * 2. Methods of retaining evidence. Adequate evidence of compliance does not necessarily mean actual paper copies of disclosure statements or other business records. The evidence may be retained by any method that reproduces records accurately (including computer programs). Unless otherwise required, the creditor need retain only enough information to reconstruct the required disclosures or other records. Thus, for example, the creditor need not retain each open-end periodic statement, so long as the specific information on each statement can be retrieved. * * * * * 25(c) Records related to certain requirements for mortgage loans. 25(c)(3) Records related to minimum standards for transactions secured by a dwelling. 1. Evidence of compliance with repayment ability provisions. A creditor must retain evidence of compliance with § 1026.43 for three years after the date of consummation of a consumer credit transaction covered by that section. (See comment 25(c)-2 for guidance on the retention of evidence of compliance with the requirement to offer a consumer a loan without a prepayment penalty under § 1026.43(g)(3).) If a creditor must verify and document information used in underwriting a transaction subject to § 1026.43, the creditor shall retain evidence sufficient to demonstrate compliance with the documentation requirements of the rule. Although a creditor need not retain actual paper copies of the documentation used in underwriting a transaction subject to § 1026.43, to comply with § 1026.25(c)(3), the creditor must be able to reproduce such records accurately. For example, if the creditor uses a consumer’s Internal Revenue Service (IRS) Form W–2 to verify the consumer’s income, the creditor must be able to reproduce the IRS Form W–2 itself, and E:\FR\FM\30JAR2.SGM 30JAR2 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations not merely the income information that was contained in the form. 2. Dwelling-secured transactions and prepayment penalties. If a transaction covered by § 1026.43 has a prepayment penalty, the creditor must maintain records that document that the creditor complied with requirements for offering the consumer an alternative transaction that does not include a prepayment penalty under § 1026.43(g)(3), (4), or (5). However, the creditor need not maintain records that document compliance with those provisions if a transaction is consummated without a prepayment penalty or if the creditor and consumer do not consummate a covered transaction. If a creditor offers a transaction with a prepayment penalty to a consumer through a mortgage broker, to evidence compliance with § 1026.43(g)(4) the creditor should retain evidence of the alternative covered transaction presented to the mortgage broker, such as a rate sheet, and the agreement with the mortgage broker required by § 1026.43(g)(4)(ii). * * * * * Subpart E—Special Rules for Certain Home Mortgage Transactions * * * * * Section 1026.32—Requirements for High-Cost Mortgages sroberts on DSK5SPTVN1PROD with * * * * * 32(b) Definitions. Paragraph 32(b)(1). 1. Known at or before consummation. Section 1026.32(b)(1) includes in points and fees for closed-end credit transactions those items listed in § 1026.32(b)(1)(i) through (vi) that are known at or before consummation. The following examples clarify how to determine whether a charge or fee is known at or before consummation. i. General. In general, a charge or fee is ‘‘known at or before consummation’’ if the creditor knows at or before consummation that the charge or fee will be imposed in connection with the transaction, even if the charge or fee is scheduled to be paid after consummation. Thus, for example, if the creditor charges the consumer $400 for an appraisal conducted by an affiliate of the creditor, the $400 is included in points and fees, even if the consumer finances it and repays it over the loan term, because the creditor knows at or before consummation that the charge or fee is imposed in connection with the transaction. By contrast, if a creditor does not know whether a charge or fee will be imposed, it is not included in points and fees. For example, charges or fees that the creditor may impose if the consumer seeks to modify a loan after consummation are not included in points and fees, because the creditor does not know at or before consummation whether the consumer will seek to modify the loan and therefore incur the fees or charges. ii. Prepayment penalties. Notwithstanding the guidance in comment 32(b)(1)-1.i, under § 1026.32(b)(1)(v) the maximum prepayment penalty that may be charged or collected under the terms of the mortgage loan is included in points and fees because the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 amount of the maximum prepayment penalty that may be charged or collected is known at or before consummation. iii. Certain mortgage and credit insurance premiums. Notwithstanding the guidance in comment 32(b)(1)-1.i, under § 1026.32(b)(1)(i)(C)(1) and (iii) premiums and charges for private mortgage insurance and credit insurance that are payable after consummation are not included in points and fees, even if the amounts of such premiums and charges are known at or before consummation. Paragraph 32(b)(1)(i). 1. General. Section 1026.32(b)(1)(i) includes in the total ‘‘points and fees’’ items included in the finance charge under § 1026.4(a) and (b). However, certain items that may be included in the finance charge are excluded from points and fees under § 1026.32(b)(1)(i)(A) through (F). Items excluded from the finance charge under other provisions of § 1026.4 are not included in the total points and fees under § 1026.32(b)(1)(i), but may be included in points and fees under § 1026.32(b)(1)(ii) through (vi). To illustrate: A fee imposed by the creditor for an appraisal performed by an employee of the creditor meets the definition of ‘‘finance charge’’ under § 1026.4(a) as ‘‘any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit.’’ However, § 1026.4(c)(7) specifies that appraisal fees are not included in the finance charge. A fee imposed by the creditor for an appraisal performed by an employee of the creditor therefore would not be included in the finance charge and would not be counted in points and fees under § 1026.32(b)(1)(i). Section 1026.32(b)(1)(iii), however, expressly includes in points and fees items listed in § 1026.4(c)(7) (including appraisal fees) if the creditor receives compensation in connection with the charge. A creditor would receive compensation for an appraisal performed by its own employee. Thus, the appraisal fee in this example must be included in the calculation of points and fees. Paragraph 32(b)(1)(i)(B). 1. Federal and State mortgage insurance premiums and guaranty fees. Under § 1026.32(b)(1)(i)(B), mortgage insurance premiums or guaranty fees in connection with a Federal or State agency program are excluded from points and fees, even though they are included in the finance charge under § 1026.4(a) and (b). For example, if a consumer is required to pay a $2,000 mortgage insurance premium for a loan insured by the Federal Housing Administration, the $2,000 must be included in the finance charge but is not counted in points and fees. Similarly, if a consumer pays a 2 percent funding fee for a loan guaranteed by the U.S. Department of Veterans Affairs or through the U.S Department of Agriculture’s Rural Development Single Family Housing Guaranteed Loan Program, the fee is included in the finance charge but is not included in points and fees. Paragraph 32(b)(1)(i)(C). 1. Private mortgage insurance premiums. i. Payable after consummation. Under § 1026.32(b)(1)(i)(C)(1), private mortgage PO 00000 Frm 00191 Fmt 4701 Sfmt 4700 6597 insurance premiums payable after consummation are excluded from points and fees. ii. Payable at or before consummation. A. General. Under § 1026.32(b)(1)(i)(C)(2), private mortgage insurance premiums payable at or before consummation (i.e., single or up-front premiums) may be excluded from points and fees, even though they are included in the finance charge under § 1026.4(a) and (b). However, the portion of the premium that exceeds the amount payable under policies in effect at the time of origination under section 203(c)(2)(A) of the National Housing Act (12 U.S.C. 1709(c)(2)(A)) is included in points and fees. To determine whether any portion of the premium exceeds the amount payable under policies in effect at the time of origination under section 203(c)(2)(A) of the National Housing Act, a creditor references the premium amount that would be payable for the transaction under that Act, as implemented by applicable regulations and other written authorities issued by the Federal Housing Administration (such as Mortgagee Letters), even if the transaction would not qualify to be insured under that Act (including, for example, because the principal amount exceeds the maximum insurable under that Act). B. Non-refundable premiums. To qualify for the exclusion from points and fees, private mortgage insurance premiums payable at or before consummation must be required to be refunded on a pro rata basis and the refund must be automatically issued upon notification of the satisfaction of the underlying mortgage loan. C. Example. Assume that a $3,000 private mortgage insurance premium charged on a closed-end mortgage loan is payable at or before closing and is required to be refunded on a pro rata basis and that the refund is automatically issued upon notification of the satisfaction of the underlying mortgage loan. Assume also that the maximum premium allowable under the National Housing Act is $2,000. In this case, the creditor could exclude $2,000 from points and fees but would have to include the $1,000 that exceeds the allowable premium under the National Housing Act. However, if the $3,000 private mortgage insurance premium were not required to be refunded on a pro rata basis or if the refund were not automatically issued upon notification of the satisfaction of the underlying mortgage loan, the entire $3,000 premium would be included in points and fees. 2. Method of paying private mortgage insurance premiums. The portion of any private mortgage insurance premiums payable at or before consummation that does not qualify for an exclusion from points and fees under § 1026.32(b)(1)(i)(C)(2) must be included in points and fees for purposes of § 1026.32(b)(1)(i) whether paid in cash or financed and whether the insurance is optional or required. Paragraph 32(b)(1)(i)(D). 1. Charges not retained by the creditor, loan originator, or an affiliate of either. In general, a creditor is not required to count in points and fees any bona fide third-party charge not retained by the creditor, loan E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6598 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations originator, or an affiliate of either. For example, if bona fide charges are imposed by a third-party settlement agent and are not retained by the creditor, loan originator, or an affiliate of either, those charges are not included in points and fees, even if those charges are included in the finance charge under § 1026.4(a)(2). The term loan originator has the same meaning as in § 1026.36(a)(1). 2. Private mortgage insurance. The exclusion for bona fide third-party charges not retained by the creditor, loan originator, or an affiliate of either is limited by § 1026.32(b)(1)(i)(C) in the general definition of ‘‘points and fees.’’ Section 1026.32(b)(1)(i)(C) requires inclusion in points and fees of premiums or other charges payable at or before consummation for any private guaranty or insurance protecting the creditor against the consumer’s default or other credit loss to the extent that the premium or charge exceeds the amount payable under policies in effect at the time of origination under section 203(c)(2)(A) of the National Housing Act (12 U.S.C. 1709(c)(2)(A)). These premiums or charges must also be included if the premiums or charges are not required to be refundable on a pro-rated basis, or the refund is not required to be automatically issued upon notification of the satisfaction of the underlying mortgage loan. Under these circumstances, even if the premiums or other charges are not retained by the creditor, loan originator, or an affiliate of either, they must be included in the points and fees calculation for qualified mortgages. See comments 32(b)(1)(i)(c)-1 and -2 for further discussion of including private mortgage insurance premiums payable at or before consummation in the points and fees calculation. 3. Real estate-related fees. The exclusion for bona fide third-party charges not retained by the creditor, loan originator, or an affiliate of either is limited by § 1026.32(b)(1)(iii) in the general definition of points and fees. Section 1026.32(b)(1)(iii) requires inclusion in points and fees of items listed in § 1026.4(c)(7) unless the charge is reasonable, the creditor receives no direct or indirect compensation in connection with the charge, and the charge is not paid to an affiliate of the creditor. If a charge is required to be included in points and fees under § 1026.32(b)(1)(iii), it may not be excluded under § 1026.32(b)(1)(i)(D), even if the criteria for exclusion in § 1026.32(b)(1)(i)(D) are satisfied. 4. Credit insurance. The exclusion for bona fide third-party charges not retained by the creditor, loan originator, or an affiliate of either is limited by § 1026.32(b)(1)(iv) in the general definition of points and fees. Section 1026.32(b)(1)(iv) requires inclusion in points and fees of premiums and other charges for credit insurance and certain other types of insurance. If a charge is required to be included in points and fees under § 1026.32(b)(1)(iv), it may not be excluded under § 1026.32(b)(1)(i)(D), even if the criteria for exclusion in § 1026.32(b)(1)(i)(D) are satisfied. Paragraph 32(b)(1)(i)(E). 1. Bona fide discount point. The term bona fide discount point is defined in § 1026.32(b)(3). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 2. Average prime offer rate. The average prime offer rate for purposes of paragraph (b)(1)(i)(E) of this section is the average prime offer rate that applies to a comparable transaction as of the date the discounted interest rate for the transaction is set. For the meaning of ‘‘comparable transaction,’’ refer to comment 35(a)(2)-2. The table of average prime offer rates published by the Bureau indicates how to identify the comparable transaction. See comment 35(a)(2)-2. 3. Example. Assume a transaction that is a first-lien, purchase-money home mortgage with a fixed interest rate and a 30-year term. Assume also that the consumer locks in an interest rate of 6 percent on May 1, 2014 that was discounted from a rate of 6.5 percent because the consumer paid two discount points. Finally, assume that the average prime offer rate as of May 1, 2014 for home mortgages with a fixed interest rate and a 30year term is 5.5 percent. The creditor may exclude two bona fide discount points from the points and fees calculation because the rate from which the discounted rate was derived (6.5 percent) exceeded the average prime offer rate for a comparable transaction as of the date the rate on the transaction was set (5.5 percent) by only 1 percentage point. Paragraph 32(b)(1)(i)(F). 1. Bona fide discount point and average prime offer rate. Comments 32(b)(1)(i)(E)-1 and -2 provide guidance concerning the definition of bona fide discount point and average prime offer rate, respectively. 2. Example. Assume a transaction that is a first-lien, purchase-money home mortgage with a fixed interest rate and a 30-year term. Assume also that the consumer locks in an interest rate of 6 percent on May 1, 2014, that was discounted from a rate of 7 percent because the consumer paid four discount points. Finally, assume that the average prime offer rate as of May 1, 2014, for home mortgages with a fixed interest rate and a 30year term is 5 percent. The creditor may exclude one discount point from the points and fees calculation because the rate from which the discounted rate was derived (7 percent) exceeded the average prime offer rate for a comparable transaction as of the date the rate on the transaction was set (5 percent) by only 2 percentage points. Paragraph 32(b)(1)(ii). 1. Loan originator compensation—general. Compensation paid by a consumer or creditor to a loan originator is included in the calculation of points and fees for a transaction, provided that such compensation can be attributed to that particular transaction at the time the interest rate is set. Loan originator compensation includes amounts the loan originator retains and is not dependent on the label or name of any fee imposed in connection with the transaction. 2. Loan originator compensation— attributable to a particular transaction. i. Loan originator compensation includes the dollar value of compensation, such as a bonus, commission, or award of merchandise, services, trips, or similar prizes, that is paid by a consumer or creditor to a loan originator and can be attributed to that particular transaction. The amount of compensation that can be attributed to a PO 00000 Frm 00192 Fmt 4701 Sfmt 4700 particular transaction is the dollar value of compensation that the loan originator will receive if the transaction is consummated. As explained in comment 32(b)(1)(ii)-3, the amount of compensation that a loan originator will receive is calculated as of the date the interest rate is set and includes compensation that is paid before, at, or after consummation. ii. Loan originator compensation excludes compensation that cannot be attributed to that transaction, including, for example: A. Compensation based on the long term performance of the loan originator’s loans. B. Compensation based on the overall quality of a loan originator’s loan files. C. The base salary of a loan originator. However, any compensation in addition to the base salary that can be attributed to the transaction at the time the interest rate is set must be included in loan originator compensation for the purpose of calculating points and fees. 3. Loan originator compensation—timing. Compensation paid to a loan originator that can be attributed to a transaction must be included in the points and fees calculation for that loan regardless of whether the compensation is paid before, at, or after consummation. The amount of loan originator compensation that can be attributed to a transaction is determined as of the date the interest rate is set. Thus, loan originator compensation for a transaction includes the portion of a bonus, commission, or award of merchandise, services, trips, or similar prizes that can be attributed to that transaction at the time the creditor sets the interest rate for the transaction, even if that bonus, commission, or award of merchandise, services, trips, or similar prizes is not paid until after consummation. For example, assume a $100,000 transaction and that, as of the date the interest rate is set, the loan originator is entitled to receive a commission equal to 1 percent of the loan amount at consummation, i.e., $1,000, payable at the end of the month. In addition, assume that after the date the interest rate is set but before consummation of the transaction, the loan originator originates other transactions that enable the loan originator to meet a loan volume threshold, which increases the loan originator’s commission to 1.25 percent of the loan amount, i.e., $1,250. In this case, the creditor need include only $1,000 as loan originator compensation in points and fees because, as of the date the interest rate was set, the loan originator would have been entitled to receive $1,000 upon consummation of the transaction. 4. Loan originator compensation— examples. The following examples illustrate the rule: i. Assume that, according to a creditor’s compensation policies, the creditor awards its loan officers a bonus every year based on the number of loan applications taken by the loan officer that result in consummated transactions during that year, and that each consummated transaction increases the yearend bonus by $100. In this case, $100 of the bonus is loan originator compensation that must be included in points and fees for the transaction. E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations ii. Assume that, according to a creditor’s compensation policies, the creditor awards its loan officers a year-end bonus equal to a flat dollar amount for each of the consummated transactions originated by the loan officer during that year. Assume also that the per-transaction dollar amount is finalized at the end of the year, according to a predetermined schedule that provides for a specific per-transaction dollar amount based on the total dollar value of consummated transactions originated by the loan officer. If on the date the interest rate for a transaction is set, the loan officer has originated total volume that qualifies the loan officer to receive a $300 bonus per transaction under the predetermined schedule, then $300 of the year-end bonus can be attributed to that particular transaction and therefore is loan originator compensation that must be included in points and fees for that transaction. iii. Assume that, according to a creditor’s compensation policies, the creditor awards its loan officers a bonus at the end of the year based on the number of consummated transactions originated by the loan officer during that year. Assume also that, for the first 10 transactions originated by the loan officer in a given year, no bonus is awarded; for the next 10 transactions originated by the loan officer up to 20, a bonus of $100 per transaction is awarded; and for each transaction originated after the first 20, a bonus of $200 per transaction is awarded. In this case, if, on the date the interest rate for the transaction is set, the loan officer has originated 10 or fewer transactions that year, then none of the year-end bonus is attributable to the transaction and therefore none of the bonus is included in points and fees for that transaction. If, on the date the interest rate for the transaction is set, the loan officer has originated at more than 10 but no more than 20 transactions, $100 of the bonus is attributable to the transaction and is included in points and fees for that transaction. If, on the date the interest rate for the transaction is set, the loan officer has originated more than 20 transactions, $200 of the bonus is attributable to the transaction and is included in points and fees for the transaction. iv. Assume that, according to a creditor’s compensation policies, the creditor pays its loan officers a base salary of $500 per week and awards its loan officers a bonus of $250 for each consummated transaction. For each transaction, none of the $500 base salary is counted in points and fees as loan originator compensation under § 1026.32(b)(1)(ii) because no precise portion of the base salary can be attributed to a particular transaction, but the $250 bonus is counted as loan originator compensation that is included in points and fees. Paragraph 32(b)(1)(iii). 1. Other charges. Section 1026.32(b)(1)(iii) defines points and fees to include all items listed in § 1026.4(c)(7), other than amounts held for the future payment of taxes, unless certain exclusions apply. An item listed in § 1026.4(c)(7) may be excluded from the points and fees calculation if the charge is reasonable; the creditor receives no direct or indirect compensation from the charge; and VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 the charge is not paid to an affiliate of the creditor. For example, a reasonable fee paid by the consumer to an independent, thirdparty appraiser may be excluded from the points and fees calculation (assuming no compensation is paid to the creditor or its affiliate and no charge is paid to an affiliate). By contrast, a fee paid by the consumer for an appraisal performed by the creditor must be included in the calculation, even though the fee may be excluded from the finance charge if it is bona fide and reasonable in amount. Paragraph 32(b)(1)(iv). 1. Credit insurance and debt cancellation or suspension coverage. In determining points and fees for purposes of § 1026.32(b)(1), premiums paid at or before consummation for credit insurance or any debt cancellation or suspension agreement or contract are included in points and fees whether they are paid in cash or, if permitted by applicable law, financed and whether the insurance or coverage is optional or required. Such charges are also included whether the amount represents the entire premium or payment for the coverage or an initial payment. 2. Credit property insurance. Credit property insurance includes insurance against loss of or damage to personal property, such as a houseboat or manufactured home. Credit property insurance covers the creditor’s security interest in the property. Credit property insurance does not include homeowners’ insurance, which, unlike credit property insurance, typically covers not only the dwelling but its contents and protects the consumer’s interest in the property. 3. Life, accident, health, or loss-of-income insurance. Premiums or other charges for these types of insurance are included in points and fees only if the creditor is a beneficiary. If the consumer or another person designated by the consumer is the sole beneficiary, then the premiums or other charges are not included in points and fees. 32(b)(3) Bona fide discount point. 32(b)(3)(i) Closed-end credit. 1. Definition of bona fide discount point. Section 1026.32(b)(3) provides that, to be bona fide, a discount point must reduce the interest rate based on a calculation that is consistent with established industry practices for determining the amount of reduction in the interest rate or time-price differential appropriate for the amount of discount points paid by the consumer. To satisfy this standard, a creditor may show that the reduction is reasonably consistent with established industry norms and practices for secondary mortgage market transactions. For example, a creditor may rely on pricing in the to-be-announced (TBA) market for mortgage-backed securities (MBS) to establish that the interest rate reduction is consistent with the compensation that the creditor could reasonably expect to receive in the secondary market. The creditor may also establish that its interest rate reduction is consistent with established industry practices by showing that its calculation complies with requirements prescribed in Fannie Mae or Freddie Mac guidelines for interest rate reductions from bona fide PO 00000 Frm 00193 Fmt 4701 Sfmt 4700 6599 discount points. For example, assume that the Fannie Mae Single-Family Selling Guide or the Freddie Mac Single Family Seller/ Servicer Guide imposes a cap on points and fees but excludes from the cap discount points that result in a bona fide reduction in the interest rate. Assume the guidelines require that, for a discount point to be bona fide so that it would not count against the cap, a discount point must result in at least a 25 basis point reduction in the interest rate. Accordingly, if the creditor offers a 25 basis point interest rate reduction for a discount point and the requirements of § 1026.32(b)(1)(i)(E) or (F) are satisfied, the discount point is bona fide and is excluded from the calculation of points and fees. 32(b)(4) Total loan amount. 32(b)(4)(i) Closed-end credit. 1. Total loan amount; examples. Below are several examples showing how to calculate the total loan amount for closed-end mortgage loans, each using a $10,000 amount borrowed, a $300 appraisal fee, and $400 in prepaid finance charges. A $500 single premium for optional credit unemployment insurance is used in one example. i. If the consumer finances a $300 fee for a creditor-conducted appraisal and pays $400 in prepaid finance charges at closing, the amount financed under § 1026.18(b) is $9,900 ($10,000 plus the $300 appraisal fee that is paid to and financed by the creditor, less $400 in prepaid finance charges). The $300 appraisal fee paid to the creditor is added to other points and fees under § 1026.32(b)(1)(iii). It is deducted from the amount financed ($9,900) to derive a total loan amount of $9,600. ii. If the consumer pays the $300 fee for the creditor-conducted appraisal in cash at closing, the $300 is included in the points and fees calculation because it is paid to the creditor. However, because the $300 is not financed by the creditor, the fee is not part of the amount financed under § 1026.18(b). In this case, the amount financed is the same as the total loan amount: $9,600 ($10,000, less $400 in prepaid finance charges). iii. If the consumer finances a $300 fee for an appraisal conducted by someone other than the creditor or an affiliate, the $300 fee is not included with other points and fees under § 1026.32(b)(1)(iii). In this case, the amount financed is the same as the total loan amount: $9,900 ($10,000 plus the $300 fee for an independently-conducted appraisal that is financed by the creditor, less the $400 paid in cash and deducted as prepaid finance charges). iv. If the consumer finances a $300 fee for a creditor-conducted appraisal and a $500 single premium for optional credit unemployment insurance, and pays $400 in prepaid finance charges at closing, the amount financed under § 1026.18(b) is $10,400 ($10,000, plus the $300 appraisal fee that is paid to and financed by the creditor, plus the $500 insurance premium that is financed by the creditor, less $400 in prepaid finance charges). The $300 appraisal fee paid to the creditor is added to other points and fees under § 1026.32(b)(1)(ii), and the $500 insurance premium is added under 1026.32(b)(1)(iv). The $300 and $500 costs are deducted from the amount financed E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6600 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations ($10,400) to derive a total loan amount of $9,600. 32(b)(6) Prepayment penalty. 1. Examples of prepayment penalties; closed-end credit transactions. For purposes of § 1026.32(b)(6)(i), the following are examples of prepayment penalties: i. A charge determined by treating the loan balance as outstanding for a period of time after prepayment in full and applying the interest rate to such ‘‘balance,’’ even if the charge results from interest accrual amortization used for other payments in the transaction under the terms of the loan contract. ‘‘Interest accrual amortization’’ refers to the method by which the amount of interest due for each period (e.g., month) in a transaction’s term is determined. For example, ‘‘monthly interest accrual amortization’’ treats each payment as made on the scheduled, monthly due date even if it is actually paid early or late (until the expiration of any grace period). Thus, under the terms of a loan contract providing for monthly interest accrual amortization, if the amount of interest due on May 1 for the preceding month of April is $3,000, the loan contract will require payment of $3,000 in interest for the month of April whether the payment is made on April 20, on May 1, or on May 10. In this example, if the consumer prepays the loan in full on April 20 and if the accrued interest as of that date is $2,000, then assessment of a charge of $3,000 constitutes a prepayment penalty of $1,000 because the amount of interest actually earned through April 20 is only $2,000. ii. A fee, such as an origination or other loan closing cost, that is waived by the creditor on the condition that the consumer does not prepay the loan. However, the term prepayment penalty does not include a waived bona fide third-party charge imposed by the creditor if the consumer pays all of a covered transaction’s principal before the date on which the principal is due sooner than 36 months after consummation. For example, assume that at consummation, the creditor waives $3,000 in closing costs to cover bona fide third-party charges but the terms of the loan agreement provide that the creditor may recoup the $3,000 in waived charges if the consumer repays the entire loan balance sooner than 36 months after consummation. The $3,000 charge is not a prepayment penalty. In contrast, for example, assume that at consummation, the creditor waives $3,000 in closing costs to cover bona fide third-party charges but the terms of the loan agreement provide that the creditor may recoup $4,500, in part to recoup waived charges, if the consumer repays the entire loan balance sooner than 36 months after consummation. The $3,000 that the creditor may impose to cover the waived bona fide third-party charges is not a prepayment penalty, but the additional $1,500 charge is a prepayment penalty and subject to the restrictions under § 1026.43(g). iii. A minimum finance charge in a simple interest transaction. iv. Computing a refund of unearned interest by a method that is less favorable to the consumer than the actuarial method, as defined by section 933(d) of the Housing and Community Development Act of 1992, 15 VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 U.S.C. 1615(d). For purposes of computing a refund of unearned interest, if using the actuarial method defined by applicable State law results in a refund that is greater than the refund calculated by using the method described in section 933(d) of the Housing and Community Development Act of 1992, creditors should use the State law definition in determining if a refund is a prepayment penalty. 2. Fees that are not prepayment penalties; closed-end credit transactions. For purposes of § 1026.32(b)(6)(i), fees that are not prepayment penalties include, for example: i. Fees imposed for preparing and providing documents when a loan is paid in full if such fees are imposed whether or not the loan is prepaid. Examples include a loan payoff statement, a reconveyance document, or another document releasing the creditor’s security interest in the dwelling that secures the loan. ii. Loan guarantee fees. * * * * * Section 1026.43—Minimum Standards for Transactions Secured by a Dwelling 1. Record retention. See § 1026.25(c)(3) and comments 25(c)(3)–1 and –2 for guidance on the required retention of records as evidence of compliance with § 1026.43. 43(a) Scope. 1. Consumer credit. In general, § 1026.43 applies to consumer credit transactions secured by a dwelling, but certain dwellingsecured consumer credit transactions are exempt or partially exempt from coverage under § 1026.43(a)(1) through (3). (See § 1026.2(a)(12) for the definition of ‘‘consumer credit.’’) Section 1026.43 does not apply to an extension of credit primarily for a business, commercial, or agricultural purpose, even if it is secured by a dwelling. See § 1026.3 and associated commentary for guidance in determining the primary purpose of an extension of credit. In addition, § 1026.43 does not apply to any change to an existing loan that is not treated as a refinancing under § 1026.20(a). 2. Real property. ‘‘Dwelling’’ means a residential structure that contains one to four units, whether or not the structure is attached to real property. See § 1026.2(a)(19). For purposes of § 1026.43, the term ‘‘dwelling’’ includes any real property to which the residential structure is attached that also secures the covered transaction. For example, for purposes of § 1026.43(c)(2)(i), the value of the dwelling that secures the covered transaction includes the value of any real property to which the residential structure is attached that also secures the covered transaction. Paragraph 43(a)(3). 1. Renewable temporary or ‘‘bridge’’ loan. Under § 1026.43(a)(3)(ii), a temporary or ‘‘bridge’’ loan with a term of 12 months or less is exempt from § 1026.43(c) through (f). Examples of such a loan are a loan to finance the purchase of a new dwelling where the consumer plans to sell a current dwelling within 12 months and a loan to finance the initial construction of a dwelling. Where a temporary or ‘‘bridge loan’’ is renewable, the loan term does not include any additional period of time that could result from a PO 00000 Frm 00194 Fmt 4701 Sfmt 4700 renewal provision provided that any renewal possible under the loan contract is for one year or less. For example, if a construction loan has an initial loan term of 12 months but is renewable for another 12-month loan term, the loan is exempt from § 1026.43(c) through (f) because the initial loan term is 12 months. 2. Construction phase of a construction-topermanent loan. Under § 1026.43(a)(3)(iii), a construction phase of 12 months or less of a construction-to-permanent loan is exempt from § 1026.43(c) through (f). A constructionto-permanent loan is a potentially multipleadvance loan to finance the construction, rehabilitation, or improvement of a dwelling that may be permanently financed by the same creditor. For such a loan, the construction phase and the permanent phase may be treated as separate transactions for the purpose of compliance with § 1026.43(c) through (f), and the construction phase of the loan is exempt from § 1026.43(c) through (f), provided the initial term is 12 months or less. See § 1026.17(c)(6)(ii), allowing similar treatment for disclosures. Where the construction phase of a construction-topermanent loan is renewable for a period of one year or less, the term of that construction phase does not include any additional period of time that could result from a renewal provision. For example, if the construction phase of a construction-to-permanent loan has an initial term of 12 months but is renewable for another 12-month term before permanent financing begins, the construction phase is exempt from § 1026.43(c) through (f) because the initial term is 12 months. Any renewal of one year or less also qualifies for the exemption. The permanent phase of the loan is treated as a separate transaction and is not exempt under § 1026.43(a)(3)(iii). It may be a qualified mortgage if it satisfies the appropriate requirements. 43(b) Definitions. 43(b)(1) Covered transaction. 1. The definition of covered transaction restates the scope of the rule as described at § 1026.43(a). 43(b)(3) Fully indexed rate. 1. Discounted and premium adjustable-rate transactions. In some adjustable-rate transactions, creditors may set an initial interest rate that is not determined by the index or formula used to make later interest rate adjustments. In some cases, the initial rate charged to consumers is lower than the rate would be if it were calculated using the index or formula that will apply after recast, as determined at consummation (i.e., a ‘‘discounted rate’’). In other cases, the initial rate may be higher (i.e., a ‘‘premium rate’’). For purposes of determining the fully indexed rate where the initial interest rate is not determined using the index or formula for subsequent interest rate adjustments, the creditor must use the interest rate that would have applied had the creditor used such index or formula plus margin at the time of consummation. That is, in determining the fully indexed rate, the creditor must not take into account any discounted or premium rate. To illustrate, assume an adjustable-rate transaction where the initial interest rate is not based on an index or formula, or is based on an index or formula that will not apply after recast, and is set at 5 percent for the first E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations five years. The loan agreement provides that future interest rate adjustments will be calculated based on a specific index plus a 3 percent margin. If the value of the index at consummation is 5 percent, the interest rate that would have been applied at consummation had the creditor based the initial rate on this index is 8 percent (5 percent plus 3 percent margin). For purposes of § 1026.43(b)(3), the fully indexed rate is 8 percent. For discussion of payment calculations based on the greater of the fully indexed rate or premium rate for purposes of the repayment ability determination under § 1026.43(c), see § 1026.43(c)(5)(i) and comment 43(c)(5)(i)–2. 2. Index or formula value at consummation. The value at consummation of the index or formula need not be used if the contract provides for a delay in the implementation of changes in an index value or formula. For example, if the contract specifies that rate changes are based on the index value in effect 45 days before the change date, the creditor may use any index value in effect during the 45 days before consummation in calculating the fully indexed rate. 3. Interest rate adjustment caps. If the terms of the legal obligation contain a periodic interest rate adjustment cap that would prevent the initial rate, at the time of the first adjustment, from changing to the rate determined using the index or formula value at consummation (i.e., the fully indexed rate), the creditor must not give any effect to that rate cap when determining the fully indexed rate. That is, a creditor must determine the fully indexed rate without taking into account any periodic interest rate adjustment cap that may limit how quickly the fully indexed rate may be reached at any time during the loan term under the terms of the legal obligation. To illustrate, assume an adjustable-rate mortgage has an initial fixed rate of 5 percent for the first three years of the loan, after which the rate will adjust annually to a specified index plus a margin of 3 percent. The loan agreement provides for a 2 percent annual interest rate adjustment cap, and a lifetime maximum interest rate of 10 percent. The index value in effect at consummation is 4.5 percent; the fully indexed rate is 7.5 percent (4.5 percent plus 3 percent), regardless of the 2 percent annual interest rate adjustment cap that would limit when the fully indexed rate would take effect under the terms of the legal obligation. 4. Lifetime maximum interest rate. A creditor may choose, in its sole discretion, to take into account the lifetime maximum interest rate provided under the terms of the legal obligation when determining the fully indexed rate. To illustrate, assume an adjustable-rate mortgage has an initial fixed rate of 5 percent for the first three years of the loan, after which the rate will adjust annually to a specified index plus a margin of 3 percent. The loan agreement provides for a 2 percent annual interest rate adjustment cap and a lifetime maximum interest rate of 7 percent. The index value in effect at consummation is 4.5 percent; under the generally applicable rule, the fully indexed rate is 7.5 percent (4.5 percent plus 3 percent). Nevertheless, the creditor may VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 choose to use the lifetime maximum interest rate of 7 percent as the fully indexed rate, rather than 7.5 percent, for purposes of § 1026.43(b)(3). Furthermore, if the creditor chooses to use the lifetime maximum interest rate and the loan agreement provides a range for the maximum interest rate, then the creditor complies by using the highest rate in that range as the maximum interest rate for purposes of § 1026.43(b)(3). 5. Step-rate and fixed-rate mortgages. Where the interest rate offered under the terms of the legal obligation is not based on, and does not vary with, an index or formula (i.e., there is no fully indexed rate), the creditor must use the maximum interest rate that may apply at any time during the loan term. To illustrate: i. Assume a step-rate mortgage with an interest rate fixed at 6.5 percent for the first two years of the loan, 7 percent for the next three years, and 7.5 percent thereafter for the remainder of loan term. For purposes of this section, the creditor must use 7.5 percent, which is the maximum rate that may apply during the loan term. ‘‘Step-rate mortgage’’ is defined in § 1026.18(s)(7)(ii). ii. Assume a fixed-rate mortgage with an interest rate at consummation of 7 percent that is fixed for the 30-year loan term. For purposes of this section, the maximum interest rate that may apply during the loan term is 7 percent, which is the interest rate that is fixed at consummation. ‘‘Fixed-rate mortgage’’ is defined in § 1026.18(s)(7)(iii). 43(b)(4) Higher-priced covered transaction. 1. Average prime offer rate. The average prime offer rate is defined in § 1026.35(a)(2). For further explanation of the meaning of ‘‘average prime offer rate,’’ and additional guidance on determining the average prime offer rate, see comments 35(a)(2)–1 through –4. 2. Comparable transaction. A higherpriced covered transaction is a consumer credit transaction that is secured by the consumer’s dwelling with an annual percentage rate that exceeds by the specified amount the average prime offer rate for a comparable transaction as of the date the interest rate is set. The published tables of average prime offer rates indicate how to identify a comparable transaction. See comment 35(a)(2)–2. 3. Rate set. A transaction’s annual percentage rate is compared to the average prime offer rate as of the date the transaction’s interest rate is set (or ‘‘locked’’) before consummation. Sometimes a creditor sets the interest rate initially and then re-sets it at a different level before consummation. The creditor should use the last date the interest rate is set before consummation. 43(b)(5) Loan amount. 1. Disbursement of the loan amount. The definition of ‘‘loan amount’’ requires the creditor to use the entire loan amount as reflected in the loan contract or promissory note, even though the loan amount may not be fully disbursed at consummation. For example, assume the consumer enters into a loan agreement where the consumer is obligated to repay the creditor $200,000 over 15 years, but only $100,000 is disbursed at consummation and the remaining $100,000 will be disbursed during the year following PO 00000 Frm 00195 Fmt 4701 Sfmt 4700 6601 consummation in a series of advances ($25,000 each quarter). For purposes of this section, the creditor must use the loan amount of $200,000, even though the loan agreement provides that only $100,000 will be disbursed to the consumer at consummation. Generally, creditors should rely on § 1026.17(c)(6) and associated commentary regarding treatment of multipleadvance and construction-to-permanent loans as single or multiple transactions. See also comment 43(a)(3)–2. 43(b)(6) Loan term. 1. General. The loan term is the period of time it takes to repay the loan amount in full. For example, a loan with an initial discounted rate that is fixed for the first two years, and that adjusts periodically for the next 28 years has a loan term of 30 years, which is the amortization period on which the periodic amortizing payments are based. 43(b)(7) Maximum loan amount. 1. Calculation of maximum loan amount. For purposes of § 1026.43(c)(2)(iii) and (c)(5)(ii)(C), a creditor must determine the maximum loan amount for a negative amortization loan by using the loan amount plus any increase in principal balance that can result from negative amortization based on the terms of the legal obligation. In determining the maximum loan amount, a creditor must assume that the consumer makes the minimum periodic payment permitted under the loan agreement for as long as possible, until the consumer must begin making fully amortizing payments; and that the interest rate rises as quickly as possible after consummation under the terms of the legal obligation. Thus, creditors must assume that the consumer makes the minimum periodic payment until any negative amortization cap is reached or until the period permitting minimum periodic payments expires, whichever occurs first. ‘‘Loan amount’’ is defined in § 1026.43(b)(5); ‘‘negative amortization loan’’ is defined in § 1026.18(s)(7)(v). 2. Assumed interest rate. In calculating the maximum loan amount for an adjustable-rate mortgage that is a negative amortization loan, the creditor must assume that the interest rate will increase as rapidly as possible after consummation, taking into account any periodic interest rate adjustment caps provided in the loan agreement. For an adjustable-rate mortgage with a lifetime maximum interest rate but no periodic interest rate adjustment cap, the creditor must assume that the interest rate increases to the maximum lifetime interest rate at the first adjustment. 3. Examples. The following are examples of how to determine the maximum loan amount for a negative amortization loan (all amounts shown are rounded, and all amounts are calculated using non-rounded values): i. Adjustable-rate mortgage with negative amortization. A. Assume an adjustable-rate mortgage in the amount of $200,000 with a 30-year loan term. The loan agreement provides that the consumer can make minimum monthly payments that cover only part of the interest accrued each month until the principal balance reaches 115 percent of its original balance (i.e., a negative E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6602 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations amortization cap of 115 percent) or for the first five years of the loan (60 monthly payments), whichever occurs first. The introductory interest rate at consummation is 1.5 percent. One month after the first day of the first full calendar month following consummation, the interest rate adjusts and will adjust monthly thereafter based on the specified index plus a margin of 3.5 percent. The maximum lifetime interest rate is 10.5 percent; there are no other periodic interest rate adjustment caps that limit how quickly the maximum lifetime rate may be reached. The minimum monthly payment for the first year is based on the initial interest rate of 1.5 percent. After that, the minimum monthly payment adjusts annually, but may increase by no more than 7.5 percent over the previous year’s payment. The minimum monthly payment is $690 in the first year, $742 in the second year, and $797 in the first part of the third year. B. To determine the maximum loan amount, assume that the initial interest rate increases to the maximum lifetime interest rate of 10.5 percent at the first adjustment (i.e., the due date of the first periodic monthly payment) and accrues at that rate until the loan is recast. Assume the consumer makes the minimum monthly payments as scheduled, which are capped at 7.5 percent from year-to-year. As a result, the consumer’s minimum monthly payments are less than the interest accrued each month, resulting in negative amortization (i.e., the accrued but unpaid interest is added to the principal balance). Thus, assuming that the consumer makes the minimum monthly payments for as long as possible and that the maximum interest rate of 10.5 percent is reached at the first rate adjustment (i.e., the due date of the first periodic monthly payment), the negative amortization cap of 115 percent is reached on the due date of the 27th monthly payment and the loan is recast. The maximum loan amount as of the due date of the 27th monthly payment is $229,251. ii. Fixed-rate, graduated payment mortgage with negative amortization. A loan in the amount of $200,000 has a 30-year loan term. The loan agreement provides for a fixed interest rate of 7.5 percent, and requires the consumer to make minimum monthly payments during the first year, with payments increasing 12.5 percent over the previous year every year for four years. The payment schedule provides for payments of $943 in the first year, $1,061 in the second year, $1,193 in the third year, $1,343 in the fourth year, and $1,511 for the remaining term of the loan. During the first three years of the loan, the payments are less than the interest accrued each month, resulting in negative amortization. Assuming that the consumer makes the minimum periodic payments for as long as possible, the maximum loan amount is $207,662, which is reached at the end of the third year of the loan (on the due date of the 36th monthly payment). See comment 43(c)(5)(ii)(C)–3 providing examples of how to determine the consumer’s repayment ability for a negative amortization loan. 43(b)(8) Mortgage-related obligations. 1. General. Section 1026.43(b)(8) defines mortgage-related obligations, which must be VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 considered in determining a consumer’s ability to repay pursuant to § 1026.43(c). Section 1026.43(b)(8) includes, in the evaluation of mortgage-related obligations, fees and special assessments owed to a condominium, cooperative, or homeowners association. Section 1026.43(b)(8) includes ground rent and leasehold payments in the definition of mortgage-related obligations. See commentary to § 1026.43(c)(2)(v) regarding the requirement to take into account any mortgage-related obligations for purposes of determining a consumer’s ability to repay. 2. Property taxes. Section 1026.43(b)(8) includes property taxes in the evaluation of mortgage-related obligations. Obligations that are related to the ownership or use of real property and paid to a taxing authority, whether on a monthly, quarterly, annual, or other basis, are property taxes for purposes of § 1026.43(b)(8). Section 1026.43(b)(8) includes obligations that are equivalent to property taxes, even if such obligations are not denominated as ‘‘taxes.’’ For example, governments may establish or allow independent districts with the authority to impose levies on properties within the district to fund a special purpose, such as a local development bond district, water district, or other public purpose. These levies may be referred to as taxes, assessments, surcharges, or by some other name. For purposes of § 1026.43(b)(8), these are property taxes and are included in the determination of mortgage-related obligations. 3. Insurance premiums and similar charges. Section 1026.43(b)(8) includes in the evaluation of mortgage-related obligations premiums and similar charges identified in § 1026.4(b)(5), (7), (8), or (10) that are required by the creditor. This includes all premiums or charges related to coverage protecting the creditor against a consumer’s default, credit loss, collateral loss, or similar loss, if the consumer is required to pay the premium or charge. For example, if Federal law requires flood insurance to be obtained in connection with the mortgage loan, the flood insurance premium is a mortgagerelated obligation for purposes of § 1026.43(b)(8). Section 1026.43(b)(8) does not include premiums or similar charges identified in § 1026.4(b)(5), (7), (8), or (10) that are not required by the creditor and that the consumer purchases voluntarily. For example: i. If a creditor does not require earthquake insurance to be obtained in connection with the mortgage loan, but the consumer voluntarily chooses to purchase such insurance, the earthquake insurance premium is not a mortgage-related obligation for purposes of § 1026.43(b)(8). ii. If a creditor requires a minimum amount of coverage for homeowners’ insurance and the consumer voluntarily chooses to purchase a more comprehensive amount of coverage, the portion of the premium allocated to the required minimum coverage is a mortgage-related obligation for purposes of § 1026.43(b)(8), while the portion of the premium allocated to the more comprehensive coverage voluntarily purchased by the consumer is not a PO 00000 Frm 00196 Fmt 4701 Sfmt 4700 mortgage-related obligation for purposes of § 1026.43(b)(8). iii. If the consumer purchases insurance or similar coverage not required by the creditor at consummation without having requested the specific non-required insurance or similar coverage and without having agreed to the premium or charge for the specific non-required insurance or similar coverage prior to consummation, the premium or charge is not voluntary for purposes of § 1026.43(b)(8) and is a mortgage-related obligation. 4. Mortgage insurance, guarantee, or similar charges. Section 1026.43(b)(8) includes in the evaluation of mortgagerelated obligations premiums or charges protecting the creditor against the consumer’s default or other credit loss. This includes all premiums or similar charges, whether denominated as mortgage insurance, guarantee insurance, or otherwise, as determined according to applicable State or Federal law. For example, monthly ‘‘private mortgage insurance’’ payments paid to a nongovernmental entity, annual ‘‘guarantee fee’’ payments required by a Federal housing program, and a quarterly ‘‘mortgage insurance’’ payment paid to a State agency administering a housing program are all mortgage-related obligations for purposes of § 1026.43(b)(8). Section 1026.43(b)(8) includes these charges in the definition of mortgage-related obligations if the creditor requires the consumer to pay them, even if the consumer is not legally obligated to pay the charges under the terms of the insurance program. For example, if a mortgage insurance program obligates the creditor to make recurring mortgage insurance payments, and the creditor requires the consumer to reimburse the creditor for such recurring payments, the consumer’s payments are mortgage-related obligations for purposes of § 1026.43(b)(8). However, if a mortgage insurance program obligates the creditor to make recurring mortgage insurance payments, and the creditor does not require the consumer to reimburse the creditor for the cost of the mortgage insurance payments, the recurring mortgage insurance payments are not mortgage-related obligations for purposes of § 1026.43(b)(8). 5. Relation to the finance charge. Section 1026.43(b)(8) includes in the evaluation of mortgage-related obligations premiums and similar charges identified in § 1026.4(b)(5), (7), (8), or (10) that are required by the creditor. These premiums and similar charges are mortgage-related obligations regardless of whether the premium or similar charge is excluded from the finance charge pursuant to § 1026.4(d). For example, a premium for insurance against loss or damage to the property written in connection with the credit transaction is a premium identified in § 1026.4(b)(8). If this premium is required by the creditor, the premium is a mortgage-related obligation pursuant to § 1026.43(b)(8), regardless of whether the premium is excluded from the finance charge pursuant to § 1026.4(d)(2). 43(b)(11) Recast. 1. Date of the recast. The term ‘‘recast’’ means, for an adjustable-rate mortgage, the expiration of the period during which E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations payments based on the introductory fixed rate are permitted; for an interest-only loan, the expiration of the period during which the interest-only payments are permitted; and, for a negative amortization loan, the expiration of the period during which negatively amortizing payments are permitted. For adjustable-rate mortgages, interest-only loans, and negative amortization loans, the date on which the recast is considered to occur is the due date of the last monthly payment based on the introductory fixed rate, the interest-only payment, or the negatively amortizing payment, respectively. To illustrate: A loan in an amount of $200,000 has a 30-year loan term. The loan agreement provides for a fixed interest rate and permits interest-only payments for the first five years of the loan (60 months). The loan is recast on the due date of the 60th monthly payment. Thus, the term of the loan remaining as of the date the loan is recast is 25 years (300 months). 43(b)(12) Simultaneous loan. 1. General. Section 1026.43(b)(12) defines a simultaneous loan as another covered transaction or a home equity line of credit (HELOC) subject to § 1026.40 that will be secured by the same dwelling and made to the same consumer at or before consummation of the covered transaction, whether it is made by the same creditor or a third-party creditor. (As with all of § 1026.43, the term ‘‘dwelling’’ includes any real property attached to a dwelling.) For example, assume a consumer will enter into a legal obligation that is a covered transaction with Creditor A. Immediately prior to consummation of the covered transaction with Creditor A, the consumer opens a HELOC that is secured by the same dwelling with Creditor B. For purposes of this section, the loan extended by Creditor B is a simultaneous loan. See commentary to § 1026.43(c)(2)(iv) and (c)(6), discussing the requirement to consider the consumer’s payment obligation on any simultaneous loan for purposes of determining the consumer’s ability to repay the covered transaction subject to this section. 2. Same consumer. For purposes of the definition of ‘‘simultaneous loan,’’ the term ‘‘same consumer’’ includes any consumer, as that term is defined in § 1026.2(a)(11), that enters into a loan that is a covered transaction and also enters into another loan (e.g., second-lien covered transaction or HELOC) secured by the same dwelling. Where two or more consumers enter into a legal obligation that is a covered transaction, but only one of them enters into another loan secured by the same dwelling, the ‘‘same consumer’’ includes the person that has entered into both legal obligations. For example, assume Consumer A and Consumer B will both enter into a legal obligation that is a covered transaction with a creditor. Immediately prior to consummation of the covered transaction, Consumer B opens a HELOC that is secured by the same dwelling with the same creditor; Consumer A is not a signatory to the HELOC. For purposes of this definition, Consumer B is the same consumer and the creditor must include the HELOC as a simultaneous loan. 43(b)(13) Third-party record. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 1. Electronic records. Third-party records include records transmitted electronically. For example, to verify a consumer’s credit history using third-party records as required by § 1026.43(c)(2)(viii) and 1026.43(c)(3), a creditor may use a credit report prepared by a consumer reporting agency that is transmitted electronically. 2. Forms. A record prepared by a third party includes a form a creditor gives to a third party to provide information, even if the creditor completes parts of the form unrelated to the information sought. For example, if a creditor gives a consumer’s employer a form for verifying the consumer’s employment status and income, the creditor may fill in the creditor’s name and other portions of the form unrelated to the consumer’s employment status or income. Paragraph 43(b)(13)(i). 1. Reviewed record. Under § 1026.43(b)(13)(i), a third-party record includes a document or other record prepared by the consumer, the creditor, the mortgage broker, or the creditor’s or mortgage broker’s agent, if the record is reviewed by an appropriate third party. For example, a profit-and-loss statement prepared by a selfemployed consumer and reviewed by a thirdparty accountant is a third-party record under § 1026.43(b)(13)(i). In contrast, a profitand-loss statement prepared by a selfemployed consumer and reviewed by the consumer’s non-accountant spouse is not a third-party record under § 1026.43(b)(13)(i). Paragraph 43(b)(13)(iii). 1. Creditor’s records. Section 1026.43(b)(13)(iii) provides that a third-party record includes a record the creditor maintains for an account of the consumer held by the creditor. Examples of such accounts include checking accounts, savings accounts, and retirement accounts. Examples of such accounts also include accounts related to a consumer’s outstanding obligations to a creditor. For example, a third-party record includes the creditor’s records for a first-lien mortgage to a consumer who applies for a subordinate-lien home equity loan. 43(c) Repayment ability. 43(c)(1) General requirement. 1. Reasonable and good faith determination. i. General. Creditors generally are required by § 1026.43(c)(1) to make reasonable and good faith determinations of consumers’ ability to repay. Section 1026.43(c) and the accompanying commentary describe certain requirements for making this ability-to-repay determination, but do not provide comprehensive underwriting standards to which creditors must adhere. For example, the rule and commentary do not specify how much income is needed to support a particular level of debt or how credit history should be weighed against other factors. So long as creditors consider the factors set forth in § 1026.43(c)(2) according to the requirements of § 1026.43(c), creditors are permitted to develop their own underwriting standards and make changes to those standards over time in response to empirical information and changing economic and other conditions. Whether a particular ability-to-repay determination is reasonable PO 00000 Frm 00197 Fmt 4701 Sfmt 4700 6603 and in good faith will depend not only on the underwriting standards adopted by the creditor, but on the facts and circumstances of an individual extension of credit and how a creditor’s underwriting standards were applied to those facts and circumstances. A consumer’s statement or attestation that the consumer has the ability to repay the loan is not indicative of whether the creditor’s determination was reasonable and in good faith. ii. Considerations. A. The following may be evidence that a creditor’s ability-to-repay determination was reasonable and in good faith: 1. The consumer demonstrated actual ability to repay the loan by making timely payments, without modification or accommodation, for a significant period of time after consummation or, for an adjustable-rate, interest-only, or negativeamortization mortgage, for a significant period of time after recast; 2. The creditor used underwriting standards that have historically resulted in comparatively low rates of delinquency and default during adverse economic conditions; or 3. The creditor used underwriting standards based on empirically derived, demonstrably and statistically sound models. B. In contrast, the following may be evidence that a creditor’s ability-to-repay determination was not reasonable or in good faith: 1. The consumer defaulted on the loan a short time after consummation or, for an adjustable-rate, interest-only, or negativeamortization mortgage, a short time after recast; 2. The creditor used underwriting standards that have historically resulted in comparatively high levels of delinquency and default during adverse economic conditions; 3. The creditor applied underwriting standards inconsistently or used underwriting standards different from those used for similar loans without reasonable justification; 4. The creditor disregarded evidence that the underwriting standards it used are not effective at determining consumers’ repayment ability; 5. The creditor disregarded evidence that the consumer may have insufficient residual income to cover other recurring obligations and expenses, taking into account the consumer’s assets other than the property securing the loan, after paying his or her monthly payments for the covered transaction, any simultaneous loans, mortgage-related obligations, and any current debt obligations; or 6. The creditor disregarded evidence that the consumer would have the ability to repay only if the consumer subsequently refinanced the loan or sold the property securing the loan. C. All of the considerations listed in paragraphs (A) and (B) above may be relevant to whether a creditor’s ability-to-repay determination was reasonable and in good faith. However, these considerations are not requirements or prohibitions with which creditors must comply, nor are they elements of a claim that a consumer must prove to E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6604 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations establish a violation of the ability-to-repay requirements. For example, creditors are not required to validate their underwriting criteria using mathematical models. These considerations also are not absolute in their application; instead they exist on a continuum and may apply to varying degrees. For example, the longer a consumer successfully makes timely payments after consummation or recast the less likely it is that the creditor’s determination of ability to repay was unreasonable or not in good faith. Finally, each of these considerations must be viewed in the context of all facts and circumstances relevant to a particular extension of credit. For example, in some cases inconsistent application of underwriting standards may indicate that a creditor is manipulating those standards to approve a loan despite a consumer’s inability to repay. The creditor’s ability-to-repay determination therefore may be unreasonable or in bad faith. However, in other cases inconsistently applied underwriting standards may be the result of, for example, inadequate training and may nonetheless yield a reasonable and good faith ability-torepay determination in a particular case. Similarly, although an early payment default on a mortgage will often be persuasive evidence that the creditor did not have a reasonable and good faith belief in the consumer’s ability to repay (and such evidence may even be sufficient to establish a prima facie case of an ability-to-repay violation), a particular ability-to-repay determination may be reasonable and in good faith even though the consumer defaulted shortly after consummation if, for example, the consumer experienced a sudden and unexpected loss of income. In contrast, an ability-to-repay determination may be unreasonable or not in good faith even though the consumer made timely payments for a significant period of time if, for example, the consumer was able to make those payments only by foregoing necessities such as food and heat. 2. Repayment ability at consummation. Section 1026.43(c)(1) requires the creditor to determine, at or before the time the loan is consummated, that a consumer will have a reasonable ability to repay the loan. A change in the consumer’s circumstances after consummation (for example, a significant reduction in income due to a job loss or a significant obligation arising from a major medical expense) that cannot be reasonably anticipated from the consumer’s application or the records used to determine repayment ability is not relevant to determining a creditor’s compliance with the rule. However, if the application or records considered at or before consummation indicate there will be a change in a consumer’s repayment ability after consummation (for example, if a consumer’s application states that the consumer plans to retire within 12 months without obtaining new employment or that the consumer will transition from full-time to part-time employment), the creditor must consider that information under the rule. 3. Interaction with Regulation B. Section 1026.43(c)(1) does not require or permit the creditor to make inquiries or verifications VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 prohibited by Regulation B, 12 CFR part 1002. 43(c)(2) Basis for determination. 1. General. Section 1026.43(c)(2) sets forth factors creditors must consider when making the ability-to-repay determination required under § 1026.43(c)(1) and the accompanying commentary provides guidance regarding these factors. Creditors must conform to these requirements and may rely on guidance provided in the commentary. However, § 1026.43(c) and the accompanying commentary do not provide comprehensive guidance on definitions and other technical underwriting criteria necessary for evaluating these factors in practice. So long as a creditor complies with the provisions of § 1026.43(c), the creditor is permitted to use its own definitions and other technical underwriting criteria. A creditor may, but is not required to, look to guidance issued by entities such as the Federal Housing Administration, the U.S. Department of Veterans Affairs, the U.S. Department of Agriculture, or Fannie Mae or Freddie Mac while operating under the conservatorship of the Federal Housing Finance Agency. For example, a creditor may refer to such guidance to classify particular inflows, obligations, or property as ‘‘income,’’ ‘‘debt,’’ or ‘‘assets.’’ Similarly, a creditor may refer to such guidance to determine what information to use when evaluating the income of a self-employed or seasonally employed consumer or what information to use when evaluating the credit history of a consumer who has obtained few or no extensions of traditional ‘‘credit’’ as defined in § 1026.2(a)(14). These examples are illustrative, and creditors are not required to conform to guidance issued by these or other such entities. However, as required by § 1026.43(c)(1), a creditor must ensure that its underwriting criteria, as applied to the facts and circumstances of a particular extension of credit, result in a reasonable, good faith determination of a consumer’s ability to repay. For example, a definition used in underwriting that is reasonable in isolation may lead to ability-to-repay determinations that are unreasonable or not in good faith when considered in the context of a creditor’s underwriting standards or when adopted or applied in bad faith. Similarly, an ability-to-repay determination is not unreasonable or in bad faith merely because the underwriting criteria used included a definition that was by itself unreasonable. Paragraph 43(c)(2)(i). 1. Income or assets generally. A creditor may base its determination of repayment ability on current or reasonably expected income from employment or other sources, assets other than the dwelling that secures the covered transaction, or both. The creditor may consider any type of current or reasonably expected income, including, for example, the following: salary; wages; selfemployment income; military or reserve duty income; bonus pay; tips; commissions; interest payments; dividends; retirement benefits or entitlements; rental income; royalty payments; trust income; public assistance payments; and alimony, child support, and separate maintenance payments. The creditor may consider any of the consumer’s assets, other than the value of PO 00000 Frm 00198 Fmt 4701 Sfmt 4700 the dwelling that secures the covered transaction, including, for example, the following: funds in a savings or checking account, amounts vested in a retirement account, stocks, bonds, certificates of deposit, and amounts available to the consumer from a trust fund. (As stated in § 1026.43(a), the value of the dwelling includes the value of the real property to which the residential structure is attached, if the real property also secures the covered transaction.) 2. Income or assets relied on. A creditor need consider only the income or assets necessary to support a determination that the consumer can repay the covered transaction. For example, if a consumer’s loan application states that the consumer earns an annual salary from both a full-time job and a parttime job and the creditor reasonably determines that the consumer’s income from the full-time job is sufficient to repay the loan, the creditor need not consider the consumer’s income from the part-time job. Further, a creditor need verify only the income (or assets) relied on to determine the consumer’s repayment ability. See comment 43(c)(4)–1. 3. Reasonably expected income. If a creditor relies on expected income in excess of the consumer’s income, either in addition to or instead of current income, the expectation that the income will be available for repayment must be reasonable and verified with third-party records that provide reasonably reliable evidence of the consumer’s expected income. For example, if the creditor relies on an expectation that a consumer will receive an annual bonus, the creditor may verify the basis for that expectation with records that show the consumer’s past annual bonuses, and the expected bonus must bear a reasonable relationship to the past bonuses. Similarly, if the creditor relies on a consumer’s expected salary from a job the consumer has accepted and will begin after receiving an educational degree, the creditor may verify that expectation with a written statement from an employer indicating that the consumer will be employed upon graduation at a specified salary. 4. Seasonal or irregular income. A creditor reasonably may determine that a consumer can make periodic loan payments even if the consumer’s income, such as self-employment income, is seasonal or irregular. For example, assume a consumer receives seasonal income from the sale of crops or from agricultural employment. Each year, the consumer’s income arrives during only a few months. If the creditor determines that the consumer’s annual income divided equally across 12 months is sufficient for the consumer to make monthly loan payments, the creditor reasonably may determine that the consumer can repay the loan, even though the consumer may not receive income during certain months. 5. Multiple applicants. When two or more consumers apply for an extension of credit as joint obligors with primary liability on an obligation, § 1026.43(c)(2)(i) does not require the creditor to consider income or assets that are not needed to support the creditor’s repayment ability determination. If the income or assets of one applicant are E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sufficient to support the creditor’s repayment ability determination, the creditor is not required to consider the income or assets of the other applicant. For example, if a husband and wife jointly apply for a loan and the creditor reasonably determines that the wife’s income is sufficient to repay the loan, the creditor is not required to consider the husband’s income. Paragraph 43(c)(2)(ii). 1. Employment status and income. Employment status need not be full-time, and employment need not occur at regular intervals. If, in determining the consumer’s repayment ability, the creditor relies on income from the consumer’s employment, then that employment may be, for example, full-time, part-time, seasonal, irregular, military, or self-employment, so long as the creditor considers those characteristics of the employment. Under § 1026.43(c)(2)(ii), a creditor must verify a consumer’s current employment status only if the creditor relies on the consumer’s employment income in determining the consumer’s repayment ability. For example, if a creditor relies wholly on a consumer’s investment income to determine repayment ability, the creditor need not verify or document employment status. See comments 43(c)(2)(i)–5 and 43(c)(4)–2 for guidance on which income to consider when multiple consumers apply jointly for a loan. Paragraph 43(c)(2)(iii). 1. General. For purposes of the repayment ability determination required under § 1026.43(c)(2), a creditor must consider the consumer’s monthly payment on a covered transaction that is calculated as required under § 1026.43(c)(5). Paragraph 43(c)(2)(iv). 1. Home equity lines of credit. For purposes of § 1026.43(c)(2)(iv), a simultaneous loan includes any covered transaction or home equity line of credit (HELOC) subject to § 1026.40 that will be made to the same consumer at or before consummation of the covered transaction and secured by the same dwelling that secures the covered transaction. A HELOC that is a simultaneous loan that the creditor knows or has reason to know about must be considered as a mortgage obligation in determining a consumer’s ability to repay the covered transaction even though the HELOC is not a covered transaction subject to § 1026.43. See § 1026.43(a) discussing the scope of this section. ‘‘Simultaneous loan’’ is defined in § 1026.43(b)(12). For further explanation of ‘‘same consumer,’’ see comment 43(b)(12)–2. 2. Knows or has reason to know. In determining a consumer’s repayment ability for a covered transaction under § 1026.43(c)(2), a creditor must consider the consumer’s payment obligation on any simultaneous loan that the creditor knows or has reason to know will be or has been made at or before consummation of the covered transaction. For example, where a covered transaction is a home purchase loan, the creditor must consider the consumer’s periodic payment obligation for any ‘‘piggyback’’ second-lien loan that the creditor knows or has reason to know will be used to finance part of the consumer’s down payment. The creditor complies with this VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 requirement where, for example, the creditor follows policies and procedures that are designed to determine whether at or before consummation the same consumer has applied for another credit transaction secured by the same dwelling. To illustrate, assume a creditor receives an application for a home purchase loan where the requested loan amount is less than the home purchase price. The creditor’s policies and procedures must require the consumer to state the source of the down payment and provide verification. If the creditor determines the source of the down payment is another extension of credit that will be made to the same consumer at or before consummation and secured by the same dwelling, the creditor knows or has reason to know of the simultaneous loan and must consider the simultaneous loan. Alternatively, if the creditor has information that suggests the down payment source is the consumer’s existing assets, the creditor would be under no further obligation to determine whether a simultaneous loan will be extended at or before consummation of the covered transaction. The creditor is not obligated to investigate beyond reasonable underwriting policies and procedures to determine whether a simultaneous loan will be extended at or before consummation of the covered transaction. 3. Scope of timing. For purposes of § 1026.43(c)(2)(iv), a simultaneous loan includes a loan that comes into existence concurrently with the covered transaction subject to § 1026.43(c). A simultaneous loan does not include a credit transaction that occurs after consummation of the covered transaction that is subject to this section. However, any simultaneous loan that specifically covers closing costs of the covered transaction, but is scheduled to be extended after consummation must be considered for the purposes of § 1026.43(c)(2)(iv). Paragraph 43(c)(2)(v). 1. General. A creditor must include in its repayment ability assessment the consumer’s monthly payment for mortgage-related obligations, such as the expected property taxes and premiums or similar charges identified in § 1026.4(b)(5), (7), (8), or (10) that are required by the creditor. See § 1026.43(b)(8) defining the term ‘‘mortgagerelated obligations.’’ Mortgage-related obligations must be included in the creditor’s determination of repayment ability regardless of whether the amounts are included in the monthly payment or whether there is an escrow account established. Section 1026.43(c)(2)(v) includes only payments that occur on an ongoing or recurring basis in the evaluation of the consumer’s monthly payment for mortgage-related obligations. One-time charges, or obligations satisfied at or before consummation, are not ongoing or recurring, and are therefore not part of the consumer’s monthly payment for purposes of § 1026.43(c)(2)(v). For example: i. Assume that a consumer will be required to pay property taxes, as described in comment 43(b)(8)–2, on a quarterly, annual, or other basis after consummation. Section 1026.43(c)(2)(v) includes these recurring property taxes in the evaluation of the consumer’s monthly payment for mortgage- PO 00000 Frm 00199 Fmt 4701 Sfmt 4700 6605 related obligations. However, if the consumer will incur a one-time charge to satisfy property taxes that are past due, § 1026.43(c)(2)(v) does not include this onetime charge in the evaluation of the consumer’s monthly payment for mortgagerelated obligations. ii. Assume that a consumer will be required to pay mortgage insurance premiums, as described in comment 43(b)(8)–2, on a monthly, annual, or other basis after consummation. Section 1026.43(c)(2)(v) includes these recurring mortgage insurance payments in the evaluation of the consumer’s monthly payment for mortgage-related obligations. However, if the consumer will incur a onetime fee or charge for mortgage insurance or similar purposes, such as an up-front mortgage insurance premium imposed at consummation, § 1026.43(c)(2)(v) does not include this up-front mortgage insurance premium in the evaluation of the consumer’s monthly payment for mortgage-related obligations. 2. Obligations to an association, other than special assessments. Section 1026.43(b)(8) defines mortgage-related obligations to include obligations owed to a condominium, cooperative, or homeowners association. However, § 1026.43(c)(2)(v) does not require a creditor to include in the evaluation of the consumer’s monthly payment for mortgagerelated obligations payments to such associations imposed in connection with the extension of credit, or imposed as an incident to the transfer of ownership, if such obligations are fully satisfied at or before consummation. For example, if a homeowners association imposes a one-time transfer fee on the transaction, and the consumer will pay the fee at or before consummation, § 1026.43(c)(2)(v) does not require the creditor to include this one-time transfer fee in the evaluation of the consumer’s monthly payment for mortgagerelated obligations. Section 1026.43(c)(2)(v) also does not require the creditor to include this fee in the evaluation of the consumer’s monthly payment for mortgage-related obligations if the consumer finances the fee in the loan amount. However, if the consumer incurs the obligation and will satisfy the obligation with recurring payments after consummation, regardless of whether the obligation is escrowed, § 1026.43(c)(2)(v) requires the creditor to include the transfer fee in the evaluation of the consumer’s monthly payment for mortgage-related obligations. 3. Special assessments imposed by an association. Section 1026.43(b)(8) defines mortgage-related obligations to include special assessments imposed by a condominium, cooperative, or homeowners association. Section 1026.43(c)(2)(v) does not require a creditor to include special assessments in the evaluation of the consumer’s monthly payment for mortgagerelated obligations if the special assessments are fully satisfied at or before consummation. For example, if a homeowners association imposes a special assessment that the consumer will have to pay in full at or before consummation, § 1026.43(c)(2)(v) does not include the special assessment in the E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6606 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations evaluation of the consumer’s monthly payment for mortgage-related obligations. Section 1026.43(c)(2)(v) does not require a creditor to include special assessments in the evaluation of the consumer’s monthly payment for mortgage-related obligations if the special assessments are imposed as a onetime charge. For example, if a homeowners association imposes a special assessment that the consumer will have to satisfy in one payment, § 1026.43(c)(2)(v) does not include this one-time special assessment in the evaluation of the consumer’s monthly payment for mortgage-related obligations. However, if the consumer will pay the special assessment on a recurring basis after consummation, regardless of whether the consumer’s payments for the special assessment are escrowed, § 1026.43(c)(2)(v) requires the creditor to include this recurring special assessment in the evaluation of the consumer’s monthly payment for mortgagerelated obligations. 4. Pro rata amount. For purposes of § 1026.43(c)(2)(v), the creditor may divide the recurring payments for mortgage-related obligations into monthly, pro rata amounts. In considering a mortgage-related obligation that is not paid monthly, if the mortgage loan is originated pursuant to a government program the creditor may determine the pro rata monthly amount of the mortgage-related obligation in accordance with the specific requirements of that program. If the mortgage loan is originated pursuant to a government program that does not contain specific standards for determining the pro rata monthly amount of the mortgage-related obligation, or if the mortgage loan is not originated pursuant to a government program, the creditor complies with § 1026.43(c)(2)(v) by dividing the total amount of a particular non-monthly mortgage-related obligation by no more than the number of months from the month that the non-monthly mortgage-related obligation was due prior to consummation until the month that the non-monthly mortgage-related obligation will be due after consummation. When determining the pro rata monthly payment amount, the creditor may also consider comment 43(c)(2)(v)–5, which explains that the creditor need not project potential changes. The following examples further illustrate how a creditor may determine the pro rata monthly amount of mortgage-related obligations, pursuant to § 1026.43(c)(2)(v): i. Assume that a consumer applies for a mortgage loan on February 1st. Assume further that the subject property is located in a jurisdiction where property taxes are paid in arrears on the first day of October. The creditor complies with § 1026.43(c)(2)(v) by determining the annual property tax amount owed in the prior October, dividing the amount by 12, and using the resulting amount as the pro rata monthly property tax payment amount for the determination of the consumer’s monthly payment for mortgagerelated obligations. The creditor complies even if the consumer will likely owe more in the next year than the amount owed the prior October because the jurisdiction normally increases the property tax rate annually, provided that the creditor does not have VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 knowledge of an increase in the property tax rate at the time of underwriting. See also comment 43(c)(2)(v)–5 regarding estimates of mortgage-related obligations. ii. Assume that a subject property is located in a special water district, the assessments for which are billed separately from local property taxes. The creditor complies with § 1026.43(c)(2)(v) by dividing the full amount that will be owed by the number of months in the assessment period, and including the resulting amount in the calculation of monthly mortgage-related obligations. However, § 1026.43(c)(2)(v) does not require a creditor to adjust the monthly amount to account for potential deviations from the average monthly amount. For example, assume in this example that the special water assessment is billed every eight months, that the consumer will have to pay the first water district bill four months after consummation, and that the seller will not provide the consumer with any funds to pay for the seller’s obligation (i.e., the four months prior to consummation). Although the consumer will be required to budget twice the average monthly amount to pay the first water district bill, § 1026.43(c)(2)(v) does not require the creditor to use the increased amount; the creditor complies with § 1026.43(c)(2)(v) by using the average monthly amount. iii. Assume that the subject property is located in an area where flood insurance is required by Federal law, and assume further that the flood insurance policy premium is paid every three years following consummation. The creditor complies with § 1026.43(c)(2)(v) by dividing the three-year premium by 36 months and including the resulting amount in the determination of the consumer’s monthly payment for mortgagerelated obligations. The creditor complies even if the consumer will not establish a monthly escrow for flood insurance. iv. Assume that the subject property is part of a homeowners association that has imposed upon the seller a special assessment of $1,200. Assume further that this special assessment will become the consumer’s obligation upon consummation of the transaction, that the consumer is permitted to pay the special assessment in twelve $100 installments after consummation, and that the mortgage loan will not be originated pursuant to a government program that contains specific requirements for prorating special assessments. The creditor complies with § 1026.43(c)(2)(v) by dividing the $1,200 special assessment by 12 months and including the resulting $100 monthly amount in the determination of the consumer’s monthly payment for mortgage-related obligations. The creditor complies by using this calculation even if the consumer intends to pay the special assessment in a manner other than that used by the creditor in determining the monthly pro rata amount, such as where the consumer intends to pay six $200 installments. 5. Estimates. Estimates of mortgage-related obligations should be based upon information that is known to the creditor at the time the creditor underwrites the mortgage obligation. Information is known if it is reasonably available to the creditor at the PO 00000 Frm 00200 Fmt 4701 Sfmt 4700 time of underwriting the loan. Creditors may rely on guidance provided under comment 17(c)(2)(i)–1 in determining if information is reasonably available. For purposes of this section, the creditor need not project potential changes, such as by estimating possible increases in taxes and insurance. See comment 43(c)(2)(v)–4 for additional examples discussing the projection of potential changes. The following examples further illustrate the requirements of § 1026.43(c)(2)(v): i. Assume that the property is subject to a community governance association, such as a homeowners association. The creditor complies with § 1026.43(c)(2)(v) by relying on an estimate of mortgage-related obligations prepared by the homeowners association. In accordance with the guidance provided under comment 17(c)(2)(i)–1, the creditor need only exercise due diligence in determining mortgage-related obligations, and complies with § 1026.43(c)(2)(v) by relying on the representations of other reliable parties in preparing estimates. ii. Assume that the homeowners association has imposed a special assessment on the seller, but the seller does not inform the creditor of the special assessment, the homeowners association does not include the special assessment in the estimate of expenses prepared for the creditor, and the creditor is unaware of the special assessment. The creditor complies with § 1026.43(c)(2)(v) if it does not include the special assessment in the determination of mortgage-related obligations. The creditor may rely on the representations of other reliable parties, in accordance with the guidance provided under comment 17(c)(2)(i)–1. iii. Assume that the homeowners association imposes a special assessment after the creditor has completed underwriting, but prior to consummation. The creditor does not violate § 1026.43(c)(2)(v) if the creditor does not include the special assessment in the determination of the consumer’s monthly payment for mortgage-related obligations, provided the homeowners association does not inform the creditor about the special assessment during underwriting. Section 1026.43(c)(2)(v) does not require the creditor to re-underwrite the loan. The creditor has complied with § 1026.43(c)(2)(v) by including the obligations known to the creditor at the time the loan is underwritten, even if the creditor learns of new mortgagerelated obligations before the transaction is consummated. Paragraph 43(c)(2)(vi). 1. Consideration of current debt obligations. Section 1026.43(c)(2)(vi) requires creditors to consider a consumer’s current debt obligations and any alimony or child support the consumer is required to pay. Examples of current debt obligations include student loans, automobile loans, revolving debt, and existing mortgages that will not be paid off at or before consummation. Creditors have significant flexibility to consider current debt obligations in light of attendant facts and circumstances, including that an obligation is likely to be paid off soon after consummation. For example, a creditor may take into account that an existing mortgage is E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations likely to be paid off soon after consummation because there is an existing contract for sale of the property that secures that mortgage. Similarly, creditors should consider whether debt obligations in forbearance or deferral at the time of underwriting are likely to affect the consumer’s ability to repay based on the payment for which the consumer will be liable upon expiration of the forbearance or deferral period and other relevant facts and circumstances, such as when the forbearance or deferral period will expire. 2. Multiple applicants. When two or more consumers apply for an extension of credit as joint obligors with primary liability on an obligation, § 1026.43(c)(2)(vi) requires a creditor to consider the debt obligations of all such joint applicants. For example, if a coapplicant is repaying a student loan at the time of underwriting, the creditor complies with § 1026.43(c)(2)(vi) by considering the co-applicant’s student loan obligation. If one consumer is merely a surety or guarantor, § 1026.43(c)(2)(vi) does not require a creditor to consider the debt obligations of such surety or guarantor. The requirements of § 1026.43(c)(2)(vi) do not affect the disclosure requirements of this part, such as, for example, §§ 1026.17(d), 1026.23(b), 1026.31(e), 1026.39(b)(3), and 1026.46(f). Paragraph 43(c)(2)(vii). 1. Monthly debt-to-income ratio and residual income. See § 1026.43(c)(7) and its associated commentary regarding the definitions and calculations for the monthly debt-to-income ratio and residual income. Paragraph 43(c)(2)(viii). 1. Consideration of credit history. ‘‘Credit history’’ may include factors such as the number and age of credit lines, payment history, and any judgments, collections, or bankruptcies. Section 1026.43(c)(2)(viii) does not require creditors to obtain or consider a consolidated credit score or prescribe a minimum credit score that creditors must apply. The rule also does not specify which aspects of credit history a creditor must consider or how various aspects of credit history should be weighed against each other or against other underwriting factors. Some aspects of a consumer’s credit history, whether positive or negative, may not be directly indicative of the consumer’s ability to repay. A creditor therefore may give various aspects of a consumer’s credit history as much or as little weight as is appropriate to reach a reasonable, good faith determination of ability to repay. Where a consumer has obtained few or no extensions of traditional ‘‘credit,’’ as defined in § 1026.2(a)(14), a creditor may, but is not required to, look to nontraditional credit references, such as rental payment history or utility payments. 2. Multiple applicants. When two or more consumers apply for an extension of credit as joint obligors with primary liability on an obligation, § 1026.43(c)(2)(viii) requires a creditor to consider the credit history of all such joint applicants. If a consumer is merely a surety or guarantor, § 1026.43(c)(2)(viii) does not require a creditor to consider the credit history of such surety or guarantor. The requirements of § 1026.43(c)(2)(viii) do not affect the disclosure requirements of this part, such as, for example, §§ 1026.17(d), VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 1026.23(b), 1026.31(e), 1026.39(b)(3), and 1026.46(f). 43(c)(3) Verification using third-party records. 1. Records specific to the individual consumer. Records a creditor uses for verification under § 1026.43(c)(3) and (4) must be specific to the individual consumer. Records regarding average incomes in the consumer’s geographic location or average wages paid by the consumer’s employer, for example, are not specific to the individual consumer and are not sufficient for verification. 2. Obtaining records. To conduct verification under § 1026.43(c)(3) and (4), a creditor may obtain records from a thirdparty service provider, such as a party the consumer’s employer uses to respond to income verification requests, as long as the records are reasonably reliable and specific to the individual consumer. A creditor also may obtain third-party records directly from the consumer, likewise as long as the records are reasonably reliable and specific to the individual consumer. For example, a creditor using payroll statements to verify the consumer’s income, as allowed under § 1026.43(c)(4)(iii), may obtain the payroll statements from the consumer. 3. Credit report as a reasonably reliable third-party record. A credit report generally is considered a reasonably reliable thirdparty record under § 1026.43(c)(3) for purposes of verifying items customarily found on a credit report, such as the consumer’s current debt obligations, monthly debts, and credit history. Section 1026.43(c)(3) generally does not require creditors to obtain additional reasonably reliable third-party records to verify information contained in a credit report. For example, if a credit report states the existence and amount of a consumer’s debt obligation, the creditor is not required to obtain additional verification of the existence or amount of that obligation. In contrast, a credit report does not serve as a reasonably reliably third-party record for purposes of verifying items that do not appear on the credit report. For example, certain monthly debt obligations, such as legal obligations like alimony or child support, may not be reflected on a credit report. Thus, a credit report that does not list a consumer’s monthly alimony obligation does not serve as a reasonably reliable third-party record for purposes of verifying that obligation. If a credit report reflects a current debt obligation that a consumer has not listed on the application, the creditor complies with § 1026.43(c)(3) if the creditor considers the existence and amount of the debt obligation as it is reflected in the credit report. However, in some cases a creditor may know or have reason to know that a credit report may be inaccurate in whole or in part. For example, a creditor may have information indicating that a credit report is subject to a fraud alert, extended alert, active duty alert, or similar alert identified in 15 U.S.C. 1681c– 1 or that a debt obligation listed on a credit report is subject to a statement of dispute pursuant to 15 U.S.C. 1681i(b). A creditor may also have other reasonably reliable thirdparty records or other information or PO 00000 Frm 00201 Fmt 4701 Sfmt 4700 6607 evidence that the creditor reasonably finds to be reliable that contradict the credit report or otherwise indicate that the credit report is inaccurate. If a creditor knows or has reason to know that a credit report may be inaccurate in whole or in part, the creditor complies with § 1026.43(c)(3) by disregarding an inaccurate or disputed item, items, or credit report, but does not have to obtain additional third-party records. The creditor may also, but is not required, to obtain other reasonably reliable third-party records to verify information with respect to which the credit report, or item therein, may be inaccurate. For example, the creditor might obtain statements or bank records regarding a particular debt obligation subject to a statement of dispute. See also comment 43(c)(3)–6, which describes a situation in which a consumer reports a debt obligation that is not listed on a credit report. 4. Verification of simultaneous loans. Although a credit report may be used to verify current obligations, it will not reflect a simultaneous loan that has not yet been consummated and may not reflect a loan that has just recently been consummated. If the creditor knows or has reason to know that there will be a simultaneous loan extended at or before consummation, the creditor may verify the simultaneous loan by obtaining third-party verification from the third-party creditor of the simultaneous loan. For example, the creditor may obtain a copy of the promissory note or other written verification from the third-party creditor. For further guidance, see comments 43(c)(3)–1 and –2 discussing verification using thirdparty records. 5. Verification of mortgage-related obligations. Creditors must make the repayment ability determination required under § 1026.43(c)(2) based on information verified from reasonably reliable records. For general guidance regarding verification see comments 43(c)(3)–1 and –2, which discuss verification using third-party records. With respect to the verification of mortgage-related obligations that are property taxes required to be considered under § 1026.43(c)(2)(v), a record is reasonably reliable if the information in the record was provided by a governmental organization, such as a taxing authority or local government. The creditor complies with § 1026.43(c)(2)(v) by relying on property taxes referenced in the title report if the source of the property tax information was a local taxing authority. With respect to other information in a record provided by an entity assessing charges, such as a homeowners association, the creditor complies with § 1026.43(c)(2)(v) if it relies on homeowners association billing statements provided by the seller. Records are also reasonably reliable if the information in the record was obtained from a valid and legally executed contract. For example, the creditor complies with § 1026.43(c)(2)(v) by relying on the amount of monthly ground rent referenced in the ground rent agreement currently in effect and applicable to the subject property. Records, other than those discussed above, may be reasonably reliable for purposes of § 1026.43(c)(2)(v) if the source provided the information objectively. 6. Verification of current debt obligations. Section 1026.43(c)(3) does not require E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6608 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations creditors to obtain additional records to verify the existence or amount of obligations shown on a consumer’s credit report or listed on the consumer’s application, absent circumstances described in comment 43(c)(3)–3. Under § 1026.43(c)(3)(iii), if a creditor relies on a consumer’s credit report to verify a consumer’s current debt obligations and the consumer’s application lists a debt obligation not shown on the credit report, the creditor may consider the existence and amount of the obligation as it is stated on the consumer’s application. The creditor is not required to further verify of the existence or amount of the obligation, absent circumstances described in comment 43(c)(3)–3. 7. Verification of credit history. To verify credit history, a creditor may, for example, look to credit reports from credit bureaus or to reasonably reliable third-party records that evidence nontraditional credit references, such as evidence of rental payment history or public utility payments. 8. Verification of military employment. A creditor may verify the employment status of military personnel by using a military Leave and Earnings Statement or by using the electronic database maintained by the Department of Defense to facilitate identification of consumers covered by credit protections provided pursuant to 10 U.S.C. 987. 43(c)(4) Verification of income or assets. 1. Income or assets relied on. A creditor need consider, and therefore need verify, only the income or assets the creditor relies on to evaluate the consumer’s repayment ability. See comment 43(c)(2)(i)–2. For example, if a consumer’s application states that the consumer earns a salary and is paid an annual bonus and the creditor relies on only the consumer’s salary to evaluate the consumer’s repayment ability, the creditor need verify only the salary. See also comments 43(c)(3)–1 and –2. 2. Multiple applicants. If multiple consumers jointly apply for a loan and each lists income or assets on the application, the creditor need verify only the income or assets the creditor relies on in determining repayment ability. See comment 43(c)(2)(i)– 5. 3. Tax-return transcript. Under § 1026.43(c)(4), a creditor may verify a consumer’s income using an Internal Revenue Service (IRS) tax-return transcript, which summarizes the information in a consumer’s filed tax return, another record that provides reasonably reliable evidence of the consumer’s income, or both. A creditor may obtain a copy of a tax-return transcript or a filed tax return directly from the consumer or from a service provider. A creditor need not obtain the copy directly from the IRS or other taxing authority. See comment 43(c)(3)–2. Paragraph 43(c)(4)(vi). 1. Government benefits. In verifying a consumer’s income, a creditor may use a written or electronic record from a government agency of the amount of any benefit payments or awards, such as a ‘‘proof of income letter’’ issued by the Social Security Administration (also known as a ‘‘budget letter,’’ ‘‘benefits letter,’’ or ‘‘proof of award letter’’). VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 43(c)(5) Payment calculation. 43(c)(5)(i) General rule. 1. General. For purposes of § 1026.43(c)(2)(iii), a creditor must determine the consumer’s ability to repay the covered transaction using the payment calculation methods set forth in § 1026.43(c)(5). The payment calculation methods differ depending on the type of credit extended. The payment calculation method set forth in § 1026.43(c)(5)(i) applies to any covered transaction that does not have a balloon payment, or that is not an interest-only or negative amortization loan, whether such covered transaction is a fixed-rate, adjustable-rate or step-rate mortgage. The terms ‘‘fixed-rate mortgage,’’ ‘‘adjustable-rate mortgage,’’ ‘‘step-rate mortgage,’’ ‘‘interestonly loan’’ and ‘‘negative amortization loan’’ are defined in § 1026.18(s)(7)(iii), (i), (ii), (iv) and (v), respectively. For the meaning of the term ‘‘balloon payment,’’ see § 1026.18(s)(5)(i). The payment calculation methods set forth in § 1026.43(c)(5)(ii) apply to any covered transaction that is a loan with a balloon payment, interest-only loan, or negative amortization loan. See comment 43(c)(5)(i)–5 and the commentary to § 1026.43(c)(5)(ii), which provide examples for calculating the monthly payment for purposes of the repayment ability determination required under § 1026.43(c)(2)(iii). 2. Greater of the fully indexed rate or introductory rate; premium adjustable-rate transactions. A creditor must determine a consumer’s repayment ability for the covered transaction using substantially equal, monthly, fully amortizing payments that are based on the greater of the fully indexed rate or any introductory interest rate. In some adjustable-rate transactions, creditors may set an initial interest rate that is not determined by the index or formula used to make later interest rate adjustments. Sometimes, this initial rate charged to consumers is lower than the rate would be if it were determined by using the index plus margin, or formula (i.e., fully indexed rate). However, an initial rate that is a premium rate is higher than the rate based on the index or formula. In such cases, creditors must calculate the fully amortizing payment based on the initial ‘‘premium’’ rate. ‘‘Fully indexed rate’’ is defined in § 1026.43(b)(3). 3. Monthly, fully amortizing payments. Section 1026.43(c)(5)(i) does not prescribe the terms or loan features that a creditor may choose to offer or extend to a consumer, but establishes the calculation method a creditor must use to determine the consumer’s repayment ability for a covered transaction. For example, the terms of the loan agreement may require that the consumer repay the loan in quarterly or bi-weekly scheduled payments, but for purposes of the repayment ability determination, the creditor must convert these scheduled payments to monthly payments in accordance with § 1026.43(c)(5)(i)(B). Similarly, the loan agreement may not require the consumer to make fully amortizing payments, but for purposes of the repayment ability determination under § 1026.43(c)(5)(i), the creditor must convert any non-amortizing payments to fully amortizing payments. PO 00000 Frm 00202 Fmt 4701 Sfmt 4700 4. Substantially equal. In determining whether monthly, fully amortizing payments are substantially equal, creditors should disregard minor variations due to paymentschedule irregularities and odd periods, such as a long or short first or last payment period. That is, monthly payments of principal and interest that repay the loan amount over the loan term need not be equal, but the monthly payments should be substantially the same without significant variation in the monthly combined payments of both principal and interest. For example, where no two monthly payments vary from each other by more than 1 percent (excluding odd periods, such as a long or short first or last payment period), such monthly payments would be considered substantially equal for purposes of this section. In general, creditors should determine whether the monthly, fully amortizing payments are substantially equal based on guidance provided in § 1026.17(c)(3) (discussing minor variations), and § 1026.17(c)(4)(i) through (iii) (discussing payment-schedule irregularities and measuring odd periods due to a long or short first period) and associated commentary. 5. Examples. The following are examples of how to determine the consumer’s repayment ability based on substantially equal, monthly, fully amortizing payments as required under § 1026.43(c)(5)(i) (all amounts shown are rounded, and all amounts are calculated using non-rounded values): i. Fixed-rate mortgage. A loan in an amount of $200,000 has a 30-year loan term and a fixed interest rate of 7 percent. For purposes of § 1026.43(c)(2)(iii), the creditor must determine the consumer’s ability to repay the loan based on a payment of $1,331, which is the substantially equal, monthly, fully amortizing payment that will repay $200,000 over 30 years using the fixed interest rate of 7 percent. ii. Adjustable-rate mortgage with discount for five years. A loan in an amount of $200,000 has a 30-year loan term. The loan agreement provides for a discounted interest rate of 6 percent that is fixed for an initial period of five years, after which the interest rate will adjust annually based on a specified index plus a margin of 3 percent, subject to a 2 percent annual periodic interest rate adjustment cap. The index value in effect at consummation is 4.5 percent; the fully indexed rate is 7.5 percent (4.5 percent plus 3 percent). Even though the scheduled monthly payment required for the first five years is $1199, for purposes of § 1026.43(c)(2)(iii) the creditor must determine the consumer’s ability to repay the loan based on a payment of $1,398, which is the substantially equal, monthly, fully amortizing payment that will repay $200,000 over 30 years using the fully indexed rate of 7.5 percent. iii. Step-rate mortgage. A loan in an amount of $200,000 has a 30-year loan term. The loan agreement provides that the interest rate will be 6.5 percent for the first two years of the loan, 7 percent for the next three years of the loan, and 7.5 percent thereafter. Accordingly, the scheduled payment amounts are $1,264 for the first two years, $1,328 for the next three years, and $1,388 thereafter for the remainder of the term. For E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations purposes of § 1026.43(c)(2)(iii), the creditor must determine the consumer’s ability to repay the loan based on a payment of $1,398, which is the substantially equal, monthly, fully amortizing payment that would repay $200,000 over 30 years using the fully indexed rate of 7.5 percent. 43(c)(5)(ii) Special rules for loans with a balloon payment, interest-only loans, and negative amortization loans. Paragraph 43(c)(5)(ii)(A). 1. General. For loans with a balloon payment, the rules differ depending on whether the loan is a higher-priced covered transaction, as defined under § 1026.43(b)(4), or is not a higher-priced covered transaction because the annual percentage rate does not exceed the applicable threshold calculated using the applicable average prime offer rate (APOR) for a comparable transaction. ‘‘Average prime offer rate’’ is defined in § 1026.35(a)(2); ‘‘higher-priced covered transaction’’ is defined in § 1026.43(b)(4). For higher-priced covered transactions with a balloon payment, the creditor must consider the consumer’s ability to repay the loan based on the payment schedule under the terms of the legal obligation, including any required balloon payment. For loans with a balloon payment that are not higher-priced covered transactions, the creditor should use the maximum payment scheduled during the first five years of the loan following the date on which the first regular periodic payment will be due. ‘‘Balloon payment’’ is defined in § 1026.18(s)(5)(i). 2. First five years after the date on which the first regular periodic payment will be due. Under § 1026.43(c)(5)(ii)(A)(1), the creditor must determine a consumer’s ability to repay a loan with a balloon payment that is not a higher-priced covered transaction using the maximum payment scheduled during the first five years (60 months) after the date on which the first regular periodic payment will be due. To illustrate: i. Assume a loan that provides for regular monthly payments and a balloon payment due at the end of a six-year loan term. The loan is consummated on August 15, 2014, and the first monthly payment is due on October 1, 2014. The first five years after the first monthly payment end on October 1, 2019. The balloon payment must be made on the due date of the 72nd monthly payment, which is September 1, 2020. For purposes of determining the consumer’s ability to repay the loan under § 1026.43(c)(2)(iii), the creditor need not consider the balloon payment that is due on September 1, 2020. ii. Assume a loan that provides for regular monthly payments and a balloon payment due at the end of a five-year loan term. The loan is consummated on August 15, 2014, and the first monthly payment is due on October 1, 2014. The first five years after the first monthly payment end on October 1, 2019. The balloon payment must be made on the due date of the 60th monthly payment, which is September 1, 2019. For purposes of determining the consumer’s ability to repay the loan under § 1026.43(c)(2)(iii), the creditor must consider the balloon payment that is due on September 1, 2019. 3. Renewable balloon-payment mortgage; loan term. A balloon-payment mortgage that VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 is not a higher-priced covered transaction could provide that a creditor is unconditionally obligated to renew a balloonpayment mortgage at the consumer’s option (or is obligated to renew subject to conditions within the consumer’s control). See comment 17(c)(1)–11 discussing renewable balloonpayment mortgages. For purposes of this section, the loan term does not include any period of time that could result from a renewal provision. To illustrate, assume a three-year balloon-payment mortgage that is not a higher-priced covered transaction contains an unconditional obligation to renew for another three years at the consumer’s option. In this example, the loan term for the balloon-payment mortgage is three years, and not the potential six years that could result if the consumer chooses to renew the loan. Accordingly, the creditor must underwrite the loan using the maximum payment scheduled in the first five years after consummation, which includes the balloon payment due at the end of the three-year loan term. See comment 43(c)(5)(ii)(A)–4.ii, which provides an example of how to determine the consumer’s repayment ability for a three-year renewable balloon-payment mortgage that is not a higher-priced covered transaction. 4. Examples of loans with a balloon payment that are not higher-priced covered transactions. The following are examples of how to determine the maximum payment scheduled during the first five years after the date on which the first regular periodic payment will be due (all amounts shown are rounded, and all amounts are calculated using non-rounded values): i. Balloon-payment mortgage with a threeyear loan term; fixed interest rate. A loan agreement provides for a fixed interest rate of 6 percent, which is below the APORcalculated threshold for a comparable transaction; thus the loan is not a higherpriced covered transaction. The loan amount is $200,000, and the loan has a three-year loan term but is amortized over 30 years. The monthly payment scheduled for the first three years following consummation is $1,199, with a balloon payment of $193,367 due at the end of the third year. For purposes of § 1026.43(c)(2)(iii), the creditor must determine the consumer’s ability to repay the loan based on the balloon payment of $193,367. ii. Renewable balloon-payment mortgage with a three-year loan term. Assume the same facts above in comment 43(c)(5)(ii)(A)–4.i, except that the loan agreement also provides that the creditor is unconditionally obligated to renew the balloon-payment mortgage at the consumer’s option at the end of the threeyear term for another three years. In determining the maximum payment scheduled during the first five years after the date on which the first regular periodic payment will be due, the creditor must use a loan term of three years. Accordingly, for purposes of § 1026.43(c)(2)(iii), the creditor must determine the consumer’s ability to repay the loan based on the balloon payment of $193,367. iii. Balloon-payment mortgage with a sixyear loan term; fixed interest rate. A loan provides for a fixed interest rate of 6 percent, PO 00000 Frm 00203 Fmt 4701 Sfmt 4700 6609 which is below the APOR threshold for a comparable transaction, and thus, the loan is not a higher-priced covered transaction. The loan amount is $200,000, and the loan has a six-year loan term but is amortized over 30 years. The loan is consummated on March 15, 2014, and the monthly payment scheduled for the first six years following consummation is $1,199, with the first monthly payment due on May 1, 2014. The first five years after the date on which the first regular periodic payment will be due end on May 1, 2019. The balloon payment of $183,995 is required on the due date of the 72nd monthly payment, which is April 1, 2020 (more than five years after the date on which the first regular periodic payment will be due). For purposes of § 1026.43(c)(2)(iii), the creditor may determine the consumer’s ability to repay the loan based on the monthly payment of $1,199, and need not consider the balloon payment of $183,995 due on April 1, 2020. 5. Higher-priced covered transaction with a balloon payment. Where a loan with a balloon payment is a higher-priced covered transaction, the creditor must determine the consumer’s repayment ability based on the loan’s payment schedule, including any balloon payment. For example (all amounts are rounded): Assume a higher-priced covered transaction with a fixed interest rate of 7 percent. The loan amount is $200,000 and the loan has a ten year loan term, but is amortized over 30 years. The monthly payment scheduled for the first ten years is $1,331, with a balloon payment of $172,955. For purposes of § 1026.43(c)(2)(iii), the creditor must consider the consumer’s ability to repay the loan based on the payment schedule that fully repays the loan amount, including the balloon payment of $172,955. Paragraph 43(c)(5)(ii)(B). 1. General. For loans that permit interestonly payments, the creditor must use the fully indexed rate or introductory rate, whichever is greater, to calculate the substantially equal, monthly payment of principal and interest that will repay the loan amount over the term of the loan remaining as of the date the loan is recast. For discussion regarding the fully indexed rate, and the meaning of ‘‘substantially equal,’’ see comments 43(b)(3)–1 through –5 and 43(c)(5)(i)–4, respectively. Under § 1026.43(c)(5)(ii)(B), the relevant term of the loan is the period of time that remains as of the date the loan is recast to require fully amortizing payments. For a loan on which only interest and no principal has been paid, the loan amount will be the outstanding principal balance at the time of the recast. ‘‘Loan amount’’ and ‘‘recast’’ are defined in § 1026.43(b)(5) and (b)(11), respectively. ‘‘Interest-only’’ and ‘‘Interest-only loan’’ are defined in § 1026.18(s)(7)(iv). 2. Examples. The following are examples of how to determine the consumer’s repayment ability based on substantially equal, monthly payments of principal and interest under § 1026.43(c)(5)(ii)(B) (all amounts shown are rounded, and all amounts are calculated using non-rounded values): i. Fixed-rate mortgage with interest-only payments for five years. A loan in an amount E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6610 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations of $200,000 has a 30-year loan term. The loan agreement provides for a fixed interest rate of 7 percent, and permits interest-only payments for the first five years. The monthly payment of $1,167 scheduled for the first five years would cover only the interest due. The loan is recast on the due date of the 60th monthly payment, after which the scheduled monthly payments increase to $1,414, a monthly payment that repays the loan amount of $200,000 over the 25 years remaining as of the date the loan is recast (300 months). For purposes of § 1026.43(c)(2)(iii), the creditor must determine the consumer’s ability to repay the loan based on a payment of $1,414, which is the substantially equal, monthly, fully amortizing payment that would repay $200,000 over the 25 years remaining as of the date the loan is recast using the fixed interest rate of 7 percent. ii. Adjustable-rate mortgage with discount for three years and interest-only payments for five years. A loan in an amount of $200,000 has a 30-year loan term, but provides for interest-only payments for the first five years. The loan agreement provides for a discounted interest rate of 5 percent that is fixed for an initial period of three years, after which the interest rate will adjust each year based on a specified index plus a margin of 3 percent, subject to an annual interest rate adjustment cap of 2 percent. The index value in effect at consummation is 4.5 percent; the fully indexed rate is 7.5 percent (4.5 percent plus 3 percent). The monthly payments for the first three years are $833. For the fourth year, the payments are $1,167, based on an interest rate of 7 percent, calculated by adding the 2 percent annual adjustment cap to the initial rate of 5 percent. For the fifth year, the payments are $1,250, applying the fully indexed rate of 7.5 percent. These first five years of payments will cover only the interest due. The loan is recast on the due date of the 60th monthly payment, after which the scheduled monthly payments increase to $1,478, a monthly payment that will repay the loan amount of $200,000 over the remaining 25 years of the loan (300 months). For purposes of § 1026.43(c)(2)(iii), the creditor must determine the consumer’s ability to repay the loan based on a monthly payment of $1,478, which is the substantially equal, monthly payment of principal and interest that would repay $200,000 over the 25 years remaining as of the date the loan is recast using the fully indexed rate of 7.5 percent. Paragraph 43(c)(5)(ii)(C). 1. General. For purposes of determining the consumer’s ability to repay a negative amortization loan, the creditor must use substantially equal, monthly payments of principal and interest based on the fully indexed rate or the introductory rate, whichever is greater, that will repay the maximum loan amount over the term of the loan that remains as of the date the loan is recast. Accordingly, before determining the substantially equal, monthly payments the creditor must first determine the maximum loan amount and the period of time that remains in the loan term after the loan is recast. ‘‘Recast’’ is defined in § 1026.43(b)(11). Second, the creditor must VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 use the fully indexed rate or introductory rate, whichever is greater, to calculate the substantially equal, monthly payment amount that will repay the maximum loan amount over the term of the loan remaining as of the date the loan is recast. For discussion regarding the fully indexed rate and the meaning of ‘‘substantially equal,’’ see comments 43(b)(3)–1 through –5 and 43(c)(5)(i)–4, respectively. For the meaning of the term ‘‘maximum loan amount’’ and a discussion of how to determine the maximum loan amount for purposes of § 1026.43(c)(5)(ii)(C), see § 1026.43(b)(7) and associated commentary. ‘‘Negative amortization loan’’ is defined in § 1026.18(s)(7)(v). 2. Term of loan. Under § 1026.43(c)(5)(ii)(C), the relevant term of the loan is the period of time that remains as of the date the terms of the legal obligation recast. That is, the creditor must determine substantially equal, monthly payments of principal and interest that will repay the maximum loan amount based on the period of time that remains after any negative amortization cap is triggered or any period permitting minimum periodic payments expires, whichever occurs first. 3. Examples. The following are examples of how to determine the consumer’s repayment ability based on substantially equal, monthly payments of principal and interest as required under § 1026.43(c)(5)(ii)(C) (all amounts shown are rounded, and all amounts are calculated using non-rounded values): i. Adjustable-rate mortgage with negative amortization. A. Assume an adjustable-rate mortgage in the amount of $200,000 with a 30-year loan term. The loan agreement provides that the consumer can make minimum monthly payments that cover only part of the interest accrued each month until the date on which the principal balance reaches 115 percent of its original balance (i.e., a negative amortization cap of 115 percent) or for the first five years of the loan (60 monthly payments), whichever occurs first. The introductory interest rate at consummation is 1.5 percent. One month after consummation, the interest rate adjusts and will adjust monthly thereafter based on the specified index plus a margin of 3.5 percent. The index value in effect at consummation is 4.5 percent; the fully indexed rate is 8 percent (4.5 percent plus 3.5 percent). The maximum lifetime interest rate is 10.5 percent; there are no other periodic interest rate adjustment caps that limit how quickly the maximum lifetime rate may be reached. The minimum monthly payment for the first year is based on the initial interest rate of 1.5 percent. After that, the minimum monthly payment adjusts annually, but may increase by no more than 7.5 percent over the previous year’s payment. The minimum monthly payment is $690 in the first year, $742 in the second year, and $797 in the first part of the third year. B. To determine the maximum loan amount, assume that the interest rate increases to the maximum lifetime interest rate of 10.5 percent at the first adjustment (i.e., the due date of the first periodic monthly payment), and interest accrues at PO 00000 Frm 00204 Fmt 4701 Sfmt 4700 that rate until the loan is recast. Assume that the consumer makes the minimum monthly payments scheduled, which are capped at 7.5 percent from year-to-year, for the maximum possible time. Because the consumer’s minimum monthly payments are less than the interest accrued each month, negative amortization occurs (i.e., the accrued but unpaid interest is added to the principal balance). Thus, assuming that the consumer makes the minimum monthly payments for as long as possible and that the maximum interest rate of 10.5 percent is reached at the first rate adjustment (i.e., the due date of the first periodic monthly payment), the negative amortization cap of 115 percent is reached on the due date of the 27th monthly payment and the loan is recast as of that date. The maximum loan amount as of the due date of the 27th monthly payment is $229,251, and the remaining term of the loan is 27 years and nine months (333 months). C. For purposes of § 1026.43(c)(2)(iii), the creditor must determine the consumer’s ability to repay the loan based on a monthly payment of $1,716, which is the substantially equal, monthly payment of principal and interest that will repay the maximum loan amount of $229,251 over the remaining loan term of 333 months using the fully indexed rate of 8 percent. See comments 43(b)(7)–1 and –2 discussing the calculation of the maximum loan amount, and § 1026.43(b)(11) for the meaning of the term ‘‘recast.’’ ii. Fixed-rate, graduated payment mortgage. A loan in the amount of $200,000 has a 30-year loan term. The loan agreement provides for a fixed interest rate of 7.5 percent, and requires the consumer to make minimum monthly payments during the first year, with payments increasing 12.5 percent over the previous year every year for four years (the annual payment cap). The payment schedule provides for payments of $943 in the first year, $1,061 in the second year, $1,193 in the third year, $1,343 in the fourth year, and then requires $1,511 for the remaining term of the loan. During the first three years of the loan, the payments are less than the interest accrued each month, resulting in negative amortization. Assuming the minimum payments increase year-to-year up to the 12.5 percent payment cap, the consumer will begin making payments that cover at least all of the interest accrued at the end of the third year. Thus, the loan is recast on the due date of the 36th monthly payment. The maximum loan amount on that date is $207,662, and the remaining loan term is 27 years (324 months). For purposes of § 1026.43(c)(2)(iii), the creditor must determine the consumer’s ability to repay the loan based on a monthly payment of $1,497, which is the substantially equal, monthly payment of principal and interest that will repay the maximum loan amount of $207,662 over the remaining loan term of 27 years using the fixed interest rate of 7.5 percent. 43(c)(6) Payment calculation for simultaneous loans. 1. Scope. In determining the consumer’s repayment ability for a covered transaction under § 1026.43(c)(2)(iii), a creditor must include consideration of any simultaneous loan which it knows, or has reason to know, will be made at or before consummation of E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations the covered transaction. For a discussion of the standard ‘‘knows or has reason to know,’’ see comment 43(c)(2)(iv)–2. For the meaning of the term ‘‘simultaneous loan,’’ see § 1026.43(b)(12). 2. Payment calculation—covered transaction. For a simultaneous loan that is a covered transaction, as that term is defined under § 1026.43(b)(1), a creditor must determine a consumer’s ability to repay the monthly payment obligation for a simultaneous loan as set forth in § 1026.43(c)(5), taking into account any mortgage-related obligations required to be considered under § 1026.43(c)(2)(v). For the meaning of the term ‘‘mortgage-related obligations,’’ see § 1026.43(b)(8). 3. Payment calculation—home equity line of credit. For a simultaneous loan that is a home equity line of credit subject to § 1026.40, the creditor must consider the periodic payment required under the terms of the plan when assessing the consumer’s ability to repay the covered transaction secured by the same dwelling as the simultaneous loan. Under § 1026.43(c)(6)(ii), a creditor must determine the periodic payment required under the terms of the plan by considering the actual amount of credit to be drawn by the consumer at consummation of the covered transaction. The amount to be drawn is the amount requested by the consumer; when the amount requested will be disbursed, or actual receipt of funds, is not determinative. Any additional draw against the line of credit that the creditor of the covered transaction does not know or have reason to know about before or during underwriting need not be considered in relation to ability to repay. For example, where the creditor’s policies and procedures require the source of down payment to be verified, and the creditor verifies that a simultaneous loan that is a HELOC will provide the source of down payment for the first-lien covered transaction, the creditor must consider the periodic payment on the HELOC by assuming the amount drawn is at least the down payment amount. In general, a creditor should determine the periodic payment based on guidance in the commentary to § 1026.40(d)(5) (discussing payment terms). 43(c)(7) Monthly debt-to-income ratio or residual income. 1. Monthly debt-to-income ratio or monthly residual income. Under § 1026.43(c)(2)(vii), the creditor must consider the consumer’s monthly debt-to-income ratio, or the consumer’s monthly residual income, in accordance with the requirements in § 1026.43(c)(7). In contrast to the qualified mortgage provisions in § 1026.43(e), § 1026.43(c) does not prescribe a specific monthly debt-to-income ratio with which creditors must comply. Instead, an appropriate threshold for a consumer’s monthly debt-to-income ratio or monthly residual income is for the creditor to determine in making a reasonable and good faith determination of a consumer’s ability to repay. 2. Use of both monthly debt-to-income ratio and monthly residual income. If a creditor considers the consumer’s monthly debt-to-income ratio, the creditor may also VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 consider the consumer’s residual income as further validation of the assessment made using the consumer’s monthly debt-toincome ratio. 3. Compensating factors. The creditor may consider factors in addition to the monthly debt-to-income ratio or residual income in assessing a consumer’s repayment ability. For example, the creditor may reasonably and in good faith determine that a consumer has the ability to repay despite a higher debt-toincome ratio or lower residual income in light of the consumer’s assets other than the dwelling, including any real property attached to the dwelling, securing the covered transaction, such as a savings account. The creditor may also reasonably and in good faith determine that a consumer has the ability to repay despite a higher debtto-income ratio in light of the consumer’s residual income. 43(d) Refinancing of non-standard mortgages. 43(d)(1) Definitions. 43(d)(1)(i) Non-standard mortgage. Paragraph 43(d)(1)(i)(A). 1. Adjustable-rate mortgage with an introductory fixed rate. Under § 1026.43(d)(1)(i)(A), an adjustable-rate mortgage with an introductory fixed interest rate for one year or longer is considered a ‘‘non-standard mortgage.’’ For example, a covered transaction that has a fixed introductory rate for the first two, three, or five years and then converts to a variable rate for the remaining 28, 27, or 25 years, respectively, is a ‘‘non-standard mortgage.’’ A covered transaction with an introductory rate for six months that then converts to a variable rate for the remaining 29 and onehalf years is not a ‘‘non-standard mortgage.’’ 43(d)(1)(ii) Standard mortgage. Paragraph 43(d)(1)(ii)(A). 1. Regular periodic payments. Under § 1026.43(d)(1)(ii)(A), a ‘‘standard mortgage’’ must provide for regular periodic payments that do not result in an increase of the principal balance (negative amortization), allow the consumer to defer repayment of principal (see comment 43(e)(2)(i)–2), or result in a balloon payment. Thus, the terms of the legal obligation must require the consumer to make payments of principal and interest on a monthly or other periodic basis that will repay the loan amount over the loan term. Except for payments resulting from any interest rate changes after consummation in an adjustable-rate or step-rate mortgage, the periodic payments must be substantially equal. For an explanation of the term ‘‘substantially equal,’’ see comment 43(c)(5)(i)–4. In addition, a single-payment transaction is not a ‘‘standard mortgage’’ because it does not require ‘‘regular periodic payments.’’ See also comment 43(e)(2)(i)–1. Paragraph 43(d)(1)(ii)(D). 1. First five years after consummation. A ‘‘standard mortgage’’ must have an interest rate that is fixed for at least the first five years (60 months) after consummation. For example, assume an adjustable-rate mortgage that applies the same fixed interest rate to determine the first 60 payments of principal and interest due. The loan is consummated on August 15, 2013, and the first monthly payment is due on October 1, 2013. The date PO 00000 Frm 00205 Fmt 4701 Sfmt 4700 6611 that is five years after consummation is August 15, 2018. The first interest rate adjustment occurs on September 1, 2018. This loan meets the criterion for a ‘‘standard mortgage’’ under § 1026.43(d)(1)(ii)(D) because the interest rate is fixed until September 1, 2018, which is more than five years after consummation. For guidance regarding step-rate mortgages, see comment 43(e)(2)(iv)–3.iii. Paragraph 43(d)(1)(ii)(E). 1. Permissible use of proceeds. To qualify as a ‘‘standard mortgage,’’ the loan’s proceeds may be used for only two purposes: paying off the non-standard mortgage and paying for closing costs, including paying escrow amounts required at or before closing. If the proceeds of a covered transaction are used for other purposes, such as to pay off other liens or to provide additional cash to the consumer for discretionary spending, the transaction does not meet the definition of a ‘‘standard mortgage.’’ 43(d)(2) Scope. 1. Written application. For an explanation of the requirements for a ‘‘written application’’ in § 1026.43(d)(2)(iii), (d)(2)(iv), and (d)(2)(v), see comment 19(a)(1)(i)–3. Paragraph 43(d)(2)(ii). 1. Materially lower. The exemptions afforded under § 1026.43(d)(3) apply to a refinancing only if the monthly payment for the new loan is ‘‘materially lower’’ than the monthly payment for an existing nonstandard mortgage. The payments to be compared must be calculated based on the requirements under § 1026.43(d)(5). Whether the new loan payment is ‘‘materially lower’’ than the non-standard mortgage payment depends on the facts and circumstances. In all cases, a payment reduction of 10 percent or more meets the ‘‘materially lower’’ standard. Paragraph 43(d)(2)(iv). 1. Late payment—12 months prior to application. Under § 1026.43(d)(2)(iv), the exemptions in § 1026.43(d)(3) apply to a covered transaction only if, during the 12 months immediately preceding the creditor’s receipt of the consumer’s written application for a refinancing, the consumer has made no more than one payment on the non-standard mortgage more than 30 days late. (For an explanation of ‘‘written application,’’ see comment 43(d)(2)–1.) For example, assume a consumer applies for a refinancing on May 1, 2014. Assume also that the consumer made a non-standard mortgage payment on August 15, 2013, that was 45 days late. The consumer made no other late payments on the non-standard mortgage between May 1, 2013, and May 1, 2014. In this example, the requirement under § 1026.43(d)(2)(iv) is met because the consumer made only one payment that was over 30 days late within the 12 months prior to applying for the refinancing (i.e., eight and one-half months prior to application). 2. Payment due date. Whether a payment is more than 30 days late is measured in relation to the contractual due date not accounting for any grace period. For example, if the contractual due date for a non-standard mortgage payment is the first day of every month, but no late fee will be charged as long as the payment is received E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6612 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations by the 16th of the month, the payment due date for purposes of § 1026.43(d)(2)(iv) and (v) is the first day of the month, not the 16th day of the month. Thus, a payment due under the contract on October 1st that is paid on November 1st is made more than 30 days after the payment due date. Paragraph 43(d)(2)(v). 1. Late payment—six months prior to application. Under § 1026.43(d)(2)(v), the exemptions in § 1026.43(d)(3) apply to a covered transaction only if, during the six months immediately preceding the creditor’s receipt of the consumer’s written application for a refinancing, the consumer has made no payments on the non-standard mortgage more than 30 days late. (For an explanation of ‘‘written application’’ and how to determine the payment due date, see comments 43(d)(2)–1 and 43(d)(2)(iv)–2.) For example, assume a consumer with a nonstandard mortgage applies for a refinancing on May 1, 2014. If the consumer made a payment on March 15, 2014, that was 45 days late, the requirement under § 1026.43(d)(2)(v) is not met because the consumer made a payment more than 30 days late one and onehalf months prior to application. If the number of months between consummation of the non-standard mortgage and the consumer’s application for the standard mortgage is six or fewer, the consumer may not have made any payment more than 30 days late on the non-standard mortgage. Paragraph 43(d)(2)(vi). 1. Non-standard mortgage loan made in accordance with ability-to-repay or qualified mortgage requirements. For non-standard mortgages that are consummated on or after January 10, 2014, § 1026.43(d)(2)(vi) provides that the refinancing provisions set forth in § 1026.43(d) apply only if the non-standard mortgage was made in accordance with the requirements of § 1026.43(c) or (e), as applicable. For example, if a creditor originated a non-standard mortgage on or after January 10, 2014 that did not comply with the requirements of § 1026.43(c) and was not a qualified mortgage pursuant to § 1026.43(e), § 1026.43(d) would not apply to the refinancing of the non-standard mortgage loan into a standard mortgage loan. However, § 1026.43(d) applies to the refinancing of a non-standard mortgage loan into a standard mortgage loan, regardless of whether the nonstandard mortgage loan was made in compliance with § 1026.43(c) or (e), if the non-standard mortgage loan was consummated prior to January 10, 2014. 43(d)(3) Exemption from repayment ability requirements. 1. Two-part determination. To qualify for the exemptions in § 1026.43(d)(3), a creditor must have considered, first, whether the consumer is likely to default on the existing mortgage once that loan is recast and, second, whether the new mortgage likely would prevent the consumer’s default. 43(d)(4) Offer of rate discounts and other favorable terms. 1. Documented underwriting practices. In connection with a refinancing made pursuant to § 1026.43(d), § 1026.43(d)(4) requires a creditor offering a consumer rate discounts and terms that are the same as, or better than, the rate discounts and terms offered to new VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 consumers to make such an offer consistent with the creditor’s documented underwriting practices. Section 1026.43(d)(4) does not require a creditor making a refinancing pursuant to § 1026.43(d) to comply with the underwriting requirements of § 1026.43(c). Rather, § 1026.43(d)(4) requires creditors providing such discounts to do so consistent with documented policies related to loan pricing, loan term qualifications, or other similar underwriting practices. For example, assume that a creditor is providing a consumer with a refinancing made pursuant to § 1026.43(d) and that this creditor has a documented practice of offering rate discounts to consumers with credit scores above a certain threshold. Assume further that the consumer receiving the refinancing has a credit score below this threshold, and therefore would not normally qualify for the rate discount available to consumers with high credit scores. This creditor complies with § 1026.43(d)(4) by offering the consumer the discounted rate in connection with the refinancing made pursuant to § 1026.43(d), even if the consumer would not normally qualify for that discounted rate, provided that the offer of the discounted rate is not prohibited by applicable State or Federal law. However, § 1026.43(d)(4) does not require a creditor to offer a consumer such a discounted rate. 43(d)(5) Payment calculations. 43(d)(5)(i) Non-Standard mortgage. 1. Payment calculation for a non-standard mortgage. In determining whether the monthly periodic payment for a standard mortgage is materially lower than the monthly periodic payment for the nonstandard mortgage under § 1026.43(d)(2)(ii), the creditor must consider the monthly payment for the non-standard mortgage that will result after the loan is ‘‘recast,’’ assuming substantially equal payments of principal and interest that amortize the remaining loan amount over the remaining term as of the date the mortgage is recast. For guidance regarding the meaning of ‘‘substantially equal,’’ see comment 43(c)(5)(i)–4. For the meaning of ‘‘recast,’’ see § 1026.43(b)(11) and associated commentary. 2. Fully indexed rate. The term ‘‘fully indexed rate’’ in § 1026.43(d)(5)(i)(A) for calculating the payment for a non-standard mortgage is generally defined in § 1026.43(b)(3) and associated commentary. Under § 1026.43(b)(3) the fully indexed rate is calculated at the time of consummation. For purposes of § 1026.43(d)(5)(i), however, the fully indexed rate is calculated within a reasonable period of time before or after the date the creditor receives the consumer’s written application for the standard mortgage. Thirty days is generally considered ‘‘a reasonable period of time.’’ 3. Written application. For an explanation of the requirements for a ‘‘written application’’ in § 1026.43(d)(5)(i), see comment 19(a)(1)(i)–3. 4. Payment calculation for an adjustablerate mortgage with an introductory fixed rate. Under § 1026.43(d)(5)(i), the monthly periodic payment for an adjustable-rate mortgage with an introductory fixed interest rate for a period of one or more years must be calculated based on several assumptions. PO 00000 Frm 00206 Fmt 4701 Sfmt 4700 i. First, the payment must be based on the outstanding principal balance as of the date on which the mortgage is recast, assuming all scheduled payments have been made up to that date and the last payment due under those terms is made and credited on that date. For example, assume an adjustable-rate mortgage with a 30-year loan term. The loan agreement provides that the payments for the first 24 months are based on a fixed rate, after which the interest rate will adjust annually based on a specified index and margin. The loan is recast on the due date of the 24th payment. If the 24th payment is due on September 1, 2014, the creditor must calculate the outstanding principal balance as of September 1, 2014, assuming that all 24 payments under the fixed rate terms have been made and credited timely. ii. Second, the payment calculation must be based on substantially equal monthly payments of principal and interest that will fully repay the outstanding principal balance over the term of the loan remaining as of the date the loan is recast. Thus, in the example above, the creditor must assume a loan term of 28 years (336 monthly payments). iii. Third, the payment must be based on the fully indexed rate, as described in § 1026.43(d)(5)(i)(A). 5. Example of payment calculation for an adjustable-rate mortgage with an introductory fixed rate. The following example illustrates the rule described in comment 43(d)(5)(i)–4: i. A loan in an amount of $200,000 has a 30-year loan term. The loan agreement provides for a discounted introductory interest rate of 5 percent that is fixed for an initial period of two years, after which the interest rate will adjust annually based on a specified index plus a margin of 3 percentage points. ii. The non-standard mortgage is consummated on February 15, 2014, and the first monthly payment is due on April 1, 2014. The loan is recast on the due date of the 24th monthly payment, which is March 1, 2016. iii. On March 15, 2015, the creditor receives the consumer’s written application for a refinancing after the consumer has made 12 monthly on-time payments. On this date, the index value is 4.5 percent. iv. To calculate the non-standard mortgage payment that must be compared to the standard mortgage payment under § 1026.43(d)(2)(ii), the creditor must use: A. The outstanding principal balance as of March 1, 2016, assuming all scheduled payments have been made up to March 1, 2016, and the last payment due under the fixed rate terms is made and credited on March 1, 2016. In this example, the outstanding principal balance is $193,948. B. The fully indexed rate of 7.5 percent, which is the index value of 4.5 percent as of March 15, 2015 (the date on which the application for a refinancing is received) plus the margin of 3 percent. C. The remaining loan term as of March 1, 2016, the date of the recast, which is 28 years (336 monthly payments). v. Based on these assumptions, the monthly payment for the non-standard mortgage for purposes of determining E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations whether the standard mortgage monthly payment is lower than the non-standard mortgage monthly payment (see § 1026.43(d)(2)(ii)) is $1,383. This is the substantially equal, monthly payment of principal and interest required to repay the outstanding principal balance at the fully indexed rate over the remaining term. 6. Payment calculation for an interest-only loan. Under § 1026.43(d)(5)(i), the monthly periodic payment for an interest-only loan must be calculated based on several assumptions: i. First, the payment must be based on the outstanding principal balance as of the date of the recast, assuming all scheduled payments are made under the terms of the legal obligation in effect before the mortgage is recast. For a loan on which only interest and no principal has been paid, the outstanding principal balance at the time of recast will be the loan amount, as defined in § 1026.43(b)(5), assuming all scheduled payments are made under the terms of the legal obligation in effect before the mortgage is recast. For example, assume that a mortgage has a 30-year loan term, and provides that the first 24 months of payments are interest-only. If the 24th payment is due on September 1, 2015, the creditor must calculate the outstanding principal balance as of September 1, 2015, assuming that all 24 payments under the interest-only payment terms have been made and credited timely and that no payments of principal have been made. ii. Second, the payment calculation must be based on substantially equal monthly payments of principal and interest that will fully repay the loan amount over the term of the loan remaining as of the date the loan is recast. Thus, in the example above, the creditor must assume a loan term of 28 years (336 monthly payments). iii. Third, the payment must be based on the fully indexed rate, as described in § 1026.43(d)(5)(i)(A). 7. Example of payment calculation for an interest-only loan. The following example illustrates the rule described in comment 43(d)(5)(i)–6: i. A loan in an amount of $200,000 has a 30-year loan term. The loan agreement provides for a fixed interest rate of 7 percent, and permits interest-only payments for the first two years (the first 24 payments), after which time amortizing payments of principal and interest are required. ii. The non-standard mortgage is consummated on February 15, 2014, and the first monthly payment is due on April 1, 2014. The loan is recast on the due date of the 24th monthly payment, which is March 1, 2016. iii. On March 15, 2015, the creditor receives the consumer’s written application for a refinancing, after the consumer has made 12 monthly on-time payments. The consumer has made no additional payments of principal. iv. To calculate the non-standard mortgage payment that must be compared to the standard mortgage payment under § 1026.43(d)(2)(ii), the creditor must use: A. The loan amount, which is the outstanding principal balance as of March 1, VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 2016, assuming all scheduled interest-only payments have been made and credited up to that date. In this example, the loan amount is $200,000. B. An interest rate of 7 percent, which is the interest rate in effect at the time of consummation of this fixed-rate nonstandard mortgage. C. The remaining loan term as of March 1, 2016, the date of the recast, which is 28 years (336 monthly payments). v. Based on these assumptions, the monthly payment for the non-standard mortgage for purposes of determining whether the standard mortgage monthly payment is lower than the non-standard mortgage monthly payment (see § 1026.43(d)(2)(ii)) is $1,359. This is the substantially equal, monthly payment of principal and interest required to repay the loan amount at the fully indexed rate over the remaining term. 8. Payment calculation for a negative amortization loan. Under § 1026.43(d)(5)(i), the monthly periodic payment for a negative amortization loan must be calculated based on several assumptions: i. First, the calculation must be based on the maximum loan amount, determined after adjusting for the outstanding principal balance. If the consumer makes only the minimum periodic payments for the maximum possible time, until the consumer must begin making fully amortizing payments, the outstanding principal balance will be the maximum loan amount, as defined in § 1026.43(b)(7). In this event, the creditor complies with § 1026.43(d)(5)(i)(C)(3) by relying on the examples of how to calculate the maximum loan amount, see comment 43(b)(7)–3. If the consumer makes payments above the minimum periodic payments for the maximum possible time, the creditor must calculate the maximum loan amount based on the outstanding principal balance. In this event, the creditor complies with § 1026.43(d)(5)(i)(C)(3) by relying on the examples of how to calculate the maximum loan amount in comment 43(d)(5)(i)–10. ii. Second, the calculation must be based on substantially equal monthly payments of principal and interest that will fully repay the maximum loan amount over the term of the loan remaining as of the date the loan is recast. For example, if the loan term is 30 years and the loan is recast on the due date of the 60th monthly payment, the creditor must assume a remaining loan term of 25 years (300 monthly payments). iii. Third, the payment must be based on the fully indexed rate as of the date of the written application for the standard mortgage. 9. Example of payment calculation for a negative amortization loan if only minimum payments made. The following example illustrates the rule described in comment 43(d)(5)(i)–8: i. A loan in an amount of $200,000 has a 30-year loan term. The loan agreement provides that the consumer can make minimum monthly payments that cover only part of the interest accrued each month until the date on which the principal balance increases to the negative amortization cap of PO 00000 Frm 00207 Fmt 4701 Sfmt 4700 6613 115 percent of the loan amount, or for the first five years of monthly payments (60 payments), whichever occurs first. The loan is an adjustable-rate mortgage that adjusts monthly according to a specified index plus a margin of 3.5 percent. ii. The non-standard mortgage is consummated on February 15, 2014, and the first monthly payment is due on April 1, 2014. Assume that the consumer has made only the minimum periodic payments. Assume further that, based on the calculation of the maximum loan amount required under § 1026.43(b)(7) and associated commentary, the negative amortization cap of 115 percent would be reached on June 1, 2016, the due date of the 27th monthly payment. iii. On March 15, 2015, the creditor receives the consumer’s written application for a refinancing, after the consumer has made 12 monthly on-time payments. On this date, the index value is 4.5 percent. iv. To calculate the non-standard mortgage payment that must be compared to the standard mortgage payment under § 1026.43(d)(2)(ii), the creditor must use: A. The maximum loan amount of $229,251 as of June 1, 2016; B. The fully indexed rate of 8 percent, which is the index value of 4.5 percent as of March 15, 2015 (the date on which the creditor receives the application for a refinancing) plus the margin of 3.5 percent; and C. The remaining loan term as of June 1, 2016, the date of the recast, which is 27 years and nine months (333 monthly payments). v. Based on these assumptions, the monthly payment for the non-standard mortgage for purposes of determining whether the standard mortgage monthly payment is lower than the non-standard mortgage monthly payment (see § 1026.43(d)(2)(ii)) is $1,716. This is the substantially equal, monthly payment of principal and interest required to repay the maximum loan amount at the fully indexed rate over the remaining term. 10. Example of payment calculation for a negative amortization loan if payments above minimum amount made. The following example illustrates the rule described in comment 43(d)(5)(i)–8: i. A loan in an amount of $200,000 has a 30-year loan term. The loan agreement provides that the consumer can make minimum monthly payments that cover only part of the interest accrued each month until the date on which the principal balance increases to the negative amortization cap of 115 percent of the loan amount, or for the first five years of monthly payments (60 payments), whichever occurs first. The loan is an adjustable-rate mortgage that adjusts monthly according to a specified index plus a margin of 3.5 percent. The introductory interest rate at consummation is 1.5 percent. One month after consummation, the interest rate adjusts and will adjust monthly thereafter based on the specified index plus a margin of 3.5 percent. The maximum lifetime interest rate is 10.5 percent; there are no other periodic interest rate adjustment caps that limit how quickly the maximum lifetime rate may be reached. The minimum monthly payment for the first year is based E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6614 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations on the initial interest rate of 1.5 percent. After that, the minimum monthly payment adjusts annually, but may increase by no more than 7.5 percent over the previous year’s payment. The minimum monthly payment is $690 in the first year, $742 in the second year, $798 in the third year, $857 in the fourth year, and $922 in the fifth year. ii. The non-standard mortgage is consummated on February 15, 2014, and the first monthly payment is due on April 1, 2014. Assume that the consumer has made more than the minimum periodic payments, and that after the consumer’s 12th monthly on-time payment the outstanding principal balance is $195,000. Based on the calculation of the maximum loan amount after adjusting for this outstanding principal balance, the negative amortization cap of 115 percent would be reached on March 1, 2019, the due date of the 60th monthly payment. iii. On March 15, 2015, the creditor receives the consumer’s written application for a refinancing, after the consumer has made 12 monthly on-time payments. On this date, the index value is 4.5 percent. iv. To calculate the non-standard mortgage payment that must be compared to the standard mortgage payment under § 1026.43(d)(2)(ii), the creditor must use: A. The maximum loan amount of $229,219 as of March 1, 2019. B. The fully indexed rate of 8 percent, which is the index value of 4.5 percent as of March 15, 2015 (the date on which the creditor receives the application for a refinancing) plus the margin of 3.5 percent. C. The remaining loan term as of March 1, 2019, the date of the recast, which is exactly 25 years (300 monthly payments). v. Based on these assumptions, the monthly payment for the non-standard mortgage for purposes of determining whether the standard mortgage monthly payment is lower than the non-standard mortgage monthly payment (see § 1026.43(d)(2)(ii)) is $1,769. This is the substantially equal, monthly payment of principal and interest required to repay the maximum loan amount at the fully indexed rate over the remaining term. 43(d)(5)(ii) Standard mortgage. 1. Payment calculation for a standard mortgage. In determining whether the monthly periodic payment for a standard mortgage is materially lower than the monthly periodic payment for a non-standard mortgage, the creditor must consider the monthly payment for the standard mortgage that will result in substantially equal, monthly, fully amortizing payments (as defined in § 1026.43(b)(2)) using the rate as of consummation. For guidance regarding the meaning of ‘‘substantially equal’’ see comment 43(c)(5)(i)–4. For a mortgage with a single, fixed rate for the first five years after consummation, the maximum rate that will apply during the first five years after consummation will be the rate at consummation. For a step-rate mortgage, however, the rate that must be used is the highest rate that will apply during the first five years after consummation. For example, if the rate for the first two years after the date on which the first regular periodic payment will be due is 4 percent, the rate for the VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 following two years is 5 percent, and the rate for the next two years is 6 percent, the rate that must be used is 6 percent. 2. Example of payment calculation for a standard mortgage. The following example illustrates the rule described in comment 43(d)(5)(ii)–1: A loan in an amount of $200,000 has a 30-year loan term. The loan agreement provides for an interest rate of 6 percent that is fixed for an initial period of five years, after which time the interest rate will adjust annually based on a specified index plus a margin of 3 percent, subject to a 2 percent annual interest rate adjustment cap. The creditor must determine whether the standard mortgage monthly payment is materially lower than the non-standard mortgage monthly payment (see § 1026.43(d)(2)(ii)) based on a standard mortgage payment of $1,199. This is the substantially equal, monthly payment of principal and interest required to repay $200,000 over 30 years at an interest rate of 6 percent. 43(e) Qualified mortgages. 43(e)(1) Safe harbor and presumption of compliance. 1. General. Section 1026.43(c) requires a creditor to make a reasonable and good faith determination at or before consummation that a consumer will be able to repay a covered transaction. Section 1026.43(e)(1)(i) and (ii) provide a safe harbor and presumption of compliance, respectively, with the repayment ability requirements of § 1026.43(c) for creditors and assignees of covered transactions that satisfy the requirements of a qualified mortgage under § 1026.43(e)(2), (e)(4), or (f). See § 1026.43(e)(1)(i) and (ii) and associated commentary. 43(e)(1)(i) Safe harbor for transactions that are not higher-priced covered transactions. 1. Safe harbor. To qualify for the safe harbor in § 1026.43(e)(1)(i), a covered transaction must meet the requirements of a qualified mortgage under § 1026.43(e)(2), (e)(4), or (f) and must not be a higher-priced covered transaction, as defined in § 1026.43(b)(4). For guidance on determining whether a loan is a higher-priced covered transaction, see comment 43(b)(4)–1. 43(e)(1)(ii) Presumption of compliance for higher-priced covered transactions. 1. General. Under § 1026.43(e)(1)(ii), a creditor or assignee of a qualified mortgage under § 1026.43(e)(2), (e)(4), or (f) that is a higher-priced covered transaction is presumed to comply with the repayment ability requirements of § 1026.43(c). To rebut the presumption, it must be proven that, despite meeting the standards for a qualified mortgage (including either the debt-toincome standard in § 1026.43(e)(2)(vi) or the standards of one of the entities specified in § 1026.43(e)(4)(ii)), the creditor did not have a reasonable and good faith belief in the consumer’s repayment ability. Specifically, it must be proven that, at the time of consummation, based on the information available to the creditor, the consumer’s income, debt obligations, alimony, child support, and the consumer’s monthly payment (including mortgage-related obligations) on the covered transaction and on any simultaneous loans of which the PO 00000 Frm 00208 Fmt 4701 Sfmt 4700 creditor was aware at consummation would leave the consumer with insufficient residual income or assets other than the value of the dwelling (including any real property attached to the dwelling) that secures the loan with which to meet living expenses, including any recurring and material nondebt obligations of which the creditor was aware at the time of consummation, and that the creditor thereby did not make a reasonable and good faith determination of the consumer’s repayment ability. For example, a consumer may rebut the presumption with evidence demonstrating that the consumer’s residual income was insufficient to meet living expenses, such as food, clothing, gasoline, and health care, including the payment of recurring medical expenses of which the creditor was aware at the time of consummation, and after taking into account the consumer’s assets other than the value of the dwelling securing the loan, such as a savings account. In addition, the longer the period of time that the consumer has demonstrated actual ability to repay the loan by making timely payments, without modification or accommodation, after consummation or, for an adjustable-rate mortgage, after recast, the less likely the consumer will be able to rebut the presumption based on insufficient residual income and prove that, at the time the loan was made, the creditor failed to make a reasonable and good faith determination that the consumer had the reasonable ability to repay the loan. 43(e)(2) Qualified mortgage defined— general. Paragraph 43(e)(2)(i). 1. Regular periodic payments. Under § 1026.43(e)(2)(i), a qualified mortgage must provide for regular periodic payments that may not result in an increase of the principal balance (negative amortization), deferral of principal repayment, or a balloon payment. Thus, the terms of the legal obligation must require the consumer to make payments of principal and interest, on a monthly or other periodic basis, that will fully repay the loan amount over the loan term. The periodic payments must be substantially equal except for the effect that any interest rate change after consummation has on the payment in the case of an adjustable-rate or step-rate mortgage. In addition, because § 1026.43(e)(2)(i) requires that a qualified mortgage provide for regular periodic payments, a single-payment transaction may not be a qualified mortgage. 2. Deferral of principal repayment. Under § 1026.43(e)(2)(i)(B), a qualified mortgage’s regular periodic payments may not allow the consumer to defer repayment of principal, except as provided in § 1026.43(f). A loan allows the deferral of principal repayment if one or more of the periodic payments may be applied solely to accrued interest and not to loan principal. Deferred principal repayment also occurs if the payment is applied to both accrued interest and principal but the consumer is permitted to make periodic payments that are less than the amount that would be required under a payment schedule that has substantially equal payments that fully repay the loan amount over the loan term. Graduated payment mortgages, for E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations example, allow deferral of principal repayment in this manner and therefore may not be qualified mortgages. Paragraph 43(e)(2)(ii). 1. General. The 30-year term limitation in § 1026.43(e)(2)(ii) is applied without regard to any interim period between consummation and the beginning of the first full unit period of the repayment schedule. For example, assume a covered transaction is consummated on March 20, 2014 and the due date of the first regular periodic payment is April 30, 2014. The beginning of the first full unit period of the repayment schedule is April 1, 2014 and the loan term therefore ends on April 1, 2044. The transaction would comply with the 30-year term limitation in § 1026.43(e)(2)(ii). Paragraph 43(e)(2)(iv). 1. Maximum interest rate during the first five years. For a qualified mortgage, the creditor must underwrite the loan using a periodic payment of principal and interest based on the maximum interest rate that may apply during the first five years after the date on which the first regular periodic payment will be due. Creditors must use the maximum rate that could apply at any time during the first five years after the date on which the first regular periodic payment will be due, regardless of whether the maximum rate is reached at the first or subsequent adjustment during the five year period. 2. Fixed-rate mortgage. For a fixed-rate mortgage, creditors should use the interest rate in effect at consummation. ‘‘Fixed-rate mortgage’’ is defined in § 1026.18(s)(7)(iii). 3. Interest rate adjustment caps. For an adjustable-rate mortgage, creditors should assume the interest rate increases after consummation as rapidly as possible, taking into account the terms of the legal obligation. That is, creditors should account for any periodic interest rate adjustment cap that may limit how quickly the interest rate can increase under the terms of the legal obligation. Where a range for the maximum interest rate during the first five years is provided, the highest rate in that range is the maximum interest rate for purposes of § 1026.43(e)(2)(iv). Where the terms of the legal obligation are not based on an index plus margin or formula, the creditor must use the maximum interest rate that occurs during the first five years after the date on which the first regular periodic payment will be due. To illustrate: i. Adjustable-rate mortgage with discount for three years. Assume an adjustable-rate mortgage has an initial discounted rate of 5 percent that is fixed for the first three years, measured from the first day of the first full calendar month following consummation, after which the rate will adjust annually based on a specified index plus a margin of 3 percent. The index value in effect at consummation is 4.5 percent. The loan agreement provides for an annual interest rate adjustment cap of 2 percent, and a lifetime maximum interest rate of 12 percent. The first rate adjustment occurs on the due date of the 36th monthly payment; the rate can adjust to no more than 7 percent (5 percent initial discounted rate plus 2 percent annual interest rate adjustment cap). The second rate adjustment occurs on the due VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 date of the 48th monthly payment; the rate can adjust to no more than 9 percent (7 percent rate plus 2 percent annual interest rate adjustment cap). The third rate adjustment occurs on the due date of the 60th monthly payment; the rate can adjust to no more than 11 percent (9 percent rate plus 2 percent annual interest rate cap adjustment). The maximum interest rate during the first five years after the date on which the first regular periodic payment will be due is 11 percent (the rate on the due date of the 60th monthly payment). For further discussion of how to determine whether a rate adjustment occurs during the first five years after the date on which the first regular periodic payment will be due, see comment 43(e)(2)(iv)–7. ii. Adjustable-rate mortgage with discount for three years. Assume the same facts as in paragraph 3.i except that the lifetime maximum interest rate is 10 percent, which is less than the maximum interest rate in the first five years after the date on which the first regular periodic payment will be due of 11 percent that would apply but for the lifetime maximum interest rate. The maximum interest rate during the first five years after the date on which the first regular periodic payment will be due is 10 percent. iii. Step-rate mortgage. Assume a step-rate mortgage with an interest rate fixed at 6.5 percent for the first two years, measured from the first day of the first full calendar month following consummation, 7 percent for the next three years, and then 7.5 percent for the remainder of the loan term. The maximum interest rate during the first five years after the date on which the first regular periodic payment will be due is 7.5 percent. 4. First five years after the date on which the first regular periodic payment will be due. Under § 1026.43(e)(2)(iv)(A), the creditor must underwrite the loan using the maximum interest rate that may apply during the first five years after the date on which the first regular periodic payment will be due. To illustrate, assume an adjustable-rate mortgage with an initial fixed interest rate of 5 percent for the first five years, measured from the first day of the first full calendar month following consummation, after which the interest rate will adjust annually to the specified index plus a margin of 6 percent, subject to a 2 percent annual interest rate adjustment cap. The index value in effect at consummation is 5.5 percent. The loan consummates on September 15, 2014, and the first monthly payment is due on November 1, 2014. The first rate adjustment to no more than 7 percent (5 percent plus 2 percent annual interest rate adjustment cap) occurs on the due date of the 60th monthly payment, which is October 1, 2019, and therefore, the rate adjustment occurs during the first five years after the date on which the first regular periodic payment will be due. To meet the definition of qualified mortgage under § 1026.43(e)(2), the creditor must underwrite the loan using a monthly payment of principal and interest based on an interest rate of 7 percent. 5. Loan amount. To meet the definition of qualified mortgage under § 1026.43(e)(2), a creditor must determine the periodic payment of principal and interest using the PO 00000 Frm 00209 Fmt 4701 Sfmt 4700 6615 maximum interest rate permitted during the first five years after the date on which the first regular periodic payment will be due that repays either: i. The outstanding principal balance as of the earliest date the maximum interest rate during the first five years after the date on which the first regular periodic payment will be due can take effect under the terms of the legal obligation, over the remaining term of the loan. To illustrate, assume a loan in an amount of $200,000 has a 30-year loan term. The loan agreement provides for a discounted interest rate of 5 percent that is fixed for an initial period of three years, measured from the first day of the first full calendar month following consummation, after which the interest rate will adjust annually based on a specified index plus a margin of 3 percent, subject to a 2 percent annual interest rate adjustment cap and a lifetime maximum interest rate of 9 percent. The index value in effect at consummation equals 4.5 percent. Assuming the interest rate increases after consummation as quickly as possible, the rate adjustment to the lifetime maximum interest rate of 9 percent occurs on the due date of the 48th monthly payment. The outstanding principal balance on the loan at the end of the fourth year (after the 48th monthly payment is credited) is $188,218. The creditor will meet the definition of qualified mortgage if it underwrites the covered transaction using the monthly payment of principal and interest of $1,564 to repay the outstanding principal balance of $188,218 over the remaining 26 years of the loan term (312 months) using the maximum interest rate during the first five years of 9 percent; or ii. The loan amount, as that term is defined in § 1026.43(b)(5), over the entire loan term, as that term is defined in § 1026.43(b)(6). Using the same example above, the creditor will meet the definition of qualified mortgage if it underwrites the covered transaction using the monthly payment of principal and interest of $1,609 to repay the loan amount of $200,000 over the 30-year loan term using the maximum interest rate during the first five years of 9 percent. 6. Mortgage-related obligations. Section 1026.43(e)(2)(iv) requires creditors to take the consumer’s monthly payment for mortgagerelated obligations into account when underwriting the loan. For the meaning of the term ‘‘mortgage-related obligations,’’ see § 1026.43(b)(8) and associated commentary. 7. Examples. The following are examples of how to determine the periodic payment of principal and interest based on the maximum interest rate during the first five years after the date on which the first regular periodic payment will be due for purposes of meeting the definition of qualified mortgage under § 1026.43(e) (all payment amounts shown are rounded, and all amounts are calculated using non-rounded values; all initial fixed interest rate periods are measured from the first day of the first full calendar month following consummation): i. Fixed-rate mortgage. A loan in an amount of $200,000 has a 30-year loan term and a fixed interest rate of 7 percent. The maximum interest rate during the first five years after the date on which the first regular E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6616 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations periodic payment will be due for a fixed-rate mortgage is the interest rate in effect at consummation, which is 7 percent under this example. The monthly fully amortizing payment scheduled over the 30 years is $1,331. The creditor will meet the definition of qualified mortgage if it underwrites the loan using the fully amortizing payment of $1,331. ii. Adjustable-rate mortgage with discount for three years. A. A loan in an amount of $200,000 has a 30-year loan term. The loan agreement provides for a discounted interest rate of 5 percent that is fixed for an initial period of three years, after which the interest rate will adjust annually based on a specified index plus a margin of 3 percent, subject to a 2 percent annual interest rate adjustment cap and a lifetime maximum interest rate of 9 percent. The index value in effect at consummation is 4.5 percent. The loan is consummated on March 15, 2014, and the first regular periodic payment is due May 1, 2014. The loan agreement provides that the first rate adjustment occurs on April 1, 2017 (the due date of the 36th monthly payment); the second rate adjustment occurs on April 1, 2018 (the due date of the 48th monthly payment); and the third rate adjustment occurs on April 1, 2019 (the due date of the 60th monthly payment). Under this example, the maximum interest rate during the first five years after the date on which the first regular periodic payment due is 9 percent (the lifetime interest rate cap), which applies beginning on April 1, 2018 (the due date of the 48th monthly payment). The outstanding principal balance at the end of the fourth year (after the 48th payment is credited) is $188,218. B. The transaction will meet the definition of a qualified mortgage if the creditor underwrites the loan using the monthly payment of principal and interest of $1,564 to repay the outstanding principal balance at the end of the fourth year of $188,218 over the remaining 26 years of the loan term (312 months), using the maximum interest rate during the first five years after the date on which the first regular periodic payment will be due of 9 percent. Alternatively, the transaction will meet the definition of a qualified mortgage if the creditor underwrites the loan using the monthly payment of principal and interest of $1,609 to repay the loan amount of $200,000 over the 30-year loan term, using the maximum interest rate during the first five years after the date on which the first regular periodic payment will be due of 9 percent. iii. Adjustable-rate mortgage with discount for five years. A. A loan in an amount of $200,000 has a 30-year loan term. The loan agreement provides for a discounted interest rate of 6 percent that is fixed for an initial period of five years, after which the interest rate will adjust annually based on a specified index plus a margin of 3 percent, subject to a 2 percent annual interest rate adjustment cap. The index value in effect at consummation is 4.5 percent. The loan consummates on March 15, 2014 and the first regular periodic payment is due May 1, 2014. Under the terms of the loan agreement, the first rate adjustment to no more than 8 percent (6 percent plus 2 percent annual VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 interest rate adjustment cap) is on April 1, 2019 (the due date of the 60th monthly payment), which occurs less than five years after the date on which the first regular periodic payment will be due. Thus, the maximum interest rate under the terms of the loan during the first five years after the date on which the first regular periodic payment will be due is 8 percent. B. The transaction will meet the definition of a qualified mortgage if the creditor underwrites the loan using the monthly payment of principal and interest of $1,436 to repay the outstanding principal balance at the end of the fifth year of $186,109 over the remaining 25 years of the loan term (300 months), using the maximum interest rate during the first five years after the date on which the first regular periodic payment will be due of 8 percent. Alternatively, the transaction will meet the definition of a qualified mortgage if the creditor underwrites the loan using the monthly payment of principal and interest of $1,468 to repay the loan amount of $200,000 over the 30-year loan term, using the maximum interest rate during the first five years after the date on which the first regular periodic payment will be due of 8 percent. iv. Adjustable-rate mortgage with discount for seven years. A. A loan in an amount of $200,000 has a 30-year loan term. The loan agreement provides for a discounted interest rate of 6 percent that is fixed for an initial period of seven years, after which the interest rate will adjust annually based on a specified index plus a margin of 3 percent, subject to a 2 percent annual interest rate adjustment cap. The index value in effect at consummation is 4.5 percent. The loan is consummated on March 15, 2014, and the first regular periodic payment is due May 1, 2014. Under the terms of the loan agreement, the first rate adjustment is on April 1, 2021 (the due date of the 84th monthly payment), which occurs more than five years after the date on which the first regular periodic payment will be due. Thus, the maximum interest rate under the terms of the loan during the first five years after the date on which the first regular periodic payment will be due is 6 percent. B. The transaction will meet the definition of a qualified mortgage if the creditor underwrites the loan using the monthly payment of principal and interest of $1,199 to repay the loan amount of $200,000 over the 30-year loan term using the maximum interest rate during the first five years after the date on which the first regular periodic payment will be due of 6 percent. iv. Step-rate mortgage. A. A loan in an amount of $200,000 has a 30-year loan term. The loan agreement provides that the interest rate is 6.5 percent for the first two years of the loan, 7 percent for the next three years, and then 7.5 percent for remainder of the loan term. The maximum interest rate during the first five years after the date on which the first regular periodic payment will be due is 7.5 percent, which occurs on the due date of the 60th monthly payment. The outstanding principal balance at the end of the fifth year (after the 60th payment is credited) is $187,868. B. The transaction will meet the definition of a qualified mortgage if the creditor PO 00000 Frm 00210 Fmt 4701 Sfmt 4700 underwrites the loan using a monthly payment of principal and interest of $1,388 to repay the outstanding principal balance of $187,868 over the remaining 25 years of the loan term (300 months), using the maximum interest rate during the first five years after the date on which the first regular periodic payment will be due of 7.5 percent. Alternatively, the transaction will meet the definition of a qualified mortgage if the creditor underwrites the loan using a monthly payment of principal and interest of $1,398 to repay $200,000 over the 30-year loan term using the maximum interest rate during the first five years after the date on which the first regular periodic payment will be due of 7.5 percent. Paragraph 43(e)(2)(v). 1. General. For guidance on satisfying § 1026.43(e)(2)(v), a creditor may rely on commentary to § 1026.43(c)(2)(i) and (vi), (c)(3), and (c)(4). 2. Income or assets. Section 1026.43(e)(2)(v)(A) requires creditors to consider and verify the consumer’s current or reasonably expected income or assets. For purposes of this requirement, the creditor must consider and verify, at a minimum, any income specified in appendix Q. A creditor may also consider and verify any other income in accordance with § 1026.43(c)(2)(i) and (c)(4); however, such income would not be included in the total monthly debt-toincome ratio determination required by § 1026.43(e)(2)(vi). 3. Debts. Section 1026.43(e)(2)(v)(B) requires creditors to consider and verify the consumer’s current debt obligations, alimony, and child support. For purposes of this requirement, the creditor must consider and verify, at a minimum, any debt or liability specified in appendix Q. A creditor may also consider and verify other debt in accordance with § 1026.43(c)(2)(vi) and (c)(3); however, such debt would not be included in the total monthly debt-to-income ratio determination required by § 1026.43(e)(2)(vi). Paragraph 43(e)(2)(vi). 1. Calculation of monthly payment on the covered transaction and simultaneous loans. As provided in appendix Q, for purposes of § 1026.43(e)(2)(vi), creditors must include in the definition of ‘‘debt’’ a consumer’s monthly housing expense. This includes, for example, the consumer’s monthly payment on the covered transaction (including mortgage-related obligations) and on simultaneous loans. Accordingly, § 1026.43(e)(2)(vi)(B) provides the method by which a creditor calculates the consumer’s monthly payment on the covered transaction and on any simultaneous loan that the creditor knows or has reason to know will be made. 43(e)(3) Limits on points and fees for qualified mortgages. Paragraph 43(e)(3)(i). 1. Total loan amount. The term ‘‘total loan amount’’ is defined in § 1026.32(b)(4)(i). For an explanation of how to calculate the ‘‘total loan amount’’ under § 1026.43(e)(3)(i), see comment 32(b)(4)(i)–1. 2. Calculation of allowable points and fees. A creditor must determine which category the loan falls into based on the face amount E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations of the note (the ‘‘loan amount’’ as defined in § 1026.43(b)(5)). For categories with a percentage limit, the creditor must apply the allowable points and fees percentage to the ‘‘total loan amount,’’ which may be different than the loan amount. A creditor must calculate the allowable amount of points and fees for a qualified mortgage as follows: i. First, the creditor must determine the ‘‘tier’’ into which the loan falls based on the loan amount. The loan amount is the principal amount the consumer will borrow, as reflected in the promissory note or loan contract. See § 1026.43(b)(5). For example, if the loan amount is $55,000, the loan falls into the tier for loans greater than or equal to $20,000 but less than $60,000, to which a 5 percent cap on points and fees applies. For tiers with a prescribed dollar limit on points and fees (e.g., for loans from $60,000 up to $100,000, the limit is $3,000), the creditor does not need to do any further calculations. ii. Second, for tiers with a percentage limit, the creditor must determine the total loan amount based on the calculation for the total loan amount under comment 32(b)(4)(i)–1. If the loan amount is $55,000, for example, the total loan amount may be a different amount, such as $52,000. iii. Third, the creditor must apply the percentage cap on points and fees to the total loan amount. For example, for a loan of $55,000 where the total loan amount is $52,000, the allowable points and fees are 5 percent of $52,000, or $2,600. 3. Sample determination of allowable points and fees. i. A covered transaction with a loan amount of $105,000 falls into the first points and fees tier, to which a points and fees cap of 3 percent of the total loan amount applies. See § 1026.43(e)(3)(i)(A). Therefore, if the calculation under comment 32(b)(4)(i)–1 results in a total loan amount of $102,000, then the allowable total points and fees for this loan are 3 percent of $102,000, or $3,060. ii. A covered transaction with a loan amount of $75,000 falls into the second points and fees tier, to which a points and fees cap of $3,000 applies. See § 1026.43(e)(3)(i)(B). The allowable total points and fees for this loan are $3,000, regardless of the total loan amount. iii. A covered transaction with a loan amount of $50,000 falls into the third points and fees tier, to which a points and fees cap of 5 percent of the total loan amount applies. See § 1026.43(e)(3)(i)(C). Therefore, if the calculation under comment 32(b)(4)(i)–1 results in a total loan amount of $48,000, then the allowable total points and fees for this loan are 5 percent of $48,000, or $2,400. iv. A covered transaction with a loan amount of $15,000 falls into the fourth points and fees tier, to which a points and fees cap of $1,000 applies. See § 1026.43(e)(3)(i)(D). The allowable total points and fees for this loan are $1,000, regardless of the total loan amount. v. A covered transaction with a loan amount of $10,000 falls into the fifth points and fees tier, to which a points and fees cap of 8 percent of the total loan amount applies. See § 1026.43(e)(3)(i)(E). Therefore, if the calculation under comment 32(b)(4)(i)–1 results in a total loan amount of $7,000, then VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 the allowable total points and fees for this loan are 8 percent of $7,000, or $560. Paragraph 43(e)(3)(ii). 1. Annual adjustment for inflation. The dollar amounts, including the loan amounts, in § 1026.43(e)(3)(i) will be adjusted annually on January 1 by the annual percentage change in the CPI–U that was in effect on the preceding June 1. The Bureau will publish adjustments after the June figures become available each year. 43(e)(4) Qualified mortgage defined— special rules. 1. Alternative definition. Subject to the sunset provided under § 1026.43(e)(4)(iii), § 1026.43(e)(4) provides an alternative definition of qualified mortgage to the definition provided in § 1026.43(e)(2). To be a qualified mortgage under § 1026.43(e)(4), the creditor must satisfy the requirements under § 1026.43(e)(2)(i) through (iii), in addition to being one of the types of loans specified in § 1026.43(e)(4)(ii)(A) through (E). 2. Termination of conservatorship. Section 1026.43(e)(4)(ii)(A) requires that a covered transaction be eligible for purchase or guarantee by the Federal National Mortgage Association (‘‘Fannie Mae’’) or the Federal Home Loan Mortgage Corporation (‘‘Freddie Mac’’) (or any limited-life regulatory entity succeeding the charter of either) operating under the conservatorship or receivership of the Federal Housing Finance Agency pursuant to section 1367 of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (12 U.S.C. 4617). The special rule under § 1026.43(e)(4)(ii)(A) does not apply if Fannie Mae or Freddie Mac (or any limited-life regulatory entity succeeding the charter of either) has ceased operating under the conservatorship or receivership of the Federal Housing Finance Agency. For example, if either Fannie Mae or Freddie Mac (or succeeding limited-life regulatory entity) ceases to operate under the conservatorship or receivership of the Federal Housing Finance Agency, § 1026.43(e)(4)(ii)(A) would no longer apply to loans eligible for purchase or guarantee by that entity; however, the special rule would be available for a loan that is eligible for purchase or guarantee by the other entity still operating under conservatorship or receivership. 3. Timing. Under § 1026.43(e)(4)(iii), the definition of qualified mortgage under paragraph (e)(4) applies only to loans consummated on or before January 10, 2021, regardless of whether Fannie Mae or Freddie Mac (or any limited-life regulatory entity succeeding the charter of either) continues to operate under the conservatorship or receivership of the Federal Housing Finance Agency. Accordingly, § 1026.43(e)(4) is available only for covered transactions consummated on or before the earlier of either: i. The date Fannie Mae or Freddie Mac (or any limited-life regulatory entity succeeding the charter of either), respectively, cease to operate under the conservatorship or receivership of the Federal Housing Finance Agency pursuant to section 1367 of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (12 U.S.C. 4617); or ii. January 10, 2021, as provided by § 1026.43(e)(4)(iii). PO 00000 Frm 00211 Fmt 4701 Sfmt 4700 6617 4. Eligible for purchase, guarantee, or insurance. To satisfy § 1026.43(e)(4)(ii), a loan need not be actually purchased or guaranteed by Fannie Mae or Freddie Mac or insured or guaranteed by the U.S. Department of Housing and Urban Development, U.S. Department of Veterans Affairs, U.S. Department of Agriculture, or Rural Housing Service. Rather, § 1026.43(e)(4)(ii) requires only that the loan be eligible (i.e., meet the criteria) for such purchase, guarantee, or insurance. For example, for purposes of § 1026.43(e)(4), a creditor is not required to sell a loan to Fannie Mae or Freddie Mac (or any limitedlife regulatory entity succeeding the charter of either) to be a qualified mortgage; however, the loan must be eligible for purchase or guarantee by Fannie Mae or Freddie Mac (or any limited-life regulatory entity succeeding the charter of either), including satisfying any requirements regarding consideration and verification of a consumer’s income or assets, credit history, and debt-to-income ratio or residual income. To determine eligibility, a creditor may rely on an underwriting recommendation provided by Fannie Mae or Freddie Mac’s Automated Underwriting Systems (AUSs) or written guide in effect at the time. Accordingly, a covered transaction is eligible for purchase or guarantee by Fannie Mae or Freddie Mac if: i. The loan conforms to the standards set forth in the Fannie Mae Single-Family Selling Guide or the Freddie Mac SingleFamily Seller/Servicer Guide; or ii. The loan receives one of the following recommendations from the corresponding automated underwriting system: A. An ‘‘Approve/Eligible’’ recommendation from Desktop Underwriter (DU); or B. An ‘‘Accept and Eligible to Purchase’’ recommendation from Loan Prospector (LP). 43(f) Balloon-Payment qualified mortgages made by certain creditors. 43(f)(1) Exemption. Paragraph 43(f)(1)(i). 1. Satisfaction of qualified mortgage requirements. Under § 1026.43(f)(1)(i), for a mortgage that provides for a balloon payment to be a qualified mortgage, the mortgage must satisfy the requirements for a qualified mortgage in paragraphs (e)(2)(i)(A), (e)(2)(ii), (iii), and (v). Therefore, a covered transaction with balloon payment terms must provide for regular periodic payments that do not result in an increase of the principal balance, pursuant to § 1026.43(e)(2)(i)(A); must have a loan term that does not exceed 30 years, pursuant to § 1026.43(e)(2)(ii); must have total points and fees that do not exceed specified thresholds pursuant to § 1026.43(e)(2)(iii); and must satisfy the consideration and verification requirements in § 1026.43(e)(2)(v). Paragraph 43(f)(1)(ii). 1. Example. Under § 1026.43(f)(1)(ii), if a qualified mortgage provides for a balloon payment, the creditor must determine that the consumer is able to make all scheduled payments under the legal obligation other than the balloon payment. For example, assume a loan in an amount of $200,000 that has a five-year loan term, but is amortized E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with 6618 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations over 30 years. The loan agreement provides for a fixed interest rate of 6 percent. The loan consummates on March 3, 2014, and the monthly payment of principal and interest scheduled for the first five years is $1,199, with the first monthly payment due on April 1, 2014. The balloon payment of $187,308 is required on the due date of the 60th monthly payment, which is April 1, 2019. The loan can be a qualified mortgage if the creditor underwrites the loan using the scheduled principal and interest payment of $1,199, plus the consumer’s monthly payment for all mortgage-related obligations, and satisfies the other criteria set forth in § 1026.43(f). 2. Creditor’s determination. A creditor must determine that the consumer is able to make all scheduled payments other than the balloon payment to satisfy § 1026.43(f)(1)(ii), in accordance with the legal obligation, together with the consumer’s monthly payments for all mortgage-related obligations and excluding the balloon payment, to meet the repayment ability requirements of § 1026.43(f)(1)(ii). A creditor satisfies § 1026.43(f)(1)(ii) if it uses the maximum payment in the payment schedule, excluding any balloon payment, to determine if the consumer has the ability to make the scheduled payments. Paragraph 43(f)(1)(iii). 1. Debt-to-income or residual income. A creditor must consider and verify the consumer’s monthly debt-to-income ratio or residual income to meet the requirements of § 1026.43(f)(1)(iii). To calculate the consumer’s monthly debt-to-income or residual income for purposes of § 1026.43(f)(1)(iii), the creditor may rely on the definitions and calculation rules in § 1026.43(c)(7) and its accompanying commentary, except for the calculation rules for a consumer’s total monthly debt obligations (which is a component of debt-toincome and residual income under § 1026.43(c)(7)). For purposes of calculating the consumer’s total monthly debt obligations under § 1026.43(f)(1)(iii), the creditor must calculate the monthly payment on the covered transaction using the payment calculation rules in § 1026.43(f)(1)(iv)(A), together with all mortgage-related obligations and excluding the balloon payment. Paragraph 43(f)(1)(iv). 1. Scheduled payments. Under § 1026.43(f)(1)(iv)(A), the legal obligation must provide that scheduled payments must be substantially equal and determined using an amortization period that does not exceed 30 years. Balloon payments often result when the periodic payment would fully repay the loan amount only if made over some period that is longer than the loan term. For example, a loan term of 10 years with periodic payments based on an amortization period of 20 years would result in a balloon payment being due at the end of the loan term. Whatever the loan term, the amortization period used to determine the scheduled periodic payments that the consumer must pay under the terms of the legal obligation may not exceed 30 years. 2. Substantially equal. The calculation of payments scheduled by the legal obligation under § 1026.43(f)(1)(iv)(A) are required to result in substantially equal amounts. This VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 means that the scheduled payments need to be similar, but need not be equal. For further guidance on substantially equal payments, see comment 43(c)(5)(i)–4. 3. Interest-only payments. A mortgage that only requires the payment of accrued interest each month does not meet the requirements of § 1026.43(f)(1)(iv)(A). Paragraph 43(f)(1)(v). 1. Forward commitments. A creditor may make a mortgage loan that will be transferred or sold to a purchaser pursuant to an agreement that has been entered into at or before the time the transaction is consummated. Such an agreement is sometimes known as a ‘‘forward commitment.’’ A balloon-payment mortgage that will be acquired by a purchaser pursuant to a forward commitment does not satisfy the requirements of § 1026.43(f)(1)(v), whether the forward commitment provides for the purchase and sale of the specific transaction or for the purchase and sale of transactions with certain prescribed criteria that the transaction meets. However, a purchase and sale of a balloon-payment qualified mortgage to another person that separately meets the requirements of § 1026.43(f)(1)(vi) is permitted. For example: assume a creditor that meets the requirements of § 1026.43(f)(1)(vi) makes a balloon-payment mortgage that meets the requirements of § 1026.43(f)(1)(i) through (iv); if the balloonpayment mortgage meets the purchase criteria of an investor with which the creditor has an agreement to sell such loans after consummation, then the balloon-payment mortgage does not meet the definition of a qualified mortgage in accordance with § 1026.43(f)(1)(v). However, if the investor meets the requirement of § 1026.43(f)(1)(vi), the balloon-payment qualified mortgage retains its qualified mortgage status. Paragraph 43(f)(1)(vi). 1. Creditor qualifications. Under § 1026.43(f)(1)(vi), to make a qualified mortgage that provides for a balloon payment, the creditor must satisfy three criteria that are also required under § 1026.35(b)(2)(iii)(A), (B) and (C), which require: i. During the preceding calendar year, the creditor extended over 50 percent of its total first-lien covered transactions, as defined in § 1026.43(b)(1), on properties that are located in counties that are designated either ‘‘rural’’ or ‘‘underserved,’’ as defined in § 1026.35(b)(2)(iv), to satisfy the requirement of § 1026.35(b)(2)(iii)(A). Pursuant to § 1026.35(b)(2)(iv), a county is considered to be rural if it is neither in a metropolitan statistical area, nor a micropolitan statistical area adjacent to a metropolitan statistical area, as those terms are defined by the U.S. Office of Management and Budget. A county is considered to be underserved if no more than two creditors extend covered transactions secured by a first lien five or more times in that county during a calendar year. The Bureau determines annually which counties in the United States are rural or underserved and publishes on its public Web site lists of those counties to enable creditors to determine whether they meet this criterion. Thus, for example, if a creditor originated 90 first-lien covered transactions PO 00000 Frm 00212 Fmt 4701 Sfmt 4700 during 2013, the creditor meets this element of the exception in 2014 if at least 46 of those transactions are secured by first liens on properties located in one or more counties that are on the Bureau’s lists for 2013. ii. During the preceding calendar year, the creditor together with its affiliates originated 500 or fewer first-lien covered transactions, as defined by § 1026.43(b)(1), to satisfy the requirement of § 1026.35(b)(2)(iii)(B). iii. As of the end of the preceding calendar year, the creditor had total assets that do not exceed the current asset threshold established by the Bureau, to satisfy the requirement of § 1026.35(b)(2)(iii)(C). For calendar year 2013, the asset threshold was $2,000,000,000. 43(f)(2) Post-consummation transfer of balloon-payment qualified mortgage. 1. Requirement to hold in portfolio. Creditors generally must hold a balloonpayment qualified mortgage in portfolio to maintain the transaction’s status as a qualified mortgage under § 1026.43(f)(1), subject to four exceptions. Unless one of these exceptions applies, a balloon-payment qualified mortgage is no longer a qualified mortgage under § 1026.43(f)(1) once legal title to the debt obligation is sold, assigned, or otherwise transferred to another person. Accordingly, unless one of the exceptions applies, the transferee could not benefit from the presumption of compliance for qualified mortgages under § 1026.43(f)(1) unless the loan also met the requirements of another qualified mortgage definition. 2. Application to subsequent transferees. The exceptions contained in § 1026.43(f)(2) apply not only to an initial sale, assignment, or other transfer by the originating creditor but to subsequent sales, assignments, and other transfers as well. For example, assume Creditor A originates a qualified mortgage under § 1026.43(f)(1). Six months after consummation, Creditor A sells the qualified mortgage to Creditor B pursuant to § 1026.43(f)(2)(ii) and the loan retains its qualified mortgage status because Creditor B complies with the limits on operating predominantly in rural or underserved areas, asset size, and number of transactions. If Creditor B sells the qualified mortgage, it will lose its qualified mortgage status under § 1026.43(f)(1) unless the sale qualifies for one of the § 1026.43(f)(2) exceptions for sales three or more years after consummation, to another qualifying institution, as required by supervisory action, or pursuant to a merger or acquisition. Paragraph 43(f)(2)(i). 1. Transfer three years after consummation. Under § 1026.43(f)(2)(i), if a balloon-payment qualified mortgage under § 1026.43(f)(1) is sold, assigned, or otherwise transferred three years or more after consummation, the balloon-payment qualified mortgage retains its status as a qualified mortgage under § 1026.43(f)(1) following the sale. The transferee need not be eligible to originate qualified mortgages under § 1026.43(f)(1)(vi). The balloonpayment qualified mortgage will continue to be a qualified mortgage throughout its life, and the transferee, and any subsequent transferees, may invoke the presumption of compliance for qualified mortgages under § 1026.43(f)(1). E:\FR\FM\30JAR2.SGM 30JAR2 sroberts on DSK5SPTVN1PROD with Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations Paragraph 43(f)(2)(ii). 1. Transfer to another qualifying creditor. Under § 1026.43(f)(2)(ii), a balloon-payment qualified mortgage under § 1026.43(f)(1) may be sold, assigned, or otherwise transferred at any time to another creditor that meets the requirements of § 1026.43(f)(1)(vi). That section requires that a creditor: (1) Operate predominantly in a rural or underserved area during the preceding calendar year; (2) during the preceding calendar year, together with all affiliates, originated 500 or fewer first-lien covered transactions; and (3) had total assets less than $2 billion (as adjusted for inflation) at the end of the preceding calendar year. A balloon-payment qualified mortgage under § 1026.43(f)(1) transferred to a creditor that meets these criteria would retain its qualified mortgage status even if it is transferred less than three years after consummation. Paragraph 43(f)(2)(iii). 1. Supervisory sales. Section 1026.43(f)(2)(iii) facilitates sales that are deemed necessary by supervisory agencies to revive troubled creditors and resolve failed creditors. A balloon-payment qualified mortgage under § 1026.43(f)(1) retains its qualified mortgage status if it is sold, assigned, or otherwise transferred to another person pursuant to: (1) A capital restoration plan or other action under 12 U.S.C. 1831o; (2) the actions or instructions of any person acting as conservator, receiver, or bankruptcy trustee; (3) an order of a State or Federal government agency with jurisdiction to examine the creditor pursuant to State or Federal law; or (4) an agreement between the creditor and such an agency. A balloonpayment qualified mortgage under § 1026.43(f)(1) that is sold, assigned, or otherwise transferred under these circumstances retains its qualified mortgage status regardless of how long after consummation it is sold and regardless of the size or other characteristics of the transferee. Section 1026.43(f)(2)(iii) does not apply to transfers done to comply with a generally applicable regulation with future effect designed to implement, interpret, or prescribe law or policy in the absence of a specific order by or a specific agreement with a governmental agency described in § 1026.43(f)(2)(iii) directing the sale of one or more qualified mortgages under § 1026.43(f)(1) held by the creditor or one of the other circumstances listed in § 1026.43(f)(2)(iii). For example, a balloonpayment qualified mortgage under § 1026.43(f)(1) that is sold pursuant to a capital restoration plan under 12 U.S.C. 1831o would retain its status as a qualified mortgage following the sale. However, if the creditor simply chose to sell the same qualified mortgage as one way to comply with general regulatory capital requirements in the absence of supervisory action or agreement it would lose its status as a qualified mortgage following the sale unless it qualifies under another definition of qualified mortgage. Paragraph 43(f)(2)(iv). 1. Mergers and acquisitions. A qualified mortgage under § 1026.43(f)(1) retains its qualified mortgage status if a creditor merges with, is acquired by another person, or VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 acquires another person regardless of whether the creditor or its successor is eligible to originate new balloon-payment qualified mortgages under § 1026.43(f)(1) after the merger or acquisition. However, the creditor or its successor can originate new balloon-payment qualified mortgages under § 1026.43(f)(1) only if it complies with all of the requirements of § 1026.43(f)(1) after the merger or acquisition. For example, assume a small creditor that originates 250 first-lien covered transactions each year and originates balloon-payment qualified mortgages under § 1026.43(f)(1) is acquired by a larger creditor that originates 10,000 first-lien covered transactions each year. Following the acquisition, the small creditor would no longer be able to originate balloon-payment qualified mortgages because, together with its affiliates, it would originate more than 500 first-lien covered transactions each year. However, the balloon-payment qualified mortgages originated by the small creditor before the acquisition would retain their qualified mortgage status. 43(g) Prepayment penalties. 43(g)(2) Limits on prepayment penalties. 1. Maximum period and amount. Section 1026.43(g)(2) establishes the maximum period during which a prepayment penalty may be imposed and the maximum amount of the prepayment penalty. A covered transaction may include a prepayment penalty that may be imposed during a shorter period or in a lower amount than provided under § 1026.43(g)(2). For example, a covered transaction may include a prepayment penalty that may be imposed for two years after consummation and that equals 1 percent of the amount prepaid in each of those two years. 43(g)(3) Alternative offer required. Paragraph 43(g)(3)(i). 1. Same type of interest rate. Under § 1026.43(g)(3)(i), if a creditor offers a consumer a covered transaction with a prepayment penalty, the creditor must offer the consumer an alternative covered transaction without a prepayment penalty and with an annual percentage rate that cannot increase after consummation. Under § 1026.43(g)(3)(i), if the covered transaction with a prepayment penalty is a fixed-rate mortgage, as defined in § 1026.18(s)(7)(iii), then the alternative covered transaction without a prepayment penalty must also be a fixed-rate mortgage. Likewise, if the covered transaction with a prepayment penalty is a step-rate mortgage, as defined in § 1026.18(s)(7)(ii), then the alternative covered transaction without a prepayment penalty must also be a step-rate mortgage. Paragraph 43(g)(3)(iv). 1. Points and fees. Whether or not an alternative covered transaction without a prepayment penalty satisfies the points and fees conditions for a qualified mortgage is determined based on the information known to the creditor at the time the creditor offers the consumer the transaction. At the time a creditor offers a consumer an alternative covered transaction without a prepayment penalty under § 1026.43(g)(3), the creditor may know the amount of some, but not all, of the points and fees that will be charged for the transaction. For example, a creditor may PO 00000 Frm 00213 Fmt 4701 Sfmt 4700 6619 not know that a consumer intends to buy single-premium credit unemployment insurance, which would be included in the points and fees for the covered transaction. The points and fees condition under § 1026.43(g)(3)(iv) is satisfied if a creditor reasonably believes, based on information known to the creditor at the time the offer is made, that the amount of points and fees to be charged for an alternative covered transaction without a prepayment penalty will be less than or equal to the amount of points and fees allowed for a qualified mortgage under § 1026.43(e)(2)(iii). Paragraph 43(g)(3)(v). 1. Transactions for which the consumer likely qualifies. Under § 1026.43(g)(3)(v), the alternative covered transaction without a prepayment penalty the creditor must offer under § 1026.43(g)(3) must be a transaction for which the creditor has a good faith belief the consumer likely qualifies. For example, assume the creditor has a good faith belief the consumer can afford monthly payments of up to $800. If the creditor offers the consumer a fixed-rate mortgage with a prepayment penalty for which monthly payments are $700 and an alternative covered transaction without a prepayment penalty for which monthly payments are $900, the requirements of § 1026.43(g)(3)(v) are not met. The creditor’s belief that the consumer likely qualifies for the covered transaction without a prepayment penalty should be based on the information known to the creditor at the time the creditor offers the transaction. In making this determination, the creditor may rely on information provided by the consumer, even if the information subsequently is determined to be inaccurate. 43(g)(4) Offer through a mortgage broker. 1. Rate sheet. Under § 1026.43(g)(4), where the creditor offers covered transactions with a prepayment penalty to consumers through a mortgage broker, as defined in § 1026.36(a)(2), the creditor must present the mortgage broker an alternative covered transaction that satisfies the requirements of § 1026.43(g)(3). Creditors may comply with this requirement by providing a rate sheet to the mortgage broker that states the terms of such an alternative covered transaction without a prepayment penalty. 2. Alternative to creditor’s offer. Section 1026.43(g)(4)(ii) requires that the creditor provide, by agreement, for the mortgage broker to present the consumer an alternative covered transaction that satisfies the requirements of § 1026.43(g)(3) offered by either the creditor or by another creditor, if the other creditor offers a covered transaction with a lower interest rate or a lower total dollar amount of discount points and origination points or fees. The agreement may provide for the mortgage broker to present both the creditor’s covered transaction and an alternative covered transaction offered by another creditor with a lower interest rate or a lower total dollar amount of origination discount points and points or fees. See comment 36(e)(3)–3 for guidance in determining which step-rate mortgage has a lower interest rate. 3. Agreement. The creditor’s agreement with a mortgage broker for purposes of E:\FR\FM\30JAR2.SGM 30JAR2 6620 Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 / Rules and Regulations sroberts on DSK5SPTVN1PROD with § 1026.43(g)(4) may be part of another agreement with the mortgage broker, for example, a compensation agreement. Thus, the creditor need not enter into a separate agreement with the mortgage broker with respect to each covered transaction with a prepayment penalty. 43(g)(5) Creditor that is a loan originator. 1. Loan originator. The definition of ‘‘loan originator’’ in § 1026.36(a)(1) applies for purposes of § 1026.43(g)(5). Thus, a loan originator includes any creditor that satisfies the definition of loan originator but makes use of ‘‘table-funding’’ by a third party. See comment 36(a)–1.i and ii. VerDate Mar<15>2010 20:04 Jan 29, 2013 Jkt 229001 2. Lower interest rate. Under § 1026.43(g)(5), a creditor that is a loan originator must present an alternative covered transaction without a prepayment penalty that satisfies the requirements of § 1026.43(g)(3) offered by either the assignee for the covered transaction or another person, if that other person offers a transaction with a lower interest rate or a lower total dollar amount of origination points or fees or discount points. See comment 36(e)(3)–3 for guidance in determining which step-rate mortgage has a lower interest rate. 43(h) Evasion; open-end credit. PO 00000 Frm 00214 Fmt 4701 Sfmt 9990 1. Subject to closed-end credit rules. Where a creditor documents a loan as open-end credit but the features and terms, or other circumstances, demonstrate that the loan does not meet the definition of open-end credit in § 1026.2(a)(20), the loan is subject to the rules for closed-end credit, including § 1026.43. Dated: January 10, 2013. Richard Cordray, Director, Bureau of Consumer Financial Protection. [FR Doc. 2013–00736 Filed 1–16–13; 11:15 am] BILLING CODE 4810–AM–P E:\FR\FM\30JAR2.SGM 30JAR2

Agencies

BUREAU OF CONSUMER FINANCIAL PROTECTION

[Federal Register Volume 78, Number 20 (Wednesday, January 30, 2013)]
[Rules and Regulations]
[Pages 6407-6620]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-00736]

[[Page 6407]]

Vol. 78

Wednesday,

No. 20

January 30, 2013

Part II

Bureau of Consumer Financial Protection

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12 CFR Part 1026

Ability-to-Repay and Qualified Mortgage Standards under the Truth in
Lending Act (Regulation Z); Final Rule

Federal Register / Vol. 78, No. 20 / Wednesday, January 30, 2013 /
Rules and Regulations

[[Page 6408]]

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BUREAU OF CONSUMER FINANCIAL PROTECTION

12 CFR Part 1026

[CFPB-2011-0008; CFPB-2012-0022]
RIN 3170-AA17

Ability-to-Repay and Qualified Mortgage Standards Under the Truth
in Lending Act (Regulation Z)

AGENCY: Bureau of Consumer Financial Protection.

ACTION: Final rule; official interpretations.

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SUMMARY: The Bureau of Consumer Financial Protection (Bureau) is
amending Regulation Z, which implements the Truth in Lending Act
(TILA). 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 final rule implements sections 1411 and 1412 of the
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank
Act), which generally require creditors to make a reasonable, good
faith determination of a consumer's ability to repay any consumer
credit transaction secured by a dwelling (excluding an open-end credit
plan, timeshare plan, reverse mortgage, or temporary loan) and
establishes certain protections from liability under this requirement
for ``qualified mortgages.'' The final rule also implements section
1414 of the Dodd-Frank Act, which limits prepayment penalties. Finally,
the final rule requires creditors to retain evidence of compliance with
the rule for three years after a covered loan is consummated.

DATES: The rule is effective January 10, 2014.

FOR FURTHER INFORMATION CONTACT: Joseph Devlin, Gregory Evans, David
Friend, Jennifer Kozma, Eamonn K. Moran, or Priscilla Walton-Fein,
Counsels; Thomas J. Kearney or Mark Morelli, Senior Counsels; or
Stephen Shin, Managing Counsel, Office of Regulations, at (202) 435-
7700.

SUPPLEMENTARY INFORMATION:

I. Summary of the Final Rule

The Consumer Financial Protection Bureau (Bureau) is issuing a
final rule to implement laws requiring mortgage lenders to consider
consumers' ability to repay home loans before extending them credit.
The rule will take effect on January 10, 2014.
The Bureau is also releasing a proposal to seek comment on whether
to adjust the final rule for certain community-based lenders, housing
stabilization programs, certain refinancing programs of the Federal
National Mortgage Association (Fannie Mae) or the Federal Home Loan
Mortgage Corporation (Freddie Mac) (collectively, the GSEs) and Federal
agencies, and small portfolio creditors. The Bureau expects to finalize
the concurrent proposal this spring so that affected creditors can
prepare for the January 2014 effective date.

Background

During the years preceding the mortgage crisis, too many mortgages
were made to consumers without regard to the consumer's ability to
repay the loans. Loose underwriting practices by some creditors--
including failure to verify the consumer's income or debts and
qualifying consumers for mortgages based on ``teaser'' interest rates
that would cause monthly payments to jump to unaffordable levels after
the first few years--contributed to a mortgage crisis that led to the
nation's most serious recession since the Great Depression.
In response to this crisis, in 2008 the Federal Reserve Board
(Board) adopted a rule under the Truth in Lending Act which prohibits
creditors from making ``higher-price mortgage loans'' without assessing
consumers' ability to repay the loans. Under the Board's rule, a
creditor is presumed to have complied with the ability-to-repay
requirements if the creditor follows certain specified underwriting
practices. This rule has been in effect since October 2009.
In the 2010 Dodd-Frank Wall Street Reform and Consumer Protection
Act, Congress required that for residential mortgages, creditors must
make 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. Congress also established a
presumption of compliance for a certain category of mortgages, called
``qualified mortgages.'' These provisions are similar, but not
identical to, the Board's 2008 rule and cover the entire mortgage
market rather than simply higher-priced mortgages. The Board proposed a
rule to implement the new statutory requirements before authority
passed to the Bureau to finalize the rule.

Summary of Final Rule

The final rule contains the following key elements:
Ability-to-Repay Determinations. The final rule describes certain
minimum requirements for creditors making ability-to-repay
determinations, but does not dictate that they follow particular
underwriting models. At a minimum, creditors generally must consider
eight underwriting factors: (1) Current or reasonably expected income
or assets; (2) current employment status; (3) the monthly payment on
the covered transaction; (4) the monthly payment on any simultaneous
loan; (5) the monthly payment for mortgage-related obligations; (6)
current debt obligations, alimony, and child support; (7) the monthly
debt-to-income ratio or residual income; and (8) credit history.
Creditors must generally use reasonably reliable third-party records to
verify the information they use to evaluate the factors.
The rule provides guidance as to the application of these factors
under the statute. For example, monthly payments must generally be
calculated by assuming that the loan is repaid in substantially equal
monthly payments during its term. For adjustable-rate mortgages, the
monthly payment must be calculated using the fully indexed rate or an
introductory rate, whichever is higher. Special payment calculation
rules apply for loans with balloon payments, interest-only payments, or
negative amortization.
The final rule also provides special rules to encourage creditors
to refinance ``non-standard mortgages''--which include various types of
mortgages which can lead to payment shock that can result in default--
into ``standard mortgages'' with fixed rates for at least five years
that reduce consumers' monthly payments.
Presumption for Qualified Mortgages. The Dodd-Frank Act provides
that ``qualified mortgages'' are entitled to a presumption that the
creditor making the loan satisfied the ability-to-repay requirements.
However, the Act did not specify whether the presumption of compliance
is conclusive (i.e., creates a safe harbor) or is rebuttable. The final
rule provides a safe harbor for loans that satisfy the definition of a
qualified mortgage and are not ``higher-priced,'' as generally defined
by the Board's 2008 rule. The final rule provides a rebuttable
presumption for higher-priced mortgage loans, as described further
below.
The line the Bureau is drawing is one that has long been recognized
as a rule of thumb to separate prime loans from subprime loans. Indeed,
under the existing regulations that were adopted by the Board in 2008,
only higher-priced mortgage loans are subject to an ability-to-repay
requirement and a rebuttable presumption of compliance if creditors
follow certain requirements. The new rule strengthens the requirements
needed to qualify for a rebuttable presumption for subprime loans and

[[Page 6409]]

defines with more particularity the grounds for rebutting the
presumption. Specifically, the final rule provides that consumers may
show a violation with regard to a subprime qualified mortgage by
showing that, at the time the loan was originated, the consumer's
income and debt obligations left insufficient residual income or assets
to meet living expenses. The analysis would consider the consumer's
monthly payments on the loan, loan-related obligations, and any
simultaneous loans of which the creditor was aware, as well as any
recurring, material living expenses of which the creditor was aware.
Guidance accompanying the rule notes that the longer the period of time
that the consumer has demonstrated actual ability to repay the loan by
making timely payments, without modification or accommodation, after
consummation or, for an adjustable-rate mortgage, after recast, the
less likely the consumer will be able to rebut the presumption based on
insufficient residual income.
With respect to prime loans--which are not currently covered by the
Board's ability-to-repay rule--the final rule applies the new ability-
to-repay requirements but creates a strong presumption for those prime
loans that constitute qualified mortgages. Thus, if a prime loan
satisfies the qualified mortgage criteria described below, it will be
conclusively presumed that the creditor made a good faith and
reasonable determination of the consumer's ability to repay.
General Requirements for Qualified Mortgages. The Dodd-Frank Act
sets certain product-feature prerequisites and affordability
underwriting requirements for qualified mortgages and vests discretion
in the Bureau to decide whether additional underwriting or other
requirements should apply. The final rule implements the statutory
criteria, which generally prohibit loans with negative amortization,
interest-only payments, balloon payments, or terms exceeding 30 years
from being qualified mortgages. So-called ``no-doc'' loans where the
creditor does not verify income or assets also cannot be qualified
mortgages. Finally, a loan generally cannot be a qualified mortgage if
the points and fees paid by the consumer exceed three percent of the
total loan amount, although certain ``bona fide discount points'' are
excluded for prime loans. The rule provides guidance on the calculation
of points and fees and thresholds for smaller loans.
The final rule also establishes general underwriting criteria for
qualified mortgages. Most importantly, the general rule requires that
monthly payments be calculated based on the highest payment that will
apply in the first five years of the loan and that the consumer have a
total (or ``back-end'') debt-to-income ratio that is less than or equal
to 43 percent. The appendix to the rule details the calculation of
debt-to-income for these purposes, drawing upon Federal Housing
Administration guidelines for such calculations. The Bureau believes
that these criteria will protect consumers by ensuring that creditors
use a set of underwriting requirements that generally safeguard
affordability. At the same time, these criteria provide bright lines
for creditors who want to make qualified mortgages.
The Bureau also believes that there are many instances in which
individual consumers can afford a debt-to-income ratio above 43 percent
based on their particular circumstances, but that such loans are better
evaluated on an individual basis under the ability-to-repay criteria
rather than with a blanket presumption. In light of the fragile state
of the mortgage market as a result of the recent mortgage crisis,
however, the Bureau is concerned that creditors may initially be
reluctant to make loans that are not qualified mortgages, even though
they are responsibly underwritten. The final rule therefore provides
for a second, temporary category of qualified mortgages that have more
flexible underwriting requirements so long as they satisfy the general
product feature prerequisites for a qualified mortgage and also satisfy
the underwriting requirements of, and are therefore eligible to be
purchased, guaranteed or insured by either (1) the GSEs while they
operate under Federal conservatorship or receivership; or (2) the U.S.
Department of Housing and Urban Development, Department of Veterans
Affairs, or Department of Agriculture or Rural Housing Service. This
temporary provision will phase out over time as the various Federal
agencies issue their own qualified mortgage rules and if GSE
conservatorship ends, and in any event after seven years.
Rural Balloon-Payment Qualified Mortgages. The final rule also
implements a special provision in the Dodd-Frank Act that would treat
certain balloon-payment mortgages as qualified mortgages if they are
originated and held in portfolio by small creditors operating
predominantly in rural or underserved areas. This provision is designed
to assure credit availability in rural areas, where some creditors may
only offer balloon-payment mortgages. Loans are only eligible if they
have a term of at least five years, a fixed-interest rate, and meet
certain basic underwriting standards; debt-to-income ratios must be
considered but are not subject to the 43 percent general requirement.
Creditors are only eligible to make rural balloon-payment qualified
mortgages if they originate at least 50 percent of their first-lien
mortgages in counties that are rural or underserved, have less than $2
billion in assets, and (along with their affiliates) originate no more
than 500 first-lien mortgages per year. The Bureau will designate a
list of ``rural'' and ``underserved'' counties each year, and has
defined coverage more broadly than originally had been proposed.
Creditors must generally hold the loans on their portfolios for three
years in order to maintain their ``qualified mortgage'' status.
Other Final Rule Provisions. The final rule also implements Dodd-
Frank Act provisions that generally prohibit prepayment penalties
except for certain fixed-rate, qualified mortgages where the penalties
satisfy certain restrictions and the creditor has offered the consumer
an alternative loan without such penalties. To match with certain
statutory changes, the final rule also lengthens to three years 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
that does not meet the definition of open-end credit as an open-end
plan.

Summary of Concurrent Proposal

The concurrent proposal seeks comment on whether the general
ability-to-repay and qualified mortgage rule should be modified to
address potential adverse consequences on certain narrowly-defined
categories of lending programs. Because those measures were not
proposed by the Board originally, the Bureau believes additional public
input would be helpful. Specifically, the proposal seeks comment on
whether it would be appropriate to exempt designated non-profit
lenders, homeownership stabilization programs, and certain Federal
agency and GSE refinancing programs from the ability-to-repay
requirements because they are subject to their own specialized
underwriting criteria.
The proposal also seeks comment on whether to create a new category
of qualified mortgages, similar to the one for rural balloon-payment
mortgages, for loans without balloon-payment features that are
originated and held on portfolio by small creditors. The new category
would not be limited to lenders that operate predominantly in rural or

[[Page 6410]]

underserved areas, but would use the same general size thresholds and
other criteria as the rural balloon-payment rules. The proposal also
seeks comment on whether to increase the threshold separating safe
harbor and rebuttable presumption qualified mortgages for both rural
balloon-payment qualified mortgages and the new small portfolio
qualified mortgages, in light of the fact that small creditors often
have higher costs of funds than larger creditors. Specifically, the
Bureau is proposing a threshold of 3.5 percentage points above APOR for
first-lien loans.

II. Background

For over 20 years, consumer advocates, legislators, and regulators
have raised concerns 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
foreclosure rates increased dramatically, caused in part by the
loosening of underwriting standards. See 73 FR 44524 (July 30, 2008).
The following discussion provides background information, including a
brief summary of the legislative and regulatory responses to the
foregoing concerns, which culminated in the enactment of the Dodd-Frank
Act on July 21, 2010, the Board's May 11, 2011, proposed rule to
implement certain amendments to TILA made by the Dodd-Frank Act, and
now the Bureau's issuance of this final rule to implement sections
1411, 1412, and 1414 of that act.

A. The Mortgage Market

Overview of the Market and the Mortgage Crisis
The mortgage market is the single largest market for consumer
financial products and services in the United States, with
approximately $9.9 trillion in mortgage loans outstanding.\1\ During
the last decade, the market went through an unprecedented cycle of
expansion and contraction that was fueled in part by the securitization
of mortgages and creation of increasingly sophisticated derivative
products. So many other parts of the American financial system were
drawn into mortgage-related activities that, when the housing market
collapsed in 2008, it sparked the most severe recession in the United
States since the Great Depression.\2\
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\1\ Fed. Reserve Sys., Flow of Funds Accounts of the United
States, at 67 tbl.L.10 (2012), available at https://www.federalreserve.gov/releases/z1/Current/z1.pdf (as of the end of
the third quarter of 2012).
\2\ See Thomas F. Siems, Branding the Great Recession, Fin.
Insights (Fed. Reserve Bank of Dall.) May 13, 2012, at 3, available
at https://www.dallasfed.org/assets/documents/banking/firm/fi/fi1201.pdf (stating that the [great recession] ``was the longest and
deepest economic contraction, as measured by the drop in real GDP,
since the Great Depression.'').
---------------------------------------------------------------------------

The expansion in this market is commonly attributed to both
particular economic conditions (including an era of low interest rates
and rising housing prices) and to changes within the industry. Interest
rates dropped significantly--by more than 20 percent--from 2000 through
2003.\3\ Housing prices increased dramatically--about 152 percent--
between 1997 and 2006.\4\ Driven by the decrease in interest rates and
the increase in housing prices, the volume of refinancings increased
rapidly, from about 2.5 million loans in 2000 to more than 15 million
in 2003.\5\
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\3\ See U.S. Dep't of Hous. & Urban Dev., An Analysis of
Mortgage Refinancing, 2001-2003, at 2 (2004) (``An Analysis of
Mortgage Refinancing, 2001-2003''), available at www.huduser.org/Publications/pdf/MortgageRefinance03.pdf; Souphala Chomsisengphet &
Anthony Pennington-Cross, The Evolution of the Subprime Mortgage
Market, 88 Fed. Res. Bank of St. Louis Rev. 31, 48 (2006), available
at https://research.stlouisfed.org/publications/review/article/5019.
\4\ U.S. Fin. Crisis Inquiry Comm'n, The Financial Crisis
Inquiry Report: Final Report of the National Commission on the
Causes of the Financial and Economic Crisis in the United States 156
(Official Gov't ed. 2011) (``FCIC Report''), available at https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.
\5\ An Analysis of Mortgage Refinancing, 2001-2003, at 1.
---------------------------------------------------------------------------

In the mid-2000s, the market experienced a steady deterioration of
credit standards in mortgage lending, with evidence that loans were
made solely against collateral, or even against expected increases in
the value of collateral, and without consideration of ability to repay.
This deterioration of credit standards was particularly evidenced by
the growth of ``subprime'' and ``Alt-A'' products, which consumers were
often unable to repay.\6\ Subprime products were sold primarily to
consumers with poor or no credit history, although there is evidence
that some consumers who would have qualified for ``prime'' loans were
steered into subprime loans as well.\7\ The Alt-A category of loans
permitted consumers to take out mortgage loans while providing little
or no documentation of income or other evidence of repayment ability.
Because these loans involved additional risk, they were typically more
expensive to consumers than ``prime'' mortgages, although many of them
had very low introductory interest rates. In 2003, subprime and Alt-A
origination volume was about $400 billion; in 2006, it had reached $830
billion.\8\
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\6\ FCIC Report at 88. These products included most notably 2/28
and 3/27 hybrid adjustable rate mortgages (ARMs) and option ARM
products. Id. at 106. A hybrid ARM is an adjustable rate mortgage
loan that has a low fixed introductory rate for a certain period of
time. An option ARM is an adjustable rate mortgage loan that has a
scheduled loan payment that may result in negative amortization for
a certain period of time, but that expressly permits specified
larger payments in the contract or servicing documents, such as an
interest-only payment or a fully amortizing payment. For these
loans, the scheduled negatively amortizing payment was typically
described in marketing and servicing materials as the ``optional
payment.'' These products were often marketed to subprime customers.
\7\ For example, the Federal Reserve Board on July 18, 2011,
issued a consent cease and desist order and assessed an $85 million
civil money penalty against Wells Fargo & Company of San Francisco,
a registered bank holding company, and Wells Fargo Financial, Inc.,
of Des Moines. The order addresses allegations that Wells Fargo
Financial employees steered potential prime-eligible consumers into
more costly subprime loans and separately falsified income
information in mortgage applications. In addition to the civil money
penalty, the order requires that Wells Fargo compensate affected
consumers. See Press Release, Fed. Reserve Bd. (July 20, 2011),
available at https://www.federalreserve.gov/newsevents/press/enforcement/20110720a.htm.
\8\ Inside Mortg. Fin., Mortgage Originations by Product, in 1.
The 2011 Mortgage Market Statistical Annual 20 (2011).
---------------------------------------------------------------------------

So long as housing prices were continuing to increase, it was
relatively easy for consumers to refinance their existing loans into
more affordable products to avoid interest rate resets and other
adjustments. When housing prices began to decline in 2005, however,
refinancing became more difficult and delinquency rates on subprime and
Alt-A products increased dramatically.\9\ More and more consumers,
especially those with subprime and Alt-A loans, were unable or
unwilling to make their mortgage payments. An early sign of the
mortgage crisis was an upswing in early payment defaults--generally
defined as borrowers being 60 or more days delinquent within the first
year. Prior to 2006, 1.1 percent of mortgages would end up 60 or more
days delinquent within the first two years.\10\ Taking a more expansive
definition of early payment default to include 60 days delinquent
within the first two years, this figure was double the historic average
during 2006, 2007 and 2008.\11\ In 2006, 2007, and 2008, 2.3 percent,
2.1 percent, and 2.3 percent of mortgages ended up 60 or more days
delinquent within the first two years, respectively. By the summer of
2006, 1.5 percent of loans less than a year old were in

[[Page 6411]]

default, and this figure peaked at 2.5 percent in late 2007, well above
the 1.0 percent peak in the 2000 recession.\12\ First payment
defaults--mortgages taken out by consumers who never made a single
payment--exceeded 1.5 percent of loans in early 2007.\13\ In addition,
as the economy worsened, the rates of serious delinquency (90 or more
days past due or in foreclosure) for the subprime and Alt-A products
began a steep increase from approximately 10 percent in 2006, to 20
percent in 2007, to more than 40 percent in 2010.\14\
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\9\ FCIC Report at 215-217.
\10\ CoreLogic's TrueStandings Servicing (reflects first-lien
mortgage loans) (data service accessible only through paid
subscription).
\11\ Id.
\12\ Id. at 215. (CoreLogic Chief Economist Mark Fleming told
the FCIC that the early payment default rate ``certainly correlates
with the increase in the Alt-A and subprime shares and the turn of
the housing market and the sensitivity of those loan products.'').
\13\ Id.
\14\ Id. at 217.
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The impact of this level of delinquencies was severe on creditors
who held loans on their books and on private investors who purchased
loans directly or through securitized vehicles. Prior to and during the
bubble, the evolution of the securitization of mortgages attracted
increasing involvement from financial institutions that were not
directly involved in the extension of credit to consumers and from
investors worldwide. Securitization of mortgages allows originating
creditors to sell off their loans (and reinvest the funds earned in
making new ones) to investors who want an income stream over time.
Securitization had been pioneered by what are now called government-
sponsored enterprises (GSEs), including the Federal National Mortgage
Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation
(Freddie Mac). But by the early 2000s, large numbers of private
financial institutions were deeply involved in creating increasingly
complex mortgage-related investment vehicles through securities and
derivative products. The private securitization-backed subprime and
Alt-A mortgage market ground to a halt in 2007 in the face of the
rising delinquencies on subprime and Alt-A products.\15\
---------------------------------------------------------------------------

\15\ Id. at 124.
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Six years later, the United States continues to grapple with the
fallout. The fall in housing prices is estimated to have resulted in
about $7 trillion in household wealth losses.\16\ In addition,
distressed homeownership and foreclosure rates remain at unprecedented
levels.\17\
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\16\ The U.S. Housing Market: Current Conditions and Policy
Considerations, at 3 (Fed. Reserve Bd., White Paper, 2012),
available at https://www.federalreserve.gov/publications/other-reports/files/housing-white-paper-20120104.pdf.
\17\ Lender Processing Servs., PowerPoint Presentation, LPS
Mortgage Monitor: May 2012 Mortgage Performance Observations, Data
as of April 2012 Month End, 3, 11 (May 2012), available at https://www.lpsvcs.com/LPSCorporateInformation/CommunicationCenter/DataReports/Pages/Mortgage-Monitor.aspx.
---------------------------------------------------------------------------

Response and Government Programs
In light of these conditions, the Federal government began
providing support to the mortgage markets in 2008 and continues to do
so at extraordinary levels today. The Housing and Economic Recovery Act
of 2008, which became effective on October 1, 2008, provided both new
safeguards and increased regulation for Fannie Mae and Freddie Mac, as
well as provisions to assist troubled borrowers and to the hardest hit
communities. Fannie Mae and Freddie Mac, which supported the mainstream
mortgage market, experienced heavy losses and were placed in
conservatorship by the Federal government in 2008 to support the
collapsing mortgage market.\18\ Because private investors have
withdrawn from the mortgage securitization market and there are no
other effective secondary market mechanisms in place, the GSEs'
continued operations help ensure that the secondary mortgage market
continues to function and to assist consumers in obtaining new
mortgages or refinancing existing mortgages. The Troubled Asset Relief
Program (TARP), created to implement programs to stabilize the
financial system during the financial crisis, was authorized through
the Emergency Economic Stabilization Act of 2008 (EESA), as amended by
the American Recovery and Reinvestment Act of 2009, and includes
programs to help struggling homeowners avoid foreclosure.\19\ Since
2008, several other Federal government efforts have endeavored to keep
the country's housing finance system functioning, including the
Treasury Department's and the Federal Reserve System's mortgage-backed
securities (MBS) purchase programs to help keep interest rates low and
the Federal Housing Administration's (FHA's) increased market presence.
As a result, mortgage credit has remained available, albeit with more
restrictive underwriting terms that limit or preclude some consumers'
access to credit. These same government agencies together with the GSEs
and other market participants have also undertaken a series of efforts
to help families avoid foreclosure through loan-modification programs,
loan-refinance programs and foreclosure alternatives.\20\
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\18\ The Housing and Economic Recovery Act of 2008 (HERA), which
created the Federal Housing Finance Agency (FHFA), granted the
Director of FHFA discretionary authority to appoint FHFA conservator
or receiver of the Enterprises ``for the purpose of reorganizing,
rehabilitating, or winding up the affairs of a regulated entity.''
Housing and Economic Recovery Act of 2008, section 1367 (a)(2),
amending the Federal Housing Enterprises Financial Safety and
Soundness Act of 1992, 12 U.S.C. 4617(a)(2). On September 6, 2008,
FHFA exercised that authority, placing the Federal National Mortgage
Association (Fannie Mae) and the Federal Home Loan Mortgage
Corporation (Freddie Mac) into conservatorships. The two GSEs have
since received more than $180 billion in support from the Treasury
Department. Through the second quarter of 2012, Fannie Mae has drawn
$116.1 billion and Freddie Mac has drawn $71.3 billion, for an
aggregate draw of $187.5 billion from the Treasury Department. Fed.
Hous. Fin. Agency, Conservator's Report on the Enterprises'
Financial Performance, at 17 (Second Quarter 2012), available at
https://www.fhfa.gov/webfiles/24549/ConservatorsReport2Q2012.pdf.
\19\ The Making Home Affordable Program (MHA) is the umbrella
program for Treasury's homeowner assistance and foreclosure
mitigation efforts. The main MHA components are the Home Affordable
Modification Program (HAMP), a Treasury program that uses TARP funds
to provide incentives for mortgage servicers to modify eligible
first-lien mortgages, and two initiatives at the GSEs that use non-
TARP funds. Incentive payments for modifications to loans owned or
guaranteed by the GSEs are paid by the GSEs, not TARP. Treasury over
time expanded MHA to include sub-programs designed to overcome
obstacles to sustainable HAMP modifications. Treasury also allocated
TARP funds to support two additional housing support efforts: An FHA
refinancing program and TARP funding for 19 state housing finance
agencies, called the Housing Finance Agency Hardest Hit Fund. In the
first half of 2012, Treasury extended the application period for
HAMP by a year to December 31, 2013, and opened HAMP to non-owner-
occupied rental properties and to consumers with a wider range of
debt-to-income ratios under ``HAMP Tier 2.''
\20\ The Home Affordable Refinance Program (HARP) is designed to
help eligible homeowners refinance their mortgage. HARP is designed
for those homeowners who are current on their mortgage payments but
have been unable to get traditional refinancing because the value of
their homes has declined. For a mortgage to be considered for a HARP
refinance, it must be owned or guaranteed by the GSEs. HARP ends on
December 31, 2013.
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Size and Volume of the Current Mortgage Origination Market
Even with the economic downturn and tightening of credit standards,
approximately $1.28 trillion in mortgage loans were originated in
2011.\21\ In exchange for an extension of mortgage credit, consumers
promise to make regular mortgage payments and provide their home or
real property as collateral. The overwhelming majority of homebuyers
continue to use mortgage loans to finance at least some of the

[[Page 6412]]

purchase price of their property. In 2011, 93 percent of all home
purchases were financed with a mortgage credit transaction.\22\
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\21\ Moody's Analytics, Credit Forecast 2012 (2012) (``Credit
Forecast 2012''), available at https://www.economy.com/default.asp
(reflects first-lien mortgage loans) (data service accessibly only
through paid subscription).
\22\ Inside Mortg. Fin., New Homes Sold by Financing, in 1 The
2012 Mortgage Market Statistical Annual 12 (2012).
---------------------------------------------------------------------------

Consumers may obtain mortgage credit to purchase a home, to
refinance an existing mortgage, to access home equity, or to finance
home improvement. Purchase loans and refinancings together produced 6.3
million new first-lien mortgage loan originations in 2011.\23\ The
proportion of loans that are for purchases as opposed to refinances
varies with the interest rate environment and other market factors. In
2011, 65 percent of the market was refinance transactions and 35
percent was purchase loans, by volume.\24\ Historically the
distribution has been more even. In 2000, refinances accounted for 44
percent of the market while purchase loans comprised 56 percent; in
2005, the two products were split evenly.\25\
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\23\ Credit Forecast 2012.
\24\ Inside Mortg. Fin., Mortgage Originations by Product, in
The 2012 Mortgage Market Statistical Annual 17 (2012).
\25\ Id. These percentages are based on the dollar amount of the
loans.
---------------------------------------------------------------------------

With a home equity transaction, a homeowner uses his or her equity
as collateral to secure consumer credit. The credit proceeds can be
used, for example, to pay for home improvements. Home equity credit
transactions and home equity lines of credit resulted in an additional
1.3 million mortgage loan originations in 2011.\26\
---------------------------------------------------------------------------

\26\ Credit Forecast (2012) (reflects open-end and closed-end
home equity loans).
---------------------------------------------------------------------------

The market for higher-priced mortgage loans remains significant.
Data reported under the Home Mortgage Disclosure Act (HMDA) show that
in 2011 approximately 332,000 transactions, including subordinate
liens, were reportable as higher-priced mortgage loans. Of these
transactions, refinancings accounted for approximately 44 percent of
the higher-priced mortgage loan market, and 90 percent of the overall
higher-priced mortgage loan market involved first-lien transactions.
The median first-lien higher-priced mortgage loan was for $81,000,
while the interquartile range (quarter of the transactions are below,
quarter of the transactions are above) was $47,000 to $142,000.
GSE-eligible loans, together with the other federally insured or
guaranteed loans, cover the majority of the current mortgage market.
Since entering conservatorship in September 2008, the GSEs have bought
or guaranteed roughly three of every four mortgages originated in the
country. Mortgages guaranteed by FHA make up most of the rest.\27\
Outside of the securitization available through the Government National
Mortgage Association (Ginnie Mae) for loans primarily backed by FHA,
there are very few alternatives in place today to assume the secondary
market functions served by the GSEs.\28\
---------------------------------------------------------------------------

\27\ Fed. Hous. Fin. Agency, A Strategic Plan for Enterprise
Conservatorships: The Next Chapter in a Story that Needs an Ending,
at 14 (2012) (``FHFA Report''), available at https://www.fhfa.gov/webfiles/23344/StrategicPlanConservatorshipsFINAL.pdf.
\28\ FHFA Report at 8-9. Secondary market issuance remains
heavily reliant upon the explicitly government guaranteed securities
of FNMA, FHLMC, and GNMA. Through the first three quarters of 2012,
approximately $1.2 trillion of the $1.33 trillion in mortgage
originations have been securitized, less than $10 billion of the
$1.2 trillion were non-agency mortgage backed securities. Inside
Mortgage Finance (Nov. 2, 2012), at 4.
---------------------------------------------------------------------------

Continued Fragility of the Mortgage Market
The current mortgage market is especially fragile as a result of
the recent mortgage crisis. Tight credit remains an important factor in
the contraction in mortgage lending seen over the past few years.
Mortgage loan terms and credit standards have tightened most for
consumers with lower credit scores and with less money available for a
down payment. According to CoreLogic's TrueStandings Servicing, a
proprietary data service that covers about two-thirds of the mortgage
market, average underwriting standards have tightened considerably
since 2007. Through the first nine months of 2012, for consumers that
have received closed-end first-lien mortgages, the weighted average
FICO \29\ score was 750, the loan-to-value (LTV) ratio was 78 percent,
and the debt-to-income (DTI) ratio was 34.5 percent.\30\ In comparison,
in the peak of the housing bubble in 2007, the weighted average FICO
score was 706, the LTV was 80 percent, and the DTI was 39.8
percent.\31\
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\29\ FICO is a type of credit score that makes up a substantial
portion of the credit report that lenders use to assess an
applicant's credit risk and whether to extend a loan
\30\ CoreLogic, TrueStandings Servicing Database, available at
https://www.truestandings.com (data reflects first-lien mortgage
loans) (data service accessible only through paid subscription).
According to CoreLogic's TrueStandings Servicing, FICO reports that
in 2011, approximately 38 percent of consumers receiving first-lien
mortgage credit had a FICO score of 750 or greater.
\31\ Id.
---------------------------------------------------------------------------

In this tight credit environment, the data suggest that creditors
are not willing to take significant risks. In terms of the distribution
of origination characteristics, for 90 percent of all the Fannie Mae
and Freddie Mac mortgage loans originated in 2011, consumers had a FICO
score over 700 and a DTI less than 44 percent.\32\ According to the
Federal Reserve's Senior Loan Officer Opinion Survey on Bank Lending
Practices, in April 2012 nearly 60 percent of creditors reported that
they would be much less likely, relative to 2006, to originate a
conforming home-purchase mortgage \33\ to a consumer with a 10 percent
down payment and a credit score of 620--a traditional marker for those
consumers with weaker credit histories.\34\ The Federal Reserve Board
calculates that the share of mortgage borrowers with credit scores
below 620 has fallen from about 17 percent of consumers at the end of
2006 to about 5 percent more recently.\35\ Creditors also appear to
have pulled back on offering these consumers loans insured by the FHA,
which provides mortgage insurance on loans made by FHA-approved
creditors throughout the United States and its territories and is
especially structured to help promote affordability.\36\
---------------------------------------------------------------------------

\32\ Id.
\33\ A conforming mortgage is one that is eligible for purchase
or credit guarantee by Fannie Mae or Freddie Mac.
\34\ Fed. Reserve Bd., Senior Loan Officer Opinion Survey on
Bank Lending Practices, available at https://www.federalreserve.gov/boarddocs/SnLoanSurvey/default.htm.
\35\ Federal Reserve Board staff calculations based on the
Federal Reserve Bank of New York Consumer Credit Panel. The 10th
percentile of credit scores on mortgage originations rose from 585
in 2006 to 635 at the end of 2011.
\36\ FHA insures mortgages on single family and multifamily
homes including manufactured homes and hospitals. It is the largest
insurer of mortgages in the world, insuring over 34 million
properties since its inception in 1934.
---------------------------------------------------------------------------

The Bureau is acutely aware of the high levels of anxiety in the
mortgage market today. These concerns include the continued slow pace
of recovery, the confluence of multiple major regulatory and capital
initiatives, and the compliance burdens of the various Dodd-Frank Act
rulemakings (including uncertainty on what constitutes a qualified
residential mortgage (QRM), which, as discussed below, relates to the
Dodd-Frank Act's credit risk retention requirements and mortgage
securitizations). These concerns are causing discussion about whether
creditors will consider exiting the business. The Bureau acknowledges
that it will likely take some time for the mortgage market to stabilize
and that creditors will need to adjust their operations to account for
several major regulatory and capital regimes.

B. TILA and Regulation Z

In 1968, Congress enacted the Truth in Lending Act (TILA), 15
U.S.C. 1601

[[Page 6413]]

et seq., based on findings that the informed use of credit resulting
from consumers' awareness of the cost of credit would enhance economic
stability and competition among consumer credit providers. One of the
purposes of TILA is to promote the informed use of consumer credit by
requiring disclosures about its costs and terms. See 15 U.S.C. 1601.
TILA requires additional disclosures for loans secured by consumers'
homes and permits consumers to rescind certain transactions secured by
their principal dwellings when the required disclosures are not
provided. 15 U.S.C. 1635, 1637a. Section 105(a) of TILA directs the
Bureau (formerly directed the Board of Governors of the Federal Reserve
System) to prescribe regulations to carry out TILA's purposes and
specifically authorizes the Bureau, 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 Bureau's judgment are necessary or proper to effectuate the
purposes of TILA, facilitate compliance thereof, or prevent
circumvention or evasion therewith. See 15 U.S.C. 1604(a).
General rulemaking authority for TILA transferred to the Bureau in
July 2011, other than for certain motor vehicle dealers in accordance
with the Dodd-Frank Act section 1029, 12 U.S.C. 5519. Pursuant to the
Dodd-Frank Act and TILA, as amended, the Bureau published for public
comment an interim final rule establishing a new Regulation Z, 12 CFR
part 1026, implementing TILA (except with respect to persons excluded
from the Bureau's rulemaking authority by section 1029 of the Dodd-
Frank Act). 76 FR 79768 (Dec. 22, 2011). This rule did not impose any
new substantive obligations but did make technical and conforming
changes to reflect the transfer of authority and certain other changes
made by the Dodd-Frank Act. The Bureau's Regulation Z took effect on
December 30, 2011. The Official Staff Interpretations interpret the
requirements of the regulation and provides guidance to creditors in
applying the rules to specific transactions. See 12 CFR part 1026,
Supp. I.

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

In response to evidence of abusive practices in the home-equity
lending market, in 1994 Congress amended TILA by enacting the Home
Ownership and Equity Protection Act (HOEPA) as part of the Riegle
Community Development and Regulatory Improvement Act of 1994. Public
Law 103-325, 108 Stat. 2160. HOEPA was enacted as an amendment to TILA
to address abusive practices in refinancing and home-equity mortgage
loans with high interest rates or high fees.\37\ Loans that meet
HOEPA's high-cost triggers are subject to special disclosure
requirements and restrictions on loan terms, and consumers with high-
cost mortgages have enhanced remedies for violations of the law.\38\
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\37\ HOEPA amended TILA by adding new sections 103(aa) and 129,
15 U.S.C. 1602(aa) and 1639.
\38\ 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. 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 Dodd-Frank Act
section 1431; TILA section 103(aa). For simplicity and consistency,
this final rule uses the term ``high-cost mortgages'' to refer to
mortgages covered by the HOEPA amendments.
---------------------------------------------------------------------------

The statute applied generally to closed-end mortgage credit, but
excluded purchase money mortgage loans and reverse mortgages. Coverage
was triggered where a loan's annual percentage rate (APR) exceeded
comparable Treasury securities by specified thresholds for particular
loan types, or where points and fees exceeded eight percent of the
total loan amount or a dollar threshold.\39\
---------------------------------------------------------------------------

\39\ The Dodd-Frank Act adjusted the baseline for the APR
comparison, lowered the points and fees threshold, and added a
prepayment trigger.
---------------------------------------------------------------------------

For high-cost loans meeting either of those thresholds, HOEPA
required creditors to provide special pre-closing disclosures,
restricted prepayment penalties and certain other loan terms, and
regulated various creditor practices, such as extending credit without
regard to a consumer's ability to repay the loan. HOEPA also provided a
mechanism for consumers to rescind covered loans that included certain
prohibited terms and to obtain higher damages than are allowed for
other types of TILA violations. Finally, HOEPA amended TILA section
131, 15
U.S.C. 1641, to provide that purchasers of high-cost loans
generally are subject to all claims and defenses against the original
creditor with respect to the mortgage, including a creditor's failure
to make an ability-to-repay determination before making the loan. HOEPA
created special substantive protections for high-cost mortgages, such
as 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, HOEPA expanded the Board's rulemaking authority, among other
things, to prohibit acts or practices the Board found to be unfair and
deceptive in connection with mortgage loans.\40\
---------------------------------------------------------------------------

\40\ As discussed above, with the enactment of the Dodd-Frank
Act, general rulemaking authority for TILA, including HOEPA,
transferred from the Board to the Bureau on July 21, 2011.
---------------------------------------------------------------------------

In 1995, the Board implemented the HOEPA amendments at Sec. Sec.
226.31, 226.32, and 226.33 \41\ of Regulation Z. See 60 FR 15463 (Mar.
24, 1995). In particular, Sec. 226.32(e)(1) \42\ implemented TILA
section 129(h)'s ability-to-repay requirements to prohibit a creditor
from engaging in a pattern or practice of extending a high-cost
mortgage based on the consumer's collateral without regard to the
consumer's repayment ability, including the consumer's current income,
current obligations, and employment status.
---------------------------------------------------------------------------

\41\ Subsequently renumbered as sections 1026.31, 1026.32, and
1026.33 of Regulation Z. As discussed above, pursuant to the Dodd-
Frank Act and TILA, as amended, the Bureau published for public
comment an interim final rule establishing a new Regulation Z, 12
CFR part 1026, implementing TILA (except with respect to persons
excluded from the Bureau's rulemaking authority by section 1029 of
the Dodd-Frank Act). 76 FR 79768 (Dec. 22, 2011). The Bureau's
Regulation Z took effect on December 30, 2011.
\42\ Subsequently renumbered as section 1026.32(e)(1) of
Regulation Z.
---------------------------------------------------------------------------

In 2001, the Board published additional significant changes to
expand both HOEPA's protections to more loans by revising the annual
percentage rate (APR) threshold for first-lien mortgage loans, expanded
the definition of points and fees to include the cost of optional
credit insurance and debt cancellation premiums, and enhanced the
restrictions associated with high-cost loans. See 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 consumer's repayment
ability.

[[Page 6414]]

D. 2006 and 2007 Interagency Supervisory Guidance

In December 2005, the Federal banking agencies \43\ 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 consumer to defer repayment of
principal and sometimes interest. The guidance advised institutions of
the need to reduce ``risk layering'' with respect to these products,
such as by failing to document income or lending nearly the full
appraised value of the home. The final guidance issued in September
2006 specifically advised creditors that layering risks in
nontraditional mortgage loans to consumers receiving subprime credit
may significantly increase risks to consumers as well as institutions.
See Interagency Guidance on Nontraditional Mortgage Product Risks, 71
FR 58609 (Oct. 4, 2006) (2006 Nontraditional Mortgage Guidance).
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\43\ Along with the Board, the other Federal banking agencies
included the Office of the Comptroller of the Currency (OCC), the
Federal Deposit Insurance Corporation (FDIC), Office of Thrift
Supervision (OTS), and the National Credit Union Administration
(NCUA).
---------------------------------------------------------------------------

The 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'' interest 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 consumers in the subprime market obtain loans they can afford to
repay. Among other steps, the guidance advised creditors: (1) To use
the fully indexed rate and fully-amortizing payment when qualifying
consumers for loans with adjustable rates and potentially non-
amortizing payments; (2) to limit stated income and reduced
documentation loans to cases where mitigating factors clearly minimize
the need for full documentation of income; and (3) to provide that
prepayment penalty clauses expire a reasonable period before reset,
typically at least 60 days. See Statement on Subprime Mortgage Lending,
72 FR 37569 (July 10, 2007) (2007 Subprime Mortgage Statement).\44\ 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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\44\ The 2006 Nontraditional Mortgage Guidance and the 2007
Subprime Mortgage Statement will hereinafter be referred to
collectively as the ``Interagency Supervisory Guidance.''
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E. 2008 HOEPA Final Rule

After the Board finalized the 2001 HOEPA rules, new consumer
protection issues arose in the mortgage market. 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 (July 30,
2008). The Board was also urged to adopt additional 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. As discussed above, in 1995 the Board
implemented TILA section 129(h)'s ability-to-repay requirements for
high-cost mortgage loans. In 2008, the Board exercised its authority
under HOEPA to extend certain consumer protections concerning a
consumer's ability to repay and prepayment penalties to a new category
of ``higher-priced mortgage loans'' (HPMLs) \45\ with APRs that are
lower than those prescribed for high-cost loans but that nevertheless
exceed the average prime offer rate by prescribed amounts. This new
category of loans was designed to include subprime credit.
Specifically, the Board exercised its authority to revise HOEPA's
restrictions on high-cost loans based on a conclusion that the
revisions were necessary to prevent unfair and deceptive acts or
practices in connection with mortgage loans. 73 FR 44522 (July 30,
2008) (2008 HOEPA Final Rule). The Board determined that imposing the
burden to prove ``pattern or practice'' on an individual consumer would
leave many consumers with a lesser remedy, such as those provided under
some State laws, or without any remedy for loans made without regard to
repayment ability. In particular, the Board concluded that a
prohibition on making individual loans without regard for repayment
ability was necessary to ensure a remedy for consumers who are given
unaffordable loans and to deter irresponsible lending, which injures
individual consumers. The 2008 HOEPA Final Rule provides a presumption
of compliance with the higher-priced mortgage ability-to-repay
requirements if the creditor follows certain procedures regarding
underwriting the loan payment, assessing the debt-to-income ratio or
residual income, and limiting the features of the loan, in addition to
following certain procedures mandated for all creditors. See Sec.
1026.34(a)(4)(iii) and (iv). However, the 2008 HOEPA Final Rule makes
clear that even if the creditor follows the required and optional
criteria, the creditor has merely obtained a presumption of compliance
with the repayment ability requirement. The consumer can still rebut or
overcome that presumption by showing that, despite following the
required and optional procedures, the creditor nonetheless disregarded
the consumer's ability the loan.
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\45\ Under the Board's 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. The definition of a ``higher-priced mortgage loan''
includes practically all ``high-cost mortgages'' because the latter
transactions are determined by higher loan pricing threshold tests.
See 12 CFR 226.35(a)(1), since codified in parallel by the Bureau at
12 CFR 1026.35(a)(1).
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F. The Dodd-Frank Act

In 2007, Congress held numerous hearings focused on rising subprime
foreclosure rates and the extent to which lending practices contributed
to them.\46\ Consumer advocates testified

[[Page 6415]]

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
consumers. In response to these hearings, the House of Representatives
passed the Mortgage Reform and Anti-Predatory Lending Act, both in 2007
and again in 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. Instead, both houses shifted
their focus to enacting comprehensive financial reform legislation.
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\46\ E.g., Progress in Administration and Other Efforts to
Coordinate and Enhance Mortgage Foreclosure Prevention: Hearing
before the H. Comm. on Fin. Servs., 110th Cong. (2007); Legislative
Proposals on Reforming Mortgage Practices: Hearing before the H.
Comm. on Fin. Servs., 110th Cong. (2007); Legislative and Regulatory
Options for Minimizing and Mitigating Mortgage Foreclosures: Hearing
before the H. Comm. on Fin. Servs., 110th Cong. (2007); Ending
Mortgage Abuse: Safeguarding Homebuyers: Hearing before the S.
Subcomm. on Hous., Transp., and Cmty. Dev. of the S. Comm. on
Banking, Hous., and Urban Affairs, 110th Cong. (2007); Improving
Federal Consumer Protection in Financial Services: Hearing before
the H. Comm. on Fin. Servs., 110th Cong. (2007); The Role of the
Secondary Market in Subprime Mortgage Lending: Hearing before the
Subcomm. on Fin. Insts. and Consumer Credit of the H. Comm. on Fin.
Servs., 110th Cong. (2007); Possible Responses to Rising Mortgage
Foreclosures: Hearing before the H. Comm. on Fin. Servs., 110th
Cong. (2007); Subprime Mortgage Market Turmoil: Examining the Role
of Securitization: Hearing before the Subcomm. on Secs., Ins., and
Inv. of the S. Comm. on Banking, Hous., and Urban Affairs, 110th
Cong. (2007); Subprime and Predatory Lending: New Regulatory
Guidance, Current Market Conditions, and Effects on Regulated
Financial Institutions: Hearing before the Subcomm. on Fin. Insts.
and Consumer Credit of the H. Comm. on Fin. Servs., 110th Cong.
(2007); Mortgage Market Turmoil: Causes and Consequences, Hearing
before the S. Comm. on Banking, Hous., and Urban Affairs, 110th
Cong. (2007); Preserving the American Dream: Predatory Lending
Practices and Home Foreclosures, Hearing before the S. Comm. on
Banking, Hous., and Urban Affairs, 110th Cong. (2007).
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In December 2009, the House passed the Wall Street Reform and
Consumer Protection Act of 2009, its version of comprehensive financial
reform legislation, which included an ability-to-repay and qualified
mortgage provision. H.R. 4173, 111th Cong. (2009). In May 2010, the
Senate passed its own version of ability-to-repay requirements in its
own version of comprehensive financial reform legislation, called the
Restoring American Financial Stability Act of 2010. S. 3217, 111th
Cong. (2010). After conference committee negotiations, the Dodd-Frank
Act was passed by both houses of Congress and was signed into law on
July 21, 2010. Public Law 111-203, 124 Stat. 1376 (2010).
In the Dodd-Frank Act, Congress established the Bureau and, under
sections 1061 and 1100A, generally consolidated the rulemaking
authority for Federal consumer financial laws, including TILA and
RESPA, in the Bureau.\47\ Congress also provided the Bureau, among
other things, with supervision authority for Federal consumer financial
laws over certain entities, including insured depository institutions
and credit unions with total assets over $10 billion and their
affiliates, and mortgage-related non-depository financial services
providers.\48\ In addition, Congress provided the Bureau with
authority, subject to certain limitations, to enforce the Federal
consumer financial laws, including the 18 enumerated consumer laws.
Title X of the Dodd-Frank Act, and rules thereunder. The Bureau can
bring civil actions in court and administrative enforcement proceedings
to obtain remedies such as civil penalties and cease-and-desist orders.
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\47\ Sections 1011 and 1021 of the Dodd-Frank Act, in title X,
the ``Consumer Financial Protection Act,'' Public Law 111-203, secs.
1001-1100H, codified at 12 U.S.C. 5491, 5511. The Consumer Financial
Protection Act is substantially codified at 12 U.S.C. 5481-5603.
Section 1029 of the Dodd-Frank Act excludes from this transfer of
authority, subject to certain exceptions, any rulemaking authority
over a motor vehicle dealer that is predominantly engaged in the
sale and servicing of motor vehicles, the leasing and servicing of
motor vehicles, or both. 12 U.S.C. 5519.
\48\ Sections 1024 through 1026 of the Dodd-Frank Act, codified
at 12 U.S.C. 5514 through 5516.
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At the same time, Congress significantly amended the statutory
requirements governing mortgage practices with the intent to restrict
the practices that contributed to the crisis. Title XIV of the Dodd-
Frank Act contains a modified version of the Mortgage Reform and Anti-
Predatory Lending Act.\49\ The Dodd-Frank Act requires the Bureau to
propose consolidation of the major federal mortgage disclosures,
imposes new requirements and limitations to address a wide range of
consumer mortgage issues, and imposes credit risk retention
requirements in connection with mortgage securitization.
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\49\ Although S. Rept. No. 111-176 contains general legislative
history concerning the Dodd-Frank Act and the Senate ability-to-
repay provisions, it does not address the House Mortgage Reform and
Anti-Predatory Lending Act. Separate legislative history for the
predecessor House bills is available in H. Rept. No. 110-441 for
H.R. 3915 (2007), and H. Rept. No. 111-194 for H.R. 1728 (2009).
---------------------------------------------------------------------------

Through the Dodd-Frank Act, Congress expanded HOEPA to apply to
more types of mortgage transactions, including purchase money mortgage
loans and home-equity lines of credit. Congress also amended HOEPA's
existing high-cost triggers, added a prepayment penalty trigger, and
expanded the protections associated with high-cost mortgages.\50\
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\50\ Under the Dodd-Frank Act, HOEPA protections would be
triggered where: (1) A loan's annual percentage rate (APR) exceeds
the average prime offer rate by 6.5 percentage points for most
first-lien mortgages and 8.5 percentage points for subordinate lien
mortgages; (2) a loan's points and fees exceed 5 percent of the
total transaction amount, or a higher threshold for loans below
$20,000; or (3) the creditor may charge a prepayment penalty more
than 36 months after loan consummation or account opening, or
penalties that exceed more than 2 percent of the amount prepaid.
---------------------------------------------------------------------------

In addition, sections 1411, 1412, and 1414 of the Dodd-Frank Act
created new TILA section 129C, which establishes, among other things,
new ability-to-repay requirements and new limits on prepayment
penalties. Section 1402 of 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.'' TILA
section 129B(a)(1), 15 U.S.C. 1639b(a)(1). Section 1402 of 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.'' TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2).
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, credit secured by an interest in a 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 does not exceed
certain thresholds for points and fees on the loan and which meets such
other criteria as the Bureau may prescribe.
Prohibits prepayment penalties unless the mortgage is a
fixed-rate qualified mortgage that is not a higher-priced mortgage
loan, and the amount and duration of the prepayment penalty are
limited.
The statutory ability-to-repay standards reflect Congress's belief
that certain lending practices (such as low- or no-documentation loans
or underwriting loans without regard to principal repayment) led to
consumers having mortgages they could not afford, resulting in high
default and foreclosure rates. Accordingly, new TILA section 129C
generally prohibits a creditor from making a residential 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.
To provide more certainty to creditors while protecting consumers
from unaffordable loans, the Dodd-Frank Act provides a presumption of
compliance with the ability-to-repay requirements for certain
``qualified mortgages.'' TILA section 129C(b)(1) states that a creditor

[[Page 6416]]

or assignee may presume that a loan has met the repayment ability
requirement if the loan is a qualified mortgage. Qualified mortgages
are prohibited from containing certain features that Congress
considered to increase risks to consumers and must comply with certain
limits on points and fees.
The Dodd-Frank Act creates special remedies for violations of TILA
section 129C. As amended by section 1416 of the Dodd-Frank Act, TILA
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, unless
the creditor demonstrates that the failure to comply is not material.
TILA section 130(a). This recovery is in addition to: (1) Actual
damages; (2) statutory damages in an individual action or class action,
up to a prescribed threshold; and (3) court costs and attorney fees
that would be available for violations of other TILA provisions. In
addition, the statute of limitations 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 most other TILA violations, except for
actions brought under section 129 or 129B, or actions brought by a
State attorney general to enforce a violation of section 129, 129B,
129C, 129D, 129E, 129F, 129G, or 129H, which may be brought not later
than 3 years after the date on which the violation occurs, and private
education loans under 15 U.S.C. 1650(a), which may be brought not later
than one year from the due date of first regular payment of principal).
TILA section 130(e). Moreover, as amended by section 1413 of the Dodd-
Frank Act, TILA provides that when a creditor, or an assignee, other
holder or their agent initiates a foreclosure action, a consumer may
assert a violation of TILA section 129C(a) ``as a matter of defense by
recoupment or setoff.'' TILA section 130(k). There is no time limit on
the use of this defense and the amount of recoupment or setoff is
limited, with respect to the special statutory damages, to no more than
three years of finance charges and fees. For high-cost loans an
assignee generally continues to be subject to all claims and defenses,
not only in foreclosure, with respect to that mortgage that the
consumer could assert against the creditor of the mortgage, unless the
assignee demonstrates, by a preponderance of evidence, that a
reasonable person exercising ordinary due diligence, could not
determine that the mortgage was a high-cost mortgage. TILA section
131(d).
In addition to the foregoing ability-to-repay provisions, the Dodd-
Frank Act established other new standards concerning a wide range of
mortgage lending practices, including compensation of mortgage
originators,\51\ Federal mortgage disclosures,\52\ and mortgage
servicing.\53\ Those and other Dodd-Frank Act provisions are the
subjects of other rulemakings by the Bureau. For additional information
on those other rulemakings, see the discussion below in part III.C.
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\51\ Sections 1402 through 1405 of the Dodd-Frank Act, codified
at 15 U.S.C. 1639b.
\52\ Section 1032(f) of the Dodd-Frank Act, codified at 12
U.S.C. 5532(f).
\53\ Sections 1418, 1420, 1463, and 1464 of the Dodd-Frank Act,
codified at 12 U.S.C. 2605; 15 U.S.C. 1638, 1638a, 1639f, and 1639g.
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G. Qualified Residential Mortgage Rulemaking

Section 15G of the Securities Exchange Act of 1934, added by
section 941(b) of the Dodd-Frank Act, generally requires the
securitizer of asset-backed securities (ABS) to retain not less than
five percent of the credit risk of the assets collateralizing the ABS.
15 U.S.C. 78o-11. The Dodd-Frank Act's credit risk retention
requirements are aimed at addressing weaknesses and failures in the
securitization process and the securitization markets.\54\ By requiring
that the securitizer retain a portion of the credit risk of the assets
being securitized, the Dodd-Frank Act provides securitizers an
incentive to monitor and ensure the quality of the assets underlying a
securitization transaction. Six Federal agencies (not including the
Bureau) are tasked with implementing this requirement. Those agencies
are the Board, Office of the Comptroller of the Currency (OCC), Federal
Deposit Insurance Corporation (FDIC), Securities and Exchange
Commission (SEC), Federal Housing Finance Agency (FHFA), and Department
of Housing and Urban Development (HUD) (collectively, the QRM
agencies).
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\54\ As noted in the legislative history of section 15G of the
Securities Exchange Act of 1934, ``[w]hen securitizers retain a
material amount of risk, they have `skin in the game,' aligning
their economic interest with those of investors in asset-backed
securities.'' See S. Rept. 176, 111th Cong., at 129 (2010).
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Section 15G of the Securities Exchange Act of 1934 provides that
the credit risk retention requirements shall not apply to an issuance
of ABS if all of the assets that collateralize the ABS are ``qualified
residential mortgages'' (QRMs). See 15 U.S.C. 78o-11(c)(1)(C)(iii),
(4)(A) and (B). Section 15G requires the QRM agencies to jointly define
what constitutes a QRM, taking into consideration underwriting and
product features that historical loan performance data indicate result
in a lower risk of default. See 15 U.S.C. 78o-11(e)(4). Notably,
section 15G also provides that the definition of a QRM shall be ``no
broader than'' the definition of a ``qualified mortgage,'' as the term
is defined under TILA section 129C(b)(2), as amended by the Dodd-Frank
Act, and regulations adopted thereunder. 15 U.S.C. 78o-11(e)(4)(C).
On April 29, 2011, the QRM agencies issued joint proposed risk
retention rules, including a proposed QRM definition (2011 QRM Proposed
Rule). See 76 FR 24090 (Apr. 29, 2011). The proposed rule has not been
finalized. Among other requirements, the 2011 QRM Proposed Rule
incorporates the qualified mortgage restrictions on negative
amortization, interest-only, and balloon payments, limits points and
fees to three percent of the loan amount, and prohibits prepayment
penalties. The proposed rule also establishes underwriting standards
designed to ensure that QRMs have high credit quality, including:
A maximum ``front-end'' monthly debt-to-income ratio
(which looks at only the consumer's mortgage payment relative to
income, but not at other debts) of 28 percent;
A maximum ``back-end'' monthly debt-to-income ratio (which
includes all of the consumer's debt, not just the mortgage payment) of
36 percent;
A maximum loan-to-value (LTV) ratio of 80 percent in the
case of a purchase transaction (with a lesser combined LTV permitted
for refinance transactions);
A 20 percent down payment requirement in the case of a
purchase transaction; and
Credit history verification and documentation
requirements.
The proposed rule also includes appraisal requirements,
restrictions on the assumability of the mortgage, and requires the
creditor to commit to certain servicing policies and procedures
regarding loss mitigation. See 76 FR at 24166-67.
To provide clarity on the definitions, calculations, and
verification requirements for the QRM standards, the 2011 QRM Proposed
Rule incorporates certain definitions and key terms established by HUD
and required to be used by creditors originating FHA-insured
residential mortgages. See 76 FR at 24119. Specifically, the 2011 QRM
Proposed Rule incorporates the definitions and standards set out in the
HUD Handbook 4155.1 (New Version),

[[Page 6417]]

Mortgage Credit Analysis for Mortgage Insurance, as in effect on
December 31, 2010, for determining and verifying the consumer's funds
and the consumer's monthly housing debt, total monthly debt, and
monthly gross income.\55\
---------------------------------------------------------------------------

\55\ See U.S. Dep't of Hous. & Urban Dev., Housing Handbook
4155.1, Mortgage Credit Analysis for Mortgage Insurance (rev. Mar.
2011) (``HUD Handbook 4155.1''), available at https://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/handbooks/hsgh/4155.1.
---------------------------------------------------------------------------

The qualified mortgage and QRM definitions are distinct and relate
to different parts of the Dodd-Frank Act with different purposes, but
both are designed to address problems that had arisen in the mortgage
origination process. The qualified mortgage standard provides creditors
with a presumption of compliance with the requirement in TILA section
129C(a) to assess a consumer's ability to repay a residential mortgage
loan. The purpose of these provisions is to ensure that consumers are
offered and receive residential mortgage loans on terms that reasonably
reflect their ability to repay the loans. See TILA section 129B(a)(2).
The Dodd-Frank Act's credit risk retention requirements are intended to
address problems in the securitization markets and in mortgage markets
by requiring that securitizers, as a general matter, retain an economic
interest in the credit risk of the assets they securitize. The QRM
credit risk retention requirement was meant to incentivize creditors to
make more responsible loans because they will need to keep some skin in
the game.\56\
---------------------------------------------------------------------------

\56\ See S. Rept. 176, 111th Cong., at 129 (2010).
---------------------------------------------------------------------------

Nevertheless, as discussed above, the Dodd-Frank Act requires that
the QRM definition be ``no broader than'' the qualified mortgage
definition. Therefore, in issuing the 2011 QRM Proposed Rule, the QRM
agencies sought to incorporate the statutory qualified mortgage
standards, in addition to other requirements, into the QRM definition.
76 FR at 24118. This approach was designed to minimize the potential
for conflicts between the QRM standards in the proposed rule and the
qualified mortgage definition that the Bureau would ultimately adopt in
a final rule.
In the 2011 QRM Proposed Rule, the QRM agencies stated their
expectation to monitor the rules adopted by the Bureau under TILA to
define a qualified mortgage and to review those rules to ensure that
the definition of QRM in the final rule is ``no broader'' than the
definition of a qualified mortgage and to appropriately implement the
Dodd-Frank Act's credit risk retention requirement. See 76 FR at 24118.
In preparing this final rule, the Bureau has consulted regularly with
the QRM agencies to coordinate the qualified mortgage and qualified
residential mortgage definitions. However, while the Bureau's qualified
mortgage definition will set the outer boundary of a QRM, the QRM
agencies have discretion under the Dodd-Frank Act to define QRMs in a
way that is stricter than the qualified mortgage definition.

III. Summary of the Rulemaking Process

A. The Board's Proposal

In 2011, the Board published for public comment a proposed rule
amending Regulation Z to implement the foregoing ability-to-repay
amendments to TILA made by the Dodd-Frank Act. See 76 FR 27390 (May 11,
2011) (2011 ATR Proposal, the Board's proposal or the proposal).
Consistent with the Dodd-Frank Act, the Board's proposal applied the
ability-to-repay requirements to any consumer credit transaction
secured by a dwelling (including vacation home loans and home equity
loans), except an open-end credit plan, extension of credit secured by
a consumer's interest in a timeshare plan, reverse mortgage, or
temporary loan with a term of 12 months or less.
The Board's proposal provided four options for complying with the
ability-to-repay requirement, including by making a ``qualified
mortgage.'' First, the proposal would have allowed a creditor to meet
the general ability-to-repay standard by originating a covered mortgage
loan for which the creditor considered and verified eight underwriting
factors in determining repayment ability, and, for adjustable rate
loans, the mortgage payment calculation is based on the fully indexed
rate.\57\ Second, the proposal would have allowed a creditor to
refinance a ``non-standard mortgage'' into a ``standard mortgage.''
\58\ Under this option, the proposal would not have required the
creditor to verify the consumer's income or assets. Third, the proposal
would have allowed a creditor to originate a qualified mortgage, which
provides special protection from liability for creditors. Because the
Board determined that it was unclear whether that protection is
intended to be a safe harbor or a rebuttable presumption of compliance
with the repayment ability requirement, the Board proposed two
alternative definitions of a qualified mortgage.\59\ Finally, the
proposal would have allowed a small creditor operating predominantly in
rural or underserved areas to originate 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.\60\ The Board's proposal also would have implemented
the Dodd-Frank Act's limits on prepayment penalties, lengthened the
time creditors must retain evidence of compliance with the ability-to-
repay and prepayment penalty provisions, and prohibited evasion of the
rule by structuring a closed-end extension of credit that does not meet
the definition of an open-end plan. As discussed above, rulemaking
authority under TILA generally transferred from the Board to the Bureau
in July 2011, including the authority under Dodd-Frank Act section 1412
to prescribe regulations to carry out the purposes of the qualified
mortgage rules. 12 U.S.C. 5512; 12 U.S.C. 5581; 15 U.S.C. 1639c. As
discussed above, TILA section 105(a) directs the Bureau to prescribe
regulations to carry out the purposes of

[[Page 6418]]

TILA. Except with respect to the substantive restrictions on high-cost
mortgages provided in TILA section 129, TILA section 105(a) authorizes
the Bureau to prescribe regulations that may contain additional
requirements, classifications, differentiations, or other provisions,
and may provide for such adjustments and exceptions for all or any
class of transactions that the Bureau determines are necessary or
proper to effectuate the purposes of TILA, to prevent circumvention or
evasion thereof, or to facilitate compliance therewith.
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\57\ The eight factors are: (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.
\58\ This alternative is based on a Dodd-Frank Act provision
that is meant to provide flexibility for certain streamlined
refinancings, which are no- or low-documentation transactions
designed to refinance a consumer quickly under certain
circumstances, when such refinancings would move consumers out of
risky mortgages and into more stable mortgage products--what the
proposal defined as mortgage loans that, among other things, do not
contain negative amortization, interest-only payments, or balloon
payments, and have limited points and fees. TILA section
129C(a)(6)(E); 15 U.S.C. 1639c(a)(6)(E).
\59\ The Board's proposed first alternative would have operated
as a legal safe harbor and define 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; (b) the total points and fees do not exceed
3 percent of the total loan amount; (c) the consumer's income or
assets are verified and documented; and (d) the underwriting of the
mortgage is based on the maximum interest rate in the first five
years, uses a payment schedule that fully amortizes the loan over
the loan term, and takes into account any mortgage-related
obligations. The Board's proposed second alternative would have
provided a rebuttable presumption of compliance and defined a
``qualified mortgage'' as including the criteria listed above in the
first alternative as well as considering and verifying the following
additional underwriting requirements from the ability-to-repay
standard: The consumer's employment status, the monthly payment for
any simultaneous loan, the consumer's current debt obligations, the
total debt-to-income ratio or residual income, and the consumer's
credit history.
\60\ This alternative is based on statutory provision. TILA
section 129C(b)(2)(E); 15 U.S.C. 1639c. As the Board's proposal
noted, this standard is evidently meant to accommodate community
banks that originate balloon-payment mortgages in lieu of
adjustable-rate mortgages to hedge against interest rate risk.
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B. Comments and Post-Proposal Outreach

The Board received numerous comments on the proposal, including
comments regarding the criteria for a ``qualified mortgage'' and
whether a qualified mortgage provides a safe harbor or a presumption of
compliance with the repayment ability requirements. As noted above, in
response to the proposed rule, the Board received approximately 1,800
letters from commenters, including members of Congress, creditors,
consumer groups, trade associations, mortgage and real estate market
participants, and individual consumers. As of July 21, 2011, the Dodd-
Frank Act generally transferred the Board's rulemaking authority for
TILA, among other Federal consumer financial laws, to the Bureau.
Accordingly, all comment letters on the proposed rule were also
transferred to the Bureau. Materials submitted were filed in the record
and are publicly available at https://www.regulations.gov.
Through various comment letters and the Bureau's own collection of
data, the Bureau received additional information and new data
pertaining to the proposed rule. Accordingly, in May 2012, the Bureau
reopened the comment period in order to solicit further comment on data
and new information, including data that may assist the Bureau in
defining loans with characteristics that make it appropriate to presume
that the creditor complied with the ability-to-repay requirements or
assist the Bureau in assessing the benefits and costs to consumers,
including access to credit, and covered persons, as well as the market
share covered by, alternative definitions of a ``qualified mortgage.''
The Bureau received approximately 160 comments in response to the
reopened comment period from a variety of commenters, including
creditors, consumer groups, trade associations, mortgage and real
estate market participants, individuals, small entities, the SBA's
Office of Advocacy, and FHA. As discussed in more detail below, the
Bureau has considered these comments in adopting this final rule.

C. Other Rulemakings

In addition to this final rule, the Bureau is adopting several
other final rules and issuing one proposal, all relating to mortgage
credit to implement requirements of title XIV of the Dodd-Frank Act.
The Bureau is also issuing a final rule jointly with other Federal
agencies to implement requirements for mortgage appraisals in title
XIV. Each of the final rules follows a proposal issued in 2011 by the
Board or in 2012 by the Bureau alone or jointly with other Federal
agencies. Collectively, these proposed and final rules are referred to
as the Title XIV Rulemakings.
Ability to Repay: Simultaneously with this final rule (the
2013 ATR Final Rule), the Bureau is issuing a proposal to amend certain
provisions of the final rule, including by the addition of exemptions
for certain nonprofit creditors and certain homeownership stabilization
programs and a definition of a ``qualified mortgage'' for certain loans
made and held in portfolio by small creditors (the 2013 ATR Concurrent
Proposal). The Bureau expects to act on the 2013 ATR Concurrent
Proposal on an expedited basis, so that any exceptions or adjustments
can take effect simultaneously with this final rule.
Escrows: The Bureau is finalizing a rule, following a
March 2011 proposal issued by the Board (the Board's 2011 Escrows
Proposal),\61\ to implement certain provisions of the Dodd-Frank Act
expanding on existing rules that require escrow accounts to be
established for higher-priced mortgage loans and creating an exemption
for certain loans held by creditors operating predominantly in rural or
underserved areas, pursuant to TILA section 129D as established by
Dodd-Frank Act sections 1461. 15 U.S.C. 1639d. The Bureau's final rule
is referred to as the 2013 Escrows Final Rule.
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\61\ 76 FR 11598 (Mar. 2, 2011).
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HOEPA: Following its July 2012 proposal (the 2012 HOEPA
Proposal),\62\ the Bureau is issuing a final rule to implement Dodd-
Frank Act requirements expanding protections for ``high-cost
mortgages'' under the Homeownership and Equity Protection Act (HOEPA),
pursuant to TILA sections 103(bb) and 129, as amended by Dodd-Frank Act
sections 1431 through 1433. 15 U.S.C. 1602(bb) and 1639. The Bureau
also is finalizing rules to implement certain title XIV requirements
concerning homeownership counseling, including a requirement that
creditors provide lists of homeownership counselors to applicants for
federally related mortgage loans, pursuant to RESPA section 5(c), as
amended by Dodd-Frank Act section 1450. 12 U.S.C. 2604(c). The Bureau's
final rule is referred to as the 2013 HOEPA Final Rule.
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\62\ 77 FR 49090 (Aug. 15,2012).
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Servicing: Following its August 2012 proposals (the 2012
RESPA Servicing Proposal and 2012 TILA Servicing Proposal),\63\ the
Bureau is adopting final rules to implement Dodd-Frank Act requirements
regarding force-placed insurance, error resolution, information
requests, and payment crediting, as well as requirements for mortgage
loan periodic statements and adjustable-rate mortgage reset
disclosures, pursuant to section 6 of RESPA and sections 128, 128A,
129F, and 129G of TILA, as amended or established by Dodd-Frank Act
sections 1418, 1420, 1463, and 1464. 12 U.S.C. 2605; 15 U.S.C. 1638,
1638a, 1639f, and 1639g. The Bureau also is finalizing rules on early
intervention for troubled and delinquent consumers, and loss mitigation
procedures, pursuant to the Bureau's authority under section 6 of
RESPA, as amended by Dodd-Frank Act section 1463, to establish
obligations for mortgage servicers that it finds to be appropriate to
carry out the consumer protection purposes of RESPA, and its authority
under section 19(a) of RESPA to prescribe rules necessary to achieve
the purposes of RESPA. The Bureau's final rule under RESPA with respect
to mortgage servicing also establishes requirements for general
servicing standards policies and procedures and continuity of contact
pursuant to its authority under section 19(a) of RESPA. The Bureau's
final rules are referred to as the 2013 RESPA Servicing Final Rule and
the 2013 TILA Servicing Final Rule, respectively.
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\63\ 77 FR 57200 (Sept. 17, 2012) (RESPA); 77 FR 57318 (Sept.
17, 2012) (TILA).
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Loan Originator Compensation: Following its August 2012
proposal (the 2012 Loan Originator Proposal),\64\ the Bureau is issuing
a final rule to implement provisions of the Dodd-Frank Act requiring
certain creditors and loan originators to meet certain duties of care,
including qualification requirements; requiring the establishment of
certain compliance procedures by depository institutions; prohibiting
loan originators, creditors, and the affiliates of both from receiving
compensation in various forms (including based on the terms of the
transaction) and from sources other than

[[Page 6419]]

the consumer, with specified exceptions; and establishing restrictions
on mandatory arbitration and financing of single premium credit
insurance, pursuant to TILA sections 129B and 129C as established by
Dodd-Frank Act sections 1402, 1403, and 1414(a). 15 U.S.C. 1639b,
1639c. The Bureau's final rule is referred to as the 2013 Loan
Originator Final Rule.
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\64\ 77 FR 55272 (Sept. 7, 2012).
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Appraisals: The Bureau, jointly with other Federal
agencies,\65\ is issuing a final rule implementing Dodd-Frank Act
requirements concerning appraisals for higher-risk mortgages, pursuant
to TILA section 129H as established by Dodd-Frank Act section 1471. 15
U.S.C. 1639h. This rule follows the agencies' August 2012 joint
proposal (the 2012 Interagency Appraisals Proposal).\66\ The agencies'
joint final rule is referred to as the 2013 Interagency Appraisals
Final Rule. In addition, following its August 2012 proposal (the 2012
ECOA Appraisals Proposal),\67\ the Bureau is issuing a final rule to
implement provisions of the Dodd-Frank Act requiring that creditors
provide applicants with a free copy of written appraisals and
valuations developed in connection with applications for loans secured
by a first lien on a dwelling, pursuant to section 701(e) of the Equal
Credit Opportunity Act (ECOA) as amended by Dodd-Frank Act section
1474. 15 U.S.C. 1691(e). The Bureau's final rule is referred to as the
2013 ECOA Appraisals Final Rule.
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\65\ Specifically, the Board of Governors of the Federal Reserve
System, the Office of the Comptroller of the Currency, the Federal
Deposit Insurance Corporation, the National Credit Union
Administration, and the Federal Housing Finance Agency.
\66\ 77 FR 54722 (Sept. 5, 2012).
\67\ 77 FR 50390 (Aug. 21, 2012).
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The Bureau is not at this time finalizing proposals concerning
various disclosure requirements that were added by title XIV of the
Dodd-Frank Act, integration of mortgage disclosures under TILA and
RESPA, or a simpler, more inclusive definition of the finance charge
for purposes of disclosures for closed-end mortgage transactions under
Regulation Z. The Bureau expects to finalize these proposals and to
consider whether to adjust regulatory thresholds under the Title XIV
Rulemakings in connection with any change in the calculation of the
finance charge later in 2013, after it has completed quantitative
testing, and any additional qualitative testing deemed appropriate, of
the forms that it proposed in July 2012 to combine TILA mortgage
disclosures with the good faith estimate (RESPA GFE) and settlement
statement (RESPA settlement statement) required under the Real Estate
Settlement Procedures Act, pursuant to Dodd-Frank Act section 1032(f)
and sections 4(a) of RESPA and 105(b) of TILA, as amended by Dodd-Frank
Act sections 1098 and 1100A, respectively (the 2012 TILA-RESPA
Proposal).\68\ Accordingly, the Bureau already has issued a final rule
delaying implementation of various affected title XIV disclosure
provisions.\69\ The Bureau's approaches to coordinating the
implementation of the Title XIV Rulemakings and to the finance charge
proposal are discussed in turn below.
---------------------------------------------------------------------------

\68\ 77 FR 51116 (Aug. 23, 2012).
\69\ 77 FR 70105 (Nov. 23, 2012).
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Coordinated Implementation of Title XIV Rulemakings
As noted in all of its foregoing proposals, the Bureau regards each
of the Title XIV Rulemakings as affecting aspects of the mortgage
industry and its regulations. Accordingly, as noted in its proposals,
the Bureau is coordinating carefully the Title XIV Rulemakings,
particularly with respect to their effective dates. The Dodd-Frank Act
requirements to be implemented by the Title XIV Rulemakings generally
will take effect on January 21, 2013, unless final rules implementing
those requirements are issued on or before that date and provide for a
different effective date. See Dodd-Frank Act section 1400(c), 15 U.S.C.
1601 note. In addition, some of the Title XIV Rulemakings are to take
effect no later than one year after they are issued. Id.
The comments on the appropriate effective date for this final rule
are discussed in detail below in part VI of this notice. In general,
however, consumer advocates requested that the Bureau put the
protections in the Title XIV Rulemakings into effect as soon as
practicable. In contrast, the Bureau received some industry comments
indicating that implementing so many new requirements at the same time
would create a significant cumulative burden for creditors. In
addition, many commenters also acknowledged the advantages of
implementing multiple revisions to the regulations in a coordinated
fashion.\70\ Thus, a tension exists between coordinating the adoption
of the Title XIV Rulemakings and facilitating industry's implementation
of such a large set of new requirements. Some have suggested that the
Bureau resolve this tension by adopting a sequenced implementation,
while others have requested that the Bureau simply provide a longer
implementation period for all of the final rules.
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\70\ Of the several final rules being adopted under the Title
XIV Rulemakings, six entail amendments to Regulation Z, with the
only exceptions being the 2013 RESPA Servicing Final Rule
(Regulation X) and the 2013 ECOA Appraisals Final Rule (Regulation
B); the 2013 HOEPA Final Rule also amends Regulation X, in addition
to Regulation Z. The six Regulation Z final rules involve numerous
instances of intersecting provisions, either by cross-references to
each other's provisions or by adopting parallel provisions. Thus,
adopting some of those amendments without also adopting certain
other, closely related provisions would create significant technical
issues, e.g., new provisions containing cross-references to other
provisions that do not yet exist, which could undermine the ability
of creditors and other parties subject to the rules to understand
their obligations and implement appropriate systems changes in an
integrated and efficient manner.
---------------------------------------------------------------------------

The Bureau recognizes that many of the new provisions will require
creditors to make changes to automated systems and, further, that most
administrators of large systems are reluctant to make too many changes
to their systems at once. At the same time, however, the Bureau notes
that the Dodd-Frank Act established virtually all of these changes to
institutions' compliance responsibilities, and contemplated that they
be implemented in a relatively short period of time. And, as already
noted, the extent of interaction among many of the Title XIV
Rulemakings necessitates that many of their provisions take effect
together. Finally, notwithstanding commenters' expressed concerns for
cumulative burden, the Bureau expects that creditors actually may
realize some efficiencies from adapting their systems for compliance
with multiple new, closely related requirements at once, especially if
given sufficient overall time to do so.
Accordingly, the Bureau is requiring that, as a general matter,
creditors and other affected persons begin complying with the final
rules on January 10, 2014. As noted above, section 1400(c) of the Dodd-
Frank Act requires that some provisions of the Title XIV Rulemakings
take effect no later than one year after the Bureau issues them.
Accordingly, the Bureau is establishing January 10, 2014, one year
after issuance of this final rule and the Bureau's 2013 Escrows and
HOEPA Final Rules (i.e., the earliest of the title XIV final rules), as
the baseline effective date for most of the Title XIV Rulemakings. The
Bureau believes that, on balance, this approach will facilitate the
implementation of the rules' overlapping provisions, while also
affording creditors sufficient time to implement the more complex or
resource-intensive new requirements.
The Bureau has identified certain rulemakings or selected aspects
thereof, however, that do not present significant implementation
burdens for industry. Accordingly, the Bureau is setting

[[Page 6420]]

earlier effective dates for those final rules or certain aspects
thereof, as applicable. Those effective dates are set forth and
explained in the Federal Registers notices for those final rules.
More Inclusive Finance Charge Proposal
As noted above, the Bureau proposed in the 2012 TILA-RESPA Proposal
to make the definition of finance charge more inclusive, thus rendering
the finance charge and annual percentage rate a more useful tool for
consumers to compare the cost of credit across different alternatives.
77 FR 51116, 51143 (Aug. 23, 2012). Because the new definition would
include additional costs that are not currently counted, it would cause
the finance charges and APRs on many affected transactions to increase.
This in turn could cause more such transactions to become subject to
various compliance regimes under Regulation Z. Specifically, the
finance charge is central to the calculation of a transaction's
``points and fees,'' which in turn has been (and remains) a coverage
threshold for the special protections afforded ``high-cost mortgages''
under HOEPA. Points and fees also will be subject to a 3-percent limit
for purposes of determining whether a transaction is a ``qualified
mortgage'' under this final rule. Meanwhile, the APR serves as a
coverage threshold for HOEPA protections as well as for certain
protections afforded ``higher-priced mortgage loans'' under Sec.
1026.35, including the mandatory escrow account requirements being
amended by the 2013 Escrows Final Rule. Finally, because the 2013
Interagency Appraisals Final Rule uses the same APR-based coverage test
as is used for identifying higher-priced mortgage loans, the APR
affects that rulemaking as well. Thus, the proposed more inclusive
finance charge would have had the indirect effect of increasing
coverage under HOEPA and the escrow and appraisal requirements for
higher-priced mortgage loans, as well as decreasing the number of
transactions that may be qualified mortgages--even holding actual loan
terms constant--simply because of the increase in calculated finance
charges, and consequently APRs, for closed-end mortgage transactions
generally.
As noted above, these expanded coverage consequences were not the
intent of the more inclusive finance charge proposal. Accordingly, as
discussed more extensively in the Escrows Proposal, the HOEPA Proposal,
the ATR Proposal, and the Interagency Appraisals Proposal, the Board
and subsequently the Bureau (and other agencies) sought comment on
certain adjustments to the affected regulatory thresholds to counteract
this unintended effect. First, the Board and then the Bureau proposed
to adopt a ``transaction coverage rate'' for use as the metric to
determine coverage of these regimes in place of the APR. The
transaction coverage rate would have been calculated solely for
coverage determination purposes and would not have been disclosed to
consumers, who still would have received only a disclosure of the
expanded APR. The transaction coverage rate calculation would exclude
from the prepaid finance charge all costs otherwise included for
purposes of the APR calculation except charges retained by the
creditor, any mortgage broker, or any affiliate of either. Similarly,
the Board and Bureau proposed to reverse the effects of the more
inclusive finance charge on the calculation of points and fees; the
points and fees figure is calculated only as a HOEPA and qualified
mortgage coverage metric and is not disclosed to consumers. The Bureau
also sought comment on other potential mitigation measures, such as
adjusting the numeric thresholds for particular compliance regimes to
account for the general shift in affected transactions' APRs.
The Bureau's 2012 TILA-RESPA Proposal sought comment on whether to
finalize the more inclusive finance charge proposal in conjunction with
the Title XIV Rulemakings or with the rest of the TILA-RESPA Proposal
concerning the integration of mortgage disclosure forms. 77 FR 51116,
51125 (Aug. 23, 2012). Upon additional consideration and review of
comments received, the Bureau decided to defer a decision whether to
adopt the more inclusive finance charge proposal and any related
adjustments to regulatory thresholds until it later finalizes the TILA-
RESPA Proposal. 77 FR 54843 (Sept. 6, 2012); 77 FR 54844 (Sept. 6,
2012).\71\ Accordingly, this final rule and the 2013 Escrows, HOEPA,
and Interagency Appraisals Final Rules all are deferring any action on
their respective proposed adjustments to regulatory thresholds.
---------------------------------------------------------------------------

\71\ These notices extended the comment period on the more
inclusive finance charge and corresponding regulatory threshold
adjustments under the 2012 TILA-RESPA and HOEPA Proposals. It did
not change any other aspect of either proposal.
---------------------------------------------------------------------------

IV. Legal Authority

The final rule was issued on January 10, 2013, in accordance with
12 CFR 1074.1. The Bureau issued this final rule pursuant to its
authority under TILA and the Dodd-Frank Act. See TILA section 105(a),
15 U.S.C. 1604(a). On July 21, 2011, section 1061 of the Dodd-Frank Act
transferred to the Bureau the ``consumer financial protection
functions'' previously vested in certain other Federal agencies,
including the Board. The term ``consumer financial protection
function'' is defined to include ``all authority to prescribe rules or
issue orders or guidelines pursuant to any Federal consumer financial
law, including performing appropriate functions to promulgate and
review such rules, orders, and guidelines.'' \72\ TILA is defined as a
Federal consumer financial law.\73\ Accordingly, the Bureau has
authority to issue regulations pursuant to TILA.
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\72\ 12 U.S.C. 5581(a)(1).
\73\ Dodd-Frank Act section 1002(14), 12 U.S.C. 5481(14)
(defining ``Federal consumer financial law'' to include the
``enumerated consumer laws'' and the provisions of title X of the
Dodd-Frank Act), Dodd-Frank Act section 1002(12), 12 U.S.C. 5481(12)
(defining ``enumerated consumer laws'' to include TILA).
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A. TILA Ability-to-Repay and Qualified Mortgage Provisions

As discussed above, the Dodd-Frank Act amended TILA to generally
prohibit a creditor from making a residential mortgage loan without a
reasonable and good faith determination that, at the time the loan is
consummated, the consumer has a reasonable ability to repay the loan,
along with taxes, insurance, and assessments. TILA section 129C(a), 15
U.S.C. 1639c(a). As described below in part IV.B, the Bureau has
authority to prescribe regulations to carry out the purposes of TILA
pursuant to TILA section 105(a). 15 U.S.C. 1604(a). In particular, it
is the purpose of TILA section 129C, as amended by the Dodd-Frank Act,
to assure that consumers are offered and receive residential mortgage
loans on terms that reasonably reflect their ability to repay the loans
and that are understandable and not unfair, deceptive, and abusive.
TILA section 129B(a)(2); 15 U.S.C. 1639b(a)(2).
The Dodd-Frank Act also provides creditors originating ``qualified
mortgages'' special protection from liability under the ability-to-
repay requirements. TILA section 129C(b), 15 U.S.C. 1639c(b). TILA
generally defines a ``qualified mortgage'' as a residential mortgage
loan 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 loan amount; the income or assets are considered and verified; and
the underwriting is based on the maximum rate during the first five
years, uses a

[[Page 6421]]

payment schedule that fully amortizes the loan over the loan term, and
takes into account all mortgage-related obligations. TILA section
129C(b)(2), 15 U.S.C. 1639c(b)(2). In addition, to constitute a
qualified mortgage a loan must meet ``any guidelines or regulations
established by the Bureau relating to ratios of total monthly debt to
monthly income or alternative measures of ability to pay regular
expenses after payment of total monthly debt, taking into account the
income levels of the borrower and such other factors as the Bureau may
determine are relevant and consistent with the purposes described in
[TILA section 129C(b)(3)(B)(i)].''
The Dodd-Frank Act also provides the Bureau with authority to
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
are necessary and appropriate to effectuate the purposes of the
ability-to-repay requirements, to prevent circumvention or evasion
thereof, or to facilitate compliance with TILA sections 129B and 129C.
TILA section 129C(b)(3)(B)(i), 15 U.S.C. 1639c(b)(3)(B)(i). In
addition, TILA section 129C(b)(3)(A) provides the Bureau with authority
to prescribe regulations to carry out the purposes of the qualified
mortgage provisions, such as to ensure that responsible, affordable
mortgage credit remains available to consumers in a manner consistent
with the purposes of TILA section 129C. TILA section 129C(b)(3)(A), 15
U.S.C. 1939c(b)(3)(A). As discussed in the section-by-section analysis
below, the Bureau is issuing certain provisions of this rule pursuant
to its authority under TILA section 129C(b)(3)(B)(i).
The Dodd-Frank Act provides the Bureau with other specific grants
of rulewriting authority with respect to the ability-to-repay and
qualified mortgage provisions. With respect to the ability-to-repay
provisions, TILA section 129C(a)(6)(D)(i) through (iii) provides that
when calculating the payment obligation that will be used to determine
whether the consumer can repay a covered transaction, the creditor must
use a fully amortizing payment schedule and assume that: (1) The loan
proceeds are fully disbursed on the date the loan is consummated; (2)
the loan is repaid in substantially equal, monthly amortizing payments
for principal and interest over the entire term of the loan with no
balloon payment; and (3) the interest rate over the entire term of the
loan is a fixed rate equal to the fully indexed rate at the time of the
loan closing, without considering the introductory rate. 15 U.S.C.
1639c(a)(6)(D)(i) through (iii). However, TILA section 129C(a)(6)(D)
authorizes the Bureau to prescribe regulations for calculating the
payment obligation for loans that require more rapid repayment
(including balloon payments), and which have an annual percentage rate
that does not exceed a certain rate threshold. 15 U.S.C.
1639c(a)(6)(D).
With respect to the qualified mortgage provisions, the Dodd-Frank
Act contains several specific grants of rulewriting authority. First,
as described above, for purposes of defining ``qualified mortgage,''
TILA section 129C(b)(2)(A)(vi) provides the Bureau with authority to
establish guidelines or regulations relating to monthly debt-to-income
ratios or alternative measures of ability to pay. Second, TILA section
129C(b)(2)(D) provides that the Bureau shall prescribe rules adjusting
the qualified mortgage points and fees limits described above to permit
creditors that extend smaller loans to meet the requirements of the
qualified mortgage provisions. 15 U.S.C. 1639c(b)(2)(D)(ii). In
prescribing such rules, the Bureau must consider their potential impact
on rural areas and other areas where home values are lower. Id. Third,
TILA section 129C(b)(2)(E) provides the Bureau with authority to
include in the definition of ``qualified mortgage'' loans with balloon
payment features, if those loans meet certain underwriting criteria and
are originated by creditors that operate predominantly in rural or
underserved areas, have total annual residential mortgage originations
that do not exceed a limit set by the Bureau, and meet any asset size
threshold and any other criteria as the Bureau may establish,
consistent with the purposes of TILA. 15 U.S.C. 1639c(b)(2)(E). As
discussed in the section-by-section analysis below, the Bureau is
issuing certain provisions of this rule pursuant to its authority under
TILA sections 129C(a)(6)(D), (b)(2)(A)(vi), (b)(2)(D), and (b)(2)(E).

B. Other Rulemaking and Exception Authorities

This final rule also relies on other rulemaking and exception
authorities specifically granted to the Bureau by TILA and the Dodd-
Frank Act, including the authorities discussed below.
TILA
TILA section 105(a). As amended by the Dodd-Frank Act, TILA section
105(a), 15 U.S.C. 1604(a), directs the Bureau to prescribe regulations
to carry out the purposes of TILA, and provides that such regulations
may contain additional requirements, classifications, differentiations,
or other provisions, and may provide for such adjustments and
exceptions for all or any class of transactions that the Bureau judges
are necessary or proper to effectuate the purposes of TILA, to prevent
circumvention or evasion thereof, or to facilitate compliance
therewith. A purpose of TILA is ``to assure a meaningful disclosure of
credit terms so that the consumer will be able to compare more readily
the various credit terms available to him and avoid the uninformed use
of credit.'' TILA section 102(a), 15 U.S.C. 1601(a). This stated
purpose is informed by Congress's finding that ``economic stabilization
would be enhanced and the competition among the various financial
institutions and other firms engaged in the extension of consumer
credit would be strengthened by the informed use of credit[.]'' TILA
section 102(a). Thus, strengthened competition among financial
institutions is a goal of TILA, achieved through the effectuation of
TILA's purposes.
Historically, TILA section 105(a) has served as a broad source of
authority for rules that promote the informed use of credit through
required disclosures and substantive regulation of certain practices.
However, Dodd-Frank Act section 1100A clarified the Bureau's section
105(a) authority by amending that section to provide express authority
to prescribe regulations that contain ``additional requirements'' that
the Bureau finds are necessary or proper to effectuate the purposes of
TILA, to prevent circumvention or evasion thereof, or to facilitate
compliance therewith. This amendment clarified the authority to
exercise TILA section 105(a) to prescribe requirements beyond those
specifically listed in the statute that meet the standards outlined in
section 105(a). The Dodd-Frank Act also clarified the Bureau's
rulemaking authority over high-cost mortgages under HOEPA pursuant to
section 105(a). As amended by the Dodd-Frank Act, TILA section 105(a)
authority to make adjustments and exceptions to the requirements of
TILA applies to all transactions subject to TILA, except with respect
to the substantive provisions of TILA section 129, 15 U.S.C. 1639, that
apply to the high-cost mortgages defined in TILA section 103(bb), 15
U.S.C. 1602(bb).
TILA, as amended by the Dodd-Frank Act, states that it is the
purpose of the ability-to-repay requirements of TILA

[[Page 6422]]

section 129C to assure that consumers are offered and receive
residential mortgage loans on terms that reasonably reflect their
ability to repay the loans and that are understandable and not unfair,
deceptive, or abusive. TILA section 129B(a)(2). The Bureau interprets
this addition as a new purpose of TILA. Therefore, the Bureau believes
that its authority under TILA section 105(a) to make exceptions,
adjustments, and additional provisions, among other things, that the
Bureau finds are necessary or proper to effectuate the purposes of
TILA, to prevent circumvention or evasion thereof, or to facilitate
compliance therewith applies with respect to the purpose of section
129C as well as the purpose described in section TILA section
129B(a)(2).
The purpose of TILA section 129C is informed by the findings
articulated in section 129B(a) 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 and affordable mortgage credit remains
available to consumers.
As discussed in the section-by-section analysis below, the Bureau
is issuing regulations to carry out TILA's purposes, including such
additional requirements, adjustments, and exceptions as, in the
Bureau's judgment, are necessary and proper to carry out the purposes
of TILA, prevent circumvention or evasion thereof, or to facilitate
compliance therewith. In developing these aspects of the final rule
pursuant to its authority under TILA section 105(a), the Bureau has
considered the purposes of TILA, including the purposes of TILA section
129C, and the findings of TILA, including strengthening competition
among financial institutions and promoting economic stabilization, and
the findings of TILA section 129B(a)(1), 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. The Bureau believes that ensuring that
mortgage credit is offered and received on terms consumers can afford
ensures the availability of responsible, affordable mortgage credit.
TILA section 129B(e). Dodd-Frank Act section 1405(a) amended TILA
to add new section 129B(e), 15 U.S.C. 1639B(e). That section authorizes
the Bureau to prohibit or condition terms, acts, or practices relating
to residential mortgage loans that the Bureau finds to be abusive,
unfair, deceptive, predatory, necessary or proper to ensure that
responsible, affordable mortgage credit remains available to consumers
in a manner consistent with the purposes of TILA section 129C,
necessary or proper to effectuate the purposes of sections 129B and
129C, to prevent circumvention or evasion thereof, or to facilitate
compliance with such sections, or are not in the interest of the
consumer. In developing rules under TILA section 129B(e), the Bureau
has considered whether the rules are in the interest of the consumer,
as required by the statute. As discussed in the section-by-section
analysis below, the Bureau is issuing portions of this rule pursuant to
its authority under TILA section 129B(e).
The Dodd-Frank Act
Dodd-Frank Act section 1022(b). Section 1022(b)(1) of the Dodd-
Frank Act authorizes the Bureau to prescribe rules ``as may be
necessary or appropriate to enable the Bureau to administer and carry
out the purposes and objectives of the Federal consumer financial laws,
and to prevent evasions thereof.'' 12 U.S.C. 5512(b)(1). TILA and title
X of the Dodd-Frank Act are Federal consumer financial laws.
Accordingly, the Bureau is exercising its authority under Dodd-Frank
Act section 1022(b) to prescribe rules that carry out the purposes and
objectives of TILA and title X and prevent evasion of those laws.

V. Section-by-Section Analysis

Section 1026.25 Record Retention

25(a) General Rule
Section 1416 of the Dodd-Frank Act revised TILA section 130(e) to
extend the statute of limitations for civil liability for a violation
of TILA section 129C, as well as sections 129 and 129B, to three years
after the date a violation occurs. Existing Sec. 1026.25(a) requires
that creditors retain evidence of compliance with Regulation Z for two
years after disclosures must be made or action must be taken.
Accordingly, the Board proposed to revise Sec. 226.25(a) \74\ to
require that creditors retain records that show compliance with
proposed Sec. 226.43, which would implement TILA section 129C, for at
least three years after consummation. The Board did not propose to
alter the regulation's existing clarification that administrative
agencies responsible for enforcing Regulation Z may require creditors
under the agency's jurisdiction to retain records for a longer period,
if necessary to carry out the agency's enforcement responsibilities
under TILA section 108, 15 U.S.C. 1607. Under TILA section 130(e), as
amended by Dodd-Frank, the statute of limitations for civil liability
for a violation of other sections of TILA remains one year after the
date a violation occurs, except for private education loans under 15
U.S.C. 1650(a), actions brought under section 129 or 129B, or actions
brought by a State attorney general to enforce a violation of section
129, 129B, 129C, 129D, 129E, 129F, 129G, or 129H. 15 U.S.C. 1640(e).
Moreover, as amended by section 1413 of the Dodd-Frank Act, TILA
provides that when a creditor, an assignee, other holder or their agent
initiates a foreclosure action, a consumer may assert a violation of
TILA section 129C(a) ``as a matter of defense by recoupment or
setoff.'' TILA section 130(k). There is no time limit on the use of
this defense.
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\74\ This section-by-section analysis discusses the Board's
proposal by reference to the Board's Regulation Z, 12 CFR part 226,
which the Board proposed to amend, and discusses the Bureau's final
rule by reference to the Bureau's Regulation Z, 12 CFR part 1026,
which this final rule amends.
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As discussed below, the Bureau is adopting minor modifications to
Sec. 1026.25(a) and adding in new Sec. 1026.25(c) to reflect section
1416 of the Dodd-Frank Act, in Sec. 1026.25(c)(3) as well as other
exceptional record retention requirements related to mortgage loans.
25(c) Records Related to Certain Requirements for Mortgage Loans
The Bureau is adopting the revision proposed in Sec. 226.25(a) to
require a creditor to retain records demonstrating compliance with
Sec. 1026.43 consistent with the extended statute of limitations for
violations of that section, though the Bureau is adopting this
requirement in Sec. 1026.25(c)(3) to provide additional clarity. As
the 2012 TILA-RESPA Proposal proposed new Sec. 1026.25(c)(1) and the
2012 Loan Originator Proposal proposed new Sec. 1026.25(c)(2), the
Bureau concludes that adding new Sec. 1026.25(c)(3) eases compliance
burden by placing all record retention requirements that are related to
mortgage loans and which differ from the general record retention in
one section, Sec. 1026.25(c). Likewise, the Bureau is amending Sec.
1026.25(a) to reflect that certain record retention requirements, such
as records related to minimum standards for transactions secured by a
dwelling, are governed by Sec. 1026.43(c).
Commenters did not provide the Bureau with significant, specific
feedback with respect to proposed Sec. 226.25(a), although industry

[[Page 6423]]

commenters generally expressed concern with respect to the compliance
burden of the 2011 ATR Proposal. Increasing the period a creditor must
retain records from two to three years may impose some marginal
increase in the creditor's compliance burden in the form of incremental
cost of storage. However, the Bureau believes that even absent the
rule, responsible creditors will likely elect to retain records of
compliance with Sec. 1026.43 for a period of time well beyond three
years, given that the statute allows consumers to bring a defensive
claim for recoupment or setoff in the event that a creditor or assignee
initiates foreclosure proceedings. Indeed, at least one commenter noted
this tension and requested that the Bureau provide further regulatory
instruction, although the Bureau does not deem it necessary to mandate
recordkeeping burdens beyond what is required by section 1416 of the
Dodd-Frank Act. Furthermore, the record-keeping burden imposed by the
rule is tailored only to show compliance with Sec. 1026.43, and the
Bureau believes is justified to protect the interests of both creditors
and consumers in the event that an affirmative claim is brought during
the first three years after consummation.
The Bureau believes that calculating the record retention period
under Sec. 1026.43 from loan consummation facilitates compliance by
establishing a single, clear start to the period, even though a
creditor will take action (e.g., underwriting the covered transaction
and offering a consumer the option of a covered transaction without a
prepayment penalty) over several days or weeks prior to consummation.
The Bureau is thus adopting the timeframe as proposed to reduce
compliance burden.
Existing comment 25(a)-2 clarifies that, in general, a creditor
need retain only enough information to reconstruct the required
disclosures or other records. The Board proposed, and the Bureau is
adopting, amendments to comment 25(a)-2 and a new comment 25(c)(3)-1 to
clarify that, if a creditor must verify and document information used
in underwriting a transaction subject to Sec. 1026.43, the creditor
must retain evidence sufficient to demonstrate having done so, in
compliance with Sec. 1026.25(a) and Sec. 1026.25(c)(3). In an effort
to reduce compliance burden, comment 25(c)(3)-1 also clarifies that
creditors need not retain actual paper copies of the documentation used
to underwrite a transaction but that creditors must be able to
reproduce those records accurately.
The Board proposed comment 25(a)-7 to provide guidance on retaining
records evidencing compliance with the requirement to offer a consumer
an alternative covered transaction without a prepayment penalty, as
discussed below in the section-by-section analysis of Sec.
1026.43(g)(3) through (5). The Bureau believes the requirement to offer
a transaction without a prepayment penalty under TILA section
129C(c)(4) is intended to ensure that consumers who choose an
alternative covered transaction with a prepayment penalty do so
voluntarily. The Bureau further believes it is unnecessary, and
contrary to the Bureau's efforts to streamline its regulations,
facilitate regulatory compliance, and minimize compliance burden, for a
creditor to document compliance with the requirement to offer an
alternative covered transaction without a prepayment penalty when a
consumer does not choose a transaction with a prepayment penalty or if
the covered transaction is not consummated. Accordingly, the Bureau is
adopting as proposed comment 25(a)-7 as comment 25(c)(3)-2, to clarify
that a creditor must retain records that document compliance with that
requirement if a transaction subject to Sec. 1026.43 is consummated
with a prepayment penalty, but need not retain such records if a
covered transaction is consummated without a prepayment penalty or a
covered transaction is not consummated. See Sec. 1026.43(g)(6).
The Board proposed comment 25(a)-7 also to provide specific
guidance on retaining records evidencing compliance with the
requirement to offer a consumer an alternative covered transaction
without a prepayment penalty when a creditor offers a transaction
through a mortgage broker. As discussed in detail below in the section-
by-section analysis of Sec. 1026.43(g)(4), the Board proposed that if
the creditor offers a covered transaction with a prepayment penalty
through a mortgage broker, the creditor must present the mortgage
broker an alternative covered transaction without a prepayment penalty.
Also, the creditor must provide, by agreement, for the mortgage broker
to present to the consumer that transaction or an alternative covered
transaction without a prepayment penalty offered by another creditor
that has a lower interest rate or a lower total dollar amount of
origination points or fees and discount points than the creditor's
presented alternative covered transaction. The Bureau did not receive
significant comment on this clarification, and is adopting the comment
largely as proposed, renumbered as comment 25(c)(3)-2. Comment
25(c)(3)-2 also clarifies that, to demonstrate compliance with Sec.
1026.43(g)(4), the creditor must retain a record of (1) the alternative
covered transaction without a prepayment penalty presented to the
mortgage broker pursuant to Sec. 1026.43(g)(4)(i), such as a rate
sheet, and (2) the agreement with the mortgage broker required by Sec.
1026.34(g)(4)(ii).

Section 1026.32 Requirements for High-Cost Mortgages

32(b) Definitions
32(b)(1)
Points and Fees--General
Section 1412 of the Dodd-Frank Act added TILA section
129C(b)(2)(A)(vii), which defines a ``qualified mortgage'' as a loan
for which, among other things, the total ``points and fees'' do not
exceed 3 percent of the total loan amount. The limits on points and
fees for qualified mortgages are implemented in new Sec.
1026.43(e)(3).
TILA section 129C(b)(2)(C) generally defines ``points and fees''
for qualified mortgages to have the same meaning as in TILA section
103(aa)(4) (renumbered as section 103(bb)(4)), which defines ``points
and fees'' for the purpose of determining whether a transaction
qualifies as a high-cost mortgage under HOEPA.\75\ TILA section
103(aa)(4) is implemented in current Sec. 1026.32(b)(1). Accordingly,
the Board proposed in Sec. 226.43(b)(9) that, for a qualified
mortgage, ``points and fees'' has the same meaning as in Sec.
226.32(b)(1).
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\75\ The Dodd-Frank Act renumbered existing TILA section
103(aa), which contains the definition of ``points and fees,'' for
the high-cost mortgage points and fees threshold, as section
103(bb). See Sec. 1100A(1)(A) of the Dodd-Frank Act. However, in
defining points and fees for the qualified mortgage points and fees
limits, TILA section 129C(b)(2)(C) refers to TILA section 103(aa)(4)
rather than TILA section 103(bb)(4). To give meaning to this
provision, the Bureau concludes that the reference to TILA section
in 103(aa)(4) in TILA section 129C(b)(2)(C) is mistaken and
therefore interprets TILA section 129C(b)(2)(C) as referring to the
points and fees definition in renumbered TILA section 103(bb)(4).
This proposal generally references TILA section 103(aa) to refer to
the pre-Dodd-Frank provision, which is in effect until the Dodd-
Frank Act's amendments take effect, and TILA section 103(bb) to
refer to the provision as amended.
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The Board also proposed in the 2011 ATR Proposal to amend Sec.
226.32(b)(1) to implement revisions to the definition of ``points and
fees'' under section 1431 of the Dodd-Frank Act. Among other things,
the Dodd-Frank Act excluded certain private mortgage insurance premiums
from, and added loan originator compensation and prepayment penalties
to, the definition of ``points and fees'' that had previously

[[Page 6424]]

applied to high-cost mortgage loans under HOEPA. In the Bureau's 2012
HOEPA Proposal, the Bureau republished the Board's proposed revisions
to Sec. 226.32(b)(1), with only minor changes, in renumbered Sec.
1026.32(b)(1).
The Bureau noted in its 2012 HOEPA Proposal that it was
particularly interested in receiving comments concerning any newly-
proposed language and the application of the definition in the high-
cost mortgage context. The Bureau received numerous comments from both
industry and consumer advocacy groups, the majority of which were
neither specific to newly-proposed language nor to the application of
the definition to high-cost mortgages. These comments largely
reiterated comments that the Board and the Bureau had received in the
ATR rulemaking docket. The Bureau is addressing comments received in
response to 2012 HOEPA Proposal in the 2013 HOEPA Final Rule.
Similarly, comments received in response to the Board's 2011 ATR
Proposal are discussed in this final rule. The Bureau is carefully
coordinating the 2013 HOEPA and ATR Final Rules to ensure a consistent
and cohesive regulatory framework. The Bureau is now finalizing Sec.
1026.32(b)(1), (b)(3), (b)(4)(i), (b)(5), and (b)(6)(i) in this rule in
response to the comments received on both proposals. The Bureau is
finalizing Sec. 1026.32(b)(2), (b)(4)(ii), and (b)(6)(ii) in the 2013
HOEPA Final Rule.
Existing Sec. 1026.32(b)(1) defines ``points and fees'' by listing
included charges in Sec. 1026.32(b)(1)(i) through (iv). As discussed
below, the Board proposed revisions to Sec. 226.32(b)(1)(i) through
(iv) and proposed to add new Sec. 226.32(b)(1)(v) and (vi). In the
2012 HOEPA Proposal, the Bureau proposed to add the phrase ``in
connection with a closed-end mortgage loan'' to Sec. 1026.32(b)(1) to
clarify that its definition of ``points and fees'' would have applied
only for closed-end mortgages. The Bureau also proposed to define
``points and fees'' in Sec. 1026.32(b)(3) for purposes of defining
which open-end credit plans qualify as ``high-cost mortgages'' under
HOEPA. However, that section is not relevant to this rulemaking because
the ability-to-repay requirement in TILA section 129C does not apply to
open-end credit. Accordingly, the Bureau is adopting Sec.
1026.32(b)(1) with the clarification that its definition of ``points
and fees'' is ``in connection with a closed-end mortgage loan.''
Payable at or before consummation. In the 2011 ATR Proposal, the
Board noted that the Dodd-Frank Act removed the phrase ``payable at or
before closing'' from the high-cost mortgage points and fees test in
TILA section 103(aa)(1)(B). See TILA section 103(bb)(1)(A)(ii). Prior
to the Dodd-Frank Act, fees and charges were included in points and
fees for the high-cost mortgage points and fees test only if they were
payable at or before closing. The phrase ``payable at or before
closing'' is also not in TILA's provisions on the points and fees cap
for qualified mortgages. See TILA section 129C(b)(2)(A)(vii),
(b)(2)(C). Thus, the Board stated that, with a few exceptions, the
statute provides that any charge that falls within the ``points and
fees'' definition must be counted toward the limits on points and fees
for both high-cost mortgages and qualified mortgages, even if it is
payable after loan closing. The Board noted that the exceptions are
mortgage insurance premiums and charges for credit insurance and debt
cancellation and suspension coverage. The statute expressly states that
these premiums and charges are included in points and fees only if
payable at or before closing. See TILA section 103(bb)(1)(C) (for
mortgage insurance) and TILA section 103(bb)(4)(D) (for credit
insurance and debt cancellation and suspension coverage).
The Board expressed concern that some fees that occur after
closing, such as fees to modify a loan, might be deemed to be points
and fees. If so, the Board cautioned that calculating the points and
fees to determine whether a transaction is a qualified mortgage may be
difficult because the amount of future fees (e.g., loan modification
fees) cannot be known prior to closing. The Board noted that creditors
might be exposed to excessive litigation risk if consumers were able at
any point during the life of a mortgage to argue that the points and
fees for the loan exceed the qualified mortgage limits due to fees
imposed after loan closing. The Board expressed concern that creditors
therefore might be discouraged from making qualified mortgages, which
would undermine Congress's goal of increasing incentives for creditors
to make more stable, affordable loans. The Board requested comment on
whether any other types of fees should be included in points and fees
only if they are ``payable at or before closing.''
Several industry commenters stated that charges paid after closing
should not be included in points and fees and requested that the Bureau
clarify whether such charges are included. For example, some industry
commenters sought confirmation that charges for a subsequent loan
modification would not be included in points and fees. More generally,
industry commenters argued that they would have difficulty calculating
charges that would be paid after closing and that including such
charges in points and fees would create uncertainty and litigation
risk. In response to the Bureau's 2012 HOEPA Proposal, one consumer
advocate noted that there are inconsistent and confusing standards for
when charges must be payable to be included in points and fees. This
commenter recommended that the Bureau adopt a ``known at or before
closing'' standard, arguing that this standard would clarify that
financed points are included, would prevent creditors from evading the
points and fees test by requiring consumers to pay charges after
consummation, and would provide certainty to creditors that must know
the amount of points and fees at or before closing.
The Bureau appreciates that creditors need certainty in calculating
points and fees so they can ensure that they are originating qualified
mortgages (or are not exceeding the points and fees thresholds for
high-cost mortgages). The Dodd-Frank Act provides that for the points
and fees tests for both qualified mortgages and high-cost mortgages,
only charges ``payable in connection with'' the transaction are
included in points and fees. See TILA sections 103(bb)(1)(A)(ii) (high-
cost mortgages) and 129C(b)(2)(A)(vii) (qualified mortgages). The
Bureau interprets this ``in connection with'' requirement as limiting
the universe of charges that need to be included in points and fees. To
clarify when charges or fees are ``in connection with'' a transaction,
the Bureau is specifying in Sec. 1026.32(b)(1) that fees or charges
are included in points and fees only if they are ``known at or before
consummation.''
The Bureau is also adding new comment 32(b)(1)-1, which provides
examples of fees and charges that are and are not known at or before
consummation. The comment explains that charges for a subsequent loan
modification generally would not be included in points and fees
because, at consummation, the creditor would not know whether a
consumer would seek to modify the loan and therefore would not know
whether charges in connection with a modification would ever be
imposed. Indeed, loan modification fees likely would not be included in
the finance charge under Sec. 1026.4, as they would not be charges
imposed by creditor as an incident to or a condition of the extension
of credit. Thus, this clarification is consistent with the definition
of the finance charge. Comment 32(b)(1)-1 also

[[Page 6425]]

clarifies that the maximum prepayment penalties that may be charged or
collected under the terms of a mortgage loan are included in points and
fees under Sec. 1026.32(b)(1)(v). In addition, comment 32(b)(1)-1
notes that, under Sec. 1026.32(b)(1)(i)(C)(1) and (iv), premiums or
other charges for private mortgage insurance and credit insurance
payable after consummation are not included in points and fees. This
means that such charges may be included in points and fees only if they
are payable at or before consummation. Thus, even if the amounts of
such premiums or other charges are known at or before consummation,
they are included in points and fees only if they are payable at or
before consummation.
32(b)(1)(i)
Points and Fees--Included in the Finance Charge
TILA section 103(aa)(4)(A) specifies that ``points and fees''
includes all items included in the finance charge, except interest or
the time-price differential. This provision is implemented in current
Sec. 1026.32(b)(1)(i). Section 1431 of the Dodd-Frank Act added TILA
section 103(bb)(1)(C), which excludes from points and fees certain
types and amounts of mortgage insurance premiums.
The Board proposed to revise Sec. 226.32(b)(1)(i) to implement
these provisions. The Board proposed to move the exclusion of interest
or the time-price differential to new Sec. 226.32(b)(1)(i)(A). The
Board also proposed to add Sec. 226.32(b)(1)(i)(B) to implement the
new exclusion for certain mortgage insurance. In Sec. 226.32(b)(1)(i),
the Board proposed to revise the phrase ``all items required to be
disclosed under Sec. 226.4(a) and 226.4(b)'' to read ``all items
considered to be a finance charge under Sec. 226.4(a) and 226.4(b)''
because Sec. 226.4 does not itself require disclosure of the finance
charge.
One industry commenter argued that the definition of points and
fees was overbroad because it included all items considered to be a
finance charge. The commenter asserted that several items that are
included in the finance charge under Sec. 1026.4(b) are vague or
inapplicable in the context of mortgage transactions or duplicate items
specifically addressed in other provisions. Several industry commenters
also requested clarification about whether certain types of fees and
charges are included in points and fees. At least two commenters asked
that the Bureau clarify that closing agent costs are not included in
points and fees.
The Bureau is adopting renumbered Sec. 1026.32(b)(1)(i) and (i)(A)
substantially as proposed, with certain clarifications in the
commentary and in other parts of the rule as discussed below to address
commenters' requests for clarification. For consistency with the
language in Sec. 1026.4, the Bureau is revising Sec. 1026.32(b)(1)(i)
to refer to ``items included in the finance charge'' rather than
``items considered to be a finance charge.''
As noted above, several commenters requested clarification
regarding whether certain types of charges would be included in points
and fees. With respect to closing agent charges, Sec. 1026.4(a)(2)
provides a specific rule for when such charges must be included in the
finance charge. If they are not included in the finance charge, they
would not be included in points and fees. Moreover, as discussed below
and in new comment 32(b)(1)(i)(D)-1, certain closing agent charges may
also be excluded from points and fees as bona fide third-party charges
that are not retained by the creditor, loan originator, or an affiliate
of either.
The Board also proposed to revise comment 32(b)(1)(i)-1, which
states that Sec. 226.32(b)(1)(i) includes in the total ``points and
fees'' items defined as finance charges under Sec. 226.4(a) and
226.4(b). The comment explains that items excluded from the finance
charge under other provisions of Sec. 226.4 are not included in the
total ``points and fees'' under Sec. 226.32(b)(1)(i), but may be
included in ``points and fees'' under Sec. 226.32(b)(1)(ii) and (iii).
The Board proposed to revise this comment to state that items excluded
from the finance charge under other provisions of Sec. 226.4 may be
included in ``points and fees'' under Sec. 226.32(b)(1)(ii) through
(vi).\76\ The proposed revision was intended to reflect the additional
items added to the definition of ``points and fees'' by the Dodd-Frank
Act and corrected the previous omission of Sec. 226.32(b)(1)(iv). See
proposed Sec. 226.32(b)(1)(v) and (vi).
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\76\ Proposed comment 32(b)(1)(i)-1 contained a typographical
error. It stated that ``[i]tems excluded from the finance charge
under other provisions of Sec. 226.4 are not excluded in the total
``points and fees'' under Sec. 226.32(b)(1)(i), but may be included
in ``points and fees'' under Sec. 226.32(b)(1)(ii) through Sec.
226.32(b)(1)(vi).'' (emphasis added). It should have read that such
items ``are not included in the total ``points and fees'' under
Sec. 226.32(b)(1)(i), but may be included in ``points and fees''
under Sec. 226.32(b)(1)(ii) through Sec. 226.32(b)(1)(vi).''
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The proposed comment also would have added an example of how this
rule would operate. Under that example, a fee imposed by the creditor
for an appraisal performed by an employee of the creditor meets the
general definition of ``finance charge'' under Sec. 226.4(a) as ``any
charge payable directly or indirectly by the consumer and imposed
directly or indirectly by the creditor as an incident to or a condition
of the extension of credit.'' However, Sec. 226.4(c)(7) expressly
provides that appraisal fees are not finance charges. Therefore, under
the general rule in proposed Sec. 226.32(b)(1)(i) providing that
finance charges must be counted as points and fees, a fee imposed by
the creditor for an appraisal performed by an employee of the creditor
would not have been counted in points and fees. Proposed Sec.
226.32(b)(1)(iii), however, would have expressly included in points and
fees items listed in Sec. 226.4(c)(7) (including appraisal fees) if
the creditor receives compensation in connection with the charge. A
creditor would receive compensation for an appraisal performed by its
own employee. Thus, the appraisal fee in this example would have been
included in the calculation of points and fees.
The Bureau did not receive substantial comment on this proposed
guidance. The Bureau is adopting comment 32(b)(1)(i)-1, with certain
revisions for clarity. As revised, comment 32(b)(1)(i)-1 explains that
certain items that may be included in the finance charge under Sec.
1026.32(b)(1)(i) are excluded under Sec. 1026.32(b)(1)(i)(A) through
(F).
Mortgage Insurance
Under existing Sec. 1026.32(b)(1)(i), mortgage insurance premiums
are included in the finance charge and therefore are included in points
and fees if payable at or before closing. As noted above, the Board
proposed new Sec. 226.32(b)(1)(i)(B) to implement TILA section
103(bb)(1)(C), which provides that points and fees shall exclude
certain charges for mortgage insurance premiums. Specifically, the
statute excludes: (1) Any premium charged for insurance provided by an
agency of the Federal Government or an agency of a State; (2) any
amount that is not in excess of the amount payable under policies in
effect at the time of origination under section 203(c)(2)(A) of the
National Housing Act, provided that the premium, charge, or fee is
required to be refundable on a pro-rated basis and the refund is
automatically issued upon notification of the satisfaction of the
underlying mortgage loan; and (3) any premium paid by the consumer
after closing.
The Board noted that the exclusions for certain premiums could
plausibly be interpreted to apply to the definition of points and fees
solely for purposes of high-cost mortgages and not for qualified
mortgages. TILA section

[[Page 6426]]

129C(b)(2)(C)(i) cross-references TILA section 103(aa)(4) (renumbered
as 103(bb)(4)) for the definition of ``points and fees,'' but the
provision on mortgage insurance appears in TILA section 103(bb)(1)(C)
and not in section 103(bb)(4). The Board also noted that certain
provisions in the Dodd-Frank Act's high-cost mortgage section regarding
points and fees are repeated in the qualified mortgage section on
points and fees. For example, both the high-cost mortgage provisions
and the qualified mortgage provisions expressly exclude from points and
fees ``bona fide third party charges not retained by the mortgage
originator, creditor, or an affiliate of the creditor or mortgage
originator.'' TILA sections 103(bb)(1)(A)(ii) (for high-cost
mortgages), 129C(b)(2)(C)(i) (for qualified mortgages). The mortgage
insurance provision, however, does not separately appear in the
qualified mortgage section.
Nonetheless, the Board concluded that the better interpretation of
the statute is that the mortgage insurance provision in TILA section
103(bb)(1)(C) applies to the meaning of points and fees for both high-
cost mortgages and qualified mortgages. The Board noted that the
statute's structure reasonably supports this view: by its plain
language, the mortgage insurance provision prescribes how points and
fees should be computed ``for purposes of paragraph (4),'' i.e., for
purposes of TILA section 103(bb)(4). The mortgage insurance provision
contains no caveat limiting its application solely to the points and
fees calculation for high-cost mortgages. Thus, the Board determined
that the cross-reference in the qualified mortgage provisions to TILA
section 103(bb)(4) should be read to include provisions that expressly
prescribe how points and fees should be calculated under TILA section
103(bb)(4), wherever located.
The Board noted that its proposal to apply the mortgage insurance
provision to the meaning of points and fees for both high-cost
mortgages and qualified mortgages is also supported by the Board's
authority under TILA section 105(a) to make adjustments to facilitate
compliance with TILA. The Board also cited its authority under TILA
section 129B(e) to condition terms, acts or practices relating to
residential mortgage loans that the Board finds necessary or proper to
effectuate the purposes of TILA. The purposes of TILA include
``assur[ing] that consumers are offered and receive residential
mortgage loan on terms that reasonably reflect their ability to repay
the loans.'' TILA section 129B(a)(2).
The Board also expressed concern about the increased risk of
confusion and compliance error if points and fees were to have two
separate meanings in TILA--one for determining whether a loan is a
high-cost mortgage and another for determining whether a loan is a
qualified mortgage. The Board stated that the proposal is intended to
facilitate compliance by applying the mortgage insurance provision to
the meaning of points and fees for both high-cost mortgages and
qualified mortgages.
In addition, the Board expressed concern that market distortions
could result due to different treatment of mortgage insurance in
calculating points and fees for high-cost mortgages and qualified
mortgages. ``Points and fees'' for both high-cost mortgages and
qualified mortgages generally excludes ``bona fide third party charges
not retained by the mortgage originator, creditor, or an affiliate of
the creditor or mortgage originator.'' TILA sections 103(bb)(1)(A)(ii),
129C(b)(2)(C)(i). Under this general provision standing alone, premiums
for up-front private mortgage insurance would be excluded from points
and fees. However, as noted, the statute's specific provision on
mortgage insurance (TILA section 103(bb)(1)(C)) imposes certain
limitations on the amount and conditions under which up-front premiums
for private mortgage insurance are excluded from points and fees.
Applying the mortgage insurance provision to the definition of points
and fees only for high-cost mortgages would mean that any premium
amount for up-front private mortgage insurance could be charged on
qualified mortgages; in most cases, none of that amount would be
subject to the cap on points and fees for qualified mortgages because
it would be excluded as a ``bona fide third party fee'' that is not
retained by the creditor, loan originator, or an affiliate of either.
The Board noted that, as a result, consumers who obtain qualified
mortgages could be vulnerable to paying excessive up-front private
mortgage insurance costs. The Board concluded that this outcome would
undercut Congress's clear intent to ensure that qualified mortgages are
products with limited fees and more safe features.
For the reasons noted by the Board, the Bureau interprets the
mortgage insurance provision in TILA section 103(bb)(1)(C) as applying
to the meaning of points and fees for both high-cost mortgages and
qualified mortgages. The Bureau is also adopting this approach pursuant
to its authority under TILA sections 105(a) and 129C(b)(3)(B)(i).
Applying the mortgage insurance provision to the meaning of points and
fees for qualified mortgages is necessary and proper to effectuate the
purposes of, and facilitate compliance with the purposes of, the
ability-to-repay requirements in TILA section 129C. Similarly, the
Bureau finds that it is necessary and proper to use its authority under
TILA section 129C(b)(3)(B)(i) to revise, add to, or subtract from the
criteria that define a qualified mortgage. As noted above, construing
the mortgage insurance provision as applying to qualified mortgages
will reduce the likelihood that consumers who obtain qualified
mortgages will pay excessive private mortgage insurance premiums, and
therefore will help ensure that responsible, affordable credit remains
available to consumers in a manner consistent with the purposes of TILA
section 129C.
Proposed Sec. 226.32(b)(1)(i)(B) tracked the substance of the
statute with one exception. The Board interpreted the statute as
excluding from points and fees not only up-front mortgage insurance
premiums under government programs but also charges for mortgage
guaranties under government programs. The Board noted that it was
proposing the exclusion from points and fees of both mortgage insurance
premiums and guaranty fees under government programs pursuant to its
authority under TILA section 105(a) to make adjustments to facilitate
compliance with TILA and its purposes and to effectuate the purposes of
TILA. The Board also found that the exclusion is further supported by
the Board's authority under TILA section 129B(e) to condition terms,
acts or practices relating to residential mortgage loans that the Board
finds necessary or proper to effectuate the purposes of TILA. The
purposes of TILA include ``assur[ing] that consumers are offered and
receive residential mortgage loan on terms that reasonably reflect
their ability to repay the loans.'' TILA section 129B(a)(2).
The Board noted that both the U.S. Department of Veterans Affairs
(VA) and the U.S. Department of Agriculture (USDA) expressed concerns
that, if up-front charges for guaranties provided by those agencies and
State agencies were included in points and fees, their loans might
exceed high-cost thresholds and exceed the cap for qualified mortgages,
thereby disrupting these programs and jeopardizing an important source
of credit for many consumers. The Board requested comment on its
proposal to exclude up-front charges for any guaranty under a Federal
or State government program, as well as any up-front mortgage insurance
premiums under government programs.
Several industry commenters argued that premiums for private
mortgage

[[Page 6427]]

insurance should be excluded altogether, even if the premiums do not
satisfy the statutory standard for exclusion. These commenters noted
that private mortgage insurance provides substantial benefits, allowing
consumers who cannot afford a down payment an alternative for obtaining
credit. Another commenter noted that the refundability requirement of
the rule would make private mortgage insurance more expensive.
One industry commenter asserted that the language in proposed Sec.
226.32(b)(1)(i)(B)(2) was inconsistent with the statutory language and
the example in the commentary. The commenter suggested that a literal
reading of proposed Sec. 226.32(b)(1)(i)(B)(2) would require exclusion
of the entire premium if it exceeded the FHA insurance premium, rather
than merely exclusion of that portion of the premium in excess of the
FHA premium. Another industry commenter maintained that the term
``upfront'' is vague and that the Bureau instead should use the phrase
``payable at or before closing.''
The Bureau is adopting proposed Sec. 226.32(b)(1)(i)(B) as
reunumbered Sec. 1026.32(b)(1)(i)(B) with no substantive changes but
with revisions for clarity. The Bureau is dividing proposed Sec.
226.32(b)(1)(i)(B) into two parts. The first part, Sec.
1026.32(b)(1)(i)(B), addresses insurance premiums and guaranty charges
under government programs. The second part, Sec. 1026.32(b)(1)(i)(C),
addresses premiums for private mortgage insurance.
Consistent with the Board's proposal, Sec. 1026.32(b)(1)(i)(B)
excludes from points and fees charges for mortgage guaranties under
government programs, as well as premiums for mortgage insurance under
government programs. The Bureau concurs with the Board's interpretation
that, in addition to mortgage insurance premiums under government
programs, the statute also excludes from points and fees charges for
mortgage guaranties under government programs. Like the Board, the
Bureau believes that this conclusion is further supported by TILA
sections 105(a) and 129C(b)(3)(B)(i) and that it is necessary and
proper to invoke this authority. The exclusion from points and fees of
charges for mortgage guaranties under government programs is necessary
and proper to effectuate the purposes of TILA. The Bureau is concerned
that including such charges in points and fees could cause loans
offered through government programs to exceed high-cost mortgage
thresholds and qualified mortgage points and fees limits, potentially
disrupting an important source of affordable financing for many
consumers. This exclusion helps ensure that loans do not unnecessarily
exceed the points and fees limits for qualified mortgages, which is
consistent with the purpose, stated in TILA section 129B(a)(2), of
assuring that consumers are offered and receive residential mortgage
loans on terms that reasonably reflect their ability to repay the loans
and with the purpose stated in TILA section 129C(b)(3)(B)(i) of
ensuring that responsible, affordable mortgage credit remains available
to consumers in a manner consistent with the purposes of TILA section
129C.
Proposed comment 32(b)(1)(i)-2 provided an example of a mortgage
insurance premium that is not counted in points and fees because the
loan was insured by the FHA. The Bureau is renumbering this comment as
32(b)(1)(i)(B)-1 and revising it to add an additional example to
clarify that mortgage guaranty fees under government programs, such as
VA and USDA funding fees, are excluded from points and fees. The Bureau
is also deleting the reference to ``up-front'' premiums and charges.
Under the statute, premiums for mortgage insurance or guaranty fees in
connection with a Federal or State government program are excluded from
points and fees whenever paid. The statutory provision excluding
premiums or charges paid after consummation applies only to private
mortgage insurance.
The Bureau is addressing exclusions for private mortgage insurance
in Sec. 1026.32(b)(1)(i)(C). For private mortgage insurance premiums
payable after consummation, Sec. 1026.32(b)(1)(i)(C)(1) provides that
the entire amount of the premium is excluded from points and fees. For
private mortgage insurance premiums payable at or before consummation,
Sec. 1026.32(b)(1)(i)(C)(1) provides that the portion of the premium
not in excess of the amount payable under policies in effect at the
time of origination under section 203(c)(2)(A) of the National Housing
Act is excluded from points and fees, provided that the premium is
required to be refundable on a pro-rated basis and the refund is
automatically issued upon notification of the satisfaction of the
underlying mortgage loan.
As noted by one commenter, the language in proposed Sec.
226.32(b)(1)(i)(B) could be read to conflict with the statute and the
commentary because it suggested that, if a private mortgage insurance
premium payable at or before consummation exceeded the FHA insurance
premium, then the entire private mortgage insurance premium would be
included in points and fees. The Bureau is clarifying in Sec.
1026.32(b)(1)(i)(C)(2) that only the portion of the private mortgage
insurance premium that exceeds the FHA premium must be included in
points and fees. With respect to the comments requesting that all
private mortgage insurance premiums be excluded from points and fees,
the Bureau notes that TILA section 103(bb)(1)(C) prescribes specific
and detailed conditions for excluding private mortgage insurance
premiums. Under these circumstances, the Bureau does not believe it
would be appropriate to exercise its exception authority to reverse
Congress's decision.
Proposed comment 32(b)(1)(i)-3 explained that private mortgage
insurance premiums payable at or before consummation need not be
included in points and fees to the extent that the premium does not
exceed the amount payable under policies in effect at the time of
origination under section 203(c)(2)(A) of the National Housing Act and
the premiums are required to be refunded on a pro-rated basis and the
refund is automatically issued upon notification of satisfaction of the
underlying mortgage loan. Proposed comment 32(b)(1)(i)-3 also provided
an example of this exclusion. Proposed comment 32(b)(1)(i)-4 explained
that private mortgage insurance premiums that do not qualify for an
exclusion must be included in points and fees whether paid at or before
consummation, in cash or financed, whether optional or required, and
whether the amount represents the entire premium or an initial payment.
The Bureau did not receive substantial comments on these proposed
interpretations. The Bureau is adopting comments 32(b)(1)(i)-3, and -4
with certain revisions for clarity and renumbered as comments
32(b)(1)(i)(C)-1 and -2. Comment 32(b)(1)(i)(C)-1.i is revised to
specify that private mortgage insurance premiums paid after
consummation are excluded from points and fees. The Bureau also adopts
clarifying changes that specify that creditors originating conventional
loans--even such loans that are not eligible to be FHA loans (i.e.,
because their principal balance is too high)--should look to the
permissible up-front premium amount for FHA loans, as implemented by
applicable regulations and other written authorities issued by the FHA
(such as Mortgagee Letters). For example, pursuant to HUD's Mortgagee
Letter 12-4 (published March 6, 2012), the allowable up-front FHA
premium for single-family homes is 1.75

[[Page 6428]]

percent of the base loan amount.\77\ Finally, the Bureau clarifies that
only the portion of the single or up-front PMI premium in excess of the
allowable FHA premium (i.e., rather than any monthly premium or portion
thereof) must be included in points and fees. Comments 32(b)(1)(i)(C)-1
and -2 also have both been revised for clarity and consistency. For
example, the comments as adopted refer to premiums ``payable at or
before consummation'' rather than ``up-front'' premiums and to
``consummation'' rather than ``closing.'' The Bureau notes that the
statute refers to ``closing'' rather than ``consummation.'' However,
for consistency with the terminology in Regulation Z, the Bureau is
using the term ``consummation.''
---------------------------------------------------------------------------

\77\ See Department of Housing and Urban Development, Mortgagee
Letter 12-4 (Mar. 6, 2012), available at https://portal.hud.gov/hudportal/documents/huddoc?id=12-04ml.pdf.
---------------------------------------------------------------------------

Bona Fide Third-Party Charges and Bona Fide Discount Points
The Dodd-Frank Act amended TILA to add nearly identical provisions
excluding certain bona fide third-party charges and bona fide discount
points from the calculation of points and fees for both qualified
mortgages and high-cost mortgages.\78\ Specifically, section 1412 of
the Dodd-Frank Act added new TILA section 129C(b)(2)(C), which excludes
certain bona fide third-party charges and bona fide discount points
from the calculation of points and fees for the qualified mortgage
points and fees threshold. Similarly, section 1431 of the Dodd-Frank
Act amended TILA section 103(bb)(1)(A)(ii) and added TILA section
103(dd) to provide for nearly identical exclusions in calculating
points and fees for the high-cost mortgage threshold.
---------------------------------------------------------------------------

\78\ The exclusions differ in only one respect. To exclude two
or one bona fide discount points from the points and fees test for
determining whether a loan is a high-cost mortgage, TILA section
103(dd)(1)(B) and (C) specified that the interest rate for personal
property loans before the discount must be within 1 or 2 percentage
points, respectively, of the average rate on a loan in connection
with which insurance is provided under title I of the National
Housing Act. TILA section 129C(b)(2)(C), which prescribes conditions
for excluding bona fide discount points from points and fees for
qualified mortgages, does not contain analogous provisions.
---------------------------------------------------------------------------

In the 2011 ATR Proposal, the Board proposed to implement in Sec.
226.43(e)(3)(ii)(A) through (C) the exclusion of certain bona fide
third-party charges and bona fide discount points only for the
calculation of points and fees for the qualified mortgage points and
fees threshold. In the 2012 HOEPA Proposal, the Bureau proposed to
implement these exclusions in proposed Sec. 1026.32(b)(5) for the
points and fees threshold for high-cost mortgages. The Bureau noted
that proposed Sec. 1026.32(b)(5) was generally consistent with the
Board's proposed Sec. 226.43(e)(3)(ii)(A) through (C).
The Bureau believes that it is appropriate to consolidate these
exclusions in a single provision. The Bureau is now finalizing both
rules, and the exclusions are nearly identical for both the qualified
mortgage and high-cost mortgage contexts. Moreover, under the Board's
ATR Proposal, the points and fees calculation for the qualified
mortgage points and fees threshold already would have cross-referenced
the definition of points and fees for high-cost mortgages in Sec.
226.32(b)(1). Given that the points and fees calculations for both the
qualified mortgage and high-cost mortgage points and fees thresholds
will use the same points and fees definition in Sec. 1026.32(b)(1),
the Bureau believes it is unnecessary to implement nearly identical
exclusions from points and fees in separate provisions for qualified
mortgages and high-cost mortgages. Accordingly, the Bureau is
consolidating the exclusions for certain bona fide third-party charges
and bona fide discount points for both qualified mortgages and high-
cost mortgages in new Sec. 1026.32(b)(1)(i)(D) through (F). In
addition, the definition of ``bona fide discount points'' for the
purposes of Sec. 1026.32(b)(1)(i)(E) and (F), which the 2011 ATR
Proposal would have implemented in Sec. 226.43(e)(3)(iv), is instead
being implemented in Sec. 1026.32(b)(3).
Bona fide third-party charges. TILA Section 129C(b)(2)(C)(i)
excludes from points and fees ``bona fide third party charges not
retained by the mortgage originator, creditor, or an affiliate of the
creditor or mortgage originator.'' Tracking the statute, proposed Sec.
226.43(e)(3)(ii)(A) would have excluded from ``points and fees'' for
qualified mortgages any bona fide third party charge not retained by
the creditor, loan originator, or an affiliate of either. Proposed
Sec. 226.43(e)(3)(iii) would have specified that the term ``loan
originator'' has the same meaning as in Sec. 226.36(a)(1).
Proposed Sec. 226.43(e)(3)(ii)(A) would also have implemented TILA
section 103(bb)(1)(C), which requires that premiums for private
mortgage insurance be included in ``points and fees'' as defined in
TILA section 103(bb)(4) under certain circumstances. Applying general
rules of statutory construction, the Board concluded that the more
specific provision on private mortgage insurance supersedes the more
general provision permitting any bona fide third party charge not
retained by the creditor, mortgage originator, or an affiliate of
either to be excluded from ``points and fees.'' Thus, proposed Sec.
226.43(e)(3)(ii)(A) would have excluded from points and fees any bona
fide third party charge not retained by the creditor, loan originator,
or an affiliate of either unless the charges were premiums for private
mortgage insurance that were included in points and fees under Sec.
226.32(b)(1)(i)(B).
The Board noted that, in setting the purchase price for specific
loans, Fannie Mae and Freddie Mac make loan-level price adjustments
(LLPAs) to compensate offset added risks, such as a high LTV or low
credit score, among many other risk factors. Creditors may, but are not
required to, increase the interest rate charged to the consumer so as
to offset the impact of the LLPAs or increase the costs to the consumer
in the form of points to offset the lost revenue resulting from the
LLPAs. The Board noted that, during outreach, some creditors argued
that these points should not be counted in points and fees for
qualified mortgages under the exclusion for ``bona fide third party
charges not retained by the loan originator, creditor, or an affiliate
of either'' in TILA section 129C(b)(2)(C).
The Board acknowledged creditors' concerns about exceeding the
qualified mortgage points and fees thresholds due to LLPAs required by
the GSEs. However, the Board questioned whether an exemption for LLPAs
would be consistent with congressional intent in limiting points and
fees for qualified mortgages. The Board noted that points charged to
meet GSE risk-based price adjustment requirements are arguably no
different than other points charged on loans sold to any secondary
market purchaser to compensate that purchaser for added loan-level
risks. Congress clearly contemplated that discount points generally
should be included in points and fees for qualified mortgages.
The Board noted that an exclusion for points charged by creditors
in response to secondary market LLPAs also would raise questions about
the appropriate treatment of points charged by creditors to offset
loan-level risks on mortgage loans that they hold in portfolio. The
Board reasoned that, under normal circumstances, these points are
retained by the creditor, so it would not be appropriate to exclude
them from points and fees under the ``bona fide third party charge''
exclusion. However, the Board cautioned that requiring that these
points be included in points and fees, when similar charges on loans
sold into the secondary market are excluded, may create undesirable
market

[[Page 6429]]

imbalances between loans sold to the secondary market and loans held in
portfolio.
The Board also noted that creditors may offset risks on their
portfolio loans (or on loans sold into the secondary market) by
charging a higher rate rather than additional points and fees; however,
the Board recognized the limits of this approach to loan-level risk
mitigation due to concerns such as exceeding high-cost mortgage rate
thresholds. Nonetheless, the Board noted that in practice, an exclusion
from the qualified mortgage points and fees calculation for all points
charged to offset loan-level risks may create compliance and
enforcement difficulties. The Board questioned whether meaningful
distinctions between points charged to offset loan-level risks and
other points and fees charged on a loan could be made clearly and
consistently. In addition, the Board observed that such an exclusion
could be overbroad and inconsistent with Congress's intent that points
generally be counted toward the points and fees threshold for qualified
mortgages.
The Board requested comment on whether and on what basis the final
rule should exclude from points and fees for qualified mortgages points
charged to meet risk-based price adjustment requirements of secondary
market purchasers and points charged to offset loan-level risks on
mortgages held in portfolio.
Consumer advocates did not comment on this issue. Many industry
commenters argued that LLPAs should be excluded from points and fees as
bona fide third party charges. The GSE commenters agreed that LLPAs
should be excluded as bona fide third party charges, noting that they
are not retained by the creditor. One GSE commenter noted that LLPAs
are set fees that are transparent and accessible via the GSEs' Web
sites. Some industry commenters contended that including LLPAs in
points and fees would cause many loans to exceed the points and fees
cap for qualified mortgages. Other industry commenters argued that
requiring LLPAs to be included in points and fees would force creditors
to recover the costs through increases in the interest rate. One of the
GSE commenters acknowledged the concern that creditors holding loans in
portfolio could be at a disadvantage if LLPAs were excluded from points
and fees and suggested that the Bureau consider allowing such creditors
to exclude published loan level risk adjustment fees.
One industry commenter urged the Bureau to coordinate with the
agencies responsible for finalizing the 2011 QRM Proposed Rule to avoid
unintended consequences. The 2011 ARM Proposed Rule, if adopted, would
require, in certain circumstances, that sponsors of MBS create premium
capture cash reserve accounts to limit sponsors' ability to monetize
the excess spread between the proceeds from the sale of the interests
and the par value of those interests. See 76 FR 24113. The commenter
stated that this would result in any premium in the price of a
securitization backed by residential mortgage loans being placed in a
first-loss position in the securitization. The commenter argued that
this would make premium loans too expensive to originate and that
creditors would not be able to recover LLPAs through interest rate
adjustments. The commenter maintained that if the LLPAs were included
in the calculation for the qualified mortgage points and fees limit,
creditors would also be severely constrained in recovering LLPAs
through points. The commenter argued that LLPAs therefore should be
excluded from the points and fees calculation for qualified mortgages.
The Bureau is adopting Sec. 226.43(e)(3)(ii)(A), with certain
revisions, as renumbered Sec. 1026.32(b)(1)(i)(D). As revised, Sec.
1026.32(b)(1)(i)(D) provides that a bona fide third party charge not
retained by the creditor, loan originator, or an affiliate of either
the general is excluded from points and fees unless the charge is
required to be included under Sec. 1026.32(b)(1)(i)(C) (for mortgage
insurance premiums), (iii) (for real estate related fees), or (iv) (for
credit insurance premiums). As noted above, the Board proposed that the
specific provision regarding mortgage insurance, TILA section
103(bb)(1)(C), should govern the exclusion of private mortgage
insurance premiums of points and fees, rather than TILA section
129C(b)(2)(C), which provides generally for the exclusion of certain
bona fide third-party charges. The Bureau likewise believes that the
specific statutory provisions regarding real estate related fees and
credit insurance premiums in TILA section 103(bb)(4)(C) and (D) should
govern whether these charges are included in points and fees rather
than the more general provisions regarding exclusion of bona fide
third-party charges, TILA sections 103(bb)(1)(A)(ii) (for high-cost
mortgages) or 129C(b)(2)(C) (for qualified mortgages). Thus, Sec.
1026.32(b)(1)(i)(D) provides that the general exclusion for bona fide
third-party charges applies unless the charges are required to be
included under Sec. 1026.32(b)(1)(i)(C), (iii), or (iv).
The Bureau acknowledges that TILA sections 103(bb)(1)(A)(ii) and
129C(b)(2)(C) could plausibly be read to provide for a two-step
calculation of points and fees: first, the creditor would calculate
points and fees as defined in TILA section 103(bb)(4); and, second, the
creditor would exclude all bona fide third-party charges not retained
by the mortgage originator, creditor, or an affiliate of either, as
provided in TILA sections 103(bb)(1)(A)(ii) (for high-cost mortgages)
and 129C(b)(2)(C) (for qualified mortgages). Under this reading,
charges for, e.g., private mortgage insurance could initially, in step
one, be included in points and fees but then, in step two, be excluded
as bona fide third-party charges under TILA sections 103(bb)(1)(A)(ii)
or 129C(b)(2)(C).
To give meaning to the specific statutory provisions regarding
mortgage insurance, real estate related fees, and credit insurance, the
Bureau believes that the better reading is that these specific
provisions should govern whether such charges are included in points
and fees, rather than the general provisions excluding certain bona
fide third-party charges. For example, Congress added TILA section
103(bb)(1)(C), which prescribes certain conditions under which private
mortgage insurance premiums would be included in points and fees. The
Bureau believes that the purpose of this provision is to help ensure
that consumers with a qualified mortgage are not charged excessive
private mortgage insurance premiums. If such premiums could be excluded
as bona fide third-party charges under TILA sections 103(bb)(1)(A)(ii)
or 129C(b)(2)(C), then the purpose of this provision would be
undermined. In further support of its interpretation, the Bureau is
invoking its authority under TILA section 105(a) to make such
adjustments and exceptions as are necessary and proper to effectuate
the purposes of TILA, including that consumers are offered and receive
residential mortgage loans on terms that reasonably reflect their
ability to repay the loans. Similarly, the Bureau finds that it is
necessary, proper and appropriate to use its authority under TILA
section 129C(b)(3)(B)(i) to revise and subtract from the statutory
language. This use of authority ensures that responsible, affordable
mortgage credit remains available to consumers in a manner consistent
with the purpose of TILA section 129C, referenced above, as well as
effectuating that purpose.
As noted above, several industry commenters argued that points
charged

[[Page 6430]]

by creditors to offset LLPAs should be excluded from points and fees
under Sec. 1026.32(b)(1)(i)(D). In setting the purchase price for
loans, the GSEs impose LLPAs to offset certain credit risks, and
creditors may but are not required to recoup the revenue lost as a
result of the LLPAs by increasing the costs to consumers in the form of
points. The Bureau believes that the manner in which creditors respond
to LLPAs is better viewed as a fundamental component of how the pricing
of a mortgage loan is determined rather than as a third party charge.
As the Board noted, allowing creditors to exclude points charged to
offset LLPAs could create market imbalances between loans sold on the
secondary market and loans held in portfolio. While such imbalances
could be addressed by excluding risk adjustment fees more broadly,
including fees charged by creditors for loans held in portfolio, the
Bureau agrees with the Board that this could create compliance and
enforcement difficulties. Thus, the Bureau concludes that points
charged to offset LLPAs may not be excluded from points and fees under
Sec. 1026.32(b)(1)(i)(D). To the extent that creditors offer consumers
the opportunity to pay points to lower the interest rate that the
creditor would otherwise charge to recover the lost revenue from the
LLPAs, such points may, if they satisfy the requirements of Sec.
1026.32(b)(1)(i)(E) or (F), be excluded from points and fees as bona
fide discount points.
As noted above, one commenter expressed concern that if the
requirements for premium capture cash reserve accounts proposed in the
2011 QRM Proposed Rule were adopted, creditors would have difficulty in
recovering the costs of LLPAs through rate and that, because of the
points and fees limits for qualified mortgages, creditors would also
have trouble recovering the costs of LLPAs through up-front charges to
consumers. The Bureau notes that, as proposed, the premium capture cash
reserve account requirement would not apply to securities sponsored by
the GSEs and would not apply to securities comprised solely of QRMs.
See 76 FR 24112, 24120. Thus, it is not clear, that even if it were
adopted, the requirement would have as substantial an impact as
suggested by the commenter. In any event, the requirement has merely
been proposed, not finalized. The Bureau will continue to coordinate
with the agencies responsible for finalizing the 2011 QRM Proposed Rule
to consider the combined effects of that rule and the instant rule.
The Board proposed comment 43(e)(3)(ii)-1 to clarify the meaning in
proposed Sec. 226.43(e)(3)(ii)(A) of ``retained by'' the loan
originator, creditor, or an affiliate of either. Proposed comment
43(e)(3)(ii)-1 provided that if a creditor charges a consumer $400 for
an appraisal conducted by a third party not affiliated with the
creditor, pays the third party appraiser $300 for the appraisal, and
retains $100, the creditor may exclude $300 of this fee from ``points
and fees'' but must count the $100 it retains in ``points and fees.''
As noted above, several commenters expressed confusion about the
relationship between proposed Sec. 226.43(e)(3)(ii)(A), which would
have excluded bona fide third party charges not retained by the loan
originator, creditor, or an affiliate of either, and proposed Sec.
226.32(b)(1)(iii), which would have excluded certain real estate
related charges if they are reasonable, if the creditor receives no
direct or indirect compensation in connection with the charges, and the
charges are not paid to an affiliate of the creditor. As explained
above, the Bureau interprets the more specific provision governing the
inclusion in points and fees of real estate related charges
(implemented in Sec. 1026.32(b)(1)(iii)) as taking precedence over the
more general exclusion for bona fide third party charges in renumbered
Sec. 1026.32(b)(1)(i)(D). Accordingly, the Bureau does not believe
that the example in proposed comment 43(e)(3)(ii)-1 is appropriate for
illustrating the exclusion for bona fide third party charges because
the subject of the example, appraisals, is specifically addressed in
Sec. 1026.32(b)(1)(iii).
The Bureau therefore is revising renumbered comment 32(b)(1)(i)(D)-
1 by using a settlement agent charge to illustrate the exclusion for
bona fide third party charges. By altering this example to address
closing agent charges, the Bureau is also responding to requests from
commenters that the Bureau provide more guidance on whether closing
agent charges are included in points and fees. As noted above, proposed
Sec. 226.43(e)(3)(iii) would have specified that the term ``loan
originator,'' as used in proposed Sec. 226.43(e)(3)(ii)(A), has the
same meaning as in Sec. 226.36(a)(1). The Bureau is moving the cross-
reference to the definition of ``loan originator'' in Sec.
226.36(a)(1) to comment 32(b)(1)(i)(D)-1.
The Board proposed comment 43(e)(3)(ii)-2 to explain that, under
Sec. 226.32(b)(1)(i)(B), creditors would have to include in ``points
and fees'' premiums or charges payable at or before consummation for
any private guaranty or insurance protecting the creditor against the
consumer's default or other credit loss to the extent that the premium
or charge exceeds the amount payable under policies in effect at the
time of origination under section 203(c)(2)(A) of the National Housing
Act (12 U.S.C. 1709(c)(2)(A)). The proposed comment also would have
explained that these premiums or charges would be included if the
premiums or charges were not required to be refundable on a pro-rated
basis, or the refund is not automatically issued upon notification of
the satisfaction of the underlying mortgage loan. The comment would
have clarified that, under these circumstances, even if the premiums
and charges were not retained by the creditor, loan originator, or an
affiliate of either, they would be included in the ``points and fees''
calculation for qualified mortgages. The comment also would have cross-
referenced proposed comments 32(b)(1)(i)-3 and -4 for further
discussion of including private mortgage insurance premiums in the
points and fees calculation.
The Bureau is adopting proposed comment 43(e)(3)(ii)-2
substantially as proposed, renumbered as comment 32(b)(i)(D)-2. In
addition, the Bureau also is adopting new comments 32(b)(i)(D)-3 and -4
to explain that the exclusion of bona fide third party charges under
Sec. 1026.32(b)(1)(i)(D) does not apply to real estate-related charges
and credit insurance premiums. The inclusion of these items in points
and fees is specifically addressed in Sec. 1026.32(b)(iii) and (iv),
respectively.
Bona fide discount points. TILA section 129C(b)(2)(C)(ii) excludes
up to two bona fide discount points from points and fees under certain
circumstances. Specifically, it excludes up to two bona fide discount
points if the interest rate before the discount does not exceed the
average prime offer rate by more than two percentage points.
Alternatively, it excludes up to one discount point if the interest
rate before the discount does not exceed the average prime offer rate
by more than one percentage point. The Board proposed to implement this
provision in proposed Sec. 226.43(e)(3)(ii)(B) and (C).
Proposed Sec. 226.43(e)(3)(ii)(B) would have permitted a creditor
to exclude from points and fees for a qualified mortgage up to two bona
fide discount points paid by the consumer in connection with the
covered transaction, provided that: (1) The interest rate before the
rate is discounted does not exceed the average

[[Page 6431]]

prime offer rate, as defined in Sec. 226.45(a)(2)(ii), by more than
one percent; and (2) the average prime offer rate used for purposes of
paragraph 43(e)(3)(ii)(B)(1) is the same average prime offer rate that
applies to a comparable transaction as of the date the discounted
interest rate for the covered transaction is set.
Proposed Sec. 226.43(e)(3)(ii)(C) would have permitted a creditor
to exclude from points and fees for a qualified mortgage up to one bona
fide discount point paid by the consumer in connection with the covered
transaction, provided that: (1) The interest rate before the discount
does not exceed the average prime offer rate, as defined in Sec.
226.45(a)(2)(ii), by more than two percent; (2) the average prime offer
rate used for purposes of Sec. 226.43(e)(3)(ii)(C)(1) is the same
average prime offer rate that applies to a comparable transaction as of
the date the discounted interest rate for the covered transaction is
set; and (3) two bona fide discount points have not been excluded under
Sec. 226.43(e)(3)(ii)(B).
Several industry commenters argued that creditors should be
permitted to exclude from points and fees more than two discount
points. Some industry commenters maintained that creditors should be
permitted to exclude as many discount points as consumers choose to
pay. Another commenter contended that creditors should be able to
exclude as many as three discount points.
A few industry commenters requested eliminating the requirement
that, for the discount points to be bona fide, the interest rate before
the discount must be within one or two percentage points of the average
prime offer rate. One industry commenter argued that this requirement
is too inflexible. Several commenters recommended that this requirement
be adjusted for jumbo loans and for second homes. Another commenter
claimed that this requirement would limit the options for consumers
paying higher interest rates and that these are the consumers for whom
it would be most beneficial to pay down their interest rates.
Several commenters argued that the effect of these two limitations
for excluding discount points from points and fees--the limit on the
number of discount points that could be excluded and the requirement
that the pre-discount rate be within one or two points of the average
prime offer rate--would have a negative impact on consumers. They
maintained that these limitations would prevent consumers from choosing
their optimal combination of interest rate and points for their
financial circumstances.
One commenter noted that proposed Sec. 226.43(e)(3)(ii)(B) and (C)
would require that, for the discount points or point to be excluded
from points and fees, the interest rate before the discount must not
exceed the average prime offer rate by more than one or two
``percent,'' respectively. The commenter recommended that, for clarity
and consistency with the statute, the requirement should instead
require that the interest rate before the discount be within one or two
``percentage points'' of the average prime offer rate.
The Bureau is adopting proposed Sec. 226.43(e)(3)(ii)(B) and (C),
renumbered as Sec. 1026.32(b)(1)(i)(E) and (F), with certain
revisions. As suggested by a commenter, the Bureau is revising both
Sec. 1026.32(b)(1)(i)(E)(1) and (F)(1) to require that, to exclude the
discount points or point, the interest rate must be within one or two
``percentage points'' (rather than ``percent'') of the average prime
offer rate. This formulation is clearer and consistent with the
statutory language. The Bureau is also adding Sec.
1026.32(b)(1)(i)(E)(2) and (F)(2) to implement TILA section
103(dd)(1)(B) and (C), which specify that, to exclude discount points
from points and fees for purposes of determining whether a loan is a
high-cost mortgage, the interest rate for personal property loans
before the discount must be within one or two percentage points,
respectively, of the average rate on a loan in connection with which
insurance is provided under title I of the National Housing Act. This
provision does not apply to the points and fees limit for qualified
mortgages, regardless of whether a loan is a high-cost mortgage. The
provision is included in the final rule for completeness. Finally, in
Sec. 1026.32(b)(1)(i)(F), the Bureau is clarifying that bona fide
discount points cannot be excluded under Sec. 1026.32(b)(1)(i)(F) if
any bona fide discount points already have been excluded under Sec.
1026.32(b)(1)(i)(E).
As noted above, several commenters urged the Bureau to alter or
eliminate the limitations on how many discount points may be excluded
and the requirement that the pre-discount interest rate must be within
one or two points of the average prime offer rate. A few industry
commenters also requested that the Bureau adjust the limitation on the
pre-discount interest rate specifically for jumbo loans and loans for
vacation homes. These commenters noted that interest rates for such
loans otherwise would often be too high to qualify for the exclusion
for bona fide discount points. The Bureau recognizes that these
limitations may circumscribe the ability of consumers to purchase
discount points to lower their interest rates. Nevertheless, the Bureau
does not believe it would be appropriate to exercise its exception
authority. Congress apparently concluded that there was a greater
probability of consumer injury when consumers purchased more than two
discount points or when the consumers were using discount points to buy
down higher interest rates. The Bureau also notes that, in other
sections of the Dodd-Frank Act, Congress prescribed different
thresholds above the average prime offer rate for jumbo loans. See TILA
sections 129C(c)(1)(B) (prepayment penalties) and 129H(f)(2)
(appraisals). Congress did not do so in the provision regarding
exclusion of bona fide discount points.
The Bureau is adding new comment 32(b)(1)(i)(E)-2 to note that the
term ``bona fide discount point'' is defined in Sec. 1026.32(b)(3). To
streamline the rule, the Bureau is moving into new comment
32(b)(1)(i)(E)-2 the explanation that the average prime offer rate used
for purposes of for both Sec. 1026.32(b)(1)(i)(E) and (F) is the
average prime offer rate that applies to a comparable transaction as of
the date the discounted interest rate for the covered transaction is
set. The Board proposed comment 43(e)(3)(ii)-5 to clarify that the
average prime offer rate table indicates how to identify the comparable
transaction. The Bureau is adding the language from proposed comment
43(e)(3)(ii)-5 to new comment 32(b)(1)(i)(E)-2, with a revision to the
cross-reference for the comment addressing ``comparable transaction.''
Proposed comment 43(e)(3)(ii)-3 would have included an example to
illustrate the rule permitting exclusion of two bona fide discount
points. The example would have assumed a covered transaction that is a
first-lien, purchase money home mortgage with a fixed interest rate and
a 30-year term. It would also have assumed that the consumer locks in
an interest rate of 6 percent on May 1, 2011, that was discounted from
a rate of 6.5 percent because the consumer paid two discount points.
Finally, assume that the average prime offer rate as of May 1, 2011 for
first-lien, purchase money home mortgages with a fixed interest rate
and a 30-year term is 5.5 percent. In this example, the creditor would
have been able to exclude two discount points from the ``points and
fees'' calculation because the rate from which the discounted rate was
derived exceeded the average prime offer rate for a comparable
transaction as of the date the rate on the covered transaction was set
by only 1 percent.

[[Page 6432]]

The Bureau is adopting proposed comment 43(e)(3)(ii)-3
substantially as proposed but renumbered as comment 32(b)(1)(i)(E)-3.
The Bureau is also adding new comment 32(b)(1)(i)(F)-1 to explain that
comments 32(b)(1)(i)(E)-1 and -2 provide guidance concerning the
definitions of ``bona fide discount point'' and ``average prime offer
rate,'' respectively.
Proposed comment 43(e)(3)(ii)-4 would have provided an example to
illustrate the rule permitting exclusion of one bona fide discount
point. The example assumed a covered transaction that is a first-lien,
purchase money home mortgage with a fixed interest rate and a 30-year
term. The example also would have assumed that the consumer locks in an
interest rate of 6 percent on May 1, 2011, that was discounted from a
rate of 7 percent because the consumer paid four discount points.
Finally, the example would have assumed that the average prime offer
rate as of May 1, 2011, for first-lien, purchase money home mortgages
with a fixed interest rate and a 30-year term is 5 percent.
In this example, the creditor would have been able to exclude one
discount point from the ``points and fees'' calculation because the
rate from which the discounted rate was derived (7 percent) exceeded
the average prime offer rate for a comparable transaction as of the
date the rate on the covered transaction was set (5 percent) by only 2
percent. The Bureau is adopting proposed comment 43(e)(3)(ii)-4
substantially as proposed but renumbered as comment 32(b)(1)(i)(F)-2.
32(b)(1)(ii)
When HOEPA was enacted in 1994, it required that ``all compensation
paid to mortgage brokers'' be counted toward the threshold for points
and fees that triggers special consumer protections under the statute.
Specifically, TILA section 103(aa)(4) provided that charges are
included in points and fees only if they are payable at or before
consummation and did not expressly address whether ``backend'' payments
from creditors to mortgage brokers funded out of the interest rate
(commonly referred to as yield spread premiums) are included in points
and fees.\79\ This requirement is implemented in existing Sec.
1026.32(b)(1)(ii), which requires that all compensation paid by
consumers directly to mortgage brokers be included in points and fees,
but does not address compensation paid by creditors to mortgage brokers
or compensation paid by any company to individual employees (such as
loan officers who are employed by a creditor or mortgage broker).
---------------------------------------------------------------------------

\79\ Some commenters use the term ``yield spread premium'' to
refer to any payment from a creditor to a mortgage broker that is
funded by increasing the interest rate that would otherwise be
charged to the consumer in the absence of that payment. These
commenters generally assume that any payment to the brokerage firm
by the creditor is funded out of the interest rate, reasoning that
had the consumer paid the brokerage firm directly, the creditor
would have had lower expenses and would have been able to charge a
lower rate. Other commenters use the term ``yield spread premium''
more narrowly to refer only to a payment from a creditor to a
mortgage broker that is based on the interest rate, i.e., the
mortgage broker receives a larger payment if the consumer agrees to
a higher interest rate. To avoid confusion, the Bureau is limiting
its use of the term and is instead more specifically describing the
payment at issue.
---------------------------------------------------------------------------

The Dodd-Frank Act substantially expanded the scope of compensation
included in points and fees for both the high-cost mortgage threshold
in HOEPA and the qualified mortgage points and fees limits.\80\ Section
1431 of the Dodd-Frank Act amended TILA to require that ``all
compensation paid directly or indirectly by a consumer or creditor to a
mortgage originator from any source, including a mortgage originator
that is also the creditor in a table-funded transaction,'' be included
in points and fees. TILA section 103(bb)(4)(B) (emphasis added). Under
amended TILA section 103(bb)(4)(B), compensation paid to anyone that
qualifies as a ``mortgage originator'' is to be included in points and
fees.\81\ Thus, in addition to compensation paid to mortgage brokerage
firms and individual brokers, points and fees also includes
compensation paid to other mortgage originators, including employees of
a creditor (i.e., loan officers). In addition, as noted above, the
Dodd-Frank Act removed the phrase ``payable at or before closing'' from
the high-cost mortgage points and fees test and did not apply the
``payable at or before closing'' limitation to the points and fees cap
for qualified mortgages. See TILA sections 103(bb)(1)(A)(ii) and
129C(b)(2)(A)(vii), (b)(2)(C). Thus, the statute appears to contemplate
that even compensation paid to mortgage brokers and other loan
originators after consummation should be counted toward the points and
fees thresholds.
---------------------------------------------------------------------------

\80\ Currently, the points and fees threshold for determining
whether a loan is a high-cost mortgage is the greater of 8 percent
of the total loan amount or $400 (adjusted for inflation). Section
1431 of the Dodd-Frank Act lowered the points and fees threshold for
determining whether a loan is a high-cost mortgage to 5 percent of
the total transaction amount for loans of $20,000 or more and to the
lesser of 8 percent of the total transaction amount or $1,000 for
loans less than $20,000.
\81\ ``Mortgage originator'' is generally defined to include
``any person who, for direct or indirect compensation or gain, or in
the expectation of direct or indirect compensation or gain--(i)
takes a residential mortgage loan application; (ii) assists a
consumer in obtaining or applying to obtain a residential mortgage
loan; or (iii) offers or negotiates terms of a residential mortgage
loan.'' TILA section 103(dd)(2). The statute excludes certain
persons from the definition, including a person who performs purely
administrative or clerical tasks; an employee of a retailer of
manufactured homes who does not take a residential mortgage
application or offer or negotiate terms of a residential mortgage
loan; and, subject to certain conditions, real estate brokers,
sellers who finance three or fewer properties in a 12-month period,
and servicers. TILA section 103(dd)(2)(C) through (F).
---------------------------------------------------------------------------

This change is one of several provisions in the Dodd-Frank Act that
focus on loan originator compensation and regulation, in apparent
response to concerns that industry compensation practices contributed
to the mortgage market crisis by creating strong incentives for brokers
and retail loan officers to steer consumers into higher-priced loans.
Specifically, loan originators were often paid a commission by
creditors that increased with the interest rate on a transaction. These
commissions were funded by creditors through the increased revenue
received by the creditor as a result of the higher rate paid by the
consumer and were closely tied to the price the creditor expected to
receive for the loan on the secondary market as a result of that higher
rate.\82\ In addition, many mortgage brokers charged consumers up-front
fees to cover some of their costs at the same time that they accepted
backend payments from creditors out of the rate. This may have
contributed to consumer confusion about where the brokers' loyalties
lay.
---------------------------------------------------------------------------

\82\ For more detailed discussions, see the Bureau's 2012 Loan
Originator Proposal and the final rule issued by the Board in 2010.
77 FR 55272, 55276, 55290 (Sept. 7, 2012); 75 FR 58509, 5815-16,
58519-20 (Sept. 24, 2010) (2010 Loan Originator Final Rule).
---------------------------------------------------------------------------

The Dodd-Frank Act took a number of steps to address loan
originator compensation issues, including: (1) Adopting requirements
that loan originators be ``qualified'' as defined by Bureau
regulations; (2) generally prohibiting compensation based on rate and
other terms (except for loan amount) and prohibiting a loan originator
from receiving compensation from both consumers and other parties in a
single transaction; (3) requiring the promulgation of additional rules
to prohibit steering consumers to less advantageous transactions; (4)
requiring the disclosure of loan originator compensation; and (5)
restricting loan originator compensation under HOEPA and the qualified
mortgage provisions by including such compensation within the points
and fees calculations. See TILA sections 103(bb)(4)(A)(ii), (B);

[[Page 6433]]

128(a)(18); 129B(b), (c); 129C(b)(2)(A)(vii), (C)(i).
The Board proposed revisions to Sec. 226.32(b)(1)(ii) to implement
the inclusion of more forms of loan originator compensation into the
points and fees thresholds. Those proposed revisions tracked the
statutory language, with two exceptions. First, proposed Sec.
226.32(b)(1)(ii) did not include the phrase ``from any source.'' The
Board noted that the statute covers compensation paid ``directly or
indirectly'' to the loan originator, and concluded that it would be
redundant to cover compensation ``from any source.'' Second, for
consistency with Regulation Z, the proposal used the term ``loan
originator'' as defined in Sec. 226.36(a)(1), rather than the term
``mortgage originator'' that appears in section 1401 of the Dodd-Frank
Act. See TILA section 103(cc)(2). The Board explained that it
interpreted the definitions of mortgage originator under the statute
and loan originator under existing Regulation Z to be generally
consistent, with one exception that the Board concluded was not
relevant for purposes of the points and fees thresholds. Specifically,
the statutory definition refers to ``any person who represents to the
public, through advertising or other means of communicating or
providing information (including the use of business cards, stationery,
brochures, signs, rate lists, or other promotional items), that such
person can or will provide'' the services listed in the definition
(such as offering or negotiating loan terms), while the existing
Regulation Z definition does not include persons solely on this basis.
The Board concluded that it was not necessary to add this element of
the definition to implement the points and fees calculations anyway,
reasoning that the calculation of points and fees is concerned only
with loan originators that receive compensation for performing defined
origination functions in connection with a consummated loan. The Board
noted that a person who merely represents to the public that such
person can offer or negotiate mortgage terms for a consumer has not yet
received compensation for that function, so there is no compensation to
include in the calculation of points and fees for a particular
transaction.
In the proposed commentary, the Board explained what compensation
would and would not have been included in points and fees under
proposed Sec. 226.32(b)(1)(ii). The Board proposed to revise existing
comment 32(b)(1)(ii)-1 to clarify that compensation paid by either a
consumer or a creditor to a loan originator, as defined in Sec.
1026.36(a)(1), would be included in points and fees. Proposed comment
32(b)(1)(ii)-1 also stated that loan originator compensation already
included in points and fees because it is included in the finance
charge under Sec. 226.32(b)(1)(i) would not be counted again under
Sec. 226.32(b)(1)(ii).
Proposed comment 32(b)(1)(ii)-2.i stated that, in determining
points and fees, loan originator compensation includes the dollar value
of compensation paid to a loan originator for a specific transaction,
such as a bonus, commission, yield spread premium, award of
merchandise, services, trips, or similar prizes, or hourly pay for the
actual number of hours worked on a particular transaction. Proposed
comment 32(b)(1)(ii)-2.ii clarified that loan originator compensation
excludes compensation that cannot be attributed to a transaction at the
time of origination, including, for example, the base salary of a loan
originator that is also the employee of the creditor, or compensation
based on the performance of the loan originator's loans or on the
overall quality of a loan originator's loan files. Proposed comment
32(b)(1)(ii)-2.i also explained that compensation paid to a loan
originator for a covered transaction must be included in the points and
fees calculation for that transaction whenever paid, whether at or
before closing or any time after closing, as long as the compensation
amount can be determined at the time of closing. In addition, proposed
comment 32(b)(1)(ii)-2.i provided three examples of compensation paid
to a loan originator that would have been included in the points and
fees calculation.
Proposed comment 32(b)(1)(ii)-3 stated that loan originator
compensation includes amounts the loan originator retains and is not
dependent on the label or name of any fee imposed in connection with
the transaction. Proposed comment 32(b)(1)(ii)-3 offered an example of
a loan originator imposing and retaining a ``processing fee'' and
stated that such a fee is loan originator compensation, regardless of
whether the loan originator expends the fee to process the consumer's
application or uses it for other expenses, such as overhead.
The Board requested comment on the types of loan originator
compensation that must be included in points and fees. The Board also
sought comment on the appropriateness of specific examples given in the
commentary.
Many industry commenters objected to the basic concept of including
loan originator compensation in points and fees, urging the Bureau to
use its exception authority to exclude loan originator compensation
from points and fees altogether. Several industry commenters contended
that other statutory provisions and rules, including the Secure and
Fair Enforcement for Mortgage Licensing Act of 2008 (SAFE Act), the
Board's 2010 Loan Originator Final Rule, and certain Dodd-Frank Act
provisions (including those proposed to be implemented in the Bureau's
2012 Loan Originator Proposal), adequately regulate loan originator
compensation and prohibit or restrict problematic loan originator
compensation practices. Accordingly, they argued it is therefore
unnecessary to include loan originator compensation in points and fees.
Many industry commenters also asserted that the amount of
compensation paid to loan originators has little or no bearing on a
consumer's ability to repay a mortgage, and thus that including loan
originator compensation in points and fees under this rulemaking is
unnecessary. They further asserted that including loan originator
compensation in points and fees would greatly increase compliance
burdens on creditors, discourage creditors from making qualified
mortgages, and ultimately reduce access to credit and increase the cost
of credit.
Several industry commenters argued that, if the Bureau does not
exclude all loan originator compensation from points and fees, then the
Bureau should at least exclude compensation paid to individual loan
originators (i.e., loan officers who are employed by creditors or
mortgage brokerage firms). They argued that compensation paid to
individual loan originators is already included in the cost of the
loan, either in the interest rate or in origination fees. They
maintained that including compensation paid to individual loan
originators in points and fees would therefore constitute double
counting.
Several industry commenters also claimed that they would face
significant challenges in determining the amount of compensation for
individual loan originators. They noted that creditors need clear,
objective standards for determining whether loans satisfy the qualified
mortgage standard, and that the complexity of apportioning compensation
to individual loans at the time of each closing to determine the amount
of loan originator compensation to count toward the points and fees cap
would create uncertainty. They also noted that having to track
individual loan originators' compensation and allocate that
compensation to individual

[[Page 6434]]

loans would create additional compliance burdens, particularly for
compensation paid after closing. Several industry commenters also
stated that estimating loan originator compensation in table-funded
transactions would prove difficult because the funding assignee may not
know the amount paid by the table-funded creditor to the individual
loan originator.
Several industry commenters also asserted that including
compensation paid to individual loan originators would lead to
anomalous results: Otherwise identical loans could have significant
differences in points and fees depending on the timing of the mortgage
loan or the identity of the loan officer. They noted, for example, that
a loan that qualifies a loan officer for a substantial bonus because it
enables a loan officer to satisfy a long-term (e.g., annual)
origination-volume target or a loan that is originated by a high-
performing loan officer could have substantially higher loan originator
compensation, and thus substantially higher points and fees, than an
otherwise identical loan. Because the consumers would not be paying
higher fees or interest rates because of such circumstances, the
commenters argued that the result would not further the goals of the
statute.
Some industry commenters made a separate argument that the proposed
method for including loan originator compensation in points and fees
would create an unfair playing field for mortgage brokers. These
commenters noted that, since a brokerage firm can be paid by only one
source under the Board's 2010 Loan Originator Final Rule and related
provisions of the Dodd-Frank Act, a payment by a creditor to a mortgage
broker must cover both the broker's overhead costs and the cost of
compensating the individual that worked on the transaction. The
creditor's entire payment to the mortgage broker is loan originator
compensation that is included in points and fees, so that loan
originator compensation in a wholesale transaction includes both the
compensation received from the creditor to cover the overhead costs of
the mortgage broker and the compensation that the broker passes through
to the individual employee who worked on the transaction. By contrast,
in a loan obtained directly from a creditor, the creditor would have to
include in points and fees the compensation paid to the loan officer,
but could choose to recover its overhead costs through the interest
rate rather than an up-front charge that would count toward the points
and fees thresholds. One industry commenter provided examples
illustrating that, as a result of this difference, loans obtained
through a mortgage broker could have interest rates and fees identical
to those in a loan obtained directly through a creditor but could have
significantly higher loan originator compensation included in points
and fees. Thus, particularly for smaller loan amounts, commenters
expressed concern that it would be difficult for loans originated
through mortgage brokers to remain under the points and fees limits for
qualified mortgages.
A nonprofit loan originator commenter also argued that including
loan originator compensation in points and fees could undercut programs
that help low and moderate income consumers obtain affordable
mortgages. This commenter noted that it relies on payments from
creditors to help it provide services to consumers and that counting
such payments as loan originator compensation and including them in
points and fees could jeopardize its programs. The commenter requested
that this problem be addressed by excluding nonprofit organizations
from the definition of loan originator or by excluding payments by
creditors to nonprofit organizations from points and fees.
Consumer advocates approved of including loan originator
compensation in points and fees, regardless of when and by whom the
compensation is paid. They asserted that including loan originator
compensation would promote more consistent treatment by ensuring that
all payments that loan originators receive count toward the points and
fees thresholds, regardless of whether the payment is made by the
consumer or the creditor and whether it is paid through the rate or
through up-front fees. They maintained that the provision was intended
to help prevent consumers from paying excessive amounts for loan
origination services. More specifically, some consumer advocates argued
that the Dodd-Frank Act provision requiring inclusion of loan
originator compensation in points and fees is an important part of a
multi-pronged approach to address widespread steering of consumers into
more expensive mortgage transactions, and in particular, to address the
role of commissions funded through the interest rate in such steering.
The consumer advocates noted that separate prohibitions on compensation
based on terms and on a loan originator's receiving compensation from
both the consumer and another party do not limit the amount of
compensation a loan originator can receive or prevent a loan originator
from inducing consumers to agree to above-market interest rates. They
expressed concern that, particularly in the subprime market, loan
originators could specialize in originating transactions with above-
market interest rates, with the expectation they could arrange to
receive above-market compensation for all of their transactions.
Consumer advocates argued that counting all methods of loan originator
compensation toward the points and fees thresholds was intended to
deter such conduct.
Consumer advocates also pointed out that in the wholesale context,
the consumer has the option of paying the brokerage firm directly for
its services. Such payments have always been included within the
calculation of points and fees for HOEPA purposes. The advocates argued
that when a consumer elects not to make the up-front payment but
instead elects to fund the same amount of money for the brokerage
through an increased rate, there is no justification for treating the
money received by the brokerage as a result of the consumer's decision
any differently.
The Bureau has carefully considered the comments received in light
of the concerns about various issues with regard to loan originator
compensation practices, the general concerns about the impacts of the
ability-to-repay/qualified mortgage rule and revised HOEPA thresholds
on a market in which access to mortgage credit is already extremely
tight, differences between the retail and wholesale origination
channels, and practical considerations regarding both the burdens of
day-to-day implementation and the opportunities for evasion by parties
who wish to engage in rent-seeking. As discussed further below, the
Bureau is concerned about implementation burdens and anomalies created
by the requirement to include loan originator compensation in points
and fees, the impacts that it could have on pricing and access to
credit, and the risks that rent-seekers will continue to find ways to
evade the statutory scheme. Nevertheless, the Bureau believes that, in
light of the historical record and of Congress's evident concern with
loan originator compensation practices, it would not be appropriate to
waive the statutory requirement that loan originator compensation be
included in points and fees. The Bureau has, however, worked to craft
the rule that implements Congress's judgment in a way that is
practicable and that reduces potential negative impacts of the
statutory requirement, as discussed below. The Bureau is also seeking
comment in the

[[Page 6435]]

concurrent proposal being published elsewhere in today's Federal
Register on whether additional measures would better protect consumers
and reduce implementation burdens and unintended consequences.
Accordingly, the Bureau in adopting Sec. 1026.32(b)(1)(ii) has
generally tracked the statutory language and the Board's proposal in
the regulation text, but has expanded the commentary to provide more
detailed guidance to clarify what compensation must be included in
points and fees. The Dodd-Frank Act requires inclusion in points and
fees of ``all compensation paid directly or indirectly by a consumer or
creditor to a mortgage originator from any source, including a mortgage
originator that is also the creditor in a table-funded transaction.''
See TILA section 103(bb)(4)(B). Consistent with the Board's proposal,
revised Sec. 1026.32(b)(ii) does not include the phrase ``from any
source.'' The Bureau agrees that the phrase is unnecessary because the
provision expressly covers compensation paid ``directly or indirectly''
to the loan originator. Like the Board's proposal, the final rule also
uses the term ``loan originator'' as defined in Sec. 1026.36(a)(1),
not the term ``mortgage originator'' under section 1401 of the Dodd-
Frank Act. See TILA section 103(cc)(2). The Bureau agrees that the
definitions are consistent in relevant respects and notes that it is in
the process of amending the regulatory definition to harmonize it even
more closely with the Dodd-Frank Act definition of ``mortgage
originator.'' \83\ Accordingly, the Bureau believes use of consistent
terminology in Regulation Z will facilitate compliance. Finally, as
revised, Sec. 1026.32(b)(1)(ii) also does not include the language in
proposed Sec. 226.32(b)(1)(ii) that specified that the provision also
applies to a loan originator that is the creditor in a table-funded
transaction. The Bureau has concluded that that clarification is
unnecessary because a creditor in a table-funded transaction is already
included in the definition of loan originator in Sec. 1026.36(a)(1).
To clarify what compensation must be included in points and fees,
revised Sec. 1026.32(b)(1)(ii) specifies that compensation must be
included if it can be attributed to the particular transaction at the
time the interest rate is set. These limitations are discussed in more
detail below.
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\83\ See 2012 Loan Originator Proposal, 77 FR 55283-88.
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In adopting the general rule, the Bureau carefully considered
arguments by industry commenters that loan originator compensation
should not be included in points and fees because other statutory
provisions and rules already regulate loan originator compensation,
because loan originator compensation is already included in the costs
of mortgage loans, and because including loan originator compensation
in points and fees would push many loans over the 3 percent cap on
points and fees for qualified mortgages (or even over the points and
fees limits for determining whether a loan is a high-cost mortgage
under HOEPA), which would increase costs and impair access to credit.
The Bureau views the fact that other provisions within the Dodd-
Frank Act address other aspects of loan originator compensation and
activity as evidence of the high priority that Congress placed on
regulating such compensation. The other provisions pointed to by the
commenters address specific compensation practices that created
particularly strong incentives for loan originators to ``upcharge''
consumers on a loan-by-loan basis and particular confusion about loan
originators' loyalties. The Bureau believes that the inclusion of loan
originator compensation in points and fees has distinct purposes. In
addition to discouraging more generalized rent-seeking and excessive
loan originator compensation, the Bureau believes that Congress may
have been focused on particular risks to consumers. Thus, with respect
to qualified mortgages, including loan originator compensation in
points and fees helps to ensure that, in cases in which high up-front
compensation might otherwise cause the creditor and/or loan originator
to be less concerned about long-term sustainability, the creditor is
not able to invoke a presumption of compliance if challenged to
demonstrate that it made a reasonable and good faith determination of
the consumer's ability to repay the loan. Similarly in HOEPA, the
threshold triggers additional consumer protections, such as enhanced
disclosures and housing counseling, for the loans with the highest up-
front pricing.
The Bureau recognizes that the method that Congress chose to
effectuate these goals does not ensure entirely consistent results as
to whether a loan is a qualified mortgage or a high-cost transaction.
For instance, loans that are identical to consumers in terms of up-
front costs and interest rate may nevertheless have different points
and fees based on the identity of the loan originator who handled the
transaction for the consumer, since different individual loan
originators in a retail environment or different brokerage firms in a
wholesale environment may earn different commissions from the creditor
without that translating in differences in costs to the consumer. In
addition, there are anomalies introduced by the fact that ``loan
originator'' is defined to include mortgage broker firms and individual
employees hired by either brokers or creditors, but not creditors
themselves. As a result, counting the total compensation paid to a
mortgage broker firm will capture both the firm's overhead costs and
the compensation that the firm passes on to its individual loan
officer. By contrast, in a retail transaction, the creditor would have
to include in points and fees the compensation that it paid to its loan
officer, but would continue to have the option of recovering its
overhead costs through the interest rate, instead of an up-front
charge, to avoid counting them toward the points and fees thresholds.
Indeed, the Bureau expects that the new requirement may prompt
creditors to shift certain other expenses into rate to stay under the
thresholds.
Nevertheless, to the extent there are anomalies from including loan
originator compensation in points and fees, these anomalies appear to
be the result of deliberate policy choices by Congress to expand the
historical definition of points and fees to include all methods of loan
originator compensation, whether derived from up-front charges or from
the rate, without attempting to capture all overhead expenses by
creditors or the gain on sale that the creditor can realize upon
closing a mortgage. The Bureau agrees that counting loan originator
compensation that is structured through rate toward the points and fees
thresholds could cause some loans not to be classified as qualified
mortgages and to trigger HOEPA protections, compared to existing
treatment under HOEPA and its implementing regulation. However, the
Bureau views this to be exactly the result that Congress intended.
In light of the express statutory language and Congress's evident
concern with increasing consumer protections in connection with high
levels of loan originator compensation, the Bureau does not believe
that it is appropriate to use its exception or adjustment authority in
TILA section 105(a) or in TILA section 129C(b)(3)(B)(i) to exclude loan
originator compensation entirely from points and fees for qualified
mortgages and HOEPA. As discussed below, however, the Bureau is
attempting to implement the points and fees

[[Page 6436]]

requirements with as much sensitivity as practicable to potential
impacts on the pricing of and availability of credit, anomalies and
unintended consequences, and compliance burdens.
The Bureau also carefully considered comments urging it to exclude
compensation paid to individual loan originators from points and fees,
but ultimately concluded that such a result would be inconsistent with
the plain language of the statute and could exacerbate the potential
inconsistent effects of the rule on different mortgage origination
channels. As noted above, many industry commenters argued that, even if
loan originator compensation were not excluded altogether, at least
compensation paid to individual loan originators should be excluded
from points and fees. Under this approach, only payments to mortgage
brokers would be included in points and fees. The commenters contended
that it would be difficult to track compensation paid to individual
loan originators, particularly when that compensation may be paid after
consummation of the loan and that it would create substantial
compliance problems. They also argued that including compensation paid
to individual loan originators in points and fees would create
anomalies, in which identical transactions from the consumer's
perspective (i.e., the same interest rate and up-front costs) could
nevertheless have different points and fees because of loan originator
compensation.
As explained above, the Bureau does not believe it is appropriate
to use its exception authority to exclude loan originator compensation
from points and fees, and even using that exception authority more
narrowly to exclude compensation paid to individual loan originators
could undermine Congress's apparent goal of providing stronger consumer
protections in cases of high loan originator compensation. Although
earlier versions of legislation focused specifically on compensation to
``mortgage brokers,'' which is consistent with existing HOEPA, the
Dodd-Frank Act refers to compensation to ``mortgage originators,'' a
term that is defined in detail elsewhere in the statute to include
individual loan officers employed by both creditors and brokers, in
addition to the brokers themselves. To the extent that Congress
believed that high levels of loan originator compensation evidenced
additional risk to consumers, excluding individual loan originators
from consideration appears inconsistent with this policy judgment.
Moreover, the Bureau notes that using exception authority to
exclude compensation paid to individual loan originators would
exacerbate the differential treatment between the retail and wholesale
channels concerning overhead costs. As noted above, compensation paid
by the consumer or creditor to the mortgage broker necessarily will
include amounts for both the mortgage broker's overhead and profit and
for the compensation the mortgage broker passes on to its loan officer.
Excluding individual loan officer compensation on the retail side,
however, would effectively exempt creditors from counting any loan
originator compensation at all toward points and fees. Thus, for
transactions that would be identical from the consumer's perspective in
terms of interest rate and up-front costs, the wholesale transaction
could have significantly higher points and fees (because the entire
payment from the creditor to the mortgage broker would be captured in
points and fees), while the retail transaction might include no loan
origination compensation at all in points and fees. Such a result would
put brokerage firms at a disadvantage in their ability to originate
qualified mortgages and put them at significantly greater risk of
originating HOEPA loans. This in turn could constrict the supply of
loan originators and the origination channels available to consumers to
their detriment.
The Bureau recognizes that including compensation paid to
individual loan originators, such as loan officers, with respect to
individual transactions may impose additional burdens. For example,
creditors will have to track employee compensation for purposes of
complying with the rule, and the calculation of points and fees will be
more complicated. However, the Bureau notes that creditors and brokers
already have to monitor compensation more carefully as a result of the
2010 Loan Originator Final Rule and the related Dodd-Frank Act
restrictions on compensation based on terms and on dual compensation.
The Bureau also believes that these concerns can be reduced by
providing clear guidance on issues such as what types of compensation
are covered, when compensation is determined, and how to avoid
``double-counting'' payments that are already included in points and
fees calculations. The Bureau has therefore revised the Board's
proposed regulation and commentary to provide more detailed guidance,
and is seeking comment in the proposal published elsewhere in the
Federal Register today on additional guidance and potential
implementation issues among other matters.
As noted above, the Bureau is revising Sec. 1026.32(b)(1)(ii) to
clarify that compensation must be counted toward the points and fees
thresholds if it can be attributed to the particular transaction at the
time the interest rate is set. The Bureau is also revising comment
32(b)(1)(ii)-1 to explain in general terms when compensation qualifies
as loan originator compensation that must be included in points and
fees. In particular, compensation paid by a consumer or creditor to a
loan originator is included in the calculation of points and fees,
provided that such compensation can be attributed to that particular
transaction at the time the interest rate is set. The Bureau also
incorporates part of proposed comment 32(b)(1)(ii)-3 into revised
comment 32(b)(1)(ii)-1, explaining that loan originator compensation
includes amounts the loan originator retains, and is not dependent on
the label or name of any fee imposed in connection with the
transaction. However, revised comment 32(b)(1)(ii)-1 does not include
the example from proposed comment 32(b)(1)(ii)-3, which stated that, if
a loan originator imposes a processing fee and retains the fee, the fee
is loan originator compensation under Sec. 1026.32(b)(1)(ii) whether
the originator expends the fee to process the consumer's application or
uses it for other expenses, such as overhead. That example may be
confusing in this context because a processing fee paid to a loan
originator likely would be a finance charge under Sec. 1026.4 and
would therefore already be included in points and fees under Sec.
1026.32(b)(1)(i).
Revised comment 32(b)(1)(ii)-2.i explains that compensation, such
as a bonus, commission, or an award of merchandise, services, trips or
similar prizes, must be included only if it can be attributed to a
particular transaction. The requirement that compensation is included
in points and fees only if it can be attributed to a particular
transaction is consistent with the statutory language. The Dodd-Frank
Act provides that, for the points and fees tests for both qualified
mortgages and high-cost mortgages, only charges that are ``in
connection with'' the transaction are included in points and fees. See
TILA sections 103(bb)(1)(A)(ii) (high-cost mortgages) and
129C(b)(2)(A)(vii) (qualified mortgages). Limiting loan originator
compensation to compensation that is attributable to the transaction
implements the statutory requirement that points and fees are ``in
connection'' with the transaction. This

[[Page 6437]]

limitation also makes the rule more workable. Compensation is included
in points and fees only if it can be attributed to a specific
transaction to facilitate compliance with the rule and avoid over-
burdening creditors with complex calculations to determine, for
example, the portion of a loan officer's salary that should be counted
in points and fees.\84\ For clarity, the Bureau has moved the
discussion of the timing of loan originator compensation into new
comment 32(b)(1)(ii)-3, and has added additional examples to
32(b)(1)(ii)-4, to illustrate the types and amount of compensation that
should be included in points and fees.
---------------------------------------------------------------------------

\84\ In contrast, the existing restrictions on particular loan
originator compensation structures in Sec. 1026.36 apply to all
compensation such as salaries, hourly wages, and contingent bonuses
because those restrictions apply only at the time such compensation
is paid, and therefore they can be applied with certainty. Moreover,
those rules also provide for different treatment of compensation
that is not ``specific to, and paid solely in connection with, the
transaction,'' where such a distinction is necessary for reasons of
practical application of the rule. See comment 36(d)(2)-1
(prohibition of loan originator receiving compensation directly from
consumer and also from any other person does not prohibit consumer
payments where loan originator also receives salary or hourly wage).
---------------------------------------------------------------------------

Revised comment 32(b)(1)(ii)-2.ii explains that loan originator
compensation excludes compensation that cannot be attributed to a
particular transaction at the time the interest rate is set, including,
for example, compensation based on the long-term performance of the
loan originator's loans or on the overall quality of the loan
originator's loan files. The base salary of a loan originator is also
excluded, although additional compensation that is attributable to a
particular transaction must be included in points and fees. The Bureau
has decided to seek further comment in the concurrent proposal
regarding treatment of hourly wages for the actual number of hours
worked on a particular transaction. The Board's proposal would have
included hourly pay for the actual number of hours worked on a
particular transaction in loan originator compensation for purposes of
the points and fees thresholds, and the Bureau agrees that such wages
are attributable to the particular transaction. However, the Bureau is
unclear as to whether industry actually tracks compensation this way in
light of the administrative burdens. Moreover, while the general rule
provides for calculation of loan originator compensation at the time
the interest rate is set for the reasons discussed above, the actual
hours of hours worked on a transaction would not be known at that time.
The Bureau is therefore seeking comment on issues relating to hourly
wages, including whether to require estimates of the hours to be worked
between rate set and consummation.
New comment 32(b)(1)(ii)-3 explains that loan originator
compensation must be included in the points and fees calculation for a
transaction whenever the compensation is paid, whether before, at or
after closing, as long as that compensation amount can be attributed to
the particular transaction at the time the interest rate is set. Some
industry commenters expressed concern that it would be difficult to
determine the amount of compensation that would be paid after
consummation and that creditors might have to recalculate loan
originator compensation (and thus points and fees) after underwriting
if, for example, a loan officer became eligible for higher compensation
because other transactions had been consummated. The Bureau appreciates
that industry participants need certainty at the time of underwriting
as to whether transactions will exceed the points and fees limits for
qualified mortgages (and for high-cost mortgages). To address this
concern, the comment 32(b)(1)(ii)-3 explains that loan originator
compensation should be calculated at the time the interest rate is set.
The Bureau believes that the date the interest rate is set is an
appropriate standard for calculating loan originator compensation. It
would allow creditors to be able to calculate points and fees with
sufficient certainty so that they know early in the process whether a
transaction will be a qualified mortgage or a high-cost mortgage.
As noted above, several industry commenters argued that including
loan originator compensation in points and fees would result in double
counting. They stated that creditors often will recover loan originator
compensation costs through origination charges, and these charges are
already included in points and fees under Sec. 1026.32(b)(1)(i).
However, the underlying statutory provisions as amended by the Dodd-
Frank Act do not express any limitation on its requirement to count
loan originator compensation toward the points and fees test. Rather,
the literal language of TILA section 103(bb)(4) as amended by the Dodd-
Frank Act defines points and fees to include all items included in the
finance charge (except interest rate), all compensation paid directly
or indirectly by a consumer or creditor to a loan originator, ``and''
various other enumerated items. The use of ``and'' and the references
to ``all'' compensation paid ``directly or indirectly'' and ``from any
source'' suggest that compensation should be counted as it flows
downstream from one party to another so that it is counted each time
that it reaches a loan originator, whatever the previous source.
The Bureau believes the statute would be read to require that loan
originator compensation be treated as additive to the other elements of
points and fees. The Bureau believes that an automatic literal reading
of the statute in all cases, however, would not be in the best interest
of either consumers or industry. For instance, the Bureau does not
believe that it is necessary or appropriate to count the same payment
made by a consumer to a mortgage broker firm twice, simply because it
is both part of the finance charge and loan originator compensation.
Similarly, the Bureau does not believe that, where a payment from
either a consumer or a creditor to a mortgage broker is counted toward
points and fees, it is necessary or appropriate to count separately
funds that the broker then passes on to its individual employees. In
each case, any costs and risks to the consumer from high loan
originator compensation are adequately captured by counting the funds a
single time against the points and fees cap; thus, the Bureau does not
believe the purposes of the statute would be served by counting some or
all of the funds a second time, and is concerned that doing so could
have negative impacts on the price and availability of credit.
Determining the appropriate accounting rule is significantly more
complicated, however, in situations in which a consumer pays some up-
front charges to the creditor and the creditor pays loan originator
compensation to either its own employee or to a mortgage broker firm.
Because money is fungible, tracking how a creditor spends money it
collects in up-front charges versus amounts collected through the rate
to cover both loan originator compensation and its other overhead
expenses would be extraordinarily complex and cumbersome. To facilitate
compliance, the Bureau believes it is appropriate and necessary to
adopt one or more generalized rules regarding the accounting of various
payments. However, the Bureau does not believe it yet has sufficient
information with which to choose definitively between the additive
approach provided for in the statutory language and other potential
methods of accounting for payments in light of the multiple practical
and complex policy considerations involved.
The potential downstream effects of different accounting methods
are

[[Page 6438]]

significant. Under the additive approach where no offsetting consumer
payments against creditor-paid loan originator compensation is allowed,
creditors whose combined loan originator compensation and up-front
charges would otherwise exceed the points and fees limits would have
strong incentives to cap their up-front charges for other overhead
expenses under the threshold and instead recover those expenses by
increasing interest rates to generate higher gains on sale. This would
adversely affect consumers who prefer a lower interest rate and higher
up-front costs and, at the margins, could result in some consumers
being unable to qualify for credit. Additionally, to the extent
creditors responded to a ``no offsetting'' rule by increasing interest
rates, this could increase the number of qualified mortgages that
receive a rebuttable rather than conclusive presumption of compliance.
One alternative would be to allow all consumer payments to offset
creditor-paid loan originator compensation. However, a ``full
offsetting'' approach would allow creditors to offset much higher
levels of up-front points and fees against expenses paid through rate
before the heightened consumer protections required by the Dodd-Frank
Act would apply. Particularly under HOEPA, this may raise tensions with
Congress's apparent intent. Other alternatives might use a hybrid
approach depending on the type of expense, type of loan, or other
factors, but would involve more compliance complexity.
In light of the complex considerations, the Bureau believes it is
necessary to seek additional notice and comment. The Bureau therefore
is finalizing this rule without qualifying the statutory result and is
proposing two alternative comments in the concurrent proposal, one of
which would explicitly preclude offsetting, and the other of which
would allow full offsetting of any consumer-paid charges against
creditor-paid loan originator compensation. The Bureau is also
proposing comments to clarify treatment of compensation paid by
consumers to mortgage brokers and by mortgage brokers to their
individual employees. The Bureau is seeking comment on all aspects of
this issue, including the market impacts and whether adjustments to the
final rule would be appropriate. In addition, the Bureau is seeking
comment on whether it would be helpful to provide for additional
adjustment of the rules or additional commentary to clarify any
overlaps in definitions between the points and fees provisions in this
rulemaking and the HOEPA rulemaking and the provisions that the Bureau
is separately finalizing in connection with the Bureau's 2012 Loan
Originator Compensation Proposal.
Finally, comment 32(b)(1)(ii)-4 includes revised versions of
examples in proposed comment 32(b)(1)(ii)-2, as well as additional
examples to provide additional guidance regarding what compensation
qualifies as loan originator compensation that must be included in
points and fees. These examples illustrate when compensation can be
attributed to a particular transaction at the time the interest rate is
set. New comment 32(b)(1)(ii)-5 adds an example explaining how salary
is treated for purposes of loan originator compensation for calculating
points and fees.
32(b)(1)(iii)
TILA section 103(aa)(4)(C) provides that points and fees include
certain real estate-related charges listed in TILA section 106(e) and
is implemented in Sec. 1026.32(b)(1)(iii). The Dodd-Frank Act did not
amend TILA section 103(aa)(4)(C) (but did renumber it as section
103(bb)(4)(C)). Although the Board indicated in the Supplementary
Information that it was not proposing any changes, proposed Sec.
226.32(b)(1)(iii) would have added the phrase ``payable at or before
closing of the mortgage'' loan and would have separated the elements
into three new paragraphs (A) through (C). Thus, proposed Sec.
226.32(b)(1)(iii) would have included in points and fees ``all items
listed in Sec. 226.4(c)(7) (other than amounts held for future payment
of taxes) payable at or before closing of the mortgage loan, unless:
(A) The charge is reasonable; (B) the creditor receives no direct or
indirect compensation in connection with the charge; and (C) the charge
is not paid to an affiliate of the creditor.'' The Board noted that the
statute did not exclude these charges if they were payable after
closing and questioned whether such a limitation was necessary because
these charges could reasonably be viewed as charges that by definition
are payable only at or before closing. As noted in the section-by-
section analysis of Sec. 1026.32(b)(1), the Board requested comment on
whether there are any other types of fees that should be included in
points and fees only if they are payable at or before closing.
The Board noted that during outreach creditors had raised concerns
about including in points and fees real-estate related fees paid to an
affiliate of the creditor, such as an affiliated title company.
Although these fees always have been included in points and fees for
high-cost loans, creditors using affiliated title companies were
concerned they would have difficulty meeting the lower threshold for
points and fees for qualified mortgages. The Board, however, did not
propose to exempt fees paid to creditor-affiliated settlement service
providers, noting that Congress appeared to have rejected excluding
such fees from points and fees.
Industry commenters criticized the Board's proposed treatment of
fees paid to affiliates as overbroad. Industry commenters argued that a
creditor's affiliation with a service provider, such as a title
insurance agency, does not have any impact on the consumer's ability to
repay a loan. They maintained that studies over the past two decades
have shown that title services provided by affiliated businesses are
competitive in cost compared to services provided by unaffiliated
businesses. They contended that the rule should instead focus solely on
whether the fee is bona fide.
These commenters also argued that the largest real estate-related
charge, title insurance fees, are often either mandated by State law or
required to be filed with the relevant state authority and do not vary.
Regardless of whether the State sets the rate or requires that the rate
be filed, these commenters argued that there are so few insurers that
rates tend to be nearly identical among providers.
These commenters also argued that including fees to affiliates
would negatively affect consumers. They claimed that the inclusion of
fees paid to affiliates would cause loans that would otherwise be
qualified mortgages to exceed the points and fees cap, resulting in
more expense to the creditor, which would be passed through to
consumers in the form of higher interest rates or fees, or in more
denials of credit. They also claimed that the proposal would harm
consumers by reducing competition among settlement service providers
and by eliminating operational efficiencies. One industry trade
association reported that some of its members with affiliates would
discontinue offering mortgages, which would reduce competition among
creditors, especially for creditors offering smaller loans, since these
loans would be most affected by the points and fees cap. They claimed
that treating affiliated and unaffiliated providers differently would
incentivize creditors to use unaffiliated third-party service providers
to stay within the qualified mortgage points and fees cap.
Several industry commenters noted that RESPA permits affiliated
business arrangements and provides protections

[[Page 6439]]

for consumers, including a prohibition against requiring that consumers
use affiliates, a requirement to disclose affiliation to consumers, and
a limitation that compensation include only return on ownership
interest. These commenters argued that charges paid to affiliates
should be excluded from points and fees as long the RESPA requirements
are satisfied. Several industry commenters objected to the requirement
that charges be ``reasonable'' to be excluded from points and fees.
They argued that the requirement was vague and that it would be
difficult for a creditor to judge whether a third-party charge met the
standard. Several commenters also argued that the Dodd-Frank Act
provision permitting exclusion of certain bona fide third-party charges
should apply rather than the three-part test for items listed in Sec.
1026.4(c)(7). See TILA section 129C(b)(2)(C)(i).
Two consumer advocates commented on this aspect of the proposal.
They supported including in points and fees all fees paid to any
settlement service provider affiliated with the creditor.
The Bureau is adopting Sec. 226.32(b)(1)(iii) as proposed but
renumbered as Sec. 1026.32(b)(1)(iii). TILA section 103(bb)(4)
specifically mandates that fees paid to and retained by affiliates of
the creditor be included in points and fees. The Bureau acknowledges
that including fees paid to affiliates in points and fees could make it
more difficult for creditors using affiliated service providers to stay
under the points and fees cap for qualified mortgages and that, as a
result, creditors could be disincented from using affiliated service
providers. This is especially true with respect to affiliated title
insurers because of the cost of title insurance. On the other hand,
despite RESPA's regulation of fees charged by affiliates, concerns have
nonetheless been raised that fees paid to an affiliate pose greater
risks to the consumer, since affiliates of a creditor may not have to
compete in the market with other providers of a service and thus may
charge higher prices that get passed on to the consumer. The Bureau
believes that Congress weighed these competing considerations and made
a deliberate decision not to exclude fees paid to affiliates. This
approach is further reflected throughout title XIV, which repeatedly
amended TILA to treat fees paid to affiliates as the equivalent to fees
paid to a creditor or loan originator. See, e.g., Dodd-Frank Act
sections 1403, 1411, 1412, 1414, and 1431. For example, as noted above,
TILA section 129C(b)(2)(C)(i), as added by section 1412 of the Dodd-
Frank Act, provides that for purposes of the qualified mortgage points
and fees test, bona fide third-party charges are excluded other than
charges ``retained by * * * an affiliate of the creditor or mortgage
originator.'' Similarly, TILA section 129B(c)(2)(B)(ii), added by
section 1403 of the Dodd-Frank Act, restricts the payment of points and
fees but permits the payment of bona fide third-party charges unless
those charges are ``retained by * * * an affiliate of the creditor or
originator.'' In light of these considerations, the Bureau does not
believe there is sufficient justification to use its exception
authority in this instance as the Bureau cannot find, given Congress's
clear determination, that excluding affiliate fees from the calculation
of points and fees is necessary or proper to effectuate the purposes of
TILA, to prevent circumvention or evasion thereof, or to facilitate
compliance therewith.
As noted above, some commenters objected to the requirement that
charges be ``reasonable.'' The Bureau notes that a ``reasonable''
requirement has been in place for many years before the Dodd-Frank Act.
TILA section 103(aa)(4)(C) specifically provides that charges listed in
TILA section 106(e) are included in points and fees for high-cost
mortgages unless, among other things, the charge is reasonable. This
requirement is implemented in existing Sec. 1026.32(b)(1)(iii).
Similarly, a charge may be excluded from the finance charge under Sec.
1026.4(c)(7) only if it is reasonable. In the absence of any evidence
that this requirement has been unworkable, the Bureau declines to alter
it. The fact that a transaction for such services is conducted at arms-
length ordinarily should be sufficient to make the charge reasonable.
The reasonableness requirement is not intended to invite an inquiry
into whether a particular appraiser or title insurance company is
imposing excessive charges.
Some commenters also maintained that the provision permitting
exclusion of certain bona fide third-party charges should apply rather
than the three-part test for items listed in Sec. 1026.4(c)(7). See
TILA section 129C(b)(2)(C)(i). As discussed in more detail in the
section-by-section analysis of Sec. 1026.32(b)(1)(i)(D), the Bureau
concludes that Sec. 1026.32(b)(1)(iii), which specifically addresses
exclusion of items listed in Sec. 1026.4(c)(7), takes precedence over
the more general exclusion in Sec. 1026.32(b)(1)(i)(D).
The Board's proposed comment 32(b)(1)(iii)-1 was substantially the
same as existing comment 32(b)(1)(ii)-2. It would have provided an
example of the inclusion or exclusion of real-estate related charges.
The Bureau did not receive substantial comment on the proposed comment.
The Bureau is therefore adopting comment 32(b)(1)(ii)-1 substantially
as proposed, with revisions for clarity.
32(b)(1)(iv)
As amended by section 1431 of the Dodd-Frank Act, TILA section
103(bb)(4)(D) includes in points and fees premiums for various forms of
credit insurance and charges for debt cancellation or suspension
coverage. The Board proposed Sec. 226.32(b)(1)(iv) to implement this
provision. The Board also proposed to revise comment 32(b)(1)(iv)-1 to
reflect the revised statutory language and to add new comment
32(b)(1)(iv)-2 to clarify that ``credit property insurance'' includes
insurance against loss or damage to personal property such as a
houseboat or manufactured home.
Several commenters argued that proposed Sec. 226.32(b)(1)(iv) did
not accurately implement the provision in Dodd-Frank Act section 1431
that specifies that ``insurance premiums or debt cancellation or
suspension fees calculated and paid in full on a monthly basis shall
not be considered financed by the creditor.'' They argued that comment
32(b)(1)(iv)-1 should be revised so that it expressly excludes monthly
premiums for credit insurance from points and fees, including such
premiums payable in the first month. At least one industry commenter
also argued that voluntary credit insurance premiums should not be
included in points and fees. Consumer advocates supported inclusion of
credit insurance premiums in points and fees, noting that these
services can add significant costs to mortgages.
The Bureau is adopting Sec. 226.32(b)(1)(iv) substantially as
proposed, with revisions for clarity, as renumbered Sec.
1026.32(b)(1)(iv). As revised, Sec. 1026.32(b)(1)(iv) states that
premiums or other charges for ``any other life, accident, health, or
loss-of-income insurance'' are included in points and fees only if the
insurance is for the benefit of the creditor. The Bureau is also
adopting proposed comments 32(b)(1)(iv)-1 and -2 substantially as
proposed, with revisions for clarity and consistency with terminology
in Regulation Z. The Bureau is also adopting new comment 32(b)(1)(iv)-3
to clarify that premiums or other charges for ``any other life,
accident, health, or loss-of-income insurance'' are included in points
and fees only if the creditor is a beneficiary of the insurance.

[[Page 6440]]

As noted above, several commenters argued that premiums paid
monthly, including the first such premium, should not be included in
points and fees. The statute requires that premiums ``payable at or
before closing'' be included in points and fees; it provides only that
premiums ``calculated and paid in full on a monthly basis shall not be
considered financed by the creditor.'' TILA section 103(bb)(4)(D).
Thus, if the first premium is payable at or before closing, that
payment is included in points and fees even though the subsequent
monthly payments are not.
Another commenter argued that voluntary credit insurance premiums
should be excluded from points and fees. However, under the current
rule, voluntary credit insurance premiums are included in points and
fees. In light of the fact that the Dodd-Frank Act expanded the types
of credit insurance that must be included in points and fees, the
Bureau does not believe it would be appropriate to reconsider whether
voluntary credit insurance premiums should be included in points and
fees.
32(b)(1)(v)
As added by the Dodd-Frank Act, new TILA section 103(bb)(4)(E)
includes in points and fees ``the maximum prepayment penalties which
may be charged or collected under the terms of the credit
transaction.'' The Board's proposed Sec. 226.32(b)(1)(v) closely
tracked the statutory language, but it cross-referenced proposed Sec.
226.43(b)(10) for the definition of ``prepayment penalty.''
Few commenters addressed this provision. One industry commenter
argued that the maximum prepayment penalty should not be included in
points and fees because a prepayment that triggers the penalty may
never occur and thus the fee may never be assessed.
The Bureau is adopting Sec. 226.32(b)(1)(v) substantially as
proposed but renumbered as Sec. 1026.32(b)(1)(v), with a revision to
its definitional cross-reference. As revised, Sec. 1026.32(b)(1)(v)
refers to the definition of prepayment penalty in Sec.
1026.32(b)(6)(i). With respect to the comment arguing that prepayment
penalties should not be included in points and fees, the statute
requires inclusion in points and fees of the maximum prepayment
penalties that ``may be charged or collected.'' Thus, under the
statutory language, the imposition of the charge need not be certain
for the prepayment penalty to be included in points and fees. In this
provision (and other provisions added by the Dodd-Frank Act, such as
TILA section 129C(c)), Congress sought to limit and deter the use of
prepayment penalties, and the Bureau does not believe that it would be
appropriate to exercise its exception authority in a manner that could
undermine that goal.
32(b)(1)(vi)
New TILA section 103(bb)(4)(F) requires that points and fees
include ``all prepayment fees or penalties that are incurred by the
consumer if the loan refinances a previous loan made or currently held
by the same creditor or an affiliate of the creditor.'' The Board's
proposed Sec. 226.32(b)(1)(vi) would have implemented this provision
by including in points and fees the total prepayment penalty, as
defined in Sec. 226.43(b)(10), incurred by the consumer if the
mortgage loan is refinanced by the current holder of the existing
mortgage loan, a servicer acting on behalf of the current holder, or an
affiliate of either. The Board stated its belief that this provision is
intended in part to curtail the practice of ``loan flipping,'' which
involves a creditor refinancing an existing loan for financial gain
resulting from prepayment penalties and other fees that a consumer must
pay to refinance the loan--regardless of whether the refinancing is
beneficial to the consumer. The Board noted that it departed from the
statutory language to use the phrases ``current holder of the existing
mortgage loan'' and ``servicer acting on behalf of the current holder''
in proposed Sec. 226.32(b)(1)(vi) because, as a practical matter,
these are the entities that would refinance the loan and directly or
indirectly gain from associated prepayment penalties.
Few commenters addressed this provision. Two consumer groups
expressed support for including these prepayment penalties in points
and fees, arguing that many consumers were victimized by loan flipping
and the resulting fees and charges.
The Bureau is adopting Sec. 226.32(b)(1)(vi) substantially as
proposed but renumbered as Sec. 1026.32(b)(1)(vi). In addition to
revising for clarity, the Bureau has also revised Sec.
1026.32(b)(1)(vi) to refer to the definition of prepayment penalty in
Sec. 1026.32(b)(6)(i). Like the Board, the Bureau believes that it is
appropriate for Sec. 1026.32(b)(1)(vi) to apply to the current holder
of the existing mortgage loan, the servicer acting on behalf of the
current holder, or an affiliate of either. These are the entities that
would refinance the loan and gain from the prepayment penalties on the
previous loan. Accordingly, the Bureau is invoking its exception and
adjustment authority under TILA sections 105(a) and 129C(b)(3)(B)(i).
The Bureau believes that adjusting the statutory language to more
precisely target the entities that would benefit from refinancing loans
with prepayment penalties will more effectively deter loan flipping to
collect prepayment penalties and help preserve consumers' access to
safe, affordable credit. It also will lessen the compliance burden on
other entities that lack the incentive for loan flipping, such as a
creditor that originated the existing loan but no longer holds the
loan. For these reasons, the Bureau believes that use of its exception
and adjustment authority is necessary and proper under TILA section
105(a) to effectuate the purposes of TILA and to facilitate compliance
with TILA and its purposes, including the purpose of assuring that
consumers are offered and receive residential mortgage loans on terms
that reasonably reflect their ability to repay the loans. Similarly,
the Bureau finds that it is necessary, proper, and appropriate to use
its authority under TILA section 129C(b)(3)(B)(i) to revise and
subtract from statutory language. This use of authority ensures that
responsible, affordable mortgage credit remains available to consumers
in a manner consistent with and effectuates the purpose of TILA section
129C, referenced above, and facilitates compliance with section 129C of
TILA.
32(b)(2)
Proposed Provisions Not Adopted
As noted in the section-by-section analysis of Sec.
1026.32(b)(1)(ii) above, section 1431(c) of the Dodd-Frank Act amended
TILA to require that all compensation paid directly or indirectly by a
consumer or a creditor to a ``mortgage originator'' be included in
points and fees for high-cost mortgages and qualified mortgages. As
also noted above, the Board's 2011 ATR Proposal proposed to implement
this statutory change in proposed Sec. 226.32(b)(1)(ii) using the term
``loan originator,'' as defined in existing Sec. 1026.36(a)(1), rather
than the statutory term ``mortgage originator.'' In turn, the Board
proposed new Sec. 226.32(b)(2) to exclude from points and fees
compensation paid to certain categories of persons specifically
excluded from the definition of ``mortgage originator'' in amended TILA
section 103, namely employees of a retailer of manufactured homes under
certain circumstances, certain real estate brokers, and servicers.
The Bureau is not adopting proposed Sec. 226.32(b)(2). The Bureau
is amending

[[Page 6441]]

the definition of ``loan originator'' Sec. 1026.36(a)(1) and the
associated commentary to incorporate the statutory exclusion of these
persons from the definition. Accordingly, to the extent these persons
are excluded from the definition of loan originator compensation, their
compensation is not loan originator compensation that must be counted
in points and fees, and the exclusions in proposed Sec. 226.32(b)(2)
are no longer necessary.
Instead, in the 2013 HOEPA Final Rule, the Bureau is finalizing the
definition of points and fees for HELOCs in Sec. 1026.32(b)(2).
Current Sec. 1026.32(b)(2), which contains the definition of
``affiliate,'' is being renumbered as Sec. 1026.32(b)(5).
32(b)(3) Bona Fide Discount Point
32(b)(3)(i) Closed-End Credit
The Dodd-Frank Act defines the term ``bona fide discount points''
as used in Sec. 1026.32(b)(1)(i)(E) and (F), which, as discussed
above, permit exclusion of ``bona fide discount points'' from points
and fees for qualified mortgages. TILA section 129C(b)(2)(C)(iii)
defines the term ``bona fide discount points'' as ``loan discount
points which are knowingly paid by the consumer for the purpose of
reducing, and which in fact result in a bona fide reduction of, the
interest rate or time-price differential applicable to the mortgage.''
TILA section 129C(b)(2)(C)(iv) limits the types of discount points that
may be excluded from ``points and fees'' to those for which ``the
amount of the interest rate reduction purchased is reasonably
consistent with established industry norms and practices for secondary
market transactions.''
Proposed Sec. 226.43(e)(3)(iv) would have implemented these
provisions by defining the term ``bona fide discount point'' as ``any
percent of the loan amount'' paid by the consumer that reduces the
interest rate or time-price differential applicable to the mortgage
loan by an amount based on a calculation that: (1) Is consistent with
established industry practices for determining the amount of reduction
in the interest rate or time-price differential appropriate for the
amount of discount points paid by the consumer; and (2) accounts for
the amount of compensation that the creditor can reasonably expect to
receive from secondary market investors in return for the mortgage
loan.
The Board's proposal would have required that the creditor be able
to show a relationship between the amount of interest rate reduction
purchased by a discount point and the value of the transaction in the
secondary market. The Board observed that, based on outreach with
representatives of creditors and GSEs, the value of a rate reduction in
a particular mortgage transaction on the secondary market is based on
many complex factors, which interact in a variety of complex ways. The
Board noted that these factors may include, among others:
The product type, such as whether the loan is a fixed-rate
or adjustable-rate mortgage, or has a 30-year term or a 15-year term.
How much the MBS market is willing to pay for a loan at
that interest rate and the liquidity of an MBS with loans at that rate.
How much the secondary market is willing to pay for excess
interest on the loan that is available for capitalization outside of
the MBS market.
The amount of the guaranty fee required to be paid by the
creditor to the investor.
The Board indicated that it was offering a flexible proposal
because of its concern that a more prescriptive interpretation would be
operationally unworkable for most creditors and would lead to excessive
legal and regulatory risk. In addition, the Board also noted that, due
to the variation in inputs described above, a more prescriptive rule
likely would require continual updating, creating additional compliance
burden and potential confusion.
The Board also noted a concern that small creditors such as
community banks that often hold loans in portfolio rather than sell
them on the secondary market may have difficulty complying with this
requirement. The Board therefore requested comment on whether it would
be appropriate to provide any exemptions from the requirement that the
interest rate reduction purchased by a ``bona fide discount point'' be
tied to secondary market factors.
Many industry commenters criticized the second prong of the Board's
proposal, which would have required that the interest rate reduction
account for the amount of compensation that the creditor can reasonably
expect to receive from secondary market investors in return for the
mortgage loan. Several industry commenters argued that this test would
be complex and difficult to apply and that, if challenged, it would be
difficult for creditors to prove that the calculation was done
properly. Two industry commenters noted that creditors do not always
sell or plan to sell loans in the secondary market at the time of
origination and so would not know what compensation they would receive
on the secondary market. Several industry commenters emphasized that
the secondary market test would be impracticable for creditors holding
loans in portfolio. Consumer groups did not comment on this issue.
As noted above, the Bureau is consolidating the exclusions for
certain bona fide third-party charges and bona fide discount points in
Sec. 1026.32(b)(1)(i)(D) through (F). As a result, the Bureau is
adopting proposed Sec. 226.43(e)(3)(iv), with the revision discussed
below, as renumbered Sec. 1026.32(b)(3)(i). In the 2013 HOEPA Final
Rule, the Bureau is adopting a definition of bona fide discount point
for open-end credit in Sec. 1026.32(b)(3)(ii).
After carefully considering the comments, the Bureau is modifying
the definition of ``bona fide discount point.'' Specifically, the
Bureau believes it would be difficult, if not impossible, for many
creditors to account for the secondary market compensation in
calculating interest rate reductions. This is particularly true for
loans held in portfolio. Therefore, the Board is removing from Sec.
1026.32(b)(3)(i) the requirement that interest rate reductions take
into account secondary market compensation. Instead, as revised, Sec.
1026.32(b)(3)(i) requires only that the calculation of the interest
rate reduction be consistent with established industry practices for
determining the amount of reduction in the interest rate or time-price
differential appropriate for the amount of discount points paid by the
consumer.
The Bureau finds that removing the secondary market component of
the ``bona fide'' discount point definition is necessary and proper
under TILA section 105(a) to effectuate the purposes of and facilitate
compliance with TILA. Similarly, the Bureau finds that it is necessary
and proper to use its authority under TILA section 129C(b)(3)(B)(i) to
revise and subtract from the criteria that define a qualified mortgage
by removing the secondary market component from the bona fide discount
point definition. It will provide creditors sufficient flexibility to
demonstrate that they are in compliance with the requirement that, to
be excluded from points and fees, discount points must be bona fide. In
clarifying the definition, it also will facilitate the use of bona fide
discount points by consumers to help create the appropriate combination
of points and rate for their financial situation, thereby helping
ensure that consumers are offered and receive residential mortgage loan
on terms that reasonably reflect their ability to repay the loans and
that responsible, affordable mortgage credit

[[Page 6442]]

remains available to consumers in a manner consistent with the purposes
of TILA as provided in TILA section 129C.
To provide some guidance on how creditors may comply with this
requirement, the Bureau is adding new comment 32(b)(3)(i)-1. This
comment explains how creditors can comply with ``established industry
practices'' for calculating interest rate reductions. Specifically,
comment 32(b)(3)(i)-1 notes that one way creditors can satisfy this
requirement is by complying with established industry norms and
practices for secondary mortgage market transactions. Comment
32(b)(3)(i)-1 then provides two examples. First a creditor may rely on
pricing in the to-be-announced (TBA) market for MBS to establish that
the interest rate reduction is consistent with the compensation that
the creditor could reasonably expect to receive in the secondary
market. Second, a creditor could comply with established industry
practices, such as guidelines from Fannie Mae or Freddie Mac that
prescribe when an interest rate reduction from a discount point is
considered bona fide. However, because these examples from the
secondary market are merely illustrations of how a creditor could
comply with the ``established industry practices'' requirement for bona
fide interest rate reduction, creditors, and in particular creditors
that retain loans in portfolio, will have flexibility to use other
approaches for complying with this requirement.
32(b)(4) Total Loan Amount
32(b)(4)(i) Closed-End Credit
As added by section 1412 of the Dodd-Frank Act, TILA section
129C(b)(2)(A)(vii) defines a ``qualified mortgage'' as a mortgage for
which, among other things, ``the total points and fees * * * payable in
connection with the loan do not exceed 3 percent of the total loan
amount.'' For purposes of implementing the qualified mortgage
provisions, the Board proposed to retain existing comment 32(a)(1)(ii)-
1 explaining the meaning of the term ``total loan amount,'' with
certain minor revisions discussed below, while also seeking comment on
an alternative approach.
The proposal would have revised the ``total loan amount''
calculation under current comment 32(a)(1)(ii)-1 to account for charges
added to TILA's definition of points and fees by the Dodd-Frank Act.
Under Regulation Z for purposes of applying the existing points and
fees trigger for high-cost loans, the ``total loan amount'' is
calculated as the amount of credit extended to or on behalf of the
consumer, minus any financed points and fees. Specifically, under
current comment 32(a)(1)(ii)-1, the ``total loan amount'' is calculated
by ``taking the amount financed, as determined according to Sec.
1026.18(b), and deducting any cost listed in Sec. 1026.32(b)(1)(iii)
and Sec. 1026.32(b)(1)(iv) that is both included as points and fees
under Sec. 1026.32(b)(1) and financed by the creditor.'' Section
1026.32(b)(1)(iii) and (b)(1)(iv) pertain to ``real estate-related
fees'' listed in Sec. 1026.4(c)(7) and premiums or other charges for
credit insurance or debt cancellation coverage, respectively.
The Board proposed to revise this comment to cross-reference
additional financed points and fees described in proposed Sec.
226.32(b)(1)(vi) as well. This addition would have required a creditor
also to deduct from the amount financed any prepayment penalties that
are incurred by the consumer if the mortgage loan refinances a previous
loan made or currently held by the creditor refinancing the loan or an
affiliate of the creditor--to the extent that the prepayment penalties
are financed by the creditor. As a result, the 3 percent limit on
points and fees for qualified mortgages would have been based on the
amount of credit extended to the consumer without taking into account
any financed points and fees.
The Board's proposal also would have revised one of the
commentary's examples of the ``total loan amount'' calculation.
Specifically, the Board proposed to revise the example of a $500 single
premium for optional ``credit life insurance'' used in comment
32(b)(1)(i)-1.iv to be a $500 single premium for optional ``credit
unemployment insurance.'' The Board stated that this change was
proposed because, under the Dodd-Frank Act, single-premium credit
insurance--including credit life insurance--is prohibited in covered
transactions except for certain limited types of credit unemployment
insurance. See TILA section 129C(d). The Board requested comment on the
proposed revisions to the comment explaining how to calculate the
``total loan amount,'' including whether additional guidance is needed.
The Board also requested comment on whether to streamline the
calculation to ensure that the ``total loan amount'' would include all
credit extended other than financed points and fees. Specifically, the
Board solicited comment on whether to revise the calculation of ``total
loan amount'' to be the ``principal loan amount'' (as defined in Sec.
226.18(b) and accompanying commentary), minus charges that are points
and fees under Sec. 226.32(b)(1) and are financed by the creditor. The
Board explained that the purpose of using the ``principal loan amount''
instead of the ``amount financed'' would be to streamline the
calculation to facilitate compliance and to ensure that no charges
other than financed points and fees are excluded from the ``total loan
amount.'' \85\ In general, the revised calculation would have yielded a
larger ``total loan amount'' to which the percentage points and fees
thresholds would have to be applied than would the proposed (and
existing) ``total loan amount'' calculation, because only financed
points and fees and no other financed amounts would be excluded. Thus,
creditors in some cases would be able to charge more points and fees on
the same loan under the alternative outlined by the Board than under
either the proposed or existing rule.
---------------------------------------------------------------------------

\85\ Specifically, under the alternative approach, prepaid
finance charges would not be deducted from the principal loan
amount. Only financed points and fees would be deducted.
---------------------------------------------------------------------------

In the 2012 HOEPA Proposal, the Bureau proposed the following for
organizational purposes: (1) To move the existing definition of ``total
loan amount'' for closed-end mortgage loans from comment 32(a)(1)(ii)-1
to proposed Sec. 1026.32(b)(6)(i); and (2) to move the examples
showing how to calculate the total loan amount for closed-end mortgage
loans from existing comment 32(a)(1)(ii)-1 to proposed comment
32(b)(6)(i)-1. The Bureau proposed to specify that the calculation
applies to closed-end mortgage loans because the Bureau also proposed
to define ``total loan amount'' separately for open-end credit plans.
The Bureau also proposed to amend the definition of ``total loan
amount'' in a manner similar to the Board's alternative proposal
described above. The Bureau indicated this proposed revision would
streamline the total loan amount calculation to facilitate compliance
and would be sensible in light of the more inclusive definition of the
finance charge proposed in the Bureau's 2012 TILA-RESPA Integration
Proposal.
Few commenters addressed the Board's proposal regarding total loan
amount. Several industry commenters recommended that the alternative
method of calculating total loan amount be used because it would be
easier to calculate. At least two industry commenters recommended that,
for simplicity, the amount recited in the note be used for calculating
the permitted points and fees.
After reviewing the comments, the Bureau is following the 2012
HOEPA

[[Page 6443]]

Proposal and moving the definition of total loan amount into the text
of the rule in Sec. 1026.32(b)(4)(i). In 2013 HOEPA Final Rule, the
Bureau is adopting a definition of total loan amount for open-end
credit in Sec. 1026.32(b)(4)(ii). The examples showing how to
calculate the total loan amount are moved to comment 32(b)(4)(i)-1.
However, the Bureau has concluded that, at this point, the current
approach to calculating the total loan amount should remain in place.
Creditors are familiar with the method from using it for HOEPA points
and fees calculations. Moreover, as noted above, the Bureau is
deferring action on the more inclusive definition of the finance charge
proposed in the Bureau's 2012 TILA-RESPA Integration Proposal. If the
Bureau expands the definition of the finance charge, the Bureau will at
the same time consider the effect on coverage thresholds that rely on
the finance charge or the APR.
32(b)(5)
The final rule renumbers existing Sec. 1026.32(b)(2) defining the
term ``affiliate'' as Sec. 1026.32(b)(5) for organizational purposes.
32(b)(6) Prepayment Penalty
The Dodd-Frank Act's Amendments to TILA Relating to Prepayment
Penalties
Sections 1431 and 1432 of the Dodd-Frank Act (relating to high-cost
mortgages) and section 1414 of the Dodd-Frank Act (relating to
qualified mortgages) amended TILA to restrict and, in many cases,
prohibit a creditor from imposing prepayment penalties in dwelling-
secured credit transactions. The Dodd-Frank Act restricted prepayment
penalties in three main ways.
First, as the Board discussed in its 2011 ATR Proposal, the Dodd-
Frank Act added new TILA section 129C(c)(1) relating to qualified
mortgages, which generally provides that a covered transaction (i.e.,
in general, a closed-end, dwelling-secured credit transaction) may
include a prepayment penalty only if it; (1) Is a qualified mortgage,
to be defined by the Board, (2) has an APR that cannot increase after
consummation, and (3) is not a higher-priced mortgage loan. The Board
proposed to implement TILA section 129C(c)(1) in Sec. 226.43(g)(1) and
to define the term prepayment penalty in Sec. 226.43(b)(10). Under new
TILA section 129C(c)(3), moreover, even loans that meet the statutorily
prescribed criteria (i.e., fixed-rate, non-higher-priced qualified
mortgages) are capped in the amount of prepayment penalties that may be
charged, starting at three percent in the first year after consummation
and decreasing annually by increments of one percentage point
thereafter so that no penalties may be charged after the third year.
The Board proposed to implement TILA section 129C(c)(3) in Sec.
226.43(g)(2).
Second, section 1431(a) of the Dodd-Frank Act amended TILA section
103(bb)(1)(A)(iii) to provide that a credit transaction is a high-cost
mortgage if the credit transaction documents permit the creditor to
charge or collect prepayment fees or penalties more than 36 months
after the transaction closing or if such fees or penalties exceed, in
the aggregate, more than two percent of the amount prepaid. Moreover,
under amended TILA section 129(c)(1), high-cost mortgages are
prohibited from having a prepayment penalty. Accordingly, any
prepayment penalty in excess of two percent of the amount prepaid on
any closed end mortgage would both trigger and violate the rule's high-
cost mortgage provisions. The Bureau's 2012 HOEPA Proposal proposed to
implement these requirements with several minor clarifications in Sec.
1026.32(a)(1)(iii). See 77 FR 49090, 49150 (Aug. 15, 2012).
Third, both qualified mortgages and most closed-end mortgage loans
and open-end credit plans secured by a consumer's principal dwelling
are subject to additional limitations on prepayment penalties through
the inclusion of prepayment penalties in the definition of points and
fees for qualified mortgages and high-cost mortgages. See the section-
by-section analysis of proposed Sec. 226.32(b)(1)(v) and (vi); 77 FR
49090, 49109-10 (Aug. 15, 2012).
Taken together, the Dodd-Frank Act's amendments to TILA relating to
prepayment penalties mean that most closed-end, dwelling-secured
transactions: (1) May provide for a prepayment penalty only if the
transaction is a fixed-rate, qualified mortgage that is neither high-
cost nor higher-priced under Sec. Sec. 1026.32 and 1026.35; (2) may
not, even if permitted to provide for a prepayment penalty, charge the
penalty more than three years following consummation or in an amount
that exceeds two percent of the amount prepaid; and (3) may be required
to limit any penalty even further to comply with the points and fees
limitations for qualified mortgages or to stay below the points and
fees trigger for high-cost mortgages.
In the interest of lowering compliance burden and to provide
additional clarity for creditors, the Bureau has elected to define
prepayment penalty in a consistent manner for purposes of all of the
Dodd-Frank Act's amendments. This definition is located in Sec.
1026.32(b)(6). New Sec. 1026.43(b)(10) cross-references this
prepayment definition to provide consistency.
TILA establishes certain disclosure requirements for transactions
for which a penalty is imposed upon prepayment, but TILA does not
define the term ``prepayment penalty.'' The Dodd-Frank Act also does
not define the term. TILA section 128(a)(11) requires that the
transaction-specific disclosures for closed-end consumer credit
transactions disclose a ``penalty'' imposed upon prepayment in full of
a closed-end transaction, without using the term ``prepayment
penalty.'' 15 U.S.C. 1638(a)(11).\86\ Comment 18(k)(1)-1 clarifies that
a ``penalty'' imposed upon prepayment in full is a charge assessed
solely because of the prepayment of an obligation and includes, for
example, ``interest'' charges for any period after prepayment in full
is made and a minimum finance charge.
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\86\ Also, TILA section 128(a)(12) requires that the
transaction-specific disclosures state that the consumer should
refer to the appropriate contract document for information regarding
certain loan terms or features, including ``prepayment * * *
penalties.'' 15 U.S.C. 1638(a)(12). In addition, TILA section 129(c)
limits the circumstances in which a high-cost mortgage may include a
``prepayment penalty.'' 15 U.S.C. 1639(c).
---------------------------------------------------------------------------

The Board's 2011 ATR Proposal proposed to implement the Dodd-Frank
Act's prepayment penalty-related amendments to TILA for qualified
mortgages by defining ``prepayment penalty'' for most closed-end,
dwelling-secured transactions in new Sec. 226.43(b)(10), and by cross-
referencing proposed Sec. 226.43(b)(10) in the proposed joint
definition of points and fees for qualified and high-cost mortgages in
Sec. 226.32(b)(1)(v) and (vi). The definition of prepayment penalty
proposed in the Board's 2011 ATR Proposal differed from the Board's
prior proposals and existing guidance in the following respects: (1)
Proposed Sec. 226.43(b)(10) defined prepayment penalty with reference
to a payment of ``all or part of'' the principal in a transaction
covered by the provision, while Sec. 1026.18(k) and associated
commentary and the Board's 2009 Closed-End Proposal and 2010 Mortgage
Proposal referred to payment ``in full;'' (2) the examples provided
omitted reference to a minimum finance charge and loan guarantee fees;
and (3) proposed Sec. 226.43(b)(10) did not incorporate, and the
Board's 2011 ATR Proposal did not otherwise address, the language in
Sec. 1026.18(k)(2) and associated commentary regarding

[[Page 6444]]

disclosure of a rebate of a precomputed finance charge, or the language
in Sec. 1026.32(b)(6) and associated commentary concerning prepayment
penalties for high-cost mortgages.
The Board proposal generally received support from industry
commenters and consumer advocates for accurately implementing section
129C(c) by using a plain language definition of prepayment penalty.
Many commenters, particularly consumer groups, supported a rule that
eliminates or tightly restricts the availability of prepayment
penalties. Some industry commenters, however, cautioned the Bureau
against implementing an overbroad definition of prepayment penalty,
citing primarily a concern over consumers' access to credit. At least
one commenter argued that a prepayment penalty ban should be more
narrowly focused on the subprime loan market, noting that the proposal
affected prepayment penalties on a wider variety of products. Other
industry commenters expressed a concern about the Board's approach to
the monthly interest accrual amortization method, as discussed in more
detail below as part of the discussion of comment 32(b)(6)-1.
The Bureau adopts the definition of prepayment penalty under Sec.
1026.32(b)(6) largely as proposed by the Board in order to create a
clear application of the term prepayment penalty that is consistent
with the definitions proposed in the Bureau's 2012 TILA-RESPA Proposal
(which itself draws from the definition adopted in the Bureau's 2013
HOEPA Final Rule). However, the Bureau adds to Sec. 1026.32(b)(6) an
explicit exclusion from the definition of prepayment penalty for a
waived bona fide third-party charge that the creditor imposes if the
consumer, sooner than 36 months after consummation, pays all of a
covered transaction's principal before the date on which the principal
is due. This addition is discussed in detail below. Consistent with
TILA section 129(c)(1), existing Sec. 1026.32(d)(6), and the Board's
proposed Sec. 226.43(b)(10) for qualified mortgages, Sec.
1026.32(b)(6)(i) provides that, for a closed-end mortgage loan, a
``prepayment penalty'' means a charge imposed for paying all or part of
the transaction's principal before the date on which the principal is
due, though the Bureau has added a carve-out from this definition to
accommodate the repayment of certain conditionally waived closing costs
when the consumer prepays in full. The Bureau adopts this definition of
prepayment penalty under Sec. 1026.32(b)(6), rather than under Sec.
1026.43(b)(10), to facilitate compliance for creditors across
rulemakings. The definition of ``prepayment penalty'' under Sec.
1026.32(b)(6) thus will apply to prepayment penalty restrictions, as
applied under Sec. 1026.43(g). Section 1026.32(b)(6) also contains
requirements and guidance related to the Bureau's 2013 HOEPA Final
Rule, such as a definition of prepayment penalty that applies to open-
end credit.
The Board's 2011 ATR Proposal included as an example of a
prepayment penalty a fee that the creditor waives unless the consumer
prepays the covered transaction. Some industry commenters contended
that such conditional fee waivers should be excluded from the
definition of prepayment penalties. The commenters argued that
creditors imposed conditional fee waivers not to increase profit, but
to ensure compensation for fixed costs associated with originating the
loan. At least one commenter directed the Bureau to a 1996 National
Credit Union Administration opinion letter that concluded that a
conditional waiver of closing costs by a credit union was a benefit to
the consumer. Other comments characterized the conditional fee waiver
as a ``reimbursement,'' rather than compensation.
The Bureau finds such comments persuasive, particularly with
respect to a situation in which the creditor waives a bona fide third-
party charge (or charges) on condition that the consumer reimburse the
creditor for the cost of that charge if the consumer prepays the loan.
In such situations, the Bureau recognizes that the creditor receives no
profit from imposing or collecting such charges and the Bureau believes
that treating such charges as a prepayment penalty might very well have
the effect of reducing consumer choice without providing any
commensurate consumer benefit. In an effort to provide a sensible way
to permit a creditor to protect itself from losing money paid at
closing to third parties on the consumer's behalf, prior to such time
as the creditor can otherwise recoup such costs through the interest
rate on the mortgage loan, while balancing consumer protection
interests, the Bureau has concluded that such fees should be
permissible for a limited time after consummation. The Bureau thus
adopts Sec. 1032(b)(6)(i) to clarify that the term prepayment penalty
does not include a waived bona fide third-party charge imposed by the
creditor if the consumer pays all of a covered transaction's principal
before the date on which the principal is due sooner than 36 months
after consummation. The Bureau concludes that limiting the duration of
the possible charge to 36 months after consummation is consistent with
TILA 129C(c)(3)(D), which prohibits any prepayment penalty three years
after loan consummation, while accommodating the concerns discussed
above. Moreover, Sec. 1032(b)(6)(i) excludes from the definition of
prepayment penalty only those charges that a creditor imposes to recoup
waived bona-fide third party charges in such cases where the consumer
prepays in full. Thus, for example, if one month after loan
consummation, the consumer prepays $100 of principal earlier than it is
due, where the total principal is $100,000, then any fee that the
creditor imposes for such prepayment is a prepayment penalty under
Sec. 1032(b)(6)(i) and such a fee is restricted in accordance with
Sec. 1026.43(g).
The Bureau believes that Sec. 1026.32(b)(6) accurately implements
TILA section 129C(c), which significantly limits the applicability and
duration of prepayment penalties. Some commenters argued that
restrictions on prepayment penalties should be more narrowly focused on
specific products or consumers, because not all consumers need
protection from the pitfalls of prepayment penalties. The Bureau agrees
that prepayment penalties are not always harmful to consumers and that,
in some cases, allowing a creditor to charge a prepayment penalty may
lead to increased consumer choice and access to credit. Congress
recognized this balance by allowing a creditor to charge a prepayment
penalty only in certain circumstances, such as requiring the loan to be
a qualified mortgage, under TILA section 129C(c)(1)(A), and by limiting
a creditor to charging a prepayment penalty to no more than three years
following consummation, under TILA section 129C(c)(3)(D). Section
1026.32(b)(6) remains faithful to that balance, with the Bureau's minor
clarification with respect to waived bona fide third party charges, as
described above.
The Board's 2011 ATR Proposal included several other examples of a
prepayment penalty under proposed Sec. 226.43(b)(10)(i). For clarity,
the Bureau incorporates these examples as comment 32(b)(6)-1.i and ii,
and the Bureau is adding comment 32(b)(6)-1.iii and iv to provide
additional clarity. Likewise, the Bureau is largely adopting the
Board's proposed Sec. 226.43(b)(10)(ii), an example of what is not a
prepayment penalty, as comment 32(b)(6)-3.i, as well as adding comment
32(b)(6)-3.ii.
Comment 32(b)(6)-1.i through iv gives the following examples of
prepayment penalties: (1) A charge determined by treating the loan
balance as outstanding for a period of time after prepayment in

[[Page 6445]]

full and applying the interest rate to such ``balance,'' even if the
charge results from interest accrual amortization used for other
payments in the transaction under the terms of the loan contract; (2) a
fee, such as an origination or other loan closing cost, that is waived
by the creditor on the condition that the consumer does not prepay the
loan; (3) a minimum finance charge in a simple interest transaction;
and (4) computing a refund of unearned interest by a method that is
less favorable to the consumer than the actuarial method, as defined by
section 933(d) of the Housing and Community Development Act of 1992, 15
U.S.C. 1615(d).
Post-payoff interest charges. The Board proposal included as an
example of a prepayment penalty in proposed Sec. 226.43(b)(10)(i)(A) a
charge determined by the creditor or servicer treating the loan balance
as outstanding for a period of time after prepayment in full. Some
industry commenters expressed reservations about treating this monthly
interest accrual amortization method as a prepayment penalty, arguing
that such a rule might cause higher resale prices in the secondary
mortgage market to account for cash flow uncertainty. Other commenters
noted that this calculation method is currently used by FHA to compute
interest on its loans (including loans currently in Ginnie Mae pools),
or that such charges were not customarily considered a prepayment
penalty. Some commenters expressed concern that the rule would disrupt
FHA lending.
After careful consideration of the comments received, the Bureau
concludes that going forward (e.g., for loans a creditor originates
after the effective date), it is appropriate to designate higher
interest charges for consumers based on accrual methods that treat a
loan balance as outstanding for a period of time after prepayment in
full as prepayment penalties under Sec. 1026.32(b)(6) and comment
32(b)(6)-1.i. In such instances, the consumer submits a payment before
it is due, but the creditor nonetheless charges interest on the portion
of the principal that the creditor has already received. The Bureau
believes that charging a consumer interest after the consumer has
repaid the principal is the functional equivalent of a prepayment
penalty. Comment 32(b)(6)-1.i further clarifies that ``interest accrual
amortization'' refers to the method by which the amount of interest due
for each period (e.g., month) in a transaction's term is determined and
notes, for example, that ``monthly interest accrual amortization''
treats each payment as made on the scheduled, monthly due date even if
it is actually paid early or late (until the expiration of any grace
period). The proposed comment also provides an example where a
prepayment penalty of $1,000 is imposed because a full month's interest
of $3,000 is charged even though only $2,000 in interest was earned in
the month during which the consumer prepaid.
With respect to FHA practices relating to monthly interest accrual
amortization, the Bureau has consulted extensively with HUD in issuing
this final rule as well as the 2013 HOEPA Final Rule. Based on these
consultations, the Bureau understands that HUD must engage in
rulemaking to end its practice of imposing interest charges on
consumers for the balance of the month in which consumers prepay in
full. The Bureau further understands that HUD requires approximately 24
months to complete its rulemaking process. Accordingly, in recognition
of the important role that FHA-insured credit plays in the current
mortgage market and to facilitate FHA creditors' ability to comply with
this aspect of the 2013 ATR and HOEPA Final Rules, the Bureau is using
its authority under TILA section 105(a) to provide for optional
compliance until January 15, 2015 with Sec. 1026.32(b)(6)(i) and the
official interpretation of that provision in comment 32(b)(6)-1.i
regarding monthly interest accrual amortization. Specifically, Sec.
1026.32(b)(6)(i) provides that interest charged consistent with the
monthly interest accrual amortization method is not a prepayment
penalty for FHA loans consummated before January 21, 2015. FHA loans
consummated on or after January 21, 2015 must comply with all aspects
of the final rule. The Bureau is making this adjustment pursuant to its
authority under TILA section 105(a), which provides that the Bureau's
regulations may contain such additional requirements, classifications,
differentiations, or other provisions, and may provide for such
adjustments and exceptions for all or any class of transactions as in
the Bureau's judgment are necessary or proper to effectuate the
purposes of TILA, prevent circumvention or evasion thereof, or
facilitate compliance therewith. 15 U.S.C. 1604(a). The purposes of
TILA include the purposes that apply to 129C, to assure that consumers
are offered and receive residential mortgage loans on terms that
reasonably reflect their ability to repay the loan. See 15 U.S.C.
1639b(a)(2). The Bureau believes it is necessary and proper to make
this adjustment to ensure that consumers receive loans on affordable
terms and to facilitate compliance with TILA and its purposes while
mitigating the risk of disruption to the market. For purposes of this
rulemaking, the Bureau specifically notes that the inclusion of
interest charged consistent with the monthly interest accrual
amortization method in the definition of prepayment penalty for
purposes of determining whether a transaction is in compliance with the
requirements of Sec. 1026.43(g) applies only to transactions
consummated on or after January 10, 2014; for FHA loans, compliance
with this aspect of the definition of prepayment penalties is optional
for transactions consummated prior to January 21, 2015.
With regard to general concerns that loans subject to these
interest accrual methods may be subject to higher prices on the
secondary market, the Bureau is confident that the secondary market
will be able to price the increased risk of prepayment, if any, that
may occur as a result of the limits that will apply to monthly interest
accrual amortization-related prepayment penalties. The secondary market
already does so for various other types of prepayment risk on investor
pools, such as the risk of refinancing or sale of the property.
Comment 32(b)(6)-1.ii further explains the 36 month carve-out for a
waived bona fide third-party charge imposed by the creditor if the
consumer pays all of a covered transaction's principal before the date
on which the principal is due sooner than 36 months after consummation,
as included in Sec. 1026.32(b)(6)(i). The comment explains that if a
creditor waives $3,000 in closing costs to cover bona fide third party
charges but the terms of the loan agreement provide that the creditor
may recoup $4,500, in part to recoup waived charges, then only $3,000
that the creditor may impose to cover the waived bona fide third party
charges is considered not to be a prepayment penalty, while any
additional $1,500 charge for prepayment is a prepayment penalty and
subject to the restrictions under Sec. 1026.43(g). This comment also
demonstrates that the only amount excepted from the definition of
prepayment penalty under Sec. 1026.32(b)(6)(i) is the actual amount
that the creditor pays to a third party for a waived, bona fide charge.
Minimum finance charges; unearned interest refunds. Although
longstanding Regulation Z commentary has listed a minimum finance
charge in a simple interest transaction as an example of a prepayment
penalty, the Board proposed to omit that example from proposed Sec.
226.43(b)(10) because the

[[Page 6446]]

Board reasoned that such a charge typically is imposed with open-end,
rather than closed-end, transactions. The Bureau did not receive
substantial comment on this omission, but the Bureau has elected to
continue using this example in comment 32(b)(6)-1.iii for consistency.
Likewise, the Board did not propose to include the example of computing
a refund of unearned interest by a method that is less favorable to the
consumer than the actuarial method, but the Bureau is nonetheless using
this example in comment 32(b)(6)-1.iv because similar language is found
in longstanding Regulation Z commentary.
Examples of fees that are not prepayment penalties. The Board
included in proposed Sec. 226.43(b)(10)(ii) an example of a fee not
considered a prepayment penalty. For the sake of clarity, the Bureau is
moving this example into comment 32(b)(6)-2.i, rather than keep the
example in the text of the regulation. The Bureau also is adding a
second example in comment 32(b)(6)-2.ii.
Comment 32(b)(6)-2.i explains that fees imposed for preparing and
providing documents when a loan is paid in full are not prepayment
penalties when such fees are imposed whether or not the loan is prepaid
or the consumer terminates the plan prior to the end of its term.
Commenters did not provide substantial feedback on this example, which
the Bureau has reworded slightly from the Board proposal to provide
conformity and clarity.
The Board proposed omitting text from preexisting commentary on
Regulation Z stating that a prepayment penalty did not include loan
guarantee fees, noting that loan guarantee fees are not charges imposed
for paying all or part of a loan's principal before the date on which
the principal is due. The Bureau did not receive substantial comment on
this omission. While the Bureau agrees with the Board's analysis, the
Bureau nonetheless elects to include this example in comment 43(b)(6)-
2.ii to clarify that loan guarantee fees continue to fall outside the
definition of a prepayment penalty. Moreover, including this example of
a fee that is not a prepayment penalty is consistent with the Bureau's
efforts to streamline definitions and ease regulatory burden.
Construction-to-permanent financing. Some industry commenters
advocated that, for construction-to-permanent loans, the Bureau should
exclude from the definition of prepayment penalty charges levied by a
creditor if a consumer does not convert the construction loan into a
permanent loan with the same creditor within a specified time period.
The Bureau believes that the concern expressed by these commenters that
the cost of credit for these construction-to-permanent loans would
increase if such charges were treated as prepayment penalties is
misplaced primarily because in many cases, such charges are not, in
fact, a prepayment penalty. A prepayment penalty is ``a charge imposed
for paying all or part of a covered transaction's principal before the
date on which the principal is due.'' First, the case where the
creditor charges the consumer a fee for failing to convert a loan
within a specified period after completing the repayment of a
construction loan as scheduled is not a prepayment penalty; the fee is
not assessed for an early payment of principal, but rather for the
consumer's failure to take an action upon scheduled repayment of
principal. Second, the case where a consumer does convert the
construction loan to a permanent loan in a timely manner, but incurs a
fee for converting the loan with another creditor, is also likely not
prepayment penalty. While such cases depend highly on contractual
wording, in the example above, the consumer is charged a fee not for
his early payment of principal, but rather for his use of another
creditor. Third, the case where the creditor charges the consumer a fee
for converting the construction loan to a permanent loan earlier than
specified by agreement, even with the same creditor, likely is a
prepayment penalty. While this example is not the same as the
hypothetical described by most commenters, who expressed concern if a
consumer does not convert the construction loan into a permanent loan
with the same creditor within a specified time period, this is an
example of a prepayment penalty, as the creditor has imposed a charge
for paying all or part of a covered transaction's principal before the
date on which the principal was due. As the above examples demonstrate,
whether a construction-to-permanent loan contains a prepayment penalty
is fact-specific, and the Bureau has decided that adding a comment
specifically addressing such loans would not be instructive. The Bureau
sees no policy reason to generally exclude fees specific to
construction-to-permanent loan from the definition of prepayment
penalty and its statutory limits. The Bureau was not presented with any
evidence that the risks inherent in construction-to-permanent loans
could not be priced by creditors through alternative means, such as the
examples described above, via interest rate, or charging closing costs.
The Bureau also notes that, because of the scope of the rule, described
in the section-by-section analysis of Sec. 1026.43(a), as well as the
prepayment penalty restrictions, described in the section-by-section
analysis of Sec. 1026.43(g), construction-to-permanent loans cannot be
qualified mortgages, and thus under Sec. 1026.43(g)(1)(ii)(B) cannot
include a prepayment penalty. Construction-to-permanent loans are
discussed in more detail in the section-by-section analysis of Sec.
1026.43(a).
Open-end credit. The Bureau is concurrently adopting comments
32(b)(6)-3 and -4 to clarify its approach to prepayment penalties with
respect to open-end credit. As the Board's 2011 ATR Proposal did not
address open-end credit plans, the Bureau is not clarifying prepayment
penalties with respect to open-end credit plans in this final rule.
Instead, guidance is provided in comments 32(b)(6)-3 and -4, which the
Bureau is adopting in the concurrent 2013 HOEPA Final Rule.

Section 1026.43 Minimum Standards for Transactions Secured by a
Dwelling 43(a) Scope

Sections 1411, 1412 and 1414 of the Dodd-Frank Act add new TILA
section 129C, which requires creditors to determine a consumer's
ability to repay a ``residential mortgage loan'' and establishes new
rules and prohibitions on prepayment penalties. Section 1401 of the
Dodd-Frank Act adds new TILA section 103(cc),\87\ which defines
``residential mortgage loan'' to mean, with some exceptions, any
consumer credit transaction secured by a mortgage, deed of trust, or
other equivalent consensual security interest on ``a dwelling or on
residential real property that includes a dwelling.'' TILA section
103(v) defines ``dwelling'' to mean a residential structure or mobile
home which contains one- to four-family housing units, or individual
units of condominiums or cooperatives. Thus, a ``residential mortgage
loan'' is a dwelling-secured consumer credit transaction, regardless of
whether the consumer credit transaction involves a home purchase,
refinancing, home equity loan, first lien or subordinate lien, and
regardless of whether the dwelling is a principal residence, second
home, vacation home (other than a timeshare residence), a one- to four-
unit residence, condominium, cooperative, mobile home, or manufactured
home.
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\87\ Two TILA subsections designated 103(cc) exist due to a
discrepancy in the instructions given by the Dodd-Frank Act. See
Dodd-Frank Act sections 1100A and 1401.

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[[Page 6447]]

However, the Dodd-Frank Act specifically excludes from the term
``residential mortgage loan'' an open-end credit plan or an extension
of credit secured by an interest in a timeshare plan, for purposes of
the repayment ability and prepayment penalty provisions under TILA
section 129C, among other provisions. See TILA section 103(cc)(5); see
also TILA section 129C(i) (providing that timeshare transactions are
not subject to TILA section 129C). Further, the repayment ability
provisions of TILA section 129C(a) do not apply to reverse mortgages or
temporary or ``bridge'' loans with a term of 12 months or less,
including a loan to purchase a new dwelling where the consumer plans to
sell another dwelling within 12 months. See TILA section 129C(a)(8).
The repayment ability provisions of TILA section 129C(a) also do not
apply to consumer credit transactions secured by vacant land. See TILA
section 103(cc)(5) and 129C(a)(1).
TILA Section 103(cc) defines ``residential mortgage loan'' to mean
a consumer credit transaction secured by a mortgage or equivalent
consensual security interest ``on a dwelling or on residential real
property that includes a dwelling.'' Under TILA and Regulation Z, the
term ``dwelling'' means a residential structure with one to four units,
whether or not the structure is attached to real property, and includes
a condominium or cooperative unit, mobile home, and trailer, if used as
a residence. See 15 U.S.C. 1602(v), Sec. 1026.2(a)(19). To facilitate
compliance by using consistent terminology throughout Regulation Z, the
proposal used the term ``dwelling,'' as defined in Sec. 1026.2(a)(19),
and not the phrase ``residential real property that includes a
dwelling.'' Proposed comment 43(a)-2 clarified that, for purposes of
proposed Sec. 226.43, the term ``dwelling'' would include any real
property to which the residential structure is attached that also
secures the covered transaction.
Proposed Sec. 226.43(a) generally defined the scope of the
ability-to-repay provisions to include any consumer credit transaction
that is secured by a dwelling, other than home equity lines of credit,
mortgage transactions secured by an interest in a timeshare plan, or
for certain provisions reverse mortgages or temporary loans with a term
of 12 months or less. Proposed comment 43(a)-1 clarified that proposed
Sec. 226.43 would not apply to an extension of credit primarily for a
business, commercial, or agricultural purpose and cross-referenced the
existing guidance on determining the primary purpose of an extension of
credit in commentary on Sec. 1026.3.
Numerous commenters requested additional exemptions from coverage
beyond the statutory exemptions listed at proposed Sec. 226.43(a)(1)
through (3). The Bureau received requests for exemptions from the rule
for seller-financed transactions, loans secured by non-primary
residences, community development loans, downpayment assistance loans,
loans eligible for purchase by GSEs, and housing stabilization
refinances. The requested exemptions related to community development
loans, downpayment assistance loans, and housing stabilization
refinances are not being included in this final rule, but are addressed
in the Bureau's proposed rule regarding amendments to the ability-to-
repay requirements, published elsewhere in today's Federal Register.
The requested exemptions that are not being included in the rule and
are not being addressed in today's concurrent proposal are discussed
immediately below.
The Bureau received numerous letters from individuals concerned
that the rule would cover individual home sellers who finance the
buyer's purchase, either through a loan or an installment sale.
However, because the definition of ``creditor'' for mortgages generally
covers only persons who extend credit secured by a dwelling more than
five times in a calendar year, the overwhelming majority of individual
seller-financed transactions will not be covered by the rule. Those
creditors who self-finance six or more transactions in a calendar year,
whether through loans or installment sales, will need to comply with
the ability-to-repay provisions of Sec. 1026.43, just as they must
comply with other relevant provisions of Regulation Z.
An association of State bank regulators suggested that the scope of
the ability-to-repay requirements be limited to owner-occupied primary
residences, stating that ability to repay on vacation homes and
investment properties should be left to an institution's business
judgment. The Bureau believes it is not appropriate or necessary to
exercise its exception authority to change the scope of the provision
in this way for several reasons. First, as discussed in proposed
comment 43(a)-1, loans that have a business purpose \88\ are not
covered by TILA, and so would not be covered by the ability-to-repay
provisions as proposed and adopted. Investment purpose loans are
considered to be business purpose loans. Second, vacation home loans
are consumer credit transactions that can have marked effects on a
consumer's finances. If a consumer is unable to repay a mortgage on a
vacation home, the consumer will likely suffer severe financial
consequences and the spillover effects on property values and other
consumers in the affected area can be substantial as well. Third, the
Bureau understands that default rates on vacation homes are generally
higher than those on primary residences, and an exemption could
increase this disparity.
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\88\ 12 CFR 1026.3(a).
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For the reasons discussed below, the general scope provision and
the statutory exemptions in Sec. 1026.43(a)(1) through (3)(ii) are
adopted substantially as proposed, with minor changes as discussed in
the relevant sections below, and the addition of Sec.
1026.43(a)(3)(iii) to provide an exemption for the construction phase
of a construction-to-permanent loan.
The general scope provision at Sec. 1026.43(a) now includes
language making clear that real property attached to a dwelling will be
considered a part of the dwelling for purposes of compliance with Sec.
1026.43. Although as discussed above similar language was included in
the official commentary in the proposed rule, the Bureau believes this
important legal requirement should be part of the regulatory text.
Comment 43(a)-1 now includes a reference to Sec. 1026.20(a), which
describes different types of changes to an existing loan that will not
be treated as refinancings, to make clear that creditors may rely on
that section in determining whether or not Sec. 1026.43 will apply to
a particular change to an existing loan.
43(a)(1)
The Board's proposal included an exemption from the scope of
section 226.43 for ``[a] home equity line of credit subject to Sec.
226.5b,'' \89\ which implemented the exclusion of HELOCs from coverage
in the statutory definition of ``residential mortgage loan.'' Dodd-
Frank Act section 1401. The Bureau received two comments asking that
the HELOC exemption be reconsidered. The commenters stated that HELOCs
had contributed to the crisis in the mortgage market and that failure
to include them in the ability-to-repay rule's coverage would likely
lead to more consumer abuse and systemic problems.
---------------------------------------------------------------------------

\89\ The Regulation Z section on HELOCs has been relocated and
is now at 12 CFR 1026.40.
---------------------------------------------------------------------------

The Bureau notes that Congress specifically exempted open-end lines
of credit from the ability-to-repay

[[Page 6448]]

requirements, even though the Dodd-Frank Act extends other consumer
protections to such loans, including the requirements for high-cost
mortgages under HOEPA. The Bureau also notes that home equity lines of
credit have consistently had lower delinquency rates than other forms
of consumer credit.\90\ Furthermore, the requirements contained in the
Dodd-Frank Act with respect to assessing a consumer's ability to repay
a residential mortgage, and the regulations the Bureau is adopting
thereunder, were crafted to apply to the underwriting of closed-end
loans and are not necessarily transferrable to underwriting for an
open-end line of credit secured by real estate. In light of these
considerations, the Bureau does not believe there is sufficient
justification to find it necessary or proper to use its adjustment and
exception authority to expand the ability-to-repay provisions to HELOCs
at this time. However, as discussed in detail below, the Bureau is
adopting the Board's proposal to require creditors to consider and
verify contemporaneous HELOCs in addition to other types of
simultaneous loans for the purpose of complying with the ability-to-
repay provisions. See the section-by-section analysis of Sec.
1026.43(b)(12) below. In addition, the final rule includes the Board's
proposed anti-evasion provision, which forbids the structuring of
credit that does not meet the definition of open-end credit as an open-
end plan in order to evade the requirements of this rule. See Sec.
1026.43(h). Accordingly, Sec. 1026.43(a)(1) is adopted as proposed,
with the embedded citation updated. However, the Bureau intends to
monitor the HELOC exemption through its supervision function and may
revisit the issue as part of its broader review of the ability-to-repay
rule under section 1022(d) of the Dodd-Frank Act, which requires the
Bureau to publish an assessment of a significant rule or order not
later than five years after its effective date.
---------------------------------------------------------------------------

\90\ See Fed. Reserve Bank of N.Y., Quarterly Report on
Household Debt and Credit, at 9 (Nov. 2012), available at https://www.newyorkfed.org/research/national_economy/householdcredit/DistrictReport_Q32012.pdf.
---------------------------------------------------------------------------

43(a)(2)
The Bureau did not receive comments on the statutory timeshare
exemption included in proposed Sec. 226.43(a)(2). Accordingly, the
Bureau is adopting Sec. 1026.43(a)(2) as proposed.
43(a)(3)
43(a)(3)(i)
Proposed Sec. 226.43(a)(3)(i) created an exemption from the
ability-to-repay requirements in Sec. 226.43(c) through (f) for
reverse mortgages, as provided in the statute. The Bureau did not
receive comments on this exemption.\91\ Accordingly, the Bureau is
adopting Sec. 1026.43(a)(3)(i) as proposed.
---------------------------------------------------------------------------

\91\ Comments were received regarding the possible description
of a reverse mortgage qualified mortgage, and they are discussed
below. These commenters did not discuss or question the general
exemption from the ability-to-repay rule.
---------------------------------------------------------------------------

43(a)(3)(ii)
Proposed Sec. 226.43(a)(3)(ii) provided an exemption from the
ability-to-repay requirements in Sec. 226.43(c) through (f) for ``[a]
temporary or `bridge' loan with a term of 12 months or less, such as a
loan to finance the purchase of a new dwelling where the consumer plans
to sell a current dwelling within 12 months or a loan to finance the
initial construction of a dwelling.'' Furthermore, proposed comment
43(a)-3 provided that, ``[w]here a temporary or bridge loan is
renewable, the loan term does not include any additional period of time
that could result from a renewal provision.'' The Board solicited
comment on whether a decision to treat renewals in this manner would
lead to evasion of the rule. The statute includes the one-year
exemption implemented in the proposed rule but does not specifically
address renewals. TILA section 129C(a)(8), 15 U.S.C. 1639c(a)(8).
Generally, commenters did not specifically address the proposal's
request for comment on renewals of short-term financing; however, one
industry commenter stated that the statutory one-year limitation would
interfere with construction loans, which often require more than a year
to complete. The Bureau understands that construction loans often go
beyond a single year. Although the comment did not specify that
disregarding potential renewals would alleviate this concern, the
Bureau believes that disregarding renewals would facilitate compliance
and prevent unwarranted restrictions on access to construction loans.
Commenters did not respond to the Board's query about whether or
not disregarding renewals of transactions with one-year terms would
lead to evasion of the rule. Upon further analysis, the Bureau believes
that this concern does not warrant changing the proposed commentary.
However, the Bureau intends to monitor the issue through its
supervision function and to revisit the issue as part of its broader
review of the ability-to-repay rule under section 1022(d) of the Dodd-
Frank Act, which requires the Bureau to conduct an assessment of
significant rules five years after they are adopted.
One industry trade association commented on the wording of the
temporary financing exemption, suggesting that the inclusion of the two
examples, bridge loans and construction loans, would create uncertainty
as to whether the exemption would apply to temporary financing of other
types. However, the Bureau believes further clarification is not
required because the exemption applies to any temporary loan with a
term of 12 months or less, and the examples are merely illustrative.
The Bureau is aware of and provides clarifying examples of certain
common loan products that are temporary or ``bridge'' loans. The
commenter did not note other common types of temporary loan products.
The Bureau further believes that the rule permits other types of
temporary financing as long as the loan satisfies the requirements of
the exemption.
Accordingly, Sec. 1026.43(a)(3)(ii) and associated commentary are
adopted substantially as proposed.
43(a)(3)(iii)
The Bureau also received comments requesting clarification on how
the temporary financing exemption would apply to construction-to-
permanent loans, i.e., construction financing that will be permanently
financed by the same creditor. Typically, such loans have a short
construction period, during which payments are made of interest only,
followed by a fully amortizing permanent period, often an additional 30
years. Because of this hybrid form, the loans do not appear to qualify
for the temporary financing exemption, nor would they be qualified
mortgages because of the interest-only period and the fact that the
entire loan term will often slightly exceed 30 years. However, such
loans may have significant consumer benefits because they avoid the
inconvenience and expense of a second closing, and also avoid the risk
that permanent financing will be unavailable when the construction loan
is due.
The Bureau notes that existing Sec. 1026.17(c)(6)(ii) provides
that construction-to-permanent loans may be disclosed as either a
single transaction or as multiple transactions at the creditor's
option. Consistent with that provision, the Bureau is using its
adjustment and exception authority to allow the construction phase of a
construction-to-permanent loan to be

[[Page 6449]]

exempt from the ability-to-repay requirements as a temporary loan;
however, the permanent phase of the loan is subject to Sec. 1026.43.
Because the permanent phase is subject to Sec. 1026.43, it may be a
qualified mortgage if it satisfies the appropriate requirements.
As amended by the Dodd-Frank Act, TILA section 105(a), 15 U.S.C.
1604(a), directs the Bureau to prescribe regulations to carry out the
purposes of TILA, and provides that such regulations may contain
additional requirements, classifications, differentiations, or other
provisions, and may provide for such adjustments and exceptions for all
or any class of transactions that the Bureau judges are necessary or
proper to effectuate the purposes of TILA, to prevent circumvention or
evasion thereof, or to facilitate compliance therewith. The main
purpose of section 129C is articulated in section 129B(a)(2)--``to
assure that consumers are offered and receive residential mortgage
loans on terms that reasonably reflect their ability to repay the loans
and that are not unfair, deceptive or abusive.'' Creditors' ability to
continue originating construction-to-permanent loans in a cost
effective manner will help to ensure that consumers are offered and
receive loans on terms that reasonably reflect their ability to repay.
The construction-to-permanent product avoids the possibility of a
consumer being unable to repay a construction loan, because the
permanent financing is already part of the contract. Without the
ability to treat the permanent financing as a qualified mortgage, and
the construction phase as exempt, it is not clear how many creditors
would continue to offer such loans, especially in the short term. In
addition, consumers will benefit from the potentially lower costs
associated with qualified mortgages. In addition to effectuating the
purpose of ensuring ability to repay, this exemption will greatly
facilitate compliance for creditors providing this product.
Proposed comment 43(a)(3)-1 provided that, where a temporary or
``bridge'' loan is renewable, the loan term does not include any
additional period of time that could result from a renewal provision.
The Bureau is adding comment 43(a)(3)-2 to make clear that if a
construction-to-permanent loan is treated as multiple transactions in
regard to compliance with the ability-to-repay requirements, and the
initial one-year construction phase is renewable, the loan term of the
construction phase does not include any additional period of time that
could result from a renewal of that construction phase that is one year
or less in duration. Comment 43(a)(3)-2 also makes clear that if the
construction phase of a construction-to-permanent loan is treated as
exempt, the permanent financing phase may be a qualified mortgage if it
meets the appropriate requirements.
Accordingly, Sec. 1026.43(a)(3)(iii) and comment 43(a)(3)-2 are
added to this final rule.
43(b) Definitions
43(b)(1)
The definition of ``covered transaction'' restates the scope of the
rule, discussed above, which implements the statutory term
``residential mortgage loan'' defined at TILA Sec. 103(cc)(5). The
Bureau did not receive any comments specifically on this provision and
is adopting it as proposed in Sec. 1026.43(b)(1). For clarity, the
Bureau has added comment 43(b)(1)-1 explaining that the term ``covered
transaction'' restates the scope of the rule as described in Sec.
1026.43(a).
43(b)(2)
TILA section 129C(a)(3) requires that ``[a] creditor shall
determine the ability of the consumer to repay using a payment schedule
that fully amortizes the loan over the term of the loan.'' In
implementing this provision, the proposed rule defined a ``fully
amortizing payment'' as ``a periodic payment of principal and interest
that will fully repay the loan amount over the loan term.'' The term
``fully amortizing payment'' is used in the general ``payment
calculation'' provision in Sec. 1026.43(c)(5)(i)(B), which requires
the use of ``[m]onthly, fully amortizing payments that are
substantially equal.'' The Bureau has determined that the definition of
``fully amortizing payment'' enables accurate implementation of the
payment calculation process envisioned by the statute, and no comments
focused on or questioned this definition. Accordingly, Sec.
1026.43(b)(2) is adopted as proposed.
43(b)(3)
TILA section 129C(a)(6)(D) provides that, for purposes of making
the repayment ability determination required under TILA section
129C(a), the creditor must calculate the monthly payment on the
mortgage obligation based on several assumptions, including that the
monthly payment be calculated using the fully indexed rate at the time
of loan closing, without considering the introductory rate. See TILA
section 129C(a)(6)(D)(iii). TILA section 129C(a)(7) defines the term
``fully indexed rate'' as ``the index rate prevailing on a residential
mortgage loan at the time the loan is made plus the margin that will
apply after the expiration of any introductory interest rates.''
The term ``fully indexed rate'' appeared in proposed Sec.
226.43(c)(5), which implemented TILA section 129C(a)(6)(D)(iii) and
provided the payment calculation rules for covered transactions. The
term also appeared in proposed Sec. 226.43(d)(5), which provided
special rules for creditors that refinance a consumer from a non-
standard mortgage to a standard mortgage.
Proposed Sec. 226.43(b)(3) defined the term ``fully indexed rate''
as ``the interest rate calculated using the index or formula at the
time of consummation and the maximum margin that can apply at any time
during the loan term.'' This proposed definition was consistent with
the statutory language of TILA sections 129C(a)(6)(D)(iii) and
129C(a)(7), but revised certain text to provide clarity. First, for
consistency with current Regulation Z and to facilitate compliance, the
proposal replaced the phrases ``at the time of the loan closing'' in
TILA section 129C(a)(6)(D)(iii) and ``at the time the loan is made'' in
TILA section 129C(a)(7) with the phrase ``at the time of consummation''
for purposes of identifying the fully indexed rate. The Board
interpreted these statutory phrases to have the same meaning as the
phrase ``at the time of consummation.'' See current Sec. 1026.2(a)(7),
defining the term ``consummation'' for purposes of Regulation Z
requirements as ``the time that a consumer becomes contractually
obligated on a credit transaction.''
In requiring that the fully indexed rate be determined using the
specified index at consummation, the Board was concerned that the
possible existence of loans that use more than one index could
complicate this determination. Given the increasing relevance of market
indices, the Board solicited comment on whether loan products currently
exist that base the interest rate on a specific index at consummation,
but then base subsequent rate adjustments on a different index, and
whether further guidance addressing how to calculate the fully indexed
rate for such loan products would be needed.
The proposed rule interpreted the statutory reference to the margin
that will apply ``after the expiration of any introductory interest
rates'' as a reference to the maximum margin that can apply ``at any
time during the loan term.'' The Bureau agrees with this
interpretation, because the statutory use

[[Page 6450]]

of the plural ``rates'' modified by the all-inclusive term ``any''
clearly indicates not only that something more than the initial
introductory rate is meant, but that ``any'' preliminary rate should be
disregarded. In addition, the statutory term itself, ``fully indexed
rate,'' appears to require such a reading. Referencing the entire loan
term as the relevant period of time during which the creditor must
identify the maximum margin that can occur under the loan makes the
phrase ``after the expiration of any introductory interest rates''
unnecessary and allows for simplicity and consistency with new TILA
section 103(bb), the high cost mortgage provision.
Because the proposal required that the creditor use the ``maximum''
margin that can apply when determining the fully indexed rate, the
creditor would be required to take into account the largest margin that
could apply under the terms of the legal obligation. The approach of
using the maximum margin that can apply at any time during the loan
term is consistent with the statutory language contained in TILA
section 103(bb), as amended by section 1431 of the Dodd-Frank Act,
which defines a high-cost mortgage. This statutory provision provides
that, for purposes of the definition of a ``high-cost mortgage'' under
HOEPA, for a mortgage with an interest rate that varies solely in
accordance with an index, the annual percentage rate must be based on
``the interest rate determined by adding the index rate in effect on
the date of consummation of the transaction to the maximum margin
permitted at any time during the loan agreement.'' \92\ Furthermore,
although the Board was not aware of any current loan products that
possess more than one margin that may apply over the loan term, the
Board proposed this clarification to address the possibility that
creditors may create products that permit different margins to take
effect at different points throughout the loan term. The proposal
solicited comment on this approach.
---------------------------------------------------------------------------

\92\ Previous to the passage of the Dodd-Frank Act, the annual
percentage rate used for this determination was calculated the same
way as for the rest of the Truth in Lending Act, pursuant to Sec.
1026.14.
---------------------------------------------------------------------------

The proposed definition of ``fully indexed rate'' was also
generally consistent with the definition of ``fully indexed rate'' as
used in the MDIA Interim Final Rule,\93\ and with the Federal banking
agencies' use of the term ``fully indexed rate'' in the 2006
Nontraditional Mortgage Guidance and 2007 Subprime Mortgage Statement.
---------------------------------------------------------------------------

\93\ See 2010 MDIA Interim Final Rule, 75 FR 58470, 58484 (Sept.
24, 2010) (defines fully indexed rate as ``the interest rate
calculated using the index value and margin''); see also 75 FR 81836
(Dec. 29, 2010) (revising the MDIA Interim Final Rule).
---------------------------------------------------------------------------

Proposed comment 43(b)(3)-1 noted that in some adjustable-rate
transactions, creditors may set an initial interest rate that is not
determined by the index or formula used to make later interest rate
adjustments. This proposed comment explained that this initial rate
charged to consumers will sometimes be lower than the rate would be if
it were calculated using the index or formula at consummation (i.e., a
``discounted rate''); in some cases, this initial rate may be higher
(i.e., a ``premium rate''). The proposed comment clarified that when
determining the fully indexed rate where the initial interest rate is
not determined using the index or formula for subsequent interest rate
adjustments, the creditor must use the interest rate that would have
applied had the creditor used such index or formula plus margin at the
time of consummation. The proposed comment further clarified that this
means, in determining the fully indexed rate, the creditor must not
take into account any discounted or premium rate. (In addition, to
facilitate compliance, this comment directed creditors to commentary
that addresses payment calculations based on the greater of the fully
indexed rate or ``premium rate'' for purposes of the repayment ability
determination under proposed Sec. 226.43(c)). See final rule Sec.
1026.43(c)(5)(i)(A) and comment 43(c)(5)(i)-2.)
Proposed comment 43(b)(3)-1 differed from guidance on disclosure
requirements in current comment 17(c)(1)-10.i, which provides that in
cases where the initial interest rate is not calculated using the index
or formula for later rate adjustments, the creditor should disclose a
composite annual percentage rate that reflects both the initial rate
and the fully indexed rate. The Board believed the different approach
taken in proposed comment 43(b)(3)-1 was required by the statutory
language and was appropriate in the present case where the purpose of
the statute is to determine whether the consumer can repay the loan
according to its terms, including any potential increases in required
payments. TILA section 129B(a)(2), 15 U.S.C 1639b(a)(2).
Proposed comment 43(b)(3)-2 further clarified that if the contract
provides for a delay in the implementation of changes in an index value
or formula, the creditor need not use the index or formula in effect at
consummation, and provides an illustrative example. This proposed
comment was consistent with current guidance in Regulation Z regarding
the use of the index value at the time of consummation where the
contract provides for a delay. See comments 17(c)(1)-10.i and
18(s)(2)(iii)(C)-1, which address the fully indexed rate for purposes
of disclosure requirements.
Proposed comment 43(b)(3)-3 explained that the creditor must
determine the fully indexed rate without taking into account any
periodic interest rate adjustment caps that may limit how quickly the
fully indexed rate may be reached at any time during the loan term
under the terms of the legal obligation. As the proposal noted, the
guidance contained in proposed comment 43(b)(3)-3 differed from
guidance contained in current comment 17(c)(1)-10.iii, which states
that, when disclosing the annual percentage rate, creditors should give
effect to periodic interest rate adjustment caps.
Nonetheless, the Board believed the approach in proposed comment
43(b)(3)-3 was consistent with, and required by, the statutory language
that states that the fully indexed rate must be determined without
considering any introductory rate and by using the margin that will
apply after expiration of any introductory interest rates. See TILA
section 129C(a)(6)(D)(iii) and (7). In addition, the Board noted that
the proposed definition of fully indexed rate, and its use in the
proposed payment calculation rules, was designed to assess whether the
consumer has the ability to repay the loan according to its terms. TILA
section 129B(a)(2), 15 U.S.C 1639b(a)(2). This purpose differs from the
principal purpose of disclosure requirements, which is to help ensure
that consumers avoid the uninformed use of credit. TILA section 102(a),
15 U.S.C. 1601(a). Furthermore, the guidance contained in proposed
comment 43(b)(3)-3 was consistent with the Federal banking agencies'
use of the term fully indexed rate in the 2006 Nontraditional Mortgage
Guidance and 2007 Subprime Mortgage Statement.
Proposed comment 43(b)(3)-4 clarified that when determining the
fully indexed rate, a creditor may choose, in its sole discretion, to
take into account the lifetime maximum interest rate provided under the
terms of the legal obligation. This comment explained, however, that
where the creditor chooses to use the lifetime maximum interest rate,
and the loan agreement provides a range for the maximum interest rate,
the creditor must use the highest rate in that range as the maximum
interest rate. In allowing creditors to use the lifetime maximum
interest rate provided under

[[Page 6451]]

the terms of the obligation, the Board was apparently interested in
simplifying compliance and benefiting consumers by encouraging
reasonable lifetime interest rate caps. In doing so, the Board was
apparently reading its proposed definition of fully indexed rate to
allow the maximum margin that can apply at any time during the loan
term to refer to the maximum margin as determined at consummation. In
other words, when the index value is determined at consummation, the
maximum margin that can apply at any time during the loan term will be
the difference between the lifetime interest rate cap and that index
value. Consequently, adding the index value at consummation to that
maximum margin, as required by the fully indexed rate definition, will
yield the lifetime interest rate cap as the fully indexed rate.
Commenters generally did not focus specifically on the definition
of ``fully indexed rate'' and associated commentary proposed by the
Board, or provide examples of loans with more than one index or more
than one margin. An organization representing state bank regulators
supported the use of the maximum margin that can apply at any time
during the loan term, suggesting that it would prevent evasion. (Some
commenter groups did urge the Bureau to use its adjustment authority to
require creditors to use a rate higher than the fully indexed rate in
assessing a consumer's ability to repay; these comments are discussed
below in the section-by-section analysis of Sec. 1026.43(c)(5)(i)).
The Bureau is adopting the rule and commentary largely as proposed,
with some modifications for clarity. Specifically, the Bureau decided
to include language in the definition that will make clear that the
index used in determining the fully indexed rate is the index that will
apply after the loan is recast, so that any index that might be used
earlier in determining an initial or intermediate rate would not be
used. This new language is included for clarification only, and does
not change the intended meaning of the proposed definition.
In the proposed rule, the Board noted that the statutory construct
of the payment calculation rules, and the requirement to calculate
payments based on the fully indexed rate, apply to all loans that are
subject to the ability-to-repay provisions, including loans that do not
base the interest rate on an index and therefore, do not have a fully
indexed rate. Specifically, the statute states that ``[f]or purposes of
making any determination under this subsection, a creditor shall
calculate the monthly payment amount for principal and interest on any
residential mortgage loan by assuming'' several factors, including the
fully indexed rate, as defined in the statute (emphasis added). See
TILA section 129C(a)(6)(D). The statutory definition of ``residential
mortgage loan'' includes loans with variable-rate features that are not
based on an index or formula, such as step-rate mortgages. See TILA
section 103(cc); see also proposed Sec. 226.43(a), which addressed the
proposal's scope, and proposed Sec. 226.43(b)(1), which defined
``covered transaction.'' However, because step-rate mortgages do not
have a fully indexed rate, it was unclear what interest rate the
creditor should assume when calculating payment amounts for the purpose
of determining the consumer's ability to repay the covered transaction.
As discussed above, the proposal interpreted the statutory
requirement to use the ``margin that can apply at any time after the
expiration of any introductory interest rates'' to mean that the
creditor must use the ``maximum margin that can apply at any time
during the loan term'' when determining the fully indexed rate.
Accordingly, consistent with this approach, the proposal clarified in
proposed comment 43(b)(3)-5 that where there is no fully indexed rate
because the interest rate offered in the loan is not based on, and does
not vary with, an index or formula, the creditor must use the maximum
interest rate that may apply at any time during the loan term. Proposed
comment 43(b)(3)-5 provided illustrative examples of how to determine
the maximum interest rate for a step-rate and a fixed-rate mortgage.
The Board believed this approach was appropriate because the
purpose of TILA section 129C is to require creditors to assess whether
the consumer can repay the loan according to its terms, including any
potential increases in required payments. TILA section 129B(a)(2), 15
U.S.C 1639b(a)(2). Requiring creditors to use the maximum interest rate
would help to ensure that consumers could repay their loans. However,
the Board was also concerned that by requiring creditors to use the
maximum interest rate in a step-rate mortgage, the monthly payments
used to determine the consumer's repayment ability might be overstated
and potentially restrict credit availability. Therefore, the Board
solicited comment on this approach, and whether authority under TILA
sections 105(a) and 129B(e) should be used to provide an exception for
step-rate mortgages, possibly requiring creditors to use the maximum
interest rate that occurs in only the first 5 or 10 years, or some
other appropriate time horizon.
The Bureau received few comments on the use of the maximum interest
rate that may apply at any time during the loan term for step-rate
mortgages. A consumer group and a regulatory reform group stated that
this method was better and more protective of consumers than using a
seven- or ten-year horizon. An organization representing state bank
regulators suggested that the Bureau use a five-year horizon, provided
that the loan has limits on later rate increases. An industry trade
association suggested that the maximum rate only be applied to the
balance remaining when that maximum rate is reached.
The Bureau believes that the proposal's method of using the maximum
interest rate that may apply at any time during the loan term for step-
rate mortgages is appropriate. This approach most closely approximates
the statutorily required fully indexed rate because it employs the
highest rate ascertainable at consummation, as does the fully indexed
rate, and it applies that rate to the entire original principal of the
loan, as the calculation in Sec. 1026.43(c)(5)(i) does with the fully
indexed rate. In addition, this method most effectively ensures the
consumer's ability to repay the loan.
For the reasons stated above, Sec. 1026.43(b)(3) is adopted
substantially as proposed, with the clarification discussed above
specifying that the index used in determining the fully indexed rate is
the index that will apply after the loan is recast. Issues regarding
the use of the fully indexed rate in the payment calculations required
by Sec. 1026.43(c)(5) are discussed in the section-by-section analysis
of that section below.
43(b)(4)
The Dodd-Frank Act added TILA section 129C(a)(6)(D)(ii)(II), which
provides that a creditor making a balloon-payment loan with an APR at
or above certain thresholds must determine ability to repay ``using the
contract's repayment schedule.'' The thresholds required by the statute
are 1.5 or more percentage points above the average prime offer rate
(APOR) for a comparable transaction for a first lien, and 3.5 or more
percentage points above APOR for a subordinate lien. These thresholds
are the same as those used in the Board's 2008 HOEPA Final Rule \94\ to
designate a new category of ``higher-priced mortgage loans'' (HPMLs),
which was amended by the Board's 2011 Jumbo Loans Escrows Final Rule to

[[Page 6452]]

include a separate threshold for jumbo loans for purposes of certain
escrows requirements.\95\ Implementing these thresholds for use with
the payment underwriting determination for balloon-payment mortgages,
the proposed rule defined a ``higher-priced covered transaction'' as
one in which the annual percentage rate (APR) ``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 a first-lien
covered transaction, or by 3.5 or more percentage points for a
subordinate-lien covered transaction.'' As explained further below and
provided for in the statute, the designation of certain covered
transactions as higher-priced affects the ability-to-repay
determination for balloon-payment mortgages, and requires that those
higher-priced transactions be analyzed using the loan contract's full
repayment schedule, including the balloon payment. Sec.
1026.43(c)(5)(ii)(A)(2).
---------------------------------------------------------------------------

\94\ 73 FR 44522 (July 30, 2008).
\95\ See 76 FR 11319 (Mar. 2, 2011).
---------------------------------------------------------------------------

Proposed comment 43(b)(4)-1 provided guidance on the term ``average
prime offer rate.'' Proposed comment 43(b)(4)-2 stated that the table
of average prime offer rates published by the Board would indicate how
to identify the comparable transaction for a higher-priced covered
transaction. Proposed comment 43(b)(4)-3 clarified that a transaction's
annual percentage rate is compared to the average prime offer rate as
of the date the transaction's interest rate is set (or ``locked'')
before consummation. This proposed comment also explained that
sometimes a creditor sets the interest rate initially and then resets
it at a different level before consummation, and clarified that in
these cases, the creditor should use the last date the interest rate is
set before consummation.
The Board explained in its proposed rule that it believed the
ability-to-repay requirements for higher-priced balloon-payment loans
was meant to apply to the subprime market, but that use of the annual
percentage rate could lead to prime loans being exposed to this test.
For this reason, the Board was concerned that the statutory formula for
a higher-priced covered transaction might be over-inclusive.
Accordingly, the Board solicited comment on whether the ``transaction
coverage rate'' (TCR) should be used for this determination, instead of
the annual percentage rate. 76 FR 27412. The TCR had previously been
proposed in conjunction with a more inclusive version of the APR, in
order to avoid having the more inclusive, hence higher, APRs trigger
certain requirements unnecessarily. The TCR includes fewer charges, and
the Board's 2011 Escrows Proposal proposed to use it in the threshold
test for determining application of those requirements. 76 FR 11598,
11626-11627 (Mar. 2, 2011).
The only comment substantively discussing the possible substitution
of the TCR for the APR was strongly opposed to the idea, stating that
it would create unnecessary compliance difficulty and costs. The Bureau
has determined that possible transition to a TCR standard will
implicate several rules and is not appropriate at the present time.
However, the issue will be considered further as part of the Bureau's
TILA/RESPA rulemaking. See 77 FR 51116, 51126 (Aug. 23, 2012).
The Board also solicited comment on whether or not to provide a
higher threshold for jumbo balloon-payment mortgages or for balloon-
payment mortgages secured by a residence that is not the consumer's
principal dwelling, e.g., a vacation home. 76 FR 27412. The Board
requested this information due to its belief that higher interest rates
charged for these loans might render them unavailable without the
adjustment. The margin above APOR suggested for first-lien jumbo
balloon-payment mortgages was 2.5 percentage points.
Two industry commenters supported the higher threshold for jumbo
loans, arguing that the current thresholds would interfere with credit
accessibility. One of these commenters also stated that the higher
threshold should be available for all balloon-payment mortgages. No
commenters discussed the non-principal-dwelling threshold.
Many other commenters objected strongly to the statutory
requirement, implemented in the proposed rule, that the balloon payment
be considered in applying the ability-to-repay requirements to higher-
priced covered transaction balloon-payment mortgages. These industry
commenters felt that the percentage point thresholds were too low, and
that many loans currently being made would become unavailable. They did
not, however, submit sufficient data to help the Bureau assess these
claims. Other commenters, including several consumer protection
advocacy organizations, argued that the higher-priced rule would be
helpful in ensuring consumers' ability to repay their loans.
The Bureau has evaluated the proposed definition of ``higher-priced
covered transaction'' not only in relation to its use in the payment
determination for balloon-payment mortgages, but also in the light of
its application in other provisions of the final rule. For example, as
discussed below, the final rule varies the strength of the presumption
of compliance for qualified mortgages. A qualified mortgage designated
as a higher-priced covered transaction will be presumed to comply with
the ability-to repay-provision at Sec. 1026.43(c)(1), but will not
qualify for the safe harbor provision. See Sec. 1026.43(e)(1)(ii) and
(i).
Specifically, the Bureau has considered whether to adopt a
different threshold to define high price mortgage loans for jumbo loans
than for other loans. The Bureau notes that the Board expressly
addressed this issue in its 2008 HOEPA Final Rule and concluded not to
do so. The Board explained that although prime jumbo loans have always
had somewhat higher rates than prime conforming loans, the spread has
been quite volatile.\96\ The Board concluded that it was sounder to err
on the side of being over-inclusive than to set a higher threshold for
jumbo loans and potentially fail to include subprime jumbo loans.\97\
The Bureau is persuaded by the Board's reasoning.
---------------------------------------------------------------------------

\96\ See 73 FR 44537 (July 30, 2008)
\97\ Id.
---------------------------------------------------------------------------

The Bureau recognizes that in the Dodd-Frank Act Congress, in
requiring creditors to establish escrows accounts for certain
transactions and in requiring appraisals for certain transactions based
upon the interest rate of the transactions, did establish a separate
threshold for jumbo loans. The Bureau is implementing that separate
threshold in its 2013 Escrows Final Rule which is being issued
contemporaneously with this final rule. However, the Bureau also notes
that in the ability-to-repay provision of the Dodd-Frank Act, Congress
mandated underwriting rules for balloon-payment mortgages which vary
based upon the pricing of the loan, and in doing so Congress followed
the thresholds adopted by the Board in its 2008 HOEPA Final Rule and
did not add a separate threshold for jumbo loans. The fact that the Act
uses the Board's criteria in the ability to repay context lends further
support to the Bureau's decision to use those criteria as well in
defining higher-priced loans under the final rule.
Accordingly, the Bureau is not providing for a higher threshold for
jumbo or non-principal dwelling balloon-payment mortgages at this time.
In regard to the possibility of a higher threshold for non-principal
dwellings such as vacation homes, the Bureau understands that such
products have historically been considered to be at higher risk of
default than loans on

[[Page 6453]]

principal dwellings. Therefore, any difference in rates is likely
driven by the repayment risk associated with the product, and a rule
meant to ensure a consumer's ability to repay the loan should not
provide an exemption under these circumstances. And further, the Bureau
did not receive and is not aware of any data supporting such an
exemption.
The Bureau does not believe that these decisions regarding jumbo
and non-principal-dwelling balloon-payment mortgages are likely to
create any credit accessibility problems. In this final rule at Sec.
1026.43(f), the Bureau is adopting a much wider area in which
institutions that provide credit in rural or underserved areas may
originate qualified mortgages that are balloon-payment loans than did
the proposed rule. Because these are the areas in which balloon-payment
loans are considered necessary to preserve access to credit, and
higher-priced balloon-payment mortgages in these areas can meet the
criteria for a qualified mortgage and thus will not have to include the
balloon payment in the ability-to-repay evaluation, access to necessary
balloon-payment mortgages will not be reduced.
Accordingly, Sec. 1026.43(b)(4) is adopted as proposed. The
associated commentary is amended with revisions to update information
and citations.
43(b)(5)
The proposed rule defined ``loan amount'' as ``the principal amount
the consumer will borrow as reflected in the promissory note or loan
contract.'' This definition implemented the statutory language
requiring that the monthly payment be calculated assuming that ``the
loan proceeds are fully disbursed on the date of consummation of the
loan.'' Dodd-Frank Act section 1411(a)(2), TILA section
129C(a)(6)(D)(i). The term ``loan amount'' was used in the proposed
definition of ``fully amortizing payment'' in Sec. 226.43(b)(2), which
was then used in the general ``payment calculation'' at Sec.
226.43(c)(5)(i)(B). The payment calculation required the use of
payments that pay off the loan amount over the actual term of the loan.
The statute further requires that creditors assume that the loan
amount is ``fully disbursed on the date of consummation of the loan.''
See TILA Section 129C(a)(6)(D)(i). The Board recognized that some loans
do not disburse the entire loan amount to the consumer at consummation,
but may, for example, provide for multiple disbursements up to an
amount stated in the loan agreement. See current Sec. 1026.17(c)(6),
discussing multiple-advance loans and comment 17(c)(6)-2 and -3. In
these cases, the loan amount, as reflected in the promissory note or
loan contract, does not accurately reflect the amount disbursed at
consummation. Thus, to reflect the statutory requirement that the
creditor assume the loan amount is fully disbursed at consummation, the
Board clarified that creditors must use the entire loan amount as
reflected in the loan contract or promissory note, even where the loan
amount is not fully disbursed at consummation. Proposed comment
43(b)(5)-1 provided an illustrative example and stated that generally,
creditors should rely on Sec. 1026.17(c)(6) and associated commentary
regarding treatment of multiple-advance and construction loans that
would be covered by the ability-to-repay requirements (i.e., loans with
a term greater than 12 months). See Sec. 1026.43(a)(3) discussing
scope of coverage and term length.
The Board specifically solicited comment on whether further
guidance was needed regarding determination of the loan amount for
loans with multiple disbursements. The Bureau did not receive comments
on the definition of ``loan amount'' or its application to loans with
multiple disbursements. The Bureau believes that the loan amount for
multiple disbursement loans that are covered transactions must be
determined assuming that ``the loan proceeds are fully disbursed on the
date of consummation of the loan'' \98\ as required by the statute and
the rule, and explained in comment 43(b)(5)-1.
---------------------------------------------------------------------------

\98\ Dodd-Frank Act section 1411(a)(2), TILA section
129C(a)(6)(D)(i).
---------------------------------------------------------------------------

Accordingly, the Bureau is adopting Sec. 1026.43(b)(5) and
associated commentary as proposed.
43(b)(6)
The interchangeable phrases ``loan term'' and ``term of the loan''
appear in the ability-to-repay and qualified mortgage provisions of
TILA, with no definition. See TILA section 129C(c)(3),
129C(a)(6)(D)(ii), 129C(b)(2)(A)(iv) and (v); 15 U.S.C. 1639c(c)(3),
1639c(a)(6)(D)(ii), 1639c(b)(2)(A)(iv) and (v). The proposed rule
defined ``loan term'' as ``the period of time to repay the obligation
in full.'' Proposed comment 43(b)(6)-1 clarified that the loan term is
the period of time it takes to repay the loan amount in full, and
provided an example. The term is used in Sec. 1026.43(b)(2), the
``fully amortizing payment'' definition, which is then used in Sec.
1026.43(c)(5)(i), the payment calculation general rule. It is also used
in the qualified mortgage payment calculation at Sec.
1026.43(e)(2)(iv). The Bureau did not receive any comments on this
definition, and considers it to be an accurate and appropriate
implementation of the statutory language. Accordingly, proposed Sec.
1026.43(b)(6) is adopted as proposed.
43(b)(7)
The definition of ``maximum loan amount'' and the calculation for
which it is used implement the requirements regarding negative
amortization loans in new TILA section 129C(a)(6)(C) and (D). The
statute requires that a creditor ``take into consideration any balance
increase that may accrue from any negative amortization provision.''
The ``maximum loan amount'' is defined in the proposed rule as
including the loan balance and any amount that will be added to the
balance as a result of negative amortization assuming the consumer
makes only minimum payments and the maximum interest rate is reached at
the earliest possible time. The ``maximum loan amount'' is used to
determine a consumer's ability to repay for negative amortization loans
under Sec. 1026.43(c)(5)(ii)(C) by taking into account any loan
balance increase that may occur as a result of negative amortization.
The term ``maximum loan amount'' is also used for negative amortization
loans in the ``refinancing of non-standard mortgages'' provision, at
Sec. 1026.43(d)(5)(i)(C)(3). The proposed rule included commentary on
how to calculate the maximum loan amount, with examples. See comment
43(b)(7)-1 through -3.
The Bureau did not receive any comments on this definition and
considers it to be an accurate and appropriate implementation of the
statute. Accordingly, Sec. 1026.43(b)(7) and associated commentary are
adopted as proposed.
43(b)(8)
TILA section 129C(a)(1) and (3), as added by section 1411 of the
Dodd-Frank Act, requires creditors to consider and verify mortgage-
related obligations as part of the ability-to-repay determination
``according to [the loan's] terms, and all applicable taxes, insurance
(including mortgage guarantee insurance), and assessments.'' TILA
section 129C(a)(2) provides that consumers must have ``a reasonable
ability to repay the combined payments of all loans on the same
dwelling according to the terms of those loans and all applicable
taxes, insurance (including mortgage guarantee insurance), and
assessments.'' Although the Dodd-Frank Act did not establish or

[[Page 6454]]

define a single, collective term, the foregoing requirements recite
ongoing obligations that are substantially similar to the definition of
``mortgage-related obligation'' used elsewhere in Regulation Z. Section
1026.34(a)(4)(i), which was added by the 2008 HOEPA Final Rule, defines
mortgage-related obligations as expected property taxes, premiums for
mortgage-related insurance required by the creditor as set forth in the
relevant escrow provisions of Regulation Z, and similar expenses.
Comment 34(a)(4)(i)-1 clarifies that, for purposes of Sec.
1026.34(a)(4)(i), similar expenses include homeowners association dues
and condominium or cooperative fees. Section 1026.35(b)(3)(i), which
addresses escrows, states that ``premiums for mortgage-related
insurance required by the creditor, [include] insurance against loss of
or damage to property, or against liability arising out of the
ownership or use of the property, or insurance protecting the creditor
against the consumer's default or other credit loss.''
Under the Board's proposed Sec. 226.43(b)(8), ``mortgage-related
obligations'' was defined to mean property taxes; mortgage related
insurance premiums required by the creditor as set forth in proposed
Sec. 226.45(b)(1); homeowners association, condominium, and
cooperative fees; ground rent or leasehold payments; and special
assessments. The Board's proposed definition was substantially similar
to the definition under Sec. 1026.34(a)(4)(i), with three
clarifications. First, the proposed definition of mortgage-related
obligations would have included a reference to ground rent or leasehold
payments, which are payments made to the real property owner or
leaseholder for use of the real property. Second, the proposed
definition would have included a reference to ``special assessments.''
Proposed comment 43(b)(8)-1 would have clarified that special
assessments include, for example, assessments that are imposed on the
consumer at or before consummation, such as a one-time homeowners
association fee that will not be paid by the consumer in full at or
before consummation. Third, mortgage-related obligations would have
referenced proposed Sec. 226.45(b)(1), where the Board proposed to
recodify the existing escrow requirement for higher-priced mortgage
loans, to include mortgage-related insurance premiums required by the
creditor, such as insurance against loss of or damage to property, or
against liability arising out of the ownership or use of the property,
or insurance protecting the creditor against the consumer's default or
other credit loss. The Board solicited comment on how to address any
issues that may arise in connection with homeowners association
transfer fees and costs associated with loans for energy efficient
improvements.
Proposed comment 43(b)(8)-1 would have clarified further that
mortgage-related obligations include mortgage-related insurance
premiums only if required by the creditor. This comment would have
explained that the creditor need not include premiums for mortgage-
related insurance that the creditor does not require, such as
earthquake insurance or credit insurance, or fees for optional debt
suspension and debt cancellation agreements. To facilitate compliance,
this comment would have referred to commentary associated with proposed
Sec. 226.43(c)(2)(v), which sets forth the requirement to take into
account any mortgage-related obligations for purposes of the repayment
ability determination required under proposed Sec. 226.43(c).
Industry commenters and consumer advocates generally supported the
Board's proposed definition of mortgage-related obligations. One
industry commenter opposed including community transfer fees, which are
deed-based fees imposed upon the transfer of the property. This
commenter was concerned that subjecting these fees to Federal law might
affect existing contracts, deeds, and covenants related to these fees,
which are subject to State and local regulation, as well as common law
regarding the transfer of real property. The commenter also asked that
special assessments not fall under the definition of mortgage-related
obligations. The commenter recommended that, if special assessments are
included, creditors be required to consider only current special
assessments, not future special assessments. The commenter noted that,
while common assessments should be included in the definition of
mortgage-related obligations, the Bureau should provide guidance to
creditors on the substance of questionnaires seeking information from
third parties about mortgage-related obligations.
Certain consumer advocates suggested that voluntary insurance
premiums be included in the definition of mortgage-related obligations.
One consumer advocate explained that premiums such as these are
technically voluntary, but many consumers believe them to be required,
or have difficulty cancelling them if they choose to cancel them.
Community advocates and several industry commenters also recommended
that homeowners association dues, and similar charges, be included in
the definition of mortgage-related obligations. They argued that such a
requirement would further transparency in the mortgage loan origination
process and would help ensure that consumers receive only credit they
can reasonably expect to repay.
For the reasons discussed below, the Bureau concludes that property
taxes, certain insurance premiums required by the creditor, obligations
to community governance associations, such as cooperative, condominium,
and homeowners associations, ground rent, and lease payments should be
included in the definition of mortgage-related obligations. These
obligations are incurred in connection with the mortgage loan
transaction but are in addition to the obligation to repay principal
and interest. Thus, the cost of these obligations should be considered
with the obligation to repay principal and interest for purposes of
determining a consumer's ability to repay. Further, the Bureau believes
that the word `assessments' in TILA section 129C is most appropriately
interpreted to refer to all obligations imposed on consumers in
connection with ownership of the dwelling or real property, such as
ground rent, lease payments, and, as discussed in detail below,
obligations to community governance associations, whether denominated
as association dues, special assessments, or otherwise. While the
provision adopted by the Bureau is substantially similar to the
provision proposed, the Bureau was persuaded by the comment letters
that additional clarity and guidance is required. The Bureau is
especially sensitive to the fact that many of the loans that will be
subject to the ability-to-repay rules may be made by small
institutions, which are often unable to devote substantial resources to
analysis of regulatory compliance.
To address the concerns and feedback raised in the comment letters,
the Bureau has revised Sec. 1026.43(b)(8) and related commentary in
two ways. First, the language of Sec. 1026.43(b)(8) is being modified
to add additional clarity. As adopted, Sec. 1026.43(b)(8) refers to
premiums and similar charges identified in Sec. 1026.4(b)(5), (7),
(8), or (10), if required by the creditor, instead of the proposed
language, which referred to ``mortgage-related insurance.'' Second, the
commentary is being significantly expanded to provide additional
clarification and guidance.
As adopted, Sec. 1026.43(b)(8) defines ``mortgage-related
obligations'' to mean

[[Page 6455]]

property taxes; premiums and similar charges identified in Sec.
1026.4(b)(5), (7), (8), or (10) that are required by the creditor; fees
and special assessments imposed by a condominium, cooperative, or
homeowners association; ground rent; and leasehold payments. As
proposed, comment 43(b)(8)-1 discussed all components of the proposed
definition. To provide further clarity, the final rule splits the
content of proposed comment 43(b)(8)-1 into four separate comments,
each of which provides additional guidance. As adopted by the Bureau,
comment 43(b)(8)-1 contains general guidance and a cross-reference to
Sec. 1026.43(c)(2)(v), which contains the requirement to take into
account any mortgage-related obligations for purposes of determining a
consumer's ability to repay.
The multitude of requests for additional guidance and clarification
suggests that additional clarification of the meaning of ``property
tax'' is needed. Comment 43(b)(8)-2 further clarifies that Sec.
1026.43(b)(8) includes obligations that are functionally equivalent to
property taxes, even if such obligations follow a different naming
convention. For example, governments may establish independent
districts with the authority to impose recurring levies on properties
within the district to fund a special purpose, such as a local
development bond district, water district, or other public purpose.
These recurring levies may have a variety of names, such as taxes,
assessments, or surcharges. Comment 43(b)(8)-2 clarifies that
obligations such as these are property taxes based on the character of
the obligation, as opposed to the name of the obligation, and therefore
are mortgage-related obligations.
Most comments supported the inclusion of insurance premiums in the
ability-to-repay determination. However, the Bureau believes that some
modifications to the proposed ``mortgage-related insurance premium''
language are appropriate. The Bureau is persuaded that additional
clarification and guidance is important, and the Bureau is especially
sensitive to concerns related to regulatory complexity. The Bureau has
determined that the proposed language should be clarified by revising
the text to refer to the current definition of finance charge under
Sec. 1026.4. The components of the finance charge are long-standing
parts of Regulation Z. Explicitly referring to existing language should
facilitate compliance. Therefore, Sec. 1026.43(b)(8) defines mortgage-
related obligations to include all premiums or other charges related to
protection against a consumer's default, credit loss, collateral loss,
or similar loss as identified in Sec. 1026.4(b)(5), (7), (8), or (10)
except, as explained above, those premiums or charges that that are not
required by the creditor. Comment 43(b)(8)-3 also contains illustrative
examples of this definition. For example, if Federal law requires flood
insurance to be obtained in connection with the mortgage loan, the
flood insurance premium is a mortgage-related obligation for purposes
of Sec. 1026.43(b)(8).
Several commenters stated that insurance premiums and similar
charges should be included in the determination even if the creditor
does not require them in connection with the loan transaction. The
Bureau has carefully considered these arguments, but has determined
that insurance premiums and similar charges should not be considered
mortgage-related obligations if such premiums and charges are not
required by the creditor and instead have been voluntarily purchased by
the consumer. The Bureau acknowledges that obligations such as these
are usually paid from a consumer's monthly income and, in a sense,
affect a consumer's ability to repay. But the consumer is free to
cancel recurring obligations such as these at any time, provided they
are truly voluntary. Thus, they are not ``obligations'' in the sense
required by section 129C(a)(3) of TILA. The Bureau shares the concern
raised by several commenters that unscrupulous creditors may mislead
consumers into believing that these charges are not optional or cannot
be cancelled. However, the Bureau does not believe that altering the
ability-to-repay calculation for all is the appropriate method for
combatting the harmful actions of a few. The Bureau believes that the
better course of action is to exclude such premiums and charges from
the definition of mortgage-related obligations only if they are truly
voluntary, and is confident that violations of this requirement will be
apparent in specific cases from the facts. Also, in the scenarios
described by commenters where consumers are misled into believing that
such charges are required, the premium or charge would not be voluntary
for purposes of the definition of finance charge under Sec. 1026.4(d),
and would therefore be a mortgage-related obligation for the purposes
of Sec. 1026.43(b)(8). Therefore, comment 43(b)(8)-3 clarifies that
insurance premiums and similar charges identified in Sec.
1026.4(b)(5), (7), (8), or (10) that are not required by the creditor
and that the consumer purchases voluntarily are not mortgage-related
obligations for purposes of Sec. 1026.43(b)(8). For example, if a
creditor does not require earthquake insurance to be obtained in
connection with the mortgage loan, but the consumer voluntarily chooses
to purchase such insurance, the earthquake insurance premium is not a
mortgage-related obligation for purposes of Sec. 1026.43(b)(8). Or, if
a creditor requires a minimum amount of coverage for homeowners'
insurance and the consumer voluntarily chooses to purchase a more
comprehensive amount of coverage, the portion of the premium allocated
to the minimum coverage is a mortgage-related obligation for the
purposes of Sec. 1026.43(b)(8), while the portion of the premium
allocated to the more comprehensive coverage voluntarily purchased by
the consumer is not a mortgage-related obligation for the purposes of
Sec. 1026.43(b)(8). However, if the consumer purchases non-required
insurance or similar coverage at consummation without having requested
the specific non-required insurance or similar coverage and without
having agreed to the premium or charge for the specific non-required
insurance or similar coverage prior to consummation, the premium or
charge is not voluntary for purposes of Sec. 1026.43(b)(8) and is a
mortgage-related obligation.
Several commenters supported the inclusion of mortgage insurance in
the definition of mortgage-related obligations. The Bureau also has
received several informal requests for guidance regarding the meaning
of the term ``mortgage insurance'' in the context of certain
disclosures required by Regulation Z. The Bureau has decided to clarify
this issue with respect to the requirements of Sec. 1026.43. Thus,
comment 43(b)(8)-4 clarifies that Sec. 1026.43(b)(8) includes all
premiums or similar charges for coverage protecting the creditor
against the consumer's default or other credit loss in the
determination of mortgage-related obligations, whether denominated as
mortgage insurance, guarantee insurance, or otherwise, as determined
according to applicable State or Federal law. For example, monthly
``private mortgage insurance'' payments paid to a non-governmental
entity, annual ``guarantee fee'' payments required by a Federal housing
program, and a quarterly ``mortgage insurance'' payment paid to a State
agency administering a housing program are all mortgage-related
obligations for purposes of Sec. 1026.43(b)(8). Comment

[[Page 6456]]

43(b)(8)-4 also clarifies that Sec. 1026.43(b)(8) includes these
charges in the definition of mortgage-related obligations if the
creditor requires the consumer to pay them, even if the consumer is not
legally obligated to pay the charges under the terms of the insurance
program. Comment 43(b)(8)-4 also contains several other illustrative
examples.
Several comment letters stressed the importance of including
homeowners association dues and similar obligations in the
determination of ability to repay. These letters noted that, during the
subprime crisis, the failure to account for these obligations led to
many consumers qualifying for mortgage loans that they could not
actually afford. The Bureau agrees with these assessments. Recurring
financial obligations payable to community governance associations,
such as homeowners association dues, should be taken into consideration
in determining whether a consumer has the ability to repay the
obligation. While several comment letters identified practical problems
with including obligations such as these in the calculation, these
issues stemmed from difficulties that may arise in calculating,
estimating, or verifying these obligations, rather than whether the
obligations should be included in the ability-to-repay calculation.
Based on this feedback, Sec. 1026.43(b)(8) includes obligations to a
homeowners association, condominium association, or condominium
association in the determination of mortgage-related obligations. The
Bureau has addressed the concerns related to difficulties in
calculating, estimating, or verifying such obligations in the
commentary to Sec. 1026.43(c)(2)(v) and (c)(3).
One comment letter focused extensively on community transfer fees,
which are deed-based fees imposed upon the transfer of the property.
The Bureau recognizes that this topic is complex and is often the
subject of special requirements imposed at the State and local level.
However, the Bureau does not believe that the requirements of Sec.
1026.43 implicate these complex issues. The narrow question is whether
such obligations should be considered mortgage-related obligations for
purposes of determining the consumer's ability to repay. The Bureau
agrees with the argument, advanced by several commenters, that the
entirety of the consumer's ongoing obligations should be included in
the determination. A responsible determination of the consumer's
ability to repay requires an accounting of such obligations, whether
the purpose of the obligation is to satisfy the payment of a community
transfer fee or traditional homeowners association dues. As with other
obligations owed to condominium, cooperative, or homeowners
associations discussed above, the Bureau believes that the practical
problems with these obligations relate to when such obligations should
be included in the determination of the consumer's ability to repay,
rather than whether the obligations should be considered mortgage-
related obligations. Therefore, the Bureau has addressed the concerns
related to these obligations in the commentary to Sec.
1026.43(c)(2)(v) and (c)(3).
In response to the request for feedback in the 2011 ATR Proposal,
several commenters addressed the proposed treatment of special
assessments. Unlike community transfer fees, which are generally
identified in the deed or master community plan, creditors may
encounter difficulty determining whether special assessments exist.
However, as with similar charges discussed above, these concerns relate
to determining the consumer's monthly payment for mortgage-related
obligations, rather than whether these charges should be considered
mortgage-related obligations. Special assessments may be significant
and may affect the consumer's ability to repay a mortgage loan. Thus,
the Bureau has concluded that special assessments should be included in
the definition of mortgage-related obligations under Sec.
1026.43(b)(8) and has addressed the concerns raised by commenters
related to calculating, estimating, or verifying these obligations in
the commentary to Sec. 1026.43(c)(2)(v) and (c)(3).
New comment 43(b)(8)-5 explains that Sec. 1026.43(b)(8) includes
in the evaluation of mortgage-related obligations premiums and similar
charges identified in Sec. 1026.4(b)(5), (7), (8), or (10) that are
required by the creditor. These premiums and similar charges are
mortgage-related obligations regardless of whether the premium or
similar charge is excluded from the finance charge pursuant to Sec.
1026.4(d). For example, a premium for insurance against loss or damage
to the property written in connection with the credit transaction is a
premium identified in Sec. 1026.4(b)(8). If this premium is required
by the creditor, the premium is a mortgage-related obligation pursuant
to Sec. 1026.43(b)(8), regardless of whether the premium is excluded
from the finance charge pursuant to Sec. 1026.4(d)(2). Commenters did
not request this guidance specifically, but the Bureau believes that
this comment is needed to provide additional clarity.
43(b)(9)
TILA section 129C(b)(2)(C) generally defines ``points and fees''
for a qualified mortgage to have the same meaning as in TILA section
103(bb)(4), which defines points and fees for the purpose of
determining whether a transaction exceeds the HOEPA points and fees
threshold. Proposed Sec. 226.43(b)(9) would have provided that
``points and fees'' has the same meaning as in Sec. 226.32(b)(1). The
Bureau adopts this provision as renumbered Sec. 1026.43(b)(9).
43(b)(10)
Sections 1414, 1431, and 1432 of the Dodd-Frank Act amended TILA to
restrict, and in many cases, prohibit a creditor from imposing
prepayment penalties in dwelling-secured credit transactions. TILA does
not, however, define the term ``prepayment penalty.'' In an effort to
address comprehensively prepayment penalties in a fashion that eases
compliance burden, as discussed above, the Bureau is defining
prepayment penalty in Sec. 1026.43(b)(10) by cross-referencing Sec.
1026.32(b)(6). For a full discussion of the Bureau's approach to
defining prepayment penalties, see Sec. 1026.32(b)(6), its commentary,
and the section-by-section analysis of those provisions above.
43(b)(11)
TILA in several instances uses the term ``reset'' to refer to the
time at which the terms of a mortgage loan are adjusted, usually
resulting in higher required payments. For example, TILA section
129C(a)(6)(E)(ii) states that a creditor that refinances a loan may,
under certain conditions, ``consider if the extension of new credit
would prevent a likely default should the original mortgage reset and
give such concerns a higher priority as an acceptable underwriting
practice.'' 15 U.S.C. 1639c(a)(6)(E)(ii). The legislative history
further indicates that, for adjustable-rate mortgages with low, fixed
introductory rates, Congress understood the term ``reset'' to mean the
time at which low introductory rates convert to indexed rates,
resulting in ``significantly higher monthly payments for homeowners.''
\99\
---------------------------------------------------------------------------

\99\ See Comm. on Fin. Servs., Report on H.R. 1728, Mortgage
Reform and Anti-Predatory Lending Act, H. Rept. 94, 111th Cong., at
52 (2009).
---------------------------------------------------------------------------

Outreach conducted prior to issuance of the proposed rule indicated
that the term ``recast'' is typically used in reference to the time at
which fully amortizing payments are required for interest-only and
negative amortization loans and that the term ``reset'' is more

[[Page 6457]]

frequently used to indicate the time at which adjustable-rate mortgages
with an introductory fixed rate convert to a variable rate. For
simplicity and clarity, however, the Board proposed to use the term
``recast'' to cover the conversion to generally less favorable terms
and higher payments not only for interest-only loans and negative
amortization loans, but also for adjustable-rate mortgages.
Proposed Sec. 226.43(b)(11) defined the term ``recast,'' which was
used in two provisions of proposed Sec. 226.43: (1) Proposed Sec.
226.43(c)(5)(ii) regarding certain required payment calculations that
creditors must consider in determining a consumer's ability to repay a
covered transaction; and (2) proposed Sec. 226.43(d) regarding payment
calculations required for refinancings that are exempt from the
ability-to-repay requirements in Sec. 226.43(c).
Specifically, proposed Sec. 226.43(b)(11) defined the term
``recast'' as follows: (1) For an adjustable-rate mortgage, as defined
in Sec. 1026.18(s)(7)(i),\100\ the expiration of the period during
which payments based on the introductory interest rate are permitted
under the terms of the legal obligation; (2) for an interest-only loan,
as defined in Sec. 1026.18(s)(7)(iv),\101\ the expiration of the
period during which interest-only payments are permitted under the
terms of the legal obligation; and (3) for a negative amortization
loan, as defined in Sec. 1026.18(s)(7)(v),\102\ the expiration of the
period during which negatively amortizing payments are permitted under
the terms of the legal obligation.
---------------------------------------------------------------------------

\100\ ``The term ``adjustable-rate mortgage'' means a
transaction secured by real property or a dwelling for which the
annual percentage rate may increase after consummation.'' 12 CFR
1026.18(s)(7)(i).
\101\ ``The term ``interest-only'' means that, under the terms
of the legal obligation, one or more of the periodic payments may be
applied solely to accrued interest and not to loan principal; an
``interest-only loan'' is a loan that permits interest-only
payments.'' 12 CFR 1026.18(s)(7)(iv).
\102\ ``[T]he term ``negative amortization'' means payment of
periodic payments that will result in an increase in the principal
balance under the terms of the legal obligation; the term ``negative
amortization loan'' means a loan, other than a reverse mortgage
subject to section 1026.33, that provides for a minimum periodic
payment that covers only a portion of the accrued interest,
resulting in negative amortization.'' 12 CFR 1026.18(s)(7)(v).
---------------------------------------------------------------------------

Proposed comment 43(b)(11)-1 explained that the date on which the
``recast'' occurs is the due date of the last monthly payment based on
the introductory fixed rate, the last interest-only payment, or the
last negatively amortizing payment, as applicable. Proposed comment
43(b)(11)-1 also provided an illustration showing how to determine the
date of the recast.
Commenters did not focus specifically on the definition of
``recast,'' except that an association of State bank regulators agreed
with the benefit of using a single term for the shift to higher
payments for adjustable-rate, interest-only, and negative amortization
loans.
The Bureau considers the proposed provision to be an accurate and
appropriate implementation of the statute. Accordingly, the Bureau is
adopting proposed Sec. 226.43(b)(11) as proposed, in renumbered Sec.
1026.43(b)(11).
43(b)(12)
New TILA section 129C(a)(2) provides that ``if a creditor knows, or
has reason to know, that 1 or more residential mortgage loans secured
by the same dwelling will be made to the same consumer,'' that creditor
must make the ability-to-repay determination for ``the combined
payments of all loans on the same dwelling according to the terms of
those loans and all applicable taxes, insurance (including mortgage
guarantee insurance), and assessments.'' This section, entitled
``multiple loans,'' follows the basic ability-to-repay requirements for
a single loan, in new TILA section 129C(a)(1).
The proposed rule implemented the main requirement of the
``multiple loans'' provision by mandating in proposed Sec.
226.43(c)(2)(iv) that a creditor, in making its ability-to-repay
determination on the primary loan, take into account the payments on
any ``simultaneous loan'' about which the creditor knows or has reason
to know. ``Simultaneous loan'' was defined in proposed Sec.
226.43(b)(12) as ``another covered transaction or home equity line of
credit subject to Sec. 226.5b \103\ that will be secured by the same
dwelling and made to the same consumer at or before consummation of the
covered transaction.'' Thus, although the statute referred only to
closed-end ``residential mortgage loans,'' the Board proposed to expand
the requirement to include consideration of simultaneous HELOCs. The
proposed definition did not include pre-existing mortgage obligations,
which would be considered as ``current debt obligations'' under Sec.
1026.43(c)(2)(vi).
---------------------------------------------------------------------------

\103\ The Board's Sec. 226.5b was recodified in the Bureau's
Regulation Z as Sec. 1026.40.
---------------------------------------------------------------------------

The Board chose to include HELOCs in the definition of
``simultaneous loan'' because it believed that new TILA section
129C(a)(2) was meant to help ensure that creditors account for the
increased risk of consumer delinquency or default on the covered
transaction where more than one loan secured by the same dwelling is
originated concurrently. The Board believed that this increased risk
would be present whether the other mortgage obligation was a closed-end
credit obligation or a HELOC. For these reasons, and several others
explained in detail below, the Board proposed to use its exception and
adjustment authority under TILA section 105(a) to include HELOCs within
the scope of new TILA section 129C(a)(2). 76 FR 27417-27418. Because
one of the main reasons for including HELOCs was the likelihood of a
consumer drawing on the credit line to provide the down payment in a
purchase transaction, the Board solicited comment on whether this
exception should be limited to purchase transactions.
TILA section 105(a), as amended by section 1100A of the Dodd-Frank
Act, authorized the Board, and now the Bureau, to prescribe regulations
to carry out the purposes of TILA and Regulation Z, to prevent
circumvention or evasion, or to facilitate compliance. 15 U.S.C.
1604(a). The inclusion of HELOCs was further supported by the Board's
authority under TILA section 129B(e) to condition terms, acts or
practices relating to residential mortgage loans that the Board found
necessary or proper to effectuate the purposes of TILA. 15 U.S.C.
1639b(e). One purpose of the statute is set forth in TILA section
129B(a)(2), which states that ``[i]t is the purpose[] of * * *
[S]ection 129C to assure that consumers are offered and receive
residential mortgage loans on terms that reasonably reflect their
ability to repay the loans.'' 15 U.S.C. 1639b. For the reasons stated
below, the Board believed that requiring creditors to consider
simultaneous loans that are HELOCs for purposes of TILA section
129C(a)(2) would help to ensure that consumers are offered, and
receive, loans on terms that reasonably reflect their ability to repay.
First, the Board proposed in Sec. 226.43(c)(2)(vi) that the
creditor must consider current debt obligations in determining a
consumer's ability to repay a covered transaction. Consistent with
current Sec. 1026.34(a)(4), proposed Sec. 226.43(c)(2)(vi) would not
have distinguished between pre-existing closed-end and open-end
mortgage obligations. The Board believed consistency required that it
take the same approach when determining how to consider mortgage
obligations that come into existence concurrently with a first-lien
loan as would be taken for pre-existing mortgage obligations, whether
the first-lien is a purchase or non-purchase transaction (i.e.,
refinancing). Including HELOCs in the proposed definition of
``simultaneous loan'' for purposes of TILA section 129C(a)(2) was

[[Page 6458]]

also considered generally consistent with current comment 34(a)(4)-3,
and the 2006 Nontraditional Mortgage Guidance regarding simultaneous
second-lien loans.\104\
---------------------------------------------------------------------------

\104\ See 2006 Nontraditional Mortgage Guidance, 71 FR 58609,
58614 (Oct. 4, 2006).
---------------------------------------------------------------------------

Second, data indicate that where a subordinate loan is originated
concurrently with a first-lien loan to provide some or all of the down
payment (i.e., a ``piggyback loan''), the default rate on the first-
lien loan increases significantly, and in direct correlation to
increasing combined loan-to-value ratios.\105\ The data does not
distinguish between ``piggyback loans'' that are closed-end or open-end
credit transactions, or between purchase and non-purchase transactions.
However, empirical evidence demonstrates that approximately 60 percent
of consumers who open a HELOC concurrently with a first-lien loan
borrow against the line of credit at the time of origination,\106\
suggesting that in many cases the HELOC may be used to provide some, or
all, of the down payment on the first-lien loan.
---------------------------------------------------------------------------

\105\ Kristopher Gerardi et al., Making Sense of the Subprime
Crisis, Brookings Papers on Econ. Activity (Fall 2008), at 40 tbl.3.
\106\ The Board conducted independent analysis using data
obtained from the FRBNY Consumer Credit Panel to determine the
proportion of piggyback HELOCs taken out in the same month as the
first-lien loan that have a draw at the time of origination. Data
used was extracted from credit record data in years 2003 through
2010. See Donghoon Lee and Wilbert van der Klaauw, An Introduction
to the FRBNY Consumer Credit Panel (Fed. Reserve Bd. Of N.Y.C.,
Staff Rept. No. 479, 2010), available at https://data.newyorkfed.org/research/staff_reports/sr479.pdf (providing
further description of the database).
---------------------------------------------------------------------------

The Board recognized that consumers have varied reasons for
originating a HELOC concurrently with the first-lien loan, for example,
to reduce overall closing costs or for the convenience of having access
to an available credit line in the future. However, the Board believed
concerns relating to HELOCs originated concurrently for savings or
convenience, and not to provide payment towards the first-lien home
purchase loan, might be mitigated by the Board's proposal to require
that a creditor consider the periodic payment on the simultaneous loan
based on the actual amount drawn from the credit line by the consumer.
See proposed Sec. 226.43(c)(6)(ii), discussing payment calculation
requirements for simultaneous loans that are HELOCs. Still, the Board
recognized that in the case of a non-purchase transaction (e.g., a
refinancing) a simultaneous loan that is a HELOC might be unlikely to
be originated and drawn upon to provide payment towards the first-lien
loan, except perhaps towards closing costs. Thus, the Board solicited
comment on whether it should narrow the requirement to consider
simultaneous loans that are HELOCs to apply only to purchase
transactions.
Third, in developing this proposal Board staff conducted outreach
with a variety of participants that consistently expressed the view
that second-lien loans significantly impact a consumer's performance on
the first-lien loan, and that many second-lien loans are HELOCs. One
industry participant explained that the vast majority of ``piggyback
loans'' it originated were HELOCs that were fully drawn at the time of
origination and used to assist in the first-lien purchase transaction.
Another outreach participant stated that HELOCs make up approximately
90 percent of its simultaneous loan book-of-business. Industry outreach
participants generally indicated that it is a currently accepted
underwriting practice to include HELOCs in the repayment ability
assessment on the first-lien loan, and generally confirmed that the
majority of simultaneous liens considered during the underwriting
process are HELOCs. For these reasons, the Board proposed to use its
authority under TILA sections 105(a) and 129B(e) to broaden the scope
of TILA section 129C(a)(2), and accordingly proposed to define the term
``simultaneous loan'' to include HELOCs.
Proposed comment 43(b)(12)-1 clarified that the definition of
``simultaneous loan'' includes any loan that meets the definition,
whether made by the same creditor or a third-party creditor, and
provides an illustrative example of this principle.
Proposed comment 43(b)(12)-2 further clarified the meaning of the
term ``same consumer,'' and explained that for purposes of the
definition of ``simultaneous loan,'' the term ``same consumer'' would
include any consumer, as that term is defined in Sec. 1026.2(a)(11),
that enters into a loan that is a covered transaction and also enters
into another loan (e.g., a second-lien covered transaction or HELOC)
secured by the same dwelling. This comment further explained that where
two or more consumers enter into a legal obligation that is a covered
transaction, but only one of them enters into another loan secured by
the same dwelling, the ``same consumer'' includes the person that has
entered into both legal obligations. The Board believed this comment
would reflect statutory intent to include any loan that could impact
the consumer's ability to repay the covered transaction according to
its terms (i.e., to require the creditor to consider the combined
payment obligations of the consumer(s) obligated to repay the covered
transaction). See TILA Sec. 129C(a)(2).
Both industry and consumer advocate commenters overwhelmingly
supported inclusion of HELOCs as simultaneous loans, with only one
industry commenter objecting. The objecting commenter stated that there
was no persuasive policy argument for deviating from the statute, but
did not provide any reason to believe that concurrent HELOCs are less
relevant to an assessment of a consumer's ability to repay than
concurrent closed-end second liens. As explained in the proposed rule,
most industry participants are already considering HELOCs in the
underwriting of senior-lien loans on the same property. 76 FR 27418.
For the reasons set forth by the Board and discussed above, the
Bureau has determined that inclusion of HELOCs in the definition of
simultaneous loans is an appropriate use of its TILA authority to make
adjustments and additional requirements.
TILA section 105(a), as amended by section 1100A of the Dodd-Frank
Act, authorizes the Bureau to prescribe regulations that may contain
such additional requirements, classifications, differentiations, or
other provisions, and may provide for such adjustments and exceptions
for all or any class of transactions, as in the judgment of the Bureau
are necessary or proper to effectuate the purposes of TILA, to prevent
circumvention or evasion of TILA, or to facilitate compliance with
TILA. 15 U.S.C. 1604(a). The Bureau finds that the inclusion of HELOCs
is necessary and proper to effectuate the purposes of TILA. The
inclusion of HELOCs is further supported by the Bureau's authority
under TILA section 129B(e) to condition terms, acts or practices
relating to residential mortgage loans that the Bureau finds necessary
or proper to effectuate the purposes of TILA. 15 U.S.C. 1639b(e). TILA
section 129B(a)(2) states that ``[i]t is the purpose[] of * * *
[S]ection 129C to assure that consumers are offered and receive
residential mortgage loans on terms that reasonably reflect their
ability to repay the loans.'' 15 U.S.C. 1639b. Inclusion of HELOCs as
simultaneous loans will help to carry out this purpose of TILA by
helping to ensure that consumers receive loans on affordable terms, as
further explained above.
Accordingly, the Bureau is adopting Sec. 1026.43(b)(12) and
associated commentary as proposed, with clarifying edits to ensure that
simultaneous loans scheduled after

[[Page 6459]]

consummation will be considered in determining ability to repay.
43(b)(13)
TILA section 129C(a)(1) requires that a creditor determine a
consumer's repayment ability using ``verified and documented
information,'' and TILA section 129C(a)(4) specifically requires the
creditor to verify a consumer's income or assets relied on to determine
repayment ability using a consumer's tax return or ``third-party
documents'' that provide reasonably reliable evidence of the consumer's
income or assets, as discussed in detail below in the section-by-
section analysis of Sec. 1026.43(c)(3) and (4). The Board proposed to
define the term ``third-party record'' to mean: (1) A document or other
record prepared or reviewed by a person other than the consumer, the
creditor, any mortgage broker, as defined in Sec. 1026.36(a)(2), or
any agent of the creditor or mortgage broker; (2) a copy of a tax
return filed with the Internal Revenue Service or a state taxing
authority; (3) a record the creditor maintains for an account of the
consumer held by the creditor; or (4) if the consumer is an employee of
the creditor or the mortgage broker, a document or other record
regarding the consumer's employment status or income. The Board
explained that, in general, a creditor should refer to reasonably
reliable records prepared by or reviewed by a third party to verify
repayment ability under TILA section 129C(a), a principle consistent
with verification requirements previously outlined under the Board's
2008 HOEPA Final Rule. See Sec. 1026.34(a)(4)(ii).
Commenters generally supported the Board's broad definition of a
third-party record as a reasonable definition that allows a creditor to
use a wide variety of documents and sources, while ensuring that the
consumer does not remain the sole source of information. Some consumer
advocates, however, cautioned the Bureau against relying upon tax
records to provide a basis for verifying income history, pursuant to
amended TILA section 129C(a)(4)(A), to avoid penalizing consumers who
may not have access to accurate tax records. The Bureau does not
address comments with respect to consumers who may not maintain
accurate tax records because the definition provided in 1026.43(b)(13)
of third-party record merely ensures that a creditor may use any of a
wide variety of documents, including tax records, as a method of income
verification without mandating their use. Rather than rely solely on
tax records, for example, a creditor might look to other third-party
records for verification purposes, including the creditor's records
regarding a consumer's savings account held by the creditor, which
qualifies as a third-party record under Sec. 1026.43(b)(13)(iii), or
employment records for a consumer employed by the creditor, which
qualifies as a third-party record under Sec. 1026.43(b)(13)(iv).
The Board proposed comment 43(b)(13)-1 to clarify that third-party
records would include records transmitted or viewed electronically, for
example, a credit report prepared by a consumer reporting agency and
transmitted or viewed electronically. The Bureau did not receive
significant feedback on the proposed comment and is adopting the
comment largely as proposed. The Bureau is clarifying that an
electronic third-party record should be transmitted electronically,
such as via email or if the creditor is able to click on a secure
hyperlink to access a consumer's credit report. The Bureau is making
this slight clarification to convey that mere viewing of a record,
without the ability to capture or maintain the record, would likely be
problematic with respect to record retention under Sec. 1026.25(a) and
(c). While it seems unlikely that an electronic record could be viewed
without being transmitted as well, the Bureau is making this alteration
to avoid any confusion.
The Bureau is adopting the remaining comments to 43(b)(13) largely
as proposed by the Board. These comments did not elicit significant
public feedback. Comment 43(b)(13)-1 assures creditors that a third-
party record may be transmitted electronically. Comment 43(b)(13)-2
explains that a third-party record includes a form a creditor provides
to a third party for providing information, even if the creditor
completes parts of the form unrelated to the information sought. Thus,
for example, a creditor may send a Webform, or mail a paper form,
created by the creditor, to a consumer's current employer, on which the
employer could check a box that indicates that the consumer works for
the employer. The creditor may even elect to fill in the creditor's
name, or other portions of the form, so long as those portions are
unrelated to the information that the creditor seeks to verify, such as
income or employment status.
Comment 43(b)(13)(i)-1 clarifies that a third-party record includes
a document or other record prepared by the consumer, the creditor, the
mortgage broker, or an agent of the creditor or mortgage broker, if the
record is reviewed by a third party. For example, a profit-and-loss
statement prepared by a self-employed consumer and reviewed by a third-
party accountant is a third-party record under Sec. 1026.43(b)(13)(i).
The Bureau is including comment 43(b)(13)(i)-1 to explain how some
first-party records, e.g., documents originally prepared by the
consumer, may become third-party records by virtue of an appropriate,
disinterested third-party's review or audit. It is the third party
review, the Bureau believes, that provides reasonably reliable evidence
of the underlying information in the document, just as if the document
were originally prepared by the third party. Moreover, this
clarification allows the creditor to consult a wider variety of
documents in its determination of a consumer's ability to repay.
Creditors should be cautioned not to assume, however, that merely
because a document is a third-party record as defined by Sec.
1026.43(b)(13), and the creditor uses the information provided by that
document to make a determination as to whether the consumer will have a
reasonable ability to repay the loan according to its terms, that the
creditor has satisfied the requirements of this rule. The creditor also
must make a reasonable and good faith determination at or before
consummation that the consumer will have a reasonable ability, at the
time of consummation, to repay the loan according to its terms. For a
full discussion of the Bureau's approach to this determination, see
Sec. 1026.43(c)(1), its commentary, and the section-by-section
analysis of those provisions below.
Finally, comment 43(b)(13)(iii)-1 clarifies that a third-party
record includes a record that the creditor maintains for the consumer's
account. Such examples might include records of a checking account,
savings account, and retirement account that the consumer holds, or has
held, with the creditor. Comment 43(b)(13)(iii)-1 also provides the
example of a creditor's records for an account related to a consumer's
outstanding obligations to the creditor, such as the creditor's records
for a first-lien mortgage to a consumer who applies for a subordinate-
lien home equity loan. This comment helps assure industry that such
records are a legitimate basis for determining a consumer's ability to
repay, and/or for verifying income and assets because it is unlikely to
be in a creditor's interest to falsify such records for purposes of
satisfying Sec. 1026.43(b)(13), as falsifying records would violate
the good faith requirement of Sec. 1026.43(c)(1). In addition, this
comment should help

[[Page 6460]]

assure creditors that the rule does not inhibit a creditor's ability to
``cross-sell'' products to consumers, by avoiding placing the creditor
at a disadvantage with respect to verifying a consumer's information by
virtue of the creditor's existing relationship with the consumer.
43(c) Repayment Ability
As enacted by the Dodd-Frank Act, TILA section 129C(a)(1) provides
that no creditor may make a residential mortgage loan unless the
creditor makes a reasonable and good faith determination, based on
verified and documented information, that, at the time the loan is
consummated, the consumer has a reasonable ability to repay the loan
according to its terms and all applicable taxes, insurance, and
assessments. TILA section 129C(a)(2) extends the same requirement to a
combination of multiple residential mortgage loans secured by the same
dwelling where the creditor knows or has reason to know that such loans
will be made to the same consumer. TILA sections 129C(a)(3) and (a)(4)
specify factors that must be considered in determining a consumer's
ability to repay and verification requirements for income and assets
considered as part of that determination. Proposed Sec. 226.43(c)
would have implemented TILA section 129C(a)(1) through (4) in a manner
substantially similar to the statute.
Proposed Sec. 226.43(c)(1) would have implemented the requirement
in TILA section 129C(a)(1) that creditors make a reasonable and good
faith determination that a consumer will have a reasonable ability to
repay the loan according to its terms. Proposed Sec. 226.43(c)(2)
would have required creditors to consider the following factors in
making a determination of repayment ability, as required by TILA
section 129C(a)(1) through (3): the consumer's current or reasonably
expected income or assets (other than the property that secures the
loan); the consumer's employment status, if the creditor relies on
employment income; the consumer's monthly payment on the loan; the
consumer's monthly payment on any simultaneous loan that the creditor
knows or has reason to know will be made; the consumer's monthly
payment for mortgage-related obligations; the consumer's current debt
obligations; and the consumer's monthly debt-to-income ratio or
residual income. Proposed Sec. 226.43(c)(3) would have required that
creditors verify the information they use in making an ability-to-repay
determination using third-party records, as required by TILA section
129C(a)(1). Proposed Sec. 226.43(c)(4) would have specified methods
for verifying income and assets as required by TILA section 129C(a)(1)
and (4). Proposed Sec. 226.43(c)(5) and (6) would have specified how
to calculate the monthly mortgage and simultaneous loan payments
required to be considered under proposed Sec. 226.43(c)(2). Proposed
Sec. 226.43(c)(7) would have specified how to calculate the monthly
debt-to-income ratio or monthly residual income required to be
considered under proposed Sec. 226.43(c)(2). As discussed in detail
below, the Bureau is adopting Sec. 1026.43(c) substantially as
proposed, with various modifications and clarifications.
Proposed comment 43(c)-1 would have indicated that creditors may
look to widely accepted governmental or nongovernmental underwriting
standards, such as the handbook on Mortgagee Credit Analysis for
Mortgage Insurance on One- to Four-Unit Mortgage Loans issued by FHA,
to evaluate a consumer's ability to repay. The proposed comment would
have stated that creditors may look to such standards in determining,
for example, whether to classify particular inflows, obligations, or
property as ``income,'' ``debt,'' or ``assets''; factors to consider in
evaluating the income of a self-employed or seasonally employed
consumer; or factors to consider in evaluating the credit history of a
consumer who has obtained few or no extensions of traditional
``credit'' as defined in Sec. 1026.2(a)(14). In the Supplemental
Information regarding proposed comment 43(c)-1, the Board stated that
the proposed rule and commentary were intended to provide flexibility
in underwriting standards so that creditors could adapt their
underwriting processes to a consumer's particular circumstances. The
Board stated its belief that such flexibility is necessary because the
rule covers such a wide variety of consumers and mortgage products.
Commenters generally supported giving creditors significant
flexibility to develop and apply their own underwriting standards.
However, commenters had concerns regarding the specific approach taken
in proposed comment 43(c)-1. Commenters raised a number of questions
about what kinds of underwriting standards might be considered widely
accepted, such as whether a creditor's proprietary underwriting
standards could ever be considered widely accepted. Commenters also
were uncertain whether the proposed comment required creditors to adopt
particular governmental underwriting standards in their entirety and
requested clarification on that point. At least one commenter, an
industry trade group, noted that FHA-insured loans constitute a small
percentage of the mortgage market and questioned whether FHA
underwriting standards therefore are widely accepted. This commenter
also questioned whether it is appropriate to encourage creditors to
apply FHA underwriting standards other than with respect to FHA-insured
loans, as FHA programs are generally designed to make mortgage credit
available in circumstances where private creditors are unwilling to
extend such credit without a government guarantee. Finally, consumer
group commenters asserted that underwriting standards do not accurately
determine ability to repay merely because they are widely accepted and
pointed to the widespread proliferation of lax underwriting standards
that predated the recent financial crisis.
The Bureau believes that the Board did not intend to require
creditors to use any particular governmental underwriting standards,
including FHA standards, in their entirety or to prohibit creditors
from using proprietary underwriting standards. The Bureau also does not
believe that the Board intended to endorse lax underwriting standards
on the basis that those standards may be prevalent in the mortgage
market at a particular time. The Bureau therefore is adopting two new
comments to provide greater clarity regarding the role of underwriting
standards in ability-to-repay determinations and is not adopting
proposed comment 43(c)-1.
The Bureau is concerned based on the comments received that
referring creditors to widely accepted governmental and nongovernmental
underwriting standards could lead to undesirable misinterpretations and
confusion. The discussion of widely accepted standards in proposed
comment 43(c)-1 could be misinterpreted to suggest that the
underwriting standards of any single market participant with a large
market share are widely accepted and therefore to be emulated. The
widely accepted standard also could be misinterpreted to indicate that
proprietary underwriting standards cannot yield reasonable, good faith
determinations of a consumer's ability to repay because they are unique
to a particular creditor and not employed throughout the mortgage
market. Similarly, the widely accepted standard could be misinterpreted
to encourage a creditor that lends in a limited geographic area or in a
particular market niche to apply widely accepted underwriting standards
that

[[Page 6461]]

are inappropriate for that particular creditor's loans.
The Bureau also is concerned that evaluating underwriting standards
based on whether they are widely accepted could have other undesirable
consequences. In a market bubble or economic crisis, many creditors may
change their underwriting standards in similar ways, leading to widely
accepted underwriting standards becoming unreasonably lax or
unreasonably tight. A regulatory directive to use underwriting
standards that are widely accepted could exacerbate those effects.
Also, referring creditors to widely accepted governmental and
nongovernmental underwriting standards could hinder creditors' ability
to respond to changing market and economic conditions and stifle market
growth and positive innovation.
Finally, the Bureau is concerned that focusing on whether
underwriting standards are widely accepted could distract creditors
from focusing on their obligation under TILA section 129C and Sec.
1026.43(c) to make ability-to-repay determinations that are reasonable
and in good faith. The Bureau believes that a creditor's underwriting
standards are an important factor in making reasonable and good faith
ability-to-repay determinations. However, how those standards are
applied to the individual facts and circumstances of a particular
extension of credit is equally or more important.
In light of these issues, the Bureau is not adopting proposed
comment 43(c)-1. Instead, the Bureau is adopting two new comments,
comment 43(c)(1)-1 and comment 43(c)(2)-1. New comment 43(c)(1)-1
clarifies that creditors are permitted to develop and apply their own
underwriting standards as long as those standards lead to ability-to-
repay determinations that are reasonable and in good faith. New comment
43(c)(2)-1 clarifies that creditors are permitted to use their own
definitions and other technical underwriting criteria and notes that
underwriting guidelines issued by governmental entities such as the FHA
are a source to which creditors may refer for guidance on definitions
and technical underwriting criteria. These comments are discussed below
in the section-by-section of Sec. 1026.43(c)(1) and (2).
43(c)(1) General Requirement
Proposed Sec. 226.43(c)(1) would have implemented TILA section
129C(a)(1) by providing that a creditor shall not make a loan that is a
covered transaction unless the creditor makes a reasonable and good
faith determination at or before consummation that the consumer will
have a reasonable ability, at the time of consummation, to repay the
loan according to its terms, including any mortgage-related
obligations. Commenters generally agreed that creditors should not make
loans to consumers unable to repay them and supported the requirement
to consider ability to repay. Accordingly, Sec. 1026.43(c)(1) is
adopted substantially as proposed, with two technical and conforming
changes.
As adopted, Sec. 1026.43(c)(1) requires creditors to make a
reasonable and good faith determination at or before consummation that
the consumer will have a reasonable ability to repay the loan according
to its terms. Section 1026.43(c)(1) as adopted omits the reference in
the proposed rule to determining that a consumer has a reasonable
ability ``at the time of consummation'' to repay the loan according to
its terms. The Bureau believes this phrase is potentially misleading
and does not accurately reflect the intent of either the Board or the
Bureau. Mortgage loans are not required to be repaid at the time of
consummation; instead, they are required to be repaid over months or
years after consummation. Creditors are required to make a predictive
judgment at the time of consummation that a consumer is likely to have
the ability to repay a loan in the future. The Bureau believes that the
rule more clearly reflects this requirement without the reference to
ability ``at the time of consummation'' to repay the loan. The
creditor's determination will necessarily be based on the consumer's
circumstances at or before consummation and evidence, if any, that
those circumstances are likely to change in the future. Section
1026.43(c)(1) as adopted also omits the reference in the proposed rule
to mortgage-related obligations. The Bureau believes this reference is
unnecessary because Sec. 1026.43(c)(2) requires creditors to consider
consumers' monthly payments for mortgage-related obligations and could
create confusion because Sec. 1026.43(c)(1) does not include
references to other factors creditors must consider under Sec.
1026.43(c)(2).
As noted above, the Bureau is adopting new comment 43(c)(1)-1,
which provides guidance regarding, among other things, how the
requirement to make a reasonable and good faith determination of
ability to repay relates to a creditor's underwriting standards. New
comment 43(c)(1)-1 replaces in part and responds to comments regarding
proposed comment 43(c)-1, discussed above.
New comment 43(c)(1)-1 emphasizes that creditors are to be
evaluated on whether they make a reasonable and good faith
determination that a consumer will have a reasonable ability to repay
as required by Sec. 1026.43(c)(1). The comment acknowledges that Sec.
1026.43(c) and the accompanying commentary describe certain
requirements for making ability-to-repay determinations, but do not
provide comprehensive underwriting standards to which creditors must
adhere. As an example, new comment 43(c)(1)-1 notes that the rule and
commentary do not specify how much income is needed to support a
particular level of debt or how to weigh credit history against other
factors.
The Bureau believes that a variety of underwriting standards can
yield reasonable, good faith ability-to-repay determinations. New
comment 43(c)(1)-1 explains that, so long as creditors consider the
factors set forth in Sec. 1026.43(c)(2) according to the requirements
of Sec. 1026.43(c), creditors are permitted to develop and apply their
own proprietary underwriting standards and to make changes to those
standards over time in response to empirical information and changing
economic and other conditions. The Bureau believes this flexibility is
necessary given the wide range of creditors, consumers, and mortgage
products to which this rule applies. The Bureau also believes that
there are no indicators in the statutory text or legislative history of
the Dodd-Frank Act that Congress intended to replace proprietary
underwriting standards with underwriting standards dictated by
governmental or government-sponsored entities as part of the ability-
to-repay requirements. The Bureau therefore believes that preserving
this flexibility here is consistent with Congressional intent. The
comment emphasizes that whether a particular ability-to-repay
determination is reasonable and in good faith will depend not only on
the underwriting standards adopted by the creditor, but on the facts
and circumstances of an individual extension of credit and how the
creditor's underwriting standards were applied to those facts and
circumstances. The comment also states that a consumer's statement or
attestation that the consumer has the ability to repay the loan is not
indicative of whether the creditor's determination was reasonable and
in good faith.
Concerns have been raised that creditors and others will have
difficulty evaluating whether a particular ability-

[[Page 6462]]

to-repay determination is reasonable and in good faith. Although the
statute and the rule specifies certain factors that a creditor must
consider in making such a determination, the Bureau does not believe
that there is any litmus test that can be prescribed to determine
whether a creditor, in considering those factors, arrived at a belief
in the consumer's ability to repay which was both objectively
reasonable and in subjective good faith. Nevertheless, new comment
43(c)(1)-1 lists considerations that may be relevant to whether a
creditor who considered and verified the required factors in accordance
with the rule arrived at an ability-to-repay determination that was
reasonable and in good faith. The comment states that the following may
be evidence that a creditor's ability-to-repay determination was
reasonable and in good faith: (1) The consumer demonstrated actual
ability to repay the loan by making timely payments, without
modification or accommodation, for a significant period of time after
consummation or, for an adjustable-rate, interest-only, or negative-
amortization mortgage, for a significant period of time after recast;
(2) the creditor used underwriting standards that have historically
resulted in comparatively low rates of delinquency and default during
adverse economic conditions; or (3) the creditor used underwriting
standards based on empirically derived, demonstrably and statistically
sound models.
In contrast, new comment 43(c)(1)-1 states that the following may
be evidence that a creditor's ability-to-repay determination was not
reasonable or in good faith: (1) The consumer defaulted on the loan a
short time after consummation or, for an adjustable-rate, interest-
only, or negative-amortization mortgage, a short time after recast; (2)
the creditor used underwriting standards that have historically
resulted in comparatively high levels of delinquency and default during
adverse economic conditions; (3) the creditor applied underwriting
standards inconsistently or used underwriting standards different from
those used for similar loans without reasonable justification; (4) the
creditor disregarded evidence that the underwriting standards it used
are not effective at determining consumers' repayment ability; (5) the
creditor consciously disregarded evidence that the consumer may have
insufficient residual income to cover other recurring obligations and
expenses, taking into account the consumer's assets other than the
property securing the covered transaction, after paying his or her
monthly payments for the covered transaction, any simultaneous loan,
mortgage-related obligations and any current debt obligations; or (6)
the creditor disregarded evidence that the consumer would have the
ability to repay only if the consumer subsequently refinanced the loan
or sold the property securing the loan.
New comment 43(c)(1)-1 states the Bureau's belief that all of these
considerations may be relevant to whether a creditor's ability-to-repay
determination was reasonable and in good faith. However, the comment
also clarifies that these considerations are not requirements or
prohibitions with which creditors must comply, nor are they elements of
a claim that a consumer must prove to establish a violation of the
ability-to-repay requirements. As an example, the comment clarifies
that creditors are not required to validate their underwriting criteria
using mathematical models.
New comment 43(c)(1)-1 also clarifies that these considerations are
not absolute in their application; instead they exist on a continuum
and may apply to varying degrees. As an example, the comment states
that the longer a consumer successfully makes timely payments after
consummation or recast the less likely it is that the creditor's
determination of ability to repay was unreasonable or not in good
faith.
Finally, new comment 43(c)(1)-1 clarifies that each of these
considerations must be viewed in the context of all facts and
circumstances relevant to a particular extension of credit. As an
example, the comment states that in some cases inconsistent application
of underwriting standards may indicate that a creditor is manipulating
those standards to approve a loan despite a consumer's inability to
repay. The creditor's ability-to-repay determination therefore may be
unreasonable or in bad faith. However, in other cases inconsistently
applied underwriting standards may be the result of, for example,
inadequate training and may nonetheless yield a reasonable and good
faith ability-to-repay determination in a particular case. Similarly,
the comment states that although an early payment default on a mortgage
will often be persuasive evidence that the creditor did not have a
reasonable and good faith belief in the consumer's ability to repay
(and such evidence may even be sufficient to establish a prima facie
case of an ability-to-repay violation), a particular ability-to-repay
determination may be reasonable and in good faith even though the
consumer defaulted shortly after consummation if, for example, the
consumer experienced a sudden and unexpected loss of income. In
contrast, the comment states that an ability-to-repay determination may
be unreasonable or not in good faith even though the consumer made
timely payments for a significant period of time if, for example, the
consumer was able to make those payments only by foregoing necessities
such as food and heat.
The Board proposed comment 43(c)(1)-1 to clarify that a change in a
consumer's circumstances after consummation of a loan, such as a
significant reduction in income due to a job loss or a significant
obligation arising from a major medical expense, that cannot reasonably
be anticipated from the consumer's application or the records used to
determine repayment ability, is not relevant to determining a
creditor's compliance with the rule. The proposed comment would have
further clarified that, if the application or records considered by the
creditor at or before consummation indicate that there will be a change
in the consumer's repayment ability after consummation, such as if a
consumer's application states that the consumer plans to retire within
12 months without obtaining new employment or that the consumer will
transition from full-time to part-time employment, the creditor must
consider that information. Commenters generally supported proposed
comment 43(c)(1)-1. Proposed comment 43(c)(1)-1 is adopted
substantially as proposed and redesignated as comment 43(c)(1)-2.
The Board also proposed comment 43(c)(1)-2 to clarify that Sec.
226.43(c)(1) does not require or permit the creditor to make inquiries
or verifications prohibited by Regulation B, 12 CFR part 1002.
Commenters generally supported proposed comment 43(c)(1)-2. Proposed
comment 43(c)(1)-2 is adopted substantially as proposed and
redesignated as comment 43(c)(1)-3.
43(c)(2) Basis for Determination
As discussed above, TILA section 129C(a)(1) generally requires a
creditor to make a reasonable and good faith determination that a
consumer has a reasonable ability to repay a loan and all applicable
taxes, insurance, and assessments. TILA section 129C(a)(2) requires a
creditor to include in that determination the cost of any other
residential mortgage loans made to the same consumer and secured by the
same dwelling. TILA section 129C(a)(3) enumerates several factors a
creditor must consider in determining a consumer's ability to repay:
credit

[[Page 6463]]

history; current income; expected income; current obligations; debt-to-
income ratio or residual income; employment status; and other financial
resources other than equity in the property securing the loan.
Proposed Sec. 226.43(c)(2) would have implemented the requirements
under these sections of TILA that a creditor consider specified factors
as part of a determination of a consumer's ability to repay. Proposed
Sec. 226.43(c)(2) would have required creditors to consider the
following factors in making a determination of repayment ability, as
required by TILA section 129C(a)(1) through (3): the consumer's current
or reasonably expected income or assets, other than the dwelling that
secures the loan; the consumer's employment status, if the creditor
relies on employment income; the consumer's monthly payment on the
loan; the consumer's monthly payment on any simultaneous loan that the
creditor knows or has reason to know will be made; the consumer's
monthly payment for mortgage-related obligations; the consumer's
current debt obligations; the consumer's monthly debt-to-income ratio
or residual income; and the consumer's credit history. As discussed in
detail below, the Bureau is adopting Sec. 1026.43(c)(2) substantially
as proposed, with technical and conforming changes.
As indicated above, the Bureau also is adopting new comment
43(c)(2)-1. New comment 43(c)(2)-1 provides guidance regarding
definitional and other technical underwriting issues related to the
factors enumerated in Sec. 1026.43(c)(2). New comment 43(c)(2)-1
replaces in part and responds to comments received regarding proposed
comment 43(c)-1, as discussed above.
New comment 43(c)(2)-1 notes that Sec. 1026.43(c)(2) sets forth
factors creditors must consider when making the ability-to-repay
determination required under Sec. 1026.43(c)(1) and the accompanying
commentary provides guidance regarding these factors. New comment
43(c)(2)-1 also notes that creditors must conform to these requirements
and may rely on guidance provided in the commentary. New comment
43(c)(2)-1 also acknowledges that the rule and commentary do not
provide comprehensive guidance on definitions and other technical
underwriting criteria necessary for evaluating these factors in
practice. The comment clarifies that, so long as a creditor complies
with the provisions of Sec. 1026.43(c), the creditor is permitted to
use its own definitions and other technical underwriting criteria.
New comment 43(c)(2)-1 further provides that a creditor may, but is
not required to, look to guidance issued by entities such as the FHA,
VA, USDA, or Fannie Mae or Freddie Mac while operating under the
conservatorship of the Federal Housing Finance Administration. New
comment 43(c)(2)-1 gives several examples of instances where a creditor
could refer to such guidance, such as: classifying particular inflows,
obligations, and property as ``income,'' ``debt,'' or ``assets'';
determining what information to use when evaluating the income of a
self-employed or seasonally employed consumer; or determining what
information to use when evaluating the credit history of a consumer who
has few or no extensions of traditional credit. The comment emphasizes
that these examples are illustrative, and creditors are not required to
conform to guidance issued by these or other such entities. The Bureau
is aware that many creditors have, for example, existing underwriting
definitions of ``income'' and ``debt.'' Creditors are not required to
modify their existing definitions and other technical underwriting
criteria to conform to guidance issued by such entities, and creditors'
existing definitions and other technical underwriting criteria are not
noncompliant merely because they differ from those used in such
guidance.
Finally, new comment 43(c)(2)-1 emphasizes that a creditor must
ensure that its underwriting criteria, as applied to the facts and
circumstances of a particular extension of credit, result in a
reasonable, good faith determination of a consumer's ability to repay.
As an example, new comment 43(c)(2)-1 states that a definition used in
underwriting that is reasonable in isolation may lead to ability-to-
repay determinations that are unreasonable or not in good faith when
considered in the context of a creditor's underwriting standards or
when adopted or applied in bad faith. Similarly, an ability-to-repay
determination is not unreasonable or in bad faith merely because the
underwriting criteria used included a definition that was by itself
unreasonable.
43(c)(2)(i)
TILA section 129C(a)(3) provides that, in making the repayment
ability determination, a creditor must consider, among other factors, a
consumer's current income, reasonably expected income, and ``financial
resources'' other than the consumer's equity in the dwelling or real
property that secures loan repayment. Furthermore, under TILA section
129C(a)(9), a creditor may consider the seasonality or irregularity of
a consumer's income in determining repayment ability. The Board's
proposal generally mirrored TILA section 129C(a)(3), but differed in
two respects.
First, proposed Sec. 226.43(c)(2)(i) used the term ``assets''
rather than ``financial resources,'' to conform with terminology used
in other provisions under TILA section 129C(a) and Regulation Z. See,
e.g., TILA section 129C(a)(4) (requiring that creditors consider a
consumer's assets in determining repayment ability); Sec. 1026.51(a)
(requiring consideration of a consumer's assets in determining a
consumer's ability to pay a credit extension under a credit card
account). The Board explained that the terms ``financial resources''
and ``assets'' are synonymous as used in TILA section 129C(a), and
elected to use the term ``assets'' throughout the proposal for
consistency. The Bureau is adopting this interpretation as well, as
part of its effort to streamline regulations and reduce compliance
burden, and uses the term ``assets'' throughout Regulation Z.
Second, the Board's proposal provided that a creditor may not look
to the value of the dwelling that secures the covered transaction,
instead of providing that a creditor may not look to the consumer's
equity in the dwelling, as provided in TILA section 129C(a). The Bureau
received comments expressing concern that the Board had proposed
dispensing with the term ``equity.'' These comments protested that the
Board had assumed that congressional concern was over the foreclosure
value of the home, rather than protecting all homeowners, including
those who may have low home values. The commenters' concerns are likely
misplaced, however, as the Board's language provides, if anything,
broader protection for homeowners. TILA section 129C(a)(3) is intended
to address the risk that a creditor will consider the amount that could
be obtained through a foreclosure sale of the dwelling, which may
exceed the amount of the consumer's equity in the dwelling. For
example, the rule addresses the situation in which, several years after
consummation, the value of a consumer's home has decreased
significantly. The rule prohibits a creditor from considering, at or
before consummation, any value associated with this home, even in the
event that the ``underwater'' home is sold at foreclosure. The rule
thus avoids the situation in which the creditor might assume that
rising home values might make up the difference should the consumer be
unable to make full mortgage payments, and therefore the rule is more
protective of consumers

[[Page 6464]]

because the rule forbids the creditor from considering any value
associated with the dwelling whether the consumer's equity stake in the
dwelling is large or small.
The Bureau is adopting the Board's proposal, providing that a
creditor may not look to the value of the dwelling that secures the
covered transaction, instead of providing that a creditor may not look
to the consumer's equity in the dwelling, as provided in TILA section
129C(a). The Bureau is making this adjustment pursuant to its authority
under TILA section 105(a), which provides that the Bureau's regulations
may contain such additional requirements, classifications,
differentiations, or other provisions, and may provide for such
adjustments and exceptions for all or any class of transactions as in
the Bureau's judgment are necessary or proper to effectuate the
purposes of TILA, prevent circumvention or evasion thereof, or
facilitate compliance therewith. 15 U.S.C. 1604(a). The purposes of
TILA include the purposes that apply to 129C, to assure that consumers
are offered and receive residential mortgage loans on terms that
reasonably reflect their ability to repay the loan. See 15 U.S.C.
1639b(a)(2). As further explained above, the Bureau believes it is
necessary and proper to make this adjustment to ensure that consumers
receive loans on affordable terms and to facilitate compliance with
TILA and its purposes.
The Board proposed comment 43(c)(2)(i)-1 to clarify that a creditor
may base a determination of repayment ability on current or reasonably
expected income from employment or other sources, assets other than the
dwelling that secures the covered transaction, or both. The Bureau did
not receive significant comment on the proposal and has adopted the
Board's proposed comment. In congruence with the Bureau's adoption of
the phrase ``value of the dwelling'' in Sec. 1026.43(c)(2)(i), instead
of the consumer's equity in the dwelling, as originally provided in
TILA section 129C(a), comment 43(c)(2)(i)-1 likewise notes that the
creditor may not consider the dwelling that secures the transaction as
an asset in any respect. This comment is also consistent with comment
43(a)-2, which further clarifies that the term ``dwelling'' includes
the value of the real property to which the dwelling is attached, if
the real property also secures the covered transaction. Comment
43(c)(2)(i)-1 also provides examples of types of income the creditor
may consider, including salary, wages, self-employment income, military
or reserve duty income, tips, commissions, and retirement benefits; and
examples of assets the creditor may consider, including funds in a
savings or checking account, amounts vested in a retirement account,
stocks, and bonds. The Bureau did not receive significant comment on
the proposal and has adopted the Board's proposed comment. The Bureau
notes that there may be assets other than those listed in comment
43(c)(2)(i)-1 that a creditor may consider; the Bureau does not intend
for the list to be exhaustive, but merely illustrative.
The Board proposed comment 43(c)(2)(i)-2 to explain that, if a
creditor bases its determination of repayment ability entirely or in
part on a consumer's income, the creditor need consider only the income
necessary to support a determination that the consumer can repay the
covered transaction. The Bureau did not receive significant comment and
has adopted the Board's comment largely as proposed. This comment
clarifies that a creditor need not document and verify every aspect of
the consumer's income, merely enough income to support the creditor's
good faith determination. For example, if a consumer earns income from
a full-time job and a part-time job and the creditor reasonably
determines that the consumer's income from the full-time job is
sufficient to repay the covered transaction, the creditor need not
consider the consumer's income from the part-time job. Comment
43(c)(2)(i)-2 also cross-references comment 43(c)(4)-1 for clarity.
The Board proposed comment 43(c)(2)(i)-3 to clarify that the
creditor may rely on the consumer's reasonably expected income either
in addition to or instead of current income. This comment is similar to
existing comment 34(a)(4)(ii)-2, which describes a similar income test
for high-cost mortgages under Sec. 1026.34(a)(4).\107\ This
consistency should serve to reduce compliance burden for creditors. The
Bureau did not receive significant comment on the proposal and is
adopting the Board's comment as proposed. Comment 43(c)(2)(i)-3 further
explains that, if a creditor relies on expected income, the expectation
that the income will be available for repayment must be reasonable and
verified with third-party records that provide reasonably reliable
evidence of the consumer's expected income. Comment 43(c)(2)(i)-3 also
gives examples of reasonably expected income, such as expected bonuses
verified with documents demonstrating past bonuses or expected salary
from a job verified with a written statement from an employer stating a
specified salary. As the Board has previously stated, in some cases a
covered transaction may have a likely payment increase that would not
be affordable at the consumer's income at the time of consummation. A
creditor may be able to verify a reasonable expectation of an increase
in the consumer's income that will make the higher payment affordable
to the consumer. See 73 FR 44522, 44544 (July 30, 2008).
---------------------------------------------------------------------------

\107\ The Bureau has proposed revising comment 34(a)(4)(ii)-2,
though not in a manner that would affect the ``reasonably expected
income'' aspect of the comment. See 77 FR 49090, 49153 (Aug. 15,
2012). The Bureau is concurrently finalizing the 2012 HOEPA
Proposal.
---------------------------------------------------------------------------

TILA section 129C(a)(9) provides that a creditor may consider the
seasonality or irregularity of a consumer's income in determining
repayment ability. Accordingly, the Board proposed comment 43(c)(2)(i)-
4 to clarify that a creditor reasonably may determine that a consumer
can make periodic loan payments even if the consumer's income, such as
self-employment or agricultural employment income, is seasonal or
irregular. The Bureau received little comment on this proposal,
although at least one consumer advocate expressed concern that
creditors might interpret the rule to allow for a creditor to
differentiate among types of income. Specifically, the commenter
expressed concern that some creditors might differentiate types of
income, for example salaried income as opposed to disability payments,
and that these creditors might require the consumer to produce a letter
stating that the disability income was guaranteed for a specified
period. The Bureau understands these concerns, and cautions creditors
not to overlook the requirements imposed by the Equal Credit
Opportunity Act, implemented by the Bureau under Regulation B. See 15
U.S.C. 1601 et seq.; 12 CFR 1002.1 et seq. For example, 12 CFR
1002.6(b)(2) prohibits a creditor from taking into account whether an
applicant's income derives from any public assistance program. The
distinction here is that 43(c)(2)(i)-4 permits the creditor to consider
the regularity of the consumer's income, but such consideration must be
based on the consumer's income history, not based on the source of the
income, as both a consumer's wages or a consumer's receipt of public
assistance may or may not be irregular. The Bureau is adopting this
comment largely as proposed, as the concerns discussed above are
largely covered by Regulation B. Comment 43(c)(2)(i)-4 states that, for
example, if the creditor determines that the income

[[Page 6465]]

a consumer receives a few months each year from, for example, selling
crops or from agricultural employment is sufficient to make monthly
loan payments when divided equally across 12 months, then the creditor
reasonably may determine that the consumer can repay the loan, even
though the consumer may not receive income during certain months.
Finally, the Bureau is adding new comment 43(c)(2)(i)-5 to further
clarify, in the case of joint applicants, the consumer's current or
reasonably expected income or assets basis of the creditor's ability-
to-repay determination. This comment is similar in approach to the
Board's proposed comment 43(c)(4)-2, discussed below, however, proposed
comment 43(c)(4)-2 discussed the verification of income in the case of
joint applicants. The Bureau is adding comment 43(c)(2)(i)-5 to clarify
the creditor's basis for making an ability-to-repay determination for
joint applicants. Comment 43(c)(2)(i)-5 explains that when two or more
consumers apply for an extension of credit as joint obligors with
primary liability on an obligation, Sec. 1026.43(c)(i) does not
require the creditor to consider income or assets that are not needed
to support the creditor's repayment ability determination. Thus, the
comment explains that if the income or assets of one applicant are
sufficient to support the creditor's repayment ability determination,
then the creditor is not required to consider the income or assets of
the other applicant.
43(c)(2)(ii)
TILA section 129C(a)(3) requires that a creditor consider a
consumer's employment status in determining the consumer's repayment
ability, among other requirements. The Board proposal implemented this
requirement in proposed Sec. 226.43(c)(2)(ii) and clarified that a
creditor need consider a consumer's employment status only if the
creditor relies on income from the consumer's employment in determining
repayment ability. The Bureau did not receive significant comment on
the Board's proposal and is adopting Sec. 1026.43(c)(2)(ii) as
proposed. The Bureau sees no purpose in requiring a creditor to
consider a consumer's employment status in the case where the creditor
need not consider the income from that employment in the creditor's
reasonable and good faith determination that the consumer will have a
reasonable ability to repay the loan according to its terms.
The Board proposed, and the Bureau is adopting, comment
43(c)(2)(ii)-1 to illustrate this point further. The comment states,
for example, that if a creditor relies wholly on a consumer's
investment income to determine the consumer's repayment ability, the
creditor need not consider or verify the consumer's employment status.
The proposed comment further clarifies that employment may be full-
time, part-time, seasonal, irregular, military, or self-employment.
Comment 43(c)(2)(ii)-1 is similar to comment 34(a)(4)-6, which
discusses income, assets, and employment in determining repayment
ability for high-cost mortgages.
In its proposal, the Board explained that a creditor generally must
verify information relied on to determine repayment ability using
reasonably reliable third-party records, but may verify employment
status orally as long as the creditor prepares a record of the oral
information. The Board proposed comment 43(c)(2)(ii)-2 to add that a
creditor also may verify the employment status of military personnel
using the electronic database maintained by the Department of Defense
(DoD) to facilitate identification of consumers covered by credit
protections provided pursuant to 10 U.S.C. 987, also known as the
``Talent Amendment.'' \108\ The Board solicited comment on whether
creditors needed additional flexibility in verifying the employment
status of military personnel, such as by verifying the employment
status of a member of the military using a Leave and Earnings
Statement. As this proposed comment was designed to provide
clarification for creditors with respect to verifying a consumer's
employment, this proposed comment is discussed in the section-by-
section analysis of Sec. 1026.43(c)(3) below.
---------------------------------------------------------------------------

\108\ The Talent Amendment is contained in the John Warner
National Defense Authorization Act. See Public Law 109-364, 120
Stat. 2083, 2266 (2006); 72 FR 50580, 5088 (Aug. 31, 2007)
(discussing the DoD database in a final rule implementing the Talent
Amendment). Currently, the DoD database is available at https://www.dmdc.osd.mil/appj/mla/.
---------------------------------------------------------------------------

43(c)(2)(iii)
Proposed Sec. 226.43(c)(2)(iii) implemented the requirements under
new TILA section 129C(a)(1) and (3), in part, by requiring that the
creditor consider the consumer's monthly payment on the covered
transaction, calculated in accordance with proposed Sec. 226.43(c)(5),
for purposes of determining the consumer's repayment ability. Proposed
comment 43(c)(2)(iii)-1 clarified the regulatory language and made
clear that mortgage-related obligations must also be considered.
The Bureau did not receive comments on this provision. Accordingly,
the Bureau is adopting Sec. 1026.43(c)(2)(iii) as proposed. Comment
43(c)(2)(iii)-1 has been edited to remove the reference to mortgage-
related obligations as potentially confusing. The monthly payment for
mortgage-related obligations must be considered under Sec.
1026.43(c)(2)(v).
43(c)(2)(iv)
Proposed Sec. 226.43(c)(2)(iv) implemented the requirements under
new TILA section 129C(a)(2), in part, by requiring that the creditor
consider ``the consumer's monthly payment on any simultaneous loan that
the creditor knows or has reason to know will be made, calculated in
accordance with'' proposed Sec. 226.43(c)(6), for purposes of
determining the consumer's repayment ability. As explained above in the
section-by-section analysis of Sec. 1026.43(b)(12), ``simultaneous
loan'' is defined, in the proposed and final rules, to include HELOCs.
Proposed comment 43(c)(2)(iv)-1 clarified that for purposes of the
repayment ability determination, a simultaneous loan includes any
covered transaction or HELOC that will be made to the same consumer at
or before consummation of the covered transaction and secured by the
same dwelling that secures the covered transaction. This comment
explained that a HELOC that is a simultaneous loan that the creditor
knows or has reason to know about must be considered in determining a
consumer's ability to repay the covered transaction, even though the
HELOC is not a covered transaction subject to Sec. 1026.43.
Proposed comment 43(c)(2)(iv)-3 clarified the scope of timing and
the meaning of the phrase ``at or before consummation'' with respect to
simultaneous loans that the creditor must consider for purposes of
proposed Sec. 226.43(c)(2)(iv). Proposed comment 43(c)(2)(iv)-4
provided guidance on the verification of simultaneous loans.
The Bureau received several industry comments on the requirement,
in the regulation and the statute, that the creditor consider any
simultaneous loan it ``knows or has reason to know'' will be made. The
commenters felt that the standard was vague, and that it would be
difficult for a creditor to understand when it ``has reason to know'' a
simultaneous loan will be made.
The Board provided guidance on the ``knows or has reason to know''
standard in proposed comment 43(c)(2)(iv)-2. This comment provided
that, in regard to ``piggyback'' second-lien loans, the creditor
complies with the standard if it follows policies and procedures that
are designed to

[[Page 6466]]

determine whether at or before consummation that the same consumer has
applied for another credit transaction secured by the same dwelling.
The proposed comment provided an example in which the requested loan
amount is less than the home purchase price, indicating that there is a
down payment coming from a different funding source. The creditor's
policies and procedures must require the consumer to state the source
of the down payment, which must be verified. If the creditor determines
that the source of the down payment is another extension of credit that
will be made to the same consumer and secured by the same dwelling, the
creditor knows or has reason to know of the simultaneous loan.
Alternatively, if the creditor has verified information that the down
payment source is the consumer's existing assets, the creditor would be
under no further obligation to determine whether a simultaneous loan
will be extended at or before consummation.
The Bureau believes that comment 43(c)(2)(iv)-2 provides clear
guidance on the ``knows or has reason to know'' standard, with the
addition of language clarifying that the creditor is not obligated to
investigate beyond reasonable underwriting policies and procedures to
determine whether a simultaneous loan will be extended at or before
consummation of the covered transaction.
The Bureau considers the provision to be an accurate and
appropriate implementation of the statute. Proposed Sec.
226.43(c)(2)(iv) and associated commentary are adopted substantially as
proposed, in renumbered Sec. 1026.43(c)(2)(iv), with the addition of
the language discussed above to comment 43(c)(2)(iv)-2 and other minor
clarifying changes. Comment 43(c)(2)(iv)-3 now includes language making
clear that if the consummation of the loan transaction is extended past
the traditional closing, any simultaneous loan originated after that
traditional closing may still be interpreted as having occurred ``at''
consummation. In addition, as discussed below, comment 43(c)(2)(iv)-4,
Verification of simultaneous loans, has been grouped with other
verification comments, in comment 43(c)(3)-4.
43(c)(2)(v)
As discussed above, TILA section 129C(a)(1) and (3) requires
creditors to consider and verify mortgage-related obligations as part
of the ability-to-repay determination ``according to [the loan's]
terms, and all applicable taxes, insurance (including mortgage
guarantee insurance), and assessments.'' Section 1026.34(a)(4), which
was added by the 2008 HOEPA Final Rule, also requires creditors to
consider mortgage-related obligations in assessing repayment ability.
See the section-by-section analysis of Sec. 1026.43(b)(8) for a
discussion of the Bureau's interpretation of ``mortgage-related
obligations'' and the definition adopted in the final rule.
The Board proposed to require creditors to consider the consumer's
monthly payment for mortgage-related obligations as part of the
repayment ability determination. Proposed comment 43(c)(2)(v)-1
explained that mortgage-related obligations must be included in the
creditor's determination of repayment ability regardless of whether the
amounts are included in the monthly payment or whether there is an
escrow account established.
Proposed comment 43(c)(2)(v)-2 clarified that, in considering
mortgage-related obligations that are not paid monthly, the creditor
may look to widely accepted governmental or non-governmental standards
to determine the pro rata monthly payment amount. The Board solicited
comment on operational difficulties creditors may encounter when
complying with this monthly requirement, and whether additional
guidance was necessary.
Proposed comment 43(c)(2)(v)-3 explained that estimates of
mortgage-related obligations should be based upon information known to
the creditor at the time the creditor underwrites the mortgage
obligation. This comment explained that information is known if it is
``reasonably available'' to the creditor at the time of underwriting
the loan, and cross-referenced current comment 17(c)(2)(i)-1 for
guidance regarding ``reasonably available.'' Proposed comment
43(c)(2)(v)-3 further clarified that, for purposes of determining
repayment ability under proposed Sec. 226.43(c), the creditor would
not need to project potential changes.
Proposed comment 43(c)(2)(v)-4 stated that creditors must make the
repayment ability determination required under proposed Sec. 226.43(c)
based on information verified from reasonably reliable records. This
comment explained that guidance regarding verification of mortgage-
related obligations could be found in proposed comments 43(c)(3)-1 and
-2, which discuss verification using third-party records.
The Board solicited comment on any special concerns regarding the
requirement to document certain mortgage-related obligations, for
example, ground rent or leasehold payments, or special assessments. The
Board also solicited comment on whether it should provide that the HUD-
1 or -1A or a successor form could serve as verification of mortgage-
related obligations reflected by the form, where a legal obligation
exists to complete the form accurately.
Industry commenters and consumer advocates generally supported
including consideration and verification of mortgage-related
obligations in the ability-to-repay determination. Several industry
commenters asked that the Bureau provide creditors more flexibility in
considering and verifying mortgage-related obligations. They suggested
that a reasonable and good faith determination be deemed sufficient,
rather than use of all underwriting standards in any particular
government or non-government handbook. Community banks asserted that
flexible standards were necessary to meet their customers' needs. Some
consumer advocates suggested that creditors be permitted to draw on
only widely accepted standards that have been validated by experience
or sanctioned by a government agency.
Some industry commenters asked for more guidance on how to
calculate pro rata monthly payment amounts and estimated property
taxes. One industry commenter asked that creditors be permitted to use
pro rata monthly payment amounts for special assessments, not quarterly
or yearly amounts. The commenter requested that estimates of common
assessments be permitted. This commenter also recommended that
creditors be permitted to verify the amount of common assessments with
information provided by the consumer. One commenter noted that
verification using HUD-1 forms should be permitted because there is a
legal obligation to complete the HUD-1 accurately.
The Bureau is adopting the rule as proposed. For the reasons
discussed below, the Bureau concludes that a creditor should consider
the consumer's monthly payment for mortgage-related obligations in
determining the consumer's ability to repay, pursuant to Sec.
1026.43(c)(1). As commenters confirmed, obligations related to the
mortgage may affect the consumer's ability to satisfy the obligation to
make recurring payments of principal and interest. The Bureau also
agrees with the argument raised by many commenters that the failure to
account consistently for these obligations during the subprime crisis
harmed many consumers. Thus, the Bureau has determined that it is
appropriate to adopt Sec. 1026.43(c)(2)(v) as proposed. However, the
Bureau believes that

[[Page 6467]]

additional guidance will facilitate compliance. As explained below, the
Bureau has expanded on the proposed commentary language to provide
additional clarity and illustrative examples.
The final version of comment 43(c)(2)(v)-1 is substantially similar
to the language as proposed. As discussed under Sec. 1026.43(b)(8)
above, the Bureau is revising the language related to insurance
premiums to provide additional clarity. The modifications to the
language in proposed comment 43(c)(2)(v)-1 conform to the language
adopted under Sec. 1026.43(b)(8) and the related commentary.
Furthermore, the final version of comment 43(c)(2)(v)-1 contains
additional explanation regarding the determination of the consumer's
monthly payment, and provides additional illustrative examples to
clarify further the requirements of Sec. 1026.43(c)(2)(v). For
example, assume that a consumer will be required to pay mortgage
insurance premiums, as defined by Sec. 1026.43(b)(8), on a monthly,
annual, or other basis after consummation. Section 1026.43(c)(2)(v)
includes these recurring mortgage insurance payments in the evaluation
of the consumer's monthly payment for mortgage-related obligations.
However, if the consumer will incur a one-time fee or charge for
mortgage insurance or similar purposes, such as an up-front mortgage
insurance premium imposed at consummation, Sec. 1026.43(c)(2)(v) does
not include this up-front mortgage insurance premium in the evaluation
of the consumer's monthly payment for mortgage-related obligations.
As discussed under Sec. 1026.43(b)(8) above, several commenters
discussed the importance of including homeowners association dues and
similar obligations in the determination of ability to repay. These
commenters argued, and the Bureau agrees, that recurring financial
obligations payable to community governance associations, such as
homeowners association dues, should be taken into consideration in
determining whether a consumer has the ability to repay the obligation.
The Bureau recognizes the practical problems that may arise with
including obligations such as these in the evaluation of the consumer's
monthly payment for mortgage-related obligations. Commenters identified
issues stemming from difficulties which may arise in calculating,
estimating, and verifying these obligations. Based on this feedback,
the Bureau has determined that additional clarification is necessary.
As adopted, comment 43(c)(2)(v)-2 clarifies that creditors need not
include payments to community governance associations if such
obligations are fully satisfied at or before consummation by the
consumer. This comment further clarifies that Sec. 1026.43(c)(2)(v)
does not require the creditor to include these payments in the
evaluation of the consumer's monthly payment for mortgage-related
obligations if the consumer does not pay the fee directly at or before
consummation, and instead finances the obligation. In these cases, the
financed obligation will be included in the loan amount, and is
therefore already included in the determination of ability to repay
pursuant to Sec. 1026.43(c)(2)(iii). However, if the consumer incurs
the obligation and will satisfy the obligation with recurring payments
after consummation, regardless of whether the obligation is escrowed,
Sec. 1026.43(c)(2)(v) requires the creditor to include the obligation
in the evaluation of the consumer's monthly payment for mortgage-
related obligations. The Bureau has also addressed the concerns raised
by commenters related to calculating, estimating, and verifying these
obligations in comments 43(c)(2)(v)-4 and -5 and 43(c)(3)-5,
respectively.
As discussed under Sec. 1026.43(b)(8) above, one comment letter
focused extensively on community transfer fees. The Bureau agrees with
the argument, advanced by several commenters, that the entirety of the
consumer's ongoing obligations should be included in the determination.
A responsible determination of the consumer's ability to repay requires
an accounting of such obligations, whether the purpose of the
obligation is to satisfy the payment of a community transfer fee or
traditional homeowners association dues. An obligation that is not paid
in full at or before consummation must be paid after consummation,
which may affect the consumer's ability to repay ongoing obligations.
Thus, comment 43(c)(2)(v)-2 clarifies that community transfer fees are
included in the determination of the consumer's monthly payment for
mortgage-related obligations if such fees are paid on a recurring basis
after consummation. Additionally, the Bureau believes that a creditor
is not required to include community transfer fees that are imposed on
the seller, as many community transfer fees are, in the ability-to-
repay calculation.
In response to the request for feedback in the proposed rule,
several commenters addressed the proposed treatment of special
assessments. Unlike community transfer fees, which are generally
identified in the deed or master community plan, creditors may
encounter difficulty determining whether special assessments exist.
Special assessments are often imposed in response to some urgent or
unexpected need. Consequently, neither the creditor nor the community
governance association may be able to predict the frequency and
magnitude of special assessments. However, this difficulty does not
exist for special assessments that are known at the time of
underwriting. Known special assessments, which the buyer must pay and
which may be significant, may affect the consumer's ability to repay
the obligation. Thus, comment 43(c)(2)(v)-3 clarifies that the creditor
must include special assessments in the evaluation of the consumer's
monthly payment for mortgage-related obligations if such fees are paid
by the consumer on a recurring basis after consummation, regardless of
whether an escrow is established for these fees. For example, if a
homeowners association imposes a special assessment that the consumer
will have to pay in full at or before consummation, Sec.
1026.43(c)(2)(v) does not include the special assessment in the
evaluation of the consumer's monthly payment for mortgage-related
obligations. Section 1026.43(c)(2)(v) does not require a creditor to
include special assessments in the evaluation of the consumer's monthly
payment for mortgage-related obligations if the special assessments are
imposed as a one-time charge. For example, if a homeowners association
imposes a special assessment that the consumer will have to satisfy in
one payment, Sec. 1026.43(c)(2)(v) does not include this one-time
special assessment in the evaluation of the consumer's monthly payment
for mortgage-related obligations. However, if the consumer will pay the
special assessment on a recurring basis after consummation, regardless
of whether the consumer's payments for the special assessment are
escrowed, Sec. 1026.43(c)(2)(v) requires the creditor to include this
recurring special assessment in the evaluation of the consumer's
monthly payment for mortgage-related obligations. Comment 43(c)(2)(v)-3
also includes several other examples illustrating this requirement.
The Bureau agrees that clear and detailed guidance regarding
determining pro rata monthly payments of mortgage-related obligations
should be provided. However, the Bureau believes that it is important
to strike a balance between providing clear guidance and providing
creditors with the flexibility to serve the evolving mortgage market.
The comments identified significant concerns with the use of ``widely

[[Page 6468]]

accepted governmental and non-governmental standards'' for purposes of
determining the pro rata monthly payment amount for mortgage-related
obligations. While commenters generally stated that ``widely accepted
governmental standards'' was an appropriate standard, others commented
that ``non-governmental standards'' may not be sufficiently clear. The
Bureau believes that ``governmental standards'' could be relied on to
perform pro rata calculations of monthly mortgage related obligations
because such standards provide detailed and comprehensive guidance and
are frequently revised to adapt to the needs of the evolving
residential finance market. However, the comments noted that ``non-
governmental standards'' is not sufficiently descriptive to illustrate
clearly how to calculate pro rata monthly payments. Additionally, the
Bureau believes that clear guidance is also needed to address the
possibility that a particular government program may not specifically
describe how to calculate pro rata monthly payment amounts for
mortgage-related obligations. Thus, the Bureau believes that it is
appropriate to revise and further develop the concept of ``widely
accepted governmental and non-governmental standards.''
Based on this feedback, the Bureau has revised and expanded the
comment clarifying how to calculate pro rata monthly mortgage
obligations. As adopted, comment 43(c)(2)(v)-4 provides that, if the
mortgage loan is originated pursuant to a governmental program, the
creditor may determine the pro rata monthly amount of the mortgage-
related obligation in accordance with the specific requirements of that
program. If the mortgage loan is originated pursuant to a government
program that does not contain specific standards for determining the
pro rata monthly amount of the mortgage-related obligation, or if the
mortgage loan is not originated pursuant to a government program, the
creditor complies with Sec. 1026.43(c)(2)(v) by dividing the total
amount of a particular non-monthly mortgage-related obligation by no
more than the number of months from the month that the non-monthly
mortgage-related obligation last was due prior to consummation until
the month that the non-monthly mortgage-related obligation next will be
due after consummation. Comment 43(c)(2)(v)-4 also includes several
examples which illustrate the conversion of non-monthly obligations
into monthly, pro rata payments. For example, assume that a consumer
applies for a mortgage loan on February 1st. Assume further that the
subject property is located in a jurisdiction where property taxes are
paid in arrears annually on the first day of October. The creditor
complies with Sec. 1026.43(c)(2)(v) by determining the annual property
tax amount owed in the prior October, dividing the amount by 12, and
using the resulting amount as the pro rata monthly property tax payment
amount for the determination of the consumer's monthly payment for
mortgage-related obligations. The creditor complies even if the
consumer will likely owe more in the next year than the amount owed the
prior October because the jurisdiction normally increases the property
tax rate annually, provided that the creditor does not have knowledge
of an increase in the property tax rate at the time of underwriting.
The Bureau is adopting comment 43(c)(2)(v)-5 in a form that is
substantially similar to the version proposed. One industry commenter
was especially concerned about estimating costs for community
governance organizations, such as cooperative, condominium, or
homeowners associations. This commenter noted that, because of industry
concerns about TILA liability, many community governance organizations
refuse to provide estimates of association expenses absent agreements
disclaiming association liability. This commenter expressed concern
that the ability-to-repay requirements would make community governance
organizations less likely to provide estimates of association expenses,
which would result in mortgage loan processing delays. The Bureau does
not believe that the ability-to-repay requirements will lead to
difficulties in exchanging information between creditors and
associations because the ability-to-repay requirements generally apply
only to creditors, as defined under Sec. 1026.2(a)(17). However, the
Bureau recognizes that consumers may be harmed if mortgage loan
transactions are needlessly delayed by concerns arising from the
ability-to-repay requirements. Thus, the Bureau has decided to address
these concerns by adding several examples to comment 43(c)(2)(v)-5
illustrating the requirements of Sec. 1026.43(c)(2)(v). For example,
the creditor complies with Sec. 1026.43(c)(2)(v) by relying on an
estimate of mortgage-related obligations prepared by the homeowners
association. In accordance with the guidance provided under comment
17(c)(2)(i)-1, the creditor need only exercise due diligence in
determining mortgage-related obligations, and complies with Sec.
1026.43(c)(2)(v) by relying on the representations of other reliable
parties in preparing estimates. Or, assume that the homeowners
association has imposed a special assessment on the seller, but the
seller does not inform the creditor of the special assessment, the
homeowners association does not include the special assessment in the
estimate of expenses prepared for the creditor, and the creditor is
unaware of the special assessment. The creditor complies with Sec.
1026.43(c)(2)(v) if it does not include the special assessment in the
determination of mortgage-related obligations. The creditor may rely on
the representations of other reliable parties, in accordance with the
guidance provided under comment 17(c)(2)(i)-1.
43(c)(2)(vi)
TILA section 129C(a)(1) and (3) requires creditors to consider
``current obligations'' as part of an ability-to-repay determination.
Proposed Sec. 226.43(c)(2)(vi) would have implemented the requirement
under TILA section 129C(a)(1) and (3) by requiring creditors to
consider current debt obligations. Proposed comment 43(c)(2)(vi)-1
would have specified that current debt obligations creditors must
consider include, among other things, alimony and child support. The
Bureau believes that it is reasonable to consider child support and
alimony as ``debts'' given that the term ``debt'' is not defined in the
statute. However, the Bureau understands that while alimony and child
support are obligations, they may not be considered debt obligations
unless and until they are not paid in a timely manner. Therefore, Sec.
1026.43(c)(2)(vi) specifies that creditors must consider current debt
obligations, alimony, and child support to clarify that alimony and
child support are included whether or not they are paid in a timely
manner.
Proposed comment 43(c)(2)(vi)-1 would have referred creditors to
widely accepted governmental and non-governmental underwriting
standards in determining how to define ``current debt obligations.''
The proposed comment would have given examples of current debt
obligations, such as student loans, automobile loans, revolving debt,
alimony, child support, and existing mortgages. The Board solicited
comment on proposed comment 43(c)(2)(vi)-1 and on whether more specific
guidance should be provided to creditors. Commenters generally
supported giving creditors significant flexibility and did not
encourage the Bureau to adopt more specific guidance.

[[Page 6469]]

Because the Bureau believes that a wide range of criteria and
guidelines for considering current debt obligations will contribute to
reasonable, good faith ability-to-repay determinations, comment
43(c)(2)(vi)-1 as adopted preserves the flexible approach of the
Board's proposed comment. The comment gives examples of current debt
obligations but does not provide an exhaustive list. The comment
therefore preserves substantial flexibility for creditors to develop
their own underwriting guidelines regarding consideration of current
debt obligations. Reference to widely accepted governmental and non-
governmental underwriting standards has been omitted, as discussed
above in the section-by-section analysis of Sec. 1026.43(c).
The Board also solicited comment on whether additional guidance
should be provided regarding consideration of debt obligations that are
almost paid off. Commenters generally stated that creditors should be
required to consider obligations that are almost paid off only if they
affect repayment ability. The Bureau agrees that many different
standards for considering obligations that are almost paid off could
lead to reasonable, good faith ability-to-repay determinations. As
adopted, comment 43(c)(2)(vi)-1 includes additional language clarifying
that creditors have significant flexibility to consider current debt
obligations in light of attendant facts and circumstances, including
that an obligation is likely to be paid off soon after consummation. As
an example, comment 43(c)(2)(vi)-1 states that a creditor may take into
account that an existing mortgage is likely to be paid off soon after
consummation because there is an existing contract for sale of the
property that secures that mortgage.
The Board also solicited comment on whether additional guidance
should be provided regarding consideration of debt obligations in
forbearance or deferral. Several commenters, including both creditors
and consumer advocates, supported requiring creditors to consider
obligations in forbearance or deferral. At least one large creditor
objected to requiring creditors to consider such obligations in all
cases. The Bureau believes that many different standards for
considering obligations in forbearance or deferral could lead to
reasonable, good faith determinations of ability to repay. As adopted,
comment 43(c)(2)(vi)-1 therefore includes additional language
clarifying that creditors should consider whether debt obligations in
forbearance or deferral at the time of underwriting are likely to
affect a consumer's ability to repay based on the payment for which the
consumer will be liable upon expiration of the forbearance or deferral
period and other relevant facts and circumstances, such as when the
forbearance or deferral period will expire.
Parts of proposed comment 43(c)(2)(vi)-1 and proposed comment
43(c)(2)(vi)-2 would have provided guidance on verification of current
debt obligations. All guidance regarding verification has been moved to
the commentary to Sec. 1026.43(c)(3) and is discussed below in the
section-by-section analysis of that provision.
The Board solicited comment on whether it should provide guidance
on consideration of current debt obligations for joint applicants.
Commenters generally did not comment on consideration of current debt
obligations for joint applicants. One trade association commenter
stated that joint applicants should be subject to the same standards as
individual applicants. Because the Bureau believes that the current
debt obligations of all joint applicants must be considered to reach a
reasonable, good faith determination of ability to repay, the Bureau is
adopting new comment 43(c)(2)(vi)-2. New comment 43(c)(2)(vi)-2
clarifies that when two or more consumers apply for credit as joint
obligors, a creditor must consider the debt obligations of all such
joint applicants. The comment also explains that creditors are not
required to consider the debt obligations of a consumer acting merely
as surety or guarantor. Finally, the comment clarifies that the
requirements of Sec. 1026.43(c)(2)(vi) do not affect various
disclosure requirements.
43(c)(2)(vii)
TILA section 129C(a)(3) requires creditors to consider the
consumer's monthly debt-to-income ratio or residual income the consumer
will have after paying non-mortgage debt and mortgage-related
obligations, as part of the ability-to-repay determination under TILA
section 129C(a)(1). This provision is consistent with the 2008 HOEPA
Final Rule, which grants a creditor in a high-cost or higher-priced
mortgage loan a presumption of compliance with the requirement that the
creditor assess repayment ability if, among other things, the creditor
considers the consumer's debt-to-income ratio or residual income. See
Sec. 1026.34(a)(4)(iii)(C), (b)(1). Existing comment 34(a)(4)(iii)(C)-
1 provides that creditors may look to widely accepted governmental and
non-governmental underwriting standards in defining ``income'' and
``debt'' including, for example, those set forth in the FHA Handbook on
Mortgage Credit Analysis for Mortgage Insurance on One-to-Four Unit
Mortgage Loans.
Proposed Sec. 226.43(c)(2)(vii) would have implemented TILA
section 129C(a)(3) by requiring creditors, as part of the repayment
ability determination, to consider the consumer's monthly debt-to-
income ratio or residual income. Proposed comment 43(c)(2)(vii)-1 would
have cross-referenced Sec. 226.43(c)(7), regarding the definitions and
calculations for the monthly debt-to-income and residual income.
Consistent with the 2008 HOEPA Final Rule, the proposed rule would have
provided creditors flexibility to determine whether to use a debt-to-
income ratio or residual income metric in assessing the consumer's
repayment ability. As the Board noted, if one of these metrics alone
holds as much predictive power as the two together, then requiring
creditors to use both metrics could reduce credit access without an
offsetting increase in consumer protection. 76 FR 27390, 27424-25 (May
11, 2011), citing 73 FR 44550 (July 30, 2008). The proposed rule did
not specifically address creditors' use of both metrics if such an
approach would provide incremental predictive power of assessing a
consumer's repayment ability. However, as discussed above in the
section-by-section analysis of Sec. 1026.43(c), the Board's proposed
comment 43(c)-1 would have provided that, in evaluating the consumer's
repayment ability under Sec. 226.43(c), creditors may look to widely
accepted governmental or non-governmental underwriting standards, such
as the FHA Handbook on Mortgage Credit Analysis for Mortgage Insurance
on One-to-Four Unit Mortgage Loans, consistent with existing comment
34(a)(4)(iii)(C)-1.
In response to the proposed rule, industry commenters and consumer
advocates generally supported including consideration of the debt-to-
income ratio or residual income in the ability-to-repay determination.
Several industry commenters asked that the Bureau provide creditors
more flexibility in considering and verifying the debt-to-income ratio
or residual income. They suggested that a reasonable and good faith
determination be deemed sufficient, rather than use of all underwriting
standards in any particular government or non-government handbook.
Community banks asserted that flexible standards are necessary to meet
their customers' needs. Some consumer advocates suggested that
creditors be permitted only to draw on widely accepted

[[Page 6470]]

standards that have been validated by experience or sanctioned by a
government agency. They argued that more specific standards would help
ensure safe and sound underwriting criteria, higher compliance rates,
and a larger number of performing loans.
Section 1026.43(c)(2)(vii) adopts the Board's proposal by requiring
a creditor making the repayment determination under Sec. 1026.43(c)(1)
to consider the consumer's monthly debt-to-income ratio or residual
income, in accordance with Sec. 1026.43(c)(7). The Bureau believes
that a flexible approach to evaluating a consumer's debt-to-income
ratio or residual income is appropriate because stricter guidelines may
limit access to credit and create fair lending problems. Broad
guidelines will provide creditors necessary flexibility to serve the
whole of the mortgage market effectively and responsibly. Accordingly,
the final rule sets minimum underwriting standards while providing
creditors with flexibility to use their own reasonable guidelines in
making the repayment ability determination required by Sec.
1026.43(c)(1). Moreover, and as in the 2008 HOEPA Final Rule, the
approach would provide creditors flexibility to determine whether to
use a debt-to-income ratio or residual income, or both, in assessing a
consumer's repayment ability.
As discussed above in the section-by-section analysis of Sec.
1026.43(c), the Bureau is not finalizing the Board's proposed comment
43(c)-1 regarding the use of widely accepted governmental or non-
governmental underwriting standards in evaluating the consumer's
repayment ability. Instead, for the reasons discussed above, comment
43(c)(2)-1 provides that the rule and commentary permit creditors to
adopt reasonable standards for evaluating factors in underwriting a
loan, such as whether to classify particular inflows or obligations as
``income'' or ``debt,'' and that, in evaluating a consumer's repayment
ability, a creditor may look to governmental underwriting standards.
See section-by-section analysis of Sec. 1026.43(c)(2).
The Bureau believes a flexible approach to evaluating debt and
income is appropriate in making the repayment ability determination
under Sec. 1026.43(c). However, for the reasons discussed below, the
Bureau believes a quantitative standard for evaluating a consumer's
debt-to-income ratio should apply to loans that are ``qualified
mortgages'' that receive a safe harbor or presumption of compliance
with the repayment ability determination under Sec. 1026.43(c). For a
discussion of the quantitative debt-to-income standard that applies to
qualified mortgages pursuant to Sec. 1026.43(e)(2) and the rationale
for applying a quantitative standard in the qualified mortgage space,
see the section-by-section analysis of Sec. 1026.43(e)(2).
43(c)(2)(viii)
TILA section 129C(a)(1) and (3) requires creditors to consider
credit history as part of the ability-to-repay determination. Proposed
Sec. 226.43(c)(2)(viii) would have implemented the requirement under
TILA section 129C(a)(1) and (3) by adopting the statutory requirement
that creditors consider credit history as part of an ability-to-repay
determination. Proposed comment 43(c)(2)(viii)-1 would have referred
creditors to widely accepted governmental and non-governmental
underwriting standards to define credit history. The proposed comment
would have given examples of factors creditors could consider, such as
the number and age of credit lines, payment history, and any judgments,
collections, or bankruptcies. The proposed comment also would have
referred creditors to credit bureau reports or to nontraditional credit
references such as rental payment history or public utility payments.
Commenters generally did not object to the proposed adoption of the
statutory requirement to consider credit history as part of ability-to-
repay determinations. Commenters generally supported giving creditors
significant flexibility in how to consider credit history. Creditors
also generally supported clarifying that creditors may look to
nontraditional credit references such as rental payment history or
public utility payments.
Section 1026.43(c)(2)(viii) is adopted as proposed. Comment
43(c)(2)(viii)-1 as adopted substantially maintains the proposed
comment's flexible approach to consideration of credit history. Comment
43(c)(2)(viii)-1 notes that ``credit history'' may include factors such
as the number and age of credit lines, payment history, and any
judgments, collections, or bankruptcies. The comment clarifies that the
rule does not require creditors to obtain or consider a consolidated
credit score or prescribe a minimum credit score that creditors must
apply. The comment further clarifies that the rule does not specify
which aspects of credit history a creditor must consider or how various
aspects of credit history could be weighed against each other or
against other underwriting factors. The comment explains that some
aspects of a consumer's credit history, whether positive or negative,
may not be directly indicative of the consumer's ability to repay and
that a creditor therefore may give various aspects of a consumer's
credit history as much or as little weight as is appropriate to reach a
reasonable, good faith determination of ability to repay. The Bureau
believes that this flexible approach is appropriate because of the wide
range of creditors, consumers, and loans to which the rule will apply.
The Bureau believes that a wide range of approaches to considering
credit history will contribute to reasonable, good faith ability-to-
repay determinations. As in the proposal, the comment, as adopted,
clarifies that creditors may look to non-traditional credit references
such as rental payment history or public utility payments, but are not
required to do so. Reference to widely accepted governmental and non-
governmental underwriting standards has been omitted, as discussed in
the section-by-section analysis of Sec. 1026.43(c), above.
Portions of proposed comment 43(c)(2)(viii)-1 discussed
verification of credit history. All guidance regarding verification has
been moved to the commentary to Sec. 1026.43(c)(3) and is discussed
below in the section-by-section analysis of that provision.
Because the Bureau believes that the credit history of all joint
applicants must be considered to reach a reasonable, good faith
determination of joint applicants' ability to repay, and for conformity
with the commentary to Sec. 1026.43(c)(2)(vi) regarding consideration
of current debt obligations for multiple applicants, the Bureau is
adopting new comment 43(c)(2)(viii)-2 regarding multiple applicants.
The comment clarifies that, when two or more consumers apply jointly
for credit, the creditor is required by Sec. 1026.43(c)(2)(viii) to
consider the credit history of all joint applicants. New comment
43(c)(2)(viii)-2 also clarifies that creditors are not required to
consider the credit history of a consumer who acts merely as a surety
or guarantor. Finally, the comment clarifies that the requirements of
Sec. 1026.43(c)(2)(viii) do not affect various disclosure
requirements.
43(c)(3) Verification Using Third-Party Records
TILA section 129C(a)(1) requires that a creditor make a reasonable
and good faith determination, based on ``verified and documented
information,'' that a consumer has a reasonable ability to repay the
covered transaction. The Board's 2008 HOEPA Final Rule required that a
creditor verify the

[[Page 6471]]

consumer's income or assets relied on to determine repayment ability
and the consumer's current obligations under Sec. 1026.34(a)(4)(ii)(A)
and (C). Thus, TILA section 129C(a)(1) differs from existing repayment
ability rules by requiring a creditor to verify information relied on
in considering the consumer's ability to repay according to the
considerations required under TILA section 129C(a)(3), which are
discussed above in the section-by-section analysis of Sec.
1026.43(c)(2).
The Board's proposal would have implemented TILA section
129C(a)(1)'s general requirement to verify a consumer's repayment
ability in proposed Sec. 226.43(c)(3), which required that a creditor
verify a consumer's repayment ability using reasonably reliable third-
party records, with two exceptions. Under the first exception, proposed
Sec. 226.43(c)(3)(i) provided that a creditor may orally verify a
consumer's employment status, if the creditor subsequently prepares a
record of the oral employment status verification. Under the second
exception, proposed Sec. 226.43(c)(3)(ii) provided that, in cases
where a creditor relies on a consumer's credit report to verify a
consumer's current debt obligations and the consumer's application
states a current debt obligation not shown in the consumer's credit
report, the creditor need not independently verify the additional debt
obligation, as reported. Proposed comment 43(c)(3)-1 clarified that
records a creditor uses to verify a consumer's repayment ability under
proposed Sec. 226.43(c)(3) must be specific to the individual
consumer. Records regarding, for example, average incomes in the
consumer's geographic location or average incomes paid by the
consumer's employer would not be specific to the individual consumer
and are not sufficient.
Proposed comment 43(c)(3)-2 provided that a creditor may obtain
third-party records from a third-party service provider, as long as the
records are reasonably reliable and specific to the individual
consumer. As stated in Sec. 1026.43(c)(3), the standard for
verification is that the creditor must use ``reasonably reliable third-
party records,'' which is fulfilled for reasonably reliable documents,
specific to the consumer, provided by a third-party service provider.
Also, proposed comment 43(c)(3)-2 clarified that a creditor may obtain
third-party records, for example, payroll statements, directly from the
consumer, again as long as the records are reasonably reliable.
The Board also solicited comment on whether any documents or
records prepared by the consumer and not reviewed by a third party
appropriately could be considered in determining repayment ability, for
example, because a particular record provides information not
obtainable using third-party records. In particular, the Board
solicited comment on methods currently used to ensure that documents
prepared by self-employed consumers (such as a year-to-date profit and
loss statement for the period after the period covered by the
consumer's latest income tax return, or an operating income statement
prepared by a consumer whose income includes rental income) are
reasonably reliable for use in determining repayment ability.
Commenters generally supported the Board's proposal to implement
the Dodd-Frank Act's verification requirements. Consumer groups
generally found the proposal to be an accurate implementation of the
statute and posited that the proposal would provide much-needed
protection for consumers. Industry commenters generally also supported
the proposal, noting that most underwriters already engaged in
similarly sound underwriting practices. Some industry commenters noted
that verifying a consumer's employment status imposes a burden upon the
consumer's employer as well, however the Bureau has concluded that the
oral verification provision provided by Sec. 1026.43(c)(3)(ii),
discussed below, alleviates such concerns.
The Bureau is adopting Sec. 1026.43(c)(3) substantially as
proposed, with certain clarifying changes which are described below.
The final rule also adds new comment 43(c)(3)-3. In addition, for
organizational purposes, the final rule generally adopts proposed
comments 43(c)(2)(iv)-4, 43(c)(2)(v)-4, 43(c)(2)(vi)-1, 43(c)(2)(viii)-
1, and 43(c)(2)(ii)-2 in renumbered comments 43(c)(3)-4 through -8 with
revisions as discussed below. These changes and additions to Sec.
1026.43(c)(3) and its commentary are discussed below.
First, the final rule adds a new Sec. 1026.43(c)(3)(i), which
provides that, for purposes of Sec. 1026.43(c)(2)(i), a creditor must
verify a consumer's income or assets in accordance with Sec.
1026.43(c)(4). This is an exception to the general rule in Sec.
1026.43(c)(3) that a creditor must verify the information that the
creditor relies on in determining a consumer's repayment ability under
Sec. 1026.43(c)(2) using reasonably reliable third-party records.
Because of this new provision, proposed Sec. 226.43(c)(3)(i) and (ii)
are adopted as proposed in Sec. 1026.43(c)(3)(ii) and (iii), with
minor technical revisions. In addition, the Bureau is adopting proposed
comments 43(c)(3)-1 and -2 substantially as proposed with revisions to
clarify that the guidance applies to both Sec. 1026.43(c)(3) and
(c)(4).
The Bureau is adding new comment 43(c)(3)-3 to clarify that a
credit report generally is considered a reasonably reliable third-party
record. The Board's proposed comment 43(c)(2)(vi)-2 stated, among other
things, that a credit report is deemed a reasonably reliable third-
party record under proposed Sec. 226.43(c)(3). Commenters did not
address that aspect of proposed comment 43(c)(2)(vi)-2. The Bureau
believes credit reports are generally reasonably reliable third-party
records for verification purposes. Comment 43(c)(3)-3 also explains
that a creditor is not generally required to obtain additional
reasonably reliable third-party records to verify information contained
in a credit report, as the report itself is the means of verification.
Likewise, comment 43(c)(3)-3 explains that if information is not
included in the credit report, then the credit report cannot serve as a
means of verifying that information. The comment further explains,
however, that if the creditor may know or have reason to know that a
credit report is not reasonably reliable, in whole or in part, then the
creditor complies with Sec. 1026.43(c)(3) by disregarding such
inaccurate or disputed items or reports. The creditor may also, but is
not required, to obtain other reasonably reliable third-party records
to verify information with respect to which the credit report, or item
therein, may be inaccurate. The Bureau believes that this guidance
strikes the appropriate balance between acknowledging that in many
cases, a credit report is a reasonably reliable third-party record for
verification and documentation for many creditors, but also that a
credit report may be subject to a fraud alert, extended alert, active
duty alert, or similar alert identified in 15 U.S.C. 1681c-1, or may
contain debt obligations listed on a credit report is subject to a
statement of dispute pursuant to 15 U.S.C. 1681i(b). Accordingly, for
the reasons discussed above, the Bureau is adopting new comment
43(c)(3)-3.
As noted above, the Bureau is adopting proposed comment
43(c)(2)(iv)-4 as comment 43(c)(3)-4 for organizational purposes. The
Board proposed comment 43(c)(2)(iv)-4 to explain that although a
creditor could use a credit report to verify current obligations, the
report would not reflect a simultaneous loan that has not yet been
consummated or has just recently

[[Page 6472]]

been consummated. Proposed comment 43(c)(2)(iv)-2 clarified that if the
creditor knows or has reason to know that there will be a simultaneous
loan extended at or before consummation, then the creditor may verify
the simultaneous loan by obtaining third-party verification from the
third-party creditor of the simultaneous loan. The proposed comment
provided, as an example, that the creditor may obtain a copy of the
promissory note or other written verification from the third-party
creditor in accordance with widely accepted governmental or non-
governmental standards. In addition, proposed comment 43(c)(2)(iv)-2
cross-referenced comments 43(c)(3)-1 and -2, which discuss verification
using third-party records. The Bureau generally did not receive comment
with respect to this proposed comment; however, at least one commenter
supported the example that a promissory note would serve as appropriate
documentation for verifying a simultaneous loan. The Bureau is adopting
proposed comment 43(c)(2)(iv)-4 as comment 43(c)(3)-4 with the
following amendment. For consistency with other aspects of the rule,
comment 43(c)(3)-4 does not include the Board's proposed reference to
widely accepted governmental or non-governmental standards.
The Board proposed comment 43(c)(2)(v)-4, which stated that
creditors must make the repayment ability determination required under
proposed Sec. 226.43(c) based on information verified from reasonably
reliable records. The Board solicited comment on any special concerns
regarding the requirement to document certain mortgage-related
obligations, for example, ground rent or leasehold payments, or special
assessments. The Board also solicited comment on whether it should
provide that the HUD-1 or -1A or a successor form could serve as
verification of mortgage-related obligations reflected by the form,
where a legal obligation exists to complete the HUD-1 or -1A
accurately. To provide additional clarity, the Bureau is moving
guidance that discusses verification, including proposed comment
43(c)(2)(v)-4, as part of the section-by-section analysis of, and
commentary to, Sec. 1026.43(c)(3). Additional comments from the
Board's proposal with respect to mortgage-related obligations are in
the section-by-section analysis of Sec. 1026.43(c)(2)(v), above.
Industry commenters and consumer advocates generally supported
including consideration and verification of mortgage-related
obligations in the ability-to-repay determination. Several industry
commenters asked that the Bureau provide creditors more flexibility in
considering and verifying mortgage-related obligations. Several
consumer advocate commenters discussed the importance of verifying
mortgage-related obligations based on reliable records, noting that
inadequate, or non-existent, verification measures played a significant
part in the subprime crisis. Industry commenters agreed that
verification was appropriate, but these commenters also stressed the
importance of clear and detailed guidance. Several commenters were
concerned about the meaning of ``reasonably reliable records'' in the
context of mortgage-related obligations. Some commenters asked the
Bureau to designate certain items as reasonably reliable, such as taxes
referenced in a title report, statements of common expenses provided by
community associations, or items identified in the HUD-1 or HUD-1A.
The Bureau is adopting proposed comment 43(c)(2)(v)-4 as comment
43(c)(3)-5 with revision to provide further explanation of its approach
to verifying mortgage-related obligations. While the reasonably
reliable standard contains an element of subjectivity, the Bureau
concludes that this flexibility is necessary. The Bureau believes that
it is important to craft a regulation with the flexibility to
accommodate an evolving mortgage market. The Bureau determines that the
reasonably reliable standard is appropriate in this context given the
nature of the items that are defined as mortgage-related obligations.
Thus, comment 43(c)(3)-5 incorporates by reference comments 43(c)(3)-1
and -2. Mortgage-related obligations refer to a limited set of charges,
such as property taxes and lease payments, which a creditor can
generally verify from an independent or objective source. Thus, in the
context of mortgage-related obligations this standard provides
certainty while being sufficiently flexible to adapt as underwriting
practices develop over time.
To address the concerns raised by several commenters, the Bureau is
providing further clarification in 43(c)(3)-5 to provide detailed
guidance and several examples illustrating these requirements. For
example, comment 43(c)(3)-5 clarifies that records are reasonably
reliable for purposes Sec. 1026.43(c)(2)(v) if the information in the
record was provided by a governmental organization, such as a taxing
authority or local government. Comment 43(c)(3)-5 also explains that a
creditor complies with Sec. 1026.43(c)(2)(v) if it relies on, for
example, homeowners association billing statements provided by the
seller to verify other information in a record provided by an entity
assessing charges, such as a homeowners association. Comment 43(c)(3)-5
further illustrates that records are reasonably reliable if the
information in the record was obtained from a valid and legally
executed contract, such as a ground rent agreement. Comment 43(c)(3)-5
also clarifies that other records may be reasonably reliable if the
creditor can demonstrate that the source provided the information
objectively.
The Board's proposal solicited comment regarding whether the HUD-1,
or similar successor document, should be considered a reasonably
reliable record. The Board noted, and commenters confirmed, that the
HUD-1, HUD-1A, or successor form might be a reasonably reliable record
because a legal obligation exists to complete the form accurately.
Although the Bureau agrees with these considerations, the Bureau does
not believe that a document provided in final form at consummation,
such as the HUD-1, should be used for the purposes of determining
ability to repay pursuant to Sec. 1026.43(c)(2)(v). The Bureau expects
the ability-to-repay determination to be conducted in advance of
consummation. It therefore may be impractical for a creditor to rely on
a document that is produced in final form at, or shortly before,
consummation for verification purposes. The Bureau is also concerned
that real estate transactions may be needlessly disrupted or delayed if
creditors delay determining the consumer's ability to repay until the
HUD-1, or similar successor document, is prepared. Given these
concerns, and strictly as a matter of policy, the Bureau does not wish
to encourage the use of the HUD-1, or similar successor document, for
the purposes of determining a consumer's ability to repay, and the
Bureau is not specifically designating the HUD-1 as a reasonably
reliable record in either Sec. 1026.43(c)(2)(v) or related commentary,
such as comment 43(c)(3)-5. However, the Bureau acknowledges that the
HUD-1, HUD-1A, or similar successor document may comply with Sec.
1026.43(c)(3).
The Board proposed comment 43(c)(2)(vi)-1, which discussed both
consideration and verification of current debt obligations. The Bureau
discusses portions of proposed comment 43(c)(2)(vi)-1, regarding
consideration of current debt obligations, in the section-by-section
analysis of Sec. 1026.43(c)(2)(vi). As noted above, for organizational
purposes and to provide

[[Page 6473]]

additional clarity, however, the Bureau is moving guidance that
discusses verification, including portions of proposed comment
43(c)(2)(vi)-1, as part of the commentary to Sec. 1026.43(c)(3). With
respect to verification, proposed comment 43(c)(2)(vi)-1 stated that:
(1) In determining how to verify current debt obligations, a creditor
may look to widely accepted governmental and nongovernmental
underwriting standards; and (2) a creditor may, for example, look to
credit reports, student loan statements, automobile loan statements,
credit card statements, alimony or child support court orders and
existing mortgage statements. Commenters did not provide the Bureau
with significant comment with respect to this proposal, although at
least one large bank commenter specifically urged the Bureau to allow
creditors to verify current debt obligations using a credit report. For
the reasons discussed below, the Bureau is adopting, in relevant part,
proposed comment 43(c)(2)(vi)-1 as comment 43(c)(3)-6. The Bureau
believes that the proposed guidance regarding verification using
statements and orders related to individual obligations could be
misinterpreted as implying that credit reports are not sufficient
verification of current debt obligations and that creditors must obtain
statements and other documentation pertaining to each individual
obligation. Comment 43(c)(3)-6 therefore explains that a creditor is
not required to further verify the existence or amount of the
obligation listed in a credit report, absent circumstances described in
comment 43(c)(3)-3. The Bureau believes that a credit report is a
reasonably reliable third-party record and is sufficient verification
of current debt obligations in most cases. The Bureau also believes
that this approach is reflected in the Board's proposal. For example,
proposed comment 43(c)(2)(vi)-2 stated that a credit report is a
reasonably reliable third-party record; and proposed Sec.
1026.43(c)(3)(ii) indicated that a creditor could rely on a consumer's
credit report to verify a consumer's current debt obligations. Unlike
proposed comment 43(c)(2)(vi)-1, comment 43(c)(3)-6 does not include
reference to widely accepted governmental and nongovernmental
underwriting standards for consistency with the amendments in other
parts of the rule. To understand the Bureau's approach to verification
standards, see the section-by-section analysis, commentary, and
regulation text of Sec. 1026.43(c) and Sec. 1026.43(c)(1) above. The
Board proposed comment 43(c)(2)(viii)-1, which discussed both the
consideration and verification of credit history. The Bureau discusses
portions of proposed comment 43(c)(2)(viii)-1, those regarding
consideration of credit history, in the section-by-section analysis of
Sec. 1026.43(c)(2)(viii). However, the Bureau is moving guidance on
verification, including portions of proposed comment 43(c)(2)(viii)-1,
to Sec. 1026.43(c)(3) and its commentary. Regarding verification,
proposed comment 43(c)(2)(viii)-1 stated that: (1) Creditors may look
to widely accepted governmental and nongovernmental underwriting
standards to determine how to verify credit history; and (2) a creditor
may, for example, look to credit reports from credit bureaus, or other
nontraditional credit references contained in third-party documents,
such as rental payment history or public utility payments to verify
credit history. Commenters did not object to the Board's proposed
approach to verification of credit history. The Bureau is adopting this
approach under comment 43(c)(3)-7 with the following exception.
References to widely accepted governmental and nongovernmental
underwriting standards have been removed, as discussed above in the
section-by-section analysis of Sec. 1026.43(c). Portions of proposed
comment 43(c)(2)(viii)-1 regarding verification are otherwise adopted
substantially as proposed in new comment 43(c)(3)-7.
The Board proposed comment 43(c)(2)(ii)-2 to clarify that a
creditor also may verify the employment status of military personnel
using the electronic database maintained by the DoD to facilitate
identification of consumers covered by credit protections provided
pursuant to 10 U.S.C. 987, also known as the ``Talent Amendment.''
\109\ The Board also sought additional comment as to whether creditors
needed additional flexibility in verifying the employment status of
military personnel, such as by verifying the employment status of a
member of the military using a Leave and Earnings Statement.
---------------------------------------------------------------------------

\109\ See supra note 105.
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Industry commenters requested that the Bureau provide additional
flexibility for creditors to verify military employment. For example,
some industry commenters noted that a Leave and Earnings Statement was
concrete evidence of employment status and income for military
personnel and other industry commenters stated that institutions that
frequently work with military personnel have built their own expertise
in determining the reliability of using the Leave and Earnings
Statement. These commenters argued that using a Leave and Earnings
Statement is as reliable a means of verifying the employment status of
military personnel as using a payroll statement to verify that
employment status of a civilian.
Accordingly, the Bureau is adopting proposed comment 43(c)(2)(ii)-2
as comment 43(c)(3)-8, for organizational purposes, with the following
additional clarification. Comment 43(c)(3)-8 clarifies that a creditor
may verify military employment by means of a military Leave and
Earnings Statement. Therefore, comment 43(c)(3)-8 provides that a
creditor may verify the employment status of military personnel by
using either a military Leave and Earnings Statement or by using the
electronic database maintained by the DoD.
The Board solicited comment on whether a creditor might
appropriately verify a consumer's repayment ability using any documents
or records prepared by the consumer and not reviewed by a third party,
perhaps because a particular record might provide information not
obtainable using third-party records. The Bureau did not receive
sufficient indication that such records would qualify as reasonably
reliable and has thus not added additional regulatory text or
commentary to allow for the use of such records. However, a creditor
using reasonable judgment nevertheless may determine that such
information is useful in verifying a consumer's ability to repay. For
example, the creditor may consider and verify a self-employed
consumer's income from the consumer's 2013 income tax return, and the
consumer then may offer an unaudited year-to-date profit and loss
statement that reflects significantly lower expected income in 2014.
The creditor might reasonably use the lower 2014 income figure as a
more conservative method of underwriting. However, should the
unverified 2014 income reflect significantly greater income than the
income tax return showed for 2013, a creditor instead would verify this
information in accordance with Sec. 1026.43(c)(4).
43(c)(4) Verification of Income or Assets
TILA section 129C(a)(4) requires that a creditor verify amounts of
income or assets that a creditor relied upon to determine repayment
ability by reviewing the consumer's Internal Revenue Service (IRS) Form
W-2, tax returns, payroll statements, financial

[[Page 6474]]

institution records, or other third-party documents that provide
reasonably reliable evidence of the consumer's income or assets. TILA
section 129C(a)(4) further provides that, in order to safeguard against
fraudulent reporting, any consideration of a consumer's income history
must include the verification of income using either (1) IRS
transcripts of tax returns; or (2) an alternative method that quickly
and effectively verifies income documentation by a third-party, subject
to rules prescribed by the Board, and now the Bureau. TILA section
129C(a)(4) is similar to existing Sec. 1026.34(a)(4)(ii)(A), adopted
by the Board's 2008 HOEPA Final Rule, although TILA section
129C(a)(4)(B) provides for the alternative methods of third-party
income documentation (other than use of an IRS tax-return transcript)
to be both ``reasonably reliable'' and to ``quickly and effectively''
verify a consumer's income. The Board proposed to implement TILA
section 129C(a)(4)(B), adjusting the requirement to (1) require the
creditor to use reasonably reliable third-party records, consistent
with TILA section 129C(a)(4), rather than the ``quickly and
effectively'' standard of TILA section 129C(a)(4)(B); and (2) provide
examples of reasonably reliable records that a creditor can use to
efficiently verify income, as well as assets. As discussed in the
Board's proposal, the Board proposed these adjustments pursuant to its
authority under TILA sections 105(a) and 129B(e). The Board believed
that considering reasonably reliable records effectuates the purposes
of TILA section 129C(a)(4), is an effective means of verifying a
consumer's income, and helps ensure that consumers are offered and
receive loans on terms that reasonably reflect their repayment ability.
Industry and consumer group commenters generally supported proposed
Sec. 226.43(c)(4) because the proposal would permit a creditor to use
a wide variety of documented income and/or asset verification methods,
while maintaining the appropriate goal of ensuring accurate
verification procedures. Some commenters requested that the Bureau
allow a creditor to underwrite a mortgage based on records maintained
by a financial institution that show an ability to repay. Specifically,
commenters raised concerns with respect to customers who may not have
certain documents, such as IRS Form W-2, because of their employment or
immigration status. The Bureau expects that Sec. 1026.43(c)(4)
provides that the answer to such concerns is self-explanatory; a
creditor need not, by virtue of the requirements of Sec.
1026.43(c)(4), require a consumer to produce an IRS Form W-2 in order
to verify income. Some industry commenters argued that the Bureau
should also permit creditors to verify information for certain
applicants, such as the self-employed, by using non-third party
reviewed documents, arguing it would reduce costs for consumers. The
Bureau does not find such justification to be persuasive, as other
widely available documents, such as financial institution records or
tax records, could easily serve as means of verification without
imposing significant cost to the consumer or creditor. See also the
discussion of comment 43(b)(13)(i)-1, addressing third-party records.
Some industry commenters advocated, in addition, that creditors be
allowed to employ broader, faster sources of income verification, such
as internet-based tools that employ aggregate employer data, or be
allowed to rely on statistically qualified models to estimate income or
assets. The Bureau, however, believes that permitting creditors to use
statistical models or aggregate data to verify income or assets would
be contrary to the purposes of TILA section 129C(a)(4). Although the
statute uses the words ``quickly and effectively,'' these words cannot
be read in isolation, but should instead be read in context of the
entirety of TILA section 129C(a)(4). As noted above, the Bureau
believes that TILA section 129C(a)(4) is primarily intended to
safeguard against fraudulent reporting and inaccurate underwriting,
rather than accelerate the process of verifying a consumer's income, as
the statute specifically notes that a creditor must verify a consumer's
income history ``[i]n order to safeguard against fraudulent
reporting.'' The Bureau further believes that permitting the use of
aggregate data or non-individualized estimates would undermine the
requirements to verify a consumer's income and to determine a
consumer's ability to repay. Rather, the Bureau believes that the
statute requires verification of the amount of income or assets relied
upon using evidence of an individual's income or assets.
For substantially the same reasons stated in the Board's proposal,
the Bureau is adopting proposed Sec. 226.43(c)(4) and its accompanying
commentary substantially as proposed in renumbered Sec. 1026.43(c)(4),
with revisions for clarity. Accordingly, the Bureau is implementing
TILA section 129C(a)(4) in Sec. 1026.43(c)(4), which provides that a
creditor must verify the amounts of income or assets it relies on to
determine a consumer's ability to repay a covered transaction using
third-party records that provide reasonably reliable evidence of the
consumer's income or assets. Section 1026.43(c)(4) further provides a
list of illustrative examples of methods of verifying a consumer's
income or asserts using reasonably reliable third-party records. Such
examples include: (1) Copies of tax returns the consumer filed with the
IRS or a State taxing authority; (2) IRS Form W-2s or similar IRS forms
for reporting wages or tax withholding; (3) payroll statements,
including military Leave and Earnings Statements; (4) financial
institution records; (5) records from the consumer's employer or a
third party that obtained consumer-specific income information from the
consumer's employer; (6) records from a government agency stating the
consumer's income from benefits or entitlements, such as a ``proof of
income'' letter issued by the Social Security Administration; (7) check
cashing receipts; and (8) receipts from a consumer's use of funds
transfer services. The Bureau also believes that by providing such
examples of acceptable records, the Bureau enables creditors to quickly
and effectively verify a consumer's income, as provided in TILA section
129C(a)(4)(B).
Comment 43(c)(4)-1 clarifies that under Sec. 1026.43(c)(4), a
creditor need verify only the income or assets relied upon to determine
the consumer's repayment ability. Comment 43(c)(4)-1 also provides an
example where the creditor need not verify a consumer's annual bonus
because the creditor relies on only the consumer's salary to determine
the consumer's repayment ability. This comment also clarifies that
comments 43(c)(3)-1 and -2, discussed above, are instructive with
respect to income and asset verification.
Comment 43(c)(4)-2 clarifies that, if consumers jointly apply for a
loan and each consumer lists his or her income or assets on the
application, the creditor need verify only the income or assets the
creditor relies on to determine repayment ability. Comment 43(c)(2)(i)-
5, discussed above, may also be instructive in cases of multiple
applicants.
Comment 43(c)(4)-3 provides that a creditor may verify a consumer's
income using an IRS tax-return transcript that summarizes the
information in the consumer's filed tax return, another record that
provides reasonably reliable evidence of the consumer's income, or
both. Comment 43(c)(4)-3 also clarifies that a creditor may obtain a
copy of an IRS tax-return transcript or filed tax return from a service
provider or from the consumer,

[[Page 6475]]

and the creditor need not obtain the copy directly from the IRS or
other taxing authority. For additional guidance, Comment 43(c)(4)-3
cross-references guidance on obtaining records in comment 43(c)(3)-2.
Finally, comment 43(c)(4)(vi)-1 states that an example of a record
from a Federal, State, or local government agency stating the
consumer's income from benefits or entitlements is a ``proof of income
letter'' (also known as a ``budget letter,'' ``benefits letter,'' or
``proof of award letter'') from the Social Security Administration.
As discussed above, the Bureau is adopting Sec. 1026.43(c)(4) as
enabling creditors to quickly and effectively verify a consumer's
income, as provided in TILA section 129C(a)(4)(B). In addition, for
substantially the same rationale as discussed in the Board's proposal,
the Bureau is adopting Sec. 1026.43(c)(4) using its authority under
TILA section 105(a) to prescribe regulations to carry out the purposes
of TILA. One of the purposes of TILA section 129C is to assure that
consumers are offered and receive covered transactions on terms that
reasonably reflect their ability to repay the loan. See TILA section
129B(a)(2). The Bureau believes that a creditor consulting reasonably
reliable records is an effective means of verifying a consumer's income
and helps ensure that consumers are offered and receive loans on terms
that reasonably reflect their repayment ability. The Bureau further
believes that TILA section 129C(a)(4) is intended to safeguard against
fraudulent or inaccurate reporting, rather than to accelerate the
creditor's ability to verify a consumer's income. Indeed, the Bureau
believes that there is a risk that requiring a creditor to use quick
methods to verify the consumer's income would undermine the
effectiveness of the ability-to-repay requirements by sacrificing
thoroughness for speed. The Bureau believes instead that requiring the
use of reasonably reliable records effectuates the purposes of TILA
section 129C(a)(4) without suggesting that creditors must obtain
records or complete income verification within a specific period of
time. The Bureau is adopting the examples of reasonably reliable
records, proposed by the Board, that a creditor may use to efficiently
verify income or assets, because the Bureau believes that it will
facilitate compliance by providing clear guidance to creditors.
The Bureau notes that the Board proposal solicited comment on
whether it should provide an affirmative defense for a creditor that
can show that the amounts of the consumer's income or assets that the
creditor relied upon in determining the consumer's repayment ability
were not materially greater than the amounts the creditor could have
verified using third-party records at or before consummation. Such an
affirmative defense, while not specified under TILA, would be
consistent with the Board's 2008 HOEPA Final Rule. See Sec.
1026.34(a)(4)(ii)(B).\110\ Consumer group commenters generally opposed
an affirmative defense, arguing that such an allowance would
essentially gut the income and asset verification requirement provided
by the rule. Other commenters noted that providing an affirmative
defense might result in confusion, and possible litigation, over what
the term ``material'' may mean, and that a rule permitting an
affirmative defense would need to define materiality specifically,
including from whose perspective materiality should be measured (i.e.,
the creditor's or the consumer's). Based on the comments received, the
Bureau believes that an affirmative defense is not warranted. The
Bureau believes that permitting an affirmative defense could result in
circumvention of the Sec. 1026.43(c)(4) verification requirement. For
the reasons stated, the Bureau is not adopting an affirmative defense
for a creditor that can show that the amounts of the consumer's income
or assets that the creditor relied upon in determining the consumer's
repayment ability were not materially greater than the amounts the
creditor could have verified using third-party records at or before
consummation.
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\110\ The Bureau's 2012 HOEPA Proposal proposed to amend this
subsection, though not in a manner that affected the overall effect
of an affirmative defense. See 77 FR 49090, 49153 (Aug. 15, 2012).
---------------------------------------------------------------------------

43(c)(5) Payment Calculation
The Board proposed Sec. 226.43(c)(5) to implement the payment
calculation requirements of TILA section 129C(a), as enacted by section
1411 of the Dodd-Frank Act. TILA section 129C(a) contains the general
requirement that a creditor determine the consumer's ``ability to repay
the loan, according to its terms, and all applicable taxes, insurance
(including mortgage guarantee insurance), and assessments,'' based on
several considerations, including ``a payment schedule that fully
amortizes the loan over the term of the loan.'' TILA section 129C(a)(1)
and (3). The statutory requirement to consider mortgage-related
obligations, as defined in Sec. 1026.43(b)(8), is discussed above in
the section-by-section analysis of Sec. 1026.43(c)(2)(v).
TILA section 129C(a) requires, among other things, that a creditor
make a determination that a consumer ``has a reasonable ability to
repay'' a residential mortgage loan. TILA section 129C(a)(6)(D)
provides the process for calculating the monthly payment amount ``[f]or
purposes of making any determination under this subsection,'' i.e.,
subsection (a), for ``any residential mortgage loan.'' TILA section
129C(a)(6)(A) through (D) requires creditors to make uniform
assumptions when calculating the payment obligation for purposes of
determining the consumer's repayment ability for the covered
transaction. Specifically, TILA section 129C(a)(6)(D)(i) through (iii)
provides that, when calculating the payment obligation that will be
used to determine whether the consumer can repay the covered
transaction, the creditor must use a fully amortizing payment schedule
and assume that: (1) The loan proceeds are fully disbursed on the date
the loan is consummated; (2) the loan is repaid in substantially equal,
monthly amortizing payments for principal and interest over the entire
term of the loan with no balloon payment; and (3) the interest rate
over the entire term of the loan is a fixed rate equal to the fully
indexed rate at the time of the loan closing, without considering the
introductory rate. The term ``fully indexed rate'' is defined in TILA
section 129C(a)(7).
TILA section 129C(a)(6)(D)(ii)(I) and (II), however, provides two
exceptions to the second assumption regarding ``substantially equal,
monthly payments over the entire term of the loan with no balloon
payment'' for loans that require ``more rapid repayment (including
balloon payment).'' First, this statutory provision authorizes the
Bureau to prescribe regulations for calculating the payment obligation
for loans that require more rapid repayment (including balloon
payment), and which have an annual percentage rate that does not exceed
the threshold for higher-priced mortgage loans. TILA section
129C(a)(6)(D)(ii)(I). Second, for loans that ``require more rapid
repayment (including balloon payment),'' and which exceed the higher-
priced mortgage loan threshold, the statute requires that the creditor
use the loan contract's repayment schedule. TILA section
129C(a)(6)(D)(ii)(II). The statute does not define the term ``rapid
repayment.''
The statute also provides three additional clarifications to the
assumptions stated above for loans that contain certain features.
First, for variable-rate loans that defer repayment of any principal or
interest, TILA

[[Page 6476]]

section 129C(a)(6)(A) states that for purposes of the repayment ability
determination a creditor must use ``a fully amortizing repayment
schedule.'' This provision generally reiterates the requirement
provided under TILA section 129C(a)(3) to use a payment schedule that
fully amortizes the loan. Second, for covered transactions that permit
or require interest-only payments, the statute requires that the
creditor determine the consumers' repayment ability using ``the payment
amount required to amortize the loan by its final maturity.'' TILA
section 129C(a)(6)(B). Third, for covered transactions with negative
amortization, the statute requires the creditor to also take into
account ``any balance increase that may accrue from any negative
amortization provision'' when making the repayment ability
determination. TILA section 129C(a)(6)(C). The statute does not define
the terms ``variable-rate,'' ``fully amortizing,'' ``interest-only,''
or ``negative amortization.'' Proposed Sec. 226.43(c)(5)(i) and (ii)
implemented these statutory provisions, as discussed in further detail
below.
TILA section 129C(a), as enacted by section 1411 of the Dodd-Frank
Act, largely codifies many aspects of the repayment ability rule under
Sec. 1026.34(a)(4) from the Board's 2008 HOEPA Final Rule and extends
such requirements to the entire mortgage market regardless of the
loan's interest rate. Similarly to Sec. 1026.34(a)(4), the statutory
framework of TILA section 129C(a) focuses on prescribing the
requirements that govern the underwriting process and extension of
credit to consumers, rather than dictating which credit terms may or
may not be permissible. However, there are differences between TILA
section 129C(a) and the 2008 HOEPA Final Rule with respect to payment
calculation requirements.
Current Sec. 1026.34(a)(4) does not address how a creditor must
calculate the payment obligation for a loan that cannot meet the
presumption of compliance under Sec. 1026.34(a)(4)(iii)(B). For
example, Sec. 1026.34(a)(4) does not specify how to calculate the
periodic payment required for a negative amortization loan or balloon-
payment mortgage with a term of less than seven years. In contrast, the
Dodd-Frank Act lays out a specific framework for underwriting any loan
subject to TILA section 129C(a). In taking this approach, the statutory
requirements in TILA section 129C(a)(6)(D) addressing payment
calculation requirements differ from Sec. 1026.34(a)(4)(iii) in the
following manner: (1) The statute generally premises repayment ability
on monthly payment obligations calculated using the fully indexed rate,
with no limit on the term of the loan that should be considered for
such purpose; (2) the statute permits underwriting loans with balloon
payments to differ depending on whether the loan's annual percentage
rate exceeds the applicable loan pricing benchmark, or meets or falls
below the applicable loan pricing benchmark; and (3) the statute
expressly addresses underwriting requirements for loans with interest-
only payments or negative amortization.
In 2006 and 2007 the Board and other Federal banking agencies
addressed concerns regarding the increased risk to creditors and
consumers presented by loans that permit consumers to defer repayment
of principal and sometimes interest, and by adjustable-rate mortgages
in the subprime market. The Interagency Supervisory Guidance stated
that creditors should determine a consumer's repayment ability using a
payment amount based on the fully indexed rate, assuming a fully
amortizing schedule. In addition, the 2006 Nontraditional Mortgage
Guidance addressed specific considerations for negative amortization
and interest-only loans. State supervisors issued parallel statements
to this guidance, which most states have adopted. TILA section
129C(a)(3) and (6) is generally consistent with this longstanding
Interagency Supervisory Guidance and largely extends the guidance
regarding payment calculation assumptions to all loan types covered
under TILA section 129C(a), regardless of a loan's interest rate. The
Board proposed Sec. 226.43(c)(5) to implement the payment calculation
requirements of TILA section 129C(a)(1), (3) and (6) for purposes of
the repayment ability determination required under proposed Sec.
226.43(c). Consistent with these statutory provisions, proposed Sec.
226.43(c)(5) did not prohibit the creditor from offering certain credit
terms or loan features, but rather focused on the calculation process
the creditor would be required to use to determine whether the consumer
could repay the loan according to its terms. Under the proposal,
creditors generally would have been required to determine a consumer's
ability to repay a covered transaction using the fully indexed rate or
the introductory rate, whichever is greater, to calculate monthly,
fully amortizing payments that are substantially equal, unless a
special rule applies. See proposed Sec. 226.43(c)(5)(i). For clarity
and simplicity, proposed Sec. 226.43(c)(5)(i) used the terms ``fully
amortizing payment'' and ``fully indexed rate,'' which were defined
separately under proposed Sec. 226.43(b)(2) and (3), respectively, as
discussed above. Proposed comment 43(c)(5)(i)-1 clarified that the
general rule would apply whether the covered transaction is an
adjustable-, step-, or fixed-rate mortgage, as those terms are defined
in Sec. 1026.18(s)(7)(i), (ii), and (iii), respectively.
Proposed Sec. 226.43(c)(5)(ii)(A) through (C) created exceptions
to the general rule and provided special rules for calculating the
payment obligation for balloon-payment mortgages, interest-only loans
or negative amortization loans, as follows:
Balloon-payment mortgages. Consistent with TILA section
129C(a)(6)(D)(ii)(I) and (II), for covered transactions with a balloon
payment, proposed Sec. 226.43(c)(5)(ii)(A) provided special rules that
differed depending on the loan's rate. Proposed Sec.
226.43(c)(5)(ii)(A)(1) stated that for covered transactions with a
balloon payment that are not higher-priced covered transactions, the
creditor must determine a consumer's ability to repay the loan using
the maximum payment scheduled in the first five years after
consummation. Proposed Sec. 226.43(c)(5)(ii)(A)(2) further stated that
for covered transactions with balloon payments that are higher priced
covered transactions, the creditor must determine the consumer's
ability to repay according to the loan's payment schedule, including
any balloon payment. For clarity, proposed Sec. 226.43(c)(5)(ii)(A)
used the term ``higher-priced covered transaction'' to refer to a
covered transaction that exceeds the applicable higher-priced mortgage
loan coverage threshold. ``Higher-priced covered transaction'' is
defined in Sec. 1026.43(b)(4), discussed above. The term ``balloon
payment'' has the same meaning as in current Sec. 1026.18(s)(5)(i).
Interest-only loans. Consistent with TILA section 129C(a)(6)(B) and
(D), proposed Sec. 226.43(c)(5)(ii)(B) provided special rules for
interest-only loans. Proposed Sec. 226.43(c)(5)(ii)(B) required that
the creditor determine the consumer's ability to repay the interest-
only loan using (1) the fully indexed rate or the introductory rate,
whichever is greater; and (2) substantially equal, monthly payments of
principal and interest that will repay the loan amount over the term of
the loan remaining as of the date the loan is recast. For clarity,
proposed Sec. 226.43(c)(5)(ii)(B) used the terms ``loan amount'' and
``recast,'' which are defined and discussed under Sec. 1026.43(b)(5)
and (11), respectively. The term ``interest-only loan'' has the

[[Page 6477]]

same meaning as in current Sec. 1026.18(s)(7)(iv).
Negative amortization loans. Consistent with TILA section
129C(a)(6)(C) and (D), proposed Sec. 226.43(c)(5)(ii)(C) provided
special rules for negative amortization loans. Proposed Sec.
226.43(c)(5)(ii)(C) required that the creditor determine the consumer's
ability to repay the negative amortization loan using (1) the fully
indexed rate or the introductory rate, whichever is greater; and (2)
substantially equal, monthly payments of principal and interest that
will repay the maximum loan amount over the term of the loan remaining
as of the date the loan is recast. Proposed comment 43(c)(5)(ii)(C)-1
clarified that for purposes of the rule, the creditor would first have
to determine the maximum loan amount and the period of time that
remains in the loan term after the loan is recast. For clarity,
proposed Sec. 226.43(c)(5)(ii)(C) used the terms ``maximum loan
amount'' and ``recast,'' which are defined and discussed under Sec.
1026.43(b)(7) and (11), respectively. The term ``negative amortization
loan'' has the same meaning as in current Sec. 1026.18(s)(7)(v) and
comment 18(s)(7)-1.
43(c)(5)(i) General Rule
Proposed Sec. 226.43(c)(5)(i) implemented the payment calculation
requirements in TILA section 129C(a)(3), 129C(6)(D)(i) through (iii),
and stated the general rule for calculating the payment obligation on a
covered transaction for purposes of the ability-to-repay provisions.
Consistent with the statute, proposed Sec. 226.43(c)(5)(i) provided
that unless an exception applies under proposed Sec. 226.43(c)(5)(ii),
a creditor must make the repayment ability determination required under
proposed Sec. 226.43(c)(2)(iii) by using the greater of the fully
indexed rate or any introductory interest rate, and monthly, fully
amortizing payments that are substantially equal. That is, under the
proposed general rule the creditor would calculate the consumer's
monthly payment amount based on the loan amount, and amortize that loan
amount in substantially equal payments over the loan term, using the
fully indexed rate.
Proposed comment 43(c)(5)(i)-1 explained that the payment
calculation method set forth in proposed Sec. 226.43(c)(5)(i) applied
to any covered transaction that does not have a balloon payment or that
is not an interest-only loan or negative amortization loan, whether it
is a fixed-rate, adjustable-rate or step-rate mortgage. This comment
further explained that the payment calculation method set forth in
proposed Sec. 226.43(c)(5)(ii) applied to any covered transaction that
is a loan with a balloon payment, interest-only loan, or negative
amortization loan. To facilitate compliance, this comment listed the
defined terms used in proposed Sec. 226.43(c)(5) and provided cross-
references to their definitions.
The fully indexed rate or introductory rate, whichever is greater.
Proposed Sec. 226.43(c)(5)(i)(A) implemented the requirement in TILA
section 129C(a)(6)(D)(iii) to use the fully indexed rate when
calculating the monthly, fully amortizing payment for purposes of the
repayment ability determination. Proposed Sec. 226.43(c)(5)(i)(A) also
provided that when creditors calculate the monthly, fully amortizing
payment for adjustable-rate mortgages, they would have to use the
introductory interest rate if it were greater than the fully indexed
rate (i.e., a premium rate). In some adjustable-rate transactions,
creditors may set an initial interest rate that is not determined by
the index or formula used to make later interest rate adjustments.
Sometimes this initial rate charged to consumers is lower than the rate
would be if it were determined by using the index plus margin, or
formula (i.e., the fully indexed rate). However, an initial rate that
is a premium rate is higher than the rate based on the index or
formula. Thus, requiring creditors to use only the fully indexed rate
would result in creditors underwriting loans that have a ``premium''
introductory rate at a rate lower than the rate on which the consumer's
initial payments would be based. The Board believed that requiring
creditors to assess the consumer's ability to repay on the initial
higher payments would better effectuate the statutory intent and
purpose. Proposed comment 43(c)(5)(i)-2 provided guidance on using the
greater of the premium or fully indexed rate.
Monthly, fully amortizing payments. For simplicity, proposed Sec.
226.43(c)(5)(i) used the term ``fully amortizing payment'' to refer to
the statutory requirements that a creditor use a payment schedule that
repays the loan assuming that (1) the loan proceeds are fully disbursed
on the date of consummation of the loan; and (2) the loan is repaid in
amortizing payments for principal and interest over the entire term of
the loan. See TILA sections 129C(a)(3) and (6)(D)(i) and (ii). As
discussed above, Sec. 1026.43(b)(2) defines ``fully amortizing
payment'' to mean a periodic payment of principal and interest that
will fully repay the loan amount over the loan term. The terms ``loan
amount'' and ``loan term'' are defined in Sec. 1026.43(b)(5) and
(b)(6), respectively, and discussed above.
The statute also expressly requires that a creditor use ``monthly
amortizing payments'' for purposes of the repayment ability
determination. TILA section 129C(6)(D)(ii). The Board recognized that
some loan agreements require consumers to make periodic payments with
less frequency, for example quarterly or semi-annually. Proposed Sec.
226.43(c)(5)(i)(B) did not dictate the frequency of payment under the
terms of the loan agreement, but did require creditors to convert the
payment schedule to monthly payments to determine the consumer's
repayment ability. Proposed comment 43(c)(5)(i)-3 clarified that the
general payment calculation rules do not prescribe the terms or loan
features that a creditor may choose to offer or extend to a consumer,
but establish the calculation method a creditor must use to determine
the consumer's repayment ability for a covered transaction. This
comment explained, by way of example, that the terms of the loan
agreement may require that the consumer repay the loan in quarterly or
bi-weekly scheduled payments, but for purposes of the repayment ability
determination, the creditor must convert these scheduled payments to
monthly payments in accordance with proposed Sec. 226.43(c)(5)(i)(B).
This comment also explained that the loan agreement may not require the
consumer to make fully amortizing payments, but for purposes of the
repayment ability determination the creditor must convert any non-
amortizing payments to fully amortizing payments.
Substantially equal. Proposed comment 43(c)(5)(i)-4 provided
additional guidance to creditors for determining whether monthly, fully
amortizing payments are ``substantially equal.'' See TILA section
129C(a)(6)(D)(ii). This comment stated that creditors should disregard
minor variations due to payment-schedule irregularities and odd
periods, such as a long or short first or last payment period. The
comment explained that monthly payments of principal and interest that
repay the loan amount over the loan term need not be equal, but that
the monthly payments should be substantially the same without
significant variation in the monthly combined payments of both
principal and interest. Proposed comment 43(c)(5)(i)-4 further
explained that where, for example, no two monthly payments vary from
each other by more than 1 percent (excluding odd periods, such as a
long or short first or last

[[Page 6478]]

payment period), such monthly payments would be considered
substantially equal for purposes of the rule. The comment further
provided that, in general, creditors should determine whether the
monthly, fully amortizing payments are substantially equal based on
guidance provided in current Sec. 1026.17(c)(3) (discussing minor
variations), and Sec. 1026.17(c)(4)(i) through (iii) (discussing
payment-schedule irregularities and measuring odd periods due to a long
or short first period) and associated commentary. The proposal
solicited comment on operational difficulties that arise by ensuring
payment amounts meet the ``substantially equal'' condition. The
proposal also solicited comment on whether a 1 percent variance is an
appropriate tolerance threshold.
Examples of payment calculations. Proposed comment Sec.
226.43(c)(5)(i)-5 provided illustrative examples of how to determine
the consumer's repayment ability based on substantially equal, monthly,
fully amortizing payments as required under proposed Sec.
226.43(c)(5)(i) for a fixed-rate, adjustable-rate and step-rate
mortgage.
The Board recognized that, although consistent with the statute,
the proposed framework would require creditors to underwrite certain
loans, such as hybrid ARMs with a discounted rate period of five or
more years (e.g., 5/1, 7/1, and 10/1 ARMs) to a more stringent standard
as compared to the underwriting standard set forth in proposed Sec.
226.43(e)(2)(v) for qualified mortgages.\111\ The Board believed this
approach was consistent with the statute's intent to ensure consumers
can reasonably repay their loans, and that in both cases consumers'
interests are properly protected. See TILA section 129B(a)(2), 15
U.S.C. 1639b(a)(2). To meet the definition of a qualified mortgage, a
loan cannot have certain risky terms or features, such as provisions
that permit deferral of principal or a term that exceeds 30 years; no
similar restrictions apply to loans subject to the ability-to-repay
standard. See proposed Sec. 226.43(e)(2)(i) and (ii). As a result, the
risk of potential payment shock is diminished significantly for
qualified mortgages. For this reason, the Board believed that
maintaining the potentially more lenient statutory underwriting
standard for loans that satisfy the qualified mortgage criteria would
help to ensure that responsible and affordable credit remains available
to consumers. See TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2).
---------------------------------------------------------------------------

\111\ The Bureau has also determined that in many instances the
fully indexed rate would result in a more lenient underwriting
standard than the qualified mortgage calculation. See the discussion
of non-qualified mortgage ARM underwriting below.
---------------------------------------------------------------------------

Loan amount or outstanding principal balance. As noted above,
proposed Sec. 226.43(c)(5)(i) was consistent with the statutory
requirements regarding payment calculations for purposes of the
repayment ability determination. The Board believed that the intent of
these statutory requirements was to prevent creditors from assessing
the consumer's repayment ability based on understated payment
obligations, especially when risky features can be present on the loan.
However, the Board was concerned that the statute, as implemented in
proposed Sec. 226.43(c)(5)(i), would require creditors to determine,
in some cases, a consumer's repayment ability using overstated payment
amounts because the creditor would have to assume that the consumer
repays the loan amount in substantially equal payments based on the
fully indexed rate, regardless of when the fully indexed rate could
take effect under the terms of the loan. The Board was concerned that
this approach might restrict credit availability, even where consumers
were able to demonstrate that they can repay the payment obligation
once the fully indexed rate takes effect.
For this reason, the proposal solicited comment on whether
authority should be exercised under TILA sections 105(a) and 129B(e) to
provide that the creditor may calculate the monthly payment using the
fully indexed rate based on the outstanding principal balance as of the
date the fully indexed rate takes effect under the loan's terms,
instead of the loan amount at consummation.
Step-rate and adjustable-rate calculations. Due to concerns
regarding credit availability, the proposal also solicited comment on
alternative means to calculate monthly payments for step-rate and
adjustable-rate mortgages. The proposal asked for comment on whether or
not the rule should require that creditors underwrite a step-rate or an
adjustable-rate mortgage using the maximum interest rate in the first
seven or ten years or some other appropriate time horizon that would
reflect a significant introductory rate period. The section-by-section
analysis of the ``fully indexed rate'' definition, at Sec.
1026.43(b)(3) above, discusses this issue in regard to step-rate
mortgages. For discussion of payment calculation methods for
adjustable-rate mortgages, see below.
Safe harbor to facilitate compliance. The Board recognized that
under its proposal, creditors would have to comply with multiple
assumptions when calculating the particular payment for purposes of the
repayment ability determination. The Board was concerned that the
complexity of the proposed payment calculation requirements might
increase the potential for unintentional errors to occur, making
compliance difficult, especially for small creditors that might be
unable to invest in advanced technology or software needed to ensure
payment calculations are compliant. At the same time, the Board noted
that the intent of the statutory framework and the proposal was to
ensure consumers are offered and receive loans on terms that they can
reasonably repay. Thus, the Board solicited comment on whether
authority under TILA sections 105(a) and 129B(e) should be exercised to
provide a safe harbor for creditors that use the largest scheduled
payment that can occur during the loan term to determine the consumer's
ability to repay, to facilitate compliance with the requirements under
proposed Sec. 226.43(c)(5)(i) and (ii).
Final Rule
The final rule requires creditors to underwrite the loan at the
premium rate if greater than the fully indexed rate for purposes of the
repayment ability determination using the authority under TILA section
105(a). 15 U.S.C. 1604(a). TILA section 105(a), as amended by section
1100A of the Dodd-Frank Act, provides that the Bureau's regulations may
contain such additional requirements, classifications,
differentiations, or other provisions, and may provide for such
adjustments and exceptions for all or any class of transactions as in
the Bureau's judgment are necessary or proper to effectuate the
purposes of TILA, prevent circumvention or evasion thereof, or
facilitate compliance therewith. 15 U.S.C. 1604(a). This approach is
further supported by the authority under TILA section 129B(e) to
condition terms, acts or practices relating to residential mortgage
loans that the Bureau finds necessary and proper to ensure that
responsible, affordable mortgage credit remains available to consumers
in a manner consistent with and which effectuates the purposes of
sections 129B and 129C, and which are in the interest of the consumer.
15 U.S.C. 1639b(e). The purposes of TILA include the purpose of TILA
sections 129B and 129C, to assure that consumers are offered and
receive residential mortgage loans on terms that reasonably reflect
their ability to repay the loan, among other things. TILA section
129B(b), 15 U.S.C. 1639b. For the reasons discussed above, the Bureau
believes that

[[Page 6479]]

requiring creditors to underwrite the loan to the premium rate for
purposes of the repayment ability determination is necessary and proper
to ensure that consumers are offered, and receive, loans on terms that
reasonably reflect their ability to repay, and to prevent circumvention
or evasion. Without a requirement to consider payments based on a
premium rate, a creditor could originate loans with introductory-period
payments that consumers do not have the ability to repay. Therefore,
this provision is also in the interest of consumers.
As discussed above, the Board solicited comment on whether payments
for non-qualified mortgage ARMs should be calculated similarly to
qualified mortgage ARMs, by using the maximum rate that will apply
during a certain period, such as the first seven years or some other
appropriate time horizon. Consumer and community groups were divided on
this issue. Some supported use of the fully indexed rate, but one
stated that underwriting ARMs based on the initial period of at least
five years may be appropriate. Another suggested that for non-qualified
mortgage ARMs the rule should require use of the maximum interest rate
or interest rate cap, whichever is greater, to better protect against
payment shock. A civil rights organization also advocated that ARMs
that are not qualified mortgages should be underwritten to several
points above the fully indexed rate. A combined comment from consumer
advocacy organizations also supported non-qualified mortgage ARMs being
underwritten more strictly, suggesting that because this is the market
segment that will have the fewest controls, the predatory practices
will migrate here, and there is significant danger of payment shock
when using the fully indexed rate in a low-rate environment such as
today's market. They suggested that the rule follow Fannie Mae's
method, which requires underwriting that uses the fully indexed rate or
the note rate plus 2 percent, whichever is greater, for ARMs with
initial fixed periods of up to five years. In addition, one joint
industry and consumer advocacy comment suggested adding 2 percent to
the fully indexed rate in order to calculate the monthly payment
amount.
Industry groups were strongly in favor of using a specific time
period for underwriting, generally suggesting five years. One credit
union association stated that use of the fully indexed rate is
excessive and unnecessary, and will increase the cost of credit.
Industry commenters stated that creditors generally consider only the
fixed-rate period, and ARMs with fixed periods of at least five years
are considered safe. One large bank stated that the calculation for
ARMs, whether or not they are qualified mortgages, should be uniform to
ease compliance.
The Bureau has determined that it will not use its exception and
adjustment authority to change the statutory underwriting scheme for
non-qualified mortgage ARMs. The statutory scheme clearly
differentiates between the qualified mortgage and non-qualified
mortgage underwriting strategies. The qualified mortgage underwriting
rules ignore any adjustment in interest rate that may occur after the
first five years; thus, for example, for an ARM with an initial
adjustment period of seven years, the interest rate used for the
qualified mortgage calculation will be the initial interest rate. In
addition, the qualified mortgage rules, by using the ``maximum interest
rate,'' take into account any adjustment in interest rate that can
occur during the first five years, including adjustments attributable
to changes in the index rate. In contrast, the non-qualified mortgage
rules have an unlimited time horizon but do not take into account
adjustments attributable to changes in the index rate.
Based on the its research and analysis, the Bureau notes that the
data indicate that neither the fully indexed rate nor the maximum rate
during a defined underwriting period produces consistent results with
regard to ability-to-repay calculations. The Bureau finds that the
underwriting outcomes under the two methods vary depending on a number
of complex variables, such as the terms of the loan (e.g., the length
of the initial adjustment period and interest rate caps) and the
interest rate environment. In other words, for a particular loan,
whether the monthly payment may be higher under a calculation that uses
the fully indexed rate, as opposed to the maximum rate in the first
five years, depends on a number of factors. Given the fact-specific
nature of the payment calculation outcomes, the Bureau believes that
overriding the statutory scheme would be inappropriate.
The Bureau also believes that adjusting the interest rate to be
used for non-qualified mortgage ability-to-repay calculations to
somewhere between the fully indexed rate specified in the statute and
the maximum interest rate mandated for qualified mortgage underwriting;
for example through an adjustment to the fully indexed rate of an
additional 2 percent, would be inappropriate. The fully indexed rate
had been in use since it was adopted by the Interagency Supervisory
Guidance in 2006, and Congress was likely relying on that experience in
crafting the statutory scheme. Adding to the fully indexed rate would
potentially reduce the availability of credit. Such an adjustment also
could result in a calculated interest rate and monthly payment that are
higher than the interest rate and payment calculated for qualified
mortgage underwriting, given that the qualified mortgage rules look
only to potential adjustments during the first five years.
The Bureau recognizes that underwriting practices today often take
into account potential adjustments in an ARM that can result from
increases in the index rate. For example, Fannie Mae requires
underwriting that uses the fully indexed rate or the note rate plus 2
percent, whichever is greater, for ARMs with initial fixed periods of
up to five years. The Bureau notes that underwriters have the
flexibility to adjust their practices in response to changing interest
rate environments whereas the process an administrative agency like the
Bureau must follow to amend a rule is more time consuming. The Bureau
also notes that the creditor must make a reasonable determination that
the consumer has the ability to repay the loan according to its terms.
Therefore, in situations where there is a significant likelihood that
the consumer will face an adjustment that will take the interest rate
above the fully indexed rate, a creditor whose debt-to-income or
residual income calculation indicates that a consumer cannot afford to
absorb any such increase may not have a reasonable belief in the
consumer's ability to repay the loan according to its terms. See
comment 43(c)(1)-1.
Although the Bureau has determined to implement the statutory
scheme as written and require use of the fully indexed rate for non-
qualified mortgage ARMs, it will monitor this issue through its
mandatory five-year review, and may make adjustments as necessary.
As discussed above, the Board also solicited comment on whether or
not to allow the fully indexed rate to be applied to the balance
projected to be remaining when the fully indexed rate goes into effect,
instead of the full loan amount, and thus give a potentially more
accurate figure for the maximum payment that would be required for
purposes of determining ability to repay. A consumer group and a group
advocating for financial reform supported this possibility, saying that
allowing lenders to apply the fully indexed rate to the balance
remaining when the rate changes, rather than the full loan amount, will
encourage longer

[[Page 6480]]

fixed-rate periods and safer lending, as well as preserve access to
credit. An association representing credit unions also agreed with the
possible amendment, stating that the new method would yield a more
accurate measure of the maximum payment that could be owed.
The Bureau believes it is appropriate for the final rule to remain
consistent with the statutory scheme. The Bureau believes that changing
the calculation method, required by the statute,\112\ would not be an
appropriate use of its exception and adjustment authority. The Bureau
believes the potentially stricter underwriting method of calculating
the monthly payment by applying the imputed (i.e., fully indexed)
interest rate to the full loan amount for non-qualified mortgage ARMs,
provides greater assurance of the ability to repay. In addition,
payment calculation using the fully indexed rate can only approximate
the consumer's payments after recast, since the index may have
increased significantly by then. Accordingly, the Bureau believes that
requiring the use of the full loan amount will reduce the potential
inaccuracy of the ability-to-repay determination in such a situation.
---------------------------------------------------------------------------

\112\ ``A creditor shall determine the ability of the consumer
to repay using a payment schedule that fully amortizes the loan over
the loan term.'' TILA Sec. 129C(a)(3).
---------------------------------------------------------------------------

In addition, the Board solicited comment on whether to provide a
safe harbor for any creditor that underwrites using the ``largest
scheduled payment that can occur during the loan term.'' To provide
such a safe harbor the Bureau would have to employ its exception and
adjustment authority because the use of the fully indexed rate
calculation is required by TILA section 129C(a)(6)(D)(iii). Two
industry commenters and an association of state bank regulators
supported this exemption, but none of them provided a developed
rationale for their support or included information useful in assessing
the possible exemption. The Bureau does not believe that it would be
appropriate at this time to alter the statutory scheme in this manner.
As discussed above, the Board also solicited comment on how to
lessen any operational difficulties of ensuring that payment amounts
meet the ``substantially equal'' condition, and whether or not allowing
a one percent variance between payments provided an appropriate
threshold. Only two commenters mentioned this issue. One industry
commenter stated that the 1 percent threshold was appropriate, but an
association of state bank regulators believed that a 5 percent
threshold would work better. Because the 1 percent threshold appears to
be sufficient to allow for payment variance and industry commenters did
not express a need for a higher threshold, the Bureau does not believe
that the provision should be amended.
For the reasons stated above, the Bureau is adopting Sec.
1026.43(c)(5)(i) and associated commentary substantially as proposed,
with minor clarifying revisions.
43(c)(5)(ii) Special Rules for Loans With a Balloon Payment, Interest-
Only Loans, and Negative Amortization Loans
Proposed Sec. 226.43(c)(5)(ii) created exceptions to the general
rule under proposed Sec. 226.43(c)(5)(i), and provided special rules
in proposed Sec. 226.43(c)(5)(ii)(A) through (C) for loans with a
balloon payment, interest-only loans, and negative amortization loans,
respectively, for purposes of the repayment ability determination
required under proposed Sec. 226.43(c)(2)(iii). In addition to TILA
section 129C(a)(6)(D)(i) through (iii), proposed Sec.
226.43(c)(5)(ii)(A) through (C) implemented TILA sections 129C(a)(6)(B)
and (C), and TILA section 129C(a)(6)(D)(ii)(I) and (II). Each of these
proposed special rules is discussed below.
43(c)(5)(ii)(A)
Implementing the different payment calculation methods in TILA
section 129C(a)(6)(D)(ii), the Board proposed different rules for
balloon-payment mortgages that are higher-priced covered transactions
and those that are not, in Sec. 1026.43(c)(5)(ii)(A)(1) and (2).
Proposed comment 43(c)(5)(ii)(A)-1 provided guidance on applying these
two methods. This guidance is adopted as proposed with minor changes
for clarity and to update a citation. The language describing the
calculation method for balloon-payment mortgages that are not higher-
priced covered transactions has been changed to reflect the use of the
first regular payment due date as the start of the relevant five-year
period. Pursuant to the Bureau's rulewriting authority under TILA
section 129C(a)(6)(D)(ii)(I), this change has been made to facilitate
compliance through consistency with the amended underwriting method for
qualified mortgages. See the section-by-section analysis of Sec.
1026.43(e)(2)(iv)(A). As with the recast on five-year adjustable-rate
qualified mortgages, the Bureau believes that consumers will benefit
from having a balloon payment moved to at least five years after the
first regular payment due date, rather than five years after
consummation.
43(c)(5)(ii)(A)(1)
The statute provides an exception from the general payment
calculation discussed above for loans that require ``more rapid
repayment (including balloon payment).'' See TILA section
129C(a)(6)(D)(ii)(I) and (II). For balloon-payment loans that are not
higher-priced covered transactions (as determined by using the margins
above APOR in TILA section 129C(a)(6)(D)(ii)(I) and implemented at
Sec. 1026.43(b)(4)), the statute provides that the payment calculation
will be determined by regulation. The Board proposed that a creditor be
required to make the repayment determination under proposed Sec.
226.43(c)(2)(iii) for ``[t]he maximum payment scheduled during the
first five years after consummation * * *''
The Board chose a five-year period in order to preserve access to
affordable short-term credit, and because five years was considered an
adequate period for a consumer's finances to improve sufficiently to
afford a fully amortizing loan. The Board believed that balloon-payment
loans of less than five years presented more risk of inability to
repay. The Board also believed that the five-year period would
facilitate compliance and create a level playing field because of its
uniformity with the general qualified mortgage provision (see Sec.
1026.43(e)), and balloon-payment qualified mortgage provision (see
Sec. 1026.43(f)). The Board solicited comment on whether the five-year
horizon was appropriate. Proposed comment Sec. 226.43(c)(5)(ii)(A)-2
provided further guidance to creditors on determining whether a balloon
payment occurs in the first five years after consummation. Proposed
comment 43(c)(5)(ii)(A)-3 addressed renewable balloon-payment loans.
This comment discussed balloon-payment loans that are not higher-priced
covered transactions which provide an unconditional obligation to renew
a balloon-payment loan at the consumer's option or obligation to renew
subject to conditions within the consumer's control. This comment
clarified that for purposes of the repayment ability determination, the
loan term does not include the period of time that could result from a
renewal provision.
The Board recognized that proposed comment 43(c)(5)(ii)(A)-3 did
not take the same approach as guidance contained in comment 17(c)(1)-11
regarding treatment of renewable balloon-payment loans for disclosure
purposes, or with guidance contained in

[[Page 6481]]

current comment 34(a)(4)(iv)-2 of the Board's 2008 HOEPA Final Rule.
Although the proposal differed from current guidance in Regulation Z,
the Board believed this approach was appropriate for several reasons.
First, the ability-to-repay provisions in the Dodd-Frank Act do not
address extending the term of a balloon-payment loan with an
unconditional obligation to renew provision. Second, permitting short-
term ``prime'' balloon-payment loans to benefit from the special
payment calculation rule when a creditor includes an unconditional
obligation to renew, but retains the right to increase the interest
rate at the time of renewal, would create a significant loophole in the
balloon payment rules. Such an approach could frustrate the objective
to ensure consumers obtain mortgages on affordable terms for a
reasonable period of time because the interest rate could escalate
within a short period of time, increasing the potential risk of payment
shock to the consumer. This is particularly the case where no limits
exist on the interest rate that the creditor can choose to offer to the
consumer at the time of renewal. See TILA Section 129B(a)(2), 15 U.S.C.
1639b(a)(2), and TILA Section 129C(b)(2)(A)(v). Moreover, the Board
believed it would be speculative to posit the interest rate at the time
of renewal for purposes of the repayment ability determination. Third,
the guidance contained in comment 17(c)(1)-11 regarding treatment of
renewable balloon-payment loans is meant to help ensure consumers are
aware of their loan terms and avoid the uninformed use of credit, which
differs from the stated purpose of this proposed provision, which was
to help ensure that consumers receive loans on terms that reasonably
reflect their repayment ability. TILA section 102(a), 15 U.S.C.
1601(a)(2), and TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2).
Proposed comment 43(c)(5)(ii)(A)-4 provided several illustrative
examples of how to determine the maximum payment scheduled during the
first five years after consummation for loans with a balloon payment
that are not higher-priced covered transactions.
In regard to the proposed five-year underwriting period, some
commenters suggested that the payment period considered should be
increased to ten years, stating that balloon-payment loans were
repeatedly used in an abusive manner during the years of heavy subprime
lending. The combined consumer advocacy organizations' comment stated
that the five-year underwriting might lead to an increase in five-year
balloon-payment loans, which would be bad for sustainable lending. On
the other hand, a trade association representing credit unions
supported the five-year rule. One industry commenter objected to the
whole balloon underwriting scheme, including the five-year rule,
apparently preferring something less.
For the reasons discussed by the Board in the proposal, and
described above, the Bureau has determined that five years is an
appropriate time frame for determining the ability to repay on balloon-
payment mortgages that are not higher-priced covered transactions.
However, for the sake of uniformity and ease of compliance with the
qualified mortgage calculation and ability-to-repay calculation for
non-qualified mortgage adjustable-rate mortgages, the proposed
provision has been changed to state that the five years will be
measured from the date of the first regularly scheduled payment, rather
than the date of consummation. The Bureau has made this determination
pursuant to the authority granted by TILA section 129C(a)(6)(D)(ii)(I)
to prescribe regulations for calculating payments to determine
consumers' ability to repay balloon-payment mortgages that are not
higher-cost covered transactions.
TILA section 129C(a)(6)(D)(ii)) refers to loans requiring ``more
rapid repayment (including balloon payment).'' The Board solicited
comment about whether this statutory language should be read as
referring to loan types other than balloon-payment loans. The Bureau
did not receive comments on this matter, and has determined that the
rule language does not need to be amended to include other types of
``rapid repayment'' loans at this time.
The Board also solicited comment about balloon-payment loans that
have an unconditional obligation to renew. The Board asked whether or
not such loans should be allowed to comply with the ability-to-repay
requirements using the total of the mandatory renewal terms, instead of
just the first term. As discussed above, proposed comment
43(c)(5)(ii)(A)-3 made clear that this would not be allowed under the
rule as proposed. The Board also solicited comment on any required
conditions that the renewal obligation should have, if such an
amendment were made. However, the Bureau did not receive comments on
this matter, and the provision and staff comment are adopted as
proposed. A creditor making any non-higher-priced balloon-payment
mortgage of less than five years with a clear obligation to renew can
avoid having the ability-to-repay determination applied to the balloon
payment by including the renewal period in the loan term so that the
balloon payment occurs after five years.
Accordingly, the Bureau is adopting Sec. 1026.43(c)(5)(ii)(A)(1)
and associated commentary substantially as proposed, with minor changes
for clarification, as well as new language to reflect that the five-
year underwriting period begins with the due date of the first payment,
as discussed above. In addition, the Bureau has added a second example
to comment 43(c)(5)(ii)(A)-2 to demonstrate the effect of the change to
the beginning of the underwriting period.
43(c)(5)(ii)(A)(2)
Proposed Sec. 226.43(c)(5)(ii)(A)(2) implemented TILA section
129C(a)(6)(D)(ii)(II) and provided that for a higher-priced covered
transaction, the creditor must determine the consumer's ability to
repay a loan with a balloon payment using the scheduled payments
required under the terms of the loan, including any balloon payment.
TILA section 129C(a)(6)(D)(ii)(II) states that for loans that require
``more rapid repayment \113\ (including balloon payment),'' and which
exceed the loan pricing threshold set forth, the creditor must
underwrite the loan using the ``[loan] contract's repayment schedule.''
For purposes of proposed Sec. 226.43(c)(5)(i)(A), ``higher-priced
covered transaction'' means a covered transaction with an annual
percentage rate that exceeds the average prime offer rate for a
comparable transaction as of the date the interest rate is set by 1.5
or more percentage points for a first-lien covered transaction, or by
3.5 or more percentage points for a subordinate-lien covered
transaction. See Sec. 1026.43(b)(4).
---------------------------------------------------------------------------

\113\ See the previous section, .43(c)(5)(ii)(A)(1), for
discussion of this statutory language.
---------------------------------------------------------------------------

The proposed rule interpreted the statutory requirement that the
creditor use the loan contract's payment schedule to mean that the
creditor must use all scheduled payments under the terms of the loan
needed to fully amortize the loan, consistent with the requirement
under TILA section 129C(a)(3). Payment of the balloon, either at
maturity or during any intermittent period, is necessary to fully
amortize the loan, and so a consumer's ability to pay the balloon
payment would need to be considered. Proposed comment 43(c)(5)(ii)(A)-5
provided an illustrative example of how to determine the consumer's
repayment ability based on the loan contract's payment schedule,
including any

[[Page 6482]]

balloon payment. The proposed rule applied to ``non-prime'' loans with
a balloon payment regardless of the length of the term or any contract
provision that provides for an unconditional guarantee to renew.
In making this proposal, the Board expressed concern that this
approach could lessen credit choice for non-prime consumers and
solicited comment, with supporting data, on the impact of this approach
for low-to-moderate income consumers. In addition, the Board asked for
comment on whether or not a consumer's ability to refinance out of a
balloon-payment loan should be considered in determining ability to
repay.
Industry commenters who focused on this provision opposed applying
the ability-to-repay determination to the entire payment schedule. Two
trade associations representing small and mid-size banks strongly
objected to including the balloon payment in the underwriting, and one
stated that many of the loans its members currently make would fall
into the higher-priced category, making these loans unavailable.
However, the statutory scheme for including the balloon payment was
supported by a state housing agency and the combined consumer
protection advocacy organizations submitting joint comments.
None of the commenters submitted data supporting the importance of
higher-priced balloon-payment mortgages for credit availability, or
whether consideration of a consumer's ability to obtain refinancing
would make the ability-to-repay determination less significant in this
context. The Bureau notes that under Sec. 1026.43(f) a balloon-payment
mortgage that is a higher-priced covered transaction made by certain
creditors in rural or underserved areas may also be a qualified
mortgage and thus the creditor would not have to consider the
consumer's ability to repay the balloon payment. Because this final
rule adopts a wider definition of ``rural or underserved area'' than
the Board proposed, potential credit accessibility concerns have been
lessened. See the section-by-section analysis of Sec. 1026.43(f),
below.
The statute requires the consideration of the balloon payment for
higher-priced covered transactions, and the Bureau does not believe
that using its exception and adjustment authority would be appropriate
for this issue. Accordingly, Sec. 1026.43(c)(5)(ii)(A)(2) and
associated commentary are adopted substantially as proposed, with minor
changes for clarification.
43(c)(5)(ii)(B)
The Board's proposed Sec. 226.43(c)(5)(ii)(B) implemented TILA
section 129C(a)(6)(B), which requires that the creditor determine the
consumer's repayment ability using ``the payment amount required to
amortize the loan by its final maturity.'' For clarity, the proposed
rule used the term ``recast,'' which is defined for interest-only loans
as the expiration of the period during which interest-only payments are
permitted under the terms of the legal obligation. See Sec.
1026.43(b)(11). The statute does not define the term ``interest-only.''
For purposes of this rule, the terms ``interest-only loan'' and
``interest-only'' have the same meaning as in Sec. 1026.18(s)(7)(iv).
For interest-only loans (i.e., loans that permit interest only
payments for any part of the loan term), proposed Sec.
226.43(c)(5)(ii)(B) provided that the creditor must determine the
consumer's ability to repay the interest-only loan using (1) the fully
indexed rate or any introductory rate, whichever is greater; and (2)
substantially equal, monthly payments of principal and interest that
will repay the loan amount over the term of the loan remaining as of
the date the loan is recast. The proposed payment calculation rule for
interest-only loans paralleled the general rule proposed in Sec.
226.43(c)(5)(i), except that proposed Sec. 226.43(c)(5)(ii)(B)(2)
required a creditor to determine the consumer's ability to repay the
loan amount over the term that remains after the loan is recast, rather
than requiring the creditor to use fully amortizing payments, as
defined under proposed Sec. 226.43(b)(2).
The Board interpreted the statutory text in TILA section
129C(a)(6)(B) as requiring the creditor to determine the consumer's
ability to repay an interest-only loan using the monthly principal and
interest payment amount needed to repay the loan amount once the
interest-only payment period expires, rather than using, for example,
an understated monthly principal and interest payment that would
amortize the loan over its entire term, similar to a 30-year fixed
mortgage. The proposed rule would apply to all interest-only loans,
regardless of the length of the interest-only period. The Board
believed this approach most accurately assessed the consumer's ability
to repay the loan once it begins to amortize; this is consistent with
the approach taken for interest-only loans in the 2006 Nontraditional
Mortgage Guidance.
Proposed comment 43(c)(5)(ii)(B)-1 provided guidance on the monthly
payment calculation for interest-only loans, and clarified that the
relevant term of the loan for calculating these payments is the period
of time that remains after the loan is recast. This comment also
explained that for a loan on which only interest and no principal has
been paid, the loan amount will be the outstanding principal balance at
the time of the recast.
Proposed comment 43(c)(5)(ii)(B)-2 provided illustrative examples
for how to determine the consumer's repayment ability based on
substantially equal monthly payments of principal and interest for
interest-only loans.
Commenters did not focus on the calculation for interest-only
loans. The Bureau considers the Board's interpretation and
implementation of the statute to be accurate and appropriate.
Accordingly, Sec. 1026.43(c)(5)(ii)(B) and associated commentary are
adopted as proposed.
43(c)(5)(ii)(C)
Proposed Sec. 226.43(c)(5)(ii)(C) implemented the statutory
requirement in TILA section 129C(a)(6)(C) that the creditor consider
``any balance increase that may accrue from any negative amortization
provision when making the repayment ability determination.'' The
statute does not define the term ``negative amortization.''
For such loans, proposed Sec. 226.43(c)(5)(ii)(C) provided that a
creditor must determine the consumer's repayment ability using (1) the
fully indexed rate or any introductory interest rate, whichever is
greater; and (2) substantially equal, monthly payments of principal and
interest that will repay the maximum loan amount over the term of the
loan remaining as of the date the loan is recast. The proposed payment
calculation rule for negative amortization loans paralleled the general
rule in proposed Sec. 226.43(c)(5)(i), except that proposed Sec.
226.43(c)(5)(ii)(C)(2) required the creditor to use the monthly payment
amount that repays the maximum loan amount over the term of the loan
that remains after the loan is recast, rather than requiring the
creditor to use fully amortizing payments, as defined under Sec.
1026.43(b)(2). The proposed rule used the terms ``maximum loan amount''
and ``recast,'' which are defined and discussed at Sec. 1026.43(b)(7)
and (b)(11), respectively.
The Board proposed that the term ``negative amortization loan''
have the same meaning as set forth in Sec. 226.18(s)(7)(v), which
provided that the term ``negative amortization loan'' means a loan,
other than a reverse mortgage subject to Sec. 226.33, that

[[Page 6483]]

provides for a minimum periodic payment that covers only a portion of
the accrued interest, resulting in negative amortization. As defined,
the term ``negative amortization loan'' does not cover other loan types
that may have a negative amortization feature, but which do not permit
the consumer multiple payment options, such as seasonal income loans.
Accordingly, proposed Sec. 226.43(c)(5)(ii)(C) covered only loan
products that permit or require minimum periodic payments, such as
payment-option loans and graduated payment mortgages with negative
amortization.\114\ The Board believed that covering these types of
loans in proposed Sec. 226.43(c)(5)(ii)(C) was consistent with
statutory intent to account for the negative equity that can occur when
a consumer makes payments that defer some or all principal or interest
for a period of time, and to address the impact that any potential
payment shock might have on the consumer's ability to repay the loan.
See TILA section 129C(a)(6)(C).
---------------------------------------------------------------------------

\114\ Graduated payment mortgages that have negative
amortization and fall within the definition of ``negative
amortization loans'' provide for step payments that may be less than
the interest accrued for a fixed period of time. The unpaid interest
is added to the principal balance of the loan.
---------------------------------------------------------------------------

In contrast, in a transaction such as a seasonal loan that has a
negative amortization feature, but which does not provide for minimum
periodic payments that permit deferral of some or all principal, the
consumer repays the loan with fully amortizing payments in accordance
with the payment schedule. Accordingly, the same potential for payment
shock due to accumulating negative amortization does not exist. These
loans with a negative amortization feature are therefore not covered by
the proposed term ``negative amortization loan,'' and would not be
subject to the special payment calculation requirements for negative
amortization loans at proposed Sec. 226.43(c)(5)(ii)(C).
For purposes of determining the consumer's ability to repay a
negative amortization loan under proposed Sec. 226.43(c)(5)(ii)(C),
creditors would be required to make a two-step payment calculation.
Step one: maximum loan amount. Proposed Sec. 226.43(c)(5)(ii)(C)
would have required that the creditor first determine the maximum loan
amount and period of time that remains in the loan term after the loan
is recast before determining the consumer's repayment ability on the
loan. See comment 43(c)(5)(ii)(C)-1; see also proposed Sec.
226.43(b)(11), which defined the term ``recast'' to mean the expiration
of the period during which negatively amortizing payments are permitted
under the terms of the legal obligation. Proposed comment
43(c)(5)(ii)(C)-2 further clarified that recast for a negative
amortization loan occurs after the maximum loan amount is reached
(i.e., the negative amortization cap) or the introductory minimum
periodic payment period expires.
As discussed above, Sec. 1026.43(b)(7) defines ``maximum loan
amount'' as the loan amount plus any increase in principal balance that
results from negative amortization, as defined in Sec.
1026.18(s)(7)(v), based on the terms of the legal obligation. Under the
proposal, creditors would make the following two assumptions when
determining the maximum loan amount: (1) The consumer makes only the
minimum periodic payments for the maximum possible time, until the
consumer must begin making fully amortizing payments; and (2) the
maximum interest rate is reached at the earliest possible time.
As discussed above under the proposed definition of ``maximum loan
amount,'' the Board interpreted the statutory language in TILA section
129C(a)(6)(C) as requiring creditors to fully account for any potential
increase in the loan amount that might result under the loan's terms
where the consumer makes only the minimum periodic payments required.
The Board believed the intent of this statutory provision was to help
ensure that the creditor consider the consumer's capacity to absorb the
increased payment amounts that would be needed to amortize the larger
loan amount once the loan is recast. The Board recognized that the
approach taken towards calculating the maximum loan amount requires
creditors to assume a ``worst-case scenario,'' but believed this
approach was consistent with statutory intent to take into account the
greatest potential increase in the principal balance.
Moreover, the Board noted that calculating the maximum loan amount
based on these assumptions is consistent with the approach in the 2010
MDIA Interim Final Rule,\115\ which addresses disclosure requirements
for negative amortization loans, and also the 2006 Nontraditional
Mortgage Guidance, which provides guidance to creditors regarding
underwriting negative amortization loans.\116\
---------------------------------------------------------------------------

\115\ See 12 CFR 1026.18(s)(2)(ii) and comment 18(s)(2)(ii)-2.
\116\ See 2006 Nontraditional Mortgage Guidance, at 58614, n.7.
---------------------------------------------------------------------------

Step two: payment calculation. Once the creditor knows the maximum
loan amount and period of time that remains after the loan is recast,
the proposed payment calculation rule for negative amortization loans
would require the creditor to use the fully indexed rate or
introductory rate, whichever is greater, to calculate the substantially
equal, monthly payment amount that will repay the maximum loan amount
over the term of the loan that remains as of the date the loan is
recast. See proposed Sec. 226.43(c)(5)(ii)(C)(1) and (2).
Proposed comment 43(c)(5)(ii)(C)-1 clarified that creditors must
follow this two-step approach when determining the consumer's repayment
ability on a negative amortization loan, and also provided cross-
references to aid compliance. Proposed comment 43(c)(5)(ii)(C)-2
provided further guidance to creditors regarding the relevant term of
the loan that must be used for purposes of the repayment ability
determination. Proposed comment 43(c)(5)(ii)(C)-3 provided illustrative
examples of how to determine the consumer's repayment ability based on
substantially equal monthly payments of principal and interest as
required under proposed Sec. 226.43(c)(5)(ii)(C) for a negative
amortization loan.
In discussing the ability-to-repay requirements for negative
amortization loans, the Board noted the anomaly that a graduated
payment mortgage may have a largest scheduled payment that is larger
than the payment calculated under proposed Sec. 226.43(c)(5)(ii)(C).
The Board solicited comment on whether or not the largest scheduled
payment should be used in determining ability to repay. The Bureau
received one comment on this issue, from an association of State bank
regulators, arguing that the rule should use the largest payment
scheduled. However, the Bureau does not believe that a special rule for
graduated payment mortgages, which would require an exception from the
statute, is necessary to ensure ability to repay these loans. It is
unlikely that the calculated payment will be very different from the
largest scheduled payment, and introducing this added complexity to the
rule is unnecessary. Also, the one comment favoring such a choice did
not include sufficient data to support use of the exception and
adjustment authority under TILA, and the Bureau is not aware any such
data.
Final Rule
The Bureau did not receive comments on the proposed method for
calculating payments for negative amortization

[[Page 6484]]

loans. The Bureau believes that the method proposed by the Board
implements the statutory provision accurately and appropriately.
Accordingly, Sec. 1026.43(c)(5)(ii)(C) and associated commentary are
adopted substantially as proposed, with minor changes for
clarification.
43(c)(6) Payment Calculation for Simultaneous Loans
43(c)(6)(i)
The Board's proposed rule provided that for purposes of determining
a consumer's ability to repay a loan, ``a creditor must consider a
consumer's payment on a simultaneous loan that is--(i) a covered
transaction, by following paragraphs (c)(5)(i) and (ii) of this
section'' (i.e., the payment calculation rules for the covered
transaction itself).
Proposed comment 43(c)(6)-1 stated that in determining the
consumer's repayment ability for a covered transaction, the creditor
must include consideration of any simultaneous loan which it knows or
has reason to know will be made at or before consummation of the
covered transaction. Proposed comment 43(c)(6)-2 explained that for a
simultaneous loan that is a covered transaction, as that term was
defined in proposed Sec. 226.43(b)(1), the creditor must determine a
consumer's ability to repay the monthly payment obligation for a
simultaneous loan as set forth in proposed Sec. 226.43(c)(5), taking
into account any mortgage-related obligations.
The Bureau did not receive comments on this specific language or
the use of the covered transaction payment calculation for simultaneous
loans. For discussion of other issues regarding simultaneous loans, see
the section-by-section analysis of Sec. 1026.43(b)(12), .43(c)(2)(iv)
and .43(c)(6)(ii).
The Bureau considers the language of proposedSec. 226.43(c)(6)(i)
to be an accurate and appropriate implementation of the statute.
Accordingly, the Bureau is adopting Sec. 1026.43(c)(6)(i) and
associated commentary substantially as proposed, with minor changes for
clarity. The requirement to consider any mortgage-related obligations,
presented in comment 43(c)(6)-2, is now also part of the regulatory
text, at Sec. 1026.43(c)(6).
43(c)(6)(ii)
For a simultaneous loan that is a HELOC, the consumer is generally
not committed to using the entire credit line at consummation. The
amount of funds drawn on a simultaneous HELOC may differ greatly
depending, for example, on whether the HELOC is used as a ``piggyback
loan'' to help towards payment on a home purchase transaction or if the
HELOC is opened for convenience to be drawn down at a future time. In
the proposed rule, the Board was concerned that requiring the creditor
to underwrite a simultaneous HELOC assuming a full draw on the credit
line might unduly restrict credit access, especially in connection with
non-purchase transactions, because it would require creditors to assess
the consumer's repayment ability using potentially overstated payment
amounts. For this reason, the Board proposed under Sec.
226.43(c)(6)(ii) that the creditor calculate the payment for the
simultaneous HELOC based on the amount of funds to be drawn by the
consumer at consummation of the covered transaction. The Board
solicited comment on whether this approach was appropriate.
Proposed comment 43(c)(6)-3 clarified that for a simultaneous loan
that is a HELOC, the creditor must consider the periodic payment
required under the terms of the plan when assessing the consumer's
ability to repay the covered transaction secured by the same dwelling
as the simultaneous loan. This comment explained that under proposed
Sec. 226.43(c)(6)(ii), the creditor must determine the periodic
payment required under the terms of the plan by considering the actual
amount of credit to be drawn by the consumer at or before consummation
of the covered transaction. This comment clarified that the amount to
be drawn is the amount requested by the consumer; when the amount
requested will be disbursed, or actual receipt of funds, is not
determinative.
Several industry commenters objected that it is difficult to know
the actual amount drawn on a HELOC if it is held by another lender. One
commenter suggested finding another way to do this calculation, such as
by adding 1 percent of the full HELOC line to the overall monthly
payment. Two banking trade associations said that the full line of
credit should be considered, and if the consumer does not qualify, the
line of credit can be reduced in order to qualify safely. One bank
stated that creditors regulated by Federal banking agencies are bound
by the interagency ``Credit Risk Guidance for Home Equity Lending''
(2005) to consider the full line of credit, and this will create an
uneven playing field.
Other industry commenters supported use of the actual amount drawn
at consummation. Both Freddie Mac and Fannie Mae stated that the
Board's proposal for considering the actual amount drawn at closing was
consistent with their underwriting standards. In addition, an
association representing one state's credit unions stated that
requiring consideration of a 100 percent draw would be onerous and
inaccurate. It also asked that we make clear that the creditor does not
have to recalculate a consumer's ability to repay if the amount drawn
changes at consummation.
The Bureau believes that requiring consideration of 100 percent of
a home equity line of credit would unnecessarily restrict credit
availability for consumers. Available but unaccessed credit is not
considered in determining ability to repay a mortgage when the consumer
has other types of credit lines, such as credit cards. Although HELOCs
are secured by the consumer's dwelling, and thus differ from other
types of available but unaccessed credit, this difference does not seem
determinative. Any potential dwelling-secured home equity line of
credit that a creditor might grant to a consumer could simply be
requested by the consumer immediately following consummation of the
covered transaction. The fact that the potential credit line has been
identified and enumerated prior to the transaction, rather than after,
does not seem significant compared to the fact that the consumer has
chosen not to access that credit, and will not be making payments on
it. As with the rest of the ability-to-repay requirements, creditors
should apply appropriate underwriting procedures, and are not
restricted to the legally mandated minimum required by this rule, as
long as they satisfy that minimum.
The requirements of the 2005 ``Credit Risk Guidance for Home Equity
Lending'' do not change the Bureau's view of this issue. The Guidance
covers home equity lending itself, not consideration of HELOCs as
simultaneous loans when determining ability to repay for senior non-
HELOCs. The requirement to consider the entire home equity line of
credit controls only a bank's granting of that line of credit. For this
reason, the Bureau does not believe that banks following this guidance
will be disadvantaged. In addition, the Bureau will not be implementing
the suggested alternative of adding 1 percent to the calculated monthly
payment on the covered transaction. The Bureau is not aware of any data
supporting the accuracy of such an approach.
In regard to the comments concerning difficulty in determining the
amount of the draw and the monthly HELOC payment, the Bureau as
discussed above

[[Page 6485]]

in the section-by-section analysis of Sec. 1026.43(c)(2)(iv) has added
language to comment 43(c)(2)(iv)-4 providing more specific guidance in
applying the knows or has reason to know standard. In addition,
language has been added to comment 43(c)(6)-3, regarding payment
calculations for simultaneous HELOCs, making clear that a creditor does
not need to reconsider ability to repay if the consumer unexpectedly
draws more money than planned at closing from a HELOC issued by a
different creditor. In addition, the regulation language has been
clarified to state that the creditor must use the amount of credit ``to
be'' drawn at consummation, making clear that a violation does not
occur if the creditor did not know or have reason to know that a
different amount would be drawn.
The Board also solicited comment on whether or not a safe harbor
should be given to those creditors who consider the full HELOC credit
line. However, commenters did not focus on this possibility. The Bureau
believes that although a creditor may choose to underwrite using the
full credit line as a means of considering ability to repay in relation
to the actual draw, a safe harbor is not warranted. Because the full
credit line should always be equal to or greater than the actual draw,
appropriate use of the full credit line in underwriting will constitute
appropriate compliance without a safe harbor.
In addition to the amount of a HELOC that needs to be considered in
determining ability to repay, the Board also solicited comment on
whether the treatment of HELOCs as simultaneous loans should be limited
to purchase transactions. The Board suggested that concerns regarding
``piggyback loans'' were not as acute with non-purchase transactions.
Consumer and public interest groups opposed limiting the
consideration of HELOCs to purchase transactions. Several consumer
advocacy groups suggested that if only purchase transactions were
covered, the abuses would migrate to the unregulated space. Some
commenters said they did not see a reason to exclude the cost of a
simultaneous loan when it is extended as part of a refinance. Industry
commenters did not focus much on this issue, but an association
representing credit unions supported limiting consideration to purchase
transactions in order to reduce regulatory burden on credit unions and
streamline the refinancing process.
The Bureau believes that requiring consideration of HELOCs as
simultaneous loans is appropriate in both purchase and non-purchase
transactions. In both situations the HELOC is a lien on the consumer's
dwelling with a cost that affects the viability of the covered
transaction loan. The Bureau recognizes that a simultaneous HELOC in
connection with a refinancing is more likely to be a convenience than
one issued simultaneously with a purchase transaction, which will often
cover down payment, transaction costs or other major expenses. However,
the final rule accommodates this difference by allowing the creditor to
base its ability-to-repay determination on the actual draw. The Bureau
did not receive and is not aware of any information or data that
justifies excluding actual draws on simultaneous HELOCs in connection
with refinances from this rule.
For the reasons stated above, the Bureau considers the language of
proposedSec. 226.43(c)(6)(ii) to be an accurate and appropriate
implementation of the statute. Accordingly, the Bureau is adopting
Sec. 1026.43(c)(6)(ii) and associated commentary as proposed, with
minor changes for clarity.
43(c)(7) Monthly Debt-to-Income Ratio or Residual Income
As discussed above, TILA section 129C(a)(3) requires creditors to
consider the debt-to-income ratio or residual income the consumer will
have after paying non-mortgage debt and mortgage-related obligations,
as part of the ability-to-repay determination under TILA section
129C(a)(1). The Board's proposal would have implemented this
requirement in Sec. 226.43(c)(2)(vii). The Board proposed definitions
and calculations for the monthly debt-to-income ratio and residual
income in Sec. 226.43(c)(7).
With respect to the definitions, proposed Sec. 226.43(c)(7)(i)(A)
would have defined the total monthly debt obligations as the sum of:
the payment on the covered transaction, as required to be calculated by
proposed Sec. 226.43(c)(2)(iii) and (c)(5); the monthly payment on any
simultaneous loans, as required to be calculated by proposed Sec.
226.43(c)(2)(iv) and (c)(6); the monthly payment amount of any
mortgage-related obligations, as required to be considered by proposed
Sec. 226.43(c)(2)(v); and the monthly payment amount of any current
debt obligations, as required to be considered by proposed Sec.
226.43(c)(2)(vi). Proposed Sec. 1026.43(c)(7)(i)(B) would have defined
the total monthly income as the sum of the consumer's current or
reasonably expected income, including any income from assets, as
required to be considered by proposed Sec. 226.43(c)(2)(i) and (c)(4).
With respect to the calculations, proposed Sec.
226.43(c)(7)(ii)(A) would have required the creditor to consider the
consumer's monthly debt-to-income ratio by taking the ratio of the
consumer's total monthly debt obligations to total monthly income.
Proposed Sec. 226.43(c)(7)(ii)(B) would have required the creditor to
consider the consumer's residual income by subtracting the consumer's
total monthly debt obligations from the total monthly income. The Board
solicited comment on whether consideration of residual income should
account for loan amount, region of the country, and family size, and on
whether creditors should be required to include Federal and State taxes
in the consumer's obligations to calculate the residual income.
Proposed comment 43(c)(7)-1 would have stated that a creditor must
calculate the consumer's total monthly debt obligations and total
monthly income in accordance with the requirements in proposed Sec.
226.43(c)(7). The proposed comment would have explained that creditors
may look to widely accepted governmental and non-governmental
underwriting standards to determine the appropriate thresholds for the
debt-to-income ratio or residual income.
Proposed comment 43(c)(7)-2 would have clarified that if a creditor
considers both the consumer's debt-to-income ratio and residual income,
the creditor may base its determination of ability to repay on either
the consumer's debt-to-income ratio or residual income, even if the
determination would differ with the basis used. In the section-by-
section analysis of proposed Sec. 226.43(c)(7), the Board explained
that it did not wish to create an incentive for creditors to consider
and verify as few factors as possible in the repayment ability
determination.
Proposed comment 43(c)(7)-3 would have provided that creditors may
consider compensating factors to mitigate a higher debt-to-income ratio
or lower residual income. The proposed comment would have provided that
the creditor may, for example, consider the consumer's assets other
than the dwelling securing the covered transaction or the consumer's
residual income as a compensating factor for a higher debt-to-income
ratio. The proposed comment also would have provided that, in
determining whether and in what manner to consider compensating
factors, creditors may look to widely accepted governmental and non-
governmental underwriting

[[Page 6486]]

standards. The Board solicited comment on whether it should provide
more guidance on what factors creditors may consider, and on how
creditors may include compensating factors in the repayment ability
determination.
In addition, the Board solicited comment on two issues related to
the use of automated underwriting systems. The Board solicited comment
on providing a safe harbor for creditors relying on automated
underwriting systems that use monthly debt-to-income ratios, if the
system developer certifies that the system's use of monthly debt-to-
income ratios in determining repayment ability is empirically derived
and statistically sound. The Board also solicited comment on other
methods to facilitate creditor reliance on automated underwriting
systems, while ensuring that creditors can demonstrate compliance with
the rule.
As discussed above in the section-by-section analysis of Sec.
1026.43(c)(2)(vii), industry commenters and consumer advocates largely
supported including consideration of the monthly debt-to-income ratio
or residual income in the ability-to-repay determination and generally
favored a flexible approach to consideration of those factors. In
response to the Board's proposal, some consumer advocates asked that
the Bureau conduct research on the debt-to-income ratio and residual
income. They requested a standard that reflects the relationship
between the debt-to-income ratio and residual income. One industry
commenter recommended that the Bureau adopt the VA calculation of
residual income. Another industry commenter suggested that the Bureau
adopt the same definitions of the debt-to-income ratio and residual
income as for qualified residential mortgages, to reduce compliance
burdens and the possibility of errors. One industry commenter asked
that consideration of residual income be permitted to vary with family
size and geographic location. The commenter suggested that the residual
income calculation account for Federal and State taxes. Several
consumer advocates suggested that the Bureau review the VA residual
income guidelines and update the cost of living tiers. They affirmed
that all regularly scheduled debt payments should be included in the
residual income calculation. They noted that residual income should be
sufficient to cover basic living necessities, including food,
utilities, clothing, transportation, and known health care expenses.
One industry commenter asked that the Bureau provide guidance on
and additional examples of compensating factors, for example,
situations where a consumer has many assets but a low income or high
debt-to-income ratio. The commenter suggested that the Bureau clarify
that the list of examples was not exclusive. Consumer advocates
recommended that the Bureau not permit extensions of credit based on a
good credit history or involving a high loan-to-value ratio if the
debt-to-income ratio or residual income does not reflect an ability to
repay. These commenters argued that credit scores and down payments
reflect past behavior and incentives to make down payments, not ability
to repay.
The Bureau is largely adopting Sec. 1026.43(c)(7) as proposed,
with certain clarifying changes to the commentary. Specifically,
comment 43(c)(7)-1 clarifies that Sec. 1026.43(c) does not prescribe a
specific debt-to-income ratio with which creditors must comply. For the
reasons discussed above in the section-by-section analysis of Sec.
1026.43(c), the Bureau is not finalizing the portion of proposed
comment 43(c)(7)-1 which would have provided that the creditor may look
to widely accepted governmental and non-governmental underwriting
standards to determine the appropriate threshold for the monthly debt-
to-income ratio or the monthly residual income. Instead, comment
43(c)(7)-1 provides that an appropriate threshold for a consumer's
monthly debt-to-income ratio or monthly residual income is for the
creditor to determine in making a reasonable and good faith
determination of a consumer's repayment ability.
Comment 43(c)(7)-2 clarifies guidance regarding use of both monthly
debt-to-income and monthly residual income by providing that if a
creditor considers the consumer's monthly debt-to-income ratio, the
creditor may also consider the consumer's residual income as further
validation of the assessment made using the consumer's monthly debt-to-
income ratio. The Bureau is not finalizing proposed comment 43(c)(7)-2,
which would have provided that if a creditor considers both the
consumer's monthly debt-to-income ratio and residual income, the
creditor may base the ability-to-repay determination on either metric,
even if the ability-to-repay determination would differ with the basis
used. The Bureau believes the final guidance better reflects how the
two standards work together in practice, but the change is not intended
to alter the rule.
Comment 43(c)(7)-3 also clarifies guidance regarding the use of
compensating factors in assessing a consumer's ability to repay by
providing that, for example, the creditor may reasonably and in good
faith determine that an individual consumer has the ability to repay
despite a higher monthly debt-to-income ratio or lower residual income
in light of the consumer's assets other than the dwelling securing the
covered transaction, such as a savings account. The creditor may also
reasonably and in good faith determine that a consumer has the ability
to repay despite a higher debt-to-income ratio in light of the
consumer's residual income. The Bureau believes that not permitting use
of compensating factors may reduce access to credit in some cases, even
if the consumer could afford the mortgage. The Bureau does not believe,
however, that the rule should provide an extensive list of compensating
factors that the creditor may consider in assessing repayment ability.
Instead, creditors should make reasonable and good faith determinations
of the consumer's repayment ability in light of the facts and
circumstances. This approach to compensating factors is consistent with
the final rule's flexible approach to the requirement that creditors
make a reasonable and good faith of a consumer's repayment ability
throughout Sec. 1026.43(c).
The Bureau will consider conducting a future study on the debt-to-
income ratio and residual income. Except for one small creditor and the
VA, the Bureau is not aware of any creditors that routinely use
residual income in underwriting, other than as a compensating
factor.\117\ The VA underwrites its loans to veterans based on a
residual income table developed in 1997. The Bureau understands that
the table shows the residual income desired for the consumer based on
the loan amount, region of the country, and family size, but does not
account for differences in housing or living costs within regions (for
instance rural Vermont versus New York City). The Bureau also
understands that the residual income is calculated by deducting
obligations, including Federal and State taxes, from effective income.
However, at this time, the Bureau is unable to conduct a detailed
review of the VA residual income guidelines, which would include an
analysis of whether those guidelines are predictive of repayment
ability, to determine if those standards should be incorporated, in
whole or in part, into the ability-to-

[[Page 6487]]

repay analysis that applies to the entire residential mortgage market.
Further, the Bureau believes that providing broad standards for the
definition and calculation of residual income will help preserve
flexibility if creditors wish to develop and refine more nuanced
residual income standards in the future. The Bureau accordingly does
not find it necessary or appropriate to specify a detailed methodology
in the final rule for consideration of residual income.
---------------------------------------------------------------------------

\117\ See also Michael E. Stone, What is Housing Affordability?
The Case for the Residual Income Approach, 17 Housing Pol'y Debate
179 (2006) (advocating use of a residual income approach but
acknowledging that it ``is neither well known, particularly in this
country, nor widely understood, let alone accepted'').
---------------------------------------------------------------------------

The final rule also does not provide a safe harbor for creditors
relying on automated underwriting systems that use monthly debt-to-
income ratios. The Bureau understands that creditors routinely rely on
automated underwriting systems, many of which are proprietary and thus
lack transparency to the individual creditors using the systems. Such
systems may decide, for example, whether the debt-to-income ratio and
compensating factors are appropriate, but may not disclose to the
individual creditors using such systems which compensating factors were
used for loan approval. However, the Bureau does not believe a safe
harbor is necessary in light of the flexibility the final rule provides
to creditors in assessing a consumer's repayment ability, including
consideration of monthly debt-to-income ratios. See comments 43(c)(1)-1
and 43(c)(2)-1.
Finally, the Bureau notes the contrast between the flexible
approach to considering and calculating debt-to-income in Sec.
1026.43(c)(2)(vii) and (7) and the specific standards for evaluating
debt-to-income for purposes of determining whether a covered
transaction is a qualified mortgage under Sec. 1026.43(e)(2). For the
reasons discussed below in the section-by-section analysis of Sec.
1026.43(e)(2), the Bureau believes a specific, quantitative standard
for evaluating a consumer's debt-to-income ratio is appropriate in
determining whether a loan receives either a safe harbor or presumption
of compliance with the repayment ability requirements of Sec.
1026.43(c)(1) pursuant to Sec. 1026.43(e)(2). However, the ability-to-
repay requirements in Sec. 1026.43(c) will apply to the whole of the
mortgage market and therefore require flexibility to permit creditors
to assess repayment ability while ensuring continued access to
responsible, affordable mortgage credit. Accordingly, the final rule
sets minimum underwriting standards while providing creditors with
flexibility to use their own quantitative standards in making the
repayment ability determination required by Sec. 1026.43(c)(1).
43(d) Refinancing of Non-Standard Mortgages
Two provisions of section 1411 of the Dodd-Frank Act address the
refinancing of existing mortgage loans under the ability-to-repay
requirements. As provided in the Dodd-Frank Act, TILA section
129C(a)(5) provides that certain Federal agencies may create an
exemption from the income verification requirements in TILA section
129C(a)(4) if certain conditions are met. 15 U.S.C. 1639c(a)(5). In
addition, TILA section 129C(a)(6)(E) provides certain special ability-
to-repay requirements to encourage applications to refinance existing
``hybrid loans'' into a ``standard loans'' with the same creditor,
where the consumer has not been delinquent on any payments on the
existing loan and the monthly payments would be reduced under the
refinanced loan. The statute allows creditors to give special weight to
the consumer's good standing and to consider whether the refinancing
would prevent a likely default, as well as other potentially favorable
treatment to the consumer. However, it does not expressly exempt
applications for such ``payment shock refinancings'' from TILA's
general ability-to-repay requirements or define ``hybrid'' or
``standard loans.'' \118\ 15 U.S.C. 1639c(a)(6)(E).
---------------------------------------------------------------------------

\118\ Section 128A of TILA, as added by Section 1418 of the
Dodd-Frank Act, includes a definition of ``hybrid adjustable rate
mortgage.'' However, that definition applies to the adjustable rate
mortgage disclosure requirements under TILA section 128A, not the
ability-to-repay requirements under TILA section 129C.
---------------------------------------------------------------------------

The Board noted in its proposal that it reviewed the Dodd-Frank
Act's legislative history, consulted with consumer advocates and
representatives of both industry and the GSEs, and examined
underwriting rules and guidelines for the refinance programs of private
creditors, GSEs and Federal agencies, as well as for the Home
Affordable Modification Program (HAMP). The Board noted that it also
considered TILA section 129C(a)(5), which permits Federal agencies to
adopt rules exempting refinancings from certain of the ability-to-repay
requirements in TILA section 129C(a).
In proposing Sec. 226.43(d) to implement TILA section
129C(a)(6)(E), the Board interpreted the statute as being intended to
afford greater flexibility to creditors of certain home mortgage
refinancings when complying with the general ability-to-repay
provisions in TILA section 129C(a). Consistent with this reading of the
statute, the proposal would have provided an exemption from certain
criteria required to be considered as part of the general repayment
ability determination under TILA section 129C(a). Specifically, the
Board's proposal would have permitted creditors to evaluate qualifying
applications without having to verify the consumer's income and assets
as prescribed in the general ability-to-repay requirements, provided
that a number of additional conditions were met. In addition, the
proposal would have permitted a creditor to calculate the monthly
payment used for determining the consumer's ability to repay the new
loan based on assumptions that would typically result in a lower
monthly payment than those required to be used under the general
ability-to-repay requirements. The proposal also clarified the
conditions that must be met in a home mortgage refinancing in order for
this greater flexibility to apply.
The Board noted that TILA section 129C(a)(6)(E)(ii) permits
creditors to give prevention of a ``likely default should the original
mortgage reset a higher priority as an acceptable underwriting
practice.'' 15 U.S.C. 1639c(a)(6)(E)(ii). The Board interpreted this
provision to mean that certain ability-to-repay criteria under TILA
section 129C(a) should not apply to refinances that meet the requisite
conditions. TILA section 129C(a) specifically prescribes the
requirements that creditors must meet to satisfy the obligation to
determine a consumer's ability to repay a mortgage loan. The Board
concluded that the term ``underwriting practice'' could reasonably be
interpreted to refer to the underwriting rules prescribed in earlier
portions of TILA section 129C(a); namely, those concerning the general
ability-to-repay underwriting requirements.
The Board also structured its proposal to provide for flexibility
in underwriting that is characteristic of so-called ``streamlined
refinances,'' which are offered by creditors to existing customers
without having to go through a full underwriting process appropriate
for a new origination. The Board noted that section 1411 of the Dodd-
Frank Act specifically authorizes streamlined refinancings of loans
made, guaranteed, or insured by Federal agencies, and concluded that
TILA section 129C(a)(6)(E) is most reasonably interpreted as being
designed to address the remaining market for streamlined refinancings;
namely, those offered under programs of private creditors and the GSEs.
The Board stated that in its understanding typical streamlined
refinance programs do not require documentation of income and assets,
although a verbal verification of

[[Page 6488]]

employment may be required. The Board further noted that TILA section
129C(a)(6)(E) includes three central elements of typical streamlined
refinance programs, in that it requires that the creditor be the same
for the existing and new mortgage loan obligation, that the consumer
have a positive payment history on the existing mortgage loan
obligation, and that the payment on the new refinancing be lower than
on the existing mortgage loan obligation.
One difference the Board noted between the statute and typical
streamlined refinance programs is that the statute targets consumers
facing ``likely default'' if the existing mortgage ``reset[s].'' The
Board indicated that, by contrast, streamlined refinance programs may
not be limited to consumers at risk in this way. For example,
streamlined refinancing programs may assist consumers who are not
facing potential default but who simply wish to take advantage of lower
rates despite a drop in their home value or wish to switch from a less
stable variable-rate product to a fixed-rate product. The Board noted
parallels between TILA's new refinancing provisions and the focus of
HAMP, a government program specifically aimed at providing
modifications for consumers at risk of ``imminent default,'' or in
default or foreclosure.\119\ However, the Board noted that underwriting
criteria for a HAMP modification are considerably more stringent than
for a typical streamlined refinance.
---------------------------------------------------------------------------

\119\ See, e.g., Fannie Mae, FM 0509, Home Affordable
Modification Program, at 1 (2009).
---------------------------------------------------------------------------

On balance, the Board interpreted the statutory language as being
modeled on the underwriting standards of typical streamlined refinance
programs rather than the tighter standards of HAMP. The Board concluded
that Congress intended to facilitate opportunities to refinance loans
on which payments could become significantly higher and thus
unaffordable. The Board cautioned that applying underwriting standards
that are too stringent could impede refinances that Congress intended
to encourage. In particular, the statutory language permitting
creditors to give ``likely default'' a ``higher priority as an
acceptable underwriting practice'' indicates that flexibility in these
special refinances should be permitted. In addition, underwriting
standards that go significantly beyond those used in existing
streamlined refinance programs could create a risk that these programs
would be unable to meet the TILA ability-to-repay requirements; thus,
an important refinancing resource for at-risk consumers would be
compromised and the overall mortgage market potentially disrupted at a
vulnerable time.
The Board noted, however, that consumers at risk of default when
higher payments are required might present greater credit risks to the
institutions holding their loans when those loans are refinanced
without verifying the consumer's income and assets. Accordingly, the
Board's proposal would have imposed some requirements that are more
stringent than those of typical streamlined refinance programs as a
prerequisite to the refinancing provision under proposed Sec.
226.43(d). For example, the proposal would have permitted a consumer to
have had only one delinquency of more than 30 days in the 24 months
immediately preceding the consumer's application for a refinance. By
contrast, the Board indicated that streamlined refinance programs of
which it is aware tend to consider the consumer's payment history for
only the last 12 months.\120\ In addition, the proposal would have
defined the type of loan into which a consumer may refinance under
TILA's new refinancing provisions to include several characteristics
designed to ensure that those loans are stable and affordable. These
include a requirement that the interest rate be fixed for the first
five years after consummation and that the points and fees be capped at
three percent of the total loan amount, subject to a limited exemption
for smaller loans.
---------------------------------------------------------------------------

\120\ See, e.g., Fannie Mae, Home Affordable Refinance Refi Plus
Options, at 2 (Mar. 29, 2010); Freddie Mac, Pub. No. 387, Freddie
Mac-owned Streamlined Refinance Mortgage, at 2 (2010).
---------------------------------------------------------------------------

43(d)(1) Definitions
In the Board's proposal, Sec. 226.43(d)(1) established the scope
of paragraph (d) and set forth the conditions under which the special
refinancing provisions applied, while proposed Sec. 226.43(d)(2)
addressed the definitions for ``non-standard mortgage,'' ``standard
mortgage,'' and ``refinancing.'' The Bureau believes that paragraph (d)
should begin with the relevant definitions, before proceeding to the
scope and conditions of the special refinancing provisions. The rule
finalized by the Bureau is accordingly reordered. The following
discussion details the definitions adopted in Sec. 1026.43(d)(1),
which were proposed by the Board under Sec. 226.43(d)(2).
Proposed Sec. 226.43(d)(2) defined the terms ``non-standard
mortgage'' and ``standard mortgage.'' As noted earlier, the statute
does not define the terms ``hybrid loan'' and ``standard loan'' used in
the special refinancing provisions of TILA section 129C(a)(6)(E).
Therefore, the Board proposed definitions it believed to be consistent
with the policy objective underlying these special provisions:
Facilitating the refinancing of home mortgages on which consumers risk
a likely default due to impending payment shock into more stable and
affordable products.
43(d)(1)(i) Non-Standard Mortgage
As noted above, the statute does not define the terms ``hybrid
loan'' and ``standard loan'' used in TILA section 129C(a)(6)(E). The
Board proposed definitions it believed to be consistent with Congress's
objectives. Proposed Sec. 226.43(d)(2)(i) substituted the term ``non-
standard mortgage'' for the statutory term ``hybrid loan'' and would
have defined non-standard mortgage as any ``covered transaction,'' as
defined in proposed Sec. 226.43(b)(1), that is:
An adjustable-rate mortgage, as defined in Sec.
226.18(s)(7)(i), with an introductory fixed interest rate for a period
of one year or longer; \121\
---------------------------------------------------------------------------

\121\ ``The term `adjustable-rate mortgage' means a transaction
secured by real property or a dwelling for which the annual
percentage rate may increase after consummation.'' 12 CFR
1026.18(s)(7)(i).
---------------------------------------------------------------------------

An interest-only loan, as defined in Sec.
226.18(s)(7)(iv); \122\ or
---------------------------------------------------------------------------

\122\ ``The term `interest-only' means that, under the terms of
the legal obligation, one or more of the periodic payments may be
applied solely to accrued interest and not to loan principal; an
`interest-only loan' is a loan that permits interest-only
payments.'' 12 CFR 1026.18(s)(7)(iv).
---------------------------------------------------------------------------

A negative amortization loan, as defined in Sec.
226.18(s)(7)(v).\123\
---------------------------------------------------------------------------

\123\ ``[T]he term `negative amortization' means payment of
periodic payments that will result in an increase in the principal
balance under the terms of the legal obligation; the term `negative
amortization loan' means a loan that permits payments resulting in
negative amortization, other than a reverse mortgage subject to
section 226.33.'' 12 CFR 1026.18(s)(7)(v).
---------------------------------------------------------------------------

Proposed comment 43(d)(2)(i)(A)-1 explained the application of the
definition of non-standard mortgage to an adjustable-rate mortgage with
an introductory fixed interest rate for one or more years. This
proposed comment clarified that, for example, a covered transaction
with a fixed introductory rate for the first two, three or five years
that then converts to a variable rate for the remaining 28, 27 or 25
years, respectively, is a non-standard mortgage. By contrast, a covered
transaction with an introductory rate for six months that then converts
to a variable rate for the remaining 29 and \1/2\ years is not a non-
standard mortgage.
The Board articulated several rationales for its proposed
definition of

[[Page 6489]]

a non-standard mortgage. First, the Board noted that the legislative
history of the Dodd-Frank Act describes ``hybrid'' mortgages as
mortgages with a ``blend'' of fixed-rate and adjustable-rate
characteristics--generally loans with an initial fixed period and
adjustment periods, such as ``2/23s and 3/27s.'' \124\ The Board also
stated that the legislative history indicates that Congress was
concerned about consumers being trapped in mortgages likely to result
in payments that would suddenly become significantly higher--often
referred to as ``payment shock''--because their home values had
dropped, thereby ``making refinancing difficult.'' \125\
---------------------------------------------------------------------------

\124\ See Comm. on Fin. Servs., Report on H.R. 1728, Mortgage
Reform and Anti-Predatory Lending Act, H. Rept. 94, 110th Cong., at
5 (2009).
\125\ Id. at 51-52.
---------------------------------------------------------------------------

The Board interpreted Congress' concern about consumers being at
risk due to payment shock as supporting an interpretation of the term
``hybrid loan'' to encompass both loans that are ``hybrid'' in that
they start with a fixed interest rate and convert to a variable rate,
but also loans that are ``hybrid'' in that consumers can make payments
that do not pay down principal for a period of time that then convert
to higher payments covering all or a portion of principal. By defining
``non-standard mortgage'' in this way, the proposal was intended to
increase refinancing options for a wide range of at-risk consumers
while conforming to the statutory language and legislative intent.
The proposed definition of ``non-standard mortgage'' would not have
included adjustable-rate mortgages whose rate is fixed for an initial
period of less than one year. In those instances, the Board posited
that a consumer may not face ``payment shock'' because the consumer has
paid the fixed rate for such a short period of time. The Board also
expressed concern that allowing streamlined refinancings under this
provision where the interest rate is fixed for less than one year could
result in ``loan flipping.'' A creditor, for example, could make a
covered transaction and then only a few months later refinance that
loan under proposed Sec. 226.43(d) to take advantage of the exemption
from certain ability-to-repay requirements while still profiting from
the refinancing fees.
The Board expressed concern that under its proposed definition, a
consumer could refinance out of a relatively stable product, such as an
adjustable-rate mortgage with a fixed interest rate for a period of 10
years, which then adjusts to a variable rate for the remaining loan
term, and that it was unclear whether TILA section 129C(a)(6)(E) was
intended to cover this type of product. The Board solicited comment on
whether adjustable-rate mortgages with an initial fixed rate should be
considered non-standard mortgages regardless of how long the initial
fixed rate applies, or if the proposed initial fixed-rate period of at
least one year should otherwise be revised.
The proposed definition of non-standard mortgage also did not
include balloon-payment mortgages. The Board noted that balloon-payment
mortgages are not clearly ``hybrid'' products, given that the monthly
payments on a balloon-payment mortgage do not necessarily increase or
change from the time of consummation; rather, the entire outstanding
principal balance becomes due on a particular, predetermined date. The
Board stated that consumers of balloon-payment mortgages typically
expect that the entire loan balance will be due at once at a certain
point in time and are generally aware well in advance that they will
need to repay the loan or refinance.
The Board solicited comment on whether to use its legal authority
to include balloon-payment mortgages in the definition of non-standard
mortgage for purposes of the special refinancing provisions of TILA
section 129C(a)(6)(E). The Board also requested comment generally on
the appropriateness of the proposed definition of non-standard
mortgage.
Commenters on this aspect of the proposal generally urged the
Bureau to expand in various ways the proposed definition of non-
standard mortgage and either supported or did not address the proposed
definition's inclusion of adjustable-rate mortgages, interest-only
loans, or negative amortization loans. One consumer group commented
that it supported the Board's proposed definition of non-standard
mortgage. Other consumer group commenters stated that the Bureau should
use its exemption and adjustment authority under TILA to include
balloon-payment loans within the scope of proposed Sec. 226.43(d). In
addition, one industry commenter stated that creditors should have
flexibility to refinance a performing balloon-payment loan within the
six months preceding, or three months following, a balloon payment date
without regard to the ability-to-pay requirements. In contrast, one
industry commenter stated that balloon-payment loans should not be
included in the definition of non-standard mortgage, because consumers
are generally well aware of the balloon payment feature in a loan,
which is clearly explained to customers. This industry commenter
further stated that during the life of a balloon-payment loan, its
customers often make regular payments that reduce the principal balance
and that balloon-payment loans do not make it more likely that a
consumer will default.
While the Bureau agrees that many consumers may need to seek a
refinancing when a balloon loan payment comes due, given the approach
that the Bureau has taken to implementing the payment shock refinancing
provision in Sec. 1026.43(d), the Bureau is declining to expand the
definition of non-standard mortgage to include balloon-payment
mortgages. As discussed in more detail in the supplementary information
to Sec. 1026.43(d)(3), as adopted Sec. 1026.43(d) provides a broad
exemption to all of the general ability-to-repay requirements set forth
in Sec. 1026.43(c) when a non-standard mortgage is refinanced into a
standard mortgage provided that certain conditions are met. The point
of this exemption is to enable creditors, without going through full
underwriting, to offer consumers who are facing increased monthly
payments due to the recast of a loan a new loan with lower monthly
payments. Thus, a key element of the exemption is that the monthly
payment on the standard mortgage be materially lower than the monthly
payment for the non-standard mortgage. As discussed in the section-by-
section analysis of Sec. 1026.43(d)(1) below, the Bureau is adopting a
safe harbor for reductions of 10 percent. Balloon payments pose a
different kind of risk to consumers, one that arises not from the
monthly payments (which often tend to be low) but from the balloon
payment due when the entire remaining balance becomes due. The
provisions of Sec. 1026.43(d)(1) are not meant to address this type of
risk. Accordingly, the Bureau declines to expand the definition of non-
standard mortgage to include balloon-payment loans. The Bureau
believes, however, that where a consumer is performing under a balloon-
payment mortgage and is offered a new loan of a type that would qualify
as a standard loan with monthly payments at or below the payments of
the balloon-payment mortgage, creditors will have little difficulty in
satisfying the ability-to-repay requirements.
Consumer group commenters and one GSE commenter argued that the
definition of non-standard mortgage should accommodate GSE-held loans.
These commenters stated that these loans should receive the same income
verification exemption as Federal

[[Page 6490]]

agency streamlined refinancing programs. These commenters noted that
while the GSEs are held in conservatorship by the Federal government,
GSE-held loans should be treated the same as FHA for purposes of
streamlined refinance programs, which are ultimately about reducing the
risk to the taxpayer by avoiding default by consumers who could receive
lower-cost mortgage loans. Consumer group commenters further urged that
GSE streamlined refinance programs should be subject to standards at
least as stringent as those for the FHA streamlined refinance program.
In addition, one of the GSEs questioned the policy justification
for the differences between sections 129C(a)(5) and 129C(a)(6)(E) of
TILA. TILA section 129C(a)(5), which applies to certain government
loans, permits Federal agencies to exempt certain refinancings from the
income and asset verification requirement without regard to the
original mortgage product, in contrast to TILA section 129C(a)(6)(E),
which as discussed above applies only when the original loan is a
``hybrid'' loan. This commenter noted that consumers with certain types
of mortgage loans, such as fixed-rate and balloon-payment loans, may
have to go through a more costly and cumbersome process to refinance
their mortgages than consumers with government loans.
The Bureau declines to adopt regulations implementing TILA section
129C(a)(5). The Bureau notes that TILA section 129C(a)(5) expressly
confers authority on certain Federal agencies (i.e., HUD, VA, USDA, and
RHS) to exempt from the income verification requirement refinancings of
certain loans made, guaranteed, or insured by such Federal agencies.
The scope of TILA section 129C(a)(5) is limited to such Federal
agencies or government-guaranteed or -insured loans. The Bureau also
declines to expand the scope of Sec. 1026.43(d) to include GSE
refinancings that do not otherwise fall within the scope of Sec.
1026.43(d). While accommodation for GSE-held mortgage loans that are
not non-standard mortgages under Sec. 1026.43(d) may be appropriate,
the Bureau wishes to obtain additional information in connection with
GSE refinancings and has requested feedback in a proposed rule
published elsewhere in today's Federal Register. However, the Bureau
notes that to the extent a loan held by the GSEs (or a loan made,
guaranteed or insured by the Federal agencies above) qualifies as a
non-standard mortgage under Sec. 1026.43(d)(1)(i) and the other
conditions in Sec. 1026.43(d) are met, the refinancing provisions of
general applicability in Sec. 1026.43(d) would be available for
refinancing a GSE-held loan.
Industry commenters and one industry trade association commented
that special ability-to-repay requirements should be available for all
rate-and-term refinancings, regardless of whether the refinancings are
insured or guaranteed by the Federal government or involve a non-
standard mortgage. One industry trade association stated that such
special ability-to-repay requirements should incorporate similar
standards to those established for certain government loans in TILA
section 129C(a)(5), including a requirement that the consumer not be 30
or more days delinquent. For such loans, this trade association stated
that other requirements under TILA section 129C(a)(6)(E) regarding
payment history should not be imposed, because the consumer is already
obligated to pay the debt and the note holder in many cases will
already bear the credit risk. Other commenters stated that because a
rate-and-term refinancing would offer the consumer a better rate
(except in the case of adjustable rate mortgages), there is no reason
to deny the creditor the ability to improve its credit risk and to
offer the consumer better financing. Several industry commenters and
one GSE noted that streamlined refinancing programs are an important
resource for consumers seeking to refinance into a lower monthly
payment mortgage even when the underlying mortgage loan is not a non-
standard mortgage, and urged the Bureau to considering modifying
proposed Sec. 226.43(d) to include conventional loans where the party
making or purchasing the new loan already owns the credit risk.
The Bureau declines to expand the scope of Sec. 1026.43(d) to
include rate-and-term refinancings when the underlying mortgage is not
a non-standard mortgage, as defined in Sec. 1026.43(d)(1)(i). The
Bureau believes that the statute clearly limits the refinancing
provision in TILA section 129(C)(6)(E) to circumstances where the loan
being refinanced is a ``hybrid loan'' and where the refinancing could
``prevent a likely default.'' The Bureau agrees with the Board that
TILA section 129C(a)(6)(E) is intended to address concerns about loans
involving possible payment shock. Where a consumer has proven capable
of making payments, is about to experience payment shock, is at risk of
default, and is refinancing to a mortgage with a lower monthly payment
and with product terms that do not pose any increased risk, the Bureau
believes that the benefits of the refinancing outweigh the consumer
protections afforded by the ability-to-repay requirements. Absent these
exigent circumstances, the Bureau believes that creditors should
determine that the consumer has the ability to repay the mortgage loan.
The Bureau does not believe that a consumer who receives an initial
lower monthly payment from a rate-and-term refinancing actually
receives a benefit if the consumer cannot reasonably be expected to
repay the loan. Also, the Bureau notes that some of the scenarios
identified by commenters, such as offering a consumer a better rate
with a rate-and-term refinancing where the creditor bears the credit
risk, would be exempt from the ability-to-repay requirements. A
refinancing that results in a reduction in the APR with a corresponding
change in the payment schedule and meets the other conditions in Sec.
1026.20(a) is not a ``refinancing'' for purposes of Sec. 1026.43, and
therefore is not subject to the ability-to-repay requirements. As with
other terms used in TILA section 129C, the Bureau believes that this
interpretation is necessary to achieve Congress's intent.
Several other industry commenters urged the Bureau to broaden the
definition of non-standard mortgage to include refinancings extended
pursuant to the Home Affordable Refinance Program (HARP) and similar
programs. One such commenter indicated that under HARP, a loan can only
be refinanced if the consumer is not in default, the new payment is
fully amortizing, and both the original and new loans comply with
agency requirements. This commenter stated that HARP permits consumers
who would not otherwise be able to refinance due to a high loan-to-
value ratio or other reasons to refinance into another loan, providing
a consumer benefit. The commenter indicated that HARP loans do not meet
all of the proposed ability-to-repay requirements and that the Bureau
should use its authority to provide that HARP and other similar
programs are exempt from the ability-to-repay requirements, as they
promote credit availability and increasing stability in the housing
market. The Bureau acknowledges that HARP refinancings and the payment
shock refinancings addressed under TILA section 129C(a)(6)(E) are both
intended to assist consumers harmed by the financial crisis. Although
both types of refinancings are motivated by similar goals, the Bureau
does not believe that expanding Sec. 1026.43(d) to include all HARP
refinancings is consistent with TILA section 129C(a)(6)(E) because HARP
refinancings are not predicated

[[Page 6491]]

on the occurrence of payment shock and a consumer's likely default. For
example, a consumer with a mortgage loan that will not recast and who
is not at risk of default may qualify for a HARP refinancing if the
consumer's loan-to-value ratio exceeds 80 percent. The Bureau strongly
believes that Sec. 1026.43(d) should be limited to instances where a
consumer is facing payment shock and likely default.
While not limited to the prevention of payment shock and default,
the Bureau acknowledges that extensions of credit made pursuant to
programs such as HARP are intended to assist consumers harmed by the
financial crisis. Furthermore, these programs employ complex
underwriting requirements to determine a consumer's ability to repay.
Thus, it may be appropriate to modify the ability-to-repay requirements
to accommodate such programs. However, an appropriate balance between
helping affected consumers and ensuring that these consumers are
offered and receive residential mortgage loans on terms that reasonably
reflect consumers' ability to repay must be found. To determine how to
strike this balance, the Bureau wishes to obtain additional information
in connection with these programs and has requested feedback in a
proposed rule published elsewhere in today's Federal Register.
Accordingly, the definition of ``non-standard mortgage'' is adopted
as proposed, renumbered as Sec. 1026.43(d)(1)(i). In addition, comment
43(d)(2)(i)(A)-1 also is adopted as proposed, renumbered as
43(d)(1)(i)(A)-1.
43(d)(1)(ii) Standard Mortgage
Proposed Sec. 226.43(d)(2)(ii) would have substituted the term
``standard mortgage'' for the statutory term ``standard loan'' and
defined this term to mean a covered transaction that has the following
five characteristics:
First, the regular periodic payments may not: (1) Cause
the principal balance to increase; (2) allow the consumer to defer
repayment of principal; or (3) result in a balloon payment.
Second, the total points and fees payable in connection
with the transaction may not exceed three percent of the total loan
amount, with exceptions for smaller loans specified in proposed Sec.
226.43(e)(3).
Third, the loan term may not exceed 40 years.
Fourth, the interest rate must be fixed for the first five
years after consummation.
Fifth, the proceeds from the loan may be used solely to
pay--(1) the outstanding principal balance on the non-standard
mortgage; and (2) closing or settlement charges required to be
disclosed under RESPA.
Proposed limitations on regular periodic payments. Proposed Sec.
226.43(d)(2)(ii)(A) would have required that a standard mortgage
provide for regular periodic payments that do not result in negative
amortization, deferral of principal repayment, or a balloon payment.
Proposed comment 43(d)(2)(ii)(A)-1 clarified that ``regular periodic
payments'' are payments that do not result in an increase of the
principal balance (negative amortization) or allow the consumer to
defer repayment of principal. The proposed comment explained that the
requirement for ``regular periodic payments'' means that the
contractual terms of the standard mortgage must obligate the consumer
to make payments of principal and interest on a monthly or other
periodic basis that will repay the loan amount over the loan term.
Proposed comment 43(d)(2)(ii)(A)-1 further explained that, with the
exception of payments resulting from any interest rate changes after
consummation in an adjustable-rate or step-rate mortgage, the periodic
payments must be substantially equal, with a cross-reference to
proposed comment 43(c)(5)(i)-3 regarding the meaning of ``substantially
equal.'' In addition, the comment clarified that ``regular periodic
payments'' do not include a single-payment transaction and cross-
referenced similar commentary on the meaning of ``regular periodic
payments'' under proposed comment 43(e)(2)(i)-1. Proposed comment
43(d)(2)(ii)(A)-1 also cross-referenced proposed comment 43(e)(2)(i)-2
to explain the prohibition on payments that ``allow the consumer to
defer repayment of principal.''
One consumer group commenter stated that it supported the exclusion
of negative amortization, interest-only payments, and balloon payments
from the definition of standard mortgage. In addition, several other
consumer groups commented in support of the Board's proposal to exclude
balloon-payment loans from the definition of standard mortgage. These
commenters stated that balloon-payment products, even with self-
executing renewal, should not be permitted to take advantage of an
exemption from the general underwriting standards in Sec. 1026.43(c).
Consumer groups expressed concern that, in cases where the consumer
does not have assets sufficient to make the balloon payment, balloon-
payment loans will necessarily require another refinance or will lead
to a default. The Bureau agrees with the concerns expressed by such
commenters and believes that it is appropriate to require that balloon-
payment loans be underwritten in accordance with the general ability-
to-repay standard, rather than under the payment shock refinancing
provision in Sec. 1026.43(d). Accordingly, the Bureau is not expanding
the definition of standard mortgage to include balloon-payment
mortgages.
The Bureau received no other comment on this proposed definition.
Accordingly, the Bureau is adopting the definition of standard mortgage
as proposed, renumbered as Sec. 1026.43(d)(1)(ii)(A). Similarly, the
Bureau received no comment on proposed comment 43(d)(2)(ii)(A)-1, which
is adopted as proposed and renumbered as 43(d)(1)(ii)(A)-1.
Proposed three percent cap on points and fees. Proposed Sec.
226.43(d)(2)(ii)(B) would have prohibited creditors from charging
points and fees on the mortgage loan of more than three percent of the
total loan amount, with certain exceptions for small loans.
Specifically, proposed Sec. 226.43(d)(2)(ii)(B) cross-referenced the
points and fees provisions under proposed Sec. 226.43(e)(3), thereby
applying the points and fees limitations for a ``qualified mortgage''
to a standard mortgage. The points and fees limitation for a
``qualified mortgage'' and the relevant exception for small loans are
discussed in detail in the section-by-section analysis of Sec.
1026.43(e)(3) below.
The Board noted several reasons for the proposed limitation on the
points and fees that may be charged on a standard mortgage. First, the
limitation was intended to prevent creditors from undermining the
provision's purpose--placing at-risk consumers into more affordable
loans--by charging excessive points and fees for the refinance. Second,
the points and fees limitation was intended to ensure that consumers
attain a net benefit in refinancing their non-standard mortgage. The
higher a consumer's up-front costs to refinance a home mortgage, the
longer it will take for the consumer to recoup those costs through
lower payments on the new mortgage. By limiting the amount of points
and fees that can be charged in a refinance covered by proposed Sec.
226.43(d), the provision increases the likelihood that the consumer
will hold the loan long enough to recoup those costs. Third, the
proposed limitation was intended to be consistent with the provisions
set forth in TILA section 129C(a)(5) regarding certain refinancings
under Federal agency programs.

[[Page 6492]]

The Board requested comment on the proposal to apply the same limit
on the points and fees that may be charged for a ``qualified mortgage''
under Sec. 226.43(e) to the points and fees that may be charged on a
``standard mortgage'' under Sec. 226.43(d). The Bureau received no
comments on this proposed points and fees threshold, which is adopted
as proposed, renumbered as Sec. 1026.43(d)(1)(ii)(B). See the section-
by-section analysis of Sec. 1026.43(e)(3) below for more specific
information regarding the limitations applicable to ``points and fees''
for qualified mortgages and refinancings under Sec. 1026.43(d).
Proposed loan term of no more than 40 years. Proposed Sec.
226.43(d)(2)(ii)(C) would have provided that, to qualify as a standard
mortgage under proposed Sec. 226.43(d), a covered transaction may not
have a loan term of more than 40 years. The Board stated that this
condition was intended to ensure that creditors and consumers have
sufficient options to refinance a 30-year loan, for example, which is
unaffordable for the consumer in the near term, into a loan with lower,
more affordable payments over a longer term. This flexibility may be
especially important in higher cost areas where loan amounts on average
exceed loan amounts in other areas.
The Board noted that loans with longer terms may cost more over
time, but indicated that it was reluctant to foreclose options for
consumers for whom the lower payment of a 40-year loan might make the
difference between defaulting and not defaulting. The Board also noted
that prevalent streamlined refinance programs permit loan terms of up
to 40 years and expressed concern about disrupting the current mortgage
market at a vulnerable time. The Board specifically requested comment
on the proposed condition to allow a standard mortgage to have a loan
term of up to 40 years. The Bureau received no comment on this proposed
condition, which is adopted as proposed, renumbered as Sec.
1026.43(d)(1)(ii)(C).
Proposed requirement that the interest rate be fixed for the first
five years. Proposed Sec. 226.43(d)(2)(ii)(D) would have required that
a standard mortgage have a fixed interest rate for the first five years
after consummation. Proposed comment 43(d)(2)(ii)(D)-1 provided an
illustrative example. The proposed comment also cross-referenced
proposed comment 43(e)(2)(iv)-3.iii for guidance regarding step-rate
mortgages.
The Board articulated several reasons for requiring a minimum five-
year fixed-rate period for standard mortgages. First, the Board noted
that a fixed rate for five years is consistent with TILA section
129C(b)(2)(A)(v), which requires the creditor to underwrite a qualified
mortgage based on the maximum interest rate that may apply during the
first five years. The Board indicated that Congress intended both
qualified mortgages and standard mortgages to be stable loan products,
and therefore that the required five-year fixed-rate period for
qualified mortgages would also be an appropriate benchmark for standard
mortgages. The Board further stated that the safeguard of a fixed rate
for five years after consummation would help to ensure that consumers
refinance into products that are stable for a substantial period of
time. In particular, a fixed payment for five years after consummation
would constitute a significant improvement in the circumstances of a
consumer who may have defaulted absent the refinance. The Board
specifically noted that the proposal would permit so-called ``5/1
ARMs,'' where the interest rate is fixed for the first five years,
after which time the rate becomes variable, to be standard mortgages.
The Board requested comment on the proposal defining a standard
mortgage as a mortgage loan with an interest rate that is fixed for at
least the first five years after consummation, including on whether the
rate should be required to be fixed for a shorter or longer period and
data to support any alternative time period. One consumer group
commenter stated that the use of adjustable-rate mortgages should be
limited in the definition of standard mortgage. This commenter stated
that adjustable-rate mortgage loans contributed to the subprime lending
expansion and the financial crisis that followed. In particular, this
commenter expressed concern that adjustable-rate mortgage loans were
utilized in loan-flipping schemes that trapped consumers in
unaffordable loans, forcing such consumers to refinance into less
affordable mortgage loans. This commenter indicated that standard
mortgages should be limited to fixed and step-rate loans and, in low or
moderate interest rate environments, adjustable-rate mortgages with a
5-year or longer-term fixed period. However, this commenter urged the
Bureau to consider permitting shorter-term adjustable-rate mortgages to
be standard mortgages in high interest rate environments because in
such circumstance, an adjustable-rate mortgage could potentially reduce
the consumer's monthly payments at recast, which may outweigh the risks
of increased payments for some consumers.
The Bureau is adopting the requirement that a standard mortgage
have a fixed interest rate for the first five years after consummation
as proposed, renumbered as Sec. 1026.43(d)(1)(ii)(D). The Bureau
agrees with the Board that the intent of TILA section 129C(a)(6)(E)
appears to be to facilitate refinances of riskier mortgages into more
stable loan products, and accordingly, believes that a standard
mortgage should provide for a significant period of time during which
payments will be predictable, based on a fixed rate or step rates that
are set at the time of consummation. The Bureau believes that five
years is an appropriate standard in part because it is consistent with
the statutory requirement for a qualified mortgage under section
129C(b)(2)(A)(v). The Bureau believes that predictability for consumers
is best effectuated by a single rule that applies in all interest rate
environments, rather than a rule that depends on the interest rate
environment in effect at the time of the refinancing. Further, given
that Sec. 1026.43(d) provides an exemption from the general ability-
to-repay requirements in Sec. 1026.43(c), the Bureau believes that it
is important that a refinancing conducted in accordance with Sec.
1026.43(d) result in a stable loan product and predictable payments for
a significant period of time.
In addition, the Board solicited comment on whether a balloon-
payment mortgage of at least five years should be considered a standard
mortgage under the refinancing provisions of proposed Sec. 226.43(d).
The Board noted that in some circumstances, a balloon-payment mortgage
with a fixed, monthly payment for five years might benefit a consumer
who otherwise would have defaulted. The Board further noted that a
five-year balloon-payment mortgage may not be appreciably less risky
for the consumer than a ``5/1 ARM,'' which is permitted under the
proposal, depending on the terms of the rate adjustment scheduled to
occur in year five.
As discussed above, several consumer groups stated that balloon
products, even with self-executing renewal, should not be permitted to
take advantage of an exemption from the general underwriting standards
in Sec. 1026.43(c). Consumer groups expressed concern that, in cases
where the consumer does not have assets sufficient to make the balloon
payment, balloon-payment mortgages will necessarily require another
refinance or will lead to a default. For the reasons discussed in the
supplementary information to Sec. 1026.43(d)(1)(ii)(A)

[[Page 6493]]

above, the Bureau is not expanding the definition of ``standard
mortgage'' to include balloon-payment mortgages.
Proposed requirement that loan proceeds be used for limited
purposes. Proposed Sec. 226.43(d)(2)(ii)(E) would have restricted the
use of the proceeds of a standard mortgage to two purposes:
To pay off the outstanding principal balance on the non-
standard mortgage; and
To pay closing or settlement charges required to be
disclosed under the Real Estate Settlement Procedures Act, 12 U.S.C.
2601 et seq., which includes amounts required to be deposited in an
escrow account at or before consummation.
Proposed comment 43(d)(2)(ii)(E)-1 clarified that if the proceeds
of a covered transaction are used for other purposes, such as to pay
off other liens or to provide additional cash to the consumer for
discretionary spending, the transaction does not meet the definition of
a ``standard mortgage.''
The Board expressed concern that permitting the consumers to lose
additional equity in their homes under the proposed refinancing
provisions could undermine the financial stability of those consumers,
thus contravening the purposes of TILA section 129C(a)(6)(E). The Board
requested comment, however, on whether some de minimis amount of cash
to the consumer should be permitted, either because this allowance
would be operationally necessary to cover transaction costs or for
other reasons, such as to reimburse a consumer for closing costs that
were over-estimated but financed.
The Bureau received only one comment on this aspect of the
proposal. An association of State bank regulators agreed that the rule
should generally restrict the use of the proceeds of the standard
mortgage to paying off the outstanding balance on the non-standard
mortgage or to pay closing or settlement costs. However, they urged the
Bureau to provide an exemption that would permit loan proceeds to be
used to pay for known home repair needs and suggested that any such
exemption require the consumer to provide verified estimates in advance
in order to ensure that loan proceeds are used only for required home
repairs.
The Bureau is adopting the limitation on the use of loan proceeds
as proposed, renumbered as Sec. 1026.43(d)(1)(ii)(E). The Bureau
declines to permit the proceeds of a refinancing conducted in
accordance with Sec. 1026.43(d) to be used for home repair purposes,
for several reasons. First, the Bureau believes that such an exemption
would be inconsistent with the statutory purposes of TILA section
129C(a)(6)(E), which is intended to permit refinancings on the basis of
less stringent underwriting in the narrow circumstances where a
consumer's non-standard mortgage is about to recast and lead to a
likely default by the consumer. The Bureau believes that permitting a
consumer to utilize home equity for home repairs in connection with a
refinancing conducted pursuant to Sec. 1026.43(d) could further
compromise the financial position of consumers who are already in a
risky financial position. The Bureau believes that it would be more
appropriate, where home repairs are needed, for a creditor to perform
the underwriting required to advance any credit required in connection
with those repairs. In addition, the Bureau believes that such an
exemption could be subject to manipulation by fraudulent home
contractors, by the creditor, and even by a consumer. It would be
difficult, even with a requirement that the consumer provide verified
estimates, to ensure that amounts being disbursed for home repairs
actually are needed, and in fact used, for that purpose.
43(d)(1)(iii)
Proposed Sec. 226.43(d)(2)(iii) would have defined the term
``refinancing'' to have the same meaning as in Sec. 1026.20(a).\126\
Section 1026.20(a) defines the term ``refinancing'' generally to mean a
transaction in which an existing obligation is ``satisfied and replaced
by a new obligation undertaken by the same consumer.'' Official
commentary explains that ``[w]hether a refinancing has occurred is
determined by reference to whether the original obligation has been
satisfied or extinguished and replaced by a new obligation, based on
the parties' contract and applicable law.'' See comment 20(a)-1.
However, the following are not considered ``refinancings'' for purposes
of Sec. 1026.20(a): (1) A renewal of a payment obligation with no
change in the original terms; and (2) a reduction in the annual
percentage rate with a corresponding change in the payment schedule.
See Sec. 1026.20(a)(1) and (a)(2), and comment 20(a)-2.
---------------------------------------------------------------------------

\126\ The Board's proposal originally referred to 226.20(a),
which was subsequently renumbered as 12 CFR 1026.20(a).
---------------------------------------------------------------------------

The Board requested comment on whether the proposed meaning of
``refinancing'' should be expanded to include a broader range of
transactions or otherwise should be defined differently or explained
more fully than proposed. The Bureau received no comments on this
proposed definition. Accordingly, the Bureau is adopting the definition
of refinancing as proposed, renumbered as Sec. 1026.43(d)(1)(iii).
43(d)(2) Scope
In the Board's proposal, Sec. 226.43(d)(2) addressed the
definitions for ``non-standard mortgage,'' ``standard mortgage,'' and
``refinancing,'' while proposed Sec. 226.43(d)(1) established the
scope of paragraph (d) and set forth the conditions under which the
special refinancing provisions applied. The Bureau believes that
paragraph (d) should begin with the relevant definitions, before
proceeding to the scope and conditions of the special refinancing
provisions. The rule finalized by the Bureau is accordingly reordered.
The following discussion details the provisions adopted in Sec.
1026.43(d)(2), which were proposed by the Board under Sec.
226.43(d)(1).
Proposed Sec. 226.43(d)(1) would have defined the scope of the
refinancing provisions under proposed Sec. 226.43(d). Specifically,
proposed Sec. 226.43(d) applied when a non-standard mortgage is
refinanced into a standard mortgage and the following conditions are
met--
The creditor of the standard mortgage is the current
holder of the existing non-standard mortgage or the servicer acting on
behalf of the current holder.
The monthly payment for the standard mortgage is
significantly lower than the monthly payment for the non-standard
mortgage, as calculated under proposed Sec. 226.43(d)(5).
The creditor receives the consumer's written application
for the standard mortgage before the non-standard mortgage is
``recast.''
The consumer has made no more than one payment more than
30 days late on the non-standard mortgage during the 24 months
immediately preceding the creditor's receipt of the consumer's written
application for the standard mortgage.
The consumer has made no payments more than 30 days late
during the six months immediately preceding the creditor's receipt of
the consumer's written application for the standard mortgage.
Proposed comment 43(d)(1)-1 clarified that the requirements for a
``written application,'' a term that appears in Sec.
226.43(d)(1)(iii), (d)(1)(iv) and (d)(1)(v), discussed in detail below,
are found in comment 19(a)(1)(i)-3. Comment 19(a)(1)(i)-3 states that
creditors may rely on the Real Estate Settlement Procedures Act (RESPA)
and Regulation X (including any interpretations issued by HUD) in

[[Page 6494]]

deciding whether a ``written application'' has been received. This
comment further states that, in general, Regulation X defines
``application'' to mean the submission of a borrower's financial
information in anticipation of a credit decision relating to a
federally related mortgage loan. See 12 CFR 1024.2(b). Comment
19(a)(1)(i)-3 clarifies that an application is received when it reaches
the creditor in any of the ways applications are normally transmitted,
such as by mail, hand delivery, or through an intermediary agent or
broker. The comment further clarifies that, if an application reaches
the creditor through an intermediary agent or broker, the application
is received when it reaches the creditor, rather than when it reaches
the agent or broker. Comment 19(a)(1)(i)-3 also cross-references
comment 19(b)-3 for guidance in determining whether or not the
transaction involves an intermediary agent or broker. The Bureau
received no comments on this proposed comment, which is adopted as
proposed, renumbered as 43(d)(2)-1.
43(d)(2)(i)
Proposed Sec. 226.43(d)(1)(i) would have required that the
creditor for the new mortgage loan also be either the current holder of
the existing non-standard mortgage or the servicer acting on behalf of
the current holder. This provision was intended to implement the
requirement in TILA section 129C(a)(6)(E) that the existing loan must
be refinanced by ``the creditor into a standard loan to be made by the
same creditor.''
The Board interpreted the statutory phrase ``same creditor'' to
mean that the creditor refinancing the loan must have an existing
relationship with the consumer. The Board explained that the existing
relationship is important because the creditor must be able to easily
access the consumer's payment history and potentially other information
about the consumer in lieu of documenting the consumer's income and
assets. The Board also noted that this statutory provision is intended
to ensure that the creditor of the refinancing has an interest in
placing the consumer into a new loan that is affordable and beneficial.
The proposal would have permitted the creditor of the refinanced loan
to be the holder, or servicer acting on behalf of the holder, of the
existing mortgage. The Board further explained that the existing
servicer may be the entity conducting the refinance, particularly for
refinances held by GSEs. By also permitting the creditor on the
refinanced loan to be the servicer acting on behalf of the holder of
the existing mortgage, the proposal was intended to apply to a loan
that has been sold to a GSE, refinanced by the existing servicer, and
continues to be held by the same GSE. The Board solicited comment on
whether the proposed rule could be structured differently to better
ensure that the creditor retains an interest in the performance of the
new loan and whether additional guidance is needed.
Several commenters urged the Bureau to impose a specific period
following a refinancing under Sec. 226.43(d) during which the creditor
must remain the current holder of the loan. Consumer group commenters
suggested that to be eligible for the non-standard mortgage refinancing
the creditor should be required to maintain full interest in the
refinanced loan for a minimum of 12 months. These commenters expressed
concern that the lack of such a retention requirement would permit
creditors to refinance loans that are likely to fail without performing
the robust underwriting that would otherwise be required for a new
loan. If such loans were to be immediately sold to a third party,
consumer groups indicated that it could invite abuse by creditors with
an incentive to sell riskier loans without providing full value to the
consumer. An association of State bank regulators urged the Bureau to
adopt a two-year holding period during which the creditor must remain
the current holder of the loan.
One industry commenter indicated that the Bureau should broaden the
scope to permit a subservicer of the loan to be the creditor with
respect to the standard loan. Another industry commenter stated that
the scope should be expanded to allow a creditor to refinance a non-
standard mortgage that it did not originate or is not servicing. This
commenter indicated that due to the volume of requests for refinancing
received by some creditors, consumers may benefit from more timely
refinancing if a third-party creditor is eligible to use non-standard
refinancing provisions.
The Bureau is adopting this requirement as proposed, renumbered as
Sec. 1026.43(d)(2)(i). As discussed in more detail below, as adopted
Sec. 1026.43(d) provides a broad exemption to all of the ability-to-
repay requirements set forth in Sec. 1026.43(c) when a non-standard
mortgage is refinanced into a standard mortgage provided that certain
conditions are met. Section 1026.43(d)(2)(i) is adopted pursuant to the
Bureau's authority under section 105(a) of TILA. The Bureau finds that
this adjustment is necessary to effectuate the purposes of TILA by
ensuring that consumers are offered and receive residential mortgage
loans on terms that reasonably reflect their ability to repay, while
ensuring that consumers at risk of default due to payment shock are
able to obtain responsible, affordable refinancing credit from the
current holder of the consumer's mortgage loan, or the servicer acting
on behalf of the current holder. To prevent unscrupulous creditors from
using Sec. 1026.43(d) to engage in loan-flipping, and to ensure that
this exemption is available only in those cases where consumer benefit
is the most likely, the Bureau believes that it is important that the
creditor of the standard loan be the holder of, or the servicer acting
on behalf of the holder of, the non-standard loan. In such cases, the
Bureau agrees with the Board that the creditor has a better incentive
to refinance the consumer into a more stable and affordable loan.
Therefore, the Bureau declines to extend the scope of Sec. 1026.43(d)
to cover cases in which the creditor of the non-standard loan is not
the current holder of the nonstandard loan or servicer acting on behalf
of that holder.
The Bureau believes that the combination of this restriction and
the other protections contained in Sec. 1026.43(d) is sufficient to
prevent unscrupulous creditors from engaging in loan-flipping.
Therefore, the Bureau does not believe that it is necessary to impose a
specified period during which the creditor of the standard mortgage
must remain the holder of the loan. As discussed in the section-by-
section analysis of Sec. 1026.43(d)(2)(vi) below, the Bureau has
conditioned use of Sec. 1026.43(d), for non-standard loans consummated
after the effective date of this final rule, on the non-standard loan
having been made in accordance with the ability-to-repay requirements
in Sec. 1026.43(c), including consideration of the eight factors
listed in Sec. 1026.43(c)(2). The Bureau believes that this will help
to ensure that creditors cannot use the refinancing provisions of Sec.
1026.43(d) to systematically make and divest riskier mortgages, or to
cure substandard underwriting on a non-standard mortgage by refinancing
the consumer into a loan with a lower, but still unaffordable, payment.
TILA section 130(k)(1) provides that consumers may assert as a defense
to foreclosure by way of recoupment or setoff violations of TILA
section 129C(a) (of which TILA section 129C(a)(6)(E) comprises a
subpart). 15 U.S.C. 1640(k)(1). This defense to foreclosure applies
against assignees of the loan in addition to the original creditor.
Therefore, given that

[[Page 6495]]

the non-standard loan having been originated in accordance with Sec.
1026.43(c) is a condition for using the refinancing provision in Sec.
1026.43(d), a consumer may assert violations of Sec. 1026.43(c) on the
original non-standard loan as a defense to foreclosure for the standard
loan made under Sec. 1026.43(d), even if that standard loan is
subsequently sold by the creditor.
In addition to believing that imposition of a holding period is
unnecessary, the Bureau has concerns that imposition of a holding
period also could create adverse consequences for the safety and
soundness of financial institutions. In some circumstances, a creditor
may need for safety and soundness reasons to sell a portion of its
portfolio, which may include a residential mortgage loan that was made
in accordance with Sec. 1026.43(d). However, such a creditor may not
know at the time of the refinancing that it ultimately will need to
sell the loan, and may even intend to remain the holder the loan for a
longer period of time at the time of consummation. The Bureau has
concerns about the burden imposed on issuers by a holding period in
such circumstances where the creditor does not or cannot know at the
time of the refinance under Sec. 1026.43(d) that the loan will need to
be sold within the next 12 months.
43(d)(2)(ii)
Proposed Sec. 226.43(d)(1)(ii) would have required that the
monthly payment on the new mortgage loan be ``materially lower'' than
the monthly payment for the existing mortgage loan. This proposed
provision would have implemented the requirement in TILA section
129C(a)(6)(E) that there be ``a reduction in monthly payment on the
existing hybrid loan'' in order for the special provisions to apply to
a refinancing. Proposed comment 43(d)(1)(ii)-1 provided that the
monthly payment for the new loan must be ``materially lower'' than the
monthly payment for an existing non-standard mortgage and clarifies
that the payments that must be compared must be calculated according to
proposed Sec. 226.43(d)(5). The proposed comment also clarified that
whether the new loan payment is ``materially lower'' than the non-
standard mortgage payment depends on the facts and circumstances, but
that, in all cases, a payment reduction of 10 percent or greater would
meet the ``materially lower'' standard.
Consumer groups and an association of State bank regulators
supported the adoption of a 10 percent safe harbor for the ``materially
lower'' standard. In contrast, industry commenters opposed the
requirement that payment on the standard mortgage be ``materially
lower'' than the payment on the non-standard mortgage. These commenters
urged the Bureau not to adopt the 10 percent safe harbor proposed by
the Board and stated that the 10 percent safe harbor would become the
de facto rule if adopted. These commenters expressed concerns that the
``materially lower'' standard would unduly restrict access to credit
for many consumers and suggested that the Bureau instead adopt a
standard that would permit more consumers to qualify for the non-
standard refinancing provisions. Several commenters indicated that the
Bureau should adopt a five percent safe harbor rather than the proposed
ten percent. One industry commenter recommended that the Bureau permit
reductions of a minimum dollar amount to satisfy the rule, particularly
in cases where the monthly payment is already low. Finally, one
industry commenter asked the Bureau to provide guidance regarding the
meaning of ``materially lower'' when the reduction in payment is less
than 10 percent.
The Bureau is adopting as proposed the requirement that the payment
on the standard mortgage be ``materially lower'' than the non-standard
mortgage and the safe harbor for a 10 percent or greater reduction,
renumbered as Sec. 1026.43(d)(2)(ii) and comment 43(d)(2)(ii)-1. The
Bureau agrees with the Board that it would be inconsistent with the
statutory purpose to permit the required reduction to be merely de
minimis. In such cases, the consumer likely would not obtain a
meaningful benefit that would help to prevent default. As discussed in
the section-by-section analysis below, Sec. 1026.43(d)(3) exempts
refinancings from the ability-to-repay requirements in Sec.
1026.43(c), provided that certain conditions are met. Given that Sec.
1026.43(d) provides a broad exemption to the ability-to-repay
requirements, the Bureau believes that it is important that the
reduction in payment provide significant value to the consumer and
increase the likelihood that the refinancing will improve the
consumer's ability to repay the loan. Accordingly, the Bureau is
adopting the 10 percent safe harbor as proposed. The Bureau declines to
adopt a dollar amount safe harbor because the appropriate dollar amount
would depend on a number of factors, including the amount of the loan
and monthly payment, but notes that reductions of less than 10 percent
could nonetheless meet the ``materially lower'' standard depending on
the relevant facts and circumstances.
43(d)(2)(iii)
Proposed Sec. 226.43(d)(1)(iii) would have required that the
creditor for the refinancing receive the consumer's written application
for the refinancing before the existing non-standard mortgage is
``recast.'' As discussed in the section-by-section analysis of Sec.
1026.43(b)(11) above, the proposal defined the term ``recast'' to mean,
for an adjustable-rate mortgage, the expiration of the period during
which payments based on the introductory fixed rate are permitted; for
an interest-only loan, the expiration of the period during which the
interest-only payments are permitted; and, for a negative amortization
loan, the expiration of the period during which negatively amortizing
payments are permitted.
The Board explained that the proposal was intended to implement
TILA section 129C(a)(6)(E)(ii), which permits creditors of certain
refinances to ``consider if the extension of new credit would prevent a
likely default should the original mortgage reset.'' This statutory
language implies that the special refinancing provisions apply only
where the original mortgage has not yet ``reset.'' Accordingly, the
Board concluded that Congress's concern likely was prevention of
default in the event of a ``reset,'' not loss mitigation on a mortgage
for which a default on the ``reset'' payment has already occurred.
However, in recognition of the fact that a consumer may not realize
that a loan will be recast until the recast occurs and that the
consumer could not refinance the loan under proposed Sec. 226.43(d),
the Board also requested comment on whether it would be appropriate to
use legal authority to make adjustments to TILA to permit refinancings
after a loan is recast.
Consumer groups urged the Bureau to expand the scope of the non-
standard refinancing provisions to apply to applications filed after
the initial recast of a non-standard loan has occurred. These
commenters stated that the intent of the proposal is to avoid ``likely
default'' and indicated that for some consumers, notification that the
consumer's interest rate has adjusted and their payment has increased
may be their first notice that their payment has gone up and increased
their likelihood of default. One consumer group commenter stated that
these consumers may be better credit risks than those consumers whose
loans have not yet recast and they would clearly benefit from a
materially lower monthly payment.

[[Page 6496]]

Several industry commenters similarly urged the Bureau to modify
the provisions to apply to applications for refinancings received after
recast of the non-standard loan. One of these commenters stated that
the timing of the application is irrelevant to the consumer's ability
to repay or the consumer's need to refinance. One industry commenter
stated that processing an application and assessing a consumer's
ability to repay a new loan may require additional time well before the
recast date. This commenter urged the Bureau to expand the scope of the
non-standard refinancing provisions to include refinancings after a
loan is recast that are in the best interests of consumers.
For the reasons discussed below, the Bureau is adopting Sec.
1026.43(d)(2)(iii), which provides that Sec. 1026.43(d) applies to the
refinancing of a non-standard mortgage into a standard mortgage when
the creditor receives the consumer's written application for the
standard mortgage no later than two months after the non-standard
mortgage has recast, provided certain other conditions are met. The
Bureau believes that the best reading of TILA section 129C(a)(6)(E) is
that it is intended to facilitate refinancings for consumers at risk of
default due to the ``payment shock'' that may occur upon the recast of
the consumer's loan to a higher rate or fully amortizing payments. The
Bureau acknowledges that the statutory language contemplates that such
recast has not yet occurred. However, the Bureau does not believe that
Congress intended to provide relief for consumers facing imminent
``payment shock'' based on how promptly the consumer filed, or how
quickly the creditor processed, an application for a refinancing. For
example, the periodic rate on a mortgage loan may recast on July 1st,
but the higher payment reflecting the recast interest rate would not be
due until August 1st. In this example, a consumer may not experience
payment shock until a month after the consumer's rate recasts.
Additionally, it may take a significant amount of time for a consumer
to provide the creditor with all of the information required by the
creditor, thereby triggering the receipt of an application for purposes
of the ability-to-repay requirements. The Bureau does not believe that
Congress intended the special treatment afforded by TILA section
129C(a)(6)(E) to hinge on paperwork delays such as these. The Bureau
agrees with the arguments raised by commenters and believes that the
purposes of TILA are best effectuated by permitting consumers to submit
applications for refinancings for a short period of time after recast
occurs. The Bureau has determined that permitting a consumer to apply
for a refinancing within two months of the date of recast strikes the
appropriate balance between the language of the statute and the
practical considerations involved with submitting an application for a
refinancing in response to payment shock. Pursuant to its authority
under TILA section 105(a), the Bureau finds that modifying Sec.
1026.43(d) to apply to extensions of credit where the creditor receives
the consumer's written application for the standard mortgage no later
than two months after the non-standard mortgage has recast ensures that
consumers are offered and receive residential mortgage loans on terms
that reasonably reflect their ability to repay while ensuring that
responsible, affordable mortgage credit remains available to consumers
at risk of default due to higher payments resulting from the recast.
43(d)(2)(iv)
Proposed Sec. 226.43(d)(1)(iv) would have required that, during
the 24 months immediately preceding the creditor's receipt of the
consumer's written application for the standard mortgage, the consumer
has made no more than one payment on the non-standard mortgage more
than 30 days late. Proposed comment 43(d)(1)(iv)-1 provided an
illustrative example. Together with proposed Sec. 226.43(d)(1)(v),
proposed Sec. 226.43(d)(1)(iv) would have implemented the portion of
TILA section 129C(a)(6)(E) that requires that the consumer not have
been ``delinquent on any payment on the existing hybrid loan.''
Although TILA section 129C(a)(6)(E) contains a statutory
prohibition on ``any'' delinquencies on the existing non-standard
(``hybrid'') mortgage, the Board interpreted its proposal as consistent
with the statute in addition to being consistent with the consumer
protection purpose of TILA and current industry practices. In addition,
the Board noted its authority under TILA sections 105(a) and 129B(e)--
which has since transferred to the Bureau--to adjust provisions of TILA
and condition practices ``to assure that consumers are offered and
receive residential mortgage loan on terms that reasonably reflect
their ability to repay the loans and that are understandable and not
unfair, deceptive, or abusive.'' 15 U.S.C. 1604(a); 15 U.S.C. 1639b(e);
TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2).
The Board provided several reasons for proposing to require a look-
back period for payment history of 24 months, rather than a 12-month
period. First, the Board noted that consumers at risk of default when
higher payments are required might present greater credit risks to the
institutions holding their loans, even if the institutions refinance
those loans. Second, the Board noted views expressed during outreach by
GSE and creditor representatives that consumers with positive payment
histories tend to be less likely than other consumers to become
obligated on a new loan for which they cannot afford the monthly
payments. The Board solicited comment on the proposal to require that
the consumer have only one delinquency during the 24 months prior to
applying for a refinancing, particularly on whether a longer or shorter
look-back period should be required.
In addition, under the proposal, late payments of 30 days or fewer
on the existing, non-standard mortgage would not disqualify a consumer
from refinancing the non-standard mortgage under the streamlined
refinance provisions of proposed Sec. 226.43(d). The Board stated that
allowing delinquencies of 30 or fewer days is consistent with the
statutory prohibition on ``any'' delinquency for several reasons.
First, the Board noted that delinquencies of this length may occur for
many reasons outside of the consumer's control, such as mailing delays,
miscommunication about where the payment should be sent, or payment
crediting errors. Second, many creditors incorporate a late fee ``grace
period'' into their payment arrangements, which permits consumers to
make their monthly payments for a certain number of days after the
contractual due date without incurring a late fee. Accordingly, the
Board noted that the statute should not be read to prohibit consumers
from obtaining needed refinances due to payments that are late but
within a late fee grace period. Finally, the Board indicated that the
predominant streamlined refinance programs of which it is aware
uniformly measure whether a consumer has a positive payment history
based on whether the consumer has made any payments late by 30 days
(or, as in the proposal, more than 30 days).
Proposed comment 43(d)(1)(iv)-2 would have clarified that whether a
payment is more than 30 days late depends on the contractual due date
not accounting for any grace period and provided an illustrative
example. The Board indicated that using the contractual due date for
determining

[[Page 6497]]

whether a payment has been made more than 30 days after the due date
would facilitate compliance and enforcement by providing clarity.
Whereas late fee ``grace periods'' are often not stated in writing, the
contractual due date is unambiguous. Finally, the Board stated that
using the contractual due date for determining whether a loan payment
is made on time is consistent with standard home mortgage loan
contracts. The Board requested comment on whether the delinquencies
that creditors are required to consider under Sec. 226.43(d)(1) should
be late payments of more than 30 days as proposed, 30 days or more, or
some other time period.
Consumer groups supported the Board's proposal to identify late
payments as late payments of more than 30 days. However, they stated
that the requirement that consumers not have more than one delinquency
in the past 24 months to qualify for a refinance under Sec. 1026.43(d)
was overly stringent and that the appropriate standard would be no
delinquencies in the past 12 months.
Several industry commenters similarly urged the Bureau to adopt a
12-month period rather than the proposed 24-month period in which a
consumer may have one late payment. These commenters stated that
permitting only one 30-day late payment in the past 24 months is too
restrictive and would require a creditor to overlook a recent history
of timely payments. In addition, one industry commenter stated that the
standard for defining a late payment should be late payments of more
than 60 days.
The Bureau is adopting this provision generally as proposed,
renumbered as Sec. 1026.43(d)(2)(iv), with one substantive change. The
Bureau is adopting a 12-month look-back period rather than the 24-month
period proposed by the Board. The Bureau believes that reviewing a
consumer's payment history over the last 12 months would be more
appropriate than a 24-month period, and agrees that a 24-month period
may unduly restrict consumer access to the Sec. 1026.43(d) refinancing
provisions. The Bureau believes that the requirement that a consumer's
account have no more than one 30-day late payment in the past 12 months
will best effectuate the purposes of TILA by ensuring that only those
consumers with positive payment histories are eligible for the non-
standard refinancing provisions under Sec. 1026.43(d). Section
1026.43(d)(2)(iv) is adopted pursuant to the Bureau's authority under
section 105(a) of TILA. The Bureau finds that this adjustment is
necessary and proper to effectuate the purposes of TILA by ensuring
that consumers are offered and receive residential mortgage loans on
terms that reasonably reflect their ability to repay, while ensuring
that consumers at risk of default due to payment shock are able to
obtain responsible, affordable refinancing credit.
The Bureau also is adopting comments 43(d)(1)(iv)-1 and
43(d)(1)(iv)-2 generally as proposed, with conforming amendments to
reflect the 12-month look-back period in Sec. 1026.43(d)(2)(iv), and
renumbered as 43(d)(2)(iv)-1 and 43(d)(2)(iv)-2. The Bureau has made
several technical amendments to the example in comment 43(d)(2)(iv)-1
for clarity. As proposed, the examples in the comment referred to dates
prior to the effective date of this rule; the Bureau has updated the
dates in the examples so that they will occur after this rule becomes
effective.
43(d)(2)(v)
Proposed Sec. 226.43(d)(1)(v) would have required that the
consumer have made no payments on the non-standard mortgage more than
30 days late during the six months immediately preceding the creditor's
receipt of the consumer's written application for the standard
mortgage. This provision complemented proposed Sec. 226.43(d)(1)(iv),
discussed above, in implementing the portion of TILA section
129C(a)(6)(E) that requires that the consumer not have been
``delinquent on any payment on the existing hybrid loan.'' Taken
together with proposed Sec. 226.43(d)(1)(iv), the Board believed that
this is a reasonable interpretation of the prohibition on ``any''
delinquencies on the non-standard mortgage and is supported by the
Board's authority under TILA sections 105(a) and 129B(e)--which has
transferred to the Bureau--to adjust provisions of TILA and condition
practices ``to assure that consumers are offered and receive
residential mortgage loans on terms that reasonably reflect their
ability to repay the loans and that are understandable and not unfair,
deceptive, or abusive.'' 15 U.S.C. 1604(a); TILA section 129B(a)(2), 15
U.S.C. 1639b(a)(2).
The Board stated that a six-month ``clean'' payment record
indicates a reasonable level of financial stability on the part of the
consumer applying for a refinancing. In addition, the Board noted that
participants in its outreach indicated that a prohibition on
delinquencies of more than 30 days for the six months prior to
application for the refinancing was generally consistent with common
industry practice and would not be unduly disruptive to existing
streamlined refinance programs with well-performing loans.
Proposed comment 43(d)(1)(v)-1 provided an illustrative example of
the proposed rule and clarified that if the number of months between
consummation of the non-standard mortgage and the consumer's
application for the standard mortgage is six or fewer, the consumer may
not have made any payment more than 30 days late on the non-standard
mortgage. The comment cross-referenced proposed comments 43(d)(1)-2 and
43(d)(1)(iv)-2 for an explanation of ``written application'' and how to
determine the payment due date, respectively.
One industry commenter stated that the prohibition on late payments
in the past six months should be amended to provide flexibility when
the late payment was due to extenuating circumstances. The Bureau
declines to adopt a rule providing an adjustment for extenuating
circumstances, for several reasons. First, the existence or absence of
extenuating circumstances is a fact-specific question and it would be
difficult to distinguish by regulation between extenuating
circumstances that reflect an ongoing risk with regard to the
consumer's ability to repay the loan versus extenuating circumstances
that present less risk. In addition, an adjustment for extenuating
circumstances appears to be inconsistent with the purposes of TILA
section 129C(a)(6)(E), which contemplates that the consumer ``has not
been delinquent on any payment on the existing hybrid loan,'' without
distinguishing between payments that are delinquent due to extenuating
circumstances or otherwise. Furthermore, by defining a late payment as
more than 30 days late, the Bureau believes that many extenuating
circumstances, for example a payment made three weeks late due to mail
delivery issues, will not preclude use of Sec. 1026.43(d).
Accordingly, the Bureau is adopting this provision as proposed,
renumbered as Sec. 1026.43(d)(2)(v). Similarly, the Bureau is adopting
comment 43(d)(1)(v)-1 generally as proposed, with several technical
amendments for clarity and renumbered as 43(d)(2)(v)-1. As proposed,
the examples in the comment referred to dates prior to the effective
date of this rule; the Bureau has updated the dates in the examples so
that they will occur after this rule becomes effective. Pursuant to its
authority under TILA section 105(a), the Bureau finds that requiring
that the consumer have made no payments on the non-standard mortgage
more than 30 days late during the six months

[[Page 6498]]

immediately preceding the creditor's receipt of the consumer's written
application for the standard mortgage ensures that consumers are
offered and receive residential mortgage loans on terms that reasonably
reflect their ability to repay while ensuring that responsible,
affordable mortgage credit remains available to consumers at risk of
default due to higher payments resulting from the recast.
43(d)(2)(vi)
For the reasons discussed in the section-by-section analysis of
Sec. 1026.43(d)(3), the Bureau is adopting a new Sec.
1026.43(d)(2)(vi) that generally conditions use of Sec. 1026.43(d) on
the existing non-standard mortgage having been made in accordance with
Sec. 1026.43(c), provided that the existing non-standard mortgage loan
was consummated on or after January 10, 2014. For the reasons discussed
in the section-by-section analysis of Sec. 1026.43(d)(3), the Bureau
believes that this provision is necessary and proper to prevent use of
Sec. 1026.43(d)'s streamlined refinance provision to circumvent or
``cure'' violations of the ability-to-repay requirements in Sec.
1026.43(c). Section 1026.43(d)(2)(vi) is adopted pursuant to the
Bureau's authority under TILA section 105(a). The Bureau finds that
this adjustment is necessary to effectuate the purposes of TILA by
ensuring that consumers are offered and receive residential mortgage
loans on terms that reasonably reflect their ability to repay, while
ensuring that consumers at risk of default due to payment shock are
able to obtain responsible and affordable refinancing credit.
Furthermore, the Bureau believes that this adjustment is necessary to
prevent unscrupulous creditors from using Sec. 1026.43(d) to engage in
loan-flipping or other practices that are harmful to consumers, thereby
circumventing the requirements of TILA.
43(d)(3) Exemption From Repayment Ability Requirements
Under specific conditions, proposed Sec. 226.43(d)(3) would have
exempted a creditor in a refinancing from two of the ability-to-repay
requirements under proposed Sec. 226.43(c). First, the proposal
provided that a creditor is not required to comply with the income and
asset verification requirements of proposed Sec. 226.43(c)(2)(i) and
(c)(4). Second, the proposal provided that the creditor is not required
to comply with the payment calculation requirements of proposed Sec.
226.43(c)(2)(iii) and (c)(5); the creditor may instead use payment
calculations prescribed in proposed Sec. 226.43(d)(5)(ii).
For these exemptions to apply, proposed Sec. 226.43(d)(3)(i)(A)
would have required that all of the conditions in proposed Sec.
226.43(d)(1)(i) through (v) be met. In addition, proposed Sec.
226.43(d)(3)(i)(B) would have required that the creditor consider
whether the standard mortgage will prevent a likely default by the
consumer on the non-standard mortgage when the non-standard mortgage is
recast. This proposed provision implemented TILA section
129C(a)(6)(E)(ii), which permits a creditor to ``consider if the
extension of new credit would prevent a likely default should the
original mortgage reset and give such concerns a higher priority as an
acceptable underwriting practice.'' As clarified in proposed comment
43(d)(3)(i)-1, the Board interpreted TILA section 129(a)(6)(E)(ii) to
require a creditor to consider whether: (1) The consumer is likely to
default on the existing mortgage once new, higher payments are
required; and (2) the new mortgage will prevent the consumer's default.
The Board solicited comment regarding whether these proposed provisions
were appropriate, and also specifically solicited comment on whether
exemptions from the ability-to-repay requirements, other than those
proposed, were appropriate.
Several commenters expressly supported this proposed provision. An
association of State bank supervisors stated that refinancing designed
to put a consumer in a higher-quality standard mortgage before the
existing lower-quality mortgage recasts should be given greater
deference and further stated that it is sound policy to encourage
refinancing where it protects both the economic interest of the
creditor and the financial health of the consumer. Consumer groups
commented that limited and careful exemption from income verification,
provided that protections are in place, can help consumers and
communities, while preventing reckless and abusive lending on the basis
of little or no documentation. Civil rights organizations also stated
that the streamlined refinance option would provide much-needed relief
for consumers with loans that are not sustainable in the long term but
who are not yet in default. These commenters also stated that minority
consumers have been targeted in the past for unsustainable loans and
that this provision could help to prevent further foreclosures and
economic loss in minority communities, as well as for homeowners in
general.
Other consumer group commenters stated that an exemption to the
income verification requirement for refinancing into standard mortgages
is problematic. One commenter stated that, because the refinance would
be executed by the same creditor that made the original hybrid loan,
income verification would not be difficult. This commenter urged the
Bureau to encourage income documentation when implementing the Dodd-
Frank Act.
Several industry commenters urged the Bureau to provide additional
relief for refinancings made in accordance with proposed Sec.
226.43(d), either by permitting the standard loan to be classified as a
qualified mortgage or by providing exemptions from other of the
proposed ability-to-repay requirements. One industry commenter stated
that in addition to the proposed exemption for the verification of
income and assets, refinancings conducted in accordance with Sec.
226.43(d) also should be exempt from the requirements to consider the
consumer's debt-to-income ratio or residual income, if the consumer is
still employed and has not incurred significant additional debt
obligations prior to the refinance. This commenter stated that overly
rigid standards could significantly reduce the number of consumers who
qualify for this exemption. Similarly, one industry trade association
urged the Bureau to exempt refinancings from the requirement to
consider the consumer's debt obligations, debt-to-income ratio, and
employment. This commenter stated that the proposed requirement to
consider these additional underwriting factors was seemingly in
conflict with the purpose of proposed Sec. 226.43(d) and would
preclude consumers from taking advantage of beneficial and less costly
refinancing opportunities. In addition, several industry commenters and
one industry trade association commented that standard mortgages made
in accordance with Sec. 226.43(d) should be treated as qualified
mortgages.
The Bureau agrees with the concerns raised by commenters that the
proposed exemptions were drawn too narrowly. The Bureau believes that
TILA section 129C(a)(6)(E) is intended to create incentives for
creditors to refinance loans in circumstances where consumers have non-
standard loans on which they are currently able to make payments but on
which they are likely to be unable to make the payments after recast
and therefore default on the loan. Accordingly, the Bureau believes
that in order to create incentives for creditors to use the non-
standard refinancing provision, TILA section 129C(a)(6)(E) must be
intended to provide at least a

[[Page 6499]]

limited exemption from the general ability-to-repay determination as
adopted in Sec. 1026.43(c). Otherwise, creditors may have little
incentive to provide consumers at risk of default with refinancings
that result in ``materially lower'' payments. The Bureau believes,
however, that in implementing TILA section 129C(a)(6)(E) it is
important to balance the creation of additional flexibility and
incentives for creditors to refinance non-standard mortgages into
standard mortgages against the likelihood of benefit to the consumer.
The Bureau notes that under the final rule as adopted, the
availability of the non-standard refinancing provision contains several
conditions that are intended to benefit the consumer. First, the
special ability-to-repay requirements in Sec. 1026.43(d) are available
only if the conditions in Sec. 1026.43(d)(2) are met. These conditions
include limiting the scope of Sec. 1026.43(d) to refinancings of non-
standard mortgages into standard mortgages, which generally are more
stable products with reduced risk of payment shock. The definition of
standard mortgage in Sec. 1026.43(d)(1)(ii) includes a number of
limitations that are intended to ensure that creditors may only use the
provisions in Sec. 1026.43(d) to offer a consumer a product with safer
features. For example, as discussed in the section-by-section analysis
of Sec. 1026.43(d)(1)(ii) a standard mortgage may not include negative
amortization, an interest-only feature, or a balloon payment; in
addition, the term of the standard mortgage may not exceed 40 years,
the interest rate must be fixed for at least the first five years, the
loan is subject to a limitation on the points and fees that may be
charged, and there are limitations on the use of proceeds from the
refinancing. Furthermore, Sec. 1026.43(d)(2)(ii) requires that the
monthly payment on the standard mortgage be materially lower than the
monthly payment for the non-standard mortgage and, as discussed above,
the Bureau is adopting a 10 percent safe harbor for what constitutes a
``material'' reduction.
The Bureau has concerns that, as proposed by the Board, an
exemption only from the requirement to consider and verify the
consumer's income or assets may create insufficient incentives for
creditors to make refinancings to assist consumers at risk of default.
For example, the proposal would have required creditors to comply with
the requirement in Sec. 1026.43(c)(2)(vii) to consider the consumer's
debt-to-income ratio or residual income. Accordingly, notwithstanding
an exemption from income or asset verification, the proposal would have
required consideration of income, as well as consideration of all of
the other underwriting criteria set forth in Sec. 1026.43(c)(2).
The Bureau believes that in light of the safeguards imposed by
other portions of Sec. 1026.43(d), as discussed above, it is
appropriate to provide an exemption to all of the ability-to-repay
requirements under Sec. 1026.43(c) for a refinance conducted in
accordance with Sec. 1026.43(d). The Bureau believes that a broad
exemption from the general ability-to-repay determination is
appropriate in order to create incentives for creditors to quickly and
efficiently refinance consumers whose non-standard mortgages are about
to recast, thus rendering them likely to default, into more affordable,
more stable mortgage loans. The Bureau is aware that some consumers may
nonetheless default on a standard mortgage made in accordance with
Sec. 1026.43(d), but those consumers likely would have defaulted had
the non-standard mortgage remained in place. For others, the material
reduction in payment required under Sec. 1026.43(d)(2) and the more
stable product type following refinancing may be sufficient to enable
consumers to avoid default. The Bureau believes that a refinancing
conducted in accordance with Sec. 1026.43(d) will generally improve a
consumer's chances of avoiding default. Section 1026.43(d)(3) is
adopted pursuant to the Bureau's authority under TILA section 105(a).
The Bureau finds that this adjustment is necessary to effectuate the
purposes of TILA by ensuring that consumers are offered and receive
residential mortgage loans on terms that reasonably reflect their
ability to repay, while ensuring that consumers at risk of default due
to payment shock are able to obtain responsible and affordable
refinancing credit.
However, to prevent evasion or circumvention of the ability-to-
repay requirements in Sec. 1026.43(c), the Bureau is imposing one
additional condition on the use of Sec. 1026.43(d). Specifically, new
Sec. 1026.43(d)(2)(vi) conditions the use of Sec. 1026.43(d), for
non-standard mortgages consummated on or after the effective date of
this rule, on the non-standard mortgage having been made in accordance
with Sec. 1026.43(c). The Bureau has concerns that absent Sec.
1026.43(d)(2)(vi), a creditor might attempt to use a refinancing
conducted in accordance with Sec. 1026.43(d) to ``cure'' substandard
underwriting of the prior non-standard mortgage. For example, without
Sec. 1026.43(d)(2)(vi), if a creditor discovered that it had made an
error in consideration of the underwriting factors under Sec.
1026.43(c)(2) for a non-standard mortgage, the creditor might consider
conducting a refinancing under Sec. 1026.43(d), in order to argue that
the consumer may no longer raise as a defense to foreclosure the
underwriting of the original non-standard mortgage. The Bureau believes
that conditioning the use of Sec. 1026.43(d) on the earlier loan
having been made in accordance with Sec. 1026.43(c) will better
effectuate the purposes of TILA by ensuring that consumers are offered
and receive residential mortgage loans on terms that reasonably reflect
their ability to repay while preventing unscrupulous creditors from
evading the ability-to-repay requirements.
New Sec. 1026.43(d)(2)(vi) applies only to non-standard mortgages
consummated on or after the effective date of this rule. For non-
standard loans consummated before the effective date of this final
rule, a refinancing under Sec. 1026.43(d) would not be subject to this
condition. The Bureau believes that non-standard mortgages made prior
to the effective date, to which the ability-to-repay requirements in
Sec. 1026.43(c) did not apply, may present an increased risk of
default when they are about to recast, so that facilitating refinancing
into more stable mortgages may be particularly important even if the
consumer could not qualify for a new loan under traditional ability-to-
repay requirements. The Bureau believes that, on balance, given the
conditions that apply to refinances under Sec. 1026.43(d), refinances
of these loans are more likely to benefit consumers than to harm
consumers, notwithstanding the inapplicability of Sec.
1026.43(d)(2)(vi). In addition, the concern about a creditor using
Sec. 1026.43(d) to ``cure'' prior violations of Sec. 1026.43(c) does
not apply to loans made before the effective date of this rule, as such
loans were not required to be made in accordance with Sec. 1026.43.
Proposed condition that the consumer will likely default. Proposed
comment 43(d)(3)(i)-2 would have clarified that, in considering whether
the consumer's default on the non-standard mortgage is ``likely,'' the
creditor may look to widely accepted governmental and non-governmental
standards for analyzing a consumer's likelihood of default. The
proposal was not intended, however, to constrain servicers and other
relevant parties from using other methods to determine a consumer's
likelihood of default, including those tailored specifically to that
servicer. As discussed in the supplementary information to the
proposal, the Board

[[Page 6500]]

considered certain government refinancing programs as well as feedback
from outreach participants, each of which suggested that there may be
legitimate differences in servicer assessments of a consumer's
likelihood of default. The Board noted that it considered an ``imminent
default'' standard but heard from consumer advocates that ``imminent
default'' may be a standard that is too high for the refinancing
provisions in TILA section 129C(a)(6)(E) and could prevent many
consumers from obtaining a refinancing to avoid payment shock.
Accordingly, the Board's proposal used the exact statutory wording--
``likely default''--in implementing the provision permitting a creditor
to prioritize prevention of default in underwriting a refinancing. The
Board solicited comment on the proposal to use the term ``likely
default'' in implementing TILA section 129C(a)(6)(E)(ii) and on whether
additional guidance is needed on how to meet the requirement that a
creditor must reasonably and in good faith determine that a standard
mortgage will prevent a likely default should the non-standard mortgage
be recast.
Two industry trade associations urged the Bureau to remove proposed
Sec. 226.43(d)(3)(i)(B) as a condition to the availability of the non-
standard refinancing provisions. One of these commenters noted that a
creditor would have to underwrite a consumer's income and assets to
determine whether the consumer would likely default, which would defeat
the purpose of the proposed provision. Several industry commenters also
indicated that the ``likelihood of default'' standard is vague and
accordingly subjects creditors to potential liability for waiving
certain ability-to-repay requirements, and questioned the extent to
which creditors would utilize the streamline refinance option in light
of this potential liability. One such commenter urged the Bureau to
eliminate this requirement or, in the alternative, to provide
additional guidance regarding when a consumer is ``likely to go into
default.''
An association of State bank supervisors stated that there can be
no quantifiable standard for the definition of ``likely default.''
These commenters further stated that institutions must use sound
judgment and regulators must provide responsible oversight to ensure
that abuses are not occurring through the refinancing exemption set
forth in Sec. 1026.43(d).
The Bureau is adopting the provision as proposed, renumbered as
Sec. 1026.43(d)(3)(i)(B), and is also adopting comments 43(d)(3)(i)-1
and 43(d)(3)(i)-2 as proposed. The Bureau believes that eliminating the
requirement that a creditor consider whether the extension of new
credit would prevent a likely default would be inconsistent with TILA
section 129C(a)(6)(E), which expressly includes language regarding
consideration by the creditor of ``[whether] the extension of new
credit would prevent a likely default should the original mortgage
reset.'' At the same time, the Bureau agrees with the association of
State bank supervisors that it would be difficult to impose by
regulation a single standard for what constitutes a likely default.
Accordingly, the Bureau is adopting the flexible approach proposed by
the Board, which would permit but not require creditors to look to
widely-accepted standards for analyzing a consumer's likelihood of
default. The Bureau does not believe that this flexible approach
requires a creditor to consider the consumer's income and assets if,
for example, statistical evidence indicates that consumers who
experience a payment shock of the type that the consumer is about to
experience have a high incidence of defaulting following the payment
shock.
Proposed payment calculation for repayment ability determination.
Proposed comment 43(d)(3)(ii)-1 would have explained that, if the
conditions in proposed Sec. 226.43(d)(1) are met, the creditor may
satisfy the payment calculation requirements for determining a
consumer's ability to repay the new loan by applying the calculation
prescribed under proposed Sec. 226.43(d)(5)(ii), rather than the
calculation prescribed under proposed Sec. 226.43(c)(2)(iii) and
(c)(5). As discussed in the section-by-section analysis above, as
adopted Sec. 1026.43(d)(3) provides an exemption from the requirements
of Sec. 1026.43(c) if certain conditions are met. Accordingly, while
the creditor is required to determine whether there is a material
reduction in payment consistent with Sec. 1026.43(d)(2)(ii) by using
the payment calculations prescribed in Sec. 1026.43(d)(5), the
creditor is not required to use these same payment calculations for
purposes of Sec. 1026.43(c). Accordingly, the Bureau is withdrawing
proposed comment 43(d)(3)(ii)-1 as unnecessary.
43(d)(4) Offer of Rate Discounts and Other Favorable Terms
Proposed Sec. 226.43(d)(4) would have provided that a creditor
making a loan under the special refinancing provisions of Sec.
226.43(d) may offer to the consumer the same or better rate discounts
and other terms that the creditor offers to any new consumer,
consistent with the creditor's documented underwriting practices and to
the extent not prohibited by applicable State or Federal law. This
aspect of the proposal was intended to implement TILA section
129C(a)(6)(E)(iii), which permits creditors of refinancings subject to
special ability-to-repay requirements in TILA section 129C(a)(6)(E) to
``offer rate discounts and other favorable terms'' to the consumer
``that would be available to new customers with high credit ratings
based on such underwriting practice.''
The Bureau received no comments on this provision, which is adopted
as proposed and renumbered as Sec. 1026.43(d)(4). The Bureau is
concerned that the phrase ``consistent with the creditor's underwriting
practice'' could be misinterpreted to refer to the underwriting
requirements in Sec. 1026.43(c). As this final rule provides an
exemption under Sec. 1026.43(d) for all of the requirements in Sec.
1026.43(c), subject to the other conditions discussed above, the Bureau
believes that additional clarification is needed to address this
potential misinterpretation. Thus, the Bureau is adopting comment
43(d)(4)-1, which clarifies that in connection with a refinancing made
pursuant to Sec. 1026.43(d), Sec. 1026.43(d)(4) requires a creditor
offering a consumer rate discounts and terms that are the same as, or
better than, the rate discounts and terms offered to new consumers to
make such an offer consistent with the creditor's documented
underwriting practices. Section 1026.43(d)(4) does not require a
creditor making a refinancing pursuant to Sec. 1026.43(d) to comply
with the underwriting requirements of Sec. 1026.43(c). Rather, Sec.
1026.43(d)(4) requires creditors providing such discounts to do so
consistent with documented policies related to loan pricing, loan term
qualifications, or other similar underwriting practices. For example,
assume that a creditor is providing a consumer with a refinancing made
pursuant to Sec. 1026.43(d) and that this creditor has a documented
practice of offering rate discounts to consumers with credit scores
above a certain threshold. Assume further that the consumer receiving
the refinancing has a credit score below this threshold, and therefore
would not normally qualify for the rate discount available to consumers
with high credit scores. This creditor complies with Sec.
1026.43(d)(4) by offering the consumer the discounted rate in
connection with the refinancing made pursuant to Sec. 1026.43(d), even
if the consumer would not normally

[[Page 6501]]

qualify for that discounted rate, provided that the offer of the
discounted rate is not prohibited by applicable State or Federal law.
However, Sec. 1026.43(d)(4) does not require a creditor to offer a
consumer such a discounted rate.
43(d)(5) Payment Calculations
Proposed Sec. 226.43(d)(5) would have prescribed the payment
calculations for determining whether the consumer's monthly payment for
a standard mortgage will be ``materially lower'' than the monthly
payment for the non-standard mortgage. Proposed Sec. 226.43(d)(5) thus
was intended to complement proposed Sec. 226.43(d)(1)(ii) in
implementing TILA section 129C(a)(6)(E), which requires a ``reduction''
in the monthly payment for the existing non-standard (``hybrid'')
mortgage when refinanced into a standard mortgage.
43(d)(5)(i) Non-Standard mortgage
Proposed Sec. 226.43(d)(5)(i) would have required that the monthly
payment for a non-standard mortgage be based on substantially equal,
monthly, fully amortizing payments of principal and interest that would
result once the mortgage is recast. The Board stated that comparing the
payment on the standard mortgage to the payment amount on which the
consumer likely would have defaulted (i.e., the payment resulting on
the existing non-standard mortgage once the introductory terms cease
and a higher payment results) would promote needed refinances
consistent with Congress's intent.
The Board noted that the payment that the consumer is currently
making on the existing non-standard mortgage may be an inappropriately
low payment to compare to the standard mortgage payment. The existing
payments may be interest-only or negatively amortizing; these
temporarily lower payment amounts would be difficult for creditors to
``reduce'' with a refinanced loan that has a comparable term length and
principal amount. Indeed, the payment on a new loan with a fixed-rate
rate and fully-amortizing payment, as is required for the payment
calculation of a standard mortgage under the proposal, for example, is
likely to be higher than the interest-only or negative amortization
payment. As a result, few refinancings would yield a lower monthly
payment, so many consumers could not receive the benefits of
refinancing into a more stable loan product.
Accordingly, the proposal would have required a creditor to
calculate the monthly payment for a non-standard mortgage using--
The fully indexed rate as of a reasonable period of time
before or after the date on which the creditor receives the consumer's
written application for the standard mortgage;
The term of the loan remaining as of the date of the
recast, assuming all scheduled payments have been made up to the recast
date and the payment due on the recast date is made and credited as of
that date; and
A remaining loan amount that is--
[cir] For an adjustable-rate mortgage, the outstanding principal
balance as of the date the mortgage is recast, assuming all scheduled
payments have been made up to the recast date and the payment due on
the recast date is made and credited as of that date;
[cir] For an interest-only loan, the loan amount, assuming all
scheduled payments have been made up to the recast date and the payment
due on the recast date is made and credited as of that date;
[cir] For a negative amortization loan, the maximum loan amount.
Proposed comment 43(d)(5)(i)-1 would have explained that, to
determine whether the monthly periodic payment for a standard mortgage
is materially lower than the monthly periodic payment for the non-
standard mortgage under proposed Sec. 226.43(d)(1)(ii), the creditor
must consider the monthly payment for the non-standard mortgage that
will result after the loan is recast, assuming substantially equal
payments of principal and interest that amortize the remaining loan
amount over the remaining term as of the date the mortgage is recast.
The proposed comment noted that guidance regarding the meaning of
``substantially equal'' and ``recast'' is provided in comment
43(c)(5)(i)-4 and Sec. 226.43(b)(11), respectively.
Proposed comment 43(d)(5)(i)-2 would have explained that the term
``fully indexed rate'' used for calculating the payment for a non-
standard mortgage is generally defined in proposed Sec. 226.43(b)(3)
and associated commentary. The proposed comment explained an important
difference between the ``fully indexed rate'' as defined in proposed
Sec. 226.43(b)(3), however, and the meaning of ``fully indexed rate''
in Sec. 226.43(d)(5)(i). Specifically, under proposed Sec.
226.43(b)(3), the fully indexed rate is calculated at the time of
consummation. Under proposed Sec. 226.43(d)(5)(i), the fully indexed
rate would be calculated within a reasonable period of time before or
after the date on which the creditor receives the consumer's written
application for the standard mortgage. Comment 43(d)(5)(i)-2 clarified
that 30 days would generally be considered a ``reasonable period of
time.''
Proposed comment 43(d)(5)(i)-3 would have clarified that the term
``written application'' is explained in comment 19(a)(1)(i)-3. Comment
19(a)(1)(i)-3 states that creditors may rely on RESPA and Regulation X
(including any interpretations issued by HUD) in deciding whether a
``written application'' has been received. In general, Regulation X
defines ``application'' to mean the submission of a borrower's
financial information in anticipation of a credit decision relating to
a federally related mortgage loan. See 12 CFR 1024.2(b). As explained
in comment 19(a)(1)(i)-3, an application is received when it reaches
the creditor in any of the ways applications are normally transmitted,
such as by mail, hand delivery, or through an intermediary agent or
broker. If an application reaches the creditor through an intermediary
agent or broker, the application is received when it reaches the
creditor, rather than when it reaches the agent or broker. This
proposed comment also cross-referenced comment 19(b)-3 for guidance in
determining whether the transaction involves an intermediary agent or
broker.
Proposed payment calculation for an adjustable-rate mortgage with
an introductory fixed rate. Proposed comments 43(d)(5)(i)-4 and -5
would have clarified the payment calculation for an adjustable-rate
mortgage with an introductory fixed rate under proposed Sec.
226.43(d)(5)(i). Proposed comment 43(d)(5)(i)-4 clarified that the
monthly periodic payment for an adjustable-rate mortgage with an
introductory fixed interest rate for a period of one or more years must
be calculated based on several assumptions. First, the payment must be
based on the outstanding principal balance as of the date on which the
mortgage is recast, assuming all scheduled payments have been made up
to that date and the last payment due under those terms is made and
credited on that date. Second, the payment calculation must be based on
substantially equal monthly payments of principal and interest that
will fully repay the outstanding principal balance over the term of the
loan remaining as of the date the loan is recast. Third, the payment
must be based on the fully indexed rate, as defined in Sec.
226.43(b)(3), as of the date of the written application for the
standard mortgage. The proposed comment set forth an illustrative
example. Proposed comment 43(d)(5)(i)-5 would have provided a second
illustrative example of the payment calculation for an

[[Page 6502]]

adjustable-rate mortgage with an introductory fixed rate.
Proposed payment calculation for an interest-only loan. Proposed
comments 43(d)(5)(i)-6 and -7 would have explained the payment
calculation for an interest-only loan under proposed Sec.
226.43(d)(5)(i). Proposed comment 43(d)(5)(i)-6 would have clarified
that the monthly periodic payment for an interest-only loan must be
calculated based on several assumptions. First, the payment must be
based on the loan amount, as defined in Sec. 226.43(b)(5), assuming
all scheduled payments are made under the terms of the legal obligation
in effect before the mortgage is recast. The comment provides an
example of a mortgage with a 30-year loan term for which the first 24
months of payments are interest-only. The comment then explains that,
if the 24th payment is due on September 1, 2013, the creditor must
calculate the outstanding principal balance as of September 1, 2013,
assuming that all 24 payments under the interest-only payment terms
have been made and credited.
Second, the payment calculation must be based on substantially
equal monthly payments of principal and interest that will fully repay
the loan amount over the term of the loan remaining as of the date the
loan is recast. Thus, in the example above, the creditor must assume a
loan term of 28 years (336 payments). Third, the payment must be based
on the fully indexed rate as of the date of the written application for
the standard mortgage.
Proposed comment 43(d)(5)(i)-7 would have provided an illustration
of the payment calculation for an interest-only loan. The example
assumes a loan in an amount of $200,000 that has a 30-year loan term.
The loan agreement provides for a fixed interest rate of 7 percent, and
permits interest-only payments for the first two years, after which
time amortizing payments of principal and interest are required.
Second, the example states that the non-standard mortgage is
consummated on February 15, 2011, and the first monthly payment is due
on April 1, 2011. The loan is recast on the due date of the 24th
monthly payment, which is March 1, 2013. Finally, the example assumes
that on March 15, 2012, the creditor receives the consumer's written
application for a refinancing, after the consumer has made 12 monthly
on-time payments.
Proposed comment 43(d)(5)(i)-7 would have further explained that,
to calculate the non-standard mortgage payment that must be compared to
the standard mortgage payment, the creditor must use--
The loan amount, which is the outstanding principal
balance as of March 1, 2013, assuming all scheduled interest-only
payments have been made and credited up to that date. In this example,
the loan amount is $200,000.
An interest rate of 7 percent, which is the interest rate
in effect at the time of consummation of this fixed-rate non-standard
mortgage.
The remaining loan term as of March 1, 2013, the date of
the recast, which is 28 years.
The comment concluded by stating that, based on the assumptions
above, the monthly payment for the non-standard mortgage for purposes
of determining whether the standard mortgage monthly payment is lower
than the non-standard mortgage monthly payment is $1,359. This is the
substantially equal, monthly payment of principal and interest required
to repay the loan amount at the fully indexed rate over the remaining
term.
Proposed payment calculation for a negative amortization loan.
Proposed comments 43(d)(5)(i)-8 and -9 would have explained the payment
calculation for a negative amortization loan under proposed Sec.
226.43(d)(5)(i)(C). Proposed comment 43(d)(5)(i)-8 would have clarified
that the monthly periodic payment for a negative amortization loan must
be calculated based on several assumptions. First, the calculation must
be based on the maximum loan amount. The comment further stated that
examples of how to calculate the maximum loan amount are provided in
proposed comment 43(b)(7)-3.
Second, the payment calculation must be based on substantially
equal monthly payments of principal and interest that will fully repay
the maximum loan amount over the term of the loan remaining as of the
date the loan is recast. For example, the comment states, if the loan
term is 30 years and the loan is recast on the due date of the 60th
monthly payment, the creditor must assume a loan term of 25 years.
Third, the payment must be based on the fully indexed rate as of the
date of the written application for the standard mortgage.
Proposed comment 43(d)(5)(i)-9 would have provided an illustration
of the payment calculation for a negative amortization loan. The
example assumes a loan in an amount of $200,000 that has a 30-year loan
term. The loan agreement provides that the consumer can make minimum
monthly payments that cover only part of the interest accrued each
month until the date on which the principal balance increases to the
negative amortization cap of 115 percent of the loan amount, or for the
first five years of monthly payments, whichever occurs first. The loan
is an adjustable-rate mortgage that adjusts monthly according to a
specified index plus a margin of 3.5 percent.
The example also assumed that the non-standard mortgage is
consummated on February 15, 2011, and the first monthly payment is due
on April 1, 2011. Further, the example assumes that, based on the
calculation of the maximum loan amount required under Sec.
226.43(b)(7) and associated commentary, the negative amortization cap
of 115 percent is reached on July 1, 2013, the due date of the 28th
monthly payment. Finally, the example assumes that on March 15, 2012,
the creditor receives the consumer's written application for a
refinancing, after the consumer has made 12 monthly on-time payments.
On this date, the index value is 4.5 percent.
Proposed comment 43(d)(5)(i)-9 then stated that, to calculate the
non-standard mortgage payment that must be compared to the standard
mortgage payment under proposed Sec. 226.43(d)(1)(ii), the creditor
must use--
The maximum loan amount of $229,243 as of July 1, 2013.
The fully indexed rate of 8 percent, which is the index
value of 4.5 percent as of March 15, 2012 (the date on which the
creditor receives the application for a refinancing) plus the margin of
3.5 percent.
The remaining loan term as of July 1, 2013, the date of
the recast, which is 27 years and 8 months (332 monthly payments).
The comment concluded by stating that, based on the assumptions
above, the monthly payment for the non-standard mortgage for purposes
of determining whether the standard mortgage monthly payment is lower
than the non-standard mortgage monthly payment is $1,717. This is the
substantially equal, monthly payment of principal and interest required
to repay the maximum loan amount at the fully indexed rate over the
remaining term.
The Board requested comment on the proposed payment calculation for
a non-standard mortgage and on the appropriateness and usefulness of
the proposed payment calculation examples.
The Bureau received no specific comment on the payment calculations
for non-standard mortgages set forth in proposed Sec. 226.43(d)(5)(i)
and its associated commentary. Accordingly, the provision that is being
adopted is substantially similar to the version proposed, renumbered as
Sec. 1026.43(d)(5)(i). The Bureau also is

[[Page 6503]]

adopting the associated commentary generally as proposed. The Bureau
has made several technical amendments to the examples in comments
43(d)(5)(i)-4, -5, -6, -7, and -9 for clarity. As proposed, the
examples in the comment referred to dates prior to the effective date
of this rule; the Bureau has updated the dates in the examples so that
they will occur after this rule becomes effective.
The Bureau believes that it is necessary to clarify the provisions
related to payment calculations for interest-only loans and negative
amortization loans. The provisions adopted clarify that the payment
calculation required by Sec. 1026.43(d)(5)(i) must be based on the
outstanding principal balance, rather than the original amount of
credit extended. Accordingly, as adopted Sec. 1026.43(d)(5)(i)(C)(2)
requires the remaining loan amount for an interest-only loan to be
based on the outstanding principal balance as of the date of the
recast, assuming all scheduled payments have been made up to the recast
date and the payment due on the recast date is made and credited as of
that date. Similarly, Sec. 1026.43(d)(5)(i)(C)(3) requires the
remaining loan amount for a negative amortization loan to be based on
the maximum loan amount, determined after adjusting for the outstanding
principal balance. The Bureau has made technical amendments to the
example in comments 43(d)(5)(i)-6, -7, -8, and -9 to conform to this
clarification.
Additionally, the Bureau has added new comment 43(d)(5)(i)-10 to
add an additional illustration of the payment calculation for a
negative amortization loan. As adopted, comment 43(d)(5)(i)-10 provides
an illustrative example, clarifying that, pursuant to the example and
assumptions included in the example, to calculate the non-standard
mortgage payment on a negative amortization loan for which the consumer
has made more than the minimum required payment that must be compared
to the standard mortgage payment under Sec. 1026.43(d)(1)(i), the
creditor must use the maximum loan amount of $229,219 as of March 1,
2019, the fully indexed rate of 8 percent, which is the index value of
4.5 percent as of March 15, 2012 (the date on which the creditor
receives the application for a refinancing) plus the margin of 3.5
percent, and the remaining loan term as of March 1, 2019, the date of
the recast, which is 25 years (300 monthly payments). The comment
further explains that, based on these assumptions, the monthly payment
for the non-standard mortgage for purposes of determining whether the
standard mortgage monthly payment is lower than the non-standard
mortgage monthly payment is $1,769. This is the substantially equal,
monthly payment of principal and interest required to repay the maximum
loan amount at the fully indexed rate over the remaining term. The
Bureau finds that comment 43(d)(5)(i)-10, which is adopted pursuant to
the Bureau's authority under section 105(a) of TILA, is necessary to
facilitate compliance with TILA.
43(d)(5)(ii) Standard Mortgage
Proposed Sec. 226.43(d)(5)(ii) would have prescribed the required
calculation for the monthly payment on a standard mortgage that must be
compared to the monthly payment on a non-standard mortgage under
proposed Sec. 226.43(d)(1)(ii). The same payment calculation must also
be used by creditors of refinances under proposed Sec. 226.43(d) in
determining whether the consumer has a reasonable ability to repay the
standard mortgage, as would have been required under proposed Sec.
226.43(c)(2)(ii).
Specifically, the monthly payment for a standard mortgage must be
based on substantially equal, monthly, fully amortizing payments using
the maximum interest rate that may apply to the standard mortgage
within the first five years after consummation. Proposed comment
43(d)(5)(ii)-1 would have clarified that the meaning of ``fully
amortizing payment'' is defined in Sec. 226.43(b)(2), and that
guidance regarding the meaning of ``substantially equal'' may be found
in proposed comment 43(c)(5)(i)-4. Proposed comment 43(d)(5)(ii)-1 also
explained that, for a mortgage with a single, fixed rate for the first
five years, the maximum rate that will apply during the first five
years after consummation will be the rate at consummation. For a step-
rate mortgage, however, which is a type of fixed-rate mortgage, the
rate that must be used is the highest rate that will apply during the
first five years after consummation. For example, if the rate for the
first two years is 4 percent, the rate for the second two years is 5
percent, and the rate for the next two years is 6 percent, the rate
that must be used is 6 percent.
Proposed comment 43(d)(5)(ii)-2 would have provided an illustration
of the payment calculation for a standard mortgage. The example assumes
a loan in an amount of $200,000 with a 30-year loan term. The loan
agreement provides for an interest rate of 6 percent that is fixed for
an initial period of five years, after which time the interest rate
will adjust annually based on a specified index plus a margin of 3
percent, subject to a 2 percent annual interest rate adjustment cap.
The comment states that, based on the above assumptions, the creditor
must determine whether the standard mortgage payment is materially
lower than the non-standard mortgage payment based on a standard
mortgage payment of $1,199. This is the substantially equal, monthly
payment of principal and interest required to repay $200,000 over 30
years at an interest rate of 6 percent.
The Bureau received no specific comment on the payment calculations
for standard mortgages set forth in proposed Sec. 226.43(d)(5)(ii) and
its associated commentary. Accordingly, this provisions is adopted as
proposed, renumbered as Sec. 1026.43(d)(5)(ii). The Bureau also is
adopting the associated commentary generally as proposed, with several
technical amendments for clarity.
43(e) Qualified Mortgages
Background
As discussed above, TILA section 129C(a)(1) prohibits a creditor
from making a residential mortgage loan unless the creditor makes a
reasonable and good faith determination, at or before consummation,
based on verified and documented information, that at the time of
consummation the consumer has a reasonable ability to repay the loan.
TILA section 129C(a)(1) through (4) and (6) through (9) requires
creditors specifically to consider and verify various factors relating
to the consumer's income and other assets, debts and other obligations,
and credit history. However, the ability-to-repay provisions do not
directly restrict features, term, or costs of the loan.
TILA section 129C(b), in contrast, provides that loans that meet
certain requirements shall be deemed ``qualified mortgages,'' which are
entitled to a presumption of compliance with the ability-to-repay
requirements. The section sets forth a number of qualified mortgage
requirements which focus mainly on prohibiting certain risky features
and practices (such as negative amortization and interest-only periods
or underwriting a loan without verifying the consumer's income) and on
generally limiting points and fees in excess of 3 percent of the total
loan amount. The only underwriting provisions in the statutory
definition of qualified mortgage are a requirement that ``income and
financial resources relied upon to qualify the [borrowers] be verified
and documented'' and a further requirement that underwriting be based

[[Page 6504]]

upon a fully amortizing schedule using the maximum rate permitted
during the first five years of the loan. TILA section
129C(b)(2)(A)(iii) through (v). However, TILA section 129C(b)(2)(A)(vi)
authorizes the Bureau to adopt ``guidelines or regulations * * *
relating to ratios of total monthly debt to monthly income or
alternative measures of ability to pay * * * .'' And TILA section
129C(b)(3)(B)(i) further authorizes the Bureau to revise, add to, or
subtract from the criteria that define a qualified mortgage upon a
finding that the changes are necessary or proper to ensure that
responsible, affordable mortgage credit remains available to consumers
in a manner consistent with the purposes of TILA section 129C,
necessary and appropriate to effectuate the purposes of TILA sections
129C and 129B, to prevent circumvention or evasion thereof, or to
facilitate compliance with TILA sections 129C and 129B.\127\
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\127\ TILA section 129B contains requirements and restrictions
relating to mortgage originators. TILA section 129B(b) requires a
loan originator to be qualified and, when required, registered and
licensed as a mortgage originator under the Secure and Fair
Enforcement of Mortgage Licensing Act of 2008 (SAFE Act), and to
include on all loan documents any unique identifier of the mortgage
originator provided by the Nationwide Mortgage Licensing System and
Registry. That section also requires the Bureau to prescribe
regulations requiring depository institutions to establish and
maintain procedures designed to ensure and monitor compliance of
such institutions, including their subsidiaries and employees, with
the SAFE Act. TILA section 129B(c) contains certain prohibitions on
loan originator steering, including restrictions on various
compensation practices, and requires the Bureau to prescribe
regulations to prohibit certain specific steering activities.
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The qualified mortgage requirements are critical to implementation
of various parts of the Dodd-Frank Act. For example, several consumer
protection requirements in title XIV of the Dodd-Frank Act treat
qualified mortgages differently than non-qualified mortgages or key off
elements of the qualified mortgage definition.\128\ In addition, the
requirements concerning retention of risk by parties involved in the
securitization process under title IX of the Dodd-Frank Act provide
special treatment for ``qualified residential mortgages,'' which under
section 15G of the Securities Exchange Act of 1934, as amended by
section 941(b) of the Dodd-Frank Act, ``shall be no broader than the
term `qualified mortgage,''' as defined by TILA section 129C(b) and the
Bureau's implementing regulations. 15 U.S.C. 780-11(e)(4).\129\
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\128\ For example, as described in the section-by-section
analysis of Sec. 1026.43(g), TILA section 129C(c), added by section
1414(a) of the Dodd-Frank Act, provides that a residential mortgage
loan that is not a ``qualified mortgage'' may not contain a
prepayment penalty. In addition, section 1471 of the Dodd-Frank Act
establishes a new TILA section 129H, which sets forth appraisal
requirements applicable to higher-risk mortgages. The definition of
``higher-risk mortgage'' expressly excludes qualified mortgages.
\129\ See part II.G for a discussion of the 2011 QRM Proposed
Rule.
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For present purposes, however, the definition of a qualified
mortgage is perhaps most significant because of its implications for
ability-to-repay claims. TILA section 129C(b)(1) provides that ``[a]ny
creditor with respect to any residential mortgage loan, and any
assignee of such loan subject to liability under this title, may
presume that the loan has met the [ability-to-repay] requirements of
subsection (a), if the loan is a qualified mortgage.'' But the statute
does not describe the strength of the presumption or what if anything
could be used to rebut it. As discussed further below, there are legal
and policy arguments that support interpreting the presumption as
either rebuttable or conclusive.
Determining the definition and scope of protection afforded to
qualified mortgages is the area of this rulemaking which has engendered
perhaps the greatest interest and comment. Although TILA section
129C(a)(1) requires only that a creditor make a ``reasonable and good
faith determination'' of the consumer's ``reasonable ability to repay''
a residential mortgage, considerable concern has arisen about the
actual and perceived litigation and liability risk to creditors and
assignees under the statute. Commenters tended to focus heavily on the
choice between a presumption that is rebuttable and one that is
conclusive as a means of mitigating that risk, although the criteria
that define a qualified mortgage are also important because a creditor
would have to prove status as a qualified mortgage in order to invoke
any (rebuttable or conclusive) presumption of compliance.
In assessing the potential impacts of the statute, it is important
to note that regulations issued after the mortgage crisis but prior to
the enactment of the Dodd-Frank Act have already imposed ability-to-
repay requirements for high-cost and higher-priced mortgages and
created a presumption of compliance for such mortgages if the creditor
satisfied certain underwriting and verification requirements.
Specifically, under provisions of the Board's 2008 HOEPA Final Rule
that took effect in October 2009, creditors are prohibited from
extending high-cost or higher-priced mortgage loans without regard to
the consumer's ability to repay. See Sec. 1026.34(a)(4). The rules
provide a presumption of compliance with those ability-to-repay
requirements if the creditor follows certain optional procedures
regarding underwriting the loan payment, assessing the debt-to-income
(DTI) ratio or residual income, and limiting the features of the loan,
in addition to following certain procedures mandated for all creditors.
See Sec. 1026.34(a)(4)(iii) and (iv) and comment 34(a)(4)(iii)-1.
However, the 2008 HOEPA Final Rule makes clear that even if the
creditor follows these criteria, the presumption of compliance is
rebuttable. See comment 34(a)(4)(iii)-1. The consumer can still
overcome 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 or residual income, the debt-to-income
ratio was very high or the residual income was very low. 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 extends a requirement to assess consumers'
ability to repay to the full mortgage market, and establishes a
presumption using a different set of criteria that focus more on
product features than underwriting practices. Further, the statute
establishes similar but slightly different remedies than are available
under the existing requirements. Section 1416 of the Dodd-Frank Act
amended TILA section 130(a) to provide that a consumer who brings a
timely action against a creditor for a violation 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. The
statute of limitations is three years from the date of the occurrence
of the violation. Moreover, as amended by section 1413 of the Dodd-
Frank Act, TILA section 130(k) provides that when a creditor, assignee,
or other holder initiates a foreclosure action, a consumer may assert a
violation of the ability-to-repay requirements as a matter of defense
by recoupment or setoff. There is no time limit on the use of this
defense, but the amount of recoupment or setoff is limited with respect
to the special statutory damages to no more than three years of finance
charges and fees. This limit on setoff is more restrictive than under
the existing regulations, but also expressly applies to assignees.

[[Page 6505]]

In light of the statutory ambiguities, complex policy
considerations, and concerns about litigation risk, the Board's
proposal mapped out two alternatives at the opposite ends of a spectrum
for defining a qualified mortgage and the protection afforded to such
mortgages. At one end, the Board's Alternative 1 would have defined
qualified mortgage only to include the mandated statutory elements
listed in TILA section 129C(b)(2), most of which, as noted above,
relate to product features and not to the underwriting decision or
process itself. This alternative would have provided creditors with a
safe harbor to establish compliance with the general repayment ability
requirement in proposed Sec. 226.43(c)(1). As the Board recognized,
this would provide strong incentives for creditors to make qualified
mortgages in order to minimize litigation risk and compliance burden
under general ability-to-repay requirements, but might prevent
consumers from seeking redress for failure to assess their ability to
repay. In Alternative 2, the Board proposed a definition of qualified
mortgage which incorporated both the statutory product feature
restrictions and additional underwriting elements drawn from the
general ability-to-repay requirements, as well as seeking comment on
whether to establish a specific debt-to-income requirement. Alternative
2 also specified that consumers could rebut the presumption of
compliance by demonstrating that a creditor did not adequately
determine the consumers' ability to repay the loan. As the Board
recognized, this would better ensure that creditors fully evaluate
consumers' ability to repay qualified mortgages and preserve consumers'
rights to seek redress. However, the Board expressed concern that
Alternative 2 would provide little incentive to make qualified
mortgages in the first place, given that the requirements may be
challenging to satisfy and the strength of protection afforded would be
minimal.
Overview of Final Rule
As noted above and discussed in greater detail in the section-by-
section analysis below, the Dodd-Frank Act accords the Bureau
significant discretion in defining the scope of, and legal protections
afforded to, a qualified mortgage. In developing the rules for
qualified mortgages, the Bureau has carefully considered numerous
factors, including the Board's proposal to implement TILA section
129C(b), comments and ex parte communications, current regulations and
the current state of the mortgage market, and the implications of the
qualified mortgage rule on other parts of the Dodd-Frank Act. The
Bureau is acutely aware of the problematic practices that gave rise to
the financial crisis and sees the ability-to-pay requirement as an
important bulwark to prevent a recurrence of those practices by
establishing a floor for safe underwriting. At the same time, the
Bureau is equally aware of the anxiety in the mortgage market today
concerning the continued slow pace of recovery and the confluence of
multiple major regulatory and capital initiatives. Although every
industry representative that has communicated with the Bureau
acknowledges the importance of assessing a consumer's ability to repay
before extending a mortgage to the consumer--and no creditor claims to
do otherwise--there is nonetheless a widespread fear about the
litigation risks associated with the Dodd-Frank Act ability-to-repay
requirements. Even community banks, deeply ingrained within their local
communities and committed to a relationship lending model, have
expressed to the Bureau their fear of litigation. In crafting the rules
to implement the qualified mortgage provision, the Bureau has sought to
balance creating new protections for consumers and new responsibilities
for creditors with preserving consumers' access to credit and allowing
for appropriate lending and innovation.
The Bureau recognizes both the need for certainty in the short term
and the risk that actions taken by the Bureau in order to provide such
certainty could, over time, defeat the prophylactic aims of the statute
or impede recovery in various parts of the market. For instance, in
defining the criteria for a qualified mortgage, the Bureau is called
upon to identify a class of mortgages which can be presumed to be
affordable. The boundaries must be clearly drawn so that consumers,
creditors, and secondary market investors can all proceed with
reasonable assurance as to whether a particular loan constitutes a
qualified mortgage. Yet the Bureau believes that it is not possible by
rule to define every instance in which a mortgage is affordable, and
the Bureau fears that an overly broad definition of qualified mortgage
could stigmatize non-qualified mortgages or leave insufficient
liquidity for such loans. If the definition of qualified mortgage is so
broad as to deter creditors from making non-qualified mortgages
altogether, the regulation would curtail access to responsible credit
for consumers and turn the Bureau's definition of a qualified mortgage
into a straitjacket setting the outer boundary of credit availability.
The Bureau does not believe such a result would be consistent with
congressional intent or in the best interests of consumers or the
market.
The Bureau is thus attuned to the problems of the past, the
pressures that exist today, and the ways in which the market might
return in the future. As a result, the Bureau has worked to establish
guideposts in the final rule to make sure that the market's return is
healthy and sustainable for the long-term. Within that framework, the
Bureau is defining qualified mortgages to strike a clear and calibrated
balance as follows:
First, the final rule provides meaningful protections for consumers
while providing clarity to creditors about what they must do if they
seek to invoke the qualified mortgage presumption of compliance.
Accordingly, the qualified mortgage criteria include not only the
minimum elements required by the statute--including prohibitions on
risky loan features, a cap on points and fees, and special underwriting
rules for adjustable-rate mortgages--but additional underwriting
features to ensure that creditors do in fact evaluate individual
consumers' ability to repay the qualified mortgages. The qualified
mortgage criteria thus incorporate key elements of the verification
requirements under the ability-to-repay standard and strengthen the
consumer protections established by the ability-to-repay requirements.
In particular, the final rule provides a bright-line threshold for
the consumer's total debt-to-income ratio, so that under a qualified
mortgage, the consumer's total monthly debt payments cannot exceed 43
percent of the consumer's total monthly income. The bright-line
threshold for debt-to-income serves multiple purposes. First, it
protects consumer interests because debt-to-income ratios are a common
and important tool for evaluating consumers' ability to repay their
loans over time, and the 43 percent threshold has been utilized by the
Federal Housing Administration (FHA) for many years as its general
boundary for defining affordability. Relative to other benchmarks that
are used in the market (such as GSE guidelines) that have a benchmark
of 36 percent, before consideration of compensating factors, this
threshold is a relatively liberal one which allows ample room for
consumers to qualify for an affordable mortgage. Second, it provides a
well-established and well-understood rule

[[Page 6506]]

that will provide certainty for creditors and help to minimize the
potential for disputes and costly litigation over whether a mortgage is
a qualified mortgage. Third, it allows room for a vibrant market for
non-qualified mortgages over time. The Bureau recognizes that there
will be many instances in which individual consumers can afford an even
higher debt-to-income ratio based on their particular circumstances,
although the Bureau believes that such loans are better evaluated on an
individual basis under the ability-to-repay criteria rather than with a
blanket presumption. The Bureau also believes that there are a
sufficient number of potential borrowers who can afford a mortgage that
would bring their debt-to-income ratio above 43 percent that
responsible creditors will continue to make such loans as they become
more comfortable with the new regulatory framework. To preserve access
to credit during the transition period, the Bureau has also adopted
temporary measures as discussed further below.
The second major feature of the final rule is the provision of
carefully calibrated presumptions of compliance afforded to different
types of qualified mortgages. Following the approach developed by the
Board in the existing ability-to-repay rules to distinguish between
prime and subprime loans, the final rule distinguishes between two
types of qualified mortgages based on the mortgage's Annual Percentage
Rate (APR) relative to the Average Prime Offer Rate (APOR).\130\ For
loans that exceed APOR by a specified amount--loans denominated as
``higher-priced mortgage loans''--the final rule provides a rebuttable
presumption. In other words, the creditor is presumed to have satisfied
the ability-to-repay requirements, but a consumer may rebut that
presumption under carefully defined circumstances.\131\ For all other
loans, i.e., loans that are not ``higher-priced,'' the final rule
provides a conclusive presumption that the creditor has satisfied the
ability-to-repay requirements once the creditor proves that it has in
fact made a qualified mortgage. In other words, the final rule provides
a safe harbor from ability-to-repay challenges for the least risky type
of qualified mortgages, while providing room to rebut the presumption
for qualified mortgages whose pricing is indicative of a higher level
of risk.\132\ The Bureau believes that this calibration will further
encourage creditors to extend credit responsibly and provide certainty
that promotes access to credit.
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\130\ APOR means ``the average prime offer rate for a comparable
transaction as of the date on which the interest rate for the
transaction is set, as published by the Bureau.'' TILA section
129C(b)(2)(B).
\131\ As described further below, under a qualified mortgage
with a rebuttable presumption, a consumer can rebut that presumption
by showing that, in fact, at the time the loan was made the consumer
did not have sufficient income or assets (other than the value of
the dwelling that secures the transaction), after paying his or her
mortgage and other debts, to be able to meet his or her other living
expenses of which the creditor was aware.
\132\ The threshold for determining which treatment applies
generally matches the threshold for ``higher-priced mortgage loans''
under existing Regulation Z, except that the rule does not provide a
separate, higher threshold for jumbo loans. The Dodd-Frank Act
itself codified the same thresholds for other purposes. See Dodd-
Frank Act section 1411, enacting TILA section 129C(6)(d)(ii). In
adopting the ``higher-priced mortgage loans'' threshold in 2008, the
Board explained that the aim was to ``cover the subprime market and
generally exclude the prime market.'' 73 FR 44522, 44532 (July 30,
2008).
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The Bureau believes that loans that fall within the rebuttable
presumption category will be loans made to consumers who are more
likely to be vulnerable \133\ so that, even if the loans satisfy the
criteria for a qualified mortgage, those consumers should be provided
the opportunity to prove that, in an individual case, the creditor did
not have a reasonable belief that the loan would be affordable for that
consumer. Under a qualified mortgage with a safe harbor, most of the
loans within this category will be the loans made to prime borrowers
who pose fewer risks. Furthermore, considering the difference in
historical performance levels between prime and subprime loans, the
Bureau believes that it is reasonable to presume conclusively that a
creditor who has verified a consumer's debt and income, determined in
accordance with specified standards that the consumer has a debt-to-
income ratio that does not exceed 43 percent, and made a prime mortgage
with the product features required for a qualified mortgage has
satisfied its obligation to assess the consumer's ability to repay.
This approach will provide significant certainty to creditors operating
in the prime market. The approach will also create lesser but still
important protection for creditors in the subprime market who follow
the qualified mortgage rules, while preserving consumer remedies and
creating strong incentives for more responsible lending in the part of
the market in which the most abuses occurred prior to the financial
crisis.
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\133\ See generally, id. at 44533.
---------------------------------------------------------------------------

Third, the final rule provides a temporary special rule for certain
qualified mortgages to provide a transition period to help ensure that
sustainable credit will return in all parts of the market over time.
The temporary special rule expands the definition of a qualified
mortgage to include any loan that is eligible to be purchased,
guaranteed, or insured by various Federal agencies or by the GSEs while
they are operating under conservatorship. This temporary provision
preserves access to credit in today's market by permitting a loan that
does not satisfy the 43 percent debt-to-income ratio threshold to
nonetheless be a qualified mortgage based upon an underwriting
determination made pursuant to guidelines created by the GSEs while in
conservatorship or one of the Federal agencies. This temporary
provision will sunset in a maximum of seven years. As with loans that
satisfy the 43 percent debt-to-income ratio threshold, qualified
mortgages under this temporary rule will receive either a rebuttable or
conclusive presumption of compliance depending upon the pricing of the
loan relative to APOR. The Bureau believes this provision will provide
sufficient consumer protection while providing adequate time for
creditors to adjust to the new requirements of the final rule as well
as to changes in other regulatory, capital, and economic conditions.
A detailed description of the qualified mortgage definition is set
forth below. Section 1026.43(e)(1) provides the presumption of
compliance provided to qualified mortgages. Section 1026.43(e)(2)
provides the criteria for a qualified mortgage under the general
definition, including the restrictions on certain product features,
verification requirements, and a specified debt-to-income ratio
threshold. Section 1026.43(e)(3) provides the limits on points and fees
for qualified mortgages, including the limits for smaller loan amounts.
Section 1026.43(e)(4) provides the temporary special rule for qualified
mortgages. Lastly, Sec. 1026.43(f) implements a statutory exemption
permitting certain balloon-payment loans by creditors operating
predominantly in rural or underserved areas to be qualified mortgages.
43(e)(1) Safe Harbor and Presumption of Compliance
As discussed above, the Dodd-Frank Act provides a presumption of
compliance with the ability-to-repay requirements for qualified
mortgages, but the statute is not clear as to whether that presumption
is intended to be conclusive so as to create a safe harbor that cuts
off litigation or a rebuttable presumption of compliance with the
ability-to-repay requirements. The title of section 1412 refers to both
a ``safe

[[Page 6507]]

harbor and rebuttable presumption,'' and as discussed below there are
references to both safe harbors and presumptions in other provisions of
the statute. As the Board's proposal discussed, an analysis of the
statutory construction and policy implications demonstrates that there
are sound reasons for adopting either interpretation. See 76 FR 27390,
27452-55 (May 11, 2011).
Several aspects of the statutory structure favor a safe harbor
interpretation. First, TILA section 129C(b)(1) states that a creditor
or assignee may presume that a loan has ``met the requirements of
subsection (a), if the loan is a qualified mortgage.'' TILA section
129C(a) contains the general ability-to repay requirement, and also a
set of specific underwriting criteria that must be considered by a
creditor in assessing the consumer's repayment ability. Rather than
stating that the presumption of compliance applies only to TILA section
129C(a)(1) for the general ability-to-repay requirements, it appears
Congress intended creditors who make qualified mortgages to be presumed
to comply with both the ability-to-repay requirements and all of the
specific underwriting criteria. Second, TILA section 129C(b)(2) does
not define a qualified mortgage as requiring compliance with all of the
underwriting criteria of the general ability-to-repay standard.
Therefore, unlike the approach found in the 2008 HOEPA Final Rule, it
appears that meeting the criteria for a qualified mortgage is an
alternative way of establishing compliance with all of the ability-to-
repay requirements, which could suggest that meeting the qualified
mortgage criteria conclusively satisfies these requirements. In other
words, given that a qualified mortgage satisfies the ability-to-repay
requirements, one could assume that meeting the qualified mortgage
definition conclusively establishes compliance with those requirements.
In addition, TILA section 129C(b)(3)(B), which provides the Bureau
authority to revise, add to, or subtract from the qualified mortgage
criteria upon making certain findings, is titled ``Revision of Safe
Harbor Criteria.'' Further, in section 1421 of the Dodd-Frank Act,
Congress instructed the Government Accountability Office to issue a
study on the effect ``on the mortgage market for mortgages that are not
within the safe harbor provided in the amendments made by this
subtitle.''
Certain policy considerations also favor a safe harbor. Treating a
qualified mortgage as a safe harbor provides greater legal certainty
for creditors and secondary market participants than a rebuttable
presumption of compliance. Increased legal certainty may benefit
consumers if as a result creditors are encouraged to make loans that
satisfy the qualified mortgage criteria, as such loans cannot have
certain risky features and have a cap on upfront costs. Furthermore,
increased certainty may result in loans with a lower cost than would be
charged in a world of legal uncertainty. Thus, a safe harbor may also
allow creditors to provide consumers additional or more affordable
access to credit by reducing their expected total litigation costs.
On the other hand, there are also several aspects of the statutory
structure that favor interpreting qualified mortgage as creating a
rebuttable presumption of compliance. With respect to statutory
construction, TILA section 129C(b)(1) states that a creditor or
assignee ``may presume'' that a loan has met the repayment ability
requirement if the loan is a qualified mortgage. As the Board's
proposal notes, this could suggest that originating a qualified
mortgage provides a presumption of compliance with the repayment
ability requirements, which the consumer can rebut with evidence that
the creditor did not, in fact, make a good faith and reasonable
determination of the consumer's ability to repay the loan. Similarly,
in the smaller loans provisions in TILA section 129C(b)(2)(D), Congress
instructed the Bureau to adjust the points and fees cap for qualified
mortgages ``to permit lenders that extend smaller loans to meet the
requirements of the presumption of compliance'' in TILA section
129C(b)(1).\134\ As noted above, the 2008 HOEPA Final Rule also
contains a rebuttable presumption of compliance with respect to the
ability-to-repay requirements that currently apply to high-cost and
higher-priced mortgages.
---------------------------------------------------------------------------

\134\ In prescribing such rules, the Bureau is to consider the
potential impact of such rules on rural areas and other areas where
home values are lower. This provision did not appear in earlier
versions of title XIV of the Dodd-Frank Act, so there is no
legislative history to explain the use of the word ``presumption''
in this context.
---------------------------------------------------------------------------

The legislative history of the Dodd-Frank Act may also favor
interpreting ``qualified mortgage'' as a rebuttable presumption of
compliance. As described in a joint comment letter from several
consumer advocacy groups, a prior version of Dodd-Frank Act title XIV
from 2007 contemplated a dual track for liability in litigation: a
rebuttable presumption for creditors and a safe harbor for secondary
market participants.\135\ That draft legislation would have provided
that creditors, assignees, and securitizers could presume compliance
with the ability-to-repay provision if the loan met certain
requirements.\136\ However, the presumption of compliance would have
been rebuttable only against the creditor, effectively creating a safe
harbor for assignees and securitizers.\137\ The caption ``safe harbor
and rebuttable presumption'' appears to have originated from the 2007
version of the legislation. The 2009 version of the legislation did not
contain this dual track approach.\138\ Instead, the language simply
stated that creditors, assignees, and securitizers ``may presume'' that
qualified mortgages satisfied ability-to-repay requirements, without
specifying the nature of the presumption.\139\ The committee report of
the 2009 bill described the provision as establishing a ``limited safe
harbor'' for qualified mortgages, while also stating that ``the
presumption can be rebutted.'' \140\ This suggests that Congress
contemplated that qualified mortgages would receive a rebuttable
presumption of compliance with the ability-to-repay provisions,
notwithstanding Congress's use of the term ``safe harbor'' in the
heading of section 129C(b) and elsewhere in the statute and legislative
history.
---------------------------------------------------------------------------

\135\ See Mortgage Reform and Anti-Predatory Lending Act of
2007, H.R. 3915, 110th Cong. (2007).
\136\ See H.R. 3915 Sec. 203. Specifically, that prior version
of title XIV would have created two types of qualified mortgages:
(1) a ``qualified mortgage,'' which included loans with prime
interest rates or government insured VA or FHA loans, and (2) a
``qualified safe harbor mortgage,'' which met underwriting standards
and loan term restrictions similar to the definition of qualified
mortgage eventually codified at TILA section 129C(b)(2).
\137\ Id.
\138\ See Mortgage Reform and Anti-Predatory Lending Act of
2009, H.R. 1728.
\139\ See H.R. 1728 Sec. 203.
\140\ Mortgage Reform and Anti-Predatory Lending Act of 2009, H.
Rept. No. 94, 111th Cong., at 48 (2009).
---------------------------------------------------------------------------

There are also policy reasons that favor interpreting ``qualified
mortgage'' as a rebuttable presumption of compliance. The ultimate aim
of the statutory provisions is to assure that, before making a mortgage
loan, the creditor makes a determination of the consumer's ability to
repay. No matter how many elements the Bureau might add to the
definition of qualified mortgage, it still would not be possible to
define a class of loans which ensured that every consumer within the
class could necessarily afford a particular loan. In light of this,
interpreting the statute to provide a safe harbor that precludes a
consumer from challenging the creditor's determination of repayment
ability seems to raise

[[Page 6508]]

tensions with the requirement to determine repayment ability. In
contrast, interpreting a qualified mortgage as providing a rebuttable
presumption of compliance would better ensure that creditors consider
each consumer's ability to repay the loan rather than only satisfying
the qualified mortgage criteria.
The Board's Proposal
As described above, in light of the statutory ambiguity and
competing policy considerations, the Board proposed two alternative
definitions for a qualified mortgage, which generally represent two
ends of the spectrum of possible definitions. Alternative 1 would have
applied only the specific requirements listed for qualified mortgages
in TILA section 129C(b)(2), and would have provided creditors with a
safe harbor to establish compliance with the general repayment ability
requirement in proposed Sec. 226.43(c)(1). Alternative 2 would have
required a qualified mortgage to satisfy the specific requirements
listed in the TILA section 129C(b)(2), as well as additional
requirements taken from the general ability-to-repay standard in
proposed Sec. 226.43(c)(2) through (7). Alternative 2 would have
provided a rebuttable presumption of compliance with the ability-to-
repay requirements. Although the Board specifically proposed two
alternative qualified mortgage definitions, it also sought comment on
other approaches by soliciting comment on other alternative
definitions. The Board also specifically solicited comment on what
criteria should be included in the definition of a qualified mortgage
to ensure that the definition provides an incentive to creditors to
make qualified mortgages, while also ensuring that consumers have the
ability to repay those loans. In particular, the Board sought comment
on whether the qualified mortgage definition should require
consideration of a consumer's debt-to-income ratio or residual income,
including whether and how to include a quantitative standard for the
debt-to-income ratio or residual income for the qualified mortgage
definition.
Comments
Generally, numerous industry and other commenters, including some
members of Congress, supported a legal safe harbor while consumer
groups and other commenters, including an association of State bank
regulators, supported a rebuttable presumption. However, as described
below, commenters did not necessarily support the two alternative
proposals specifically as drafted by the Board. For instance, a
significant number of industry commenters advocated incorporating the
general ability-to-repay requirements into the qualified mortgage
definition, while providing a safe harbor for those loans that met the
enhanced standards. And a coalition of industry and consumer advocates
presented a proposal to the Bureau that would have provided a tiered
approach to defining a qualified mortgage. Under the first tier, if the
consumer's back-end debt-to-income (total debt-to-income) ratio is 43
percent or less, the loan would be a qualified mortgage, and no other
tests would be required. Under the second tier, if the consumer's total
debt-to-income ratio is more than 43 percent, the creditor would apply
a series of tests related to the consumer's front-end debt-to-income
ratio (housing debt-to-income), stability of income and past payment
history, availability of reserves, and residual income to determine if
a loan is a qualified mortgage.
Comments in favor of safe harbor. Industry commenters strongly
supported a legal safe harbor from liability for qualified mortgages.
These commenters believe that a broad safe harbor with clear, bright
lines would provide certainty and clarity for creditors and assignees.
Generally, industry commenters argued that a safe harbor is needed in
order: (i) To ensure creditors make loans, (ii) to ensure the
availability of and access to affordable credit without increasing the
costs of borrowing; (iii) to promote certainty and saleability in the
secondary market, and (iv) to contain litigation risk and costs for
creditors and assignees.
Generally, although acknowledging ambiguities in the statutory
language, industry commenters argued that the statute's intent and
legislative history indicate that qualified mortgages are meant to be a
legal safe harbor, in lieu of the ability-to-repay standards. Industry
commenters argued that a safe harbor would best ensure safe, well-
documented, and properly underwritten loans without limiting the
availability of credit or increasing the costs of credit to consumers.
Many industry commenters asserted that a legal safe harbor from
liability would ensure access to affordable credit. Other industry
commenters argued that a safe harbor ultimately benefits consumers with
increased access to credit, reduced loan fees and interest rates, and
less-risky loan features. In contrast, various industry commenters
contended that a rebuttable presumption would not provide enough
certainty for creditors and the secondary market. Commenters argued
that if creditors cannot easily ascertain whether a loan satisfies the
ability-to-repay requirements, creditors will either not make loans or
will pass the cost of uncertain legal risk to consumers, which in turn
would increase the cost of borrowing.
Numerous industry commenters argued for a legal safe harbor because
of the liabilities of an ability-to-repay violation and the costs
associated with ability-to-repay litigation. Generally, commenters
argued that a rebuttable presumption for qualified mortgages would
invite more extensive litigation than necessary that will result in
greater costs being borne by all consumers. Commenters emphasized the
relatively severe penalties for ability-to-repay violations under the
Dodd-Frank Act, including enhanced damages, an extended three-year
statute of limitations, a recoupment or set-off provision as a defense
to foreclosure, and new enforcement authorities by State attorneys
general. In addition, assignee liabilities are amplified because of the
recoupment and set-off provision in TILA section 130(k). Commenters
asserted that the increased costs associated with litigation could make
compliance too costly for smaller creditors, which would reduce
competition and credit availability from the market. In particular,
community bank trade association commenters argued that the Bureau
should adopt a safe harbor for qualified mortgage loans and include
bright-line requirements to protect community banks from litigation and
ease the compliance burden. Ultimately, community bank trade
association commenters stated that few, if any, banks would risk
providing a mortgage that only has a rebuttable presumption attached.
Industry commenters generally believed that a rebuttable
presumption would increase the incidence of litigation because any
consumer who defaults on a loan would be likely to sue for recoupment
in foreclosure. Commenters were also concerned about frivolous
challenges in court as well as heightened scrutiny by regulators. In
particular, a credit union association commenter supported a safe
harbor because of concerns that a rebuttable presumption would cause
credit unions to be faced with significant amounts of frivolous
foreclosure defense litigation in the future. In addition to increased
incidence of litigation, industry commenters and other interested
parties argued that the estimated costs of litigation under a
rebuttable presumption would be overly burdensome for creditors and
assignees. Some commenters and interested parties presented estimates
of the litigation costs associated with claims alleging a

[[Page 6509]]

violation of the ability-to-repay requirements. For example, one
industry trade association commenter estimated that the attorney's fees
for a claim involving a qualified mortgage under a safe harbor would
cost $30,000, compared to $50,000 for a claim under a rebuttable
presumption. That commenter provided a separate estimation from a law
firm that the attorneys' fees to the creditor will be approximately
$26,000 in cases where the matter is disposed of on a motion to
dismiss, whereas the fees for the cost of a full trial could reach
$155,000. That commenter asserted that safe harbor claims are more
likely to be dismissed on a motion to dismiss than the rebuttable
presumption.
An industry commenter and other interested parties argued that the
estimated costs to creditors associated with litigation and penalties
for an ability-to-repay violation could be substantial and provided
illustrations of costs under the proposal, noting potential cost
estimates of the possible statutory damages and attorney's fees. For
example, the total estimated costs and damages ranged between
approximately $70,000 and $110,000 depending on various assumptions,
such as the interest rate on a loan or whether the presumption of
compliance is conclusive or rebuttable.
Industry commenters also generally argued that a safe harbor would
promote access to credit because creditors would be more willing to
extend credit where they receive protections under the statutory
scheme. One industry trade association commenter cited the 2008 HOEPA
Final Rule, which provided a rebuttable presumption of compliance with
the requirement to consider a consumer's repayment ability upon meeting
certain criteria, as causing a significant drop in higher-priced
mortgage loan originations, and suggested that access to general
mortgage credit would be similarly restricted if the final rule adopts
a rebuttable presumption for the market as a whole. A large bank
commenter similarly noted the lack of lending in the higher-priced
mortgage space since the 2008 HOEPA Final Rule took effect.
In addition to the liquidity constraints for non-qualified
mortgages, commenters argued that the liability and damages from a
potential ability-to-repay TILA violation would be a disincentive for a
majority of creditors to make non-qualified mortgage loans. Further,
some commenters suggested that creditors could face reputational risk
from making non-qualified mortgage loans because consumers would view
them as ``inferior'' to qualified mortgages. Other commenters argued
that reducing the protections afforded to qualified mortgages could
cause creditors to act more conservatively and restrict credit or
result in the denial of credit at a higher rate and increase the cost
of credit. Many commenters argued that the most serious effects and
impacts on the availability and cost of credit would be for minority,
low- to moderate-income, and first-time borrowers. Therefore, industry
commenters believed that a bright-line safe harbor would provide the
strongest incentive for creditors to provide sustainable mortgage
credit to the widest array of qualified consumers. Furthermore, one
industry trade association commenter argued that not providing strong
incentives for creditors would diminish the possibility of recovery of
the housing market and the nation's economy.
Industry commenters also expressed concerns regarding secondary
market considerations and assignee liability. Commenters urged the
Bureau to consider commercial litigation costs associated with the
contractually required repurchase (``put-back'') of loans sold on the
secondary market where there is litigation over those loans, as well as
the risk of extended foreclosure timelines because of ongoing ability-
to-repay litigation. Industry commenters asserted that a safe harbor is
critical to promote saleability of loans in the secondary market. In
particular, they stated that clarity and certainty provided by a safe
harbor would promote efficiencies in the secondary market because
investors in securitized residential mortgage loans (mortgage backed
securities, or MBS) could be more certain that they are not purchasing
compliance risk along with their investments. Commenters asserted that
without a safe harbor, the resulting uncertainty would eliminate the
efficiencies provided by secondary sale or securitization of loans. By
extension, commenters claimed that the cost of borrowing for consumers
would ultimately increase. Large bank commenters stated that although
they might originate non-qualified mortgage loans, the number would be
relatively small and held in portfolio because they believe it is
unlikely that non-qualified mortgage loans will be saleable in the
secondary market. Generally, industry commenters asserted that
creditors, regardless of size, would be unwilling to risk exposure
outside the qualified mortgage space. One large bank commenter stated
that the 2008 HOEPA Final Rule did not create a defense to foreclosure
against assignees for the life of the loan, as does the Dodd-Frank
Act's ability-to-repay provisions. Accordingly, industry commenters
strongly supported broad coverage of qualified mortgages, as noted
above.
Commenters asserted that the secondary market will demand a ``safe
harbor'' for quality assurance and risk avoidance. If the regulatory
framework does not provide a safe harbor, commenters asserted that
investors would require creditors to agree to additional, strict
representations and warranties when assigning loans. Contracts between
loan originators and secondary market purchasers often require
originators to repurchase loans should a loan perform poorly, and these
commenters expect that future contracts will include provisions related
to the ability-to-repay rule. Commenters assert that the risks and
costs associated with additional potential put-backs to the creditor
would increase liability and risk to creditors, which would ultimately
increase the cost of credit to consumers. Furthermore, commenters
contended that if the rule is too onerous in its application to the
secondary market, then the secondary market participants may purchase
fewer loans or increase pricing to account for the additional risk,
such as is now the case for high-cost mortgages.
Commenters noted that the risks associated with assignee liability
are heightened by any vagueness in standards in the rule. One secondary
market purchaser commenter argued that a rebuttable presumption would
present challenges because purchasers (or assignees) are not part of
the origination process. It is not feasible for purchasers to evaluate
all of the considerations that went into an underwriting decision, so
they must rely on the creditor's representations that the loan was
originated in compliance with applicable laws and the purchaser's
requirements. However, assignees may have to defend a creditor's
underwriting decision at any time during the life of the loan because
there is no statute of limitations on raising the failure to make an
ability-to-repay determination as a defense to foreclosure. The
commenters argued that defending these cases would be difficult and
costly, and that such burdens would be reduced by safe harbor
protections.
Comments in favor of rebuttable presumption of compliance. Consumer
group commenters generally urged the Bureau to adopt a rebuttable
presumption for qualified mortgages. Commenters argued that Congress
intended a rebuttable presumption, not a safe harbor. In particular,
commenters contended that the Dodd-Frank Act's

[[Page 6510]]

legislative history and statutory text strongly support a rebuttable
presumption. Commenters noted that the statute is designed to strike a
fair balance between market incentives and market discipline, as well
as a balance between consumers' legal rights and excessive exposure to
litigation risk for creditors. Commenters asserted that the purpose of
the qualified mortgage designation is to foster sustainable lending
products and practices built upon sound product design and sensible
underwriting. To that end, a rebuttable presumption would accomplish
the goal of encouraging creditors to originate loans that meet the
qualified mortgage definition while assuring consumers of significantly
greater protection from abusive or ineffective underwriting than if a
safe harbor were adopted. Consumer group commenters contended that
qualified mortgages can earn and deserve the trust of both consumers
and investors only if they carry the assurance that they are soundly
designed and properly underwritten. Many consumer group commenters
asserted that a rebuttable presumption would provide better protections
for consumers as well as improving safeguards against widespread risky
lending while helping ensure that there would be no shortcuts on common
sense underwriting. They argued that a legal safe harbor could invite
abusive lending because consumers will have no legal recourse. Several
commenters also asserted that no qualified mortgage definition could
cover all contingencies in which such abuses could occur.
Some commenters argued that a legal safe harbor would leave
consumers unprotected against abuses, such as those associated with
simultaneous liens or from inadequate consideration of employment and
income. An association of State bank regulators favored a rebuttable
presumption because, although a rebuttable presumption provides less
legal protection than a safe harbor, a rebuttable presumption
encourages institutions to consider repayment factors that are part of
a sound underwriting process. That commenter contended that a creditor
should not be granted blanket protection from a foreclosure defense of
an ability-to-repay violation if the creditor failed to consider and
verify such crucial information as a consumer's employment status and
credit history, for example. On this point, the rebuttable presumption
proposed by the Board would require creditors to make individualized
determinations that the consumer has the ability to repay the loan
based on all of the underwriting factors listed in the general ability-
to-repay standard.
Consumer group commenters observed that a rebuttable presumption
would better ensure that creditors actually consider a consumer's
ability to repay the loan. Consumer group commenters also asserted that
the goals of safe, sound, sustainable mortgage lending and a balanced
system of accountability are best served by a rebuttable presumption
because consumers should be able to put evidence before a court that
the creditor's consideration and verification of the consumer's ability
to repay the loan was unreasonable or in bad faith. To that end, a
rebuttable presumption would allow the consumer to 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.
Without this accountability, commenters argued that the Dodd-Frank
Act's effectiveness would be undermined.
Ultimately, consumer group commenters believed that a rebuttable
presumption would not exacerbate current issues with credit access and
availability, but would instead allow room for honest, efficient
competition and affordable credit. Consumer group commenters generally
contended that the fear of litigation and estimated costs and risks
associated with ability-to-repay violations are overstated and based on
misunderstanding of the extent of exposure to TILA liability. Consumer
group commenters and some ex parte communications asserted that the
potential incidence of litigation is relatively small, and therefore
liability cost and risk are minimal for any given mortgage creditor.
For example, consumer group commenters asserted that there are
significant practical limitations to consumers bringing an ability-to-
repay claim, suggesting that few distressed homeowners would be able to
obtain legal representation often necessary to mount a successful
rebuttal in litigation. Consumer groups provided percentages of
borrowers in foreclosure who are represented by lawyers, noting the
difficulty of bringing a TILA violation claim, and addressed estimates
of litigation costs, such as attorneys' fees. Consumer groups provided
estimates of the number of cases in foreclosure and the percentage of
cases that involve TILA claims, such as a claim of rescission.
Furthermore, consumer group commenters argued that the three-year
cap on enhanced damages (equal to the sum if all finance charges and
fees paid by the consumer within three years of consummation) for
violation of the ability-to-repay requirements limits litigation risk
significantly. Commenters contended that, as a general rule, a court is
more likely to find that the ability-to-repay determination at
consummation was not reasonable and in good faith the earlier in the
process a default occurs, and at that point the amount of interest paid
by a consumer (a component of enhanced damages) will be relatively
small. Commenters argued that the longer it takes a consumer to
default, the harder the burden it will be for the consumer to show that
the default was reasonably predictable at consummation and was caused
by improper underwriting rather than a subsequent income or expense
shock; moreover, even if the consumer can surmount that burden, the
amount of damages is still capped at three years' worth of paid
interest. In addition, consumer group commenters contended that the
penalties to which creditors could be subject on a finding of failure
to meet the ability-to-repay requirements would not be so injurious or
even so likely to be applied in all but the most egregious situations
as to impose any meaningful risk upon creditors.
Moreover, many consumer group commenters observed that creditors
that comply with the rules and ensure that their loan originators are
using sound, well documented and verified underwriting will be
adequately protected by a rebuttable presumption.
Final Rule
As described above, the presumption afforded to qualified mortgages
in the final rule balances consumers' ability to invoke the protections
of the Dodd-Frank Act scheme with the need to create sufficient
certainty to promote access to credit in all parts of the market.
Specifically, the final rule provides a safe harbor with the ability-
to-repay requirements for loans that meet the qualified mortgage
criteria and pose the least risk, while providing a rebuttable
presumption for ``higher-priced'' mortgage loans, defined as having an
APR that exceeds APOR by 1.5 percentage points for first liens and 3.5
percentage points for second liens.\141\ The final rule also
specifically defines the grounds on which the presumption accorded to
more expensive qualified mortgages can be rebutted. In issuing this
final rule, the

[[Page 6511]]

Bureau has drawn on the experiences from the current ability-to-repay
provisions that apply to higher-priced mortgages, described above.
Based on the difference in historical performance levels between prime
and subprime loans, the Bureau believes that this approach will provide
significant certainty to creditors while preserving consumer remedies
and creating strong incentives for more responsible lending in the part
of the market in which the most abuses occurred prior to the financial
crisis.
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\141\ For the reasons discussed above in the section-by-section
analysis of Sec. 1026.43(b)(4), the Bureau does not adopt a
separate threshold for jumbo loans in the higher-priced covered
transaction definition for purposes of Sec. 1026.43(e)(1).
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In issuing this final rule, the Bureau carefully considered the
comments received and the interpretive and policy considerations for
providing qualified mortgages either a safe harbor or rebuttable
presumption of compliance with the repayment ability requirements. For
the reasons set forth by the Board and discussed above, the Bureau
finds that the statutory language is ambiguous and does not mandate a
particular approach. In adopting the final rule, the Bureau accordingly
focused on which interpretation would best promote the various policy
goals of the statute, taking into account the Bureau's authority, among
other things, to make adjustments and exceptions necessary or proper to
effectuate the purposes of TILA, as amended by the Dodd-Frank Act.
Discouraging unsafe underwriting. As described in part II above,
the ability-to-repay provisions of the Dodd-Frank Act were codified in
response to lax lending terms and practices in the mid-2000's, which
led to increased foreclosures, particularly for subprime borrowers. The
statutory underwriting requirements for a qualified mortgage--for
example, the requirement that loans be underwritten on a fully
amortized basis using the maximum interest rate during the first five
years and not a teaser rate, and the requirement to consider and verify
a consumer's income or assets--will help prevent a return to such lax
lending. So, too, will the requirement that a consumer's debt-to-income
ratio (including mortgage-related obligations and obligations on
simultaneous second liens) not exceed 43 percent, as discussed further
below.
Notwithstanding these requirements, however, the Bureau recognizes
that it is not possible to define by a bright-line rule a class of
mortgages as to which it will always be the case that each individual
consumer has the ability to repay his or her loan. That is especially
true with respect to subprime loans. In many cases, the pricing of a
subprime loan is the result of loan level price adjustments established
by the secondary market and calibrated to default risk. Furthermore,
the subprime segment of the market is comprised of borrowers who tend
to be less sophisticated and who have fewer options available to them,
and thus are more susceptible to being victimized by predatory lending
practices. The historical performance of subprime loans bears all this
out.\142\ The Bureau concludes, therefore, that for subprime loans
there is reason to impose heightened standards to protect consumers and
otherwise promote the policies of the statute. Accordingly, the Bureau
believes that it is important to afford consumers the opportunity to
rebut the presumption of compliance that applies to qualified mortgages
with regard to higher-priced mortgages by showing that, in fact, the
creditor did not have a good faith and reasonable belief in the
consumer's reasonable ability to repay the loan at the time the loan
was made.
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\142\ For example, data from the MBA delinquency survey show
that serious delinquency rates for conventional prime mortgages
averaged roughly 2 percent from 1998 through 2011 and peaked at 7
percent following the recent housing collapse. In contrast, the
serious delinquency rates averaged 13 percent over the same period.
In late 2009, it peaked at over 30 percent.'' Mortgage Bankers
Association, National Delinquency Survey. For a discussion of the
historical performance of subprime loans, see 2008 HOEPA Final Rule,
73 FR 44522, 44524-26 (July 30, 2008).
---------------------------------------------------------------------------

These same considerations lead to the opposite result with respect
to prime loans which satisfy the requirements for a qualified mortgage.
The fact that a consumer receives a prime rate is itself indicative of
the absence of any indicia that would warrant a loan level price
adjustment, and thus is suggestive of the consumer's ability to repay.
Historically, prime rate loans have performed significantly better than
subprime rate loans and the prime segment of the market has been
subject to fewer abuses.\143\ Moreover, requiring creditors to prove
that they have satisfied the qualified mortgage requirements in order
to invoke the presumption of compliance will itself ensure that the
loans in question do not contain certain risky features and are
underwritten with careful attention to consumers' debt-to-income
ratios. Accordingly, the Bureau believes that where a loan is not a
higher-priced covered transaction and meets both the product and
underwriting requirements for a qualified mortgage, there are
sufficient grounds for concluding that the creditor had a reasonable
and good faith belief in the consumer's ability to repay to warrant a
safe harbor.
---------------------------------------------------------------------------

\143\ See id.
---------------------------------------------------------------------------

This approach carefully balances the likelihood of consumers
needing redress with the potential benefits to both consumers and
industry of reducing uncertainty concerning the new regime. To the
extent that the rule reduces litigation risk concerns for prime
qualified mortgages, consumers in the prime market may benefit from
enhanced competition (although, as discussed below, the Bureau believes
litigation costs will be small and manageable for almost all
creditors). In particular, the Bureau believes that larger creditors
may expand correspondent lending relationships with smaller banks with
respect to prime qualified mortgages. Larger creditors may also relax
currently restrictive credit overlays (creditor-created underwriting
requirements that go beyond GSE or agency guidelines), thereby
increasing access to credit.
Scope of rebuttable presumption. In light of the heightened
protections for subprime loans, the final rule also carefully defines
the grounds on which the presumption that applies to higher-priced
qualified mortgages can be rebutted. The Bureau believes that this
feature is critical to ensuring that creditors have sufficient
incentives to provide higher-priced qualified mortgages to consumers.
Given the historical record of abuses in the subprime market, the
Bureau believes it is particularly important to ensure that consumers
are able to access qualified mortgages in light of their product
feature restrictions and other protections.
Specifically, the final rule defines the standard by which a
consumer may rebut the presumption of compliance afforded to higher-
priced qualified mortgages, and provides an example of how a consumer
may rebut the presumption. As described below, the final rule provides
that consumers may rebut the presumption with regard to a higher-priced
covered transaction by showing that, at the time the loan was
originated, the consumer's income and debt obligations left
insufficient residual income or assets to meet living expenses. The
analysis would consider the consumer's monthly payments on the loan,
mortgage-related obligations, and any simultaneous loans of which the
creditor was aware, as well as any recurring, material living expenses
of which the creditor was aware.
The Bureau believes the rebuttal standard in the final rule
appropriately balances the consumer protection and access to credit
considerations described above. This standard is consistent with the
standard in the 2008 HOEPA Final Rule, and is specified as the
exclusive means of rebutting the presumption. Commentary to the

[[Page 6512]]

existing rule provides as an example of how its presumption may be
rebutted that the consumer could show ``a very high debt-to-income
ratio and a very limited residual income.'' Under the definition of
qualified mortgage that the Bureau is adopting, however, the creditor
generally is not entitled to a presumption if the debt-to-income ratio
is ``very high.'' As a result, the Bureau is focusing the standard for
rebutting the presumption in the final rule on whether, despite meeting
a debt-to-income test, the consumer nonetheless had insufficient
residual income to cover the consumer's living expenses. The Bureau
believes this standard is sufficiently broad to provide consumers a
reasonable opportunity to demonstrate that the creditor did not have a
good faith and reasonable belief in the consumer's repayment ability,
despite meeting the prerequisites of a qualified mortgage. At the same
time, the Bureau believes the rebuttal standard in the final rule is
sufficiently clear to provide certainty to creditors, investors, and
regulators about the standards by which the presumption can
successfully be challenged in cases where creditors have correctly
followed the qualified mortgage requirements.
Several commenters raised concerns about the use of oral evidence
to impeach the information contained in the loan file. For example, a
consumer may seek to show that a loan does not meet the requirements of
a qualified mortgage by relying on information provided orally to the
creditor or loan originator to establish that the debt-to-income ratio
was miscalculated. Alternatively, a consumer may seek to show that the
creditor should have known, based upon facts disclosed orally to the
creditor or loan originator, that the consumer had insufficient
residual income to be able to afford the mortgage. The final rule does
not preclude the use of such oral evidence in ability-to-repay cases.
The Bureau believes that courts will determine the weight to be given
to such evidence on a case-by-case basis. To exclude such evidence
across the board would invite abuses in which consumers could be misled
or coerced by an unscrupulous loan originator into keeping certain
facts out of the written record.
Litigation risks and access to credit. In light of the continuing
and widespread concern about litigation risk under the Dodd-Frank Act
regime, the Bureau, in the course of developing the framework described
above, carefully analyzed the impacts of potential litigation on non-
qualified mortgages, any qualified mortgages with a rebuttable
presumption, and any qualified mortgages with a safe harbor. The Bureau
also considered secondary market dynamics, including the potential
impacts on creditors from loans that the secondary market ``puts back''
on the originators because of ability-to-repay litigation. The Bureau's
analysis is described in detail in the section 1022(b)(2) analysis
under part VII; the results of that analysis helped to shape the
calibrated approach that the Bureau is adopting in the final rule and
suggest that the mortgage market will be able to absorb litigation
risks under the rule without jeopardizing access to credit.
Specifically, as discussed in the section 1022(b)(2) analysis under
part VII, the Bureau believes that even without the benefit of any
presumption of compliance, the actual increase in costs from the
litigation risk associated with ability-to-pay requirements would be
quite modest. This is a function of the relatively small number of
potential claims, the relatively small size of those claims, and the
relatively low likelihood of claims being filed and successfully
prosecuted. The Bureau notes that litigation likely would arise only
when a consumer in fact was unable to repay the loan (i.e. was
seriously delinquent or had defaulted), and even then only if the
consumer elects to assert a claim and is able to secure a lawyer to
provide representation; the consumer can prevail only upon proving that
the creditor lacked a reasonable and good faith belief in the
consumer's ability to repay at consummation or failed to consider the
statutory factors in arriving at that belief.
The rebuttable presumption of compliance being afforded to
qualified mortgages that are higher-priced reduces the litigation risk,
and hence the potential transaction costs, still further. As described
above, the Bureau has crafted the presumption of compliance being
afforded to subprime loans so that it is not materially different than
the presumption that exists today under the 2008 HOEPA Final Rule.
Indeed, the Bureau is defining with more particularity the requirements
for rebutting this presumption. No evidence has been presented to the
Bureau to suggest that the presumption under the 2008 HOEPA Final Rule
has led to significant litigation or to any distortions in the market
for higher-priced mortgages. As noted above, commenters noted the lack
of lending in the higher-priced mortgage space since the 2008 HOEPA
Final Rule took effect, but the Bureau is unaware of evidence
suggesting the low lending levels are the result of the Board's rule,
as compared to the general state of the economy, uncertainty over
multiple regulatory and capital initiatives, and other factors.
Relative to the Dodd-Frank Act, the Bureau notes that the existing
regime already provides for attorneys' fees and the same remedies
against creditors in affirmative cases, and actually provides for
greater remedies against creditors in foreclosure defense situations.
Nevertheless, the incidence of claims under the existing ability-to-
repay rules for high-cost and higher-priced loans and analogous State
laws is relatively low. The Bureau's analysis shows that cost estimates
remain modest for both loans that are not qualified mortgages and loans
that are qualified mortgages with a rebuttable presumption of
compliance, and even more so for qualified mortgages with a safe
harbor.
The Bureau recognizes, of course, that under the Dodd-Frank Act
ability-to-repay provisions, a consumer can assert a claim against an
assignee as a ``defense by recoupment or set off'' in a foreclosure
action. There is no time limit on the use of this defense, but the
consumer cannot recover as special statutory damages more than three
years of finance charges and fees. To the extent this leads to
increased litigation potential with respect to qualified mortgages as
to which the presumption of compliance is rebuttable, this may cause
creditors to take greater care when underwriting these riskier products
to avoid potential put-back risk from investors. The Bureau believes
that this is precisely what Congress intended--to create incentives for
creditors to engage in sound underwriting and for secondary market
investors to monitor the quality of the loans they buy--and that these
incentives are particularly warranted with respect to the subprime
market.
At the same time, the Bureau does not believe that the potential
assignee liability with respect to higher-priced qualified mortgages
will preclude such loans from being sold on the secondary market.
Specifically, in analyzing impacts on the secondary market the Bureau
notes that investors are purchasing higher-priced mortgage loans that
are subject to the existing ability-to-repay requirements and
presumption of compliance and that the GSEs have already incorporated
into their contracts with creditors a representation and warranty
designed to provide investor protection in the event of an ability-to-
repay violation. The Bureau agrees with industry and secondary market
participant commenters that investors will likely require creditors to
agree to similar representations and warranties when assigning or
selling loans under the new

[[Page 6513]]

rule because secondary market participants will not want to be held
accountable for ability-to-repay compliance which investors will view
as the responsibility of the creditor. For prime loans, this may
represent an incremental risk of put-back to creditors, given that such
loans are not subject to the current regime, but those loans are being
provided a safe harbor if they are qualified mortgages. For subprime
(higher risk) loans it is not clear that there is any incremental risk
beyond that which exists today under the Board's rule. There are also
some administrative costs associated with such ``put-backs'' (e.g.,
costs associated with the process of putting back loans from the issuer
or insurer or servicer on behalf of the securitization trust to the
creditor as a result of the ability-to-repay claims), but those costs
are unlikely to be material for qualified mortgages subject to the
rebuttable presumption and will not affect either the pricing of the
loans or the availability of a secondary market for these loans.
In sum, the Bureau has crafted the calibrated presumptions to
ensure that these litigation and secondary market impacts do not
jeopardize access to credit. With regard to subprime loans, there is
some possibility that creditors who are less sophisticated or less able
to bear any litigation risk may elect to refrain from engaging in
subprime lending, but as discussed below, the Bureau believes that
there are sufficient creditors with the capabilities of making
responsible subprime loans so as to avoid significant adverse impact on
credit availability in that market.
Specific provisions. For the reasons discussed above, in Sec.
1026.43(e)(1), the Bureau is providing a safe harbor and rebuttable
presumption with the ability-to-repay requirements for loans that meet
the definition of a qualified mortgage. As explained in comment
43(e)(1)-1, Sec. 1026.43(c) requires a creditor to make a reasonable
and good faith determination at or before consummation that a consumer
will be able to repay a covered transaction. Section 1026.43(e)(1)(i)
and (ii) provide a safe harbor and rebuttable presumption of
compliance, respectively, with the repayment ability requirements of
Sec. 1026.43(c) for creditors and assignees of covered transactions
that satisfy the requirements of a qualified mortgage under Sec.
1026.43(e)(2), (e)(4), or (f).
Section 1026.43(e)(1)(i) provides a safe harbor for qualified
mortgages that are not higher-priced covered transactions, by stating
that a creditor or assignee of a qualified mortgage as defined in Sec.
1026.43(e)(2), (e)(4), or (f) that is not a higher-priced covered
transaction, as defined in Sec. 1026.43(b)(4), complies with the
repayment ability requirements of Sec. 1026.43(c). Comment
43(e)(1)(i)-1 clarifies that, to qualify for the safe harbor in Sec.
1026.43(e)(1)(i), a covered transaction must meet the requirements of a
qualified mortgage in Sec. 1026.43(e)(2), (e)(4), or (f) and must not
be a higher-priced covered transaction, as defined in Sec.
1026.43(b)(4).
For qualified mortgages that are higher-priced covered
transactions, Sec. 1026.43(e)(1)(ii)(A) provides a rebuttable
presumption of compliance with the repayment ability requirements. That
section provides that a creditor or assignee of a qualified mortgage as
defined in Sec. 1026.43(e)(2), (e)(4), or (f) that is a higher-priced
covered transaction, as defined Sec. 1026.43(b)(4), is presumed to
comply with the repayment ability requirements of Sec. 1026.43(c).
Section 1026.43(e)(1)(ii)(B) provides that to rebut the presumption of
compliance, it must be proven that, despite meeting the requirements of
Sec. 1026.43(e)(2), (e)(4), or (f), the creditor did not make a
reasonable and good faith determination of the consumer's repayment
ability at the time of consummation, by showing that the consumer's
income, debt obligations, alimony, child support, and the consumer's
monthly payment (including mortgage-related obligations) on the covered
transaction and on any simultaneous loans of which the creditor was
aware at consummation would leave the consumer with insufficient
residual income or assets other than the value of the dwelling
(including any real property attached to the dwelling) that secures the
loan with which to meet living expenses, including any recurring and
material non-debt obligations of which the creditor was aware at the
time of consummation.
Comment 43(e)(1)(ii)-1 clarifies that a creditor or assignee of a
qualified mortgage under Sec. 1026.43(e)(2), (e)(4), or (f) that is a
higher-priced covered transaction is presumed to comply with the
repayment ability requirements of Sec. 1026.43(c). To rebut the
presumption, it must be proven that, despite meeting the standards for
a qualified mortgage (including either the debt-to-income standard in
Sec. 1026.43(e)(2)(vi) or the standards of one of the entities
specified in Sec. 1026.43(e)(4)(ii)), the creditor did not have a
reasonable and good faith belief in the consumer's repayment ability.
To rebut the presumption, it must be proven that, despite meeting the
standards for a qualified mortgage (including either the debt-to-income
standard in Sec. 1026.43(e)(2)(vi) or the standards of one of the
entities specified in Sec. 1026.43(e)(4)(ii)), the creditor did not
have a reasonable and good faith belief in the consumer's repayment
ability. Specifically, it must be proven that, at the time of
consummation, based on the information available to the creditor, the
consumer's income, debt obligations, alimony, child support, and the
consumer's monthly payment (including mortgage-related obligations) on
the covered transaction and on any simultaneous loans of which the
creditor was aware at consummation would leave the consumer with
insufficient residual income or assets other than the value of the
dwelling (including any real property attached to the dwelling) that
secures the loan with which to meet living expenses, including any
recurring and material non-debt obligations of which the creditor was
aware at the time of consummation, and that the creditor thereby did
not make a reasonable and good faith determination of the consumer's
repayment ability. The comment also provides, by way of example, that a
consumer may rebut the presumption with evidence demonstrating that the
consumer's residual income was insufficient to meet living expenses,
such as food, clothing, gasoline, and health care, including the
payment of recurring medical expenses of which the creditor was aware
at the time of consummation, and after taking into account the
consumer's assets other than the value of the dwelling securing the
loan, such as a savings account. In addition, the longer the period of
time that the consumer has demonstrated actual ability to repay the
loan by making timely payments, without modification or accommodation,
after consummation or, for an adjustable-rate mortgage, after recast,
the less likely the consumer will be able to rebut the presumption
based on insufficient residual income and prove that, at the time the
loan was made, the creditor failed to make a reasonable and good faith
determination that the consumer had the reasonable ability to repay the
loan.
As noted above, the Bureau believes that the statutory language
regarding whether qualified mortgages receive either a safe harbor or
rebuttable presumption of compliance is ambiguous, and does not plainly
mandate one approach over the other. Furthermore, the Bureau has the
authority to tailor the strength of the

[[Page 6514]]

presumption of compliance based on the characteristics associated with
the different types of qualified mortgages. Accordingly, the Bureau
interprets TILA section 129C(b)(1) to create a rebuttable presumption,
but exercises its adjustment authority under TILA section 105(a) to
limit the ability to rebut the presumption in two ways, because an
open-ended rebuttable presumption would unduly restrict access to
credit without a corresponding benefit to consumers.
First, the Bureau uses its adjustment authority under section
105(a) to limit the ability to rebut the presumption to insufficient
residual income or assets other than the dwelling that secures the
transaction because the Bureau believes exercise of this authority is
necessary and proper to facilitate compliance with and to effectuate a
purpose of section 129 and TILA. The Bureau believes this approach,
while preserving consumer remedies, provides clear standards to
creditors and courts regarding the basis upon which the presumption of
compliance that applies to higher-priced covered transactions may be
rebutted, thereby enhancing creditor certainty and encouraging lending
in the higher-priced mortgage market. The Bureau finds this approach is
necessary and proper to ensure that consumers are offered and receive
residential mortgage loans on terms that reasonably reflect their
ability to repay the loans, a purpose of section 129 and TILA.
Second, with respect to prime loans (loans with an APR that does
not exceed APOR by 1.5 percentage points for first liens and 3.5
percentage points for second liens), the Bureau also uses its
adjustment authority under TILA section 105(a) to provide a conclusive
presumption (e.g., a safe harbor). Under the conclusive presumption, if
a prime loan satisfies the criteria for being a qualified mortgage, the
loan will be deemed to satisfy section 129C's ability-to-repay criteria
and will not be subject to rebuttal based on residual income or
otherwise. The Bureau finds that this approach balances the competing
consumer protection and access to credit considerations described
above. As discussed above, the Bureau will not extend the safe harbor
to higher-priced loans because that approach would provide insufficient
protection to consumers in loans with higher interest rates who may
require greater protection than consumers in prime rate loans. On the
other hand, an approach that provided a rebuttable presumption of
compliance for all qualified mortgages (including prime loans which
historically have a low default rate) could lead creditors to make
fewer mortgage loans to certain consumers, which could restrict access
to credit (or unduly raise the cost of credit) without a corresponding
benefit to consumers. The Bureau finds that this adjustment providing a
safe harbor for prime loans is necessary and proper to facilitate
compliance with and to effectuate the purposes of section 129C and
TILA, including to assure that consumers are offered and receive
residential mortgage loans on terms that reasonably reflect their
ability to repay the loans.\144\
---------------------------------------------------------------------------

\144\ These adjustments are consistent with the Bureau's
authority under TILA section 129C(b)(3)(B)(i) to 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 this section, necessary and appropriate to
effectuate the purposes of TILA section 129B and section 129C, to
prevent circumvention or evasion thereof, or to facilitate
compliance with such sections.
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43(e)(2) Qualified Mortgage Defined--General
As discussed above, TILA section 129C(b)(2) defines the
requirements for qualified mortgages to limit certain loan terms and
features. The statute generally prohibits a qualified mortgage from
permitting an increase of the principal balance on the loan (negative
amortization), interest-only payments, balloon payments (except for
certain balloon-payment qualified mortgages pursuant to TILA section
129C(b)(2)(E)), a term greater than 30 years, or points and fees that
exceed a specified threshold.
In addition, the statute incorporates limited underwriting criteria
that overlap with some elements of the general ability-to-repay
standard. Specifically, the statutory definition of qualified mortgage
requires the creditor to (1) verify and document the income and
financial resources relied upon to qualify the obligors on the loan;
and (2) underwrite the loan based on a fully amortizing payment
schedule and the maximum interest rate during the first five years,
taking into account all applicable taxes, insurance, and assessments.
As noted above, these requirements appear to be focused primarily on
ensuring that certain mortgage products--no-documentation loans and
loans underwritten based only on a consumer's ability to make payments
during short introductory periods with low ``teaser'' interest rates--
are not eligible to be qualified mortgages.
In addition to these limited underwriting criteria, the statute
also authorizes the Bureau to establish additional criteria relating to
ratios of total monthly debt to monthly income or alternative measures
of ability to pay regular expenses after payment of total monthly debt,
taking into account the income levels of the consumer and other factors
the Bureau determines relevant and consistent with the purposes
described in TILA section 129C(b)(3)(B)(i). To the extent the Bureau
incorporates a debt-to-income or residual income requirement into the
qualified mortgage definition, several additional elements of the
general ability-to-repay standard would effectively also be
incorporated into the qualified mortgage definition, since debt-to-
income and residual income analyses by their nature require assessment
of income, debt (including simultaneous loans), and mortgage-related
obligations. As discussed above, the Board proposed two alternatives to
implement the qualified mortgage elements. Both alternatives under the
Board's proposal would have incorporated the statutory elements of a
qualified mortgage (e.g., product feature and loan term restrictions,
limits on points and fees, payment calculation requirements, and the
requirement to consider and verify the consumer's income or assets).
However, Alternative 2 also included the additional factors in the
general ability-to-repay standard.
Comments
Qualified mortgage definition. As an initial matter, the majority
of commenters generally favored defining qualified mortgages to reach a
broad portion of the overall market and to provide clarity with regard
to the required elements. Commenters agreed that clarity promotes the
benefits of creditors lending with confidence and consumers receiving
loans that comply with the basic requirements of an affordable loan. In
addition, commenters generally agreed that a qualified mortgage should
be broad, encompassing the vast majority of the existing mortgage
market. Numerous commenters indicated that creditors believed that the
difference between the legal protections afforded (or risks associated
with) qualified mortgages and non-qualified mortgages would result in
very little lending outside of qualified mortgages. Commenters asserted
that a narrowly defined qualified mortgage would leave loans outside
the legal protections of qualified mortgages and would result in
constrained credit or increased cost of credit.
As discussed in the section-by-section analysis of Sec.
1026.43(e)(1), commenters did not necessarily support the two

[[Page 6515]]

alternatives specifically as proposed by the Board, but suggested
variations on the definition of qualified mortgage that contain some or
all of the Board's proposed criteria, or additional criteria not
specifically included in either of the Board's proposed alternatives.
For example, as described below, a coalition of industry and consumer
advocates suggested a tiered approach to defining qualified mortgage,
based primarily on meeting a specific back-end debt-to-income
requirement, with alternative means of satisfying the qualified
mortgage definition (such as housing debt-to-income, reserves, and
residual income) if the back-end debt-to-income test is not satisfied.
Similarly, one industry commenter suggested using a weighted approach
to defining qualified mortgage, which would weight some underwriting
factors more heavily than others and permit a significant factor in one
area to compensate for a weak or missing factor in another area.
Consumer group commenters and some industry commenters generally
supported excluding from the definition of qualified mortgage certain
risky loan features which result in ``payment shock,'' such as negative
amortization or interest-only features. Consumer group commenters also
supported limiting qualified mortgages to a 30-year term, as required
by statute. Consumer group commenters and one industry trade
association strongly supported requiring creditors to consider and
verify the all the ability-to-repay requirements. These commenters
contended that the ability-to-repay requirements represent prudent
mortgage underwriting techniques and are essential to sustainable
lending. To that point, these commenters argued that qualified mortgage
loans should represent the best underwritten and most fully documented
loans, which would justify some form of protection from future
liability. In addition, several consumer group commenters suggested
adding a further requirement that when assessing the consumer's income
and determining whether the consumer will be able to meet the monthly
payments, a creditor must also take into account other recurring but
non-debt related expenses. These commenters argued that many consumers,
and especially low- and moderate-income consumers, face significant
monthly recurring expenses, such as medical care or prescriptions and
child care expense needed to enable the borrower or co-borrower to work
outside the home. These commenters further argued that even where the
percentage of disposable income in such situations seems reasonable,
the nominal amounts left to low- and moderate-income consumers may be
insufficient to enable such households to reasonably meet all their
obligations. While one consumer group commenter specifically supported
the inclusion of a consumer's credit history as an appropriate factor
for a creditor to consider and verify when underwriting a loan, several
commenters argued that the consumer's credit history should be not
included in the ability-to-repay requirements because, although credit
history may be relevant in prudent underwriting, it involves a
multitude of factors that need to be taken into consideration. In
addition, one association of State bank regulators also favored
consideration of the repayment factors that are part of a sound
underwriting process.
As noted above, some industry commenters also generally supported
including the underwriting requirements as proposed in Alternative 2,
with some adjustments, so long as the resulting qualified mortgage was
entitled to a safe harbor. These commenters stated that most creditors
today are already complying with the full ability-to-repay underwriting
standards, and strong standards will help them resist competitive
forces to lower underwriting standards in the future. Other industry
commenters argued that the qualified mortgage criteria should not
exclude specific loan products because the result will be that such
products will be unavailable in the market.
Some commenters generally supported aligning the definition of
qualified mortgage with the definition proposed by several Federal
agencies to define ``qualified residential mortgages'' (QRM) for
purposes of the risk retention requirements in title IX of the Dodd-
Frank Act. For example, one commenter suggested that the required
payment calculation for qualified mortgages be consistent with the QRM
proposed requirement that the payment calculation be based on the
maximum rate in the first five years after the first full payment
required. An association of reverse mortgage lenders requested that a
``qualified'' reverse mortgage be defined to ensure that the Federal
agencies finalizing the QRM rule are able to make a proprietary reverse
mortgage a QRM, which would be exempt from the risk retention
requirements. Lastly, numerous consumer group commenters argued that
high-cost mortgages be excluded from being a qualified mortgage.
Quantitative standards. Some industry commenters supported
including quantitative standards for such variables as debt-to-income
ratios and credit score with compensating factors in the qualified
mortgage definition. These commenters contended that quantitative
standards provide certainty and would help ensure creditworthy
consumers have access to qualified mortgage loans. One consumer group
commenter argued that, without specific quantitative standards, bank
examiners and assignees would have no benchmarks against which to
measure a creditor's compliance or safety and soundness. One industry
commenter favored quantitative standards such as a maximum back-end
debt-to-income ratio because that would provide sufficient certainty to
creditors and investors. One consumer group commenter supported
including quantitative standards for the debt-to-income ratio because,
without this, every loan would be open to debate as to whether the
consumer had the ability to repay at the time of loan consummation.
As described further below, certain commenters and interested
parties requested that the Bureau adopt a specific debt-to-income ratio
requirement for qualified mortgages. For example, some suggested that
if a consumer's total debt-to-income ratio is below a specified
threshold, the mortgage loan should satisfy the qualified mortgage
requirements, assuming other relevant conditions are met. In addition
to a debt-to-income requirement, some commenters and interested parties
suggested that the Bureau should include within the definition of a
``qualified mortgage'' loans with a debt-to-income ratio above a
certain threshold if the consumer has a certain amount of assets, such
as money in a savings or similar account, or a certain amount of
residual income.
Some industry commenters advocated against including quantitative
standards for such variables as debt-to-income ratios and residual
income. Those commenters argued that underwriting a loan involves
weighing a variety of factors, and creditors and investors should be
allowed to exercise discretion and weigh risks for each individual
loan. To that point, one industry trade group commenter argued that
community banks, for example, generally have conservative requirements
for a consumer's debt-to-income ratio, especially for loans that are
held in portfolio by the bank, and consider many factors when
underwriting mortgage loans, such as payment history, liquid reserves,
and other assets. Because several factors are considered and evaluated
in the underwriting process, this commenter asserted that community
banks can be

[[Page 6516]]

flexible when underwriting mortgage loans and provide arrangements for
certain consumers that fall outside of the normal debt-to-income ratio
for a certain loan. This commenter contended that strict quantitative
standards would inhibit community banks' relationship lending and
ability to use their sound judgment in the lending process. Some
commenters contended that requiring specific quantitative standards
could restrict credit access and availability for consumers.
Generally, industry commenters and some consumer group commenters
believed compensating factors are beneficial in underwriting and should
be permitted. These commenters generally believe compensating factors
should be incorporated into the qualified mortgage criteria, such as in
circumstances when a specified debt-to-income ratio threshold was
exceeded. In their view, lending is an individualized decision and
compensating factors can, for example, mitigate a consumer's high debt-
to-income ratio or low residual income. One industry trade group
commenter argued that the inclusion of compensating factors would allow
for a broader underwriting approach and should include family history,
repayment history, potential income growth, and inter-family
transactions. One association of State bank regulators suggested that
the rule provide guidance on mitigating factors for creditors to
consider when operating outside of standard parameters. For example,
creditors lending outside of typical debt-to-income standards can rely
upon other assets or the fact that a consumer has a high income. Other
industry commenters argued that the rule should provide for enough
flexibility to allow for common-sense underwriting and avoid rigid
limits or formulas that would exclude consumers on the basis of one or
a few underwriting factors.
Another commenter stated that the rule should not set thresholds or
limits on repayment ability factors. Instead, the rule should allow the
creditor to consider the required factors and be held to a good faith
standard. Such a rule permits individualized determinations to be made
based on each consumer, local markets, and the risk tolerance of each
creditor.
Final Rule
Section 1026.43(e)(2) of the final rule contains the general
qualified mortgage definition. As set forth below, the final rule
defines qualified mortgages under Sec. 1026.43(e)(2) as loans that
satisfy all of the qualified mortgage criteria required by the statute
(including underwriting to the maximum interest rate during the first
five years of the loan and consideration and verification of the
consumer's income or assets), for which the creditor considers and
verifies the consumer's current debt obligations, alimony, and child
support, and that have a total (``back-end'') monthly debt-to-income
ratio of no greater than 43 percent, following the standards for
``debt'' and ``income'' set forth in appendix Q.
While the general definition of qualified mortgage in Sec.
1026.43(e)(2) contains all of the statutory qualified mortgage
elements, it does not separately incorporate all of the general
ability-to-repay underwriting requirements that would have been part of
the qualified mortgage definition under the Board's proposed
Alternative 2. In particular, the definition of qualified mortgage in
Sec. 1026.43(e)(2) does not specifically require consideration of the
consumer's employment status, monthly payment on the covered
transaction (other than the requirement to underwrite the loan to the
maximum rate in the first five years), monthly payment on any
simultaneous loans, or the consumer's credit history, which are part of
the general ability-to-repay analysis under Sec. 1026.43(c)(2).
Instead, most of these requirements are incorporated into the standards
for determining ``debt'' and ``income'' pursuant to Sec.
1026.43(e)(2)(vi)(A) and (B), to which the creditor must look to
determine if the loan meets the 43 percent debt-to-income ratio
threshold as required in Sec. 1026.43(e)(2)(vi). In particular, that
calculation will require the creditor to verify, among other things,
the consumer's employment status (to determine current or expected
income) and the monthly payment on the covered transaction (including
mortgage-related obligations) and on any simultaneous loans that the
creditor knows or has reason to know will be made. In addition,
although consideration and verification of a consumer's credit history
is not specifically incorporated into the qualified mortgage
definition, creditors must verify a consumer's debt obligations using
reasonably reliable third-party records, which may include use of a
credit report or records that evidence nontraditional credit
references. See section-by-section analysis of Sec. 1026.43(e)(2)(v)
and (c)(3).
The final rule adopts this approach because the Bureau believes
that the statute is fundamentally about assuring that the mortgage
credit consumers receive is affordable. Qualified mortgages are
intended to be mortgages as to which it can be presumed that the
creditor made a reasonable determination of the consumer's ability to
repay. Such a presumption would not be reasonable--indeed would be
imprudent--if a creditor made a mortgage loan without considering and
verifying core aspects of the consumer's individual financial picture,
such as income or assets and debt. Incorporating these ability-to-repay
underwriting requirements into the qualified mortgage definition thus
ensures that creditors assess the consumer's repayment ability for a
qualified mortgage using robust and appropriate underwriting
procedures. The specific requirements for a qualified mortgage under
Sec. 1026.43(e)(2) are described below.
The Bureau notes that the final rule does not define a
``qualified'' reverse mortgage. As described above, TILA section
129C(a)(8) excludes reverse mortgages from the repayment ability
requirements. See section-by-section analysis of Sec.
1026.43(a)(3)(i). However, TILA section 129C(b)(2)(ix) provides that
the term ``qualified mortgage'' may include a ``residential mortgage
loan'' that is ``a reverse mortgage which meets the standards for a
qualified mortgage, as set by the Bureau in rules that are consistent
with the purposes of this subsection.'' The Board's proposal did not
include reverse mortgages in the definition of a ``qualified
mortgage.'' Because reverse mortgages are exempt from the ability-to-
repay requirements, the effects of defining a reverse mortgage as a
``qualified mortgage'' would be, for example, to allow for certain
otherwise banned prepayment penalties and permit reverse mortgages to
be QRMs under the Dodd-Frank Act's risk retention rules. The Bureau
believes that the first effect is contrary to the purposes of the
statute. With respect to the QRM rulemaking, the Bureau will continue
to coordinate with the Federal agencies finalizing the QRM rulemaking
to determine the appropriate treatment of reverse mortgages.
43(e)(2)(i)
TILA section 129C(b)(2)(A)(i) states that the regular periodic
payments of a qualified mortgage may not result in an increase of the
principal balance or allow the consumer to defer repayment of principal
(except for certain balloon-payment loans made by creditors operating
predominantly in rural or underserved areas, discussed below in the
section-by-section analysis of Sec. 1026.43(f)). TILA section
129C(b)(2)(A)(ii) states that the terms of a qualified mortgage may not
include a balloon payment (subject to an exception for creditors
operating

[[Page 6517]]

predominantly in rural or underserved areas). The statute defines
``balloon payment'' as ``a scheduled payment that is more than twice as
large as the average of earlier scheduled payments.'' TILA section
129C(b)(2)(A)(ii).
The Board's proposed Sec. 226.43(e)(2)(i) would have implemented
TILA sections 129C(b)(2)(A)(i) and (ii). First, the proposed provision
would have required that a qualified mortgage provide for regular
periodic payments. Second, proposed Sec. 226.43(e)(2)(i) would have
provided that the regular periodic payments may not (1) result in an
increase of the principal balance; (2) allow the consumer to defer
repayment of principal, except as provided in proposed Sec. 226.43(f);
or (3) result in a balloon payment, as defined in proposed Sec.
226.18(s)(5)(i), except as provided in proposed Sec. 226.43(f).
Proposed comment 43(e)(2)(i)-1 would have explained that, as a
consequence of the foregoing requirements, a qualified mortgage must
require the consumer to make payments of principal and interest, on a
monthly or other periodic basis, that will fully repay the loan amount
over the loan term. These periodic payments must be substantially equal
except for the effect that any interest rate change after consummation
has on the payment amount in the case of an adjustable-rate or step-
rate mortgage. The proposed comment would have also provided that,
because proposed Sec. 226.43(e)(2)(i) would have required that a
qualified mortgage provide for regular, periodic payments, a single-
payment transaction may not be a qualified mortgage. This comment would
have clarified a potential evasion of the regulation, as a creditor
otherwise could structure a transaction with a single payment due at
maturity that technically would not be a balloon payment as defined in
proposed Sec. 226.18(s)(5)(i) because it is not more than two times a
regular periodic payment.
Proposed comment 43(e)(2)(i)-2 would have provided additional
guidance on the requirement in proposed Sec. 226.43(e)(2)(i)(B) that a
qualified mortgage may not allow the consumer to defer repayment of
principal. The comment would have clarified that, in addition to
interest-only terms, deferred principal repayment also occurs if the
payment is applied to both accrued interest and principal but the
consumer makes periodic payments that are less than the amount that
would be required under a payment schedule that has substantially equal
payments that fully repay the loan amount over the loan term. Graduated
payment mortgages, for example, allow deferral of principal repayment
in this manner and therefore may not be qualified mortgages.
As noted above, the Dodd-Frank Act defines ``balloon payment'' as
``a scheduled payment that is more than twice as large as the average
of earlier scheduled payments.'' However, proposed Sec.
226.43(e)(2)(i)(C) would have cross-referenced Regulation Z's existing
definition of ``balloon payment'' in Sec. 226.18(s)(5)(i), which
provides that a balloon payment is ``a payment that is more than two
times a regular periodic payment.'' The Board noted that this
definition is substantially similar to the statutory one, except that
it uses as its benchmark any regular periodic payment rather than the
average of earlier scheduled payments. The Board explained that the
difference in wording between the statutory definition and the existing
regulatory definition does not yield a significant difference in what
constitutes a ``balloon payment'' in the qualified mortgage context.
Specifically, the Board stated its belief that because a qualified
mortgage generally must provide for substantially equal, fully
amortizing payments of principal and interest, a payment that is
greater than twice any one of a loan's regular periodic payments also
generally will be greater than twice the average of its earlier
scheduled payments.
Accordingly, to facilitate compliance, the Board proposed to cross-
reference the existing definition of ``balloon payment.'' The Board
proposed this adjustment to the statutory definition pursuant to its
authority under TILA section 105(a) to make such adjustments for all or
any class of transactions as in the judgment of the Board are necessary
or proper to facilitate compliance with TILA. The Board stated that
this approach is further supported by its authority under TILA section
129B(e) to condition terms, acts or practices relating to residential
mortgage loans that the Board finds necessary or proper to facilitate
compliance.
Finally, in the preamble to the Board's proposal, the Board noted
that some balloon-payment loans are renewable at maturity and that such
loans might appropriately be eligible to be qualified mortgages,
provided the terms for renewal eliminate the risk of the consumer
facing a large, unaffordable payment obligation, which underlies the
rationale for generally excluding balloon-payment loans from the
definition of qualified mortgages. If the consumer is protected by the
terms of the transaction from that risk, the Board stated that such a
transaction might appropriately be treated as though it effectively is
not a balloon-payment loan even if it is technically structured as one.
The Board solicited comment on whether it should include an exception
providing that, notwithstanding proposed Sec. 226.43(e)(2)(i)(C), a
qualified mortgage may provide for a balloon payment if the creditor is
unconditionally obligated to renew the loan at the consumer's option
(or is obligated to renew subject to conditions within the consumer's
control). The Board sought comment on how such an exception should be
structured to ensure that the large-payment risk ordinarily
accompanying a balloon-payment loan is fully eliminated by the renewal
terms and on how such an exception might be structured to avoid the
potential for circumvention.
As discussed above, commenters generally supported excluding from
the definition of qualified mortgage certain risky loan features which
result in ``payment shock,'' such as negative amortization or interest-
only features. Commenters generally recognized such features as
significant contributors to the recent housing crisis. Industry
commenters noted that such restrictions are objective criteria which
creditors can conclusively demonstrate were met at the time of
origination. However, one mortgage company asserted that such
limitations should not apply in loss mitigation transactions, such as
loan modifications and extensions, or to loan assumptions. That
commenter noted that while negative amortization is not common in most
loan modification programs, the feature can be used at times to help
consumers work through default situations. The commenter also noted
that deferral of payments, including principal payments, and balloon
payment structures are commonly used to relieve payment default
burdens. One bank commenter argued that the rule should permit
qualified mortgages to have balloon payment features if the creditor is
unconditionally obligated to renew the loan at the consumer's option,
or is obligated to renew subject to conditions within the consumer's
control.
For the reasons discussed in the proposed rule, the Bureau is
adopting Sec. 226.43(e)(2)(i) as proposed in renumbered Sec.
1026.43(e)(2)(i), with certain clarifying changes. In particular, in
addition to the proposed language, section 1026.43(e)(2)(i) specifies
that a qualified mortgage is a covered transaction that provides for
regular periodic payments that are substantially equal, ``except for
the effect that any interest rate change after consummation has on the
payment in the case of an adjustable-rate or step-rate mortgage.''

[[Page 6518]]

This language appeared in the commentary to Sec. 226.43(e)(2)(i) in
the proposed rule, but to provide clarity, the Bureau is adopting this
language in the text of Sec. 1026.43(e)(2)(i) in the final rule.
Notably, the Bureau is adopting in Sec. 1026.43(e)(2)(i) the
proposed cross-reference to the existing Regulation Z definition of
balloon payment. Like the Board, the Bureau finds that the statutory
definition and the existing regulatory definition do not yield a
significant difference in what constitutes a ``balloon payment'' in the
qualified mortgage context. Accordingly, the Bureau makes this
adjustment pursuant to its authority under TILA section 105(a) because
the Bureau believes that affording creditors a single definition of
balloon payment within Regulation Z is necessary and proper to
facilitate compliance with and effectuate the purposes of TILA.
In addition, like the proposal, the final rule does not provide
exceptions from the prohibition on qualified mortgages providing for
balloon payments, other than the exception for creditors operating
predominantly in rural or underserved areas, described below in the
section-by-section analysis of Sec. 1026.43(f). The Bureau believes
that it is appropriate to implement the rule consistent with statutory
intent, which specifies only a narrow exception from this general rule
for creditors operating predominantly in rural or underserved areas
rather than a broader exception to the general prohibition on qualified
mortgages containing balloon payment features. With respect to
renewable balloon-payment loans, the Bureau does not believe that the
risk that a consumer will face a significant payment shock from the
balloon feature can be fully eliminated, and that a rule that attempts
to provide such special treatment for renewable balloon-payment loans
would be subject to abuse.
43(e)(2)(ii)
TILA section 129C(b)(2)(A)(viii) requires that a qualified mortgage
must not provide for a loan term that exceeds 30 years, ``except as
such term may be extended under paragraph (3), such as in high-cost
areas.'' As discussed above, TILA section 129C(b)(3)(B)(i) authorizes
the Bureau to revise, add to, or subtract from the qualified mortgage
criteria if the Bureau makes certain findings, including that such
revision is necessary or proper to ensure that responsible, affordable
mortgage credit remains available to consumers in a manner consistent
with the purposes of TILA section 129C(b) or necessary and appropriate
to effectuate the purposes of section 129C.
Proposed Sec. 226.43(e)(2)(ii) would have implemented the 30-year
maximum loan term requirement in the statute without exception. The
preamble to the proposed rule explains that, based on available
information, the Board believed that mortgage loans with terms greater
than 30 years are rare and, when made, generally are for the
convenience of consumers who could qualify for a loan with a 30-year
term but prefer to spread out their payments further. Therefore, the
Board believed such an exception is generally unnecessary. The Board
solicited comment on whether there are any ``high-cost areas'' in which
loan terms in excess of 30 years are necessary to ensure that
responsible, affordable credit is available and, if so, how they should
be identified for purposes of such an exception. The Board also sought
comment on whether any other exceptions would be appropriate,
consistent with the Board's authority in TILA section 129C(b)(3)(B)(i).
As noted above, commenters generally supported the 30-year term
limitation. One commenter suggested the final rule should clarify that
a loan term that is slightly longer than 30 years because of the due
date of the first regular payment nevertheless meets the 30-year term
requirement. One trade association commenter suggested that creditors
be provided flexibility to originate 40-year loans in order to
accommodate consumers in regions of the country where housing prices
are especially high, but did not provide any information regarding the
historic performance of 40-year loans or discuss how the Bureau should
define high-cost areas in a way that avoids abuse. An association of
State bank regulators also suggested that the rule permit loan terms
beyond 30 years in high-cost areas and suggested that those areas could
be determined based on housing price indices. That commenter, two large
industry trade associations, and one mortgage company commenter argued
that the 30-year term limitation should not apply to loan modifications
that provide a consumer with a loan with a lower monthly payment than
he or she may otherwise face. One such commenter noted that, as a
general matter, the rule should clarify that modifications of existing
loans should not be subject to the same ability-to-repay requirements
to avoid depriving consumers of beneficial modifications.
For the reasons discussed in the proposed rule, the Bureau is
generally adopting Sec. 226.43(e)(2)(ii) as proposed in renumbered
Sec. 1026.43(e)(2)(ii). In response to commenter concern, the final
rule clarifies in comment 43(e)(2)(ii)-1 that the 30-year term
limitation in Sec. 1026.43(e)(2)(ii) is applied without regard to any
interim period between consummation and the beginning of the first full
unit period of the repayment schedule. Consistent with the Board's
analysis, the final rule does not provide exceptions to the 30-year
loan limitation. Like the Board, the Bureau is unaware of a basis upon
which to conclude that an exception to the 30-year loan term limitation
for qualified mortgages in high-cost areas is appropriate. In
particular, the Bureau believes that loans with terms greater than 30
years are rare and that, when made, generally are for the convenience
of consumers who could qualify for a loan with a 30-year term.
The final rule also does not provide additional guidance on the 30-
year loan term limitation in the context of loan modifications. The
Bureau understands that private creditors may offer loan modifications
to consumers at risk of default or foreclosure, and that such
modifications may extend the duration of the loan beyond the initial
term. If such modification results in the satisfaction and replacement
of the original obligation, the loan would be a refinance under current
Sec. 1026.20(a), and therefore the new transaction must comply with
the ability-to-repay requirements of Sec. 1026.43(c) or satisfy the
criteria for a qualified mortgage, independent of any ability-to-repay
analysis or the qualified mortgage status of the initial transaction.
However, if the transaction does not meet the criteria in 1026.20(a),
which determines a refinancing--generally resulting in the satisfaction
and replacement of the original obligation--the loan would not be a
refinance under Sec. 1026.20(a), and would instead be an extension of
the original loan. In such a case, compliance with the ability-to-repay
provision, including a loan's qualified mortgage status, would be
determined as of the date of consummation of the initial transaction,
regardless of a later modification.
43(e)(2)(iii)
TILA section 129C(b)(2)(A)(vii) defines a qualified mortgage as a
loan for which, among other things, the total points and fees payable
in connection with the loan do not exceed three percent of the total
loan amount. TILA section 129C(b)(2)(D) requires the Bureau to
prescribe rules adjusting this threshold to ``permit lenders that
extend smaller loans to meet the requirements of the presumption of
compliance.'' The statute further requires the Bureau, in prescribing
such rules, to ``consider the potential impact of such rules on rural

[[Page 6519]]

areas and other areas where home values are lower.''
Proposed Sec. 226.43(e)(2)(iii) would have implemented these
provisions by providing that a qualified mortgage is a loan for which
the total points and fees payable in connection with the loan do not
exceed the amounts specified under proposed Sec. 226.43(e)(3). As
discussed in detail in the section-by-section analysis of Sec.
1026.43(e)(3), the Board proposed two alternatives for calculating the
allowable points and fees for a qualified mortgage: One approach would
have consisted of five ``tiers'' of loan sizes and corresponding limits
on points and fees, while the other approach would have consisted of
three ``tiers'' of points and fees based on a formula yielding a
greater allowable percentage of the total loan amount to be charged in
points and fees for each dollar increase in loan size. Additionally,
proposed Sec. 226.43(b)(9) would have defined ``points and fees'' to
have the same meaning as in proposed Sec. 226.32(b)(1).
For the reasons discussed in the proposed rule, the Bureau is
generally adopting Sec. 226.43(e)(2)(iii) as proposed in renumbered
Sec. 1026.43(e)(2)(iii). For a discussion of the final rule's approach
to calculating allowable points and fees for a qualified mortgage, see
the section-by-section analysis of Sec. 1026.43(e)(3). For a
discussion of the definition of points and fees, see the section-by-
section analysis of Sec. 1026.32(b)(1).
As noted above, several consumer group commenters requested that
high-cost mortgages be prohibited from receiving qualified mortgage
status. Those commenters noted that high-cost mortgages have been
singled out by Congress as deserving of special regulatory treatment
because of their potential to be abusive to consumers. They argue that
it would seem incongruous for any high-cost mortgage to be given a
presumption of compliance with the ability-to-repay rule. However, the
final rule does not prohibit a high-cost mortgage from being a
qualified mortgage. Under the Dodd-Frank Act, a mortgage loan is a
high-cost mortgage when (1) the annual percentage rate exceeds APOR by
more than 6.5 percentage points for first-liens or 8.5 percentage
points for subordinate-liens; (2) points and fees exceed 5 percent,
generally; or (3) when prepayment penalties may be imposed more than
three years after consummation or exceed 2 percent of the amount
prepaid. Neither the Board's 2011 ATR-QM Proposal nor the Bureau's 2012
HOEPA Proposal would have prohibited loans that are high-cost mortgages
as a result of a high interest rate from receiving qualified mortgage
status.
As a general matter, the ability-to-repay requirements in this
final rule apply to most closed-end mortgage loans, including closed-
end high-cost mortgages. Notwithstanding the Dodd-Frank Act's creation
of a new ability-to-repay regime for mortgage loans, Congress did not
modify an existing prohibition in TILA section 129(h) against
originating a high-cost mortgage without regard to a consumer's
repayment ability (HOEPA ability-to-repay). Thus, under TILA (as
amended by the Dodd-Frank Act), closed-end high-cost mortgages are
subject both to the general ability-to-repay provisions and to HOEPA's
ability-to-repay requirement.\145\ As implemented in existing Sec.
1026.34(a)(4), the HOEPA ability-to-repay rules contain a rebuttable
presumption of compliance if the creditor takes certain steps that are
generally less rigorous than the Dodd-Frank Act's ability-to-repay
requirements, as implemented in this rule. For this reason, and as
explained further in that rulemaking, the Bureau's 2013 HOEPA Final
Rule provides that a creditor complies with the high-cost mortgage
ability-to-repay requirement by complying with the general ability-to-
repay provision, as implemented by this final rule.\146\
---------------------------------------------------------------------------

\145\ The statutory HOEPA ability-to-repay provisions prohibit
creditors from engaging in a pattern or practice of making loans
without regard to the consumer's repayment ability. In the 2008
HOEPA Final Rule, the Board eliminated the ``pattern or practice''
requirement under the HOEPA ability-to-repay provision and also
applied the repayment ability requirement to higher-priced mortgage
loans.
\146\ The Bureau notes that, among other restrictions, the 2013
HOEPA Final Rule also includes in Sec. 1026.32(d)(1) a prohibition
on balloon payment features for most high-cost mortgages, and
retains the current restrictions on high-cost mortgages permitting
negative amortization. As noted, high-cost mortgages will be subject
to these restrictions in addition to the requirements imposed in
this final rule. With respect to prepayment penalty revisions, the
Dodd-Frank Act deleted the statutory restrictions applicable to
high-cost mortgages. The new Dodd-Frank Act prepayment penalty
restrictions of section 1414 are implemented as discussed below.
---------------------------------------------------------------------------

The final rule does not prohibit high-cost mortgages from being
qualified mortgages for several reasons. First, the Dodd-Frank Act does
not prohibit high-cost mortgages from receiving qualified mortgage
status. While the statute imposes a points and fees limit on qualified
mortgages (3 percent, generally) that effectively prohibits loans that
trigger the high-cost mortgage points and fee threshold from receiving
qualified mortgage status, it does not impose an annual percentage rate
limit on qualified mortgages.\147\ Therefore, nothing in the statute
prohibits a creditor from making a loan with a very high interest rate
such that the loan is a high-cost mortgage while still meeting the
criteria for a qualified mortgage.
---------------------------------------------------------------------------

\147\ The points and fees limit for qualified mortgages set
forth in the Dodd-Frank Act, as implemented in Sec. 1026.43(e) of
this final rule (including separate points and fees limits for
smaller loans), is lower than the high-cost mortgage points and fees
threshold. Thus, any loan that triggers the high-cost mortgage
provisions through the points and fees criteria could not satisfy
the qualified mortgage definition. Likewise, Sec. 1026.43(g) of
this final rule provides that, where qualified mortgages are
permitted to have prepayment penalties, such penalties may not be
imposed more than three years after consummation or in an amount
that exceeds 2 percent of the amount prepaid. This limitation aligns
with the prepayment penalty trigger for the high-cost mortgage
provisions, such that a loan that satisfies the qualified mortgage
requirements would never trigger the high-cost mortgage provisions
as a result of a prepayment penalty.
---------------------------------------------------------------------------

In addition, the final rule does not prohibit high-cost mortgages
from being qualified mortgages because the Bureau believes that, for
loans that meet the qualified mortgage definition, there is reason to
presume, subject to rebuttal, that the creditor had a reasonable and
good faith belief in the consumer's ability to repay notwithstanding
the high interest rate. High-cost mortgages will be less likely to meet
qualified mortgage criteria because the higher interest rate will
generate higher monthly payments and thus require higher income to
satisfy the debt-to-income test for a qualified mortgage. But where
that test is satisfied--that is, where the consumer has an acceptable
debt-to-income ratio calculated in accordance with qualified mortgage
underwriting rules--there is no logical reason to exclude the loan from
the definition of a qualified mortgage.
Allowing a high-cost mortgage to be a qualified mortgage can
benefit consumers. The Bureau anticipates that, in the small loan
market, creditors may sometimes exceed high-cost mortgage thresholds
due to the unique structure of their business. The Bureau believes it
would be in the interest of consumers to afford qualified mortgage
status to loans meeting the qualified mortgage criteria so as to remove
any incremental impediment that the general ability-to-repay provisions
would impose on making such loans. The Bureau also believes this
approach could provide an incentive to creditors making high-cost
mortgages to satisfy the qualified mortgage requirements, which would
provide additional consumer protections, such as restricting interest-
only payments and limiting loan terms to 30 years, which are not
requirements under HOEPA.

[[Page 6520]]

Furthermore, allowing high-cost mortgage loans to be qualified
mortgages would not impact the various impediments to making high-cost
mortgage loans, including enhanced disclosure and counseling
requirements and the enhanced liability for HOEPA violations. Thus,
there would remain strong disincentives to making high-cost mortgages.
The Bureau does not believe that allowing high-cost mortgages to be
qualified mortgages would incent creditors who would not otherwise make
high-cost mortgages to start making them.
43(e)(2)(iv)
TILA section 129C(b)(2)(A)(iv) and (v) provides as a condition to
meeting the definition of a qualified mortgage, in addition to other
criteria, that the underwriting process for a fixed-rate or adjustable-
rate loan be based on ``a payment schedule that fully amortizes the
loan over the loan term and takes into account all applicable taxes,
insurance, and assessments.'' The statute further states that for an
adjustable-rate loan, the underwriting must be based on ``the maximum
rate permitted under the loan during the first 5 years.'' See TILA
section 129C(b)(2)(A)(v). The statute does not define the terms ``fixed
rate,'' ``adjustable-rate,'' or ``loan term,'' and provides no
additional assumptions regarding how to calculate the payment
obligation.
These statutory requirements differ from the payment calculation
requirements set forth in existing Sec. 1026.34(a)(4)(iii), which
provides a presumption of compliance with the repayment ability
requirements for higher-priced mortgage loans, where the creditor
underwrites the loan using the largest payment of principal and
interest scheduled in the first seven years following consummation. The
existing presumption of compliance under Sec. 1026.34(a)(4)(iii) is
available for all high-cost and higher-priced mortgage loans, except
for loans with negative amortization or balloon-payment mortgages with
a term less than seven years. In contrast, TILA section 129C(b)(2)(A)
requires the creditor to underwrite the loan based on the maximum
payment during the first five years, and does not extend the scope of
qualified mortgages to any loan that contains certain risky features or
a loan term exceeding 30 years. Loans with a balloon-payment feature
would not meet the definition of a qualified mortgage regardless of
term length, unless made by a creditor that satisfies the conditions in
Sec. 1026.43(f).
The Board proposed to implement the underwriting requirements of
TILA section 129C(b)(2)(A)(iv) and (v), for purposes of determining
whether a loan meets the definition of a qualified mortgage, in
proposed Sec. 226.43(e)(2)(iv). Under the proposal, creditors would
have been required to underwrite a loan that is a fixed-, adjustable-,
or step-rate mortgage using a periodic payment of principal and
interest based on the maximum interest rate permitted during the first
five years after consummation. The terms ``adjustable-rate mortgage,''
``step-rate mortgage,'' and ``fixed-rate mortgage'' would have had the
meaning as in current Sec. 1026.18(s)(7)(i) through (iii),
respectively.
Specifically, proposed Sec. 226.43(e)(2)(iv) would have provided
that meeting the definition of a qualified mortgage is contingent, in
part, on creditors meeting the following underwriting requirements:
(1) Proposed Sec. 226.43(e)(2)(iv) would have required that the
creditor take into account any mortgage-related obligations when
underwriting the consumer's loan;
(2) Proposed Sec. 226.43(e)(2)(iv)(A) would have required the
creditor to use the maximum interest rate that may apply during the
first five years after consummation; and
(3) Proposed Sec. 226.43(e)(2)(iv)(B) would have required that the
periodic payments of principal and interest repay either the
outstanding principal balance over the remaining term of the loan as of
the date the interest rate adjusts to the maximum interest rate that
can occur during the first five years after consummation, or the loan
amount over the loan term.
These three underwriting conditions under proposed Sec.
226.43(e)(2)(iv), and the approach to these criteria adopted in the
final rule, are discussed below.
Proposed Sec. 226.43(e)(2)(iv) would have implemented TILA section
129C(b)(2)(A)(iv) and (v), in part, and provided that, to be a
qualified mortgage under proposed Sec. 1026.43(e)(2), the creditor
must underwrite the loan taking into account any mortgage-related
obligations. Proposed comment 43(e)(2)(iv)-6 would have provided cross-
references to proposed Sec. 226.43(b)(8) and associated commentary.
The Board proposed to use the term ``mortgage-related obligations'' in
place of ``all applicable taxes, insurance (including mortgage
guarantee insurance), and assessments.'' Proposed Sec. 226.43(b)(8)
would have defined the term ``mortgage-related obligations'' to mean
property taxes; mortgage-related insurance premiums required by the
creditor as set forth in proposed Sec. 226.45(b)(1); homeowners
association, condominium, and cooperative fees; ground rent or
leasehold payments; and special assessments.
Commenters generally supported the inclusion of mortgage-related
obligations in the underwriting requirement in proposed Sec.
226.43(e)(2)(iv). Several industry trade associations, banks, civil
rights organizations, and consumer advocacy groups specifically
supported the requirement. Several commenters requested clear guidance
on the amounts to be included in the monthly payment amount, including
mortgage-related obligations. In addition, a civil rights organization
and several consumer advocacy groups argued that the creditor should
also be required to consider recurring, non-debt expenses, such as
medical supplies and child care.
As discussed above in the section-by-section analysis of Sec.
1026.43(b)(8), the Bureau is adopting the proposed definition of
mortgage-related obligations in renumbered Sec. 1026.43(b)(8), with
certain clarifying changes and additional examples.
For the reasons discussed above, the Bureau is adopting the
mortgage-related obligations portion of Sec. 226.43(e)(2)(vi) as
proposed in renumbered Sec. 1026.43(e)(2)(vi). The final rule does not
contain a specific requirement that the creditor consider, when
underwriting the consumer's monthly payment, recurring non-debt
expenses, such as medical supplies and child care. However, such
expenses, if known to the creditor at the time of consummation, may be
relevant to a consumer's ability to rebut the presumption of compliance
that applies to qualified mortgages that are higher-priced covered
transactions. See section-by-section analysis of Sec.
1026.43(e)(1)(ii)(B).
43(e)(2)(iv)(A)
Proposed Sec. 226.43(e)(2)(iv)(A) would have implemented TILA
section 129C(b)(2)(A)(iv) and (v), in part, and provided that, to be a
qualified mortgage under proposed Sec. 1026.43(e)(2), the creditor
must underwrite the loan using the maximum interest rate that may apply
during the first five years after consummation. However, the statute
does not define the term ``maximum rate,'' nor does the statute clarify
whether the phrase ``the maximum rate permitted under the loan during
the first 5 years'' means the creditor should use the maximum interest
rate that occurs during the first five years of the loan beginning with
the first periodic payment due under the loan, or during

[[Page 6521]]

the first five years after consummation of the loan. The former
approach would capture the rate recast for a 5/1 hybrid adjustable-rate
mortgage that occurs on the due date of the 60th monthly payment, and
the latter would not.
The Board interpreted the phrase ``maximum rate permitted'' as
requiring creditors to underwrite the loan based on the maximum
interest rate that could occur under the terms of the loan during the
first five years after consummation, assuming a rising index value. See
proposed comment 43(e)(2)(iv)-1. The Board noted that this
interpretation is consistent with current guidance contained in
Regulation Z regarding disclosure of the maximum interest rate. See
MDIA Interim Rule, 75 FR 58471 (Sept. 24, 2010). The Board further
stated that this interpretation is consistent with congressional intent
to encourage creditors to make loans to consumers that are less risky
and that afford the consumer a reasonable period of time to repay
(i.e., 5 years) on less risky terms. For the reasons described in the
proposed rule, the Bureau is adopting the ``maximum interest rate''
provision in Sec. 1026.43(e)(2)(iv) as proposed in renumbered Sec.
1026.43(e)(2)(iv).
The Board proposed to interpret the phrase ``during the first 5
years'' as requiring creditors to underwrite the loan based on the
maximum interest rate that may apply during the first five years after
consummation. TILA section 129C(b)(2)(A)(v). The preamble to the
proposed rule explains several reasons for this interpretation. First,
the Board noted that a plain reading of the statutory language conveys
that the ``first five years'' is the first five years of the loan once
it comes into existence (i.e., once it is consummated). The Board
believed that interpreting the phrase to mean the first five years
beginning with the first periodic payment due under the loan would
require an expansive reading of the statutory text.
Second, the Board noted that the intent of this underwriting
condition is to ensure that the consumer can afford the loan's payments
for a reasonable amount of time and that Congress intended for a
reasonable amount of time to be the first five years after
consummation.
Third, the Board proposed this approach because it is consistent
with prior iterations of this statutory text and the Board's 2008 HOEPA
Final Rule. As noted above, the Dodd-Frank Act codifies many aspects of
the repayment ability requirements contained in existing Sec.
1026.34(a)(4) of the Board's 2008 HOEPA Final Rule.
Fourth, the Board believed that interpreting the phrase ``during
the first five years'' as including the rate adjustment at the end of
the fifth year would be of limited benefit to consumers because
creditors could easily structure their product offerings to avoid
application of the rule. For example, a creditor could move a rate
adjustment that typically occurs on the due date of the 60th monthly
payment to due date of the first month that falls outside the specified
time horizon, making any proposal to extend the time period in order to
include the rate adjustment of diminished value.
Finally, the Board believed that the proposed timing of the five-
year period could appropriately differ from the approach used under the
2010 MDIA Interim Final Rule, given the different purposes of the
rules. The Board amended the 2010 MDIA Interim Final Rule to require
that creditors base their interest rate and payment disclosures on the
first five years after the due date of the first regular periodic
payment rather than the first five years after consummation. See 75 FR
81836, 81839 (Dec. 29, 2010). The revision clarified that the
disclosure requirements for \5/1\ hybrid adjustable-rate mortgages must
include the rate adjustment that occurs on the due date of the 60th
monthly payment, which typically occurs more than five years after
consummation. The disclosure requirements under the 2010 MDIA Interim
Final Rule, as revised, are intended to help make consumers aware of
changes to their loan terms that may occur if they choose to stay in
the loan beyond five years and therefore, helps to ensure consumers
avoid the uninformed use of credit. The Board believed a different
approach is appropriate under proposed Sec. 226.43(e)(2)(iv) because
that requirement seeks to ensure that the loan's payments are
affordable for a reasonable period of time. For the reasons stated
above, the Board believed that Congress intended the first five years
after consummation to be a reasonable period of time to ensure that the
consumer has the ability to repay the loan according to its terms.
For all the above-listed reasons, the Board interpreted the
statutory text as requiring that the creditor underwrite the loan using
the maximum interest rate during the first five years after
consummation. The Board solicited comment on its interpretation of the
phrase ``first five years'' and the appropriateness of this approach.
The Board also proposed clarifying commentary and examples, which are
described below.
As described above, commenters generally supported the payment
calculation requirements in the proposed rule, including the five-year
payment calculation. A comment from a coalition of consumer advocates
suggested that the period may not be long enough to assure a consumer's
ability to repay given that the average homeowner holds their mortgage
for approximately seven years, and suggested that the five-year payment
calculation requirement be extended to reflect the average mortgage
duration of the first ten years of the loan. Two industry commenters
suggested that the time horizon in the required payment calculation for
qualified mortgages be consistent with the proposed requirement in the
2011 QRM Proposed Rule that the payment calculation be based on the
maximum rate in the first five years after the date on which the first
regular periodic payment will be due. One such commenter noted that the
payment calculation approach in the 2011 QRM Proposed Rule is more
protective of consumers. Another industry commenter suggested that the
final rule should measure the first five years from the first regularly
scheduled payment, for consistency with the 2010 MDIA Interim Final
Rule. An association of State bank regulators agreed with the Board's
reasoning, noting that creditors could structure loans to recast
outside any parameter set by the rule and that an effective way to
prevent purposeful evasion of the payment calculation provision would
require legislation.
Notwithstanding the Board's proposed approach, the Bureau
interprets the phrase ``during the first 5 years'' as requiring
creditors to underwrite the loan based on the maximum interest rate
that may apply during the first five years after the first regular
periodic payment will be due. Like the Board, the Bureau finds the
statutory language to be ambiguous. However, the Bureau believes that
the statutory phrase ``during the first 5 years'' could be given either
meaning, and that this approach provides greater protections to
consumers by requiring creditors to underwrite qualified mortgages
using the rate that would apply after the recast of a five-year
adjustable rate mortgage. Further, as noted, this approach is
consistent with the payment calculation in the 2011 QRM Proposed Rule
and in existing Regulation Z with respect to the disclosure
requirements for interest rates on adjustable-rate amortizing loans.
Accordingly, Sec. 1026.43(e)(2)(iv)(A) provides that a qualified
mortgage under Sec. 1026.43(e)(2) must be underwritten, taking into
account any mortgage-

[[Page 6522]]

related obligations, using the maximum interest rate that may apply
during the first five years after the date on which the first regular
periodic payment will be due. Although the Bureau is finalizing the
commentary and examples to Sec. 226.43(e)(2)(iv) as proposed in the
commentary to renumbered Sec. 1026.43(e)(2)(iv), the final rule makes
conforming changes to the proposed commentary to reflect the adjusted
time horizon. The proposed commentary and the changes to the proposed
commentary as implemented in the final rule are described below.
The Bureau is finalizing comment 43(e)(2)(iv)-1 as proposed, but
with conforming changes to reflect the new time horizon. In the final
rule, the comment provides guidance to creditors on how to determine
the maximum interest rate during the first five years after the date on
which the first regular periodic payment will be due. This comment
explains that creditors must use the maximum rate that could apply at
any time during the first five years after the date on which the first
regular periodic payment will be due, regardless of whether the maximum
rate is reached at the first or subsequent adjustment during such five
year period.
The Bureau is finalizing comment 43(e)(2)(iv)(A)-2 as proposed.
That comment clarifies that for a fixed-rate mortgage, creditors should
use the interest rate in effect at consummation, and provides a cross-
reference to Sec. 1026.18(s)(7)(iii) for the meaning of the term
``fixed-rate mortgage.''
The Bureau is finalizing comment 43(e)(2)(iv)-3 as proposed, but
with conforming changes to reflect the new time horizon. That comment
provides guidance to creditors regarding treatment of periodic interest
rate adjustment caps, and explains that, for an adjustable-rate
mortgage, creditors should assume the interest rate increases after
consummation as rapidly as possible, taking into account the terms of
the legal obligation. The comment further explains that creditors
should account for any periodic interest rate adjustment cap that may
limit how quickly the interest rate can increase under the terms of the
legal obligation. The comment states that where a range for the maximum
interest rate during the first five years is provided, the highest rate
in that range is the maximum interest rate for purposes of this
section. Finally, the comment clarifies that where the terms of the
legal obligation are not based on an index plus a margin, or formula,
the creditor must use the maximum interest rate that occurs during the
first five years after the date on which the first regular periodic
payment will be due.
The Bureau is also adopting comment 43(e)(2)(iv)-3.i through .iii
as proposed, but with conforming changes to the comment to reflect the
new time horizon. Those comments provide examples of how to determine
the maximum interest rate. For example, comment 43(e)(2)(iv)-3.1
illustrates how to determine the maximum interest rate in the first
five years after the date on which the first regular periodic payment
will be due for an adjustable-rate mortgage with a discounted rate for
three years.
The Bureau is also finalizing comment 43(e)(2)(iv)-4 as proposed,
but with conforming changes to reflect the new time horizon. Comment
43(e)(2)(iv)-4 clarifies the meaning of the phrase ``first five years
after the date on which the first regular periodic payment will be
due.'' This comment provides that under Sec. 1026.43(e)(2)(iv)(A), the
creditor must underwrite the loan using the maximum interest rate that
may apply during the first five years after the date on which the first
regular periodic payment will be due, and provides an illustrative
example.
43(e)(2)(iv)(B)
Proposed Sec. 226.43(e)(2)(iv)(B) would have implemented TILA
section 129C(b)(2)(A)(iv) and (v), in part, by providing, as part of
meeting the definition of a qualified mortgage under proposed Sec.
1026.43(e)(2), that the creditor underwrite the loan using periodic
payments of principal and interest that will repay either (1) the
outstanding principal balance over the remaining term of the loan as of
the date the interest rate adjusts to the maximum interest rate that
occurs during the first five years after consummation; or (2) the loan
amount over the loan term. See proposed Sec. 226.43(e)(2)(iv)(B)(1)
and (2).
TILA section 129C(b)(2)(A)(iv) and (v) states that underwriting
should be based ``on a payment schedule that fully amortizes the loan
over the loan term.'' The Board noted that unlike the payment
calculation assumptions set forth for purposes of the general ability-
to-repay rule, under TILA section 129C(a)(6), the underwriting
conditions for purposes of meeting the definition of a qualified
mortgage do not specify the loan amount that should be repaid, and do
not define ``loan term.'' For consistency and to facilitate compliance,
the Board proposed to use the terms ``loan amount'' and ``loan term''
in proposed Sec. 226.43(b)(5) and (b), respectively, for purposes of
this underwriting condition.
However, the Board also believed that a loan that meets the
definition of a qualified mortgage and which has the benefit of other
safeguards, such as limits on loan features and fees, merits
flexibility in the underwriting process. Accordingly, the Board
proposed to permit creditors to underwrite the loan using periodic
payments of principal and interest that will repay either the
outstanding principal balance as of the date the maximum interest rate
during the first five years after consummation takes effect under the
terms of the loan, or the loan amount as of the date of consummation.
The Board believed the former approach more accurately reflects the
largest payment amount that the consumer would need to make under the
terms of the loan during the first five years after consummation,
whereas the latter approach would actually overstate the payment
amounts required. This approach would have set a minimum standard for
qualified mortgages, while affording creditors latitude to choose
either approach to facilitate compliance.
For the reasons described in the proposed rule, the Bureau is
finalizing Sec. 226.43(e)(2)(iv)(A) as proposed in renumbered Sec.
1026.43(e)(2)(iv)(A). However, the final rule makes conforming changes
to the proposed commentary to reflect the adjusted time-horizon to the
first five years after the due date of the first regular periodic
payment. The proposed commentary and the changes to the proposed
commentary in the final rule are described below.
The Bureau is finalizing comment 43(e)(2)(iv)-5 as proposed, but
with conforming changes to reflect the new time horizon. Comment
43(e)(2)(iv)-5 provides further clarification to creditors regarding
the loan amount to be used for purposes of this second condition in
Sec. 1026.43(e)(2)(iv). The comment explains that for a creditor to
meet the definition of a qualified mortgage under Sec. 1026.43(e)(2),
the creditor must determine the periodic payment of principal and
interest using the maximum interest rate permitted during the first
five years after the date on which the first regular periodic payment
will be due that repays either (1) the outstanding principal balance as
of the earliest date the maximum interest rate can take effect under
the terms of the legal obligation, over the remaining term of the loan,
or (2) the loan amount, as that term is defined in Sec. 1026.43(b)(5),
over the entire loan term, as that term is defined in Sec.
1026.43(b)(6). This comment provides illustrative examples for both
approaches.

[[Page 6523]]

The Bureau is finalizing comment 43(c)(2)(iv)-6 as proposed. That
comment reiterates that Sec. 1026.43(e)(2)(iv) requires creditors to
take mortgage-related obligations into account when underwriting the
loan and refers to Sec. 1026.43(b)(8) and its associated commentary
for the meaning of mortgage-related obligations.
The Bureau is also finalizing comment 43(e)(2)(iv)-7 as proposed,
but with conforming changes to reflect the new time horizon. Comment
43(e)(2)(iv)-7 provides examples of how to determine the periodic
payment of principal and interest based on the maximum interest rate
during the first five years after the date on which the first regular
periodic payment will be due under Sec. 1026.43(e)(2)(iv). The final
rule provides an additional example of how to determine the periodic
payment of principal and interest based on the maximum interest rate
during the first five years after the date on which the first regular
periodic payment will be due under Sec. 1026.43(e)(2)(iv) for an
adjustable-rate mortgage with a discount of seven years, to illustrate
how the payment calculation applies in a loan that adjusts after the
five-year time horizon. Comment 43(e)(2)(iv)-7.iv provides an example
of a loan in an amount of $200,000 with a 30-year loan term, that
provides for a discounted interest rate of 6 percent that is fixed for
an initial period of seven years, after which the interest rate will
adjust annually based on a specified index plus a margin of 3 percent,
subject to a 2 percent annual interest rate adjustment cap. The index
value in effect at consummation is 4.5 percent. The loan is consummated
on March 15, 2014, and the first regular periodic payment is due May 1,
2014. Under the terms of the loan agreement, the first rate adjustment
is on April 1, 2021 (the due date of the 84th monthly payment), which
occurs more than five years after the date on which the first regular
periodic payment will be due. Thus, the maximum interest rate under the
terms of the loan during the first five years after the date on which
the first regular periodic payment will be due is 6 percent. Under this
example, the transaction will meet the definition of a qualified
mortgage if the creditor underwrites the loan using the monthly payment
of principal and interest of $1,199 to repay the loan amount of
$200,000 over the 30-year loan term using the maximum interest rate
during the first five years after the date on which the first regular
periodic payment will be due of 6 percent.
43(e)(2)(v)
43(e)(2)(v)(A)
TILA section 129C(b)(2)(A)(iii) provides that a condition for
meeting the requirements of a qualified mortgage is that the income and
financial resources relied upon to qualify the obligors on the
residential mortgage loan are verified and documented. This requirement
is consistent with requirement under the general ability-to-repay
standard to consider and verify a consumer's income or assets using
third-party records, pursuant to TILA section 129C(a)(1) and (3), as
discussed above in the section-by-section analysis of Sec.
1026.43(c)(2)(i) and (c)(4).
Proposed Sec. 226.43(e)(2)(v) would have implemented TILA section
129C(b)(2)(A)(iii) by providing that for a covered transaction to be a
qualified mortgage, the creditor must consider and verify the
consumer's current or reasonably expected income or assets to determine
the consumer's repayment ability, as required by proposed Sec.
226.43(c)(2)(i) and (c)(4). The proposal used the term ``assets''
instead of ``financial resources'' for consistency with other
provisions in Regulation Z and, as noted above, the Bureau believes
that the terms have the same meaning. Proposed comment 43(e)(2)(v)-1
would have clarified that creditors may rely on commentary to proposed
Sec. 226.43(c)(2)(i), (c)(3) and (c)(4) for guidance regarding
considering and verifying the consumer's income or assets to satisfy
the conditions for a qualified mortgage under proposed Sec.
226.43(e)(2)(v).
For the reasons discussed in the proposal, the Bureau is finalizing
Sec. 226.43(e)(2)(v)(A) as proposed in renumbered Sec.
1026.43(e)(2)(v)(A), with additional clarification that the value of
the dwelling includes any real property to which the dwelling is
attached. Renumbered Sec. 1026.43(e)(2)(v)(A) also provides that the
creditor must consider and verify the consumer's current or reasonably
expected income or assets other than the value of the dwelling
(including any real property attached to the dwelling) that secures the
loan, in accordance with appendix Q, in addition to Sec.
1026.43(c)(2)(i) and (c)(4). Comment 43(e)(2)(v)-2 clarifies this
provision, by explaining that, for purposes of this requirement, the
creditor must consider and verify, at a minimum, any income specified
in appendix Q. A creditor may also consider and verify any other income
in accordance with Sec. 1026.43(c)(2)(i) and (c)(4); however, such
income would not be included in the total monthly debt-to-income ratio
determination by Sec. 1026.43(e)(2)(vi). As described below, appendix
Q contains specific standards for defining ``income,'' to provide
certainty to creditors as to whether a loan meets the requirements for
a qualified mortgage. The final rule includes this reference to
appendix Q and additional comment to clarify the relationship between
the requirement to consider a consumer's current or reasonably expected
income in Sec. 1026.43(e)(2)(v)(A) and the definition of ``income'' in
appendix Q. In other words, a creditor who considers ``income'' as
defined in appendix Q meets the income requirement in Sec.
1026.43(e)(2)(v)(A), so long as that income is verified pursuant to
Sec. 1026.43(c)(4). In addition, comment 43(e)(2)(v)-1 provides that
for guidance on satisfying Sec. 1026.43(e)(2)(v), a creditor may rely
on commentary to Sec. 1026.43(c)(2)(i) and (vi), (c)(3), and (c)(4).
43(e)(2)(v)(B)
The Board's proposed Alternative 2 would have required that
creditors consider and verify the following additional underwriting
requirements, which are also required under the general ability-to-
repay standard: the consumer's employment status, the consumer's
monthly payment on any simultaneous loans, the consumer's current debt
obligations, the consumer's monthly debt-to-income ratio or residual
income, and the consumer's credit history. The commentary would have
provided that creditors could look to commentary on the general
repayment ability provisions under proposed Sec. 226.43(c)(2)(i),
(ii), (iv), and (vi) through (viii), and (c)(3), (c)(4), (c)(6), and
(c)(7) for guidance regarding considering and verifying the consumer's
repayment ability to satisfy the conditions under Sec. 226.43(e)(2)(v)
for a qualified mortgage. See proposed comment 43(e)(2)(v)-1 under
Alternative 2. The Board proposed these additions pursuant to its legal
authority under TILA section 129C(b)(3)(B)(i). The Board believed that
adding these requirements may be necessary to better ensure that the
consumers are offered and receive loans on terms that reasonably
reflect their ability to repay the loan.
In the final rule, Sec. 1026.43(e)(2)(v)(B) provides that, to meet
the requirements for a qualified mortgage under Sec. 1026.43(e)(2),
the creditor must consider and verify the consumer's current debt
obligations, alimony, and child support, in accordance with appendix Q
and Sec. 1026.43(c)(2)(vi) and (c)(3). In addition, new comment
43(e)(2)(v)-3 clarifies that, for purposes

[[Page 6524]]

of considering and verifying the consumer's current debt obligations,
alimony, and child support pursuant to Sec. 1026.43(e)(2)(v)(B), the
creditor must consider and verify, at a minimum, any debt or liability
specified in appendix Q. A creditor may also consider and verify other
debt in accordance with Sec. 1026.43(c)(2)(vi) and (c)(3); however,
such debt would not be included in the total monthly debt-to-income
ratio determination required by Sec. 1026.43(e)(2)(vi). As described
below, appendix Q contains specific standards for defining ``debt,'' to
provide certainty to creditors as to whether a loan meets the
requirements for a qualified mortgage. The final rule includes this
reference to appendix Q and additional comment to clarify the
relationship between the requirement to consider a consumer's current
debt obligations, alimony, and child support in Sec.
1026.43(e)(2)(v)(B) and the definition of ``debt'' in appendix Q. In
other words, a creditor who considers ``debt'' as defined in appendix Q
meets the requirement in Sec. 1026.43(e)(2)(v)(B), so long as that
income is verified pursuant to Sec. 1026.43(c)(3).
The Bureau is incorporating the requirement that the creditor
consider and verify the consumer's current debt obligations, alimony,
and child support into the definition of a qualified mortgage in Sec.
1026.43(e)(2) pursuant to its authority under TILA section
129C(b)(3)(B)(i). The Bureau finds that this addition to the qualified
mortgage criteria is necessary and proper to ensure that responsible,
affordable mortgage credit remains available to consumers in a manner
that is consistent with the purposes of TILA section 129C and necessary
and appropriate to effectuate the purposes of TILA section 129C, which
includes assuring that consumers are offered and receive residential
mortgage loans on terms that reasonably reflect their ability to repay
the loan. The Bureau also incorporates this requirement pursuant to its
authority under TILA section 105(a) to issue regulations that, among
other things, contain such additional requirements, other provisions,
or that provide for such adjustments for all or any class of
transactions, that in the Bureau's judgment are necessary or proper to
effectuate the purposes of TILA, which include the above purpose of
section 129C, among other things. The Bureau believes that this
addition to the qualified mortgage criteria is necessary and proper to
achieve this purpose. In particular, as discussed above, the Bureau
finds that incorporating the requirement that a creditor consider and
verify a consumer's current debt obligations, alimony, and child
support into the qualified mortgage criteria ensures that creditors
consider, on an individual basis, and verify whether a consumer has the
ability to repay a qualified mortgage. Furthermore, together with the
requirement to consider and verify income, the Bureau believes this
requirement to consider and verify debt obligations, alimony, and child
support strengthens consumer protection and is fundamental to the
underlying components of the requirement in Sec. 1026.43(e)(2)(vi),
which provides a specific debt-to-income ratio threshold.
Ultimately, the Bureau believes that the statute is fundamentally
about establishing standards for determining a consumer's reasonable
ability to repay and therefore believes it is appropriate to
incorporate the ability-to-repay underwriting requirements into the
qualified mortgage definition to ensure consistent consumer protections
for repayment ability for a qualified mortgage. However, as described
above, most of the ability-to-repay requirements must be considered and
verified to satisfy the specific debt-to-income ratio requirement in
Sec. 1026.43(e)(2)(vi), which requires the creditor to follow the
standards for ``debt'' and ``income'' in appendix Q, including the
consumer's employment status, monthly payment on the covered
transaction, monthly payment on simultaneous loans of which the
creditor is aware, and monthly payment on mortgage-related obligations.
For this reason, unlike the Board's proposed Alternative 2, the final
rule does not separately require consideration and verification of
these factors that are part of the general ability-to-repay analysis.
43(e)(2)(vi)
TILA section 129C(b)(2)(vi) states that the term qualified mortgage
includes any mortgage loan ``that complies with any guidelines or
regulations established by the Bureau relating to ratios of total
monthly debt to monthly income or alternative measure of ability to pay
regular expenses after payment of total monthly debt, taking into
account the income levels of the consumer and such other factors as the
Bureau may determine relevant and consistent with the purposes
described in paragraph (3)(B)(i).''
Board's Proposal
Under proposed Sec. 226.43(e)(2)(v) under Alternative 1, creditors
would not have been required to consider the consumer's debt-to-income
ratio or residual income to make a qualified mortgage. The Board noted
several reasons for proposing this approach. First, the Board noted
that the debt-to-income ratio and residual income are based on widely
accepted standards which, although flexible, do not provide certainty
that a loan is a qualified mortgage. The Board believed this approach
is contrary to Congress' apparent intent to provide incentives to
creditors to make qualified mortgages, since they have less risky
features and terms. Second, the Board noted that because the definition
of a qualified mortgage under Alternative 1 would not require
consideration of current debt obligations or simultaneous loans, it
would be impossible for a creditor to calculate the debt-to-income
ratio or residual income without adding those requirements as well.
Third, the Board stated that data shows that the debt-to-income ratio
generally does not have a significant predictive power of loan
performance once the effects of credit history, loan type, and loan-to-
value ratio are considered.\148\ Fourth, the Board noted that although
consideration of the mortgage debt-to-income ratio (or ``front-end''
debt-to-income) might help consumers receive loans on terms that
reasonably reflect their ability to repay the loans, the Board's
outreach indicated that creditors often do not find that ``front-end''
debt-to-income ratio is a strong predictor of ability to repay.
Finally, the Board stated its concern that the benefit of including the
debt-to-income ratio or residual income in the definition of qualified
mortgage may not outweigh the cost to certain consumers who may not
meet widely accepted debt-to-income ratio standards, but may have other
compensating factors, such as sufficient residual income or other
resources to be able to reasonably afford the mortgage. A definition of
qualified mortgage that required consideration of the consumer's debt-
to-income or residual income could limit the availability of credit to
those consumers.
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\148\ The proposal cited Yuliya Demyanyk & Otto Van Hemert,
Understanding the Subprime Mortgage Crisis, 24 Rev. Fin. Stud. 1848
(2011); James A. Berkovec et al., Race, Redlining, and Residential
Mortgage Loan Performance, 9 J. Real Est. Fin. & Econs. 263 (1994).
---------------------------------------------------------------------------

However, under proposed Sec. 226.43(e)(2)(v) under Alternative 2,
a qualified mortgage would have been defined as a loan which, among
other things, the creditor considers the consumer's monthly debt-to-
income ratio or residual income, pursuant to proposed Sec.
226.43(c)(2)(vii) and (c)(7). The Board noted that, without determining
the consumer's debt-to-income ratio, a creditor could originate

[[Page 6525]]

a qualified mortgage without any requirement to consider the effect of
the new loan payment on the consumer's overall financial picture. The
consumer could have a very high total debt-to-income ratio under
reasonable underwriting standards, and be predicted to default soon
after the first scheduled mortgage payment. Accordingly, the Board
believed that including the debt-to-income ratio or residual income in
the definition of qualified mortgage might ensure that the consumer has
a reasonable ability to repay the loan.
The Board did not propose a quantitative standard for the debt-to-
income ratio in the qualified mortgage definition, but solicited
comment on the appropriateness of such an approach. The Board's
proposal noted several reasons for declining to introduce a specific
debt-to-income ratio for qualified mortgages. First, as explained in
the 2008 HOEPA Final Rule, the Board was concerned that setting a
specific debt-to-income ratio could limit credit availability without
providing adequate off-setting benefits. 73 FR 4455 (July 30, 2008).
The Board sought comment on what exceptions may be necessary for low-
income consumers or consumers living in high-cost areas, or for other
cases, if the Board were to adopt a quantitative debt-to-income
standard.
Second, outreach conducted by the Board revealed a range of
underwriting guidelines for debt-to-income ratios based on product
type, whether creditors used manual or automated underwriting, and
special considerations for high- and low-income consumers. The Board
believed that setting a quantitative standard would require it to
address the operational issues related to the calculation of the debt-
to-income ratio. For example, the Board would need clearly to define
income and current debt obligations, as well as compensating factors
and the situations in which creditors may use compensating factors. In
addition, the debt-to-income ratio is often a floating metric, since
the percentage changes as new information about income or current debt
obligations becomes available. A quantitative standard would require
guidelines on the timing of the debt-to-income ratio calculation, and
what circumstances would necessitate a re-calculation of the debt-to-
income ratio. Furthermore, a quantitative standard may also need to
provide tolerances for mistakes made in calculating the debt-to-income
ratio. The rule would also need to address the use of automated
underwriting systems in determining the debt-to-income.
For all these reasons, the Board did not propose a quantitative
standard for the debt-to-income ratio. The Board recognized, however,
that creditors, and ultimately consumers, may benefit from a higher
degree of certainty surrounding the qualified mortgage definition that
a quantitative standard could provide. Therefore, the Board solicited
comment on whether and how it should prescribe a quantitative standard
for the debt-to-income ratio or residual income for the qualified
mortgage definition.
Comments
As noted above, the Bureau received comments in response to the
Board's 2011 ATR Proposal and in response to the Bureau's May 2012
notice to reopen the comment period. The reopened comment period
solicited comment specifically on new data and information obtained
from the Federal Housing Finance Agency (FHFA) after the close of the
original comment period. In the notice to reopen the comment period,
the Bureau, among other things, solicited comment on data and
information as well as sought comment specifically on certain
underwriting factors, such as a debt-to-income ratio, and their
relationship to measures of delinquency or their impact on the number
or percentage of mortgage loans that would be a qualified mortgage. In
addition, the Bureau sought comment and data on estimates of litigation
costs and liability risks associated with claims alleging a violation
of ability-to-repay requirements.
Comments on general debt-to-income ratio or residual income
requirement. In response to the proposed rule, some industry commenters
argued that the final rule should not require consideration and
verification of a consumer's monthly debt-to-income ratio or residual
income for a qualified mortgage. They argued that such an approach
would create a vague, subjective definition of qualified mortgage.
Certain industry commenters requested that if the Bureau added
consideration and verification of the debt-to-income ratio or residual
income to the definition of a qualified mortgage, the Bureau establish
flexible standards. These commenters argued that imposing low debt-to-
income ratio requirements would be devastating to many potential
creditworthy homebuyers.
Other industry commenters suggested that if the Bureau added
consideration and verification of the debt-to-income ratio or residual
income to the definition of a qualified mortgage, the Bureau provide
clear and objective standards. For example, one industry trade group
commenter noted that, historically, the debt-to-income ratio has been a
key metric used to assess a consumer's ability to repay a mortgage
loan, and has been incorporated into both manual and automated
underwriting systems used in the industry. Some industry commenters
asked that the final rule adopt the VA calculation of residual income.
See also the section-by-section analysis of section 1026.43(c)(7).
Another industry commenter suggested that any mortgage with a residual
income of at least $600 be sufficient for a qualified mortgage. Another
industry commenter suggested that, at a minimum, residual income
considerations would require a workable standard with clear, specific,
and objective criteria and be explicitly limited to specific expense
items. An industry trade group commenter recommended that if the Bureau
requires the use of residual income, creditors be allowed flexibility
in considering residual income along with other factors in loan
underwriting. Comments that addressed a specific debt-to-income ratio
are discussed below.
Several industry commenters recommended that if the Bureau required
consideration and verification of the debt-to-income ratio or residual
income for a qualified mortgage, creditors be permitted to take
compensating factors into account. They suggested that the Bureau
provide examples of compensating factors, such as: (1) The property
being an energy-efficient home; (2) the consumer having probability for
increased earnings based on education, job training, or length of time
in a profession; (3) the consumer having demonstrated ability to carry
a higher total debt-load while maintaining a good credit history for at
least 12 months; (4) future expenses being lower, such as child-support
payments to cease for child soon to reach age of majority; or (5) the
consumer having substantial verified liquid assets.
Consumer advocates generally supported adding consideration and
verification of the debt-to-income ratio or residual income to the
definition of a qualified mortgage. They noted that such inclusion
would help ensure that consumers receive mortgages they can afford and
that such factors are basic, core features of common-sense underwriting
that are clearly related to the risk of consumer default. To that
point, these commenters contended that residual income is an essential
component, especially for lower-income families. One consumer group
commenter stressed that residual income standards should be

[[Page 6526]]

incorporated, and pointed to the FHFA data in the Bureau's notice to
reopen the comment period to demonstrate that relying solely on debt-
to-income ratios is insufficient to ensure sound lending based on a
consumer's ability to repay.
Many industry and consumer group commenters and interested parties
supported use of a specific debt-to-income ratio threshold. For
example, some suggested that if a consumer's total debt-to-income ratio
is below a specified threshold, the mortgage loan should satisfy the
qualified mortgage requirements, assuming other relevant conditions are
met. At least one industry commenter supported allowing the use of FHA
underwriting guidelines to define ``debt'' and ``income.''
Although many commenters supported the use of a specific debt-to-
income ratio threshold, both industry and consumer group commenters
noted that relying on debt-to-income is only one element of
underwriting, and that creditors have used other compensating factors
and underwriting criteria. Some commenters acknowledged that a
consumer's debt-to-income ratio is a useful measure of loan
performance; however, they asserted that the year of origination (i.e.,
vintage) has more bearing on loan performance. In addition, some
commenters argued that measures of consumer credit history and loan-to-
value are more predictive, and that broader economic factors largely
determine loan performance. Several industry commenters recommended a
debt-to-income ratio cutoff that is at the upper end of today's
relatively conservative lending standards, while permitting creditors
to consider loans that exceed that debt-to-income ratio threshold if
the consumer satisfies other objective criteria (such as reserves,
housing payment history, and residual income), that help creditors
assess the consumer's ability to repay the loan. These commenters
argued that the FHFA data in the Bureau's notice to reopen the comment
period demonstrate that when loans are properly underwritten, debt-to-
income ratios can be relatively high without significantly affecting
loan performance.
Numerous commenters argued that the Bureau should consider the
costs and benefits of selecting a maximum debt-to-income ratio for
qualified mortgages. Many industry and consumer group commenters argued
that a debt-to-income threshold that is too low would unnecessarily
exclude a large percentage of consumers from qualified mortgages. One
joint industry and consumer group comment letter suggested a 43 percent
total debt-to-income ratio. In addition to a debt-to-income
requirement, some commenters and interested parties suggested that the
Bureau should include within the definition of a ``qualified mortgage''
loans with a debt-to-income ratio above a certain threshold if the
consumer has a certain amount of assets, such as money in a savings or
similar account, or a certain amount of residual income. For example,
an industry commenter suggested a 45 percent total debt-to-income
ratio, with an allowance for higher total debt-to-income ratios of up
to 50 percent for consumers with significant assets (e.g., at least one
year's worth of reserves). This commenter asked that the Bureau carve
out consumers who have shown ability to maintain a high debt-to-income
ratio or who have a nontraditional credit history. This commenter
explained that the higher the debt-to-income ratio, the more likely a
brief interruption in income or unexpected large expense could
compromise repayment ability. The commenter noted that only a numerical
standard would provide sufficient certainty for creditors and
investors, since they may otherwise end up litigating what is a
reasonable debt-to-income ratio. Another industry commenter asked that
a 50 percent back-end debt-to-income ratio be sufficient. This
commenter noted that without clear and objective standards, creditors
trying to make a qualified mortgage would fall back on the qualified
residential mortgage standards.
Another industry trade association commenter argued that a total
debt-to-income ratio threshold of 43 percent is problematic because
according to the FHFA data in the Bureau's notice to reopen the comment
period, there is no appreciable difference in performance for loans
with a 43 percent debt-to-income ratio and loans with 46 percent debt-
to-income ratio. In other words, commenters argued that the FHFA data
supports a higher debt-to-income ratio threshold, such as 46 percent.
Another commenter noted that the FHFA data does not include data on
portfolio loans.
Some consumer group commenters suggested that the Bureau conduct
further research into the role of debt-to-income ratios and the
relationship between a consumer's debt-to-income ratio and residual
income. One commenter noted that the Bureau should consider a tiered-
approach for higher-income consumers who can support a higher debt-to-
income ratio. Another consumer group commenter argued that residual
income should be incorporated into the definition of qualified
mortgage. Several commenters suggested that the Bureau use the general
residual income standards of the VA as a model for a residual income
test, and one of these commenters recommended that the Bureau
coordinate with FHFA to evaluate the experiences of the GSEs in using
residual income in determining a consumer's ability to repay.
Some commenters opposed including a specific debt-to-income ratio
threshold into the qualified mortgage criteria. For example, one
commenter argued that though the qualified mortgage criteria should be
as objective as possible, a specific debt-to-income threshold should
not be imposed because the criteria should be flexible to account for
changing markets. Another commenter argued that creditors should be
able to consider debt-to-income and residual income ratios, but
creditors should not be restricted to using prescribed debt-to-income
or residual income ratios. One industry commenter contended that if the
Bureau were to impose a 45 percent total debt-to-income ratio, for
example, most larger secondary market investors/servicers would impose
a total debt-to-income ratio that is much lower (such as 43 percent or
41 percent) as a general rule of risk management.
Final Rule
The Bureau believes, based upon its review of the data it has
obtained and the comments received, that the use of total debt-to-
income as a qualified mortgage criterion provides a widespread and
useful measure of a consumer's ability to repay, and that the Bureau
should exercise its authority to adopt a specific debt-to-income ratio
that must be met in order for a loan to meet the requirements of a
qualified mortgage. The Bureau believes that the qualified mortgage
criteria should include a standard for evaluating whether consumers
have the ability to repay their mortgage loans, in addition to the
product feature requirements specified in the statute. At the same
time, the Bureau recognizes concerns that creditors should readily be
able to determine whether individual mortgage transactions will be
deemed qualified mortgages. The Bureau addresses these concerns by
adopting a bright-line debt-to-income ratio threshold of 43 percent, as
well as clear and specific standards, based on FHA guidelines, set
forth in appendix Q for calculating the debt-to-income ratio in
individual cases.
The Bureau believes that a consumer's debt-to-income ratio is
generally predictive of the likelihood of default, and is a useful
indicator of such. At a basic level, the lower the debt-to-income
ratio, the greater the consumer's ability to pay back a mortgage loan
would be

[[Page 6527]]

under existing conditions as well as changed circumstances, such as an
increase in an adjustable rate, a drop in future income, or
unanticipated expenses or new debts. The Bureau's analysis of FHFA's
Historical Loan Performance (HLP) dataset, data provided by the
FHA,\149\ and data provided by commenters all bear this out. These data
indicate that debt-to-income ratio correlates with loan performance, as
measured by delinquency rate (where delinquency is defined as being
over 60 days late), in any credit cycle. Within a typical range of
debt-to-income ratios for prudent underwriting (e.g., under 32 percent
debt-to-income to 46 percent debt-to-income), the Bureau notes that
generally, there is a gradual increase in delinquency with higher debt-
to-income ratio.\150\ The record also shows that debt-to-income ratios
are widely used as an important part of the underwriting processes of
both governmental programs and private lenders.
---------------------------------------------------------------------------

\149\ The FHA's comment letter provided in response to the 2012
notice to reopen the comment period describes this data.
\150\ See, e.g., 77 F.R. 33120, 33122-23 (June 5, 2012) (Table
2: Ever 60+ Delinquency Rates, summarizing the HLP dataset by volume
of loans and percentage that were ever 60 days or more delinquent,
tabulated by the total DTI on the loans and year of origination).
---------------------------------------------------------------------------

The Bureau recognizes the Board's initial assessment that debt-to-
income ratios may not have significant predictive power once the
effects of credit history, loan type, and loan-to-value are considered.
In the same vein, the Bureau notes that some commenters suggested that
the Bureau include compensating factors in addition to a specific debt-
to-income ratio threshold. Even if a standard that takes into account
multiple factors produces more accurate ability-to-pay determinations
in specific cases, incorporating a multi-factor test or compensating
factors into the definition of a qualified mortgage would undermine the
goal of ensuring that creditors and the secondary market can readily
determine whether a particular loan is a qualified mortgage. Further,
the Bureau believes that compensating factors would be too complex to
calibrate into a bright-line rule and that some compensating factors
suggested by commenters as appropriate, such as loan-to-value ratios,
do not speak to a consumer's repayment ability.
Therefore, as permitted by the statute, the Bureau is adopting a
specific debt-to-income ratio threshold because this approach provides
a clear, bright line criterion for a qualified mortgage that ensures
that creditors in fact evaluate consumers' ability to repay qualified
mortgages and provides certainty for creditors to know that a loan
satisfies the definition of a qualified mortgage. A specific debt-to-
income ratio threshold also provides additional certainty to assignees
and investors in the secondary market, which should help reduce
possible concerns regarding legal risk and potentially promote credit
availability. As numerous commenters have urged, there is significant
value to providing objective requirements that can be determined based
on loan files. As described below, the final rule generally requires
creditors to use the standards for defining ``debt'' and ``income'' in
appendix Q, which are adapted from current FHA guidelines, to minimize
burden and provide consistent standards. The standards set forth in
appendix Q provide sufficient detail and clarity to address concerns
that creditors may not have adequate certainty about whether a
particular loan satisfies the requirements for being a qualified
mortgage, and therefore will not deter creditors from providing
qualified mortgages to consumers. The Bureau anticipates that the
standards will facilitate compliance with the Dodd-Frank Act risk
retention requirements, as the 2011 QRM Proposed Rule relied on FHA
standards for defining ``debt'' and ``income.'' The Bureau has
consulted with the Federal agencies responsible for the QRM rulemaking
in developing this rule, and will continue to do so going forward.
Based on analysis of available data and comments received, the
Bureau believes that 43 percent is an appropriate ratio for a specific
debt-to-income threshold, and that this approach advances the goals of
consumer protection and preserving access to credit. The Bureau
acknowledges, based on its analysis of the data, that there is no
``magic number'' which separates affordable from unaffordable
mortgages; rather, as noted above, there is a gradual increase in
delinquency rates as debt-to-income ratios increase. That being said,
the Bureau understands that 43 percent is within the range of debt-to-
income ratios used by many creditors and generally comports with
industry standards and practices for prudent underwriting. As noted
above, 43 percent is the threshold used by the FHA as its general
boundary. Although the Bureau notes that Fannie Mae's and Freddie Mac's
guidelines generally require a 36 percent debt-to-income ratio, without
compensating factors, the Bureau believes that a 43 percent debt-to-
income threshold represents an appropriate method to define which loans
merit treatment as qualified mortgages. In particular, the Bureau
believes that 43 percent represents a prudent outer boundary for a
categorical presumption of a consumer's ability to repay.
As discussed above, there was significant debate among the
commenters about the precise debt-to-income ratio threshold to
establish. Although a lower debt-to-income threshold would provide
greater assurance of a consumer's ability to repay a loan, many
commenters argued, and the Bureau agrees, that establishing a debt-to-
income ratio threshold significantly below 43 percent would curtail
many consumers' access to qualified mortgages. One commenter estimated
that roughly half of conventional borrowers would not be eligible for
qualified mortgage loans if the debt-to-income ratio was set at 32
percent, while 85 percent of borrowers would be eligible with a ratio
set at 45 percent.
At the same time, the Bureau declines to establish a debt-to-income
ratio threshold higher than 43 percent. The Bureau recognizes that some
commenters suggested that debt-to-income ratios above 43 percent would
not significantly increase the likelihood of default (depending to some
extent on the presence of compensating factors), and that some
consumers may face greater difficulty obtaining qualified mortgages
absent a higher threshold. However, as the debt-to-income ratio
increases, the presence of compensating factors becomes more important
to the underwriting process and in ensuring that consumers have the
ability to repay the loan. The general ability-to-repay procedures,
rather than the qualified mortgage framework, is better suited for
consideration of all relevant factors that go to a consumer's ability
to repay a mortgage loan.
Thus, the Bureau emphasizes that it does not believe that a 43
percent debt-to-income ratio represents the outer boundary of
responsible lending. The Bureau notes that even in today's credit-
constrained market, approximately 22 percent of mortgage loans are made
with a debt-to-income ratio that exceeds 43 percent and that prior to
the mortgage boom approximately 20 percent of mortgage loans were made
above that threshold. Various governmental agencies, GSEs, and
creditors have developed a range of compensating factors that are
applied on a case by case basis to assess a consumer's ability to repay
when the consumer's debt-to-income ratio exceeds a specified ratio.
Many community banks and credit

[[Page 6528]]

unions have found that they can prudently lend to consumers with a
higher debt-to-income ratio based upon their firsthand knowledge of the
individual consumer. As discussed below, many of those loans will fall
within the temporary exception that the Bureau is recognizing for
qualified mortgages. Over the long term, as the market recovers from
the mortgage crisis and adjusts to the ability-to-repay rules, the
Bureau expects that there will be a robust and sizable market for
prudent loans beyond the 43 percent threshold even without the benefit
of the presumption of compliance that applies to qualified mortgages.
In short, the Bureau does not believe that consumers who do not receive
a qualified mortgage because of the 43 percent debt-to-income ratio
threshold should be cut off from responsible credit, and has structured
the rule to try to ensure that a robust and affordable ability-to-repay
market develops over time.
The Bureau also believes that there would be significant negative
consequences to the market from setting a higher threshold. For
instance, if the qualified mortgage debt-to-income ratio threshold were
set above 43 percent, it might sweep in many mortgages in which there
is not a sound reason to presume that the creditor had a reasonable
belief in the consumer's ability to repay. At a minimum, adopting a
higher debt-to-income threshold to define qualified mortgages would
require a corresponding weakening of the strength of the presumption of
compliance--which would largely defeat the point of adopting a higher
debt-to-income threshold. Additionally, the Bureau also fears that if
the qualified mortgage boundary were to cover substantially all of the
mortgage market, creditors might be unwilling to make non-qualified
mortgage loans, with the result that the qualified mortgage rule would
define the limit of credit availability. The Bureau believes that
lending in the non-qualified mortgage market can and should be robust
and competitive over time. The Bureau expects that, as credit
conditions ease, creditors will continue making prudent, profitable
loans in non-traditional segments, such as to consumers who have
sufficient total assets or future earning potential to be able to
afford a loan with a higher debt-to-income ratio or consumers who have
a demonstrated ability to pay housing expenses at or above the level of
a contemplated mortgage.
Finally, the Bureau acknowledges arguments that residual income may
be a better measure of repayment ability in the long run. A consumer
with a relatively low household income may not be able to afford a 43
percent debt-to-income ratio because the remaining income, in absolute
dollar terms, is too small to enable the consumer to cover his or her
living expenses. Conversely, a consumer with a relatively high
household income may be able to afford a higher debt ratio and still
live comfortably on what is left over. Unfortunately, however, the
Bureau lacks sufficient data, among other considerations, to mandate a
bright-line rule based on residual income at this time. The Bureau
expects to study residual income further in preparation for the five-
year review of this rule required by the Dodd-Frank Act. See also
section-by-section analysis of Sec. 1026.43(c)(7).
The Bureau believes that it is important that the final rule
provide clear standards by which creditors calculate a consumer's
monthly debt-to-income ratio for purposes of the specific debt-to-
income threshold in Sec. 1026.43(e)(2)(vi). For this reason, the final
rule provides specific standards for defining ``debt'' and ``income''
in appendix Q. These standards are based on the definitions of debt and
income used by creditors originating residential mortgages that are
insured by the FHA. In particular, appendix Q incorporates the
definitions and standards in the HUD Handbook 4155.1, Mortgage Credit
Analysis for Mortgage Insurance on One-to-Four-Unit Mortgage Loans, to
determine and verify a consumer's total monthly debt and monthly
income, with limited modifications to remove portions unique to the FHA
underwriting process, such as references to the TOTAL Scorecard
Instructions. The use of FHA guidelines for this purpose provides
clear, well-established standards for determining whether a loan is a
qualified mortgage under Sec. 1026.43(e)(2). This approach is also
consistent with the proposed approach to defining debt and income in
the 2011 QRM Proposed Rule, and therefore could facilitate compliance
for creditors. The Bureau has consulted with the Federal agencies
responsible for the QRM rulemaking and will continue to do so going
forward as that rulemaking is completed, as well as to discuss changes
to FHA guidelines that may occur over time.
Accordingly, Sec. 1026.43(e)(2)(vi) provides that, as a condition
to being a qualified mortgage under Sec. 1026.43(e)(2), the consumer's
total monthly debt-to-income ratio does not exceed 43 percent. For
purposes of Sec. 1026.43(e)(2)(vi), the consumer's monthly debt-to-
income ratio is calculated in accordance with appendix Q, except as
provided in Sec. 1026.43(e)(2)(vi)(B). Section 1026.43(e)(2)(vi)(B)
contains additional requirements regarding the calculation of ``debt,''
for consistency with other parts of the qualified mortgage definition
and Sec. 1026.43. Specifically, that section provides that the
consumer's monthly debt-to-income ratio must be calculated using the
consumer's monthly payment on the covered transaction, including
mortgage-related obligations, in accordance with Sec.
1026.43(e)(2)(iv), and any simultaneous loan that the creditor knows or
has reason to know will be made, in accordance with Sec.
1026.43(c)(2)(iv) and (c)(6). Comment 43(e)(2)(vi)-1 clarifies the
relationship between the definition of ``debt'' in appendix Q and the
requirements of Sec. 1026.43(e)(2)(vi)(B). Specifically, the comment
states that, as provided in appendix Q, for purposes of Sec.
1026.43(e)(2)(vi), creditors must include in the definition of ``debt''
a consumer's monthly housing expense. This includes, for example, the
consumer's monthly payment on the covered transaction (including
mortgage-related obligations) and simultaneous loans. Accordingly,
Sec. 1026.43(e)(2)(vi)(B) provides the method by which a creditor
calculates the consumer's monthly payment on the covered transaction
and on any simultaneous loan that the creditor knows or has reason to
know will be made.
The Bureau notes that the specific 43 percent debt-to-income
requirement applies only to qualified mortgages under Sec.
1026.43(e)(2). For the reasons discussed below, the specific debt-to-
income ratio requirement does not apply to loans that meet the
qualified mortgage definitions in Sec. 1026.43(e)(4) or (f).
43(e)(3) Limits on Points and Fees for Qualified Mortgages
43(e)(3)(i)
TILA section 129C(b)(2)(A)(vii) defines a ``qualified mortgage'' as
a loan for which, among other things, the total points and fees payable
in connection with the loan do not exceed 3 percent of the total loan
amount. TILA section 129C(b)(2)(D) requires the Bureau to prescribe
rules adjusting this limit to ``permit lenders that extend smaller
loans to meet the requirements of the presumption of compliance.'' The
statute further requires the Bureau to ``consider the potential impact
of such rules on rural areas and other areas where home values are
lower.'' The statute does not define and the

[[Page 6529]]

legislative history does not provide guidance on the term ``smaller
loan'' or the phrase ``rural areas and other areas where home values
are lower.''
The Board proposed two alternative versions of Sec.
226.43(e)(3)(i) to implement the 3 percent points and fees cap for
qualified mortgages and the adjustment to the cap for smaller loans.
For both alternatives, the Board proposed a threshold of $75,000,
indexed to inflation, for smaller loans. For loans above the $75,000
threshold, the 3 percent points and fees cap for qualified mortgages
would have applied. For loans below $75,000, different limits would
have applied, depending on the amount of the loan.
The Board explained that it set the smaller loan threshold at
$75,000 because it believed that Congress intended the exception to the
3 percent points and fees cap to apply to more than a minimal, but
still limited, proportion of home-secured loans. The Board noted that
HMDA data show that 8.4 percent of first-lien, home-purchase (site-
built) mortgages in 2008 and 9.7 percent of such mortgages in 2009 had
a loan amount of $74,000 or less. The Board also stated that outreach
and research indicated that $2,250--3 percent of $75,000--is within
range of average costs to originate a first-lien home mortgage. Thus,
the Board concluded that $75,000 appears to be an appropriate benchmark
for applying the 3 percent limit on points and fees, with higher limits
below that threshold offering creditors a reasonable opportunity to
recover their origination costs.
Both of the Board's proposed alternatives would have separated
loans into tiers based on loan size, with each tier subject to
different limits on points and fees. The Board's proposed Alternative 1
would have consisted of five tiers of loan sizes and corresponding
limits on points and fees:
For a loan amount of $75,000 or more, 3 percent of the
total loan amount;
For a loan amount greater than or equal to $60,000 but
less than $75,000, 3.5 percent of the total loan amount;
For a loan amount greater than or equal to $40,000 but
less than $60,000, 4 percent of the total loan amount;
For a loan amount greater than or equal to $20,000 but
less than $40,000, 4.5 percent of the total loan amount; and
For a loan amount less than $20,000, 5 percent of the
total loan amount.
Alternative 2 would have consisted of three tiers of loan sizes and
corresponding limits on points and fees. The first and third tiers were
consistent with Alternative 1. The middle tier was a sliding scale that
reduced the points and fees cap (as a percentage of the loan amount)
with each dollar increase in loan size. The three tiers of Alternative
2 would have consisted of:
For a loan amount of $75,000 or more, 3 percent of the
total loan amount;
For a loan amount greater than or equal to $20,000 but
less than $75,000, a percentage of the total loan amount yielded by the
following formula:
[cir] Total loan amount-$20,000 = $Z
[cir] $Z x 0.0036 basis points = Y basis points
[cir] 500 basis points-Y basis points = X basis points
[cir] X basis points x 0.01 = Allowable points and fees as a
percentage of the total loan amount.
For a loan amount less than $20,000, 5 percent of the
total loan amount.
The approach in Alternative 2 would have smoothed the transition
from one tier to another and fixed an anomaly of Alternative 1. Under
Alternative 1, for loans just above and below the dividing line between
tiers, a greater dollar amount of points and fees would have been
allowed on the smaller loans than on the larger loans. For example, the
allowable points and fees on a total loan amount of $76,000 would have
been $2,280 (3 percent of $76,000), but the permissible points and fees
on a total loan amount of $70,000 would have been $2,450 (3.5 percent
of $70,000).
The Board noted that its proposal was designed to ensure that if a
loan is a qualified mortgage it would not also be a high-cost mortgage
based on the points and fees. The Board stated its belief that the
statute is designed to reduce the compliance burden on creditors when
they make qualified mortgages, in order to encourage creditors to make
loans with stable, understandable loan features. The Board expressed
concern that creating points and fees thresholds for small loans that
might result in qualified mortgages also being high-cost mortgages
would discourage creditors from making qualified mortgages because the
requirements and limitations of high-cost loans are generally more
stringent than for other loans.
The Board requested comment on the proposed alternative loan size
ranges and corresponding points and fees limits for qualified
mortgages. The Board also requested comment on whether the loan size
ranges should be indexed for inflation.
The Board stated that, instead of using a smaller loan threshold
with different tiers, it had considered adjusting the criteria for
smaller loans by narrowing the types of charges that would be included
in points and fees for smaller loans. The Board indicated that outreach
participants disfavored this approach because it would have required
different ways of calculating points and fees, depending on loan size,
and thus likely would have increased the burden of complying with the
rules and the risk of error. The Board also stated that it had
considered proposing an alternative points and fees threshold for
certain geographical areas. As the Board noted, however, property
values shift over time, and there is substantial variation in property
values and loan amounts within geographical areas. Thus, adjusting the
limits on points and fees based solely on geographic areas would have
been a less straightforward and less precise method of addressing the
statute's concern with smaller loans. No commenters supported these
approaches.
Several industry commenters argued that points and fees have
little, if any, relationship to consumers' ability to repay their
mortgage loans and that qualified mortgages should therefore not be
subject to limits on points and fees. Although they acknowledged that
the Dodd-Frank Act generally prescribed a 3 percent limit on points and
fees for qualified mortgages, they urged the Bureau to use its
authority to eliminate this requirement.
Several industry commenters contended that the 3 percent limit on
points and fees for qualified mortgages is too low. They maintained
that the 3 percent cap would require creditors to increase interest
rates to recover their costs and would limit consumers' flexibility to
arrange their optimal combination of interest rates and points and
fees. Industry commenters also claimed that the 3 percent limit would
have a negative impact on consumers' access to affordable credit. Some
industry commenters noted that the GSEs' seller/servicer guides contain
standards that limit points and fees for loans that the GSEs purchase
or securitize, with the current standards limiting points and fees to
the greater of 5 percent of the mortgage amount or $1,000. The
commenters argued that Bureau should use its authority adopt the GSEs'
standards instead of the requirements prescribed by the Dodd-Frank Act.
One commenter argued that, because of the complexity of the points and
fees test, the Bureau should adopt a tolerance of one-quarter of 1
percent or $250 for the 3 percent limit so that de minimis errors in
calculating points and fees would not prevent a loan from

[[Page 6530]]

retaining the legal protection of a qualified mortgage.
With respect to the two proposed alternative versions of section
43(e)(3)(i), industry commenters generally preferred Alternative 1.
They explained that Alternative 2 was too complex, would be difficult
to implement, and would increase compliance and litigation costs. Some
consumer advocates preferred Alternative 2, stating that it would be
more beneficial to consumers. Other consumer advocates preferred
Alternative 1, asserting that its simplicity would minimize
miscalculations that could harm consumers. They stated that the
difference to the consumer between Alternative 1 and Alternative 2 was
marginal. Some of these consumer advocates argued that the benefit
afforded by simplicity would outweigh the small pricing distortions.
Commenters did not object to the Board's general approach of
setting a threshold amount for smaller loans and adjusting the points
and fees cap for loans below the threshold. Instead, the comments
discussed what the threshold loan amount should be for smaller loans
and what limits should be imposed on points and fees for loans below
the threshold.
Industry commenters contended that the Board's proposed limits on
points and fees for smaller loans would be too low and would not permit
creditors to recover their costs. They stated that many origination
costs are fixed regardless of loan size. They asserted that if a
creditor could not cover those costs through points and fees, the
creditor would either not make the mortgage or increase the interest
rate to cover the costs. Industry commenters expressed concern that,
for smaller loans, a rate increase might result in the loan becoming a
high-cost mortgage or in some consumers no longer being eligible for
the loan. They contended that creditors would be reluctant to make
these loans and credit availability would be compromised, in particular
for low-income, minority, and rural consumers, and first-time home
buyers. One commenter reported that if a consumer were offered a high
interest rate to cover costs and the rate were increased to offset the
costs of a smaller loan, the consumer would pay thousands of dollars
more over the life of the loan. Industry commenters asserted that the
proposed alternatives did not capture the congressional intent of
providing creditors sufficient incentives to make smaller loans.
Industry commenters urged the Bureau to revise the proposal to allow
creditors to recover more of their costs through points and fees,
either by increasing the threshold for smaller loans or raising the
limits for loans below the threshold or by doing both.
Many industry commenters recommended raising the threshold for
smaller loans from the $75,000 threshold proposed by the Board. One
industry commenter suggested setting the threshold at $100,000, indexed
to inflation. Relying on loan balances for median home prices, another
industry commenter asked that the Bureau raise the threshold to
$125,000. Many other industry commenters recommended raising the
threshold to $150,000. One commenter noted that the average loan size
in the United States at the end of the second quarter of 2010 was
$193,800 and suggested using 80 percent of the average loan size,
rounding off to the nearest $10,000.
In addition to urging the Bureau to raise the smaller loan
threshold, many industry commenters recommended that the Bureau revise
the proposal to permit creditors to charge higher points and fees for
loans below the smaller loan threshold for qualified mortgages. Several
industry commenters asked that the Bureau set the cap between 3.5 and 5
percent, indexed to inflation, for all loans under the smaller loans
threshold. One industry commenter noted that Fannie Mae and Freddie Mac
permit points and fees up to 5 percent. An industry commenter suggested
a cap equal to the greater of 3 percent or $2,000, indexed to
inflation. A combination of industry commenters and consumer advocates
recommended a cap equal to the greater of 3 percent or $3,000. One
industry commenter advocated a 4 percent cap for all loans below
$125,000. Several industry commenters recommended that the cap be set
at a fixed amount plus a percentage to lessen the impact of moving from
one tier to the next.
In support of their arguments to raise the smaller loan threshold
and to raise the limits on points and fees for loans below the
threshold, several industry commenters provided data showing that many
smaller loans would have exceeded the proposed points and fees caps.
For example, a trade association commenter drew on data submitted by a
member bank that showed that the majority of loans under $100,000 would
exceed the points and fees cap, assuming fees paid to an affiliate
title company were included, and that many loans between $100,000 and
$150,000 would also exceed the cap. A trade association industry
commenter shared data from one of its members, a financial services
provider. The member reviewed over 250,000 of its recent loans and
found that none of the loans under $75,000 would meet the proposed cap
and that 50 percent of the loans under $125,000 would meet the cap.
Several industry commenters reported that if the Bureau raised the
smaller loan threshold to $150,000, a significantly smaller percentage
of loans would exceed the points and fees cap.
A trade association representing the manufactured housing industry
noted the Board's concern about setting the points and fees cap so high
that some qualified mortgages would be deemed high-cost mortgages under
HOEPA. The commenter argued, however, that the Bureau has authority to
change high-cost mortgage thresholds and urged the Bureau to exercise
this authority. The commenter cited section 1431 of the Dodd-Frank Act
for the proposition that the Board may increase the amount of
origination costs above $1,000 for loans less than $20,000. The
commenter also said that section 1022 of the Dodd-Frank Act may grant
the Board authority to exempt certain smaller sized manufactured home
loans from the 5 percent points and fees caps on high-cost mortgages
for loans above $20,000, based on asset class, transaction volume, and
existing consumer protections.
Consumer advocates generally endorsed the $75,000 threshold for
smaller loans. They questioned industry concerns that the 3 percent
threshold would limit the availability of credit for consumers with
comparatively low loan amounts. Instead, the commenters emphasized the
importance of ensuring that qualified mortgages are affordable. In
their view, the 3 percent points and fees cap is a key factor in
ensuring affordability, so the exception for smaller loans should apply
to only a limited proportion of loans. Consumer advocates argued that
the points and fees cap should not exceed the 5 percent HOEPA trigger.
They asserted that points and fees should be reasonable, reflect actual
origination costs, and not result in disparate pricing schemes
disadvantaging consumers with smaller loans.
One consumer advocate recommended analyzing the impact of a 3
percent points and fees cap on access to credit for low- and moderate-
income consumers, in particular for Community Reinvestment Act loans.
The commenter asked that the Bureau describe in preamble the results of
any analysis of points and fees by loan amount, and for Community
Reinvestment Act and non-Community Reinvestment Act loans.
In light of these comments, the Bureau is adopting revised

[[Page 6531]]

Sec. 1026.43(e)(3)(i) to implement the limits on points and fees for
qualified mortgages. As noted above, several industry commenters argued
that points and fees have little if any bearing on consumers' ability
to repay their mortgage loans and that the points and fees limits would
result in higher interest rates and reduced access to credit. They
urged the Bureau to use its authority to eliminate the limits on points
and fees for qualified mortgages. As an alternative to eliminating the
points and fees limits entirely, some industry commenters requested
that the Bureau adopt the GSEs' standards limiting points and fees for
loans that they purchase or securitize. Those standards currently limit
points and fees to the greater of 5 percent of the loan amount or
$1,000.
The Bureau does not believe it would be appropriate to eliminate
the limits on points and fees for qualified mortgages. The Bureau also
declines to adopt the GSEs' current standards and raise the general 3
percent limit on points and fees. The goal of TILA section 129C is to
assure that consumers are able to repay their mortgages over the term
of the loans. Originators that make large sums up front may be less
careful in assuring the consumers' ability to repay over time.
Moreover, Congress may have believed that the points and fees limits
may deter originators from imposing unnecessary or excessive up-front
charges. In the absence of persuasive evidence that the points and fees
limits will undermine consumers' access to affordable credit, the
Bureau does not believe it would be appropriate to eliminate the points
and fees limits or to raise the general 3 percent limit. As discussed
in more detail below, however, the Bureau is implementing revised
points and fees limits for smaller loans. The Bureau also notes that
the Dodd-Frank Act did not adopt a tolerance that would allow creditors
to exceed the points and fees limits by small amounts and declines to
adopt such a tolerance.
As noted above, a consumer advocate requested that the Bureau
conduct an analysis of the 3 percent points and fees cap on access to
credit for low- and moderate-income consumers, in particular for
Community Reinvestment Act loans. Given the lack of available data, it
has not been practicable for the Bureau to perform such an analysis
while finalizing this and other title XIV rules. The Bureau will
consider whether it is possible and valuable to conduct such an
analysis in the future.
Revised Sec. 1026.43(e)(3)(i) employs an approach similar to that
proposed by the Board to implement the 3 percent cap on points and fees
and the adjustment to the cap for smaller loans. Like the Board's
proposal, Sec. 1026.43(e)(3)(i) sets a threshold for smaller loans,
establishes tiers based on loan size, and sets limits on points and
fees within each tier. However, Sec. 1026.43(e)(3)(i) uses a mix of
percentage and flat dollar limits to avoid anomalous results at tier
margins and also adjusts the definition of smaller loan to include more
transactions.
Although most commenters favored this tiering methodology, as noted
above, some commenters suggested that the Bureau reject the Board's
tiered approach and instead adopt a simpler mechanism, with all loan
amounts below the threshold subject to a single percentage cap or
dollar amount cap on points and fees. Like the Board, the Bureau
believes the tiered approach provides a more flexible and calibrated
mechanism for implementing the limits on points and fees for smaller
loans. A single percentage cap that would apply to all smaller loans
may not allow creditors a reasonable opportunity to recover costs for
very small loans. It also may create a distortion in which loans just
below the smaller loan threshold would be permitted to have
significantly higher points and fees than loans just above the smaller
loan threshold. A single dollar amount cap (e.g., $3,000) could result
in points and fees that are a very high percentage of the very smallest
loans and, as a result, could result in qualified mortgages also
triggering the obligations of high-cost mortgages.
Thus, as in the Board's proposal, the final rule sets a threshold
for smaller loans and establishes tiers, based on loan size, with
different limits on points and fees. Specifically, Sec.
1026.43(e)(3)(i) provides that a transaction is not a qualified
mortgage unless the total points and fees payable in connection with
the loan do not exceed:
For a loan amount greater than or equal to $100,000, 3
percent of the total loan amount;
For a loan amount greater than or equal to $60,000 but
less than $100,000, $3,000;
For a loan amount greater than or equal to $20,000 but
less than $60,000, 5 percent of the total loan amount;
For a loan amount greater than or equal to $12,500 but
less than $20,000, $1,000 of the total loan amount;
For a loan amount of less than $12,500, 8 percent of the
total loan amount.
The Bureau's final rule departs from the proposal in two ways.
First, Sec. 1026.43(e)(3)(i) raises the threshold for smaller loans to
$100,000. Second, for loans below the $100,000 threshold, Sec.
1026.43(e)(3)(i) revises the points and fees caps for smaller loans
within the various tiers. The general effect of these revisions will be
to increase the points and fees that creditors can charge for smaller
loans while still permitting those loans to meet the standard for a
qualified mortgage. These two changes are discussed at greater length
below.
$100,000 Threshold for Smaller Loans
To fulfill the stated purpose of the adjustment for smaller loans,
the threshold should be set at a level that is sufficient to permit
creditors making smaller loans a reasonable opportunity to recoup their
origination costs and still offer qualified mortgages but not so high
as to cause loans to exceed the HOEPA threshold to become high-cost
mortgages. As noted above, the Board proposed to set the smaller loan
threshold so that three percent of that amount would have provided
creditors with a reasonable opportunity to recover their costs, with
loans below that threshold subject to higher caps on points and fees.
Thus, the Board's proposed $75,000 threshold would have created a
benchmark of $2,250. The Board stated that its outreach and research
indicated that $2,250 would be within the range of average costs to
originate a first-lien home mortgage. However, as noted above, several
industry commenters reported, based on recent loan data, that
creditors' points and fees often exceed $2,250 for smaller loans and
that a significant number of loans above $75,000 would exceed the three
percent cap.\151\
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\151\ As the Board noted, resources that provide data on
origination costs tend to use different methodologies to calculate
points and fees and do not use the methodology prescribed under TILA
as amended by the Dodd-Frank Act. The same concerns apply to
commenters' data on points and fees.
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This evidence suggests that the $2,250 benchmark (and the
corresponding $75,000 smaller loan threshold) in the proposal could
have been insufficient to permit creditors to recoup all or even most
of their origination costs. The Bureau is aware that the commenters'
loan data reflects creditors' points and fees, and not the underlying
costs. Nevertheless, the evidence that substantial proportions of
smaller loans would have exceeded the points and fees limits raises
concerns that the creditors would not be able to recover their costs
through points and fees and still originate qualified mortgages.
Creditors that are unable to recover their origination costs through
points and fees would have to attempt to recover those costs through
higher rates. If the higher rates would trigger the additional

[[Page 6532]]

regulatory requirements applicable to high-cost loans under HOEPA or
would render some potential consumers ineligible, then access to credit
for at least some consumers could be compromised. Moreover, for
consumers who plan to remain in their homes (and their loans) for a
long time, a higher interest rate would result in higher payments over
the life of the loan.
Some commenters claimed that a substantial portion of loans up to
$125,000 or $150,000 would exceed the 3 percent points and fees cap and
that the Bureau should raise the threshold accordingly. The Bureau
disagrees for two reasons. First, this would stretch the meaning of
``smaller loans.'' In 2011, slightly under 21 percent of first-lien
home mortgages were below $100,000 and another 22 percent were between
$100,000 and $150,000. Thus, increasing the threshold to $150,000 would
more than double the number of loans entitled to an exception to the
congressionally-established points and fees cap and would capture over
40 percent of the market. The Bureau believes that this would be an
overly expansive construction of the term ``smaller loans'' for the
purpose of the exception to the general rule capping points and fees
for qualified mortgages at 3 percent. Such a broad definition of
``smaller loans'' could allow the exception to undermine the cap on
points and fees and frustrate congressional intent that qualified
mortgages include limited points and fees. The function of the smaller
loan exception to the points and fees cap is to make it possible for
creditors making smaller loans to originate qualified mortgages. The
smaller loan exception should provide creditors a reasonable
opportunity to recover most, if not all, of their origination costs for
smaller loans and still originate qualified mortgages. It should not be
transformed into a mechanism that ensures that creditors can continue
to charge the same points and fees they have in the past and still have
their loans meet the qualified mortgage standard.
The Bureau concludes that a $100,000 small loan threshold strikes
an appropriate balance between congressional goals of allowing
creditors offering smaller loans to meet the standard for qualified
mortgages and ensuring that qualified mortgages include limited points
and fees. The $100,000 threshold (and, as discussed below, the
corresponding adjustments to the points and fees limits for loans under
that threshold) should provide creditors with a reasonable opportunity
to recover most, if not all, of their origination costs through points
and fees, reducing the likelihood that any increase in rates would
trigger obligations of high-cost loans or would cause loans to be
higher-priced covered transactions under Sec. 1026.43(b)(4). At the
same time, the $100,000 threshold would not render the smaller loan
exception so broad that it undermines the general 3 percent cap on
points and fees. It would cover a significant but still limited
proportion of mortgages. According to the 2011 Home Mortgage Disclosure
Act \152\ (HMDA) data, 20.4 percent of first-lien home purchase
mortgages and 20.9 percent of first-lien refinances were less than
$100,000.\153\
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\152\ 12 U.S.C. 2801 et seq.
\153\ The proportion of loans under the $100,000 threshold would
of course be larger than under a $75,000 threshold. As indicated in
the Board's proposal, in 2008, 8.3 percent of first-lien home
purchase mortgages and 7.6 percent of refinances were under $75,000
for owner-occupied, one- to four-family, site-built properties.
According to 2011 HMDA data, 10.6 percent of first-lien home
purchases and 11 percent of first-lien refinances were under
$75,000. Nevertheless, the Bureau believes that the $100,000
threshold is sufficiently limited that it remains faithful to the
statute's framework, with the smaller loan exception not undermining
the general 3 percent limit on points and fees.
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Limits on Points and Fees for Smaller Loans
In addition to raising the smaller loan threshold to $100,000,
Sec. 1026.43(e)(3)(i) also differs from the Board's proposal by
setting higher limits on points and fees for smaller loans. As noted
above, the Bureau is concerned that the Board's proposal would not have
provided creditors with a reasonable opportunity to recover their
origination costs. Thus, Sec. 1026.43(e)(3)(i) allows creditors higher
limits on points and fees for smaller loans. Specifically, for loans of
$60,000 up to $100,000, Sec. 1026.43(e)(3)(i) allows points and fees
of no more than $3,000. For loans of $20,000 up to $60,000, Sec.
1026.43(e)(3)(i) allows points and fees of no more than 5 percent of
the total loan amount. For loans of $12,500 up to $20,000, Sec.
1026.43(e)(3)(i) allows points and fees of no more than $1,000. For
loan amounts less than $12,500, Sec. 1026.43(e)(3)(i) allows points
and fees of no more than 8 percent of the total loan amount.
In contrast with the Board's proposed Alternative 1, Sec.
1026.43(e)(3)(i) creates smooth transitions between the tiers. As noted
above, under Alternative 1, the one-half percent changes in the points
and fees cap between tiers would have produced the anomalous result
that some smaller loans would have been permitted to include a higher
dollar amount of points and fees than larger loans. While proposed
Alternative 2 would have avoided this problem, it would also have been
somewhat more complex, thereby increasing the risk of errors. The tiers
in Sec. 1026.43(e)(3)(i) all feature easy-to-calculate limits, making
compliance easier.
Finally, the three lower tiers are tied to the comparable
thresholds for high-cost loans to ensure that the points and fees on
loans that satisfy the qualified mortgage standard do not trigger the
additional obligations of high-cost mortgages. Under TILA as amended, a
high-cost mortgage has points and fees equal to 5 percent of the total
transaction amount if the transaction is $20,000 or more, and points
and fees equal to the lesser of 8 percent of the total transaction
amount or $1,000, if the transaction is less than $20,000. See TILA
section 103(bb)(1)(A)(ii)(I) and (II). Setting the maximum points and
fees caps based on the HOEPA triggers will help ensure that a qualified
mortgage is not a high-cost mortgage because of the points and fees.
Proposed comment 43(e)(3)(i)-1 would have cross-referenced comment
32(a)(ii)-1 for an explanation of how to calculate the ``total loan
amount.'' The Bureau adopts comment 43(e)(3)(i)-1 substantially as
proposed, but it adds an explanation for tiers in which the prescribed
points and fees limit is a fixed dollar amount rather than a percentage
and revises the cross-reference because the explanation of calculating
``total loan amount'' is moved to comment 32(b)(5)(i)-1.
Proposed comment 43(e)(3)(i)-2 would have explained that a creditor
must determine which category the loan falls into based on the face
amount of the note (the ``loan amount''), but must apply the allowable
points and fees percentage to the ``total loan amount,'' which may be
an amount that is different than the face amount of the note. The
Bureau adopts comment 43(e)(3)(i)-2 substantially as proposed, but it
revises some of the limits to reflect the changes described above.
Proposed comment 43(e)(3)(i)-3 would have provided examples of
calculations for different loan amounts. The Bureau adopts comment
43(e)(3)(i)-3 with revisions to reflect the changes to some of the
limits described above.
Impact on Rural Areas and Other Areas Where Home Values Are Lower
TILA section 129C(b)(2)(D) requires the Bureau to consider the
rules' potential impact on ``rural areas and other areas where home
values are lower.'' The Bureau considered the concerns raised by
industry commenters that if the limits on points and fees for smaller
loans were set too low, access to credit could be impaired, in
particular

[[Page 6533]]

for low income, minority, and rural consumers, and first-time home
buyers. Setting the threshold for smaller loans too low may also
negatively affect access to credit for manufactured housing, which
disproportionately serves lower-income consumers and rural areas. The
higher threshold and higher limits on points and fees for smaller loans
should help to ensure that creditors are able to offer qualified
mortgages in rural areas and other areas where home values are lower.
The Bureau declines to adopt the recommendation of one commenter
that it exempt smaller loans for manufactured homes from the points and
fees triggers for high-cost mortgages. Section 1431 of the Dodd Frank
Act provides that a loan of $20,000 or more is deemed a high-cost
mortgage if total points and fees exceed 5 percent of the total
transaction amount and that a loan of less than $20,000 is deemed a
high-cost mortgage if total points and fees exceed the lesser of 8
percent of the total transaction amount or $1,000, or other such dollar
amount as the Bureau may prescribe by regulations. Such a change is
beyond the scope of this rulemaking and is more appropriately addressed
in the parallel HOEPA rulemaking.
43(e)(3)(ii)
Bona Fide Third-party Charges and Bona Fide Discount Points
As discussed in the section-by-section analysis of Sec.
1026.32(b)(1)(i), the Bureau is moving the provisions excluding certain
bona fide third-party charges and bona fide discount points to Sec.
1026.32(b)(1)(i)(D) through (F). The Board had proposed to implement
these provisions in proposed Sec. 226.43(e)(3)(ii) through (iv).
Indexing Points and Fees Limits for Inflation
The Board requested comment on whether the loan size ranges for the
qualified mortgage points and fees limits should be indexed for
inflation. A few industry commenters recommended that the loan size
ranges or the permitted dollar amounts of points and fees be adjusted
for inflation. The Bureau believes that it is appropriate to adjust the
points and fees limits to reflect inflation. In addition, the Bureau
notes that, as prescribed by TILA section 103(aa)(3), what was
originally a $400 points and fees limit for high-cost loans has been
adjusted annually for inflation, and that the dollar amounts of the new
high-cost points and fees thresholds in TILA section
103(bb)(1)(A)(ii)(II) will also be adjusted annually for inflation. The
Bureau believes the points and fees thresholds for high-cost loans and
qualified mortgages should be treated consistently with respect to
inflation adjustments. Accordingly, in new Sec. 1026.43(e)(3)(ii), the
Bureau provides that the dollar amounts, including the loan amounts,
shall be adjusted annually to reflect changes in the Consumer Price
Index for All Urban Consumers (CPI-U). The adjusted amounts will be
published in new comment 43(e)(3)(ii)-1.
43(e)(4) Qualified Mortgage Defined--Special Rules
As discussed above, the Bureau is finalizing the general qualified
mortgage definition in Sec. 1026.43(e)(2). Under that definition,
qualified mortgages would be limited to loans that satisfy the
qualified mortgage product feature criteria in the statute (including
prohibitions on certain risky loan features, limitations on points and
fees, and the requirement to underwrite to the maximum rate in the
first five years of the loan), for which the creditor considers and
verifies the consumer's income and assets and current debt obligations,
alimony, and child support, and for which the consumer's total (or
``back-end'') debt-to-income ratio is less than or equal to 43
percent.\154\
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\154\ As noted above, the Board proposed two alternative
definitions of qualified mortgage, but also solicited comment on
other alternative definitions. The Board specifically requested
comment on what criteria should be included in the definition of a
qualified mortgage to ensure that the definition provides an
incentive to creditors to make qualified mortgages, while also
ensuring that consumers have the ability to repay those loans. In
addition, as described above, the Board's proposed comment 43(c)-1
would have provided that creditors may look to widely accepted
governmental or non-governmental underwriting standards when
assessing a consumer's repayment ability under the general ability-
to-repay standard, including assessing the eight specific
underwriting criteria under proposed Sec. Sec. 226.43(c)(2) and
(e)(2)(v)-Alternative 2. Similarly, proposed comment 43(c)(7)-1
would have provided that, to determine the appropriate threshold for
monthly debt-to-income ratio or residual income, the creditor may
look to widely accepted governmental and non-governmental
underwriting standards. As noted, various commenters suggested that
the final rule should look to certain Federal agency underwriting
standards for purposes of determining whether a loan has met certain
aspects of the qualified mortgage definition (for example, debt-to-
income ratios and residual income).
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The Bureau believes this approach establishes an appropriate
benchmark over the long term for distinguishing which loans should be
presumed to meet the ability-to-repay requirements under the Dodd-Frank
Act, while also leaving room for the provision of responsible mortgage
credit over time to consumers with higher debt-to-income ratios under
the general ability-to-repay requirements. However, the Bureau
acknowledges it may take some time for the non-qualified mortgage
market to establish itself in light of the market anxiety regarding
litigation risk under the ability-to-repay rules, the general slow
recovery of the mortgage market, and the need for creditors to adjust
their operations to account for several other major regulatory and
capital regimes. In light of these factors, the Bureau has concluded
that it is appropriate to provide a temporary alternative definition of
qualified mortgage. This will help ensure access to responsible,
affordable credit is available for consumers with debt-to-income ratios
above 43 percent and facilitate compliance by creditors by promoting
the use of widely recognized, federally-related underwriting standards.
Under this temporary provision, as a substitute for the general
qualified mortgage definition in Sec. 1026.43(e)(2), which contains a
43 percent debt-to-income ratio threshold, the final rule provides a
second definition of qualified mortgage in Sec. 1026.43(e)(4) for
loans that meet the prohibitions on certain risky loan features (e.g.,
negative amortization and interest only features) and the limitations
on points and fees under Sec. 1026.43(e)(2) and are eligible for
purchase or guarantee by the GSEs, while under the conservatorship of
the FHFA, or eligible to be insured or guaranteed by the U.S.
Department of Housing and Urban Development under the National Housing
Act (12 U.S.C. 1707 et seq.) (FHA), the VA, the USDA, or the Rural
Housing Service (RHS).\155\ The FHA, VA, USDA, and RHS have authority
under the statute to define qualified mortgage standards for their own
loans, so coverage under Sec. 1026.43(e)(4), will sunset once each
agency promulgates its own qualified mortgage standards, and such rules
take effect. See TILA section 129C(b)(3)(ii). Coverage of GSE-eligible
loans will sunset when conservatorship ends.
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\155\ Eligibility standards for the GSEs and Federal agencies
are available at: Fannie Mae, Single Family Selling Guide, https://www.fanniemae.com/content/guide/sel111312.pdf; Freddie Mac, Single-
Family Seller/Servicer Guide, https://www.freddiemac.com/sell/guide/;
HUD Handbook 4155.1, https://www.hud.gov/offices/adm/hudclips/handbooks/hsgh/4155.1/41551HSGH.pdf; Lenders Handbook--VA Pamphlet
26-7, Web Automated Reference Material System (WARMS), https://www.benefits.va.gov/warms/pam26_7.asp; Underwriting Guidelines:
USDA Rural Development Guaranteed Rural Housing Loan Program, https://www.rurdev.usda.gov/SupportDocuments/CA-SFH-GRHUnderwritingGuide.pdf.
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Even if the Federal agencies do not issue additional rules or
conservatorship does not end, the temporary qualified mortgage
definition in Sec. 1026.43(e)(4) will expire seven

[[Page 6534]]

years after the effective date of the rule. The Bureau believes that
this will provide an adequate period for economic, market, and
regulatory conditions to stabilize. Because the Bureau is obligated by
statute to analyze the impact and status of the ability-to-repay rule
five years after its effective date, the Bureau will have an
opportunity to confirm that it is appropriate to allow the temporary
provision to expire prior to the sunset. Covered transactions that
satisfy the requirements of Sec. 1026.43(e)(4) that are consummated
before the sunset of Sec. 1026.43(e)(4) will retain their qualified
mortgage status after the temporary definition expires. However, a loan
consummated after the sunset of Sec. 1026.43(e)(4) may only be a
qualified mortgage if it satisfies the requirements of Sec.
1026.43(e)(2) or (f).
The alternative definition of qualified mortgage recognizes that
the current mortgage market is especially fragile as a result of the
recent mortgage crisis. It also recognizes the government's
extraordinary efforts to address the crisis; GSE-eligible loans,
together with the other federally insured or guaranteed loans, cover
roughly 80 percent of the current mortgage market. In light of this
significant Federal role and the government's focus on affordability in
the wake of the mortgage crisis, the Bureau believes it is appropriate,
for the time being, to presume that loans that are eligible for
purchase, guarantee, or insurance by the designated Federal agencies
and the GSEs while under conservatorship have been originated with
appropriate consideration of consumers' ability to repay, where those
loans also satisfy the requirements of Sec. 1026.43(e)(2) concerning
restrictions on product features and total points and fees limitations.
The temporary definition is carefully calibrated to provide a
reasonable transition period to the general qualified mortgage
definition, including the 43 percent debt-to-income ratio requirement.
While this temporary definition is in effect, the Bureau will monitor
the market to ensure it remains appropriate to presume that the loans
falling within those programs have been originated with appropriate
consideration of the consumer's repayment ability. The Bureau believes
this temporary approach will ultimately benefit consumers by minimizing
any increases in the cost of credit as a result of this rule while the
markets adjust to the new regulations.
The Bureau believes this temporary alternative definition will
provide an orderly transition period, while preserving access to credit
and effectuating the broader purposes of the ability-to-repay statute
during the interim period. The Bureau believes that responsible loans
can be made above a 43 percent debt-to-income ratio threshold, and has
consciously structured the qualified mortgage requirements in a way
that leaves room for responsible lending on both sides of the qualified
mortgage line. The temporary exception has been carefully structured to
cover loans that are eligible to be purchased, guaranteed, or insured
by the GSEs (while in conservatorship) or Federal agencies regardless
of whether the loans are actually so purchased, guaranteed, or insured;
this will leave room for private investors to return to the market and
secure the same legal protection as the GSEs and Federal agencies. At
the same time, as the market recovers and the GSEs and FHA are able to
reduce their presence in the market, the percentage of loans that are
granted qualified mortgage status under the temporary definition will
shrink towards the long-term structure.
In addition to being a loan that is eligible to be made,
guaranteed, or insured by the above-described Federal agencies or the
GSEs while in conservatorship, to meet the definition of qualified
mortgage under Sec. 1026.43(e)(4), the loan must satisfy the statutory
qualified mortgage criteria regarding prohibitions on certain risky
loan features and limitations on points and fees. Specifically, Sec.
1026.43(e)(4)(i) provides that, notwithstanding Sec. 1026.43(e)(2), a
qualified mortgage is a covered transaction that satisfies the
requirements of Sec. 1026.43(e)(2)(i) through (iii). As discussed
above, those provisions require: that the loan provide for regular
periodic payments that do not result in an increase of the principal
balance, allow the consumer to defer repayment of principal, or result
in a balloon payments; that the loan term does not exceed 30 years; and
that the total points and fees payable in connection with the loan do
not exceed the threshold set forth in Sec. 1026.43(e)(3). As described
further below, the temporary definition does not include requirements
to (1) verify and document the consumer's income or assets relied upon
in qualifying the consumer; (2) underwrite a fixed rate loan based on a
payment schedule that fully amortizes the loan over the term and takes
into account all applicable taxes, insurance, and assessments; or (3)
underwrite an adjustable-rate loan using the maximum interest rate
permitted in the first five years. The Bureau highlights that a loan
need not be actually purchased or guaranteed by the GSEs or insured or
guaranteed by the above-listed Federal agencies to qualify for the
temporary definition in Sec. 1026.43(e)(4). Rather, the loan need only
be eligible for such purchase, guarantee, or insurance.
Notably, the temporary qualified mortgage definition does not
include ``jumbo loans.'' The Bureau does not believe that creditors
making jumbo loans need the benefit of the temporary exception, as the
Bureau views the jumbo market as already robust and stable. Jumbo loans
can still be qualified mortgages if they meet the general rule (i.e.
are within the 43 percent debt-to-income ratio and underwritten in
accordance with the general qualified mortgage requirements).
Section 1026.43(e)(4)(iii) contains the sunset provisions for the
special qualified mortgage definition in Sec. 1026.43(e)(4).
Specifically, Sec. 1026.43(e)(4)(iii)(A) provides that each respective
special rule in Sec. 1026.43(e)(4)(ii)(B) (FHA loans), (e)(4)(ii)(C)
(VA loans), (e)(4)(ii)(D) (USDA loans); and (e)(4)(ii)(E) (RHS loans)
shall expire on the effective date of a rule issued by each respective
agency pursuant to its authority under TILA section 129C(b)(3)(ii) to
define a qualified mortgage. Section 1026.43(e)(4)(iii)(B) provides
that, unless otherwise expired under Sec. 1026.43(e)(4)(iii)(A), the
special rules in Sec. 1026.43(e)(4) are available only for covered
transactions consummated on or before a date that is seven years after
the effective date of this rule.
Comment 43(e)(4)-1 provides additional clarification regarding the
special qualified mortgage definition. Specifically, the comment
provides that, subject to the sunset provided under Sec.
1026.43(e)(4)(iii), Sec. 1026.43(e)(4) provides an alternative
definition of qualified mortgage to the definition provided in Sec.
1026.43(e)(2). To be a qualified mortgage under Sec. 1026.43(e)(4),
the creditor must satisfy the requirements under Sec. Sec.
1026.43(e)(2)(i) through (iii), in addition to being one of the types
of loans specified in Sec. Sec. 1026.43(e)(4)(ii)(A) through (E).
Comment 43(e)(4)-2 clarifies the effect that a termination of
conservatorship would have on loans that satisfy the qualified mortgage
definition under Sec. 1026.43(e)(4) because of their eligibility for
purchase or guarantee by Fannie Mae or Freddie Mac. The comment
provides that Sec. 1026.43(e)(4)(ii)(A) requires that a covered
transaction be eligible for purchase or guarantee by Fannie Mae or
Freddie Mac (or any limited-life regulatory entity succeeding the
charter

[[Page 6535]]

of either) operating under the conservatorship or receivership of the
FHFA pursuant to section 1367 of the Federal Housing Enterprises
Financial Safety and Soundness Act of 1992 (12 U.S.C. 4617), as amended
by the Housing and Economic Recovery Act of 2008). The special rule
under Sec. 1026.43(e)(4)(ii)(A) does not apply if Fannie Mae or
Freddie Mac (or any limited-life regulatory entity succeeding the
charter of either) has ceased operating under the conservatorship or
receivership of the FHFA. For example, if either Fannie Mae or Freddie
Mac (or succeeding limited-life regulatory entity) ceases to operate
under the conservatorship or receivership of the FHFA, Sec.
1026.43(e)(4)(ii)(A) would no longer apply to loans eligible for
purchase or guarantee by that entity; however, the special rule would
be available for a loan that is eligible for purchase or guarantee by
the other entity still operating under conservatorship or receivership.
Comment 43(e)(4)(iii)-3 clarifies that the definition of qualified
mortgage under Sec. 1026.43(e)(4) applies only to loans consummated on
or before a date that is seven years after the effective date of the
rule, regardless of whether Fannie Mae or Freddie Mac (or any limited-
life regulatory entity succeeding the charter of either) continues to
operate under the conservatorship or receivership of the FHFA.
Accordingly, Sec. 1026.43(e)(4) is available only for covered
transactions consummated on or before the earlier of either: (i) The
date Fannie Mae or Freddie Mac (or any limited-life regulatory entity
succeeding the charter of either), respectively, cease to operate under
the conservatorship or receivership of the FHFA pursuant to section
1367 of the Federal Housing Enterprises Financial Safety and Soundness
Act of 1992 (12 U.S.C. 4617), as amended by the Housing and Economic
Recovery Act of 2008; or (ii) a date that is seven years after the
effective date of the rule, as provided by Sec. 1026.43(e)(4)(iii).
Finally, comment 43(e)(4)(iii)-4 clarifies that, to satisfy Sec.
1026.43(e)(4)(ii), a loan need not be actually purchased or guaranteed
by the GSEs or insured or guaranteed by the FHA, VA, USFA, or RHS.
Rather, Sec. 1026.43(e)(4)(ii) requires only that the loan be eligible
for such purchase, guarantee, or insurance. Rather, Sec.
1026.43(e)(4)(ii) requires only that the loan be eligible for such
purchase, guarantee, or insurance. For example, for purposes of Sec.
1026.43(e)(4), a creditor is not required to sell a loan to Fannie Mae
or Freddie Mac (or any limited-life regulatory entity succeeding the
charter of either) to be a qualified mortgage. Rather, the loan must be
eligible for purchase or guarantee by Fannie Mae or Freddie Mac (or any
limited-life regulatory entity succeeding the charter of either),
including satisfying any requirements regarding consideration and
verification of a consumer's income or assets, current debt
obligations, and debt-to-income ratio or residual income. To determine
eligibility, a creditor may rely on an underwriting recommendation
provided by Fannie Mae and Freddie Mac's Automated Underwriting Systems
(AUSs) or written guide. Accordingly, a covered transaction is eligible
for purchase or guarantee by Fannie Mae or Freddie Mac if: (i) The loan
conforms to the standards set forth in the Fannie Mae Single-Family
Selling Guide or the Freddie Mac Single-Family Seller/Servicer Guide;
or (ii) the loan receives an ``Approve/Eligible'' recommendation from
Desktop Underwriter (DU); or an ``Accept and Eligible to Purchase''
recommendation from Loan Prospector (LP).
The Bureau is finalizing Sec. 1026.43(e)(4) pursuant to its
authority under TILA section 129C(b)(3)(B)(i) to prescribe regulations
that revise, add to, or subtract from the criteria that define a
qualified mortgage upon the findings described above. The Bureau
believes the temporary qualified mortgage definition is necessary and
proper to ensure that responsible, affordable mortgage credit remains
available to consumers in a manner consistent with the purposes of TILA
section 129C and necessary and appropriate to effectuate the purposes
of TILA section 129C, which includes assuring that consumers are
offered and receive residential mortgage loans on terms that reasonably
reflect their ability to repay the loan.
As described above, the Bureau believes that the provision of
qualified mortgage status to loans that are eligible for purchase,
guarantee, or to be insured by the Federal entities described above
will provide a smooth transition to a more normal mortgage market.
Similarly, the Bureau believes that including all loans that are
eligible to be made, guaranteed, or insured by agencies of the Federal
government and the GSEs while under conservatorship, will minimize the
risk of disruption as the market adjusts to the ability-to-repay
requirements of this rule. This adjustment to the qualified mortgage
definition will also facilitate compliance with the ability-to-repay
requirements. The Bureau is also finalizing Sec. 1026.43(e)(4)
pursuant to its authority under TILA section 105(a) to issue
regulations with such requirements, classifications, differentiations,
or other provisions, and that provide for such adjustments and
exceptions for all or any class of transactions, as in the judgment of
the Bureau are necessary and proper to effectuate the purposes of TILA,
to prevent circumvention or evasion thereof, or to facilitate
compliance therewith. For the reasons described above, the Bureau
believes the adjustments to the definition of qualified mortgage are
necessary to effectuate the purposes of TILA, which include the above-
described purpose of TILA section 129C, among other things, and to
facilitate compliance therewith.
The Bureau is exercising this authority to remove certain qualified
mortgage statutory criteria, as discussed further below, and to add
criteria related to eligibility for Federal agency programs and GSEs
while conservatorship, as outlined above, in order to create this
qualified mortgage definition.
As noted above, Sec. 1026.43(e)(4) applies to loans that are
eligible for guarantee or insurance by the Federal agencies listed
above. The provisions of section 1412 apply to all residential mortgage
loans, including loans that are eligible for and are guaranteed or
insured by the Federal agencies listed above. However, TILA section
129C(b)(3)(B)(ii) provides the Federal agencies listed above with
authority, in consultation with the Bureau, to prescribe rules defining
the types of loans they insure, guarantee or administer, as the case
may be, that are qualified mortgages and such rules may revise, add to,
or subtract from the criteria used to define a qualified mortgage upon
certain findings. Consistent with this authority, the Bureau leaves to
these agencies, in consultation with the Bureau, further prescribing
qualified mortgage rules defining the types of loans they respectively
insure, guarantee or administer, and their rules may further revise the
qualified mortgage criteria finalized in this rule with respect to
these loans. In light of the Federal agencies' authority in TILA
section 129C(b)(3)(B)(ii), Sec. 1026.43(e)(4) will sunset once each
agency has exercised its authority to promulgate their own qualified
mortgage standards.
As noted above, the final rule does not specifically include in the
temporary definition the statutory requirements to (1) verify and
document the consumer's income or assets relied upon in qualifying the
consumer; (2) underwrite a fixed rate loan based on a payment schedule
that fully amortizes the loan over the term and takes into account all
applicable taxes, insurance,

[[Page 6536]]

and assessments; or (3) underwrite an adjustable-rate loan using the
maximum interest rate permitted in the first five years. As discussed
above, the Bureau believes it is appropriate, for the time being, to
presume that loans that are eligible for purchase, guarantee, or
insurance by the designated Federal agencies and the GSEs while under
conservatorship have been originated with appropriate consideration of
consumers' ability to repay where the loans satisfy the requirements of
Sec. 1026.43(e)(2) concerning restrictions on product features and
total points and fees limitations. Layering additional and different
underwriting requirements on top of the requirements that are unique to
each loan program would undermine the purpose of the temporary
definition, namely, to preserve access to credit during a transition
period while the mortgage industry adjusts to this final rule and
during a time when the market is especially fragile. Accordingly, as
noted above, the Bureau is using its authority under TILA section
129C(b)(3)(B)(i) to remove these statutory requirements from the
qualified mortgage definition in Sec. 1026.43(e)(4). For similar
reasons the Bureau is not requiring that loans that meet this qualified
mortgage definition meet the 43 percent debt-to-income ratio
requirement in Sec. 1026.43(e)(2). The eligibility requirements of the
GSEs and Federal agencies incorporate debt-to-income ratio thresholds.
However, the GSEs and Federal agencies also permit consideration of
certain compensating factors that are unique to each loan program. The
Bureau declines to layer an additional debt-to-income ratio requirement
to avoid undermining the purpose of the temporary qualified mortgage
definition.
43(f) Balloon-Payment Qualified Mortgages Made by Certain Creditors
TILA section 129C(b)(2)(E) authorizes the Bureau to permit
qualified mortgages with balloon payments, provided the loans meet four
conditions. Specifically, those conditions are that: (1) The loan meets
certain of the criteria for a qualified mortgage; (2) the creditor
makes a determination that the consumer is able to make all scheduled
payments, except the balloon payment, out of income or assets other
than the collateral; (3) the loan is underwritten based on a payment
schedule that fully amortizes the loan over a period of not more than
30 years and takes into account all applicable taxes, insurance, and
assessments; and (4) the creditor meets four prescribed qualifications.
Those four qualifications are that the creditor: (1) Operates
predominantly in rural or underserved areas; (2) together with all
affiliates, has total annual residential mortgage loan originations
that do not exceed a limit set by the Bureau; (3) retains the balloon-
payment loans in portfolio; and (4) meets any asset-size threshold and
any other criteria the Bureau may establish, consistent with the
purposes of this subtitle.
The four creditor qualifications are nearly identical to provisions
in section 1461 of the Dodd-Frank Act, which authorizes the Bureau
under TILA section 129D(c) to exempt small creditors that operate
predominantly in rural or underserved areas from a requirement to
establish escrow accounts for certain first-lien, higher-priced
mortgage loans. Specifically, the statute authorizes creation of an
exemption for any creditor that (1) operates predominantly in rural or
underserved areas; (2) together with all affiliates has total annual
residential mortgage transaction originations that do not exceed a
limit set by the Bureau; (3) retains its mortgage debt obligations in
portfolio; and (4) meets any asset-size thresholds and any other
criteria that the Bureau may establish.
The Board interpreted the two provisions as serving similar but not
identical purposes, and thus varied certain aspects of the proposals to
implement the balloon-payment qualified mortgage and escrow provisions.
Specifically, the Board interpreted the qualified mortgage provision as
being designed to ensure access to credit in rural and underserved
areas where consumers may be able to obtain credit only from community
banks offering balloon-payment mortgages, and the escrow provision to
exempt creditors that do not possess economies of scale to cost-
effectively offset the burden of establishing escrow accounts by
maintaining a certain minimum portfolio size from being required to
establish escrow accounts on higher-priced mortgage loans. Accordingly,
the two Board proposals would have used common definitions of ``rural''
and ``underserved,'' but did not provide uniformity in calculating and
defining various other elements. For the balloon balloon-payment
qualified mortgage provisions, for instance, the Board's proposed Sec.
226.43(f) would have required that the creditor (1) in the preceding
calendar year, have made more than 50 percent of its balloon-payment
mortgages in rural or underserved areas; and (2) have assets that did
not exceed $2 billion. The Board proposed two alternatives each for
qualifications relating to (1) the total annual originations limit; and
(2) the retention of balloon-payment mortgages in portfolio. The
proposal also would have implemented the four conditions for balloon-
payment qualified mortgages under TILA section 129C(b)(2)(E) and used
its adjustment and exception authority to add a requirement that the
loan term be five years or longer.
In contrast, the Board's proposal for the escrows exemption under
proposed Sec. 226.45(b)(2)(iii) would have required that the creditor
have (1) in the preceding calendar year, have made more than 50 percent
of its first-lien mortgages in rural or underserved areas; (2) together
with all affiliates, originated and retained servicing rights to no
more than 100 first-lien mortgage debt obligations in either the
current or prior calendar year; and (3) together with all affiliates,
not maintained an escrow account on any consumer credit secured by real
property. The Board also sought comment on whether to add a requirement
for the creditor to meet an asset-size limit and what that size should
be.
In both cases, the Board proposed to use a narrow definition of
rural based on the Economic Research Service (ERS) of the USDA's
``urban influence codes'' (UICs). The UICs are based on the definitions
of ``metropolitan statistical areas'' of at least one million residents
and ``micropolitan statistical areas'' with a town of at least 2,500
residents, as developed by the Office of Management and Budget, along
with other factors reviewed by the ERS that place counties into twelve
separately defined UICs depending on the size of the largest city and
town in the county. The Board's proposal would have limited the
definition of rural to certain ``non-core'' counties that are not
located in or adjacent to any metropolitan or micropolitan area. This
definition corresponded with UICs of 7, 10, 11, and 12, which would
have covered areas in which only 2.3 percent of the nation's population
lives.
In light of the overlap in criteria between the balloon-payment
qualified mortgage and escrow exemption provisions, the Bureau
considered comments responding to both proposals in determining how to
finalize the particular elements of each rule as discussed further
below. With regard to permitting qualified mortgages with balloon
payments generally, consumer group commenters stated that the balloon-
payment qualified mortgage exemption is a discretionary provision, as
TILA section 129C(b)(2)(E) states that the Bureau ``may'' provide an
exemption for balloon-payment mortgages to be qualified mortgages, and

[[Page 6537]]

stated that such an exemption should not be provided in the final rule
because such exemption would have a negative effect on consumers'
access to responsible and affordable credit. Trade association and
industry commenters generally supported the balloon-payment qualified
mortgage exemption, with some comments related to the specific
provisions that are discussed below. One trade association commented
that the exemption should extend to all balloon-payment mortgages held
in portfolio by financial institutions; as such a broader exemption
would achieve Congress's intent as well as reduce the difficulty that
creditors would have in complying with the requirements in the
proposal. Three trade associations and several industry commenters
commented that the balloon-payment qualified mortgage exemption was
needed to ensure access to credit for consumers in rural areas because
smaller institutions in those areas use balloon-payment mortgages to
control interest rate risk.
The Bureau believes Congress enacted the exemption in TILA section
129C(b)(2)(E) because it was concerned that the restrictions on
balloon-payment mortgages under the ability to repay and general
qualified mortgage provisions might unduly constrain access to credit
in rural and underserved areas, where consumers may be able to obtain
credit only from a limited number of creditors, including some
community banks that may offer only balloon-payment mortgages. Because
Congress explicitly set out detailed criteria, indicating that it did
not intend to exclude balloon-payment mortgages from treatment as
qualified mortgages that meet those criteria, and the Bureau is
implementing the statutory exemption for balloon-payment mortgages to
be qualified mortgages provided they meet the conditions described
below. The Bureau believes those criteria reflect a careful judgment by
Congress concerning the circumstances in which the potential negative
impact from restricting consumers' access to responsible and affordable
credit would outweigh any benefit of prohibiting qualified mortgages
from providing for balloon payments. The Bureau therefore believes that
the scope of the exemption provided in this final rule implements
Congress's judgment as to the proper balance between those two
imperatives.
The Bureau believes that there are compelling reasons underlying
Congress's decision not to allow balloon-payment mortgages to enjoy
qualified-mortgage status except in carefully limited circumstances. It
is the rare consumer who can afford to make a balloon payment when due.
Thus, ordinarily a consumer facing a balloon payment must obtain new
financing. Depending on market conditions at the time and also the
consumer's own economic circumstances, consumers may find it difficult
to obtain affordable credit. Some consumers may be forced to sell their
homes to pay off the balloon-payment mortgage. Others may find it
necessary to take on a new loan on terms that create hardships for the
consumers. Unscrupulous lenders may seek to take advantage of consumers
faced with the necessity of making a balloon payment by offering loans
on predatory terms.
On the other hand, in rural and other underserved areas, it is not
uncommon for consumers to seek a mortgage loan of a type that cannot be
sold on the secondary market, because of special characteristics of
either the property in question or the consumer. Many community banks
make mortgages that are held in portfolio in these circumstances. To
manage interest rate risk and avoid complexities in originating and
servicing adjustable rate mortgages, these banks generally make
balloon-payment mortgage loans which the banks roll over, at then
current market interest rate, when the balloon-payment mortgage comes
due. For example, data available through the National Credit Union
Administration indicates that among credit unions which make mortgages
in rural areas (using the definition of rural described below), 25
percent make only balloon-payment or hybrid mortgages.
There are also substantial data suggesting that the small portfolio
creditors that are most likely to rely on balloon-payment mortgages to
manage their interest rate risks (or to have difficulty maintaining
escrow accounts) have a significantly better track record than larger
creditors with regard to loan performance. As discussed in more depth
in the 2013 ATR Concurrent Proposal, because small portfolio lenders
retain a higher percentage of their loans on their own books, they have
strong incentives to engage in thorough underwriting. To minimize
performance risk, small community lenders have developed underwriting
standards that are different than those employed by larger
institutions. Small lenders generally engage in ``relationship
banking,'' in which underwriting decisions rely at least in part on
qualitative information gained from personal relationships between
lenders and consumers. This qualitative information focuses on
subjective factors such as consumer character and reliability which
``may be difficult to quantify, verify, and communicate through the
normal transmission channels of banking organization.'' \156\ While it
is not possible to disaggregate the impact of each of the elements of
the community banking model, the combined effect is highly beneficial.
Moreover, where consumers have trouble paying their mortgage debt
obligations, small portfolio creditors have strong incentives to work
with the consumers to get them back on track, both to protect the
creditors' balance sheets and their reputations in their local
communities. Market-wide data demonstrate that loan delinquency and
charge-off rates are significantly lower at smaller banks than larger
ones.\157\
---------------------------------------------------------------------------

\156\ See Allen N. Berger & Gregory F. Udell, Small Business
Credit Availability and Relationship Lending: The Importance of Bank
Organizational Structure, 112 Econ. J. F32 (2002).
\157\ See 2013 ATR Concurrent Proposal; Fed. Deposit Ins. Corp.,
FDIC Community Banking Study, (Dec. 2012), available at https://fdic.gov/regulations/resources/cbi/study.html.
---------------------------------------------------------------------------

The Bureau believes that these kinds of considerations underlay
Congress's decision to authorize the Bureau to establish an exemption
under TILA section 129C(b)(2)(E) 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 mortgages.
Thus, the Bureau concludes that exercising its authority is
appropriate, but also that the exemption should implement the statutory
criteria to ensure it effectuates Congress's intent. Accordingly, as
discussed in more detail below, the Bureau adopts Sec. 1026.43(f)
largely as proposed but with certain changes described below to
implement TILA section 129C(b)(2)(E).
In particular, the Bureau has concluded that it is appropriate to
make the specific creditor qualifications much more consistent between
the balloon-payment qualified mortgage and escrow exemptions than
originally proposed by the Board.\158\ The Bureau believes that this
approach is justified by several considerations, including the largely
identical statutory language, the similar congressional intents
underlying the two provisions, and the fact that requiring small
creditors operating predominantly in rural or underserved

[[Page 6538]]

areas to track overlapping but not identical sets of technical criteria
for each separate provision could create unwarranted compliance burden
that itself would frustrate the intent of the statutes. Although the
Bureau has recast and loosened some of the criteria in order to promote
consistency, the Bureau has carefully calibrated the changes to further
the purposes of each rulemaking and in light of the evidence suggesting
that small portfolio lenders' relationship banking model provides
significant consumer protections in its own right.
---------------------------------------------------------------------------

\158\ The Bureau has similarly attempted to maintain consistency
between the asset size, annual originations threshold, and
requirements concerning portfolio loans as between the final rules
that it is adopting with regard to balloon qualified mortgages and
the escrow exemption and its separate proposal to create a new type
of qualified mortgages originated and held by small portfolio
creditors. The Bureau is seeking comment in that proposal on these
elements and on whether other adjustments are appropriate to the
existing rules to maintain continuity and reduce compliance burden.
See 2013 ATR Concurrent Proposal.
---------------------------------------------------------------------------

For the foregoing reasons, the Bureau is adopting Sec.
1026.43(f)(1)(vi) to implement TILA section 129C(b)(2)(E)(iv) by
providing that a balloon loan that meets the other criteria specified
in the regulation is a qualified mortgage if the creditor: (1) In the
preceding calendar year made more than 50 percent of its covered
transactions secured by a first lien in counties designated by the
Bureau as ``rural'' or ``underserved''; (2) together with all
affiliates extended 500 or fewer first-lien covered transactions in the
preceding calendar year; and (3) has total assets that are less than $2
billion, adjusted annually for inflation. The final rule also creates
greater parallelism with the escrow provision with regard to the
requirement that the affected loans be held in portfolio by requiring
in both rules that the transactions not be subject to a ``forward
commitment'' agreement to sell the loan at the time of consummation.
These qualifications and the other requirements under the final rule
are discussed in more detail below.
43(f)(1) Exemption
The Bureau believes that the provisions of TILA section
129C(b)(2)(E) are designed to require that balloon-payment qualified
mortgages meet the same criteria for qualified mortgages as described
in TILA section 129C(b)(2)(A), except where the nature of the balloon-
payment mortgage itself requires adjustment to the general rules. In
TILA section 129C(b)(2)(A), a qualified mortgage cannot allow the
consumer to defer repayment of principal. Deferred principal repayment
may occur if the payment is applied to both accrued interest and
principal but the consumer makes periodic payments that are less than
the amount that would be required under a payment schedule that has
substantially equal payments that fully repay the loan amount over the
loan term. The scheduled payments that fully repay a balloon-payment
mortgage over the loan term include the balloon payment itself and,
therefore, are not substantially equal. Thus, balloon-payment mortgages
permit the consumer to defer repayment of principal. Additionally, a
qualified mortgage must explicitly fully amortize the loan amount over
the loan term and explicitly cannot result in a balloon payment under
TILA section 129C(b)(2)(A). Since TILA section 129C(b)(2)(A) contains
these provisions, TILA section 129C(b)(2)(E) exempts balloon-payment
qualified mortgages from meeting those requirements. TILA section
129C(b)(2)(E) has additional requirements that a creditor consider the
consumer's ability to repay the scheduled payments using a calculation
methodology appropriate for a balloon-payment mortgage.
Accordingly, the Bureau is adjusting the ability-to-repay
requirements generally applicable to qualified mortgages under Sec.
1026.43(e)(2) for the balloon-payment qualified mortgage exemption.
Requirements that are the same in both the generally applicable
qualified mortgage requirements and the balloon-payment qualified
mortgage exemption are specifically described in paragraph (f)(1)(i).
The requirements in the generally applicable qualified mortgage
requirements that are inapplicable, for the reasons described below, to
the balloon-payment qualified mortgage exemption are replaced by
requirements in paragraph (f)(1)(ii), (iii) and (iv) that specifically
address the provisions inherent in balloon-payment mortgages.
43(f)(1)(i)
TILA section 129C(b)(2)(E)(i) requires that a balloon-payment
qualified mortgage meet all of the criteria for a qualified mortgage,
except for the provisions that require the loan to have: (1) Regular
periodic payments that provide for the complete repayment of principal
over the loan term, (2) terms that do not result in a balloon payment,
and (3) a payment schedule that fully amortizes the mortgage over the
loan term taking into account all applicable taxes, insurance and
assessments. The Board's proposed Sec. 226.43(f)(1)(i) would have
implemented this provision by requiring that balloon-payment qualified
mortgages meet the same requirements for other qualified mortgages,
except for specific provisions of Sec. 226.43(e)(2) that would not
have to be considered. Commenters did not address these requirements
specifically. The Bureau is adopting Sec. 1026.43(f)(1)(i) to
implement TILA section 129C(b)(2)(E)(i) by providing that a balloon-
payment qualified mortgage must meet the criteria for a qualified
mortgage as required by Sec. 1026.43(e)(2)(i)(A), (e)(2)(ii),
(e)(2)(iii), and (e)(2)(v). These requirements are similar to the
requirements in the Board's proposal, except that they are stated as
affirmative requirements instead of excluding qualified mortgage
requirements that are not required to be considered for balloon-payment
qualified mortgages.
Section 1026.43(f)(1)(i), by exclusion, exempts balloon-payment
qualified mortgages from the requirements in Sec. 1026.43(e)(2)(i)(B),
(e)(2)(i)(C), (e)(2)(iv), and (e)(2)(vi), which use calculation
methodologies that would make the origination of balloon-payment
qualified mortgages difficult, if not impossible. The requirements in
subsequent provisions of Sec. 1026.43(f)(1) are adopted below to
require the consideration of scheduled payments and the debt-to-income
ratio made in conjunction with alternative calculation methodologies
that are appropriate for balloon-payment qualified mortgages.
Comment 43(f)(1)(i)-1 clarifies that a balloon-payment qualified
mortgage under this exemption must provide for regular periodic
payments that do not result in an increase of the principal balance as
required by Sec. 1026.43(e)(2)(i)(A), must have a loan term that does
not exceed 30 years as required by Sec. 1026.43(e)(2)(ii), must have
total points and fees that do not exceed specified thresholds pursuant
to Sec. 1026.43(e)(2)(iii), and must satisfy the consideration and
verification requirements in Sec. 1026.43(e)(2)(v).
43(f)(1)(ii)
TILA section 129C(b)(2)(E)(ii) requires a creditor making a
balloon-payment qualified mortgage to determine that the consumer is
able to make all scheduled payments, except the balloon payment, out of
income and assets other than the collateral. TILA section
129C(b)(2)(E)(iii) requires a creditor making a balloon-payment
qualified mortgage to determine, among other things, that the scheduled
payments include mortgage-related obligations. Proposed Sec.
226.43(f)(1)(ii) would have required that the creditor determine that
the consumer can make all of the scheduled payments, except for the
balloon payment, from the consumer's current or reasonably expected
income or assets other than the dwelling that secures the loan.
Commenters did not address this requirement specifically. The Bureau is
adopting Sec. 1026.43(f)(1)(ii) to implement TILA section
129C(b)(2)(E)(ii) and a portion of TILA section 129C(b)(2)(E)(iii) by
requiring a creditor to determine that the consumer can make all of the
payments under the terms of the legal obligation, as described in

[[Page 6539]]

Sec. 1026.43(f)(1)(iv)(A), together with all mortgage-related
obligations and excluding the balloon payment, from the consumer's
income or assets other than the dwelling that secures the loan. Comment
43(f)(1)(ii)-1 provides an example to illustrate the calculation of the
monthly payment on which this determination must be based. Comment
43(f)(1)(ii)-2 provides additional clarification on how a creditor may
make the required determination that the consumer is able to make all
scheduled payments other than the balloon payment.
43(f)(1)(iii)
TILA section 129C(b)(3)(B)(i) permits the addition of additional
requirements or revision of the criteria that define a qualified
mortgage upon the finds discussed below. The Board's proposal did not
include an explicit requirement to consider the consumer's debt-to-
income ratio in relation to a balloon-payment qualified mortgage. The
Board, however, sought comment on what criteria should be included in
the definition of a qualified mortgage to ensure that the definition
provides an incentive to creditors to make qualified mortgages, while
also ensuring that consumers have the ability to repay qualified
mortgages. One commenter advocated eliminating the balloon-payment
qualified mortgage exemption completely as they recommended that
balloon-payment mortgages should not be permitted at all, but rather
suggested that the Board and Bureau take steps to make the balloon-
payment qualified mortgage exemption rare.
As discussed above with regard to other categories of qualified
mortgages, the Bureau believes consideration of debt-to-income ratio or
residual income is fundamental to any determination of ability to
repay. A consumer is able to repay a loan if he or she has sufficient
funds to pay his or her other obligations and expenses and still make
the payments required by the terms of the loan. Thus, debt-to-income
comparisons provide a valuable predictive metric in assessing the
consumer's repayment ability. The Bureau believes that it would be
inconsistent with congressional intent to have balloon-payment
qualified mortgages not meet those same requirements, as modified to
the particular nature of a balloon-payment mortgage.
Accordingly, the Bureau is adopting Sec. 1026.43(f)(1)(iii) to
provide that, to make a balloon-payment qualified mortgage, a creditor
must consider and verify the consumer's monthly debt-to-income ratio or
residual income in accordance with Sec. 1026.43(c)(7) by using the
calculation methodology described in Sec. 1026.43(f)(iv)(A), together
with all mortgage-related obligations and excluding the balloon
payment. Comment 43(f)(1)(iii)-1 clarifies that the calculation
required under Sec. 1026.43(c)(7)(i)(A) should be made using the
payment calculation methodology under Sec. 1026.43(f)(1)(iv)(A),
together with all mortgage-related obligations and excluding the
balloon payment, in order to comply with Sec. 1026.43(f)(1)(iii).
At the same time, however, the Bureau declines to impose a specific
debt-to-income or residual threshold for this category of qualified
mortgages because, as discussed above, the Bureau believes that small
creditors excel at making highly individualized determinations of
ability to repay that take into consideration the unique
characteristics and financial circumstances of the particular consumer.
While the Bureau believes that many creditors can make mortgage loans
with consumer debt-to-income ratios above 43 percent that consumers are
able to repay, the Bureau believes that portfolio loans made by small
creditors are particularly likely to be made responsibly and to be
affordable for the consumer even if such loans exceed the 43 percent
threshold. The Bureau therefore believes that it is appropriate to
presume compliance even above the 43 percent threshold for small
creditors who meet the other criteria in Sec. 1026.43(f). The Bureau
believes that the discipline imposed when small creditors make loans
that they will hold in their portfolio is sufficient to protect
consumers' interests in this regard. Because the Bureau is not
proposing a specific limit on consumer debt-to-income ratio, the Bureau
does not believe it is necessary to require creditors to calculate
debt-to-income ratio in accordance with a particular standard such as
that set forth in appendix Q.
In adopting this requirement, the Bureau is adding a condition for
a balloon-payment qualified mortgage that is not established by TILA
section 129C(b)(2)(E). The Bureau adds this condition pursuant to TILA
section 129C(b)(3)(B)(i), which authorizes the Bureau ``to 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 this section, necessary and
appropriate to effectuate the purposes of this section and Section
129B, to prevent circumvention or evasion thereof, or to facilitate
compliance with such sections.'' A purpose of TILA section 129C, among
other things, is to ensure that consumers are offered and receive loans
on terms that they are reasonably able to repay. See TILA section
129B(a)(2). The Bureau believes that a creditor considering and
verifying the consumer's monthly debt-to-income ratio or residual
income in order for the balloon-payment mortgage to qualify as a
balloon-payment qualified mortgage is necessary, proper, and
appropriate both to effectuate the purposes of TILA section 129C to
prevent circumvention or evasion thereof and to ensure that
responsible, affordable mortgage credit remains available to consumers
in a manner consistent with the purposes of this section. For these
reasons, the Bureau believes that Sec. 1026.43(f)(1)(iii), in
requiring a creditor considering and verifying the consumer's monthly
debt-to-income ratio or residual income in order for the balloon-
payment mortgage to qualify as a balloon-payment qualified mortgage,
effectuates the purposes of TILA section 129C and prevents
circumvention or evasion thereof.
In addition the Bureau invokes its authority under section 105(a)
in order to add the above qualification for a balloon-payment qualified
mortgage. Section 105(a) authorizes the Bureau to issue regulations
that, among other things, contain such additional requirements, other
provisions, or that provide for such adjustments for all or any class
of transactions, that in the Bureau's judgment are necessary or proper
to effectuate the purposes of TILA, which include the above purpose of
section 129C, among other things. See 15 U.S.C. 1604(a). The Bureau
believes that this addition to the qualified mortgage criteria is
necessary and proper to achieve this purpose.
43(f)(1)(iv)
TILA section 126C(b)(2)(E)(iii) and the Board proposal require that
the loan be underwritten with specific payment calculation
methodologies to qualify as a balloon-payment qualified mortgage. The
underwriting of a loan is based on the terms of the legal obligation.
The general requirements of a qualified mortgage in Sec. 1026.43(e)(2)
govern loans secured by real property or a dwelling with multiple
methods of payment calculations, terms, and conditions. However, unlike
other the types of qualified mortgage, the balloon-payment qualified
mortgage deals with a specific type of transaction, a balloon-payment
mortgage, with specific characteristics that are described in the legal

[[Page 6540]]

obligation. Therefore, the Bureau considers the requirement of TILA
section 129C(b)(2)(E)(iii) to be requirements relating to the terms of
the legal obligation of the loan. Accordingly, the Bureau is adopting
Sec. 1026.43(f)(1)(iv), requiring the legal obligation of a balloon-
payment qualified mortgage to have the following terms: (1) Scheduled
payments that are substantially equal and calculated on an amortization
period that does not exceed 30 years; (2) the interest rate does not
vary during the loan term, and (3) the loan term is for five years or
longer.
Scheduled Payments
TILA section 129C(b)(2)(E)(iii) requires that a balloon-payment
qualified mortgage must be underwritten based on a payment schedule
that fully amortizes the loan over a period of not more than 30 years
and takes into account all applicable taxes, insurance, and
assessments. The Board's proposed Sec. 226.43(f)(1)(iii) incorporated
this statutory requirement. Commenters did not address this requirement
specifically.
The Bureau is adopting the Board's proposal and implements Sec.
1026.43(f)(1)(iv) to require that the scheduled payments, on which the
determinations required by Sec. 1026.43(f)(1)(ii) and (f)(1)(iii) are
based, are calculated using an amortization period that does not exceed
30 years. The requirement that the payments include all mortgage-
related obligations is required as part of Sec. 1026.43(f)(1)(ii),
above. The Bureau believes that the underwriting referenced in TILA
section 129C(b)(2)(E)(iii) corresponds to the determination of the
consumer's repayment ability referenced in TILA section
129C(b)(2)(E)(ii). Comment 43(f)(1)(iv)-1 clarifies that the
amortization period used to determine the scheduled periodic payments
that the consumer must pay under the terms of the legal obligation may
not exceed 30 years.
In its proposal, the Board sought comment on whether a balloon-
payment mortgage with interest-only payments should qualify for the
balloon-payment exemption. One association of State bank regulators
commented that loans with interest-only payments would be properly
excluded from the exemption in order to permit the exemption to be
available only to those institutions that appropriately utilize the
balloon-payment mortgages to mitigate interest rate risk. The Bureau
agrees with this assessment and believes that permitting interest-only
payments would be contrary to the intent of Congress requiring
amortizing payments as a requirement of a qualified mortgage, as
interest-only payments do not provide any reduction in principal.
Accordingly, the Bureau is adding comment 43(f)(1)(iv)-2 which
clarifies that a loan that provides for interest-only payments cannot
qualify for the balloon-payment qualified mortgage exemption, because
it would not require the consumer to make any payments towards the
principal balance of the loan contrary to the requirement that the
scheduled payments result in amortization of the loan for a period that
does not exceed 30 years.
Fixed Interest Rate
TILA section 129C(b)(3)(B)(i) permits the addition of additional
requirements upon the finding that such regulations are necessary or
proper to ensure that responsible, affordable mortgage credit remains
available to consumers. The Board's proposal did not include any
restrictions on the interest rate terms of the loan, but did observe
that community banks appear to originate balloon-payment mortgages to
hedge against interest-rate risk. The Board sought comment on what
criteria should be included in the definition of a qualified mortgage
to ensure that the definition provides an incentive to creditors to
make qualified mortgages, while also ensuring that consumers have the
ability to repay qualified mortgages.
The Bureau believes that the purpose of the exemption was to permit
balloon-payment mortgages to be originated for those consumers that
still need or want them, and to permit competition between creditors
that address interest rate risk through the use of adjustable rate
mortgages and those creditors that address interest rate risk through
the use of balloon-payment mortgages. The Bureau believes that
creditors that have the infrastructure and resources to originate
adjustable rate mortgages do not need to resort to the use of balloon-
payment mortgages to address interest rate risk. Accordingly, the
Bureau is adopting Sec. 1026.43(f)(1)(iv)(B), which requires that the
legal obligation of a balloon-payment qualified mortgage must include
an interest rate that will not increase during the term of the loan.
In adopting this requirement, the Bureau is adding a condition for
a balloon-payment qualified mortgage that is not established by TILA
section 129C(b)(2)(E). The Bureau adds this condition pursuant to TILA
section 129C(b)(3)(B)(i), which authorizes the Bureau ``to 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 this section, necessary and
appropriate to effectuate the purposes of this section and Section
129B, to prevent circumvention or evasion thereof, or to facilitate
compliance with such sections.'' A purpose of TILA section 129C is to
ensure that consumers are offered and receive loans on terms that they
are reasonably able to repay. See TILA section 129B(a)(2). The Bureau
believes that requiring the legal obligation of a balloon-payment
qualified mortgage to contain an interest rate that does not increase
during the loan term is necessary, proper, and appropriate both to
effectuate the purposes of TILA section 129C and to prevent
circumvention or evasion thereof and to ensure that responsible,
affordable mortgage credit remains available to consumers in a manner
consistent with the purposes of this section. For these reasons, the
Bureau believes that Sec. 1026.43(f)(1)(iv)(B), in requiring the legal
obligation of a balloon-payment qualified mortgage to contain an
interest rate that does not increase during the loan term, effectuates
the purposes of TILA section 129C and prevents circumvention or evasion
thereof.
In addition the Bureau invokes its authority under section 105(a)
in order to add the above qualification for a balloon-payment qualified
mortgage. Section 105(a) authorizes the Bureau to issue regulations
that, among other things, contain such additional requirements, other
provisions, or that provide for such adjustments for all or any class
of transactions, that in the Bureau's judgment are necessary or proper
to effectuate the purposes of TILA, which include the above purpose of
Section 129C, among other things. See 15 U.S.C. 1604(a). The Bureau
believes that this addition to the qualified mortgage criteria is
necessary and proper to achieve this purpose.
Loan Term of Five Years or Longer
TILA section 129C(b)(3)(B)(i) permits the adoption of additional
requirements upon the finding that such regulations are necessary or
proper to ensure that responsible, affordable mortgage credit remains
available to consumers. The Board's proposed Sec. 226.43(f)(1)(iv)
would have included the addition of a requirement that a balloon-
payment qualified mortgage must have a loan term of five years or
longer. One association of State bank regulators and an industry trade
group commented that

[[Page 6541]]

the five-year term requirement was appropriate, as the time period is
consistent with other provisions of the proposed rule. One industry
trade group and one industry commenter commented that three years would
be a more appropriate term because some of the creditors that would
qualify under proposed Sec. 226.43(f)(1)(v) utilize three-year terms.
The Bureau is not persuaded that the exemption was meant by Congress to
permit any current business practice of creditors that would satisfy
the requirements of proposed Sec. 226.43(f)(1)(v), rather the
exemption was meant to provide a reasonable exemption for some balloon-
payment mortgages that still meet other requirements of a qualified
mortgage. The Bureau notes that the statute requires underwriting for
an adjustable-rate qualified mortgage to be based on the maximum
interest rate permitted during the first five years. See TILA Section
129C(b)(2)(A)(v). Therefore, the Bureau is adopting the Board's
proposal by implementing Sec. 1026.43(f)(1)(iv)(C) requiring a loan
term of five years or longer because it reflects the statutory intent
that five years is a reasonable period to repay a loan. Since other
requirements of a qualified mortgage include a review of the mortgage
over a five-year term, it would be more consistent with the intent of
the exemption for the balloon-payment mortgage to have at least a five-
year term.
The Bureau believes that it is appropriate to structure the
exemption to prevent balloon-payment mortgages with very short loan
terms from being qualified mortgages because such loans would present
certain risks to consumers. A consumer with a loan term of less than
five years, particularly where the amortization period is especially
long, would face a balloon payment soon after consummation, in an
amount virtually equal to the original loan amount. The consumer would
establish little equity in the property under such terms, and if the
pattern is repeated the consumer may never make any significant
progress toward owning the home unencumbered. Thus, the greater the
difference between a balloon-payment mortgage's amortization period and
its loan term, the more likely the consumer would face this problem.
The Bureau's requirement of a minimum term therefore complements the
30-year maximum amortization period prescribed by TILA section
129C(b)(2)(E)(iii).
In adopting this requirement, the Bureau is adding a condition for
a balloon-payment qualified mortgage that is not established by TILA
section 129C(b)(2)(E). The Bureau adds this condition pursuant to TILA
section 129C(b)(3)(B)(i), which authorizes the Bureau ``to 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 this section, necessary and
appropriate to effectuate the purposes of this section and Section
129B, to prevent circumvention or evasion thereof, or to facilitate
compliance with such sections.'' A purpose of TILA section 129C is to
ensure that consumers are offered and receive loans on terms that they
are reasonably able to repay. See TILA section 129B(a)(2). For the
reasons discussed above, the Bureau believes that a minimum loan term
for balloon-payment mortgages is necessary and appropriate both to
effectuate the purposes of TILA section 129C and to prevent
circumvention or evasion thereof. For these reasons, the Bureau
believes that Sec. 1026.43(f)(1)(iv)(C), in limiting the exemption for
balloon-payment qualified mortgages to covered transactions with loan
terms of at least five years and thus ensuring that such products truly
support mortgage affordability, effectuates the purposes of TILA
section 129C and prevents circumvention or evasion thereof. The Bureau
also believes this minimum loan term for balloon-payment qualified
mortgages is necessary, proper, and appropriate to ensure that
responsible, affordable mortgage credit remains available to consumers
in a manner consistent with the purposes of Section 129C.
In addition the Bureau invokes its authority under section 105(a)
in order to add the above qualification for a balloon-payment qualified
mortgage. Section 105(a) authorizes the Bureau to issue regulations
that, among other things, contain such additional requirements, other
provisions, or that provide for such adjustments for all or any class
of transactions, that in the Bureau's judgment are necessary or proper
to effectuate the purposes of TILA, which include the above purpose of
Section 129C, among other things. See 15 U.S.C. 1604(a). The Bureau
believes that this addition to the qualified mortgage criteria is
necessary and proper to achieve this purpose.
43(f)(1)(v) and (vi)
TILA section 129C(b)(2)(E)(iv) includes among the conditions for a
balloon-payment qualified mortgage that the creditor (1) operates
predominantly in rural or underserved areas; (2) together with all
affiliates, has total annual residential mortgage loan originations
that do not exceed a limit set by the Bureau; (3) retains the balloon-
payment loans in portfolio; and (4) meets any asset-size threshold and
any other criteria as the Bureau may establish. The Board proposed
Sec. 226.43(f)(1)(v) to impose specific requirements to implement some
of these elements and sought comment on alternatives to implement
others. Specifically, the Board: (1) Proposed a requirement that the
creditor in the preceding year made more than 50 percent of its
balloon-payment mortgages in rural or underserved areas; (2) sought
comment on whether to adopt an annual originations limit based on
either the total volume of mortgages or the total number of mortgages
made in the last year by the creditor, together with affiliates,
without proposing a specific threshold; (3) sought comment on two
alternatives to implement the portfolio requirement by revoking a
creditor's ability to make balloon-payment qualified mortgages if the
creditor sold any balloon-payment mortgages either in the last year or
at any time after the final rule was adopted; and alternatives, and (4)
did not have assets that exceeded $2 billion, adjusted annually for
inflation.
In contrast, the Board's escrows proposal would have implemented
nearly identical statutory requirements under TILA 129D(c) by requiring
that the creditor (1) in the preceding calendar year, have made more
than 50 percent of its first-lien mortgages in rural or underserved
areas; (2) together with all affiliates, originated and retained
servicing rights to no more than 100 first-lien mortgage debt
obligations in either the current or prior calendar year; and (3) not
be permitted to invoke the exception for any first-lien higher-priced
mortgage loan that was subject to a ``forward commitment'' to sell the
loan at the time of consummation. The Board also sought comment on
whether to impose an asset limit without proposing a specific
threshold, and proposed to impose a further requirement that the
creditor and its affiliates not maintain escrow accounts for any other
loans in order to be eligible for the exception.
As stated above, the Bureau has considered the comments received
under both proposals regarding implementation of the largely identical
statutory criteria, and has concluded that it is appropriate to create
a much higher degree of consistency between the elements in the two
individual rules. Implementation of each of the

[[Page 6542]]

statutory elements is discussed further below.
Holding of Balloon-Payment Mortgages in Portfolio
TILA section 129C(b)(E)(iv) requires that the lender keep balloon-
payment mortgages in portfolio. The Board proposed to implement this
requirement by removing a creditor's eligibility for the exemption
under proposed Sec. 226.43(f)(1)(v)(C) if it sold a balloon-payment
mortgage during two alternative periods, one that would cover any time
after the adoption of the final rule and another that would look only
to sales during the preceding or current calendar year. The Board
concluded that this was the best approach to implement the statutory
requirement in the qualified mortgage context because it would allow a
creditor to determine at consummation whether a particular balloon-
payment loan was eligible to be a qualified mortgage and allow the loan
to maintain such status even if it were sold, while creating strong
safeguards against gaming of the exception by revoking the creditor's
ability to invoke the provisions if they began selling such loans to
other holders.
In contrast, the Board's 2011 Escrows Proposal would have
implemented a parallel statutory requirement under TILA section
129D(c)(3) by looking to whether the particular first-lien, higher-
priced mortgage loan was subject to sale under a ``forward
commitment.'' Forward commitments are agreements entered into at or
before consummation of a transaction under which a purchaser is
committed to acquire the specific loan or loans meeting specified
criteria from the creditor after consummation. The Board believed that
the proposal was a reasonable way to implement the statutory
requirement because it would allow the creditor and consumer to
determine at consummation whether an escrow requirement was required to
be established; the Board reasoned that fashioning the rule in a way
that would require that an escrow account be established sometime after
consummation if the particular loan was transferred to a non-eligible
holder would be potentially burdensome to consumers, since the consumer
may not have the funds available to make a large lump-sum payment at
that time. At the same time, the Board believed the rule would prevent
gaming of the escrows exception because it thought that small creditors
would be reluctant to make a loan that they did not intend to keep in
their portfolios unless they had the assurance of a committed buyer
before extending the credit.
Comments received on the escrows proposal had a divergence of
opinion on how the forward commitment requirement would work in
practice. One trade association commenter stated that the forward
commitment requirement would prevent creditors from selling portfolio
mortgage debt obligations in the future. This appears to be a
misreading of the Board's 2011 Escrows Proposal, as it would not have
restricted the sale of higher-priced mortgage loans. Instead, the
proposed forward commitment requirement provided that, so long as the
higher-priced mortgage loan was not subject to a forward commitment at
the time of consummation, the higher-priced mortgage loan could be sold
on the secondary market without requiring an escrow account to be
established at that time. One consumer advocacy group, concerned about
the possibility that creditors would use the provision to skirt the
escrow requirements, suggested a blanket rule that higher-priced
mortgage loans that are exempt must be maintained in the portfolio of
the creditor or, alternatively, that upon sale secondary market
purchasers must be required to establish escrow accounts for such
mortgage debt obligations.
After consideration of these comments and further analysis of
parallels between the two rulemakings, the Bureau believes that it is
useful and appropriate to implement the no-forward-commitment
requirement in both rules. Accordingly, the Bureau is adding Sec.
1026.43(f)(1)(v) to provide that a loan is not eligible to be a
balloon-payment qualified mortgage if it is subject, at consummation,
to a commitment to be acquired by another person, other than a person
that separately meets the requirements of Sec. 1026.43(f)(1)(vi).
Comment 43(f)(1)(v)-1 clarifies that a balloon-payment mortgage that
will be acquired by a purchaser pursuant to a forward commitment does
not satisfy the requirements of Sec. 1026.43(f)(1)(v), whether the
forward commitment refers to the specific transaction or the balloon-
payment mortgage meets prescribed criteria of the forward commitment,
along with an example. The Bureau believes the rationale for the
balloon-payment qualified mortgage exemption is not present when a loan
will be or is eligible to be acquired pursuant to a forward commitment,
even if the creditor is exempt, as the creditor does not intend to
retain the balloon-payment mortgage in its portfolio.
In adopting this requirement, the Bureau is adding a condition for
a balloon-payment qualified mortgage that is not established by TILA
section 129C(b)(2)(E). The Bureau is adopting Sec. 1026.43(f)(1)(vi)
pursuant to TILA section 129C(b)(3)(B)(i), which authorizes the Bureau
``to 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 this section, necessary and appropriate to effectuate the purposes
of this section and Section 129B, to prevent circumvention or evasion
thereof, or to facilitate compliance with such sections.'' A purpose of
TILA section 129C is to ensure that consumers are offered and receive
loans on terms that they are reasonably able to repay. See TILA section
129B(a)(2). The Bureau believes that the prohibition on mortgages
originated in conjunction with a forward commitment from qualifying as
a balloon-payment qualified mortgage is necessary, proper, and
appropriate both to effectuate the purposes of TILA section 129C and to
prevent circumvention or evasion thereof. For these reasons, the Bureau
believes that Sec. 1026.43(f)(1)(v), in limiting the exemption for
balloon-payment qualified mortgages to mortgages that are not
originated in conjunction with a forward commitment, effectuates the
purposes of TILA section 129C and prevents circumvention or evasion
thereof and is necessary, proper, and appropriate to do so. Limiting
balloon-payment qualified mortgages to those that are not originated in
conjunction with a forward commitment effectively facilitates
compliance with the statutory requirement that a balloon-payment
qualified mortgage is extended by a creditor that retains the balloon-
payment qualified mortgages in portfolio.
In addition the Bureau invokes its authority under section 105(a)
in order to add the above qualification for a balloon-payment qualified
mortgage. Section 105(a) authorizes the Bureau to issue regulations
that, among other things, contain such additional requirements, other
provisions, or that provide for such adjustments for all or any class
of transactions, that in the Bureau's judgment are necessary or proper
to effectuate the purposes of TILA, which include the above purpose of
Section 129C, among other things. See 15 U.S.C. 1604(a). The Bureau
believes that this addition to the

[[Page 6543]]

qualified mortgage criteria is necessary and proper to achieve this
purpose.
``Operates Predominantly in Rural or Underserved Areas''
Under TILA section 129C(b)(2)(E)(iv)(I), to qualify for the
exemption, a creditor must ``operate predominantly in rural or
underserved areas.'' The Board's proposed Sec. 226.43(f)(1)(v)(A)
would have required a creditor to have made during the preceding
calendar year more than 50 percent of its total balloon-payment
mortgages in ``rural or underserved'' areas. The Board sought comment
generally on the appropriateness of the proposed approach to implement
the phrase ``operate predominantly.'' Two trade group commenters
commented that the balloon exemption should extend to all creditors
that retain balloon-payment mortgages in their portfolio, and to
eliminate this proposed requirement, which would have the same effect
as the extension of the exemption proposed generally, discussed above.
Overall, the Bureau believes Congress enacted the exemption in TILA
section 129C(b)(2)(E) to ensure access to credit in rural and
underserved areas where consumers may be able to obtain credit only
from such community banks or credit unions offering balloon-payment
mortgages. The ``operates predominantly in'' requirement serves to
limit the exemption to these institutions. To remove this portion of
the qualifications of the creditor would be to circumvent Congress's
stated requirement that the exemption was intended for creditors
operating predominantly in rural and underserved areas and would
potentially extend the exemption to, for example, a national bank that
makes loans in rural areas and that is fully capable of putting on its
balance sheet fixed rate 30-year mortgage loans or adjustable rate
mortgage loans. The Bureau believes that ``predominantly'' indicates a
portion greater than half, hence the regulatory requirement of more
than 50 percent.
The Board also proposed Sec. 226.43(f)(2) to implement this
provision by defining the terms ``rural'' and ``underserved,'' which
are not defined in the statute. The Board's proposed Sec. 226.43(f)(2)
established separate criteria for both rural and underserved areas.
Commenters addressing the creditor qualifications under Sec.
226.43(f)(2) discussed the definitions themselves, and did not comment
on the necessity of creating definitions for the terms rural and
underserved. The Bureau is adopting the Board's approach by
implementing section 1026.43(f)(2) which establishes separate criteria
for both ``rural'' and ``underserved.'' This means that a property
could qualify for designation by the Bureau under either definition,
and that covered transactions made by a creditor in either a rural or
underserved area will be included in determining whether the creditor
operates predominantly in such areas.
``Rural''
As described above, the Board's proposed definition of rural for
purposes of both the balloon-payment qualified mortgage and escrows
exception relied upon the USDA ERS ``urban influence codes'' (UICs).
The UICs are based on the definitions of ``metropolitan'' and
``micropolitan'' as developed by the Office of Management and Budget,
along with other factors reviewed by the ERS, which place counties into
twelve separately defined UICs depending on the size of the largest
city and town in the county. The Board's proposal would have limited
the definition of rural to certain ``non-core'' counties that are not
located in or adjacent to any metropolitan or micropolitan area. This
definition corresponded with UICs of 7, 10, 11, or 12. The population
that would have been covered under the Board's proposed definition was
2.3 percent of the United States population under the 2000 census. The
Board believed this limited the definition of ``rural'' to those
properties most likely to have only limited sources of mortgage credit
because of their remoteness from urban centers and their resources. The
Board sought comment on all aspects of this approach to defining rural,
including whether the definition should be broader or narrower.
Many commenters in both rulemakings, including more than a dozen
trade group commenters, several individual industry commenters, one
association of State banking regulators, and a United States Senator,
suggested that this definition of a rural area was too narrow and would
exclude too many creditors from qualifying for the balloon-payment
qualified mortgage exemption and constrain the availability of credit
to rural properties. The comment from a United States Senator suggested
using the eligibility of a property to secure a single-family loan
under the USDA's Rural Housing Loan program as the definition of a
rural property. A trade association argued that because community banks
use balloon-payment mortgages to hedge against interest rate risk, the
exemption should not be confined to rural areas.
The Bureau agrees that a broader definition of ``rural'' is
appropriate to ensure access to credit with regard to both the escrows
and balloon-payment qualified mortgage exemptions. In particular, the
Bureau believes that all ``non-core'' counties should be encompassed in
the definition of rural, including counties adjacent to a metropolitan
area or a county with a town of at least 2,500 residents (i.e.,
counties with a UIC of 4, 6, and 9 in addition to the counties with the
UICs included in the Board's definition). The Bureau also believes that
micropolitan areas which are not adjacent to a metropolitan area should
be included within the definition of rural, (i.e., counties with a UIC
of 8). These counties have significantly fewer creditors originating
higher-priced mortgage loans and balloon-payment mortgages than other
counties.\159\ Including these counties within the definition of rural
would result in 9.7 percent of the population being included within
rural areas. Under this definition, only counties in metropolitan areas
or in micropolitan areas adjacent to metropolitan areas would be
excluded from the definition of rural.
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\159\ A review of data from HMDA reporting entities indicates
that there were 700 creditors in 2011 that otherwise meet the
requirements of Sec. 1026.35(b)(2)(iii), of which 391 originate
higher-priced mortgage loans in counties that meet the definition of
rural, compared to 2,110 creditors that otherwise meet the
requirements of Sec. 1026.35(b)(2)(iii) that originate balloon-
payment mortgages in counties that would not be rural. The 391
creditors originated 12,921 higher-priced mortgage loans,
representing 30 percent of their 43,359 total mortgage loan
originations. A review of data from credit unions indicates that
there were 830 creditors in 2011 that otherwise meet the
requirements of Sec. 1026.35(b)(2)(iii), of which 415 originate
balloon-payment and hybrid mortgages in counties that meet the
definition of rural, compared to 3,551 creditors that otherwise meet
the requirements of Sec. 1026.35(b)(2)(iii) that originate balloon-
payment mortgages in counties that would not be rural. The 415
creditors originated 4,980 balloon-payment mortgage originations,
representing 20 percent of their 24,968 total mortgage loan
originations.
---------------------------------------------------------------------------

The Bureau also considered adopting the definition of rural used to
determine the eligibility of a property to secure a single family loan
under the USDA's Rural Housing Loan program. For purposes of the Rural
Housing Loan program, USDA subdivides counties into rural and non-rural
areas. As a result, use of this definition would bring within the
definition of rural certain portions of metropolitan and micropolitan
counties. Given the size of some counties, particularly in western
States, this approach may provide a more nuanced measure of access to
credit in some areas than a county-by-

[[Page 6544]]

county metric. However, use of the Rural Housing Loan metrics would
incorporate such significant portions of metropolitan and micropolitan
counties that 37 percent of the United States population would be
within areas defined as rural. Based on a review of HMDA data and the
location of mortgage transactions originated by HMDA reporting
entities, the average number of creditors in the areas that would meet
the USDA's Rural Housing Loan program definition of rural is ten. The
Bureau believes that a wholesale adoption of the Rural Housing Loan
definitions would therefore expand the definition of rural beyond the
intent of the escrow and balloon-payment qualified mortgage exemptions
under sections 1412 and 1461 of the Dodd-Frank Act by incorporating
areas in which there is robust access to credit.
Accordingly, the final rule incorporates the provisions of the
escrow final rule providing that a county is rural if it is neither in
a metropolitan statistical area, nor in a micropolitan statistical area
that is adjacent to a metropolitan statistical area. The Bureau intends
to continue studying over time the possible selective use of the Rural
Housing Loan program definitions and tools provided on the USDA Web
site to determine whether a particular property is located within a
``rural'' area. For purposes of initial implementation, however, the
Bureau believes that defining ``rural'' to include more UIC categories
creates an appropriate balance to preserve access to credit and create
a system that is easy for creditors to implement.
``Underserved''
The Board's proposed Sec. 226.43(f)(2)(ii) would have defined a
county as ``underserved'' during a calendar year if no more than two
creditors extend consumer credit five or more times in that county. The
definition was based on the Board's judgment that, where no more than
two creditors are significantly active, the inability of one creditor
to offer a balloon-payment mortgage would be detrimental to consumers
who would have limited credit options because only one creditor would
be left to provide the balloon-payment mortgage. Essentially, a
consumer who could only qualify for a balloon-payment mortgage would be
required to obtain credit from the remaining creditor in that area.
Most of the same commenters that stated that the definition of rural
was too narrow, as discussed above, also stated that the definition of
underserved was too narrow, as well. The commenters proposed various
different standards, including standards that considered the extent to
which the property was in a rural area, as an alternate definition.
The Bureau believes the purpose of the exemption is to permit
creditors that rely on certain balloon-payment mortgage products to
continue to offer credit to consumers, rather than leave the mortgage
loan market, if such creditors' withdrawal would significantly limit
consumers' ability to obtain mortgage credit. In light of this
rationale, the Bureau believes that ``underserved'' should be
implemented in a way that protects consumers from losing meaningful
access to mortgage credit. The Bureau is proposing to do so by
designating as underserved only those areas where the withdrawal of a
creditor from the market could leave no meaningful competition for
consumers' mortgage business. The Bureau believes that the expanded
definition of rural, as discussed above, and the purposes of the
balloon-payment qualified mortgage exemption enable continued consumer
ability to obtain mortgage credit.
Scope of Mortgage Operations
The Bureau has made one other change to the final rule to make the
standards more consistent as between the balloon qualified mortgage and
escrows exemption with regard to what type of mortgage loan operations
are tracked for purposes of determining whether a creditor operates
predominantly in rural or underserved areas. As noted above, the
Board's proposed rule for balloon-payment qualified mortgages would
have based a creditor's eligibility on the geographic distribution of
its balloon-payment mortgages, while the escrows proposal focused on
the distribution of first-lien mortgages. Given that the underlying
statutory language regarding ``operates predominantly'' is the same in
each instance and that tracking each type of mortgage separately would
increase administrative burden, the Bureau believes it is appropriate
to base the threshold for both rules on the distribution of all first-
lien ``covered transactions'' as defined in Sec. 1026.43(b)(1).\160\
The Bureau believes that counting all transactions will facilitate
compliance, promote consistency in applying the two exemptions under
both rulemakings, and be more useful in identifying which institutions
truly specialize in serving rural and underserved areas. The Bureau
also believes that it is appropriate to measure first-lien covered
transactions because the balloon-payment mortgages that will meet the
requirements of the balloon-payment qualified mortgage exemption will
be first-lien covered transactions, as having subordinate financing
along with the balloon-payment mortgage would be rare since it further
constrains a consumer's ability to build equity in the property and
able to refinance the balloon-payment mortgage when it becomes due.
Accordingly, a creditor must have made during the preceding calendar
year more than 50 percent of its total covered transactions secured by
a first lien on property in a rural or underserved area, which is the
same as the requirement of Sec. 1026.35(b)(2)(iii)(A) in the 2013
Escrows Final Rule.
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\160\ As discussed above, Sec. 1026.43(b)(1) defines covered
transactions as closed-end consumer credit transactions that are
secured by a dwelling, other than certain tractions that are exempt
from coverage under Sec. 1026.43(a).
---------------------------------------------------------------------------

Total Annual Residential Mortgage Loan Origination
TILA section 129C(b)(2)(E)(iv)(II) requires the Bureau to establish
a limitation on the ``total annual residential mortgage loan
originations'' for a creditor seeking to fall within the balloon-
payment qualified mortgage exemption. The Board's proposed Sec.
226.43(f)(1)(v)(B) provided two alternatives to meet the statutory
requirement that the creditor ``together with all affiliates, has total
annual residential mortgage originations that do not exceed a limit set
by the Board.'' TILA section 129C(b)(2)(E)(iv)(II). The first
alternative was a volume based limit, and the second alternative was a
total annual number of covered transactions limit. The Board's proposal
did not propose any specific numeric thresholds for either alternative,
but rather sought comment on the appropriate volume or number of loans
originated based on the alternatives described in the proposal.
In contrast, the Board's escrow proposal would have restricted
eligibility to creditors that, along with their affiliates, originate
and service no more than 100 new first-lien loans per calendar year.
Although the Dodd-Frank Act requirement to establish escrow accounts
applies only to higher-priced mortgage loans that are secured by first
liens, the Board reasoned that it was appropriate to base the threshold
on all first-lien originations because creditors are free to establish
escrow accounts for all of their first-lien mortgages voluntarily in
order to achieve the scale necessary to escrow cost effectively. The
Board estimated that a minimum servicing portfolio size of 500 is
necessary to escrow cost effectively, and assumed that the average life
expectancy of a mortgage loan is about five years. Based on this
reasoning, the Board reasoned that creditors would no

[[Page 6545]]

longer need the benefit of the exemption if they originated and
serviced more than 100 new first-lien loans per year.
In response to the balloon-payment qualified mortgage loan
proposal, two trade groups and one association of State bank regulators
argued that other criteria, such as the asset-size limit or portfolio
requirement, were sufficient and neither a volume nor a total annual
number of covered transactions limit would be necessary. One trade
group commenter suggested combining the proposed alternatives and
permit creditors to pick which limit they would operate under. Other
trade group and industry commenters indicated that it would be
preferable to base the annual originations limit on the number of
transactions rather than volume because of the varying dollar amount of
loans originated, which would constrain the number of consumers with
limited credit options which could obtain balloon-payment mortgages in
rural or underserved areas. Four trade group and industry commenters
suggested increasing the threshold for the total annual number of
covered transactions by various amounts ranging from 250 to 1,000
transactions. The commenters did not articulate any particular reason
or data to support the suggested limits, other than one commenter who
indicated its suggestion was intended to be higher than its own amount
of total annual covered transactions.
Similarly in the escrows rulemaking, commenters asserted that the
100-loan threshold was not in fact sufficient to make escrowing cost-
effective. Suggestions for higher thresholds ranged from 200 to 1,000
mortgage debt obligations per year originated and serviced, though no
commenters provided data to support their suggestions for alternative
thresholds or to refute the Board's cost analysis. One consumer
advocacy commenter suggested the proposed threshold was too high
because it counted only first-lien mortgage transactions, instead of
all mortgage debt obligations, but offered no specific alternative
amount. Two industry commenters also suggested that the origination
limit should measure only the number of higher-priced mortgage loans
originated and serviced by the creditor and its affiliates.
The Bureau believes that the requirement of TILA section
129C(b)(2)(E)(iv)(II) reflects Congress's recognition that larger
creditors who operate in rural or underserved areas should be able to
make credit available without resorting to balloon-payment mortgages.
Similarly, the requirement of TILA section 129C(d) reflects a
recognition that larger creditors have the systems capability and
operational scale to establish cost-efficient escrow accounts. In light
of the strong concerns expressed in both rulemakings about the
potential negative impacts on small creditors in rural and underserved
areas, the Bureau conducted further analysis to try to determine the
most appropriate thresholds, although it was significantly constrained
by the fact that data is limited with regard to mortgage originations
in rural areas generally and in particular with regard to originations
of balloon-payment mortgages.
The Bureau started with the premise that it would be preferable to
use the same annual originations threshold in both rules in order to
reflect the consistent language in both statutory provisions focusing
on ``total annual mortgage loan originations,'' to facilitate
compliance avoiding requiring institutions to track multiple metrics,
and to promote consistent application of the two exemptions. This
requires significant reconciliation between the two proposals, however,
because the escrows proposal focused specifically on loans originated
and serviced in order to best gauge creditors' ability to maintain
escrow accounts over time, while servicing arrangements are not
directly relevant to the balloon-payment qualified mortgage. However,
to the extent that creditors chose to offer balloon-payment mortgages
to manage their interest rate risk without having to undertake the
compliance burdens involved in administering adjustable rate mortgages
over time, the Bureau believes that both provisions are focused in a
broad sense on accommodating creditors whose systems constraints might
otherwise cause them to exit the market.
With this in mind, the Bureau ultimately has decided to adopt a
threshold of 500 or fewer annual originations of first-lien loans for
both rules. The Bureau believes that this threshold will provide
greater flexibility and reduce concerns that the specific threshold
that had been proposed in the escrows rulemaking (100 loans originated
and serviced annually) would reduce access to credit by excluding
creditors who need special accommodations in light of their capacity
constraints. At the same time, the increase is not as dramatic as it
may first appear because the Bureau's analysis of HMDA data suggests
that even small creditors are likely to sell off a significant number
of loans to the secondary market. Assuming that most loans that are
retained in portfolio are also serviced in house, the Bureau estimates
that a creditor originating no more than 500 first-lien loans per year
would maintain and service a portfolio of about 670 mortgage debt
obligations over time, assuming a life expectancy of five years per
mortgage debt obligation.\161\ Thus, the higher threshold will help to
assure that creditors who are subject to the escrow requirements do in
fact maintain portfolios of sufficient size to maintain the accounts on
a cost efficient basis over time, in the event that the Board's
estimate of a minimum portfolio of 500 loans was too low.\162\ However,
the Bureau believes that the 500 annual originations threshold in
combination with the other requirements will still assure that the
balloon-payment qualified mortgage and escrow exceptions are available
only to small creditors that focus primarily on a relationship-lending
model and face significant systems constraints.
---------------------------------------------------------------------------

\161\ A review of 2011 HMDA data shows creditors that otherwise
meet the criteria of Sec. 1026.43(f)(1)(vi) and originate between
200 and 500 or fewer first-lien covered transactions per year
average 134 transactions per year retained in portfolio. Over a five
year period, the total portfolio for these creditors would average
670 mortgage debt obligations.
\162\ Given that escrow accounts are typically not maintained
for loans secured by subordinate liens, the Bureau does not believe
that it makes sense to count such loans toward the threshold because
they would not contribute to a creditor's ability to achieve cost-
efficiency. At the same time, the Bureau believes it is appropriate
to count all first-lien loans toward the threshold, since creditors
can voluntarily establish escrow accounts for such loans in order to
increase the cost-effectiveness of their program even though the
mandatory account requirements under the Dodd-Frank Act apply only
to first-lien, higher-priced mortgage loans. Focusing on all first-
lien originations also provides a metric that is useful for gauging
the relative scale of creditors' operations for purposes of the
balloon-payment qualified mortgages, while focusing solely on the
number of higher-priced mortgage loan originations would not.
---------------------------------------------------------------------------

Asset-Size Threshold
Under TILA section 129C(b)(2)(E)(iv)(IV), to qualify for the
exemption, a creditor must meet any asset-size threshold established by
the Bureau. The Board's proposed Sec. 226.43(f)(1)(v)(D) would have
established the threshold for calendar year 2013 at $2 billion, with
annual adjustments for inflation thereafter. Thus, a creditor would
satisfy this element of the test for 2013 if it had total assets of $2
billion or less on December 31, 2012. This number was based on the
limited data available to the Board at the time of the proposal. Based
on that limited information, the Board reasoned that none of the
entities it identified as operating predominantly in rural or
underserved areas had total assets as of the end of 2009 greater than
$2 billion, and therefore, the limitation should be set at $2 billion.
The Board expressly proposed setting the asset-size threshold

[[Page 6546]]

at the highest level currently held by any of the institutions that
appear to be smaller institutions that served areas with otherwise
limited credit options. The Board sought comment on what threshold
would be appropriate and whether the asset-size test is necessary at
all. Conversely, in the escrows proposal the Board did not propose an
asset threshold, but rather simply requested comment on whether a
threshold should be established and, if so, what it should be.
In response to the Board's 2011 ATR Proposal, one association of
State bank regulators suggested that the asset-size threshold be
included and be the only requirement for a creditor to qualify for the
balloon-mortgage qualified mortgage exemption. Two trade group
commenters suggested that a $2 billion asset-size threshold was
appropriate, with one also suggesting that the asset-size threshold be
the only requirement for a creditor to qualify for the balloon-mortgage
qualified mortgage exemption. One industry commenter suggested that the
asset-size threshold be $10 billion.
In response to the Board's 2011 Escrows Proposal, the association
of State bank regulators again suggested that an asset-size threshold
be the only requirement to qualify for the escrow exception, but did
not propose a specific dollar threshold. A trade association suggested
a threshold of $1 billion, but did not provide a rational for that
amount.
For reasons discussed above, the Bureau is adopting a mortgage
origination limit as contemplated by the statute. Given that
limitation, restricting the asset size of institutions that can claim
the exemption is of limited importance. Nonetheless, the Bureau
believes that an asset limitation is still helpful because very large
institutions should have sufficient resources to adapt their systems to
provide mortgages without balloon payments and with escrow accounts
even if the scale of their mortgage operations is relatively modest. A
very large institution with a relatively modest mortgage operation also
does not have the same type of reputational and balance-sheet
incentives to maintain the same kind of relationship-lending model as a
smaller community-based lender. Accordingly, the Bureau believes that
the $2 billion asset limitation by the Board remains an appropriate
limitation and should be applied in both rulemakings. Accordingly, the
creditor must have total assets of less than $2 billion \163\ as of
December 31, 2012, which is the same as the requirement of Sec.
1026.35(b)(2)(iii)(C) in the 2013 Escrows Final Rule.
---------------------------------------------------------------------------

\163\ The $2 billion threshold reflects the purposes of the
balloon-payment qualified mortgage exemption and the structure of
the mortgage lending industry. The choice of $2 billion in assets as
a threshold for purposes of TILA section 129C(b)(2)(E) does not
imply that a threshold of that type or of that magnitude would be an
appropriate way to distinguish small firms for other purposes or in
other industries.
---------------------------------------------------------------------------

Criteria Creditor Also Must Satisfy in the Final Rule Adopted From the
Board's 2011 Escrows Proposal
The Bureau notes that the three criteria discussed above are the
same in both TILA 129C(b)(2)(E)(iv) and 129D(c). Commenters in both the
Board's 2011 ATR Proposal and the Board's 2011 Escrows Proposal also
made a note of the need to have consistent application of requirements
and definitions across the Title XIV Rulemakings. The comments received
in both of the Board's proposals identified the same concerns and made
similar suggestions for each of the criteria in both the Board's 2011
ATR Proposal and 2011 Escrows Proposal. The Bureau believes the
balloon-payment qualified mortgage exemption is designed to ensure
access to credit in rural and underserved areas where consumers may be
able to obtain credit only from a limited number of creditors. One way
to ensure continued access to credit for these consumers is to reduce
and streamline regulatory requirements for creditors so that creditors
maintain participation in or enter these markets. One method by which
this can be accomplished is by having one set of requirements that are
consistent between differing regulatory purposes. These criteria, since
they are identical in TILA, can be adopted once in one section of
Regulation Z and referenced by the other section.
Accordingly, the Bureau is adopting Sec. 1026.43(f)(1)(vi) to
require the creditor to meet the satisfy the requirements stated in
Sec. 1026.35(b)(iii)(A), (B), and (C), adopted in the 2013 Escrows
Final Rule, in order to originate a balloon-payment qualified mortgage
under Sec. 1026.43(f)(1). Comment 43(f)(1)(vi)-1.i clarifies that the
Bureau publishes annually a list of counties that qualify as rural or
underserved in accordance with Sec. 1026.35(b)(2)(iii)(A). The comment
further clarifies that the Bureau's annual determination of rural or
underserved counties are based on the definitions set forth in Sec.
1026.35(b)(2)(iv). Comment 43(f)(1)(vi)-1.ii clarifies that the
creditor along with all affiliates must not originate more than 500
first lien transactions during the preceding calendar year in
accordance with Sec. 1026.35(b)(2)(iii)(B). Comment 43(f)(1)(vi)-1.iii
clarifies that the initial asset-size threshold for a creditor is $2
billion for calendar year 2013 and will be updated each December to
publish the applicable threshold for the following calendar year in
accordance withSec. 1026.35(b)(2)(iii)(C). The comment further
clarifies that a creditor that had total assets below the threshold on
December 31 of the preceding year satisfies this criterion for purposes
of the exemption during the current calendar year.
43(f)(2) Post-Consummation Transfer of Balloon-Payment Qualified
Mortgage
As noted in the discussion related to paragraph (f)(1)(v) above,
TILA section 129C(b)(E)(iv) requires that the lender keep balloon-
payment mortgages in portfolio, which addressed in both the Board's
2011 ATR Proposal and 2011 Escrows Proposal in different ways. In light
of the differences between the two rulemakings and in particular the
important ramifications of qualified mortgage status over the life of
the loan, however, the Bureau believes that it is also appropriate for
this final rule to contain additional safeguards concerning post-
consummation sales that are not pursuant to a forward commitment in
order to prevent gaming of the balloon-payment qualified mortgage
exception. As noted above, the Board had proposed an approach under
which the creditor would lose its eligibility to originate balloon-
payment qualified mortgages once it sold any balloon-payment mortgages.
Under one alternative, a single sale after the effective date of the
rule would have permanently disqualified the creditor from invoking the
exception, while the other alternative would have disqualified the
creditor from invoking the exception for two calendar years.
In addition to the comments received on the Board's 2011 Escrows
Proposal related to the forward commitment requirement discussed in
paragraph (f)(1)(v), above, two trade group commenters and one industry
commenter indicated that the second alternative was preferable, but
urged the Bureau only to look at the last calendar year, instead of the
current or prior years. Of these commenters, one trade group and the
industry commenter suggested adding a de minimis number of permitted
transfers of balloon-payment qualified mortgages. One trade group
commenter noted that the statute requires that only balloon-payment
qualified mortgages be kept in portfolio. Another trade group commenter

[[Page 6547]]

questioned the impact that either of the Board's alternatives would
have on a rural creditors' ability to sell a balloon-payment mortgage
if the creditor was directed to do pursuant to action requirements of
prudential regulators, such as a prompt corrective action notice.
The Bureau agrees with commenters that the first alternative would
work against the stated purpose of the balloon-payment qualified
mortgage exemption, as creditors that would not qualify would forever
be excluded from this exemption in the future. Over time, this would
further reduce the creditors originating balloon-payment qualified
mortgages and thereby reduce the availability of credit to those
markets. In addition, the Bureau believes the Board's second
alternative mitigates but does not eliminate these difficulties. Under
the second alternative the disqualification from originating balloon-
payment qualified mortgages would be temporary rather than permanent,
but even so creditors who found it necessary to sell off a balloon-
payment mortgage would pay a steep price in terms of their ability to
originate loans in the future, and credit availability would be
negatively impacted. Commenters that supported the second alternative
did so with the stated preference for the second alternative to the
first, instead of the requirements of the second alternative itself.
The Bureau believes these concerns can be eliminated or reduced by
providing, as a general rule, that if a balloon-payment qualified
mortgage is sold, that mortgage loses its status as a qualified
mortgage, but the creditor does not lose its ability to originate
balloon-payment qualified mortgages in the future. The rule would be
subject to four exceptions to permit a balloon-payment qualified
mortgage to be sold in narrowly defined circumstances without losing
its qualified mortgage status. The first exception would allow for a
sale to any person three years after consummation; this would require
the creditor to keep the balloon-payment qualified mortgage for the
same period of time that a consumer could bring a claim for violation
of Sec. 1026.43 under TILA section 130(e). This facilitates managing
interest rate risk by selling seasoned balloon-payment qualified
mortgages, but encourages responsible underwriting because the
originating creditor would keep all risk of affirmative claims while
those claims could be asserted. The second exemption would permit
creditors to sell to other qualifying creditors, which would provide
flexibility and consistency with the portfolio requirement. The third
exception would address the need of creditors to sell loans to comply
with requirements of prudential regulators, conservators, receivers and
others who have the responsibility to ensure creditors are operating
within the bounds of the law. The fourth exemption addresses changes in
the ownership of the creditor itself, so that the balloon-payment
qualified mortgages held by the creditor do not lose their qualified
mortgage status solely because of the change in ownership of the
creditor.
Accordingly, the Bureau is adopting Sec. 1026.43(f)(2) to require
a creditor to retain a balloon-payment qualified mortgage in its
portfolio, otherwise the balloon-payment qualified mortgage will no
longer be a qualified mortgage, with four exceptions as set forth
above. Comment 43(f)(2)-1 clarifies that creditors must generally hold
a balloon-payment qualified mortgage in portfolio, subject to four
exceptions. Comment 43(f)(2)-2 clarifies that the four exceptions apply
to all subsequent transfers, and not just the initial transfer of the
balloon-payment qualified mortgage, and provides an example. Comment
43(f)(2)(i)-1 clarifies the application of the exception relating to
transfers of the balloon-payment qualified mortgage three years or more
after consummation. Comment 43(f)(2)(ii)-1 clarifies the application of
the exemption relating to the transfer of a balloon-payment qualified
mortgage to a creditor that meets the requirements of Sec.
1026.43(f)(1)(vi). Comment 43(f)(2)(iii)-1 clarifies the application of
the exemption related to the transfer of a balloon-payment qualified
mortgage pursuant to the requirements of a supervisory regulator and
provides an example. Comment 43(f)(2)(iv)-1 clarifies the application
of the exemption related to the transfer of a balloon-payment qualified
mortgage as a result or the merger or sale of the creditor and provides
an example.
43(g) Prepayment Penalties
As discussed above regarding treatment of prepayment penalties
under the points and fees test for qualified mortgages and for high-
cost loans under HOEPA in Sec. 1026.32(b)(1) and the definition of
prepayment penalty under Sec. 1026.32(b)(6), the Dodd-Frank Act
restricts prepayment penalties in a number of ways. Section 1026.43(g)
implements TILA section 129C(c), which establishes general limits on
prepayment penalties for all residential mortgage loans. Specifically,
TILA section 129C(c) provides that:
Only a qualified mortgage may contain a prepayment
penalty;
A qualified mortgage with a prepayment penalty may not
have an adjustable rate and may not have an annual percentage rate that
exceeds the threshold for a higher-priced mortgage loan;
The prepayment penalty may not exceed three percent of the
outstanding balance during the first year after consummation, two
percent during the second year after consummation, and one percent
during the third year after consummation;
There can be no prepayment penalty after the end of the
third year after consummation; and
A creditor may not offer a consumer a loan with a
prepayment penalty without offering the consumer a loan that does not
include a prepayment penalty.
Taken together, the Dodd-Frank Act's amendments to TILA relating to
prepayment penalties mean that most closed-end, dwelling-secured
transactions: (1) May provide for a prepayment penalty only if the
transaction is a fixed-rate, qualified mortgage that is neither high-
cost nor higher-priced under Sec. Sec. 1026.32 and 1026.35; (2) may
not, even if permitted to provide for a prepayment penalty, charge the
penalty more than three years following consummation or in an amount
that exceeds two percent of the amount prepaid; and (3) may be required
to limit any penalty even further to comply with the points and fees
limitations for qualified mortgages, or to stay below the points and
fees trigger for high-cost mortgages. Section 1026.43(g) now reflects
these principles.
The Board proposal implemented TILA section 129C(c) in Sec.
226.43(g) without significant alteration, except that under proposed
Sec. 226.43(g)(2)(ii), the Board proposed to apply the percentage
tests outlined in the statute to the amount of the outstanding loan
balance prepaid, rather than to the entire outstanding loan balance, to
provide tighter restrictions on the penalties allowed on partial
prepayments.
Commenters generally supported the Board's proposal, though some
industry commenters expressed concern that limitations on prepayment
penalties would reduce prices on the sale of mortgages in the secondary
market due to increased prepayment risk. Consumer advocates generally
supported limiting prepayment penalties, as described by amended TILA
section 129C(c), as an important element in ensuring affordability.
Other industry commenters expressed concern that

[[Page 6548]]

such a limitation on the imposition of prepayment penalties would lead
to fewer creditors conditionally waiving closing costs, noting that
this implication might limit access to credit. At least one industry
commenter argued that the Board's proposal to limit prepayment
penalties was too broad in scope, stating the legislative history
demonstrated that the true target of the prepayment penalty prohibition
of TILA section 129C(c) was limited to mortgages with teaser rates and/
or balloon payments and to protect subprime consumers, not those
consumers who chose a product with a lower interest rate in exchange
for a prepayment penalty provision. The Bureau does not find this
argument persuasive, given the plain language of amended TILA section
129C(c).
After review, the Bureau is adopting most of the Board's proposal,
although as discussed below the Bureau is altering the prepayment
limitation in the first year after consummation to reflect the separate
limitations enacted in sections 1431 and 1432 of the Dodd-Frank Act,
regarding high-cost mortgages.
Scope; Reverse Mortgages and Temporary Loans
Section 1026.43(g) implements TILA section 129C(c), which applies
to a ``residential mortgage loan,'' that is, to a consumer credit
transaction secured by a dwelling, including any real property attached
to the dwelling, other than an open-end credit plan or a transaction
secured by a consumer's interest in a timeshare plan. See TILA section
103(cc)(5). Consequently, the regulation refers to ``covered
transaction,'' which as defined in Sec. 1026.43(b)(1) and discussed
further in the section-by-section analysis of Sec. 1026.43(a) excludes
open-end credit plans and transactions secured by timeshares from
coverage consistent with statutory exclusions. However, neither the
definition of ``residential mortgage loan'' nor the TILA section
129C(c)(1) prepayment penalty prohibition excludes reverse mortgages or
temporary or ``bridge'' loans with a term of 12 months or less, such as
a loan to finance the purchase of a new dwelling where the consumer
plans to sell a current dwelling. See TILA sections 103(cc)(5),
129C(a)(8), 129C(c). Moreover, because under TILA section
129C(c)(1)(A), only a qualified mortgage may have a prepayment penalty
and reverse mortgages and temporary loans are excluded from the
ability-to-repay and qualified mortgage requirements of the Dodd-Frank
Act (and thus may not be qualified mortgages), prepayment penalties
would not be permitted on either product absent further accommodation.
The Board proposal sought comment on whether further provisions
addressing the treatment of reverse mortgages were warranted. Because
reverse mortgages are not subject to the ability-to-repay requirements,
the Board did not propose to define a category of closed-end reverse
mortgages as qualified mortgages, though it sought comment on the
possibility of using its authority to do so, given that qualified
mortgage status affects both application of the Dodd-Frank Act
prepayment penalty provisions and certain provisions concerning
securitization and ``qualified residential mortgages.'' See TILA
section 129C(b)(2)(A)(ix) and (b)(3)(B).\164\ The Board specifically
requested comment on whether special rules should be created to permit
certain reverse mortgages to have prepayment penalties. In particular,
the Board sought comment on how it might create criteria for a
``qualified mortgage'' reverse mortgage that would be consistent with
the purposes of qualified mortgages under TILA section 129C(b), and
requested any supporting data on the prepayment rates for reverse
mortgages.
---------------------------------------------------------------------------

\164\ Open-end credit plans are excluded from the definition of
``residential mortgage loan,'' and thus open-end reverse mortgages
are not subject to the prepayment penalty requirements under TILA
section 129C(c). TILA section 103(cc)(5).
---------------------------------------------------------------------------

Consumer advocates generally supported the Board's proposal to
apply the prepayment penalty requirements to reverse mortgages, and
industry commenters did not object. Moreover, commenters did not
provide data or other advocacy to refute the Board's reasoning for
including reverse mortgages within the scope of Sec. 1026.43(g): (1)
That the overwhelming majority of reverse mortgages being originated in
the current market are insured by the FHA, which does not allow reverse
mortgages to contain prepayment penalties; and (2) excluding
``qualified'' reverse mortgages from coverage of the prepayment penalty
prohibition would not be necessary or appropriate to effectuate the
purposes of TILA section 129C, absent an articulated reason why such
exclusion would ``assure that consumers are offered and receive
residential mortgage loans on terms that reasonably affect their
ability to repay the loans and that are understandable and not unfair,
deceptive, or abusive.'' See TILA section 129B(a)(2).
While the Board did not specifically seek comment with respect to
whether further provisions addressing the treatment of bridge loans
under Sec. 1026.43(g) were warranted, commenters nevertheless
discussed the intersection of bridge loans and prepayment penalties. As
discussed in the section-by-section analysis of Sec. 1026.32(b)(6),
some industry commenters expressed concern that the availability of, or
cost of, construction-to-permanent loans might suffer, should the rule
restrict the permissible prepayment penalty charges levied by a
creditor if a consumer does not convert the construction loan into a
permanent loan with the same creditor within a specified time period.
As discussed in the section-by-section analysis of Sec. 1026.32(b)(6),
some commenters may have been mistaken with respect to whether certain
fees were, in fact, a prepayment penalty. To the extent fees charged by
a bridge loan are a prepayment penalty, however, they are prohibited as
of the effective date. According to Sec. 1026.43(a)(3)(iii), the
construction phase of a construction-to-permanent loan cannot be a
qualified mortgage, and thus under Sec. 1026.43(g)(1)(ii)(B) such a
loan cannot include a prepayment penalty. Construction-to-permanent
loans are discussed in more detail in the section-by-section analysis
of Sec. 1026.43(a).
Accordingly, the Bureau is finalizing the rule at this time without
special provisions to otherwise alter the general scope of this rule,
as discussed in the section-by-section analysis of Sec. 1026.43(a),
such as by allowing the application of prepayment penalties for either
reverse mortgages or temporary loans. The Bureau may revisit the issue
in subsequent years, either as part of a future rulemaking to evaluate
application of all title XIV requirements to reverse mortgages or as
part of the five-year review of significant rules required under
section 1022(d) of the Dodd-Frank Act.
43(g)(1) When Permitted
TILA section 129C(c)(1)(A) provides that a covered transaction must
not include a penalty for paying all or part of the principal balance
before it is due unless the transaction is a qualified mortgage as
defined in TILA section 129C(b)(2). TILA section 129C(c)(1)(B) further
restricts the range of qualified mortgages on which prepayment
penalties are permitted by excluding qualified mortgages that have an
adjustable rate or that meet the thresholds for ``higher-priced
mortgage loans'' because their APRs exceed the average prime offer rate
for a

[[Page 6549]]

comparable transaction by a specified number of percentage points.\165\
---------------------------------------------------------------------------

\165\ The applicable APR threshold depends on whether a first
lien or subordinate lien secures the transaction and whether or not
the transaction's original principal obligation exceeds the maximum
principal obligation for a loan eligible for purchase by Freddie
Mac, that is, whether or not the covered transaction is a ``jumbo''
loan. Specifically, the APR threshold is: (1) 1.5 percentage points
above the average prime offer rate, for a first-lien, non-``jumbo''
loan; (2) 2.5 percentage points above the average prime offer rate,
for a first-lien ``jumbo'' loan; and (3) 3.5 percentage points above
the average prime offer rate, for a subordinate-lien loan.
---------------------------------------------------------------------------

To implement TILA section 129C(c)(1), the Board proposed Sec.
226.43(g)(1), which provided that a covered transaction may not include
a prepayment penalty unless the prepayment penalty is otherwise
permitted by law, and the transaction: (1) Has an APR that cannot
increase after consummation; (2) is a qualified mortgage, as defined in
Sec. 226.43(e) or (f); and (3) is not a higher-priced mortgage loan,
as defined in Sec. 226.45(a). The Board proposed under Sec.
226.43(g)(1)(i) that a prepayment penalty must be otherwise permitted
by applicable law. The Board reasoned that TILA section 129C(c) limits,
but does not specifically authorize, including a prepayment penalty
with a covered transaction. Thus, TILA section 129C(c) does not
override other applicable laws, such as State laws, that may be more
restrictive with respect to prepayment penalties, so a prepayment
penalty would not be permitted if otherwise prohibited by applicable
law. This approach is consistent with prepayment penalty requirements
for high-cost mortgages under Sec. 1026.32(d)(7)(i) and higher-priced
mortgage loans under Sec. 1026.35(b)(2)(i).
The Board proposed Sec. 226.43(g)(1)(ii)(A) to interpret the
statutory language to apply to covered transactions for which the APR
may increase after consummation. This regulatory language is consistent
with other uses of ``variable-rate'' within Regulation Z, such as
comment 17(c)(1)-11, which provides examples of variable-rate
transactions.
Some consumer advocates did not support the Board's proposal,
arguing that for certain mortgages (specifically step-rate mortgages)
the interest rate can increase after consummation without affecting the
APR. These commenters argued that the purpose of TILA section
129C(c)(1)(B)(i) is to avoid allowing a creditor to lock a consumer
into a rising-cost mortgage via a prepayment penalty and a rising
interest rate. Consumer groups expressed concern that a consumer might
become ``trapped'' by a prepayment penalty on the one hand, and a
rising interest rate on the other. The Bureau does not find this
argument persuasive. TILA section 129C(1)(B)(i) prohibits a transaction
with ``an adjustable rate'' from including a prepayment penalty.
Longstanding rules under Regulation Z for closed-end transactions
generally categorize transactions based on the possibility of APR
changes, rather than interest rate changes.\166\ This distinction is
relevant because covered transactions may have an APR that cannot
increase after consummation even though a specific interest rate, or
payments, may increase after consummation. For example, the APR for a
``step-rate mortgage'' without a variable-rate feature does not change
after consummation, because the rates that will apply and the periods
for which they will apply are known at consummation. See Sec.
1026.18(s)(7)(ii) (defining ``step-rate mortgage'' for purposes of
transaction-specific interest rate and payment disclosures). Thus, the
danger of an interest rate/prepayment penalty ``trap'' is mitigated in
a step-rate loan because the consumer knowledge of the exact payments
to expect each month for the 36 months following consummation during
which a prepayment penalty might apply. The Bureau therefore is
adopting Sec. 1026.43(g)(1)(ii)(A) as proposed. A fixed-rate mortgage
or a step-rate mortgage therefore may have a prepayment penalty, but an
adjustable-rate mortgage may not have a prepayment penalty. See Sec.
1026.18(s)(7)(i) through (iii) (defining ``fixed-rate mortgage,''
``step-rate mortgage,'' and ``adjustable-rate mortgage'').
---------------------------------------------------------------------------

\166\ See, e.g., Sec. 1026.18(f) (requiring disclosures
regarding APR increases), Sec. 1026.18(s)(7)(i) through (iii)
(categorizing disclosures for purposes of interest rate and payment
disclosures), Sec. 1026.36(e)(2)(i) and (ii) (categorizing
transactions for purposes of the safe harbor for the anti-steering
requirement under Sec. 1026.36(e)(1)).
---------------------------------------------------------------------------

Balloon-Payment Mortgages
Under TILA section 129C(c)(1)(A), a covered transaction may not
include a prepayment penalty unless the transaction is a qualified
mortgage under TILA section 129C(b)(2). The Board proposed to implement
TILA section 129C(c)(1)(A) in Sec. 226.43(g)(1)(ii)(B) and noted that,
under section 129C(b)(2)(e), a covered transaction with a balloon
payment may be a qualified mortgage if the creditor originates covered
transactions primarily in ``rural'' or ``underserved'' areas, as
discussed in detail above in the section-by-section analysis of Sec.
1026.43(f); thus, a consumer could face a prepayment penalty if the
consumer attempts to refinance out of a balloon-payment qualified
mortgage before the balloon payment is due. The Board solicited comment
on whether it would be appropriate to use its legal authority under
TILA sections 105(a) and 129B(e) to provide that a balloon-payment
qualified mortgage may not have a prepayment penalty in any case. Most
commenters generally supported the Board's decision not to extend the
prepayment penalty ban to all balloon-payment loans, noting the need
for such financial products in rural and underserved areas. In light of
the access concerns, the Bureau declines to exercise its exception
authority under TILA sections 105(a) and 129B(e) to add a blanket
prohibition of prepayment penalties for all balloon-payment loans.
Accordingly, the Bureau is adopting Sec. 1026.43(g)(1)(ii)(B) as
proposed. The Bureau will continue to monitor the use of balloon-
payment qualified mortgages and their use of prepayment penalties.
Threshold for a Higher-Priced Mortgage Loan
Under TILA section 129C(c)(1)(B), a covered transaction may not
include a prepayment penalty unless the transaction's APR is below the
specified threshold for ``higher-priced mortgage loans.'' As discussed
above, those thresholds are determined by reference to the applicable
average prime offer rate. The Board proposed under Sec.
226.43(g)(1)(ii)(C) that a creditor would determine whether a
transaction is a higher-priced mortgage loan based on the transaction
coverage rate rather than the APR, for purposes of the prepayment
penalty restriction, because APRs are based on a broader set of
charges, including some third-party charges such as mortgage insurance
premiums, than average prime offer rates. The Board expressed a concern
that using the APR metric posed a risk of over-inclusive coverage
beyond the subprime market and instead proposed using the transaction
coverage rate.
In August 2012, the Bureau extended the notice-and-comment period
for comments relating to the proposed adoption of the more inclusive
finance charge, including the transaction coverage rate. At that time,
the Bureau noted that it would not be finalizing the more inclusive
finance charge in January 2013. See 77 FR 54843 (Sept. 6, 2012). The
Bureau therefore does not address in this rulemaking the numerous
public comments that it received concerning the proposed alternatives
for the APR coverage test. The Bureau instead will address such
comments in connection with its finalization of the 2012 TILA-RESPA

[[Page 6550]]

Integration Proposal, thus resolving that issue together with the
Bureau's determination whether to adopt the more inclusive finance
charge. The Bureau is thus adopting the definition of a higher-priced
loan as defined in Sec. 1026.35(a), which corresponds to the
thresholds specified in TILA section 129C(1)(B)(ii).
43(g)(2) Limits on Prepayment Penalties
TILA section 129C(c)(3) provides that a prepayment penalty may not
be imposed more than three years after the covered transaction is
consummated and limits the maximum amount of the prepayment penalty.
Specifically, TILA section 129C(c)(3) limits the prepayment penalty to
(1) three percent of the outstanding principal balance during the first
year following consummation; (2) two percent during the second year
following consummation; and (3) one percent during the third year
following consummation.
The Board's proposed Sec. 226.43(g)(2) was substantially similar
to TILA section 129C(c)(3) except that the Board proposed to determine
the maximum penalty amount by applying the percentages established in
the statute to the amount of the outstanding loan balance prepaid,
rather than to the entire outstanding loan balance. The Board reasoned
that calculating the maximum prepayment penalty based on the amount of
the outstanding loan balance that is prepaid, rather than the entire
outstanding loan balance, would effectuate the purposes of TILA section
129C(c) to facilitate partial (and full) prepayment by more strictly
limiting the amounts of prepayment penalties imposed.
The Board noted in its proposal that under HOEPA as amended by the
Dodd-Frank Act, TILA section 103(bb)(1)(A)(iii) now defines a ``high-
cost mortgage'' as any loan secured by the consumer's principal
dwelling in which the creditor may charge prepayment fees or penalties
more than 36 months after the closing of the transaction, or in which
the fees or penalties exceed, in the aggregate, more than two percent
of the amount prepaid. Moreover, under amended TILA section 129(c)(1),
high-cost mortgages are prohibited from having prepayment penalties.
Accordingly, any prepayment penalty in excess of two percent of the
amount prepaid on any closed-end mortgage would both trigger and
violate HOEPA's high-cost mortgage protections. The Board did not
propose to implement these limitations on prepayment penalties in Sec.
226.43(g)(2), but did solicit comment on whether the proposed text
should be modified to incorporate the limitation of prepayment penalty
amounts to two percent of the amount prepaid, as provided under TILA
sections 103(bb)(1)(A)(iii) and 129(c)(1). The Board also solicited
comment on whether to adopt some other threshold to account for the
limitations on points and fees, including prepayment penalties, to
satisfy the requirements for ``qualified mortgages,'' under TILA
section 129C(b)(2)(A)(vii) and proposed Sec. 226.43(e)(2)(iii).
The Bureau did not receive significant comment on the proposed
adjustment of determining the maximum penalty amount by applying the
percentages established in the statute to the amount of the outstanding
loan balance prepaid, rather than to the entire outstanding loan
balance, and therefore is adopting Sec. 1026.43(g)(2) to measure
prepayment penalties using the outstanding loan balance prepaid, as
proposed. The Bureau is making this adjustment pursuant to its
authority under TILA section 105(a) to issue regulations with such
requirements, classifications, differentiations, or other provisions,
and that provide for such adjustments and exceptions for all or any
class of transactions, as in the judgment of the Bureau are necessary
and proper to effectuate the purposes of TILA, to prevent circumvention
or evasion thereof, or to facilitate compliance therewith. For
instance, the Bureau believes that it would be inconsistent with
congressional intent to strong disfavor and limit prepayment penalties
for the Bureau to allow creditors to charge one or two percent of the
entire outstanding loan balance every time that a consumer pays even a
slightly greater amount than the required monthly payment due.
The Bureau did not receive significant comment on how to resolve
the differing prepayment thresholds for high-cost mortgages and
qualified mortgages, as described by the Board. But the Bureau believes
that it is imperative to provide clear guidance to creditors with
respect to all new limitations on prepayment penalties in dwelling-
secured credit transactions, as imposed by the Dodd-Frank Act. As noted
by the Board, new TILA section 129C(c)(3) limits prepayment penalties
for fixed-rate, non-higher-priced qualified mortgages to three percent,
two percent, and one percent of the outstanding loan balance prepaid
during the first, second, and third years following consummation,
respectively. However, amended TILA sections 103(bb)(1)(A)(iii) and
129(c)(1) for high-cost mortgages effectively prohibit prepayment
penalties in excess of two percent of the amount prepaid at any time
following consummation for most credit transactions secured by a
consumer's principal dwelling by providing that HOEPA protections
(including a ban on prepayment penalties) apply to mortgage loans with
prepayment penalties that exceed two percent of the outstanding loan
balance prepaid. The Bureau concludes that, to comply with both the
high-cost mortgage provisions and the qualified mortgage provisions,
creditors originating most closed-end mortgage loans secured by a
consumer's principal dwelling would need to limit the prepayment
penalty on the transaction to: (1) No more than two percent of the
amount prepaid during the first and second years following
consummation, (2) no more than one percent of the amount prepaid during
the third year following consummation, and (3) zero thereafter.
Accordingly, the Bureau is modifying the final rule to reflect the
two percent cap imposed by the Dodd-Frank Act amendments to HOEPA. As
adopted in final form, Sec. 1026.43(g)(2) amends the maximum
prepayment penalty threshold for qualified mortgages during the first
year following consummation, specified as three percent in TILA section
129C(c), to two percent, to reflect the interaction of the qualified
mortgage and HOEPA revisions. In addition to finalizing this provision
as a matter of reasonable interpretation of how the statutory
provisions work together, the Bureau is making this adjustment pursuant
to its authority under TILA section 105(a) to issue regulations with
such requirements, classifications, differentiations, or other
provisions, and that provide for such adjustments and exceptions for
all or any class of transactions, as in the judgment of the Bureau are
necessary and proper to effectuate the purposes of TILA, to prevent
circumvention or evasion thereof, or to facilitate compliance
therewith. The Bureau is exercising this adjustment to prevent creditor
uncertainty regarding the interaction of qualified mortgages and high-
cost mortgage rules, thus facilitating compliance. For example, assume
a creditor issues a loan that meets the specifications of a Sec.
1026.43(e) qualified mortgage. The loan terms specify that this
creditor may charge up to three percent of any prepaid amount in the
year following consummation. If the Bureau implements TILA section
129C(c) and sections 103(bb)(1)(A)(iii) and 129(c)(1) for high-cost
mortgages, which effectively prohibit prepayment

[[Page 6551]]

penalties in excess of two percent of the amount prepaid at any time
following consummation, then the creditor will have complied with
certain provisions of TILA while violating others. Thus, to avoid this
complex interaction, the Bureau is eliminating the possibility of
simultaneous compliance with and violation of TILA by reducing the
maximum prepayment penalty allowed in the year following consummation
to two percent under Sec. 1026.43(g)(2)(ii)(A).
Comment 43(g)(2)-1 clarifies that a covered transaction may include
a prepayment penalty that may be imposed only during a shorter period
or in a lower amount than provided in Sec. 1026.43(g)(2). Comment
43(g)(2)-1 provides the example of a prepayment penalty that a creditor
may impose for two years after consummation that is limited to one
percent of the amount prepaid. The Bureau is changing the prepayment
example in comment 43(g)(2)-1 to reflect the Bureau's adjustment in
Sec. 1026.43(g)(2)(ii)(A) of the maximum prepayment penalty in the
first year after consummation from three percent to two percent.
The Bureau recognizes that TILA section 129C(b)(2)(A)(vii)
indirectly limits the amount of a prepayment penalty for a qualified
mortgage, by limiting the maximum ``points and fees'' for a qualified
mortgage to three percent of the total loan amount. See Sec.
1026.43(e)(2)(iii), discussed above. The definition of ``points and
fees'' includes the maximum prepayment penalty that may be charged, as
well as any prepayment penalty incurred by the consumer if the loan
refinances a previous loan made or currently held by the same creditor
or an affiliate of the creditor. See TILA section 103(bb)(4)(E), Sec.
1026.32(b)(1), and accompanying section-by-section analysis. Thus, if a
creditor wants to include the maximum two percent prepayment penalty as
a term of a qualified mortgage, it generally would have to forego any
other charges that are included in the definition of points and fees.
See the section-by-section analysis of Sec. 1026.32(b)(1).
43(g)(3) Alternative Offer Required
Under TILA section 129C(c)(4), if a creditor offers a consumer a
covered transaction with a prepayment penalty, the creditor also must
offer the consumer a covered transaction without a prepayment penalty.
The Board proposed Sec. 226.43(g)(3), which contained language to
implement TILA section 129C(c)(4) and added provisions to ensure
comparability between the two alternative offers. Specifically, the
proposed rule would mandate that the alternative covered transaction
without a prepayment penalty must: (1) Have an APR that cannot increase
after consummation and the same type of interest rate as the covered
transaction with a prepayment penalty (that is, both must be fixed-rate
mortgages or both must be step-rate mortgages); (2) have the same loan
term as the covered transaction with a prepayment penalty; (3) satisfy
the periodic payment conditions for qualified mortgages; and (4)
satisfy the points and fees conditions for qualified mortgages.
Proposed Sec. 226.43(g)(3) also provided that the alternative covered
transaction must be a transaction for which the consumer likely
qualifies.
The Bureau did not receive significant comment on the proposal and
is adopting Sec. 1026.43(g)(3) as proposed. The Bureau is adding the
additional conditions proposed by the Board to those specified in TILA
section 129C(c)(4) to ensure that the alternative covered transactions
is a realistic alternative for the consumer: A loan under substantially
similar terms as the loan with a prepayment penalty for which the
consumer likely qualifies. The Bureau is including these additional
requirements pursuant to the Bureau's authority under TILA section
105(a) to prescribe regulations that contain such additional
requirements, classifications, differentiations, or other provisions,
or provide for such adjustments or exceptions for all or any class of
transactions, as in the judgment of the Bureau are necessary or proper
to effectuate the purposes of TILA, to prevent circumvention or evasion
thereof, or to facilitate compliance therewith.
The Bureau believes that requirements designed to ensure that the
alternative covered transactions effectuate the purposes of TILA
section 129C(c)(4) by enabling the consumer to focus on a prepayment
penalty's risks and benefits without having to consider or evaluate
other differences between the alternative covered transactions. For
example, under final Sec. 1026.43(g)(3), a consumer is able to compare
a fixed-rate mortgage with a prepayment penalty with a fixed-rate
mortgage without a prepayment penalty, rather than with a step-rate
mortgage without a prepayment penalty. Also, the Bureau believes
requiring that the alternative covered transaction without a prepayment
penalty be one for which the consumer likely qualifies effectuates the
purposes of and prevents circumvention of TILA section 129C(c)(4), by
providing for consumers to be able to choose between options that
likely are available.
Under Sec. 1026.43(g)(1)(i), a covered transaction with an APR
that may increase after consummation may not have a prepayment penalty.
The Board proposed in Sec. 226.43(g)(3)(i) that, if a creditor offers
a covered transaction with a prepayment penalty, the creditor must
offer an alternative covered transaction without a prepayment penalty
and with an APR that may not increase after consummation. The Board
also proposed that the covered transaction with a prepayment penalty
and the alternative covered transaction without a prepayment penalty
must have the same type of interest rate. The Board offered these
proposals to ensure that a consumer is able to choose between
substantially similar alternative transactions. The Bureau did not
receive significant comment on the proposal and is adopting the Board's
proposal regarding the APR and the type of interest rate for the
alternative transaction.
Higher-priced mortgage loans. The Board proposed that, under Sec.
226.43(g)(3), if a creditor offers a covered transaction with a
prepayment penalty, which may not be a higher-priced mortgage loan, the
creditor may offer the consumer an alternative covered transaction
without a prepayment penalty that is a higher-priced mortgage loan. The
Board reasoned that TILA section 129C(c)(4) is intended to ensure that
a consumer has a choice whether to obtain a covered transaction with a
prepayment penalty, not to limit the pricing of the alternative covered
transaction without a prepayment penalty that the creditor must offer.
In fact, all things being equal, one would expect a creditor to cover
the increased risk of prepayment by increasing the rate, thereby
increasing the likelihood that the transaction might be a higher-priced
mortgage loan. Furthermore, the Board noted that restricting the
pricing of the required alternative covered transaction without a
prepayment penalty might result in some creditors choosing to offer
fewer loans. The Board thus did not propose to limit rate increases for
the alternative covered transaction. The Bureau did not receive
significant comment on this aspect of the proposal and is adopting the
rule as proposed.
Timing of offer. The Board proposal concerning the alternative
offer without a prepayment penalty that a creditor is required to offer
under TILA section 129C(c)(4) did not specify that the creditor makes
this alternative offer at or by a particular time. The Board proposal
was consistent with Sec. 1026.36(e)(2) and (3), which provide a safe
harbor for the anti-steering requirement if a loan

[[Page 6552]]

originator presents certain loan options to the consumer. These rules
also do not contain a timing requirement. The Board solicited comment
on whether it would be appropriate to require that creditors offer the
alternative covered transaction without a prepayment penalty during a
specified time period, such as before the consumer pays a non-
refundable fee or at least fifteen calendar days before consummation.
The Board also solicited comment on whether, if a timing requirement
were included for the required alternative offer, whether a timing
requirement should also be included under the safe harbor for the anti-
steering requirement, for consistency. The Bureau did not receive
significant comment on the proposal and is not including a specific
timing requirement. The Bureau will continue to study required
alternative offers to ensure that creditors offer consumers a
meaningful alternative transaction that does not contain a prepayment
penalty, in accordance with the purposes of TILA section 129C(c)(4). In
the course of its review, if the Bureau determines that more specific
timing requirements would provide more consumer choice, the Bureau may
propose to revise Sec. 1026.43(g)(3) accordingly.
The Board proposed comment 43(g)(3)(i)-1 to clarify that the
covered transaction with a prepayment penalty and the alternative
covered transaction without a prepayment penalty both must be either
fixed-rate mortgages or step-rate mortgages. The Bureau did not receive
significant comment on the proposal and is adopting the comment with
some revisions for clarification only. For purposes of Sec.
1026.43(g)(3)(i), the term ``type of interest rate'' means whether the
covered transaction is a fixed-rate mortgage, as defined in Sec.
1026.18(s)(7)(iii), or a step-rate mortgage, as defined in Sec.
1026.18(s)(7)(ii).
Substance of offer. As discussed above, Sec. 1026.43(g)(1)(ii)(B)
provides that a covered transaction with a prepayment penalty must be a
qualified mortgage, as defined in Sec. 1026.43(e)(2), (e)(4), or (f).
The Board proposal concerning the alternative offer without a
prepayment penalty that a creditor is required to offer under TILA
section 129C(c)(4) did not mandate that the alternative covered
transaction offered without a prepayment penalty must also be a
qualified mortgage. But under proposed Sec. 226.43(g)(3)(ii) through
(iv), the Board proposed to incorporate three conditions of qualified
mortgages on the alternative offer, so that consumers may choose
between alternative covered transactions that are substantially
similar. Accordingly, the Board proposed that the alternative covered
transaction without a prepayment penalty must: (1) Have the same loan
term as the covered transaction with a prepayment penalty; (2) satisfy
the periodic payment conditions in Sec. 1026.43(e)(2)(i); and (3)
satisfy the points and fees condition under Sec. 1026.43(e)(2)(iii),
based on the information known to the creditor at the time the
transaction is offered. The Bureau did not receive significant comment
on the proposal and is adopting the Board's proposal. The Bureau is
including this provision both as part of its interpretation of TILA
section 129C(c)(4) and using its authority under TILA sections 105(a),
which provides that the Bureau's regulations may contain such
additional requirements, classifications, differentiations, or other
provisions, and may provide for such adjustments and exceptions for all
or any class of transactions as in the Bureau's judgment are necessary
or proper to effectuate the purposes of TILA, prevent circumvention or
evasion thereof, or facilitate compliance therewith. 15 U.S.C. 1604(a),
1639b(e). This approach is further supported by the authority under
TILA section 129B(e) to condition terms, acts or practices relating to
residential mortgage loans that the Bureau finds necessary and proper
to ensure that responsible, affordable mortgage credit remains
available to consumers in a manner consistent with the purposes and to
effectuate the purposes of section 129B and 129C, and that are in the
interest of the consumer, among other things. 15 U.S.C. 1639b(e). The
purposes of TILA include the purposes that apply to 129B and 129C, to
assure that consumers are offered and receive residential mortgage
loans on terms that reasonably reflect their ability to repay the loan.
See 15 U.S.C. 1639b(a)(2). The Bureau believes that requiring the
creditor that offers the consumer a loan with a prepayment penalty to
also offer the consumer the ability to choose an alternative covered
transaction that is otherwise substantially similar, besides not
including a prepayment penalty, is necessary and proper to fulfill such
purposes by ensuring that the consumer is offered a reasonable
alternative product that the consumer can repay and which does not
include a prepayment penalty. For this reason, this provision is also
in the interest of the consumer.
The Board proposed comment 43(g)(3)(iv)-1 to provide guidance for
cases where a creditor offers a consumer an alternative covered
transaction without a prepayment penalty under Sec. 1026.43(g)(3) and
knows only some of the points and fees that will be charged for the
loan. For example, a creditor may not know that a consumer intends to
buy single-premium credit unemployment insurance, which would be
included in the points and fees for the covered transaction. Proposed
comment 43(g)(3)(iv)-1 clarified that the points and fees condition is
satisfied if the creditor reasonably believes, based on the information
known to the creditor at the time the offer is made, that the amount of
points and fees to be charged for an alternative covered transaction
without a prepayment penalty will be less than or equal to the amount
of points and fees allowed for a qualified mortgage under Sec.
1026.43(e)(2)(iii). The Bureau did not receive significant comment on
the proposal and is adopting the comment largely as proposed.
The Board proposed comment 43(g)(3)(v)-1 to clarify what is meant
by an alternative transaction for which the consumer likely qualifies.
In this example, the creditor has a good faith belief the consumer can
afford monthly payments of up to $800. If the creditor offers the
consumer a fixed-rate mortgage with a prepayment penalty for which
monthly payments are $700 and an alternative covered transaction
without a prepayment penalty for which monthly payments are $900, the
requirements of Sec. 1026.43(g)(3)(v) are not met. Proposed comment
43(g)(3)(v)-1 also clarified that, in making the determination the
consumer likely qualifies for the alternative covered transaction, the
creditor may rely on information provided by the consumer, even if the
information subsequently is determined to be inaccurate. The Bureau did
not receive significant comment on the proposal and is adopting the
Board's comment as proposed. Comment 43(g)(3)(v)-1 is substantially
similar to comment 36(e)(3)-4, which provides clarification under the
rules providing a safe harbor for the anti-steering requirements if,
among other things, a loan originator presents the consumer with loan
options for which the consumer likely qualifies.\167\ In addition to
agreeing with

[[Page 6553]]

the Board's reasoning, the Bureau is adopting this rule and comment to
promote consistency and further the Bureau's initiative to provide
streamlined regulatory guidance.
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\167\ Section 1026.36(e) generally prohibits, in a consumer
credit transaction, a loan originator from ``steering'' a consumer
to consummate a transaction based on the fact that the originator
will receive greater compensation from the creditor in that
transaction than in other transactions the originator offered or
could have offered to the consumer, unless the consummated
transaction is in the consumer's interest. Section 1026.36(e)(3)
explains that there is a safe harbor for this anti-steering
requirement when the loan originator presents the consumer with: (1)
The loan option with the lowest interest rate overall, (2) the loan
option with the lowest interest rate without certain risky features,
including a prepayment penalty, and (3) the loan option with the
lowest total origination points or fees and discount points. See
Sec. 1026.36(e)(3)(i).
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43(g)(4) Offer Through a Mortgage Broker
The requirement to offer an alternative covered transaction without
a prepayment penalty applies to a ``creditor.'' See TILA section
129C(c)(4). TILA section 103(f), in relevant part, defines ``creditor''
to mean a person who both: (1) Regularly extends consumer credit which
is payable by agreement in more than four installments or for which the
payment of a finance charge is or may be required, and (2) is the
person to whom the debt arising from the consumer credit transaction is
initially payable on the face of the evidence of indebtedness (or, if
there is no such evidence of indebtedness, by agreement). 15 U.S.C.
1602(f).
The Board proposed Sec. 226.43(g)(4), which would apply when a
creditor offers a covered transaction with a prepayment penalty through
a mortgage broker, as defined in Sec. 1026.36(a)(2), to account for
operational differences in offering a covered transaction through the
wholesale channel versus through the retail channel.\168\ The Board
proposed under Sec. 226.43(g)(4) that, if a creditor offers a covered
transaction to a consumer through a mortgage broker, as defined in
Sec. 1026.36(a)(2), the creditor must present to the mortgage broker
an alternative covered transaction without a prepayment penalty that
meets the conditions in Sec. 1026.43(g)(3). The Board reasoned that
the requirement to offer an alternative covered transaction without a
prepayment penalty properly is applied to creditors and not to mortgage
brokers, because creditors ``offer'' covered transactions, even if
mortgage brokers present those offers to consumers. Further, the Board
noted that, if Congress had intended to apply TILA section 129C(c)(4)
to mortgage brokers, Congress would have explicitly applied that
provision to ``mortgage originators'' in addition to creditors.\169\
The Board's proposal also provided under proposed Sec.
226.43(g)(4)(ii) that the creditor must establish, by agreement, that
the mortgage broker must present the consumer an alternative covered
transaction without a prepayment penalty that meets the conditions in
Sec. 1026.43(g)(3) offered by (1) the creditor, or (2) another
creditor, if the transaction has a lower interest rate or a lower total
dollar amount of origination points or fees and discount points.
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\168\ For ease of discussion, the terms ``mortgage broker'' and
``loan originator'' as used in this discussion have the same meaning
as under the Bureau's requirements for loan originator compensation.
See Sec. 1026.36(a)(1), (2).
\169\ TILA section 103(cc), as added by section 1401 of the
Dodd-Frank Act, defines ``mortgage originator'' to mean any person
who, for direct or indirect compensation or gain, or in the
expectation of direct or indirect compensation or gain, takes a
residential mortgage loan application, assists a consumer in
obtaining or applying to obtain a residential mortgage loan, or
offers or negotiates terms of a residential mortgage loan. 15 U.S.C.
1602(cc). The term ``mortgage originator'' is used, for example, for
purposes of the anti-steering requirement added to TILA by section
1403 of the Dodd-Frank Act. See TILA section 129B(c).
---------------------------------------------------------------------------

The Bureau did not receive significant comment on proposed Sec.
226.43(g)(4) and is adopting Sec. 1026.43(g)(4) largely as proposed.
By providing for the presentation of a loan option with a lower
interest rate or a lower total dollar amount of origination points or
fees and discount points than the loan option offered by the creditor,
Sec. 1026.43(g)(4) facilitates compliance with Sec. 1026.43(g)(3) and
with the safe harbor for the anti-steering requirement in connection
with a single covered transaction, as governed by Sec.
1026.36(e)(3)(i). Section 1026.43(g)(4) does not affect the conditions
that a loan originator must meet to take advantage of the safe harbor
for the anti-steering requirement, however. Thus, if a loan originator
chooses to use the safe harbor, the originator must present the
consumer with: (1) The loan option with the lowest interest rate
overall, (2) the loan option with the lowest interest rate without
certain risky features, including a prepayment penalty, and (3) the
loan option with the lowest total origination points or fees and
discount points. See Sec. 1026.36(e)(3)(i). The Bureau believes that
requiring a mortgage broker to present to a consumer the creditor's
alternative covered transaction without a prepayment penalty could
confuse the consumer if he or she is presented with numerous other loan
options under Sec. 1026.36(e). Presenting a consumer with four or more
loan options for each type of transaction in which the consumer
expresses an interest may not help the consumer to make a meaningful
choice. When compared with other loan options a mortgage broker
presents to a consumer, a creditor's covered transaction without a
prepayment penalty might not have the lowest interest rate (among
transactions either with or without risky features, such as a
prepayment penalty) or the lowest total dollar amount of origination
points or fees and discount points, and thus might not be among the
loan options most important for consumers to evaluate. Also, the
creditor may have operational difficulties in confirming whether or not
a mortgage broker has presented to the consumer the alternative covered
transaction without a prepayment penalty.
The Board proposed comment 43(g)(4)-1 to clarify that the creditor
may satisfy the requirement to present the mortgage broker such
alternative covered transaction without a prepayment penalty by
providing the mortgage broker a rate sheet that states the terms of
such an alternative covered transaction without a prepayment penalty.
The Board proposed comment 43(g)(4)-2 to clarify that the creditor's
agreement with the mortgage broker may provide for the mortgage broker
to present both the creditor's covered transaction and a covered
transaction offered by another creditor with a lower interest rate or a
lower total dollar amount of origination points or fees and discount
points. Comment 43(g)(4)-2 also cross-references comment 36(e)(3)-3 for
guidance in determining which step-rate mortgage has a lower interest
rate. The Board proposed comment 43(g)(4)-3 to clarify that a
creditor's agreement with a mortgage broker for purposes of Sec.
1026.43(g)(4) may be part of another agreement with the mortgage
broker, for example, a compensation agreement. The comment clarifies
that the creditor thus need not enter into a separate agreement with
the mortgage broker with respect to each covered transaction with a
prepayment penalty. The Bureau did not receive significant comment on
proposed comments 43(g)(4)-1 through -3 and is adopting these comments
largely as proposed.
Provisions Not Adopted
As explained in the preamble to the Board's proposal, the Board did
not propose specific rules under proposed Sec. 226.43(g)(4) to apply
in the case where the loan originator is the creditor's employee. The
Bureau did not receive significant comment on that omission and
likewise is not adopting special provisions under Sec. 1026.43(g)(4)
to apply where the loan originator is the creditor's employee. The
Bureau believes that, in such cases, the employee likely can present
alternative covered transactions with and without a prepayment penalty
to the consumer without significant operational difficulties.

[[Page 6554]]

The Board solicited comment on whether additional guidance was
needed regarding offers of covered transactions through mortgage
brokers that use the safe harbor for the anti-steering requirement,
under Sec. 226.36(e)(2) and (3). The Bureau did not receive
significant comment on the proposal and concludes that additional
guidance is not currently required. The Bureau will continue to study
the interaction between prepayment penalty restrictions, as applied to
mortgage brokers under Sec. 1026.43(g)(4) and the safe harbor for the
anti-steering requirement, under Sec. 1026.36(e)(2) and (3) to ensure
that brokers are operating with sufficient guidance. In the course of
its review, if the Bureau determines that more guidance would provide
clarity or otherwise reduce compliance burden, then the Bureau may
propose to add additional guidance.
43(g)(5) Creditor That Is a Loan Originator
The Board proposed Sec. 226.43(g)(5) to address table funding
situations, where a creditor does not provide the funds for a covered
transaction out of its own resources but rather obtains funds from
another person and, immediately after consummation, assigns the note,
loan contract, or other evidence of the debt obligation to the other
person. Such a creditor generally presents to a consumer loan options
offered by other creditors, and this creditor is a loan originator
subject to the anti-steering requirements in Sec. 1026.36(e). See
Sec. 1026.36(a)(1); comment 36(a)(1)-1. Like other loan originators,
such a creditor may use the safe harbor for the anti-steering
requirements under Sec. 1026.36(e)(2) and (3). The Board proposed
that, if the creditor is a loan originator, as defined in Sec.
1026.36(a)(1), and the creditor presents a consumer a covered
transaction with a prepayment penalty offered by a person to which the
creditor would assign the covered transaction after consummation, the
creditor must present the consumer an alternative covered transaction
without a prepayment penalty offered by (1) the prospective assignee,
or (2) another person, if the transaction offered by the other person
has a lower interest rate or a lower total dollar amount of origination
points or fees and discount points. The Board reasoned that its
proposal provided flexibility with respect to the presentation of loan
options, which facilitates compliance with Sec. 1026.43(g)(3) and with
the safe harbor for the anti-steering requirement in connection with
the same covered transaction. See Sec. 1026.36(e)(3)(i).
The Bureau did not receive significant comment on the proposal and
is adopting the Board's proposal. Like Sec. 1026.43(g)(4), Sec.
1026.43(g)(5) does not affect the conditions that a creditor that is a
loan originator must meet to take advantage of the safe harbor for the
anti-steering requirement. Accordingly, if a creditor that is a loan
originator chooses to use the safe harbor, the creditor must present
the consumer (1) the loan option with the lowest interest rate overall,
(2) the loan option with the lowest interest rate without certain risky
features, including a prepayment penalty, and (3) the loan option with
the lowest total origination points or fees and discount points. See
Sec. 1026.36(e)(3)(i).
The Board proposed comment 43(g)(5)-1 to clarify that a loan
originator includes any creditor that satisfies the definition of the
term but makes use of ``table-funding'' by a third party. The Bureau
did not receive significant comment on the proposed comment and is
adopting it as proposed. The Board proposed comment 43(g)(5)-2 to
cross-reference guidance in comment 36(e)(3)-3 on determining which
step-rate mortgage has a lower interest rate. The Bureau did not
receive significant comment on the proposal and is adopting the Board's
proposed comment.
43(g)(6) Applicability
TILA section 129C(c)(1)(A) provides that only a qualified mortgage
may contain a prepayment penalty and TILA section 129C(c)(4) further
requires the creditor to offer the consumer an alternative offer that
does not contain a prepayment penalty. The Board proposed Sec.
226.43(g)(6) to provide that Sec. 226.43(g) would apply only if a
transaction is consummated with a prepayment penalty and would not be
violated if (1) a covered transaction is consummated without a
prepayment penalty or (2) the creditor and consumer do not consummate a
covered transaction. The Bureau did not receive significant comment on
the proposal and is adopting the Board's proposal under Sec.
1026.43(g)(6).
Section 1026.43(g)(2) limits the period during which a prepayment
penalty may be imposed and the amount of any prepayment penalty. As
provided in Sec. 1026(g)(6), those prepayment penalty limitations
apply only if a covered transaction with a prepayment penalty is
consummated. Similarly, Sec. 1026.43(g)(3) requires a creditor that
offers a consumer a covered transaction with a prepayment penalty to
offer the consumer an alternative covered transaction without a
prepayment penalty. Where a consumer consummates a covered transaction
without a prepayment penalty, Sec. 1026(g)(6) states that it is
unnecessary to require that the creditor offer the consumer an
alternative covered transaction without a prepayment penalty. Thus
Sec. 1026.43(g) applies only if the consumer consummates a covered
transaction with a prepayment penalty.
43(h) Evasion; Open-End Credit
TILA section 129C, which addresses the ability-to-repay
requirements and qualified mortgages, applies to residential mortgage
loans. TILA section 103(cc)(5) defines ``residential mortgage loans''
as excluding open-end credit plans, such as HELOCs. In its proposal,
the Board recognized that the exclusion of open-end credit plans could
lead some creditors to attempt to evade the requirements of TILA
section 129C by structuring credit that otherwise would have been
structured as closed-end as open-end instead.
The Board proposed Sec. 226.43(h) to prohibit a creditor from
evading the requirements of Sec. 226.43 by structuring a transaction
that does not meet the definition of open-end credit in Sec.
226.2(a)(20) as open-end credit, such as a HELOC. The Board proposed
comment 43(h)-1 to explain that where a loan is documented as open-end
credit but the features and terms, or other circumstances, demonstrate
that the loan does not meet the definition of open-end credit, then the
loan is subject to the rules for closed-end credit, including Sec.
226.43. The Board proposed these provisions using its authority under
TILA sections 105(a) and 129B(e) to prevent circumvention or evasion.
The Board noted that an overly broad anti-evasion rule could limit
consumer choice by casting doubt on the validity of legitimate open-end
plans, and the Board thus solicited comment on whether to limit the
anti-evasion rule's application, for example, to HELOCs secured by
first liens where the consumer draws down all or most of the entire
line of credit immediately after the account is opened.
Consumer groups generally supported the proposed anti-evasion
provision; some consumer groups suggested that the provision should be
expanded to require all HELOCs to comply with all Dodd-Frank Act
requirements, expressing concern over the potential for consumer abuse.
Industry commenters generally sought clarification on the anti-evasion
rule, noting that ambiguity with respect to the provision might limit
creditors' ability, or willingness, to offer HELOCs or other open-end
credit products.

[[Page 6555]]

The Bureau is adopting the Board's proposal largely as proposed.
Section 1026.43(h) is also consistent with the Board's 2008 HOEPA Final
Rule, Sec. 1026.35(b)(4), which provides a similar anti-evasion
provision with respect to higher-priced mortgage loans. The Bureau is
including this provision both as part of its interpretation of TILA
section 129C and using its authority under TILA section 105(a), which
provides that the Bureau's regulations may contain such additional
requirements, classifications, differentiations, or other provisions,
and may provide for such adjustments and exceptions for all or any
class of transactions as in the Bureau's judgment are necessary or
proper to effectuate the purposes of TILA, prevent circumvention or
evasion thereof, or facilitate compliance therewith, and TILA section
129B(e) to prevent circumvention or evasion. 15 U.S.C. 1604(a),
1639b(e). The purposes of TILA include the purposes that apply to
section 129C, to assure that consumers are offered and receive
residential mortgage loans on terms that reasonably reflect their
ability to repay the loan. See 15 U.S.C. 1639b(a)(2). While some
industry commenters requested further clarification on this provision,
so as to avoid limiting consumer choice, the Bureau believes that no
further commentary is required. A creditor that offers a consumer an
open-end line of credit in the ordinary course of business need not be
concerned with running afoul of the anti-evasion requirement, and a
creditor need not undertake any additional compliance or reporting
steps to do so. A creditor only violates Sec. 1026.43(h) when the
creditor structures credit secured by a consumer's dwelling that does
not meet the definition of open-end credit in Sec. 1026.2(a)(20) as an
open-end plan in order to evade the ability-to-repay requirements. The
Bureau's approach should allow creditors acting in good faith to
continue to provide credit to consumers in the manner best fit for
business needs and consumer demand, without concern of accidentally
running afoul of the anti-evasion requirement.

VI. Effective Date

This final rule is effective on January 10, 2014. The rule applies
to transactions for which the creditor received an application on or
after that date. As discussed above in part III.C, the Bureau believes
that this approach is consistent with the timeframes established in
section 1400(c) of the Dodd-Frank Act and, on balance, will facilitate
the implementation of the rules' overlapping provisions, while also
affording creditors sufficient time to implement the more complex or
resource-intensive new requirements.
As noted above, in response to the proposal, some industry
commenters requested that the Bureau provide additional time for
compliance because the Bureau is finalizing several mortgage rules at
the same time. These commenters expressed concern over both the breadth
and complexity of new rules expected from the Bureau and from other
regulators. Some commenters stated that small institutions, in
particular, might face a higher cost of compliance under the timeframes
established in section 1400(c) of the Dodd-Frank Act. One industry
commenter explained that the new rules would require creditors to alter
financial products, modify compliance systems, and train staff. Another
industry commenter noted that some credit unions and other institutions
that rely on third-party providers, such as software vendors, to assist
with compliance might face particular challenges with implementing
necessary changes over a short time period since such third parties
will need time to incorporate necessary updates and conduct testing,
and include the changes in their scheduled releases. Some commenters
urged the Bureau to coordinate publishing and effective dates among the
title XIV rules and the QRM rulemaking, in order to assist creditors in
minimizing compliance burden.
For the reasons already discussed above, the Bureau believes that
an effective date of January 10, 2014 for this final rule and most
provisions of the other title XIV final rules will ensure that
consumers receive the protections in these rules as soon as reasonably
practicable, taking into account the timeframes established by the
Dodd-Frank Act, the need for a coordinated approach to facilitate
implementation of the rules' overlapping provisions, and the need to
afford creditors and other affected entities sufficient time to
implement the more complex or resource-intensive new requirements.

VII. Dodd-Frank Act Section 1022(b)(2) Analysis

A. Overview

In developing the final rule, the Bureau has considered potential
benefits, costs, and impacts.\170\ In addition, the Bureau has
consulted, or offered to consult with, the prudential regulators, SEC,
HUD, FHFA, the Federal Trade Commission, and the Department of the
Treasury, including regarding consistency with any prudential, market,
or systemic objectives administered by such agencies. The Bureau also
held discussions with or solicited feedback from the United States.
Department of Agriculture, Rural Housing Service, the Federal Housing
Administration, and the Department of Veterans Affairs regarding the
potential impacts of the final rule on those entities' loan programs.
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\170\ Specifically, section 1022(b)(2)(A) of the Dodd-Frank Act
calls for the Bureau to consider the potential benefits and costs of
a regulation to consumers and covered persons, including the
potential reduction of access by consumers to consumer financial
products or services; the impact on depository institutions and
credit unions with $10 billion or less in total assets as described
in section 1026 of the Dodd-Frank Act; and the impact on consumers
in rural areas.
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The Board issued the 2011 ATR Proposal prior to the transfer of
rulemaking authority to the Bureau. As the Board was not subject to
Dodd-Frank Act section 1022(b)(2), the 2011 ATR Proposal did not
contain a proposed Dodd-Frank Act section 1022 analysis.
The Dodd-Frank Act and the final rule establish minimum standards
for consideration of a consumer's repayment ability for creditors
originating certain closed-end, residential mortgage loans. These
underwriting requirements are similar, but not identical, to the
ability-to-repay requirements that apply to high-cost and higher-priced
mortgage loans under current regulations.\171\ In general, the Act and
the final rule prohibit a creditor from making a covered transaction
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.
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\171\ The Bureau notes that under the final rule, ``higher-
priced covered transaction'' is defined in Sec. 1026.43(b)(4).
``Higher-priced mortgage loan'' (HPML) is defined in Sec. 1026.35.
``High-cost mortgage'' is defined in Sec. 1026.32. The Bureau
further notes that interest rate thresholds specified in the
``higher-priced covered transaction'' definition (higher-priced
threshold) are similar to the HPML thresholds, except the final
rule's higher-priced threshold does not include a specified rate
threshold for ``jumbo'' loans, as provided in Sec. 1026.35.
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These documentation and verification requirements effectively
prohibit no documentation and limited documentation loans that were
common in the later years of the housing bubble. The final rule
generally requires the creditor to verify the information relied on in
considering a consumer's debts relative to income or residual income
after paying debts, using reasonably reliable third-party records, with
special

[[Page 6556]]

rules for verifying a consumer's income or assets. The creditor must
calculate the monthly mortgage payment based on the greater of the
fully-indexed rate or any introductory rate, assuming monthly, fully
amortizing payments that are substantially equal. The final rule
provides special payment calculation rules for loans with balloon
payments, interest-only loans, and negative amortization loans.
The final rule provides special rules for complying with the
ability-to-repay requirements for a creditor refinancing a ``non-
standard mortgage'' into a ``standard mortgage.'' Under the final rule,
a non-standard mortgage is defined as an adjustable-rate mortgage with
an introductory fixed interest rate for a period of one year or longer,
an interest-only loan, or a negative amortization loan. Under this
provision, a creditor refinancing a non-standard mortgage into a
standard mortgage does not have to consider the specific underwriting
criteria a lender must otherwise consider under the general ability-to-
repay option, if certain conditions are met.
To provide creditors more certainty about their potential liability
under the ability-to-pay standards while protecting consumers from
unaffordable loans, the Dodd-Frank Act creates a presumption of
compliance with the ability-to-pay requirement when creditors make
``qualified mortgages.'' According to the statute, covered
transactions, in general, are qualified mortgages where: the loan does
not contain negative amortization, interest-only payments, or balloon
payments (except in certain limited circumstances); the term does not
exceed 30 years; points and fees (excluding up to two bona fide
discount points) do not exceed three percent of the total loan amount;
the income or assets and debt obligations are considered and verified;
the underwriting is based on the maximum rate during the first five
years, uses a payment schedule that fully amortizes the loan over the
loan term, and takes into account all mortgage-related obligations.
Under the final rule creditors have three options for originating a
qualified mortgage. Under the first option, the loan must satisfy basic
documentation and verification requirements for income or assets and
debt, and the consumer must have a total (or ``back-end'') debt-to-
income ratio that is less than or equal to 43 percent. With respect to
a loan that satisfies these criteria and is not a higher-priced covered
transaction, there is a conclusive presumption that the creditor
satisfied the ability-to-pay requirements so that the loan qualifies
for a legal safe harbor under the ability-to-repay requirements. A loan
that satisfies these criteria and is a higher-priced covered
transaction receives a rebuttable presumption of compliance with the
ability-to-repay requirements.
The second option for originating a qualified mortgage provides a
temporary expansion of the general definition. Through this option, a
loan is a qualified mortgage if it meets the prohibitions on certain
loan features, the limitations on points and fees and loan terms that
apply under the general definition and also meets one of the following
requirements: is eligible for purchase or guarantee by the Federal
National Mortgage Association (Fannie Mae) or the Federal Home Loan
Mortgage Corporation (Freddie Mac) (collectively, the GSEs), while
operating under the conservatorship or receivership of the FHFA; is
eligible to be purchased or guaranteed by any limited-life regulatory
entity succeeding the charter of either the GSEs; or is eligible to be
insured by the FHA, VA or USDA or USDA RHS. This temporary provision
expires with respect to GSE-eligible loans when conservatorship of the
GSEs ends and expires with respect to each other category of loans on
the effective date of a rule issued by each respective Federal agency
pursuant to its authority under TILA section 129C(b)(3)(ii) to define a
qualified mortgage. Alternatively, if GSE conservatorship continues or
the Federal agencies do not issue rules defining qualified mortgage
pursuant to TILA section 129C(b)(3)(ii), the temporary qualified
mortgage definition expires seven years after the effective date of the
rule.
Unlike loans that are qualified mortgages under the general
definition, there is no specific monthly debt-to-income ratio threshold
to be a qualified mortgage under this temporary provision, except as
may be required to be eligible for purchase or guarantee or to be
insured by the GSEs or Federal agencies. The temporary qualified
mortgage definition does not specifically include documentation and
verification requirements or a specific payment calculation
requirement. The Bureau understands that, to be eligible for purchase
or guarantee by the GSE's or to be eligible to be guaranteed or insured
by the Federal agencies, a loan must first satisfy certain payment
calculation requirements and repayment ability analyses (which include
consideration of a consumer's total monthly debt-to-income ratio) and
the information on which the calculation is based must be documented
and verified. As is true with respect to the first category of
qualified mortgages described above, a loan that satisfies these
criteria and is not a higher-priced covered transaction receives a
legal safe harbor under the ability-to-repay requirements. A loan that
satisfies these criteria and is a higher-priced covered transaction
receives a rebuttable presumption of compliance with the ability-to-
repay requirements.
The third option for qualified mortgages exists only for small
creditors operating predominantly in rural or underserved areas, who
are allowed under the rule to originate a balloon-payment qualified
mortgage. Specifically, this option exists for lenders originating 500
or fewer covered transactions, secured by a first lien, in the
preceding calendar year, with assets equal to or under $2 billion (to
be adjusted annually), and who made more than 50 percent of their total
covered transactions secured by first liens on properties in counties
that are ``rural'' or ``underserved.'' These creditors are allowed to
offer loans with balloon payments assuming the loan also meets certain
loan-specific criteria: the creditor must satisfy the requirements
under the general qualified mortgage definition regarding consideration
and verification of income or assets and debt obligations; the loan
cannot permit negative amortization; the creditor must determine that
the consumer can make all of the scheduled payments (other than the
final balloon payment) under the terms of the legal obligation from the
consumer's current or reasonably expected income or assets other than
the dwelling that secures the transaction; the loan must have a term of
least five years and no more than 30 years; the interest rate is fixed
during the term of the loan; the creditor must base the payment
calculation on the scheduled periodic payments, excluding the balloon
payment; and the loan must not be subject to a forward commitment at
the time of consummation.
Unlike loans that are qualified mortgages under the general
definition, there is no specific debt-to-income ratio requirement for
balloon-payment qualified mortgages. However, creditors must generally
consider and verify a consumer's monthly debt-to-income ratio. Like the
other qualified mortgage definitions, a loan that satisfies the
criteria for a balloon-payment qualified mortgage and is not a higher-
priced covered transaction receives a legal safe harbor under the
ability-to-repay requirements for as long as the loan is held in
portfolio by the creditor who originated the loan. The safe harbor also

[[Page 6557]]

applies to balloon-payment qualified mortgages which are sold three
years or more after consummation. A loan that satisfies the balloon
payment qualified mortgage criteria and is a higher-priced covered
transaction receives a rebuttable presumption of compliance with the
ability-to-repay requirements.
As discussed above, the final rule provides a conclusive
presumption of compliance with the ability-to-repay requirements for
loans that satisfy the definition of a qualified mortgage and are not
higher-priced covered transactions (i.e., APR does not exceed Average
Prime Offer Rate (APOR) + 1.5 percentage points for first liens or 3.5
percentage points for subordinate liens).\172\ The final rule provides
a rebuttable presumption of compliance with ability-to-repay
requirements for all other qualified mortgage loans, meaning qualified
mortgage loans that are higher-priced covered transactions. A consumer
who seeks to rebut the presumption must prove that, at the time of
consummation, in light of the consumer's income and debt obligations,
the consumer's monthly payment (including mortgage-related obligations)
on the covered transaction and any simultaneous loans of which the
creditor was aware, would leave the consumer with insufficient residual
income to pay living expenses, including recurring and material
obligations or expenses of which the creditor was aware.
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\172\ The Average Prime Offer Rate means ``the average prime
offer rate for a comparable transaction as of the date on which the
interest rate for the transaction is set, as published by the
Bureau.'' TILA section 129C(b)(2)B).
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Finally, the final rule implements the Dodd-Frank Act 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 this rule, in connection
with credit that does not meet the definition of open-end credit, by
structuring a closed-end extension of credit as an open-end plan.
A consumer who brings an action against a creditor for a violation
of the ability-to-repay requirements within three years from when the
violation occurs may be able to recover special statutory damages equal
to the sum of all finance charges and fees paid by the consumer, unless
the creditor demonstrates that the failure to comply is not material;
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. After
the expiration of the three-year time period, the consumer is precluded
from bringing an affirmative claim against the creditor. At any time,
when a creditor or an assignee initiates a foreclosure action, a
consumer may assert a violation of these provisions ``as a matter of
defense by recoupment or setoff.'' There is no time limit on the use of
this defense, although the recoupment or setoff of finance charge and
fees is limited to the first three years of finance charges and fees
paid by the consumer under the mortgage.

B. Data and Quantification of Benefits, Costs and Impacts

Section 1022 of the Dodd-Frank Act requires that the Bureau, in
adopting the rule, consider potential benefits and costs to consumers
and covered persons resulting from the rule, including the potential
reduction of access by consumers to consumer financial products or
services resulting from the rule, as noted above; it also requires the
Bureau to consider the impact of proposed rules on covered persons and
the impact on consumers in rural areas. These potential benefits and
costs, and these impacts, however, are not generally susceptible to
particularized or definitive calculation in connection with this rule.
The incidence and scope of such potential benefits and costs, and such
impacts, will be influenced very substantially by economic cycles,
market developments, and business and consumer choices, that are
substantially independent from adoption of the rule. No commenter has
advanced data or methodology that it claims would enable precise
calculation of these benefits, costs, or impacts. Moreover, the
potential benefits of the rule on consumers and covered persons in
creating market changes anticipated to address market failures are
especially hard to quantify.
In considering the relevant potential benefits, costs, and impacts,
the Bureau has utilized the available data discussed in this preamble,
where the Bureau has found it informative, and applied its knowledge
and expertise concerning consumer financial markets, potential business
and consumer choices, and economic analyses that it regards as most
reliable and helpful, to consider the relevant potential benefits and
costs, and relevant impacts. The data relied upon by the Bureau
includes the public comment record established by the proposed rule, as
well as the data described in the Bureau's Federal Register notice
reopening the comment for this rule,\173\ and the public comments
thereon.
---------------------------------------------------------------------------

\173\ See 77 FR 33120 (June 5, 2012)
---------------------------------------------------------------------------

However, the Bureau notes that for some aspects of this analysis,
there are limited data available with which to quantify the potential
costs, benefits, and impacts of the final rule. For example, data on
the number and volume of various loan products originated for the
portfolios of bank and non-bank lenders exists only in certain
circumstances. Data regarding many of the benefits of the rule such as
the benefits from prevented defaults or from prevented injuries to the
financial system are also limited.
In light of these data limitations, the analysis below generally
provides a qualitative discussion of the benefits, costs, and impacts
of the final rule. General economic principles, together with the
limited data that are available, provide insight into these benefits,
costs, and impacts. Where possible, the Bureau has made quantitative
estimates based on these principles and the data that are available.
For the reasons stated in this preamble, the Bureau considers that the
rule as adopted faithfully implements the purposes and objectives of
Congress in the statute. Based on each and all of these considerations,
the Bureau has concluded that the rule is appropriate as an
implementation of the Act.

C. Baseline for Analysis

The provisions of Dodd Frank concerning minimum loan standards and
the ability-to-repay requirement are self-effectuating, and the Dodd-
Frank Act does not require the Bureau to adopt a regulation to
implement these amendments. The Act does require the Bureau to issue
regulations to ``carry out the purposes of'' the subsection governing
qualified mortgages, which includes the ``presumption of compliance''
accorded those mortgages. In the absence of such regulations, the
statutory provisions would take effect on January 21, 2013, and there
would be no clarification beyond the statute as to the meaning of the
ability-to-repay requirement, which mortgages meet the statutory
criteria for a qualified mortgage, and the nature of the presumption of
compliance with respect to such mortgages. Thus, many costs and
benefits of the final rule considered below would arise largely or
entirely from the statute, not from the final rule. The final rule
would provide substantial benefits compared to allowing these
provisions to take effect alone by clarifying parts of the statute that
are ambiguous. Greater clarity on these

[[Page 6558]]

issues should reduce the compliance burdens on covered persons by
reducing costs for attorneys and compliance officers as well as
potential costs of over-compliance and unnecessary litigation.
Section 1022 of the Dodd-Frank Act permits the Bureau to consider
the benefits and costs of the rule solely compared to the state of the
world in which the statute takes effect without an implementing
regulation. To provide the public better information about the benefits
and costs of the statute, however, the Bureau has nonetheless chosen to
evaluate the benefits, costs, and impacts of the major provisions of
the final rule against a pre-statutory baseline. That is, the Bureau's
analysis below considers the benefits, costs, and impacts of the
relevant provisions of the Dodd-Frank Act combined with the final rule
implementing those provisions relative to the regulatory regime that
pre-dates the Act and remains in effect until the final rule takes
effect. As noted, current regulations have parallel but not identical
ability-to-repay rules applied to higher-price and high-cost mortgage
loans.\174\
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\174\ The Bureau has chosen, as a matter of discretion, to
consider the benefits and costs of those provisions that are
required by the Dodd-Frank Act in order to better inform the
rulemaking. The Bureau has discretion in future rulemakings to
choose the relevant provisions to discuss and to choose the most
appropriate baseline for that particular rulemaking.
---------------------------------------------------------------------------

In the analysis, in addition to referring to present market
conditions, the Bureau refers at times to data from other historical
periods--the market as it existed from 1997 to 2003 and the years of
the bubble and the collapse--to provide the public a fuller sense of
the potential impacts of the rule in other market conditions.\175\
Considering the current state of the market makes clear the near term
benefits and costs of the provisions. However, at this point in the
credit cycle, the market is highly restrictive and operating under very
tight credit conditions.\176\ Against this background, the benefits and
the costs of the rule may appear smaller than otherwise.
---------------------------------------------------------------------------

\175\ The statute and final rule are designed to ensure a
minimal level of underwriting across various states of the housing
market and credit cycle. As a result, the Bureau determined, as a
matter of discretion, that it was beneficial to compare certain
aspects of the rule against different scenarios, using different
historical data.
\176\ See Board of Governors of the Federal Reserve System,
``Monetary Policy Report to the Congress,'' (July 17, 2012),
available at https://www.federalreserve.gov/monetarypolicy/files/20120717_mprfullreport.pdf.
---------------------------------------------------------------------------

The Bureau considers the mortgage market as it existed from 1997
through 2003 useful to assess some of the rule's possible effects when
credit conditions, and the economy more generally, return to normal.
During this period, home prices were generally rising and the housing
market was in a positive phase. Notably, interest rates were falling in
2002 and 2003, which created a very large surge in refinancing
activity. This period may not be perfectly representative of an
``average'' market, but these years span almost a full business cycle,
capturing the end of 1990's expansion, the early 2000's recession and
the beginning of the next expansion.\177\
---------------------------------------------------------------------------

\177\ Reliable loan level data from earlier time periods is
generally unavailable.
---------------------------------------------------------------------------

The analysis also uses data from the period 2004 through 2009.
Beginning in 2004, the mortgage market in the United States was in the
height of the housing bubble. In 2007 home prices, mortgage lending,
and the economy more generally collapsed. The period that covers the
``bubble'' years and the crash that followed is also useful to gauge
the impacts of the final rule. It is exactly the lending conditions
during those years, and the damage they caused, that the statute and
the final rule are primarily designed to prevent. Examining the
performance and effects of the mortgages offered during this period,
loans that were largely originated based on the perceived value of
collateral, offers insights into the potential benefits and costs of
the rule.

D. Coverage of the Final Rule

The provisions of the final rule require creditors to determine a
consumer's ability to repay a ``residential mortgage loan, '' excluding
reverse mortgages and temporary bridge loans of 12 months or less,
(referred to as ``covered transactions'') ''and establish new rules and
prohibitions on prepayment penalties. For these purposes, this rule
covers with some exceptions, any dwelling-secured consumer credit
transaction, regardless of whether the consumer credit transaction
involves a home purchase, refinancing, home equity loan, first lien or
subordinate lien, and regardless of whether the dwelling is a principal
residence, second home, vacation home (other than a timeshare
residence), a one- to four-unit residence, condominium, cooperative,
mobile home, or manufactured home. However, the Dodd-Frank Act
specifically excludes from these provisions open-end credit plans or
extensions of credit secured by an interest in a timeshare plan. The
final rule generally also excludes reverse mortgages, residential
construction loans, and bridge loans with a term of 12 months or less.

E. Potential Benefits and Costs to Consumers and Covered Persons

In the analysis of benefits, costs and impacts, the Bureau has
chosen to consider the ability-to-repay provisions together with the
various qualified mortgage provisions. The discussion below first
addresses the economics of an ability-to-repay standard, and considers
the specific market failures that the statute and the rule aim to
address. In general, market failures may include incomplete markets,
externalities, imperfect competition, imperfect information, or
imperfect information processing by consumers and several of those are
discussed here.\178\ The benefits and costs of the requirement to
assess ability to repay based upon documented and verified information
are then discussed along with the impacts of the new liabilities, and
the presumption of compliance that mitigates those liabilities
established under the Dodd-Frank Act.
---------------------------------------------------------------------------

\178\ For a general discussion of market failures, including
incomplete markets, see Chapter 4 (``Market Failure'') in Joseph E.
Stiglitz. Economics of the Public Sector, 3d edition. New York: W.
W. Norton & Company, Inc. (2000).
---------------------------------------------------------------------------

Additional provisions of the rule are considered including the
impacts of the provisions related to points and fees, prepayment
penalties and the definition of ``rural or underserved''. The
relationship between these provisions and other mortgage related
rulemakings is discussed. The benefits, costs and impacts of the final
rule in relation to several major alternatives are then discussed.
1. Economics of Ability To Repay
The basic requirement of Section 1411 of the Dodd-Frank Act is that
a covered transaction may only be made when the creditor has made a
``reasonable and good faith'' determination that the consumer will be
able to repay the loan. In the absence of any market imperfections,
when negotiating a loan, both the lender and borrower would understand
and consider the probability of default and the related costs should
such a default occur. Creditors would extend credit if, and only if,
the ``price'' of the loan, i.e., the risk-adjusted return (the return
taking into account the expected loss from default) is high enough to
justify the investment. Informed consumers would accept the loan if,
and only if, the benefits of financing the property are worth the
costs, including any expected costs in the likelihood that they default
and

[[Page 6559]]

cannot maintain access to the specific property.
The primary benefits or costs from an ability-to-repay requirement
therefore derive from situations, where, absent such a requirement,
these conditions are not met or where certain externalities may exist.
These may include situations where the originator or creditor is not
fully informed or has incorrect information about the transaction. More
likely, a fully informed originator or creditor may not fully
internalize all of the relevant costs, and is willing to extend credit
even though the consumer may lack the ability to repay. Since the
consumer willingly enters into the transaction, he or she must also be
uninformed of either the true likelihood or true costs of default, or
must not fully internalize all of the relevant costs. As discussed
below, some of these situations arise when the lender or the borrower,
fully understanding the risks of the loan and the inherent costs to
themselves, do not factor costs borne by parties outside the
transactions into their decisions.
Collateral based or ``hard money'' lending is one possible case
where such lending could occur. If the lender is assured (or believes
he is assured) of recovering the value of the loan by gaining
possession of the asset, the lender may not pay sufficient attention to
the ability of the borrower to repay the loan or to the impact of
default on third parties. For very low loan-to-value (LTV) mortgages,
i.e., those where the value of the property more than covers the value
of the loan, the lender may not care at all if the borrower can afford
the payments. Even for higher LTV mortgages, if prices are rising
sharply, borrowers with even limited equity in the home may be able to
gain financing since lenders can expect a profitable sale or
refinancing of the property as long as prices continue to rise.
Other cases may involve loan originators who do not bear the credit
risk of the loan, and therefore do not bear the ultimate costs of
default. The common case is lenders who sell their loans: these lenders
earn upfront origination fees from consumers and gains on sale but
(absent complete contracts that provide otherwise) may not generally
bear the costs of a later borrower default. As the relative size of the
upfront fees increase, the potential agency problems do as well. The
market recognizes the informational issues in these transactions and
has developed mechanisms to mitigate adverse selection and moral
hazard. For example, purchasers of loans engage in due diligence,
either directly or by hiring third parties, validating the information
provided about the loans and ensuring that the seller has provided only
loans that meet agreed upon criteria. In addition, contracts provide
that ex-post, should a loan perform poorly, the originator may have to
repurchase the loan. This contracting feature is also designed to
ensure that the initial creditor of the loan has the proper incentives
to verify the borrower's ability to repay or the collateral value.
Still, not all information about the loan may be captured and passed
among sequential owners of the loan; some tacit information, not passed
on, may give the creditor an informational advantage over others and
diminishes the creditors' incentives to verify the consumer's ability
to repay.\179\
---------------------------------------------------------------------------

\179\ Some consumers may also benefit from informational
asymmetries that lead to the secondary market purchasing their
mortgages without full information about the characteristics of the
loan.
---------------------------------------------------------------------------

However, even lenders who maintain loans in portfolio may pay
insufficient attention to the borrower's ability to repay. Cases where
the loan creditor can earn sufficiently high up-front compensation, or
where incentives of the individual loan originators and the creditor
differ, may lead to lending that does not include a realistic
assessment of the borrower's ability to repay. For example, a retail
loan originator who earns commission may not have the same incentives
as the owners of the bank that employs the loan originator and who will
bear the ultimate cost of the loan once on portfolio. Even if such loan
originators do not have final decision-making authority as to whether
the creditor will make the loan, the loan originator controls the
information that the underwriter receives and may have an information
advantage that could systematically bias underwriting decisions.\180\
This information problem, and therefore the risk of poorly underwritten
portfolio loans, may be even greater where the originator is not an
employee of the creditor as is true in the brokerage and correspondent
lending contexts.
---------------------------------------------------------------------------

\180\ Examples of empirical evidence of the persistence of moral
hazard among employees in commercial and retail lending, include
originators of residential mortgages, appears in Sumit Agarwal and
and Itzhak Ben-David, ``Do Loan Officers' Incentives Lead to Lax
Lending Standards?'' Federal Reserve Bank of Chicago working paper
(2012); Aritje Berndt; and Burton Hollifield, and Patrik Sandas,
2010, The Role of Mortgage Brokers in the Subprime Crisis, Working
paper, Carnegie Mellon University. Cole, Shawn, Martin Kanz, and
Leora Klapper (2010), Rewarding Calculated Risk-Taking: Evidence
from a Series of Experiments with Commercial Bank Loan Officers,
Working paper, Harvard Business School.
---------------------------------------------------------------------------

In all these cases, the common problem is the failure of the
originator or creditor to internalize particular costs, often magnified
by information failures and systematic biases that lead to
underestimation of the risks involved. The first such costs are simply
the pecuniary costs from a defaulted loan--if the loan originator or
the creditor does not bear the ultimate credit risk, he or she will not
invest sufficiently in verifying the consumer's ability to repay. Even
in cases where the lender does bear those costs, he or she will usually
not fully internalize the private costs that a defaulting borrower will
incur should default occur. Further, there are social costs from
default that creditors may not internalize, as discussed below.\181\
---------------------------------------------------------------------------

\181\ With these market failures, even if regulation limits
opportunities for lenders to extend credit without retaining a
portion of the risk, there may be cases where lenders will not pay
enough attention to a borrower's ability to repay.
---------------------------------------------------------------------------

As noted earlier, the borrower also must decide whether to enter
into the mortgage, and fully informed, perfectly rational consumers
should consider their own risk of default and private costs in the
event of default. However, as with lenders, borrowers may not fully
anticipate the future probability or costs of default, either because
they are uninformed or for other reasons. Consumers may underestimate
the true costs of homeownership or be overly optimistic about their own
future (or even current) financial condition. This can be exacerbated
in the case of less sophisticated consumers negotiating with more
informed mortgage professionals who have an interest in closing the
loan and who may falsely reassure consumers about the consumers'
ability to repay.
Consumers (and as noted above, creditors) may also misjudge the
current or future value of the property securing the loan.\182\ This
latter phenomenon was very much in evidence during the later years of
the housing bubble as many consumers simply assumed that in times of
financial stress, they could always sell or refinance. Further,
consumers may not understand or may underestimate the costs they will
incur in the event of default, such as the loss of the borrower's own
home, costs of relocation, and the borrower's loss of future credit,
employment and other

[[Page 6560]]

opportunities for which credit reports or credit scores weigh in the
decision.\183\
---------------------------------------------------------------------------

\182\ See Foote, Christopher L., Kristopher S. Gerardi, and Paul
S. Willen, ``Why Did So Many People Make So Many Ex Post Bad
Decisions? The Causes of the Foreclosure Crisis,'' Public Policy
Discussions Papers, Federal Reserve Bank of Boston (2012), available
at https://www.bostonfed.org/economic/ppdp/2012/ppdp1202.pdf.
\183\ See for example, Kenneth P. Brevoort and Cheryl R. Cooper,
Foreclosure's Wake: The Credit Experiences of Individuals Following
Foreclosure, Working Paper, 2010 available at https://works.bepress.com/kbrevoort/2.
---------------------------------------------------------------------------

As noted above, neither party to the transaction is likely to
internalize costs to third parties. Even among very informed consumers
and creditors, most will not internalize the social costs that
delinquency or foreclosure can have.\184\ Research has consistently
shown that a foreclosure will have a negative effect on the other
homeowners in the vicinity either through the displacement of demand
that otherwise would have increased the neighborhood prices, reduced
valuations of future sales if the buyers and/or the appraisers are
using the sold foreclosed property as a comparable, vandalism, and
disinvestment.\185\ While the estimated magnitudes and the breadth of
the impact differ, researchers seem to agree that there is a negative
impact on houses in the vicinity of the foreclosure, and this impact is
the highest for the houses that are the closest to the foreclosed house
and for the houses that get sold within a short period of time of the
foreclosed sale.\186\
---------------------------------------------------------------------------

\184\ Section 1022 requires consideration of benefits and costs
to consumers and covered persons. The ability to pay rule also has
important potential benefits and costs for other individuals and
firms, and for society at large. The Bureau discusses these benefits
and costs here because they are particularly important to the
Bureau's development, and public understanding of, the final rule.
The rule implements statutory provisions, enacted in the wake of the
financial crisis, that seem clearly intended to help prevent the
potential negative social externalities of poor underwriting while
preserving the potential positive social externalities of mortgage
lending. The Bureau reserves discretion in the case of each rule
whether to discuss benefits and costs other than to consumers and
covered persons.
\185\ There are several papers documenting various magnitudes of
the negative effect on the nearby properties. Data in Massachusetts
from 1987 to 2009 indicate that aside from a 27% reduction in the
value of a house (possibly due to losses associated with
abandonment), foreclosures lead to a 1% reduction in the value of
every other house within 5 tenths of a mile. See John Y. Campbell,
Stefano Giglio, and Parag Pathak, Forced Sales and House Prices,
American Economic Review 101(5) (2011), abstract available at:
https://www.aeaweb.org/articles.php?doi=10.1257/aer.101.5.2108. Data
from Fannie Mae for the Chicago MSA, show that a foreclosure within
0.9 kilometers can decrease the price of a house by as much as 8.7%,
however the magnitude decreases to under 2% within five years of the
foreclosure. See Zhenguo Lin, Eric Rosenblatt, and Vincent W. Yao.
``Spillover Effects of Foreclosures on Neighborhood Property
Values,'' The Journal of Real Estate Finance and Economics, 2009,
38(4), 387-407. Similarly, data from a Maryland dataset for 2006-
2009 show that a foreclosure results in a 28% increase in the
default risk to its nearest neighbors. See Charles Towe and Chad
Lawley, 2011, ``The Contagion Effect of Neighboring Foreclosures,''
SSRN Working Paper 1834805.
\186\ Frame, W. Scott (2010): Estimating the effect of mortgage
foreclosures on nearby property values: A critical review of the
literature, Economic Review, Federal Reserve Bank of Atlanta, ISSN
0732-1813, Vol. 95, https://hdl.handle.net/10419/57661.
---------------------------------------------------------------------------

Research is also beginning to examine other spillover effects from
foreclosures including increases in neighborhood crime \187\ and social
effects on family members such as hampered school performance.\188\
Social policy has long favored homeownership for the societal benefits
that may ensue; the negative spillovers from foreclosures can be seen
as the inverse of this dynamic.\189\
---------------------------------------------------------------------------

\187\ See for example, Ingrid Gould Ellen, Johanna Lacoe, and
Claudia Sharygin, Do Foreclosures Cause Crime?, Working Paper 2011.
\188\ A summary of recent and ongoing research is presented in
Julia B. Isaacs, The Ongoing Impact of Foreclosures on Children,
First Focus/The Brookings Institution, April 2012. See also Samuel
R. Dastrup and Julian R. Betts, Elementary Education Outcomes and
Stress at Home: Evidence from Mortgage Default in San Diego.
\189\ See for example, the literature summarized in Dwight
Jaffee and John M. Quigley, The future of the government sponsored
enterprises: the role for government in the U.S. mortgage market,
NBER Working Paper Series, Working Paper 17685, available at https://www.nber.org/papers/w17685.
---------------------------------------------------------------------------

The Dodd-Frank Act and the final rule address these potential
market failures through minimum underwriting requirements at
origination and new liability for originators and assignees in cases
where the standards are found not to be met. For qualified mortgages
that have earned the conclusive presumption, meeting the qualified
mortgage product criteria and underwriting requirements and pricing of
the loan at a prime rate are judged in the rule to be enough to ensure
that the lender made a reasonable and good faith determination that the
borrower will be able to repay the loan. For loans where the final rule
creates a presumption of compliance but leaves room for the borrower to
rebut the presumption of compliance, or loans for which there is no
presumption (i.e., loans that are not qualified mortgages) the lender
may exert greater care in underwriting the loan than would be true in
the absence of any liability for extending a loan which the consumer
cannot afford to repay. Lenders therefore face an initial market
tradeoff when choosing the optimal level of costs to bear in
documenting and underwriting the loan and assessing the ability to
repay (subject to the minimum standards all loans must meet): some
increased effort (and therefore increased cost) at the time of
origination may lower costs resulting from possible liability should
the borrower become delinquent or default. Since assignees now share
this liability, they have an additional incentive to monitor the
behavior of the original creditor. The ex-post liability to the
consumer mitigates the incentives for the creditor to shirk on the ex-
ante investments in the underwriting.
Even creditors making the optimal choice of effort when
documenting, verifying and underwriting the loan may still face some
legal challenges from consumers ex-post. This will occur when a
consumer proves unable to repay a loan and wrongly believes (or chooses
to assert) that the creditor failed to properly assess the consumer's
ability to repay before making the loan. This will likely result in
some litigation expense, although the Bureau believes that over time,
that expense will likely diminish as experience with litigation
resolves more precise guidelines regarding what level of compliance is
considered complete. After some experience, litigation expense will
most likely result where compliance is insufficient or from limited
novel sets of facts and circumstances where some ambiguity
remains.\190\ Regardless of which party incurs the costs, the economic
costs of these actions are the resources used to litigate these cases,
thereby helping to ensure compliance and limiting the incidence of
loosely documented originations. The reimbursement of interest and
fees, along with the statutory damages, paid to the borrower,
constitute, in economic terms, a transfer--a cost to the originator or
assignee and a benefit to the compensated borrower.\191\
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\190\ The Bureau recognizes that there may always be some
frivolous lawsuits for which lenders will pay legal expenses. In
addition, uncertainty inherent in the legal system also implies a
base level of litigation.
\191\ In a cost benefit accounting, the ex-post realization of
the contingent payment from the creditor to the borrower is a
transfer, a cost on one side and a benefit on the other. For risk-
averse consumers, the ex-ante insurance value of the contingent
payment is also a benefit. In other words, consumers are better off
knowing that if they are harmed, they will recover some damages.
---------------------------------------------------------------------------

2. Potential Benefits of the Ability-To-Repay Provisions for Consumers
and Covered Persons
The final rule will help to ensure that loans are not made without
regard for the borrower's ability to repay and thereby protect
consumers and as noted above, others affected by defaults and
foreclosures. (These others are themselves consumers and the adverse
spillover effect from defaults and foreclosures very much impacts their
economic well being.) Historically, the conditions under which credit
is extended have been cyclical in nature. Periods of tight credit, such
as the

[[Page 6561]]

conditions that exist in the current mortgage market, are marked by
reduced loan activity, very stringent lending standards, and extreme
care in underwriting. In such periods, the benefits of a regime
designed to require prudent underwriting, may be less apparent, and, in
the near term, adopting such a regime, as the final rule does, will
likely have little direct and immediate effect either on consumers or
covered persons. As explained further in the discussion of costs to
consumers and covered persons, lenders generally are already doing what
the rule requires and a large majority of their loans will qualify for
the conclusive presumption of compliance.
However, as credit expands, as it almost inevitably will, the final
rule will help to ensure that loans are made properly and with regard
for the borrower's ability to repay. To assess the benefits of the
final rule, therefore, it is useful to examine the provisions of the
final rule in the context of the recent housing bubble and its collapse
in 2007.
There is growing evidence that many of the market failures in the
previous discussion were in play in the years leading up to the housing
collapse. In some cases, lenders and borrowers entered into loan
contracts on the misplaced belief that the home's value would provide
sufficient protection. These cases included subprime borrowers who were
offered loans because the lender believed that the house value either
at the time of origination or in the near future could cover any
default. Some of these borrowers were also counting on increased
housing values and a future opportunity to refinance; others likely
understood less about the transaction and were at an informational
disadvantage relative to the lender. These cases also included Alt-A
loans taken by borrowers hoping to speculate on housing values.
In both of these situations, these loans frequently involved less
traditional products, loans structured with minimal monthly payments in
order to allow the borrower to qualify and to carry the loan for a
period of time with minimal expense. Many of these loans were sold into
the secondary market, limiting the lenders' credit risk, but many
lenders also retained these loans on their own portfolios either with
the intent of earning the full anticipated profits from such loans over
time or with the intent to hold the loans for a period of time before
selling them. And throughout the housing boom, most lenders and
borrowers entering into such agreements failed to consider the costs
that default would inflict on other properties (and the consumers who
inhabited them) and on the financial system and economy writ large.
The benefits from the ability-to-repay requirements therefore come
from further limiting and deterring unaffordable lending, above and
beyond the current ability-to-pay requirements for higher-priced
mortgage loans, and thereby reducing the ensuing private and social
costs of excess delinquency and default. For example, the basic
requirement that all loans be underwritten based on documented income
and debt would have eliminated many of the loans made later in the
bubble that led to crisis. Described as ``stated-income'' loans or
``liar-loans,'' these mortgages became very prevalent in the later
years of the expansion and had very poor, and worse than expected,
performance when the markets collapsed.\192\ There is also growing
evidence that incomes on many mortgage applications were overstated in
the years before the crash.\193\ Importantly, while limited and reduced
documentation loans were a large segment of the subprime market, many
of these loans were also made to prime, higher credit score borrowers
and on properties with lower loan-to-value ratios.\194\ This suggests a
substantial benefit to the documentation and verification requirements
across all segments of the market, particularly the substantial
majority of covered transactions that current ability-to-pay
requirements do not cover now and are not expected to cover in the
future.
---------------------------------------------------------------------------

\192\ From 2000 to 2009, reduced documentation loans grew from 2
percent of outstandings to 9 percent. See FCIC Report pgs 110-111
for discussion of these loans. Other research documents the poor
performance of these loans and that the increased risk was not
properly priced. See, for example, Michael LaCour-Little and Jing
Yang, Taking the Lie Out of Liar Loans: The Effect of Reduced
Documentation on the Performance and Pricing of Alt-A and Subprime
Mortgages, 2012, Working Paper and Wei Jiang, Ashlyn Aiko Nelson,
and Edward Vytlacil, Liar's Loan? Effects of Origination Channel and
Information Falsification on Mortgage Delinquency, 2011, Working
Paper. Some authors have tried to understand the differences between
cases where lenders offered these loans as a benefit to certain
customers and cases where customers simply chose a higher-priced
limited doc alternative. See Irina Paley and Konstantinos Tzioumis,
Rethinking Stated-income Loans: Separating the Wheat from The Chaff,
Working Paper, 2011. For evidence that the risk on these loans was
not fully priced, see Cost of Freddie Mac's Affordable Housing
Mission, presentation to Board of Directors, 2009 at https://fcic-static.law.stanford.edu/cdn_media/fcic-docs/2009-06-04FreddieMac-CostofAffordableHousingMission.pdf p.12 analyzing the ``unexpectedly
poor performance of * * * Alt-A purchases''
\193\ For example, see Robert B. Avery, Neil Bhutta, Kenneth P.
Brevoort, and Glenn B. Canner, The Mortgage Market in 2011:
Highlights from the Data Reported under the Home Mortgage Disclosure
Act, FEDS Working Paper Series, 2012. See also FCIC Report, pgs.
110-111; LaCour-Little and Yang, 2012; Jiang, Nelson, and Vytlacil,
2011; Paley and Tzioumis, 2011.
\194\ See FCIC Report, pgs. 110-111; LaCour-Little and Yang,
2012; Jiang, Nelson, and Vytlacil, 2011; Paley and Tzioumis, 2011.
---------------------------------------------------------------------------

As prices rose, aspiring homeowners borrowed money by misstating
their income; many loan originators were at least indifferent to or
even complicit or proactive in these endeavors. The systemic effects
were evident: the extension of credit against inflated incomes expanded
the supply of credit, which in turn continued the rapid rise of house
prices in the later years of the housing boom and exacerbated the
eventual crash.\195\
---------------------------------------------------------------------------

\195\ See Financial Stability Oversight Council, Macroeconomic
Effects of Risk Retention Requirements, January 2011, at 12.
(``[T]here is some evidence that the increased supply in subprime
mortgage credit was in part responsible for greater home price
appreciation * * * [and] increases in home prices may have
reinforced expectations for future appreciation, which may have
fueled more lending. Increases in loan volume, in turn, may have
precipitated further increases in home prices.''); Mian, Atif and
Amir Sufi, ``The Consequences of Mortgage Credit Expansion: Evidence
from the U.S. Mortgage Default Crisis,'' Quarterly Journal of
Economics, vol. 124, no. 4 (2009).
---------------------------------------------------------------------------

The statute and the final rule also require that creditors must
underwrite based on an amortizing payment using the fully indexed rate
(or the maximum rate in five years for qualified mortgages) and
including, with limited exceptions, any balloon payments in the first
five years. This effectively bans the practice of underwriting loans
based upon low upfront payments, either the lower interest-only
payments on interest-only loans or negatively amortizing option ARMs or
the teaser rates on hybrid ARMs.
In their later incarnations, interest-only and negatively
amortizing loans (along with loans with terms greater than 30 years)
were often sold on the basis of the consumer's ability to afford the
initial payments and without regard to the consumer's ability to afford
subsequent payments once the rate was recast. At the peak of the
market, between 2004 and 2006, the percentage of loans that were
interest-only, option ARMs or 40-year mortgages rose from just 7
percent of originations to 29 percent. The lower payment possibility
for these loans allows borrowers to qualify for loans that they
otherwise may not have been able to afford; but this comes with the
same risks just described. The performance of many of these loans was
also very poor, and worse than expected, with the onset of the
downturn.\196\ The final rule does not

[[Page 6562]]

ban such products outright, but rather requires that lenders that make
such loans have a ``reasonable and good faith'' belief in the
borrower's ability to repay and that in formulating such a belief the
lender must calculate the monthly payment based on the fully indexed
rate and fully amortizing payments, and does not allow these loans to
enjoy the presumption of compliance associated with qualified mortgage
status. The new underwriting requirements, coupled with the liability
for violating these rules, should deter improper loans and ensure
proper underwriting and diligence when making such loans; again
limiting cases of personal or social harm.
---------------------------------------------------------------------------

\196\ See Amromin, Gene, Jennifer Huang, Clemens Sialm, and
Edward Zhong, ``Complex Mortgages,'' Federal Reserve Bank of Chicago
Working Paper 2010-17 (2010), available at https://www.chicagofed.org/digital_assets/publications/working_papers/2010/wp2010_17.pdf.
---------------------------------------------------------------------------

Underwriting hybrid ARMs to the teaser rate was also a very common
practice, in particular among subprime loans of the early 2000's. So
called ``2/28'' and ``3/27'' loans were often underwritten based on the
low initial payment,\197\ and exposed the borrower to potential payment
shocks, and a need to refinance, two or three years into the
mortgage.\198\ For example, in 2005, the teaser rate on subprime ARMs
with an initial fixed-rate period of two or three years was 3.5
percentage points below the fully indexed rate.\199\ As a result,
mortgages originated in that year faced a potentially large change in
the interest rate and payment, or ``payment shock,'' at the first
adjustment even absent any change in the index.
---------------------------------------------------------------------------

\197\ See for example, Christopher Mayer, Karen Pence, and Shane
M. Sherlund, ``The Rise in Mortgage Defaults,'' Journal of Economic
Perspectives 23, no. 1 (Winter 2009): Table 2, Attributes for
Mortgages in Subprime and Alt-A Pools, p. 31. (showing that from
2003 to mid-2007, about 70 percent of subprime loans in securitized
pools were hybrid adjustable rate mortgage loans.)
\198\ Brent W. Ambrose & Michael LaCour-Little, Prepayment Risk
in Adjustable Rate Mortgages Subject to Initial Year Discounts: Some
New Evidence, 29 Real Est. Econs. 305 (2001) (showing that the
expiration of teaser rates causes more ARM prepayments, using data
from the 1990s). The same result, using data from the 2000s and
focusing on subprime mortgages, is reported in Shane Sherland, The
Past, Present and Future of Subprime Mortgages, (Div. of Research &
Statistics and Div. of Monetary Affairs, Fed. Reserve Bd.,
Washington, DC 2008); The result that larger payment increases
generally cause more ARM prepayments, using data from the 1980s,
appears in James Vanderhoff, Adjustable and Fixed Rate Mortgage
Termination, Option Values and Local Market Conditions, 24 Real Est.
Econs. 379 (1996).
\199\ See Christopher Mayer, Karen Pence, & Shane Sherlund, The
Rise in Mortgage Defaults, 23 J. Econ. Persps. 27, 37 (2009).
---------------------------------------------------------------------------

The evidence is mixed on whether payment shock at the initial
interest rate adjustment causes default.\200\ And indeed, for some
borrowers, these loans can be efficient contracts that allow for the
extension of credit (see discussion below).\201\ However, the
widespread use of the product put many borrowers in precarious
financial positions and may also have fueled the systemic rise in home
prices.\202\ The elimination of these products should limit both the
individual and the systemic harms which ultimately translate, in the
largest part, into harms to individual consumers.
---------------------------------------------------------------------------

\200\ Mayer, Pence, & Sherlund, supra note 125, at 37 provide
data from the 2000s that does not find a causal relationship between
payment shock at the initial interest rate adjustment and default.
In contrast, see Anthony Pennington-Cross & Giang Ho, The
Termination of Subprime Hybrid and Fixed-Rate Mortgages, 38 Real
Est. Econs. 399, 420 (2010), for evidence that among consumers with
certain hybrid ARMs originated in the 2000s, a substantial number
experienced an increase in monthly payment of at least 5% at the
initial interest rate adjustment, and that the default rate for
these loans was three times higher than it would have been if the
payment had not changed.
\201\ See for example, Gary Gorton, The Panic of 2007, paper
presented at the Federal Reserve Bank of Kansas City's Jackson Hole
Conference, August 2008, p. 12-18.
\202\ .See for example, Mian and Sufi, 2009.
---------------------------------------------------------------------------

The final rule reduces the likelihood that these products will
reemerge on a broad scale and thus should limit the potential for
individual and the systemic harms. The final rule bans no-doc and the
old low-doc loans since the level of documentation is lower than that
required by the rule). * * * The rule reduces the incentive to offer
these other alternative mortgage products by requiring that
underwriting be done assuming a fully amortizing payment at the fully
indexed rate. The final rule also does not provide any legal protection
for the lender that makes these loans (or the investor that acquires or
guarantees them) as the loans are categorically disqualified from being
qualified mortgage. These non-amortizing products will likely persist
only in narrow niches for more sophisticated borrowers who want to
match their mortgage payment to changes in their expected income stream
and who have the resources to qualify for the products under the
stringent underwriting assumptions the statute and regulation require.
But these products will not likely be marketed as broadly as they were
during the bubble.
In addition to the products just described, loans with points and
fees (except for bona fide discount points) that exceed three percent
of the total amount cannot be qualified mortgages, except as applicable
for smaller loans as defined. Creditors may take more care in
originating a loan when more of the return derives from performance
over time (interest payments) rather from upfront payments (points and
fees). As such, this provision may offer lenders more incentive to
underwrite these loans carefully. As loans with higher points and fees
are usually assumed to be offered to borrowers in weaker financial
circumstances, this provision offers protection to that class of
borrowers.\203\
---------------------------------------------------------------------------

\203\ In general, smaller dollar loans are more likely to be
impacted by the points and fees provisions.
---------------------------------------------------------------------------

As discussed above, the various liability provisions provide the
incentives for lenders to take proper care judging the borrower's
ability to repay. This incentive is strongest for loans that are not
qualified mortgages. Within the qualified mortgage space, higher priced
mortgage loans (HPMLs) are still subject to ability-to-repay liability
but afforded a rebuttable presumption of compliance. This liability
already exists under rules that took effect in October 2009 for HPMLs,
so that relative to existing rules, there are few benefits (or costs)
associated with the liability provisions for such loans. However, there
are some material differences in the underwriting requirements and
smaller differences in the scope of the presumption where the liability
now applies where it did not in the past. The new assignee liability
may also strengthen the incentives relative to the existing rules.
Comparing the rebuttable presumption for higher priced qualified
mortgages to the conclusive presumption (safe harbor) provision for
qualified mortgages below the higher-priced threshold highlights the
benefit of leaving the possibility of rebuttal in place. Borrowers
paying higher rates on mortgage loans that meet the qualified mortgage
product features are most likely to have lower credit scores, lower
incomes and/or other risk factors; as such, it is among these subprime
borrowers that a greater possibility exists for lenders to place the
borrower into a loan that he or she may not have the ability to repay.
The ability of the borrower to rebut the presumption of compliance
leaves lenders with the additional incentive to ``double check'' the
loan to examine further the borrower's financial condition and residual
income, and to ensure that these higher risk borrowers have the means
to live in the home they just purchased or refinanced.
Where a consumer is unable to afford his or her mortgage--and
proves that the lender lacked a reasonable and good faith belief in the
consumer's repayment ability at the time the loan was made--the damages
the borrower recovers are a benefit to that party. The same damages
should also be considered a

[[Page 6563]]

cost to the lender and as such, estimates regarding the frequency of
such actions and the dollar amounts involved are in the next section
discussing costs.
Another impact of the differentiated structure of the final rule,
where certain loans enjoy a conclusive presumption, others are given a
rebuttable presumption and still others are subject to ability to repay
scrutiny without the benefit of a presumption, is that some borrowers
may gain ``better'' loans as lenders choose to make loans that qualify
for the highest level of legal protection. Lenders in less competitive
environments who have some flexibility over product offerings and/or
pricing power may find it more profitable to offer a borrower a
qualified mortgage rather than a non-qualified mortgage if, for such
lenders, the expected value of the heightened legal protection is
enough of an expected cost savings to offset any revenue reduction from
making the qualified mortgage. For example, a creditor may restructure
the price of a transaction with points and fees otherwise just above
the points and fees limit for a qualified mortgage to have fewer
upfront costs, and a higher interest rate, so that the loan is then
under the limit and a qualified mortgage. Similarly, situations could
exist where lowering the price on a loan would make the loan eligible
for the safe harbor rather than the rebuttable presumption. The
prevalence of these situations, or others similar situations, is hard
to predict and depends on the future prices for mortgages in each of
these segments, the competitive nature of the segments, and the
individual lender's and borrower's situation.
The benefits of the rule, as discussed above, will be widely shared
among individual borrowers, creditors, investors, and the public
(consumers) generally. As discussed above, the loss that occurs when a
consumer is unable to repay a loan is felt by the consumer, the
holder(s) of that loan, and other parties outside the transaction
including other consumers and would-be-consumers. Ensuring that lenders
make a reasonable and good faith determination of the borrower's
ability to repay should prevent a widespread deterioration of
underwriting standards, the extension of excess credit and the broader
negative effects that can have on these parties. To the extent lenders
are deterred from making unaffordable loans, or encouraged to make more
affordable loans, all of these parties will benefit.
3. Potential Costs of the Ability-To-Repay Provisions to Consumers and
Covered Persons
In this part the Bureau considers costs to consumers and covered
persons of the ability to repay provisions of the statute and final
rule, including any potential cost in the form of reduced access to
credit for consumers. The primary ongoing costs of the requirements of
the final rule rest in the underwriting costs, including costs at
origination to verify information on which the lender relies in the
underwriting decision and the increased liability on lenders and
assignees. As previously noted, in the current environment, lenders are
already largely complying with these requirements and thus the rule
should impose minimal, if any, ex ante costs. But in other credit
environments, when creditors may wish to lower their underwriting
criteria and require less documentation and perform less verification,
the rule would require them to make a good faith and reasonable
determination of ability to repay and to require them to incur ex-ante
costs to document, verify and consider income and debt (and credit
history). This should increase the quality of underwriting of mortgages
at origination and thereby limit the prevalence of future delinquency
and default, and the level of ex-post costs. (Of course, exogenous or
unanticipated events and borrower behavior will still result in some
delinquent and defaulting loans and some possible legal actions.) In
this scheme, the possibility of legal recourse by the borrower serves
as an incentive for better lender assessment of repayment ability as
well as offering borrowers redress for wrongdoing. Lenders will
determine the optimal combination of upfront underwriting cost and ex-
post liability costs; to the extent these costs increase and
competitive conditions allow lenders to pass this cost onto borrowers,
some borrowers will pay more for their loans. At the margin, certain
loans that were made in the past, namely those where the borrower has
limited ability to repay, will not be made.
a. Costs of the Documentation and Underwriting Requirements
Two distinct requirements of the final rule--the requirement to
verify income or assets, debt, and credit history, and the requirement
to underwrite a mortgage based on an assessment of debt load using the
fully indexed rate and fully amortizing payment--create costs for
certain creditors and consumers. The final rule follows the statute in
requiring that all creditors verify borrowers' income, debt and credit
history. Reduced documentation loans were originally offered to high
credit quality borrowers with substantial incomes. However, in the
2000's, the prevalence of these loans increased substantially and the
borrowers to whom they were offered changed. Anecdotally, some of these
loans could have been made with full documentation; however, for that
subset of loans, it was precisely the reduced processing times and
paperwork costs of originating these loans that made them popular among
mortgage brokers and originators during the boom.
From this perspective, for certain consumers and creditors,
requiring full documentation and verification may result in the loan
being made with a less efficient contractual form, or possibly in the
loan not being made. In these latter cases, consumers would lose the
benefits they get from the mortgage (the benefits of owning a home, for
example, or the benefits of obtaining better terms on a loan through a
refinancing) and creditors would lose any profits on the loan. However,
for most other originators, and consumers, reduced documentation loans
were a way to grant credit to unqualified borrowers who did not have
the means to afford the mortgage. As discussed in the benefits section,
the elimination of these loans in these circumstances is a principal
benefit of the rule.\204\
---------------------------------------------------------------------------

\204\ In these cases, the requirements of the final rule are the
benefits that were described earlier.
---------------------------------------------------------------------------

For borrowers for whom the most efficient outcome (from a societal
perspective) is, in fact, a reduced documentation mortgage, the
requirements in the final rule have two possible costs. The time and
material to verify the required underwriting elements with documents
are true resource costs; depending on competitive conditions, the
lender or the borrower may bear the actual costs. Precise estimates of
these costs from time and motion studies or cost function analyses are
not available, but the required pay stubs or tax records should not be
a large burden. The final rule allows income to be verified utilizing
copies of tax returns which the consumer can provide the creditor and
permits debts to be verified utilizing a credit report. For those with
more idiosyncratic income sources that would somehow not be reflected
on a tax return, the costs may be slightly higher. However, it is also
possible that certain loans that would be made absent the documentation
requirements would not be made under the rule. This could happen, for
example, in cases where the

[[Page 6564]]

cost of documenting the required factors is sufficiently high or where
the borrower pays an exorbitant ``privacy'' cost in disclosing the
documents. The final rule only requires that income or assets be
verified to the extent they are relied upon by the creditor in
assessing the consumer's ability to repay; thus the consumer is not
required to disclose or document income or assets except if the
consumer prefers to have her ability to repay assessed without regard
to the undisclosed information. In the event that there are cases in
which, despite these rules, a consumer who could qualify for a mortgage
is unwilling to incur the privacy cost in documenting income or assets,
the transaction will not occur: and the benefit to consumers and
lenders from these `lost' transactions is the relevant cost.
Relative to industry practice today, these requirements are likely
to impose only a very limited burden for creditors. With the exception
of the two situations discussed below, most loans today are made under
very stringent, and perhaps inefficiently high, documentation
requirements.\205\ The Bureau understands that full documentation is
required for all purchase loans and many refinance loans being
supported by government programs such as FHA. In addition, both Fannie
Mae and Freddie Mac currently require full documentation. The Bureau
believe that only a small subset of loans that creditors intend to hold
on portfolio are underwritten today without the documentation that
meets or is very close to the documentation required by the final rule.
For this limited set of loans, the rule imposes the costs already
described: The direct compliance costs to collect the required
documentation in order to verify the information provided by the
consumer and any costs from forgone transactions.
---------------------------------------------------------------------------

\205\ To the extent that these requirements are inefficiently
high, the cost is due to current practice and not to the final rule
discussed here.
---------------------------------------------------------------------------

One exception to the stringent documentation requirements now
prevailing in the market (and exceeding the requirements of the rule)
are certain streamlined refinance programs aimed at aiding the housing
market recovery and certain targeted housing support programs offered
to low and moderate income borrowers. The Bureau recognizes that the
requirements of the final rule could greatly increase costs for these
programs and hinder their success. It also recognizes that the
possibility of consumer harm is likely limited in these contexts. As a
result, elsewhere in today's Federal Register the Bureau is proposing
certain exemptions from these requirements and seeking comment on the
scope of such exemptions.
There may also be some situations where lenders may have systems to
document and verify the required information, but who do so in a manner
that varies slightly from the provisions of the rule. These lenders may
have to bear some costs to modify their systems or practices, but as
noted above the Bureau understands there to be few such cases. Lenders
who do collect information as required by the final rule, but who may
use it differently may also incur some costs. For example, certain
lenders may have systems or procedures in which the calculation of the
DTI ratio does not conform to the requirements in appendix Q. Such a
creditor could continue its current practices, which should they
satisfy the ability-to-repay requirements, albeit without the benefit
of a presumption of compliance. Lenders that prefer to make qualified
mortgages with a presumption of compliance would have to bear the costs
to modify systems or make other changes in order to calculate the
required figures according to the rule. Modifications to information
technology systems may also be necessary to enable lenders to label and
track qualified mortgages.
More broadly, the Bureau also recognizes that the establishment of
the ability-to-pay requirements and the related distinction for
qualified mortgages under the Act, will require modifications to
existing compliance systems and to creditors' other management policies
and procedures. For example, review and monitoring procedures may have
to be altered to ensure compliance with the new requirements. Again,
given the current state of the mortgage market, it is likely that many
of these procedures are largely already in place.
If measured relative to the benchmark of the earlier periods,
either the period from 1997 to 2003 or the later years of the bubble,
the requirements of the final rule could be seen to impose more
substantial costs. Over the former period, there were more limited
documentation loans than today, however it appears that many of these
arose in the situations described where such lending is efficient. By
the latter period, there were even more such loans and the balance
appears to have shifted to one where many if not most of the limited
documentation loans had misstated income and other deficiencies.
During those periods there were likely some lenders, as evidenced
by the existence of no-income, no-asset (NINA) loans, that used
underwriting systems that did not look at or verify income, debts, or
assets, but rather relied primarily on credit score and LTV. Under the
final rule, these lenders would be impacted in two ways: They would
have to collect and verify income, assets and debts; and more
importantly, they would have to change much of their underlying
business model to consider the required factors. As noted, the Bureau
does not believe such lending is currently being practiced, and the
benefits of preventing such lending may be substantial (as discussed
above).
The requirements that all loans be underwritten assuming a fully
amortizing payment and the fully indexed rate (or to obtain qualified
mortgage status the maximum rate within 5 years of origination) have
costs similar in nature to the documentation requirements. There are
some individuals or households with projected increases in income that
will match the projected increased housing costs; the final rule allows
the creditor to factor expected future income into the denominator of
the debt-to-income calculation but does require that the numerator be
calculated on the fully-indexed payment. There also may be individuals
with constant income but a housing need that is shorter than the
introductory period. In at least these latter cases, there may be some
loans where it is efficient to qualify the borrower only on the current
payment or some other amount. It is difficult to quantify the set of
borrowers affected in this way, however to the extent that those loans
are not made, both the lender and borrower will incur the costs of lost
profits and lost consumer benefits, respectively.
The provisions of the rule requiring extended retention times for
documentation sufficient to show compliance with the rule (from two
years to three years) will also impose some very limited costs on
creditors. Electronic storage, communication and backup are very
inexpensive and are likely to decrease in costs further.
b. Liability Costs
Creditor may trade off the ex-ante underwriting cost just discussed
with ex-post liability costs that stem from TILA's liability provisions
and their interaction with the rule's qualified mortgage and
presumption of compliance provisions.\206\ Qualified

[[Page 6565]]

mortgages with interest rates below the threshold for higher-priced
covered transactions enjoy a conclusive presumption of compliance
(although disputes may arise as to whether a particular loan meets the
qualified mortgage test); qualified mortgages above the specified
interest rate threshold enjoy a rebuttable presumption of compliance
with the ability-to-repay requirements; and, loans that are not
qualified mortgages are subject to general ability-to-repay provisions,
under which the borrower will bear the burden of proof for establishing
a violation. Within each segment, lenders and borrowers (or their
attorneys in contingency arrangements) must pay for the costs of
litigation, whether such litigation arises in the context of a private
right of action brought by the borrower, or a defense raised by the
borrower to a foreclosure. Originators and assignees also face various
contingencies that may arise if such a claim is raised or succeeds.
---------------------------------------------------------------------------

\206\ The Bureau's regulations are accompanied by some form of
liability for non-compliance, and the Bureau generally does not
address litigation costs and liability as part of its analysis under
Section 1022 because the considerations are self-evident and the
analysis is simplified by assuming full compliance. In general, to
the extent regulated entities under-comply with a consumer
protection regulation, they will experience less compliance costs,
consumers will experience less benefits, and the entities will be at
a higher risk of litigation costs and liability, including from
private suits to the extent the relevant statute, such as TILA,
provides for private liability. In addition, even if there is full
compliance, there will always be some residual risk of non-
meritorious litigation. The Bureau, however, has chosen to discuss
litigation costs and liability in this analysis because these
considerations are particularly important in the context of this
final rule. The meaning and effect of the presumption of compliance
that attaches to qualified mortgages is a key issue in this
rulemaking and has been a major focus for commenters and interested
parties. As such, the Bureau is addressing these considerations in
this analysis. In other rulemakings, the Bureau notes that
consideration of litigation costs is not always necessary and
remains at its discretion.
---------------------------------------------------------------------------

Within each segment, the additional costs increase proportionally
with borrowers' probability of delinquency or default. For example, the
additional cost for qualified mortgages with a rebuttable presumption
of compliance is smallest for lower debt-to-income (DTI) ratio loans
(since these borrowers are less likely to be in a position to need or
want to bring claims) and increases as the DTI ratio (keeping other
factors constant) rises. The same is true as the interest rate of a
loan increases, assuming that interest rate is accurately calibrated to
risk.
In estimating empirically the long-run additional liability costs
from alleged or actual violations of the final rule, the Bureau
examines the mortgage market as it existed from 1997 to 2003. The
Bureau applies that market data and the pre-statute baseline to compare
the liability for creditors under the final rule to the liability they
would have incurred under the legal regime that existed under federal
law just before passage of the Act.
i. Size of the Market Segments
The data used in estimating liability costs comes from several
sources. Data regarding the loans guaranteed or purchased by Fannie Mae
and Freddie Mac are from the Historical Loan Performance (HLP) dataset
maintained by FHFA. The FHFA shared a one percent random sample of
these loans with the Bureau, along with information about their
characteristics and performance. In the notice to reopen the comment
period for this rulemaking, the Bureau detailed these data and
requested comment. Commenters were generally supportive of using these
data, but suggested looking at other sources as well including
proprietary industry datasets available for sale. These data cover a
large but select portion of GSE loans. In contrast, the HLP data cover
the entire universe of GSE loans and even the one percent sample is
more representative. As such, the Bureau believes the HLP data are the
better data for the GSE segment of the market and has consulted with
the suggested sources in other parts of the analysis. Over the 1997-
2003 period loans guaranteed or purchased by the GSEs comprised roughly
47 percent of the mortgage market.
Similarly, information on loans insured by the FHA was provided by
the FHA in response to the June 5, 2012 notice. The data cover the
years from 1997 to 2011 and exclude Home Equity Conversion Mortgages
(HECM) as well as mortgages with seller-funded downpayment.\207\
Combined with loan insured by the Veterans Administration or the Rural
Housing Service, these loans comprised an estimated 9 percent of the
market during this period. The Bureau did not get loan-level data from
the VA or RHS.\208\
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\207\ As described in the comment letter, ``the data conform
generally to the type and kind of FHA data featured in a recent
Discussion Paper published by the Philadelphia Federal Reserve in
December 2011, FHA Lending: Recent Trends and Their Implication for
the Future.'' The letter contains charts and data from that paper.
\208\ In sizing the mortgage market and various components, the
Bureau relied on aggregate market data from the Mortgage Market
Annual, published by Inside Mortgage Finance and on data provided by
the Market Data section of the FHA Web site which can be found at
https://www.fhfa.gov/Default.aspx?Page=70.
---------------------------------------------------------------------------

Data on mortgages in non-agency securitizations were taken from
proprietary industry sources that the Bureau has licensed. While less
complete than the HLP files, these data also include data on the
characteristics and performance of individual loans. Over the 1997 to
2003 period, this segment comprised roughly 13 percent of originations.
The remaining loans are those held on the balance sheets of banks,
thrifts and credit unions. While aggregate data regarding the
performance of these portfolios is available, comprehensive loan level
data similar to the enterprise, FHA and private-label loans is
not.\209\ As a result, the actual characteristics of individual loans
are not available.
---------------------------------------------------------------------------

\209\ The proprietary industry data available for sale only
contains loan level information for portfolio loans that are
serviced by the largest servicers in the country.
---------------------------------------------------------------------------

Without the temporary provisions granting qualified mortgage status
to certain loans that are eligible to be purchased by the GSEs or
insured by FHA, VA and RHS, of the mortgages originated during the 1997
to 2003 period, the Bureau estimates that roughly 70 percent of would
have been qualified mortgages. Most of these loans would qualify for
the safe harbor, and perhaps one to four percent points of these loans
would have been qualified mortgages subject to the rebuttable
presumption. Another 22 percent of loans would have been non-qualified
mortgages subject to the ability-to-repay requirements. The remaining 8
percent of loans made over that period were appear to have been made
without sufficient documentation to be permitted under TILA section
129C documentation or were subprime hybrid adjustable rate mortgages
underwritten to teaser rates in a way that is no longer allowed under
the final rule. An important caveat is that these estimates are not
adjusted to account for: (1) Loans with total points and fees above the
thresholds and therefore not eligible to be qualified mortgages; (2)
the exception of rural balloon loans to qualified mortgages; or the
exception for streamlined refinancings of non-traditional loans.\210\
---------------------------------------------------------------------------

\210\ Estimates for the GSE loans and the FHA loans are derived
from the datasets provided to the CFPB and described above. For
loans in private label securities, estimates are made based upon
reported average characteristics of loans in subprime and Alt-A
securitizations. The aggregate value of loans originated and held on
balance sheet are estimated using data from Inside Mortgage Finance
and the distribution of DTI is assumed to mirror the distribution at
the GSEs. Statistical projections described below support such an
assumption.
---------------------------------------------------------------------------

Based on data from 2011, the Bureau estimates that without the
temporary provisions granting qualified mortgage status to certain
loans purchasable by the GSEs or insurable by FHA, VA and RHS, 76
percent of mortgages would have been qualified mortgages inside

[[Page 6566]]

the safe harbor, 2 percent of mortgages would have been qualified
mortgages with a rebuttable presumption, and 22 percent of mortgages
would have been subject to the ability-to-repay requirements. These
estimates are subject to the same limitation stated above.\211\
---------------------------------------------------------------------------

\211\ The estimates in this analysis are based upon data and
statistical analyses performed by the Bureau. To estimate counts and
properties of mortgages for entities that do not report under HMDA,
the Bureau has matched HMDA data to Call Report data and MCR data
and has statistically projected estimated loan counts for those
depository institutions that do not report these data either under
HMDA or on the NCUA call report. The Bureau has projected
originations of higher-priced mortgage loans for depositories that
do not report HMDA in a similar fashion. These projections use
Poisson regressions that estimate loan volumes as a function of an
institution's total assets, employment, mortgage holdings and
geographic presence. Neither HMDA nor the Call Report data have loan
level estimates of the DTI. To estimate these figures, the Bureau
has matched the HMDA data to data on the HLP dataset provided by the
FHFA. This allows estimation of coefficients in a probit model to
predict DTI using loan amount, income and other variables. This
model is then used to estimate DTI for loans in HMDA.
---------------------------------------------------------------------------

ii. Liability Costs for Qualified Mortgages
For qualified mortgages claimed to be within the safe harbor,
borrowers will have no claim against the lender for ability-to-repay
violations unless the loan does not in fact meet the requirements for
safe harbor treatment. Based on the experience of loans originated
during the 1997-2003 period, the Bureau estimates that roughly four
percent of qualified mortgages loans will ever be 60 days delinquent
and less than one percent are expected to result in foreclosure.\212\
The performance of the qualified mortgages that have a conclusive
presumption of compliance is expected to be slightly better than these
averages.
---------------------------------------------------------------------------

\212\ In the HLP data, under four percent of loans originated
from 1997 to 2003 that satisfy most of the requirements of the first
definition of a qualified mortgage (i.e.,not no-doc or low-doc, not
IO, not neg-am and with DTI ratio equal to or below 43%) were ever
60 days delinquent. Among all FHA insured loans over the same years,
just under 6 percent of loans with a DTI ratio equal to or below 43
percent were ever 60 days delinquent. Some of these loans would have
a conclusive presumption of compliance with the ability-to-pay
requirements and others would have the rebuttable presumption. The
four percent and one percent figures are likely to slightly
overestimate the rates for loans in the safe harbor and may be
underestimates for loans with the rebuttable presumption.
---------------------------------------------------------------------------

The Bureau believes that only a very small fraction of these
delinquent or foreclosed-upon borrowers would seek to raise an ability-
to-repay claim. The conclusive presumption precludes liability for
loans which meet the eligbility criteria for a safe haror, i.e. loans
whose product features make them eligible; for which the lender
verified income, assets, and debts and properly calculated the DTI
ratio to be 43 percent or less; and which are not higher priced. And
even if a loan is erroneously categorized as a qualified mortgage with
a safe harbor, a borrower still cannot recover unless the lender has
violated the general ability-to-repay requirements, including the
requirement that the lender make a ``reasonable and good faith''
determination that the consumer had the ability to repay. Generally,
only a small percentage of borrowers contest foreclosure and even
smaller percentage do so with the benefit of legal representation. This
fact, and the limited chance of success for borrowers to raise
successful claims, makes it very unlikely that many claims will arise
from borrowers with these qualified mortgages.
For qualified mortgage loans above the higher-priced threshold,
costs (as well as benefits) of the final rule derive from the
differences, including differences with respect to the originator and
assignee liability, between the existing liability rules and the final
rule. Under existing rules, creditors that make a higher-priced
mortgage loan (HPML) are not allowed to extend credit without regard to
``the consumer's repayment ability as of consummation, including the
consumer's current and reasonably expected income, employment, assets
other than the collateral, current obligations, and mortgage-related
obligations.'' Further, a creditor is presumed to have complied if the
creditor properly verifies and documents income and assets, made the
determination using the largest payment of principal and interest
scheduled in the first seven years following consummation, and took
into account the ratio of total debt obligations to income, or the
income the consumer had after paying debt obligations.
As noted, 1 to 4 percent of loans, based on data from the 1997-
2003 period, are estimated to be qualified mortgages with a rebuttable
presumption. As just described, the delinquency rates and default rates
are expected to be just around 4 percent and 1 percent respectively.
Nearly all of the mortgages that will be qualified mortgages above
the higher-priced threshold are currently covered by the existing HPML
presumption of compliance,\213\ because the requirements in the final
rule that qualified mortgage loans be fully documented, have verified
income and be underwritten to the maximum payment in the first five
years of the loan (with the exception for rural balloon loans) will in
most cases also satisfy the requirements for obtaining the presumption
under the 2008 HOEPA Final Rule. The final rule's requirements for
obtaining the status of a qualified mortgage (and thus the rebuttable
presumption) are slightly more prescriptive than the existing rules for
gaining that presumption and this difference in the criteria for
qualification may leave borrowers with slightly less opportunity to
rebut the presumption of compliance.\214\
---------------------------------------------------------------------------

\213\ There may be some loans that are currently made with a
rebuttable presumption that will no longer have that presumption but
instead will be covered the general ability to repay standards. For
example, higher priced covered transactions with more than three
points and fees will not qualify for the presumption under the final
rule.
\214\ Under the Board's rule, the presumption of compliance
attaches if the creditor ``tak[es] into account'' either the ``ratio
of total debt obligations to income or the income the consumer will
have after paying debt obligations.'' The consumer may rebut the
presumption ``with evidence that the creditor nonetheless
disregarded repayment'' such as by offering ``evidence of a very
high debt-to-income ratio and very limited residual income.'' Under
the final rule, however, a creditor cannot claim the benefit of the
presumption of compliance if the debt to income is very high, since
the final rule contains specific debt-to-income criteria for
qualified mortgages. Thus, under the final rule, to rebut the
presumption the consumer must prove insufficient residual income.
---------------------------------------------------------------------------

For the subset of these borrowers that are in default more than
three years into the mortgage, that seek to and are able to
successfully rebut the lender's presumption of compliance (when seeking
an offset during foreclosure), and that are therefore entitled to
compensation, the returns from this action are in fact reduced relative
to the existing rules which do not limit the recovery period in a claim
for offset in a foreclosure proceeding brought by the creditor. As
such, the probability that lenders will have to defend such an action
is reduced relative to current rules although the subset described
above is likely to be so small that the impact will be immaterial. As
discussed below, relative to the existing rules lenders may face
increased putback risk from investors although that, too, is small.
For the set of borrowers that are in default within the first three
years, potential damages are not reduced; however, the increased
requirements at origination to qualify for qualified mortgage status,
and the correspondingly more limited grounds on which to rebut the
presumption reduce the probability of a successful challenge. So here
too, the probability that lenders will have to defend such an action
may be reduced or at least held constant relative to current rules.
Overall, therefore the ex-post liabilities

[[Page 6567]]

for lenders are likely reduced for these loans.
Relative to current rules for HPMLs, the current rule extends
liability to assignees.\215\ The establishment of assignee liability
does not increase the amount that a borrower can obtain from a
successful legal action; however, it does increase the number of
parties from whom the borrower can seek redress. Borrowers in a
foreclosure action in a judicial state can now assert their claim
against the assignee bringing the foreclosure action, rather than
having to initiate an affirmative lawsuit against the originator that
no longer holds the loan. The effect is to reduce the costs of bringing
these defensive actions and therefore increasing their likely number.
For loans that are not sold, or for borrowers wishing to bring
affirmative actions, the establishment of assignee liability has little
or no effect.
---------------------------------------------------------------------------

\215\ As amended by section 1413 of the Dodd-Frank Act, TILA
provides that when a creditor, an assignee, other holder or their
agent initiates a foreclosure action, a consumer may assert a
violation of TILA section 129C(a) ``as a matter of defense by
recoupment or setoff.'' TILA section 130(k). There is no time limit
on the use of this defense and the amount of recoupment or setoff is
limited, with respect to the special statutory damages, to no more
than three years of finance charges and fees. In contrast, for high
cost loans as under existing law, an assignee generally continues to
be subject to all claims and defenses, not only in foreclosure, with
respect to that mortgage that the consumer could assert against the
creditor of the mortgage, unless the assignee demonstrates, by a
preponderance of evidence, that a reasonable person exercising
ordinary due diligence, could not determine that the mortgage was a
high cost mortgage. TILA 131(d).
---------------------------------------------------------------------------

The extension of liability to assignees may also increase the cost
of contracting between the two parties. Under the final rule, the
borrower now has a contingent claim against two parties. As a result,
the two parties will want to contract ex-ante about the extent of each
party's liability under the various contingencies. This increase in
contracting costs should be small for two reasons. First, even in the
absence of assignee liability, the market has already included these
contingencies in standard contracts. For example, following the Board's
2008 rule, the Fannie Mae seller servicer guide was amended to include
provisions that HPMLs are ``eligible for delivery to Fannie Mae
provided [that] * * * lenders represent and warrant when they sell an
HPML to Fannie Mae that the mortgage complies in all respects with
Regulation Z requirements for HPMLs, including the underwriting and
consumer protection requirements.\216\'' The Freddie Mac seller
servicer guide has similar provisions.\217\ With contracts like these
already in place, it appears that amending contracts for the
particulars of the final rule should be small. Second, underwriting
guidelines, pooling and servicing agreements and other contracts in the
mortgage market are currently being reworked and refined.\218\ Among
the myriad of changes, addenda to manage the ability-to-repay
liabilities of the current rule should be only a small cost.
---------------------------------------------------------------------------

\216\ See Fannie Mae, ``Delivery of Higher-Priced Mortgage
Loans, Revised Qualifying Rate Requirements, Assessment of Late
Charges, Clarifications to Points and Fees Limitation, and Updates
to Reporting under the Home Mortgage Disclosure Act,'' Announcement
09-24 (July 10, 2009), available at https://www.fanniemae.com/content/announcement/0924.pdf.
\217\ See Freddie Mac, ``Higher-Priced Mortgages Loans and Rate
Spread Data,'' Bulletin 2009-17 (July 8, 2009), available at https://www.freddiemac.com/sell/guide/bulletins/pdf/bll0917.pdf.
\218\ See Federal Housing Finance Agency, ``Strategic Plan for
Enterprise Conservatorships,'' (Feb. 21, 2012), available at https://www.fhfa.gov/webfiles/23344/StrategicPlanConservatorshipsFINAL.pdf.
Also see Federal Housing Finance Agency, ``Building a New
Infrastucture for the Secondary Mortgage Market,'' available at
https://www.fhfa.gov/webfiles/24572/FHFASecuritizationWhitePaper100412FINAL.pdf.
---------------------------------------------------------------------------

iii. Non-Qualified Mortgages and Estimation of Costs
The remaining loans are not qualified mortgages. These include for
example, mortgage loans with a back-end DTI ratio over 43 percent,
loans with points and fees above three percent of the loan balance,
mortgages with a term over 30 years, or balloon loans that do not
qualify for qualified mortgage balloon definition.\219\ For loans in
this segment priced below the higher-priced threshold, the obligation
to assess the consumer's ability to repay and the liability where the
lender fails to do so is a new liability for both the originator and
any assignees. For loans in this segment above the higher-priced
threshold, lenders cannot invoke a rebuttable presumption of compliance
and for those loans that are not high-cost loans, assignees are subject
to expanded liability as compared to current rules.\220\
---------------------------------------------------------------------------

\219\ The Bureau believes that the requirements for higher-
priced balloon loans made by lenders who do not meet the rural or
underserved test effectively ban these products.
\220\ Note that several state laws have ability-to-repay
requirements applicable to conforming loans and/or higher priced
loans, and there are variations in their applicability,
requirements, and liability provisions. The benefits and costs of
the final rule will be attenuated to the extent that certain states
already provide similar requirements.
---------------------------------------------------------------------------

The Bureau has estimated litigation costs under the new ability to
pay standards for non-qualified mortgages. Estimating costs for non-
qualified mortgages should reasonably serve an upper bound for the
costs for qualified mortgages. Costs for putbacks, or loans the buyers
of which force the sellers to take back on their books because they do
not satisfy the final rule are also estimated.
Estimating the increased liability costs involves a series of
assumptions about the performance of these loans, the probability that
borrowers will bring particular actions, and the subsequent behavior of
lenders and courts. Some assumptions about costs are also necessary.
Under the ability-to-repay provisions, consumers can bring an
action against the lender at any point during the first three years of
the loan or as an offset to foreclosure at any time. In the latter
cases, the recovery of interest and finance charges is capped at the
amount paid during the first three years.
The Bureau has estimated these costs as follows. To begin, assume
an average loan balance of $210,000 (just below the mean balance for
first lien loans reported in HMDA in 2011), an average interest rate of
7 percent (the average mortgage rate for 30 yr. mortgages from 1997 to
2003) \221\, and an average of $3,150 (1.5 points) paid up front in
fees. Further, assume that, on average, affirmative cases and contested
early foreclosures happen at the midpoint of the period, 18 months
after consummation. This implies that for the affirmative cases, and
the early foreclosures borrowers contest, successful borrowers are
reimbursed for fees and interest an average of roughly $29,200.\222\
(The Bureau assumes in this calculation that all prevailing borrowers
receive $4,000 in statutory TILA damages.) For the later foreclosures,
defined here as foreclosure that occur three or more years after loan
consummation, borrowers who contest foreclosure are reimbursed for 36
months of interest or roughly $51,250.
---------------------------------------------------------------------------

\221\ H.15 monthly series from Federal Reserve Board of
Governors downloaded from St, Louis Fred at https://research.stlouisfed.org/fred2/series/MORTG/downloaddata?cid=114.
\222\ Because some of the costs are independent of loan size,
one has to make assumptions about the underlying loan value;
otherwise, all calculations could simply be done as percentages of
loan balances. The figures used here are consistent with those used
by commenters that provided similar calculations.
---------------------------------------------------------------------------

Based on data from the FHFA for 1997-2003 for loans with DTI ratios
above 43 percent, it is reasonable to assume, 3.5 percent of loans
reach 60 day delinquency during the first three years of the loan but
do not start a foreclosure process, an additional 1.5 percent of loans
start the foreclosure process within the first three years, and an
additional 1.5 percent of loans start the foreclosure process after
three

[[Page 6568]]

years.\223\ The Bureau believes that consumers who have fallen behind
on their mortgage payments are unlikely to initiate an ability to repay
claim in court prior to foreclosure. Rather, they will likely seek to
work with their servicer and the owner of the loan to cure the
delinquency through, e.g., forbearance or some form of loan
modification, or where that is not possible, to reach an agreement to
enable the consumer to walk away from the property and the loan (i.e.,
deed in lieu or short sale). Once a foreclosure proceeding is
commenced, however, it will then be in the interest of consumers to
assert ability-to-repay claims where there is a plausible basis to do
so; this is especially true in judicial foreclosure states because an
ability-to-repay claim can be asserted as a defense by way of offset
against whoever holds the loan at the time of the foreclosure (i.e.,
the originator or assignee).
---------------------------------------------------------------------------

\223\ These values are derived from GSE loans with at DTI ratio
above 43% originated during the 1997-2003 period. For these loans,
roughly 7 percent ever reached 60 days late, one-half of those in
the first three years. Roughly 3 percent ever reached 180 days
delinquent which is a rough proxy for foreclosure. One could also
assume that some additional borrowers simply stop paying their loans
strategically in order to extract funds from the originator or
assignee, however that possibility seems unreasonable.
---------------------------------------------------------------------------

The ability of consumers to assert such claims either defensively
or, in non-judicial foreclosure states, in affirmative actions will
depend to some extent upon their ability to obtain legal
representation. In its notice reopening the comment period for the
rule, the Bureau specifically requested information and data regarding
the frequency of such actions. In general, industry commenters
asserted, that even under the rebuttable presumption standard, future
legal actions under the rule would be very common. In contrast,
consumer and community groups pointed to the available evidence and
experience to suggest that only a very small minority of consumers in
foreclosure are represented and that very few claims are brought.
Consumer group commenters pointed out the practical limitations of
consumers to bring an ability-to-repay claim, noting that few
distressed homeowners would be able to afford and obtain legal
representation often necessary to mount a successful rebuttal in
litigation. Consumer groups also provided percentages of borrowers in
foreclosure who are represented by lawyers, noting the difficulty of
bringing a TILA violation claim, and addressed estimates of litigation
costs, such as attorney's fees. The data provided however are quite
limited: two commenters (both representing industry) suggest that
during the recent years there were roughly 900 mortgage-related TILA
cases filed each year in Federal court while data regarding the number
of TILA claims brought in state courts were not provided.\224\
---------------------------------------------------------------------------

\224\ See Mortgage Bankers Association comment letter, docket
CFPB-2012-0029, submitted Sep. 7, 2012. See also National Consumer
Law Center comment letter, docket CFPB-2012-0029, submitted Sep. 7,
2012.
---------------------------------------------------------------------------

More specifically the Bureau has considered the available evidence
with respect to the extent of litigation under laws potentially
analogous to this one, such as the 2008 HOEPA Final Rule (which does
not provide assignee liability, except as applicable to high cost
mortgages) and under HOEPA and state anti-predatory lending laws (which
generally do provide for assignee liability). So far as the Bureau is
aware, claims under these rules have been very infrequent. Industry
participants likely have access to the most complete information about
litigation activity, much of which activity is not reported in legal
databases such as Lexis and Westlaw. Industry commenters, however, did
not bring forth any evidence to suggest that claims have been anything
but rare. Thus, relative to the one to two million annual foreclosure
starts from 2009 through 2011,\225\ the record supports a conclusion
that litigation under TILA generally and under the most directly
analogous federal and state laws has been very limited.
---------------------------------------------------------------------------

\225\ MBA National Delinquency Survey.
---------------------------------------------------------------------------

Industry commenters maintained that past experience is not a guide
because new liability under the Dodd-Frank Act will increase incentives
for litigation. The Bureau recognizes that the availability of new
ability-to-repay remedies may make it easier for consumers to obtain
representation (by providing those consumers whose loans are not
currently covered by the Board rule with new rights; and those
consumers whose loans are covered, with more easily asserted, and to
that extent more valuable claims). Thus, the analysis below of
litigation costs relies on very conservative (likely unrealistic)
assumptions about the extent to which the Dodd-Frank liability
provisions will increase litigation levels above levels under current
laws.
Among the three percent of borrowers that are in foreclosure, the
Bureau assumes that 20 percent will bring an action against the lender
for failing to meet the ability-to-repay requirements; that implies
that 0.6 percent of borrowers will bring claims. As noted, this value
is many times higher than recent experience with the 2008 HOEPA Final
Rule or analogous state laws would suggest and is a very conservative
upper bound. One half of these borrowers, should they prevail, are
assumed to be entitled to 18 months of interest and the other half to
36 months of interest. Based on our assumed loan size ($210,000),
interest rate (7%), and origination fees ($3,150) as discussed above,
on average a successful borrower will have a claim of $40,225
(including the statutory TILA damages, before legal costs).
To estimate legal costs, assume that in each case, the lender will
move for summary judgment based upon what they are likely to claim to
be undisputed evidence documenting their consideration of borrowers'
ability to pay. The consumer would likely claim that he or she was
unable to pay the mortgage from its inception, and would have to
present evidence from which it could be inferred that the creditor did
not make a ``reasonable and good faith determination'' of the
consumer's ability to repay. To estimate legal costs, assume that in
each case, following any discovery permitted, the lender will move for
summary judgment, which is a written request for a judgment in the
moving party's favor (along with a written legal brief in support of
the motion with supporting documents and affidavits) before a lawsuit
goes to trial, claiming that all factual and legal issues can be
decided in the moving party's favor, as a means to avoid trial
altogether. The opposing party (i.e., the consumer) would need to show
that there are triable issues of fact. The analysis assumes that, in
these motions, the lender will succeed four-fifths of the time. In the
remaining one fifth of cases, the lender settles prior to summary
judgment and pays the full value of the claim. This assumption is also
conservative. In evidence provided by industry commenters which the
commenters suggested were analogous, lenders prevailed in nearly all of
the cases cited.
To litigate these cases, the borrower is assumed to spend 60 hours
of attorney time up to and including responding to the motion for
summary judgment while the lender, given its resources, is assumed to
spend 170 hours up to and including filing the relevant motions.\226\
In 2011, the average wage for lawyers in the legal services industry
was $68.75/hr; adjusting that figure to reflect benefits and other
forms of

[[Page 6569]]

compensation, and a 50 percent mark-up for firm yields an hourly rate
for legal services of $150/hr. With these assumptions, borrowers are
willing to bring cases, and lenders will defend them, since on average
both sides are ahead relative to simply dropping the claim or paying it
in full.\227\ To reflect the expected value of these costs, the costs
of non-qualified mortgages would increase by 10 basis points (0.1
percent of the loan amount, or roughly $212 for the $210,000
loan).\228\ Assuming loans with a weighted average life of four years,
this could add roughly 2.5 basis points (0.025 percentage points) to
the rate of each loan. Were the whole cost passed on to the consumer,
increasing the rate from 7.0 percent to 7.025 percent, the monthly
payment would rise by roughly $3.50. The resource cost to litigate this
case is also roughly 10 basis points since it includes the lenders' and
the borrowers' legal expenses of $25,500 and $9,000, respectively, and
excludes the transfer of $40,225 that occurs in successful cases.
---------------------------------------------------------------------------

\226\ Comment letters submitted to the Board suggest roughly
this number of hours when assessing the cost of a rebuttable
presumption. See MBA Comment Letter dated July 22, 2011.
\227\ For illustration purposes, the Bureau assumes that 20
percent of the potential litigants have private costs of litigation
of less than $1,000. Under the assumptions above, the creditor
prefers to incur the legal costs to file for summary judgment as
opposed to settling outright (the creditor's expected payoff is
roughly $5,000 dollars more in this case).
\228\ This is calculated as 0.6 percent of borrowers bringing
cases multiplied by $35,345 in expected lender costs per case
divided by the $210,000 loan amount.
---------------------------------------------------------------------------

iv. Sensitivity Analysis
As part of a sensitivity analysis, the Bureau has estimated these
costs under different assumptions. Notably, industry commenters
provided estimates of the costs for various types of cases related to
mortgage actions. These comments suggest a much higher cost for legal
expenses of $300 per hour and closer to 300 hours to litigate cases
that involve motions for summary judgment. Using these figures (and the
assumption that borrowers' legal expenses include a proportionally
higher 150 hours at $300/hr), the increased cost of each loan is
approximately 31 basis points or an increase in the interest rate of
just under 8 basis points (0.08 percentage points). Importantly, in
this scenario, using the assumptions set forth previously about loan
size and other factors, lenders would spend $107,000 to defend claims
worth substantially less than the legal costs ($40,225).\229\ It is
possible, however, that lenders would be willing to litigate such cases
in order to discourage future litigation but, if so, one would expect a
corresponding diminution of litigation over time.
---------------------------------------------------------------------------

\229\ At the same time, higher litigation costs may deter
certain consumers from bringing suit.
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As a second sensitivity test, going back to the original legal cost
estimates, one can assume that of the 3.5 percent of borrowers who find
themselves behind on their payments during the first three years, 84
percent (or 3 percent of total borrowers) chose to bring affirmative
claims. This would quintuple the original estimates on a per loan basis
to fifty basis points spread over a four-year average life. Similarly,
one could assume that a larger percentage of borrowers in default bring
claims. Raising that assumption from 20 percent to 40 percent results
in estimated costs of 20 basis points per loan.
Originators and assignees share the liability for ability-to-repay
violations. Depending on the contract in place, lenders will bear some
repurchase risk for those loans that are sold into the secondary
market. For example, sellers of loans to the GSEs already bear this
risk for HPMLs since the enterprises have the right to put the loan
back in case of ability-to-repay violations. In cases where the lender
is defunct or there are other issues affecting the lender's capacity to
reassume the risk, the purchaser of the loan may be unable to exercise
that right and will bear the additional liability costs. The need of
both the seller and the buyer to budget for expected capital and
liquidity charges in these situations, and to negotiate the specific
transactions, will also add some costs. However, in recent work, some
economists have estimated that even for loans from the 2005 to 2008
vintage repurchase risk added conservatively about 19 basis points (or
0.19 percent of the loan amount) to the cost of a loan. Given the much
lower default rates in the coming years (based on the default rates
during the 1997-2003 period), and the increased underwriting
requirements mandated by the final rule even for non-qualified
mortgages, these costs are likely to be closer to 1-3 basis points at
most.\230\
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\230\ Securitized loans performed very poorly just following the
bubble, with delinquency rates many times that of loans in more
typical times. Adjusting the figures to reflect this better
performance and the increased origination standards in the final
rule, yields the 1-3 basis points. See Andreas Fuster, Laurie
Goodman, David Lucca and Laurel Madar, Linsey Molloy, Paul Willen,
The Rising Gap Between Primary and Seconadary Mortgage Rates,
November 2012 available at: https://www.newyorkfed.org/research/conference/2012/mortgage/primsecsprd_frbny.pdf.
---------------------------------------------------------------------------

v. Summary of Litigation Costs
Combining liability costs and repurchase costs, estimated costs for
non-qualified mortgage loans (loans made under the ability-to-repay
standard without any presumption of compliance) are estimated to
increase by approximately twelve basis points (or 3 basis points (0.03
percentage points) on the rate); under very conservative estimates,
this figure could be as high as forty basis points (or ten basis points
(0.01 percentage points) on the rate). Depending on the competitive
conditions in the relevant product and geographic markets, some of this
increase will be passed on to borrowers and the rest will be absorbed
by lenders. Certain borrowers may be priced out of the market as a
result of the price increase. However, the number of such borrowers is
likely to be very small given the values above since an increase of
even ten basis points on the rate on an average mortgage would increase
the monthly payment by less than $10.
vi. Temporary Provisions for Qualified Mortgages
As described in the preamble, the final rule recognizes the
fragility of the current mortgage market and therefore includes
temporary measures extending qualified mortgage status to loans that in
the long run may not be qualified mortgages. These include loans with a
DTI above 43 percent and that nonetheless can be purchased or
guaranteed by the GSEs, insured by the FHA, VA or RHS. Based on the
data as of year-end 2011, such loans are approximately 18 percent of
the market. Without fuller data on the points and fees and product
features associated with most loans, it is hard to estimate precisely
the size of this segment or predict how large it would be several years
from now with, or without, the statute taking effect. Ignoring those
features, based on information about the rates and fees on these loans
we believe roughly 97 percent of these loans should qualify for the
legal safe harbor with the conclusive presumption of compliance (i.e.,
they are not higher-priced covered transactions) and 3 percent are
estimated to qualify for the rebuttable presumption (i.e., they are
higher-priced covered transactions). The temporary expansion of the
definition of a qualified mortgage results in over 95 percent of the
market being granted qualified mortgage status.
Extending qualified mortgage status to these loans reduces costs to
lenders as described above and limits some of the consumer protections
that an increased possibility of liability would create if a creditor
were able to satisfy the GSE or federal agency underwriting standards
without having a reasonable and good faith believe in the consumer's
ability to repay. However, the added certainty

[[Page 6570]]

from this reduced liability should benefit both consumers and covered
persons. The mortgage market is still fragile, even four plus years
past the most turbulent portions of the financial crisis. With lenders
and the markets in general adjusting to new regulations designed to
counter the forces behind the crisis, extending qualified mortgage
status to these segments of loans should limit any disruption to the
supply of mortgage credit with only limited effects on consumers. The
extension of qualified mortgage status to these loans should allow the
market time to digest the rules and for any increase in premia
associated with uncertainty about litigation and putback costs to
diminish.
c. Access to Credit
Overall, the Bureau believes that the final rule will not lead to a
significant reduction in consumers' access to consumer financial
products and services, namely mortgage credit. The Bureau notes the
potential for the ability to repay requirements, including increased
documentation and amortization requirements, to prevent some consumers
from qualifying for a loan. First, the final rule generally bans no-doc
and low-doc loans to the extent the level of documentation is lower
than that required by the rule. The final rule would by definition
prevent borrowers who would only qualify for these types of loans from
receiving a mortgage; as discussed, that is one of the benefits of the
rule. Second, the final rule generally increases documentation
requirements for mortgage loans and requires underwriting to be done
based on an assumed fully amortizing loan at the fully indexed rate.
As noted above, when measured against the current marketplace, the
Bureau anticipates the effect of these requirements on access to credit
to be very small. The Bureau anticipates that, as the economy recovers,
the currently restrictive credit environment will loosen. Indeed, if
anything, the Bureau anticipates that the immediate effect of the rule
may be to contribute to the recovery of the mortgage market by reducing
legal uncertainty which may be affecting lending. This is especially
true if the impact of the rule were compared to a post-statutory
baseline (i.e. to the implementation of the Dodd-Frank ability to pay
and qualified mortage provisions without implementing regulations.)
Measured against the years leading up to the financial crisis, when
lending standards were quite loose, the effects of the final rule on
access to credit would of course have been significantly larger. The
final rule will set a floor to the loosening of credit in order to
prevent the deterioration of lending standards to dangerous levels. A
primary goal of the statute was to prevent a repeat of the
deterioration of lending standards that contributed to the financial
crisis, which harmed consumers in various ways and significantly
curtailed their access to credit. Such a goal will, by definition,
entail some potential diminution of access to credit as market
standards change over time. The Bureau believes that, to the extent the
final rule reduces credit access, it will primarily reduce inefficient
lending that ignores or inappropriately discounts a consumer's ability
to repay the loan, thereby preventing consumer harm, rather than
impeding access to credit for borrowers that do have an ability to
repay. The Bureau notes that the rule may have a disproportionate
impact on access to credit for consumers with atypical financial
characteristics, such as income streams that are inconsistent over time
or particularly difficult to document.
There also exists the potential for both increased documentation
requirements and increased liability to increase the price of mortgage
loans for some consumers. As discussed above, price increases from both
increased documentation requirements and increased liability should be
small. The documentation requirements, such as providing a pay stub or
tax return, will impose relatively little additional cost to most
consumers. Similarly, the increased documentation costs for creditors
should not be significant, or result in more than relatively small
increases in the cost of mortgage loans.
With respect to liability costs, the Bureau notes that over 95
percent of the current market is estimated to satisfy one of the
definitions of a qualified mortgage, greatly reducing the expected cost
of litigation. The Bureau also notes that the clear standards
established for determining whether a loan is a qualified mortgage
should reduce uncertainty regarding litigation costs, which will
mitigate any resulting impact on access to credit. In light of the
foregoing considerations, the Bureau believes that the ability to repay
requirements and the accompanying potential litigation costs will
create, at most, relatively small price increases for mortgage loans.
These small price increases, in turn, are not likely to result in the
denial of credit to more than a relatively small number of borrowers,
some of whom commenters pointed out could be low income, at the margin.
The Bureau notes that concerns have been raised concerning the
application of increased documentation and amortization requirements to
such entities as certain nonprofits and state housing finance agencies,
as well as certain refinancing programs. As applied to such entities
and programs, the final rule may restrict access to mortgage credit,
including for consumers who may otherwise have limited credit options,
while doing little to further the consumer protection purposes of the
statute. To address these concerns, the Bureau has proposed separately
to exempt some such entities and programs from these documentation and
amortization requirements.
The Bureau also notes that concerns have been raised regarding the
application of the qualified mortgage criteria and the general ability
to repay requirements to certain small creditors. These concerns arise
from the observation that for many community banks and credit unions,
for example, compliance resources are scarce and compliance costs as a
percentage of revenue can be high. At the same time, these institutions
employ a traditional model of relationship lending that did not succumb
to the general deterioration in lending standards that contributed to
the financial crisis. Moreover, because this business model may be
based on particularized knowledge of customers and the development of
durable customer relationships, the resulting loans may be beneficial
to customers even when they do not conform to the general standards set
forth in the final rule. Further, these institutions have particularly
strong incentives not only to maintain positive reputations in their
communities, but also, because they often keep the loans they make in
their own portfolios, to pay appropriate attention to the borrower's
ability to repay the loan. Accordingly, the Bureau has proposed
separately to provide additional criteria by which certain small
portfolio lenders may make qualified mortgages.
Greater access to credit can be associated with higher home prices
and higher homeownership rates, and as discussed in the section on
costs, there is some evidence of positive social effects from home
ownership. As such, were the rule to overly restrict credit, it is
important to note that these positive spillovers would also be limited.
However, the Bureau does not believe that the rule will result in an
inappropriate reduction in access to credit; rather, over time, the
final rule should ensure that lending standards do not deteriorate to
dangerous levels, while at the same time ensuring that lending not be
too restrictive.

[[Page 6571]]

4. Potential impacts of other provisions
Below, the Bureau discusses the impacts of several other provisions
of the final rule and notes their interaction with other rulemakings.
These include the points and fees provisions (which interact with the
HOEPA rulemaking), the provisions of the statute regarding prepayment
penalties, and the definition of rural or underserved areas (which
interacts with the current rulemaking regarding escrow account
requirements for certain higher-priced mortgage loans and with the 2013
HOEPA final rule). The interagency rule on appraisal requirements for
high-risk mortgage loans also interacts with the QM definition.
a. Points and Fees Provisions
To be a ``qualified mortgage,'' the statute requires (among the
other requirements already discussed) that the total points and fees
payable in connection with the loan do not exceed 3 percent of the
total loan amount and requires the Bureau to prescribe rules adjusting
this limit to ``permit lenders that extend smaller loans to meet the
requirements of the presumption of compliance.'' As noted earlier, such
a restriction may have the effect of limiting cases where creditors,
having received more funds up front, are less concerned about the long-
term performance of the loan.
In the final rule, that limit is amended to a tiered approach with
the following limits: for a loan amount greater than or equal to
$100,000, three percent of the total loan amount; for a loan amount
greater than or equal to $60,000 but less than $100,000, $3,000; for a
loan amount greater than or equal to $20,000 but less than $60,000,
five percent of the total loan amount; for a loan amount greater than
or equal to $12,500 but less than $20,000, $1,000 of the total loan
amount; and, for a loan amount of less than $12,500, eight percent of
the total loan amount.
The higher limits for smaller dollar loans should allow more loans
to be made as qualified mortgages. Data on the points and fees
associated with a representative set of loans is not currently
available. As a result, the Bureau cannot estimate precisely how many
loans are impacted by this change. Under TILA as amended, a high-cost
mortgage has points and fees equal to five percent of the total
transaction amount if the transaction is $20,000 or more, and points
and fees equal to the lesser of eight percent of the total transaction
amount or $1,000, if the transaction is less than $20,000. Setting the
maximum points and fees caps based on the HOEPA triggers will help
ensure that a qualified mortgage is not a high-cost mortgage because of
the points and fees.
The Dodd-Frank Act substantially expanded the scope of compensation
included in points and fees for both the qualified mortgage and high-
cost mortgage points and fees limits. In addition to compensation paid
to mortgage brokerage firms and individual brokers, points and fees
also includes compensation paid to other mortgage originators,
including employees of a creditor (i.e., loan officers). Under the
existing rule, only consumer payments to mortgage brokers are included
in points and fees for the high-cost mortgage threshold. Also under the
Act, any fees paid to and retained by affiliates of the creditor must
be included in points and fees (except for any bona fide third-party
charge not retained by the creditor, loan originator, or an affiliate
of either, unless otherwise required under the rule). The final rule
restates these provisions.
In a concurrent proposal published elsewhere in today's Federal
Register, the Bureau proposed one alternative which would permit loan
originator compensation to be netted against other upfront charges paid
by the consumer and one that would not. Still, the inclusion of loan
originator compensation in points and fees under the Final Rule
(together with the statutory provisions implementing in the Final Rule
regarding the treatment of charges due to third parties affiliated with
the creditor) could have the effect of limiting the number of loans
eligible to be qualified mortgages. For most prime loans, the Bureau
believes that this change will not have a major impact: current
industry pricing practices and the exemption for bona fide discount
points suggest that few of these loans will be constrained by the
points and fees limits.
For loans near the border of higher-priced loans (i.e. loans one
percentage point above APOR), the exemption for bona-fide discount
points is reduced and for loans priced at two percentage points or more
above APOR the exemption is eliminated. For these loans, the inclusion
of loan originator compensation and affiliate fees could limit
qualified mortgage status for certain loans. Loans that will qualify
for the safe harbor, but where the borrower pays for these charges
through a higher interest rate, may lose the conclusive presumption of
compliance and instead have only the rebuttable presumption. This
impact is most likely greater for lenders with affiliated companies
whose charges must be included in the points and fees calculations.
b. Prepayment Penalties
The Final Rule implements the provisions of Dodd-Frank with respect
to prepayment penalties. Specifically, in accordance with the statute,
the rule prohibits prepayment penalties for any mortgage other than a
fixed-rate mortgage that is a qualified mortgage and not a higher-
priced mortgage.\231\ Where the Final Rule permits prepayment
penalties, it limits these penalties to 2 percent of the outstanding
balance on the loan during the first year after consummation and 1
percent of the outstanding balance during the second year after
consummation.
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\231\ For purposes of this provision of the rule, a higher
priced mortgage is defined in the Act as a first lien, non-jumbo
mortgage with an APR that is more than 150 basis points above APOR;
a first lien, jumbo mortgage with an APR that is more than 250 basis
points above APOR; and a second lien mortgage with an APR that is
350 basis points above APOR.
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Available information from the sources described above suggests
that loans originated today do not contain prepayment penalties, and
this is likely to be true for the foreseeable future. Neither loans
originated for sale to Fannie Mae and Freddie Mac, nor loans insured by
FHA generally contain prepayment penalties.\232\ Moreover, the Bureau
understands that prime loans, which make up the vast majority of
originations today, have in recent years rarely had prepayment
penalties.\233\ Some originators may make subprime loans they hold on
portfolio for which they charge prepayment penalties, but data on terms
of loans on portfolio are not available and at least in the current
market, this is likely to be a very small number of loans. With the low
interest rates that prevail today, lenders see little reason to limit
prepayment risk by charging prepayment penalties.
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\232\ As explained in the final rule, FHA loans used a method of
interest calculaton which results in consumers who pay off loans
during the course of a month being obligated to pay interest until
the end of the month. The Final Rule treats that as a prepayment
penalty and provides an extended compliance period to allow time for
FHA to change this feature of its loans.
\233\ See 73 FR 44522 (July 30, 2008).
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Prepayment penalties by design impose costs on consumers to switch
from their current loans to loans with lower interest rates. This cost
can be particularly high for consumers with potentially increasing
payments and who seek to refinance to avoid the increases. Moreover,
these penalties are complex and often not transparent to consumers.
Consumers may not focus on prepayment penalty terms because they are
more focused on the terms they

[[Page 6572]]

find more salient, such as interest rate and payment amount. Leading up
to the mortgage crisis, some loan originators sometimes took advantage
of consumers' lack of awareness or understanding of prepayment
penalties.\234\ Originators could sell unsuspecting consumers loans
with substantial expected payment increases as well as substantial
prepayment penalties that would prevent the consumer from refinancing.
---------------------------------------------------------------------------

\234\ Over 70 percent of subprime loans from 2001 through 2007
had prepayment penalties. See Demyank and Hemert, Review of
Financial Studies, 24,6, 2011.
---------------------------------------------------------------------------

By limiting prepayment penalties to prime, fixed-rate qualified
mortgages, the Final Rule benefits consumers by limiting these cases
and lowering the cost of exiting a mortgage. Consumers will be able to
refinance at lower cost, either when market rates drop or when the
consumer's risk profile improves. In other cases, consumers who are
sold mortgages with rates higher than their risk profile warrants will
be able to refinance their mortgages to a market rate at lower cost. In
still other cases, consumers will be able to sell their homes and move
at lower cost. This cost reduction from restriction of prepayment
penalties is particularly important to consumers who incur drops in
income or increases in expenses that cause them to struggle to make
their mortgage payments.
However, to the extent prepayment penalties compensate investors
for legitimate prepayment risk, restricting penalties will reduce the
value of certain mortgages and limit the returns to creditors and
investors (which includes entities that are covered persons as well as
entities that are not covered persons). In these cases, the cost of
credit for some consumers will rise as creditors raise prices to
compensate for increased prepayment risk. Currently, the number of
loans that would have prepayment penalties but for the Final Rule
appears to be very small, however, so costs to consumers and covered
persons are expected to be de minimis.
c. Definition of Small Lenders, Rural and Underserved
The final rule allows certain small creditors operating
predominantly in rural or underserved areas to originate balloon-
payment qualified mortgages. Specifically, this option exists for
lenders originating 500 or fewer covered transactions (including their
affiliates), secured by a first lien, in the preceding calendar year,
with assets under $2 billion (to be adjusted annually), and who made
more than 50 percent of their total covered transactions secured by
first liens on properties in counties that are ``rural'' or
``underserved.'' For the purposes of the final rule, and the 2013
Escrow rule published elsewhere in today's Federal Register, the Bureau
has defined rural to include noncore counties and those micropolitan
counties that are not adjacent to metropolitan statistical areas using
the Department of Agriculture's urban influence codes. Relative to the
proposed rule that only included a subset of rural counties, the final
rule expands the exemption. The Bureau has not altered the definition
of underserved from that contained in the proposed rule.
Although there is no comprehensive evidence with respect to the
prevalence of balloon loans, the Bureau understands anecdotally from
outreach that in these rural areas, creditors sometimes have difficulty
selling certain loans on the secondary market either because of unique
features of the rural property or of the rural borrower. In these
instances, the creditors will make a portfolio loan. Because of their
small size, some of these creditors eschew ARMs and manage interest
rate risk by making balloon payment loans which the creditors then
roll-over based on then-current interest rate when the balloon payment
comes due.
Relative to a pre-statutory baseline, the rural balloon provisions
of the rule have minimal effect. Relative to a post-statutory baseline
in which the statute was implemented without the exception for rural
lenders, the provisions of the rule have the following impacts on
consumers and covered persons. Creditors covered by the rule's
definition are permitted to make balloon loans which are qualified
mortgages, potentially mitigating consumer access to credit issues that
might arise if balloon payment mortgages were restricted. The rule
creates certain minimum, consumer-protective requirements with respect
to such balloon loans, such as a minimum term of five years and a
requirement that the interest rate be fixed for that period of time.
The rule also requires that creditors verify and consider income and
debts before making such loans (albeit without a fixed debt-to-income
requirement). However, to the extent these creditors rely on this
permission to make balloon loans rather than other types of qualified
mortgages, the rule also denies these consumers the consumer
protections associated with not giving balloon loans qualified mortgage
status.
According to the definition used in the final rule, approximately
10 percent of the U.S. population lives in areas that the Bureau
defines as rural or underserved: the Bureau estimates that 2,707 small
creditors, currently issuing first-lien mortgages and operating
predominantly in rural or underserved areas, will be able to originate
balloon qualified mortgages as a result of the provision. Given the low
population density of the areas currently defined as rural, the
corresponding limits on the number of creditors, and the challenges of
making loans that could be sold in the secondary market, keeping this
source of credit in the community with the safeguards added by the rule
is likely more important to consumers than the consumer protections
associated with not allowing balloon loans to be qualified mortgages.
In somewhat less rural areas, for example the micropolitan counties not
covered by the definition in the final rule, there are more creditors
that can provide alternative forms of credit, such as ARM loans, and
more creditors in general.
d. Qualified Mortgages and Appraisals
One impact of the current definition of qualified mortgage is
related to higher-risk mortgages as defined in the Act. The Act
contains special appraisal requirements with respect to higher-risk
mortgages; those requirements are the subject of an interagency
rulemaking process which resulted in a proposed rule in August which
the agencies expect to finalize shortly. The Act generally defines a
higher-risk mortgage as a closed-end consumer credit transaction
secured by a principal dwelling with an APR exceeding rate thresholds
substantially similar to rate triggers currently in Regulation Z for
higher-priced mortgage loans, but excluding qualified mortgages. In
general, as the number of loans defined as qualified mortgages
increases, the number of loans that would be covered by the proposed
appraisal requirements decreases. Based on the general definition of
qualified mortgage in the final rule, those higher priced mortgage
loans with a debt-to-income ratio of 43 or less would be exempt from
the new requirements for interior appraisals. The temporary provision
allowing additional loans (e.g. loans with a higher debt to income
ratio and that are purchasable by the GSEs or insurable by FHA), to be
qualified mortgages could further remove mortgages from that
requirement. The impact of this reduction in the scope of appraisal
requirements is relatively muted for first lien mortgages because of
the small number of high-risk mortgages to begin

[[Page 6573]]

with and the fact that most lenders already do a full interior
appraisal and share the results with the consumer.

E. Potential Specific Impacts of the Final Rule

1. Depository Institutions and Credit Unions With $10 Billion or Less
in Total Assets, as Described in Section 1026
Some depository institutions and credit unions with $10 billion or
less in total assets as described in Section 1026 may see different
impacts from the final rule than larger institutions. These differences
are driven by the lending practices and portfolios at smaller
depository institutions and credit unions, notably those below roughly
$2 billion in assets, and by the nature of these institutions'
relationship to the secondary market.
The Bureau understands that lending practices at many smaller
institutions (according to comment letters and outreach) are based on a
more personal relationship-based model, and less on automated systems,
at least when the lender plans to keep the loan on portfolio rather
than sell it. To the extent that the documentation and verification
requirements in the final rule differ from current practice at these
institutions, the final rule may impose some new compliance costs.
However, unless these institutions keep all of the loans they originate
on portfolio, which seems unlikely, they are already subject to
documentation requirements from the secondary market so that any
incremental costs are likely to be small. In addition, data from HMDA
indicate that, on average, a larger proportion of loan originations at
smaller institutions are higher-priced mortgage loans and will
therefore have the rebuttable presumption of compliance rather than the
safe harbor. These loans already are subject to an obligation to assess
repayment ability and a rebuttable presumption under the Board's 2009
rule, so any new effects on these loans from the final rule, at least
the loans these institutions keep on portfolio, are expected to be
limited. Historically, delinquency rates on mortgages at smaller
institutions are lower than the average in the industry and as such,
the expected litigation costs for these loans are also probably quite
low. Nevertheless, the proposal posted elsewhere in today's Federal
Register asks for comment on whether the safe harbor should be extended
to additional loans at particular smaller institutions.
The establishment of assignee liability for violation of the
ability-to-repay provisions may also differentially impact smaller
institutions by increasing counterparty risk for entities purchasing
mortgages from these institutions. As described above, creditors and
secondary market purchasers are expected to contract around the new
ability-to-repay liability. For example, both Fannie Mae and Freddie
Mac require lenders to represent and warrant that loans sold to the
enterprises meet the current ability-to-repay requirements and to
repurchase loans in cases where violations are found. Under such an
arrangement,\235\ should a consumer bring a claim, the purchaser will
look to the originator to repurchase the loan; if the originator is no
longer in business or does not have the financial means to do so, the
purchaser will have to bear the risk. This places greater incentive on
purchasers to vet potential counterparties and may impact some smaller
institutions' ability to sell loans. The impact is likely greatest for
loans made under the general ability-to-repay standard rather than for
qualified mortgages. In the near term, the temporary provisions
expanding the number of qualified mortgages, will greatly mitigate
costs for these institutions.
---------------------------------------------------------------------------

\235\ It is also possible that other contracting arrangements
will develop. The industry is currently working on various changes
to the traditional pooling and servicing agreements, for example.
---------------------------------------------------------------------------

2. Impact of the Provisions on Consumers in Rural Areas
The final rule should have minimal differential impacts on
consumers in rural areas. In these areas, a greater fraction of loans
are made by smaller institutions and carried on portfolio. The
availability or pricing for fixed rate or adjustable-rate loans that
are qualified mortgages is likely to be unaffected. Notably, the
liability for these loans is nearly unchanged; those below the
threshold will be subject to the safe harbor while those above the
threshold have a rebuttable presumption similar to the one in place
under existing regulation. Only the very small number of loans made by
these institutions and then sold may be impacted by the changes in
counterparty risk. Consumers constrained to borrow from these lenders
may see a small increase in the price of credit, either from the
lenders now having to fund the loan on the balance sheet or facing
reduced prices in the secondary market. The possible increases in
compliance costs just described may also lead to very small increases
in rates.
An important difference between the rural and the non-rural
consumers is the availability of balloon loans following the rule.
While the balloon loans in the non-rural areas that are not underserved
cannot be qualified mortgages, small lenders operating predominantly in
the rural or underserved areas can, under certain conditions, originate
balloons loans that are qualified mortgages. Thus, rural consumers will
preserve access to credit, while potentially experiencing the lack of
protection associated with prohibiting balloon transactions from being
qualified mortgages. Despite the fact that excluding a small creditor
from the balloon loan market generally does not significantly disrupt
the price-setting process, this might not be true for rural markets. In
particular, there are 567 counties that have three creditors or fewer
(that originate five or more covered transactions per year), according
to HMDA 2011. Going from three creditors to two could significantly
increase prices for consumers.
Data regarding the specific mortgages originated and held on bank
and credit union portfolios is very limited; the exception is the data
on the credit union call report showing the total number and amount of
balloon loans together with hybrid adjustable-rate mortgages. According
to these data, there appear to be few institutions, and therefore very
few consumers affected in this way. In counties where the problem
should be worst, namely micropolitan counties not covered by the rural
or underserved definition, there are just under 50 credit unions that
extend balloon loans and not ARMs; in total they originate 1,200
balloon loans. Consumers seeking credit at these institutions, or
similarly situated banks or thrifts, may face some costs in taking a
different product or in switching institutions depending on the product
offerings and prices in the market. The Bureau believes any price
increase is likely not significant as these areas are served by
multiple lenders. On average, according to the 2011 HMDA data, 16
lenders on average made higher-priced mortgage loans in these counties,
a proxy for what could be balloon loans.

F. Alternatives Considered

Two factors are most relevant when comparing the benefits, costs
and impacts of the final rule to alternative regulatory
implementations: the requirements for underwriting each loan and the
eventual legal liability attached to that loan. The current rule
differs from the Board's proposal along both dimensions, particularly
in regard to qualified mortgages, as it uses a slightly different
structure overall, such as incorporating a specific debt-to-income

[[Page 6574]]

ratio requirement. It also varies in structure from some other
proposals offered by commenters. However, even within the structure
developed in the final rule, the parameters within the rule (e.g. the
DTI ratio threshold) could have been different. In order to more fully
illuminate the impacts of the final rule, this section first considers
the final rule in comparison to the proposals and then to other
reasonable alternatives.
In the 2011 ATR Proposal, the Board proposed two alternative
definitions for a qualified mortgage. The Board's Alternative 1
proposed to define a qualified mortgage using only the statutory
provisions (except for the discretionary requirement to consider the
consumer's debt-to-income ratio or residual income). That is, the
definition of a qualified mortgage would be based on product features,
cost limitations (points and fees limit) and income verification but
would not require the creditor to follow any other specific
underwriting procedures. Alternative 1 would have operated as a legal
safe harbor with the conclusive presumption of compliance.
The final rule maintains a minimum standard for documenting and
verifying loans and varies the legal liability with the perceived
consumer risk. Alternative 1, on the other hand, placed more emphasis
on the restrictions on product features to protect consumers. Loans
without interest-only, negative amortization or balloon features, or
where total points and fees do not exceed three points were assumed
safe and therefore had limited requirements for documenting income and
debt (relative to other loans) and were afforded the conclusive
presumption of compliance.
Compared to this alternative, the final rule with the temporary
provisions likely offers qualified mortgage status to a similar number
of loans: without the effects of the temporary provisions, fewer loans
would qualify as qualified mortgages. The final rule also mandates
stricter documentation and verification of qualified mortgages and
limits the presumption of compliance in the case of higher-priced
covered transactions. Compared to Alternative 1, only those loans that
meet the product, features and point-and-fee limitations and that have
a DTI ratio less than or equal to 43 percent are qualified mortgages.
This approach limits the reliance on compensating factors when
underwriting high DTI ratio loans and recognizes that while such loans
may be in the creditor's interest, there is a greater possibility that
the consumer may not have the ability to repay the loan. This change
likely increases costs slightly in order to provide this consumer
protection. Requiring the additional verification of debts for
qualified mortgages also provides additional consumer protection. Since
this is current practice in the market today, this likely adds very
little cost for the time being; however, it does impose costs as credit
expands to the point that the market would otherwise relax verification
requirements--as well as benefits to consumers and society at large
from preventing loans based on unverified (or no) data. Compared to
Alternative 1, the only difference in the strength of the liability
protection for qualified mortgages is for those loans above the higher-
priced threshold. In the final rule, these loans have a rebuttable
presumption of compliance rather than a conclusive presumption.
However, given that the legal standard today is a rebuttable
presumption, the final rule nearly maintains the status quo for
borrowers with HPMLs; adopting Alternative 1 would have been a slight
diminution of these borrower's legal rights.
The Board's Alternative 2 would have provided the lender with a
rebuttable presumption of compliance and would have defined a
``qualified mortgage'' as including the statutory criteria as well the
additional underwriting requirements from the general ability-to-repay
standard. The Board proposed to permit, but not require, creditors to
comply with the underwriting requirements by looking to ``widely
accepted governmental and non-governmental underwriting standards''
(such as the FHA's standards). The important difference between this
aspect of Alternative 2 and Alternative 1 is that, under Alternative 2,
the relative weights for such tradeoffs had to be derived from widely
accepted standards.
Compared to Alternative 2, the final rule with the temporary
provisions likely offers qualified mortgage status to a similar number
of loans; without the effects of the temporary provisions, fewer loans
would be eligible to be qualified mortgages. Under the final rule,
there is little difference in the documentation and verification
requirements; however, the presumption of compliance is strengthened
for the majority of qualified mortgages. Compared to Alternative 2 (and
to Alternative 1), only those loans that meet the product, features and
cost limitations and that have a DTI ratio less than or equal to 43
percent are qualified mortgages. This limits the use of compensating
factors for high DTI loans and recognizes that while such loans may be
in the creditor's interest, there is a greater possibility that the
consumer may not have the ability to repay the loan. This change likely
increases costs slightly in order to provide this consumer protection.
Both Alternative 2 and the final rule have very similar documentation
and verification standards so there is little difference in the
benefits and costs along that dimension. Relative to Alternative 2, the
difference in the liability standard is for those qualified mortgages
below the higher-priced threshold. In the final rule, these loans have
a conclusive presumption of compliance rather than just a rebuttable
presumption.
As noted in the preamble, a coalition of industry and consumer
advocates presented another alternative proposal to the Bureau that
would have provided a tiered approach to defining a qualified mortgage.
Under the first tier, if the consumer's total debt-to-income ratio is
43 percent or less, the loan would be a qualified mortgage, and no
other tests would be required. Under the second tier, if the consumer's
total debt-to-income ratio is more than 43 percent, the creditor would
apply a series of tests related to the consumer's front-end debt-to-
income ratio (housing debt to income), stability of income and past
payment history, availability of reserves, and residual income to
determine if a loan is a qualified mortgage. This would have allowed
some loans with up to 50 percent DTI ratios to meet the qualified
mortgage definition. To the extent that it relies on additional factors
beyond the DTI ratio, this alternative is similar to the Board's
approach. However, the coalition's proposal generally restricted the
factors considered to be factors related to ability to repay, rather
than other factors related to credit or collateral in its
determination. These commenters also supported a rebuttable presumption
standard for qualified mortgages.
Relative to this alternative, the final rule will likely include
fewer loans as qualified mortgages. The loans that will not be
qualified mortgages are those that would qualify only under one or more
of the additional factors besides DTI ratio that the alternative
included: housing expenses, stability of income, reserves etc. As a
result, these loans will have to meet the ability-to-repay standard of
the final rule, providing additional consumer protections with the
minor added costs described above. Relative to a rule including these
factors, the final rule is simpler and easier to implement for
industry, lowering costs overall. In addition, creditors are free to
include such factors in their own credit decisions and to

[[Page 6575]]

develop the best models for their inclusion. The Bureau views this more
dynamic outcome as a benefit relative to a more prescriptive rule
detailing how such factors should be traded off against each other.
This alternative did include a rebuttable presumption of compliance for
all qualified mortgages; as such, the final rule's safe harbor limits
liability costs and consumer benefits, as already discussed, for those
qualified mortgages that are not higher priced covered transactions.
As noted, the Bureau also considered certain alternatives to its
own version of the final rule. One such alternative would have used a
threshold of a 36 percent DTI ratio to define qualified mortgages. This
would have left roughly an additional 15 percent of loans, both during
the 1997-2003 period and during 2011, without a presumption of
compliance. As noted however, the Bureau believes that 43 percent is a
more efficient threshold: it is an accepted market standard, rates of
delinquency and default for borrowers between 36 and 43 percent are
still modest, and many borrowers--particularly in higher cost housing
markets--borrow at these levels.
The Bureau also considered whether all qualified mortgages should
have the same degree of presumption with the qualified mortgage
standard--either all being afforded a conclusive presumption of
compliance or all being afforded a rebuttable presumption. As discussed
in the section-by-section analysis, the Bureau determined that the
bifurcated approach in which only higher-priced covered transactions
provide the consumer with the opportunity to rebut the presumption of
compliance best balances the concerns of costs, certainty, and consumer
protection.

VIII. Final Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA) generally requires an agency
to conduct an initial regulatory flexibility analysis (IRFA) and a
final regulatory flexibility analysis (FRFA) of any rule subject to
notice-and-comment rulemaking requirements, unless the agency certifies
that the rule will not have a significant economic impact on a
substantial number of small entities.\236\ The Bureau also is subject
to certain additional procedures under the RFA involving the convening
of a panel to consult with small business representatives prior to
proposing a rule for which an IRFA is required.\237\
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\236\ For purposes of assessing the impacts of the final rule on
small entities, ``small entities'' is defined in the RFA to include
small businesses, small not-for-profit organizations, and small
government jurisdictions. 5 U.S.C. 601(6). A ``small business'' is
determined by application of Small Business Administration
regulations and reference to the North American Industry
Classification System (NAICS) classifications and size standards. 5
U.S.C. 601(3). A ``small organization'' is any ``not-for-profit
enterprise which is independently owned and operated and is not
dominant in its field.'' 5 U.S.C. 601(4). A ``small governmental
jurisdiction'' is the government of a city, county, town, township,
village, school district, or special district with a population of
less than 50,000. 5 U.S.C. 601(5).
\237\ 5 U.S.C. 609.
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In the 2011 ATR Proposal, the Board did not certify that the rule
would not have a significant economic impact on a substantial number of
small entities and therefore prepared an IRFA.\238\ In this IRFA the
Board solicited comment on any costs, compliance requirements, or
changes in operating procedures arising from the application of the
proposed rule to small businesses, comment regarding any state or local
statutes or regulations that would duplicate, overlap, or conflict with
the proposed rule, and comment on alternative means of compliance for
small entities with the ability-to-repay requirements and restrictions
on prepayment penalties. Comments addressing the ability-to-repay
requirements and restrictions on prepayment penalties are addressed in
the section-by-section analysis above. Comments addressing the impact
on the cost of credit are discussed below.
---------------------------------------------------------------------------

\238\ 76 FR 27479-27480.
---------------------------------------------------------------------------

1. A Statement of the Need for, and Objectives of, the Rule
The Bureau is publishing a final rule to establish new ability-to-
repay requirements related to mortgage origination. As discussed in the
preamble, the final rule's amendments to Regulation Z implement certain
amendments to TILA that were added by sections 1411, 1412, 1413, and
1414 of the Dodd-Frank Act in response to the recent foreclosure crisis
to address certain lending practices (such as low- or no-documentation
loans or underwriting mortgages without including any principal
repayments in the underwriting determination) that led to consumers
having mortgages they could not afford, thereby contributing to high
default and foreclosure rates.
A full discussion of the market failures motivating these
provisions of the Dodd-Frank Act and the final rule is included in the
preamble and in the Bureau's section 1022 analysis above. Those
discussions also describe the specific ways the final rule addresses
these issues. However, in general, the purpose of the Dodd-Frank Act
ability-to-repay requirements is to assure that consumers are offered
and receive residential mortgage loans on terms that reasonably reflect
their ability to repay the loans and that are understandable and not
unfair, deceptive or abusive. Prior to the Dodd-Frank Act, existing
Regulation Z provided ability-to-repay requirements for high-cost and
higher-priced mortgages. Accordingly, new TILA section 129C generally
prohibits a creditor from making a residential 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, including any
mortgage-related obligations (such as property taxes and mortgage
insurance). Consistent with the statute, the final rule applies the
ability-to-repay requirements of TILA section 129C to any consumer
credit transaction secured by a dwelling, except an open-end credit
plan, timeshare plan, reverse mortgage, or temporary loan.
Congress also recognized the importance of maintaining access to
responsible, affordable mortgage credit. To provide creditors more
certainty about their potential liability under the ability-to-repay
standards while protecting consumers from unaffordable loans, the Dodd-
Frank Act creates a presumption of compliance with the ability-to-repay
requirement when creditors make ``qualified mortgages.'' Qualified
mortgages do not contain certain features that Congress deemed to
create a risk to consumers' ability to repay, and must be underwritten
using standards set forth in the statute that are designed to assure
that consumers will have the ability to repay these loans. The final
rule establishes standards for complying with the ability-to-repay
requirements, including defining ``qualified mortgage.'' The final rule
provides three options for originating a qualified mortgage: under the
general definition in Sec. 1026.43(e)(2), for loans where the
consumer's monthly debt-to-income ratio would not exceed 43 percent;
under the definition Sec. 1026.43(e)(4), for a maximum of seven years,
for loans that are eligible for purchase by the GSEs while in
conservatorship or certain other Federal agencies, and under Sec.
1026.43(f), for loans that have balloon-payment features if the
creditor operates predominantly in rural or underserved areas and meets
certain asset-size and transaction volume limits.
Congress did not explicitly define the nature of the presumption of
compliance that attaches to a qualified mortgage. Congress also left
some contours of a qualified mortgage

[[Page 6576]]

undefined, such as whether there should be a minimum debt-to-income
ratio. Congress left these decisions to the Bureau and granted broad
authority to revise, add to, or subtract from the qualified mortgage
criteria upon a finding that doing so is ``necessary or proper'' or
``necessary and appropriate'' to achieve certain specified standards,
such as ensuring that responsible, affordable mortgage credit remains
available to consumers.
As discussed above, the final rule recognizes both the need to
assure that consumers are offered and receive loans based on a
reasonable and good faith determination of their repayment ability and
the need to ensure that responsible, affordable mortgage credit remains
available to consumers. The Bureau believes, based upon its analysis of
the data available to it, that, under the final rule, the vast majority
of loans originated today can meet the standards for a qualified
mortgage so long as creditors follow the required procedures, such as
verifying income or assets, and current debt obligations, alimony and
child support. The Bureau also believes, based upon its analysis of the
historical performance of loans meeting the rule's definition of
``qualified mortgages,'' that consumers will be able to repay these
loans. The Bureau believes that the final rule will not restrict
creditors' ability to make responsible loans, both within and outside
the qualified mortgage space.
The final rule provides special rules for complying with the
ability-to-repay requirements for a creditor refinancing a ``non-
standard mortgage'' into a ``standard mortgage.'' The purpose of this
provision is to provide flexibility for creditors to refinance a
consumer out of a risky mortgage into a more stable one without
undertaking a full underwriting process.
In addition to the ability-to-repay and qualified mortgage
provisions, the final rule implements the Dodd-Frank Act limits on
prepayment penalties and lengthens the time creditors must retain
records that evidence compliance with the ability-to-repay and
prepayment penalty provisions.
2. Summary of Significant Issues Raised by Comments in Response to the
Initial Regulatory Flexibility Analysis, Statement of the Assessment of
the Bureau of Such Issues, and a Statement of Any Changes Made as a
Result of Such Comments
The Board's IRFA estimated the possible compliance costs for small
entities from each major component of the rule against a pre-statute
baseline. The Board requested comments on the IRFA.
The Board did not receive any comments in its IRFA. Industry
commenters generally expressed concern with respect to the costs they
anticipated from the 2011 ATR Proposal. The Bureau received numerous
comments describing in general terms the impact of the proposed rule on
small creditors and the need for the qualified mortgage definition to
be structured as a safe harbor with clear, well-defined standards to
ensure that the largest number of consumers possible can access credit.
Small creditors are particularly concerned about the litigation risk
associated with the requirement to make a reasonable and good faith
determination of consumers' ability to repay based on verified and
documented information. Because of their size, small creditors note
that they are particularly unsuited to bear the burden and cost of
litigation and would find it particularly difficult to absorb the cost
of an adverse judgment. Indeed, small creditors insist that they will
not continue to make mortgage loans unless they are protected from
liability for violations of the ability-to-repay rules by a conclusive
presumption of compliance or ``safe harbor.'' These small creditors'
concerns about compliance with the ability-to-repay rule and associated
litigation risk have been repeatedly expressed to the Bureau by their
trade associations and prudential regulators.
Several commenters on the proposal urged the Bureau to adopt less
stringent regulatory requirements for small creditors or for loans held
in portfolio by small creditors. For example, at least two commenters
on the proposal, a credit union and a state trade group for small
banks, urged the Bureau to exempt small portfolio creditors from the
ability-to-repay and qualified mortgage rule. Two other trade group
commenters urged the Bureau to adopt less stringent regulatory
requirements for small creditors than for larger creditors at least in
part because mortgage loans made by small creditors often are held in
portfolio and therefore historically have been conservatively
underwritten.
Some industry commenters supported not including quantitative
standards for such variables as debt-to-income ratios and residual
income because they argued that underwriting a loan involves weighing a
variety of factors, and creditors and investors should be allowed to
exercise discretion and weigh risks for each individual loan. To that
point, one industry trade group commenter argued that community banks,
for example, generally have conservative requirements for a consumer's
debt-to-income ratio, especially for loans that are held in portfolio
by the bank, and consider many factors when underwriting for mortgage
loans, such as payment history, liquid reserves, and other assets.
Because several factors are considered and evaluated in the
underwriting process, this commenter asserted that community banks can
be flexible when underwriting for mortgage loans and provide
arrangements for certain consumers that fall outside of the normal
debt-to-income ratio for a certain loan. This commenter contended that
strict quantitative standards would inhibit community banks'
relationship lending and ability to use their sound judgment in the
lending process. Some commenters contended that requiring specific
quantitative standards could restrict credit access and availability
for consumers.
A number of other commenters expressed concerns that the
availability of portfolio mortgage loans from small creditors would be
severely limited because the proposed exception for rural balloon loans
was too restrictive. Some industry commenters urged the Bureau to allow
balloon mortgage loans held in portfolio by the originating banks for
the life of the loan to be included under this safe harbor so that
small creditors could continue to meet the specific needs of their
customers.
These comments, and the responses, are discussed in the section-by-
section analysis and element 6-1 of this FRFA.
3. Response to the Small Business Administration Chief Counsel for
Advocacy
The SBA Office of Advocacy (Advocacy) provided a formal comment
letter to the Bureau in response to the Bureau's reopening of the
comment period for certain issues relating to the ability-to-repay/
qualified mortgage rulemaking. Among other things, this letter
expressed concern about the following issues: the qualified mortgage
definition and the use of data as a means for measuring a consumer's
ability to repay.
First, Advocacy expressed concern that the qualified mortgage
definition will have major implications on the viability of community
banks. Advocacy pointed to the assertion made by small banks that they
will no longer originate mortgage loans if they are only provided with
a rebuttable presumption of compliance. In addition, according to
Advocacy, small banks contend that establishing the qualified mortgage
as a

[[Page 6577]]

rebuttable presumption of compliance will reduce the availability and
affordability of mortgages to consumers due to increased litigation and
compliance costs, and the exit by certain small lenders unable to
manage the risk. According to Advocacy, small banks assert that one way
to enable them to compete effectively (and to ensure consumers can
obtain affordable loans) is to establish the qualified mortgage as a
safe harbor and allow for non-traditional loans such as mortgages with
balloon payments to continue to be made.
The Bureau carefully considered the arguments for establishing the
qualified mortgage as a safe harbor or rebuttable presumption of
compliance in light of the proposed rule, and a complete discussion of
the consideration of the Bureau's final rule can be found in the
respective section of the section-by-section analysis, the Bureau's
section 1022(b)(2) discussion, and in element 6-1 of this FRFA.
As discussed in more detail elsewhere, the final rule provides a
safe harbor under the ability-to-repay requirements for mortgage loans
that satisfy the definition of a qualified mortgage and are not higher-
priced covered transactions (i.e., APR does not exceed Average Prime
Offer Rate (APOR) \239\ + 1.5 percentage points for first liens or 3.5
percentage points for subordinate liens). The final rule provides a
rebuttable presumption for all other qualified mortgage loans, meaning
qualified mortgage loans that are higher-priced covered transactions
(i.e., APR exceeds APOR + 1.5 percentage points for first lien or 3.5
percentage points for subordinate lien). The Bureau believes that a
bifurcated approach to the presumption of compliance provides the best
way of balancing consumer protection and access to credit
considerations and is consistent with the purposes of the statute,
while calibrating consumer protections and risk levels to match the
historical record of loan performance. To reduce uncertainty in
potential litigation, the final rule defines the standard by which a
consumer may rebut the presumption of compliance afforded to higher-
priced qualified mortgages.
---------------------------------------------------------------------------

\239\ The Average Prime Offer Rate means ``the average prime
offer rate for a comparable transaction as of the date on which the
interest rate for the transaction is set, as published by the
Bureau.'' TILA section 129C(b)(2)B).
---------------------------------------------------------------------------

The Bureau notes that the Board's proposed Sec. 1026.43 did not
include special provisions for portfolio loans made by small creditors
and the Board's proposal did not address such an accommodation.
However, this final rule is related to a proposed rule published
elsewhere in today's Federal Register. As discussed in more detail
below, in that proposal, the Bureau is proposing certain amendments to
this final rule, including a proposal to define as a qualified mortgage
a larger category of loans made and held in portfolio by small
creditors than this final rule defines as a qualified mortgage.
Second, Advocacy expressed concern about using loan performance, as
measured by the delinquency rate, as an appropriate metric to evaluate
whether consumers had the ability to repay at the time their loans were
consummated. Advocacy noted that a consumer's circumstances might
change after the loan was made due to unemployment or illness. The
Bureau agrees that consumers' circumstances can change and lead to
delinquency or default. However, the Bureau also believes that DTI is
an indicator of the consumer's ability to repay. All things being
equal, consumers carrying loans with higher DTI ratios will be less
able to absorb any such shocks and are more likely to default.
4. A Description of and an Estimate of the Number of Small Entities to
Which the Rule Will Apply
The final rule will apply to creditors that engage in originating
or extending certain dwelling-secured credit. The credit provisions of
TILA and Regulation Z have broad applicability to individuals and
businesses that originate and extend even small numbers of home-secured
credit. See 1026.1(c)(1).\240\ Small entities that originate or extend
closed-end loans secured by a dwelling are potentially subject to at
least some aspects of the final rule.
---------------------------------------------------------------------------

\240\ Regulation Z generally applies to ``each individual or
business that offers or extends credit when four conditions are met:
(i) The credit is offered or extended to consumers; (ii) the
offering or extension of credit is done regularly; (iii) the credit
is subject to a finance charge or is payable by a written agreement
in more than four installments, and (iv) the credit is primarily for
personal, family, or household purposes.'' Section 1026.1(c)(1).
Regulation Z provides, in general, that a person regularly extends
consumer credit only if the person extended credit more than 5 times
for transactions secured by a dwelling in the preceding year.
---------------------------------------------------------------------------

For purposes of assessing the impacts of the final rule on small
entities, ``small entities'' is defined in the RFA to include small
businesses, small nonprofit organizations, and small government
jurisdictions. 5 U.S.C. 601(6). A ``small business'' is determined by
application of SBA regulations and reference to the North American
Industry Classification System (NAICS) classifications and size
standards.\241\ 5 U.S.C. 601(3). Under such standards, banks and other
depository institutions are considered ``small'' if they have $175
million or less in assets, and for other financial businesses, the
threshold is average annual receipts (i.e., annual revenues) that do
not exceed $7 million.\242\
---------------------------------------------------------------------------

\241\ The current SBA size standards are found on SBA's Web site
at https://www.sba.gov/content/table-small-business-size-standards.
\242\ See id.
---------------------------------------------------------------------------

The Bureau can identify through data under the Home Mortgage
Disclosure Act, Reports of Condition and Income (Call Reports), and
data from the National Mortgage Licensing System (NMLS) the approximate
numbers of small depository institutions that will be subject to the
final rule. Origination data is available for entities that report in
HMDA, NMLS or the credit union call reports; for other entities, the
Bureau has estimated their origination activities using statistical
projection methods.
The following table provides the Bureau's estimate of the number
and types of entities to which the rule will apply:

[[Page 6578]]

[GRAPHIC] [TIFF OMITTED] TR30JA13.000

5. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
The final rule does not impose new reporting requirements. The
final rule does, however, impose new recordkeeping and other compliance
requirements on certain small entities. The requirements on small
entities from each major component of the rule are presented below.
The Bureau discusses impacts against a pre-statute baseline. This
baseline assumes compliance with the Federal rules that overlap with
the final rule. The impact of the rule relative to the pre-statute
baseline will be smaller than the impact would be if not for compliance
with the existing Federal rules. In particular, creditors have already
incurred some of the one-time costs necessary to comply with the final
rule when they came into compliance with the 2008 HOEPA Final Rule on
higher-priced mortgage loans. And creditors already have budgeted for
some of the ongoing costs of the final rule to the extent those are
costs necessary to remaining in compliance with the 2008 HOEPA Final
Rule. These expenses attributable to the 2008 HOEPA Final Rule will
facilitate and thereby reduce the cost of compliance with this final
rule.
Recordkeeping Requirements
The final rule imposes new record retention requirements on covered
persons. As discussed above, the final rule requires creditors to
retain evidence of compliance with Sec. 1026.43 (containing the
ability-to-repay/qualified mortgage provisions and prepayment penalty
restrictions) for three years after consummation. The final rule
clarifies that creditors need not maintain actual paper copies of the
documentation used to underwrite a transaction. For most covered
persons, the required records will be kept in electronic form and
creditors need retain only enough information to reconstruct the
required records. This should limit any burden associated with the
record retention requirement for creditors.
Other Compliance Requirements
As discussed in detail in the section-by-section analysis and the
Bureau's section 1022(b)(2) discussion above, the final rule imposes
new compliance requirements on creditors. In general, creditors will
have to update their policies and procedures; additionally, creditors
may have to update their systems, for example, to store flags
identifying qualified mortgages, and to ensure compliance. The Bureau
believes that small creditors' major one-time costs will be to learn
about the final rule, consider whether they need to modify their
underwriting practices and procedures to comply with the rule and, if
necessary, modify their practices and procedures. The precise costs to
small entities of modifying their underwriting practices, should they
need to do so, are difficult to predict. These costs will depend on a
number of factors, including, among other things, the current practices
and systems used by such entities to collect and analyze consumer
income, asset, and liability information, the complexity of the terms
of credit products that they offer, and the range of such product
offerings. To the extent that most small creditors' processes already
align with the rule, any additional compliance costs should be minimal.
When originating mortgages, the creditor must calculate the monthly
mortgage payment based on the greater of the fully indexed rate or any
introductory rate, assuming monthly, fully amortizing payments that are
substantially equal. The final rule provides special payment
calculation rules for loans with balloon payments, interest-only loans,
and negative amortization loans. The final rule may therefore increase
compliance costs for small entities, particularly for creditors that
offer products that contain balloon payments, interest-only loans, and
negative amortization loans. The precise costs to small entities of
updating their processes and systems to account for these additional
calculations are difficult to predict, but these costs are mitigated,
in some circumstances, by the presumption of compliance or safe harbor
for qualified mortgages.
The Final Rule also includes requirements for documentation and
verification of certain information that the creditor must consider in
assessing a consumer's repayment ability. The final rule provides
special rules for verification of a consumer's income or assets, and
provides examples of records that can be used. Different verification

[[Page 6579]]

requirements apply to qualified mortgages. Creditors that originate
qualified mortgages under the general definition must verify a
consumer's income or assets, current debt obligations, alimony, and
child support, and must also verify a consumer's monthly debt-to-income
ratio. The final rule does not contain specific verification
requirements for creditors originating qualified mortgages under the
temporary provisions; however, such loans must comply with eligibility
requirements (including underwriting requirements) of the GSEs or the
Federal agency program applicable to the loan.
The final rule also provides special rules for complying with the
ability-to-repay requirements for a creditor refinancing a ``non-
standard mortgage'' into a ``standard mortgage.'' This provision is
based on TILA section 129C(a)(6)(E), which contains special rules for
the refinance of a ``hybrid loan'' into a ``standard loan.'' The
purpose of this provision is to provide flexibility for creditors to
refinance a consumer out of a risky mortgage into a more stable one
without undertaking a full underwriting process. Under the final rule,
a non-standard mortgage is defined as an adjustable-rate mortgage with
an introductory fixed interest rate for a period of one year or longer,
an interest-only loan, or a negative amortization loan. Under this
option, a creditor refinancing a non-standard mortgage into a standard
mortgage does not have to consider the eight specific underwriting
criteria under the general ability-to-repay option, if certain
conditions are met, thus reducing compliance costs for small entities.
Prepayment limitations, as discussed in detail in the section-by-
section analysis and the Bureau's section 1022 analysis, are also
included in the final rule.
Estimate of the Classes of Small Entities Which Will Be Subject to the
Requirement
Section 603(b)(4) of the RFA requires an estimate of the classes of
small entities which will be subject to the requirement. The classes of
small entities which will be subject to the reporting, recordkeeping,
and compliance requirements of the final rule are the same classes of
small entities that are identified above in part VIII.B.4.
Section 604(a)(5) of the RFA also requires an estimate of the type
of professional skills necessary for the preparation of the reports or
records. The Bureau anticipates that the professional skills required
for compliance with the final rule are the same or similar to those
required in the ordinary course of business of the small entities
affected by the final rule. Compliance by the small entities that will
be affected by the final rule will require continued performance of the
basic functions that they perform today: Managing information about
consumers and conducting sound underwriting practices for mortgage
originations.
6-1. Description of the Steps the Agency has Taken To Minimize the
Significant Economic Impact on Small Entities
The Bureau understands the new provisions will impose a cost on
small entities, and has attempted to mitigate the burden consistent
with statutory objectives. The Bureau has also taken numerous
additional steps that are likely to reduce the overall cost of the
rule. Nevertheless, the rule will certainly create new one-time and
ongoing costs for creditors. The section-by-section analysis of each
provision and the Bureau's section 1022 analysis contain a complete
discussion of the following steps taken to mitigate the burden.
The final rule provides small creditors with the option of offering
only qualified mortgages, which will enjoy either a presumption of
compliance with respect to the repayment ability requirement (for
higher-priced covered transactions) or a safe harbor from the repayment
ability requirement, thus reducing litigation risks and costs for small
creditors.
The Bureau believes that a variety of underwriting standards can
yield reasonable, good faith ability-to-repay determinations. The
Bureau is permitting creditors to develop and apply their own
underwriting standards (and to make changes to those standards over
time in response to empirical information and changing economic and
other conditions) as long as those standards lead to ability-to-repay
determinations that are reasonable and in good faith. In addition, the
Bureau will permit creditors to use their own definitions and other
technical underwriting criteria and notes that underwriting guidelines
issued by governmental entities such as the FHA are a source to which
creditors may refer for guidance on definitions and technical
underwriting criteria. The Bureau believes this flexibility is
necessary given the wide range of creditors, consumers, and mortgage
products to which this rule applies. The Bureau believes this increased
flexibility will reduce the burden on small creditors by allowing them
to determine the practices that fit best with their business model.
Qualified Mortgage Provisions
The general definition of the qualified mortgage includes a very
clear standard of 43 percent for the debt-to-income threshold and clear
methods to compute that figure. The clarity of this provision, and
others, should make implementation of and compliance with these
provisions of the rule. The Bureau carefully considered the arguments
for establishing the qualified mortgage as a safe harbor or rebuttable
presumption of compliance in light of the proposed rule, and a complete
discussion of the consideration of the Bureau's final rule can be found
in the respective section of the section-by-section analysis. The final
rule establishes standards for complying with the ability-to-repay
requirements, including defining ``qualified mortgage.'' The final rule
provides three options for originating a qualified mortgage: under the
general definition in Sec. 1026.43(e)(2), for loans where the
consumer's monthly debt-to-income ratio would not exceed 43 percent;
under the definition Sec. 1026.43(e)(4), for a maximum of seven years,
for loans that are eligible for purchase by the GSEs while in
conservatorship or certain other Federal agencies, and under Sec.
1026.43(f), for loans that have balloon-payment features if the
creditor operates predominantly in rural or underserved areas and meets
certain asset-size and transaction volume limits. The final rule
provides a safe harbor under the ability-to-repay requirements for
mortgage loans that satisfy the definition of a qualified mortgage and
are not higher-priced covered transactions (i.e., APR does not exceed
Average Prime Offer Rate (APOR) \243\ + 1.5 percentage points for first
liens or 3.5 percentage points for subordinate liens). The final rule
provides a rebuttable presumption for all other qualified mortgage
loans, meaning qualified mortgage loans that are higher-priced covered
transactions (i.e., APR exceeds APOR + 1.5 percentage points for first
lien or 3.5 percentage points for subordinate lien).
---------------------------------------------------------------------------

\243\ The Average Prime Offer Rate means ``the average prime
offer rate for a comparable transaction as of the date on which the
interest rate for the transaction is set, as published by the
Bureau.'' TILA section 129C(b)(2)B).
---------------------------------------------------------------------------

The Bureau believes that a bifurcated approach to the presumption
of compliance provides the best way of balancing consumer protection
and access to credit considerations and is consistent with the purposes
of the statute, while calibrating consumer protections and risk levels
to match the historical record of loan performance. To reduce
uncertainty in potential

[[Page 6580]]

litigation, the final rule defines the standard by which a consumer may
rebut the presumption of compliance afforded to higher-priced qualified
mortgages. The Bureau's approach to the standards with which a consumer
can rebut the presumption that applies to higher-priced transactions is
further designed to ensure careful calibration.
The Bureau considered several alternatives, including only the safe
harbor standard and only the rebuttable presumption standard. In its
rulemaking, the Bureau tried to balance consumers' access to credit
concerns with the consumer protection associated with reducing
consumers' cost of litigation. Compared to the final rule, only the
safe harbor standard marginally increased consumers' access to credit,
but significantly reduced consumer protection. Conversely, only the
rebuttable presumption standard marginally increased consumer
protection, but significantly decreased consumers' access to credit.
Balloon-Payment Qualified Mortgage Provisions
The Bureau has also provided an exception to the general provision
that a qualified mortgage may not provide for a balloon payment for
loans that are originated by certain small creditors and that meet
specified criteria. The Bureau understands that community banks
originate balloon-payment loans to hedge against interest rate risk,
rather than making adjustable-rate mortgages, and that community banks
hold these balloon-payment loans in portfolio virtually without
exception because they are not eligible for sale in the secondary
market. Under the final rule, the Bureau is permitting small creditors
operating predominantly in rural or underserved areas to originate a
balloon-payment qualified mortgage.
Unlike loans that are qualified mortgages under the general
definition, there is no specific debt-to-income ratio requirement for
balloon-payment qualified mortgages. However, creditors must consider
and verify a consumer's monthly debt-to-income ratio. Like the other
qualified mortgage definitions, a loan that satisfies the criteria for
a balloon-payment qualified mortgage and is not a higher-priced covered
transaction receives a legal safe harbor under the ability-to-repay
requirements. A loan that satisfies those criteria and is a higher-
priced covered transaction receives a rebuttable presumption of
compliance with the ability-to-repay requirements. The Bureau believes
that this exception will decrease the economic impact of the final rule
on small entities. In response to concerns regarding the proposed
provisions for holding balloon-payment loans in portfolio, the final
rule provides more flexible portfolio requirements which permit certain
transfers.
Concurrent Proposal for Portfolio Loans Made by Small Creditors
The Bureau notes that the Board's proposal did not include special
provisions for portfolio loans made by small creditors and the Board's
proposal did not address such an accommodation.
The Bureau understands that creditors generally have in place
underwriting policies, procedures, and internal controls that require
verification of the consumer's reasonably expected income or assets,
employment status, debt obligations and simultaneous loans, and debt-
to-income or residual income. Notably, in response to the proposal,
commenters stated that most creditors today are already complying with
the full ability-to-repay underwriting standards. For these
institutions, there would be no additional burden as a result of the
verification requirements in the final rule, since those institutions
collect the required information in the normal course of business. To
the extent small creditors do not verify and document some or all of
the information required by the proposed rule in the normal course of
business, they will need to engage in certain one-time implementation
efforts and system adjustments. These one-time costs might include
expenses related to creditors needing to reanalyze their product lines,
retrain staff, and reorganize the processing and administrative
elements of their mortgage operations.
In a related proposed rule published elsewhere in today's Federal
Register, the Bureau is proposing certain amendments to this final
rule, including an additional definition of a qualified mortgage for
certain loans made and held in portfolio by small creditors. The
proposed new category would include certain loans originated by small
creditors that: (1) Have total assets less than $2 billion at the end
of the previous calendar year; and (2) together with all affiliates,
originated 500 or fewer covered transactions, secured by first-liens
during the previous calendar year. These loans generally conform the
requirements under the general definition of a qualified mortgage
except the 43 percent limit on monthly debt-to-income ratio. Under the
proposed additional definition, a creditor would not have to use the
instructions in the appendix to the final rule to calculate debt-to-
income ratio, and a loan with a consumer debt-to-income ratio higher
than 43 percent could be a qualified mortgage if all other criteria are
met.
The Bureau also is proposing to allow small creditors to charge a
higher annual percentage rate for first-lien qualified mortgages in the
proposed new category and still benefit from a conclusive presumption
of compliance or ``safe harbor.'' In addition, the Bureau also is
proposing to allow small creditors operating predominantly in rural or
underserved areas to offer first-lien balloon loans with a higher
annual percentage rate and still benefit from a conclusive presumption
of compliance with the ability to repay rules or ``safe harbor.'' The
Bureau is proposing these changes because it believes they may be
necessary to preserve access to credit for some consumers. The
regulatory requirement to make a reasonable and good faith
determination based on verified and documented evidence that a consumer
has a reasonable ability to repay may entail significant litigation
risk for small creditors. The Bureau believes that small creditors have
historically engaged in responsible mortgage underwriting that includes
thorough and thoughtful determinations of consumers' ability to repay,
at least in part because they bear the risk of default associated with
loans held in their portfolios. The Bureau also believes that because
small creditors' lending model is based on maintaining ongoing,
mutually beneficial relationships with their customers, they therefore
have a more comprehensive understanding of their customers' financial
circumstances and are better able to assess ability to repay than
larger creditors.
Further, the Bureau understands that the only sources of mortgage
credit available to consumers in rural and underserved areas may be
small creditors because larger creditors may be unable or unwilling to
lend in these areas. For these reasons, the Bureau is proposing a new
category of qualified mortgages that would include small creditor
portfolio loans and is also proposing to raise the annual percentage
rate threshold for the safe harbor to accommodate small creditors'
higher costs. The Bureau believes these steps may be necessary to
preserve some rural and underserved consumers' access to non-conforming
credit.
6-2. Description of the Steps the Agency Has Taken To Minimize Any
Additional Cost of Credit for Small Entities
Section 603(d) of the RFA requires the Bureau to consult with small
entities regarding the potential impact of the proposed rule on the
cost of credit for small entities and related matters. 5

[[Page 6581]]

U.S.C. 603(d). The Bureau notes that the Board was not subject to this
requirement when it issued its IRFA.
The Bureau does not believe that the final rule will result in an
increase in the cost of business credit for small entities. Instead,
the final rule will apply only to mortgage loans obtained by consumers
primarily for personal, family, or household purposes and the final
rule will not apply to loans obtained primarily for business purposes.
Given that the final rule does not increase the cost of credit for
small entities, the Bureau has not taken additional steps to minimize
the cost of credit for small entities.

IX. Paperwork Reduction Act Analysis

Certain provisions of this final rule contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995 (44 U.S.C. 3501 et seq.) (Paperwork Reduction Act
or PRA).
This final rule amends 12 CFR part 1026 (Regulation Z). Regulation
Z currently contains collections of information approved by the Office
of Management and Budget (OMB). The Bureau's OMB control number for
Regulation Z is 3170-0015. The PRA (44 U.S.C 3507(a), (a)(2) and
(a)(3)) requires that a Federal agency may not conduct or sponsor a
collection of information unless OMB approved the collection under the
PRA and the OMB control number obtained is displayed. Further,
notwithstanding any other provision of law, no person is required to
comply with, or is subject to any penalty for failure to comply with, a
collection of information that does not display a currently valid OMB
control number (44 U.S.C. 3512).
This final rule contains information collection requirements that
have not been approved by the OMB and, therefore, are not effective
until OMB approval is obtained. The unapproved information collection
requirements are contained in sections 1026.25(c)(3) and 1026.43(c)-(f)
of these regulations. The Bureau will publish a separate notice in the
Federal Register announcing the submission of these information
collection requirements to OMB as well as OMB's action on these
submissions; including, the OMB control number and expiration date.
On May 11, 2011, the Board of Governors of the Federal Reserve
System (Board) published notice of the proposed rule in the Federal
Register (76 FR 27390). The information collection requirements in
Sec. Sec. 1026.25(c)(3) and 1026.43(c)-(f) were contained in the
Board's proposal; however, these requirements were not separately
discussed in the proposal's PRA section. For full public transparency,
the Bureau now claims these requirements as information collections.
The Bureau received no PRA-related comments to the Board's proposal on
the information collections in Sec. Sec. 1026.25(c)(3) and 1026.43(c).

A. Overview

As described below, the final rule amends the collections of
information currently in Regulation Z to implement amendments to TILA
made by the Dodd-Frank Act. The Dodd-Frank 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).
TILA section 129C(a); 15 U.S.C. 1639c(a). The Dodd-Frank Act provides
special protection from liability for creditors who make ``qualified
mortgages.'' TILA section 129C(b); 15 U.S.C. 1639c(b). The purpose of
the Dodd-Frank Act ability-to-repay requirement is to assure that
consumers are offered and receive residential mortgage loans on terms
that reasonably reflect their ability to repay the loans and that are
understandable and not unfair, deceptive or abusive. TILA section
129B(a)(2); 15 U.S.C. 1639b(a)(2). Prior to the Dodd-Frank Act,
existing Regulation Z provided ability-to-repay requirements for high-
cost and higher-priced mortgage loans. The Dodd-Frank Act expanded the
scope of the ability-to-repay requirement to cover all residential
mortgage loans.
The final rule establishes standards for complying with the
ability-to-repay requirement, including defining ``qualified
mortgage.'' The final rule provides three options for originating a
qualified mortgage: under the general definition in Sec.
1026.43(e)(2), for loans where the consumer's monthly debt-to-income
ratio do not exceed 43 percent; under the definition Sec.
1026.43(e)(4), for a maximum of seven years, for loans that are
eligible for purchase by the GSEs while in conservatorship or certain
other Federal agencies, and under Sec. 1026.43(f), for loans that have
a balloon-payment if the creditor operates predominantly in rural or
underserved areas and meets certain underwriting requirements, and
asset-size and transaction volume limits.
In addition to the ability-to-repay and qualified mortgage
provisions, the final rule implements the Dodd-Frank Act limits on
prepayment penalties and lengthens the time creditors must retain
records that evidence compliance with the ability-to-repay and
prepayment penalty provisions. Currently, Regulation Z requires
creditors to retain evidence of compliance for two years after
disclosures must be made or action must be taken. The final rule amends
Regulation Z to require creditors to retain evidence of compliance with
the ability-to-repay/qualified mortgage provisions and prepayment
penalty restrictions in Sec. 1026.43 for three years after
consummation for consistency with statute of limitations on claims
under TILA section 129C. See generally the section-by-section analysis
of Sec. Sec. 1026.25 and 1026.43, above.
The information collection in the final rule is required to provide
benefits for consumers and would be mandatory. See 15 U.S.C. 1601 et
seq.; 12 U.S.C. 2601 et seq. Because the Bureau does not collect any
information under the final rule, no issue of confidentiality arises.
The likely respondents would be depository institutions (i.e.,
commercial banks/savings institutions and credit unions) and non-
depository institutions (i.e., mortgage companies or other non-bank
lenders) subject to Regulation Z.\244\
---------------------------------------------------------------------------

\244\ For purposes of this PRA analysis, references to
``creditors'' or ``lenders'' shall be deemed to refer collectively
to commercial banks, savings institutions, credit unions, and
mortgage companies (i.e., non-depository lenders), unless otherwise
stated. Moreover, reference to ``respondents'' shall generally mean
all categories of entities identified in the sentence to which this
footnote is appended, except as otherwise stated or if the context
indicates otherwise.
---------------------------------------------------------------------------

Under the final rule, the Bureau generally accounts for the
paperwork burden associated with Regulation Z for the following
respondents pursuant to its administrative enforcement authority:
insured depository institutions with more than $10 billion in total
assets, their depository institution affiliates, and certain
nondepository lenders. The Bureau and the FTC generally both have
enforcement authority over non-depository institutions for Regulation
Z. Accordingly, the Bureau has allocated to itself half of the
estimated burden to non-depository institutions. Other Federal agencies
are responsible for estimating and reporting to OMB the total paperwork
burden for the institutions for which they have administrative
enforcement authority. They may, but are not required to, use the
Bureau's burden estimation methodology.
Using the Bureau's burden estimation methodology, the total
estimated burden under the changes to Regulation Z for all of the
nearly 14,300 institutions subject to the final rule, including

[[Page 6582]]

Bureau respondents,\245\ would be approximately 14,300 hours for one-
time changes. The aggregate estimates of total burdens presented in
this part VIII are based on estimated costs that are weighted averages
across respondents. The Bureau expects that the amount of time required
to implement each of the changes for a given institution may vary based
on the size, complexity, and practices of the respondent.
---------------------------------------------------------------------------

\245\ There are 153 depository institutions (and their
depository affiliates) that are subject to the Bureau's
administrative enforcement authority. In addition there are 146
privately insured credit unions that are subject to the Bureau's
administrative enforcement authority. For purposes of this PRA
analysis, the Bureau's respondents under Regulation Z are 135
depository institutions that originate either open or closed-end
mortgages; 77 privately insured credit unions that originate either
open or closed-end mortgages; and an estimated 2,787 non-depository
institutions that are subject to the Bureau's administrative
enforcement authority. Unless otherwise specified, all references to
burden hours and costs for the Bureau respondents for the collection
under Regulation Z are based on a calculation that includes one half
of burden for the estimated 2,787 nondepository institutions and 77
privately insured credit unions.
---------------------------------------------------------------------------

B. Information Collection Requirements

The Bureau believes the following aspects of the final rule would
be information collection requirements under the PRA.
1. Ability-To-Repay Verification and Documentation Requirements
Section 1026.43(c)(2) of the final rule contains eight specific
criteria that a creditor must consider in assessing a consumer's
repayment ability. Section 1026.43(c)(3) of the final rule requires
creditors originating residential mortgage loans to verify the
information that the creditor relies on in determining a consumer's
repayment ability under Sec. 1026.43(c)(2) using reasonably reliable
third-party records. Section 1026.43(c)(4) of the final rule provides
special rules for verification of a consumer's income or assets, and
provides examples of records that can be used to verify the consumer's
income or assets (for example, tax-return and payroll transcripts).
If a creditor chooses to make a qualified mortgage, different
verification requirements apply to qualified mortgages. Creditors that
originate qualified mortgages under Sec. 1026.43(e)(2) or (f) must
verify a consumer's income or assets, and current debt obligations,
alimony and child support and must also verify a consumer's monthly
debt-to-income ratio (or, in the case of qualified mortgages under
Sec. 1026.43(f), residual income). The final rule does not contain
specific verification requirements for creditors originating qualified
mortgages under Sec. 1026.43(e)(4); however, such loans must comply
with eligibility requirements (including underwriting requirements) of
the GSEs or the Federal agency program applicable to the loan.
The Bureau estimates one-time and ongoing costs to respondents of
complying with the requirements in Sec. 1026.43 as follows.
One-time costs. The Bureau estimates that covered persons will
incur one-time costs associated with reviewing the final rule.
Specifically, the Bureau estimates that, for each covered person, one
attorney and one compliance officer will each take 21 minutes (42
minutes in total) to read and review the sections of the Federal
Register that describe the verification and documentation requirements,
based on the length of the sections.
The Bureau estimates the one-time costs to the 135 depository
institutions (including their depository affiliates) that are mortgage
originator respondents of the Bureau under Regulation Z would be
$7,700, or 94 hours. For the estimated 2,787 nondepository institutions
and 77 privately insured credit unions that are subject to the Bureau's
administrative enforcement authority, the Bureau is taking the half the
burden for purposes of this PRA analysis. Accordingly, the Bureau
estimates the total one-time costs across all relevant providers of
reviewing the relevant sections of the Federal Register to be about
1000 hours or roughly $81,000.
Ongoing costs. The Bureau does not believe that the verification
and documentation requirements of the final rule will result in
additional ongoing costs for most covered persons. The Bureau
understands that creditors generally have in place underwriting
policies, procedures, and internal controls that require verification
of the consumer's reasonably expected income or assets, employment
status, debt obligations and simultaneous loans, credit history, and
debt-to-income or residual income. Notably, in response to the 2011 ATR
Proposal, commenters stated that most creditors today are already
complying with the full ability-to-repay underwriting standards. For
these institutions, there would be no additional burden as a result of
the verification requirements in the final rule, since those
institutions collect the required information in the normal course of
business.
2. Record Retention Requirement
The final rule imposes new record retention requirements on covered
persons. As discussed above in part V, the final rule requires
creditors to retain evidence of compliance with Sec. 1026.43
(containing the ability-to-repay/qualified mortgage provisions and
prepayment penalty restrictions) for three years after consummation.
See part V above, section-by-section analysis of Sec. 1026.25.
The Bureau estimates one-time and ongoing costs to respondents of
complying with the record retention requirement in Sec. 1026.25 as
follows.
One-time costs. The Bureau estimates that covered persons will
incur one-time costs associated with reviewing the final rule.
Specifically, the Bureau estimates that, for each covered person, one
attorney and one compliance officer will each take 9 minutes (18
minutes in total) to read and review the sections of the final rule
that describe the record retention requirements, based on the length of
the sections.
The Bureau estimates the one-time costs to the 135 depository
institutions (including their depository affiliates) that are mortgage
originator respondents of the Bureau under Regulation Z would be
$3,300, or 40 hours. For the estimated 2,787 nondepository institutions
and 77 privately insured credit unions that are subject to the Bureau's
administrative enforcement authority, the Bureau is taking the half the
burden for purposes of this PRA analysis. Accordingly, the Bureau
estimates the total one-time costs across all relevant providers of
reviewing the relevant sections of the Federal Register to be about 430
hours or roughly $35,000.
Ongoing costs. The Bureau believes that any burden associated with
the final rule's record keeping requirement will be minimal or de
minimis. Under current rules, creditors must retain evidence of
compliance with Regulation Z for two years after consummation; the
final rule extends that period to three years after consummation for
evidence of compliance with the ability-to-repay/qualified mortgage
provisions and the prepayment penalty limitations in this final rule.
The final rule clarifies that creditors need retain only enough
information to reconstruct the required records.
The final rule clarifies that creditors need not maintain actual
paper copies of the documentation used to underwrite a transaction. See
comments 25(a)(2) and 25(c)(3)-1. For most covered persons, the
required records will be kept in electronic form. This further reduces
any burden associated with the final rule's record retention
requirement for creditors that keep the required records in electronic
form, as the only additional requirement will be to store data for an
additional year, to

[[Page 6583]]

the extent such creditors are currently storing such data for the
minimum period required by Regulation Z.
Furthermore, the Bureau believes that many creditors will retain
such records for at least three years in the ordinary course of
business, even in the absence of a change to record retention
requirements, due to the Dodd-Frank Act's extension of the statute of
limitations for civil liability for violations of the prepayment
penalty provisions or ability-to-repay provisions (including the
qualified mortgage provisions) to three years after the date of a
violation. Even absent the rule, the Bureau believes that most
creditors will retain records of compliance with Sec. 1026.43 for the
life of the loan, given that the statute allows borrowers to bring a
defensive claim for recoupment or setoff in the event that a creditor
or assignee initiates foreclosure proceedings.

C. Summary of Burden Hours

The below table summarizes the one time and annual burdens under
Regulation Z associated with information collections affected by the
final rule for Bureau respondents under the PRA. For the two
collections, the one-time burden for Bureau respondents is
approximately 1,570 hours.
The Consumer Financial Protection Bureau has a continuing interest
in the public's opinions of our collections of information. At any
time, comments regarding the burden estimate, or any other aspect of
this collection of information, including suggestions for reducing the
burden, may be sent to:
The Consumer Financial Protection Bureau (Attention: PRA Office),
1700 G Street NW., Washington, DC, 20552, or by the internet to CFPB_Public_PRA@cfpb.gov.

List of Subjects in 12 CFR Part 1026

Advertising, Consumer protection, Mortgages, Reporting and
recordkeeping requirements, Truth in Lending.

Authority and Issuance

For the reasons set forth in the preamble, the Bureau amends
Regulation Z, 12 CFR part 1026, as set forth below:

PART 1026--TRUTH IN LENDING (REGULATION Z)

0
1. The authority citation for part 1026 continues to read as follows:

Authority: 12 U.S.C. 2601; 2603-2605, 2607, 2609, 2617, 5511,
5512, 5532, 5581; 15 U.S.C. 1601 et seq.

Subpart D--Miscellaneous

0
2. Section 1026.25 is amended by:
0
A. Revising paragraph (a); and
0
B. Adding and reserving paragraphs (c)(1) and (c)(2).
0
C. Adding paragraph (c)(3).
The additions and revisions read as follows:

Sec. 1026.25 Record retention.

(a) General rule. A creditor shall retain evidence of compliance
with this regulation, other than advertising requirements under
Sec. Sec. 1026.16 and 1026.24 and certain requirements for mortgage
loans under paragraph (c) of this section, for two years after the date
disclosures are required to be made or action is required to be taken.
The administrative agencies responsible for enforcing the regulation
may require a creditor under their jurisdictions to retain records for
a longer period if necessary to carry out their enforcement
responsibilities under section 108 of the Act.
* * * * *
(c) Records related to certain requirements for mortgage loans. (1)
[Reserved]
(2) [Reserved]
(3) Records related to minimum standards for transactions secured
by a dwelling. Notwithstanding paragraph (a) of this section, a
creditor shall retain evidence of compliance with Sec. 1026.43 of this
regulation for three years after consummation of a transaction covered
by that section.

Subpart E--Special Rules for Certain Home Mortgage Transactions

0
3. Section 1026.32 is amended by:
0
A. Revising the section heading;
0
B. Revising paragraph (b)(1);
0
C. Removing and reserving paragraph (b)(2);
0
D. Adding paragraph (b)(3) through (6)
The additions and revisions read as follows:

Sec. 1026.32 Requirements for high-cost mortgages.

* * * * *
(b) Definitions. For purposes of this subpart, the following
definitions apply:
(1) In connection with a closed-end credit transaction, points and
fees means the following fees or charges that are known at or before
consummation:
(i) All items included in the finance charge under Sec. 1026.4(a)
and (b), except that the following items are excluded:
(A) Interest or the time-price differential;
(B) Any premium or other charge imposed in connection with any
Federal or State agency program for any guaranty or insurance that
protects the creditor against the consumer's default or other credit
loss;
(C) For any guaranty or insurance that protects the creditor
against the consumer's default or other credit loss and that is not in
connection with any Federal or State agency program:
(1) If the premium or other charge is payable after consummation,
the entire amount of such premium or other charge; or
(2) If the premium or other charge is payable at or before
consummation, the portion of any such premium or other charge that is
not in excess of the amount payable under policies in effect at the
time of origination under section 203(c)(2)(A) of the National Housing
Act (12 U.S.C. 1709(c)(2)(A)), provided that the premium or charge is
required to be refundable on a pro rata basis and the refund is
automatically issued upon notification of the satisfaction of the
underlying mortgage loan;
(D) Any bona fide third-party charge not retained by the creditor,
loan originator, or an affiliate of either, unless the charge is
required to be included in points and fees under paragraph
(b)(1)(i)(C), (iii), or (iv) of this section;
(E) Up to two bona fide discount points paid by the consumer in
connection with the transaction, if the interest rate without any
discount does not exceed:
(1) The average prime offer rate, as defined in Sec.
1026.35(a)(2), by more than one percentage point; or
(2) For purposes of paragraph (a)(1)(ii) of this section, for
transactions that are secured by personal property, the average rate
for a loan insured under Title I of the National Housing Act (12 U.S.C.
1702 et seq.) by more than one percentage point; and
(F) If no discount points have been excluded under paragraph
(b)(1)(i)(E) of this section, then up to one bona fide discount point
paid by the consumer in connection with the transaction, if the
interest rate without any discount does not exceed:
(1) The average prime offer rate, as defined in Sec.
1026.35(a)(2), by more than two percentage points; or
(2) For purposes of paragraph (a)(1)(ii) of this section, for
transactions that are secured by personal property, the average rate
for a loan insured under Title I of the National Housing Act (12 U.S.C.
1702 et seq.) by more than two percentage points;
(ii) All compensation paid directly or indirectly by a consumer or
creditor to a loan originator, as defined in Sec. 1026.36(a)(1), that
can be attributed to

[[Page 6584]]

that transaction at the time the interest rate is set;
(iii) All items listed in Sec. 1026.4(c)(7) (other than amounts
held for future payment of taxes), unless:
(A) The charge is reasonable;
(B) The creditor receives no direct or indirect compensation in
connection with the charge; and
(C) The charge is not paid to an affiliate of the creditor;
(iv) Premiums or other charges payable at or before consummation
for any credit life, credit disability, credit unemployment, or credit
property insurance, or any other life, accident, health, or loss-of-
income insurance for which the creditor is a beneficiary, or any
payments directly or indirectly for any debt cancellation or suspension
agreement or contract;
(v) The maximum prepayment penalty, as defined in paragraph
(b)(6)(i) of this section, that may be charged or collected under the
terms of the mortgage loan; and
(vi) The total prepayment penalty, as defined in paragraph
(b)(6)(i) of this section, incurred by the consumer if the consumer
refinances the existing mortgage loan with the current holder of the
existing loan, a servicer acting on behalf of the current holder, or an
affiliate of either.
(2) [Reserved]
(3) Bona fide discount point--(i) Closed-end credit. The term bona
fide discount point means an amount equal to 1 percent of the loan
amount paid by the consumer that reduces the interest rate or time-
price differential applicable to the transaction based on a calculation
that is consistent with established industry practices for determining
the amount of reduction in the interest rate or time-price differential
appropriate for the amount of discount points paid by the consumer.
(ii) [Reserved]
(4) Total loan amount--(i) Closed-end credit. The total loan amount
for a closed-end credit transaction is calculated by taking the amount
financed, as determined according to Sec. 1026.18(b), and deducting
any cost listed in Sec. 1026.32(b)(1)(iii), (iv), or (vi) that is both
included as points and fees under Sec. 1026.32(b)(1) and financed by
the creditor.
(ii) [Reserved]
(5) Affiliate means any company that controls, is controlled by, or
is under common control with another company, as set forth in the Bank
Holding Company Act of 1956 (12 U.S.C. 1841 et seq.).
(6) Prepayment penalty--(i) Closed-end credit transactions. For a
closed-end credit transaction, prepayment penalty means a charge
imposed for paying all or part of the transaction's principal before
the date on which the principal is due, other than a waived, bona fide
third-party charge that the creditor imposes if the consumer prepays
all of the transaction's principal sooner than 36 months after
consummation, provided, however, that interest charged consistent with
the monthly interest accrual amortization method is not a prepayment
penalty for extensions of credit insured by the Federal Housing
Administration that are consummated before January 21, 2015.
(ii) [Reserved]
* * * * *
0
4. Add Sec. 1026.43 to read as follows:

Sec. 1026.43 Minimum standards for transactions secured by a
dwelling.

(a) Scope. This section applies to any consumer credit transaction
that is secured by a dwelling, as defined in Sec. 1026.2(a)(19),
including any real property attached to a dwelling, other than:
(1) A home equity line of credit subject to Sec. 1026.40;
(2) A mortgage transaction secured by a consumer's interest in a
timeshare plan, as defined in 11 U.S.C. 101(53(D)); or
(3) For purposes of paragraphs (c) through (f) of this section:
(i) A reverse mortgage subject to Sec. 1026.33;
(ii) A temporary or ``bridge'' loan with a term of 12 months or
less, such as a loan to finance the purchase of a new dwelling where
the consumer plans to sell a current dwelling within 12 months or a
loan to finance the initial construction of a dwelling; or
(iii) A construction phase of 12 months or less of a construction-
to-permanent loan.
(b) Definitions. For purposes of this section:
(1) Covered transaction means a consumer credit transaction that is
secured by a dwelling, as defined in Sec. 1026.2(a)(19), including any
real property attached to a dwelling, other than a transaction exempt
from coverage under paragraph (a) of this section.
(2) Fully amortizing payment means a periodic payment of principal
and interest that will fully repay the loan amount over the loan term.
(3) Fully indexed rate means the interest rate calculated using the
index or formula that will apply after recast, as determined at the
time of consummation, and the maximum margin that can apply at any time
during the loan term.
(4) Higher-priced covered transaction means a covered transaction
with an annual percentage rate that exceeds the average prime offer
rate for a comparable transaction as of the date the interest rate is
set by 1.5 or more percentage points for a first-lien covered
transaction, or by 3.5 or more percentage points for a subordinate-lien
covered transaction.
(5) Loan amount means the principal amount the consumer will borrow
as reflected in the promissory note or loan contract.
(6) Loan term means the period of time to repay the obligation in
full.
(7) Maximum loan amount means the loan amount plus any increase in
principal balance that results from negative amortization, as defined
in Sec. 1026.18(s)(7)(v), based on the terms of the legal obligation
assuming:
(i) The consumer makes only the minimum periodic payments for the
maximum possible time, until the consumer must begin making fully
amortizing payments; and
(ii) The maximum interest rate is reached at the earliest possible
time.
(8) Mortgage-related obligations mean property taxes; premiums and
similar charges identified in Sec. 1026.4(b)(5), (7), (8), and (10)
that are required by the creditor; fees and special assessments imposed
by a condominium, cooperative, or homeowners association; ground rent;
and leasehold payments.
(9) Points and fees has the same meaning as in Sec. 1026.32(b)(1).
(10) Prepayment penalty has the same meaning as in Sec.
1026.32(b)(6).
(11) Recast means:
(i) For an adjustable-rate mortgage, as defined in Sec.
1026.18(s)(7)(i), the expiration of the period during which payments
based on the introductory fixed interest rate are permitted under the
terms of the legal obligation;
(ii) For an interest-only loan, as defined in Sec.
1026.18(s)(7)(iv), the expiration of the period during which interest-
only payments are permitted under the terms of the legal obligation;
and
(iii) For a negative amortization loan, as defined in Sec.
1026.18(s)(7)(v), the expiration of the period during which negatively
amortizing payments are permitted under the terms of the legal
obligation.
(12) Simultaneous loan means another covered transaction or home
equity line of credit subject to Sec. 1026.40 that will be secured by
the same dwelling and made to the same consumer at or before
consummation of the covered transaction or, if to be made after
consummation, will cover closing costs of the first covered
transaction.
(13) Third-party record means:

[[Page 6585]]

(i) A document or other record prepared or reviewed by an
appropriate person other than the consumer, the creditor, or the
mortgage broker, as defined in Sec. 1026.36(a)(2), or an agent of the
creditor or mortgage broker;
(ii) A copy of a tax return filed with the Internal Revenue Service
or a State taxing authority;
(iii) A record the creditor maintains for an account of the
consumer held by the creditor; or
(iv) If the consumer is an employee of the creditor or the mortgage
broker, a document or other record maintained by the creditor or
mortgage broker regarding the consumer's employment status or
employment income.
(c) Repayment ability--(1) General requirement. A creditor shall
not make a loan that is a covered transaction unless the creditor makes
a reasonable and good faith determination at or before consummation
that the consumer will have a reasonable ability to repay the loan
according to its terms.
(2) Basis for determination. Except as provided otherwise in
paragraphs (d), (e), and (f) of this section, in making the repayment
ability determination required under paragraph (c)(1) of this section,
a creditor must consider the following:
(i) The consumer's current or reasonably expected income or assets,
other than the value of the dwelling, including any real property
attached to the dwelling, that secures the loan;
(ii) If the creditor relies on income from the consumer's
employment in determining repayment ability, the consumer's current
employment status;
(iii) The consumer's monthly payment on the covered transaction,
calculated in accordance with paragraph (c)(5) of this section;
(iv) The consumer's monthly payment on any simultaneous loan that
the creditor knows or has reason to know will be made, calculated in
accordance with paragraph (c)(6) of this section;
(v) The consumer's monthly payment for mortgage-related
obligations;
(vi) The consumer's current debt obligations, alimony, and child
support;
(vii) The consumer's monthly debt-to-income ratio or residual
income in accordance with paragraph (c)(7) of this section; and
(viii) The consumer's credit history.
(3) Verification using third-party records. A creditor must verify
the information that the creditor relies on in determining a consumer's
repayment ability under Sec. 1026.43(c)(2) using reasonably reliable
third-party records, except that:
(i) For purposes of paragraph (c)(2)(i) of this section, a creditor
must verify a consumer's income or assets that the creditor relies on
in accordance with Sec. 1026.43(c)(4);
(ii) For purposes of paragraph (c)(2)(ii) of this section, a
creditor may verify a consumer's employment status orally if the
creditor prepares a record of the information obtained orally; and
(iii) For purposes of paragraph (c)(2)(vi) of this section, if a
creditor relies on a consumer's credit report to verify a consumer's
current debt obligations and a consumer's application states a current
debt obligation not shown in the consumer's credit report, the creditor
need not independently verify such an obligation.
(4) Verification of income or assets. A creditor must verify the
amounts of income or assets that the creditor relies on under Sec.
1026.43(c)(2)(i) to determine a consumer's ability to repay a covered
transaction using third-party records that provide reasonably reliable
evidence of the consumer's income or assets. A creditor may verify the
consumer's income using a tax-return transcript issued by the Internal
Revenue Service (IRS). Examples of other records the creditor may use
to verify the consumer's income or assets include:
(i) Copies of tax returns the consumer filed with the IRS or a
State taxing authority;
(ii) IRS Form W-2s or similar IRS forms used for reporting wages or
tax withholding;
(iii) Payroll statements, including military Leave and Earnings
Statements;
(iv) Financial institution records;
(v) Records from the consumer's employer or a third party that
obtained information from the employer;
(vi) Records from a Federal, State, or local government agency
stating the consumer's income from benefits or entitlements;
(vii) Receipts from the consumer's use of check cashing services;
and
(viii) Receipts from the consumer's use of a funds transfer
service.
(5) Payment calculation--(i) General rule. Except as provided in
paragraph (c)(5)(ii) of this section, a creditor must make the
consideration required under paragraph (c)(2)(iii) of this section
using:
(A) The fully indexed rate or any introductory interest rate,
whichever is greater; and
(B) Monthly, fully amortizing payments that are substantially
equal.
(ii) Special rules for loans with a balloon payment, interest-only
loans, and negative amortization loans. A creditor must make the
consideration required under paragraph (c)(2)(iii) of this section for:
(A) A loan with a balloon payment, as defined in Sec.
1026.18(s)(5)(i), using:
(1) The maximum payment scheduled during the first five years after
the date on which the first regular periodic payment will be due for a
loan that is not a higher-priced covered transaction; or
(2) The maximum payment in the payment schedule, including any
balloon payment, for a higher-priced covered transaction;
(B) An interest-only loan, as defined in Sec. 1026.18(s)(7)(iv),
using:
(1) The fully indexed rate or any introductory interest rate,
whichever is greater; and
(2) Substantially equal, monthly payments of principal and interest
that will repay the loan amount over the term of the loan remaining as
of the date the loan is recast.
(C) A negative amortization loan, as defined in Sec.
1026.18(s)(7)(v), using:
(1) The fully indexed rate or any introductory interest rate,
whichever is greater; and
(2) Substantially equal, monthly payments of principal and interest
that will repay the maximum loan amount over the term of the loan
remaining as of the date the loan is recast.
(6) Payment calculation for simultaneous loans. For purposes of
making the evaluation required under paragraph (c)(2)(iv) of this
section, a creditor must consider, taking into account any mortgage-
related obligations, a consumer's payment on a simultaneous loan that
is:
(i) A covered transaction, by following paragraph (c)(5)of this
section; or
(ii) A home equity line of credit subject to Sec. 1026.40, by
using the periodic payment required under the terms of the plan and the
amount of credit to be drawn at or before consummation of the covered
transaction.
(7) Monthly debt-to-income ratio or residual income--(i)
Definitions. For purposes of this paragraph (c)(7), the following
definitions apply:
(A) Total monthly debt obligations. The term total monthly debt
obligations means the sum of: the payment on the covered transaction,
as required to be calculated by paragraphs (c)(2)(iii) and (c)(5) of
this section; simultaneous loans, as required by paragraphs (c)(2)(iv)
and (c)(6) of this section; mortgage-related obligations, as required
by paragraph (c)(2)(v) of this section; and current debt obligations,
alimony, and child support, as required by paragraph (c)(2)(vi) of this
section.
(B) Total monthly income. The term total monthly income means the
sum of the consumer's current or reasonably

[[Page 6586]]

expected income, including any income from assets, as required by
paragraphs (c)(2)(i) and (c)(4) of this section.
(ii) Calculations-- (A) Monthly debt-to-income ratio. If a creditor
considers the consumer's monthly debt-to-income ratio under paragraph
(c)(2)(vii) of this section, the creditor must consider the ratio of
the consumer's total monthly debt obligations to the consumer's total
monthly income.
(B) Monthly residual income. If a creditor considers the consumer's
monthly residual income under paragraph (c)(2)(vii) of this section,
the creditor must consider the consumer's remaining income after
subtracting the consumer's total monthly debt obligations from the
consumer's total monthly income.
(d) Refinancing of non-standard mortgages--(1) Definitions. For
purposes of this paragraph (d), the following definitions apply:
(i) Non-standard mortgage. The term non-standard mortgage means a
covered transaction that is:
(A) An adjustable-rate mortgage, as defined in Sec.
1026.18(s)(7)(i), with an introductory fixed interest rate for a period
of one year or longer;
(B) An interest-only loan, as defined in Sec. 1026.18(s)(7)(iv);
or
(C) A negative amortization loan, as defined in Sec.
1026.18(s)(7)(v).
(ii) Standard mortgage. The term standard mortgage means a covered
transaction:
(A) That provides for regular periodic payments that do not:
(1) Cause the principal balance to increase;
(2) Allow the consumer to defer repayment of principal; or
(3) Result in a balloon payment, as defined in Sec.
1026.18(s)(5)(i);
(B) For which the total points and fees payable in connection with
the transaction do not exceed the amounts specified in paragraph (e)(3)
of this section;
(C) For which the term does not exceed 40 years;
(D) For which the interest rate is fixed for at least the first
five years after consummation; and
(E) For which the proceeds from the loan are used solely for the
following purposes:
(1) To pay off the outstanding principal balance on the non-
standard mortgage; and
(2) To pay closing or settlement charges required to be disclosed
under the Real Estate Settlement Procedures Act, 12 U.S.C. 2601 et seq.
(iii) Refinancing. The term refinancing has the same meaning as in
Sec. 1026.20(a).
(2) Scope. The provisions of this paragraph (d) apply to the
refinancing of a non-standard mortgage into a standard mortgage when
the following conditions are met:
(i) The creditor for the standard mortgage is the current holder of
the existing non-standard mortgage or the servicer acting on behalf of
the current holder;
(ii) The monthly payment for the standard mortgage is materially
lower than the monthly payment for the non-standard mortgage, as
calculated under paragraph (d)(5) of this section.
(iii) The creditor receives the consumer's written application for
the standard mortgage no later than two months after the non-standard
mortgage has recast.
(iv) The consumer has made no more than one payment more than 30
days late on the non-standard mortgage during the 12 months immediately
preceding the creditor's receipt of the consumer's written application
for the standard mortgage.
(v) The consumer has made no payments more than 30 days late during
the six months immediately preceding the creditor's receipt of the
consumer's written application for the standard mortgage; and
(vi) If the non-standard mortgage was consummated on or after
January 10, 2014, the non-standard mortgage was made in accordance with
paragraph (c) or (e) of this section, as applicable.
(3) Exemption from repayment ability requirements. A creditor is
not required to comply with the requirements of paragraph (c) of this
section if:
(i) The conditions in paragraph (d)(2) of this section are met; and
(ii) The creditor has considered whether the standard mortgage
likely will prevent a default by the consumer on the non-standard
mortgage once the loan is recast.
(4) Offer of rate discounts and other favorable terms. A creditor
making a covered transaction under this paragraph (d) may offer to the
consumer rate discounts and terms that are the same as, or better than,
the rate discounts and terms that the creditor offers to new consumers,
consistent with the creditor's documented underwriting practices and to
the extent not prohibited by applicable State or Federal law.
(5) Payment calculations. For purposes of determining whether the
consumer's monthly payment for a standard mortgage will be materially
lower than the monthly payment for the non-standard mortgage, the
following provisions shall be used:
(i) Non-standard mortgage. For purposes of the comparison conducted
pursuant to paragraph (d)(2)(ii) of this section, the creditor must
calculate the monthly payment for a non-standard mortgage based on
substantially equal, monthly, fully amortizing payments of principal
and interest using:
(A) The fully indexed rate as of a reasonable period of time before
or after the date on which the creditor receives the consumer's written
application for the standard mortgage;
(B) The term of the loan remaining as of the date on which the
recast occurs, assuming all scheduled payments have been made up to the
recast date and the payment due on the recast date is made and credited
as of that date; and
(C) A remaining loan amount that is:
(1) For an adjustable-rate mortgage under paragraph (d)(1)(i)(A) of
this section, the outstanding principal balance as of the date of the
recast, assuming all scheduled payments have been made up to the recast
date and the payment due on the recast date is made and credited as of
that date;
(2) For an interest-only loan under paragraph (d)(1)(i)(B) of this
section, the outstanding principal balance as of the date of the
recast, assuming all scheduled payments have been made up to the recast
date and the payment due on the recast date is made and credited as of
that date; or
(3) For a negative amortization loan under paragraph (d)(1)(i)(C)
of this section, the maximum loan amount, determined after adjusting
for the outstanding principal balance.
(ii) Standard mortgage. For purposes of the comparison conducted
pursuant to paragraph (d)(2)(ii) of this section, the monthly payment
for a standard mortgage must be based on substantially equal, monthly,
fully amortizing payments based on the maximum interest rate that may
apply during the first five years after consummation.
(e) Qualified mortgages--(1) Safe harbor and presumption of
compliance--(i) Safe harbor for transactions that are not higher-priced
covered transactions. A creditor or assignee of a qualified mortgage,
as defined in paragraphs (e)(2), (e)(4), or (f) of this section, that
is not a higher-priced covered transaction, as defined in paragraph
(b)(4) of this section, complies with the repayment ability
requirements of paragraph (c) of this section.
(ii) Presumption of compliance for higher-priced covered
transactions. (A) A creditor or assignee of a qualified mortgage, as
defined in paragraphs (e)(2), (e)(4), or (f) of this section, that is a
higher-priced covered transaction, as

[[Page 6587]]

defined in paragraph (b)(4) of this section, is presumed to comply with
the repayment ability requirements of paragraph (c) of this section.
(B) To rebut the presumption of compliance described in paragraph
(e)(1)(ii)(A) of this section, it must be proven that, despite meeting
the requirements of paragraphs (e)(2), (e)(4), or (f) of this section,
the creditor did not make a reasonable and good faith determination of
the consumer's repayment ability at the time of consummation, by
showing that the consumer's income, debt obligations, alimony, child
support, and the consumer's monthly payment (including mortgage-related
obligations) on the covered transaction and on any simultaneous loans
of which the creditor was aware at consummation would leave the
consumer with insufficient residual income or assets other than the
value of the dwelling (including any real property attached to the
dwelling) that secures the loan with which to meet living expenses,
including any recurring and material non-debt obligations of which the
creditor was aware at the time of consummation.
(2) Qualified mortgage defined--general. Except as provided in
paragraphs (e)(4) or (f) of this section, a qualified mortgage is a
covered transaction:
(i) That provides for regular periodic payments that are
substantially equal, except for the effect that any interest rate
change after consummation has on the payment in the case of an
adjustable-rate or step-rate mortgage, that do not:
(A) Result in an increase of the principal balance;
(B) Allow the consumer to defer repayment of principal, except as
provided in paragraph (f) of this section; or
(C) Result in a balloon payment, as defined in Sec.
1026.18(s)(5)(i), except as provided in paragraph (f) of this section;
(ii) For which the loan term does not exceed 30 years;
(iii) For which the total points and fees payable in connection
with the loan do not exceed the amounts specified in paragraph (e)(3)
of this section;
(iv) For which the creditor underwrites the loan, taking into
account the monthly payment for mortgage-related obligations, using:
(A) The maximum interest rate that may apply during the first five
years after the date on which the first regular periodic payment will
be due; and
(B) Periodic payments of principal and interest that will repay
either:
(1) The outstanding principal balance over the remaining term of
the loan as of the date the interest rate adjusts to the maximum
interest rate set forth in paragraph (e)(2)(iv)(A) of this section,
assuming the consumer will have made all required payments as due prior
to that date; or
(2) The loan amount over the loan term;
(v) For which the creditor considers and verifies at or before
consummation the following:
(A) The consumer's current or reasonably expected income or assets
other than the value of the dwelling (including any real property
attached to the dwelling) that secures the loan, in accordance with
appendix Q and paragraphs (c)(2)(i) and (c)(4) of this section; and
(B) The consumer's current debt obligations, alimony, and child
support in accordance with appendix Q and paragraphs (c)(2)(vi) and
(c)(3) of this section; and
(vi) For which the ratio of the consumer's total monthly debt to
total monthly income at the time of consummation does not exceed 43
percent. For purposes of this paragraph (e)(2)(vi), the ratio of the
consumer's total monthly debt to total monthly income is determined:
(A) Except as provided in paragraph (e)(2)(vi)(B) of this section,
in accordance with the standards in appendix Q;
(B) Using the consumer's monthly payment on:
(1) The covered transaction, including the monthly payment for
mortgage-related obligations, in accordance with paragraph (e)(2)(iv)
of this section; and
(2) Any simultaneous loan that the creditor knows or has reason to
know will be made, in accordance with paragraphs (c)(2)(iv) and (c)(6)
of this section.
(3) Limits on points and fees for qualified mortgages. (i) A
covered transaction is not a qualified mortgage unless the
transaction's total points and fees, as defined in Sec. 1026.32(b)(1),
do not exceed:
(A) For a loan amount greater than or equal to $100,000 (indexed
for inflation): 3 percent of the total loan amount;
(B) For a loan amount greater than or equal to $60,000 (indexed for
inflation) but less than $100,000 (indexed for inflation): $3,000
(indexed for inflation);
(C) For a loan amount greater than or equal to $20,000 (indexed for
inflation) but less than $60,000 (indexed for inflation): 5 percent of
the total loan amount;
(D) For a loan amount greater than or equal to $12,500 (indexed for
inflation) but less than $20,000 (indexed for inflation): $1,000
(indexed for inflation);
(E) For a loan amount less than $12,500 (indexed for inflation): 8
percent of the total loan amount.
(ii) The dollar amounts, including the loan amounts, in paragraph
(e)(3)(i) of this section shall be adjusted annually on January 1 by
the annual percentage change in the Consumer Price Index for All Urban
Consumers (CPI-U) that was reported on the preceding June 1. See the
official commentary to this paragraph (e)(3)(ii) for the current dollar
amounts.
(4) Qualified mortgage defined--special rules--(i) General.
Notwithstanding paragraph (e)(2) of this section, a qualified mortgage
is a covered transaction that satisfies:
(A) The requirements of paragraphs (e)(2)(i) through (iii) of this
section; and
(B) One or more of the criteria in paragraph (e)(4)(ii) of this
section.
(ii) Eligible loans. A qualified mortgage under this paragraph
(e)(4) must be one of the following at consummation:
(A) A loan that is eligible:
(1) To be purchased or guaranteed by the Federal National Mortgage
Association or the Federal Home Loan Mortgage Corporation operating
under the conservatorship or receivership of the Federal Housing
Finance Agency pursuant to section 1367(a) of the Federal Housing
Enterprises Financial Safety and Soundness Act of 1992 (12 U.S.C.
4617(a)); or
(2) To be purchased or guaranteed by any limited-life regulatory
entity succeeding the charter of either the Federal National Mortgage
Association or the Federal Home Loan Mortgage Corporation pursuant to
section 1367(i) of the Federal Housing Enterprises Financial Safety and
Soundness Act of 1992 (12 U.S.C. 4617(i));
(B) A loan that is eligible to be insured by the U.S. Department of
Housing and Urban Development under the National Housing Act (12 U.S.C.
1707 et seq.);
(C) A loan that is eligible to be guaranteed the U.S. Department of
Veterans Affairs;
(D) A loan that is eligible to be guaranteed by the U.S. Department
of Agriculture pursuant to 42 U.S.C. 1472(h); or
(E) A loan that is eligible to be insured by the Rural Housing
Service.
(iii) Sunset of special rules. (A) Each respective special rule
described in paragraph (e)(4)(ii)(B), (C), (D), or (E) of this section
shall expire on the effective date of a rule issued by each respective

[[Page 6588]]

agency pursuant to its authority under TILA section 129C(b)(3)(ii) to
define a qualified mortgage.
(B) Unless otherwise expired under paragraph (e)(4)(iii)(A) of this
section, the special rules in this paragraph (e)(4) are available only
for covered transactions consummated on or before January 10, 2021.
(f) Balloon-payment qualified mortgages made by certain creditors--
(1) Exemption. Notwithstanding paragraph (e)(2) of this section, a
qualified mortgage may provide for a balloon payment, provided:
(i) The loan satisfies the requirements for a qualified mortgage in
paragraphs (e)(2)(i)(A), (e)(2)(ii), (e)(2)(iii), and (e)(2)(v) of this
section, but without regard to the standards in appendix Q;
(ii) The creditor determines at or before consummation that the
consumer can make all of the scheduled payments under the terms of the
legal obligation, as described in paragraph (f)(1)(iv) of this section,
together with the consumer's monthly payments for all mortgage-related
obligations and excluding the balloon payment, from the consumer's
current or reasonably expected income or assets other than the dwelling
that secures the loan;
(iii) The creditor considers at or before consummation the
consumer's monthly debt-to-income ratio or residual income and verifies
the debt obligations and income used to determine that ratio in
accordance with paragraph (c)(7) of this section, except that the
calculation of the payment on the covered transaction for purposes of
determining the consumer's total monthly debt obligations in
(c)(7)(i)(A) shall be determined in accordance with paragraph
(f)(iv)(A) of this section, together with the consumer's monthly
payments for all mortgage-related obligations and excluding the balloon
payment;
(iv) The legal obligation provides for:
(A) Scheduled payments that are substantially equal, calculated
using an amortization period that does not exceed 30 years;
(B) An interest rate that does not increase over the term of the
loan; and
(C) A loan term of five years or longer.
(v) The loan is not subject, at consummation, to a commitment to be
acquired by another person, other than a person that satisfies the
requirements of paragraph (f)(1)(vi) of this section; and
(vi) The creditor satisfies the requirements stated in Sec.
1026.35(b)(2)(iii)(A), (B), and (C).
(2) Post-consummation transfer of balloon-payment qualified
mortgage. A balloon-payment qualified mortgage, extended pursuant to
paragraph (f)(1), immediately loses its status as a qualified mortgage
under paragraph (f)(1) if legal title to the balloon-payment qualified
mortgage is sold, assigned, or otherwise transferred to another person
except when:
(i) The balloon-payment qualified mortgage is sold, assigned, or
otherwise transferred to another person three years or more after
consummation of the balloon-payment qualified mortgage;
(ii) The balloon-payment qualified mortgage is sold, assigned, or
otherwise transferred to a creditor that satisfies the requirements of
paragraph (f)(1)(vi) of this section;
(iii) The balloon-payment qualified mortgage is sold, assigned, or
otherwise transferred to another person pursuant to a capital
restoration plan or other action under 12 U.S.C. 1831o, actions or
instructions of any person acting as conservator, receiver or
bankruptcy trustee, an order of a State or Federal governmental agency
with jurisdiction to examine the creditor pursuant to State or Federal
law, or an agreement between the creditor and such an agency; or
(iv) The balloon-payment qualified mortgage is sold, assigned, or
otherwise transferred pursuant to a merger of the creditor with another
person or acquisition of the creditor by another person or of another
person by the creditor.
(g) Prepayment penalties--(1) When permitted. A covered transaction
must not include a prepayment penalty unless:
(i) The prepayment penalty is otherwise permitted by law; and
(ii) The transaction:
(A) Has an annual percentage rate that cannot increase after
consummation;
(B) Is a qualified mortgage under paragraph (e)(2), (e)(4), or (f)
of this section; and
(C) Is not a higher-priced mortgage loan, as defined in Sec.
1026.35(a).
(2) Limits on prepayment penalties. A prepayment penalty:
(i) Must not apply after the three-year period following
consummation; and
(ii) Must not exceed the following percentages of the amount of the
outstanding loan balance prepaid:
(A) 2 percent, if incurred during the first two years following
consummation; and
(B) 1 percent, if incurred during the third year following
consummation.
(3) Alternative offer required. A creditor must not offer a
consumer a covered transaction with a prepayment penalty unless the
creditor also offers the consumer an alternative covered transaction
without a prepayment penalty and the alternative covered transaction:
(i) Has an annual percentage rate that cannot increase after
consummation and has the same type of interest rate as the covered
transaction with a prepayment penalty; for purposes of this paragraph
(g), the term ``type of interest rate'' refers to whether a
transaction:
(A) Is a fixed-rate mortgage, as defined in Sec.
1026.18(s)(7)(iii); or
(B) Is a step-rate mortgage, as defined in Sec. 1026.18(s)(7)(ii);
(ii) Has the same loan term as the loan term for the covered
transaction with a prepayment penalty;
(iii) Satisfies the periodic payment conditions under paragraph
(e)(2)(i) of this section;
(iv) Satisfies the points and fees conditions under paragraph
(e)(2)(iii) of this section, based on the information known to the
creditor at the time the transaction is offered; and
(v) Is a transaction for which the creditor has a good faith belief
that the consumer likely qualifies, based on the information known to
the creditor at the time the creditor offers the covered transaction
without a prepayment penalty.
(4) Offer through a mortgage broker. If the creditor offers a
covered transaction with a prepayment penalty to the consumer through a
mortgage broker, as defined in Sec. 1026.36(a)(2), the creditor must:
(i) Present the mortgage broker an alternative covered transaction
without a prepayment penalty that satisfies the requirements of
paragraph (g)(3) of this section; and
(ii) Establish by agreement that the mortgage broker must present
the consumer an alternative covered transaction without a prepayment
penalty that satisfies the requirements of paragraph (g)(3) of this
section, offered by:
(A) The creditor; or
(B) Another creditor, if the transaction offered by the other
creditor has a lower interest rate or a lower total dollar amount of
discount points and origination points or fees.
(5) Creditor that is a loan originator. If the creditor is a loan
originator, as defined in Sec. 1026.36(a)(1), and the creditor
presents the consumer a covered transaction offered by a person to
which the creditor would assign the covered transaction after
consummation, the creditor must present the consumer an alternative
covered transaction without a prepayment penalty that satisfies the
requirements of paragraph (g)(3) of this section, offered by:
(i) The assignee; or

[[Page 6589]]

(ii) Another person, if the transaction offered by the other person
has a lower interest rate or a lower total dollar amount of origination
discount points and points or fees.
(6) Applicability. This paragraph (g) applies only if a covered
transaction is consummated with a prepayment penalty and is not
violated if:
(i) A covered transaction is consummated without a prepayment
penalty; or
(ii) The creditor and consumer do not consummate a covered
transaction.
(h) Evasion; open-end credit. In connection with credit secured by
a consumer's dwelling that does not meet the definition of open-end
credit in Sec. 1026.2(a)(20), a creditor shall not structure the loan
as an open-end plan to evade the requirements of this section.
5. Reserved appendices N, O, and P are added, and appendix Q is
added to read as follows:

Appendix N to Part 1026--[Reserved]

Appendix O to Part 1026--[Reserved]

Appendix P to Part 1026--[Reserved]

Appendix Q to Part 1026--Standards for Determining Monthly Debt and
Income

Section 1026.43(e)(2)(vi) provides that, to satisfy the
requirements for a qualified mortgage under Sec. 1026.43(e)(2), the
ratio of the consumer's total monthly debt to total monthly income
at the time of consummation cannot exceed 43 percent. Section
1026.43(e)(2)(vi)(A) requires the creditor to calculate the ratio of
the consumer's total monthly debt to total monthly income using the
following standards, with additional requirements for calculating
debt and income appearing in Sec. 1026.43(e)(2)(vi)(B).

I. Consumer Eligibility

A. Stability of Income.
1. Effective Income. Income may not be used in calculating the
consumer's income ratios if it comes from any source that cannot be
verified, is not stable, or will not continue.
2. Verifying Employment History.
a. The creditor must verify the consumer's employment for the
most recent two full years, and the consumer must:
i. Explain any gaps in employment that span one or more months,
and
ii. Indicate if he/she was in school or the military for the
recent two full years, providing evidence supporting this claim,
such as college transcripts, or discharge papers.
b. Allowances can be made for seasonal employment, typical for
the building trades and agriculture, if documented by the creditor.

Note: A consumer with a 25 percent or greater ownership interest
in a business is considered self-employed and will be evaluated as a
self-employed consumer for underwriting purposes.

3. Analyzing a Consumer's Employment Record.
a. When analyzing the probability of continued employment,
creditors must examine:
i. The consumer's past employment record;
ii. Qualifications for the position;
iii. Previous training and education; and
iv. The employer's confirmation of continued employment.
b. Favorably consider a consumer for a mortgage if he/she
changes jobs frequently within the same line of work, but continues
to advance in income or benefits. In this analysis, income stability
takes precedence over job stability.
4. Consumers Returning to Work After an Extended Absence. A
consumer's income may be considered effective and stable when
recently returning to work after an extended absence if he/she:
a. Is employed in the current job for six months or longer; and
b. Can document a two-year work history prior to an absence from
employment using:
i. Traditional employment verifications; and/or
ii. Copies of IRS Form W-2s or pay stubs.

Note: An acceptable employment situation includes individuals
who took several years off from employment to raise children, then
returned to the workforce.

c. Important: Situations not meeting the criteria listed above
may not be used in qualifying. Extended absence is defined as six
months.
B. Salary, Wage and Other Forms of Income.
1. General Policy on Consumer Income Analysis.
a. The income of each consumer who will be obligated for the
mortgage debt must be analyzed to determine whether his/her income
level can be reasonably expected to continue through at least the
first three years of the mortgage loan.
b. In most cases, a consumer's income is limited to salaries or
wages. Income from other sources can be considered as effective,
when properly verified and documented by the creditor.
Notes:
i. Effective income for consumers planning to retire during the
first three-year period must include the amount of:
a. Documented retirement benefits;
b. Social Security payments; or
c. Other payments expected to be received in retirement.
ii. Creditors must not ask the consumer about possible, future
maternity leave.
2. Overtime and Bonus Income.
a. Overtime and bonus income can be used to qualify the consumer
if he/she has received this income for the past two years, and it
will likely continue. If the employment verification states that the
overtime and bonus income is unlikely to continue, it may not be
used in qualifying.
b. The creditor must develop an average of bonus or overtime
income for the past two years. Periods of overtime and bonus income
less than two years may be acceptable, provided the creditor can
justify and document in writing the reason for using the income for
qualifying purposes.
3. Establishing an Overtime and Bonus Income Earning Trend.
a. The creditor must establish and document an earnings trend
for overtime and bonus income. If either type of income shows a
continual decline, the creditor must document in writing a sound
rationalization for including the income when qualifying the
consumer.
b. A period of more than two years must be used in calculating
the average overtime and bonus income if the income varies
significantly from year to year.
4. Qualifying Part-Time Income.
a. Part-time and seasonal income can be used to qualify the
consumer if the creditor documents that the consumer has worked the
part-time job uninterrupted for the past two years, and plans to
continue. Many low and moderate income families rely on part-time
and seasonal income for day to day needs, and creditors should not
restrict consideration of such income when qualifying these
consumers.
b. Part-time income received for less than two years may be
included as effective income, provided that the creditor justifies
and documents that the income is likely to continue.
c. Part-time income not meeting the qualifying requirements may
not be used in qualifying.
Note: For qualifying purposes, ``part-time'' income refers to
employment taken to supplement the consumer's income from regular
employment; part-time employment is not a primary job and it is
worked less than 40 hours.
5. Income from Seasonal Employment.
a. Seasonal income is considered uninterrupted, and may be used
to qualify the consumer, if the creditor documents that the
consumer:
i. Has worked the same job for the past two years, and
ii. Expects to be rehired the next season.
b. Seasonal employment includes:
i. Umpiring baseball games in the summer; or
ii. Working at a department store during the holiday shopping
season.
6. Primary Employment Less Than 40 Hour Work Week.
a. When a consumer's primary employment is less than a typical
40-hour work week, the creditor should evaluate the stability of
that income as regular, on-going primary employment.
b. Example: A registered nurse may have worked 24 hours per week
for the last year. Although this job is less than the 40-hour work
week, it is the consumer's primary employment, and should be
considered effective income.
7. Commission Income.
a. Commission income must be averaged over the previous two
years. To qualify commission income, the consumer must provide:
i. Copies of signed tax returns for the last two years; and
ii. The most recent pay stub.
b. Consumers whose commission income was received for more than
one year, but less than two years may be considered favorably if the
underwriter can:

[[Page 6590]]

i. Document the likelihood that the income will continue, and
ii. Soundly rationalize accepting the commission income.
Notes:
i. Unreimbursed business expenses must be subtracted from gross
income.
ii. A commissioned consumer is one who receives more than 25
percent of his/her annual income from commissions.
iii. A tax transcript obtained directly from the IRS may be used
in lieu of signed tax returns, and the cost of the transcript may be
charged to the consumer.
8. Qualifying Commission Income Earned for Less Than One Year.
a. Commission income earned for less than one year is not
considered effective income. Exceptions may be made for situations
in which the consumer's compensation was changed from salary to
commission within a similar position with the same employer.
b. A consumer may also qualify when the portion of earnings not
attributed to commissions would be sufficient to qualify the
consumer for the mortgage.
9. Employer Differential Payments. If the employer subsidizes a
consumer's mortgage payment through direct payments, the amount of
the payments:
a. Is considered gross income, and
b. Cannot be used to offset the mortgage payment directly, even
if the employer pays the servicing creditor directly.
10. Retirement Income. Retirement income must be verified from
the former employer, or from Federal tax returns. If any retirement
income, such as employer pensions or 401(k)'s, will cease within the
first full three years of the mortgage loan, such income may not be
used in qualifying.
11. Social Security Income. Social Security income must be
verified by the Social Security Administration or on Federal tax
returns. If any benefits expire within the first full three years of
the loan, the income source may not be used in qualifying.
Notes:
i. The creditor must obtain a complete copy of the current
awards letter.
ii. Not all Social Security income is for retirement-aged
recipients; therefore, documented continuation is required.
iii. Some portion of Social Security income may be ``grossed
up'' if deemed nontaxable by the IRS.
12. Automobile Allowances and Expense Account Payments.
a. Only the amount by which the consumer's automobile allowance
or expense account payments exceed actual expenditures may be
considered income.
b. To establish the amount to add to gross income, the consumer
must provide the following:
i. IRS Form 2106, Employee Business Expenses, for the previous
two years; and
ii. Employer verification that the payments will continue.
c. If the consumer uses the standard per-mile rate in
calculating automobile expenses, as opposed to the actual cost
method, the portion that the IRS considers depreciation may be added
back to income.
d. Expenses that must be treated as recurring debt include:
i. The consumer's monthly car payment; and
ii. Any loss resulting from the calculation of the difference
between the actual expenditures and the expense account allowance.
C. Consumers Employed by a Family Owned Business.
1. Income Documentation Requirement.
In addition to normal employment verification, a consumer
employed by a family owned business is required to provide evidence
that he/she is not an owner of the business, which may include:
a. Copies of signed personal tax returns, or
b. A signed copy of the corporate tax return showing ownership
percentage.
Note: A tax transcript obtained directly from the IRS may be
used in lieu of signed tax returns, and the cost of the transcript
may be charged to the consumer.
D. General Information on Self-Employed Consumers and Income
Analysis.
1. Definition: Self Employed Consumer. A consumer with a 25
percent or greater ownership interest in a business is considered
self-employed.
2. Types of Business Structures. There are four basic types of
business structures. They include:
a. Sole proprietorships;
b. Corporations;
c. Limited liability or ``S'' corporations; and
d. Partnerships.
3. Minimum Length of Self Employment.
a. Income from self-employment is considered stable, and
effective, if the consumer has been self-employed for two or more
years.
b. Due to the high probability of failure during the first few
years of a business, the requirements described in the table below
are necessary for consumers who have been self-employed for less
than two years.
[GRAPHIC] [TIFF OMITTED] TR30JA13.001

4. General Documentation Requirements for Self Employed
Consumers. Self-employed consumers must provide the following
documentation:
a. Signed, dated individual tax returns, with all applicable tax
schedules for the most recent two years;
b. For a corporation, ``S'' corporation, or partnership, signed
copies of Federal business income tax returns for the last two
years, with all applicable tax schedules;
c. Year to date profit and loss (P&L) statement and balance
sheet; and
d. Business credit report for corporations and ``S''
corporations.
5. Establishing a Consumer's Earnings Trend.
a. When qualifying a consumer for a mortgage loan, the creditor
must establish the consumer's earnings trend from the previous two
years using the consumer's tax returns.
b. If a consumer:
i. Provides quarterly tax returns, the income analysis may
include income through the period covered by the tax filings, or
ii. Is not subject to quarterly tax returns, or does not file
them, then the income shown on the P&L statement may be included in
the analysis, provided the income stream based on the P&L is
consistent with the previous years' earnings.
c. If the P&L statements submitted for the current year show an
income stream considerably greater than what is supported by the
previous year's tax returns, the creditor must base the income
analysis solely on the income verified through the tax returns.

[[Page 6591]]

d. If the consumer's earnings trend for the previous two years
is downward and the most recent tax return or P&L is less than the
prior year's tax return, the consumer's most recent year's tax
return or P&L must be used to calculate his/her income.
6. Analyzing the Business's Financial Strength:
a. To determine if the business is expected to generate
sufficient income for the consumer's needs, the creditor must
carefully analyze the business's financial strength, including the:
i. Source of the business's income;
ii. General economic outlook for similar businesses in the area.
b. Annual earnings that are stable or increasing are acceptable,
while businesses that show a significant decline in income over the
analysis period are not acceptable.
E. Income Analysis: Individual Tax Returns (IRS Form 1040).
1. General Policy on Adjusting Income Based on a Review of IRS
Form 1040. The amount shown on a consumer's IRS Form 1040 as
adjusted gross income must either be increased or decreased based on
the creditor's analysis of the individual tax return and any related
tax schedules.
2. Guidelines for Analyzing IRS Form 1040. The table below
contains guidelines for analyzing IRS Form 1040:

[[Page 6592]]

[GRAPHIC] [TIFF OMITTED] TR30JA13.002

F. Income Analysis: Corporate Tax Returns (IRS Form 1120).
1. Description: Corporation. A corporation is a State-chartered
business owned by its stockholders.
2. Need To Obtain Consumer Percentage of Ownership Information.
a. Corporate compensation to the officers, generally in
proportion to the percentage of ownership, is shown on the:
i. Corporate tax return IRS Form 1120; and
ii. Individual tax returns.
b. When a consumer's percentage of ownership does not appear on
the tax returns, the creditor must obtain the

[[Page 6593]]

information from the corporation's accountant, along with evidence
that the consumer has the right to any compensation.
3. Analyzing Corporate Tax Returns.
a. In order to determine a consumer's self-employed income from
a corporation the adjusted business income must:
i. Be determined; and
ii. Multiplied by the consumer's percentage of ownership in the
business.
b. The table below describes the items found on IRS Form 1120
for which an adjustment must be made in order to determine adjusted
business income.
[GRAPHIC] [TIFF OMITTED] TR30JA13.003

G. Income Analysis: ``S'' Corporation Tax Returns (IRS Form
1120S).
1. Description: ``S'' Corporation.
a. An ``S'' corporation is generally a small, start-up business,
with gains and losses passed to stockholders in proportion to each
stockholder's percentage of business ownership.
b. Income for owners of ``S'' corporations comes from IRS Form
W-2 wages, and is taxed at the individual rate. The IRS Form 1120S,
Compensation of Officers line item is transferred to the consumer's
individual IRS Form 1040.
2. Analyzing ``S'' Corporation Tax Returns.
a. ``S'' corporation depreciation and depletion may be added
back to income in proportion to the consumer's share of the
corporation's income.
b. In addition, the income must also be reduced proportionately
by the total obligations payable by the corporation in less than one
year.
c. Important: The consumer's withdrawal of cash from the
corporation may have a severe negative impact on the corporation's
ability to continue operating, and must be considered in the income
analysis.
H. Income Analysis: Partnership Tax Returns (IRS Form 1065).
1. Description: Partnership.
a. A partnership is formed when two or more individuals form a
business, and share in profits, losses, and responsibility for
running the company.
b. Each partner pays taxes on his/her proportionate share of the
partnership's net income.
2. Analyzing Partnership Tax Returns.
a. Both general and limited partnerships report income on IRS
Form 1065, and the partners' share of income is carried over to
Schedule E of IRS Form 1040.
b. The creditor must review IRS Form 1065 to assess the
viability of the business. Both depreciation and depletion may be
added back to the income in proportion to the consumer's share of
income.
c. Income must also be reduced proportionately by the total
obligations payable by the partnership in less than one year.
d. Important: Cash withdrawals from the partnership may have a
severe negative impact on the partnership's ability to continue
operating, and must be considered in the income analysis.

II. Non-Employment Related Consumer Income

A. Alimony, Child Support, and Maintenance Income Criteria.
Alimony, child support, or maintenance income may be considered
effective, if:
1. Payments are likely to be received consistently for the first
three years of the mortgage;
2. The consumer provides the required documentation, which
includes a copy of the:
i. Final divorce decree;
ii. Legal separation agreement;
iii. Court order; or
iv. Voluntary payment agreement; and
3. The consumer can provide acceptable evidence that payments
have been received during the last 12 months, such as:
i. Cancelled checks;
ii. Deposit slips;
iii. Tax returns; or
iv. Court records.
Notes:
i. Periods less than 12 months may be acceptable, provided the
creditor can adequately document the payer's ability and willingness
to make timely payments.
ii. Child support may be ``grossed up'' under the same
provisions as non-taxable income sources.
B. Investment and Trust Income.
1. Analyzing Interest and Dividends.
a. Interest and dividend income may be used as long as tax
returns or account statements support a two-year receipt history.
This income must be averaged over the two years.
b. Subtract any funds that are derived from these sources, and
are required for the cash investment, before calculating the
projected interest or dividend income.
2. Trust Income.
a. Income from trusts may be used if guaranteed, constant
payments will continue for at least the first three years of the
mortgage term.
b. Required trust income documentation includes a copy of the
Trust Agreement or other trustee statement, confirming the:
i. Amount of the trust;
ii. Frequency of distribution; and
iii. Duration of payments.
c. Trust account funds may be used for the required cash
investment if the consumer provides adequate documentation that the
withdrawal of funds will not negatively affect income. The consumer
may use funds from the trust account for the required cash
investment, but the trust income used to determine repayment ability
cannot be affected negatively by its use.
3. Notes Receivable Income.
a. In order to include notes receivable income to qualify a
consumer, he/she must provide:
i. A copy of the note to establish the amount and length of
payment, and
ii. Evidence that these payments have been consistently received
for the last 12 months through deposit slips, cancelled checks, or
tax returns.
b. If the consumer is not the original payee on the note, the
creditor must establish that the consumer is now a holder in due
course, and able to enforce the note.
4. Eligible Investment Properties.
Follow the steps in the table below to calculate an investment
property's income or loss if the property to be subject to a
mortgage is an eligible investment property.

[[Page 6594]]

[GRAPHIC] [TIFF OMITTED] TR30JA13.004

C. Military, Government Agency, and Assistance Program Income.
1. Military Income.
a. Military personnel not only receive base pay, but oftentimes
are entitled to additional forms of pay, such as:
i. Income from variable housing allowances;
ii. Clothing allowances;
iii. Flight or hazard pay;
iv. Rations; and
v. Proficiency pay.
b. These types of additional pay are acceptable when analyzing a
consumer's income as long as the probability of such pay to continue
is verified in writing.
Note: The tax-exempt nature of some of the above payments should
also be considered.
2. VA Benefits.
a. Direct compensation for service-related disabilities from the
Department of Veterans Affairs (VA) is acceptable, provided the
creditor receives documentation from the VA.
b. Education benefits used to offset education expenses are not
acceptable.
3. Government Assistance Programs.
a. Income received from government assistance programs is
acceptable as long as the paying agency provides documentation
indicating that the income is expected to continue for at least
three years.
b. If the income from government assistance programs will not be
received for at least three years, it may not be used in qualifying.
c. Unemployment income must be documented for two years, and
there must be reasonable assurance that this income will continue.
This requirement may apply to seasonal employment.
4. Mortgage Credit Certificates.
a. If a government entity subsidizes the mortgage payments
either through direct payments or tax rebates, these payments may be
considered as acceptable income.
b. Either type of subsidy may be added to gross income, or used
directly to offset the mortgage payment, before calculating the
qualifying ratios.
5. Homeownership Subsidies.
a. A monthly subsidy may be treated as income, if a consumer is
receiving subsidies under the housing choice voucher home ownership
option from a public housing agency (PHA). Although continuation of
the homeownership voucher subsidy beyond the first year is subject
to Congressional appropriation, for the purposes of underwriting,
the subsidy will be assumed to continue for at least three years.
b. If the consumer is receiving the subsidy directly, the amount
received is treated as income. The amount received may also be
treated as nontaxable income and be ``grossed up'' by 25 percent,
which means that the amount of the subsidy, plus 25 percent of that
subsidy may be added to the consumer's income from employment and/or
other sources.
c. Creditors may treat this subsidy as an ``offset'' to the
monthly mortgage payment (that is, reduce the monthly mortgage
payment by the amount of the home ownership assistance payment
before dividing by the monthly income to determine the payment-to-
income and debt-to-income ratios). The subsidy payment must not pass
through the consumer's hands.
d. The assistance payment must be:
i. Paid directly to the servicing creditor; or
ii. Placed in an account that only the servicing creditor may
access.
Note: Assistance payments made directly to the consumer must be
treated as income.
D. Rental Income.
1. Analyzing the Stability of Rental Income.
a. Rent received for properties owned by the consumer is
acceptable as long as the creditor can document the stability of the
rental income through:
i. A current lease;
ii. An agreement to lease, or
iii. A rental history over the previous 24 months that is free
of unexplained gaps greater than three months (such gaps could be
explained by student, seasonal, or military renters, or property
rehabilitation).
b. A separate schedule of real estate is not required for rental
properties as long as all properties are documented on the Uniform
Residential Loan Application.
Note: The underwriting analysis may not consider rental income
from any property being vacated by the consumer, except under the
circumstances described below.
2. Rental Income From Consumer Occupied Property.
a. The rent for multiple unit property where the consumer
resides in one or more units and charges rent to tenants of other
units may be used for qualifying purposes.
b. Projected rent for the tenant-occupied units only may:
i. Be considered gross income, only after deducting vacancy and
maintenance factors, and
ii. Not be used as a direct offset to the mortgage payment.
3. Income from Roommates in a Single Family Property.
a. Income from roommates in a single family property occupied as
the consumer's primary residence is not acceptable. Rental income
from boarders however, is acceptable, if the boarders are related by
blood, marriage, or law.
b. The rental income may be considered effective, if shown on
the consumer's tax return. If not on the tax return, rental income
paid by the boarder may not be used in qualifying.
4. Documentation Required To Verify Rental Income. Analysis of
the following required documentation is necessary to verify all
consumer rental income:
a. IRS Form 1040 Schedule E; and
b. Current leases/rental agreements.
5. Analyzing IRS Form 1040 Schedule E.
a. The IRS Form 1040 Schedule E is required to verify all rental
income. Depreciation shown on Schedule E may be added back to the
net income or loss.
b. Positive rental income is considered gross income for
qualifying purposes, while negative income must be treated as a
recurring liability.
c. The creditor must confirm that the consumer still owns each
property listed, by comparing Schedule E with the real estate owned
section of the URLA.
6. Using Current Leases To Analyze Rental Income.
a. The consumer can provide a current signed lease or other
rental agreement for a property that was acquired since the last
income tax filing, and is not shown on Schedule E.
b. In order to calculate the rental income:
i. Reduce the gross rental amount by 25 percent for vacancies
and maintenance;
ii. Subtract PITI and any homeowners association dues; and
iii. Apply the resulting amount to income, if positive, or
recurring debts, if negative.
7. Exclusion of Rental Income From Property Being Vacated by the
Consumer. Underwriters may not consider any rental income from a
consumer's principal residence that is being vacated in favor of
another principal residence, except under the conditions described
below:
Notes:
i. This policy assures that a consumer either has sufficient
income to make both mortgage payments without any rental

[[Page 6595]]

income, or has an equity position not likely to result in defaulting
on the mortgage on the property being vacated.
ii. This applies solely to a principal residence being vacated
in favor of another principal residence. It does not apply to
existing rental properties disclosed on the loan application and
confirmed by tax returns (Schedule E of form IRS 1040).
8. Policy Exceptions Regarding the Exclusion of Rental Income
From a Principal Residence Being Vacated by a Consumer.
When a consumer vacates a principal residence in favor of
another principal residence, the rental income, reduced by the
appropriate vacancy factor, may be considered in the underwriting
analysis under the circumstances listed in the table below.
[GRAPHIC] [TIFF OMITTED] TR30JA13.005

E. Non Taxable and Projected Income.
1. Types of Non Taxable Income.
Certain types of regular income may not be subject to Federal
tax. Such types of nontaxable income include:
a. Some portion of Social Security, some Federal government
employee retirement income, Railroad Retirement Benefits, and some
State government retirement income:
b. Certain types of disability and public assistance payments;
c. Child support;
d. Military allowances; and
e. Other income that is documented as being exempt from Federal
income taxes.
2. Adding Non Taxable Income to a Consumer's Gross Income.
a. The amount of continuing tax savings attributed to regular
income not subject to Federal taxes may be added to the consumer's
gross income.
b. The percentage of non-taxable income that may be added cannot
exceed the appropriate tax rate for the income amount. Additional
allowances for dependents are not acceptable.
c. The creditor:
i. Must document and support the amount of income grossed up for
any non-taxable income source, and
ii. Should use the tax rate used to calculate the consumer's
last year's income tax.
Note: If the consumer is not required to file a Federal tax
return, the tax rate to use is 25 percent.
3. Analyzing Projected Income.
a. Projected or hypothetical income is not acceptable for
qualifying purposes. However, exceptions are permitted for income
from the following sources:
i. Cost-of-living adjustments;
ii. Performance raises; and
iii. Bonuses.
b. For the above exceptions to apply, the income must be:
i. Verified in writing by the employer; and
ii. Scheduled to begin within 60 days of loan closing.
4. Project Income for New Job.
a. Projected income is acceptable for qualifying purposes for a
consumer scheduled to start a new job within 60 days of loan closing
if there is a guaranteed, non-revocable contract for employment.
b. The creditor must verify that the consumer will have
sufficient income or cash reserves to support the mortgage payment
and any other obligations between loan closing and the start of
employment. Examples of this type of scenario are teachers whose
contracts begin with the new school year, or physicians beginning a
residency after the loan closes fall under this category.
c. The loan is not eligible for endorsement if the loan closes
more than 60 days before the consumer starts the new job. To be
eligible for endorsement, the creditor must obtain from the consumer
a pay stub or other acceptable evidence indicating that he/she has
started the new job.

III. Consumer Liabilities: Recurring Obligations

1. Types of Recurring Obligation. Recurring obligations include:
a. All installment loans;
b. Revolving charge accounts;
c. Real estate loans;
d. Alimony;
e. Child support; and
f. Other continuing obligations.
2. Debt to Income Ratio Computation for Recurring Obligations.
a. The creditor must include the following when computing the
debt to income ratios for recurring obligations:
i. Monthly housing expense; and
ii. Additional recurring charges extending ten months or more,
such as
a. Payments on installment accounts;
b. Child support or separate maintenance payments;
c. Revolving accounts; and
d. Alimony.
b. Debts lasting less than ten months must be included if the
amount of the debt affects the consumer's ability to pay the
mortgage during the months immediately after loan closing,
especially if the consumer will have limited or no cash assets after
loan closing.

[[Page 6596]]

Note: Monthly payments on revolving or open-ended accounts,
regardless of the balance, are counted as a liability for qualifying
purposes even if the account appears likely to be paid off within 10
months or less.
3. Revolving Account Monthly Payment Calculation. If the credit
report shows any revolving accounts with an outstanding balance but
no specific minimum monthly payment, the payment must be calculated
as the greater of:
a. 5 percent of the balance; or
b. $10.
Note: If the actual monthly payment is documented from the
creditor or the creditor obtains a copy of the current statement
reflecting the monthly payment, that amount may be used for
qualifying purposes.
4. Reduction of Alimony Payment for Qualifying Ratio
Calculation. Since there are tax consequences of alimony payments,
the creditor may choose to treat the monthly alimony obligation as a
reduction from the consumer's gross income when calculating
qualifying ratios, rather than treating it as a monthly obligation.

IV. Consumer Liabilities: Contingent Liability

1. Definition: Contingent Liability. A contingent liability
exists when an individual is held responsible for payment of a debt
if another party, jointly or severally obligated, defaults on the
payment.
2. Application of Contingent Liability Policies. The contingent
liability policies described in this topic apply unless the consumer
can provide conclusive evidence from the debt holder that there is
no possibility that the debt holder will pursue debt collection
against him/her should the other party default.
3. Contingent Liability on Mortgage Assumptions. Contingent
liability must be considered when the consumer remains obligated on
an outstanding FHA-insured, VA-guaranteed, or conventional mortgage
secured by property that:
a. Has been sold or traded within the last 12 months without a
release of liability, or
b. Is to be sold on assumption without a release of liability
being obtained.
4. Exemption From Contingent Liability Policy on Mortgage
Assumptions. When a mortgage is assumed, contingent liabilities need
not be considered if the:
a. Originating creditor of the mortgage being underwritten
obtains, from the servicer of the assumed loan, a payment history
showing that the mortgage has been current during the previous 12
months, or
b. Value of the property, as established by an appraisal or the
sales price on the HUD-1 Settlement Statement from the sale of the
property, results in a loan-to-value (LTV) ratio of 75 percent or
less.
5. Contingent Liability on Cosigned Obligations.
a. Contingent liability applies, and the debt must be included
in the underwriting analysis, if an individual applying for a
mortgage is a cosigner/co-obligor on:
i. A car loan;
ii. A student loan;
iii. A mortgage; or
iv. Any other obligation.
b. If the creditor obtains documented proof that the primary
obligor has been making regular payments during the previous 12
months, and does not have a history of delinquent payments on the
loan during that time, the payment does not have to be included in
the consumer's monthly obligations.

V. Consumer Liabilities: Projected Obligations and Obligations Not
Considered Debt

1. Projected Obligations.
a. Debt payments, such as a student loan or balloon-payment note
scheduled to begin or come due within 12 months of the mortgage loan
closing, must be included by the creditor as anticipated monthly
obligations during the underwriting analysis.
b. Debt payments do not have to be classified as projected
obligations if the consumer provides written evidence that the debt
will be deferred to a period outside the 12-month timeframe.
c. Balloon-payment notes that come due within one year of loan
closing must be considered in the underwriting analysis.
2. Obligations Not Considered Debt. Obligations not considered
debt, and therefore not subtracted from gross income, include:
a. Federal, State, and local taxes;
b. Federal Insurance Contributions Act (FICA) or other
retirement contributions, such as 401(k) accounts (including
repayment of debt secured by these funds):
c. Commuting costs;
d. Union dues;
e. Open accounts with zero balances;
f. Automatic deductions to savings accounts;
g. Child care; and
h. Voluntary deductions.
6. In Supplement I to Part 1026--Official Interpretations:
A. Under Section 1026.25--Record Retention:
i. Under 25(a) General rule, paragraph 2 is revised.
ii. Section 25(c) Records related to certain requirements for
mortgage loans, 25(c)(3) Records related to minimum standards for
transactions secured by a dwelling, and paragraphs 1 and 2 are
added.
B. The heading for Section 1026.32 is revised.
C. Under revised Section 1026.32:
i. Under 32(b) Definitions:
a. Paragraph 32(b)(1) and paragraph 1 are added.
b. Under Paragraph 32(b)(1)(i), paragraph 1 is revised.
c. Paragraph 32(b)(1)(i)(B) and paragraph 1 are added.
d. Paragraph 32(b)(1)(i)(C) and paragraphs 1 and 2 are added.
e. Paragraph 32(b)(1)(i)(D) and paragraphs 1, 2, 3, and 4 are
added.
f. Paragraph 32(b)(1)(i)(E) and paragraphs 1, 2, and 3 are
added.
g. Paragraph 32(b)(1)(i)(F) and paragraphs 1 and 2 are added.
h. Under Paragraph 32(b)(1)(ii), paragraphs 1 and 2 are revised
and paragraphs 3 and 4 are added.
i. Paragraph 32(b)(1)(iii) and paragraph 1 are added.
j. Under Paragraph 32(b)(1)(iv), paragraph 1 is revised and
paragraphs 2 and 3 are added.
k. 32(b)(3) Bona fide discount point, 32(b)(3)(i) Closed-end
credit, and paragraph 1 are added.
l. 32(b)(4) Total loan amount, 32(b)(4)(i) Closed-end credit,
and paragraph 1 are added.
m. 32(b)(6) Prepayment penalty and paragraphs 1 and 2 are added.
D. Section 1026.43--Minimum Standards for Transactions Secured
by a Dwelling is added.
The revisions and additions read as follows:

Supplement I to Part 1026--Official Interpretations

* * * * *

Subpart D--Miscellaneous

* * * * *

Section 1026.25--Record Retention

25(a) General rule.
* * * * *
2. Methods of retaining evidence. Adequate evidence of
compliance does not necessarily mean actual paper copies of
disclosure statements or other business records. The evidence may be
retained by any method that reproduces records accurately (including
computer programs). Unless otherwise required, the creditor need
retain only enough information to reconstruct the required
disclosures or other records. Thus, for example, the creditor need
not retain each open-end periodic statement, so long as the specific
information on each statement can be retrieved.
* * * * *
25(c) Records related to certain requirements for mortgage
loans.
25(c)(3) Records related to minimum standards for transactions
secured by a dwelling.
1. Evidence of compliance with repayment ability provisions. A
creditor must retain evidence of compliance with Sec. 1026.43 for
three years after the date of consummation of a consumer credit
transaction covered by that section. (See comment 25(c)-2 for
guidance on the retention of evidence of compliance with the
requirement to offer a consumer a loan without a prepayment penalty
under Sec. 1026.43(g)(3).) If a creditor must verify and document
information used in underwriting a transaction subject to Sec.
1026.43, the creditor shall retain evidence sufficient to
demonstrate compliance with the documentation requirements of the
rule. Although a creditor need not retain actual paper copies of the
documentation used in underwriting a transaction subject to Sec.
1026.43, to comply with Sec. 1026.25(c)(3), the creditor must be
able to reproduce such records accurately. For example, if the
creditor uses a consumer's Internal Revenue Service (IRS) Form W-2
to verify the consumer's income, the creditor must be able to
reproduce the IRS Form W-2 itself, and

[[Page 6597]]

not merely the income information that was contained in the form.
2. Dwelling-secured transactions and prepayment penalties. If a
transaction covered by Sec. 1026.43 has a prepayment penalty, the
creditor must maintain records that document that the creditor
complied with requirements for offering the consumer an alternative
transaction that does not include a prepayment penalty under Sec.
1026.43(g)(3), (4), or (5). However, the creditor need not maintain
records that document compliance with those provisions if a
transaction is consummated without a prepayment penalty or if the
creditor and consumer do not consummate a covered transaction. If a
creditor offers a transaction with a prepayment penalty to a
consumer through a mortgage broker, to evidence compliance with
Sec. 1026.43(g)(4) the creditor should retain evidence of the
alternative covered transaction presented to the mortgage broker,
such as a rate sheet, and the agreement with the mortgage broker
required by Sec. 1026.43(g)(4)(ii).
* * * * *

Subpart E--Special Rules for Certain Home Mortgage Transactions

* * * * *

Section 1026.32--Requirements for High-Cost Mortgages

* * * * *
32(b) Definitions.
Paragraph 32(b)(1).
1. Known at or before consummation. Section 1026.32(b)(1)
includes in points and fees for closed-end credit transactions those
items listed in Sec. 1026.32(b)(1)(i) through (vi) that are known
at or before consummation. The following examples clarify how to
determine whether a charge or fee is known at or before
consummation.
i. General. In general, a charge or fee is ``known at or before
consummation'' if the creditor knows at or before consummation that
the charge or fee will be imposed in connection with the
transaction, even if the charge or fee is scheduled to be paid after
consummation. Thus, for example, if the creditor charges the
consumer $400 for an appraisal conducted by an affiliate of the
creditor, the $400 is included in points and fees, even if the
consumer finances it and repays it over the loan term, because the
creditor knows at or before consummation that the charge or fee is
imposed in connection with the transaction. By contrast, if a
creditor does not know whether a charge or fee will be imposed, it
is not included in points and fees. For example, charges or fees
that the creditor may impose if the consumer seeks to modify a loan
after consummation are not included in points and fees, because the
creditor does not know at or before consummation whether the
consumer will seek to modify the loan and therefore incur the fees
or charges.
ii. Prepayment penalties. Notwithstanding the guidance in
comment 32(b)(1)-1.i, under Sec. 1026.32(b)(1)(v) the maximum
prepayment penalty that may be charged or collected under the terms
of the mortgage loan is included in points and fees because the
amount of the maximum prepayment penalty that may be charged or
collected is known at or before consummation.
iii. Certain mortgage and credit insurance premiums.
Notwithstanding the guidance in comment 32(b)(1)-1.i, under Sec.
1026.32(b)(1)(i)(C)(1) and (iii) premiums and charges for private
mortgage insurance and credit insurance that are payable after
consummation are not included in points and fees, even if the
amounts of such premiums and charges are known at or before
consummation.
Paragraph 32(b)(1)(i).
1. General. Section 1026.32(b)(1)(i) includes in the total
``points and fees'' items included in the finance charge under Sec.
1026.4(a) and (b). However, certain items that may be included in
the finance charge are excluded from points and fees under Sec.
1026.32(b)(1)(i)(A) through (F). Items excluded from the finance
charge under other provisions of Sec. 1026.4 are not included in
the total points and fees under Sec. 1026.32(b)(1)(i), but may be
included in points and fees under Sec. 1026.32(b)(1)(ii) through
(vi). To illustrate: A fee imposed by the creditor for an appraisal
performed by an employee of the creditor meets the definition of
``finance charge'' under Sec. 1026.4(a) as ``any charge payable
directly or indirectly by the consumer and imposed directly or
indirectly by the creditor as an incident to or a condition of the
extension of credit.'' However, Sec. 1026.4(c)(7) specifies that
appraisal fees are not included in the finance charge. A fee imposed
by the creditor for an appraisal performed by an employee of the
creditor therefore would not be included in the finance charge and
would not be counted in points and fees under Sec.
1026.32(b)(1)(i). Section 1026.32(b)(1)(iii), however, expressly
includes in points and fees items listed in Sec. 1026.4(c)(7)
(including appraisal fees) if the creditor receives compensation in
connection with the charge. A creditor would receive compensation
for an appraisal performed by its own employee. Thus, the appraisal
fee in this example must be included in the calculation of points
and fees.
Paragraph 32(b)(1)(i)(B).
1. Federal and State mortgage insurance premiums and guaranty
fees. Under Sec. 1026.32(b)(1)(i)(B), mortgage insurance premiums
or guaranty fees in connection with a Federal or State agency
program are excluded from points and fees, even though they are
included in the finance charge under Sec. 1026.4(a) and (b). For
example, if a consumer is required to pay a $2,000 mortgage
insurance premium for a loan insured by the Federal Housing
Administration, the $2,000 must be included in the finance charge
but is not counted in points and fees. Similarly, if a consumer pays
a 2 percent funding fee for a loan guaranteed by the U.S. Department
of Veterans Affairs or through the U.S Department of Agriculture's
Rural Development Single Family Housing Guaranteed Loan Program, the
fee is included in the finance charge but is not included in points
and fees.
Paragraph 32(b)(1)(i)(C).
1. Private mortgage insurance premiums. i. Payable after
consummation. Under Sec. 1026.32(b)(1)(i)(C)(1), private mortgage
insurance premiums payable after consummation are excluded from
points and fees.
ii. Payable at or before consummation. A. General. Under Sec.
1026.32(b)(1)(i)(C)(2), private mortgage insurance premiums payable
at or before consummation (i.e., single or up-front premiums) may be
excluded from points and fees, even though they are included in the
finance charge under Sec. 1026.4(a) and (b). However, the portion
of the premium that exceeds the amount payable under policies in
effect at the time of origination under section 203(c)(2)(A) of the
National Housing Act (12 U.S.C. 1709(c)(2)(A)) is included in points
and fees. To determine whether any portion of the premium exceeds
the amount payable under policies in effect at the time of
origination under section 203(c)(2)(A) of the National Housing Act,
a creditor references the premium amount that would be payable for
the transaction under that Act, as implemented by applicable
regulations and other written authorities issued by the Federal
Housing Administration (such as Mortgagee Letters), even if the
transaction would not qualify to be insured under that Act
(including, for example, because the principal amount exceeds the
maximum insurable under that Act).
B. Non-refundable premiums. To qualify for the exclusion from
points and fees, private mortgage insurance premiums payable at or
before consummation must be required to be refunded on a pro rata
basis and the refund must be automatically issued upon notification
of the satisfaction of the underlying mortgage loan.
C. Example. Assume that a $3,000 private mortgage insurance
premium charged on a closed-end mortgage loan is payable at or
before closing and is required to be refunded on a pro rata basis
and that the refund is automatically issued upon notification of the
satisfaction of the underlying mortgage loan. Assume also that the
maximum premium allowable under the National Housing Act is $2,000.
In this case, the creditor could exclude $2,000 from points and fees
but would have to include the $1,000 that exceeds the allowable
premium under the National Housing Act. However, if the $3,000
private mortgage insurance premium were not required to be refunded
on a pro rata basis or if the refund were not automatically issued
upon notification of the satisfaction of the underlying mortgage
loan, the entire $3,000 premium would be included in points and
fees.
2. Method of paying private mortgage insurance premiums. The
portion of any private mortgage insurance premiums payable at or
before consummation that does not qualify for an exclusion from
points and fees under Sec. 1026.32(b)(1)(i)(C)(2) must be included
in points and fees for purposes of Sec. 1026.32(b)(1)(i) whether
paid in cash or financed and whether the insurance is optional or
required.
Paragraph 32(b)(1)(i)(D).
1. Charges not retained by the creditor, loan originator, or an
affiliate of either. In general, a creditor is not required to count
in points and fees any bona fide third-party charge not retained by
the creditor, loan

[[Page 6598]]

originator, or an affiliate of either. For example, if bona fide
charges are imposed by a third-party settlement agent and are not
retained by the creditor, loan originator, or an affiliate of
either, those charges are not included in points and fees, even if
those charges are included in the finance charge under Sec.
1026.4(a)(2). The term loan originator has the same meaning as in
Sec. 1026.36(a)(1).
2. Private mortgage insurance. The exclusion for bona fide
third-party charges not retained by the creditor, loan originator,
or an affiliate of either is limited by Sec. 1026.32(b)(1)(i)(C) in
the general definition of ``points and fees.'' Section
1026.32(b)(1)(i)(C) requires inclusion in points and fees of
premiums or other charges payable at or before consummation for any
private guaranty or insurance protecting the creditor against the
consumer's default or other credit loss to the extent that the
premium or charge exceeds the amount payable under policies in
effect at the time of origination under section 203(c)(2)(A) of the
National Housing Act (12 U.S.C. 1709(c)(2)(A)). These premiums or
charges must also be included if the premiums or charges are not
required to be refundable on a pro-rated basis, or the refund is not
required to be automatically issued upon notification of the
satisfaction of the underlying mortgage loan. Under these
circumstances, even if the premiums or other charges are not
retained by the creditor, loan originator, or an affiliate of
either, they must be included in the points and fees calculation for
qualified mortgages. See comments 32(b)(1)(i)(c)-1 and -2 for
further discussion of including private mortgage insurance premiums
payable at or before consummation in the points and fees
calculation.
3. Real estate-related fees. The exclusion for bona fide third-
party charges not retained by the creditor, loan originator, or an
affiliate of either is limited by Sec. 1026.32(b)(1)(iii) in the
general definition of points and fees. Section 1026.32(b)(1)(iii)
requires inclusion in points and fees of items listed in Sec.
1026.4(c)(7) unless the charge is reasonable, the creditor receives
no direct or indirect compensation in connection with the charge,
and the charge is not paid to an affiliate of the creditor. If a
charge is required to be included in points and fees under Sec.
1026.32(b)(1)(iii), it may not be excluded under Sec.
1026.32(b)(1)(i)(D), even if the criteria for exclusion in Sec.
1026.32(b)(1)(i)(D) are satisfied.
4. Credit insurance. The exclusion for bona fide third-party
charges not retained by the creditor, loan originator, or an
affiliate of either is limited by Sec. 1026.32(b)(1)(iv) in the
general definition of points and fees. Section 1026.32(b)(1)(iv)
requires inclusion in points and fees of premiums and other charges
for credit insurance and certain other types of insurance. If a
charge is required to be included in points and fees under Sec.
1026.32(b)(1)(iv), it may not be excluded under Sec.
1026.32(b)(1)(i)(D), even if the criteria for exclusion in Sec.
1026.32(b)(1)(i)(D) are satisfied.
Paragraph 32(b)(1)(i)(E).
1. Bona fide discount point. The term bona fide discount point
is defined in Sec. 1026.32(b)(3).
2. Average prime offer rate. The average prime offer rate for
purposes of paragraph (b)(1)(i)(E) of this section is the average
prime offer rate that applies to a comparable transaction as of the
date the discounted interest rate for the transaction is set. For
the meaning of ``comparable transaction,'' refer to comment
35(a)(2)-2. The table of average prime offer rates published by the
Bureau indicates how to identify the comparable transaction. See
comment 35(a)(2)-2.
3. Example. Assume a transaction that is a first-lien, purchase-
money home mortgage with a fixed interest rate and a 30-year term.
Assume also that the consumer locks in an interest rate of 6 percent
on May 1, 2014 that was discounted from a rate of 6.5 percent
because the consumer paid two discount points. Finally, assume that
the average prime offer rate as of May 1, 2014 for home mortgages
with a fixed interest rate and a 30-year term is 5.5 percent. The
creditor may exclude two bona fide discount points from the points
and fees calculation because the rate from which the discounted rate
was derived (6.5 percent) exceeded the average prime offer rate for
a comparable transaction as of the date the rate on the transaction
was set (5.5 percent) by only 1 percentage point.
Paragraph 32(b)(1)(i)(F).
1. Bona fide discount point and average prime offer rate.
Comments 32(b)(1)(i)(E)-1 and -2 provide guidance concerning the
definition of bona fide discount point and average prime offer rate,
respectively.
2. Example. Assume a transaction that is a first-lien, purchase-
money home mortgage with a fixed interest rate and a 30-year term.
Assume also that the consumer locks in an interest rate of 6 percent
on May 1, 2014, that was discounted from a rate of 7 percent because
the consumer paid four discount points. Finally, assume that the
average prime offer rate as of May 1, 2014, for home mortgages with
a fixed interest rate and a 30-year term is 5 percent. The creditor
may exclude one discount point from the points and fees calculation
because the rate from which the discounted rate was derived (7
percent) exceeded the average prime offer rate for a comparable
transaction as of the date the rate on the transaction was set (5
percent) by only 2 percentage points.
Paragraph 32(b)(1)(ii).
1. Loan originator compensation--general. Compensation paid by a
consumer or creditor to a loan originator is included in the
calculation of points and fees for a transaction, provided that such
compensation can be attributed to that particular transaction at the
time the interest rate is set. Loan originator compensation includes
amounts the loan originator retains and is not dependent on the
label or name of any fee imposed in connection with the transaction.
2. Loan originator compensation--attributable to a particular
transaction. i. Loan originator compensation includes the dollar
value of compensation, such as a bonus, commission, or award of
merchandise, services, trips, or similar prizes, that is paid by a
consumer or creditor to a loan originator and can be attributed to
that particular transaction. The amount of compensation that can be
attributed to a particular transaction is the dollar value of
compensation that the loan originator will receive if the
transaction is consummated. As explained in comment 32(b)(1)(ii)-3,
the amount of compensation that a loan originator will receive is
calculated as of the date the interest rate is set and includes
compensation that is paid before, at, or after consummation.
ii. Loan originator compensation excludes compensation that
cannot be attributed to that transaction, including, for example:
A. Compensation based on the long term performance of the loan
originator's loans.
B. Compensation based on the overall quality of a loan
originator's loan files.
C. The base salary of a loan originator. However, any
compensation in addition to the base salary that can be attributed
to the transaction at the time the interest rate is set must be
included in loan originator compensation for the purpose of
calculating points and fees.
3. Loan originator compensation--timing. Compensation paid to a
loan originator that can be attributed to a transaction must be
included in the points and fees calculation for that loan regardless
of whether the compensation is paid before, at, or after
consummation. The amount of loan originator compensation that can be
attributed to a transaction is determined as of the date the
interest rate is set. Thus, loan originator compensation for a
transaction includes the portion of a bonus, commission, or award of
merchandise, services, trips, or similar prizes that can be
attributed to that transaction at the time the creditor sets the
interest rate for the transaction, even if that bonus, commission,
or award of merchandise, services, trips, or similar prizes is not
paid until after consummation. For example, assume a $100,000
transaction and that, as of the date the interest rate is set, the
loan originator is entitled to receive a commission equal to 1
percent of the loan amount at consummation, i.e., $1,000, payable at
the end of the month. In addition, assume that after the date the
interest rate is set but before consummation of the transaction, the
loan originator originates other transactions that enable the loan
originator to meet a loan volume threshold, which increases the loan
originator's commission to 1.25 percent of the loan amount, i.e.,
$1,250. In this case, the creditor need include only $1,000 as loan
originator compensation in points and fees because, as of the date
the interest rate was set, the loan originator would have been
entitled to receive $1,000 upon consummation of the transaction.
4. Loan originator compensation--examples. The following
examples illustrate the rule:
i. Assume that, according to a creditor's compensation policies,
the creditor awards its loan officers a bonus every year based on
the number of loan applications taken by the loan officer that
result in consummated transactions during that year, and that each
consummated transaction increases the year-end bonus by $100. In
this case, $100 of the bonus is loan originator compensation that
must be included in points and fees for the transaction.

[[Page 6599]]

ii. Assume that, according to a creditor's compensation
policies, the creditor awards its loan officers a year-end bonus
equal to a flat dollar amount for each of the consummated
transactions originated by the loan officer during that year. Assume
also that the per-transaction dollar amount is finalized at the end
of the year, according to a predetermined schedule that provides for
a specific per-transaction dollar amount based on the total dollar
value of consummated transactions originated by the loan officer. If
on the date the interest rate for a transaction is set, the loan
officer has originated total volume that qualifies the loan officer
to receive a $300 bonus per transaction under the predetermined
schedule, then $300 of the year-end bonus can be attributed to that
particular transaction and therefore is loan originator compensation
that must be included in points and fees for that transaction.
iii. Assume that, according to a creditor's compensation
policies, the creditor awards its loan officers a bonus at the end
of the year based on the number of consummated transactions
originated by the loan officer during that year. Assume also that,
for the first 10 transactions originated by the loan officer in a
given year, no bonus is awarded; for the next 10 transactions
originated by the loan officer up to 20, a bonus of $100 per
transaction is awarded; and for each transaction originated after
the first 20, a bonus of $200 per transaction is awarded. In this
case, if, on the date the interest rate for the transaction is set,
the loan officer has originated 10 or fewer transactions that year,
then none of the year-end bonus is attributable to the transaction
and therefore none of the bonus is included in points and fees for
that transaction. If, on the date the interest rate for the
transaction is set, the loan officer has originated at more than 10
but no more than 20 transactions, $100 of the bonus is attributable
to the transaction and is included in points and fees for that
transaction. If, on the date the interest rate for the transaction
is set, the loan officer has originated more than 20 transactions,
$200 of the bonus is attributable to the transaction and is included
in points and fees for the transaction.
iv. Assume that, according to a creditor's compensation
policies, the creditor pays its loan officers a base salary of $500
per week and awards its loan officers a bonus of $250 for each
consummated transaction. For each transaction, none of the $500 base
salary is counted in points and fees as loan originator compensation
under Sec. 1026.32(b)(1)(ii) because no precise portion of the base
salary can be attributed to a particular transaction, but the $250
bonus is counted as loan originator compensation that is included in
points and fees.
Paragraph 32(b)(1)(iii).
1. Other charges. Section 1026.32(b)(1)(iii) defines points and
fees to include all items listed in Sec. 1026.4(c)(7), other than
amounts held for the future payment of taxes, unless certain
exclusions apply. An item listed in Sec. 1026.4(c)(7) may be
excluded from the points and fees calculation if the charge is
reasonable; the creditor receives no direct or indirect compensation
from the charge; and the charge is not paid to an affiliate of the
creditor. For example, a reasonable fee paid by the consumer to an
independent, third-party appraiser may be excluded from the points
and fees calculation (assuming no compensation is paid to the
creditor or its affiliate and no charge is paid to an affiliate). By
contrast, a fee paid by the consumer for an appraisal performed by
the creditor must be included in the calculation, even though the
fee may be excluded from the finance charge if it is bona fide and
reasonable in amount.
Paragraph 32(b)(1)(iv).
1. Credit insurance and debt cancellation or suspension
coverage. In determining points and fees for purposes of Sec.
1026.32(b)(1), premiums paid at or before consummation for credit
insurance or any debt cancellation or suspension agreement or
contract are included in points and fees whether they are paid in
cash or, if permitted by applicable law, financed and whether the
insurance or coverage is optional or required. Such charges are also
included whether the amount represents the entire premium or payment
for the coverage or an initial payment.
2. Credit property insurance. Credit property insurance includes
insurance against loss of or damage to personal property, such as a
houseboat or manufactured home. Credit property insurance covers the
creditor's security interest in the property. Credit property
insurance does not include homeowners' insurance, which, unlike
credit property insurance, typically covers not only the dwelling
but its contents and protects the consumer's interest in the
property.
3. Life, accident, health, or loss-of-income insurance. Premiums
or other charges for these types of insurance are included in points
and fees only if the creditor is a beneficiary. If the consumer or
another person designated by the consumer is the sole beneficiary,
then the premiums or other charges are not included in points and
fees.
32(b)(3) Bona fide discount point.
32(b)(3)(i) Closed-end credit.
1. Definition of bona fide discount point. Section 1026.32(b)(3)
provides that, to be bona fide, a discount point must reduce the
interest rate based on a calculation that is consistent with
established industry practices for determining the amount of
reduction in the interest rate or time-price differential
appropriate for the amount of discount points paid by the consumer.
To satisfy this standard, a creditor may show that the reduction is
reasonably consistent with established industry norms and practices
for secondary mortgage market transactions. For example, a creditor
may rely on pricing in the to-be-announced (TBA) market for
mortgage-backed securities (MBS) to establish that the interest rate
reduction is consistent with the compensation that the creditor
could reasonably expect to receive in the secondary market. The
creditor may also establish that its interest rate reduction is
consistent with established industry practices by showing that its
calculation complies with requirements prescribed in Fannie Mae or
Freddie Mac guidelines for interest rate reductions from bona fide
discount points. For example, assume that the Fannie Mae Single-
Family Selling Guide or the Freddie Mac Single Family Seller/
Servicer Guide imposes a cap on points and fees but excludes from
the cap discount points that result in a bona fide reduction in the
interest rate. Assume the guidelines require that, for a discount
point to be bona fide so that it would not count against the cap, a
discount point must result in at least a 25 basis point reduction in
the interest rate. Accordingly, if the creditor offers a 25 basis
point interest rate reduction for a discount point and the
requirements of Sec. 1026.32(b)(1)(i)(E) or (F) are satisfied, the
discount point is bona fide and is excluded from the calculation of
points and fees.
32(b)(4) Total loan amount.
32(b)(4)(i) Closed-end credit.
1. Total loan amount; examples. Below are several examples
showing how to calculate the total loan amount for closed-end
mortgage loans, each using a $10,000 amount borrowed, a $300
appraisal fee, and $400 in prepaid finance charges. A $500 single
premium for optional credit unemployment insurance is used in one
example.
i. If the consumer finances a $300 fee for a creditor-conducted
appraisal and pays $400 in prepaid finance charges at closing, the
amount financed under Sec. 1026.18(b) is $9,900 ($10,000 plus the
$300 appraisal fee that is paid to and financed by the creditor,
less $400 in prepaid finance charges). The $300 appraisal fee paid
to the creditor is added to other points and fees under Sec.
1026.32(b)(1)(iii). It is deducted from the amount financed ($9,900)
to derive a total loan amount of $9,600.
ii. If the consumer pays the $300 fee for the creditor-conducted
appraisal in cash at closing, the $300 is included in the points and
fees calculation because it is paid to the creditor. However,
because the $300 is not financed by the creditor, the fee is not
part of the amount financed under Sec. 1026.18(b). In this case,
the amount financed is the same as the total loan amount: $9,600
($10,000, less $400 in prepaid finance charges).
iii. If the consumer finances a $300 fee for an appraisal
conducted by someone other than the creditor or an affiliate, the
$300 fee is not included with other points and fees under Sec.
1026.32(b)(1)(iii). In this case, the amount financed is the same as
the total loan amount: $9,900 ($10,000 plus the $300 fee for an
independently-conducted appraisal that is financed by the creditor,
less the $400 paid in cash and deducted as prepaid finance charges).
iv. If the consumer finances a $300 fee for a creditor-conducted
appraisal and a $500 single premium for optional credit unemployment
insurance, and pays $400 in prepaid finance charges at closing, the
amount financed under Sec. 1026.18(b) is $10,400 ($10,000, plus the
$300 appraisal fee that is paid to and financed by the creditor,
plus the $500 insurance premium that is financed by the creditor,
less $400 in prepaid finance charges). The $300 appraisal fee paid
to the creditor is added to other points and fees under Sec.
1026.32(b)(1)(ii), and the $500 insurance premium is added under
1026.32(b)(1)(iv). The $300 and $500 costs are deducted from the
amount financed

[[Page 6600]]

($10,400) to derive a total loan amount of $9,600.
32(b)(6) Prepayment penalty.
1. Examples of prepayment penalties; closed-end credit
transactions. For purposes of Sec. 1026.32(b)(6)(i), the following
are examples of prepayment penalties:
i. A charge determined by treating the loan balance as
outstanding for a period of time after prepayment in full and
applying the interest rate to such ``balance,'' even if the charge
results from interest accrual amortization used for other payments
in the transaction under the terms of the loan contract. ``Interest
accrual amortization'' refers to the method by which the amount of
interest due for each period (e.g., month) in a transaction's term
is determined. For example, ``monthly interest accrual
amortization'' treats each payment as made on the scheduled, monthly
due date even if it is actually paid early or late (until the
expiration of any grace period). Thus, under the terms of a loan
contract providing for monthly interest accrual amortization, if the
amount of interest due on May 1 for the preceding month of April is
$3,000, the loan contract will require payment of $3,000 in interest
for the month of April whether the payment is made on April 20, on
May 1, or on May 10. In this example, if the consumer prepays the
loan in full on April 20 and if the accrued interest as of that date
is $2,000, then assessment of a charge of $3,000 constitutes a
prepayment penalty of $1,000 because the amount of interest actually
earned through April 20 is only $2,000.
ii. A fee, such as an origination or other loan closing cost,
that is waived by the creditor on the condition that the consumer
does not prepay the loan. However, the term prepayment penalty does
not include a waived bona fide third-party charge imposed by the
creditor if the consumer pays all of a covered transaction's
principal before the date on which the principal is due sooner than
36 months after consummation. For example, assume that at
consummation, the creditor waives $3,000 in closing costs to cover
bona fide third-party charges but the terms of the loan agreement
provide that the creditor may recoup the $3,000 in waived charges if
the consumer repays the entire loan balance sooner than 36 months
after consummation. The $3,000 charge is not a prepayment penalty.
In contrast, for example, assume that at consummation, the creditor
waives $3,000 in closing costs to cover bona fide third-party
charges but the terms of the loan agreement provide that the
creditor may recoup $4,500, in part to recoup waived charges, if the
consumer repays the entire loan balance sooner than 36 months after
consummation. The $3,000 that the creditor may impose to cover the
waived bona fide third-party charges is not a prepayment penalty,
but the additional $1,500 charge is a prepayment penalty and subject
to the restrictions under Sec. 1026.43(g).
iii. A minimum finance charge in a simple interest transaction.
iv. Computing a refund of unearned interest by a method that is
less favorable to the consumer than the actuarial method, as defined
by section 933(d) of the Housing and Community Development Act of
1992, 15 U.S.C. 1615(d). For purposes of computing a refund of
unearned interest, if using the actuarial method defined by
applicable State law results in a refund that is greater than the
refund calculated by using the method described in section 933(d) of
the Housing and Community Development Act of 1992, creditors should
use the State law definition in determining if a refund is a
prepayment penalty.
2. Fees that are not prepayment penalties; closed-end credit
transactions. For purposes of Sec. 1026.32(b)(6)(i), fees that are
not prepayment penalties include, for example:
i. Fees imposed for preparing and providing documents when a
loan is paid in full if such fees are imposed whether or not the
loan is prepaid. Examples include a loan payoff statement, a
reconveyance document, or another document releasing the creditor's
security interest in the dwelling that secures the loan.
ii. Loan guarantee fees.
* * * * *

Section 1026.43--Minimum Standards for Transactions Secured by a
Dwelling

1. Record retention. See Sec. 1026.25(c)(3) and comments
25(c)(3)-1 and -2 for guidance on the required retention of records
as evidence of compliance with Sec. 1026.43.
43(a) Scope.
1. Consumer credit. In general, Sec. 1026.43 applies to
consumer credit transactions secured by a dwelling, but certain
dwelling-secured consumer credit transactions are exempt or
partially exempt from coverage under Sec. 1026.43(a)(1) through
(3). (See Sec. 1026.2(a)(12) for the definition of ``consumer
credit.'') Section 1026.43 does not apply to an extension of credit
primarily for a business, commercial, or agricultural purpose, even
if it is secured by a dwelling. See Sec. 1026.3 and associated
commentary for guidance in determining the primary purpose of an
extension of credit. In addition, Sec. 1026.43 does not apply to
any change to an existing loan that is not treated as a refinancing
under Sec. 1026.20(a).
2. Real property. ``Dwelling'' means a residential structure
that contains one to four units, whether or not the structure is
attached to real property. See Sec. 1026.2(a)(19). For purposes of
Sec. 1026.43, the term ``dwelling'' includes any real property to
which the residential structure is attached that also secures the
covered transaction. For example, for purposes of Sec.
1026.43(c)(2)(i), the value of the dwelling that secures the covered
transaction includes the value of any real property to which the
residential structure is attached that also secures the covered
transaction.
Paragraph 43(a)(3).
1. Renewable temporary or ``bridge'' loan. Under Sec.
1026.43(a)(3)(ii), a temporary or ``bridge'' loan with a term of 12
months or less is exempt from Sec. 1026.43(c) through (f). Examples
of such a loan are a loan to finance the purchase of a new dwelling
where the consumer plans to sell a current dwelling within 12 months
and a loan to finance the initial construction of a dwelling. Where
a temporary or ``bridge loan'' is renewable, the loan term does not
include any additional period of time that could result from a
renewal provision provided that any renewal possible under the loan
contract is for one year or less. For example, if a construction
loan has an initial loan term of 12 months but is renewable for
another 12-month loan term, the loan is exempt from Sec. 1026.43(c)
through (f) because the initial loan term is 12 months.
2. Construction phase of a construction-to-permanent loan. Under
Sec. 1026.43(a)(3)(iii), a construction phase of 12 months or less
of a construction-to-permanent loan is exempt from Sec. 1026.43(c)
through (f). A construction-to-permanent loan is a potentially
multiple-advance loan to finance the construction, rehabilitation,
or improvement of a dwelling that may be permanently financed by the
same creditor. For such a loan, the construction phase and the
permanent phase may be treated as separate transactions for the
purpose of compliance with Sec. 1026.43(c) through (f), and the
construction phase of the loan is exempt from Sec. 1026.43(c)
through (f), provided the initial term is 12 months or less. See
Sec. 1026.17(c)(6)(ii), allowing similar treatment for disclosures.
Where the construction phase of a construction-to-permanent loan is
renewable for a period of one year or less, the term of that
construction phase does not include any additional period of time
that could result from a renewal provision. For example, if the
construction phase of a construction-to-permanent loan has an
initial term of 12 months but is renewable for another 12-month term
before permanent financing begins, the construction phase is exempt
from Sec. 1026.43(c) through (f) because the initial term is 12
months. Any renewal of one year or less also qualifies for the
exemption. The permanent phase of the loan is treated as a separate
transaction and is not exempt under Sec. 1026.43(a)(3)(iii). It may
be a qualified mortgage if it satisfies the appropriate
requirements.
43(b) Definitions.
43(b)(1) Covered transaction.
1. The definition of covered transaction restates the scope of
the rule as described at Sec. 1026.43(a).
43(b)(3) Fully indexed rate.
1. Discounted and premium adjustable-rate transactions. In some
adjustable-rate transactions, creditors may set an initial interest
rate that is not determined by the index or formula used to make
later interest rate adjustments. In some cases, the initial rate
charged to consumers is lower than the rate would be if it were
calculated using the index or formula that will apply after recast,
as determined at consummation (i.e., a ``discounted rate''). In
other cases, the initial rate may be higher (i.e., a ``premium
rate''). For purposes of determining the fully indexed rate where
the initial interest rate is not determined using the index or
formula for subsequent interest rate adjustments, the creditor must
use the interest rate that would have applied had the creditor used
such index or formula plus margin at the time of consummation. That
is, in determining the fully indexed rate, the creditor must not
take into account any discounted or premium rate. To illustrate,
assume an adjustable-rate transaction where the initial interest
rate is not based on an index or formula, or is based on an index or
formula that will not apply after recast, and is set at 5 percent
for the first

[[Page 6601]]

five years. The loan agreement provides that future interest rate
adjustments will be calculated based on a specific index plus a 3
percent margin. If the value of the index at consummation is 5
percent, the interest rate that would have been applied at
consummation had the creditor based the initial rate on this index
is 8 percent (5 percent plus 3 percent margin). For purposes of
Sec. 1026.43(b)(3), the fully indexed rate is 8 percent. For
discussion of payment calculations based on the greater of the fully
indexed rate or premium rate for purposes of the repayment ability
determination under Sec. 1026.43(c), see Sec. 1026.43(c)(5)(i) and
comment 43(c)(5)(i)-2.
2. Index or formula value at consummation. The value at
consummation of the index or formula need not be used if the
contract provides for a delay in the implementation of changes in an
index value or formula. For example, if the contract specifies that
rate changes are based on the index value in effect 45 days before
the change date, the creditor may use any index value in effect
during the 45 days before consummation in calculating the fully
indexed rate.
3. Interest rate adjustment caps. If the terms of the legal
obligation contain a periodic interest rate adjustment cap that
would prevent the initial rate, at the time of the first adjustment,
from changing to the rate determined using the index or formula
value at consummation (i.e., the fully indexed rate), the creditor
must not give any effect to that rate cap when determining the fully
indexed rate. That is, a creditor must determine the fully indexed
rate without taking into account any periodic interest rate
adjustment cap that may limit how quickly the fully indexed rate may
be reached at any time during the loan term under the terms of the
legal obligation. To illustrate, assume an adjustable-rate mortgage
has an initial fixed rate of 5 percent for the first three years of
the loan, after which the rate will adjust annually to a specified
index plus a margin of 3 percent. The loan agreement provides for a
2 percent annual interest rate adjustment cap, and a lifetime
maximum interest rate of 10 percent. The index value in effect at
consummation is 4.5 percent; the fully indexed rate is 7.5 percent
(4.5 percent plus 3 percent), regardless of the 2 percent annual
interest rate adjustment cap that would limit when the fully indexed
rate would take effect under the terms of the legal obligation.
4. Lifetime maximum interest rate. A creditor may choose, in its
sole discretion, to take into account the lifetime maximum interest
rate provided under the terms of the legal obligation when
determining the fully indexed rate. To illustrate, assume an
adjustable-rate mortgage has an initial fixed rate of 5 percent for
the first three years of the loan, after which the rate will adjust
annually to a specified index plus a margin of 3 percent. The loan
agreement provides for a 2 percent annual interest rate adjustment
cap and a lifetime maximum interest rate of 7 percent. The index
value in effect at consummation is 4.5 percent; under the generally
applicable rule, the fully indexed rate is 7.5 percent (4.5 percent
plus 3 percent). Nevertheless, the creditor may choose to use the
lifetime maximum interest rate of 7 percent as the fully indexed
rate, rather than 7.5 percent, for purposes of Sec. 1026.43(b)(3).
Furthermore, if the creditor chooses to use the lifetime maximum
interest rate and the loan agreement provides a range for the
maximum interest rate, then the creditor complies by using the
highest rate in that range as the maximum interest rate for purposes
of Sec. 1026.43(b)(3).
5. Step-rate and fixed-rate mortgages. Where the interest rate
offered under the terms of the legal obligation is not based on, and
does not vary with, an index or formula (i.e., there is no fully
indexed rate), the creditor must use the maximum interest rate that
may apply at any time during the loan term. To illustrate:
i. Assume a step-rate mortgage with an interest rate fixed at
6.5 percent for the first two years of the loan, 7 percent for the
next three years, and 7.5 percent thereafter for the remainder of
loan term. For purposes of this section, the creditor must use 7.5
percent, which is the maximum rate that may apply during the loan
term. ``Step-rate mortgage'' is defined in Sec. 1026.18(s)(7)(ii).
ii. Assume a fixed-rate mortgage with an interest rate at
consummation of 7 percent that is fixed for the 30-year loan term.
For purposes of this section, the maximum interest rate that may
apply during the loan term is 7 percent, which is the interest rate
that is fixed at consummation. ``Fixed-rate mortgage'' is defined in
Sec. 1026.18(s)(7)(iii).
43(b)(4) Higher-priced covered transaction.
1. Average prime offer rate. The average prime offer rate is
defined in Sec. 1026.35(a)(2). For further explanation of the
meaning of ``average prime offer rate,'' and additional guidance on
determining the average prime offer rate, see comments 35(a)(2)-1
through -4.
2. Comparable transaction. A higher-priced covered transaction
is a consumer credit transaction that is secured by the consumer's
dwelling with an annual percentage rate that exceeds by the
specified amount the average prime offer rate for a comparable
transaction as of the date the interest rate is set. The published
tables of average prime offer rates indicate how to identify a
comparable transaction. See comment 35(a)(2)-2.
3. Rate set. A transaction's annual percentage rate is compared
to the average prime offer rate as of the date the transaction's
interest rate is set (or ``locked'') before consummation. Sometimes
a creditor sets the interest rate initially and then re-sets it at a
different level before consummation. The creditor should use the
last date the interest rate is set before consummation.
43(b)(5) Loan amount.
1. Disbursement of the loan amount. The definition of ``loan
amount'' requires the creditor to use the entire loan amount as
reflected in the loan contract or promissory note, even though the
loan amount may not be fully disbursed at consummation. For example,
assume the consumer enters into a loan agreement where the consumer
is obligated to repay the creditor $200,000 over 15 years, but only
$100,000 is disbursed at consummation and the remaining $100,000
will be disbursed during the year following consummation in a series
of advances ($25,000 each quarter). For purposes of this section,
the creditor must use the loan amount of $200,000, even though the
loan agreement provides that only $100,000 will be disbursed to the
consumer at consummation. Generally, creditors should rely on Sec.
1026.17(c)(6) and associated commentary regarding treatment of
multiple-advance and construction-to-permanent loans as single or
multiple transactions. See also comment 43(a)(3)-2.
43(b)(6) Loan term.
1. General. The loan term is the period of time it takes to
repay the loan amount in full. For example, a loan with an initial
discounted rate that is fixed for the first two years, and that
adjusts periodically for the next 28 years has a loan term of 30
years, which is the amortization period on which the periodic
amortizing payments are based.
43(b)(7) Maximum loan amount.
1. Calculation of maximum loan amount. For purposes of Sec.
1026.43(c)(2)(iii) and (c)(5)(ii)(C), a creditor must determine the
maximum loan amount for a negative amortization loan by using the
loan amount plus any increase in principal balance that can result
from negative amortization based on the terms of the legal
obligation. In determining the maximum loan amount, a creditor must
assume that the consumer makes the minimum periodic payment
permitted under the loan agreement for as long as possible, until
the consumer must begin making fully amortizing payments; and that
the interest rate rises as quickly as possible after consummation
under the terms of the legal obligation. Thus, creditors must assume
that the consumer makes the minimum periodic payment until any
negative amortization cap is reached or until the period permitting
minimum periodic payments expires, whichever occurs first. ``Loan
amount'' is defined in Sec. 1026.43(b)(5); ``negative amortization
loan'' is defined in Sec. 1026.18(s)(7)(v).
2. Assumed interest rate. In calculating the maximum loan amount
for an adjustable-rate mortgage that is a negative amortization
loan, the creditor must assume that the interest rate will increase
as rapidly as possible after consummation, taking into account any
periodic interest rate adjustment caps provided in the loan
agreement. For an adjustable-rate mortgage with a lifetime maximum
interest rate but no periodic interest rate adjustment cap, the
creditor must assume that the interest rate increases to the maximum
lifetime interest rate at the first adjustment.
3. Examples. The following are examples of how to determine the
maximum loan amount for a negative amortization loan (all amounts
shown are rounded, and all amounts are calculated using non-rounded
values):
i. Adjustable-rate mortgage with negative amortization. A.
Assume an adjustable-rate mortgage in the amount of $200,000 with a
30-year loan term. The loan agreement provides that the consumer can
make minimum monthly payments that cover only part of the interest
accrued each month until the principal balance reaches 115 percent
of its original balance (i.e., a negative

[[Page 6602]]

amortization cap of 115 percent) or for the first five years of the
loan (60 monthly payments), whichever occurs first. The introductory
interest rate at consummation is 1.5 percent. One month after the
first day of the first full calendar month following consummation,
the interest rate adjusts and will adjust monthly thereafter based
on the specified index plus a margin of 3.5 percent. The maximum
lifetime interest rate is 10.5 percent; there are no other periodic
interest rate adjustment caps that limit how quickly the maximum
lifetime rate may be reached. The minimum monthly payment for the
first year is based on the initial interest rate of 1.5 percent.
After that, the minimum monthly payment adjusts annually, but may
increase by no more than 7.5 percent over the previous year's
payment. The minimum monthly payment is $690 in the first year, $742
in the second year, and $797 in the first part of the third year.
B. To determine the maximum loan amount, assume that the initial
interest rate increases to the maximum lifetime interest rate of
10.5 percent at the first adjustment (i.e., the due date of the
first periodic monthly payment) and accrues at that rate until the
loan is recast. Assume the consumer makes the minimum monthly
payments as scheduled, which are capped at 7.5 percent from year-to-
year. As a result, the consumer's minimum monthly payments are less
than the interest accrued each month, resulting in negative
amortization (i.e., the accrued but unpaid interest is added to the
principal balance). Thus, assuming that the consumer makes the
minimum monthly payments for as long as possible and that the
maximum interest rate of 10.5 percent is reached at the first rate
adjustment (i.e., the due date of the first periodic monthly
payment), the negative amortization cap of 115 percent is reached on
the due date of the 27th monthly payment and the loan is recast. The
maximum loan amount as of the due date of the 27th monthly payment
is $229,251.
ii. Fixed-rate, graduated payment mortgage with negative
amortization. A loan in the amount of $200,000 has a 30-year loan
term. The loan agreement provides for a fixed interest rate of 7.5
percent, and requires the consumer to make minimum monthly payments
during the first year, with payments increasing 12.5 percent over
the previous year every year for four years. The payment schedule
provides for payments of $943 in the first year, $1,061 in the
second year, $1,193 in the third year, $1,343 in the fourth year,
and $1,511 for the remaining term of the loan. During the first
three years of the loan, the payments are less than the interest
accrued each month, resulting in negative amortization. Assuming
that the consumer makes the minimum periodic payments for as long as
possible, the maximum loan amount is $207,662, which is reached at
the end of the third year of the loan (on the due date of the 36th
monthly payment). See comment 43(c)(5)(ii)(C)-3 providing examples
of how to determine the consumer's repayment ability for a negative
amortization loan.
43(b)(8) Mortgage-related obligations.
1. General. Section 1026.43(b)(8) defines mortgage-related
obligations, which must be considered in determining a consumer's
ability to repay pursuant to Sec. 1026.43(c). Section 1026.43(b)(8)
includes, in the evaluation of mortgage-related obligations, fees
and special assessments owed to a condominium, cooperative, or
homeowners association. Section 1026.43(b)(8) includes ground rent
and leasehold payments in the definition of mortgage-related
obligations. See commentary to Sec. 1026.43(c)(2)(v) regarding the
requirement to take into account any mortgage-related obligations
for purposes of determining a consumer's ability to repay.
2. Property taxes. Section 1026.43(b)(8) includes property taxes
in the evaluation of mortgage-related obligations. Obligations that
are related to the ownership or use of real property and paid to a
taxing authority, whether on a monthly, quarterly, annual, or other
basis, are property taxes for purposes of Sec. 1026.43(b)(8).
Section 1026.43(b)(8) includes obligations that are equivalent to
property taxes, even if such obligations are not denominated as
``taxes.'' For example, governments may establish or allow
independent districts with the authority to impose levies on
properties within the district to fund a special purpose, such as a
local development bond district, water district, or other public
purpose. These levies may be referred to as taxes, assessments,
surcharges, or by some other name. For purposes of Sec.
1026.43(b)(8), these are property taxes and are included in the
determination of mortgage-related obligations.
3. Insurance premiums and similar charges. Section 1026.43(b)(8)
includes in the evaluation of mortgage-related obligations premiums
and similar charges identified in Sec. 1026.4(b)(5), (7), (8), or
(10) that are required by the creditor. This includes all premiums
or charges related to coverage protecting the creditor against a
consumer's default, credit loss, collateral loss, or similar loss,
if the consumer is required to pay the premium or charge. For
example, if Federal law requires flood insurance to be obtained in
connection with the mortgage loan, the flood insurance premium is a
mortgage-related obligation for purposes of Sec. 1026.43(b)(8).
Section 1026.43(b)(8) does not include premiums or similar charges
identified in Sec. 1026.4(b)(5), (7), (8), or (10) that are not
required by the creditor and that the consumer purchases
voluntarily. For example:
i. If a creditor does not require earthquake insurance to be
obtained in connection with the mortgage loan, but the consumer
voluntarily chooses to purchase such insurance, the earthquake
insurance premium is not a mortgage-related obligation for purposes
of Sec. 1026.43(b)(8).
ii. If a creditor requires a minimum amount of coverage for
homeowners' insurance and the consumer voluntarily chooses to
purchase a more comprehensive amount of coverage, the portion of the
premium allocated to the required minimum coverage is a mortgage-
related obligation for purposes of Sec. 1026.43(b)(8), while the
portion of the premium allocated to the more comprehensive coverage
voluntarily purchased by the consumer is not a mortgage-related
obligation for purposes of Sec. 1026.43(b)(8).
iii. If the consumer purchases insurance or similar coverage not
required by the creditor at consummation without having requested
the specific non-required insurance or similar coverage and without
having agreed to the premium or charge for the specific non-required
insurance or similar coverage prior to consummation, the premium or
charge is not voluntary for purposes of Sec. 1026.43(b)(8) and is a
mortgage-related obligation.
4. Mortgage insurance, guarantee, or similar charges. Section
1026.43(b)(8) includes in the evaluation of mortgage-related
obligations premiums or charges protecting the creditor against the
consumer's default or other credit loss. This includes all premiums
or similar charges, whether denominated as mortgage insurance,
guarantee insurance, or otherwise, as determined according to
applicable State or Federal law. For example, monthly ``private
mortgage insurance'' payments paid to a non-governmental entity,
annual ``guarantee fee'' payments required by a Federal housing
program, and a quarterly ``mortgage insurance'' payment paid to a
State agency administering a housing program are all mortgage-
related obligations for purposes of Sec. 1026.43(b)(8). Section
1026.43(b)(8) includes these charges in the definition of mortgage-
related obligations if the creditor requires the consumer to pay
them, even if the consumer is not legally obligated to pay the
charges under the terms of the insurance program. For example, if a
mortgage insurance program obligates the creditor to make recurring
mortgage insurance payments, and the creditor requires the consumer
to reimburse the creditor for such recurring payments, the
consumer's payments are mortgage-related obligations for purposes of
Sec. 1026.43(b)(8). However, if a mortgage insurance program
obligates the creditor to make recurring mortgage insurance
payments, and the creditor does not require the consumer to
reimburse the creditor for the cost of the mortgage insurance
payments, the recurring mortgage insurance payments are not
mortgage-related obligations for purposes of Sec. 1026.43(b)(8).
5. Relation to the finance charge. Section 1026.43(b)(8)
includes in the evaluation of mortgage-related obligations premiums
and similar charges identified in Sec. 1026.4(b)(5), (7), (8), or
(10) that are required by the creditor. These premiums and similar
charges are mortgage-related obligations regardless of whether the
premium or similar charge is excluded from the finance charge
pursuant to Sec. 1026.4(d). For example, a premium for insurance
against loss or damage to the property written in connection with
the credit transaction is a premium identified in Sec.
1026.4(b)(8). If this premium is required by the creditor, the
premium is a mortgage-related obligation pursuant to Sec.
1026.43(b)(8), regardless of whether the premium is excluded from
the finance charge pursuant to Sec. 1026.4(d)(2).
43(b)(11) Recast.
1. Date of the recast. The term ``recast'' means, for an
adjustable-rate mortgage, the expiration of the period during which

[[Page 6603]]

payments based on the introductory fixed rate are permitted; for an
interest-only loan, the expiration of the period during which the
interest-only payments are permitted; and, for a negative
amortization loan, the expiration of the period during which
negatively amortizing payments are permitted. For adjustable-rate
mortgages, interest-only loans, and negative amortization loans, the
date on which the recast is considered to occur is the due date of
the last monthly payment based on the introductory fixed rate, the
interest-only payment, or the negatively amortizing payment,
respectively. To illustrate: A loan in an amount of $200,000 has a
30-year loan term. The loan agreement provides for a fixed interest
rate and permits interest-only payments for the first five years of
the loan (60 months). The loan is recast on the due date of the 60th
monthly payment. Thus, the term of the loan remaining as of the date
the loan is recast is 25 years (300 months).
43(b)(12) Simultaneous loan.
1. General. Section 1026.43(b)(12) defines a simultaneous loan
as another covered transaction or a home equity line of credit
(HELOC) subject to Sec. 1026.40 that will be secured by the same
dwelling and made to the same consumer at or before consummation of
the covered transaction, whether it is made by the same creditor or
a third-party creditor. (As with all of Sec. 1026.43, the term
``dwelling'' includes any real property attached to a dwelling.) For
example, assume a consumer will enter into a legal obligation that
is a covered transaction with Creditor A. Immediately prior to
consummation of the covered transaction with Creditor A, the
consumer opens a HELOC that is secured by the same dwelling with
Creditor B. For purposes of this section, the loan extended by
Creditor B is a simultaneous loan. See commentary to Sec.
1026.43(c)(2)(iv) and (c)(6), discussing the requirement to consider
the consumer's payment obligation on any simultaneous loan for
purposes of determining the consumer's ability to repay the covered
transaction subject to this section.
2. Same consumer. For purposes of the definition of
``simultaneous loan,'' the term ``same consumer'' includes any
consumer, as that term is defined in Sec. 1026.2(a)(11), that
enters into a loan that is a covered transaction and also enters
into another loan (e.g., second-lien covered transaction or HELOC)
secured by the same dwelling. Where two or more consumers enter into
a legal obligation that is a covered transaction, but only one of
them enters into another loan secured by the same dwelling, the
``same consumer'' includes the person that has entered into both
legal obligations. For example, assume Consumer A and Consumer B
will both enter into a legal obligation that is a covered
transaction with a creditor. Immediately prior to consummation of
the covered transaction, Consumer B opens a HELOC that is secured by
the same dwelling with the same creditor; Consumer A is not a
signatory to the HELOC. For purposes of this definition, Consumer B
is the same consumer and the creditor must include the HELOC as a
simultaneous loan.
43(b)(13) Third-party record.
1. Electronic records. Third-party records include records
transmitted electronically. For example, to verify a consumer's
credit history using third-party records as required by Sec.
1026.43(c)(2)(viii) and 1026.43(c)(3), a creditor may use a credit
report prepared by a consumer reporting agency that is transmitted
electronically.
2. Forms. A record prepared by a third party includes a form a
creditor gives to a third party to provide information, even if the
creditor completes parts of the form unrelated to the information
sought. For example, if a creditor gives a consumer's employer a
form for verifying the consumer's employment status and income, the
creditor may fill in the creditor's name and other portions of the
form unrelated to the consumer's employment status or income.
Paragraph 43(b)(13)(i).
1. Reviewed record. Under Sec. 1026.43(b)(13)(i), a third-party
record includes a document or other record prepared by the consumer,
the creditor, the mortgage broker, or the creditor's or mortgage
broker's agent, if the record is reviewed by an appropriate third
party. For example, a profit-and-loss statement prepared by a self-
employed consumer and reviewed by a third-party accountant is a
third-party record under Sec. 1026.43(b)(13)(i). In contrast, a
profit-and-loss statement prepared by a self-employed consumer and
reviewed by the consumer's non-accountant spouse is not a third-
party record under Sec. 1026.43(b)(13)(i).
Paragraph 43(b)(13)(iii).
1. Creditor's records. Section 1026.43(b)(13)(iii) provides that
a third-party record includes a record the creditor maintains for an
account of the consumer held by the creditor. Examples of such
accounts include checking accounts, savings accounts, and retirement
accounts. Examples of such accounts also include accounts related to
a consumer's outstanding obligations to a creditor. For example, a
third-party record includes the creditor's records for a first-lien
mortgage to a consumer who applies for a subordinate-lien home
equity loan.
43(c) Repayment ability.
43(c)(1) General requirement.
1. Reasonable and good faith determination. i. General.
Creditors generally are required by Sec. 1026.43(c)(1) to make
reasonable and good faith determinations of consumers' ability to
repay. Section 1026.43(c) and the accompanying commentary describe
certain requirements for making this ability-to-repay determination,
but do not provide comprehensive underwriting standards to which
creditors must adhere. For example, the rule and commentary do not
specify how much income is needed to support a particular level of
debt or how credit history should be weighed against other factors.
So long as creditors consider the factors set forth in Sec.
1026.43(c)(2) according to the requirements of Sec. 1026.43(c),
creditors are permitted to develop their own underwriting standards
and make changes to those standards over time in response to
empirical information and changing economic and other conditions.
Whether a particular ability-to-repay determination is reasonable
and in good faith will depend not only on the underwriting standards
adopted by the creditor, but on the facts and circumstances of an
individual extension of credit and how a creditor's underwriting
standards were applied to those facts and circumstances. A
consumer's statement or attestation that the consumer has the
ability to repay the loan is not indicative of whether the
creditor's determination was reasonable and in good faith.
ii. Considerations. A. The following may be evidence that a
creditor's ability-to-repay determination was reasonable and in good
faith:
1. The consumer demonstrated actual ability to repay the loan by
making timely payments, without modification or accommodation, for a
significant period of time after consummation or, for an adjustable-
rate, interest-only, or negative-amortization mortgage, for a
significant period of time after recast;
2. The creditor used underwriting standards that have
historically resulted in comparatively low rates of delinquency and
default during adverse economic conditions; or
3. The creditor used underwriting standards based on empirically
derived, demonstrably and statistically sound models.
B. In contrast, the following may be evidence that a creditor's
ability-to-repay determination was not reasonable or in good faith:
1. The consumer defaulted on the loan a short time after
consummation or, for an adjustable-rate, interest-only, or negative-
amortization mortgage, a short time after recast;
2. The creditor used underwriting standards that have
historically resulted in comparatively high levels of delinquency
and default during adverse economic conditions;
3. The creditor applied underwriting standards inconsistently or
used underwriting standards different from those used for similar
loans without reasonable justification;
4. The creditor disregarded evidence that the underwriting
standards it used are not effective at determining consumers'
repayment ability;
5. The creditor disregarded evidence that the consumer may have
insufficient residual income to cover other recurring obligations
and expenses, taking into account the consumer's assets other than
the property securing the loan, after paying his or her monthly
payments for the covered transaction, any simultaneous loans,
mortgage-related obligations, and any current debt obligations; or
6. The creditor disregarded evidence that the consumer would
have the ability to repay only if the consumer subsequently
refinanced the loan or sold the property securing the loan.
C. All of the considerations listed in paragraphs (A) and (B)
above may be relevant to whether a creditor's ability-to-repay
determination was reasonable and in good faith. However, these
considerations are not requirements or prohibitions with which
creditors must comply, nor are they elements of a claim that a
consumer must prove to

[[Page 6604]]

establish a violation of the ability-to-repay requirements. For
example, creditors are not required to validate their underwriting
criteria using mathematical models. These considerations also are
not absolute in their application; instead they exist on a continuum
and may apply to varying degrees. For example, the longer a consumer
successfully makes timely payments after consummation or recast the
less likely it is that the creditor's determination of ability to
repay was unreasonable or not in good faith. Finally, each of these
considerations must be viewed in the context of all facts and
circumstances relevant to a particular extension of credit. For
example, in some cases inconsistent application of underwriting
standards may indicate that a creditor is manipulating those
standards to approve a loan despite a consumer's inability to repay.
The creditor's ability-to-repay determination therefore may be
unreasonable or in bad faith. However, in other cases inconsistently
applied underwriting standards may be the result of, for example,
inadequate training and may nonetheless yield a reasonable and good
faith ability-to-repay determination in a particular case.
Similarly, although an early payment default on a mortgage will
often be persuasive evidence that the creditor did not have a
reasonable and good faith belief in the consumer's ability to repay
(and such evidence may even be sufficient to establish a prima facie
case of an ability-to-repay violation), a particular ability-to-
repay determination may be reasonable and in good faith even though
the consumer defaulted shortly after consummation if, for example,
the consumer experienced a sudden and unexpected loss of income. In
contrast, an ability-to-repay determination may be unreasonable or
not in good faith even though the consumer made timely payments for
a significant period of time if, for example, the consumer was able
to make those payments only by foregoing necessities such as food
and heat.
2. Repayment ability at consummation. Section 1026.43(c)(1)
requires the creditor to determine, at or before the time the loan
is consummated, that a consumer will have a reasonable ability to
repay the loan. A change in the consumer's circumstances after
consummation (for example, a significant reduction in income due to
a job loss or a significant obligation arising from a major medical
expense) that cannot be reasonably anticipated from the consumer's
application or the records used to determine repayment ability is
not relevant to determining a creditor's compliance with the rule.
However, if the application or records considered at or before
consummation indicate there will be a change in a consumer's
repayment ability after consummation (for example, if a consumer's
application states that the consumer plans to retire within 12
months without obtaining new employment or that the consumer will
transition from full-time to part-time employment), the creditor
must consider that information under the rule.
3. Interaction with Regulation B. Section 1026.43(c)(1) does not
require or permit the creditor to make inquiries or verifications
prohibited by Regulation B, 12 CFR part 1002.
43(c)(2) Basis for determination.
1. General. Section 1026.43(c)(2) sets forth factors creditors
must consider when making the ability-to-repay determination
required under Sec. 1026.43(c)(1) and the accompanying commentary
provides guidance regarding these factors. Creditors must conform to
these requirements and may rely on guidance provided in the
commentary. However, Sec. 1026.43(c) and the accompanying
commentary do not provide comprehensive guidance on definitions and
other technical underwriting criteria necessary for evaluating these
factors in practice. So long as a creditor complies with the
provisions of Sec. 1026.43(c), the creditor is permitted to use its
own definitions and other technical underwriting criteria. A
creditor may, but is not required to, look to guidance issued by
entities such as the Federal Housing Administration, the U.S.
Department of Veterans Affairs, the U.S. Department of Agriculture,
or Fannie Mae or Freddie Mac while operating under the
conservatorship of the Federal Housing Finance Agency. For example,
a creditor may refer to such guidance to classify particular
inflows, obligations, or property as ``income,'' ``debt,'' or
``assets.'' Similarly, a creditor may refer to such guidance to
determine what information to use when evaluating the income of a
self-employed or seasonally employed consumer or what information to
use when evaluating the credit history of a consumer who has
obtained few or no extensions of traditional ``credit'' as defined
in Sec. 1026.2(a)(14). These examples are illustrative, and
creditors are not required to conform to guidance issued by these or
other such entities. However, as required by Sec. 1026.43(c)(1), a
creditor must ensure that its underwriting criteria, as applied to
the facts and circumstances of a particular extension of credit,
result in a reasonable, good faith determination of a consumer's
ability to repay. For example, a definition used in underwriting
that is reasonable in isolation may lead to ability-to-repay
determinations that are unreasonable or not in good faith when
considered in the context of a creditor's underwriting standards or
when adopted or applied in bad faith. Similarly, an ability-to-repay
determination is not unreasonable or in bad faith merely because the
underwriting criteria used included a definition that was by itself
unreasonable.
Paragraph 43(c)(2)(i).
1. Income or assets generally. A creditor may base its
determination of repayment ability on current or reasonably expected
income from employment or other sources, assets other than the
dwelling that secures the covered transaction, or both. The creditor
may consider any type of current or reasonably expected income,
including, for example, the following: salary; wages; self-
employment income; military or reserve duty income; bonus pay; tips;
commissions; interest payments; dividends; retirement benefits or
entitlements; rental income; royalty payments; trust income; public
assistance payments; and alimony, child support, and separate
maintenance payments. The creditor may consider any of the
consumer's assets, other than the value of the dwelling that secures
the covered transaction, including, for example, the following:
funds in a savings or checking account, amounts vested in a
retirement account, stocks, bonds, certificates of deposit, and
amounts available to the consumer from a trust fund. (As stated in
Sec. 1026.43(a), the value of the dwelling includes the value of
the real property to which the residential structure is attached, if
the real property also secures the covered transaction.)
2. Income or assets relied on. A creditor need consider only the
income or assets necessary to support a determination that the
consumer can repay the covered transaction. For example, if a
consumer's loan application states that the consumer earns an annual
salary from both a full-time job and a part-time job and the
creditor reasonably determines that the consumer's income from the
full-time job is sufficient to repay the loan, the creditor need not
consider the consumer's income from the part-time job. Further, a
creditor need verify only the income (or assets) relied on to
determine the consumer's repayment ability. See comment 43(c)(4)-1.
3. Reasonably expected income. If a creditor relies on expected
income in excess of the consumer's income, either in addition to or
instead of current income, the expectation that the income will be
available for repayment must be reasonable and verified with third-
party records that provide reasonably reliable evidence of the
consumer's expected income. For example, if the creditor relies on
an expectation that a consumer will receive an annual bonus, the
creditor may verify the basis for that expectation with records that
show the consumer's past annual bonuses, and the expected bonus must
bear a reasonable relationship to the past bonuses. Similarly, if
the creditor relies on a consumer's expected salary from a job the
consumer has accepted and will begin after receiving an educational
degree, the creditor may verify that expectation with a written
statement from an employer indicating that the consumer will be
employed upon graduation at a specified salary.
4. Seasonal or irregular income. A creditor reasonably may
determine that a consumer can make periodic loan payments even if
the consumer's income, such as self-employment income, is seasonal
or irregular. For example, assume a consumer receives seasonal
income from the sale of crops or from agricultural employment. Each
year, the consumer's income arrives during only a few months. If the
creditor determines that the consumer's annual income divided
equally across 12 months is sufficient for the consumer to make
monthly loan payments, the creditor reasonably may determine that
the consumer can repay the loan, even though the consumer may not
receive income during certain months.
5. Multiple applicants. When two or more consumers apply for an
extension of credit as joint obligors with primary liability on an
obligation, Sec. 1026.43(c)(2)(i) does not require the creditor to
consider income or assets that are not needed to support the
creditor's repayment ability determination. If the income or assets
of one applicant are

[[Page 6605]]

sufficient to support the creditor's repayment ability
determination, the creditor is not required to consider the income
or assets of the other applicant. For example, if a husband and wife
jointly apply for a loan and the creditor reasonably determines that
the wife's income is sufficient to repay the loan, the creditor is
not required to consider the husband's income.
Paragraph 43(c)(2)(ii).
1. Employment status and income. Employment status need not be
full-time, and employment need not occur at regular intervals. If,
in determining the consumer's repayment ability, the creditor relies
on income from the consumer's employment, then that employment may
be, for example, full-time, part-time, seasonal, irregular,
military, or self-employment, so long as the creditor considers
those characteristics of the employment. Under Sec.
1026.43(c)(2)(ii), a creditor must verify a consumer's current
employment status only if the creditor relies on the consumer's
employment income in determining the consumer's repayment ability.
For example, if a creditor relies wholly on a consumer's investment
income to determine repayment ability, the creditor need not verify
or document employment status. See comments 43(c)(2)(i)-5 and
43(c)(4)-2 for guidance on which income to consider when multiple
consumers apply jointly for a loan.
Paragraph 43(c)(2)(iii).
1. General. For purposes of the repayment ability determination
required under Sec. 1026.43(c)(2), a creditor must consider the
consumer's monthly payment on a covered transaction that is
calculated as required under Sec. 1026.43(c)(5).
Paragraph 43(c)(2)(iv).
1. Home equity lines of credit. For purposes of Sec.
1026.43(c)(2)(iv), a simultaneous loan includes any covered
transaction or home equity line of credit (HELOC) subject to Sec.
1026.40 that will be made to the same consumer at or before
consummation of the covered transaction and secured by the same
dwelling that secures the covered transaction. A HELOC that is a
simultaneous loan that the creditor knows or has reason to know
about must be considered as a mortgage obligation in determining a
consumer's ability to repay the covered transaction even though the
HELOC is not a covered transaction subject to Sec. 1026.43. See
Sec. 1026.43(a) discussing the scope of this section.
``Simultaneous loan'' is defined in Sec. 1026.43(b)(12). For
further explanation of ``same consumer,'' see comment 43(b)(12)-2.
2. Knows or has reason to know. In determining a consumer's
repayment ability for a covered transaction under Sec.
1026.43(c)(2), a creditor must consider the consumer's payment
obligation on any simultaneous loan that the creditor knows or has
reason to know will be or has been made at or before consummation of
the covered transaction. For example, where a covered transaction is
a home purchase loan, the creditor must consider the consumer's
periodic payment obligation for any ``piggyback'' second-lien loan
that the creditor knows or has reason to know will be used to
finance part of the consumer's down payment. The creditor complies
with this requirement where, for example, the creditor follows
policies and procedures that are designed to determine whether at or
before consummation the same consumer has applied for another credit
transaction secured by the same dwelling. To illustrate, assume a
creditor receives an application for a home purchase loan where the
requested loan amount is less than the home purchase price. The
creditor's policies and procedures must require the consumer to
state the source of the down payment and provide verification. If
the creditor determines the source of the down payment is another
extension of credit that will be made to the same consumer at or
before consummation and secured by the same dwelling, the creditor
knows or has reason to know of the simultaneous loan and must
consider the simultaneous loan. Alternatively, if the creditor has
information that suggests the down payment source is the consumer's
existing assets, the creditor would be under no further obligation
to determine whether a simultaneous loan will be extended at or
before consummation of the covered transaction. The creditor is not
obligated to investigate beyond reasonable underwriting policies and
procedures to determine whether a simultaneous loan will be extended
at or before consummation of the covered transaction.
3. Scope of timing. For purposes of Sec. 1026.43(c)(2)(iv), a
simultaneous loan includes a loan that comes into existence
concurrently with the covered transaction subject to Sec.
1026.43(c). A simultaneous loan does not include a credit
transaction that occurs after consummation of the covered
transaction that is subject to this section. However, any
simultaneous loan that specifically covers closing costs of the
covered transaction, but is scheduled to be extended after
consummation must be considered for the purposes of Sec.
1026.43(c)(2)(iv).
Paragraph 43(c)(2)(v).
1. General. A creditor must include in its repayment ability
assessment the consumer's monthly payment for mortgage-related
obligations, such as the expected property taxes and premiums or
similar charges identified in Sec. 1026.4(b)(5), (7), (8), or (10)
that are required by the creditor. See Sec. 1026.43(b)(8) defining
the term ``mortgage-related obligations.'' Mortgage-related
obligations must be included in the creditor's determination of
repayment ability regardless of whether the amounts are included in
the monthly payment or whether there is an escrow account
established. Section 1026.43(c)(2)(v) includes only payments that
occur on an ongoing or recurring basis in the evaluation of the
consumer's monthly payment for mortgage-related obligations. One-
time charges, or obligations satisfied at or before consummation,
are not ongoing or recurring, and are therefore not part of the
consumer's monthly payment for purposes of Sec. 1026.43(c)(2)(v).
For example:
i. Assume that a consumer will be required to pay property
taxes, as described in comment 43(b)(8)-2, on a quarterly, annual,
or other basis after consummation. Section 1026.43(c)(2)(v) includes
these recurring property taxes in the evaluation of the consumer's
monthly payment for mortgage-related obligations. However, if the
consumer will incur a one-time charge to satisfy property taxes that
are past due, Sec. 1026.43(c)(2)(v) does not include this one-time
charge in the evaluation of the consumer's monthly payment for
mortgage-related obligations.
ii. Assume that a consumer will be required to pay mortgage
insurance premiums, as described in comment 43(b)(8)-2, on a
monthly, annual, or other basis after consummation. Section
1026.43(c)(2)(v) includes these recurring mortgage insurance
payments in the evaluation of the consumer's monthly payment for
mortgage-related obligations. However, if the consumer will incur a
one-time fee or charge for mortgage insurance or similar purposes,
such as an up-front mortgage insurance premium imposed at
consummation, Sec. 1026.43(c)(2)(v) does not include this up-front
mortgage insurance premium in the evaluation of the consumer's
monthly payment for mortgage-related obligations.
2. Obligations to an association, other than special
assessments. Section 1026.43(b)(8) defines mortgage-related
obligations to include obligations owed to a condominium,
cooperative, or homeowners association. However, Sec.
1026.43(c)(2)(v) does not require a creditor to include in the
evaluation of the consumer's monthly payment for mortgage-related
obligations payments to such associations imposed in connection with
the extension of credit, or imposed as an incident to the transfer
of ownership, if such obligations are fully satisfied at or before
consummation. For example, if a homeowners association imposes a
one-time transfer fee on the transaction, and the consumer will pay
the fee at or before consummation, Sec. 1026.43(c)(2)(v) does not
require the creditor to include this one-time transfer fee in the
evaluation of the consumer's monthly payment for mortgage-related
obligations. Section 1026.43(c)(2)(v) also does not require the
creditor to include this fee in the evaluation of the consumer's
monthly payment for mortgage-related obligations if the consumer
finances the fee in the loan amount. However, if the consumer incurs
the obligation and will satisfy the obligation with recurring
payments after consummation, regardless of whether the obligation is
escrowed, Sec. 1026.43(c)(2)(v) requires the creditor to include
the transfer fee in the evaluation of the consumer's monthly payment
for mortgage-related obligations.
3. Special assessments imposed by an association. Section
1026.43(b)(8) defines mortgage-related obligations to include
special assessments imposed by a condominium, cooperative, or
homeowners association. Section 1026.43(c)(2)(v) does not require a
creditor to include special assessments in the evaluation of the
consumer's monthly payment for mortgage-related obligations if the
special assessments are fully satisfied at or before consummation.
For example, if a homeowners association imposes a special
assessment that the consumer will have to pay in full at or before
consummation, Sec. 1026.43(c)(2)(v) does not include the special
assessment in the

[[Page 6606]]

evaluation of the consumer's monthly payment for mortgage-related
obligations. Section 1026.43(c)(2)(v) does not require a creditor to
include special assessments in the evaluation of the consumer's
monthly payment for mortgage-related obligations if the special
assessments are imposed as a one-time charge. For example, if a
homeowners association imposes a special assessment that the
consumer will have to satisfy in one payment, Sec. 1026.43(c)(2)(v)
does not include this one-time special assessment in the evaluation
of the consumer's monthly payment for mortgage-related obligations.
However, if the consumer will pay the special assessment on a
recurring basis after consummation, regardless of whether the
consumer's payments for the special assessment are escrowed, Sec.
1026.43(c)(2)(v) requires the creditor to include this recurring
special assessment in the evaluation of the consumer's monthly
payment for mortgage-related obligations.
4. Pro rata amount. For purposes of Sec. 1026.43(c)(2)(v), the
creditor may divide the recurring payments for mortgage-related
obligations into monthly, pro rata amounts. In considering a
mortgage-related obligation that is not paid monthly, if the
mortgage loan is originated pursuant to a government program the
creditor may determine the pro rata monthly amount of the mortgage-
related obligation in accordance with the specific requirements of
that program. If the mortgage loan is originated pursuant to a
government program that does not contain specific standards for
determining the pro rata monthly amount of the mortgage-related
obligation, or if the mortgage loan is not originated pursuant to a
government program, the creditor complies with Sec.
1026.43(c)(2)(v) by dividing the total amount of a particular non-
monthly mortgage-related obligation by no more than the number of
months from the month that the non-monthly mortgage-related
obligation was due prior to consummation until the month that the
non-monthly mortgage-related obligation will be due after
consummation. When determining the pro rata monthly payment amount,
the creditor may also consider comment 43(c)(2)(v)-5, which explains
that the creditor need not project potential changes. The following
examples further illustrate how a creditor may determine the pro
rata monthly amount of mortgage-related obligations, pursuant to
Sec. 1026.43(c)(2)(v):
i. Assume that a consumer applies for a mortgage loan on
February 1st. Assume further that the subject property is located in
a jurisdiction where property taxes are paid in arrears on the first
day of October. The creditor complies with Sec. 1026.43(c)(2)(v) by
determining the annual property tax amount owed in the prior
October, dividing the amount by 12, and using the resulting amount
as the pro rata monthly property tax payment amount for the
determination of the consumer's monthly payment for mortgage-related
obligations. The creditor complies even if the consumer will likely
owe more in the next year than the amount owed the prior October
because the jurisdiction normally increases the property tax rate
annually, provided that the creditor does not have knowledge of an
increase in the property tax rate at the time of underwriting. See
also comment 43(c)(2)(v)-5 regarding estimates of mortgage-related
obligations.
ii. Assume that a subject property is located in a special water
district, the assessments for which are billed separately from local
property taxes. The creditor complies with Sec. 1026.43(c)(2)(v) by
dividing the full amount that will be owed by the number of months
in the assessment period, and including the resulting amount in the
calculation of monthly mortgage-related obligations. However, Sec.
1026.43(c)(2)(v) does not require a creditor to adjust the monthly
amount to account for potential deviations from the average monthly
amount. For example, assume in this example that the special water
assessment is billed every eight months, that the consumer will have
to pay the first water district bill four months after consummation,
and that the seller will not provide the consumer with any funds to
pay for the seller's obligation (i.e., the four months prior to
consummation). Although the consumer will be required to budget
twice the average monthly amount to pay the first water district
bill, Sec. 1026.43(c)(2)(v) does not require the creditor to use
the increased amount; the creditor complies with Sec.
1026.43(c)(2)(v) by using the average monthly amount.
iii. Assume that the subject property is located in an area
where flood insurance is required by Federal law, and assume further
that the flood insurance policy premium is paid every three years
following consummation. The creditor complies with Sec.
1026.43(c)(2)(v) by dividing the three-year premium by 36 months and
including the resulting amount in the determination of the
consumer's monthly payment for mortgage-related obligations. The
creditor complies even if the consumer will not establish a monthly
escrow for flood insurance.
iv. Assume that the subject property is part of a homeowners
association that has imposed upon the seller a special assessment of
$1,200. Assume further that this special assessment will become the
consumer's obligation upon consummation of the transaction, that the
consumer is permitted to pay the special assessment in twelve $100
installments after consummation, and that the mortgage loan will not
be originated pursuant to a government program that contains
specific requirements for prorating special assessments. The
creditor complies with Sec. 1026.43(c)(2)(v) by dividing the $1,200
special assessment by 12 months and including the resulting $100
monthly amount in the determination of the consumer's monthly
payment for mortgage-related obligations. The creditor complies by
using this calculation even if the consumer intends to pay the
special assessment in a manner other than that used by the creditor
in determining the monthly pro rata amount, such as where the
consumer intends to pay six $200 installments.
5. Estimates. Estimates of mortgage-related obligations should
be based upon information that is known to the creditor at the time
the creditor underwrites the mortgage obligation. Information is
known if it is reasonably available to the creditor at the time of
underwriting the loan. Creditors may rely on guidance provided under
comment 17(c)(2)(i)-1 in determining if information is reasonably
available. For purposes of this section, the creditor need not
project potential changes, such as by estimating possible increases
in taxes and insurance. See comment 43(c)(2)(v)-4 for additional
examples discussing the projection of potential changes. The
following examples further illustrate the requirements of Sec.
1026.43(c)(2)(v):
i. Assume that the property is subject to a community governance
association, such as a homeowners association. The creditor complies
with Sec. 1026.43(c)(2)(v) by relying on an estimate of mortgage-
related obligations prepared by the homeowners association. In
accordance with the guidance provided under comment 17(c)(2)(i)-1,
the creditor need only exercise due diligence in determining
mortgage-related obligations, and complies with Sec.
1026.43(c)(2)(v) by relying on the representations of other reliable
parties in preparing estimates.
ii. Assume that the homeowners association has imposed a special
assessment on the seller, but the seller does not inform the
creditor of the special assessment, the homeowners association does
not include the special assessment in the estimate of expenses
prepared for the creditor, and the creditor is unaware of the
special assessment. The creditor complies with Sec.
1026.43(c)(2)(v) if it does not include the special assessment in
the determination of mortgage-related obligations. The creditor may
rely on the representations of other reliable parties, in accordance
with the guidance provided under comment 17(c)(2)(i)-1.
iii. Assume that the homeowners association imposes a special
assessment after the creditor has completed underwriting, but prior
to consummation. The creditor does not violate Sec.
1026.43(c)(2)(v) if the creditor does not include the special
assessment in the determination of the consumer's monthly payment
for mortgage-related obligations, provided the homeowners
association does not inform the creditor about the special
assessment during underwriting. Section 1026.43(c)(2)(v) does not
require the creditor to re-underwrite the loan. The creditor has
complied with Sec. 1026.43(c)(2)(v) by including the obligations
known to the creditor at the time the loan is underwritten, even if
the creditor learns of new mortgage-related obligations before the
transaction is consummated.
Paragraph 43(c)(2)(vi).
1. Consideration of current debt obligations. Section
1026.43(c)(2)(vi) requires creditors to consider a consumer's
current debt obligations and any alimony or child support the
consumer is required to pay. Examples of current debt obligations
include student loans, automobile loans, revolving debt, and
existing mortgages that will not be paid off at or before
consummation. Creditors have significant flexibility to consider
current debt obligations in light of attendant facts and
circumstances, including that an obligation is likely to be paid off
soon after consummation. For example, a creditor may take into
account that an existing mortgage is

[[Page 6607]]

likely to be paid off soon after consummation because there is an
existing contract for sale of the property that secures that
mortgage. Similarly, creditors should consider whether debt
obligations in forbearance or deferral at the time of underwriting
are likely to affect the consumer's ability to repay based on the
payment for which the consumer will be liable upon expiration of the
forbearance or deferral period and other relevant facts and
circumstances, such as when the forbearance or deferral period will
expire.
2. Multiple applicants. When two or more consumers apply for an
extension of credit as joint obligors with primary liability on an
obligation, Sec. 1026.43(c)(2)(vi) requires a creditor to consider
the debt obligations of all such joint applicants. For example, if a
co-applicant is repaying a student loan at the time of underwriting,
the creditor complies with Sec. 1026.43(c)(2)(vi) by considering
the co-applicant's student loan obligation. If one consumer is
merely a surety or guarantor, Sec. 1026.43(c)(2)(vi) does not
require a creditor to consider the debt obligations of such surety
or guarantor. The requirements of Sec. 1026.43(c)(2)(vi) do not
affect the disclosure requirements of this part, such as, for
example, Sec. Sec. 1026.17(d), 1026.23(b), 1026.31(e),
1026.39(b)(3), and 1026.46(f).
Paragraph 43(c)(2)(vii).
1. Monthly debt-to-income ratio and residual income. See Sec.
1026.43(c)(7) and its associated commentary regarding the
definitions and calculations for the monthly debt-to-income ratio
and residual income.
Paragraph 43(c)(2)(viii).
1. Consideration of credit history. ``Credit history'' may
include factors such as the number and age of credit lines, payment
history, and any judgments, collections, or bankruptcies. Section
1026.43(c)(2)(viii) does not require creditors to obtain or consider
a consolidated credit score or prescribe a minimum credit score that
creditors must apply. The rule also does not specify which aspects
of credit history a creditor must consider or how various aspects of
credit history should be weighed against each other or against other
underwriting factors. Some aspects of a consumer's credit history,
whether positive or negative, may not be directly indicative of the
consumer's ability to repay. A creditor therefore may give various
aspects of a consumer's credit history as much or as little weight
as is appropriate to reach a reasonable, good faith determination of
ability to repay. Where a consumer has obtained few or no extensions
of traditional ``credit,'' as defined in Sec. 1026.2(a)(14), a
creditor may, but is not required to, look to nontraditional credit
references, such as rental payment history or utility payments.
2. Multiple applicants. When two or more consumers apply for an
extension of credit as joint obligors with primary liability on an
obligation, Sec. 1026.43(c)(2)(viii) requires a creditor to
consider the credit history of all such joint applicants. If a
consumer is merely a surety or guarantor, Sec. 1026.43(c)(2)(viii)
does not require a creditor to consider the credit history of such
surety or guarantor. The requirements of Sec. 1026.43(c)(2)(viii)
do not affect the disclosure requirements of this part, such as, for
example, Sec. Sec. 1026.17(d), 1026.23(b), 1026.31(e),
1026.39(b)(3), and 1026.46(f).
43(c)(3) Verification using third-party records.
1. Records specific to the individual consumer. Records a
creditor uses for verification under Sec. 1026.43(c)(3) and (4)
must be specific to the individual consumer. Records regarding
average incomes in the consumer's geographic location or average
wages paid by the consumer's employer, for example, are not specific
to the individual consumer and are not sufficient for verification.
2. Obtaining records. To conduct verification under Sec.
1026.43(c)(3) and (4), a creditor may obtain records from a third-
party service provider, such as a party the consumer's employer uses
to respond to income verification requests, as long as the records
are reasonably reliable and specific to the individual consumer. A
creditor also may obtain third-party records directly from the
consumer, likewise as long as the records are reasonably reliable
and specific to the individual consumer. For example, a creditor
using payroll statements to verify the consumer's income, as allowed
under Sec. 1026.43(c)(4)(iii), may obtain the payroll statements
from the consumer.
3. Credit report as a reasonably reliable third-party record. A
credit report generally is considered a reasonably reliable third-
party record under Sec. 1026.43(c)(3) for purposes of verifying
items customarily found on a credit report, such as the consumer's
current debt obligations, monthly debts, and credit history. Section
1026.43(c)(3) generally does not require creditors to obtain
additional reasonably reliable third-party records to verify
information contained in a credit report. For example, if a credit
report states the existence and amount of a consumer's debt
obligation, the creditor is not required to obtain additional
verification of the existence or amount of that obligation. In
contrast, a credit report does not serve as a reasonably reliably
third-party record for purposes of verifying items that do not
appear on the credit report. For example, certain monthly debt
obligations, such as legal obligations like alimony or child
support, may not be reflected on a credit report. Thus, a credit
report that does not list a consumer's monthly alimony obligation
does not serve as a reasonably reliable third-party record for
purposes of verifying that obligation. If a credit report reflects a
current debt obligation that a consumer has not listed on the
application, the creditor complies with Sec. 1026.43(c)(3) if the
creditor considers the existence and amount of the debt obligation
as it is reflected in the credit report. However, in some cases a
creditor may know or have reason to know that a credit report may be
inaccurate in whole or in part. For example, a creditor may have
information indicating that a credit report is subject to a fraud
alert, extended alert, active duty alert, or similar alert
identified in 15 U.S.C. 1681c-1 or that a debt obligation listed on
a credit report is subject to a statement of dispute pursuant to 15
U.S.C. 1681i(b). A creditor may also have other reasonably reliable
third-party records or other information or evidence that the
creditor reasonably finds to be reliable that contradict the credit
report or otherwise indicate that the credit report is inaccurate.
If a creditor knows or has reason to know that a credit report may
be inaccurate in whole or in part, the creditor complies with Sec.
1026.43(c)(3) by disregarding an inaccurate or disputed item, items,
or credit report, but does not have to obtain additional third-party
records. The creditor may also, but is not required, to obtain other
reasonably reliable third-party records to verify information with
respect to which the credit report, or item therein, may be
inaccurate. For example, the creditor might obtain statements or
bank records regarding a particular debt obligation subject to a
statement of dispute. See also comment 43(c)(3)-6, which describes a
situation in which a consumer reports a debt obligation that is not
listed on a credit report.
4. Verification of simultaneous loans. Although a credit report
may be used to verify current obligations, it will not reflect a
simultaneous loan that has not yet been consummated and may not
reflect a loan that has just recently been consummated. If the
creditor knows or has reason to know that there will be a
simultaneous loan extended at or before consummation, the creditor
may verify the simultaneous loan by obtaining third-party
verification from the third-party creditor of the simultaneous loan.
For example, the creditor may obtain a copy of the promissory note
or other written verification from the third-party creditor. For
further guidance, see comments 43(c)(3)-1 and -2 discussing
verification using third-party records.
5. Verification of mortgage-related obligations. Creditors must
make the repayment ability determination required under Sec.
1026.43(c)(2) based on information verified from reasonably reliable
records. For general guidance regarding verification see comments
43(c)(3)-1 and -2, which discuss verification using third-party
records. With respect to the verification of mortgage-related
obligations that are property taxes required to be considered under
Sec. 1026.43(c)(2)(v), a record is reasonably reliable if the
information in the record was provided by a governmental
organization, such as a taxing authority or local government. The
creditor complies with Sec. 1026.43(c)(2)(v) by relying on property
taxes referenced in the title report if the source of the property
tax information was a local taxing authority. With respect to other
information in a record provided by an entity assessing charges,
such as a homeowners association, the creditor complies with Sec.
1026.43(c)(2)(v) if it relies on homeowners association billing
statements provided by the seller. Records are also reasonably
reliable if the information in the record was obtained from a valid
and legally executed contract. For example, the creditor complies
with Sec. 1026.43(c)(2)(v) by relying on the amount of monthly
ground rent referenced in the ground rent agreement currently in
effect and applicable to the subject property. Records, other than
those discussed above, may be reasonably reliable for purposes of
Sec. 1026.43(c)(2)(v) if the source provided the information
objectively.
6. Verification of current debt obligations. Section
1026.43(c)(3) does not require

[[Page 6608]]

creditors to obtain additional records to verify the existence or
amount of obligations shown on a consumer's credit report or listed
on the consumer's application, absent circumstances described in
comment 43(c)(3)-3. Under Sec. 1026.43(c)(3)(iii), if a creditor
relies on a consumer's credit report to verify a consumer's current
debt obligations and the consumer's application lists a debt
obligation not shown on the credit report, the creditor may consider
the existence and amount of the obligation as it is stated on the
consumer's application. The creditor is not required to further
verify of the existence or amount of the obligation, absent
circumstances described in comment 43(c)(3)-3.
7. Verification of credit history. To verify credit history, a
creditor may, for example, look to credit reports from credit
bureaus or to reasonably reliable third-party records that evidence
nontraditional credit references, such as evidence of rental payment
history or public utility payments.
8. Verification of military employment. A creditor may verify
the employment status of military personnel by using a military
Leave and Earnings Statement or by using the electronic database
maintained by the Department of Defense to facilitate identification
of consumers covered by credit protections provided pursuant to 10
U.S.C. 987.
43(c)(4) Verification of income or assets.
1. Income or assets relied on. A creditor need consider, and
therefore need verify, only the income or assets the creditor relies
on to evaluate the consumer's repayment ability. See comment
43(c)(2)(i)-2. For example, if a consumer's application states that
the consumer earns a salary and is paid an annual bonus and the
creditor relies on only the consumer's salary to evaluate the
consumer's repayment ability, the creditor need verify only the
salary. See also comments 43(c)(3)-1 and -2.
2. Multiple applicants. If multiple consumers jointly apply for
a loan and each lists income or assets on the application, the
creditor need verify only the income or assets the creditor relies
on in determining repayment ability. See comment 43(c)(2)(i)-5.
3. Tax-return transcript. Under Sec. 1026.43(c)(4), a creditor
may verify a consumer's income using an Internal Revenue Service
(IRS) tax-return transcript, which summarizes the information in a
consumer's filed tax return, another record that provides reasonably
reliable evidence of the consumer's income, or both. A creditor may
obtain a copy of a tax-return transcript or a filed tax return
directly from the consumer or from a service provider. A creditor
need not obtain the copy directly from the IRS or other taxing
authority. See comment 43(c)(3)-2.
Paragraph 43(c)(4)(vi).
1. Government benefits. In verifying a consumer's income, a
creditor may use a written or electronic record from a government
agency of the amount of any benefit payments or awards, such as a
``proof of income letter'' issued by the Social Security
Administration (also known as a ``budget letter,'' ``benefits
letter,'' or ``proof of award letter'').
43(c)(5) Payment calculation.
43(c)(5)(i) General rule.
1. General. For purposes of Sec. 1026.43(c)(2)(iii), a creditor
must determine the consumer's ability to repay the covered
transaction using the payment calculation methods set forth in Sec.
1026.43(c)(5). The payment calculation methods differ depending on
the type of credit extended. The payment calculation method set
forth in Sec. 1026.43(c)(5)(i) applies to any covered transaction
that does not have a balloon payment, or that is not an interest-
only or negative amortization loan, whether such covered transaction
is a fixed-rate, adjustable-rate or step-rate mortgage. The terms
``fixed-rate mortgage,'' ``adjustable-rate mortgage,'' ``step-rate
mortgage,'' ``interest-only loan'' and ``negative amortization
loan'' are defined in Sec. 1026.18(s)(7)(iii), (i), (ii), (iv) and
(v), respectively. For the meaning of the term ``balloon payment,''
see Sec. 1026.18(s)(5)(i). The payment calculation methods set
forth in Sec. 1026.43(c)(5)(ii) apply to any covered transaction
that is a loan with a balloon payment, interest-only loan, or
negative amortization loan. See comment 43(c)(5)(i)-5 and the
commentary to Sec. 1026.43(c)(5)(ii), which provide examples for
calculating the monthly payment for purposes of the repayment
ability determination required under Sec. 1026.43(c)(2)(iii).
2. Greater of the fully indexed rate or introductory rate;
premium adjustable-rate transactions. A creditor must determine a
consumer's repayment ability for the covered transaction using
substantially equal, monthly, fully amortizing payments that are
based on the greater of the fully indexed rate or any introductory
interest rate. In some adjustable-rate transactions, creditors may
set an initial interest rate that is not determined by the index or
formula used to make later interest rate adjustments. Sometimes,
this initial rate charged to consumers is lower than the rate would
be if it were determined by using the index plus margin, or formula
(i.e., fully indexed rate). However, an initial rate that is a
premium rate is higher than the rate based on the index or formula.
In such cases, creditors must calculate the fully amortizing payment
based on the initial ``premium'' rate. ``Fully indexed rate'' is
defined in Sec. 1026.43(b)(3).
3. Monthly, fully amortizing payments. Section 1026.43(c)(5)(i)
does not prescribe the terms or loan features that a creditor may
choose to offer or extend to a consumer, but establishes the
calculation method a creditor must use to determine the consumer's
repayment ability for a covered transaction. For example, the terms
of the loan agreement may require that the consumer repay the loan
in quarterly or bi-weekly scheduled payments, but for purposes of
the repayment ability determination, the creditor must convert these
scheduled payments to monthly payments in accordance with Sec.
1026.43(c)(5)(i)(B). Similarly, the loan agreement may not require
the consumer to make fully amortizing payments, but for purposes of
the repayment ability determination under Sec. 1026.43(c)(5)(i),
the creditor must convert any non-amortizing payments to fully
amortizing payments.
4. Substantially equal. In determining whether monthly, fully
amortizing payments are substantially equal, creditors should
disregard minor variations due to payment-schedule irregularities
and odd periods, such as a long or short first or last payment
period. That is, monthly payments of principal and interest that
repay the loan amount over the loan term need not be equal, but the
monthly payments should be substantially the same without
significant variation in the monthly combined payments of both
principal and interest. For example, where no two monthly payments
vary from each other by more than 1 percent (excluding odd periods,
such as a long or short first or last payment period), such monthly
payments would be considered substantially equal for purposes of
this section. In general, creditors should determine whether the
monthly, fully amortizing payments are substantially equal based on
guidance provided in Sec. 1026.17(c)(3) (discussing minor
variations), and Sec. 1026.17(c)(4)(i) through (iii) (discussing
payment-schedule irregularities and measuring odd periods due to a
long or short first period) and associated commentary.
5. Examples. The following are examples of how to determine the
consumer's repayment ability based on substantially equal, monthly,
fully amortizing payments as required under Sec. 1026.43(c)(5)(i)
(all amounts shown are rounded, and all amounts are calculated using
non-rounded values):
i. Fixed-rate mortgage. A loan in an amount of $200,000 has a
30-year loan term and a fixed interest rate of 7 percent. For
purposes of Sec. 1026.43(c)(2)(iii), the creditor must determine
the consumer's ability to repay the loan based on a payment of
$1,331, which is the substantially equal, monthly, fully amortizing
payment that will repay $200,000 over 30 years using the fixed
interest rate of 7 percent.
ii. Adjustable-rate mortgage with discount for five years. A
loan in an amount of $200,000 has a 30-year loan term. The loan
agreement provides for a discounted interest rate of 6 percent that
is fixed for an initial period of five years, after which the
interest rate will adjust annually based on a specified index plus a
margin of 3 percent, subject to a 2 percent annual periodic interest
rate adjustment cap. The index value in effect at consummation is
4.5 percent; the fully indexed rate is 7.5 percent (4.5 percent plus
3 percent). Even though the scheduled monthly payment required for
the first five years is $1199, for purposes of Sec.
1026.43(c)(2)(iii) the creditor must determine the consumer's
ability to repay the loan based on a payment of $1,398, which is the
substantially equal, monthly, fully amortizing payment that will
repay $200,000 over 30 years using the fully indexed rate of 7.5
percent.
iii. Step-rate mortgage. A loan in an amount of $200,000 has a
30-year loan term. The loan agreement provides that the interest
rate will be 6.5 percent for the first two years of the loan, 7
percent for the next three years of the loan, and 7.5 percent
thereafter. Accordingly, the scheduled payment amounts are $1,264
for the first two years, $1,328 for the next three years, and $1,388
thereafter for the remainder of the term. For

[[Page 6609]]

purposes of Sec. 1026.43(c)(2)(iii), the creditor must determine
the consumer's ability to repay the loan based on a payment of
$1,398, which is the substantially equal, monthly, fully amortizing
payment that would repay $200,000 over 30 years using the fully
indexed rate of 7.5 percent.
43(c)(5)(ii) Special rules for loans with a balloon payment,
interest-only loans, and negative amortization loans.
Paragraph 43(c)(5)(ii)(A).
1. General. For loans with a balloon payment, the rules differ
depending on whether the loan is a higher-priced covered
transaction, as defined under Sec. 1026.43(b)(4), or is not a
higher-priced covered transaction because the annual percentage rate
does not exceed the applicable threshold calculated using the
applicable average prime offer rate (APOR) for a comparable
transaction. ``Average prime offer rate'' is defined in Sec.
1026.35(a)(2); ``higher-priced covered transaction'' is defined in
Sec. 1026.43(b)(4). For higher-priced covered transactions with a
balloon payment, the creditor must consider the consumer's ability
to repay the loan based on the payment schedule under the terms of
the legal obligation, including any required balloon payment. For
loans with a balloon payment that are not higher-priced covered
transactions, the creditor should use the maximum payment scheduled
during the first five years of the loan following the date on which
the first regular periodic payment will be due. ``Balloon payment''
is defined in Sec. 1026.18(s)(5)(i).
2. First five years after the date on which the first regular
periodic payment will be due. Under Sec. 1026.43(c)(5)(ii)(A)(1),
the creditor must determine a consumer's ability to repay a loan
with a balloon payment that is not a higher-priced covered
transaction using the maximum payment scheduled during the first
five years (60 months) after the date on which the first regular
periodic payment will be due. To illustrate:
i. Assume a loan that provides for regular monthly payments and
a balloon payment due at the end of a six-year loan term. The loan
is consummated on August 15, 2014, and the first monthly payment is
due on October 1, 2014. The first five years after the first monthly
payment end on October 1, 2019. The balloon payment must be made on
the due date of the 72nd monthly payment, which is September 1,
2020. For purposes of determining the consumer's ability to repay
the loan under Sec. 1026.43(c)(2)(iii), the creditor need not
consider the balloon payment that is due on September 1, 2020.
ii. Assume a loan that provides for regular monthly payments and
a balloon payment due at the end of a five-year loan term. The loan
is consummated on August 15, 2014, and the first monthly payment is
due on October 1, 2014. The first five years after the first monthly
payment end on October 1, 2019. The balloon payment must be made on
the due date of the 60th monthly payment, which is September 1,
2019. For purposes of determining the consumer's ability to repay
the loan under Sec. 1026.43(c)(2)(iii), the creditor must consider
the balloon payment that is due on September 1, 2019.
3. Renewable balloon-payment mortgage; loan term. A balloon-
payment mortgage that is not a higher-priced covered transaction
could provide that a creditor is unconditionally obligated to renew
a balloon-payment mortgage at the consumer's option (or is obligated
to renew subject to conditions within the consumer's control). See
comment 17(c)(1)-11 discussing renewable balloon-payment mortgages.
For purposes of this section, the loan term does not include any
period of time that could result from a renewal provision. To
illustrate, assume a three-year balloon-payment mortgage that is not
a higher-priced covered transaction contains an unconditional
obligation to renew for another three years at the consumer's
option. In this example, the loan term for the balloon-payment
mortgage is three years, and not the potential six years that could
result if the consumer chooses to renew the loan. Accordingly, the
creditor must underwrite the loan using the maximum payment
scheduled in the first five years after consummation, which includes
the balloon payment due at the end of the three-year loan term. See
comment 43(c)(5)(ii)(A)-4.ii, which provides an example of how to
determine the consumer's repayment ability for a three-year
renewable balloon-payment mortgage that is not a higher-priced
covered transaction.
4. Examples of loans with a balloon payment that are not higher-
priced covered transactions. The following are examples of how to
determine the maximum payment scheduled during the first five years
after the date on which the first regular periodic payment will be
due (all amounts shown are rounded, and all amounts are calculated
using non-rounded values):
i. Balloon-payment mortgage with a three-year loan term; fixed
interest rate. A loan agreement provides for a fixed interest rate
of 6 percent, which is below the APOR-calculated threshold for a
comparable transaction; thus the loan is not a higher-priced covered
transaction. The loan amount is $200,000, and the loan has a three-
year loan term but is amortized over 30 years. The monthly payment
scheduled for the first three years following consummation is
$1,199, with a balloon payment of $193,367 due at the end of the
third year. For purposes of Sec. 1026.43(c)(2)(iii), the creditor
must determine the consumer's ability to repay the loan based on the
balloon payment of $193,367.
ii. Renewable balloon-payment mortgage with a three-year loan
term. Assume the same facts above in comment 43(c)(5)(ii)(A)-4.i,
except that the loan agreement also provides that the creditor is
unconditionally obligated to renew the balloon-payment mortgage at
the consumer's option at the end of the three-year term for another
three years. In determining the maximum payment scheduled during the
first five years after the date on which the first regular periodic
payment will be due, the creditor must use a loan term of three
years. Accordingly, for purposes of Sec. 1026.43(c)(2)(iii), the
creditor must determine the consumer's ability to repay the loan
based on the balloon payment of $193,367.
iii. Balloon-payment mortgage with a six-year loan term; fixed
interest rate. A loan provides for a fixed interest rate of 6
percent, which is below the APOR threshold for a comparable
transaction, and thus, the loan is not a higher-priced covered
transaction. The loan amount is $200,000, and the loan has a six-
year loan term but is amortized over 30 years. The loan is
consummated on March 15, 2014, and the monthly payment scheduled for
the first six years following consummation is $1,199, with the first
monthly payment due on May 1, 2014. The first five years after the
date on which the first regular periodic payment will be due end on
May 1, 2019. The balloon payment of $183,995 is required on the due
date of the 72nd monthly payment, which is April 1, 2020 (more than
five years after the date on which the first regular periodic
payment will be due). For purposes of Sec. 1026.43(c)(2)(iii), the
creditor may determine the consumer's ability to repay the loan
based on the monthly payment of $1,199, and need not consider the
balloon payment of $183,995 due on April 1, 2020.
5. Higher-priced covered transaction with a balloon payment.
Where a loan with a balloon payment is a higher-priced covered
transaction, the creditor must determine the consumer's repayment
ability based on the loan's payment schedule, including any balloon
payment. For example (all amounts are rounded): Assume a higher-
priced covered transaction with a fixed interest rate of 7 percent.
The loan amount is $200,000 and the loan has a ten year loan term,
but is amortized over 30 years. The monthly payment scheduled for
the first ten years is $1,331, with a balloon payment of $172,955.
For purposes of Sec. 1026.43(c)(2)(iii), the creditor must consider
the consumer's ability to repay the loan based on the payment
schedule that fully repays the loan amount, including the balloon
payment of $172,955.
Paragraph 43(c)(5)(ii)(B).
1. General. For loans that permit interest-only payments, the
creditor must use the fully indexed rate or introductory rate,
whichever is greater, to calculate the substantially equal, monthly
payment of principal and interest that will repay the loan amount
over the term of the loan remaining as of the date the loan is
recast. For discussion regarding the fully indexed rate, and the
meaning of ``substantially equal,'' see comments 43(b)(3)-1 through
-5 and 43(c)(5)(i)-4, respectively. Under Sec.
1026.43(c)(5)(ii)(B), the relevant term of the loan is the period of
time that remains as of the date the loan is recast to require fully
amortizing payments. For a loan on which only interest and no
principal has been paid, the loan amount will be the outstanding
principal balance at the time of the recast. ``Loan amount'' and
``recast'' are defined in Sec. 1026.43(b)(5) and (b)(11),
respectively. ``Interest-only'' and ``Interest-only loan'' are
defined in Sec. 1026.18(s)(7)(iv).
2. Examples. The following are examples of how to determine the
consumer's repayment ability based on substantially equal, monthly
payments of principal and interest under Sec. 1026.43(c)(5)(ii)(B)
(all amounts shown are rounded, and all amounts are calculated using
non-rounded values):
i. Fixed-rate mortgage with interest-only payments for five
years. A loan in an amount

[[Page 6610]]

of $200,000 has a 30-year loan term. The loan agreement provides for
a fixed interest rate of 7 percent, and permits interest-only
payments for the first five years. The monthly payment of $1,167
scheduled for the first five years would cover only the interest
due. The loan is recast on the due date of the 60th monthly payment,
after which the scheduled monthly payments increase to $1,414, a
monthly payment that repays the loan amount of $200,000 over the 25
years remaining as of the date the loan is recast (300 months). For
purposes of Sec. 1026.43(c)(2)(iii), the creditor must determine
the consumer's ability to repay the loan based on a payment of
$1,414, which is the substantially equal, monthly, fully amortizing
payment that would repay $200,000 over the 25 years remaining as of
the date the loan is recast using the fixed interest rate of 7
percent.
ii. Adjustable-rate mortgage with discount for three years and
interest-only payments for five years. A loan in an amount of
$200,000 has a 30-year loan term, but provides for interest-only
payments for the first five years. The loan agreement provides for a
discounted interest rate of 5 percent that is fixed for an initial
period of three years, after which the interest rate will adjust
each year based on a specified index plus a margin of 3 percent,
subject to an annual interest rate adjustment cap of 2 percent. The
index value in effect at consummation is 4.5 percent; the fully
indexed rate is 7.5 percent (4.5 percent plus 3 percent). The
monthly payments for the first three years are $833. For the fourth
year, the payments are $1,167, based on an interest rate of 7
percent, calculated by adding the 2 percent annual adjustment cap to
the initial rate of 5 percent. For the fifth year, the payments are
$1,250, applying the fully indexed rate of 7.5 percent. These first
five years of payments will cover only the interest due. The loan is
recast on the due date of the 60th monthly payment, after which the
scheduled monthly payments increase to $1,478, a monthly payment
that will repay the loan amount of $200,000 over the remaining 25
years of the loan (300 months). For purposes of Sec.
1026.43(c)(2)(iii), the creditor must determine the consumer's
ability to repay the loan based on a monthly payment of $1,478,
which is the substantially equal, monthly payment of principal and
interest that would repay $200,000 over the 25 years remaining as of
the date the loan is recast using the fully indexed rate of 7.5
percent.
Paragraph 43(c)(5)(ii)(C).
1. General. For purposes of determining the consumer's ability
to repay a negative amortization loan, the creditor must use
substantially equal, monthly payments of principal and interest
based on the fully indexed rate or the introductory rate, whichever
is greater, that will repay the maximum loan amount over the term of
the loan that remains as of the date the loan is recast.
Accordingly, before determining the substantially equal, monthly
payments the creditor must first determine the maximum loan amount
and the period of time that remains in the loan term after the loan
is recast. ``Recast'' is defined in Sec. 1026.43(b)(11). Second,
the creditor must use the fully indexed rate or introductory rate,
whichever is greater, to calculate the substantially equal, monthly
payment amount that will repay the maximum loan amount over the term
of the loan remaining as of the date the loan is recast. For
discussion regarding the fully indexed rate and the meaning of
``substantially equal,'' see comments 43(b)(3)-1 through -5 and
43(c)(5)(i)-4, respectively. For the meaning of the term ``maximum
loan amount'' and a discussion of how to determine the maximum loan
amount for purposes of Sec. 1026.43(c)(5)(ii)(C), see Sec.
1026.43(b)(7) and associated commentary. ``Negative amortization
loan'' is defined in Sec. 1026.18(s)(7)(v).
2. Term of loan. Under Sec. 1026.43(c)(5)(ii)(C), the relevant
term of the loan is the period of time that remains as of the date
the terms of the legal obligation recast. That is, the creditor must
determine substantially equal, monthly payments of principal and
interest that will repay the maximum loan amount based on the period
of time that remains after any negative amortization cap is
triggered or any period permitting minimum periodic payments
expires, whichever occurs first.
3. Examples. The following are examples of how to determine the
consumer's repayment ability based on substantially equal, monthly
payments of principal and interest as required under Sec.
1026.43(c)(5)(ii)(C) (all amounts shown are rounded, and all amounts
are calculated using non-rounded values):
i. Adjustable-rate mortgage with negative amortization. A.
Assume an adjustable-rate mortgage in the amount of $200,000 with a
30-year loan term. The loan agreement provides that the consumer can
make minimum monthly payments that cover only part of the interest
accrued each month until the date on which the principal balance
reaches 115 percent of its original balance (i.e., a negative
amortization cap of 115 percent) or for the first five years of the
loan (60 monthly payments), whichever occurs first. The introductory
interest rate at consummation is 1.5 percent. One month after
consummation, the interest rate adjusts and will adjust monthly
thereafter based on the specified index plus a margin of 3.5
percent. The index value in effect at consummation is 4.5 percent;
the fully indexed rate is 8 percent (4.5 percent plus 3.5 percent).
The maximum lifetime interest rate is 10.5 percent; there are no
other periodic interest rate adjustment caps that limit how quickly
the maximum lifetime rate may be reached. The minimum monthly
payment for the first year is based on the initial interest rate of
1.5 percent. After that, the minimum monthly payment adjusts
annually, but may increase by no more than 7.5 percent over the
previous year's payment. The minimum monthly payment is $690 in the
first year, $742 in the second year, and $797 in the first part of
the third year.
B. To determine the maximum loan amount, assume that the
interest rate increases to the maximum lifetime interest rate of
10.5 percent at the first adjustment (i.e., the due date of the
first periodic monthly payment), and interest accrues at that rate
until the loan is recast. Assume that the consumer makes the minimum
monthly payments scheduled, which are capped at 7.5 percent from
year-to-year, for the maximum possible time. Because the consumer's
minimum monthly payments are less than the interest accrued each
month, negative amortization occurs (i.e., the accrued but unpaid
interest is added to the principal balance). Thus, assuming that the
consumer makes the minimum monthly payments for as long as possible
and that the maximum interest rate of 10.5 percent is reached at the
first rate adjustment (i.e., the due date of the first periodic
monthly payment), the negative amortization cap of 115 percent is
reached on the due date of the 27th monthly payment and the loan is
recast as of that date. The maximum loan amount as of the due date
of the 27th monthly payment is $229,251, and the remaining term of
the loan is 27 years and nine months (333 months).
C. For purposes of Sec. 1026.43(c)(2)(iii), the creditor must
determine the consumer's ability to repay the loan based on a
monthly payment of $1,716, which is the substantially equal, monthly
payment of principal and interest that will repay the maximum loan
amount of $229,251 over the remaining loan term of 333 months using
the fully indexed rate of 8 percent. See comments 43(b)(7)-1 and -2
discussing the calculation of the maximum loan amount, and Sec.
1026.43(b)(11) for the meaning of the term ``recast.''
ii. Fixed-rate, graduated payment mortgage. A loan in the amount
of $200,000 has a 30-year loan term. The loan agreement provides for
a fixed interest rate of 7.5 percent, and requires the consumer to
make minimum monthly payments during the first year, with payments
increasing 12.5 percent over the previous year every year for four
years (the annual payment cap). The payment schedule provides for
payments of $943 in the first year, $1,061 in the second year,
$1,193 in the third year, $1,343 in the fourth year, and then
requires $1,511 for the remaining term of the loan. During the first
three years of the loan, the payments are less than the interest
accrued each month, resulting in negative amortization. Assuming the
minimum payments increase year-to-year up to the 12.5 percent
payment cap, the consumer will begin making payments that cover at
least all of the interest accrued at the end of the third year.
Thus, the loan is recast on the due date of the 36th monthly
payment. The maximum loan amount on that date is $207,662, and the
remaining loan term is 27 years (324 months). For purposes of Sec.
1026.43(c)(2)(iii), the creditor must determine the consumer's
ability to repay the loan based on a monthly payment of $1,497,
which is the substantially equal, monthly payment of principal and
interest that will repay the maximum loan amount of $207,662 over
the remaining loan term of 27 years using the fixed interest rate of
7.5 percent.
43(c)(6) Payment calculation for simultaneous loans.
1. Scope. In determining the consumer's repayment ability for a
covered transaction under Sec. 1026.43(c)(2)(iii), a creditor must
include consideration of any simultaneous loan which it knows, or
has reason to know, will be made at or before consummation of

[[Page 6611]]

the covered transaction. For a discussion of the standard ``knows or
has reason to know,'' see comment 43(c)(2)(iv)-2. For the meaning of
the term ``simultaneous loan,'' see Sec. 1026.43(b)(12).
2. Payment calculation--covered transaction. For a simultaneous
loan that is a covered transaction, as that term is defined under
Sec. 1026.43(b)(1), a creditor must determine a consumer's ability
to repay the monthly payment obligation for a simultaneous loan as
set forth in Sec. 1026.43(c)(5), taking into account any mortgage-
related obligations required to be considered under Sec.
1026.43(c)(2)(v). For the meaning of the term ``mortgage-related
obligations,'' see Sec. 1026.43(b)(8).
3. Payment calculation--home equity line of credit. For a
simultaneous loan that is a home equity line of credit subject to
Sec. 1026.40, the creditor must consider the periodic payment
required under the terms of the plan when assessing the consumer's
ability to repay the covered transaction secured by the same
dwelling as the simultaneous loan. Under Sec. 1026.43(c)(6)(ii), a
creditor must determine the periodic payment required under the
terms of the plan by considering the actual amount of credit to be
drawn by the consumer at consummation of the covered transaction.
The amount to be drawn is the amount requested by the consumer; when
the amount requested will be disbursed, or actual receipt of funds,
is not determinative. Any additional draw against the line of credit
that the creditor of the covered transaction does not know or have
reason to know about before or during underwriting need not be
considered in relation to ability to repay. For example, where the
creditor's policies and procedures require the source of down
payment to be verified, and the creditor verifies that a
simultaneous loan that is a HELOC will provide the source of down
payment for the first-lien covered transaction, the creditor must
consider the periodic payment on the HELOC by assuming the amount
drawn is at least the down payment amount. In general, a creditor
should determine the periodic payment based on guidance in the
commentary to Sec. 1026.40(d)(5) (discussing payment terms).
43(c)(7) Monthly debt-to-income ratio or residual income.
1. Monthly debt-to-income ratio or monthly residual income.
Under Sec. 1026.43(c)(2)(vii), the creditor must consider the
consumer's monthly debt-to-income ratio, or the consumer's monthly
residual income, in accordance with the requirements in Sec.
1026.43(c)(7). In contrast to the qualified mortgage provisions in
Sec. 1026.43(e), Sec. 1026.43(c) does not prescribe a specific
monthly debt-to-income ratio with which creditors must comply.
Instead, an appropriate threshold for a consumer's monthly debt-to-
income ratio or monthly residual income is for the creditor to
determine in making a reasonable and good faith determination of a
consumer's ability to repay.
2. Use of both monthly debt-to-income ratio and monthly residual
income. If a creditor considers the consumer's monthly debt-to-
income ratio, the creditor may also consider the consumer's residual
income as further validation of the assessment made using the
consumer's monthly debt-to-income ratio.
3. Compensating factors. The creditor may consider factors in
addition to the monthly debt-to-income ratio or residual income in
assessing a consumer's repayment ability. For example, the creditor
may reasonably and in good faith determine that a consumer has the
ability to repay despite a higher debt-to-income ratio or lower
residual income in light of the consumer's assets other than the
dwelling, including any real property attached to the dwelling,
securing the covered transaction, such as a savings account. The
creditor may also reasonably and in good faith determine that a
consumer has the ability to repay despite a higher debt-to-income
ratio in light of the consumer's residual income.
43(d) Refinancing of non-standard mortgages.
43(d)(1) Definitions.
43(d)(1)(i) Non-standard mortgage.
Paragraph 43(d)(1)(i)(A).
1. Adjustable-rate mortgage with an introductory fixed rate.
Under Sec. 1026.43(d)(1)(i)(A), an adjustable-rate mortgage with an
introductory fixed interest rate for one year or longer is
considered a ``non-standard mortgage.'' For example, a covered
transaction that has a fixed introductory rate for the first two,
three, or five years and then converts to a variable rate for the
remaining 28, 27, or 25 years, respectively, is a ``non-standard
mortgage.'' A covered transaction with an introductory rate for six
months that then converts to a variable rate for the remaining 29
and one-half years is not a ``non-standard mortgage.''
43(d)(1)(ii) Standard mortgage.
Paragraph 43(d)(1)(ii)(A).
1. Regular periodic payments. Under Sec. 1026.43(d)(1)(ii)(A),
a ``standard mortgage'' must provide for regular periodic payments
that do not result in an increase of the principal balance (negative
amortization), allow the consumer to defer repayment of principal
(see comment 43(e)(2)(i)-2), or result in a balloon payment. Thus,
the terms of the legal obligation must require the consumer to make
payments of principal and interest on a monthly or other periodic
basis that will repay the loan amount over the loan term. Except for
payments resulting from any interest rate changes after consummation
in an adjustable-rate or step-rate mortgage, the periodic payments
must be substantially equal. For an explanation of the term
``substantially equal,'' see comment 43(c)(5)(i)-4. In addition, a
single-payment transaction is not a ``standard mortgage'' because it
does not require ``regular periodic payments.'' See also comment
43(e)(2)(i)-1.
Paragraph 43(d)(1)(ii)(D).
1. First five years after consummation. A ``standard mortgage''
must have an interest rate that is fixed for at least the first five
years (60 months) after consummation. For example, assume an
adjustable-rate mortgage that applies the same fixed interest rate
to determine the first 60 payments of principal and interest due.
The loan is consummated on August 15, 2013, and the first monthly
payment is due on October 1, 2013. The date that is five years after
consummation is August 15, 2018. The first interest rate adjustment
occurs on September 1, 2018. This loan meets the criterion for a
``standard mortgage'' under Sec. 1026.43(d)(1)(ii)(D) because the
interest rate is fixed until September 1, 2018, which is more than
five years after consummation. For guidance regarding step-rate
mortgages, see comment 43(e)(2)(iv)-3.iii.
Paragraph 43(d)(1)(ii)(E).
1. Permissible use of proceeds. To qualify as a ``standard
mortgage,'' the loan's proceeds may be used for only two purposes:
paying off the non-standard mortgage and paying for closing costs,
including paying escrow amounts required at or before closing. If
the proceeds of a covered transaction are used for other purposes,
such as to pay off other liens or to provide additional cash to the
consumer for discretionary spending, the transaction does not meet
the definition of a ``standard mortgage.''
43(d)(2) Scope.
1. Written application. For an explanation of the requirements
for a ``written application'' in Sec. 1026.43(d)(2)(iii),
(d)(2)(iv), and (d)(2)(v), see comment 19(a)(1)(i)-3.
Paragraph 43(d)(2)(ii).
1. Materially lower. The exemptions afforded under Sec.
1026.43(d)(3) apply to a refinancing only if the monthly payment for
the new loan is ``materially lower'' than the monthly payment for an
existing non-standard mortgage. The payments to be compared must be
calculated based on the requirements under Sec. 1026.43(d)(5).
Whether the new loan payment is ``materially lower'' than the non-
standard mortgage payment depends on the facts and circumstances. In
all cases, a payment reduction of 10 percent or more meets the
``materially lower'' standard.
Paragraph 43(d)(2)(iv).
1. Late payment--12 months prior to application. Under Sec.
1026.43(d)(2)(iv), the exemptions in Sec. 1026.43(d)(3) apply to a
covered transaction only if, during the 12 months immediately
preceding the creditor's receipt of the consumer's written
application for a refinancing, the consumer has made no more than
one payment on the non-standard mortgage more than 30 days late.
(For an explanation of ``written application,'' see comment
43(d)(2)-1.) For example, assume a consumer applies for a
refinancing on May 1, 2014. Assume also that the consumer made a
non-standard mortgage payment on August 15, 2013, that was 45 days
late. The consumer made no other late payments on the non-standard
mortgage between May 1, 2013, and May 1, 2014. In this example, the
requirement under Sec. 1026.43(d)(2)(iv) is met because the
consumer made only one payment that was over 30 days late within the
12 months prior to applying for the refinancing (i.e., eight and
one-half months prior to application).
2. Payment due date. Whether a payment is more than 30 days late
is measured in relation to the contractual due date not accounting
for any grace period. For example, if the contractual due date for a
non-standard mortgage payment is the first day of every month, but
no late fee will be charged as long as the payment is received

[[Page 6612]]

by the 16th of the month, the payment due date for purposes of Sec.
1026.43(d)(2)(iv) and (v) is the first day of the month, not the
16th day of the month. Thus, a payment due under the contract on
October 1st that is paid on November 1st is made more than 30 days
after the payment due date.
Paragraph 43(d)(2)(v).
1. Late payment--six months prior to application. Under Sec.
1026.43(d)(2)(v), the exemptions in Sec. 1026.43(d)(3) apply to a
covered transaction only if, during the six months immediately
preceding the creditor's receipt of the consumer's written
application for a refinancing, the consumer has made no payments on
the non-standard mortgage more than 30 days late. (For an
explanation of ``written application'' and how to determine the
payment due date, see comments 43(d)(2)-1 and 43(d)(2)(iv)-2.) For
example, assume a consumer with a non-standard mortgage applies for
a refinancing on May 1, 2014. If the consumer made a payment on
March 15, 2014, that was 45 days late, the requirement under Sec.
1026.43(d)(2)(v) is not met because the consumer made a payment more
than 30 days late one and one-half months prior to application. If
the number of months between consummation of the non-standard
mortgage and the consumer's application for the standard mortgage is
six or fewer, the consumer may not have made any payment more than
30 days late on the non-standard mortgage.
Paragraph 43(d)(2)(vi).
1. Non-standard mortgage loan made in accordance with ability-
to-repay or qualified mortgage requirements. For non-standard
mortgages that are consummated on or after January 10, 2014, Sec.
1026.43(d)(2)(vi) provides that the refinancing provisions set forth
in Sec. 1026.43(d) apply only if the non-standard mortgage was made
in accordance with the requirements of Sec. 1026.43(c) or (e), as
applicable. For example, if a creditor originated a non-standard
mortgage on or after January 10, 2014 that did not comply with the
requirements of Sec. 1026.43(c) and was not a qualified mortgage
pursuant to Sec. 1026.43(e), Sec. 1026.43(d) would not apply to
the refinancing of the non-standard mortgage loan into a standard
mortgage loan. However, Sec. 1026.43(d) applies to the refinancing
of a non-standard mortgage loan into a standard mortgage loan,
regardless of whether the non-standard mortgage loan was made in
compliance with Sec. 1026.43(c) or (e), if the non-standard
mortgage loan was consummated prior to January 10, 2014.
43(d)(3) Exemption from repayment ability requirements.
1. Two-part determination. To qualify for the exemptions in
Sec. 1026.43(d)(3), a creditor must have considered, first, whether
the consumer is likely to default on the existing mortgage once that
loan is recast and, second, whether the new mortgage likely would
prevent the consumer's default.
43(d)(4) Offer of rate discounts and other favorable terms.
1. Documented underwriting practices. In connection with a
refinancing made pursuant to Sec. 1026.43(d), Sec. 1026.43(d)(4)
requires a creditor offering a consumer rate discounts and terms
that are the same as, or better than, the rate discounts and terms
offered to new consumers to make such an offer consistent with the
creditor's documented underwriting practices. Section 1026.43(d)(4)
does not require a creditor making a refinancing pursuant to Sec.
1026.43(d) to comply with the underwriting requirements of Sec.
1026.43(c). Rather, Sec. 1026.43(d)(4) requires creditors providing
such discounts to do so consistent with documented policies related
to loan pricing, loan term qualifications, or other similar
underwriting practices. For example, assume that a creditor is
providing a consumer with a refinancing made pursuant to Sec.
1026.43(d) and that this creditor has a documented practice of
offering rate discounts to consumers with credit scores above a
certain threshold. Assume further that the consumer receiving the
refinancing has a credit score below this threshold, and therefore
would not normally qualify for the rate discount available to
consumers with high credit scores. This creditor complies with Sec.
1026.43(d)(4) by offering the consumer the discounted rate in
connection with the refinancing made pursuant to Sec. 1026.43(d),
even if the consumer would not normally qualify for that discounted
rate, provided that the offer of the discounted rate is not
prohibited by applicable State or Federal law. However, Sec.
1026.43(d)(4) does not require a creditor to offer a consumer such a
discounted rate.
43(d)(5) Payment calculations.
43(d)(5)(i) Non-Standard mortgage.
1. Payment calculation for a non-standard mortgage. In
determining whether the monthly periodic payment for a standard
mortgage is materially lower than the monthly periodic payment for
the non-standard mortgage under Sec. 1026.43(d)(2)(ii), the
creditor must consider the monthly payment for the non-standard
mortgage that will result after the loan is ``recast,'' assuming
substantially equal payments of principal and interest that amortize
the remaining loan amount over the remaining term as of the date the
mortgage is recast. For guidance regarding the meaning of
``substantially equal,'' see comment 43(c)(5)(i)-4. For the meaning
of ``recast,'' see Sec. 1026.43(b)(11) and associated commentary.
2. Fully indexed rate. The term ``fully indexed rate'' in Sec.
1026.43(d)(5)(i)(A) for calculating the payment for a non-standard
mortgage is generally defined in Sec. 1026.43(b)(3) and associated
commentary. Under Sec. 1026.43(b)(3) the fully indexed rate is
calculated at the time of consummation. For purposes of Sec.
1026.43(d)(5)(i), however, the fully indexed rate is calculated
within a reasonable period of time before or after the date the
creditor receives the consumer's written application for the
standard mortgage. Thirty days is generally considered ``a
reasonable period of time.''
3. Written application. For an explanation of the requirements
for a ``written application'' in Sec. 1026.43(d)(5)(i), see comment
19(a)(1)(i)-3.
4. Payment calculation for an adjustable-rate mortgage with an
introductory fixed rate. Under Sec. 1026.43(d)(5)(i), the monthly
periodic payment for an adjustable-rate mortgage with an
introductory fixed interest rate for a period of one or more years
must be calculated based on several assumptions.
i. First, the payment must be based on the outstanding principal
balance as of the date on which the mortgage is recast, assuming all
scheduled payments have been made up to that date and the last
payment due under those terms is made and credited on that date. For
example, assume an adjustable-rate mortgage with a 30-year loan
term. The loan agreement provides that the payments for the first 24
months are based on a fixed rate, after which the interest rate will
adjust annually based on a specified index and margin. The loan is
recast on the due date of the 24th payment. If the 24th payment is
due on September 1, 2014, the creditor must calculate the
outstanding principal balance as of September 1, 2014, assuming that
all 24 payments under the fixed rate terms have been made and
credited timely.
ii. Second, the payment calculation must be based on
substantially equal monthly payments of principal and interest that
will fully repay the outstanding principal balance over the term of
the loan remaining as of the date the loan is recast. Thus, in the
example above, the creditor must assume a loan term of 28 years (336
monthly payments).
iii. Third, the payment must be based on the fully indexed rate,
as described in Sec. 1026.43(d)(5)(i)(A).
5. Example of payment calculation for an adjustable-rate
mortgage with an introductory fixed rate. The following example
illustrates the rule described in comment 43(d)(5)(i)-4:
i. A loan in an amount of $200,000 has a 30-year loan term. The
loan agreement provides for a discounted introductory interest rate
of 5 percent that is fixed for an initial period of two years, after
which the interest rate will adjust annually based on a specified
index plus a margin of 3 percentage points.
ii. The non-standard mortgage is consummated on February 15,
2014, and the first monthly payment is due on April 1, 2014. The
loan is recast on the due date of the 24th monthly payment, which is
March 1, 2016.
iii. On March 15, 2015, the creditor receives the consumer's
written application for a refinancing after the consumer has made 12
monthly on-time payments. On this date, the index value is 4.5
percent.
iv. To calculate the non-standard mortgage payment that must be
compared to the standard mortgage payment under Sec.
1026.43(d)(2)(ii), the creditor must use:
A. The outstanding principal balance as of March 1, 2016,
assuming all scheduled payments have been made up to March 1, 2016,
and the last payment due under the fixed rate terms is made and
credited on March 1, 2016. In this example, the outstanding
principal balance is $193,948.
B. The fully indexed rate of 7.5 percent, which is the index
value of 4.5 percent as of March 15, 2015 (the date on which the
application for a refinancing is received) plus the margin of 3
percent.
C. The remaining loan term as of March 1, 2016, the date of the
recast, which is 28 years (336 monthly payments).
v. Based on these assumptions, the monthly payment for the non-
standard mortgage for purposes of determining

[[Page 6613]]

whether the standard mortgage monthly payment is lower than the non-
standard mortgage monthly payment (see Sec. 1026.43(d)(2)(ii)) is
$1,383. This is the substantially equal, monthly payment of
principal and interest required to repay the outstanding principal
balance at the fully indexed rate over the remaining term.
6. Payment calculation for an interest-only loan. Under Sec.
1026.43(d)(5)(i), the monthly periodic payment for an interest-only
loan must be calculated based on several assumptions:
i. First, the payment must be based on the outstanding principal
balance as of the date of the recast, assuming all scheduled
payments are made under the terms of the legal obligation in effect
before the mortgage is recast. For a loan on which only interest and
no principal has been paid, the outstanding principal balance at the
time of recast will be the loan amount, as defined in Sec.
1026.43(b)(5), assuming all scheduled payments are made under the
terms of the legal obligation in effect before the mortgage is
recast. For example, assume that a mortgage has a 30-year loan term,
and provides that the first 24 months of payments are interest-only.
If the 24th payment is due on September 1, 2015, the creditor must
calculate the outstanding principal balance as of September 1, 2015,
assuming that all 24 payments under the interest-only payment terms
have been made and credited timely and that no payments of principal
have been made.
ii. Second, the payment calculation must be based on
substantially equal monthly payments of principal and interest that
will fully repay the loan amount over the term of the loan remaining
as of the date the loan is recast. Thus, in the example above, the
creditor must assume a loan term of 28 years (336 monthly payments).
iii. Third, the payment must be based on the fully indexed rate,
as described in Sec. 1026.43(d)(5)(i)(A).
7. Example of payment calculation for an interest-only loan. The
following example illustrates the rule described in comment
43(d)(5)(i)-6:
i. A loan in an amount of $200,000 has a 30-year loan term. The
loan agreement provides for a fixed interest rate of 7 percent, and
permits interest-only payments for the first two years (the first 24
payments), after which time amortizing payments of principal and
interest are required.
ii. The non-standard mortgage is consummated on February 15,
2014, and the first monthly payment is due on April 1, 2014. The
loan is recast on the due date of the 24th monthly payment, which is
March 1, 2016.
iii. On March 15, 2015, the creditor receives the consumer's
written application for a refinancing, after the consumer has made
12 monthly on-time payments. The consumer has made no additional
payments of principal.
iv. To calculate the non-standard mortgage payment that must be
compared to the standard mortgage payment under Sec.
1026.43(d)(2)(ii), the creditor must use:
A. The loan amount, which is the outstanding principal balance
as of March 1, 2016, assuming all scheduled interest-only payments
have been made and credited up to that date. In this example, the
loan amount is $200,000.
B. An interest rate of 7 percent, which is the interest rate in
effect at the time of consummation of this fixed-rate non-standard
mortgage.
C. The remaining loan term as of March 1, 2016, the date of the
recast, which is 28 years (336 monthly payments).
v. Based on these assumptions, the monthly payment for the non-
standard mortgage for purposes of determining whether the standard
mortgage monthly payment is lower than the non-standard mortgage
monthly payment (see Sec. 1026.43(d)(2)(ii)) is $1,359. This is the
substantially equal, monthly payment of principal and interest
required to repay the loan amount at the fully indexed rate over the
remaining term.
8. Payment calculation for a negative amortization loan. Under
Sec. 1026.43(d)(5)(i), the monthly periodic payment for a negative
amortization loan must be calculated based on several assumptions:
i. First, the calculation must be based on the maximum loan
amount, determined after adjusting for the outstanding principal
balance. If the consumer makes only the minimum periodic payments
for the maximum possible time, until the consumer must begin making
fully amortizing payments, the outstanding principal balance will be
the maximum loan amount, as defined in Sec. 1026.43(b)(7). In this
event, the creditor complies with Sec. 1026.43(d)(5)(i)(C)(3) by
relying on the examples of how to calculate the maximum loan amount,
see comment 43(b)(7)-3. If the consumer makes payments above the
minimum periodic payments for the maximum possible time, the
creditor must calculate the maximum loan amount based on the
outstanding principal balance. In this event, the creditor complies
with Sec. 1026.43(d)(5)(i)(C)(3) by relying on the examples of how
to calculate the maximum loan amount in comment 43(d)(5)(i)-10.
ii. Second, the calculation must be based on substantially equal
monthly payments of principal and interest that will fully repay the
maximum loan amount over the term of the loan remaining as of the
date the loan is recast. For example, if the loan term is 30 years
and the loan is recast on the due date of the 60th monthly payment,
the creditor must assume a remaining loan term of 25 years (300
monthly payments).
iii. Third, the payment must be based on the fully indexed rate
as of the date of the written application for the standard mortgage.
9. Example of payment calculation for a negative amortization
loan if only minimum payments made. The following example
illustrates the rule described in comment 43(d)(5)(i)-8:
i. A loan in an amount of $200,000 has a 30-year loan term. The
loan agreement provides that the consumer can make minimum monthly
payments that cover only part of the interest accrued each month
until the date on which the principal balance increases to the
negative amortization cap of 115 percent of the loan amount, or for
the first five years of monthly payments (60 payments), whichever
occurs first. The loan is an adjustable-rate mortgage that adjusts
monthly according to a specified index plus a margin of 3.5 percent.
ii. The non-standard mortgage is consummated on February 15,
2014, and the first monthly payment is due on April 1, 2014. Assume
that the consumer has made only the minimum periodic payments.
Assume further that, based on the calculation of the maximum loan
amount required under Sec. 1026.43(b)(7) and associated commentary,
the negative amortization cap of 115 percent would be reached on
June 1, 2016, the due date of the 27th monthly payment.
iii. On March 15, 2015, the creditor receives the consumer's
written application for a refinancing, after the consumer has made
12 monthly on-time payments. On this date, the index value is 4.5
percent.
iv. To calculate the non-standard mortgage payment that must be
compared to the standard mortgage payment under Sec.
1026.43(d)(2)(ii), the creditor must use:
A. The maximum loan amount of $229,251 as of June 1, 2016;
B. The fully indexed rate of 8 percent, which is the index value
of 4.5 percent as of March 15, 2015 (the date on which the creditor
receives the application for a refinancing) plus the margin of 3.5
percent; and
C. The remaining loan term as of June 1, 2016, the date of the
recast, which is 27 years and nine months (333 monthly payments).
v. Based on these assumptions, the monthly payment for the non-
standard mortgage for purposes of determining whether the standard
mortgage monthly payment is lower than the non-standard mortgage
monthly payment (see Sec. 1026.43(d)(2)(ii)) is $1,716. This is the
substantially equal, monthly payment of principal and interest
required to repay the maximum loan amount at the fully indexed rate
over the remaining term.
10. Example of payment calculation for a negative amortization
loan if payments above minimum amount made. The following example
illustrates the rule described in comment 43(d)(5)(i)-8:
i. A loan in an amount of $200,000 has a 30-year loan term. The
loan agreement provides that the consumer can make minimum monthly
payments that cover only part of the interest accrued each month
until the date on which the principal balance increases to the
negative amortization cap of 115 percent of the loan amount, or for
the first five years of monthly payments (60 payments), whichever
occurs first. The loan is an adjustable-rate mortgage that adjusts
monthly according to a specified index plus a margin of 3.5 percent.
The introductory interest rate at consummation is 1.5 percent. One
month after consummation, the interest rate adjusts and will adjust
monthly thereafter based on the specified index plus a margin of 3.5
percent. The maximum lifetime interest rate is 10.5 percent; there
are no other periodic interest rate adjustment caps that limit how
quickly the maximum lifetime rate may be reached. The minimum
monthly payment for the first year is based

[[Page 6614]]

on the initial interest rate of 1.5 percent. After that, the minimum
monthly payment adjusts annually, but may increase by no more than
7.5 percent over the previous year's payment. The minimum monthly
payment is $690 in the first year, $742 in the second year, $798 in
the third year, $857 in the fourth year, and $922 in the fifth year.
ii. The non-standard mortgage is consummated on February 15,
2014, and the first monthly payment is due on April 1, 2014. Assume
that the consumer has made more than the minimum periodic payments,
and that after the consumer's 12th monthly on-time payment the
outstanding principal balance is $195,000. Based on the calculation
of the maximum loan amount after adjusting for this outstanding
principal balance, the negative amortization cap of 115 percent
would be reached on March 1, 2019, the due date of the 60th monthly
payment.
iii. On March 15, 2015, the creditor receives the consumer's
written application for a refinancing, after the consumer has made
12 monthly on-time payments. On this date, the index value is 4.5
percent.
iv. To calculate the non-standard mortgage payment that must be
compared to the standard mortgage payment under Sec.
1026.43(d)(2)(ii), the creditor must use:
A. The maximum loan amount of $229,219 as of March 1, 2019.
B. The fully indexed rate of 8 percent, which is the index value
of 4.5 percent as of March 15, 2015 (the date on which the creditor
receives the application for a refinancing) plus the margin of 3.5
percent.
C. The remaining loan term as of March 1, 2019, the date of the
recast, which is exactly 25 years (300 monthly payments).
v. Based on these assumptions, the monthly payment for the non-
standard mortgage for purposes of determining whether the standard
mortgage monthly payment is lower than the non-standard mortgage
monthly payment (see Sec. 1026.43(d)(2)(ii)) is $1,769. This is the
substantially equal, monthly payment of principal and interest
required to repay the maximum loan amount at the fully indexed rate
over the remaining term.
43(d)(5)(ii) Standard mortgage.
1. Payment calculation for a standard mortgage. In determining
whether the monthly periodic payment for a standard mortgage is
materially lower than the monthly periodic payment for a non-
standard mortgage, the creditor must consider the monthly payment
for the standard mortgage that will result in substantially equal,
monthly, fully amortizing payments (as defined in Sec.
1026.43(b)(2)) using the rate as of consummation. For guidance
regarding the meaning of ``substantially equal'' see comment
43(c)(5)(i)-4. For a mortgage with a single, fixed rate for the
first five years after consummation, the maximum rate that will
apply during the first five years after consummation will be the
rate at consummation. For a step-rate mortgage, however, the rate
that must be used is the highest rate that will apply during the
first five years after consummation. For example, if the rate for
the first two years after the date on which the first regular
periodic payment will be due is 4 percent, the rate for the
following two years is 5 percent, and the rate for the next two
years is 6 percent, the rate that must be used is 6 percent.
2. Example of payment calculation for a standard mortgage. The
following example illustrates the rule described in comment
43(d)(5)(ii)-1: A loan in an amount of $200,000 has a 30-year loan
term. The loan agreement provides for an interest rate of 6 percent
that is fixed for an initial period of five years, after which time
the interest rate will adjust annually based on a specified index
plus a margin of 3 percent, subject to a 2 percent annual interest
rate adjustment cap. The creditor must determine whether the
standard mortgage monthly payment is materially lower than the non-
standard mortgage monthly payment (see Sec. 1026.43(d)(2)(ii))
based on a standard mortgage payment of $1,199. This is the
substantially equal, monthly payment of principal and interest
required to repay $200,000 over 30 years at an interest rate of 6
percent.
43(e) Qualified mortgages.
43(e)(1) Safe harbor and presumption of compliance.
1. General. Section 1026.43(c) requires a creditor to make a
reasonable and good faith determination at or before consummation
that a consumer will be able to repay a covered transaction. Section
1026.43(e)(1)(i) and (ii) provide a safe harbor and presumption of
compliance, respectively, with the repayment ability requirements of
Sec. 1026.43(c) for creditors and assignees of covered transactions
that satisfy the requirements of a qualified mortgage under Sec.
1026.43(e)(2), (e)(4), or (f). See Sec. 1026.43(e)(1)(i) and (ii)
and associated commentary.
43(e)(1)(i) Safe harbor for transactions that are not higher-
priced covered transactions.
1. Safe harbor. To qualify for the safe harbor in Sec.
1026.43(e)(1)(i), a covered transaction must meet the requirements
of a qualified mortgage under Sec. 1026.43(e)(2), (e)(4), or (f)
and must not be a higher-priced covered transaction, as defined in
Sec. 1026.43(b)(4). For guidance on determining whether a loan is a
higher-priced covered transaction, see comment 43(b)(4)-1.
43(e)(1)(ii) Presumption of compliance for higher-priced covered
transactions.
1. General. Under Sec. 1026.43(e)(1)(ii), a creditor or
assignee of a qualified mortgage under Sec. 1026.43(e)(2), (e)(4),
or (f) that is a higher-priced covered transaction is presumed to
comply with the repayment ability requirements of Sec. 1026.43(c).
To rebut the presumption, it must be proven that, despite meeting
the standards for a qualified mortgage (including either the debt-
to-income standard in Sec. 1026.43(e)(2)(vi) or the standards of
one of the entities specified in Sec. 1026.43(e)(4)(ii)), the
creditor did not have a reasonable and good faith belief in the
consumer's repayment ability. Specifically, it must be proven that,
at the time of consummation, based on the information available to
the creditor, the consumer's income, debt obligations, alimony,
child support, and the consumer's monthly payment (including
mortgage-related obligations) on the covered transaction and on any
simultaneous loans of which the creditor was aware at consummation
would leave the consumer with insufficient residual income or assets
other than the value of the dwelling (including any real property
attached to the dwelling) that secures the loan with which to meet
living expenses, including any recurring and material non-debt
obligations of which the creditor was aware at the time of
consummation, and that the creditor thereby did not make a
reasonable and good faith determination of the consumer's repayment
ability. For example, a consumer may rebut the presumption with
evidence demonstrating that the consumer's residual income was
insufficient to meet living expenses, such as food, clothing,
gasoline, and health care, including the payment of recurring
medical expenses of which the creditor was aware at the time of
consummation, and after taking into account the consumer's assets
other than the value of the dwelling securing the loan, such as a
savings account. In addition, the longer the period of time that the
consumer has demonstrated actual ability to repay the loan by making
timely payments, without modification or accommodation, after
consummation or, for an adjustable-rate mortgage, after recast, the
less likely the consumer will be able to rebut the presumption based
on insufficient residual income and prove that, at the time the loan
was made, the creditor failed to make a reasonable and good faith
determination that the consumer had the reasonable ability to repay
the loan.
43(e)(2) Qualified mortgage defined--general.
Paragraph 43(e)(2)(i).
1. Regular periodic payments. Under Sec. 1026.43(e)(2)(i), a
qualified mortgage must provide for regular periodic payments that
may not result in an increase of the principal balance (negative
amortization), deferral of principal repayment, or a balloon
payment. Thus, the terms of the legal obligation must require the
consumer to make payments of principal and interest, on a monthly or
other periodic basis, that will fully repay the loan amount over the
loan term. The periodic payments must be substantially equal except
for the effect that any interest rate change after consummation has
on the payment in the case of an adjustable-rate or step-rate
mortgage. In addition, because Sec. 1026.43(e)(2)(i) requires that
a qualified mortgage provide for regular periodic payments, a
single-payment transaction may not be a qualified mortgage.
2. Deferral of principal repayment. Under Sec.
1026.43(e)(2)(i)(B), a qualified mortgage's regular periodic
payments may not allow the consumer to defer repayment of principal,
except as provided in Sec. 1026.43(f). A loan allows the deferral
of principal repayment if one or more of the periodic payments may
be applied solely to accrued interest and not to loan principal.
Deferred principal repayment also occurs if the payment is applied
to both accrued interest and principal but the consumer is permitted
to make periodic payments that are less than the amount that would
be required under a payment schedule that has substantially equal
payments that fully repay the loan amount over the loan term.
Graduated payment mortgages, for

[[Page 6615]]

example, allow deferral of principal repayment in this manner and
therefore may not be qualified mortgages.
Paragraph 43(e)(2)(ii).
1. General. The 30-year term limitation in Sec.
1026.43(e)(2)(ii) is applied without regard to any interim period
between consummation and the beginning of the first full unit period
of the repayment schedule. For example, assume a covered transaction
is consummated on March 20, 2014 and the due date of the first
regular periodic payment is April 30, 2014. The beginning of the
first full unit period of the repayment schedule is April 1, 2014
and the loan term therefore ends on April 1, 2044. The transaction
would comply with the 30-year term limitation in Sec.
1026.43(e)(2)(ii).
Paragraph 43(e)(2)(iv).
1. Maximum interest rate during the first five years. For a
qualified mortgage, the creditor must underwrite the loan using a
periodic payment of principal and interest based on the maximum
interest rate that may apply during the first five years after the
date on which the first regular periodic payment will be due.
Creditors must use the maximum rate that could apply at any time
during the first five years after the date on which the first
regular periodic payment will be due, regardless of whether the
maximum rate is reached at the first or subsequent adjustment during
the five year period.
2. Fixed-rate mortgage. For a fixed-rate mortgage, creditors
should use the interest rate in effect at consummation. ``Fixed-rate
mortgage'' is defined in Sec. 1026.18(s)(7)(iii).
3. Interest rate adjustment caps. For an adjustable-rate
mortgage, creditors should assume the interest rate increases after
consummation as rapidly as possible, taking into account the terms
of the legal obligation. That is, creditors should account for any
periodic interest rate adjustment cap that may limit how quickly the
interest rate can increase under the terms of the legal obligation.
Where a range for the maximum interest rate during the first five
years is provided, the highest rate in that range is the maximum
interest rate for purposes of Sec. 1026.43(e)(2)(iv). Where the
terms of the legal obligation are not based on an index plus margin
or formula, the creditor must use the maximum interest rate that
occurs during the first five years after the date on which the first
regular periodic payment will be due. To illustrate:
i. Adjustable-rate mortgage with discount for three years.
Assume an adjustable-rate mortgage has an initial discounted rate of
5 percent that is fixed for the first three years, measured from the
first day of the first full calendar month following consummation,
after which the rate will adjust annually based on a specified index
plus a margin of 3 percent. The index value in effect at
consummation is 4.5 percent. The loan agreement provides for an
annual interest rate adjustment cap of 2 percent, and a lifetime
maximum interest rate of 12 percent. The first rate adjustment
occurs on the due date of the 36th monthly payment; the rate can
adjust to no more than 7 percent (5 percent initial discounted rate
plus 2 percent annual interest rate adjustment cap). The second rate
adjustment occurs on the due date of the 48th monthly payment; the
rate can adjust to no more than 9 percent (7 percent rate plus 2
percent annual interest rate adjustment cap). The third rate
adjustment occurs on the due date of the 60th monthly payment; the
rate can adjust to no more than 11 percent (9 percent rate plus 2
percent annual interest rate cap adjustment). The maximum interest
rate during the first five years after the date on which the first
regular periodic payment will be due is 11 percent (the rate on the
due date of the 60th monthly payment). For further discussion of how
to determine whether a rate adjustment occurs during the first five
years after the date on which the first regular periodic payment
will be due, see comment 43(e)(2)(iv)-7.
ii. Adjustable-rate mortgage with discount for three years.
Assume the same facts as in paragraph 3.i except that the lifetime
maximum interest rate is 10 percent, which is less than the maximum
interest rate in the first five years after the date on which the
first regular periodic payment will be due of 11 percent that would
apply but for the lifetime maximum interest rate. The maximum
interest rate during the first five years after the date on which
the first regular periodic payment will be due is 10 percent.
iii. Step-rate mortgage. Assume a step-rate mortgage with an
interest rate fixed at 6.5 percent for the first two years, measured
from the first day of the first full calendar month following
consummation, 7 percent for the next three years, and then 7.5
percent for the remainder of the loan term. The maximum interest
rate during the first five years after the date on which the first
regular periodic payment will be due is 7.5 percent.
4. First five years after the date on which the first regular
periodic payment will be due. Under Sec. 1026.43(e)(2)(iv)(A), the
creditor must underwrite the loan using the maximum interest rate
that may apply during the first five years after the date on which
the first regular periodic payment will be due. To illustrate,
assume an adjustable-rate mortgage with an initial fixed interest
rate of 5 percent for the first five years, measured from the first
day of the first full calendar month following consummation, after
which the interest rate will adjust annually to the specified index
plus a margin of 6 percent, subject to a 2 percent annual interest
rate adjustment cap. The index value in effect at consummation is
5.5 percent. The loan consummates on September 15, 2014, and the
first monthly payment is due on November 1, 2014. The first rate
adjustment to no more than 7 percent (5 percent plus 2 percent
annual interest rate adjustment cap) occurs on the due date of the
60th monthly payment, which is October 1, 2019, and therefore, the
rate adjustment occurs during the first five years after the date on
which the first regular periodic payment will be due. To meet the
definition of qualified mortgage under Sec. 1026.43(e)(2), the
creditor must underwrite the loan using a monthly payment of
principal and interest based on an interest rate of 7 percent.
5. Loan amount. To meet the definition of qualified mortgage
under Sec. 1026.43(e)(2), a creditor must determine the periodic
payment of principal and interest using the maximum interest rate
permitted during the first five years after the date on which the
first regular periodic payment will be due that repays either:
i. The outstanding principal balance as of the earliest date the
maximum interest rate during the first five years after the date on
which the first regular periodic payment will be due can take effect
under the terms of the legal obligation, over the remaining term of
the loan. To illustrate, assume a loan in an amount of $200,000 has
a 30-year loan term. The loan agreement provides for a discounted
interest rate of 5 percent that is fixed for an initial period of
three years, measured from the first day of the first full calendar
month following consummation, after which the interest rate will
adjust annually based on a specified index plus a margin of 3
percent, subject to a 2 percent annual interest rate adjustment cap
and a lifetime maximum interest rate of 9 percent. The index value
in effect at consummation equals 4.5 percent. Assuming the interest
rate increases after consummation as quickly as possible, the rate
adjustment to the lifetime maximum interest rate of 9 percent occurs
on the due date of the 48th monthly payment. The outstanding
principal balance on the loan at the end of the fourth year (after
the 48th monthly payment is credited) is $188,218. The creditor will
meet the definition of qualified mortgage if it underwrites the
covered transaction using the monthly payment of principal and
interest of $1,564 to repay the outstanding principal balance of
$188,218 over the remaining 26 years of the loan term (312 months)
using the maximum interest rate during the first five years of 9
percent; or
ii. The loan amount, as that term is defined in Sec.
1026.43(b)(5), over the entire loan term, as that term is defined in
Sec. 1026.43(b)(6). Using the same example above, the creditor will
meet the definition of qualified mortgage if it underwrites the
covered transaction using the monthly payment of principal and
interest of $1,609 to repay the loan amount of $200,000 over the 30-
year loan term using the maximum interest rate during the first five
years of 9 percent.
6. Mortgage-related obligations. Section 1026.43(e)(2)(iv)
requires creditors to take the consumer's monthly payment for
mortgage-related obligations into account when underwriting the
loan. For the meaning of the term ``mortgage-related obligations,''
see Sec. 1026.43(b)(8) and associated commentary.
7. Examples. The following are examples of how to determine the
periodic payment of principal and interest based on the maximum
interest rate during the first five years after the date on which
the first regular periodic payment will be due for purposes of
meeting the definition of qualified mortgage under Sec. 1026.43(e)
(all payment amounts shown are rounded, and all amounts are
calculated using non-rounded values; all initial fixed interest rate
periods are measured from the first day of the first full calendar
month following consummation):
i. Fixed-rate mortgage. A loan in an amount of $200,000 has a
30-year loan term and a fixed interest rate of 7 percent. The
maximum interest rate during the first five years after the date on
which the first regular

[[Page 6616]]

periodic payment will be due for a fixed-rate mortgage is the
interest rate in effect at consummation, which is 7 percent under
this example. The monthly fully amortizing payment scheduled over
the 30 years is $1,331. The creditor will meet the definition of
qualified mortgage if it underwrites the loan using the fully
amortizing payment of $1,331.
ii. Adjustable-rate mortgage with discount for three years. A. A
loan in an amount of $200,000 has a 30-year loan term. The loan
agreement provides for a discounted interest rate of 5 percent that
is fixed for an initial period of three years, after which the
interest rate will adjust annually based on a specified index plus a
margin of 3 percent, subject to a 2 percent annual interest rate
adjustment cap and a lifetime maximum interest rate of 9 percent.
The index value in effect at consummation is 4.5 percent. The loan
is consummated on March 15, 2014, and the first regular periodic
payment is due May 1, 2014. The loan agreement provides that the
first rate adjustment occurs on April 1, 2017 (the due date of the
36th monthly payment); the second rate adjustment occurs on April 1,
2018 (the due date of the 48th monthly payment); and the third rate
adjustment occurs on April 1, 2019 (the due date of the 60th monthly
payment). Under this example, the maximum interest rate during the
first five years after the date on which the first regular periodic
payment due is 9 percent (the lifetime interest rate cap), which
applies beginning on April 1, 2018 (the due date of the 48th monthly
payment). The outstanding principal balance at the end of the fourth
year (after the 48th payment is credited) is $188,218.
B. The transaction will meet the definition of a qualified
mortgage if the creditor underwrites the loan using the monthly
payment of principal and interest of $1,564 to repay the outstanding
principal balance at the end of the fourth year of $188,218 over the
remaining 26 years of the loan term (312 months), using the maximum
interest rate during the first five years after the date on which
the first regular periodic payment will be due of 9 percent.
Alternatively, the transaction will meet the definition of a
qualified mortgage if the creditor underwrites the loan using the
monthly payment of principal and interest of $1,609 to repay the
loan amount of $200,000 over the 30-year loan term, using the
maximum interest rate during the first five years after the date on
which the first regular periodic payment will be due of 9 percent.
iii. Adjustable-rate mortgage with discount for five years. A. A
loan in an amount of $200,000 has a 30-year loan term. The loan
agreement provides for a discounted interest rate of 6 percent that
is fixed for an initial period of five years, after which the
interest rate will adjust annually based on a specified index plus a
margin of 3 percent, subject to a 2 percent annual interest rate
adjustment cap. The index value in effect at consummation is 4.5
percent. The loan consummates on March 15, 2014 and the first
regular periodic payment is due May 1, 2014. Under the terms of the
loan agreement, the first rate adjustment to no more than 8 percent
(6 percent plus 2 percent annual interest rate adjustment cap) is on
April 1, 2019 (the due date of the 60th monthly payment), which
occurs less than five years after the date on which the first
regular periodic payment will be due. Thus, the maximum interest
rate under the terms of the loan during the first five years after
the date on which the first regular periodic payment will be due is
8 percent.
B. The transaction will meet the definition of a qualified
mortgage if the creditor underwrites the loan using the monthly
payment of principal and interest of $1,436 to repay the outstanding
principal balance at the end of the fifth year of $186,109 over the
remaining 25 years of the loan term (300 months), using the maximum
interest rate during the first five years after the date on which
the first regular periodic payment will be due of 8 percent.
Alternatively, the transaction will meet the definition of a
qualified mortgage if the creditor underwrites the loan using the
monthly payment of principal and interest of $1,468 to repay the
loan amount of $200,000 over the 30-year loan term, using the
maximum interest rate during the first five years after the date on
which the first regular periodic payment will be due of 8 percent.
iv. Adjustable-rate mortgage with discount for seven years. A. A
loan in an amount of $200,000 has a 30-year loan term. The loan
agreement provides for a discounted interest rate of 6 percent that
is fixed for an initial period of seven years, after which the
interest rate will adjust annually based on a specified index plus a
margin of 3 percent, subject to a 2 percent annual interest rate
adjustment cap. The index value in effect at consummation is 4.5
percent. The loan is consummated on March 15, 2014, and the first
regular periodic payment is due May 1, 2014. Under the terms of the
loan agreement, the first rate adjustment is on April 1, 2021 (the
due date of the 84th monthly payment), which occurs more than five
years after the date on which the first regular periodic payment
will be due. Thus, the maximum interest rate under the terms of the
loan during the first five years after the date on which the first
regular periodic payment will be due is 6 percent.
B. The transaction will meet the definition of a qualified
mortgage if the creditor underwrites the loan using the monthly
payment of principal and interest of $1,199 to repay the loan amount
of $200,000 over the 30-year loan term using the maximum interest
rate during the first five years after the date on which the first
regular periodic payment will be due of 6 percent.
iv. Step-rate mortgage. A. A loan in an amount of $200,000 has a
30-year loan term. The loan agreement provides that the interest
rate is 6.5 percent for the first two years of the loan, 7 percent
for the next three years, and then 7.5 percent for remainder of the
loan term. The maximum interest rate during the first five years
after the date on which the first regular periodic payment will be
due is 7.5 percent, which occurs on the due date of the 60th monthly
payment. The outstanding principal balance at the end of the fifth
year (after the 60th payment is credited) is $187,868.
B. The transaction will meet the definition of a qualified
mortgage if the creditor underwrites the loan using a monthly
payment of principal and interest of $1,388 to repay the outstanding
principal balance of $187,868 over the remaining 25 years of the
loan term (300 months), using the maximum interest rate during the
first five years after the date on which the first regular periodic
payment will be due of 7.5 percent. Alternatively, the transaction
will meet the definition of a qualified mortgage if the creditor
underwrites the loan using a monthly payment of principal and
interest of $1,398 to repay $200,000 over the 30-year loan term
using the maximum interest rate during the first five years after
the date on which the first regular periodic payment will be due of
7.5 percent.
Paragraph 43(e)(2)(v).
1. General. For guidance on satisfying Sec. 1026.43(e)(2)(v), a
creditor may rely on commentary to Sec. 1026.43(c)(2)(i) and (vi),
(c)(3), and (c)(4).
2. Income or assets. Section 1026.43(e)(2)(v)(A) requires
creditors to consider and verify the consumer's current or
reasonably expected income or assets. For purposes of this
requirement, the creditor must consider and verify, at a minimum,
any income specified in appendix Q. A creditor may also consider and
verify any other income in accordance with Sec. 1026.43(c)(2)(i)
and (c)(4); however, such income would not be included in the total
monthly debt-to-income ratio determination required by Sec.
1026.43(e)(2)(vi).
3. Debts. Section 1026.43(e)(2)(v)(B) requires creditors to
consider and verify the consumer's current debt obligations,
alimony, and child support. For purposes of this requirement, the
creditor must consider and verify, at a minimum, any debt or
liability specified in appendix Q. A creditor may also consider and
verify other debt in accordance with Sec. 1026.43(c)(2)(vi) and
(c)(3); however, such debt would not be included in the total
monthly debt-to-income ratio determination required by Sec.
1026.43(e)(2)(vi).
Paragraph 43(e)(2)(vi).
1. Calculation of monthly payment on the covered transaction and
simultaneous loans. As provided in appendix Q, for purposes of Sec.
1026.43(e)(2)(vi), creditors must include in the definition of
``debt'' a consumer's monthly housing expense. This includes, for
example, the consumer's monthly payment on the covered transaction
(including mortgage-related obligations) and on simultaneous loans.
Accordingly, Sec. 1026.43(e)(2)(vi)(B) provides the method by which
a creditor calculates the consumer's monthly payment on the covered
transaction and on any simultaneous loan that the creditor knows or
has reason to know will be made.
43(e)(3) Limits on points and fees for qualified mortgages.
Paragraph 43(e)(3)(i).
1. Total loan amount. The term ``total loan amount'' is defined
in Sec. 1026.32(b)(4)(i). For an explanation of how to calculate
the ``total loan amount'' under Sec. 1026.43(e)(3)(i), see comment
32(b)(4)(i)-1.
2. Calculation of allowable points and fees. A creditor must
determine which category the loan falls into based on the face
amount

[[Page 6617]]

of the note (the ``loan amount'' as defined in Sec. 1026.43(b)(5)).
For categories with a percentage limit, the creditor must apply the
allowable points and fees percentage to the ``total loan amount,''
which may be different than the loan amount. A creditor must
calculate the allowable amount of points and fees for a qualified
mortgage as follows:
i. First, the creditor must determine the ``tier'' into which
the loan falls based on the loan amount. The loan amount is the
principal amount the consumer will borrow, as reflected in the
promissory note or loan contract. See Sec. 1026.43(b)(5). For
example, if the loan amount is $55,000, the loan falls into the tier
for loans greater than or equal to $20,000 but less than $60,000, to
which a 5 percent cap on points and fees applies. For tiers with a
prescribed dollar limit on points and fees (e.g., for loans from
$60,000 up to $100,000, the limit is $3,000), the creditor does not
need to do any further calculations.
ii. Second, for tiers with a percentage limit, the creditor must
determine the total loan amount based on the calculation for the
total loan amount under comment 32(b)(4)(i)-1. If the loan amount is
$55,000, for example, the total loan amount may be a different
amount, such as $52,000.
iii. Third, the creditor must apply the percentage cap on points
and fees to the total loan amount. For example, for a loan of
$55,000 where the total loan amount is $52,000, the allowable points
and fees are 5 percent of $52,000, or $2,600.
3. Sample determination of allowable points and fees.
i. A covered transaction with a loan amount of $105,000 falls
into the first points and fees tier, to which a points and fees cap
of 3 percent of the total loan amount applies. See Sec.
1026.43(e)(3)(i)(A). Therefore, if the calculation under comment
32(b)(4)(i)-1 results in a total loan amount of $102,000, then the
allowable total points and fees for this loan are 3 percent of
$102,000, or $3,060.
ii. A covered transaction with a loan amount of $75,000 falls
into the second points and fees tier, to which a points and fees cap
of $3,000 applies. See Sec. 1026.43(e)(3)(i)(B). The allowable
total points and fees for this loan are $3,000, regardless of the
total loan amount.
iii. A covered transaction with a loan amount of $50,000 falls
into the third points and fees tier, to which a points and fees cap
of 5 percent of the total loan amount applies. See Sec.
1026.43(e)(3)(i)(C). Therefore, if the calculation under comment
32(b)(4)(i)-1 results in a total loan amount of $48,000, then the
allowable total points and fees for this loan are 5 percent of
$48,000, or $2,400.
iv. A covered transaction with a loan amount of $15,000 falls
into the fourth points and fees tier, to which a points and fees cap
of $1,000 applies. See Sec. 1026.43(e)(3)(i)(D). The allowable
total points and fees for this loan are $1,000, regardless of the
total loan amount.
v. A covered transaction with a loan amount of $10,000 falls
into the fifth points and fees tier, to which a points and fees cap
of 8 percent of the total loan amount applies. See Sec.
1026.43(e)(3)(i)(E). Therefore, if the calculation under comment
32(b)(4)(i)-1 results in a total loan amount of $7,000, then the
allowable total points and fees for this loan are 8 percent of
$7,000, or $560.
Paragraph 43(e)(3)(ii).
1. Annual adjustment for inflation. The dollar amounts,
including the loan amounts, in Sec. 1026.43(e)(3)(i) will be
adjusted annually on January 1 by the annual percentage change in
the CPI-U that was in effect on the preceding June 1. The Bureau
will publish adjustments after the June figures become available
each year.
43(e)(4) Qualified mortgage defined--special rules.
1. Alternative definition. Subject to the sunset provided under
Sec. 1026.43(e)(4)(iii), Sec. 1026.43(e)(4) provides an
alternative definition of qualified mortgage to the definition
provided in Sec. 1026.43(e)(2). To be a qualified mortgage under
Sec. 1026.43(e)(4), the creditor must satisfy the requirements
under Sec. 1026.43(e)(2)(i) through (iii), in addition to being one
of the types of loans specified in Sec. 1026.43(e)(4)(ii)(A)
through (E).
2. Termination of conservatorship. Section 1026.43(e)(4)(ii)(A)
requires that a covered transaction be eligible for purchase or
guarantee by the Federal National Mortgage Association (``Fannie
Mae'') or the Federal Home Loan Mortgage Corporation (``Freddie
Mac'') (or any limited-life regulatory entity succeeding the charter
of either) operating under the conservatorship or receivership of
the Federal Housing Finance Agency pursuant to section 1367 of the
Federal Housing Enterprises Financial Safety and Soundness Act of
1992 (12 U.S.C. 4617). The special rule under Sec.
1026.43(e)(4)(ii)(A) does not apply if Fannie Mae or Freddie Mac (or
any limited-life regulatory entity succeeding the charter of either)
has ceased operating under the conservatorship or receivership of
the Federal Housing Finance Agency. For example, if either Fannie
Mae or Freddie Mac (or succeeding limited-life regulatory entity)
ceases to operate under the conservatorship or receivership of the
Federal Housing Finance Agency, Sec. 1026.43(e)(4)(ii)(A) would no
longer apply to loans eligible for purchase or guarantee by that
entity; however, the special rule would be available for a loan that
is eligible for purchase or guarantee by the other entity still
operating under conservatorship or receivership.
3. Timing. Under Sec. 1026.43(e)(4)(iii), the definition of
qualified mortgage under paragraph (e)(4) applies only to loans
consummated on or before January 10, 2021, regardless of whether
Fannie Mae or Freddie Mac (or any limited-life regulatory entity
succeeding the charter of either) continues to operate under the
conservatorship or receivership of the Federal Housing Finance
Agency. Accordingly, Sec. 1026.43(e)(4) is available only for
covered transactions consummated on or before the earlier of either:
i. The date Fannie Mae or Freddie Mac (or any limited-life
regulatory entity succeeding the charter of either), respectively,
cease to operate under the conservatorship or receivership of the
Federal Housing Finance Agency pursuant to section 1367 of the
Federal Housing Enterprises Financial Safety and Soundness Act of
1992 (12 U.S.C. 4617); or
ii. January 10, 2021, as provided by Sec. 1026.43(e)(4)(iii).
4. Eligible for purchase, guarantee, or insurance. To satisfy
Sec. 1026.43(e)(4)(ii), a loan need not be actually purchased or
guaranteed by Fannie Mae or Freddie Mac or insured or guaranteed by
the U.S. Department of Housing and Urban Development, U.S.
Department of Veterans Affairs, U.S. Department of Agriculture, or
Rural Housing Service. Rather, Sec. 1026.43(e)(4)(ii) requires only
that the loan be eligible (i.e., meet the criteria) for such
purchase, guarantee, or insurance. For example, for purposes of
Sec. 1026.43(e)(4), a creditor is not required to sell a loan to
Fannie Mae or Freddie Mac (or any limited-life regulatory entity
succeeding the charter of either) to be a qualified mortgage;
however, the loan must be eligible for purchase or guarantee by
Fannie Mae or Freddie Mac (or any limited-life regulatory entity
succeeding the charter of either), including satisfying any
requirements regarding consideration and verification of a
consumer's income or assets, credit history, and debt-to-income
ratio or residual income. To determine eligibility, a creditor may
rely on an underwriting recommendation provided by Fannie Mae or
Freddie Mac's Automated Underwriting Systems (AUSs) or written guide
in effect at the time. Accordingly, a covered transaction is
eligible for purchase or guarantee by Fannie Mae or Freddie Mac if:
i. The loan conforms to the standards set forth in the Fannie
Mae Single-Family Selling Guide or the Freddie Mac Single-Family
Seller/Servicer Guide; or
ii. The loan receives one of the following recommendations from
the corresponding automated underwriting system:
A. An ``Approve/Eligible'' recommendation from Desktop
Underwriter (DU); or
B. An ``Accept and Eligible to Purchase'' recommendation from
Loan Prospector (LP).
43(f) Balloon-Payment qualified mortgages made by certain
creditors.
43(f)(1) Exemption.
Paragraph 43(f)(1)(i).
1. Satisfaction of qualified mortgage requirements. Under Sec.
1026.43(f)(1)(i), for a mortgage that provides for a balloon payment
to be a qualified mortgage, the mortgage must satisfy the
requirements for a qualified mortgage in paragraphs (e)(2)(i)(A),
(e)(2)(ii), (iii), and (v). Therefore, a covered transaction with
balloon payment terms must provide for regular periodic payments
that do not result in an increase of the principal balance, pursuant
to Sec. 1026.43(e)(2)(i)(A); must have a loan term that does not
exceed 30 years, pursuant to Sec. 1026.43(e)(2)(ii); must have
total points and fees that do not exceed specified thresholds
pursuant to Sec. 1026.43(e)(2)(iii); and must satisfy the
consideration and verification requirements in Sec.
1026.43(e)(2)(v).
Paragraph 43(f)(1)(ii).
1. Example. Under Sec. 1026.43(f)(1)(ii), if a qualified
mortgage provides for a balloon payment, the creditor must determine
that the consumer is able to make all scheduled payments under the
legal obligation other than the balloon payment. For example, assume
a loan in an amount of $200,000 that has a five-year loan term, but
is amortized

[[Page 6618]]

over 30 years. The loan agreement provides for a fixed interest rate
of 6 percent. The loan consummates on March 3, 2014, and the monthly
payment of principal and interest scheduled for the first five years
is $1,199, with the first monthly payment due on April 1, 2014. The
balloon payment of $187,308 is required on the due date of the 60th
monthly payment, which is April 1, 2019. The loan can be a qualified
mortgage if the creditor underwrites the loan using the scheduled
principal and interest payment of $1,199, plus the consumer's
monthly payment for all mortgage-related obligations, and satisfies
the other criteria set forth in Sec. 1026.43(f).
2. Creditor's determination. A creditor must determine that the
consumer is able to make all scheduled payments other than the
balloon payment to satisfy Sec. 1026.43(f)(1)(ii), in accordance
with the legal obligation, together with the consumer's monthly
payments for all mortgage-related obligations and excluding the
balloon payment, to meet the repayment ability requirements of Sec.
1026.43(f)(1)(ii). A creditor satisfies Sec. 1026.43(f)(1)(ii) if
it uses the maximum payment in the payment schedule, excluding any
balloon payment, to determine if the consumer has the ability to
make the scheduled payments.
Paragraph 43(f)(1)(iii).
1. Debt-to-income or residual income. A creditor must consider
and verify the consumer's monthly debt-to-income ratio or residual
income to meet the requirements of Sec. 1026.43(f)(1)(iii). To
calculate the consumer's monthly debt-to-income or residual income
for purposes of Sec. 1026.43(f)(1)(iii), the creditor may rely on
the definitions and calculation rules in Sec. 1026.43(c)(7) and its
accompanying commentary, except for the calculation rules for a
consumer's total monthly debt obligations (which is a component of
debt-to-income and residual income under Sec. 1026.43(c)(7)). For
purposes of calculating the consumer's total monthly debt
obligations under Sec. 1026.43(f)(1)(iii), the creditor must
calculate the monthly payment on the covered transaction using the
payment calculation rules in Sec. 1026.43(f)(1)(iv)(A), together
with all mortgage-related obligations and excluding the balloon
payment.
Paragraph 43(f)(1)(iv).
1. Scheduled payments. Under Sec. 1026.43(f)(1)(iv)(A), the
legal obligation must provide that scheduled payments must be
substantially equal and determined using an amortization period that
does not exceed 30 years. Balloon payments often result when the
periodic payment would fully repay the loan amount only if made over
some period that is longer than the loan term. For example, a loan
term of 10 years with periodic payments based on an amortization
period of 20 years would result in a balloon payment being due at
the end of the loan term. Whatever the loan term, the amortization
period used to determine the scheduled periodic payments that the
consumer must pay under the terms of the legal obligation may not
exceed 30 years.
2. Substantially equal. The calculation of payments scheduled by
the legal obligation under Sec. 1026.43(f)(1)(iv)(A) are required
to result in substantially equal amounts. This means that the
scheduled payments need to be similar, but need not be equal. For
further guidance on substantially equal payments, see comment
43(c)(5)(i)-4.
3. Interest-only payments. A mortgage that only requires the
payment of accrued interest each month does not meet the
requirements of Sec. 1026.43(f)(1)(iv)(A).
Paragraph 43(f)(1)(v).
1. Forward commitments. A creditor may make a mortgage loan that
will be transferred or sold to a purchaser pursuant to an agreement
that has been entered into at or before the time the transaction is
consummated. Such an agreement is sometimes known as a ``forward
commitment.'' A balloon-payment mortgage that will be acquired by a
purchaser pursuant to a forward commitment does not satisfy the
requirements of Sec. 1026.43(f)(1)(v), whether the forward
commitment provides for the purchase and sale of the specific
transaction or for the purchase and sale of transactions with
certain prescribed criteria that the transaction meets. However, a
purchase and sale of a balloon-payment qualified mortgage to another
person that separately meets the requirements of Sec.
1026.43(f)(1)(vi) is permitted. For example: assume a creditor that
meets the requirements of Sec. 1026.43(f)(1)(vi) makes a balloon-
payment mortgage that meets the requirements of Sec.
1026.43(f)(1)(i) through (iv); if the balloon-payment mortgage meets
the purchase criteria of an investor with which the creditor has an
agreement to sell such loans after consummation, then the balloon-
payment mortgage does not meet the definition of a qualified
mortgage in accordance with Sec. 1026.43(f)(1)(v). However, if the
investor meets the requirement of Sec. 1026.43(f)(1)(vi), the
balloon-payment qualified mortgage retains its qualified mortgage
status.
Paragraph 43(f)(1)(vi).
1. Creditor qualifications. Under Sec. 1026.43(f)(1)(vi), to
make a qualified mortgage that provides for a balloon payment, the
creditor must satisfy three criteria that are also required under
Sec. 1026.35(b)(2)(iii)(A), (B) and (C), which require:
i. During the preceding calendar year, the creditor extended
over 50 percent of its total first-lien covered transactions, as
defined in Sec. 1026.43(b)(1), on properties that are located in
counties that are designated either ``rural'' or ``underserved,'' as
defined in Sec. 1026.35(b)(2)(iv), to satisfy the requirement of
Sec. 1026.35(b)(2)(iii)(A). Pursuant to Sec. 1026.35(b)(2)(iv), a
county is considered to be rural if it is neither in a metropolitan
statistical area, nor a micropolitan statistical area adjacent to a
metropolitan statistical area, as those terms are defined by the
U.S. Office of Management and Budget. A county is considered to be
underserved if no more than two creditors extend covered
transactions secured by a first lien five or more times in that
county during a calendar year. The Bureau determines annually which
counties in the United States are rural or underserved and publishes
on its public Web site lists of those counties to enable creditors
to determine whether they meet this criterion. Thus, for example, if
a creditor originated 90 first-lien covered transactions during
2013, the creditor meets this element of the exception in 2014 if at
least 46 of those transactions are secured by first liens on
properties located in one or more counties that are on the Bureau's
lists for 2013.
ii. During the preceding calendar year, the creditor together
with its affiliates originated 500 or fewer first-lien covered
transactions, as defined by Sec. 1026.43(b)(1), to satisfy the
requirement of Sec. 1026.35(b)(2)(iii)(B).
iii. As of the end of the preceding calendar year, the creditor
had total assets that do not exceed the current asset threshold
established by the Bureau, to satisfy the requirement of Sec.
1026.35(b)(2)(iii)(C). For calendar year 2013, the asset threshold
was $2,000,000,000.
43(f)(2) Post-consummation transfer of balloon-payment qualified
mortgage.
1. Requirement to hold in portfolio. Creditors generally must
hold a balloon-payment qualified mortgage in portfolio to maintain
the transaction's status as a qualified mortgage under Sec.
1026.43(f)(1), subject to four exceptions. Unless one of these
exceptions applies, a balloon-payment qualified mortgage is no
longer a qualified mortgage under Sec. 1026.43(f)(1) once legal
title to the debt obligation is sold, assigned, or otherwise
transferred to another person. Accordingly, unless one of the
exceptions applies, the transferee could not benefit from the
presumption of compliance for qualified mortgages under Sec.
1026.43(f)(1) unless the loan also met the requirements of another
qualified mortgage definition.
2. Application to subsequent transferees. The exceptions
contained in Sec. 1026.43(f)(2) apply not only to an initial sale,
assignment, or other transfer by the originating creditor but to
subsequent sales, assignments, and other transfers as well. For
example, assume Creditor A originates a qualified mortgage under
Sec. 1026.43(f)(1). Six months after consummation, Creditor A sells
the qualified mortgage to Creditor B pursuant to Sec.
1026.43(f)(2)(ii) and the loan retains its qualified mortgage status
because Creditor B complies with the limits on operating
predominantly in rural or underserved areas, asset size, and number
of transactions. If Creditor B sells the qualified mortgage, it will
lose its qualified mortgage status under Sec. 1026.43(f)(1) unless
the sale qualifies for one of the Sec. 1026.43(f)(2) exceptions for
sales three or more years after consummation, to another qualifying
institution, as required by supervisory action, or pursuant to a
merger or acquisition.
Paragraph 43(f)(2)(i).
1. Transfer three years after consummation. Under Sec.
1026.43(f)(2)(i), if a balloon-payment qualified mortgage under
Sec. 1026.43(f)(1) is sold, assigned, or otherwise transferred
three years or more after consummation, the balloon-payment
qualified mortgage retains its status as a qualified mortgage under
Sec. 1026.43(f)(1) following the sale. The transferee need not be
eligible to originate qualified mortgages under Sec.
1026.43(f)(1)(vi). The balloon-payment qualified mortgage will
continue to be a qualified mortgage throughout its life, and the
transferee, and any subsequent transferees, may invoke the
presumption of compliance for qualified mortgages under Sec.
1026.43(f)(1).

[[Page 6619]]

Paragraph 43(f)(2)(ii).
1. Transfer to another qualifying creditor. Under Sec.
1026.43(f)(2)(ii), a balloon-payment qualified mortgage under Sec.
1026.43(f)(1) may be sold, assigned, or otherwise transferred at any
time to another creditor that meets the requirements of Sec.
1026.43(f)(1)(vi). That section requires that a creditor: (1)
Operate predominantly in a rural or underserved area during the
preceding calendar year; (2) during the preceding calendar year,
together with all affiliates, originated 500 or fewer first-lien
covered transactions; and (3) had total assets less than $2 billion
(as adjusted for inflation) at the end of the preceding calendar
year. A balloon-payment qualified mortgage under Sec. 1026.43(f)(1)
transferred to a creditor that meets these criteria would retain its
qualified mortgage status even if it is transferred less than three
years after consummation.
Paragraph 43(f)(2)(iii).
1. Supervisory sales. Section 1026.43(f)(2)(iii) facilitates
sales that are deemed necessary by supervisory agencies to revive
troubled creditors and resolve failed creditors. A balloon-payment
qualified mortgage under Sec. 1026.43(f)(1) retains its qualified
mortgage status if it is sold, assigned, or otherwise transferred to
another person pursuant to: (1) A capital restoration plan or other
action under 12 U.S.C. 1831o; (2) the actions or instructions of any
person acting as conservator, receiver, or bankruptcy trustee; (3)
an order of a State or Federal government agency with jurisdiction
to examine the creditor pursuant to State or Federal law; or (4) an
agreement between the creditor and such an agency. A balloon-payment
qualified mortgage under Sec. 1026.43(f)(1) that is sold, assigned,
or otherwise transferred under these circumstances retains its
qualified mortgage status regardless of how long after consummation
it is sold and regardless of the size or other characteristics of
the transferee. Section 1026.43(f)(2)(iii) does not apply to
transfers done to comply with a generally applicable regulation with
future effect designed to implement, interpret, or prescribe law or
policy in the absence of a specific order by or a specific agreement
with a governmental agency described in Sec. 1026.43(f)(2)(iii)
directing the sale of one or more qualified mortgages under Sec.
1026.43(f)(1) held by the creditor or one of the other circumstances
listed in Sec. 1026.43(f)(2)(iii). For example, a balloon-payment
qualified mortgage under Sec. 1026.43(f)(1) that is sold pursuant
to a capital restoration plan under 12 U.S.C. 1831o would retain its
status as a qualified mortgage following the sale. However, if the
creditor simply chose to sell the same qualified mortgage as one way
to comply with general regulatory capital requirements in the
absence of supervisory action or agreement it would lose its status
as a qualified mortgage following the sale unless it qualifies under
another definition of qualified mortgage.
Paragraph 43(f)(2)(iv).
1. Mergers and acquisitions. A qualified mortgage under Sec.
1026.43(f)(1) retains its qualified mortgage status if a creditor
merges with, is acquired by another person, or acquires another
person regardless of whether the creditor or its successor is
eligible to originate new balloon-payment qualified mortgages under
Sec. 1026.43(f)(1) after the merger or acquisition. However, the
creditor or its successor can originate new balloon-payment
qualified mortgages under Sec. 1026.43(f)(1) only if it complies
with all of the requirements of Sec. 1026.43(f)(1) after the merger
or acquisition. For example, assume a small creditor that originates
250 first-lien covered transactions each year and originates
balloon-payment qualified mortgages under Sec. 1026.43(f)(1) is
acquired by a larger creditor that originates 10,000 first-lien
covered transactions each year. Following the acquisition, the small
creditor would no longer be able to originate balloon-payment
qualified mortgages because, together with its affiliates, it would
originate more than 500 first-lien covered transactions each year.
However, the balloon-payment qualified mortgages originated by the
small creditor before the acquisition would retain their qualified
mortgage status.
43(g) Prepayment penalties.
43(g)(2) Limits on prepayment penalties.
1. Maximum period and amount. Section 1026.43(g)(2) establishes
the maximum period during which a prepayment penalty may be imposed
and the maximum amount of the prepayment penalty. A covered
transaction may include a prepayment penalty that may be imposed
during a shorter period or in a lower amount than provided under
Sec. 1026.43(g)(2). For example, a covered transaction may include
a prepayment penalty that may be imposed for two years after
consummation and that equals 1 percent of the amount prepaid in each
of those two years.
43(g)(3) Alternative offer required.
Paragraph 43(g)(3)(i).
1. Same type of interest rate. Under Sec. 1026.43(g)(3)(i), if
a creditor offers a consumer a covered transaction with a prepayment
penalty, the creditor must offer the consumer an alternative covered
transaction without a prepayment penalty and with an annual
percentage rate that cannot increase after consummation. Under Sec.
1026.43(g)(3)(i), if the covered transaction with a prepayment
penalty is a fixed-rate mortgage, as defined in Sec.
1026.18(s)(7)(iii), then the alternative covered transaction without
a prepayment penalty must also be a fixed-rate mortgage. Likewise,
if the covered transaction with a prepayment penalty is a step-rate
mortgage, as defined in Sec. 1026.18(s)(7)(ii), then the
alternative covered transaction without a prepayment penalty must
also be a step-rate mortgage.
Paragraph 43(g)(3)(iv).
1. Points and fees. Whether or not an alternative covered
transaction without a prepayment penalty satisfies the points and
fees conditions for a qualified mortgage is determined based on the
information known to the creditor at the time the creditor offers
the consumer the transaction. At the time a creditor offers a
consumer an alternative covered transaction without a prepayment
penalty under Sec. 1026.43(g)(3), the creditor may know the amount
of some, but not all, of the points and fees that will be charged
for the transaction. For example, a creditor may not know that a
consumer intends to buy single-premium credit unemployment
insurance, which would be included in the points and fees for the
covered transaction. The points and fees condition under Sec.
1026.43(g)(3)(iv) is satisfied if a creditor reasonably believes,
based on information known to the creditor at the time the offer is
made, that the amount of points and fees to be charged for an
alternative covered transaction without a prepayment penalty will be
less than or equal to the amount of points and fees allowed for a
qualified mortgage under Sec. 1026.43(e)(2)(iii).
Paragraph 43(g)(3)(v).
1. Transactions for which the consumer likely qualifies. Under
Sec. 1026.43(g)(3)(v), the alternative covered transaction without
a prepayment penalty the creditor must offer under Sec.
1026.43(g)(3) must be a transaction for which the creditor has a
good faith belief the consumer likely qualifies. For example, assume
the creditor has a good faith belief the consumer can afford monthly
payments of up to $800. If the creditor offers the consumer a fixed-
rate mortgage with a prepayment penalty for which monthly payments
are $700 and an alternative covered transaction without a prepayment
penalty for which monthly payments are $900, the requirements of
Sec. 1026.43(g)(3)(v) are not met. The creditor's belief that the
consumer likely qualifies for the covered transaction without a
prepayment penalty should be based on the information known to the
creditor at the time the creditor offers the transaction. In making
this determination, the creditor may rely on information provided by
the consumer, even if the information subsequently is determined to
be inaccurate.
43(g)(4) Offer through a mortgage broker.
1. Rate sheet. Under Sec. 1026.43(g)(4), where the creditor
offers covered transactions with a prepayment penalty to consumers
through a mortgage broker, as defined in Sec. 1026.36(a)(2), the
creditor must present the mortgage broker an alternative covered
transaction that satisfies the requirements of Sec. 1026.43(g)(3).
Creditors may comply with this requirement by providing a rate sheet
to the mortgage broker that states the terms of such an alternative
covered transaction without a prepayment penalty.
2. Alternative to creditor's offer. Section 1026.43(g)(4)(ii)
requires that the creditor provide, by agreement, for the mortgage
broker to present the consumer an alternative covered transaction
that satisfies the requirements of Sec. 1026.43(g)(3) offered by
either the creditor or by another creditor, if the other creditor
offers a covered transaction with a lower interest rate or a lower
total dollar amount of discount points and origination points or
fees. The agreement may provide for the mortgage broker to present
both the creditor's covered transaction and an alternative covered
transaction offered by another creditor with a lower interest rate
or a lower total dollar amount of origination discount points and
points or fees. See comment 36(e)(3)-3 for guidance in determining
which step-rate mortgage has a lower interest rate.
3. Agreement. The creditor's agreement with a mortgage broker
for purposes of

[[Page 6620]]

Sec. 1026.43(g)(4) may be part of another agreement with the
mortgage broker, for example, a compensation agreement. Thus, the
creditor need not enter into a separate agreement with the mortgage
broker with respect to each covered transaction with a prepayment
penalty.
43(g)(5) Creditor that is a loan originator.
1. Loan originator. The definition of ``loan originator'' in
Sec. 1026.36(a)(1) applies for purposes of Sec. 1026.43(g)(5).
Thus, a loan originator includes any creditor that satisfies the
definition of loan originator but makes use of ``table-funding'' by
a third party. See comment 36(a)-1.i and ii.
2. Lower interest rate. Under Sec. 1026.43(g)(5), a creditor
that is a loan originator must present an alternative covered
transaction without a prepayment penalty that satisfies the
requirements of Sec. 1026.43(g)(3) offered by either the assignee
for the covered transaction or another person, if that other person
offers a transaction with a lower interest rate or a lower total
dollar amount of origination points or fees or discount points. See
comment 36(e)(3)-3 for guidance in determining which step-rate
mortgage has a lower interest rate.
43(h) Evasion; open-end credit.
1. Subject to closed-end credit rules. Where a creditor
documents a loan as open-end credit but the features and terms, or
other circumstances, demonstrate that the loan does not meet the
definition of open-end credit in Sec. 1026.2(a)(20), the loan is
subject to the rules for closed-end credit, including Sec. 1026.43.

Dated: January 10, 2013.
Richard Cordray,
Director, Bureau of Consumer Financial Protection.
[FR Doc. 2013-00736 Filed 1-16-13; 11:15 am]
BILLING CODE 4810-AM-P

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