mortgage lending and hoepa - american bankers association

What the New Rules on

Mortgage Lendingand HOEPA

Mean to Your Bank

1-800-BANKERS

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ABA MEMBERS ONLY

ABAW rkson Regulation Z

ABAWorks on Mortgage ReformIn July, 2008, the Federal Reserve amended Regulation Z, which implements the Truth in Lending Act and the HomeOwnership Equity Protection Act. The effective date is October 2009, except for the early disclosure provisions, which mustbe implemented by July 2009. In addition to new regulations that apply to all mortgage loans in areas such as appraisals,servicing, disclosure, and advertising, the new regulation also creates a new subset of loans considered to be “higher-pricedmortgage loans.” For many banks, this definition will include subprime loans as well as some loans previously considered to beprime loans.

This ABAWorks is designed to help you better understand and make decisions about whether and how to offer “higher-pricedmortgage loans” and to help you reorganize your compliance framework to take into account the new requirements that applyto all mortgages.

Who Should Read This ABAWorks?ABAWorks on Mortgage Reform is designed to help bank presidents, CEOs and chief compliance officers understand the scopeof the guidance and how to reorganize your compliance framework to ensure compliance with the new regulation. Any bankthat offers residential mortgages of all types — both prime and subprime — should read this ABAWorks. Besides seniormanagement, the guidance also focuses on the role of the Board of Directors, and we encourage you to use sections of thisABAWorks to advise your directors about ways they might be affected by the new regulations. ABAWorks is not a legal treatise,and you should always consult your bank’s counsel about any questions you have concerning the law.

How is This ABAWorks Organized?There are five sections to this ABAWorks. The first section presents a snapshot of the regulation and presents the case that allbanks should review these new regulations, even if they don’t currently make subprime loans. Because the new definition of“higher priced mortgage loans” picks up some prime loans, it’s critical to ascertain whether the mortgage loans you make arecovered under the regulation. The second section reviews the evolution of less-than-prime lending and why the FederalReserve Board determined it was necessary to implement new regulations regarding mortgage lending. The third section coversthe new category of “higher-priced mortgage loans.” This section includes a detailed definition of that loan category and adescription of all of the compliance issues associated with it. The fourth section covers the new regulations that will now beapplied to all mortgage lending, regardless of rate. The fifth section contains a framework and checklists to guide bank effortsto comply with the new rules.

The American Bankers Association brings together banks of all sizes and charters into one association. ABA works to enhance the competitiveness of the nation’s banking industry and strengthen America’s economy and communities. Its members — the majority of which are banks with less than $125 millionin assets — represent over 95 percent of the industry’s $13.6 trillion in assets and employ over two million men and women.

© 2009 American Bankers Association, Washington, D.C.

This publication was paid for in part with the dues of ABA member financial institutions and is intended solely for their use. Please call 1-800-BANKERS if you have any questions about this resource, ABA membership or would like to copy or license any part of this publication.

This publication is designed to provide accurate information on the subject addressed. It is provided with the understanding that neither the authors, contributors nor the publisher is engaged in rendering legal, accounting or other expert or professional services. If legal or other expert assistance is required,the services of a competent professional should be sought. This guide in no way intends or effectuates a restraint of trade or other illegal concerted action.

BANKER ADVISORS & REVIEWERS

C. AngelottiExecutive AssistantInsignia BankSarasota, FL

Tracy R. ArmstrongVice President - Lending ComplianceManagerGuaranty BankAustin, TX

Paul G. Balaschak, CMBVice President, Lending Compliance,CRA OfficerFirst Federal Bank of CaliforniaLos Angeles, CA

Howard T. Boyle IIPresident & CEOHome Savings BankKent, OH

Brian BrandtVice President - ComplianceGuaranty BankAustin, TX

Charles G. Brown IIIChairman & CEOInsignia BankSarasota, FL

Dennis CardelloPresident & CEOCollinsville Savings SocietyCanton, CT

William Grant Chairman & CEOFirst United Bank & TrustOakland, MD

Richard T. NadolskiSenior Vice PresidentNorth Shore BankBrookfield, WI

Larry S. KesselTrust Vice President and Loan OfficerFirst United Bank & TrustOakland, MD

Kenneth WitteVice President & DirectorFirst United Bank & TrustOakland, MD

ABA STAFF CONTRIBUTORS

Jim ChessenChief Economist

Susan EinfaltSenior Designer

Mako ParkerSenior Program Manager

Ellen CollierManager

Deanne MariñoWriter/Policy Analyst

Rod AlbaVP & Senior Regulatory Counsel

Richard RieseSVP, Center for Regulatory Compliance

Mark TenhundfeldSVP, Regulatory Policy

Ginny O’NeillSenior Counsel I

Rachaell DavisSenior Program Assistant

Ryan ZagoneSenior Research Assistant

Bob DavisExecutive Vice President

CONSULTANTS

Jeffrey P. NaimonPartnerBuckley Kolar, LLPWashington, DC

Thomas Pinkowish PresidentCommunity Lending Associates, LLCEssex, CT

Suzanne GarwoodAssociate Venable LLPWashington, DC

Special thanks to Krista Shonk, who began this project at ABA before moving to a new position at Freddie Mac.

What the New Rules on MortgageLending and HOEPA Mean to Your Bank

SECTION ONE

Executive Summary 1

SECTION TWO

The Evolution of Less-Than-Prime Mortgage Lending 5

SECTION THREE

Higher-Priced Mortgage Loans (§ 226.32-226.35) 11

SECTION FOUR

Requirements Applicable to Mortgage Loans Regardless of Rate 29

SECTION FIVE

ADApT to Mortgage Reform: A Framework for Achieving Compliance 39

APPENDICES

Appendix A: Methodology for Determining Average Prime Offer Rates 53Appendix B: Functional Impact on Bank and Lending Areas 57

In the past few years, many mortgage loanswere extended that were poorly underwrittenor whose terms were inadequately disclosed ... The resulting costs have been felt not only byborrowers but also by entire communities ... The decline in the national housing market,which has been a major cause of the broaderslowdown in economic activity, was in turngreatly exacerbated by the collapse of subprime lending.

Federal Reserve Board Chairman Ben BernankeJuly 8, 2008

Requirements for Higher-Priced Mortgage Loans

Requirements for All Mortgage Loans

Lenders that make higher-priced loans arerequired to engage in an underwriting anddocumentation process that is more extensivethan was previously required by law.

Creditors must:

• Determine and verify a borrower’sability to repay the loan;

• Establish an escrow account forproperty taxes and homeownersinsurance; and

• Limit prepayment penalties incertain circumstances.

The new regulations that apply to allconsumer mortgage loans address:

• Appraisals;

• Loan servicing practices;

• Disclosure requirements; and

• Advertising practices.

AMERICAN BANKERS ASSOCIATION

September 2009 ABAWorks on Regulation Z

1

SECTION ONE

Executive SummaryABA is publishing this ABAWorks to inform bankers about important changes to the regulations thatgovern mortgage lending practices. In July 2008, the Federal Reserve amended Regulation Z, whichimplements the Truth in Lending Act and the Home Ownership Equity Protection Act (HOEPA). Acopy of the final rule is available at 73 Fed. Reg. 44522 (July 30, 2008). The effective dateof the regulation is October 2009, except the early disclosure provisions, which must beimplemented by July 2009. These regulatory changes are intended to address concernsabout lending, servicing, and advertising practices that occurred in the residential mortgagemarket. While some provisions of the new regulations are focused on a new category of“higher-priced mortgage loans,” other provisions apply to all closed-end loans secured bythe borrower’s dwelling. All bank functional areas will be affected by these new regulations.See Appendix B for a chart that illustrates this impact. In addition to improving consumerprotections for borrowers, the revised rules are intended to provide certainty to investors and,in turn, provide stability to mortgage and credit markets. The regulations do not apply tocommercial mortgage loans.

Overview of the New RegulationsThe new regulations are divided into two sections. The first section addresses a new subset ofmortgages called “higher-priced mortgage loans.” The second section applies to all closed-end mortgage loans.

Regulation Z

Effective Date:

October 2009

Early Disclosure

Provisions

Effective Date:

July 2009


ABAWorks on Regulation Z September 2009

2

Why Read This ABAWorks?

• You may make higher-priced loans even though you are not a subprime lender.

• The regulation may require changes to your loan policy.

• Non-compliance could be costly — violating the new requirements can subject lenders toadministrative action and litigation, including special damages and class action lawsuits.

• Utilize checklists provided to help comply with the regulation.

• Get examples of how to comply with new underwriting requirements.

• Gather tips for implementing an escrow system.

• Learn about new advertising and disclosure requirements.

• Make sure you don’t violate restrictions on prepayment penalties.

The Higher-Priced Loan Regulations Will Impact All Banks

In general, the new requirements for higher-priced loans were crafted to apply to all subprime loans,though the scope of the rule may be sufficiently broad to reach to some segments of the primemarket as well. That means that the new regulations may impact lenders that make only prime,conforming loans as well as subprime lenders. Thus, it will require all lenders to ascertain whetherany loan they make is covered by these requirements. Based on current market rates, there is someevidence that some prime products will be classified as higher-priced loans.

The penalties for non-compliance could be severe — including the possibility of both expensivebank-specific penalties and class action litigation. As a result, it is important that all lenders assesstheir current loan policies and practices to ensure they can identify all higher-priced loans that theyoriginate and to ensure that any such loans conform to the new regulatory requirements. Someinstitutions may elect not to make higher-priced loans in order to avoid potential legal andreputation risks associated with these kinds of loans. Institutions that elect not to make higher-pricedloans should consider implementing a monitoring system in order to flag any loans thatunintentionally cross the threshold for higher-priced loans and should ensure that such an electiondoes not inadvertently create or exacerbate fair lending or Community Reinvestment Act issues.

This ABAWorks summarizes the new regulations and provides practical information that will helpbanks to comply with the new requirements.



3

Snapshot of the New Mortgage Lending Regulations

Effective Date: October 1, 2009

Requirements for Higher-Priced Loans Requirements for All Mortgage Loans

• Repayment: Creditors must determineand verify a borrower’s ability to repaythe loan.

• Escrow: An escrow account for propertytaxes and homeowners insurance isrequired for at least the first 12 monthsof the loan.

• Prepayment Penalties: Prepaymentpenalties are limited in certaincircumstances.

• Structuring: A creditor may notstructure a higher-priced loan as an open-end loan to evade the regulation.

• Appraisals: Creditors and mortgagebrokers cannot coerce or improperlyinfluence appraisers to misrepresent thevalue of a home. In addition, a creditorcannot extend credit if it knows or hasreason to know that a broker has coercedan appraiser.

• Servicing:Loan servicers:– Must credit a payment to a borrower

on the date it is received.– Must provide a payoff-statement

within a reasonable time afterreceiving a request for suchinformation — typically five days.

– Are prohibited from “pyramiding”late fees.

• Advertising: Advertisements for closed-end and open-end mortgage credit mustinclude additional information aboutbuy-downs, variable and promotionalrate transactions, and balloon payments.Alternative disclosures are permitted fortelevision and radio advertisements.

• Early Disclosures/Early Fee Restriction:Creditors must provide a good faithestimate of loan costs within three daysafter a borrower applies for a closed-endmortgage loan that is secured by aborrower’s dwelling. Consumers cannotbe charged any fee until after they receivethe early disclosures, except a reasonablefee for obtaining a credit report. (Theseprovisions were amended by the Housingand Economic Recovery Act of 2008 andmust be implemented by July 2009. Seepage 35 for more information.)

In recent years, mortgage markets have seen aremarkable wave of financial innovation. … Butsome of these innovations also have negativeaspects … The Board is responding to theseproblems with proposed rules that were carefullycrafted with an eye toward deterring improperlending and advertising practices withoutunduly restricting mortgage credit availability.

Federal Reserve Board Chairman Ben BernankeDecember 18, 2007

The year 2008 will go down as one of the mostvolatile periods in history for financial markets.Economic growth has stopped and economiesaround the world are in recession. While manyfactors contributed to this collapse of confidence,the precipitating event was the bursting of thehouse price bubble that had been ballooning inmany areas of the U.S. and, indeed, around theglobe. No one could predict just how widespreadthe collapse of home prices would be felt — orthat it would reverberate throughout so much ofthe financial world.

Though amendments to Regulation Z weren’tcreated to address the economic collapse, theFederal reserve was looking to use its authorityunder the Truth in Lending Act and the HomeOwnership and Equity Protection Act to addresssome concerns that led to the house price bubbleand the accompanying overextension of credit thatensued. The Federal Reserve pointed to threeprimary areas of concern:

• Escalating mortgage delinquency and default rates for subprime and Alt-A (nearprime/nonconforming) mortgages;

• The loosening of underwriting standardsover the course of the real estate boom,especially among nondepository financialinstitutions; and

• Increased market imperfections, particularlymortgage product complexity, that made itharder for borrowers to protect themselves.

The United States mortgage industry, particularlysince the 1980s, has dramatically increased itsvolume and variety of products, greatly enhancingthe ability of individuals to become homeowners.

Upon the release of the final regulation, on July14, 2008, Chairman Ben Bernanke praised themortgage market’s “financial innovation” for theincreased capital allowed by a large secondarymarket and the widening access to credit thatcapital enabled. However, he also noted that theseinnovations have brought “negative aspects,” aswell. Particularly, he commented that, “[a]s themortgage market has become more segmentedand as risk has become more dispersed, marketdiscipline has in some cases broken down and theincentives to follow prudent lending procedureshave, at times, eroded.”

Of course, the events since last July when theregulation was released has demonstrated justhow dramatic the consequences can be. TheFederal Reserve did note that nondepositoryfinancial institutions were competingaggressively for market share, seeking clientswho may not have qualified for a mortgagepreviously. Many of these homebuyers werebarely able to make the initial mortgagepayment, as some lenders allowed inflatedincome estimates to pass through theunderwriting process. Such buyers were at ahigh risk of default when adjustable interestrates reset higher.

Another element to this mix, from theperspective of the Federal Reserve, were“market imperfections” that could “make itharder for consumers to protect themselvesfrom abusive or unaffordable loans, even withthe best disclosures.” The Federal Reserve haspointed to subprime products as particularlycomplex and difficult to compare betweenlenders, especially ones originated through amortgage broker. This complexity has made it

SECTION TWO

The Evolution of Less-Than-PrimeMortgage Lending

5AMERICAN BANKERS ASSOCIATION


“Developments in thehousing sector havebecome interlinkedwith the evolution of financial markets and the economy as a whole.”

Federal Reserve BoardChairman Ben Bernanke,December 4, 2008



6

[C]ertain practiceshave led too manypeople into homeownership thatthey cannot sustain.When this happens,especially when this happens in large or concentratednumbers, consumerssuffer, and their neighbors and communities suffer, as well …

Former Federal ReserveBoard Governor Randall S. Kroszner

Chart 1 Chart 2

Percent of Annual

Mortgage Originations

Yearly Mortgage OriginationsDollars in Trillions

Source: Inside Mortgage Finance, September 5, 2008 Source: Inside Mortgage Finance, September 5, 2008

difficult for borrowers to shop around. Whenthey did shop, consumers were offereddisclosures that were focused on too fewelements of the product — monthly paymentor initial (teaser) interest rate — rather than thewhole loan package, causing borrowers to“unwittingly accept loans that they [would]have difficulty repaying” [73 FR 1676].

Such complexity has also led to the FederalReserve’s view that disclosures alone cannottake care of these structural imperfections. Agrowing consensus emerged that borrowerslacked enough basic financial knowledge tounderstand the mortgage products, even withadequate disclosures, and thus had a need for“protection” rather than simply information.This section reviews the changes in themortgage markets that led to the rapidexpansion of less-than-prime lending, theloosening of underwriting criteria, and theregulatory philosophy underpinning thechanges in the regulations.

CHANGING MORTGAGE MARKETS

The prime and subprime mortgage marketshave undergone dramatic change this decadespurred by the low interest rate environment of2001-2005 and a desire for buyers to ride theappreciating values in the housing market.During this period, housing starts grew rapidly,

rising from a seasonally adjusted annual rate of1.6 million units following the 2001 recessionto a peak of 2.2 million units in February 2005.Refinancing also accelerated; homeowners wereanxious to extract equity via “cash-out”refinancing as home values appreciated.Less-qualified borrowers wishing to ride thiswave found non-traditional, “affordability”mortgage products to be a good option(see Charts 1 and 2). These loans wereattractive, because most borrowers believed thatthe rise in home values would enable them torefinance their loans well before the lower initialfixed rate period expired and the new — muchhigher — adjustable rate period began. Othernon-traditional and non-conforming loans,such as Alt-A mortgage loans, also expandedduring this time. The percentage and dollarvolume of sub-prime and Alt-A loanoriginations together actually exceeded primeloan originations in 2005 and 2006, beforesignificantly receding in 2007 and almostceasing entirely in 2008 to date.

As real estate markets cooled, however, bettingon rapidly rising home values proved to beimprudent; many borrowers were unable, orunwilling, either to make the higher paymentor to refinance, leading to defaults. Of course,neither the lender nor borrower benefits from aforeclosure. Homeowners face the loss ofaccumulated home equity, higher rates for



7

Underwriting standards loosened in largeparts of the mortgagemarket in recent years as lenders —particularly nondepository institutions, many ofwhich have sinceceased to exist —competed moreaggressively for market share.

Federal Register, Vol. 73,No. 6/ Wednesday, January 9, 2008 Pg 1674

Chart 3

Subprime Loans:

Structure and Underwriting of 2006 Vintage

Source: FDIC

other credit transactions, and reducedaccess to credit. Such foreclosures haveadded to the supply of homes for sale,overwhelming what little demand thatexists. As a consequence, sales of new andexisting homes have reached the lowestlevels since the housing recession of the early 1990s. And when foreclosures are clustered, they can injure entirecommunities by reducing property values in surrounding areas.

THE LOOSENING OF

UNDERWRITING STANDARDS

As home values drop, the consequences of poor underwriting are being felt:delinquencies, defaults and foreclosures haverisen rapidly and precipitated a collapse ofconfidence across financial markets. This wasparticularly pronounced in the subprimesector, where the frequent combination ofseveral riskier loan attributes — high loan-to-value ratio, payment shock on adjustable-ratemortgages, no verification of borrowerincome, and no escrow for taxes and insurance— increased the risk of default for subprimeloans originated in 2005 through early 2007.

The vast majority of subprime loans closedin 2006, at the very height of their

popularity, were adjustable rate loanstypically with a fixed teaser rate (below thecomparable risk-adjusted rate) and a two- orthree-year first reset (so-called 2/28s and3/27s). A majority, 56 percent, of suchloans were refinances, and almost half, 46percent, were either low- or no-doc loans(see Charts 3, 4 and 5).

Before the dramatic fall in home prices,borrowers were able to refinance out of these2/28s and 3/27s. With home values falling,this became impossible, and “paymentshock” became a well-worn term. Withstated income often inflated by borrowers,the burden of these payment increases wouldbe much heavier. Even though the reductionin interest rates by the Federal Reservehelped to close the gap between the initialand reset rates, defaults have continued. Infact, about one-third of all the adjustablerate subprime loans were in default beforethe first reset, indicating that borrowers were unable to meet their obligations almost from the start. Moreover,prepayment penalty clauses, which weretypical of most subprime loans, made itharder for borrowers to refinance.

Loose underwriting was not limited to thesubprime market. Interest-only mortgages(most of them with adjustable rates)

Purchase vs. Refinance



8

A decline in underwriting standards does notjust increase the riskthat borrowers will be provided loans they cannot repay. It also increases the risk that originatorswill engage in abusive tactics.

Chart 4 Chart 5

Alt-A Loans:

Structure and Underwriting of 2006 Vintage

Underwriting Performance Ratios

Source: FDIC Source: FDIC

accounted for 43 percent of all Alt-A loans closedduring 2006. Thirty-five percent of such loanscarried negative amortization and 83 percentwere low- or no-doc. While the resets of the 2/28s and 3/27s have most likely peaked, most of the Alt-A mortgages have not. These will startto increase this year to levels similar to thesubprime market.

It is too soon to tell how these Alt-A loans will perform, as the reset period is typicallyfive years. However, many Alt-A loans hadnegative amortization features and havealready reached the maximum adjustment,triggering an early reset. The failures ofIndyMac and the problems suffered byWashington Mutual and Wachovia show how devastating the fallout from these non-traditional loans can be.

The market for subprime and Alt-A mortgageloans has practically disappeared, while themarket for conventional/conforming loanscontinues to rebound (see Charts 6 and 7).Nonetheless, delinquencies and foreclosureinitiations in subprime ARMs are expected to rise further as more of these mortgages seetheir rates and payments reset at significantlyhigher levels. Home price declines, which have exceeded 30 percent from last year in the largest 20 metropolitan markets, havedestroyed homeowners’ equity (which in

many cases was small to begin with) and willcontinue to create problems for repayment of these mortgages.

REGULATION REQUIRED TO PREVENT ABUSIVEAND UNAFFORDABLE LOANS

Underpinning the rulemaking is thephilosophy that “market imperfections” orother “structural factors” make regulationsnecessary to prevent a recurrence of theproblems. Thus, the natural adjustment ofunderwriting standards and repricing of riskthat is occurring — and which isacknowledged by the Federal Reserve to beproceeding rapidly — is not enough toovercome all the problems that could lead toabusive and unaffordable loans. The factorsnoted by the Federal Reserve include: (1)limited transparency and limits of disclosure;(2) limited ability of borrowers to effectivelyshop around and compare offers; (3) thetendency on the part of borrowers to focusonly on a few loan attributes to the exclusionof others; (4) limits of disclosures to protectborrowers from unfair loan terms or lendingpractices; and (5) misaligned incentives andobstacles to monitoring inherent in the“originate-to-distribute” model. The followingbriefly reviews the philosophy underlying each factor:

100%

80%

60%

40%

20%

0%



9

While the cost of continuing to shop is likely obvious, the benefit may not beclear or may appearquite small.

A borrower’s focus on the initial monthlypayment during a complex subprimemortgage transactioncan greatly increasehis or her risk.

Chart 6 Chart 7

Quarterly Mortgage OriginationsPercent of Annual Mortgage Originations

Changes in Residential Real Estate

Underwriting StandardsPercent of Responses

Source: Inside Mortgage Finance, September 5, 2008 Source: OCC

Limited Transparency and Limits of DisclosureThe Federal Reserve argues that thecombination of complex products and lack ofcomparable pricing information makes it“harder for consumers to protect themselvesfrom abusive or unaffordable loans, even withthe best disclosures.” Such an outcome is“often compounded by misleading orinaccurate advertising,” which often focuses on“easy approval and low payments.” The FederalReserve cites as examples of complexity the useof adjustable rate loan products, whichaccounted for nearly three-quarters of allsubprime originations and which were oftenaccompanied by prepayment penalties.

The Federal Reserve also noted that the role ofmortgage brokers — which accounted for asmuch as 60 percent of all originations — isoften misunderstood. Many borrowers, theFederal Reserve posits, believe withoutquestion that the broker is working in theirbest interest to find the best interest rate andmost suitable loan terms available. Inparticular, the Federal Reserve stated that“consumers are often unaware that a creditorpays a broker more to originate a loan with a rate higher than the rate the borrower qualifies for based on the creditor’sunderwriting criteria.”

Limited Ability of Borrowers to Shop Around and Compare OffersThe Federal Reserve expresses the concern thatsubprime borrowers may not shop beyond thefirst approval and, thus, may be willing toaccept unfavorable terms. This is more likely inthis market as borrowers have often been turneddown by several lenders before being approved.Thus, once approved, there is little advantage tocontinuing to shop. Plus, the Federal Reservenotes that “the costs of further shopping may besignificant, including completing anotherapplication form and paying yet anotherapplication fee.” Finally, the Federal Reservecommented that: “An unscrupulous originatormay also seek to discourage a borrower fromshopping by intentionally understating the costof an offered loan.”

Limited Focus of Borrowers on Only a Few Characteristics of the LoanWith complex loans, borrowers may choose tofocus on a few attributes of the product orservice that seem most important, or whichhave the most obvious and immediateconsequence, e.g., loan amount, downpayment, initial monthly payment, initialinterest rate, and up-front fees. As aconsequence, other features — future increasesin payment amounts or interest rates,prepayment penalties, negative amortization,income verification, and escrows for future tax



10

Obtaining widespread customer under-standing of the many potentially significantfeatures of a typicalsubprime product is a major challenge.

Weak underwritingstandards, the FederalReserve noted,increases the risk that “originators willengage in an abusive strategy of‘flipping’ borrowers in a succession ofrefinancing” that ultimately “strip borrowers’ equity and provide them nobenefit. Moreover, the Federal Reservenoted that an atmosphere of relaxedstandards may attractless scrupulous originators and morevulnerable borrowersinto the market whichwould lead borrowersto pay more for loans than their riskprofiles warrant.

and insurance obligations — may be ignored.Thus, the Federal Reserve concludes:“consumers may unwittingly accept loans thatthey will have difficulty repaying.”

Disclosures May Not Sufficiently ProtectBorrowers from Unfair Loan TermsWhile acknowledging that disclosuresdescribing the multiplicity of features of acomplex loan “could help some consumers inthe subprime market,” the Federal Reserve notesthat “disclosures may not be sufficient to protectthem against unfair loan terms or lendingpractices.” Moreover, the Federal Reserve statesthat “even if all of a loan’s features are disclosedclearly to consumers, they may continue tofocus on a few features that appear mostsignificant. Alternatively, disclosing all featuresmay ‘overload’ consumers and make it moredifficult for them to discern which features aremost important.”

Furthermore, the Federal Reserve notesdisclosures cannot be effective unless there is acertain minimum level of understanding of themarkets and products by the borrower andcomments that: “Disclosures themselves likelycannot provide this minimum understanding fortransactions that are complex and thatconsumers engage in infrequently.” Due to thelack of knowledge, borrowers may rely more ontheir originators to explain the disclosures whenthe transaction is complex and “some originatorsmay have incentives to misrepresent thedisclosures so as to obscure the transaction’s risksto the borrower.” Such a misrepresentation ismore likely if the originator is face-to-face withthe customer.

Misaligned Incentives and Obstacles to MonitoringIn justifying the changes in regulations, theFederal Reserve also sets forth the concern thatincentives — particularly of originators thatintend only to sell the loan quickly — are notaligned with the interests of borrowers. TheFederal Reserve cites the recent dramatic rise inserious delinquencies on subprime mortgages asclear evidence that originators did not give“adequate attention to repayment ability” andhad little incentive to do so as the risk upon saletypically is passed to the purchaser and theoriginator bears little loss if the mortgagesdefaulted. The Federal Reserve also noted thatwarranties by sellers and other repurchase loanagreements have “little meaningful benefit if

originators have limited assets.” Finally, riskrises in cases where originator fees are related toloan volume, which encourages aggressive push-marketing strategies.

The Federal Reserve also believes that themonitoring of sellers by purchasers of loans isinadequate to impose sufficient discipline onthe originator to prevent abusive practices.Moreover, “investors may not exercise adequatedue diligence on mortgages in the pools inwhich they are invested, and may instead relyheavily on credit-ratings firms to determine thequality of the investment.”

The fragmentation of the originator market canfurther exacerbate the problem, according to theFederal Reserve. Thus, a securitized pool ofmortgages may have been the product of tens oflenders and thousands of brokers. The FederalReserve notes that: “Investors have limitedability to directly monitor these originators’activities. Similarly, a lender may receive ahandful of loans from each of hundreds orthousands of small brokers every year. A lenderhas limited ability or incentive to monitor everysmall brokerage’s operations and performance.”

A ROLE FOR NEW HOEPA RULES

Given the market imperfection, the FederalReserve concluded that borrowers in thesubprime market “face serious constraints on their ability to protect themselves from abusiveor unaffordable loans, even with the best disclosures; originators themselves may at timeslack sufficient market incentives to ensure loansthey sell are affordable; and regulators face limits on their ability to oversee a fragmentedsubprime origination market.” The conclusion isthat regulations are needed to ensure thatborrowers receive the mortgage loans they canafford to repay.

The ABA supports the Federal Reserve’s effortsto curb abusive mortgage lending practices andto provide increased transparency for borrowers.While ABA believes that its members are alreadyadhering to the loan origination, underwritingand servicing standards that protect mortgagecustomers and the bank, it is appropriate for theFederal Reserve to provide additional consumerprotections, and to apply that uniform standardto all financial firms that make mortgage loans,including non-federally regulated lenders.

SECTION THREE

Higher-Priced Mortgage Loans(§ 226.32-226.35)



11

The new amendments to Regulation Z providespecial consumer protections to a subset ofconsumer residential mortgages called “higher-priced mortgage loans.” While the rules forhigher-priced mortgages are intended to applyprimarily to loans that have historically beencategorized as subprime, the definition of“higher-priced mortgage loan” is based on theloan’s Annual Percentage Rate (APR) instead ofborrower credit or loan product characteristics.As a result, this new category is likely to includemany prime loans in certain markets, dependingon market conditions. The new rules requirethat lenders that make higher-priced loans mustengage in an underwriting and documentationprocess that is more extensive than was previouslyrequired by law. The new regulations requirecreditors to:

• Determine and document a borrower’sability to repay the loan;

• Limit prepayment penalties in certaincircumstances; and

• Establish an escrow account for propertytaxes and homeowners’ insurance.

Most insured depository institutions have time-tested lending standards that substantiallycomply with many of the new requirements forhigher-priced loans. Nevertheless, banks of allsizes and levels of complexity — includingprime-only lenders — should review their loanpolicies and underwriting standards todetermine whether any changes are necessary in

order to fully comply with the consumer protectionrequirements for higher-pricedloans. As explained in greaterdetail below, some prime loansmay be classified as higher-pricedloans even though the newrequirements are intended to applyto only subprime loans.

Rationale Behind the New Rule

The Federal Reserve goal in issuingthe new rule was to protect vulnerableborrowers from lending practices they consider unfair.

Subprime Lending Not Prohibited

Subprime lending can include borrowers whohave little or no credit history or have weakenedcredit histories as a result of late payments,charge-offs, judgments, and bankruptcies. It can also include borrowers with fewer assetsnecessary to make a downpayment or withundocumented income or higher debt-to-income ratios. However, the Federal Reservebelieves that when underwritten correctly,subprime mortgage credit can be beneficial tosome borrowers. For this reason, the changes toRegulation Z do not ban all subprime lending.

Some prime loans may be classified ashigher-priced loanseven though the newrequirements aredesigned to regulatesubprime loans.

Regulation Z

Effective Date:

October 2009

Early Disclosure

Provisions

Effective Date:

July 2009

Focus on Price, Not Products

The regulation identifies subprime loans on thebasis of loan price (discussed fully later in thissection) rather than borrower characteristics orspecific loan products or terms. The FederalReserve reasoned that focusing solely on loanswith particular features may not capture all of theloans in the subprime market. In addition, theFederal Reserve believes that identifyingsubprime loans on the basis of price is morelikely to remain relevant over time as creditorsintroduce new products into the marketplace andas lending practices change.

Rule Will Likely Apply to Some Prime Loans

While the new regulations for higher-pricedloans are intended to apply to subprime loans,the Federal Reserve noted that there is “inherentuncertainty” in crafting rules that cover thesubprime market but that generally exclude theprime market. In the end, the Federal Reserveopted to err on the side of being over-inclusiverather than under-inclusive. Depending onmarket conditions, the rules are likely to applyto the Alt-A market and to some primeproducts. For example, if the new rules were ineffect at the time of the publication of thisABAWorks, a substantial portion of the “JumboA” market would be considered higher-pricedmortgage loans. Therefore, it is important thatall banks examine all of their lending policiesand procedures to ensure that they comply withthe new regulations. Later in this section there isan in-depth discussion of the extent to which thenew regulations could extend to prime loans.

Parties Covered by the Higher-Priced Loan Regulation

Banks and savings associations have generallymaintained conservative and prudent mortgageunderwriting standards. They are heavilyregulated and examined regularly by thebanking regulatory agencies for compliancewith laws and regulations. Most of theseinstitutions and their employees are linked

closely to the communities in which they lendand, therefore, have very strong incentives tomake responsible, sustainable loans. This hasnot consistently been the case with mortgagebrokers and non-federally regulated lenders.

Non-bank lenders and brokers have not beensubject to the same lending requirements andregulatory oversight as federally-insureddepository institutions. To address this problem,the higher-priced loan regulations apply to“creditors,” which includes insured depositoryinstitutions as well as non-federally regulatedbanks and other lenders.1 Applying theregulation to all creditors is one step towardestablishing national standards that protectborrowers from practices the Federal Reserveconsiders abusive. However, the regulation onits own will not impose on non-bank lendersexactly the same standards.

In most cases, non-federally regulated lendersdo not undergo bank-like examination andsupervision and have marketed products that, insome cases, resulted in borrowers financinghomes that they could not afford over the long-term. Despite the progress made by theamendments to Regulation Z, policy-makersand regulators still have much work to do inorder to provide comparable supervision andenforcement for insured depository institutionsand non-bank financial firms. Under thecurrent regulatory and enforcement structure,non-bank lenders are unlikely to be examinedfor underwriting decisions and tend to be lesscomprehensively examined for compliance.Until there is a comparable enforcementprogram for all lenders, compliance obligationswill be uneven.

Similarly, policy-makers are still contemplatinghow to best regulate and oversee the actions ofmortgage brokers. Mortgage brokers have beena major conduit for home loans in recent years.Despite their significant role in the mortgagemarket, brokers are not “creditors” underRegulation Z and, therefore, are not directlysubject to most of the new requirements forhigher-priced loans. Brokers are, however,subject to the provisions prohibiting influencing



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The higher-priced loan regulations apply to “creditors,”which includesinsured depositoryinstitutions as well as non-banks and other lenders.

Brokers are not“creditors” underRegulation Z and,therefore, are notsubject to the newrequirements forhigher-priced loans.

1. 12 C.F.R. §226.35(b).

appraisals. As a result, banks are responsiblefor ensuring that broker-originated higher-priced loans comply with the regulation’sunderwriting, escrow, and prepaymentprovisions. Banks will need to monitor broker-generated loans closer than ever before toensure that these loans comply with regulatoryrequirements as well as with the bank’s ownpolicies regarding higher-priced loans.

What is a Higher-Priced Loan?

Whether a loan is classified as higher-priceddepends on two factors: the type of the loanand the price of the loan. Below is a detaileddiscussion of this two-part test for determiningwhether a loan is subject to the three newconsumer protection requirements that areapplicable to higher-priced mortgages.

Loan Type

The protections for higher-priced loans apply tofirst-lien and subordinate-lien closed-endmortgages that are secured by the borrower’sprincipal dwelling. In contrast to HOEPAloans, this includes home purchase loans as wellas refinancings that meet the pricing trigger(explained below) as long as the borrower’sprimary residence serves as the collateral forthose loans.2

The regulation does not apply to home equity lines of credit, reverse mortgages,3

construction-only loans, bridge loans, andloans having primarily a real estateinvestment purpose. Loans for the purchaseor the improvement of a second home willnot be considered higher-priced unless theloan for the second home was secured bythe borrower’s principal dwelling.4

In excluding some second homes and loanswith a real estate investment purpose from thedefinition of higher-priced loans, the FederalReserve reasoned that (1) real estate investorsare expected to be more sophisticated than

ordinary borrowers about the real estatefinancing process, and (2) applying the newregulations to real estate investments would beinconsistent with TILA’s focus on consumer-purpose transactions.

✲ COMPLIANCE ALERT

Construction-Only Loans

As noted above, construction-only loans that are solelyfor the purpose of financing the initial construction of adwelling are excluded from the requirements for higher-priced loans. However, the permanent financing that isput into place after construction is completed could be ahigher-priced loan depending on the price of the loanand the type of the loan.

In excluding construction-only loans, theFederal Reserve reasoned that these loans donot present the same risk of customer abuse asother loans that the rule covers. In addition,construction loans typically have a higherinterest rate than permanent financingreflecting higher relative risk of loss.

Discussions with ABA members have raisedquestions about how to treat constructionfinancing arrangements that do not separate theconstruction loan from the permanentfinancing for the home. Under these kinds ofarrangements, the interest rate during theconstruction period is higher than the interestrate for the remainder of the loan. Theborrower is given one TILA disclosure andthere is only one loan closing. Since thesearrangements are treated as one loan, the higherrate of interest that is charged during theconstruction period will increase the likelihoodthat these kinds of loans will exceed thethreshold for higher-priced loans. ABA willwork with the Federal Reserve to determinehow these financing arrangements should betreated for purposes of complying with therequirements for higher-priced loans.



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2. Id. at §226.35(a).3. Id. at §226.35(a)(2). 4. 73 FR 44538 (July 30, 2008).

The protections forhigher-priced loansapply to first-lien and subordinate-lienclosed-end mortgagesthat are secured by the borrower’sprincipal dwelling and exceed thehigher-priced loanthresholds.

The Federal Reserve isreviewing reversemortgage products inan initiative that isseparate from thisrulemaking in order todetermine whetheradditional consumerprotection measuresare necessary forthese kinds of loans.


Bridge Loans

Bridge loans are also excluded from the requirementsapplicable to higher-priced loans. The Federal Reservebelieves that this exemption is “in borrowers’ interestand support homeownership.”5

The Federal Reserve warns creditors againstattempting to circumvent the higher-pricedloan requirements by financing a series of short-term mortgage loans. For example, a 12-monthloan with a substantial balloon payment wouldnot qualify for the exemption where it wasclearly intended to lead a borrower to refinancerepeatedly into a chain of 12-month loans.

Loan Price

The APR of a loan is the second factor indetermining whether a loan triggers therequirements for higher-priced mortgages. Theregulation defines a higher-priced loan as aconsumer residential mortgage loan with anAPR of 150 basis points or more over the“average prime offer rate” for first liens and 350basis points or more over the average primeoffer rate for subordinate liens.6 This sectionexplains how the Federal Reserve will determinethe average prime offer rate and discusses theFederal Reserve’s rationale in adopting the APRpricing test for higher-priced loans.

Average Prime Offer Rate

The “average prime offer rate” is defined as anAPR “that is derived from average interest rates,points, and other pricing terms offered … by arepresentative sample of creditors for mortgagetransactions that have low-risk pricingcharacteristics.”7

The Federal Reserve will calculate the averageprime offer rate of different kinds of loans usingthe weekly Freddie Mac Primary MortgageMarket Survey (PMMS). Each week, FreddieMac surveys lenders about the rates and pointsfor their 30-year fixed-rate, 15-year fixed-rate,5/1 hybrid amortizing adjustable-rate, and 1-year amortizing adjustable rate mortgageproducts.8 The Federal Reserve will use thepricing terms from the PMMS, such as interestrate and points, in order to calculate an APR foreach of the four types of transactions that thePMMS reports.9 This APR will be the averageprime offer rate for the four products includedin the PMMS.

The Federal Reserve will publish these rates intwo tables, one each for variable-rate and non-variable-rate loans. The tables will set forthaverage prime offer rates for each of the 14products (six variable rate and eight non-variable-rate loans), and the methodologyprovides assignment rules for all other initial,fixed-rate periods or terms to maturity, asapplicable.10 In short, the site will carry a fullexplanation of how to identify a comparabletransaction (and therefore the average primeoffer rate), in the event an institution develops aloan product for which the Federal Reserve hasnot derived an average prime offer rate.



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5. One example of a temporary or a bridge loan is a loan to purchase a new dwelling where the consumer plans to sell a current dwelling within 12 months. The Federal Reserve noted that this is not the only potentialexample of a temporary or a bridge loan. 73 FR 44539 (July 30, 2008).

6. 12 C.F.R. §226.35(a).7. 12 C.F.R. §226.35(a)(2).8. The survey is based on first-lien prime conventional conforming mortgages

with a loan-to-value ratio of 80 percent. The adjustable-rate mortgage(ARM) products are indexed to constant-maturity U.S. Treasury rates andlenders are asked for both the initial coupon rate and points as well as the margin on the ARM products. Currently, 125 lenders are surveyed eachweek and the mix of lender types — thrifts, commercial banks and mort-gage lending companies — is roughly proportional to the level of mortgage business that each type commands nationwide. The survey is collectedfrom Monday through Wednesday and the results are posted on Thursdays.http://www.freddiemac.com/dlink/html/PMMS/display/PMMSOutputYr.jsp.

9. For multiple reasons, the Federal Reserve elected to use the PMMS as thebasis for calculating the average prime offer rate. First, the PMMS is the onlypublicly available data source that has rates for more than one kind of fixed-rate mortgage and more than one kind of variable-rate mortgage. Therefore, itprovides a firmer basis for estimating the rates for other fixed and variablerate products that are not included in this or other publicly available data.Second, the survey includes information that will allow for the calculation ofan APR rather than an average offered contract rate. This will make the rule’scoverage more accurate and consistent. 73 FR 44535 (July 30, 2008).

10. The preamble states that the indices’ methodology will remain on the Website along with the tables.

The Federal Reservewarns creditorsagainst attempting to circumvent thehigher-priced loanrequirements byfinancing a series of short-term mortgage loans.

Average Prime Offer Rate

The Federal Reserve will calculate theaverage prime offer rate of differentkinds of loans using the weekly FreddieMac Primary Mortgage Market Survey(PMMS). The full methodology isincluded as Appendix A.

ABA SUCCESS

The final rule adopts ABA’s recommendation that higher-priced mortgages should be based on an index that reflects loan pric-ing in the mortgage market. As originally proposed, the rule would have used Treasury securities as the benchmark for identi-fying higher-priced loans. ABA pointed out that relying on Treasuries would have resulted in a substantial portion of primeloans being classified as higher-priced loans and that an index that consistently tracks mortgage rates would be especiallyimportant when the yield curve is inverted. ABA specifically recommended the PMMS as a preferable alternative to usingTreasury securities as the basis for determining whether a loan is higher-priced.

AMERICAN BANKERS ASSOCIATIONSSeptemberSep


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“Two loans withidentical riskcharacteristics willlikely have differentAPRs if they wereoriginated whenmarket rates weredifferent. It isimportant to normalizethe APR by an indexthat moves withmortgage market rates so that loanswith the same riskcharacteristics will be treated the sameregardless of when the loans wereoriginated.”

73 FR 44533 (July 30, 2008).

Historical Interest Rate Comparison

Spread Between the 10-Year Treasuryand 30-Year PMMS Plus 150 B.P.

APR: Spread Over the Average Prime Offer Rate

A first-lien, closed-end mortgage loan with an APRof 150 basis points or more over the average primeoffer rate (350 basis points or more for subordinateliens) will be classified as a higher-priced loan. Afterconsulting loan data for subprime and Alt-Asecuritized pools for the period 2004 to 2007, theFederal Reserve believes that these benchmarks willcapture all of the subprime market and part of theAlt-A market.

When to Determine Whether a Loan isHigher-Priced

In order to determine whether a loan is higher-priced, a lender must compare the APR of theloan to the average prime offer rate as of thedate that the interest rate is locked beforeclosing (also known as the lock date). In theevent that a creditor sets the interest rateinitially and then resets it at a different levelbefore consummation, the creditor should usethe last date that the interest rate is set.11

Under the new rules, creditors must use themost recently available average prime offer rateas of the rate-lock date. Since PMMS figures areupdated weekly, the Federal Reserve will alsoupdate average prime offer rates weekly. This

will, in turn, require that lenders revise theirtrigger calculations on a weekly basis. TheFederal Reserve states that updates to the tablesmade each Friday will be effective the followingMonday.12

The Federal Reserve is not changing the currentmeaning of when the rate is “set” for purposesof defining the comparable APR. Thus, if aloan’s rate is subject to change for any reason,then it has not been “set” for the final timebefore closing. The final rules preserve theexisting “assignment rules” currently applicableunder HMDA, where (1) a loan with a termnot represented among the Treasury securityterms listed in the table matches to the Treasurysecurity with the term closest to the loan’s term,and (2) when a loan has a term exactly halfwaybetween two Treasury security terms it matchesto the Treasury security with the shorter of thetwo terms.


Higher-Priced Loan Determined by APR

The actual APR of a mortgage loan — that is, the APRat closing — will determine whether a loan is higher-priced. Lenders must compare this APR to the averageprime offer rate as of the date that the rate is locked.



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Lenders shouldmonitor loans that are between theapproval and theclosing process toensure that last-minute adjustments(i.e., customer opts to pay morepoints, broker feesincrease, etc.) do notinadvertently causethe loan to becomehigher-priced.

ABA SUCCESS

The ABA cautioned against creating separate definitions of higher-priced loans under Regulation Z and higher-cost loansunder Regulation C, which implements the Home Mortgage Disclosure Act (HMDA). Having separate definitions for nearlyidentical concepts pertaining to subprime mortgage loans would add complexity and regulatory burden without protectingborrowers or improving the stability of the mortgage market.

Consistent with the ABA’s recommendations, the Federal Reserve has proposed to conform the triggers for higher-cost loansunder Regulation C to the new triggers for higher-priced loans under Regulation Z. Under this approach, HMDA reportingwould be required for loans that have a spread of 150 basis points or more above the average prime offer rate forfirst liens and 350 basis points or more above the average prime offer rate for subordinate liens. Currently, Regulation Crequires lenders to report the spread between the APR on a loan and the yield on Treasury securities of comparable maturity ifthe spread meets or exceeds 300 basis points above Treasuries for a first-lien or 500 basis points for a subordinate-lien.

Aligning the definitions of “higher-priced” and “higher-cost” would reduce compliance complexities and would standardize themeanings of similar terms that are intended to identify subprime loans.

11. 73 FR 44537 and 44613 (July 30, 2008).12. For consistency’s sake, lenders may not apply new benchmarks before the Monday following publication, even if their systems are capable of applying the new

benchmarks earlier.

Lenders should monitor loans that are betweenthe approval and the closing process to ensurethat last-minute adjustments (e.g., customeropts to pay more points, broker fees increase,etc.) do not inadvertently cause the loan tobecome higher-priced. Banks that decide not tomake higher-priced loans due to the legal andreputation risks associated with these kinds ofloans should be especially vigilant about theeffect that last-minute changes have on theactual APR of a loan.

Practical Application: Some Prime Loans Higher-Priced

It is possible that some popular prime loanproducts will exceed the pricing threshold forhigher-priced loans.

Financial institutions commonly price a riskpremium into loan products based on manyfactors, including the amount of the loan, theamount of the borrower’s down payment, theterm of the loan, and whether the loan will beheld in portfolio. Risk-based pricing practicescommonly associated with popular creditproducts may cause some loans to becategorized as higher-priced even if they areprime loans that are made to prime borrowers.

ABA members should review all of theirmortgage lending policies and procedures inorder to: (1) ensure that they are in compliancewith the new regulation, and (2) to minimizepossible legal risk. Lenders should pay particularattention to the impact that the regulation willhave on the following prime mortgage products.

Jumbo Loans: The vast majority of jumboloans are made to low-risk borrowers withprime credit. However, these loans may exceedthe triggers for higher-priced loans. This isbecause jumbo loans typically carry higherinterest rates than conforming loans that areeligible to be purchased by Fannie Mae andFreddie Mac. The higher rate compensates theinvestment community for a lack of GSEguarantee. After pricing for this risk, however,jumbo mortgages have an increased likelihoodof being classified as higher-priced loans.

Historically, jumbo loans had interest rates thatwere 25 to 50 basis points higher than the ratefor conforming loans. However, recenttightening in the credit markets has resulted injumbo loan rates that are 100 to 125 basispoints higher than the rates charged onconforming loans.


Requirements in High-Cost Areas

Lenders in high-cost areas, such as Washington, D.C.,California, New York, and Florida where jumbomortgages are common should pay particular attentionto the new requirements for higher-priced mortgages. If the spread between conforming and jumbo loansremains wide when the rule takes effect in October2009, the regulation will cover a significant share oftransactions that would be prime jumbo loans. TheFederal Reserve declined to create a separatebenchmark for jumbo loans that would prevent theseprime loans from being classified as “higher priced.” The Federal Reserve reasoned that the pricing onjumbo loans may not always trigger the higher-pricedloan requirements in the future.

First Lien Home Equity Loans: Home equityloans that are first liens have an increasedlikelihood of being higher-priced loans underthe new requirements.13 First lien home equityloans have funding, origination costs, and loanterms that differ from other first mortgages(such as a home purchase loan), even thoughthey are in the same loan position and aresecured by the same collateral. Often, banksprice home equity loans on the assumption thatthey are second liens, so the pricing on a firstlien will not improve based on lien position.Home equity loans are fixed for a specific term,typically ranging from 60 to 360 months. Abank’s cost of funds for these loans can vary byover 200 basis points. Due to these pricingfactors, first lien home equity loans couldtrigger the requirements for higher-priced loanswhen market conditions are similar to thosethat we are experiencing at this time. In somecases, this leaves little room for an institution toprice for risk and make a profit withoutcrossing the proposed higher-priced threshold.



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13. A home equity loan can be in first lien position when the initial mortgage onthe property is paid in full.

Lenders in areaswhere jumbomortgages arecommon, such asWashington, D.C.,California, New York,and Florida, shouldpay particularattention to the newrequirements forhigher-pricedmortgages.

Zero Upfront Closing Costs: Loan productswith no upfront closing costs (such as loanapplication fees, title insurance costs, appraisalfees, or credit report fees) are a popular way for borrowers to reduce the initial costs associatedwith purchasing or refinancing a home. Lendersthat provide zero closing cost loans usuallycharge a higher rate of interest in order torecoup their origination costs on this product.These products can be very helpful to youngfamilies with good credit that are trying topurchase their first home. However, lendersshould be aware that loans with zero closingcosts (including no closing cost home equityloans) have an increased likelihood of exceedingthe pricing triggers for higher-priced loans.

Small Mortgage Loans: Small mortgage loansare another example of common prime loanproducts that may be categorized as higher-priced loans.

The cost of a home varies dramaticallydepending on where the property is located inthe United States. For example, ABA memberslocated in the nation’s mid-section and in partsof the southern U.S. report that they commonlyoriginate mortgage loans ranging between$50,000 and $75,000. In addition, many banks provide loans for the purchase of manufactured(mobile) homes. The cost of mobile homes canrange from several thousand dollars to over$15,000 or $20,000.

Small mortgage loans are commonly held inportfolio and often have pricing structures thatare different than other mortgage products. Forexample, lenders incur comparable costs fororiginating and servicing mortgage loans,regardless of the size of the loan, but institutionssometimes charge a higher rate of interest on asmaller loan in order to recover overhead costsand to ensure that the loan is profitable. Inaddition, pricing for small loans can be affectedby characteristics that are unique to thecollateral that secures the loan or by specificloan terms that may not be available for largermortgage loans. For instance, mobile homespose a higher risk to creditors as compared to

site-built homes due to the collateral’s tendencyto depreciate. As a result, these loans commonlycarry a higher interest rate than homes that arefixed to real property and may be more likely tobe classified as higher-priced mortgage loans.

Construction Loans: Banks should alsomonitor whether their lending policies andprocedures would cause the APR on aconstruction loan to trigger the requirements forhigher-priced loans. While construction-onlyloans are excluded from the requirements forhigher-priced loans, some banks finance theconstruction of a home without separating theconstruction financing and the permanentfinancing. As mentioned previously in thisABAWorks, there is concern that since thesearrangements are treated as one loan, the higherrate of interest during the construction period willincrease the likelihood that these kinds of loanswill exceed the threshold for higher-priced loans.

Loans with Private Mortgage Insurance: Inaddition, recent adjustments to the rates formortgage guarantee insurance will impact theprice of a home loan. Like the GSEs, privatemortgage insurance companies have adjustedtheir pricing structure in recent months in orderto protect against additional losses stemmingfrom the downturn in the housing market. Onaverage, mortgage insurance premiums haveadded 50 basis points to the cost of a loan. This amount can increase or decreasedepending on the borrower’s credit score andthe property’s loan-to-value ratio and theseamounts may change as mortgage insurersreassess their risk, including with respect todeclining collateral values.

Because premiums for private mortgageinsurance must be incorporated into APR andfinance charge disclosures, increasing premiumsfor private mortgage insurance will increase thelikelihood that prime mortgage loans would fall inadvertently into the higher-priced category.Mortgage insurance premiums will not bereflected in average prime offer rate because thePMMS surveys lenders on rates and fees forloans with an 80 percent loan-to-value ratio.



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Banks should discussthe new mortgagelending rules withtheir software vendorsas soon as possible.Banks should inquirewhat preparations thevendor is undertakingin order to help thebank flag higher-priced loans.



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Test for Whether a Loan is “Higher-Priced”

Loans Covered by Rule Loans That are Excluded from the Rule

This is a two-part test. If the answer toboth questions is “yes,” then the loanis a higher-priced loan.

Question #1: Loan Type. Is the loan aclosed-end consumer mortgage loan thatis secured by the borrower’s principaldwelling? Examples include:

• First-lien mortgage

• Subordinate-lien mortgage

• Home refinancing

• Home equity loans

• Second home secured by borrower’sprincipal dwelling

Question #2: Loan Price. Does the loanhave an APR that is 150 basis points ormore above the average prime offer ratefor first liens or 350 basis points or morefor subordinate liens?

• Home equity lines of credit

• Loans having primarily a real estateinvestment purpose

• Reverse mortgages

• Construction-only loans

• Bridge loans

• Commercial real estate mortgages

• Second mortgage secured by a secondhome or another investment property

Special ComplianceRequirements for Higher-Priced Loans

Higher-priced loans must meet three newcompliance requirements. Lenders must:

1. Determine a borrower’s ability to repaythe higher-priced loan based on verifiedincome and non-collateral assets;

2. Limit prepayment penalties in certaincircumstances;14 and

3. Establish an escrow account for taxesand insurance.

This section of the ABAWorks explains thesecompliance requirements as well as the litigationand reputation risks that could be associatedwith higher-priced loans. It also provides acompliance checklist as well as a list of factorsthat institutions may want to consider whendeciding whether to include higher-priced loansin their loan product mix.

Evaluate and Verify the Borrower’sAbility to Repay the Loan

Evaluating a borrower’s repayment ability is akey principle of safe and sound lending.However, all too often, loosely-regulated non-bank lenders and brokers appear to haveengaged in practices that resulted in borrowerstaking out loans that they did not understandand/or could not afford. In some cases,borrowers misrepresented their ability to repayunaffordable loans or whether they intended tooccupy the property as their principal residence.To address these problems, the new regulationspecifically requires creditors to evaluate andverify a borrower’s ability to repay a higher-priced mortgage loan.16

Repayment Ability

In determining a borrower’s ability to repay aloan, creditors are responsible for consideringfactors such as the borrower’s current andreasonably expected income, current andreasonably expected obligations, employment,and assets other than the collateral. In addition,creditors must verify the borrower’s repaymentability using third-party documents that“provide reasonably reliable evidence of theborrower’s income or assets.”17

Verification of income, assets, andemployment: The regulation provides broadflexibility and gives examples of the types ofincome, assets, and employment on which acreditor may rely when extending credit. Thecommentary to the regulation clarifies that acreditor may use information about current orexpected salary, wages, bonus pay, tips,commissions, interest or dividends, retirementbenefits, public assistance, alimony, childsupport, and assets held in a bank account whenevaluating a borrower’s ability to repay a loan.18

Lenders may use a variety of third-party sourcesto verify this information, including W-2s, taxforms, payroll receipts, check-cashing receipts,and remittance receipts. The documentationprovision is intended to be flexible. The onetype of verification that may not be used is astatement only from the borrower regarding theborrower’s assets and income.



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14. 12 C.F.R. §226.35(b).15. 73 FR 44532 (July 30, 2008).16. 12 C.F.R. 226.35(b)(1); 226.34(a)(4).17. 73 FR 44546 (July 30, 2008).18. Comment 6 to 12 C.F.R. 226.34(a)(4).

“The Board believes that the practices in §226.35 would prohibit — lending without regardto ability to pay from verified income and non-collateral assets, failure to establish an escrowfor taxes and insurance, and prepayment penalties outside of prescribed limits — are soclearly injurious on balance to consumers within the subprime market that they should becategorically barred in that market.”15

Previous regulatoryprovisions imposing“ability to repay”standards underHOEPA werestructured asprohibitions againstengaging in a“pattern andpractice” of makingunaffordable loans.

Under the new TILArequirements, aborrower does notneed to demonstratethat a violation ofthis standard is partof a “pattern orpractice.” A lenderwould violate thestandard based on a single instance of making anunaffordable loan.



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Employment Verification

Some lenders currently obtain a borrower’s writtenpermission to verify employment and income directlywith the borrower’s employer. These kinds of employerverifications are often verbal. At this stage, it is unclearwhether this practice would meet the income verificationrequirement for higher-priced loans. Verbal verification ofemployment is a well-established underwriting procedureand ABA will raise this potentially significant underwritingchange with the Federal Reserve. In the meantime,lenders that use this practice should prepare to makeadjustments to their income verification procedures.Because a “higher priced mortgage loan” borrower will beable to assert a violation of this underwriting requirementas a counterclaim for all finance charges from closinguntil the foreclosure action, most banks will seek to havewritten verifications in the loan file to ensure that they canprove the verification took place.

Ability to repay as of consummation:Lenders are responsible for assessing aborrower’s repayment ability based on facts andcircumstances that the lender is aware of on thedate of consummation. A lender will not bepresumed to have violated the ability to repayrequirement in the event that a borrowerdefaults because of significant expenses orincome loss after the loan is closed.19

Obligations: A creditor must consider theborrower’s current non-mortgage debt obligationsas well as non-principal and interest mortgage-related obligations (i.e., taxes and insurance).Lenders may use a credit report to verify currentobligations. However, a creditor is responsible forconsidering obligations that it knows about, evenif those obligations are not reflected on a creditreport. For example, a creditor that knows of a“piggy-back” second, (i.e., a loan that isundertaken at the same time as the primarymortgage transaction) must include it.


Unknown Subordinate Liens

Banks should request that both borrowers andsettlement agents certify to them that there is not a“piggy-back” second lien being obtained other than asfully disclosed to the bank.

Presumption of Compliance

A creditor is presumed to have complied withthe ability to repay requirement if it completesthe following underwriting procedures:

• Verify the borrower’s repayment ability(discussed above);

• Determine the borrower’s ability torepay using the largest payment sched-uled in the first seven years followingconsummation (taking into accountcurrent obligations); and

• Assessing the borrower’s repaymentability using either a debt-to-incomeratio (DTI) or the borrower’s residualincome after paying debt obligations.20

While the vast majority of insured depositoryinstitutions already comply with theseunderwriting requirements, lenders should notethat the Federal Reserve has stated that “thecreditor’s presumption of compliance forsatisfying these requirements is not conclusive.”In order to better document that it meets thepresumption, banks should consider whether to require the loan underwriter to certify at the time of loan approval that each of thosesteps has been completed, thus creating acontemporaneous business record of the actionsfor inclusion in the loan file. A borrower mayrebut the presumption of compliance withevidence that the creditor disregardedrepayment ability despite following these threesteps. As an example, the Federal Reserve statedthat “evidence of a very high debt-to-incomeratio and a very limited residual income couldbe sufficient to rebut the presumption,depending on all of the facts andcircumstances.”21

Lenders are required to comply with the firstunderwriting practice — verifying a borrower’sability to repay a higher-priced loan. However,the second and third practices — underwritingto the fully-indexed rate and evaluating acustomer’s DTI or residual income — areoptional. A lender that does not use the second

A lender that does notuse the second andthird underwritingcriteria —underwriting to thefully-indexed rate and evaluating aborrower’s DTI orresidual income —will not be deemed tohave violated theability to repayrequirement per se.

Rather, the lender willnot be presumed tohave met the ability torepay requirement. Inthis circumstance,whether a lender hasevaluated theborrower’s ability torepay the loan willdepend on the totalityof the facts andcircumstances.

Nevertheless, there isrisk that lenders whodo not qualify for thepresumption ofcompliance may find itdifficult to provecompliance otherwise.

19. 12 C.F.R. §226.34(a)(4) and Comment 5 to §226.34(a)(4).20. 12 C.F.R. §226.34(a)(4)(iii).21. Comment 1 to §226.34(a)(4)(iii).

and third underwriting criteria will not bedeemed to have violated the ability to repayrequirement per se. Rather, the lender will notbe presumed to have met the ability to repayrequirement. In this circumstance, whether alender has evaluated the borrower’s ability torepay the loan will depend on the totality of thefacts and circumstances. Nevertheless, there isrisk that lenders who do not qualify for thepresumption of compliance may find it difficultto prove compliance otherwise.

Repayment ability based on a fully indexedrate and fully amortizing payment: In orderto obtain a presumption of compliance with therule’s ability to repay requirement, a lendermust evaluate the borrower’s ability to repay avariable rate loan using the largest scheduledpayment of principal and interest in the firstseven years of the loan. A lender may elect touse a lower payment in its underwriting, butthe lender would not be presumed to complywith the repayment requirement.

Ratio of debt obligations: To have thepresumption of compliance, creditors mustfactor into the evaluation of the borrower’sability to repay the loan either (1) thecustomer’s DTI ratio or (2) the income that the borrower will have after paying debtobligations. While the rule requires creditors touse only one of these metrics in order to obtainthe presumption, banks may opt to use bothmeasures to predict repayment ability.

The final rule does not contain quantitativethresholds for either DTI or residual income. In declining to set acceptable benchmarks, theFederal Reserve noted that establishing specificdebt-to-income ratios or residual income levelscould limit the availability of credit withoutsubstantially benefitting borrowers. Someindustry participants agree that the FederalReserve should not be overly prescriptive ordiscourage new ideas and innovative thinking.Others, however, believe that the Federal Reserveshould establish specific parameters in order tominimize the legal risk for responsible lendersthat make higher-priced loans. Ironically, theFederal Reserve observed that “it is not clearwhat thresholds would be appropriate.”22


Affordability Standards

Banks seeking to limit their exposure might considersetting their DTI and residual income standards to be consistent with federal government affordabilitystandards embedded in the Federal HousingAdministration and Department of Veterans Affairs loanprograms and the FDIC’s loss mitigation program. Whilethe Federal Reserve has not created an express safeharbor for these standards, most experts expect thatfew courts would find an “ability to repay” violation for aloan that meets FHA, VA or FDIC standards foraffordability. It is less clear whether setting a bank’sstandards to be consistent with Fannie Mae or FreddieMac standards would give similar protection.



22

22. 73 FR 44550 (July 30, 2008).



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Limit Prepayment Penalties OnlyTo Specific Circumstances

In addition to ensuring that at-risk borrowersare able to repay their mortgage, the newregulations governing higher-priced loans areintended to limit certain prepayment penalties.

Prepayment penalties that are clearly disclosedcan benefit both borrowers and lenders.Consumers can benefit from receiving a lowerinterest rate or lower closing costs, while lenderscan benefit from increased predictability forloan duration.

The Federal Reserve believes that some productsin the mortgage market contained prepaymentpenalties that were not fair to borrowers. Forexample, some products effectively prohibitedcustomers from refinancing hybrid ARM loansthat had low teaser rates for an initial period(typically two or three years) but had asignificantly higher rate after the initial period.

The restrictions limited this ability of theborrower to refinance in anticipation of thereset. To address this practice, the amendmentsto Regulation Z impose the followingrestrictions on prepayment penalties:

• Prepayment penalties are prohibited onloans where payments can change dur-ing the first four years of a higher-priced loan.

• If payments cannot change for the firstfour years, the prepayment penalty ispermitted only for the first two yearsafter the loan is closed. This provisionprovides the borrower with a penalty-free window of two years before thepayment may increase. In addition, aprepayment penalty is permitted onlyif: (1) it is not otherwise prohibited byapplicable law, and (2) by its terms it isnot applicable if the source of the pre-payment funds is the same creditor orits affiliate.23

Are Prepayment Penalties Permissiblefor Higher-Priced Loans?

Loan Payments Prepayment Penalty

• Loan payments CAN change during first four years of the loan

• Loan payments CANNOT changeduring first four years of the loan

• Prepayment penalty prohibited

• Prepayment penalties allowed duringfirst two years only

• Prepayment penalty must be permittedby other law

• Prepayment penalty cannot apply ifthe funds for refinancing are providedby the same creditor or its affiliate

23. 12 C.F.R. §226.35(b)(2).

Establish an Escrow Account(§226.35(b)(3))

In many cases, subprime loans wereunderwritten solely on the basis of monthlymortgage payments but without respect toother costs of owning a home — includingannual property taxes and homeowners’insurance premiums.

To ensure that borrowers are able to pay their obligations associated with a mortgage,federally regulated financial institutions qualifyborrowers for a loan based on the principal andthe interest that must be paid on the loan, as wellas the taxes and insurance for the property. Thenew rules for higher-priced mortgages take thisunderwriting process a step further and makeescrow accounts mandatory for all first-lienhigher-priced mortgage loans.24 In fact, theFederal Reserve stated that it is unfair for a lenderto make a higher-priced mortgage loan withoutestablishing an escrow account for at least twelvemonths. The Federal Reserve recognizes thatsome borrowers prefer to manage their ownproperty taxes and insurance premiums, butbelieves that the benefit of the escrowrequirement for higher-priced borrowers willoutweigh the opportunity for some individuals topay taxes and insurance on their own or to gaininterest on funds that are otherwise escrowed.

A lender must escrow for property taxes,homeowners’ insurance, and other insurancecoverage that it requires a borrower to purchase.The escrow requirement does not apply tooptional insurance items that are chosen by theborrower and that are not otherwise required by the creditor.25


The Escrow Requirement

Some lenders do not escrow for jumbo loans or small-dollar mortgage loans. Banks that make these kinds ofloans will need to pay particular attention to whethertheir loan originations are higher-priced and whetherthey will need to comply with the escrow requirement.

Optional Cancellation After One Year

Banks may allow borrowers to opt out of the escrow account one year after theconsummation of the loan. Lenders are notrequired to allow higher-priced borrowers tocancel the escrow account; institutions thatprefer to continue the escrow after one yearmay require that their customers continue to doso if that requirement is consistent with otherapplicable law. Creditors that permit borrowersto cancel an escrow account must require theborrower to submit a dated, writtencancellation request.



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24. Unlike the other provisions applicable to higher-priced loans, escrows are not required for subordinate liens. 25. Comment 3 to 226.35(b)(3)(i).

ABA SUCCESS

The ABA cautioned the Federal Reserve that while federally regulated banks are already required to consider the ability of aborrower to pay property taxes and insurance when evaluating creditworthiness, not all lenders currently escrow due to thecosts and compliance requirements associated with these accounts. ABA pointed out that an escrow requirement wouldrequire major system and infrastructure changes by creditors that do not currently have escrow capabilities. As a result, theFederal Reserve is allowing additional time for lenders to conduct due diligence on vendors and software providers, imple-ment new systems and procedures, and to take other steps necessary in order to implement an escrow system.

The Federal Reserve extended the time to comply with the escrow requirements for higher-priced manufactured homesbecause manufactured homes are considered personal property in many jurisdictions and limited infrastructure is in place toescrow for these homes.



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Exemption: Cooperatives andCondominiums

Cooperatives: Creditors are not required toestablish escrows for property taxes andinsurance premiums for first-lien higher-pricedmortgage loans that are secured by shares in acooperative if the cooperative association paysproperty tax and insurance premiums.26 TheFederal Reserve reasoned that property taxesand insurance premiums are commonlyincluded in the monthly association dues,thereby making an escrow account unnecessary.

Condominiums: Similarly, the final ruleexempts homeowners’ insurance premiumsfrom the escrow requirements as long as thecondominium association pays for insurancethrough a master policy that covers individualcondominium units. However, lenders muststill establish escrow accounts for property taxbecause individual condominium owners paythe property tax for the unit.


Escrow Requirement Effective in 2010

The escrow requirement becomes effective in 2010,which is different from the effective date for all of theother provisions of the amendments. The specificeffective date for the escrow requirement depends onwhether the collateral for the loan is a site-built home or a manufactured home.

✢ Site-built homes. Escrows are required for loanapplications received on or after April 1, 2010.

✢ Manufactured homes. Escrows are required forloan applications received on or after October 1, 2010.


Evasion Through Open-End Credit(§226.35(b)(5))

Creditors are prohibited from structuring a closed-endtransaction as a home equity line of credit in order toavoid the compliance requirements for higher-pricedloans. The Federal Reserve stated that this provision“is intended to reach cases where creditors havestructured loans as open-end ‘revolving’ credit, evenif the features and terms or other circumstancesdemonstrate that the creditor had no reasonableexpectation of repeat transactions under a reusable line of credit.”27

26. A cooperative association typically owns the building, land, and improvements, and each unit owner holds a cooperative share loan based on the appraisal value ofthe shareholder’s unit. Creditors typically require cooperative associations to maintain insurance coverage under a single package policy, commonly called an associationmaster policy, for common elements, including fixtures, service equipment and common personal property. 73 FR 44561 (July 30, 2008).

27. 73 FR 44563 (July 30, 2008).



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Considerations When Establishing an Escrow ProgramNot all banks currently require borrowers to escrow for taxes and insurance. ABA membersfrom across the country offer the following tips for institutions that need to start an escrowprogram from scratch.

• Research the laws of the states in which you operate. Some states require credi-tors to pay interest to borrowers for escrowed funds. The final rule does not pre-empt these kinds of requirements. Lenders should research the laws of the states inwhich they operate to determine whether such laws are in place. In addition, somestates allow only one month of reserves to be escrowed, not two months, as desig-nated by the Real Estate Settlement Procedures Act (RESPA). Other states prohib-it requiring escrows when the loan-to-value ratio is low enough. While such a pro-hibition would be pre-empted for the first year when TILA requires the creditor toestablish an escrow account, once that requirement has expired, the underlyingstate law would then have to be considered.

• Consult the RESPA Rules. RESPA establishes rules for administering escrowaccounts, including how creditors handle initial and annual disclosures, initialescrow deposits, cushions, and advances to cover shortages, and adjustments to theaccount on a no-less-than-annual basis.

Section 10 of RESPA generally limits the amount of money a lender may requirethe borrower to hold in an escrow account for payment of taxes, insurance, etc.RESPA also governs the timing of disbursements from mortgage escrow accounts,and requires the lender/servicer to provide initial and annual escrow account state-ments. RESPA also establishes formal written complaint mechanisms to addressand resolve escrow-related problems and irregularities.

Through this general authority, HUD has issued a series of regulations that coverthe more important aspects of escrow management. Under Regulation X (24 CFRPart 3500.17) HUD establishes the definition of an escrow account, the accept-able accounting methods during the phase-in period, methods of escrow analysis,methods for calculating payments on assessments of longer than one year, yearlyescrow analysis methodologies, collections of deficiencies and shortages, escrowaccount statements and notifications of various types, among other things. HUD’sregulations on escrows constitute the most comprehensive set of rules applicable toescrow account servicing, and provide a virtual roadmap, with mathematical exam-ples and actual numbers, on how to administer such accounts.

• Don’t forget flood insurance. Lenders that escrow for taxes and homeowners insur-ance must also escrow for flood insurance if the property is located in a floodplain,thereby adding to the compliance burden that is associated with these accounts. TheNational Flood Insurance Program (NFIP) requires that flood insurance premiumsbe escrowed if the creditor requires escrow for other obligations such as hazard insur-ance.28 The NFIP requires banks to ensure that a building or manufactured homeand any applicable personal property securing a loan in a special flood hazard areaare covered by adequate flood insurance for the term of the loan.

(Continued)

28. Congress authorized the National Flood Insurance Program (NFIP) through the National Flood Insurance Act of 1968 (42 U.S.C. §4001), which provides propertyowners with an opportunity to purchase flood insurance protection made available by the federal government for buildings and their contents.



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Escrow Program Considerations, continued

• Budget realistically. Escrow operations are very difficult to implement due to thevarious laws and regulations that apply to these accounts. In addition, compliancerequirements mandated by RESPA can make it expensive for institutions to serviceescrow accounts. In calculating the costs of implementing an escrow system, banksshould consider whether additional staff are needed to manage the escrow process.Third-party servicing could be one way for small banks to minimize escrow costs.But ABA members report that it can be difficult to locate reputable escrow servicers.

• Don’t run short on time. Allow ample time to conduct vendor due diligence andpurchase new computer software to help manage the escrow program. One largeABA member recently established an escrow program for its subprime loans at acost of over $1 million, excluding ongoing staffing costs. This institution spentone year to hire a vendor and implement the program.



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Higher-Priced Loan Considerations

❏ Is your institution prepared to handle the additional requirements pertaining toHigher-Priced Mortgages, particularly the capacity to manage escrow accounts forproperty taxes and homeowners insurance?

❏ Does your bank perceive that there are reputation risks associated with doing businessin the Higher-Priced segment of mortgage lending?

❏ Is your institution prepared to develop the necessary processes to ensure that loansoriginated in the new Higher-Priced segment meet all fair lending requirements,consistent with laws and regulations?

❏ Has your regulator opined on making Higher-Priced loans, and has your bank fullyimplemented any additional guidelines that your regulator may impose on such loans?

❏ Does your institution consider that it needs to make Higher-Priced Loans in order tomeet CRA requirements, or otherwise meet the credit demands of their communities?

❏ Has your bank fully considered the legal consequences for non-compliance under thesenew rules, as described on page 36?

❏ Is lending in the Higher-Priced Loan segment consistent with your institution’smissions and objectives?

Deciding Whether to MakeHigher-Priced Loans

At a minimum, the new compliancerequirements and potential legal liabilitiesrequire all banks to evaluate their currentlending procedures. As a practical matter,institutions will have to determine whether to:(1) adjust its policies, procedures, and practicesto comply with the new requirements forhigher-priced loans (even if made on anoccasional basis), or (2) forego making higher-priced loans entirely. Banks will need to evaluate

whether the benefit — both to the bank and tothe community — of making higher-pricedmortgage loans outweighs the compliance,litigation, and reputation risks that could beassociated with such products.

While there is no one-size-fits-all method forevaluating the pros and cons of making higher-priced loans, the Advisory Group for thisABAWorks — composed of bankers from acrossthe country — helped compile the following listof factors and questions that banks may want toconsider when deciding whether to makehigher-priced mortgage loans.

The Federal Reserve’s new regulations do muchmore than give new protections to customerspurchasing higher-priced loans. Some of thenew regulations apply to closed-end mortgageloans secured by the borrower’s principaldwelling regardless of rate and cover three areasintended to prevent unfair practices:

• Appraisals,

• Loan servicing,

• Advertising, and

• Early disclosures.

Additionally, other new regulations apply to allmortgage loans (both open-end and closed-end)regardless of rate and are intended to preventunfair advertising practices. As with the newhigher-priced loans, most insured depositoryinstitutions have practices that substantially

comply with these new regulations.However, it is important that bankcompliance professionals review thenew regulations, comparing themwith current bank policy, to ensurethe bank is compliant in all areas. A failure to comply could give theborrower a right to set off all financecharges paid from inception to thetime of the foreclosure action; thus,the bank has to be prepared to prove its compliance with the new rule.

Unlike the federal bank regulators’guidance on non-traditional and subprimemortgage lending, these new rules, like RegulationZ generally, apply to the entire universe of“creditors” as defined by TILA and it extends toregulating loan-related practices generally, withinthe standards set forth in the statute.



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SECTION FOUR

Requirements Applicable toMortgage Loans Regardless of Rate

All lenders shouldreview their lendingpolicies and practicesto ensure that they arein compliance with the new regulationsgoverning appraisal,loan servicing andearly disclosures.

Authority for Broad ChangesThe Federal Reserve commented on its broad authority to regulate

Section 129(l)(2) is not limited to acts or practices by creditors, nor is it limited to loan termsor lending practices. See 15 U.S.C. 1639(l)(2). It authorizes protections against unfair ordeceptive practices when such practices are “in connection with mortgage loans,” and itauthorizes protections against abusive practices “in connection with refinancing of mortgageloans.” Thus, the Federal Reserve’s authority is not limited to regulating specific contractualterms of mortgage loan agreements.

Regulation Z

Effective Date:

October 2009

Early Disclosure

Provisions

Effective Date:

July 2009

Appraisals(§226.36(b))

Definition

The definition of an “appraiser” is broad andincludes not only the person carrying out theappraisal, but all of the people who employ,refer, or manage appraisers or the affiliates ofthe appraiser.

Despite the important function that accurateappraisals serve, there have been wide-spreadreports that some parties involved in the realestate process, most typically mortgage loanbrokers, attempted to improperly pressure orcoerce appraisers to overstate the value of aproperty that was for sale or that was beingrefinanced.

The Federal Reserve’s new rules expresslyprohibit creditors and mortgage brokers from coercing, influencing, or otherwiseencouraging an appraiser to provide a misstatedappraisal in connection with a mortgage loan.This is consistent with an appraiser’s obligationto perform assignments with impartiality,objectivity, and independence.

If the purpose of an appraisal is to ascertain anaccurate, independent, and unbiased opinion asto the value of a property, it seems obvious tosay that appraisers must not be coerced intooverstating the value of a property. But the rulegoes beyond “coercion” and also prohibitscreditors and brokers from “influencing” or“otherwise encouraging” a misstatement ofvalue. These terms are broad and sometimesvague, leading to uncertainties on the part oflenders that any contact with appraisers couldlead to charges of improper influence.

The Federal Reserve does not specificallydefine the terms “coerce, influence, orotherwise encourage.” Instead, the FederalReserve has provided some guidance regardingthe meaning of these terms through illustrativeexamples. These examples are extremelyimportant as they are the only directionprovided by the Federal Reserve that allowslenders to craft guidelines for lendingoperations. Additionally, bank examiners, law

enforcement officials and courts likely willlook to these illustrations as guidance indetermining whether a lender has coerced,influenced, or otherwise encouraged anappraiser to overstate the value of a property.

Creditors may not make a loan if they areaware that an appraiser has overstated thevalue of the property. Under the new standard,a lender would violate the regulation if itknows, at or before consummation, that anappraiser has overstated the value of theproperty due to coercion, influence, or otherencouragement. The Federal Reserve has alsowarned that lenders cannot avoid thisrequirement by willfully disregarding violations.Regulators no doubt will be specifically lookingfor some process or mechanism in place toguard against violations.

There are exceptions to this rule, however. Ifprohibited conduct has occurred, knowledge orsuspicion of a breach should not automaticallyrequire a lender to halt the transaction. Thelender may still extend credit if it acts with“reasonable diligence” to determine that theappraisal does not “materially misstate ormisrepresent” the value of the dwelling in question.



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From the Rule

The final rule states that “pressure” or“coercion” would include such actions as:

• Implying that retention of theappraiser depends on the amount atwhich the appraiser values theproperty.

• Failing to compensate or retain anappraiser in the future because theappraisal comes in too low.

• Conditioning compensation on theloan closing.

Creditors may notmake a loan if theyare aware that anappraiser hasoverstated the valueof the property.


Appraisal Influence

Banks may wish to identify a non-production bank officer(such as the CFO, head of audit, or General Counsel) towhom an appraiser is required to report any efforts toinfluence or coerce the appraiser with respect to anappraisal. When hiring the appraiser, the appraiserwould agree to make a report to the identified individual.Even though the current Fannie Mae Form 1004 alreadyincludes appraiser certifications to the effect that theappraiser arrived at the valuation in a professionalmanner and without undue influence, banks may seek toadd an additional documentary step when an appraisalis delivered that requires the appraiser to: (1)acknowledge that the bank is prohibited by law fromusing an appraisal that was performed under coercion orundue influence; (2) certify that either the appraisal meetsthe standard for lack of undue influence or the appraiserreported any coercion or efforts to unduly influence theappraisal; and (3) agree that the bank can rely on thecertification and the appraisal in making a loan.

Servicing (§226.36(c))

The new rules prohibit three specific servicingpractices: failure to credit consumers’ periodicpayments, late fee “pyramiding,” and failure toprovide timely payoff statements. These rulesare also noteworthy in two respects: (1) it isvery unusual for the Federal Reserve to use itsTILA authority to regulate the servicing aspectsof closed-end mortgage credit transactions; and(2) the fact that the rules apply to “servicers.” It is unclear how and whether TILA liabilitywould apply for a violation by a servicer whichwas not the original creditor on the loan.

Prompt Crediting

Generally, the new rule requires that a servicer credit payments as of the date thepayment is received. There are exceptions andsafe harbors included to accommodate anumber of potential situations, described indetail below:

Method and Timing The rule permits aservicer to record the payment on a date otherthan the date received — so long as the delay increditing does not result in a charge to the

borrower or a negative report to be made to aconsumer-reporting agency. This provision isincluded to accommodate grace periods allottedto borrowers as well as “monthly interest accrualmethods” employed by some servicers. Thismeans that banks must have procedures thateither ensure that all payments are processed onthe date they are received or create a record ofthe date the payment is received and proof thatthe borrower did not suffer as a result of thelater crediting to their account.

Payment Requirements The rule permitsservicers to specify in writing reasonablerequirements for making payments. Forexample, a servicer may:

• require that payments be accompaniedby the account number or paymentcoupon;

• set a cut-off hour for payment to bereceived, or set different hours for payment by mail and payments madein person;

• specify that only checks or moneyorders should be sent by mail;

• specify that payment is to be made inU.S. dollars; and

• specify one particular address forreceiving payments, such as a postoffice box.

The servicer is prohibited, however, fromrequiring payment solely by preauthorizedelectronic fund transfer.

If a consumer’s payment does not conform tothe servicer’s requirements, but the serviceraccepts the payment, it must be credited withinfive days of receipt. If the payment is non-conforming and the servicer does not accept it,there is no violation of the rule if the servicerreturns the payment.

Partial Payments The final rule provides thatcrediting or non-crediting of partial payments isgoverned by the legal obligation between thecreditor and borrower. If, under the terms ofthe contracts governing the loan, the requiredpayment includes principal, interest, and



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The servicer isprohibited fromrequiring paymentsolely by preauthorizedelectronic fundtransfer.

escrow payments, then servicers would not berequired to credit payments that include onlyprincipal and interest payments. Additionalrestrictions (discussed below) on fee pyramidingaddress other concerns about partial payments.

Pyramiding Late Fees

Pyramiding late fees occurs when a servicercharges a borrower a late fee if a paymentreceived does not include payment for aprevious late fee but includes all other paymentrequirements. This practice is alreadyimpermissible under current regulations thatapply to banks and savings associations.

Loan Payoff Statements

The final rule requires servicers to providepayoff statements to borrowers requesting apayoff statement within a “reasonable” timeperiod. The Federal Reserve’s guidance providesthat a five-day time period is a safe harbor for areasonable period, although a longer time framemay be deemed reasonable if a servicer isexperiencing an unusually high volume ofrefinancing requests. It is important to note thatif a third party requests a payoff statement for aborrower, the reasonable time frame is nottriggered until the servicer has had reasonableopportunity to verify the identity of personsacting on behalf of a borrower and to obtain theborrower’s authorization to release information.

Advertising Rules (§226.16, .17, .24)

The rules for open-end home equity plans focuson the clear and conspicuous standard and theadvertisement of promotional terms. These rulesalso implement provisions of the BankruptcyAbuse Prevention and Consumer Protection Actof 2005 requiring disclosure of the taximplications of certain home equity plans.

The rules for closed-end credit secured by adwelling, like the rules for open-end credit,apply the same “clear and conspicuous”standard and the same rules regardingadvertisement of promotional terms and rates.

Required changes in advertising rules for each ofthese types of loans are detailed separately below.

Open-End Home Equity Plans

Clear and Conspicuous Standard The finalrule establishes that advertisements for homeequity plans regarding promotional rates orother payment options must containdisclosures in close proximity to the triggeringterms. The rule does not set specificrequirements for the format of advertisements,but does deem that disclosures meet therequirements of the rule if they appearimmediately next to or directly above or belowthe trigger terms — in the same type size as thetrigger terms — without any intervening text orgraphical displays.

These requirements apply to all visual textadvertisements except for televisionadvertisements. Television advertisements thatcomply with recently amended rules underSection 226.16(c) are deemed compliant. Fororal disclosures (e.g., radio and televisionadvertisements), the new rule requires thatdisclosures be made in a speed and volumesufficient for a consumer to hear them and sothat they are intelligible for the consumer.Alternatively, the rule allows for use of toll-freetelephone numbers that consumers may call forthe disclosures in lieu of providing the disclosuresin radio and television advertisements.

For Internet advertisements, a linkaccompanying a triggering term, which takesthe consumer to the additional disclosures, isdeemed acceptable. The rule also requires thatdisclosures may not be obscured by graphicaldisplays, shading, coloration or other techniquesmaking them difficult to read. The disclosuresmust be displayed in a manner that makes themreadable, but an exception is made for thevarying sizes of screens, and the rule allows fordisclosures that would not be readable on ahandheld or portable television screen.

Discounted and Premium Rates To ensurethat consumers understand the true cost ofcredit, advertisements for variable rate homeequity plans must include the period of timethat the initial rate will be in effect and a“reasonably current” annual percentage rate thatwould have been in effect based upon the index



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Advertisements for home equityplans regardingpromotional rates or other paymentoptions mustcontain disclosuresin close proximity tothe triggering terms.

and margin used to determine future rateincreases. These additional terms are identifiedas being most important with respect toadvertisements that state a “promotional rate,”or rate not based on the index or margin thatwill be used to make rate or paymentadjustments. The additional terms mandatedunder this section must be stated with equalprominence and close proximity to thestatement of the promotional APR. The ruleprovides several safe harbors for whatconstitutes a “reasonably current index andmargin” depending upon the medium in whichthe advertisement is made. These generallyinclude rates that were in effect for 60 daysprior to direct mail advertisements, and 30 daysprior to other advertisements, including print,Internet and e-mail.

Exception for television and radio. When anadvertisement for an open-end home equity planstates that extensions of credit greater than thefair market value of the home are available, theadvertisement must include a statement that theinterest on the portion of the credit extensionthat is greater than the fair market value of thedwelling is not deductible for federal income taxpurposes. In addition, the advertisement mustindicate that the consumer should consult a taxadviser for further information on the taxdeductibility of the interest.

Balloon Payments If an advertisementcontains a minimum periodic paymentamount, disclosures of any balloon payment orother increase in payment must be made withequal prominence and in close proximity to theminimum payment amount advertised. Thiswas seen to be especially important where aballoon payment may result if only theminimum payments are made, or if by makingonly the minimum payments the outstandingbalance of the loan would not be fullyamortized by a specified date and time.

Tax Implications When an advertisement foran open-end home equity plan states thatextensions of credit greater than the fair marketvalue of the home are available, the new rulerequires that the advertisement include astatement that the interest on the portion of the

credit extension that is greater than the fairmarket value of the dwelling is not deductiblefor Federal income tax purposes. In addition,the advertisement must indicate that theconsumer should consult a tax adviser forfurther information on the tax deductibility of the interest.

Promotional Rates and PaymentsAdvertisements for loan products includingpromotional rates or payments (i.e., generally,rates or payments that are not calculated withreference to index and margin that areotherwise applicable to the plan), must disclose— with equal prominence and in closeproximity — the period of time that thepromotional rate or payment will apply, and theAPR (in the case of a promotional rate) orpayment (in the case of a promotionalpayment) that will apply. This requirement doesnot apply to the envelopes in which asolicitation is sent or a banner or pop-upadvertisement. The further guidance from theFederal Reserve indicates that the use offootnotes does not meet the “closely proximate”standard. Special requirements apply to radioand television advertisements.

Closed-End Credit Secured by a Dwelling

Clear and Conspicuous Standard The finalrule establishes that advertisements for homeequity plans regarding promotional rates orother payment options must containdisclosures in close proximity to the triggeringterms. The rule does not set specificrequirements for the format of advertisements,but does deem that disclosures meet therequirements of the rule if they appearimmediately next to or directly above or belowthe trigger terms — in the same type size as thetrigger terms — without any intervening text or graphical displays.

These requirements apply to all visual textadvertisements except for televisionadvertisements. Television advertisements thatcomply with recently amended rules underSection 226.16(c) are deemed compliant.



33

Advertisements for loan productsincluding promotionalrates or paymentsmust disclose theperiod of time that thepromotional rate orpayment will apply,and the APR that will apply.

For Internet advertisements, a linkaccompanying a triggering term, which takes theconsumer to the additional disclosures, isdeemed acceptable. The rule also requires thatdisclosures may not be obscured by graphicaldisplays, shading, coloration or other techniquesmaking them difficult to read. The disclosuresmust be displayed in a manner that makes themreadable, but an exception is made for thevarying sizes of screens, and the rule allows fordisclosures that would not be readable on ahandheld or portable television screen.

For oral disclosures (e.g., radio and televisionadvertisements), the new rule requires thatdisclosures be made in a speed and volumesufficient for a consumer to hear them and sothat they are intelligible for the consumer.Alternatively, the rule allows for use of toll-freetelephone numbers that consumers may call forthe disclosures in lieu of providing the disclosuresin radio and television advertisements.

Discounted Rates and PremiumsAdvertisements are required to disclose all ratesor payments that will apply over the term of theloan as well as the time periods for which thoserates or payments will apply.

Advertisements cannot state any rate other thanan APR, except that a simple annual rate that isapplied to an unpaid balance may be stated inconjunction with, but not more conspicuouslythan, the APR.

Buydowns. Additional disclosures would berequired when an advertisement includesinformation showing the effect of the buydownagreement on the payment schedule.

Discounted variable-rate transactions. Anadvertisement for a discounted variable-ratetransaction that advertises a reduced ordiscounted simple annual rate must show thelimited term to which the simple annual rateapplies and the APR that will apply after theterm of the initial rate expires.

Disclosure of all rates. An advertisement thatstates a simple annual rate of interest whenmore than one simple annual rate of interest

will apply over the term of the advertised loanmust clearly and conspicuously disclose:

1. Each simple annual rate of interest;

2. The period of time during which eachsimple annual rate of interest willapply; and

3. The APR for the loan.

Disclosure of all payments. An advertisementthat states the amount of any payment must disclose:

1. Payments that will apply over the termof the loan (including any balloon pay-ment if the consumer makes only theminimum payments specified in anadvertisement), not just the repaymentterms that will apply for a limited time;

2. The period of time during which eachpayment will apply; and

3. The fact that the payments do notinclude amounts for taxes and insurance premiums, if applicable. This requirement would apply for only first liens.

Tax Implications The new rule clarifies thatadvertisements for mortgage loan products thatexceed the value of the security property mustdisclose that the interest on the portion of theloan that is greater than the fair market value ofthe home is not tax deductible for federalincome tax purposes.

Prohibited Acts or Practices The new rules alsoenumerate seven prohibited acts or practices forclosed-end credit secured by a dwelling.

• Using the word “fixed” to refer to ratesor payments when the rate or paymentwould be “fixed” for only a limited time.

• Comparing a borrower’s actual or hypo-thetical current payments or rates andany payment that would apply if theborrower obtains the advertised loanunless the advertisement includes both acomparison to all applicable payments orrates for the advertised product that willoccur over the term of the loan and a



34

statement that the advertised paymentsdo not include amounts for taxes andinsurance, if applicable.

• Advertising a product as being endorsedor sponsored by a governmental entity,unless the advertisement is for an FHA,VA, or similar loan program that isendorsed or sponsored by a federal,state or local government entity.

• Displaying the name of the borrower’scurrent lender in an advertisementunless the ad also prominently disclos-es that it is not associated with the customer’s current lender.

• Claiming that the advertised productwill eliminate debt or result in a waiveror forgiveness of a borrower’s existingloan obligations with another creditor.

• Giving the false impression that a broker or lender has a fiduciary rela-tionship with the borrower by usingthe word “counselor” to refer to a for-profit mortgage broker or creditor.

• Providing information about triggerterms or required disclosures only in aforeign language, but providing othertrigger terms or required disclosures onlyin English in the same advertisement.



35

Creditors are requiredto provide the earlymortgage loandisclosures withinthree days after aconsumer applies for any mortgage loan secured by the consumer’sprincipal dwelling and before theborrower pays a fee.

These rules will verylikely serve as aframework for anotherset of rules underdevelopment now thatwill implement theMortgage DisclosureImprovement Act (partof the Housing andEconomic RecoveryAct of 2008), whichwas passed byCongress and signedby the President inJuly 2008.

Early Disclosure ProvisionsThe new rules include a section on earlydisclosures that requires creditors to provide the early mortgage loan disclosures within threedays after a consumer applies for any mortgageloan secured by the consumer’s principaldwelling and before the borrower pays a fee.

In July 2008, however, the Congress enacted theHousing and Economic Recovery Act of 2008,which included amendments to TILA, knownas the Mortgage Disclosure Improvement Act of2008 (MDIA). This new law codified the July2008 amendments by the Federal Reserve, whilealso adding new statutory provisions that theFederal Reserve is now implementing.

When the rules are available to implement thenew law, ABA will create an addendum to thisABAWorks detailing the changes and providingassistance to banks on implementing thesechanges. Until then, the following summary ofthe new law will give bank officials an idea ofthe changes that will be coming to disclosures.

Generally, congress passed MDIA in order toensure that consumers receive cost disclosuresearlier in the mortgage process. The MDIArequires creditors to give good faith estimates ofmortgage loan costs (“early disclosures”) withinthree business days after receiving a consumer’sapplication for a mortgage loan, and before anyfees are collected from the consumer, other thana reasonable fee for obtaining the consumer’s

credit history. The MDIA would apply thisrequirement to all loans secured by dwellingsother than the consumer’s principal dwelling,such as second homes.

MDIA adds a seven business day “waitingperiod” before mortgage loans may close. Thisseven day period may be waived in the event ofa bona fide personal emergency.

MDIA requires that, in instances where theAPR set forth in the early disclosures changesbeyond specified tolerances, then the consumermust be presented with new correcteddisclosures, not later than three business daysbefore closing or settlement.

MDIA mandates that early disclosures containthe following statement: “You are not requiredto complete this agreement merely because youhave received these disclosures or signed aloan application.” This additional disclosuremust be included in any corrected disclosures.

Finally, for variable rate or paymenttransactions, the payment schedule must belabeled to note that payments will vary based oninterest rate changes; after consumer testing, theFederal Reserve must publish regulationsproviding rules for disclosing examples of how aconsumer’s payment may change based oninterest rate changes.

Legal Consequences for Non-Compliance

The majority of these new rules are enactedpursuant to the Federal Reserve’s HOEPAauthority, which allows the Federal Reserve toregulate unfair or abusive practices under theTruth in Lending Act (TILA) Section 129(l)(2)for virtually all mortgage loans. This is the firsttime the Federal Reserve has created rules underits authority in this area, so these provisionsmerit special attention by legal counsel inbanking institutions.

The “unfair, deceptive and abusive” provisionsunder TILA are very broadly worded in the law. The Federal Reserve is using this authorityin the final rules to define the specificcircumstances it deems to fit under thatdefinition. As a result, the rules that are madeunder TILA Section 129(l)(2) authority carryenhanced liability implications, including civilpenalties and administrative enforcementactions. Bank policy decisions for all mortgages— and especially for whether and how to offerhigher priced loans — should take into accountthe legal consequences for non-compliance withthe new rules. The new rules made under thisauthority include all of the rules related tohigher-priced loans and the prohibitions relatedto appraisals and mortgage loan servicing. Therules also include seven advertising practicesidentified as misleading (see pages 34-35). Theother advertising rules are subject to thestandard TILA damages provisions.


“Unfair, Deceptive and Abusive” Provision

The approach of regulating mortgage market activitiesunder the “unfair, deceptive and abusive” provision ofTILA is novel and has not been tested, either incompliance evaluations or in the courts. Theconsequences of violations under Section 129(l)(2) are,therefore, not well understood. Although the liability forbreaking the new rules is not specifically discussed bythe Federal Reserve in the final regulations, TILA’sliability provisions must be read in conjunction with thenew rules in order to fully understand the risks inherentin these new requirements.

The penalties for violating a rule passed underthe Federal Reserve’s Section 129(l)(2) authorityfall into five categories: (1) actual damages, (2)statutory damages, (3) damages for class actionchallenges, (4) enhanced damages, and (5) rightof rescission claims for the full three year“extended” period.

Actual Damages

Lenders would pay the amount of any “actualdamage” sustained by a borrower as a result of afinding of unfair or deceptive acts or practices.By definition, an “actual” damage is extremelydifficult to assess with any degree of precision,and may include a great variety of differentharms. While actual damages for TILAviolations have been very difficult, if notimpossible, for borrowers to prove in the past, itis possible that borrowers will be moresuccessful in showing actual damages forviolations of the new rules. For example, for aviolation of the appraisal influencerequirements, the borrower could claim to havepaid too much for the home or to haveborrowed too much against it. As a result,individual borrower TILA actions may becomea serious concern.

Statutory Damages

These damages, assessed as punitive fines underthe law, can range from not less than $400 orgreater than $4000. These were increased from$200 - $2000 by the Mortgage DisclosureImprovement Act of 2008, which is acomponent of the Housing and EconomicRecovery Act of 2008.

Special Damages For Class ActionChallenges

Special damages are permitted for whatever amounta court may allow, up to a maximum that cannotexceed the lesser of $500,000 or one percent of thenet worth of the creditor.

Specific Damages For Failure To ComplyWith Section 129

Additional remedies are allowed of “an amountequal to the sum of all finance charges and feespaid by the borrower, unless the creditor



36

There is no cap ondamages for failure tocomply with Section129 in class actions.

demonstrates that the failure to comply is notmaterial.” Note that being assessed a penalty of“all finance charges” may amount to enormousamounts of money — almost as much asrescission, but without the requirement that theborrower return the outstanding loan principal.These damages, often referred to as “enhanceddamages,” would not have been available hadthe Federal Reserve exercised its authority under Section 105 instead of Section 129. Note that there is no cap on these damages inclass actions.

Right of Rescission Claims

Borrowers have three years to discover a breachof the new prepayment penalty provisions forhigher cost loans under the new rules. If abreach is found, the borrower may rescind theloan. In addition, creditors will be liable forcosts of the action, together with a reasonableattorney’s fee as determined by the court.

As with other actions under other provisions ofTILA, state attorneys general may bring anaction to enforce the new higher-priced loanprovisions “not later than 3 years after the dateon which the violation occurs.” In actionsbrought by borrowers, the general statute of

limitations is one year. Crucial from a liabilityperspective, however, is that a borrower againstwhom a foreclosure has been filed is generallyable to assert a claim in recoupment or set-offfor the life of the loan. This means thatborrowers in foreclosure could potentially havea claim for “all finance charges” for the life ofthe loan as a counterclaim to the foreclosure.Banks should carefully weigh this potentialdefault-related risk when assessing credit risk inhome-secured lending.

Assignee Liability

Finally, it is important to note that the FederalReserve did not impose assignee liability forviolations of these new provisions. Althoughassignee liability continues to apply to high-costloans that exceed the statutory HOEPAthresholds (i.e., an APR that exceeds thecomparable Treasury security by more than 8percent or points and/or fees (as defined)greater than 8percent), assignee liability isgenerally inapplicable to the new higher-pricedloan category defined under this rule and toother violations of the new rule. This aspect ofthe rule may allow secondary market sources tobe receptive to loans that cross the higher-priced loan thresholds.



37

A borrower againstwhom a foreclosurehas been filed isgenerally able toassert a claim inrecoupment or set-offfor the life of the loan.This means thatborrowers inforeclosure couldpotentially have aclaim for “all financecharges” for the life of the loan as acounterclaim to theforeclosure.



38

AMERICAN BANKERS ASSOCIATION 39

SECTION FIVE

ADApT to Mortgage Reform:A Framework for Achieving Compliance

Achieving compliance with the amendments to Regulation Z by the October 2009 deadline willdemand significant, coordinated effort by your bank’s Board of Directors, senior management andstaff working in a variety of functional areas including: mortgage lending operations and servicing,compliance, audit, marketing, and systems/information technology. Their work will be a multi-stepprocess requiring review and analysis of the bank’s business strategy, appetite for risk, and existingmortgage operations; revision of bank policies and procedures; implementation of systems changes;training; and finally, testing. Clearly, achieving timely compliance will demand thoughtful planningand coordination of the many players and steps in the process. ABA encourages banks to use the“ADApT” framework to organize and coordinate this significant undertaking.

ADApT Framework

A nalyze your current mortgage operations against the regulatory amendments,keeping in mind your business strategy and risk appetite to identify the complianceand operational gaps that must be addressed.

D evelop those aspects of your program that require improvement to meetregulatory requirements, operational needs and your business expectations.

Apply your revised mortgage compliance plan by implementing programenhancements.

T est your updated program to ensure that it functions as intended.

The ADApTation Team and Plan

The ADApT framework provides a dynamic approach to accommodating regulatory and marketchange with roles for the board, senior management and staff. An “ADApTation Team” should becomprised of representatives from each of the affected operational areas that are involved with yourmortgage lending program, including audit, compliance, marketing, loan production, loan servicing,operations, and information systems. To simplify the process, we will focus on the responsibilities offour primary groups: governance, compliance, lending operations, and information systems; theywill make up the members of your bank’s ADApTation Team. Then, using the ADApT framework,we will outline the necessary steps for effecting compliance with the new rules for mortgage lendingand will define each group’s responsibilities. Finally, we will provide preparedness checklists tailoredto each group.

The ADApTation Team is charged with devising and executing a plan that will achieve compliancewith the new mortgage regulations in a timely manner by following a sensible sequence of steps thatenable the participating organizational units to fulfill their roles and responsibilities in a coordinatedfashion that is accountable to the bank’s senior authorities. Those steps are the components of theADApT framework whose accomplishment is demonstrated by intermediate milestones that progresstoward the compliance deadline (evidenced by preparedness checklists) and are performed by assignedstaff in accordance with your plan.



40

29. Your bank may have different organizational divisions of responsibility, but in all cases you will have people or offices functioning in these four areas.

ADApTation Team

Your bank’s ADApTation Team should be organized to include representatives from thefollowing functional areas: 29

❏ Governance Group includes the board of directors, board committees, and seniormanagement, including the chief risk officer and audit manager.

❏ Compliance Group includes the chief compliance officer and compliance staff in mostbanks, but it may also embrace the bank’s legal staff and training departments.

❏ Mortgage Lending Group is a descriptive term that encompasses staff involved withmortgage marketing, production, servicing, and quality assurance. It also includes thebank’s loan committee and any individuals responsible for secondary market sales.

❏ Information Systems Group encompasses staff with responsibility for the integrationof loan operations with internal and/or third-party processing and reporting systems aswell as staff responsible for information security.

Analyze

Review your existing mortgage lendingoperations against the regulatory amendments,keeping in mind the bank’s business strategy,appetite for risk, and available resources.

• Become fully versed in therequirements of the new mortgageregulations so that the Team memberscan make necessary judgments from aninformed perspective.

• Determine whether existing mortgagelending operations are likely to includeloans going forward that will fall withinthe new category of “higher-pricedmortgage loans” paying particular heedto pricing thresholds in connection with:

– Broker-originated loans

– Mortgage loans that combineconstruction and permanentfinancing

– Jumbo loans

– First lien home equity loans

– Small mortgage loans

– Loans with private mortgageinsurance

And if you so conclude that you are likely to originate higher-pricedmortgage loans, then:

– Identify where changes will beneeded to current policies, procedures, controls and systems toachieve compliance for such“higher-priced mortgage loans.”

– Evaluate whether the bank’s existing resources and staff can meetthe additional reporting,qualification, and servicingrequirements for higher-pricedmortgage loans and the implicationsof these new obligations for thebank’s risk profile.

– Prepare appropriate report andrecommendation to seniorauthority to obtain any necessaryapprovals for adjustments to thebank’s business plan in light ofnewly identified risk ramifications.

• Compare how your current inventoryof mortgage loan products and theirmarketing, underwriting, processing,servicing, and secondary marketprocedures match-up with the newrequirements for all mortgage loans(e.g., appraisals, servicing, advertisingand early disclosures/fee restrictions)and list gaps that must be addressed inpolicies, procedures, controls andsystems to attain compliance.

• Consider how the new mortgagerequirements will impact relationshipswith and services provided by third-party service providers, especially withrespect to your use and management ofappraisers.

• Determine whether these gaps andimpacts represent material changes tothe risk profile of the bank’s mortgagebusiness and elevate to senior authoritywhere necessary for appropriateconsideration.

• Identify any deficiencies in yourcurrent staff expertise and wheretraining, audit and quality assurancewill need to be updated.



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Following the ADApT Framework



42

“ANALYZE” Preparedness Checklists

Governance Group❏ Senior management establishes ADApTation Team to identify

compliance and business operations risks from regulatorychanges and to devise and execute a plan to achieve timelycompliance.

❏ Senior management reports to the board of directors onexpected impact of mortgage reform standards on bankoperations, provides broad outline of plan to achieve timelycompliance and explains expected role of the board of directors.

Compliance Group❏ Reads ABAWorks and expands expertise on the regulatory

changes by tracking agency guidance and other sources andconveys necessary information to other members of Team.

❏ Communicates to senior management and staff the newdefinition of a higher-priced mortgage loan and the regulatorychanges that apply to all mortgage loans.

❏ Helps mortgage lending group and information systems staffunderstand the operational impact of the regulatory changes.

❏ Coordinates analysis of, and documents the risks presented by,each of the bank’s mortgage loan products and identifies thecompliance and operational policy, procedure, control andsystem gaps that will need to be addressed to achieve timelycompliance.

❏ Responsible for integrating ADApTation Team input on thebusiness implications of the new compliance obligations and therisks of non-compliance into a risk assessment to be presented tothe Governance Group.

Mortgage Lending Group❏ Reads ABAWorks.

❏ Identifies whether the bank currently originates higher-pricedmortgage loans.

(Continued)

Target Date

Person(s)Responsible



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“ANALYZE” Preparedness Checklists, continued

Mortgage Lending Group, continued

❏ Works with the Compliance Group to identify and evaluatethe impact of Regulation Z changes on:–– Product design –– Advertising–– Pre-quali/app procedures–– Early disclosures–– Appraisals

❏ Considers impact of the regulatory changes on bank operations,information reporting systems, and third-party service providerrelationships.

❏ Considers impact of the regulatory changes on secondarymarket, government agency, and private investor guidelines andprograms.

❏ Determines whether existing resources and staffing in theMortgage Lending Group are adequate or whether additionalsoftware, systems, employees, or third-party service providerswill be necessary to achieve timely compliance.

❏ Reports the information above to the Compliance Group forinclusion in the risk assessment.

Information Systems Group❏ Works with the Compliance Group to identify and evaluate the

impact of Regulation Z changes on bank operations andinformation reporting systems, including those provided bythird-party service providers.

❏ Evaluates existing system capabilities to handle the additionalmonitoring and reporting requirements for higher-pricedmortgage loans.

❏ Considers the impact the regulations will have on existinghardware and software programs.

❏ Considers whether information security issues are presented bythe anticipated operational and reporting changes.

❏ Reports the information above to the Compliance Group forinclusion in the risk assessment.

Target Date


–– Underwriting–– Loan setup–– Closing/escrow operations–– Servicing –– Internal reporting



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Develop

After analyzing your current mortgage lendingproducts, policies, procedures, and the riskspresented, you will need to make operationaland policy changes to comply with RegulationZ’s new requirements.

• Assign responsibilities for addressingcompliance deficiencies identified dur-ing the Analyze phase of ADApT andhow progress will be monitored andreported to the Governance Group.

• If your bank will offer higher-pricedmortgage loans, create necessary poli-cies, procedures, controls and systems:

– To identify when such higher-priced loans are being offered ororiginated so that they can beproperly tracked and reported.

– To calculate and document a borrower’s ability to repay the loan.

– To establish necessary escrowaccounts and accounting.

– To limit prepayment penalties tolegally acceptable situations.

– To modify third-party and secondary market arrangements toaccount for new responsibilitiesand liabilities.

• If your bank intends not to offer higher-priced mortgage loans, prepareappropriate policies, procedures, controls and systems to monitor loanpricing to avoid inadvertently pricingloans in a manner that exceeds the regulatory thresholds and incursunwanted liabilities.

• Update your bank’s appraisal, loan production, servicing and advertisingpolicies, procedures, controls and systems to address any gaps previouslyidentified between current mortgageoperations and the new regulatorystandards.

• Draft new contract language to address changes appropriate for compliant third-party and secondarymarket arrangements.

• Prepare any necessary new curriculumto assure that staff is sufficientlytrained to abide by new policies, procedures, controls and systems and isadequately informed about how newregulatory standards impact their jobs.

• Revise audit and quality assurance programs to monitor new policies, procedures, controls and systems.

• Prepare a timetable for rolling-out new policies, procedures, controls andsystems scheduled to achieve timelycompliance and reserve adequate timefor testing.



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“DEVELOP” Preparedness Checklists

Governance Group❏ Senior Risk Management participates as called for in

ADApTation plan dependent on degree of operational/compliance risk and bank’s general governance approach.

❏ Approves any necessary bank policy changes at appropriatelevels.

Compliance Group❏ Assembles the ADApTation plan with input from other Team

members to guide accomplishment of milestones and roll-out ofprogram changes.

❏ Works with the Mortgage Lending Group to revise or to draftnew policies, procedures and practices that address the newregulatory requirements applicable to:–– Loan product design –– Advertising–– Pre-qualification and application –– Early Disclosures–– Underwriting –– Appraisals–– Escrow–– Servicing (payment, payoff and pyramiding rules)–– Secondary market sales

❏ Works with the Information Systems Group to identify andmake necessary changes to: –– Accommodate additional monitoring, reporting, and

servicing requirements for higher-priced loan activity–– Update hardware and software programs–– Revise servicing, escrow, payment, and payoff processing

and reporting systems –– Revise third-party service provider operations and

agreements–– Ensure information security

❏ Develops training programs for all staff affected by theregulatory changes.

❏ Works with audit staff to modify annual audit program toencompass the policy and procedure changes.

(Continued)

Target Date




46

“DEVELOP” Preparedness Checklists, continued

Compliance Group, continuted❏ Coordinates input from Team to prepare appropriate progress

reports and recommendations for necessary approvals of policies, procedures, controls and systems by appropriate senior authority.

Mortgage Lending Group

❏ Identifies loan products that could exceed the pricing thresholdfor a higher-priced mortgage loan.

❏ Updates pricing and monitoring procedures, includingmonitoring between approval and closing to identify loans thatcross the high-price threshold.

❏ Works with marketing to evaluate the impact of the newregulatory standards on mortgage product design and advertising.

❏ Updates procedures for pre-application counseling, pre-qualification, application, and revises underwriting guidelinesfor higher-priced loans.

❏ Works with the Compliance Group to revise early disclosures forall mortgage loan originations.

❏ Establishes the following for higher-priced mortgage loans: –– Additional loan setup, monitoring, and reporting

capabilities–– Escrow program –– Limitations on pre-payment provisions

❏ Reviews and revises, as necessary, servicing and payoffprocedures for all mortgage products.

❏ Works with the Compliance Group to review and revise, asnecessary, the following policies, procedures, and practices: –– Advertising–– Appraisals–– Secondary market sales

❏ Reviews and revises agreements with third-party service providers.

❏ Modifies quality control procedures to conform to the newregulatory requirements for higher-priced and standardmortgage loan products.

(Continued)

Target Date




47

“DEVELOP” Preparedness Checklists, continued

Information Systems Group❏ Works with the Mortgage Group and the Compliance Group to

modify loan production and reporting systems from applicationthrough closing.

❏ Revises escrow, servicing, and payment systems.

❏ Works with the Mortgage Group to develop new monitoringand reporting systems to comply with the regulatoryrequirements for higher-priced mortgage loans.

❏ Revises all hardware and software programs.

❏ Works with third-party service providers to update systems toachieve timely compliance with the new regulations.

❏ Addresses data security issues arising from system changes.

Target Date




48

Apply

• Apply the ADApTation Plan through-out affected day-to-day operations.

• Implement revisions to policies, procedures, controls and systemsaccording to the roll-out schedule.

• Coordinate among compliance staff,lending operations and informationsystems to assure that necessarychanges to forms and processes areavailable to fulfill obligations to deliverany new consumer disclosures andmake any necessary underwriting andprocessing decisions.

• Conduct training of staff and re-assignduties as necessary to match expertisewith responsibilities under the updatedoperations and compliance program.

• Revise marketing plans and processesso that sales and advertising is updatedto reflect latest standards.

• Institute monitoring and reportingrequirements with respect to yourbank’s business strategy regarding higher-priced mortgage loans.

• Execute necessary changes to agree-ments with third-parties and secondarymarket investors to reflect new obliga-tions and warranties.

• Assure that adequate resources andstaff have been assigned to meet theadditional operational and complianceburdens.

• Prepare progress reports to seniorauthority as appropriate to the complexity of the changes being made in your lending and compliance operations.



49

“APPLY” Preparedness Checklists

Governance Group❏ Reviews periodic progress reports on ADApTation Plan

implementation.

❏ Implements new audit standards for new operations andcompliance programs.

Compliance Group❏ Distributes new policies and procedures to affected staff.

❏ Conducts staff training on new policies and procedures.

❏ Monitors the Mortgage Lending Group and the InformationSystems Group efforts to modify loan production, monitoring,servicing, and reporting systems.

❏ Monitors outreach to third-party service providers and theirefforts to achieve compliance.

❏ Reports to the Governance Group on the status of ADApTationPlan implementation.

Mortgage Lending Group❏ Implements updated policies, procedures, controls and systems.

❏ Participates in training sessions and implements operationalchanges.

❏ With legal/compliance staff support, reaches out to third-partyand secondary market representatives to update contracts.

❏ Provides input to the Compliance Group on the status ofADApTation Plan implementation.

Information Systems Group❏ Implements revised systems to effectuate updated policies,

procedures and controls.

❏ Participates in training sessions and implements systems changes.

❏ Monitors third-party service provider progress toward achievingcompliance.

❏ Provides input to the Compliance Group on the status ofADApTation Plan implementation.

Target Date




50

Test

Test to ensure that all systems and programsfunction as intended.

• Conduct early testing of new proce-dures, controls and systems to identifyprogram shortcomings and prepare necessary revisions to operations andcompliance programs.

• Ask whether staff and service providerimplementation is keeping pace withour operational needs. For instance,

– Are there performance gaps in theroll out of the program that requireadditional training or anadjustment to, or rethinking of,resource allocation?

– Have needs been identified forenhanced technological capabilities?

– Does it appear that staff allocationneeds adjustment?

– Are service providers faithfullyexecuting their responsibilities toyour new program and policies?

• Evaluate whether your reporting andrecordkeeping systems are providingyou with reliable assurances of regulatory compliance.

• Track areas where modifications to policies, procedures, controls or systemshave been recommended due to yourtesting and assure that correctiveactions have been completed.

• Finalize report on experience ofADApTation Plan and achievement ofoperational and compliance objectives.



51

“TEST” Preparedness Checklists

Governance Group❏ Audits tests updated policies, procedures, controls and systems

and provides feedback to Team about deficiencies identified.

❏ Senior management/Board of Directors reviews final reports onADApTation Plan implementation.

Compliance Group❏ Revises new policies, procedures, and controls for internal

processes and third-party/secondary market processes that arenecessary to redress any deficiencies revealed by testing.

❏ Prepares updates to training and communication to staff tocorrect problems arising from implementation.

❏ Tracks any necessary corrections to loan production,monitoring, servicing, and reporting systems.

❏ Assembles and maintains paper trail of steps taken todemonstrate achievement of timely compliance to regulators.

❏ Reports to the Governance Group on the accomplishment ofADApTation Plan objectives.

Mortgage Lending Group❏ Incorporates revisions to policies, procedures, controls and

systems that redress deficiencies revealed by testing.

❏ Disseminates updated training materials and implementsoperational changes to correct any implementation problems.

❏ Adjusts tracking and reporting obligations to redress anyidentified deficiencies.

❏ Provides input to the Compliance Group on the results ofADApTation Plan implementation and responsiveness to anycorrective action taken as a result of testing.

(Continued)

Target Date




52

“TEST” Preparedness Checklists, continued

Information Systems Group❏ Corrects systems to conform to revised policies, procedures and

controls responsive to testing deficiencies.

❏ Finalizes information system manuals.

❏ Corrects any deficiencies to systems used for third-party serviceprovider and secondary market oversight.

❏ Provides input to the Compliance Group on the results ofADApTation Plan implementation and responsiveness to anycorrective action taken as a result of testing.

Target Date




53

APPENDIX A

Methodology for Determining Average Prime Offer Rates

The calculation of average prime offer rates isbased on the Freddie Mac Primary MortgageMarket Survey® (PMMS). The survey collectsdata for a hypothetical, “best quality,” 80percent loan-to-value, first-lien loan for fourmortgage products: (1) 30-year fixed-rate; (2)15-year fixed-rate; (3) one-year variable-rate;and (4) five-year variable-rate.1 Each of thevariable-rate products adjusts to an index basedon the one-year Treasury rate plus a margin andadjusts annually after the initial, fixed-rateperiod. This Methodology first describes all thesteps necessary to calculate average prime offerrates and then provides a numerical exampleillustrating each step with the data from theweek of May 19, 2008.

The PMMS collects nationwide average offerprices during the Monday through Wednesdayperiod each week and publicly releases theaverages on Thursday. For each loan type theaverage commitment loan rate and total feesand points (“points”) are reported, with thepoints expressed as percentages of the initialloan balance. For the fixed-rate products, thecommitment rate is the contract rate on theloan; for the variable-rate products it is theinitial contract rate. For the variable-rateproducts, the average margin is also reported.

The PMMS data are used to compute anannual percentage rate (APR) for the 30- and 15-year fixed-rate products. For the twovariable-rate products, an estimate of the

fully-indexed rate (the sum of the index andmargin) is calculated as the margin (collected inthe survey) plus the current one-year Treasuryrate, which is estimated as the average of theclose-of-business, one-year Treasury rates forMonday, Tuesday, and Wednesday of the surveyweek. If data are available for fewer than threedays, only yields for the available days are usedfor the average. Survey data on the initialinterest rate and points, and the estimated fullyindexed rate, are used to compute a compositeAPR for the one- and five-year variable-ratemortgage products. See Regulation Z officialstaff commentary, 12 CFR part 226, Supp. I,comment 17(c)(1)-10 (creditors to compute acomposite APR where the initial rate onvariable-rate transaction is not determined byreference to index and margin).

In computing the APR for all four PMMSproducts, a fully amortizing loan is assumed,with monthly compounding. A two-percentage-point cap on the annual interest rateadjustments is assumed for the variable-rateproducts. For all four products, the APR iscalculated using the actuarial method, pursuantto Appendix J to Regulation Z. A paymentschedule is used that assumes equal monthlypayments (even if this entails fractions of cents),assumes each payment due date to be the first

1. The “30-year” and “15-year” fixed-rate product designations refer to thoseproducts’ terms to maturity. The “one-year” and “five-year” variable-rateproduct designations, on the other hand, refer to those products’ initial,fixed-rate periods. All variable-rate products discussed in this Methodologyhave 30-year terms to maturity.

of the month regardless of the calendar day onwhich it falls, treats all months as having 30days, and ignores the occurrence of leap years.See 12 CFR 226.17(c)(3). The APR calculationalso assumes no irregular first period or perdiem interest collected.

The PMMS data do not cover fixed-rate loanswith terms to maturity of other than 15 or 30years and do not cover variable-rate mortgageswith initial, fixed-rate periods of other than oneor five years. The Board uses interpolationtechniques to estimate APRs for ten additionalproducts (two-, three-, seven-, and ten-yearvariable-rate loans and one-, two-, three-, five-,seven-, and ten-year fixed-rate loans) to usealong with the four products directly surveyedin the PMMS.

The Treasury Department makes available yieldson its securities with terms to maturity of,among others, one, two, three, five, seven, andten years (see http://www.treas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml). The Board uses these data toestimate APRs for two-, three-, seven-, and ten-year variable-rate mortgages. These additionalvariable-rate products are assumed to have thesame terms and features as the one- and five-year variable-rate products surveyed in thePMMS other than the length of the initialfixed-rate period.

The margin and points for the two- and three-year variable-rate products are estimated asweighted averages of the margins and points ofthe one-year and five-year variable-rateproducts reported in the PMMS. For the two-year variable-rate loan the weights are 3/4 forthe one-year variable-rate and 1/4 for the five-year variable-rate. For the three-yearvariable-rate product, the weights are 1/2 eachfor the one-year and the five-year variable rate.For the seven- and ten-year variable-rateproducts, because they fall outside of the rangebetween the one- and five-year PMMSvariable-rate products, the margin and pointsof the five-year variable-rate product reportedin the PMMS are used instead of calculating aweighted average.

The initial interest rate for each of theinterpolated variable-rate products is estimatedby a two-step process. First, “Treasury spreads”are computed for the two- and three-yearvariable rate loans as the weighted averages ofthe spreads between the initial interest rates onthe one- and five-year PMMS variable-rateproducts and the one- and five-year Treasuryyields, respectively. The weights used are thesame as those used in the calculation of marginsand points. For seven- and ten-year variable-rateloans, because they fall outside of the rangebetween the one- and five-year PMMS variable-rate products, the spread between theinitial interest rate on the five-year PMMSvariable-rate product and the five-year Treasuryyield is used as the Treasury spread instead ofcalculating a weighted average. The second stepis to add the appropriate Treasury spread to theTreasury yield for the appropriate initial, fixed-rate period.

All Treasury yields used in this two-step processare the Monday-Wednesday close-of-businessaverages, as described above. Thus, for example,for the two-year variable-rate product, theestimated, two-year Treasury spread is added tothe average two-year Treasury rate, and for theten-year variable-rate product the five-yearTreasury spread is added to the average ten-yearTreasury rate.

Thus estimated, the initial rates, margins, andpoints are used to calculate a fully-indexed rateand ultimately an APR for the two-, three-,seven- and ten-year variable-rate products. To estimate APRs for one-, two-, three-, five-, seven-, and ten-year fixed-rate loans,respectively, the Board uses the initial interestrates and points, but not the fully-indexedrates, of the one-, two-, three-, five-, seven-,and ten-year variable-rate loan productscalculated above.

For any loan for which an APR of the sameterm to maturity or initial, fixed-rate period, asapplicable, (collectively, for purposes of thisparagraph, “term”) is not included among the14 products derived or estimated from thePMMS data by the calculations above, the



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comparable transaction is identified by the following assignment rules: For a loan with ashorter term than the shortest applicable termfor which an APR is derived or estimated above,the APR of the shortest term is used. For a loanwith a longer term than the longest applicableterm for which an APR is derived or estimatedabove, the APR of the longest term is used. Forall other loans, the APR of the applicable termclosest to the loan’s term is used; if the loan isexactly halfway between two terms, the shorterof the two is used. For example: for a loan witha term of eight years, the applicable (fixed-rateor variable-rate) seven-year APR is used; with aterm of six months, the applicable one-yearAPR is used; with a term of nine years, theapplicable ten-year APR is used; with a term of11 years, the applicable ten-year APR is used;and with a term of four years, the applicablethree-year APR is used. For a fixed-rate loanwith a term of 16 years, the 15-year fixed-rate

APR is used; and with a term of 35 years, the30-year fixed-rate APR is used.

The four APRs derived directly from PMMSproduct data, the ten additional APRsestimated from PMMS data in the mannerdescribed above, and the APRs determined bythe foregoing assignment rules are the averageprime offer rates for their respectivecomparable transactions. The PMMS dataneeded for the above calculations generally areavailable on the Freddie Mac Web site(http://www.freddiemac.com/dlink/html/PMMS/display/PMMSOutputYr.jsp) on Thursdayof each week. APRs representing average primeoffer rates for the 14 products derived orestimated as above, are posted in tables on theFFIEC Web site the following day. Thoseaverage prime offer rates are effective beginningthe following Monday and until the nextposting takes effect.



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AMERICAN BANKERS ASSOCIATION 57

APPENDIX B

Functional Impact on Bankand Lending Areas

The following chart provides an overview of the impact the amendments to Regulation Z will haveon the functional areas at your bank. Note that the new regulation will have a broad impactregardless of whether your bank chooses to offer higher-priced mortgages.

Gove

rnan

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mpl

ianc

eM

ortg

age

Lend

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Info

. Sys

tem

s



58

BANK / LENDING AREA REGULATION SECTION / GENERAL PROCEDURE

Open-EndCredit - AdvertisingRules226.16(d)

Closed-EndCredit -GeneralDisclosureRequirements226.17

Closed-EndCredit - InitialDisclosures/Fees226.19(a)

Closed-EndCredit -AdvertisingRules 226.24

Certain HomeMortgageTransactions -PrepaymentPenaltyRestrictions226.32

Certain HomeMortgageTransactions -UnderwritingRequirements226.34

Certain HomeMortgageTransactions -APR Analysis226.35(a)

Certain HomeMortgageTransactions -UnderwritingRequirements226.35(b)

Board of Directors

Risk Management

Compliance

Training

Marketing / Advertising

Retail / Consumer Banking

Loan Committee

Mortgage Dept. Management

Loan Product Design

Loan Production

Pre-Application

Application

Processing

Underwriting

Closing

Loan Servicing

Customer Service

Payment Processing

Escrow Administration

Collections

Payoffs

Secondary Mktg./Investor Rel.

Quality Assurance

Operations

Data Processing

Regulation Z Revision Checklist FUNCTIONAL IMPACT ON BANK AND LENDING AREAS

Direct Impact Monitors Procedure No Impact

Gove

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mpl

ianc

eM

ortg

age

Lend

ing

Info

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tem

s



59

Regulation Z Revision Checklist FUNCTIONAL IMPACT ON BANK AND LENDING AREAS

BANK / LENDING AREA REGULATION SECTION / GENERAL PROCEDURE

Certain HomeMortgageTransactions -PrepaymentPenalties226.35(b)

Certain HomeMortgageTransactions -Escrows226.35(b)

Certain HomeMortgageTransactions -MortgageBrokerDefinition226.36(a)

Certain HomeMortgageTransactions -AppraisalCoercion226.36(b)

Certain HomeMortgageTransactions -PaymentProcessingand Late Fees226.36(c)

Certain HomeMortgageTransactions -PayoffStatementPractices226.36(c)

Certain HomeMortgageTransactions -IrregularPayments226.36(c)

Certain HomeMortgageTransactions -ValidServicingCharges226.36(c)

Board of Directors

Risk Management

Compliance

Training

Marketing / Advertising

Retail / Consumer Banking

Loan Committee

Mortgage Dept. Management

Loan Product Design

Loan Production

Pre-Application

Application

Processing

Underwriting

Closing

Loan Servicing

Customer Service

Payment Processing

Escrow Administration

Collections

Payoffs

Secondary Mktg./Investor Rel.

Quality Assurance

Operations

Data Processing

Direct Impact Monitors Procedure No Impact

About Our Consultants

Suzanne Garwood focuses her practice on state and federal law relating to consumer credit andfinancial services. In addition, she manages issues arising under the Truth in Lending Act, the RealEstate Settlement Practices Act, state anti-predatory lending and unfair and deceptive practices laws,and other consumer credit regulations. Ms. Garwood’s practice often requires her to representfinancial institutions before all branches of government.

Jeff Naimon and Kirk Jensen are partners with Buckley Kolar LLP. With offices in Washington,DC and Los Angeles, CA, and a practice and client base that is national in scope, Buckley Kolar hasone of the largest and deepest groups of financial services attorneys in the country. We serve a broadrange of banks and other financial services firms, offering the full range of regulatory, litigation,enforcement, corporate transactional, chartering and licensing, and public policy services and haveextensive experience across a range of issues. We provide prudent, practical legal advice based on athorough knowledge of the markets in which our clients are operating, the business operationsnecessary to offer their products and services, and the legal and regulatory environment facingfinancial services providers.

Thomas Pinkowish is President of Community Lending Associates, a consulting firm thatspecializes in assisting community banks and regulators with mortgage and consumer lending andcompliance. Tom has over twenty-six years experience in lending and compliance, with managementpositions in: residential and consumer lending; secondary marketing; loan servicing; compliance;and operations. In addition to managing lending departments and staff, Tom’s experience includes:underwriting in over 31 states; integrating mortgage banking operations into community banks;redesigning loan origination and servicing departments; and developing policies, procedures, andoperations for residential, consumer, construction, income property, and secondary market lending.Community Lending Associates provides the following services: advises on lending strategies,programs, and operations; develops lending programs, policies, and procedures specific to local areaand strategic objectives; performs contract underwriting; and offers training for customer contactand department staff to help implement these programs successfully.



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1120 Connecticut Avenue, NWWashington, DC 20036

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