Important comment periods have now begun for creditors making
loans subject to the Truth in Lending Act ("TILA").
As required under the Dodd-Frank Act, the Federal Reserve Board
("Board") recently proposed amendments to Regulation Z
(collectively, the "Proposed Regulation"), which
implements the TILA. The Proposed Regulation would implement
Dodd-Frank's requirement that any creditor extending a loan for
a "dwelling-secured consumer credit transaction" (which
includes not only primary residential homes but also vacation homes
and home equity loans) determine the borrower's ability to
repay the loan. The rule does not apply to reverse mortgages,
timeshare plans, home equity lines of credit, open-end credit
plans, or temporary loans with terms of 12 months or less. The
474-page proposal is extensive, and key provisions are summarized
below. Creditors should consider commenting on the "qualified
mortgage" and prepayment penalty portions of the regulation
before the July 22, 2011 deadline.
Complying with the Proposed Regulation
Under the Proposed Regulation, creditors are prohibited from
making "dwelling-secured" mortgage loans unless they
first make a reasonable and good faith determination, based on
verified and documented information, that the borrower has a
reasonable ability to repay the loan and any mortgage-related
obligations (such as property taxes). To satisfy the new regulatory
requirements, creditors must do one of the following:
Option 1: Meet the general ability-to-repay
standard. They can do so by (1) considering and verifying
eight underwriting factors, including: income and/or assets
underlying the ability-to-repay determination; current employment
status; monthly mortgage payment; monthly payment on any
simultaneous mortgage; monthly payment for mortgage-related
obligations (such as insurance and property taxes); current debt
obligations; monthly debt-to-income ratio or residual income; and
credit history; or (2) underwriting the payment for an ARM based on
the fully indexed rate.
Option 2: Originate a "qualified
mortgage," which is arguably exempt from liability
(depending on how "qualified mortgage" is ultimately
defined, see infra). Qualified mortgages are
loans that do not contain negative amortization, interest-only
payments, or balloon payments; do not exceed a 30-year term; are
accompanied by points and fees of less than 3 percent of the total
loan amount; are given to borrowers whose assets or income have
been considered and verified, and whose debt-to-income ratio or
residual income complies with Board guidelines and regulations; and
are underwritten based on the maximum rate during the first five
years, using a payment schedule that fully amortizes the loan over
the loan's term, and factors in mortgage-related
obligations.
Option 3: Operate in predominantly rural or underserved
areas (for example, a community bank) in order to
originate a balloon-payment mortgage. In addition, the loan term
must be five years or more and otherwise meet the qualified
mortgage definition, and the creditor must underwrite the mortgage
based on the scheduled payment, except for the balloon
payment.
Option 4: Refinance a "nonstandard"
mortgage (what Dodd-Frank refers to as a
"hybrid" mortgage), which is an interest-only, negative
amortization ARM with a fixed interest rate for a number of years,
into a "standard" mortgage, which has limits on loan fees
and does not contain negative amortization, interest-only payments,
or a balloon payment. The creditor must also consider and verify
the factors listed in the general ability-to-repay standard, except
the requirement to consider and verify the consumer's income
and assets. In addition, the creditor must underwrite the standard
mortgage based on the maximum interest rate that can apply in the
first five years.
Prepayment Penalty Proposal
Dodd-Frank places extensive restrictions on the ability of
creditors to impose a "prepayment penalty," including the
amount of the penalty, the period during which a penalty may be
imposed, and transactions to which a penalty may apply. Qualified
mortgages are subject to even further restrictions because the cap
on points and fees for qualified mortgages includes any prepayment
penalties. Under the Proposed Regulation, a prepayment penalty is
one where the creditor imposes a charge if the borrower pays any or
part of the loan's principal before the principal is due. The
Board expansively defines the scope of prepayment penalties to
include interest payments due after a loan has been prepaid in full
and any fee (such as a loan closing cost) that is waived unless the
borrower prepays the loan. Creditors should consider submitting
comments on the prudence of such an expansive understanding of
"prepayment penalty," and whether such a reading will
affect the availability of certain types of mortgage loans.
"Qualified Mortgage": Safe Harbor or
Presumption of Compliance?
Dodd-Frank states that creditors may presume the
ability-to-repay requirements are met if the loan in question is a
"qualified mortgage." Under Dodd-Frank's definition
of "qualified mortgage," the creditor is not required to
consider and verify certain underwriting factors that would
otherwise be required under the ability-to-repay considerations
(such as the borrower's employment status, debts, and credit
history, as well as the payment of any simultaneous loans). The
Board is unsettled on whether the origination of a "qualified
mortgage" gives the creditor an alternative to meeting the
ability-to-repay requirements, thus offering the creditor a safe
harbor from liability, or whether the creditor is entitled merely
to a rebuttable presumption of compliance.
The Board has thus proposed two alternative definitions of
"qualified mortgage." The first alternative limits
"qualified mortgages" to certain loan terms, features,
and costs, and requires that the loan be underwritten based on
certain straightforward assumptions using certain verified
information. Under this definition, qualified mortgages would give
creditors a safe harbor for compliance with the general
ability-to-repay requirements. The second alternative would require
the creditor to consider and verify more information about the
borrower's financial situation, and it entitles the creditor
only to a rebuttable presumption of compliance. The Board
acknowledges that if creditors of qualified mortgages are entitled
only to a presumption of compliance, they are left with little
legal certainty as to their liability exposure and thus have less
incentive to extend qualified mortgages with loan fee limits.
Creditors should consider submitting comments on the implications
of treating qualified mortgages as offering creditors a safe
harbor, as opposed to a mere rebuttable presumption of compliance,
and whether this will affect creditors' incentives to extend
qualified mortgages.
Statute of Limitations and Record Retention
TILA grants consumers a right to bring suit against a creditor
for a TILA violation. In addition to actual damages, the consumer
may be able to recover special statutory damages equal to the sum
of all finance charges and fees the consumer paid, unless the
creditor can show that its failure to comply with TILA is not
material. Dodd-Frank extends the statute of limitations for
violations of the ability-to-repay requirements to three years
after the date of the violation. Additionally, there is no statute
of limitations on a borrower's right to raise an
ability-to-repay violation as a defense to foreclosure. To reflect
the extension of the statute of limitations, the Board proposes to
require creditors to retain all records documenting compliance with
the ability-to-repay requirements for three years after
consummation of the transaction.
Although the Board drafted the Proposed Regulation and is
seeking comments, the final rule will be authorized by the newly
created Consumer Financial Protection Bureau, which will have sole
rulemaking authority for TILA as of July 21, 2011. Comments on the
Proposed Rule are due by July 22, 2011.
Jones Day's Consumer Financial Products & Services team
advises clients regarding the issues addressed in this Alert,
including compliance and potential litigation issues raised by the
Board's proposed "Ability to Repay" regulation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.