New Reg Z Rule Applies to All Mortgage Lenders

The Federal Reserve Board recently approved a final rule for home mortgage loans. The rule is intended to provide better protections for consumers and facilitate responsible lending.

The rule amends Regulation Z (Truth in Lending) and was adopted under the Home Ownership and Equity Protection Act (HOEPA). The final rule largely follows a proposal released by the Board in December 2007, with some changes that take into account public comments, consumer testing and further analysis.

"Importantly, the new rules will apply to all mortgage lenders, not just those supervised and examined by the Federal Reserve," says Federal Reserve Chairman Ben S. Bernanke. "Besides offering broader protection for consumers, a uniform set of rules will level the playing field for lenders and increase competition in the mortgage market, to the ultimate benefit of borrowers."

The final rule adds four protections to a newly defined category of "higher-priced mortgage loans" secured by a consumer's principal dwelling:

• A lender is prohibited from making a loan without regard to the borrower's ability to repay the loan from income and assets other than the home's value. A lender complies, in part, by assessing repayment ability based on the highest scheduled payment in the first seven years of the loan. To show that a lender violated this rule, a consumer does not need to demonstrate that it is part of a pattern or practice.
• Creditors are required to verify the income and assets they rely on to determine repayment ability.
• Prepayment penalties are banned if the payment can change in the initial four years. For other higher-priced loans, a prepayment penalty period cannot last for more than two years. This rule is substantially more restrictive than originally proposed.
• Creditors are required to establish escrow accounts for property taxes and home-owner's insurance for all first-lien mortgage loans.

The rules also adopt the following protections for loans secured by a consumer's principal dwelling, regardless of whether the loan is higher-priced.

• Creditors and mortgage brokers may not coerce a real estate appraiser to misstate a home's value.
• Companies that service mortgage loans may not engage in certain practices, such as pyramiding late fees. In addition, servicers are required to credit consumers' loan payments as of the date of receipt and provide a payoff statement within a reasonable time of request.
• Creditors must provide a good-faith estimate of the loan costs, including a schedule of payments, within three days after a consumer applies for any mortgage loan secured by a consumer's principal dwelling, such as a home improvement loan or a loan to refinance an existing loan. Currently, early cost estimates are only required for home-purchase loans. Consumers cannot be charged any fee until after they receive the early disclosures, except a reasonable fee for obtaining the consumers' credit history.

For all mortgages, advertising rules now require additional information about rates, monthly payments and other loan features. The final rule bans seven deceptive advertising practices, including representing that a rate or payment is fixed when it can change.

The rule's definition of "higher-priced mortgage loans" will capture virtually all loans in the subprime market, but generally exclude loans in the prime market. To provide an index, the Federal Reserve Board will publish the average prime offer rate, based on a survey currently published by Freddie Mac. A loan is higher-priced if it is a first-lien mortgage and has an annual percentage rate that is 1.5 percentage points or more above this index, or 3.5 percentage points if it is a subordinate-lien mortgage. This definition overcomes certain technical problems with the original proposal, but the expected market coverage is similar.

One element of the original proposal has been withdrawn. The Federal Reserve Board had asked for public comment on certain requirements pertaining to so-called “yield-spread premiums." During the intervening period, the Board engaged in consumer testing that cast significant doubt on the effectiveness of the proposed rule. As part of its ongoing review of closed-end loan rules under Regulation Z, however, the Board will consider alternative approaches.

The new rules take effect on Oct. 1, 2009. The single exception is the escrow requirement, which will be phased in during 2010 to allow lenders to establish new systems as needed.