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Following calls by Congress and consumers to use its powers under the Home Ownership and Equity Protection Act ("HOEPA") to make changes to regulations to avoid adverse and improper practice in the housing credit sector, the Board of Governors of the Federal Reserve System ("Board") has adopted a definitive regulation amending Regulation Z to include new safeguards for consumers.
A definitive regulation, including changes to the official staff commentary on Regulation Z ("Comment"), will enter into force on 1 October 2009 (with the exception of the new escrow requirement, which will enter into force in 2010). There are three major classifications of changes made by the definitive rule: Basic new regulations for "higher endowed mortgage loans.
" Under the new rules, a new class of mortgages will be created, known as " higher-priced mortgages" ("HPMLs"), giving additional protection to those who receive them. HPML are not as expensive as "high-priced mortgages " already backed by HOEPA ("HOEPA loans"), so even more mortgages will now be protected under the Truth-in-Lending Act ("TILA").
The term APML is used to describe any mortgages guaranteed by the borrower's main residence and having an APR that surpasses a new index called the "average primary interest rate" that the Board of Directors will release by a specified amount. However, a First Diene Senior Term Note is an APML if it has an APR that is 1.5 per cent or more above the average prime offering rate for a similar trade, and a subordinated pledge is an APML if it has an APR that is 3.5 per cent or more above the average prime offering rate for a similar trade.
HPMLs will also benefit from extra protection for most, if not all, HOEPA mortgages, as such mortgages are now highly likely to be included in the new HPML group. Charge restrictions, more disclosure for most mortgages taken out. Under the new rules, creditors of all covered mortgages collateralised by the borrower's main home (regardless of the borrower's annual percentage rate of charge) ("CMLs") will be offered extended cover for the TILA requirements to make early disclosure for all existing credit lines, and the lender's or broker's option to charge charges related to a CML will be restricted before early disclosure is made to the lender.
Sets new standards for the promotion of all mortgages TILA covers. The following debate provides an outline of the main changes made to Regulation No. 1 as a result of the definitive regulation. Although we also note some of the more significant commentary changes that are part of the definitive rules, anyone in charge of enforcing the definitive rules should check the commentary changes in their totality.
Important information is contained in the changes to the commentary and in the detailed additional information provided by the Executive Board, which is attached to the definitive regulation. Liberated credits - Certain credits that would otherwise be covered by the HPML are excluded from the HPML safeguards. This includes either temp or "bridge" mortgages with a maturity of 12 month or less (e.g. a home buyer who is planning to buy his present home within 12 months), reversal mortgages and home equity facilities ("HELOCs").
Solvency - For HOEPA lending, TILA currently bans a sample or practise of lending on the basis of security provided by a non-repayable user and suspects an infringement if a lender has a sample or practise not to check and record the repayability.
However, the definitive provision annuls the qualifying "pattern or practice", so that if an HPML or HOEPA senior note (other than a HOEPA senior note, which is a 12-month or less transient or "bridge" senior note) is renewed on the basis of the security, the TILA is now in breach, regardless of the borrower's capacity to pay back earnings and asset other than the security.
Review of incomes and wealth - Under the definitive rules, bondholders must review the incomes and wealth they depend on to produce HPMLs (in reality, the prohibition of stated incomes HPMLs). That is a harder attitude than the Board adopted the proposal to extend easily the existing Regulation Z for HOEPA lending to HPMLs, which provides that a model or noncontrol practise gives a suspicion of infringement.
However, the definitive rules again waive the "sample or practice" eligibility and make the verification of the borrower's repayability and ongoing commitments a positive condition for all HOEPA and HPMLs. Assumption effect - The definitive provision provides that a lender has presumably fulfilled the obligation to take into consideration the borrower's repayability when the lender:
1. verify the consumer's eligibility for reimbursement by means of appropriate documentation; 2. determine the consumer's eligibility for reimbursement using the highest planned repayments of interest and principal during the first seven years after drawdown (which in most cases requires the use of the fully-indexed variable rate of interest for floating-rate borrowings and the full repayments for borrowings that allow less than full amortisation), taking into consideration real estate taxes, insurances and similar mortgage-related expenditure; and 3. determine the consumer's eligibility for reimbursement either on the basis of a relationship of aggregate indebtedness to aggregate indebtedness to a relationship of indebtedness to similar mortgage-related expenditure; and 3. determine the consumer's eligibility for reimbursement using the highest planned repayments and interest paid during the first seven years after drawdown (which in most cases requires the use of the full-fixed rate for floating rate borrowings and the full repayments for borrowings that allow less than full amortisation).
However, this presumption of conformity is not available for credits with a ballon due in less than seven years or credits with planned repayments that result in adverse amortisation within the first seven years. Evade - The last exception forbids structuring an open-ended mortgage based on HTML to prevent new demands on HPMLs.
Punishments; Withdrawal - Under the definitive rules, an HPML with a down payment that does not meet the new requirement is governed by a borrower's three-year right of withdrawal (unless the HPML is a home buying credit or another class of credit that is exempted from withdrawal).
As the new HPML and CML limitations (see below) are the result of the Board's power under HOEPA, it seems that TILA will hold breaches of these limitations (as well as the new HOEPA loan limitations) liable under common law, as well as the increased legal damage currently available for breaches of current HOEPA loan covenants.
This last provision introduces new constraints that affect all CLMs, regardless of the annual percentage rate of charge. Expert Influence - The ultimate rules prohibit any lender or realtor, or any affiliated company of a lender or realtor, from directly or indirectly forcing, inducing or otherwise discouraging an expert to falsely state or present the value of a home that backs a CML.
This last regulation contains various instances of acts that infringe and do not infringe the ban. Likewise, it shall prohibit a believer who knows that there has been a breach of the mandatory ban of the expert in relation to an expert opinion from granting a loan on the basis of that expert opinion unless the believer has documented that he has established with due care that the expert opinion does not substantially erroneously state or present the value of the real estate.
Delayed charges, crediting of payments, refund offers - The definitive rules also apply to CML service providers. The Commission forbids staff members to pyramid delay charges - a delay charge if a full amount has been paid on schedule and the only delay is due to a delay charge levied on a previous one. Irrespective of the fact that the Mortgagor transfers a cheque and the Service Provider accept a cheque that does not comply with the Service Provider's original money order, the Service Provider will be requested to issue a cheque within five workingdays of receiving the cheque.
Also, the definitive rules prohibit staff from missing out within a reasonable deadline after a call for tenders, and the changes to the comment which form part of the definitive rules establish a five-day safety harbour after call. A further ban in the proposition, which would have obliged staff members to submit a scale of fees on demand, was not adopted in the definitive regulation.
Indemnification of the realtor: One of the most significant and contentious changes included in the proposal was the requirements that a hypothecary disclose in advance to his CML clients the aggregate amount of indemnification he will obtain in the deal from both the borrowers and the lenders, and that a borrower does not provide a hypothecary with indemnification that would cause the aggregate indemnification of the hypothecary to surpass the amount so revealed.
Great message for real estate agents is that this part of the proposal has been retracted by the Board in the definitive scheme. The Board of Directors stated, however, that it would further explore ways to address possible injustices to customers in the context of brokerage agreements, such as return differential premium, and would further consider possible disclosures or other redress against such possible injustices in the context of its on-going full revision of Regulation Z. The definitive regime also provides that for any loans for which an early TIL must be provided, no charge other than a charge for a loan statement may be made by a lender or any other individual before the customer makes the early TIL available to the Group.
Finally, the definitive rules also change the definitions of'business day' in Regulation Z so that, for the purpose of this assumption, a'business day' has the same significance as the measurement of the three-day withdrawal time. Commentary changes in the definitive rules give an indication of how the restriction on fees should be applied to mortgages filed by estate agents.
There is good information that the Board has refused to allow any attempt by consumers groups to widen HOEPA's liability under commercial law to include breaches of early TILs. This last regulation aims to remove certain deceptive marketing techniques which have been observed in recent years and which are likely to have helped the sub-prime mortgage crises. Open credits - The definitive rules impose new disclosures when an ad for a HELOC contains a "promotion rate" or "promotion payment".
" Promotion Rate" means an annual rate of interest payable on a HELOC floating rate that is not indexed and does not depend on the spread used to adjust the Plans and is less than an appropriate annual rate of interest that would be in effect on the basis of that index and spread. An " incentive amount " for a Floating Scheme is the amount of each minima that is not index linked and does not depend on the margins used to calculate the amount of other minima and, in the case of an implied net amount, is less than the amount of other minima that would otherwise be applied in a relatively recent index and margins use.
In the case of fixed rate schemes, a'grant payment' is the amount of any minima lower than the amount of other minima from the scheme, assuming a net outturn. According to the new rules, any inclusion in an ad of a promotion tariff or payout triggers the need to clearly and conspicuously display "with equivalent emphasis and in the immediate vicinity of" the promotion tariff or payout, the duration of the promotion tariff or payout, and information about the tariffs or payouts after the promotion.
Changes to the new rules require this extra information to be considered equivalent and closely related if it is in the same font and immediately adjacent to or directly above or directly below the promotion tariffs or payment, without the need for intermediate text or graphic display.
Changes to the commentary in the definitive rules contain new commentaries that interprete the clear and prominent current standard for web, TV and verbal advertising for heelocs. Furthermore, the definitive rules contain a new alternate means of disclosing HELOC advertising on TV and in broadcasting. Likewise, the definitive rules incorporate new disclosures regarding the fiscal impact of schemes where advertising indicates that the loan being promoted may be in excess of the property's current value.
Loans contracted - The definitive regulation modifies Regulation Z to include a "clear and conspicuous" default that specifically covers all contracted loans advertising, as well as new reporting obligations and bans that cover advertising for contracted loans backed by home visits. According to the definitive rules, the incorporation of a single interest rate into an ad for a home collateral ised if, during the period of the promised advance, more than one single interest rate per annum is applicable, or the amount of a single annuity triggers the need to publish supplementary information about the single interest rate(s) and the APR or the payment(s).
Such supplementary information shall be made public "with the same emphasis and in the immediate vicinity" of the tariff promoted or of the transaction which gave rise to the supplementary information. Commentary changes, which are part of the definitive rules, specify the use of the clear and prominent norm on intrinsically safe credit advertising on the web, on TV and orally, and also specify the equivalence and closeness criteria that are part of this norm.
Furthermore, the definitive rules include a new alternate display possibility for TV and radiobroadcasting based on the similar new open credits policy. According to the definitive rules, only a single interest rate per annum may be published in connection with the APR for concluded intrinsically safe credits. Furthermore, for all contracted exposures, the equivalence and closeness requirements are extended to the advertising of floating rate exposures that encourage an early discount rate, and it is clarified that when the'repayment terms' disclosures requirements are initiated, those conditions must mirror repayments commitments throughout the life of the exposure, up to and beyond a certain period, even if a bubble is paid.
Ballon payments of this kind are also equally important in terms of celebrity and spatial closeness. As well as implementing the Bankruptcy Act rules, the definitive scheme contains new obligations to disclose the fiscal impact of locked credits where advertising indicates that the loan applied for may be greater than the property's commercial value.
The following deceptive promotional techniques are prohibited by the ultimate rule relating to a contracted, intrinsically safe credit: (1) the use of the term "fixed" to reference interest rate, repayment or lending in an advert for floating-rate debt or other debt where the repayment rises when certain terms are not met; (2) the comparison of a consumer's present real or implied interest rate or repayment amount with the interest rate or repayment amount available under the promised debt where certain terms are not met; (3) the false use of the term "fixed" to designate the interest rate, repayment or lending in an advert for a floating-rate debt or other debt where the repayment rises when certain terms are not met;
4. use the name of the consumer's present mortgagor in advertising, such as advertising, without specifying who is advertising and that that individual is not affiliated with or acts on the creditor's creditor's behalf; 5. make deceptive allegations that a credit eliminates the debts;
6. Use the word'adviser' to designate a for-profit creditor or agent; and 7. Advertise information about certain triggers or other necessary disclosure, such as an initially reduced interest rate, in a non-English language, while information about other triggers or necessary disclosure, such as a fully indexed interest rate, is provided only in English.
Commercial Violation Liabilities - Since the new seven bans on deceptive marketing activities in relation to committed, household-backed loans, such as the new HPML and CML safeguards, are also rooted in the HOEPA Board of Directors' agency, it seems that breaches of these bans would also be liable to similar commercial liabilities, with increased HOEPA legal losses.
The implementation of the new rules will involve significant changes in operations, but the definitive regime is unlikely to entail any significant changes in the markets, as in many ways it merely codifies the changes in practice that have already been made. Some of the most serious instances of abuse have already been curbed, notably by the drastic reduction in the appetites of alternative players for sub-prime and Alt-A credit, which are the most widespread, and in part by the guidance papers on sub-prime and non-traditional mortgages issued last year by US regulatory authorities (and now adopted by most state regulators).
Whilst the definitive rules are unlikely to significantly change the originality policies of originators and intermediaries, the definitive rules are likely to have a significant effect on promotional policies. In recent years, with little opposition from regulatory authorities, some mortgages and brokerage firms have routinely described their product and/or misled their offerings in their ads and prompts, thereby giving them a distinct advantage over other creditors and brokerage firms.
Under the assumption that the regulatory authorities enforce forcefully the marketing limitations contained in the definitive regulation and that the capacity for legal redress results in stricter regulatory enforcement, both consumer and serious creditors and intermediaries should profit.