by Amy Kleinschmit, Director of Compliance

DATES: The rule is effective January 10, 2014.

Final rule and CFPB material can be found here: http://www.consumerfinance.gov/regulations/ability-to-repay-and-qualified-mortgage-standards-under-the-truth-in-lending-act-regulation-z/

This final rule amends record retention requirements under §1026.25 to extend the time frame by one year, now three years, that a creditor must retain evidence of compliance for transactions covered by §1026.43, which is the new section under Regulation Z titled, Minimum standards for transactions secured by a dwelling.  The documentation requirements of this new section direct that the creditor be able to demonstrate compliance.  The creditor does not need to retain the actual paper copy used in underwriting, but must be able to reproduce the record accurately. For example, if the creditor uses a consumer’s IRS Form W-2 to verify the consumer’s income, the creditor must be able to reproduce the IRS Form W-2 itself, and not merely the income information that was contained in the form.

The scope of new §1026.43, applies to any consumer credit transaction that is secured by a dwelling, including any real property attached to a dwelling, other than: (1) A home equity line of credit subject to § 1026.40; and (2) A mortgage transaction secured by a consumer’s interest in a timeshare plan, as defined in 11 U.S.C. 101(53(D)).  A dwelling means “a residential structure that contains one to four units, whether or not that structure is attached to real property. The term includes an individual condominium unit, cooperative unit, mobile home, and trailer, if it is used as a residence.” 12 CFR 1026.2(a)(19) For purposes of §1026.43 (c) repayment ability, (d) refinancing of non-standard mortgages, (e) qualified mortgages and (f) balloon-payment qualified mortgages made by certain creditors, a reverse mortgage subject to § 1026.33; a temporary or “bridge” loan with a term of 12 months or less, such as a loan to finance the purchase of a new dwelling where the consumer plans to sell a current dwelling within 12 months or a loan to finance the initial construction of a dwelling; or a construction phase of 12 months or less of a construction-to-permanent loan are also excluded from the scope of this section.  §1026.43 does not apply to an extension of credit primarily for a business, commercial, or agricultural purpose, even if it is secured by a dwelling.

A creditor cannot structure a loan as an open-end plan to evade the requirements of this section. Credit secured by a consumer’s dwelling that does not meet the definition of open-end credit in § 1026.2(a)(20), has to comply with this section unless otherwise exempt under these rules.

Repayment ability.  This is found under the new §1026.43(c). This section requires that a creditor make a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan according to its terms.  This requirement applies to “covered transactions” which is a new term defined as “a consumer credit transaction that is secured by a dwelling, including any real property attached to a dwelling, other than a transaction exempt from coverage under paragraph (a) of this section.”   Note, “coverage under paragraph (a)” refers to the scope of this new section as discussed above.

To make this “reasonable and good faith” determination the creditor must consider eight factors. These factors are (i) the consumer’s current or reasonably expected income or assets, other than the value of the dwelling, including any real property attached to the dwelling, that secures the loan; (ii) If the creditor relies on income from the consumer’s employment in determining repayment ability, the consumer’s current employment status; (iii) The consumer’s monthly payment on the covered transaction, calculated in accordance with this regulation; (iv) The consumer’s monthly payment on any simultaneous loan that the creditor knows or has reason to know will be made, calculated in accordance with this regulation; (v) The consumer’s monthly payment for mortgage-related obligations; (vi) The consumer’s current debt obligations, alimony, and child support; (vii) The consumer’s monthly debt-to-income ratio or residual income in accordance with this regulation; and (viii) The consumer’s credit history.

Commentary to this new section explains that “whether a particular ability-to-repay determination is reasonable and in good faith will depend not only on the underwriting standards adopted by the creditor, but on the facts and circumstances of an individual extension of credit and how a creditor’s underwriting standards were applied to those facts and circumstances.  A consumer’s statement or attestation that the consumer has the ability to repay the loan is not indicative of whether the creditor’s determination was reasonable and in good faith.”

This determination must be made at or before consummation. An unanticipated change after consummation that cannot be reasonably determined from the application or records is not relevant for determining compliance; however, if the records and/or application reviewed at or before consummation indicate there will be a change in a consumer’s repayment ability after consummation the creditor must consider that information under the rule.  For example, if a consumer’s application states that the consumer plans to retire within 12 months without obtaining new employment or that the consumer will transition from full-time to part-time employment, this information must be considered under the rule. However, creditors still must comply with Regulation B and its requirements.

Generally, this information must be verified using “reasonably reliable” third party records.  For purposes of verifying the amounts of “income or assets” the new regulation provides specific examples of documents that the creditor can use, such as verifying the consumer’s income using a tax return transcript issued by the IRS. Some examples of other records the creditor may use to verify the consumer’s income or assets include: copies of tax returns the consumer filed with the IRS or a State taxing authority; IRS Form W-2s or similar IRS forms used for reporting wages or tax withholding; payroll statements, including military Leave and Earnings Statements; or financial institution records.  The records need to be specific to the consumer and not, for example, average incomes in the consumer’s geographic location or average wages paid by the consumer’s employer.

As noted above, the creditor must determine “the consumer’s monthly payment on the covered transaction, calculated in accordance with this regulation.”  This means using the fully indexed rate or any introductory interest rate, whichever is greater; and monthly, fully amortizing payments that are substantially equal.  The commentary to this new section provides examples of how to determine the consumer’s repayment ability based on substantially equal, monthly, fully amortizing payments.

There are special rules for making the “monthly payment” determination for loans with a balloon payment, interest-only loans and negative amortization loans. For example, with reference to a loan with a balloon payment, the creditor must use the maximum payment scheduled during the first five years after the date on which the first regular periodic payment will be due for a loan that is not a higher-priced covered transaction; or the maximum payment in the payment schedule, including any balloon payment, for a higher-priced covered transaction.  Which brings up another new phrase “higher-priced covered transaction” and in this situation means “a covered transaction with an annual percentage rate that exceeds the average prime offer rate for a comparable transaction as of the date the interest rate is set by 1.5 or more percentage points for a first-lien covered transaction, or by 3.5 or more percentage points for a subordinate-lien covered transaction.”

With regard to determining monthly debt-to-income ratio or residual income the regulation provides additional guidance.  For monthly debt-to-income ratios, the creditor must consider the ratio of the consumer’s total monthly debt obligations to the consumer’s total monthly income. “Total monthly debt obligations” mean the sum of the payment on the covered transaction; simultaneous loans; mortgage-related obligations; and current debt obligations, alimony, and child support. “Total monthly income” means the sum of the consumer’s current or reasonably expected income, including any income from assets.

If a creditor chooses to consider the consumer’s monthly residual income, then the creditor must consider the consumer’s remaining income after subtracting the consumer’s total monthly debt obligations from the consumer’s total monthly income.

This final rule also addresses refinancing of non-standard mortgages.  A “non-standard mortgage” is a “covered transaction” (as defined above) that is an adjustable-rate mortgage, with an introductory fixed interest rate for a period of one year or longer; an interest-only loan, or a negative amortization loan.  New §1026.43(d) will apply when a non-standard mortgage is refinanced into a standard mortgage if certain conditions are met.  If the requirements and conditions are met under this paragraph it provides an exemption to the “repayment ability” requirements previously discussed.  To qualify for the exemptions, a creditor must have considered, first, whether the consumer is likely to default on the existing mortgage once that loan is recast and, second, whether the new mortgage likely would prevent the consumer’s default.

Also, if a transaction meets all these requirements the creditor has some flexibility to offer the consumer rate discounts and terms that are the same as, or better than, the rate discounts and terms that the creditor offers to new consumers.

The conditions/requirements that must be met in addition to the two part determination, include (i) The creditor for the standard mortgage is the current holder of the existing nonstandard mortgage or the servicer acting on behalf of the current holder; (ii) The monthly payment for the standard mortgage is materially lower than the monthly payment for the non-standard mortgage, as calculated under the regulation (Whether the new loan payment is “materially lower” than the non-standard mortgage payment depends on the facts and circumstances. In all cases, a payment reduction of 10 percent or more meets this criteria.); (iii) The creditor receives the consumer’s written application for the standard mortgage no later than two months after the non-standard mortgage has recast; (iv) The consumer has made no more than one payment more than 30 days late on the non-standard mortgage during the 12 months immediately preceding the creditor’s receipt of the consumer’s written application for the standard mortgage; (v) The consumer has made no payments more than 30 days late during the six months immediately preceding the creditor’s receipt of the consumer’s written application for the standard mortgage; and (vi) If the non-standard mortgage was consummated on or after January 10, 2014, the non-standard mortgage was made in accordance with the regulation (ability to repay requirements).

A “standard mortgage” as used under this section means “a covered transaction:

·       That provides for regular periodic payments that do not: (1) Cause the principal balance to increase; (2) Allow the consumer to defer repayment of principal; or (3) Result in a balloon payment;

·       For which the total points and fees payable in connection with the transaction do not exceed the amounts specified in the regulation;

·       For which the term does not exceed 40 years;

·       For which the interest rate is fixed for at least the first five years after consummation; and

·       For which the proceeds from the loan are used solely for the following purposes: (1) To pay off the outstanding principal balance on the non-standard mortgage; and (2) To pay closing or settlement charges required to be disclosed under the Real Estate Settlement Procedures Act, 12 U.S.C. 2601 et seq.”

As noted above in the definition of a “standard mortgage,” to fall within this category the proceeds from the loan can only be used for two purposes.  If the proceeds of a covered transaction are used for other purposes, such as to pay off other liens or to provide additional cash to the consumer for discretionary spending, the transaction does not meet the definition of a “standard mortgage.”

Paragraph (g) of the new §1026.43 addresses prepayment penalties, including specifying when prepayment penalties are permitted and limits on prepayment penalties.  This section also restricts a creditor from offering a consumer a “covered transaction” with a prepayment penalty unless the creditor also offers the consumer an alternative “covered transaction” without a prepayment penalty.  This alternative must meet certain conditions in the regulation.

Should you have any questions or concerns on this or any other compliance issue, please do not hesitate to contact Amy Kleinschmit at akleinschmit@cuad.coop or 701.214.9721.