“Higher Priced Mortgage Loans” or How I Learned to Stop Worrying and Love Regulation Z

By DocuTech Compliance Team

On October 1, 2009 the Federal Reserve implemented a new rule designed to regulate the closed-end subprime mortgage market.  The rule can be found in Regulation Z at 12 C.F.R. § 226.35.  It is commonly referred to as Section 35 or the “higher-priced mortgage loan” rule.  The rule establishes triggers for categorizing loans as “higher-priced mortgage loans” and sets forth special rules and restrictions that apply to loans that fall into the category.  This article will refer to Higher Priced Mortgage Loans as “HPML.”  The rule was designed to protect consumers from unfair, deceptive and abusive lending and servicing practices, improve mortgage advertising and to provide consumers with disclosures early in the lending process.  This article will provide an overview of the rule and explain how DocuTech can help.

HPMLs are defined as a “consumer credit transaction secured by the consumers principal dwelling” where certain APR thresholds are met (which are discussed later).  In order to determine which loans are covered one must look at the definitions of “consumer credit” and “principal dwelling.”    “Consumer credit” is defined by the regulation as “credit offered or extended to a consumer primarily for family, or household purposes.”  12 C.F.R. § 226.2(a)(12).  The meaning of “principal dwelling” is clarified in the commentary to Regulation Z and is generally understood to mean owner occupied real property.  Thus loans that are not extended primarily for family or household purposes are excluded, so are loans that are not occupied by the owner.  Construction loans, reverse mortgages, bridge loans and home equity lines of credit are also excluded from the HPML regulation.  The regulation covers all other loans for which a creditor receives an application on or after October 1, 2009.

An HPML is defined as a consumer credit transaction secured by the consumer’s principal dwelling for which the APR 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 loans secured by a first lien on a dwelling, or by 3.5 or more percentage points for loans secured by a subordinate lien.

The thresholds are based on the “average prime offer rate” (APOR).  The APOR is defined as an annual percentage rate that is derived from average interest rates, points, and other loan pricing terms currently offered to consumers by a representative sample of creditors for mortgage transactions that have low-risk pricing characteristics. The Board publishes average prime offer rates for a broad range of types of transactions in a table updated at least weekly as well as the methodology the Board uses to derive these rates.

HPMLs are subject to the following restrictions:

1. Repayment Ability – creditors are prohibited from extending credit based on the consumer’s collateral without regard to the consumer’s repayment ability.
2. Prepayment Penalties – Prepayment penalties are prohibited unless the penalty will not apply after the two year period following consummation, the penalty will not apply if the source fo the prepayment funds is a refinancing by the creditor or an affiliate of the creditor, and the amount of the periodic payment of principal or interest or both may not change during the four year period following consummation.  The Federal Reserve Board has recently issued clarification regarding interest charges on FHA loans that are prepaid, those charges are not considered prepayment penalties under the rule.
3. Escrows - A creditor may not extend a loan secured by a first lien on a principal dwelling unless an escrow account is established before consummation for payment of property taxes and premiums for mortgage-related insurance required by the creditor, such as insurance against loss of or damage to property, or against liability arising out of the ownership or use of the property, or insurance protecting the creditor against the consumer’s default or other credit loss.  This escrow restriction does not apply to loans secured by shares in a cooperative or for condominium units where the condominium association has an obligation to the condominium unit owners to maintain a master policy insuring the units.  The creditor may permit the consumer to cancel the escrow account only in response to a consumer’s written request dated no earlier than 365 days following consummation.

This new regulation, as with most others, has good intentions.  Its aim is to protect borrowers from abuses that were common in the subprime mortgage market.  Unfortunately there is virtually no subprime mortgage market to regulate at this time.  The actual impact of the HPML rule is yet to be determined, but hopefully it does not overreach its original intent and disrupt the non-subprime mortgage business.  In a way it already has because now lenders have one more compliance concern to worry about.  DocuTech is committed to helping its customers navigate this increasingly complex regulatory landscape.  For this reason, DocuTech has teamed up with Interthinx to provide PredCheck loan audits through ConformX.  The PredCheck tests will audit loans to ensure that they are compliant with the new HMPL regulations.