New Business Rules for Higher Priced Mortgage Loans

By Fredric J. Gooch - General Counsel, DocuTech Corporation

(Note:  This is a revised article from several months ago addressing this topic.  The article has been updated to include information about new data integrity checks added to the ConformX application)

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.

HMPLs 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 of 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.  The escrow requirements are effective on April 1, 2010 for site-built homes, and on October 1, 2010 for manufactured homes.

DocuTech has implemented several software modifications to help lenders comply with these new rules.  The PredCheck service provided by Interthinx through the ConformX interface will run tests to determine if a loan if an HPML.  If a loan qualifies as an HPML ConformX will run three data integrity tests to ensure that the loan meets all the HPML requirements.  The first will warn the user if the loan is a first lien HMPL without an escrow account.  The second test will warn the users if the HPML has a prepayment penalty that lasts more than two years.  The third test will warn the user if the HPML has a prepayment penalty if the loan payment can change during the four years.  The Interthinx tests along with these new business rules inside of ConformX will help make sure that you have a solid safety net in place to avoid costly regulatory errors.

We are starting to see states such as California, Connectiut, Maine, Maryland, New York, North Carolina and Oklahoma pass their own state versions of the HPML loans to regulate the subprime mortgage market.  These state tests are also checked inside the PredCheck service and state specific disclosures will print based off a failed test.  We will continue to see states mimic the federal law and pass their own legislation as time passes, so DocuTech will continue to ensure that the tests are updated and that the correct documents are printing where applicable.     

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 lenders now have one more compliance concern to worry about.  DocuTech is committed to helping its customers navigate this increasingly complex regulatory landscape through providing compliant services and technology makes it easier for lenders to cope with these challenging regulations.