The Board of Governors of the Federal Reserve Board (the “Board”) published an interim rule on September 24, 2010 for which optional compliance began October 25, 2010 and is mandatory for transactions for which an application for credit for a mortgage transaction is received by a creditor on or after January 30, 2011. If you have any questions concerning this Compliance Memorandum, please contact Laura LaRaia.
The interim rule implements certain requirements of the Mortgage Disclosure Improvement Act of 2008 (“MDIA”) which amended the Truth in Lending Act (“TILA”). The amendments and this interim rule require creditors extending credit secured by real property or a dwelling (including cooperatives) to disclose certain information about interest rates and payment changes, in a tabular format, as well as a statement that consumers are not guaranteed to be able to refinance their transactions in the future. The interest rate and payment summary tables replace the payment schedule previously required as part of the TILA disclosure for mortgage transactions. Regulation Z disclosures for consumer credit such as unsecured loans and personal property secured loans will continue with the current payment schedule. Therefore, there is now a TILA disclosure specifically for mortgage transactions.
This memorandum will discuss the changes with regard to the interest rate and payment summary tables which will be implemented by MRG no later than the mandatory date.
The MDIA requires disclosure of payment examples if the loan’s interest rate or payments can change. The MDIA also requires disclosure of a statement that there is no guarantee the consumer will be able to refinance the transaction in the future.
Please note this is an interim rule. The Board is requesting input with regard to this rule.
Summary of the Rule
Under the interim rule, creditors are required to disclose in a tabular format the contract interest rate together with the corresponding monthly payment, including any escrows for taxes and property and/or mortgage insurance. Special disclosure requirements are imposed for adjustable-rate or step-rate loans to show the interest rate and payment at consummation, the maximum interest rate and payment at any time during the first 5 years after consummation, and the maximum interest rate and payment possible during the life of the loan. Additional disclosures are required for loans with negatively-amortizing payment options, introductory interest rates, interest-only payments, and balloon payments. The interim rule also requires the disclosure of a statement that there is no guarantee the consumer will be able to refinance the loan with a new transaction in the future. The Board intends to conduct additional testing of these and other disclosure requirements and may revise these interim provisions further in light of further testing results.
The rule contained model forms. The Board requires that disclosures be “substantially similar” to the model forms; however, the disclosures need not include shading which the model forms contain. A disclosure that does not include the shading shown in a model clause but otherwise follows the model clause’s headings and formats is substantially similar to the model clause.
This rule, adds a new Section 226.18(s) to Regulation Z to implement the MDIA.
“Adjustable-rate mortgage” means a transaction secured by real property or a dwelling for which the annual percentage rate may increase after consummation.
“Step-rate mortgage” means a transaction secured by real property or a dwelling for which the interest rate will change after consummation, and the rates that will apply and the periods for which they will apply are known at consummation.
“Fixed-rate mortgage” is not an adjustable-rate or step-rate mortgage.
“Interest-only” means that one or more of the periodic payments may be applied solely to the interest and not to loan principal.
“Amortizing loan” means a loan in which the payment of the periodic payments does not result in an increase of the principal balance.
“Negative amortization” means the regular periodic payments will result in an increase of the principal balance. “Negative amortization loan” is a loan with a negative amortization feature but explicitly excludes a reverse mortgage.
“Fully-indexed rate” means the interest rate calculated using the index value and margin at the time of consummation.
Regulation Z Section 226.18(s)
Section 226.18(s) requires creditors to disclose the contract interest rate, regular periodic payment and balloon payment, if applicable. For adjustable-rate or step-rate amortizing loans, up to 3 interest rates and corresponding periodic payments are required, including the maximum possible interest rate and payment. If payments are scheduled to increase independent of an interest-rate adjustment, the increased payment must be disclosed. Payments for amortizing loans must separately itemize an estimate of the amount for taxes and insurance if the creditor establishes an escrow account. If a borrower may make one or more payments of interest only, all payment amounts disclosed must be itemized to show the amount that will be applied to interest and the amount that will be applied to principal. Special rate and payment disclosures are required for loans with negative amortization. Creditors must provide the information about interest rates and payments in the form of a table, and creditors are not permitted to include other, unrelated information in the table.
When these disclosures are adopted in final form, the Board anticipates it will exclude reverse mortgages from the coverage of closed-end mortgage disclosure requirements. In the meantime, the Board is excluding reverse mortgages from the definition of “negative amortization mortgage” because the special interest rate and payment summary requirements for negative amortization mortgages would be especially unworkable for reverse mortgages. However, reverse mortgages are to be disclosed under the fixed-rate summary tables which will be discussed herein.
Fixed-Rate Fixed-Payment Loans
The new rule applies to fixed-rate fixed-payment mortgage loans as well as adjustable-rate loans even though the law itself applies to loans where the rate, payment or both may change. The interest rate and payment summary table is required for all transactions secured by real property or a dwelling, including fixed-rate fixed-payment mortgages.
The new disclosures are to be referred to as “Interest Rate and Payment Summary” rather than “Payment Schedule: Payments will Vary Based on Interest Rate Changes.”
Interest Rate and Payment Disclosures
If the interest rate is adjustable, the table indicates changes in the interest rate over time. Payment changes that are not based on adjustments to the interest rate are indicated in the table.
The interest rate and payment information must be disclosed in the form of a table. The MDIA requires conspicuous type size for the examples. Therefore, the table must be in a minimum 10-point font to ensure it is clear and conspicuous. The interim rule also prescribes the number of interest rates and payments that may be shown in the table. The number of columns and rows for the table will vary depending on whether the loan is an amortizing loan and whether it has an adjustable rate. In all cases, the tables must have no more than 5 columns across to avoid information overload for consumers.
Interest Rates – Amortizing Loans
For fixed-rate mortgages with no scheduled payment increases or balloon payments, the creditor discloses only the one interest rate which is applicable at consummation. Fixed-rate loans with payment increases require the creditor to disclose the interest rate along with each payment increase, even if the interest rate does not change. If a fixed rate mortgage has scheduled payment increases, the creditor must show the interest rate associated with the payment, even though the rate has not changed.
Interest Rates for Adjustable-Rate Mortgages and Step-Rate Mortgages
Creditors must disclose examples of payment increases, including the maximum possible payment for adjustable rate mortgages and other mortgages where payments may vary. Creditors must disclose more than one interest rate for adjustable-rate mortgages and step-rate mortgages because payments can vary.
The creditor must provide the interest rate at consummation and the period of time until the first adjustment labeled as “Introductory Rate and Monthly Payment.” Also required is the disclosure of the maximum possible rate at any time during the first 5 years after consummation, even if that is not the first adjustment, and the earliest date that the rate may apply.
Creditors are required to disclose the maximum interest rate that could apply at any time, and the earliest date on which the rate could apply. This disclosure is required for step-rate mortgages as well, because the rate and payment may increase. If an amortizing adjustable-rate mortgage has intermediate limitations on interest rate increases, then the table will have at least 3 columns; if the transaction has no intermediate limitations on interest rates, then the table will have 2 columns, one showing the rate at consummation and the other showing the maximum possible under the loan’s terms.
Interest Rate Applicable at Scheduled Payment Increases
Where a payment increase does not coincide with an interest rate adjustment, the creditor must include a column that discloses the interest rate that would apply at the time the adjustment is scheduled to occur, and the date on which the increase would occur. For a fixed rate mortgage, the creditor will show the same interest rate twice (and corresponding payments). This also applies to adjustable-rate mortgages and step-rate mortgages. Some adjustable rate mortgages permit the borrower to make interest-only payments for a specified period such as the first 5 years following consummation. A scheduled payment increase may or may not coincide with a scheduled interest rate adjustment. If a scheduled payment increase does not coincide with an interest rate adjustment (or rate increase for a step-rate mortgage), creditors must include a column that discloses the interest rate that will apply at the time of the increase, the date the increase is scheduled to occur, and an appropriate description such as “First Increase” or “First Adjustment”, as appropriate.
Interest Rates for Negative Amortization Loans
The interest rate at consummation is required to be disclosed. Some ARM loans do not provide any limitations on interest rate increases (interest rate caps); the only cap is the maximum possible interest rate. For these payment option loans, the creditor must disclose the interest rate in effect at consummation and assume that the interest rate reaches the maximum at the next adjustment, which could be the second month after consummation. A creditor must disclose that rate for the first and second scheduled payment increases. A creditor must also disclose that rate a third time, in the last column, when the loan has recast, i.e., converted to fully amortizing payments over the remainder of the loan’s term.
Introductory Rate Disclosure for Amortizing Adjustable-Rate Mortgages
A special disclosure is required of any introductory rate. An explanation of the introductory rate below the table itself is required. The introductory rate, how long it will last, and that the interest rate will increase at the first scheduled adjustment even if market rates do not increase are required disclosures. Creditors must also disclose the fully indexed rate that otherwise would apply at consummation or three days prior to consummation pursuant to MDIA. This disclosure is placed in a box beneath the table.
If a contract specifies that rate changes are based on an index in effect 45 days before the change date, creditors may use any index value in effect during the 45 days before consummation (or any earlier date of disclosure) in calculating the fully-indexed rate to be disclosed.
Payments for Amortizing Loans
Disclosure of the principal and interest payment amount that corresponds to each interest rate is required. Disclosure of the payment amount at any scheduled payment increase that does not coincide with an interest rate adjustment and the date on which the increase is scheduled to occur must be made.
If an escrow account will be established, the creditor must disclose the estimated payment amount for taxes and insurance including any mortgage insurance. The payment amount should reflect the consumer’s mortgage insurance payments until the date on which the creditor automatically terminates coverage under applicable law, even though the consumer may have a right to request the insurance be cancelled earlier. Periodic mortgage insurance payments should be included in the escrow line of the summary table even if they are not escrowed and even if there is no escrow account established for the transaction.
Credit insurance premiums or payments should not be included in disclosed escrow amounts.
Total Periodic Payments
The total estimated monthly payment is the sum of principal and interest payments and estimated taxes and insurance payments.
With regard to interest-only payments, these rules apply only if the loan is not a negative amortization loan. If the loan is a negative amortization loan, even if it has only an interest-only feature, payments are disclosed under the negative amortization rules discussed below.
If any regular periodic payment amounts will include interest but not principal, all payments for the loan must be itemized into principal and interest. For a payment that includes no principal, the creditor is required to indicate that none of the payment amount will be applied to principal. The creditor must label the dollar amount to be applied to interest as “Interest Payment.” This itemization and labeling is to highlight for consumers the impact of making interest-only payments.
Payments for Negative Amortization Loans
For each interest rate disclosed for a loan with negative amortization, the creditor must disclose payments in two separate rows. One row of the table shows the fully amortizing payment for each interest rate. For purposes of calculating these payments, the creditor must assume that the interest rate reaches the maximum at the earliest possible date and that the consumer makes only fully amortizing payments. The other row of the table shows the minimum required payment for each rate, until the recast point. At the recast point, the minimum payment row shows the fully amortizing payment. For purposes of the minimum payment row, creditors must assume that the interest rate reaches the maximum at the earliest possible date and that the consumer makes only the minimum required payment for as long as permitted under the terms of the legal obligation.
The interest rate and payment summary would display only two payment options, even if the terms of the legal obligation provide for others: the option to make minimum payments that would result in negative amortization and the option to make fully amortizing payments.
In all negative amortization cases, the rule requires that creditors reflect all applicable terms, including rate adjustment caps, maximum negative amortization amounts and periods, and maximum interest rates.
The rule also requires a disclosure of the amount of the minimum required payment applicable for each interest rate to be disclosed and the date on which that payment becomes applicable.
If adjustments in the minimum payment amount are limited such as the payment will not fully amortize the loan even after the interest rate has reached the maximum, a disclosure of the minimum payment amount at the first and second payment adjustments is required. Where the first interest rate adjustment will be the only interest rate adjustment, but payment adjustments will continue to occur before the minimum payment recasts to a fully amortizing payment, a disclosure of up to two additional minimum payment adjustments is required.
The creditor must also provide a statement that the minimum payment will cover only some of the accrued interest and none of the principal and will cause the principal balance to increase.
Disclosure of fully amortizing payments that will be required when the loan recasts must be made. This payment amount must reflect the maximum possible interest rate that will be applicable at that time based on the terms of the legal obligation.
Disclosures are required in a separate row of the table of the fully amortizing payment, assuming that the consumer makes only fully amortizing payments beginning at closing. The fully amortizing row must be completed for each interest rate required to be disclosed.
If a loan’s terms provide for a balloon payment, the payment must be disclosed in the last row of the table rather than in a column, unless it coincides with an interest rate adjustment or other payment increase such as the expiration of an interest-only option.
Special Disclosures for Negative Amortization Loans
A statement of the amount of the increase in the loan’s principal balance if the consumer makes only minimum payments and the earliest month and year in which the minimum payment will recast to a fully amortizing payment, assuming that the interest rate reaches its maximum at the earliest possible time, is required.
A statement directly above the interest rate and payment summary table explaining that the loan offers payment options is required. The explanation preceding the table must also state the maximum possible interest rate and the smallest number of months or years in which the interest rate could reach its maximum. The creditor also must disclose whether an escrow account will be established, and if so, an estimate of the amount of taxes and insurance included in each payment. Mortgage insurance payments decline over a loan’s term, and the payment amounts shown in the table should reflect the mortgage insurance payment that will be applicable at the time each disclosed periodic payment will be in effect. The disclosed mortgage insurance payment will be zero if it corresponds to a periodic payment that will occur after the creditor will be legally required to terminate mortgage insurance.
The fact there is no guarantee that the consumer will be able to refinance the transaction to lower the interest rate or monthly payment must be made in conspicuous type size and format on the TILA disclosure form.