27390 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

FEDERAL RESERVE SYSTEM 

12 CFR Part 226 

[Regulation Z; Docket No. R–1417] 

RIN 7100–AD75 

Regulation Z; Truth in Lending 

AGENCY: Board of Governors of the 

Federal Reserve System. 

ACTION: Proposed rule; request for 

public comment. 

SUMMARY: The Board is publishing for 

public comment a proposed rule 

amending Regulation Z (Truth in 

Lending) to implement amendments to 

the Truth in Lending Act (TILA) made 

by the Dodd-Frank Wall Street Reform 

and Consumer Protection Act (DoddFrank Act or Act). Regulation Z 

currently prohibits a creditor from 

making a higher-priced mortgage loan 

without regard to the consumer’s ability 

to repay the loan. The proposal would 

implement statutory changes made by 

the Dodd-Frank Act that expand the 

scope of the ability-to-repay 

requirement to cover any consumer 

credit transaction secured by a dwelling 

(excluding an open-end credit plan, 

timeshare plan, reverse mortgage, or 

temporary loan). In addition, the 

proposal would establish standards for 

complying with the ability-to-repay 

requirement, including by making a 

‘‘qualified mortgage.’’ The proposal also 

implements the Act’s limits on 

prepayment penalties. Finally, the 

proposal would require creditors to 

retain evidence of compliance with this 

rule for three years after a loan is 

consummated. General rulemaking 

authority for TILA is scheduled to 

transfer to the Consumer Financial 

Protection Bureau (CFPB) on July 21, 

2011. Accordingly, this rulemaking will 

become a proposal of the CFPB and will 

not be finalized by the Board. 

DATES: Comments on this proposed rule 

must be received on or before July 22, 

2011. All comment letters will be 

transferred to the Consumer Financial 

Protection Bureau. 

ADDRESSES: You may submit comments, 

identified by Docket No. R–1417 and 

RIN No. 7100–AD75, by any of the 

following methods: 

• Agency Web Site: http:// 

www.federalreserve.gov. Follow the 

instructions for submitting comments at 

http://www.federalreserve.gov/ 

generalinfo/foia/ProposedRegs.cfm. 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

• E-mail: 

regs.comments@federalreserve.gov. 

Include the docket number in the 

subject line of the message. 

• Fax: (202) 452–3819 or (202) 452– 

3102. 

• Mail: Address to Jennifer J. Johnson, 

Secretary, Board of Governors of the 

Federal Reserve System, 20th Street and 

Constitution Avenue, NW., Washington, 

DC 20551. 

All public comments will be made 

available on the Board’s Web site at 

http://www.federalreserve.gov/ 

generalinfo/foia/ProposedRegs.cfm as 

submitted, unless modified for technical 

reasons. Accordingly, comments will 

not be edited to remove any identifying 

or contact information. Public 

comments may also be viewed 

electronically or in paper in Room MP– 

500 of the Board’s Martin Building (20th 

and C Streets, NW.) between 9 a.m. and 

5 p.m. on weekdays. 

FOR FURTHER INFORMATION CONTACT: 

Jamie Z. Goodson, Catherine Henderson, 

or Priscilla Walton-Fein, Attorneys; Paul 

Mondor, Lorna Neill, Nikita M. Pastor, 

or Maureen C. Yap, Senior Attorneys; or 

Brent Lattin, Counsel; Division of 

Consumer and Community Affairs, 

Board of Governors of the Federal 

Reserve System, Washington, DC 20551, 

at (202) 452–2412 or (202) 452–3667. 

For users of Telecommunications 

Device for the Deaf (TDD) only, contact 

(202) 263–4869. 

SUPPLEMENTARY INFORMATION: 

I. Summary of the Proposed Rule 

The Dodd-Frank Wall Street Reform 

and Consumer Protection Act (DoddFrank Act or Act) amends the Truth in 

Lending Act (TILA) to prohibit creditors 

from making mortgage loans without 

regard to the consumer’s repayment 

ability. Public Law 111–203 § 1411, 124 

Stat. 1376, 2142 (to be codified at 15 

U.S.C. 1639c). The Act’s underwriting 

requirements are substantially similar 

but not identical to the ability-to-repay 

requirements adopted by the Board for 

higher-priced mortgage loans in July 

2008 under the Home Ownership and 

Equity Protection Act. 73 FR 44522, Jul. 

30, 2008 (‘‘2008 HOEPA Final Rule’’). 

General rulemaking authority for TILA 

is scheduled to transfer to the Consumer 

Financial Protection Bureau (CFPB) in 

July 2011. Accordingly, this rulemaking 

will become a proposal of the CFPB and 

will not be finalized by the Board. 

Consistent with the Act, the proposal 

applies the ability-to-repay 

requirements to any consumer credit 

transaction secured by a dwelling, 

except an open-end credit plan, 

timeshare plan, reverse mortgage, or 

temporary loan. Thus, unlike the 

Board’s 2008 HOEPA Final Rule, the 

proposal is not limited to higher-priced 

mortgage loans or loans secured by the 

consumer’s principal dwelling. The Act 

prohibits a creditor from making a 

mortgage loan unless the creditor makes 

a reasonable and good faith 

determination, based on verified and 

documented information, that the 

consumer will have a reasonable ability 

to repay the loan, including any 

mortgage-related obligations (such as 

property taxes). 

Consistent with the Act, the proposal 

provides four options for complying 

with the ability-to-repay requirement. 

First, a creditor can meet the general 

ability-to-repay standard by originating 

a mortgage loan for which: 

• The creditor considers and verifies 

the following eight underwriting factors 

in determining repayment ability: (1) 

Current or reasonably expected income 

or assets; (2) current employment status; 

(3) the monthly payment on the 

mortgage; (4) the monthly payment on 

any simultaneous loan; (5) the monthly 

payment for mortgage-related 

obligations; (6) current debt obligations; 

(7) the monthly debt-to-income ratio, or 

residual income; and (8) credit history; 

and 

• The mortgage payment calculation 

is based on the fully indexed rate. 

Second, a creditor can refinance a 

‘‘non-standard mortgage’’ into a 

‘‘standard mortgage.’’ This is based on a 

statutory provision that is meant to 

provide flexibility for streamlined 

refinancings, which are no- or lowdocumentation transactions designed to 

quickly refinance a consumer out of a 

risky mortgage into a more stable 

product. Under this option, the creditor 

does not have to verify the consumer’s 

income or assets. The proposal defines 

a ‘‘standard mortgage’’ as a mortgage 

loan that, among other things, does not 

contain negative amortization, interestonly payments, or balloon payments; 

and has limited points and fees. 

Third, a creditor can originate a 

‘‘qualified mortgage,’’ which provides 

special protection from liability for 

creditors who make ‘‘qualified 

mortgages.’’ It is unclear whether that 

protection is intended to be a safe 

harbor or a rebuttable presumption of 

compliance with the repayment ability 

requirement. Therefore, the Board is 

proposing two alternative definitions of 

a ‘‘qualified mortgage.’’ 

Alternative 1 operates as a legal safe 

harbor and defines a ‘‘qualified 

mortgage’’ as a mortgage for which: 

(a) The loan does not contain negative 

amortization, interest-only payments, or 

balloon payments, or a loan term 

exceeding 30 years; 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27391 

1Mortgages covered by the HOEPA amendments 

have been referred to as ‘‘HOEPA loans,’’ ‘‘Section 

32 loans,’’ or ‘‘high-cost mortgages.’’ The DoddFrank Act now refers to these loans as ‘‘high-cost 

mortgages.’’ See the Dodd-Frank Act § 1431; TILA 

Section 103(aa). For simplicity and consistency, 

this proposal will use the term ‘‘high-cost 

mortgages’’ to refer to mortgages covered by the 

HOEPA amendments. 

(b) The total points and fees do not 

exceed 3% of the total loan amount; 

(c) The borrower’s income or assets 

are verified and documented; and 

(d) The underwriting of the mortgage 

(1) is based on the maximum interest 

rate in the first five years, (2) uses a 

payment schedule that fully amortizes 

the loan over the loan term, and 

(3) takes into account any mortgagerelated obligations. 

Alternative 2 provides a rebuttable 

presumption of compliance and defines 

a ‘‘qualified mortgage’’ as including the 

criteria listed under Alternative 1 as 

well as the following additional 

underwriting requirements from the 

ability-to-repay standard: (1) The 

consumer’s employment status, (2) the 

monthly payment for any simultaneous 

loan, (3) the consumer’s current debt 

obligations, (4) the total debt-to-income 

ratio or residual income, and (5) the 

consumer’s credit history. 

Finally, a small creditor operating 

predominantly in rural or underserved 

areas can originate a balloon-payment 

qualified mortgage. This standard is 

evidently meant to accommodate 

community banks that originate balloon 

loans to hedge against interest rate risk. 

Under this option, a small creditor can 

make a balloon-payment qualified 

mortgage if the loan term is five years 

or more, and the payment calculation is 

based on the scheduled periodic 

payments, excluding the balloon 

payment. 

The proposal also implements the 

Dodd-Frank Act’s limits on prepayment 

penalties, lengthens the time creditors 

must retain records that evidence 

compliance with the ability-to-repay 

and prepayment penalty provisions, and 

prohibits evasion of the rule by 

structuring a closed-end extension of 

credit as an open-end plan. The DoddFrank Act contains other consumer 

protections for mortgages, which will be 

implemented in subsequent 

rulemakings. 

II. Background 

Over the years, concerns have been 

raised about creditors originating 

mortgage loans without regard to the 

consumer’s ability to repay the loan. 

Beginning in about 2006, these concerns 

were heightened as mortgage 

delinquencies and foreclosures rates 

increased dramatically, caused in part 

by the loosening of underwriting 

standards. See 73 FR 44524, Jul. 30, 

2008. Following is background 

information, including a brief summary 

of the legislative and regulatory 

responses to this issue, which 

culminated in the enactment of the 

Dodd-Frank Act on July 21, 2010. 

A. TILA and Regulation Z 

In 1968, Congress enacted TILA, 15 

U.S.C. 1601 et seq., based on findings 

that economic stability would be 

enhanced and competition among 

consumer credit providers would be 

strengthened by the informed use of 

credit resulting from consumers’ 

awareness of the cost of credit. One of 

the purposes of TILA is to promote the 

informed use of consumer credit by 

requiring disclosures about its costs and 

terms. TILA requires additional 

disclosures for loans secured by 

consumers’ homes and permits 

consumers to rescind certain 

transactions that involve their principal 

dwelling. TILA directs the Board to 

prescribe regulations to carry out the 

purposes of the law, and specifically 

authorizes the Board, among other 

things, to issue regulations that contain 

such additional requirements, 

classifications, differentiations, or other 

provisions, or that provide for such 

adjustments and exceptions for all or 

any class of transactions, that in the 

Board’s judgment are necessary or 

proper to effectuate the purposes of 

TILA, facilitate compliance with TILA, 

or prevent circumvention or evasion. 15 

U.S.C. 1604(a). TILA is implemented by 

the Board’s Regulation Z, 12 CFR part 

226. An Official Staff Commentary 

interprets the requirements of the 

regulation and provides guidance to 

creditors in applying the rules to 

specific transactions. See 12 CFR part 

226, Supp. I. 

B. The Home Ownership and Equity 

Protection Act (HOEPA) and HOEPA 

Rules 

In response to evidence of abusive 

practices in the home-equity lending 

market, Congress amended TILA by 

enacting the Home Ownership and 

Equity Protection Act (HOEPA) in 1994. 

Public Law 103–325, 108 Stat. 2160. 

HOEPA defines a class of ‘‘high-cost 

mortgages,’’ which are generally closedend home-equity loans (excluding 

home-purchase loans) with annual 

percentage rates (APRs) or total points 

and fees exceeding prescribed 

thresholds.1 HOEPA created special 

substantive protections for high-cost 

mortgages, including prohibiting a 

creditor from engaging in a pattern or 

practice of extending a high-cost 

mortgage to a consumer based on the 

consumer’s collateral without regard to 

the consumer’s repayment ability, 

including the consumer’s current and 

expected income, current obligations, 

and employment. TILA Section 129(h); 

15 U.S.C. 1639(h). In addition to the 

disclosures and limitations specified in 

the statute, TILA Section 129, as added 

by HOEPA, expanded the Board’s 

rulemaking authority. TILA Section 

129(l)(2)(A) authorizes the Board to 

prohibit acts or practices the Board 

finds to be unfair and deceptive in 

connection with mortgage loans. 15 

U.S.C. 1639(l)(2)(A). TILA Section 

129(l)(2)(B) authorizes the Board to 

prohibit acts or practices in connection 

with the refinancing of mortgage loans 

that the board finds to be associated 

with abusive lending practices, or that 

are otherwise not in the interest of the 

borrower. 15 U.S.C. 1639(l)(2)(B). 

In addition, HOEPA created three 

special remedies for a violation of its 

provisions. First, a consumer who 

brings a timely action against a creditor 

for a violation of rules issued under 

TILA Section 129 may be able to recover 

special statutory damages equal to the 

sum of all finance charges and fees paid 

by the consumer (often referred to as 

‘‘HOEPA damages’’), unless the creditor 

demonstrates that the failure to comply 

is not material. TILA Section 130(a); 15 

U.S.C. 1640(a). This recovery is in 

addition to actual damages; statutory 

damages in an individual action or class 

action, up to a prescribed threshold; and 

court costs and attorney fees that would 

be available for violations of other TILA 

provisions. Second, if a creditor assigns 

a high-cost mortgage to another person, 

the consumer may be able to obtain 

from the assignee all of the foregoing 

damages. TILA Section 131(d); 15 U.S.C. 

1641(d). For all other loans, TILA 

Section 131(e), 15 U.S.C. 1641(e), limits 

the liability of assignees for violations of 

Regulation Z to disclosure violations 

that are apparent on the face of the 

disclosure statement required by TILA. 

Finally, a consumer has a right to 

rescind a transaction for up to three 

years after consummation when the 

mortgage contains a provision 

prohibited by a rule adopted under the 

authority of TILA Section 129(l)(2). 

TILA Section 125 and 129(j); 15 U.S.C. 

1635 and 1639(j). Any consumer who 

has the right to rescind a transaction 

may rescind the transaction as against 

any assignee. TILA Section 131(c); 15 

U.S.C. 1641(c). The right of rescission 

does not extend, however, to home 

purchase loans, construction loans, or 

certain refinancings with the same 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27392 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

2The 2006 Nontraditional Mortgage Guidance 

and the 2007 Subprime Mortgage Statement will 

hereinafter collectively be referred to as the 

‘‘Interagency Supervisory Guidance.’’ 

3Although S. Rpt. No. 111–176 generally contains 

the legislative history for the Dodd-Frank Act, it 

does not contain the legislative history for the 

Mortgage Reform and Anti-Predatory Lending Act. 

Therefore, the Board has relied on the legislative 

history for the 2007 and 2009 House bills for 

guidance in interpreting the statute. See H. Rpt. No. 

110–441 for H.R. 3915 (2007), and H. Rpt. No. 111– 

194 for H.R. 1728 (2009). 

creditor. TILA Section 125(e); 15 U.S.C. 

1635(e). 

In 1995, the Board implemented the 

HOEPA amendments at § 226.31, 

226.32, and 226.33 of Regulation Z. 60 

FR 15463, March 24, 1995. In particular, 

§ 226.32(e)(1) implemented TILA 

Section 129(h) to prohibit a creditor 

from extending a high-cost mortgage 

based on the consumer’s collateral if, 

considering the consumer’s current and 

expected income, current obligations, 

and employment status, the consumer 

would be unable to make the scheduled 

payments. In 2001, the Board amended 

these regulations to expand HOEPA’s 

protections to more loans by revising 

the APR threshold, and points and fees 

definition. 66 FR 65604, Dec. 20, 2001. 

In addition, the ability-to-repay 

provisions in the regulation were 

revised to provide for a presumption of 

a violation of the rule if the creditor 

engages in a pattern or practice of 

making high-cost mortgages without 

verifying and documenting the 

consumers’ repayment ability. 

C. 2006 and 2007 Interagency 

Supervisory Guidance 

In December 2005, the Board and the 

other Federal banking agencies 

responded to concerns about the rapid 

growth of nontraditional mortgages in 

the previous two years by proposing 

supervisory guidance. Nontraditional 

mortgages are mortgages that allow the 

borrower to defer repayment of 

principal and sometimes interest. The 

guidance advised institutions of the 

need to reduce ‘‘risk layering’’ practices 

with respect to these products, such as 

failing to document income or lending 

nearly the full appraised value of the 

home. The final guidance issued in 

September 2006 specifically advised 

lenders that layering risks in 

nontraditional mortgage loans to 

subprime borrowers may significantly 

increase risks to borrowers as well as 

institutions. Interagency Guidance on 

Nontraditional Mortgage Product Risks, 

71 FR 58609, Oct. 4, 2006 (‘‘2006 

Nontraditional Mortgage Guidance’’). 

The Board and the other Federal 

banking agencies addressed concerns 

about the subprime market in March 

2007 with proposed supervisory 

guidance addressing the heightened 

risks to consumers and institutions of 

adjustable-rate mortgages with two- or 

three-year ‘‘teaser’’ rates followed by 

substantial increases in the rate and 

payment. The guidance, finalized in 

June of 2007, set out the standards 

institutions should follow to ensure 

borrowers in the subprime market 

obtain loans they can afford to repay. 

Among other steps, the guidance 

advised lenders to (1) use the fullyindexed rate and fully-amortizing 

payment when qualifying borrowers for 

loans with adjustable rates and 

potentially non-amortizing payments; 

(2) limit stated income and reduced 

documentation loans to cases where 

mitigating factors clearly minimize the 

need for full documentation of income; 

and (3) provide that prepayment penalty 

clauses expire a reasonable period 

before reset, typically at least 60 days. 

Statement on Subprime Mortgage 

Lending, 72 FR 37569, Jul. 10, 2007 

(‘‘2007 Subprime Mortgage Statement’’).2

The Conference of State Bank 

Supervisors (‘‘CSBS’’) and the American 

Association of Residential Mortgage 

Regulators (‘‘AARMR’’) issued parallel 

statements for state supervisors to use 

with state-supervised entities, and many 

states adopted the statements. 

D. 2008 HOEPA Final Rule 

In 2006 and 2007, the Board held a 

series of national hearings on consumer 

protection issues in the mortgage 

market. During those hearings, 

consumer advocates and government 

officials expressed a number of 

concerns, and urged the Board to 

prohibit or restrict certain underwriting 

practices, such as ‘‘stated income’’ or 

‘‘low documentation’’ loans, and certain 

product features, such as prepayment 

penalties. See 73 FR 44527, Jul. 30, 

2008. The Board was also urged to adopt 

regulations under HOEPA, because, 

unlike the Interagency Supervisory 

Guidance, the regulations would apply 

to all creditors and would be 

enforceable by consumers through civil 

actions. 

In response to these hearings, in July 

of 2008, the Board adopted final rules 

pursuant to the Board’s authority in 

TILA Section 129(l)(2)(A). 73 FR 44522, 

Jul. 30, 2008 (‘‘2008 HOEPA Final 

Rule’’). The Board’s 2008 HOEPA Final 

Rule defined a new class of ‘‘higherpriced mortgage loans,’’ . Under the 

2008 HOEPA Final Rule, a higher-priced 

mortgage loan is a consumer credit 

transaction secured by the consumer’s 

principal dwelling with an APR that 

exceeds the average prime offer rate 

(APOR) 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 the dwelling, 

or by 3.5 or more percentage points for 

loans secured by a subordinate lien on 

the dwelling. Section 226.35(a)(1). The 

definition of a ‘‘higher-priced mortgage 

loan’’ includes those loans that are 

defined as ‘‘high-cost mortgages.’’ 

Among other things, the Board’s 2008 

HOEPA Final Rule revised the abilityto-repay requirements for high-cost 

mortgages, and extended these 

requirements to higher-priced mortgage 

loans. Sections 226.34(a)(4), 

226.35(b)(1). Specifically, the rule: 

• Prohibits a creditor from extending 

a higher-priced mortgage loan based on 

the collateral and without regard to the 

consumer’s repayment ability. 

• Prohibits a creditor from relying on 

income or assets to assess repayment 

ability unless the creditor verifies such 

amounts using third-party documents 

that provide reasonably reliable 

evidence of the consumer’s income and 

assets. 

In addition, the Board’s 2008 Final Rule 

provides certain restrictions on 

prepayment penalties for high-cost 

mortgages and higher-priced mortgage 

loans. Sections 226.32(d), 226.35(b)(2). 

E. The Dodd-Frank Act 

In 2007, Congress held hearings 

focused on rising subprime foreclosure 

rates and the extent to which lending 

practices contributed to them. See 73 FR 

44528, Jul. 30, 2008. Consumer 

advocates testified that certain lending 

terms or practices contributed to the 

foreclosures, including a failure to 

consider the consumer’s ability to repay, 

low- or no-documentation loans, hybrid 

adjustable-rate mortgages, and 

prepayment penalties. Industry 

representatives, on the other hand, 

testified that adopting substantive 

restrictions on subprime loan terms 

would risk reducing access to credit for 

some borrowers. In response to these 

hearings, the House of Representatives 

passed the Mortgage Reform and AntiPredatory Lending Act in 2007 and 

2009. H.R. 3915, 110th Cong. (2007); 

H.R. 1728, 111th Cong. (2009). Both 

bills would have amended TILA to 

provide consumer protections for 

mortgages, including ability-to-repay 

requirements, but neither bill was 

passed by the Senate. 

Then, on July 21, 2010, the DoddFrank Act was signed into law. Public 

Law 111–203, 124 Stat. 1376 (2010). 

Title XIV of the Dodd-Frank Act 

contains the Mortgage Reform and AntiPredatory Lending Act.3 Sections 1411, 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27393 

4The MDIA is contained in Sections 2501 

through 2503 of the Housing and Economic 

Recovery Act of 2008, Public Law 110–289, enacted 

on July 30, 2008. The MDIA was later amended by 

the Emergency Economic Stabilization Act of 2008, 

Public Law 110–343, enacted on October 3, 2008. 

1412, and 1414 of the Dodd-Frank Act 

create new TILA Section 129C, which, 

among other things, establishes new 

ability-to-repay requirements and new 

limits on prepayment penalties. Public 

Law 111–203, § 1411, 1412, 1414, 124 

Stat. 1376, 2142–53 (to be codified at 15 

U.S.C. 1639c). The Dodd-Frank Act 

states that Congress created new TILA 

Section 129C upon a finding that 

‘‘economic stabilization would be 

enhanced by the protection, limitation, 

and regulation of the terms of 

residential mortgage credit and the 

practices related to such credit, while 

ensuring that responsible, affordable 

mortgage credit remains available to 

consumers.’’ Dodd-Frank Act Section 

1402; TILA Section 129B(a)(1). The 

Dodd-Frank Act further states that the 

purpose of TILA Section 129C is to 

‘‘assure that consumers are offered and 

receive residential mortgage loans on 

terms that reasonably reflect their ability 

to repay the loans.’’ Dodd-Frank Act 

Section 1402; TILA Section 129B(a)(2). 

Specifically, TILA Section 129C: 

• Expands coverage of the ability-torepay requirements to any consumer 

credit transaction secured by a dwelling, 

except an open-end credit plan, 

timeshare plan, reverse mortgage, or 

temporary loan. 

• Prohibits a creditor from making a 

mortgage loan unless the creditor makes 

a reasonable and good faith 

determination, based on verified and 

documented information, that the 

consumer has a reasonable ability to 

repay the loan according to its terms, 

and all applicable taxes, insurance, and 

assessments. 

• Provides a presumption of 

compliance with the ability-to-repay 

requirements if the mortgage loan is a 

‘‘qualified mortgage,’’ which does not 

contain certain risky features and limits 

points and fees on the loan. 

• Prohibits prepayment penalties 

unless the mortgage is a prime, fixedrate qualified mortgage, and the amount 

of the prepayment penalty is limited. 

The Dodd-Frank Act creates special 

remedies for violations of TILA Section 

129C. Section 1416 of the Dodd-Frank 

Act provides that a consumer who 

brings a timely action against a creditor 

for a violation of TILA Section 129C(a) 

(the ability-to-repay requirements) may 

be able to recover special statutory 

damages equal to the sum of all finance 

charges and fees paid by the consumer 

(often referred to as ‘‘HOEPA damages’’), 

unless the creditor demonstrates that 

the failure to comply is not material. 

TILA Section 130(a). This recovery is in 

addition to actual damages; statutory 

damages in an individual action or class 

action, up to a prescribed threshold; and 

court costs and attorney fees that would 

be available for violations of other TILA 

provisions. In addition, the statute of 

limitations for an action for a violation 

of TILA Section 129C is three years from 

the date of the occurrence of the 

violation (as compared to one year for 

other TILA violations). TILA Section 

130(e). Moreover, Section 1413 of the 

Dodd-Frank Act provides that a 

consumer may assert a violation of TILA 

Section 129C(a) as a defense to 

foreclosure by recoupment or set off. 

TILA Section 130(k). There is no time 

limit on the use of this defense. 

F. Other Recent Board Actions 

In addition to the 2008 HOEPA Final 

Rule, the Board has recently published 

several proposed or final rules for 

mortgages that are referenced in or 

relevant to this proposal. 

2009 Closed-End Mortgage Proposal. 

In August 2009, the Board issued two 

proposals to amend Regulation Z: One 

for closed-end mortgages and one for 

home equity lines of credit (‘‘HELOCs’’). 

For closed-end mortgages, the August 

2009 proposal would revise the 

disclosure requirements to highlight 

potentially risky features, such as 

adjustable rates and negative 

amortization, and address other issues, 

such as the timing of disclosures. See 74 

FR 43232, Aug. 26, 2009 (‘‘2009 ClosedEnd Mortgage Proposal’’). For HELOCs, 

the August 2009 proposal would revise 

the disclosure requirements and address 

other issues, such as account 

terminations. 74 FR 43428, Aug. 26, 

2009 (‘‘2009 HELOC Proposal’’). Public 

comments for both proposals were due 

by December 24, 2009. 

2010 Mortgage Proposal. In 

September 2010, the Board issued a 

proposal that would revise Regulation Z 

with respect to rescission, refinancing, 

reverse mortgages, and the refund of 

certain fees. See 75 FR 58539, Sept. 24, 

2010 (‘‘2010 Mortgage Proposal’’). Public 

comments for this proposal were due by 

December 23, 2010. On February 1, 

2011, the Board issued a press release 

stating that it does not expect to finalize 

the 2009 Closed-End Mortgage Proposal, 

2009 HELOC Proposal, or the 2010 

Mortgage Proposal prior to the transfer 

of authority for such rulemakings to the 

Consumer Financial Protection Bureau 

in July 2011. 

2010 Loan Originator Compensation 

Rule. In September 2010, the Board 

adopted a final rule on loan originator 

compensation to prohibit compensation 

to mortgage brokers and loan officers 

(collectively, ‘‘loan originators’’) that is 

based on a loan’s interest rate or other 

terms. The final rule also prohibits loan 

originators from steering consumers to 

loans that are not in the consumers’ 

interest to increase the loan originator’s 

compensation. 75 FR 58509, Sept. 24, 

2010 (‘‘2010 Loan Originator 

Compensation Rule’’). This rule became 

effective April 6, 2011. 

2010 MDIA Interim Final Rule. In May 

2009, the Board adopted final rules 

implementing the amendments to TILA 

under the Mortgage Disclosure 

Improvement Act of 2008 (‘‘MDIA’’).4

Among other things, the MDIA and the 

final rules require early, transactionspecific disclosures for mortgage loans 

secured by a dwelling, and requires 

waiting periods between the time when 

disclosures are given and 

consummation of the transaction. These 

rules became effective July 30, 2009, as 

required by the statute. See 74 FR 

23289, May 19, 2009. The MDIA also 

requires disclosure of payment 

examples if the loan’s interest rate or 

payments can change, along with a 

statement that there is no guarantee that 

the consumer will be able to refinance 

the transaction in the future. Under the 

statute, these provisions of the MDIA 

became effective on January 30, 2011. 

On September 24, 2010, the Board 

published an interim rule to implement 

these requirements. See 75 FR 58470, 

Sept. 24, 2010. In particular, the rule 

provided definitions for a ‘‘balloon 

payment,’’ ‘‘adjustable-rate mortgage,’’ 

‘‘step-rate mortgage,’’ ‘‘fixed-rate 

mortgage,’’ ‘‘interest-only loan,’’ 

‘‘negative amortization loan,’’ and the 

‘‘fully indexed rate.’’ See § 226.18(s)(5) 

and (s)(7). Subsequently, the Board 

issued an interim rule to make certain 

clarifying changes. See 75 FR 81836, 

Dec. 29, 2010. The term ‘‘2010 MDIA 

Interim Final Rule’’ is used to refer to 

the September 2010 final rule as revised 

by the December 2010 final rule. 

2011 Escrow Proposal and Final Rule. 

In March 2011, the Board issued a 

proposal to implement Sections 1461 

and 1462 of the Dodd-Frank Act, which 

create new TILA Section 129D and 

provide certain escrow requirements for 

higher-priced mortgage loans. See 76 FR 

11599, March 2, 2011 (‘‘2011 Escrow 

Proposal’’). In particular, the proposal 

would revise the definition of a ‘‘higherpriced mortgage loan,’’ and create an 

exemption from the escrow requirement 

for any loan extended by a creditor that 

makes most of its first-lien higher-priced 

mortgage loans in counties designated 

by the Board as ‘‘rural or underserved,’’ 

has annual originations of 100 or fewer 


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first-lien mortgage loans, and does not 

escrow for any mortgage transaction it 

services. 

In March 2011, the Board also issued 

a final rule that implements a provision 

of the Dodd-Frank Act that increases the 

APR threshold used to determine 

whether a mortgage lender is required to 

establish an escrow account for property 

taxes and insurance for first-lien, 

‘‘jumbo’’ mortgage loans. See 76 FR 

11319, March 2, 2011 (‘‘2011 Jumbo 

Loan Escrow Final Rule’’). Jumbo loans 

are loans exceeding the conforming 

loan-size limit for purchase by Freddie 

Mac, as specified by the legislation. 

2011 Risk Retention Proposal. On 

March 31, 2011, the Board, the Office of 

the Comptroller of the Currency, the 

Federal Deposit Insurance Corporation, 

the Securities and Exchange 

Commission, the U.S. Department of 

Housing and Urban Development, and 

the Federal Housing Finance Agency 

(‘‘Agencies’’) issued a proposal to 

implement Section 941 of the DoddFrank Act, which adds a new Section 

15G to the Securities Exchange Act of 

1934. 15 U.S.C. 78o–11. As required by 

the Act, the proposal generally requires 

the sponsor of an asset-backed security 

to retain not less than five percent of the 

credit risk of the assets collateralizing 

the security. The Act and the proposal 

include a variety of exemptions, 

including an exemption for an assetbacked security that is collateralized 

exclusively by ‘‘qualified residential 

mortgages.’’ The Act requires the 

Agencies to define the term ‘‘qualified 

residential mortgage’’ taking into 

consideration underwriting and product 

features that historical loan performance 

data indicate result in a lower risk of 

default. The Act further provides that 

the definition of a ‘‘qualified residential 

mortgage’’ can be ‘‘no broader than’’ the 

definition of a ‘‘qualified mortgage’’ 

under TILA Section 129C(b)(2). The 

2011 Risk Retention Proposal 

implements these provisions of the Act. 

Public comments for this proposal are 

due by June 10, 2011. 

G. Development of This Proposal 

In developing this proposal, the Board 

reviewed the laws, regulations, 

proposals, and legislative history 

described above as well as state abilityto-repay laws. The Board also 

conducted extensive outreach with 

consumer advocates, industry 

representatives, and Federal and state 

regulators, and examined underwriting 

rules and guidelines for the Federal 

Housing Administration, the U.S. 

Department of Veterans’ Affairs, Fannie 

Mae, Freddie Mac, the Home Affordable 

Modification Program, and private 

creditors. Finally, the Board conducted 

independent analyses regarding the 

effect of various underwriting 

procedures and loan features on loan 

performance. 

III. Legal Authority 

TILA Section 105(a) mandates that the 

Board prescribe regulations to carry out 

the purposes of the Act. 15 U.S.C. 

1604(a). In addition, TILA, as amended 

by the Dodd-Frank Act, specifically 

authorizes the Board to: 

• Issue regulations that contain such 

additional requirements, classifications, 

differentiations, or other provisions, or 

that provide for such adjustments and 

exceptions for all or any class of 

transactions, that in the Board’s 

judgment are necessary or proper to 

effectuate the purposes of TILA, 

facilitate compliance with the Act, or 

prevent circumvention or evasion. TILA 

Section 105(a); 15 U.S.C. 1604(a). 

• By regulation, prohibit or condition 

terms, acts or practices relating to 

residential mortgage loans that the 

Board finds to be abusive, unfair, 

deceptive, or predatory; necessary or 

proper to ensure that responsible, 

affordable mortgage credit remains 

available to consumers in a manner 

consistent with the purposes of the 

ability-to-repay requirements; necessary 

or proper to effectuate the purposes of 

the ability-to-repay requirements, to 

prevent circumvention or evasion 

thereof, or to facilitate compliance; or 

are not in the interest of the borrower. 

TILA Section 129B(e); 15 U.S.C. 

1639b(e). 

• Prescribe regulations that revise, 

add to, or subtract from the criteria that 

define a qualified mortgage upon a 

finding that such regulations are 

necessary or proper to ensure that 

responsible, affordable mortgage credit 

remains available to consumers in a 

manner consistent with the purposes of 

the ability-to-repay requirements; or 

necessary and appropriate to effectuate 

the purposes of the ability-to-repay 

requirements, to prevent circumvention 

or evasion thereof, or to facilitate 

compliance. TILA Section 

129C(b)(3)(B)(i); 15 U.S.C. 

1639c(b)(3)(B)(i). 

TILA, as amended by the Dodd-Frank 

Act, states that it is the purpose of the 

ability-to-repay requirements to assure 

that consumers are offered and receive 

residential mortgage loans on terms that 

reasonably reflect their ability to repay 

the loans. TILA Section 129B(a)(2); 15 

U.S.C. 1639b(a)(2). 

IV. Discussion of the Proposed Rule 

A. Scope of Coverage 

Consistent with the Dodd-Frank Act, 

the proposal applies to any dwellingsecured consumer credit transaction, 

including vacation homes and home 

equity loans. The proposal does not 

apply to open-end credit plans, 

timeshare plans, reverse mortgages, or 

temporary loans with terms of 12 

months or less. The Act essentially 

codifies the ability-to-repay 

requirements of the Board’s 2008 

HOEPA Final Rule and expands the 

scope to the covered transactions 

described above. 

B. Ability-to-Repay Requirements 

Consistent with the Dodd-Frank Act, 

the proposal provides that a creditor 

may not make a covered mortgage loan 

unless the creditor makes a reasonable 

and good faith determination, based on 

verified and documented information, 

that the consumer will have a 

reasonable ability to repay the loan, 

including any mortgage-related 

obligations (such as property taxes). 

TILA Section 129C; 15 U.S.C. 1639C. 

The Act and the proposal provide four 

options for complying with the abilityto-repay requirement. Specifically, a 

creditor can: 

• Originate a covered transaction 

under the general ability-to-repay 

standard; 

• Refinance a ‘‘non-standard 

mortgage’’ into a ‘‘standard mortgage’’; 

• Originate a ‘‘qualified mortgage,’’ 

which provides a presumption of 

compliance with the rule; or 

• Originate a balloon-payment 

qualified mortgage, which provides a 

presumption of compliance with the 

rule. 

Each of these methods is discussed 

below, with a description of: (1) Limits 

on the loan features or term, (2) limits 

on points and fees, (3) underwriting 

requirements, and (4) payment 

calculations. 

General Ability-to-Repay Standard 

Limits on loan features, term, and 

points and fees. Under the general 

ability-to-repay standards, there are no 

limits on the loan’s features, term, or 

points and fees, but the creditor must 

follow certain underwriting 

requirements and payment calculations. 

Underwriting requirements. 

Consistent with the Dodd-Frank Act, the 

proposal requires the creditor to 

consider and verify the following eight 

underwriting factors: 

• Current or reasonably expected 

income or assets; 

• Current employment status; 


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5The Act provides separate underwriting 

requirements for balloon loans depending on 

whether the loan’s APR exceeds the APOR by 1.5 

percent for a first-lien loan or by 3.5 percent for a 

subordinate-lien loan. 

• The monthly payment on the 

covered transaction; 

• The monthly payment on any 

simultaneous loan; 

• The monthly payment for mortgagerelated obligations; 

• Current debt obligations; 

• The monthly debt-to-income ratio, 

or residual income; and 

• Credit history. 

The proposal permits the creditor to 

consider and verify these underwriting 

factors based on widely accepted 

underwriting standards. 

The proposal is generally consistent 

with the Act except in one respect. The 

Act does not require the creditor to 

consider simultaneous loans that are 

home equity lines of credit (‘‘HELOCs’’), 

but the Board is using its adjustment 

and exception authority and 

discretionary regulatory authority to 

include HELOCs within the definition 

of simultaneous loans. The Board 

believes that such inclusion would help 

ensure the consumer’s ability to repay 

the loan. Data and outreach indicated 

that the origination of a simultaneous 

HELOC markedly increases the rate of 

default. In addition, this approach is 

consistent with the Board’s 2008 

HOEPA Final Rule. 

Payment calculations. Under the 

general ability-to-repay standard, the 

Dodd-Frank Act does not ban mortgage 

features, but instead requires the 

creditor to underwrite the mortgage 

payment according to certain 

assumptions and calculations. 

Specifically, consistent with the Act, the 

proposal requires creditors to calculate 

the mortgage payment using: (1) The 

fully indexed rate; and (2) monthly, 

substantially equal payments that 

amortize the loan amount over the loan 

term. In addition, the Board is using its 

adjustment and exception authority and 

discretionary regulatory authority to 

require the creditor to underwrite the 

payment based on the introductory 

interest rate if it is greater than the fully 

indexed rate. Some transactions use a 

premium initial rate that is higher than 

the fully indexed rate. The Board 

believes this approach would help 

ensure the consumer’s ability to repay 

the loan and prevent circumvention or 

evasion. 

The Act and proposal also provide 

special payment calculations for 

interest-only loans, negative 

amortization loans, and balloon loans. 

In particular, the requirements for 

balloon loans depend on whether the 

loan is ‘‘higher-priced’’ 5 or not. 

Consistent with the Act, the proposal 

requires a creditor to underwrite a 

higher-priced loan with a balloon 

payment by considering the consumer’s 

ability to make the balloon payment 

(without refinancing). As a practical 

matter, this would mean that a creditor 

would not be able to make a higherpriced balloon loan unless the consumer 

had substantial documented assets or 

income. 

The Act permits a creditor to 

underwrite a balloon loan that is not 

higher-priced in accordance with 

regulations prescribed by the Board. The 

proposal requires creditors to 

underwrite a balloon loan using the 

maximum payment scheduled during 

the first five years after consummation. 

This approach would not capture the 

balloon payment for a balloon loan with 

a term of five years or more. The Board 

believes five years is the appropriate 

time horizon in order to ensure 

consumers have a reasonable ability to 

repay the loan, and to preserve credit 

choice and availability. Moreover, the 

five year time horizon is consistent with 

other provisions in the Act and the 

proposal, which require underwriting 

based on the first five years after 

consummation (for qualified mortgages 

and the refinancing of a non-standard 

mortgage) or which require a minimum 

term of five years (for balloon-payment 

qualified mortgages made by certain 

creditors). 

Refinancing of a Non-Standard Mortgage 

The Dodd-Frank Act provides an 

exception to the ability-to-repay 

standard’s underwriting requirements if: 

(1) The same creditor is refinancing a 

‘‘hybrid mortgage’’ into a ‘‘standard 

mortgage,’’ (2) the consumer’s monthly 

payment is reduced through the 

refinancing, and (3) the consumer has 

not been delinquent on any payment on 

the existing hybrid mortgage. This 

provision appears to be intended to 

provide flexibility for streamlined 

refinancings, which are no- or lowdocumentation loans designed to 

quickly refinance a consumer in a risky 

mortgage into a more stable product. 

Streamlined refinancings have 

substantially increased in recent years 

to accommodate consumers at risk of 

default. 

Definitions—loan features, term, and 

points and fees. Although the Act uses 

the term ‘‘hybrid mortgage,’’ the 

proposal uses the term ‘‘non-standard 

mortgage,’’ defined as (1) an adjustablerate mortgage with an introductory fixed 

interest rate for a period of years, (2) an 

interest-only loan, and (3) a negative 

amortization loan. The Board believes 

that this definition is consistent with 

the legislative history, which indicates 

that Congress was generally concerned 

with loans that provide for ‘‘payment 

shock’’ through significantly higher 

payments over the life of the loan. 

The proposal defines the term 

‘‘standard mortgage’’ as a covered 

transaction which, among other things, 

does not contain negative amortization, 

interest-only payments, or balloon 

payments; and limits the points and 

fees. 

Underwriting requirements. If the 

conditions described above are met, the 

Act states that the creditor may give 

concerns about preventing a likely 

default a ‘‘higher priority as an 

acceptable underwriting practice.’’ The 

Board interprets this provision to 

provide an exception from the general 

ability-to-repay requirements for income 

and asset verification. The Board 

believes that this approach is consistent 

with the statute and would preserve 

access to streamlined refinancings. 

Payment calculations. The proposal 

provides specific payment calculations 

for purposes of determining whether the 

refinancing reduces the consumer’s 

monthly mortgage payment, and for 

determining whether the consumer has 

the ability to repay the standard 

mortgage. The calculation for the nonstandard mortgage would reflect the 

highest payment that would occur as of 

the date of the expiration of the period 

during which introductory-rate 

payments, interest-only payments, or 

negatively amortizing payments are 

permitted. For a standard mortgage, the 

calculation would be based on: (1) The 

maximum interest rate that may apply 

during the first five years after 

consummation, and (2) monthly, 

substantially equal payments that 

amortize the loan amount over the loan 

term. 

Safe Harbor or Presumption of 

Compliance for a Qualified Mortgage 

Under the Board’s 2008 HOEPA Final 

Rule, a creditor may obtain a 

presumption of compliance with the 

repayment ability requirement if it 

follows the required procedures, such as 

verifying the consumer’s income or 

assets, and additional optional 

procedures, such as assessing the 

consumer’s debt-to-income ratio. 

However, the 2008 HOEPA Final Rule 

makes clear that even if the creditor 

follows the required and optional 

criteria, the creditor has only obtained 

a presumption of compliance with the 

repayment ability requirement. The 

consumer can still rebut or overcome 


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27396 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

that presumption by showing that, 

despite following the required and 

optional procedures, the creditor 

nonetheless disregarded the consumer’s 

ability to repay the loan. For example, 

the consumer could present evidence 

that although the creditor assessed the 

consumer’s debt-to-income ratio, that 

ratio was very high with little residual 

income. This evidence may be sufficient 

to overcome the presumption of 

compliance and demonstrate that the 

creditor extended credit without regard 

to the consumer’s ability to repay the 

loan. 

The Dodd-Frank Act provides special 

protection from liability for creditors 

who make ‘‘qualified mortgages,’’ but it 

is unclear whether that protection is 

intended to be a safe harbor or a 

rebuttable presumption of compliance 

with the repayment ability requirement. 

The Act states that a creditor or assignee 

‘‘may presume’’ that a loan has met the 

repayment ability requirement if the 

loan is a ‘‘qualified mortgage.’’ This 

might suggest that originating a 

qualified mortgage only provides a 

presumption of compliance, which the 

consumer can rebut by providing 

evidence that the creditor did not, in 

fact, make a good faith and reasonable 

determination of the consumer’s ability 

to repay the loan. 

However, the Act does not state that 

a creditor that makes a ‘‘qualified 

mortgage’’ must comply with all of the 

underwriting criteria of the general 

ability-to-repay standard. Specifically, 

the Act defines a ‘‘qualified mortgage’’ as 

a covered transaction for which: 

• The loan does not contain negative 

amortization, interest-only payments, or 

balloon payments; 

• The term does not exceed 30 years; 

• The points and fees generally do 

not exceed three percent of the total 

loan amount; 

• The income or assets are considered 

and verified; 

• The total debt-to-income ratio or 

residual income complies with any 

guideline or regulation prescribed by 

the Board; and 

• The underwriting: (1) Is based on 

the maximum rate during the first five 

years, (2) uses a payment schedule that 

fully amortizes the loan over the loan 

term, and (3) takes into account all 

mortgage-related obligations. 

The definition of a ‘‘qualified mortgage’’ 

does not require the creditor to consider 

and verify the following underwriting 

requirements that are part of the general 

ability-to-repay standard: (1) The 

consumer’s employment status, (2) the 

payment of any simultaneous loans of 

which the creditor knows or has reason 

to know, (3) the consumer’s current 

obligations, and (4) the consumer’s 

credit history. Thus, if the ‘‘qualified 

mortgage’’ definition is deemed to be a 

safe harbor, the consumer could not 

allege the creditor violated the 

repayment ability requirement by failing 

to consider and verify employment 

status, simultaneous loans, current 

obligations, or credit history. Under this 

approach, originating a ‘‘qualified 

mortgage’’ would be an alternative to 

complying with the general ability-torepay standard and would operate as a 

safe harbor. Thus, if a creditor satisfied 

the qualified mortgage criteria, the 

consumer could not assert that the 

creditor had violated the ability-to-repay 

provisions. The consumer could only 

show that the creditor did not comply 

with one of the qualified mortgage safe 

harbor criteria. 

There are sound policy reasons for 

interpreting a ‘‘qualified mortgage’’ as 

providing either a safe harbor or a 

presumption of compliance. Interpreting 

a ‘‘qualified mortgage’’ as a safe harbor 

would provide creditors with an 

incentive to make qualified mortgages. 

That is, in exchange for limiting loan 

fees and features, the creditor’s 

regulatory burden and exposure to 

liability would be reduced. Consumers 

may benefit by being provided with 

mortgage loans that do not have certain 

risky features or high costs. However, 

the drawback to this approach is that a 

creditor could not be challenged for 

failing to underwrite a loan based on the 

consumer’s employment status, 

simultaneous loans, current debt 

obligations, or credit history, or for 

generally not making a reasonable and 

good faith determination of the 

consumer’s ability to repay the loan. 

Interpreting a ‘‘qualified mortgage’’ as 

providing a rebuttable presumption of 

compliance would better ensure that 

creditors consider a consumer’s ability 

to repay the loan. Creditors would have 

to make individualized determinations 

that the consumer had the ability to 

repay the loan based on all of the 

underwriting factors listed in the 

general ability-to-repay standard. This 

approach would require the creditor to 

comply with all of the ability-to-repay 

standards, and preserve the consumer’s 

ability to use these standards in a 

defense to foreclosure or other legal 

action. In addition, a consumer could 

assert that, despite complying with the 

criteria for a qualified mortgage and the 

ability-to-repay standard, the creditor 

did not make a reasonable and good 

faith determination of the consumer’s 

ability to repay the loan. However, the 

drawback of this approach is that it 

provides little legal certainty for the 

creditor, and thus, little incentive to 

make a ‘‘qualified mortgage,’’ which 

limits loan fees and features. 

Because of the statutory ambiguity 

and these competing concerns, the 

Board is proposing two alternative 

definitions of a ‘‘qualified mortgage.’’ 

Alternative 1 defines a ‘‘qualified 

mortgage’’ based on the criteria listed in 

the Act, and the definition operates as 

a legal safe harbor and alternative to 

complying with the general ability-torepay standard. Alternative 1 does not 

define a ‘‘qualified mortgage’’ to include 

a requirement to consider the 

consumer’s debt-to-income ratio or 

residual income. Because of the 

discretion inherent in making these 

calculations, such a requirement would 

not provide certainty that the loan is a 

qualified mortgage. 

Alternative 2 defines a ‘‘qualified 

mortgage’’ to include the requirements 

listed in the Act as well as the other 

underwriting requirements that are in 

the general ability-to-repay standard 

(i.e., employment status, simultaneous 

loans, current debt obligations, debt-toincome ratio, and credit history). The 

definition provides a presumption of 

compliance that could be rebutted by 

the consumer. 

Limits on points and fees. The DoddFrank Act defines a ‘‘qualified mortgage’’ 

as a loan for which, among other things, 

the total points and fees do not exceed 

three percent of the total loan amount. 

In addition, the Act requires the Board 

to prescribe rules adjusting this 

threshold for ‘‘smaller loans’’ and to 

‘‘consider the potential impact of such 

rules on rural areas and other areas 

where home values are lower.’’ If the 

threshold were not adjusted for smaller 

loans, then creditors might not be able 

to recover their fixed costs for 

originating the loan. This could deter 

some creditors from originating smaller 

loans, thus reducing access to credit. 

The Board is proposing two 

alternatives for implementing the limits 

on points and fees for qualified 

mortgages. Alternative A is based on 

certain tiers of loan amounts (e.g., a 

points and fees threshold of 3.5 percent 

of the total loan amount for a loan 

amount greater than or equal to $60,000 

but less than $75,000). Alternative A is 

designed to be an easier calculation for 

creditors, but may result in some 

anomalies (e.g., a points and fees 

threshold of $2,250 for a $75,000 loan, 

but a points and fees threshold of $2,450 

for a $70,000 loan). Alternative B is 

designed to remedy these anomalies by 

providing a more precise sliding scale, 

but may be cumbersome for some 

creditors. The proposal solicits 

comment on these approaches. 


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Definition of ‘‘points and fees.’’ 

Generally, a qualified mortgage cannot 

have points and fees that exceed three 

percent of the total loan amount. 

Consistent with the Act, the proposal 

revises Regulation Z to define ‘‘points 

and fees’’ to now include: (1) Certain 

mortgage insurance premiums in excess 

of the amount payable under Federal 

Housing Administration provisions; (2) 

all compensation paid directly or 

indirectly by a consumer or creditor to 

a loan originator; and (3) the 

prepayment penalty on the covered 

transaction, or on the existing loan if it 

is refinanced by the same creditor. The 

proposal also provides exceptions to the 

calculation of points and fees for: (1) 

Any bona fide third party charge not 

retained by the creditor, loan originator, 

or an affiliate of either, and (2) certain 

bona fide discount points. 

Underwriting requirements. As 

discussed above, it is not clear whether 

the Act intends the definition of a 

‘‘qualified mortgage’’ to be a somewhat 

narrowly-defined safe harbor or a more 

broadly-defined presumption of 

compliance. For this reason, the Board 

is proposing two alternative definitions 

with respect to the underwriting 

requirements. Under Alternative 1, the 

underwriting requirements for a 

qualified mortgage are limited to 

requiring a creditor to consider and 

verify the consumer’s current or 

reasonably expected income or assets. 

Under Alternative 2, the definition of a 

qualified mortgage requires a creditor to 

consider and verify all of the 

underwriting factors required under the 

general ability-to-repay standard, 

namely: (1) The currently or reasonably 

expected income, (2) the employment 

status, (3) the monthly payment on any 

simultaneous loan, (4) the current debt 

obligations, (5) the monthly debt-toincome ratio or residual income, and (6) 

the credit history. 

Payment calculations. Consistent with 

the Dodd-Frank Act, the proposal 

defines a qualified mortgage to require 

the creditor to calculate the mortgage 

payment using the periodic payment of 

principal and interest based on the 

maximum interest rate that may apply 

during the first five years after 

consummation. 

Balloon-Payment Qualified Mortgages 

Made by Certain Creditors 

The Board is exercising the authority 

provided under the Dodd-Frank Act to 

provide an exception to the definition of 

a ‘‘qualified mortgage’’ for a balloonpayment loan made by a creditor that 

meets the criteria set forth in the Act. 

Based on outreach, it appears that some 

community banks make short-term 

balloon loans as a means of hedging 

against interest rate risk, and that the 

community banks typically hold these 

loans in portfolio. The Board believes 

Congress enacted this exception to 

ensure access to credit in rural and 

underserved areas where consumers 

may be able to obtain credit only from 

such community banks offering these 

balloon-payment loans. This exception 

is similar to the exemption from the 

escrow requirements provided in 

another section of the Dodd-Frank Act. 

The proposal provides an exception 

for a creditor that meets the following 

four criteria, with some alternatives: 

(1) Operates in predominantly rural or 

underserved areas. The creditor, during 

the preceding calendar year, must have 

extended more than 50% of its total 

covered transactions that provide for 

balloon payments in one or more 

counties designated by the Board as 

‘‘rural’’ or ‘‘underserved.’’ 

(2) Total annual covered transactions. 

Under Alternative 1, the creditor, 

together with all affiliates, extended 

covered transactions of some dollar 

amount or less during the preceding 

calendar year. Under Alternative 2, the 

creditor, together with all affiliates, 

extended some number of covered 

transactions or fewer during the 

preceding calendar year. The proposal 

solicits comment on an appropriate 

dollar amount or number of 

transactions. 

(3) Balloon loans in portfolio. Under 

Alternative 1, the creditor must not sell 

any balloon-payment loans on or after 

the effective date of the final rule. Under 

Alternative 2, the creditor must not have 

sold any balloon-payment loans during 

the preceding and current calendar year. 

(4) Asset size. The creditor must meet 

an asset size threshold set annually by 

the Board, which for calendar year 2011 

would be $2 billion. 

Limits on loan features. The DoddFrank Act generally provides that a 

balloon-payment qualified mortgage 

contains the same limits on loan 

features and the loan term as a qualified 

mortgage, except for allowing the 

balloon payment. In addition, the Board 

is using its adjustment and exception 

authority and discretionary regulatory 

authority to add a requirement that the 

loan term be five years or longer. The 

Board believes that this requirement 

would help ensure the consumer’s 

ability to repay the loan by providing 

more time for the consumer to build 

equity. 

Points and fees and underwriting 

requirements. Consistent with the DoddFrank Act, the proposal requires that a 

balloon-payment qualified mortgage 

provide for the same limits on points 

and fees and underwriting requirements 

as a qualified mortgage. 

Payment calculations. Consistent with 

the Dodd-Frank Act, the proposal 

provides that a creditor may underwrite 

a balloon-payment qualified mortgage 

using all of the scheduled payments, 

except the balloon payment. 

Other Protections 

Limits on prepayment penalties. 

Consistent with the Dodd-Frank Act, the 

proposal provides that a covered 

transaction may not include a 

prepayment penalty unless the 

transaction: (1) Has an APR that cannot 

increase after consummation (i.e., a 

fixed-rate or step-rate mortgage), (2) is a 

qualified mortgage, and (3) is not a 

higher-priced mortgage loan. The 

proposal further provides, consistent 

with the Act, that the prepayment 

penalty may not exceed three percent of 

the outstanding loan balance during the 

first year after consummation, two 

percent during the second year after 

consummation, and one percent during 

the third year after consummation. 

Prepayment penalties are not permitted 

after the end of the third year after 

consummation. Finally, pursuant to the 

Act, the proposal requires a creditor 

offering a consumer a loan with a 

prepayment penalty to also offer that 

consumer a loan without a prepayment 

penalty. 

Expansion of record retention rules. 

Currently, Regulation Z requires 

creditors to retain evidence of 

compliance for two years after 

disclosures must be made or action 

must be taken. The Dodd-Frank Act 

extends the statute of limitations for 

civil liability for a violation of the 

prepayment penalty provisions or 

ability-to-repay provisions (including 

the qualified mortgage provisions) to 

three years after the date of a violation. 

The proposal revises Regulation Z to 

lengthen the record retention 

requirement to three years after 

consummation for consistency with the 

Dodd-Frank Act. 

Prohibition on evasion through openend credit. Currently, Regulation Z 

prohibits a creditor from structuring a 

closed-end loan as an open-end plan to 

evade the requirements for higherpriced mortgage loans. The Board is 

using its adjustment and exception 

authority and discretionary regulatory 

authority to include a similar provision 

in this proposal in order to prevent 

circumvention or evasion. 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
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6Public Law 111–203, 124 Stat. 1376, Title XIV, 

§ 1431. 7 Id. § 1412; TILA Section 129C(b)(2)(A)(vii), 

(b)(2)(C)(i); 15 U.S.C. 1639c(b)(2)(A)(vii), (b)(2)(C)(i). 8 Id. § 1431–1433. The Dodd-Frank Act defines a 

high-cost mortgage to include a mortgage for which 

‘‘the total points and fees payable in connection 

with the transaction, other than bona fide third 

party charges not retained by the mortgage 

originator, creditor, or an affiliate of the creditor or 

mortgage originator, exceed—(I) in the case of a 

transaction for $20,000 or more, 5 percent of the 

total transaction amount; or (II) in the case of a 

transaction for less than $20,000, the lesser of 8 

percent of the total transaction amount or $1,000 (or 

such other dollar amount as the Board shall 

prescribe by regulation.’’ Id. § 1431(a); TILA Section 

103(aa)(1)(A)(ii); 15 U.S.C. 1602(aa)(1)(A)(ii). 

V. Section-by-Section Analysis 

Section 226.25 Record Retention 

25(a) General Rule 

Currently, § 226.25(a) requires that 

creditors retain evidence of compliance 

with Regulation Z for two years after 

disclosures must be made or action 

must be taken. Section 226.25(a) also 

clarifies that administrative agencies 

responsible for enforcing Regulation Z 

may require creditors under their 

jurisdictions to retain records for a 

longer period, if necessary to carry out 

their enforcement responsibilities under 

TILA Section 108. 15 U.S.C. 1607. 

Under TILA Section 130(e), the statute 

of limitations for civil liability for a 

violation of TILA is one year after the 

date a violation occurs. 15 U.S.C. 1640. 

The proposal would implement the 

requirement to consider a consumer’s 

repayment ability under TILA Section 

129C(a), alternative requirements for 

‘‘qualified mortgages’’ under TILA 

Section 129C(b), and prepayment 

penalty requirements under TILA 

Section 129C(c) in proposed § 226.43, as 

discussed in detail below. Section 1416 

of the Dodd-Frank Act extends the 

statute of limitations for civil liability 

for a violation of TILA Section 129C, 

among other provisions, to three years 

after the date a violation occurs. 

Accordingly, the Board proposes to 

revise § 226.25(a) to require that 

creditors retain records that evidence 

compliance with proposed § 226.43 for 

at least three years after consummation. 

Although creditors will take action 

required under proposed § 226.43 

(underwriting covered transactions and 

offering consumers the option of a 

covered transaction without a 

prepayment penalty) before a 

transaction is consummated, the Board 

believes calculating the record retention 

period from the time of consummation 

would facilitate compliance by 

establishing a clear time period for 

record retention. The proposal to extend 

the required period for retention of 

evidence of compliance with § 226.43 

would not affect the record retention 

period for other requirements under 

Regulation Z. Increasing the period 

creditors must retain records evidencing 

compliance with § 226.43 from two to 

three years would increase creditors’ 

compliance burden. The Board believes 

many creditors will retain such records 

for at least three years, even in the 

absence of a change to record retention 

requirements, due to the extension of 

the statute of limitations for civil 

liability. 

Currently, comment 25(a)–2 clarifies 

that in general creditors need retain 

only enough information to reconstruct 

the required disclosures or other 

records. The Board proposes a new 

comment 25(a)–6 that clarifies that if a 

creditor must verify and document 

information used in underwriting a 

transaction subject to proposed § 226.43, 

the creditor should retain evidence 

sufficient to demonstrate compliance 

with the documentation requirements of 

§ 226.25(a). Proposed comment 25(a)–6 

also clarifies that creditors need not 

retain actual paper copies of the 

documentation used to underwrite a 

transaction, but they should be able to 

reproduce those records accurately, for 

example, by retaining a reproduction of 

a consumer’s Internal Revenue Service 

Form W–2 rather than merely the 

income information on the form. The 

Board also proposes to revise comment 

25(a)–2 to remove obsolete references to 

particular documentation methods and 

to reflect that in some cases creditors 

must be able to reproduce (not merely 

reconstruct) records. 

Proposed comment 25(a)–7 provides 

guidance regarding retention of records 

evidencing compliance with the 

requirement to offer a consumer an 

alternative covered transaction without 

a prepayment penalty, discussed below 

in the section-by-section analyses of 

proposed § 226.43(g)(3) through (5). 

Proposed comment 25(a)–7 clarifies that 

creditors must retain records that 

document compliance with that 

requirement if a transaction subject to 

proposed § 226.43 is consummated with 

a prepayment penalty, but need not 

retain such records if a covered 

transaction is consummated without a 

prepayment penalty or a covered 

transaction is not consummated. See 

proposed § 226.43(g)(6). The Board 

believes the requirement to offer a 

transaction without a prepayment 

penalty under TILA Section 129C(c)(4) 

is intended to ensure that consumers 

can voluntarily choose an alternative 

covered transaction with a prepayment 

penalty. The Board therefore believes it 

is unnecessary for creditors to document 

compliance with the offer requirement 

when a consumer does not choose a 

transaction with a prepayment penalty, 

or if the covered transaction is not 

consummated. 

As discussed in detail below in the 

section-by-section analysis of proposed 

§ 226.43(g)(4), if the creditor offers a 

covered transaction with a prepayment 

penalty through a mortgage broker, the 

creditor must present the mortgage 

broker an alternative covered 

transaction without a prepayment 

penalty. Also, the creditor must provide, 

by agreement, for the mortgage broker to 

present the consumer that transaction or 

an alternative covered transaction 

without a prepayment penalty offered 

by another creditor that has a lower 

interest rate or a lower total dollar 

amount of origination points or fees and 

discount points. Proposed comment 

25(a)–7 clarifies that, to evidence 

compliance with proposed 

§ 226.43(g)(4), the creditor should retain 

a record of (1) the alternative covered 

transaction without a prepayment 

penalty presented to the mortgage 

broker pursuant to proposed 

§ 226.43(g)(4)(i), such as a rate sheet, 

and (2) the agreement with the mortgage 

broker required by proposed 

§ 226.34(g)(4)(ii). 

Section 226.32 Requirements for 

Certain Closed-End Home Mortgages 

Introduction 

The Board proposes to revise the 

definition of ‘‘points and fees’’ in 

§ 226.32(b)(1) to incorporate 

amendments to this definition under the 

Dodd-Frank Act.6 Formerly, the 

definition of ‘‘points and fees’’ in both 

TILA and Regulation Z applied only for 

determining whether a home mortgage 

is a ‘‘high-cost mortgage’’ under TILA. 

See TILA Section 103(aa)(4), 15 U.S.C. 

1602(aa)(4); § 226.32. As discussed 

earlier, however, the Dodd-Frank Act 

amended TILA to create a new type of 

mortgage—a ‘‘qualified mortgage’’—to 

which certain limits on the points and 

fees that may be charged apply.7 Under 

the new TILA amendments, the term 

‘‘points and fees’’ for qualified mortgages 

has the same meaning as ‘‘points and 

fees’’ for high-cost mortgages. 

The Board proposes amendments to 

the definition of ‘‘points and fees’’ to 

implement the limitation on points and 

fees for qualified mortgages. The Board 

is not currently proposing regulations to 

implement the Dodd-Frank Act’s 

amendments to TILA’s high-cost 

mortgage rules generally.8 For example, 

the Board is not proposing at this time 

to implement revisions to the points and 

fees thresholds for high-cost mortgages 

that exclude from the threshold 


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Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27399 

9Public Law 111–203, 124 Stat. 1376, Title XIV, 

§ 1431(a) and (d); TILA Section 103(aa)(1) and (dd); 

15 U.S.C. 1602(aa)(1) and (dd). 

10Public Law 111–203, 124 Stat. 1376, Title XIV, 

§ 1412; TILA Section 129C(b)(2)(C); 15 U.S.C. 

1639c(b)(2)(C). Thus, if the rule on qualified 

mortgages is finalized prior to the rule on high-cost 

mortgages, the calculation of the points and fees 

threshold for each type of mortgage would be 

different, but the baseline definition of ‘‘points and 

fees’’ would be the same. 

11Similarly, prior to being revised by the DoddFrank Act, TILA Section 103(aa)(1)(B) defined a 

high-cost mortgage to include a mortgage for which 

‘‘the total points and fees payable by the consumer 

at or before closing will exceed the greater of (i) 

eight percent of the total loan amount; or (ii) $400’’ 

(emphasis added). Regulation Z currently defines a 

high-cost mortgage to include a loan for which the 

total points and fees payable by the consumer at or 

before closing exceed a certain percentage of the 

‘‘total loan amount’’ or a dollar amount adjusted 

annually for inflation. See § 226.32(a)(1)(ii). 

Commentary to § 226.32(a)(1)(ii) explains the term 

‘‘total loan amount.’’ See comment 32(a)(1)(ii)–1. 

Section 1431 of the Dodd-Frank Act now defines a 

high-cost mortgage to include a mortgage for which 

the points and fees do not exceed a certain 

percentage of the ‘‘total transaction amount,’’ rather 

than using the term ‘‘total loan amount.’’ TILA 

Section 103(aa)(1)(A)(ii). The Dodd-Frank Act does 

not define the term ‘‘total transaction amount.’’ 

However, as discussed above, the Board is not at 

this time proposing to revise the definition of highcost mortgage in § 226.32 to implement Dodd-Frank 

Act amendments to TILA’s high-cost mortgage 

provisions. 

12Public Law 111–203, 124 Stat. 1376, Title XIV, 

§ 1414. The Board is not at this time proposing to 

implement the restrictions on single-premium 

credit insurance under the Dodd-Frank Act. 

calculation ‘‘bona fide third party 

charges not retained by the mortgage 

originator, creditor, or an affiliate of the 

creditor or mortgage originator’’ and that 

permit creditors to exclude certain 

‘‘bona fide discount points.’’ 9 By 

contrast, identical provisions in the 

Dodd-Frank Act defining the points and 

fees threshold for qualified mortgages 

are proposed to be implemented in new 

§ 226.43(e)(3), discussed below.10

32(a) Coverage 

32(a)(1) Calculation of the ‘‘Total Loan 

Amount’’ 

TILA Section 129C(b)(2)(A)(vii) 

defines a ‘‘qualified mortgage’’ as a 

mortgage for which, among other things, 

‘‘the total points and fees [] payable in 

connection with the loan do not exceed 

3 percent of the total loan amount’’ 

(emphasis added).11 Therefore, for 

purposes of implementing the qualified 

mortgage provisions, the Board proposes 

to retain existing comment 32(a)(1)(ii)– 

1 explaining the meaning of the term 

‘‘total loan amount,’’ with the minor 

revisions discussed below. 

First, the proposal revises the ‘‘total 

loan amount’’ calculation under current 

comment 32(a)(1)(ii)–1 to account for 

charges added to TILA’s definition of 

points and fees by the Dodd-Frank Act 

(proposed to be implemented under 

revisions to § 226.32(b)(1), discussed 

below). Under Regulation Z, the ‘‘total 

loan amount’’ is calculated to ensure 

that the allowable points and fees is a 

percentage of the amount of credit 

extended to the consumer, without 

taking into account the financed points 

and fees themselves. Specifically, under 

current comment 32(a)(1)(ii)–1, the 

‘‘total loan amount’’ is calculated by 

‘‘taking the amount financed, as 

determined according to § 226.18(b), 

and deducting any cost listed in 

§ 226.32(b)(1)(iii) and § 226.32(b)(1)(iv) 

that is both included as points and fees 

under § 226.32(b)(1) and financed by the 

creditor.’’ Section 226.32(b)(1)(iii) and 

(b)(1)(iv) pertain to ‘‘real estate-related 

fees’’ listed in § 226.4(c)(7) and 

premiums or other charges for credit 

insurance or debt cancellation coverage, 

respectively. 

The Board proposes to revise this 

comment to cross-reference additional 

financed points and fees described in 

proposed § 226.32(b)(1)(vi) as well. This 

addition would require a creditor also to 

deduct from the amount financed any 

prepayment penalties that are ‘‘incurred 

by the consumer if the mortgage loan 

refinances a previous loan made or 

currently held by the creditor 

refinancing the loan or an affiliate of the 

creditor’’—to the extent that the 

prepayment penalties are financed by 

the creditor into the new loan. See 

proposed § 226.32(b)(1)(vi), 

implementing TILA Section 

103(aa)(4)(F). In this way, the three 

percent limit on points and fees for 

qualified mortgages will be based on the 

amount of credit extended to the 

borrower without taking into account 

the financed points and fees themselves. 

The proposal also revises one of the 

commentary’s examples of the ‘‘total 

loan amount’’ calculation. Specifically, 

the Board proposes to revise the 

example of a $500 single premium for 

optional ‘‘credit life insurance’’ used in 

comment 32(b)(1)(i)–1.iv to be a $500 

single premium for optional ‘‘credit 

unemployment insurance.’’ This change 

is proposed because, under the DoddFrank Act, single-premium credit 

insurance—including credit life 

insurance—is prohibited in covered 

transactions except for certain limited 

types of credit unemployment 

insurance.12 See TILA Section 129C(d); 

15 U.S.C. 1639c(d). 

Alternative calculation of ‘‘total loan 

amount’’ based on the ‘‘principal loan 

amount.’’ As noted, currently the ‘‘total 

loan amount’’ is calculated by taking the 

‘‘amount financed’’ (as determined 

under § 226.18(b)) and deducting any 

cost listed in § 226.32(b)(1)(iii) and 

§ 226.32(b)(1)(iv) that is both included 

as points and fees under § 226.32(b)(1) 

and financed by the creditor. The Board 

requests comment on whether to 

streamline the calculation to better 

ensure that the ‘‘total loan amount’’ 

includes all credit extended other than 

financed points and fees. 

Specifically, the Board solicits 

comment on whether to revise the 

calculation of ‘‘total loan amount’’ to be 

the following: ‘‘principal loan amount’’ 

(as defined in § 226.18(b) and 

accompanying commentary), minus 

charges that are points and fees under 

§ 226.32(b)(1) and are financed by the 

creditor. The purpose of using the 

‘‘principal loan amount’’ instead of the 

‘‘amount financed’’ would be to 

streamline the calculation to facilitate 

compliance and to ensure that no 

charges other than financed points and 

fees are excluded from the ‘‘total loan 

amount.’’ In general, the revised 

calculation would yield a larger ‘‘total 

loan amount’’ to which the percentage 

points and fees thresholds would have 

to be applied than would the proposed 

(and existing) ‘‘total loan amount’’ 

calculation, because only financed 

points and fees and no other financed 

amounts would be excluded. Thus, 

creditors in some cases would be able to 

charge more points and fees on the same 

loan than under the proposed (and 

existing) rule. 

To illustrate, under the proposed (and 

current) rule, the ‘‘total loan amount’’ for 

a loan with a ‘‘principal loan amount’’ of 

$100,000 and a $3,000 upfront mortgage 

insurance premium is $97,000. This is 

because the ‘‘amount financed,’’ from 

which the ‘‘total loan amount’’ is 

derived, excludes prepaid finance 

charges. The $3,000 upfront mortgage 

origination charge meets the definition 

of a prepaid finance charge (see 

§ 226.2(a)(23)) and thus would be 

excluded from the ‘‘principal loan 

amount’’ to derive the ‘‘amount 

financed.’’ The ‘‘total loan amount’’ is 

the ‘‘amount financed’’ ($97,000) minus 

any points and fees listed in 

§ 226.32(b)(1)(iii) or (b)(1)(iv) that are 

financed. In this example, there are no 

charges under § 226.32(b)(1)(iii) or 

(b)(1)(iv), so the ‘‘total loan amount’’ is 

$97,000. The allowable points and fees 

under the qualified mortgage test in this 

example is three percent of $97,000 or 

$2,910. 

If the ‘‘total loan amount’’ is derived 

simply by subtracting from the 

‘‘principal loan amount’’ all points and 

fees that are financed, however, a 

different result occurs. In the example 

above, assume that the allowable 

upfront mortgage insurance premium 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27400 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

for FHA loans is $2,000. Under 

proposed § 226.32(b)(1)(i)(B) (discussed 

in detail below), only the $1,000 

difference between the $3,000 upfront 

private mortgage insurance premium 

and the $2,000 amount that would be 

allowable for an FHA loan must be 

counted as points and fees. To 

determine the ‘‘total loan amount,’’ the 

creditor would subtract $1,000 from the 

‘‘principal loan amount’’ ($100,000), 

resulting in $99,000. The allowable 

points and fees under the qualified 

mortgage test in this example is three 

percent of $99,000 or $2,970. 

The Board requests comment on the 

proposed revisions to the comment 

explaining how to calculate the ‘‘total 

loan amount,’’ including whether 

additional guidance is needed. 

32(b) Definitions 

32(b)(1) 

The proposed rule would revise 

existing elements of Regulation Z’s 

definition of ‘‘points and fees’’ (see 

proposed § 226.32(b)(1)(i)–(iv)) and add 

certain items not previously included in 

‘‘points and fees’’ but now mandated by 

statute to be included (see proposed 

§ 226.32(b)(1)(v) and (vi)). These 

changes are discussed in turn below. 

32(b)(1)(i) Finance Charge 

Current § 226.32(b)(1)(i) requires that 

‘‘points and fees’’ include ‘‘all items 

required to be disclosed under § 226.4(a) 

and 226.4(b)’’—the provisions that 

define the term ‘‘finance charge’’ 

—‘‘except interest or the time-price 

differential.’’ Proposed § 226.32(b)(1)(i) 

would revise the current provision to 

include in points and fees ‘‘all items 

considered to be a finance charge under 

§ 226.4(a) and 226.4(b), except— 

• Interest or the time-price 

differential; and 

• Any premium or charge for any 

guarantee or insurance protecting the 

creditor against the consumer’s default 

or other credit loss to the extent that the 

premium or charge is assessed— 

Æ in connection with any Federal or 

state agency program; 

Æ not in excess of the amount payable 

under policies in effect at the time of 

origination under Section 203(c)(2)(A) 

of the National Housing Act (12 U.S.C. 

1709(c)(2)(A)) (i.e., for Federal Housing 

Administration (FHA) loans), provided 

that the premium or charge is required 

to be refundable on a pro-rated basis 

and the refund is automatically issued 

upon notification of the satisfaction of 

the underlying mortgage loan; or 

Æ payable after the loan closing. 

See proposed § 226.32(b)(1)(i)(A)-(C). 

The Board proposes to revise the 

existing phrase, ‘‘all items required to be 

disclosed under § 226.4(a) and 226.4(b)’’ 

to read, ‘‘all items considered to be a 

finance charge under § 226.4(a) and 

226.4(b)’’ in part because § 226.4 itself 

does not require disclosure of the 

finance charge (see instead, for example, 

§ 226.18(d)). 

The Board also proposes to revise 

comment 32(b)(1)(i)–1. Existing 

comment 32(b)(1)(i)–1 states that 

§ 226.32(b)(1)(i) includes in the total 

‘‘points and fees’’ items defined as 

finance charges under § 226.4(a) and 

226.4(b). The comment explains that 

items excluded from the finance charge 

under other provisions of § 226.4 are not 

included in the total ‘‘points and fees’’ 

under § 226.32(b)(1)(i), but may be 

included in ‘‘points and fees’’ under 

§ 226.32(b)(1)(ii) and 226.32(b)(1)(iii). 

The Board proposes to revise this 

comment to state that items excluded 

from the finance charge under other 

provision of § 226.4 may be included in 

‘‘points and fee’’ under § 226.32(b)(1)(ii) 

through 226.32(b)(1)(vi). This change is 

proposed to reflect the additional items 

added to the definition of ‘‘points and 

fees’’ by the Dodd-Frank Act and to 

correct the previous omission of 

§ 226.32(b)(1)(iv). 

In addition, the Board proposes to 

incorporate into this comment an 

example of how this rule operates. 

Thus, the proposed comment notes that 

a fee imposed by the creditor for an 

appraisal performed by an employee of 

the creditor meets the definition of 

‘‘finance charge’’ under § 226.4(a) as 

‘‘any charge payable directly or 

indirectly by the consumer and imposed 

directly or indirectly by the creditor as 

an incident to or a condition of the 

extension of credit.’’ However, 

§ 226.4(c)(7) expressly provides that 

appraisal fees are not finance charges. 

Therefore, under the general rule 

regarding the finance charges that must 

be counted as points and fees, a fee 

imposed by the creditor for an appraisal 

performed by an employee of the 

creditor would not be counted in points 

and fees. Section 226.32(b)(1)(iii), 

however, expressly includes in points 

and fees items listed in § 226.4(c)(7) 

(including appraisal fees) if the creditor 

receives compensation in connection 

with the charge. A creditor would 

receive compensation for an appraisal 

performed by its own employee. Thus, 

the appraisal fee in this example must 

be included in the calculation of points 

and fees. Comment 32(b)(1)(i)–1 is also 

proposed to be updated to include 

cross-references that correspond to 

provisions added to the definition of 

‘‘points and fees’’ by the Dodd-Frank Act 

(see proposed § 226.32(b)(1)(v) and 

(b)(1)(vi)). 

32(b)(1)(i)(B) Mortgage Insurance 

Proposed § 226.32(b)(1)(i)(B) adds a 

new provision to the current definition 

of ‘‘points and fees’’ regarding charges 

for mortgage insurance and similar 

products. As stated above, under this 

provision, points and fees would 

include all items considered to be a 

finance charge under § 226.4(a) and 

226.4(b) except mortgage insurance 

premiums or mortgage guarantee 

charges or fees to the extent that the 

premium or charge is— 

• assessed in connection with any 

Federal or state agency program; 

• not in excess of the amount payable 

under FHA mortgage insurance policies 

(provided that the premium or charge is 

required to be refundable on a pro-rated 

basis and the refund is automatically 

issued upon notification of the 

satisfaction of the underlying mortgage 

loan); or 

• payable after the loan closing. 

This provision implements TILA 

Section 103(aa)(1)(C), which specifies 

how ‘‘mortgage insurance’’ should be 

treated in the statutory definition of 

points and fees under TILA Section 

103(aa)(4). 

Exclusion of government insurance 

premiums and guaranty fees. The Board 

proposes to incorporate the new 

statutory exclusion from points and fees 

of ‘‘any premium provided by an agency 

of the Federal Government or an agency 

of a State,’’ with revisions. TILA Section 

103(aa)(1)(C)(i). Specifically, the 

proposal excludes ‘‘any premium or 

charge for any guaranty or insurance’’ 

under a Federal or state government 

program. See proposed 

§ 226.32(b)(1)(i)(B)(1). Proposed 

comment 32(b)(1)(i)–2 explains that, 

under § 226.32(b)(1)(i)(B)(1) and (3), 

upfront mortgage insurance premiums 

or guaranty fees in connection with a 

Federal or state agency program are not 

‘‘points and fees,’’ even though they are 

finance charges under § 226.4(a) and (b). 

The comment provides the following 

example: If a consumer is required to 

pay a $2,000 mortgage insurance 

premium before or at closing for a loan 

insured by the U.S. Federal Housing 

Administration, the $2,000 must be 

treated as a finance charge but need not 

be counted in ‘‘points and fees.’’ 

The Board interprets the statute to 

exclude from points and fees not only 

upfront mortgage insurance premiums 

under government programs but also 

charges for mortgage guaranties under 

government programs, which typically 

are assessed upfront as well. The 

proposed exclusion from points and fees 

of both mortgage insurance premiums 

and guaranty fees under government 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
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13The statute authorizes certain agencies, 

including the VA and USDA, to prescribe rules 

defining the loans under their programs that are 

qualified mortgages; until those rules take effect, 

however, it appears that even loans under 

government programs will be subject to the general 

ability-to-repay requirements and the criteria for 

qualified mortgages. See TILA Section 

129C(b)(3)(ii). 

programs is also supported by the 

Board’s authority under TILA Section 

105(a) to make adjustments to facilitate 

compliance with TILA and to effectuate 

the purposes of TILA. 15 U.S.C. 1604(a). 

The exclusion is further supported by 

the Board’s authority under TILA 

Section 129B(e) to condition terms, acts 

or practices relating to residential 

mortgage loans that the Board finds 

necessary or proper to effectuate the 

purposes of TILA. 15 U.S.C. 1639b(e). 

The purposes of TILA include 

‘‘assur[ing] that consumers are offered 

and receive residential mortgage loan on 

terms that reasonably reflect their ability 

to repay the loans.’’ TILA Section 

129B(a)(2); 15 U.S.C. 1629b(a)(2). 

Representatives of both the U.S. 

Department of Veterans Affairs (VA) and 

the U.S. Department of Agriculture 

(USDA) expressed concerns to Board 

staff that the statute, which excludes 

only ‘‘premiums’’ under government 

programs, could be read to mean that 

upfront charges for guaranties offered 

under loan programs of these agencies 

and any state agencies must be counted 

in ‘‘points and fees.’’ The Board 

understands that this interpretation of 

the statute could disrupt these loan 

guaranty programs, jeopardizing an 

important home mortgage credit 

resource for many consumers. 

According to VA representatives, for 

example, if VA ‘‘funding fees’’ for the VA 

mortgage loan guaranty are included in 

points and fees, for example, VA loans 

might exceed high-cost mortgage 

thresholds and likely would exceed the 

points and fees cap for a qualified 

mortgage.13 In sum, the Board believes 

that the proposal is necessary to ensure 

consumer’s access to credit through 

state and Federal government programs. 

The Board requests comment on the 

proposal to exclude from ‘‘points and 

fees’’ upfront premiums as well as 

charges for any insurance or guaranty 

under a Federal or state government 

program. 

Inclusion of upfront private mortgage 

insurance. Proposed 

§ 226.32(b)(1)(i)(B)(2) excludes from 

points and fees any premium or charge 

for any guaranty or insurance protecting 

the creditor against the consumer’s 

default or other credit loss to the extent 

the premium or charge does not exceed 

the amount payable under policies in 

effect at the time of origination under 

Section 203(c)(2)(A) of the National 

Housing Act (12 U.S.C. 1709(c)(2)(A)) 

(i.e., for Federal Housing 

Administration (FHA) loans). Upfront 

private mortgage insurance charges may 

only be excluded from points and fees, 

however, if the premium or charge is 

required to be refundable on a pro-rated 

basis and the refund is automatically 

issued upon notification of the 

satisfaction of the underlying mortgage 

loan. Proposed § 226.32(b)(1)(i)(B)(3) 

excludes from points and fees any 

premium or charge for any guarantee or 

insurance protecting the creditor against 

the consumer’s default or other credit 

loss to the extent that the premium or 

charge is payable after the loan closing. 

Comment 32(b)(1)(i)–3 explains that, 

under proposed § 226.32(b)(1)(i)(B)(2) 

and (3), upfront private mortgage 

insurance premiums are not ‘‘points and 

fees,’’ even though they are finance 

charges under § 226.4(a) and (b)—but 

only to the extent that the premium 

amount does not exceed the amount 

payable under policies in effect at the 

time of origination under Section 

203(c)(2)(A) of the National Housing Act 

(12 U.S.C. 1709(c)(2)(A)). In addition, 

upfront private mortgage insurance 

premiums are excluded from ‘‘points 

and fees’’ only if they are required to be 

refunded on a pro rata basis and the 

refund is automatically issued upon 

notification of the satisfaction of the 

underlying mortgage loan. This 

comment provides the following 

example: Assume that a $3,000 upfront 

private mortgage insurance premium 

charged on a covered transaction is 

required to be refunded on a pro rata 

basis and automatically issued upon 

notification of the satisfaction of the 

underlying mortgage loan. Assume also 

that the maximum upfront premium 

allowable under the National Housing 

Act is $2,000. In this case, the creditor 

could exclude $2,000 from ‘‘points and 

fees’’ but would have to include in 

points and fees the remaining $1,000, 

because this is the amount that exceeds 

the allowable premium under the 

National Housing Act. However, if the 

$3,000 upfront private mortgage 

insurance premium were not required to 

be refunded on a pro rata basis and 

automatically issued upon notification 

of the satisfaction of the underlying 

mortgage loan, the entire $3,000 

premium must be included in ‘‘points 

and fees.’’ 

Proposed comment 32(b)(1)(i)–4 

explains that upfront private mortgage 

insurance premiums that do not qualify 

for an exclusion from ‘‘points and fees’’ 

under § 226.32(b)(1)(i)(B)(2) must be 

included in ‘‘points and fees’’ whether 

paid before or at closing, in cash or 

financed, and whether the insurance is 

optional or required. This comment 

further explains that these charges are 

also included whether the amount 

represents the entire premium or an 

initial payment. This proposed 

comment is consistent with existing 

comment 32(b)(1)(iv)–1 regarding the 

treatment of credit insurance premiums. 

TILA’s new mortgage insurance 

provision could plausibly be interpreted 

to apply to the definition of points and 

fees solely for purposes of high-cost 

mortgages and not for qualified 

mortgages. In this regard, the Board 

notes that the statutory provision 

mandating a three percent cap on points 

and fees for qualified mortgages 

specifically cross-references TILA 

Section 103(aa)(4) for the definition of 

‘‘points and fees’’ applicable to qualified 

mortgages. The provision on mortgage 

insurance, however, does not appear in 

TILA Section 103(aa)(4), but appears 

rather as part of the general definition 

of a high-cost mortgage. See TILA 

Section 103(aa)(1). The Board also notes 

that certain provisions in the DoddFrank Act’s high-cost mortgage section 

regarding points and fees are repeated in 

the qualified mortgage section on points 

and fees. For example, both the highcost mortgage provisions and the 

qualified mortgage provisions expressly 

exclude from points and fees ‘‘bona fide 

third party charges not retained by the 

mortgage originator, creditor, or an 

affiliate of the creditor or mortgage 

originator.’’ TILA Sections 

103(aa)(1)(A)(ii) (for high-cost 

mortgages), 129C(b)(2)(C)(i) (for 

qualified mortgages). The mortgage 

insurance provision, however, does not 

separately appear in the qualified 

mortgage section. 

Nonetheless, the Board believes that 

the better interpretation of the statute is 

that the mortgage insurance provision in 

TILA Section 103(aa)(1)(C) applies to 

the meaning of points and fees for both 

high-cost mortgages and qualified 

mortgages. The statute’s structure 

reasonably supports this view: By its 

plain language, the mortgage insurance 

provision prescribes how points and 

fees should be computed ‘‘for purposes 

of paragraph (4)’’—namely, for purposes 

of TILA Section 103(aa)(4). The 

mortgage insurance provision contains 

no caveat limiting its application solely 

to the points and fees calculation for 

high-cost mortgages. The cross-reference 

in the qualified mortgage provisions to 

TILA Section 103(aa)(4) appropriately 

can be read to include provisions that 

expressly prescribe how points and fees 

should be calculated under TILA 

Section 103(aa)(4), wherever located. 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27402 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

14Section 226.36(a)(1) defines the term ‘‘loan 

originator’’ to mean, ‘‘with respect to a particular 

transaction, a person who for compensation or other 

monetary gain, or in expectation of compensation 

or other monetary gain, arranges, negotiates, or 

otherwise obtains an extension of credit for another 

person. The term ‘loan originator’ includes an 

employee of the creditor if the employee meets this 

definition. The term ‘loan originator’ includes the 

creditor only if the creditor does not provide the 

funds for the transaction at consummation out of 

the creditor’s own resources, including drawing on 

a bona fide warehouse line of credit, or out of 

deposits held by the creditor.’’ Section 226.36(a)(1). 

15Public Law 111–203, 124 Stat. 1376, Title XIV, 

§ 1401. 

Applying the mortgage insurance 

provision to the meaning of points and 

fees for both high-cost mortgages and 

qualified mortgages is also supported by 

the Board’s authority under TILA 

Section 105(a) to make adjustments to 

facilitate compliance with TILA 15 

U.S.C. 1604(a). The exclusion is further 

supported by the Board’s authority 

under TILA Section 129B(e) to 

condition terms, acts or practices 

relating to residential mortgage loans 

that the Board finds necessary or proper 

to effectuate the purposes of TILA. 15 

U.S.C. 1639b(e). The purposes of TILA 

include ‘‘assur[ing] that consumers are 

offered and receive residential mortgage 

loan on terms that reasonably reflect 

their ability to repay the loans.’’ TILA 

Section 129B(a)(2); 15 U.S.C. 

1629b(a)(2). 

From a practical standpoint, the 

Board is concerned about the increased 

risk of confusion and compliance error 

if points and fees has two separate 

meanings in TILA—one for determining 

whether a loan is a high-cost mortgage 

and another for determining whether a 

loan is a qualified mortgage. The 

proposal is intended to facilitate 

compliance by applying the mortgage 

insurance provision to the meaning of 

points and fees for both high-cost 

mortgages and qualified mortgages. 

In addition, the Board is concerned 

that market distortions could result due 

to different treatment of mortgage 

insurance in calculating points and fees 

for high-cost mortgages and qualified 

mortgages. As noted, ‘‘points and fees’’ 

for both high-cost mortgages and 

qualified mortgages generally excludes 

‘‘bona fide third party charges not 

retained by the mortgage originator, 

creditor, or an affiliate of the creditor or 

mortgage originator.’’ TILA Sections 

103(aa)(1)(A)(ii), 129C(b)(2)(C)(i). Under 

this general provision standing alone, 

premiums for upfront private mortgage 

insurance would be excluded from 

points and fees. However, as noted, the 

statute’s specific provision on mortgage 

insurance (TILA Section 103(aa)(1)(C)) 

requires that any portion of upfront 

premiums for private mortgage 

insurance that exceeds amounts 

allowable for upfront insurance 

premiums in FHA mortgage loan 

transactions be counted in points and 

fees. It further provides that upfront 

private mortgage insurance premiums 

must be included in points and fees if 

they are not required to be refunded on 

a pro rata basis and the refund is not 

automatically issued upon notification 

of the satisfaction of the underlying 

mortgage loan. 

Narrowly applying the mortgage 

insurance provision to the definition of 

points and fees only for high-cost 

mortgages would mean that any 

premium amount for upfront private 

mortgage insurance could be charged on 

qualified mortgages; in most cases, none 

of that amount would be subject to the 

cap on points and fees for qualified 

mortgages because it would be excluded 

as a ‘‘bona fide third party fee’’ that is 

not retained by the creditor, loan 

originator, or an affiliate of either. As a 

result, consumers of qualified mortgages 

could be vulnerable to paying excessive 

upfront private mortgage insurance 

costs. In the Board’s view, this outcome 

would undercut Congress’s clear intent 

to ensure that qualified mortgages are 

products with limited fees and more 

safe features. 

32(b)(1)(ii) Loan Originator 

Compensation 

The Board proposes revisions to 

§ 226.32(b)(ii) to reflect statutory 

amendments under the Dodd-Frank Act. 

Current § 226.32(b)(ii) requires 

inclusion in points and fees of ‘‘all 

compensation paid to a mortgage 

broker.’’ Proposed § 226.32(b)(ii) would 

implement a new statutory provision 

that requires inclusion in points and 

fees of ‘‘all compensation paid directly 

or indirectly by a consumer or creditor 

to a mortgage originator from any 

source, including a mortgage originator 

that is also the creditor in a table-funded 

transaction.’’ See TILA Section 

103(aa)(4)(B), 15 U.S.C. 1602(aa)(4)(B). 

Consistent with the statute, the Board 

also proposes to exclude from points 

and fees compensation paid to certain 

persons. See proposed § 226.32(b)(2), 

discussed below. 

Proposed § 226.32(b)(1)(ii) mirrors the 

statutory language, with two exceptions. 

First, the statute requires inclusion of 

‘‘compensation paid directly or 

indirectly by a consumer or creditor to 

a mortgage originator from any source. 

***’’ The proposed rule does not 

include the phrase ‘‘from any source’’ 

because the provision expressly covers 

compensation paid ‘‘directly or 

indirectly’’ to the loan originator, which 

would have the same effect. The Board 

requests comment on whether any 

reason exists to include the phrase 

‘‘from any source’’ to describe loan 

originator compensation for purposes of 

implementing TILA Section 

103(aa)(4)(B). 

Second, the proposal uses the term 

‘‘loan originator’’ as defined in 

§ 226.36(a)(1),14 not the term ‘‘mortgage 

originator’’ under Section 1401 of the 

Dodd-Frank Act.15 See TILA Section 

103(cc)(2); 15 U.S.C. 1602(cc)(2). The 

term ‘‘loan originator’’ is used for 

consistency with existing Regulation Z 

provisions under § 226.36. The Board 

believes that the term ‘‘loan originator,’’ 

as defined in § 226.36(a)(1), is 

appropriately used in proposed 

§ 226.32(b)(1)(ii) because the meaning of 

‘‘loan originator’’ under § 226.36(a)(1) 

and the statutory definition of ‘‘mortgage 

originator’’ are consistent in several key 

respects, discussed below. 

In addition, new § 226.32(b)(2) would 

account for the distinctions between the 

Dodd-Frank Act’s definition of 

‘‘mortgage originator’’ and the definition 

of ‘‘loan originator’’ under § 226.36(a)(1). 

Proposed § 226.32(b)(2) exempts from 

points and fees compensation paid to 

certain persons expressly excluded from 

the statutory definition of ‘‘mortgage 

originator.’’ See section-by-section 

analysis of § 226.32(b)(2), below. Use of 

the term ‘‘loan originator’’ in proposed 

§ 226.32(b)(1)(ii). 

Loan originator functions. The DoddFrank Act defines the term ‘‘mortgage 

originator’’ to mean ‘‘any person who, 

for direct or indirect compensation or 

gain, or in the expectation of direct or 

indirect compensation or gain—(i) takes 

a residential mortgage loan application; 

(ii) assists a consumer in obtaining or 

applying to obtain a residential 

mortgage loan; or (iii) offers or 

negotiates terms of a residential 

mortgage loan . * * *’’ TILA Section 

103(cc)(2)(A). The statute further 

defines ‘‘assists a consumer in obtaining 

or applying to obtain a residential 

mortgage loan’’ to mean, ‘‘among other 

things, advising on residential mortgage 

loan terms (including rates, fees, and 

other costs), preparing residential 

mortgage loan packages, or collecting 

information on behalf of the consumer 

with regard to a residential mortgage 

loan.’’ 

The definition of ‘‘loan originator’’ in 

§ 226.36 includes all of the activities 

listed in the statute as part of the 

definition of ‘‘mortgage originator,’’ with 

one exception. Unlike the statutory 

definition of ‘‘mortgage originator,’’ 

however, Regulation Z’s definition of 

‘‘loan originator’’ does not include ‘‘any 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27403 

16Loan originator compensation would, of 

course, need to be consistent with the Interagency 

Guidance on Sound Incentive Compensation 

Policies. 75 FR 36395, June 25, 2010. 

person who represents to the public, 

through advertising or other means of 

communicating or providing 

information (including the use of 

business cards, stationery, brochures, 

signs, rate lists, or other promotional 

items), that such person can or will 

provide any of the activities’’ described 

above. TILA Section 103(cc)(2)(B); 15 

U.S.C. 1602(cc)(2)(B). The Board does 

not believe that adding this element of 

the definition of ‘‘mortgage originator’’ to 

Regulation Z’s definition of ‘‘loan 

originator’’ is necessary at this time 

because § 226.36 and the proposed 

definition of ‘‘points and fees’’ are 

concerned solely with loan originators 

that receive compensation for 

performing defined origination 

functions. A person who solely 

represents to the public that he is able 

to offer or negotiate mortgage terms for 

a consumer has not yet received 

compensation for that function; thus, 

there is no compensation to account for 

in calculating ‘‘points and fees’’ for a 

particular transaction. 

The Board solicits comment on the 

proposal not to include in the definition 

of ‘‘loan originator’’ a ‘‘person who 

represents to the public, through 

advertising or other means of 

communicating or providing 

information (including the use of 

business cards, stationery, brochures, 

signs, rate lists, or other promotional 

items), that such person can or will 

provide’’ the services of a loan 

originator. 

Administrative tasks. The Board also 

believes that the definition of ‘‘loan 

originator’’ in § 226.32(a)(1) is consistent 

with the Dodd-Frank Act’s definition of 

‘‘mortgage originator’’ in that both 

exclude persons that perform solely 

administrative or clerical tasks. 

Specifically, the statute excludes any 

person who does not perform the tasks 

in the paragraph above and ‘‘who 

performs purely administrative or 

clerical tasks on behalf of a person who 

[performs those tasks].’’ TILA Section 

103(cc)(2)(B); 15 U.S.C. 1602(cc)(2)(B). 

Similarly, Regulation Z’s current 

definition of ‘‘loan originator’’ excludes 

‘‘managers, administrative staff, and 

similar individuals who are employed 

by a creditor or loan originator but do 

not arrange, negotiate, or otherwise 

obtain an extension of credit for a 

consumer, and whose compensation is 

not based on whether any particular 

loan is originated.’’ Comment 36(a)(1)–4. 

Seller financing. In addition, the 

existing definition of ‘‘loan originator’’ 

in § 226.36(a)(1) is consistent with the 

statutory definition of ‘‘mortgage 

originator’’ in that both exclude persons 

and entities that provide seller financing 

for properties that they own. See TILA 

Section 103(cc)(2)(E); 15 U.S.C. 

1602(cc)(2)(E). Under the definition of 

‘‘loan originator’’ in § 226.36(a)(1), these 

persons would be ‘‘creditors’’—but they 

are not ‘‘creditors’’ that use table 

funding. As noted below, creditors that 

use table funding are ‘‘loan originators’’ 

under § 226.36. However, all other 

‘‘creditors’’ are not ‘‘loan originators.’’ 

See 75 FR 58509, 58510 (Sept. 24, 2010). 

Creditors in table-funded 

transactions. Both the existing 

definition of ‘‘loan originator’’ in 

§ 226.36(a)(1) and the statutory 

definition of ‘‘mortgage originator’’ 

exclude the creditor, except for the 

creditor in a table-funded transaction. 

See TILA Section 103(cc)(2)(F); 15 

U.S.C. 1602(cc)(2)(F); see also comment 

36(a)–1.i. Both also include employees 

of a creditor, individual brokers and 

mortgage brokerage firms, including 

entities that close loans in their own 

names that are table funded by a third 

party. 

Secondary market transactions. 

Finally, neither the definition of ‘‘loan 

originator’’ in § 226.36(a)(1) nor the 

statutory definition of ‘‘mortgage 

originator’’ includes entities that earn 

compensation on the sale of loans by 

creditors to secondary market 

purchasers—transactions to which 

consumers are not a direct party. See 

generally TILA Section 103(cc)(2); 15 

U.S.C. 1602(cc)(2). 

Comments 32(b)(1)(ii)–1, –2, and –3. 

Proposed comments 32(b)(1)(ii)–1, –2, 

and –3 provide guidance on the types of 

loan originator compensation 16

included in ‘‘points and fees.’’ Existing 

comment 32(b)(1)(ii)–1 would be 

revised to clarify that compensation 

paid by either a consumer or a creditor 

to a loan originator, as defined in 

§ 226.32(a)(1), is included in ‘‘points and 

fees.’’ No other substantive changes are 

intended. 

New comment 32(b)(1)(ii)–2.i would 

clarify that, in determining ‘‘points and 

fees,’’ loan originator compensation 

includes the dollar value of 

compensation paid to a loan originator 

for a covered transaction, such as a 

bonus, commission, yield spread 

premium, award of merchandise, 

services, trips, or similar prizes, or 

hourly pay for the actual number of 

hours worked on a particular 

transaction. The proposed comment 

would further clarify that compensation 

paid to a loan originator for a covered 

transaction must be included in the 

‘‘points and fees’’ calculation for that 

transaction whenever paid, whether at 

or before closing or anytime after 

closing, as long as that compensation 

amount can be determined at the time 

of closing. Thus, loan originator 

compensation for a covered transaction 

includes compensation that will be paid 

as part of a periodic bonus, commission, 

or gift if a portion of the dollar value of 

the bonus, commission, or gift can be 

attributed to that transaction. 

Proposed comment 32(b)(1)(ii)–2.i 

then provides three examples of 

compensation paid to a loan originator 

that must be included in the points and 

fees calculation. The first example 

assumes that, according to a creditor’s 

compensation policies, the creditor 

awards its loan officers a bonus every 

year based on the number of loan 

applications taken by the loan officer 

that result in consummated transactions 

during that year, and that each 

consummated transaction increases the 

bonus by $100. In this case, the $100 

bonus must be counted in the amount 

of loan originator compensation that the 

creditor includes in ‘‘points and fees.’’ 

The second example assumes that, 

according to a creditor’s compensation 

policies, the creditor awards its loan 

officers a bonus every year based on the 

dollar value of consummated 

transactions originated by the loan 

officer during that year. Also assumed is 

that, for each transaction of up to 

$100,000, the creditor awards its loan 

officers a bonus of $100; for each 

transaction of more than $100,000 up to 

$250,000, the creditor awards its loan 

officers $200; and for each transaction of 

more than $250,000, the creditor awards 

its loan officers $300. In this case, for a 

mortgage transaction of $300,000, the 

$300 bonus is loan originator 

compensation that must be included in 

‘‘points and fees.’’ 

The third example assumes that, 

according to a creditor’s compensation 

policies, the creditor awards its loan 

officers a bonus every year based on the 

number of consummated transactions 

originated by the loan officer during that 

year. Also assumed is that for the first 

10 transactions originated by the loan 

officer in a given year, no bonus is 

awarded; for the next 10 transactions 

originated by the loan officer up to 20, 

a bonus of $100 per transaction is 

awarded; and for each transaction 

originated after the first 20, a bonus of 

$200 per transaction is awarded. In this 

case, for the first 10 transactions 

originated by a loan officer during a 

given year, no amount of loan originator 

compensation need be included in 

‘‘points and fees.’’ For any mortgage 

transaction made after the first 10, up to 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27404 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

17See Mortgage Reform and Anti-Predatory 

Lending Act, H. Rep. 111–94, p. 121 (May 4, 2009). 

An earlier version of the Dodd-Frank Act would 

have amended the statutory provision implemented 

by § 226.32(b)(1)(iii) to read as follows (added 

language italicized): 

* * * [P]oints and fees shall include— 

* * * 

(C) each of the charges listed in section 106(e) 

(except an escrow for future payment of taxes), 

unless— 

(i) the charge is reasonable; 

(ii) the creditor receives no direct or indirect 

compensation, except where applied to the charges 

set forth in section 106(e)(1) where a creditor may 

receive indirect compensation solely as a result of 

obtaining distributions of profits from an affiliated 

entity based on its ownership interest in compliance 

with section 8(c)(4) of the Real Estate Settlement 

Procedures Act of 1974; and 

(iii) the charge is paid to a third party unaffiliated 

with the creditor. 

See id. 

18Section 226.4(c)(7) implements TILA Section 

106(e), which states: ‘‘The following items, when 

charged in connection with any extension of credit 

secured by an interest in real property, shall not be 

included in the computation of the finance charge 

with respect to that transaction: (1) Fees or 

premiums for title examination, title insurance, or 

similar purposes. (2) Fees for preparation of loanrelated documents. (3) Escrows for future payments 

of taxes and insurance. (4) Fees for notarizing deeds 

and other documents. (5) Appraisal fees, including 

fees related to any pest infestation or flood hazard 

inspections conducted prior to closing. (6) Credit 

reports’’ (emphasis added). 15 U.S.C. 1605(e). 

the 20th transaction, $100 must be 

included in ‘‘points and fees.’’ For any 

mortgage transaction made after the first 

20, $200 must be included in ‘‘points 

and fees.’’ 

Proposed comment 32(b)(1)(ii)–2.ii 

clarifies that, in determining ‘‘points and 

fees,’’ loan originator compensation 

excludes compensation that cannot be 

attributed to a transaction at the time of 

origination, including, for example: 

• Compensation based on the 

performance of the loan originator’s 

loans. 

• Compensation based on the overall 

quality of a loan originator’s loan files. 

• The base salary of a loan originator 

who is also the employee of the creditor, 

not accounting for any bonuses, 

commissions, pay raises, or other 

financial awards based solely on a 

particular transaction or the number or 

amount of covered transactions 

originated by the loan originator. 

Proposed comment 32(b)(1)(ii)–3 

explains that loan originator 

compensation includes amounts the 

loan originator retains and is not 

dependent on the label or name of any 

fee imposed in connection with the 

transaction. For example, if a loan 

originator imposes a ‘‘processing fee’’ 

and retains the fee, the fee is loan 

originator compensation under 

paragraph 32(b)(1)(ii) whether the 

originator expends the fee to process the 

consumer’s application or uses it for 

other expenses, such as overhead. The 

proposed comment is consistent with 

comment 36(d)(1)–1.ii for loan 

originator compensation. 

The Board requests comment on the 

proposal regarding the types of loan 

originator compensation that must be 

included in points and fees, including 

the appropriateness of specific examples 

given in the commentary. 

32(b)(1)(iii) Real Estate-Related Fees 

Consistent with the statute, the Board 

proposes no changes to existing 

§ 226.32(b)(1)(iii), which includes in 

points and fees ‘‘all items listed in 

§ 226.4(c)(7) (other than amounts held 

for future payment of taxes) unless the 

charge is reasonable, the creditor 

receives no direct or indirect 

compensation in connection with the 

charge, and the charge is not paid to an 

affiliate of the creditor.’’ During 

outreach, creditor representatives raised 

concerns about the inclusion in points 

and fees of real estate-related fees paid 

to an affiliate of the creditor, such as an 

affiliated title company. These fees have 

historically been included in points and 

fees for high-cost mortgages under both 

TILA and Regulation Z, but the points 

and fees threshold for qualified 

mortgages is much lower than for the 

high-cost mortgage threshold. Thus, 

creditors that use affiliated settlement 

service providers such as title 

companies are concerned that they will 

have difficulty making loans that meet 

the qualified mortgage points and fees 

threshold. 

The Board is not proposing an 

exemption for fees paid to creditoraffiliated settlement services providers. 

The Board notes that Congress appears 

to have rejected excluding from points 

and fees real estate-related fees where a 

creditor would receive indirect 

compensation as a result of obtaining 

distributions of profits from an affiliated 

entity based on the creditor’s ownership 

interest in compliance with RESPA.17

The Board requests comment on the 

proposal not to exclude from the points 

and fees calculation for qualified 

mortgages fees paid to creditor-affiliated 

settlement services providers. The 

Board invites commenters favoring this 

exclusion to explain why excluding 

these fees from the points and fees 

calculation would be consistent with 

the purposes of the statute. 

Payable at or before closing. The 

Dodd-Frank Act removed the phrase 

‘‘payable at or before closing’’ from the 

high-cost mortgage points and fees test 

in TILA Section 103(aa)(1)(B). See TILA 

Section 103(aa)(1)(A)(ii). The phrase 

‘‘payable at or before closing’’ is also not 

in TILA’s provisions on the points and 

fees cap for qualified mortgages. See 

TILA Section 129C(b)(2)(A)(vii), 

(b)(2)(C). Thus, with a few exceptions, 

any item listed in the ‘‘points and fees’’ 

definition under § 226.32(b)(1) must be 

counted toward the limits on points and 

fees for both high-cost mortgages and 

qualified mortgages, even if it is payable 

after loan closing. The exceptions are 

mortgage insurance premiums and 

charges for credit insurance and debt 

cancellation and suspension coverage. 

The statute expressly states that these 

premiums and charges are included in 

points and fees only if payable at or 

before closing. See TILA Section 

103(aa)(1)(C) (for mortgage insurance) 

and TILA Section 103(aa)(4)(D) (for 

credit insurance and debt cancellation 

and suspension coverage). The statute 

does not so limit § 226.4(c)(7) charges, 

possibly because these charges could 

reasonably be viewed as charges that by 

definition are only payable at or before 

closing.18

Nonetheless, regarding the mortgage 

loan transaction costs that are deemed 

points and fees, the Board requests 

comment on whether any other types of 

fees should be included in points and 

fees only if they are ‘‘payable at or before 

closing.’’ The Board is concerned that 

some fees that occur after closing, such 

as fees to modify a loan, might be 

deemed to be points and fees. If so, 

calculating the points and fees to 

determine whether a transaction is a 

qualified mortgage may be difficult 

because the amount of future fees (e.g., 

loan modification fees) cannot be 

known prior to closing. Creditors might 

be exposed to excessive litigation risk if 

consumers were able at any point 

during the life of a mortgage to argue 

that the points and fees for the loan 

exceed the qualified mortgage limits due 

to fees imposed after loan closing. 

Creditors therefore might be 

discouraged from making qualified 

mortgages, which would thwart 

Congress’s goal of increasing incentives 

for creditors to make more stable, 

affordable loans. 

32(b)(1)(iv) Credit Insurance and Debt 

Cancellation or Suspension Coverage 

The Board proposes to revise 

§ 226.32(b)(1)(iv) to reflect statutory 

changes under the Dodd-Frank Act. See 

TILA Section 103(aa)(4)(D). Specifically, 

proposed § 226.32(b)(1)(iv) includes in 

points and fees ‘‘[p]remiums or other 

charges payable at or before closing of 

the mortgage loan for any credit life, 

credit disability, credit unemployment, 

or credit property insurance, or any 

other life, accident, health, or loss-ofVerDate Mar<15>2010 16:56 May 10, 2011 Jkt 223001 PO 00000 Frm 00016 Fmt 4701 Sfmt 4702 E:\FR\FM\11MYP2.SGM 11MYP2

jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27405 

19Public Law 111–203, 124 Stat. 1376, Title XIV, 

§ 1414. The Board is not at this time proposing to 

implement the restrictions on single-premium 

credit insurance under the Dodd-Frank Act. 

income insurance, or any payments 

directly or indirectly for any debt 

cancellation or suspension agreement or 

contract.’’ Except for non-substantive 

changes in the ordering of the items 

listed, this provision mirrors the 

statutory language. 

TILA’s new points and fees provision 

regarding charges for credit insurance 

and debt cancellation and suspension 

coverage adds certain types of credit 

insurance-related products to the 

existing list of credit insurance products 

for which payments at or before closing 

must be considered points and fees in 

existing § 226.32(b)(1)(iv). Accordingly, 

proposed revisions to § 226.32(b)(1)(iv) 

add to the list of products the following 

new items: Credit disability, credit 

unemployment, or credit property 

insurance and debt suspension 

coverage. (Other life, accident, health, or 

loss-of-income insurance, or any 

payments directly or indirectly for any 

debt cancellation or suspension 

agreement or contract are included in 

the existing provision.) In a separate 

provision, however, the Dodd-Frank Act 

bans single-premium credit insurance 

and debt protection products of all the 

types listed above, except for credit 

unemployment insurance meeting 

certain conditions. See TILA Section 

129C(d); 15 U.S.C. 1639c(d). The Board 

notes that the practical result of these 

combined amendments is that only 

single-premium credit unemployment 

insurance meeting certain conditions is 

permitted; therefore only singlepremium credit unemployment 

insurance will be included in points 

and fees.19

The proposal revises current comment 

32(b)(1)(iv)–1 to clarify that upfront 

charges for debt cancellation or 

suspension agreements or contracts are 

expressly included in points and fees. 

Another proposed revision clarifies that 

upfront credit insurance premiums and 

debt cancellation or suspension charges 

must be included in ‘‘points and fees’’ 

regardless of whether the insurance or 

coverage is optional or voluntary. The 

proposal adds new comment 

32(b)(1)(iv)–2 to clarify that ‘‘credit 

property insurance’’ includes insurance 

against loss of or damage to personal 

property, such as a houseboat or 

manufactured home. The comment 

states that ‘‘credit property insurance’’ as 

used in § 226.32(b)(1)(iv) covers the 

creditor’s security interest in the 

property. The comment explains that 

‘‘credit property insurance’’ does not 

include homeowners insurance, which, 

unlike ‘‘credit property insurance,’’ 

typically covers not only the dwelling 

but its contents, and designates the 

consumer, not the creditor, as the 

beneficiary. 

The Board requests comment on the 

proposal to implement the statutory 

provision that includes upfront 

premiums and charges for credit 

insurance and debt cancellation and 

suspension coverage in the definition of 

‘‘points and fees.’’ 

32(b)(1)(v) Prepayment Penalties That 

May be Charged on the Loan 

Proposed § 226.32(b)(1)(v) includes in 

points and fees ‘‘the maximum 

prepayment penalty, as defined in 

§ 226.43(b)(10), that may be charged or 

collected under the terms of the 

mortgage loan.’’ This provision 

implements TILA Section 103(aa)(4)(E) 

and incorporates the statutory language, 

with the exception of minor nonsubstantive changes, such as that the 

proposed regulatory provision crossreferences proposed § 226.43(b)(10) for 

the definition of ‘‘prepayment penalty.’’ 

See section-by-section analysis of 

§ 226.43(b)(10), below. 

32(b)(1)(vi) Total Prepayment Penalties 

Incurred in a Refinance 

Proposed § 226.32(b)(1)(vi) includes 

in points and fees ‘‘the total prepayment 

penalty, as defined in § 226.43(b)(10), 

incurred by the consumer if the 

mortgage loan is refinanced by the 

current holder of the existing mortgage 

loan, a servicer acting on behalf of the 

current holder, or an affiliate of either.’’ 

This provision implements TILA 

Section 103(aa)(4)(F), which includes in 

points and fees prepayment penalties 

incurred by a consumer ‘‘if the mortgage 

loan refinances a previous loan made or 

currently held by the creditor 

refinancing the loan or an affiliate of the 

creditor.’’ See 15 U.S.C. 1602(aa)(4)(F). 

The Board believes that this statutory 

provision is intended in part to curtail 

the practice of ‘‘loan flipping,’’ which 

involves a creditor refinancing an 

existing loan for financial gain due to 

prepayment penalties and other fees 

that a consumer must pay to refinance 

the loan—regardless of whether the 

refinance is beneficial to the consumer. 

The Board uses the phrases ‘‘current 

holder of the existing mortgage loan’’ 

and ‘‘servicer acting on behalf of the 

current holder’’ to describe the parties 

that refinance a loan subject to this 

provision because, as a practical matter, 

these are the entities that would 

refinance the loan and directly or 

indirectly gain from associated 

prepayment penalties. The Board also 

uses the phrase ‘‘an affiliate of the 

current holder’’ to describe a third party 

that refinances a loan subject to this 

provision to be consistent with the 

statute, which, as noted, applies to 

prepayment penalties incurred in 

connection with refinances by ‘‘the 

creditor * * * or an affiliate of the 

creditor.’’ 

The proposed regulatory provision 

also cross-references proposed 

§ 226.43(b)(10) for the definition of 

‘‘prepayment penalty.’’ See section-bysection analysis of § 226.43(b)(10), 

below. 

The Board requests comment on the 

proposal to incorporate into the 

definition of ‘‘points and fees’’ the 

prepayment penalty provisions of TILA 

Section 103(aa)(4)(E) and (F) and solicits 

comment in particular on whether 

additional guidance is needed to 

facilitate compliance with these 

provisions. 

32(b)(2) Exclusion From ‘‘Points and 

Fees’’ of Compensation Paid to Certain 

Persons 

The Board proposes new 

§ 226.32(b)(2) to reflect statutory 

amendments under the Dodd-Frank Act. 

Current § 226.32(b)(2), defining 

‘‘affiliate,’’ is proposed to be renumbered as § 226.32(b)(3). Proposed 

§ 226.32(b)(2) is intended to exempt 

from ‘‘points and fees’’ compensation 

paid to certain persons expressly 

excluded from the meaning of ‘‘mortgage 

originator’’ under the Dodd-Frank Act. 

Employees of retailers of 

manufactured homes. Specifically, 

proposed § 226.32(b)(2)(i) excludes from 

‘‘points and fees’’ compensation paid to 

‘‘an employee of a retailer of 

manufactured homes who does not take 

a residential mortgage loan application, 

offer or negotiate terms of a residential 

mortgage loan, or advise a consumer on 

loan terms (including rates, fees, and 

other costs) but who, for compensation 

or other monetary gain, or in 

expectation of compensation or other 

monetary gain, assists a consumer in 

obtaining or applying to obtain a 

residential mortgage loan.’’ This 

proposed exemption is necessary to 

implement the revised definition of 

‘‘points and fees’’ under TILA Section 

103(aa)(4)(B) (quoted above), because 

the statutory definition of ‘‘mortgage 

originator’’ excludes ‘‘an employee of a 

retailer of manufactured homes’’ who, 

for compensation or other monetary 

gain, or in expectation of compensation 

or other monetary gain, prepares 

residential mortgage loan packages or 

collects information on behalf of a 


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20Specifically, the statute excludes from the 

definition of ‘‘mortgage originator’’ ‘‘any person who 

is * * * (ii) an employee of a retailer of 

manufactured homes who is not described in clause 

(i) [takes a residential mortgage loan application] or 

(iii) [offers or negotiates terms of a residential 

mortgage loan] of subparagraph (A) and who does 

not advise a consumer on loan terms (including 

rates, fees, and other costs).’’ TILA Section 

103(cc)(2)(A)(i), (cc)(2)(A)(iii) and (cc)(2)(A)(C); 15 

U.S.C. 1602(cc)(2)(A) and (C). Thus, an employee of 

a retailer of manufactured homes is not considered 

a ‘‘mortgage originator’’ even if that person ‘‘for 

direct or indirect compensation or gain, or in the 

expectation of direct or indirect compensation or 

gain * * * assists a consumer in obtaining or 

applying for a residential mortgage loan.’’ TILA 

Section 103(cc)(2)(A)(ii). The statute further defines 

‘‘assists a consumer in obtaining or applying for a 

residential mortgage loan’’ to mean ‘‘among other 

things, advising on residential mortgage loan terms 

(including rates, fees, and other costs), preparing 

residential mortgage loan packages, or collecting 

information on behalf of the consumer with regard 

to a residential mortgage loan.’’ TILA Section 

103(cc)(4). 

21The statutory definition of ‘‘mortgage 

originator’’ excludes ‘‘a person or entity that only 

performs real estate brokerage activities and is 

licensed or registered in accordance with applicable 

State law, unless such person or entity is 

compensated by a lender, a mortgage broker, or 

other mortgage originator or by any agent of such 

lender, mortgage broker, or other mortgage 

originator.’’ TILA Section 103(cc)(2)(D). 

consumer with regard to a residential 

mortgage loan.20

Real estate brokers. Proposed 

§ 226.32(b)(2)(ii) excludes from ‘‘points 

and fees’’ compensation paid to ‘‘a 

person that only performs real estate 

brokerage activities and is licensed or 

registered in accordance with applicable 

state law, unless such person is 

compensated by a creditor or loan 

originator, as defined in § 226.36(a)(1), 

or by any agent of the creditor or loan 

originator.’’ This proposed exemption is 

necessary to implement the revised 

definition of ‘‘points and fees’’ under 

TILA Section 103(aa)(4)(B), because the 

statutory definition of ‘‘mortgage 

originator’’ contains a nearly identical 

exclusion.21

Proposed § 226.32(b)(2)(ii) uses the 

term ‘‘person’’ rather than the phrase 

‘‘person or entity’’ used in the statute 

because ‘‘person’’ is defined in 

Regulation Z to mean ‘‘a natural person 

or an organization, including a 

corporation, partnership, 

proprietorship, association, cooperative, 

estate, trust, or government unit.’’ 

Section 226.2(a)(22). The proposed 

regulation uses the term ‘‘loan 

originator’’ as defined in § 226.36(a)(1) 

rather than the terms ‘‘mortgage broker, 

or other mortgage originator’’ because 

the term ‘‘loan originator’’ under 

§ 226.36(a)(1) includes a mortgage 

broker and is consistent with the 

statutory definition of ‘‘mortgage 

originator’’ in respects relevant to this 

provision. See section-by-section 

analysis of § 226.32(b)(1)(ii) for a 

discussion of consistencies between the 

meaning of ‘‘loan originator’’ in 

§ 226.36(a)(1) and ‘‘mortgage originator’’ 

in the Dodd-Frank Act. 

The term ‘‘loan originator’’ in 

§ 226.36(a)(1) applies only to parties 

who arrange, negotiate, or obtain an 

extension of mortgage credit for a 

consumer in return for compensation or 

other monetary gain. Thus, a ‘‘loan 

originator’’ would not include a person 

engaged only in real estate brokerage 

activities. See 75 FR 58509, 58510 (Sept. 

24, 2010). However, the exemption for 

real estate brokers from the meaning of 

‘‘mortgage originator’’ is more precise in 

the Dodd-Frank Act. First, for the 

compensation of a real estate broker to 

be exempt, the broker must be licensed 

or registered under state law. In 

addition, the Dodd-Frank Act does not 

exclude real estate brokers from the 

definition of ‘‘mortgage originator’’ if 

they are compensated by the ‘‘lender, 

mortgage broker, or other mortgage 

originator’’ or an agent of any of these 

parties. 

Servicers. Proposed § 226.32(b)(2)(ii) 

excludes from ‘‘points and fees’’ 

compensation paid to ‘‘a servicer or 

servicer employees, agents and 

contractors, including but not limited to 

those who offer or negotiate terms of a 

covered transaction for purposes of 

renegotiating, modifying, replacing and 

subordinating principal of existing 

mortgages where borrowers are behind 

in their payments, in default or have a 

reasonable likelihood of being in default 

or falling behind.’’ This proposed 

exemption is necessary to implement 

the revised definition of ‘‘points and 

fees’’ under TILA Section 103(aa)(4)(B), 

because the statutory definition of 

‘‘mortgage originator’’ excludes this 

compensation. TILA Section 

103(cc)(2)(G). 

The term ‘‘loan originator’’ (as defined 

in § 226.36(a)(1)), which is used in 

proposed § 226.32(b)(1)(ii) to describe 

the persons whose compensation must 

be counted in points and fees, does not 

apply to a loan servicer when the 

servicer modifies an existing loan on 

behalf of the current owner of the loan. 

See TILA Section 103(cc)(2)(G); 15 

U.S.C. 1602(cc)(2)(G). See also comment 

36(a)–1.iii. However, a ‘‘loan originator’’ 

under existing § 226.36(a)(1) includes a 

servicer who refinances a mortgage. See 

comment 36(a)–1.iii. A ‘‘refinancing’’ 

under § 226.36(a)(1) is defined as the 

satisfaction and replacement of an 

existing obligation subject to TILA by a 

new obligation by the same consumer. 

See § 226.20(a) and accompanying 

commentary. 

By contrast, the exclusion for 

servicers under the statutory definition 

of ‘‘mortgage originator’’ appears to be 

broader than the definition of ‘‘loan 

originator’’ under existing § 226.36(a)(1). 

First, the exclusion expressly applies to 

‘‘a servicer or servicer employees, agents 

and contractors.’’ Second, the exclusion 

applies not only when these persons 

offer or negotiate terms of residential 

mortgage loan for purposes of modifying 

a loan, but also for purposes of 

‘‘replacing and subordinating principal 

of existing mortgages where borrowers 

are behind in their payments, in default 

or have a reasonable likelihood of being 

in default or falling behind.’’ TILA 

Section 103(cc)(2)(G). 

The Board requests comment on the 

proposed exemptions from the 

definition of ‘‘points and fees’’ for 

compensation paid to certain persons 

not considered ‘‘mortgage originators’’ 

under the Dodd-Frank Act. 

32(b)(3) Definition of ‘‘Affiliate’’ 

Current § 226.32(b)(2) defining the 

term ‘‘affiliate’’ is re-numbered as 

§ 226.32(b)(3) to accommodate the new 

proposed § 226.32(b)(2) regarding 

compensation for the purposes of points 

and fees. No substantive change is 

intended. 

Section 226.34 Prohibited Acts or 

Practices in Connection With Credit 

Subject to § 226.32 

34(a) Prohibited Acts or Practices for 

Loans Subject to § 226.32 

34(a)(4) Repayment Ability 

Currently, Regulation Z prohibits 

creditors making high-cost loans from 

extending credit without regard to a 

consumer’s ability to repay. See 

§ 226.34(a)(4). As discussed in greater 

detail in the section-by-section analysis 

to § 226.43 below, the Dodd-Frank Act 

now requires creditors to consider a 

consumer’s ability to repay prior to 

making any residential mortgage loan, 

as defined in TILA Section 103(cc)(5). 

Proposed § 226.43 would implement 

this requirement and render 

unnecessary § 226.34(a)(4). The Board 

therefore proposes to remove 

§ 226.34(a)(4) and its accompanying 

commentary. For ease of reading, the 

Board is not reprinting § 226.34(a)(4) 

and its accompanying commentary in 

this proposed rule. 

Section 226.35 Prohibited Acts or 

Practices in Connection With HigherPriced Mortgage Loans 

Currently, § 226.35 prohibits certain 

acts or practices in connection with 

higher-priced mortgage loans. Section 

226.35(a) provides the coverage test for 


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higher-priced mortgage loans. Section 

226.35(b)(1) contains the ability to repay 

requirement for higher-priced mortgage 

loans. Section 226.35(b)(2) sets forth 

restrictions on prepayment penalties for 

higher-priced mortgage loans. Section 

226.35(b)(3) contains escrow rules for 

higher-priced mortgage loans. Section 

226.35(b)(4) prohibits evasion of the 

higher-priced mortgage loan protections 

by structuring a transaction as open-end 

credit. 

The proposed changes to Regulation Z 

in the 2011 Escrow Proposal and this 

proposal would render all of current 

§ 226.35 unnecessary. The 2011 Escrow 

Proposal would adopt in proposed 

§ 226.45(a) the coverage test for higherpriced mortgage loans in 226.35(a); 

would revise and adopt in § 226.45(b) 

the escrow requirements in 

§ 226.35(b)(3); and would adopt in 

proposed § 226.45(d) the prohibition of 

evasion of the higher-priced mortgage 

loan protections by structuring a 

transaction as open-end credit, now in 

§ 226.35(b)(4). This proposal, as 

discussed below, would supersede in 

§ 226.43(a)–(f) the ability to repay 

requirement in § 226.35(b)(1), and 

would supersede in § 226.43(g) the 

prepayment penalty rules in 

§ 226.34(b)(2). Accordingly, the Board 

proposes to remove and reserve § 226.35 

and its accompanying commentary. For 

ease of reading, the Board is not 

reprinting § 226.35 and its 

accompanying commentary in this 

proposed rule. 

Section 226.43 Minimum Standards 

for Transactions Secured by a Dwelling 

TILA Sections 129C(a), (b), and (c) 

establish, for residential mortgage loans: 

(1) A requirement to consider a 

consumer’s repayment ability; (2) 

alternative requirements for ‘‘qualified 

mortgages’’; and (3) limits on 

prepayment penalties, respectively. The 

Board proposes to implement TILA 

Section 129C(a) through (c) in new 

§ 226.43, as discussed in detail below. 

43(a) Scope 

Background 

Section 1411 of the Dodd-Frank Act 

adds a new TILA Section 129C that 

requires creditors to determine a 

consumer’s ability to repay a 

‘‘residential mortgage loan.’’ Section 

1401 of the Act adds a new TILA 

Section 103(cc) that defines ‘‘residential 

mortgage loan’’ to mean, with some 

exceptions, any consumer credit 

transaction secured by a mortgage, deed 

of trust, or other equivalent consensual 

security interest on ‘‘a dwelling or on 

residential real property that includes a 

dwelling.’’ TILA Section 103(v) defines 

‘‘dwelling’’ to mean a residential 

structure or mobile home which 

contains one- to four-family housing 

units, or individual units of 

condominiums or cooperatives. Thus, a 

‘‘residential mortgage loan’’ is a 

dwelling-secured consumer credit 

transaction, which can include: (1) A 

home purchase, refinancing, or home 

equity loan; (2) a loan secured by a first 

lien or a subordinate lien on a dwelling; 

(3) a loan secured by a dwelling that is 

a principal residence, second home, or 

vacation home (other than a timeshare 

residence); or (4) a loan secured by a 

one-to-four unit residence, 

condominium, cooperative, mobile 

home, or manufactured home. 

However, the term ‘‘residential 

mortgage loan’’ does not include an 

open-end credit plan or an extension of 

credit relating to a timeshare plan, for 

purposes of the Act’s repayment ability 

and prepayment penalty provisions 

under TILA Section 129C, among other 

provisions. See TILA Section 103(cc)(5); 

see also TILA Section 129C(i) 

(providing that timeshare transactions 

are not subject to TILA Section 129C). 

Further, the repayment ability 

provisions of TILA Section 129C(a) do 

not apply to reverse mortgages or 

temporary or ‘‘bridge’’ loans with a loan 

term of 12 months or less, including a 

loan to purchase a new dwelling where 

the consumer plans to sell another 

dwelling within 12 months. See TILA 

Section 129C(a)(8). The repayment 

ability provisions of TILA Section 

129C(a) also do not apply to consumer 

credit transactions secured by vacant 

land and not by a dwelling. 

The scope of the 2008 HOEPA Final 

Rule differs from the scope of TILA 

Section 129C in three respects. First, as 

discussed above, the 2008 HOEPA Final 

Rule applies only to loans designated 

‘‘higher-priced mortgage loans’’ or ‘‘highcost mortgages’’ based on their APR or 

points and fees. Section 226.34(a)(4), 

226.35(b)(1). By contrast, TILA Sections 

129C(a) through (c) apply regardless of 

the residential mortgage loan’s cost. 

Second, the 2008 HOEPA Final Rule is 

limited to loans secured by the 

consumer’s principal dwelling. Section 

226.32(a)(1), 226.35(a)(1). Finally, the 

2008 HOEPA Final Rule does not 

exempt transactions secured by a 

consumer’s interest in a timeshare plan. 

The Board’s Proposal 

Proposed § 226.43(a) describes the 

scope of the requirement to determine a 

consumer’s ability to repay a residential 

mortgage loan. Proposed § 226.43(a)(1) 

and (2) provide that the repayment 

ability provisions under proposed 

§ 226.43 apply to consumer credit 

transactions secured by a dwelling, as 

defined in § 226.2(a)(19), except for (1) 

a home equity line of credit (HELOC) 

subject to § 226.5b, 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)). The exemptions 

under proposed § 226.43(a)(1) and (2) 

implement the exclusions from the 

definition of ‘‘residential mortgage loan’’ 

under TILA Section 103(cc)(5). 

Proposed § 226.43(a)(3) provides that 

the following transactions are exempt 

from coverage by proposed § 226.43(c) 

through (f): (1) A reverse mortgage 

subject to § 226.33; and (2) 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. 

As discussed in detail below, 

proposed § 226.43(c) and (d) implement 

repayment ability provisions and 

special rules for refinancings of ‘‘nonstandard’’ mortgages into ‘‘standard’’ 

mortgages under TILA Section 129C(a). 

TILA Section 129C(a)(8) specifically 

provides that reverse mortgages and 

temporary or ‘‘bridge’’ loans with a term 

of 12 months or less are not subject to 

TILA Section 129C(a). The Board also 

proposes to apply this exception for 

purposes of alternative requirements for 

‘‘qualified mortgages’’ and balloonpayment qualified mortgages pursuant 

to TILA Section 129C(b). Although TILA 

Section 129C(b) does not specifically 

exempt reverse mortgages or temporary 

or ‘‘bridge’’ loans with a term of 12 

months or less from coverage by the 

alternative requirements for qualified 

mortgages, the Board believes the 

alternative requirements for qualified 

mortgages are relevant only if a 

transaction is subject to the repayment 

ability requirements. Accordingly, 

proposed § 226.43(a)(3) provides that 

reverse mortgages and temporary or 

‘‘bridge’’ loans with a term of 12 months 

or less are not subject to the alternative 

requirements for qualified mortgages 

and balloon-payment qualified 

mortgages, under proposed § 226.43(e) 

or (f). Such transactions nevertheless are 

subject to the prepayment penalty 

restrictions under proposed § 226.43(g), 

discussed in detail below. 

‘‘Residential mortgage loan.’’ Proposed 

§ 226.43(a) clarifies that requirements 

under proposed § 226.43 apply to any 

consumer credit transaction secured by 

a dwelling, as defined in § 226.2(a)(19), 

with certain exceptions discussed 

above. Proposed § 226.43(a) does not 

use the term ‘‘residential mortgage loan,’’ 


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22See, e.g., TILA Section 129C(a)(8) (providing an 

exemption from repayment ability requirements for 

reverse mortgages and temporary or ‘‘bridge’’ loans 

with a term of 12 months or less); TILA Section 

129D(d), (e) (authorizing an exemption from escrow 

requirements for certain creditors operating 

predominantly in rural or underserved areas and 

providing an exemption from escrow requirements 

for transactions secured by shares in a cooperative). 

for two reasons. First, the usefulness of 

the defined term ‘‘residential mortgage 

loan’’ is limited, because the coverage of 

provisions applicable to ‘‘residential 

mortgage loans’’ varies under different 

TILA provisions. For example, TILA 

Section 103(cc) excludes transactions 

secured by a consumer’s interest in a 

timeshare transaction from the 

definition of ‘‘residential mortgage loan’’ 

for purposes of some, but not all, TILA 

provisions, and the Dodd-Frank Act 

provides or authorizes other specific 

exemptions from coverage by 

requirements for ‘‘residential mortgage 

loans.’’ 22 Specifying which transactions 

are subject to and exempt from coverage 

by proposed § 226.43 in a scope 

provision thus would facilitate 

compliance better than using the 

defined term ‘‘residential mortgage 

loan.’’ 

Second, the term ‘‘residential 

mortgage loan’’ could be confused with 

the similar term ‘‘residential mortgage 

transaction,’’ which means a transaction 

in which a mortgage or equivalent 

consensual security interest is created or 

retained against the consumer’s 

dwelling to finance the acquisition or 

initial construction of the dwelling. See 

15 U.S.C. 1602(w). The term ‘‘residential 

mortgage transaction,’’ used in 

connection with rescission provisions 

under § 226.15 and 226.23, does not 

encompass such transactions as 

refinance transactions and home equity 

loans. Using the similar term 

‘‘residential mortgage loan,’’ which 

encompasses refinance transactions and 

home equity loans, could confuse 

creditors subject to proposed § 226.43. 

Owner occupancy; consumer credit 

transaction. If a transaction is a 

dwelling-secured extension of consumer 

credit, proposed § 226.43 applies 

regardless of whether or not the 

consumer occupies the dwelling (unless 

an exception from coverage applies 

under proposed § 226.43(a)(1)-(3)). 

However, TILA and Regulation Z do not 

apply to credit extensions that are 

primarily for business purposes. 15 

U.S.C. 1603(l); § 226.3(a)(1). Current 

guidance in comment 3(a)-2 clarifies the 

factors to be considered to determine 

whether a credit extension is business 

or consumer credit. Further, comment 

3(a)-3 states that credit extended to 

acquire, improve, or maintain rental 

property that is not owner-occupied 

(that is, in which the owner does not 

expect to live for more than fourteen 

days during the coming year) is deemed 

to be for business purposes. Proposed 

comment 43(a)-1 clarifies that § 226.43 

does not apply to an extension of credit 

primarily for a business, commercial, or 

agricultural purpose and crossreferences the existing guidance on 

determining the primary purpose of an 

extension of credit in commentary on 

§ 226.3. 

Dwelling. TILA Section 129(cc) 

defines ‘‘residential mortgage loan’’ to 

mean a consumer credit transaction 

secured by a mortgage or equivalent 

consensual security interest ‘‘on a 

dwelling or on residential real property 

that includes a dwelling.’’ Under TILA 

and Regulation Z, the term ‘‘dwelling’’ 

means a residential structure with one 

to four units, whether or not the 

structure is attached to real property, 

and includes a condominium or 

cooperative unit, mobile home, and 

trailer, if used as a residence. See 15 

U.S.C. 1602(v); § 226.2(a)(19). To 

facilitate compliance by using 

consistent terminology throughout 

Regulation Z, the proposal uses the term 

‘‘dwelling,’’ as defined in § 226.2(a)(19), 

and not the phrase ‘‘residential real 

property that includes a dwelling.’’ 

Proposed comment 43(a)-2 clarifies that, 

for purposes of § 226.43, the term 

‘‘dwelling’’ includes any real property to 

which the residential structure is 

attached that also secures the covered 

transaction. 

Renewable temporary or ‘‘bridge’’ 

loan. As discussed above, proposed 

§ 226.43(a)(3)(ii) provides that 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 and 

a loan to finance the initial construction 

of a dwelling, is excluded from coverage 

by § 226.43(c) through (f). Proposed 

comment 43(a)-3 clarifies that, where a 

temporary or ‘‘bridge loan’’ is renewable, 

the loan term does not include any 

additional period of time that could 

result from a renewal provision. 

Proposed comment 43(a)-3 also provides 

an example where a construction loan 

has an initial loan term of 12 months 

but is renewable for another 12-month 

loan term. In that example, the loan is 

excluded from coverage by § 226.43(c) 

through (f), because the initial loan term 

is 12 months. 

The Board recognizes the risk that 

determining coverage by ability-to-repay 

requirements for a renewable temporary 

or ‘‘bridge’’ loan with an initial loan term 

of 12 months or less based only on the 

initial loan term may allow 

circumvention of those requirements. 

The Board solicits comment on whether 

or not renewal loan terms should be 

considered under proposed 

§ 226.43(a)(3)(ii). In particular, the 

Board requests comment on whether the 

proposed exclusion should be limited to 

certain types of temporary or ‘‘bridge’’ 

loans, such as loans to finance the 

initial construction of a dwelling, or 

should not apply for certain types of 

temporary or ‘‘bridge’’ loans, such as 

balloon-payment loans. 

Interaction with RESPA. TILA Section 

129C applies to dwelling-secured 

consumer credit transactions (other than 

those specifically excluded from 

coverage), even if they are not ‘‘federally 

related mortgage loans’’ subject to the 

Real Estate Settlement Procedures Act 

(RESPA). See 12 U.S.C. 2602(1); 24 CFR 

3500.2(b), 3500.5. Consistent with TILA 

Section 129C, proposed § 226.43(a) 

applies broadly to consumer credit 

transactions secured by a dwelling 

(other than transactions excepted from 

coverage under § 226.43(a)(1)-(3)). 

43(b) Definitions 

Section § 226.43(b) provides several 

definitions for purposes of 

implementing the ability-to-repay, 

qualified mortgage, and prepayment 

penalty provisions under § 226.43(b) 

through (g), which implement TILA 

Sections 129C(a) through (c), as added 

by Sections 1411, 1412 and 1414 of the 

Dodd-Frank Act. These proposed 

defined terms are discussed in detail 

below. 

43(b)(1) Covered Transaction 

As discussed above in the section-bysection analysis of the scope provisions 

under proposed § 226.43(a), the Board 

proposes to apply § 226.43 to consumer 

credit transactions secured by a 

dwelling, other than (1) a HELOC; (2) a 

mortgage transaction secured by a 

consumer’s interest in a timeshare plan; 

and (3) except for purposes of 

prepayment penalty requirements under 

proposed § 226.43(g), a reverse mortgage 

or a temporary or ‘‘bridge’’ loan with a 

loan term of 12 months or less. 

Accordingly, proposed § 226.43(b)(1) 

defines ‘‘covered transaction’’ to mean a 

consumer credit transaction that is 

secured by a dwelling, other than a 

transaction exempt from coverage under 

proposed § 226.43(a), for purposes of 

proposed § 226.43. 

43(b)(2) Fully Amortizing Payment 

TILA Section 129C(a)(3) requires, in 

part, that the creditor determine the 

consumer’s ability to repay a loan ‘‘using 

a payment schedule that fully amortizes 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27409 

23See current 12 CFR § 226.17(c)(1) and comment 

17(c)(1)–10, and 12 CFR § 226.18(s)(7)(vi), which 

identify the index in effect at consummation as the 

index value to be used in determining the fully 

indexed rate. 

24See the 2010 MDIA Interim Final Rule, 75 FR 

58470, 58484, Sept. 24, 2010, which defines fully 

indexed rate as ‘‘the interest rate calculated using 

the index value and margin’’; see also 75 FR 81836, 

Dec. 29, 2010 (revising the MDIA Interim Final 

Rule. 

the loan over the term of the loan.’’ TILA 

Section 129C(a)(6)(D) provides that for 

purposes of making the repayment 

ability determination required under 

TILA Section 129C(a), the creditor must 

calculate the payment on the mortgage 

obligation assuming the loan is repaid 

in ‘‘monthly amortizing payments for 

principal and interest over the entire 

term of the loan.’’ The Board proposes 

to use the term ‘‘fully amortizing 

payment’’ to refer to periodic amortizing 

payments for principal and interest over 

the entire term of the loan, for 

simplicity. 

Accordingly, consistent with statutory 

language, and with minor modifications 

for clarity, proposed § 226.43(b)(2) 

would define ‘‘fully amortizing 

payment’’ to mean a periodic payment of 

principal and interest that will fully 

repay the loan amount (as defined in 

proposed § 226.43(b)(5)) over the loan 

term (as defined in proposed 

§ 226.43(b)(6)). This term appears 

primarily in proposed § 226.43(c)(5) and 

(d)(5), which provides, respectively, that 

(1) the creditor determine the 

consumer’s ability to repay the covered 

transaction using the fully indexed rate 

or introductory rate, whichever is 

greater, and monthly, fully amortizing 

payments that are substantially equal; 

and (2) the creditor can refinance the 

consumer from a non-standard to 

standard mortgage if, among other 

things, the calculation of the payments 

for the non-standard and standard 

mortgage are based on monthly, fully 

amortizing payments that are 

substantially equal. 

43(b)(3) Fully Indexed Rate 

TILA Section 129C(a)(6)(D) requires 

that for purposes of making the 

repayment ability determination 

required under TILA Section 129C(a), 

the creditor must calculate the monthly 

payment on the mortgage obligation 

based on several assumptions, including 

that the monthly payment be calculated 

using the fully indexed rate at the time 

of loan closing, without considering the 

introductory rate. See TILA Section 

129C(a)(6)(D)(iii). TILA Section 

129C(a)(7) defines the term ‘‘fully 

indexed rate’’ as ‘‘the index rate 

prevailing on a residential mortgage 

loan at the time the loan is made plus 

the margin that will apply after the 

expiration of any introductory interest 

rates.’’ The term ‘‘fully indexed rate’’ 

appears in proposed § 226.43(c)(5), 

which implements TILA Section 

129C(a)(6)(iii) and provides the payment 

calculation rules for covered 

transactions. The term also appears in 

§ 226.43(d)(5), which provides special 

rules for creditors that refinance a 

consumer from a non-standard mortgage 

to a standard mortgage. These proposed 

provisions are discussed below. 

The Board proposes § 226.43(b)(3) to 

define the term ‘‘fully indexed rate’’ as 

‘‘the interest rate calculated using the 

index or formula at the time of 

consummation and the maximum 

margin that can apply at any time 

during the loan term.’’ This proposed 

definition is consistent with the 

statutory language of TILA Sections 

129C(a)(6)(D)(iii) and 129C(a)(7), but 

revises certain statutory text to provide 

clarity.23 First, for consistency with 

current Regulation Z and to facilitate 

compliance, the Board proposes to 

replace the phrases ‘‘at the time of the 

loan closing’’ in TILA Section 

129C(a)(6)(D)(iii) and ‘‘at the time the 

loan is made’’ in TILA Section 

129C(a)(7) with the phrase ‘‘at the time 

of consummation’’ for purposes of 

identifying the fully indexed rate. The 

Board interprets these statutory phrases 

to have the same meaning as the phrase 

‘‘at the time of consummation.’’ See 

current § 226.2(a)(7), defining the term 

‘‘consummation’’ for purposes of 

Regulation Z requirements as ‘‘the time 

that a consumer becomes contractually 

obligated on a credit transaction.’’ 

Second, the Board interprets the 

reference to the margin that will apply 

‘‘after the expiration of any introductory 

interest rates’’ as a reference to the 

maximum margin that can apply ‘‘at any 

time during the loan term,’’ for 

simplicity and consistency with TILA 

Section 103(a), discussed above. 

Referencing the entire loan term as the 

relevant period of time during which 

the creditor must identify the maximum 

margin that can occur under the loan 

makes the phrase ‘‘after the expiration of 

any introductory interest rates’’ 

unnecessary. 

Third, the Board clarifies that the 

creditor should use the ‘‘maximum’’ 

margin that can apply when 

determining the fully indexed rate. 

Accordingly, the creditor would be 

required to take into account the largest 

margin that could apply under the terms 

of the legal obligation. The approach of 

using the maximum margin that can 

apply at any time during the loan term 

is consistent with the statutory language 

contained in TILA Section 103(aa), as 

amended by Section 1431 of the DoddFrank Act, which defines a high-cost 

mortgage. This statutory provision 

provides that, for purposes of the 

definition of a ‘‘high-cost mortgage,’’ for 

a mortgage with an interest rate that 

varies solely in accordance with an 

index, the annual percentage rate must 

be based on ‘‘the interest rate 

determined by adding the index rate in 

effect on the date of consummation of 

the transaction to the maximum margin 

permitted at any time during the loan 

agreement.’’ Furthermore, although the 

Board is not aware of any loan products 

used today that possess more than one 

margin that may apply over the loan 

term, the Board proposes this 

clarification to address the possibility 

that creditors may create products that 

permit different margins to take effect at 

different points throughout the loan 

term. The Board solicits comment on 

this approach. 

The proposed definition of ‘‘fully 

indexed rate’’ is also generally 

consistent with the definition of fullyindexed rate, as used in the MDIA 

Interim Final Rule,24 and with the 

Federal banking agencies’ use of the 

term ‘‘fully indexed rate’’ in the 2006 

Nontraditional Mortgage Guidance and 

2007 Subprime Mortgage Statement. 

Proposed comment 43(b)(3)–1 notes 

that in some adjustable-rate 

transactions, creditors may set an initial 

interest rate that is not determined by 

the index or formula used to make later 

interest rate adjustments. This comment 

would explain that, typically, this initial 

rate charged to consumers is lower than 

the rate would be if it were calculated 

using the index or formula at 

consummation (i.e., a ‘‘discounted rate’’); 

in some cases, this initial rate may be 

higher (i.e., a ‘‘premium rate’’). The 

comment would clarify that when 

determining the fully indexed rate 

where the initial interest rate is not 

determined using the index or formula 

for subsequent interest rate adjustments, 

the creditor must use the interest rate 

that would have applied had the 

creditor used such index or formula 

plus margin at the time of 

consummation. This comment would 

further clarify that this means, in 

determining the fully indexed rate, the 

creditor must not take into account any 

discounted or premium rate. 

Proposed comment 43(b)(3)–1 

provides an illustration of this 

principle. This comment first assumes 

an adjustable-rate transaction where the 

initial interest rate is not based on an 

index or formula, and is set at 5% for 

the first five years. The loan agreement 

provides that future interest rate 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27410 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

25See Mark Schweitzer and Guhan Venkatu, 

Adjustable-Rate Mortgages and the LIBOR Surprise, 

at http://www.clevelandfed.org/research/ 

commentary/2009/012109.cfm. 

adjustments will be calculated based on 

the London Interbank Offered Rate 

(LIBOR) plus a 3% margin. This 

comment explains that if the value of 

the LIBOR at consummation is 5%, the 

interest rate that would have been 

applied at consummation had the 

creditor based the initial rate on this 

index is 8% (5% plus 3% margin), and 

therefore, the fully indexed rate is 8%. 

To facilitate compliance, this comment 

would direct creditors to commentary 

that addresses payment calculations 

based on the greater of the fully indexed 

rate or ‘‘premium rate’’ for purposes of 

the repayment ability determination 

under § 226.43(c). See § 226.43(c)(5)(i) 

and comment 43(c)(5)(i)–2. 

This proposed comment differs from 

guidance in current comment 17(c)(1)– 

10.i, which provides that in cases where 

the initial interest rate is not calculated 

using the index or formula for later rate 

adjustments, the creditor should 

disclose a composite annual percentage 

rate that reflects both the initial rate and 

the fully indexed rate. The Board 

believes the different approach taken in 

proposed comment 43(b)(3)–1 is 

required by the statutory language 

which specifies that, for purposes of 

determining the consumer’s repayment 

ability, the fully indexed rate must be 

determined ‘‘without considering the 

introductory rate,’’ and is the rate ‘‘that 

will apply after the expiration of any 

introductory interest rates.’’ See TILA 

Sections 129C(a)(6)(D)(iii) and (7). 

Furthermore, the Board believes this 

approach is appropriate in the present 

case where the purpose of the statute is 

to determine whether the consumer can 

repay the loan according to its terms, 

including any potential increases in 

required payments. TILA Section 

129B(a)(2); 15 U.S.C 1639b(a)(2). 

The Board notes that the choice of 

which market index to use for later 

interest rate adjustments has become 

more germane for both creditors and 

consumers due to recent market 

developments. For example, in recent 

years consumers of adjustable-rate 

mortgages that are tied to a LIBOR index 

have paid more than they would have 

had their loans been tied to the U.S. 

Treasury index.25 This divergence in 

index values is recent, and has not 

occurred historically. Given the 

increasing relevance of market indices, 

the Board solicits comment on whether 

loan products currently exist that base 

the interest rate on a specific index at 

consummation, but then base 

subsequent rate adjustments on a 

different index, and whether further 

guidance addressing how to calculate 

the fully indexed rate for such loan 

products is needed. 

Proposed comment 43(b)(3)–2 further 

clarifies if the contract provides for a 

delay in the implementation of changes 

in an index value or formula, the 

creditor need not use that the index or 

formula in effect at consummation, and 

provides an illustrative example. This 

proposed comment is consistent with 

current guidance in Regulation Z 

regarding the use of the index value at 

the time of consummation where the 

contract provides for a delay. See 

comments 17(c)(1)–10.i and 

18(s)(2)(iii)(C)–1, which addresses the 

fully indexed rate for purposes of 

disclosure requirements. 

Proposed comment 43(b)(3)–3 

explains that the creditor must 

determine the fully indexed rate 

without taking into account any 

periodic interest rate adjustment cap 

that may limit how quickly the fully 

indexed rate may be reached at any time 

during the loan term under the terms of 

the legal obligation. To illustrate, 

assume an adjustable-rate mortgage has 

an initial fixed rate of 5% for the first 

three years of the loan, after which the 

rate will adjust annually to a specified 

index plus a margin of 3%. The loan 

agreement provides for a 2% annual 

interest rate adjustment cap, and a 

lifetime maximum interest rate of 10%. 

The index value in effect at 

consummation is 4.5%. The fully 

indexed rate is 7.5% (4.5% plus 3%), 

regardless of the 2% annual interest rate 

adjustment cap that would limit when 

the fully indexed rate would take effect 

under the terms of the legal obligation. 

The Board notes that guidance 

contained in proposed comment 

43(b)(3)–3 also differs from guidance 

contained in current comment 17(c)(1)– 

10.iii, which addresses disclosure of the 

annual percentage rate on the TILA. 

Comment 17(c)(1)–10.iii states that 

when disclosing the annual percentage 

rate, creditors should give effect to 

periodic interest rate adjustment caps 

provided under the terms of the legal 

obligation (i.e., to take into account any 

caps that would prevent the initial rate 

at the time of first adjustment from 

changing to the fully-indexed rate). 

The Board believes the approach in 

proposed comment 43(b)(3)–3 is 

consistent with, and required by, the 

statutory language that states the fully 

indexed rate must be determined 

without considering any introductory 

rate and by using the margin that will 

apply after expiration of any 

introductory interest rates. See TILA 

Sections 129C(a)(6)(D)(iii) and (7). In 

addition, the Board notes the proposed 

definition of fully indexed rate, and its 

use in the proposed payment 

calculation rules, is designed to assess 

whether the consumer has the ability to 

repay the loan according to its terms. 

TILA Section 129B(a)(2); 15 U.S.C. 

1639b(a)(2). This purpose differs from 

the principal purpose of disclosure 

requirements, which is to help ensure 

that consumers avoid the uninformed 

use of credit. TILA Section 102(a); 15 

U.S.C. 1601(a). The Board believes 

disregarding the operation of adjustment 

caps in determining the payment for the 

covered transaction helps to ensure that 

the consumer can reasonably repay the 

loan once the interest rate adjusts. 

Furthermore, the guidance contained in 

proposed comment 43(b)(3)–3 is 

consistent with the Federal banking 

agencies’ use of the term fully indexed 

rate in the 2006 Nontraditional 

Mortgage Guidance and 2007 Subprime 

Mortgage Statement. 

Proposed comment 43(b)(3)–4 

clarifies that when determining the fully 

indexed rate, a creditor may choose, in 

its sole discretion, to take into account 

the lifetime maximum interest rate 

provided under the terms of the legal 

obligation. This comment would 

explain, however, that where the 

creditor chooses to use the lifetime 

maximum interest rate, and the loan 

agreement provides a range for the 

maximum interest rate, the creditor 

must use the highest rate in that range 

as the maximum interest rate. To 

illustrate, assume an adjustable-rate 

mortgage has an initial fixed rate of 5% 

for the first three years of the loan, after 

which the rate will adjust annually to a 

specified index plus a margin of 3%. 

The loan agreement provides for a 2% 

annual interest rate adjustment cap, and 

a lifetime maximum interest rate of 7%. 

The index value in effect at 

consummation is 4.5%; the fully 

indexed rate is 7.5% (4.5% plus 3%). 

The creditor can choose to use the 

lifetime maximum interest rate of 7%, 

instead of the fully indexed rate of 

7.5%, for purposes of this section. 

The Board notes that the statutory 

construct of the payment calculation 

rules, and the requirement to calculate 

payments based on the fully indexed 

rate, apply to all loans that are subject 

to the ability-to-repay provisions, 

including loans that do not base the 

interest rate on an index and therefore, 

do not have a fully indexed rate. 

Specifically, the statute states that ‘‘[f]or 

purposes of making any determination 

under this subsection, a creditor shall 

calculate the monthly payment amount 

for principal and interest on any 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27411 

26A ‘‘jumbo’’ loan includes a loan whose original 

principal balance exceeds the current maximum 

loan balance for loans eligible for sale to Freddie 

Mac as of the date the transaction’s rate is set. See 

TILA Section 129D(b)(3)(B), as enacted by Section 

1461 of the Dodd-Frank Act; see also Board’s March 

2011 Jumbo Loan Escrow Final Rule, 76 FR 11319, 

11324 (Mar. 2, 2011), which establishes the ‘‘jumbo’’ 

threshold in existing § 226.35(a)(1)(v). 

27The Board’s Jumbo Loan Escrow Final Rule 

added new § 226.35(a)(1)(v) to provide a separate, 

higher rate threshold for determining when the 

Board’s escrow requirement applies to higherpriced mortgage loans that are ‘‘jumbo loans.’’ The 

Board incorporated the identical provision 

regarding the ‘‘jumbo’’ threshold in its 2011 Escrow 

Proposal for the reasons stated therein, and in 

anticipation of the Board proposing to remove 

§ 226.35 in its entirety, as discussed above. See 

proposed § 226.45(a)(1). 

residential mortgage loan by assuming’’ 

several factors, including the fully 

indexed rate, as defined in the statute 

(emphasis added). See TILA Section 

129C(a)(6)(D). The statutory definition 

of ‘‘residential mortgage loan’’ includes 

loans with variable-rate features that are 

not based on an index or formula, such 

as step-rate mortgages. See TILA Section 

103(cc); see also proposed § 226.43(a), 

addressing the proposal’s scope, and 

proposed § 226.43(b)(1), defining 

‘‘covered transaction.’’ However, because 

step-rate mortgages do not have a fully 

indexed rate, it is unclear what interest 

rate the creditor must assume when 

calculating payment amounts for 

purposes of determining the consumer’s 

ability to repay the covered transaction. 

As discussed above, the Board 

interprets the statutory requirement to 

use the ‘‘margin that can apply at any 

time after the expiration of any 

introductory interest rates’’ to mean that 

the creditor must use the ‘‘maximum 

margin that can apply at any time 

during the loan term’’ when determining 

the fully indexed rate. Accordingly, 

consistent with this approach, Board 

proposes to clarify in proposed 

comment 43(b)(3)–5 that where the 

interest rate offered in the loan is not 

based on, and does not vary with, an 

index or formula (i.e., there is no fully 

indexed rate), the creditor must use the 

maximum interest rate that may apply at 

any time during the loan term. Proposed 

comment 43(b)(3)–5 provides 

illustrative examples for a step-rate and 

fixed-rate mortgage. This comment, for 

example, would assume a step-rate 

mortgage with an interest rate fixed at 

6.5% for the first two years of the loan, 

7% for the next three years, and 7.5% 

thereafter for the remainder of loan 

term. This comment would explain that, 

for purposes of determining the 

consumer’s repayment ability, the 

creditor must use 7.5%, which is the 

maximum rate that may apply during 

the loan term. This comment would also 

provide an illustrative example for a 

fixed-rate mortgage. 

The Board believes this approach is 

appropriate because the purpose of 

TILA Section 129C is to require 

creditors to assess whether the 

consumer can repay the loan according 

to its terms, including any potential 

increases in required payments. TILA 

Section 129B(a)(2), 15 U.S.C. 

1639b(a)(2). Requiring creditors to use 

the maximum interest rate helps to 

ensure that consumers can repay the 

loan, without needing to refinance, for 

example. However, for the reasons 

discussed more fully below under 

proposed § 226.43(c)(5)(i), which 

discusses the general rule for payment 

calculations, the Board is equally 

concerned that by requiring creditors to 

use the maximum interest rate in a steprate mortgage, the monthly payments 

used to determine the consumer’s 

repayment ability will be overstated and 

may inappropriately restrict credit 

availability. For these reasons, the Board 

is soliciting comment on this approach, 

and whether the Board should exercise 

its authority under TILA Sections 105(a) 

and 129B(e) to provide an exception for 

step-rate mortgages. For example, 

should the Board require creditors to 

use the maximum interest rate that 

occurs in the first 5 or 10 years, or some 

other appropriate time horizon? 

43(b)(4) Higher-Priced Covered 

Transaction 

Proposed § 226.43(b)(4) defines 

‘‘higher-priced covered transaction’’ to 

mean 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. The proposed 

definition of ‘‘higher-priced covered 

transaction’’ replicates the statutory 

language used in TILA Section 

129C(a)(6)(D)(ii)(I) and (II), which grants 

the Board the authority to implement 

special payment calculation rules for a 

balloon loan that ‘‘has an annual 

percentage rate that does not exceed the 

average prime offer rate for a 

comparable transaction’’ by certain rate 

spreads. These rules appear in proposed 

§ 226.43(c)(5)(ii)(A), and are discussed 

below. 

The proposed definition of ‘‘higherpriced covered transaction’’ uses the 

term ‘‘average prime offer rate.’’ To 

facilitate compliance and maintain 

consistency, the term ‘‘average prime 

offer rate’’ has the same meaning as in 

the Board’s proposed § 226.45(a)(2)(ii). 

Proposed § 226.45(a)(2)(ii) defines 

‘‘average prime offer rate’’ for purposes 

of determining the applicability of 

escrow requirements to ‘‘higher-priced 

mortgage loans’’ (as defined in proposed 

§ 226.45(a)(1)), and states that the 

‘‘average prime offer rate’’ means ‘‘an 

annual percentage rate that is derived 

from average interest rate, 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.’’ See 2011 Escrow Proposal, 

76 FR 11598, Mar. 2, 2011, which 

implements new TILA Section 129D for 

escrow requirements. As discussed in 

the Board’s 2011 Escrow Proposal, the 

proposed definition of ‘‘average prime 

offer rate’’ is identical to the definition 

of ‘‘average prime offer rate’’ in current 

§ 226.35(a)(2), which the Board is 

proposing to remove, and consistent 

with the provisions of the Dodd-Frank 

Act, which generally codify the 

regulation’s current definition of 

‘‘average prime offer rate.’’ See TILA 

Sections 129C(b)(2)(B) and 129D(b)(3). 

However, the proposed definition of 

‘‘higher-priced covered transaction’’ 

differs from the proposed definition of 

‘‘higher-priced mortgage loan’’ included 

in the Board’s 2011 Escrow Proposal in 

three respects: (1) To reflect statutory 

text, the proposed definition of ‘‘higherpriced covered transaction’’ would 

provide that the annual percentage rate, 

rather than the ‘‘transaction coverage 

rate,’’ is the loan pricing metric to be 

used to determine whether a transaction 

is a higher-priced covered transaction; 

(2) consistent with the scope of the 

ability-to-repay provisions, ‘‘higherpriced covered transaction’’ would cover 

consumer credit transactions secured by 

a dwelling, and would not be limited to 

transactions secured by the consumer’s 

principal dwelling; and (3) consistent 

with the statutory authority, the 

applicable thresholds in ‘‘higher-priced 

covered transaction’’ would not reflect 

the special, separate coverage threshold 

of 2.5 percentage points above the 

average prime offer rate for ‘‘jumbo’’ 

loans,26 as provided for by the Board’s 

2011 Escrow Proposal and 2011 Jumbo 

Loan Escrow Final Rule. See 76 FR 

11598, 11608–09, Mar. 2, 2011; 76 FR 

11319, Mar. 2, 2011.27 As a result of 

these differences, proposed commentary 

to ‘‘average prime offer rate’’ that 

clarifies the meaning of ‘‘comparable 

transaction’’ and ‘‘rate set’’ for purposes 

of higher-priced mortgage loans uses the 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27412 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

28 2011 Escrow Proposal, 76 FR 11598, 11626– 

11627, Mar. 2, 2011. 

29See, e.g., Shane M. Sherland, ‘‘The JumboConforming Spread: A Semiparametric Approach,’’ 

Finance and Economics Discussion Series, 

Divisions of Research & Statistics and Monetary 

Affairs, Federal Reserve Board (2008–01). 

terms ‘‘transaction coverage rate,’’ and 

refers to the consumer’s principal 

dwelling. See proposed comments 

45(a)(2)(ii)–2 and –3.28

To reduce the risk of confusion that 

may occur by cross-referencing to 

proposed commentary in the Board’s 

2011 Escrow Proposal that uses different 

terminology, the Board proposes 

commentary to proposed § 226.43(b)(4) 

to clarify the meaning of the terms 

‘‘average prime offer rate,’’ ‘‘comparable 

transaction’’ and ‘‘rate set,’’ as those 

terms are used in the proposed 

definition of ‘‘higher-priced covered 

transaction.’’ 

Proposed comment 43(b)(4)–1 

explains that the term ‘‘average prime 

offer rate’’ generally has the same 

meaning as in proposed 

§ 226.45(a)(2)(ii), and would crossreference proposed comments 

45(a)(2)(ii)–1,–4, and –5, for further 

guidance on how to determine the 

average prime offer rate and for further 

explanation of the Board table. Proposed 

comment 43(b)(4)–2 states that the table 

of average prime offer rates published 

by the Board indicates how to identify 

the comparable transaction for a higherpriced covered transaction, as defined. 

Proposed comment 43(b)(4)–3 clarifies 

that a transaction’s annual percentage 

rate is compared to the average prime 

offer rate as of the date the transaction’s 

interest rate is set (or ‘‘locked’’) before 

consummation. This proposed comment 

also explains that sometimes a creditor 

sets the interest rate initially and then 

re-sets it at a different level before 

consummation, and clarify that in these 

cases, the creditor should use the last 

date the interest rate is set before 

consummation. 

As discussed above, the Board is 

proposing to replace the term ‘‘annual 

percentage rate’’ with the ‘‘transaction 

coverage rate’’ for reasons stated in the 

Board’s 2011 Escrow Proposal and 2010 

Closed-End Proposal. See the Board’s 

2011 Escrow Proposal at 76 FR 11598, 

11609, Mar. 2, 2011 and the Board’s 

2010 Closed-End Mortgage Proposal at 

75 FR 58539, 58660–61, Sept. 24, 2010. 

As discussed more fully in these 

proposals, the Board recognized that the 

use of the annual percentage rate as the 

coverage metric for the higher-priced 

mortgage loan protections posed a risk 

of over inclusive coverage; the 

protections were intended to be limited 

to the subprime market. Specifically, the 

Board recognized that the term annual 

percentage rate would include a broader 

set of charges, causing the spread 

between the annual percentage rate and 

the average prime offer rate to widen. 

Although the purpose differs, the 

Board similarly recognizes that the use 

of the term annual percentage rate in 

‘‘higher-priced covered transaction’’ 

means that the scope of balloon loans 

that may exceed the applicable loan 

pricing thresholds will likely be greater. 

The Board is concerned that using an 

over inclusive metric to compare to the 

average prime offer rate may cover some 

prime loans and unnecessarily limit 

credit access to these loan products, 

contrary to statutory intent. For these 

reasons and also for consistency, the 

Board solicits comment on whether it 

should exercise its authority under 

Section TILA Sections 105(a) and 

129B(e) to similarly replace ‘‘annual 

percentage rate’’ with ‘‘transaction 

coverage rate’’ as the loan pricing 

benchmark for higher-priced covered 

transactions. 15 U.S.C. 1604(a). 

In addition, the Board notes that 

‘‘jumbo’’ loans typically carry a premium 

interest rate to reflect the increased 

credit risk of such loans.29 These loans 

are more likely to exceed the average 

prime offer rate coverage threshold and 

be considered higher-priced covered 

transactions under the thresholds 

established by TILA Section 

129C(a)(6)(D)(ii). Accordingly, under 

this proposal creditors would have to 

underwrite such loans using the 

scheduled payments, including any 

balloon payment, regardless of the loan 

term. See proposed 

§ 226.43(c)(5)(ii)(A)(2), discussed below. 

The Board is concerned that this 

approach may unnecessarily restrict 

credit access and choice in the ‘‘jumbo’’ 

balloon loan market. Thus, the Board 

also solicits comment on whether it 

should exercise its authority under 

TILA Sections 105(a) and 129B(e) to 

incorporate the special, separate 

coverage threshold of 2.5 percentage 

points in the proposed definition of 

‘‘higher-priced covered transaction’’ to 

permit more ‘‘jumbo’’ balloon loans that 

have ‘‘prime’’ loan pricing to benefit 

from the special payment calculation 

rule set forth under proposed 

§ 226.43(c)(5)(ii)(A)(1) for balloon loans. 

15 U.S.C. 1604(a). See 76 FR 11598, 

11608, Mar. 2 2011, which discusses the 

proposed ‘‘jumbo’’ threshold in relation 

to the proposed escrow requirements. 

The Board similarly recognizes that 

loans secured by non-principal 

dwellings also generally carry a higher 

interest rate to reflect increased credit 

risk, regardless of loan size. As 

discussed above, the scope of this 

proposal extends to any dwellingsecured transaction, not just principal 

dwellings, and therefore second homes 

(e.g., vacation homes) would be covered. 

A non-‘‘jumbo’’ balloon loan for a 

vacation home, for example, would be 

subject to the same rate threshold that 

would apply to a non-‘‘jumbo’’ loan 

secured by a principal dwelling. As a 

result, balloon loans secured by nonprincipal dwellings would be more 

likely to exceed the applicable rate 

threshold and be subject to the more 

stringent underwriting requirements 

discussed above. The Board is 

concerned that this approach may 

inappropriately restrict credit access in 

this market. Accordingly, the Board 

solicits comment, and supporting data, 

on whether it should exercise its 

authority under TILA Sections 105(a) 

and 129B(e) to incorporate a special, 

separate coverage threshold in the 

proposed definition of ‘‘higher-priced 

covered transaction’’ for loans secured 

by non-principal dwellings, and what 

rate threshold would be appropriate for 

such loans. 

43(b)(5) Loan Amount 

TILA Section 129C(a)(6)(D) requires 

that when the creditor makes the 

repayment ability determination under 

TILA Section 129C(a), it must calculate 

the monthly payment on the mortgage 

obligation based on several 

assumptions, including calculating the 

monthly payment assuming that ‘‘the 

loan proceeds are fully disbursed on the 

date of consummation of the loan.’’ See 

TILA Section 129C(a)(6)(D)(i). This 

proposal replaces the phrase ‘‘loan 

proceeds are fully disbursed on the date 

of consummation of the loan’’ with the 

term ‘‘loan amount’’ for simplicity, and 

also to provide clarity. 

Proposed § 226.43(b)(5) defines ‘‘loan 

amount’’ to mean the principal amount 

the consumer will borrow as reflected in 

the promissory note or loan contract. 

The Board believes that the loan 

contract or promissory note would 

accurately reflect all loan proceeds to be 

disbursed under the loan agreement to 

the consumer, including any proceeds 

the consumer uses to cover costs of the 

transaction. In addition, the term ‘‘loan 

amount’’ is generally used by industry 

and consumers to refer to the amount 

the consumer borrows and is obligated 

to repay under the loan agreement. The 

proposed term ‘‘loan amount’’ is 

consistent with the Board’s 2009 

Closed-End Mortgage Proposal, which 

proposed to define the term ‘‘loan 

amount’’ for purposes of disclosure. See 

74 FR 43232, 43333, Aug. 26, 2009. 


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The statute further requires that 

creditors assume that the loan amount is 

‘‘fully disbursed on the date of 

consummation of the loan.’’ See TILA 

Section 129C(a)(6)(D)(i). The Board 

recognizes that some loans do not 

disburse the entire loan amount to the 

consumer at consummation, but may, 

for example, provide for multiple 

disbursements up to an amount stated 

in the loan agreement. See current 

§ 226.17(c)(6), discussing multipleadvance loans and comment 17(c)(6)–2 

and –3, discussing construction-topermanent financing loans. In these 

cases, the loan amount, as reflected in 

the promissory note or loan contract, 

does not accurately reflect the amount 

disbursed at consummation. Thus, to 

reflect the statutory requirement that the 

creditor assume the loan amount is fully 

disbursed at consummation, the Board 

would clarify that creditors must use the 

entire loan amount as reflected in the 

loan contract or promissory note, even 

where the loan amount is not fully 

disbursed at consummation. See 

proposed comment 43(b)(5)–1. This 

comment would provide an illustrative 

example. The example assumes the 

consumer enters into a loan agreement 

where the consumer is obligated to 

repay the creditor $200,000 over 15 

years, but only $100,000 is disbursed at 

consummation and the remaining 

$100,000 will be disbursed during the 

year following consummation ($25,000 

each quarter). This comment would 

explain that the creditor must use the 

loan amount of $200,000 even though 

the loan agreement provides that only 

$100,000 will be disbursed to the 

consumer at consummation. This 

comment would state that generally, 

creditors should rely on § 226.17(c)(6) 

and associated commentary regarding 

treatment of multiple-advance and 

construction loans that would be 

covered by this proposal (i.e., loans with 

a term greater than 12 months). See 

proposed § 226.43(a)(3) discussing 

scope of coverage and term length. The 

Board solicits comment on whether 

further guidance regarding treatment of 

loans that provide for multiple 

disbursements, such as construction-topermanent loans that are treated as as a 

single transaction, is needed. 

The term ‘‘loan amount’’ appears in 

proposed § 226.43(b)(2), which defines 

‘‘fully amortizing payment,’’ and in 

proposed § 226.43(c)(5)(ii)(B), which 

implements the requirement under 

TILA Section 129C(a)(6)(D)(i) that the 

creditor assume that ‘‘the loan proceeds 

are fully disbursed on the date of 

consummation of the loan’’ when 

determining the consumer’s ability to 

repay a loan. In addition, the term ‘‘loan 

amount’’ appears in proposed 

§ 226.43(d)(5)(i)(C)(2) which 

implements TILA Section 129C(a)(6)(E) 

and provides the payment calculation 

for a non-standard mortgage with 

interest-only payments. The term ‘‘loan 

amount’’ also appears in proposed 

§ 226.43(e)(2)(iv), which implements the 

requirement under TILA Sections 

129C(b)(iv) and (v) that the creditor 

underwrite the loan using a periodic 

payment of principal and interest that 

will repay the loan to meet the 

definition of a qualified mortgage. 

43(b)(6) Loan Term 

TILA Section 129C(a)(3) requires that 

a creditor determine a consumer’s 

repayment ability on a loan ‘‘using a 

payment schedule that fully amortizes 

the loan over the term of the loan.’’ TILA 

Section 129C(a)(6)(D)(ii) also requires 

that for purposes of making the 

repayment ability determination under 

TILA Section 129C(a), the creditor 

calculate the monthly payment on the 

mortgage obligation assuming that the 

loan is repaid ‘‘over the entire term of 

the loan with no balloon payment.’’ In 

addition, TILA Section 129C(b)(2)(A)(iv) 

and (v) require that a creditor 

underwrite the loan using ‘‘a payment 

schedule that fully amortizes the loan 

over the loan term’’ to meet the 

definition of a qualified mortgage. The 

Dodd-Frank Act does not define the 

term ‘‘loan term.’’ 

This proposal refers to the term of the 

loan as the ‘‘loan term,’’ as defined, for 

simplicity. Proposed § 226.43(b)(6) 

provides that the ‘‘loan term’’ means the 

period of time to repay the obligation in 

full. This proposed definition is 

consistent with the proposed definition 

of ‘‘loan term’’ for disclosure purposes in 

the Board’s 2009 Closed-End Mortgage 

Proposal. See 74 FR 43232, 43333, Aug. 

26, 2009. This term primarily appears in 

proposed § 226.43(c)(5)(i), which 

implements TILA Section 

129(a)(6)(D)(ii) and requires creditors to 

determine a consumer’s ability to repay 

the loan based on fully amortizing 

payments. See proposed § 226.43(b)(2), 

which defines ‘‘fully amortizing 

payments’’ as periodic payments that 

will fully repay the loan amount over 

the loan term. ‘‘Loan term’’ also is used 

in proposed § 226.43(e)(2)(iv), which 

implements TILA Section 129C(b)(2)(iv) 

and (v) and requires creditors to 

underwrite the loan using the periodic 

payment of principal and interest that 

will repay the loan over the loan term 

to meet the definition of a qualified 

mortgage. 

Proposed comment 43(b)(6)–1 

clarifies that the loan term is the period 

of time it takes to repay the loan amount 

in full. For example, a loan with an 

initial discounted rate that is fixed for 

the first two years, and that adjusts 

periodically for the next 28 years has a 

loan term of 30 years, which is the 

amortization period on which the 

periodic amortizing payments are based. 

43(b)(7) Maximum Loan Amount 

Proposed § 226.43(b)(7) defines 

‘‘maximum loan amount’’ to mean the 

loan amount plus any increase in 

principal balance that results from 

negative amortization (defined in 

current § 226.18(s)(7)(v)), based on the 

terms of the legal obligation assuming 

that: (1) The consumer makes only the 

minimum periodic payments for the 

maximum possible time, until the 

consumer must begin making fully 

amortizing payments; and (2) the 

maximum interest rate is reached at the 

earliest possible time. The term 

‘‘maximum loan amount’’ implements, 

in part, TILA Section 129(a)(6)(C), 

which states that when making the 

payment calculation for loans with 

negative amortization, ‘‘a creditor shall 

also take into consideration any balance 

increase that may accrue from any 

negative amortization provision.’’ 

Loans with negative amortization 

typically permit consumers to make 

payments that cover only part of the 

interest accrued each month, and none 

of the principal. The unpaid but accrued 

interest is added to the principal 

balance, causing negative equity (i.e., 

negative amortization). This accrued but 

unpaid interest can be significant if the 

loan terms do not provide for any 

periodic interest rate adjustment caps, 

thereby permitting the accrual interest 

rate to quickly escalate to the lifetime 

maximum interest rate. As a result of 

these loan features, consumers of loans 

with negative amortization are more 

likely to encounter payment shock once 

fully amortizing payments are required. 

For these reasons, the Board believes it 

is appropriate to interpret the phrase 

‘‘any balance increase that may accrue’’ 

as requiring the creditor to account for 

the greatest potential increase in the 

principal balance that could occur 

under in a loan with negative 

amortization. See TILA Section 

129(a)(6)(C). The Board also believes 

this interpretation is consistent with the 

overall statutory construct that requires 

creditors to determine whether the 

consumer is able to manage payments 

that may be required at any time during 

the loan term, especially where 

payments can escalate significantly in 

amount. The proposed definition of 

‘‘maximum loan amount’’ is also 

consistent with the approach in the 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27414 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

30See 12 CFR 226.18(s)(2)(ii) and comment 

18(s)(2)(ii)–2, which discusses assumptions made 

for the interest rates in adjustable-rate mortgages 

that are negative amortization loans. 

31See 2006 Nontraditional Mortgage Guidance at 

58614, n.7. 

MDIA Interim Final Rule,30 which 

addresses disclosure requirements for 

negative amortization loans, and the 

2006 Nontraditional Mortgage 

Guidance, which provides guidance to 

creditors regarding underwriting 

negative amortization loans.31

The term ‘‘maximum loan amount’’ is 

used in proposed § 226.43(c)(5)(ii)(C), 

which implements the statutory 

requirements under new TILA Section 

129C(a)(6)(C) and (D) regarding payment 

calculations for negative amortization 

loans. See proposed § 226.43(c)(5)(ii)(C), 

which discusses more fully the scope of 

loans covered by the term ‘‘negative 

amortization loan,’’ as defined in current 

§ 226.18(s)(7)(v). The term also appears 

in proposed § 226.43(d), which 

addresses the exception to the 

repayment ability provision for the 

refinancing of a non-standard mortgage. 

Proposed comment 43(b)(7)–1 

clarifies that in determining the 

maximum loan amount, the creditor 

must assume that the consumer makes 

the minimum periodic payment 

permitted under the loan agreement for 

as long as possible, until the consumer 

must begin making fully amortizing 

payments, and that the interest rate rises 

as quickly as possible after 

consummation under the terms of the 

legal obligation. The proposed comment 

further clarifies that creditors must 

assume the consumer makes the 

minimum periodic payment until any 

negative amortization cap is reached or 

until the period permitting minimum 

periodic payments expires, whichever 

occurs first. This comment would crossreference proposed § 226.43(b)(5) and 

§ 226.18(s)(7)(v) for the meaning of the 

terms ‘‘loan amount’’ and ‘‘negative 

amortization loan,’’ respectively. 

Proposed comment 43(b)(7)–2 

provides further guidance to creditors 

regarding the assumed interest rate to 

use when determining the maximum 

loan amount. This comment would 

explain that when calculating the 

maximum loan amount for an 

adjustable-rate mortgage that is a 

negative amortization loan, the creditor 

must assume that the interest rate will 

increase as rapidly as possible after 

consummation, taking into account any 

periodic interest rate adjustment caps 

provided in the loan agreement. This 

comment would further explain that for 

an adjustable-rate mortgage with a 

lifetime maximum interest rate but no 

periodic interest rate adjustment cap, 

the creditor must assume the interest 

rate increases to the maximum lifetime 

interest rate at the first adjustment. 

Proposed comment 43(b)(7)–3 

provides examples illustrating the 

application of the proposed definition of 

‘‘maximum loan amount’’ for a negative 

amortization loan that is an adjustablerate mortgage and for a fixed-rate, 

graduated payment mortgage. For 

example, proposed comment 43(b)(7)– 

3.i assumes an adjustable-rate mortgage 

in the amount of $200,000 with a 30- 

year loan term. The loan agreement 

provides that the consumer can make 

minimum monthly payments that cover 

only part of the interest accrued each 

month until the principal balance 

reaches 115% of its original balance 

(i.e., a negative amortization cap of 

115%) or for the first five years of the 

loan (60 monthly payments), whichever 

occurs first. The introductory interest 

rate at consummation is 1.5%. One 

month after consummation, the interest 

rate adjusts and will adjust monthly 

thereafter based on the specified index 

plus a margin of 3.5%. The maximum 

lifetime interest rate is 10.5%; there are 

no other periodic interest rate 

adjustment caps that limit how quickly 

the maximum lifetime rate may be 

reached. The minimum monthly 

payment for the first year is based on 

the initial interest rate of 1.5%. After 

that, the minimum monthly payment 

adjusts annually, but may increase by 

no more than 7.5% over the previous 

year’s payment. The minimum monthly 

payment is $690 in the first year, $740 

in the second year, and $798 in the first 

part of the third year. See proposed 

comment 43(b)(7)–3.i(A). 

This comment then states that to 

determine the maximum loan amount, 

creditors should assume that the interest 

rate increases to the maximum lifetime 

interest rate of 10.5% at the first 

adjustment (i.e., the second month) and 

accrues at that rate until the loan is 

recast. This proposed comment further 

assumes the consumer makes the 

minimum monthly payments as 

scheduled, which are capped at 7.5% 

from year-to-year. This comment would 

explain that as a result, the consumer’s 

minimum monthly payments are less 

than the interest accrued each month, 

resulting in negative amortization (i.e., 

the accrued but unpaid interest is added 

to the principal balance). 

This comment concludes that on the 

basis of these assumptions (that the 

consumer makes the minimum monthly 

payments for as long as possible and 

that the maximum interest rate of 10.5% 

is reached at the first rate adjustment 

(i.e., the second month)), the negative 

amortization cap of 115% is reached on 

the due date of the 27th monthly 

payment and the loan is recast. The 

maximum loan amount as of the due 

date of the 27th monthly payment is 

$229,243. See proposed comment 

43(b)(7)–3.i(B). 

43(b)(8) Mortgage-Related Obligations 

The Board proposes to use the term 

‘‘mortgage-related obligations’’ to refer to 

‘‘all applicable taxes, insurance 

(including mortgage guarantee 

insurance), and assessments’’ for 

purposes of TILA Sections 129C(a)(1) 

through (3) and (b)(2)(A)(iv) and (v). 

TILA Sections 129C(a)(1) and (2) require 

that a creditor determine a consumer’s 

ability to repay the loan ‘‘according to 

[the loan’s] terms, and all applicable 

taxes, insurance (including mortgage 

guarantee insurance), and assessments.’’ 

TILA Section 129C(a)(3) further states 

that the creditor must consider the 

consumer’s debt-to-income ratio after 

allowing for ‘‘non-mortgage debt and 

mortgage-related obligations.’’ In 

addition, TILA Sections 

129C(b)(2)(A)(iv) and (v) provide that to 

meet the qualified mortgage standard, 

the creditor must underwrite the loan 

‘‘tak[ing] into account all applicable 

taxes, insurance, and assessments[.]’’ 

The Dodd-Frank Act does not define the 

term ‘‘mortgage-related obligations.’’ 

However, these statutory requirements 

are substantially similar to current 

§ 226.34(a)(4) of the Board’s 2008 

HOEPA Final Rule, which requires the 

creditor to consider mortgage-related 

obligations when determining the 

consumer’s repayment ability on a loan. 

Current § 226.34(a)(4)(i) defines 

‘‘mortgage-related obligations’’ as 

expected property taxes, premiums for 

mortgage-related insurance required by 

the creditor as set forth in current 

§ 226.35(b)(3)(i), and similar expenses, 

such as homeowners’ association dues 

and condominium or cooperative fees. 

See comment 34(a)(4)(i)–1. 

Proposed § 226.43(b)(8) defines the 

term ‘‘mortgage-related obligations’’ to 

mean property taxes; mortgage-related 

insurance premiums required by the 

creditor as set forth in proposed 

§ 226.45(b)(1); homeowner’s association, 

condominium, and cooperative fees; 

ground rent or leasehold payments; and 

special assessments. Proposed 

§ 226.43(b)(8) is consistent with TILA 

Sections 129C(a)(1)–(3) and 

129C(b)(2)(A)(iv) and (v), with 

modifications to the statutory language 

to provide greater clarity to creditors 

regarding what items are included in the 

phrase ‘‘taxes, insurance (including 

mortgage guarantee insurance), and 

assessments.’’ Based on outreach, the 

Board believes greater specificity in 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
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32Also, TILA Section 128(a)(12) requires that the 

transaction-specific disclosures state that the 

consumer should refer to the appropriate contract 

document for information regarding certain loan 

terms or features, including ‘‘prepayment * * * 

penalties.’’ 15 U.S.C. 1638(a)(12). In addition, TILA 

Section 129(c) limits the circumstances in which a 

high-cost mortgage may include a ‘‘prepayment 

penalty.’’ 15 U.S.C. 1639(c). 

33Prepayment penalty disclosure requirements 

under § 226.18(k) apply to closed-end mortgage and 

non-mortgage transactions. In the 2009 Closed-End 

Mortgage Proposal, the Board proposed to establish 

a new § 226.38(a)(5) for disclosure of prepayment 

penalties specifically for closed-end mortgage 

transactions. 

defining the term ‘‘mortgage-related 

obligations’’ would address concerns 

that some creditors may have difficulty 

determining which items should be 

included as mortgage-related obligations 

when determining the total monthly 

debt a consumer will owe in connection 

with a loan. The proposed term would 

also track the current meaning of the 

term mortgage-related obligations in 

current § 226.34(a)(4)(i) and comment 

34(a)(4)(i)–1, which the Board is 

proposing to remove, with several 

clarifications. 

The Board proposes to define the term 

‘‘mortgage-related obligations’’ with 

three clarifications. First, consistent 

with current underwriting practices, the 

proposed definition of ‘‘mortgage-related 

obligations’’ would include reference to 

ground rent or leasehold payments, 

which are payments made to the land 

owner or leaseholder for use of the land. 

Second, the proposed term would 

include reference to ‘‘special 

assessments.’’ Proposed comment 

43(b)(8)–1 clarifies that special 

assessments include, for example, 

assessments that are imposed on the 

consumer at or before consummation, 

such as a one-time homeowners’ 

association fee that will not be paid by 

the consumer in full at or before 

consummation. Third, the term 

‘‘mortgage-related obligations’’ would 

reference proposed § 226.45(b)(1) to 

include mortgage-related insurance 

premiums 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. Proposed 

§ 226.45(b)(1) parallels current 

§ 226.35(b)(3)(i), which the Board is 

proposing to remove. See 76 FR 11598, 

11610, Mar. 2, 2011 for discussion of 

proposed § 226.45(b)(1). The Board 

solicits comment on how to address any 

issues that may arise in connection with 

homeowners’ association transfer fees 

and costs associated with loans for 

energy-efficient improvement. 

Proposed comment 43(b)(8)–1 further 

clarifies that mortgage-related 

obligations include expected property 

taxes and premiums for mortgagerelated insurance required by the 

creditor as set forth in § 226.45(b)(1), 

such as insurance against loss of or 

damage to property or against liability 

arising out of the ownership or use of 

the property, and insurance protecting 

the creditor against the consumer’s 

default or other credit loss. This 

comment would explain that the 

creditor need not include premiums for 

mortgage-related insurance that it does 

not require, such as earthquake 

insurance or credit insurance, or fees for 

optional debt suspension and debt 

cancellation agreements. To facilitate 

compliance, this comment would refer 

to commentary associated with 

proposed § 226.43(c)(2)(v), which 

discusses the requirement to take into 

account any mortgage-related 

obligations for purposes of the 

repayment ability determination 

required under proposed § 226.43(b)(2). 

The term ‘‘mortgage-related 

obligations’’ appears in proposed 

§ 226.43(c)(2)(v), which implements 

new TILA Sections 129C(a)(1) through 

(3) and requires that the creditor 

determine a consumer’s ability to repay 

a covered transaction, taking into 

account mortgage-related obligations. 

The term also appears in proposed 

§ 226.43(e)(2)(iv), which implements 

new TILA Section 129C(b)(2)(A)(iv) and 

(v) and requires that the creditor 

underwrite a loan taking into account 

mortgage-related obligations to meet the 

qualified mortgage definition. Proposed 

§ 226.43(c) and (e) are discussed in 

further detail below. 

43(b)(9) Points and Fees 

For ease of reference, proposed 

§ 226.43(b)(9) states that the term 

‘‘points and fees’’ has the same meaning 

as in § 226.32(b)(1). 

43(b)(10) Prepayment Penalty 

TILA Section 129C(c), as added by 

Section 1414 of the Dodd-Frank Act, 

limits the transactions that may include 

a ‘‘prepayment penalty,’’ the period 

during which a prepayment penalty 

may be imposed, and the maximum 

amount of a prepayment penalty. TILA 

Section 129C(c) also requires creditors 

to offer a consumer a covered 

transaction without a prepayment 

penalty if they offer the consumer a 

covered transaction with a prepayment 

penalty. Qualified mortgages are subject 

to additional limitations on prepayment 

penalties, pursuant to points and fees 

limitations under Section 1412 of the 

Act. TILA Section 129C(b)(2)(A)(viii) 

limits the points and fees that may be 

charged for a qualified mortgage to three 

percent of the total loan amount. TILA 

Section 103(aa)(4)(E) and (F), as added 

by Section 1431(c) of the Dodd-Frank 

Act, define ‘‘points and fees’’ to include 

(1) the maximum prepayment fees and 

penalties that may be charged under the 

terms of the covered transaction; and (2) 

all prepayment fees or penalties that are 

incurred by the consumer if the loan 

refinances a previous loan made or 

currently held by the same creditor or 

an affiliate of the creditor. 

TILA establishes certain disclosure 

requirements for transactions for which 

a penalty is imposed upon prepayment 

but does not define the term 

‘‘prepayment penalty.’’ TILA Section 

128(a)(11) requires that the transactionspecific disclosures for closed-end 

consumer credit transactions disclose a 

‘‘penalty’’ imposed upon prepayment in 

full of a closed-end transaction, without 

using the term ‘‘prepayment penalty.’’ 15 

U.S.C. 1638(a)(11).32 Current 

commentary on § 226.18(k)(1), which 

implements TILA Section 128(a)(11), 

clarifies that a ‘‘penalty’’ imposed upon 

prepayment in full is a charge assessed 

solely because of the prepayment of an 

obligation and includes, for example, 

‘‘interest’’ charges for any period after 

prepayment in full is made and a 

minimum finance charge.33 See 

comment 18(k)–1. The Board’s 2009 

Closed-End Mortgage Proposal clarifies 

that prepayment penalties include 

origination or other charges that a 

creditor waives unless the consumer 

prepays, but do not include fees 

imposed for preparing a payoff 

statement, among other clarifications. 

See 74 FR 43232, 43413, Aug. 29, 2009. 

Also, the Board’s 2010 Mortgage 

Proposal clarifies that prepayment 

penalties include ‘‘interest’’ charges after 

prepayment in full even if the charge 

results from the interest accrual 

amortization method used on the 

transaction. See 75 FR 58539, 58756, 

Sept. 24, 2010. 

Proposed § 226.43(b)(10) defines 

‘‘prepayment penalty’’ as a charge 

imposed for paying all or part of a 

covered transaction’s principal before 

the date on which the principal is due. 

Also, proposed § 226.43(b)(10)(i) 

provides the following examples of 

‘‘prepayment penalties’’ for purposes of 

§ 226.43: (1) A charge determined by 

treating the loan balance as outstanding 

for a period of time after prepayment in 

full and applying the interest rate to 

such ‘‘balance,’’ even if the charge 

results from the interest accrual 

amortization method used for other 

payments in the transaction; and (2) a 

fee, such as a loan closing cost, that is 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27416 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

34 ‘‘The term ‘adjustable-rate mortgage’ means a 

transaction secured by real property or a dwelling 

for which the annual percentage rate may increase 

after consummation.’’ 12 CFR 226.18(s)(7)(i). 

35 ‘‘The term ‘interest-only’ means that, under the 

terms of the legal obligation, one or more of the 

periodic payments may be applied solely to accrued 

interest and not to loan principal; an ‘interest-only 

loan’ is a loan that permits interest-only payments.’’ 

12 CFR 226.18(s)(7)(iv). 

36 ‘‘[T]he term ‘negative amortization’ means 

payment of periodic payments that will result in an 

increase in the principal balance under the terms 

of the legal obligation; the term ‘negative 

amortization loan’ means a loan that permits 

payments resulting in negative amortization, other 

than a reverse mortgage subject to section 226.33.’’ 

12 CFR 226.18(s)(7)(v). 

37See U.S. House of Reps., Comm. on Fin. 

Services, Report on H.R. 1728, Mortgage Reform 

and Anti-Predatory Lending Act, No. 111–94, 52 

(May 4, 2009). 

waived unless the consumer prepays the 

covered transaction. Proposed comment 

43(b)(10)(A)–1 clarifies that ‘‘interest 

accrual amortization’’ refers to the 

method used to determine the amount 

of interest due for each period (for 

example, a month) in a transaction’s 

term. The proposed comment also 

provides an example where a 

prepayment penalty of $1,000 is 

imposed because a full month’s interest 

of $3,000 is charged even though only 

$2,000 in interest was earned in the 

month during which the consumer 

prepaid. Proposed § 226.43(b)(10)(ii) 

provides that a prepayment penalty 

does not include fees imposed for 

preparing and providing documents 

when a loan is paid in full, whether or 

not the loan is prepaid, such as a loan 

payoff statement, a reconveyance 

document, or another document 

releasing the creditor’s security interest 

in the dwelling that secures the loan. 

Proposed § 226.43(b)(10) uses 

language substantially similar to the 

language used in TILA Section 129C(c), 

but proposed § 226.43(b)(10) refers to 

charges for payment ‘‘before the date on 

which the principal is due’’ rather than 

‘‘after the loan is consummated,’’ for 

clarity. Proposed § 226.43(b)(10)(i) and 

(ii) are substantially similar to the 

current guidance on prepayment 

penalties in comment 18(k)–1 and in 

proposed § 226.38(a)(5) under the 

Board’s 2009 Closed-End Mortgage 

Proposal and 2010 Mortgage Proposal, 

discussed above. However, proposed 

§ 226.43(b)(10) omits commentary 

providing: (1) Examples of prepayment 

penalties include a minimum finance 

charge because such charges typically 

are imposed with open-end, rather than 

closed-end, transactions; and (2) 

examples of prepayment penalties do 

not include loan guarantee fees because 

loan guarantee fees are not charges 

imposed for paying all or part of a loan’s 

principal before the date on which the 

principal is due. See comment 18(k)(1)– 

1. The term ‘‘prepayment penalty’’ 

appears in the ‘‘points and fees’’ 

definition in proposed § 226.32(b)(1)(v) 

and (vi) and in the requirements for 

prepayment penalties in § 226.43(g). 

The Board recognizes that the effect of 

including particular types of charges in 

the proposed definition of a 

‘‘prepayment penalty’’ is to apply the 

limitations on prepayment penalties 

under TILA Section 129C(c) to those 

types of charges, which in turn could 

limit the availability of credit. In 

particular, if ‘‘prepayment penalty’’ is 

defined to include a provision that 

requires the consumer to pay ‘‘interest’’ 

for a period after prepayment in full, or 

a provision that waives fees unless the 

consumer prepays, pursuant to TILA 

Section 129C(c) a covered transaction 

may not include such provisions unless 

the transaction: (1) Has an APR that 

cannot increase, (2) is a qualified 

mortgage, and (3) is not a higher-priced 

mortgage loan, as discussed in detail in 

the section-by-section analysis of 

proposed § 226.43(g). Also, the amount 

of the ‘‘interest’’ charged after 

prepayment, or the amount of fees 

waived unless the consumer prepays, 

would be limited. Finally, the creditor 

would have to offer an alternative 

covered transaction for which ‘‘interest’’ 

will not be charged after prepayment or 

for which fees are waived even if the 

consumer prepays (although under the 

Board’s proposal the alternative covered 

transaction could have a different 

interest rate). Thus, the Board solicits 

comment on whether or not it is 

appropriate to include ‘‘interest’’ 

charged for a period after prepayment, 

or fees waived unless the consumer 

prepays, in the definition of 

‘‘prepayment penalty’’ under proposed 

§ 226.43(b)(10). Specifically, the Board 

requests comment on the possible 

effects of including those charges on the 

availability of particular types of 

covered transactions. 

43(b)(11) Recast 

Proposed § 226.43(b)(11) defines the 

term ‘‘recast,’’ which is used in two 

paragraphs of proposed § 226.43: (1) 

Proposed § 226.43(c)(5)(ii) regarding 

certain required payment calculations 

that creditors must consider in 

determining a consumer’s ability to 

repay a covered transaction; and (2) 

proposed § 226.43(d) regarding payment 

calculations required for refinancings 

that are exempt from the ability-to-repay 

requirements in § 226.43(c). 

Specifically, § 226.43(b)(11) defines 

the term ‘‘recast’’ as follows: (1) For an 

adjustable-rate mortgage, as defined in 

§ 226.18(s)(7)(i),34 the expiration of the 

period during which payments based on 

the introductory interest rate are 

permitted under the terms of the legal 

obligation; (2) for an interest-only loan, 

as defined in § 226.18(s)(7)(iv),35 the 

expiration of the period during which 

interest-only payments are permitted 

under the terms of the legal obligation; 

and (3) for a negative amortization loan, 

as defined in § 226.18(s)(7)(v),36 the 

expiration of the period during which 

negatively amortizing payments are 

permitted under the terms of the legal 

obligation. 

Proposed comment 43(b)(11)–1 

explains that the date on which the 

‘‘recast’’ occurs is the due date of the last 

monthly payment based on the 

introductory fixed rate, the interest-only 

payment, or the negatively amortizing 

payment, as applicable. Proposed 

comment 43(b)(11)–1 also provides an 

illustration of this rule for a loan in an 

amount of $200,000 with a 30-year loan 

term, where the loan agreement 

provides for a fixed interest rate and 

permits interest-only payments for the 

first five years of the loan (60 months). 

Under proposed § 226.43(b)(11), the 

loan is ‘‘recast’’ on the due date of the 

60th monthly payment. Thus, the term 

of the loan remaining as of the date the 

loan is recast is 25 years (300 months). 

The statute uses the term ‘‘reset’’ to 

suggest the time at which the terms of 

a mortgage loan are adjusted, resulting 

in higher required payments. For 

example, TILA Section 129C(a)(6)(E)(ii) 

states that a creditor that refinances a 

loan may, under certain conditions, 

‘‘consider if the extension of new credit 

would prevent a likely default should 

the original mortgage reset and give 

such concerns a higher priority as an 

acceptable underwriting practice.’’ 15 

U.S.C. 1639c(a)(6)(E)(ii). The legislative 

history further indicates that, for 

adjustable-rate mortgages with low, 

fixed introductory rates, Congress 

understood the term ‘‘reset’’ to mean the 

time at which the low teaser rates 

converted to fully indexed rates, 

resulting in ‘‘significantly higher 

monthly payments for homeowners.’’ 37

Outreach participants indicated that 

the term ‘‘recast’’ is typically used to 

reference the time at which fully 

amortizing payments are required for 

interest-only and negative amortization 

loans and that the term ‘‘reset’’ is more 

frequently used to indicate the time at 

which adjustable-rate mortgages with an 

introductory fixed rate convert to a 

variable rate. For simplicity and clarity, 

however, the Board proposes to use the 

term ‘‘recast’’ to cover the conversion to 

less favorable terms and higher 


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38See 2006 Nontraditional Mortgage Guidance, 

71 FR 58609, 58614 (Oct.4, 2006). 

39 Kristopher Gerardi, Andreas Lehnert, Shane 

Sherlund, and Paul S. Willen, ‘‘Making Sense of the 

Subprime Crisis,’’ Brookings Papers on Economic 

Activity (Fall 2008), at 40, Table 3. 

40The Board conducted independent analysis 

using data obtained from the FRBNY Consumer 

Credit Panel to determine the proportion of 

piggyback HELOCs taken out in the same month as 

the first-lien loan that have a draw at the time of 

origination. Data used is extracted from credit 

record data in years 2003 through 2010. See 

Donghoon Less and Wilbert van der Klaauw, ‘‘An 

Introduction to the FRBNY Consumer Credit Panel,’’ 

Staff Rept. No. 479 (Nov. 2010), at http:// 

data.newyorkfed.org/research/staff_reports/ 

sr479.pdf, for further description of the database. 

payments not only for interest-only 

loans and negative amortization loans 

but also for adjustable-rate mortgages. 

The Board solicits comment on the 

proposed definition of ‘‘recast’’ for 

purposes of proposed § 226.43(c) and 

(d). 

43(b)(12) Simultaneous Loan 

The Board proposes to use the term 

‘‘simultaneous loan’’ to refer to loans 

that are subject to TILA Section 

129C(a)(2), which states that ‘‘if a 

creditor knows, or has reason to know, 

that 1 or more residential mortgage 

loans secured by the same dwelling will 

be made to the same consumer, the 

creditor shall make a reasonable and 

good faith determination, based on 

verified and documented information, 

that the consumer has a reasonable 

ability to repay the combined payments 

of all loans on the same dwelling 

according to the terms of those loans 

and all applicable taxes, insurance 

(including mortgage guarantee 

insurance), and assessments.’’ TILA 

Section 129C(a)(2) uses the term 

‘‘residential mortgage loan,’’ which is 

defined in TILA Section 103(cc)(5) as 

excluding home equity lines of credit 

(HELOCs) for purposes of TILA Section 

129C. See proposed § 226.43(a), 

discussing the scope of the ability-torepay provisions. Thus, TILA Section 

129C(a)(2) does not require a creditor to 

consider a simultaneous HELOC when 

determining a consumer’s repayment 

ability on the covered transaction. 

By contrast, § 226.34(a)(4) of the 

Board’s 2008 HOEPA Final Rule 

requires the creditor to consider the 

consumer’s current obligations when 

making its repayment ability 

determination. Current comment 

34(a)(4)–3 clarifies the meaning of the 

term ‘‘current obligations,’’ and provides 

that it includes other dwelling-secured 

credit obligations undertaken prior to or 

at consummation of the transaction 

subject to § 226.34(a)(4) of which the 

creditor has knowledge. This comment 

does not distinguish between closedend and open-end credit transactions for 

purposes of ‘‘other dwelling-secured 

obligations.’’ Accordingly, under current 

comment 34(a)(4)–3 the creditor must 

consider in the repayment ability 

assessment a HELOC of which it has 

knowledge if the HELOC will be 

undertaken at or before consummation 

and will be secured by the same 

dwelling that secures the transaction. 

Proposed § 226.43(b)(12) would 

define the term ‘‘simultaneous loan’’ to 

refer to other loans that are secured by 

the same dwelling and made to the same 

consumer at or before consummation of 

the covered transaction. The term would 

include HELOCs as well as closed-end 

mortgages for purposes of TILA Section 

129C(a)(2). The Board believes TILA 

Section 129C(a)(2) is meant to help 

ensure that creditors account for the 

increased risk of consumer delinquency 

or default on the covered transaction 

where more than one loan secured by 

the same dwelling is originated 

concurrently, and therefore requires 

creditors to consider the combined 

payments on such loans. The Board 

believes this increased risk is present 

whether the other mortgage obligation is 

a closed-end credit transaction or a 

HELOC. 

The Board proposes to broaden the 

scope of TILA Section 129C(a)(2) to 

include HELOCs, and accordingly 

proposes to define the term 

‘‘simultaneous loan’’ to include HELOCs, 

using its authority under TILA Section 

105(a). 15 U.S.C. 1604(a). TILA Section 

105(a), as amended by Section 1100A of 

the Dodd-Frank Act, authorizes the 

Board to prescribe regulations to carry 

out the purposes of TILA and 

Regulation Z, to prevent circumvention 

or evasion, or to facilitate compliance. 

15 U.S.C. 1604(a). The inclusion of 

HELOCs is further supported by the 

Board’s authority under TILA Section 

129B(e) to condition terms, acts or 

practices relating to residential mortgage 

loans that the Board finds necessary or 

proper to effectuate the purposes of 

TILA. 15 U.S.C. 1639b(e). One purpose 

of the statute is set forth in TILA Section 

129B(a)(2), which states that ‘‘[i]t is the 

purpose[] of * * * [S]ection 129C to 

assure that consumers are offered and 

receive residential mortgage loans on 

terms that reasonably reflect their ability 

to repay the loans.’’ 15 U.S.C. 1639b. For 

the reasons stated below, the Board 

believes requiring creditors to consider 

simultaneous loans that are HELOCs for 

purposes of TILA Section 129C(a)(2) 

would help to ensure that consumers 

are offered, and receive, loans on terms 

that reasonably reflect their ability to 

repay. 

First, the Board is proposing in 

§ 226.43(c)(2)(vi) that the creditor must 

consider current debt obligations in 

determining a consumer’s ability to 

repay a covered transaction. Consistent 

with current § 226.34(a)(4), proposed 

§ 226.43(c)(2)(vi) would not distinguish 

between pre-existing closed-end and 

open-end mortgage obligations. The 

Board believes consistency requires that 

it take the same approach when 

determining how to consider mortgage 

obligations that come into existence 

concurrently with a first-lien loan as is 

taken for pre-existing mortgage 

obligations, whether the first-lien is a 

purchase or non-purchase transaction 

(i.e., refinancing). Including HELOCs in 

the proposed definition of 

‘‘simultaneous loan’’ for purposes of 

TILA Section 129C(a)(2) is also 

generally consistent with current 

comment 34(a)(4)–3, and the 2006 

Nontraditional Mortgage Guidance 

regarding simultaneous second-lien 

loans.38

Second, data indicate that where a 

subordinate loan is originated 

concurrently with a first-lien loan to 

provide some or all of the downpayment 

(i.e., ‘‘piggyback loan’’), the default rate 

on the first-lien loan increases 

significantly, and in direct correlation to 

increasing combined loan-to-value 

ratios.39 The data does not distinguish 

between ‘‘piggyback loans’’ that are 

closed-end or open-end credit 

transactions, or between purchase and 

non-purchase transactions. However, 

empirical evidence demonstrates that 

approximately 60% of consumers who 

open a HELOC concurrently with a firstlien loan borrow against the line of 

credit at the time of origination,40

suggesting that in many cases the 

HELOC may be used to provide some, 

or all, of the downpayment on the firstlien loan. 

The Board recognizes that consumers 

have varied reasons for originating a 

HELOC concurrently with the first-lien 

loan, for example, to reduce overall 

closing costs or for the convenience of 

having access to an available credit line 

in the future. However, the Board 

believes concerns relating to HELOCs 

originated concurrently for savings or 

convenience, and not to provide 

payment towards the first-lien home 

purchase loan, may be mitigated by the 

Board’s proposal to require that a 

creditor consider the periodic payment 

on the simultaneous loan based on the 

actual amount drawn from the credit 

line by the consumer. See proposed 

§ 226.43(c)(6)(ii), discussing payment 

calculation requirements for 

simultaneous loans that are HELOCs. 

Still, the Board recognizes that in the 

case of a non-purchase transaction (e.g., 


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a refinancing) a simultaneous loan that 

is a HELOC is unlikely to be originated 

and drawn upon to provide payment 

towards the first-lien loan, except 

perhaps towards closing costs. The 

Board solicits comment on whether it 

should narrow the requirement to 

consider simultaneous loans that are 

HELOCs to apply only to purchase 

transactions. See discussion under 

proposed § 226.43(c)(6). 

Third, in developing this proposal 

staff conducted outreach with a variety 

of participants that consistently 

expressed the view that second-lien 

loans significantly impact a consumer’s 

performance on the first-lien loan, and 

that many second-lien loans are 

HELOCs. One industry participant 

explained that the vast majority of 

‘‘piggyback loans’’ it originated were 

HELOCs that were fully drawn at the 

time of origination and used to assist in 

the first-lien purchase transaction. 

Another outreach participant stated that 

HELOCs make up approximately 90% of 

their simultaneous loan book-ofbusiness. Industry outreach participants 

generally indicated that it is a currently 

an accepted underwriting practice to 

include HELOCs in the repayment 

ability assessment on the first-lien loan, 

and generally confirmed that the 

majority of simultaneous liens 

considered during the underwriting 

process are HELOCs. Thus, for these 

reasons, the Board proposes to use its 

authority under TILA Sections 105(a) 

and 129B(e) to broaden the scope of 

TILA Section 129C(a)(2), and 

accordingly proposes to define the term 

‘‘simultaneous loan’’ to include HELOCs. 

Proposed § 226.43(b)(12) defines a 

‘‘simultaneous loan’’ to mean another 

covered transaction or home equity line 

of credit subject to § 226.5b that will be 

secured by the same dwelling and made 

to the same consumer at or before 

consummation of the covered 

transaction. The proposed definition 

generally tracks the meaning of ‘‘other 

dwelling-secured obligations’’ under 

current comment 34(a)(4)–3, as well as 

the statutory language of TILA Section 

129C(a)(2) with the notable difference 

that the proposed term would include 

HELOCs, as discussed above. The Board 

proposes to replace the term ‘‘residential 

mortgage loan’’ with the term ‘‘covered 

transaction,’’ as defined in proposed 

§ 226.43(b)(1), for clarity. The Board 

also proposes to add a reference to the 

phrase ‘‘at or before consummation of 

the covered transaction’’ to further 

clarify that the definition does not 

include pre-existing mortgage 

obligations. Pre-existing mortgage 

obligations would be included as 

current debt obligations under proposed 

§ 226.43(c)(2)(vi), which is discussed 

below. Last, the Board proposes to not 

include the statutory language that ‘‘the 

creditor shall make a reasonable and 

good faith determination, based on 

verified and documented information, 

that the consumer has a reasonable 

ability to repay the combined payments 

of all loans on the same dwelling 

according to the terms of those loans 

and all applicable taxes, insurance 

(including mortgage guarantee 

insurance), and assessments,’’ because 

these statutory requirements are 

addressed in the repayment ability 

provisions in proposed § 226.43(c)(2)(iv) 

and (v), which are discussed more fully 

below. 

Proposed comment 43(b)(12)–1 

clarifies that the definition of 

‘‘simultaneous loan’’ includes any loan 

that meets the definition, whether made 

by the same creditor or a third-party 

creditor, and provides an illustrative 

example of this principle. This 

proposed comment assumes a consumer 

will enter into a legal obligation that is 

a covered transaction with Creditor A. 

Immediately prior to consummation of 

the covered transaction with Creditor A, 

the consumer opens a HELOC that is 

secured by the same dwelling with 

Creditor B. This proposed comment 

explains that for purposes of this 

section, the loan extended by Creditor B 

is a simultaneous loan. To facilitate 

compliance, the comment would crossreference to § 226.43(c)(2)(iv) and (c)(6) 

and associated commentary for further 

discussion of the requirement to 

consider the consumer’s payment 

obligation on any simultaneous loan for 

purposes of determining the consumer’s 

ability to repay the covered transaction 

subject to this section. 

Proposed comment 43(b)(12)–2 

further clarifies the meaning of the term 

‘‘same consumer, and explains that for 

purposes of the definition of 

‘‘simultaneous loan,’’ the term ‘‘same 

consumer’’ includes any consumer, as 

that term is defined in § 226.2(a)(11), 

that enters into a loan that is a covered 

transaction and also enters into another 

loan (e.g., second-lien covered 

transaction or HELOC) secured by the 

same dwelling. This comment further 

explains that where two or more 

consumers enter into a legal obligation 

that is a covered transaction, but only 

one of them enters into another loan 

secured by the same dwelling, the ‘‘same 

consumer’’ includes the person that has 

entered into both legal obligations. This 

proposed comment provides the 

following illustrative example: Assume 

Consumer A and Consumer B will both 

enter into a legal obligation that is a 

covered transaction with a creditor. 

Immediately prior to consummation of 

the covered transaction, Consumer B 

opens a HELOC that is secured by the 

same dwelling with the same creditor; 

Consumer A is not a signatory to the 

HELOC. For purposes of the definition 

of ‘‘simultaneous loan,’’ Consumer B is 

the same consumer and the creditor 

must include the HELOC as a 

simultaneous loan. The Board believes 

this comment reflects statutory intent to 

include any loan that could impact the 

consumer’s ability to repay the covered 

transaction according to its terms (i.e., 

to require the creditor to consider the 

combined payment obligations of the 

consumer(s) obligated to repay the 

covered transaction). See TILA 

129C(a)(2). 

The term ‘‘simultaneous loan’’ appears 

in the following provisions: (1) 

Proposed § 226.43(c)(2)(iv), which 

implements the requirement under 

TILA § 129C(a)(2) that a creditor 

consider a consumer’s monthly payment 

obligation on a simultaneous loan that 

the creditor ‘‘knows or has reason to 

know’’ will be made to the consumer; (2) 

proposed § 226.43(c)(6), which 

addresses the payment calculations for 

a simultaneous loan for purposes of 

proposed § 226.43(c)(2)(iv); and (3) 

proposed Alternative 2— 

§ 226.43(e)(2)(v)(C), which requires the 

creditor to consider a simultaneous loan 

as a condition to meeting the definition 

of a qualified mortgage. 

43(b)(13) Third-Party Record 

TILA Section 129C(a)(1) requires that 

creditors determine a consumer’s 

repayment ability using ‘‘verified and 

documented information,’’and TILA 

Section 129C(a)(4) specifically requires 

verifying a consumer’s income or assets 

relied on to determine repayment ability 

using a consumer’s tax return or ‘‘thirdparty documents’’ that provide 

reasonably reliable evidence of the 

consumer’s income or assets, as 

discussed in detail below in the sectionby-section analysis of proposed 

§ 226.43(c)(3) and (4). The Board 

believes that in general creditors should 

rely on reasonably reliable records 

prepared by a third party to verify 

repayment ability under TILA Section 

129C(a), consistent with verification 

requirements under the Board’s 2008 

HOEPA Final Rule. See 

§ 226.34(a)(4)(ii). However, the Board 

believes that in some cases a record 

prepared by the creditor for a covered 

transaction can provide reasonably 

reliable evidence of a consumer’s 

repayment ability, such as a creditor’s 

records regarding a consumer’s savings 

account held by the creditor or 

employment records for a consumer 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
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employed by the creditor. Further, TILA 

Section 129C(a)(4) allows creditors to 

use a consumer-prepared tax return to 

verify the consumer’s income or assets. 

Proposed § 226.43(b)(13) therefore 

would define the term ‘‘third-party 

records’’ to include certain records 

prepared by the consumer or creditor, 

for consistency and simplicity in 

implementing verification requirements 

under TILA Sections 129C(a)(1) and (4). 

Proposed § 226.43(b)(13) provides that 

‘‘third-party record’’ means: (1) A 

document or other record prepared or 

reviewed by a person other than the 

consumer, the creditor, any mortgage 

broker, as defined in § 226.36(a)(2), or 

any agent of the creditor or mortgage 

broker; (2) a copy of a tax return filed 

with the Internal Revenue Service or a 

state taxing authority; (3) a record the 

creditor maintains for an account of the 

consumer held by the creditor; or (4) if 

the consumer is an employee of the 

creditor or the mortgage broker, a 

document or other record regarding the 

consumer’s employment status or 

income. See proposed 

§ 226.43(b)(13)(i)–(iv). 

Proposed comment 43(b)(13)–1 

clarifies that third party records include 

records transmitted or viewed 

electronically, for example, a credit 

report prepared by a consumer reporting 

agency and transmitted or viewed 

electronically. Proposed comment 

43(b)(13)–2 explains that a third-party 

record includes a form a creditor 

provides to a third party for providing 

information, even if the creditor 

completes parts of the form unrelated to 

the information sought. Proposed 

comment 43(b)(13)–2 provides an 

example where the creditor gives the 

consumer’s employer a form for 

verifying the consumer’s employment 

status and income and clarifies that the 

creditor may fill in the creditor’s name 

and other portions of the form unrelated 

to the consumer’s employment status or 

income. Proposed comment 

43(b)(13)(i)–1 clarifies that a third-party 

record includes a document or other 

record prepared by the consumer, the 

creditor, the mortgage broker, or an 

agent of the creditor or mortgage broker, 

if the record is reviewed by a third 

party. For example, a profit-and-loss 

statement prepared by a self-employed 

consumer and reviewed by a third-party 

accountant is a third-party record under 

§ 226.43(b)(13)(i). Finally, proposed 

comment 43(b)(13)(iii)–1 clarifies that a 

third-party record includes a record the 

creditor maintains for an account of the 

consumer held by the creditor, and 

provides the examples of checking 

accounts, savings accounts, and 

retirement accounts. Proposed comment 

43(b)(13)(iii)–1 also provides the 

example of a creditor’s records for an 

account related to a consumer’s 

outstanding obligations to the creditor, 

such as the creditor’s records for a firstlien mortgage to a consumer who 

applies for a subordinate-lien home 

equity loan. 

43(c) Repayment Ability 

TILA Section 129C(a)(1) provides that 

no creditor may make a residential 

mortgage loan unless the creditor makes 

a reasonable and good faith 

determination that, at the time the loan 

is consummated, the consumer has a 

reasonable ability to repay the loan 

according to its terms and all applicable 

taxes, insurance, and assessments. TILA 

Section 129C(a)(2) provides that if a 

creditor knows or has reason to know 

that one or more residential mortgage 

loans secured by the dwelling that 

secures the covered transaction will be 

made to the same consumer, the creditor 

must make a reasonable and good faith 

determination that the consumer has a 

reasonable ability to repay the other 

loan(s) and all taxes, insurance, and 

assessments applicable to the other 

loan(s). TILA Section 129C(a)(3) 

provides that to determine the 

consumer’s repayment ability creditors 

must consider: The consumer’s (1) 

credit history; (2) current income and 

reasonably expected income; (3) current 

obligations; (4) debt-to-income ratio or 

the residual income the consumer will 

have after paying non-mortgage debt 

and mortgage-related obligations; (5) 

employment status; and (6) financial 

resources other than the consumer’s 

equity in the dwelling that secures 

repayment of the loan. Further, creditors 

must base their determination of the 

consumer’s repayment ability on 

verified and documented information. 

Finally, TILA Section 129C(a)(3) 

provides that creditors must use a 

payment schedule that fully amortizes 

the loan over the loan term in 

determining the consumer’s repayment 

ability. These TILA provisions are 

substantially similar to the repayment 

ability requirements under the Board’s 

2008 HOEPA Final Rule. See 

§ 226.34(a)(4), 226.35(b)(1). 

Proposed § 226.43(c) would 

implement TILA Section 129C(a)(1)–(3) 

and is substantially similar to those 

provisions. Specifically, proposed 

§ 226.43(c) provides that a creditor: 

• Must not make a covered transaction 

unless the creditor makes a 

reasonable and good faith 

determination at or before 

consummation that the consumer 

will have a reasonable ability, at the 

time of consummation, to repay the 

loan according to its terms, 

including any mortgage-related 

obligations; 

• Must make the repayment ability 

determination by considering the 

consumer’s: 

Æ Current or reasonably expected 

income or assets other than the 

value of the dwelling, or of any real 

property to which the dwelling is 

attached, that secures the loan; 

Æ Employment status, if the creditor 

relies on income from the 

consumer’s employment in 

determining repayment ability; 

Æ Monthly payment on the covered 

transaction; 

Æ Monthly payment on any 

simultaneous loan that the creditor 

knows or has reason to know will 

be made; 

Æ Monthly payment for mortgagerelated obligations; 

Æ Current debt obligations; 

Æ Monthly debt-to-income ratio or 

residual income; and 

Æ Credit history; and 

• Must verify a consumer’s repayment 

ability using reasonably reliable 

third-party records. 

Proposed comment 43(c)–1 clarifies 

that, to evaluate a consumer’s 

repayment ability, creditors may look to 

widely accepted governmental or nongovernmental underwriting standards, 

such as the Federal Housing 

Administration’s Handbook on 

Mortgage Credit Analysis for Mortgage 

Insurance on One-to-Four Unit Mortgage 

Loans. Proposed comment 43(c)–1 

states, for example, that creditors may 

use such standards in determining: (1) 

Whether to classify particular inflows, 

obligations, or property as ‘‘income,’’ 

‘‘debt,’’ or ‘‘assets’’; (2) factors to consider 

in evaluating the income of a selfemployed or seasonally-employed 

consumer; and (3) factors to consider in 

evaluating the credit history of a 

consumer who has obtained few or no 

extensions of traditional ‘‘credit,’’ as 

defined in § 226.2(a)(14). Proposed 

comment 43(c)–1 is consistent with, but 

broader than, current commentary on 

determining a consumer’s debt-toincome ratio to meet the presumption of 

compliance with the repayment ability 

requirement of the Board’s 2008 HOEPA 

Final Rule. See § 226.34(a)(4)(iii)(C), 

226.35(b)(1). Currently, comment 

34(a)(4)(iii)(C)–1 states that creditors 

may look to widely accepted 

underwriting standards to determine 

whether to classify particular inflows or 

obligations as ‘‘income’’ or ‘‘debt.’’ 

The Board’s proposed rule provides 

flexibility in underwriting standards so 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27420 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

that creditors may adapt their 

underwriting processes to a consumer’s 

particular circumstances, such as to the 

needs of self-employed consumers and 

consumers heavily dependent on 

bonuses and commissions, consistent 

with the Board’s 2008 HOEPA Final 

Rule. See 73 FR 44522, 44547, July 30, 

2008. For example, the proposed rule 

does not prescribe: How many years of 

tax returns or other information a 

creditor must consider to determine the 

consumer’s repayment ability; which 

income figure on tax returns creditors 

must use; the elements of credit history 

to be considered, such as late payments 

or bankruptcies; the way in which to 

verify credit history, such as by using a 

tri-merge report or records of rental 

payments; or a specific maximum debtto-income ratio or the compensating 

factors to allow a consumer to exceed 

such a ratio. The Board believes such 

flexibility is necessary because the rule 

would cover such a wide variety of 

consumers and mortgage products. 

Removal of § 226.34(a)(4) and 

226.35(b)(1). Repayment ability 

requirements under TILA Section 

129C(a) apply to all dwelling-secured 

consumer credit transactions, other than 

HELOCs, reverse mortgages, temporary 

or ‘‘bridge’’ loans with a loan term of 12 

months or less, and timeshare 

transactions, as discussed in detail 

above in the section-by-section analysis 

of proposed § 226.43(a). Accordingly, 

the Board proposes to implement TILA 

Section 129C in a new § 226.43 and 

remove requirements to consider 

repayment ability for high-cost 

mortgages under § 226.34(a)(4) and for 

higher-priced mortgage loans under 

§ 226.35(b)(1), as discussed in detail 

above in the section-by-section analysis 

of § 226.34 and 226.35. 

43(c)(1) General Requirement 

Proposed § 226.43(c)(1) would 

implement TILA Section 129C(a)(1) and 

provides that no creditor may make a 

covered transaction unless the creditor 

makes a reasonable and good faith 

determination at or before 

consummation that the consumer will 

have a reasonable ability, at the time of 

consummation, to repay the covered 

transaction according to its terms, 

including any mortgage-related 

obligations. Proposed comment 

43(c)(1)–1 clarifies that a change in the 

consumer’s circumstances after 

consummation (for example, a 

significant reduction in income due to 

a job loss or a significant obligation 

arising from a major medical expense) 

that is not reflected in the consumer’s 

application or the records used to 

determine repayment ability is not 

relevant to determining a creditor’s 

compliance with the rule. However, 

proposed comment 43(c)(1)–1 states 

further that if such application or 

records state there will be a change in 

the consumer’s repayment ability after 

consummation (for example, if a 

consumer’s application states that the 

consumer plans to retire within twelve 

months without obtaining new 

employment or transition from full-time 

to part-time employment), the creditor 

must consider that information. 

Proposed comment 43(c)(1)–1 is 

substantially similar to current 

comment 34(a)(4)–5 adopted by the 

Board’s 2008 HOEPA Final Rule. 

Proposed comment 43(c)(1)–2 clarifies 

that proposed § 226.43(c)(1) does not 

require or permit the creditor to make 

inquiries prohibited by Regulation B, 12 

CFR part 202, consistent with current 

comment 34(a)(4)–7 adopted by the 

Board’s 2008 HOEPA Final Rule. 

43(c)(2) Basis for Determination 

TILA Section 129C(a)(3) provides that 

to determine a consumer’s repayment 

ability, creditors must consider a 

consumer’s credit history, current and 

reasonably expected income, current 

obligations, debt-to-income ratio or the 

residual income the consumer will have 

after paying non-mortgage debt and 

mortgage-related obligations, 

employment status, and ‘‘financial 

resources’’ other than the consumer’s 

equity in the dwelling or real property 

that secures repayment of the loan. 

TILA Section 129C(a)(3) also provides 

that creditors must determine 

repayment ability using a repayment 

schedule that fully amortizes the loan 

over the loan term. Proposed 

§ 226.43(c)(2) would implement the 

requirement to consider specific factors 

in determining repayment ability. 

Proposed § 226.43(c)(2) is substantially 

similar to TILA Section 129C(a)(3), 

except for some minor terminology 

changes, as discussed below. 

43(c)(2)(i) Income or Assets 

TILA Section 129C(a)(3) provides that 

in making the repayment ability 

determination, creditors must consider, 

among other factors, a consumer’s 

current income, reasonably expected 

income, and ‘‘financial resources’’ other 

than the consumer’s equity in the 

dwelling or real property that secures 

loan repayment. Furthermore, under 

TILA Section 129C(a)(9), creditors may 

consider the seasonality or irregularity 

of a consumer’s income in determining 

repayment ability. 

Proposed § 226.43(c)(2)(i) generally 

mirrors TILA Section 129C(a)(3) but 

differs in two respects. First, proposed 

§ 226.43(c)(2)(i) uses the term ‘‘assets’’ 

rather than ‘‘financial resources,’’ to 

conform with terminology used in other 

provisions under TILA Section 129C(a) 

and Regulation Z. See, e.g. TILA Section 

129C(a)(4) (requiring that creditors 

consider a consumer’s assets in 

determining repayment ability); 

§ 226.51(a) (requiring consideration of a 

consumer’s assets in determining a 

consumer’s ability to repay a credit 

extension under a credit card account). 

The Board believes the terms ‘‘financial 

resources’’ and ‘‘assets’’ are synonymous 

as used in TILA Section 129C(a), and 

the term ‘‘assets’’ is used throughout the 

proposal for consistency. 

Second, proposed § 226.43(c)(2)(i) 

provides that creditors may not look to 

the value of the dwelling that secures 

the covered transaction, instead of 

providing that creditors may not look to 

the consumer’s equity in the dwelling. 

The Board believes that TILA Section 

129C(a)(3) is intended to address the 

risk that creditors will consider the 

amount that could be obtained through 

a foreclosure sale of the dwelling, which 

may exceed the amount of the 

consumer’s equity in the dwelling. This 

approach is consistent with the Board’s 

2008 HOEPA Final Rule, which 

prohibits a creditor from extending 

credit ‘‘based on the value of the 

consumer’s collateral.’’ See 

§ 226.34(a)(4), 226.35(b)(1). The Board 

proposes this adjustment pursuant to its 

authority under TILA Section 105(a), 

which provides that the Board’s 

regulations may contain such additional 

requirements, classifications, 

differentiations, or other provisions, and 

may provide for such adjustments and 

exceptions for all or any class of 

transactions as in the Board’s judgment 

are necessary or proper to effectuate the 

purposes of TILA, prevent 

circumvention or evasion thereof, or 

facilitate compliance therewith. 15 

U.S.C. 1604(a). This approach is further 

supported by the Board’s authority 

under TILA Section 129B(e) to 

condition terms, acts or practices 

relating to residential mortgage loans 

that the Board finds necessary or proper 

to effectuate the purposes of TILA. 15 

U.S.C. 1639b(e). One of the purposes of 

TILA is to ‘‘assure that consumers are 

offered and receive residential mortgage 

loan on terms that reasonably reflect 

their ability to repay the loans.’’ TILA 

Section 129B(a)(2); 15 U.S.C. 

1629b(a)(2). The Board believes 

providing that creditors may not 

consider the value of the dwelling is 

proper to effectuate the purposes of 

TILA Section 129C(a) that creditors 

extend credit based on the consumer’s 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27421 

41The Talent Amendment is contained in the 

John Warner National Defense Authorization Act. 

See Public Law 109–364, 120 Stat. 2083, 2266, Oct. 

17, 2006; see also 72 FR 50580, 5088, Aug. 31, 2007 

(discussing the DoD database in a final rule 

implementing the Talent Amendment). Currently, 

the DoD database is available at https:// 

www.dmdc.osd.mil/appj/mla/. 

repayment ability rather than on the 

dwelling’s foreclosure value. See TILA 

Section 129B(a)(2). 

Proposed comment 43(c)(2)(i)–1 

clarifies that creditors may base a 

determination of repayment ability on 

current or reasonably expected income 

from employment or other sources, 

assets other than the dwelling that 

secures the covered transaction, or both. 

Proposed comment 43(c)(2)(i)–2 crossreferences proposed comment 43(a)–2 to 

clarify that the value of the dwelling 

includes the value of the real property 

to which the dwelling is attached, if the 

real property also secures the covered 

transaction. Proposed comment 

43(c)(2)(i)–1 also provides examples of 

types of income the creditor may 

consider, including salary, wages, selfemployment income, military or reserve 

duty income, tips, commissions, and 

retirement benefits; and examples of 

assets the creditor may consider, 

including funds in a savings or checking 

account, amounts vested in a retirement 

account, stocks, and bonds. The 

proposed comment is substantially 

similar to comment 34(a)(4)–6 adopted 

by the Board’s 2008 HOEPA Final Rule, 

but adds additional examples of income 

and assets to facilitate compliance. 

Proposed comment 43(c)(2)(i)–2 clarifies 

that if a creditor bases its determination 

of repayment ability entirely or in part 

on a consumer’s income, the creditor 

need consider only the income 

necessary to support a determination 

that the consumer can repay the covered 

transaction. For example, if a consumer 

earns income from a full-time job and a 

part-time job and the creditor 

reasonably determines that the 

consumer’s income from a full-time job 

is sufficient to repay the covered 

transaction, the creditor need not 

consider the consumer’s income from 

the part-time job. Further, the creditor 

need verify only the income (and assets) 

relied on to determine the consumer’s 

repayment ability, as discussed below in 

the section-by-section analysis of 

proposed § 226.43(c)(4). Proposed 

comment 43(c)(2)(i)–2 cross-references 

proposed comment 43(c)(4)–1, which is 

substantially similar to current 

comment 34(a)(4)(ii)–1, adopted by the 

Board’s 2008 HOEPA Final Rule. 

Expected income. TILA Section 

129C(a) provides that creditors must 

consider a consumer’s current and 

reasonably expected income to 

determine repayment ability. This is 

consistent with current § 226.34(a)(4), 

but commentary on § 226.34(a)(4) 

clarifies that creditors need consider a 

consumer’s reasonably expected income 

only if the creditor relies on such 

income in determining repayment 

ability. See comments 34(a)(4)(ii)–1, –3. 

The Board believes that the requirement 

to consider a consumer’s reasonably 

expected income under TILA Section 

129C(a) should be interpreted consistent 

with current § 226.34(a)(4), in light of 

the substantial similarity between the 

provisions. Accordingly, proposed 

§ 226.43(c)(2)(i) provides that creditors 

must consider a consumer’s current 

income or reasonably expected income. 

Proposed comment 43(c)(2)(i)–3 clarifies 

that the creditor may rely on the 

consumer’s reasonably expected income 

either in addition to or instead of 

current income. 

Proposed comment 43(c)(2)(i)–3 

further clarifies that if creditors rely on 

expected income, the expectation that 

the income will be available for 

repayment must be reasonable and 

verified with third-party records that 

provide reasonably reliable evidence of 

the consumer’s expected income. 

Proposed comment 43(c)(2)(i)–3 also 

gives examples of expected bonuses 

verified with documents demonstrating 

past bonuses, and expected salary from 

a job verified with a written statement 

from an employer stating a specified 

salary, consistent with current comment 

34(a)(4)(ii)–3 adopted by the Board’s 

2008 HOEPA Final Rule. As the Board 

stated in connection with the 2008 

HOEPA Final Rule, in some cases a 

covered transaction may have a likely 

payment increase that would not be 

affordable at the borrower’s income at 

the time of consummation. A creditor 

may be able to verify a reasonable 

expectation of an increase in the 

borrower’s income that will make the 

higher payment affordable to the 

borrower. See 73 FR 44522, 44544, July 

30, 2008. 

Seasonal or irregular income. TILA 

Section 129C(a)(9) provides that 

creditors may consider the seasonality 

or irregularity of a consumer’s income 

in determining repayment ability. 

Accordingly, proposed comment 

43(c)(2)(i)–4 clarifies that a creditor 

reasonably may determine that a 

consumer can make periodic loan 

payments even if the consumer’s 

income, such as self-employment 

income, is seasonal or irregular. 

Proposed comment 43(c)(2)(i)–4 states, 

for example, that if the creditor 

determines that the income a consumer 

receives a few months each year from 

selling crops is sufficient to make 

monthly loan payments when divided 

equally across 12 months, the creditor 

reasonably may determine that the 

consumer can repay the loan, even 

though the consumer may not receive 

income during certain months. 

Comment 43(c)(2)(i)–4 is consistent 

with current comment 34(a)(4)–6 

adopted by the Board’s 2008 HOEPA 

Final Rule but provides an example of 

seasonal or irregular income that is not 

employment income. 

43(c)(2)(ii) Employment Status 

TILA Section 129C(a)(3) requires that 

creditors consider a consumer’s 

employment status in determining the 

consumer’s repayment ability, among 

other requirements. Proposed 

§ 226.43(c)(2)(ii) implements this 

requirement and clarifies that creditors 

need consider a consumer’s 

employment status only if they rely on 

income from the consumer’s 

employment in determining repayment 

ability. Proposed comment 43(c)(2)(ii)–1 

states, for example, that if a creditor 

relies wholly on a consumer’s 

investment income to determine the 

consumer’s repayment ability, the 

creditor need not verify the consumer’s 

employment status. Proposed comment 

43(c)(2)(ii)–1 clarifies that employment 

may be full-time, part-time, seasonal, 

irregular, military, or self-employment. 

This comment is consistent with current 

comment 34(a)(4)–6 adopted by the 

Board’s 2008 HOEPA Final Rule. 

Employment status of military 

personnel. Creditors in general must 

verify information relied on to 

determine repayment ability using 

reasonably reliable third-party records 

but may verify employment status orally 

as long as they prepare a record of the 

oral information, as discussed below in 

the section-by-section analysis of 

proposed § 226.43(c)(3)(ii). Proposed 

comment 43(c)(2)(ii)–2 clarifies that 

creditors also may verify the 

employment status of military personnel 

using the electronic database 

maintained by the Department of 

Defense (DoD) to facilitate identification 

of consumers covered by credit 

protections provided pursuant to 10 

U.S.C. 987, also known as the ‘‘Talent 

Amendment.’’ 41 The Board solicits 

comment on whether additional 

flexibility in verifying the employment 

status of military personnel is necessary 

to facilitate compliance and whether 

comment 43(c)(2)(ii)–2 also should state 

that creditors may verify the 

employment status of a member of the 

military using a Leave and Earnings 

Statement. Is a Leave and Earnings 

Statement as reliable a means of 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27422 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

verifying the employment status of 

military personnel as using the 

electronic database maintained by the 

DoD? Is a Leave and Earnings Statement 

equally reliable for determining 

employment status for a civilian 

employee of the military as for a service 

member? 

The Board solicits comment on this 

approach, and on whether there are 

other specific employment situations for 

which additional guidance should be 

provided. 

43(c)(2)(iii) Monthly Payment on the 

Covered Transaction 

Proposed § 226.43(c)(2)(iii) would 

implement the requirements under 

TILA Section 129C(a)(1) and (3), in part, 

by requiring that the creditor consider 

the consumer’s monthly payment on the 

covered transaction, calculated in 

accordance with proposed § 226.43(c)(5) 

for purposes of determining the 

consumer’s repayment ability on a 

covered transaction. See proposed 

§ 226.43(c)(5) for a discussion of the 

proposed payment calculation 

requirements. Proposed comment 

43(c)(2)(iii)–1 would clarify that for 

purposes of the repayment ability 

determination, the creditor must 

consider the consumer’s monthly 

payment on a covered transaction that is 

calculated as required under proposed 

§ 226.43(c)(5), taking into account any 

mortgage-related obligations. This 

comment would also provide a crossreference to proposed § 226.43(b)(8) for 

the meaning of the term ‘‘mortgagerelated obligations.’’ 

43(c)(2)(iv) Simultaneous Loans 

Proposed § 226.43(c)(2)(iv) requires 

that the creditor consider the 

consumer’s monthly payment obligation 

on any simultaneous loan that the 

creditor knows or has reason to know 

will be made to the consumer. Proposed 

§ 226.43(c)(2)(iv) also requires that the 

consumer’s monthly payment obligation 

on the simultaneous loan be calculated 

in accordance with proposed 

§ 226.43(c)(6), which is discussed 

below. Proposed § 226.43(c)(2)(iv) 

implements TILA Section 129C(a)(2), 

which provides that ‘‘if a creditor 

knows, or has reason to know, that 1 or 

more residential mortgage loans secured 

by the same dwelling will be made to 

the same consumer, the creditor shall 

make a reasonable and good faith 

determination, based on verified and 

documented information, that the 

consumer has a reasonable ability to 

repay the combined payments of all 

loans on the same dwelling according to 

the terms of those loans and all 

applicable taxes, insurance (including 

mortgage guarantee insurance), and 

assessments.’’ As discussed under 

proposed § 226.43(b)(12), the Board is 

proposing to use its authority under 

TILA Sections 105(a) and 129B(e) to 

broaden the scope of TILA Section 

129C(a)(2) to include HELOCs, and 

define the term ‘‘simultaneous loan’’ 

accordingly, for purposes of the 

requirements under proposed 

§ 226.43(c)(2)(iv) and (c)(6). 15 U.S.C. 

1604(a). 

Proposed comment 43(c)(2)(iv)–1 

clarifies that for purposes of the 

repayment ability determination, a 

simultaneous loan includes any covered 

transaction or HELOC that will be made 

to the same consumer at or before 

consummation of the covered 

transaction and secured by the same 

dwelling that secures the covered 

transaction. This comment explains that 

a HELOC that is a simultaneous loan 

that the creditor knows or has reason to 

know about must be considered as a 

mortgage obligation in determining a 

consumer’s ability to repay the covered 

transaction, even though the HELOC is 

not a covered transaction subject to 

§ 226.43. To facilitate compliance, this 

comment cross-references proposed 

§ 226.43(a), which discusses the scope 

of the ability-to-repay provisions, 

proposed § 226.43(b)(12) for the 

meaning of the term ‘‘simultaneous 

loan,’’ and proposed comment 

43(b)(12)–2 for further explanation of 

the term ‘‘same consumer.’’ 

Proposed comment 43(c)(2)(iv)–2 

provides additional guidance regarding 

the standard ‘‘knows or has reason to 

know’’ for purposes of proposed 

§ 226.43(c)(2)(iv) and explains that, for 

example, where a covered transaction is 

a home purchase loan, the creditor must 

consider the consumer’s periodic 

payment obligation for any ‘‘piggyback’’ 

second-lien loan that the creditor knows 

or has reason to know will be used to 

finance part of the consumer’s down 

payment. This comment would provide 

that the creditor complies with this 

requirement where, for example, the 

creditor follows policies and procedures 

that show at or before consummation 

that the same consumer has applied for 

another credit transaction secured by 

the same dwelling. 

This proposed comment would 

provide the following illustrative 

example: Assume a creditor receives an 

application for a home purchase loan 

where the requested loan amount is less 

than the home purchase price. The 

creditor’s policies and procedures 

require the consumer to state the source 

of the downpayment. If the creditor 

determines the source of the 

downpayment is another extension of 

credit that will be made to the same 

consumer at consummation and secured 

by the same dwelling, the creditor 

knows or has reason to know of the 

simultaneous loan and must consider 

the simultaneous loan. Alternatively, if 

the creditor has information that 

suggests the downpayment source is the 

consumer’s income or existing assets, 

the creditor would be under no further 

obligation to determine whether a 

simultaneous loan will be extended at 

or before consummation of the covered 

transaction. 

Proposed comment 43(c)(2)(iv)–3 

clarifies the scope of timing and the 

meaning of the phrase ‘‘at or before 

consummation’’ with respect to 

simultaneous loans that the creditor 

must consider for purposes of proposed 

§ 226.43(c)(2)(iv). This comment would 

explain that a simultaneous loan 

includes a loan that comes into 

existence concurrently with the covered 

transaction subject to proposed 

§ 226.43(c). The comment would further 

state that, in all cases, a simultaneous 

loan does not include a credit 

transaction that occurs after 

consummation of the covered 

transaction subject to proposed 

§ 226.43(c). 

Proposed comment 43(c)(2)(iv)–4 

provides further guidance regarding 

verification of simultaneous loans. This 

comment would state that although a 

credit report may be used to verify 

current obligations, it will not reflect a 

simultaneous loan that has not yet been 

consummated or has just recently been 

consummated. This comment would 

explain that if the creditor knows or has 

reason to know that there will be a 

simultaneous loan extended at or before 

consummation, the creditor may verify 

the simultaneous loan by obtaining 

third-party verification from the thirdparty creditor of the simultaneous loan. 

The comment would provide, as an 

example, that the creditor may obtain a 

copy of the promissory note or other 

written verification from the third-party 

creditor in accordance with widely 

accepted governmental or nongovernmental standards. To facilitate 

compliance, the comment would crossreference proposed comments 43(c)(3)– 

1 and –2, which discuss verification 

using third-party records. Based on 

outreach, the Board believes it is 

feasible for creditors to obtain copies of 

promissory notes or other written 

verification from third-party creditors, 

but solicits comment on other examples 

the Board could provide to facilitate 

creditors’ compliance with the proposed 

verification requirement with respect to 

simultaneous loans. 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27423 

42See 2011 Escrow Proposal, 76 FR 11598, 11621, 

Mar. 2, 2011. 

The Board notes that proposed 

§ 226.43(c)(2)(iv) requires creditors to 

consider a simultaneous loan when 

assessing the consumer’s ability to repay 

a covered transaction, regardless of 

whether the simultaneous loan is made 

in connection with a purchase or nonpurchase covered transaction (i.e., 

refinancing). As discussed more fully 

below under proposed § 226.43(c)(6), 

which addresses payment calculation 

requirements for simultaneous loans, 

the Board recognizes that in the case of 

a non-purchase transaction, a 

simultaneous loan that is a HELOC is 

unlikely to be originated and drawn 

upon to provide payment towards the 

first-lien loan being refinanced, except 

perhaps towards closing costs. The 

Board is soliciting comment on whether 

it should narrow the requirement to 

consider simultaneous loans that are 

HELOCs to apply only to purchase 

transactions. See discussion under 

proposed § 226.43(c)(6) regarding 

payment calculations for simultaneous 

loans. 

43(c)(2)(v) Mortgage-Related Obligations 

Proposed § 226.43(c)(2)(v) implements 

the requirement under TILA Sections 

129C(a)(1)–(3) that the creditor 

determine a consumer’s repayment 

ability taking into account the 

consumer’s monthly payment for any 

mortgage-related obligations, based on 

verified and documented information as 

required under proposed § 226.43(c)(3). 

TILA Sections 129C(a)(1) and (2) require 

that the creditor determine a consumer’s 

repayment ability on a covered 

transaction based on verified and 

documented information, ‘‘according to 

[the loans’s] terms, and all applicable 

taxes, insurance (including mortgage 

guarantee insurance), and assessments.’’ 

TILA Section 129C(a)(3) further requires 

that a consumer’s debt-to-income ratio 

be considered as part of the repayment 

ability determination after allowing for 

‘‘non-mortgage debt and mortgagerelated obligations.’’ The Dodd-Frank 

Act does not define the term ‘‘mortgagerelated obligations.’’ As discussed in 

proposed § 226.43(b)(8), the Board 

proposes to use the term ‘‘mortgagerelated obligations’’ to refer to ‘‘all 

applicable taxes, insurance (including 

mortgage guarantee insurance), and 

assessments.’’ Proposed § 226.43(b)(8) 

would define the term ‘‘mortgage-related 

obligations’’ to mean property taxes; 

mortgage-related insurance premiums 

required by the creditor as set forth in 

proposed § 226.45(b)(1); 42 homeowner 

association, condominium, and 

cooperative fees; ground rent or 

leasehold payments; and special 

assessments. 

Proposed § 226.43(c)(2)(v) is generally 

consistent with the requirement under 

current § 226.34(a)(4) of the Board’s 

2008 HOEPA Final Rule that the 

creditor include mortgage-related 

obligations when determining the 

consumer’s repayment ability on the 

loan, except that § 226.34(a)(4) does not 

extend the verification requirement to 

mortgage-related obligations. In 

contrast, under proposed § 226.43(c)(3) 

creditors would need to verify mortgagerelated obligations for purposes of the 

repayment ability determination. See 

proposed § 226.43(c)(3) and associated 

commentary discussing the verification 

requirement generally. 

Proposed comment 43(c)(2)(v)–1 

states that the creditor must include in 

its repayment ability assessment the 

consumer’s mortgage-related 

obligations, such as the expected 

property taxes and premiums for 

mortgage-related insurance required by 

the creditor as set forth in proposed 

§ 226.45(b)(1). This comment would 

clarify, however, that creditors need not 

include mortgage-related insurance 

premiums that the creditor does not 

require, such as credit insurance or fees 

for optional debt suspension and debt 

cancellation agreements. This comment 

would also explain that mortgagerelated obligations must be included in 

the creditor’s determination of 

repayment ability regardless of whether 

the amounts are included in the 

monthly payment or whether there is an 

escrow account established. To facilitate 

compliance, this comment would crossreference proposed § 226.43(b)(8) for the 

meaning of the term ‘‘mortgage-related 

obligations.’’ 

As discussed more fully below under 

proposed § 226.43(c)(5), the Dodd-Frank 

Act provisions require creditors to 

determine the consumer’s ability to 

repay based on monthly payments, 

taking into account mortgage-related 

obligations. However, the Board 

recognizes that creditors will need to 

convert mortgage-related obligations 

that are not monthly to pro rata monthly 

amounts to comply with this proposed 

requirement. Thus, proposed comment 

43(c)(2)(v)–2 clarifies that, in 

considering mortgage-related obligations 

that are not paid monthly, the creditor 

may look to widely accepted 

governmental or non-governmental 

standards in determining the pro rata 

monthly payment amount. The Board 

solicits comment on operational 

difficulties creditors may encounter 

when complying with this ‘‘monthly’’ 

requirement, and whether additional 

guidance is necessary. 

Proposed comment 43(c)(2)(v)–3 

explains that estimates of mortgagerelated obligations should be based 

upon information that is known to the 

creditor at the time the creditor 

underwrites the mortgage obligation. 

This comment would further explain 

that information is known if it is 

‘‘reasonably available’’ to the creditor at 

the time of underwriting the loan, and 

would cross-reference current comment 

17(c)(2)(i)–1 for the meaning of 

‘‘reasonably available.’’ The Board 

believes it is appropriate to permit 

creditors to use estimates of mortgagerelated obligations because actual 

amounts may be unknown at the time of 

underwriting. For example, outreach 

participants confirmed that the current 

underwriting practice is to use estimates 

of property taxes because actual 

property tax amounts are typically 

unknown until consummation. 

Proposed comment 43(c)(2)(v)–3 further 

clarifies that for purposes of proposed 

§ 226.43(c), the creditor would not need 

to project potential changes, such as by 

estimating possible increases in taxes 

and insurance. 

Proposed comment 43(c)(2)(v)–4 

states that creditors must make the 

repayment ability determination 

required under proposed § 226.43(c) 

based on information verified from 

reasonably reliable records. This 

comment would explain that guidance 

regarding verification of mortgagerelated obligations can be found in 

proposed comments 43(c)(3)–1 and –2, 

which discuss verification using thirdparty records. The Board solicits 

comment on any special concerns 

regarding the requirement to document 

certain mortgage-related obligations, 

such as for ground rent or leasehold 

payments, or special assessments. The 

Board also solicits comment on whether 

it should provide, by way of example, 

that the HUD–1 or 1A, or a successor 

form, can serve as verification of certain 

mortgage-related obligations reflected 

therein (e.g., title insurance), where a 

legal obligation exists to complete the 

HUD–1 or 1A accurately. See 24 CFR 

3500.1 et seq. of Regulation X, which 

implements the Real Estate Settlement 

Procedures Act (RESPA), 15 U.S.C. 2601 

et seq. 

43(c)(2)(vi) Current Debt Obligations 

TILA Section 129C(a)(1) and (3) 

requires creditors to consider and verify 

‘‘current obligations’’ as part of the 

repayment ability determination. This 

new TILA provision is consistent with 

the 2008 HOEPA Final Rule, which 

prohibits creditors from extending 


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credit without regard to a consumer’s 

repayment ability, including a 

consumer’s current obligations, and 

requires creditors to verify the 

consumer’s current obligations. Sections 

226.34(a)(4) and (a)(4)(ii)(C), 

226.35(b)(1). In addition, current 

comment 34(a)(4)(iii)(C)–1 provides that 

creditors may look to widely accepted 

governmental and non-governmental 

underwriting standards in defining 

‘‘debt,’’ including, for example, those set 

forth in the Federal Housing 

Administration’s (FHA) handbook on 

Mortgage Credit Analysis for Mortgage 

Insurance on One- to Four-Unit 

Mortgage Loans. Finally, current 

comment 34(a)(4)(ii)(C)–1 provides that 

a credit report may be used to verify 

current obligations. If, however, a credit 

report does not reflect an obligation that 

a consumer has listed on an application, 

then the creditor is responsible for 

considering the obligation, but is not 

required to verify the existence or 

amount of the obligation through 

another source. If a creditor nevertheless 

verifies an obligation, the creditor must 

consider the obligation based on the 

information from the verified source. 

Proposed § 226.43(c)(2)(vi) 

implements TILA Section 129C(a)(1) 

and (3) and requires creditors to 

consider the consumer’s current debt 

obligations as part of the repayment 

ability determination. As discussed 

below, proposed § 226.43(c)(3) 

implements TILA Section 129C(a)(1) by 

requiring that a creditor verify a 

consumer’s repayment ability, which 

would include the consumer’s current 

debt obligations. 

Proposed comment 43(c)(2)(vi)–1 

clarifies that creditors may look to 

widely accepted governmental and nongovernmental underwriting standards in 

determining how to define ‘‘current debt 

obligations’’ and how to verify such 

obligations. For example, a creditor 

would be required to consider student 

loans, automobile loans, revolving debt, 

alimony, child support, and existing 

mortgages. To verify current debt 

obligations as required by § 226.43(c)(3), 

a creditor would be permitted, for 

instance, look to credit reports, student 

loan statements, automobile loan 

statements, credit card statements, 

alimony or child support court orders, 

and existing mortgage statements. This 

approach would parallel the 2008 

HOEPA Final Rule’s model for 

consideration and verification of income 

and would preserve flexibility for 

creditors. The Board solicits comment 

on this approach, and on whether more 

specific guidance should be provided. 

Proposed comment 43(c)(2)(vi)–2 

states that if a credit report reflects a 

current debt obligation that a consumer 

has not listed on the application, the 

creditor must consider the obligation. 

The credit report is deemed a 

reasonably reliable third-party record 

under § 226.43(b)(3). Consistent with 

commentary to the 2008 HOEPA Final 

Rule, the proposed comment further 

provides that if a credit report does not 

reflect a current debt obligation that a 

consumer has listed on the application, 

the creditor must consider the 

obligation. However, the creditor need 

not verify the existence or amount of the 

obligation through another source, as 

discussed in the section-by-section 

analysis for § 226.43(c)(3) below. If a 

creditor nevertheless verifies an 

obligation, the creditor must consider 

the obligation based on the information 

from the verified source. The Board 

solicits comment on the feasibility of 

requiring creditors independently to 

verify current debt obligations not 

reflected in the credit report that a 

consumer has listed on the application. 

Such a requirement would be consistent 

with TILA Section 129C(a)(1), which 

requires the repayment ability 

determination to be based on verified 

information. On the other hand, 

requiring creditors to verify these 

obligations may result in increased 

compliance and litigation costs without 

offsetting benefits. 

The Board solicits comment on three 

additional issues. First, the Board 

solicits comment on whether it should 

provide additional guidance on 

considering debt obligations that are 

almost paid off. For example, some 

underwriting standards limit the 

consideration of current debt obligations 

to recurring obligations extending 10 

months or more, and recurring 

obligations extending less than 12 

months if they affect the consumer’s 

repayment ability in the months 

immediately after consummation. 

Requiring creditors to consider debts 

that are almost paid off would advance 

safe and responsible lending, but may 

unduly limit access to credit. 

Second, the Board solicits comment 

on whether it should provide additional 

guidance on considering debt 

obligations that are in forbearance or 

deferral. For example, some 

underwriting standards do not include 

consideration of projected obligations 

deferred for at least 12 months, in 

particular student loans. Many 

creditors, however, consider all 

projected obligations. Permitting 

creditors not to consider debt 

obligations that are in forbearance or 

deferral may further limit access to 

credit, but may also run counter to safe 

and responsible lending. 

Finally, the Board solicits comment 

on whether it should provide guidance 

on consideration and verification of 

current debt obligations for joint 

applicants. The Board also solicits 

comment on whether the guidance 

should differ for non-occupant joint 

applicants and occupant joint 

applicants. 

43(c)(2)(vii) Debt-to-Income Ratio or 

Residual Income 

TILA Section 129C(a)(3) requires 

creditors, as part of the repayment 

ability determination, to consider the 

debt-to-income ratio or the residual 

income the consumer will have after 

paying mortgage-related obligations and 

current debt obligations. This new TILA 

provision is consistent with the Board’s 

2008 HOEPA Final Rule, in which a 

creditor is presumed to have complied 

with the repayment ability requirement 

if, among other things, the creditor 

‘‘assesses the consumer’s repayment 

ability taking into account at least one 

of the following: The ratio of total debt 

obligations to income, or the income the 

consumer will have after paying debt 

obligations.’’ Section 226.34(a)(4)(iii)(C), 

226.35(b)(1). In addition, comment 

34(a)(4)(iii)(C)–1 provides that creditors 

may look to widely accepted 

governmental and non-governmental 

underwriting standards in defining 

‘‘income’’ and ‘‘debt,’’ including, for 

example, those set forth in the Federal 

Housing Administration’s (FHA) 

handbook on Mortgage Credit Analysis 

for Mortgage Insurance on One- to FourUnit Mortgage Loans. 

Proposed § 226.43(c)(2)(vii) 

implements TILA Section 129C(a)(3) 

and requires creditors, as part of the 

repayment ability determination, to 

consider the consumer’s monthly debtto-income ratio, or residual income. 

Proposed comment 43(c)(2)(vii)–1 crossreferences § 226.43(c)(7) regarding the 

definitions and calculations for the 

monthly debt-to-income ratio and 

residual income. 

Consistent with the 2008 HOEPA 

Final Rule, TILA Section 129C(a)(3) 

requires creditors to consider either the 

consumer’s debt-to-income ratio or the 

consumer’s residual income. As in the 

2008 HOEPA Final Rule, the proposal 

provides creditors flexibility to 

determine whether using a debt-toincome ratio or residual income 

increases a creditor’s ability to predict 

repayment ability. If one of these 

metrics alone holds as much predictive 

power as the two together, as may be 

true of certain underwriting models at 

certain times, then requiring creditors to 

use both metrics could reduce access to 

credit without an offsetting increase in 


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consumer protection. 73 FR 44550, July 

30, 2008. Outreach conducted by Board 

staff also indicates that residual income 

appears not to be as widely used or 

tested as the debt-to-income ratio. 

43(c)(2)(viii) Credit History 

TILA Section 129C(a)(1) and (3) 

requires creditors to consider and verify 

credit history as part of the ability-torepay determination. Creditors must 

accordingly assess willingness to repay 

and not simply ability to repay. By 

contrast, the 2008 HOEPA Final Rule 

does not require consideration of credit 

history. 

Proposed § 226.43(c)(2)(vii) 

implements TILA Section 129C(a)(3) 

and requires creditors to consider the 

consumer’s credit history as part of the 

repayment ability determination. As 

discussed below, proposed 

§ 226.43(c)(3) implements TILA Section 

129C(a)(1) by requiring that a creditor 

verify a consumer’s repayment ability, 

which would include the consumer’s 

credit history. 

Proposed comment 43(c)(2)(viii)–1 

clarifies that creditors may look to 

widely accepted governmental and nongovernmental underwriting standards to 

define and verify ‘‘credit history.’’ For 

example, a creditor may consider factors 

such as the number and age of credit 

lines, payment history, and any 

judgments, collections, or bankruptcies. 

To verify credit history as required by 

§ 226.43(c)(3), a creditor may, for 

instance, look to credit reports from 

credit bureaus, or other nontraditional 

credit references contained in thirdparty documents, such as rental 

payment history or public utility 

payments. The Board solicits comment 

on this approach. 

43(c)(3) Verification Using Third-Party 

Records 

TILA Section 129C(a)(1) requires that 

creditors make a reasonable and good 

faith determination, based on ‘‘verified 

and documented information,’’ that a 

consumer has a reasonable ability to 

repay the covered transaction. The 

Board’s 2008 HOEPA Final Rule 

requires that creditors verify the 

consumer’s income or assets relied on to 

determine repayment ability and the 

consumer’s current obligations. See 

§ 226.34(a)(4)(ii)(A), (C). Thus, TILA 

Section 129C(a)(1) differs from the 

Board’s 2008 HOEPA Final Rule by 

requiring creditors to verify information 

relied on in considering each of the 

specific factors required to be 

considered under TILA Section 

129C(a)(3), which are discussed above 

in the section-by-section analysis of 

proposed § 226.43(c)(2). 

Proposed § 226.43(c)(3) would 

implement the general requirement to 

verify a consumer’s repayment ability 

under TILA Section 129C(a)(1) and 

requires that creditors verify a 

consumer’s repayment ability using 

reasonably reliable third-party records, 

with two exceptions. First, creditors 

may orally verify a consumer’s 

employment status, if they prepare a 

record of the oral employment status 

information. See proposed 

§ 226.43(c)(3)(i). The Board believes that 

creditors in general should use 

reasonably reliable third-party records 

to verify information they rely on to 

determine repayment ability, to 

document that independent information 

supports their determination. Based on 

outreach to several creditors and 

secondary market investors, however, 

the Board believes that allowing 

creditors to verify a consumer’s 

employment status orally may increase 

the efficiency of the process of verifying 

employment status without reducing the 

reliability of the information obtained. 

Over time, many creditors and 

secondary market investors have come 

to allow oral verification of employment 

status as long as the consumer’s 

employment income is verified using 

third-party records. The Board is not 

aware of a reduction in the reliability of 

employment status information as a 

result of the shift from written to oral 

verification of employment status. Also, 

some employers may prefer to orally 

verify a consumer’s employment status, 

for example, because of efficiency 

considerations or concerns about 

appearing to commit to continuing to 

employ the consumer. Proposed 

§ 226.43(c)(3)(ii) does not allow 

creditors to orally verify a consumer’s 

employment income, however. 

The second exception to the 

requirement to verify repayment ability 

using third-party records applies in 

cases where a creditor relies on a 

consumer’s credit report to verify a 

consumer’s current debt obligations, 

and the consumer’s application states a 

current debt obligation not shown in the 

consumer’s credit report. Under 

proposed § 226.43(c)(3)(ii), the creditor 

need not independently verify such 

current debt obligations. Proposed 

§ 226.43(c)(3)(ii) is consistent with 

current comment 34(a)(4)(ii)(C)–1 

adopted by the Board’s 2008 HOEPA 

Final Rule. 

Proposed comment 43(c)(3)–1 

explains that records used to verify a 

consumer’s repayment ability under 

proposed § 226.43(c)(1)(ii) must be 

specific to the individual consumer. 

Records regarding average incomes in 

the consumer’s geographic location or 

average incomes paid by the consumer’s 

employer, for example, would not be 

specific to the individual consumer and 

are not sufficient. Proposed comment 

43(c)(3)–2 explains that creditors may 

obtain third-party records from a thirdparty service provider, as long as the 

records are reasonably reliable and 

specific to the individual consumer. 

Creditors also may obtain third-party 

records, for example, payroll statements, 

directly from the consumer. Proposed 

comments 43(c)(3)–1 and –2 are 

consistent with current commentary and 

the supplementary information 

discussing how creditors may obtain 

records relied on to determine 

repayment ability under the Board’s 

2008 HOEPA Final Rule. See comments 

34(a)(4)(ii)(A)–1, –2, and –4; 73 FR 

44522, 44547, July 30, 2008 (‘‘Creditors 

may [* * *] rely on third party 

documentation the consumer provides 

directly to the creditor.’’) 

The Board solicits comment on 

whether any documents or records 

prepared by the consumer and not 

reviewed by a third party appropriately 

can be considered in determining 

repayment ability, for example, because 

a particular record provides information 

not obtainable using third-party records. 

In particular, the Board solicits 

comment on methods currently used to 

ensure that documents prepared by selfemployed consumers (such as a year-todate profit and loss statement for the 

period after the period covered by the 

consumer’s latest income tax return, or 

an operating income statement prepared 

by a consumer whose income includes 

rental income) are reasonably reliable 

for use in determining repayment 

ability. 

43(c)(4) Verification of Income or Assets 

TILA Section 129C(a)(4) requires that 

creditors verify amounts of income or 

assets relied upon to determine 

repayment ability by reviewing the 

consumer’s Internal Revenue Service 

(IRS) Form W–2, tax returns, payroll 

statements, financial institution records, 

or other third-party documents that 

provide reasonably reliable evidence of 

the consumer’s income or assets. TILA 

Section 129C(a)(4) provides further that, 

to safeguard against fraudulent 

reporting, creditors must consider either 

(1) IRS transcripts of tax returns or (2) 

an alternative method that quickly and 

effectively verifies third-party income 

documentation, subject to rules 

prescribed by the Board. TILA Section 

129C(a)(4) is substantially similar to 

§ 226.34(a)(4)(ii)(A), adopted by the 

Board’s 2008 HOEPA Final Rule. 

However, TILA Section 129C(a)(4)(B) 

provides for the alternative methods of 


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27426 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

third-party income documentation 

(other than use of an IRS tax-return 

transcript) to be both ‘‘reasonably 

reliable’’ and to ‘‘quickly and effectively’’ 

verify a consumer’s income. The Board 

proposes to adjust the requirement that 

such alternative method ‘‘quickly and 

effectively’’ verify a consumer’s income. 

See TILA Section 129C(a)(4)(B). 

Specifically, the Board proposes to 

implement TILA Section 129C(a)(4) 

without using the phrase ‘‘quickly and 

effectively’’ and instead to (1) require 

the use of third-party records that are 

reasonably reliable; and (2) provide 

examples of reasonably reliable records 

that creditors can use to efficiently 

verify income, as well as assets. See 

proposed § 226.43(c)(4). 

The Board proposes this approach 

pursuant to the Board’s authority under 

TILA Section 105(a) to prescribe 

regulations that contain such additional 

requirements, classifications, 

differentiations, or other provisions or 

provide for such adjustments and 

exceptions for all or any class of 

transactions as in the judgment of the 

Board are necessary or proper to 

effectuate the purposes of TILA, prevent 

circumvention or evasion thereof, or to 

facilitate compliance therewith. 15 

U.S.C. 1604(a). This approach is further 

supported by the Board’s authority 

under TILA Section 129B(e) to 

condition terms, acts or practices 

relating to residential mortgage loans 

that the Board finds necessary or proper 

to effectuate the purposes of TILA. 15 

U.S.C. 1639b(e). One of the purposes of 

TILA Section 129C is to assure that 

consumers are offered and receive 

covered transactions on terms that 

reasonably reflect their ability to repay 

the loan. See TILA Section 129B(a)(2). 

The Board believes that considering 

reasonably reliable records is an 

effective means of verifying a 

consumer’s income and helps ensure 

that consumers are offered and receive 

loans on terms that reasonably reflect 

their repayment ability. The Board 

believes further that TILA Section 

129C(a)(4) is intended to safeguard 

against fraudulent reporting, rather than 

to speed the process of verifying a 

consumer’s income. Indeed, there is a 

risk that requiring that creditors use 

quick methods to verify the consumer’s 

income would undermine the 

effectiveness of the ability-to-repay 

requirement by sacrificing speed for 

thoroughness. The Board believes that, 

by contrast, requiring the use of 

reasonably reliable records effectuates 

the purposes of TILA Section 129C(a)(4) 

without suggesting that creditors must 

obtain records or complete income 

verification within a specific period of 

time. The Board also believes that 

providing examples of reasonably 

reliable records creditors may use to 

efficiently verify income or assets 

facilitates compliance by providing 

clear guidance to creditors. In addition, 

providing examples of such records is 

consistent with TILA Section 

129C(a)(4)(B), which authorizes the 

Board to prescribe the types of records 

that can be used to quickly and 

effectively verify a consumer’s income. 

Proposed § 226.43(c)(4) implements 

TILA Section 129C(a)(4) and provides 

that a creditor must verify the amounts 

of income or assets it relies on to 

determine a consumer’s ability to repay 

a covered transaction using third-party 

records that provide reasonably reliable 

evidence of the consumer’s income or 

assets. The proposed rule and associated 

commentary provide the following 

examples of third-party records 

creditors may use to verify the 

consumer’s income or assets, in 

addition to or instead of tax-return 

transcripts issued by the IRS: (1) Copies 

of tax returns the consumer filed with 

the IRS or a state taxing authority; (2) 

IRS Form W–2s or similar IRS forms for 

reporting wages or tax withholding; (3) 

payroll statements, including military 

Leave and Earnings Statements; (4) 

financial institution records; (5) records 

from the consumer’s employer or a third 

party that obtained consumer-specific 

income information from the 

consumer’s employer; (6) records from a 

government agency stating the 

consumer’s income from benefits or 

entitlements, such as a ‘‘proof of 

income’’ letter issued by the Social 

Security Administration; (7) check 

cashing receipts; and (8) receipts from a 

consumer’s use of funds transfer 

services. See proposed § 226.43(c)(4)(i)– 

(viii); proposed comment 43(c)(4)(vi)–1. 

Those examples are illustrative, not 

exhaustive, and creditors may 

determine that other records provide 

reasonably reliable evidence of the 

income relied upon in determining a 

consumer’s repayment ability. 

Creditors need consider only the 

income or assets relied upon to 

determine the consumer’s repayment 

ability, as discussed above in the 

section-by-section analysis of proposed 

§ 226.43(c)(2)(i). See proposed comment 

43(c)(2)(i)–2. Accordingly, proposed 

comment 43(c)(4)–1 clarifies that 

creditors need verify only the income or 

assets relied upon to determine the 

consumer’s repayment ability. Proposed 

comment 43(c)(4)–1 also provides an 

example where the creditor need not 

verify a consumer’s annual bonus 

because the creditor relies on only the 

consumer’s salary to determine the 

consumer’s repayment ability. Proposed 

comment 43(c)(4)–2 clarifies that, if 

multiple consumers apply jointly for a 

loan and each lists income or assets on 

the application, the creditor need verify 

only the income or assets the creditor 

relies on to determine repayment 

ability. Proposed comment 43(c)(4)–3 

clarifies that creditors may verify a 

consumer’s income using an IRS taxreturn transcript that summarizes the 

information in the consumer’s filed tax 

return, another record that provides 

reasonably reliable evidence of the 

consumer’s income, or both. Proposed 

comment 43(c)(4)–3 also clarifies that 

creditors may obtain a copy of an IRS 

tax-return transcript or filed tax return 

from a service provider or the consumer 

and need not obtain the copy directly 

from the IRS or other taxing authority, 

and cross-references guidance on 

obtaining records in proposed comment 

43(c)(3)–2. Proposed comments 

43(c)(4)–1, –2, and –3 are consistent 

with current commentary adopted by 

the Board’s 2008 HOEPA Final Rule. 

See comments 34(a)(4)–7, 

34(a)(4)(ii)(A)–1 and –2. Proposed 

comment 43(c)(4)(vi)–1 clarifies that an 

example of a record from a Federal, 

state, or local government agency stating 

the consumer’s income from benefits or 

entitlements is a ‘‘proof of income letter’’ 

(also known as a ‘‘budget letter,’’ 

‘‘benefits letter,’’ or ‘‘proof of award 

letter’’) from the Social Security 

Administration. 

The Board generally solicits comment 

on this approach. In addition, the Board 

specifically solicits comment on 

whether, consistent with the Board’s 

2008 HOEPA Final Rule, the Board 

should provide an affirmative defense 

for a creditor that can show that the 

amounts of the consumer’s income or 

assets relied upon in determining the 

consumer’s repayment ability were not 

materially greater than the amounts the 

creditor could have verified using thirdparty records at or before 

consummation. See § 226.34(a)(4)(ii)(B). 

43(c)(5) Payment Calculation 

Background 

Requirements of TILA Sections 

129C(a)(1), (3) and (6) 

The Board proposes § 226.43(c)(5) to 

implement the payment calculation 

requirements of TILA Section 129C(a), 

as enacted by Section 1411 of the DoddFrank Act. TILA Section 129C(a) 

contains the general requirement that a 

creditor determine the consumer’s 

‘‘ability to repay the loan, according to 

its terms, and all applicable taxes, 

insurance (including mortgage 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27427 

guarantee insurance), and assessments,’’ 

based on several considerations, 

including ‘‘a payment schedule that 

fully amortizes the loan over the term of 

the loan.’’ TILA Sections 129C(a)(1) and 

(3). The statutory requirement to 

consider mortgage-related obligations, 

as defined under proposed 

§ 226.43(b)(8), is discussed above in the 

section-by-section analysis for proposed 

§ 226.43(c)(2)(v). 

TILA Sections 129C(a)(6)(A)–(D) also 

require creditors to make uniform 

assumptions when calculating the 

payment obligation for purposes of 

determining the consumer’s repayment 

ability for the covered transaction. 

Specifically, TILA Section 

129C(a)(6)(D)(i)–(iii) provides that when 

calculating the payment obligation that 

will be used to determine whether the 

consumer can repay the covered 

transaction, the creditor must use a fully 

amortizing payment schedule and 

assume that— 

(1) The loan proceeds are fully 

disbursed on the date the loan is 

consummated; 

(2) the loan is repaid in substantially 

equal, monthly amortizing payments for 

principal and interest over the entire 

term of the loan with no balloon 

payment; and 

(3) the interest rate over the entire 

term of the loan is a fixed rate equal to 

the fully-indexed rate at the time of the 

loan closing, without considering the 

introductory rate. 

The statute defines the term ‘‘fullyindexed rate’’ in TILA Section 

129C(a)(7). 

TILA Section 129C(a)(6)(D)(ii)(I) and 

(II), however, provides two exceptions 

to the second assumption regarding 

‘‘substantially equal, monthly payments 

over the entire term of the loan with no 

balloon payment’’ for loans that require 

‘‘more rapid repayment (including 

balloon payment).’’ First, this statutory 

provision authorizes the Board to 

prescribe regulations for calculating the 

payment obligation for loans that 

require more rapid repayment 

(including balloon payment), and which 

have an annual percentage rate that does 

not exceed a certain rate threshold. 

TILA Section 129C(a)(6)(D)(ii)(I). 

Second, for loans that ‘‘require more 

rapid repayment (including balloon 

payment),’’ and which exceed a certain 

rate threshold, the statute requires that 

the creditor use the loan contract’s 

repayment schedule. TILA Section 

129C(a)(6)(D)(ii)(II). The statute does not 

define the term ‘‘rapid repayment.’’ 

The statute also provides three 

additional clarifications to the 

assumptions stated above for loans that 

contain certain features. First, for 

variable-rate loans that defer repayment 

of any principal or interest, TILA 

Section 129C(a)(6)(A) states that for 

purposes of the repayment ability 

determination a creditor must use ‘‘a 

fully amortizing repayment schedule.’’ 

This provision generally reiterates the 

requirement provided under TILA 

Section 129C(a)(3) to use a payment 

schedule that fully amortizes the loan. 

Second, for covered transactions that 

permit or require interest-only 

payments, the statute requires that the 

creditor determine the consumers’ 

repayment ability using ‘‘the payment 

amount required to amortize the loan by 

its final maturity.’’ TILA Section 

129C(a)(6)(B). 

Third, for covered transactions with 

negative amortization, the statute 

requires the creditor to also take into 

account ‘‘any balance increase that may 

accrue from any negative amortization 

provision’’ when making the repayment 

ability determination. TILA Section 

129C(a)(6)(C). The statute does not 

define the terms ‘‘variable-rate,’’ ‘‘fully 

amortizing,’’ ‘‘interest-only,’’ or ‘‘negative 

amortization.’’ Proposed § 226.43(c)(5)(i) 

and (ii) implement these statutory 

provisions, and are discussed in further 

detail below. 

2008 HOEPA Final Rule 

TILA Section 129C(a), as enacted by 

Section 1411 of the Dodd-Frank Act, 

largely codifies many aspects of the 

repayment ability rule under 

§ 226.34(a)(4) of the Board’s 2008 

HOEPA Final Rule, which the Board is 

proposing to remove, and extends such 

requirements to the entire mortgage 

market regardless of the loan’s interest 

rate. Similar to § 226.34(a)(4), the 

statutory framework of TILA Section 

129C(a) focuses on prescribing the 

requirements that govern the 

underwriting process and extension of 

credit to consumers, rather than 

dictating which credit terms may or may 

not be permissible. However, there are 

differences between TILA Section 

129C(a) and the Board’s 2008 HOEPA 

Final Rule with respect to payment 

calculation requirements. 

Current § 226.34(a)(4) does not 

address how a creditor must calculate 

the payment obligation for a loan that 

cannot meet the presumption of 

compliance under § 226.34(a)(4)(iii)(B). 

For example, § 226.34(a)(4) does not 

specify how to calculate the periodic 

payment required for a negative 

amortization loan or balloon loan with 

a term of less than seven years. In 

contrast, the Dodd-Frank Act lays out a 

specific framework for underwriting any 

loan subject to proposed § 226.43(c). In 

taking this approach, the statutory 

requirements in TILA Section 

129C(a)(6)(D) addressing payment 

calculation requirements differ from 

§ 226.34(a)(4)(iii) in the following 

manner: (1) The statute generally 

premises repayment ability on monthly 

payment obligations calculated using 

the fully indexed rate, with no limit on 

the term of the loan that should be 

considered for such purpose; (2) the 

statute permits underwriting loans with 

balloon payments to differ depending 

on whether the loan’s annual percentage 

rate exceeds the applicable loan pricing 

metric, or meets or falls below the 

applicable loan pricing metric; and (3) 

the statute expressly addresses 

underwriting requirements for loans 

with interest-only payments or negative 

amortization. 

Interagency Supervisory Guidance 

As discussed above in Part II.C, in 

2006 and 2007 the Board and other 

Federal banking agencies addressed 

concerns regarding the increased risk to 

creditors and consumers presented by 

loans that permit consumers to defer 

repayment of principal and sometimes 

interest, and by adjustable-rate 

mortgages in the subprime market. The 

Interagency Supervisory Guidance 

stated that creditors should determine a 

consumer’s repayment ability using a 

payment amount based on the fully 

indexed rate, assuming a fully 

amortizing schedule. In addition, the 

2006 Nontraditional Mortgage Guidance 

addressed specific considerations for 

negative amortization and interest-only 

loans. State supervisors issued parallel 

statements to this guidance, which most 

states have adopted. TILA Sections 

129C(a)(3) and (6) are generally 

consistent with this longstanding 

Interagency Supervisory Guidance, and 

largely extend the guidance regarding 

payment calculation assumptions to all 

loan types covered under TILA Section 

129C(a), regardless of loan’s interest 

rate. 

The Board’s Proposal 

The Board proposes § 226.43(c)(5) to 

implement the payment calculation 

requirements of TILA Sections 

129C(a)(1), (3) and (6) for purposes of 

the repayment ability determination 

required under proposed § 226.43(c). 

Consistent with these statutory 

provisions, proposed § 226.43(c)(5) does 

not prohibit the creditor from offering 

certain credit terms or loan features, but 

rather focuses on the calculation process 

the creditor must use to determine 

whether the consumer can repay the 

loan according to its terms. Under the 

proposal, creditors generally would be 

required to determine a consumer’s 


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ability to repay a covered transaction 

using the fully indexed rate or the 

introductory rate, whichever is greater, 

to calculate monthly, fully amortizing 

payments that are substantially equal, 

unless a special rule applies. See 

proposed § 226.43(c)(5)(i). For clarity 

and simplicity, proposed 

§ 226.43(c)(5)(i) would use the terms 

‘‘fully amortizing payment’’ and ‘‘fully 

indexed rate,’’ as discussed above under 

proposed § 226.43(b)(2) and (3), 

respectively. Proposed comment 

43(c)(5)(i)-1 would clarify that the 

general rule would apply whether the 

covered transaction is an adjustable-, 

step-, or fixed-rate mortgage, as those 

terms are defined in § 226.18(s)(7)(i), 

(ii), and (iii), respectively. 

Proposed § 226.43(c)(5)(ii)(A)–(C) 

create exceptions to the general rule and 

provide special rules for calculating the 

payment obligation for balloon-payment 

loans, interest-only loans or negative 

amortization loans, as follows: 

Balloon-payment loans. Consistent 

with TILA Section 129C(a)(6)(D)(ii)(I) 

and (II) of the Dodd-Frank Act, 

proposed § 226.43(c)(5)(ii)(A) provides 

special rules for covered transactions 

with a balloon payment that would 

differ depending on the loan’s rate. 

Proposed § 226.43(c)(5)(ii)(A)(1) states 

that for covered transactions with a 

balloon payment that are not higherpriced covered transactions, the creditor 

must determine a consumer’s ability to 

repay the loan using the maximum 

payment scheduled in the first five 

years after consummation. Proposed 

§ 226.43(c)(5)(ii)(A)(2) further states that 

for covered transactions with balloon 

payments that are higher priced covered 

transactions, the creditor must 

determine the consumer’s ability to 

repay according to the loan’s payment 

schedule, including any balloon 

payment. For clarity, proposed 

§ 226.43(c)(5)(ii)(A) would use the term 

‘‘higher-priced covered transaction’’ to 

refer to a loan that exceeds the 

applicable loan rate threshold, and is 

defined in proposed § 226.43(b)(4), 

discussed above. The term ‘‘balloon 

payment’’ has the same meaning as in 

current § 226.18(s)(5)(i). 

Interest-only loans. Consistent with 

TILA Sections 129C(a)(6)(B) and (D) of 

the Dodd-Frank Act, proposed 

§ 226.43(c)(5)(ii)(B) provides special 

rules for interest-only loans. Proposed 

§ 226.43(c)(5)(ii)(B) requires that the 

creditor determine the consumer’s 

ability to repay the interest-only loan 

using (1) the fully indexed rate or the 

introductory rate, whichever is greater; 

and (2) substantially equal, monthly 

payments of principal and interest that 

will repay the loan amount over the 

term of the loan remaining as of the date 

the loan is recast. For clarity, proposed 

§ 226.43(c)(5)(ii)(B) would use the terms 

‘‘loan amount’’ and ‘‘recast,’’ which are 

defined and discussed under proposed 

§ 226.43(b)(5) and (11), respectively. 

The term ‘‘interest-only loan’’ has the 

same meaning as in current 

§ 226.18(s)(7)(iv). 

Negative amortization loans. 

Consistent with TILA Sections 

129C(a)(6)(C) and (D) of the Dodd-Frank 

Act, proposed § 226.43(c)(5)(ii)(C) 

provides special rules for negative 

amortization loans. Proposed 

§ 226.43(c)(5)(ii)(C) requires that the 

creditor determine the consumer’s 

ability to repay the negative 

amortization loan using (1) the fully 

indexed rate or the introductory rate, 

whichever is greater; and (2) 

substantially equal, monthly payments 

of principal and interest that will repay 

the maximum loan amount over the 

term of the loan remaining as of the date 

the loan is recast. Proposed comment 

43(c)(5)(ii)(C)–1 clarifies that for 

purposes of this proposed rule, the 

creditor must first determine the 

maximum loan amount and the period 

of time that remains in the loan term 

after the loan is recast. For clarity, 

proposed § 226.43(c)(5)(ii)(C) would use 

the terms ‘‘maximum loan amount’’ and 

‘‘recast,’’ which are defined and 

discussed under proposed § 226.43(b)(7) 

and (11), respectively. The term 

‘‘negative amortization loan’’ has the 

same meaning as in current 

§ 226.18(s)(7)(v) and comment 

18(s)(7)(v)–1. 

Each of these proposed payment 

calculation provisions is discussed in 

greater detail below. 

43(c)(5)(i) General rule 

Proposed § 226.43(c)(5)(i) implements 

the payment calculation requirements in 

TILA Sections 129C(a)(3) and (6)(D)(i)– 

(iii), and states the general rule for 

calculating the payment obligation on a 

covered transaction for purposes of the 

ability-to-repay provisions. Consistent 

with the statute, proposed 

§ 226.43(c)(5)(i) provides that unless an 

exception applies under proposed 

§ 226.43(c)(5)(ii), a creditor must make 

the repayment ability determination 

required under proposed 

§ 226.43(c)(2)(iii) by using the greater of 

the fully indexed rate or any 

introductory interest rate, and monthly, 

fully amortizing payments that are 

substantially equal. That is, under this 

proposed general rule the creditor 

would calculate the consumer’s 

monthly payment amount based on the 

loan amount, and amortize that loan 

amount in substantially equal payments 

over the loan term, using the fully 

indexed rate. 

Proposed comment 43(c)(5)(i)–1 

would explain that the payment 

calculation method set forth in 

§ 226.43(c)(5)(i) applies to any covered 

transaction that does not have a balloon 

payment, or that is not an interest-only 

loan or negative amortization loan, 

whether it is a fixed-rate, adjustable-rate 

or step-rate mortgage. This comment 

would further explain that the payment 

calculation method set forth in 

§ 226.43(c)(5)(ii) applies to any covered 

transaction that is a loan with a balloon 

payment, interest-only loan, or negative 

amortization loan. To facilitate 

compliance, this comment would list 

the defined terms used in proposed 

§ 226.43(c)(5) and provide crossreferences to their definitions. 

The fully indexed rate or introductory 

rate, whichever is greater. Proposed 

§ 226.43(c)(5)(i)(A) implements the 

requirement in TILA Section 

129C(a)(6)(D)(iii) to use the fully 

indexed rate when calculating the 

monthly, fully amortizing payment for 

purposes of the repayment ability 

determination. Proposed 

§ 226.43(c)(5)(i)(A) would also provide 

that when creditors calculate the 

monthly, fully amortizing payment for 

adjustable-rate mortgages, they must use 

the introductory interest rate if it is 

greater than the fully indexed rate (i.e., 

a premium rate). In some adjustable-rate 

transactions, creditors may set an initial 

interest rate that is not determined by 

the index or formula used to make later 

interest rate adjustments. Typically, this 

initial rate charged to consumers is 

lower than the rate would be if it were 

determined by using the index plus 

margin, or formula (i.e., the fully 

indexed rate). However, an initial rate 

that is a premium rate is higher than the 

rate based on the index or formula. See 

proposed comment 43(c)(5)(i)–2. Thus, 

requiring creditors to use only the fully 

indexed rate would result in creditors 

underwriting loans that have a 

‘‘premium’’ introductory rate at a rate 

lower than the rate on which the 

consumer’s initial payments would be 

based. The Board believes requiring 

creditors to assess the consumer’s 

ability to repay on the initial higher 

payments better effectuates the statutory 

intent and purpose. 

The Board proposes to require 

creditors to underwrite the loan at the 

premium rate if greater than the fully 

indexed rate for purposes of the 

repayment ability determination using 

its authority under TILA Section 105(a). 

15 U.S.C. 1604(a). TILA Section 105(a), 

as amended by Section 1100A of the 

Dodd-Frank Act, authorizes the Board to 


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prescribe regulations to carry out the 

purposes of TILA and Regulation Z, to 

prevent circumvention or evasion, or to 

facilitate compliance. 15 U.S.C. 1604(a). 

This approach is further supported by 

the Board’s authority under TILA 

Section 129B(e) to condition terms, acts 

or practices relating to residential 

mortgage loans that the Board finds 

necessary or proper to effectuate the 

purposes of TILA. 15 U.S.C. 1639b(e). 

The stated purpose of TILA Section 

129C is to assure that consumers are 

offered and receive residential mortgage 

loans on terms that reasonably reflect 

their ability to repay the loan. TILA 

Section 129B(b), 15 U.S.C. 1639b. For 

the reasons discussed above, the Board 

believes requiring creditors to 

underwrite the loan to the premium rate 

for purposes of the repayment ability 

determination will help to ensure that 

the consumers are offered, and receive, 

loans on terms that reasonably reflect 

their ability to repay, and to prevent 

circumvention or evasion. 

Monthly, fully amortizing payments. 

For simplicity, proposed 

§ 226.43(c)(5)(i) uses the term ‘‘fully 

amortizing payment’’ to refer to the 

statutory requirements that a creditor 

use a payment schedule that repays the 

loan assuming that (1) the loan proceeds 

are fully disbursed on the date of 

consummation of the loan; and (2) the 

loan is repaid in amortizing payments 

for principal and interest over the entire 

term of the loan. See TILA Sections 

129C(a)(3) and (6)(D)(i)–(ii). As 

discussed above, proposed 

§ 226.43(b)(2) defines ‘‘fully amortizing 

payment’’ to mean a periodic payment of 

principal and interest that will fully 

repay the loan amount over the loan 

term. The terms ‘‘loan amount’’ and 

‘‘loan term’’ are defined in proposed 

§ 226.43(b)(5) and (b)(6), respectively, 

and discussed above. 

The statute also expressly requires 

that a creditor use ‘‘monthly amortizing 

payments’’ for purposes of the 

repayment ability determination. TILA 

Section 129C(6)(D)(ii). The Board 

recognizes that some loan agreements 

require consumers to make periodic 

payments with less frequency, for 

example quarterly or semi-annually. 

Proposed § 226.43(c)(5)(i)(B) does not 

dictate the frequency of payment under 

the terms of the loan agreement, but 

does require creditors to convert the 

payment schedule to monthly payments 

to determine the consumer’s repayment 

ability. Proposed comment 43(c)(5)(i)–3 

clarifies that the general payment 

calculation rules do not prescribe the 

terms or loan features that a creditor 

may choose to offer or extend to a 

consumer, but establishes the 

calculation method a creditor must use 

to determine the consumer’s repayment 

ability for a covered transaction. This 

comment explains, by way of example, 

that the terms of the loan agreement 

may require that the consumer repay the 

loan in quarterly or bi-weekly scheduled 

payments, but for purposes of the 

repayment ability determination, the 

creditor must convert these scheduled 

payments to monthly payments in 

accordance with § 226.43(c)(5)(i)(B). 

This comment would also explain that 

the loan agreement may not require the 

consumer to make fully amortizing 

payments, but for purposes of the 

repayment ability determination the 

creditor must convert any nonamortizing payments to fully amortizing 

payments. 

Substantially equal. Proposed 

comment 43(c)(5)(i)–4 provides 

additional guidance to creditors for 

determining whether monthly, fully 

amortizing payments are ‘‘substantially 

equal.’’ See TILA Section 

129C(a)(6)(D)(ii). This comment would 

state that creditors should disregard 

minor variations due to paymentschedule irregularities and odd periods, 

such as a long or short first or last 

payment period. The comment would 

explain that monthly payments of 

principal and interest that repay the 

loan amount over the loan term need 

not be equal, but that the monthly 

payments should be substantially the 

same without significant variation in the 

monthly combined payments of both 

principal and interest. Proposed 

comment 43(c)(5)(i)–4 further explains 

that where, for example, no two 

monthly payments vary from each other 

by more than 1% (excluding odd 

periods, such as a long or short first or 

last payment period), such monthly 

payments would be considered 

substantially equal for purposes of this 

proposal. The comment would further 

provide that, in general, creditors 

should determine whether the monthly, 

fully amortizing payments are 

substantially equal based on guidance 

provided in § 226.17(c)(3) (discussing 

minor variations), and § 226.17(c)(4)(i)– 

(iii) (discussing payment-schedule 

irregularities and measuring odd 

periods due to a long or short first 

period) and associated commentary. The 

Board solicits comment on operational 

difficulties that arise by ensuring 

payment amounts meet the 

‘‘substantially equal’’ condition. The 

Board also solicits comment on whether 

a 1% variance is an appropriate 

tolerance threshold. 

Examples of payment calculations. 

Proposed comment § 226.43(c)(5)(i)–5 

provides illustrative examples of how to 

determine the consumer’s repayment 

ability based on substantially equal, 

monthly, fully amortizing payments as 

required under proposed 

§ 226.43(c)(5)(i) for a fixed-rate, 

adjustable-rate and step-rate mortgage. 

For example, proposed comment 

43(c)(5)(i)–5.ii provides an illustration 

of the payment calculation for an 

adjustable-rate mortgage with a five-year 

discounted rate. The example first 

assumes a loan in an amount of 

$200,000 has a 30-year loan term. The 

loan agreement provides for a 

discounted interest rate of 6% that is 

fixed for an initial period of five years, 

after which the interest rate will adjust 

annually based on a specified index 

plus a margin of 3%, subject to a 2% 

annual periodic interest rate adjustment 

cap. The index value in effect at 

consummation is 4.5%; the fully 

indexed rate is 7.5% (4.5% plus 3%). 

See proposed comment 43(c)(5)(i)–5.ii. 

This proposed comment explains that 

even though the scheduled monthly 

payment required for the first five years 

is $1,199, for purposes of 

§ 226.43(c)(2)(iii) the creditor must 

determine the consumer’s ability to 

repay the loan based on a payment of 

$1,398, which is the substantially equal, 

monthly, fully amortizing payment that 

will repay $200,000 over 30 years using 

the fully indexed rate of 7.5%. 

The Board recognizes that, although 

consistent with the statute, the proposed 

framework would require creditors to 

underwrite certain loans, such as hybrid 

ARMs with a discounted rate period of 

five or more years (e.g., 5/1, 7/1, and 

10/1 ARMs) to a more stringent standard 

as compared to the underwriting 

standard set forth in proposed 

§ 226.43(e)(2)(v) for qualified mortgages. 

The Board believes this approach is 

consistent with the statute’s intent to 

ensure consumers can reasonably repay 

their loan, and that in both cases 

consumers’ interests are properly 

protected. See TILA Section 129B(a)(2), 

15 U.S.C. 1639b(a)(2). To meet the 

definition of a qualified mortgage, a loan 

cannot have certain risky terms or 

features, such as provisions that permit 

deferral of principal or a term that 

exceeds 30 years; no similar restrictions 

apply to loans subject to the ability-torepay standard. See proposed 

§ 226.43(e)(2)(i) and (ii). As a result, the 

risk of potential payment shock is 

diminished significantly for qualified 

mortgages. For this reason, the Board 

believes maintaining the more lenient 

statutory underwriting standard for 

loans that satisfy the qualified mortgage 

criteria will help to ensure that 

responsible and affordable credit 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27430 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

remains available to consumers. See 

TILA 129B(a)(2), 15 U.S.C. 1639b(a)(2). 

Requests for Comment 

Loan amount or outstanding principal 

balance. As noted above, proposed 

§ 226.43(c)(5)(i) is consistent with the 

statutory requirements regarding 

payment calculations for purposes of 

the repayment ability determination. 

The Board believes the intent of these 

statutory requirements is to prevent 

creditors from assessing the consumer’s 

repayment ability based on understated 

payment obligations, especially when 

risky features can be present on the 

loan. However, the Board is concerned 

that the statute, as implemented in 

proposed § 226.43(c)(5)(i), would 

require creditors to determine, in some 

cases, a consumer’s repayment ability 

using overstated payment amounts 

because the creditor must assume that 

the consumer repays the loan amount in 

substantially equal payments based on 

the fully indexed rate, regardless of 

when the fully indexed rate can take 

effect under the terms of the loan. The 

Board is concerned that this approach 

may restrict credit availability, even 

where consumers are able to 

demonstrate that they can repay the 

payment obligation once the fully 

indexed rate takes effect. 

For this reason, the Board solicits 

comment on whether it should exercise 

its authority under TILA Sections 105(a) 

and 129B(e) to provide that the creditor 

may calculate the monthly payment 

using the fully indexed rate based on 

the outstanding principal balance as of 

the date the fully indexed rate takes 

effect under the loan’s terms, instead of 

the loan amount at consummation. 15 

U.S.C. 1604(a). Under this approach, the 

creditor would determine the 

consumer’s repayment ability using the 

largest payment that could occur under 

the loan’s terms based on the fully 

indexed rate, rather than using monthly, 

fully amortizing payments that are 

substantially equal. For example, for 

loans with a significant introductory 

rate period of 7 years or longer, it may 

be reasonable for the creditor to 

underwrite the consumer by applying 

the fully indexed rate to the outstanding 

principal balance at the end of the 7 

year introductory period. To illustrate 

this approach (all amounts are 

rounded), assume an adjustable-rate 

mortgage in the amount of $200,000 

with a seven-year discounted rate of 

6.5%, after which the interest rate will 

adjust annually to the specified index 

plus a margin of 3%. The index value 

at consummation is 4.5%; the fully 

indexed rate is 7.5%. At the end of the 

seventh year (after the 84th monthly 

payment is credited), when the fully 

indexed rate takes effect, the 

outstanding principal balance is 

$180,832. Under this approach, the 

creditor could underwrite the loan 

based on the monthly payment of 

principal and interest of $1,377 to repay 

the outstanding principal balance of 

$180,832, instead of the monthly 

payment of $1,398 to repay the loan 

amount of $200,000. Such an approach 

would seem to be consistent with the 

purpose of TILA Section 129B(a)(2), 

which is to ensure the consumer can 

reasonably repay the loan according to 

its terms. 15 U.S.C. 1639b(a)(2). 

Step-rate mortgages. The Board also 

notes that for purposes of the repayment 

ability determination, a step-rate 

mortgage would be subject to the 

general payment calculation rule under 

proposed § 226.43(c)(5)(i), or the special 

rules under proposed § 226.43(c)(5)(ii), 

if it did not otherwise meet the 

definition of a ‘‘qualified mortgage.’’ See 

proposed comment 43(c)(5)(i)–1. As 

discussed in proposed § 226.43(b)(3), 

which defines the term ‘‘fully indexed 

rate’’ for purposes of the repayment 

ability determination, the proposed 

payment calculation requirements 

would require creditors to determine a 

consumer’s ability to repay a step-rate 

mortgage using the maximum rate that 

can occur at any time during the loan 

term. The Board notes that this 

approach is consistent with the 

requirement that the creditor give effect 

to the largest margin that can apply at 

any time during the loan term when 

determining the fully indexed rate. See 

TILA Section 129C(a)(6)(iii) and (7). 

However, the Board notes that by 

requiring creditors to use the maximum 

rate in a step-rate mortgage, the monthly 

payments used to determine the 

consumer’s repayment ability will be 

higher than the consumer’s actual 

maximum payment. 

The Board is concerned that this 

approach could restrict credit 

availability. The Board recognizes that 

this concern is also present for 

adjustable-rate mortgages, but notes that 

a step-rate product differs from an 

adjustable-rate mortgage in that future 

interest rate adjustments are known in 

advance and do not fluctuate over time 

in accordance with a market index. The 

Board believes this feature of a step-rate 

product could mitigate the payment 

shock risk to the consumer because the 

exact rate and payment increases would 

be disclosed to the consumer in 

advance, with no potential for the 

payment amounts to be greater 

depending on market conditions. 

On the other hand, the Board 

recognizes that a step-rate mortgage that 

does not have a balloon payment, and 

is not an interest-only or negative 

amortization loan, can meet the 

definition of a qualified mortgage if the 

other underwriting criteria required are 

also met. As a result, step-rate mortgages 

that would need to comply with the 

payment calculation rules under 

proposed § 226.43(c)(5) may be more 

likely to be loans that contain a risky 

feature. The Board solicits comment, 

and supporting data for alternative 

approaches, on whether it should 

exercise its authority under TILA 

Sections 105(a) and 129B(e) to provide 

an exception for step-rate mortgages 

subject to the payment calculation rules 

in proposed § 226.43(c)(5). For example, 

should the Board require that creditors 

underwrite the step-rate mortgage using 

the maximum rate in the first seven 

years, ten years, or some other 

appropriate time horizon? Should the 

Board similarly require that creditors 

underwrite an adjustable-rate mortgage 

using the maximum interest rate in the 

first seven years or some other 

appropriate time horizon that reflects a 

significant introductory rate period? 

Safe harbor to facilitate compliance. 

The Board recognizes that under this 

proposal, creditors must comply with 

multiple assumptions when calculating 

the particular payment for purposes of 

the repayment ability determination. 

For example, creditors would need to 

ensure that the monthly payment 

amounts are ‘‘substantially equal.’’ 

Creditors would also need to follow 

different payment calculation rules 

depending on the type of loan being 

underwritten (i.e., balloon-payment loan 

vs. a negative amortization loan), as 

discussed below under proposed 

§ 226.43(c)(5)(ii). The Board is 

concerned that the complexity attendant 

to the proposed payment calculation 

requirements may increase the potential 

for unintentional errors to occur, 

making compliance difficult, especially 

for small creditors that may be unable 

to invest in advanced technology or 

software needed to ensure payment 

calculations are compliant. At the same 

time, the Board notes that the intent of 

the statutory framework and this 

proposal is to ensure consumers are 

offered and receive loans on terms that 

they can reasonably repay. Thus, the 

Board solicits comment on whether it 

should exercise its authority under 

TILA Sections 105(a) and 129B(e) to 

provide a safe harbor for creditors that 

use the largest scheduled payment that 

can occur during the loan term to 

determine the consumer’s ability to 

repay to facilitate compliance with the 

requirements under proposed 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27431 

§ 226.43(c)(5)(i) and (ii). 15 U.S.C. 

1604(a). 

43(c)(5)(ii) Special Rules: Balloon, 

Interest-Only, and Negative 

Amortization Loans 

Proposed § 226.43(c)(5)(ii) creates 

exceptions to the general rule under 

proposed § 226.43(c)(5)(i), and provides 

special rules in proposed 

§ 226.43(c)(5)(ii)(A)–(C) for loans with a 

balloon payment, interest-only loans, 

and negative amortization loans, 

respectively, for purposes of the 

repayment ability determination 

required under proposed 

§ 226.43(c)(2)(iii). In addition to TILA 

Section 129C(a)(6)(D)(i)–(iii), proposed 

§ 226.43(c)(5)(ii)(A)–(C) implement 

TILA Sections 129C(a)(6)(B) and (C), 

and TILA Section 129C(a)(6)(D)(ii)(I)- 

(II). Each of these proposed special rules 

is discussed below. 

43(c)(5)(i)(A) Balloon Loans 

The statute provides an exception to 

the requirement that creditors determine 

a consumer’s repayment ability using 

substantially equal, monthly payments 

for loans that require ‘‘more rapid 

repayment (including balloon 

payment).’’ See TILA Section 

129C(a)(6)(D)(ii)(I) and (II). First, the 

statute authorizes the Board to prescribe 

regulations for calculating the payment 

obligation for loans that require more 

rapid repayment (including balloon 

payment), and which have an annual 

percentage rate that does not exceed the 

average prime offer rate for a 

comparable transaction by 1.5 or more 

percentage points for a first-lien 

transaction, and by 3.5 or more 

percentage points for a subordinate-lien 

transaction (i.e., a ‘‘prime’’ loan). See 

TILA Section 129C(a)(6)(D)(ii)(I). 

Second, for loans that ‘‘require more 

rapid repayment (including balloon 

payment),’’ and exceed the loan pricing 

threshold set forth (i.e., a ‘‘nonprime’’ 

loan), the statute requires that the 

creditor use the loan contract’s 

repayment schedule. See TILA Section 

129C(a)(6)(D)(ii)(II). The Board 

interprets these statutory provisions as 

authorizing the Board to prescribe 

special payment calculation rules for 

‘‘prime’’ balloon loans, as discussed 

more fully below. 

Scope. The scope of loans covered by 

the phrase ‘‘more rapid repayment 

(including balloon payment)’’ in TILA 

Section 129C(a)(6)(D)(ii) is unclear, and 

the statute does not define the term 

‘‘rapid repayment.’’ The Board interprets 

the use of the term ‘‘including,’’ which 

qualifies the phrase ‘‘more rapid 

repayment,’’ as meaning that balloon 

loans are covered, but that other loan 

types are also intended to be covered. 

The Board notes, however, that loans 

with a balloon payment actually require 

less rapid payment of principal and 

interest because the amortization period 

used is much longer than the term, 

thereby causing the balloon payment of 

principal and interest at maturity. Thus, 

the reference to the phrase ‘‘including 

balloon payment’’ makes it unclear 

whether the scope of this provision is 

meant to cover loans that permit, for 

example, consumers to make initial 

payments that are not fully amortizing, 

such as loans with negative 

amortization, but that later require 

larger payments of principal and 

interest, or other loan types. 

Outreach participants offered various 

interpretations of the phrase ‘‘more 

rapid repayment (including balloon 

payment).’’ Participants suggested that 

the loan types that could be covered by 

the phrase ‘‘more repaid repayment’’ 

could range from graduated payment 

mortgages and negative amortization 

loans (where initial payments do not 

cover principal and only some interest, 

and therefore higher payments of 

principal and interest are required once 

the loan recasts to require fully 

amortizing payments), to niche-market 

balloon-payment loans (where a series 

of balloon payments are required 

intermittently throughout the loan), to 

growth-equity mortgages (where the 

loan is paid in full earlier than the term 

used to calculate initial payments 

required under the payment schedule). 

The Board does not believe it is 

feasible for the phrase ‘‘more rapid 

repayment’’ to cover all these loan types 

given that each one has varying terms 

and features. Thus, the Board is 

proposing to use its authority under 

TILA Section 129C(a)(6)(D)(i)(I) only 

with respect to balloon loans. The Board 

solicits comment on the meaning of the 

phrase ‘‘more rapid repayment’’ and 

what loan products should be covered 

by this phrase. For example, the Board 

solicits comment on whether the phrase 

‘‘more rapid repayment’’ should include 

any loan where the payments of 

principal and interest are based on an 

amortization period that is shorter than 

the term of the loan during which 

scheduled payments are permitted. For 

example, a loan may amortize the loan 

amount over a 30-year period to 

determine monthly payment of interest 

during the first five years, but fully 

amortizing payments begin after five 

years, and therefore are amortized over 

a period of time that is shorter than the 

term of the loan (i.e., 25 years). The 

Board further solicits comment on the 

specific terms and features of loans that 

would result in ‘‘more rapid repayment.’’ 

Higher-priced covered transaction. 

The Board is proposing 

§ 226.43(c)(5)(i)(A)(1) and (2) to provide 

special payment calculation rules for a 

covered transaction with a balloon 

payment that would differ depending on 

whether the loan is or is not a higherpriced covered transaction. For 

purposes of proposed 

§ 226.43(c)(5)(i)(A), the Board would 

define ‘‘higher-priced covered 

transaction’’ to mean 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. See proposed 

§ 226.43(b)(4). 

As noted above under the proposed 

definition of higher-priced covered 

transaction, the Board recognizes that 

‘‘jumbo’’ loans typically carry a premium 

interest rate to reflect the increased 

credit risk and cost associated with 

lending larger loan amounts to 

consumers. Such loans are more likely 

to be considered ‘‘higher-priced covered 

transactions’’ and as a result, creditors 

would need to underwrite such loans 

using the loan’s payment schedule, 

including any balloon payment. See 

proposed § 226.43(c)(5)(i)(A)(2), 

discussed below. The Board is 

concerned that this would restrict credit 

availability for consumers in the 

‘‘jumbo’’ balloon market. Accordingly, 

the Board is soliciting comment on 

whether it should use its authority 

under TILA Sections 105(a) and 129B(e) 

to incorporate the special, separate 

coverage threshold of 2.5 percentage 

points for ‘‘jumbo loans’’ to permit more 

jumbo loans to benefit from the special 

payment calculation rule under 

proposed § 226.43(c)(5)(ii)(A)(1), and 

also to be consistent with proposed 

§ 226.45(a)(1), which implements rate 

thresholds for the proposed escrow 

account requirement and certain 

appraisal-related requirements. See 76 

FR 11598, Mar. 2, 2011; 75 FR 66554, 

Oct. 28, 2010. 

The Board further notes under 

proposed § 226.43(b)(4) that premium 

interest rates are typically required for 

loans secured by non-principal 

dwellings, such as vacation homes, 

which are covered by this proposal. 

Accordingly, the Board also solicits 

comment and supporting data on 

whether it should exercise its authority 

under TILA Sections 105(a) and 129B(e) 

to incorporate a special, separate 

coverage threshold to address loans 

secured by non-principal dwellings, and 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27432 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

what rate threshold would be 

appropriate for such loans. 

Proposed comment 43(c)(5)(ii)(A)–1 

clarifies that for higher-priced covered 

transactions with a balloon payment, 

the creditor must consider the 

consumer’s ability to repay the loan 

based on the payment schedule under 

the terms of the legal obligation, 

including any required balloon 

payment. This comment would explain 

that for loans with a balloon payment 

that are not higher-priced covered 

transactions, the creditor should use the 

maximum payment scheduled during 

the first five years of the loan following 

consummation. To facilitate 

compliance, the comment would crossreference to the definition of ‘‘balloon 

payment’’ in current § 226.18(s)(5)(i). 

43(c)(5)(ii)(A)(1) ‘‘Prime’’ Balloon Loans 

Proposed § 226.43(c)(5)(ii)(A)(1) 

requires a creditor to determine a 

consumer’s ability to repay a loan with 

a balloon payment using the maximum 

payment scheduled during the first five 

years after consummation where the 

loan is not a higher-priced covered 

transaction (i.e., a ‘‘prime’’ loan). This 

proposed rule would apply to ‘‘prime’’ 

loans with a balloon payment that have 

a term of five or more years. 

Legal authority. The Board proposes 

this approach using its authority under 

TILA Section 129C(a)(6)(D)(ii)(I), which 

authorizes the Board to prescribe 

regulations for ‘‘prime’’ balloon loans. In 

addition, TILA Sections 105(a) and 

129B(e) authorize the Board to prescribe 

regulations that are consistent with the 

purposes of TILA. 15 U.S.C. 1604(a); 15 

U.S.C. 1639b(e). One of the purposes of 

TILA is to ‘‘assure that consumers are 

offered and receive residential mortgage 

loan on terms that reasonably reflect 

their ability to repay the loans.’’ TILA 

Section 129B(a)(2); 15 U.S.C. 

1629b(a)(2). The Board believes 

proposing to require the creditor to use 

the largest payment that can occur 

during the first five years after 

consummation to determine repayment 

ability helps to ensure that consumers 

are offered and receive loans on terms 

that reasonably reflect their ability to 

repay the loan, and also facilitates 

compliance. 

First five years after consummation. 

For several reasons, the Board believes 

that five years is the appropriate time 

horizon for purposes of determining the 

consumer’s ability to repay a balloon 

loan. First, the Board believes this 

approach preserves credit choice for 

consumers interested in financing 

options that are based on interest rates 

more consistent with shorter-term 

maturities, and therefore typically less 

expensive than 30-year fixed-rate loans, 

but that may offer more stability than 

some adjustable-rate loans. Five-year 

balloon loans generally offer consumers 

a fixed rate for the entire term that is 

lower than the prevailing rate for a 30- 

year fixed. Consumers may choose this 

type of loan as short-term financing 

with the intent to refinance in the near 

future into a fully amortizing, longer 

term loan once the consumer’s personal 

finances, market rate conditions, or 

some other set of facts and 

circumstances improves. The Board 

believes that five years is a sufficient 

period of time for consumers to improve 

personal finances, for example, and that 

there is an increased likelihood that a 

consumer may refinance, move or 

relocate during such time frame. In 

contrast, as discussed in proposed 

§ 226.43(f)(1)(iv), balloon loans with 

terms less than five years, but with 

extended amortization periods, such as 

30 or more years, may prevent 

consumers from growing equity and 

therefore, likely present greater credit 

risk. 

Second, the Board notes that using the 

first five years after consummation to 

determine the consumer’s repayment 

ability on a ‘‘prime’’ balloon loan is 

consistent with other proposed 

repayment ability provisions, and 

therefore facilitates compliance. For 

example, proposed § 226.43(d)(5)(ii) and 

(e)(2)(iv) require the creditor to use the 

five-year period after consummation for 

purposes of the determining whether an 

exception applies to the repayment 

ability rules for certain refinancings, 

and when underwriting the loan to meet 

the qualified mortgage standard, 

respectively. The Board further notes 

that the five-year period under proposed 

§ 226.43(e)(2)(iv) implements the 

statutory requirement that creditors 

underwrite a loan, for purposes of the 

qualified mortgage standard, based on 

the maximum rate permitted during the 

first five years after consummation, and 

therefore, reflects the statutory intent 

that a five-year period is a reasonable 

period of time to repay a loan. See TILA 

Section 129(b)(2)(A)(v). 

Third, the Board also is proposing to 

require that balloon loans made by 

creditors in rural or underserved areas 

have a minimum five-year term to be 

considered qualified mortgages. See 

proposed § 226.43(f)(1), discussed 

below. The Board believes it is 

appropriate for all types of creditors to 

use the same loan term when 

determining a consumer’s ability to 

repay a balloon loan to create a more 

level playing field. The Board 

recognizes this concern may be 

mitigated in part by the proposed asset 

threshold requirement, see proposed 

§ 226.43(f)(1)(v)(D), but believes a 

consistent approach to underwriting 

balloon loans helps to prevent 

unintended consequences. For these 

reasons, the Board believes this 

approach preserves credit availability 

and choice of loan products that may 

offer more favorable terms to 

consumers, and also facilitates 

compliance. 

In developing the proposed approach 

for ‘‘prime’’ balloon loans, the Board 

considered several different alternatives. 

For example, the Board considered 

requiring the creditor to determine 

whether the consumer could refinance 

the loan before incurring the balloon 

payment, using a fully amortizing 

payment based on the then prevailing 

interest rate for a fixed-rate mortgage 

with a 30-year term. The Board also 

considered requiring the creditor to use 

a fully amortizing payment based on a 

rate that would be two times the 

contractual rate offered during the first 

five years of the loan with the balloon 

payment. The Board believes both 

approaches are speculative in nature, 

and that neither can accurately predict 

the interest rate that would be available 

to consumers at the time they may want 

to refinance. Moreover, the Board 

believes both approaches would likely 

overstate the consumer’s actual payment 

obligation for purposes of the repayment 

ability determination where, for 

example, the interest rate on a five-year 

balloon loan is typically lower than the 

rate offered on a 30-year fixed. For these 

reasons, the Board did not believe these 

approaches were appropriate. 

The Board notes that the proposed 

five-year horizon for purposes of 

determining the consumers repayment 

ability for a ‘‘prime’’ balloon loan does 

not parallel the time horizon used for 

balloon loans under the Board’s antisteering provisions regarding loan 

originator compensation. See 75 FR 

58509, Sept. 24, 2010. The Board’s antisteering rules prohibit a loan originator 

from steering or directing a consumer to 

a loan to earn more compensation, 

unless the transaction is in the 

consumer’s interest. See current 

§ 226.36(e). The Board provides a safe 

harbor for loan originators if certain 

conditions are met, including offering 

certain loan options to the consumer. 

One such loan option must be a loan 

with no risky features; a balloon 

payment that occurs in the first 7 years 

of the life of the loan is deemed a risky 

feature for this purpose. The Board 

believes the different approaches are 

warranted by the different purposes 

served by the respective rules. Although 

the anti-steering provisions help to 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27433 

ensure consumers’ are offered certain 

loan options for which they likely 

qualify, they are primarily intended to 

prevent loan originators from offering 

loan options with features that may not 

benefit the consumer, or that the 

consumer may not want or need, but 

which yield the loan originator greater 

compensation. In contrast, the proposed 

repayment ability provisions are meant 

to help ensure that the loan offered or 

chosen by the consumer has terms that 

the consumer can reasonably repay. 

The Board solicits comment on 

whether the five-year term is an 

appropriate time horizon, with 

supporting data for any alternative 

approaches. 

Proposed comment 

§ 226.43(c)(5)(ii)(A)(1)–2 provides 

further guidance to creditors on 

determining whether a balloon payment 

occurs in the first five years after 

consummation. This comment would 

clarify that in considering the 

consumer’s repayment ability for a 

balloon loan that is not a higher-priced 

covered transaction, the creditor must 

use the maximum payment scheduled 

during the first five years, or first 60 

months, of the loan after the date of 

consummation. This comment would 

provide an illustrative example that 

assumes a loan with a balloon payment 

due at the end of a five-year loan term 

is consummated on August 15, 2011. 

The first monthly payment is due on 

October 1, 2011. The first five years after 

consummation occurs on August 15, 

2016, with a balloon payment required 

on the due date of the 60th monthly 

payment, which is September 1, 2016. 

This comment would conclude that in 

this example, the creditor does not need 

to consider the balloon payment when 

determining the consumer’s ability to 

repay this loan. 

Proposed comment 43(c)(5)(ii)(A)(1)– 

3 addresses renewable balloon loans. 

This comment recognizes balloon loans 

that are not higher-priced covered 

transactions which provide an 

unconditional obligation to renew a 

balloon loan at the consumer’s option or 

obligation to renew subject to 

conditions within the consumer’s 

control. This comment would clarify 

that for purposes of the repayment 

ability determination, the loan term 

does not include the period of time that 

could result from a renewal provision. 

This comment would provide the 

following illustration to provide further 

clarification: Assume a 3-year balloon 

loan that is not a higher-priced covered 

transaction contains an unconditional 

obligation to renew for another three 

years at the consumer’s option. In this 

example, the loan term for the balloon 

loan is 3 years, and not the potential 6 

years that could result if the consumer 

chooses to renew the loan. Accordingly, 

the creditor must underwrite the loan 

using the maximum payment scheduled 

in the first five years after 

consummation, which includes the 

balloon payment due at the end of the 

3-year loan term. This comment would 

cross-reference proposed comment 

43(c)(5)(ii)(A).ii, which provides an 

example of how to determine the 

consumer’s repayment ability for a 3- 

year renewable balloon loan, and 

comment 17(c)(1)–11 for a discussion of 

renewable balloon payment loans. 

The Board recognizes that proposed 

comment 43(c)(5)(ii)(A)(1)–3 does not 

take the same approach as guidance 

contained in comment 17(c)(1)–11 

regarding treatment of renewable 

balloon loans for disclosure purposes, or 

with guidance contained in current 

comment 34(a)(4)(iv)–2 of the Board’s 

2008 HOEPA Final Rule. Current 

comment 17(c)(1)–11 states that 

creditors may make the required TILA 

disclosures based on a period of time 

that accounts for any unconditional 

obligation to renew (i.e., the payment 

amortization period), assuming the 

interest rate in effect at the time of 

consummation. Comment 34(a)(4)(iv)–2, 

which the Board is proposing to remove, 

provides that where the creditor is 

unconditionally obligated to renew the 

balloon loan, the full term resulting 

from such renewal is the relevant term 

for purposes of the exclusion of certain 

balloon-payment loans from the abilityto-repay presumption of compliance. 

Although the proposal differs from 

current guidance in Regulation Z, the 

Board believes this approach is 

appropriate for several reasons. First, 

the ability-to-repay provisions in the 

Dodd-Frank Act do not address 

extending the term of a balloon loan 

with an unconditional obligation to 

renew provision. Second, permitting 

short-term ‘‘prime’’ balloon loans to 

benefit from the special payment 

calculation rule when a creditor 

includes an unconditional obligation to 

renew, but retains the right to increase 

the interest rate at the time of renewal, 

would create a significant loophole in 

the balloon payment rules. Such an 

approach could frustrate the objective to 

ensure consumers obtain mortgages on 

affordable terms for a reasonable period 

of time because the interest rate could 

escalate within a short period of time, 

increasing the potential risk of payment 

shock to the consumer. This is 

particularly the case where no limits 

exist on the interest rate that the 

creditor can choose to offer to the 

consumer at the time of renewal. TILA 

Section 129B(a)(2), 15 U.S.C. 

1639b(a)(2), and TILA Section 

129C(b)(2)(A)(v). Moreover, the Board 

believes it would be speculative to posit 

the interest rate at the time of renewal 

for purposes of the repayment ability 

determination. Third, the guidance 

contained in comment 17(c)(1)–11 

regarding treatment of renewable 

balloon loans is to help ensure 

consumers are aware of their loan terms 

and avoid the uninformed use of credit, 

which differs from the stated purpose of 

this proposed provision which is to help 

ensure that consumers receive loans on 

terms that reasonably reflect their 

repayment ability. TILA Section 102(a), 

15 U.S.C. 1601(a)(2), and TILA Section 

129B(a)(2), 15 U.S.C. 1639b(a)(2). 

At the same time, the Board 

recognizes that small creditors with 

limited capital and reserves may use 

these short-term balloon loans with 

unconditional obligations to renew to 

hedge their market rate risk. Not treating 

renewable balloon loans in the same 

manner as comment 17(c)(1)–11 could 

restrict credit access to ‘‘prime’’ balloon 

loans. Accordingly, the Board solicits 

comment on whether creditors should 

be able to treat the loan term of a 

‘‘prime’’ balloon loan with an 

unconditional obligation to renew as 

extended by the renewal provision for 

purposes of proposed 

§ 226.43(c)(5)(ii)(A), subject to certain 

conditions. Specifically, the Board 

solicits comment on how to ensure 

consumers can reasonably repay the 

loan on its terms at the time of renewal. 

The Board further solicits comment on 

methods to address the risk of 

circumvention and potential payment 

shock risk to consumers where creditors 

are able to unilaterally increase the 

interest rate at the time of renewal. For 

example, should the Board permit loan 

terms to be extended by renewal 

provisions for purposes of proposed 

§ 226.43(c)(5)(ii)(A) when the creditor 

underwrites the ‘‘prime’’ balloon loan 

based on an average fully indexed rate 

for a comparable transaction? 

Proposed 226.43(c)(5)(ii)(A)(1)–4 

would provide several illustrative 

examples of how to determine the 

maximum payment scheduled during 

the first five years after consummation 

for loans with a balloon payment that 

are not higher-priced covered 

transactions. For example, this comment 

would illustrate the payment 

calculation rule for a balloon payment 

loan with a five-year loan term and 

fixed interest rate. This comment would 

assume that a loan provides for a fixed 

interest rate of 6%, which is below the 

APOR threshold for a comparable 

transaction, and thus the loan is not a 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27434 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

43See 12 CFR 226.18(s)(7)(iv), defining ‘‘interest 

only’’ to mean that under the terms of the legal 

obligation, one or more of the periodic payments 

may be applied solely to accrued interest and not 

to loan principal, and ‘‘interest-only loan’’ to mean 

a loan that permits interest-only payments. 

higher-priced covered transaction. The 

comment would further assume that the 

loan amount is $200,000, and that the 

loan has a five-year loan term but is 

amortized over 30 years. The loan is 

consummated on March 15, 2011, and 

the monthly payment scheduled for the 

first five years following consummation 

is $1,199, with the first monthly 

payment due on May 1, 2011. The first 

five years after consummation end on 

March 15, 2016. The balloon payment of 

$187,308 is required on the due date of 

the 60th monthly payment, which is 

April 1, 2016 (more than five years after 

consummation). See proposed comment 

226.43(c)(5)(ii)(A)(1)–4.iii. This 

comment explains that for purposes of 

§ 226.43(c)(2)(iii), the creditor must 

determine the consumer’s ability to 

repay the loan based on the monthly 

payment of $1,199, and need not 

consider the balloon payment of 

$187,308 due on April 1, 2016. 

43(c)(5)(ii)(A)(2) ‘‘Non-Prime’’ Balloon 

Loans 

Proposed § 226.43(c)(5)(ii)(A)(2) 

implements TILA Section 

129C(a)(6)(D)(ii)(II) and provides that for 

a higher-priced covered transaction, the 

creditor must determine the consumer’s 

ability to repay a loan with a balloon 

payment using the scheduled payments 

required under the terms of the loan, 

including any balloon payment. TILA 

Section 129C(a)(6)(D)(ii)(II) states that 

for loans that require more rapid 

repayment (including balloon payment), 

and which exceed the loan pricing 

threshold set forth, the creditor must 

underwrite the loan using the ‘‘[loan] 

contract’s repayment schedule.’’ The 

Board interprets the statutory 

requirement that the creditor use ‘‘the 

loan contract’s payment schedule’’ to 

mean that the creditor must use all 

scheduled payments under the terms of 

the loan needed to fully amortize the 

loan, consistent with the requirement 

under TILA Section 129C(a)(3). Payment 

of the balloon payment, either at 

maturity or during at any intermittent 

period, is necessary to fully amortize the 

loan. The proposed rule would apply to 

‘‘non-prime’’ loans with a balloon 

payment regardless of the length of the 

term or any contract provision that 

provides for an unconditional guarantee 

to renew. The Board is concerned that 

this approach could lessen credit choice 

for non-prime borrowers, restrict credit 

availability and negatively impact 

competition for this credit market. 

Accordingly, the Board solicits 

comment, with supporting data, on the 

impact of this approach for low-tomoderate income borrowers. In 

addition, under proposed § 226.43(c)(2), 

the creditor would be required to 

determine that the consumer has a 

reasonable ability to repay the loan, 

including the balloon payment, from 

current or reasonably expected income 

or assets other than the value of the 

dwelling. As a result, the creditor would 

not be able to consider the consumer’s 

ability to refinance the loan in order to 

pay, or avoid, the balloon payment. The 

Board requests comment on this 

approach. 

Proposed comment 

§ 226.43(c)(5)(ii)(A)(2)–5 provides an 

illustrative example of how to 

determine the consumer’s repayment 

ability based on the loan contract’s 

payment schedule, including any 

balloon payment, for higher-priced 

covered transactions with a balloon 

payment. This comment would provide 

an illustrative example for a balloon 

payment loan with a 10-year loan term; 

fixed interest rate. This comment would 

assume that the loan is a higher-priced 

covered transaction with a fixed interest 

rate of 7%. This comment would also 

assume that the loan amount is 

$200,000 and the loan has a 10-year 

loan term, but is amortized over 30 

years. This comment would state that 

the monthly payment scheduled for the 

first ten years is $1,331, with a balloon 

payment of $172,956. This comment 

would explain that for purposes of 

§ 226.43(c)(2)(iii), the creditor must 

consider the consumer’s ability to repay 

the loan based on the payment schedule 

that repays the loan amount, including 

the balloon payment of $172,956. 

43(c)(5)(i)(B) Interest-Only Loans 

For interest-only loans (i.e., loans that 

permit interest only payments for any 

part of the loan term), proposed 

§ 226.43(c)(5)(ii)(B) provides that the 

creditor must determine the consumer’s 

ability to repay the interest-only loan 

using (1) the fully indexed rate or any 

introductory rate, whichever is greater; 

and (2) substantially equal, monthly 

payments of principal and interest that 

will repay the loan amount over the 

term of the loan remaining as of the date 

the loan is recast. The proposed 

payment calculation rule for interestonly loans parallels the general rule 

proposed in § 226.43(c)(5)(i), except that 

proposed § 226.43(c)(5)(ii)(B)(2) requires 

a creditor to determine the consumer’s 

ability to repay the loan amount over 

the term that remains after the loan is 

recast, rather than requiring the creditor 

to use fully amortizing payments, as 

defined under proposed § 226.43(b)(2). 

Proposed § 226.43(c)(5)(ii)(B)(2) 

implements TILA Section 129C(a)(6)(B), 

which requires that the creditor 

determine the consumer’s repayment 

ability using ‘‘the payment amount 

required to amortize the loan by its final 

maturity.’’ For clarity, this proposed rule 

uses the term ‘‘recast,’’ which is defined 

for interest-only loans as the expiration 

of the period during which interest-only 

payments are permitted under the terms 

of the legal obligation. See proposed 

§ 226.43(b)(11). The statute does not 

define the term ‘‘interest-only.’’ For 

purposes of this proposal, the terms 

‘‘interest-only loan’’ and ‘‘interest-only’’ 

have the same meaning as in 

§ 226.18(s)(7)(iv).43

Interest-only loans typically provide a 

fixed introductory payment period, such 

as five or ten years, during which the 

consumer may make payments that pay 

only accrued interest, but no principal. 

When the interest-only period expires, 

the payment amount required under the 

terms of the loan is the principal and 

interest payment that will repay the 

loan amount over the remainder of the 

loan term. The Board interprets the 

statutory text in TILA Section 

129C(a)(6)(B) as requiring the creditor to 

determine the consumer’s ability to 

repay an interest-only loan using the 

monthly principal and interest payment 

amount needed to repay the loan 

amount once the interest-only payment 

period expires, rather than using, for 

example, an understated monthly 

principal and interest payment that 

would amortize the loan over its entire 

term, similar to a 30-year fixed 

mortgage. The proposed rule would 

apply to all interest-only loans, 

regardless of the length of the interestonly period. The Board believes this 

approach most accurately assesses the 

consumer’s ability to repay the loan 

once it begins to amortize; this is 

consistent with the approach taken for 

interest-only loans in the Interagency 

Supervisory Guidance. 

Proposed comment 43(c)(5)(ii)(B)–1 

would clarify that for loans that permit 

interest-only payments, the creditor 

must use the fully indexed rate or 

introductory rate, whichever is greater, 

to calculate the substantially equal, 

monthly payment of principal and 

interest that will repay the loan amount 

over the term of the loan remaining as 

of the date the loan is recast for 

purposes of the repayment ability 

determination. This comment would 

also clarify that under proposed 

§ 226.43(c)(5)(ii)(B), the relevant term of 

the loan is the period of time that 

remains after the loan is recast to 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27435 

44See the 2010 MDIA Interim Final Rule, 75 FR 

58470, Sept. 24, 2010, revised by 75 FR 81836, 

81840, Dec. 29, 2010, which defines the terms 

‘‘negative amortization’’ and ‘‘negative amortization 

loan.’’ The term ‘‘negative amortization’’ means 

payment of periodic payments that will result in an 

increase in the principal balance under the terms 

of the legal obligation. See § 226.18(s)(7)(v). 

require payments that will repay the 

loan amount. This comment would also 

explain that for a loan on which only 

interest and no principal has been paid, 

the loan amount will be the outstanding 

principal balance at the time of the 

recast. To facilitate compliance, this 

comment would cross-reference to 

proposed comments 43(b)(3)–1 through 

–5, which provide further guidance on 

determining the fully indexed rate on 

the transaction, and proposed comment 

43(c)(5)(i)–4, which provides further 

guidance on the meaning of 

‘‘substantially equal.’’ This comment 

would also provide cross-references to 

defined terms. 

Proposed comment 43(c)(5)(ii)(B)–2 

would provide illustrative examples for 

how to determine the consumer’s 

repayment ability based on substantially 

equal, monthly payments of principal 

and interest for interest-only loans. This 

comment would provide the following 

illustration of the payment calculation 

rule for a fixed-rate mortgage with 

interest-only payments for five years: A 

loan in an amount of $200,000 has a 30- 

year loan term. The loan agreement 

provides for a fixed interest rate of 7%, 

and permits interest-only payments for 

the first five years. The monthly 

payment of $1167 scheduled for the first 

five years would cover only the interest 

due. The loan is recast on the due date 

of the 60th monthly payment, after 

which the scheduled monthly payments 

increase to $1414, a monthly payment 

that repays the loan amount of $200,000 

over the 25 years remaining as of the 

date the loan is recast (300 months). For 

purposes of § 226.43(c)(2)(iii), the 

creditor must determine the consumer’s 

ability to repay the loan based on a 

payment of $1414, which is the 

substantially equal, monthly, fully 

amortizing payment that would repay 

$200,000 over the 25 years remaining as 

of the date the loan is recast using the 

fixed interest rate of 7%. 

43(c)(5)(i)(C) Negative Amortization 

Loans 

For negative amortization loans, 

proposed § 226.43(c)(5)(ii)(C) provides 

that a creditor must determine the 

consumer’s repayment ability using (1) 

the fully indexed rate or any 

introductory interest rate, whichever is 

greater; and (2) substantially equal, 

monthly payments of principal and 

interest that will repay the maximum 

loan amount over the term of the loan 

remaining as of the date the loan is 

recast. This proposed payment 

calculation rule for negative 

amortization loans parallels the general 

rule in proposed § 226.43(c)(5)(i), except 

that proposed § 226.43(c)(5)(ii)(C)(2) 

requires the creditor to use the monthly 

payment amount that repays the 

maximum loan amount over the term of 

the loan that remains after the loan is 

recast, rather than requiring the creditor 

to use fully amortizing payments, as 

defined under proposed § 226.43(b)(2). 

This proposed rule uses the terms 

‘‘maximum loan amount’’ and ‘‘recast,’’ 

which are defined and discussed under 

proposed § 226.43(b)(7) and (b)(11), 

respectively. Proposed 

§ 226.43(c)(5)(ii)(C)(2) implements the 

statutory requirement in TILA Section 

129C(a)(6)(C) that the creditor consider 

‘‘any balance increase that may accrue 

from any negative amortization 

provision when making the repayment 

ability determination.’’ The statute does 

not define the term ‘‘negative 

amortization.’’ 

Scope. The Board proposes that the 

term ‘‘negative amortization loan’’ have 

the same meaning as set forth in current 

§ 226.18(s)(7)(v) for purposes of the 

repayment ability determination. The 

Board recently amended 

§ 226.18(s)(7)(v) to clarify that the term 

‘‘negative amortization loan’’ covers a 

loan, other than a reverse mortgage 

subject to current § 226.33, that provides 

for a minimum periodic payment that 

covers only a portion of the accrued 

interest, resulting in negative 

amortization. As defined, the term 

‘‘negative amortization loan’’ does not 

cover other loan types that may have a 

negative amortization feature, but which 

do not permit the consumer multiple 

payment options, such as seasonal 

income loans.44 Accordingly, proposed 

§ 226.43(c)(5)(ii)(C) covers only loan 

products that permit or require 

minimum periodic payments, such as 

pay option loans and graduated 

payment mortgages with negative 

amortization. 

Negative amortization loans typically 

permit borrowers to defer principal and 

interest repayment for a fixed period of 

time, such as five years, or until the 

principal balance increases to the 

maximum amount allowed under the 

terms of the loan (i.e., the negative 

amortization cap). When the 

introductory period permitting such 

minimum periodic payments expires or 

the negative amortization cap is 

reached, whichever is earlier, the 

payment amount required under the 

terms of the loan is the monthly 

principal and interest payment that will 

repay the loan amount, plus any balance 

increase, over the remaining term of the 

loan. These loans are also often referred 

to as ‘‘pay option’’ loans because they 

offer multiple payment options to the 

consumer. Similarly, graduated 

payment mortgages that have negative 

amortization and fall within the 

definition of ‘‘negative amortization 

loans’’ provide for step payments that 

may be less than the interest accrued for 

a fixed period of time. The unpaid 

interest is added to the principal 

balance of the loan. When the 

introductory payment period expires, 

the payment amount required under the 

terms of the loan is the monthly 

principal and interest payment that will 

repay the loan amount, plus any 

principal balance increase, over the 

remaining term of the loan. The Board 

believes covering both types of loans in 

proposed § 226.43(c)(5)(ii)(C) is 

consistent with statutory intent to 

account for the negative equity that can 

occur when a consumer makes 

payments that defer some or all 

principal or interest for a period of time, 

and to address the impact any potential 

payment shock may have on the 

consumer’s ability to repay the loan. See 

TILA Section 129C(a)(6)(C). 

In contrast, in a transaction that has 

a negative amortization feature, but 

which does not provide for minimum 

periodic payments that permit deferral 

of some or all principal, the consumer 

repays the loan with fully amortizing 

payments in accordance with the 

payment schedule and therefore, the 

same potential for payment shock or 

negative equity does not exist. For 

example, certain loans are designed to 

permit borrowers with seasonal income 

to make periodic payments that repay 

the loan amount for part of the year, and 

then to skip payments during certain 

months. During those months when no 

payments are made, accrued interest 

results in an increase in the principal 

balance. However, when the monthly 

required payments resume, they are 

fully amortizing payments that repay 

the principal and interest accrued 

during that year. See comment 18(s)(7)– 

1 discussing negative amortization 

loans, and providing an example of a 

seasonal income loan that is not covered 

by the term. Loans not covered by the 

term ‘‘negative amortization loan,’’ but 

which may have a negative amortization 

feature, would be subject to the payment 

calculation requirements under the 

proposed general rule for purposes of 

determining the consumer’s repayment 

ability. See proposed § 226.43(c)(5)(i). 

Thus, seasonal income loans and 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27436 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

45See 12 CFR 226.18(s)(2)(ii) and comment 

18(s)(2)(ii)–2. 

46See 2006 Nontraditional Mortgage Guidance at 

58614, n.7. 

graduated payment mortgages that do 

not fall within the definition of a 

‘‘negative amortization loan’’ would be 

covered by the general payment 

calculation rule in proposed 

§ 226.43(c)(5)(i). 

For purposes of determining the 

consumer’s ability to repay a negative 

amortization loan under proposed 

§ 226.43(c)(5)(ii)(C), creditors must 

make a two-step payment calculation. 

Step one: maximum loan amount. 

Proposed § 226.43(c)(5)(ii)(C) requires 

that the creditor first determine the 

maximum loan amount and period of 

time that remains in the loan term after 

the loan is recast before determining the 

consumer’s repayment ability on the 

loan. See proposed comment 

43(c)(5)(ii)(C)–1; see also proposed 

§ 226.43(b)(11), which defines the term 

‘‘recast’’ to mean the expiration of the 

period during which negatively 

amortizing payments are permitted 

under the terms of the legal obligation. 

Proposed comment 43(c)(5)(ii)(C)–2 

would further clarify that recast for a 

negative amortization loan occurs after 

the maximum loan amount is reached 

(i.e., the negative amortization cap) or 

the introductory minimum periodic 

payment period expires. See proposed 

comment 43(c)(5)(ii)(C)–2. 

As discussed above, proposed 

§ 226.43(b)(7) defines ‘‘maximum loan 

amount’’ as the loan amount plus any 

increase in principal balance that results 

from negative amortization, as defined 

in § 226.18(s)(7)(v), based on the terms 

of the legal obligation. Under the 

proposal, creditors would make the 

following two assumptions when 

determining the maximum loan amount: 

(1) The consumer makes only the 

minimum periodic payments for the 

maximum possible time, until the 

consumer must begin making fully 

amortizing payments; and (2) the 

maximum interest rate is reached at the 

earliest possible time. 

As discussed above under the 

proposed definition of ‘‘maximum loan 

amount,’’ the Board interprets the 

statutory language in TILA Section 

129C(a)(6)(C) as requiring creditors to 

fully account for any potential increase 

in the loan amount that may result 

under the loan’s terms where the 

consumer makes only the minimum 

periodic payments required. The Board 

believes the intent of this statutory 

provision is to help ensure that the 

creditor consider the consumer’s 

capacity to absorb the increased 

payment amounts that would be needed 

to amortize the larger loan amount once 

the loan is recast. The Board recognizes 

that the approach taken towards 

calculating the maximum loan amount 

requires creditors to assume a ‘‘worstcase scenario,’’ but believes this 

approach is consistent with statutory 

intent to take into account the greatest 

potential increase in the principal 

balance. 

Moreover, the Board believes that 

where negative equity occurs in the 

loan, it can be more difficult for the 

consumer to refinance out of the loan 

because no principal has been reduced; 

a dropping home value market can 

further aggravate this situation. In these 

cases, the consumer is more likely to 

incur the increased payment obligation 

once the loan is recast. Accordingly, the 

Board believes it is appropriate to 

ensure that the consumer can make 

these increased payment amounts 

assuming the maximum loan amount, 

consistent with the statute. The Board 

also notes that calculating the maximum 

loan amount based on these 

assumptions is consistent with the 

approach in the 2010 MDIA Interim 

Final Rule,45 which addresses 

disclosure requirements for negative 

amortization loans, and also the 2006 

Nontraditional Mortgage Guidance, 

which provides guidance to creditors 

regarding underwriting negative 

amortization loans.46 Both the 2010 

MDIA Interim Final Rule and the 2006 

Nontraditional Mortgage Guidance 

provide that the loan amount plus any 

balance increase should be taken into 

account when disclosing terms or 

calculating the monthly principal and 

interest payment obligation, 

respectively. 

As discussed above, comment 

proposed 43(b)–1 would clarify that in 

determining the maximum loan amount, 

the creditor must assume that the 

consumer makes the minimum periodic 

payment until any negative amortization 

cap is reached or until the period 

permitting minimum periodic payments 

expires, whichever occurs first. 

Comment 43(b)–2 would provide further 

guidance to creditors regarding the 

assumed interest rate. Comment 43(b)– 

3 would provide examples illustrating 

how to calculate the maximum loan 

amount for negative amortization loans 

for purposes of proposed 

§ 226.43(c)(5)(ii)(C). 

Step two: payment calculation. Once 

the creditor knows the maximum loan 

amount and period of time that remains 

after the loan is recast, the proposed 

payment calculation rule for negative 

amortization loans requires the creditor 

to use the fully indexed rate or 

introductory rate, whichever is greater, 

to calculate the substantially equal, 

monthly payment amount that will 

repay the maximum loan amount over 

the term of the loan that remains as of 

the date the loan is recast. See proposed 

§ 226.43(c)(5)(ii)(C)(1) and (2). 

Proposed comment 43(c)(5)(ii)(C)–1 

would clarify that creditors must follow 

this two-step approach when 

determining the consumer’s repayment 

ability on a negative amortization loan, 

and would also cross-reference to the 

following defined terms: ‘‘maximum 

loan amount,’’ ‘‘negative amortization 

loan,’’ ‘‘fully indexed rate,’’ and ‘‘recast.’’ 

To facilitate compliance, this comment 

would also cross-reference to proposed 

comment 43(c)(5)(i)–4 for further 

guidance on the ‘‘substantially equal’’ 

requirement. 

Proposed comment 43(c)(5)(ii)(C)–2 

would provide further guidance to 

creditors regarding the relevant term of 

the loan that must be used for purposes 

of the repayment ability determination. 

This comment would explain that the 

relevant term of the loan is the period 

of time that remains as of the date the 

terms of the legal obligation recast. This 

comment would further explain that the 

creditor must determine substantially 

equal, monthly payments of principal 

and interest that will repay the 

maximum loan amount based on the 

period of time that remains after any 

negative amortization cap is triggered or 

any period permitting minimum 

periodic payments expires, whichever 

occurs first. 

Proposed comment 43(c)(5)(ii)(C)–3 

would provide illustrative examples of 

how to determine the consumer’s 

repayment ability based on substantially 

equal, monthly payments of principal 

and interest as required under proposed 

§ 226.43(c)(5)(ii)(C) for a negative 

amortization loan. For example, 

proposed comment 43(c)(5)(ii)(C)–3.ii 

would illustrate the payment 

calculation rule for a graduated payment 

mortgage with a fixed-interest rate that 

is a negative amortization loan. This 

comment would first assume a loan in 

the amount of $200,000 has a 30-year 

loan term. Second, the comment 

assumes that the loan agreement 

provides for a fixed-interest rate of 

7.5%, and requires the consumer to 

make minimum monthly payments 

during the first year, with payments 

increasing 12.5% every year (the annual 

payment cap) for four years. This 

comment would state that the payment 

schedule provides for payments of $943 

in the first year, $1061 in the second 

year, $1194 in the third year, $1343 in 

the fourth year, and then requires $1511 

for the remaining term of the loan. This 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27437 

comment would then explain that 

during the first three years of the loan, 

the payments are less than the interest 

accrued each month, resulting in 

negative amortization. Assuming the 

minimum payments increase year-toyear up to the 12.5% payment cap, the 

consumer will begin making payments 

that cover at least all of the interest 

accrued at the end of the third year. 

Thus, the loan is recast on the due date 

of the 36th monthly payment. The 

maximum loan amount on that date is 

$207,659, and the remaining loan term 

is 27 years (324 months). See proposed 

comment 43(c)(5)(ii)(C)–3.ii. 

This comment would conclude that 

for purposes of the repayment ability 

determination required in 

§ 226.43(c)(2)(iii), the creditor must 

determine the consumer’s ability- to 

repay the loan based on a monthly 

payment of $1497, which is the 

substantially equal, monthly payment of 

principal and interest that will repay the 

maximum loan amount of $207,659 over 

the remaining loan term of 27 years 

using the fixed interest rate of 7.5%. 

The Board recognizes that the 

payment calculation requirements, 

which are consistent with statutory 

requirements, will sometimes require 

the creditor to underwrite a graduated 

payment mortgage using a monthly 

payment that is lower than the largest 

payment the consumer would be 

required to pay. For example, as 

illustrated in proposed comment 

43(c)(5)(ii)(C)–3.ii, the creditor would 

underwrite the loan using a monthly 

payment of $1497 for purposes of the 

repayment ability determination, even 

though the consumer will need to begin 

making monthly payments of $1511 

beginning in the fifth year of the loan. 

This anomaly occurs because the 

creditor must assume substantially 

equal payments over the term of the 

loan remaining as of the date the loan 

is recast. As discussed above in relation 

to step-rate mortgages, the Board solicits 

comment on whether it should exercise 

its authority under TILA Sections 105(a) 

and 129B(e) to require the creditor to 

use the largest payment scheduled when 

determining the consumer’s ability to 

repay the loan. 15 U.S.C. 1604(a). 

43(c)(6) Payment Calculation for 

Simultaneous Loans 

As discussed above, proposed 

§ 226.43(c)(2)(iv) implements TILA 

Section 129C(a)(2) and requires that 

when determining the consumer’s 

repayment ability on a covered 

transaction, the creditor must consider 

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 

proposed § 226.43(c)(6). Furthermore, as 

discussed under proposed 

§ 226.43(b)(12), the Board is proposing 

to use its authority under TILA Sections 

105(a) and 129B(e) to broaden the scope 

of TILA Section 129C(a)(2) to include 

HELOCs, and define the term 

‘‘simultaneous loan’’ accordingly, for 

purposes of the requirements under 

proposed § 226.43(c)(2)(iv) and (c)(6). 15 

U.S.C. 1604(a). 

Proposed § 226.43(c)(6) provides the 

payment calculation for a simultaneous 

loan that is a closed-end covered 

transaction or a HELOC. Specifically, 

proposed § 226.43(c)(6) requires that the 

creditor consider the consumer’s 

payment on a simultaneous loan that is: 

(1) A covered transaction, by following 

proposed § 226.43(c)(5)(i)–(ii); or (2) a 

HELOC, by using the periodic payment 

required under the terms of the plan 

using the amount of credit that will be 

drawn at consummation of the covered 

transaction. That is, with respect to 

simultaneous loans that are covered 

transactions (i.e., closed-end loans 

subject to proposed § 226.43(c)), 

proposed § 226.43(c)(6)(i) requires the 

creditor to calculate the payment 

obligation consistent with the rules that 

apply to covered transactions under 

proposed § 226.43(c)(5). Under those 

proposed rules, the creditor must make 

the repayment ability determination 

using the greater of the fully indexed 

rate or any introductory rate, to 

calculate monthly, fully amortizing 

payments that are substantially equal. 

Under proposed § 226.43(b)(2), a ‘‘fully 

amortizing payment’’ is defined as a 

periodic payment of principal and 

interest that will repay the loan amount 

over the loan term. Thus, in the case of 

a simultaneous loan that is a closed-end 

credit transaction, the payment is based 

on the loan amount. Typically, in 

closed-end transactions the consumer is 

committed to using the entire loan 

amount because there is full 

disbursement of funds at 

consummation. See proposed comment 

43(b)(5)–1, which discusses the 

definition of loan amount and clarifies 

that the amount disbursed at 

consummation is not determinative for 

purposes of the payment calculation 

rules. See proposed § 226.43(c)(5) for 

further discussion of the payment 

calculation requirements for covered 

transactions. 

By contrast, for a simultaneous loan 

that is a HELOC, the consumer is 

generally not committed to using the 

entire credit line at consummation. The 

amount of funds drawn on a 

simultaneous HELOC may differ greatly 

depending, for example, on whether the 

HELOC is used as a ‘‘piggyback loan’’ to 

help towards payment on a home 

purchase transaction or if the HELOC is 

opened for convenience to be drawn 

down at a future time. The Board is 

concerned that requiring the creditor to 

underwrite a simultaneous HELOC 

assuming a full draw on the credit line 

may unduly restrict credit access, 

especially in connection with nonpurchase transactions (i.e., 

refinancings), because it would require 

creditors to assess the consumer’s 

repayment ability using potentially 

overstated payment amounts. Thus, the 

Board is proposing under 

§ 226.43(c)(6)(ii) that the creditor 

calculate the payment for the 

simultaneous HELOC based on the 

amount of funds to be drawn by the 

consumer at consummation of the 

covered transaction. As discussed in 

further detail below under proposed 

comment 43(c)(6)–3, the Board solicits 

comment on whether this approach is 

appropriate. 

Proposed comment 43(c)(6)–1 states 

that in determining the consumer’s 

repayment ability for a covered 

transaction, the creditor must include 

consideration of any simultaneous loan 

which it knows or has reason to know 

will be made at or before consummation 

of the covered transaction. To facilitate 

compliance, the comment would crossreference to proposed comment 

43(c)(2)(iv)–2 for further discussion on 

the standard ‘‘knows or has reason to 

know,’’ and proposed § 226.43(b)(12) for 

the meaning of the term ‘‘simultaneous 

loan.’’ 

Proposed comment 43(c)(6)–2 

explains that for a simultaneous loan 

that is a covered transaction, as that 

term is defined in proposed 

§ 226.43(b)(1), the creditor must 

determine a consumer’s ability to repay 

the monthly payment obligation for a 

simultaneous loan as set forth in 

§ 226.43(c)(5), taking into account any 

mortgage-related obligations. The 

comment would provide a crossreference to proposed § 226.43(b)(8) for 

the meaning of the term ‘‘mortgagerelated obligations.’’ 

Proposed comment 43(c)(6)–3 clarifies 

that for a simultaneous loan that is a 

HELOC, the creditor must consider the 

periodic payment required under the 

terms of the plan when assessing the 

consumer’s ability to repay the covered 

transaction secured by the same 

dwelling as the simultaneous loan. This 

comment would explain that under 

proposed § 226.43(c)(6)(ii), the creditor 

must determine the periodic payment 

required under the terms of the plan by 

considering the actual amount of credit 

to be drawn by the consumer at or 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27438 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

before consummation of the covered 

transaction. This comment would 

clarify that the amount to be drawn is 

the amount requested by the consumer; 

when the amount requested will be 

disbursed, or actual receipt of funds, is 

not determinative. This comment would 

provide the following example: Where 

the creditor’s policies and procedures 

require the source of downpayment to 

be verified, and the creditor verifies that 

a simultaneous loan that is a HELOC 

will provide the source of 

downpayment for the first-lien covered 

transaction, the creditor must consider 

the periodic payment on the HELOC by 

assuming the amount to be drawn at 

consummation is the downpayment 

amount. The Board recognizes that 

determining the actual amount to be 

drawn by the consumer may depend on 

a number of variables, and may not be 

readily determined prior to 

consummation. As discussed more fully 

below, the Board is soliciting comment 

on the appropriateness of this approach. 

Proposed comment 43(c)(6)–3 would 

further clarify that, in general, the 

creditor should determine the periodic 

payment based on guidance in staff 

commentary to § 226.5b(d)(5), which 

discusses disclosure of payment terms 

for HELOCs. 

The Board recognizes that consumers 

may fully draw on available credit 

immediately after closing on the firstlien loan, which could significantly 

impact their repayment ability on both 

the first-lien and second-lien mortgage 

obligations. Although this risk is present 

with respect to any credit line available 

to a consumer post-consummation, 

unlike credit cards, HELOCs are secured 

by a consumer’s dwelling. Inability to 

repay the first- or second-lien loan 

could result in foreclosure and loss of 

the home. In addition, outreach revealed 

that creditors take varied approaches to 

determining the periodic payment they 

consider when underwriting a 

simultaneous HELOC, with some 

participants indicating they assume a 

full draw and calculate the periodic 

payment based on the fully indexed 

rate, and other participants indicating 

that a 50% draw is assumed and only 

the minimum periodic payment is 

considered. 

For these reasons, the Board solicits 

comment on the appropriateness of the 

approach provided under proposed 

§ 226.43(c)(6)(ii) and comment 43(c)(6)– 

3 regarding the payment calculation for 

simultaneous HELOCs, with supporting 

data for any alternative approaches. 

Specifically, the Board solicits comment 

on what amount of credit should be 

assumed as drawn by the consumer for 

purposes of the payment calculation for 

simultaneous HELOCs. For example, 

should the Board require creditors to 

assume a full draw (i.e., requested 

amount to be used) of the credit line, a 

50% draw, or some other amount 

instead of the actual amount to be 

drawn by the consumer? The Board also 

solicits comment on whether it would 

facilitate compliance to provide a safe 

harbor where creditors assume the full 

credit line is drawn at consummation. 

In addition, as noted above, proposed 

§ 226.43(c)(2)(iv) and (c)(6) do not 

distinguish between purchase and nonpurchase covered transactions when 

requiring creditors to consider a 

periodic payment required on a 

simultaneous loan that is a HELOC for 

purposes of the repayment ability 

determination. The Board recognizes, 

however, that concerns regarding 

‘‘piggyback loans’’ may not be as acute 

with non-purchase transactions (i.e., 

refinancings) where HELOCs generally 

are taken against established equity in 

the home, and are opened concurrently 

with the refinancing of the first-lien 

loan for convenience and savings in 

closing costs. In addition, the Board 

notes that with respect to simultaneous 

HELOCs originated in connection with 

a refinancing, proposed 

§ 226.43(c)(2)(iv) and (c)(6) could be 

circumvented, or its value diminished 

significantly, where consumers do not 

draw on the credit line until after the 

covered transaction is consummated. 

Moreover, the Board is concerned that 

the proposal could encourage creditors 

and consumers to simply originate 

HELOCs immediately subsequent to the 

consummation of a covered transaction 

that is a refinancing, resulting in lost 

savings and convenience to consumers. 

For these reasons, the Board solicits 

comment, and supporting data, on 

whether the Board should narrow the 

requirement under proposed 

§ 226.43(c)(2)(iv) and (c)(6) to require 

creditors to consider simultaneous 

HELOCs only in connection with 

purchase transactions. 

43(c)(7) Monthly Debt-to-Income Ratio 

or Residual Income 

As discussed above, proposed 

§ 226.43(c)(2)(vii) implements TILA 

Section 129C(a)(3) and requires 

creditors, as part of the repayment 

ability determination, to consider the 

consumer’s monthly debt-to-income 

ratio or residual income. Proposed 

§ 226.43(c)(7) provides the definitions 

and calculations for the monthly debtto-income ratio and residual income. 

With respect to the definitions, 

proposed § 226.43(c)(7)(i)(A) defines the 

term ‘‘total monthly debt obligations’’ to 

mean the sum of: The payment on the 

covered transaction, as required to be 

calculated by § 226.43(c)(2)(iii) and 

(c)(5); the monthly payment on any 

simultaneous loans, as required to be 

calculated by § 226.43(c)(2)(iv) and 

(c)(6); the monthly payment amount of 

any mortgage-related obligations, as 

required to be considered by 

§ 226.43(c)(2)(v); and the monthly 

payment amount of any current debt 

obligations, as required to be considered 

by § 226.43(c)(2)(vi). Proposed 

§ 226.43(c)(7)(i)(B) defines the term 

‘‘total monthly income’’ to mean the sum 

of the consumer’s current or reasonably 

expected income, including any income 

from assets, as required to be considered 

by § 226.43(c)(2)(i) and (c)(4). 

With respect to the calculations, 

proposed § 226.43(c)(7)(ii)(A) requires 

the creditor to consider the consumer’s 

monthly debt-to-income ratio for 

purposes of § 226.43(c)(2)(vii) using the 

ratio of the consumer’s total monthly 

debt obligations to total monthly 

income. Proposed § 226.43(c)(7)(ii)(B) 

requires the creditor to consider the 

consumer’s remaining income after 

subtracting the consumer’s total 

monthly debt obligations from the total 

monthly income. 

Proposed comment 43(c)(7)–1 states 

that creditors must calculate the 

consumer’s total monthly debt 

obligations and total monthly income in 

accordance with the requirements in 

proposed § 226.43(c)(7). The 

commentary explains that creditors may 

look to widely accepted governmental 

and non-governmental underwriting 

standards to determine the appropriate 

thresholds for the debt-to-income ratio 

or residual income. 

Proposed comment 43(c)(7)–2 

explains that if a creditor considers both 

the consumer’s debt-to-income ratio and 

residual income, the creditor may base 

its repayment ability determination on 

either the consumer’s debt-to-income 

ratio or residual income, even if the 

ability-to-repay determination would 

differ with the basis used. Indeed, the 

Board does not wish to create an 

incentive for creditors to consider and 

verify as few factors as possible in the 

repayment ability determination. 

Proposed comment 43(c)(7)–3 clarifies 

that creditors may consider 

compensating factors to mitigate a 

higher debt-to-income ratio or lower 

residual income. For example, creditors 

may consider the consumer’s assets 

other than the dwelling securing the 

covered transaction, or the consumer’s 

residual income as compensating factors 

for a higher debt-to-income ratio. The 

proposed commentary permits creditors 

to look to widely accepted governmental 

and non-governmental underwriting 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27439 

47See also, Michael E. Stone, What is Housing 

Affordability? The Case for the Residual Income 

Approach, 17 Housing Policy Debate 179 (Fannie 

Mae 2006) (advocating use of a residual income 

approach but acknowledging that it ‘‘is neither well 

known, particularly in this country, nor widely 

understood, let alone accepted’’). 

standards in determining whether and 

in what manner to include the 

compensating factors. The Board solicits 

comment on whether it should provide 

more guidance on what compensating 

factors creditors may consider, and on 

how creditors may include 

compensating factors in the repayment 

ability determination. 

Residual income. Except for one small 

creditor and the U.S. Department of 

Veterans’ Affairs (VA), the Board is not 

aware of any creditors that routinely use 

residual income in underwriting, other 

than as a compensating factor.47 The VA 

underwrites its loans to veterans based 

on a residual income table developed in 

1997. The table shows the residual 

income required for the borrower based 

on the loan amount, region of the 

country, and family size. The residual 

income is calculated by deducting 

obligations, including Federal and state 

taxes, from effective income. The Board 

solicits comment on whether 

consideration of residual income should 

account for loan amount, region of the 

country, and family size. The Board also 

solicits comment on whether creditors 

should be required to include Federal 

and state taxes in the consumer’s 

obligations for purposes of calculating 

residual income. 

Automated underwriting systems. The 

Board understands that creditors 

routinely rely on automated 

underwriting systems. Many of those 

systems are proprietary and thus lack 

transparency to the individual creditors 

using the systems. The Board solicits 

comment on providing a safe harbor for 

creditors relying on automated 

underwriting systems that use monthly 

debt-to-income ratios, if the system 

developer certifies that the system’s use 

of monthly debt-to-income ratios in 

determining repayment ability is 

empirically derived and statistically 

sound. The Board also solicits comment 

on other methods to facilitate creditor 

reliance on automated underwriting 

systems, while ensuring that creditors 

can demonstrate compliance with the 

rule. 

43(d) Refinancing of Non-Standard 

Mortgages 

Introduction 

Proposed § 226.43(d) exempts 

creditors of refinancings under certain 

limited circumstances from the 

requirement to verify income and assets 

in determining whether a consumer has 

the ability to repay a covered 

transaction. See proposed 

§ 226.43(c)(2)(ii). It also applies a 

different payment calculation 

requirement to creditors determining 

whether a consumer has the ability to 

repay these special types of refinanced 

loans. See proposed § 226.43(c)(2)(iii), 

and (c)(5). Proposed § 226.43(d) 

implements TILA Section 129C(a)(6)(E), 

which was added to TILA under § 1411 

of the Dodd-Frank Act. 15 U.S.C. 

1639c(a)(6)(E). As previously noted, 

Section 1411 of the Dodd-Frank Act 

amends TILA by adding new Section 

129C(a), which requires creditors to 

determine whether a consumer has a 

reasonable ability to repay a home 

mortgage loan before making the loan 

and sets the parameters for that 

determination (detailed above in the 

section-by-section analysis of 

§ 226.43(c)). 15 U.S.C. 1639c(a). TILA 

Section 129C(a)(6)(E) applies special 

ability-to-repay provisions to 

transactions in which a ‘‘hybrid loan’’ is 

refinanced into a ‘‘standard loan’’ and 

the following additional conditions are 

met: 

• The ‘‘creditor’’ for the hybrid loan 

and the standard loan is the ‘‘same’’; 

• There is a ‘‘reduction’’ in the 

consumer’s monthly payment from the 

hybrid loan to the standard loan; and 

• The consumer ‘‘has not been 

delinquent on any payment on the 

existing hybrid mortgage.’’ 

15 U.S.C. 1639c(a)(6)(E). 

Specifically, ‘‘in considering any 

application for a refinancing,’’ the 

creditor may— 

• Consider the consumer’s ‘‘good 

standing on the existing mortgage.’’ 

• Consider whether the extension of 

new credit would prevent a likely 

default should the original mortgage 

reset and may give this concern a 

‘‘higher priority as an acceptable 

underwriting practice.’’ 

• Offer rate discounts and other 

favorable terms to the consumer that 

would be available to ‘‘new customers 

with high credit ratings based on [the 

creditor’s] underwriting practice.’’ 

TILA Section 129C(a)(6)(E)(i)–(iii); 15 

U.S.C. 1639c(a)(6)(E)(i)–(iii). 

The Dodd-Frank Act does not define 

the terms ‘‘hybrid loan’’ or ‘‘standard 

loan.’’ The statute also does not 

expressly state that a creditor is exempt 

from the statutory ability to repay 

requirements in refinancings for which 

the above conditions are met. To 

determine the meaning of these 

provisions, the Board reviewed the 

Dodd-Frank Act’s legislative history; 

consulted with consumer advocates and 

representatives of both industry and 

government-sponsored housing finance 

enterprises (GSEs); and examined 

underwriting rules and guidelines for 

the streamlined refinance programs of 

private creditors, GSEs and government 

agencies, as well as for the Home 

Affordable Modification Program 

(HAMP). For additional guidance, the 

Board also considered the Dodd-Frank 

Act provisions exempting streamlined 

refinancings under Federal government 

agency programs. See TILA Section 

129C(a)(5); 15 U.S.C. 1639c(a)(5). 

In the Board’s view, both the statutory 

text and additional research support 

interpreting TILA Section 129C(a)(6)(E) 

to mean that creditors of refinancings 

meeting certain conditions should have 

greater flexibility to comply with the 

general ability-to-repay provisions in 

TILA Section 129C(a) (proposed to be 

implemented by § 226.43(c)). 

Accordingly, the proposal: (1) Clarifies 

the conditions that must be met in home 

mortgage refinancings to which greater 

flexibility applies; and (2) provides an 

exemption for creditors of these 

refinancings from certain limited 

criteria required to be considered as part 

of the general repayment ability 

determination under TILA Section 

129C(a) (see proposed § 226.43(c)). 

Under the proposal, loans that can 

result in ‘‘payment shock’’ may be 

refinanced without the creditor having 

to verify the borrower’s income and 

assets with written documentation as 

prescribed in the general ability-torepay requirements (see the section-bysection analysis of § 226.43(c)(2)(ii) and 

(c)(4)), as long as a number of additional 

conditions are met. In addition, the 

creditor is permitted to calculate the 

monthly payment used for determining 

the consumer’s ability to repay the new 

loan based on assumptions that would 

typically result in a lower monthly 

payment than those required to be used 

under the general ability-to-repay 

requirements (see the section-by-section 

analysis of § 226.43(c)(2)(iii) and (c)(5)). 

As a result, when all of the special 

refinancing conditions are met, creditors 

may be better able to qualify a consumer 

for a new loan than under the general 

ability-to-repay requirements. 

A central provision of TILA Section 

129C(a)(6)(E) permits creditors to give 

prevention of a ‘‘likely default should 

the original mortgage reset a higher 

priority as an acceptable underwriting 

practice.’’ TILA Section 129C(a)(6)(E)(ii); 

15 U.S.C. 1639c(a)(6)(E)(ii). The Board 

believes that the structure of the statute 

supports interpreting this provision to 

mean that certain ability-to-repay 

criteria under TILA Section 129C(a) 

should not apply to refinances that meet 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27440 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

48See id. at 4. See also, e.g., Freddie Mac SingleFamily Seller/Servicer Guide, Vol. 1, Ch. 24: 

Refinance Mortgages/24.4: Requirements for 

Freddie Mac-owned streamlined refinance 

mortgages (Sept. 1, 2010). As of May 1, 2011, 

Freddie Mac will no longer purchase Freddie Macowned streamlined refinance mortgages. See 

Freddie Mac Bulletin 2011–2 (Jan. 18, 2011). 

49 During outreach, Fannie Mae provided data to 

the Board indicating that for 2010, Fannie Mae, 

Freddie Mac and Ginnie Mae refinancings totaled 

$925 billion, while non-GSE refinancings totaled 

$73 billion. Of the combined GSE refinancings, 

$288.6 billion were ‘‘streamlined refinances’’— 

approximately one-third of all GSE refinancings. 

50See, e.g., Fannie Mae, ‘‘Home Affordable 

Refinance Refi PlusTM Options,’’ p. 1 (Mar. 29, 

2010). 

51See, e.g., Fannie Mae, ‘‘Home Affordable 

Refinance Refi PlusTM Options,’’ p. 1 (Mar. 29, 

2010); Freddie Mac, ‘‘Freddie Mac-owned 

Streamlined Refinance Mortgage,’’ Pub. No. 387, pp. 

1–2 (Aug. 2010). 

52See, e.g., Fannie Mae, ‘‘Home Affordable 

Modification Program,’’ p. 1, FM 0509 (2009). 

53See, Fannie Mae, ‘‘Making Home AffordableSM

Program, Handbook for Servicers of Non-GSE 

Mortgages,’’ Ch. II, § 5, pp. 59–62 (Dec. 2, 2010). 

the requisite conditions. The special 

refinancing provisions of TILA Section 

129C(a)(6)(E) are part of TILA Section 

129C(a), entitled ‘‘Ability to Repay,’’ the 

paragraph that specifically prescribes 

the requirements that creditors must 

meet to satisfy the obligation to 

determine a consumer’s ability to repay 

a home mortgage. In the Board’s view, 

the term ‘‘underwriting practice’’ is 

reasonably interpreted to refer to the 

underwriting rules prescribed in earlier 

portions of TILA Section 129C(a)— 

namely, those concerning the general 

ability to repay underwriting 

requirements. 

Overall, the Board interprets the 

special refinancing provisions of TILA 

Section 129C(a)(6)(E) as intended to 

allow for the greater flexibility in 

underwriting that is characteristic of socalled ‘‘streamlined refinances.’’ The 

Board notes in particular that typical 

streamlined refinance programs do not 

require documentation of income and 

assets, although a verbal verification of 

employment may be required.48 The 

Board’s interpretation is based both on 

the statutory text and on the Board’s 

research and outreach with concerned 

parties. 

Regarding the Board’s research and 

outreach, the Board understands that 

streamlined refinances have been an 

important resource for consumers, 

particularly in recent years, who faced 

impending payment shock, could not 

qualify for a typical refinance because of 

property value declines, or both. To 

address these problems, many lenders 

as well as the GSEs and government 

agencies developed lending programs to 

allow borrowers of loans held by them 

to refinance despite high loan-to-value 

ratios or other characteristics that might 

otherwise impede refinancing. 

Representatives of creditors and GSEs in 

particular informed the Board that their 

streamlined refinance programs are a 

significant proportion of their portfolios 

and that they view their programs as 

valuable to both consumers and loan 

holders. Consumers are able to take 

advantage of lower rates to obtain a 

more affordable loan (and lower 

payments) and, in some cases, to avoid 

default or even foreclosure. At the same 

time, loan holders strengthen their 

portfolios by replacing potentially 

unaffordable and unstable loans with 

affordable, stable products. 

Regarding the statutory text, the Board 

notes that the refinancing provisions 

under TILA Section 129C(a)(6)(E) 

include three central elements of typical 

streamlined refinance programs.49 First, 

the creditor for both the existing 

mortgage and the new mortgage must be 

the same (see the section-by-section 

analysis of § 226.43(d)(1)(i) discussing 

the Board’s interpretation of ‘‘same 

creditor’’ to mean the current holder of 

the loan or the servicer acting on behalf 

of the current holder). 15 U.S.C. 

1639C(a)(6)(E). Second, the borrower 

must have a positive payment history on 

the existing mortgage (see the sectionby-section analysis of § 226.43(d)(1)(iv) 

and (d)(1)(v) for further discussion). 

Third, TILA’s special refinancing 

provisions require that the payment on 

the new mortgage be lower than the 

payment on the existing mortgage—a 

common objective of typical 

streamlined refinance programs.50

Finally, as noted, TILA Section 

129C(a) includes a provision that 

specifically addresses how the general 

ability-to-repay requirements apply to 

streamlined refinances under programs 

of government agencies such as the 

Federal Housing Administration and 

U.S. Department of Veterans’ Affairs. 

See TILA Section 129C(a)(5), 15 U.S.C. 

1639c(a)(5). In the Board’s view, the 

most reasonable interpretation of the 

additional section on refinancings under 

TILA Section 129C(a)(6)(E) is that it is 

intended to cover the remaining market 

for streamlined refinances—namely, 

those offered under programs of private 

creditors and the GSEs. 

One difference between the statute 

and typical streamlined refinance 

programs, however, is that the statute 

targets consumers facing ‘‘likely default’’ 

if the existing mortgage ‘‘reset[s].’’ The 

Board understands that, by contrast, 

streamlined refinance programs are not 

normally limited to borrowers at risk in 

this way. For example, they often assist 

consumers who are not facing potential 

default but who simply wish to take 

advantage of lower rates despite a drop 

in their home value or wish to switch 

from a less stable variable-rate product 

to a fixed-rate product.51 However, the 

focus of TILA’s new refinancing 

provisions is similar to the focus of 

HAMP, a government program 

specifically aimed at providing 

modifications for borrowers at risk of 

‘‘imminent default,’’ or in default or 

foreclosure.52 Underwriting criteria for a 

HAMP modification are considerably 

more stringent than for a typical 

streamlined refinance; for example, 

income verification documentation is 

required, in addition to documented 

verification of expenses.53 Concerns 

about the potential risks posed by loans 

to troubled borrowers may explain the 

robust underwriting standards for 

HAMP modifications. 

On balance, the Board believes that 

the statutory language is most 

appropriately interpreted to be modeled 

on the underwriting standards of typical 

streamlined refinance programs rather 

than the tighter standards of HAMP. The 

plain language of the Dodd-Frank Act 

indicates that Congress intended to 

facilitate opportunities to refinance 

loans on which their payments could 

become significantly higher and thus 

unaffordable. Applying the strict 

underwriting standards that are too 

stringent could impede refinances that 

Congress intended to encourage. In 

particular, the statutory language 

permitting creditors to give ‘‘likely 

default’’ a ‘‘higher priority as an 

acceptable underwriting practice’’ 

indicates that flexibility in these special 

refinances should be permitted. In 

addition, underwriting standards that go 

significantly beyond those used in 

existing streamlined refinance programs 

could create a risk that these programs 

would be unable to meet the TILA 

ability-to-repay requirements; thus, an 

important refinancing resource for atrisk borrowers would be compromised 

and the overall mortgage market 

potentially disrupted at a vulnerable 

time. 

At the same time, the Board 

recognizes that borrowers at risk of 

default when higher payments are 

required might present greater credit 

risks to the institutions holding their 

loans when those loans are refinanced 

without verifying the consumer’s 

income and assets. For example, a 

consumer may be paying $525 per 

month as an interest-only payment on 

an existing adjustable-rate loan. When 

refinanced at a lower, fixed rate with 

fully amortizing payments, however, the 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27441 

54See, e.g., Fannie Mae, ‘‘Home Affordable 

Refinance Refi PlusTM Options,’’ p. 2 (Mar. 29, 

2010); Freddie Mac, ‘‘Freddie Mac-owned 

Streamlined Refinance Mortgage,’’ Pub. No. 387, p. 

2 (Aug. 2010). 

payment may go up somewhat from the 

previous interest-only level—for 

example, to $650—because the new 

payments now cover both principal and 

interest. (For further discussion of how 

this scenario is possible under the 

proposal, see the section-by-section 

analysis of proposed § 226.43(d)(5).) The 

new payment of $650 is likely to be 

lower than the ‘‘reset’’ payment at the 

fully-indexed rate on the existing 

mortgage; nonetheless, the creditor 

incurs some risk that the consumer may 

not be able to afford the new payments. 

For this reason, to qualify for the 

ability to repay exemptions under 

proposed § 226.43(d), a consumer must 

meet some requirements that are more 

stringent than those of typical 

streamlined refinance programs. Under 

the proposal, for example, a consumer 

may have had only one delinquency of 

more than 30 days in the 24 months 

immediately preceding the consumer’s 

application for a refinance. See 

proposed § 226.43(d)(1)(iv). By contrast, 

streamlined refinance programs of 

which the Board is aware tend to 

consider the consumer’s payment 

history for only the last 12 months.54 As 

another safeguard against risk, the Board 

defines the type of loan into which a 

consumer may refinance under TILA’s 

new refinancing provisions to include 

several characteristics designed to 

ensure that those loans are stable and 

affordable. These include a requirement 

that the interest rate be fixed for the first 

five years after consummation (see 

proposed § 226.43(d)(2)(ii)(D)) and that 

the points and fees be capped at three 

percent of the total loan amount, subject 

to a limited exemption for smaller loans 

(see proposed § 226.43(d)(2)(ii)(B))). 

The Board’s Proposal 

43(d)(1) Scope 

Proposed § 226.43(d)(1) defines the 

scope of the provisions regarding the 

refinancing of non-standard mortgages 

under proposed § 226.43(d). 

Specifically, this provision states that 

§ 226.43(d) applies to the refinancing of 

a ‘‘non-standard mortgage’’ (defined in 

proposed § 226.43(d)(2)(i)) into a 

‘‘standard mortgage’’ (defined in 

proposed § 226.43(d)(2)(ii)) when the 

following conditions are met— 

• The creditor of the standard 

mortgage is the current holder of the 

existing non-standard mortgage or the 

servicer acting on behalf of the current 

holder. 

• The monthly payment for the 

standard mortgage is significantly lower 

than the monthly payment for the nonstandard mortgage, as calculated under 

proposed § 226.43(d)(5). 

• The creditor receives the 

consumer’s written application for the 

standard mortgage before the nonstandard mortgage is ‘‘recast’’ (defined in 

proposed § 226.43(b)(11)). 

• The consumer has made no more 

than one payment more than 30 days 

late on the non-standard mortgage 

during the 24 months immediately 

preceding the creditor’s receipt of the 

consumer’s written application for the 

standard mortgage. 

• 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. 

As discussed further below, proposed 

§ 226.43(d)(2)(iii) defines the term 

‘‘refinancing’’ to have the same meaning 

as in § 226.20(a). 

Proposed comment 43(d)(1)–1 

clarifies that the requirements for a 

‘‘written application,’’ a term that 

appears in § 226.43(d)(1)(iii), (d)(1)(iv) 

and (d)(1)(v), discussed in detail below, 

are found in comment 19(a)(1)(i)–3. 

Comment 19(a)(1)(i)–3 states that 

creditors may rely on the Real Estate 

Settlement Procedures Act (RESPA) and 

Regulation X (including any 

interpretations issued by HUD) in 

deciding whether a ‘‘written 

application’’ has been received. This 

comment further states that, in general, 

Regulation X defines ‘‘application’’ to 

mean the submission of a borrower’s 

financial information in anticipation of 

a credit decision relating to a Federally 

related mortgage loan. See 24 CFR 

3500.2(b). The comment clarifies that an 

application is received when it reaches 

the creditor in any of the ways 

applications are normally transmitted— 

by mail, hand delivery, or through an 

intermediary agent or broker. The 

comment further clarifies that, if an 

application reaches the creditor through 

an intermediary agent or broker, the 

application is received when it reaches 

the creditor, rather than when it reaches 

the agent or broker. This comment also 

cross-references comment 19(b)–3 for 

guidance in determining whether or not 

the transaction involves an intermediary 

agent or broker. 

43(d)(1)(i) Creditor is the Current Holder 

or Servicer Acting on Behalf of Current 

Holder 

Proposed § 226.43(d)(1)(i) requires 

that the creditor for the new mortgage 

(the ‘‘standard mortgage’’) also be either 

the current holder of the existing ‘‘nonstandard mortgage’’ or the servicer 

acting on behalf of the current holder. 

This provision implements the statutory 

requirement that the existing loan must 

be refinanced by ‘‘the creditor into a 

standard loan to be made by the same 

creditor.’’ TILA Section 129C(a)(6)(E); 15 

U.S.C. 1639c(a)(6)(E). The Board 

believes that this statutory provision 

requires the entity refinancing the loan 

to have an existing relationship with the 

consumer. The existing relationship is 

important because the creditor must be 

able to easily access the consumer’s 

payment history and potentially other 

information about the consumer in lieu 

of documenting the consumer’s income 

and assets. In addition, the Board reads 

the statute to be intended in part to 

ensure the safety and soundness of 

financial institutions by giving them 

greater flexibility to improve the quality 

of their loan portfolios through 

streamlined refinances. 

The Board also believes that this 

statutory provision is intended to ensure 

that the creditor of the refinancing have 

an interest in placing the consumer into 

new loan that is affordable and 

beneficial. In the Board’s view, the 

creditor of the new loan will in most 

cases retain an interest in the 

consumer’s well-being when the 

creditor is also the current holder of the 

loan or the servicer acting on the current 

holder’s behalf. In cases where a 

creditor holds a loan and will hold the 

loan after it is refinanced, the creditor 

has a direct interest in refinancing the 

consumer into a more stable and 

affordable product. In addition, the 

Board understands that the existing 

servicer often will be the entity 

conducting the refinance, particularly 

for refinances held by GSEs. By also 

permitting the creditor on the 

refinanced loan to be the servicer acting 

on behalf of the holder of the existing 

mortgage, the proposal is intended 

clearly to cover instances where a loan 

that has been sold to a GSE is refinanced 

by the existing servicer and continues to 

be held by the same GSE. 

At the same time, the Board 

recognizes that the creditor on the new 

mortgage may not necessarily retain an 

interest in the new loan if the creditor 

immediately sells the loan to a new 

holder. The Board requests comment on 

whether the proposed rule could be 

structured differently to better ensure 

that the creditor on a refinancing under 

§ 226.43(d) retains an interest in the 

performance of the new loan and 

whether additional guidance is needed. 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27442 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

55See, e.g., Fannie Mae, ‘‘Home Affordable 

Refinance Refi PlusTM Options,’’ p. 2 (Mar. 29, 

2010); Freddie Mac, ‘‘Freddie Mac-owned 

Streamlined Refinance Mortgage,’’ Pub. No. 387, p. 

2 (Aug. 2010). 

43(d)(1)(ii) Monthly Payment for the 

Standard Mortgage is Materially Lower 

Than the Monthly Payment for the NonStandard Mortgage 

Proposed § 226.43(d)(1)(ii) requires 

that the monthly payment on the new 

loan (the ‘‘standard mortgage’’) be 

‘‘materially lower’’ than the monthly 

payment for the existing loan (the ‘‘nonstandard mortgage’’). This provision 

implements the statutory requirement 

that there be ‘‘a reduction in monthly 

payment on the existing hybrid loan’’ in 

order for the special provisions to apply 

to a refinancing. TILA Section 

129C(a)(6)(E); 15 U.S.C. 1639c(a)(6)(E). 

Proposed comment 43(d)(1)(ii)–1 

provides that the exemptions afforded 

under § 226.43(d)(3) (discussed below) 

apply to a refinancing only if the 

monthly payment for the new loan is 

‘‘materially lower’’ than the monthly 

payment for an existing non-standard 

mortgage and clarifies that the payments 

that must be compared must be 

calculated based on the requirements 

under § 226.43(d)(5) (discussed below). 

This comment also explains that 

whether the new loan payment is 

‘‘materially lower’’ than the nonstandard mortgage payment depends on 

the facts and circumstances, but that, in 

all cases, a payment reduction of 10 

percent or greater would meet the 

‘‘materially lower’’ standard. 

For several reasons, the Board 

interprets the statutory requirement for 

a ‘‘reduction in monthly payment’’ to 

mean that the new payment must be 

‘‘materially lower’’ than the payment 

under the existing mortgage and that a 

10 percent or greater reduction is a 

reasonable safe harbor. First, if the 

required reduction could be merely de 

minimis—such as a reduction of a few 

cents or dollars—the statutory purpose 

would not be met. In such cases, the 

consumer would not obtain a 

meaningful benefit that would prevent 

default—in other words, the reduction 

would not be ‘‘material.’’ Second, based 

on outreach, the Board understands that 

a 10 percent reduction in the payment 

is a reasonable minimum reduction that 

can provide a meaningful benefit to the 

consumer. 

The Board requests comment on 

whether a requirement that the payment 

on the standard mortgage must be 

‘‘materially lower’’ than the payment on 

the non-standard mortgage (as 

calculated under § 226.43(d)(5)(ii) and 

(d)(5)(i), respectively) and whether a 10 

percent reduction or some other 

percentage or dollar amount would be a 

more appropriate safe harbor for 

compliance with this requirement. The 

Board also requests comment on 

whether a percentage or dollar amount 

reduction would be more appropriate a 

rule rather than a safe harbor. 

43(d)(1)(iii) Creditor Receives the 

Consumer’s Written Application for the 

Standard Mortgage Before the NonStandard Mortgage is Recast 

Proposed § 226.43(d)(1)(iii) requires 

that the creditor for the refinancing 

receive the consumer’s written 

application for the refinancing before 

the existing non-standard mortgage is 

‘‘recast.’’ As discussed in the section-bysection analysis of § 226.43(b)(11), the 

Board defines the term ‘‘recast’’ to mean, 

for an adjustable-rate mortgage, the 

expiration of the period during which 

payments based on the introductory 

fixed rate are permitted; for an interestonly loan, the expiration of the period 

during which the interest-only 

payments are permitted; and, for a 

negative amortization loan, the 

expiration of the period during which 

negatively amortizing payments are 

permitted. 

The Board believes that proposed 

§ 226.43(d)(1)(iii) is necessary to 

implement TILA Section 

129C(a)(6)(E)(ii), which permits 

creditors of certain refinances to 

‘‘consider if the extension of new credit 

would prevent a likely default should 

the original mortgage reset.’’ 15 U.S.C. 

1639c(a)(6)(E)(ii). This statutory 

language implies that the special 

refinancing provisions apply only where 

the original mortgage has not yet ‘‘reset.’’ 

Congress’s concern appears to be 

prevention of default in the event of a 

‘‘reset,’’ not loss mitigation on a 

mortgage for which a default on the 

‘‘reset’’ payment has already occurred. 

The Board recognizes that a consumer 

may not realize that a loan will be recast 

until the recast occurs and that, at that 

point, the consumer could not refinance 

the loan under the special streamlined 

refinancing provisions of proposed 

§ 226.43(d). The Board requests 

comment on whether to use its legal 

authority to make adjustments to TILA 

to permit streamlined refinancings even 

after a loan is recast. 

43(d)(1)(iv) One Payment More Than 30 

Days Late During the 24 Months 

Immediately Preceding the Creditor’s 

Receipt of the Consumer’s Written 

Application 

Proposed § 226.43(d)(1)(iv) requires 

that, during the 24 months immediately 

preceding the creditor’s receipt of the 

consumer’s written application for the 

standard mortgage, the consumer has 

made no more than one payment on the 

non-standard mortgage more than 30 

days late. Together with 

§ 226.43(d)(1)(v) (discussed below), 

§ 226.43(d)(1)(iv) implements the 

portion of TILA Section 129C(a)(6)(E) 

that requires that the borrower not have 

been ‘‘delinquent on any payment on the 

existing hybrid loan.’’ 15 U.S.C. 

1639c(a)(6)(E). 

The Board believes that the proposal 

is consistent with the statutory 

prohibition on ‘‘any’’ delinquencies on 

the existing non-standard (‘‘hybrid’’) 

mortgage, in addition to being 

consistent with the consumer protection 

purpose of TILA and industry practices 

under many current streamlined 

refinance programs. Further, the 

proposal is supported by the Board’s 

authority under TILA Sections 105(a) 

and 129B(e) to adjust provisions of TILA 

and condition practices ‘‘to assure that 

consumers are offered and receive 

residential mortgage loan on terms that 

reasonably reflect their ability to repay 

the loans and that are understandable 

and not unfair, deceptive, or abusive.’’ 

15 U.S.C. 1604(a); 15 U.S.C. 1639b(e); 

TILA Section 129B(a)(2), 15 U.S.C. 

1639b(a)(2). The proposal is designed to 

further this purpose by facilitating 

transactions that help consumers 

refinance out of unaffordable loans. 

During outreach, the Board learned 

that a delinquency of more than 30 days 

often can occur at the time of loan setup due to errors in the set-up process 

outside of the consumer’s control. The 

Board also noted, as discussed above, 

that all of the streamlined refinance 

programs reviewed by the Board permit 

at least one 30- or 31-day delinquency, 

although usually during the last 12 

months rather than the last 24 months 

prior to application for a refinancing.55

Thus the proposal is more stringent than 

typical streamlined refinance programs, 

but does not prohibit all delinquencies. 

24–Month Look-Back Period. The 

Board proposes to require a look-back 

period for payment history of 24 

months, rather than a 12-month period, 

for several reasons. First, as noted 

earlier, typical streamlined refinance 

programs are often aimed at helping 

borrowers with no risk of default. The 

Board recognizes that borrowers at risk 

of default when higher payments are 

required might present greater credit 

risks to the institutions holding their 

loans, even if the institutions refinance 

those loans. In the Board’s view, when 

income and assets are not required to be 

verified, as proposed, the borrower’s 

payment history takes on greater 


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56See, e.g., Freddie Mac Single-Family Seller/ 

Servicer Guide, Vol. 1, Ch. 24: Refinance 

Mortgages/24.4: Requirements for Freddie Macowned streamlined refinance mortgages (Sept. 1, 

2010) (requiring that the consumer has been current 

on the existing mortgage ‘‘for the most recent 90 

days and has not been 30 days delinquent more 

than once in the most recent 21 months, or if the 

Mortgage being refinanced is seasoned for less than 

12 months, since the Mortgage Note Date’’). 

57See Fannie Mae/Freddie Mac Uniform 

Instrument, Multistate Fixed Rate Note—Single 

Family, Form 3200, §§ 3, 6. 

importance, especially in dealing with 

at-risk borrowers. 

Second, the Board sees some merit in 

the views expressed during outreach by 

GSE and creditor representatives that 

borrowers with positive payment 

histories tend to be less likely than other 

borrowers to sign up for a new loan for 

which they cannot afford the monthly 

payments. At the same time, the Board 

acknowledges that a positive payment 

history on payments at low levels due 

to temporarily favorable loan terms is no 

guaranty that the consumer can afford 

the payments on a new loan. The Board 

solicits comment on the proposal to 

require that the consumer have only one 

delinquency during the 24 months prior 

to applying for a refinancing, 

particularly on whether a longer or 

shorter look-back period should be 

required. 

Delinquency of 30 days or fewer 

permitted. Under the proposal, late 

payments of 30 days or fewer on the 

existing, non-standard mortgage would 

not disqualify a consumer from 

refinancing the non-standard mortgage 

under the streamlined refinance 

provisions of proposed § 226.43(d). The 

Board believes that allowing 

delinquencies of 30 or fewer days is 

consistent with the statutory prohibition 

on ‘‘any’’ delinquency for several 

reasons. First, delinquencies of this 

length may occur for many reasons 

outside of the consumer’s control, such 

as mailing delays, miscommunication 

about where the payment should be 

sent, or payment crediting errors. 

Second, many creditors incorporate a 

late fee ‘‘grace period’’ into their 

payment arrangements, which permits 

consumers to make their monthly 

payments for a certain number of days 

after the contractual due date without 

incurring a late fee. Thus, many 

consumers regularly make their 

payments after the contractual due date 

and may even set up automated 

withdrawals for their payments to be 

made after the contractual due date in 

order to coincide with the consumer’s 

pay periods. The Board does not believe 

that the statute is reasonably interpreted 

to prohibit consumers from obtaining 

needed refinances due to payments that 

are late but within a late fee grace 

period. 

In addition, as discussed above, the 

Board interprets TILA Section 

129C(a)(6)(E) to be intended as a 

mechanism for allowing existing 

streamlined refinance programs to 

continue should the entities offering 

them wish to maintain these programs. 

The predominant streamlined refinance 

programs of which the Board is aware 

uniformly measure whether a consumer 

has a positive payment history based on 

whether the consumer has made any 

payments late by 30 days or more (or, 

as in the proposal, more than 30 days).56

Proposed comment 43(d)(1)(iv)–1 

provides the following illustration of the 

rule under § 226.43(d)(1)(iv): Assume a 

consumer applies for a refinancing on 

May 1, 2011. Assume also that the 

consumer made a non-standard 

mortgage payment on August 15, 2009, 

that was 45 days late, but made no other 

late payments on the non-standard 

mortgage between May 1, 2009, and 

May 1, 2011. In this example, the 

requirement under § 226.43(d)(1)(iv) is 

met because the consumer made only 

one payment that was over 30 days late 

within the 24 months prior to applying 

for the refinancing (i.e., 20 and one-half 

months prior to application). 

Payment due date. Proposed comment 

43(d)(1)(iv)–2 clarifies that whether a 

payment is more than 30 days late 

depends on the contractual due date not 

accounting for any grace period. The 

comment provides the following 

example: The contractual due date for a 

non-standard mortgage payment is the 

first day of every month, but no late fee 

will be charged as long as the payment 

is received by the 16th day of the 

month. Here, the ‘‘payment due date’’ is 

the first day of the month rather than 

the 16th day of the month. Thus, a 

payment due under the contract on 

September 1st that is paid on October 

1st is made more than 30 days after the 

payment due date. 

The Board believes that using the 

contractual due date for determining 

whether a payment has been made more 

than 30 days after the due date will 

facilitate compliance and enforcement 

by providing clarity. Whereas late fee 

‘‘grace periods’’ are often not stated in 

writing, the contractual due date is 

unambiguous. In addition, using the 

contractual due date for determining 

whether a loan payment is made on 

time is consistent with standard home 

mortgage loan contracts.57

The Board requests comment on 

whether the delinquencies that creditors 

are required to consider under 

§ 226.43(d)(1) should be late payments 

of more than 30 days as proposed, 30 

days or more, or some other time period. 

43(d)(1)(v) No Payments More Than 30 

Days Late During the Six Months 

Immediately Preceding the Creditor’s 

Receipt of the Consumer’s Written 

Application 

Proposed § 226.43(d)(1)(v) requires 

that the consumer have made no 

payments on the non-standard mortgage 

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. This provision is intended to 

complement proposed § 226.43(d)(1)(iv), 

discussed above, in implementing the 

portion of TILA Section 129C(a)(6)(E) 

that requires that the borrower not have 

been ‘‘delinquent on any payment on the 

existing hybrid loan.’’ 15 U.S.C. 

1639C(a)(6)(E). The Board believes that, 

together with proposed 

§ 226.43(d)(1)(iv), this aspect of the 

proposal is a reasonable interpretation 

of the prohibition on ‘‘any’’ 

delinquencies on the non-standard 

mortgage and is supported by the 

Board’s authority under TILA Sections 

105(a) and 129B(e) to adjust provisions 

of TILA and condition practices ‘‘to 

assure that consumers are offered and 

receive residential mortgage loan on 

terms that reasonably reflect their ability 

to repay the loans and that are 

understandable and not unfair, 

deceptive, or abusive.’’ 15 U.S.C. 

1604(a); TILA Section 129B(a)(2), 15 

U.S.C. 1639b(a)(2). 

The Board believes that a six-month 

‘‘clean’’ payment record indicates a 

reasonable level of financial stability on 

the part of the consumer applying for a 

refinancing. This measure of financial 

stability is especially important where 

income and assets are not required to be 

verified. In addition, some outreach 

participants indicated that a prohibition 

on delinquencies of more than 30 days 

for the six months prior to application 

for the refinancing was generally 

consistent with common industry 

practice and would not be unduly 

disruptive to existing streamlined 

refinance programs with wellperforming loans. 

Proposed comment 43(d)(1)(v)–1 

provides the following examples of the 

proposed rule: Assume a consumer in a 

non-standard mortgage applies for a 

refinancing on May 1, 2011. If the 

consumer made a 45-day late payment 

on March 15, 2011, the requirement 

under § 226.43(d)(1)(v) is not met 

because the consumer made a payment 

more than 30 days late just one and onehalf months prior to application. 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27444 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

58 ‘‘The term ‘adjustable-rate mortgage’ means a 

transaction secured by real property or a dwelling 

for which the annual percentage rate may increase 

after consummation.’’ 12 CFR 226.18(s)(7)(i). 

59 ‘‘The term ‘interest-only’ means that, under the 

terms of the legal obligation, one or more of the 

periodic payments may be applied solely to accrued 

interest and not to loan principal; an ‘interest-only 

loan’ is a loan that permits interest-only payments.’’ 

12 CFR 226.18(s)(7)(iv). 

60 ‘‘[T]he term ‘negative amortization’ means 

payment of periodic payments that will result in an 

increase in the principal balance under the terms 

of the legal obligation; the term ‘negative 

amortization loan’ means a loan that permits 

payments resulting in negative amortization, other 

than a reverse mortgage subject to section 226.33.’’ 

12 CFR 226.18(s)(7)(v). 

61See U.S. House of Reps., Comm. on Fin. 

Services, Report on H.R. 1728, Mortgage Reform 

and Anti-Predatory Lending Act, No. 111–94, 51 

(May 4, 2009). 

62 Id. at 51–52. 

The comment further clarifies that if 

the number of months between 

consummation of the non-standard 

mortgage and the consumer’s 

application for the standard mortgage is 

six or fewer, the consumer may not have 

made any payment more than 30 days 

late on the non-standard mortgage. The 

comment cross-references proposed 

comments 43(d)(1)–2 and 43(d)(1)(iv)–2 

for an explanation of ‘‘written 

application’’ and how to determine the 

payment due date, respectively. 

43(d)(2) Definitions 

Proposed Section 226.43(d)(2) defines 

the terms ‘‘non-standard mortgage’’ and 

‘‘standard mortgage’’ in proposed 

§ 226.43(d). As noted earlier, the statute 

does not define the terms ‘‘hybrid loan’’ 

and ‘‘standard loan’’ used in the special 

refinancing provisions of TILA Section 

129C(a)(6)(E). Therefore, the Board 

proposes definitions that in its view are 

consistent with the policy objective 

underlying these special provisions: 

Facilitating the refinancing of home 

mortgages on which consumers risk a 

likely default due to impending 

payment shock into more stable and 

affordable products. 

43(d)(2)(i) Non-Standard Mortgage 

Proposed § 226.43(d)(2)(i) substitutes 

the term ‘‘non-standard mortgage’’ for 

the statutory term ‘‘hybrid loan’’ and 

defines this term to mean a covered 

transaction on which the loan has a 

fixed ‘‘teaser’’ rate for a period of one 

year or longer after consummation, 

which then adjusts to a variable rate 

plus a margin for the remaining term of 

the loan; or the minimum periodic 

payments (whether required or optional) 

are either interest-only or negatively 

amortizing. Specifically, a ‘‘nonstandard mortgage’’ is any ‘‘covered 

transaction’’ (defined in proposed 

§ 226.43(b)(1)) that is: 

• An adjustable-rate mortgage, as 

defined in § 226.18(s)(7)(i), with an 

introductory fixed interest rate for a 

period of one year or longer; 58

• An interest-only loan, as defined in 

§ 226.18(s)(7)(iv); 59 or 

• A negative amortization loan, as 

defined in § 226.18(s)(7)(v).60

Proposed comment 43(d)(2)(i)(A)–1 

explains what it means that a ‘‘nonstandard mortgage’’ includes an 

adjustable-rate mortgage with an 

introductory fixed interest rate for one 

or more years. This comment clarifies 

that, for example, a covered transaction 

with a fixed introductory rate for the 

first two, three or five years and then 

converts to a variable rate for the 

remaining 28, 27 or 25 years, 

respectively, is a ‘‘non-standard 

mortgage.’’ By contrast, a covered 

transaction with an introductory rate for 

six months that then converts to a 

variable rate for the remaining 29 and 1⁄2

years is not a ‘‘non-standard mortgage.’’ 

The Board believes that the proposed 

definition of a ‘‘non-standard mortgage’’ 

is consistent with congressional intent. 

First, the legislative history of the DoddFrank Act describes ‘‘hybrid’’ mortgages 

as mortgages with a ‘‘blend’’ of fixed-rate 

and adjustable-rate characteristics— 

generally loans with an initial fixed 

period and adjustment periods, such as 

‘‘2/23s and 3/27s.’’ 61 The legislative 

history also indicates that Congress was 

concerned about borrowers being 

trapped in mortgages likely to result in 

payments that would suddenly become 

significantly higher—often referred to as 

‘‘payment shock’’—because their home 

values had dropped, thereby ‘‘making 

refinancing difficult.’’ 62

The Board believes that Congress’s 

overriding concern about consumers 

being at risk due to payment shock 

supports an interpretation of the term 

‘‘hybrid loan’’ to encompass both loans 

that are ‘‘hybrid’’ in that they start with 

a fixed interest rate and convert to a 

variable rate, but also loans that are 

‘‘hybrid’’ in that borrowers can make 

payments that do not pay down 

principal for a period of time that then 

convert to higher payments covering all 

or a portion of principal. By defining 

‘‘non-standard mortgage’’ in this way, 

the proposal is intended to increase 

refinancing options for a wide range of 

at-risk consumers while remaining true 

to the statutory language and legislative 

intent. 

The proposed definition of ‘‘nonstandard mortgage’’ does not include 

adjustable-rate mortgages whose rate is 

fixed for an initial period of less than 

one year. In those instances, a consumer 

arguably does not face ‘‘payment shock’’ 

because the consumer has paid the fixed 

rate for such a short period of time. 

Another concern is that allowing 

streamlined refinancings under this 

provision where the interest rate is fixed 

for less than one year could result in 

‘‘loan flipping.’’ A creditor, for example, 

could make a covered transaction and 

then only a few months later refinance 

that loan under § 226.43(d) to take 

advantage of the exemption from certain 

ability-to-repay requirements while still 

profiting from the refinancing fees. 

The Board recognizes that under this 

definition, a consumer could refinance 

out of a relatively stable product, such 

as an adjustable-rate mortgage with a 

fixed interest rate for a period of 10 

years, which then adjusts to a variable 

rate for the remaining loan term (a ‘‘10/ 

1 ARM’’). Whether this is the type of 

product that the special refinancing 

provisions were meant to accommodate 

is unclear. The Board solicits comment 

on whether adjustable-rate mortgages 

with an initial fixed rate should be 

considered ‘‘non-standard mortgages’’ 

regardless of how long the initial fixed 

rate applies, or if the proposed initial 

fixed-rate period of at least one year 

should otherwise be revised. 

The proposed definition of ‘‘nonstandard mortgage’’ also does not 

include balloon mortgages. As discussed 

above, the Board understands 

Congress’s intent to be to cover ‘‘hybrid’’ 

loans, meaning loans on which the 

monthly payment will jump because 

new monthly payment terms take effect, 

making the loan unaffordable for the 

remaining loan term. Balloon mortgages 

are not clearly ‘‘hybrid’’ in this sense. 

The monthly payments on a balloon 

mortgage do not necessarily increase or 

change from the time of consummation; 

rather, the entire outstanding principal 

balance becomes due on a particular, 

predetermined date. Consumers of 

balloon mortgages typically expect that 

the entire loan balance will be due at 

once at a certain point in time and are 

generally aware well in advance that 

they will need to repay the loan or 

refinance. 

However, the Board recognizes that 

consumers of balloon mortgages may be 

at risk of being unable to pay the 

outstanding principal balance when due 

and may need refinancing assistance. 

Thus the Board solicits comment on 

whether to use its legal authority to 

include balloon mortgages in the 

definition of ‘‘non-standard mortgage’’ 

for purposes of the special refinancing 

provisions of TILA Section 

129C(a)(6)(E). The Board also requests 

comment generally on the 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27445 

appropriateness of the proposed 

definition of ‘‘non-standard mortgage.’’ 

43(d)(2)(ii) Standard Mortgage 

Proposed § 226.43(d)(2)(ii) substitutes 

the term ‘‘standard mortgage’’ for the 

statutory term ‘‘standard loan’’ and 

defines this term to mean a covered 

transaction (see proposed § 226.43(b)(1)) 

that has the following five 

characteristics, each of which will be 

discussed in more detail further below: 

• First, the regular periodic payments 

may not (1) cause the principal balance 

to increase; (2) allow the consumer to 

defer repayment of principal; or (3) 

result in a balloon payment. In other 

words, to qualify as a standard 

mortgage, a covered transaction may not 

provide for negative amortization 

payments, payments of interest only or 

of only a portion of the principal 

required to pay off the loan amount over 

the loan term, or a balloon payment. 

• Second, the total points and fees 

payable in connection with the 

transaction may not exceed three 

percent of the total loan amount, with 

exceptions for smaller loans specified in 

proposed § 226.43(e)(3), discussed in 

detail below. 

• Third, the loan term may not 

exceed 40 years. 

• Fourth, the interest rate must be 

fixed for the first five years after 

consummation. 

• Fifth, the proceeds from the loan 

may be used solely to pay—(1) the 

outstanding principal balance on the 

non-standard mortgage; and (2) closing 

or settlement charges required to be 

disclosed under RESPA. In other words, 

the refinance must be what is commonly 

referred to as a ‘‘no-cash-out’’ 

refinancing, in which the consumer 

receives no funds from the loan 

proceeds for discretionary spending. 

In general, the criteria for a ‘‘standard 

mortgage’’ is designed to be similar to 

the criteria for a ‘‘qualified mortgage’’ 

under proposed § 226.43(e)(2), which 

places certain limits on loan features 

and fees. The Board believes that this 

approach is appropriate to ensure that 

standard mortgages provide product 

stability and affordability for 

consumers. 

Limitations on regular periodic 

payments. Under proposed 

§ 226.43(d)(2)(ii)(A), to qualify as a 

standard mortgage, a covered 

transaction must provide for regular 

periodic payments that do not result in 

negative amortization, deferral of 

principal repayment, or a balloon 

payment. The Board believes that these 

limitations promote the statutory 

purpose of facilitating refinances that 

place at-risk consumers in more 

sustainable mortgages. These provisions 

are also consistent with the definition of 

a ‘‘qualified mortgage’’ under proposed 

§ 226.43(e)(2)(i). See section-by-section 

analysis of § 226.43(e)(2), below. 

Proposed comment 43(d)(2)(ii)(A)–1 

explains the meaning of ‘‘regular 

periodic payments’’ that do not result in 

an increase of the principal balance 

(negative amortization) or allow the 

consumer to defer repayment of 

principal (see proposed comment 

43(e)(2)(i)–2, discussed below). The 

comment explains that the requirement 

for ‘‘regular periodic payments’’ means 

that the contractual terms of the 

standard mortgage must obligate the 

consumer to make payments of 

principal and interest on a monthly or 

other periodic basis that will repay the 

loan amount over the loan term. The 

comment further explains that, with the 

exception of payments resulting from 

any interest rate changes after 

consummation in an adjustable-rate or 

step-rate mortgage, the periodic 

payments must be substantially equal. 

This comment notes that meaning of 

‘‘substantially equal’’ is explained in 

proposed comment 43(c)(5)(i)–3 

(discussed above in the section-bysection analysis of proposed 

§ 226.43(c)(5)). In addition, the 

comment clarifies that ‘‘regular periodic 

payments’’ do not include a singlepayment transaction and crossreferences similar commentary on the 

meaning of ‘‘regular periodic payments’’ 

for the purposes of a ‘‘qualified 

mortgage’’ (proposed comment 

43(e)(2)(i)–1). 

Proposed comment 43(d)(2)(ii)(A)–1 

also cross-references proposed comment 

43(e)(2)(i)–2 to explain the prohibition 

on payments that ‘‘allow the consumer 

to defer repayment of principal.’’ 

Proposed comment 43(e)(2)(i)-2 

describes the meaning of this phrase in 

the context of defining the term 

‘‘qualified mortgage’’ under proposed 

§ 226.43(e); however, the phrase has the 

same meaning in the definition of 

‘‘standard mortgage’’ under proposed 

§ 226.43(d). Specifically, the comment 

states that deferral of principal 

repayment includes interest-only terms, 

under which one or more of the periodic 

payments may be applied solely to 

accrued interest and not to loan 

principal. Deferral of principal 

repayment also includes terms under 

which part of the periodic payment is 

applied to loan principal but is 

insufficient to pay off the loan amount 

over the loan term, requiring an increase 

in later periodic payments (or a balloon 

payment) to make up the principal 

shortfall of earlier payments. Graduated 

payment mortgages, for example, allow 

deferral of principal repayment in this 

manner and therefore generally may not 

be standard mortgages or qualified 

mortgages. 

Three percent cap on points and fees. 

Proposed § 226.43(d)(2)(ii)(B) prohibits 

creditors from charging points and fees 

on the mortgage transaction of more 

than three percent of the total loan 

amount, with certain exceptions for 

small loans. Specifically, proposed 

§ 226.43(d)(2)(ii)(B) cross-references the 

points and fees provisions under 

proposed § 226.43(e)(3), thereby 

applying the points and fees limitations 

for a ‘‘qualified mortgage’’ to a ‘‘standard 

mortgage.’’ The points and fees 

limitation for a ‘‘qualified mortgage’’ is 

discussed in detail in the section-bysection analysis of proposed 

§ 226.43(e)(3), below. In sum, under 

proposed § 226.43(e)(3)(i), the total 

points and fees payable in connection 

with a loan may not exceed— 

Alternative 1: 

• For a loan amount of $75,000 or more, 

3 percent of the total loan amount; 

• For a loan amount of greater than or 

equal to $60,000 but less than 

$75,000, 3.5 percent of the total 

loan amount; 

• For a loan amount of greater than or 

equal to $40,000 but less than 

$60,000, 4 percent of the total loan 

amount; 

• For a loan amount of greater than or 

equal to $ 20,000 but less than 

$40,000, 4.5 percent of the total 

loan amount; and 

• For a loan amount of less than 

$20,000, 5 percent of the total loan 

amount. 

Alternative 2: 

• For a loan amount of $75,000 or more, 

3 percent of the total loan amount; 

• For a loan amount of greater than or 

equal to $20,000 but less than 

$75,000, a percent of the total loan 

amount not to exceed the amount 

produced by the following 

formula— 

Æ Total loan amount ¥ $20,000 = $Z 

Æ $Z × .0036 basis points = Y basis 

points 

Æ 500 basis points ¥ Y basis points 

= X basis points 

Æ X basis points × .01 = Allowable 

points and fees as a percentage of the 

total loan amount. 

• For a loan amount of less than 

$20,000, 5 percent of the total loan 

amount. 

For a detailed discussion of the 

alternative points and fees thresholds 

for qualified mortgages, see the sectionby-section analysis of proposed 

§ 226.43(e)(3), below. 

In the Board’s view, the proposed 

limitation on the points and fees that 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27446 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

63See, e.g., Fannie Mae, ‘‘Home Affordable 

Refinance—New Refinance Options for Existing 

Fannie Mae Loans,’’ Announcement 09–04, p. 8 

(Mar. 4, 2009) (permitting ‘‘[f]ully-amortizing fixedrate mortgage loans with a term up to 40 years’’). 

64See, e.g., id. (permitting ‘‘[f]ully-amortizing 

ARM loans with an initial fixed period of five years 

or greater with a term up to 40 years’’). 

may be charged on a ‘‘standard 

mortgage’’ is important for at least three 

reasons. First, the limitation prevents 

creditors from undermining the purpose 

of the provision—placing at-risk 

consumers into more affordable loans— 

by charging excessive points and fees 

for the refinance. Second, the points and 

fees cap helps ensure that consumers 

attain a net benefit in refinancing their 

non-standard mortgage. The higher a 

consumer’s upfront costs to refinance a 

home mortgage, the longer it will take 

for the consumer to recoup those costs 

through lower payments on the new 

mortgage. By limiting the amount of 

points and fees that can be charged in 

a refinance covered by § 226.43(d), the 

proposal reduces the amount of time it 

will take for the consumer to recoup his 

transaction costs, thus increasing the 

likelihood that the consumer will hold 

the loan long enough to in fact recoup 

those costs. Third, this provision is 

consistent with the exemption from 

income verification requirements for 

streamlined refinances under Federal 

government programs. See TILA Section 

129C(a)(5). The Board is not aware of 

any reason why points and fees should 

be capped for government streamlined 

refinances but not for private 

streamlined refinances. 

The Board requests comment on the 

proposal to apply the same limit on the 

points and fees that may be charged for 

a ‘‘qualified mortgage’’ under § 226.43(e) 

to the points and fees that may be 

charged on a ‘‘standard mortgage’’ under 

§ 226.43(d). 

Loan term of no more than 40 years. 

Proposed § 226.43(d)(2)(ii)(C) provides 

that, to qualify as a standard mortgage 

under proposed § 226.43(d), a covered 

transaction may not have a loan term of 

more than 40 years. The Board believes 

that allowing a loan term of up to 40 

years is consistent with the statutory 

goal of promoting refinances for 

borrowers in potential crisis, as well as 

with the statutory language that requires 

the monthly payment for the standard 

mortgage to be lower than the payment 

for the non-standard mortgage. The 

proposal is intended to ensure that 

creditors and consumers have sufficient 

options to refinance a 30-year loan, for 

example, which is unaffordable for the 

consumer in the near term, into a loan 

with lower, more affordable payments 

over a longer term. This flexibility may 

be especially important in higher cost 

areas where loan amounts on average 

exceed loan amounts in other areas. At 

the same time, the Board recognizes that 

loans of longer terms cost more over 

time for the consumer. 

During outreach, the Board heard 

concerns from consumer advocates that 

allowing a loan term of 40 years on any 

mortgage is detrimental to consumers 

and the market as a whole. Consumer 

advocates argued that 40-year loans are 

expensive and do not save consumers 

sufficient money on the monthly 

payment to offset this expense. Among 

other information, consumer advocates 

provided an example of a $300,000 loan 

at an 8 percent fixed interest rate. The 

difference between the 20 and 30 year 

payment is $308.03 a month ($2,509.32 

reduced to $2,201.29). The difference 

between the 30- and 40-year loan is 

$115.36 a month. Consumer advocates 

question the advantages of a monthly 

payment reduction of $115.36 per 

month when the loan costs an 

additional $208,783 over the 40 years 

more than the 30-year loan. 

A more appropriate comparison may 

be the total interest paid for the two 

types of loans during an equal, shorter 

period rather than for the life of each 

loan. A shorter period is relevant 

because most loans are prepaid well 

before the stated end of the term. For 

instance, during the first year, the total 

interest paid on the 30-year loan would 

be $23,909, compared to $23,961 for the 

40-year loan. Over the first five years, 

total interest paid on the 30-year loan 

would be $117,287, compared to 

$118,842 on the 40-year loan, which is 

a difference of $1,555 more for the 40- 

year loan. Over the first 10 years, total 

interest paid on the 30-year loan would 

be $227,329, compared to $234,591 on 

the 40-year loan, which is a difference 

of $7,262 more for the 40-year loan. 

While recognizing that a 40-year 

mortgage is more expensive than a 30- 

year mortgage over the long term, the 

Board is reluctant to foreclose options 

for consumers for whom the lower 

payment of a 40-year loan might make 

the difference between defaulting and 

not defaulting. The Board also notes that 

prevalent streamlined refinance 

programs permit loan terms of up to 40 

years and is concerned about disrupting 

the current mortgage market at a 

vulnerable time.63 The Board requests 

comment on the proposal to allow a 

standard mortgage to have a loan term 

of up to 40 years. 

Interest rate is fixed for the first five 

years. Proposed § 226.43(d)(2)(ii)(D) 

requires that a standard mortgage have 

a fixed interest rate for the first five 

years (60 months) after consummation. 

Proposed comment 43(d)(2)(ii)(D)–1 

illustrates this rule for an adjustable-rate 

mortgage with an initial fixed interest 

rate for the first five years after 

consummation. In the example 

provided, the adjustable-rate mortgage 

consummates on August 15, 2011, and 

the first monthly payment is due on 

October 1, 2011. The first five years after 

consummation occurs on August 15, 

2016. The first interest rate adjustment 

occurs on the due date of the 60th 

monthly payment, which is September 

1, 2016. As explained in the comment, 

this loan meets the requirement that the 

rate be fixed for the first five years after 

consummation because the interest rate 

is fixed until September 1, 2016—more 

than five years after consummation. 

This comment also cross-references 

proposed comment 43(e)(2)(iv)–3.iii for 

guidance regarding step-rate mortgages. 

Step-rate mortgages may have a ‘‘fixed’’ 

interest rate for five years that is not the 

same rate for the entire five-year period. 

The Board proposes a minimum fiveyear fixed-rate period for standard 

mortgages for several reasons. First, 

requiring a fixed rate for five years is 

consistent with the statutory 

requirement for a qualified mortgage, 

which requires the creditor to 

underwrite the mortgage based on the 

maximum interest rate that may apply 

during the first five years after 

consummation. See TILA Section 

129C(b)(2)(A)(v); see also proposed 

§ 226.43(e)(2)(iv)(A). The Board 

understands that Congress intended 

both qualified mortgages and standard 

mortgages to be stable loan products, 

and therefore believes that the required 

five-year fixed-rate period for qualified 

mortgages is an appropriate benchmark 

for standard mortgages as well. As a 

matter of policy, the Board believes that 

the safeguard of a fixed rate for five 

years after consummation is necessary 

to ensure that consumers refinance into 

products that are stable for a substantial 

period of time. In the Board’s view, a 

fixed payment for five years after 

consummation is a significant 

improvement in the circumstances of a 

consumer who may have defaulted 

absent the refinance. In effect, the 

proposal permits so-called ‘‘5/1 ARMs,’’ 

where the interest rate is fixed for the 

first five years, after which time the rate 

becomes variable. In this regard, the 

proposal is intended to be generally 

consistent with existing streamlined 

refinance programs.64 The Board’s 

understanding based on outreach is that 

5/1 ARMs in existing streamlined 

refinance programs have performed 

well. 


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65 75 FR 58539, 58594–58604, 58697–58699, 

58761–58764, Sept. 24, 2010. 

Consumer advocates have expressed 

the view that a longer fixed-rate period 

for standard mortgages is necessary, 

preferably at least seven years, arguing 

that consumers may hold their loans 

longer than five years and be faced with 

payment shock sooner than they can 

afford. The Board requests comment on 

the proposal to require that a standard 

mortgage under proposed § 226.43(d) 

have an interest rate that is fixed for at 

least the first five years after 

consummation, including on whether 

the rate should be required to be fixed 

for a shorter or longer period and data 

to support any alternative time period. 

In addition, the Board requests 

comment on whether a balloon 

mortgage of at least five years should be 

considered a ‘‘standard mortgage’’ under 

the streamlined refinancing provisions 

of § 226.43(d). Arguably, a balloon 

mortgage with a fixed, monthly payment 

for five years would benefit a consumer 

who otherwise would have defaulted. 

Also, a five-year balloon mortgage may 

not be appreciably less risky for the 

consumer than a ‘‘5/1 ARM,’’ which is 

permitted under the proposal, 

depending on the terms of the rate 

adjustment scheduled to occur in year 

five. 

Loan proceeds used for limited 

purposes. Proposed § 226.43(d)(2)(ii)(E) 

restricts the use of the proceeds of a 

standard mortgage to two purposes: 

• To pay off the outstanding principal 

balance on the non-standard mortgage; 

and 

• To pay closing or settlement 

charges required to be disclosed under 

the Real Estate Settlement Procedures 

Act, 12 U.S.C. 2601 et seq., which 

includes amounts required to be 

deposited in an escrow account at or 

before consummation. 

Proposed comment 43(d)(2)(ii)(E)–1 

clarifies that 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.’’ 

This proposal is intended to ensure 

that the consumer does not incur 

additional home mortgage debt as part 

of a refinance designed to prevent the 

consumer from defaulting on an existing 

home mortgage. The Board believes that 

permitting the consumer to lose 

additional equity in his or her home 

under TILA’s special refinancing 

provisions would undermine the 

financial stability of the consumer, thus 

contravening the purposes of the statute. 

The Board requests comment, however, 

on whether some de minimis amount of 

cash to the consumer should be 

permitted, either because this allowance 

would be operationally necessary to 

cover transaction costs or for other 

reasons, such as to reimburse a 

consumer for closing costs that were 

over-estimated but financed. 

43(d)(2)(iii) Refinancing 

Proposed § 226.43(d)(2)(iii) defines 

the term ‘‘refinancing’’ to have the same 

meaning as in § 226.20(a). Section 

226.20(a) defines the term ‘‘refinancing’’ 

generally to mean a transaction in 

which an existing obligation is ‘‘satisfied 

and replaced by a new obligation 

undertaken by the same consumer.’’ 

Official staff commentary explains that 

‘‘[w]hether a refinancing has occurred is 

determined by reference to whether the 

original obligation has been satisfied or 

extinguished and replaced by a new 

obligation, based on the parties’ contract 

and applicable law.’’ See comment 

20(a)–1. However, the following, among 

other transaction events, are not 

considered ‘‘refinancings’’: (1) A renewal 

of a payment obligation with no change 

in the original terms; and (2) a reduction 

in the annual percentage rate with a 

corresponding change in the payment 

schedule. See § 226.20(a)(1) and (a)(2), 

and comment 20(a)–2. 

In the Board’s 2010 Mortgage 

Proposal, the Board proposed to revise 

the meaning of ‘‘refinancing’’ in § 226.20 

to include a broader range of 

transactions for which creditors would 

be required to give consumers new TILA 

disclosures.65 The Board requests 

comment on whether the meaning of 

‘‘refinancing’’ in § 226.43(d) should be 

expanded to include a broader range of 

transactions, similar to those covered 

under the proposed revisions to 

§ 226.20, or otherwise should be defined 

differently or explained more fully than 

proposed. 

43(d)(3) Exemption From Certain 

Repayment Ability Requirements 

Under specific conditions, proposed 

§ 226.43(d)(3) exempts a creditor in a 

refinancing from two of the 

requirements under proposed 

§ 226.43(c) for determining a consumer’s 

ability to repay a home mortgage. First, 

the creditor is not required to comply 

with the income and asset verification 

requirements of proposed 

§ 226.43(c)(2)(i) and (c)(4). Second, the 

creditor is not required to comply with 

the payment calculation requirements of 

proposed § 226.43(c)(2)(iii) and (c)(5); 

the creditor may instead use payment 

calculations prescribed in proposed 

§ 226.43(d)(5)(ii), discussed in more 

detail in the section-by-section analysis 

of that provision. 

For these exemptions to apply, all of 

the conditions in proposed 

§ 226.43(d)(1)(i)–(v) described above 

must be met. See proposed 

§ 226.43(d)(3)(i). In addition, the 

creditor must consider whether the 

standard mortgage will prevent a likely 

default by the consumer on the nonstandard mortgage when the nonstandard mortgage is recast. See 

proposed § 226.43(d)(3)(ii). This 

proposed provision implements TILA 

Section 129C(a)(6)(E)(ii), which permits 

a creditor to ‘‘consider if the extension 

of new credit would prevent a likely 

default should the original mortgage 

reset and give such concerns a higher 

priority as an acceptable underwriting 

practice.’’ 15 U.S.C. 1639c(a)(6)(E)(ii). As 

clarified in proposed comment 

43(d)(3)(i)–1, the Board believes that 

this statutory provision requires a 

creditor consider whether: 

• the consumer is likely to default on 

the existing mortgage once new, higher 

payments are required; and 

• the new mortgage will prevent the 

consumer’s default. 

Likely default. Proposed comment 

43(d)(3)(i)–2 clarifies that, in 

considering whether the consumer’s 

default on the non-standard mortgage is 

‘‘likely,’’ the creditor may look to widely 

accepted governmental and nongovernmental standards for analyzing a 

consumer’s likelihood of default. The 

Board does not intend to constrain 

servicers and other relevant parties from 

using other methods to determine a 

consumer’s likelihood of default, 

including those tailored specifically to 

that servicer. Outreach participants 

informed the Board that servicers and 

others use a variety of methods for 

determining a consumer’s likelihood of 

default, some of which are based on the 

particular servicer’s historical 

experience with the loans it has 

serviced. 

The Board has also considered the 

meaning of ‘‘imminent default’’ in 

HAMP, which, as noted, is a 

government program designed to assist 

consumers facing ‘‘imminent default’’ or 

who are in default or foreclosure. The 

Board’s understanding, based on 

research and discussions with outreach 

participants, is that the requirements for 

determining what constitutes ‘‘imminent 

default’’ were not precisely defined in 

the HAMP rules due to the legitimate 

differences in servicer assessments of a 

consumer’s likelihood of default. In 

addition, a servicer may use more than 

one method. For example, Freddie Mac 

representatives informed the Board that 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27448 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

its tool for calculating ‘‘imminent 

default’’—the Imminent Default 

Indicator or IDI—is one factor among 

several that Freddie Mac Seller/ 

Servicers review in determining a 

consumer’s likelihood of default and 

that these additional factors may vary 

depending on the type of loan and other 

characteristics of a particular 

transaction or borrower. 

The Board heard from consumer 

advocates that ‘‘imminent default,’’ as it 

has been interpreted by some to date, 

may be a standard that is too high for 

the refinancing provisions in TILA 

Section 129C(a)(6)(E) and could prevent 

many consumers from obtaining needed 

streamlined refinances. The proposal 

therefore uses the exact statutory 

wording—‘‘likely default’’—in 

implementing the provision permitting 

a creditor to prioritize prevention of 

default in underwriting a refinancing. 

See TILA Section 129C(a)(6)(E)(ii); 15 

U.S.C. 1639c(a)(6)(E)(ii). In this way, the 

proposal is intended to distinguish the 

required standard for a consumer’s 

potential default under TILA’s new 

refinancing provisions from any 

particular meaning that may have been 

ascribed to the term ‘‘imminent default’’ 

in connection with HAMP. 

The Board solicits comment on the 

proposal to use the term ‘‘likely default’’ 

in implementing TILA Section 

129C(a)(6)(E)(ii) and on whether 

additional guidance is needed on how 

to meet the requirement that a creditor 

must reasonably and in good faith 

determine that a standard mortgage will 

prevent a likely default should the nonstandard mortgage be recast. 

Payment calculation for repayment 

ability determination. Proposed 

comment 43(d)(3)(ii)–1 explains that, if 

the conditions in § 226.43(d)(1) are met 

(discussed above), the creditor may 

satisfy the payment calculation 

requirements for determining a 

consumer’s ability to repay the new loan 

by applying the calculation prescribed 

under § 226.43(d)(5)(ii), rather than the 

calculation prescribed under 

§ 226.43(c)(2)(iii) and (c)(5). 

Specifically, as discussed in more detail 

under proposed § 226.43(d)(5)(ii) below, 

the creditor must calculate the standard 

mortgage payment based on the rate at 

consummation of the standard 

mortgage. This is the rate that will apply 

for the first five years after 

consummation; to qualify as a ‘‘standard 

mortgage,’’ a mortgage must have an 

interest rate that is fixed for at least the 

first five years after consummation of 

the loan (see proposed 

§ 226.43(d)(2)(ii)(D), discussed below). 

The comment explains that, as a result, 

if the standard mortgage is a ‘‘5/1 ARM’’ 

with a fixed rate for the first five years 

of payments (60 payments) followed by 

a variable rate, the creditor would not be 

required to determine the consumer’s 

ability to repay the loan based on a 

payment that would result once the 

variable rate applies. If the loan 

consummates on August 15, 2011, and 

the first monthly payment is due on 

October 1, 2011, five years after 

consummation occurs on August 15, 

2016, and the first interest rate 

adjustment occurs on the due date of the 

60th monthly payment, which is 

September 1, 2016. Thus, under 

proposed § 226.43(d)(3)(ii), to calculate 

the payment required for the ability to 

repay rule under proposed 

§ 226.43(c)(2)(iii), the creditor should 

use the payment based on the interest 

rate that is fixed for the first five years 

after consummation (from August 15, 

2011, until August 15, 2016) and is not 

required to account for the payment 

resulting after the first interest rate 

adjustment on September 1, 2016. 

The Board proposes this exemption 

from the general ability to repay 

payment calculation requirements for 

three reasons. First, in the Board’s view, 

TILA Section 129C(a)(6)(E) is clearly 

intended to encourage creditors to 

refinance loans on which consumers are 

likely to default due to impending 

‘‘payment shock.’’ The proposal is 

consistent with this policy objective 

because underwriting a refinance based 

on the payment due prior to the recast 

means that more consumers can qualify 

for loans to ensure sustained 

homeownership. Second, the safeguards 

built into the definition of a ‘‘standard 

mortgage,’’ discussed under the sectionby-section analysis of proposed 

§ 226.43(d)(3)(ii), mitigate risks of not 

accounting for the payment due after the 

recast in determining a consumer’s 

ability to repay. A standard mortgage, 

for example, may never have negative 

amortization payments, interest-only 

payments, or a balloon payment. 

Third, the statute in general seeks to 

ensure that consumers obtain mortgages 

for which the payments are affordable 

for a reasonable period of time. Based 

on the definition of a ‘‘qualified 

mortgage,’’ the Board believes that 

Congress considered a reasonable 

amount of time to be the first five years 

after consummation of a loan. 

Specifically, as discussed in more detail 

below in the section-by-section analysis 

of proposed § 226.43(e)(2)(iv), an 

adjustable-rate mortgage is deemed to be 

a qualified mortgage only if, among 

other factors, the underwriting is based 

on the maximum rate permitted under 

the loan during the first five years. TILA 

Section 129C(b)(2)(A)(v), 15 U.S.C. 

1639c(b)(2)(A)(v). The Board believes 

that the same standard is appropriately 

applied to determining a consumer’s 

ability to repay a ‘‘standard mortgage’’ 

under § 226.43(d). The statute is 

structured to encourage creditors to 

make both ‘‘qualified mortgages’’ and 

‘‘standard mortgages,’’ consistent with 

congressional findings on the 

importance of ‘‘ensuring that 

responsible, affordable mortgage credit 

remains available to consumers.’’ TILA 

Section 129B(a)(1). In particular, the 

statute affords creditors of both 

qualified mortgages and standard 

mortgages additional flexibility in 

complying with the general ability to 

repay underwriting requirements of 

TILA Section 129C(a). See TILA Section 

129C(a)(6)(E) (for standard mortgages) 

and 129C(b) (for qualified mortgages), 

15 U.S.C. 1639c(a)(6)(E), (b). 

Accordingly, the proposal requires that 

standard mortgages have most of the 

product features and restrictions 

assigned by Congress to qualified 

mortgages to ensure product stability 

and affordability for consumers. 

Finally, the Board believes that this 

aspect of the proposal will facilitate 

compliance by allowing creditors to use 

a single payment calculation for 

determining whether: (1) The payment 

on the standard mortgage is ‘‘materially 

lower’’ than the payment on the nonstandard mortgage; and (2) the 

consumer has a reasonable ability to 

repay the standard mortgage. 

The Board requests comment on the 

proposal to exempt creditors of 

refinances that meet the conditions 

under proposed § 226.43(d)(1) from the 

income and asset verification 

requirements and the payment 

calculation requirements of the general 

ability-to-repay rules in proposed 

§ 226.43(c). The Board solicits comment 

on whether an exemption from other 

ability to repay requirements under 

proposed § 226.43(c), such as 

consideration of credit history under 

proposed § 226.43(c)(2)(viii), may also 

be appropriate. 

43(d)(4) Offer of Rate Discounts and 

Other Favorable Terms 

Proposed § 226.43(d)(4) provides that 

a creditor making a loan under the 

special refinancing provisions of 

§ 226.43(d) may offer to the consumer 

the same or better rate discounts and 

other terms that the creditor offers to 

any new consumer, consistent with the 

creditor’s documented underwriting 

practices and to the extent not 

prohibited by applicable state or Federal 

law. This provision implements TILA 

Section 129C(a)(6)(E)(iii), which permits 

creditors of refinancings under the 


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Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27449 

special conditions of TILA Section 

129C(a)(6)(E) to ‘‘offer rate discounts and 

other favorable terms’’ to the borrower 

‘‘that would be available to new 

customers with high credit ratings based 

on such underwriting practice.’’ 15 

U.S.C. 1639c(a)(6)(E)(iii). 

The statutory provision is consistent 

with the congressional goal of 

facilitating beneficial refinancings for 

borrowers facing potential payment 

shock; the provision allows creditors to 

give their refinancing customers rate 

discounts and favorable terms they 

might offer to new customers with high 

credit ratings. The Board recognizes that 

the meaning of ‘‘high credit ratings’’ may 

vary by creditor and that the 

underwriting practices for these types of 

customers may vary also, including the 

terms that are offered. Thus the proposal 

does not use the term ‘‘high credit 

ratings’’ but simply states that the rate 

discounts and terms offered to a 

consumer of a § 226.43(d) loan may be 

the same or better than those offered to 

any other consumer. 

The proposal does require, however, 

that a creditor have ‘‘documented 

underwriting practices’’ to support the 

creditor’s offer of rate discounts and 

loan terms. In this way, the proposal is 

intended to promote transparency for 

examiners and consumers in 

understanding the basis for any special 

discounts or terms that the creditor 

offers to borrowers refinancing their 

home mortgages under proposed 

§ 226.43(d). In addition, the Board 

recognizes that state or Federal laws 

may regulate the rates and terms offered 

to consumers depending on various 

consumer characteristics or other 

factors. For this reason, the Board 

proposes that the rates and terms offered 

to consumers under § 226.43(d) not be 

prohibited by other applicable state or 

Federal law. 

The Board requests comment on the 

proposed interpretation of TILA Section 

129C(a)(6)(E)(iii) and whether 

additional guidance on the meaning of 

proposed § 226.43(d)(4) is needed. 

43(d)(5) Payment Calculations 

Proposed § 226.43(d)(5) prescribes the 

payment calculations that must be used 

to determine whether the consumer’s 

monthly payment for a standard 

mortgage will be ‘‘materially lower’’ than 

the monthly payment for the nonstandard mortgage, as required under 

proposed § 226.43(d)(1)(ii), discussed 

above. Proposed § 226.43(d)(5) thus 

complements proposed § 226.43(d)(1)(ii) 

in implementing the statutory provision 

that requires a ‘‘reduction’’ in the 

monthly payment for the existing nonstandard (‘‘hybrid’’) mortgage when 

refinanced into a standard mortgage. 

TILA Section 129C(a)(6)(E), 15 U.S.C. 

1639c(a)(6)(E). As noted above, the 

payment calculation for a standard 

mortgage required under proposed 

§ 226.43(d)(5)(ii) is also the payment 

calculation that a creditor must use to 

calculate the monthly payment on the 

standard loan in determining whether 

the consumer is reasonably able to repay 

the mortgage. See proposed 

§ 226.43(c)(2)(iii). 

43(d)(5)(i) Non-Standard Mortgage 

Payment Calculation 

Proposed § 226.43(d)(5)(i) requires 

that the monthly payment for a nonstandard mortgage be based on 

substantially equal, monthly, fully 

amortizing payments of principal and 

interest that would result once the 

mortgage is ‘‘recast,’’ as that term is 

defined in § 226.43(b)(11) and discussed 

in the section-by-section analysis of that 

provision. The Board believes that 

comparing the payment on the standard 

mortgage to the payment amount on 

which the consumer likely would have 

defaulted (i.e., the payment resulting on 

the existing non-standard mortgage once 

the favorable terms cease and a higher 

payment results) promotes needed 

refinances consistent with congressional 

intent. 

In the Board’s view, the payment that 

the consumer is currently making on the 

existing non-standard mortgage may be 

an inappropriately low payment to 

compare to the standard mortgage 

payment. The existing payments may be 

interest-only or negatively amortizing; 

these temporarily lower payment 

amounts would be difficult for creditors 

to ‘‘reduce’’ with a refinanced loan that 

has a comparable term length and 

principal amount. Indeed, the payment 

on a new loan with a fixed-rate rate and 

fully-amortizing payment, as is required 

for the payment calculation of a 

standard mortgage under proposed 

§ 226.43(d)(5)(ii), for example, is likely 

to be higher than the interest-only or 

negative amortization payment. As a 

result, few refinancings would yield a 

lower monthly payment, so many 

consumers could not receive the 

benefits of refinancing into a more 

stable loan product. In addition, 

streamlined refinances by GSEs and 

private creditors might be severely 

hampered, with potentially detrimental 

effects on the market. 

Thus the proposal requires a creditor 

to calculate the monthly payment for a 

non-standard mortgage using— 

• The fully indexed rate as of a 

reasonable period of time before or after 

the date on which the creditor receives 

the consumer’s written application for 

the standard mortgage; 

• The term of the loan remaining as 

of the date of the recast, assuming all 

scheduled payments have been made up 

to the recast date and the payment due 

on the recast date is made and credited 

as of that date; and 

• A remaining loan amount that is— 

Æ For an adjustable-rate mortgage 

under § 226.43(d)(2)(i)(A), the 

outstanding principal balance as of the 

date the mortgage is recast, assuming all 

scheduled payments have been made up 

to the recast date and the payment due 

on the recast date is made and credited 

as of that date; 

Æ For an interest-only loan under 

§ 226.43(d)(2)(i)(B), the loan amount, 

assuming all scheduled payments have 

been made up to the recast date and the 

payment due on the recast date is made 

and credited as of that date; 

Æ For a negative amortization loan 

under § 226.43(d)(2)(i)(C), the maximum 

loan amount. 

Proposed comment 43(d)(5)(i)–1 

explains that, to determine whether the 

monthly periodic payment for a 

standard mortgage is materially lower 

than the monthly periodic payment for 

the non-standard mortgage under 

§ 226.43(d)(1)(ii), the creditor must 

consider the monthly payment for the 

non-standard mortgage that will result 

after the loan is ‘‘recast,’’ as defined in 

§ 226.43(b)(11), assuming substantially 

equal payments of principal and interest 

that amortize the remaining loan 

amount over the remaining term as of 

the date the mortgage is recast. This 

comment notes that guidance regarding 

the meaning of ‘‘substantially equal’’ and 

‘‘recast’’ is provided comment 

43(c)(5)(i)–4 and § 226.43(b)(11), 

respectively (discussed above). 

Proposed comment 43(d)(5)(i)–2 

explains that the term ‘‘fully indexed 

rate’’ used in § 226.43(d)(5)(i)(A) for 

calculating the payment for a nonstandard mortgage is generally defined 

in § 226.43(b)(3) and associated 

commentary. The comment explains an 

important difference between the ‘‘fully 

indexed rate’’ as defined in 

§ 226.43(b)(3), however, and the 

meaning of ‘‘fully indexed rate’’ in 

§ 226.43(d)(5)(i). Specifically, under 

§ 226.43(b)(3), the fully indexed rate is 

calculated at the time of consummation. 

Under § 226.43(d)(5)(i), the fully 

indexed rate is calculated within 

reasonable period of time before or after 

the date on which the creditor receives 

the consumer’s written application for 

the standard mortgage. Comment 

43(d)(5)(i)–2 clarifies that 30 days 

would generally be considered a 

‘‘reasonable period of time.’’ 


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27450 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

Proposed comment 43(d)(5)(i)–3 

clarifies that the term ‘‘written 

application’’ is explained in comment 

19(a)(1)(i)–3. Comment 19(a)(1)(i)–3 

states that creditors may rely on RESPA 

and Regulation X (including any 

interpretations issued by HUD) in 

deciding whether a ‘‘written 

application’’ has been received. In 

general, Regulation X defines 

‘‘application’’ to mean the submission of 

a borrower’s financial information in 

anticipation of a credit decision relating 

to a Federally related mortgage loan. See 

24 CFR 3500.2(b). As explained in 

comment 19(a)(1)(i)–3, an application is 

received when it reaches the creditor in 

any of the ways applications are 

normally transmitted—by mail, hand 

delivery, or through an intermediary 

agent or broker. If an application 

reaches the creditor through an 

intermediary agent or broker, the 

application is received when it reaches 

the creditor, rather than when it reaches 

the agent or broker. This comment also 

cross-references comment 19(b)–3 for 

guidance in determining whether the 

transaction involves an intermediary 

agent or broker. 

Payment calculation for an 

adjustable-rate mortgage with an 

introductory fixed rate. Proposed 

comments 43(d)(5)(i)–4 and –5 explain 

the payment calculation for an 

adjustable-rate mortgage with an 

introductory fixed rate under proposed 

§ 226.43(d)(5)(i). Proposed comment 

43(d)(5)(i)–4 clarifies that the monthly 

periodic payment for an adjustable-rate 

mortgage with an introductory fixed 

interest rate for a period of one or more 

years must be calculated based on 

several assumptions. First, the payment 

must be based on the outstanding 

principal balance as of the date on 

which the mortgage is recast, assuming 

all scheduled payments have been made 

up to that date and the last payment due 

under those terms is made and credited 

on that date. For example, assume an 

adjustable-rate mortgage with a 30-year 

loan term. The loan agreement provides 

that the payments for the first 24 

months are based on a fixed rate, after 

which the interest rate will adjust 

annually based on a specified index and 

margin. The loan is recast on the due 

date of the 24th payment. If the 24th 

payment is due on September 1, 2013, 

the creditor must calculate the 

outstanding principal balance as of 

September 1, 2013, assuming that all 24 

payments under the fixed rate terms 

have been made and credited on time. 

See comment 43(d)(5)(i)–4.i. 

Second, the payment calculation must 

be based on substantially equal monthly 

payments of principal and interest that 

will fully repay the outstanding 

principal balance over the term of the 

loan remaining as of the date the loan 

is recast. Thus, the comment states, in 

the example above, the creditor must 

assume a loan term of 28 years (336 

payments). See comment 43(d)(5)(i)– 

4.ii. Third, the payment must be based 

on the fully indexed rate, as defined in 

§ 226.43(b)(3), as of the date of the 

written application for the standard 

mortgage. See comment 43(d)(5)(i)–4.iii. 

Proposed comment 43(d)(5)(i)–5 

provides an illustration of the payment 

calculation for an adjustable-rate 

mortgage with an introductory fixed 

rate. The example first assumes a loan 

in an amount of $200,000 has a 30-year 

loan term. The loan agreement provides 

for a discounted introductory interest 

rate of 5% that is fixed for an initial 

period of two years, after which the 

interest rate will adjust annually based 

on a specified index plus a margin of 3 

percentage points. See comment 

43(d)(5)(i)–5.i. Second, the example 

states that the non-standard mortgage is 

consummated on February 15, 2011, 

and the first monthly payment is due on 

April 1, 2011. The loan is recast on the 

due date of the 24th monthly payment, 

which is March 1, 2013. See comment 

43(d)(5)(i)–5.ii. Finally, the example 

assumes that on March 15, 2012, the 

creditor receives the consumer’s written 

application for a refinancing after the 

consumer has made 12 monthly on-time 

payments and that, on this date, the 

index value is 4.5%. See comment 

43(d)(5)(i)–5.iii. 

Proposed comment 43(d)(5)(i)–5 then 

states that, to calculate the non-standard 

mortgage payment that must be 

compared to the standard mortgage 

payment under § 226.43(d)(1)(ii), the 

creditor must use— 

• The outstanding principal balance 

as of March 1, 2013, assuming all 

scheduled payments have been made up 

to March 1, 2013, and the last payment 

due under the fixed rate terms is made 

and credited on March 1, 2013. In this 

example, the outstanding principal 

balance is $193,948. 

• The fully indexed rate of 7.5%, 

which is the index value of 4.5% as of 

March 15, 2012 (the date on which the 

application for a refinancing is received) 

plus the margin of 3%. 

• The remaining loan term as of 

March 1, 2013, the date of the recast, 

which is 28 years (336 payments). 

See comment 43(d)(5)(i)–5.iv. 

The comment concludes by stating 

that, based on the assumptions above, 

the monthly payment for the nonstandard mortgage for purposes of 

determining whether the standard 

mortgage monthly payment is lower 

than the non-standard mortgage 

monthly payment (see proposed 

§ 226.43(d)(1)(ii)) is $1,383. This is the 

substantially equal, monthly payment of 

principal and interest required to repay 

the outstanding principal balance at the 

fully-indexed rate over the remaining 

term. See comment 43(d)(5)(i)–5.v. 

Payment calculation for an interestonly loan. Proposed comments 

43(d)(5)(i)–6 and –7 explain the 

payment calculation for an interest-only 

loan under proposed § 226.43(d)(5)(i). 

Proposed comment 43(d)(5)(i)–6 

clarifies that the monthly periodic 

payment for an interest-only loan must 

be calculated based on several 

assumptions. First, the payment must be 

based on the loan amount, as defined in 

§ 226.43(b)(5) (for a loan on which only 

interest and no principal has been paid, 

the ‘‘loan amount’’ will be the 

outstanding principal balance at the 

time of the recast), assuming all 

scheduled payments are made under the 

terms of the legal obligation in effect 

before the mortgage is recast. The 

comment provides an example of a 

mortgage with a 30-year loan term for 

which the first 24 months of payments 

are interest-only. The comment then 

explains that, if the 24th payment is due 

on September 1, 2013, the creditor must 

calculate the outstanding principal 

balance as of September 1, 2013, 

assuming that all 24 payments under the 

interest-only payment terms have been 

made and credited. See comment 

43(d)(5)(i)–6.i. 

Second, the payment calculation must 

be based on substantially equal monthly 

payments of principal and interest that 

will fully repay the loan amount over 

the term of the loan remaining as of the 

date the loan is recast. Thus, in the 

example above, the creditor must 

assume a loan term of 28 years (336 

payments). See comment 43(d)(5)(i)– 

6.ii. Third, the payment must be based 

on the fully indexed rate, as defined in 

§ 226.43(b)(3), as of the date of the 

written application for the standard 

mortgage. See comment 43(d)(5)(i)–6.iii. 

Proposed comment 43(d)(5)(i)–7 

provides an illustration of the payment 

calculation for an interest-only loan. 

The example assumes a loan in an 

amount of $200,000 that has a 30-year 

loan term. The loan agreement provides 

for a fixed interest rate of 7%, and 

permits interest-only payments for the 

first two years (the first 24 payments), 

after which time amortizing payments of 

principal and interest are required. See 

comment 43(d)(5)(i)–7.i. Second, the 

example states that the non-standard 

mortgage is consummated on February 

15, 2011, and the first monthly payment 

is due on April 1, 2011. The loan is 


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recast on the due date of the 24th 

monthly payment, which is March 1, 

2013. See comment 43(d)(5)(i)–7.ii. 

Finally, the example assumes that on 

March 15, 2012, the creditor receives 

the consumer’s written application for a 

refinancing, after the consumer has 

made 12 monthly on-time payments. 

See comment 43(d)(5)(i)–7.iii. 

Proposed comment 43(d)(5)(i)–7 then 

states that, to calculate the non-standard 

mortgage payment that must be 

compared to the standard mortgage 

payment under § 226.43(d)(1)(ii), the 

creditor must use— 

• The loan amount, which is the 

outstanding principal balance as of 

March 1, 2013, assuming all scheduled 

interest-only payments have been made 

and credited up to that date. In this 

example, the loan amount is $200,000. 

• An interest rate of 7%, which is the 

interest rate in effect at the time of 

consummation of this fixed-rate nonstandard mortgage. 

• The remaining loan term as of 

March 1, 2013, the date of the recast, 

which is 28 years (336 payments). 

The comment concludes by stating 

that, based on the assumptions above, 

the monthly payment for the nonstandard mortgage for purposes of 

determining whether the standard 

mortgage monthly payment is lower 

than the non-standard mortgage 

monthly payment (see § 226.43(d)(1)(ii)) 

is $1,359. This is the substantially 

equal, monthly payment of principal 

and interest required to repay the loan 

amount at the fully-indexed rate over 

the remaining term. See comment 

43(d)(5)(i)–7.v. 

Payment calculation for a negative 

amortization loan. Proposed comments 

43(d)(5)(i)–8 and –9 explain the 

payment calculation for a negative 

amortization loan under proposed 

§ 226.43(d)(5)(i)(C). Proposed comment 

43(d)(5)(i)–8 clarifies that the monthly 

periodic payment for a negative 

amortization loan must be calculated 

based on several assumptions. First, the 

calculation must be based on the 

maximum loan amount, as defined in 

proposed § 226.43(b)(7); The comment 

further states that examples of how to 

calculate the maximum loan amount are 

provided in proposed comment 

43(b)(7)–3 (see the section-by-section 

analysis of § 226.43(b)(7), above). See 

comment 43(d)(5)(i)–8.i. 

Second, the payment calculation must 

be based on substantially equal monthly 

payments of principal and interest that 

will fully repay the maximum loan 

amount over the term of the loan 

remaining as of the date the loan is 

recast. For example, the comment states, 

if the loan term is 30 years and the loan 

is recast on the due date of the 60th 

monthly payment, the creditor must 

assume a loan term of 25 years (300 

payments). See comment 43(d)(5)(i)– 

8.ii. Third, the payment must be based 

on the fully-indexed rate as of the date 

of the written application for the 

standard mortgage. See comment 

43(d)(5)(i)–8.iii. 

Proposed comment 43(d)(5)(i)–9 

provides an illustration of the payment 

calculation for a negative amortization 

loan. The example assumes loan in an 

amount of $200,000 that has a 30-year 

loan term. The loan agreement provides 

that the consumer can make minimum 

monthly payments that cover only part 

of the interest accrued each month until 

the date on which the principal balance 

increases to the negative amortization 

cap of 115% of the loan amount, or for 

the first five years of monthly payments 

(60 payments), whichever occurs first. 

The loan is an adjustable-rate mortgage 

that adjusts monthly according to a 

specified index plus a margin of 3.5%. 

See comment 43(d)(5)(i)–9.i. 

The example also states that the nonstandard mortgage is consummated on 

February 15, 2011, and the first monthly 

payment is due on April 1, 2011. 

Further, the example assumes that, 

based on the calculation of the 

maximum loan amount required under 

§ 226.43(b)(7) and associated 

commentary, the negative amortization 

cap of 115% is reached on July 1, 2013, 

the due date of the 28th monthly 

payment (i.e., before the 60th payment 

is due). See comment 43(d)(5)(i)–9.ii. 

Finally, the example assumes that on 

March 15, 2012, the creditor receives 

the consumer’s written application for a 

refinancing, after the consumer has 

made 12 monthly on-time payments. On 

this date, the index value is 4.5%. See 

comment 43(d)(5)(i)–9.iii. 

Proposed comment 43(d)(5)(i)–9 then 

states that, to calculate the non-standard 

mortgage payment that must be 

compared to the standard mortgage 

payment under § 226.43(d)(1)(ii), the 

creditor must use— 

• The maximum loan amount of 

$229,243 as of July 1, 2013. 

• The fully indexed rate of 8%, which 

is the index value of 4.5% as of March 

15, 2012 (the date on which the creditor 

receives the application for a 

refinancing) plus the margin of 3.5%. 

• The remaining loan term as of July 

1, 2013, the date of the recast, which is 

27 years and 8 months (332 monthly 

payments). 

See comment 43(d)(5)(i)–9.iv. 

The comment concludes by stating 

that, based on the assumptions above, 

the monthly payment for the nonstandard mortgage for purposes of 

determining whether the standard 

mortgage monthly payment is lower 

than the non-standard mortgage 

monthly payment (see § 226.43(d)(1)(ii)) 

is $1,717. This is the substantially 

equal, monthly payment of principal 

and interest required to repay the 

maximum loan amount at the fullyindexed rate over the remaining term. 

See comment 43(d)(5)(i)–9.v. 

The Board requests comment on the 

proposed payment calculation for a nonstandard mortgage and on the 

appropriateness and usefulness of the 

proposed payment calculation 

examples. 

43(d)(5)(ii) Standard Mortgage Payment 

Calculation 

Proposed § 226.43(d)(5)(ii) prescribes 

the required calculation for the monthly 

payment on a standard mortgage that 

must be compared to the monthly 

payment on a non-standard mortgage 

under proposed § 226.43(d)(1)(ii). The 

same payment calculation must also be 

used by creditors of refinances under 

proposed § 226.43(d) in determining 

whether the consumer has a reasonable 

ability to repay the standard mortgage, 

as required under proposed 

§ 226.43(c)(2)(ii). 

Specifically, the monthly payment for 

a standard mortgage must be based on 

substantially equal, monthly, fully 

amortizing payments using the 

maximum interest rate that may apply 

to the standard mortgage within the first 

five years after consummation. Proposed 

comment 43(d)(5)(ii)–1 clarifies that the 

meaning of ‘‘fully amortizing payment’’ 

is defined in § 226.43(b)(2), discussed 

above, and that guidance regarding the 

meaning of ‘‘substantially equal’’ may be 

found in proposed comment 43(c)(5)(i)– 

4, also discussed above. Proposed 

comment 43(d)(5)(ii)–1 also explains 

that, for a mortgage with a single, fixed 

rate for the first five years, the 

maximum rate that will apply during 

the first five years after consummation 

will be the rate at consummation. For a 

step-rate mortgage, however, which is a 

type of fixed-rate mortgage, the rate that 

must be used is the highest rate that will 

apply during the first five years after 

consummation. For example, if the rate 

for the first two years is 4%, the rate for 

the second two years is 5%, and the rate 

for the next two years is 6%, the rate 

that must be used is 6%. 

Proposed comment 43(d)(5)(ii)–2 

provides an illustration of the payment 

calculation for a standard mortgage. The 

example assumes a loan in an amount 

of $200,000 with a 30-year loan term. 

The loan agreement provides for a 

discounted interest rate of 6% that is 

fixed for an initial period of five years, 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
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after which time the interest rate will 

adjust annually based on a specified 

index plus a margin of 3%, subject to a 

2% annual interest rate adjustment cap. 

The comment states that, based on the 

above assumptions, the creditor must 

determine whether the standard 

mortgage payment is materially lower 

than the non-standard mortgage 

payment based on a standard mortgage 

payment of $1,199. This is the 

substantially equal, monthly payment of 

principal and interest required to repay 

$200,000 over 30 years at an interest 

rate of 6%. 

The Board requests comment on the 

proposed payment calculation for a 

standard mortgage. 

43(e) Qualified Mortgages 

Background 

The Dodd-Frank Act. TILA Section 

129C(a)(1) prohibits a creditor from 

making a residential mortgage loan 

unless the creditor makes a reasonable 

and good faith determination, based on 

verified and documented information, 

that the consumer has a reasonable 

ability to repay the loan. TILA Section 

129C(a)(1)–(4) and (6)–(9) provides that 

the ability-to-repay determination must 

be based on consideration of the 

following underwriting factors: 

• The consumer’s current income, 

expected income the consumer is 

reasonably ensured of receiving, and 

other financial resources other than the 

consumer’s equity in the dwelling or 

real property that secures repayment of 

the loan; 

• The consumer’s employment status; 

• The payment of the residential 

mortgage loan based on a fully 

amortizing payment schedule and the 

fully-indexed rate; 

• The payment of any simultaneous 

liens of which the creditor knows or has 

reason to know; 

• The payment of all applicable taxes, 

insurance (including mortgage 

guarantee insurance), and assessments; 

• The consumer’s current obligations; 

• The consumer’s debt-to-income 

ratio or the residual income the 

consumer will have after paying 

mortgage related obligations and current 

debt obligations; and 

• The consumer’s credit history. 

The ability-to-repay requirements do 

not contain any limits on the features, 

term, or costs of the loan. 

TILA Section 129C(b) provides a 

presumption of compliance with the 

ability-to-repay requirements if the loan 

is a ‘‘qualified mortgage.’’ Specifically, 

TILA Section 129C(b)(1) provides that 

‘‘[a]ny creditor with respect to any 

residential mortgage loan, and any 

assignee of such loan subject to liability 

under this title, may presume that the 

loan has met the requirements of 

subsection (a).’’ With respect to 

underwriting requirements, TILA 

Section 129C(b)(2) defines a ‘‘qualified 

mortgage’’ as any residential mortgage 

loan— 

• For which the income and financial 

resources relied upon to qualify the 

obligors on the loan are verified and 

documented; 

• For which the underwriting of the 

residential mortgage loan is based on a 

fully amortizing payment schedule and 

the maximum interest rate during the 

first 5 years, and takes into account all 

applicable taxes, insurance, and 

assessments; and 

• That complies with any guidelines 

or regulations established by the Board 

relating to ratios of total monthly debt 

to monthly income or alternative 

measures of ability to pay regular 

expenses after payment of total monthly 

debt, taking into account the income 

levels of the borrower and such other 

factors as the Board may determine 

relevant and consistent with the 

purposes of TILA Section 

129C(b)(3)(B)(i). 

In addition, the term ‘‘qualified 

mortgage’’ contains certain limits on the 

features, term, and costs of the loan. 

Specifically, TILA Section 129C(b) 

provides that a ‘‘qualified mortgage’’ is 

any residential mortgage loan— 

• For which the regular periodic 

payments may not result in an increase 

of the principal balance (negative 

amortization) or allow the consumer to 

defer repayment of principal (interestonly payments); 

• The terms of which do not result in 

a balloon payment; 

• For which the loan term does not 

exceed 30 years; and 

• For which the points and fees do 

not exceed 3 percent of the total loan 

amount. 

Accordingly, a qualified mortgage 

cannot have an increase of the principal 

balance, interest-only payments, balloon 

payments, a term greater than 30 years, 

or points and fees that exceed the 

threshold set forth in § 226.43(e)(4). 

However, while the term ‘‘qualified 

mortgage’’ limits the terms of loans in 

ways that the general ability-to-repay 

requirements do not, the term ‘‘qualified 

mortgage’’ omits certain underwriting 

factors. Specifically, the term ‘‘qualified 

mortgage’’ does not include the 

following underwriting factors that are 

part of the ability-to-repay requirements: 

• The consumer’s employment status; 

• The payment of any simultaneous 

liens of which the creditor knows or has 

reason to know; 

• The consumer’s current obligations; 

and 

• The consumer’s credit history. 

2008 HOEPA Final Rule. Sections 

226.34(a)(4) and 226.35(b)(1) prohibit a 

creditor from extending credit that is a 

high-cost loan or higher-priced mortgage 

loan without regard to the consumer’s 

ability to repay. Specifically, for higherpriced mortgage loans and high-cost 

mortgages, the creditor must follow 

required procedures, such as verifying 

the consumer’s income or assets. 

Section 226.34(a)(4) and comments 

34(a)(4)–2 and –3. The 2008 HOEPA 

Final Rule further provides a 

presumption of compliance with the 

ability-to-repay requirements if the 

creditor follows additional optional 

procedures regarding underwriting the 

loan payment, assessing the debt-toincome ratio or residual income, and 

limiting the features of the loan. Section 

226.34(a)(4)(iii)–(iv) and comment 

34(a)(4)(iii)–1. However, the 2008 

HOEPA Final Rule makes clear that 

even if the creditor follows the required 

and optional criteria, the creditor has 

merely obtained a presumption of 

compliance with the repayment ability 

requirement. Comment 34(a)(4)(iii)–1. 

The consumer can still rebut or 

overcome that presumption by showing 

that, despite following the required and 

optional procedures, the creditor 

nonetheless disregarded the consumer’s 

ability to repay the loan. For example, 

the consumer could present evidence 

that although the creditor assessed the 

creditor’s debt-to-income ratio, the debtto-income ratio was very high with little 

residual income. This evidence may be 

sufficient to overcome the presumption 

of compliance and demonstrate that the 

creditor extended credit without regard 

to the consumer’s ability to repay the 

loan. 

Qualified Mortgages and the 

Presumption of Compliance 

With regard to the ability-to-repay 

requirement, the Dodd-Frank Act 

provides special protection from 

liability for creditors who make 

‘‘qualified mortgages.’’ However, it is 

unclear whether that protection is 

intended to be a safe harbor or a 

presumption of compliance with the 

ability-to-repay requirement. An 

analysis of the statutory construction 

and policy implications demonstrate 

that there are sound reasons for 

adopting either interpretation. For this 

reason, the Board is proposing two 

alternative definitions of a ‘‘qualified 

mortgage’’: One that operates as a safe 

harbor and one that operates as a 

presumption of compliance. 


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With respect to statutory construction, 

on the one hand, the Dodd-Frank Act 

states that a creditor or assignee ‘‘may 

presume’’ that a loan has met the 

repayment ability requirement if the 

loan is a qualified mortgage. TILA 

Section 129C(b)(1). This suggests that 

originating a qualified mortgage 

provides a presumption of compliance, 

which the consumer can rebut by 

providing evidence that the creditor did 

not, in fact, make a good faith and 

reasonable determination of the 

consumer’s ability to repay the loan. 

On the other hand, the statutory 

structure suggests that the ‘‘qualified 

mortgage’’ is an alternative to the general 

ability-to-repay standard and thus 

would operate as a safe harbor. First, 

TILA Section 129C(b)(1) states that a 

creditor or assignee may presume that a 

loan has ‘‘met the requirements of 

subsection (a), if the loan is a qualified 

mortgage.’’ TILA Section 129C(a) 

contains the ability-to-repay 

requirement as well as all of the 

underwriting criteria for the general 

ability-to-repay standard. Rather than 

stating that the presumption of 

compliance applies only to TILA 

Section 129C(a)(1) for the ability-torepay requirement, it appears Congress 

intended creditors who make qualified 

mortgages to be presumed to comply 

with both the ability-to-repay 

requirement and the underwriting 

criteria for the general ability-to-repay 

standard. Second, TILA Section 

129C(b)(2) does not define a ‘‘qualified 

mortgage’’ as requiring compliance with 

all of the underwriting criteria of the 

general ability-to-repay standard. 

Therefore, unlike the approach found in 

the 2008 HOEPA Final Rule, it appears 

that the criteria for a ‘‘qualified 

mortgage’’ would be an alternative to the 

general ability-to-repay standard, rather 

than an addition to that standard. 

With respect to the policy 

implications, there are sound reasons 

for interpreting a qualified mortgage as 

providing either a safe harbor or a 

presumption of compliance. On the one 

hand, interpreting a ‘‘qualified 

mortgage’’ as a safe harbor would 

provide creditors with an incentive to 

make qualified mortgages. That is, in 

exchange for limiting loan fees and 

features, the creditor’s regulatory 

burden and exposure to liability would 

be reduced. Consumers may benefit by 

being provided with mortgage loans that 

do not have certain risky features or 

high costs. 

However, there are at least two 

drawbacks to the ‘‘safe harbor’’ 

approach. First, the definition of a 

‘‘qualified mortgage’’ is not necessarily 

consistent with ensuring the consumer’s 

ability to repay the loan. Some of the 

key elements in the statutory definition 

of a qualified mortgage, while designed 

to ensure that qualified mortgages do 

not contain risky features, do not 

directly address whether a qualified 

mortgage is affordable for a particular 

borrower. Although the qualified 

mortgage limits on loan terms and costs 

may, in general, tend to make loans 

more affordable (in part because loan 

terms would be more transparent to 

consumers thus enabling consumers to 

more easily determine affordability for 

themselves), the limits on loan terms 

and costs would not ensure that a given 

consumer could necessarily afford a 

particular loan. Second, the ‘‘safe 

harbor’’ approach would limit the 

consumer’s ability to challenge a 

creditor’s determination of repayment 

ability. That is, creditors could not be 

challenged for failing to underwrite the 

loan based on the consumer’s 

employment status, simultaneous loans, 

current debt obligations, or credit 

history, or for generally not making a 

reasonable and good faith determination 

of the consumer’s ability to repay the 

loan. 

On the other hand, interpreting a 

‘‘qualified mortgage’’ as providing a 

rebuttable presumption of compliance 

would better ensure that creditors 

consider a consumer’s ability to repay 

the loan. Creditors would have to make 

individualized determinations that the 

consumer has the ability to repay the 

loan based on all of the underwriting 

factors listed in the general ability-torepay standard. This approach would 

require the creditor to comply with all 

of the ability-to-repay standards, and 

preserve the consumer’s ability to use 

these standards in a defense to 

foreclosure or other legal action. In 

addition, a consumer could assert that, 

despite complying with the criteria for 

a qualified mortgage and the ability-torepay standard, the creditor did not 

make a reasonable and good faith 

determination of the consumer’s ability 

to repay the loan. 

The drawback of treating a ‘‘qualified 

mortgage’’ as providing a presumption of 

compliance is that it provides little legal 

certainty for the creditor, and thus little 

incentive to make a ‘‘qualified 

mortgage,’’ which limits loan fees and 

features. As stated above, the 

underwriting requirements found in the 

general repayment ability rule are based 

on individualized determinations that 

will vary from consumer to consumer. 

As such, creditors or assignees may not 

be able to make bright-line judgments as 

to whether or not a loan complies with 

these underwriting requirements. In 

many cases sound underwriting 

practices require judgment about the 

relative weight of various risk factors 

(such as the tradeoff between a 

consumer’s credit history and debt-toincome ratio). These decisions are 

usually based on complex statistical 

default models or lender judgments, 

which will differ across originators and 

over time. While the Board’s proposal 

would allow creditors to look to widely 

accepted underwriting standards in 

complying with the general ability-torepay standard, those standards may 

leave room for the exercise of discretion 

and judgment by creditors and loan 

originators which could increase 

potential compliance and litigation risk, 

thus weakening the incentive to make 

qualified mortgages (even with a 

presumption of compliance for qualified 

mortgages). As stated above, a violation 

of the ability-to-repay requirement now 

provides a consumer with a defense to 

foreclosure for an unlimited amount of 

time. Dodd-Frank Act Section 1413; 

TILA Section 130(k). 

The Board’s Proposal 

Given the statutory ambiguity and 

competing concerns described above, 

the Board proposes two alternative 

definitions for a qualified mortgage. 

Under Alternative 1, a qualified 

mortgage would include only the 

specific requirements listed in TILA 

Section 129C(b)(2), and would provide 

creditors with a safe harbor to establish 

compliance with the general repayment 

ability requirement in proposed 

§ 226.43(c)(1). That is, a consumer 

would have to show that a loan was not 

a qualified mortgage under § 226.43(e) 

(e.g., that the loan permits negative 

amortization) in order to assert that the 

loan violated the repayment ability 

requirement under § 226.43(c). Under 

Alternative 2, a qualified mortgage 

would include the specific requirements 

listed in the TILA Section 129C(b)(2), as 

well as additional requirements taken 

from the proposed general ability-torepay standard in § 226.43(c)(2)–(7). 

Because Alternative 2 would require 

compliance with the general ability-torepay standard, it would provide a 

presumption of compliance with the 

ability-to-repay requirement. However, 

as discussed more fully below, a 

consumer would be able to rebut the 

presumption of compliance (even if the 

loan was a qualified mortgage) by 

demonstrating that the creditor did not 

adequately determine the consumer’s 

ability to repay the loan. 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
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66See Demyanyk Yuliya & Van Hemert, Otto 

Understanding the Subprime Mortgage Crisis, The 

Review of Financial Studies (2009); Berkovec, 

James A., Canner, Glenn B., Gabriel, Stuart A., and 

Hannan, Timothy H., Race, Redlining, and 

Residential Mortgage Loan Performance. The 

Journal of Real Estate Finance and Economics 

(2004). 

43(e)(1) In General 

ALTERNATIVE 1 

Proposed § 226.43(e)(1) would 

implement TILA Section 129C(b)(1) and 

state that the creditor or assignee 

complies with § 226.43(c)(1) if the 

covered transaction is a qualified 

mortgage, as defined in § 226.43(e)(2). 

Proposed § 226.43(e)(2) would 

implement TILA Section 129C(b)(2), 

and state that a ‘‘qualified mortgage’’ is 

a covered transaction— 

• That provides for regular periodic 

payments that do not— 

Æ Result in an increase of the 

principal balance (negative 

amortization); 

Æ Allow the consumer to defer 

repayment of principal (i.e., interestonly payments); or 

Æ Result in a balloon payment; 

• For which the loan term does not 

exceed 30 years; 

• For which the total points and fees 

payable in connection with the loan do 

not exceed the threshold set forth in 

§ 226.43(e)(3); 

• For which the creditor underwrites 

the loan using the following method: 

Æ The creditor uses a periodic 

payment of principal and interest based 

on the maximum interest rate that may 

apply during the first 5 years after 

consummation; 

Æ The periodic payments of principal 

and interest would fully repay either the 

loan amount over the loan term; or the 

outstanding principal balance as of the 

date the interest rate adjusts to the 

maximum interest rate; 

Æ The creditor takes into account any 

mortgage-related obligations; and 

• For which the creditor considers 

and verifies the consumer’s current or 

reasonably expected income or assets. 

Alternative 1 would construe the 

statutory text to provide creditors with 

bright-line standards as an incentive to 

make loans without certain risky 

features and high costs. The statutory 

definition of a ‘‘qualified mortgage’’ 

includes only items which would allow 

creditors and assignees to easily and 

efficiently verify whether or not a loan 

is a ‘‘qualified mortgage.’’ By confining 

the qualified mortgage definition to 

certain loan terms, features, and costs, 

and by requiring only that the loan be 

underwritten based on certain 

straightforward assumptions and using 

verified information about the 

consumer’s income or assets, creditors 

and assignees can obtain a high degree 

of certainty that a loan is a qualified 

mortgage. Moreover, by clarifying that a 

qualified mortgage is a safe harbor for 

compliance with the general repayment 

ability rule, Alternative 1 would provide 

creditors and assignees with the highest 

level of certainty about potential legal 

and compliance risks and, 

concomitantly, the strongest incentive 

to make qualified mortgages. 

Accordingly, proposed comment 

43(e)(1)–1-Alternative 1 would clarify 

that a creditor assignee complies with 

§ 226.43(c)(1) if a covered transaction 

meets the conditions for a ‘‘qualified 

mortgage’’ under § 226.43(e)(2) (or 

§ 226.43(f), if applicable). That is, a 

creditor or assignee need not 

demonstrate compliance with 

§ 226.43(c)(2)–(7) if the terms of the loan 

comply with § 226.43(e)(2)(i)–(ii) (or 

§ 226.43(f), if applicable); the loan’s 

points and fees do not exceed the limits 

set forth in § 226.43(e)(2)(iii); and the 

creditor has complied with the 

underwriting criteria described in 

§ 226.43(e)(2)(iv)–(v) (or § 226.43(f), if 

applicable). The consumer may show 

the loan is not a qualified mortgage with 

evidence that the terms, points and fees, 

or underwriting not comply with 

§ 226.43(e)(2) (or § 226.43(f), if 

applicable). If a loan is not a qualified 

mortgage (for example because the loan 

provides for negative amortization), 

then the creditor or assignee must 

demonstrate that loan complies with all 

of the requirements in § 226.43(c) (or 

§ 226.43(d), if applicable). 

Debt-to-income ratio and residual 

income. While consideration of a 

consumer’s debt-to-income ratio is 

required under the general ability-torepay standard, TILA Section 

129C(b)(2)(A)(vi) provides that qualified 

mortgages must comply with any 

guidelines or regulations established by 

the Board for the consumer’s DTI ratio 

or residual income. For several reasons, 

under Alternative 1 the Board is not 

proposing to require creditors to 

consider the consumer’s debt-to-income 

ratio or residual income to make a 

qualified mortgage. First, the debt-toincome ratio and residual income are 

based on widely accepted standards, 

which, although flexible, do not provide 

certainty that a loan is a qualified 

mortgage. Congress seems to have 

intended to provide incentives to 

creditors to make qualified mortgages, 

since they have less risky terms and 

features. Second, because the definition 

of a qualified mortgage under 

Alternative 1 would not require 

consideration of current debt obligations 

or simultaneous loans, it would be 

impossible for a creditor to calculate the 

debt-to-income ratio or residual income 

without adding those requirements as 

well. Third, data show that the debt-toincome ratio generally does not have 

significant predictive power of loan 

performance once the effects of credit 

history, loan type, and loan-to-value 

ratio are considered.66 Fourth, although 

consideration of the mortgage debt-toincome ratio, the so-called ‘‘front-end 

debt-to-income ratio,’’ might help ensure 

that consumers receive loans on terms 

that reasonably reflect their ability to 

repay the loans, Board outreach 

indicated that creditors often do not 

find that the ‘‘front-end debt-to-income 

ratio’’ is a strong predictor of ability to 

repay. 

Finally, the Board is concerned that 

the benefit of including the debt-toincome ratio or residual income in the 

definition of ‘‘qualified mortgage’’ may 

not outweigh the cost to certain 

consumers. In some cases, consumers 

may not meet widely accepted debt-toincome ratio standards, but may have 

other compensating factors, such as 

sufficient residual income or other 

resources, to be able to reasonably to 

afford mortgage payments. A definition 

of ‘‘qualified mortgage’’ that required 

creditors to consider the consumer’s 

debt-to-income ratio or residual income 

could limit the availability of credit to 

those consumers. While some creditors 

may be willing to take on the potential 

compliance costs associated with 

considering compensating factors, other 

creditors may choose not to extend 

qualified mortgages to consumers who 

do not meet the creditor’s specific 

thresholds. 

ALTERNATIVE 2 

Under Alternative 2, a qualified 

mortgage would include the 

requirements in proposed 

§ 226.43(e)(2)–Alternative 1, as well as 

additional ability-to-repay requirements. 

Specifically, proposed § 226.43(e)(2)(v)– 

Alternative 2 would require the creditor 

(by a cross-reference to the creditor’s 

obligations in § 226.43(c)) to consider 

the following under the ability-to-repay 

requirements: (1) The consumer’s 

employment status, (2) any 

simultaneous loans, (3) the consumer’s 

current debt obligations, and (4) the 

consumer’s credit history. Proposed 

§ 226.43(e)(1)–Alternative 2 would 

implement TILA Section 129C(b)(1), 

and state that a creditor or assignee of 

a covered transaction is presumed to 

have complied with the repayment 

ability requirement of § 226.43(c)(1) if 

the covered transaction is a qualified 

mortgage, as defined in § 226.43(e)(2). 


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67As discussed below in this section-by-section 

analysis, in certain limited situations, a creditor 

may comply with the requirements of § 226.43(f) 

instead of certain requirements § 226.43(e). 

As discussed further below, the Board 

proposes these revisions to the 

definition of a ‘‘qualified mortgage’’ 

under its authority under TILA Section 

129C(b)(3)B)(i). The Board believes this 

alternative definition would further the 

purpose of TILA Section 129C by 

requiring creditors to consider specific 

underwriting criteria to ensure a 

consumer’s ability to repay a qualified 

mortgage. In addition, proposed 

§ 226.43(e)(2)(v)–Alternative 2 

implements TILA Section 129C(b)(2)(vi) 

by requiring creditors to consider the 

consumer’s monthly debt-to-income 

ratio or residual income, as provided in 

proposed § 226.43(c)(2)(vii). 

Proposed comment 43(e)(1)–1– 

Alternative 2 provides that a creditor or 

assignee is presumed to have complied 

with the requirement of § 226.43(c)(1) if 

the terms of the loan comply with 

§ 226.43(e)(2)(i)–(ii) (or § 226.43(f), if 

applicable); the loan’s points and fees 

do not exceed the limit set forth in 

§ 226.43(e)(2)(iii); and the creditor has 

complied with the underwriting criteria 

described in § 226.43(e)(2)(iv)–(v) (or 

§ 226.43(f), if applicable). If the loan is 

not a qualified mortgage (for example, 

because the loan provides for negative 

amortization), then the creditor or 

assignee must demonstrate that the loan 

complies with all of the requirements of 

§ 226.43(c) (or § 226.43(d), if 

applicable). However, even if the loan is 

a qualified mortgage, the consumer may 

rebut the presumption of compliance 

with evidence that the loan did not 

comply with § 226.43(c)(1). For 

example, evidence of a debt-to-income 

ratio with no compensating factors, such 

as adequate residual income, could be 

used to rebut the presumption. The 

Board solicits comment on this 

approach. 

The Board solicits comments on the 

two proposed alternative definitions of 

a qualified mortgage, or other alternative 

definitions. The Board specifically 

solicits comment, including supporting 

data, on what criteria should be 

included in the definition of a qualified 

mortgage to ensure that the definition 

provides an incentive to creditors to 

make qualified mortgages, while also 

ensuring that consumers have the ability 

to repay qualified mortgages. 

43(e)(2) Qualified Mortgage Defined 

Proposed § 226.43(e)(2) implements 

TILA Section 129C(b)(2) and states that 

a ‘‘qualified mortgage’’ is a covered 

transaction— 

• That provides for regular periodic 

payments that do not: 

Æ Result in an increase of the 

principal balance (i.e., negative 

amortization); 

Æ Allow the consumer to defer 

repayment of principal (i.e., interestonly payments); or 

Æ Result in a balloon payment; 

• For which the loan term does not 

exceed 30 years; 

• For which the total points and fees 

payable in connection with the loan do 

not exceed the threshold set forth in 

§ 226.43(e)(3); 

• For which the creditor underwrites 

the loan using the following method: 

Æ The creditor uses a periodic 

payment of principal and interest based 

on the maximum interest rate that may 

apply during the first 5 years after 

consummation; 

Æ The periodic payments of principal 

and interest would fully repay either the 

loan amount over the loan term; or the 

outstanding principal balance as of the 

date the interest adjusts to the 

maximum interest rate; 

Æ The creditor takes into account any 

mortgage-related obligations; and 

• For which the creditor considers 

and verifies the consumer’s current or 

reasonably expected income or assets.67

43(e)(2)(i) Limits on Periodic Payments 

TILA Section 129C(b)(2)(A)(i) states 

that the regular periodic payments of a 

qualified mortgage may not result in an 

increase of the principal balance or 

allow the consumer to defer repayment 

of principal (except for certain balloonpayment loans, discussed below in the 

section-by-section analysis for 

§ 226.43(f)). TILA Section 

129C(b)(2)(A)(ii) states that the terms of 

a qualified mortgage may not include a 

balloon payment (except for certain 

balloon-payment loans, discussed below 

in the section-by-section analysis for 

§ 226.43(f)). The statute defines ‘‘balloon 

payment’’ as ‘‘a scheduled payment that 

is more than twice as large as the 

average of earlier scheduled payments.’’ 

Proposed § 226.43(e)(2)(i) implements 

TILA Sections 129C(b)(2)(A)(i) and (ii). 

First, the proposed provision requires 

that a qualified mortgage provide for 

regular periodic payments. Proposed 

comment 43(e)(2)(i)–1 clarifies that, for 

this reason, a single-payment 

transaction, where no payment of 

principal or interest is required until 

maturity, may not be a qualified 

mortgage. Second, proposed 

§ 226.43(e)(2)(i) provides that the 

regular periodic payments may not 

(1) result in an increase of the principal 

balance; (2) allow the consumer to defer 

repayment of principal, except as 

provided in § 226.43(f), discussed 

below; or (3) result in a balloon 

payment, as defined in § 226.18(s)(5)(i), 

except as provided in § 226.43(f), 

discussed below. 

Proposed comment 43(e)(2)(i)–1 

explains that, as a consequence of the 

foregoing prerequisites, a qualified 

mortgage must require the consumer to 

make payments of principal and 

interest, on a monthly or other periodic 

basis, that will fully repay the loan 

amount over the loan term. These 

periodic payments must be substantially 

equal except for the effect that any 

interest rate change after consummation 

has on the payment amount in the case 

of an adjustable-rate or step-rate 

mortgage. The proposed comment also 

notes that, because § 226.43(e)(2)(i) 

requires that a qualified mortgage 

provide for regular, periodic payments, 

a single-payment transaction may not be 

a qualified mortgage. This result would 

prevent potential evasion, as a creditor 

otherwise could structure a transaction 

with a single payment due at maturity 

(economically, a near equivalent to a 

balloon-payment loan) that technically 

would not be a balloon payment as 

defined in § 226.18(s)(5)(i) because it is 

not more than two times a regular 

periodic payment. 

Proposed comment 43(e)(2)(i)–2 

provides additional guidance on the 

requirement in proposed 

§ 226.43(e)(2)(i)(B) that a qualified 

mortgage may not allow the consumer to 

defer repayment of principal. The 

comment clarifies that, in addition to 

interest-only terms, deferred principal 

repayment also occurs if the payment is 

applied to both accrued interest and 

principal but the consumer makes 

periodic payments that are less than the 

amount that would be required under a 

payment schedule that has substantially 

equal payments that fully repay the loan 

amount over the loan term. Graduated 

payment mortgages, for example, allow 

deferral of principal repayment in this 

manner and therefore may not be 

qualified mortgages. 

As noted above, the statute defines 

‘‘balloon payment’’ as ‘‘a scheduled 

payment that is more than twice as large 

as the average of earlier scheduled 

payments.’’ Proposed § 226.43(e)(2)(i)(C) 

cross-references Regulation Z’s existing 

definition of ‘‘balloon payment’’ in 

§ 226.18(s)(5)(i). That definition 

provides that a balloon payment is ‘‘a 

payment that is more than two times a 

regular periodic payment.’’ This 

definition is substantially similar to the 

statutory one, except that it uses as its 

benchmark any regular periodic 

payment rather than the average of 

earlier scheduled payments. 


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The Board believes that, because a 

qualified mortgage generally must 

provide for substantially equal, fully 

amortizing payments of principal and 

interest, a payment that is greater than 

twice any one of a loan’s regular 

periodic payments also generally will be 

greater than twice the average of its 

earlier scheduled payments. Thus, the 

Board believes that the difference in 

wording between the statutory 

definition and the existing regulatory 

definition, as a practical matter, does 

not yield a significant difference in what 

constitutes a ‘‘balloon payment’’ in the 

qualified mortgage context. 

Accordingly, in the interest of 

facilitating compliance by affording 

creditors a single definition within 

Regulation Z, the Board is proposing to 

cross-reference § 226.18(s)(5)(i)’s 

definition of ‘‘balloon payment’’ in 

§ 226.43(e)(2)(i)(C). The Board proposes 

this adjustment to the statutory 

definition pursuant to its authority 

under TILA Section 105(a) to make such 

adjustments for all or any class of 

transactions as in the judgment of the 

Board are necessary or proper to 

facilitate compliance with TILA. 15 

U.S.C. 1604(a). The class of transactions 

for which this adjustment is proposed is 

all covered transactions, i.e., closed-end 

consumer credit transactions that are 

secured by a dwelling. The Board 

solicits comment on the appropriateness 

of this proposed adjustment to the 

definition of ‘‘balloon payment.’’ This 

approach is further supported by the 

Board’s authority under TILA Section 

129B(e) to condition terms, acts or 

practices relating to residential mortgage 

loans that the Board finds necessary or 

proper to facilitate compliance. 15 

U.S.C. 1639b(e). 

The Board recognizes that some 

balloon-payment loans are renewable at 

maturity. Such loans might 

appropriately be eligible to be qualified 

mortgages, provided the terms for 

renewal eliminate the risk of the 

consumer facing a large, unaffordable 

payment obligation, which underlies the 

rationale for generally excluding 

balloon-payment loans from the 

definition of qualified mortgages. If the 

consumer is protected by the terms of 

the transaction from that risk, such a 

transaction might appropriately be 

treated as though it effectively is not a 

balloon-payment loan even if it is 

technically structured as one. 

Accordingly, the Board solicits 

comment on whether it should include 

an exception providing that, 

notwithstanding § 226.43(e)(2)(i)(C), a 

qualified mortgage may provide for a 

balloon payment if the creditor is 

unconditionally obligated to renew the 

loan at the consumer’s option (or is 

obligated to renew subject to conditions 

within the consumer’s control). The 

Board also seeks comment on how such 

an exception should be structured to 

ensure that the large-payment risk 

ordinarily accompanying a balloonpayment loan is fully eliminated by the 

renewal terms. For example, the 

exception might provide that the 

balloon-payment loan must be 

renewable on terms that either (1) do 

not include a balloon payment; or 

(2) obligate the creditor unconditionally 

(or subject to conditions within the 

consumer’s control) to renew the loan 

again upon expiration of each renewed 

loan term, and the loan term resulting 

from such multiple renewals is at least 

equal to the amortization period of the 

loan. Finally, the Board recognizes that 

such an exception could enable a 

creditor to circumvent the prohibition 

on qualified mortgages providing for 

balloon payments by structuring a 

balloon-payment loan as 

unconditionally renewable but with 

new terms that effectively render the 

loan as renewed unaffordable for the 

consumer, such as a substantially 

greater interest rate. The Board seeks 

comment on how such an exception 

might be structured to avoid the 

potential for such circumvention. 

43(e)(2)(ii) Loan Term 

TILA Section 129C(b)(2)(A)(viii) 

requires that a qualified mortgage must 

not provide for a loan term that exceeds 

30 years, ‘‘except as such term may be 

extended under paragraph (3), such as 

in high-cost areas.’’ Under TILA Section 

129C(b)(3)(B)(i), the Board is authorized 

‘‘to revise, add to, or subtract from the 

criteria that define a qualified mortgage 

upon a finding that such regulations are 

necessary or proper to ensure that 

responsible, affordable mortgage credit 

remains available to consumers in a 

manner consistent with the purposes of 

this section, necessary and appropriate 

to effectuate the purposes of this section 

and section 129B, to prevent 

circumvention or evasion thereof, or to 

facilitate compliance with such 

sections.’’ 

Proposed § 226.43(e)(2)(ii) 

implements the 30-year maximum loan 

term without any exception. Based on 

information available through outreach 

and data analysis, the Board believes 

that mortgage loans with terms greater 

than 30 years are rare and, when made, 

generally are for the convenience of 

customers who could qualify for a loan 

with a 30-year term but prefer to spread 

out their payments further. Therefore, 

the Board believes such an exception 

generally is not necessary ‘‘to ensure 

that responsible, affordable mortgage 

credit remains available to consumers’’ 

in ‘‘high-cost areas.’’ This belief is in 

contrast with the Board’s proposal to 

implement TILA Section 129C(a)(6)(E) 

concerning refinancing of an existing 

hybrid loan into a standard loan, in 

proposed § 226.43(d). As discussed in 

more detail above, proposed 

§ 226.43(d)(2) provides an exemption 

from certain repayment ability 

requirements when a creditor refinances 

a non-standard mortgage into a standard 

mortgage. Proposed § 226.43(d)(4)(ii)(C) 

permits a standard mortgage to have a 

loan term of up to 40 years. The Board 

believes that a 40-year loan term may be 

necessary to ensure affordable mortgage 

credit remains available for a 

refinancing that is being extended 

specifically to prevent a likely default, 

as provided in proposed 

§ 226.43(d)(2)(i)(B). 

The Board solicits comment on 

whether there are any ‘‘high-cost areas’’ 

in which loan terms in excess of 30 

years are necessary to ensure that 

responsible, affordable credit is 

available and, if so, how they should be 

identified for purposes of such an 

exception. The Board also seeks 

comment on whether any other 

exceptions would be appropriate, 

consistent with the Board’s authority in 

TILA Section 129C(b)(3)(B)(i). 

43(e)(2)(iii) Points and Fees 

TILA Section 129C(b)(2)(A)(vii) 

defines a ‘‘qualified mortgage’’ as a loan 

for which, among other things, the total 

points and fees payable in connection 

with the loan do not exceed three 

percent of the total loan amount. TILA 

Section 129C(b)(2)(D) requires the Board 

to prescribe rules adjusting this 

threshold to ‘‘permit lenders that extend 

smaller loans to meet the requirements 

of the presumption of compliance.’’ The 

statute further requires the Board, in 

prescribing such rules, to ‘‘consider the 

potential impact of such rules on rural 

areas and other areas where home 

values are lower.’’ Proposed 

§ 226.43(e)(2)(iii) implements these 

provisions by providing that a qualified 

mortgage is a loan for which the total 

points and fees payable in connection 

with the loan do not exceed the 

amounts specified under § 226.43(e)(3). 

As discussed in detail in the section-bysection analysis for § 226.43(e)(3), the 

Board proposes two alternatives for 

calculating the allowable points and 

fees for a qualified mortgage. Proposed 

§ 226.43(b)(9) defines ‘‘points and fees’’ 

to have the same meaning as in 

§ 226.32(b)(1), addressed above. 


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43(e)(2)(iv) Underwriting of the Loan 

TILA Sections 129C(b)(2)(A)(iv) and 

(v) provide as a condition to meeting the 

definition of a qualified mortgage, in 

addition to other criteria, that the 

underwriting process for a fixed-rate or 

adjustable-rate loan be based on ‘‘a 

payment schedule that fully amortizes 

the loan over the loan term and takes 

into account all applicable taxes, 

insurance, and assessments.’’ The statute 

further states that for an adjustable-rate 

loan, the underwriting must be based on 

‘‘the maximum rate permitted under the 

loan during the first 5 years.’’ See TILA 

Section 129C(b)(2)(A)(v). The statute 

does not define the terms ‘‘fixed rate,’’ 

adjustable rate,’’ or ‘‘loan term,’’ and 

provides no additional set of 

assumptions regarding how to calculate 

the payment obligation. 

These statutory requirements differ 

from the payment calculation 

requirements set forth under 

§ 226.34(a)(4)(iii) of the Board’s 2008 

HOEPA Final Rule. Section 

226.34(a)(4)(iii) states that a 

presumption of compliance exists where 

the creditor underwrites the loan using 

the largest payment of principal and 

interest scheduled in the first seven 

years following consummation. The 

existing presumption of compliance 

under § 226.34(a)(4)(iii) is available for 

all loan types, except for loans with 

negative amortization or balloon loans 

with a term less than seven years. In 

contrast, TILA Section 129C(b)(2)(A) 

provides a five-year time horizon for 

purposes of underwriting the loan to the 

maximum interest rate, and does not 

extend the scope of qualified mortgages 

to any loan that contains certain risky 

features or a loan term exceeding 

30 years. For example, loans that permit 

deferral of principal or that have a term 

greater than 30 years would not meet 

the definition of a qualified mortgage. 

See proposed § 226.43(e)(2)(i) and (ii). 

In addition, loans with a balloon feature 

would not meet the definition of a 

qualified mortgage regardless of term 

length, unless made by a creditor that 

satisfies the conditions set forth under 

the proposed exception. See proposed 

§ 226.43(f)(1). 

The Board’s Proposal 

The Board proposes § 226.43(e)(2)(iv) 

to implement the underwriting 

requirements of TILA Sections 

129C(b)(2)(A)(iv) and (v), as enacted by 

Section 1412 of the Dodd-Frank Act, for 

purposes of determining whether a loan 

meets the definition of a qualified 

mortgage. Under the proposal, creditors 

would be required to underwrite the 

consumer for a loan that is a fixed-, 

adjustable-, or step-rate mortgage using 

a periodic payment of principal and 

interest based on the maximum interest 

rate permitted during the first five years 

after consummation. The terms 

‘‘adjustable-rate mortgage,’’ step-rate 

mortgage,’’ and ‘‘fixed-rate mortgage’’ 

have the meaning as in current 

§ 226.18(s)(7)(i)–(iii), respectively. 

Specifically, proposed 

§ 226.43(e)(2)(iv) provides that meeting 

the definition of a qualified mortgage is 

contingent, in part, on creditors 

underwriting the loan in the following 

manner: 

(1) First, proposed § 226.43(e)(2)(iv) 

requires that the creditor take into 

account any mortgage-related 

obligations when underwriting the 

consumer’s loan. 

(2) Second, proposed 

§ 226.43(e)(2)(iv)(A) requires creditors to 

use the maximum interest rate that may 

apply during the first five years after 

consummation; 

(3) Third, proposed 

§ 226.43(e)(2)(iv)(B) requires that the 

periodic payments of principal and 

interest repay either the outstanding 

principal balance over the remaining 

term of the loan as of the date the 

interest rate adjusts to the maximum 

interest rate that can occur during the 

first five years after consummation, or 

the loan amount over the loan term; and 

These three underwriting conditions 

under proposed § 226.43(e)(2)(iv) are 

discussed below. 

43(e)(2)(iv) Mortgage-Related 

Obligations 

Proposed § 226.43(e)(2)(iv) 

implements TILA Section 

129C(b)(2)(A)(iv) and (v), in part, and 

provides that the creditor underwrite 

the loan taking into account any 

mortgage-related obligations. As 

discussed in proposed § 226.43(b)(8), 

the Board proposes to use the term 

‘‘mortgage-related obligations’’ to refer to 

‘‘all applicable taxes, insurance 

(including mortgage guarantee 

insurance), and assessments.’’ Proposed 

§ 226.43(b)(8) would define the term 

‘‘mortgage-related obligations’’ to mean 

property taxes; mortgage-related 

insurance premiums required by the 

creditor as set forth in proposed 

§ 226.45(b)(1); homeowner association, 

condominium, and cooperative fees; 

ground rent or leasehold payments; and 

special assessments. Unlike the 

requirement under proposed 

§ 226.43(c)(5)(v), however, creditors 

would not need to verify and document 

mortgage-related obligations for 

purposes of satisfying this underwriting 

condition. Proposed comment 

43(e)(2)(iv)–6 provides cross-references 

to proposed § 226.43(b)(8) and 

associated commentary to facilitate 

compliance. 

43(e)(2)(iv)(A) Maximum Interest Rate 

During First Five Years 

Proposed § 226.43(e)(2)(iv)(A) 

implements TILA Sections 

129C(b)(2)(A)(iv) and (v), in part, and 

provides as a condition to meeting the 

definition of a qualified mortgage that 

the creditor underwrite the loan using 

the maximum interest rate that may 

apply during the first five years after 

consummation. The statute does not 

define the term ‘‘maximum rate.’’ In 

addition, the statute does not clarify 

whether the phrase ‘‘the maximum rate 

permitted under the loan during the first 

5 years’’ means the creditor should use 

the maximum interest rate that occurs 

during the first five years of the loan 

beginning with the first periodic 

payment due under the loan, or during 

the first five years after consummation 

of the loan. The distinction between 

these two approaches is that the former 

would capture the rate reset for a 5⁄1

hybrid ARM that occurs on the due date 

of the 60th monthly payment, and the 

latter would not. 

Maximum interest rate. The Board 

interprets the phrase ‘‘maximum rate 

permitted’’ as requiring creditors to 

underwrite the loan based on the 

maximum interest rate that could occur 

under the terms of the loan during the 

first five years after consummation, 

assuming a rising index value. See TILA 

Section 129C(b)(2)(A)(v). The plain 

meaning of ‘‘maximum’’ is to the greatest 

possible degree or amount. For this 

reason, the Board believes it is 

reasonable to interpret the phrase as 

requiring the creditor to use the 

maximum rate possible, assuming that 

the index value is increasing. See 

proposed comment 43(e)(2)(iv)–1. This 

interpretation is consistent with current 

guidance contained in Regulation Z 

regarding disclosure of the maximum 

interest rate. See MDIA Interim Rule, 75 

FR 58471, Sept. 24, 2010. The Board 

further believes this interpretation is 

consistent with Congressional intent to 

encourage creditors to make loans to 

consumers that are less risky and that 

afford the consumer a reasonable period 

of time to repay (i.e., 5 years) on less 

risky terms. 

First five years after consummation. 

For several reasons, the Board proposes 

to interpret the phrase ‘‘during the first 

5 years’’ as requiring creditors to 

underwrite the loan based on the 

maximum interest rate that may apply 

during the first five years after 

consummation. TILA Section 

129C(b)(2)(A)(v). First, a plain reading 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27458 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

68See, e.g., Mortgage Reform and Anti-Predatory 

Lending Act, H. Rep. 111–94, p. 39 (2009). 

of the statutory language conveys that 

the ‘‘first 5 years’’ is the first five years 

of the loan once it comes into existence 

(i.e., once it is consummated). 

Interpreting the phrase to mean the first 

five years beginning with the first 

periodic payment due under the loan 

would require an expansive reading of 

the statutory text. 

Second, the Board believes the intent 

of this underwriting condition is to 

ensure that the consumer can afford the 

loan’s payments for a reasonable 

amount of time. The Board believes that 

Congress intended for a reasonable 

amount of time to be the first five years 

after consummation, and therefore 

interprets the statutory text ‘‘maximum 

rate permitted during the first five 

years’’ accordingly. 

Third, the Board believes this 

approach is consistent with prior 

iterations of this statutory text and the 

Board’s 2008 HOEPA Final Rule. As 

noted above, the Dodd-Frank Act 

codifies many aspects of the repayment 

ability requirements contained in 

§ 226.34(a)(4) of the Board’s 2008 

HOEPA Final Rule. Previous versions of 

this statutory text provided that 

creditors underwrite the loan using the 

maximum interest rate during the first 

seven years; 68 this time horizon 

parallels § 226.34(a)(4)(iii), which 

requires creditors to determine a 

consumers repayment ability using the 

largest payment in first seven years 

‘‘following consummation.’’ 

Fourth, the Board believes that 

interpreting the phrase ‘‘during the first 

five years’’ as including the rate 

adjustment at the end of the fifth year 

would be of limited benefit to 

consumers because creditors could 

easily structure their product offerings 

to avoid application of the rule. For 

example, a creditor could move a rate 

adjustment that typically occurs on the 

due date of the 60th monthly payment 

to due date of the first month that falls 

outside the specified time horizon, 

making any proposal to extend the time 

period in order to include the rate 

adjustment of diminished value. 

Finally, the Board recognizes that the 

proposed timing of the five-year period 

differs slightly from the approach used 

under the 2010 MDIA Interim Final 

Rule, but believes this is appropriate 

given the different purposes of the rules. 

The Board recently amended the 2010 

MDIA Interim Final Rule to require that 

creditors base their disclosures on the 

first five years after the first regular 

periodic payment due date rather than 

the first five years after consummation. 

See 75 FR 81836, Dec. 29, 2010. The 

revision clarifies that the disclosure 

requirements for 5/1 hybrid ARMs must 

include the rate adjustment that occurs 

on the due date of the 60th monthly 

payment, which typically occurs more 

than five years after consummation. The 

disclosure requirements under the 2010 

MDIA Interim Final Rule, as revised, are 

intended to help make consumers aware 

of changes to their loan terms that may 

occur if they choose to stay in the loan 

beyond five years and therefore, helps to 

ensure consumers avoid the uninformed 

use of credit. 

By contrast, consistent with statutory 

intent, proposed § 226.43(e)(2)(iv) seeks 

to ensure that the loan’s payments are 

affordable for a reasonable period of 

time. For the reasons stated above, the 

Board believes that Congress intended 

the first five years after consummation 

to be a reasonable period of time to 

ensure that the consumer has the ability 

to repay the loan according to its terms. 

The Board also notes that the 2010 

MDIA Interim Final Rule and 

226.43(e)(2)(iv) complement, rather than 

conflict, with each other. That is, 

consistent with Congressional intent, 

proposed 226.43(e)(2)(iv) would ensure 

that a consumer could repay the loan for 

the first five years after consummation. 

For those borrowers that want to stay in 

the mortgage longer than five years, the 

disclosure required under the 2010 

MDIA Interim Final Rule provides 

information about any potential increase 

in payments so that the consumer can 

decide whether those payments are 

affordable. 

For these reasons, the Board believes 

it is appropriate to interpret the 

statutory text as requiring that the 

creditor underwrite the loan using the 

maximum interest rate during the first 

five years after consummation. The 

Board solicits comment on its 

interpretation of the phrase ‘‘first five 

years’’ and the appropriateness of this 

approach. 

Proposed comment 43(e)(2)(iv)–1 

would provide additional guidance to 

creditors on how to determine the 

maximum interest rate during the first 

five years after consummation. This 

comment would explain that creditors 

must use the maximum rate that could 

apply at any time during the first five 

years after consummation, regardless of 

whether the maximum rate is reached at 

the first or subsequent adjustment 

during such five year period. Proposed 

comment 43(e)(2)(iv)(A)–2 would clarify 

that for a fixed-rate mortgage, creditors 

should use the interest rate in effect at 

consummation, and provide a crossreference to § 226.18(s)(7)(iii) for the 

meaning of the term ‘‘fixed-rate 

mortgage.’’ 

Proposed comment 43(e)(2)(iv)–3 

would provide further guidance to 

creditors regarding treatment of periodic 

interest rate adjustment caps. This 

comment would explain that for an 

adjustable-rate mortgage, creditors 

should assume the interest rate 

increases after consummation as rapidly 

as possible, taking into account the 

terms of the legal obligation. This 

comment would further explain that 

creditors should account for any 

periodic interest rate adjustment cap 

that may limit how quickly the interest 

rate can increase under the terms of the 

legal obligation. This comment would 

also state that where a range for the 

maximum interest rate during the first 

five years is provided, the highest rate 

in that range is the maximum interest 

rate for purposes of this section. Finally, 

this comment would clarify that where 

the terms of the legal obligation are not 

based on an index plus a margin, or 

formula, the creditor must use the 

maximum interest rate that occurs 

during the first five years after 

consummation. 

Proposed comment 43(e)(2)(iv)–3 

provides several illustrative examples of 

how to determine the maximum interest 

rate. For example, this comment would 

illustrate how to determine the 

maximum interest rate in the first five 

years after consummation for an 

adjustable-rate mortgage with a 

discounted rate for three years. The 

example first assumes an adjustable-rate 

mortgage that has an initial discounted 

rate of 5% that is fixed for the first three 

years of the loan, after which the rate 

will adjust annually based on a 

specified index plus a margin of 3%. 

This comment assumes the index value 

in effect at consummation is 4.5%. This 

comment states that the loan agreement 

provides for an annual interest rate 

adjustment cap of 2%, and a lifetime 

maximum interest rate of 10%. The first 

rate adjustment occurs on the due date 

of the 36th monthly payment; the rate 

can adjust to no more than 7% (5% 

initial discounted rate plus 2% annual 

interest rate adjustment cap). The 

second rate adjustment occurs on the 

due date of the 48th monthly payment; 

the rate can adjust to no more than 9% 

(7% rate plus 2% annual interest rate 

adjustment cap). The third rate 

adjustment occurs on the due date of the 

60th monthly payment, which occurs 

more than five years after 

consummation. This proposed comment 

explains that the maximum interest rate 

during the first five years after 

consummation is 9% (the rate on the 

due date of the 48th monthly payment). 


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Proposed comment 43(e)(2)(iv)–4 

would further clarify the meaning of the 

phrase ‘‘first five years after 

consummation.’’ This comment would 

reiterate that under proposed 

§ 226.43(e)(2)(iv)(A), the creditor must 

underwrite the loan using the maximum 

interest rate that may apply during the 

first five years after consummation of 

the loan, and would provide the 

following illustrative example: Assume 

an adjustable-rate mortgage with an 

initial fixed interest rate of 5% for the 

first five years after consummation, after 

which the interest rate will adjust 

annually to the specified index plus a 

margin of 6%, subject to a 2% annual 

interest rate adjustment cap. The index 

value in effect at consummation is 

5.5%. The loan consummates on 

September 15, 2011, and the first 

monthly payment is due on 

November 1, 2011. The first five years 

after consummation occurs on 

September 15, 2016. The first rate 

adjustment to no more than 7% (5% 

plus 2% annual interest rate adjustment 

cap) occurs on the due date of the 60th 

monthly payment, which is October 1, 

2016 and therefore, the rate adjustment 

does not occur during the first five years 

after consummation. To meet the 

definition of qualified mortgage under 

§ 226.43(e)(2), the creditor must 

underwrite the loan using a monthly 

payment of principal and interest based 

on an interest rate of 5%, which is the 

maximum interest rate during the first 

five years after consummation. 

43(e)(2)(iv)(B) Amortizing Payments of 

Principal and Interest 

Proposed § 226.43(e)(2)(iv)(B) 

implements TILA Section 

129C(b)(2)(A)(iv) and (v), in part, and 

provides as a condition to meeting the 

definition of a qualified mortgage that 

the creditor underwrite the loan using 

periodic payments of principal and 

interest that will repay either (1) the 

outstanding principal balance over the 

remaining term of the loan as of the date 

the interest rate adjusts to the maximum 

interest rate that occurs during the first 

five years after consummation; or (2) the 

loan amount over the loan term. See 

proposed § 226.43(e)(2)(iv)(B)(1) and (2). 

TILA Section 129C(b)(2)(A)(iv) and (v) 

state that underwriting should be based 

‘‘on a payment schedule that fully 

amortizes the loan over the loan term.’’ 

The Board notes that unlike the 

payment calculation assumptions set 

forth for purposes of the general abilityto-repay rule under TILA Section 

129C(a)(6), the underwriting conditions 

for purposes of meeting the definition of 

a qualified mortgage do not specify the 

loan amount that should be repaid, and 

do not define ‘‘loan term.’’ For 

consistency and to facilitate 

compliance, the Board proposes to use 

the terms ‘‘loan amount’’ and ‘‘loan term’’ 

in proposed § 226.43(b)(5) and (b)(6), 

respectively, for purposes of this 

underwriting condition. 

However, the Board believes that a 

loan that meets the definition of a 

qualified mortgage and which has the 

benefit of other safeguards, such as 

limits on loan features and fees, merits 

flexibility in the underwriting process. 

Accordingly, the Board proposes to 

permit creditors to underwrite the loan 

using periodic payments of principal 

and interest that will repay either the 

outstanding principal balance as of the 

date the maximum interest rate takes 

effect under the terms of the loan, or the 

loan amount as of the date of 

consummation. The Board believes 

permitting the former approach more 

accurately reflects the largest payment 

amount that the borrower would need to 

make under the terms of the loan during 

the first five years after consummation, 

where as the latter approach would 

actually overstate the payment amounts 

required. This approach sets a minimum 

standard for qualified mortgages, but 

affords creditors to choose either 

approach to facilitate compliance. 

Proposed comment 43(e)(2)(iv)–5 

would provide further clarification to 

creditors regarding the loan amount to 

be used for purposes of this second 

condition. This comment would explain 

that for a creditor to meet the definition 

of a qualified mortgage under proposed 

§ 226.43(e)(2), the creditor must 

determine the periodic payment of 

principal and interest using the 

maximum interest rate permitted during 

the first five years after consummation 

that repays either (1) the outstanding 

principal balance as of the earliest date 

the maximum interest rate can take 

effect under the terms of the legal 

obligation, over the remaining term of 

the loan, or (2) the loan amount, as that 

term is defined in § 226.43(b)(5), over 

the entire loan term, as that term is 

defined in § 226.43(b)(6). This comment 

would provide illustrative examples for 

both approaches. 

Proposed comment 43(e)(2)(iv)–7 

provides illustrative examples of how to 

determine the periodic payment of 

principal and interest based on the 

maximum interest rate during the first 

five years after consummation under 

proposed § 226.43(e)(2)(iv). For 

example, this comment would illustrate 

the payment calculation rule for an 

adjustable-rate mortgage with discount 

for five years. This comment first 

assumes a loan in an amount of 

$200,000 that has a 30-year loan term. 

Second, the comment would assume 

that the loan agreement provides for a 

discounted interest rate of 6% that is 

fixed for an initial period of five years, 

after which the interest rate will adjust 

annually based on a specified index 

plus a margin of 3%, subject to a 2% 

annual interest rate adjustment cap. 

The index value in effect at 

consummation is 4.5%. The loan 

consummates on March 15, 2011 and 

the first regular periodic payment is due 

May 1, 2011. Under the terms of the 

loan agreement, the first rate adjustment 

is on April 1, 2016 (the due date of the 

60th monthly payment), which occurs 

more than five years after 

consummation of the loan. This 

proposed comment explains that the 

maximum interest rate under the terms 

of the loan during the first five years 

after consummation is 6%. See 

proposed comment 43(e)(2)(iv)–7.iii. 

This comment concludes that the 

creditor will meet the definition of a 

qualified mortgage if it underwrites the 

loan using the monthly payment of 

principal and interest of $1,199 to repay 

the loan amount of $200,000 over the 

30-year loan term using the maximum 

interest rate during the first five years of 

6%. 

The Board notes that in the case of an 

adjustable-rate mortgage with a fixed 

interest rate for the first five years after 

consummation, the creditor will use the 

fixed initial rate as the maximum 

interest rate to calculate the monthly 

payment using that will repay the loan 

amount, in accordance with 

requirements in proposed 

§ 226.43(e)(2)(iv). Because the fixed 

initial rate does not adjust during the 

first five years after consummation, the 

outstanding principal balance at the end 

of the fifth year is equivalent to the 

balance of the loan amount, assuming 

the first 60 monthly payments under the 

loan are made as scheduled. Thus, there 

is no alternative calculation. 

43(e)(2)(v) 

Income or Assets (ALTERNATIVE 1) or 

Underwriting Requirements 

(ALTERNATIVE 2) 

As discussed above, it is not clear 

whether the Act intends the definition 

of a ‘‘qualified mortgage’’ to be a 

somewhat narrowly-defined safe harbor 

or a more broadly-defined presumption 

of compliance. Thus, the Board is 

proposing two alternative requirements 

for the ‘‘qualified mortgage’’ definition. 

Under Alternative 1, the underwriting 

requirements for a qualified mortgage 

would be limited to what is contained 

in the statutory definition, namely, 

considering and verifying the 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27460 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

69The LPS data include mortgage underwriting 

and performance information. The LPS data do not 

include detailed information on borrower income 

consumer’s current or reasonably 

expected income or assets. Under 

Alternative 2, the qualified mortgage 

definition would require a creditor 

consider and verify all of the 

underwriting criteria required under the 

general ability-to-repay standard, 

namely: (1) The consumer’s current or 

reasonably expected income, (2) the 

consumer’s employment status, (3) the 

monthly payment on any simultaneous 

loans, (4) the consumer’s current debt 

obligations, (5) the consumer’s monthly 

debt-to-income ratio or residual income, 

and (6) the consumer’s credit history. 

ALTERNATIVE 1 

43(e)(2)(v) Income or Assets 

Under TILA Section 

129C(b)(2)(A)(iii), a condition for a 

‘‘qualified mortgage’’ is that the income 

and financial resources relied upon to 

qualify the obligors on the residential 

mortgage loan are verified and 

documented. This requirement is 

consistent with the repayment ability 

requirement to consider and verify a 

consumer’s income or assets using 

third-party records, under TILA Section 

129C(a)(1) and (3), as discussed above in 

the section-by-section analysis of 

proposed § 226.43(c)(2)(i) and (c)(4). 

Proposed § 226.43(e)(2)(v) would 

implement TILA Section 

129C(b)(2)(A)(iii) and provides that for a 

covered transaction to be a ‘‘qualified 

mortgage,’’ the creditor must consider 

and verify the consumer’s current or 

reasonably expected income or assets to 

determine the consumer’s repayment 

ability, as required by proposed 

§ 226.43(c)(2)(i) and (c)(4). The Board 

believes creditors must consider and not 

merely verify a consumer’s income or 

assets for a covered transaction to be a 

‘‘qualified mortgage,’’ because TILA 

Section 129C(b)(2)(A)(iii) integrates a 

requirement to consider the consumer’s 

income or assets by referring to 

qualifying a consumer for a covered 

transaction. Qualifying a consumer for a 

covered transaction in general involves 

considering whether or not the 

consumer’s income or assets are 

sufficient for the consumer to meet his 

payment obligations under the covered 

transaction. In addition, the proposal 

uses the term ‘‘assets’’ instead of 

‘‘financial resources’’ for consistency 

with other provisions in Regulation Z, 

as discussed above in the section-bysection analysis of proposed 

§ 226.43(c)(2)(i). Under the first 

alternative requirement, proposed 

comment 43(e)(2)(v)–1 clarifies that 

creditors may rely on commentary to 

§ 226.43(c)(2)(i), (c)(3) and (c)(4) for 

guidance regarding considering and 

verifying the consumer’s income or 

assets to satisfy the conditions under 

§ 226.43(e)(2)(v) for a ‘‘qualified 

mortgage.’’ 

ALTERNATIVE 2 

43(e)(2)(v)(A)–(F) Underwriting 

Requirements 

Under Alternative 2, proposed 

§ 226.43(e)(2)(v) would implement TILA 

Section 129C(b)(2)(A)(iii) and require 

that creditors consider and verify the 

consumer’s current or reasonably 

expected income or assets to determine 

the consumer’s repayment ability, as 

required by proposed § 226.43(c)(2)(i) 

and (c)(4). This proposed requirement, 

which under Alternative 2 is designated 

§ 226.43(e)(2)(v)(A), is discussed in 

detail under Alternative 1 above. 

In addition, proposed 

§ 226.43(e)(2)(v)—Alternative 2 would 

require that creditors consider and 

verify the following additional 

underwriting requirements, which are 

also required under the general abilityto-repay standard: The consumer’s 

employment status, the consumer’s 

monthly payment on any simultaneous 

loans, the consumer’s current debt 

obligations, and the consumer’s credit 

history. Creditors could look to 

commentary on the general repayment 

ability provisions under proposed 

§ 226.43(c)(2)(i), (ii), (iv), and (vi) 

through (viii), and (c)(3), (c)(4), (c)(6), 

and (c)(7) for guidance regarding 

considering and verifying the 

consumer’s repayment ability to satisfy 

the conditions under § 226.43(e)(2)(v) 

for a ‘‘qualified mortgage.’’ See proposed 

comment 43(e)(2)(v)–1 (Alternative 2). 

The Board proposes these additions 

pursuant to its legal authority pursuant 

under TILA Section 129C(b)(3)(B)(i). 

The Board believes that adding these 

requirements may be necessary to better 

ensure that the consumers are offered 

and receive loans on terms that 

reasonably reflect their ability to repay 

the loan. 

The Board solicits comments on 

adding each of these criteria to the 

definition of a ‘‘qualified mortgage.’’ 

Specifically, the Board solicits comment 

on whether, for each criterion, the 

inclusion of the criterion strikes the 

appropriate balance between ensuring 

the consumer’s ability to repay the loan 

and providing creditors with an 

incentive to make a qualified mortgage. 

In addition, the Board solicits comment 

on whether consideration of 

simultaneous loans should be required 

for both purchase transactions and nonpurchase transactions (i.e., 

refinancings). 

43(e)(2)(v)(E) Debt-to-Income Ratio or 

Residual Income 

TILA Section 129C(b)(2)(vi) states that 

the term ‘‘qualified mortgage’’ includes 

any mortgage loan ‘‘that complies with 

any guidelines or regulations 

established by the Board relating to 

ratios of total monthly debt to monthly 

income or alternative measure of ability 

to pay regular expenses after payment of 

total monthly debt, taking into account 

the income levels of the borrower and 

such other factors as the Board may 

determine relevant and consistent with 

the purposes described in paragraph 

(3)(B)(i).’’ As stated above, under 

proposed § 226.43(e)(2)(v)—Alternative 

1, creditors are not required to consider 

the consumer’s debt-to-income ratio or 

residual income to make a qualified 

mortgage. However, under proposed 

§ 226.43(e)(2)(v)—Alternative 2, a 

‘‘qualified mortgage’’ is a loan for which, 

among other things, the creditor 

considers the consumer’s monthly debtto-income ratio or residual income, as 

required by § 226.43(c)(2)(vii) and (c)(7). 

Without determining the consumer’s 

debt-to-income ratio, a creditor could 

originate a qualified mortgage without 

any requirement to consider the effect of 

the new loan payment on the 

consumer’s overall financial picture. 

The consumer could have a very high 

total debt-to-income ratio under widely 

accepted underwriting standards, and 

be predicted to default soon after the 

first scheduled mortgage payment. 

Accordingly, including the debt-toincome ratio or residual income in the 

definition of ‘‘qualified mortgage’’ might 

ensure that the consumer has a 

reasonable ability to repay the loan. 

The Board solicits comment on 

whether consideration of the debt-toincome ratio or residual income should 

be part of the criteria for a ‘‘qualified 

mortgage.’’ 

Quantitative standards. The Board is 

not proposing a quantitative standard 

for the debt-to-income ratio or residual 

income in the qualified mortgage 

definition for several reasons. First, as 

explained in the Board’s 2008 HOEPA 

Final Rule, the Board is concerned that 

setting a specific debt-to-income ratio or 

residual income level could limit credit 

availability without providing adequate 

off-setting benefits. 73 FR 44550, July 

30, 2008. For this proposal, the Board 

analyzed data from the Applied 

Analytics division (formerly McDash 

Analytics) of Lender Processing Services 

(LPS) for the years 2005–2008 69 and 


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Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27461 

and on other debts the borrower may have in 

addition to the mortgage. 70The SCF is conducted every three years by the 

Board, in cooperation with the U.S. Department of 

Treasury, to provide detailed information on the 

finances of U.S. families. The SCF collects 

information on the balance sheet, pension, income, 

and other demographic characteristics of U.S. 

families. To ensure the representativeness of the 

study, respondents are selected randomly using a 

scientific sampling methodology that allows a 

relatively small number of families to represent all 

types of families in the nation. Additional 

information on the SCF is available at http:// 

www.federalreserve.gov/pubs/oss/oss2/ 

method.html. 

71See also Wardrip, Keith, An Annual Look at the 

Housing Affordability Challenges of America’s 

Working Households (Center for Housing Policy 

2011) (showing that just over 20 percent of working 

households, defined as households that report 

household members working at least 20 hours per 

week, on average, with incomes no higher than 120 

percent of the median income in their area, who 

own a home spend more than half its income on 

housing costs). 

72See also Stone, Michael E., What is Housing 

Affordability? The Case for the Residual Income 

Approach, 17 Housing Policy Debate 179 (Fannie 

Mae 2006) (advocating use of a residual income 

approach but acknowledging that it ‘‘is neither well 

known, particularly in this country, nor widely 

understood, let alone accepted’’). 

data from the Survey of Consumer 

Finances (the SCF) for the years 2005– 

2007.70 Using the LPS data, the Board 

found that about 23 percent of all 

borrowers exceeded a debt-to-income 

ratio of 45 percent, the typical 

maximum permitted by creditors and 

the secondary market for loans that are 

manually underwritten. The data show 

that this rate was even higher for 

borrowers living in low-income or highcost areas. Using the SCF data, the 

Board found that about 44 percent of 

borrowers located in low-income areas 

and about 31 percent of borrowers 

located in high-cost areas exceeded the 

45 percent limit.71 If the Board were to 

adopt a quantitative standard, the Board 

seeks comment on what exceptions may 

be necessary for low-income borrowers 

or borrowers living in high-cost areas, or 

for other cases. 

Second, outreach conducted by the 

Board revealed a range of underwriting 

guidelines for debt-to-income ratios 

based on product type, whether 

creditors used manual or automated 

underwriting, and special 

considerations for high- and low-income 

borrowers. Setting a quantitative 

standard would require the Board to 

address the operational issues related to 

the calculation of the debt-to-income 

ratio or residual income. For example, 

the Board would need clearly to define 

income and current debt obligations, as 

well as compensating factors and the 

situations in which creditors may use 

compensating factors, In addition, the 

debt-to-income ratio is often a floating 

metric, since the percentage changes as 

new information about income or 

current debt obligations becomes 

available. A quantitative standard 

would require guidelines on the timing 

of the debt-to-income ratio calculation, 

and what circumstances would 

necessitate a re-calculation of the debtto-income ratio. Furthermore, a 

quantitative standard may also need to 

provide tolerances for mistakes made in 

calculating the debt-to-income ratio. 

The rule would also need to address the 

use of automated underwriting systems 

in determining the debt-to-income ratio 

or residual income. 

Finally, setting a quantitative 

standard for residual income could 

prove particularly challenging. Except 

for one small creditor and the 

Department of Veterans’ Affairs, the 

Board is not aware of any creditors that 

routinely use residual income in 

underwriting, other than as a 

compensating factor.72 As noted in the 

supplementary information to the 2008 

HOEPA Final Rule, the residual income 

guidelines of the Department of 

Veterans’ Affairs may be appropriate for 

the limited segment of the mortgage 

market this agency is authorized to 

serve, but they are not necessarily 

appropriate for the large segment of the 

mortgage market this regulation will 

cover. 73 FR 44550, July 30, 2008. 

Moreover, the residual income 

guidelines developed by the Department 

of Veterans’ Affairs have not been 

updated since 1997. It is not clear that 

such guidelines would be appropriate or 

provide sufficient flexibility for 

consumers outside the market served by 

the Department of Veterans’ Affairs. 

For these reasons, the Board is not 

proposing a quantitative standard for 

the debt-to-income ratio or residual 

income. The Board recognizes, however, 

that creditors, and ultimately 

consumers, may benefit from a higher 

degree of certainty surrounding the 

qualified mortgage definition that a 

quantitative standard could provide. 

Therefore, the Board solicits comment 

on whether and how it should prescribe 

a quantitative standard for the debt-toincome ratio or residual income for the 

qualified mortgage definition. 

43(e)(3) Limits on Points and Fees for 

Qualified Mortgages 

Proposed § 226.43(e)(3) sets forth two 

alternative proposals establishing the 

points and fees that a creditor may 

charge on a qualified mortgage: 

Alternative 1 

• For a loan amount of $75,000 or 

more, 3 percent of the total loan 

amount; 

• For a loan amount of greater than or 

equal to $60,000 but less than $75,000, 

3.5 percent of the total loan amount; 

• For a loan amount of greater than or 

equal to $40,000 but less than $60,000, 

4 percent of the total loan amount; 

• For a loan amount of greater than or 

equal to $20,000 but less than $40,000, 

4.5 percent of the total loan amount; and 

• For a loan amount of less than 

$20,000, 5 percent of the total loan 

amount. 

Alternative 2 

• For a loan amount of $75,000 or 

more, 3 percent of the total loan 

amount; 

• For a loan amount of greater than or 

equal to $20,000 but less than $75,000, 

a percent of the total loan amount not 

to exceed the percentage of the total 

loan amount yielded by the following 

formula— 

Æ Total loan amount¥$20,000 = $Z 

Æ $Z × .0036 basis points = Y basis 

points 

Æ 500 basis points ¥Y basis points = 

X basis points 

Æ X basis points × .01 = Allowable 

points and fees as a percentage of the 

total loan amount. 

• For a loan amount of less than 

$20,000, 5 percent of the total loan 

amount. 

For both alternatives, Proposed 

comment 43(e)(3)(i)–1 cross-references 

comment 32(a)(1)(ii)–1 for an 

explanation of how to calculate the 

‘‘total loan amount’’ under this 

provision. Proposed comment 

43(e)(3)(i)–2 also clarifies that a creditor 

must determine which category the loan 

falls into based on the face amount of 

the note (the ‘‘loan amount’’), but must 

apply the allowable points and fees 

percentage to the ‘‘total loan amount,’’ 

which may be an amount that is 

different than the face amount of the 

note. Specifically, the comment 

explains that a creditor must calculate 

the allowable amount of points and fees 

for a qualified mortgage as follows: 

• First, the creditor must determine 

the ‘‘tier’’ into which the loan falls based 

on the loan amount. The loan amount is 

the principal amount the consumer will 

borrow as reflected in the promissory 

note or loan contract. See § 226.43(b)(5). 

For example, if the loan amount is 

$75,000, the loan falls into the tier for 

loans of $75,000 or more, to which a 

three percent cap on points and fees 

applies. 

• Second, the creditor must 

determine the ‘‘total loan amount’’ based 

on the calculation for the ‘‘total loan 

amount’’ under comment 32(a)(1)(ii)–1. 

If the loan amount is $75,000, for 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27462 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

example, the ‘‘total loan amount’’ may be 

a different amount, such as $73,000. 

• Third, the creditor must apply the 

percentage cap on points and fees to the 

‘‘total loan amount.’’ For example, for a 

loan of $75,000 where the ‘‘total loan 

amount’’ is $73,000, the allowable 

points and fees is three percent of 

$73,000 or $2,190. 

For a discussion of the Board’s proposed 

revisions to the ‘‘total loan amount’’ 

calculation, see the section-by-section 

analysis of § 226.32(a)(1)(ii), above. 

Discussion 

The Board proposes the two 

alternative calculations for the qualified 

mortgage points and fees test to 

implement TILA Section 

129C(b)(2)(A)(vii), which requires that 

the points and fees of a qualified 

mortgage may not exceed three percent 

of the total loan amount. 15 U.S.C. 

1639c(b)(2)(A)(vii). Proposed 

§ 226.43(e)(3) is also intended to 

implement TILA Section 129C(b)(2)(D), 

which requires the Board to adjust this 

three percent points and fees limit for 

‘‘smaller loans’’ and also requires that, 

‘‘[i]n prescribing such rules, the Board 

* * * consider the potential impact of 

such rules on rural areas and other areas 

where home values are lower.’’ 15 U.S.C. 

1639C(b)(2)(D). The statute does not 

define, and the legislative history does 

not provide guidance on, the terms 

‘‘smaller loan’’ or the phrase ‘‘rural areas 

and other areas where home values are 

lower.’’ 

Therefore, to gather information on 

how best to implement the statutory 

requirement that the Board ‘‘adjust’’ the 

points and fees threshold for ‘‘smaller 

loans,’’ Board staff consulted with 

consumer advocates and numerous 

types of creditors, including 

representatives of banks and credit 

unions in rural areas, as well as 

manufactured home loan creditors. In 

addition, Board staff also examined 

recent data on loan size distributions for 

home purchase loans and refinances by 

county and based on whether the loan 

was a conventional mortgage or a 

mortgage secured by manufactured 

homes. The Board also considered that 

creditors can, to some extent, increase 

the interest rate to offset limits on points 

and fees. The Board recognizes that loan 

pricing is typically a blend of points and 

fees and interest rate and that limits on 

points and fees tend to drive loan costs 

into the rate. 

As an initial matter, the Board 

considered a few options for 

implementing the statutory mandate to 

‘‘adjust[] the criteria’’ of the three 

percent points and fees cap—namely, 

narrowing the charges required to be 

included in the ‘‘points and fees’’ 

calculation, raising the percentage cap, 

or a combination of both. Outreach 

participants generally disfavored an 

approach that would require different 

ways of calculating points and fees 

depending on loan size. Industry 

representatives in particular raised 

concerns about compliance burden and 

the increased risk of error resulting from 

a more complex rule. The Board 

believes that requiring separate ways of 

calculating points and fees is 

unnecessary to effect the statutory 

mandate to ‘‘adjust the criteria’’ for the 

qualified mortgage three percent points 

and fees threshold. The proposal 

therefore simply would set higher 

percentage caps on points and fees for 

loans of less than $75,000. 

Outreach participants had varying 

views on appropriate loan size 

thresholds for an alternative points and 

fees limitation applicable to ‘‘smaller 

loans.’’ Industry representatives shared a 

concern that loans below a certain size 

could not meet the three percent points 

and fees cap because the minimum costs 

to originate any loan would exceed 

three percent of loans of that size. While 

recognizing that loan costs can be 

covered in part by charging a higher 

interest rate, creditors were concerned 

that for smaller loans, the needed rate 

increase might result in loan becoming 

a high-cost mortgage; as a result, 

creditors would be reluctant to make 

these loans and credit availability 

would be compromised. Based on 

calculations using loans in their own 

portfolios, some creditors indicated that 

the point at which minimum loan 

origination costs exceed three percent of 

the total loan amount is $50,000 to 

$75,000. At least one creditor indicated 

that, in addition, for loans of $40,000 or 

less, the creditor would be unable to 

meet a four percent cap on points and 

fees. Others suggested $100,000 as the 

appropriate ‘‘smaller loan’’ threshold, 

while still others recommended that the 

Board propose a ‘‘smaller loan’’ 

threshold of greater than $100,000, such 

as at least $150,000. Community bank 

representatives in particular raised 

concerns that they would be unable to 

retain profitability without an 

adjustment to the points and fees cap for 

loans of less than $100,000. They argued 

that the sizes of loans originated by 

community banks and other institutions 

in less populated areas are ‘‘small’’ on 

average, leaving less opportunity for 

community banks than larger 

institutions to make up any losses on 

originations of small loans through 

originations of larger loans. 

Industry representatives also 

generally expressed concerns about 

limiting the availability of credit to lowincome or rural borrowers if the points 

and fees cap for qualified mortgages 

were too low with respect to ‘‘smaller 

loans.’’ If creditors could not meet the 

qualified mortgage points and fees cap, 

these loans would not meet the 

definition of a ‘‘qualified mortgage’’ and 

creditors therefore would be less likely 

to make these loans. 

Consumer advocates generally favored 

a narrower exception to the three 

percent qualified mortgage points and 

fees threshold for ‘‘smaller loans,’’ 

recommending a ‘‘smaller loan’’ size of 

no higher than $50,000 and preferably 

lower. They questioned industry 

concerns that the three percent 

threshold would limit the availability of 

credit for borrowers of comparatively 

low loan amounts. Instead, they 

emphasized the importance of ensuring 

that qualified mortgages are affordable 

because, depending on the Board’s 

interpretation of the statute, these loans 

potentially would not be subject to some 

or all of the specific repayment ability 

requirements in TILA Section 129C(a) 

(see proposed § 226.43(c)). (For a 

detailed discussion of the Board’s 

alternative proposals regarding which of 

the general repayment ability 

requirements apply to creditors of 

qualified mortgages, see the section-bysection analysis of proposed § 226.43(e), 

above.) In their view, the three percent 

points and fees cap is a centerpiece of 

ensuring affordability and should be 

relaxed only in very limited 

circumstances. 

The Board’s Proposal 

Based on outreach and the Board’s 

research, the Board is issuing two 

alternative proposals to implement the 

points and fees limitation on qualified 

mortgages. The first consists of five 

‘‘tiers’’ of loan sizes and corresponding 

limits on points and fees. The second 

consists of three ‘‘tiers,’’ with the middle 

tier of allowable points and fees based 

on a formula yielding a greater 

allowable percentage of the total loan 

amount to be charged in points and fees 

for each dollar increase in loan size. 

The Board proposes a ‘‘tiered’’ 

approach, rather than a single ‘‘smaller 

loan’’ threshold and a single alternate 

points and fees cap for loans at or below 

that amount, for several reasons. First, 

the Board understands that most 

creditors have a minimum cost for 

originating a mortgage loan of any size 

and that this cost may vary somewhat 

by creditor. If a single minimum 

origination cost is assumed, that cost 

will obviously comprise a different 

percentage of a loan depending on its 

size. Total points and fees of $2,500 will 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27463 

obviously be a smaller percentage of a 

loan of $100,000 (2.5%) than for a loan 

of $50,000 (5%), for example. A single 

threshold therefore may not be 

sufficiently flexible to allow loans of a 

full range of sizes to be deemed 

qualified mortgages. 

In addition, the Board believes that a 

rule allowing for incremental increases 

in the points and fees cap for several 

ranges of loan sizes will help mitigate 

market distortions that might otherwise 

result. For example, a rule setting a five 

percent points and fees cap for all loans 

less than $75,000 would create a 

significant disparity between the 

amount of points and fees that could be 

charged on loans of substantially equal 

amounts. For a loan of $75,000, for 

instance, a creditor could charge up to 

$2,250 (3% of $75,000). But for a loan 

of $74,000, a creditor could charge as 

much as $3,700 (5% of $74,000). As a 

result, loans slightly above the threshold 

at which a five percent cap applies—for 

example, from $75,000 to $85,000— 

might be less likely to be made at all. 

Finally, the Board is reluctant to 

require a single threshold due to 

limitations inherent in available data on 

origination costs. Various resources that 

track points and fees in loan 

originations tend to use different 

methods for calculating the points and 

fees and to date do not include all items 

that must be counted as points and fees 

under TILA as amended by the DoddFrank Act. See TILA Section 103(aa)(4); 

15 U.S.C. 1602(aa)(4). See also sectionby-section analysis of § 226.32, above. 

Alternative 1. The five-tiered 

approach proposed as Alternative 1 is 

intended to facilitate compliance by 

setting clear categories based on loan 

size to which specific points and fees 

thresholds apply. The Board derived the 

loan size ranges for each category (with 

corresponding points and fees 

thresholds of three percent, 3.5 percent, 

four percent, 4.5 percent, and five 

percent of the ‘‘total loan amount,’’ 

respectively) based on a calculation that 

would generally achieve a ‘‘sliding 

scale’’ points and fees cap from three to 

five percent for loans from $20,000 to 

$75,000. To make the proposal more 

straightforward, the Board chose 

increments of .5% and rounded the loan 

size ranges proposed for each category. 

Thus, for example: 

• An $80,000 loan would fall into the 

category for loans of $75,000 or more, to 

which a three percent points and fees 

rate cap applies. Assuming that the 

‘‘total loan amount’’ for the loan is also 

$80,000, the dollar amount of allowable 

points and fees for this loan would be 

$2,400. 

• A $60,000 loan would fall into the 

category for loans of $60,000 but less 

than $75,000, to which a 3.5 percent 

points and fees rate cap applies. 

Assuming that the ‘‘total loan amount’’ 

for the loan is also $60,000, the dollar 

amount of allowable points and fees for 

this loan would be $2,100. 

• A $40,000 loan would fall into the 

category for loans of $40,000 but less 

than $60,000, to which a four percent 

points and fees rate cap applies. 

Assuming that the ‘‘total loan amount’’ 

for the loan is also $40,000, the dollar 

amount of allowable points and fees for 

this loan would be $1,600. 

• A $20,000 loan would fall into the 

category for loans of $20,000 but less 

than $40,000, to which a 4.5 percent 

points and fees rate cap applies. 

Assuming that the ‘‘total loan amount’’ 

for the loan is also $40,000, the dollar 

amount of allowable points and fees for 

this loan would be $900. 

• A $10,000 loan would fall into the 

category for loans of less than $20,000, 

to which a five percent points and fees 

rate cap applies. Assuming that the 

‘‘total loan amount’’ for the loan is also 

$10,000, the dollar amount of allowable 

points and fees for this loan would be 

$500. 

Proposed alternative comment 

43(e)(3)(i)–3 provides the following 

illustration of how to calculate the 

allowable points and fees for a $50,000 

loan with a $48,000 total loan amount: 

A covered transaction with a loan 

amount of $50,000 falls into the third 

points and fees tier, to which a points 

and fees cap of 3.5 percent of the total 

loan amount applies. See 

§ 226.43(e)(3)(i)(C). If a $48,000 total 

loan amount is assumed, the allowable 

points and fees for this loan is 3.5 

percent of $48,000 or $1,920. 

One concern is that this approach 

yields anomalous results in some 

instances—namely, that a greater dollar 

amount of points and fees would be 

allowable on some loans than on other 

loans of a larger size. For example, the 

allowable points and fees that could be 

charged on a loan of $40,000 (also 

assuming in this example a ‘‘total loan 

amount’’ of $40,000) would be $1,600— 

four percent of the total loan amount. At 

the same time, the allowable points and 

fees that could be charged on a loan of 

$38,000 (also assuming in this example 

a ‘‘total loan amount’’ of $38,000) would 

be $1,710—4.5 percent of the total loan 

amount. The Board considered and 

could revise the first alternative to solve 

the anomalies mathematically, but not 

without adding significant complexity 

to the regulation, which in turn would 

increase the risk of compliance errors. 

For these reasons, the Board is also 

proposing the alternative discussed 

below. 

Alternative 2. The Board proposes an 

alternative with three tiers that 

incorporates a formula designed to 

ensure that allowable points and fees as 

a dollar amount will increase as the loan 

amount increases, thus eliminating the 

anomalies resulting from the proposed 

five-tier approach. Specifically, as 

noted, for a loan amount of $75,000 or 

more, allowable points and fees would 

be 3 percent of the total loan amount. 

For a loan amount of less than $20,000, 

allowable points and fees would be 5 

percent of the total loan amount. These 

two categories correspond with the first 

and last tiers of the five-tiered approach 

discussed above. 

For a loan amount of greater than or 

equal to $20,000 but less than $75,000, 

however, the allowable points and fees 

would be a percentage of the total loan 

amount not to exceed the amount 

yielded by the following formula— 

Æ Total loan amount¥$20,000 = $Z 

Æ $Z × .0036 = Y basis points 

Æ 500 basis points¥Y basis points = 

X basis points 

Æ X basis points × .01 = Allowable 

points and fees as a percentage of the 

total loan amount. 

In effect, for every dollar increase in the 

total loan amount, the allowable points 

and fees would increase by .0036 basis 

points. Proposed alternative comment 

43(e)(3)(i)–3 provides the following 

illustration of how to apply this 

formula: Assume a loan amount of 

$50,000 with a ‘‘total loan amount’’ of 

$48,000. The amount of $20,000 must be 

subtracted from $48,000 to yield the 

number of dollars to which the .0036 

basis points multiple must be applied— 

in this case, $28,000. $28,000 must be 

multiplied by .0036 basis points—in 

this case resulting in 100.8 basis points. 

This amount must be subtracted from 

the maximum allowable points and fees 

on any loan, which, under the proposed 

rule, is 500 basis points. (Five percent 

of the total loan amount for loans of less 

than $20,000 is the maximum allowable 

points and fees on any loan. Five 

percent expressed in basis points is 

500.) Five hundred minus 100.8 equals 

399.2 basis points: This is the allowable 

points and fees in basis points. 

Translating basis points into a 

percentage of the total loan amount 

requires multiplying 399.2 by .01— 

resulting, in this case, in 3.99 percent. 

Allowable points and fees for this loan 

as a dollar figure is therefore 3.99 

percent of $48,000 (i.e., the total loan 

amount), or $1,915.20. 

The Board recognizes that a formula 

is potentially more complex for 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27464 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

73Public Law 111–203, 124 Stat. 1376, Title XIV, 

§ 1431. 

74 Id. § 1432, 1433. 

75 12 U.S.C. 2801 et seq. 

76See The 2008 HMDA Data: The Mortgage 

Market during a Turbulent Year, Federal Reserve 

Bulletin, vol. 95, p. A201 (April 2010). 

77See HMDA data for 2009 is available at Federal 

Financial Institutions Examination Council, http:// 

www.ffiec.gov.hmda/hmdaproducts.htm. 

78See The 2008 HMDA Data: The Mortgage 

Market during a Turbulent Year, Federal Reserve 

Bulletin, vol. 95, p. A201 (April 2010); Federal 

Financial Institutions Examination Council, http:// 

www.ffiec.gov/hmda/hmdaproducts.htm 

79The proposed loan size threshold would have 

applied to the majority of second-lien homepurchase and refinance loans secured by site-built 

homes in 2008 and 2009. In 2008, 78.3 percent of 

all second-lien home-purchase (site-built) 

mortgages were $74,000 or less and 75.3 percent of 

all second-lien refinances (site-built) were $74,000 

or less. See The 2008 HMDA Data: The Mortgage 

Market during a Turbulent Year, Federal Reserve 

Bulletin, vol. 95, p. A201 (April 2010). In 2009, 85.1 

percent of all second-lien home-purchase (sitebuilt) and 78.1 percent of all second-lien refinance 

(site-built) mortgages were in an amount of $75,000 

or less. See Federal Financial Institutions 

Examination Council, http://www.ffiec.gov/hmda/ 

hmdaproducts.htm. 

creditors to comply with than the 

multiple tiers proposed under the first 

alternative. In particular, the Board 

requests comment on whether a formula 

would be difficult for smaller creditors 

to integrate into their lending 

operations. 

Three to five percent cap. The upper 

end of the points and fees cap for 

smaller loans is proposed to be five 

percent for loans of less than $20,000. 

One reason for the maximum cap of five 

percent for loans of less than $20,000 is 

to achieve general consistency with the 

Dodd-Frank Act amendments to the 

points and fees thresholds for high-cost 

mortgages.73 Specifically, TILA now 

defines a high-cost mortgage as one for 

which the points and fees equal five 

percent of the total transaction amount 

if the transaction is $20,000 or more 

and, if the transaction is less than 

$20,000, the lesser of eight percent of 

the total transaction amount or $1,000. 

See TILA Section 103(aa)(1)(A)(ii)(I) and 

(II); 15 U.S.C. 1602(aa)(1)(A)(ii)(I) and 

(II). 

The proposal seeks to ensure that if a 

loan is a qualified mortgage, it would 

not also be a high-cost mortgage based 

on the points and fees, and therefore 

subject to the more stringent high-cost 

mortgage rules of TILA Section 129 (as 

amended by the Dodd-Frank Act).74 For 

example, five percent of a loan of 

$19,999 is $999.95. Thus, for this loan 

to meet the points and fees test for 

qualified mortgages, the maximum 

points and fees that could be charged 

would be $999.95. If the maximum 

points and fees that could be charged on 

this loan under the qualified mortgage 

test were $1,000, this loan would also be 

a high-cost mortgage. 

As discussed earlier, the Board 

believes that the statute is designed to 

reduce the compliance burden on 

creditors when they make qualified 

mortgages, in order to encourage 

creditors to make loans with stable, 

understandable loan features. Creating 

points and fees thresholds for small 

loans that might result in qualified 

mortgages also being high-cost 

mortgages would discourage creditors 

from making qualified mortgages 

because the requirements and 

limitations of high-cost loans are 

generally more stringent than for other 

loans. High-cost mortgages, for example, 

are subject to a cap on the late fees that 

may be imposed and timing restrictions 

regarding when the fee may be imposed, 

but other mortgages are not subject to 

these and several other rules applicable 

solely to high-cost mortgages. See TILA 

Section 129(k); 15 U.S.C. 1639(k). They 

also require that the consumer obtain 

‘‘pre-loan counseling’’ not required for 

other mortgages. See TILA Section 

129(u); 15 U.S.C. 1639(u). 

Three percent cap for loans of 

$75,000 or greater. The Board proposes 

a loan size of $75,000 as the point at 

which the statutory three percent points 

and fees cap begins to apply for several 

reasons. First, the Board believes that 

Congress intended the exception to the 

qualified mortgage points and fees cap 

to affect more than a minimal—although 

still limited—proportion of homesecured loans. The 2008 Home Mortgage 

Disclosure Act 75 (HMDA) data show 

that 8.4 percent of first-lien, homepurchase (site-built) mortgages had a 

loan amount of $74,000 or less.76 That 

percentage significantly drops for loans 

of $49,000 or less, to 2.8 percent, with 

only .5 percent of all loans at $24,000 

or less. The percentage of first-lien, 

home-purchase (site-built) mortgages of 

$100,000 or less is significantly higher 

than 8.4 percent, however—totaling 16 

percent of the market. 

Similarly, in 2009, the percentage of 

first-lien home-purchase (site-built) 

mortgages was 9.7 percent, with a 

significant drop for loans of $50,000 or 

less to 3.3 percent of the total market 

and .3 percent for loans of $20,000 or 

less.77 Again, however, the percentage 

of first-lien home-purchase (site-built) 

mortgages jumps substantially—from 

9.7 percent to 18.5 percent—for loans of 

$100,000 or less. Parallel results 

occurred for first-lien refinances 

secured by site-built homes.78

Thus, the Board believes that a loan 

size of less than $75,000 would capture 

a material portion of the first-lien homepurchase (site-built) mortgage market 

(close to 10 percent), but would not 

undermine the statute by creating an 

exception that might be over-broad.79

Second, Board outreach and research 

indicate that $2,250—three percent of 

$75,000—is within range of average 

costs to originate a first-lien home 

mortgage. Thus $75,000 appears to be an 

appropriate benchmark for applying the 

three percent limit, with a higher 

percent limit applying to loans below 

that amount to afford creditors of these 

loans a reasonable opportunity to 

recoup their origination costs. The 

sliding scale approach to loans below 

$75,000 is intended in part to help 

ensure that creditors of these loans 

would not have to add a significant 

amount to the rate to recoup their 

origination costs and thus cannot be 

classified as high-cost mortgages. In 

addition, the Board seeks to limit 

compensating rate increases because it 

recognizes that increasing the rate is not 

necessarily in the consumer’s interest— 

for example, a loan with a higher rate 

can be costly for a consumer who plans 

to stay in the home (and loan) for a long 

time. Higher rates also can decrease 

credit access because some consumers 

may not be able to make the resulting 

payments over time, but may have the 

cash to pay the costs upfront. 

Third, the Board interprets Congress’s 

express concern for ‘‘loans in areas 

where home values are lower’’ to 

encompass not only geographic areas 

but also ‘‘areas’’ of mortgage lending 

generally—in particular, property types 

such as manufactured homes, which 

tend to be less expensive than site-built 

homes. Regarding property types, the 

Board focused on manufactured homes 

and found that, in 2009, 74.8 percent of 

all first-lien home-purchase loans 

secured by manufactured homes were 

$75,000 or less, while 61.8 percent of all 

first-lien refinances secured by 

manufactured homes were $75,000 or 

less. Thus the Board believes that the 

proposal would appropriately address 

Congress’s concern with the ‘‘lower’’ 

home values typical of manufactured 

homes. The Board considers 

manufactured homes to be an important 

homeownership option for many 

consumers and intends through this 

proposal to protect manufactured home 

loan consumers from excessive costs, 

while allowing more of these loans to be 

deemed qualified mortgages. 

In general, the Board is reluctant to 

propose an adjustment to the three 

percent qualified mortgage points and 

fees cap based on geographic area alone. 

Property values shift over time, and in 

some cases, properties in what today are 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27465 

80See Federal Financial Institutions Examination 

Council, http://www.ffiec.gov/hmda/ 

hmdaproducts.htm. 

81See 76 FR 11319, March 2, 2011 (2011 Jumbo 

Loan Escrow Final Rule). 

remote, inexpensive areas may become 

more populated and costly over time. 

The Board considered imposing an 

alternate points and fees threshold for 

defined geographic areas such as ‘‘nonMSA’’ areas. However, even within 

those areas, origination costs and loan 

sizes may vary widely, so the Board 

believes that an inadequate basis exists 

for such a proposal. 

Nevertheless, regarding whether loan 

sizes are ‘‘lower’’ on average in some 

geographic areas than others, the Board 

has conducted preliminary research on 

loan size by county. HMDA data 

indicate that in 2009, for example, there 

were eight counties in which loans 

under $75,000 comprised more than 90 

percent of all first-lien mortgages made 

in those counties, and 1,366 counties in 

which loans under $75,000 comprised 

more than 90 percent of all second-lien 

loans made in those counties.80 The 

Board also noted that counties in which 

at least 70 percent of second-lien 

mortgages made were under $75,000 

(2,616 counties) accounted for 91 

percent of the entire second-lien 

mortgage market for loans of under 

$75,000. These data suggest that the 

proposal may affect access to credit 

differently across the country. 

The Board requests comment on the 

proposed alternative loan size ranges 

and corresponding points and fees caps 

for qualified mortgages. The Board 

encourages commenters to provide 

specific data to support their 

recommendations. The Board also 

solicits comment on whether the 

proposal should index the loan size 

ranges for inflation and periodically 

change them by regulation. In addition, 

the Board requests comment on the 

potential impact of the proposal on 

access to credit, particularly on how the 

impact may vary based on geographic 

area. 

43(e)(3)(ii) Exclusions From Points and 

Fees for Qualified Mortgages 

Proposed § 226.43(e)(3)(ii) excludes 

three types of charges from the points 

and fees calculation for qualified 

mortgages: 

• Any bona fide third party charge 

not retained by the creditor, loan 

originator, or an affiliate of either, 

subject to the limitations under 

proposed § 226.32(b)(1)(i)(B), which 

requires that premiums for private 

mortgage insurance be included in 

points and fees under certain 

circumstances, even if they are not 

retained by the creditor, loan originator, 

or an affiliate of either. 

• Up to two bona fide discount points 

paid by the consumer in connection 

with the covered transaction, but only if 

certain conditions are met (discussed 

below). 

• Up to one bona fide discount point 

paid by the consumer in connection 

with the covered transaction, but only if 

certain conditions are met (discussed 

below). 

See proposed § 226.43(e)(3)(ii)(A)–(C). 

43(e)(3)(ii)(A) Bona Fide Third Party 

Charges 

Proposed § 226.43(e)(3)(ii)(A) 

excludes from ‘‘points and fees’’ for 

qualified mortgages ‘‘any bona fide third 

party charge not retained by the 

creditor, loan originator, or an affiliate 

of either, unless the charge is required 

to be included in ‘points and fees’ under 

§ 226.32(b)(1)(i)(B).’’ This provision 

would implement TILA Section 

129C(b)(2)(C), which defines ‘‘points 

and fees’’ for qualified mortgages to have 

the same meaning as ‘‘points and fees’’ 

for high-cost mortgages (TILA Section 

103(aa)(4)), but expressly excludes 

‘‘bona fide third party charges not 

retained by the mortgage originator, 

creditor, or an affiliate of the creditor or 

mortgage originator.’’ 15 U.S.C. 

1602(aa)(4), 1639c(b)(2)(C). With the 

following example, proposed comment 

43(e)(3)(ii)–1 clarifies the meaning of 

‘‘retained by’’ the loan originator, 

creditor, or an affiliate of either: If a 

creditor charges a consumer $400 for an 

appraisal conducted by a third party not 

affiliated with the creditor, pays the 

third party appraiser $300 for the 

appraisal, and retains $100, the creditor 

may exclude $300 of this fee from 

‘‘points and fees’’ but must count the 

$100 it retains in ‘‘points and fees.’’ 

Proposed § 226.43(e)(3)(ii)(A) would 

also implement TILA Section 

103(aa)(1)(C), which requires that 

premiums for private mortgage 

insurance be included in ‘‘points and 

fees’’ as defined in TILA Section 

103(aa)(4) under certain circumstances. 

15 U.S.C. 1602(aa)(1)(C). Applying 

general rules of statutory construction, 

the Board believes that the more specific 

provision on private mortgage insurance 

supersedes the more general provision 

permitting any bona fide third party 

charge not retained by the creditor, 

mortgage originator, or an affiliate of 

either to be excluded from ‘‘points and 

fees.’’ Thus, comment 43(e)(3)(ii)–2 

explains that § 226.32(b)(1)(i)(B) 

requires creditors to include in ‘‘points 

and fees’’ premiums or charges payable 

at or before closing for any private 

guaranty or insurance protecting the 

creditor against the consumer’s default 

or other credit loss to the extent that the 

premium or charge exceeds the amount 

payable under policies in effect at the 

time of origination under Section 

203(c)(2)(A) of the National Housing Act 

(12 U.S.C. 1709(c)(2)(A)). These 

premiums or charges must also be 

included if the premiums or charges are 

not required to be refundable on a prorated basis, or the refund is not 

automatically issued upon notification 

of the satisfaction of the underlying 

mortgage loan. The comment clarifies 

that, under these circumstances, even if 

the premiums and charges are not 

retained by the creditor, loan originator, 

or an affiliate of either, they must be 

included in the ‘‘points and fees’’ 

calculation for qualified mortgages. The 

comment also cross-references 

comments 32(b)(1)(i)–3 and –4 for 

further discussion of including upfront 

private mortgage insurance premiums in 

the points and fees calculation. 

For a detailed discussion of the 

Board’s proposal to apply the DoddFrank Act provisions on mortgage 

insurance to the meaning of ‘‘points and 

fees’’ for qualified mortgages, see the 

section-by-section analysis of proposed 

§ 226.32(b)(1)(i) (implementing TILA 

Section 103(aa)(1)(C)). 

43(e)(3)(ii)(B) and 43(e)(3)(ii)(C) Bona 

Fide Discount Points 

Proposed § 226.43(e)(3)(ii)(B) and 

(e)(3)(ii)(C) permit a creditor to exclude 

a limited number of discount points 

from the calculation of points and fees 

under specific circumstances. These 

provisions are proposed to implement 

TILA Section 129C(b)(2)(C)(ii), (iii), and 

(iv), and mirror the statutory language 

with minor clarifying revisions. 15 

U.S.C. 1639c(b)(2)(C)(ii), (iii), and (iv). 

Exclusion of up to two bona fide 

discount points. Specifically, proposed 

§ 226.43(e)(3)(ii)(B) permits a creditor to 

exclude from points and fees for a 

qualified mortgage up to two bona fide 

discount points paid by the consumer in 

connection with the covered 

transaction, provided that the following 

conditions are met— 

• The interest rate before the rate is 

discounted does not exceed the average 

prime offer rate, as defined in 

§ 226.45(a)(2)(ii),81 by more than one 

percent; and 

• The average prime offer rate used 

for purposes of paragraph 

43(e)(3)(ii)(B)(1) is the same average 

prime offer rate that applies to a 

comparable transaction as of the date 


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82See id. 

83Federal Financial Institutions Examination 

Council (FFIEC), ‘‘FFIEC Rate Spread Calculator,’’ 

http://www.ffiec.gov/ratespread/newcalc.aspx. 

84See e.g., Fannie Mae, ‘‘Loan-Level Price 

Adjustment (LLPA) Matrix and Adverse Market 

Delivery Charge (AMDC) Information,’’ Selling 

Guide (Dec. 23, 2010). 

the discounted interest rate for the 

covered transaction is set. 

Proposed comment 43(e)(3)(ii)–3 

provides the following example to 

illustrate this rule: Assume a covered 

transaction that is a first-lien, purchase 

money home mortgage with a fixed 

interest rate and a 30-year term. Assume 

also that the consumer locks in an 

interest rate of 6.00 percent on May 1, 

2011, that was discounted from a rate of 

6.50 percent because the consumer paid 

two discount points. Finally, assume 

that the average prime offer rate (APOR) 

as of May 1, 2011 for first-lien, purchase 

money home mortgages with a fixed 

interest rate and a 30-year term is 5.50 

percent. 

In this example, the creditor may 

exclude two discount points from the 

‘‘points and fees’’ calculation because 

the rate from which the discounted rate 

was derived exceeded APOR for a 

comparable transaction as of the date 

the rate on the covered transaction was 

set by only one percent. 

Exclusion of up to one bona fide 

discount point. Proposed 

§ 226.43(e)(3)(ii)(C) permits a creditor to 

exclude from points and fees for a 

qualified mortgage up to one bona fide 

discount point paid by the consumer in 

connection with the covered 

transaction, provided that the following 

conditions are met— 

• The interest rate before the discount 

does not exceed the average prime offer 

rate, as defined in § 226.45(a)(2)(ii),82 by 

more than two percent; 

• The average prime offer rate used 

for purposes of § 226.43(e)(3)(ii)(C)(1) is 

the same average prime offer rate that 

applies to a comparable transaction as of 

the date the discounted interest rate for 

the covered transaction is set; and 

• Two bona fide discount points have 

not been excluded under 

§ 226.43(e)(3)(ii)(B) of this section. 

Proposed comment 43(e)(3)(ii)–4 

provides the following example to 

illustrate this rule: Assume a covered 

transaction that is a first-lien, purchase 

money home mortgage with a fixed 

interest rate and a 30-year term. Assume 

also that the consumer locks in an 

interest rate of 6.00 percent on May 1, 

2011, that was discounted from a rate of 

7.00 percent because the consumer paid 

four discount points. Finally, assume 

that the average prime offer rate (APOR) 

as of May 1, 2011 for first-lien, purchase 

money home mortgages with a fixed 

interest rate and a 30-year term is 5.00 

percent. 

In this example, the creditor may 

exclude one discount point from the 

‘‘points and fees’’ calculation because 

the rate from which the discounted rate 

was derived (7.00 percent) exceeded 

APOR for a comparable transaction as of 

the date the rate on the covered 

transaction was set (5.00 percent) by 

only two percent. 

Comparable transaction. Both 

proposed exclusions for bona fide 

discount points require the creditor to 

determine the APOR for a ‘‘comparable 

transaction.’’ Comment 43(e)(3)(ii)–5 

clarifies that the APOR table published 

by the Board indicates how to identify 

the comparable transaction.83 This 

comment also cross-references proposed 

comment 45(a)(2)(ii)–2 contained in the 

2011 Escrow Proposal (see also existing 

comment 35(a)(2)–2), which makes the 

same clarification in a different context. 

Currently, the APOR table published by 

the Board indicates that one loan 

characteristic on which the APOR may 

vary is whether the rate is fixed or 

adjustable. Another variable is the 

length of the loan term. For a fixed-rate 

mortgage, the relevant term is the length 

of the entire contractual obligation, such 

as 30 years. For an adjustable-rate 

mortgage, the relevant term is the length 

of the initial fixed-rate period. The 

examples provided in proposed 

comments 43(e)(3)(ii)–3 and –4 are 

based on a fixed-rate mortgage with a 

30-year term and accordingly refer to 

the APOR for a fixed-rate mortgage with 

a 30-year term. 

Risk-based price adjustments. The 

Board is aware that, in setting the 

purchase price for specific loans, Fannie 

Mae and Freddie Mac make loan-level 

price adjustments (LLPAs) to 

compensate offset added risks, such as 

a high LTV or low credit score, among 

many other risk factors.84 Creditors 

may, but are not required to, pass the 

resulting costs directly through to the 

consumer in the form of points. During 

outreach, some creditors argued that 

these points should not be counted in 

points and fees for qualified mortgages 

under the exclusion for ‘‘bona fide third 

party charges not retained by the loan 

originator, creditor, or an affiliate of 

either.’’ Proposed § 226.43(e)(3)(ii)(A); 

TILA Section 129C(b)(2)(C). 

The Board understands creditors’ 

concerns about exceeding the qualified 

mortgage points and fees thresholds due 

to LLPAs required by the GSEs. At the 

same time, the Board questions whether 

an exemption for LLPAs is consistent 

with congressional intent in limiting 

points and fees for qualified mortgages. 

Points charged to meet GSE risk-based 

price adjustment requirements are 

arguably no different than other points 

charged on loans sold to any secondary 

market purchaser to compensate that 

purchaser for added loan-level risks. 

Congress clearly contemplated that 

discount points generally should be 

included in points and fees for qualified 

mortgages; as discussed above, the 

Dodd-Frank Act exempts from the 

qualified mortgage points and fees 

calculation up to only two discount 

points, and under limited 

circumstances. See TILA Section 

129C(b)(2)(C)(ii), (iii), and (iv), proposed 

to be implemented in new 

§ 226.43(e)(3)(ii)(B) and (e)(3)(ii)(C). 

An exclusion for points charged by 

creditors in response to secondary 

market LLPAs also raises questions 

about the appropriate treatment of 

points charged by creditors to offset 

loan-level risks on mortgage loans that 

they hold in portfolio. Under normal 

circumstances, these points are retained 

by the creditor, so an argument that they 

should be excluded from points and fees 

under the ‘‘bona fide third party charge’’ 

exclusion (see above) seems inapt. Yet 

requiring that these points be included 

in points and fees, when similar charges 

on loans sold into the secondary market 

are excluded, may create undesirable 

market imbalances between loans sold 

to the secondary market and loans held 

in portfolio. 

Creditors may offset risks on their 

portfolio loans (or on loans sold into the 

secondary market) by charging a higher 

rate rather than additional points and 

fees; however, the Board recognizes the 

limits of this approach to loan-level risk 

mitigation due to concerns such as 

exceeding high-cost mortgage rate 

thresholds. Nonetheless, in practice, an 

exclusion from the qualified mortgage 

points and fees calculation for all points 

charged to offset loan-level risks may 

create compliance and enforcement 

difficulties. The Board questions 

whether meaningful distinctions 

between points charged to offset loanlevel risks and other points and fees 

charged on a loan can be made clearly 

and consistently. In addition, such an 

exclusion could be overbroad and 

inconsistent with Congress’s intent that 

points generally be counted toward the 

points and fees threshold for qualified 

mortgages. 

The Board requests comment on 

whether and on what basis the final rule 

should exclude from points and fees for 

qualified mortgages points charged to 

meet risk-based price adjustment 

requirements of secondary market 

purchasers and points charged to offset 


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Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27467 

loan-level risks on mortgages held in 

portfolio. 

43(e)(3)(iii) Definition of Loan 

Originator 

Proposed § 226.43(e)(3)(iii) defines 

the term ‘‘loan originator’’ in 

§ 226.43(e)(3) to have the same meaning 

as in § 226.36(a)(1). For a discussion of 

the Board’s proposal to use the term 

‘‘loan originator’’ as defined in 

§ 226.36(a)(1) rather than the statutory 

term ‘‘mortgage originator,’’ see the 

section-by-section analysis of proposed 

§ 226.32(b)(1)(ii). 

43(e)(3)(iv) Definition of Bona Fide 

Discount Point 

Proposed § 226.43(e)(3)(iv) defines the 

term ‘‘bona fide discount point’’ as used 

in the exclusions of certain ‘‘bona fide 

discount points’’ from ‘‘points and fees’’ 

for qualified mortgages described above. 

This provision is intended to implement 

TILA Section 129C(b)(2)(C)(iii), which 

defines the term ‘‘bona fide discount 

point,’’ as well as TILA Section 

129C(b)(2)(C)(iv), which limits the types 

of discount points that may be excluded 

from ‘‘points and fees’’ to those for 

which ‘‘the amount of the interest rate 

reduction purchased is reasonably 

consistent with established industry 

norms and practices for secondary 

market transactions.’’ 15 U.S.C. 

1639c(b)(2)(C)(iii) and (iv). 

Thus, ‘‘bona fide discount point’’ is 

proposed to be defined as ‘‘any percent 

of the loan amount’’ paid by the 

consumer that reduces the interest rate 

or time-price differential applicable to 

the mortgage loan by an amount based 

on a calculation that— 

• Is consistent with established 

industry practices for determining the 

amount of reduction in the interest rate 

or time-price differential appropriate for 

the amount of discount points paid by 

the consumer; and 

• Accounts for the amount of 

compensation that the creditor can 

reasonably expect to receive from 

secondary market investors in return for 

the mortgage loan. 

Consistent with the express statutory 

language, the Board’s proposal requires 

that the creditor be able to show a 

relationship between the amount of 

interest rate reduction purchased by a 

discount point to the value of the 

transaction in the secondary market. 

Based on outreach with representatives 

of creditors and government-sponsored 

enterprises (GSEs) in particular, the 

Board understands that the value of a 

rate reduction in a particular mortgage 

transaction on the secondary market is 

based on many complex factors, which 

interact in a variety of complex ways. 

These factors may include, among 

others: 

• The product type, such as whether 

the loan is a fixed-rate or adjustable-rate 

mortgage, or has a 30-year term or a 15- 

year term. 

• How much the mortgage-backed 

securities (MBS) market is willing to 

pay for a loan at that interest rate and 

the liquidity of an MBS with loans at 

that rate. 

• How much the secondary market is 

willing to pay for excess interest on the 

loan that is available for capitalization 

outside of the MBS market. 

• The amount of the guaranty fee 

required to be paid by the creditor to the 

investor. 

The proposal therefore is intended to 

facilitate compliance by affording 

flexibility, while still requiring, as 

mandated by the statute, that the 

amount of discount points paid by 

consumers for a particular interest rate 

reduction be tied to the capital markets. 

The Board is concerned that a more 

prescriptive interpretation would be 

operationally unworkable for most 

creditors and would lead to excessive 

legal and regulatory risk. In addition, 

the Board recognizes that, due to the 

variation in inputs described above, a 

more prescriptive rule likely would 

require continual updating, creating 

additional compliance burden and 

potential confusion. 

Concerns have been raised that small 

creditors such as community banks that 

often hold loans in portfolio rather than 

sell them on the secondary market may 

have difficulty complying with this 

requirement. The Board requests 

comment on whether any exemptions 

from the requirement that the interest 

rate reduction purchased by a ‘‘bona fide 

discount point’’ be tied to secondary 

market factors are appropriate. 

43(f) Balloon-Payment Qualified 

Mortgages Made by Certain Creditors 

As discussed above, under this 

proposal, a qualified mortgage generally 

may not provide for a balloon payment. 

TILA Section 129C(b)(2)(E), however, 

authorizes the Board to permit qualified 

mortgages with balloon payments, 

provided the loans meet four 

conditions. Those conditions are that (1) 

the loan meets all of the criteria for a 

qualified mortgage, with certain 

exceptions discussed in the more 

detailed section-by-section analysis, 

below; (2) the creditor makes a 

determination that the consumer is able 

to make all scheduled payments, except 

the balloon payment, out of income or 

assets other than the collateral; (3) the 

loan is underwritten based on a 

payment schedule that fully amortizes 

the loan over a period of not more than 

30 years and takes into account all 

applicable taxes, insurance, and 

assessments; and (4) the creditor meets 

four prescribed qualifications. Those 

four qualifications are that the creditor 

(1) operates predominantly in rural or 

underserved areas; (2) together with all 

affiliates, has total annual residential 

mortgage loan originations that do not 

exceed a limit set by the Board; (3) 

retains the balloon-payment loans in 

portfolio; and (4) meets any asset-size 

threshold and any other criteria the 

Board may establish. 

Based on outreach, certain 

community banks appear to originate 

balloon-payment loans to hedge against 

interest rate risk, rather than making 

adjustable-rate mortgages. The Board 

understands that the community banks 

hold these balloon-payment loans in 

portfolio virtually without exception 

because they are not eligible for sale in 

the established secondary market. The 

Board believes Congress enacted the 

exception in TILA Section 129C(b)(2)(E) 

to ensure access to credit in rural and 

underserved areas where consumers 

may be able to obtain credit only from 

such community banks offering these 

balloon-payment loans. Accordingly, 

proposed § 226.43(f) implements TILA 

Section 129C(b)(2)(E) by providing an 

exception to the general provision that 

a qualified mortgage may not provide 

for a balloon payment. 

Proposed § 226.43(f)(1) sets forth the 

four statutory conditions described 

above, as well as an additional 

condition that the loan term be five 

years or longer, which the Board is 

proposing pursuant to its authority to 

‘‘revise, add to, or subtract from the 

criteria that define a qualified mortgage’’ 

under TILA Section 129C(b)(3)(B)(i). 

Proposed § 226.43(f)(2) provides 

definitions of ‘‘rural’’ and ‘‘underserved’’ 

for use in determining whether the 

creditor satisfies the first qualification 

that it ‘‘operates predominantly in rural 

or underserved areas.’’ These proposed 

provisions are discussed in greater 

detail below. 

43(f)(1) Exception 

43(f)(1)(i) Criteria for a Qualified 

Mortgage 

Proposed § 226.43(f)(1)(i) implements 

TILA Section 129C(b)(2)(E)(i) by 

providing that a balloon-payment 

qualified mortgage must meet all of the 

criteria for a qualified mortgage except 

those requiring that the loan (1) not 

provide for deferral of principal 

repayment, (2) not provide for a balloon 

payment, and (3) be underwritten based 

on a fully amortizing payment schedule 


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27468 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

that takes into account all mortgagerelated obligations and using the 

maximum interest rate that may apply 

during the first five years after 

consummation. Proposed comment 

43(f)(1)(i)–1 clarifies that a balloonpayment qualified mortgage under this 

exception therefore must provide for 

regular periodic payments that do not 

result in an increase of the principal 

balance as required by 

§ 226.43(e)(2)(i)(A), must have a loan 

term that does not exceed 30 years as 

required by § 226.43(e)(2)(ii), must have 

total points and fees that do not exceed 

specified thresholds pursuant to 

§ 226.43(e)(2)(iii), and must satisfy the 

consideration and verification 

requirements in § 226.43(e)(2)(v). 

Under this provision, in accordance 

with the statutory provisions, the 

exception would excuse balloonpayment qualified mortgages from the 

requirement in proposed 

§ 226.43(e)(2)(i)(B) that a qualified 

mortgage not allow the consumer to 

defer repayment of principal. As noted 

above, deferred principal repayment 

may occur if the payment is applied to 

both accrued interest and principal but 

the consumer makes periodic payments 

that are less than the amount that would 

be required under a payment schedule 

that has substantially equal payments 

that fully repay the loan amount over 

the loan term. The scheduled payments 

that fully repay a balloon-payment loan 

over the loan term include the balloon 

payment itself and, therefore, are not 

substantially equal. Thus, balloonpayment loans permit the consumer to 

defer repayment of principal. The Board 

believes that Congress excused balloonpayment qualified mortgages from the 

restriction on principal repayment 

deferral for this reason. That rationale, 

however, does not necessarily extend to 

loans that permit principal repayment 

deferral by providing for interest-only 

payments. The Board solicits comment 

on whether the exception should 

provide that balloon-payment qualified 

mortgages may permit only principal 

repayment deferral resulting from the 

use of an amortization period that 

exceeds the loan term, as balloonpayment loans commonly do, but may 

not permit principal repayment deferral 

resulting from interest-only payments. 

43(f)(1)(ii) Underwriting Using 

Scheduled Payments 

Proposed § 226.43(f)(1)(ii) implements 

TILA Section 129C(b)(2)(E)(ii) by 

providing that, to make a balloonpayment qualified mortgage, a creditor 

must determine that the consumer can 

make all of the scheduled payments 

under the terms of the legal obligation, 

except the balloon payment, from the 

consumer’s current or reasonably 

expected income or assets other than the 

dwelling that secures the loan. Proposed 

comment 43(f)(1)(ii)–1 provides the 

following example to illustrate the 

calculation of the monthly payment on 

which this determination must be 

based: Assume a loan in an amount of 

$200,000 that has a five-year loan term, 

but is amortized over 30 years. The loan 

agreement provides for a fixed interest 

rate of 6%. The loan consummates on 

March 15, 2011, and the monthly 

payment of principal and interest 

scheduled for the first five years is 

$1,199, with the first monthly payment 

due on May 1, 2011. The balloon 

payment of $187,308 is required on the 

due date of the 60th monthly payment, 

which is April 1, 2016. The loan 

remains a qualified mortgage if the 

creditor underwrites the loan using the 

scheduled principal and interest 

payment of $1,199 (plus all mortgagerelated obligations, pursuant to 

§ 226.43(f)(1)(iii)(B)). 

Proposed comment 43(f)(1)(ii)–2 

provides additional clarification on how 

a creditor may make the required 

determination that the consumer is able 

to make all scheduled payments other 

than the balloon payment. It states that 

a creditor must determine that the 

consumer is able to make all scheduled 

payments other than the balloon 

payment to satisfy § 226.43(f)(1)(ii), but 

the creditor is not required to meet the 

repayment ability requirements of 

§ 226.43(c)(2)–(7) because those 

requirements apply only to covered 

transactions that are not qualified 

mortgages. Nevertheless, a creditor 

satisfies § 226.43(f)(1)(ii) if it complies 

with the requirements of § 226.43(c)(2)– 

(7). A creditor also may make the 

determination that the consumer is able 

to make the scheduled payments (other 

than the balloon payment) by other 

means. For example, a creditor need not 

determine that the consumer is able to 

make the scheduled payments based on 

a payment amount that is calculated in 

accordance with § 226.43(c)(5)(ii)(A) or 

may choose to consider a debt-toincome ratio that is not determined in 

accordance with § 226.43(c)(7). 

43(f)(1)(iii) Calculation of Scheduled 

Payments 

TILA Section 129C(b)(2)(E)(iii) 

provides that a balloon-payment 

qualified mortgage must be 

underwritten based on a payment 

schedule that fully amortizes the loan 

over a period of not more than 30 years 

and takes into account all applicable 

taxes, insurance, and assessments. To 

implement this provision, proposed 

§ 226.43(f)(1)(iii) requires that the 

scheduled payments on which the 

determination required by 

§ 226.43(f)(1)(ii) is based are calculated 

using an amortization period that does 

not exceed 30 years and include all 

mortgage-related obligations. The Board 

believes that the underwriting 

referenced in TILA Section 

129C(b)(2)(E)(iii) corresponds to the 

determination of the consumer’s 

repayment ability referenced in TILA 

Section 129C(b)(2)(E)(ii). 

Further, the Board believes that the 

statutory reference to ‘‘a payment 

schedule that fully amortizes the loan 

over a period of not more than 30 years’’ 

refers to the amortization period used to 

determine the scheduled periodic 

payments (other than the balloon 

payment) under the legal obligation and 

not to the actual loan term of the 

obligation, which often is considerably 

shorter for a balloon-payment loan. 

Proposed comment 43(f)(1)(iii)–1 

clarifies that balloon payments often 

result when the periodic payment 

would fully repay the loan amount only 

if made over some period that is longer 

than the loan term. The Board believes 

this type of transaction was the reason 

for the statutory exception for certain 

balloon-payment loans. 

43(f)(1)(iv) Loan Term 

As noted above, the Board is 

proposing to add a condition for a 

balloon-payment qualified mortgage that 

is not established by TILA Section 

129C(b)(2)(E). Proposed 

§ 226.43(f)(1)(iv) provides that a 

balloon-payment qualified mortgage 

must have a loan term of five years or 

longer. The Board makes this proposal 

pursuant to TILA Section 

129C(b)(3)(B)(i), which authorizes the 

Board ‘‘to revise, add to, or subtract from 

the criteria that define a qualified 

mortgage upon a finding that such 

regulations are necessary or proper to 

ensure that responsible, affordable 

mortgage credit remains available to 

consumers in a manner consistent with 

the purposes of this section, necessary 

and appropriate to effectuate the 

purposes of this section and Section 

129B, to prevent circumvention or 

evasion thereof, or to facilitate 

compliance with such sections.’’ The 

purpose of TILA Section 129C is to 

ensure that consumers are offered and 

receive loans on terms that they are 

reasonably able to repay. TILA Section 

129B(a)(2). The Board believes that a 

minimum loan term for balloonpayment loans is necessary and 

appropriate both to effectuate the 

purposes of TILA Section 129C and to 


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Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27469 

prevent circumvention or evasion 

thereof. 

The Board believes that the exception 

should be structured to prevent balloonpayment loans with very short loan 

terms from being qualified mortgages 

because such loans would present 

certain risks to consumers. A consumer 

with a loan term of less than five years, 

particularly where the amortization 

period is especially long, would face a 

balloon payment soon after 

consummation, in an amount virtually 

equal to the original loan amount. The 

consumer would establish little equity 

in the property under such terms, and 

if the pattern is repeated the consumer 

may never make any significant progress 

toward owning the home 

unencumbered. Thus, the greater the 

difference between a balloon-payment 

loan’s amortization period and its loan 

term, the more likely the consumer 

would face this problem. The Board’s 

proposal to require a minimum term 

therefore complements the 30-year 

maximum amortization period 

prescribed by TILA Section 

129C(b)(2)(E)(iii). 

In addition, the Board believes that 

some consumers may obtain balloonpayment loans as a temporary solution 

when they cannot afford a longer-term, 

fully amortizing loan. That is, because 

the interest rate is likely to be lower on 

a shorter-term obligation, a consumer 

may use a balloon-payment loan for 

more affordable financing currently, 

intending to refinance into a longerterm, fully amortizing loan once either 

the consumer’s financial condition has 

improved or current market rates have 

become more favorable, or both. The 

Board believes that the proposed fiveyear minimum loan term would help 

ensure that qualified mortgages with 

balloon payments provide consumers an 

adequate time window in which to 

refinance into longer-term loans. Thus, 

the Board believes that the purpose of 

ensuring that consumers are offered and 

receive affordable loan terms would be 

served by requiring that balloonpayment qualified mortgages have a 

minimum loan term of five years. 

The Board notes that the statute 

requires underwriting for an adjustablerate qualified mortgage to be based on 

the maximum interest rate permitted 

during the first five years. TILA Section 

129C(b)(2)(A)(v). Therefore, proposed 

§ 226.43(f)(1)(iv) reflects the statutory 

intent that five years is a reasonable 

period to repay a loan. 

For the foregoing reasons, the Board 

believes that proposed § 226.43(f)(1)(iv), 

in limiting the exception for balloonpayment qualified mortgages to covered 

transactions with loan terms of at least 

five years and thus ensuring that such 

products truly support mortgage 

affordability, would effectuate the 

purposes of TILA Section 129C and 

prevent circumvention or evasion 

thereof. The Board solicits comment on 

the appropriateness of this proposed 

additional condition as well as on the 

proposed use of five years as the 

minimum loan term. 

43(f)(1)(v) Creditor Qualifications 

TILA Section 129C(b)(2)(E)(iv) 

includes among the conditions for a 

balloon-payment qualified mortgage that 

the creditor (1) operates predominantly 

in rural or underserved areas; (2) 

together with all affiliates, has total 

annual residential mortgage loan 

originations that do not exceed a limit 

set by the Board; (3) retains the balloonpayment loans in portfolio; and (4) 

meets any asset-size threshold and any 

other criteria as the Board may 

establish. These four creditor 

qualifications are similar to the 

conditions for an exemption from the 

requirement that an escrow account be 

established for certain mortgages set 

forth in TILA Section 129D(c), as 

enacted by Section 1461 of the DoddFrank Act. The Board proposed to 

implement the escrow exemption in the 

2011 Escrow Proposal. The provisions 

of proposed § 226.43(f)(1)(v), which 

implement TILA Section 

129C(b)(2)(E)(iv), differ in some respects 

from the provisions of proposed 

§ 226.45(b)(2)(iii) in the 2011 Escrow 

Proposal because of differences in the 

rationales underlying the two 

exceptions. 

Proposed § 226.43(f)(1)(v) implements 

TILA Section 129C(b)(2)(E)(iv) by 

providing that a balloon-payment loan 

may be a qualified mortgage if the 

creditor (1) makes most of its balloonpayment loans in counties designated 

by the Board as ‘‘rural or underserved,’’ 

(2) together with all affiliates extended 

only limited covered transactions, (3) 

has not sold, assigned, or otherwise 

transferred ownership of its balloonpayment loans, and (4) has total assets 

that do not exceed a threshold 

established and published annually by 

the Board, based on the year-to-year 

change in the average of the Consumer 

Price Index for Urban Wage Earners and 

Clerical Workers. These qualifications 

are discussed in more detail in the 

following parts of this section-bysection analysis. 

‘‘Operates Predominantly in Rural or 

Underserved Areas’’ 

Under TILA Section 

129C(b)(2)(E)(iv)(I), to qualify for the 

exception, a creditor must ‘‘operate 

predominantly in rural or underserved 

areas.’’ To implement this provision, 

proposed § 226.43(f)(1)(v)(A) provides 

that, during the preceding calendar year, 

a creditor must have made more than 

50% of its total balloon-payment loans 

in counties designated by the Board as 

‘‘rural or underserved.’’ Proposed 

comment 43(f)(1)(v)–1.i states that the 

Board publishes annually a list of 

counties that qualify as ‘‘rural’’ or 

‘‘underserved.’’ The Board’s annual 

determinations would be based on the 

criteria set forth in proposed 

§ 226.43(f)(2), discussed below. 

‘‘Areas.’’ In determining what is a 

rural or underserved area, the Board is 

proposing to use counties as the 

relevant area. The Board believes that 

the county level is the most appropriate 

area for this purpose, even though the 

sizes of counties can vary. In 

determining the relevant area for 

consumers who are shopping for 

mortgage loans, census tracts would be 

too small, while states generally would 

be too large. Because a single standard 

nationwide would facilitate compliance, 

the Board is proposing to use counties 

for all geographic areas. The Board seeks 

comment on the appropriateness of this 

approach. 

‘‘Operates predominantly.’’ As noted, 

the proposed rule requires a creditor to 

have made during the preceding 

calendar year more than 50% of its total 

balloon-payment loans in ‘‘rural or 

underserved’’ counties. The Board 

believes that ‘‘predominantly’’ indicates 

a portion greater than half, hence the 

proposed regulatory requirement of 

more than 50%. The Board proposes to 

implement ‘‘operates’’ consistently with 

the scope of the relevant qualified 

mortgage provision. Thus, because the 

definition of qualified mortgage 

generally excludes balloon-payment 

loans, see proposed § 226.43(e)(2)(i)(C), 

only those loans would be counted 

toward this element of the exception. 

The Board solicits comment on the 

appropriateness of both of these 

proposed approaches to implementing 

the phrase, ‘‘operates predominantly.’’ 

Total Annual Residential Mortgage Loan 

Originations 

Under TILA Section 

129C(b)(2)(E)(iv)(II), to qualify for the 

exception, the creditor and all affiliates 

together must have total annual 

residential mortgage loan originations 

that do not exceed a limit set by the 

Board. The Board has identified two 

primary issues presented in 

implementing this provision: (1) 

Whether total annual originations 

should be measured by number of loans 

or by aggregate dollar volume; and (2) 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
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the appropriate threshold under either 

measure. 

The Board has only limited 

information on which to base the 

foregoing determinations. Thrift 

Financial Reports provide limited data 

concerning thrifts’ balloon-payment 

loan originations; other types of 

depository institutions do not identify 

which of their mortgage originations are 

balloon-payment loans. Moreover, the 

balloon-payment loans reported by 

thrifts include some unknown number 

of commercial-purpose loans, which 

would not be subject to Regulation Z. 

Based on the limited thrift data 

available from 2009, the Board estimates 

that a threshold of $100 million in 

annual aggregate loan amounts 

originated would make approximately 

two-thirds of all thrifts eligible for the 

exception (assuming they also meet the 

other qualifications), and those thrifts 

are responsible for approximately 10% 

of all thrift-originated balloon-payment 

loans. Thus, at least among thrifts, the 

vast majority of balloon-payment loans 

are made by a minority of creditors with 

relatively large overall mortgage 

origination volumes. It is not clear, 

however, that 10% is the correct 

percentage of all balloon-payment loans 

to be eligible for the exception. 

In light of these uncertainties, the 

Board is not proposing a specific 

threshold. To implement TILA Section 

129C(b)(2)(E)(iv)(II), the Board is 

proposing two alternative versions of 

§ 226.43(f)(1)(v)(B). Alternative 1 would 

require that, during the preceding 

calendar year, the creditor together with 

all affiliates have extended covered 

transactions with principal amounts 

that in the aggregate total a to-bedetermined dollar amount or less. 

Alternative 2 would require that, during 

the preceding calendar year, the creditor 

together with all affiliates have 

extended a to-be-determined number of 

covered transactions or fewer. The 

Board is soliciting comment on both 

which alternative is more appropriate 

and the correct dollar amount or 

number of loans, as applicable. For 

example, should the threshold be 100 

loans per year, something greater, or 

something less? Alternatively, should 

the threshold be $100 million in 

aggregate covered-transaction loan 

amounts per year, something greater, or 

something less? The Board also requests 

that commenters explain their rationales 

for any suggested thresholds. In 

particular, how would a specific 

threshold correlate with the size and 

scope of activity of creditors that, in the 

absence of the exception, would be 

likely to cease offering balloon-payment 

loans and consequently leave 

consumers in their markets with limited 

access to responsible, affordable 

mortgage credit? The Board also 

requests that commenters share any data 

on which their recommendations are 

based. 

Retention of Balloon-Payment Loans in 

Portfolio 

Under TILA Section 

129C(b)(2)(E)(iv)(III), to qualify for the 

exception, the creditor must ‘‘retain[] the 

balloon loans in portfolio.’’ Read as 

literally as possible, this requirement 

would apply to all balloon-payment 

loans ever made by the creditor, even 

those made prior to the enactment of the 

statute. The Board believes, however, 

that very few creditors, if any, would be 

eligible for the exception under such a 

reading. Therefore, the Board is 

proposing two alternative versions of 

§ 226.43(f)(1)(v)(C) to implement this 

provision, both of which would require 

that the creditor not have sold, assigned, 

or otherwise transferred legal title to the 

debt obligation for any balloon-payment 

loan. The difference between the two 

alternatives lies entirely in the period 

during which any such transfer may not 

occur. 

Alternative 1 would provide that the 

creditor must not sell any balloonpayment loan on or after the effective 

date of the final rule made pursuant to 

this proposal. This approach would 

implement the statute’s language 

requiring that the creditor ‘‘retain[] the 

balloon loans in portfolio.’’ The Board 

recognizes, however, that even this 

approach may be unduly limited as a 

practical matter; once a creditor sold 

even one balloon-payment loan after the 

effective date, it would become 

permanently ineligible for the 

exception. By contrast, Alternative 2 

would limit the period during which the 

creditor must not have sold any balloonpayment loan to the preceding and 

current calendar years. 

The Board solicits comment on the 

relative merits of Alternatives 1 and 2. 

The Board also seeks comment on 

whether, under either alternative, some 

de minimis number of transfers that may 

be made without losing eligibility for 

the exception, such as two per calendar 

year, would be appropriate. Finally, the 

Board seeks comment on whether there 

are any other situations in which 

creditors should be permitted to transfer 

balloon-payment loans without 

becoming ineligible for the exception, 

such as troubled institutions that need 

to raise capital by selling assets or 

institutions that enter into mergers or 

acquisitions. 

Asset-Size Threshold 

Under TILA Section 

129C(b)(2)(E)(iv)(IV), to qualify for the 

exception, a creditor must meet any 

asset-size threshold established by the 

Board. Accordingly, proposed 

§ 226.43(f)(1)(v)(D) requires the creditor 

to have total assets as of December 31 

of the preceding calendar year that do 

not exceed an asset threshold 

established and published annually by 

the Board. The threshold dollar amount 

would be adjusted annually based on 

the year-to-year change in the average of 

the Consumer Price Index for Urban 

Wage Earners and Clerical Workers, not 

seasonally adjusted, for each 12-month 

period ending in November, with 

rounding to the nearest million dollars. 

Comment 43(f)(1)(v)–1.iv would be 

updated each December to publish the 

applicable threshold for the following 

calendar year. The comment would 

clarify that creditors that had total assets 

at or below the threshold on December 

31 of the preceding year satisfy this 

criterion for purposes of the exception 

during the current calendar year. 

This proposal would set the threshold 

for calendar year 2011 at $2 billion. 

Thus, a creditor would satisfy this 

element of the test if it had total assets 

of $2 billion or less on December 31, 

2010. This number is based on the 

limited data available to the Board 

through Thrift Financial Reports, noted 

above, and information from 

commercial banks’ Consolidated 

Reports of Condition and Income. 

Because of the limited information 

available on originations of balloonpayment loans, the Board cannot 

identify which creditors make more 

than 50% of such loans in ‘‘rural’’ or 

‘‘underserved’’ counties. The Board can 

identify, however, the institutions that 

likely conduct the majority of their 

overall business in such locations by 

reference to their office locations and to 

the origins of their deposits. The Board 

believes that the locations in which 

creditors have offices and from which 

they draw their deposits likely correlate 

with the locations in which they extend 

balloon-payment loans. Of those 

institutions that either have over 50% of 

their office locations in or derive over 

50% of their deposits from ‘‘rural’’ or 

‘‘underserved’’ counties (under the 

proposed definitions of those terms, 

discussed below), none had total assets 

as of the end of 2009 greater than $2 

billion. 

The Board believes that Congress’s 

intent in authorizing the Board to 

establish an asset-size test is to ensure 

that only smaller institutions that serve 

areas with otherwise limited credit 


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85See http://www.ers.usda.gov/briefing/Rurality/ 

UrbanInf/. 

options may qualify for the exception. 

At the same time, the Board believes 

that the asset-size test should not 

exclude creditors that otherwise 

probably are the type of community 

bank for which the exception is 

intended, i.e., those engaged primarily 

in serving rural or underserved areas. 

Accordingly, the Board is proposing to 

set the asset-size threshold at the 

highest level currently held by any of 

the institutions that appear to meet that 

description. The annual adjustment to 

the threshold would ensure that 

institutions growing at a pace consistent 

with inflation continue to be eligible for 

the exception. If an institution should 

grow substantially beyond the rate of 

inflation, however, it would effectively 

‘‘outgrow’’ the exception, consistent 

with Congress’s intent to restrict the 

exception to relatively small creditors. 

The Board seeks comment on the 

appropriateness of the proposed $2 

billion asset-size threshold and of the 

proposed annual adjustments thereto. 

TILA Section 129C(b)(2)(E)(iv)(IV) 

authorizes but does not require an assetsize test. The Board recognizes that the 

other qualifications that a creditor must 

satisfy, discussed above, likely would be 

satisfied only by relatively small 

creditors. Thus, there may be no need 

for a separate asset-size test, and the 

exception may be as readily 

implemented with lesser burden to 

creditors by omitting such a test. 

Moreover, in the parallel provisions of 

the 2011 Escrow Proposal, the Board 

proposed no asset-size test on the belief 

that it would be unnecessary. 

Accordingly, the Board seeks comment 

on whether an asset-size test is 

necessary to this exception. The Board 

also seeks comment on what threshold 

is appropriate, and why, if an asset-size 

test is necessary. The Board requests 

that commenters provide any data they 

have underlying their recommendations 

on these questions. 

43(f)(2) ‘‘Rural’’ and ‘‘Underserved’’ 

Defined 

Proposed § 226.43(f)(2) sets out the 

criteria for a county to be designated by 

the Board as ‘‘rural or underserved’’ for 

purposes of proposed 

§ 226.43(f)(1)(v)(A), discussed above. 

Under that section, a creditor’s balloonpayment loan originations in all 

counties designated as ‘‘rural or 

underserved’’ during a calendar year are 

measured as a percentage of the 

creditor’s total balloon-payment loan 

originations during that calendar year to 

determine whether the creditor may be 

eligible for the exemption during the 

following calendar year. If the creditor’s 

balloon-payment loan originations in 

‘‘rural or underserved’’ counties during a 

calendar year exceeded 50% of the 

creditor’s total balloon-payment loan 

originations in that calendar year, the 

creditor would satisfy 

§ 226.43(f)(1)(v)(A) for purposes of the 

following calendar year. 

Proposed § 226.43(f)(2) establishes 

separate criteria for both ‘‘rural’’ and 

‘‘underserved,’’ thus a county could 

qualify for designation by the Board 

under either definition. Under proposed 

§ 226.43(f)(2)(i), a county is designated 

as ‘‘rural’’ during a calendar year if it is 

not in a metropolitan statistical area or 

a micropolitan statistical area, as those 

terms are defined by the U.S. Office of 

Management and Budget, and either (1) 

it is not adjacent to any metropolitan or 

micropolitan area; or (2) it is adjacent to 

a metropolitan area with fewer than one 

million residents or adjacent to a 

micropolitan area, and it contains no 

town with 2,500 or more residents. 

Under proposed § 226.43(f)(2)(ii), a 

county is designated as ‘‘underserved’’ 

during a calendar year if no more than 

two creditors extend covered 

transactions five or more times in that 

county. 

These two definitions, discussed in 

more detail below, parallel the 

definitions of the same terms as they are 

used in proposed § 226.45(b)(2)(iv) as 

set forth in the Board’s 2011 Escrow 

Proposal. See proposed 

§ 226.45(b)(2)(iv), 76 FR 11598, 11621; 

March 2, 2011. Both sets of proposed 

regulatory definitions are for purposes 

of implementing identical statutory 

provisions, thus the Board believes 

consistent definitions are appropriate. 

See TILA Sections 129C(b)(2)(E)(iv)(I) 

and 129D(c)(1) (‘‘operates 

predominantly in rural or underserved 

areas’’). 

‘‘Rural’’ 

The Board is proposing to limit the 

definition of ‘‘rural’’ areas to those areas 

most likely to have only limited sources 

of mortgage credit because of their 

remoteness from urban centers and their 

resources. The test for ‘‘rural’’ in 

proposed § 226.43(f)(2)(i), described 

above, is based on the ‘‘urban influence 

codes’’ numbered 7, 10, 11, and 12, 

maintained by the Economic Research 

Service (ERS) of the United States 

Department of Agriculture. The ERS 

devised the urban influence codes to 

reflect such factors as counties’ relative 

population sizes, degrees of 

‘‘urbanization,’’ access to larger 

communities, and commuting 

patterns.85 The four codes captured in 

the proposed ‘‘rural’’ definition 

represent the most remote rural areas, 

where ready access to the resources of 

larger, more urban communities and 

mobility are most limited. Proposed 

comment 43(f)(2)–1 states that the Board 

classifies a county as ‘‘rural’’ if it is 

categorized under ERS urban influence 

code 7, 10, 11, or 12. The Board seeks 

comment on all aspects of this approach 

to designating ‘‘rural’’ counties, 

including whether the definition should 

be broader or narrower, as well as 

whether the designation should be 

based on information other than the ERS 

urban influence codes. 

‘‘Underserved’’ 

In determining what areas should be 

considered ‘‘underserved,’’ the Board 

has considered the minimum number of 

creditors that must be engaged in 

significant mortgage operations in an 

area for consumers to have meaningful 

access to mortgage credit. The test for 

‘‘underserved’’ in proposed 

§ 226.43(f)(2)(ii), described above, is 

based on the Board’s judgment that, 

where no more than two creditors are 

significantly active (measured by 

extending mortgage credit at least five 

times in a year), the unwillingness of 

one creditor to offer a balloon-payment 

loan would be detrimental to consumers 

with otherwise limited credit options. 

Thus, proposed § 226.43(f)(2)(ii) 

designates a county as ‘‘underserved’’ 

during a calendar year if no more than 

two creditors extend covered 

transactions five or more times in that 

county. Proposed comment 43(f)(2)–1 

states that the Board bases its 

determinations of whether counties are 

‘‘underserved’’ for purposes of 

§ 226.43(f)(1)(v)(A) by reference to data 

submitted by mortgage lenders under 

the Home Mortgage Disclosure Act 

(HMDA). 

The Board believes the purpose of the 

exception is to permit creditors that rely 

on certain balloon-payment loan 

products to continue to offer credit to 

consumers, rather than leave the 

mortgage loan market, if such creditors’ 

withdrawal would significantly limit 

consumers’ ability to obtain mortgage 

credit. In light of this rationale, the 

Board believes that ‘‘underserved’’ 

should be implemented in a way that 

protects consumers from losing 

meaningful access to mortgage credit. 

The Board is proposing to do so by 

designating as ‘‘underserved’’ only those 

areas where the withdrawal of a creditor 

from the market could leave no 

meaningful competition for consumers’ 

mortgage business. The Board seeks 

comment on the appropriateness of both 

the proposed use of two or fewer 


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27472 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

86Also, TILA Section 129C(c)(2) requires weekly 

publication of the ‘‘average prime offer rate’’ used 

to determine if a transaction is a ‘‘higher-priced 

mortgage loan.’’ 

87 In particular, the high-cost mortgage cannot be 

a higher-priced mortgage loan. See proposed 

§ 226.43(g)(1)(ii)(C). Also, the prepayment penalty 

must be permitted by applicable law. See 

§ 226.32(d)(7); proposed § 226.43(g)(1)(i). 

88Open-end credit plans are excluded from the 

definition of ‘‘residential mortgage loan,’’ and thus 

open-end reverse mortgages are not subject to the 

prepayment penalty requirements under TILA 

Section 129C(c). TILA Section 103(cc)(5). 

89See Hui Shan, ‘‘Reversing the Trend: The 

Recent Expansion of the Reverse Mortgage Market 

Finance and Economics Discussion Series,’’ Board 

of Governors of the Federal Reserve System, 2009– 

42 (2009), available at http:// 

www.federalreserve.gov/pubs/feds/2009/200942/ 

200942pap.pdf.; 24 CFR 209(a). 

existing competitors to delineate areas 

that are ‘‘underserved’’ and the proposed 

use of five or more covered transaction 

originations to identify competitors with 

a significant presence in a market. 

43(g) Prepayment Penalties 

Proposed § 226.43(g) would 

implement TILA Section 129C(c), which 

establishes certain limits on prepayment 

penalties for covered transactions. 

Specifically, TILA Section 129C(c) 

provides that: 

• Only a covered transaction that is a 

qualified mortgage may contain a 

prepayment penalty; 

• A qualified mortgage with a 

prepayment penalty may not have an 

adjustable rate and may not have an 

annual percentage rate that exceeds the 

threshold for a higher-priced mortgage 

loan; 

• The prepayment penalty may not 

exceed three percent of the outstanding 

balance during the first year after 

consummation, two percent during the 

second year after consummation, and 

one percent during the third year after 

consummation; 

• There can be no prepayment 

penalty after the end of the third year 

after consummation; and 

• A creditor may not offer a consumer 

a loan with a prepayment penalty 

without offering the consumer a loan 

that does not include a prepayment 

penalty.86

The Board’s proposal to implement 

TILA Section 129C(c) is discussed in 

detail below. The Board at this time 

does not propose to implement 

limitations on prepayment penalties the 

Dodd-Frank Act adds under other TILA 

provisions, also discussed below. 

Limitations for higher-priced 

mortgage loans. Currently, 

§ 226.35(b)(2) prohibits a prepayment 

penalty for higher-priced mortgage 

loans, unless certain conditions are met. 

In particular, the prepayment penalty 

must not apply after the two-year period 

following consummation, and the 

amount of the periodic payment of 

principal and interest or both must not 

change during the four-year period 

following consummation. New TILA 

Section 129C(c), as added by Section 

1414 of the Dodd-Frank Act, establishes 

limitations on prepayment penalties 

that apply to all covered transactions. 

Thus, TILA Section 129C(c) renders 

superfluous the limitations on 

prepayment penalties with higherpriced mortgage loans adopted in the 

Board’s 2008 HOEPA Final Rule. See 15 

U.S.C. 1639(c), (l); § 226.35(b)(2). The 

Board accordingly proposes to remove 

the limitations on prepayment penalties 

for higher-priced mortgage loans under 

§ 226.35(b)(2) and other requirements 

under § 226.35, as discussed in detail 

above in the section-by-section analysis 

of proposed § 226.35. 

Limitations for high-cost mortgages. 

Section 1432(a) of the Dodd-Frank Act 

prohibits prepayment penalties with 

high-cost mortgages by removing TILA 

Section 129(c)(2), which had allowed 

prepayment penalties with high-cost 

mortgages in certain circumstances. 

Currently, § 226.32(d)(7) implements 

TILA Section 129(c)(2). At this time, the 

Board does not propose to remove 

§ 226.32(d)(7) because the proposal in 

general does not propose to implement 

the other revisions to the high-cost 

mortgage requirements under Section 

1431 of the Act. Nevertheless, under the 

proposal, a high-cost mortgage can 

include a prepayment penalty only if 

the high-cost mortgage meets the 

conditions under both current 

§ 226.32(d)(7) and proposed 

§ 226.43(g)(1). The joint operation of 

those two sets of conditions 

significantly limits the circumstances in 

which a high-cost mortgage may have a 

prepayment penalty.87

Scope; reverse mortgages. Proposed 

§ 226.43(g) implements TILA Section 

129C(c), which applies to a ‘‘residential 

mortgage loan,’’ that is, to a consumer 

credit transaction secured by a dwelling, 

other than an open-end credit plan or a 

transaction secured by a consumer’s 

interest in a timeshare plan. See TILA 

Section 103(cc)(5). In contrast with the 

exclusions for open-end credit plans 

and transactions secured by timeshares 

from coverage by ability-to-repay 

requirements, neither the definition of 

‘‘residential mortgage loan’’ nor the 

prepayment penalty provision excludes 

reverse mortgages or temporary or 

‘‘bridge’’ loans 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. See TILA Sections 103(cc)(5), 

129C(a)(8), 129C(c). Accordingly, the 

prepayment penalty requirements in 

proposed § 226.43(g) apply to such 

transactions. See proposed 

§ 226.43(a)(3). 

A covered transaction may include a 

prepayment penalty only if the 

transaction is a qualified mortgage. See 

TILA Section 129C(c)(1)(A); see also 

proposed § 226.43(g)(1)(ii)(B). Among 

other limitations, a qualified mortgage 

may not have a prepayment penalty if 

the transaction provides for an increase 

in the principal balance. Reverse 

mortgages provide for interest and fees 

to be added to the principal balance and 

thus could not include a prepayment 

penalty. However, the Board has 

authority to define a category of 

‘‘qualified’’ closed-end reverse mortgages 

that can include a prepayment penalty 

if certain other conditions are met, 

pursuant to authority under TILA 

Sections 129C(b)(2)(A)(ix) and 

129C(b)(3)(B).88 Section 

129C(b)(2)(A)(ix) authorizes the Board 

to define a ‘‘qualified’’ reverse mortgage 

that ‘‘meets the standards for a qualified 

mortgage, as set by the Board in rules 

that are consistent with the purposes’’ of 

TILA Section 129C(b). Also, TILA 

Section 129C(b)(3)(B) authorizes the 

Board to prescribe regulations that 

revise, add to, or subtract from the 

criteria that define a qualified mortgage 

upon a finding that such regulations are 

(1) necessary or proper to ensure that 

responsible, affordable mortgage credit 

remains available to consumers in a 

manner consistent with the purposes of 

Section 129C(b), or (2) necessary and 

appropriate to effectuate the purposes of 

Sections 129B and 129C, to prevent 

circumvention or evasion thereof, or to 

facilitate compliance therewith. 

The Board does not propose to 

exclude ‘‘qualified’’ reverse mortgages 

from the coverage of the prepayment 

penalty requirements, for two reasons. 

First, the Board does not believe that 

such exclusion is necessary or proper to 

ensure that responsible, affordable 

mortgage credit remains available to 

consumers. The overwhelming majority 

of reverse mortgages to date have been 

insured by the Federal Housing 

Administration, which does not allow 

reverse mortgages to contain 

prepayment penalties.89 The Board 

believes that most proprietary reverse 

mortgages also do not contain 

prepayment penalties. Accordingly, the 

Board believes that applying 

prepayment penalty requirements under 

TILA Section 129C(c) to closed-end 

reverse mortgages would have little or 

no effect on the availability of reverse 


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90Open-end credit plans are excluded from the 

definition of ‘‘residential mortgage loan,’’ and thus 

open-end reverse mortgages are not subject to the 

prepayment penalty requirements under TILA 

Section 129C(c). TILA Section 103(cc)(5). 

91 76 FR 11598, 11608, Mar. 2, 2011 (discussing 

proposed new § 226.45(a)). 

92See, e.g., § 226.18(f) (requiring disclosures 

regarding APR increases), 226.18(s)(7)(i)–(iii) 

(categorizing disclosures for purposes of interest 

rate and payment disclosures), 226.36(e)(2)(i)–(ii) 

(categorizing transactions for purposes of the safe 

harbor for the anti-steering requirement under 

§ 226.36(e)(1)). 

mortgages. Second, the Board believes 

that excluding ‘‘qualified’’ reverse 

mortgages from coverage of the 

prepayment penalty requirements is not 

necessary or appropriate to effectuate 

the purposes of TILA Section 129C, 

because the Board is unaware of a 

reason why such exclusion would 

‘‘assure that consumers are offered and 

receive residential mortgage loans on 

terms that reasonably affect their ability 

to repay the loans and that are 

understandable and not unfair, 

deceptive, or abusive.’’ See TILA Section 

129B(a)(2). 

Only a qualified mortgage may have a 

prepayment penalty, and reverse 

mortgages typically do not satisfy the 

qualified mortgage conditions. In 

particular, a qualified mortgage may not 

provide for an increase in the 

transaction’s principal balance. See 

TILA Section 129C(b)(2)(A)(i). However, 

a reverse mortgage provides for interest 

and fees to be added to the loan balance, 

instead of providing for the consumer to 

make payments during the loan term. 

Also, creditors do not consider a 

consumer’s repayment ability for a 

reverse mortgage because the consumer 

does not make payments. Thus, because 

the proposal does not establish special 

conditions for reverse mortgages to be 

qualified mortgages, closed-end reverse 

mortgages likely may not have 

prepayment penalties.90 See TILA 

Section 129C(c)(1)(A). 

The Board requests comment on 

whether special rules should be created 

to permit certain reverse mortgages to 

have prepayment penalties. In 

particular, the Board requests comment 

on how applying such conditions would 

be consistent with the purposes of the 

alternative requirements for qualified 

mortgages under TILA Section 129C(b). 

The Board also requests comment and 

any supporting data on the prepayment 

rates for reverse mortgages. 

43(g)(1) When Permitted 

TILA Section 129C(c)(1)(A) provides 

that a covered transaction must not 

include a penalty for paying all or part 

of the principal balance after 

consummation unless the transaction is 

a qualified mortgage as defined in TILA 

Section 129C(b)(2). TILA Section 

129C(c)(1)(B) provides that, for purposes 

of TILA Section 129C(c), a qualified 

mortgage does not include a covered 

transaction that has an adjustable rate or 

a covered transaction that has an APR 

that exceeds the average prime offer rate 

for a comparable transaction, as of the 

date the rate is set, by a specified 

number of percentage points. The 

applicable APR threshold depends on 

whether a first lien or subordinate lien 

secures the transaction and whether or 

not the transaction’s original principal 

obligation exceeds the maximum 

principal obligation for a loan eligible 

for purchase by Freddie Mac, that is, 

whether or not the covered transaction 

is a ‘‘jumbo’’ loan. Specifically, the APR 

threshold is: (1) 1.5 percentage points 

above the average prime offer rate, for a 

first-lien, non-‘‘jumbo’’ loan; (2) 2.5 

percentage points above the average 

prime offer rate, for a first-lien ‘‘jumbo’’ 

loan; and (3) 3.5 percentage points 

above the average prime offer rate, for a 

subordinate-lien loan. These thresholds 

also are used for purposes of escrow 

account requirements for ‘‘higher-priced 

mortgage loans,’’ as discussed in the 

2011 Escrow Proposal.91 Proposed 

§ 226.43(g)(1) would implement TILA 

Section 129C(c)(1) and provides that a 

covered transaction may not include a 

prepayment penalty unless the 

prepayment penalty is otherwise 

permitted by law, and the transaction: 

(1) Has an APR that cannot increase 

after consummation; (2) is a qualified 

mortgage, as defined in proposed 

§ 226.43(e) or (f); and (3) is not a higherpriced mortgage loan, as defined in 

proposed § 226.45(a). 

43(g)(1)(i) Permitted by Applicable Law 

Under proposed § 226.43(g)(1)(i), a 

prepayment penalty must be otherwise 

permitted by applicable law. The Board 

believes that TILA Section 129C(c) 

limits, but does not specifically 

authorize, including a prepayment 

penalty with a covered transaction. That 

is, TILA Section 129C(c) does not 

override other applicable laws, such as 

state laws, that may be more restrictive. 

Thus, a prepayment penalty would not 

be permitted if otherwise prohibited by 

applicable law. This approach is 

consistent with prepayment penalty 

requirements for high-cost mortgages 

and higher-priced mortgage loans. See 

§ 226.32(d)(7)(i), 226.35(b)(2)(i). 

43(g)(1)(ii) Transaction Conditions 

43(g)(1)(ii)(A) APR Cannot Increase 

After Consummation 

TILA Section 129C(c)(1)(B)(i) 

provides that a covered transaction may 

not include a prepayment penalty if the 

transaction has an ‘‘adjustable rate.’’ The 

statute differs from the Board’s 2008 

HOEPA Final Rule, in which a high-cost 

mortgage or a higher-priced mortgage 

loan may not include a prepayment 

penalty if the periodic payment of 

principal or interest may change during 

the first four years after consummation. 

See § 226.32(d)(7)(iv), 226.35(b)(2)(C). 

TILA Section 129C(c)(1)(B)(i) does not 

specify whether the term ‘‘adjustable 

rate’’ refers to the transaction’s interest 

rate or annual percentage rate. Rules 

under Regulation Z for closed-end 

transactions generally categorize 

transactions based on the possibility of 

APR changes rather than interest rate 

changes.92 This distinction is relevant 

because covered transactions may have 

an APR that cannot increase after 

consummation even though the interest 

rate or payments may increase after 

consummation. For example, the APR 

for a ‘‘step-rate mortgage’’ without a 

variable rate feature does not change 

after consummation, because the rates 

that will apply and the periods for 

which they will apply are known at 

consummation. Cf. § 226.18(s)(7)(ii) 

(defining ‘‘step-rate mortgage’’ for 

purposes of transaction-specific interest 

rate and payment disclosures). 

The Board proposes to interpret the 

prohibition on a prepayment penalty 

with a covered transaction that has an 

‘‘adjustable rate’’ in TILA Section 

129C(c)(1)(B)(i) to apply to covered 

transactions for which the APR can 

increase after consummation, to 

facilitate creditors’ compliance with the 

various rate-related requirements under 

Regulation Z. Accordingly, to 

implement TILA Section 

129C(c)(1)(B)(i), proposed 

§ 226.43(g)(1)(ii)(A) provides that a 

covered transaction cannot include a 

prepayment penalty unless the 

transaction’s APR cannot increase after 

consummation. Thus, under the Board’s 

proposal a fixed-rate mortgage or a steprate mortgage may have a prepayment 

penalty, but an adjustable-rate mortgage 

may not have a prepayment penalty. See 

§ 226.18(s)(7)(i)–(iii) (defining ‘‘fixedrate mortgage,’’ ‘‘step-rate mortgage,’’ and 

‘‘adjustable-rate mortgage’’). The Board 

solicits comment on this approach. 

43(g)(1)(ii)(B) Qualified Mortgage 

Under TILA Section 129C(c)(1)(A), a 

covered transaction may not include a 

prepayment penalty unless the 

transaction is a qualified mortgage 

under TILA Section 129C(b)(2). 

Proposed § 226.43(g)(1)(ii)(B) would 

implement TILA Section 129C(c)(1)(A) 


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93See 74 FR 58539, 58709–58710, Sept. 24, 2010 

(proposing revisions to the definition of ‘‘higherpriced mortgage loan’’ under § 226.35(a)). 

94See 74 FR at 58660–58662. 

95See 75 FR 11598, 11620, Mar. 2, 2011 

(proposing a new § 226.45(a)). 

and provides that a covered transaction 

must not include a prepayment penalty 

unless the transaction is a qualified 

mortgage under § 226.43(e) or (f). To be 

a qualified mortgage, a covered 

transaction in general may not have a 

balloon payment. However, a covered 

transaction with a balloon payment may 

be a qualified mortgage if the creditor 

originates covered transactions 

primarily in ‘‘rural’’ or ‘‘underserved’’ 

areas, as discussed in detail above in the 

section-by-section analysis of 

§ 226.43(f). Thus, there are certain 

situations in which a consumer could 

face a prepayment penalty if she 

attempts to refinance out of a balloonpayment qualified mortgage before the 

balloon payment is due. The Board 

solicits comment on whether it would 

be appropriate to use legal authority 

under TILA Sections 105(a) and 129B(e) 

to provide that a balloon-payment 

qualified mortgage may not have a 

prepayment penalty in any case. 

43(g)(1)(ii)(C) Threshold for a HigherPriced Mortgage Loan 

Under TILA Section 129C(c)(1)(B), a 

covered transaction may not include a 

prepayment penalty unless the 

transaction’s APR is below specified 

thresholds. Accordingly, to implement 

TILA Section 129C(c)(1)(B), proposed 

§ 226.43(g)(1)(ii)(C) provides that a 

consummated covered transaction must 

not include a prepayment penalty 

unless the transaction is not a higherpriced mortgage loan, as defined in 

proposed § 226.45(a) of the 2011 Escrow 

Proposal. 

Under the Board’s 2010 Mortgage 

Proposal, creditors would determine 

whether a transaction is a higher-priced 

mortgage loan by comparing the 

transaction’s ‘‘transaction coverage rate,’’ 

rather than APR, to the average prime 

offer rate, as discussed in detail in that 

proposal.93 Under the 2010 Mortgage 

Proposal, the transaction coverage rate 

is a transaction-specific rate that is used 

solely for coverage determinations and 

would not be disclosed to consumers. 

The creditor would calculate the 

transaction coverage rate based on 

Regulation Z’s rules for calculating the 

APR, except the creditor would make 

the calculation using a modified value 

for the prepaid finance charge. In 

summary, the Board explained that 

using the APR as the coverage metric for 

requirements for higher-priced mortgage 

loans poses a risk of over-inclusive 

coverage beyond the subprime market.94

The Board noted that the average prime 

offer rate is based on Freddie Mac’s 

Primary Mortgage Market Survey® of the 

contract interest rates and points of 

loans offered to consumers with lowrisk transaction terms and credit 

profiles. APRs, however, are based on a 

broader set of charges, including some 

third-party charges such as mortgage 

insurance premiums. The Board also 

recognized that, under the Board’s 2009 

Closed-End Mortgage Proposal, the APR 

would be based on a finance charge that 

includes most third-party fees in 

addition to points, origination fees, and 

any other fees the creditor retains. Thus, 

the 2009 Closed-End Mortgage Proposal 

would expand the existing difference 

between fees included in the APR and 

fees included in the average prime offer 

rate. 

To address this concern, the Board 

proposed in the 2010 Mortgage Proposal 

to require creditors to compare the 

transaction coverage rate, rather than 

the APR, to the average prime offer rate 

to determine whether a transaction is 

covered by the protections for higherpriced mortgage loans. The Board also 

proposed to use the transaction coverage 

rate for the definition of a higher-priced 

mortgage loan in the 2011 Escrow 

Proposal.95 Similarly, under the present 

proposal, creditors would determine 

whether a transaction is a higher-priced 

mortgage loan based on the transaction 

coverage rate rather than the APR, for 

purposes of the prepayment penalty 

restriction. The Board solicits comment 

on this approach. 

43(g)(2) Limits on Prepayment Penalties 

TILA Section 129C(c)(3) provides that 

a prepayment penalty may not be 

imposed more than three years after the 

covered transaction is consummated 

and limits the maximum amount of the 

prepayment penalty. Specifically, a 

prepayment penalty is limited to (1) 

three percent of the outstanding 

principal balance during the first year 

following consummation; (2) two 

percent during the second year 

following consummation; and (3) one 

percent during the third year following 

consummation. 

Proposed § 226.43(g)(2) would 

implement and is substantially similar 

to TILA Section 129C(c)(3). However, 

under proposed § 226.43(g)(2) the 

maximum penalty amount is 

determined based on the amount of the 

outstanding loan balance prepaid, rather 

than the entire outstanding loan 

balance, because the requirements 

under TILA Section 129C(c) apply if a 

penalty is imposed for either partial or 

full prepayment. Thus, for example, if 

the outstanding loan balance is 

$100,000 when the consumer prepays 

$20,000 eleven months after 

consummation, the maximum 

prepayment penalty is $600 (three 

percent of $20,000), rather than $3,000 

(three percent of $100,000). The Board 

proposes this adjustment pursuant to 

the Board’s authority under TILA 

Section 105(a) to issue regulations with 

such requirements, classifications, 

differentiations, or other provisions, and 

that provide for such adjustments and 

exceptions for all or any class of 

transactions, as in the judgment of the 

Board are necessary and proper to 

effectuate the purposes of TILA, to 

prevent circumvention or evasion 

thereof, or to facilitate compliance 

therewith. 15 U.S.C. 1604(a). The Board 

believes that calculating the maximum 

prepayment penalty based on the 

amount of the outstanding loan balance 

that is prepaid, rather than the entire 

outstanding loan balance, would 

effectuate the purposes of TILA Section 

129C(c) to facilitate partial (and full) 

prepayment by limiting the amount of a 

prepayment penalty. The Board believes 

it would be inconsistent with 

congressional intent, for example, for a 

consumer that makes several partial 

prepayments to pay a percentage of the 

outstanding loan balance each time. The 

Board also believes that the proposed 

adjustment would facilitate compliance, 

because determining the maximum 

prepayment penalty is simpler if the 

calculation is based on the amount of 

the outstanding balance prepaid in all 

cases, whether the consumer prepays in 

full or in part. 

Proposed comment 43(g)(2)–1 clarifies 

that a covered transaction may include 

a prepayment penalty that may be 

imposed only during a shorter period or 

in a lower amount than provided in 

proposed § 226.43(g)(2). Proposed 

comment 43(g)(2)–1 provides the 

example of a prepayment penalty that a 

creditor may impose for two years after 

consummation that is limited to two 

percent of the amount prepaid. 

The Board recognizes that two other 

sections of TILA may limit the 

maximum amount of the prepayment 

penalty. First, TILA Section 

129C(b)(2)(A)(vii) indirectly limits the 

maximum amount of a prepayment 

penalty with a qualified mortgage, by 

limiting the maximum ‘‘points and fees’’ 

for a qualified mortgage, which include 

prepayment penalties, to three percent 

of the total loan amount. See also 

proposed § 226.43(e)(2)(iii), discussed 

above. The definition of ‘‘points and 

fees’’ includes the maximum 


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prepayment penalty that may be 

charged, as well as any prepayment 

penalty incurred by the consumer if the 

loan refinances a previous loan made or 

currently held by the same creditor or 

an affiliate of the creditor. See TILA 

Section 103(aa)(4)(E) and proposed 

§ 226.32(b)(1), discussed above. Thus, if 

a creditor wants to include the 

maximum three percent prepayment 

penalty as a term of a qualified 

mortgage, it generally would have to 

forego any other charges that are 

included in the definition of points and 

fees. 

Second, TILA Section 

103(aa)(1)(A)(iii) defines a ‘‘high-cost 

mortgage’’ as any loan secured by the 

consumer’s principal dwelling in which 

the creditor may charge prepayment fees 

or penalties more than 36 months after 

the closing of the transaction, or in 

which the fees or penalties exceed, in 

the aggregate, more than two percent of 

the amount prepaid. In turn, a high-cost 

mortgage may not contain a prepayment 

penalty under TILA Section 129(c), as 

amended by Section 1432 of the DoddFrank Act. At this time, the Board is not 

proposing to implement these 

limitations on prepayment penalties. 

The Board nevertheless solicits 

comment on whether proposed 

§ 226.43(g)(2) should incorporate the 

limitation of prepayment penalty 

amounts to two percent of the amount 

prepaid, as provided under TILA 

Section 103(aa)(1)(A)(iii), or some other 

threshold to account for the limitation 

of points and fees, including 

prepayment penalties, for ‘‘qualified 

mortgages,’’ under TILA Section 

129C(b)(2)(A)(vii) and proposed 

§ 226.43(e)(2)(iii). 

43(g)(3) Alternative Offer Required 

Under TILA Section 129C(c)(4), if a 

creditor offers a consumer a covered 

transaction with a prepayment penalty, 

the creditor also must offer the 

consumer a covered transaction without 

a prepayment penalty. As discussed in 

detail below, proposed § 226.43(g)(3) 

would implement TILA Section 

129C(c)(4) and includes additional 

conditions: The alternative covered 

transaction without a prepayment 

penalty must (1) have an APR that 

cannot increase after consummation and 

the same type of interest rate as the 

covered transaction with a prepayment 

penalty (that is, both must be fixed-rate 

mortgages or both must be step-rate 

mortgages); (2) have the same loan term 

as the covered transaction with a 

prepayment penalty; (3) satisfy the 

periodic payment conditions for 

qualified mortgages; and (4) satisfy the 

points and fees conditions for qualified 

mortgages. The proposed additional 

conditions are intended to ensure that 

the alternative covered transactions 

offered have substantially similar terms. 

Also, proposed § 226.43(g)(3) requires 

that the alternative covered transaction 

be a transaction for which the consumer 

likely qualifies. 

The Board proposes these additional 

requirements pursuant to the Board’s 

authority under TILA Section 105(a) to 

prescribe regulations that contain such 

additional requirements, classifications, 

differentiations, or other provisions, or 

provide for such adjustments or 

exceptions for all or any class of 

transactions, as in the judgment of the 

Board are necessary or proper to 

effectuate the purposes of TILA, to 

prevent circumvention or evasion 

thereof, or to facilitate compliance 

therewith. 15 U.S.C. 1604(a). The Board 

believes that requirements designed to 

ensure that the alternative covered 

transaction with and without a 

prepayment penalty are substantially 

similar would effectuate the purposes of 

TILA Section 129C(c)(4), by enabling 

consumers to focus on a prepayment 

penalty’s risks and benefits without 

having to consider or evaluate other 

differences between the alternative 

covered transactions. For example, a 

consumer would compare a fixed-rate 

mortgage with a prepayment penalty 

with a fixed-rate mortgage without a 

prepayment penalty, not with a step-rate 

mortgage without a prepayment penalty. 

Also, the Board believes that requiring 

the alternative covered transaction 

without a prepayment penalty be one 

for which the consumer likely qualifies 

would effectuate the purposes of and 

prevent circumvention of TILA Section 

129C(c)(4), by providing for consumers 

to be able to choose between options 

that likely are available. Finally, 

proposed comment 43(g)(3)–1 crossreferences comment 25(a)–7, discussed 

above, for guidance on the requirements 

for retaining records as evidence of 

compliance with § 226.43(g)(3). 

Higher-priced mortgage loans. Under 

the proposal, a covered transaction 

cannot have a prepayment penalty if the 

transaction is a higher-priced mortgage 

loan. However, the requirement to offer 

an alternative covered transaction 

without a prepayment penalty is not 

similarly restricted. Although the Board 

believes the covered transaction with a 

prepayment penalty and the alternative 

covered transaction without a 

prepayment penalty must be 

substantially similar, the Board also 

believes a higher-priced mortgage loan 

without a prepayment penalty should be 

a permissible alternative transaction for 

a non-higher-priced mortgage loan with 

a prepayment penalty, for two reasons. 

First, the Board believes TILA Section 

129C(c)(4) is intended to ensure 

consumers have a choice whether or not 

to obtain a covered transaction with a 

prepayment penalty, not to limit the 

pricing of the alternative covered 

transaction without a prepayment 

penalty that the creditor must offer. 

Second, the Board is concerned about 

the likely consequences of restricting 

the pricing of the required alternative 

covered transaction without a 

prepayment penalty. If the alternative 

covered transaction must not be a 

higher-priced mortgage loan, the 

creditor may choose not to offer the 

consumer a loan at all, or to offer the 

consumer only a higher-priced mortgage 

loan. For example, assume that the 

higher-priced mortgage loan coverage 

threshold for a 30-year, non-jumbo, 

fixed-rate covered transaction is 6.50 

percent, and that the creditor charges 

0.25 percentage points more in interest 

for a covered transaction without a 

prepayment penalty. Assume further 

that the creditor would make such a 

loan to a consumer in a covered 

transaction either (1) with a prepayment 

penalty and with a transaction coverage 

rate of 6.45 percent (Transaction A); or 

(2) without a prepayment penalty and 

with a transaction coverage rate of 6.70 

percent (Transaction B). However, if 

offering Transaction A means the 

creditor must offer the consumer an 

alternative covered transaction without 

a prepayment penalty that is not a 

higher-priced mortgage loan, the 

creditor may choose not to offer the 

consumer a covered transaction at all. 

Alternatively, the creditor might elect to 

offer the consumer only Transaction B, 

which is a higher-priced mortgage loan. 

For the foregoing reasons, under 

proposed § 226.43(g)(3) if a creditor 

offers a covered transaction with a 

prepayment penalty, which may not be 

a higher-priced mortgage loan, the 

creditor may offer the consumer an 

alternative covered transaction without 

a prepayment penalty that is a higherpriced mortgage loan. 

Timing of offer. Proposed 

§ 226.43(g)(3) does not require that the 

creditor offer an alternative covered 

transaction without a prepayment 

penalty at or by a particular time. This 

is consistent with § 226.36(e)(2) and (3), 

which provide a safe harbor for the 

anti–steering requirement if a loan 

originator presents certain loan options 

to the consumer, but do not contain a 

timing requirement. The Board 

recognizes that there may be costs and 

benefits to this approach. 

On the one hand, a timing 

requirement could ensure that 


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27476 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

96Under the Board’s 2010 Mortgage Proposal, a 

non–refundable fee could be imposed no earlier 

than three business days after a consumer receives 

the early disclosures that creditors must provide 

soon after receiving the consumer’s application 

(within three business days). See 75 FR 58539, 

58696–58697, Sept. 24, 2010 (proposing a new 

§ 226.19(a)(1)(iv)). 

97Under § 226.18(s)(7)(i)–(iii), a transaction 

secured by real property or a dwelling is (1) an 

‘‘adjustable-rate mortgage’’ if the APR may increase 

after consummation, (2) a ‘‘step-rate mortgage’’ if 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, or (3) 

a ‘‘fixed-rate mortgage,’’ if the transaction is not an 

adjustable-rate mortgage or a step-rate mortgage. 

consumers can consider an offer of an 

alternative covered transaction without 

a prepayment penalty before committing 

to a transaction, for example, by 

requiring that creditors present such an 

offer before the consumer pays a non– 

refundable fee, other than a fee for 

obtaining the consumer’s credit 

history.96 Alternatively, consumers 

might benefit from being offered an 

alternative covered transaction without 

a prepayment penalty later in the 

lending process, after the creditor has 

underwritten the loan and determined 

the terms on which it would originate 

an alternative covered transaction to the 

consumer. On the other hand, timing 

requirements might unduly limit 

creditors’ flexibility to determine the 

terms on which they will offer a 

particular consumer an alternative 

covered transaction without a 

prepayment penalty. In addition, there 

may be operational difficulties in 

determining exactly when a creditor 

offered the alternative covered 

transaction (for example, when a 

consumer accesses options for covered 

loans via the Internet) and how to cure 

a violation if the creditor offers the 

required alternative after the required 

time. 

The Board solicits comment on 

whether it would be appropriate to 

require that creditors offer the 

alternative covered transaction without 

a prepayment penalty during a specified 

time period, for example, before the 

consumer pays a non–refundable fee or 

at least fifteen calendar days before 

consummation. If a timing requirement 

is included for purposes of proposed 

§ 226.43(g)(3), the Board also solicits 

comment on whether a timing 

requirement should be included under 

the safe harbor for the anti–steering 

requirement under § 226.36(e)(2) and 

(3), for consistency. 

43(g)(3)(i) APR Cannot Increase After 

Consummation 

Under proposed § 226.43(g)(1)(i), a 

covered transaction with an APR that 

can increase after consummation may 

not have a prepayment penalty. 

Proposed § 226.43(g)(3)(i) provides that, 

if a creditor offers a covered transaction 

with a prepayment penalty, the creditor 

must offer an alternative covered 

transaction without a prepayment 

penalty and with an APR that cannot 

increase after consummation, to ensure 

consumers are able to choose between 

substantially similar alternative 

transactions. See proposed 

§ 226.43(g)(1)(ii)(A). Proposed 

§ 226.43(g)(3)(i) also requires that the 

covered transaction with a prepayment 

penalty and the alternative covered 

transaction without a prepayment 

penalty have the same type of interest 

rate. For purposes of proposed 

§ 226.43(g)(3)(i), the term ‘‘type of 

interest rate’’ means whether the 

covered transaction is a fixed–rate 

mortgage, as defined in 

§ 226.18(s)(7)(iii), or a step–rate 

mortgage, as defined in 

§ 226.18(s)(7)(ii).97 Proposed comment 

43(g)(3)(i)-1 clarifies that the covered 

transaction with a prepayment penalty 

and the alternative covered transaction 

without a prepayment penalty must 

either both be fixed-rate mortgages or 

both be step-rate mortgages. 

43(g)(3)(ii) Through (iv) Criteria for a 

Qualified Mortgage 

As discussed above, proposed 

§ 226.43(g)(1)(ii)(A) provides that a 

covered transaction with a prepayment 

penalty must be a qualified mortgage, as 

defined under proposed § 226.43(e)(2) 

or (f). The Board also proposes to 

require that an alternative covered 

transaction offered without a 

prepayment penalty must meet three 

conditions for qualified mortgages, so 

that consumers may choose between 

alternative covered transactions that are 

substantially similar. Accordingly, 

proposed § 226.43(g)(3)(ii) through (iv) 

provide that an alternative covered 

transaction without a prepayment 

penalty must: (1) Have the same loan 

term as the covered transaction with a 

prepayment penalty; (2) satisfy the 

periodic payment conditions in 

§ 226.43(e)(2)(i); and (3) satisfy the 

points and fees condition under 

§ 226.43(e)(2)(iii), based on the 

information known to the creditor at the 

time the transaction is offered. Proposed 

comment 43(g)(3)(iv)-1 provides 

guidance for cases where a creditor 

offers a consumer an alternative covered 

transaction without a prepayment 

penalty under proposed § 226.43(g)(3) 

and knows only some of the points and 

fees that will be charged for the loan. 

For example, a creditor may not know 

that a consumer intends to buy singlepremium credit unemployment 

insurance, which would be included in 

the points and fees for the covered 

transactions. Proposed comment 

43(g)(3)(iv)-1 clarifies that the points 

and fees condition is satisfied if the 

creditor reasonably believes, based on 

the information known to the creditor at 

the time the offer is made, that the 

amount of points and fees to be charged 

for an alternative covered transaction 

without a prepayment penalty will be 

less than or equal to the amount of 

points and fees allowed for a qualified 

mortgage under § 226.43(e)(2)(iii). 

43(g)(3)(v) Likely Qualifies 

Proposed § 226.43(g)(3)(v) provides 

that the alternative covered transaction 

without a prepayment penalty must be 

a transaction for which the creditor has 

a good faith belief that the consumer 

likely qualifies, as determined based on 

the information known to the creditor at 

the time the creditor offers the 

alternative covered transaction. 

Proposed comment 43(g)(3)(v)-1 

provides an example where the creditor 

has a good faith belief the consumer can 

afford monthly payments of up to $800. 

The proposed comment clarifies that, if 

the creditor offers the consumer a fixedrate mortgage with a prepayment 

penalty for which monthly payments 

are $700 and an alternative covered 

transaction without a prepayment 

penalty for which monthly payments 

are $900, the requirements of 

§ 226.43(g)(3)(v) are not met. Proposed 

comment 43(g)(3)(v)-1 also clarifies that, 

in making the determination the 

consumer likely qualifies for the 

alternative covered transaction, the 

creditor may rely on information 

provided by the consumer, even if the 

information subsequently is determined 

to be inaccurate. Proposed 

§ 226.43(g)(3)(v) and proposed comment 

43(g)(3)(v)-1 are substantially similar to 

§ 226.36(e)(3)(ii), which provides a safe 

harbor for the anti-steering requirements 

if, among other things, a loan originator 

presents the consumer with loan 

options for which the consumer likely 

qualifies. See also comment 36(e)(3)-4 

(providing guidance on information 

used to determine whether or not a 

consumer likely qualifies for a 

transaction). 

43(g)(4) Offer Through a Mortgage 

Broker 

The requirement to offer an 

alternative covered transaction without 

a prepayment penalty applies to a 

‘‘creditor.’’ See TILA Section 129C(c)(4). 

TILA Section 103(f), in relevant part, 

defines ‘‘creditor’’ to mean a person who 


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98For ease of discussion, the terms ‘‘mortgage 

broker’’ and ‘‘loan originator’’ as used in this 

discussion have the same meaning as under the 

Board’s requirements for loan originator 

compensation. See § 226.36(a)(1), (2). 

99Current § 226.36(e) provides that a loan 

originator for a dwelling-secured consumer credit 

transaction must not direct or ‘‘steer’’ a consumer to 

consummate a transaction based on the fact that the 

originator will receive greater compensation from 

the creditor in that transaction than in other 

transactions the originator offered or could have 

offered the consumer, unless the consummated 

transaction is in the consumer’s interest. 

both (1) regularly extends consumer 

credit which is payable by agreement in 

more than four installments or for 

which the payment of a finance charge 

is or may be required, and (2) is the 

person to whom the debt arising from 

the consumer credit transaction is 

initially payable on the face of the 

evidence of indebtedness (or, if there is 

no such evidence of indebtedness, by 

agreement). 15 U.S.C. 1602(f); 

§ 226.2(a)(17). The Board proposes 

special rules where a creditor offers a 

covered transaction with a prepayment 

penalty through a mortgage broker, as 

defined in § 226.36(a)(2), to account for 

operational differences in offering a 

covered transaction through the 

wholesale channel versus through the 

retail channel.98 As discussed below in 

the section-by-section analysis of 

proposed § 226.43(g)(5), the Board 

proposes special rules for cases where a 

creditor in a table-funded transaction 

also is a ‘‘loan originator,’’ as defined in 

§ 226.36(a)(1), because those creditors 

generally present to consumers loan 

options offered by multiple persons that 

provide table-funding. The Board does 

not propose special rules for cases 

where the loan originator is the 

creditor’s employee, because the Board 

believes that in such cases the employee 

likely can present alternative covered 

transactions with and without a 

prepayment penalty to the consumer 

without significant operational 

difficulties. 

The Board believes the requirement to 

offer an alternative covered transaction 

without a prepayment penalty properly 

is applied to creditors and not to 

mortgage brokers, because creditors 

‘‘offer’’ covered transactions, even if 

mortgage brokers present those offers to 

consumers. Further, the Board believes 

that if Congress had intended to apply 

TILA Section 129C(c)(4) to mortgage 

brokers, Congress explicitly would have 

applied that provision to ‘‘mortgage 

originators’’ in addition to creditors. 

TILA Section 103(cc), as added by 

Section 1401 of the Dodd-Frank Act, 

defines ‘‘mortgage originator’’ to mean 

any person who, for direct or indirect 

compensation or gain, or in the 

expectation of direct or indirect 

compensation of gain, takes a residential 

mortgage loan application, assists a 

consumer in obtaining or applying to 

obtain a residential mortgage loan, or 

offers or negotiates terms of a residential 

mortgage loan. 15 U.S.C. 1602(cc). The 

term ‘‘mortgage originator’’ is used, for 

example, for purposes of the antisteering requirement added to TILA by 

Section 1403 of the Dodd-Frank Act. See 

TILA Section 129B(c). 

The Board also believes that requiring 

mortgage brokers to present to 

consumers a creditor’s alternative 

covered transaction without a 

prepayment penalty could confuse 

consumers if they are presented with 

numerous other loan options. Presenting 

a consumer more than four loan options 

for each type of transaction in which the 

consumer expresses an interest may not 

help the consumer to make a 

meaningful choice. When compared 

with other loan options a mortgage 

broker presents to a consumer, a 

creditor’s covered transaction without a 

prepayment penalty might not have the 

lowest interest rate (among transactions 

either with or without risky features, 

such as a prepayment penalty) or the 

lowest total dollar amount of origination 

points or fees and discount points, and 

thus might not be among the loan 

options most important for consumers 

to evaluate. Also, the Board is 

concerned that creditors may have 

operational difficulties in confirming 

whether or not a mortgage broker has 

presented to the consumer the 

alternative covered transaction without 

a prepayment penalty. 

Accordingly, proposed § 226.43(g)(4) 

provides that, if a creditor offers a 

covered transaction to a consumer 

through a mortgage broker, as defined in 

§ 226.36(a)(2), the creditor must present 

to the mortgage broker an alternative 

covered transaction without a 

prepayment penalty that meets the 

conditions under § 226.43(g)(3). 

Proposed § 226.43(g)(4) also provides 

that the creditor must establish, by 

agreement, that the mortgage broker 

must present the consumer an 

alternative covered transaction without 

a prepayment penalty that meets the 

conditions under § 226.43(g)(3) offered 

by (1) the creditor, or (2) another 

creditor, if the transaction has a lower 

interest rate or a lower total dollar 

amount of origination points or fees and 

discount points. By providing for the 

presentation of a loan option with a 

lower interest rate or a lower total dollar 

amount of origination points or fees and 

discount points than the loan option 

offered by the creditor, proposed 

§ 226.43(g)(4) facilitates compliance 

with proposed § 226.43(g)(3) and with 

the safe harbor for the anti-steering 

requirement in connection with a single 

covered transaction. See 

§ 226.36(e)(3)(i).99 Proposed 

§ 226.43(g)(4) does not affect the 

conditions that a a loan originator must 

meet to take advantage of the safe harbor 

for the anti-steering requirement, 

however. Thus, if loan originators 

choose to use the safe harbor, they must 

present the consumer the loan option 

with (1) the lowest interest rate overall, 

(2) the loan option with the lowest 

interest rate without certain risky 

features, including a prepayment 

penalty, and (3) the loan option with the 

lowest total origination points or fees 

and discount points. See 

§ 226.36(e)(3)(i). 

Proposed comment 43(g)(4)–1 clarifies 

that the creditor may satisfy the 

requirement to present the mortgage 

broker such alternative covered 

transaction without a prepayment 

penalty by providing the mortgage 

broker a rate sheet that states the terms 

of such an alternative covered 

transaction without a prepayment 

penalty. Proposed comment 43(g)(4)–2 

clarifies that the creditor’s agreement 

with the mortgage broker may provide 

for the mortgage broker to present both 

the creditor’s covered transaction and a 

covered transaction offered by another 

creditor with a lower interest rate or a 

lower total dollar amount of origination 

points or fees and discount points. 

Proposed comment 43(g)(4)–2 also 

cross-references comment 36(e)(3)–3 for 

guidance in determining which step-rate 

mortgage has a lower interest rate. 

Proposed comment 43(g)(4)–3 clarifies 

that a creditor’s agreement with a 

mortgage broker for purposes of 

proposed § 226.43(g)(4) may be part of 

another agreement with the mortgage 

broker, for example, a compensation 

agreement. The proposed comment 

clarifies that the creditor thus need not 

enter into a separate agreement with the 

mortgage broker with respect to each 

covered transaction with a prepayment 

penalty. 

The Board solicits comment on the 

approach proposed under § 226.43(g)(4) 

for offering an alternative covered 

transaction without a prepayment 

penalty through a mortgage broker. In 

particular, the Board solicits comment 

on whether additional guidance is 

needed regarding offers of covered 

transactions through mortgage brokers 

that use the safe harbor for the antiVerDate Mar<15>2010 16:56 May 10, 2011 Jkt 223001 PO 00000 Frm 00089 Fmt 4701 Sfmt 4702 E:\FR\FM\11MYP2.SGM 11MYP2

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steering requirement, under 

§ 226.36(e)(2) and (3). 

43(g)(5) Creditor That Is a Loan 

Originator 

Proposed § 226.43(g)(5) addresses 

cases where a creditor does not provide 

the funds for a covered transaction out 

of its own resources but rather obtains 

funds from another person and, 

immediately after consummation, 

assigns the note, loan contract, or other 

evidence of the debt obligation to the 

other person. Such creditors generally 

present to consumers loan options 

offered by other persons and are loan 

originators subject to the anti-steering 

requirements under § 226.36(e). See 

§ 226.36(a)(1); comment 36(a)(1)–1. Like 

other loan originators, such creditors 

may use the safe harbor for the antisteering requirements under 

§ 226.36(e)(2) and (3). Proposed 

§ 226.43(g)(5) provides that, if the 

creditor is a loan originator, as defined 

in § 226.36(a)(1), and the creditor 

presents a consumer a covered 

transaction with a prepayment penalty 

offered by a person to which the 

creditor would assign the covered 

transaction after consummation, the 

creditor may present the consumer an 

alternative covered transaction without 

a prepayment penalty offered by (1) the 

assignee, or (2) another person, if the 

transaction offered by the other person 

has a lower interest rate or a lower total 

dollar amount of origination points or 

fees and discount points. Thus, 

proposed § 226.43(g)(5) provides 

flexibility with respect to the 

presentation of loan options, which 

facilitates compliance with proposed 

§ 226.43(g)(3) and with the safe harbor 

for the anti-steering requirement in 

connection with the same covered 

transaction. See § 226.36(e)(3)(i). Like 

proposed § 226.43(g)(4), however, 

proposed § 226.43(g)(5) does not affect 

the conditions that a creditor that is a 

loan originator must meet to take 

advantage of the safe harbor for the antisteering requirement. Accordingly, if 

creditors that are loan originators 

choose to use the safe harbor, they must 

present the consumer the loan option 

with (1) the lowest interest rate overall, 

(2) the loan option with the lowest 

interest rate without certain risky 

features, including a prepayment 

penalty, and (3) the loan option with the 

lowest total origination points or fees 

and discount points. See 

§ 226.36(e)(3)(i). 

Proposed comment 43(g)(5)–1 clarifies 

that a loan originator includes any 

creditor that satisfies the definition of 

the term but makes use of ‘‘tablefunding’’ by a third party. See 

§ 226.36(a)(1), comment 36(a)–1.i, –1.ii. 

Proposed comment 43(g)(5)–2 crossreferences guidance in comment 

36(e)(3)–3 on determining which steprate mortgage has a lower interest rate. 

43(g)(6) Applicability 

Proposed § 226.43(g)(6) provides that 

proposed § 226.43(g) applies only if a 

transaction is consummated with a 

prepayment penalty and is not violated 

if (1) a covered transaction is 

consummated without a prepayment 

penalty or (2) the creditor and consumer 

do not consummate a covered 

transaction. Proposed § 226.43(g)(2) 

limits the period during which a 

prepayment penalty may be imposed 

and the amount of any prepayment 

penalty. Those limitations apply only if 

a covered transaction with a 

prepayment penalty is consummated. 

Proposed § 226.43(g)(3) requires 

creditors that offer a consumer a 

covered transaction with a prepayment 

penalty offer the consumer an 

alternative covered transaction without 

a prepayment penalty, and proposed 

§ 226.43(g)(4) and (5) establish 

requirements for creditors to comply 

with proposed § 226.43(g)(3) if they (1) 

offer covered transactions with a 

prepayment penalty through a mortgage 

broker or (2) are loan originators, 

respectively. Where a consumer 

consummates a covered transaction 

without a prepayment penalty, it is 

unnecessary to require that the creditor 

offer the consumer an alternative 

covered transaction without a 

prepayment penalty. Further, if the 

creditor does not consummate a covered 

transaction with the consumer, the issue 

is irrelevant; the purpose of the 

requirement to offer an alternative 

covered transaction without a 

prepayment penalty is for consumers 

not to have to accept a covered 

transaction with a prepayment penalty. 

Accordingly, proposed § 226.43(g) 

applies only if the consumer 

consummates a covered transaction 

with a prepayment penalty. In 

particular, proposed comment 25(a)–7 

clarifies that, if a creditor offers the 

consumer a covered transaction with a 

prepayment penalty but a covered 

transaction is consummated without a 

prepayment penalty or if the creditor 

and consumer do not consummate a 

covered transaction, the creditor need 

not maintain records that document 

compliance with the requirement that 

the creditor offer an alternative covered 

transaction without a prepayment 

penalty under proposed § 226.43(g)(2) 

through (5), as discussed above in the 

section-by-section analysis of proposed 

§ 226.25(a). 

43(h) Evasion; Open-End Credit 

As discussed above, TILA Section 

129C, which addresses the repayment 

ability requirements and qualified 

mortgages, applies only to residential 

mortgage loans. TILA Section 103(cc)(5) 

defines ‘‘residential mortgage loans’’ as 

excluding open-end credit plans, such 

as HELOCs. The Board recognizes that 

the exclusion of open-end credit plans 

could lead some creditors to attempt to 

evade the requirements of TILA Section 

129C by structuring credit as open-end 

instead of closed-end. Sections 

226.34(b) and 226.35(b)(4) address this 

risk by prohibiting structuring a 

transaction that does not meet the 

definition of ‘‘open-end credit’’ as a 

HELOC to evade the repayment ability 

and other requirements for high-cost 

mortgages and higher-priced mortgage 

loans. The Board proposes to extend 

this approach to new § 226.43, which 

would implement TILA Section 129C. 

Proposed § 226.43(h) prohibits a 

creditor from structuring a transaction 

that does not meet the definition of 

open-end credit in § 226.2(a)(20) as a 

HELOC to evade the requirements of 

proposed § 226.43. Proposed comment 

43(h)–1 clarifies that where a loan is 

documented as open-end credit but the 

features and terms or other 

circumstances demonstrate that it does 

not meet the definition of open-end 

credit, the loan is subject to the rules for 

closed-end credit, including § 226.43. 

The Board proposes this provision using 

its authority under TILA Sections 105(a) 

and 129B(e) to prevent circumvention or 

evasion. 

As noted in the SUPPLEMENTARY

INFORMATION to the Board’s 2008 HOEPA 

Final Rule, the Board recognizes that 

consumers may prefer HELOCs to 

closed-end home equity loans because 

of the added flexibility HELOCs provide 

them. See 73 FR 1697, Jan. 9, 2008. It 

is not the Board’s intention to limit 

consumers’ ability to choose between 

these two ways of structuring home 

equity credit. An overly broad antievasion rule could potentially limit 

consumer choices by casting doubt on 

the validity of legitimate open-end 

plans. The Board seeks comment on the 

extent to which the proposed antievasion rule could have this 

consequence, and solicits suggestions 

for a more narrowly tailored rule. For 

example, the primary concern would 

appear to be with HELOCs that are 

substituted for closed-end home 

purchase loans and refinancings, which 

are usually first-lien loans, rather than 

with HELOCs taken for home 

improvement or other consumer 

purposes. The Board seeks comment on 


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100 13 CFR 121.201; see also SBA, Table of Small 

Business Size Standards Matched to North 

American Industry Classification System Codes, 

available at http://www.sba.gov/sites/default/files/ 

Size_Standards_Table.pdf. 

101TILA Section 103(cc) generally defines 

‘‘residential mortgage loan’’ to mean any consumer 

credit transaction secured by a mortgage, deed of 

trust, or other equivalent consensual security 

interest on ‘‘a dwelling or on residential real 

property that includes a dwelling.’’ The term does 

not include an open-end credit plan or an extension 

of credit relating to a timeshare plan, for purposes 

of the repayment ability provisions. See TILA 

Section 103(cc)(5). 

102Regulation Z generally applies to ‘‘each 

individual or business that offers or extends credit 

when four conditions are met: (i) The credit is 

offered or extended to consumers; (ii) the offering 

or extension of credit is done regularly, (iii) the 

credit is subject to a finance charge or is payable 

by a written agreement in more than four 

installments, and (iv) the credit is primarily for 

personal, family, or household purposes.’’ Section 

226.1(c)(1). 

103For purposes of this analysis, thrifts include 

savings banks, savings and loan entities, cooperative banks, and industrial banks. 

104The 8,022 lenders (both depository 

institutions and mortgage companies) covered by 

HMDA in 2009 accounted for the majority of home 

lending in the United States. Under HMDA, lenders 

use a ‘‘loan/application register’’ (HMDA/LAR) to 

report information annually to their Federal 

supervisory agencies for each application and loan 

acted on during the calendar year. Only lenders that 

have offices (or, for non-depository institutions, 

lenders that are deemed to have offices) in 

Continued 

whether it should limit an anti-evasion 

rule to HELOCs secured by first liens 

where the consumer draws down all or 

most of the entire line of credit 

immediately after the account is 

opened, and whether such a rule would 

be effective in preventing evasion. 

VI. Paperwork Reduction Act 

In accordance with the Paperwork 

Reduction Act (PRA) of 1995 (44 U.S.C. 

3506; 5 CFR part 1320 Appendix A.1), 

the Board reviewed the proposed rule 

under the authority delegated to the 

Board by the Office of Management and 

Budget. The rule contains no collections 

of information under the PRA. See 44 

U.S.C. 3502(3). Accordingly, there is no 

paperwork burden associated with the 

rule. 

VII. Initial Regulatory Flexibility 

Analysis 

In accordance with Section 3(a) of the 

Regulatory Flexibility Act (RFA), 5 

U.S.C. 601–612, the Board is publishing 

an initial regulatory flexibility analysis 

for the proposed amendments to 

Regulation Z. The RFA requires an 

agency either to provide an initial 

regulatory flexibility analysis with a 

proposed rule or to certify that the 

proposed rule will not have a significant 

economic impact on a substantial 

number of small entities. Under 

regulations issued by the Small 

Business Administration (SBA), an 

entity is considered ‘‘small’’ if it has 

$175 million or less in assets for banks 

and other depository institutions, and 

$7 million or less in revenues for nonbank mortgage lenders and loan 

servicers.100

Based on its analysis and for the 

reasons stated below, the Board believes 

that this proposed rule will have a 

significant economic impact on a 

substantial number of small entities. A 

final regulatory flexibility analysis will 

be conducted after consideration of 

comments received during the public 

comment period. The Board requests 

public comment in the following areas. 

A. Reasons for the Proposed Rule 

Congress enacted TILA based on 

findings that economic stability would 

be enhanced and competition among 

consumer credit providers would be 

strengthened by the informed use of 

credit resulting from consumers’ 

awareness of the cost of credit. As a 

result, TILA contains procedural and 

substantive protections for consumers, 

and also directs the Board to prescribe 

regulations to carry out the purposes of 

the statute. TILA is implemented by the 

Board’s Regulation Z. 

The proposed amendments to 

Regulation Z implement certain 

amendments to TILA as a result of the 

Dodd-Frank Act. Sections 1411 and 

1412 of the Dodd-Frank Act amend 

TILA to prohibit a creditor from making 

any ‘‘residential mortgage loan’’ 101

unless the creditor makes a reasonable 

and good faith determination that the 

consumer has a reasonable ability to 

repay the loan. A creditor complies with 

this requirement by: (i) Making a 

residential mortgage loan that satisfies 

the ability-to-repay provisions, which 

include certain underwriting criteria; 

(ii) refinancing a ‘‘non-standard 

mortgage’’ into a ‘‘standard mortgage’’; 

(iii) making a ‘‘qualified mortgage,’’ 

which is defined by prohibiting certain 

terms, limiting certain costs, and using 

certain underwriting criteria; or (iv) 

making a balloon-payment qualified 

mortgage. In addition, Section 1414 of 

the Dodd-Frank Act amends TILA to 

add new restrictions on prepayment 

penalties that may be imposed on 

residential mortgage loans. 

B. Statement of Objectives and Legal 

Basis 

The SUPPLEMENTARY INFORMATION

contains the statement of objectives and 

legal basis for the proposed rule. In 

summary, the proposed amendments to 

Regulation Z are designed to: (1) Add 

new § 226.43(a)–(f) to require creditors 

to determine a consumer’s repayment 

ability prior to making any residential 

mortgage loan; (2) provide a 

presumption of compliance with the 

repayment ability requirement or safe 

harbor from the repayment ability 

requirement for qualified mortgages in 

new § 226.43(e); (3) add new § 226.43(g) 

regarding prepayment penalty 

requirements for residential mortgage 

loans; and (4) provide record retention 

requirements in § 226.25(a) that 

evidence compliance with proposed 

§ 226.43. 

The legal basis for the proposed rule 

is in Sections 105(a), 129B(e) and 

129C(b)(3)(B)(i) of TILA. 15 U.S.C. 

1604(a), 1639b(e) and 1639c(b)(3)(B)(i). 

A more detailed discussion of the 

Board’s rulemaking authority is set forth 

in part III of the SUPPLEMENTARY

INFORMATION. 

C. Description of Small Entities to 

Which the Proposed Rule Would Apply 

The proposed regulations would 

apply to all institutions and entities that 

engage in originating or extending 

home-secured credit. The Board is not 

aware of a reliable source for the total 

number of small entities likely to be 

affected by the proposal, and the credit 

provisions of TILA and Regulation Z 

have broad applicability to individuals 

and businesses that originate and extend 

even small numbers of home-secured 

credit. See § 226.1(c)(1).102 All small 

entities that originate or extend closedend loans secured by a dwelling are 

potentially subject to at least some 

aspects of the proposed rule. 

The Board can, however, identify 

through data from Reports of Condition 

and Income (‘‘Call Reports’’) 

approximate numbers of small 

depository institutions that would be 

subject to the proposed rule. Based on 

December 2010 Call Report data, 

approximately 8,579 small institutions 

would be subject to the proposed rule. 

Approximately 15,217 depository 

institutions in the United States filed 

Call Report data, approximately 10,816 

of which had total domestic assets of 

$175 million or less and thus were 

considered small entities for purposes of 

the RFA. Of 3,749 banks, 502 thrifts 103

and 6,565 credit unions that filed Call 

Report data and were considered small 

entities, 3,621 banks, 477 thrifts, and 

4,481 credit unions, totaling 8,579 

institutions, originated or extended 

mortgage credit. 

The Board cannot identify with 

certainty the number of small nondepository institutions that would be 

subject to the proposed rule. Home 

Mortgage Disclosure Act (HMDA) 104


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metropolitan areas are required to report under 

HMDA. However, if a lender is required to report, 

it must report information on all of its home loan 

applications and loans in all locations, including 

non-metropolitan areas. 

105The 2009 HMDA Data, available at http:// 

www.ffiec.gov/hmda/default.htm. 

data indicate that 870 non-depository 

institutions filed HMDA reports in 

2009.105 Based on the small volume of 

lending activity reported by these 

institutions, most are likely to be small. 

D. Projected Reporting, Recordkeeping, 

and Other Compliance Requirements 

The compliance requirements of the 

proposed rule are described in part V of 

the SUPPLEMENTARY INFORMATION. The 

effect of the proposed revisions to 

Regulation Z on small entities is 

unknown. Some small entities would be 

required, among other things, to modify 

their underwriting practices to account 

for the repayment ability analysis for 

covered transactions in order to comply 

with the revised rule. The precise costs 

to small entities of modifying their 

underwriting practices are difficult to 

predict. These costs will depend on a 

number of unknown factors, including, 

among other things, the current 

practices used by such entities to collect 

and analyze consumer income, asset, 

and liability information, the 

complexity of the terms of credit 

products that they offer, and the range 

of such product offerings. The proposed 

rule would provide small entities the 

option of offering only qualified 

mortgages, which will enjoy either a 

presumption of compliance with respect 

to the repayment ability requirement or 

a safe harbor from the repayment ability 

requirement, thus reducing litigation 

risks and costs for small entities. 

The proposed rule also requires 

creditors to determine a consumer’s 

repayment ability using a payment 

schedule based on monthly, fullyamortizing payments at the fullyindexed rate or introductory rate, 

whichever is greater. Under the 

proposed rule, special payment 

calculation rules apply to loans with a 

balloon payment, interest-only loans, 

and negative amortization loans. The 

proposed rule may therefore increase 

compliance costs for small entities, 

particularly for creditors that offer 

products that contain balloon payments, 

interest-only loans, and negative 

amortization loans. The precise costs to 

small entities of updating their 

processes and systems to account for 

these additional calculations are 

difficult to predict, but these costs are 

mitigated, in some circumstances, by 

the proposed presumption of 

compliance or safe harbor for qualified 

mortgages. 

Under the proposed rule, creditors 

must retain evidence of compliance 

with proposed § 226.43 for three years 

after the consummation of a covered 

transaction. Currently, § 226.25(a) 

requires that creditors retain evidence of 

compliance with Regulation Z for two 

years after disclosures must be made or 

an action must be taken, though 

§ 226.25(a) also clarifies that 

administrative agencies responsible for 

enforcing Regulation Z may require 

creditors to retain records for a longer 

period if necessary to carry out their 

enforcement responsibilities. While 

increasing the period creditors must 

retain certain records from two to three 

years would increase creditors’ 

compliance burden, the precise costs to 

small entities is difficult to predict. 

However, the Board believes many 

creditors will retain such records for at 

least three years, in an abundance of 

caution, which would minimize the 

overall burden increase. The 

compliance burden is also mitigated by 

proposed comment 25(a)–6, which 

clarifies that creditors need not retain 

actual paper copies of the 

documentation used to underwrite a 

transaction. Furthermore, the proposal 

to extend the required retention period 

for evidence of compliance with 

proposed § 226.43 would not affect the 

retention period for other requirements 

under Regulation Z. 

The Board believes that costs of the 

proposed rule as a whole will have a 

significant economic effect on small 

entities, including small mortgage 

creditors. The Board seeks information 

and comment on any costs, compliance 

requirements, or changes in operating 

procedures arising from the application 

of the proposed rule to small businesses. 

E. Identification of Duplicative, 

Overlapping, or Conflicting Federal 

Rules Other Federal Rules 

The Board has not identified any 

Federal rules that conflict with the 

proposed revisions to Regulation Z. 

F. Identification of Duplicative, 

Overlapping, or Conflicting State Laws 

State Equivalents to TILA 

Many states regulate consumer credit 

through statutory disclosure schemes 

similar to TILA. Under TILA Section 

111, the proposed rule would not 

preempt such state laws except to the 

extent they are inconsistent with the 

proposal’s requirements. 15 U.S.C. 1610. 

The Board is also aware that some 

states regulate mortgage loans under 

ability-to-repay laws that resemble the 

proposed rule, and that many states 

regulate only high-cost or high-priced 

mortgage loans under ability-to-repay 

laws. The proposed rule would not 

preempt such state laws except to the 

extent they are inconsistent with the 

proposal’s requirements. Id. 

The Board seeks comment regarding 

any state or local statutes or regulations 

that would duplicate, overlap, or 

conflict with the proposed rule. 

G. Discussion of Significant Alternatives 

The steps the Board has taken to 

minimize the economic impact and 

compliance burden on small entities, 

including the factual, policy, and legal 

reasons for selecting the alternatives 

adopted and why each one of the other 

significant alternatives was not 

accepted, are described above in the 

SUPPLEMENTARY INFORMATION. The Board 

has provided an exception to the general 

provision that a qualified mortgage may 

not provide for a balloon payment for 

loans that are originated by certain 

small creditors and that meet specified 

criteria, as the Board understands that 

community banks originate balloonpayment loans to hedge against interest 

rate risk, rather than making adjustablerate mortgages, and that community 

banks hold these balloon-payment loans 

in portfolio virtually without exception 

because they are not eligible for sale in 

the secondary market. The Board 

believes that this exception will 

decrease the economic impact of the 

proposed rules on small entities. 

The Board welcomes comments on 

any significant alternatives consistent 

with the provisions of Sections 1411, 

1412, and 1414 of the Dodd-Frank Act 

that would minimize the impact of the 

proposed regulations on small entities. 

List of Subjects in 12 CFR Part 226 

Advertising, Consumer protection, 

Federal Reserve System, Mortgages, 

Reporting and recordkeeping 

requirements, Truth in Lending. 

Text of Proposed Revisions 

Certain conventions have been used 

to highlight the proposed revisions. 

New language is shown inside bold 

arrows, and language that would be 

deleted in shown inside bold brackets. 

Authority and Issuance 

For the reasons set forth in the 

preamble, the Board proposes to amend 

Regulation Z, 12 CFR part 226, as 

follows: 

PART 226—TRUTH IN LENDING 

(REGULATION Z) 

1. The authority citation for part 226 

is revised to read as follows: 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27481 

Authority: 12 U.S.C. 3806; 15 U.S.C. 1604, 

1637(c)(5), and 1639(l); Sec. 2, Pub. L. 111– 

24, 123 Stat. 1734; Pub. L. 111–203, 124 Stat. 

1376. 

Subpart D—Miscellaneous 

2. Section 226.25 is amended by 

revising paragraph (a) to read as follows: 

§ 226.25 Record retention. 

(a) General rule. A creditor shall 

retain evidence of compliance with 

øthis regulation¿fl§ 226.43 of this 

regulation for 3 years after 

consummation of a transaction covered 

by that section and shall retain evidence 

of compliance with all other sections of 

this regulationfi (other than advertising 

requirements under §§ 226.16 and 

226.24) for 2 years after the date 

disclosures are required to be made or 

action is required to be taken. The 

administrative agencies responsible for 

enforcing the regulation may require 

creditors under their jurisdictions to 

retain records for a longer period if 

necessary to carry out their enforcement 

responsibilities under section 108 of the 

act. 

* * * * * 

Subpart E—Special Rules for Certain 

Home Mortgage Transactions 

3. Section 226.32 is amended by 

revising paragraph (b) to read as follows: 

§ 226.32 Requirements for certain closedend home mortgages. 

* * * * * 

(b) Definitions. For purposes of this 

subpart, the following definitions apply: 

(1) For purposes of paragraph (a)(1)(ii) 

of this section, points and fees means: 

(i) All items flconsidered to be a 

finance chargefi ørequired to be 

disclosed¿ under § 226.4(a) and 

226.4(b), except fl—fi øinterest or the 

time-price differential¿ 

fl(A) Interest or the time-price 

differential; 

(B) Any premium or other charge for 

any guaranty or insurance protecting the 

creditor against the consumer’s default 

or other credit loss to the extent that the 

premium or charge is— 

(1) Assessed in connection with any 

Federal or state agency program; 

(2) Not in excess of the amount 

payable under policies in effect at the 

time of origination under section 

203(c)(2)(A) of the National Housing Act 

(12 U.S.C. 1709(c)(2)(A)), provided that 

the premium or charge is required to be 

refundable on a pro rata basis and the 

refund is automatically issued upon 

notification of the satisfaction of the 

underlying mortgage loan; or 

(3) Payable after the loan closing.fi 

(ii) All compensation paid øto 

mortgage brokers¿ fldirectly or 

indirectly by a consumer or creditor to 

a loan originator, as defined in 

§ 226.36(a)(1), including a loan 

originator that is also the creditor in a 

table-funded transaction;fi 

(iii) All items listed in § 226.4(c)(7) 

(other than amounts held for future 

payment of taxes) flpayable at or before 

closing of the mortgage loan,fi unless— 

øthe charge is reasonable, the creditor 

receives no direct or indirect 

compensation in connection with the 

charge, and the charge is not paid to an 

affiliate of the creditor; and¿ 

fl(A) The charge is reasonable; 

(B) The creditor receives no direct or 

indirect compensation in connection 

with the charge; and 

(C) The charge is not paid to an 

affiliate of the creditor; fi 

(iv) flPremiums or other charges 

payable at or before closing of the 

mortgage loan for any credit life, credit 

disability, credit unemployment, or 

credit property insurance, or any other 

life, accident, health, or loss-of-income 

insurance, or any payments directly or 

indirectly for any debt cancellation or 

suspension agreement or contract.fi 

øPremiums or other charges for credit 

life, accident, health, or loss-of-income 

insurance, or debt-cancellation coverage 

(whether or not the debt-cancellation 

coverage is insurance under applicable 

law) that provides for cancellation of all 

or part of the consumer’s liability in the 

event of the loss of life, health, or 

income or in the case of accident, 

written in connection with the credit 

transaction.¿ 

fl(v) The maximum prepayment 

penalty, as defined in § 226.43(b)(10), 

that may be charged or collected under 

the terms of the mortgage loan; and 

(vi) The total prepayment penalty, as 

defined in § 226.43(b)(10), incurred by 

the consumer if the mortgage loan is 

refinanced by the current holder of the 

existing mortgage loan, a servicer acting 

on behalf of the current holder, or an 

affiliate of either. 

(2) For purposes of paragraph (b)(1)(ii) 

of this section, the term points and fees 

does not include compensation paid 

to— 

(i) An employee of a retailer of 

manufactured homes who does not take 

a residential mortgage loan application, 

offer or negotiate terms of a residential 

mortgage loan, or advise a consumer on 

loan terms (including rates, fees, and 

other costs) but who, for compensation 

or other monetary gain, or in 

expectation of compensation or other 

monetary gain, assists a consumer in 

obtaining or applying to obtain a 

residential mortgage loan; 

(ii) A person that only performs real 

estate brokerage activities and is 

licensed or registered in accordance 

with applicable state law, unless such 

person is compensated by a creditor or 

loan originator, as defined in 

§ 226.36(a)(1), or by any agent of the 

creditor or loan originator; or 

(iii) A servicer or servicer employees, 

agents and contractors, including but 

not limited to those who offer or 

negotiate terms of a covered transaction 

for purposes of renegotiating, 

modifying, replacing and subordinating 

principal of existing mortgages where 

borrowers are behind in their payments, 

in default or have a reasonable 

likelihood of being in default or falling 

behind. 

(3)fiø(2)¿ Affiliate means any 

company that controls, is controlled by, 

or is under common control with 

another company, as set forth in the 

Bank Holding Company Act of 1956 (12 

U.S.C. 1841 et seq.). 

* * * * * 

4. Section 226.34, is amended by 

removing paragraph (a)(4). 

§ 226.34 Prohibited acts or practices in 

connection with credit subject to § 226.32. 

(a) * * * 

[(4) Repayment ability. Extend credit 

subject to § 226.32 to a consumer based 

on the value of the consumer’s collateral 

without regard to the consumer’s 

repayment ability as of consummation, 

including the consumer’s current and 

reasonably expected income, 

employment, assets other than the 

collateral, current obligations, and 

mortgage-related obligations. 

(i) Mortgage-related obligations. For 

purposes of this paragraph (a)(4), 

mortgage-related obligations are 

expected property taxes, premiums for 

mortgage-related insurance required by 

the creditor as set forth in 

§ 226.35(b)(3)(i), and similar expenses. 

(ii) Verification of repayment ability. 

Under this paragraph (a)(4) a creditor 

must verify the consumer’s repayment 

ability as follows: 

(A) A creditor must verify amounts of 

income or assets that it relies on to 

determine repayment ability, including 

expected income or assets, by the 

consumer’s Internal Revenue Service 

Form W–2, tax returns, payroll receipts, 

financial institution records, or other 

third-party documents that provide 

reasonably reliable evidence of the 

consumer’s income or assets. 

(B) Notwithstanding paragraph 

(a)(4)(ii)(A), a creditor has not violated 

paragraph (a)(4)(ii) if the amounts of 

income and assets that the creditor 

relied upon in determining repayment 

ability are not materially greater than 


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27482 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

the amounts of the consumer’s income 

or assets that the creditor could have 

verified pursuant to paragraph 

(a)(4)(ii)(A) at the time the loan was 

consummated. 

(C) A creditor must verify the 

consumer’s current obligations. 

(iii) Presumption of compliance. A 

creditor is presumed to have complied 

with this paragraph (a)(4) with respect 

to a transaction if the creditor: 

(A) Verifies the consumer’s repayment 

ability as provided in paragraph 

(a)(4)(ii); 

(B) Determines the consumer’s 

repayment ability using the largest 

payment of principal and interest 

scheduled in the first seven years 

following consummation and taking 

into account current obligations and 

mortgage-related obligations as defined 

in paragraph (a)(4)(i); and 

(C) Assesses the consumer’s 

repayment ability taking into account at 

least one of the following: The ratio of 

total debt obligations to income, or the 

income the consumer will have after 

paying debt obligations. 

(iv) Exclusions from presumption of 

compliance. Notwithstanding the 

previous paragraph, no presumption of 

compliance is available for a transaction 

for which: 

(A) The regular periodic payments for 

the first seven years would cause the 

principal balance to increase; or 

(B) The term of the loan is less than 

seven years and the regular periodic 

payments when aggregated do not fully 

amortize the outstanding principal 

balance. 

(v) Exemption. This paragraph (a)(4) 

does not apply to temporary or ‘‘bridge’’ 

loans with terms of twelve months or 

less, such as a loan to purchase a new 

dwelling where the consumer plans to 

sell a current dwelling within twelve 

months.¿ 

* * * * * 

§ 226.35 [Removed and reserved] 

5. Section 226.35 is removed and 

reserved. 

6. Add § 226.43 to read as follows: 

fl§ 226.43 Minimum standards for 

transactions secured by a dwelling. 

(a) Scope. This section applies to any 

consumer credit transaction that is 

secured by a dwelling, as defined in 

§ 226.2(a)(19), other than: 

(1) A home equity line of credit 

subject to § 226.5b; 

(2) A mortgage transaction secured by 

a consumer’s interest in a timeshare 

plan, as defined in 11 U.S.C. 101(53(D)); 

or 

(3) For purposes of paragraphs (c) 

through (f) of this section— 

(i) A reverse mortgage subject to 

§ 226.33; or 

(ii) 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. 

(b) Definitions. For purposes of this 

section: 

(1) Covered transaction means a 

consumer credit transaction that is 

secured by a dwelling, as defined in 

§ 226.2(a)(19), other than a transaction 

exempt from coverage under paragraph 

(a) of this section. 

(2) Fully amortizing payment means a 

periodic payment of principal and 

interest that will fully repay the loan 

amount over the loan term. 

(3) Fully indexed rate means the 

interest rate calculated using the index 

or formula at the time of consummation 

and the maximum margin that can 

apply at any time during the loan term. 

(4) Higher-priced covered transaction 

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. 

(5) Loan amount means the principal 

amount the consumer will borrow as 

reflected in the promissory note or loan 

contract. 

(6) Loan term means the period of 

time to repay the obligation in full. 

(7) Maximum loan amount means the 

loan amount plus any increase in 

principal balance that results from 

negative amortization, as defined in 

§ 226.18(s)(7)(v), based on the terms of 

the legal obligation assuming— 

(i) The consumer makes only the 

minimum periodic payments for the 

maximum possible time, until the 

consumer must begin making fully 

amortizing payments; and 

(ii) The maximum interest rate is 

reached at the earliest possible time. 

(8) Mortgage-related obligations mean 

property taxes; mortgage-related 

insurance premiums required by the 

creditor as set forth in § 226.45(b)(1); 

homeowner’s association, 

condominium, and cooperative fees; 

ground rent or leasehold payments; and 

special assessments. 

(9) Points and fees has the same 

meaning as in § 226.32(b)(1). 

(10) Prepayment penalty means a 

charge imposed for paying all or part of 

a covered transaction’s principal before 

the date on which the principal is due. 

For purposes of this section— 

(i) The following are examples of 

prepayment penalties: 

(A) A charge determined by treating 

the loan balance as outstanding for a 

period of time after prepayment in full 

and applying the interest rate to such 

‘‘balance,’’ even if the charge results 

from the interest accrual amortization 

method used for other payments in the 

transaction; and 

(B) A fee, such as a loan closing cost, 

that is waived unless the consumer 

prepays the covered transaction. 

(ii) A prepayment penalty does not 

include fees imposed for preparing and 

providing documents when a loan is 

paid in full, whether or not the loan is 

prepaid, such as a loan payoff 

statement, a reconveyance document, or 

another document releasing the 

creditor’s security interest in the 

dwelling that secures the loan. 

(11) Recast means— 

(i) For an adjustable-rate mortgage, as 

defined in § 226.18(s)(7)(i), the 

expiration of the period during which 

payments based on the introductory 

fixed interest rate are permitted under 

the terms of the legal obligation; 

(ii) For an interest-only loan, as 

defined in § 226.18(s)(7)(iv), the 

expiration of the period during which 

interest-only payments are permitted 

under the terms of the legal obligation; 

and 

(iii) For a negative amortization loan, 

as defined in § 226.18(s)(7)(v), the 

expiration of the period during which 

negatively amortizing payments are 

permitted under the terms of the legal 

obligation. 

(12) Simultaneous loan means 

another covered transaction or home 

equity line of credit subject to § 226.5b 

that will be secured by the same 

dwelling and made to the same 

consumer at or before consummation of 

the covered transaction. 

(13) Third-party record means— 

(i) A document or other record 

prepared or reviewed by a person other 

than the consumer, the creditor, or the 

mortgage broker, as defined in 

§ 226.36(a)(2), or an agent of the creditor 

or mortgage broker; 

(ii) A copy of a tax return filed with 

the Internal Revenue Service or a state 

taxing authority; 

(iii) A record the creditor maintains 

for an account of the consumer held by 

the creditor; or 

(iv) If the consumer is an employee of 

the creditor or the mortgage broker, a 

document or other record maintained by 

the creditor or mortgage broker 

regarding the consumer’s employment 

status or employment income. 


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(c) Repayment ability—(1) General 

requirement. A creditor shall not make 

a loan in a covered transaction unless 

the creditor makes a reasonable and 

good faith determination at or before 

consummation that the consumer will 

have a reasonable ability, at the time of 

consummation, to repay the loan 

according to its terms, including any 

mortgage-related obligations. 

(2) Basis for determination. Except as 

provided otherwise in paragraphs (d), 

(e), and (f) of this section, in making the 

repayment ability determination 

required under paragraph (c)(1) of this 

section, a creditor must consider the 

following: 

(i) The consumer’s current or 

reasonably expected income or assets, 

other than the value of 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 paragraph (c)(5) of this 

section; 

(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 paragraph (c)(6) of this section; 

(v) The consumer’s monthly payment 

for mortgage-related obligations; 

(vi) The consumer’s current debt 

obligations; 

(vii) The consumer’s monthly debt-toincome ratio, or residual income in 

accordance with paragraph (c)(7) of this 

section; and 

(viii) The consumer’s credit history. 

(3) Verification using third-party 

records. A creditor must verify a 

consumer’s repayment ability using 

reasonably reliable third-party records, 

except that— 

(i) For purposes of paragraph (c)(2)(ii) 

of this section, a creditor may verify a 

consumer’s employment status orally if 

the creditor prepares a record of the 

information obtained orally; and 

(ii) For purposes of paragraph 

(c)(2)(vi) of this section, if a creditor 

relies on a consumer’s credit report to 

verify a consumer’s current debt 

obligations and a consumer’s 

application states a current debt 

obligation not shown in the consumer’s 

credit report, the creditor need not 

independently verify such obligation. 

(4) Verification of income or assets. A 

creditor must verify the amounts of 

income or assets it relies on to 

determine a consumer’s ability to repay 

a covered transaction using third-party 

records that provide reasonably reliable 

evidence of the consumer’s income or 

assets. A creditor may verify the 

consumer’s income using a tax-return 

transcript issued by the Internal 

Revenue Service (IRS). Examples of 

other records the creditor may use to 

verify the consumer’s income or assets 

include: 

(i) Copies of tax returns the consumer 

filed with the Internal Revenue Service 

or a state taxing authority; 

(ii) IRS Form W–2s or similar IRS 

forms used for reporting wages or tax 

withholding; 

(iii) Payroll statements, including 

military Leave and Earnings Statements; 

(iv) Financial institution records; 

(v) Records from the consumer’s 

employer or a third-party that obtained 

information from the employer; 

(vi) Records from a Federal, state, or 

local government agency stating the 

consumer’s income from benefits or 

entitlements; 

(vii) Receipts from the consumer’s use 

of check cashing services; and 

(viii) Receipts from the consumer’s 

use of a funds transfer service. 

(5) Payment calculation—(i) General 

rule. Except as provided in paragraph 

(c)(5)(ii) of this section, a creditor must 

make the determination required under 

paragraph (c)(2)(iii) using— 

(A) The fully indexed rate or any 

introductory interest rate, whichever is 

greater; and 

(B) Monthly, fully amortizing 

payments that are substantially equal. 

(ii) Special rules for loans with a 

balloon payment, interest-only loans, 

and negative amortization loans. A 

creditor must make the determination 

required under paragraph (c)(2)(iii) for— 

(A) A loan with a balloon payment, as 

defined in § 226.18(s)(5)(i), using— 

(1) The maximum payment scheduled 

during the first five years after 

consummation for a loan that is not a 

higher-priced covered transaction; or 

(2) The maximum payment in the 

payment schedule, including any 

balloon payment, for a higher-priced 

covered transaction; 

(B) An interest-only loan, as defined 

in § 226.18(s)(7)(iv), using— 

(1) The fully indexed rate or any 

introductory interest rate, whichever is 

greater; and 

(2) Substantially equal, monthly 

payments of principal and interest that 

will repay the loan amount over the 

term of the loan remaining as of the date 

the loan is recast. 

(C) A negative amortization loan, as 

defined in § 226.18(s)(7), using— 

(1) The fully indexed rate or any 

introductory interest rate, whichever is 

greater; and 

(2) Substantially equal, monthly 

payments of principal and interest that 

will repay the maximum loan amount 

over the term of the loan remaining as 

of the date the loan is recast. 

(6) Payment calculation for 

simultaneous loans. For purposes of 

making the determination required 

under paragraph (c)(2)(iv) of this 

section, a creditor must consider a 

consumer’s payment on a simultaneous 

loan that is— 

(i) A covered transaction, by following 

paragraphs (c)(5)(i)–(ii) of this section; 

or 

(ii) A home equity line of credit 

subject to § 226.5b, by using the 

periodic payment required under the 

terms of the plan and the amount of 

credit drawn at consummation of the 

covered transaction. 

(7) Monthly debt-to-income ratio or 

residual income—(i) Definitions. For 

purposes of this paragraph, the 

following definitions apply— 

(A) Total monthly debt obligations. 

The term total monthly debt obligations 

means the sum of: the payment on the 

covered transaction, as required to be 

calculated by paragraphs (c)(2)(iii) and 

(c)(5) of this section; simultaneous 

loans, as required by paragraphs 

(c)(2)(iv) and (c)(6) of this section; 

mortgage-related obligations, as required 

by paragraph (c)(2)(v) of this section; 

and current debt obligations, as required 

by paragraph (c)(2)(vi) of this section. 

(B) Total monthly income. The term 

total monthly income means the sum of 

the consumer’s current or reasonably 

expected income, including any income 

from assets, as required paragraphs 

(c)(2)(i) and (c)(4) of this section. 

(ii) Calculations. (A) Monthly debt-toincome ratio. For purposes of 

considering the consumer’s monthly 

debt-to-income ratio under paragraph 

(c)(2)(vii) of this section, the creditor 

must consider the ratio of the 

consumer’s total monthly debt 

obligations to total monthly income. 

(B) Monthly residual income. For 

purposes of considering the consumer’s 

monthly residual income under 

paragraph (c)(2)(vii) of this section, the 

creditor must consider the consumer’s 

remaining income after subtracting the 

consumer’s total monthly debt 

obligations from the total monthly 

income. 

(d) Refinancing of non-standard 

mortgages—(1) Scope. The provisions of 

this paragraph (d) apply to the 

refinancing of a non-standard mortgage 

into a standard mortgage when the 

following conditions are met— 

(i) The creditor for the standard 

mortgage is the current holder of the 

existing non-standard mortgage or the 

servicer acting on behalf of the current 

holder. 


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(ii) The monthly payment for the 

standard mortgage is materially lower 

than the monthly payment for the nonstandard mortgage, as calculated under 

paragraph (d)(5) of this section. 

(iii) The creditor receives the 

consumer’s written application for the 

standard mortgage before the nonstandard mortgage is recast. 

(iv) The consumer has made no more 

than one payment more than 30 days 

late on the non-standard mortgage 

during the 24 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. 

(2) Definitions. For purposes of this 

paragraph (d), the following definitions 

apply: 

(i) Non-standard mortgage. The term 

non-standard mortgage means a covered 

transaction that is— 

(A) An adjustable-rate mortgage, as 

defined in § 226.18(s)(7)(i), with an 

introductory fixed interest rate for a 

period of one year or longer; 

(B) An interest-only loan, as defined 

in § 226.18(s)(7)(iv); or 

(C) A negative amortization loan, as 

defined in § 226.18(s)(7)(v). 

(ii) Standard mortgage. The term 

standard mortgage means a covered 

transaction— 

(A) 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, as 

defined in § 226.18(s)(5)(i); 

(B) For which the total points and fees 

payable in connection with the 

transaction do not exceed the amounts 

specified in paragraph (e)(3) of this 

section; 

(C) For which the term does not 

exceed 40 years; 

(D) For which the interest rate is fixed 

for at least the first five years after 

consummation; and 

(E) 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. 

(iii) Refinancing. The term 

refinancing has the same meaning as in 

§ 226.20(a). 

(3) Exemption from certain repayment 

ability requirements. (i) A creditor is not 

required to comply with the income and 

asset verification requirements of 

paragraphs (c)(2)(i) and (c)(4) of this 

section or the payment calculation 

requirements under paragraphs 

(c)(2)(iii) and (c)(5) of this section if— 

(A) The conditions in paragraph (d)(1) 

of this section are met; and 

(B) The creditor has considered 

whether the standard mortgage will 

prevent a likely default by the consumer 

on the non-standard mortgage at the 

time of its recast. 

(ii) If the conditions in paragraph 

(d)(3)(i) of this section are met, the 

creditor shall satisfy the requirements 

under paragraphs (c)(2)(iii) and (c)(5) of 

this section for the standard mortgage by 

using the payment calculation 

prescribed under paragraph (d)(5)(ii) of 

this section. 

(4) Offer of rate discounts and other 

favorable terms. A creditor making a 

covered transaction under this 

paragraph (d) may offer to the consumer 

the same or better rate discounts and 

terms that the creditor offers to new 

consumers, consistent with the 

creditor’s documented underwriting 

practices and to the extent not 

prohibited by applicable state or Federal 

law. 

(5) Payment calculations. For 

purposes of determining whether the 

consumer’s monthly payment for a 

standard mortgage will be materially 

lower than the monthly payment for the 

non-standard mortgage, the following 

provisions shall be used: 

(i) Non-standard mortgage. The 

monthly payment for a non-standard 

mortgage must be based on substantially 

equal, monthly, fully amortizing 

payments of principal and interest 

using— 

(A) The fully indexed rate as of a 

reasonable period of time before or after 

the date on which the creditor receives 

the consumer’s written application for 

the standard mortgage; 

(B) The term of the loan remaining as 

of the date on which the recast occurs, 

assuming all scheduled payments have 

been made up to the recast date and the 

payment due on the recast date is made 

and credited as of that date; and 

(C) A remaining loan amount that is— 

(1) For an adjustable-rate mortgage 

under paragraph (d)(2)(i)(A) of this 

section, the outstanding principal 

balance as of the date of the recast, 

assuming all scheduled payments have 

been made up to the recast date and the 

payment due on the recast date is made 

and credited as of that date; 

(2) For an interest-only loan under 

paragraph (d)(2)(i)(B) of this section, the 

loan amount, assuming all scheduled 

payments have been made up to the 

recast date and the payment due on the 

recast date is made and credited as of 

that date; 

(3) For a negative amortization loan 

under paragraph (d)(2)(i)(C) of this 

section, the maximum loan amount. 

(ii) Standard mortgage. The monthly 

payment for a standard mortgage must 

be based on substantially equal, 

monthly, fully amortizing payments 

based on the maximum interest rate that 

may apply during the first five years 

after consummation. 

(e) Qualified mortgages. 

Alternative 1—Paragraph (e)(1) 

(1) Safe harbor. A creditor or assignee 

of a covered transaction complies with 

the repayment ability requirement of 

paragraph (c)(1) of this section if the 

covered transaction is a qualified 

mortgage, as defined in paragraph (e)(2) 

of this section. 

Alternative 2—Paragraph (e)(1) 

(1) Presumption of compliance. A 

creditor or assignee of a covered 

transaction is presumed to have 

complied with the repayment ability 

requirements of paragraph (c)(1) of this 

section if the covered transaction is a 

qualified mortgage, as defined in 

paragraph (e)(2) of this section. 

(2) Qualified mortgage defined. A 

qualified mortgage is a covered 

transaction— 

(i) That provides for regular periodic 

payments that do not— 

(A) Result in an increase of the 

principal balance; 

(B) Allow the consumer to defer 

repayment of principal, except as 

provided in paragraph (f) of this section; 

or 

(C) Result in a balloon payment, as 

defined in § 226.18(s)(5)(i), except as 

provided in paragraph (f) of this section; 

(ii) For which the loan term does not 

exceed 30 years; 

(iii) For which the total points and 

fees payable in connection with the loan 

do not exceed the amounts specified in 

paragraph (e)(3) of this section; 

(iv) For which the creditor 

underwrites the loan, taking into 

account any mortgage-related 

obligations, using— 

(A) The maximum interest rate that 

may apply during the first five years 

after consummation; and 

(B) Periodic payments of principal 

and interest that will repay either— 

(1) The outstanding principal balance 

over the remaining term of the loan as 

of the date the interest rate adjusts to the 

maximum interest rate set forth in 

paragraph (e)(2)(iv)(A) of this section; or 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
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(2) The loan amount over the loan 

term. 

Alternative 1—Paragraph (e)(2)(v) 

(v) For which the creditor considers 

and verifies the consumer’s current or 

reasonably expected income or assets to 

determine the consumer’s repayment 

ability, as required by paragraphs 

(c)(2)(i), (c)(3), and (c)(4) of this section. 

Alternative 2—Paragraph (e)(2)(v) 

(v) For which the creditor considers 

and verifies, in accordance with 

paragraph (c)(3) of this section, the 

following: 

(A) The consumer’s current or 

reasonably expected income or assets 

other than the value of the dwelling that 

secures the loan, in accordance with 

paragraphs (c)(2)(i) and (c)(4) of this 

section; 

(B) If the creditor relies on income 

from the consumer’s employment in 

determining repayment ability, the 

consumer’s current employment status, 

in accordance with paragraph (c)(2)(ii) 

of this section; 

(C) The consumer’s monthly payment 

on any simultaneous loan that the 

creditor knows or has reason to know 

will be made, in accordance with 

paragraphs (c)(2)(iv) and (c)(6) of this 

section; 

(D) The consumer’s current debt 

obligations, in accordance with 

paragraph (c)(2)(vi) of this section; 

(E) The consumer’s monthly debt-toincome ratio, or residual income, in 

accordance with paragraphs (c)(2)(vii) 

and (c)(7) of this section; and 

(F) The consumer’s credit history, in 

accordance with paragraph (c)(viii) of 

this section. 

(3) Limits on points and fees for 

qualified mortgages. 

Alternative 1—Paragraph (e)(3)(i) 

(i) A covered transaction is not a 

qualified mortgage unless the total 

points and fees payable in connection 

with the loan do not exceed— 

(A) For a loan amount of $75,000 or 

more, three percent of the total loan 

amount; 

(B) For a loan amount of greater than 

or equal to $60,000 but less than 

$75,000, 3.5 percent of the total loan 

amount; 

(C) For a loan amount of greater than 

or equal to $40,000 but less than 

$60,000, four percent of the total loan 

amount; 

(D) For a loan amount of greater than 

or equal to $20,000 but less than 

$40,000, 4.5 percent of the total loan 

amount; and 

(E) For a loan amount of less than 

$20,000, five percent of the total loan 

amount. 

Alternative 2—Paragraph (e)(3)(i) 

(i) A covered transaction is not a 

qualified mortgage unless the total 

points and fees payable in connection 

with the loan do not exceed— 

(A) For a loan amount of $75,000 or 

more, three percent of the total loan 

amount; 

(B) For a loan amount of greater than 

or equal to $20,000 but less than 

$75,000, a percentage of the total loan 

amount resulting from the following 

formula— 

(1) Total loan amount ¥ $20,000 = 

$Z; 

(2) $Z × .0036 = Y; 

(3) 500 ¥ Y = X; and 

(4) X × .01 = Allowable points and 

fees as a percentage of the total loan 

amount; and 

(C) For a loan amount of less than 

$20,000, five percent of the total loan 

amount. 

(ii) For purposes of calculating the 

total amount of points and fees that are 

payable in connection with a covered 

transaction under (e)(3)(i), the following 

may be excluded: 

(A) Any bona fide third party charge 

not retained by the creditor, loan 

originator, or an affiliate of either, 

unless the charge is required to be 

included in ‘‘points and fees’’ under 

§ 226.32(b)(1)(i)(B). 

(B) Up to two bona fide discount 

points paid by the consumer in 

connection with the transaction, 

provided that the following conditions 

are met— 

(1) The interest rate before the 

discount does not exceed the average 

prime offer rate, as defined in 

§ 226.45(a)(2)(ii), by more than one 

percent; and 

(2) The average prime offer rate used 

for purposes of paragraph (e)(3)(ii)(B)(1) 

of this section is the same average prime 

offer rate that applies to a comparable 

transaction as of the date the discounted 

interest rate for the transaction is set. 

(C) Up to one bona fide discount point 

paid by the consumer in connection 

with the transaction, provided that the 

following conditions are met— 

(1) The interest rate before the 

discount does not exceed the average 

prime offer rate, as defined in 

§ 226.45(a)(2)(ii), by more than two 

percent; 

(2) The average prime offer rate used 

for purposes of paragraph (e)(3)(ii)(C)(1) 

of this section is the same average prime 

offer rate that applies to a comparable 

transaction as of the date the discounted 

interest rate for the transaction is set; 

and 

(3) Two bona fide discount points 

have not been excluded under 

paragraph (e)(3)(ii)(B) of this section. 

(iii) The term loan originator has the 

same meaning as in § 226.36(a)(1). 

(iv) The term bona fide discount point 

means any percent of the loan amount 

of a covered transaction paid by the 

consumer that reduces the interest rate 

or time-price differential applicable to 

the covered transaction based on a 

calculation that— 

(A) Is consistent with established 

industry practices for determining the 

amount of reduction in the interest rate 

or time-price differential appropriate for 

the amount of discount points paid by 

the consumer; and 

(B) Accounts for the amount of 

compensation that the creditor can 

reasonably expect to receive from 

secondary market investors in return for 

the mortgage loan. 

(f) Balloon-payment qualified 

mortgages made by certain creditors— 

(1) Exception. Notwithstanding 

paragraph (e)(2)(i)(C) of this section, a 

qualified mortgage may provide for a 

balloon payment, provided— 

(i) The loan satisfies all of the 

requirements for a qualified mortgage in 

paragraph (e)(2) of this section, other 

than paragraphs (e)(2)(i)(B), (e)(2)(i)(C), 

and (e)(2)(iv) of this section; 

(ii) The creditor determines that the 

consumer can make all of the scheduled 

payments under the terms of the legal 

obligation, except the balloon payment, 

from the consumer’s current or 

reasonably expected income or assets 

other than the dwelling that secures the 

loan; 

(iii) The scheduled payments on 

which the determination required by 

paragraph (f)(1)(ii) of this section is 

based: 

(A) Are calculated using an 

amortization period that does not 

exceed 30 years; and 

(B) Include all mortgage-related 

obligations; 

(iv) The loan term is five years or 

longer; and 

(v) The creditor: 

(A) During the preceding calendar 

year, extended more than 50% of its 

total covered transactions that provide 

for balloon payments in one or more 

counties designated by the Board as 

‘‘rural’’ or ‘‘underserved,’’ as defined in 

paragraph (f)(2) of this section; 

Alternative 1—Paragraph (f)(1)(v)(B) 

(B) During the preceding calendar 

year, together with all affiliates, 

extended covered transactions with loan 

amounts that in the aggregate total $___ 

or less; 

Alternative 2—Paragraph (f)(1)(v)(B) 

(B) During the preceding calendar 

year, together with all affiliates, 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27486 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

extended ___ or fewer covered 

transactions; 

Alternative 1—Paragraph (f)(1)(v)(C) 

(C) On or after [effective date of final 

rule], has not sold, assigned, or 

otherwise transferred legal title to the 

debt obligation for any covered 

transaction that provides for a balloon 

payment; and 

Alternative 2—Paragraph (f)(1)(v)(C) 

(C) During the preceding and current 

calendar year, has not sold, assigned, or 

otherwise transferred legal title to the 

debt obligation for any covered 

transaction that provides for a balloon 

payment; and 

(D) As of the end of the preceding 

calendar year, had total assets that do 

not exceed the asset threshold 

established and published annually by 

the Board, based on the year-to-year 

change in the average of the Consumer 

Price Index for Urban Wage Earners and 

Clerical Workers, not seasonally 

adjusted, for each 12-month period 

ending in November, with rounding to 

the nearest million dollars. (See staff 

comment 43(f)(1)(v)–1.iv for the current 

threshold.) 

(2) ‘‘Rural’’ and ‘‘underserved’’ 

defined. For purposes of paragraph 

(f)(1)(v)(A) of this section— 

(i) A county is ‘‘rural’’ during a 

calendar year if it is not in a 

metropolitan statistical area or a 

micropolitan statistical area, as those 

terms are defined by the U.S. Office of 

Management and Budget, and: 

(A) It is not adjacent to any 

metropolitan area or micropolitan area; 

or 

(B) It is adjacent to a metropolitan 

area with fewer than one million 

residents or adjacent to a micropolitan 

area, and it contains no town with 2,500 

or more residents. 

(ii) A county is ‘‘underserved’’ during 

a calendar year if no more than two 

creditors extend covered transactions 

five or more times in the county. 

(g) Prepayment penalties—(1) When 

permitted. A covered transaction must 

not include a prepayment penalty 

unless: 

(i) The prepayment penalty is 

otherwise permitted by law; and 

(ii) The transaction— 

(A) Has an annual percentage rate that 

cannot increase after consummation; 

(B) Is a qualified mortgage under 

paragraph (e)(2) or (f) of this section; 

and 

(C) Is not a higher-priced mortgage 

loan, as defined in § 226.45(a). 

(2) Limits on prepayment penalties. A 

prepayment penalty— 

(i) Must not apply after the three-year 

period following consummation; and 

(ii) Must not exceed the following 

percentages of the amount of the 

outstanding loan balance prepaid: 

(A) Three percent, if incurred during 

the first year following consummation; 

(B) Two percent, if incurred during 

the second year following 

consummation; and 

(C) One percent, if incurred during 

the third year following consummation. 

(3) Alternative offer required. Except 

as provided otherwise in paragraph 

(g)(4) or (g)(5) of this section, a creditor 

must not offer a consumer a covered 

transaction with a prepayment penalty 

unless the creditor also offers the 

consumer an alternative covered 

transaction without a prepayment 

penalty and the alternative covered 

transaction— 

(i) Has an annual percentage rate that 

cannot increase after consummation and 

has the same type of interest rate as the 

covered transaction with a prepayment 

penalty. For purposes of this paragraph 

(g), the term ‘‘type of interest rate’’ refers 

to whether a transaction: 

(A) Is a fixed-rate mortgage, as defined 

in § 226.18(s)(7)(iii); or 

(B) Is a step-rate mortgage, as defined 

in § 226.18(s)(7)(ii). 

(ii) Has the same loan term as the loan 

term for the covered transaction with a 

prepayment penalty; 

(iii) Satisfies the periodic payment 

conditions under paragraph (e)(2)(i) of 

this section; 

(iv) Satisfies the points and fees 

conditions under paragraph (e)(2)(iii) of 

this section, based on the information 

known to the creditor at the time the 

transaction is offered; and 

(v) Is a transaction for which the 

creditor has a good faith belief that the 

consumer likely qualifies, based on the 

information known to the creditor at the 

time the creditor offers the covered 

transaction without a prepayment 

penalty. 

(4) Offer through a mortgage broker. If 

the creditor offers a covered transaction 

with a prepayment penalty to the 

consumer through a mortgage broker, as 

defined in § 226.36(a)(2), the creditor 

must— 

(i) Present the mortgage broker an 

alternative covered transaction without 

a prepayment penalty that satisfies the 

requirements of paragraph (g)(3) of this 

section; and 

(ii) Establish by agreement that the 

mortgage broker must present the 

consumer an alternative covered 

transaction without a prepayment 

penalty that satisfies the requirements of 

paragraph (g)(3) of this section, offered 

by— 

(A) The creditor; or 

(B) Another creditor, if the transaction 

offered by the other creditor has a lower 

interest rate or a lower total dollar 

amount of origination points or fees and 

discount points. 

(5) Creditor that is a loan originator. 

If the creditor is a loan originator, as 

defined in § 226.36(a)(1), and the 

creditor presents the consumer a 

covered transaction offered by a person 

to which the creditor would assign the 

covered transaction after 

consummation, the creditor must 

present the consumer an alternative 

covered transaction without a 

prepayment penalty that satisfies the 

requirements of paragraph (g)(3) of this 

section, offered by— 

(i) The assignee; or 

(ii) Another person, if the transaction 

offered by the other person has a lower 

interest rate or a lower total dollar 

amount of origination points or fees and 

discount points. 

(6) Applicability. This paragraph (g) 

applies only if a covered transaction is 

consummated with a prepayment 

penalty and is not violated if: 

(i) A covered transaction is 

consummated without a prepayment 

penalty; or 

(ii) The creditor and consumer do not 

consummate a covered transaction. 

(h) Evasion; open-end credit. In 

connection with credit secured by a 

consumer’s dwelling that does not meet 

the definition of open-end credit in 

§ 226.2(a)(20), a creditor shall not 

structure a home-secured loan as an 

open-end plan to evade the 

requirements of this section.fi 

7. In Supplement I to Part 226: 

A. Under Section 226.25—Record 

Retention, 25(a) General rule, paragraph 

2 is revised and paragraphs 6 and 7 are 

added. 

B. Under Section 226.32— 

Requirements for Certain Closed-End 

Home Mortgages, 

(1) In subheading 32(a) Coverage, 

Paragraph 32(a)(1)(ii), paragraph 1 is 

revised; 

(2) In subheading 32(b) Definitions, 

Paragraph 32(b)(1)(i), paragraph 1 is 

revised and paragraphs 2, 3, and 4 are 

added; 

(i) Paragraph 32(b)(1)(ii), paragraph 1 

is revised, paragraph 2. is redesignated 

as Paragraph 32(b)(1)(iii), paragraph 1, 

and revised, and new paragraphs 2 and 

3 are added to Paragraph 32(b)(1)(ii); 

(ii) Paragraph 32(b)(1)(iv), paragraph 

1 is revised and paragraph 2 is added. 

C. Under Section 226.34—Prohibited 

Acts or Practices in Connection with 

Credit Subject to § 226.32, subheading 

34(a) Prohibited acts or practices for 

loans subject to § 226.32, paragraph 

34(a)(4) Repayment ability is removed 

and reserved. 

D. Section 226.35—Prohibited Acts or 

Practices in Connection with HigherVerDate Mar<15>2010 16:56 May 10, 2011 Jkt 223001 PO 00000 Frm 00098 Fmt 4701 Sfmt 4702 E:\FR\FM\11MYP2.SGM 11MYP2

jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27487 

Priced Mortgage Loans is removed and 

reserved. 

E. New entry Section 226.43— 

Minimum Standards for Transactions 

Secured by a Dwelling is added. 

The revisions, removals, and 

additions read as follows: 

Supplement I to Part 226—Official Staff 

Interpretations 

* * * * * 

Subpart D—Miscellaneous 

* * * * * 

Section 226.25—Record Retention 

25(a) General rule. 

* * * * * 

2. Methods of retaining evidence. 

Adequate evidence of compliance does 

not necessarily mean actual paper 

copies of disclosure statements or other 

business records. The evidence may be 

retained [on microfilm, microfiche, or] 

by any [other] method that reproduces 

records accurately (including computer 

programs). flUnless otherwise 

required,fi the creditor need retain only 

enough information to reconstruct the 

required disclosures or other records. 

Thus, for example, the creditor need not 

retain each open-end periodic 

statement, so long as the specific 

information on each statement can be 

retrieved. 

* * * * * 

fl6. Evidence of compliance with 

§ 226.43. Creditors must retain evidence 

of compliance with § 226.43 for three 

years after the date of consummation of 

a consumer credit transaction covered 

by that section. (See comment 25(a)–7 

for guidance on the retention of 

evidence of compliance with the 

requirement to offer a consumer a loan 

without a prepayment penalty under 

§ 226.43(g)(3).) If a creditor must verify 

and document information used in 

underwriting a transaction subject to 

§ 226.43, the creditor should retain 

evidence sufficient to demonstrate 

compliance with the documentation 

requirements of the rule. Although 

creditors need not retain actual paper 

copies of the documentation used in 

underwriting a transaction subject to 

§ 226.43, creditors should be able to 

reproduce such records accurately. For 

example, if the creditor uses a 

consumer’s Internal Revenue Service 

(IRS) Form W–2 to verify the 

consumer’s income, the creditor should 

be able to reproduce the IRS Form W– 

2 itself, and not merely the income 

information that was contained in the 

form. 

7. Dwelling-secured transactions and 

prepayment penalties. If a transaction 

covered by § 226.43 has a prepayment 

penalty, the creditor must maintain 

records that document that the creditor 

complied with requirements for offering 

the consumer an alternative transaction 

that does not include a prepayment 

penalty under § 226.43(g)(3), (4), or (5). 

However, the creditor need not maintain 

records that document compliance with 

those provisions if a transaction is 

consummated without a prepayment 

penalty or if the creditor and consumer 

do not consummate a covered 

transaction. See § 226.43(g)(6). If a 

creditor offers a transaction with a 

prepayment penalty to a consumer 

through a mortgage broker, to evidence 

compliance with § 226.43(g)(4) the 

creditor should retain records of the 

alternative covered transaction 

presented to the mortgage broker, such 

as a rate sheet, and the agreement with 

the mortgage broker required by 

§ 226.43(g)(4)(ii).fi 

* * * * * 

Subpart E—Special Rules for Certain 

Home Mortgage Transactions 

* * * * * 

Section 226.32—Requirements for 

Certain Closed-End Home Mortgages 

32(a) Coverage. 

* * * * * 

Paragraph 32(a)(1)(ii). 

1. Total loan amount. For purposes of 

the ‘‘points and fees’’ test, the total loan 

amount is calculated by taking the 

amount financed, as determined 

according to § 226.18(b), and deducting 

any cost listed in § 226.32(b)(1)(iii)fl,fi 

[and 226.32] (b)(1)(iv)fland (b)(1)(vi)fi 

that is both included as points and fees 

under § 226.32(b)(1) and financed by the 

creditor. Some examples follow, each 

using a $10,000 amount borrowed, a 

$300 appraisal fee, and $400 in points. 

A $500 flsinglefi premium for 

optional credit flunemploymentfi 

ølife¿ insurance is used in one example. 

i. If the consumer finances a $300 fee 

for a creditor-conducted appraisal and 

pays $400 in points at closing, the 

amount financed under § 226.18(b) is 

$9,900 ($10,000 plus the $300 appraisal 

fee that is paid to and financed by the 

creditor, less $400 in prepaid finance 

charges). The $300 appraisal fee paid to 

the creditor is added to other points and 

fees under § 226.32(b)(1)(iii). It is 

deducted from the amount financed 

($9,900) to derive a total loan amount of 

$9,600. 

ii. If the consumer pays the $300 fee 

for the creditor-conducted appraisal in 

cash at closing, the $300 is included in 

the points and fees calculation because 

it is paid to the creditor. However, 

because the $300 is not financed by the 

creditor, the fee is not part of the 

amount financed under § 226.18(b). In 

this case, the amount financed is the 

same as the total loan amount: $9,600 

($10,000, less $400 in prepaid finance 

charges). 

iii. If the consumer finances a $300 

fee for an appraisal conducted by 

someone other than the creditor or an 

affiliate, the $300 fee is not included 

with other points and fees under 

§ 226.32(b)(1)(iii). flIn this case, the 

amount financed is the same as the total 

loan amount:fi $9,900 ($10,000 plus 

the $300 fee for an independently 

conducted appraisal that is financed by 

the creditor, less the $400 paid in cash 

and deducted as prepaid finance 

charges). 

iv. If the consumer finances a $300 fee 

for a creditor-conducted appraisal and a 

$500 single premium for optional credit 

flunemploymentfi ølife¿ insurance, 

and pays $400 in points at closing, the 

amount financed under § 226.18(b) is 

$10,400 ($10,000, plus the $300 

appraisal fee that is paid to and 

financed by the creditor, plus the $500 

insurance premium that is financed by 

the creditor, less $400 in prepaid 

finance charges). The $300 appraisal fee 

paid to the creditor is added to other 

points and fees under § 226.32(b)(1)(iii), 

and the $500 insurance premium is 

added under section 226.32(b)(1)(iv). 

The $300 and $500 costs are deducted 

from the amount financed ($10,400) to 

derive a total loan amount of $9,600. 

* * * * * 

32(b) Definitions. 

Paragraph 32(b)(1)(i) 

1. General. Section 226.32(b)(1)(i) 

includes in the total ‘‘points and fees’’ 

items defined as finance charges under 

§ 226.4(a) and 226.4(b). Items excluded 

from the finance charge under other 

provisions of § 226.4 are not excluded in 

the total ‘‘points and fees’’ under 

§ 226.32(b)(1)(i), but may be included in 

‘‘points and fees’’ under § 226.32(b)(1)(ii) 

flthrough § 226.32(b)(1)(vi).fiøand 

§ 226.32(b)(1)(iv)¿. Interest, including 

per diem interest, is excluded from 

‘‘points and fees under § 226.32(b)(1). 

flTo illustrate: A fee imposed by the 

creditor for an appraisal performed by 

an employee of the creditor meets the 

definition of ‘‘finance charge’’ under 

§ 226.4(a) as ‘‘any charge payable 

directly or indirectly by the consumer 

and imposed directly or indirectly by 

the creditor as an incident to or a 

condition of the extension of credit.’’ 

However, § 226.4(c)(7) expressly 

provides that appraisal fees are not 

finance charges. Therefore, under the 

general rule regarding the finance 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27488 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

charges that must be counted as points 

and fees, a fee imposed by the creditor 

for an appraisal performed by an 

employee of the creditor would not be 

counted in points and fees. Section 

226.32(b)(1)(iii), however, expressly reincludes in points and fees items listed 

in § 226.4(c)(7) (including appraisal 

fees) if the creditor receives 

compensation in connection with the 

charge. A creditor would receive 

compensation for an appraisal 

performed by its own employee. Thus, 

the appraisal fee in this example must 

be included in the calculation of points 

and fees. 

2. Upfront Federal and state mortgage 

insurance premiums and guaranty fees. 

Under § 226.32(b)(1)(i)(B)(1) and (3), 

upfront mortgage insurance premiums 

or guaranty fees in connection with a 

Federal or state agency program are not 

‘‘points and fees,’’ even though they are 

finance charges under § 226.4(a) and (b). 

For example, if a consumer is required 

to pay a $2,000 mortgage insurance 

premium before or at closing for a loan 

insured by the U.S. Federal Housing 

Administration, the $2,000 must be 

treated as a finance charge but need not 

be counted in ‘‘points and fees.’’ 

3. Upfront private mortgage insurance 

premiums. i. Under 

§ 226.32(b)(1)(i)(B)(2) and (3), upfront 

private mortgage insurance premiums 

are not ‘‘points and fees,’’ even though 

they are finance charges under 

§ 226.4(a) and (b)—but only to the 

extent that the premium amount does 

not exceed the amount payable under 

policies in effect at the time of 

origination under section 203(c)(2)(A) of 

the National Housing Act (12 U.S.C. 

1709(c)(2)(A)). 

ii. In addition, to qualify for the 

exclusion from points and fees, upfront 

private mortgage insurance premiums 

must be required to be refunded on a 

pro rata basis and the refund must be 

automatically issued upon notification 

of the satisfaction of the underlying 

mortgage loan. 

iii. To illustrate: Assume that a $3,000 

upfront private mortgage insurance 

premium charged on a covered 

transaction is required to be refunded 

on a pro rata basis and automatically 

issued upon notification of the 

satisfaction of the underlying mortgage 

loan. Assume also that the maximum 

upfront premium allowable under the 

National Housing Act is $2,000. In this 

case, the creditor could exclude $2,000 

from ‘‘points and fees’’ but would have 

to include the $1,000 that exceeds the 

allowable premium under the National 

Housing Act. However, if the $3,000 

upfront private mortgage insurance 

premium were not required to be 

refunded on a pro rata basis and 

automatically issued upon notification 

of the satisfaction of the underlying 

mortgage loan, the entire $3,000 

premium must be included in ‘‘points 

and fees.’’ 

4. Method of paying private mortgage 

insurance premiums. Upfront private 

mortgage insurance premiums that do 

not qualify for an exclusion from ‘‘points 

and fees’’ under § 226.32(b)(1)(i)(B)(2) 

must be included in ‘‘points and fees’’ 

for purposes of this section whether 

paid before or at closing, in cash or 

financed, and whether the insurance is 

optional or required. Such charges are 

also included whether the amount 

represents the entire premium or an 

initial payment.fi 

Paragraph 32(b)(1)(ii). 

1. [Mortgage broker fees]flLoan 

originator compensation—generalfi. In 

determining ‘‘points and fees’’ for 

purposes of this section, compensation 

paid by a consumer flor creditorfi to 

a flloan originatorfi [mortgage broker 

(directly or through the creditor for 

delivery to the broker)] is included in 

the calculation whether or not the 

amount is disclosed as a finance charge. 

[Mortgage broker fees that are not paid 

by the consumer are not included.] 

flLoan originatorfi[Mortgage broker] 

fees already included in flpoints and 

feesfi calculation as finance charges 

under § 226.32(b)(1)(i) need not be 

counted again under § 226.32(b)(1)(ii). 

fl2. Loan originator compensation— 

examples. i. In determining ‘‘points and 

fees’’ under this section, loan originator 

compensation includes the dollar value 

of compensation paid to a loan 

originator for a covered transaction, 

such as a bonus, commission, yield 

spread premium, award of merchandise, 

services, trips, or similar prizes, or 

hourly pay for the actual number of 

hours worked on a particular 

transaction. Compensation paid to a 

loan originator for a covered transaction 

must be included in the ‘‘points and 

fees’’ calculation for that loan whenever 

paid, whether before, at, or after closing, 

as long as that compensation amount 

can be determined at the time of closing. 

Thus, loan originator compensation for 

a covered transaction includes 

compensation that will be paid as part 

of a periodic bonus, commission, or gift 

if a portion of the dollar value of the 

bonus, commission, or gift can be 

attributed to that loan. The following 

examples illustrate the rule: 

A. Assume that, according to a 

creditor’s compensation policies, the 

creditor awards its loan officers a bonus 

every year based on the number of loan 

applications taken by the loan officer 

that result in consummated transactions 

during that year, and that each 

consummated transaction increases the 

bonus by $100. In this case, the $100 

bonus must be counted in the amount 

of loan originator compensation that the 

creditor includes in ‘‘points and fees.’’ 

B. Assume that, according to a 

creditor’s compensation policies, the 

creditor awards its loan officers a yearend bonus equal to a flat dollar amount 

for each of the consummated 

transactions originated by the loan 

officer during that year. Assume also 

that the per-transaction dollar amount is 

determined at the end of the year, based 

on the total dollar value of 

consummated transactions originated by 

the loan officer. If at the time a mortgage 

transaction is consummated the loan 

officer has originated total volume that 

qualifies the loan officer to receive a 

$300 bonus per transaction, the $300 

bonus is loan originator compensation 

that must be included in ‘‘points and 

fees’’ for the transaction. 

C. Assume that, according to a 

creditor’s compensation policies, the 

creditor awards its loan officers a bonus 

every year based on the number of 

consummated transactions originated by 

the loan officer during that year. 

Assume also that for the first 10 

transactions originated by the loan 

officer in a given year, no bonus is 

awarded; for the next 10 transactions 

originated by the loan officer up to 20, 

a bonus of $100 per transaction is 

awarded; and for each transaction 

originated after the first 20, a bonus of 

$200 per transaction is awarded. In this 

case, for the first 10 transactions 

originated by a loan officer during a 

given year, no amount of loan originator 

compensation need be included in 

‘‘points and fees.’’ For any mortgage 

transaction made after the first 10, up to 

the 20th transaction, $100 must be 

included in ‘‘points and fees.’’ For any 

mortgage transaction made after the first 

20, $200 must be included in ‘‘points 

and fees.’’ 

ii. In determining ‘‘points and fees’’ 

under this section, loan originator 

compensation excludes compensation 

that cannot be attributed to a particular 

transaction at the time or origination, 

including, for example: 

A. Compensation based on the longterm performance of the loan 

originator’s loans. 

B. Compensation based on the overall 

quality of a loan originator’s loan files. 

C. The base salary of a loan originator 

who is also the employee of the creditor, 

not accounting for any bonuses, 

commissions, pay raises, or other 

financial awards based solely on a 

particular transaction or the number or 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27489 

amount of covered transactions 

originated by the loan originator. 

3. Name of fee. Loan originator 

compensation includes amounts the 

loan originator retains and is not 

dependent on the label or name of any 

fee imposed in connection with the 

transaction. For example, if a loan 

originator imposes a ‘‘processing fee’’ 

and retains the fee, the fee is loan 

originator compensation under 

§ 226.32(b)(1)(ii) whether the originator 

expends the fee to process the 

consumer’s application or uses it for 

other expenses, such as overhead. 

Paragraph 32(b)(1)(iii). 

1. Other charges.fi[2. Example.] 

Section 32(b)(1)(iii) defines ‘‘points and 

fees’’ to include all items listed in 

§ 226.4(c)(7), other than amounts held 

for the future payment of taxes. An item 

listed in § 226.4(c)(7) may be excluded 

from the ‘‘points and fees’’ calculation, 

however, if the charge is reasonablefl; 

fi[,] the creditor receives no direct or 

indirect compensation from the 

chargefl;fi[,] and the charge is not paid 

to an affiliate of the creditor. For 

example, a reasonable fee paid by the 

consumer to an independent, thirdparty appraiser may be excluded from 

the ‘‘points and fees’’ calculation 

(assuming no compensation is paid to 

the creditorfl or its affiliatefi). flBy 

contrast, afi[A] fee paid by the 

consumer for an appraisal performed by 

the creditor must be included in the 

calculation, even though the fee may be 

excluded from the finance charge if it is 

bona fide and reasonable in amount. 

Paragraph 32(b)(1)(iv). 

1. flCredit insurance and debt 

cancellation or suspension coverage 

fi[Premium amount]. In determining 

‘‘points and fees’’ for purposes of this 

section, premiums paid at or before 

closing for credit insurance or flany 

debt cancellation or suspension 

agreement or contractfi are included 

flin ‘‘points and fees’’ if they are paid 

at or before closing,fi whether they are 

paid in cash or financed, fland whether 

the insurance or coverage is optional or 

required. Such charges are also 

includedfi[and] whether the amount 

represents the entire premium or 

payment for the coverage or an initial 

payment. 

fl2. Credit property insurance. Credit 

property insurance includes insurance 

against loss of or damage to personal 

property, such as a houseboat or 

manufactured home. Credit property 

insurance covers the creditor’s security 

interest in the property. Credit property 

insurance does not include homeowners 

insurance, which, unlike credit property 

insurance, typically covers not only the 

dwelling but its contents, and 

designates the consumer, not the 

creditor, as the beneficiary.fi 

* * * * * 

Section 226.34—Prohibited Acts or 

Practices in Connection with Credit 

Subject to § 226.32 

34(a) Prohibited acts or practices for 

loans subject to § 226.32. 

* * * * * 

34(a)(4) Repayment ability. 

fløReserved.¿fi 

* * * * * 

Section 226.35 fløReserved.¿fi 

* * * * * 

flSection 226.43—Minimum Standards 

for Transactions Secured by a Dwelling 

1. Record retention. See § 226.25(a) 

and comments 25(a)–6 and –7 for 

guidance on the required retention of 

records as evidence of compliance with 

§ 226.43. 

43(a) Scope. 

1. Consumer credit. In general, 

§ 226.43 applies to consumer credit 

transactions secured by a dwelling, but 

certain dwelling-secured consumer 

credit transactions are exempt from 

coverage under § 226.43(a)(1)–(3). (See 

§ 226.2(a)(12) for the definition of 

‘‘consumer credit.’’) Section 226.43 does 

not apply to an extension of credit 

primarily for a business, commercial, or 

agricultural purpose, even if it is 

secured by a dwelling. See § 226.3 and 

associated commentary for guidance in 

determining the primary purpose of an 

extension of credit. 

2. Real property. ‘‘Dwelling’’ means a 

residential structure that contains one to 

four units, whether or not the structure 

is attached to real property. See 

§ 226.2(a)(19). For purposes of § 226.43, 

the term ‘‘dwelling’’ includes any real 

property to which the residential 

structure is attached that also secures 

the covered transaction. For example, 

for purposes of § 226.43(c)(2)(i), the 

value of the dwelling that secures the 

covered transaction includes the value 

of any real property to which the 

residential structure is attached that also 

secures the covered transaction. 

3. Renewable temporary or ‘‘bridge’’ 

loan. Under § 226.43(a)(3)(ii), a 

temporary or ‘‘bridge’’ loan with a term 

of 12 months or less is excluded from 

coverage by § 226.43(c) through (f). 

Examples of such a loan are a loan to 

finance the purchase of a new dwelling 

where the consumer plans to sell a 

current dwelling within 12 months and 

a loan to finance the initial construction 

of a dwelling. Where a temporary or 

‘‘bridge loan’’ is renewable, the loan 

term does not include any additional 

period of time that could result from a 

renewal provision. For example, if a 

construction loan has an initial loan 

term of 12 months but is renewable for 

another 12-month loan term, the loan is 

excluded from coverage by § 226.43(c) 

through (f), because the initial loan term 

is 12 months. 

43(b) Definitions. 

43(b)(3) Fully indexed rate. 

1. Discounted and premium 

adjustable-rate transactions. In some 

adjustable-rate transactions, creditors 

may set an initial interest rate that is not 

determined by the index or formula 

used to make later interest rate 

adjustments. Typically, this initial rate 

charged to consumers is lower than the 

rate would be if it were calculated using 

the index or formula at consummation 

(i.e., a ‘‘discounted rate’’). In some cases, 

this initial rate may be higher (i.e., a 

‘‘premium rate’’). For purposes of 

determining the fully indexed rate 

where the initial interest rate is not 

determined using the index or formula 

for subsequent interest rate adjustments, 

the creditor must use the interest rate 

that would have applied had the 

creditor used such index or formula 

plus margin at the time of 

consummation. That is, in determining 

the fully indexed rate, the creditor must 

not take into account any discounted or 

premium rate. To illustrate, assume an 

adjustable-rate transaction where the 

initial interest rate is not based on an 

index or formula, and is set at 5% for 

the first five years. The loan agreement 

provides that future interest rate 

adjustments will be calculated based on 

the London Interbank Offered Rate 

(LIBOR) plus a 3% margin. If the value 

of the LIBOR at consummation is 5%, 

the interest rate that would have been 

applied at consummation had the 

creditor based the initial rate on this 

index is 8% (5% plus 3% margin). For 

purposes of this section, the fully 

indexed rate is 8%. For discussion of 

payment calculations based on the 

greater of the fully indexed rate or 

‘‘premium rate’’ for purposes of the 

repayment ability determination under 

§ 226.43(c), see § 226.43(c)(5)(i) and 

comment 43(c)(5)(i)–2. 

2. Index or formula at consummation. 

The value of the index or formula in 

effect at consummation need not be 

used if the contract provides for a delay 

in the implementation of changes in an 

index value or formula. For example, if 

the contract specifies that rate changes 

are based on the index value in effect 45 

days before the change date, the creditor 

may use any index value in effect 

during the 45 days before 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27490 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

consummation in calculating the fully 

indexed rate. 

3. Interest rate adjustment caps. If the 

terms of the legal obligation contain a 

periodic interest rate adjustment cap 

that would prevent the initial rate, at the 

time of the first adjustment, from 

changing to the rate determined using 

the index or formula at consummation 

(i.e., the fully indexed rate), the creditor 

must not give any effect to that rate cap 

when determining the fully indexed 

rate. That is, a creditor must determine 

the fully indexed rate without taking 

into account any periodic interest rate 

adjustment cap that may limit how 

quickly the fully indexed rate may be 

reached at any time during the loan 

term under the terms of the legal 

obligation. To illustrate, assume an 

adjustable-rate mortgage has an initial 

fixed rate of 5% for the first three years 

of the loan, after which the rate will 

adjust annually to a specified index plus 

a margin of 3%. The loan agreement 

provides for a 2% annual interest rate 

adjustment cap, and a lifetime 

maximum interest rate of 10%. The 

index value in effect at consummation 

is 4.5%; the fully indexed rate is 7.5% 

(4.5% plus 3%), regardless of the 2% 

annual interest rate adjustment cap that 

would limit when the fully indexed rate 

would take effect under the terms of the 

legal obligation. 

4. Lifetime maximum interest rate. A 

creditor may choose, in its sole 

discretion, to take into account the 

lifetime maximum interest rate provided 

under the terms of the legal obligation 

when determining the fully indexed 

rate. If the creditor chooses to use the 

lifetime maximum interest rate and the 

loan agreement provides a range for the 

maximum interest rate, then the creditor 

must use the highest rate in that range 

as the maximum interest rate for 

purposes of this section. To illustrate, 

assume an adjustable-rate mortgage has 

an initial fixed rate of 5% for the first 

three years of the loan, after which the 

rate will adjust annually to a specified 

index plus a margin of 3%. The loan 

agreement provides for a 2% annual 

interest rate adjustment cap, and a 

lifetime maximum interest rate of 7%. 

The index value in effect at 

consummation is 4.5%; the fully 

indexed rate is 7.5% (4.5% plus 3%). 

For purposes of this section, the creditor 

can choose to use the lifetime maximum 

interest rate of 7%, instead of the fully 

indexed rate of 7.5%, for purposes of 

this section. 

5. Step-rate and fixed-rate mortgages. 

Where the interest rate offered under the 

terms of the legal obligation is not based 

on, and does not vary with, an index or 

formula (i.e., there is no fully indexed 

rate), the creditor must use the 

maximum interest rate that may apply at 

any time during the loan term. To 

illustrate: 

i. Assume a step-rate mortgage with 

an interest rate fixed at 6.5% for the first 

two years of the loan, 7% for the next 

three years, and 7.5% thereafter for the 

remainder of loan term. For purposes of 

this section, the creditor must use 7.5%, 

which is the maximum rate that may 

apply during the loan term. ‘‘Step-rate 

mortgage’’ is defined in § 226.18(s)(7)(ii). 

ii. Assume a fixed-rate mortgage with 

an interest rate at consummation of 7% 

that is fixed for the 30-year loan term. 

For purposes of this section, the 

maximum interest rate that may apply 

during the loan term is 7%, which is the 

interest rate that is fixed at 

consummation. ‘‘Fixed-rate mortgage’’ is 

defined in § 226.18(s)(7)(iii). 

43(b)(4) Higher-priced covered 

transaction. 

1. Average prime offer rate. The 

average prime offer rate generally has 

the same meaning as in 

§ 226.45(a)(2)(ii). For further 

explanation of the meaning of ‘‘average 

prime offer rate,’’ and additional 

guidance on determining the average 

prime offer rate, see comments 

45(a)(2)(ii)–1 and –5. For further 

explanation of the Board table, see 

comment 45(a)(2)(ii)–4. 

2. Comparable transaction. A higherpriced covered transaction is a 

consumer credit transaction that is 

secured by the consumer’s dwelling 

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 the specified 

amount. The table of average prime offer 

rates published by the Board indicates 

how to identify a comparable 

transaction. See comment 45(a)(2)(ii)–2. 

3. Rate set. A transaction’s annual 

percentage rate is compared to the 

average prime offer rate as of the date 

the transaction’s interest rate is set (or 

‘‘locked’’) before consummation. 

Sometimes a creditor sets the interest 

rate initially and then re-sets it at a 

different level before consummation. 

The creditor should use the last date the 

interest rate is set before consummation. 

43(b)(5) Loan amount. 

1. Disbursement of the loan amount. 

The definition of ‘‘loan amount’’ requires 

the creditor to use the entire loan 

amount as reflected in the loan contract 

or promissory note, even though the 

loan amount may not be fully disbursed 

at consummation. For example, assume 

the consumer enters into a loan 

agreement where the consumer is 

obligated to repay the creditor $200,000 

over 15 years, but only $100,000 is 

disbursed at consummation and the 

remaining $100,000 will be disbursed 

during the year following 

consummation in a series of advances 

($25,000 each quarter). For purposes of 

this section, the creditor must use the 

loan amount of $200,000, even though 

the loan agreement provides that only 

$100,000 will be disbursed to the 

consumer at consummation. Generally, 

creditors should rely on § 226.17(c)(6) 

and associated commentary regarding 

treatment of multiple-advance and 

construction-to-permanent loans as 

single or multiple transactions. 

43(b)(6) Loan term. 

1. General. The loan term is the 

period of time it takes to repay the loan 

amount in full. For example, a loan with 

an initial discounted rate that is fixed 

for the first two years, and that adjusts 

periodically for the next 28 years has a 

loan term of 30 years, which is the 

amortization period on which the 

periodic amortizing payments are based. 

43(b)(7) Maximum loan amount. 

1. Calculation of maximum loan 

amount. For purposes of 

§ 226.43(c)(2)(iii) and (c)(5)(ii)(C), a 

creditor must determine the maximum 

loan amount for a negative amortization 

loan by using the loan amount plus any 

increase in principal balance that will 

result from negative amortization based 

on the terms of the legal obligation. In 

determining the maximum loan amount, 

a creditor must assume that the 

consumer makes the minimum periodic 

payment permitted under the loan 

agreement for as long as possible, until 

the consumer must begin making fully 

amortizing payments; and that the 

interest rate rises as quickly as possible 

after consummation under the terms of 

the legal obligation. Thus, creditors 

must assume that the consumer makes 

the minimum periodic payment until 

any negative amortization cap is 

reached or until the period permitting 

minimum periodic payments expires, 

whichever occurs first. ‘‘Loan amount’’ 

is defined in § 226.43(b)(5); ‘‘negative 

amortization loan’’ is defined in 

§ 226.18(s)(7)(v). 

2. Assumed interest rate. In 

calculating the maximum loan amount 

for an adjustable-rate mortgage that is a 

negative amortization loan, the creditor 

must assume that the interest rate will 

increase as rapidly as possible after 

consummation, taking into account any 

periodic interest rate adjustment caps 

provided in the loan agreement. For an 

adjustable-rate mortgage with a lifetime 

maximum interest rate but no periodic 

interest rate adjustment cap, the creditor 

must assume that the interest rate 

increases to the maximum lifetime 

interest rate at the first adjustment. 


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3. Examples. The following are 

examples of how to determine the 

maximum loan amount for a negative 

amortization loan (all amounts are 

rounded): 

i. Adjustable-rate mortgage with 

negative amortization. A. Assume an 

adjustable-rate mortgage in the amount 

of $200,000 with a 30-year loan term. 

The loan agreement provides that the 

consumer can make minimum monthly 

payments that cover only part of the 

interest accrued each month until the 

principal balance reaches 115% of its 

original balance (i.e., a negative 

amortization cap of 115%) or for the 

first five years of the loan (60 monthly 

payments), whichever occurs first. The 

introductory interest rate at 

consummation is 1.5%. One month after 

consummation, the interest rate adjusts 

and will adjust monthly thereafter based 

on the specified index plus a margin of 

3.5%. The maximum lifetime interest 

rate is 10.5%; there are no other 

periodic interest rate adjustment caps 

that limit how quickly the maximum 

lifetime rate may be reached. The 

minimum monthly payment for the first 

year is based on the initial interest rate 

of 1.5%. After that, the minimum 

monthly payment adjusts annually, but 

may increase by no more than 7.5% 

over the previous year’s payment. The 

minimum monthly payment is $690 in 

the first year, $742 in the second year, 

and $798 in the first part of the third 

year. 

B. To determine the maximum loan 

amount, assume that the initial interest 

rate increases to the maximum lifetime 

interest rate of 10.5% at the first 

adjustment (i.e., the second month) and 

accrues at that rate until the loan is 

recast. Assume the consumer makes the 

minimum monthly payments as 

scheduled, which are capped at 7.5% 

from year-to-year. As a result, the 

consumer’s minimum monthly 

payments are less than the interest 

accrued each month, resulting in 

negative amortization (i.e., the accrued 

but unpaid interest is added to the 

principal balance). Thus, assuming that 

the consumer makes the minimum 

monthly payments for as long as 

possible and that the maximum interest 

rate of 10.5% is reached at the first rate 

adjustment (i.e., the second month), the 

negative amortization cap of 115% is 

reached on the due date of the 27th 

monthly payment and the loan is recast. 

The maximum loan amount as of the 

due date of the 27th monthly payment 

is $229,243. 

ii. Fixed-rate, graduated payment 

mortgage with negative amortization. A 

loan in the amount of $200,000 has a 30- 

year loan term. The loan agreement 

provides for a fixed interest rate of 

7.5%, and requires the consumer to 

make minimum monthly payments 

during the first year, with payments 

increasing 12.5% every year for four 

years. The payment schedule provides 

for payments of $943 in the first year, 

$1,061 in the second year, $1,194 in the 

third year, $1,343 in the fourth year, and 

$1,511 for the remaining term of the 

loan. During the first three years of the 

loan, the payments are less than the 

interest accrued each month, resulting 

in negative amortization. Assuming that 

the consumer makes the minimum 

periodic payments for as long as 

possible, the maximum loan amount is 

$207,659, which is reached at the end 

of the third year of the loan (on the due 

date of the 36th monthly payment). See 

comment 43(c)(5)(ii)(C)–3 providing 

examples of how to determine the 

consumer’s repayment ability for a 

negative amortization loan. 

43(b)(8) Mortgage-related obligations. 

1. General. Mortgage-related 

obligations include expected property 

taxes and premiums for mortgagerelated insurance required by the 

creditor as set forth in § 226.45(b)(1), 

such as insurance against loss of or 

damage to property or against liability 

arising out of the ownership or use of 

the property, and insurance protecting 

the creditor against the consumer’s 

default or other credit loss. A creditor 

need not include premiums for 

mortgage-related insurance that it does 

not require, such as an earthquake 

insurance or credit insurance, or fees for 

optional debt suspension and debt 

cancellation agreements. Mortgagerelated obligations also include special 

assessments that are imposed on the 

consumer at or before consummation, 

such as a one-time homeowners’ 

association fee that will not be paid by 

the consumer in full at or before 

consummation. See commentary to 

§ 226.43(c)(2)(v), discussing the 

requirement to take into account any 

mortgage-related obligations. 

43(b)(10) Prepayment penalty. 

Paragraph 43(b)(10)(i)(A). 

1. Interest accrual amortization 

method. A prepayment penalty includes 

charges determined by treating the loan 

balance as outstanding for a period after 

prepayment in full and applying the 

interest rate to such balance, even if the 

charge results from the interest accrual 

amortization method used on the 

transaction. ‘‘Interest accrual 

amortization’’ refers to the method by 

which the amount of interest due for 

each period (e.g., month), in a 

transaction’s term is determined. For 

example, ‘‘monthly interest accrual 

amortization’’ treats each payment as 

made on the scheduled, monthly due 

date even if it is actually paid early or 

late (until the expiration of a grace 

period). Thus, under monthly interest 

accrual amortization, if the amount of 

interest due on May 1 for the preceding 

month of April is $3000, the creditor 

will require payment of $3000 in 

interest whether the payment is made 

on April 20, on May 1, or on May 10. 

In this example, if the interest charged 

for the month of April upon prepayment 

in full on April 20 is $3000, the charge 

constitutes a prepayment penalty of 

$1000 because the amount of interest 

actually earned through April 20 is only 

$2000. 

43(b)(11) Recast. 

1. Date of the recast. The term ‘‘recast’’ 

means, for an adjustable-rate mortgage, 

the expiration of the period during 

which payments based on the 

introductory fixed rate are permitted; for 

an interest-only loan, the expiration of 

the period during which the interestonly payments are permitted; and, for a 

negative amortization loan, the 

expiration of the period during which 

negatively amortizing payments are 

permitted. For adjustable-rate 

mortgages, interest-only loans, and 

negative amortization loans, the date on 

which the ‘‘recast’’ is considered to 

occur is the due date of the last monthly 

payment based on the introductory 

fixed rate, the interest-only payment, or 

the negatively amortizing payment, 

respectively. To illustrate: A loan in an 

amount of $200,000 has a 30-year loan 

term. The loan agreement provides for a 

fixed interest rate and permits interestonly payments for the first five years of 

the loan (60 months). The loan is recast 

on the due date of the 60th monthly 

payment. Thus, the term of the loan 

remaining as of the date the loan is 

recast is 25 years (300 months). 

43(b)(12) Simultaneous loan. 

1. General. Section 226.43(b)(12) 

defines a simultaneous loan as another 

covered transaction or home equity line 

of credit subject to § 226.5b (HELOC) 

that will be secured by the same 

dwelling and made to the same 

consumer at or before consummation of 

the covered transaction, whether it is 

made by the same creditor or a thirdparty creditor. For example, assume a 

consumer will enter into a legal 

obligation that is a covered transaction 

with Creditor A. Immediately prior to 

consummation of the covered 

transaction with Creditor A, the 

consumer opens a HELOC that is 

secured by the same dwelling with 

Creditor B. For purposes of this section, 

the loan extended by Creditor B is a 

simultaneous loan. See commentary to 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27492 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

§ 226.43(c)(2)(iv) and (c)(6), discussing 

the requirement to consider the 

consumer’s payment obligation on any 

simultaneous loan for purposes of 

determining the consumer’s ability to 

repay the covered transaction subject to 

this section. 

2. Same consumer. For purposes of 

the definition of ‘‘simultaneous loan,’’ 

the term ‘‘same consumer’’ includes any 

consumer, as that term is defined in 

§ 226.2(a)(11), that enters into a loan 

that is a covered transaction and also 

enters into another loan (e.g., secondlien covered transaction or HELOC) 

secured by the same dwelling. Where 

two or more consumers enter into a 

legal obligation that is a covered 

transaction, but only one of them enters 

into another loan secured by the same 

dwelling, the ‘‘same consumer’’ includes 

the person that has entered into both 

legal obligations. For example, assume 

Consumer A and Consumer B will both 

enter into a legal obligation that is a 

covered transaction with a creditor. 

Immediately prior to consummation of 

the covered transaction, Consumer B 

opens a HELOC that is secured by the 

same dwelling with the same creditor; 

Consumer A is not a signatory to the 

HELOC. For purposes of this definition, 

Consumer B is the same consumer and 

the creditor must include the HELOC as 

a simultaneous loan. 

43(b)(13) Third-party record. 

1. Electronic records. Third-party 

records include records transmitted 

electronically. For example, to verify a 

consumer’s credit history using thirdparty records as required by 

§ 226.43(c)(2)(viii) and 226.43(c)(3), 

creditors may use a credit report 

prepared by a consumer reporting 

agency and transmitted or viewed 

electronically. 

2. Forms. A record prepared by a third 

party includes a form a creditor gives a 

third party for providing information, 

even if the creditor completes parts of 

the form unrelated to the information 

sought. For example, if a creditor gives 

a consumer’s employer a form for 

verifying the consumer’s employment 

status and income, the creditor may fill 

in the creditor’s name and other 

portions of the form unrelated to the 

consumer’s employment status or 

income. 

Paragraph 43(b)(13)(i). 

1. Reviewed record. Under 

§ 226.43(b)(13)(i), a third-party record 

includes a document or other record 

prepared by the consumer, the creditor, 

the mortgage broker, or the creditor’s or 

mortgage broker’s agent, if the record is 

reviewed by a third party. For example, 

a profit-and-loss statement prepared by 

a self-employed consumer and reviewed 

by a third-party accountant is a thirdparty record under § 226.43(b)(13)(i). 

Paragraph 43(b)(13)(iii). 

1. Creditor’s records. Section 

226.43(b)(13)(iii) provides that thirdparty record includes a record the 

creditor maintains for an account of the 

consumer held by the creditor. 

Examples of such accounts include 

checking accounts, savings accounts, 

and retirement accounts. Examples of 

such accounts also include accounts 

related to a consumer’s outstanding 

obligations to a creditor. For example, a 

third-party record includes the 

creditor’s records for a first-lien 

mortgage to a consumer who applies for 

a subordinate-lien home equity loan. 

43(c) Repayment ability. 

1. Widely accepted standards. To 

evaluate a consumer’s repayment ability 

under § 226.43(c), creditors may look to 

widely accepted governmental or nongovernmental underwriting standards, 

such as the Federal Housing 

Administration’s handbook on Mortgage 

Credit Analysis for Mortgage Insurance 

on One- to Four-Unit Mortgage Loans. 

For example, creditors may use such 

standards in determining: 

i. Whether to classify particular 

inflows, obligations, or property as 

‘‘income,’’ ‘‘debt,’’ or ‘‘assets’’; 

ii. Factors to consider in evaluating 

the income of a self-employed or 

seasonally employed consumer; and 

iii. Factors to consider in evaluating 

the credit history of a consumer who 

has obtained few or no extensions of 

traditional ‘‘credit,’’ as defined in 

§ 226.2(a)(14). 

43(c)(1) General requirement. 

1. Repayment ability at 

consummation. Section 226.43(c)(1) 

requires the creditor to determine that a 

consumer will have a reasonable ability 

at the time the loan is consummated to 

repay the loan. A change in the 

consumer’s circumstances after 

consummation (for example, a 

significant reduction in income due to 

a job loss or a significant obligation 

arising from a major medical expense) 

that is not reflected in the consumer’s 

application or the records used to 

determine repayment ability is not 

relevant to determining a creditor’s 

compliance with the rule. However, if 

the application or records state there 

will be a change in a consumer’s 

repayment ability after consummation 

(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), the 

creditor must consider that information. 

2. Interaction with Regulation B. 

Section 226.43(c)(1) does not require or 

permit the creditor to make inquiries or 

verifications that would be prohibited 

by Regulation B, 12 CFR part 202. 

Paragraph 43(c)(2)(i). 

1. Income or assets generally. A 

creditor may base its determination of 

repayment ability on current or 

reasonably expected income from 

employment or other sources, assets 

other than the dwelling that secures the 

covered transaction, or both. The 

creditor may consider any type of 

current or reasonably expected income, 

including, for example, the following: 

Salary; wages; self-employment income; 

military or reserve duty income; bonus 

pay; tips; commissions; interest 

payments; dividends; retirement 

benefits or entitlements; rental income; 

royalty payments; trust income; public 

assistance payments; and alimony, child 

support, and separate maintenance 

payments. The creditor may consider 

any of the consumer’s assets, other than 

the value of the dwelling that secures 

the covered transaction, including, for 

example, the following: funds in a 

savings or checking account, amounts 

vested in a retirement account, stocks, 

bonds, certificates of deposit, and 

amounts available to the consumer from 

a trust fund. (For purposes of 

§ 226.43(c)(2)(i), the value of the 

dwelling includes the value of the real 

property to which the real property is 

attached, if the real property also 

secures the covered transaction. See 

comment 43(a)–2.) 

2. Income or assets relied on. If a 

creditor bases its determination of 

repayment ability entirely or in part on 

a consumer’s income, the creditor need 

consider only the income necessary to 

support a determination that the 

consumer can repay the covered 

transaction. For example, if a 

consumer’s loan application states that 

the consumer earns an annual salary 

from both a full-time job and a part-time 

job and the creditor reasonably 

determines that the consumer’s income 

from the full-time job is sufficient to 

repay the loan, the creditor need not 

consider the consumer’s income from 

the part-time job. Further, a creditor 

need verify only the income (and assets) 

relied on to determine the consumer’s 

repayment ability. See comment 

43(c)(4)–1. 

3. Expected income. If a creditor relies 

on expected income, either in addition 

to or instead of current income, the 

expectation that the income will be 

available for repayment must be 

reasonable and verified with third-party 

records that provide reasonably reliable 

evidence of the consumer’s expected 


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income. For example, if the creditor 

relies on an expectation that a consumer 

will receive an annual bonus, the 

creditor may verify the basis for that 

expectation with records that show the 

consumer’s past annual bonuses, and 

the expected bonus must bear a 

reasonable relationship to the past 

bonuses. Similarly, if the creditor relies 

on a consumer’s expected salary from a 

job the consumer has accepted and will 

begin after receiving an educational 

degree, the creditor may verify that 

expectation with a written statement 

from an employer indicating that the 

consumer will be employed upon 

graduation at a specified salary. 

4. Seasonal or irregular income. A 

creditor reasonably may determine that 

a consumer can make periodic loan 

payments even if the consumer’s 

income, such as self-employment 

income, is seasonal or irregular. For 

example, assume a consumer receives 

income during a few months each year 

from the sale of crops. If the creditor 

determines that the consumer’s annual 

income divided equally across 12 

months is sufficient for the consumer to 

make monthly loan payments, the 

creditor reasonably may determine that 

the consumer can repay the loan, even 

though the consumer may not receive 

income during certain months. 

Paragraph 43(c)(2)(ii). 

1. Employment status and income. 

Employment may be full-time, parttime, seasonal, irregular, military, or 

self-employment. Under 

§ 226.43(c)(2)(ii), a creditor need verify 

a consumer’s current employment status 

only if the creditor relies on the 

consumer’s employment income in 

determining the consumer’s repayment 

ability. For example, if a creditor relies 

wholly on a consumer’s investment 

income to determine repayment ability, 

the creditor need not verify or document 

employment status. See comment 

43(c)(4)–2 for guidance on which 

income to consider where multiple 

consumers apply jointly for a loan. 

2. Military personnel. Creditors may 

verify the employment status of military 

personnel using the electronic database 

maintained by the Department of 

Defense to facilitate identification of 

consumers covered by credit protections 

provided pursuant to 10 U.S.C. 987. 

Paragraph 43(c)(2)(iii). 

1. General. For purposes of the 

repayment ability determination 

required under § 226.43(c)(2), a creditor 

must consider the consumer’s monthly 

payment on a covered transaction that is 

calculated as required under 

§ 226.43(c)(5), taking into account any 

mortgage-related obligations. ‘‘Mortgagerelated obligations’’ is defined in 

§ 226.43(b)(8). 

Paragraph 43(c)(2)(iv). 

1. Home equity lines of credit. For 

purposes of § 226.43(c)(2)(iv), a 

simultaneous loan includes any covered 

transaction or home equity line of credit 

subject to § 226.5b (HELOC) that will be 

made to the same consumer at or before 

consummation of the covered 

transaction and secured by the same 

dwelling that secures the covered 

transaction. A HELOC that is a 

simultaneous loan that the creditor 

knows or has reason to know about 

must be considered as a mortgage 

obligation in determining a consumer’s 

ability to repay the covered transaction 

even though the HELOC is not a covered 

transaction subject to § 226.43. See 

§ 226.43(a) discussing the scope of this 

section. ‘‘Simultaneous loan’’ is defined 

in § 226.43(b)(12). For further 

explanation of ‘‘same consumer,’’ see 

comment 43(b)(12)–2. 

2. Knows or has reason to know. In 

determining a consumer’s repayment 

ability for a covered transaction under 

§ 226.43(c)(2), a creditor must consider 

the consumer’s payment obligation on 

any simultaneous loan that the creditor 

knows or has reason to know will be 

made at or before consummation of the 

covered transaction. For example, where 

a covered transaction is a home 

purchase loan, the creditor must 

consider the consumer’s periodic 

payment obligation for any ‘‘piggyback’’ 

second-lien loan that the creditor knows 

or has reason to know will be used to 

finance part of the consumer’s down 

payment. The creditor complies with 

this requirement where, for example, 

the creditor follows policies and 

procedures that show at or before 

consummation that the same consumer 

has applied for another credit 

transaction secured by the same 

dwelling. To illustrate, assume a 

creditor receives an application for a 

home purchase loan where the 

requested loan amount is less than the 

home purchase price. The creditor’s 

policies and procedures require the 

consumer to state the source of the 

downpayment. If the creditor 

determines the source of the 

downpayment is another extension of 

credit that will be made to the same 

consumer at or before consummation 

and secured by the same dwelling, the 

creditor knows or has reason to know of 

the simultaneous loan and must 

consider the simultaneous loan. 

Alternatively, if the creditor has 

information that suggests the 

downpayment source is the consumer’s 

income or existing assets, the creditor 

would be under no further obligation to 

determine whether a simultaneous loan 

will be extended at or before 

consummation of the covered 

transaction. 

3. Scope of timing. For purposes of 

§ 226.43(c)(2)(iv), a simultaneous loan 

includes a loan that comes into 

existence concurrently with the covered 

transaction subject to § 226.43(c). In all 

cases, a simultaneous loan does not 

include a credit transaction that occurs 

after consummation of the covered 

transaction that is subject to this 

section. 

4. Verification of simultaneous loans. 

Although a credit report may be used to 

verify current obligations, it will not 

reflect a simultaneous loan that has not 

yet been consummated or has just 

recently been consummated. If the 

creditor knows or has reason to know 

that there will be a simultaneous loan 

extended at or before consummation, 

the creditor may verify the simultaneous 

loan by obtaining third-party 

verification from the third-party creditor 

of the simultaneous loan. For example, 

the creditor may obtain a copy of the 

promissory note or other written 

verification from the third-party creditor 

in accordance with widely accepted 

governmental or non-governmental 

standards. For further guidance, see 

comments 43(c)(3)–1 and –2 discussing 

verification using third-party records. 

43(c)(2)(v) Mortgage-related 

obligations. 

1. General. A creditor must include in 

its repayment ability assessment the 

consumer’s mortgage-related 

obligations, such as the expected 

property taxes and premiums for 

mortgage-related insurance required by 

the creditor as set forth in § 226.45(b)(1), 

but need not include mortgage-related 

insurance premiums that the creditor 

does not require, such as credit 

insurance or fees for operational debt 

suspension and debt cancellation 

agreements. Mortgage-related 

obligations must be included in the 

creditor’s determination of repayment 

ability regardless of whether the 

amounts are included in the monthly 

payment or whether there is an escrow 

account established. See § 226.43(b)(8) 

defining the term ‘‘mortgage-related 

obligations.’’ 

2. Pro rata amount. In considering 

mortgage-related obligations that are not 

paid monthly, a creditor may look to 

widely accepted governmental or nongovernmental standards in determining 

the pro rata monthly payment amount. 

3. Estimates. Estimates of mortgagerelated obligations should be based 

upon information that is known to the 

creditor at the time the creditor 

underwrites the mortgage obligation. 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27494 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

Information is known if it is reasonably 

available to the creditor at the time of 

underwriting the loan. See comment 

17(c)(2)(i)–1 discussing the ‘‘reasonably 

available’’ standard. For purposes of this 

section, the creditor need not project 

potential changes, such as by estimating 

possible increases in taxes and 

insurance. 

4. Verification of mortgage-related 

obligations. Creditors must make the 

repayment ability determination 

required under § 226.43(c) based on 

information verified from reasonably 

reliable records. For guidance regarding 

verification of mortgage-related 

obligations see comments 43(c)(3)–1 and 

–2, which discuss verification using 

third-party records. 

Paragraph 43(c)(2)(vi). 

1. Consideration and verification of 

current debt obligations. In determining 

how to define ‘‘current debt obligations’’ 

and how to verify such obligations, 

creditors may look to widely accepted 

governmental and non-governmental 

underwriting standards. For example, a 

creditor must consider student loans, 

automobile loans, revolving debt, 

alimony, child support, and existing 

mortgages. To verify the obligations as 

required by § 226.43(c)(3), a creditor 

may, for instance, look to credit reports, 

student loan statements, automobile 

loan statements, credit card statements, 

alimony or child support court orders, 

and existing mortgage statements. 

2. Discrepancies between a credit 

report and an application. If a credit 

report reflects a current debt obligation 

that a consumer has not listed on the 

application, the creditor must consider 

the obligation. The credit report is 

deemed a reasonably reliable third-party 

record under § 226.43(c)(3). If a credit 

report does not reflect a current debt 

obligation that a consumer has listed on 

the application, the creditor must 

consider the obligation. However, the 

creditor need not verify the existence or 

amount of the obligation through 

another source. If a creditor nevertheless 

verifies an obligation, the creditor must 

consider the obligation based on the 

information from the verified source. 

Paragraph 43(c)(2)(vii). 

1. Monthly debt-to-income ratio and 

residual income. See § 226.43(c)(7) 

regarding the definitions and 

calculations for the monthly debt-toincome ratio and residual income. 

Paragraph 43(c)(2)(viii). 

1. Consideration and verification of 

credit history. In determining how to 

define ‘‘credit history’’ and how to verify 

credit history, creditors may look to 

widely accepted governmental and nongovernmental underwriting standards. 

For example, a creditor may consider 

factors such as the number and age of 

credit lines, payment history, and any 

judgments, collections, or bankruptcies. 

To verify credit history as required by 

§ 226.43(c)(3), a creditor may, for 

instance, look to credit reports from 

credit bureaus, or nontraditional credit 

references contained in third-party 

documents, such as rental payment 

history or public utility payments. 

43(c)(3) Verification using third-party 

records. 

1. Records specific to the individual 

consumer. Records used to verify a 

consumer’s repayment ability must be 

specific to the individual consumer. 

Records regarding average incomes in 

the consumer’s geographic location or 

average incomes paid by the consumer’s 

employer, for example, would not be 

specific to the individual consumer and 

are not sufficient. 

2. Obtaining records. To determine 

repayment ability, creditors may obtain 

records from a third-party service 

provider, such as a party the consumer’s 

employer uses to respond to income 

verification requests, as long as the 

records are reasonably reliable and 

specific to the individual consumer. 

Creditors also may obtain third-party 

records directly from the consumer. For 

example, creditors using payroll 

statements to verify the consumer’s 

income (as allowed under 

§ 226.43(c)(4)(iii) may obtain the payroll 

statements from the consumer. 

43(c)(4) Verification of income or 

assets. 

1. Income or assets relied on. A 

creditor need consider, and therefore 

need verify, only the income or assets 

the creditor relies on to evaluate the 

consumer’s repayment ability. See 

comment 43(c)(2)(i)–2. For example, if a 

consumer’s application states that the 

consumer earns a salary and is paid an 

annual bonus and the creditor relies on 

only the consumer’s salary to evaluate 

the consumer’s repayment ability, the 

creditor need verify only the salary. 

2. Multiple applicants. If multiple 

consumers jointly apply for a loan and 

each lists income or assets on the 

application, the creditor need verify 

only the income or assets the creditor 

relies on in determining repayment 

ability. 

3. Tax-return transcript. Under 

§ 226.43(c)(4), creditors may verify a 

consumer’s income using an Internal 

Revenue Service (IRS) tax-return 

transcript, which summarizes the 

information in a consumer’s filed tax 

return, another record that provides 

reasonably reliable evidence of the 

consumer’s income, or both. Creditors 

may obtain a copy of a tax-return 

transcript or a filed tax return directly 

from the consumer or from a service 

provider and need not obtain the copy 

directly from the IRS or other taxing 

authority. See comment 43(c)(3)–2. 

Paragraph 43(c)(4)(vi). 

1. Government benefits. In verifying a 

consumer’s income, creditors may use a 

written or electronic record from a 

government agency of the amount of any 

benefit payments or awards, such as a 

‘‘proof of income letter’’ issued by the 

Social Security Administration (also 

known as a ‘‘budget letter,’’ ‘‘benefits 

letter,’’ or ‘‘proof of award letter’’). 

43(c)(5) Payment calculation. 

43(c)(5)(i) General rule. 

1. General. For purposes of 

§ 226.43(c)(2)(iii), a creditor must 

determine the consumer’s ability to 

repay the covered transaction using the 

payment calculation methods set forth 

in § 226.43(c)(5). The payment 

calculation methods differ depending 

on whether the covered transaction has 

a balloon payment, or is an interest-only 

or negative amortization loan. The 

payment calculation method set forth in 

§ 226.43(c)(5)(i) applies to any covered 

transaction that does not have a balloon 

payment, or that is not an interest-only 

or negative amortization loan, whether 

it is a fixed-rate, adjustable-rate or steprate mortgage. The terms ‘‘fixed-rate 

mortgage,’’ ‘‘adjustable-rate mortgage,’’ 

‘‘step-rate mortgage,’’ ‘‘interest-only loan’’ 

and ‘‘negative amortization loan,’’ are 

defined in § 226.18(s)(7)(i), (ii), (iii), (iv) 

and (v), respectively. For the meaning of 

the term ‘‘balloon payment,’’ see 

§ 226.18(s)(5)(i). The payment 

calculation method set forth in 

§ 226.43(c)(5)(ii) applies to any covered 

transaction that is a loan with a balloon 

payment, interest-only loan, or negative 

amortization loan. See commentary to 

§ 226.43(c)(5)(i) and (ii), which provides 

examples for calculating the monthly 

payment for purposes of the repayment 

ability determination required under 

§ 226.43(c)(2)(iii). 

2. Greater of the fully indexed rate or 

introductory rate; premium adjustablerate transactions. A creditor must 

determine a consumer’s repayment 

ability for the covered transaction using 

substantially equal, monthly, fully 

amortizing payments that are based on 

the greater of the fully indexed rate or 

any introductory interest rate. In some 

adjustable-rate transactions, creditors 

may set an initial interest rate that is not 

determined by the index or formula 

used to make later interest rate 

adjustments. Typically, this initial rate 

charged to consumers is lower than the 

rate would be if it were determined by 

using the the index plus margin, or 

formula (i.e., fully indexed rate). 

However, an initial rate that is a 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27495 

premium rate is higher than the rate 

based on the index or formula. In such 

cases, creditors must calculate the fully 

amortizing payment based on the initial 

‘‘premium’’ rate. ‘‘Fully indexed rate’’ is 

defined in § 226.43(b)(3). 

3. Monthly, fully amortizing 

payments. Section 226.43(c)(5)(i) does 

not prescribe the terms or loan features 

that a creditor may choose to offer or 

extend to a consumer, but establishes 

the calculation method a creditor must 

use to determine the consumer’s 

repayment ability for a covered 

transaction. For example, the terms of 

the loan agreement may require that the 

consumer repay the loan in quarterly or 

bi-weekly scheduled payments, but for 

purposes of the repayment ability 

determination, the creditor must convert 

these scheduled payments to monthly 

payments in accordance with 

§ 226.43(c)(5)(i)(B). Similarly, the loan 

agreement may not require the 

consumer to make fully amortizing 

payments, but for purposes of the 

repayment ability determination the 

creditor must convert any nonamortizing payments to fully amortizing 

payments. 

4. Substantially equal. In determining 

whether monthly, fully amortizing 

payments are substantially equal, 

creditors should disregard minor 

variations due to payment-schedule 

irregularities and odd periods, such as 

a long or short first or last payment 

period. That is, monthly payments of 

principal and interest that repay the 

loan amount over the loan term need 

not be equal, but the monthly payments 

should be substantially the same 

without significant variation in the 

monthly combined payments of both 

principal and interest. For example, 

where no two monthly payments vary 

from each other by more than 1% 

(excluding odd periods, such as a long 

or short first or last payment period), 

such monthly payments would be 

considered substantially equal for 

purposes of this section. In general, 

creditors should determine whether the 

monthly, fully amortizing payments are 

substantially equal based on guidance 

provided in § 226.17(c)(3) (discussing 

minor variations), and § 226.17(c)(4)(i)– 

(iii) (discussing payment-schedule 

irregularities and measuring odd 

periods due to a long or short first 

period) and associated commentary. 

5. Examples. The following are 

examples of how to determine the 

consumer’s repayment ability based on 

substantially equal, monthly, fully 

amortizing payments as required under 

§ 226.43(c)(5)(i) (all amounts are 

rounded): 

i. Fixed-rate mortgage. A loan in an 

amount of $200,000 has a 30-year loan 

term and a fixed interest rate of 7%. For 

purposes of § 226.43(c)(2)(iii), the 

creditor must determine the consumer’s 

ability to repay the loan based on a 

payment of $1,331, which is the 

substantially equal, monthly, fully 

amortizing payment that will repay 

$200,000 over 30 years using the fixed 

interest rate of 7%. 

ii. Adjustable-rate mortgage with 

discount for five years. A loan in an 

amount of $200,000 has a 30-year loan 

term. The loan agreement provides for a 

discounted interest rate of 6% that is 

fixed for an initial period of five years, 

after which the interest rate will adjust 

annually based on a specified index 

plus a margin of 3%, subject to a 2% 

annual periodic interest rate adjustment 

cap. The index value in effect at 

consummation is 4.5%; the fully 

indexed rate is 7.5% (4.5% plus 3%). 

Even though the scheduled monthly 

payment required for the first five years 

is $1,199, for purposes of 

§ 226.43(c)(2)(iii) the creditor must 

determine the consumer’s ability to 

repay the loan based on a payment of 

$1,398, which is the substantially equal, 

monthly, fully amortizing payment that 

will repay $200,000 over 30 years using 

the fully indexed rate of 7.5%. 

iii. Step-rate mortgage. A loan in an 

amount of $200,000 has a 30-year loan 

term. The loan agreement provides that 

the interest rate will be 6.5% for the first 

two years of the loan, 7% for the next 

three years of the loan, and 7.5% 

thereafter. Accordingly, the scheduled 

payment amounts are $1,264 for the first 

two years, $1,328 for the next three 

years, and $1,388 thereafter for the 

remainder of the term. For purposes of 

§ 226.43(c)(2)(iii), the creditor must 

determine the consumer’s ability to 

repay the loan based on a payment of 

$1,398, which is the substantially equal, 

monthly, fully amortizing payment that 

would repay $200,000 over 30 years 

using the fully indexed rate of 7.5%. 

43(c)(5)(ii) Special rules for loans with 

a balloon payment, interest-only loans, 

and negative amortization loans. 

Paragraph 43(c)(5)(ii)(A). 

1. General. For loans with a balloon 

payment, the rules differ depending on 

whether the loan is a higher-priced 

covered transaction, as defined under 

§ 226.43(b)(4), or is not a higher-priced 

covered transaction because the annual 

percentage rate does not exceed the 

applicable average prime offer rate 

(APOR) for a comparable transaction. 

‘‘Average prime offer rate’’ is defined in 

§ 226.45(a)(2)(ii); ‘‘higher-priced covered 

transaction’’ is defined in § 226.43(b)(4). 

For higher-priced covered transactions 

with a balloon payment, the creditor 

must consider the consumer’s ability to 

repay the loan based on the payment 

schedule under the terms of the legal 

obligation, including any required 

balloon payment. For loans with a 

balloon payment that are not higherpriced covered transactions, the creditor 

should use the maximum payment 

scheduled during the first five years of 

the loan following consummation. 

‘‘Balloon payment’’ is defined in 

§ 226.18(s)(5)(i). 

2. First five years after consummation. 

Under § 226.43(c)(5)(ii)(A)(1), the 

creditor must determine a consumer’s 

ability to repay a loan with a balloon 

payment that is not a higher-priced 

covered transaction using the maximum 

payment scheduled during the first five 

years (60 months) after consummation. 

For example, assume a loan with a 

balloon payment due at the end of a 

five-year loan term. The loan is 

consummated on August 15, 2011, and 

the first monthly payment is due on 

October 1, 2011. The first five years after 

consummation occurs on August 15, 

2016. The balloon payment must be 

made on the due date of the 60th 

monthly payment, which is September 

1, 2016. For purposes of determining the 

consumer’s ability to repay the loan 

under § 226.43(c)(2)(iii), the creditor 

need not consider the balloon payment 

that is due on September 1, 2016. 

3. Renewable balloon loan; loan term. 

A balloon loan that is not a higherpriced covered transaction could 

provide that a creditor is 

unconditionally obligated to renew a 

balloon loan at the consumer’s option 

(or is obligated to renew subject to 

conditions within the consumer’s 

control). See comment 17(c)(1)–11 

discussing renewable balloon loans. For 

purposes of this section, the loan term 

does not include any the period of time 

that could result from a renewal 

provision. To illustrate, assume a 3-year 

balloon loan that is not a higher-priced 

covered transaction contains an 

unconditional obligation to renew for 

another three years at the consumer’s 

option. In this example, the loan term 

for the balloon loan is 3 years, and not 

the potential 6 years that could result if 

the consumer chooses to renew the loan. 

Accordingly, the creditor must 

underwrite the loan using the maximum 

payment scheduled in the first five 

years after consummation, which 

includes the balloon payment due at the 

end of the 3-year loan term. See 

comment 43(c)(5)(ii)(A).ii, which 

provides an example of how to 

determine the consumer’s repayment 

ability for a 3-year renewable balloon 

loan. 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27496 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

4. Examples of loans with a balloon 

payment that are not higher-priced 

covered transactions. The following are 

examples of how to determine the 

maximum payment scheduled during 

the first five years after consummation 

(all amounts are rounded): 

i. Balloon payment loan with a threeyear loan term; fixed interest rate. A 

loan agreement provides for a fixed 

interest rate of 6%, which is below the 

APOR threshold for a comparable 

transaction, thus the loan is not a 

higher-priced covered transaction. The 

loan amount is $200,000, and the loan 

has a three-year loan term but is 

amortized over 30 years. The monthly 

payment scheduled for the first three 

years following consummation is 

$1,199, with a balloon payment of 

$193,367 due at the end of the third 

year. For purposes of § 226.43(c)(2)(iii), 

the creditor must determine the 

consumer’s ability to repay the loan 

based on the balloon payment of 

$193,367. 

ii. Renewable balloon payment loan 

with a three-year loan term. Assume the 

same facts above in 43(c)(5)(ii)(A).i, 

except that the loan agreement also 

provides that the creditor is 

unconditionally obligated to renew the 

balloon payment mortgage at the 

consumer’s option at the end of the 

three-year term for another three years 

(the creditor retains the option to 

increase the interest rate at the time of 

renewal). In determining the maximum 

payment scheduled during the first five 

years after consummation, the creditor 

must use a loan term of three years. 

Accordingly, for purposes of 

§ 226.43(c)(2)(iii), the creditor must 

determine the consumer’s ability to 

repay the loan based on the balloon 

payment of $193,367. 

iii. Balloon payment loan with a fiveyear loan term; fixed interest rate. A 

loan provides for a fixed interest rate of 

6%, which is below the APOR threshold 

for a comparable transaction, and thus, 

the loan is not a higher-priced covered 

transaction. The loan amount is 

$200,000, and the loan has a five-year 

loan term but is amortized over 30 

years. The loan is consummated on 

March 15, 2011, and the monthly 

payment scheduled for the first five 

years following consummation is 

$1,199, with the first monthly payment 

due on May 1, 2011. The first five years 

after consummation end on March 15, 

2016. The balloon payment of $187,308 

is required on the due date of the 60th 

monthly payment, which is April 1, 

2016 (more than five years after 

consummation). For purposes of 

§ 226.43(c)(2)(iii), the creditor must 

determine the consumer’s ability to 

repay the loan based on the monthly 

payment of $1,199, and need not 

consider the balloon payment of 

$187,308 due on April 1, 2016. 

5. Example of a higher-priced covered 

transaction with a balloon payment. 

The following is an example of how to 

determine the consumer’s repayment 

ability based on the loan’s payment 

schedule, including any balloon 

payment (all amounts are rounded): 

i. Balloon payment loan with a 10- 

year loan term; fixed interest rate. The 

loan is a higher-priced covered 

transaction with a fixed interest rate of 

7%. The loan amount is $200,000 and 

the loan has a 10-year loan term, but is 

amortized over 30 years. The monthly 

payment scheduled for the first ten 

years is $1,331, with a balloon payment 

of $172,956. For purposes of 

§ 226.43(c)(2)(iii), the creditor must 

consider the consumer’s ability to repay 

the loan based on the payment schedule 

that fully repays the loan amount, 

including the balloon payment of 

$172,956. 

Paragraph 43(c)(5)(ii)(B). 

1. General. For loans that permit 

interest-only payments, the creditor 

must use the fully indexed rate or 

introductory rate, whichever is greater, 

to calculate the substantially equal, 

monthly payment of principal and 

interest that will repay the loan amount 

over the term of the loan remaining as 

of the date the loan is recast. For 

discussion regarding the fully indexed 

rate and the meaning of ‘‘substantially 

equal,’’ see comments 43(b)(3)–1 

through –5 and 43(c)(5)(i)–4, 

respectively. Under § 226.43(c)(5)(ii)(B), 

the relevant term of the loan is the 

period of time that remains as of the 

date the loan is recast to require fully 

amortizing payments. For a loan on 

which only interest and no principal 

has been paid, the loan amount will be 

the outstanding principal balance at the 

time of the recast. ‘‘Loan amount’’ and 

‘‘recast’’ are defined in § 226.43(b)(5) and 

(b)(11), respectively. ‘‘Interest-only’’ and 

‘‘Interest-only loan’’ are defined in 

§ 226.18(s)(7)(iv). 

2. Examples. The following are 

examples of how to determine the 

consumer’s repayment ability based on 

substantially equal, monthly payments 

of principal and interest under 

§ 226.43(c)(5)(ii)(B) (all amounts are 

rounded): 

i. Fixed-rate mortgage with interestonly payments for five years. A loan in 

an amount of $200,000 has a 30-year 

loan term. The loan agreement provides 

for a fixed interest rate of 7%, and 

permits interest-only payments for the 

first five years. The monthly payment of 

$1167 scheduled for the first five years 

would cover only the interest due. The 

loan is recast on the due date of the 60th 

monthly payment, after which the 

scheduled monthly payments increase 

to $1414, a monthly payment that 

repays the loan amount of $200,000 over 

the 25 years remaining as of the date the 

loan is recast (300 months). For 

purposes of § 226.43(c)(2)(iii), the 

creditor must determine the consumer’s 

ability to repay the loan based on a 

payment of $1414, which is the 

substantially equal, monthly, fully 

amortizing payment that would repay 

$200,000 over the 25 years remaining as 

of the date the loan is recast using the 

fixed interest rate of 7%. 

ii. Adjustable-rate mortgage with 

discount for three years and interestonly payments for five years. A loan in 

an amount of $200,000 has a 30-year 

loan term, but provides for interest-only 

payments for the first five years. The 

loan agreement provides for a 

discounted interest rate of 5% that is 

fixed for an initial period of three years, 

after which the interest rate will adjust 

each year based on a specified index 

plus a margin of 3%, subject to an 

annual interest rate adjustment cap of 

2%. The index value in effect at 

consummation is 4.5%; the fully 

indexed rate is 7.5% (4.5% plus 3%). 

The monthly payments of $833 for the 

first three years and $1250 for the 

following two years would cover only 

the interest due. The loan is recast on 

the due date of the 60th monthly 

payment, after which the scheduled 

monthly payments increase to $1478, a 

monthly payment that will repay the 

loan amount of $200,000 over the 

remaining 25 years of the loan (300 

months). For purposes of 

§ 226.43(c)(2)(iii), the creditor must 

determine the consumer’s ability to 

repay the loan based on a monthly 

payment of $1,478, which is the 

substantially equal, monthly payment of 

principal and interest that would repay 

$200,000 over the 25 years remaining as 

of the date the loan is recast using the 

fully indexed rate of 7.5%. 

Paragraph 43(c)(5)(ii)(C). 

1. General. For purposes of 

determining the consumer’s ability to 

repay a negative amortization loan, the 

creditor must use substantially equal, 

monthly payments of principal and 

interest based on the fully indexed rate 

or the introductory rate, whichever is 

greater, that will repay the maximum 

loan amount over the term of the loan 

that remains as of the date the loan is 

recast. Accordingly, before determining 

the substantially equal, monthly 

payments the creditor must first 

determine the maximum loan amount 

and the period of time that remains in 


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the loan term after the loan is recast. 

‘‘Recast’’ is defined in § 226.43(b)(11). 

Second, the creditor must use the fully 

indexed rate or introductory rate, 

whichever is greater, to calculate the 

substantially equal, monthly payment 

amount that will repay the maximum 

loan amount over the term of the loan 

remaining as of the date the loan is 

recast. For discussion regarding the 

fully indexed rate and the meaning of 

‘‘substantially equal,’’ see comments 

43(b)(3)–1 through –5 and 43(c)(5)(i)–4, 

respectively. For the meaning of the 

term ‘‘maximum loan amount’’ and a 

discussion of how to determine the 

maximum loan amount for purposes of 

§ 226.43(c)(5)(ii)(C), see § 226.43(b)(7) 

and associated commentary. ‘‘Negative 

amortization loan’’ is defined in 

§ 226.18(s)(7)(v). 

2. Term of loan. Under 

§ 226.43(c)(5)(ii)(C), the relevant term of 

the loan is the period of time that 

remains as of the date the terms of the 

legal obligation recast. That is, the 

creditor must determine substantially 

equal, monthly payments of principal 

and interest that will repay the 

maximum loan amount based on the 

period of time that remains after any 

negative amortization cap is triggered or 

any period permitting minimum 

periodic payments expires, whichever 

occurs first. 

3. Examples. The following are 

examples of how to determine the 

consumer’s repayment ability based on 

substantially equal, monthly payments 

of principal and interest as required 

under § 226.43(c)(5)(ii)(C) (all amounts 

are rounded): 

i. Adjustable-rate mortgage with 

negative amortization. A. Assume an 

adjustable-rate mortgage in the amount 

of $200,000 with a 30-year loan term. 

The loan agreement provides that the 

consumer can make minimum monthly 

payments that cover only part of the 

interest accrued each month until the 

date on which the principal balance 

reaches 115% of its original balance 

(i.e., a negative amortization cap of 

115%) or for the first five years of the 

loan (60 monthly payments), whichever 

occurs first. The introductory interest 

rate at consummation is 1.5%. One 

month after consummation, the interest 

rate adjusts and will adjust monthly 

thereafter based on the specified index 

plus a margin of 3.5%. The index value 

in effect at consummation is 4.5%; the 

fully indexed rate is 8% (4.5% plus 

3.5%). The maximum lifetime interest 

rate is 10.5%; there are no other 

periodic interest rate adjustment caps 

that limit how quickly the maximum 

lifetime rate may be reached. The 

minimum monthly payment for the first 

year is based on the initial interest rate 

of 1.5%. After that, the minimum 

monthly payment adjusts annually, but 

may increase by no more than 7.5% 

over the previous year’s payment. The 

minimum monthly payment is $690 in 

the first year, $742 in the second year, 

and $798 in the first part of the third 

year. 

B. To determine the maximum loan 

amount, assume that the interest rate 

increases to the maximum lifetime 

interest rate of 10.5% at the first 

adjustment (i.e., the second month), and 

interest accrues at that rate until the 

loan is recast. Assume that the 

consumer makes the minimum monthly 

payments scheduled, which are capped 

at 7.5% from year-to-year, for the 

maximum possible time. Because the 

consumer’s minimum monthly 

payments are less than the interest 

accrued each month, negative 

amortization occurs (i.e., the accrued 

but unpaid interest is added to the 

principal balance). Thus, assuming that 

the consumer makes the minimum 

monthly payments for as long as 

possible and that the maximum interest 

rate of 10.5% is reached at the first rate 

adjustment (i.e., the second month), the 

negative amortization cap of 115% is 

reached on the due date of the 27th 

monthly payment and the loan is recast 

as of that date. The maximum loan 

amount as of the due date of the 27th 

monthly payment is $229,243, and the 

remaining term of the loan is 27 years 

and nine months (333 months). 

C. For purposes of § 226.43(c)(2)(iii), 

the creditor must determine the 

consumer’s ability to repay the loan 

based on a monthly payment of $1,716, 

which is the substantially equal, 

monthly payment of principal and 

interest that will repay the maximum 

loan amount of $229,243 over the 

remaining loan term of 333 months 

using the fully indexed rate of 8%. See 

comments 43(b)(7)–1 and –2 discussing 

the calculation of the maximum loan 

amount, and § 226.43(b)(11) for the 

meaning of the term ‘‘recast.’’ 

ii. Fixed-rate, graduated payment 

mortgage. A loan in the amount of 

$200,000 has a 30-year loan term. The 

loan agreement provides for a fixedinterest rate of 7.5%, and requires the 

consumer to make minimum monthly 

payments during the first year, with 

payments increasing 12.5% every year 

for four years (the annual payment cap). 

The payment schedule provides for 

payments of $943 in the first year, 

$1061 in the second year, $1194 in the 

third year, $1343 in the fourth year, and 

then requires $1511 for the remaining 

term of the loan. During the first three 

years of the loan, the payments are less 

than the interest accrued each month, 

resulting in negative amortization. 

Assuming the minimum payments 

increase year-to-year up to the 12.5% 

payment cap, the consumer will begin 

making payments that cover at least all 

of the interest accrued at the end of the 

third year. Thus, the loan is recast on 

the due date of the 36th monthly 

payment. The maximum loan amount 

on that date is $207,659, and the 

remaining loan term is 27 years (324 

months). For purposes of 

§ 226.43(c)(2)(iii), the creditor must 

determine the consumer’s ability to 

repay the loan based on a monthly 

payment of $1497, which is the 

substantially equal, monthly payment of 

principal and interest that will repay the 

maximum loan amount of $207,659 over 

the remaining loan term of 27 years 

using the fixed interest rate of 7.5%. 

43(c)(6) Payment calculation for 

simultaneous loans. 

1. Scope. In determining the 

consumer’s repayment ability for a 

covered transaction under 

§ 226.43(c)(2)(iii), creditors must 

include consideration of any 

simultaneous loan which it knows, or 

has reason to know, will be made at or 

before consummation of the covered 

transaction. For a discussion of the 

standard ‘‘knows or has reason to 

know,’’ see comment 43(c)(2)(iv)–2. For 

the meaning of the term ‘‘simultaneous 

loan,’’ see § 226.43(b)(12). 

2. Payment calculation—covered 

transaction. For a simultaneous loan 

that is a covered transaction, as that 

term is defined under § 226.43(b)(12), a 

creditor must determine a consumer’s 

ability to repay the monthly payment 

obligation for a simultaneous loan as set 

forth in § 226.43(c)(5), taking into 

account any mortgage-related 

obligations. For the meaning of the term 

‘‘mortgage-related obligations,’’ see 

§ 226.43(b)(8). 

3. Payment calculation—home equity 

line of credit. For a simultaneous loan 

that is a home equity line of credit 

subject to § 226.5b, the creditor must 

consider the periodic payment required 

under the terms of the plan when 

assessing the consumer’s ability to repay 

the covered transaction secured by the 

same dwelling as the simultaneous loan. 

Under § 226.43(c)(6)(ii), a creditor must 

determine the periodic payment 

required under the terms of the plan by 

considering the actual amount of credit 

to be drawn by the consumer at 

consummation of the covered 

transaction. The amount to be drawn is 

the amount requested by the consumer; 

when the amount requested will be 

disbursed, or actual receipt of funds, is 

not determinative. For example, where 


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the creditor’s policies and procedures 

require the source of downpayment to 

be verified, and the creditor verifies that 

a simultaneous loan that is a HELOC 

will provide the source of 

downpayment for the first-lien covered 

transaction, the creditor must consider 

the periodic payment on the HELOC by 

assuming the amount drawn is the 

downpayment amount. In general, a 

creditor should determine the periodic 

payment based on guidance in staff 

commentary to § 226.5b(d)(5) 

(discussing payment terms). 

43(c)(7) Monthly debt-to-income ratio 

or residual income. 

1. Monthly debt-to-income ratio and 

monthly residual income. Under 

§ 226.43(c)(2)(vii), the creditor must 

consider the consumer’s monthly debtto-income ratio, or the consumer’s 

monthly residual income, in accordance 

with the requirements in § 226.43(c)(7). 

To determine the appropriate threshold 

for the monthly debt-to-income ratio or 

the monthly residual income, the 

creditor may look to widely accepted 

governmental and non-governmental 

underwriting standards. 

2. Use of both debt-to-income ratio 

and monthly residual income. If a 

creditor considers both the consumer’s 

monthly debt-to-income ratio and the 

residual income, the creditor may base 

the ability-to-repay determination on 

either the consumer’s debt-to-income 

ratio or residual income, even if the 

ability-to-repay determination would 

differ with the basis used. 

3. Compensating factors. The creditor 

may consider compensating factors to 

mitigate a higher debt-to-income ratio or 

lower residual income. For example, the 

creditor may consider the consumer’s 

assets other than the dwelling securing 

the covered transaction or the 

consumer’s residual income as a 

compensating factor for a higher debt-toincome ratio. In determining whether 

and in what manner to consider 

compensating factors, creditors may 

look to widely accepted governmental 

and non-governmental underwriting 

standards. 

43(d) Refinancing of non-standard 

mortgages. 

43(d)(1) Scope. 

1. Written application. For an 

explanation of the requirements for a 

‘‘written application’’ in 

§ 226.43(d)(1)(iii), (d)(1)(iv) and 

(d)(1)(v), see comment 19(a)(1)(i)–3. 

Paragraph 43(d)(1)(ii). 

1. Materially lower. The exemptions 

afforded under § 226.43(d)(3) apply to a 

refinancing only if the monthly payment 

for the new loan is ‘‘materially lower’’ 

than the monthly payment for an 

existing non-standard mortgage. The 

payments to be compared must be 

calculated based on the requirements 

under § 226.43(d)(5). 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 the ‘‘materially 

lower’’ standard. 

Paragraph 43(d)(1)(iv). 

1. Late payment—24 months prior to 

application. Under § 226.43(d)(1)(iv), 

the exemptions in § 226.43(d)(3) apply 

to a covered transaction only if, during 

the 24 months immediately preceding 

the creditor’s receipt of the consumer’s 

written application for a refinancing, the 

consumer has made no more than one 

payment on the non-standard mortgage 

more than 30 days late. (For an 

explanation of ‘‘written application,’’ see 

comment 43(d)(1)–1.) For example, 

assume a consumer applies for a 

refinancing on May 1, 2011. Assume 

also that the consumer made a nonstandard mortgage payment on August 

15, 2009, that was 45 days late. The 

consumer made no other late payments 

on the non-standard mortgage between 

May 1, 2009, and May 1, 2011. In this 

example, the requirement under 

§ 226.43(d)(1)(iv) is met because the 

consumer made only one payment that 

was over 30 days late within the 24 

months prior to applying for the 

refinancing (i.e., 20 and one-half months 

prior to application). 

2. Payment due date. Whether a 

payment is more than 30 days late is 

measured in relation to the contractual 

due date not accounting for any grace 

period. For example, if the contractual 

due date for a non-standard mortgage 

payment is the first day of every month, 

but no late fee will be charged as long 

as the payment is received by the 16th 

of the month, the payment due date for 

purposes of § 226.43(d)(1)(iv) and 

(d)(1)(v) is the first day of the month, 

not the 16th day of the month. Thus, a 

payment due under the contract on 

September 1st that is paid on October 

1st is made more than 30 days after the 

payment due date. 

Paragraph 43(d)(1)(v). 

1. Late payment—six months prior to 

application. Under § 226.43(d)(1)(v), the 

exemptions in § 226.43(d)(3) apply to a 

covered transaction only if, during the 

six months immediately preceding the 

creditor’s receipt of the consumer’s 

written application for a refinancing, the 

consumer has made no payments on the 

non-standard mortgage more than 30 

days late. (For an explanation of 

‘‘written application’’ and how to 

determine the payment due date, see 

comments 43(d)(1)–1 and 43(d)(1)(iv)– 

2.) For example, assume a consumer 

with a non-standard mortgage applies 

for a refinancing on May 1, 2011. If the 

consumer made a 45-day late payment 

on March 15, 2011, the requirement 

under § 226.43(d)(1)(v) is not met 

because the consumer made a payment 

more than 30 days late just one and onehalf months prior to application. If the 

number of months between 

consummation of the non-standard 

mortgage and the consumer’s 

application for the standard mortgage is 

six or fewer, the consumer may not have 

made any payment more than 30 days 

late on the non-standard mortgage. 

43(d)(2) Definitions. 

43(d)(2)(i) Non-standard mortgage. 

Paragraph 43(d)(2)(i)(A). 

1. Adjustable-rate mortgage with an 

introductory fixed rate. Under 

§ 226.43(d)(2)(i)(A), an adjustable-rate 

mortgage with an introductory fixed 

interest rate for one year or longer is 

considered a ‘‘non-standard mortgage.’’ 

For example, a covered transaction that 

has a fixed introductory rate for the first 

two, three or five years and then 

converts to a variable rate for the 

remaining 28, 27 or 25 years, 

respectively, is a ‘‘non-standard 

mortgage.’’ A covered transaction with 

an introductory rate for six months that 

then converts to a variable rate for the 

remaining 29 and 1⁄2 years is not a ‘‘nonstandard mortgage.’’ 

43(d)(2)(ii) Standard mortgage. 

Paragraph 43(d)(2)(ii)(A). 

1. Regular periodic payments. Under 

§ 226.43(d)(2)(ii)(A), a ‘‘standard 

mortgage’’ must provide for regular 

periodic payments that do not result in 

an increase of the principal balance 

(negative amortization), allow the 

consumer to defer repayment of 

principal (see comment 43(e)(2)(i)–2), or 

result in a balloon payment. Thus, the 

terms of the legal obligation must 

require the consumer to make payments 

of principal and interest on a monthly 

or other periodic basis that will repay 

the loan amount over the loan term. 

Except for payments resulting from any 

interest rate changes after 

consummation in an adjustable-rate or 

step-rate mortgage, the periodic 

payments must be substantially equal. 

For an explanation of the term 

‘‘substantially equal,’’ see comment 

43(c)(5)(i)–4. In addition, a singlepayment transaction is not a ‘‘standard 

mortgage’’ because it does not require 

‘‘regular periodic payments.’’ See also 

comment 43(e)(2)(i)–1. 

Paragraph 43(d)(2)(ii)(D). 

1. First five years after consummation. 

A ‘‘standard mortgage’’ must have an 

interest rate that is fixed for at least the 

first five years (60 months) after 

consummation. For example, assume an 


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adjustable-rate mortgage that applies the 

same fixed interest rate to determine the 

first 60 payments of principal and 

interest due. The loan consummates on 

August 15, 2011, and the first monthly 

payment is due on October 1, 2011. The 

first five years after consummation 

occurs on August 15, 2016. The first 

interest rate adjustment occurs on the 

due date of the 60th monthly payment, 

which is September 1, 2016. This loan 

meets the criterion for a ‘‘standard 

mortgage’’ under § 226.43(d)(2)(ii)(D) 

because the interest rate is fixed until 

September 1, 2016, which is more than 

five years after consummation. For 

guidance regarding step-rate mortgages, 

see comment 43(e)(2)(iv)–3.iii. 

Paragraph 43(d)(2)(ii)(E). 

1. Permissible use of proceeds. To 

qualify as a ‘‘standard mortgage,’’ the 

mortgage proceeds may be used for only 

two purposes: paying off the nonstandard mortgage and paying for 

closing costs, including paying escrow 

amounts required at or before closing. 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.’’ 

43(d)(3) Exemption from certain 

repayment ability requirements. 

Paragraph 43(d)(3)(i). 

1. Two-part determination. To qualify 

for the exemptions in § 226.43(d)(3), 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 will prevent the 

consumer’s default. 

2. Likely default. In considering 

whether a consumer is likely to default 

on the standard mortgage once it is 

recast, a creditor may look to widelyaccepted governmental and nongovernmental standards for analyzing a 

consumer’s likelihood of default. 

Paragraph 43(d)(3)(ii). 

1. Payment calculation for repayment 

ability requirements. If the conditions in 

§ 226.43(d)(3)(i) are met, the creditor 

may meet the payment calculation 

requirements for determining a 

consumer’s ability to repay the new loan 

by applying the calculation prescribed 

under § 226.43(d)(5)(ii), rather than the 

calculations prescribed under 

§ 226.43(c)(2)(iii) and (c)(5). For 

example, assume that a ‘‘standard 

mortgage’’ is an adjustable-rate mortgage 

that has an initial fixed interest rate for 

the first five years after consummation. 

The loan consummates on August 15, 

2011, and the first monthly payment is 

due on October 1, 2011. Five years after 

consummation occurs on August 15, 

2016. The first interest rate adjustment 

occurs on the due date of the 60th 

monthly payment, which is September 

1, 2016. Under § 226.43(d)(3)(ii), to 

calculate the payment required for the 

ability-to-repay rule under 

§ 226.43(c)(2)(iii), the creditor should 

use the payment based on the interest 

rate that is fixed for the first five years 

after consummation (from August 15, 

2011, until August 15, 2016), and is not 

required to account for the payment 

resulting after the first interest rate 

adjustment on September 1, 2016. 

43(d)(5) Payment calculations. 

43(d)(5)(i) Non-standard mortgage. 

1. Payment calculation for a nonstandard mortgage. In determining 

whether the monthly periodic payment 

for a standard mortgage is materially 

lower than the monthly periodic 

payment for the non-standard mortgage 

under § 226.43(d)(1)(ii), the creditor 

must consider the monthly payment for 

the non-standard mortgage that will 

result after the loan is ‘‘recast,’’ assuming 

substantially equal payments of 

principal and interest that amortize the 

remaining loan amount over the 

remaining term as of the date the 

mortgage is recast. For guidance 

regarding the meaning of ‘‘substantially 

equal,’’ see comment 43(c)(5)(i)–4. For 

the meaning of ‘‘recast,’’ see 

§ 226.43(b)(11) and associated 

commentary. 

2. Fully indexed rate. The term ‘‘fully 

indexed rate’’ in § 226.43(d)(5)(i)(A) for 

calculating the payment for a nonstandard mortgage is generally defined 

in § 226.43(b)(3) and associated 

commentary. Under § 226.43(b)(3) the 

fully indexed rate is calculated at the 

time of consummation. For purposes of 

§ 226.43(d)(5)(i), however, the fully 

indexed rate is calculated within a 

reasonable period of time before or after 

the date the creditor receives the 

consumer’s written application for the 

standard mortgage. Thirty days is 

generally considered ‘‘a reasonable 

period of time.’’ 

3. Written application. For an 

explanation of the requirements for a 

‘‘written application’’ in 

§ 226.43(d)(5)(i), see comment 

19(a)(1)(i)–3. 

4. Payment calculation for an 

adjustable-rate mortgage with an 

introductory fixed rate. Under 

§ 226.43(d)(5)(i), the monthly periodic 

payment for an adjustable-rate mortgage 

with an introductory fixed interest rate 

for a period of one or more years must 

be calculated based on several 

assumptions. 

i. First, the payment must be based on 

the outstanding principal balance as of 

the date on which the mortgage is 

recast, assuming all scheduled 

payments have been made up to that 

date and the last payment due under 

those terms is made and credited on that 

date. For example, assume an 

adjustable-rate mortgage with a 30-year 

loan term. The loan agreement provides 

that the payments for the first 24 

months are based on a fixed rate, after 

which the interest rate will adjust 

annually based on a specified index and 

margin. The loan is recast on the due 

date of the 24th payment. If the 24th 

payment is due on September 1, 2013, 

the creditor must calculate the 

outstanding principal balance as of 

September 1, 2013, assuming that all 24 

payments under the fixed rate terms 

have been made and credited timely. 

ii. Second, the payment calculation 

must be based on substantially equal 

monthly payments of principal and 

interest that will fully repay the 

outstanding principal balance over the 

term of the loan remaining as of the date 

the loan is recast. Thus, in the example 

above, the creditor must assume a loan 

term of 28 years (336 payments). 

iii. Third, the payment must be based 

on the fully indexed rate, as defined in 

§ 226.43(b)(3), as of the date of the 

written application for the standard 

mortgage. 

5. Example of payment calculation for 

an adjustable-rate mortgage with an 

introductory fixed rate. The following 

example illustrates the rule described in 

comment 43(d)(5)(i)–4: 

i. A loan in an amount of $200,000 

has a 30-year loan term. The loan 

agreement provides for a discounted 

introductory interest rate of 5% that is 

fixed for an initial period of two years, 

after which the interest rate will adjust 

annually based on a specified index 

plus a margin of 3 percentage points. 

ii. The non-standard mortgage 

consummates on February 15, 2011, and 

the first monthly payment is due on 

April 1, 2011. The loan is recast on the 

due date of the 24th monthly payment, 

which is March 1, 2013. 

iii. On March 15, 2012, the creditor 

receives the consumer’s written 

application for a refinancing after the 

consumer has made 12 monthly on-time 

payments. On this date, the index value 

is 4.5%. 

iv. To calculate the non-standard 

mortgage payment that must be 

compared to the standard mortgage 

payment under § 226.43(d)(1)(ii), the 

creditor must use— 

A. The outstanding principal balance 

as of March 1, 2013, assuming all 

scheduled payments have been made up 

to March 1, 2013, and the last payment 

due under the fixed rate terms is made 


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and credited on March 1, 2013. In this 

example, the outstanding principal 

balance is $193,948. 

B. The fully indexed rate of 7.5%, 

which is the index value of 4.5% as of 

March 15, 2012 (the date on which the 

application for a refinancing is received) 

plus the margin of 3%. 

C. The remaining loan term as of 

March 1, 2013, the date of the recast, 

which is 28 years (336 payments). 

v. Based on these assumptions, the 

monthly payment for the non-standard 

mortgage for purposes of determining 

whether the standard mortgage monthly 

payment is lower than the non-standard 

mortgage monthly payment (see 

§ 226.43(d)(1)(ii)) is $1,383. This is the 

substantially equal, monthly payment of 

principal and interest required to repay 

the outstanding principal balance at the 

fully-indexed rate over the remaining 

term. 

6. Payment calculation for an interestonly loan. Under § 226.43(d)(5)(i), the 

monthly periodic payment for an 

interest-only loan must be calculated 

based on several assumptions. 

i. First, the payment must be based on 

the loan amount, as defined in 

§ 226.43(b)(5) (for a loan on which only 

interest and no principal has been paid, 

the ‘‘loan amount’’ will be the 

outstanding principal balance at the 

time of the recast), assuming all 

scheduled payments are made under the 

terms of the legal obligation in effect 

before the mortgage is recast. For 

example, assume that a mortgage has a 

30-year loan term, and provides that the 

first 24 months of payments are interestonly. If the 24th payment is due on 

September 1, 2013, the creditor must 

calculate the outstanding principal 

balance as of September 1, 2013, 

assuming that all 24 payments under the 

interest-only payment terms have been 

made and credited timely. 

ii. Second, the payment calculation 

must be based on substantially equal 

monthly payments of principal and 

interest that will fully repay the loan 

amount over the term of the loan 

remaining as of the date the loan is 

recast. Thus, in the example above, the 

creditor must assume a loan term of 28 

years (336 payments). 

iii. Third, the payment must be based 

on the fully indexed rate, as defined in 

§ 226.43(b)(3), as of the date of the 

written application for the standard 

mortgage. 

7. Example of payment calculation for 

an interest-only loan. The following 

example illustrates the rule described in 

comment 43(d)(5)(i)–6: 

i. A loan in an amount of $200,000 

has a 30-year loan term. The loan 

agreement provides for a fixed interest 

rate of 7%, and permits interest-only 

payments for the first two years (the first 

24 payments), after which time 

amortizing payments of principal and 

interest are required. 

ii. The non-standard mortgage 

consummates on February 15, 2011, and 

the first monthly payment is due on 

April 1, 2011. The loan is recast on the 

due date of the 24th monthly payment, 

which is March 1, 2013. 

iii. On March 15, 2012, the creditor 

receives the consumer’s written 

application for a refinancing, after the 

consumer has made 12 monthly on-time 

payments. 

iv. To calculate the non-standard 

mortgage payment that must be 

compared to the standard mortgage 

payment under § 226.43(d)(1)(ii), the 

creditor must use— 

A. The loan amount, which is the 

outstanding principal balance as of 

March 1, 2013, assuming all scheduled 

interest-only payments have been made 

and credited up to that date. In this 

example, the loan amount is $200,000. 

B. An interest rate of 7%, which is the 

interest rate in effect at the time of 

consummation of this fixed-rate nonstandard mortgage. 

C. The remaining loan term as of 

March 1, 2013, the date of the recast, 

which is 28 years (336 payments). 

v. Based on these assumptions, the 

monthly payment for the non-standard 

mortgage for purposes of determining 

whether the standard mortgage monthly 

payment is lower than the non-standard 

mortgage monthly payment (see 

§ 226.43(d)(1)(ii)) is $1,359. This is the 

substantially equal, monthly payment of 

principal and interest required to repay 

the loan amount at the fully-indexed 

rate over the remaining term. 

8. Payment calculation for a negative 

amortization loan. Under 

§ 226.43(d)(5)(i), the monthly periodic 

payment for a negative amortization 

loan must be calculated based on 

several assumptions. 

i. First, the calculation must be based 

on the maximum loan amount, as 

defined in § 226.43(b)(7). For examples 

of how to calculate the maximum loan 

amount, see comment 43(b)(7)–3. 

ii. Second, the calculation must be 

based on substantially equal monthly 

payments of principal and interest that 

will fully repay the maximum loan 

amount over the term of the loan 

remaining as of the date the loan is 

recast. For example, if the loan term is 

30 years and the loan is recast on the 

due date of the 60th monthly payment, 

the creditor must assume a loan term of 

25 years (300 payments). 

iii. Third, the payment must be based 

on the fully-indexed rate as of the date 

of the written application for the 

standard mortgage. 

9. Example of payment calculation for 

a negative amortization loan. The 

following example illustrates the rule 

described in comment 43(d)(5)(i)–8: 

i. A loan in an amount of $200,000 

has a 30-year loan term. The loan 

agreement provides that the consumer 

can make minimum monthly payments 

that cover only part of the interest 

accrued each month until the date on 

which the principal balance increases to 

the negative amortization cap of 115% 

of the loan amount, or for the first five 

years of monthly payments (60 

payments), whichever occurs first. The 

loan is an adjustable-rate mortgage that 

adjusts monthly according to a specified 

index plus a margin of 3.5%. 

ii. The non-standard mortgage 

consummates on February 15, 2011, and 

the first monthly payment is due on 

April 1, 2011. Assume that, based on the 

calculation of the maximum loan 

amount required under § 226.43(b)(7) 

and associated commentary, the 

negative amortization cap of 115% 

would be reached on July 1, 2013, the 

due date of the 28th monthly payment. 

iii. On March 15, 2012, the creditor 

receives the consumer’s written 

application for a refinancing, after the 

consumer has made 12 monthly on-time 

payments. On this date, the index value 

is 4.5%. 

iv. To calculate the non-standard 

mortgage payment that must be 

compared to the standard mortgage 

payment under § 226.43(d)(1)(ii), the 

creditor must use— 

A. The maximum loan amount of 

$229,243 as of July 1, 2013. 

B. The fully indexed rate of 8%, 

which is the index value of 4.5% as of 

March 15, 2012 (the date on which the 

creditor receives the application for a 

refinancing) plus the margin of 3.5%. 

C. The remaining loan term as of July 

1, 2013, the date of the recast, which is 

27 years and eight months (332 monthly 

payments). 

v. Based on these assumptions, the 

monthly payment for the non-standard 

mortgage for purposes of determining 

whether the standard mortgage monthly 

payment is lower than the non-standard 

mortgage monthly payment (see 

§ 226.43(d)(1)(ii)) is $1,717. This is the 

substantially equal, monthly payment of 

principal and interest required to repay 

the maximum loan amount at the fullyindexed rate over the remaining term. 

43(d)(5)(ii) Standard mortgage. 

1. Payment calculation for a standard 

mortgage. In determining whether the 

monthly periodic payment for a 

standard mortgage is materially lower 

than the monthly periodic payment for 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
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a non-standard mortgage, the creditor 

must consider the monthly payment for 

the standard mortgage that will result in 

substantially equal, monthly, fully 

amortizing payments (as defined in 

§ 226.43(b)(2)) using the rate as of 

consummation. For guidance regarding 

the meaning of ‘‘substantially equal’’ see 

comment 43(c)(5)(i)–4. For a mortgage 

with a single, fixed rate for the first five 

years, the maximum rate that will apply 

during the first five years after 

consummation will be the rate at 

consummation. For a step-rate mortgage, 

however, which is a type of fixed-rate 

mortgage, the rate that must be used is 

the highest rate that will apply during 

the first five years after consummation. 

For example, if the rate for the first two 

years is 4%, the rate for the second two 

years is 5%, and the rate for the next 

two years is 6%, the rate that must be 

used is 6%. 

2. Example of payment calculation for 

a standard mortgage. The following 

example illustrates the rule described in 

comment 43(d)(5)(ii)–1: A loan in an 

amount of $200,000 has a 30-year loan 

term. The loan agreement provides for a 

discounted interest rate of 6% that is 

fixed for an initial period of five years, 

after which time the interest rate will 

adjust annually based on a specified 

index plus a margin of 3%, subject to a 

2% annual interest rate adjustment cap. 

The creditor must determine whether 

the standard mortgage monthly payment 

is materially lower than the nonstandard mortgage monthly payment 

(see § 226.43(d)(1)(ii)) based on a 

standard mortgage payment of $1,199. 

This is the substantially equal, monthly 

payment of principal and interest 

required to repay $200,000 over 30 years 

at an interest rate of 6%. 

43(e) Presumption of compliance for 

qualified mortgages. 

Alternative 1—Paragraph 43(e)(1)–1 

43(e)(1) Safe harbor. 

1. In general. A creditor or assignee 

that satisfies the requirements of 

§ 226.43(e)(2) or § 226.43(f), as 

applicable, is deemed to have complied 

with § 226.43(c)(1). That is, a creditor or 

assignee need not demonstrate 

compliance with § 226.43(c)(2)–(7) if the 

terms of the loan comply with 

§ 226.43(e)(2)(i)–(ii) (or, if applicable, 

§ 226.43(f)); the loan’s points and fees 

do not exceed the limits set forth in 

§ 226.43(e)(2)(iii); and the creditor has 

complied with the underwriting criteria 

described in § 226.43(e)(2)(iv)–(v) (or, if 

applicable, § 226.43(f)). The consumer 

may show the loan is not a qualified 

mortgage with evidence that the terms, 

points and fees, or underwriting did not 

comply with § 226.43(e)(2)(i)–(v) (or 

§ 226.43(f), if applicable). If a loan is not 

a qualified mortgage (for example 

because the loan provides for negative 

amortization), then the creditor or 

assignee must demonstrate that the loan 

complies with all of the requirements in 

§ 226.43(c) (or, if applicable, 

§ 226.43(d)). 

Alternative 2—Paragraph 43(e)(1)–1 

43(e)(1) Presumption of compliance. 

1. In general. Under § 226.43(c)(1), a 

creditor must make a reasonable and 

good faith determination at or before 

consummation that the consumer will 

have a reasonable ability, at the time of 

consummation, to repay the loan 

according to its terms, including any 

mortgage-related obligations. Under 

§ 226.43(e)(1), a creditor or assignee of 

a covered transaction is presumed to 

have complied with the repayment 

ability requirement of § 226.43(c)(1) if 

the terms of the loan comply with 

§ 226.43(e)(2)(i)–(ii) (or, if applicable, 

§ 226.43(f)); the points and fees do not 

exceed the limit set forth in 

§ 226.43(e)(2)(iii), and the creditor has 

complied with the underwriting criteria 

described in § 226.43(e)(2)(iv)–(v) (or, if 

applicable, § 226.43(f)). If a loan is not 

a qualified mortgage (for example 

because the loan provides for negative 

amortization), then the creditor or 

assignee must demonstrate that the loan 

complies with all of the requirements in 

§ 226.43(c) (or, if applicable, 

§ 226.43(d)). However, even if the loan 

is a qualified mortgage, the consumer 

may rebut the presumption of 

compliance with evidence that the loan 

did not comply with § 226.43(c)(1). For 

example, evidence of a high debt-toincome ratio with no compensating 

factors, such as adequate residual 

income, could be sufficient to rebut the 

presumption. 

43(e)(2) Qualified mortgage defined. 

Paragraph 43(e)(2)(i). 

1. Regular periodic payments. Under 

§ 226.43(e)(2)(i), a qualified mortgage 

must provide for regular periodic 

payments that may not result in an 

increase of the principal balance 

(negative amortization), deferral of 

principal repayment, or a balloon 

payment. Thus, the terms of the legal 

obligation must require the consumer to 

make payments of principal and 

interest, on a monthly or other periodic 

basis, that will fully repay the loan 

amount over the loan term. The periodic 

payments must be substantially equal 

except for the effect that any interest 

rate change after consummation has on 

the payment in the case of an 

adjustable-rate or step-rate mortgage. In 

addition, because § 226.43(e)(2)(i) 

requires that a qualified mortgage 

provide for regular periodic payments, a 

single-payment transaction may not be a 

qualified mortgage. 

2. Deferral of principal repayment. 

Under § 226.43(e)(2)(i)(B), a qualified 

mortgage’s regular periodic payments 

may not allow the consumer to defer 

repayment of principal, except as 

provided in § 226.43(f). A loan allows 

the deferral of principal repayment if 

one or more of the periodic payments 

may be applied solely to accrued 

interest and not to loan principal. 

Deferred principal repayment also 

occurs if the payment is applied to both 

accrued interest and principal but the 

consumer is permitted to make periodic 

payments that are less than the amount 

that would be required under a payment 

schedule that has substantially equal 

payments that fully repay the loan 

amount over the loan term. Graduated 

payment mortgages, for example, allow 

deferral of principal repayment in this 

manner and therefore may not be 

qualified mortgages. 

Paragraph 43(e)(2)(iv). 

1. Maximum interest rate during the 

first five years after consummation. For 

a qualified mortgage, the creditor must 

underwrite the loan using a periodic 

payment of principal and interest based 

on the maximum interest rate that may 

apply during the first five years after 

consummation. Creditors must use the 

maximum rate that could apply at any 

time during the first five years after 

consummation, regardless of whether 

the maximum rate is reached at the first 

or subsequent adjustment during the 

five year period. 

2. Fixed-rate mortgage. For a fixedrate mortgage, creditors should use the 

interest rate in effect at consummation. 

‘‘Fixed-rate mortgage’’ is defined in 

§ 226.18(s)(7)(iii). 

3. Interest rate adjustment caps. For 

an adjustable-rate mortgage, creditors 

should assume the interest rate 

increases after consummation as rapidly 

as possible, taking into account the 

terms of the legal obligation. That is, 

creditors should account for any 

periodic interest rate adjustment cap 

that may limit how quickly the interest 

rate can increase under the terms of the 

legal obligation. Where a range for the 

maximum interest rate during the first 

five years is provided, the highest rate 

in that range is the maximum interest 

rate for purposes of this section. Where 

the terms of the legal obligation are not 

based on an index plus margin or 

formula, the creditor must use the 

maximum interest rate that occurs 

during the first five years after 

consummation. To illustrate: 

i. Adjustable-rate mortgage with 

discount for three years. Assume an 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27502 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

adjustable-rate mortgage has an initial 

discounted rate of 5% that is fixed for 

the first three years of the loan, after 

which the rate will adjust annually 

based on a specified index plus a 

margin of 3%. The index value in effect 

at consummation is 4.5%. The loan 

agreement provides for an annual 

interest rate adjustment cap of 2%, and 

a lifetime maximum interest rate of 

10%. The first rate adjustment occurs on 

the due date of the 36th monthly 

payment; the rate can adjust to no more 

than 7% (5% initial discounted rate 

plus 2% annual interest rate adjustment 

cap). The second rate adjustment occurs 

on the due date of the 48th monthly 

payment; the rate can adjust to no more 

than 9% (7% rate plus 2% annual 

interest rate adjustment cap). The third 

rate adjustment occurs on the due date 

of the 60th monthly payment, which 

occurs more than five years after 

consummation. The maximum interest 

rate during the first five years after 

consummation is 9% (the rate on the 

due date of the 48th monthly payment). 

For further discussion of how to 

determine whether a rate adjustment 

occurs during the first five years after 

consummation, see comment 

43(e)(2)(iv)-2. 

ii. Adjustable-rate mortgage with 

discount for three years. Assume the 

same facts above except that the lifetime 

maximum interest rate is 8%, which is 

less than the maximum interest rate in 

the first five years of 9%. The maximum 

interest rate during the first five years 

after consummation is 8%. 

iii. Step-rate mortgage. Assume a 

step-rate mortgage with an interest rate 

fixed at 6.5% for the first two years, 7% 

for the next three years, and then 7.5% 

for remainder of the loan term. The 

maximum interest rate during the first 

five years after consummation is 7%. 

4. First five years after consummation. 

Under § 226.43(e)(2)(iv)(A), the creditor 

must underwrite the loan using the 

maximum interest rate that may apply 

during the first five years after 

consummation. To illustrate, assume an 

adjustable-rate mortgage with an initial 

fixed interest rate of 5% for the first five 

years after consummation, after which 

the interest rate will adjust annually to 

the specified index plus a margin of 6%, 

subject to a 2% annual interest rate 

adjustment cap. The index value in 

effect at consummation is 5.5%. The 

loan consummates on September 15, 

2011, and the first monthly payment is 

due on November 1, 2011. The first five 

years after consummation occurs on 

September 15, 2016. The first rate 

adjustment to no more than 7% (5% 

plus 2% annual interest rate adjustment 

cap) occurs on the due date of the 60th 

monthly payment, which is October 1, 

2016, and therefore, the rate adjustment 

does not occur during the first five years 

after consummation. To meet the 

definition of qualified mortgage under 

§ 226.43(e)(2), the creditor must 

underwrite the loan using a monthly 

payment of principal and interest based 

on an interest rate of 5%, which is the 

maximum interest rate during the first 

five years after consummation. 

5. Loan amount. To meet the 

definition of qualified mortgage under 

§ 226.43(e)(2), a creditor must determine 

the periodic payment of principal and 

interest using the maximum interest rate 

permitted during the first five years after 

consummation that repays either— 

i. The outstanding principal balance 

as of the earliest date the maximum 

interest rate during the first five years 

after consummation can take effect 

under the terms of the legal obligation, 

over the remaining term of the loan. To 

illustrate, assume a loan in an amount 

of $200,000 has a 30-year loan term. The 

loan agreement provides for a 

discounted interest rate of 5% that is 

fixed for an initial period of three years, 

after which the interest rate will adjust 

annually based on a specified index 

plus a margin of 3%, subject to a 2% 

annual interest rate adjustment cap and 

a lifetime maximum interest rate of 

10%. The index value in effect at 

consummation equals 4.5%. Assuming 

the interest rate increases after 

consummation as quickly as possible, 

the rate adjustment to the maximum 

interest rate of 9% occurs on the due 

date of the 48th monthly payment. The 

outstanding principal balance on the 

loan at the end of the fourth year (after 

the 48th monthly payment is credited) 

is $188,218. The creditor will meet the 

definition of qualified mortgage if it 

underwrites the covered transaction 

using the monthly payment of principal 

and interest of $1,564 to repay the 

outstanding principal balance of 

$188,218 over the remaining 26 years of 

the loan term (312 months) using the 

maximum interest rate during the first 

five years of 9%; or 

ii. The loan amount, as that term is 

defined in § 226.43(b)(5), over the entire 

loan term, as that term is defined in 

§ 226.43(b)(6). Using the same example 

above, the creditor will meet the 

definition of qualified mortgage if it 

underwrites the covered transaction 

using the monthly payment of principal 

and interest of $1,609 to repay the loan 

amount of $200,000 over the 30-year 

loan term using the maximum interest 

rate during the first five years of 9%. 

6. Mortgage-related obligations. 

Section 226.43(e)(2)(iv) requires 

creditors to take mortgage-related 

obligations into account when 

underwriting the loan. For the meaning 

of the term ‘‘mortgage-related 

obligations,’’ see § 226.43(b)(8) and 

associated commentary. 

7. Examples. The following are 

examples of how to determine the 

periodic payment of principal and 

interest based on the maximum interest 

rate during the first five years after 

consummation for purposes of meeting 

the definition of qualified mortgage 

under § 226.43(e) (all payment amounts 

are rounded): 

i. Fixed-rate mortgage. A loan in an 

amount of $200,000 has a 30-year loan 

term and a fixed interest rate of 7%. The 

maximum interest rate during the first 

five years after consummation for a 

fixed-rate mortgage is the interest rate in 

effect at consummation, which is 7% 

under this example. The monthly fully 

amortizing payment scheduled over the 

30 years is $1,331. The creditor will 

meet the definition of qualified 

mortgage if it underwrites the loan using 

the fully amortizing payment of $1,331. 

ii. Adjustable-rate mortgage with 

discount for three years. 

A. A loan in an amount of $200,000 

has a 30-year loan term. The loan 

agreement provides for a discounted 

interest rate of 5% that is fixed for an 

initial period of three years, after which 

the interest rate will adjust annually 

based on a specified index plus a 

margin of 3%, subject to a 2% annual 

interest rate adjustment cap. The index 

value in effect at consummation is 

4.5%. The loan consummates on March 

15, 2011, and the first regular periodic 

payment is due May 1, 2011. The loan 

agreement provides that the first rate 

adjustment occurs on April 1, 2014 (the 

due date of the 36th monthly payment); 

the second rate adjustment occurs on 

April 1, 2015 (the due date of the 48th 

monthly payment); and the third rate 

adjustment occurs on April 1, 2016 (the 

due date of the 60th monthly payment), 

which occurs more than five years after 

consummation of the loan. Under this 

example, the maximum interest rate 

during the first five years after 

consummation is 9%, which applies 

beginning on April 1, 2015 (the due date 

of the 48th monthly payment). The 

outstanding principal balance at the end 

of the fourth year (after the 48th 

payment is credited) is $188,218. 

B. The creditor will meet the 

definition of a qualified mortgage if it 

underwrites the loan using the monthly 

payment of principal and interest of 

$1,564 to repay the outstanding 

principal balance at the end of the 

fourth year of $188,218 over the 

remaining 26 years of the loan term (312 

months), using the maximum interest 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 27503 

rate during the first five years after 

consummation of 9%. Alternatively, the 

creditor will meet the definition of a 

qualified mortgage if it underwrites the 

loan using the monthly payment of 

principal and interest of $1,609 to repay 

the loan amount of $200,000 over the 

30-year loan term, using the maximum 

interest rate during the first five years 

after consummation of 9%. 

iii. Adjustable-rate mortgage with 

discount for five years. 

A. A loan in an amount of $200,000 

has a 30-year loan term. The loan 

agreement provides for a discounted 

interest rate of 6% that is fixed for an 

initial period of five years, after which 

the interest rate will adjust annually 

based on a specified index plus a 

margin of 3%, subject to a 2% annual 

interest rate adjustment cap. The index 

value in effect at consummation is 

4.5%. The loan consummates on March 

15, 2011 and the first regular periodic 

payment is due May 1, 2011. Under the 

terms of the loan agreement, the first 

rate adjustment is on April 1, 2016 (the 

due date of the 60th monthly payment), 

which occurs more than five years after 

consummation of the loan. Thus, the 

maximum interest rate under the terms 

of the loan during the first five years 

after consummation is 6%. 

B. The creditor will meet the 

definition of a qualified mortgage if it 

underwrites the loan using the monthly 

payment of principal and interest of 

$1,199 to repay the loan amount of 

$200,000 over the 30-year loan term 

using the maximum interest rate during 

the first five years of 6%. 

iv. Step-rate mortgage. A. A loan in an 

amount of $200,000 has a 30-year loan 

term. The loan agreement provides that 

the interest rate is 6.5% for the first two 

years of the loan, 7% for the next three 

years, and then 7.5% for remainder of 

the loan term. The maximum interest 

rate during the first five years after 

consummation is 7%, which occurs on 

the due date of the 24th monthly 

payment. The outstanding principal 

balance at the end of the second year 

(after the 24th payment is credited) is 

$195,379. 

B. The creditor will meet the 

definition of a qualified mortgage if it 

underwrites the loan using a monthly 

payment of principal and interest of 

$1,328 to repay the outstanding 

principal balance of $195,379 over the 

remaining 28 years of the loan term (336 

months), using the maximum interest 

rate during the first five years of 7%. 

Alternatively, the creditor will meet the 

definition of a qualified mortgage if it 

underwrites the loan using a monthly 

payment of principal and interest of 

$1,331 to repay $200,000 over the 30- 

year loan term using the maximum 

interest rate during the first five years of 

7%. 

Alternative 1—Paragraph 43(e)(2)(v) 

Paragraph 43(e)(2)(v). 

1. Income or assets. Creditors may 

rely on commentary to § 226.43(c)(2)(i), 

(c)(3), and (c)(4) for guidance regarding 

considering and verifying the 

consumer’s income or assets to satisfy 

the conditions under § 226.43(e)(2)(v) 

for a ‘‘qualified mortgage.’’ 

Alternative 2—Paragraph 43(e)(2)(v) 

Paragraph 43(e)(2)(v). 

1. Repayment ability. Creditors may 

rely on commentary to § 226.43(c)(2)(i), 

(ii), (iv), and (vi) through (viii), (c)(3), 

(c)(4), (c)(6), and (c)(7) for guidance 

regarding considering and verifying the 

consumer’s repayment ability to satisfy 

the conditions under § 226.43(e)(2)(v) 

for a ‘‘qualified mortgage.’’ 

43(e)(3) Limits on points and fees for 

qualified mortgages. 

Paragraph 43(e)(3)(i). 

1. Total loan amount. For an 

explanation of how to calculate the 

‘‘total loan amount’’ under 

§ 226.43(e)(3)(i), see comment 

32(a)(1)(ii)-1. 

2. Calculation of allowable points and 

fees. A creditor must determine which 

category the loan falls into based on the 

face amount of the note (the ‘‘loan 

amount’’), but must apply the allowable 

points and fees percentage to the ‘‘total 

loan amount,’’ which may be different 

than the face amount of the note. A 

creditor must calculate the allowable 

amount of points and fees for a qualified 

mortgage as follows: 

i. First, the creditor must determine 

the ‘‘tier’’ into which the loan falls based 

on the loan amount. The loan amount is 

the principal amount the consumer will 

borrow as reflected in the promissory 

note or loan contract. See § 226.43(b)(5). 

For example, if the loan amount is 

$75,000, the loan falls into the tier for 

loans of $75,000 or more, to which a 

three percent cap on points and fees 

applies. 

ii. Second, the creditor must 

determine the ‘‘total loan amount’’ based 

on the calculation for the ‘‘total loan 

amount’’ under comment 32(a)(1)(ii)–1. 

If the loan amount is $75,000, for 

example, the ‘‘total loan amount’’ may be 

a different amount, such as $73,000. 

iii. Third, the creditor must apply the 

percentage cap on points and fees to the 

‘‘total loan amount.’’ For example, for a 

loan of $75,000 where the ‘‘total loan 

amount’’ is $73,000, the allowable 

points and fees is three percent of 

$73,000 or $2,190. 

Alternative 1—Comment 43(e)(3)(i)–3 

3. Sample determination of allowable 

points and fees for a $50,000 loan. A 

covered transaction with a loan amount 

of $50,000 falls into the third points and 

fees tier, to which a points and fees cap 

of 3.5 percent of the total loan amount 

applies. See § 226.43(e)(3)(i)(C). If a 

$48,000 total loan amount is assumed, 

the allowable points and fees for this 

$50,000 loan is 3.5 percent of $48,000 

or $1,920. 

Alternative 2—Comment 43(e)(3)(i)–3 

3. Sample determination of allowable 

points and fees for a $50,000 loan. A 

covered transaction with a loan amount 

of $50,000 falls into the second points 

and fees tier, requiring application of a 

formula to derive the allowable points 

and fees. See § 226.43(e)(3)(i)(B). If a 

$48,000 total loan amount is assumed, 

the required formula must be applied as 

follows: 

i. First, the amount of $20,000 must 

be subtracted from $48,000 to yield the 

number of dollars to which the .0036 

basis points multiple must be applied— 

in this case, $28,000. 

ii. Second, $28,000 must be 

multiplied by .0036—in this case 

resulting in 100.8. 

iii. Third, 100.8 must be subtracted 

from 500. (The maximum allowable 

points and fees on any loan is five 

percent of the total loan amount for 

loans of less than $20,000. Five percent 

expressed in basis points is 500). Five 

hundred minus 100.8 equals 399.2, 

which is the allowable points and fees 

in basis points. 

iv. Finally, the allowable points and 

fees in basis points must be translated 

into the appropriate percentage of the 

‘‘total loan amount,’’ which is achieved 

by multiplying 399.2 by .01. The result 

is 3.99 percent. Accordingly, the 

allowable points and fees for this 

$50,000 loan as a dollar figure is 3.99 

percent of $48,000 or $1,915.20. 

Paragraph 43(e)(3)(ii). 

1. Charges not retained by the 

creditor, loan originator, or an affiliate 

of either. In general, a creditor is not 

required to count in ‘‘points and fees’’ 

for a qualified mortgage any bona fide 

third party charge not retained by the 

creditor, loan originator, or an affiliate 

of either. For example, if a creditor 

charges a consumer $400 for an 

appraisal conducted by a third party not 

affiliated with the creditor, pays the 

third party appraiser $300 for the 

appraisal, and retains $100, the creditor 

may exclude $300 of this fee but count 

the $100 it retains in ‘‘points and fees’’ 

for a qualified mortgage. 

2. Private mortgage insurance. For 

qualified mortgages, the exclusion for 


jlentini on DSKJ8SOYB1PROD with PROPOSALS2
27504 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

bona fide third party charges not 

retained by the creditor, loan originator, 

or an affiliate of either is limited by 

§ 226.32(b)(1)(i)(B) in the general 

definition of ‘‘points and fees.’’ Section 

226.32(b)(1)(i)(B) requires inclusion in 

‘‘points and fees’’ of premiums or other 

charges payable at or before closing for 

any private guaranty or insurance 

protecting the creditor against the 

consumer’s default or other credit loss 

to the extent that the premium or charge 

exceeds the amount payable under 

policies in effect at the time of 

origination under section 203(c)(2)(A) of 

the National Housing Act (12 U.S.C. 

1709(c)(2)(A)). These premiums or 

charges must also be included if the 

premiums or charges are not required to 

be refundable on a pro-rated basis, or 

the refund is not required to be 

automatically issued upon notification 

of the satisfaction of the underlying 

mortgage loan. Under these 

circumstances, even if the premiums or 

other charges are not retained by the 

creditor, loan originator, or an affiliate 

of either, they must be included in the 

‘‘points and fees’’ calculation for 

qualified mortgages. See comments 

32(b)(1)(i)–3 and –4 for further 

discussion of including upfront private 

mortgage insurance premiums in the 

points and fees calculation. 

3. Exclusion of up to two bona fide 

discount points. Section 

226.43(e)(3)(ii)(B) provides that, under 

certain circumstances, up to two ‘‘bona 

fide discount points,’’ as defined in 

§ 226.43(e)(3)(iii), may be excluded from 

the ‘‘points and fees’’ calculation for a 

qualified mortgage. The following 

example illustrates the rule: 

i. Assume a covered transaction that 

is a first-lien, purchase money home 

mortgage with a fixed interest rate and 

a 30-year term. Assume also that the 

consumer locks in an interest rate of 

6.00 percent on May 1, 2011, that was 

discounted from a rate of 6.50 percent 

because the consumer paid two 

discount points. Finally, assume that 

the average prime offer rate (APOR) as 

of May 1, 2011 for home mortgages with 

a fixed interest rate and a 30-year term 

is 5.50 percent. 

ii. The creditor may exclude two 

discount points from the ‘‘points and 

fees’’ calculation because the rate from 

which the discounted rate was derived 

(6.50 percent) exceeded APOR for a 

comparable transaction as of the date 

the rate on the covered transaction was 

set (5.25 percent) by only one percent. 

For the meaning of ‘‘comparable 

transaction,’’ refer to comment 

43(e)(3)(ii)–5. 

4. Exclusion of up to one bona fide 

discount point. Section 

226.43(e)(3)(ii)(C) provides that, under 

certain circumstances, up to one ‘‘bona 

fide discount point,’’ as defined in 

§ 226.43(e)(3)(iii), may be excluded from 

the ‘‘points and fees’’ calculation for a 

qualified mortgage. The following 

example illustrates the rule: 

i. Assume a covered transaction that 

is a first-lien, purchase money home 

mortgage with a fixed interest rate and 

a 30-year term. Assume also that the 

consumer locks in an interest rate of 

6.00 percent on May 1, 2011, that was 

discounted from a rate of 7.00 percent 

because the consumer paid four 

discount points. Finally, assume that 

the average prime offer rate (APOR) as 

of May 1, 2011, for home mortgages 

with a fixed interest rate and a 30-year 

term is 5.00 percent. 

ii. The creditor may exclude one 

discount point from the ‘‘points and 

fees’’ calculation because the rate from 

which the discounted rate was derived 

(7.00 percent) exceeded APOR for a 

comparable transaction as of the date 

the rate on the covered transaction was 

set (5.00 percent) by only two percent. 

5. Comparable transaction. The table 

of average prime offer rates published 

by the Board indicates how to identify 

the comparable transaction. See 

comment 45(a)(2)(ii)-2. 

43(f) Balloon-payment qualified 

mortgages made by certain creditors. 

43(f)(1) Exception. 

Paragraph 43(f)(1)(i). 

1. Satisfaction of qualified mortgage 

requirements. Under § 226.43(f)(1)(i), a 

qualified mortgage that provides for a 

balloon payment must satisfy all of the 

requirements for a qualified mortgage in 

§ 226.43(e)(2), other than 

§ 226.43(e)(2)(i)(B), (e)(2)(i)(C), and 

(e)(2)(iv). Therefore, to satisfy this 

condition, a covered transaction with 

balloon payment terms must provide for 

regular periodic payments that do not 

result in an increase of the principal 

balance, pursuant to § 226.43(e)(2)(i)(A); 

must have a loan term that does not 

exceed 30 years, pursuant to 

§ 226.43(e)(2)(ii); must have total points 

and fees that do not exceed specified 

thresholds pursuant to 

§ 226.43(e)(2)(iii); and must satisfy the 

consideration and verification 

requirements in § 226.43(e)(2)(v). 

Paragraph 43(f)(1)(ii). 

1. Example. Under § 226.43(f)(1)(ii), if 

a qualified mortgage provides for a 

balloon payment, the creditor must 

determine that the consumer is able to 

make all scheduled payments under the 

legal obligation other than the balloon 

payment. For example, assume a loan in 

an amount of $200,000 that has a fiveyear loan term, but is amortized over 30 

years. The loan agreement provides for 

a fixed interest rate of 6%. The loan 

consummates on March 15, 2011, and 

the monthly payment of principal and 

interest scheduled for the first five years 

is $1,199, with the first monthly 

payment due on May 1, 2011. The 

balloon payment of $187,308 is required 

on the due date of the 60th monthly 

payment, which is April 1, 2016. The 

loan remains a qualified mortgage if the 

creditor underwrites the loan using the 

scheduled principal and interest 

payment of $1,199 (plus all mortgagerelated obligations, pursuant to 

§ 226.43(f)(1)(iii)(B)). 

2. Creditor’s determination. A creditor 

must determine that the consumer is 

able to make all scheduled payments 

other than the balloon payment to 

satisfy § 226.43(f)(1)(ii), but the creditor 

is not required to meet the repayment 

ability requirements of § 226.43(c)(2)–(7) 

because those requirements apply only 

to covered transactions that are not 

qualified mortgages. Nevertheless, a 

creditor satisfies § 226.43(f)(1)(ii) if it 

complies with the requirements of 

§ 226.43(c)(2)–(7). A creditor also may 

make the determination that the 

consumer is able to make the scheduled 

payments (other than the balloon 

payment) by other means. For example, 

a creditor need not determine that the 

consumer is able to make the scheduled 

payments based on a payment amount 

that is calculated in accordance with 

§ 226.43(c)(5)(ii)(A) or may choose to 

consider a debt-to-income ratio that is 

not determined in accordance with 

§ 226.43(c)(7). 

Paragraph 43(f)(1)(iii). 

1. Amortization period. Under 

§ 226.43(f)(1)(ii), if a qualified mortgage 

provides for a balloon payment, the 

creditor must determine that the 

consumer is able to make all scheduled 

payments under the legal obligation 

other than the balloon payment. Under 

§ 226.43(f)(1)(iii), those scheduled 

payments must be determined using an 

amortization period that does not 

exceed 30 years and must include all 

mortgage-related obligations. Balloon 

payments often result when the periodic 

payment would fully repay the loan 

amount only if made over some period 

that is longer than the loan term. For 

example, a loan term of 10 years with 

periodic payments based on an 

amortization period of 20 years would 

result in a balloon payment being due 

at the end of the loan term. Whatever 

the loan term, the amortization period 

used to determine the scheduled 

periodic payments that the consumer 

must pay under the terms of the legal 

obligation may not exceed 30 years. 

Paragraph 43(f)(1)(v). 


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1. Creditor qualifications. Under 

§ 226.43(f)(1)(v), to make a qualified 

mortgage that provides for a balloon 

payment, the creditor must satisfy the 

following four criteria: 

i. During the preceding calendar year, 

the creditor extended over 50% of its 

total covered transactions with balloon 

payment terms in counties that are 

‘‘rural’’ or ‘‘underserved,’’ as defined in 

§ 226.43(f)(2). Pursuant to that section, 

the Board determines annually which 

counties in the United States are rural 

or underserved and publishes on its 

public Web site a list of those counties 

to enable creditors to determine whether 

they meet this criterion. Thus, for 

example, if a creditor originated 90 

covered transactions with balloon 

payment terms during 2010, the creditor 

meets this element of the exception in 

2011 if at least 46 of those loans are 

secured by properties located in one or 

more counties that are on the Board’s 

list for 2010. 

Alternative 1—Paragraph 43(f)(1)(v)–1.ii 

ii. During the preceding calendar year, 

the creditor together with all affiliates 

extended covered transactions with 

principal amounts that in the aggregate 

total $____ or less. 

Alternative 2—Paragraph 43(f)(1)(v)–1.ii 

ii. During the preceding calendar year, 

the creditor together with all affiliates 

extended ___ or fewer covered 

transactions. 

Alternative 1—Paragraph 43(f)(1)(v)– 

1.iii 

iii. On and after [effective date of final 

rule], the creditor has not sold, assigned, 

or otherwise transferred legal title to the 

debt obligation for any covered 

transaction with a balloon-payment 

term. 

Alternative 2—Paragraph 43(f)(1)(v)– 

1.iii 

iii. During the preceding or current 

calendar year, the creditor has not sold, 

assigned, or otherwise transferred legal 

title to the debt obligation for any 

covered transaction with a balloonpayment term. Thus, for example, if a 

creditor sells a covered transaction with 

a balloon-payment term on April 1, 

2012, the creditor becomes ineligible for 

the exception for the remainder of 2012 

(but not retroactively for January 

through March of 2012) and all of 2013. 

If the creditor sells no covered 

transactions with balloon-payment 

terms during 2013, it then may become 

eligible again for the exception 

beginning on January 1, 2014 and 

remains eligible until and unless it sells 

such loans during 2014. 

iv. As of the end of the preceding 

calendar year, the creditor had total 

assets that do not exceed the current 

asset threshold established by the 

Board. For calendar year 2011, the asset 

threshold is $2,000,000,000. Creditors 

that had total assets of $2,000,000,000 or 

less on December 31, 2010 satisfy this 

criterion for purposes of the exception 

during 2011. 

43(f)(2) ‘‘Rural’’ and ‘‘underserved’’ 

defined. 

1. Requirements for ‘‘rural or 

underserved’’ status. A county is 

considered ‘‘rural or underserved’’ for 

purposes of § 226.43(f)(1)(v)(A) if it 

satisfies either of the two tests in 

§ 226.43(f)(2). The Board applies both 

tests to each county in the United States 

and, if a county satisfies either test, 

includes that county on the annual list 

of ‘‘rural or underserved’’ counties. The 

Board publishes on its public Web site 

the applicable list for each calendar year 

by the end of that year. A creditor’s 

originations of covered transactions 

with balloon-payment terms in such 

counties during that year are considered 

in determining whether the creditor 

satisfies the condition in 

§ 226.43(f)(1)(v)(A) and therefore will be 

eligible for the exception during the 

following calendar year. The Board 

determines whether each county is 

‘‘rural’’ by reference to the currently 

applicable Urban Influence Codes 

(UICs), established by the United States 

Department of Agriculture’s Economic 

Research Service (USDA–ERS). 

Specifically, the Board classifies a 

county as ‘‘rural’’ if the USDA–ERS 

categorizes the county under UIC 7, 10, 

11, or 12. The Board determines 

whether each county is ‘‘underserved’’ 

by reference to data submitted by 

mortgage lenders under the Home 

Mortgage Disclosure Act (HMDA). 

43(g) Prepayment penalties. 

43(g)(2) Limits on prepayment 

penalties. 

1. Maximum period and amount. 

Section 226.43(g)(2) establishes the 

maximum period during which a 

prepayment penalty may be imposed 

and the maximum amount of the 

prepayment penalty. A covered 

transaction may include a prepayment 

penalty that may be imposed during a 

shorter period or in a lower amount 

than provided under § 226.43(g)(2). For 

example, a covered transaction may 

include a prepayment penalty that may 

be imposed for two years after 

consummation and equals two percent 

of the amount prepaid in each of those 

two years. 

43(g)(3) Alternative offer required. 

Paragraph 43(g)(3)(i). 

1. Same type of interest rate. Under 

§ 226.43(g)(3)(i), if a creditor offers a 

consumer a covered transaction with a 

prepayment penalty, the creditor must 

offer the consumer an alternative 

covered transaction without a 

prepayment penalty and with an annual 

percentage rate that cannot increase 

after consummation. Further, the 

covered transaction with a prepayment 

penalty and the alternative covered 

transaction without a prepayment 

penalty must both be fixed-rate 

mortgages or both be step-rate 

mortgages, as defined in 

§ 226.18(s)(7)(iii) and (ii), respectively. 

Paragraph 43(g)(3)(iv). 

1. Points and fees. Whether or not an 

alternative covered transaction without 

a prepayment penalty satisfies the 

points and fees conditions for a 

qualified mortgage is determined based 

on the information known to the 

creditor at the time the creditor offers 

the consumer the transaction. At the 

time a creditor offers a consumer an 

alternative covered transaction without 

a prepayment penalty under 

§ 226.43(g)(3), the creditor may know 

the amount of some, but not all, of the 

points and fees that will be charged for 

the transaction. For example, a creditor 

may not know that a consumer intends 

to buy single-premium credit 

unemployment insurance, which would 

be included in the points and fees for 

the covered transaction. The points and 

fees condition under § 226.43(g)(3)(ii)(C) 

is satisfied if a creditor reasonably 

believes, based on information known to 

the creditor at the time the offer is 

made, that the amount of points and 

fees to be charged for an alternative 

covered transaction without a 

prepayment penalty will be less than or 

equal to the amount of points and fees 

allowed for a qualified mortgage under 

§ 226.43(e)(2)(iii). 

Paragraph 43(g)(3)(v). 

1. Transactions for which the 

consumer likely qualifies. Under 

§ 226.43(g)(3)(v), the alternative covered 

transaction without a prepayment 

penalty the creditor must offer under 

§ 226.43(g)(3) must be a transaction for 

which the creditor has a good faith 

belief the consumer likely qualifies. For 

example, assume the creditor has a good 

faith belief the consumer can afford 

monthly payments of up to $800. If the 

creditor offers the consumer a fixed-rate 

mortgage with a prepayment penalty for 

which monthly payments are $700 and 

an alternative covered transaction 

without a prepayment penalty for which 

monthly payments are $900, the 

requirements of § 226.43(g)(3)(v) are not 

met. The creditor’s belief that the 

consumer likely qualifies for the 


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27506 Federal Register / Vol. 76, No. 91 / Wednesday, May 11, 2011 / Proposed Rules 

covered transaction without a 

prepayment penalty should be based on 

the information known to the creditor at 

the time the creditor offers the 

transaction. In making this 

determination, the creditor may rely on 

information provided by the consumer, 

even if the information subsequently is 

determined to be inaccurate. 

43(g)(4) Offer through a mortgage 

broker. 

1. Rate sheet. Under § 226.43(g)(4), 

where the creditor offers covered 

transactions with a prepayment penalty 

to consumers through a mortgage 

broker, as defined in § 226.36(a)(2), the 

creditor must present the mortgage 

broker an alternative covered 

transaction that satisfies the 

requirements of § 226.43(g)(3). Creditors 

may comply with this requirement by 

providing a rate sheet to the mortgage 

broker that states the terms of such an 

alternative covered transaction without 

a prepayment penalty. 

2. Alternative to creditor’s offer. 

Section 226.43(g)(4)(ii) requires that the 

creditor provide, by agreement, for the 

mortgage broker to present the 

consumer an alternative covered 

transaction without a prepayment 

penalty offered by either (1) the creditor, 

or (2) another creditor, if the other 

creditor offers a covered transaction 

with a lower interest rate or a lower 

total dollar amount of origination points 

or fees and discount points. The 

agreement may provide for the mortgage 

broker to present both the creditor’s 

covered transaction and a covered 

transaction offered by another creditor 

with a lower interest rate or a lower 

total dollar amount of origination points 

or fees and discount points. See 

comment 36(e)(3)–3 for guidance in 

determining which step-rate mortgage 

has a lower interest rate. 

3. Agreement. The creditor’s 

agreement with a mortgage broker for 

purposes of § 226.43(g)(4) may be part of 

another agreement with the mortgage 

broker, for example, a compensation 

agreement. Thus, the creditor need not 

enter into a separate agreement with the 

mortgage broker with respect to each 

covered transaction with a prepayment 

penalty. 

43(g)(5) Creditor that is a loan 

originator. 

1. Loan originator. The definition of 

‘‘loan originator’’ in § 226.36(a)(1) 

applies for purposes of § 226.43(g)(5). 

Thus, a loan originator includes any 

creditor that satisfies the definition of 

loan originator but makes use of ‘‘tablefunding’’ by a third party. See comment 

36(a)–1.i, –1.ii. 

2. Lower interest rate. Under 

§ 226.43(g)(5), a creditor that is a loan 

originator must present an alternative 

covered transaction without a 

prepayment penalty that satisfies the 

requirements of § 226.43(g)(3) offered by 

either the assignee for the covered 

transaction or another person, if that 

other person offers a transaction with a 

lower interest rate or a lower total dollar 

amount of origination points or fees or 

discount points. See comment 36(e)(3)– 

3 for guidance in determining which 

step-rate mortgage has a lower interest 

rate. 

43(h) Evasion; open-end credit. 

1. Subject to closed-end credit rules. 

Where a loan is documented as openend credit but the features and terms or 

other circumstances demonstrate that it 

does not meet the definition of openend credit, the loan is subject to the 

rules for closed-end credit, including 

§ 226.43.fi 

* * * * * 

By order of the Board of Governors of the 

Federal Reserve System, April 18, 2011. 

Jennifer J. Johnson, 

Secretary of the Board. 

[FR Doc. 2011–9766 Filed 5–10–11; 8:45 am] 

BILLING CODE 6210–01–P 


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