```

[Federal Register Volume 76, Number 91 (Wednesday, May 11, 2011)]
[Proposed Rules]
[Pages 27390-27506]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-9766]

[[Page 27389]]

Vol. 76

Wednesday,

No. 91

May 11, 2011

Part II

Federal Reserve System

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12 CFR Part 226

Regulation Z; Truth in Lending; Proposed Rule

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

[[Page 27390]]

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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.

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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 (Dodd-Frank 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 
(Dodd-Frank 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 Sec.  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 low-documentation 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, 
interest-only 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;

[[Page 27391]]

    (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 mortgage-related 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 Dodd-Frank 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 closed-end 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).
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    \1\ Mortgages covered by the HOEPA amendments have been referred 
to as ``HOEPA loans,'' ``Section 32 loans,'' or ``high-cost 
mortgages.'' The Dodd-Frank Act now refers to these loans as ``high-
cost mortgages.'' See the Dodd-Frank Act Sec.  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.
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    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

[[Page 27392]]

creditor. TILA Section 125(e); 15 U.S.C. 1635(e).
    In 1995, the Board implemented the HOEPA amendments at Sec.  
226.31, 226.32, and 226.33 of Regulation Z. 60 FR 15463, March 24, 
1995. In particular, Sec.  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 fully-indexed 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.
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    \2\ The 2006 Nontraditional Mortgage Guidance and the 2007 
Subprime Mortgage Statement will hereinafter collectively be 
referred to as the ``Interagency Supervisory Guidance.''
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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 ``higher-
priced 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 
ability-to-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 Anti-Predatory 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 Dodd-Frank 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 Anti-Predatory Lending Act.\3\ 
Sections 1411,

[[Page 27393]]

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, Sec.  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).
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    \3\ Although 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).
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    Specifically, TILA Section 129C:
     Expands coverage of 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.
     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, fixed-rate 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 Closed-End 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, transaction-specific 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 Sec.  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.
---------------------------------------------------------------------------

    \4\ The 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.
---------------------------------------------------------------------------

    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 ``higher-priced 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

[[Page 27394]]

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 Dodd-Frank 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 asset-backed 
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 ability-to-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 
dwelling-secured 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 ability-
to-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;

[[Page 27395]]

     The monthly payment on the covered transaction;
     The monthly payment on any simultaneous loan;
     The monthly payment for mortgage-related 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 higher-priced 
balloon loan unless the consumer had substantial documented assets or 
income.
---------------------------------------------------------------------------

    \5\ The 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 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 low-
documentation 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 adjustable-rate 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 non-standard 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

[[Page 27396]]

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-to-repay 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-to-repay 
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-
to-income ratio, and credit history). The definition provides a 
presumption of compliance that could be rebutted by the consumer.
    Limits on points and fees. The Dodd-Frank 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.

[[Page 27397]]

    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-to-income 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 balloon-payment 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 Dodd-Frank 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 
Dodd-Frank 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 open-end credit. Currently, 
Regulation Z prohibits a creditor from structuring a closed-end loan as 
an open-end plan to evade the requirements for higher-priced 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.

[[Page 27398]]

V. Section-by-Section Analysis

Section 226.25 Record Retention

25(a) General Rule
    Currently, Sec.  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 Sec.  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 Sec.  226.25(a) to require that creditors 
retain records that evidence compliance with proposed Sec.  226.43 for 
at least three years after consummation. Although creditors will take 
action required under proposed Sec.  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 Sec.  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 Sec.  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 Sec.  226.43, the 
creditor should retain evidence sufficient to demonstrate compliance 
with the documentation requirements of Sec.  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 Sec.  
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 Sec.  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 Sec.  
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 Sec.  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 Sec.  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 Sec.  226.43(g)(4)(i), such as a rate sheet, and (2) the 
agreement with the mortgage broker required by proposed Sec.  
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 Sec.  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); Sec.  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.
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    \6\ Public Law 111-203, 124 Stat. 1376, Title XIV, Sec.  1431.
    \7\ Id. Sec.  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).
---------------------------------------------------------------------------

    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

[[Page 27399]]

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 Sec.  226.43(e)(3), 
discussed below.\10\
---------------------------------------------------------------------------

    \8\ Id. Sec.  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. Sec.  1431(a); TILA 
Section 103(aa)(1)(A)(ii); 15 U.S.C. 1602(aa)(1)(A)(ii).
    \9\ Public Law 111-203, 124 Stat. 1376, Title XIV, Sec.  1431(a) 
and (d); TILA Section 103(aa)(1) and (dd); 15 U.S.C. 1602(aa)(1) and 
(dd).
    \10\ Public Law 111-203, 124 Stat. 1376, Title XIV, Sec.  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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \11\ Similarly, prior to being revised by the Dodd-Frank 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 
Sec.  226.32(a)(1)(ii). Commentary to Sec.  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 high-cost 
mortgage in Sec.  226.32 to implement Dodd-Frank Act amendments to 
TILA's high-cost mortgage provisions.
---------------------------------------------------------------------------

    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 Sec.  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 Sec.  
226.18(b), and deducting any cost listed in Sec.  226.32(b)(1)(iii) and 
Sec.  226.32(b)(1)(iv) that is both included as points and fees under 
Sec.  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 Sec.  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 Sec.  
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 
Sec.  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 Dodd-Frank 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).
---------------------------------------------------------------------------

    \12\ Public Law 111-203, 124 Stat. 1376, Title XIV, Sec.  1414. 
The Board is not at this time proposing to implement the 
restrictions on single-premium credit insurance under the Dodd-Frank 
Act.
---------------------------------------------------------------------------

    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 Sec.  226.18(b)) and deducting any cost listed in Sec.  
226.32(b)(1)(iii) and Sec.  226.32(b)(1)(iv) that is both included as 
points and fees under Sec.  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 Sec.  226.18(b) and accompanying 
commentary), minus charges that are points and fees under Sec.  
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 Sec.  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 Sec.  226.32(b)(1)(iii) or (b)(1)(iv) that 
are financed. In this example, there are no charges under Sec.  
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

[[Page 27400]]

for FHA loans is $2,000. Under proposed Sec.  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 Sec.  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 Sec.  
226.32(b)(1)(v) and (vi)). These changes are discussed in turn below.
32(b)(1)(i) Finance Charge
    Current Sec.  226.32(b)(1)(i) requires that ``points and fees'' 
include ``all items required to be disclosed under Sec.  226.4(a) and 
226.4(b)''--the provisions that define the term ``finance charge'' --
``except interest or the time-price differential.'' Proposed Sec.  
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 Sec.  
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--
    [cir] in connection with any Federal or state agency program;
    [cir] 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
    [cir] payable after the loan closing.

See proposed Sec.  226.32(b)(1)(i)(A)-(C).
    The Board proposes to revise the existing phrase, ``all items 
required to be disclosed under Sec.  226.4(a) and 226.4(b)'' to read, 
``all items considered to be a finance charge under Sec.  226.4(a) and 
226.4(b)'' in part because Sec.  226.4 itself does not require 
disclosure of the finance charge (see instead, for example, Sec.  
226.18(d)).
    The Board also proposes to revise comment 32(b)(1)(i)-1. Existing 
comment 32(b)(1)(i)-1 states that Sec.  226.32(b)(1)(i) includes in the 
total ``points and fees'' items defined as finance charges under Sec.  
226.4(a) and 226.4(b). The comment explains that items excluded from 
the finance charge under other provisions of Sec.  226.4 are not 
included in the total ``points and fees'' under Sec.  226.32(b)(1)(i), 
but may be included in ``points and fees'' under Sec.  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 Sec.  226.4 may be included in ``points and fee'' under Sec.  
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 
Sec.  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 Sec.  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, Sec.  
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 Sec.  
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 
Sec.  226.32(b)(1)(v) and (b)(1)(vi)).
32(b)(1)(i)(B) Mortgage Insurance
    Proposed Sec.  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 Sec.  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 Sec.  226.32(b)(1)(i)(B)(1). Proposed 
comment 32(b)(1)(i)-2 explains that, under Sec.  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 Sec.  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

[[Page 27401]]

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.
---------------------------------------------------------------------------

    \13\ The 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).
---------------------------------------------------------------------------

    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 Sec.  
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 Sec.  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 Sec.  
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 Sec.  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 Sec.  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 Dodd-Frank 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 
high-cost 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.

[[Page 27402]]

    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 Sec.  226.32(b)(ii) to reflect 
statutory amendments under the Dodd-Frank Act. Current Sec.  
226.32(b)(ii) requires inclusion in points and fees of ``all 
compensation paid to a mortgage broker.'' Proposed Sec.  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 Sec.  226.32(b)(2), discussed below.
    Proposed Sec.  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 Sec.  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 Sec.  226.36. 
The Board believes that the term ``loan originator,'' as defined in 
Sec.  226.36(a)(1), is appropriately used in proposed Sec.  
226.32(b)(1)(ii) because the meaning of ``loan originator'' under Sec.  
226.36(a)(1) and the statutory definition of ``mortgage originator'' 
are consistent in several key respects, discussed below.
---------------------------------------------------------------------------

    \14\ Section 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).
    \15\ Public Law 111-203, 124 Stat. 1376, Title XIV, Sec.  1401.
---------------------------------------------------------------------------

    In addition, new Sec.  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 Sec.  
226.36(a)(1). Proposed Sec.  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 Sec.  226.32(b)(2), below. Use of the term ``loan 
originator'' in proposed Sec.  226.32(b)(1)(ii).
    Loan originator functions. The Dodd-Frank 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 Sec.  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

[[Page 27403]]

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 Sec.  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 Sec.  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 Sec.  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 Sec.  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 Sec.  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 Sec.  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 Sec.  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 Sec.  226.32(a)(1), is included in ``points and fees.'' No 
other substantive changes are intended.
---------------------------------------------------------------------------

    \16\ Loan originator compensation would, of course, need to be 
consistent with the Interagency Guidance on Sound Incentive 
Compensation Policies. 75 FR 36395, June 25, 2010.
---------------------------------------------------------------------------

    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

[[Page 27404]]

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 Sec.  226.32(b)(1)(iii), which includes in points and fees 
``all items listed in Sec.  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 creditor-
affiliated 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.
---------------------------------------------------------------------------

    \17\ See 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 Sec.  
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.
---------------------------------------------------------------------------

    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 Sec.  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 
Sec.  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\
---------------------------------------------------------------------------

    \18\ Section 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 loan-related 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).
---------------------------------------------------------------------------

    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 Sec.  226.32(b)(1)(iv) to reflect 
statutory changes under the Dodd-Frank Act. See TILA Section 
103(aa)(4)(D). Specifically, proposed Sec.  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-of-

[[Page 27405]]

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 Sec.  226.32(b)(1)(iv). 
Accordingly, proposed revisions to Sec.  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 single-premium credit 
unemployment insurance will be included in points and fees.\19\
---------------------------------------------------------------------------

    \19\ Public Law 111-203, 124 Stat. 1376, Title XIV, Sec.  1414. 
The Board is not at this time proposing to implement the 
restrictions on single-premium credit insurance under the Dodd-Frank 
Act.
---------------------------------------------------------------------------

    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 Sec.  
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 Sec.  226.32(b)(1)(v) includes in points and fees ``the 
maximum prepayment penalty, as defined in Sec.  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 non-substantive 
changes, such as that the proposed regulatory provision cross-
references proposed Sec.  226.43(b)(10) for the definition of 
``prepayment penalty.'' See section-by-section analysis of Sec.  
226.43(b)(10), below.
32(b)(1)(vi) Total Prepayment Penalties Incurred in a Refinance
    Proposed Sec.  226.32(b)(1)(vi) includes in points and fees ``the 
total prepayment penalty, as defined in Sec.  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 
Sec.  226.43(b)(10) for the definition of ``prepayment penalty.'' See 
section-by-section analysis of Sec.  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 Sec.  226.32(b)(2) to reflect statutory 
amendments under the Dodd-Frank Act. Current Sec.  226.32(b)(2), 
defining ``affiliate,'' is proposed to be re-numbered as Sec.  
226.32(b)(3). Proposed Sec.  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 Sec.  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

[[Page 27406]]

consumer with regard to a residential mortgage loan.\20\
---------------------------------------------------------------------------

    \20\ Specifically, 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).
---------------------------------------------------------------------------

    Real estate brokers. Proposed Sec.  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 Sec.  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\
---------------------------------------------------------------------------

    \21\ The 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).
---------------------------------------------------------------------------

    Proposed Sec.  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 Sec.  226.36(a)(1) rather than the terms ``mortgage 
broker, or other mortgage originator'' because the term ``loan 
originator'' under Sec.  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 
Sec.  226.32(b)(1)(ii) for a discussion of consistencies between the 
meaning of ``loan originator'' in Sec.  226.36(a)(1) and ``mortgage 
originator'' in the Dodd-Frank Act.
    The term ``loan originator'' in Sec.  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 Sec.  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 Sec.  226.36(a)(1)), 
which is used in proposed Sec.  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 Sec.  226.36(a)(1) 
includes a servicer who refinances a mortgage. See comment 36(a)-1.iii. 
A ``refinancing'' under Sec.  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 Sec.  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 Sec.  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 Sec.  226.32(b)(2) defining the term ``affiliate'' is re-
numbered as Sec.  226.32(b)(3) to accommodate the new proposed Sec.  
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 Sec.  226.32

34(a) Prohibited Acts or Practices for Loans Subject to Sec.  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 Sec.  226.34(a)(4). As discussed in greater detail in the section-
by-section analysis to Sec.  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 Sec.  226.43 would implement this requirement and 
render unnecessary Sec.  226.34(a)(4). The Board therefore proposes to 
remove Sec.  226.34(a)(4) and its accompanying commentary. For ease of 
reading, the Board is not reprinting Sec.  226.34(a)(4) and its 
accompanying commentary in this proposed rule.

Section 226.35 Prohibited Acts or Practices in Connection With Higher-
Priced Mortgage Loans

    Currently, Sec.  226.35 prohibits certain acts or practices in 
connection with higher-priced mortgage loans. Section 226.35(a) 
provides the coverage test for

[[Page 27407]]

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 Sec.  226.35 unnecessary. 
The 2011 Escrow Proposal would adopt in proposed Sec.  226.45(a) the 
coverage test for higher-priced mortgage loans in 226.35(a); would 
revise and adopt in Sec.  226.45(b) the escrow requirements in Sec.  
226.35(b)(3); and would adopt in proposed Sec.  226.45(d) the 
prohibition of evasion of the higher-priced mortgage loan protections 
by structuring a transaction as open-end credit, now in Sec.  
226.35(b)(4). This proposal, as discussed below, would supersede in 
Sec.  226.43(a)-(f) the ability to repay requirement in Sec.  
226.35(b)(1), and would supersede in Sec.  226.43(g) the prepayment 
penalty rules in Sec.  226.34(b)(2). Accordingly, the Board proposes to 
remove and reserve Sec.  226.35 and its accompanying commentary. For 
ease of reading, the Board is not reprinting Sec.  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 Sec.  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 ``high-cost 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 Sec.  226.43(a) describes the scope of the requirement to 
determine a consumer's ability to repay a residential mortgage loan. 
Proposed Sec.  226.43(a)(1) and (2) provide that the repayment ability 
provisions under proposed Sec.  226.43 apply to consumer credit 
transactions secured by a dwelling, as defined in Sec.  226.2(a)(19), 
except for (1) a home equity line of credit (HELOC) subject to Sec.  
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 Sec.  226.43(a)(1) and (2) implement the exclusions from 
the definition of ``residential mortgage loan'' under TILA Section 
103(cc)(5). Proposed Sec.  226.43(a)(3) provides that the following 
transactions are exempt from coverage by proposed Sec.  226.43(c) 
through (f): (1) A reverse mortgage subject to Sec.  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 Sec.  226.43(c) and (d) 
implement repayment ability provisions and special rules for 
refinancings of ``non-standard'' 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 balloon-
payment 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 Sec.  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 Sec.  226.43(e) or (f). Such transactions nevertheless are 
subject to the prepayment penalty restrictions under proposed Sec.  
226.43(g), discussed in detail below.
    ``Residential mortgage loan.'' Proposed Sec.  226.43(a) clarifies 
that requirements under proposed Sec.  226.43 apply to any consumer 
credit transaction secured by a dwelling, as defined in Sec.  
226.2(a)(19), with certain exceptions discussed above. Proposed Sec.  
226.43(a) does not use the term ``residential mortgage loan,''

[[Page 27408]]

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 Sec.  
226.43 in a scope provision thus would facilitate compliance better 
than using the defined term ``residential mortgage loan.''
---------------------------------------------------------------------------

    \22\ See, 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).
---------------------------------------------------------------------------

    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 Sec.  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 Sec.  226.43.
    Owner occupancy; consumer credit transaction. If a transaction is a 
dwelling-secured extension of consumer credit, proposed Sec.  226.43 
applies regardless of whether or not the consumer occupies the dwelling 
(unless an exception from coverage applies under proposed Sec.  
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); Sec.  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 Sec.  226.43 does not apply to an extension of credit 
primarily for a business, commercial, or agricultural purpose and 
cross-references the existing guidance on determining the primary 
purpose of an extension of credit in commentary on Sec.  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); Sec.  
226.2(a)(19). To facilitate compliance by using consistent terminology 
throughout Regulation Z, the proposal uses the term ``dwelling,'' as 
defined in Sec.  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 Sec.  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 Sec.  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 Sec.  
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 Sec.  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 Sec.  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 Sec.  226.43(a) applies broadly to 
consumer credit transactions secured by a dwelling (other than 
transactions excepted from coverage under Sec.  226.43(a)(1)-(3)).
43(b) Definitions
    Section Sec.  226.43(b) provides several definitions for purposes 
of implementing the ability-to-repay, qualified mortgage, and 
prepayment penalty provisions under Sec.  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-by-section analysis of the scope 
provisions under proposed Sec.  226.43(a), the Board proposes to apply 
Sec.  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 Sec.  226.43(g), a 
reverse mortgage or a temporary or ``bridge'' loan with a loan term of 
12 months or less. Accordingly, proposed Sec.  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 Sec.  226.43(a), for purposes of proposed Sec.  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

[[Page 27409]]

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 Sec.  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 Sec.  226.43(b)(5)) over the loan term (as defined in proposed 
Sec.  226.43(b)(6)). This term appears primarily in proposed Sec.  
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 Sec.  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 Sec.  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 Sec.  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 Sec.  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.''
---------------------------------------------------------------------------

    \23\ See current 12 CFR Sec.  226.17(c)(1) and comment 17(c)(1)-
10, and 12 CFR Sec.  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.
---------------------------------------------------------------------------

    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 
Dodd-Frank 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 fully-indexed 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.
---------------------------------------------------------------------------

    \24\ See 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.
---------------------------------------------------------------------------

    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

[[Page 27410]]

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 Sec.  226.43(c). See Sec.  
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.
---------------------------------------------------------------------------

    \25\ See Mark Schweitzer and Guhan Venkatu, Adjustable-Rate 
Mortgages and the LIBOR Surprise, at http://www.clevelandfed.org/research/commentary/2009/012109.cfm.
---------------------------------------------------------------------------

    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

[[Page 27411]]

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 Sec.  226.43(a), addressing the 
proposal's scope, and proposed Sec.  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 Sec.  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 step-
rate 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 Sec.  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 
Sec.  226.43(c)(5)(ii)(A), and are discussed below.
    The proposed definition of ``higher-priced 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 Sec.  226.45(a)(2)(ii). 
Proposed Sec.  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 Sec.  
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 Sec.  
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 
``higher-priced 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, ``higher-priced 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

[[Page 27412]]

terms ``transaction coverage rate,'' and refers to the consumer's 
principal dwelling. See proposed comments 45(a)(2)(ii)-2 and -3.\28\
---------------------------------------------------------------------------

    \26\ A ``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 Sec.  226.35(a)(1)(v).
    \27\ The Board's Jumbo Loan Escrow Final Rule added new Sec.  
226.35(a)(1)(v) to provide a separate, higher rate threshold for 
determining when the Board's escrow requirement applies to higher-
priced 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 Sec.  
226.35 in its entirety, as discussed above. See proposed Sec.  
226.45(a)(1).
    \28\ 2011 Escrow Proposal, 76 FR 11598, 11626-11627, Mar. 2, 
2011.
---------------------------------------------------------------------------

    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 Sec.  
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 Sec.  
226.45(a)(2)(ii), and would cross-reference 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 higher-priced 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 Sec.  
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 Sec.  
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.
---------------------------------------------------------------------------

    \29\ See, e.g., Shane M. Sherland, ``The Jumbo-Conforming 
Spread: A Semiparametric Approach,'' Finance and Economics 
Discussion Series, Divisions of Research & Statistics and Monetary 
Affairs, Federal Reserve Board (2008-01).
---------------------------------------------------------------------------

    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 dwelling-secured 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 non-principal 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 Sec.  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.

[[Page 27413]]

    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 Sec.  226.17(c)(6), 
discussing multiple-advance loans and comment 17(c)(6)-2 and -3, 
discussing construction-to-permanent 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 Sec.  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 Sec.  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-to-permanent 
loans that are treated as as a single transaction, is needed.
    The term ``loan amount'' appears in proposed Sec.  226.43(b)(2), 
which defines ``fully amortizing payment,'' and in proposed Sec.  
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 Sec.  
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 Sec.  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 Sec.  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 Sec.  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 Sec.  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 Sec.  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 Sec.  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 Sec.  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

[[Page 27414]]

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\
---------------------------------------------------------------------------

    \30\ See 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.
    \31\ See 2006 Nontraditional Mortgage Guidance at 58614, n.7.
---------------------------------------------------------------------------

    The term ``maximum loan amount'' is used in proposed Sec.  
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 Sec.  
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 Sec.  226.18(s)(7)(v). The term also appears in proposed Sec.  
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 cross-reference 
proposed Sec.  226.43(b)(5) and Sec.  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 adjustable-rate 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 Sec.  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 Sec.  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 Sec.  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 Sec.  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 Sec.  
226.45(b)(1); homeowner's association, condominium, and cooperative 
fees; ground rent or leasehold payments; and special assessments. 
Proposed Sec.  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

[[Page 27415]]

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 Sec.  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 Sec.  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 Sec.  226.45(b)(1) parallels current Sec.  
226.35(b)(3)(i), which the Board is proposing to remove. See 76 FR 
11598, 11610, Mar. 2, 2011 for discussion of proposed Sec.  
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 mortgage-
related insurance required by the creditor as set forth in Sec.  
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 Sec.  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 
Sec.  226.43(b)(2).
    The term ``mortgage-related obligations'' appears in proposed Sec.  
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 Sec.  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 Sec.  226.43(c) and (e) are discussed in further detail below.
43(b)(9) Points and Fees
    For ease of reference, proposed Sec.  226.43(b)(9) states that the 
term ``points and fees'' has the same meaning as in Sec.  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 
transaction-specific 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 Sec.  
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.
---------------------------------------------------------------------------

    \32\ Also, 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).
    \33\ Prepayment penalty disclosure requirements under Sec.  
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 Sec.  226.38(a)(5) for disclosure of 
prepayment penalties specifically for closed-end mortgage 
transactions.
---------------------------------------------------------------------------

    Proposed Sec.  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 
Sec.  226.43(b)(10)(i) provides the following examples of ``prepayment 
penalties'' for purposes of Sec.  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

[[Page 27416]]

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 Sec.  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 Sec.  226.43(b)(10) uses language substantially similar to 
the language used in TILA Section 129C(c), but proposed Sec.  
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 Sec.  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 Sec.  226.38(a)(5) under the Board's 2009 
Closed-End Mortgage Proposal and 2010 Mortgage Proposal, discussed 
above. However, proposed Sec.  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 Sec.  226.32(b)(1)(v) and 
(vi) and in the requirements for prepayment penalties in Sec.  
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 
Sec.  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 Sec.  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 Sec.  226.43(b)(11) defines the term ``recast,'' which is 
used in two paragraphs of proposed Sec.  226.43: (1) Proposed Sec.  
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 Sec.  226.43(d) regarding payment 
calculations required for refinancings that are exempt from the 
ability-to-repay requirements in Sec.  226.43(c).
    Specifically, Sec.  226.43(b)(11) defines the term ``recast'' as 
follows: (1) For an adjustable-rate mortgage, as defined in Sec.  
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 
Sec.  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 
Sec.  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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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 Sec.  
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\
---------------------------------------------------------------------------

    \37\ See 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).
---------------------------------------------------------------------------

    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

[[Page 27417]]

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 Sec.  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 Sec.  226.43(a), discussing 
the scope of the ability-to-repay 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, Sec.  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 Sec.  226.34(a)(4) of which the creditor has 
knowledge. This comment does not distinguish between closed-end 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 Sec.  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 Sec.  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 Sec.  226.34(a)(4), proposed Sec.  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\
---------------------------------------------------------------------------

    \38\ See 2006 Nontraditional Mortgage Guidance, 71 FR 58609, 
58614 (Oct.4, 2006).
---------------------------------------------------------------------------

    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 first-lien 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 first-lien loan.
---------------------------------------------------------------------------

    \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.
    \40\ The 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.
---------------------------------------------------------------------------

    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 Sec.  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.,

[[Page 27418]]

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 Sec.  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-of-business. 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 Sec.  226.43(b)(12) defines a ``simultaneous loan'' to 
mean another covered transaction or home equity line of credit subject 
to Sec.  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 Sec.  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 Sec.  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 Sec.  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 cross-reference to Sec.  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 Sec.  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 Sec.  226.43(c)(2)(iv), which implements the requirement 
under TILA Sec.  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 Sec.  226.43(c)(6), which addresses the payment calculations 
for a simultaneous loan for purposes of proposed Sec.  
226.43(c)(2)(iv); and (3) proposed Alternative 2--Sec.  
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 ``third-party 
documents'' that provide reasonably reliable evidence of the consumer's 
income or assets, as discussed in detail below in the section-by-
section analysis of proposed Sec.  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 Sec.  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

[[Page 27419]]

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 Sec.  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 Sec.  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 Sec.  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 Sec.  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 Sec.  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 first-lien 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 Sec.  
226.34(a)(4), 226.35(b)(1).
    Proposed Sec.  226.43(c) would implement TILA Section 129C(a)(1)-
(3) and is substantially similar to those provisions. Specifically, 
proposed Sec.  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:
    [cir] 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;
    [cir] Employment status, if the creditor relies on income from the 
consumer's employment in determining repayment ability;
    [cir] Monthly payment on the covered transaction;
    [cir] Monthly payment on any simultaneous loan that the creditor 
knows or has reason to know will be made;
    [cir] Monthly payment for mortgage-related obligations;
    [cir] Current debt obligations;
    [cir] Monthly debt-to-income ratio or residual income; and
    [cir] 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 non-governmental 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 self-employed 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 Sec.  226.2(a)(14). Proposed 
comment 43(c)-1 is consistent with, but broader than, current 
commentary on determining a consumer's debt-to-income ratio to meet the 
presumption of compliance with the repayment ability requirement of the 
Board's 2008 HOEPA Final Rule. See Sec.  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

[[Page 27420]]

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 debt-to-
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 Sec.  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 Sec.  226.43(a). Accordingly, 
the Board proposes to implement TILA Section 129C in a new Sec.  226.43 
and remove requirements to consider repayment ability for high-cost 
mortgages under Sec.  226.34(a)(4) and for higher-priced mortgage loans 
under Sec.  226.35(b)(1), as discussed in detail above in the section-
by-section analysis of Sec.  226.34 and 226.35.
43(c)(1) General Requirement
    Proposed Sec.  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 Sec.  
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 Sec.  226.43(c)(2) would implement 
the requirement to consider specific factors in determining repayment 
ability. Proposed Sec.  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 Sec.  226.43(c)(2)(i) generally mirrors TILA Section 
129C(a)(3) but differs in two respects. First, proposed Sec.  
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); Sec.  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 Sec.  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 Sec.  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

[[Page 27421]]

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 cross-references 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, self-employment 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 Sec.  
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 Sec.  
226.34(a)(4), but commentary on Sec.  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 
Sec.  226.34(a)(4), in light of the substantial similarity between the 
provisions. Accordingly, proposed Sec.  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 Sec.  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 Sec.  
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

[[Page 27422]]

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?
---------------------------------------------------------------------------

    \41\ The 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/.
---------------------------------------------------------------------------

    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 Sec.  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 Sec.  226.43(c)(5) 
for purposes of determining the consumer's repayment ability on a 
covered transaction. See proposed Sec.  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 Sec.  226.43(c)(5), taking into account any mortgage-
related obligations. This comment would also provide a cross-reference 
to proposed Sec.  226.43(b)(8) for the meaning of the term ``mortgage-
related obligations.''
43(c)(2)(iv) Simultaneous Loans
    Proposed Sec.  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 Sec.  226.43(c)(2)(iv) also requires that the consumer's 
monthly payment obligation on the simultaneous loan be calculated in 
accordance with proposed Sec.  226.43(c)(6), which is discussed below. 
Proposed Sec.  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 
Sec.  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 Sec.  
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 Sec.  226.43. To facilitate compliance, this comment cross-
references proposed Sec.  226.43(a), which discusses the scope of the 
ability-to-repay provisions, proposed Sec.  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 Sec.  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 Sec.  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 Sec.  
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 Sec.  
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 third-party 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 non-
governmental standards. To facilitate compliance, the comment would 
cross-reference 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.

[[Page 27423]]

    The Board notes that proposed Sec.  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 non-purchase 
covered transaction (i.e., refinancing). As discussed more fully below 
under proposed Sec.  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 Sec.  
226.43(c)(6) regarding payment calculations for simultaneous loans.
43(c)(2)(v) Mortgage-Related Obligations
    Proposed Sec.  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 Sec.  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 
mortgage-related obligations.'' The Dodd-Frank Act does not define the 
term ``mortgage-related obligations.'' As discussed in proposed Sec.  
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 Sec.  
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 Sec.  226.45(b)(1); \42\ 
homeowner association, condominium, and cooperative fees; ground rent 
or leasehold payments; and special assessments.
---------------------------------------------------------------------------

    \42\ See 2011 Escrow Proposal, 76 FR 11598, 11621, Mar. 2, 2011.
---------------------------------------------------------------------------

    Proposed Sec.  226.43(c)(2)(v) is generally consistent with the 
requirement under current Sec.  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 
Sec.  226.34(a)(4) does not extend the verification requirement to 
mortgage-related obligations. In contrast, under proposed Sec.  
226.43(c)(3) creditors would need to verify mortgage-related 
obligations for purposes of the repayment ability determination. See 
proposed Sec.  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 Sec.  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 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. To facilitate compliance, this 
comment would cross-reference proposed Sec.  226.43(b)(8) for the 
meaning of the term ``mortgage-related obligations.''
    As discussed more fully below under proposed Sec.  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 mortgage-
related 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 
mortgage-related 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 Sec.  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 Sec.  226.43(c) 
based on information verified from reasonably reliable records. This 
comment would explain that guidance regarding verification of mortgage-
related obligations can be found in proposed comments 43(c)(3)-1 and -
2, which discuss verification using third-party 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

[[Page 27424]]

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 Sec.  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 Sec.  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 non-governmental 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 Sec.  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 Sec.  
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 Sec.  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 Four-Unit Mortgage Loans.
    Proposed Sec.  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 comment 43(c)(2)(vii)-1 cross-references Sec.  
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-to-income 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

[[Page 27425]]

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-to-repay 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 Sec.  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 Sec.  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 non-governmental 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 Sec.  
226.43(c)(3), a creditor may, for instance, look to credit reports from 
credit bureaus, or other nontraditional credit references contained in 
third-party 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 Sec.  
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 Sec.  
226.43(c)(2).
    Proposed Sec.  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 Sec.  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 Sec.  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 
Sec.  226.43(c)(3)(ii), the creditor need not independently verify such 
current debt obligations. Proposed Sec.  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 Sec.  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 third-
party 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 
self-employed consumers (such as a year-to-date 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 Sec.  
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

[[Page 27426]]

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 Sec.  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 Sec.  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 Sec.  
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 Sec.  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 
tax-return 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 third-party records at or before consummation. See 
Sec.  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 Sec.  226.43(c)(5) to implement the payment 
calculation requirements of TILA Section 129C(a), as enacted by Section 
1411 of the Dodd-Frank 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

[[Page 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 Sec.  226.43(b)(8), is discussed above in the 
section-by-section analysis for proposed Sec.  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 ``fully-indexed 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 Sec.  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 
Sec.  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 Sec.  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 Sec.  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 Sec.  226.34(a)(4)(iii)(B). For 
example, Sec.  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 Sec.  226.43(c). In taking this approach, the statutory 
requirements in TILA Section 129C(a)(6)(D) addressing payment 
calculation requirements differ from Sec.  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 Sec.  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 
Sec.  226.43(c). Consistent with these statutory provisions, proposed 
Sec.  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

[[Page 27428]]

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 Sec.  226.43(c)(5)(i). For clarity 
and simplicity, proposed Sec.  226.43(c)(5)(i) would use the terms 
``fully amortizing payment'' and ``fully indexed rate,'' as discussed 
above under proposed Sec.  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 Sec.  226.18(s)(7)(i), (ii), 
and (iii), respectively.
    Proposed Sec.  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 Sec.  
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 Sec.  226.43(c)(5)(ii)(A)(1) states that for covered 
transactions with a balloon payment that are not higher-priced 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 Sec.  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 Sec.  
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 Sec.  226.43(b)(4), discussed 
above. The term ``balloon payment'' has the same meaning as in current 
Sec.  226.18(s)(5)(i).
    Interest-only loans. Consistent with TILA Sections 129C(a)(6)(B) 
and (D) of the Dodd-Frank Act, proposed Sec.  226.43(c)(5)(ii)(B) 
provides special rules for interest-only loans. Proposed Sec.  
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 Sec.  
226.43(c)(5)(ii)(B) would use the terms ``loan amount'' and ``recast,'' 
which are defined and discussed under proposed Sec.  226.43(b)(5) and 
(11), respectively. The term ``interest-only loan'' has the same 
meaning as in current Sec.  226.18(s)(7)(iv).
    Negative amortization loans. Consistent with TILA Sections 
129C(a)(6)(C) and (D) of the Dodd-Frank Act, proposed Sec.  
226.43(c)(5)(ii)(C) provides special rules for negative amortization 
loans. Proposed Sec.  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 Sec.  226.43(c)(5)(ii)(C) would use the terms 
``maximum loan amount'' and ``recast,'' which are defined and discussed 
under proposed Sec.  226.43(b)(7) and (11), respectively. The term 
``negative amortization loan'' has the same meaning as in current Sec.  
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 Sec.  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 Sec.  226.43(c)(5)(i) provides 
that unless an exception applies under proposed Sec.  226.43(c)(5)(ii), 
a creditor must make the repayment ability determination required under 
proposed Sec.  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 Sec.  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 Sec.  
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 Sec.  226.43(c)(5) and provide cross-references to 
their definitions.
    The fully indexed rate or introductory rate, whichever is greater. 
Proposed Sec.  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 Sec.  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

[[Page 27429]]

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 Sec.  
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 Sec.  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 Sec.  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 Sec.  
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 Sec.  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 non-
amortizing 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 payment-schedule 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 Sec.  226.17(c)(3) (discussing minor variations), 
and Sec.  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 Sec.  
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 Sec.  
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 Sec.  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 Sec.  
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-to-repay 
standard. See proposed Sec.  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

[[Page 27430]]

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 Sec.  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 Sec.  
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 Sec.  
226.43(c)(5)(i), or the special rules under proposed Sec.  
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 Sec.  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 Sec.  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 Sec.  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 Sec.  
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

[[Page 27431]]

Sec.  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 Sec.  226.43(c)(5)(ii) creates exceptions to the general 
rule under proposed Sec.  226.43(c)(5)(i), and provides special rules 
in proposed Sec.  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 Sec.  226.43(c)(2)(iii). In addition to TILA 
Section 129C(a)(6)(D)(i)-(iii), proposed Sec.  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 Sec.  
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 higher-priced 
covered transaction. For purposes of proposed Sec.  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 Sec.  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 Sec.  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 Sec.  226.43(c)(5)(ii)(A)(1), and also to be consistent with 
proposed Sec.  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 Sec.  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

[[Page 27432]]

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 cross-reference to the definition of ``balloon payment'' in 
current Sec.  226.18(s)(5)(i).
43(c)(5)(ii)(A)(1) ``Prime'' Balloon Loans
    Proposed Sec.  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 Sec.  
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 Sec.  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 Sec.  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 Sec.  
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 Sec.  
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 anti-steering provisions regarding loan originator 
compensation. See 75 FR 58509, Sept. 24, 2010. The Board's anti-
steering 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 Sec.  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

[[Page 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 Sec.  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 ability-to-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 Sec.  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 Sec.  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

[[Page 27434]]

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 Sec.  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 Sec.  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-
to-moderate income borrowers. In addition, under proposed Sec.  
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 Sec.  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 Sec.  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 Sec.  
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 
interest-only loans parallels the general rule proposed in Sec.  
226.43(c)(5)(i), except that proposed Sec.  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 Sec.  226.43(b)(2).
    Proposed Sec.  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 Sec.  
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 Sec.  
226.18(s)(7)(iv).\43\
---------------------------------------------------------------------------

    \43\ See 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.
---------------------------------------------------------------------------

    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 
interest-only 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 
Sec.  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

[[Page 27435]]

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 Sec.  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 Sec.  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 Sec.  
226.43(c)(5)(i), except that proposed Sec.  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 Sec.  226.43(b)(2). This 
proposed rule uses the terms ``maximum loan amount'' and ``recast,'' 
which are defined and discussed under proposed Sec.  226.43(b)(7) and 
(b)(11), respectively. Proposed Sec.  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 Sec.  
226.18(s)(7)(v) for purposes of the repayment ability determination. 
The Board recently amended Sec.  226.18(s)(7)(v) to clarify that the 
term ``negative amortization loan'' covers a loan, other than a reverse 
mortgage subject to current Sec.  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 Sec.  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.
---------------------------------------------------------------------------

    \44\ See 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 Sec.  
226.18(s)(7)(v).
---------------------------------------------------------------------------

    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 Sec.  
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 Sec.  226.43(c)(5)(i). Thus, seasonal income 
loans and

[[Page 27436]]

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 Sec.  226.43(c)(5)(i).
    For purposes of determining the consumer's ability to repay a 
negative amortization loan under proposed Sec.  226.43(c)(5)(ii)(C), 
creditors must make a two-step payment calculation.
    Step one: maximum loan amount. Proposed Sec.  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 Sec.  
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 Sec.  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 Sec.  
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 ``worst-case 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.
---------------------------------------------------------------------------

    \45\ See 12 CFR 226.18(s)(2)(ii) and comment 18(s)(2)(ii)-2.
    \46\ See 2006 Nontraditional Mortgage Guidance at 58614, n.7.
---------------------------------------------------------------------------

    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 Sec.  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 Sec.  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 Sec.  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

[[Page 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-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). See 
proposed comment 43(c)(5)(ii)(C)-3.ii.
    This comment would conclude that for purposes of the repayment 
ability determination required in Sec.  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 Sec.  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 Sec.  226.43(c)(6). Furthermore, as discussed 
under proposed Sec.  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 Sec.  226.43(c)(2)(iv) and (c)(6). 15 U.S.C. 1604(a).
    Proposed Sec.  226.43(c)(6) provides the payment calculation for a 
simultaneous loan that is a closed-end covered transaction or a HELOC. 
Specifically, proposed Sec.  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 Sec.  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 Sec.  226.43(c)), proposed Sec.  
226.43(c)(6)(i) requires the creditor to calculate the payment 
obligation consistent with the rules that apply to covered transactions 
under proposed Sec.  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 Sec.  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 Sec.  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 non-
purchase 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 Sec.  
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 cross-
reference to proposed comment 43(c)(2)(iv)-2 for further discussion on 
the standard ``knows or has reason to know,'' and proposed Sec.  
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 
Sec.  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 Sec.  226.43(c)(5), taking into account any mortgage-related 
obligations. The comment would provide a cross-reference to proposed 
Sec.  226.43(b)(8) for the meaning of the term ``mortgage-related 
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 Sec.  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

[[Page 27438]]

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 Sec.  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 first-lien 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 Sec.  
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 Sec.  226.43(c)(2)(iv) and 
(c)(6) do not distinguish between purchase and non-purchase 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 Sec.  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 Sec.  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 Sec.  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 Sec.  226.43(c)(7) 
provides the definitions and calculations for the monthly debt-to-
income ratio and residual income. With respect to the definitions, 
proposed Sec.  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 Sec.  226.43(c)(2)(iii) 
and (c)(5); the monthly payment on any simultaneous loans, as required 
to be calculated by Sec.  226.43(c)(2)(iv) and (c)(6); the monthly 
payment amount of any mortgage-related obligations, as required to be 
considered by Sec.  226.43(c)(2)(v); and the monthly payment amount of 
any current debt obligations, as required to be considered by Sec.  
226.43(c)(2)(vi). Proposed Sec.  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 Sec.  226.43(c)(2)(i) and (c)(4).
    With respect to the calculations, proposed Sec.  
226.43(c)(7)(ii)(A) requires the creditor to consider the consumer's 
monthly debt-to-income ratio for purposes of Sec.  226.43(c)(2)(vii) 
using the ratio of the consumer's total monthly debt obligations to 
total monthly income. Proposed Sec.  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 Sec.  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

[[Page 27439]]

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.
---------------------------------------------------------------------------

    \47\ See 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'').
---------------------------------------------------------------------------

    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 Sec.  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 Sec.  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 Sec.  226.43(c)(2)(iii), and 
(c)(5). Proposed Sec.  226.43(d) implements TILA Section 129C(a)(6)(E), 
which was added to TILA under Sec.  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 Sec.  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 Sec.  
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 Sec.  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-to-repay requirements (see the section-by-section 
analysis of Sec.  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 Sec.  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

[[Page 27440]]

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 so-called 
``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.
---------------------------------------------------------------------------

    \48\ See id. at 4. See also, e.g., Freddie Mac Single-Family 
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 Mac-owned streamlined refinance mortgages. See 
Freddie Mac Bulletin 2011-2 (Jan. 18, 2011).
---------------------------------------------------------------------------

    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 Sec.  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 
section-by-section analysis of Sec.  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\
---------------------------------------------------------------------------

    \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.
    \50\ See, e.g., Fannie Mae, ``Home Affordable Refinance Refi 
PlusTM Options,'' p. 1 (Mar. 29, 2010).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \51\ See, 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).
    \52\ See, e.g., Fannie Mae, ``Home Affordable Modification 
Program,'' p. 1, FM 0509 (2009).
    \53\ See, Fannie Mae, ``Making Home Affordable\SM\ Program, 
Handbook for Servicers of Non-GSE Mortgages,'' Ch. II, Sec.  5, pp. 
59-62 (Dec. 2, 2010).
---------------------------------------------------------------------------

    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 at-risk 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

[[Page 27441]]

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 
Sec.  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 Sec.  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 
Sec.  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 Sec.  
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 Sec.  226.43(d)(2)(ii)(B))).
---------------------------------------------------------------------------

    \54\ See, 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).
---------------------------------------------------------------------------

The Board's Proposal
43(d)(1) Scope
    Proposed Sec.  226.43(d)(1) defines the scope of the provisions 
regarding the refinancing of non-standard mortgages under proposed 
Sec.  226.43(d). Specifically, this provision states that Sec.  
226.43(d) applies to the refinancing of a ``non-standard mortgage'' 
(defined in proposed Sec.  226.43(d)(2)(i)) into a ``standard 
mortgage'' (defined in proposed Sec.  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 non-standard 
mortgage, as calculated under proposed Sec.  226.43(d)(5).
     The creditor receives the consumer's written application 
for the standard mortgage before the non-standard mortgage is 
``recast'' (defined in proposed Sec.  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 Sec.  226.43(d)(2)(iii) defines 
the term ``refinancing'' to have the same meaning as in Sec.  
226.20(a).
    Proposed comment 43(d)(1)-1 clarifies that the requirements for a 
``written application,'' a term that appears in Sec.  
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 Sec.  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 ``non-standard 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 Sec.  226.43(d) 
retains an interest in the performance of the new loan and whether 
additional guidance is needed.

[[Page 27442]]

43(d)(1)(ii) Monthly Payment for the Standard Mortgage is Materially 
Lower Than the Monthly Payment for the Non-Standard Mortgage
    Proposed Sec.  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 ``non-standard 
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 Sec.  
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 Sec.  226.43(d)(5) (discussed below). This comment 
also explains that whether the new loan payment is ``materially lower'' 
than the non-standard 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 Sec.  
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 Non-Standard Mortgage is Recast
    Proposed Sec.  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-by-section analysis of Sec.  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 interest-only 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 Sec.  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 Sec.  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 Sec.  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 Sec.  226.43(d)(1)(v) (discussed below), Sec.  
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 set-up 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.
---------------------------------------------------------------------------

    \55\ See, 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).
---------------------------------------------------------------------------

    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

[[Page 27443]]

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 Sec.  
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\
---------------------------------------------------------------------------

    \56\ See, e.g., Freddie Mac Single-Family Seller/Servicer Guide, 
Vol. 1, Ch. 24: Refinance Mortgages/24.4: Requirements for Freddie 
Mac-owned 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'').
---------------------------------------------------------------------------

    Proposed comment 43(d)(1)(iv)-1 provides the following illustration 
of the rule under Sec.  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 
Sec.  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\
---------------------------------------------------------------------------

    \57\ See Fannie Mae/Freddie Mac Uniform Instrument, Multistate 
Fixed Rate Note--Single Family, Form 3200, Sec. Sec.  3, 6.
---------------------------------------------------------------------------

    The Board requests comment on whether the delinquencies that 
creditors are required to consider under Sec.  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 Sec.  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 Sec.  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 Sec.  
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 well-
performing 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 Sec.  226.43(d)(1)(v) 
is not met because the consumer made a payment more than 30 days late 
just one and one-half months prior to application.

[[Page 27444]]

    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 Sec.  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 Sec.  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 
``non-standard mortgage'' is any ``covered transaction'' (defined in 
proposed Sec.  226.43(b)(1)) that is:
     An adjustable-rate mortgage, as defined in Sec.  
226.18(s)(7)(i), with an introductory fixed interest rate for a period 
of one year or longer; \58\
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

     An interest-only loan, as defined in Sec.  
226.18(s)(7)(iv); \59\ or
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

     A negative amortization loan, as defined in Sec.  
226.18(s)(7)(v).\60\
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    Proposed comment 43(d)(2)(i)(A)-1 explains what it means that a 
``non-standard 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 Dodd-Frank 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\
---------------------------------------------------------------------------

    \61\ See 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 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 ``non-standard 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 Sec.  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 ``non-standard 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

[[Page 27445]]

appropriateness of the proposed definition of ``non-standard 
mortgage.''
43(d)(2)(ii) Standard Mortgage
    Proposed Sec.  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 Sec.  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 Sec.  
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 
Sec.  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 Sec.  
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 Sec.  226.43(e)(2)(i). See section-by-section analysis of 
Sec.  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-by-section 
analysis of proposed Sec.  226.43(c)(5)). In addition, the comment 
clarifies that ``regular periodic payments'' do not include a single-
payment transaction and cross-references 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 
Sec.  226.43(e); however, the phrase has the same meaning in the 
definition of ``standard mortgage'' under proposed Sec.  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 Sec.  
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 Sec.  226.43(d)(2)(ii)(B) cross-references the points and fees 
provisions under proposed Sec.  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-by-section analysis of 
proposed Sec.  226.43(e)(3), below. In sum, under proposed Sec.  
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--
    [cir] Total loan amount - $20,000 = $Z
    [cir] $Z x .0036 basis points = Y basis points
    [cir] 500 basis points - Y basis points = X basis points
    [cir] X basis points x .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 section-by-section analysis of 
proposed Sec.  226.43(e)(3), below.
    In the Board's view, the proposed limitation on the points and fees 
that

[[Page 27446]]

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 
Sec.  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 Sec.  226.43(e) to the points and fees that may be charged on a 
``standard mortgage'' under Sec.  226.43(d).
    Loan term of no more than 40 years. Proposed Sec.  
226.43(d)(2)(ii)(C) provides that, to qualify as a standard mortgage 
under proposed Sec.  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.
---------------------------------------------------------------------------

    \63\ See, 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 fixed-rate 
mortgage loans with a term up to 40 years'').
---------------------------------------------------------------------------

    Interest rate is fixed for the first five years. Proposed Sec.  
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 five-year 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 Sec.  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.
---------------------------------------------------------------------------

    \64\ See, 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'').

---------------------------------------------------------------------------

[[Page 27447]]

    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 Sec.  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 Sec.  
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 Sec.  
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 Sec.  226.43(d)(2)(iii) defines the term ``refinancing'' 
to have the same meaning as in Sec.  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 Sec.  
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 Sec.  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 Sec.  226.43(d) should be 
expanded to include a broader range of transactions, similar to those 
covered under the proposed revisions to Sec.  226.20, or otherwise 
should be defined differently or explained more fully than proposed.
---------------------------------------------------------------------------

    \65\ 75 FR 58539, 58594-58604, 58697-58699, 58761-58764, Sept. 
24, 2010.
---------------------------------------------------------------------------

43(d)(3) Exemption From Certain Repayment Ability Requirements
    Under specific conditions, proposed Sec.  226.43(d)(3) exempts a 
creditor in a refinancing from two of the requirements under proposed 
Sec.  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 Sec.  226.43(c)(2)(i) 
and (c)(4). Second, the creditor is not required to comply with the 
payment calculation requirements of proposed Sec.  226.43(c)(2)(iii) 
and (c)(5); the creditor may instead use payment calculations 
prescribed in proposed Sec.  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 
Sec.  226.43(d)(1)(i)-(v) described above must be met. See proposed 
Sec.  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 non-standard mortgage when the non-standard mortgage is recast. See 
proposed Sec.  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 non-governmental 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

[[Page 27448]]

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 non-standard mortgage 
be recast.
    Payment calculation for repayment ability determination. Proposed 
comment 43(d)(3)(ii)-1 explains that, if the conditions in Sec.  
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 
Sec.  226.43(d)(5)(ii), rather than the calculation prescribed under 
Sec.  226.43(c)(2)(iii) and (c)(5). Specifically, as discussed in more 
detail under proposed Sec.  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 
Sec.  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 Sec.  
226.43(d)(3)(ii), to calculate the payment required for the ability to 
repay rule under proposed Sec.  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 section-by-section analysis of proposed Sec.  
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 Sec.  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 Sec.  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 non-standard 
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 Sec.  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 Sec.  226.43(c). The Board solicits comment on whether an 
exemption from other ability to repay requirements under proposed Sec.  
226.43(c), such as consideration of credit history under proposed Sec.  
226.43(c)(2)(viii), may also be appropriate.
43(d)(4) Offer of Rate Discounts and Other Favorable Terms
    Proposed Sec.  226.43(d)(4) provides that a creditor making a loan 
under the special refinancing provisions of Sec.  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

[[Page 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 Sec.  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 Sec.  
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 
Sec.  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 Sec.  226.43(d)(4) is needed.
43(d)(5) Payment Calculations
    Proposed Sec.  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 non-standard mortgage, as required under proposed Sec.  
226.43(d)(1)(ii), discussed above. Proposed Sec.  226.43(d)(5) thus 
complements proposed Sec.  226.43(d)(1)(ii) in implementing the 
statutory provision that requires a ``reduction'' in the monthly 
payment for the existing non-standard (``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 Sec.  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 Sec.  
226.43(c)(2)(iii).
43(d)(5)(i) Non-Standard Mortgage Payment Calculation
    Proposed Sec.  226.43(d)(5)(i) requires that the monthly payment 
for a non-standard 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 Sec.  
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 Sec.  
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--
    [cir] For an adjustable-rate mortgage under Sec.  
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;
    [cir] For an interest-only loan under Sec.  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;
    [cir] For a negative amortization loan under Sec.  
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 Sec.  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 Sec.  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 Sec.  226.43(b)(11), respectively (discussed above).
    Proposed comment 43(d)(5)(i)-2 explains that the term ``fully 
indexed rate'' used in Sec.  226.43(d)(5)(i)(A) for calculating the 
payment for a non-standard mortgage is generally defined in Sec.  
226.43(b)(3) and associated commentary. The comment explains an 
important difference between the ``fully indexed rate'' as defined in 
Sec.  226.43(b)(3), however, and the meaning of ``fully indexed rate'' 
in Sec.  226.43(d)(5)(i). Specifically, under Sec.  226.43(b)(3), the 
fully indexed rate is calculated at the time of consummation. Under 
Sec.  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.''

[[Page 27450]]

    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 Sec.  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 Sec.  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 Sec.  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 non-standard mortgage for purposes 
of determining whether the standard mortgage monthly payment is lower 
than the non-standard mortgage monthly payment (see proposed Sec.  
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 interest-only loan. Proposed comments 
43(d)(5)(i)-6 and -7 explain the payment calculation for an interest-
only loan under proposed Sec.  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 
Sec.  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 Sec.  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

[[Page 27451]]

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 Sec.  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 non-standard 
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 non-standard mortgage for purposes 
of determining whether the standard mortgage monthly payment is lower 
than the non-standard mortgage monthly payment (see Sec.  
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 Sec.  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 Sec.  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 Sec.  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 non-standard 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 Sec.  
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 Sec.  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 non-standard mortgage for purposes 
of determining whether the standard mortgage monthly payment is lower 
than the non-standard mortgage monthly payment (see Sec.  
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 fully-indexed rate over the remaining term. See comment 
43(d)(5)(i)-9.v.
    The Board requests comment on the proposed payment calculation for 
a non-standard mortgage and on the appropriateness and usefulness of 
the proposed payment calculation examples.
43(d)(5)(ii) Standard Mortgage Payment Calculation
    Proposed Sec.  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 Sec.  
226.43(d)(1)(ii). The same payment calculation must also be used by 
creditors of refinances under proposed Sec.  226.43(d) in determining 
whether the consumer has a reasonable ability to repay the standard 
mortgage, as required under proposed Sec.  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 Sec.  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,

[[Page 27452]]

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 (interest-only 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 Sec.  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 higher-priced 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-to-income 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 debt-to-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.

[[Page 27453]]

    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-to-repay 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-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.
    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-to-
income 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-to-repay 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 Sec.  226.43(c)(1). 
That is, a consumer would have to show that a loan was not a qualified 
mortgage under Sec.  226.43(e) (e.g., that the loan permits negative 
amortization) in order to assert that the loan violated the repayment 
ability requirement under Sec.  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-to-repay standard in Sec.  
226.43(c)(2)-(7). Because Alternative 2 would require compliance with 
the general ability-to-repay 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.

[[Page 27454]]

43(e)(1) In General
ALTERNATIVE 1
    Proposed Sec.  226.43(e)(1) would implement TILA Section 129C(b)(1) 
and state that the creditor or assignee complies with Sec.  
226.43(c)(1) if the covered transaction is a qualified mortgage, as 
defined in Sec.  226.43(e)(2). Proposed Sec.  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--
    [cir] Result in an increase of the principal balance (negative 
amortization);
    [cir] Allow the consumer to defer repayment of principal (i.e., 
interest-only payments); or
    [cir] 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 Sec.  
226.43(e)(3);
     For which the creditor underwrites the loan using the 
following method:
    [cir] 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;
    [cir] 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;
    [cir] 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 Sec.  226.43(c)(1) if a 
covered transaction meets the conditions for a ``qualified mortgage'' 
under Sec.  226.43(e)(2) (or Sec.  226.43(f), if applicable). That is, 
a creditor or assignee need not demonstrate compliance with Sec.  
226.43(c)(2)-(7) if the terms of the loan comply with Sec.  
226.43(e)(2)(i)-(ii) (or Sec.  226.43(f), if applicable); the loan's 
points and fees do not exceed the limits set forth in Sec.  
226.43(e)(2)(iii); and the creditor has complied with the underwriting 
criteria described in Sec.  226.43(e)(2)(iv)-(v) (or Sec.  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 Sec.  226.43(e)(2) (or Sec.  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 Sec.  
226.43(c) (or Sec.  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-
to-repay 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-to-income 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-to-income 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-to-income 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.
---------------------------------------------------------------------------

    \66\ See 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).
---------------------------------------------------------------------------

    Finally, the Board is concerned that the benefit of including the 
debt-to-income 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-to-income 
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 Sec.  226.43(e)(2)-Alternative 1, as well as 
additional ability-to-repay requirements. Specifically, proposed Sec.  
226.43(e)(2)(v)-Alternative 2 would require the creditor (by a cross-
reference to the creditor's obligations in Sec.  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 Sec.  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 Sec.  226.43(c)(1) if the covered transaction is a 
qualified mortgage, as defined in Sec.  226.43(e)(2).

[[Page 27455]]

    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 
Sec.  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 Sec.  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 Sec.  
226.43(c)(1) if the terms of the loan comply with Sec.  
226.43(e)(2)(i)-(ii) (or Sec.  226.43(f), if applicable); the loan's 
points and fees do not exceed the limit set forth in Sec.  
226.43(e)(2)(iii); and the creditor has complied with the underwriting 
criteria described in Sec.  226.43(e)(2)(iv)-(v) (or Sec.  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 Sec.  226.43(c) (or Sec.  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 Sec.  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 Sec.  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:
    [cir] Result in an increase of the principal balance (i.e., 
negative amortization);
    [cir] Allow the consumer to defer repayment of principal (i.e., 
interest-only payments); or
    [cir] 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 Sec.  
226.43(e)(3);
     For which the creditor underwrites the loan using the 
following method:
    [cir] 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;
    [cir] 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;
    [cir] 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\
---------------------------------------------------------------------------

    \67\ As discussed below in this section-by-section analysis, in 
certain limited situations, a creditor may comply with the 
requirements of Sec.  226.43(f) instead of certain requirements 
Sec.  226.43(e).
---------------------------------------------------------------------------

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 balloon-payment loans, discussed below in the 
section-by-section analysis for Sec.  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 Sec.  
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 Sec.  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 Sec.  
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 Sec.  226.43(f), 
discussed below; or (3) result in a balloon payment, as defined in 
Sec.  226.18(s)(5)(i), except as provided in Sec.  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 Sec.  
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 Sec.  
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 Sec.  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 Sec.  226.43(e)(2)(i)(C) cross-
references Regulation Z's existing definition of ``balloon payment'' in 
Sec.  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.

[[Page 27456]]

    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 Sec.  226.18(s)(5)(i)'s definition of ``balloon payment'' in 
Sec.  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 Sec.  
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 balloon-payment 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 Sec.  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 Sec.  226.43(d). As discussed in more detail above, proposed 
Sec.  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 Sec.  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 Sec.  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 Sec.  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 Sec.  226.43(e)(3). As 
discussed in detail in the section-by-section analysis for Sec.  
226.43(e)(3), the Board proposes two alternatives for calculating the 
allowable points and fees for a qualified mortgage. Proposed Sec.  
226.43(b)(9) defines ``points and fees'' to have the same meaning as in 
Sec.  226.32(b)(1), addressed above.

[[Page 27457]]

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 Sec.  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 Sec.  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 Sec.  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 Sec.  
226.43(f)(1).
The Board's Proposal
    The Board proposes Sec.  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 
Sec.  226.18(s)(7)(i)-(iii), respectively.
    Specifically, proposed Sec.  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 Sec.  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 Sec.  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 Sec.  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 Sec.  
226.43(e)(2)(iv) are discussed below.
43(e)(2)(iv) Mortgage-Related Obligations
    Proposed Sec.  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 Sec.  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 Sec.  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 Sec.  226.45(b)(1); homeowner association, 
condominium, and cooperative fees; ground rent or leasehold payments; 
and special assessments. Unlike the requirement under proposed Sec.  
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 Sec.  226.43(b)(8) and associated commentary to 
facilitate compliance.
43(e)(2)(iv)(A) Maximum Interest Rate During First Five Years
    Proposed Sec.  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

[[Page 27458]]

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 Sec.  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 
Sec.  226.34(a)(4)(iii), which requires creditors to determine a 
consumers repayment ability using the largest payment in first seven 
years ``following consummation.''
---------------------------------------------------------------------------

    \68\ See, e.g., Mortgage Reform and Anti-Predatory Lending Act, 
H. Rep. 111-94, p. 39 (2009).
---------------------------------------------------------------------------

    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 Sec.  
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 cross-reference to Sec.  
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).

[[Page 27459]]

    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 Sec.  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 Sec.  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 Sec.  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 
Sec.  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 ability-
to-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 Sec.  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 Sec.  
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 Sec.  226.43(b)(5), over the entire loan term, as 
that term is defined in Sec.  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 Sec.  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 Sec.  
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

[[Page 27460]]

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 Sec.  226.43(c)(2)(i) and (c)(4). Proposed Sec.  
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 Sec.  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-by-
section analysis of proposed Sec.  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 Sec.  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 Sec.  226.43(e)(2)(v) 
for a ``qualified mortgage.''
ALTERNATIVE 2
43(e)(2)(v)(A)-(F) Underwriting Requirements
    Under Alternative 2, proposed Sec.  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 
Sec.  226.43(c)(2)(i) and (c)(4). This proposed requirement, which 
under Alternative 2 is designated Sec.  226.43(e)(2)(v)(A), is 
discussed in detail under Alternative 1 above.
    In addition, proposed Sec.  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 
ability-to-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 Sec.  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 Sec.  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 non-purchase 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 Sec.  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 Sec.  
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 debt-to-income ratio or residual income, as required by Sec.  
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-to-income 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-to-
income 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

[[Page 27461]]

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 high-cost 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.
---------------------------------------------------------------------------

    \69\ The LPS data include mortgage underwriting and performance 
information. The LPS data do not include detailed information on 
borrower income and on other debts the borrower may have in addition 
to the mortgage.
    \70\ The 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.
    \71\ See 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).
---------------------------------------------------------------------------

    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 debt-to-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.
---------------------------------------------------------------------------

    \72\ See 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'').
---------------------------------------------------------------------------

    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-to-income ratio or 
residual income for the qualified mortgage definition.
43(e)(3) Limits on Points and Fees for Qualified Mortgages
    Proposed Sec.  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--
    [cir] Total loan amount-$20,000 = $Z
    [cir] $Z x .0036 basis points = Y basis points
    [cir] 500 basis points -Y basis points = X basis points
    [cir] X basis points x .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 Sec.  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

[[Page 27462]]

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 Sec.  
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 Sec.  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 low-income 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 Sec.  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-by-section analysis of proposed Sec.  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

[[Page 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 Dodd-Frank Act. See TILA Section 103(aa)(4); 15 
U.S.C. 1602(aa)(4). See also section-by-section analysis of Sec.  
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 Sec.  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--
    [cir] Total loan amount-$20,000 = $Z
    [cir] $Z x .0036 = Y basis points
    [cir] 500 basis points-Y basis points = X basis points
    [cir] X basis points x .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

[[Page 27464]]

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).
---------------------------------------------------------------------------

    \73\ Public Law 111-203, 124 Stat. 1376, Title XIV, Sec.  1431.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \74\ Id. Sec.  1432, 1433.
---------------------------------------------------------------------------

    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 home-secured loans. The 2008 Home 
Mortgage Disclosure Act \75\ (HMDA) data show that 8.4 percent of 
first-lien, home-purchase (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.
---------------------------------------------------------------------------

    \75\ 12 U.S.C. 2801 et seq.
    \76\ See The 2008 HMDA Data: The Mortgage Market during a 
Turbulent Year, Federal Reserve Bulletin, vol. 95, p. A201 (April 
2010).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \77\ See HMDA data for 2009 is available at Federal Financial 
Institutions Examination Council, http://www.ffiec.gov.hmda/hmdaproducts.htm.
    \78\ See 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
---------------------------------------------------------------------------

    Thus, the Board believes that a loan size of less than $75,000 
would capture a material portion of the first-lien home-purchase (site-
built) mortgage market (close to 10 percent), but would not undermine 
the statute by creating an exception that might be over-broad.\79\
---------------------------------------------------------------------------

    \79\ The proposed loan size threshold would have applied to the 
majority of second-lien home-purchase 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 
(site-built) 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.
---------------------------------------------------------------------------

    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

[[Page 27465]]

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 ``non-MSA'' 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.
---------------------------------------------------------------------------

    \80\ See Federal Financial Institutions Examination Council, 
http://www.ffiec.gov/hmda/hmdaproducts.htm.
---------------------------------------------------------------------------

    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 Sec.  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 Sec.  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 Sec.  226.43(e)(3)(ii)(A)-(C).
43(e)(3)(ii)(A) Bona Fide Third Party Charges
    Proposed Sec.  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 
Sec.  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 Sec.  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 Sec.  
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 pro-
rated 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 
Dodd-Frank Act provisions on mortgage insurance to the meaning of 
``points and fees'' for qualified mortgages, see the section-by-section 
analysis of proposed Sec.  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 Sec.  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 Sec.  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 Sec.  
226.45(a)(2)(ii),\81\ by more than one percent; and
---------------------------------------------------------------------------

    \81\ See 76 FR 11319, March 2, 2011 (2011 Jumbo Loan Escrow 
Final Rule).
---------------------------------------------------------------------------

     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

[[Page 27466]]

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 Sec.  
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 Sec.  226.45(a)(2)(ii),\82\ by 
more than two percent;
---------------------------------------------------------------------------

    \82\ See id.
---------------------------------------------------------------------------

     The average prime offer rate used for purposes of Sec.  
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 
Sec.  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.
---------------------------------------------------------------------------

    \83\ Federal Financial Institutions Examination Council (FFIEC), 
``FFIEC Rate Spread Calculator,'' http://www.ffiec.gov/ratespread/newcalc.aspx.
---------------------------------------------------------------------------

    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 Sec.  
226.43(e)(3)(ii)(A); TILA Section 129C(b)(2)(C).
---------------------------------------------------------------------------

    \84\ See e.g., Fannie Mae, ``Loan-Level Price Adjustment (LLPA) 
Matrix and Adverse Market Delivery Charge (AMDC) Information,'' 
Selling Guide (Dec. 23, 2010).
---------------------------------------------------------------------------

    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 Sec.  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 loan-level 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

[[Page 27467]]

loan-level risks on mortgages held in portfolio.
43(e)(3)(iii) Definition of Loan Originator
    Proposed Sec.  226.43(e)(3)(iii) defines the term ``loan 
originator'' in Sec.  226.43(e)(3) to have the same meaning as in Sec.  
226.36(a)(1). For a discussion of the Board's proposal to use the term 
``loan originator'' as defined in Sec.  226.36(a)(1) rather than the 
statutory term ``mortgage originator,'' see the section-by-section 
analysis of proposed Sec.  226.32(b)(1)(ii).
43(e)(3)(iv) Definition of Bona Fide Discount Point
    Proposed Sec.  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 Sec.  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 Sec.  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 Sec.  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 Sec.  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

[[Page 27468]]

that takes into account all mortgage-related 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 balloon-
payment 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 Sec.  226.43(e)(2)(i)(A), must have a 
loan term that does not exceed 30 years as required by Sec.  
226.43(e)(2)(ii), must have total points and fees that do not exceed 
specified thresholds pursuant to Sec.  226.43(e)(2)(iii), and must 
satisfy the consideration and verification requirements in Sec.  
226.43(e)(2)(v).
    Under this provision, in accordance with the statutory provisions, 
the exception would excuse balloon-payment qualified mortgages from the 
requirement in proposed Sec.  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, balloon-payment loans permit the consumer to defer repayment of 
principal. The Board believes that Congress excused balloon-payment 
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 balloon-payment 
loans commonly do, but may not permit principal repayment deferral 
resulting from interest-only payments.
43(f)(1)(ii) Underwriting Using Scheduled Payments
    Proposed Sec.  226.43(f)(1)(ii) implements TILA Section 
129C(b)(2)(E)(ii) by providing that, to make a balloon-payment 
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 mortgage-related obligations, 
pursuant to Sec.  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 
Sec.  226.43(f)(1)(ii), but the creditor is not required to meet the 
repayment ability requirements of Sec.  226.43(c)(2)-(7) because those 
requirements apply only to covered transactions that are not qualified 
mortgages. Nevertheless, a creditor satisfies Sec.  226.43(f)(1)(ii) if 
it complies with the requirements of Sec.  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 Sec.  226.43(c)(5)(ii)(A) or may choose 
to consider a debt-to-income ratio that is not determined in accordance 
with Sec.  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 Sec.  
226.43(f)(1)(iii) requires that the scheduled payments on which the 
determination required by Sec.  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 Sec.  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 balloon-payment loans is 
necessary and appropriate both to effectuate the purposes of TILA 
Section 129C and to

[[Page 27469]]

prevent circumvention or evasion thereof.
    The Board believes that the exception should be structured to 
prevent balloon-payment 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 
balloon-payment 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 longer-term, 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 five-year 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 
balloon-payment qualified mortgages have a minimum loan term of five 
years.
    The Board notes that the statute requires underwriting for an 
adjustable-rate 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 Sec.  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 Sec.  
226.43(f)(1)(iv), in limiting the exception for balloon-payment 
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 balloon-
payment 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 
Dodd-Frank Act. The Board proposed to implement the escrow exemption in 
the 2011 Escrow Proposal. The provisions of proposed Sec.  
226.43(f)(1)(v), which implement TILA Section 129C(b)(2)(E)(iv), differ 
in some respects from the provisions of proposed Sec.  
226.45(b)(2)(iii) in the 2011 Escrow Proposal because of differences in 
the rationales underlying the two exceptions.
    Proposed Sec.  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 balloon-
payment 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 balloon-payment 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-by-section 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 Sec.  
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 Sec.  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 Sec.  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)

[[Page 27470]]

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 Sec.  
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-be-determined 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 Sec.  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 
balloon-payment 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 balloon-payment 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 Sec.  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 balloon-payment 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

[[Page 27471]]

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 asset-size 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 Sec.  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 Sec.  226.43(f)(1)(v)(A), discussed above. Under that section, 
a creditor's balloon-payment 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 Sec.  226.43(f)(1)(v)(A) for 
purposes of the following calendar year.
    Proposed Sec.  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 Sec.  
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 Sec.  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 Sec.  
226.45(b)(2)(iv) as set forth in the Board's 2011 Escrow Proposal. See 
proposed Sec.  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 Sec.  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.
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    \85\ See http://www.ers.usda.gov/briefing/Rurality/UrbanInf/.
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``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 Sec.  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 Sec.  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 Sec.  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

[[Page 27472]]

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 Sec.  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\
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    \86\ Also, 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.''

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, Sec.  
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 higher-priced 
mortgage loans adopted in the Board's 2008 HOEPA Final Rule. See 15 
U.S.C. 1639(c), (l); Sec.  226.35(b)(2). The Board accordingly proposes 
to remove the limitations on prepayment penalties for higher-priced 
mortgage loans under Sec.  226.35(b)(2) and other requirements under 
Sec.  226.35, as discussed in detail above in the section-by-section 
analysis of proposed Sec.  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, Sec.  
226.32(d)(7) implements TILA Section 129(c)(2). At this time, the Board 
does not propose to remove Sec.  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 Sec.  226.32(d)(7) and proposed Sec.  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\
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    \87\ In particular, the high-cost mortgage cannot be a higher-
priced mortgage loan. See proposed Sec.  226.43(g)(1)(ii)(C). Also, 
the prepayment penalty must be permitted by applicable law. See 
Sec.  226.32(d)(7); proposed Sec.  226.43(g)(1)(i).
---------------------------------------------------------------------------

    Scope; reverse mortgages. Proposed Sec.  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 Sec.  
226.43(g) apply to such transactions. See proposed Sec.  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 Sec.  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.
---------------------------------------------------------------------------

    \88\ Open-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).
---------------------------------------------------------------------------

    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

[[Page 27473]]

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).
---------------------------------------------------------------------------

    \89\ See 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).
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    \90\ Open-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).
---------------------------------------------------------------------------

    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 Sec.  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 Sec.  226.43(e) or (f); and (3) is not 
a higher-priced mortgage loan, as defined in proposed Sec.  226.45(a).
---------------------------------------------------------------------------

    \91\ 76 FR 11598, 11608, Mar. 2, 2011 (discussing proposed new 
Sec.  226.45(a)).
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43(g)(1)(i) Permitted by Applicable Law
    Under proposed Sec.  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 Sec.  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 Sec.  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. Sec.  226.18(s)(7)(ii) (defining 
``step-rate mortgage'' for purposes of transaction-specific interest 
rate and payment disclosures).
---------------------------------------------------------------------------

    \92\ See, e.g., Sec.  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 Sec.  226.36(e)(1)).
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    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 
Sec.  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 step-rate mortgage may have a prepayment penalty, 
but an adjustable-rate mortgage may not have a prepayment penalty. See 
Sec.  226.18(s)(7)(i)-(iii) (defining ``fixed-rate 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 Sec.  
226.43(g)(1)(ii)(B) would implement TILA Section 129C(c)(1)(A)

[[Page 27474]]

and provides that a covered transaction must not include a prepayment 
penalty unless the transaction is a qualified mortgage under Sec.  
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 Sec.  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 balloon-payment 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 Higher-Priced 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 Sec.  226.43(g)(1)(ii)(C) provides that a 
consummated covered transaction must not include a prepayment penalty 
unless the transaction is not a higher-priced mortgage loan, as defined 
in proposed Sec.  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[supreg] of the contract interest rates and points of 
loans offered to consumers with low-risk 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.
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    \93\ See 74 FR 58539, 58709-58710, Sept. 24, 2010 (proposing 
revisions to the definition of ``higher-priced mortgage loan'' under 
Sec.  226.35(a)).
    \94\ See 74 FR at 58660-58662.
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    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 higher-priced 
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.
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    \95\ See 75 FR 11598, 11620, Mar. 2, 2011 (proposing a new Sec.  
226.45(a)).
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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 Sec.  226.43(g)(2) would implement and is substantially 
similar to TILA Section 129C(c)(3). However, under proposed Sec.  
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 Sec.  
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 Sec.  
226.43(e)(2)(iii), discussed above. The definition of ``points and 
fees'' includes the maximum

[[Page 27475]]

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 Sec.  
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 
Dodd-Frank Act. At this time, the Board is not proposing to implement 
these limitations on prepayment penalties. The Board nevertheless 
solicits comment on whether proposed Sec.  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 Sec.  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 Sec.  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 Sec.  
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 cross-
references comment 25(a)-7, discussed above, for guidance on the 
requirements for retaining records as evidence of compliance with Sec.  
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 
Sec.  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 higher-priced mortgage loan.
    Timing of offer. Proposed Sec.  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 
Sec.  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

[[Page 27476]]

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.
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    \96\ Under 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 Sec.  226.19(a)(1)(iv)).
---------------------------------------------------------------------------

    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 Sec.  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 Sec.  
226.36(e)(2) and (3), for consistency.
43(g)(3)(i) APR Cannot Increase After Consummation
    Under proposed Sec.  226.43(g)(1)(i), a covered transaction with an 
APR that can increase after consummation may not have a prepayment 
penalty. Proposed Sec.  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 Sec.  226.43(g)(1)(ii)(A). 
Proposed Sec.  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 Sec.  226.43(g)(3)(i), the term ``type 
of interest rate'' means whether the covered transaction is a fixed-
rate mortgage, as defined in Sec.  226.18(s)(7)(iii), or a step-rate 
mortgage, as defined in Sec.  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.
---------------------------------------------------------------------------

    \97\ Under Sec.  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.
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43(g)(3)(ii) Through (iv) Criteria for a Qualified Mortgage
    As discussed above, proposed Sec.  226.43(g)(1)(ii)(A) provides 
that a covered transaction with a prepayment penalty must be a 
qualified mortgage, as defined under proposed Sec.  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 Sec.  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 Sec.  226.43(e)(2)(i); and (3) satisfy the points and fees condition 
under Sec.  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 Sec.  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 single-premium 
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 Sec.  
226.43(e)(2)(iii).
43(g)(3)(v) Likely Qualifies
    Proposed Sec.  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 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 Sec.  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 Sec.  
226.43(g)(3)(v) and proposed comment 43(g)(3)(v)-1 are substantially 
similar to Sec.  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

[[Page 27477]]

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); Sec.  
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 Sec.  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 Sec.  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 Sec.  
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.
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    \98\ For 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 Sec.  226.36(a)(1), (2).
---------------------------------------------------------------------------

    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 anti-steering 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 Sec.  226.43(g)(4) provides that, if a 
creditor offers a covered transaction to a consumer through a mortgage 
broker, as defined in Sec.  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 Sec.  226.43(g)(3). 
Proposed Sec.  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 Sec.  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 Sec.  226.43(g)(4) facilitates 
compliance with proposed Sec.  226.43(g)(3) and with the safe harbor 
for the anti-steering requirement in connection with a single covered 
transaction. See Sec.  226.36(e)(3)(i).\99\ Proposed Sec.  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 Sec.  226.36(e)(3)(i).
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    \99\ Current Sec.  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.
---------------------------------------------------------------------------

    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 Sec.  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 Sec.  
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 anti-

[[Page 27478]]

steering requirement, under Sec.  226.36(e)(2) and (3).
43(g)(5) Creditor That Is a Loan Originator
    Proposed Sec.  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 Sec.  
226.36(e). See Sec.  226.36(a)(1); comment 36(a)(1)-1. Like other loan 
originators, such creditors may use the safe harbor for the anti-
steering requirements under Sec.  226.36(e)(2) and (3). Proposed Sec.  
226.43(g)(5) provides that, if the creditor is a loan originator, as 
defined in Sec.  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 Sec.  
226.43(g)(5) provides flexibility with respect to the presentation of 
loan options, which facilitates compliance with proposed Sec.  
226.43(g)(3) and with the safe harbor for the anti-steering requirement 
in connection with the same covered transaction. See Sec.  
226.36(e)(3)(i). Like proposed Sec.  226.43(g)(4), however, proposed 
Sec.  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 anti-steering 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 
Sec.  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 ``table-funding'' by a third party. See Sec.  
226.36(a)(1), comment 36(a)-1.i, -1.ii. Proposed comment 43(g)(5)-2 
cross-references guidance in comment 36(e)(3)-3 on determining which 
step-rate mortgage has a lower interest rate.
43(g)(6) Applicability
    Proposed Sec.  226.43(g)(6) provides that proposed Sec.  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 Sec.  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 Sec.  
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 Sec.  
226.43(g)(4) and (5) establish requirements for creditors to comply 
with proposed Sec.  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 Sec.  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 Sec.  226.43(g)(2) through 
(5), as discussed above in the section-by-section analysis of proposed 
Sec.  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 Sec.  226.43, 
which would implement TILA Section 129C. Proposed Sec.  226.43(h) 
prohibits a creditor from structuring a transaction that does not meet 
the definition of open-end credit in Sec.  226.2(a)(20) as a HELOC to 
evade the requirements of proposed Sec.  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 Sec.  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 anti-evasion 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 anti-evasion 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

[[Page 27479]]

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 non-bank mortgage 
lenders and loan servicers.\100\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \101\ TILA 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).
---------------------------------------------------------------------------

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 Sec.  
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 Sec.  226.43(e); (3) add new Sec.  226.43(g) regarding 
prepayment penalty requirements for residential mortgage loans; and (4) 
provide record retention requirements in Sec.  226.25(a) that evidence 
compliance with proposed Sec.  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 Sec.  226.1(c)(1).\102\ All small entities 
that originate or extend closed-end loans secured by a dwelling are 
potentially subject to at least some aspects of the proposed rule.
---------------------------------------------------------------------------

    \102\ Regulation 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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \103\ For purposes of this analysis, thrifts include savings 
banks, savings and loan entities, co-operative banks, and industrial 
banks.
---------------------------------------------------------------------------

    The Board cannot identify with certainty the number of small non-
depository institutions that would be subject to the proposed rule. 
Home Mortgage Disclosure Act (HMDA) \104\

[[Page 27480]]

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.
---------------------------------------------------------------------------

    \104\ The 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 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.
    \105\ The 2009 HMDA Data, available at http://www.ffiec.gov/hmda/default.htm.
---------------------------------------------------------------------------

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, fully-
amortizing payments at the fully-indexed 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 Sec.  226.43 for three years after the 
consummation of a covered transaction. Currently, Sec.  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 Sec.  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 Sec.  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 balloon-payment loans to 
hedge against interest rate risk, rather than making adjustable-rate 
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:

[[Page 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:

Sec.  226.25  Record retention.

    (a) General rule. A creditor shall retain evidence of compliance 
with [lsqbb]this regulation[rsqbb][rtrif]Sec.  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 regulation[ltrif] (other than advertising requirements 
under Sec. Sec.  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:

Sec.  226.32  Requirements for certain closed-end 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 [rtrif]considered to be a finance charge[ltrif] 
[lsqbb]required to be disclosed[rsqbb] under Sec.  226.4(a) and 
226.4(b), except [rtrif]--[ltrif] [lsqbb]interest or the time-price 
differential[rsqbb]
    [rtrif](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.[ltrif]
    (ii) All compensation paid [lsqbb]to mortgage brokers[rsqbb] 
[rtrif]directly or indirectly by a consumer or creditor to a loan 
originator, as defined in Sec.  226.36(a)(1), including a loan 
originator that is also the creditor in a table-funded 
transaction;[ltrif]
    (iii) All items listed in Sec.  226.4(c)(7) (other than amounts 
held for future payment of taxes) [rtrif]payable at or before closing 
of the mortgage loan,[ltrif] unless--[lsqbb]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; and[rsqbb]
    [rtrif](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; [ltrif]
    (iv) [rtrif]Premiums 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.[ltrif] [lsqbb]Premiums 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.[rsqbb]
    [rtrif](v) The maximum prepayment penalty, as defined in Sec.  
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 Sec.  
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 Sec.  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)[ltrif][lsqbb](2)[rsqbb] 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).

Sec.  226.34  Prohibited acts or practices in connection with credit 
subject to Sec.  226.32.

    (a) * * *
    [(4) Repayment ability. Extend credit subject to Sec.  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 Sec.  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

[[Page 27482]]

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.[rsqbb]
* * * * *

Sec.  226.35  [Removed and reserved]

    5. Section 226.35 is removed and reserved.
    6. Add Sec.  226.43 to read as follows:

[rtrif]Sec.  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 Sec.  226.2(a)(19), other 
than:
    (1) A home equity line of credit subject to Sec.  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 Sec.  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 Sec.  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 Sec.  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 
Sec.  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 Sec.  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 Sec.  
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 Sec.  
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 Sec.  
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 Sec.  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 Sec.  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.

[[Page 27483]]

    (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-to-income 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 Sec.  
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 Sec.  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 Sec.  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 Sec.  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-to-income 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.

[[Page 27484]]

    (ii) The monthly payment for the standard mortgage is materially 
lower than the monthly payment for the non-standard 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 non-standard 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 Sec.  
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 Sec.  226.18(s)(7)(iv); or
    (C) A negative amortization loan, as defined in Sec.  
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 Sec.  
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 
Sec.  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 Sec.  
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

[[Page 27485]]

    (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-to-income 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 x .0036 = Y;
    (3) 500 - Y = X; and
    (4) X 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 Sec.  
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 Sec.  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 Sec.  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 Sec.  
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,

[[Page 27486]]

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 Sec.  
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 Sec.  
226.18(s)(7)(iii); or
    (B) Is a step-rate mortgage, as defined in Sec.  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 Sec.  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 Sec.  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 Sec.  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.[ltrif]
    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 Sec.  226.32, subheading 34(a) Prohibited acts 
or practices for loans subject to Sec.  226.32, paragraph 34(a)(4) 
Repayment ability is removed and reserved.
    D. Section 226.35--Prohibited Acts or Practices in Connection with 
Higher-

[[Page 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). [rtrif]Unless otherwise 
required,[ltrif] 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.
* * * * *
    [rtrif]6. Evidence of compliance with Sec.  226.43. Creditors must 
retain evidence of compliance with Sec.  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 Sec.  226.43(g)(3).) If a creditor 
must verify and document information used in underwriting a transaction 
subject to Sec.  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 Sec.  
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 Sec.  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 Sec.  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 Sec.  
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 Sec.  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 
Sec.  226.43(g)(4)(ii).[ltrif]
* * * * *

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 Sec.  226.18(b), and deducting any cost listed 
in Sec.  226.32(b)(1)(iii)[rtrif],[ltrif] [and 226.32] 
(b)(1)(iv)[rtrif]and (b)(1)(vi)[ltrif] that is both included as points 
and fees under Sec.  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 [rtrif]single[ltrif] premium for 
optional credit [rtrif]unemployment[ltrif] [lsqbb]life[rsqbb] 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 
Sec.  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 Sec.  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 Sec.  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 Sec.  226.32(b)(1)(iii). 
[rtrif]In this case, the amount financed is the same as the total loan 
amount:[ltrif] $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 
[rtrif]unemployment[ltrif] [lsqbb]life[rsqbb] insurance, and pays $400 
in points at closing, the amount financed under Sec.  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 Sec.  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 Sec.  226.4(a) and 
226.4(b). Items excluded from the finance charge under other provisions 
of Sec.  226.4 are not excluded in the total ``points and fees'' under 
Sec.  226.32(b)(1)(i), but may be included in ``points and fees'' under 
Sec.  226.32(b)(1)(ii) [rtrif]through Sec.  
226.32(b)(1)(vi).[ltrif][lsqbb]and Sec.  226.32(b)(1)(iv)[rsqbb]. 
Interest, including per diem interest, is excluded from ``points and 
fees under Sec.  226.32(b)(1). [rtrif]To illustrate: A fee imposed by 
the creditor for an appraisal performed by an employee of the creditor 
meets the definition of ``finance charge'' under Sec.  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, Sec.  226.4(c)(7) expressly 
provides that appraisal fees are not finance charges. Therefore, under 
the

[[Page 27488]]

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 re-includes in 
points and fees items listed in Sec.  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 Sec.  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 Sec.  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 Sec.  
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 Sec.  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 Sec.  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.[ltrif]
    Paragraph 32(b)(1)(ii).
    1. [Mortgage broker fees][rtrif]Loan originator compensation--
general[ltrif]. In determining ``points and fees'' for purposes of this 
section, compensation paid by a consumer [rtrif]or creditor[ltrif] to a 
[rtrif]loan originator[ltrif] [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.] 
[rtrif]Loan originator[ltrif][Mortgage broker] fees already included in 
[rtrif]points and fees[ltrif] calculation as finance charges under 
Sec.  226.32(b)(1)(i) need not be counted again under Sec.  
226.32(b)(1)(ii).
    [rtrif]2. 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 year-end 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 long-term 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

[[Page 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 Sec.  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.[ltrif][2. Example.] Section 32(b)(1)(iii) defines 
``points and fees'' to include all items listed in Sec.  226.4(c)(7), 
other than amounts held for the future payment of taxes. An item listed 
in Sec.  226.4(c)(7) may be excluded from the ``points and fees'' 
calculation, however, if the charge is reasonable[rtrif]; [ltrif][,] 
the creditor receives no direct or indirect compensation from the 
charge[rtrif];[ltrif][,] and the charge is not paid to an affiliate of 
the creditor. For example, a reasonable fee paid by the consumer to an 
independent, third-party appraiser may be excluded from the ``points 
and fees'' calculation (assuming no compensation is paid to the 
creditor[rtrif] or its affiliate[ltrif]). [rtrif]By contrast, 
a[ltrif][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. [rtrif]Credit insurance and debt cancellation or suspension 
coverage [ltrif][Premium amount]. In determining ``points and fees'' 
for purposes of this section, premiums paid at or before closing for 
credit insurance or [rtrif]any debt cancellation or suspension 
agreement or contract[ltrif] are included [rtrif]in ``points and fees'' 
if they are paid at or before closing,[ltrif] whether they are paid in 
cash or financed, [rtrif]and whether the insurance or coverage is 
optional or required. Such charges are also included[ltrif][and] 
whether the amount represents the entire premium or payment for the 
coverage or an initial payment.
    [rtrif]2. 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.[ltrif]
* * * * *

Section 226.34--Prohibited Acts or Practices in Connection with Credit 
Subject to Sec.  226.32

    34(a) Prohibited acts or practices for loans subject to Sec.  
226.32.
* * * * *
    34(a)(4) Repayment ability. [rtrif][lsqbb]Reserved.[rsqbb][ltrif]
* * * * *

Section 226.35 [rtrif][lsqbb]Reserved.[rsqbb][ltrif]

* * * * *

[rtrif]Section 226.43--Minimum Standards for Transactions Secured by a 
Dwelling

    1. Record retention. See Sec.  226.25(a) and comments 25(a)-6 and -
7 for guidance on the required retention of records as evidence of 
compliance with Sec.  226.43.
    43(a) Scope.
    1. Consumer credit. In general, Sec.  226.43 applies to consumer 
credit transactions secured by a dwelling, but certain dwelling-secured 
consumer credit transactions are exempt from coverage under Sec.  
226.43(a)(1)-(3). (See Sec.  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 Sec.  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 Sec.  226.2(a)(19). For purposes of Sec.  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 Sec.  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 Sec.  
226.43(a)(3)(ii), a temporary or ``bridge'' loan with a term of 12 
months or less is excluded from coverage by Sec.  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 Sec.  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 Sec.  226.43(c), see Sec.  
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

[[Page 27490]]

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 Sec.  
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 Sec.  
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 Sec.  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 higher-priced 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 Sec.  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 Sec.  
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 Sec.  
226.43(b)(5); ``negative amortization loan'' is defined in Sec.  
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.

[[Page 27491]]

    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 mortgage-related insurance required by the 
creditor as set forth in Sec.  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. 
Mortgage-related 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 Sec.  
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 
interest-only 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 
interest-only 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 
Sec.  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 third-party 
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

[[Page 27492]]

Sec.  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 Sec.  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. 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 third-party records as required by Sec.  
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 Sec.  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 third-party 
record under Sec.  226.43(b)(13)(i).
    Paragraph 43(b)(13)(iii).
    1. Creditor's records. Section 226.43(b)(13)(iii) provides that 
third-party 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 Sec.  226.43(c), creditors may look to widely accepted 
governmental or non-governmental 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 Sec.  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 
Sec.  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

[[Page 27493]]

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, part-
time, seasonal, irregular, military, or self-employment. Under Sec.  
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 Sec.  226.43(c)(2), a creditor must consider the 
consumer's monthly payment on a covered transaction that is calculated 
as required under Sec.  226.43(c)(5), taking into account any mortgage-
related obligations. ``Mortgage-related obligations'' is defined in 
Sec.  226.43(b)(8).
    Paragraph 43(c)(2)(iv).
    1. Home equity lines of credit. For purposes of Sec.  
226.43(c)(2)(iv), a simultaneous loan includes any covered transaction 
or home equity line of credit subject to Sec.  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 Sec.  226.43. See Sec.  226.43(a) discussing the scope of this 
section. ``Simultaneous loan'' is defined in Sec.  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 Sec.  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 Sec.  226.43(c)(2)(iv), a 
simultaneous loan includes a loan that comes into existence 
concurrently with the covered transaction subject to Sec.  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 Sec.  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 
Sec.  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 non-governmental standards in determining the pro rata 
monthly payment amount.
    3. Estimates. Estimates of mortgage-related obligations should be 
based upon information that is known to the creditor at the time the 
creditor underwrites the mortgage obligation.

[[Page 27494]]

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 Sec.  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 Sec.  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 Sec.  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 Sec.  
226.43(c)(7) regarding the definitions and calculations for the monthly 
debt-to-income 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 non-governmental 
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 Sec.  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 Sec.  
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 Sec.  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 Sec.  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 Sec.  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 Sec.  
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 step-
rate mortgage. The terms ``fixed-rate mortgage,'' ``adjustable-rate 
mortgage,'' ``step-rate mortgage,'' ``interest-only loan'' and 
``negative amortization loan,'' are defined in Sec.  226.18(s)(7)(i), 
(ii), (iii), (iv) and (v), respectively. For the meaning of the term 
``balloon payment,'' see Sec.  226.18(s)(5)(i). The payment calculation 
method set forth in Sec.  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 Sec.  226.43(c)(5)(i) 
and (ii), which provides examples for calculating the monthly payment 
for purposes of the repayment ability determination required under 
Sec.  226.43(c)(2)(iii).
    2. Greater of the fully indexed rate or introductory rate; premium 
adjustable-rate 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

[[Page 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 
Sec.  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 Sec.  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 non-amortizing 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 Sec.  226.17(c)(3) (discussing minor 
variations), and Sec.  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 Sec.  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 Sec.  
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 Sec.  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 Sec.  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 Sec.  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 Sec.  
226.45(a)(2)(ii); ``higher-priced covered transaction'' is defined in 
Sec.  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 higher-priced 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 Sec.  226.18(s)(5)(i).
    2. First five years after consummation. Under Sec.  
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 Sec.  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 
higher-priced 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.

[[Page 27496]]

    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 three-year 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 Sec.  
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 Sec.  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 five-year 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 Sec.  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 Sec.  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 Sec.  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 Sec.  
226.43(b)(5) and (b)(11), respectively. ``Interest-only'' and 
``Interest-only loan'' are defined in Sec.  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 Sec.  226.43(c)(5)(ii)(B) (all 
amounts are rounded):
    i. 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 Sec.  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 
interest-only 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 Sec.  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

[[Page 27497]]

the loan term after the loan is recast. ``Recast'' is defined in Sec.  
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 Sec.  226.43(c)(5)(ii)(C), see Sec.  226.43(b)(7) and 
associated commentary. ``Negative amortization loan'' is defined in 
Sec.  226.18(s)(7)(v).
    2. Term of loan. Under Sec.  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 Sec.  
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 Sec.  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 Sec.  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 
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 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 Sec.  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 Sec.  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 Sec.  226.43(b)(12).
    2. Payment calculation--covered transaction. For a simultaneous 
loan that is a covered transaction, as that term is defined under Sec.  
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 
Sec.  226.43(c)(5), taking into account any mortgage-related 
obligations. For the meaning of the term ``mortgage-related 
obligations,'' see Sec.  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 Sec.  
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 Sec.  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

[[Page 27498]]

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 Sec.  
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 
Sec.  226.43(c)(2)(vii), the creditor must consider the consumer's 
monthly debt-to-income ratio, or the consumer's monthly residual 
income, in accordance with the requirements in Sec.  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-
to-income 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 Sec.  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 Sec.  
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 Sec.  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 Sec.  
226.43(d)(1)(iv), the exemptions in Sec.  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 non-standard 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 Sec.  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 Sec.  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 Sec.  
226.43(d)(1)(v), the exemptions in Sec.  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 Sec.  226.43(d)(1)(v) is not met because the consumer 
made a payment more than 30 days late just one and one-half 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 
Sec.  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 ``non-
standard mortgage.''
    43(d)(2)(ii) Standard mortgage.
    Paragraph 43(d)(2)(ii)(A).
    1. Regular periodic payments. Under Sec.  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 single-payment 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

[[Page 27499]]

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 Sec.  
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 non-standard 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 Sec.  
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 widely-accepted governmental and non-governmental 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 Sec.  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 
Sec.  226.43(d)(5)(ii), rather than the calculations prescribed under 
Sec.  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 Sec.  226.43(d)(3)(ii), to calculate the 
payment required for the ability-to-repay rule under Sec.  
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 non-standard 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 Sec.  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 Sec.  226.43(b)(11) 
and associated commentary.
    2. Fully indexed rate. The term ``fully indexed rate'' in Sec.  
226.43(d)(5)(i)(A) for calculating the payment for a non-standard 
mortgage is generally defined in Sec.  226.43(b)(3) and associated 
commentary. Under Sec.  226.43(b)(3) the fully indexed rate is 
calculated at the time of consummation. For purposes of Sec.  
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 Sec.  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 Sec.  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 Sec.  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 Sec.  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

[[Page 27500]]

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 Sec.  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 interest-only loan. Under Sec.  
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 Sec.  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 interest-only. 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 Sec.  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 Sec.  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 non-standard 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 Sec.  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 
Sec.  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 Sec.  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 Sec.  
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 Sec.  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 Sec.  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 fully-indexed 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

[[Page 27501]]

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 Sec.  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 non-standard mortgage monthly payment (see 
Sec.  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 Sec.  226.43(e)(2) or Sec.  226.43(f), as applicable, 
is deemed to have complied with Sec.  226.43(c)(1). That is, a creditor 
or assignee need not demonstrate compliance with Sec.  226.43(c)(2)-(7) 
if the terms of the loan comply with Sec.  226.43(e)(2)(i)-(ii) (or, if 
applicable, Sec.  226.43(f)); the loan's points and fees do not exceed 
the limits set forth in Sec.  226.43(e)(2)(iii); and the creditor has 
complied with the underwriting criteria described in Sec.  
226.43(e)(2)(iv)-(v) (or, if applicable, Sec.  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 Sec.  
226.43(e)(2)(i)-(v) (or Sec. [thn x sp]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 Sec.  226.43(c) (or, if applicable, Sec.  226.43(d)).

Alternative 2--Paragraph 43(e)(1)-1
    43(e)(1) Presumption of compliance.
    1. In general. Under Sec.  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 Sec.  226.43(e)(1), a creditor or 
assignee of a covered transaction is presumed to have complied with the 
repayment ability requirement of Sec.  226.43(c)(1) if the terms of the 
loan comply with Sec.  226.43(e)(2)(i)-(ii) (or, if applicable, Sec.  
226.43(f)); the points and fees do not exceed the limit set forth in 
Sec.  226.43(e)(2)(iii), and the creditor has complied with the 
underwriting criteria described in Sec.  226.43(e)(2)(iv)-(v) (or, if 
applicable, Sec.  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 Sec.  226.43(c) (or, if applicable, Sec.  
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 Sec.  226.43(c)(1). For example, evidence of a 
high debt-to-income 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 Sec.  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 Sec.  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 Sec.  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 Sec.  
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 fixed-rate mortgage, creditors should 
use the interest rate in effect at consummation. ``Fixed-rate 
mortgage'' is defined in Sec.  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

[[Page 27502]]

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 Sec.  
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 Sec.  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 
Sec.  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 Sec.  226.43(b)(5), 
over the entire loan term, as that term is defined in Sec.  
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 Sec.  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 Sec.  
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

[[Page 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 Sec.  
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 Sec.  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 Sec.  
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 Sec.  
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 Sec.  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 Sec.  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 Sec.  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 Sec.  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

[[Page 27504]]

bona fide third party charges not retained by the creditor, loan 
originator, or an affiliate of either is limited by Sec.  
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 Sec.  
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 Sec.  
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 Sec.  
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 Sec.  226.43(e)(2), other than Sec.  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 Sec.  226.43(e)(2)(i)(A); must have a loan term 
that does not exceed 30 years, pursuant to Sec.  226.43(e)(2)(ii); must 
have total points and fees that do not exceed specified thresholds 
pursuant to Sec.  226.43(e)(2)(iii); and must satisfy the consideration 
and verification requirements in Sec.  226.43(e)(2)(v).
    Paragraph 43(f)(1)(ii).
    1. Example. Under Sec.  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 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 mortgage-related 
obligations, pursuant to Sec.  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 Sec.  226.43(f)(1)(ii), but the creditor is not 
required to meet the repayment ability requirements of Sec.  
226.43(c)(2)-(7) because those requirements apply only to covered 
transactions that are not qualified mortgages. Nevertheless, a creditor 
satisfies Sec.  226.43(f)(1)(ii) if it complies with the requirements 
of Sec.  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 Sec.  
226.43(c)(5)(ii)(A) or may choose to consider a debt-to-income ratio 
that is not determined in accordance with Sec.  226.43(c)(7).
    Paragraph 43(f)(1)(iii).
    1. Amortization period. Under Sec.  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 Sec.  
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).

[[Page 27505]]

    1. Creditor qualifications. Under Sec.  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 Sec.  
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 balloon-payment 
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 Sec.  
226.43(f)(1)(v)(A) if it satisfies either of the two tests in Sec.  
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 Sec.  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 Sec.  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 Sec.  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 Sec.  
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 
Sec.  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 Sec.  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 Sec.  226.43(e)(2)(iii).
    Paragraph 43(g)(3)(v).
    1. Transactions for which the consumer likely qualifies. Under 
Sec.  226.43(g)(3)(v), the alternative covered transaction without a 
prepayment penalty the creditor must offer under Sec.  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 Sec.  226.43(g)(3)(v) 
are not met. The creditor's belief that the consumer likely qualifies 
for the

[[Page 27506]]

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 Sec.  226.43(g)(4), where the creditor offers 
covered transactions with a prepayment penalty to consumers through a 
mortgage broker, as defined in Sec.  226.36(a)(2), the creditor must 
present the mortgage broker an alternative covered transaction that 
satisfies the requirements of Sec.  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 Sec.  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 Sec.  
226.36(a)(1) applies for purposes of Sec.  226.43(g)(5). Thus, a loan 
originator includes any creditor that satisfies the definition of loan 
originator but makes use of ``table-funding'' by a third party. See 
comment 36(a)-1.i, -1.ii.
    2. Lower interest rate. Under Sec.  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 Sec.  
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 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 Sec.  
226.43.[ltrif]
* * * * *

    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
```