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[Federal Register Volume 66, Number 245 (Thursday, December 20, 2001)]
[Rules and Regulations]
[Pages 65604-65622]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-31264]

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FEDERAL RESERVE SYSTEM

12 CFR Part 226

[Regulation Z; Docket No. R-1090]

Truth in Lending

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule.

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SUMMARY: The Board is adopting amendments to the provisions of 
Regulation Z (Truth in Lending) that implement the Home Ownership and 
Equity Protection Act (HOEPA). HOEPA was enacted in 1994, in response 
to evidence of abusive lending practices in the home-equity lending 
market. HOEPA imposes additional disclosure requirements and 
substantive limitations (for example, restricting short-term balloon 
notes) on home-equity loans bearing rates or fees above a certain 
percentage or amount. The Board's amendments to Regulation Z broaden 
the scope of mortgage loans subject to HOEPA by adjusting the price 
triggers used to determine coverage under the act. The rate-based 
trigger is lowered by two percentage points for first-lien mortgage 
loans, with no change for subordinate-lien loans. The fee-based trigger 
is revised to include the cost of optional credit insurance and similar 
debt protection products paid at closing. The amendments restrict 
certain acts and practices in connection with home-secured loans. For 
example, creditors may not engage in repeated refinancings of their 
HOEPA loans over a short time period when the transactions are not in 
the borrower's interest. The amendments also strengthen HOEPA's 
prohibition against extending credit without regard to consumers' 
repayment ability, and enhance disclosures received by consumers before 
closing for HOEPA-covered loans.

DATES: The rule is effective December 20, 2001; compliance is mandatory 
as of October 1, 2002.

FOR FURTHER INFORMATION CONTACT: Minh-Duc T. Le, Attorney, Daniel G. 
Lonergan, Counsel, or Jane E. Ahrens, Senior Counsel, Division of 
Consumer and Community Affairs, at (202) 452-3667 or 452-2412; for 
users of Telecommunications Device for the Deaf (``TDD'') only, contact 
(202) 263-4869.

SUPPLEMENTARY INFORMATION:

I. Background

    Since the mid-1990s, the subprime mortgage market has grown 
substantially, providing access to credit to borrowers with less-than-
perfect credit histories and to other borrowers who are not served by 
prime lenders. With this increase in subprime lending there has also 
been an increase in reports of ``predatory lending.'' The term 
``predatory lending'' encompasses a variety of practices. In general, 
the term is used to refer to abusive lending practices involving fraud, 
deception, or unfairness. Some abusive practices are clearly unlawful, 
but others involve loan terms that are legitimate in many instances and 
abusive in others, and thus are difficult to regulate. Loan terms that 
may benefit some borrowers, such as balloon payments, may harm other 
borrowers, particularly if they are not fully aware of the 
consequences. The reports of predatory lending have generally included 
one or more of the following: (1) Making unaffordable loans based on 
the borrower's home equity without regard to the borrower's ability to 
repay the obligation; (2) inducing a borrower to refinance a loan 
repeatedly, even though the refinancing may not be in the borrower's 
interest, and charging high points and fees each time the loan is 
refinanced, which decreases the consumer's equity in the home; and (3) 
engaging in fraud or deception to conceal the true nature of the loan 
obligation from an unsuspecting or unsophisticated borrower--for 
example, ``packing'' loans with credit insurance without a consumer's 
consent.

A. The Home Ownership and Equity Protection Act

    In response to anecdotal evidence about abusive practices involving 
home-secured loans with high rates or high fees, in 1994 the Congress 
enacted the Home Ownership and Equity Protection Act (HOEPA), Pub. L. 
103-325, 108 Stat. 2160, as an amendment to the Truth in Lending Act 
(TILA), 15 U.S.C. 1601 et seq. TILA is intended to promote the informed 
use of consumer credit by requiring disclosures about its terms and 
cost. TILA requires creditors to disclose the cost of credit as a 
dollar amount (the ``finance charge'') and as an annual percentage rate 
(the ``APR''). Uniformity in creditors' disclosures is intended to 
assist consumers in comparison shopping. TILA requires additional 
disclosures for loans secured by a consumer's home and permits

[[Page 65605]]

consumers to rescind certain transactions that involve their principal 
dwelling. TILA is implemented by the Board's Regulation Z, 12 CFR part 
226.
    HOEPA identifies a class of high-cost mortgage loans through rate 
and fee triggers, and it provides consumers entering into these 
transactions with special protections. HOEPA applies to closed-end 
home-equity loans (excluding home-purchase loans) bearing rates or fees 
above a specified percentage or amount. A loan is covered by HOEPA if 
(1) the APR exceeds the rate for Treasury securities with a comparable 
maturity by more than 10 percentage points, or (2) the points and fees 
paid by the consumer exceed the greater of 8 percent of the loan amount 
or $400. The $400 figure set in 1994 is adjusted annually based on the 
Consumer Price Index. The dollar figure for 2001 is $465 and for 2002 
is $480. 66 FR 57849, November 19, 2001.
    HOEPA is implemented in Sec. 226.32 of the Board's Regulation Z. 
HOEPA also amended TILA to require additional disclosures for reverse 
mortgages that are contained in Sec. 226.33 of Regulation Z. For 
purposes of this notice of rulemaking, however, the term ``HOEPA-
covered loan'' or ``HOEPA loan'' refers only to mortgages covered by 
Sec. 226.32 that meet HOEPA's rate or fee-based triggers.
    Creditors offering HOEPA-covered loans must give consumers an 
abbreviated disclosure statement at least three business days before 
the loan is closed, in addition to the disclosures generally required 
by TILA before or at closing. The HOEPA disclosure informs consumers 
that they are not obligated to complete the transaction and could lose 
their home if they take the loan and fail to make payments. It includes 
a few key items of cost information, including the APR. In loans where 
consumers have three business days after closing to rescind the loan, 
the HOEPA disclosure thus affords consumers a minimum of six business 
days to consider accepting key loan terms before receiving the loan 
proceeds.
    HOEPA restricts certain loan terms for high-cost loans because they 
are associated with abusive lending practices. These terms include 
short-term balloon notes, prepayment penalties, non-amortizing payment 
schedules, and higher interest rates upon default. Creditors are 
prohibited from engaging in a pattern or practice of making HOEPA loans 
based on the homeowner's equity without regard to the borrower's 
ability to repay the loan. Under HOEPA, assignees are generally subject 
to all claims and defenses with respect to a HOEPA loan that a consumer 
could assert against the creditor. HOEPA also authorizes the Board to 
prohibit acts or practices in connection with mortgage lending under 
defined criteria.

B. Continued Concerns About Predatory Lending Practices

    Since the enactment of HOEPA in 1994, the volume of home-equity 
lending has increased significantly in the subprime mortgage market. 
Based on data reported under the Home Mortgage Disclosure Act (HMDA), 
12 U.S.C. 2801 et seq., the number of nonpurchase-money loans made by 
lenders that are identified as engaging in subprime lending increased 
about five-fold--from 138,000 in 1994 to roughly 658,000 in 2000. While 
such lending benefits consumers by making credit available, it also 
raises concerns that the increase in the number of subprime loans 
brings a corresponding increase in the number of predatory loans.
    In the past two years, various initiatives to address predatory 
lending have been undertaken. The Senate Banking Committee held 
hearings in July 2001 at which consumers and representatives of 
industry and consumer groups testified; the House Banking Committee 
held hearings in May 2000 at which the banking regulators and others 
testified; and bills have been introduced to address predatory lending. 
Several states and municipalities have enacted or are considering 
legislation or regulations. The Department of Housing and Urban 
Development and the Department of Treasury held a number of public 
forums on predatory lending and issued a report in June 2000. The 
report makes recommendations to the Congress regarding legislative 
action and to the Board urging the use of its regulatory authority to 
address predatory lending practices. Fannie Mae and Freddie Mac 
published guidelines last year to avoid purchasing loans that are 
potentially predatory; they are also making efforts to develop 
consumers' awareness of their credit options.
    The Board has conferred with its Consumer Advisory Council and 
Board staff have met with other industry representatives and consumer 
advocates on the issue of predatory lending. In 2000, the Board held 
hearings in Charlotte, Boston, Chicago, and San Francisco, to consider 
approaches the Board might take in exercising its regulatory authority 
under HOEPA. The Board's hearings focused on expanding the scope of 
mortgage loans covered by HOEPA, prohibiting specific acts or 
practices, improving consumer disclosures, and educating consumers. 
Transcripts of the hearings can be accessed on the Board's Internet web 
site at http://www.federalreserve.gov/community.htm. In the notices 
announcing the hearings, the Board also solicited written comment on 
possible revisions to Regulation Z's HOEPA rules. 65 FR 45547, July 24, 
2000. The Board received approximately 450 comment letters in response 
to the notices, two-thirds of which were from consumers generally 
encouraging Board action to curb predatory lending.

C. The Board's Proposed Rule to Amend Regulation Z

    The Board published a proposed rule to amend Regulation Z in 
December 2000. 65 FR 81438, December 26, 2000. The Board proposed to 
broaden the scope of mortgage loans subject to HOEPA by adjusting the 
price triggers used to determine coverage under the act; to prohibit 
certain acts and practices in connection with home-secured loans 
covered by HOEPA; to require increased scrutiny on creditors' practices 
to document and verify income; and to enhance disclosures received by 
consumers before closing for HOEPA-covered loans.
    The Board received approximately 200 letters that specifically 
addressed the proposed revisions and represented the views of the 
mortgage lending industry, credit insurance industry, consumer and 
community development groups, and government agencies. In addition, the 
Board received approximately 1,100 identical e-mail comment letters 
from consumers generally encouraging the Board to curb predatory 
lending.
    Most of the creditors and other commenters involved in mortgage 
lending opposed making more loans subject to HOEPA. They believe that 
the coverage of more loans would reduce competition and the 
availability of credit in the range of rates affected because some 
lenders, as a matter of policy, will not make HOEPA loans. With regard 
to the new rules that would apply to HOEPA loans, creditors wanted more 
flexibility and compliance guidance. Consumer representatives and 
community development organizations generally supported the proposal as 
a step forward in addressing the problem of predatory lending but 
believed additional steps are needed to ensure consumers are protected.

II. Summary of Final Rule

    With some exceptions, the Board is adopting the revisions 
substantially as proposed to address predatory lending and unfair 
practices in the home-equity market. The revisions are adopted

[[Page 65606]]

pursuant to the Board's authority to adjust the APR trigger and add 
additional charges to the points and fees trigger. See 15 U.S.C. 
1602(aa). Revisions are also issued pursuant to the Board's authority 
under HOEPA to prohibit certain acts or practices (1) affecting 
mortgage loans if the Board finds the act or practice to be unfair, 
deceptive, or designed to evade HOEPA, or (2) affecting refinancings if 
the Board finds the act or practice to be associated with abusive 
lending or otherwise not in the interest of the borrower. 15 U.S.C. 
1639(l)(2). Revisions are also adopted pursuant to section 105(a) of 
TILA to effectuate the purposes of TILA, to prevent circumvention or 
evasion, or to facilitate compliance. 15 U.S.C. 1604(a).
    The amendments (1) extend the scope of mortgage loans subject to 
HOEPA's protections, (2) restrict certain acts or practices, (3) 
strengthen HOEPA's prohibition on loans based on homeowners' equity 
without regard to repayment ability, and (4) enhance HOEPA disclosures 
received by consumers before closing, as follows.
    The final rule adjusts the APR trigger for first-lien mortgage 
loans, from 10 percentage points to 8 percentage points above the rate 
for Treasury securities having a comparable maturity, the maximum 
amount that the Board may lower the trigger. The APR trigger for 
subordinate-lien loans remains at 10 percentage points. The fee-based 
trigger is adjusted to include amounts paid at closing for optional 
credit life, accident, health, or loss-of-income insurance, and other 
debt-protection products written in connection with the credit 
transaction.
    The final rule also addresses some ``loan flipping'' within the 
first year of a HOEPA loan. Except in limited circumstances, a creditor 
that has made a HOEPA loan to a borrower is generally prohibited for 
twelve months from refinancing any HOEPA loan made to that borrower 
into another HOEPA loan. Assignees holding or servicing a HOEPA loan 
are subject to similar restrictions.
    To prevent the evasion of HOEPA, which only covers closed-end 
loans, the final rule prohibits a creditor from wrongfully documenting 
such loans as open-end credit. For example, a high-cost mortgage may 
not be structured as a home-secured line of credit if there is no 
reasonable expectation that repeat transactions will occur under a 
reusable line of credit. To ensure that lenders do not accelerate the 
payment of HOEPA loans without cause, the final rule prohibits a 
creditor from exercising ``due-on-demand'' or call provisions in a 
HOEPA loan, unless the clause is exercised in connection with a 
consumer's default. A similar rule applies to home-secured lines of 
credit under Regulation Z.
    The final rule seeks to strengthen HOEPA's prohibition on making 
loans based on homeowners' equity without regard to repayment ability. 
It creates a presumption that a creditor has violated the statutory 
prohibition on engaging in a pattern or practice of making HOEPA loans 
without regard to repayment ability if the creditor generally does not 
verify and document consumers' repayment ability.
    The final rule revises the HOEPA disclosures (given three days 
before loan closing) for refinancings, to alert consumers to the total 
amount borrowed, which may be substantially higher than the loan amount 
requested due to the financing of credit insurance, points, and fees. 
To enhance consumer awareness, and deter insurance packing, the HOEPA 
disclosure must specify whether the total amount borrowed includes the 
cost of optional insurance.
    The staff commentary to Regulation Z has also been revised to 
provide guidance on the new rules and to clarify existing requirements. 
Revisions to the regulation and the staff commentary are discussed in 
detail below in the section-by-section analysis.

III. Section-by-Section Analysis of Final Rule

Subpart A--General

Section 226.1--Authority, Purpose, Coverage, Organization, Enforcement 
and Liability
    Section 226.1(b) on the purpose of the regulation is revised as 
proposed to reflect the addition of prohibited acts and practices in 
connection with credit secured by a consumer's dwelling. Section 
226.1(d) on the organization of the regulation is revised to reflect 
the restructuring of Subpart E (rules for certain home mortgage 
transactions).

Subpart C--Closed-end Credit

Section 226.23--Right of Rescission

23(a)  Consumer's Right to Rescind

    The proposed amendment to footnote 48 to Sec. 226.23(a)(3) is 
unnecessary given the organization of the final rule, and thus has not 
been adopted.

Subpart E--Special Rules for Certain Home Mortgage Transactions

Section 226.31--General Rules

31(c)  Timing of Disclosure

31(c)(1)(i)  Change in Terms

    Section 226.31(c)(1) requires a three-day waiting period between 
the time the consumer is furnished with disclosures required under 
Sec. 226.32 and the time the consumer becomes obligated under the loan. 
If the creditor changes any terms that make the disclosures inaccurate, 
new disclosures must be given and another three-day waiting period is 
triggered.
    Comment Sec. 226.31(c)(1)(i)-2 is added, as proposed, to clarify 
redisclosure requirements when, after a consumer receives a HOEPA 
disclosure and before consummation, loan terms change that make the 
disclosure inaccurate. The Board's 2000 hearings revealed that some 
creditors offer credit insurance and other optional products at loan 
closing. If the consumer finances the purchase of such products and as 
a result the monthly payment differs from what was previously disclosed 
under Sec. 226.32, the terms of the extension of credit have changed; 
redisclosure is required and a new three-day waiting period applies. 
See discussion below concerning Sec. 226.32(c)(3) on when optional 
items may be included in the regular payment disclosure.
Section 226.32--Requirements for Certain Closed-end Home Mortgages

32(a)  Coverage

    HOEPA disclosures and restrictions cover home-equity loans that 
meet one of the act s two high-cost triggers a rate trigger and a 
points and fees trigger. Under the final rule, both triggers are 
revised to cover more loans.
    APR trigger--Currently, a loan is covered by HOEPA if the APR 
exceeds by more than 10 percentage points the rate for Treasury 
securities with a comparable maturity. Section 103(aa) of TILA 
authorizes the Board to adjust the APR trigger by 2 percentage points 
from the current standard of 10 percentage points upon a determination 
that the increase or decrease is consistent with the consumer 
protections against abusive lending contained in HOEPA and is warranted 
by the need for credit.
    The Board had proposed to reduce the rate trigger from 10 to 8 
percentage points above the rate for Treasury securities with a 
comparable term for all loans, the maximum adjustment that the Board 
can make. With this change, based on recent rates for Treasury 
securities, home-equity loans with a term of 10 years would be subject 
to HOEPA if they have an APR of approximately 13 percent or higher.
    The Board solicited comment on an alternative approach that would 
differentiate between first- and subordinate-lien loans in the 
application of the APR trigger. Under the two-tiered alternative, the 
APR trigger for first-lien mortgages would be

[[Page 65607]]

reduced to 8 percentage points; the APR trigger for subordinate-lien 
loans would remain at 10 percentage points. The final rule adopts the 
two-tiered alternative approach.
    HOEPA provides that the Board may adjust the APR trigger after 
consulting with representatives of consumers and lenders and 
determining that the increase or decrease is consistent with the 
purpose of consumer protection in HOEPA and is warranted by the need 
for credit. (The Board may not adjust the trigger more frequently than 
once every two years.) Consistent with this mandate, the Board has held 
public hearings, considered the testimony at other hearings held by 
government agencies and the Congress, analyzed comment letters, held 
discussions with community groups and lenders, consulted its Consumer 
Advisory Council, and reviewed data from various studies and reports on 
the home-equity lending market.
    Most of the information the Board received about predatory lending 
is anecdotal, as it was when Congress passed HOEPA in 1994. The reports 
of actual cases (including additional Congressional testimony by 
consumers) are, however, widespread enough to indicate that the problem 
warrants addressing. Homeowners in certain communities--frequently the 
elderly, minorities, and women--continue to be targeted with offers of 
high-cost, home-secured credit with onerous loan terms. The loans, 
which are typically offered by nondepository institutions, carry high 
up-front fees and may be based solely on the equity in the consumers' 
homes without regard to their ability to make the scheduled payments. 
When homeowners have trouble repaying the debt, they are often 
pressured into refinancing their loans into new unaffordable, high-fee 
loans that rarely provide economic benefit to the consumers. These 
refinancings may occur frequently. The loan balances increase primarily 
due to fees that are financed resulting in reductions in the consumers' 
equity in their homes and, in some cases, foreclosure may occur. The 
loan transactions also may involve fraud and other deceptive practices.
    Creditors have expressed concern that lowering the HOEPA rate 
trigger would adversely affect credit availability for loans in the 
range of rates that would be covered by the lowered trigger. Many 
creditors, ranging from community banks to national lenders, have 
stated that they do not offer HOEPA loans due to their concerns about 
compliance burdens, potential liability, reputational risk, and 
difficulty in selling these loans to the secondary market. Some 
creditors believe there are insufficient data about the incidence of 
predatory lending occurring in loans immediately below the existing 
HOEPA triggers to support lowering the trigger.
    Anecdotal evidence suggests that subprime borrowers with rates 
below the current HOEPA triggers also have been subject to abusive 
lending practices. There are no precise data, however, on the number of 
subprime loans in the market as a whole that would be affected by 
lowering the HOEPA rate trigger. The precise effect that lowering the 
APR trigger will have on creditors' business strategies is difficult to 
predict. It seems likely that lenders that already make HOEPA loans and 
have compliance systems in place would continue making them under a 
revised APR trigger. Some creditors that choose not to make HOEPA loans 
may refrain from making loans in the range of rates that would be 
covered by the lowered threshold. But other creditors may fill any void 
left by creditors that do not make HOEPA loans, either because they 
already make HOEPA loans or because they are willing to do so in the 
future. And others may have the flexibility to avoid HOEPA's coverage 
by lowering rates or fees for some loans at the margins, consistent 
with the risk involved. Data submitted by a trade association 
representing nondepository institution lenders suggest that there is an 
active market for HOEPA loans under the current APR trigger. There is 
no evidence that the impact on credit availability will be significant 
if the trigger is lowered. Accordingly, the Board believes that 
lowering the APR trigger to expand HOEPA's protections to more loans is 
consistent with consumers' need for credit, and therefore, warranted.
    Moreover, lowering the rate trigger seeks to ensure that the need 
for credit by subprime borrowers will be fulfilled more often by loans 
that are subject to HOEPA's protections. Borrowers who have less-than-
perfect credit histories and those who might not be served by prime 
lenders have benefited from the substantial growth in the subprime 
market. But a borrower does not benefit from expanded access to credit 
if the credit is offered on unfair terms, the repayment costs are 
unaffordable, or the loan involves predatory practices. Because 
consumers who obtain subprime mortgage loans have, or perceive they 
have, fewer options than other borrowers, they may be more vulnerable 
to unscrupulous lenders or brokers.
    The Board has also determined that lowering the rate trigger is 
consistent with the consumer protections against abusive lending 
provided by HOEPA. The Act's purpose is to protect the most vulnerable 
consumers, based on the cost of the loans, from abusive lending 
practices. As noted above, anecdotal evidence suggests that subprime 
borrowers with loans priced below HOEPA's current APR trigger have been 
subject to predatory practices, such as unaffordable lending, loan 
flipping and insurance packing. These are the very types of abuses that 
HOEPA was intended to prevent. With a lowered trigger, more consumers 
with high-cost loans will receive cost disclosures three days before 
closing (instead of at closing) and will be protected by HOEPA's 
prohibitions against onerous loan terms, such as non-amortizing payment 
schedules, balloon payments on short-term loans, or interest rates that 
increase upon default. A wider range of high-cost loans will also be 
subject to HOEPA's rule against unaffordable lending, and to HOEPA's 
restrictions on prepayment penalties. The rules being adopted by the 
Board to address loan flipping will also apply to more loans. Lastly, 
more high-cost loans will be subject to the HOEPA rule that holds loan 
purchasers and other assignees liable for any violation of law by the 
original creditor with respect to the mortgage.
    Two-tiered approach--Of the 200 commenters on the proposal, about 
40 discussed the two-tiered trigger approach and were about evenly 
divided. Creditors and some consumer groups favored the two-tiered 
trigger approach. Those opposed included community groups, some 
creditors, and others that generally believe that there should be no 
distinction drawn between first-lien and subordinate-lien loans. 
Community groups believe that the maximum number of subprime mortgage 
loans should be subject to HOEPA's protections. Many suggested that the 
two-tiered approach could be helpful if both triggers were 
substantially lower than what the Board is authorized to adopt. Some 
creditors that opposed the tiered-approach believe that the Board 
should not issue a rule that might encourage the making of loans that 
would place creditors in a subordinate lien position. One institution 
noted that a subordinate-lien loan may not be more favorable to a 
consumer if it results in a combined monthly payment on the first and 
second mortgages that is higher than the monthly payment on a 
consolidated first-lien mortgage loan. Some commenters believe that 
borrowers with subordinate-lien loans face similar risks of abusive 
practices as with first-lien

[[Page 65608]]

loans. A few stated that the tiered approach would add unnecessary 
complexity to both compliance and enforcement efforts.
    Data are not available on the number of home-equity loans currently 
subject to HOEPA, or the number of loans that would be covered if the 
APR trigger were lowered. At the time of the proposal, data from the 
Mortgage Information Corporation (MIC) compiled by the Office of Thrift 
Supervision suggested that lowering the APR trigger by 2 percentage 
points could expand HOEPA's coverage from approximately 1 percent to 5 
percent of subprime mortgage loans. Further analysis of additional MIC 
data suggests that these percentages of coverage may be typical of 
longer-term, first-lien mortgages, and that the coverage percentages 
are higher for shorter-term and subordinate-lien loans.
    In response to the Board's request in the proposal, a few 
commenters provided data on the number of loans they offered in recent 
years that would have been affected by a rate trigger of 8 percentage 
points above a comparable Treasury security. The most extensive data 
were submitted by a trade association representing nondepository 
institution lenders. The association collected data from the subprime 
lending divisions of nine member institutions. The number of loans 
surveyed is about 36 percent of the number of loans of subprime lenders 
recorded under HMDA during the survey period (mid-year 1995 through 
mid-year 2000). The dollar volume for the loans surveyed is about 20 
percent of the dollar volume of loans reported by subprime lenders 
under HMDA. Overall, the trade association data show that for these 
loans, HOEPA's existing APR trigger would have covered about 9 percent 
of the first-lien loans, and that lowering the APR trigger by 2 
percentage points would have resulted in coverage of nearly 26 percent 
of the first-lien loans surveyed. For subordinate-lien loans, about 47 
percent of the surveyed loans would have been covered by HOEPA's APR 
trigger, and the data suggest that lowering the APR trigger by 2 
percentage points would have resulted in coverage of about 75 percent 
of the subordinate-lien loans.
    Most of the evidence of predatory lending brought to the Board's 
attention to date has involved abuses in connection with first-lien 
mortgage loans. When a consumer seeks a loan to consolidate debts or 
finance home repairs, some creditors require consumers to borrow 
additional funds to pay off the existing first mortgage as a condition 
of providing the loan, even though the existing first mortgage may have 
been at a lower rate. This ensures that the creditor will be the senior 
lien-holder, but it also results in an increase, perhaps significant, 
in the points and fees paid for the new loan (since the latter are 
calculated on a much larger loan amount).
    The Board's final rule lowers the APR trigger for first lien-
mortgages only. Subordinate-lien loans are already covered more 
frequently by HOEPA because the rates on these loans are higher than 
first-lien loans. The data suggests that coverage under the current 
triggers could be significant for subordinate-lien loans. Moreover, the 
evidence of abusive practices has pertained primarily to first lien 
mortgages. Based on these factors, the Board is adjusting the APR 
trigger only for first-lien loans, but retains the ability to lower the 
trigger for subordinate-lien loans at a future date.

32(b)  Definition

    Points and fees trigger--Currently, home-equity loans are subject 
to HOEPA if the points and fees payable by the consumer at or before 
loan closing exceed the greater of 8 percent of the total loan amount 
or $465. (The dollar trigger is $480 for 2002; 66 FR 57849, November 
19, 2001.) ``Points and fees'' include all finance charges except for 
interest. The trigger also includes some fees that are not finance 
charges, such as closing costs paid to the lender or an affiliated 
third party. HOEPA authorizes the Board to add ``such other charges'' 
to the points and fees trigger as the Board deems appropriate.
    The comment letters and testimony at the hearings raised a number 
of concerns about single-premium credit insurance, such as excessive 
costs, high-pressure sales tactics, consumers' confusion as to the 
voluntariness of the product, and ``insurance packing.'' The term 
``packing'' in this case refers to the practice of automatically 
including optional insurance in the loan amount without the consumer's 
request; as a result, some consumers may perceive that the insurance is 
a required part of the loan, and others may not be aware that insurance 
has been included.
    In response to the reported abuses, the Board proposed to include 
in the fee trigger premiums paid at closing for optional credit life, 
accident, health, or loss-of-income insurance and other debt-protection 
products; such premiums are typically financed. Premiums paid for 
required credit insurance policies are considered finance charges and 
are already included in the points and fees trigger.
    Many commenters expressed views on this issue. The views were 
sharply divided. In general, consumer representatives, some federal 
agencies, state law enforcement officials, and some others supported 
the inclusion of optional credit insurance premiums in HOEPA's points 
and fees trigger, although they would have preferred an outright ban on 
the purchase or financing of single-premium products. Consumer 
representatives were generally concerned about the cost of the 
insurance, its voluntariness, and its contribution to equity stripping. 
They believe that borrowers are often unaware that insurance has been 
included in their loan balance or that borrowers perceive that the 
insurance is required. They also note that these problems exist 
notwithstanding the fact that TILA currently requires creditors to 
disclose before consummation that the insurance is optional in order to 
exclude it from the HOEPA fee trigger. (If creditors fail to disclose 
that the insurance is optional, TILA requires that the cost be treated 
as a finance charge, and all finance charges other than interest are in 
the current HOEPA fee trigger.) They state that excessively high 
premiums contribute to the problem of equity stripping. They also note 
that consumers pay interest on the financed premium for the entire loan 
term even though insurance coverage typically expires much earlier.
    Most creditors and commenters representing the credit insurance 
industry strongly opposed the inclusion of optional insurance premiums 
paid at closing in the points and fees trigger. Some creditors 
questioned the Board's use of its authority under HOEPA to mandate 
inclusion; they pointed to legislative history that discusses the 
potential inclusion of credit insurance premiums if there is evidence 
that credit insurance premiums are being used to evade HOEPA. These 
commenters believe that a finding of evasion is a prerequisite to 
inclusion; they do not believe the standard has been met because the 
proposal merely noted that the change might prevent such evasions in 
the future. They also cited an exchange in the Congressional Record 
between two Senators, when the Congress was considering HOEPA 
legislation, about credit insurance being treated consistently with 
other provisions of TILA. Because premiums for optional credit 
insurance are not automatically included in the calculation of TILA's 
finance charge and APR, these commenters believe such premiums should 
not be included in HOEPA's points and fees calculation.

[[Page 65609]]

    The commenters' suggestion that credit insurance premiums can only 
be included in the HOEPA trigger if the Board finds that creditors are 
using the premiums to evade HOEPA is directly contradicted by the 
express language of the statute, which states that the Board need only 
make a finding that this action is ``appropriate.'' In construing a 
statute, the plain meaning of the statutory text generally governs. 
When the plain meaning of the statutory language is clear, there is no 
reason to resort to legislative history. In this case, if the Congress 
had intended to make ``evasions'' the sole standard of 
``appropriateness'' for including additional charges in the fee 
trigger, it would have done so expressly. For example, such language 
was used in section 129(l)(2)(A), which authorizes the Board to 
prohibit acts and practices that the Board finds to be ``unfair, 
deceptive, or designed to evade'' the provisions of HOEPA.
    In light of the unambiguous statutory text, the Board believes that 
the legislative history cited by the commenters is not dispositive, and 
that evasion is merely one example of when the Board might find that 
inclusion of additional charges is ``appropriate.'' The Senate floor 
colloquy, which refers to HOEPA as being consistent with TILA's 
treatment of insurance premiums, should not be construed as guidance on 
how the Board might, in the future, adjust HOEPA's points and fees 
trigger. It merely clarified that optional credit insurance premiums 
were not automatically included in the statutory points and fees 
trigger, as would have been the case under an earlier version of the 
legislation.
    Industry commenters opposed including optional credit insurance 
premiums in HOEPA's points and fees trigger when, for purposes of TILA 
disclosures generally, the premiums are not included in the cost of the 
credit. The Board believes that HOEPA's points and fees trigger is not 
intended to be the equivalent of the ``cost of credit,'' as measured by 
TILA's finance charge and APR. Indeed, HOEPA expressly includes certain 
charges in the points and fees trigger that are not included in the 
finance charge, and authorizes the Board to include others. The HOEPA 
points and fees trigger is intended to be used to identify transactions 
with high costs where consumers may be vulnerable and thus need the 
benefit of HOEPA's special protections.
    Creditors also asserted that, based on typical premium rates, most 
mortgage loans that include single-premium credit insurance would be 
considered high-cost and thus would be covered under HOEPA's fee-based 
trigger. As a result, they caution that lenders choosing not to make 
HOEPA loans would be foreclosed from offering single-premium credit 
insurance products to their loan customers. They asserted that the 
financing of single-premium insurance provides protection to cash-poor 
consumers who are underinsured, and in some cases offers less costly 
coverage compared with other forms of insurance. In short, these 
commenters generally support the current rule that does not include 
insurance premiums for optional credit insurance in the points and fees 
trigger. Alternatively, they recommend a rule that allows the insurance 
premiums to be excluded based on the consumers' ability to cancel the 
coverage and obtain a full refund, where consumers are also provided 
with adequate information about their rights to do so after the loan 
closing.
    The Board believes that it is appropriate and consistent with the 
purposes of HOEPA to include premiums paid by consumers at or before 
closing for credit insurance (and other debt-protection products) in 
HOEPA's points and fees trigger. The coverage is purchased by the 
consumer in connection with the mortgage transaction, and the creditor 
or the credit account is the beneficiary. In addition, creditors 
receive commissions which may be significant for selling credit 
insurance (and retain the fee assessed for debt-cancellation coverage). 
This oftentimes represents a significant addition to the cost of the 
transaction to the borrower and an increase in benefit to the creditor. 
Moreover, when financed in connection with a subprime mortgage loan, as 
is typically the case, these charges can represent a significant 
addition to the loan balance, and thus, to the cost of the transaction 
and the size of the lien on the borrower's home. For example, according 
to insurance industry commenters, the typical cost of single-premium 
credit life insurance for an individual borrower could amount to the 
equivalent of several points. The total cost of credit insurance in a 
particular mortgage transaction, however, also depends on the number of 
borrowers covered, and the types of coverage purchased. HOEPA is 
specifically designed to help borrowers in high-cost mortgage 
transactions to understand the costs of the transaction and the risk 
that they may lose their homes if they do not meet the full amount of 
their obligation under the loan.
    Importantly, anecdotal evidence has revealed that there are 
sometimes abuses associated with the sale and financing of single-
premium credit insurance, which typically occurs in subprime loans. 
Some consumers are not aware that they are purchasing the insurance, 
some may believe the insurance is required, and some may not understand 
that the term of insurance coverage may be shorter than the term of the 
loan. These abuses and misunderstandings can be addressed somewhat by 
applying HOEPA's protections and remedies, to the extent that including 
insurance in the points and fees test brings these loans under HOEPA. 
Moreover, including credit insurance premiums in HOEPA's fee-based 
trigger prevents unscrupulous creditors from evading HOEPA by packing a 
loan with such products in lieu of charging other fees that already are 
included under the current HOEPA trigger.
    One likely effect of this adjustment to the trigger is that 
significantly more of the loans that include single-premium insurance 
will be covered by HOEPA's protections. Data from a trade association 
of nondepository lenders indicate that lowering the APR trigger for 
first-lien loans by 2 percentage points and including optional credit 
insurance premiums in the points and fees tests would increase the 
percentage of first-lien mortgage loans covered by HOEPA, from 26 to 38 
percent, for the firms surveyed. With a lowered APR trigger, coverage 
of subordinate-lien mortgage loans would increase from 47 to 61 percent 
for the firms surveyed.
    When there are abuses such as coercive or deceptive sales 
practices, borrowers will benefit from HOEPA's rule requiring 
disclosures three days before closing. With the enhanced HOEPA 
disclosure of the amount borrowed, these consumers will receive advance 
notice about the additional amount they must borrow beyond their 
original loan request if they purchase the insurance. As part of that 
new disclosure, under the final rule, creditors must specify whether 
the amount borrowed includes the cost of optional insurance. Moreover, 
creditors and assignees will be subject to HOEPA's strict liability and 
remedies when there are violations of law concerning the mortgage. See 
Sec. 226.32(c)(5).
    As commenters noted, some creditors choose not to make loans 
covered by HOEPA, and if these creditors have been offering single-
premium insurance, they may decide to cease doing so in order to remain 
outside of HOEPA's coverage. To the extent that some creditors choose 
not to offer single-premium policies, they can make credit insurance 
available through other vehicles such as

[[Page 65610]]

policies that assess and bill monthly premiums on the outstanding loan 
balance.
    Industry commenters assert that single-premium policies are less 
costly than monthly premium insurance and provide greater continuity of 
coverage because a borrower's missed payments on the monthly-pay 
product might result in cancellation of insurance. Single-premium and 
monthly-premium policies have relative advantages and disadvantages. 
For example, a five-year policy with a financed single-premium may 
result in smaller monthly payments because the cost is spread over the 
full loan term, which may be ten or twenty years. But the consumer will 
also pay ``points'' (and interest over the life of the loan) on the 
additional amount financed for the coverage. Premiums assessed monthly, 
based on the outstanding loan balance, may result in a higher monthly 
expense, but they are not financed and would only be payable during the 
five years that coverage was in force, so the overall cost to the 
consumer could be lower. Regardless of the relative merits, under the 
final rule creditors will continue to have the ability to decide what 
types of insurance products they will make available to borrowers.
    The final rule also provides guidance in calculating the HOEPA fees 
trigger. A mortgage loan is covered by HOEPA if the ``points and fees'' 
exceed 8 percent of the ``total loan amount.'' The total loan amount is 
based on the ``amount financed'' as provided in Sec. 226.18(b). Comment 
32(a)(1)(ii)-1 of the staff commentary to Regulation Z discusses the 
calculation of the total loan amount. The comment is revised, as 
proposed, to illustrate that premiums or other charges for credit life, 
accident, health, loss-of-income, or debt-cancellation coverage that 
are financed by the creditor must be deducted from the amount financed 
in calculating the total loan amount.
    Disclosure alternatives--The Board solicited comment on whether 
optional credit insurance premiums should be excluded from the trigger 
when consumers have a right to cancel the policy and when disclosures 
about that right are provided after closing. Consumer representatives 
were opposed to the approach, expressing doubt that disclosures would 
be effective. Industry commenters supported the exclusion as a 
reasonable approach to address concerns about insurance packing. Upon 
further analysis, the Board believes that post-closing disclosures 
would be less effective than the HOEPA disclosures and remedies in 
deterring abusive sales practices in connection with insurance. 
Moreover, reliance on the consumer's exercise of their right to cancel 
the insurance would not prevent abuses but would unfairly require 
borrowers to take the initiative in remedying them.

32(c)  Disclosures

    Section 129(a) of TILA requires creditors offering HOEPA loans to 
provide abbreviated disclosures to consumers at least three days before 
the loan is closed, in addition to the disclosures generally required 
by TILA at or before closing. The HOEPA disclosures inform consumers 
that they are not obligated to complete the transaction and could lose 
their home if they take the loan and fail to make payments. The HOEPA 
disclosures also include a few key cost disclosures, such as the APR 
and the monthly payment (including the maximum payment for variable-
rate loans and any balloon payment). Under the final rule these 
disclosures have been enhanced somewhat to further benefit borrowers. 
Section 226.32(c) is revised to provide, in accordance with TILA 
section 129(a), that the disclosures must be in a conspicuous type 
size.

32(c)(3)  Regular Payment; Balloon Payment

    Section 226.32(c)(3) requires creditors to disclose to consumers 
the amount of the regular monthly (or other periodic) payment, 
including any balloon payment. The regulation is revised to move the 
disclosure requirement for the amount of the balloon payment from the 
commentary to the regulation, to aid in compliance. Model Sample H-16, 
which illustrates the disclosures required under Sec. 226.32(c), is 
revised to include a model clause on balloon payments.
    Under comment 32(c)(3)-1 of the staff commentary, creditors are 
allowed to include voluntary items in the regular payment disclosed 
under Sec. 226.32 only if the consumer has previously agreed to such 
items. The comment is revised for clarity as proposed.
    Testimony at the Board's 2000 public hearings and other comments 
received suggest that some HOEPA disclosures provided in advance of 
closing include insurance premiums in the monthly payment, even though 
consumers may not agree to purchase optional insurance until closing. 
Consequently, the Board solicited comment on whether consumers should 
be required to request or affirmatively agree to purchase optional 
items in writing, to aid in enforcing the rule.
    Some commenters supported having a rule where consumers would 
separately agree to purchase optional products. These commenters 
thought the rule would be useful in preventing ``packing.'' Other 
commenters, representing both consumer and industry interests, opposed 
such an approach. The consumer representatives preferred creditors to 
have the duty to ensure ``voluntariness.'' Industry representatives 
expressed a variety of concerns. Some believed that such a rule would 
be burdensome to creditors and borrowers alike, necessitating 
additional visits to sign the document at least three days before 
closing. They believed a separate affirmation to be duplicative and 
unnecessary. Others believed the rule would have the unintended effect 
of making consumers feel obligated, and ultimately less likely to 
reverse an earlier decision prior to or at closing.
    Having carefully considered commenters' concerns regarding burden, 
and the effectiveness of a separate written agreement to purchase 
optional products to reduce ``packing,'' the Board is not taking 
further action to require a separate written agreement at this time. To 
address insurance ``packing,'' pursuant to its authority under section 
129(l)(2)(B) of TILA, the Board has instead enhanced the final rule to 
require that the disclosure of the amount borrowed in mortgage 
refinancings expressly state whether optional credit insurance or debt-
cancellation coverage is included in the amount financed, as discussed 
below.
    The final rule for disclosing the ``amount borrowed'' includes a 
$100 tolerance for minor errors. As discussed below, if the amount 
borrowed is inaccurate by any amount, the regular payment disclosure 
will be inaccurate also. To be meaningful to creditors, any tolerance 
for the amount borrowed must ``pass through'' to the regular payment. 
Such an approach is consistent with TILA's rule in closed-end 
transactions secured by real property or a dwelling, where the finance 
charge as well as other disclosures affected by the finance charge are 
considered accurate within prescribed limits. Pursuant to its authority 
under section 129(l)(2)(B) of TILA, the Board is providing a tolerance 
to the regular payment disclosure required under Sec. 226.32(c)(3), if 
the payment disclosed is based on an amount borrowed that is deemed 
accurate and disclosed under Sec. 226.32(c)(5).

32(c)(5)  Amount Borrowed

    Section 226.32(c)(5) is added to require disclosure of the total 
amount the consumer will borrow, as reflected by the face amount of the 
note, pursuant

[[Page 65611]]

to the Board's authority under Section 129(l)(2)(B) of TILA. This 
disclosure responds to concerns by consumers and consumer 
representatives that consumers sometimes seek a modest loan amount such 
as for medical or home improvement costs, only to discover at closing 
(or after) that the note amount is substantially higher due to fees and 
insurance premiums that are financed along with the requested loan 
amount. The amount borrowed disclosure is enhanced in the final rule; 
when the loan amount includes premiums or other charges for optional 
credit insurance or debt-cancellation coverage, the disclosure must so 
specify, to address insurance ``packing'' where consumers may not be 
aware that insurance coverage has been added to the loan balance. 
Comment 32(c)(5)-1 to the staff commentary provides guidance regarding 
terminology for debt-cancellation coverage.
    Consumer representatives and some industry representatives 
supported the proposal as aiding consumers' understanding that 
additional fees might be financed. Other industry representatives 
opposed the proposal. Some of these commenters believed consumers would 
be confused by an ``amount borrowed'' in addition to TILA's ``amount 
financed,'' which does not include amounts borrowed to cover loan fees.
    Creditors must provide updated HOEPA disclosures if, after giving 
the disclosures required by Sec. 226.32(c) to the consumer and before 
consummation, the creditor changes any terms that make the disclosure 
inaccurate. Sec. 226.31(c)(1). The Board requested comment on whether 
it would be appropriate to provide for a tolerance for insignificant 
changes to the amount borrowed, and if so, what would be a suitable 
margin.
    Commenters had mixed views on the desirability for a tolerance. 
Consumer groups supported either no tolerance or a very small tolerance 
such as $100, consistent with the existing tolerance for understated 
finance charges in closed-end transactions secured by real property or 
a dwelling. Sec. 226.18(d)(1). Industry commenters wanted a much larger 
tolerance such as 1 percent of the loan amount or 10 percent of the 
regular payment.
    Pursuant to its authority under section 129(l)(2)(B) of TILA, the 
Board is providing a tolerance for the disclosure of the amount 
borrowed. Under the final rule, the amount borrowed is accurate if it 
is not more than $100 above or below the amount required to be 
disclosed.

Counseling

    The Board requested comment on whether a generic disclosure 
advising consumers to seek independent advice might encourage borrowers 
to seek credit counseling. Consistent with views expressed in 
connection with the Board's 2000 hearings, both consumer and creditor 
commenters acknowledged the benefits of pre-loan counseling as a means 
to counteract predatory lending. There was uniform concern, however, 
about requiring a referral to counseling for HOEPA loans because the 
actual availability of local counselors may be uncertain. Based on the 
comments received and further analysis, the Board is not adopting a 
generic counseling disclosure at this time.

32(d)  Limitations

32(d)(8)  Due-on-demand Clause

    As proposed, Sec. 226.32(d)(8) is added to restrict the use of 
``due-on-demand'' clauses or ``call'' provisions for HOEPA loans, 
unless the clause is exercised in connection with a consumer's default. 
The limitation on the use of these provisions in HOEPA loans is added 
pursuant to the Board's authority under section 129(l)(2)(A) to 
prohibit acts that are unfair or are designed to evade HOEPA. The staff 
commentary to Sec. 226.32(d)(8) provides guidance concerning the 
exercise of ``due-on-demand'' clauses when a consumer fails to meet 
repayment terms or impairs the creditor's security for the loan.
    Commenters generally supported the proposal. A few commenters 
suggested that the rule was not needed because they believe that due-
on-demand clauses were generally not being used by mortgage lenders. 
Some industry commenters asked the Board to limit the rule's 
applicability to the first five years of a HOEPA loan, to coincide with 
HOEPA's ban on balloon payments. One commenter sought clarification 
that the rule limiting ``due-on demand'' clauses would not affect 
``due-on-sale'' clauses.
    The final rule is adopted as proposed. To prevent creditors from 
forcing consumers to pay additional points and fees to refinance their 
loans or face possible foreclosure, section 129(e) of TILA prohibits 
the use of balloon payments for HOEPA loans with terms of less than 
five years. Although ``due-on-demand'' and ``call'' provisions 
currently do not appear to be widely used in HOEPA loans, a creditor 
could potentially force the consumer to refinance by exercising the 
right to call the loan and demanding payment of the entire outstanding 
balance. Restricting call provisions in HOEPA loans is intended to 
ensure that lenders do not accelerate the payment of these loans, 
without cause, at any time during the loan term, in order to force 
consumers to refinance. When a creditor can unilaterally terminate the 
loan without cause, the consumer may be subject to unnecessary 
refinancings, excessive loan fees, higher interest rates, or possible 
foreclosure. Consequently, this rule prevents creditors from using call 
provisions in a manner that would cause substantial harm to HOEPA 
borrowers.
    Loans covered by HOEPA are more likely to involve borrowers who 
have less-than-perfect credit histories, or who might not be served by 
prime lenders. As noted earlier, because these consumers either have or 
perceive they have fewer options than other borrowers, they may be more 
vulnerable to unscrupulous lenders or brokers. Accordingly, HOEPA 
includes limitations on certain loan provisions to protect these 
borrowers from onerous loan terms. The Board finds that it is also 
appropriate to protect HOEPA borrowers from the potentially harsh 
effects of allowing a creditor to exercise a ``due-on-demand'' clause 
at any time, unless there is legitimate cause.
    The hearing testimony and comments received by the Board failed to 
identify any benefits to using ``due-on-demand'' clauses in HOEPA 
loans, other than in the legitimate cases that are permitted under the 
Board's rule. The rule allows creditors to exercise such clauses when 
the creditor is faced with borrower misrepresentations or fraud, the 
borrower fails to meet repayment terms, or a borrower's action (or 
failure to act) affects the creditor's security for the loan. The rule 
does not affect creditors' use of ``due-on-sale'' clauses.
    The limitations on ``due-on-demand'' clauses adopted by the Board 
for HOEPA loans are similar to TILA's existing limits on the use of 
such clauses for home-equity lines of credit (HELOCs). See TILA, 
Section 127A; 12 CFR Sec. 226.5b(f)(2). The rule for HELOCs is 
contained in the Home Equity Loan Consumer Protection Act of 1988 (Pub. 
Law No. 100-709, 102 Stat. 4725). The 1988 act recognized that allowing 
creditors to unilaterally terminate a home-equity line (or 
significantly change loan terms) is fundamentally unfair when the 
consumer's home is at stake. Allowing creditors' unlimited discretion 
to call the loan and require immediate repayment is similarly unfair 
with HOEPA loans.

[[Page 65612]]

Section 226.34--Prohibited Acts or Practices in Connection with Credit 
Secured by a Consumer's Dwelling
    Section 129(l) of TILA authorizes the Board to prohibit acts or 
practices to curb abusive lending practices. The act provides that the 
Board shall prohibit practices: (1) In connection with all mortgage 
loans if the Board finds the practice to be unfair, deceptive, or 
designed to evade HOEPA; and (2) in connection with refinancings of 
mortgage loans if the Board finds that the practice is associated with 
abusive lending practices or otherwise not in the interest of the 
borrower. The Board is exercising this authority to prohibit certain 
acts or practices, as discussed below. The final rule is intended to 
curb unfair or abusive lending practices without unduly interfering 
with the flow of credit, creating unnecessary creditor burden, or 
narrowing consumers' options in legitimate transactions. The rule 
prohibiting ``loan flipping'' has been modified to expand its scope. 
The rule protecting low-rate loans has not been adopted due to concerns 
about the compliance burden on the home-equity lending market 
generally. Other provisions have been adopted as proposed.
    The final rule creates a new Sec. 226.34, which contains 
prohibitions against certain acts or practices in connection with 
credit secured by a consumer's dwelling. This section includes the 
rules currently contained in Sec. 226.32(e).

34(a)  Prohibited Acts or Practices for Loans Subject to Sec. 226.32

34(a)(1)  Home Improvement Contracts

    Section 226.32(e)(2) regarding home-improvement contracts is 
renumbered as Sec. 226.34(a)(1) without substantive change. Comment 
32(e)(2)(i)-1 of the staff commentary is now comment 34(a)(1)(i)-1.

34(a)(2)  Notice to Assignee

    Section 226.32 (e)(3) regarding assignee liability for claims and 
defenses that consumers may have in connection with HOEPA loans is 
renumbered as Sec. 226.34(a)(2) without substantive change. Comments 
32(e)(3)-1 and -2 are now comments 34(a)(2)-1 and -2 respectively.
    Comment 34(a)(2)-3 is added to clarify the statutory provision on 
the liability of purchasers or other assignees of HOEPA loans, as 
proposed. Section 131 of TILA provides that, with limited exceptions, 
purchasers or other assignees of HOEPA loans are subject to all claims 
and defenses with respect to a mortgage that the consumer could assert 
against the creditor. The comment clarifies that the phrase ``all 
claims and defenses'' is not limited to violations of TILA as amended 
by HOEPA. This interpretation is based on the statutory text and is 
supported by the legislative history. See Conference Report, Joint 
Statement of Conference Committee, H. Rep. No. 103-652, at 22 (Aug. 2, 
1994).

34(a)(3)  Refinancings Within One-year Period

    ``Loan flipping'' generally refers to the practice by brokers and 
creditors of frequently refinancing home-secured loans to generate 
additional fee income even though the refinancing is not in the 
borrower's interest. Loan flipping is among the more flagrant of 
lending abuses. Victims tend to be borrowers who are having difficulty 
repaying a high-cost loan; they are targeted with promises to refinance 
the loan on more affordable terms. The refinancing typically provides 
little benefit to the borrower, as the loan amount increases mostly to 
cover fees. Often, there is minimal or no reduction in the interest 
rate. The monthly payment may increase, making the loan even more 
unaffordable. Sometimes the loan is amortized so that the monthly 
payment is reduced, but the loan may still be unaffordable. As long as 
there is sufficient equity to support the financing of additional fees, 
the consumer may be targeted repeatedly, resulting in equity stripping.
    The proposed rule prohibited an originating creditor (or assignee) 
holding a HOEPA loan from refinancing that loan into another HOEPA loan 
within the first twelve months following origination, unless the new 
loan was ``in the borrower's interest.'' Pursuant to its authority 
under Section 129(l)(2)(A) of TILA, the Board is adopting a final rule 
to address ``loan flipping,'' as discussed below.
    Consumer representatives generally supported the proposal, but they 
believed the rule was too narrow and that all creditors and brokers 
should be covered. Federal agencies, community groups, and consumers 
and their representatives believe that the prohibition should be 
lengthened; suggestions ranged from 18 months to as long as four years.
    Creditors' comments mainly focused on the ``interest of the 
borrower'' test. oth creditors and consumer representatives sought 
additional guidance in this area. Consumer representatives viewed the 
standard as too lenient, while creditors believed that the standard's 
lack of certainty would subject them to litigation risk. Creditors also 
expressed concerns about the proposal's coverage of affiliates and 
sought clarification about whether an assignee merely servicing HOEPA 
loans is covered by the rule.
    The Board is adopting a final rule that broadens the proposal's 
coverage somewhat. Under the final rule, within the first twelve months 
of originating a HOEPA loan to a borrower, the creditor is prohibited 
from refinancing that loan (whether or not the creditor still holds the 
loan) or another HOEPA loan held by that borrower.
    The proposal was narrowly tailored to curb the more egregious cases 
of loan flipping: repeated refinancing by creditors that hold HOEPA 
loans in portfolio. Once a creditor assigned the loan, the assignee 
would have been covered, but the originating creditor could then have 
refinanced the HOEPA loan. Thus, the proposed rule did not cover loan 
originators that close loans in their own name and immediately assign 
them to a funding party or sell them in the secondary market. The 
hearing testimony and comments suggest that some of these originators 
are the source of unaffordable loans because they do not have a vested 
interest in the borrower's ability to repay the loan. Once they are no 
longer holding a loan, they can target the same borrower with an offer 
to refinance the loan. The final rule has been expanded to cover 
creditors (including brokers) that originate HOEPA loans, whether or 
not they continue to hold the loan. The loan flipping rule may deter 
some unaffordable lending if the parties making, holding, or servicing 
the loan are not permitted to refinance the loan within the first year.
    Assignees are covered by the rule because in some instances they 
are the ``true creditor'' funding the loan. Even when they are not 
acting as the true creditors, assignees of HOEPA loans are subject to 
the refinancing restrictions to ensure that loans are not transferred 
for the purpose of evading the prohibition and that borrowers are not 
pressured into frequent refinancings by the party holding or servicing 
their loans. Thus, the rule has been revised to clarify that it applies 
to assignees that are servicing a HOEPA loan, whether or not they own 
the obligation. Assignees will be under the same restrictions as the 
original creditor while holding or servicing the loan. Comment 
34(a)(3)-2 of the staff commentary is added to provide examples of how 
the rule is applied in specific cases.
    Under the proposal, the regulatory prohibition applicable to 
creditors would have applied to their affiliates in all cases. Industry 
commenters were concerned about the compliance burden--particularly for 
creditors with

[[Page 65613]]

broad geographic and corporate structures. The final rule has been 
narrowed and would not apply in routine cases where consumers seek a 
refinancing from an affiliate. Under the final rule, loans made by an 
affiliate are prohibited only if the creditor engages in a pattern or 
practice of arranging loans with an affiliate to evade the flipping 
prohibition, or engages in other acts or practices designed to evade 
the rule. The final rule also prohibits creditors from arranging 
refinancings of their own loans with unaffiliated creditors to evade 
the flipping prohibition.
    As noted above, some commenters believe that the prohibition should 
be lengthened. Although a longer period might further limit the 
opportunity for loan flipping, one year provides an appropriate balance 
between the need to address the clearest cases of abusive refinancings 
and the need not to restrict the free flow of credit in legitimate 
transactions. Thus, the final rule retains the one-year limitation, as 
proposed.
    Borrower's interest--Under the proposal, creditors are permitted to 
refinance a HOEPA loan within the one-year period when ``in the 
borrower's interest.'' The determination of whether or not a benefit 
exists would be based on the totality of the circumstances. Consumer 
representatives viewed the standard as too lenient. They asserted that 
the lack of specificity or examples under the proposal would lead 
creditors to liberally construe the ``borrower's interest'' standard to 
permit any borrower predicament or any arguable ``improvement'' in 
term, payment, or rate, as sufficient justification for refinancing 
within the first year. Creditors, conversely, believed that the 
standard's lack of certainty would lead to litigation, inconsistent 
application, and borrower and judicial second-guessing of creditors. 
This, creditors argued, could ultimately result in a hesitancy by 
creditors to extend refinance credit at all in the first year of 
origination of a HOEPA loan.
    Commenters offered many suggestions for more specific guidance, 
asking the Board to provide that lowering the interest rate or the 
monthly payment, or eliminating a balloon payment or variable rate 
feature, was per se, ``in the borrower's interest.'' Although a list of 
acceptable loan purposes would provide more certainty, it is difficult 
to identify circumstances that would be unequivocally in the borrower's 
interest in all or even most cases. A good reason in one context may be 
abusive in other circumstances. For example, a homeowner's equity could 
still be stripped through repeated refinancings that carry high up-
front fees even if they result in incrementally lower APRs.
    The Board believes that precisely defining circumstances that are 
``in the borrower's interest'' is not necessary, given the nature of 
the loan flipping prohibition. The prohibition applies for a relatively 
short period, and is intended as a strong deterrent for the more 
egregious cases. The ``borrower's interest'' exception must be narrowly 
construed to preserve the effectiveness of the overall prohibition. 
Moreover, the probability that a legitimate creditor would refinance 
its own HOEPA loans within twelve months is typically low.
    The Board recognizes that this approach places the primary burden 
on the creditor, in light of the totality of the circumstances, to 
weigh whether the loan is in the borrower's interest. The standard is 
intended to give legitimate creditors some flexibility for extenuating 
circumstances, while creditors that rely on the exception routinely to 
``flip'' HOEPA loans bear the risk that a court will find that they 
violated HOEPA.
    Comment 34(a)(3)-1 of the staff commentary has been expanded to 
provide additional guidance on lenders' ability to make loans that are 
in the borrower's interest notwithstanding the loan-flipping 
prohibition. A mere statement by the borrower that ``this loan is in my 
interest'' would not meet the standard. In connection with a 
refinancing that provides additional funds to the borrower, in 
determining whether a refinancing is in the borrower's interest, 
consideration should be given to whether the loan fees and charges are 
commensurate with the amount of new funds advanced, and whether the 
real estate-related charges are bona fide and reasonable in amount (see 
generally Sec. 226.4(c)(7)). A refinancing would be in the borrower's 
interest if needed for a ``bona fide personal financial emergency''; 
this is the current standard for certain consumer waivers under TILA. 
TILA authorizes the Board to permit consumers to waive the three-day 
rescission period for certain home equity loans or the three-day 
waiting period before closing a HOEPA loan, if necessary for homeowners 
to meet a bona fide personal financial emergency. See Sec. 226.23(e) 
and Sec. 226.31(c)(1)(iii). Comment 31(c)(1)(iii)-1 of the staff 
commentary provides that the imminent sale of the consumer's home at 
foreclosure during the three-day HOEPA waiting period is an example of 
a bona fide personal financial emergency.
    Limitations on refinancing low-rate loans--The December proposal 
addressed abuses involving the refinancing of low-rate loans originated 
through mortgage assistance programs designed to give low-or moderate-
income borrowers the opportunity for homeownership. Some of these 
homeowners who have unsecured debts have been targeted by unscrupulous 
lenders who consolidate the debts and replace the low-cost, first-lien 
mortgage with a substantially higher cost loan. The replacement loans 
are often unaffordable, many involve ``loan flipping,'' and as a 
result, homeowners have lost their homes. In some cases, the low-rate 
loan is replaced even though the first-lien holder may be willing to 
subordinate its security interest.
    Under the proposal creditors would have been prohibited, in the 
first five years of a zero interest rate or other low-rate loan, from 
replacing that loan with any higher-rate loan unless the refinancing 
was in the interest of the borrower. Based on the comments received and 
after consultation with the Consumer Advisory Council and further 
analysis, the Board is withdrawing the proposed provision addressing 
low-rate loans.
    Unlike the prohibition against loan flipping, which applies only to 
HOEPA creditors, the prohibition against refinancing low-rate loans, as 
proposed, would have applied to all mortgage refinancing transactions. 
While borrowers with low-rate mortgage loans could benefit from the 
rule, the benefits appear to be far outweighed by the potential 
compliance burden for all home-equity lenders. Therefore, the proposed 
rule is being withdrawn at this time for reconsideration. The Board 
will consider other approaches that appropriately protect borrowers 
with low-rate loans in order to deter harmful refinancings and provide 
adequate remedies where they occur without imposing unnecessary 
documentation requirements on the market as a whole.

34(a)(4)  Repayment Ability

    Under section 129(h) of TILA, a creditor may not engage in a 
pattern or practice of making HOEPA loans based on the equity in the 
borrower's home without regard to the consumer's repayment ability, 
taking into account the consumer's current and expected income, current 
obligations, and employment status. As proposed, the final rule, 
formerly in Sec. 226.32(e)(1), has been moved to Sec. 226.34(a)(4) and 
revised to parallel the statutory language. The revision is a 
clarification of existing law and is not a new rule.
    Currently, compliance with the prohibition against unaffordable 
lending is difficult to enforce because creditors are not required to 
document that they

[[Page 65614]]

considered the consumer's ability to repay. In addition, there have 
been reports of creditors relying on inaccurate information provided by 
unscrupulous loan brokers. To aid in solving these problems, the Board 
proposed under Sec. 226.34(a)(4)(ii) to require that creditors 
generally verify and document consumers' current or expected income, 
current obligations, and employment to the extent applicable. If a 
creditor engages in a pattern or practice of making loans without 
verifying and documenting consumers' repayment ability, there would be 
a presumption that the creditor has violated the rule. The Board adopts 
the rule as Sec. 226.34(a)(4) with minor modifications.
    Determining repayment ability--Comment 34(a)(4)-1 of the staff 
commentary, formerly comment 32(e)(1)-1, has been modified in light of 
the new verification and documentation requirements discussed below. 
The comment has also been modified to more closely track the statute.
    The reference to Sec. 226.32(d)(7) has been deleted as unnecessary; 
the sources of information listed in Sec. 226.32(d)(7) with one 
exception are listed in comment 34(a)(4)-2 on verifying and documenting 
repayment ability.
    Verification and documentation--The verification and documentation 
rule requires creditors to use independent sources to ascertain 
borrowers' ability to repay loans that are secured by their homes, and 
to memorialize and retain this information. Proposed comment 
34(a)(4)(ii)-1 provided examples of ways to verify and document the 
income and obligations of consumers who are employed, including those 
who are self-employed. The final comment, renumbered 34(a)(4)-4, adopts 
the proposed comment with modifications to accommodate creditworthy 
borrowers not employed or without traditional financial documents.
    Most of the commenters supported the rule and comment. Some 
commenters from industry pointed out that verification and 
documentation is basic to the underwriting process and already required 
for safety and soundness purposes. Government entities at both the 
federal and state levels noted that verification and documentation is 
necessary for enforcement of the prohibition against unaffordable 
mortgage lending. A few commenters were concerned that the rule was not 
sufficiently flexible in allowing creditors to make loans to 
creditworthy borrowers whose repayment ability may not be based on 
regular employment wages. The final comment clarifies that creditors 
can rely on any reliable source that provides a reasonable basis for 
believing there are sufficient funds to support repayment of the loan.
    Pattern or practice--Section 129(h) of TILA does not define 
``pattern or practice,'' nor does the legislative history provide 
guidance as to how the phrase should be applied. The Board proposed 
interpretive guidance on the ``pattern or practice'' requirement. The 
proposed comment provided that determining whether a pattern or 
practice exists depends on the totality of the circumstances. The 
proposal referenced statutes relevant to a pattern or practice 
determination, specifically, the Truth in Lending Act, the Equal Credit 
Opportunity Act, the Fair Housing Act, and Title VII of the Civil 
Rights Act of 1964 (equal employment opportunity).
    Those that commented on this aspect of the proposal generally 
requested more guidance on what would constitute a ``pattern or 
practice.'' Several requested that the Board set a specific standard. 
Industry commenters generally preferred a narrow standard, while 
representatives of consumer and community groups sought a broader 
standard that would be less onerous for consumers. Comment 34(a)(1)-2 
as adopted provides additional guidance on the ``pattern or practice'' 
requirement, but retains the totality of the circumstances test. The 
comment provides that while a ``pattern or practice'' of violations is 
not established by isolated, random, or accidental acts, it can be 
established without the use of a statistical process. The comment also 
notes that a creditor might act under a lending policy (whether written 
or unwritten) and that action alone could establish that there is a 
pattern or practice of violating the prohibition against unaffordable 
lending.
    Discounted introductory rates--Concern was raised about creditors 
determining a consumer's repayment ability based on low introductory 
rates offered under some programs. Proposed comment 34(a)(4)(i)-3 
provided that in considering consumers repayment ability in 
transactions where the creditor sets a temporary introductory interest 
rate and the rate is later adjusted (whether fixed or later determined 
by an index or formula) the creditor must consider increases in the 
consumer's payments assuming the maximum possible increases in rates in 
the shortest possible time frame. The comment was not intended to 
impose a standard for evaluating a borrower's repayment ability that is 
more stringent than current industry practice. While creditors 
typically do not evaluate a borrower's ability to repay a loan based on 
a temporary discounted rate, they also do not evaluate repayment 
ability based on the maximum interest rate that may be charged as a 
result of rate adjustments on the loan. Based on the comments and 
further analysis, the final comment treats all discounted and variable-
rate loans the same. Comment 34(a)(4)-3, as adopted, requires creditors 
to consider the consumer's ability to repay the loan assuming the non-
discounted rate for fixed-rate loans, or the fully-indexed rate for 
variable rate loans, is in effect at consummation.

34(b)  Prohibited Acts or Practices for Dwelling-Secured Loans; Open-
end Credit

    HOEPA covers only closed-end mortgage loans. In the December 
notice, the Board proposed a prohibition against structuring a home-
secured loan as a line of credit to evade HOEPA's requirements, if the 
credit does not meet the definition of open-end credit in 
Sec. 226.2(a)(20).
    Although consumer representatives supported the Board's proposal, 
they generally believe that HOEPA should cover open-end credit carrying 
rates or fees above HOEPA's price triggers. Industry commenters believe 
there is little evidence that creditors are using open-end credit to 
evade HOEPA. Moreover, they oppose the rule as unnecessary because it 
is already a violation of TILA to provide disclosures for an open-end 
credit plan if the legal obligation does not meet the criteria for 
open-end credit.
    Pursuant to the Board's authority under section 129(l)(2)(A), as 
proposed, Sec. 226.34(b) explicitly prohibits structuring a mortgage 
loan as an open-end credit line to evade HOEPA's requirements, if the 
loan does not meet the TILA definition of open-end credit. This 
prohibition responds to cases reported by consumer advocates at the 
Board's hearings and to enforcement actions brought by the Federal 
Trade Commission, where creditors have documented loans as open-end 
``revolving'' credit, even if there was no real expectation of repeat 
transactions under a reusable line of credit. Although the practice 
would currently violate TILA, the new rule will subject creditors and 
assignees to HOEPA's stricter liability rule and remedies if the credit 
carries rates and fees that exceed HOEPA's price triggers for closed-
end loans.
    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-

[[Page 65615]]

end credit, the loan is subject to the rules for closed-end credit, 
including HOEPA if the rate or fee trigger is met. In response to 
comments, comment 34(b)-1 provides guidance on how to apply HOEPA s 
triggers to transactions structured as open-end credit in violation of 
Sec. 226.34(b).
Appendix H to Part 226--Closed-End Model Forms and Clauses
    Model Form H-16--Mortgage Sample illustrates the disclosures 
required by Sec. 226.32(c), which must be provided to consumers at 
least three days before becoming obligated on a mortgage transaction 
subject to Sec. 226.32. Model Form H-16 is amended to illustrate the 
additional disclosures required for refinancings under 
Sec. 226.32(c)(5). A new comment App. H-20 clarifies that although the 
additional disclosures are required for refinancings that are subject 
to Sec. 226.32, creditors may, at their option, include these 
disclosures for any loan subject to that section. The Sample also 
includes an illustration for loans with balloon payments. Former 
comments H-20 through H-23 have been renumbered H-21 through H-24, 
respectively.

IV. Regulatory Flexibility Analysis

    The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) requires 
federal agencies either to provide a Final Regulatory Flexibility 
Analysis with a final rule or to certify that the final rule will not 
have a significant economic impact on a substantial number of small 
entities. Based on available data, the Board is unable to determine at 
this time whether the final rule would have a significant impact on a 
substantial number of small entities. For this reason, the Board has 
prepared the following Final Regulatory Flexibility Analysis.
    (1) Statement of the need for and objectives of the final rule--The 
final rule is adopted to address predatory lending and unfair practices 
in home-equity lending. As stated more fully above, the existing 
regulations are amended to broaden the scope of mortgage loans subject 
to HOEPA by adjusting the price triggers used to determine coverage 
under the act (both the interest rate trigger and points and fees 
trigger). Certain acts and practices in connection with home-secured 
loans are restricted. For example, creditors may not engage in repeated 
refinancings of HOEPA loans over a short time period when the 
transactions are not in the borrower's interest. HOEPA's prohibition 
against extending credit without regard to consumers' repayment ability 
is strengthened, and disclosures received by consumers before closing 
for HOEPA-covered loans are also enhanced.
    (2) Summary of public comment and statement of changes--Significant 
issues raised by the public comments in response to the Board s 
proposal and Initial Regulatory Flexibility Analysis are described more 
fully in the supplementary material provided above.
    Section 103(f) of TILA provides that a person becomes a creditor 
under TILA if, during any twelve-month period, the person originates 
more than one HOEPA-covered loan, or one or more HOEPA-covered loans 
through a mortgage broker. In providing protections to consumers whose 
principal dwellings secure high-cost mortgage loans, HOEPA did not 
create different rules for large and small creditors. Moreover, HOEPA 
sets forth specific limitations on the Board's authority to exempt 
mortgage products or categories of products from certain of HOEPA's 
requirements. See Section 129(l)(1) of TILA. Nevertheless, the Board 
has analyzed comments and has sought to minimize compliance burden for 
all creditors by making modifications to the proposal in the following 
ways.
     Tiered APR trigger--The final rule retains the current APR 
trigger for subordinate-lien loans at 10 percentage points above the 
rate for Treasury securities having a comparable maturity. The proposed 
across-the-board reduction of the APR trigger to 8 percentage points 
for all loans encompassed subordinate-lien loans that fall between the 
8 and 10 percentage point triggers. The final revision to the APR 
trigger reduces the impact of the rule on creditors that choose not to 
extend HOEPA-covered credit generally, and on those that make small, 
short-term home-equity loans in particular, where fixed origination 
costs may significantly impact the APR.
     Safe-harbor for refinancings in the ``borrower's 
interest''--The final rule provides additional guidance on creditors 
ability to refinance a HOEPA loan into another HOEPA loan that is in 
the borrower's interest notwithstanding the one-year general 
prohibition on such refinancings. Creditors expressed concern that the 
proposed determination for meeting the standard--the totality of the 
circumstances--was too subjective, and that as a result creditors would 
refrain from making refinancings during the one-year period to avoid 
litigation risk. In addition to providing additional guidance on 
refinancings that would be in the borrower s interest, the final rule 
permits creditors to make an additional subordinate-lien HOEPA loan 
that is not a refinancing to the same borrower.
     Low-cost loan refinancing--The proposed prohibition 
against refinancing certain low-cost loans is withdrawn. The relatively 
low number of borrowers with low-cost mortgage loans that would benefit 
from the rule appeared to be far outweighed by the compliance burden 
for all home-equity lenders.
     Tolerance for amount borrowed--The final rule, as 
proposed, requires creditors making HOEPA-covered refinancings to 
include the face amount of the note (``amount borrowed'') in the HOEPA 
disclosures provided at least three days before closing. If any term is 
changed between the time the early HOEPA disclosure is provided to the 
consumer and consummation, and the change makes the disclosure 
inaccurate, new disclosures must be provided and another three-day 
waiting period begins. The final rule contains a small tolerance for 
changes in the amount actually borrowed of $100 above or below the 
amount disclosed, and to the disclosed regular payment as it is 
affected by the disclosed amount borrowed. This reduces redisclosure 
duties for creditors making insignificant errors and mitigates the 
economic impact of the rule's overall compliance burdens and costs.
    (3) Description of the small entities to which the final rule would 
apply--The number of lenders, large or small, likely to be affected by 
the proposal is unknown. In the June 2001 Call Report, 4,547 small 
banks (assets less than $100 million) had first-lien mortgage credit 
outstanding, and 3,477 small banks had junior-lien mortgage loans 
outstanding. At the same time there were 228 small thrifts that report 
to the Office of Thrift Supervision which had closed-end first mortgage 
credit and/or junior-lien loans outstanding. The number of banks or 
thrifts active in subprime lending or HOEPA loans cannot be determined 
from information in the Call Report.
    There is no comprehensive listing of consumer finance companies, 
but informal industry contacts indicate that there may be about 2,000 
such institutions nationwide. Most of these companies are small 
entities, but apparently many, perhaps most, of the small institutions 
do not engage in mortgage lending, preferring to concentrate on 
unsecured lending and sales finance. An unknown number of small 
institutions do engage in mortgage lending, but there is no 
comprehensive listing of these institutions or estimate of their 
number.
    There also is no comprehensive listing of mortgage banks or 
mortgage

[[Page 65616]]

brokers, but informal discussions with industry sources indicate that 
there are more than 1,200 mortgage banking firms with annual mortgage 
originations of less than $100 million that are members of a national 
trade association. Some of these companies are primarily mortgage 
servicing companies and generate few or no new mortgages, but there is 
also an unknown number of other mortgage banks that do not belong to 
the association.
    The effect of expanding HOEPA coverage on small entities is 
unknown. The precise effect that adjusting the triggers will have on 
creditors' business strategies is difficult to predict. As discussed in 
the supplementary information provided above, there is an active market 
for HOEPA loans under the current triggers. Some creditors that choose 
not to make HOEPA loans may withdraw from making loans in the range of 
rates that would be covered by the lowered threshold. Others creditors 
may fill any void left by creditors that choose not to make HOEPA 
loans. And others may have the flexibility to avoid HOEPA s coverage by 
lowering rates or fees for some loans at the margins, consistent with 
the risk involved.
    (4) Reporting, recordkeeping, and compliance requirements--The 
final amendments: (1) Extend the protections of HOEPA to more loans; 
(2) strengthen HOEPA's prohibition on loans based on homeowners' equity 
without regard to repayment ability; (3) improve disclosures received 
by consumers before closing; and (4) prohibit certain acts or 
practices, to address some ``loan flipping'' within the first twelve 
months of a HOEPA loan by prohibiting a refinancing into another HOEPA 
loan to the same borrower unless the refinancing is in the borrower's 
interest. HOEPA applies to creditors that make more than one HOEPA loan 
in a twelve-month period. For firms engaged in subprime lending, 
HOEPA's existing scope of coverage, its prohibition on loans made 
without regard to consumers' repayment ability, and its mandatory pre-
closing disclosures already require the professional skills needed to 
comply with HOEPA. For some creditors (or holders or servicers of HOEPA 
loans) that seek to refinance a HOEPA loan with the same borrower into 
another HOEPA loan during a one-year period after origination, some 
recordkeeping adjustments may be necessary. However, the Board believes 
the burden will not be significant, since each of these parties has 
records that associate the borrower and the loan date for purposes of 
the one-year prohibition. Also, while the final rule imposes a new 
requirement to document and verify consumers' repayment ability for 
HOEPA loans, the Board believes that creditors' existing consideration 
of safety and soundness issues and risk assessment will result in 
little additional burden to comply with the new requirements.
    Institutions that originate subprime mortgages, including small 
entities, will have to become aware of new definitions that expand 
HOEPA coverage, and as needed, will have to comply with the additional 
disclosures and other consumer protection provisions that apply to 
HOEPA loans. To comply with the final rule, then, creditors will need, 
among other things, to prepare disclosure forms, make various 
operational changes, and train staff. Professional skills needed to 
comply with the final rule may include clerical, computer systems, 
personnel training, as well as legal advice, which will require 
internal review and other actions by programmers and systems 
specialists, employee trainers, attorneys, and senior managers. 
Significantly, however, these skills are currently required to comply 
with HOEPA's existing rules and are not new to creditors both large and 
small. Creditors can reasonably be expected to be able to rely on 
current personnel for these specialized skills and thus not experience 
undue compliance burden.
    (5) Significant alternatives to the final rule--As explained above, 
the final rule is adopted substantially as proposed to address 
predatory lending and unfair practices in the home-equity market, and 
contains several revisions to reflect suggestions or alternatives 
recommended by commenters. Specifically, the adoption of a ``tiered'' 
APR trigger, the inclusion of a tolerance for insignificant errors in 
disclosing the amount borrowed, the additional guidance for meeting the 
``borrower's interest'' standard under the refinancing restriction, and 
the withdrawal of the ``low-cost loan'' refinancing prohibition, all 
reflect an effort to incorporate practical measures to reduce 
compliance burdens for creditors. The supplementary information 
provided above discusses other alternatives suggested by commenters. 
The rule's amendments are issued pursuant to the Board's authority 
under TILA to adjust the scope of mortgage loans covered by HOEPA, to 
prohibit certain acts or practices affecting mortgage loans or 
refinancings, to effectuate the purposes of TILA, to prevent 
circumvention or evasion, or to facilitate compliance. The amendments 
are intended to target unfair or abusive lending practices without 
unduly interfering with the flow of credit, creating unnecessary credit 
burden, or narrowing consumers' options in legitimate credit 
transactions. The final rule contains specific modifications to the 
proposed rule that reduce regulatory burden.

V. Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3506; 5 CFR 1320 Appendix A.1), the Board reviewed the rule under the 
authority delegated to the Board by the Office of Management and 
Budget. The Federal Reserve may not conduct or sponsor, and an 
organization is not required to respond to, this information collection 
unless it displays a currently valid OMB control number. The OMB 
control number is 7100-0199.
    The collection of information that is revised by this rulemaking is 
found in 12 CFR part 226 and in Appendices F, G, H, J, K, and L. This 
information is mandatory (15 U.S.C. 1601 et seq.) to evidence 
compliance with the requirements of Regulation Z and the Truth in 
Lending Act (TILA). The respondents/recordkeepers are all types of 
creditors, among which are small businesses. Under the Paperwork 
Reduction Act, the Federal Reserve accounts for the paperwork burden 
associated with Regulation Z only for state member banks, their 
subsidiaries, and subsidiaries of bank holding companies (not otherwise 
regulated). Other agencies account for the paperwork burden on their 
respective constituencies under this regulation. Institutions are 
required to retain records for twenty-four months.
    The final rule broadens HOEPA's coverage (by lowering the APR 
trigger for first-lien loans by 2 percentage points and adding certain 
costs to the fee-based trigger) and revises a disclosure currently 
required by Sec. 226.32 of Regulation Z. The revised disclosure covers 
refinancings subject to HOEPA and states the total amount of the 
borrower's obligation and whether optional credit insurance or debt-
cancellation coverage is included in the amount borrowed 
(Sec. 226.32(c)(5)). Model Form H-16 illustrates this revised 
disclosure. The burden of revising the disclosure should be minimal 
because most institutions use software that automatically generates 
model forms such as Model Form H-16. The changes to the triggers also 
should impose minimal burden because the changes generally will require 
only a one-time reprogramming of systems.
    With respect to state member banks, it is estimated that there are 
976 respondent/recordkeepers and an average frequency of 136,294 
responses per respondent each year for Regulation

[[Page 65617]]

Z. Therefore, the total annual burden under the regulation for all 
state member banks is estimated to be 1,841,118 hours. In the Federal 
Reserve's April 2001 Paperwork Reduction Act submission to OMB 
addressing the electronic disclosures interim rule, the Federal Reserve 
stated its belief that state member banks do not typically offer the 
type of loans that would require HOEPA disclosures and that these 
disclosures had a negligible effect on the paperwork burden for state 
member banks. Lowering the APR trigger by 2 percentage points could, 
however, result in higher burden for the few state member banks that 
choose to make these loans. Because little information is available 
about the actual number of loans that will be affected by the coverage 
change the Federal Reserve is not changing its current burden estimates 
cited above. The Federal Reserve will, however, solicit more burden 
comments and re-estimate the burden associated with the HOEPA 
requirements in Regulation Z in the next triennial PRA review (during 
the fourth quarter 2002). The Federal Reserve also estimates the one-
time cost burden for programming systems with the revised disclosures 
and updating systems with the new triggers to be $135,000 per bank, on 
average.
    Because the records are maintained at state member banks and the 
notices are not provided to the Federal Reserve, no issue of 
confidentiality under the Freedom of Information Act arises; however, 
any information obtained by the Federal Reserve may be protected from 
disclosure under exemptions (b)(4), (6), and (8) of the Freedom of 
Information Act (5 U.S.C. 522 (b)(4), (6) and (8)). The disclosures and 
information about error allegations are confidential between creditors 
and the customer.
    The Federal Reserve has a continuing interest in the public's 
opinions of our collections of information. At any time, comments 
regarding the burden estimate, or any other aspect of this collection 
of information, including suggestions for reducing the burden, may be 
sent to: Secretary, Board of Governors of the Federal Reserve System, 
20th and C Streets, NW., Washington, DC 20551; and to the Office of 
Management and Budget, Paperwork Reduction.

List of Subjects in 12 CFR Part 226

    Advertising, Federal Reserve System, Mortgages, Reporting and 
recordkeeping requirements, Truth in lending.

    For the reasons set forth in the preamble, the Board amends 
Regulation Z, 12 CFR part 226, as set forth below:

PART 226--TRUTH IN LENDING (REGULATION Z)

    1. The authority citation for part 226 continues to read as 
follows:

    Authority: 12 U.S.C. 3806; 15 U.S.C. 1604 and 1637(c)(5).

Subpart A--General

    2. Section 226.1 is amended by:
    a. Revising paragraph (b); and
    b. Revising paragraph (d)(5).

Sec. 226.1  Authority, purpose, coverage, organization, enforcement and 
liability.

* * * * *
    (b) Purpose. The purpose of this regulation is to promote the 
informed use of consumer credit by requiring disclosures about its 
terms and cost. The regulation also gives consumers the right to cancel 
certain credit transactions that involve a lien on a consumer's 
principal dwelling, regulates certain credit card practices, and 
provides a means for fair and timely resolution of credit billing 
disputes. The regulation does not govern charges for consumer credit. 
The regulation requires a maximum interest rate to be stated in 
variable-rate contracts secured by the consumer's dwelling. It also 
imposes limitations on home equity plans that are subject to the 
requirements of Sec. 226.5b and mortgages that are subject to the 
requirements of Sec. 226.32. The regulation prohibits certain acts or 
practices in connection with credit secured by a consumer's principal 
dwelling.
* * * * *
    (d) Organization. * * *
    (5) Subpart E contains special rules for mortgage transactions. 
Section 226.32 requires certain disclosures and provides limitations 
for loans that have rates and fees above specified amounts. Section 
226.33 requires disclosures, including the total annual loan cost rate, 
for reverse mortgage transactions. Section 226.34 prohibits specific 
acts and practices in connection with mortgage transactions.
* * * * *

Subpart E--Special Rules for Certain Home Mortgage Transactions

    3. Section 226.32 is amended by:
    a. Republishing paragraph (a)(1) introductory text and revising 
paragraph (a)(1)(i);
    b. Republishing paragraph (b) introductory text and revising 
paragraph (b)(1);
    c. Revising paragraph (c) introductory text, revising paragraph 
(c)(3), and adding paragraph (c)(5);
    d. Revising paragraph (d) introductory text and adding paragraph 
(d)(8); and
    e. Removing paragraph (e).

Sec. 226.32  Requirements for certain closed-end home mortgages.

    (a) Coverage. (1) Except as provided in paragraph (a)(2) of this 
section, the requirements of this section apply to a consumer credit 
transaction that is secured by the consumer's principal dwelling, and 
in which either:
    (i) The annual percentage rate at consummation will exceed by more 
than 8 percentage points for first-lien loans, or by more than 10 
percentage points for subordinate-lien loans, the yield on Treasury 
securities having comparable periods of maturity to the loan maturity 
as of the fifteenth day of the month immediately preceding the month in 
which the application for the extension of credit is received by the 
creditor; or
* * * * *
    (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 required to be disclosed under Sec. 226.4(a) and 
226.4(b), except interest or the time-price differential;
    (ii) All compensation paid to mortgage brokers;
    (iii) 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; 
and
    (iv) 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.
* * * * *
    (c) Disclosures. In addition to other disclosures required by this 
part, in a mortgage subject to this section, the creditor shall 
disclose the following in conspicuous type size:
* * * * *
    (3) Regular payment; balloon payment. The amount of the regular 
monthly (or other periodic) payment and the amount of any balloon 
payment. The regular payment disclosed under this paragraph shall be 
treated as accurate if it is based on an amount borrowed that is deemed 
accurate and is

[[Page 65618]]

disclosed under paragraph (c)(5) of this section.
* * * * *
    (5) Amount borrowed. For a mortgage refinancing, the total amount 
the consumer will borrow, as reflected by the face amount of the note; 
and where the amount borrowed includes premiums or other charges for 
optional credit insurance or debt-cancellation coverage, that fact 
shall be stated, grouped together with the disclosure of the amount 
borrowed. The disclosure of the amount borrowed shall be treated as 
accurate if it is not more than $100 above or below the amount required 
to be disclosed.
    (d) Limitations. A mortgage transaction subject to this section 
shall not include the following terms:
* * * * *
    (8) Due-on-demand clause. A demand feature that permits the 
creditor to terminate the loan in advance of the original maturity date 
and to demand repayment of the entire outstanding balance, except in 
the following circumstances:
    (i) There is fraud or material misrepresentation by the consumer in 
connection with the loan;
    (ii) The consumer fails to meet the repayment terms of the 
agreement for any outstanding balance; or
    (iii) There is any action or inaction by the consumer that 
adversely affects the creditor's security for the loan, or any right of 
the creditor in such security.
* * * * *

    4. A new Sec. 226.34 is added to subpart E to read as follows:

Sec. 226.34  Prohibited acts or practices in connection with credit 
secured by a consumer's dwelling.

    (a) Prohibited acts or practices for loans subject to Sec. 226.32. 
A creditor extending mortgage credit subject to Sec. 226.32 shall not--
    (1) Home improvement contracts. Pay a contractor under a home 
improvement contract from the proceeds of a mortgage covered by 
Sec. 226.32, other than:
    (i) By an instrument payable to the consumer or jointly to the 
consumer and the contractor; or
    (ii) At the election of the consumer, through a third-party escrow 
agent in accordance with terms established in a written agreement 
signed by the consumer, the creditor, and the contractor prior to the 
disbursement.
    (2) Notice to assignee. Sell or otherwise assign a mortgage subject 
to Sec. 226.32 without furnishing the following statement to the 
purchaser or assignee: ``Notice: This is a mortgage subject to special 
rules under the federal Truth in Lending Act. Purchasers or assignees 
of this mortgage could be liable for all claims and defenses with 
respect to the mortgage that the borrower could assert against the 
creditor.''
    (3) Refinancings within one-year period. Within one year of having 
extended credit subject to Sec. 226.32, refinance any loan subject to 
Sec. 226.32 to the same borrower into another loan subject to 
Sec. 226.32, unless the refinancing is in the borrower's interest. An 
assignee holding or servicing an extension of mortgage credit subject 
to Sec. 226.32, shall not, for the remainder of the one-year period 
following the date of origination of the credit, refinance any loan 
subject to Sec. 226.32 to the same borrower into another loan subject 
to Sec. 226.32, unless the refinancing is in the borrower's interest. A 
creditor (or assignee) is prohibited from engaging in acts or practices 
to evade this provision, including a pattern or practice of arranging 
for the refinancing of its own loans by affiliated or unaffiliated 
creditors, or modifying a loan agreement (whether or not the existing 
loan is satisfied and replaced by the new loan) and charging a fee.
    (4) Repayment ability. Engage in a pattern or practice of extending 
credit subject to Sec. 226.32 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. There is a presumption that a creditor has 
violated this paragraph (a)(4) if the creditor engages in a pattern or 
practice of making loans subject to Sec. 226.32 without verifying and 
documenting consumers' repayment ability.
    (b) Prohibited acts or practices for dwelling-secured loans; open-
end credit. In connection with credit secured by the consumer's 
dwelling that does not meet the definition 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 Sec. 226.32.

    5. Appendix H to Part 226 is amended by revising Model Form H-16 to 
read as follows:

Appendix H to Part 226X--Closed-End Model Forms and Clauses

* * * * *
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    6. In Supplement I to Part 226, the following amendments are made:
    a. Under Section 226.31--General Rules, under Paragraph 
31(c)(1)(i), paragraph 2. is added;
    b. Under Section 226.32--Requirements for Certain Closed-End Home 
Mortgages, under Paragraph 32(a)(1)(ii), paragraph 1. introductory text 
is revised and 1.iv. is added;
    c. Under Section 226.32--Requirements for Certain Closed-End Home 
Mortgages, a new heading Paragraph 32(b)(1)(iv) is added and a new 
paragraph 1. is added;
    d. Under Section 226.32--Requirements for Certain Closed-End Home 
Mortgages, under Paragraph 32(c)(3), the heading is revised, paragraph 
1. is revised and paragraph 2. is removed; and a new heading Paragraph 
32(c)(5) is added and a new paragraph 1. is added.
    e. Under Section 226.32--Requirements for Certain Closed-End Home 
Mortgages, a new heading Paragraph 32(d)(8) is added; a new heading 
Paragraph 32(d)(8)(ii) is added and a new paragraph 1. is added; and a 
new heading Paragraph 32(d)(8)(iii) is added and new paragraphs 1. and 
2. are added.
    f. Under Section 226.32--Requirements for Certain Closed-End Home 
Mortgages, 32(e) Prohibited Acts and Practices is removed;
    g. Under subpart E, a new Section 226.34--Prohibited Acts or 
Practices in Connection with Credit Secured by a Consumer's Dwelling; 
Open-end Credit is added; and
    h. Under Appendix H--Closed-End Model Forms and Clauses, paragraphs 
20. through 23. are redesignated as paragraphs 21. through 24., and new 
paragraph 20. is added.
    The additions and revisions read as follows:
Supplement I to Part 226 Official Staff Interpretations
* * * * *

Subpart E--Special Rules for Certain Home Mortgage Transactions

Section 226.31--General Rules

* * * * *
    31(c) Timing of disclosure.
* * * * *
    Paragraph 31(c)(1)(i) Change in terms.
* * * * *
    2. Sale of optional products at consummation. If the consumer 
finances the purchase of optional products such as credit insurance and 
as a result the monthly payment differs from what was previously 
disclosed under Sec. 226.32, redisclosure is required and a new three-
day waiting period applies. (See comment 32(c)(3)-1 on when optional 
items may be included in the regular payment disclosure.)
* * * * *

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) 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. Some examples follow, each using a $10,000 amount borrowed, a 
$300 appraisal fee, and $400 in points. A $500 premium for optional 
credit life insurance is used in one example.
* * * * *
    iv. If the consumer finances a $300 fee for a creditor-conducted 
appraisal and a $500 single premium for optional credit life 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 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)(iv).
    1. Premium amount. In determining ``points and fees'' for purposes 
of this section, premiums paid at or before closing for credit 
insurance are included whether they are paid in cash or financed, and 
whether the amount represents the entire premium for the coverage or an 
initial payment.
* * * * *
    32(c) Disclosures.
* * * * *
    Paragraph 32(c)(3) Regular payment; balloon payment.
    1. General. The regular payment is the amount due from the borrower 
at regular intervals, such as monthly, bimonthly, quarterly, or 
annually. There must be at least two payments, and the payments must be 
in an amount and at such intervals that they fully amortize the amount 
owed. In disclosing the regular payment, creditors may rely on the 
rules set forth in Sec. 226.18(g); however, the amounts for voluntary 
items, such as credit life insurance, may be included in the regular 
payment disclosure only if the consumer has previously agreed to the 
amounts.
* * * * *
    Paragraph 32(c)(5) Amount borrowed.
    1. Optional insurance; debt-cancellation coverage. This disclosure 
is required when the amount borrowed in a refinancing includes 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. See comment 4(d)(3)-2 and comment app. G and H-2 regarding 
terminology for debt-cancellation coverage.
    32(d) Limitations.
* * * * *
    32(d)(8) Due-on-demand clause.
    Paragraph 32(d)(8)(ii).
    1. Failure to meet repayment terms. A creditor may terminate a loan 
and accelerate the balance when the consumer fails to meet the 
repayment terms provided for in the agreement; a creditor may do so, 
however, only if the consumer actually fails to make payments. For 
example, a creditor may not terminate and accelerate if the consumer, 
in error, sends a payment to the wrong location, such as a branch 
rather than the main office of the creditor. If a consumer files for or 
is placed in bankruptcy, the creditor may terminate and accelerate 
under this provision if the consumer fails to meet the repayment terms 
of the agreement. Section 226.32(d)(8)(ii) does not override any state 
or other law that requires a creditor to notify a borrower of a right 
to cure, or otherwise places a duty on the creditor before it can 
terminate a loan and accelerate the balance.
    Paragraph 32(d)(8)(iii).
    1. Impairment of security. A creditor may terminate a loan and 
accelerate the balance if the consumer's action or inaction adversely 
affects the creditor's security for the loan, or any right of the 
creditor in that security. Action or inaction by third parties does 
not, in itself, permit the creditor to terminate and accelerate.
    2. Examples. i. A creditor may terminate and accelerate, for 
example, if:

[[Page 65621]]

    A. The consumer transfers title to the property or sells the 
property without the permission of the creditor.
    B. The consumer fails to maintain required insurance on the 
dwelling.
    C. The consumer fails to pay taxes on the property.
    D. The consumer permits the filing of a lien senior to that held by 
the creditor.
    E. The sole consumer obligated on the credit dies.
    F. The property is taken through eminent domain.
    G. A prior lienholder forecloses.
    ii. By contrast, the filing of a judgment against the consumer 
would permit termination and acceleration only if the amount of the 
judgment and collateral subject to the judgment is such that the 
creditor's security is adversely affected. If the consumer commits 
waste or otherwise destructively uses or fails to maintain the property 
such that the action adversely affects the security, the loan may be 
terminated and the balance accelerated. Illegal use of the property by 
the consumer would permit termination and acceleration if it subjects 
the property to seizure. If one of two consumers obligated on a loan 
dies, the creditor may terminate the loan and accelerate the balance if 
the security is adversely affected. If the consumer moves out of the 
dwelling that secures the loan and that action adversely affects the 
security, the creditor may terminate a loan and accelerate the balance.
* * * * *

Section 226.34--Prohibited Acts or Practices in Connection with Credit 
Secured by a Consumer s Dwelling; Open-end Credit

    34(a) Prohibited acts or practices for loans subject to 
Sec. 226.32.
    Paragraph 34(a)(1) Home-improvement contracts.
    Paragraph 34(a)(1)(i).
    1. Joint payees. If a creditor pays a contractor with an instrument 
jointly payable to the contractor and the consumer, the instrument must 
name as payee each consumer who is primarily obligated on the note.
    Paragraph 34(a)(2) Notice to Assignee.
    1. Subsequent sellers or assignors. Any person, whether or not the 
original creditor, that sells or assigns a mortgage subject to 
Sec. 226.32 must furnish the notice of potential liability to the 
purchaser or assignee.
    2. Format. While the notice of potential liability need not be in 
any particular format, the notice must be prominent. Placing it on the 
face of the note, such as with a stamp, is one means of satisfying the 
prominence requirement.
    3. Assignee liability. Pursuant to section 131(d) of the act, the 
act's general holder-in-due course protections do not apply to 
purchasers and assignees of loans covered by Sec. 226.32. For such 
loans, a purchaser's or other assignee's liability for all claims and 
defenses that the consumer could assert against the creditor is not 
limited to violations of the act.
    Paragraph 34(a)(3) Refinancings within one-year period.
    1. In the borrower's interest. The determination of whether or not 
a refinancing covered by Sec. 226.34(a)(3) is in the borrower's 
interest is based on the totality of the circumstances, at the time the 
credit is extended. A written statement by the borrower that ``this 
loan is in my interest'' alone does not meet this standard.
    i. A refinancing would be in the borrower's interest if needed to 
meet the borrower's ``bona fide personal financial emergency'' (see 
generally Sec. 226.23(e) and Sec. 226.31(c)(1)(iii)).
    ii. In connection with a refinancing that provides additional funds 
to the borrower, in determining whether a loan is in the borrower's 
interest consideration should be given to whether the loan fees and 
charges are commensurate with the amount of new funds advanced, and 
whether the real estate-related charges are bona fide and reasonable in 
amount (see generally Sec. 226.4(c)(7)).
    2. Application of the one-year refinancing prohibition to creditors 
and assignees. The prohibition in Sec. 226.34(a)(3) applies where an 
extension of credit subject to Sec. 226.32 is refinanced into another 
loan subject to Sec. 226.32. The prohibition is illustrated by the 
following examples. Assume that Creditor A makes a loan subject to 
Sec. 226.32 on January 15, 2003, secured by a first lien; this loan is 
assigned to Creditor B on February 15, 2003:
    i. Creditor A is prohibited from refinancing the January 2003 loan 
(or any other loan subject to Sec. 226.32 to the same borrower) into a 
loan subject to Sec. 226.32, until January 15, 2004. Creditor B is 
restricted until January 15, 2004, or such date prior to January 15, 
2004 that Creditor B ceases to hold or service the loan. During the 
prohibition period, Creditors A and B may make a subordinate lien loan 
that does not refinance a loan subject to Sec. 226.32. Assume that on 
April 1, 2003, Creditor A makes but does not assign a second-lien loan 
subject to Sec. 226.32. In that case, Creditor A would be prohibited 
from refinancing either the first-lien or second-lien loans (or any 
other loans to that borrower subject to Sec. 226.32) into another loan 
subject to Sec. 226.32 until April 1, 2004.
    ii. The loan made by Creditor A on January 15, 2003 (and assigned 
to Creditor B) may be refinanced by Creditor C at any time. If Creditor 
C refinances this loan on March 1, 2003 into a new loan subject to 
Sec. 226.32, Creditor A is prohibited from refinancing the loan made by 
Creditor C (or any other loan subject to Sec. 226.32 to the same 
borrower) into another loan subject to Sec. 226.32 until January 15, 
2004. Creditor C is similarly prohibited from refinancing any loan 
subject to Sec. 226.32 to that borrower into another until March 1, 
2004. (The limitations of Sec. 226.34(a)(3) no longer apply to Creditor 
B after Creditor C refinanced the January 2003 loan and Creditor B 
ceased to hold or service the loan.)
    Paragraph 34(a)(4) Repayment ability.
    1. Income. Any expected income can be considered by the creditor, 
except equity income that would be realized from collateral. For 
example, a creditor may use information about income other than regular 
salary or wages such as gifts, expected retirement payments, or income 
from self-employment, such as housecleaning or childcare.
    2. Pattern or practice of extending credit--repayment ability. 
Whether a creditor is engaging or has engaged in a pattern or practice 
of violations of this section depends on the totality of the 
circumstances in the particular case. While a pattern or practice is 
not established by isolated, random, or accidental acts, it can be 
established without the use of a statistical process. In addition, a 
creditor might act under a lending policy (whether written or 
unwritten) and that action alone could establish a pattern or practice 
of making loans in violation of this section.
    3. Discounted introductory rates. In transactions where the 
creditor sets an initial interest rate to be adjusted later (whether 
fixed or to be determined by an index or formula), in determining 
repayment ability the creditor must consider the consumer's ability to 
make loan payments based on the non-discounted or fully-indexed rate at 
the time of consummation.
    4. Verifying and documenting income and obligations. Creditors may 
verify and document a consumer's repayment ability in various ways. A 
creditor may verify and document a consumer's income and current 
obligations through any reliable source that provides the creditor with 
a reasonable basis for believing that there are sufficient funds to 
support the loan. Reliable sources include, but are not limited to, a 
credit report, tax returns, pension statements,

[[Page 65622]]

and payment records for employment income.
    Paragraph 34(b) Prohibited acts or practices for dwelling-secured 
loans; open-end credit.
    1. Amount of credit extended. 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. 226.32 if the rate or fee trigger is met. In applying the triggers 
under Sec. 226.32, the ``amount financed,'' including the ``principal 
loan amount'' must be determined. In making the determination, the 
amount of credit that would have been extended if the loan had been 
documented as a closed-end loan is a factual determination to be made 
in each case. Factors to be considered include the amount of money the 
consumer originally requested, the amount of the first advance or the 
highest outstanding balance, or the amount of the credit line. The full 
amount of the credit line is considered only to the extent that it is 
reasonable to expect that the consumer might use the full amount of 
credit.
* * * * *

Appendix H--Closed-End Model Forms and Clauses

* * * * *
    20. Sample H-16. This sample illustrates the disclosures 
required under Sec. 226.32(c). The sample illustrates the amount 
borrowed and the disclosures about optional insurance that are 
required for mortgage refinancings under Sec. 226.32(c)(5). 
Creditors may, at their option, include these disclosures for all 
loans subject to Sec. 226.32. The sample also includes disclosures 
required under Sec. 226.32(c)(3) when the legal obligation includes 
a balloon payment.
* * * * *

    By order of the Board of Governors of the Federal Reserve 
System, December 14, 2001.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 01-31264 Filed 12-19-01; 8:45 am]
BILLING CODE 6210-01-P
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