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Rule

Ability-to-Repay and Qualified Mortgage Standards Under the Truth in Lending Act (Regulation Z)

Action

Final Rule; Official Interpretations.

Summary

The Bureau of Consumer Financial Protection (Bureau) is amending Regulation Z, which implements the Truth in Lending Act (TILA). Regulation Z currently prohibits a creditor from making a higher-priced mortgage loan without regard to the consumer's ability to repay the loan. The final rule implements sections 1411 and 1412 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which generally require creditors to make a reasonable, good faith determination of a consumer's ability to repay any consumer credit transaction secured by a dwelling (excluding an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan) and establishes certain protections from liability under this requirement for “qualified mortgages.” The final rule also implements section 1414 of the Dodd-Frank Act, which limits prepayment penalties. Finally, the final rule requires creditors to retain evidence of compliance with the rule for three years after a covered loan is consummated.

Unified Agenda

TILA Ability to Repay (Regulation Z)

3 actions from May 11th, 2011 to April 2012

  • May 11th, 2011
  • July 22nd, 2011
    • NPRM Comment Period End
  • April 2012
    • Final Rule
 

Table of Contents Back to Top

DATES: Back to Top

The rule is effective January 10, 2014.

FOR FURTHER INFORMATION CONTACT: Back to Top

Joseph Devlin, Gregory Evans, David Friend, Jennifer Kozma, Eamonn K. Moran, or Priscilla Walton-Fein, Counsels; Thomas J. Kearney or Mark Morelli, Senior Counsels; or Stephen Shin, Managing Counsel, Office of Regulations, at (202) 435-7700.

SUPPLEMENTARY INFORMATION: Back to Top

I. Summary of the Final Rule Back to Top

The Consumer Financial Protection Bureau (Bureau) is issuing a final rule to implement laws requiring mortgage lenders to consider consumers' ability to repay home loans before extending them credit. The rule will take effect on January 10, 2014.

The Bureau is also releasing a proposal to seek comment on whether to adjust the final rule for certain community-based lenders, housing stabilization programs, certain refinancing programs of the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac) (collectively, the GSEs) and Federal agencies, and small portfolio creditors. The Bureau expects to finalize the concurrent proposal this spring so that affected creditors can prepare for the January 2014 effective date.

Background

During the years preceding the mortgage crisis, too many mortgages were made to consumers without regard to the consumer's ability to repay the loans. Loose underwriting practices by some creditors—including failure to verify the consumer's income or debts and qualifying consumers for mortgages based on “teaser” interest rates that would cause monthly payments to jump to unaffordable levels after the first few years—contributed to a mortgage crisis that led to the nation's most serious recession since the Great Depression.

In response to this crisis, in 2008 the Federal Reserve Board (Board) adopted a rule under the Truth in Lending Act which prohibits creditors from making “higher-price mortgage loans” without assessing consumers' ability to repay the loans. Under the Board's rule, a creditor is presumed to have complied with the ability-to-repay requirements if the creditor follows certain specified underwriting practices. This rule has been in effect since October 2009.

In the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress required that for residential mortgages, creditors must make a reasonable and good faith determination based on verified and documented information that the consumer has a reasonable ability to repay the loan according to its terms. Congress also established a presumption of compliance for a certain category of mortgages, called “qualified mortgages.” These provisions are similar, but not identical to, the Board's 2008 rule and cover the entire mortgage market rather than simply higher-priced mortgages. The Board proposed a rule to implement the new statutory requirements before authority passed to the Bureau to finalize the rule.

Summary of Final Rule

The final rule contains the following key elements:

Ability-to-Repay Determinations. The final rule describes certain minimum requirements for creditors making ability-to-repay determinations, but does not dictate that they follow particular underwriting models. At a minimum, creditors generally must consider eight underwriting factors: (1) Current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment on the covered transaction; (4) the monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations; (6) current debt obligations, alimony, and child support; (7) the monthly debt-to-income ratio or residual income; and (8) credit history. Creditors must generally use reasonably reliable third-party records to verify the information they use to evaluate the factors.

The rule provides guidance as to the application of these factors under the statute. For example, monthly payments must generally be calculated by assuming that the loan is repaid in substantially equal monthly payments during its term. For adjustable-rate mortgages, the monthly payment must be calculated using the fully indexed rate or an introductory rate, whichever is higher. Special payment calculation rules apply for loans with balloon payments, interest-only payments, or negative amortization.

The final rule also provides special rules to encourage creditors to refinance “non-standard mortgages”—which include various types of mortgages which can lead to payment shock that can result in default—into “standard mortgages” with fixed rates for at least five years that reduce consumers' monthly payments.

Presumption for Qualified Mortgages. The Dodd-Frank Act provides that “qualified mortgages” are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. However, the Act did not specify whether the presumption of compliance is conclusive (i.e., creates a safe harbor) or is rebuttable. The final rule provides a safe harbor for loans that satisfy the definition of a qualified mortgage and are not “higher-priced,” as generally defined by the Board's 2008 rule. The final rule provides a rebuttable presumption for higher-priced mortgage loans, as described further below.

The line the Bureau is drawing is one that has long been recognized as a rule of thumb to separate prime loans from subprime loans. Indeed, under the existing regulations that were adopted by the Board in 2008, only higher-priced mortgage loans are subject to an ability-to-repay requirement and a rebuttable presumption of compliance if creditors follow certain requirements. The new rule strengthens the requirements needed to qualify for a rebuttable presumption for subprime loans and defines with more particularity the grounds for rebutting the presumption. Specifically, the final rule provides that consumers may show a violation with regard to a subprime qualified mortgage by showing that, at the time the loan was originated, the consumer's income and debt obligations left insufficient residual income or assets to meet living expenses. The analysis would consider the consumer's monthly payments on the loan, loan-related obligations, and any simultaneous loans of which the creditor was aware, as well as any recurring, material living expenses of which the creditor was aware. Guidance accompanying the rule notes that the longer the period of time that the consumer has demonstrated actual ability to repay the loan by making timely payments, without modification or accommodation, after consummation or, for an adjustable-rate mortgage, after recast, the less likely the consumer will be able to rebut the presumption based on insufficient residual income.

With respect to prime loans—which are not currently covered by the Board's ability-to-repay rule—the final rule applies the new ability-to-repay requirements but creates a strong presumption for those prime loans that constitute qualified mortgages. Thus, if a prime loan satisfies the qualified mortgage criteria described below, it will be conclusively presumed that the creditor made a good faith and reasonable determination of the consumer's ability to repay.

General Requirements for Qualified Mortgages. The Dodd-Frank Act sets certain product-feature prerequisites and affordability underwriting requirements for qualified mortgages and vests discretion in the Bureau to decide whether additional underwriting or other requirements should apply. The final rule implements the statutory criteria, which generally prohibit loans with negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years from being qualified mortgages. So-called “no-doc” loans where the creditor does not verify income or assets also cannot be qualified mortgages. Finally, a loan generally cannot be a qualified mortgage if the points and fees paid by the consumer exceed three percent of the total loan amount, although certain “bona fide discount points” are excluded for prime loans. The rule provides guidance on the calculation of points and fees and thresholds for smaller loans.

The final rule also establishes general underwriting criteria for qualified mortgages. Most importantly, the general rule requires that monthly payments be calculated based on the highest payment that will apply in the first five years of the loan and that the consumer have a total (or “back-end”) debt-to-income ratio that is less than or equal to 43 percent. The appendix to the rule details the calculation of debt-to-income for these purposes, drawing upon Federal Housing Administration guidelines for such calculations. The Bureau believes that these criteria will protect consumers by ensuring that creditors use a set of underwriting requirements that generally safeguard affordability. At the same time, these criteria provide bright lines for creditors who want to make qualified mortgages.

The Bureau also believes that there are many instances in which individual consumers can afford a debt-to-income ratio above 43 percent based on their particular circumstances, but that such loans are better evaluated on an individual basis under the ability-to-repay criteria rather than with a blanket presumption. In light of the fragile state of the mortgage market as a result of the recent mortgage crisis, however, the Bureau is concerned that creditors may initially be reluctant to make loans that are not qualified mortgages, even though they are responsibly underwritten. The final rule therefore provides for a second, temporary category of qualified mortgages that have more flexible underwriting requirements so long as they satisfy the general product feature prerequisites for a qualified mortgage and also satisfy the underwriting requirements of, and are therefore eligible to be purchased, guaranteed or insured by either (1) the GSEs while they operate under Federal conservatorship or receivership; or (2) the U.S. Department of Housing and Urban Development, Department of Veterans Affairs, or Department of Agriculture or Rural Housing Service. This temporary provision will phase out over time as the various Federal agencies issue their own qualified mortgage rules and if GSE conservatorship ends, and in any event after seven years.

Rural Balloon-Payment Qualified Mortgages. The final rule also implements a special provision in the Dodd-Frank Act that would treat certain balloon-payment mortgages as qualified mortgages if they are originated and held in portfolio by small creditors operating predominantly in rural or underserved areas. This provision is designed to assure credit availability in rural areas, where some creditors may only offer balloon-payment mortgages. Loans are only eligible if they have a term of at least five years, a fixed-interest rate, and meet certain basic underwriting standards; debt-to-income ratios must be considered but are not subject to the 43 percent general requirement.

Creditors are only eligible to make rural balloon-payment qualified mortgages if they originate at least 50 percent of their first-lien mortgages in counties that are rural or underserved, have less than $2 billion in assets, and (along with their affiliates) originate no more than 500 first-lien mortgages per year. The Bureau will designate a list of “rural” and “underserved” counties each year, and has defined coverage more broadly than originally had been proposed. Creditors must generally hold the loans on their portfolios for three years in order to maintain their “qualified mortgage” status.

Other Final Rule Provisions. The final rule also implements Dodd-Frank Act provisions that generally prohibit prepayment penalties except for certain fixed-rate, qualified mortgages where the penalties satisfy certain restrictions and the creditor has offered the consumer an alternative loan without such penalties. To match with certain statutory changes, the final rule also lengthens to three years the time creditors must retain records that evidence compliance with the ability-to-repay and prepayment penalty provisions and prohibits evasion of the rule by structuring a closed-end extension of credit that does not meet the definition of open-end credit as an open-end plan.

Summary of Concurrent Proposal

The concurrent proposal seeks comment on whether the general ability-to-repay and qualified mortgage rule should be modified to address potential adverse consequences on certain narrowly-defined categories of lending programs. Because those measures were not proposed by the Board originally, the Bureau believes additional public input would be helpful. Specifically, the proposal seeks comment on whether it would be appropriate to exempt designated non-profit lenders, homeownership stabilization programs, and certain Federal agency and GSE refinancing programs from the ability-to-repay requirements because they are subject to their own specialized underwriting criteria.

The proposal also seeks comment on whether to create a new category of qualified mortgages, similar to the one for rural balloon-payment mortgages, for loans without balloon-payment features that are originated and held on portfolio by small creditors. The new category would not be limited to lenders that operate predominantly in rural or underserved areas, but would use the same general size thresholds and other criteria as the rural balloon-payment rules. The proposal also seeks comment on whether to increase the threshold separating safe harbor and rebuttable presumption qualified mortgages for both rural balloon-payment qualified mortgages and the new small portfolio qualified mortgages, in light of the fact that small creditors often have higher costs of funds than larger creditors. Specifically, the Bureau is proposing a threshold of 3.5 percentage points above APOR for first-lien loans.

II. Background Back to Top

For over 20 years, consumer advocates, legislators, and regulators have raised concerns about creditors originating mortgage loans without regard to the consumer's ability to repay the loan. Beginning in about 2006, these concerns were heightened as mortgage delinquencies and foreclosure rates increased dramatically, caused in part by the loosening of underwriting standards. See 73 FR 44524 (July 30, 2008). The following discussion provides background information, including a brief summary of the legislative and regulatory responses to the foregoing concerns, which culminated in the enactment of the Dodd-Frank Act on July 21, 2010, the Board's May 11, 2011, proposed rule to implement certain amendments to TILA made by the Dodd-Frank Act, and now the Bureau's issuance of this final rule to implement sections 1411, 1412, and 1414 of that act.

A. The Mortgage Market

Overview of the Market and the Mortgage Crisis

The mortgage market is the single largest market for consumer financial products and services in the United States, with approximately $9.9 trillion in mortgage loans outstanding. [1] During the last decade, the market went through an unprecedented cycle of expansion and contraction that was fueled in part by the securitization of mortgages and creation of increasingly sophisticated derivative products. So many other parts of the American financial system were drawn into mortgage-related activities that, when the housing market collapsed in 2008, it sparked the most severe recession in the United States since the Great Depression. [2]

The expansion in this market is commonly attributed to both particular economic conditions (including an era of low interest rates and rising housing prices) and to changes within the industry. Interest rates dropped significantly—by more than 20 percent—from 2000 through 2003. [3] Housing prices increased dramatically—about 152 percent—between 1997 and 2006. [4] Driven by the decrease in interest rates and the increase in housing prices, the volume of refinancings increased rapidly, from about 2.5 million loans in 2000 to more than 15 million in 2003. [5]

In the mid-2000s, the market experienced a steady deterioration of credit standards in mortgage lending, with evidence that loans were made solely against collateral, or even against expected increases in the value of collateral, and without consideration of ability to repay. This deterioration of credit standards was particularly evidenced by the growth of “subprime” and “Alt-A” products, which consumers were often unable to repay. [6] Subprime products were sold primarily to consumers with poor or no credit history, although there is evidence that some consumers who would have qualified for “prime” loans were steered into subprime loans as well. [7] The Alt-A category of loans permitted consumers to take out mortgage loans while providing little or no documentation of income or other evidence of repayment ability. Because these loans involved additional risk, they were typically more expensive to consumers than “prime” mortgages, although many of them had very low introductory interest rates. In 2003, subprime and Alt-A origination volume was about $400 billion; in 2006, it had reached $830 billion. [8]

So long as housing prices were continuing to increase, it was relatively easy for consumers to refinance their existing loans into more affordable products to avoid interest rate resets and other adjustments. When housing prices began to decline in 2005, however, refinancing became more difficult and delinquency rates on subprime and Alt-A products increased dramatically. [9] More and more consumers, especially those with subprime and Alt-A loans, were unable or unwilling to make their mortgage payments. An early sign of the mortgage crisis was an upswing in early payment defaults—generally defined as borrowers being 60 or more days delinquent within the first year. Prior to 2006, 1.1 percent of mortgages would end up 60 or more days delinquent within the first two years. [10] Taking a more expansive definition of early payment default to include 60 days delinquent within the first two years, this figure was double the historic average during 2006, 2007 and 2008. [11] In 2006, 2007, and 2008, 2.3 percent, 2.1 percent, and 2.3 percent of mortgages ended up 60 or more days delinquent within the first two years, respectively. By the summer of 2006, 1.5 percent of loans less than a year old were in default, and this figure peaked at 2.5 percent in late 2007, well above the 1.0 percent peak in the 2000 recession. [12] First payment defaults—mortgages taken out by consumers who never made a single payment—exceeded 1.5 percent of loans in early 2007. [13] In addition, as the economy worsened, the rates of serious delinquency (90 or more days past due or in foreclosure) for the subprime and Alt-A products began a steep increase from approximately 10 percent in 2006, to 20 percent in 2007, to more than 40 percent in 2010. [14]

The impact of this level of delinquencies was severe on creditors who held loans on their books and on private investors who purchased loans directly or through securitized vehicles. Prior to and during the bubble, the evolution of the securitization of mortgages attracted increasing involvement from financial institutions that were not directly involved in the extension of credit to consumers and from investors worldwide. Securitization of mortgages allows originating creditors to sell off their loans (and reinvest the funds earned in making new ones) to investors who want an income stream over time. Securitization had been pioneered by what are now called government-sponsored enterprises (GSEs), including the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). But by the early 2000s, large numbers of private financial institutions were deeply involved in creating increasingly complex mortgage-related investment vehicles through securities and derivative products. The private securitization-backed subprime and Alt-A mortgage market ground to a halt in 2007 in the face of the rising delinquencies on subprime and Alt-A products. [15]

Six years later, the United States continues to grapple with the fallout. The fall in housing prices is estimated to have resulted in about $7 trillion in household wealth losses. [16] In addition, distressed homeownership and foreclosure rates remain at unprecedented levels. [17]

Response and Government Programs

In light of these conditions, the Federal government began providing support to the mortgage markets in 2008 and continues to do so at extraordinary levels today. The Housing and Economic Recovery Act of 2008, which became effective on October 1, 2008, provided both new safeguards and increased regulation for Fannie Mae and Freddie Mac, as well as provisions to assist troubled borrowers and to the hardest hit communities. Fannie Mae and Freddie Mac, which supported the mainstream mortgage market, experienced heavy losses and were placed in conservatorship by the Federal government in 2008 to support the collapsing mortgage market. [18] Because private investors have withdrawn from the mortgage securitization market and there are no other effective secondary market mechanisms in place, the GSEs' continued operations help ensure that the secondary mortgage market continues to function and to assist consumers in obtaining new mortgages or refinancing existing mortgages. The Troubled Asset Relief Program (TARP), created to implement programs to stabilize the financial system during the financial crisis, was authorized through the Emergency Economic Stabilization Act of 2008 (EESA), as amended by the American Recovery and Reinvestment Act of 2009, and includes programs to help struggling homeowners avoid foreclosure. [19] Since 2008, several other Federal government efforts have endeavored to keep the country's housing finance system functioning, including the Treasury Department's and the Federal Reserve System's mortgage-backed securities (MBS) purchase programs to help keep interest rates low and the Federal Housing Administration's (FHA's) increased market presence. As a result, mortgage credit has remained available, albeit with more restrictive underwriting terms that limit or preclude some consumers' access to credit. These same government agencies together with the GSEs and other market participants have also undertaken a series of efforts to help families avoid foreclosure through loan-modification programs, loan-refinance programs and foreclosure alternatives. [20]

Size and Volume of the Current Mortgage Origination Market

Even with the economic downturn and tightening of credit standards, approximately $1.28 trillion in mortgage loans were originated in 2011. [21] In exchange for an extension of mortgage credit, consumers promise to make regular mortgage payments and provide their home or real property as collateral. The overwhelming majority of homebuyers continue to use mortgage loans to finance at least some of the purchase price of their property. In 2011, 93 percent of all home purchases were financed with a mortgage credit transaction. [22]

Consumers may obtain mortgage credit to purchase a home, to refinance an existing mortgage, to access home equity, or to finance home improvement. Purchase loans and refinancings together produced 6.3 million new first-lien mortgage loan originations in 2011. [23] The proportion of loans that are for purchases as opposed to refinances varies with the interest rate environment and other market factors. In 2011, 65 percent of the market was refinance transactions and 35 percent was purchase loans, by volume. [24] Historically the distribution has been more even. In 2000, refinances accounted for 44 percent of the market while purchase loans comprised 56 percent; in 2005, the two products were split evenly. [25]

With a home equity transaction, a homeowner uses his or her equity as collateral to secure consumer credit. The credit proceeds can be used, for example, to pay for home improvements. Home equity credit transactions and home equity lines of credit resulted in an additional 1.3 million mortgage loan originations in 2011. [26]

The market for higher-priced mortgage loans remains significant. Data reported under the Home Mortgage Disclosure Act (HMDA) show that in 2011 approximately 332,000 transactions, including subordinate liens, were reportable as higher-priced mortgage loans. Of these transactions, refinancings accounted for approximately 44 percent of the higher-priced mortgage loan market, and 90 percent of the overall higher-priced mortgage loan market involved first-lien transactions. The median first-lien higher-priced mortgage loan was for $81,000, while the interquartile range (quarter of the transactions are below, quarter of the transactions are above) was $47,000 to $142,000.

GSE-eligible loans, together with the other federally insured or guaranteed loans, cover the majority of the current mortgage market. Since entering conservatorship in September 2008, the GSEs have bought or guaranteed roughly three of every four mortgages originated in the country. Mortgages guaranteed by FHA make up most of the rest. [27] Outside of the securitization available through the Government National Mortgage Association (Ginnie Mae) for loans primarily backed by FHA, there are very few alternatives in place today to assume the secondary market functions served by the GSEs. [28]

Continued Fragility of the Mortgage Market

The current mortgage market is especially fragile as a result of the recent mortgage crisis. Tight credit remains an important factor in the contraction in mortgage lending seen over the past few years. Mortgage loan terms and credit standards have tightened most for consumers with lower credit scores and with less money available for a down payment. According to CoreLogic's TrueStandings Servicing, a proprietary data service that covers about two-thirds of the mortgage market, average underwriting standards have tightened considerably since 2007. Through the first nine months of 2012, for consumers that have received closed-end first-lien mortgages, the weighted average FICO [29] score was 750, the loan-to-value (LTV) ratio was 78 percent, and the debt-to-income (DTI) ratio was 34.5 percent. [30] In comparison, in the peak of the housing bubble in 2007, the weighted average FICO score was 706, the LTV was 80 percent, and the DTI was 39.8 percent. [31]

In this tight credit environment, the data suggest that creditors are not willing to take significant risks. In terms of the distribution of origination characteristics, for 90 percent of all the Fannie Mae and Freddie Mac mortgage loans originated in 2011, consumers had a FICO score over 700 and a DTI less than 44 percent. [32] According to the Federal Reserve's Senior Loan Officer Opinion Survey on Bank Lending Practices, in April 2012 nearly 60 percent of creditors reported that they would be much less likely, relative to 2006, to originate a conforming home-purchase mortgage [33] to a consumer with a 10 percent down payment and a credit score of 620—a traditional marker for those consumers with weaker credit histories. [34] The Federal Reserve Board calculates that the share of mortgage borrowers with credit scores below 620 has fallen from about 17 percent of consumers at the end of 2006 to about 5 percent more recently. [35] Creditors also appear to have pulled back on offering these consumers loans insured by the FHA, which provides mortgage insurance on loans made by FHA-approved creditors throughout the United States and its territories and is especially structured to help promote affordability. [36]

The Bureau is acutely aware of the high levels of anxiety in the mortgage market today. These concerns include the continued slow pace of recovery, the confluence of multiple major regulatory and capital initiatives, and the compliance burdens of the various Dodd-Frank Act rulemakings (including uncertainty on what constitutes a qualified residential mortgage (QRM), which, as discussed below, relates to the Dodd-Frank Act's credit risk retention requirements and mortgage securitizations). These concerns are causing discussion about whether creditors will consider exiting the business. The Bureau acknowledges that it will likely take some time for the mortgage market to stabilize and that creditors will need to adjust their operations to account for several major regulatory and capital regimes.

B. TILA and Regulation Z

In 1968, Congress enacted the Truth in Lending Act (TILA), 15 U.S.C. 1601 et seq., based on findings that the informed use of credit resulting from consumers' awareness of the cost of credit would enhance economic stability and competition among consumer credit providers. One of the purposes of TILA is to promote the informed use of consumer credit by requiring disclosures about its costs and terms. See 15 U.S.C. 1601. TILA requires additional disclosures for loans secured by consumers' homes and permits consumers to rescind certain transactions secured by their principal dwellings when the required disclosures are not provided. 15 U.S.C. 1635, 1637a. Section 105(a) of TILA directs the Bureau (formerly directed the Board of Governors of the Federal Reserve System) to prescribe regulations to carry out TILA's purposes and specifically authorizes the Bureau, among other things, to issue regulations that contain such additional requirements, classifications, differentiations, or other provisions, or that provide for such adjustments and exceptions for all or any class of transactions, that in the Bureau's judgment are necessary or proper to effectuate the purposes of TILA, facilitate compliance thereof, or prevent circumvention or evasion therewith. See 15 U.S.C. 1604(a).

General rulemaking authority for TILA transferred to the Bureau in July 2011, other than for certain motor vehicle dealers in accordance with the Dodd-Frank Act section 1029, 12 U.S.C. 5519. Pursuant to the Dodd-Frank Act and TILA, as amended, the Bureau published for public comment an interim final rule establishing a new Regulation Z, 12 CFR part 1026, implementing TILA (except with respect to persons excluded from the Bureau's rulemaking authority by section 1029 of the Dodd-Frank Act). 76 FR 79768 (Dec. 22, 2011). This rule did not impose any new substantive obligations but did make technical and conforming changes to reflect the transfer of authority and certain other changes made by the Dodd-Frank Act. The Bureau's Regulation Z took effect on December 30, 2011. The Official Staff Interpretations interpret the requirements of the regulation and provides guidance to creditors in applying the rules to specific transactions. See 12 CFR part 1026, Supp. I.

C. The Home Ownership and Equity Protection Act (HOEPA) and HOEPA Rules

In response to evidence of abusive practices in the home-equity lending market, in 1994 Congress amended TILA by enacting the Home Ownership and Equity Protection Act (HOEPA) as part of the Riegle Community Development and Regulatory Improvement Act of 1994. 103, 108 Stat. 2160. HOEPA was enacted as an amendment to TILA to address abusive practices in refinancing and home-equity mortgage loans with high interest rates or high fees. [37] Loans that meet HOEPA's high-cost triggers are subject to special disclosure requirements and restrictions on loan terms, and consumers with high-cost mortgages have enhanced remedies for violations of the law. [38]

The statute applied generally to closed-end mortgage credit, but excluded purchase money mortgage loans and reverse mortgages. Coverage was triggered where a loan's annual percentage rate (APR) exceeded comparable Treasury securities by specified thresholds for particular loan types, or where points and fees exceeded eight percent of the total loan amount or a dollar threshold. [39]

For high-cost loans meeting either of those thresholds, HOEPA required creditors to provide special pre-closing disclosures, restricted prepayment penalties and certain other loan terms, and regulated various creditor practices, such as extending credit without regard to a consumer's ability to repay the loan. HOEPA also provided a mechanism for consumers to rescind covered loans that included certain prohibited terms and to obtain higher damages than are allowed for other types of TILA violations. Finally, HOEPA amended TILA section 131, 15

U.S.C. 1641, to provide that purchasers of high-cost loans generally are subject to all claims and defenses against the original creditor with respect to the mortgage, including a creditor's failure to make an ability-to-repay determination before making the loan. HOEPA created special substantive protections for high-cost mortgages, such as prohibiting a creditor from engaging in a pattern or practice of extending a high-cost mortgage to a consumer based on the consumer's collateral without regard to the consumer's repayment ability, including the consumer's current and expected income, current obligations, and employment. TILA section 129(h); 15 U.S.C. 1639(h).

In addition to the disclosures and limitations specified in the statute, HOEPA expanded the Board's rulemaking authority, among other things, to prohibit acts or practices the Board found to be unfair and deceptive in connection with mortgage loans. [40]

In 1995, the Board implemented the HOEPA amendments at §§ 226.31, 226.32, and 226.33 [41] of Regulation Z. See 60 FR 15463 (Mar. 24, 1995). In particular, § 226.32(e)(1) [42] implemented TILA section 129(h)'s ability-to-repay requirements to prohibit a creditor from engaging in a pattern or practice of extending a high-cost mortgage based on the consumer's collateral without regard to the consumer's repayment ability, including the consumer's current income, current obligations, and employment status.

In 2001, the Board published additional significant changes to expand both HOEPA's protections to more loans by revising the annual percentage rate (APR) threshold for first-lien mortgage loans, expanded the definition of points and fees to include the cost of optional credit insurance and debt cancellation premiums, and enhanced the restrictions associated with high-cost loans. See 66 FR 65604 (Dec. 20, 2001). In addition, the ability-to-repay provisions in the regulation were revised to provide for a presumption of a violation of the rule if the creditor engages in a pattern or practice of making high-cost mortgages without verifying and documenting the consumer's repayment ability.

D. 2006 and 2007 Interagency Supervisory Guidance

In December 2005, the Federal banking agencies [43] responded to concerns about the rapid growth of nontraditional mortgages in the previous two years by proposing supervisory guidance. Nontraditional mortgages are mortgages that allow the consumer to defer repayment of principal and sometimes interest. The guidance advised institutions of the need to reduce “risk layering” with respect to these products, such as by failing to document income or lending nearly the full appraised value of the home. The final guidance issued in September 2006 specifically advised creditors that layering risks in nontraditional mortgage loans to consumers receiving subprime credit may significantly increase risks to consumers as well as institutions. See Interagency Guidance on Nontraditional Mortgage Product Risks, 71 FR 58609 (Oct. 4, 2006) (2006 Nontraditional Mortgage Guidance).

The Federal banking agencies addressed concerns about the subprime market in March 2007 with proposed supervisory guidance addressing the heightened risks to consumers and institutions of adjustable-rate mortgages with two- or three-year “teaser” interest rates followed by substantial increases in the rate and payment. The guidance, finalized in June of 2007, set out the standards institutions should follow to ensure consumers in the subprime market obtain loans they can afford to repay. Among other steps, the guidance advised creditors: (1) To use the fully indexed rate and fully-amortizing payment when qualifying consumers for loans with adjustable rates and potentially non-amortizing payments; (2) to limit stated income and reduced documentation loans to cases where mitigating factors clearly minimize the need for full documentation of income; and (3) to provide that prepayment penalty clauses expire a reasonable period before reset, typically at least 60 days. See Statement on Subprime Mortgage Lending, 72 FR 37569 (July 10, 2007) (2007 Subprime Mortgage Statement). [44] The Conference of State Bank Supervisors (CSBS) and the American Association of Residential Mortgage Regulators (AARMR) issued parallel statements for state supervisors to use with state-supervised entities, and many states adopted the statements.

E. 2008 HOEPA Final Rule

After the Board finalized the 2001 HOEPA rules, new consumer protection issues arose in the mortgage market. In 2006 and 2007, the Board held a series of national hearings on consumer protection issues in the mortgage market. During those hearings, consumer advocates and government officials expressed a number of concerns, and urged the Board to prohibit or restrict certain underwriting practices, such as “stated income” or “low documentation” loans, and certain product features, such as prepayment penalties. See 73 FR 44527 (July 30, 2008). The Board was also urged to adopt additional regulations under HOEPA, because, unlike the Interagency Supervisory Guidance, the regulations would apply to all creditors and would be enforceable by consumers through civil actions. As discussed above, in 1995 the Board implemented TILA section 129(h)'s ability-to-repay requirements for high-cost mortgage loans. In 2008, the Board exercised its authority under HOEPA to extend certain consumer protections concerning a consumer's ability to repay and prepayment penalties to a new category of “higher-priced mortgage loans” (HPMLs) [45] with APRs that are lower than those prescribed for high-cost loans but that nevertheless exceed the average prime offer rate by prescribed amounts. This new category of loans was designed to include subprime credit. Specifically, the Board exercised its authority to revise HOEPA's restrictions on high-cost loans based on a conclusion that the revisions were necessary to prevent unfair and deceptive acts or practices in connection with mortgage loans. 73 FR 44522 (July 30, 2008) (2008 HOEPA Final Rule). The Board determined that imposing the burden to prove “pattern or practice” on an individual consumer would leave many consumers with a lesser remedy, such as those provided under some State laws, or without any remedy for loans made without regard to repayment ability. In particular, the Board concluded that a prohibition on making individual loans without regard for repayment ability was necessary to ensure a remedy for consumers who are given unaffordable loans and to deter irresponsible lending, which injures individual consumers. The 2008 HOEPA Final Rule provides a presumption of compliance with the higher-priced mortgage ability-to-repay requirements if the creditor follows certain procedures regarding underwriting the loan payment, assessing the debt-to-income ratio or residual income, and limiting the features of the loan, in addition to following certain procedures mandated for all creditors. See§ 1026.34(a)(4)(iii) and (iv). However, the 2008 HOEPA Final Rule makes clear that even if the creditor follows the required and optional criteria, the creditor has merely obtained a presumption of compliance with the repayment ability requirement. The consumer can still rebut or overcome that presumption by showing that, despite following the required and optional procedures, the creditor nonetheless disregarded the consumer's ability the loan.

F. The Dodd-Frank Act

In 2007, Congress held numerous hearings focused on rising subprime foreclosure rates and the extent to which lending practices contributed to them. [46] Consumer advocates testified that certain lending terms or practices contributed to the foreclosures, including a failure to consider the consumer's ability to repay, low- or no-documentation loans, hybrid adjustable-rate mortgages, and prepayment penalties. Industry representatives, on the other hand, testified that adopting substantive restrictions on subprime loan terms would risk reducing access to credit for some consumers. In response to these hearings, the House of Representatives passed the Mortgage Reform and Anti-Predatory Lending Act, both in 2007 and again in 2009. H.R. 3915, 110th Cong. (2007); H.R. 1728, 111th Cong. (2009). Both bills would have amended TILA to provide consumer protections for mortgages, including ability-to-repay requirements, but neither bill was passed by the Senate. Instead, both houses shifted their focus to enacting comprehensive financial reform legislation.

In December 2009, the House passed the Wall Street Reform and Consumer Protection Act of 2009, its version of comprehensive financial reform legislation, which included an ability-to-repay and qualified mortgage provision. H.R. 4173, 111th Cong. (2009). In May 2010, the Senate passed its own version of ability-to-repay requirements in its own version of comprehensive financial reform legislation, called the Restoring American Financial Stability Act of 2010. S. 3217, 111th Cong. (2010). After conference committee negotiations, the Dodd-Frank Act was passed by both houses of Congress and was signed into law on July 21, 2010. Public Law 111-203, 124 Stat. 1376 (2010).

In the Dodd-Frank Act, Congress established the Bureau and, under sections 1061 and 1100A, generally consolidated the rulemaking authority for Federal consumer financial laws, including TILA and RESPA, in the Bureau. [47] Congress also provided the Bureau, among other things, with supervision authority for Federal consumer financial laws over certain entities, including insured depository institutions and credit unions with total assets over $10 billion and their affiliates, and mortgage-related non-depository financial services providers. [48] In addition, Congress provided the Bureau with authority, subject to certain limitations, to enforce the Federal consumer financial laws, including the 18 enumerated consumer laws. Title X of the Dodd-Frank Act, and rules thereunder. The Bureau can bring civil actions in court and administrative enforcement proceedings to obtain remedies such as civil penalties and cease-and-desist orders.

At the same time, Congress significantly amended the statutory requirements governing mortgage practices with the intent to restrict the practices that contributed to the crisis. Title XIV of the Dodd-Frank Act contains a modified version of the Mortgage Reform and Anti-Predatory Lending Act. [49] The Dodd-Frank Act requires the Bureau to propose consolidation of the major federal mortgage disclosures, imposes new requirements and limitations to address a wide range of consumer mortgage issues, and imposes credit risk retention requirements in connection with mortgage securitization.

Through the Dodd-Frank Act, Congress expanded HOEPA to apply to more types of mortgage transactions, including purchase money mortgage loans and home-equity lines of credit. Congress also amended HOEPA's existing high-cost triggers, added a prepayment penalty trigger, and expanded the protections associated with high-cost mortgages. [50]

In addition, sections 1411, 1412, and 1414 of the Dodd-Frank Act created new TILA section 129C, which establishes, among other things, new ability-to-repay requirements and new limits on prepayment penalties. Section 1402 of the Dodd-Frank Act states that Congress created new TILA section 129C upon a finding that “economic stabilization would be enhanced by the protection, limitation, and regulation of the terms of residential mortgage credit and the practices related to such credit, while ensuring that responsible, affordable mortgage credit remains available to consumers.” TILA section 129B(a)(1), 15 U.S.C. 1639b(a)(1). Section 1402 of the Dodd-Frank Act further states that the purpose of TILA section 129C is to “assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans.” TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2).

Specifically, TILA section 129C:

  • Expands coverage of the ability-to-repay requirements to any consumer credit transaction secured by a dwelling, except an open-end credit plan, credit secured by an interest in a timeshare plan, reverse mortgage, or temporary loan.
  • Prohibits a creditor from making a mortgage loan unless the creditor makes a reasonable and good faith determination, based on verified and documented information, that the consumer has a reasonable ability to repay the loan according to its terms, and all applicable taxes, insurance, and assessments.
  • Provides a presumption of compliance with the ability-to-repay requirements if the mortgage loan is a “qualified mortgage,” which does not contain certain risky features and does not exceed certain thresholds for points and fees on the loan and which meets such other criteria as the Bureau may prescribe.
  • Prohibits prepayment penalties unless the mortgage is a fixed-rate qualified mortgage that is not a higher-priced mortgage loan, and the amount and duration of the prepayment penalty are limited.

The statutory ability-to-repay standards reflect Congress's belief that certain lending practices (such as low- or no-documentation loans or underwriting loans without regard to principal repayment) led to consumers having mortgages they could not afford, resulting in high default and foreclosure rates. Accordingly, new TILA section 129C generally prohibits a creditor from making a residential mortgage loan unless the creditor makes a reasonable and good faith determination, based on verified and documented information, that the consumer has a reasonable ability to repay the loan according to its terms.

To provide more certainty to creditors while protecting consumers from unaffordable loans, the Dodd-Frank Act provides a presumption of compliance with the ability-to-repay requirements for certain “qualified mortgages.” TILA section 129C(b)(1) states that a creditor or assignee may presume that a loan has met the repayment ability requirement if the loan is a qualified mortgage. Qualified mortgages are prohibited from containing certain features that Congress considered to increase risks to consumers and must comply with certain limits on points and fees.

The Dodd-Frank Act creates special remedies for violations of TILA section 129C. As amended by section 1416 of the Dodd-Frank Act, TILA provides that a consumer who brings a timely action against a creditor for a violation of TILA section 129C(a) (the ability-to-repay requirements) may be able to recover special statutory damages equal to the sum of all finance charges and fees paid by the consumer, unless the creditor demonstrates that the failure to comply is not material. TILA section 130(a). This recovery is in addition to: (1) Actual damages; (2) statutory damages in an individual action or class action, up to a prescribed threshold; and (3) court costs and attorney fees that would be available for violations of other TILA provisions. In addition, the statute of limitations for a violation of TILA section 129C is three years from the date of the occurrence of the violation (as compared to one year for most other TILA violations, except for actions brought under section 129 or 129B, or actions brought by a State attorney general to enforce a violation of section 129, 129B, 129C, 129D, 129E, 129F, 129G, or 129H, which may be brought not later than 3 years after the date on which the violation occurs, and private education loans under 15 U.S.C. 1650(a), which may be brought not later than one year from the due date of first regular payment of principal). TILA section 130(e). Moreover, as amended by section 1413 of the Dodd-Frank Act, TILA provides that when a creditor, or an assignee, other holder or their agent initiates a foreclosure action, a consumer may assert a violation of TILA section 129C(a) “as a matter of defense by recoupment or setoff.” TILA section 130(k). There is no time limit on the use of this defense and the amount of recoupment or setoff is limited, with respect to the special statutory damages, to no more than three years of finance charges and fees. For high-cost loans an assignee generally continues to be subject to all claims and defenses, not only in foreclosure, with respect to that mortgage that the consumer could assert against the creditor of the mortgage, unless the assignee demonstrates, by a preponderance of evidence, that a reasonable person exercising ordinary due diligence, could not determine that the mortgage was a high-cost mortgage. TILA section 131(d).

In addition to the foregoing ability-to-repay provisions, the Dodd-Frank Act established other new standards concerning a wide range of mortgage lending practices, including compensation of mortgage originators, [51] Federal mortgage disclosures, [52] and mortgage servicing. [53] Those and other Dodd-Frank Act provisions are the subjects of other rulemakings by the Bureau. For additional information on those other rulemakings, see the discussion below in part III.C.

G. Qualified Residential Mortgage Rulemaking

Section 15G of the Securities Exchange Act of 1934, added by section 941(b) of the Dodd-Frank Act, generally requires the securitizer of asset-backed securities (ABS) to retain not less than five percent of the credit risk of the assets collateralizing the ABS. 15 U.S.C. 78o-11. The Dodd-Frank Act's credit risk retention requirements are aimed at addressing weaknesses and failures in the securitization process and the securitization markets. [54] By requiring that the securitizer retain a portion of the credit risk of the assets being securitized, the Dodd-Frank Act provides securitizers an incentive to monitor and ensure the quality of the assets underlying a securitization transaction. Six Federal agencies (not including the Bureau) are tasked with implementing this requirement. Those agencies are the Board, Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), Securities and Exchange Commission (SEC), Federal Housing Finance Agency (FHFA), and Department of Housing and Urban Development (HUD) (collectively, the QRM agencies).

Section 15G of the Securities Exchange Act of 1934 provides that the credit risk retention requirements shall not apply to an issuance of ABS if all of the assets that collateralize the ABS are “qualified residential mortgages” (QRMs). See 15 U.S.C. 78o-11(c)(1)(C)(iii), (4)(A) and (B). Section 15G requires the QRM agencies to jointly define what constitutes a QRM, taking into consideration underwriting and product features that historical loan performance data indicate result in a lower risk of default. See 15 U.S.C. 78o-11(e)(4). Notably, section 15G also provides that the definition of a QRM shall be “no broader than” the definition of a “qualified mortgage,” as the term is defined under TILA section 129C(b)(2), as amended by the Dodd-Frank Act, and regulations adopted thereunder. 15 U.S.C. 78o-11(e)(4)(C).

On April 29, 2011, the QRM agencies issued joint proposed risk retention rules, including a proposed QRM definition (2011 QRM Proposed Rule). See 76 FR 24090 (Apr. 29, 2011). The proposed rule has not been finalized. Among other requirements, the 2011 QRM Proposed Rule incorporates the qualified mortgage restrictions on negative amortization, interest-only, and balloon payments, limits points and fees to three percent of the loan amount, and prohibits prepayment penalties. The proposed rule also establishes underwriting standards designed to ensure that QRMs have high credit quality, including:

  • A maximum “front-end” monthly debt-to-income ratio (which looks at only the consumer's mortgage payment relative to income, but not at other debts) of 28 percent;
  • A maximum “back-end” monthly debt-to-income ratio (which includes all of the consumer's debt, not just the mortgage payment) of 36 percent;
  • A maximum loan-to-value (LTV) ratio of 80 percent in the case of a purchase transaction (with a lesser combined LTV permitted for refinance transactions);
  • A 20 percent down payment requirement in the case of a purchase transaction; and
  • Credit history verification and documentation requirements.

The proposed rule also includes appraisal requirements, restrictions on the assumability of the mortgage, and requires the creditor to commit to certain servicing policies and procedures regarding loss mitigation. See 76 FR at 24166-67.

To provide clarity on the definitions, calculations, and verification requirements for the QRM standards, the 2011 QRM Proposed Rule incorporates certain definitions and key terms established by HUD and required to be used by creditors originating FHA-insured residential mortgages. See 76 FR at 24119. Specifically, the 2011 QRM Proposed Rule incorporates the definitions and standards set out in the HUD Handbook 4155.1 (New Version), Mortgage Credit Analysis for Mortgage Insurance, as in effect on December 31, 2010, for determining and verifying the consumer's funds and the consumer's monthly housing debt, total monthly debt, and monthly gross income. [55]

The qualified mortgage and QRM definitions are distinct and relate to different parts of the Dodd-Frank Act with different purposes, but both are designed to address problems that had arisen in the mortgage origination process. The qualified mortgage standard provides creditors with a presumption of compliance with the requirement in TILA section 129C(a) to assess a consumer's ability to repay a residential mortgage loan. The purpose of these provisions is to ensure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans. See TILA section 129B(a)(2). The Dodd-Frank Act's credit risk retention requirements are intended to address problems in the securitization markets and in mortgage markets by requiring that securitizers, as a general matter, retain an economic interest in the credit risk of the assets they securitize. The QRM credit risk retention requirement was meant to incentivize creditors to make more responsible loans because they will need to keep some skin in the game. [56]

Nevertheless, as discussed above, the Dodd-Frank Act requires that the QRM definition be “no broader than” the qualified mortgage definition. Therefore, in issuing the 2011 QRM Proposed Rule, the QRM agencies sought to incorporate the statutory qualified mortgage standards, in addition to other requirements, into the QRM definition. 76 FR at 24118. This approach was designed to minimize the potential for conflicts between the QRM standards in the proposed rule and the qualified mortgage definition that the Bureau would ultimately adopt in a final rule.

In the 2011 QRM Proposed Rule, the QRM agencies stated their expectation to monitor the rules adopted by the Bureau under TILA to define a qualified mortgage and to review those rules to ensure that the definition of QRM in the final rule is “no broader” than the definition of a qualified mortgage and to appropriately implement the Dodd-Frank Act's credit risk retention requirement. See 76 FR at 24118. In preparing this final rule, the Bureau has consulted regularly with the QRM agencies to coordinate the qualified mortgage and qualified residential mortgage definitions. However, while the Bureau's qualified mortgage definition will set the outer boundary of a QRM, the QRM agencies have discretion under the Dodd-Frank Act to define QRMs in a way that is stricter than the qualified mortgage definition.

III. Summary of the Rulemaking Process Back to Top

A. The Board's Proposal

In 2011, the Board published for public comment a proposed rule amending Regulation Z to implement the foregoing ability-to-repay amendments to TILA made by the Dodd-Frank Act. See 76 FR 27390 (May 11, 2011) (2011 ATR Proposal, the Board's proposal or the proposal). Consistent with the Dodd-Frank Act, the Board's proposal applied the ability-to-repay requirements to any consumer credit transaction secured by a dwelling (including vacation home loans and home equity loans), except an open-end credit plan, extension of credit secured by a consumer's interest in a timeshare plan, reverse mortgage, or temporary loan with a term of 12 months or less.

The Board's proposal provided four options for complying with the ability-to-repay requirement, including by making a “qualified mortgage.” First, the proposal would have allowed a creditor to meet the general ability-to-repay standard by originating a covered mortgage loan for which the creditor considered and verified eight underwriting factors in determining repayment ability, and, for adjustable rate loans, the mortgage payment calculation is based on the fully indexed rate. [57] Second, the proposal would have allowed a creditor to refinance a “non-standard mortgage” into a “standard mortgage.” [58] Under this option, the proposal would not have required the creditor to verify the consumer's income or assets. Third, the proposal would have allowed a creditor to originate a qualified mortgage, which provides special protection from liability for creditors. Because the Board determined that it was unclear whether that protection is intended to be a safe harbor or a rebuttable presumption of compliance with the repayment ability requirement, the Board proposed two alternative definitions of a qualified mortgage. [59] Finally, the proposal would have allowed a small creditor operating predominantly in rural or underserved areas to originate a balloon-payment qualified mortgage if the loan term is five years or more, and the payment calculation is based on the scheduled periodic payments, excluding the balloon payment. [60] The Board's proposal also would have implemented the Dodd-Frank Act's limits on prepayment penalties, lengthened the time creditors must retain evidence of compliance with the ability-to-repay and prepayment penalty provisions, and prohibited evasion of the rule by structuring a closed-end extension of credit that does not meet the definition of an open-end plan. As discussed above, rulemaking authority under TILA generally transferred from the Board to the Bureau in July 2011, including the authority under Dodd-Frank Act section 1412 to prescribe regulations to carry out the purposes of the qualified mortgage rules. 12 U.S.C. 5512; 12 U.S.C. 5581; 15 U.S.C. 1639c. As discussed above, TILA section 105(a) directs the Bureau to prescribe regulations to carry out the purposes of TILA. Except with respect to the substantive restrictions on high-cost mortgages provided in TILA section 129, TILA section 105(a) authorizes the Bureau to prescribe regulations that may contain additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions that the Bureau determines are necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith.

B. Comments and Post-Proposal Outreach

The Board received numerous comments on the proposal, including comments regarding the criteria for a “qualified mortgage” and whether a qualified mortgage provides a safe harbor or a presumption of compliance with the repayment ability requirements. As noted above, in response to the proposed rule, the Board received approximately 1,800 letters from commenters, including members of Congress, creditors, consumer groups, trade associations, mortgage and real estate market participants, and individual consumers. As of July 21, 2011, the Dodd-Frank Act generally transferred the Board's rulemaking authority for TILA, among other Federal consumer financial laws, to the Bureau. Accordingly, all comment letters on the proposed rule were also transferred to the Bureau. Materials submitted were filed in the record and are publicly available at http://www.regulations.gov.

Through various comment letters and the Bureau's own collection of data, the Bureau received additional information and new data pertaining to the proposed rule. Accordingly, in May 2012, the Bureau reopened the comment period in order to solicit further comment on data and new information, including data that may assist the Bureau in defining loans with characteristics that make it appropriate to presume that the creditor complied with the ability-to-repay requirements or assist the Bureau in assessing the benefits and costs to consumers, including access to credit, and covered persons, as well as the market share covered by, alternative definitions of a “qualified mortgage.” The Bureau received approximately 160 comments in response to the reopened comment period from a variety of commenters, including creditors, consumer groups, trade associations, mortgage and real estate market participants, individuals, small entities, the SBA's Office of Advocacy, and FHA. As discussed in more detail below, the Bureau has considered these comments in adopting this final rule.

C. Other Rulemakings

In addition to this final rule, the Bureau is adopting several other final rules and issuing one proposal, all relating to mortgage credit to implement requirements of title XIV of the Dodd-Frank Act. The Bureau is also issuing a final rule jointly with other Federal agencies to implement requirements for mortgage appraisals in title XIV. Each of the final rules follows a proposal issued in 2011 by the Board or in 2012 by the Bureau alone or jointly with other Federal agencies. Collectively, these proposed and final rules are referred to as the Title XIV Rulemakings.

  • Ability to Repay: Simultaneously with this final rule (the 2013 ATR Final Rule), the Bureau is issuing a proposal to amend certain provisions of the final rule, including by the addition of exemptions for certain nonprofit creditors and certain homeownership stabilization programs and a definition of a “qualified mortgage” for certain loans made and held in portfolio by small creditors (the 2013 ATR Concurrent Proposal). The Bureau expects to act on the 2013 ATR Concurrent Proposal on an expedited basis, so that any exceptions or adjustments can take effect simultaneously with this final rule.
  • Escrows: The Bureau is finalizing a rule, following a March 2011 proposal issued by the Board (the Board's 2011 Escrows Proposal), [61] to implement certain provisions of the Dodd-Frank Act expanding on existing rules that require escrow accounts to be established for higher-priced mortgage loans and creating an exemption for certain loans held by creditors operating predominantly in rural or underserved areas, pursuant to TILA section 129D as established by Dodd-Frank Act sections 1461. 15 U.S.C. 1639d. The Bureau's final rule is referred to as the 2013 Escrows Final Rule.
  • HOEPA: Following its July 2012 proposal (the 2012 HOEPA Proposal), [62] the Bureau is issuing a final rule to implement Dodd-Frank Act requirements expanding protections for “high-cost mortgages” under the Homeownership and Equity Protection Act (HOEPA), pursuant to TILA sections 103(bb) and 129, as amended by Dodd-Frank Act sections 1431 through 1433. 15 U.S.C. 1602(bb) and 1639. The Bureau also is finalizing rules to implement certain title XIV requirements concerning homeownership counseling, including a requirement that creditors provide lists of homeownership counselors to applicants for federally related mortgage loans, pursuant to RESPA section 5(c), as amended by Dodd-Frank Act section 1450. 12 U.S.C. 2604(c). The Bureau's final rule is referred to as the 2013 HOEPA Final Rule.
  • Servicing: Following its August 2012 proposals (the 2012 RESPA Servicing Proposal and 2012 TILA Servicing Proposal), [63] the Bureau is adopting final rules to implement Dodd-Frank Act requirements regarding force-placed insurance, error resolution, information requests, and payment crediting, as well as requirements for mortgage loan periodic statements and adjustable-rate mortgage reset disclosures, pursuant to section 6 of RESPA and sections 128, 128A, 129F, and 129G of TILA, as amended or established by Dodd-Frank Act sections 1418, 1420, 1463, and 1464. 12 U.S.C. 2605; 15 U.S.C. 1638, 1638a, 1639f, and 1639g. The Bureau also is finalizing rules on early intervention for troubled and delinquent consumers, and loss mitigation procedures, pursuant to the Bureau's authority under section 6 of RESPA, as amended by Dodd-Frank Act section 1463, to establish obligations for mortgage servicers that it finds to be appropriate to carry out the consumer protection purposes of RESPA, and its authority under section 19(a) of RESPA to prescribe rules necessary to achieve the purposes of RESPA. The Bureau's final rule under RESPA with respect to mortgage servicing also establishes requirements for general servicing standards policies and procedures and continuity of contact pursuant to its authority under section 19(a) of RESPA. The Bureau's final rules are referred to as the 2013 RESPA Servicing Final Rule and the 2013 TILA Servicing Final Rule, respectively.
  • Loan Originator Compensation: Following its August 2012 proposal (the 2012 Loan Originator Proposal), [64] the Bureau is issuing a final rule to implement provisions of the Dodd-Frank Act requiring certain creditors and loan originators to meet certain duties of care, including qualification requirements; requiring the establishment of certain compliance procedures by depository institutions; prohibiting loan originators, creditors, and the affiliates of both from receiving compensation in various forms (including based on the terms of the transaction) and from sources other than the consumer, with specified exceptions; and establishing restrictions on mandatory arbitration and financing of single premium credit insurance, pursuant to TILA sections 129B and 129C as established by Dodd-Frank Act sections 1402, 1403, and 1414(a). 15 U.S.C. 1639b, 1639c. The Bureau's final rule is referred to as the 2013 Loan Originator Final Rule.
  • Appraisals: The Bureau, jointly with other Federal agencies, [65] is issuing a final rule implementing Dodd-Frank Act requirements concerning appraisals for higher-risk mortgages, pursuant to TILA section 129H as established by Dodd-Frank Act section 1471. 15 U.S.C. 1639h. This rule follows the agencies' August 2012 joint proposal (the 2012 Interagency Appraisals Proposal). [66] The agencies' joint final rule is referred to as the 2013 Interagency Appraisals Final Rule. In addition, following its August 2012 proposal (the 2012 ECOA Appraisals Proposal), [67] the Bureau is issuing a final rule to implement provisions of the Dodd-Frank Act requiring that creditors provide applicants with a free copy of written appraisals and valuations developed in connection with applications for loans secured by a first lien on a dwelling, pursuant to section 701(e) of the Equal Credit Opportunity Act (ECOA) as amended by Dodd-Frank Act section 1474. 15 U.S.C. 1691(e). The Bureau's final rule is referred to as the 2013 ECOA Appraisals Final Rule.

The Bureau is not at this time finalizing proposals concerning various disclosure requirements that were added by title XIV of the Dodd-Frank Act, integration of mortgage disclosures under TILA and RESPA, or a simpler, more inclusive definition of the finance charge for purposes of disclosures for closed-end mortgage transactions under Regulation Z. The Bureau expects to finalize these proposals and to consider whether to adjust regulatory thresholds under the Title XIV Rulemakings in connection with any change in the calculation of the finance charge later in 2013, after it has completed quantitative testing, and any additional qualitative testing deemed appropriate, of the forms that it proposed in July 2012 to combine TILA mortgage disclosures with the good faith estimate (RESPA GFE) and settlement statement (RESPA settlement statement) required under the Real Estate Settlement Procedures Act, pursuant to Dodd-Frank Act section 1032(f) and sections 4(a) of RESPA and 105(b) of TILA, as amended by Dodd-Frank Act sections 1098 and 1100A, respectively (the 2012 TILA-RESPA Proposal). [68] Accordingly, the Bureau already has issued a final rule delaying implementation of various affected title XIV disclosure provisions. [69] The Bureau's approaches to coordinating the implementation of the Title XIV Rulemakings and to the finance charge proposal are discussed in turn below.

Coordinated Implementation of Title XIV Rulemakings

As noted in all of its foregoing proposals, the Bureau regards each of the Title XIV Rulemakings as affecting aspects of the mortgage industry and its regulations. Accordingly, as noted in its proposals, the Bureau is coordinating carefully the Title XIV Rulemakings, particularly with respect to their effective dates. The Dodd-Frank Act requirements to be implemented by the Title XIV Rulemakings generally will take effect on January 21, 2013, unless final rules implementing those requirements are issued on or before that date and provide for a different effective date. See Dodd-Frank Act section 1400(c), 15 U.S.C. 1601 note. In addition, some of the Title XIV Rulemakings are to take effect no later than one year after they are issued. Id.

The comments on the appropriate effective date for this final rule are discussed in detail below in part VI of this notice. In general, however, consumer advocates requested that the Bureau put the protections in the Title XIV Rulemakings into effect as soon as practicable. In contrast, the Bureau received some industry comments indicating that implementing so many new requirements at the same time would create a significant cumulative burden for creditors. In addition, many commenters also acknowledged the advantages of implementing multiple revisions to the regulations in a coordinated fashion. [70] Thus, a tension exists between coordinating the adoption of the Title XIV Rulemakings and facilitating industry's implementation of such a large set of new requirements. Some have suggested that the Bureau resolve this tension by adopting a sequenced implementation, while others have requested that the Bureau simply provide a longer implementation period for all of the final rules.

The Bureau recognizes that many of the new provisions will require creditors to make changes to automated systems and, further, that most administrators of large systems are reluctant to make too many changes to their systems at once. At the same time, however, the Bureau notes that the Dodd-Frank Act established virtually all of these changes to institutions' compliance responsibilities, and contemplated that they be implemented in a relatively short period of time. And, as already noted, the extent of interaction among many of the Title XIV Rulemakings necessitates that many of their provisions take effect together. Finally, notwithstanding commenters' expressed concerns for cumulative burden, the Bureau expects that creditors actually may realize some efficiencies from adapting their systems for compliance with multiple new, closely related requirements at once, especially if given sufficient overall time to do so.

Accordingly, the Bureau is requiring that, as a general matter, creditors and other affected persons begin complying with the final rules on January 10, 2014. As noted above, section 1400(c) of the Dodd-Frank Act requires that some provisions of the Title XIV Rulemakings take effect no later than one year after the Bureau issues them. Accordingly, the Bureau is establishing January 10, 2014, one year after issuance of this final rule and the Bureau's 2013 Escrows and HOEPA Final Rules (i.e., the earliest of the title XIV final rules), as the baseline effective date for most of the Title XIV Rulemakings. The Bureau believes that, on balance, this approach will facilitate the implementation of the rules' overlapping provisions, while also affording creditors sufficient time to implement the more complex or resource-intensive new requirements.

The Bureau has identified certain rulemakings or selected aspects thereof, however, that do not present significant implementation burdens for industry. Accordingly, the Bureau is setting earlier effective dates for those final rules or certain aspects thereof, as applicable. Those effective dates are set forth and explained in the Federal Register s notices for those final rules.

More Inclusive Finance Charge Proposal

As noted above, the Bureau proposed in the 2012 TILA-RESPA Proposal to make the definition of finance charge more inclusive, thus rendering the finance charge and annual percentage rate a more useful tool for consumers to compare the cost of credit across different alternatives. 77 FR 51116, 51143 (Aug. 23, 2012). Because the new definition would include additional costs that are not currently counted, it would cause the finance charges and APRs on many affected transactions to increase. This in turn could cause more such transactions to become subject to various compliance regimes under Regulation Z. Specifically, the finance charge is central to the calculation of a transaction's “points and fees,” which in turn has been (and remains) a coverage threshold for the special protections afforded “high-cost mortgages” under HOEPA. Points and fees also will be subject to a 3-percent limit for purposes of determining whether a transaction is a “qualified mortgage” under this final rule. Meanwhile, the APR serves as a coverage threshold for HOEPA protections as well as for certain protections afforded “higher-priced mortgage loans” under § 1026.35, including the mandatory escrow account requirements being amended by the 2013 Escrows Final Rule. Finally, because the 2013 Interagency Appraisals Final Rule uses the same APR-based coverage test as is used for identifying higher-priced mortgage loans, the APR affects that rulemaking as well. Thus, the proposed more inclusive finance charge would have had the indirect effect of increasing coverage under HOEPA and the escrow and appraisal requirements for higher-priced mortgage loans, as well as decreasing the number of transactions that may be qualified mortgages—even holding actual loan terms constant—simply because of the increase in calculated finance charges, and consequently APRs, for closed-end mortgage transactions generally.

As noted above, these expanded coverage consequences were not the intent of the more inclusive finance charge proposal. Accordingly, as discussed more extensively in the Escrows Proposal, the HOEPA Proposal, the ATR Proposal, and the Interagency Appraisals Proposal, the Board and subsequently the Bureau (and other agencies) sought comment on certain adjustments to the affected regulatory thresholds to counteract this unintended effect. First, the Board and then the Bureau proposed to adopt a “transaction coverage rate” for use as the metric to determine coverage of these regimes in place of the APR. The transaction coverage rate would have been calculated solely for coverage determination purposes and would not have been disclosed to consumers, who still would have received only a disclosure of the expanded APR. The transaction coverage rate calculation would exclude from the prepaid finance charge all costs otherwise included for purposes of the APR calculation except charges retained by the creditor, any mortgage broker, or any affiliate of either. Similarly, the Board and Bureau proposed to reverse the effects of the more inclusive finance charge on the calculation of points and fees; the points and fees figure is calculated only as a HOEPA and qualified mortgage coverage metric and is not disclosed to consumers. The Bureau also sought comment on other potential mitigation measures, such as adjusting the numeric thresholds for particular compliance regimes to account for the general shift in affected transactions' APRs.

The Bureau's 2012 TILA-RESPA Proposal sought comment on whether to finalize the more inclusive finance charge proposal in conjunction with the Title XIV Rulemakings or with the rest of the TILA-RESPA Proposal concerning the integration of mortgage disclosure forms. 77 FR 51116, 51125 (Aug. 23, 2012). Upon additional consideration and review of comments received, the Bureau decided to defer a decision whether to adopt the more inclusive finance charge proposal and any related adjustments to regulatory thresholds until it later finalizes the TILA-RESPA Proposal. 77 FR 54843 (Sept. 6, 2012); 77 FR 54844 (Sept. 6, 2012). [71] Accordingly, this final rule and the 2013 Escrows, HOEPA, and Interagency Appraisals Final Rules all are deferring any action on their respective proposed adjustments to regulatory thresholds.

IV. Legal Authority Back to Top

The final rule was issued on January 10, 2013, in accordance with 12 CFR 1074.1. The Bureau issued this final rule pursuant to its authority under TILA and the Dodd-Frank Act. See TILA section 105(a), 15 U.S.C. 1604(a). On July 21, 2011, section 1061 of the Dodd-Frank Act transferred to the Bureau the “consumer financial protection functions” previously vested in certain other Federal agencies, including the Board. The term “consumer financial protection function” is defined to include “all authority to prescribe rules or issue orders or guidelines pursuant to any Federal consumer financial law, including performing appropriate functions to promulgate and review such rules, orders, and guidelines.” [72] TILA is defined as a Federal consumer financial law. [73] Accordingly, the Bureau has authority to issue regulations pursuant to TILA.

A. TILA Ability-to-Repay and Qualified Mortgage Provisions

As discussed above, the Dodd-Frank Act amended TILA to generally prohibit a creditor from making a residential mortgage loan without a reasonable and good faith determination that, at the time the loan is consummated, the consumer has a reasonable ability to repay the loan, along with taxes, insurance, and assessments. TILA section 129C(a), 15 U.S.C. 1639c(a). As described below in part IV.B, the Bureau has authority to prescribe regulations to carry out the purposes of TILA pursuant to TILA section 105(a). 15 U.S.C. 1604(a). In particular, it is the purpose of TILA section 129C, as amended by the Dodd-Frank Act, to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans and that are understandable and not unfair, deceptive, and abusive. TILA section 129B(a)(2); 15 U.S.C. 1639b(a)(2).

The Dodd-Frank Act also provides creditors originating “qualified mortgages” special protection from liability under the ability-to-repay requirements. TILA section 129C(b), 15 U.S.C. 1639c(b). TILA generally defines a “qualified mortgage” as a residential mortgage loan for which: the loan does not contain negative amortization, interest-only payments, or balloon payments; the term does not exceed 30 years; the points and fees generally do not exceed three percent of the loan amount; the income or assets are considered and verified; and the underwriting is based on the maximum rate during the first five years, uses a payment schedule that fully amortizes the loan over the loan term, and takes into account all mortgage-related obligations. TILA section 129C(b)(2), 15 U.S.C. 1639c(b)(2). In addition, to constitute a qualified mortgage a loan must meet “any guidelines or regulations established by the Bureau relating to ratios of total monthly debt to monthly income or alternative measures of ability to pay regular expenses after payment of total monthly debt, taking into account the income levels of the borrower and such other factors as the Bureau may determine are relevant and consistent with the purposes described in [TILA section 129C(b)(3)(B)(i)].”

The Dodd-Frank Act also provides the Bureau with authority to prescribe regulations that revise, add to, or subtract from the criteria that define a qualified mortgage upon a finding that such regulations are necessary or proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of the ability-to-repay requirements; or are necessary and appropriate to effectuate the purposes of the ability-to-repay requirements, to prevent circumvention or evasion thereof, or to facilitate compliance with TILA sections 129B and 129C. TILA section 129C(b)(3)(B)(i), 15 U.S.C. 1639c(b)(3)(B)(i). In addition, TILA section 129C(b)(3)(A) provides the Bureau with authority to prescribe regulations to carry out the purposes of the qualified mortgage provisions, such as to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of TILA section 129C. TILA section 129C(b)(3)(A), 15 U.S.C. 1939c(b)(3)(A). As discussed in the section-by-section analysis below, the Bureau is issuing certain provisions of this rule pursuant to its authority under TILA section 129C(b)(3)(B)(i).

The Dodd-Frank Act provides the Bureau with other specific grants of rulewriting authority with respect to the ability-to-repay and qualified mortgage provisions. With respect to the ability-to-repay provisions, TILA section 129C(a)(6)(D)(i) through (iii) provides that when calculating the payment obligation that will be used to determine whether the consumer can repay a covered transaction, the creditor must use a fully amortizing payment schedule and assume that: (1) The loan proceeds are fully disbursed on the date the loan is consummated; (2) the loan is repaid in substantially equal, monthly amortizing payments for principal and interest over the entire term of the loan with no balloon payment; and (3) the interest rate over the entire term of the loan is a fixed rate equal to the fully indexed rate at the time of the loan closing, without considering the introductory rate. 15 U.S.C. 1639c(a)(6)(D)(i) through (iii). However, TILA section 129C(a)(6)(D) authorizes the Bureau to prescribe regulations for calculating the payment obligation for loans that require more rapid repayment (including balloon payments), and which have an annual percentage rate that does not exceed a certain rate threshold. 15 U.S.C. 1639c(a)(6)(D).

With respect to the qualified mortgage provisions, the Dodd-Frank Act contains several specific grants of rulewriting authority. First, as described above, for purposes of defining “qualified mortgage,” TILA section 129C(b)(2)(A)(vi) provides the Bureau with authority to establish guidelines or regulations relating to monthly debt-to-income ratios or alternative measures of ability to pay. Second, TILA section 129C(b)(2)(D) provides that the Bureau shall prescribe rules adjusting the qualified mortgage points and fees limits described above to permit creditors that extend smaller loans to meet the requirements of the qualified mortgage provisions. 15 U.S.C. 1639c(b)(2)(D)(ii). In prescribing such rules, the Bureau must consider their potential impact on rural areas and other areas where home values are lower. Id. Third, TILA section 129C(b)(2)(E) provides the Bureau with authority to include in the definition of “qualified mortgage” loans with balloon payment features, if those loans meet certain underwriting criteria and are originated by creditors that operate predominantly in rural or underserved areas, have total annual residential mortgage originations that do not exceed a limit set by the Bureau, and meet any asset size threshold and any other criteria as the Bureau may establish, consistent with the purposes of TILA. 15 U.S.C. 1639c(b)(2)(E). As discussed in the section-by-section analysis below, the Bureau is issuing certain provisions of this rule pursuant to its authority under TILA sections 129C(a)(6)(D), (b)(2)(A)(vi), (b)(2)(D), and (b)(2)(E).

B. Other Rulemaking and Exception Authorities

This final rule also relies on other rulemaking and exception authorities specifically granted to the Bureau by TILA and the Dodd-Frank Act, including the authorities discussed below.

TILA

TILA section 105(a). As amended by the Dodd-Frank Act, TILA section 105(a), 15 U.S.C. 1604(a), directs the Bureau to prescribe regulations to carry out the purposes of TILA, and provides that such regulations may contain additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions that the Bureau judges are necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith. A purpose of TILA is “to assure a meaningful disclosure of credit terms so that the consumer will be able to compare more readily the various credit terms available to him and avoid the uninformed use of credit.” TILA section 102(a), 15 U.S.C. 1601(a). This stated purpose is informed by Congress's finding that “economic stabilization would be enhanced and the competition among the various financial institutions and other firms engaged in the extension of consumer credit would be strengthened by the informed use of credit[.]” TILA section 102(a). Thus, strengthened competition among financial institutions is a goal of TILA, achieved through the effectuation of TILA's purposes.

Historically, TILA section 105(a) has served as a broad source of authority for rules that promote the informed use of credit through required disclosures and substantive regulation of certain practices. However, Dodd-Frank Act section 1100A clarified the Bureau's section 105(a) authority by amending that section to provide express authority to prescribe regulations that contain “additional requirements” that the Bureau finds are necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith. This amendment clarified the authority to exercise TILA section 105(a) to prescribe requirements beyond those specifically listed in the statute that meet the standards outlined in section 105(a). The Dodd-Frank Act also clarified the Bureau's rulemaking authority over high-cost mortgages under HOEPA pursuant to section 105(a). As amended by the Dodd-Frank Act, TILA section 105(a) authority to make adjustments and exceptions to the requirements of TILA applies to all transactions subject to TILA, except with respect to the substantive provisions of TILA section 129, 15 U.S.C. 1639, that apply to the high-cost mortgages defined in TILA section 103(bb), 15 U.S.C. 1602(bb).

TILA, as amended by the Dodd-Frank Act, states that it is the purpose of the ability-to-repay requirements of TILA section 129C to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans and that are understandable and not unfair, deceptive, or abusive. TILA section 129B(a)(2). The Bureau interprets this addition as a new purpose of TILA. Therefore, the Bureau believes that its authority under TILA section 105(a) to make exceptions, adjustments, and additional provisions, among other things, that the Bureau finds are necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith applies with respect to the purpose of section 129C as well as the purpose described in section TILA section 129B(a)(2).

The purpose of TILA section 129C is informed by the findings articulated in section 129B(a) that economic stabilization would be enhanced by the protection, limitation, and regulation of the terms of residential mortgage credit and the practices related to such credit, while ensuring that responsible and affordable mortgage credit remains available to consumers.

As discussed in the section-by-section analysis below, the Bureau is issuing regulations to carry out TILA's purposes, including such additional requirements, adjustments, and exceptions as, in the Bureau's judgment, are necessary and proper to carry out the purposes of TILA, prevent circumvention or evasion thereof, or to facilitate compliance therewith. In developing these aspects of the final rule pursuant to its authority under TILA section 105(a), the Bureau has considered the purposes of TILA, including the purposes of TILA section 129C, and the findings of TILA, including strengthening competition among financial institutions and promoting economic stabilization, and the findings of TILA section 129B(a)(1), that economic stabilization would be enhanced by the protection, limitation, and regulation of the terms of residential mortgage credit and the practices related to such credit, while ensuring that responsible, affordable mortgage credit remains available to consumers. The Bureau believes that ensuring that mortgage credit is offered and received on terms consumers can afford ensures the availability of responsible, affordable mortgage credit.

TILA section 129B(e). Dodd-Frank Act section 1405(a) amended TILA to add new section 129B(e), 15 U.S.C. 1639B(e). That section authorizes the Bureau to prohibit or condition terms, acts, or practices relating to residential mortgage loans that the Bureau finds to be abusive, unfair, deceptive, predatory, necessary or proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of TILA section 129C, necessary or proper to effectuate the purposes of sections 129B and 129C, to prevent circumvention or evasion thereof, or to facilitate compliance with such sections, or are not in the interest of the consumer. In developing rules under TILA section 129B(e), the Bureau has considered whether the rules are in the interest of the consumer, as required by the statute. As discussed in the section-by-section analysis below, the Bureau is issuing portions of this rule pursuant to its authority under TILA section 129B(e).

The Dodd-Frank Act

Dodd-Frank Act section 1022(b). Section 1022(b)(1) of the Dodd-Frank Act authorizes the Bureau to prescribe rules “as may be necessary or appropriate to enable the Bureau to administer and carry out the purposes and objectives of the Federal consumer financial laws, and to prevent evasions thereof.” 12 U.S.C. 5512(b)(1). TILA and title X of the Dodd-Frank Act are Federal consumer financial laws. Accordingly, the Bureau is exercising its authority under Dodd-Frank Act section 1022(b) to prescribe rules that carry out the purposes and objectives of TILA and title X and prevent evasion of those laws.

V. Section-by-Section Analysis Back to Top

Section 1026.25Record Retention

25(a) General Rule

Section 1416 of the Dodd-Frank Act revised TILA section 130(e) to extend the statute of limitations for civil liability for a violation of TILA section 129C, as well as sections 129 and 129B, to three years after the date a violation occurs. Existing § 1026.25(a) requires that creditors retain evidence of compliance with Regulation Z for two years after disclosures must be made or action must be taken. Accordingly, the Board proposed to revise § 226.25(a) [74] to require that creditors retain records that show compliance with proposed § 226.43, which would implement TILA section 129C, for at least three years after consummation. The Board did not propose to alter the regulation's existing clarification that administrative agencies responsible for enforcing Regulation Z may require creditors under the agency's jurisdiction to retain records for a longer period, if necessary to carry out the agency's enforcement responsibilities under TILA section 108, 15 U.S.C. 1607. Under TILA section 130(e), as amended by Dodd-Frank, the statute of limitations for civil liability for a violation of other sections of TILA remains one year after the date a violation occurs, except for private education loans under 15 U.S.C. 1650(a), actions brought under section 129 or 129B, or actions brought by a State attorney general to enforce a violation of section 129, 129B, 129C, 129D, 129E, 129F, 129G, or 129H. 15 U.S.C. 1640(e). Moreover, as amended by section 1413 of the Dodd-Frank Act, TILA provides that when a creditor, an assignee, other holder or their agent initiates a foreclosure action, a consumer may assert a violation of TILA section 129C(a) “as a matter of defense by recoupment or setoff.” TILA section 130(k). There is no time limit on the use of this defense.

As discussed below, the Bureau is adopting minor modifications to § 1026.25(a) and adding in new § 1026.25(c) to reflect section 1416 of the Dodd-Frank Act, in § 1026.25(c)(3) as well as other exceptional record retention requirements related to mortgage loans.

25(c) Records Related to Certain Requirements for Mortgage Loans

The Bureau is adopting the revision proposed in § 226.25(a) to require a creditor to retain records demonstrating compliance with § 1026.43 consistent with the extended statute of limitations for violations of that section, though the Bureau is adopting this requirement in § 1026.25(c)(3) to provide additional clarity. As the 2012 TILA-RESPA Proposal proposed new § 1026.25(c)(1) and the 2012 Loan Originator Proposal proposed new § 1026.25(c)(2), the Bureau concludes that adding new § 1026.25(c)(3) eases compliance burden by placing all record retention requirements that are related to mortgage loans and which differ from the general record retention in one section, § 1026.25(c). Likewise, the Bureau is amending § 1026.25(a) to reflect that certain record retention requirements, such as records related to minimum standards for transactions secured by a dwelling, are governed by § 1026.43(c).

Commenters did not provide the Bureau with significant, specific feedback with respect to proposed § 226.25(a), although industry commenters generally expressed concern with respect to the compliance burden of the 2011 ATR Proposal. Increasing the period a creditor must retain records from two to three years may impose some marginal increase in the creditor's compliance burden in the form of incremental cost of storage. However, the Bureau believes that even absent the rule, responsible creditors will likely elect to retain records of compliance with § 1026.43 for a period of time well beyond three years, given that the statute allows consumers to bring a defensive claim for recoupment or setoff in the event that a creditor or assignee initiates foreclosure proceedings. Indeed, at least one commenter noted this tension and requested that the Bureau provide further regulatory instruction, although the Bureau does not deem it necessary to mandate recordkeeping burdens beyond what is required by section 1416 of the Dodd-Frank Act. Furthermore, the record-keeping burden imposed by the rule is tailored only to show compliance with § 1026.43, and the Bureau believes is justified to protect the interests of both creditors and consumers in the event that an affirmative claim is brought during the first three years after consummation.

The Bureau believes that calculating the record retention period under § 1026.43 from loan consummation facilitates compliance by establishing a single, clear start to the period, even though a creditor will take action (e.g., underwriting the covered transaction and offering a consumer the option of a covered transaction without a prepayment penalty) over several days or weeks prior to consummation. The Bureau is thus adopting the timeframe as proposed to reduce compliance burden.

Existing comment 25(a)-2 clarifies that, in general, a creditor need retain only enough information to reconstruct the required disclosures or other records. The Board proposed, and the Bureau is adopting, amendments to comment 25(a)-2 and a new comment 25(c)(3)-1 to clarify that, if a creditor must verify and document information used in underwriting a transaction subject to § 1026.43, the creditor must retain evidence sufficient to demonstrate having done so, in compliance with § 1026.25(a) and § 1026.25(c)(3). In an effort to reduce compliance burden, comment 25(c)(3)-1 also clarifies that creditors need not retain actual paper copies of the documentation used to underwrite a transaction but that creditors must be able to reproduce those records accurately.

The Board proposed comment 25(a)-7 to provide guidance on retaining records evidencing compliance with the requirement to offer a consumer an alternative covered transaction without a prepayment penalty, as discussed below in the section-by-section analysis of § 1026.43(g)(3) through (5). The Bureau believes the requirement to offer a transaction without a prepayment penalty under TILA section 129C(c)(4) is intended to ensure that consumers who choose an alternative covered transaction with a prepayment penalty do so voluntarily. The Bureau further believes it is unnecessary, and contrary to the Bureau's efforts to streamline its regulations, facilitate regulatory compliance, and minimize compliance burden, for a creditor to document compliance with the requirement to offer an alternative covered transaction without a prepayment penalty when a consumer does not choose a transaction with a prepayment penalty or if the covered transaction is not consummated. Accordingly, the Bureau is adopting as proposed comment 25(a)-7 as comment 25(c)(3)-2, to clarify that a creditor must retain records that document compliance with that requirement if a transaction subject to § 1026.43 is consummated with a prepayment penalty, but need not retain such records if a covered transaction is consummated without a prepayment penalty or a covered transaction is not consummated. See§ 1026.43(g)(6).

The Board proposed comment 25(a)-7 also to provide specific guidance on retaining records evidencing compliance with the requirement to offer a consumer an alternative covered transaction without a prepayment penalty when a creditor offers a transaction through a mortgage broker. As discussed in detail below in the section-by-section analysis of § 1026.43(g)(4), the Board proposed that if the creditor offers a covered transaction with a prepayment penalty through a mortgage broker, the creditor must present the mortgage broker an alternative covered transaction without a prepayment penalty. Also, the creditor must provide, by agreement, for the mortgage broker to present to the consumer that transaction or an alternative covered transaction without a prepayment penalty offered by another creditor that has a lower interest rate or a lower total dollar amount of origination points or fees and discount points than the creditor's presented alternative covered transaction. The Bureau did not receive significant comment on this clarification, and is adopting the comment largely as proposed, renumbered as comment 25(c)(3)-2. Comment 25(c)(3)-2 also clarifies that, to demonstrate compliance with § 1026.43(g)(4), the creditor must retain a record of (1) the alternative covered transaction without a prepayment penalty presented to the mortgage broker pursuant to § 1026.43(g)(4)(i), such as a rate sheet, and (2) the agreement with the mortgage broker required by § 1026.34(g)(4)(ii).

Section 1026.32Requirements for High-Cost Mortgages

32(b) Definitions

32(b)(1)

Points and Fees—General

Section 1412 of the Dodd-Frank Act added TILA section 129C(b)(2)(A)(vii), which defines a “qualified mortgage” as a loan for which, among other things, the total “points and fees” do not exceed 3 percent of the total loan amount. The limits on points and fees for qualified mortgages are implemented in new § 1026.43(e)(3).

TILA section 129C(b)(2)(C) generally defines “points and fees” for qualified mortgages to have the same meaning as in TILA section 103(aa)(4) (renumbered as section 103(bb)(4)), which defines “points and fees” for the purpose of determining whether a transaction qualifies as a high-cost mortgage under HOEPA. [75] TILA section 103(aa)(4) is implemented in current § 1026.32(b)(1). Accordingly, the Board proposed in § 226.43(b)(9) that, for a qualified mortgage, “points and fees” has the same meaning as in § 226.32(b)(1).

The Board also proposed in the 2011 ATR Proposal to amend § 226.32(b)(1) to implement revisions to the definition of “points and fees” under section 1431 of the Dodd-Frank Act. Among other things, the Dodd-Frank Act excluded certain private mortgage insurance premiums from, and added loan originator compensation and prepayment penalties to, the definition of “points and fees” that had previously applied to high-cost mortgage loans under HOEPA. In the Bureau's 2012 HOEPA Proposal, the Bureau republished the Board's proposed revisions to § 226.32(b)(1), with only minor changes, in renumbered § 1026.32(b)(1).

The Bureau noted in its 2012 HOEPA Proposal that it was particularly interested in receiving comments concerning any newly-proposed language and the application of the definition in the high-cost mortgage context. The Bureau received numerous comments from both industry and consumer advocacy groups, the majority of which were neither specific to newly-proposed language nor to the application of the definition to high-cost mortgages. These comments largely reiterated comments that the Board and the Bureau had received in the ATR rulemaking docket. The Bureau is addressing comments received in response to 2012 HOEPA Proposal in the 2013 HOEPA Final Rule. Similarly, comments received in response to the Board's 2011 ATR Proposal are discussed in this final rule. The Bureau is carefully coordinating the 2013 HOEPA and ATR Final Rules to ensure a consistent and cohesive regulatory framework. The Bureau is now finalizing § 1026.32(b)(1), (b)(3), (b)(4)(i), (b)(5), and (b)(6)(i) in this rule in response to the comments received on both proposals. The Bureau is finalizing § 1026.32(b)(2), (b)(4)(ii), and (b)(6)(ii) in the 2013 HOEPA Final Rule.

Existing § 1026.32(b)(1) defines “points and fees” by listing included charges in § 1026.32(b)(1)(i) through (iv). As discussed below, the Board proposed revisions to § 226.32(b)(1)(i) through (iv) and proposed to add new § 226.32(b)(1)(v) and (vi). In the 2012 HOEPA Proposal, the Bureau proposed to add the phrase “in connection with a closed-end mortgage loan” to § 1026.32(b)(1) to clarify that its definition of “points and fees” would have applied only for closed-end mortgages. The Bureau also proposed to define “points and fees” in § 1026.32(b)(3) for purposes of defining which open-end credit plans qualify as “high-cost mortgages” under HOEPA. However, that section is not relevant to this rulemaking because the ability-to-repay requirement in TILA section 129C does not apply to open-end credit. Accordingly, the Bureau is adopting § 1026.32(b)(1) with the clarification that its definition of “points and fees” is “in connection with a closed-end mortgage loan.”

Payable at or before consummation. In the 2011 ATR Proposal, the Board noted that the Dodd-Frank Act removed the phrase “payable at or before closing” from the high-cost mortgage points and fees test in TILA section 103(aa)(1)(B). See TILA section 103(bb)(1)(A)(ii). Prior to the Dodd-Frank Act, fees and charges were included in points and fees for the high-cost mortgage points and fees test only if they were payable at or before closing. The phrase “payable at or before closing” is also not in TILA's provisions on the points and fees cap for qualified mortgages. See TILA section 129C(b)(2)(A)(vii), (b)(2)(C). Thus, the Board stated that, with a few exceptions, the statute provides that any charge that falls within the “points and fees” definition must be counted toward the limits on points and fees for both high-cost mortgages and qualified mortgages, even if it is payable after loan closing. The Board noted that the exceptions are mortgage insurance premiums and charges for credit insurance and debt cancellation and suspension coverage. The statute expressly states that these premiums and charges are included in points and fees only if payable at or before closing. See TILA section 103(bb)(1)(C) (for mortgage insurance) and TILA section 103(bb)(4)(D) (for credit insurance and debt cancellation and suspension coverage).

The Board expressed concern that some fees that occur after closing, such as fees to modify a loan, might be deemed to be points and fees. If so, the Board cautioned that calculating the points and fees to determine whether a transaction is a qualified mortgage may be difficult because the amount of future fees (e.g., loan modification fees) cannot be known prior to closing. The Board noted that creditors might be exposed to excessive litigation risk if consumers were able at any point during the life of a mortgage to argue that the points and fees for the loan exceed the qualified mortgage limits due to fees imposed after loan closing. The Board expressed concern that creditors therefore might be discouraged from making qualified mortgages, which would undermine Congress's goal of increasing incentives for creditors to make more stable, affordable loans. The Board requested comment on whether any other types of fees should be included in points and fees only if they are “payable at or before closing.”

Several industry commenters stated that charges paid after closing should not be included in points and fees and requested that the Bureau clarify whether such charges are included. For example, some industry commenters sought confirmation that charges for a subsequent loan modification would not be included in points and fees. More generally, industry commenters argued that they would have difficulty calculating charges that would be paid after closing and that including such charges in points and fees would create uncertainty and litigation risk. In response to the Bureau's 2012 HOEPA Proposal, one consumer advocate noted that there are inconsistent and confusing standards for when charges must be payable to be included in points and fees. This commenter recommended that the Bureau adopt a “known at or before closing” standard, arguing that this standard would clarify that financed points are included, would prevent creditors from evading the points and fees test by requiring consumers to pay charges after consummation, and would provide certainty to creditors that must know the amount of points and fees at or before closing.

The Bureau appreciates that creditors need certainty in calculating points and fees so they can ensure that they are originating qualified mortgages (or are not exceeding the points and fees thresholds for high-cost mortgages). The Dodd-Frank Act provides that for the points and fees tests for both qualified mortgages and high-cost mortgages, only charges “payable in connection with” the transaction are included in points and fees. See TILA sections 103(bb)(1)(A)(ii) (high-cost mortgages) and 129C(b)(2)(A)(vii) (qualified mortgages). The Bureau interprets this “in connection with” requirement as limiting the universe of charges that need to be included in points and fees. To clarify when charges or fees are “in connection with” a transaction, the Bureau is specifying in § 1026.32(b)(1) that fees or charges are included in points and fees only if they are “known at or before consummation.”

The Bureau is also adding new comment 32(b)(1)-1, which provides examples of fees and charges that are and are not known at or before consummation. The comment explains that charges for a subsequent loan modification generally would not be included in points and fees because, at consummation, the creditor would not know whether a consumer would seek to modify the loan and therefore would not know whether charges in connection with a modification would ever be imposed. Indeed, loan modification fees likely would not be included in the finance charge under § 1026.4, as they would not be charges imposed by creditor as an incident to or a condition of the extension of credit. Thus, this clarification is consistent with the definition of the finance charge. Comment 32(b)(1)-1 also clarifies that the maximum prepayment penalties that may be charged or collected under the terms of a mortgage loan are included in points and fees under § 1026.32(b)(1)(v). In addition, comment 32(b)(1)-1 notes that, under § 1026.32(b)(1)(i)(C)(1) and (iv), premiums or other charges for private mortgage insurance and credit insurance payable after consummation are not included in points and fees. This means that such charges may be included in points and fees only if they are payable at or before consummation. Thus, even if the amounts of such premiums or other charges are known at or before consummation, they are included in points and fees only if they are payable at or before consummation.

32(b)(1)(i)

Points and Fees—Included in the Finance Charge

TILA section 103(aa)(4)(A) specifies that “points and fees” includes all items included in the finance charge, except interest or the time-price differential. This provision is implemented in current § 1026.32(b)(1)(i). Section 1431 of the Dodd-Frank Act added TILA section 103(bb)(1)(C), which excludes from points and fees certain types and amounts of mortgage insurance premiums.

The Board proposed to revise § 226.32(b)(1)(i) to implement these provisions. The Board proposed to move the exclusion of interest or the time-price differential to new § 226.32(b)(1)(i)(A). The Board also proposed to add § 226.32(b)(1)(i)(B) to implement the new exclusion for certain mortgage insurance. In § 226.32(b)(1)(i), the Board proposed to revise the phrase “all items required to be disclosed under § 226.4(a) and 226.4(b)” to read “all items considered to be a finance charge under § 226.4(a) and 226.4(b)” because § 226.4 does not itself require disclosure of the finance charge.

One industry commenter argued that the definition of points and fees was overbroad because it included all items considered to be a finance charge. The commenter asserted that several items that are included in the finance charge under § 1026.4(b) are vague or inapplicable in the context of mortgage transactions or duplicate items specifically addressed in other provisions. Several industry commenters also requested clarification about whether certain types of fees and charges are included in points and fees. At least two commenters asked that the Bureau clarify that closing agent costs are not included in points and fees.

The Bureau is adopting renumbered § 1026.32(b)(1)(i) and (i)(A) substantially as proposed, with certain clarifications in the commentary and in other parts of the rule as discussed below to address commenters' requests for clarification. For consistency with the language in § 1026.4, the Bureau is revising § 1026.32(b)(1)(i) to refer to “items included in the finance charge” rather than “items considered to be a finance charge.”

As noted above, several commenters requested clarification regarding whether certain types of charges would be included in points and fees. With respect to closing agent charges, § 1026.4(a)(2) provides a specific rule for when such charges must be included in the finance charge. If they are not included in the finance charge, they would not be included in points and fees. Moreover, as discussed below and in new comment 32(b)(1)(i)(D)-1, certain closing agent charges may also be excluded from points and fees as bona fide third-party charges that are not retained by the creditor, loan originator, or an affiliate of either.

The Board also proposed to revise comment 32(b)(1)(i)-1, which states that § 226.32(b)(1)(i) includes in the total “points and fees” items defined as finance charges under § 226.4(a) and 226.4(b). The comment explains that items excluded from the finance charge under other provisions of § 226.4 are not included in the total “points and fees” under § 226.32(b)(1)(i), but may be included in “points and fees” under § 226.32(b)(1)(ii) and (iii). The Board proposed to revise this comment to state that items excluded from the finance charge under other provisions of § 226.4 may be included in “points and fees” under § 226.32(b)(1)(ii) through (vi). [76] The proposed revision was intended to reflect the additional items added to the definition of “points and fees” by the Dodd-Frank Act and corrected the previous omission of § 226.32(b)(1)(iv). See proposed § 226.32(b)(1)(v) and (vi).

The proposed comment also would have added an example of how this rule would operate. Under that example, a fee imposed by the creditor for an appraisal performed by an employee of the creditor meets the general definition of “finance charge” under § 226.4(a) as “any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit.” However, § 226.4(c)(7) expressly provides that appraisal fees are not finance charges. Therefore, under the general rule in proposed § 226.32(b)(1)(i) providing that finance charges must be counted as points and fees, a fee imposed by the creditor for an appraisal performed by an employee of the creditor would not have been counted in points and fees. Proposed § 226.32(b)(1)(iii), however, would have expressly included in points and fees items listed in § 226.4(c)(7) (including appraisal fees) if the creditor receives compensation in connection with the charge. A creditor would receive compensation for an appraisal performed by its own employee. Thus, the appraisal fee in this example would have been included in the calculation of points and fees.

The Bureau did not receive substantial comment on this proposed guidance. The Bureau is adopting comment 32(b)(1)(i)-1, with certain revisions for clarity. As revised, comment 32(b)(1)(i)-1 explains that certain items that may be included in the finance charge under § 1026.32(b)(1)(i) are excluded under § 1026.32(b)(1)(i)(A) through (F).

Mortgage Insurance

Under existing § 1026.32(b)(1)(i), mortgage insurance premiums are included in the finance charge and therefore are included in points and fees if payable at or before closing. As noted above, the Board proposed new § 226.32(b)(1)(i)(B) to implement TILA section 103(bb)(1)(C), which provides that points and fees shall exclude certain charges for mortgage insurance premiums. Specifically, the statute excludes: (1) Any premium charged for insurance provided by an agency of the Federal Government or an agency of a State; (2) any amount that is not in excess of the amount payable under policies in effect at the time of origination under section 203(c)(2)(A) of the National Housing Act, provided that the premium, charge, or fee is required to be refundable on a pro-rated basis and the refund is automatically issued upon notification of the satisfaction of the underlying mortgage loan; and (3) any premium paid by the consumer after closing.

The Board noted that the exclusions for certain premiums could plausibly be interpreted to apply to the definition of points and fees solely for purposes of high-cost mortgages and not for qualified mortgages. TILA section 129C(b)(2)(C)(i) cross-references TILA section 103(aa)(4) (renumbered as 103(bb)(4)) for the definition of “points and fees,” but the provision on mortgage insurance appears in TILA section 103(bb)(1)(C) and not in section 103(bb)(4). The Board also noted that certain provisions in the Dodd-Frank Act's high-cost mortgage section regarding points and fees are repeated in the qualified mortgage section on points and fees. For example, both the high-cost mortgage provisions and the qualified mortgage provisions expressly exclude from points and fees “bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or mortgage originator.” TILA sections 103(bb)(1)(A)(ii) (for high-cost mortgages), 129C(b)(2)(C)(i) (for qualified mortgages). The mortgage insurance provision, however, does not separately appear in the qualified mortgage section.

Nonetheless, the Board concluded that the better interpretation of the statute is that the mortgage insurance provision in TILA section 103(bb)(1)(C) applies to the meaning of points and fees for both high-cost mortgages and qualified mortgages. The Board noted that the statute's structure reasonably supports this view: by its plain language, the mortgage insurance provision prescribes how points and fees should be computed “for purposes of paragraph (4),”i.e., for purposes of TILA section 103(bb)(4). The mortgage insurance provision contains no caveat limiting its application solely to the points and fees calculation for high-cost mortgages. Thus, the Board determined that the cross-reference in the qualified mortgage provisions to TILA section 103(bb)(4) should be read to include provisions that expressly prescribe how points and fees should be calculated under TILA section 103(bb)(4), wherever located.

The Board noted that its proposal to apply the mortgage insurance provision to the meaning of points and fees for both high-cost mortgages and qualified mortgages is also supported by the Board's authority under TILA section 105(a) to make adjustments to facilitate compliance with TILA. The Board also cited its authority under TILA section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Board finds necessary or proper to effectuate the purposes of TILA. The purposes of TILA include “assur[ing] that consumers are offered and receive residential mortgage loan on terms that reasonably reflect their ability to repay the loans.” TILA section 129B(a)(2).

The Board also expressed concern about the increased risk of confusion and compliance error if points and fees were to have two separate meanings in TILA—one for determining whether a loan is a high-cost mortgage and another for determining whether a loan is a qualified mortgage. The Board stated that the proposal is intended to facilitate compliance by applying the mortgage insurance provision to the meaning of points and fees for both high-cost mortgages and qualified mortgages.

In addition, the Board expressed concern that market distortions could result due to different treatment of mortgage insurance in calculating points and fees for high-cost mortgages and qualified mortgages. “Points and fees” for both high-cost mortgages and qualified mortgages generally excludes “bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or mortgage originator.” TILA sections 103(bb)(1)(A)(ii), 129C(b)(2)(C)(i). Under this general provision standing alone, premiums for up-front private mortgage insurance would be excluded from points and fees. However, as noted, the statute's specific provision on mortgage insurance (TILA section 103(bb)(1)(C)) imposes certain limitations on the amount and conditions under which up-front premiums for private mortgage insurance are excluded from points and fees. Applying the mortgage insurance provision to the definition of points and fees only for high-cost mortgages would mean that any premium amount for up-front private mortgage insurance could be charged on qualified mortgages; in most cases, none of that amount would be subject to the cap on points and fees for qualified mortgages because it would be excluded as a “bona fide third party fee” that is not retained by the creditor, loan originator, or an affiliate of either. The Board noted that, as a result, consumers who obtain qualified mortgages could be vulnerable to paying excessive up-front private mortgage insurance costs. The Board concluded that this outcome would undercut Congress's clear intent to ensure that qualified mortgages are products with limited fees and more safe features.

For the reasons noted by the Board, the Bureau interprets the mortgage insurance provision in TILA section 103(bb)(1)(C) as applying to the meaning of points and fees for both high-cost mortgages and qualified mortgages. The Bureau is also adopting this approach pursuant to its authority under TILA sections 105(a) and 129C(b)(3)(B)(i). Applying the mortgage insurance provision to the meaning of points and fees for qualified mortgages is necessary and proper to effectuate the purposes of, and facilitate compliance with the purposes of, the ability-to-repay requirements in TILA section 129C. Similarly, the Bureau finds that it is necessary and proper to use its authority under TILA section 129C(b)(3)(B)(i) to revise, add to, or subtract from the criteria that define a qualified mortgage. As noted above, construing the mortgage insurance provision as applying to qualified mortgages will reduce the likelihood that consumers who obtain qualified mortgages will pay excessive private mortgage insurance premiums, and therefore will help ensure that responsible, affordable credit remains available to consumers in a manner consistent with the purposes of TILA section 129C.

Proposed § 226.32(b)(1)(i)(B) tracked the substance of the statute with one exception. The Board interpreted the statute as excluding from points and fees not only up-front mortgage insurance premiums under government programs but also charges for mortgage guaranties under government programs. The Board noted that it was proposing the exclusion from points and fees of both mortgage insurance premiums and guaranty fees under government programs pursuant to its authority under TILA section 105(a) to make adjustments to facilitate compliance with TILA and its purposes and to effectuate the purposes of TILA. The Board also found that the exclusion is further supported by the Board's authority under TILA section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Board finds necessary or proper to effectuate the purposes of TILA. The purposes of TILA include “assur[ing] that consumers are offered and receive residential mortgage loan on terms that reasonably reflect their ability to repay the loans.” TILA section 129B(a)(2).

The Board noted that both the U.S. Department of Veterans Affairs (VA) and the U.S. Department of Agriculture (USDA) expressed concerns that, if up-front charges for guaranties provided by those agencies and State agencies were included in points and fees, their loans might exceed high-cost thresholds and exceed the cap for qualified mortgages, thereby disrupting these programs and jeopardizing an important source of credit for many consumers. The Board requested comment on its proposal to exclude up-front charges for any guaranty under a Federal or State government program, as well as any up-front mortgage insurance premiums under government programs.

Several industry commenters argued that premiums for private mortgage insurance should be excluded altogether, even if the premiums do not satisfy the statutory standard for exclusion. These commenters noted that private mortgage insurance provides substantial benefits, allowing consumers who cannot afford a down payment an alternative for obtaining credit. Another commenter noted that the refundability requirement of the rule would make private mortgage insurance more expensive.

One industry commenter asserted that the language in proposed § 226.32(b)(1)(i)(B)(2) was inconsistent with the statutory language and the example in the commentary. The commenter suggested that a literal reading of proposed § 226.32(b)(1)(i)(B)(2) would require exclusion of the entire premium if it exceeded the FHA insurance premium, rather than merely exclusion of that portion of the premium in excess of the FHA premium. Another industry commenter maintained that the term “upfront” is vague and that the Bureau instead should use the phrase “payable at or before closing.”

The Bureau is adopting proposed § 226.32(b)(1)(i)(B) as reunumbered § 1026.32(b)(1)(i)(B) with no substantive changes but with revisions for clarity. The Bureau is dividing proposed § 226.32(b)(1)(i)(B) into two parts. The first part, § 1026.32(b)(1)(i)(B), addresses insurance premiums and guaranty charges under government programs. The second part, § 1026.32(b)(1)(i)(C), addresses premiums for private mortgage insurance.

Consistent with the Board's proposal, § 1026.32(b)(1)(i)(B) excludes from points and fees charges for mortgage guaranties under government programs, as well as premiums for mortgage insurance under government programs. The Bureau concurs with the Board's interpretation that, in addition to mortgage insurance premiums under government programs, the statute also excludes from points and fees charges for mortgage guaranties under government programs. Like the Board, the Bureau believes that this conclusion is further supported by TILA sections 105(a) and 129C(b)(3)(B)(i) and that it is necessary and proper to invoke this authority. The exclusion from points and fees of charges for mortgage guaranties under government programs is necessary and proper to effectuate the purposes of TILA. The Bureau is concerned that including such charges in points and fees could cause loans offered through government programs to exceed high-cost mortgage thresholds and qualified mortgage points and fees limits, potentially disrupting an important source of affordable financing for many consumers. This exclusion helps ensure that loans do not unnecessarily exceed the points and fees limits for qualified mortgages, which is consistent with the purpose, stated in TILA section 129B(a)(2), of assuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans and with the purpose stated in TILA section 129C(b)(3)(B)(i) of ensuring that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of TILA section 129C.

Proposed comment 32(b)(1)(i)-2 provided an example of a mortgage insurance premium that is not counted in points and fees because the loan was insured by the FHA. The Bureau is renumbering this comment as 32(b)(1)(i)(B)-1 and revising it to add an additional example to clarify that mortgage guaranty fees under government programs, such as VA and USDA funding fees, are excluded from points and fees. The Bureau is also deleting the reference to “up-front” premiums and charges. Under the statute, premiums for mortgage insurance or guaranty fees in connection with a Federal or State government program are excluded from points and fees whenever paid. The statutory provision excluding premiums or charges paid after consummation applies only to private mortgage insurance.

The Bureau is addressing exclusions for private mortgage insurance in § 1026.32(b)(1)(i)(C). For private mortgage insurance premiums payable after consummation, § 1026.32(b)(1)(i)(C)(1) provides that the entire amount of the premium is excluded from points and fees. For private mortgage insurance premiums payable at or before consummation, § 1026.32(b)(1)(i)(C)(1) provides that the portion of the premium not in excess of the amount payable under policies in effect at the time of origination under section 203(c)(2)(A) of the National Housing Act is excluded from points and fees, provided that the premium is required to be refundable on a pro-rated basis and the refund is automatically issued upon notification of the satisfaction of the underlying mortgage loan.

As noted by one commenter, the language in proposed § 226.32(b)(1)(i)(B) could be read to conflict with the statute and the commentary because it suggested that, if a private mortgage insurance premium payable at or before consummation exceeded the FHA insurance premium, then the entire private mortgage insurance premium would be included in points and fees. The Bureau is clarifying in § 1026.32(b)(1)(i)(C)(2) that only the portion of the private mortgage insurance premium that exceeds the FHA premium must be included in points and fees. With respect to the comments requesting that all private mortgage insurance premiums be excluded from points and fees, the Bureau notes that TILA section 103(bb)(1)(C) prescribes specific and detailed conditions for excluding private mortgage insurance premiums. Under these circumstances, the Bureau does not believe it would be appropriate to exercise its exception authority to reverse Congress's decision.

Proposed comment 32(b)(1)(i)-3 explained that private mortgage insurance premiums payable at or before consummation need not be included in points and fees to the extent that the premium does not exceed the amount payable under policies in effect at the time of origination under section 203(c)(2)(A) of the National Housing Act and the premiums are required to be refunded on a pro-rated basis and the refund is automatically issued upon notification of satisfaction of the underlying mortgage loan. Proposed comment 32(b)(1)(i)-3 also provided an example of this exclusion. Proposed comment 32(b)(1)(i)-4 explained that private mortgage insurance premiums that do not qualify for an exclusion must be included in points and fees whether paid at or before consummation, in cash or financed, whether optional or required, and whether the amount represents the entire premium or an initial payment.

The Bureau did not receive substantial comments on these proposed interpretations. The Bureau is adopting comments 32(b)(1)(i)-3, and -4 with certain revisions for clarity and renumbered as comments 32(b)(1)(i)(C)-1 and -2. Comment 32(b)(1)(i)(C)-1.i is revised to specify that private mortgage insurance premiums paid after consummation are excluded from points and fees. The Bureau also adopts clarifying changes that specify that creditors originating conventional loans—even such loans that are not eligible to be FHA loans (i.e., because their principal balance is too high)—should look to the permissible up-front premium amount for FHA loans, as implemented by applicable regulations and other written authorities issued by the FHA (such as Mortgagee Letters). For example, pursuant to HUD's Mortgagee Letter 12-4 (published March 6, 2012), the allowable up-front FHA premium for single-family homes is 1.75 percent of the base loan amount. [77] Finally, the Bureau clarifies that only the portion of the single or up-front PMI premium in excess of the allowable FHA premium (i.e., rather than any monthly premium or portion thereof) must be included in points and fees. Comments 32(b)(1)(i)(C)-1 and -2 also have both been revised for clarity and consistency. For example, the comments as adopted refer to premiums “payable at or before consummation” rather than “up-front” premiums and to “consummation” rather than “closing.” The Bureau notes that the statute refers to “closing” rather than “consummation.” However, for consistency with the terminology in Regulation Z, the Bureau is using the term “consummation.”

Bona Fide Third-Party Charges and Bona Fide Discount Points

The Dodd-Frank Act amended TILA to add nearly identical provisions excluding certain bona fide third-party charges and bona fide discount points from the calculation of points and fees for both qualified mortgages and high-cost mortgages. [78] Specifically, section 1412 of the Dodd-Frank Act added new TILA section 129C(b)(2)(C), which excludes certain bona fide third-party charges and bona fide discount points from the calculation of points and fees for the qualified mortgage points and fees threshold. Similarly, section 1431 of the Dodd-Frank Act amended TILA section 103(bb)(1)(A)(ii) and added TILA section 103(dd) to provide for nearly identical exclusions in calculating points and fees for the high-cost mortgage threshold.

In the 2011 ATR Proposal, the Board proposed to implement in § 226.43(e)(3)(ii)(A) through (C) the exclusion of certain bona fide third-party charges and bona fide discount points only for the calculation of points and fees for the qualified mortgage points and fees threshold. In the 2012 HOEPA Proposal, the Bureau proposed to implement these exclusions in proposed § 1026.32(b)(5) for the points and fees threshold for high-cost mortgages. The Bureau noted that proposed § 1026.32(b)(5) was generally consistent with the Board's proposed § 226.43(e)(3)(ii)(A) through (C).

The Bureau believes that it is appropriate to consolidate these exclusions in a single provision. The Bureau is now finalizing both rules, and the exclusions are nearly identical for both the qualified mortgage and high-cost mortgage contexts. Moreover, under the Board's ATR Proposal, the points and fees calculation for the qualified mortgage points and fees threshold already would have cross-referenced the definition of points and fees for high-cost mortgages in § 226.32(b)(1). Given that the points and fees calculations for both the qualified mortgage and high-cost mortgage points and fees thresholds will use the same points and fees definition in § 1026.32(b)(1), the Bureau believes it is unnecessary to implement nearly identical exclusions from points and fees in separate provisions for qualified mortgages and high-cost mortgages. Accordingly, the Bureau is consolidating the exclusions for certain bona fide third-party charges and bona fide discount points for both qualified mortgages and high-cost mortgages in new § 1026.32(b)(1)(i)(D) through (F). In addition, the definition of “bona fide discount points” for the purposes of § 1026.32(b)(1)(i)(E) and (F), which the 2011 ATR Proposal would have implemented in § 226.43(e)(3)(iv), is instead being implemented in § 1026.32(b)(3).

Bona fide third-party charges. TILA Section 129C(b)(2)(C)(i) excludes from points and fees “bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or mortgage originator.” Tracking the statute, proposed § 226.43(e)(3)(ii)(A) would have excluded from “points and fees” for qualified mortgages any bona fide third party charge not retained by the creditor, loan originator, or an affiliate of either. Proposed § 226.43(e)(3)(iii) would have specified that the term “loan originator” has the same meaning as in § 226.36(a)(1).

Proposed § 226.43(e)(3)(ii)(A) would also have implemented TILA section 103(bb)(1)(C), which requires that premiums for private mortgage insurance be included in “points and fees” as defined in TILA section 103(bb)(4) under certain circumstances. Applying general rules of statutory construction, the Board concluded that the more specific provision on private mortgage insurance supersedes the more general provision permitting any bona fide third party charge not retained by the creditor, mortgage originator, or an affiliate of either to be excluded from “points and fees.” Thus, proposed § 226.43(e)(3)(ii)(A) would have excluded from points and fees any bona fide third party charge not retained by the creditor, loan originator, or an affiliate of either unless the charges were premiums for private mortgage insurance that were included in points and fees under § 226.32(b)(1)(i)(B).

The Board noted that, in setting the purchase price for specific loans, Fannie Mae and Freddie Mac make loan-level price adjustments (LLPAs) to compensate offset added risks, such as a high LTV or low credit score, among many other risk factors. Creditors may, but are not required to, increase the interest rate charged to the consumer so as to offset the impact of the LLPAs or increase the costs to the consumer in the form of points to offset the lost revenue resulting from the LLPAs. The Board noted that, during outreach, some creditors argued that these points should not be counted in points and fees for qualified mortgages under the exclusion for “bona fide third party charges not retained by the loan originator, creditor, or an affiliate of either” in TILA section 129C(b)(2)(C).

The Board acknowledged creditors' concerns about exceeding the qualified mortgage points and fees thresholds due to LLPAs required by the GSEs. However, the Board questioned whether an exemption for LLPAs would be consistent with congressional intent in limiting points and fees for qualified mortgages. The Board noted that points charged to meet GSE risk-based price adjustment requirements are arguably no different than other points charged on loans sold to any secondary market purchaser to compensate that purchaser for added loan-level risks. Congress clearly contemplated that discount points generally should be included in points and fees for qualified mortgages.

The Board noted that an exclusion for points charged by creditors in response to secondary market LLPAs also would raise questions about the appropriate treatment of points charged by creditors to offset loan-level risks on mortgage loans that they hold in portfolio. The Board reasoned that, under normal circumstances, these points are retained by the creditor, so it would not be appropriate to exclude them from points and fees under the “bona fide third party charge” exclusion. However, the Board cautioned that requiring that these points be included in points and fees, when similar charges on loans sold into the secondary market are excluded, may create undesirable market imbalances between loans sold to the secondary market and loans held in portfolio.

The Board also noted that creditors may offset risks on their portfolio loans (or on loans sold into the secondary market) by charging a higher rate rather than additional points and fees; however, the Board recognized the limits of this approach to loan-level risk mitigation due to concerns such as exceeding high-cost mortgage rate thresholds. Nonetheless, the Board noted that in practice, an exclusion from the qualified mortgage points and fees calculation for all points charged to offset loan-level risks may create compliance and enforcement difficulties. The Board questioned whether meaningful distinctions between points charged to offset loan-level risks and other points and fees charged on a loan could be made clearly and consistently. In addition, the Board observed that such an exclusion could be overbroad and inconsistent with Congress's intent that points generally be counted toward the points and fees threshold for qualified mortgages.

The Board requested comment on whether and on what basis the final rule should exclude from points and fees for qualified mortgages points charged to meet risk-based price adjustment requirements of secondary market purchasers and points charged to offset loan-level risks on mortgages held in portfolio.

Consumer advocates did not comment on this issue. Many industry commenters argued that LLPAs should be excluded from points and fees as bona fide third party charges. The GSE commenters agreed that LLPAs should be excluded as bona fide third party charges, noting that they are not retained by the creditor. One GSE commenter noted that LLPAs are set fees that are transparent and accessible via the GSEs' Web sites. Some industry commenters contended that including LLPAs in points and fees would cause many loans to exceed the points and fees cap for qualified mortgages. Other industry commenters argued that requiring LLPAs to be included in points and fees would force creditors to recover the costs through increases in the interest rate. One of the GSE commenters acknowledged the concern that creditors holding loans in portfolio could be at a disadvantage if LLPAs were excluded from points and fees and suggested that the Bureau consider allowing such creditors to exclude published loan level risk adjustment fees.

One industry commenter urged the Bureau to coordinate with the agencies responsible for finalizing the 2011 QRM Proposed Rule to avoid unintended consequences. The 2011 ARM Proposed Rule, if adopted, would require, in certain circumstances, that sponsors of MBS create premium capture cash reserve accounts to limit sponsors' ability to monetize the excess spread between the proceeds from the sale of the interests and the par value of those interests. See 76 FR 24113. The commenter stated that this would result in any premium in the price of a securitization backed by residential mortgage loans being placed in a first-loss position in the securitization. The commenter argued that this would make premium loans too expensive to originate and that creditors would not be able to recover LLPAs through interest rate adjustments. The commenter maintained that if the LLPAs were included in the calculation for the qualified mortgage points and fees limit, creditors would also be severely constrained in recovering LLPAs through points. The commenter argued that LLPAs therefore should be excluded from the points and fees calculation for qualified mortgages.

The Bureau is adopting § 226.43(e)(3)(ii)(A), with certain revisions, as renumbered § 1026.32(b)(1)(i)(D). As revised, § 1026.32(b)(1)(i)(D) provides that a bona fide third party charge not retained by the creditor, loan originator, or an affiliate of either the general is excluded from points and fees unless the charge is required to be included under § 1026.32(b)(1)(i)(C) (for mortgage insurance premiums), (iii) (for real estate related fees), or (iv) (for credit insurance premiums). As noted above, the Board proposed that the specific provision regarding mortgage insurance, TILA section 103(bb)(1)(C), should govern the exclusion of private mortgage insurance premiums of points and fees, rather than TILA section 129C(b)(2)(C), which provides generally for the exclusion of certain bona fide third-party charges. The Bureau likewise believes that the specific statutory provisions regarding real estate related fees and credit insurance premiums in TILA section 103(bb)(4)(C) and (D) should govern whether these charges are included in points and fees rather than the more general provisions regarding exclusion of bona fide third-party charges, TILA sections 103(bb)(1)(A)(ii) (for high-cost mortgages) or 129C(b)(2)(C) (for qualified mortgages). Thus, § 1026.32(b)(1)(i)(D) provides that the general exclusion for bona fide third-party charges applies unless the charges are required to be included under § 1026.32(b)(1)(i)(C), (iii), or (iv).

The Bureau acknowledges that TILA sections 103(bb)(1)(A)(ii) and 129C(b)(2)(C) could plausibly be read to provide for a two-step calculation of points and fees: first, the creditor would calculate points and fees as defined in TILA section 103(bb)(4); and, second, the creditor would exclude all bona fide third-party charges not retained by the mortgage originator, creditor, or an affiliate of either, as provided in TILA sections 103(bb)(1)(A)(ii) (for high-cost mortgages) and 129C(b)(2)(C) (for qualified mortgages). Under this reading, charges for, e.g., private mortgage insurance could initially, in step one, be included in points and fees but then, in step two, be excluded as bona fide third-party charges under TILA sections 103(bb)(1)(A)(ii) or 129C(b)(2)(C).

To give meaning to the specific statutory provisions regarding mortgage insurance, real estate related fees, and credit insurance, the Bureau believes that the better reading is that these specific provisions should govern whether such charges are included in points and fees, rather than the general provisions excluding certain bona fide third-party charges. For example, Congress added TILA section 103(bb)(1)(C), which prescribes certain conditions under which private mortgage insurance premiums would be included in points and fees. The Bureau believes that the purpose of this provision is to help ensure that consumers with a qualified mortgage are not charged excessive private mortgage insurance premiums. If such premiums could be excluded as bona fide third-party charges under TILA sections 103(bb)(1)(A)(ii) or 129C(b)(2)(C), then the purpose of this provision would be undermined. In further support of its interpretation, the Bureau is invoking its authority under TILA section 105(a) to make such adjustments and exceptions as are necessary and proper to effectuate the purposes of TILA, including that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans. Similarly, the Bureau finds that it is necessary, proper and appropriate to use its authority under TILA section 129C(b)(3)(B)(i) to revise and subtract from the statutory language. This use of authority ensures that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purpose of TILA section 129C, referenced above, as well as effectuating that purpose.

As noted above, several industry commenters argued that points charged by creditors to offset LLPAs should be excluded from points and fees under § 1026.32(b)(1)(i)(D). In setting the purchase price for loans, the GSEs impose LLPAs to offset certain credit risks, and creditors may but are not required to recoup the revenue lost as a result of the LLPAs by increasing the costs to consumers in the form of points. The Bureau believes that the manner in which creditors respond to LLPAs is better viewed as a fundamental component of how the pricing of a mortgage loan is determined rather than as a third party charge. As the Board noted, allowing creditors to exclude points charged to offset LLPAs could create market imbalances between loans sold on the secondary market and loans held in portfolio. While such imbalances could be addressed by excluding risk adjustment fees more broadly, including fees charged by creditors for loans held in portfolio, the Bureau agrees with the Board that this could create compliance and enforcement difficulties. Thus, the Bureau concludes that points charged to offset LLPAs may not be excluded from points and fees under § 1026.32(b)(1)(i)(D). To the extent that creditors offer consumers the opportunity to pay points to lower the interest rate that the creditor would otherwise charge to recover the lost revenue from the LLPAs, such points may, if they satisfy the requirements of § 1026.32(b)(1)(i)(E) or (F), be excluded from points and fees as bona fide discount points.

As noted above, one commenter expressed concern that if the requirements for premium capture cash reserve accounts proposed in the 2011 QRM Proposed Rule were adopted, creditors would have difficulty in recovering the costs of LLPAs through rate and that, because of the points and fees limits for qualified mortgages, creditors would also have trouble recovering the costs of LLPAs through up-front charges to consumers. The Bureau notes that, as proposed, the premium capture cash reserve account requirement would not apply to securities sponsored by the GSEs and would not apply to securities comprised solely of QRMs. See 76 FR 24112, 24120. Thus, it is not clear, that even if it were adopted, the requirement would have as substantial an impact as suggested by the commenter. In any event, the requirement has merely been proposed, not finalized. The Bureau will continue to coordinate with the agencies responsible for finalizing the 2011 QRM Proposed Rule to consider the combined effects of that rule and the instant rule.

The Board proposed comment 43(e)(3)(ii)-1 to clarify the meaning in proposed § 226.43(e)(3)(ii)(A) of “retained by” the loan originator, creditor, or an affiliate of either. Proposed comment 43(e)(3)(ii)-1 provided that if a creditor charges a consumer $400 for an appraisal conducted by a third party not affiliated with the creditor, pays the third party appraiser $300 for the appraisal, and retains $100, the creditor may exclude $300 of this fee from “points and fees” but must count the $100 it retains in “points and fees.”

As noted above, several commenters expressed confusion about the relationship between proposed § 226.43(e)(3)(ii)(A), which would have excluded bona fide third party charges not retained by the loan originator, creditor, or an affiliate of either, and proposed § 226.32(b)(1)(iii), which would have excluded certain real estate related charges if they are reasonable, if the creditor receives no direct or indirect compensation in connection with the charges, and the charges are not paid to an affiliate of the creditor. As explained above, the Bureau interprets the more specific provision governing the inclusion in points and fees of real estate related charges (implemented in § 1026.32(b)(1)(iii)) as taking precedence over the more general exclusion for bona fide third party charges in renumbered § 1026.32(b)(1)(i)(D). Accordingly, the Bureau does not believe that the example in proposed comment 43(e)(3)(ii)-1 is appropriate for illustrating the exclusion for bona fide third party charges because the subject of the example, appraisals, is specifically addressed in § 1026.32(b)(1)(iii).

The Bureau therefore is revising renumbered comment 32(b)(1)(i)(D)-1 by using a settlement agent charge to illustrate the exclusion for bona fide third party charges. By altering this example to address closing agent charges, the Bureau is also responding to requests from commenters that the Bureau provide more guidance on whether closing agent charges are included in points and fees. As noted above, proposed § 226.43(e)(3)(iii) would have specified that the term “loan originator,” as used in proposed § 226.43(e)(3)(ii)(A), has the same meaning as in § 226.36(a)(1). The Bureau is moving the cross-reference to the definition of “loan originator” in § 226.36(a)(1) to comment 32(b)(1)(i)(D)-1.

The Board proposed comment 43(e)(3)(ii)-2 to explain that, under § 226.32(b)(1)(i)(B), creditors would have to include in “points and fees” premiums or charges payable at or before consummation for any private guaranty or insurance protecting the creditor against the consumer's default or other credit loss to the extent that the premium or charge exceeds the amount payable under policies in effect at the time of origination under section 203(c)(2)(A) of the National Housing Act (12 U.S.C. 1709(c)(2)(A)). The proposed comment also would have explained that these premiums or charges would be included if the premiums or charges were not required to be refundable on a pro-rated basis, or the refund is not automatically issued upon notification of the satisfaction of the underlying mortgage loan. The comment would have clarified that, under these circumstances, even if the premiums and charges were not retained by the creditor, loan originator, or an affiliate of either, they would be included in the “points and fees” calculation for qualified mortgages. The comment also would have cross-referenced proposed comments 32(b)(1)(i)-3 and -4 for further discussion of including private mortgage insurance premiums in the points and fees calculation.

The Bureau is adopting proposed comment 43(e)(3)(ii)-2 substantially as proposed, renumbered as comment 32(b)(i)(D)-2. In addition, the Bureau also is adopting new comments 32(b)(i)(D)-3 and -4 to explain that the exclusion of bona fide third party charges under § 1026.32(b)(1)(i)(D) does not apply to real estate-related charges and credit insurance premiums. The inclusion of these items in points and fees is specifically addressed in § 1026.32(b)(iii) and (iv), respectively.

Bona fide discount points. TILA section 129C(b)(2)(C)(ii) excludes up to two bona fide discount points from points and fees under certain circumstances. Specifically, it excludes up to two bona fide discount points if the interest rate before the discount does not exceed the average prime offer rate by more than two percentage points. Alternatively, it excludes up to one discount point if the interest rate before the discount does not exceed the average prime offer rate by more than one percentage point. The Board proposed to implement this provision in proposed § 226.43(e)(3)(ii)(B) and (C).

Proposed § 226.43(e)(3)(ii)(B) would have permitted a creditor to exclude from points and fees for a qualified mortgage up to two bona fide discount points paid by the consumer in connection with the covered transaction, provided that: (1) The interest rate before the rate is discounted does not exceed the average prime offer rate, as defined in § 226.45(a)(2)(ii), by more than one percent; and (2) the average prime offer rate used for purposes of paragraph 43(e)(3)(ii)(B)(1) is the same average prime offer rate that applies to a comparable transaction as of the date the discounted interest rate for the covered transaction is set.

Proposed § 226.43(e)(3)(ii)(C) would have permitted a creditor to exclude from points and fees for a qualified mortgage up to one bona fide discount point paid by the consumer in connection with the covered transaction, provided that: (1) The interest rate before the discount does not exceed the average prime offer rate, as defined in § 226.45(a)(2)(ii), by more than two percent; (2) the average prime offer rate used for purposes of § 226.43(e)(3)(ii)(C)(1) is the same average prime offer rate that applies to a comparable transaction as of the date the discounted interest rate for the covered transaction is set; and (3) two bona fide discount points have not been excluded under § 226.43(e)(3)(ii)(B).

Several industry commenters argued that creditors should be permitted to exclude from points and fees more than two discount points. Some industry commenters maintained that creditors should be permitted to exclude as many discount points as consumers choose to pay. Another commenter contended that creditors should be able to exclude as many as three discount points.

A few industry commenters requested eliminating the requirement that, for the discount points to be bona fide, the interest rate before the discount must be within one or two percentage points of the average prime offer rate. One industry commenter argued that this requirement is too inflexible. Several commenters recommended that this requirement be adjusted for jumbo loans and for second homes. Another commenter claimed that this requirement would limit the options for consumers paying higher interest rates and that these are the consumers for whom it would be most beneficial to pay down their interest rates.

Several commenters argued that the effect of these two limitations for excluding discount points from points and fees—the limit on the number of discount points that could be excluded and the requirement that the pre-discount rate be within one or two points of the average prime offer rate—would have a negative impact on consumers. They maintained that these limitations would prevent consumers from choosing their optimal combination of interest rate and points for their financial circumstances.

One commenter noted that proposed § 226.43(e)(3)(ii)(B) and (C) would require that, for the discount points or point to be excluded from points and fees, the interest rate before the discount must not exceed the average prime offer rate by more than one or two “percent,” respectively. The commenter recommended that, for clarity and consistency with the statute, the requirement should instead require that the interest rate before the discount be within one or two “percentage points” of the average prime offer rate.

The Bureau is adopting proposed § 226.43(e)(3)(ii)(B) and (C), renumbered as § 1026.32(b)(1)(i)(E) and (F), with certain revisions. As suggested by a commenter, the Bureau is revising both § 1026.32(b)(1)(i)(E)(1) and (F)(1) to require that, to exclude the discount points or point, the interest rate must be within one or two “percentage points” (rather than “percent”) of the average prime offer rate. This formulation is clearer and consistent with the statutory language. The Bureau is also adding § 1026.32(b)(1)(i)(E)(2) and (F)(2) to implement TILA section 103(dd)(1)(B) and (C), which specify that, to exclude discount points from points and fees for purposes of determining whether a loan is a high-cost mortgage, the interest rate for personal property loans before the discount must be within one or two percentage points, respectively, of the average rate on a loan in connection with which insurance is provided under title I of the National Housing Act. This provision does not apply to the points and fees limit for qualified mortgages, regardless of whether a loan is a high-cost mortgage. The provision is included in the final rule for completeness. Finally, in § 1026.32(b)(1)(i)(F), the Bureau is clarifying that bona fide discount points cannot be excluded under § 1026.32(b)(1)(i)(F) if any bona fide discount points already have been excluded under § 1026.32(b)(1)(i)(E).

As noted above, several commenters urged the Bureau to alter or eliminate the limitations on how many discount points may be excluded and the requirement that the pre-discount interest rate must be within one or two points of the average prime offer rate. A few industry commenters also requested that the Bureau adjust the limitation on the pre-discount interest rate specifically for jumbo loans and loans for vacation homes. These commenters noted that interest rates for such loans otherwise would often be too high to qualify for the exclusion for bona fide discount points. The Bureau recognizes that these limitations may circumscribe the ability of consumers to purchase discount points to lower their interest rates. Nevertheless, the Bureau does not believe it would be appropriate to exercise its exception authority. Congress apparently concluded that there was a greater probability of consumer injury when consumers purchased more than two discount points or when the consumers were using discount points to buy down higher interest rates. The Bureau also notes that, in other sections of the Dodd-Frank Act, Congress prescribed different thresholds above the average prime offer rate for jumbo loans. See TILA sections 129C(c)(1)(B) (prepayment penalties) and 129H(f)(2) (appraisals). Congress did not do so in the provision regarding exclusion of bona fide discount points.

The Bureau is adding new comment 32(b)(1)(i)(E)-2 to note that the term “bona fide discount point” is defined in § 1026.32(b)(3). To streamline the rule, the Bureau is moving into new comment 32(b)(1)(i)(E)-2 the explanation that the average prime offer rate used for purposes of for both § 1026.32(b)(1)(i)(E) and (F) is the average prime offer rate that applies to a comparable transaction as of the date the discounted interest rate for the covered transaction is set. The Board proposed comment 43(e)(3)(ii)-5 to clarify that the average prime offer rate table indicates how to identify the comparable transaction. The Bureau is adding the language from proposed comment 43(e)(3)(ii)-5 to new comment 32(b)(1)(i)(E)-2, with a revision to the cross-reference for the comment addressing “comparable transaction.”

Proposed comment 43(e)(3)(ii)-3 would have included an example to illustrate the rule permitting exclusion of two bona fide discount points. The example would have assumed a covered transaction that is a first-lien, purchase money home mortgage with a fixed interest rate and a 30-year term. It would also have assumed that the consumer locks in an interest rate of 6 percent on May 1, 2011, that was discounted from a rate of 6.5 percent because the consumer paid two discount points. Finally, assume that the average prime offer rate as of May 1, 2011 for first-lien, purchase money home mortgages with a fixed interest rate and a 30-year term is 5.5 percent. In this example, the creditor would have been able to exclude two discount points from the “points and fees” calculation because the rate from which the discounted rate was derived exceeded the average prime offer rate for a comparable transaction as of the date the rate on the covered transaction was set by only 1 percent.

The Bureau is adopting proposed comment 43(e)(3)(ii)-3 substantially as proposed but renumbered as comment 32(b)(1)(i)(E)-3. The Bureau is also adding new comment 32(b)(1)(i)(F)-1 to explain that comments 32(b)(1)(i)(E)-1 and -2 provide guidance concerning the definitions of “bona fide discount point” and “average prime offer rate,” respectively.

Proposed comment 43(e)(3)(ii)-4 would have provided an example to illustrate the rule permitting exclusion of one bona fide discount point. The example assumed a covered transaction that is a first-lien, purchase money home mortgage with a fixed interest rate and a 30-year term. The example also would have assumed that the consumer locks in an interest rate of 6 percent on May 1, 2011, that was discounted from a rate of 7 percent because the consumer paid four discount points. Finally, the example would have assumed that the average prime offer rate as of May 1, 2011, for first-lien, purchase money home mortgages with a fixed interest rate and a 30-year term is 5 percent.

In this example, the creditor would have been able to exclude one discount point from the “points and fees” calculation because the rate from which the discounted rate was derived (7 percent) exceeded the average prime offer rate for a comparable transaction as of the date the rate on the covered transaction was set (5 percent) by only 2 percent. The Bureau is adopting proposed comment 43(e)(3)(ii)-4 substantially as proposed but renumbered as comment 32(b)(1)(i)(F)-2.

32(b)(1)(ii)

When HOEPA was enacted in 1994, it required that “all compensation paid to mortgage brokers” be counted toward the threshold for points and fees that triggers special consumer protections under the statute. Specifically, TILA section 103(aa)(4) provided that charges are included in points and fees only if they are payable at or before consummation and did not expressly address whether “backend” payments from creditors to mortgage brokers funded out of the interest rate (commonly referred to as yield spread premiums) are included in points and fees. [79] This requirement is implemented in existing § 1026.32(b)(1)(ii), which requires that all compensation paid by consumers directly to mortgage brokers be included in points and fees, but does not address compensation paid by creditors to mortgage brokers or compensation paid by any company to individual employees (such as loan officers who are employed by a creditor or mortgage broker).

The Dodd-Frank Act substantially expanded the scope of compensation included in points and fees for both the high-cost mortgage threshold in HOEPA and the qualified mortgage points and fees limits. [80] Section 1431 of the Dodd-Frank Act amended TILA to require that “all compensation paid directly or indirectly by a consumer or creditor to a mortgage originator from any source, including a mortgage originator that is also the creditor in a table-funded transaction,” be included in points and fees. TILA section 103(bb)(4)(B) (emphasis added). Under amended TILA section 103(bb)(4)(B), compensation paid to anyone that qualifies as a “mortgage originator” is to be included in points and fees. [81] Thus, in addition to compensation paid to mortgage brokerage firms and individual brokers, points and fees also includes compensation paid to other mortgage originators, including employees of a creditor (i.e., loan officers). In addition, as noted above, the Dodd-Frank Act removed the phrase “payable at or before closing” from the high-cost mortgage points and fees test and did not apply the “payable at or before closing” limitation to the points and fees cap for qualified mortgages. See TILA sections 103(bb)(1)(A)(ii) and 129C(b)(2)(A)(vii), (b)(2)(C). Thus, the statute appears to contemplate that even compensation paid to mortgage brokers and other loan originators after consummation should be counted toward the points and fees thresholds.

This change is one of several provisions in the Dodd-Frank Act that focus on loan originator compensation and regulation, in apparent response to concerns that industry compensation practices contributed to the mortgage market crisis by creating strong incentives for brokers and retail loan officers to steer consumers into higher-priced loans. Specifically, loan originators were often paid a commission by creditors that increased with the interest rate on a transaction. These commissions were funded by creditors through the increased revenue received by the creditor as a result of the higher rate paid by the consumer and were closely tied to the price the creditor expected to receive for the loan on the secondary market as a result of that higher rate. [82] In addition, many mortgage brokers charged consumers up-front fees to cover some of their costs at the same time that they accepted backend payments from creditors out of the rate. This may have contributed to consumer confusion about where the brokers' loyalties lay.

The Dodd-Frank Act took a number of steps to address loan originator compensation issues, including: (1) Adopting requirements that loan originators be “qualified” as defined by Bureau regulations; (2) generally prohibiting compensation based on rate and other terms (except for loan amount) and prohibiting a loan originator from receiving compensation from both consumers and other parties in a single transaction; (3) requiring the promulgation of additional rules to prohibit steering consumers to less advantageous transactions; (4) requiring the disclosure of loan originator compensation; and (5) restricting loan originator compensation under HOEPA and the qualified mortgage provisions by including such compensation within the points and fees calculations. See TILA sections 103(bb)(4)(A)(ii), (B); 128(a)(18); 129B(b), (c); 129C(b)(2)(A)(vii), (C)(i).

The Board proposed revisions to § 226.32(b)(1)(ii) to implement the inclusion of more forms of loan originator compensation into the points and fees thresholds. Those proposed revisions tracked the statutory language, with two exceptions. First, proposed § 226.32(b)(1)(ii) did not include the phrase “from any source.” The Board noted that the statute covers compensation paid “directly or indirectly” to the loan originator, and concluded that it would be redundant to cover compensation “from any source.” Second, for consistency with Regulation Z, the proposal used the term “loan originator” as defined in § 226.36(a)(1), rather than the term “mortgage originator” that appears in section 1401 of the Dodd-Frank Act. See TILA section 103(cc)(2). The Board explained that it interpreted the definitions of mortgage originator under the statute and loan originator under existing Regulation Z to be generally consistent, with one exception that the Board concluded was not relevant for purposes of the points and fees thresholds. Specifically, the statutory definition refers to “any person who represents to the public, through advertising or other means of communicating or providing information (including the use of business cards, stationery, brochures, signs, rate lists, or other promotional items), that such person can or will provide” the services listed in the definition (such as offering or negotiating loan terms), while the existing Regulation Z definition does not include persons solely on this basis. The Board concluded that it was not necessary to add this element of the definition to implement the points and fees calculations anyway, reasoning that the calculation of points and fees is concerned only with loan originators that receive compensation for performing defined origination functions in connection with a consummated loan. The Board noted that a person who merely represents to the public that such person can offer or negotiate mortgage terms for a consumer has not yet received compensation for that function, so there is no compensation to include in the calculation of points and fees for a particular transaction.

In the proposed commentary, the Board explained what compensation would and would not have been included in points and fees under proposed § 226.32(b)(1)(ii). The Board proposed to revise existing comment 32(b)(1)(ii)-1 to clarify that compensation paid by either a consumer or a creditor to a loan originator, as defined in § 1026.36(a)(1), would be included in points and fees. Proposed comment 32(b)(1)(ii)-1 also stated that loan originator compensation already included in points and fees because it is included in the finance charge under § 226.32(b)(1)(i) would not be counted again under § 226.32(b)(1)(ii).

Proposed comment 32(b)(1)(ii)-2.i stated that, in determining points and fees, loan originator compensation includes the dollar value of compensation paid to a loan originator for a specific transaction, such as a bonus, commission, yield spread premium, award of merchandise, services, trips, or similar prizes, or hourly pay for the actual number of hours worked on a particular transaction. Proposed comment 32(b)(1)(ii)-2.ii clarified that loan originator compensation excludes compensation that cannot be attributed to a transaction at the time of origination, including, for example, the base salary of a loan originator that is also the employee of the creditor, or compensation based on the performance of the loan originator's loans or on the overall quality of a loan originator's loan files. Proposed comment 32(b)(1)(ii)-2.i also explained that compensation paid to a loan originator for a covered transaction must be included in the points and fees calculation for that transaction whenever paid, whether at or before closing or any time after closing, as long as the compensation amount can be determined at the time of closing. In addition, proposed comment 32(b)(1)(ii)-2.i provided three examples of compensation paid to a loan originator that would have been included in the points and fees calculation.

Proposed comment 32(b)(1)(ii)-3 stated that loan originator compensation includes amounts the loan originator retains and is not dependent on the label or name of any fee imposed in connection with the transaction. Proposed comment 32(b)(1)(ii)-3 offered an example of a loan originator imposing and retaining a “processing fee” and stated that such a fee is loan originator compensation, regardless of whether the loan originator expends the fee to process the consumer's application or uses it for other expenses, such as overhead.

The Board requested comment on the types of loan originator compensation that must be included in points and fees. The Board also sought comment on the appropriateness of specific examples given in the commentary.

Many industry commenters objected to the basic concept of including loan originator compensation in points and fees, urging the Bureau to use its exception authority to exclude loan originator compensation from points and fees altogether. Several industry commenters contended that other statutory provisions and rules, including the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (SAFE Act), the Board's 2010 Loan Originator Final Rule, and certain Dodd-Frank Act provisions (including those proposed to be implemented in the Bureau's 2012 Loan Originator Proposal), adequately regulate loan originator compensation and prohibit or restrict problematic loan originator compensation practices. Accordingly, they argued it is therefore unnecessary to include loan originator compensation in points and fees.

Many industry commenters also asserted that the amount of compensation paid to loan originators has little or no bearing on a consumer's ability to repay a mortgage, and thus that including loan originator compensation in points and fees under this rulemaking is unnecessary. They further asserted that including loan originator compensation in points and fees would greatly increase compliance burdens on creditors, discourage creditors from making qualified mortgages, and ultimately reduce access to credit and increase the cost of credit.

Several industry commenters argued that, if the Bureau does not exclude all loan originator compensation from points and fees, then the Bureau should at least exclude compensation paid to individual loan originators (i.e., loan officers who are employed by creditors or mortgage brokerage firms). They argued that compensation paid to individual loan originators is already included in the cost of the loan, either in the interest rate or in origination fees. They maintained that including compensation paid to individual loan originators in points and fees would therefore constitute double counting.

Several industry commenters also claimed that they would face significant challenges in determining the amount of compensation for individual loan originators. They noted that creditors need clear, objective standards for determining whether loans satisfy the qualified mortgage standard, and that the complexity of apportioning compensation to individual loans at the time of each closing to determine the amount of loan originator compensation to count toward the points and fees cap would create uncertainty. They also noted that having to track individual loan originators' compensation and allocate that compensation to individual loans would create additional compliance burdens, particularly for compensation paid after closing. Several industry commenters also stated that estimating loan originator compensation in table-funded transactions would prove difficult because the funding assignee may not know the amount paid by the table-funded creditor to the individual loan originator.

Several industry commenters also asserted that including compensation paid to individual loan originators would lead to anomalous results: Otherwise identical loans could have significant differences in points and fees depending on the timing of the mortgage loan or the identity of the loan officer. They noted, for example, that a loan that qualifies a loan officer for a substantial bonus because it enables a loan officer to satisfy a long-term (e.g., annual) origination-volume target or a loan that is originated by a high-performing loan officer could have substantially higher loan originator compensation, and thus substantially higher points and fees, than an otherwise identical loan. Because the consumers would not be paying higher fees or interest rates because of such circumstances, the commenters argued that the result would not further the goals of the statute.

Some industry commenters made a separate argument that the proposed method for including loan originator compensation in points and fees would create an unfair playing field for mortgage brokers. These commenters noted that, since a brokerage firm can be paid by only one source under the Board's 2010 Loan Originator Final Rule and related provisions of the Dodd-Frank Act, a payment by a creditor to a mortgage broker must cover both the broker's overhead costs and the cost of compensating the individual that worked on the transaction. The creditor's entire payment to the mortgage broker is loan originator compensation that is included in points and fees, so that loan originator compensation in a wholesale transaction includes both the compensation received from the creditor to cover the overhead costs of the mortgage broker and the compensation that the broker passes through to the individual employee who worked on the transaction. By contrast, in a loan obtained directly from a creditor, the creditor would have to include in points and fees the compensation paid to the loan officer, but could choose to recover its overhead costs through the interest rate rather than an up-front charge that would count toward the points and fees thresholds. One industry commenter provided examples illustrating that, as a result of this difference, loans obtained through a mortgage broker could have interest rates and fees identical to those in a loan obtained directly through a creditor but could have significantly higher loan originator compensation included in points and fees. Thus, particularly for smaller loan amounts, commenters expressed concern that it would be difficult for loans originated through mortgage brokers to remain under the points and fees limits for qualified mortgages.

A nonprofit loan originator commenter also argued that including loan originator compensation in points and fees could undercut programs that help low and moderate income consumers obtain affordable mortgages. This commenter noted that it relies on payments from creditors to help it provide services to consumers and that counting such payments as loan originator compensation and including them in points and fees could jeopardize its programs. The commenter requested that this problem be addressed by excluding nonprofit organizations from the definition of loan originator or by excluding payments by creditors to nonprofit organizations from points and fees.

Consumer advocates approved of including loan originator compensation in points and fees, regardless of when and by whom the compensation is paid. They asserted that including loan originator compensation would promote more consistent treatment by ensuring that all payments that loan originators receive count toward the points and fees thresholds, regardless of whether the payment is made by the consumer or the creditor and whether it is paid through the rate or through up-front fees. They maintained that the provision was intended to help prevent consumers from paying excessive amounts for loan origination services. More specifically, some consumer advocates argued that the Dodd-Frank Act provision requiring inclusion of loan originator compensation in points and fees is an important part of a multi-pronged approach to address widespread steering of consumers into more expensive mortgage transactions, and in particular, to address the role of commissions funded through the interest rate in such steering. The consumer advocates noted that separate prohibitions on compensation based on terms and on a loan originator's receiving compensation from both the consumer and another party do not limit the amount of compensation a loan originator can receive or prevent a loan originator from inducing consumers to agree to above-market interest rates. They expressed concern that, particularly in the subprime market, loan originators could specialize in originating transactions with above-market interest rates, with the expectation they could arrange to receive above-market compensation for all of their transactions. Consumer advocates argued that counting all methods of loan originator compensation toward the points and fees thresholds was intended to deter such conduct.

Consumer advocates also pointed out that in the wholesale context, the consumer has the option of paying the brokerage firm directly for its services. Such payments have always been included within the calculation of points and fees for HOEPA purposes. The advocates argued that when a consumer elects not to make the up-front payment but instead elects to fund the same amount of money for the brokerage through an increased rate, there is no justification for treating the money received by the brokerage as a result of the consumer's decision any differently.

The Bureau has carefully considered the comments received in light of the concerns about various issues with regard to loan originator compensation practices, the general concerns about the impacts of the ability-to-repay/qualified mortgage rule and revised HOEPA thresholds on a market in which access to mortgage credit is already extremely tight, differences between the retail and wholesale origination channels, and practical considerations regarding both the burdens of day-to-day implementation and the opportunities for evasion by parties who wish to engage in rent-seeking. As discussed further below, the Bureau is concerned about implementation burdens and anomalies created by the requirement to include loan originator compensation in points and fees, the impacts that it could have on pricing and access to credit, and the risks that rent-seekers will continue to find ways to evade the statutory scheme. Nevertheless, the Bureau believes that, in light of the historical record and of Congress's evident concern with loan originator compensation practices, it would not be appropriate to waive the statutory requirement that loan originator compensation be included in points and fees. The Bureau has, however, worked to craft the rule that implements Congress's judgment in a way that is practicable and that reduces potential negative impacts of the statutory requirement, as discussed below. The Bureau is also seeking comment in the concurrent proposal being published elsewhere in today's Federal Register on whether additional measures would better protect consumers and reduce implementation burdens and unintended consequences.

Accordingly, the Bureau in adopting § 1026.32(b)(1)(ii) has generally tracked the statutory language and the Board's proposal in the regulation text, but has expanded the commentary to provide more detailed guidance to clarify what compensation must be included in points and fees. The Dodd-Frank Act requires inclusion in points and fees of “all compensation paid directly or indirectly by a consumer or creditor to a mortgage originator from any source, including a mortgage originator that is also the creditor in a table-funded transaction.”See TILA section 103(bb)(4)(B). Consistent with the Board's proposal, revised § 1026.32(b)(ii) does not include the phrase “from any source.” The Bureau agrees that the phrase is unnecessary because the provision expressly covers compensation paid “directly or indirectly” to the loan originator. Like the Board's proposal, the final rule also uses the term “loan originator” as defined in § 1026.36(a)(1), not the term “mortgage originator” under section 1401 of the Dodd-Frank Act. See TILA section 103(cc)(2). The Bureau agrees that the definitions are consistent in relevant respects and notes that it is in the process of amending the regulatory definition to harmonize it even more closely with the Dodd-Frank Act definition of “mortgage originator.” [83] Accordingly, the Bureau believes use of consistent terminology in Regulation Z will facilitate compliance. Finally, as revised, § 1026.32(b)(1)(ii) also does not include the language in proposed § 226.32(b)(1)(ii) that specified that the provision also applies to a loan originator that is the creditor in a table-funded transaction. The Bureau has concluded that that clarification is unnecessary because a creditor in a table-funded transaction is already included in the definition of loan originator in § 1026.36(a)(1). To clarify what compensation must be included in points and fees, revised § 1026.32(b)(1)(ii) specifies that compensation must be included if it can be attributed to the particular transaction at the time the interest rate is set. These limitations are discussed in more detail below.

In adopting the general rule, the Bureau carefully considered arguments by industry commenters that loan originator compensation should not be included in points and fees because other statutory provisions and rules already regulate loan originator compensation, because loan originator compensation is already included in the costs of mortgage loans, and because including loan originator compensation in points and fees would push many loans over the 3 percent cap on points and fees for qualified mortgages (or even over the points and fees limits for determining whether a loan is a high-cost mortgage under HOEPA), which would increase costs and impair access to credit.

The Bureau views the fact that other provisions within the Dodd-Frank Act address other aspects of loan originator compensation and activity as evidence of the high priority that Congress placed on regulating such compensation. The other provisions pointed to by the commenters address specific compensation practices that created particularly strong incentives for loan originators to “upcharge” consumers on a loan-by-loan basis and particular confusion about loan originators' loyalties. The Bureau believes that the inclusion of loan originator compensation in points and fees has distinct purposes. In addition to discouraging more generalized rent-seeking and excessive loan originator compensation, the Bureau believes that Congress may have been focused on particular risks to consumers. Thus, with respect to qualified mortgages, including loan originator compensation in points and fees helps to ensure that, in cases in which high up-front compensation might otherwise cause the creditor and/or loan originator to be less concerned about long-term sustainability, the creditor is not able to invoke a presumption of compliance if challenged to demonstrate that it made a reasonable and good faith determination of the consumer's ability to repay the loan. Similarly in HOEPA, the threshold triggers additional consumer protections, such as enhanced disclosures and housing counseling, for the loans with the highest up-front pricing.

The Bureau recognizes that the method that Congress chose to effectuate these goals does not ensure entirely consistent results as to whether a loan is a qualified mortgage or a high-cost transaction. For instance, loans that are identical to consumers in terms of up-front costs and interest rate may nevertheless have different points and fees based on the identity of the loan originator who handled the transaction for the consumer, since different individual loan originators in a retail environment or different brokerage firms in a wholesale environment may earn different commissions from the creditor without that translating in differences in costs to the consumer. In addition, there are anomalies introduced by the fact that “loan originator” is defined to include mortgage broker firms and individual employees hired by either brokers or creditors, but not creditors themselves. As a result, counting the total compensation paid to a mortgage broker firm will capture both the firm's overhead costs and the compensation that the firm passes on to its individual loan officer. By contrast, in a retail transaction, the creditor would have to include in points and fees the compensation that it paid to its loan officer, but would continue to have the option of recovering its overhead costs through the interest rate, instead of an up-front charge, to avoid counting them toward the points and fees thresholds. Indeed, the Bureau expects that the new requirement may prompt creditors to shift certain other expenses into rate to stay under the thresholds.

Nevertheless, to the extent there are anomalies from including loan originator compensation in points and fees, these anomalies appear to be the result of deliberate policy choices by Congress to expand the historical definition of points and fees to include all methods of loan originator compensation, whether derived from up-front charges or from the rate, without attempting to capture all overhead expenses by creditors or the gain on sale that the creditor can realize upon closing a mortgage. The Bureau agrees that counting loan originator compensation that is structured through rate toward the points and fees thresholds could cause some loans not to be classified as qualified mortgages and to trigger HOEPA protections, compared to existing treatment under HOEPA and its implementing regulation. However, the Bureau views this to be exactly the result that Congress intended.

In light of the express statutory language and Congress's evident concern with increasing consumer protections in connection with high levels of loan originator compensation, the Bureau does not believe that it is appropriate to use its exception or adjustment authority in TILA section 105(a) or in TILA section 129C(b)(3)(B)(i) to exclude loan originator compensation entirely from points and fees for qualified mortgages and HOEPA. As discussed below, however, the Bureau is attempting to implement the points and fees requirements with as much sensitivity as practicable to potential impacts on the pricing of and availability of credit, anomalies and unintended consequences, and compliance burdens.

The Bureau also carefully considered comments urging it to exclude compensation paid to individual loan originators from points and fees, but ultimately concluded that such a result would be inconsistent with the plain language of the statute and could exacerbate the potential inconsistent effects of the rule on different mortgage origination channels. As noted above, many industry commenters argued that, even if loan originator compensation were not excluded altogether, at least compensation paid to individual loan originators should be excluded from points and fees. Under this approach, only payments to mortgage brokers would be included in points and fees. The commenters contended that it would be difficult to track compensation paid to individual loan originators, particularly when that compensation may be paid after consummation of the loan and that it would create substantial compliance problems. They also argued that including compensation paid to individual loan originators in points and fees would create anomalies, in which identical transactions from the consumer's perspective (i.e., the same interest rate and up-front costs) could nevertheless have different points and fees because of loan originator compensation.

As explained above, the Bureau does not believe it is appropriate to use its exception authority to exclude loan originator compensation from points and fees, and even using that exception authority more narrowly to exclude compensation paid to individual loan originators could undermine Congress's apparent goal of providing stronger consumer protections in cases of high loan originator compensation. Although earlier versions of legislation focused specifically on compensation to “mortgage brokers,” which is consistent with existing HOEPA, the Dodd-Frank Act refers to compensation to “mortgage originators,” a term that is defined in detail elsewhere in the statute to include individual loan officers employed by both creditors and brokers, in addition to the brokers themselves. To the extent that Congress believed that high levels of loan originator compensation evidenced additional risk to consumers, excluding individual loan originators from consideration appears inconsistent with this policy judgment.

Moreover, the Bureau notes that using exception authority to exclude compensation paid to individual loan originators would exacerbate the differential treatment between the retail and wholesale channels concerning overhead costs. As noted above, compensation paid by the consumer or creditor to the mortgage broker necessarily will include amounts for both the mortgage broker's overhead and profit and for the compensation the mortgage broker passes on to its loan officer. Excluding individual loan officer compensation on the retail side, however, would effectively exempt creditors from counting any loan originator compensation at all toward points and fees. Thus, for transactions that would be identical from the consumer's perspective in terms of interest rate and up-front costs, the wholesale transaction could have significantly higher points and fees (because the entire payment from the creditor to the mortgage broker would be captured in points and fees), while the retail transaction might include no loan origination compensation at all in points and fees. Such a result would put brokerage firms at a disadvantage in their ability to originate qualified mortgages and put them at significantly greater risk of originating HOEPA loans. This in turn could constrict the supply of loan originators and the origination channels available to consumers to their detriment.

The Bureau recognizes that including compensation paid to individual loan originators, such as loan officers, with respect to individual transactions may impose additional burdens. For example, creditors will have to track employee compensation for purposes of complying with the rule, and the calculation of points and fees will be more complicated. However, the Bureau notes that creditors and brokers already have to monitor compensation more carefully as a result of the 2010 Loan Originator Final Rule and the related Dodd-Frank Act restrictions on compensation based on terms and on dual compensation. The Bureau also believes that these concerns can be reduced by providing clear guidance on issues such as what types of compensation are covered, when compensation is determined, and how to avoid “double-counting” payments that are already included in points and fees calculations. The Bureau has therefore revised the Board's proposed regulation and commentary to provide more detailed guidance, and is seeking comment in the proposal published elsewhere in the Federal Register today on additional guidance and potential implementation issues among other matters.

As noted above, the Bureau is revising § 1026.32(b)(1)(ii) to clarify that compensation must be counted toward the points and fees thresholds if it can be attributed to the particular transaction at the time the interest rate is set. The Bureau is also revising comment 32(b)(1)(ii)-1 to explain in general terms when compensation qualifies as loan originator compensation that must be included in points and fees. In particular, compensation paid by a consumer or creditor to a loan originator is included in the calculation of points and fees, provided that such compensation can be attributed to that particular transaction at the time the interest rate is set. The Bureau also incorporates part of proposed comment 32(b)(1)(ii)-3 into revised comment 32(b)(1)(ii)-1, explaining that loan originator compensation includes amounts the loan originator retains, and is not dependent on the label or name of any fee imposed in connection with the transaction. However, revised comment 32(b)(1)(ii)-1 does not include the example from proposed comment 32(b)(1)(ii)-3, which stated that, if a loan originator imposes a processing fee and retains the fee, the fee is loan originator compensation under § 1026.32(b)(1)(ii) whether the originator expends the fee to process the consumer's application or uses it for other expenses, such as overhead. That example may be confusing in this context because a processing fee paid to a loan originator likely would be a finance charge under § 1026.4 and would therefore already be included in points and fees under § 1026.32(b)(1)(i).

Revised comment 32(b)(1)(ii)-2.i explains that compensation, such as a bonus, commission, or an award of merchandise, services, trips or similar prizes, must be included only if it can be attributed to a particular transaction. The requirement that compensation is included in points and fees only if it can be attributed to a particular transaction is consistent with the statutory language. The Dodd-Frank Act provides that, for the points and fees tests for both qualified mortgages and high-cost mortgages, only charges that are “in connection with” the transaction are included in points and fees. See TILA sections 103(bb)(1)(A)(ii) (high-cost mortgages) and 129C(b)(2)(A)(vii) (qualified mortgages). Limiting loan originator compensation to compensation that is attributable to the transaction implements the statutory requirement that points and fees are “in connection” with the transaction. This limitation also makes the rule more workable. Compensation is included in points and fees only if it can be attributed to a specific transaction to facilitate compliance with the rule and avoid over-burdening creditors with complex calculations to determine, for example, the portion of a loan officer's salary that should be counted in points and fees. [84] For clarity, the Bureau has moved the discussion of the timing of loan originator compensation into new comment 32(b)(1)(ii)-3, and has added additional examples to 32(b)(1)(ii)-4, to illustrate the types and amount of compensation that should be included in points and fees.

Revised comment 32(b)(1)(ii)-2.ii explains that loan originator compensation excludes compensation that cannot be attributed to a particular transaction at the time the interest rate is set, including, for example, compensation based on the long-term performance of the loan originator's loans or on the overall quality of the loan originator's loan files. The base salary of a loan originator is also excluded, although additional compensation that is attributable to a particular transaction must be included in points and fees. The Bureau has decided to seek further comment in the concurrent proposal regarding treatment of hourly wages for the actual number of hours worked on a particular transaction. The Board's proposal would have included hourly pay for the actual number of hours worked on a particular transaction in loan originator compensation for purposes of the points and fees thresholds, and the Bureau agrees that such wages are attributable to the particular transaction. However, the Bureau is unclear as to whether industry actually tracks compensation this way in light of the administrative burdens. Moreover, while the general rule provides for calculation of loan originator compensation at the time the interest rate is set for the reasons discussed above, the actual hours of hours worked on a transaction would not be known at that time. The Bureau is therefore seeking comment on issues relating to hourly wages, including whether to require estimates of the hours to be worked between rate set and consummation.

New comment 32(b)(1)(ii)-3 explains that loan originator compensation must be included in the points and fees calculation for a transaction whenever the compensation is paid, whether before, at or after closing, as long as that compensation amount can be attributed to the particular transaction at the time the interest rate is set. Some industry commenters expressed concern that it would be difficult to determine the amount of compensation that would be paid after consummation and that creditors might have to recalculate loan originator compensation (and thus points and fees) after underwriting if, for example, a loan officer became eligible for higher compensation because other transactions had been consummated. The Bureau appreciates that industry participants need certainty at the time of underwriting as to whether transactions will exceed the points and fees limits for qualified mortgages (and for high-cost mortgages). To address this concern, the comment 32(b)(1)(ii)-3 explains that loan originator compensation should be calculated at the time the interest rate is set. The Bureau believes that the date the interest rate is set is an appropriate standard for calculating loan originator compensation. It would allow creditors to be able to calculate points and fees with sufficient certainty so that they know early in the process whether a transaction will be a qualified mortgage or a high-cost mortgage.

As noted above, several industry commenters argued that including loan originator compensation in points and fees would result in double counting. They stated that creditors often will recover loan originator compensation costs through origination charges, and these charges are already included in points and fees under § 1026.32(b)(1)(i). However, the underlying statutory provisions as amended by the Dodd-Frank Act do not express any limitation on its requirement to count loan originator compensation toward the points and fees test. Rather, the literal language of TILA section 103(bb)(4) as amended by the Dodd-Frank Act defines points and fees to include all items included in the finance charge (except interest rate), all compensation paid directly or indirectly by a consumer or creditor to a loan originator, “and” various other enumerated items. The use of “and” and the references to “all” compensation paid “directly or indirectly” and “from any source” suggest that compensation should be counted as it flows downstream from one party to another so that it is counted each time that it reaches a loan originator, whatever the previous source.

The Bureau believes the statute would be read to require that loan originator compensation be treated as additive to the other elements of points and fees. The Bureau believes that an automatic literal reading of the statute in all cases, however, would not be in the best interest of either consumers or industry. For instance, the Bureau does not believe that it is necessary or appropriate to count the same payment made by a consumer to a mortgage broker firm twice, simply because it is both part of the finance charge and loan originator compensation. Similarly, the Bureau does not believe that, where a payment from either a consumer or a creditor to a mortgage broker is counted toward points and fees, it is necessary or appropriate to count separately funds that the broker then passes on to its individual employees. In each case, any costs and risks to the consumer from high loan originator compensation are adequately captured by counting the funds a single time against the points and fees cap; thus, the Bureau does not believe the purposes of the statute would be served by counting some or all of the funds a second time, and is concerned that doing so could have negative impacts on the price and availability of credit.

Determining the appropriate accounting rule is significantly more complicated, however, in situations in which a consumer pays some up-front charges to the creditor and the creditor pays loan originator compensation to either its own employee or to a mortgage broker firm. Because money is fungible, tracking how a creditor spends money it collects in up-front charges versus amounts collected through the rate to cover both loan originator compensation and its other overhead expenses would be extraordinarily complex and cumbersome. To facilitate compliance, the Bureau believes it is appropriate and necessary to adopt one or more generalized rules regarding the accounting of various payments. However, the Bureau does not believe it yet has sufficient information with which to choose definitively between the additive approach provided for in the statutory language and other potential methods of accounting for payments in light of the multiple practical and complex policy considerations involved.

The potential downstream effects of different accounting methods are significant. Under the additive approach where no offsetting consumer payments against creditor-paid loan originator compensation is allowed, creditors whose combined loan originator compensation and up-front charges would otherwise exceed the points and fees limits would have strong incentives to cap their up-front charges for other overhead expenses under the threshold and instead recover those expenses by increasing interest rates to generate higher gains on sale. This would adversely affect consumers who prefer a lower interest rate and higher up-front costs and, at the margins, could result in some consumers being unable to qualify for credit. Additionally, to the extent creditors responded to a “no offsetting” rule by increasing interest rates, this could increase the number of qualified mortgages that receive a rebuttable rather than conclusive presumption of compliance.

One alternative would be to allow all consumer payments to offset creditor-paid loan originator compensation. However, a “full offsetting” approach would allow creditors to offset much higher levels of up-front points and fees against expenses paid through rate before the heightened consumer protections required by the Dodd-Frank Act would apply. Particularly under HOEPA, this may raise tensions with Congress's apparent intent. Other alternatives might use a hybrid approach depending on the type of expense, type of loan, or other factors, but would involve more compliance complexity.

In light of the complex considerations, the Bureau believes it is necessary to seek additional notice and comment. The Bureau therefore is finalizing this rule without qualifying the statutory result and is proposing two alternative comments in the concurrent proposal, one of which would explicitly preclude offsetting, and the other of which would allow full offsetting of any consumer-paid charges against creditor-paid loan originator compensation. The Bureau is also proposing comments to clarify treatment of compensation paid by consumers to mortgage brokers and by mortgage brokers to their individual employees. The Bureau is seeking comment on all aspects of this issue, including the market impacts and whether adjustments to the final rule would be appropriate. In addition, the Bureau is seeking comment on whether it would be helpful to provide for additional adjustment of the rules or additional commentary to clarify any overlaps in definitions between the points and fees provisions in this rulemaking and the HOEPA rulemaking and the provisions that the Bureau is separately finalizing in connection with the Bureau's 2012 Loan Originator Compensation Proposal.

Finally, comment 32(b)(1)(ii)-4 includes revised versions of examples in proposed comment 32(b)(1)(ii)-2, as well as additional examples to provide additional guidance regarding what compensation qualifies as loan originator compensation that must be included in points and fees. These examples illustrate when compensation can be attributed to a particular transaction at the time the interest rate is set. New comment 32(b)(1)(ii)-5 adds an example explaining how salary is treated for purposes of loan originator compensation for calculating points and fees.

32(b)(1)(iii)

TILA section 103(aa)(4)(C) provides that points and fees include certain real estate-related charges listed in TILA section 106(e) and is implemented in § 1026.32(b)(1)(iii). The Dodd-Frank Act did not amend TILA section 103(aa)(4)(C) (but did renumber it as section 103(bb)(4)(C)). Although the Board indicated in the Supplementary Information that it was not proposing any changes, proposed § 226.32(b)(1)(iii) would have added the phrase “payable at or before closing of the mortgage” loan and would have separated the elements into three new paragraphs (A) through (C). Thus, proposed § 226.32(b)(1)(iii) would have included in points and fees “all items listed in § 226.4(c)(7) (other than amounts held for future payment of taxes) payable at or before closing of the mortgage loan, unless: (A) The charge is reasonable; (B) the creditor receives no direct or indirect compensation in connection with the charge; and (C) the charge is not paid to an affiliate of the creditor.” The Board noted that the statute did not exclude these charges if they were payable after closing and questioned whether such a limitation was necessary because these charges could reasonably be viewed as charges that by definition are payable only at or before closing. As noted in the section-by-section analysis of § 1026.32(b)(1), the Board requested comment on whether there are any other types of fees that should be included in points and fees only if they are payable at or before closing.

The Board noted that during outreach creditors had raised concerns about including in points and fees real-estate related fees paid to an affiliate of the creditor, such as an affiliated title company. Although these fees always have been included in points and fees for high-cost loans, creditors using affiliated title companies were concerned they would have difficulty meeting the lower threshold for points and fees for qualified mortgages. The Board, however, did not propose to exempt fees paid to creditor-affiliated settlement service providers, noting that Congress appeared to have rejected excluding such fees from points and fees.

Industry commenters criticized the Board's proposed treatment of fees paid to affiliates as overbroad. Industry commenters argued that a creditor's affiliation with a service provider, such as a title insurance agency, does not have any impact on the consumer's ability to repay a loan. They maintained that studies over the past two decades have shown that title services provided by affiliated businesses are competitive in cost compared to services provided by unaffiliated businesses. They contended that the rule should instead focus solely on whether the fee is bona fide.

These commenters also argued that the largest real estate-related charge, title insurance fees, are often either mandated by State law or required to be filed with the relevant state authority and do not vary. Regardless of whether the State sets the rate or requires that the rate be filed, these commenters argued that there are so few insurers that rates tend to be nearly identical among providers.

These commenters also argued that including fees to affiliates would negatively affect consumers. They claimed that the inclusion of fees paid to affiliates would cause loans that would otherwise be qualified mortgages to exceed the points and fees cap, resulting in more expense to the creditor, which would be passed through to consumers in the form of higher interest rates or fees, or in more denials of credit. They also claimed that the proposal would harm consumers by reducing competition among settlement service providers and by eliminating operational efficiencies. One industry trade association reported that some of its members with affiliates would discontinue offering mortgages, which would reduce competition among creditors, especially for creditors offering smaller loans, since these loans would be most affected by the points and fees cap. They claimed that treating affiliated and unaffiliated providers differently would incentivize creditors to use unaffiliated third-party service providers to stay within the qualified mortgage points and fees cap.

Several industry commenters noted that RESPA permits affiliated business arrangements and provides protections for consumers, including a prohibition against requiring that consumers use affiliates, a requirement to disclose affiliation to consumers, and a limitation that compensation include only return on ownership interest. These commenters argued that charges paid to affiliates should be excluded from points and fees as long the RESPA requirements are satisfied. Several industry commenters objected to the requirement that charges be “reasonable” to be excluded from points and fees. They argued that the requirement was vague and that it would be difficult for a creditor to judge whether a third-party charge met the standard. Several commenters also argued that the Dodd-Frank Act provision permitting exclusion of certain bona fide third-party charges should apply rather than the three-part test for items listed in § 1026.4(c)(7). See TILA section 129C(b)(2)(C)(i).

Two consumer advocates commented on this aspect of the proposal. They supported including in points and fees all fees paid to any settlement service provider affiliated with the creditor.

The Bureau is adopting § 226.32(b)(1)(iii) as proposed but renumbered as § 1026.32(b)(1)(iii). TILA section 103(bb)(4) specifically mandates that fees paid to and retained by affiliates of the creditor be included in points and fees. The Bureau acknowledges that including fees paid to affiliates in points and fees could make it more difficult for creditors using affiliated service providers to stay under the points and fees cap for qualified mortgages and that, as a result, creditors could be disincented from using affiliated service providers. This is especially true with respect to affiliated title insurers because of the cost of title insurance. On the other hand, despite RESPA's regulation of fees charged by affiliates, concerns have nonetheless been raised that fees paid to an affiliate pose greater risks to the consumer, since affiliates of a creditor may not have to compete in the market with other providers of a service and thus may charge higher prices that get passed on to the consumer. The Bureau believes that Congress weighed these competing considerations and made a deliberate decision not to exclude fees paid to affiliates. This approach is further reflected throughout title XIV, which repeatedly amended TILA to treat fees paid to affiliates as the equivalent to fees paid to a creditor or loan originator. See, e.g., Dodd-Frank Act sections 1403, 1411, 1412, 1414, and 1431. For example, as noted above, TILA section 129C(b)(2)(C)(i), as added by section 1412 of the Dodd-Frank Act, provides that for purposes of the qualified mortgage points and fees test, bona fide third-party charges are excluded other than charges “retained by * * * an affiliate of the creditor or mortgage originator.” Similarly, TILA section 129B(c)(2)(B)(ii), added by section 1403 of the Dodd-Frank Act, restricts the payment of points and fees but permits the payment of bona fide third-party charges unless those charges are “retained by * * * an affiliate of the creditor or originator.” In light of these considerations, the Bureau does not believe there is sufficient justification to use its exception authority in this instance as the Bureau cannot find, given Congress's clear determination, that excluding affiliate fees from the calculation of points and fees is necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith.

As noted above, some commenters objected to the requirement that charges be “reasonable.” The Bureau notes that a “reasonable” requirement has been in place for many years before the Dodd-Frank Act. TILA section 103(aa)(4)(C) specifically provides that charges listed in TILA section 106(e) are included in points and fees for high-cost mortgages unless, among other things, the charge is reasonable. This requirement is implemented in existing § 1026.32(b)(1)(iii). Similarly, a charge may be excluded from the finance charge under § 1026.4(c)(7) only if it is reasonable. In the absence of any evidence that this requirement has been unworkable, the Bureau declines to alter it. The fact that a transaction for such services is conducted at arms-length ordinarily should be sufficient to make the charge reasonable. The reasonableness requirement is not intended to invite an inquiry into whether a particular appraiser or title insurance company is imposing excessive charges.

Some commenters also maintained that the provision permitting exclusion of certain bona fide third-party charges should apply rather than the three-part test for items listed in § 1026.4(c)(7). See TILA section 129C(b)(2)(C)(i). As discussed in more detail in the section-by-section analysis of § 1026.32(b)(1)(i)(D), the Bureau concludes that § 1026.32(b)(1)(iii), which specifically addresses exclusion of items listed in § 1026.4(c)(7), takes precedence over the more general exclusion in § 1026.32(b)(1)(i)(D).

The Board's proposed comment 32(b)(1)(iii)-1 was substantially the same as existing comment 32(b)(1)(ii)-2. It would have provided an example of the inclusion or exclusion of real-estate related charges. The Bureau did not receive substantial comment on the proposed comment. The Bureau is therefore adopting comment 32(b)(1)(ii)-1 substantially as proposed, with revisions for clarity.

32(b)(1)(iv)

As amended by section 1431 of the Dodd-Frank Act, TILA section 103(bb)(4)(D) includes in points and fees premiums for various forms of credit insurance and charges for debt cancellation or suspension coverage. The Board proposed § 226.32(b)(1)(iv) to implement this provision. The Board also proposed to revise comment 32(b)(1)(iv)-1 to reflect the revised statutory language and to add new comment 32(b)(1)(iv)-2 to clarify that “credit property insurance” includes insurance against loss or damage to personal property such as a houseboat or manufactured home.

Several commenters argued that proposed § 226.32(b)(1)(iv) did not accurately implement the provision in Dodd-Frank Act section 1431 that specifies that “insurance premiums or debt cancellation or suspension fees calculated and paid in full on a monthly basis shall not be considered financed by the creditor.” They argued that comment 32(b)(1)(iv)-1 should be revised so that it expressly excludes monthly premiums for credit insurance from points and fees, including such premiums payable in the first month. At least one industry commenter also argued that voluntary credit insurance premiums should not be included in points and fees. Consumer advocates supported inclusion of credit insurance premiums in points and fees, noting that these services can add significant costs to mortgages.

The Bureau is adopting § 226.32(b)(1)(iv) substantially as proposed, with revisions for clarity, as renumbered § 1026.32(b)(1)(iv). As revised, § 1026.32(b)(1)(iv) states that premiums or other charges for “any other life, accident, health, or loss-of-income insurance” are included in points and fees only if the insurance is for the benefit of the creditor. The Bureau is also adopting proposed comments 32(b)(1)(iv)-1 and -2 substantially as proposed, with revisions for clarity and consistency with terminology in Regulation Z. The Bureau is also adopting new comment 32(b)(1)(iv)-3 to clarify that premiums or other charges for “any other life, accident, health, or loss-of-income insurance” are included in points and fees only if the creditor is a beneficiary of the insurance.

As noted above, several commenters argued that premiums paid monthly, including the first such premium, should not be included in points and fees. The statute requires that premiums “payable at or before closing” be included in points and fees; it provides only that premiums “calculated and paid in full on a monthly basis shall not be considered financed by the creditor.” TILA section 103(bb)(4)(D). Thus, if the first premium is payable at or before closing, that payment is included in points and fees even though the subsequent monthly payments are not.

Another commenter argued that voluntary credit insurance premiums should be excluded from points and fees. However, under the current rule, voluntary credit insurance premiums are included in points and fees. In light of the fact that the Dodd-Frank Act expanded the types of credit insurance that must be included in points and fees, the Bureau does not believe it would be appropriate to reconsider whether voluntary credit insurance premiums should be included in points and fees.

32(b)(1)(v)

As added by the Dodd-Frank Act, new TILA section 103(bb)(4)(E) includes in points and fees “the maximum prepayment penalties which may be charged or collected under the terms of the credit transaction.” The Board's proposed § 226.32(b)(1)(v) closely tracked the statutory language, but it cross-referenced proposed § 226.43(b)(10) for the definition of “prepayment penalty.”

Few commenters addressed this provision. One industry commenter argued that the maximum prepayment penalty should not be included in points and fees because a prepayment that triggers the penalty may never occur and thus the fee may never be assessed.

The Bureau is adopting § 226.32(b)(1)(v) substantially as proposed but renumbered as § 1026.32(b)(1)(v), with a revision to its definitional cross-reference. As revised, § 1026.32(b)(1)(v) refers to the definition of prepayment penalty in § 1026.32(b)(6)(i). With respect to the comment arguing that prepayment penalties should not be included in points and fees, the statute requires inclusion in points and fees of the maximum prepayment penalties that “may be charged or collected.” Thus, under the statutory language, the imposition of the charge need not be certain for the prepayment penalty to be included in points and fees. In this provision (and other provisions added by the Dodd-Frank Act, such as TILA section 129C(c)), Congress sought to limit and deter the use of prepayment penalties, and the Bureau does not believe that it would be appropriate to exercise its exception authority in a manner that could undermine that goal.

32(b)(1)(vi)

New TILA section 103(bb)(4)(F) requires that points and fees include “all prepayment fees or penalties that are incurred by the consumer if the loan refinances a previous loan made or currently held by the same creditor or an affiliate of the creditor.” The Board's proposed § 226.32(b)(1)(vi) would have implemented this provision by including in points and fees the total prepayment penalty, as defined in § 226.43(b)(10), incurred by the consumer if the mortgage loan is refinanced by the current holder of the existing mortgage loan, a servicer acting on behalf of the current holder, or an affiliate of either. The Board stated its belief that this provision is intended in part to curtail the practice of “loan flipping,” which involves a creditor refinancing an existing loan for financial gain resulting from prepayment penalties and other fees that a consumer must pay to refinance the loan—regardless of whether the refinancing is beneficial to the consumer. The Board noted that it departed from the statutory language to use the phrases “current holder of the existing mortgage loan” and “servicer acting on behalf of the current holder” in proposed § 226.32(b)(1)(vi) because, as a practical matter, these are the entities that would refinance the loan and directly or indirectly gain from associated prepayment penalties.

Few commenters addressed this provision. Two consumer groups expressed support for including these prepayment penalties in points and fees, arguing that many consumers were victimized by loan flipping and the resulting fees and charges.

The Bureau is adopting § 226.32(b)(1)(vi) substantially as proposed but renumbered as § 1026.32(b)(1)(vi). In addition to revising for clarity, the Bureau has also revised § 1026.32(b)(1)(vi) to refer to the definition of prepayment penalty in § 1026.32(b)(6)(i). Like the Board, the Bureau believes that it is appropriate for § 1026.32(b)(1)(vi) to apply to the current holder of the existing mortgage loan, the servicer acting on behalf of the current holder, or an affiliate of either. These are the entities that would refinance the loan and gain from the prepayment penalties on the previous loan. Accordingly, the Bureau is invoking its exception and adjustment authority under TILA sections 105(a) and 129C(b)(3)(B)(i). The Bureau believes that adjusting the statutory language to more precisely target the entities that would benefit from refinancing loans with prepayment penalties will more effectively deter loan flipping to collect prepayment penalties and help preserve consumers' access to safe, affordable credit. It also will lessen the compliance burden on other entities that lack the incentive for loan flipping, such as a creditor that originated the existing loan but no longer holds the loan. For these reasons, the Bureau believes that use of its exception and adjustment authority is necessary and proper under TILA section 105(a) to effectuate the purposes of TILA and to facilitate compliance with TILA and its purposes, including the purpose of assuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans. Similarly, the Bureau finds that it is necessary, proper, and appropriate to use its authority under TILA section 129C(b)(3)(B)(i) to revise and subtract from statutory language. This use of authority ensures that responsible, affordable mortgage credit remains available to consumers in a manner consistent with and effectuates the purpose of TILA section 129C, referenced above, and facilitates compliance with section 129C of TILA.

32(b)(2)

Proposed Provisions Not Adopted

As noted in the section-by-section analysis of § 1026.32(b)(1)(ii) above, section 1431(c) of the Dodd-Frank Act amended TILA to require that all compensation paid directly or indirectly by a consumer or a creditor to a “mortgage originator” be included in points and fees for high-cost mortgages and qualified mortgages. As also noted above, the Board's 2011 ATR Proposal proposed to implement this statutory change in proposed § 226.32(b)(1)(ii) using the term “loan originator,” as defined in existing § 1026.36(a)(1), rather than the statutory term “mortgage originator.” In turn, the Board proposed new § 226.32(b)(2) to exclude from points and fees compensation paid to certain categories of persons specifically excluded from the definition of “mortgage originator” in amended TILA section 103, namely employees of a retailer of manufactured homes under certain circumstances, certain real estate brokers, and servicers.

The Bureau is not adopting proposed § 226.32(b)(2). The Bureau is amending the definition of “loan originator” § 1026.36(a)(1) and the associated commentary to incorporate the statutory exclusion of these persons from the definition. Accordingly, to the extent these persons are excluded from the definition of loan originator compensation, their compensation is not loan originator compensation that must be counted in points and fees, and the exclusions in proposed § 226.32(b)(2) are no longer necessary.

Instead, in the 2013 HOEPA Final Rule, the Bureau is finalizing the definition of points and fees for HELOCs in § 1026.32(b)(2). Current § 1026.32(b)(2), which contains the definition of “affiliate,” is being renumbered as § 1026.32(b)(5).

32(b)(3) Bona Fide Discount Point

32(b)(3)(i) Closed-End Credit

The Dodd-Frank Act defines the term “bona fide discount points” as used in § 1026.32(b)(1)(i)(E) and (F), which, as discussed above, permit exclusion of “bona fide discount points” from points and fees for qualified mortgages. TILA section 129C(b)(2)(C)(iii) defines the term “bona fide discount points” as “loan discount points which are knowingly paid by the consumer for the purpose of reducing, and which in fact result in a bona fide reduction of, the interest rate or time-price differential applicable to the mortgage.” TILA section 129C(b)(2)(C)(iv) limits the types of discount points that may be excluded from “points and fees” to those for which “the amount of the interest rate reduction purchased is reasonably consistent with established industry norms and practices for secondary market transactions.”

Proposed § 226.43(e)(3)(iv) would have implemented these provisions by defining the term “bona fide discount point” as “any percent of the loan amount” paid by the consumer that reduces the interest rate or time-price differential applicable to the mortgage loan by an amount based on a calculation that: (1) Is consistent with established industry practices for determining the amount of reduction in the interest rate or time-price differential appropriate for the amount of discount points paid by the consumer; and (2) accounts for the amount of compensation that the creditor can reasonably expect to receive from secondary market investors in return for the mortgage loan.

The Board's proposal would have required that the creditor be able to show a relationship between the amount of interest rate reduction purchased by a discount point and the value of the transaction in the secondary market. The Board observed that, based on outreach with representatives of creditors and GSEs, the value of a rate reduction in a particular mortgage transaction on the secondary market is based on many complex factors, which interact in a variety of complex ways. The Board noted that these factors may include, among others:

  • The product type, such as whether the loan is a fixed-rate or adjustable-rate mortgage, or has a 30-year term or a 15-year term.
  • How much the MBS market is willing to pay for a loan at that interest rate and the liquidity of an MBS with loans at that rate.
  • How much the secondary market is willing to pay for excess interest on the loan that is available for capitalization outside of the MBS market.
  • The amount of the guaranty fee required to be paid by the creditor to the investor.

The Board indicated that it was offering a flexible proposal because of its concern that a more prescriptive interpretation would be operationally unworkable for most creditors and would lead to excessive legal and regulatory risk. In addition, the Board also noted that, due to the variation in inputs described above, a more prescriptive rule likely would require continual updating, creating additional compliance burden and potential confusion.

The Board also noted a concern that small creditors such as community banks that often hold loans in portfolio rather than sell them on the secondary market may have difficulty complying with this requirement. The Board therefore requested comment on whether it would be appropriate to provide any exemptions from the requirement that the interest rate reduction purchased by a “bona fide discount point” be tied to secondary market factors.

Many industry commenters criticized the second prong of the Board's proposal, which would have required that the interest rate reduction account for the amount of compensation that the creditor can reasonably expect to receive from secondary market investors in return for the mortgage loan. Several industry commenters argued that this test would be complex and difficult to apply and that, if challenged, it would be difficult for creditors to prove that the calculation was done properly. Two industry commenters noted that creditors do not always sell or plan to sell loans in the secondary market at the time of origination and so would not know what compensation they would receive on the secondary market. Several industry commenters emphasized that the secondary market test would be impracticable for creditors holding loans in portfolio. Consumer groups did not comment on this issue.

As noted above, the Bureau is consolidating the exclusions for certain bona fide third-party charges and bona fide discount points in § 1026.32(b)(1)(i)(D) through (F). As a result, the Bureau is adopting proposed § 226.43(e)(3)(iv), with the revision discussed below, as renumbered § 1026.32(b)(3)(i). In the 2013 HOEPA Final Rule, the Bureau is adopting a definition of bona fide discount point for open-end credit in § 1026.32(b)(3)(ii).

After carefully considering the comments, the Bureau is modifying the definition of “bona fide discount point.” Specifically, the Bureau believes it would be difficult, if not impossible, for many creditors to account for the secondary market compensation in calculating interest rate reductions. This is particularly true for loans held in portfolio. Therefore, the Board is removing from § 1026.32(b)(3)(i) the requirement that interest rate reductions take into account secondary market compensation. Instead, as revised, § 1026.32(b)(3)(i) requires only that the calculation of the interest rate reduction be consistent with established industry practices for determining the amount of reduction in the interest rate or time-price differential appropriate for the amount of discount points paid by the consumer.

The Bureau finds that removing the secondary market component of the “bona fide” discount point definition is necessary and proper under TILA section 105(a) to effectuate the purposes of and facilitate compliance with TILA. Similarly, the Bureau finds that it is necessary and proper to use its authority under TILA section 129C(b)(3)(B)(i) to revise and subtract from the criteria that define a qualified mortgage by removing the secondary market component from the bona fide discount point definition. It will provide creditors sufficient flexibility to demonstrate that they are in compliance with the requirement that, to be excluded from points and fees, discount points must be bona fide. In clarifying the definition, it also will facilitate the use of bona fide discount points by consumers to help create the appropriate combination of points and rate for their financial situation, thereby helping ensure that consumers are offered and receive residential mortgage loan on terms that reasonably reflect their ability to repay the loans and that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of TILA as provided in TILA section 129C.

To provide some guidance on how creditors may comply with this requirement, the Bureau is adding new comment 32(b)(3)(i)-1. This comment explains how creditors can comply with “established industry practices” for calculating interest rate reductions. Specifically, comment 32(b)(3)(i)-1 notes that one way creditors can satisfy this requirement is by complying with established industry norms and practices for secondary mortgage market transactions. Comment 32(b)(3)(i)-1 then provides two examples. First a creditor may rely on pricing in the to-be-announced (TBA) market for MBS to establish that the interest rate reduction is consistent with the compensation that the creditor could reasonably expect to receive in the secondary market. Second, a creditor could comply with established industry practices, such as guidelines from Fannie Mae or Freddie Mac that prescribe when an interest rate reduction from a discount point is considered bona fide. However, because these examples from the secondary market are merely illustrations of how a creditor could comply with the “established industry practices” requirement for bona fide interest rate reduction, creditors, and in particular creditors that retain loans in portfolio, will have flexibility to use other approaches for complying with this requirement.

32(b)(4) Total Loan Amount

32(b)(4)(i) Closed-End Credit

As added by section 1412 of the Dodd-Frank Act, TILA section 129C(b)(2)(A)(vii) defines a “qualified mortgage” as a mortgage for which, among other things, “the total points and fees * * * payable in connection with the loan do not exceed 3 percent of the total loan amount.” For purposes of implementing the qualified mortgage provisions, the Board proposed to retain existing comment 32(a)(1)(ii)-1 explaining the meaning of the term “total loan amount,” with certain minor revisions discussed below, while also seeking comment on an alternative approach.

The proposal would have revised the “total loan amount” calculation under current comment 32(a)(1)(ii)-1 to account for charges added to TILA's definition of points and fees by the Dodd-Frank Act. Under Regulation Z for purposes of applying the existing points and fees trigger for high-cost loans, the “total loan amount” is calculated as the amount of credit extended to or on behalf of the consumer, minus any financed points and fees. Specifically, under current comment 32(a)(1)(ii)-1, the “total loan amount” is calculated by “taking the amount financed, as determined according to § 1026.18(b), and deducting any cost listed in § 1026.32(b)(1)(iii) and § 1026.32(b)(1)(iv) that is both included as points and fees under § 1026.32(b)(1) and financed by the creditor.” Section 1026.32(b)(1)(iii) and (b)(1)(iv) pertain to “real estate-related fees” listed in § 1026.4(c)(7) and premiums or other charges for credit insurance or debt cancellation coverage, respectively.

The Board proposed to revise this comment to cross-reference additional financed points and fees described in proposed § 226.32(b)(1)(vi) as well. This addition would have required a creditor also to deduct from the amount financed any prepayment penalties that are incurred by the consumer if the mortgage loan refinances a previous loan made or currently held by the creditor refinancing the loan or an affiliate of the creditor—to the extent that the prepayment penalties are financed by the creditor. As a result, the 3 percent limit on points and fees for qualified mortgages would have been based on the amount of credit extended to the consumer without taking into account any financed points and fees.

The Board's proposal also would have revised one of the commentary's examples of the “total loan amount” calculation. Specifically, the Board proposed to revise the example of a $500 single premium for optional “credit life insurance” used in comment 32(b)(1)(i)-1.iv to be a $500 single premium for optional “credit unemployment insurance.” The Board stated that this change was proposed because, under the Dodd-Frank Act, single-premium credit insurance—including credit life insurance—is prohibited in covered transactions except for certain limited types of credit unemployment insurance. See TILA section 129C(d). The Board requested comment on the proposed revisions to the comment explaining how to calculate the “total loan amount,” including whether additional guidance is needed.

The Board also requested comment on whether to streamline the calculation to ensure that the “total loan amount” would include all credit extended other than financed points and fees. Specifically, the Board solicited comment on whether to revise the calculation of “total loan amount” to be the “principal loan amount” (as defined in § 226.18(b) and accompanying commentary), minus charges that are points and fees under § 226.32(b)(1) and are financed by the creditor. The Board explained that the purpose of using the “principal loan amount” instead of the “amount financed” would be to streamline the calculation to facilitate compliance and to ensure that no charges other than financed points and fees are excluded from the “total loan amount.” [85] In general, the revised calculation would have yielded a larger “total loan amount” to which the percentage points and fees thresholds would have to be applied than would the proposed (and existing) “total loan amount” calculation, because only financed points and fees and no other financed amounts would be excluded. Thus, creditors in some cases would be able to charge more points and fees on the same loan under the alternative outlined by the Board than under either the proposed or existing rule.

In the 2012 HOEPA Proposal, the Bureau proposed the following for organizational purposes: (1) To move the existing definition of “total loan amount” for closed-end mortgage loans from comment 32(a)(1)(ii)-1 to proposed § 1026.32(b)(6)(i); and (2) to move the examples showing how to calculate the total loan amount for closed-end mortgage loans from existing comment 32(a)(1)(ii)-1 to proposed comment 32(b)(6)(i)-1. The Bureau proposed to specify that the calculation applies to closed-end mortgage loans because the Bureau also proposed to define “total loan amount” separately for open-end credit plans. The Bureau also proposed to amend the definition of “total loan amount” in a manner similar to the Board's alternative proposal described above. The Bureau indicated this proposed revision would streamline the total loan amount calculation to facilitate compliance and would be sensible in light of the more inclusive definition of the finance charge proposed in the Bureau's 2012 TILA-RESPA Integration Proposal.

Few commenters addressed the Board's proposal regarding total loan amount. Several industry commenters recommended that the alternative method of calculating total loan amount be used because it would be easier to calculate. At least two industry commenters recommended that, for simplicity, the amount recited in the note be used for calculating the permitted points and fees.

After reviewing the comments, the Bureau is following the 2012 HOEPA Proposal and moving the definition of total loan amount into the text of the rule in § 1026.32(b)(4)(i). In 2013 HOEPA Final Rule, the Bureau is adopting a definition of total loan amount for open-end credit in § 1026.32(b)(4)(ii). The examples showing how to calculate the total loan amount are moved to comment 32(b)(4)(i)-1. However, the Bureau has concluded that, at this point, the current approach to calculating the total loan amount should remain in place. Creditors are familiar with the method from using it for HOEPA points and fees calculations. Moreover, as noted above, the Bureau is deferring action on the more inclusive definition of the finance charge proposed in the Bureau's 2012 TILA-RESPA Integration Proposal. If the Bureau expands the definition of the finance charge, the Bureau will at the same time consider the effect on coverage thresholds that rely on the finance charge or the APR.

32(b)(5)

The final rule renumbers existing § 1026.32(b)(2) defining the term “affiliate” as § 1026.32(b)(5) for organizational purposes.

32(b)(6) Prepayment Penalty

The Dodd-Frank Act's Amendments to TILA Relating to Prepayment Penalties

Sections 1431 and 1432 of the Dodd-Frank Act (relating to high-cost mortgages) and section 1414 of the Dodd-Frank Act (relating to qualified mortgages) amended TILA to restrict and, in many cases, prohibit a creditor from imposing prepayment penalties in dwelling-secured credit transactions. The Dodd-Frank Act restricted prepayment penalties in three main ways.

First, as the Board discussed in its 2011 ATR Proposal, the Dodd-Frank Act added new TILA section 129C(c)(1) relating to qualified mortgages, which generally provides that a covered transaction (i.e., in general, a closed-end, dwelling-secured credit transaction) may include a prepayment penalty only if it; (1) Is a qualified mortgage, to be defined by the Board, (2) has an APR that cannot increase after consummation, and (3) is not a higher-priced mortgage loan. The Board proposed to implement TILA section 129C(c)(1) in § 226.43(g)(1) and to define the term prepayment penalty in § 226.43(b)(10). Under new TILA section 129C(c)(3), moreover, even loans that meet the statutorily prescribed criteria (i.e., fixed-rate, non-higher-priced qualified mortgages) are capped in the amount of prepayment penalties that may be charged, starting at three percent in the first year after consummation and decreasing annually by increments of one percentage point thereafter so that no penalties may be charged after the third year. The Board proposed to implement TILA section 129C(c)(3) in § 226.43(g)(2).

Second, section 1431(a) of the Dodd-Frank Act amended TILA section 103(bb)(1)(A)(iii) to provide that a credit transaction is a high-cost mortgage if the credit transaction documents permit the creditor to charge or collect prepayment fees or penalties more than 36 months after the transaction closing or if such fees or penalties exceed, in the aggregate, more than two percent of the amount prepaid. Moreover, under amended TILA section 129(c)(1), high-cost mortgages are prohibited from having a prepayment penalty. Accordingly, any prepayment penalty in excess of two percent of the amount prepaid on any closed end mortgage would both trigger and violate the rule's high-cost mortgage provisions. The Bureau's 2012 HOEPA Proposal proposed to implement these requirements with several minor clarifications in § 1026.32(a)(1)(iii). See 77 FR 49090, 49150 (Aug. 15, 2012).

Third, both qualified mortgages and most closed-end mortgage loans and open-end credit plans secured by a consumer's principal dwelling are subject to additional limitations on prepayment penalties through the inclusion of prepayment penalties in the definition of points and fees for qualified mortgages and high-cost mortgages. See the section-by-section analysis of proposed § 226.32(b)(1)(v) and (vi); 77 FR 49090, 49109-10 (Aug. 15, 2012).

Taken together, the Dodd-Frank Act's amendments to TILA relating to prepayment penalties mean that most closed-end, dwelling-secured transactions: (1) May provide for a prepayment penalty only if the transaction is a fixed-rate, qualified mortgage that is neither high-cost nor higher-priced under §§ 1026.32 and 1026.35; (2) may not, even if permitted to provide for a prepayment penalty, charge the penalty more than three years following consummation or in an amount that exceeds two percent of the amount prepaid; and (3) may be required to limit any penalty even further to comply with the points and fees limitations for qualified mortgages or to stay below the points and fees trigger for high-cost mortgages.

In the interest of lowering compliance burden and to provide additional clarity for creditors, the Bureau has elected to define prepayment penalty in a consistent manner for purposes of all of the Dodd-Frank Act's amendments. This definition is located in § 1026.32(b)(6). New § 1026.43(b)(10) cross-references this prepayment definition to provide consistency.

TILA establishes certain disclosure requirements for transactions for which a penalty is imposed upon prepayment, but TILA does not define the term “prepayment penalty.” The Dodd-Frank Act also does not define the term. TILA section 128(a)(11) requires that the transaction-specific disclosures for closed-end consumer credit transactions disclose a “penalty” imposed upon prepayment in full of a closed-end transaction, without using the term “prepayment penalty.” 15 U.S.C. 1638(a)(11). [86] Comment 18(k)(1)-1 clarifies that a “penalty” imposed upon prepayment in full is a charge assessed solely because of the prepayment of an obligation and includes, for example, “interest” charges for any period after prepayment in full is made and a minimum finance charge.

The Board's 2011 ATR Proposal proposed to implement the Dodd-Frank Act's prepayment penalty-related amendments to TILA for qualified mortgages by defining “prepayment penalty” for most closed-end, dwelling-secured transactions in new § 226.43(b)(10), and by cross-referencing proposed § 226.43(b)(10) in the proposed joint definition of points and fees for qualified and high-cost mortgages in § 226.32(b)(1)(v) and (vi). The definition of prepayment penalty proposed in the Board's 2011 ATR Proposal differed from the Board's prior proposals and existing guidance in the following respects: (1) Proposed § 226.43(b)(10) defined prepayment penalty with reference to a payment of “all or part of” the principal in a transaction covered by the provision, while § 1026.18(k) and associated commentary and the Board's 2009 Closed-End Proposal and 2010 Mortgage Proposal referred to payment “in full;” (2) the examples provided omitted reference to a minimum finance charge and loan guarantee fees; and (3) proposed § 226.43(b)(10) did not incorporate, and the Board's 2011 ATR Proposal did not otherwise address, the language in § 1026.18(k)(2) and associated commentary regarding disclosure of a rebate of a precomputed finance charge, or the language in § 1026.32(b)(6) and associated commentary concerning prepayment penalties for high-cost mortgages.

The Board proposal generally received support from industry commenters and consumer advocates for accurately implementing section 129C(c) by using a plain language definition of prepayment penalty. Many commenters, particularly consumer groups, supported a rule that eliminates or tightly restricts the availability of prepayment penalties. Some industry commenters, however, cautioned the Bureau against implementing an overbroad definition of prepayment penalty, citing primarily a concern over consumers' access to credit. At least one commenter argued that a prepayment penalty ban should be more narrowly focused on the subprime loan market, noting that the proposal affected prepayment penalties on a wider variety of products. Other industry commenters expressed a concern about the Board's approach to the monthly interest accrual amortization method, as discussed in more detail below as part of the discussion of comment 32(b)(6)-1.

The Bureau adopts the definition of prepayment penalty under § 1026.32(b)(6) largely as proposed by the Board in order to create a clear application of the term prepayment penalty that is consistent with the definitions proposed in the Bureau's 2012 TILA-RESPA Proposal (which itself draws from the definition adopted in the Bureau's 2013 HOEPA Final Rule). However, the Bureau adds to § 1026.32(b)(6) an explicit exclusion from the definition of prepayment penalty for a waived bona fide third-party charge that the creditor imposes if the consumer, sooner than 36 months after consummation, pays all of a covered transaction's principal before the date on which the principal is due. This addition is discussed in detail below. Consistent with TILA section 129(c)(1), existing § 1026.32(d)(6), and the Board's proposed § 226.43(b)(10) for qualified mortgages, § 1026.32(b)(6)(i) provides that, for a closed-end mortgage loan, a “prepayment penalty” means a charge imposed for paying all or part of the transaction's principal before the date on which the principal is due, though the Bureau has added a carve-out from this definition to accommodate the repayment of certain conditionally waived closing costs when the consumer prepays in full. The Bureau adopts this definition of prepayment penalty under § 1026.32(b)(6), rather than under § 1026.43(b)(10), to facilitate compliance for creditors across rulemakings. The definition of “prepayment penalty” under § 1026.32(b)(6) thus will apply to prepayment penalty restrictions, as applied under § 1026.43(g). Section 1026.32(b)(6) also contains requirements and guidance related to the Bureau's 2013 HOEPA Final Rule, such as a definition of prepayment penalty that applies to open-end credit.

The Board's 2011 ATR Proposal included as an example of a prepayment penalty a fee that the creditor waives unless the consumer prepays the covered transaction. Some industry commenters contended that such conditional fee waivers should be excluded from the definition of prepayment penalties. The commenters argued that creditors imposed conditional fee waivers not to increase profit, but to ensure compensation for fixed costs associated with originating the loan. At least one commenter directed the Bureau to a 1996 National Credit Union Administration opinion letter that concluded that a conditional waiver of closing costs by a credit union was a benefit to the consumer. Other comments characterized the conditional fee waiver as a “reimbursement,” rather than compensation.

The Bureau finds such comments persuasive, particularly with respect to a situation in which the creditor waives a bona fide third-party charge (or charges) on condition that the consumer reimburse the creditor for the cost of that charge if the consumer prepays the loan. In such situations, the Bureau recognizes that the creditor receives no profit from imposing or collecting such charges and the Bureau believes that treating such charges as a prepayment penalty might very well have the effect of reducing consumer choice without providing any commensurate consumer benefit. In an effort to provide a sensible way to permit a creditor to protect itself from losing money paid at closing to third parties on the consumer's behalf, prior to such time as the creditor can otherwise recoup such costs through the interest rate on the mortgage loan, while balancing consumer protection interests, the Bureau has concluded that such fees should be permissible for a limited time after consummation. The Bureau thus adopts § 1032(b)(6)(i) to clarify that the term prepayment penalty does not include a waived bona fide third-party charge imposed by the creditor if the consumer pays all of a covered transaction's principal before the date on which the principal is due sooner than 36 months after consummation. The Bureau concludes that limiting the duration of the possible charge to 36 months after consummation is consistent with TILA 129C(c)(3)(D), which prohibits any prepayment penalty three years after loan consummation, while accommodating the concerns discussed above. Moreover, § 1032(b)(6)(i) excludes from the definition of prepayment penalty only those charges that a creditor imposes to recoup waived bona-fide third party charges in such cases where the consumer prepays in full. Thus, for example, if one month after loan consummation, the consumer prepays $100 of principal earlier than it is due, where the total principal is $100,000, then any fee that the creditor imposes for such prepayment is a prepayment penalty under § 1032(b)(6)(i) and such a fee is restricted in accordance with § 1026.43(g).

The Bureau believes that § 1026.32(b)(6) accurately implements TILA section 129C(c), which significantly limits the applicability and duration of prepayment penalties. Some commenters argued that restrictions on prepayment penalties should be more narrowly focused on specific products or consumers, because not all consumers need protection from the pitfalls of prepayment penalties. The Bureau agrees that prepayment penalties are not always harmful to consumers and that, in some cases, allowing a creditor to charge a prepayment penalty may lead to increased consumer choice and access to credit. Congress recognized this balance by allowing a creditor to charge a prepayment penalty only in certain circumstances, such as requiring the loan to be a qualified mortgage, under TILA section 129C(c)(1)(A), and by limiting a creditor to charging a prepayment penalty to no more than three years following consummation, under TILA section 129C(c)(3)(D). Section 1026.32(b)(6) remains faithful to that balance, with the Bureau's minor clarification with respect to waived bona fide third party charges, as described above.

The Board's 2011 ATR Proposal included several other examples of a prepayment penalty under proposed § 226.43(b)(10)(i). For clarity, the Bureau incorporates these examples as comment 32(b)(6)-1.i and ii, and the Bureau is adding comment 32(b)(6)-1.iii and iv to provide additional clarity. Likewise, the Bureau is largely adopting the Board's proposed § 226.43(b)(10)(ii), an example of what is not a prepayment penalty, as comment 32(b)(6)-3.i, as well as adding comment 32(b)(6)-3.ii.

Comment 32(b)(6)-1.i through iv gives the following examples of prepayment penalties: (1) A charge determined by treating the loan balance as outstanding for a period of time after prepayment in full and applying the interest rate to such “balance,” even if the charge results from interest accrual amortization used for other payments in the transaction under the terms of the loan contract; (2) a fee, such as an origination or other loan closing cost, that is waived by the creditor on the condition that the consumer does not prepay the loan; (3) a minimum finance charge in a simple interest transaction; and (4) computing a refund of unearned interest by a method that is less favorable to the consumer than the actuarial method, as defined by section 933(d) of the Housing and Community Development Act of 1992, 15 U.S.C. 1615(d).

Post-payoff interest charges. The Board proposal included as an example of a prepayment penalty in proposed § 226.43(b)(10)(i)(A) a charge determined by the creditor or servicer treating the loan balance as outstanding for a period of time after prepayment in full. Some industry commenters expressed reservations about treating this monthly interest accrual amortization method as a prepayment penalty, arguing that such a rule might cause higher resale prices in the secondary mortgage market to account for cash flow uncertainty. Other commenters noted that this calculation method is currently used by FHA to compute interest on its loans (including loans currently in Ginnie Mae pools), or that such charges were not customarily considered a prepayment penalty. Some commenters expressed concern that the rule would disrupt FHA lending.

After careful consideration of the comments received, the Bureau concludes that going forward (e.g., for loans a creditor originates after the effective date), it is appropriate to designate higher interest charges for consumers based on accrual methods that treat a loan balance as outstanding for a period of time after prepayment in full as prepayment penalties under § 1026.32(b)(6) and comment 32(b)(6)-1.i. In such instances, the consumer submits a payment before it is due, but the creditor nonetheless charges interest on the portion of the principal that the creditor has already received. The Bureau believes that charging a consumer interest after the consumer has repaid the principal is the functional equivalent of a prepayment penalty. Comment 32(b)(6)-1.i further clarifies that “interest accrual amortization” refers to the method by which the amount of interest due for each period (e.g., month) in a transaction's term is determined and notes, for example, that “monthly interest accrual amortization” treats each payment as made on the scheduled, monthly due date even if it is actually paid early or late (until the expiration of any grace period). The proposed comment also provides an example where a prepayment penalty of $1,000 is imposed because a full month's interest of $3,000 is charged even though only $2,000 in interest was earned in the month during which the consumer prepaid.

With respect to FHA practices relating to monthly interest accrual amortization, the Bureau has consulted extensively with HUD in issuing this final rule as well as the 2013 HOEPA Final Rule. Based on these consultations, the Bureau understands that HUD must engage in rulemaking to end its practice of imposing interest charges on consumers for the balance of the month in which consumers prepay in full. The Bureau further understands that HUD requires approximately 24 months to complete its rulemaking process. Accordingly, in recognition of the important role that FHA-insured credit plays in the current mortgage market and to facilitate FHA creditors' ability to comply with this aspect of the 2013 ATR and HOEPA Final Rules, the Bureau is using its authority under TILA section 105(a) to provide for optional compliance until January 15, 2015 with § 1026.32(b)(6)(i) and the official interpretation of that provision in comment 32(b)(6)-1.i regarding monthly interest accrual amortization. Specifically, § 1026.32(b)(6)(i) provides that interest charged consistent with the monthly interest accrual amortization method is not a prepayment penalty for FHA loans consummated before January 21, 2015. FHA loans consummated on or after January 21, 2015 must comply with all aspects of the final rule. The Bureau is making this adjustment pursuant to its authority under TILA section 105(a), which provides that the Bureau's regulations may contain such additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions as in the Bureau's judgment are necessary or proper to effectuate the purposes of TILA, prevent circumvention or evasion thereof, or facilitate compliance therewith. 15 U.S.C. 1604(a). The purposes of TILA include the purposes that apply to 129C, to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loan. See 15 U.S.C. 1639b(a)(2). The Bureau believes it is necessary and proper to make this adjustment to ensure that consumers receive loans on affordable terms and to facilitate compliance with TILA and its purposes while mitigating the risk of disruption to the market. For purposes of this rulemaking, the Bureau specifically notes that the inclusion of interest charged consistent with the monthly interest accrual amortization method in the definition of prepayment penalty for purposes of determining whether a transaction is in compliance with the requirements of § 1026.43(g) applies only to transactions consummated on or after January 10, 2014; for FHA loans, compliance with this aspect of the definition of prepayment penalties is optional for transactions consummated prior to January 21, 2015.

With regard to general concerns that loans subject to these interest accrual methods may be subject to higher prices on the secondary market, the Bureau is confident that the secondary market will be able to price the increased risk of prepayment, if any, that may occur as a result of the limits that will apply to monthly interest accrual amortization-related prepayment penalties. The secondary market already does so for various other types of prepayment risk on investor pools, such as the risk of refinancing or sale of the property.

Comment 32(b)(6)-1.ii further explains the 36 month carve-out for a waived bona fide third-party charge imposed by the creditor if the consumer pays all of a covered transaction's principal before the date on which the principal is due sooner than 36 months after consummation, as included in § 1026.32(b)(6)(i). The comment explains that if a creditor waives $3,000 in closing costs to cover bona fide third party charges but the terms of the loan agreement provide that the creditor may recoup $4,500, in part to recoup waived charges, then only $3,000 that the creditor may impose to cover the waived bona fide third party charges is considered not to be a prepayment penalty, while any additional $1,500 charge for prepayment is a prepayment penalty and subject to the restrictions under § 1026.43(g). This comment also demonstrates that the only amount excepted from the definition of prepayment penalty under § 1026.32(b)(6)(i) is the actual amount that the creditor pays to a third party for a waived, bona fide charge.

Minimum finance charges; unearned interest refunds. Although longstanding Regulation Z commentary has listed a minimum finance charge in a simple interest transaction as an example of a prepayment penalty, the Board proposed to omit that example from proposed § 226.43(b)(10) because the Board reasoned that such a charge typically is imposed with open-end, rather than closed-end, transactions. The Bureau did not receive substantial comment on this omission, but the Bureau has elected to continue using this example in comment 32(b)(6)-1.iii for consistency. Likewise, the Board did not propose to include the example of computing a refund of unearned interest by a method that is less favorable to the consumer than the actuarial method, but the Bureau is nonetheless using this example in comment 32(b)(6)-1.iv because similar language is found in longstanding Regulation Z commentary.

Examples of fees that are not prepayment penalties. The Board included in proposed § 226.43(b)(10)(ii) an example of a fee not considered a prepayment penalty. For the sake of clarity, the Bureau is moving this example into comment 32(b)(6)-2.i, rather than keep the example in the text of the regulation. The Bureau also is adding a second example in comment 32(b)(6)-2.ii.

Comment 32(b)(6)-2.i explains that fees imposed for preparing and providing documents when a loan is paid in full are not prepayment penalties when such fees are imposed whether or not the loan is prepaid or the consumer terminates the plan prior to the end of its term. Commenters did not provide substantial feedback on this example, which the Bureau has reworded slightly from the Board proposal to provide conformity and clarity.

The Board proposed omitting text from preexisting commentary on Regulation Z stating that a prepayment penalty did not include loan guarantee fees, noting that loan guarantee fees are not charges imposed for paying all or part of a loan's principal before the date on which the principal is due. The Bureau did not receive substantial comment on this omission. While the Bureau agrees with the Board's analysis, the Bureau nonetheless elects to include this example in comment 43(b)(6)-2.ii to clarify that loan guarantee fees continue to fall outside the definition of a prepayment penalty. Moreover, including this example of a fee that is not a prepayment penalty is consistent with the Bureau's efforts to streamline definitions and ease regulatory burden.

Construction-to-permanent financing. Some industry commenters advocated that, for construction-to-permanent loans, the Bureau should exclude from the definition of prepayment penalty charges levied by a creditor if a consumer does not convert the construction loan into a permanent loan with the same creditor within a specified time period. The Bureau believes that the concern expressed by these commenters that the cost of credit for these construction-to-permanent loans would increase if such charges were treated as prepayment penalties is misplaced primarily because in many cases, such charges are not, in fact, a prepayment penalty. A prepayment penalty is “a charge imposed for paying all or part of a covered transaction's principal before the date on which the principal is due.” First, the case where the creditor charges the consumer a fee for failing to convert a loan within a specified period after completing the repayment of a construction loan as scheduled is not a prepayment penalty; the fee is not assessed for an early payment of principal, but rather for the consumer's failure to take an action upon scheduled repayment of principal. Second, the case where a consumer does convert the construction loan to a permanent loan in a timely manner, but incurs a fee for converting the loan with another creditor, is also likely not prepayment penalty. While such cases depend highly on contractual wording, in the example above, the consumer is charged a fee not for his early payment of principal, but rather for his use of another creditor. Third, the case where the creditor charges the consumer a fee for converting the construction loan to a permanent loan earlier than specified by agreement, even with the same creditor, likely is a prepayment penalty. While this example is not the same as the hypothetical described by most commenters, who expressed concern if a consumer does not convert the construction loan into a permanent loan with the same creditor within a specified time period, this is an example of a prepayment penalty, as the creditor has imposed a charge for paying all or part of a covered transaction's principal before the date on which the principal was due. As the above examples demonstrate, whether a construction-to-permanent loan contains a prepayment penalty is fact-specific, and the Bureau has decided that adding a comment specifically addressing such loans would not be instructive. The Bureau sees no policy reason to generally exclude fees specific to construction-to-permanent loan from the definition of prepayment penalty and its statutory limits. The Bureau was not presented with any evidence that the risks inherent in construction-to-permanent loans could not be priced by creditors through alternative means, such as the examples described above, via interest rate, or charging closing costs. The Bureau also notes that, because of the scope of the rule, described in the section-by-section analysis of § 1026.43(a), as well as the prepayment penalty restrictions, described in the section-by-section analysis of § 1026.43(g), construction-to-permanent loans cannot be qualified mortgages, and thus under § 1026.43(g)(1)(ii)(B) cannot include a prepayment penalty. Construction-to-permanent loans are discussed in more detail in the section-by-section analysis of § 1026.43(a).

Open-end credit. The Bureau is concurrently adopting comments 32(b)(6)-3 and -4 to clarify its approach to prepayment penalties with respect to open-end credit. As the Board's 2011 ATR Proposal did not address open-end credit plans, the Bureau is not clarifying prepayment penalties with respect to open-end credit plans in this final rule. Instead, guidance is provided in comments 32(b)(6)-3 and -4, which the Bureau is adopting in the concurrent 2013 HOEPA Final Rule.

Section 1026.43 Minimum Standards for Transactions Secured by a Dwelling 43(a) Scope

Sections 1411, 1412 and 1414 of the Dodd-Frank Act add new TILA section 129C, which requires creditors to determine a consumer's ability to repay a “residential mortgage loan” and establishes new rules and prohibitions on prepayment penalties. Section 1401 of the Dodd-Frank Act adds new TILA section 103(cc), [87] which defines “residential mortgage loan” to mean, with some exceptions, any consumer credit transaction secured by a mortgage, deed of trust, or other equivalent consensual security interest on “a dwelling or on residential real property that includes a dwelling.” TILA section 103(v) defines “dwelling” to mean a residential structure or mobile home which contains one- to four-family housing units, or individual units of condominiums or cooperatives. Thus, a “residential mortgage loan” is a dwelling-secured consumer credit transaction, regardless of whether the consumer credit transaction involves a home purchase, refinancing, home equity loan, first lien or subordinate lien, and regardless of whether the dwelling is a principal residence, second home, vacation home (other than a timeshare residence), a one- to four-unit residence, condominium, cooperative, mobile home, or manufactured home.

However, the Dodd-Frank Act specifically excludes from the term “residential mortgage loan” an open-end credit plan or an extension of credit secured by an interest in a timeshare plan, for purposes of the repayment ability and prepayment penalty provisions under TILA section 129C, among other provisions. See TILA section 103(cc)(5); see also TILA section 129C(i) (providing that timeshare transactions are not subject to TILA section 129C). Further, the repayment ability provisions of TILA section 129C(a) do not apply to reverse mortgages or temporary or “bridge” loans with a term of 12 months or less, including a loan to purchase a new dwelling where the consumer plans to sell another dwelling within 12 months. See TILA section 129C(a)(8). The repayment ability provisions of TILA section 129C(a) also do not apply to consumer credit transactions secured by vacant land. See TILA section 103(cc)(5) and 129C(a)(1).

TILA Section 103(cc) defines “residential mortgage loan” to mean a consumer credit transaction secured by a mortgage or equivalent consensual security interest “on a dwelling or on residential real property that includes a dwelling.” Under TILA and Regulation Z, the term “dwelling” means a residential structure with one to four units, whether or not the structure is attached to real property, and includes a condominium or cooperative unit, mobile home, and trailer, if used as a residence. See 15 U.S.C. 1602(v), § 1026.2(a)(19). To facilitate compliance by using consistent terminology throughout Regulation Z, the proposal used the term “dwelling,” as defined in § 1026.2(a)(19), and not the phrase “residential real property that includes a dwelling.” Proposed comment 43(a)-2 clarified that, for purposes of proposed § 226.43, the term “dwelling” would include any real property to which the residential structure is attached that also secures the covered transaction.

Proposed § 226.43(a) generally defined the scope of the ability-to-repay provisions to include any consumer credit transaction that is secured by a dwelling, other than home equity lines of credit, mortgage transactions secured by an interest in a timeshare plan, or for certain provisions reverse mortgages or temporary loans with a term of 12 months or less. Proposed comment 43(a)-1 clarified that proposed § 226.43 would not apply to an extension of credit primarily for a business, commercial, or agricultural purpose and cross-referenced the existing guidance on determining the primary purpose of an extension of credit in commentary on § 1026.3.

Numerous commenters requested additional exemptions from coverage beyond the statutory exemptions listed at proposed § 226.43(a)(1) through (3). The Bureau received requests for exemptions from the rule for seller-financed transactions, loans secured by non-primary residences, community development loans, downpayment assistance loans, loans eligible for purchase by GSEs, and housing stabilization refinances. The requested exemptions related to community development loans, downpayment assistance loans, and housing stabilization refinances are not being included in this final rule, but are addressed in the Bureau's proposed rule regarding amendments to the ability-to-repay requirements, published elsewhere in today's Federal Register. The requested exemptions that are not being included in the rule and are not being addressed in today's concurrent proposal are discussed immediately below.

The Bureau received numerous letters from individuals concerned that the rule would cover individual home sellers who finance the buyer's purchase, either through a loan or an installment sale. However, because the definition of “creditor” for mortgages generally covers only persons who extend credit secured by a dwelling more than five times in a calendar year, the overwhelming majority of individual seller-financed transactions will not be covered by the rule. Those creditors who self-finance six or more transactions in a calendar year, whether through loans or installment sales, will need to comply with the ability-to-repay provisions of § 1026.43, just as they must comply with other relevant provisions of Regulation Z.

An association of State bank regulators suggested that the scope of the ability-to-repay requirements be limited to owner-occupied primary residences, stating that ability to repay on vacation homes and investment properties should be left to an institution's business judgment. The Bureau believes it is not appropriate or necessary to exercise its exception authority to change the scope of the provision in this way for several reasons. First, as discussed in proposed comment 43(a)-1, loans that have a business purpose [88] are not covered by TILA, and so would not be covered by the ability-to-repay provisions as proposed and adopted. Investment purpose loans are considered to be business purpose loans. Second, vacation home loans are consumer credit transactions that can have marked effects on a consumer's finances. If a consumer is unable to repay a mortgage on a vacation home, the consumer will likely suffer severe financial consequences and the spillover effects on property values and other consumers in the affected area can be substantial as well. Third, the Bureau understands that default rates on vacation homes are generally higher than those on primary residences, and an exemption could increase this disparity.

For the reasons discussed below, the general scope provision and the statutory exemptions in § 1026.43(a)(1) through (3)(ii) are adopted substantially as proposed, with minor changes as discussed in the relevant sections below, and the addition of § 1026.43(a)(3)(iii) to provide an exemption for the construction phase of a construction-to-permanent loan.

The general scope provision at § 1026.43(a) now includes language making clear that real property attached to a dwelling will be considered a part of the dwelling for purposes of compliance with § 1026.43. Although as discussed above similar language was included in the official commentary in the proposed rule, the Bureau believes this important legal requirement should be part of the regulatory text.

Comment 43(a)-1 now includes a reference to § 1026.20(a), which describes different types of changes to an existing loan that will not be treated as refinancings, to make clear that creditors may rely on that section in determining whether or not § 1026.43 will apply to a particular change to an existing loan.

43(a)(1)

The Board's proposal included an exemption from the scope of section 226.43 for “[a] home equity line of credit subject to § 226.5b,” [89] which implemented the exclusion of HELOCs from coverage in the statutory definition of “residential mortgage loan.” Dodd-Frank Act section 1401. The Bureau received two comments asking that the HELOC exemption be reconsidered. The commenters stated that HELOCs had contributed to the crisis in the mortgage market and that failure to include them in the ability-to-repay rule's coverage would likely lead to more consumer abuse and systemic problems.

The Bureau notes that Congress specifically exempted open-end lines of credit from the ability-to-repay requirements, even though the Dodd-Frank Act extends other consumer protections to such loans, including the requirements for high-cost mortgages under HOEPA. The Bureau also notes that home equity lines of credit have consistently had lower delinquency rates than other forms of consumer credit. [90] Furthermore, the requirements contained in the Dodd-Frank Act with respect to assessing a consumer's ability to repay a residential mortgage, and the regulations the Bureau is adopting thereunder, were crafted to apply to the underwriting of closed-end loans and are not necessarily transferrable to underwriting for an open-end line of credit secured by real estate. In light of these considerations, the Bureau does not believe there is sufficient justification to find it necessary or proper to use its adjustment and exception authority to expand the ability-to-repay provisions to HELOCs at this time. However, as discussed in detail below, the Bureau is adopting the Board's proposal to require creditors to consider and verify contemporaneous HELOCs in addition to other types of simultaneous loans for the purpose of complying with the ability-to-repay provisions. See the section-by-section analysis of § 1026.43(b)(12) below. In addition, the final rule includes the Board's proposed anti-evasion provision, which forbids the structuring of credit that does not meet the definition of open-end credit as an open-end plan in order to evade the requirements of this rule. See§ 1026.43(h). Accordingly, § 1026.43(a)(1) is adopted as proposed, with the embedded citation updated. However, the Bureau intends to monitor the HELOC exemption through its supervision function and may revisit the issue as part of its broader review of the ability-to-repay rule under section 1022(d) of the Dodd-Frank Act, which requires the Bureau to publish an assessment of a significant rule or order not later than five years after its effective date.

43(a)(2)

The Bureau did not receive comments on the statutory timeshare exemption included in proposed § 226.43(a)(2). Accordingly, the Bureau is adopting § 1026.43(a)(2) as proposed.

43(a)(3)

43(a)(3)(i)

Proposed § 226.43(a)(3)(i) created an exemption from the ability-to-repay requirements in § 226.43(c) through (f) for reverse mortgages, as provided in the statute. The Bureau did not receive comments on this exemption. [91] Accordingly, the Bureau is adopting § 1026.43(a)(3)(i) as proposed.

43(a)(3)(ii)

Proposed § 226.43(a)(3)(ii) provided an exemption from the ability-to-repay requirements in § 226.43(c) through (f) for “[a] temporary or `bridge' loan with a term of 12 months or less, such as a loan to finance the purchase of a new dwelling where the consumer plans to sell a current dwelling within 12 months or a loan to finance the initial construction of a dwelling.” Furthermore, proposed comment 43(a)-3 provided that, “[w]here a temporary or bridge loan is renewable, the loan term does not include any additional period of time that could result from a renewal provision.” The Board solicited comment on whether a decision to treat renewals in this manner would lead to evasion of the rule. The statute includes the one-year exemption implemented in the proposed rule but does not specifically address renewals. TILA section 129C(a)(8), 15 U.S.C. 1639c(a)(8).

Generally, commenters did not specifically address the proposal's request for comment on renewals of short-term financing; however, one industry commenter stated that the statutory one-year limitation would interfere with construction loans, which often require more than a year to complete. The Bureau understands that construction loans often go beyond a single year. Although the comment did not specify that disregarding potential renewals would alleviate this concern, the Bureau believes that disregarding renewals would facilitate compliance and prevent unwarranted restrictions on access to construction loans.

Commenters did not respond to the Board's query about whether or not disregarding renewals of transactions with one-year terms would lead to evasion of the rule. Upon further analysis, the Bureau believes that this concern does not warrant changing the proposed commentary. However, the Bureau intends to monitor the issue through its supervision function and to revisit the issue as part of its broader review of the ability-to-repay rule under section 1022(d) of the Dodd-Frank Act, which requires the Bureau to conduct an assessment of significant rules five years after they are adopted.

One industry trade association commented on the wording of the temporary financing exemption, suggesting that the inclusion of the two examples, bridge loans and construction loans, would create uncertainty as to whether the exemption would apply to temporary financing of other types. However, the Bureau believes further clarification is not required because the exemption applies to any temporary loan with a term of 12 months or less, and the examples are merely illustrative. The Bureau is aware of and provides clarifying examples of certain common loan products that are temporary or “bridge” loans. The commenter did not note other common types of temporary loan products. The Bureau further believes that the rule permits other types of temporary financing as long as the loan satisfies the requirements of the exemption.

Accordingly, § 1026.43(a)(3)(ii) and associated commentary are adopted substantially as proposed.

43(a)(3)(iii)

The Bureau also received comments requesting clarification on how the temporary financing exemption would apply to construction-to-permanent loans, i.e., construction financing that will be permanently financed by the same creditor. Typically, such loans have a short construction period, during which payments are made of interest only, followed by a fully amortizing permanent period, often an additional 30 years. Because of this hybrid form, the loans do not appear to qualify for the temporary financing exemption, nor would they be qualified mortgages because of the interest-only period and the fact that the entire loan term will often slightly exceed 30 years. However, such loans may have significant consumer benefits because they avoid the inconvenience and expense of a second closing, and also avoid the risk that permanent financing will be unavailable when the construction loan is due.

The Bureau notes that existing § 1026.17(c)(6)(ii) provides that construction-to-permanent loans may be disclosed as either a single transaction or as multiple transactions at the creditor's option. Consistent with that provision, the Bureau is using its adjustment and exception authority to allow the construction phase of a construction-to-permanent loan to be exempt from the ability-to-repay requirements as a temporary loan; however, the permanent phase of the loan is subject to § 1026.43. Because the permanent phase is subject to § 1026.43, it may be a qualified mortgage if it satisfies the appropriate requirements.

As amended by the Dodd-Frank Act, TILA section 105(a), 15 U.S.C. 1604(a), directs the Bureau to prescribe regulations to carry out the purposes of TILA, and provides that such regulations may contain additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions that the Bureau judges are necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion thereof, or to facilitate compliance therewith. The main purpose of section 129C is articulated in section 129B(a)(2)—“to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans and that are not unfair, deceptive or abusive.” Creditors' ability to continue originating construction-to-permanent loans in a cost effective manner will help to ensure that consumers are offered and receive loans on terms that reasonably reflect their ability to repay. The construction-to-permanent product avoids the possibility of a consumer being unable to repay a construction loan, because the permanent financing is already part of the contract. Without the ability to treat the permanent financing as a qualified mortgage, and the construction phase as exempt, it is not clear how many creditors would continue to offer such loans, especially in the short term. In addition, consumers will benefit from the potentially lower costs associated with qualified mortgages. In addition to effectuating the purpose of ensuring ability to repay, this exemption will greatly facilitate compliance for creditors providing this product.

Proposed comment 43(a)(3)-1 provided that, where a temporary or “bridge” loan is renewable, the loan term does not include any additional period of time that could result from a renewal provision. The Bureau is adding comment 43(a)(3)-2 to make clear that if a construction-to-permanent loan is treated as multiple transactions in regard to compliance with the ability-to-repay requirements, and the initial one-year construction phase is renewable, the loan term of the construction phase does not include any additional period of time that could result from a renewal of that construction phase that is one year or less in duration. Comment 43(a)(3)-2 also makes clear that if the construction phase of a construction-to-permanent loan is treated as exempt, the permanent financing phase may be a qualified mortgage if it meets the appropriate requirements.

Accordingly, § 1026.43(a)(3)(iii) and comment 43(a)(3)-2 are added to this final rule.

43(b) Definitions

43(b)(1)

The definition of “covered transaction” restates the scope of the rule, discussed above, which implements the statutory term “residential mortgage loan” defined at TILA § 103(cc)(5). The Bureau did not receive any comments specifically on this provision and is adopting it as proposed in § 1026.43(b)(1). For clarity, the Bureau has added comment 43(b)(1)-1 explaining that the term “covered transaction” restates the scope of the rule as described in § 1026.43(a).

43(b)(2)

TILA section 129C(a)(3) requires that “[a] creditor shall determine the ability of the consumer to repay using a payment schedule that fully amortizes the loan over the term of the loan.” In implementing this provision, the proposed rule defined a “fully amortizing payment” as “a periodic payment of principal and interest that will fully repay the loan amount over the loan term.” The term “fully amortizing payment” is used in the general “payment calculation” provision in § 1026.43(c)(5)(i)(B), which requires the use of “[m]onthly, fully amortizing payments that are substantially equal.” The Bureau has determined that the definition of “fully amortizing payment” enables accurate implementation of the payment calculation process envisioned by the statute, and no comments focused on or questioned this definition. Accordingly, § 1026.43(b)(2) is adopted as proposed.

43(b)(3)

TILA section 129C(a)(6)(D) provides that, for purposes of making the repayment ability determination required under TILA section 129C(a), the creditor must calculate the monthly payment on the mortgage obligation based on several assumptions, including that the monthly payment be calculated using the fully indexed rate at the time of loan closing, without considering the introductory rate. See TILA section 129C(a)(6)(D)(iii). TILA section 129C(a)(7) defines the term “fully indexed rate” as “the index rate prevailing on a residential mortgage loan at the time the loan is made plus the margin that will apply after the expiration of any introductory interest rates.”

The term “fully indexed rate” appeared in proposed § 226.43(c)(5), which implemented TILA section 129C(a)(6)(D)(iii) and provided the payment calculation rules for covered transactions. The term also appeared in proposed § 226.43(d)(5), which provided special rules for creditors that refinance a consumer from a non-standard mortgage to a standard mortgage.

Proposed § 226.43(b)(3) defined the term “fully indexed rate” as “the interest rate calculated using the index or formula at the time of consummation and the maximum margin that can apply at any time during the loan term.” This proposed definition was consistent with the statutory language of TILA sections 129C(a)(6)(D)(iii) and 129C(a)(7), but revised certain text to provide clarity. First, for consistency with current Regulation Z and to facilitate compliance, the proposal replaced the phrases “at the time of the loan closing” in TILA section 129C(a)(6)(D)(iii) and “at the time the loan is made” in TILA section 129C(a)(7) with the phrase “at the time of consummation” for purposes of identifying the fully indexed rate. The Board interpreted these statutory phrases to have the same meaning as the phrase “at the time of consummation.” See current § 1026.2(a)(7), defining the term “consummation” for purposes of Regulation Z requirements as “the time that a consumer becomes contractually obligated on a credit transaction.”

In requiring that the fully indexed rate be determined using the specified index at consummation, the Board was concerned that the possible existence of loans that use more than one index could complicate this determination. Given the increasing relevance of market indices, the Board solicited comment on whether loan products currently exist that base the interest rate on a specific index at consummation, but then base subsequent rate adjustments on a different index, and whether further guidance addressing how to calculate the fully indexed rate for such loan products would be needed.

The proposed rule interpreted the statutory reference to the margin that will apply “after the expiration of any introductory interest rates” as a reference to the maximum margin that can apply “at any time during the loan term.” The Bureau agrees with this interpretation, because the statutory use of the plural “rates” modified by the all-inclusive term “any” clearly indicates not only that something more than the initial introductory rate is meant, but that “any” preliminary rate should be disregarded. In addition, the statutory term itself, “fully indexed rate,” appears to require such a reading. Referencing the entire loan term as the relevant period of time during which the creditor must identify the maximum margin that can occur under the loan makes the phrase “after the expiration of any introductory interest rates” unnecessary and allows for simplicity and consistency with new TILA section 103(bb), the high cost mortgage provision.

Because the proposal required that the creditor use the “maximum” margin that can apply when determining the fully indexed rate, the creditor would be required to take into account the largest margin that could apply under the terms of the legal obligation. The approach of using the maximum margin that can apply at any time during the loan term is consistent with the statutory language contained in TILA section 103(bb), as amended by section 1431 of the Dodd-Frank Act, which defines a high-cost mortgage. This statutory provision provides that, for purposes of the definition of a “high-cost mortgage” under HOEPA, for a mortgage with an interest rate that varies solely in accordance with an index, the annual percentage rate must be based on “the interest rate determined by adding the index rate in effect on the date of consummation of the transaction to the maximum margin permitted at any time during the loan agreement.” [92] Furthermore, although the Board was not aware of any current loan products that possess more than one margin that may apply over the loan term, the Board proposed this clarification to address the possibility that creditors may create products that permit different margins to take effect at different points throughout the loan term. The proposal solicited comment on this approach.

The proposed definition of “fully indexed rate” was also generally consistent with the definition of “fully indexed rate” as used in the MDIA Interim Final Rule, [93] and with the Federal banking agencies' use of the term “fully indexed rate” in the 2006 Nontraditional Mortgage Guidance and 2007 Subprime Mortgage Statement.

Proposed comment 43(b)(3)-1 noted that in some adjustable-rate transactions, creditors may set an initial interest rate that is not determined by the index or formula used to make later interest rate adjustments. This proposed comment explained that this initial rate charged to consumers will sometimes be lower than the rate would be if it were calculated using the index or formula at consummation (i.e., a “discounted rate”); in some cases, this initial rate may be higher (i.e., a “premium rate”). The proposed comment clarified that when determining the fully indexed rate where the initial interest rate is not determined using the index or formula for subsequent interest rate adjustments, the creditor must use the interest rate that would have applied had the creditor used such index or formula plus margin at the time of consummation. The proposed comment further clarified that this means, in determining the fully indexed rate, the creditor must not take into account any discounted or premium rate. (In addition, to facilitate compliance, this comment directed creditors to commentary that addresses payment calculations based on the greater of the fully indexed rate or “premium rate” for purposes of the repayment ability determination under proposed § 226.43(c)). See final rule § 1026.43(c)(5)(i)(A) and comment 43(c)(5)(i)-2.)

Proposed comment 43(b)(3)-1 differed from guidance on disclosure requirements in current comment 17(c)(1)-10.i, which provides that in cases where the initial interest rate is not calculated using the index or formula for later rate adjustments, the creditor should disclose a composite annual percentage rate that reflects both the initial rate and the fully indexed rate. The Board believed the different approach taken in proposed comment 43(b)(3)-1 was required by the statutory language and was appropriate in the present case where the purpose of the statute is to determine whether the consumer can repay the loan according to its terms, including any potential increases in required payments. TILA section 129B(a)(2), 15 U.S.C 1639b(a)(2).

Proposed comment 43(b)(3)-2 further clarified that if the contract provides for a delay in the implementation of changes in an index value or formula, the creditor need not use the index or formula in effect at consummation, and provides an illustrative example. This proposed comment was consistent with current guidance in Regulation Z regarding the use of the index value at the time of consummation where the contract provides for a delay. See comments 17(c)(1)-10.i and 18(s)(2)(iii)(C)-1, which address the fully indexed rate for purposes of disclosure requirements.

Proposed comment 43(b)(3)-3 explained that the creditor must determine the fully indexed rate without taking into account any periodic interest rate adjustment caps that may limit how quickly the fully indexed rate may be reached at any time during the loan term under the terms of the legal obligation. As the proposal noted, the guidance contained in proposed comment 43(b)(3)-3 differed from guidance contained in current comment 17(c)(1)-10.iii, which states that, when disclosing the annual percentage rate, creditors should give effect to periodic interest rate adjustment caps.

Nonetheless, the Board believed the approach in proposed comment 43(b)(3)-3 was consistent with, and required by, the statutory language that states that the fully indexed rate must be determined without considering any introductory rate and by using the margin that will apply after expiration of any introductory interest rates. See TILA section 129C(a)(6)(D)(iii) and (7). In addition, the Board noted that the proposed definition of fully indexed rate, and its use in the proposed payment calculation rules, was designed to assess whether the consumer has the ability to repay the loan according to its terms. TILA section 129B(a)(2), 15 U.S.C 1639b(a)(2). This purpose differs from the principal purpose of disclosure requirements, which is to help ensure that consumers avoid the uninformed use of credit. TILA section 102(a), 15 U.S.C. 1601(a). Furthermore, the guidance contained in proposed comment 43(b)(3)-3 was consistent with the Federal banking agencies' use of the term fully indexed rate in the 2006 Nontraditional Mortgage Guidance and 2007 Subprime Mortgage Statement.

Proposed comment 43(b)(3)-4 clarified that when determining the fully indexed rate, a creditor may choose, in its sole discretion, to take into account the lifetime maximum interest rate provided under the terms of the legal obligation. This comment explained, however, that where the creditor chooses to use the lifetime maximum interest rate, and the loan agreement provides a range for the maximum interest rate, the creditor must use the highest rate in that range as the maximum interest rate. In allowing creditors to use the lifetime maximum interest rate provided under the terms of the obligation, the Board was apparently interested in simplifying compliance and benefiting consumers by encouraging reasonable lifetime interest rate caps. In doing so, the Board was apparently reading its proposed definition of fully indexed rate to allow the maximum margin that can apply at any time during the loan term to refer to the maximum margin as determined at consummation. In other words, when the index value is determined at consummation, the maximum margin that can apply at any time during the loan term will be the difference between the lifetime interest rate cap and that index value. Consequently, adding the index value at consummation to that maximum margin, as required by the fully indexed rate definition, will yield the lifetime interest rate cap as the fully indexed rate.

Commenters generally did not focus specifically on the definition of “fully indexed rate” and associated commentary proposed by the Board, or provide examples of loans with more than one index or more than one margin. An organization representing state bank regulators supported the use of the maximum margin that can apply at any time during the loan term, suggesting that it would prevent evasion. (Some commenter groups did urge the Bureau to use its adjustment authority to require creditors to use a rate higher than the fully indexed rate in assessing a consumer's ability to repay; these comments are discussed below in the section-by-section analysis of § 1026.43(c)(5)(i)). The Bureau is adopting the rule and commentary largely as proposed, with some modifications for clarity. Specifically, the Bureau decided to include language in the definition that will make clear that the index used in determining the fully indexed rate is the index that will apply after the loan is recast, so that any index that might be used earlier in determining an initial or intermediate rate would not be used. This new language is included for clarification only, and does not change the intended meaning of the proposed definition.

In the proposed rule, the Board noted that the statutory construct of the payment calculation rules, and the requirement to calculate payments based on the fully indexed rate, apply to all loans that are subject to the ability-to-repay provisions, including loans that do not base the interest rate on an index and therefore, do not have a fully indexed rate. Specifically, the statute states that “[f]or purposes of making any determination under this subsection, a creditor shall calculate the monthly payment amount for principal and interest on any residential mortgage loan by assuming” several factors, including the fully indexed rate, as defined in the statute (emphasis added). See TILA section 129C(a)(6)(D). The statutory definition of “residential mortgage loan” includes loans with variable-rate features that are not based on an index or formula, such as step-rate mortgages. See TILA section 103(cc); see also proposed § 226.43(a), which addressed the proposal's scope, and proposed § 226.43(b)(1), which defined “covered transaction.” However, because step-rate mortgages do not have a fully indexed rate, it was unclear what interest rate the creditor should assume when calculating payment amounts for the purpose of determining the consumer's ability to repay the covered transaction.

As discussed above, the proposal interpreted the statutory requirement to use the “margin that can apply at any time after the expiration of any introductory interest rates” to mean that the creditor must use the “maximum margin that can apply at any time during the loan term” when determining the fully indexed rate. Accordingly, consistent with this approach, the proposal clarified in proposed comment 43(b)(3)-5 that where there is no fully indexed rate because the interest rate offered in the loan is not based on, and does not vary with, an index or formula, the creditor must use the maximum interest rate that may apply at any time during the loan term. Proposed comment 43(b)(3)-5 provided illustrative examples of how to determine the maximum interest rate for a step-rate and a fixed-rate mortgage.

The Board believed this approach was appropriate because the purpose of TILA section 129C is to require creditors to assess whether the consumer can repay the loan according to its terms, including any potential increases in required payments. TILA section 129B(a)(2), 15 U.S.C 1639b(a)(2). Requiring creditors to use the maximum interest rate would help to ensure that consumers could repay their loans. However, the Board was also concerned that by requiring creditors to use the maximum interest rate in a step-rate mortgage, the monthly payments used to determine the consumer's repayment ability might be overstated and potentially restrict credit availability. Therefore, the Board solicited comment on this approach, and whether authority under TILA sections 105(a) and 129B(e) should be used to provide an exception for step-rate mortgages, possibly requiring creditors to use the maximum interest rate that occurs in only the first 5 or 10 years, or some other appropriate time horizon.

The Bureau received few comments on the use of the maximum interest rate that may apply at any time during the loan term for step-rate mortgages. A consumer group and a regulatory reform group stated that this method was better and more protective of consumers than using a seven- or ten-year horizon. An organization representing state bank regulators suggested that the Bureau use a five-year horizon, provided that the loan has limits on later rate increases. An industry trade association suggested that the maximum rate only be applied to the balance remaining when that maximum rate is reached.

The Bureau believes that the proposal's method of using the maximum interest rate that may apply at any time during the loan term for step-rate mortgages is appropriate. This approach most closely approximates the statutorily required fully indexed rate because it employs the highest rate ascertainable at consummation, as does the fully indexed rate, and it applies that rate to the entire original principal of the loan, as the calculation in § 1026.43(c)(5)(i) does with the fully indexed rate. In addition, this method most effectively ensures the consumer's ability to repay the loan.

For the reasons stated above, § 1026.43(b)(3) is adopted substantially as proposed, with the clarification discussed above specifying that the index used in determining the fully indexed rate is the index that will apply after the loan is recast. Issues regarding the use of the fully indexed rate in the payment calculations required by § 1026.43(c)(5) are discussed in the section-by-section analysis of that section below.

43(b)(4)

The Dodd-Frank Act added TILA section 129C(a)(6)(D)(ii)(II), which provides that a creditor making a balloon-payment loan with an APR at or above certain thresholds must determine ability to repay “using the contract's repayment schedule.” The thresholds required by the statute are 1.5 or more percentage points above the average prime offer rate (APOR) for a comparable transaction for a first lien, and 3.5 or more percentage points above APOR for a subordinate lien. These thresholds are the same as those used in the Board's 2008 HOEPA Final Rule [94] to designate a new category of “higher-priced mortgage loans” (HPMLs), which was amended by the Board's 2011 Jumbo Loans Escrows Final Rule to include a separate threshold for jumbo loans for purposes of certain escrows requirements. [95] Implementing these thresholds for use with the payment underwriting determination for balloon-payment mortgages, the proposed rule defined a “higher-priced covered transaction” as one in which the annual percentage rate (APR) “exceeds the average prime offer rate (APOR) for a comparable transaction as of the date the interest rate is set by 1.5 or more percentage points for a first-lien covered transaction, or by 3.5 or more percentage points for a subordinate-lien covered transaction.” As explained further below and provided for in the statute, the designation of certain covered transactions as higher-priced affects the ability-to-repay determination for balloon-payment mortgages, and requires that those higher-priced transactions be analyzed using the loan contract's full repayment schedule, including the balloon payment. § 1026.43(c)(5)(ii)(A)(2).

Proposed comment 43(b)(4)-1 provided guidance on the term “average prime offer rate.” Proposed comment 43(b)(4)-2 stated that the table of average prime offer rates published by the Board would indicate how to identify the comparable transaction for a higher-priced covered transaction. Proposed comment 43(b)(4)-3 clarified that a transaction's annual percentage rate is compared to the average prime offer rate as of the date the transaction's interest rate is set (or “locked”) before consummation. This proposed comment also explained that sometimes a creditor sets the interest rate initially and then resets it at a different level before consummation, and clarified that in these cases, the creditor should use the last date the interest rate is set before consummation.

The Board explained in its proposed rule that it believed the ability-to-repay requirements for higher-priced balloon-payment loans was meant to apply to the subprime market, but that use of the annual percentage rate could lead to prime loans being exposed to this test. For this reason, the Board was concerned that the statutory formula for a higher-priced covered transaction might be over-inclusive. Accordingly, the Board solicited comment on whether the “transaction coverage rate” (TCR) should be used for this determination, instead of the annual percentage rate. 76 FR 27412. The TCR had previously been proposed in conjunction with a more inclusive version of the APR, in order to avoid having the more inclusive, hence higher, APRs trigger certain requirements unnecessarily. The TCR includes fewer charges, and the Board's 2011 Escrows Proposal proposed to use it in the threshold test for determining application of those requirements. 76 FR 11598, 11626-11627 (Mar. 2, 2011).

The only comment substantively discussing the possible substitution of the TCR for the APR was strongly opposed to the idea, stating that it would create unnecessary compliance difficulty and costs. The Bureau has determined that possible transition to a TCR standard will implicate several rules and is not appropriate at the present time. However, the issue will be considered further as part of the Bureau's TILA/RESPA rulemaking. See 77 FR 51116, 51126 (Aug. 23, 2012).

The Board also solicited comment on whether or not to provide a higher threshold for jumbo balloon-payment mortgages or for balloon-payment mortgages secured by a residence that is not the consumer's principal dwelling, e.g., a vacation home. 76 FR 27412. The Board requested this information due to its belief that higher interest rates charged for these loans might render them unavailable without the adjustment. The margin above APOR suggested for first-lien jumbo balloon-payment mortgages was 2.5 percentage points.

Two industry commenters supported the higher threshold for jumbo loans, arguing that the current thresholds would interfere with credit accessibility. One of these commenters also stated that the higher threshold should be available for all balloon-payment mortgages. No commenters discussed the non-principal-dwelling threshold.

Many other commenters objected strongly to the statutory requirement, implemented in the proposed rule, that the balloon payment be considered in applying the ability-to-repay requirements to higher-priced covered transaction balloon-payment mortgages. These industry commenters felt that the percentage point thresholds were too low, and that many loans currently being made would become unavailable. They did not, however, submit sufficient data to help the Bureau assess these claims. Other commenters, including several consumer protection advocacy organizations, argued that the higher-priced rule would be helpful in ensuring consumers' ability to repay their loans.

The Bureau has evaluated the proposed definition of “higher-priced covered transaction” not only in relation to its use in the payment determination for balloon-payment mortgages, but also in the light of its application in other provisions of the final rule. For example, as discussed below, the final rule varies the strength of the presumption of compliance for qualified mortgages. A qualified mortgage designated as a higher-priced covered transaction will be presumed to comply with the ability-to repay-provision at § 1026.43(c)(1), but will not qualify for the safe harbor provision. See§ 1026.43(e)(1)(ii) and (i).

Specifically, the Bureau has considered whether to adopt a different threshold to define high price mortgage loans for jumbo loans than for other loans. The Bureau notes that the Board expressly addressed this issue in its 2008 HOEPA Final Rule and concluded not to do so. The Board explained that although prime jumbo loans have always had somewhat higher rates than prime conforming loans, the spread has been quite volatile. [96] The Board concluded that it was sounder to err on the side of being over-inclusive than to set a higher threshold for jumbo loans and potentially fail to include subprime jumbo loans. [97] The Bureau is persuaded by the Board's reasoning.

The Bureau recognizes that in the Dodd-Frank Act Congress, in requiring creditors to establish escrows accounts for certain transactions and in requiring appraisals for certain transactions based upon the interest rate of the transactions, did establish a separate threshold for jumbo loans. The Bureau is implementing that separate threshold in its 2013 Escrows Final Rule which is being issued contemporaneously with this final rule. However, the Bureau also notes that in the ability-to-repay provision of the Dodd-Frank Act, Congress mandated underwriting rules for balloon-payment mortgages which vary based upon the pricing of the loan, and in doing so Congress followed the thresholds adopted by the Board in its 2008 HOEPA Final Rule and did not add a separate threshold for jumbo loans. The fact that the Act uses the Board's criteria in the ability to repay context lends further support to the Bureau's decision to use those criteria as well in defining higher-priced loans under the final rule.

Accordingly, the Bureau is not providing for a higher threshold for jumbo or non-principal dwelling balloon-payment mortgages at this time. In regard to the possibility of a higher threshold for non-principal dwellings such as vacation homes, the Bureau understands that such products have historically been considered to be at higher risk of default than loans on principal dwellings. Therefore, any difference in rates is likely driven by the repayment risk associated with the product, and a rule meant to ensure a consumer's ability to repay the loan should not provide an exemption under these circumstances. And further, the Bureau did not receive and is not aware of any data supporting such an exemption.

The Bureau does not believe that these decisions regarding jumbo and non-principal-dwelling balloon-payment mortgages are likely to create any credit accessibility problems. In this final rule at § 1026.43(f), the Bureau is adopting a much wider area in which institutions that provide credit in rural or underserved areas may originate qualified mortgages that are balloon-payment loans than did the proposed rule. Because these are the areas in which balloon-payment loans are considered necessary to preserve access to credit, and higher-priced balloon-payment mortgages in these areas can meet the criteria for a qualified mortgage and thus will not have to include the balloon payment in the ability-to-repay evaluation, access to necessary balloon-payment mortgages will not be reduced.

Accordingly, § 1026.43(b)(4) is adopted as proposed. The associated commentary is amended with revisions to update information and citations.

43(b)(5)

The proposed rule defined “loan amount” as “the principal amount the consumer will borrow as reflected in the promissory note or loan contract.” This definition implemented the statutory language requiring that the monthly payment be calculated assuming that “the loan proceeds are fully disbursed on the date of consummation of the loan.” Dodd-Frank Act section 1411(a)(2), TILA section 129C(a)(6)(D)(i). The term “loan amount” was used in the proposed definition of “fully amortizing payment” in § 226.43(b)(2), which was then used in the general “payment calculation” at § 226.43(c)(5)(i)(B). The payment calculation required the use of payments that pay off the loan amount over the actual term of the loan.

The statute further requires that creditors assume that the loan amount is “fully disbursed on the date of consummation of the loan.”See TILA Section 129C(a)(6)(D)(i). The Board recognized that some loans do not disburse the entire loan amount to the consumer at consummation, but may, for example, provide for multiple disbursements up to an amount stated in the loan agreement. See current § 1026.17(c)(6), discussing multiple-advance loans and comment 17(c)(6)-2 and -3. In these cases, the loan amount, as reflected in the promissory note or loan contract, does not accurately reflect the amount disbursed at consummation. Thus, to reflect the statutory requirement that the creditor assume the loan amount is fully disbursed at consummation, the Board clarified that creditors must use the entire loan amount as reflected in the loan contract or promissory note, even where the loan amount is not fully disbursed at consummation. Proposed comment 43(b)(5)-1 provided an illustrative example and stated that generally, creditors should rely on § 1026.17(c)(6) and associated commentary regarding treatment of multiple-advance and construction loans that would be covered by the ability-to-repay requirements (i.e., loans with a term greater than 12 months). See § 1026.43(a)(3) discussing scope of coverage and term length.

The Board specifically solicited comment on whether further guidance was needed regarding determination of the loan amount for loans with multiple disbursements. The Bureau did not receive comments on the definition of “loan amount” or its application to loans with multiple disbursements. The Bureau believes that the loan amount for multiple disbursement loans that are covered transactions must be determined assuming that “the loan proceeds are fully disbursed on the date of consummation of the loan” [98] as required by the statute and the rule, and explained in comment 43(b)(5)-1.

Accordingly, the Bureau is adopting § 1026.43(b)(5) and associated commentary as proposed.

43(b)(6)

The interchangeable phrases “loan term” and “term of the loan” appear in the ability-to-repay and qualified mortgage provisions of TILA, with no definition. See TILA section 129C(c)(3), 129C(a)(6)(D)(ii), 129C(b)(2)(A)(iv) and (v); 15 U.S.C. 1639c(c)(3), 1639c(a)(6)(D)(ii), 1639c(b)(2)(A)(iv) and (v). The proposed rule defined “loan term” as “the period of time to repay the obligation in full.” Proposed comment 43(b)(6)-1 clarified that the loan term is the period of time it takes to repay the loan amount in full, and provided an example. The term is used in § 1026.43(b)(2), the “fully amortizing payment” definition, which is then used in § 1026.43(c)(5)(i), the payment calculation general rule. It is also used in the qualified mortgage payment calculation at § 1026.43(e)(2)(iv). The Bureau did not receive any comments on this definition, and considers it to be an accurate and appropriate implementation of the statutory language. Accordingly, proposed § 1026.43(b)(6) is adopted as proposed.

43(b)(7)

The definition of “maximum loan amount” and the calculation for which it is used implement the requirements regarding negative amortization loans in new TILA section 129C(a)(6)(C) and (D). The statute requires that a creditor “take into consideration any balance increase that may accrue from any negative amortization provision.”

The “maximum loan amount” is defined in the proposed rule as including the loan balance and any amount that will be added to the balance as a result of negative amortization assuming the consumer makes only minimum payments and the maximum interest rate is reached at the earliest possible time. The “maximum loan amount” is used to determine a consumer's ability to repay for negative amortization loans under § 1026.43(c)(5)(ii)(C) by taking into account any loan balance increase that may occur as a result of negative amortization. The term “maximum loan amount” is also used for negative amortization loans in the “refinancing of non-standard mortgages” provision, at § 1026.43(d)(5)(i)(C)(3). The proposed rule included commentary on how to calculate the maximum loan amount, with examples. See comment 43(b)(7)-1 through -3.

The Bureau did not receive any comments on this definition and considers it to be an accurate and appropriate implementation of the statute. Accordingly, § 1026.43(b)(7) and associated commentary are adopted as proposed.

43(b)(8)

TILA section 129C(a)(1) and (3), as added by section 1411 of the Dodd-Frank Act, requires creditors to consider and verify mortgage-related obligations as part of the ability-to-repay determination “according to [the loan's] terms, and all applicable taxes, insurance (including mortgage guarantee insurance), and assessments.” TILA section 129C(a)(2) provides that consumers must have “a reasonable ability to repay the combined payments of all loans on the same dwelling according to the terms of those loans and all applicable taxes, insurance (including mortgage guarantee insurance), and assessments.” Although the Dodd-Frank Act did not establish or define a single, collective term, the foregoing requirements recite ongoing obligations that are substantially similar to the definition of “mortgage-related obligation” used elsewhere in Regulation Z. Section 1026.34(a)(4)(i), which was added by the 2008 HOEPA Final Rule, defines mortgage-related obligations as expected property taxes, premiums for mortgage-related insurance required by the creditor as set forth in the relevant escrow provisions of Regulation Z, and similar expenses. Comment 34(a)(4)(i)-1 clarifies that, for purposes of § 1026.34(a)(4)(i), similar expenses include homeowners association dues and condominium or cooperative fees. Section 1026.35(b)(3)(i), which addresses escrows, states that “premiums for mortgage-related insurance required by the creditor, [include] insurance against loss of or damage to property, or against liability arising out of the ownership or use of the property, or insurance protecting the creditor against the consumer's default or other credit loss.”

Under the Board's proposed § 226.43(b)(8), “mortgage-related obligations” was defined to mean property taxes; mortgage related insurance premiums required by the creditor as set forth in proposed § 226.45(b)(1); homeowners association, condominium, and cooperative fees; ground rent or leasehold payments; and special assessments. The Board's proposed definition was substantially similar to the definition under § 1026.34(a)(4)(i), with three clarifications. First, the proposed definition of mortgage-related obligations would have included a reference to ground rent or leasehold payments, which are payments made to the real property owner or leaseholder for use of the real property. Second, the proposed definition would have included a reference to “special assessments.” Proposed comment 43(b)(8)-1 would have clarified that special assessments include, for example, assessments that are imposed on the consumer at or before consummation, such as a one-time homeowners association fee that will not be paid by the consumer in full at or before consummation. Third, mortgage-related obligations would have referenced proposed § 226.45(b)(1), where the Board proposed to recodify the existing escrow requirement for higher-priced mortgage loans, to include mortgage-related insurance premiums required by the creditor, such as insurance against loss of or damage to property, or against liability arising out of the ownership or use of the property, or insurance protecting the creditor against the consumer's default or other credit loss. The Board solicited comment on how to address any issues that may arise in connection with homeowners association transfer fees and costs associated with loans for energy efficient improvements.

Proposed comment 43(b)(8)-1 would have clarified further that mortgage-related obligations include mortgage-related insurance premiums only if required by the creditor. This comment would have explained that the creditor need not include premiums for mortgage-related insurance that the creditor does not require, such as earthquake insurance or credit insurance, or fees for optional debt suspension and debt cancellation agreements. To facilitate compliance, this comment would have referred to commentary associated with proposed § 226.43(c)(2)(v), which sets forth the requirement to take into account any mortgage-related obligations for purposes of the repayment ability determination required under proposed § 226.43(c).

Industry commenters and consumer advocates generally supported the Board's proposed definition of mortgage-related obligations. One industry commenter opposed including community transfer fees, which are deed-based fees imposed upon the transfer of the property. This commenter was concerned that subjecting these fees to Federal law might affect existing contracts, deeds, and covenants related to these fees, which are subject to State and local regulation, as well as common law regarding the transfer of real property. The commenter also asked that special assessments not fall under the definition of mortgage-related obligations. The commenter recommended that, if special assessments are included, creditors be required to consider only current special assessments, not future special assessments. The commenter noted that, while common assessments should be included in the definition of mortgage-related obligations, the Bureau should provide guidance to creditors on the substance of questionnaires seeking information from third parties about mortgage-related obligations.

Certain consumer advocates suggested that voluntary insurance premiums be included in the definition of mortgage-related obligations. One consumer advocate explained that premiums such as these are technically voluntary, but many consumers believe them to be required, or have difficulty cancelling them if they choose to cancel them. Community advocates and several industry commenters also recommended that homeowners association dues, and similar charges, be included in the definition of mortgage-related obligations. They argued that such a requirement would further transparency in the mortgage loan origination process and would help ensure that consumers receive only credit they can reasonably expect to repay.

For the reasons discussed below, the Bureau concludes that property taxes, certain insurance premiums required by the creditor, obligations to community governance associations, such as cooperative, condominium, and homeowners associations, ground rent, and lease payments should be included in the definition of mortgage-related obligations. These obligations are incurred in connection with the mortgage loan transaction but are in addition to the obligation to repay principal and interest. Thus, the cost of these obligations should be considered with the obligation to repay principal and interest for purposes of determining a consumer's ability to repay. Further, the Bureau believes that the word `assessments' in TILA section 129C is most appropriately interpreted to refer to all obligations imposed on consumers in connection with ownership of the dwelling or real property, such as ground rent, lease payments, and, as discussed in detail below, obligations to community governance associations, whether denominated as association dues, special assessments, or otherwise. While the provision adopted by the Bureau is substantially similar to the provision proposed, the Bureau was persuaded by the comment letters that additional clarity and guidance is required. The Bureau is especially sensitive to the fact that many of the loans that will be subject to the ability-to-repay rules may be made by small institutions, which are often unable to devote substantial resources to analysis of regulatory compliance.

To address the concerns and feedback raised in the comment letters, the Bureau has revised § 1026.43(b)(8) and related commentary in two ways. First, the language of § 1026.43(b)(8) is being modified to add additional clarity. As adopted, § 1026.43(b)(8) refers to premiums and similar charges identified in § 1026.4(b)(5), (7), (8), or (10), if required by the creditor, instead of the proposed language, which referred to “mortgage-related insurance.” Second, the commentary is being significantly expanded to provide additional clarification and guidance.

As adopted, § 1026.43(b)(8) defines “mortgage-related obligations” to mean property taxes; premiums and similar charges identified in § 1026.4(b)(5), (7), (8), or (10) that are required by the creditor; fees and special assessments imposed by a condominium, cooperative, or homeowners association; ground rent; and leasehold payments. As proposed, comment 43(b)(8)-1 discussed all components of the proposed definition. To provide further clarity, the final rule splits the content of proposed comment 43(b)(8)-1 into four separate comments, each of which provides additional guidance. As adopted by the Bureau, comment 43(b)(8)-1 contains general guidance and a cross-reference to § 1026.43(c)(2)(v), which contains the requirement to take into account any mortgage-related obligations for purposes of determining a consumer's ability to repay.

The multitude of requests for additional guidance and clarification suggests that additional clarification of the meaning of “property tax” is needed. Comment 43(b)(8)-2 further clarifies that § 1026.43(b)(8) includes obligations that are functionally equivalent to property taxes, even if such obligations follow a different naming convention. For example, governments may establish independent districts with the authority to impose recurring levies on properties within the district to fund a special purpose, such as a local development bond district, water district, or other public purpose. These recurring levies may have a variety of names, such as taxes, assessments, or surcharges. Comment 43(b)(8)-2 clarifies that obligations such as these are property taxes based on the character of the obligation, as opposed to the name of the obligation, and therefore are mortgage-related obligations.

Most comments supported the inclusion of insurance premiums in the ability-to-repay determination. However, the Bureau believes that some modifications to the proposed “mortgage-related insurance premium” language are appropriate. The Bureau is persuaded that additional clarification and guidance is important, and the Bureau is especially sensitive to concerns related to regulatory complexity. The Bureau has determined that the proposed language should be clarified by revising the text to refer to the current definition of finance charge under § 1026.4. The components of the finance charge are long-standing parts of Regulation Z. Explicitly referring to existing language should facilitate compliance. Therefore, § 1026.43(b)(8) defines mortgage-related obligations to include all premiums or other charges related to protection against a consumer's default, credit loss, collateral loss, or similar loss as identified in § 1026.4(b)(5), (7), (8), or (10) except, as explained above, those premiums or charges that that are not required by the creditor. Comment 43(b)(8)-3 also contains illustrative examples of this definition. For example, if Federal law requires flood insurance to be obtained in connection with the mortgage loan, the flood insurance premium is a mortgage-related obligation for purposes of § 1026.43(b)(8).

Several commenters stated that insurance premiums and similar charges should be included in the determination even if the creditor does not require them in connection with the loan transaction. The Bureau has carefully considered these arguments, but has determined that insurance premiums and similar charges should not be considered mortgage-related obligations if such premiums and charges are not required by the creditor and instead have been voluntarily purchased by the consumer. The Bureau acknowledges that obligations such as these are usually paid from a consumer's monthly income and, in a sense, affect a consumer's ability to repay. But the consumer is free to cancel recurring obligations such as these at any time, provided they are truly voluntary. Thus, they are not “obligations” in the sense required by section 129C(a)(3) of TILA. The Bureau shares the concern raised by several commenters that unscrupulous creditors may mislead consumers into believing that these charges are not optional or cannot be cancelled. However, the Bureau does not believe that altering the ability-to-repay calculation for all is the appropriate method for combatting the harmful actions of a few. The Bureau believes that the better course of action is to exclude such premiums and charges from the definition of mortgage-related obligations only if they are truly voluntary, and is confident that violations of this requirement will be apparent in specific cases from the facts. Also, in the scenarios described by commenters where consumers are misled into believing that such charges are required, the premium or charge would not be voluntary for purposes of the definition of finance charge under § 1026.4(d), and would therefore be a mortgage-related obligation for the purposes of § 1026.43(b)(8). Therefore, comment 43(b)(8)-3 clarifies that insurance premiums and similar charges identified in § 1026.4(b)(5), (7), (8), or (10) that are not required by the creditor and that the consumer purchases voluntarily are not mortgage-related obligations for purposes of § 1026.43(b)(8). For example, if a creditor does not require earthquake insurance to be obtained in connection with the mortgage loan, but the consumer voluntarily chooses to purchase such insurance, the earthquake insurance premium is not a mortgage-related obligation for purposes of § 1026.43(b)(8). Or, if a creditor requires a minimum amount of coverage for homeowners' insurance and the consumer voluntarily chooses to purchase a more comprehensive amount of coverage, the portion of the premium allocated to the minimum coverage is a mortgage-related obligation for the purposes of § 1026.43(b)(8), while the portion of the premium allocated to the more comprehensive coverage voluntarily purchased by the consumer is not a mortgage-related obligation for the purposes of § 1026.43(b)(8). However, if the consumer purchases non-required insurance or similar coverage at consummation without having requested the specific non-required insurance or similar coverage and without having agreed to the premium or charge for the specific non-required insurance or similar coverage prior to consummation, the premium or charge is not voluntary for purposes of § 1026.43(b)(8) and is a mortgage-related obligation.

Several commenters supported the inclusion of mortgage insurance in the definition of mortgage-related obligations. The Bureau also has received several informal requests for guidance regarding the meaning of the term “mortgage insurance” in the context of certain disclosures required by Regulation Z. The Bureau has decided to clarify this issue with respect to the requirements of § 1026.43. Thus, comment 43(b)(8)-4 clarifies that § 1026.43(b)(8) includes all premiums or similar charges for coverage protecting the creditor against the consumer's default or other credit loss in the determination of mortgage-related obligations, whether denominated as mortgage insurance, guarantee insurance, or otherwise, as determined according to applicable State or Federal law. For example, monthly “private mortgage insurance” payments paid to a non-governmental entity, annual “guarantee fee” payments required by a Federal housing program, and a quarterly “mortgage insurance” payment paid to a State agency administering a housing program are all mortgage-related obligations for purposes of § 1026.43(b)(8). Comment 43(b)(8)-4 also clarifies that § 1026.43(b)(8) includes these charges in the definition of mortgage-related obligations if the creditor requires the consumer to pay them, even if the consumer is not legally obligated to pay the charges under the terms of the insurance program. Comment 43(b)(8)-4 also contains several other illustrative examples.

Several comment letters stressed the importance of including homeowners association dues and similar obligations in the determination of ability to repay. These letters noted that, during the subprime crisis, the failure to account for these obligations led to many consumers qualifying for mortgage loans that they could not actually afford. The Bureau agrees with these assessments. Recurring financial obligations payable to community governance associations, such as homeowners association dues, should be taken into consideration in determining whether a consumer has the ability to repay the obligation. While several comment letters identified practical problems with including obligations such as these in the calculation, these issues stemmed from difficulties that may arise in calculating, estimating, or verifying these obligations, rather than whether the obligations should be included in the ability-to-repay calculation. Based on this feedback, § 1026.43(b)(8) includes obligations to a homeowners association, condominium association, or condominium association in the determination of mortgage-related obligations. The Bureau has addressed the concerns related to difficulties in calculating, estimating, or verifying such obligations in the commentary to § 1026.43(c)(2)(v) and (c)(3).

One comment letter focused extensively on community transfer fees, which are deed-based fees imposed upon the transfer of the property. The Bureau recognizes that this topic is complex and is often the subject of special requirements imposed at the State and local level. However, the Bureau does not believe that the requirements of § 1026.43 implicate these complex issues. The narrow question is whether such obligations should be considered mortgage-related obligations for purposes of determining the consumer's ability to repay. The Bureau agrees with the argument, advanced by several commenters, that the entirety of the consumer's ongoing obligations should be included in the determination. A responsible determination of the consumer's ability to repay requires an accounting of such obligations, whether the purpose of the obligation is to satisfy the payment of a community transfer fee or traditional homeowners association dues. As with other obligations owed to condominium, cooperative, or homeowners associations discussed above, the Bureau believes that the practical problems with these obligations relate to when such obligations should be included in the determination of the consumer's ability to repay, rather than whether the obligations should be considered mortgage-related obligations. Therefore, the Bureau has addressed the concerns related to these obligations in the commentary to § 1026.43(c)(2)(v) and (c)(3).

In response to the request for feedback in the 2011 ATR Proposal, several commenters addressed the proposed treatment of special assessments. Unlike community transfer fees, which are generally identified in the deed or master community plan, creditors may encounter difficulty determining whether special assessments exist. However, as with similar charges discussed above, these concerns relate to determining the consumer's monthly payment for mortgage-related obligations, rather than whether these charges should be considered mortgage-related obligations. Special assessments may be significant and may affect the consumer's ability to repay a mortgage loan. Thus, the Bureau has concluded that special assessments should be included in the definition of mortgage-related obligations under § 1026.43(b)(8) and has addressed the concerns raised by commenters related to calculating, estimating, or verifying these obligations in the commentary to § 1026.43(c)(2)(v) and (c)(3).

New comment 43(b)(8)-5 explains that § 1026.43(b)(8) includes in the evaluation of mortgage-related obligations premiums and similar charges identified in § 1026.4(b)(5), (7), (8), or (10) that are required by the creditor. These premiums and similar charges are mortgage-related obligations regardless of whether the premium or similar charge is excluded from the finance charge pursuant to § 1026.4(d). For example, a premium for insurance against loss or damage to the property written in connection with the credit transaction is a premium identified in § 1026.4(b)(8). If this premium is required by the creditor, the premium is a mortgage-related obligation pursuant to § 1026.43(b)(8), regardless of whether the premium is excluded from the finance charge pursuant to § 1026.4(d)(2). Commenters did not request this guidance specifically, but the Bureau believes that this comment is needed to provide additional clarity.

43(b)(9)

TILA section 129C(b)(2)(C) generally defines “points and fees” for a qualified mortgage to have the same meaning as in TILA section 103(bb)(4), which defines points and fees for the purpose of determining whether a transaction exceeds the HOEPA points and fees threshold. Proposed § 226.43(b)(9) would have provided that “points and fees” has the same meaning as in § 226.32(b)(1). The Bureau adopts this provision as renumbered § 1026.43(b)(9).

43(b)(10)

Sections 1414, 1431, and 1432 of the Dodd-Frank Act amended TILA to restrict, and in many cases, prohibit a creditor from imposing prepayment penalties in dwelling-secured credit transactions. TILA does not, however, define the term “prepayment penalty.” In an effort to address comprehensively prepayment penalties in a fashion that eases compliance burden, as discussed above, the Bureau is defining prepayment penalty in § 1026.43(b)(10) by cross-referencing § 1026.32(b)(6). For a full discussion of the Bureau's approach to defining prepayment penalties, see § 1026.32(b)(6), its commentary, and the section-by-section analysis of those provisions above.

43(b)(11)

TILA in several instances uses the term “reset” to refer to the time at which the terms of a mortgage loan are adjusted, usually resulting in higher required payments. For example, TILA section 129C(a)(6)(E)(ii) states that a creditor that refinances a loan may, under certain conditions, “consider if the extension of new credit would prevent a likely default should the original mortgage reset and give such concerns a higher priority as an acceptable underwriting practice.” 15 U.S.C. 1639c(a)(6)(E)(ii). The legislative history further indicates that, for adjustable-rate mortgages with low, fixed introductory rates, Congress understood the term “reset” to mean the time at which low introductory rates convert to indexed rates, resulting in “significantly higher monthly payments for homeowners.” [99]

Outreach conducted prior to issuance of the proposed rule indicated that the term “recast” is typically used in reference to the time at which fully amortizing payments are required for interest-only and negative amortization loans and that the term “reset” is more frequently used to indicate the time at which adjustable-rate mortgages with an introductory fixed rate convert to a variable rate. For simplicity and clarity, however, the Board proposed to use the term “recast” to cover the conversion to generally less favorable terms and higher payments not only for interest-only loans and negative amortization loans, but also for adjustable-rate mortgages.

Proposed § 226.43(b)(11) defined the term “recast,” which was used in two provisions of proposed § 226.43: (1) Proposed § 226.43(c)(5)(ii) regarding certain required payment calculations that creditors must consider in determining a consumer's ability to repay a covered transaction; and (2) proposed § 226.43(d) regarding payment calculations required for refinancings that are exempt from the ability-to-repay requirements in § 226.43(c).

Specifically, proposed § 226.43(b)(11) defined the term “recast” as follows: (1) For an adjustable-rate mortgage, as defined in § 1026.18(s)(7)(i), [100] the expiration of the period during which payments based on the introductory interest rate are permitted under the terms of the legal obligation; (2) for an interest-only loan, as defined in § 1026.18(s)(7)(iv), [101] the expiration of the period during which interest-only payments are permitted under the terms of the legal obligation; and (3) for a negative amortization loan, as defined in § 1026.18(s)(7)(v), [102] the expiration of the period during which negatively amortizing payments are permitted under the terms of the legal obligation.

Proposed comment 43(b)(11)-1 explained that the date on which the “recast” occurs is the due date of the last monthly payment based on the introductory fixed rate, the last interest-only payment, or the last negatively amortizing payment, as applicable. Proposed comment 43(b)(11)-1 also provided an illustration showing how to determine the date of the recast.

Commenters did not focus specifically on the definition of “recast,” except that an association of State bank regulators agreed with the benefit of using a single term for the shift to higher payments for adjustable-rate, interest-only, and negative amortization loans.

The Bureau considers the proposed provision to be an accurate and appropriate implementation of the statute. Accordingly, the Bureau is adopting proposed § 226.43(b)(11) as proposed, in renumbered § 1026.43(b)(11).

43(b)(12)

New TILA section 129C(a)(2) provides that “if a creditor knows, or has reason to know, that 1 or more residential mortgage loans secured by the same dwelling will be made to the same consumer,” that creditor must make the ability-to-repay determination for “the combined payments of all loans on the same dwelling according to the terms of those loans and all applicable taxes, insurance (including mortgage guarantee insurance), and assessments.” This section, entitled “multiple loans,” follows the basic ability-to-repay requirements for a single loan, in new TILA section 129C(a)(1).

The proposed rule implemented the main requirement of the “multiple loans” provision by mandating in proposed § 226.43(c)(2)(iv) that a creditor, in making its ability-to-repay determination on the primary loan, take into account the payments on any “simultaneous loan” about which the creditor knows or has reason to know. “Simultaneous loan” was defined in proposed § 226.43(b)(12) as “another covered transaction or home equity line of credit subject to § 226.5b [103] that will be secured by the same dwelling and made to the same consumer at or before consummation of the covered transaction.” Thus, although the statute referred only to closed-end “residential mortgage loans,” the Board proposed to expand the requirement to include consideration of simultaneous HELOCs. The proposed definition did not include pre-existing mortgage obligations, which would be considered as “current debt obligations” under § 1026.43(c)(2)(vi).

The Board chose to include HELOCs in the definition of “simultaneous loan” because it believed that new TILA section 129C(a)(2) was meant to help ensure that creditors account for the increased risk of consumer delinquency or default on the covered transaction where more than one loan secured by the same dwelling is originated concurrently. The Board believed that this increased risk would be present whether the other mortgage obligation was a closed-end credit obligation or a HELOC. For these reasons, and several others explained in detail below, the Board proposed to use its exception and adjustment authority under TILA section 105(a) to include HELOCs within the scope of new TILA section 129C(a)(2). 76 FR 27417-27418. Because one of the main reasons for including HELOCs was the likelihood of a consumer drawing on the credit line to provide the down payment in a purchase transaction, the Board solicited comment on whether this exception should be limited to purchase transactions.

TILA section 105(a), as amended by section 1100A of the Dodd-Frank Act, authorized the Board, and now the Bureau, to prescribe regulations to carry out the purposes of TILA and Regulation Z, to prevent circumvention or evasion, or to facilitate compliance. 15 U.S.C. 1604(a). The inclusion of HELOCs was further supported by the Board's authority under TILA section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Board found necessary or proper to effectuate the purposes of TILA. 15 U.S.C. 1639b(e). One purpose of the statute is set forth in TILA section 129B(a)(2), which states that “[i]t is the purpose[] of * * * [S]ection 129C to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans.” 15 U.S.C. 1639b. For the reasons stated below, the Board believed that requiring creditors to consider simultaneous loans that are HELOCs for purposes of TILA section 129C(a)(2) would help to ensure that consumers are offered, and receive, loans on terms that reasonably reflect their ability to repay.

First, the Board proposed in § 226.43(c)(2)(vi) that the creditor must consider current debt obligations in determining a consumer's ability to repay a covered transaction. Consistent with current § 1026.34(a)(4), proposed § 226.43(c)(2)(vi) would not have distinguished between pre-existing closed-end and open-end mortgage obligations. The Board believed consistency required that it take the same approach when determining how to consider mortgage obligations that come into existence concurrently with a first-lien loan as would be taken for pre-existing mortgage obligations, whether the first-lien is a purchase or non-purchase transaction (i.e., refinancing). Including HELOCs in the proposed definition of “simultaneous loan” for purposes of TILA section 129C(a)(2) was also considered generally consistent with current comment 34(a)(4)-3, and the 2006 Nontraditional Mortgage Guidance regarding simultaneous second-lien loans. [104]

Second, data indicate that where a subordinate loan is originated concurrently with a first-lien loan to provide some or all of the down payment (i.e., a “piggyback loan”), the default rate on the first-lien loan increases significantly, and in direct correlation to increasing combined loan-to-value ratios. [105] The data does not distinguish between “piggyback loans” that are closed-end or open-end credit transactions, or between purchase and non-purchase transactions. However, empirical evidence demonstrates that approximately 60 percent of consumers who open a HELOC concurrently with a first-lien loan borrow against the line of credit at the time of origination, [106] suggesting that in many cases the HELOC may be used to provide some, or all, of the down payment on the first-lien loan.

The Board recognized that consumers have varied reasons for originating a HELOC concurrently with the first-lien loan, for example, to reduce overall closing costs or for the convenience of having access to an available credit line in the future. However, the Board believed concerns relating to HELOCs originated concurrently for savings or convenience, and not to provide payment towards the first-lien home purchase loan, might be mitigated by the Board's proposal to require that a creditor consider the periodic payment on the simultaneous loan based on the actual amount drawn from the credit line by the consumer. See proposed § 226.43(c)(6)(ii), discussing payment calculation requirements for simultaneous loans that are HELOCs. Still, the Board recognized that in the case of a non-purchase transaction (e.g., a refinancing) a simultaneous loan that is a HELOC might be unlikely to be originated and drawn upon to provide payment towards the first-lien loan, except perhaps towards closing costs. Thus, the Board solicited comment on whether it should narrow the requirement to consider simultaneous loans that are HELOCs to apply only to purchase transactions.

Third, in developing this proposal Board staff conducted outreach with a variety of participants that consistently expressed the view that second-lien loans significantly impact a consumer's performance on the first-lien loan, and that many second-lien loans are HELOCs. One industry participant explained that the vast majority of “piggyback loans” it originated were HELOCs that were fully drawn at the time of origination and used to assist in the first-lien purchase transaction. Another outreach participant stated that HELOCs make up approximately 90 percent of its simultaneous loan book-of-business. Industry outreach participants generally indicated that it is a currently accepted underwriting practice to include HELOCs in the repayment ability assessment on the first-lien loan, and generally confirmed that the majority of simultaneous liens considered during the underwriting process are HELOCs. For these reasons, the Board proposed to use its authority under TILA sections 105(a) and 129B(e) to broaden the scope of TILA section 129C(a)(2), and accordingly proposed to define the term “simultaneous loan” to include HELOCs.

Proposed comment 43(b)(12)-1 clarified that the definition of “simultaneous loan” includes any loan that meets the definition, whether made by the same creditor or a third-party creditor, and provides an illustrative example of this principle.

Proposed comment 43(b)(12)-2 further clarified the meaning of the term “same consumer,” and explained that for purposes of the definition of “simultaneous loan,” the term “same consumer” would include any consumer, as that term is defined in § 1026.2(a)(11), that enters into a loan that is a covered transaction and also enters into another loan (e.g., a second-lien covered transaction or HELOC) secured by the same dwelling. This comment further explained that where two or more consumers enter into a legal obligation that is a covered transaction, but only one of them enters into another loan secured by the same dwelling, the “same consumer” includes the person that has entered into both legal obligations. The Board believed this comment would reflect statutory intent to include any loan that could impact the consumer's ability to repay the covered transaction according to its terms (i.e., to require the creditor to consider the combined payment obligations of the consumer(s) obligated to repay the covered transaction). See TILA § 129C(a)(2).

Both industry and consumer advocate commenters overwhelmingly supported inclusion of HELOCs as simultaneous loans, with only one industry commenter objecting. The objecting commenter stated that there was no persuasive policy argument for deviating from the statute, but did not provide any reason to believe that concurrent HELOCs are less relevant to an assessment of a consumer's ability to repay than concurrent closed-end second liens. As explained in the proposed rule, most industry participants are already considering HELOCs in the underwriting of senior-lien loans on the same property. 76 FR 27418.

For the reasons set forth by the Board and discussed above, the Bureau has determined that inclusion of HELOCs in the definition of simultaneous loans is an appropriate use of its TILA authority to make adjustments and additional requirements.

TILA section 105(a), as amended by section 1100A of the Dodd-Frank Act, authorizes the Bureau to prescribe regulations that may contain such additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions, as in the judgment of the Bureau are necessary or proper to effectuate the purposes of TILA, to prevent circumvention or evasion of TILA, or to facilitate compliance with TILA. 15 U.S.C. 1604(a). The Bureau finds that the inclusion of HELOCs is necessary and proper to effectuate the purposes of TILA. The inclusion of HELOCs is further supported by the Bureau's authority under TILA section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Bureau finds necessary or proper to effectuate the purposes of TILA. 15 U.S.C. 1639b(e). TILA section 129B(a)(2) states that “[i]t is the purpose[] of * * * [S]ection 129C to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans.” 15 U.S.C. 1639b. Inclusion of HELOCs as simultaneous loans will help to carry out this purpose of TILA by helping to ensure that consumers receive loans on affordable terms, as further explained above.

Accordingly, the Bureau is adopting § 1026.43(b)(12) and associated commentary as proposed, with clarifying edits to ensure that simultaneous loans scheduled after consummation will be considered in determining ability to repay.

43(b)(13)

TILA section 129C(a)(1) requires that a creditor determine a consumer's repayment ability using “verified and documented information,” and TILA section 129C(a)(4) specifically requires the creditor to verify a consumer's income or assets relied on to determine repayment ability using a consumer's tax return or “third-party documents” that provide reasonably reliable evidence of the consumer's income or assets, as discussed in detail below in the section-by-section analysis of § 1026.43(c)(3) and (4). The Board proposed to define the term “third-party record” to mean: (1) A document or other record prepared or reviewed by a person other than the consumer, the creditor, any mortgage broker, as defined in § 1026.36(a)(2), or any agent of the creditor or mortgage broker; (2) a copy of a tax return filed with the Internal Revenue Service or a state taxing authority; (3) a record the creditor maintains for an account of the consumer held by the creditor; or (4) if the consumer is an employee of the creditor or the mortgage broker, a document or other record regarding the consumer's employment status or income. The Board explained that, in general, a creditor should refer to reasonably reliable records prepared by or reviewed by a third party to verify repayment ability under TILA section 129C(a), a principle consistent with verification requirements previously outlined under the Board's 2008 HOEPA Final Rule. See§ 1026.34(a)(4)(ii).

Commenters generally supported the Board's broad definition of a third-party record as a reasonable definition that allows a creditor to use a wide variety of documents and sources, while ensuring that the consumer does not remain the sole source of information. Some consumer advocates, however, cautioned the Bureau against relying upon tax records to provide a basis for verifying income history, pursuant to amended TILA section 129C(a)(4)(A), to avoid penalizing consumers who may not have access to accurate tax records. The Bureau does not address comments with respect to consumers who may not maintain accurate tax records because the definition provided in 1026.43(b)(13) of third-party record merely ensures that a creditor may use any of a wide variety of documents, including tax records, as a method of income verification without mandating their use. Rather than rely solely on tax records, for example, a creditor might look to other third-party records for verification purposes, including the creditor's records regarding a consumer's savings account held by the creditor, which qualifies as a third-party record under § 1026.43(b)(13)(iii), or employment records for a consumer employed by the creditor, which qualifies as a third-party record under § 1026.43(b)(13)(iv).

The Board proposed comment 43(b)(13)-1 to clarify that third-party records would include records transmitted or viewed electronically, for example, a credit report prepared by a consumer reporting agency and transmitted or viewed electronically. The Bureau did not receive significant feedback on the proposed comment and is adopting the comment largely as proposed. The Bureau is clarifying that an electronic third-party record should be transmitted electronically, such as via email or if the creditor is able to click on a secure hyperlink to access a consumer's credit report. The Bureau is making this slight clarification to convey that mere viewing of a record, without the ability to capture or maintain the record, would likely be problematic with respect to record retention under § 1026.25(a) and (c). While it seems unlikely that an electronic record could be viewed without being transmitted as well, the Bureau is making this alteration to avoid any confusion.

The Bureau is adopting the remaining comments to 43(b)(13) largely as proposed by the Board. These comments did not elicit significant public feedback. Comment 43(b)(13)-1 assures creditors that a third-party record may be transmitted electronically. Comment 43(b)(13)-2 explains that a third-party record includes a form a creditor provides to a third party for providing information, even if the creditor completes parts of the form unrelated to the information sought. Thus, for example, a creditor may send a Webform, or mail a paper form, created by the creditor, to a consumer's current employer, on which the employer could check a box that indicates that the consumer works for the employer. The creditor may even elect to fill in the creditor's name, or other portions of the form, so long as those portions are unrelated to the information that the creditor seeks to verify, such as income or employment status.

Comment 43(b)(13)(i)-1 clarifies that a third-party record includes a document or other record prepared by the consumer, the creditor, the mortgage broker, or an agent of the creditor or mortgage broker, if the record is reviewed by a third party. For example, a profit-and-loss statement prepared by a self-employed consumer and reviewed by a third-party accountant is a third-party record under § 1026.43(b)(13)(i). The Bureau is including comment 43(b)(13)(i)-1 to explain how some first-party records, e.g., documents originally prepared by the consumer, may become third-party records by virtue of an appropriate, disinterested third-party's review or audit. It is the third party review, the Bureau believes, that provides reasonably reliable evidence of the underlying information in the document, just as if the document were originally prepared by the third party. Moreover, this clarification allows the creditor to consult a wider variety of documents in its determination of a consumer's ability to repay. Creditors should be cautioned not to assume, however, that merely because a document is a third-party record as defined by § 1026.43(b)(13), and the creditor uses the information provided by that document to make a determination as to whether the consumer will have a reasonable ability to repay the loan according to its terms, that the creditor has satisfied the requirements of this rule. The creditor also must make a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability, at the time of consummation, to repay the loan according to its terms. For a full discussion of the Bureau's approach to this determination, see § 1026.43(c)(1), its commentary, and the section-by-section analysis of those provisions below.

Finally, comment 43(b)(13)(iii)-1 clarifies that a third-party record includes a record that the creditor maintains for the consumer's account. Such examples might include records of a checking account, savings account, and retirement account that the consumer holds, or has held, with the creditor. Comment 43(b)(13)(iii)-1 also provides the example of a creditor's records for an account related to a consumer's outstanding obligations to the creditor, such as the creditor's records for a first-lien mortgage to a consumer who applies for a subordinate-lien home equity loan. This comment helps assure industry that such records are a legitimate basis for determining a consumer's ability to repay, and/or for verifying income and assets because it is unlikely to be in a creditor's interest to falsify such records for purposes of satisfying § 1026.43(b)(13), as falsifying records would violate the good faith requirement of § 1026.43(c)(1). In addition, this comment should help assure creditors that the rule does not inhibit a creditor's ability to “cross-sell” products to consumers, by avoiding placing the creditor at a disadvantage with respect to verifying a consumer's information by virtue of the creditor's existing relationship with the consumer.

43(c) Repayment Ability

As enacted by the Dodd-Frank Act, TILA section 129C(a)(1) provides that no creditor may make a residential mortgage loan unless the creditor makes a reasonable and good faith determination, based on verified and documented information, that, at the time the loan is consummated, the consumer has a reasonable ability to repay the loan according to its terms and all applicable taxes, insurance, and assessments. TILA section 129C(a)(2) extends the same requirement to a combination of multiple residential mortgage loans secured by the same dwelling where the creditor knows or has reason to know that such loans will be made to the same consumer. TILA sections 129C(a)(3) and (a)(4) specify factors that must be considered in determining a consumer's ability to repay and verification requirements for income and assets considered as part of that determination. Proposed § 226.43(c) would have implemented TILA section 129C(a)(1) through (4) in a manner substantially similar to the statute.

Proposed § 226.43(c)(1) would have implemented the requirement in TILA section 129C(a)(1) that creditors make a reasonable and good faith determination that a consumer will have a reasonable ability to repay the loan according to its terms. Proposed § 226.43(c)(2) would have required creditors to consider the following factors in making a determination of repayment ability, as required by TILA section 129C(a)(1) through (3): the consumer's current or reasonably expected income or assets (other than the property that secures the loan); the consumer's employment status, if the creditor relies on employment income; the consumer's monthly payment on the loan; the consumer's monthly payment on any simultaneous loan that the creditor knows or has reason to know will be made; the consumer's monthly payment for mortgage-related obligations; the consumer's current debt obligations; and the consumer's monthly debt-to-income ratio or residual income. Proposed § 226.43(c)(3) would have required that creditors verify the information they use in making an ability-to-repay determination using third-party records, as required by TILA section 129C(a)(1). Proposed § 226.43(c)(4) would have specified methods for verifying income and assets as required by TILA section 129C(a)(1) and (4). Proposed § 226.43(c)(5) and (6) would have specified how to calculate the monthly mortgage and simultaneous loan payments required to be considered under proposed § 226.43(c)(2). Proposed § 226.43(c)(7) would have specified how to calculate the monthly debt-to-income ratio or monthly residual income required to be considered under proposed § 226.43(c)(2). As discussed in detail below, the Bureau is adopting § 1026.43(c) substantially as proposed, with various modifications and clarifications.

Proposed comment 43(c)-1 would have indicated that creditors may look to widely accepted governmental or nongovernmental underwriting standards, such as the handbook on Mortgagee Credit Analysis for Mortgage Insurance on One- to Four-Unit Mortgage Loans issued by FHA, to evaluate a consumer's ability to repay. The proposed comment would have stated that creditors may look to such standards in determining, for example, whether to classify particular inflows, obligations, or property as “income,” “debt,” or “assets”; factors to consider in evaluating the income of a self-employed or seasonally employed consumer; or factors to consider in evaluating the credit history of a consumer who has obtained few or no extensions of traditional “credit” as defined in § 1026.2(a)(14). In the Supplemental Information regarding proposed comment 43(c)-1, the Board stated that the proposed rule and commentary were intended to provide flexibility in underwriting standards so that creditors could adapt their underwriting processes to a consumer's particular circumstances. The Board stated its belief that such flexibility is necessary because the rule covers such a wide variety of consumers and mortgage products.

Commenters generally supported giving creditors significant flexibility to develop and apply their own underwriting standards. However, commenters had concerns regarding the specific approach taken in proposed comment 43(c)-1. Commenters raised a number of questions about what kinds of underwriting standards might be considered widely accepted, such as whether a creditor's proprietary underwriting standards could ever be considered widely accepted. Commenters also were uncertain whether the proposed comment required creditors to adopt particular governmental underwriting standards in their entirety and requested clarification on that point. At least one commenter, an industry trade group, noted that FHA-insured loans constitute a small percentage of the mortgage market and questioned whether FHA underwriting standards therefore are widely accepted. This commenter also questioned whether it is appropriate to encourage creditors to apply FHA underwriting standards other than with respect to FHA-insured loans, as FHA programs are generally designed to make mortgage credit available in circumstances where private creditors are unwilling to extend such credit without a government guarantee. Finally, consumer group commenters asserted that underwriting standards do not accurately determine ability to repay merely because they are widely accepted and pointed to the widespread proliferation of lax underwriting standards that predated the recent financial crisis.

The Bureau believes that the Board did not intend to require creditors to use any particular governmental underwriting standards, including FHA standards, in their entirety or to prohibit creditors from using proprietary underwriting standards. The Bureau also does not believe that the Board intended to endorse lax underwriting standards on the basis that those standards may be prevalent in the mortgage market at a particular time. The Bureau therefore is adopting two new comments to provide greater clarity regarding the role of underwriting standards in ability-to-repay determinations and is not adopting proposed comment 43(c)-1.

The Bureau is concerned based on the comments received that referring creditors to widely accepted governmental and nongovernmental underwriting standards could lead to undesirable misinterpretations and confusion. The discussion of widely accepted standards in proposed comment 43(c)-1 could be misinterpreted to suggest that the underwriting standards of any single market participant with a large market share are widely accepted and therefore to be emulated. The widely accepted standard also could be misinterpreted to indicate that proprietary underwriting standards cannot yield reasonable, good faith determinations of a consumer's ability to repay because they are unique to a particular creditor and not employed throughout the mortgage market. Similarly, the widely accepted standard could be misinterpreted to encourage a creditor that lends in a limited geographic area or in a particular market niche to apply widely accepted underwriting standards that are inappropriate for that particular creditor's loans.

The Bureau also is concerned that evaluating underwriting standards based on whether they are widely accepted could have other undesirable consequences. In a market bubble or economic crisis, many creditors may change their underwriting standards in similar ways, leading to widely accepted underwriting standards becoming unreasonably lax or unreasonably tight. A regulatory directive to use underwriting standards that are widely accepted could exacerbate those effects. Also, referring creditors to widely accepted governmental and nongovernmental underwriting standards could hinder creditors' ability to respond to changing market and economic conditions and stifle market growth and positive innovation.

Finally, the Bureau is concerned that focusing on whether underwriting standards are widely accepted could distract creditors from focusing on their obligation under TILA section 129C and § 1026.43(c) to make ability-to-repay determinations that are reasonable and in good faith. The Bureau believes that a creditor's underwriting standards are an important factor in making reasonable and good faith ability-to-repay determinations. However, how those standards are applied to the individual facts and circumstances of a particular extension of credit is equally or more important.

In light of these issues, the Bureau is not adopting proposed comment 43(c)-1. Instead, the Bureau is adopting two new comments, comment 43(c)(1)-1 and comment 43(c)(2)-1. New comment 43(c)(1)-1 clarifies that creditors are permitted to develop and apply their own underwriting standards as long as those standards lead to ability-to-repay determinations that are reasonable and in good faith. New comment 43(c)(2)-1 clarifies that creditors are permitted to use their own definitions and other technical underwriting criteria and notes that underwriting guidelines issued by governmental entities such as the FHA are a source to which creditors may refer for guidance on definitions and technical underwriting criteria. These comments are discussed below in the section-by-section of § 1026.43(c)(1) and (2).

43(c)(1) General Requirement

Proposed § 226.43(c)(1) would have implemented TILA section 129C(a)(1) by providing that a creditor shall not make a loan that is a covered transaction unless the creditor makes a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability, at the time of consummation, to repay the loan according to its terms, including any mortgage-related obligations. Commenters generally agreed that creditors should not make loans to consumers unable to repay them and supported the requirement to consider ability to repay. Accordingly, § 1026.43(c)(1) is adopted substantially as proposed, with two technical and conforming changes.

As adopted, § 1026.43(c)(1) requires creditors to make a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan according to its terms. Section 1026.43(c)(1) as adopted omits the reference in the proposed rule to determining that a consumer has a reasonable ability “at the time of consummation” to repay the loan according to its terms. The Bureau believes this phrase is potentially misleading and does not accurately reflect the intent of either the Board or the Bureau. Mortgage loans are not required to be repaid at the time of consummation; instead, they are required to be repaid over months or years after consummation. Creditors are required to make a predictive judgment at the time of consummation that a consumer is likely to have the ability to repay a loan in the future. The Bureau believes that the rule more clearly reflects this requirement without the reference to ability “at the time of consummation” to repay the loan. The creditor's determination will necessarily be based on the consumer's circumstances at or before consummation and evidence, if any, that those circumstances are likely to change in the future. Section 1026.43(c)(1) as adopted also omits the reference in the proposed rule to mortgage-related obligations. The Bureau believes this reference is unnecessary because § 1026.43(c)(2) requires creditors to consider consumers' monthly payments for mortgage-related obligations and could create confusion because § 1026.43(c)(1) does not include references to other factors creditors must consider under § 1026.43(c)(2).

As noted above, the Bureau is adopting new comment 43(c)(1)-1, which provides guidance regarding, among other things, how the requirement to make a reasonable and good faith determination of ability to repay relates to a creditor's underwriting standards. New comment 43(c)(1)-1 replaces in part and responds to comments regarding proposed comment 43(c)-1, discussed above.

New comment 43(c)(1)-1 emphasizes that creditors are to be evaluated on whether they make a reasonable and good faith determination that a consumer will have a reasonable ability to repay as required by § 1026.43(c)(1). The comment acknowledges that § 1026.43(c) and the accompanying commentary describe certain requirements for making ability-to-repay determinations, but do not provide comprehensive underwriting standards to which creditors must adhere. As an example, new comment 43(c)(1)-1 notes that the rule and commentary do not specify how much income is needed to support a particular level of debt or how to weigh credit history against other factors.

The Bureau believes that a variety of underwriting standards can yield reasonable, good faith ability-to-repay determinations. New comment 43(c)(1)-1 explains that, so long as creditors consider the factors set forth in § 1026.43(c)(2) according to the requirements of § 1026.43(c), creditors are permitted to develop and apply their own proprietary underwriting standards and to make changes to those standards over time in response to empirical information and changing economic and other conditions. The Bureau believes this flexibility is necessary given the wide range of creditors, consumers, and mortgage products to which this rule applies. The Bureau also believes that there are no indicators in the statutory text or legislative history of the Dodd-Frank Act that Congress intended to replace proprietary underwriting standards with underwriting standards dictated by governmental or government-sponsored entities as part of the ability-to-repay requirements. The Bureau therefore believes that preserving this flexibility here is consistent with Congressional intent. The comment emphasizes that whether a particular ability-to-repay determination is reasonable and in good faith will depend not only on the underwriting standards adopted by the creditor, but on the facts and circumstances of an individual extension of credit and how the creditor's underwriting standards were applied to those facts and circumstances. The comment also states that a consumer's statement or attestation that the consumer has the ability to repay the loan is not indicative of whether the creditor's determination was reasonable and in good faith.

Concerns have been raised that creditors and others will have difficulty evaluating whether a particular ability- to-repay determination is reasonable and in good faith. Although the statute and the rule specifies certain factors that a creditor must consider in making such a determination, the Bureau does not believe that there is any litmus test that can be prescribed to determine whether a creditor, in considering those factors, arrived at a belief in the consumer's ability to repay which was both objectively reasonable and in subjective good faith. Nevertheless, new comment 43(c)(1)-1 lists considerations that may be relevant to whether a creditor who considered and verified the required factors in accordance with the rule arrived at an ability-to-repay determination that was reasonable and in good faith. The comment states that the following may be evidence that a creditor's ability-to-repay determination was reasonable and in good faith: (1) The consumer demonstrated actual ability to repay the loan by making timely payments, without modification or accommodation, for a significant period of time after consummation or, for an adjustable-rate, interest-only, or negative-amortization mortgage, for a significant period of time after recast; (2) the creditor used underwriting standards that have historically resulted in comparatively low rates of delinquency and default during adverse economic conditions; or (3) the creditor used underwriting standards based on empirically derived, demonstrably and statistically sound models.

In contrast, new comment 43(c)(1)-1 states that the following may be evidence that a creditor's ability-to-repay determination was not reasonable or in good faith: (1) The consumer defaulted on the loan a short time after consummation or, for an adjustable-rate, interest-only, or negative-amortization mortgage, a short time after recast; (2) the creditor used underwriting standards that have historically resulted in comparatively high levels of delinquency and default during adverse economic conditions; (3) the creditor applied underwriting standards inconsistently or used underwriting standards different from those used for similar loans without reasonable justification; (4) the creditor disregarded evidence that the underwriting standards it used are not effective at determining consumers' repayment ability; (5) the creditor consciously disregarded evidence that the consumer may have insufficient residual income to cover other recurring obligations and expenses, taking into account the consumer's assets other than the property securing the covered transaction, after paying his or her monthly payments for the covered transaction, any simultaneous loan, mortgage-related obligations and any current debt obligations; or (6) the creditor disregarded evidence that the consumer would have the ability to repay only if the consumer subsequently refinanced the loan or sold the property securing the loan.

New comment 43(c)(1)-1 states the Bureau's belief that all of these considerations may be relevant to whether a creditor's ability-to-repay determination was reasonable and in good faith. However, the comment also clarifies that these considerations are not requirements or prohibitions with which creditors must comply, nor are they elements of a claim that a consumer must prove to establish a violation of the ability-to-repay requirements. As an example, the comment clarifies that creditors are not required to validate their underwriting criteria using mathematical models.

New comment 43(c)(1)-1 also clarifies that these considerations are not absolute in their application; instead they exist on a continuum and may apply to varying degrees. As an example, the comment states that the longer a consumer successfully makes timely payments after consummation or recast the less likely it is that the creditor's determination of ability to repay was unreasonable or not in good faith.

Finally, new comment 43(c)(1)-1 clarifies that each of these considerations must be viewed in the context of all facts and circumstances relevant to a particular extension of credit. As an example, the comment states that in some cases inconsistent application of underwriting standards may indicate that a creditor is manipulating those standards to approve a loan despite a consumer's inability to repay. The creditor's ability-to-repay determination therefore may be unreasonable or in bad faith. However, in other cases inconsistently applied underwriting standards may be the result of, for example, inadequate training and may nonetheless yield a reasonable and good faith ability-to-repay determination in a particular case. Similarly, the comment states that although an early payment default on a mortgage will often be persuasive evidence that the creditor did not have a reasonable and good faith belief in the consumer's ability to repay (and such evidence may even be sufficient to establish a prima facie case of an ability-to-repay violation), a particular ability-to-repay determination may be reasonable and in good faith even though the consumer defaulted shortly after consummation if, for example, the consumer experienced a sudden and unexpected loss of income. In contrast, the comment states that an ability-to-repay determination may be unreasonable or not in good faith even though the consumer made timely payments for a significant period of time if, for example, the consumer was able to make those payments only by foregoing necessities such as food and heat.

The Board proposed comment 43(c)(1)-1 to clarify that a change in a consumer's circumstances after consummation of a loan, such as a significant reduction in income due to a job loss or a significant obligation arising from a major medical expense, that cannot reasonably be anticipated from the consumer's application or the records used to determine repayment ability, is not relevant to determining a creditor's compliance with the rule. The proposed comment would have further clarified that, if the application or records considered by the creditor at or before consummation indicate that there will be a change in the consumer's repayment ability after consummation, such as if a consumer's application states that the consumer plans to retire within 12 months without obtaining new employment or that the consumer will transition from full-time to part-time employment, the creditor must consider that information. Commenters generally supported proposed comment 43(c)(1)-1. Proposed comment 43(c)(1)-1 is adopted substantially as proposed and redesignated as comment 43(c)(1)-2.

The Board also proposed comment 43(c)(1)-2 to clarify that § 226.43(c)(1) does not require or permit the creditor to make inquiries or verifications prohibited by Regulation B, 12 CFR part 1002. Commenters generally supported proposed comment 43(c)(1)-2. Proposed comment 43(c)(1)-2 is adopted substantially as proposed and redesignated as comment 43(c)(1)-3.

43(c)(2) Basis for Determination

As discussed above, TILA section 129C(a)(1) generally requires a creditor to make a reasonable and good faith determination that a consumer has a reasonable ability to repay a loan and all applicable taxes, insurance, and assessments. TILA section 129C(a)(2) requires a creditor to include in that determination the cost of any other residential mortgage loans made to the same consumer and secured by the same dwelling. TILA section 129C(a)(3) enumerates several factors a creditor must consider in determining a consumer's ability to repay: credit history; current income; expected income; current obligations; debt-to-income ratio or residual income; employment status; and other financial resources other than equity in the property securing the loan.

Proposed § 226.43(c)(2) would have implemented the requirements under these sections of TILA that a creditor consider specified factors as part of a determination of a consumer's ability to repay. Proposed § 226.43(c)(2) would have required creditors to consider the following factors in making a determination of repayment ability, as required by TILA section 129C(a)(1) through (3): the consumer's current or reasonably expected income or assets, other than the dwelling that secures the loan; the consumer's employment status, if the creditor relies on employment income; the consumer's monthly payment on the loan; the consumer's monthly payment on any simultaneous loan that the creditor knows or has reason to know will be made; the consumer's monthly payment for mortgage-related obligations; the consumer's current debt obligations; the consumer's monthly debt-to-income ratio or residual income; and the consumer's credit history. As discussed in detail below, the Bureau is adopting § 1026.43(c)(2) substantially as proposed, with technical and conforming changes.

As indicated above, the Bureau also is adopting new comment 43(c)(2)-1. New comment 43(c)(2)-1 provides guidance regarding definitional and other technical underwriting issues related to the factors enumerated in § 1026.43(c)(2). New comment 43(c)(2)-1 replaces in part and responds to comments received regarding proposed comment 43(c)-1, as discussed above.

New comment 43(c)(2)-1 notes that § 1026.43(c)(2) sets forth factors creditors must consider when making the ability-to-repay determination required under § 1026.43(c)(1) and the accompanying commentary provides guidance regarding these factors. New comment 43(c)(2)-1 also notes that creditors must conform to these requirements and may rely on guidance provided in the commentary. New comment 43(c)(2)-1 also acknowledges that the rule and commentary do not provide comprehensive guidance on definitions and other technical underwriting criteria necessary for evaluating these factors in practice. The comment clarifies that, so long as a creditor complies with the provisions of § 1026.43(c), the creditor is permitted to use its own definitions and other technical underwriting criteria.

New comment 43(c)(2)-1 further provides that a creditor may, but is not required to, look to guidance issued by entities such as the FHA, VA, USDA, or Fannie Mae or Freddie Mac while operating under the conservatorship of the Federal Housing Finance Administration. New comment 43(c)(2)-1 gives several examples of instances where a creditor could refer to such guidance, such as: classifying particular inflows, obligations, and property as “income,” “debt,” or “assets”; determining what information to use when evaluating the income of a self-employed or seasonally employed consumer; or determining what information to use when evaluating the credit history of a consumer who has few or no extensions of traditional credit. The comment emphasizes that these examples are illustrative, and creditors are not required to conform to guidance issued by these or other such entities. The Bureau is aware that many creditors have, for example, existing underwriting definitions of “income” and “debt.” Creditors are not required to modify their existing definitions and other technical underwriting criteria to conform to guidance issued by such entities, and creditors' existing definitions and other technical underwriting criteria are not noncompliant merely because they differ from those used in such guidance.

Finally, new comment 43(c)(2)-1 emphasizes that a creditor must ensure that its underwriting criteria, as applied to the facts and circumstances of a particular extension of credit, result in a reasonable, good faith determination of a consumer's ability to repay. As an example, new comment 43(c)(2)-1 states that a definition used in underwriting that is reasonable in isolation may lead to ability-to-repay determinations that are unreasonable or not in good faith when considered in the context of a creditor's underwriting standards or when adopted or applied in bad faith. Similarly, an ability-to-repay determination is not unreasonable or in bad faith merely because the underwriting criteria used included a definition that was by itself unreasonable.

43(c)(2)(i)

TILA section 129C(a)(3) provides that, in making the repayment ability determination, a creditor must consider, among other factors, a consumer's current income, reasonably expected income, and “financial resources” other than the consumer's equity in the dwelling or real property that secures loan repayment. Furthermore, under TILA section 129C(a)(9), a creditor may consider the seasonality or irregularity of a consumer's income in determining repayment ability. The Board's proposal generally mirrored TILA section 129C(a)(3), but differed in two respects.

First, proposed § 226.43(c)(2)(i) used the term “assets” rather than “financial resources,” to conform with terminology used in other provisions under TILA section 129C(a) and Regulation Z. See, e.g., TILA section 129C(a)(4) (requiring that creditors consider a consumer's assets in determining repayment ability); § 1026.51(a) (requiring consideration of a consumer's assets in determining a consumer's ability to pay a credit extension under a credit card account). The Board explained that the terms “financial resources” and “assets” are synonymous as used in TILA section 129C(a), and elected to use the term “assets” throughout the proposal for consistency. The Bureau is adopting this interpretation as well, as part of its effort to streamline regulations and reduce compliance burden, and uses the term “assets” throughout Regulation Z.

Second, the Board's proposal provided that a creditor may not look to the value of the dwelling that secures the covered transaction, instead of providing that a creditor may not look to the consumer's equity in the dwelling, as provided in TILA section 129C(a). The Bureau received comments expressing concern that the Board had proposed dispensing with the term “equity.” These comments protested that the Board had assumed that congressional concern was over the foreclosure value of the home, rather than protecting all homeowners, including those who may have low home values. The commenters' concerns are likely misplaced, however, as the Board's language provides, if anything, broader protection for homeowners. TILA section 129C(a)(3) is intended to address the risk that a creditor will consider the amount that could be obtained through a foreclosure sale of the dwelling, which may exceed the amount of the consumer's equity in the dwelling. For example, the rule addresses the situation in which, several years after consummation, the value of a consumer's home has decreased significantly. The rule prohibits a creditor from considering, at or before consummation, any value associated with this home, even in the event that the “underwater” home is sold at foreclosure. The rule thus avoids the situation in which the creditor might assume that rising home values might make up the difference should the consumer be unable to make full mortgage payments, and therefore the rule is more protective of consumers because the rule forbids the creditor from considering any value associated with the dwelling whether the consumer's equity stake in the dwelling is large or small.

The Bureau is adopting the Board's proposal, providing that a creditor may not look to the value of the dwelling that secures the covered transaction, instead of providing that a creditor may not look to the consumer's equity in the dwelling, as provided in TILA section 129C(a). The Bureau is making this adjustment pursuant to its authority under TILA section 105(a), which provides that the Bureau's regulations may contain such additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions as in the Bureau's judgment are necessary or proper to effectuate the purposes of TILA, prevent circumvention or evasion thereof, or facilitate compliance therewith. 15 U.S.C. 1604(a). The purposes of TILA include the purposes that apply to 129C, to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loan. See 15 U.S.C. 1639b(a)(2). As further explained above, the Bureau believes it is necessary and proper to make this adjustment to ensure that consumers receive loans on affordable terms and to facilitate compliance with TILA and its purposes.

The Board proposed comment 43(c)(2)(i)-1 to clarify that a creditor may base a determination of repayment ability on current or reasonably expected income from employment or other sources, assets other than the dwelling that secures the covered transaction, or both. The Bureau did not receive significant comment on the proposal and has adopted the Board's proposed comment. In congruence with the Bureau's adoption of the phrase “value of the dwelling” in § 1026.43(c)(2)(i), instead of the consumer's equity in the dwelling, as originally provided in TILA section 129C(a), comment 43(c)(2)(i)-1 likewise notes that the creditor may not consider the dwelling that secures the transaction as an asset in any respect. This comment is also consistent with comment 43(a)-2, which further clarifies that the term “dwelling” includes the value of the real property to which the dwelling is attached, if the real property also secures the covered transaction. Comment 43(c)(2)(i)-1 also provides examples of types of income the creditor may consider, including salary, wages, self-employment income, military or reserve duty income, tips, commissions, and retirement benefits; and examples of assets the creditor may consider, including funds in a savings or checking account, amounts vested in a retirement account, stocks, and bonds. The Bureau did not receive significant comment on the proposal and has adopted the Board's proposed comment. The Bureau notes that there may be assets other than those listed in comment 43(c)(2)(i)-1 that a creditor may consider; the Bureau does not intend for the list to be exhaustive, but merely illustrative.

The Board proposed comment 43(c)(2)(i)-2 to explain that, if a creditor bases its determination of repayment ability entirely or in part on a consumer's income, the creditor need consider only the income necessary to support a determination that the consumer can repay the covered transaction. The Bureau did not receive significant comment and has adopted the Board's comment largely as proposed. This comment clarifies that a creditor need not document and verify every aspect of the consumer's income, merely enough income to support the creditor's good faith determination. For example, if a consumer earns income from a full-time job and a part-time job and the creditor reasonably determines that the consumer's income from the full-time job is sufficient to repay the covered transaction, the creditor need not consider the consumer's income from the part-time job. Comment 43(c)(2)(i)-2 also cross-references comment 43(c)(4)-1 for clarity.

The Board proposed comment 43(c)(2)(i)-3 to clarify that the creditor may rely on the consumer's reasonably expected income either in addition to or instead of current income. This comment is similar to existing comment 34(a)(4)(ii)-2, which describes a similar income test for high-cost mortgages under § 1026.34(a)(4). [107] This consistency should serve to reduce compliance burden for creditors. The Bureau did not receive significant comment on the proposal and is adopting the Board's comment as proposed. Comment 43(c)(2)(i)-3 further explains that, if a creditor relies on expected income, the expectation that the income will be available for repayment must be reasonable and verified with third-party records that provide reasonably reliable evidence of the consumer's expected income. Comment 43(c)(2)(i)-3 also gives examples of reasonably expected income, such as expected bonuses verified with documents demonstrating past bonuses or expected salary from a job verified with a written statement from an employer stating a specified salary. As the Board has previously stated, in some cases a covered transaction may have a likely payment increase that would not be affordable at the consumer's income at the time of consummation. A creditor may be able to verify a reasonable expectation of an increase in the consumer's income that will make the higher payment affordable to the consumer. See 73 FR 44522, 44544 (July 30, 2008).

TILA section 129C(a)(9) provides that a creditor may consider the seasonality or irregularity of a consumer's income in determining repayment ability. Accordingly, the Board proposed comment 43(c)(2)(i)-4 to clarify that a creditor reasonably may determine that a consumer can make periodic loan payments even if the consumer's income, such as self-employment or agricultural employment income, is seasonal or irregular. The Bureau received little comment on this proposal, although at least one consumer advocate expressed concern that creditors might interpret the rule to allow for a creditor to differentiate among types of income. Specifically, the commenter expressed concern that some creditors might differentiate types of income, for example salaried income as opposed to disability payments, and that these creditors might require the consumer to produce a letter stating that the disability income was guaranteed for a specified period. The Bureau understands these concerns, and cautions creditors not to overlook the requirements imposed by the Equal Credit Opportunity Act, implemented by the Bureau under Regulation B. See 15 U.S.C. 1601 et seq.; 12 CFR 1002.1 et seq. For example, 12 CFR 1002.6(b)(2) prohibits a creditor from taking into account whether an applicant's income derives from any public assistance program. The distinction here is that 43(c)(2)(i)-4 permits the creditor to consider the regularity of the consumer's income, but such consideration must be based on the consumer's income history, not based on the source of the income, as both a consumer's wages or a consumer's receipt of public assistance may or may not be irregular. The Bureau is adopting this comment largely as proposed, as the concerns discussed above are largely covered by Regulation B. Comment 43(c)(2)(i)-4 states that, for example, if the creditor determines that the income a consumer receives a few months each year from, for example, selling crops or from agricultural employment is sufficient to make monthly loan payments when divided equally across 12 months, then the creditor reasonably may determine that the consumer can repay the loan, even though the consumer may not receive income during certain months.

Finally, the Bureau is adding new comment 43(c)(2)(i)-5 to further clarify, in the case of joint applicants, the consumer's current or reasonably expected income or assets basis of the creditor's ability-to-repay determination. This comment is similar in approach to the Board's proposed comment 43(c)(4)-2, discussed below, however, proposed comment 43(c)(4)-2 discussed the verification of income in the case of joint applicants. The Bureau is adding comment 43(c)(2)(i)-5 to clarify the creditor's basis for making an ability-to-repay determination for joint applicants. Comment 43(c)(2)(i)-5 explains that when two or more consumers apply for an extension of credit as joint obligors with primary liability on an obligation, § 1026.43(c)(i) does not require the creditor to consider income or assets that are not needed to support the creditor's repayment ability determination. Thus, the comment explains that if the income or assets of one applicant are sufficient to support the creditor's repayment ability determination, then the creditor is not required to consider the income or assets of the other applicant.

43(c)(2)(ii)

TILA section 129C(a)(3) requires that a creditor consider a consumer's employment status in determining the consumer's repayment ability, among other requirements. The Board proposal implemented this requirement in proposed § 226.43(c)(2)(ii) and clarified that a creditor need consider a consumer's employment status only if the creditor relies on income from the consumer's employment in determining repayment ability. The Bureau did not receive significant comment on the Board's proposal and is adopting § 1026.43(c)(2)(ii) as proposed. The Bureau sees no purpose in requiring a creditor to consider a consumer's employment status in the case where the creditor need not consider the income from that employment in the creditor's reasonable and good faith determination that the consumer will have a reasonable ability to repay the loan according to its terms.

The Board proposed, and the Bureau is adopting, comment 43(c)(2)(ii)-1 to illustrate this point further. The comment states, for example, that if a creditor relies wholly on a consumer's investment income to determine the consumer's repayment ability, the creditor need not consider or verify the consumer's employment status. The proposed comment further clarifies that employment may be full-time, part-time, seasonal, irregular, military, or self-employment. Comment 43(c)(2)(ii)-1 is similar to comment 34(a)(4)-6, which discusses income, assets, and employment in determining repayment ability for high-cost mortgages.

In its proposal, the Board explained that a creditor generally must verify information relied on to determine repayment ability using reasonably reliable third-party records, but may verify employment status orally as long as the creditor prepares a record of the oral information. The Board proposed comment 43(c)(2)(ii)-2 to add that a creditor also may verify the employment status of military personnel using the electronic database maintained by the Department of Defense (DoD) to facilitate identification of consumers covered by credit protections provided pursuant to 10 U.S.C. 987, also known as the “Talent Amendment.” [108] The Board solicited comment on whether creditors needed additional flexibility in verifying the employment status of military personnel, such as by verifying the employment status of a member of the military using a Leave and Earnings Statement. As this proposed comment was designed to provide clarification for creditors with respect to verifying a consumer's employment, this proposed comment is discussed in the section-by-section analysis of § 1026.43(c)(3) below.

43(c)(2)(iii)

Proposed § 226.43(c)(2)(iii) implemented the requirements under new TILA section 129C(a)(1) and (3), in part, by requiring that the creditor consider the consumer's monthly payment on the covered transaction, calculated in accordance with proposed § 226.43(c)(5), for purposes of determining the consumer's repayment ability. Proposed comment 43(c)(2)(iii)-1 clarified the regulatory language and made clear that mortgage-related obligations must also be considered.

The Bureau did not receive comments on this provision. Accordingly, the Bureau is adopting § 1026.43(c)(2)(iii) as proposed. Comment 43(c)(2)(iii)-1 has been edited to remove the reference to mortgage-related obligations as potentially confusing. The monthly payment for mortgage-related obligations must be considered under § 1026.43(c)(2)(v).

43(c)(2)(iv)

Proposed § 226.43(c)(2)(iv) implemented the requirements under new TILA section 129C(a)(2), in part, by requiring that the creditor consider “the consumer's monthly payment on any simultaneous loan that the creditor knows or has reason to know will be made, calculated in accordance with” proposed § 226.43(c)(6), for purposes of determining the consumer's repayment ability. As explained above in the section-by-section analysis of § 1026.43(b)(12), “simultaneous loan” is defined, in the proposed and final rules, to include HELOCs.

Proposed comment 43(c)(2)(iv)-1 clarified that for purposes of the repayment ability determination, a simultaneous loan includes any covered transaction or HELOC that will be made to the same consumer at or before consummation of the covered transaction and secured by the same dwelling that secures the covered transaction. This comment explained that a HELOC that is a simultaneous loan that the creditor knows or has reason to know about must be considered in determining a consumer's ability to repay the covered transaction, even though the HELOC is not a covered transaction subject to § 1026.43.

Proposed comment 43(c)(2)(iv)-3 clarified the scope of timing and the meaning of the phrase “at or before consummation” with respect to simultaneous loans that the creditor must consider for purposes of proposed § 226.43(c)(2)(iv). Proposed comment 43(c)(2)(iv)-4 provided guidance on the verification of simultaneous loans.

The Bureau received several industry comments on the requirement, in the regulation and the statute, that the creditor consider any simultaneous loan it “knows or has reason to know” will be made. The commenters felt that the standard was vague, and that it would be difficult for a creditor to understand when it “has reason to know” a simultaneous loan will be made.

The Board provided guidance on the “knows or has reason to know” standard in proposed comment 43(c)(2)(iv)-2. This comment provided that, in regard to “piggyback” second-lien loans, the creditor complies with the standard if it follows policies and procedures that are designed to determine whether at or before consummation that the same consumer has applied for another credit transaction secured by the same dwelling. The proposed comment provided an example in which the requested loan amount is less than the home purchase price, indicating that there is a down payment coming from a different funding source. The creditor's policies and procedures must require the consumer to state the source of the down payment, which must be verified. If the creditor determines that the source of the down payment is another extension of credit that will be made to the same consumer and secured by the same dwelling, the creditor knows or has reason to know of the simultaneous loan. Alternatively, if the creditor has verified information that the down payment source is the consumer's existing assets, the creditor would be under no further obligation to determine whether a simultaneous loan will be extended at or before consummation.

The Bureau believes that comment 43(c)(2)(iv)-2 provides clear guidance on the “knows or has reason to know” standard, with the addition of language clarifying that the creditor is not obligated to investigate beyond reasonable underwriting policies and procedures to determine whether a simultaneous loan will be extended at or before consummation of the covered transaction.

The Bureau considers the provision to be an accurate and appropriate implementation of the statute. Proposed § 226.43(c)(2)(iv) and associated commentary are adopted substantially as proposed, in renumbered § 1026.43(c)(2)(iv), with the addition of the language discussed above to comment 43(c)(2)(iv)-2 and other minor clarifying changes. Comment 43(c)(2)(iv)-3 now includes language making clear that if the consummation of the loan transaction is extended past the traditional closing, any simultaneous loan originated after that traditional closing may still be interpreted as having occurred “at” consummation. In addition, as discussed below, comment 43(c)(2)(iv)-4, Verification of simultaneous loans, has been grouped with other verification comments, in comment 43(c)(3)-4.

43(c)(2)(v)

As discussed above, TILA section 129C(a)(1) and (3) requires creditors to consider and verify mortgage-related obligations as part of the ability-to-repay determination “according to [the loan's] terms, and all applicable taxes, insurance (including mortgage guarantee insurance), and assessments.” Section 1026.34(a)(4), which was added by the 2008 HOEPA Final Rule, also requires creditors to consider mortgage-related obligations in assessing repayment ability. See the section-by-section analysis of § 1026.43(b)(8) for a discussion of the Bureau's interpretation of “mortgage-related obligations” and the definition adopted in the final rule.

The Board proposed to require creditors to consider the consumer's monthly payment for mortgage-related obligations as part of the repayment ability determination. Proposed comment 43(c)(2)(v)-1 explained that mortgage-related obligations must be included in the creditor's determination of repayment ability regardless of whether the amounts are included in the monthly payment or whether there is an escrow account established.

Proposed comment 43(c)(2)(v)-2 clarified that, in considering mortgage-related obligations that are not paid monthly, the creditor may look to widely accepted governmental or non-governmental standards to determine the pro rata monthly payment amount. The Board solicited comment on operational difficulties creditors may encounter when complying with this monthly requirement, and whether additional guidance was necessary.

Proposed comment 43(c)(2)(v)-3 explained that estimates of mortgage-related obligations should be based upon information known to the creditor at the time the creditor underwrites the mortgage obligation. This comment explained that information is known if it is “reasonably available” to the creditor at the time of underwriting the loan, and cross-referenced current comment 17(c)(2)(i)-1 for guidance regarding “reasonably available.” Proposed comment 43(c)(2)(v)-3 further clarified that, for purposes of determining repayment ability under proposed § 226.43(c), the creditor would not need to project potential changes.

Proposed comment 43(c)(2)(v)-4 stated that creditors must make the repayment ability determination required under proposed § 226.43(c) based on information verified from reasonably reliable records. This comment explained that guidance regarding verification of mortgage-related obligations could be found in proposed comments 43(c)(3)-1 and -2, which discuss verification using third-party records.

The Board solicited comment on any special concerns regarding the requirement to document certain mortgage-related obligations, for example, ground rent or leasehold payments, or special assessments. The Board also solicited comment on whether it should provide that the HUD-1 or -1A or a successor form could serve as verification of mortgage-related obligations reflected by the form, where a legal obligation exists to complete the form accurately.

Industry commenters and consumer advocates generally supported including consideration and verification of mortgage-related obligations in the ability-to-repay determination. Several industry commenters asked that the Bureau provide creditors more flexibility in considering and verifying mortgage-related obligations. They suggested that a reasonable and good faith determination be deemed sufficient, rather than use of all underwriting standards in any particular government or non-government handbook. Community banks asserted that flexible standards were necessary to meet their customers' needs. Some consumer advocates suggested that creditors be permitted to draw on only widely accepted standards that have been validated by experience or sanctioned by a government agency.

Some industry commenters asked for more guidance on how to calculate pro rata monthly payment amounts and estimated property taxes. One industry commenter asked that creditors be permitted to use pro rata monthly payment amounts for special assessments, not quarterly or yearly amounts. The commenter requested that estimates of common assessments be permitted. This commenter also recommended that creditors be permitted to verify the amount of common assessments with information provided by the consumer. One commenter noted that verification using HUD-1 forms should be permitted because there is a legal obligation to complete the HUD-1 accurately.

The Bureau is adopting the rule as proposed. For the reasons discussed below, the Bureau concludes that a creditor should consider the consumer's monthly payment for mortgage-related obligations in determining the consumer's ability to repay, pursuant to § 1026.43(c)(1). As commenters confirmed, obligations related to the mortgage may affect the consumer's ability to satisfy the obligation to make recurring payments of principal and interest. The Bureau also agrees with the argument raised by many commenters that the failure to account consistently for these obligations during the subprime crisis harmed many consumers. Thus, the Bureau has determined that it is appropriate to adopt § 1026.43(c)(2)(v) as proposed. However, the Bureau believes that additional guidance will facilitate compliance. As explained below, the Bureau has expanded on the proposed commentary language to provide additional clarity and illustrative examples.

The final version of comment 43(c)(2)(v)-1 is substantially similar to the language as proposed. As discussed under § 1026.43(b)(8) above, the Bureau is revising the language related to insurance premiums to provide additional clarity. The modifications to the language in proposed comment 43(c)(2)(v)-1 conform to the language adopted under § 1026.43(b)(8) and the related commentary. Furthermore, the final version of comment 43(c)(2)(v)-1 contains additional explanation regarding the determination of the consumer's monthly payment, and provides additional illustrative examples to clarify further the requirements of § 1026.43(c)(2)(v). For example, assume that a consumer will be required to pay mortgage insurance premiums, as defined by § 1026.43(b)(8), on a monthly, annual, or other basis after consummation. Section 1026.43(c)(2)(v) includes these recurring mortgage insurance payments in the evaluation of the consumer's monthly payment for mortgage-related obligations. However, if the consumer will incur a one-time fee or charge for mortgage insurance or similar purposes, such as an up-front mortgage insurance premium imposed at consummation, § 1026.43(c)(2)(v) does not include this up-front mortgage insurance premium in the evaluation of the consumer's monthly payment for mortgage-related obligations.

As discussed under § 1026.43(b)(8) above, several commenters discussed the importance of including homeowners association dues and similar obligations in the determination of ability to repay. These commenters argued, and the Bureau agrees, that recurring financial obligations payable to community governance associations, such as homeowners association dues, should be taken into consideration in determining whether a consumer has the ability to repay the obligation. The Bureau recognizes the practical problems that may arise with including obligations such as these in the evaluation of the consumer's monthly payment for mortgage-related obligations. Commenters identified issues stemming from difficulties which may arise in calculating, estimating, and verifying these obligations. Based on this feedback, the Bureau has determined that additional clarification is necessary. As adopted, comment 43(c)(2)(v)-2 clarifies that creditors need not include payments to community governance associations if such obligations are fully satisfied at or before consummation by the consumer. This comment further clarifies that § 1026.43(c)(2)(v) does not require the creditor to include these payments in the evaluation of the consumer's monthly payment for mortgage-related obligations if the consumer does not pay the fee directly at or before consummation, and instead finances the obligation. In these cases, the financed obligation will be included in the loan amount, and is therefore already included in the determination of ability to repay pursuant to § 1026.43(c)(2)(iii). However, if the consumer incurs the obligation and will satisfy the obligation with recurring payments after consummation, regardless of whether the obligation is escrowed, § 1026.43(c)(2)(v) requires the creditor to include the obligation in the evaluation of the consumer's monthly payment for mortgage-related obligations. The Bureau has also addressed the concerns raised by commenters related to calculating, estimating, and verifying these obligations in comments 43(c)(2)(v)-4 and -5 and 43(c)(3)-5, respectively.

As discussed under § 1026.43(b)(8) above, one comment letter focused extensively on community transfer fees. The Bureau agrees with the argument, advanced by several commenters, that the entirety of the consumer's ongoing obligations should be included in the determination. A responsible determination of the consumer's ability to repay requires an accounting of such obligations, whether the purpose of the obligation is to satisfy the payment of a community transfer fee or traditional homeowners association dues. An obligation that is not paid in full at or before consummation must be paid after consummation, which may affect the consumer's ability to repay ongoing obligations. Thus, comment 43(c)(2)(v)-2 clarifies that community transfer fees are included in the determination of the consumer's monthly payment for mortgage-related obligations if such fees are paid on a recurring basis after consummation. Additionally, the Bureau believes that a creditor is not required to include community transfer fees that are imposed on the seller, as many community transfer fees are, in the ability-to-repay calculation.

In response to the request for feedback in the proposed rule, several commenters addressed the proposed treatment of special assessments. Unlike community transfer fees, which are generally identified in the deed or master community plan, creditors may encounter difficulty determining whether special assessments exist. Special assessments are often imposed in response to some urgent or unexpected need. Consequently, neither the creditor nor the community governance association may be able to predict the frequency and magnitude of special assessments. However, this difficulty does not exist for special assessments that are known at the time of underwriting. Known special assessments, which the buyer must pay and which may be significant, may affect the consumer's ability to repay the obligation. Thus, comment 43(c)(2)(v)-3 clarifies that the creditor must include special assessments in the evaluation of the consumer's monthly payment for mortgage-related obligations if such fees are paid by the consumer on a recurring basis after consummation, regardless of whether an escrow is established for these fees. For example, if a homeowners association imposes a special assessment that the consumer will have to pay in full at or before consummation, § 1026.43(c)(2)(v) does not include the special assessment in the evaluation of the consumer's monthly payment for mortgage-related obligations. Section 1026.43(c)(2)(v) does not require a creditor to include special assessments in the evaluation of the consumer's monthly payment for mortgage-related obligations if the special assessments are imposed as a one-time charge. For example, if a homeowners association imposes a special assessment that the consumer will have to satisfy in one payment, § 1026.43(c)(2)(v) does not include this one-time special assessment in the evaluation of the consumer's monthly payment for mortgage-related obligations. However, if the consumer will pay the special assessment on a recurring basis after consummation, regardless of whether the consumer's payments for the special assessment are escrowed, § 1026.43(c)(2)(v) requires the creditor to include this recurring special assessment in the evaluation of the consumer's monthly payment for mortgage-related obligations. Comment 43(c)(2)(v)-3 also includes several other examples illustrating this requirement.

The Bureau agrees that clear and detailed guidance regarding determining pro rata monthly payments of mortgage-related obligations should be provided. However, the Bureau believes that it is important to strike a balance between providing clear guidance and providing creditors with the flexibility to serve the evolving mortgage market. The comments identified significant concerns with the use of “widely accepted governmental and non-governmental standards” for purposes of determining the pro rata monthly payment amount for mortgage-related obligations. While commenters generally stated that “widely accepted governmental standards” was an appropriate standard, others commented that “non-governmental standards” may not be sufficiently clear. The Bureau believes that “governmental standards” could be relied on to perform pro rata calculations of monthly mortgage related obligations because such standards provide detailed and comprehensive guidance and are frequently revised to adapt to the needs of the evolving residential finance market. However, the comments noted that “non-governmental standards” is not sufficiently descriptive to illustrate clearly how to calculate pro rata monthly payments. Additionally, the Bureau believes that clear guidance is also needed to address the possibility that a particular government program may not specifically describe how to calculate pro rata monthly payment amounts for mortgage-related obligations. Thus, the Bureau believes that it is appropriate to revise and further develop the concept of “widely accepted governmental and non-governmental standards.”

Based on this feedback, the Bureau has revised and expanded the comment clarifying how to calculate pro rata monthly mortgage obligations. As adopted, comment 43(c)(2)(v)-4 provides that, if the mortgage loan is originated pursuant to a governmental program, the creditor may determine the pro rata monthly amount of the mortgage-related obligation in accordance with the specific requirements of that program. If the mortgage loan is originated pursuant to a government program that does not contain specific standards for determining the pro rata monthly amount of the mortgage-related obligation, or if the mortgage loan is not originated pursuant to a government program, the creditor complies with § 1026.43(c)(2)(v) by dividing the total amount of a particular non-monthly mortgage-related obligation by no more than the number of months from the month that the non-monthly mortgage-related obligation last was due prior to consummation until the month that the non-monthly mortgage-related obligation next will be due after consummation. Comment 43(c)(2)(v)-4 also includes several examples which illustrate the conversion of non-monthly obligations into monthly, pro rata payments. For example, assume that a consumer applies for a mortgage loan on February 1st. Assume further that the subject property is located in a jurisdiction where property taxes are paid in arrears annually on the first day of October. The creditor complies with § 1026.43(c)(2)(v) by determining the annual property tax amount owed in the prior October, dividing the amount by 12, and using the resulting amount as the pro rata monthly property tax payment amount for the determination of the consumer's monthly payment for mortgage-related obligations. The creditor complies even if the consumer will likely owe more in the next year than the amount owed the prior October because the jurisdiction normally increases the property tax rate annually, provided that the creditor does not have knowledge of an increase in the property tax rate at the time of underwriting.

The Bureau is adopting comment 43(c)(2)(v)-5 in a form that is substantially similar to the version proposed. One industry commenter was especially concerned about estimating costs for community governance organizations, such as cooperative, condominium, or homeowners associations. This commenter noted that, because of industry concerns about TILA liability, many community governance organizations refuse to provide estimates of association expenses absent agreements disclaiming association liability. This commenter expressed concern that the ability-to-repay requirements would make community governance organizations less likely to provide estimates of association expenses, which would result in mortgage loan processing delays. The Bureau does not believe that the ability-to-repay requirements will lead to difficulties in exchanging information between creditors and associations because the ability-to-repay requirements generally apply only to creditors, as defined under § 1026.2(a)(17). However, the Bureau recognizes that consumers may be harmed if mortgage loan transactions are needlessly delayed by concerns arising from the ability-to-repay requirements. Thus, the Bureau has decided to address these concerns by adding several examples to comment 43(c)(2)(v)-5 illustrating the requirements of § 1026.43(c)(2)(v). For example, the creditor complies with § 1026.43(c)(2)(v) by relying on an estimate of mortgage-related obligations prepared by the homeowners association. In accordance with the guidance provided under comment 17(c)(2)(i)-1, the creditor need only exercise due diligence in determining mortgage-related obligations, and complies with § 1026.43(c)(2)(v) by relying on the representations of other reliable parties in preparing estimates. Or, assume that the homeowners association has imposed a special assessment on the seller, but the seller does not inform the creditor of the special assessment, the homeowners association does not include the special assessment in the estimate of expenses prepared for the creditor, and the creditor is unaware of the special assessment. The creditor complies with § 1026.43(c)(2)(v) if it does not include the special assessment in the determination of mortgage-related obligations. The creditor may rely on the representations of other reliable parties, in accordance with the guidance provided under comment 17(c)(2)(i)-1.

43(c)(2)(vi)

TILA section 129C(a)(1) and (3) requires creditors to consider “current obligations” as part of an ability-to-repay determination. Proposed § 226.43(c)(2)(vi) would have implemented the requirement under TILA section 129C(a)(1) and (3) by requiring creditors to consider current debt obligations. Proposed comment 43(c)(2)(vi)-1 would have specified that current debt obligations creditors must consider include, among other things, alimony and child support. The Bureau believes that it is reasonable to consider child support and alimony as “debts” given that the term “debt” is not defined in the statute. However, the Bureau understands that while alimony and child support are obligations, they may not be considered debt obligations unless and until they are not paid in a timely manner. Therefore, § 1026.43(c)(2)(vi) specifies that creditors must consider current debt obligations, alimony, and child support to clarify that alimony and child support are included whether or not they are paid in a timely manner.

Proposed comment 43(c)(2)(vi)-1 would have referred creditors to widely accepted governmental and non-governmental underwriting standards in determining how to define “current debt obligations.” The proposed comment would have given examples of current debt obligations, such as student loans, automobile loans, revolving debt, alimony, child support, and existing mortgages. The Board solicited comment on proposed comment 43(c)(2)(vi)-1 and on whether more specific guidance should be provided to creditors. Commenters generally supported giving creditors significant flexibility and did not encourage the Bureau to adopt more specific guidance. Because the Bureau believes that a wide range of criteria and guidelines for considering current debt obligations will contribute to reasonable, good faith ability-to-repay determinations, comment 43(c)(2)(vi)-1 as adopted preserves the flexible approach of the Board's proposed comment. The comment gives examples of current debt obligations but does not provide an exhaustive list. The comment therefore preserves substantial flexibility for creditors to develop their own underwriting guidelines regarding consideration of current debt obligations. Reference to widely accepted governmental and non-governmental underwriting standards has been omitted, as discussed above in the section-by-section analysis of § 1026.43(c).

The Board also solicited comment on whether additional guidance should be provided regarding consideration of debt obligations that are almost paid off. Commenters generally stated that creditors should be required to consider obligations that are almost paid off only if they affect repayment ability. The Bureau agrees that many different standards for considering obligations that are almost paid off could lead to reasonable, good faith ability-to-repay determinations. As adopted, comment 43(c)(2)(vi)-1 includes additional language clarifying that creditors have significant flexibility to consider current debt obligations in light of attendant facts and circumstances, including that an obligation is likely to be paid off soon after consummation. As an example, comment 43(c)(2)(vi)-1 states that a creditor may take into account that an existing mortgage is likely to be paid off soon after consummation because there is an existing contract for sale of the property that secures that mortgage.

The Board also solicited comment on whether additional guidance should be provided regarding consideration of debt obligations in forbearance or deferral. Several commenters, including both creditors and consumer advocates, supported requiring creditors to consider obligations in forbearance or deferral. At least one large creditor objected to requiring creditors to consider such obligations in all cases. The Bureau believes that many different standards for considering obligations in forbearance or deferral could lead to reasonable, good faith determinations of ability to repay. As adopted, comment 43(c)(2)(vi)-1 therefore includes additional language clarifying that creditors should consider whether debt obligations in forbearance or deferral at the time of underwriting are likely to affect a consumer's ability to repay based on the payment for which the consumer will be liable upon expiration of the forbearance or deferral period and other relevant facts and circumstances, such as when the forbearance or deferral period will expire.

Parts of proposed comment 43(c)(2)(vi)-1 and proposed comment 43(c)(2)(vi)-2 would have provided guidance on verification of current debt obligations. All guidance regarding verification has been moved to the commentary to § 1026.43(c)(3) and is discussed below in the section-by-section analysis of that provision.

The Board solicited comment on whether it should provide guidance on consideration of current debt obligations for joint applicants. Commenters generally did not comment on consideration of current debt obligations for joint applicants. One trade association commenter stated that joint applicants should be subject to the same standards as individual applicants. Because the Bureau believes that the current debt obligations of all joint applicants must be considered to reach a reasonable, good faith determination of ability to repay, the Bureau is adopting new comment 43(c)(2)(vi)-2. New comment 43(c)(2)(vi)-2 clarifies that when two or more consumers apply for credit as joint obligors, a creditor must consider the debt obligations of all such joint applicants. The comment also explains that creditors are not required to consider the debt obligations of a consumer acting merely as surety or guarantor. Finally, the comment clarifies that the requirements of § 1026.43(c)(2)(vi) do not affect various disclosure requirements.

43(c)(2)(vii)

TILA section 129C(a)(3) requires creditors to consider the consumer's monthly debt-to-income ratio or residual income the consumer will have after paying non-mortgage debt and mortgage-related obligations, as part of the ability-to-repay determination under TILA section 129C(a)(1). This provision is consistent with the 2008 HOEPA Final Rule, which grants a creditor in a high-cost or higher-priced mortgage loan a presumption of compliance with the requirement that the creditor assess repayment ability if, among other things, the creditor considers the consumer's debt-to-income ratio or residual income. See§ 1026.34(a)(4)(iii)(C), (b)(1). Existing comment 34(a)(4)(iii)(C)-1 provides that creditors may look to widely accepted governmental and non-governmental underwriting standards in defining “income” and “debt” including, for example, those set forth in the FHA Handbook on Mortgage Credit Analysis for Mortgage Insurance on One-to-Four Unit Mortgage Loans.

Proposed § 226.43(c)(2)(vii) would have implemented TILA section 129C(a)(3) by requiring creditors, as part of the repayment ability determination, to consider the consumer's monthly debt-to-income ratio or residual income. Proposed comment 43(c)(2)(vii)-1 would have cross-referenced § 226.43(c)(7), regarding the definitions and calculations for the monthly debt-to-income and residual income. Consistent with the 2008 HOEPA Final Rule, the proposed rule would have provided creditors flexibility to determine whether to use a debt-to-income ratio or residual income metric in assessing the consumer's repayment ability. As the Board noted, if one of these metrics alone holds as much predictive power as the two together, then requiring creditors to use both metrics could reduce credit access without an offsetting increase in consumer protection. 76 FR 27390, 27424-25 (May 11, 2011), citing 73 FR 44550 (July 30, 2008). The proposed rule did not specifically address creditors' use of both metrics if such an approach would provide incremental predictive power of assessing a consumer's repayment ability. However, as discussed above in the section-by-section analysis of § 1026.43(c), the Board's proposed comment 43(c)-1 would have provided that, in evaluating the consumer's repayment ability under § 226.43(c), creditors may look to widely accepted governmental or non-governmental underwriting standards, such as the FHA Handbook on Mortgage Credit Analysis for Mortgage Insurance on One-to-Four Unit Mortgage Loans, consistent with existing comment 34(a)(4)(iii)(C)-1.

In response to the proposed rule, industry commenters and consumer advocates generally supported including consideration of the debt-to-income ratio or residual income in the ability-to-repay determination. Several industry commenters asked that the Bureau provide creditors more flexibility in considering and verifying the debt-to-income ratio or residual income. They suggested that a reasonable and good faith determination be deemed sufficient, rather than use of all underwriting standards in any particular government or non-government handbook. Community banks asserted that flexible standards are necessary to meet their customers' needs. Some consumer advocates suggested that creditors be permitted only to draw on widely accepted standards that have been validated by experience or sanctioned by a government agency. They argued that more specific standards would help ensure safe and sound underwriting criteria, higher compliance rates, and a larger number of performing loans.

Section 1026.43(c)(2)(vii) adopts the Board's proposal by requiring a creditor making the repayment determination under § 1026.43(c)(1) to consider the consumer's monthly debt-to-income ratio or residual income, in accordance with § 1026.43(c)(7). The Bureau believes that a flexible approach to evaluating a consumer's debt-to-income ratio or residual income is appropriate because stricter guidelines may limit access to credit and create fair lending problems. Broad guidelines will provide creditors necessary flexibility to serve the whole of the mortgage market effectively and responsibly. Accordingly, the final rule sets minimum underwriting standards while providing creditors with flexibility to use their own reasonable guidelines in making the repayment ability determination required by § 1026.43(c)(1). Moreover, and as in the 2008 HOEPA Final Rule, the approach would provide creditors flexibility to determine whether to use a debt-to-income ratio or residual income, or both, in assessing a consumer's repayment ability.

As discussed above in the section-by-section analysis of § 1026.43(c), the Bureau is not finalizing the Board's proposed comment 43(c)-1 regarding the use of widely accepted governmental or non-governmental underwriting standards in evaluating the consumer's repayment ability. Instead, for the reasons discussed above, comment 43(c)(2)-1 provides that the rule and commentary permit creditors to adopt reasonable standards for evaluating factors in underwriting a loan, such as whether to classify particular inflows or obligations as “income” or “debt,” and that, in evaluating a consumer's repayment ability, a creditor may look to governmental underwriting standards. See section-by-section analysis of § 1026.43(c)(2).

The Bureau believes a flexible approach to evaluating debt and income is appropriate in making the repayment ability determination under § 1026.43(c). However, for the reasons discussed below, the Bureau believes a quantitative standard for evaluating a consumer's debt-to-income ratio should apply to loans that are “qualified mortgages” that receive a safe harbor or presumption of compliance with the repayment ability determination under § 1026.43(c). For a discussion of the quantitative debt-to-income standard that applies to qualified mortgages pursuant to § 1026.43(e)(2) and the rationale for applying a quantitative standard in the qualified mortgage space, see the section-by-section analysis of § 1026.43(e)(2).

43(c)(2)(viii)

TILA section 129C(a)(1) and (3) requires creditors to consider credit history as part of the ability-to-repay determination. Proposed § 226.43(c)(2)(viii) would have implemented the requirement under TILA section 129C(a)(1) and (3) by adopting the statutory requirement that creditors consider credit history as part of an ability-to-repay determination. Proposed comment 43(c)(2)(viii)-1 would have referred creditors to widely accepted governmental and non-governmental underwriting standards to define credit history. The proposed comment would have given examples of factors creditors could consider, such as the number and age of credit lines, payment history, and any judgments, collections, or bankruptcies. The proposed comment also would have referred creditors to credit bureau reports or to nontraditional credit references such as rental payment history or public utility payments.

Commenters generally did not object to the proposed adoption of the statutory requirement to consider credit history as part of ability-to-repay determinations. Commenters generally supported giving creditors significant flexibility in how to consider credit history. Creditors also generally supported clarifying that creditors may look to nontraditional credit references such as rental payment history or public utility payments.

Section 1026.43(c)(2)(viii) is adopted as proposed. Comment 43(c)(2)(viii)-1 as adopted substantially maintains the proposed comment's flexible approach to consideration of credit history. Comment 43(c)(2)(viii)-1 notes that “credit history” may include factors such as the number and age of credit lines, payment history, and any judgments, collections, or bankruptcies. The comment clarifies that the rule does not require creditors to obtain or consider a consolidated credit score or prescribe a minimum credit score that creditors must apply. The comment further clarifies that the rule does not specify which aspects of credit history a creditor must consider or how various aspects of credit history could be weighed against each other or against other underwriting factors. The comment explains that some aspects of a consumer's credit history, whether positive or negative, may not be directly indicative of the consumer's ability to repay and that a creditor therefore may give various aspects of a consumer's credit history as much or as little weight as is appropriate to reach a reasonable, good faith determination of ability to repay. The Bureau believes that this flexible approach is appropriate because of the wide range of creditors, consumers, and loans to which the rule will apply. The Bureau believes that a wide range of approaches to considering credit history will contribute to reasonable, good faith ability-to-repay determinations. As in the proposal, the comment, as adopted, clarifies that creditors may look to non-traditional credit references such as rental payment history or public utility payments, but are not required to do so. Reference to widely accepted governmental and non-governmental underwriting standards has been omitted, as discussed in the section-by-section analysis of § 1026.43(c), above.

Portions of proposed comment 43(c)(2)(viii)-1 discussed verification of credit history. All guidance regarding verification has been moved to the commentary to § 1026.43(c)(3) and is discussed below in the section-by-section analysis of that provision.

Because the Bureau believes that the credit history of all joint applicants must be considered to reach a reasonable, good faith determination of joint applicants' ability to repay, and for conformity with the commentary to § 1026.43(c)(2)(vi) regarding consideration of current debt obligations for multiple applicants, the Bureau is adopting new comment 43(c)(2)(viii)-2 regarding multiple applicants. The comment clarifies that, when two or more consumers apply jointly for credit, the creditor is required by § 1026.43(c)(2)(viii) to consider the credit history of all joint applicants. New comment 43(c)(2)(viii)-2 also clarifies that creditors are not required to consider the credit history of a consumer who acts merely as a surety or guarantor. Finally, the comment clarifies that the requirements of § 1026.43(c)(2)(viii) do not affect various disclosure requirements.

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

TILA section 129C(a)(1) requires that a creditor make a reasonable and good faith determination, based on “verified and documented information,” that a consumer has a reasonable ability to repay the covered transaction. The Board's 2008 HOEPA Final Rule required that a creditor verify the consumer's income or assets relied on to determine repayment ability and the consumer's current obligations under § 1026.34(a)(4)(ii)(A) and (C). Thus, TILA section 129C(a)(1) differs from existing repayment ability rules by requiring a creditor to verify information relied on in considering the consumer's ability to repay according to the considerations required under TILA section 129C(a)(3), which are discussed above in the section-by-section analysis of § 1026.43(c)(2).

The Board's proposal would have implemented TILA section 129C(a)(1)'s general requirement to verify a consumer's repayment ability in proposed § 226.43(c)(3), which required that a creditor verify a consumer's repayment ability using reasonably reliable third-party records, with two exceptions. Under the first exception, proposed § 226.43(c)(3)(i) provided that a creditor may orally verify a consumer's employment status, if the creditor subsequently prepares a record of the oral employment status verification. Under the second exception, proposed § 226.43(c)(3)(ii) provided that, in cases where a creditor relies on a consumer's credit report to verify a consumer's current debt obligations and the consumer's application states a current debt obligation not shown in the consumer's credit report, the creditor need not independently verify the additional debt obligation, as reported. Proposed comment 43(c)(3)-1 clarified that records a creditor uses to verify a consumer's repayment ability under proposed § 226.43(c)(3) must be specific to the individual consumer. Records regarding, for example, average incomes in the consumer's geographic location or average incomes paid by the consumer's employer would not be specific to the individual consumer and are not sufficient.

Proposed comment 43(c)(3)-2 provided that a creditor may obtain third-party records from a third-party service provider, as long as the records are reasonably reliable and specific to the individual consumer. As stated in § 1026.43(c)(3), the standard for verification is that the creditor must use “reasonably reliable third-party records,” which is fulfilled for reasonably reliable documents, specific to the consumer, provided by a third-party service provider. Also, proposed comment 43(c)(3)-2 clarified that a creditor may obtain third-party records, for example, payroll statements, directly from the consumer, again as long as the records are reasonably reliable.

The Board also solicited comment on whether any documents or records prepared by the consumer and not reviewed by a third party appropriately could be considered in determining repayment ability, for example, because a particular record provides information not obtainable using third-party records. In particular, the Board solicited comment on methods currently used to ensure that documents prepared by self-employed consumers (such as a year-to-date profit and loss statement for the period after the period covered by the consumer's latest income tax return, or an operating income statement prepared by a consumer whose income includes rental income) are reasonably reliable for use in determining repayment ability.

Commenters generally supported the Board's proposal to implement the Dodd-Frank Act's verification requirements. Consumer groups generally found the proposal to be an accurate implementation of the statute and posited that the proposal would provide much-needed protection for consumers. Industry commenters generally also supported the proposal, noting that most underwriters already engaged in similarly sound underwriting practices. Some industry commenters noted that verifying a consumer's employment status imposes a burden upon the consumer's employer as well, however the Bureau has concluded that the oral verification provision provided by § 1026.43(c)(3)(ii), discussed below, alleviates such concerns.

The Bureau is adopting § 1026.43(c)(3) substantially as proposed, with certain clarifying changes which are described below. The final rule also adds new comment 43(c)(3)-3. In addition, for organizational purposes, the final rule generally adopts proposed comments 43(c)(2)(iv)-4, 43(c)(2)(v)-4, 43(c)(2)(vi)-1, 43(c)(2)(viii)-1, and 43(c)(2)(ii)-2 in renumbered comments 43(c)(3)-4 through -8 with revisions as discussed below. These changes and additions to § 1026.43(c)(3) and its commentary are discussed below.

First, the final rule adds a new § 1026.43(c)(3)(i), which provides that, for purposes of § 1026.43(c)(2)(i), a creditor must verify a consumer's income or assets in accordance with § 1026.43(c)(4). This is an exception to the general rule in § 1026.43(c)(3) that a creditor must verify the information that the creditor relies on in determining a consumer's repayment ability under § 1026.43(c)(2) using reasonably reliable third-party records. Because of this new provision, proposed § 226.43(c)(3)(i) and (ii) are adopted as proposed in § 1026.43(c)(3)(ii) and (iii), with minor technical revisions. In addition, the Bureau is adopting proposed comments 43(c)(3)-1 and -2 substantially as proposed with revisions to clarify that the guidance applies to both § 1026.43(c)(3) and (c)(4).

The Bureau is adding new comment 43(c)(3)-3 to clarify that a credit report generally is considered a reasonably reliable third-party record. The Board's proposed comment 43(c)(2)(vi)-2 stated, among other things, that a credit report is deemed a reasonably reliable third-party record under proposed § 226.43(c)(3). Commenters did not address that aspect of proposed comment 43(c)(2)(vi)-2. The Bureau believes credit reports are generally reasonably reliable third-party records for verification purposes. Comment 43(c)(3)-3 also explains that a creditor is not generally required to obtain additional reasonably reliable third-party records to verify information contained in a credit report, as the report itself is the means of verification. Likewise, comment 43(c)(3)-3 explains that if information is not included in the credit report, then the credit report cannot serve as a means of verifying that information. The comment further explains, however, that if the creditor may know or have reason to know that a credit report is not reasonably reliable, in whole or in part, then the creditor complies with § 1026.43(c)(3) by disregarding such inaccurate or disputed items or reports. The creditor may also, but is not required, to obtain other reasonably reliable third-party records to verify information with respect to which the credit report, or item therein, may be inaccurate. The Bureau believes that this guidance strikes the appropriate balance between acknowledging that in many cases, a credit report is a reasonably reliable third-party record for verification and documentation for many creditors, but also that a credit report may be subject to a fraud alert, extended alert, active duty alert, or similar alert identified in 15 U.S.C. 1681c-1, or may contain debt obligations listed on a credit report is subject to a statement of dispute pursuant to 15 U.S.C. 1681i(b). Accordingly, for the reasons discussed above, the Bureau is adopting new comment 43(c)(3)-3.

As noted above, the Bureau is adopting proposed comment 43(c)(2)(iv)-4 as comment 43(c)(3)-4 for organizational purposes. The Board proposed comment 43(c)(2)(iv)-4 to explain that although a creditor could use a credit report to verify current obligations, the report would not reflect a simultaneous loan that has not yet been consummated or has just recently been consummated. Proposed comment 43(c)(2)(iv)-2 clarified that if the creditor knows or has reason to know that there will be a simultaneous loan extended at or before consummation, then the creditor may verify the simultaneous loan by obtaining third-party verification from the third-party creditor of the simultaneous loan. The proposed comment provided, as an example, that the creditor may obtain a copy of the promissory note or other written verification from the third-party creditor in accordance with widely accepted governmental or non-governmental standards. In addition, proposed comment 43(c)(2)(iv)-2 cross-referenced comments 43(c)(3)-1 and -2, which discuss verification using third-party records. The Bureau generally did not receive comment with respect to this proposed comment; however, at least one commenter supported the example that a promissory note would serve as appropriate documentation for verifying a simultaneous loan. The Bureau is adopting proposed comment 43(c)(2)(iv)-4 as comment 43(c)(3)-4 with the following amendment. For consistency with other aspects of the rule, comment 43(c)(3)-4 does not include the Board's proposed reference to widely accepted governmental or non-governmental standards.

The Board proposed comment 43(c)(2)(v)-4, which stated that creditors must make the repayment ability determination required under proposed § 226.43(c) based on information verified from reasonably reliable records. The Board solicited comment on any special concerns regarding the requirement to document certain mortgage-related obligations, for example, ground rent or leasehold payments, or special assessments. The Board also solicited comment on whether it should provide that the HUD-1 or -1A or a successor form could serve as verification of mortgage-related obligations reflected by the form, where a legal obligation exists to complete the HUD-1 or -1A accurately. To provide additional clarity, the Bureau is moving guidance that discusses verification, including proposed comment 43(c)(2)(v)-4, as part of the section-by-section analysis of, and commentary to, § 1026.43(c)(3). Additional comments from the Board's proposal with respect to mortgage-related obligations are in the section-by-section analysis of § 1026.43(c)(2)(v), above.

Industry commenters and consumer advocates generally supported including consideration and verification of mortgage-related obligations in the ability-to-repay determination. Several industry commenters asked that the Bureau provide creditors more flexibility in considering and verifying mortgage-related obligations. Several consumer advocate commenters discussed the importance of verifying mortgage-related obligations based on reliable records, noting that inadequate, or non-existent, verification measures played a significant part in the subprime crisis. Industry commenters agreed that verification was appropriate, but these commenters also stressed the importance of clear and detailed guidance. Several commenters were concerned about the meaning of “reasonably reliable records” in the context of mortgage-related obligations. Some commenters asked the Bureau to designate certain items as reasonably reliable, such as taxes referenced in a title report, statements of common expenses provided by community associations, or items identified in the HUD-1 or HUD-1A.

The Bureau is adopting proposed comment 43(c)(2)(v)-4 as comment 43(c)(3)-5 with revision to provide further explanation of its approach to verifying mortgage-related obligations. While the reasonably reliable standard contains an element of subjectivity, the Bureau concludes that this flexibility is necessary. The Bureau believes that it is important to craft a regulation with the flexibility to accommodate an evolving mortgage market. The Bureau determines that the reasonably reliable standard is appropriate in this context given the nature of the items that are defined as mortgage-related obligations. Thus, comment 43(c)(3)-5 incorporates by reference comments 43(c)(3)-1 and -2. Mortgage-related obligations refer to a limited set of charges, such as property taxes and lease payments, which a creditor can generally verify from an independent or objective source. Thus, in the context of mortgage-related obligations this standard provides certainty while being sufficiently flexible to adapt as underwriting practices develop over time.

To address the concerns raised by several commenters, the Bureau is providing further clarification in 43(c)(3)-5 to provide detailed guidance and several examples illustrating these requirements. For example, comment 43(c)(3)-5 clarifies that records are reasonably reliable for purposes § 1026.43(c)(2)(v) if the information in the record was provided by a governmental organization, such as a taxing authority or local government. Comment 43(c)(3)-5 also explains that a creditor complies with § 1026.43(c)(2)(v) if it relies on, for example, homeowners association billing statements provided by the seller to verify other information in a record provided by an entity assessing charges, such as a homeowners association. Comment 43(c)(3)-5 further illustrates that records are reasonably reliable if the information in the record was obtained from a valid and legally executed contract, such as a ground rent agreement. Comment 43(c)(3)-5 also clarifies that other records may be reasonably reliable if the creditor can demonstrate that the source provided the information objectively.

The Board's proposal solicited comment regarding whether the HUD-1, or similar successor document, should be considered a reasonably reliable record. The Board noted, and commenters confirmed, that the HUD-1, HUD-1A, or successor form might be a reasonably reliable record because a legal obligation exists to complete the form accurately. Although the Bureau agrees with these considerations, the Bureau does not believe that a document provided in final form at consummation, such as the HUD-1, should be used for the purposes of determining ability to repay pursuant to § 1026.43(c)(2)(v). The Bureau expects the ability-to-repay determination to be conducted in advance of consummation. It therefore may be impractical for a creditor to rely on a document that is produced in final form at, or shortly before, consummation for verification purposes. The Bureau is also concerned that real estate transactions may be needlessly disrupted or delayed if creditors delay determining the consumer's ability to repay until the HUD-1, or similar successor document, is prepared. Given these concerns, and strictly as a matter of policy, the Bureau does not wish to encourage the use of the HUD-1, or similar successor document, for the purposes of determining a consumer's ability to repay, and the Bureau is not specifically designating the HUD-1 as a reasonably reliable record in either § 1026.43(c)(2)(v) or related commentary, such as comment 43(c)(3)-5. However, the Bureau acknowledges that the HUD-1, HUD-1A, or similar successor document may comply with § 1026.43(c)(3).

The Board proposed comment 43(c)(2)(vi)-1, which discussed both consideration and verification of current debt obligations. The Bureau discusses portions of proposed comment 43(c)(2)(vi)-1, regarding consideration of current debt obligations, in the section-by-section analysis of § 1026.43(c)(2)(vi). As noted above, for organizational purposes and to provide additional clarity, however, the Bureau is moving guidance that discusses verification, including portions of proposed comment 43(c)(2)(vi)-1, as part of the commentary to § 1026.43(c)(3). With respect to verification, proposed comment 43(c)(2)(vi)-1 stated that: (1) In determining how to verify current debt obligations, a creditor may look to widely accepted governmental and nongovernmental underwriting standards; and (2) a creditor may, for example, look to credit reports, student loan statements, automobile loan statements, credit card statements, alimony or child support court orders and existing mortgage statements. Commenters did not provide the Bureau with significant comment with respect to this proposal, although at least one large bank commenter specifically urged the Bureau to allow creditors to verify current debt obligations using a credit report. For the reasons discussed below, the Bureau is adopting, in relevant part, proposed comment 43(c)(2)(vi)-1 as comment 43(c)(3)-6. The Bureau believes that the proposed guidance regarding verification using statements and orders related to individual obligations could be misinterpreted as implying that credit reports are not sufficient verification of current debt obligations and that creditors must obtain statements and other documentation pertaining to each individual obligation. Comment 43(c)(3)-6 therefore explains that a creditor is not required to further verify the existence or amount of the obligation listed in a credit report, absent circumstances described in comment 43(c)(3)-3. The Bureau believes that a credit report is a reasonably reliable third-party record and is sufficient verification of current debt obligations in most cases. The Bureau also believes that this approach is reflected in the Board's proposal. For example, proposed comment 43(c)(2)(vi)-2 stated that a credit report is a reasonably reliable third-party record; and proposed § 1026.43(c)(3)(ii) indicated that a creditor could rely on a consumer's credit report to verify a consumer's current debt obligations. Unlike proposed comment 43(c)(2)(vi)-1, comment 43(c)(3)-6 does not include reference to widely accepted governmental and nongovernmental underwriting standards for consistency with the amendments in other parts of the rule. To understand the Bureau's approach to verification standards, see the section-by-section analysis, commentary, and regulation text of § 1026.43(c) and § 1026.43(c)(1) above. The Board proposed comment 43(c)(2)(viii)-1, which discussed both the consideration and verification of credit history. The Bureau discusses portions of proposed comment 43(c)(2)(viii)-1, those regarding consideration of credit history, in the section-by-section analysis of § 1026.43(c)(2)(viii). However, the Bureau is moving guidance on verification, including portions of proposed comment 43(c)(2)(viii)-1, to § 1026.43(c)(3) and its commentary. Regarding verification, proposed comment 43(c)(2)(viii)-1 stated that: (1) Creditors may look to widely accepted governmental and nongovernmental underwriting standards to determine how to verify credit history; and (2) a creditor may, for example, look to credit reports from credit bureaus, or other nontraditional credit references contained in third-party documents, such as rental payment history or public utility payments to verify credit history. Commenters did not object to the Board's proposed approach to verification of credit history. The Bureau is adopting this approach under comment 43(c)(3)-7 with the following exception. References to widely accepted governmental and nongovernmental underwriting standards have been removed, as discussed above in the section-by-section analysis of § 1026.43(c). Portions of proposed comment 43(c)(2)(viii)-1 regarding verification are otherwise adopted substantially as proposed in new comment 43(c)(3)-7.

The Board proposed comment 43(c)(2)(ii)-2 to clarify that a creditor also may verify the employment status of military personnel using the electronic database maintained by the DoD to facilitate identification of consumers covered by credit protections provided pursuant to 10 U.S.C. 987, also known as the “Talent Amendment.” [109] The Board also sought additional comment as to whether creditors needed additional flexibility in verifying the employment status of military personnel, such as by verifying the employment status of a member of the military using a Leave and Earnings Statement.

Industry commenters requested that the Bureau provide additional flexibility for creditors to verify military employment. For example, some industry commenters noted that a Leave and Earnings Statement was concrete evidence of employment status and income for military personnel and other industry commenters stated that institutions that frequently work with military personnel have built their own expertise in determining the reliability of using the Leave and Earnings Statement. These commenters argued that using a Leave and Earnings Statement is as reliable a means of verifying the employment status of military personnel as using a payroll statement to verify that employment status of a civilian.

Accordingly, the Bureau is adopting proposed comment 43(c)(2)(ii)-2 as comment 43(c)(3)-8, for organizational purposes, with the following additional clarification. Comment 43(c)(3)-8 clarifies that a creditor may verify military employment by means of a military Leave and Earnings Statement. Therefore, comment 43(c)(3)-8 provides that a creditor may verify the employment status of military personnel by using either a military Leave and Earnings Statement or by using the electronic database maintained by the DoD.

The Board solicited comment on whether a creditor might appropriately verify a consumer's repayment ability using any documents or records prepared by the consumer and not reviewed by a third party, perhaps because a particular record might provide information not obtainable using third-party records. The Bureau did not receive sufficient indication that such records would qualify as reasonably reliable and has thus not added additional regulatory text or commentary to allow for the use of such records. However, a creditor using reasonable judgment nevertheless may determine that such information is useful in verifying a consumer's ability to repay. For example, the creditor may consider and verify a self-employed consumer's income from the consumer's 2013 income tax return, and the consumer then may offer an unaudited year-to-date profit and loss statement that reflects significantly lower expected income in 2014. The creditor might reasonably use the lower 2014 income figure as a more conservative method of underwriting. However, should the unverified 2014 income reflect significantly greater income than the income tax return showed for 2013, a creditor instead would verify this information in accordance with § 1026.43(c)(4).

43(c)(4) Verification of Income or Assets

TILA section 129C(a)(4) requires that a creditor verify amounts of income or assets that a creditor relied upon to determine repayment ability by reviewing the consumer's Internal Revenue Service (IRS) Form W-2, tax returns, payroll statements, financial institution records, or other third-party documents that provide reasonably reliable evidence of the consumer's income or assets. TILA section 129C(a)(4) further provides that, in order to safeguard against fraudulent reporting, any consideration of a consumer's income history must include the verification of income using either (1) IRS transcripts of tax returns; or (2) an alternative method that quickly and effectively verifies income documentation by a third-party, subject to rules prescribed by the Board, and now the Bureau. TILA section 129C(a)(4) is similar to existing § 1026.34(a)(4)(ii)(A), adopted by the Board's 2008 HOEPA Final Rule, although TILA section 129C(a)(4)(B) provides for the alternative methods of third-party income documentation (other than use of an IRS tax-return transcript) to be both “reasonably reliable” and to “quickly and effectively” verify a consumer's income. The Board proposed to implement TILA section 129C(a)(4)(B), adjusting the requirement to (1) require the creditor to use reasonably reliable third-party records, consistent with TILA section 129C(a)(4), rather than the “quickly and effectively” standard of TILA section 129C(a)(4)(B); and (2) provide examples of reasonably reliable records that a creditor can use to efficiently verify income, as well as assets. As discussed in the Board's proposal, the Board proposed these adjustments pursuant to its authority under TILA sections 105(a) and 129B(e). The Board believed that considering reasonably reliable records effectuates the purposes of TILA section 129C(a)(4), is an effective means of verifying a consumer's income, and helps ensure that consumers are offered and receive loans on terms that reasonably reflect their repayment ability.

Industry and consumer group commenters generally supported proposed § 226.43(c)(4) because the proposal would permit a creditor to use a wide variety of documented income and/or asset verification methods, while maintaining the appropriate goal of ensuring accurate verification procedures. Some commenters requested that the Bureau allow a creditor to underwrite a mortgage based on records maintained by a financial institution that show an ability to repay. Specifically, commenters raised concerns with respect to customers who may not have certain documents, such as IRS Form W-2, because of their employment or immigration status. The Bureau expects that § 1026.43(c)(4) provides that the answer to such concerns is self-explanatory; a creditor need not, by virtue of the requirements of § 1026.43(c)(4), require a consumer to produce an IRS Form W-2 in order to verify income. Some industry commenters argued that the Bureau should also permit creditors to verify information for certain applicants, such as the self-employed, by using non-third party reviewed documents, arguing it would reduce costs for consumers. The Bureau does not find such justification to be persuasive, as other widely available documents, such as financial institution records or tax records, could easily serve as means of verification without imposing significant cost to the consumer or creditor. See also the discussion of comment 43(b)(13)(i)-1, addressing third-party records.

Some industry commenters advocated, in addition, that creditors be allowed to employ broader, faster sources of income verification, such as internet-based tools that employ aggregate employer data, or be allowed to rely on statistically qualified models to estimate income or assets. The Bureau, however, believes that permitting creditors to use statistical models or aggregate data to verify income or assets would be contrary to the purposes of TILA section 129C(a)(4). Although the statute uses the words “quickly and effectively,” these words cannot be read in isolation, but should instead be read in context of the entirety of TILA section 129C(a)(4). As noted above, the Bureau believes that TILA section 129C(a)(4) is primarily intended to safeguard against fraudulent reporting and inaccurate underwriting, rather than accelerate the process of verifying a consumer's income, as the statute specifically notes that a creditor must verify a consumer's income history “[i]n order to safeguard against fraudulent reporting.” The Bureau further believes that permitting the use of aggregate data or non-individualized estimates would undermine the requirements to verify a consumer's income and to determine a consumer's ability to repay. Rather, the Bureau believes that the statute requires verification of the amount of income or assets relied upon using evidence of an individual's income or assets.

For substantially the same reasons stated in the Board's proposal, the Bureau is adopting proposed § 226.43(c)(4) and its accompanying commentary substantially as proposed in renumbered § 1026.43(c)(4), with revisions for clarity. Accordingly, the Bureau is implementing TILA section 129C(a)(4) in § 1026.43(c)(4), which provides that a creditor must verify the amounts of income or assets it relies on to determine a consumer's ability to repay a covered transaction using third-party records that provide reasonably reliable evidence of the consumer's income or assets. Section 1026.43(c)(4) further provides a list of illustrative examples of methods of verifying a consumer's income or asserts using reasonably reliable third-party records. Such examples include: (1) Copies of tax returns the consumer filed with the IRS or a State taxing authority; (2) IRS Form W-2s or similar IRS forms for reporting wages or tax withholding; (3) payroll statements, including military Leave and Earnings Statements; (4) financial institution records; (5) records from the consumer's employer or a third party that obtained consumer-specific income information from the consumer's employer; (6) records from a government agency stating the consumer's income from benefits or entitlements, such as a “proof of income” letter issued by the Social Security Administration; (7) check cashing receipts; and (8) receipts from a consumer's use of funds transfer services. The Bureau also believes that by providing such examples of acceptable records, the Bureau enables creditors to quickly and effectively verify a consumer's income, as provided in TILA section 129C(a)(4)(B).

Comment 43(c)(4)-1 clarifies that under § 1026.43(c)(4), a creditor need verify only the income or assets relied upon to determine the consumer's repayment ability. Comment 43(c)(4)-1 also provides an example where the creditor need not verify a consumer's annual bonus because the creditor relies on only the consumer's salary to determine the consumer's repayment ability. This comment also clarifies that comments 43(c)(3)-1 and -2, discussed above, are instructive with respect to income and asset verification.

Comment 43(c)(4)-2 clarifies that, if consumers jointly apply for a loan and each consumer lists his or her income or assets on the application, the creditor need verify only the income or assets the creditor relies on to determine repayment ability. Comment 43(c)(2)(i)-5, discussed above, may also be instructive in cases of multiple applicants.

Comment 43(c)(4)-3 provides that a creditor may verify a consumer's income using an IRS tax-return transcript that summarizes the information in the consumer's filed tax return, another record that provides reasonably reliable evidence of the consumer's income, or both. Comment 43(c)(4)-3 also clarifies that a creditor may obtain a copy of an IRS tax-return transcript or filed tax return from a service provider or from the consumer, and the creditor need not obtain the copy directly from the IRS or other taxing authority. For additional guidance, Comment 43(c)(4)-3 cross-references guidance on obtaining records in comment 43(c)(3)-2.

Finally, comment 43(c)(4)(vi)-1 states that an example of a record from a Federal, State, or local government agency stating the consumer's income from benefits or entitlements is a “proof of income letter” (also known as a “budget letter,” “benefits letter,” or “proof of award letter”) from the Social Security Administration.

As discussed above, the Bureau is adopting § 1026.43(c)(4) as enabling creditors to quickly and effectively verify a consumer's income, as provided in TILA section 129C(a)(4)(B). In addition, for substantially the same rationale as discussed in the Board's proposal, the Bureau is adopting § 1026.43(c)(4) using its authority under TILA section 105(a) to prescribe regulations to carry out the purposes of TILA. One of the purposes of TILA section 129C is to assure that consumers are offered and receive covered transactions on terms that reasonably reflect their ability to repay the loan. See TILA section 129B(a)(2). The Bureau believes that a creditor consulting reasonably reliable records is an effective means of verifying a consumer's income and helps ensure that consumers are offered and receive loans on terms that reasonably reflect their repayment ability. The Bureau further believes that TILA section 129C(a)(4) is intended to safeguard against fraudulent or inaccurate reporting, rather than to accelerate the creditor's ability to verify a consumer's income. Indeed, the Bureau believes that there is a risk that requiring a creditor to use quick methods to verify the consumer's income would undermine the effectiveness of the ability-to-repay requirements by sacrificing thoroughness for speed. The Bureau believes instead that requiring the use of reasonably reliable records effectuates the purposes of TILA section 129C(a)(4) without suggesting that creditors must obtain records or complete income verification within a specific period of time. The Bureau is adopting the examples of reasonably reliable records, proposed by the Board, that a creditor may use to efficiently verify income or assets, because the Bureau believes that it will facilitate compliance by providing clear guidance to creditors.

The Bureau notes that the Board proposal solicited comment on whether it should provide an affirmative defense for a creditor that can show that the amounts of the consumer's income or assets that the creditor relied upon in determining the consumer's repayment ability were not materially greater than the amounts the creditor could have verified using third-party records at or before consummation. Such an affirmative defense, while not specified under TILA, would be consistent with the Board's 2008 HOEPA Final Rule. See§ 1026.34(a)(4)(ii)(B). [110] Consumer group commenters generally opposed an affirmative defense, arguing that such an allowance would essentially gut the income and asset verification requirement provided by the rule. Other commenters noted that providing an affirmative defense might result in confusion, and possible litigation, over what the term “material” may mean, and that a rule permitting an affirmative defense would need to define materiality specifically, including from whose perspective materiality should be measured (i.e., the creditor's or the consumer's). Based on the comments received, the Bureau believes that an affirmative defense is not warranted. The Bureau believes that permitting an affirmative defense could result in circumvention of the § 1026.43(c)(4) verification requirement. For the reasons stated, the Bureau is not adopting an affirmative defense for a creditor that can show that the amounts of the consumer's income or assets that the creditor relied upon in determining the consumer's repayment ability were not materially greater than the amounts the creditor could have verified using third-party records at or before consummation.

43(c)(5) Payment Calculation

The Board proposed § 226.43(c)(5) to implement the payment calculation requirements of TILA section 129C(a), as enacted by section 1411 of the Dodd-Frank Act. TILA section 129C(a) contains the general requirement that a creditor determine the consumer's “ability to repay the loan, according to its terms, and all applicable taxes, insurance (including mortgage guarantee insurance), and assessments,” based on several considerations, including “a payment schedule that fully amortizes the loan over the term of the loan.” TILA section 129C(a)(1) and (3). The statutory requirement to consider mortgage-related obligations, as defined in § 1026.43(b)(8), is discussed above in the section-by-section analysis of § 1026.43(c)(2)(v).

TILA section 129C(a) requires, among other things, that a creditor make a determination that a consumer “has a reasonable ability to repay” a residential mortgage loan. TILA section 129C(a)(6)(D) provides the process for calculating the monthly payment amount “[f]or purposes of making any determination under this subsection,”i.e., subsection (a), for “any residential mortgage loan.” TILA section 129C(a)(6)(A) through (D) requires creditors to make uniform assumptions when calculating the payment obligation for purposes of determining the consumer's repayment ability for the covered transaction. Specifically, TILA section 129C(a)(6)(D)(i) through (iii) provides that, when calculating the payment obligation that will be used to determine whether the consumer can repay the covered transaction, the creditor must use a fully amortizing payment schedule and assume that: (1) The loan proceeds are fully disbursed on the date the loan is consummated; (2) the loan is repaid in substantially equal, monthly amortizing payments for principal and interest over the entire term of the loan with no balloon payment; and (3) the interest rate over the entire term of the loan is a fixed rate equal to the fully indexed rate at the time of the loan closing, without considering the introductory rate. The term “fully indexed rate” is defined in TILA section 129C(a)(7).

TILA section 129C(a)(6)(D)(ii)(I) and (II), however, provides two exceptions to the second assumption regarding “substantially equal, monthly payments over the entire term of the loan with no balloon payment” for loans that require “more rapid repayment (including balloon payment).” First, this statutory provision authorizes the Bureau to prescribe regulations for calculating the payment obligation for loans that require more rapid repayment (including balloon payment), and which have an annual percentage rate that does not exceed the threshold for higher-priced mortgage loans. TILA section 129C(a)(6)(D)(ii)(I). Second, for loans that “require more rapid repayment (including balloon payment),” and which exceed the higher-priced mortgage loan threshold, the statute requires that the creditor use the loan contract's repayment schedule. TILA section 129C(a)(6)(D)(ii)(II). The statute does not define the term “rapid repayment.”

The statute also provides three additional clarifications to the assumptions stated above for loans that contain certain features. First, for variable-rate loans that defer repayment of any principal or interest, TILA section 129C(a)(6)(A) states that for purposes of the repayment ability determination a creditor must use “a fully amortizing repayment schedule.” This provision generally reiterates the requirement provided under TILA section 129C(a)(3) to use a payment schedule that fully amortizes the loan. Second, for covered transactions that permit or require interest-only payments, the statute requires that the creditor determine the consumers' repayment ability using “the payment amount required to amortize the loan by its final maturity.” TILA section 129C(a)(6)(B). Third, for covered transactions with negative amortization, the statute requires the creditor to also take into account “any balance increase that may accrue from any negative amortization provision” when making the repayment ability determination. TILA section 129C(a)(6)(C). The statute does not define the terms “variable-rate,” “fully amortizing,” “interest-only,” or “negative amortization.” Proposed § 226.43(c)(5)(i) and (ii) implemented these statutory provisions, as discussed in further detail below.

TILA section 129C(a), as enacted by section 1411 of the Dodd-Frank Act, largely codifies many aspects of the repayment ability rule under § 1026.34(a)(4) from the Board's 2008 HOEPA Final Rule and extends such requirements to the entire mortgage market regardless of the loan's interest rate. Similarly to § 1026.34(a)(4), the statutory framework of TILA section 129C(a) focuses on prescribing the requirements that govern the underwriting process and extension of credit to consumers, rather than dictating which credit terms may or may not be permissible. However, there are differences between TILA section 129C(a) and the 2008 HOEPA Final Rule with respect to payment calculation requirements.

Current § 1026.34(a)(4) does not address how a creditor must calculate the payment obligation for a loan that cannot meet the presumption of compliance under § 1026.34(a)(4)(iii)(B). For example, § 1026.34(a)(4) does not specify how to calculate the periodic payment required for a negative amortization loan or balloon-payment mortgage with a term of less than seven years. In contrast, the Dodd-Frank Act lays out a specific framework for underwriting any loan subject to TILA section 129C(a). In taking this approach, the statutory requirements in TILA section 129C(a)(6)(D) addressing payment calculation requirements differ from § 1026.34(a)(4)(iii) in the following manner: (1) The statute generally premises repayment ability on monthly payment obligations calculated using the fully indexed rate, with no limit on the term of the loan that should be considered for such purpose; (2) the statute permits underwriting loans with balloon payments to differ depending on whether the loan's annual percentage rate exceeds the applicable loan pricing benchmark, or meets or falls below the applicable loan pricing benchmark; and (3) the statute expressly addresses underwriting requirements for loans with interest-only payments or negative amortization.

In 2006 and 2007 the Board and other Federal banking agencies addressed concerns regarding the increased risk to creditors and consumers presented by loans that permit consumers to defer repayment of principal and sometimes interest, and by adjustable-rate mortgages in the subprime market. The Interagency Supervisory Guidance stated that creditors should determine a consumer's repayment ability using a payment amount based on the fully indexed rate, assuming a fully amortizing schedule. In addition, the 2006 Nontraditional Mortgage Guidance addressed specific considerations for negative amortization and interest-only loans. State supervisors issued parallel statements to this guidance, which most states have adopted. TILA section 129C(a)(3) and (6) is generally consistent with this longstanding Interagency Supervisory Guidance and largely extends the guidance regarding payment calculation assumptions to all loan types covered under TILA section 129C(a), regardless of a loan's interest rate. The Board proposed § 226.43(c)(5) to implement the payment calculation requirements of TILA section 129C(a)(1), (3) and (6) for purposes of the repayment ability determination required under proposed § 226.43(c). Consistent with these statutory provisions, proposed § 226.43(c)(5) did not prohibit the creditor from offering certain credit terms or loan features, but rather focused on the calculation process the creditor would be required to use to determine whether the consumer could repay the loan according to its terms. Under the proposal, creditors generally would have been required to determine a consumer's ability to repay a covered transaction using the fully indexed rate or the introductory rate, whichever is greater, to calculate monthly, fully amortizing payments that are substantially equal, unless a special rule applies. See proposed § 226.43(c)(5)(i). For clarity and simplicity, proposed § 226.43(c)(5)(i) used the terms “fully amortizing payment” and “fully indexed rate,” which were defined separately under proposed § 226.43(b)(2) and (3), respectively, as discussed above. Proposed comment 43(c)(5)(i)-1 clarified that the general rule would apply whether the covered transaction is an adjustable-, step-, or fixed-rate mortgage, as those terms are defined in § 1026.18(s)(7)(i), (ii), and (iii), respectively.

Proposed § 226.43(c)(5)(ii)(A) through (C) created exceptions to the general rule and provided special rules for calculating the payment obligation for balloon-payment mortgages, interest-only loans or negative amortization loans, as follows:

Balloon-payment mortgages. Consistent with TILA section 129C(a)(6)(D)(ii)(I) and (II), for covered transactions with a balloon payment, proposed § 226.43(c)(5)(ii)(A) provided special rules that differed depending on the loan's rate. Proposed § 226.43(c)(5)(ii)(A)(1) stated that for covered transactions with a balloon payment that are not higher-priced covered transactions, the creditor must determine a consumer's ability to repay the loan using the maximum payment scheduled in the first five years after consummation. Proposed § 226.43(c)(5)(ii)(A)(2) further stated that for covered transactions with balloon payments that are higher priced covered transactions, the creditor must determine the consumer's ability to repay according to the loan's payment schedule, including any balloon payment. For clarity, proposed § 226.43(c)(5)(ii)(A) used the term “higher-priced covered transaction” to refer to a covered transaction that exceeds the applicable higher-priced mortgage loan coverage threshold. “Higher-priced covered transaction” is defined in § 1026.43(b)(4), discussed above. The term “balloon payment” has the same meaning as in current § 1026.18(s)(5)(i).

Interest-only loans. Consistent with TILA section 129C(a)(6)(B) and (D), proposed § 226.43(c)(5)(ii)(B) provided special rules for interest-only loans. Proposed § 226.43(c)(5)(ii)(B) required that the creditor determine the consumer's ability to repay the interest-only loan using (1) the fully indexed rate or the introductory rate, whichever is greater; and (2) substantially equal, monthly payments of principal and interest that will repay the loan amount over the term of the loan remaining as of the date the loan is recast. For clarity, proposed § 226.43(c)(5)(ii)(B) used the terms “loan amount” and “recast,” which are defined and discussed under § 1026.43(b)(5) and (11), respectively. The term “interest-only loan” has the same meaning as in current § 1026.18(s)(7)(iv).

Negative amortization loans. Consistent with TILA section 129C(a)(6)(C) and (D), proposed § 226.43(c)(5)(ii)(C) provided special rules for negative amortization loans. Proposed § 226.43(c)(5)(ii)(C) required that the creditor determine the consumer's ability to repay the negative amortization loan using (1) the fully indexed rate or the introductory rate, whichever is greater; and (2) substantially equal, monthly payments of principal and interest that will repay the maximum loan amount over the term of the loan remaining as of the date the loan is recast. Proposed comment 43(c)(5)(ii)(C)-1 clarified that for purposes of the rule, the creditor would first have to determine the maximum loan amount and the period of time that remains in the loan term after the loan is recast. For clarity, proposed § 226.43(c)(5)(ii)(C) used the terms “maximum loan amount” and “recast,” which are defined and discussed under § 1026.43(b)(7) and (11), respectively. The term “negative amortization loan” has the same meaning as in current § 1026.18(s)(7)(v) and comment 18(s)(7)-1.

43(c)(5)(i) General Rule

Proposed § 226.43(c)(5)(i) implemented the payment calculation requirements in TILA section 129C(a)(3), 129C(6)(D)(i) through (iii), and stated the general rule for calculating the payment obligation on a covered transaction for purposes of the ability-to-repay provisions. Consistent with the statute, proposed § 226.43(c)(5)(i) provided that unless an exception applies under proposed § 226.43(c)(5)(ii), a creditor must make the repayment ability determination required under proposed § 226.43(c)(2)(iii) by using the greater of the fully indexed rate or any introductory interest rate, and monthly, fully amortizing payments that are substantially equal. That is, under the proposed general rule the creditor would calculate the consumer's monthly payment amount based on the loan amount, and amortize that loan amount in substantially equal payments over the loan term, using the fully indexed rate.

Proposed comment 43(c)(5)(i)-1 explained that the payment calculation method set forth in proposed § 226.43(c)(5)(i) applied to any covered transaction that does not have a balloon payment or that is not an interest-only loan or negative amortization loan, whether it is a fixed-rate, adjustable-rate or step-rate mortgage. This comment further explained that the payment calculation method set forth in proposed § 226.43(c)(5)(ii) applied to any covered transaction that is a loan with a balloon payment, interest-only loan, or negative amortization loan. To facilitate compliance, this comment listed the defined terms used in proposed § 226.43(c)(5) and provided cross-references to their definitions.

The fully indexed rate or introductory rate, whichever is greater. Proposed § 226.43(c)(5)(i)(A) implemented the requirement in TILA section 129C(a)(6)(D)(iii) to use the fully indexed rate when calculating the monthly, fully amortizing payment for purposes of the repayment ability determination. Proposed § 226.43(c)(5)(i)(A) also provided that when creditors calculate the monthly, fully amortizing payment for adjustable-rate mortgages, they would have to use the introductory interest rate if it were greater than the fully indexed rate (i.e., a premium rate). In some adjustable-rate transactions, creditors may set an initial interest rate that is not determined by the index or formula used to make later interest rate adjustments. Sometimes this initial rate charged to consumers is lower than the rate would be if it were determined by using the index plus margin, or formula (i.e., the fully indexed rate). However, an initial rate that is a premium rate is higher than the rate based on the index or formula. Thus, requiring creditors to use only the fully indexed rate would result in creditors underwriting loans that have a “premium” introductory rate at a rate lower than the rate on which the consumer's initial payments would be based. The Board believed that requiring creditors to assess the consumer's ability to repay on the initial higher payments would better effectuate the statutory intent and purpose. Proposed comment 43(c)(5)(i)-2 provided guidance on using the greater of the premium or fully indexed rate.

Monthly, fully amortizing payments. For simplicity, proposed § 226.43(c)(5)(i) used the term “fully amortizing payment” to refer to the statutory requirements that a creditor use a payment schedule that repays the loan assuming that (1) the loan proceeds are fully disbursed on the date of consummation of the loan; and (2) the loan is repaid in amortizing payments for principal and interest over the entire term of the loan. See TILA sections 129C(a)(3) and (6)(D)(i) and (ii). As discussed above, § 1026.43(b)(2) defines “fully amortizing payment” to mean a periodic payment of principal and interest that will fully repay the loan amount over the loan term. The terms “loan amount” and “loan term” are defined in § 1026.43(b)(5) and (b)(6), respectively, and discussed above.

The statute also expressly requires that a creditor use “monthly amortizing payments” for purposes of the repayment ability determination. TILA section 129C(6)(D)(ii). The Board recognized that some loan agreements require consumers to make periodic payments with less frequency, for example quarterly or semi-annually. Proposed § 226.43(c)(5)(i)(B) did not dictate the frequency of payment under the terms of the loan agreement, but did require creditors to convert the payment schedule to monthly payments to determine the consumer's repayment ability. Proposed comment 43(c)(5)(i)-3 clarified that the general payment calculation rules do not prescribe the terms or loan features that a creditor may choose to offer or extend to a consumer, but establish the calculation method a creditor must use to determine the consumer's repayment ability for a covered transaction. This comment explained, by way of example, that the terms of the loan agreement may require that the consumer repay the loan in quarterly or bi-weekly scheduled payments, but for purposes of the repayment ability determination, the creditor must convert these scheduled payments to monthly payments in accordance with proposed § 226.43(c)(5)(i)(B). This comment also explained that the loan agreement may not require the consumer to make fully amortizing payments, but for purposes of the repayment ability determination the creditor must convert any non-amortizing payments to fully amortizing payments.

Substantially equal. Proposed comment 43(c)(5)(i)-4 provided additional guidance to creditors for determining whether monthly, fully amortizing payments are “substantially equal.”See TILA section 129C(a)(6)(D)(ii). This comment stated that creditors should disregard minor variations due to payment-schedule irregularities and odd periods, such as a long or short first or last payment period. The comment explained that monthly payments of principal and interest that repay the loan amount over the loan term need not be equal, but that the monthly payments should be substantially the same without significant variation in the monthly combined payments of both principal and interest. Proposed comment 43(c)(5)(i)-4 further explained that where, for example, no two monthly payments vary from each other by more than 1 percent (excluding odd periods, such as a long or short first or last payment period), such monthly payments would be considered substantially equal for purposes of the rule. The comment further provided that, in general, creditors should determine whether the monthly, fully amortizing payments are substantially equal based on guidance provided in current § 1026.17(c)(3) (discussing minor variations), and § 1026.17(c)(4)(i) through (iii) (discussing payment-schedule irregularities and measuring odd periods due to a long or short first period) and associated commentary. The proposal solicited comment on operational difficulties that arise by ensuring payment amounts meet the “substantially equal” condition. The proposal also solicited comment on whether a 1 percent variance is an appropriate tolerance threshold.

Examples of payment calculations. Proposed comment § 226.43(c)(5)(i)-5 provided illustrative examples of how to determine the consumer's repayment ability based on substantially equal, monthly, fully amortizing payments as required under proposed § 226.43(c)(5)(i) for a fixed-rate, adjustable-rate and step-rate mortgage.

The Board recognized that, although consistent with the statute, the proposed framework would require creditors to underwrite certain loans, such as hybrid ARMs with a discounted rate period of five or more years (e.g., 5/1, 7/1, and 10/1 ARMs) to a more stringent standard as compared to the underwriting standard set forth in proposed § 226.43(e)(2)(v) for qualified mortgages. [111] The Board believed this approach was consistent with the statute's intent to ensure consumers can reasonably repay their loans, and that in both cases consumers' interests are properly protected. See TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2). To meet the definition of a qualified mortgage, a loan cannot have certain risky terms or features, such as provisions that permit deferral of principal or a term that exceeds 30 years; no similar restrictions apply to loans subject to the ability-to-repay standard. See proposed § 226.43(e)(2)(i) and (ii). As a result, the risk of potential payment shock is diminished significantly for qualified mortgages. For this reason, the Board believed that maintaining the potentially more lenient statutory underwriting standard for loans that satisfy the qualified mortgage criteria would help to ensure that responsible and affordable credit remains available to consumers. See TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2).

Loan amount or outstanding principal balance. As noted above, proposed § 226.43(c)(5)(i) was consistent with the statutory requirements regarding payment calculations for purposes of the repayment ability determination. The Board believed that the intent of these statutory requirements was to prevent creditors from assessing the consumer's repayment ability based on understated payment obligations, especially when risky features can be present on the loan. However, the Board was concerned that the statute, as implemented in proposed § 226.43(c)(5)(i), would require creditors to determine, in some cases, a consumer's repayment ability using overstated payment amounts because the creditor would have to assume that the consumer repays the loan amount in substantially equal payments based on the fully indexed rate, regardless of when the fully indexed rate could take effect under the terms of the loan. The Board was concerned that this approach might restrict credit availability, even where consumers were able to demonstrate that they can repay the payment obligation once the fully indexed rate takes effect.

For this reason, the proposal solicited comment on whether authority should be exercised under TILA sections 105(a) and 129B(e) to provide that the creditor may calculate the monthly payment using the fully indexed rate based on the outstanding principal balance as of the date the fully indexed rate takes effect under the loan's terms, instead of the loan amount at consummation.

Step-rate and adjustable-rate calculation s. Due to concerns regarding credit availability, the proposal also solicited comment on alternative means to calculate monthly payments for step-rate and adjustable-rate mortgages. The proposal asked for comment on whether or not the rule should require that creditors underwrite a step-rate or an adjustable-rate mortgage using the maximum interest rate in the first seven or ten years or some other appropriate time horizon that would reflect a significant introductory rate period. The section-by-section analysis of the “fully indexed rate” definition, at § 1026.43(b)(3) above, discusses this issue in regard to step-rate mortgages. For discussion of payment calculation methods for adjustable-rate mortgages, see below.

Safe harbor to facilitate compliance. The Board recognized that under its proposal, creditors would have to comply with multiple assumptions when calculating the particular payment for purposes of the repayment ability determination. The Board was concerned that the complexity of the proposed payment calculation requirements might increase the potential for unintentional errors to occur, making compliance difficult, especially for small creditors that might be unable to invest in advanced technology or software needed to ensure payment calculations are compliant. At the same time, the Board noted that the intent of the statutory framework and the proposal was to ensure consumers are offered and receive loans on terms that they can reasonably repay. Thus, the Board solicited comment on whether authority under TILA sections 105(a) and 129B(e) should be exercised to provide a safe harbor for creditors that use the largest scheduled payment that can occur during the loan term to determine the consumer's ability to repay, to facilitate compliance with the requirements under proposed § 226.43(c)(5)(i) and (ii).

Final Rule

The final rule requires creditors to underwrite the loan at the premium rate if greater than the fully indexed rate for purposes of the repayment ability determination using the authority under TILA section 105(a). 15 U.S.C. 1604(a). TILA section 105(a), as amended by section 1100A of the Dodd-Frank Act, provides that the Bureau's regulations may contain such additional requirements, classifications, differentiations, or other provisions, and may provide for such adjustments and exceptions for all or any class of transactions as in the Bureau's judgment are necessary or proper to effectuate the purposes of TILA, prevent circumvention or evasion thereof, or facilitate compliance therewith. 15 U.S.C. 1604(a). This approach is further supported by the authority under TILA section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Bureau finds necessary and proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with and which effectuates the purposes of sections 129B and 129C, and which are in the interest of the consumer. 15 U.S.C. 1639b(e). The purposes of TILA include the purpose of TILA sections 129B and 129C, to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loan, among other things. TILA section 129B(b), 15 U.S.C. 1639b. For the reasons discussed above, the Bureau believes that requiring creditors to underwrite the loan to the premium rate for purposes of the repayment ability determination is necessary and proper to ensure that consumers are offered, and receive, loans on terms that reasonably reflect their ability to repay, and to prevent circumvention or evasion. Without a requirement to consider payments based on a premium rate, a creditor could originate loans with introductory-period payments that consumers do not have the ability to repay. Therefore, this provision is also in the interest of consumers.

As discussed above, the Board solicited comment on whether payments for non-qualified mortgage ARMs should be calculated similarly to qualified mortgage ARMs, by using the maximum rate that will apply during a certain period, such as the first seven years or some other appropriate time horizon. Consumer and community groups were divided on this issue. Some supported use of the fully indexed rate, but one stated that underwriting ARMs based on the initial period of at least five years may be appropriate. Another suggested that for non-qualified mortgage ARMs the rule should require use of the maximum interest rate or interest rate cap, whichever is greater, to better protect against payment shock. A civil rights organization also advocated that ARMs that are not qualified mortgages should be underwritten to several points above the fully indexed rate. A combined comment from consumer advocacy organizations also supported non-qualified mortgage ARMs being underwritten more strictly, suggesting that because this is the market segment that will have the fewest controls, the predatory practices will migrate here, and there is significant danger of payment shock when using the fully indexed rate in a low-rate environment such as today's market. They suggested that the rule follow Fannie Mae's method, which requires underwriting that uses the fully indexed rate or the note rate plus 2 percent, whichever is greater, for ARMs with initial fixed periods of up to five years. In addition, one joint industry and consumer advocacy comment suggested adding 2 percent to the fully indexed rate in order to calculate the monthly payment amount.

Industry groups were strongly in favor of using a specific time period for underwriting, generally suggesting five years. One credit union association stated that use of the fully indexed rate is excessive and unnecessary, and will increase the cost of credit. Industry commenters stated that creditors generally consider only the fixed-rate period, and ARMs with fixed periods of at least five years are considered safe. One large bank stated that the calculation for ARMs, whether or not they are qualified mortgages, should be uniform to ease compliance.

The Bureau has determined that it will not use its exception and adjustment authority to change the statutory underwriting scheme for non-qualified mortgage ARMs. The statutory scheme clearly differentiates between the qualified mortgage and non-qualified mortgage underwriting strategies. The qualified mortgage underwriting rules ignore any adjustment in interest rate that may occur after the first five years; thus, for example, for an ARM with an initial adjustment period of seven years, the interest rate used for the qualified mortgage calculation will be the initial interest rate. In addition, the qualified mortgage rules, by using the “maximum interest rate,” take into account any adjustment in interest rate that can occur during the first five years, including adjustments attributable to changes in the index rate. In contrast, the non-qualified mortgage rules have an unlimited time horizon but do not take into account adjustments attributable to changes in the index rate.

Based on the its research and analysis, the Bureau notes that the data indicate that neither the fully indexed rate nor the maximum rate during a defined underwriting period produces consistent results with regard to ability-to-repay calculations. The Bureau finds that the underwriting outcomes under the two methods vary depending on a number of complex variables, such as the terms of the loan (e.g., the length of the initial adjustment period and interest rate caps) and the interest rate environment. In other words, for a particular loan, whether the monthly payment may be higher under a calculation that uses the fully indexed rate, as opposed to the maximum rate in the first five years, depends on a number of factors. Given the fact-specific nature of the payment calculation outcomes, the Bureau believes that overriding the statutory scheme would be inappropriate.

The Bureau also believes that adjusting the interest rate to be used for non-qualified mortgage ability-to-repay calculations to somewhere between the fully indexed rate specified in the statute and the maximum interest rate mandated for qualified mortgage underwriting; for example through an adjustment to the fully indexed rate of an additional 2 percent, would be inappropriate. The fully indexed rate had been in use since it was adopted by the Interagency Supervisory Guidance in 2006, and Congress was likely relying on that experience in crafting the statutory scheme. Adding to the fully indexed rate would potentially reduce the availability of credit. Such an adjustment also could result in a calculated interest rate and monthly payment that are higher than the interest rate and payment calculated for qualified mortgage underwriting, given that the qualified mortgage rules look only to potential adjustments during the first five years.

The Bureau recognizes that underwriting practices today often take into account potential adjustments in an ARM that can result from increases in the index rate. For example, Fannie Mae requires underwriting that uses the fully indexed rate or the note rate plus 2 percent, whichever is greater, for ARMs with initial fixed periods of up to five years. The Bureau notes that underwriters have the flexibility to adjust their practices in response to changing interest rate environments whereas the process an administrative agency like the Bureau must follow to amend a rule is more time consuming. The Bureau also notes that the creditor must make a reasonable determination that the consumer has the ability to repay the loan according to its terms. Therefore, in situations where there is a significant likelihood that the consumer will face an adjustment that will take the interest rate above the fully indexed rate, a creditor whose debt-to-income or residual income calculation indicates that a consumer cannot afford to absorb any such increase may not have a reasonable belief in the consumer's ability to repay the loan according to its terms. See comment 43(c)(1)-1.

Although the Bureau has determined to implement the statutory scheme as written and require use of the fully indexed rate for non-qualified mortgage ARMs, it will monitor this issue through its mandatory five-year review, and may make adjustments as necessary.

As discussed above, the Board also solicited comment on whether or not to allow the fully indexed rate to be applied to the balance projected to be remaining when the fully indexed rate goes into effect, instead of the full loan amount, and thus give a potentially more accurate figure for the maximum payment that would be required for purposes of determining ability to repay. A consumer group and a group advocating for financial reform supported this possibility, saying that allowing lenders to apply the fully indexed rate to the balance remaining when the rate changes, rather than the full loan amount, will encourage longer fixed-rate periods and safer lending, as well as preserve access to credit. An association representing credit unions also agreed with the possible amendment, stating that the new method would yield a more accurate measure of the maximum payment that could be owed.

The Bureau believes it is appropriate for the final rule to remain consistent with the statutory scheme. The Bureau believes that changing the calculation method, required by the statute, [112] would not be an appropriate use of its exception and adjustment authority. The Bureau believes the potentially stricter underwriting method of calculating the monthly payment by applying the imputed (i.e., fully indexed) interest rate to the full loan amount for non-qualified mortgage ARMs, provides greater assurance of the ability to repay. In addition, payment calculation using the fully indexed rate can only approximate the consumer's payments after recast, since the index may have increased significantly by then. Accordingly, the Bureau believes that requiring the use of the full loan amount will reduce the potential inaccuracy of the ability-to-repay determination in such a situation.

In addition, the Board solicited comment on whether to provide a safe harbor for any creditor that underwrites using the “largest scheduled payment that can occur during the loan term.” To provide such a safe harbor the Bureau would have to employ its exception and adjustment authority because the use of the fully indexed rate calculation is required by TILA section 129C(a)(6)(D)(iii). Two industry commenters and an association of state bank regulators supported this exemption, but none of them provided a developed rationale for their support or included information useful in assessing the possible exemption. The Bureau does not believe that it would be appropriate at this time to alter the statutory scheme in this manner.

As discussed above, the Board also solicited comment on how to lessen any operational difficulties of ensuring that payment amounts meet the “substantially equal” condition, and whether or not allowing a one percent variance between payments provided an appropriate threshold. Only two commenters mentioned this issue. One industry commenter stated that the 1 percent threshold was appropriate, but an association of state bank regulators believed that a 5 percent threshold would work better. Because the 1 percent threshold appears to be sufficient to allow for payment variance and industry commenters did not express a need for a higher threshold, the Bureau does not believe that the provision should be amended.

For the reasons stated above, the Bureau is adopting § 1026.43(c)(5)(i) and associated commentary substantially as proposed, with minor clarifying revisions.

43(c)(5)(ii) Special Rules for Loans With a Balloon Payment, Interest-Only Loans, and Negative Amortization Loans

Proposed § 226.43(c)(5)(ii) created exceptions to the general rule under proposed § 226.43(c)(5)(i), and provided special rules in proposed § 226.43(c)(5)(ii)(A) through (C) for loans with a balloon payment, interest-only loans, and negative amortization loans, respectively, for purposes of the repayment ability determination required under proposed § 226.43(c)(2)(iii). In addition to TILA section 129C(a)(6)(D)(i) through (iii), proposed § 226.43(c)(5)(ii)(A) through (C) implemented TILA sections 129C(a)(6)(B) and (C), and TILA section 129C(a)(6)(D)(ii)(I) and (II). Each of these proposed special rules is discussed below.

43(c)(5)(ii)(A)

Implementing the different payment calculation methods in TILA section 129C(a)(6)(D)(ii), the Board proposed different rules for balloon-payment mortgages that are higher-priced covered transactions and those that are not, in § 1026.43(c)(5)(ii)(A)(1) and (2). Proposed comment 43(c)(5)(ii)(A)-1 provided guidance on applying these two methods. This guidance is adopted as proposed with minor changes for clarity and to update a citation. The language describing the calculation method for balloon-payment mortgages that are not higher-priced covered transactions has been changed to reflect the use of the first regular payment due date as the start of the relevant five-year period. Pursuant to the Bureau's rulewriting authority under TILA section 129C(a)(6)(D)(ii)(I), this change has been made to facilitate compliance through consistency with the amended underwriting method for qualified mortgages. See the section-by-section analysis of § 1026.43(e)(2)(iv)(A). As with the recast on five-year adjustable-rate qualified mortgages, the Bureau believes that consumers will benefit from having a balloon payment moved to at least five years after the first regular payment due date, rather than five years after consummation.

43(c)(5)(ii)(A)(1)

The statute provides an exception from the general payment calculation discussed above for loans that require “more rapid repayment (including balloon payment).”See TILA section 129C(a)(6)(D)(ii)(I) and (II). For balloon-payment loans that are not higher-priced covered transactions (as determined by using the margins above APOR in TILA section 129C(a)(6)(D)(ii)(I) and implemented at § 1026.43(b)(4)), the statute provides that the payment calculation will be determined by regulation. The Board proposed that a creditor be required to make the repayment determination under proposed § 226.43(c)(2)(iii) for “[t]he maximum payment scheduled during the first five years after consummation * * *”

The Board chose a five-year period in order to preserve access to affordable short-term credit, and because five years was considered an adequate period for a consumer's finances to improve sufficiently to afford a fully amortizing loan. The Board believed that balloon-payment loans of less than five years presented more risk of inability to repay. The Board also believed that the five-year period would facilitate compliance and create a level playing field because of its uniformity with the general qualified mortgage provision (see § 1026.43(e)), and balloon-payment qualified mortgage provision (see § 1026.43(f)). The Board solicited comment on whether the five-year horizon was appropriate. Proposed comment § 226.43(c)(5)(ii)(A)-2 provided further guidance to creditors on determining whether a balloon payment occurs in the first five years after consummation. Proposed comment 43(c)(5)(ii)(A)-3 addressed renewable balloon-payment loans. This comment discussed balloon-payment loans that are not higher-priced covered transactions which provide an unconditional obligation to renew a balloon-payment loan at the consumer's option or obligation to renew subject to conditions within the consumer's control. This comment clarified that for purposes of the repayment ability determination, the loan term does not include the period of time that could result from a renewal provision.

The Board recognized that proposed comment 43(c)(5)(ii)(A)-3 did not take the same approach as guidance contained in comment 17(c)(1)-11 regarding treatment of renewable balloon-payment loans for disclosure purposes, or with guidance contained in current comment 34(a)(4)(iv)-2 of the Board's 2008 HOEPA Final Rule. Although the proposal differed from current guidance in Regulation Z, the Board believed this approach was appropriate for several reasons. First, the ability-to-repay provisions in the Dodd-Frank Act do not address extending the term of a balloon-payment loan with an unconditional obligation to renew provision. Second, permitting short-term “prime” balloon-payment loans to benefit from the special payment calculation rule when a creditor includes an unconditional obligation to renew, but retains the right to increase the interest rate at the time of renewal, would create a significant loophole in the balloon payment rules. Such an approach could frustrate the objective to ensure consumers obtain mortgages on affordable terms for a reasonable period of time because the interest rate could escalate within a short period of time, increasing the potential risk of payment shock to the consumer. This is particularly the case where no limits exist on the interest rate that the creditor can choose to offer to the consumer at the time of renewal. See TILA Section 129B(a)(2), 15 U.S.C. 1639b(a)(2), and TILA Section 129C(b)(2)(A)(v). Moreover, the Board believed it would be speculative to posit the interest rate at the time of renewal for purposes of the repayment ability determination. Third, the guidance contained in comment 17(c)(1)-11 regarding treatment of renewable balloon-payment loans is meant to help ensure consumers are aware of their loan terms and avoid the uninformed use of credit, which differs from the stated purpose of this proposed provision, which was to help ensure that consumers receive loans on terms that reasonably reflect their repayment ability. TILA section 102(a), 15 U.S.C. 1601(a)(2), and TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2).

Proposed comment 43(c)(5)(ii)(A)-4 provided several illustrative examples of how to determine the maximum payment scheduled during the first five years after consummation for loans with a balloon payment that are not higher-priced covered transactions.

In regard to the proposed five-year underwriting period, some commenters suggested that the payment period considered should be increased to ten years, stating that balloon-payment loans were repeatedly used in an abusive manner during the years of heavy subprime lending. The combined consumer advocacy organizations' comment stated that the five-year underwriting might lead to an increase in five-year balloon-payment loans, which would be bad for sustainable lending. On the other hand, a trade association representing credit unions supported the five-year rule. One industry commenter objected to the whole balloon underwriting scheme, including the five-year rule, apparently preferring something less.

For the reasons discussed by the Board in the proposal, and described above, the Bureau has determined that five years is an appropriate time frame for determining the ability to repay on balloon-payment mortgages that are not higher-priced covered transactions. However, for the sake of uniformity and ease of compliance with the qualified mortgage calculation and ability-to-repay calculation for non-qualified mortgage adjustable-rate mortgages, the proposed provision has been changed to state that the five years will be measured from the date of the first regularly scheduled payment, rather than the date of consummation. The Bureau has made this determination pursuant to the authority granted by TILA section 129C(a)(6)(D)(ii)(I) to prescribe regulations for calculating payments to determine consumers' ability to repay balloon-payment mortgages that are not higher-cost covered transactions.

TILA section 129C(a)(6)(D)(ii)) refers to loans requiring “more rapid repayment (including balloon payment).” The Board solicited comment about whether this statutory language should be read as referring to loan types other than balloon-payment loans. The Bureau did not receive comments on this matter, and has determined that the rule language does not need to be amended to include other types of “rapid repayment” loans at this time.

The Board also solicited comment about balloon-payment loans that have an unconditional obligation to renew. The Board asked whether or not such loans should be allowed to comply with the ability-to-repay requirements using the total of the mandatory renewal terms, instead of just the first term. As discussed above, proposed comment 43(c)(5)(ii)(A)-3 made clear that this would not be allowed under the rule as proposed. The Board also solicited comment on any required conditions that the renewal obligation should have, if such an amendment were made. However, the Bureau did not receive comments on this matter, and the provision and staff comment are adopted as proposed. A creditor making any non-higher-priced balloon-payment mortgage of less than five years with a clear obligation to renew can avoid having the ability-to-repay determination applied to the balloon payment by including the renewal period in the loan term so that the balloon payment occurs after five years.

Accordingly, the Bureau is adopting § 1026.43(c)(5)(ii)(A)(1) and associated commentary substantially as proposed, with minor changes for clarification, as well as new language to reflect that the five-year underwriting period begins with the due date of the first payment, as discussed above. In addition, the Bureau has added a second example to comment 43(c)(5)(ii)(A)-2 to demonstrate the effect of the change to the beginning of the underwriting period.

43(c)(5)(ii)(A)(2)

Proposed § 226.43(c)(5)(ii)(A)(2) implemented TILA section 129C(a)(6)(D)(ii)(II) and provided that for a higher-priced covered transaction, the creditor must determine the consumer's ability to repay a loan with a balloon payment using the scheduled payments required under the terms of the loan, including any balloon payment. TILA section 129C(a)(6)(D)(ii)(II) states that for loans that require “more rapid repayment [113] (including balloon payment),” and which exceed the loan pricing threshold set forth, the creditor must underwrite the loan using the “[loan] contract's repayment schedule.” For purposes of proposed § 226.43(c)(5)(i)(A), “higher-priced covered transaction” means a covered transaction with an annual percentage rate that exceeds the average prime offer rate for a comparable transaction as of the date the interest rate is set by 1.5 or more percentage points for a first-lien covered transaction, or by 3.5 or more percentage points for a subordinate-lien covered transaction. See§ 1026.43(b)(4).

The proposed rule interpreted the statutory requirement that the creditor use the loan contract's payment schedule to mean that the creditor must use all scheduled payments under the terms of the loan needed to fully amortize the loan, consistent with the requirement under TILA section 129C(a)(3). Payment of the balloon, either at maturity or during any intermittent period, is necessary to fully amortize the loan, and so a consumer's ability to pay the balloon payment would need to be considered. Proposed comment 43(c)(5)(ii)(A)-5 provided an illustrative example of how to determine the consumer's repayment ability based on the loan contract's payment schedule, including any balloon payment. The proposed rule applied to “non-prime” loans with a balloon payment regardless of the length of the term or any contract provision that provides for an unconditional guarantee to renew.

In making this proposal, the Board expressed concern that this approach could lessen credit choice for non-prime consumers and solicited comment, with supporting data, on the impact of this approach for low-to-moderate income consumers. In addition, the Board asked for comment on whether or not a consumer's ability to refinance out of a balloon-payment loan should be considered in determining ability to repay.

Industry commenters who focused on this provision opposed applying the ability-to-repay determination to the entire payment schedule. Two trade associations representing small and mid-size banks strongly objected to including the balloon payment in the underwriting, and one stated that many of the loans its members currently make would fall into the higher-priced category, making these loans unavailable. However, the statutory scheme for including the balloon payment was supported by a state housing agency and the combined consumer protection advocacy organizations submitting joint comments.

None of the commenters submitted data supporting the importance of higher-priced balloon-payment mortgages for credit availability, or whether consideration of a consumer's ability to obtain refinancing would make the ability-to-repay determination less significant in this context. The Bureau notes that under § 1026.43(f) a balloon-payment mortgage that is a higher-priced covered transaction made by certain creditors in rural or underserved areas may also be a qualified mortgage and thus the creditor would not have to consider the consumer's ability to repay the balloon payment. Because this final rule adopts a wider definition of “rural or underserved area” than the Board proposed, potential credit accessibility concerns have been lessened. See the section-by-section analysis of § 1026.43(f), below.

The statute requires the consideration of the balloon payment for higher-priced covered transactions, and the Bureau does not believe that using its exception and adjustment authority would be appropriate for this issue. Accordingly, § 1026.43(c)(5)(ii)(A)(2) and associated commentary are adopted substantially as proposed, with minor changes for clarification.

43(c)(5)(ii)(B)

The Board's proposed § 226.43(c)(5)(ii)(B) implemented TILA section 129C(a)(6)(B), which requires that the creditor determine the consumer's repayment ability using “the payment amount required to amortize the loan by its final maturity.” For clarity, the proposed rule used the term “recast,” which is defined for interest-only loans as the expiration of the period during which interest-only payments are permitted under the terms of the legal obligation. See§ 1026.43(b)(11). The statute does not define the term “interest-only.” For purposes of this rule, the terms “interest-only loan” and “interest-only” have the same meaning as in § 1026.18(s)(7)(iv).

For interest-only loans (i.e., loans that permit interest only payments for any part of the loan term), proposed § 226.43(c)(5)(ii)(B) provided that the creditor must determine the consumer's ability to repay the interest-only loan using (1) the fully indexed rate or any introductory rate, whichever is greater; and (2) substantially equal, monthly payments of principal and interest that will repay the loan amount over the term of the loan remaining as of the date the loan is recast. The proposed payment calculation rule for interest-only loans paralleled the general rule proposed in § 226.43(c)(5)(i), except that proposed § 226.43(c)(5)(ii)(B)(2) required a creditor to determine the consumer's ability to repay the loan amount over the term that remains after the loan is recast, rather than requiring the creditor to use fully amortizing payments, as defined under proposed § 226.43(b)(2).

The Board interpreted the statutory text in TILA section 129C(a)(6)(B) as requiring the creditor to determine the consumer's ability to repay an interest-only loan using the monthly principal and interest payment amount needed to repay the loan amount once the interest-only payment period expires, rather than using, for example, an understated monthly principal and interest payment that would amortize the loan over its entire term, similar to a 30-year fixed mortgage. The proposed rule would apply to all interest-only loans, regardless of the length of the interest-only period. The Board believed this approach most accurately assessed the consumer's ability to repay the loan once it begins to amortize; this is consistent with the approach taken for interest-only loans in the 2006 Nontraditional Mortgage Guidance.

Proposed comment 43(c)(5)(ii)(B)-1 provided guidance on the monthly payment calculation for interest-only loans, and clarified that the relevant term of the loan for calculating these payments is the period of time that remains after the loan is recast. This comment also explained that for a loan on which only interest and no principal has been paid, the loan amount will be the outstanding principal balance at the time of the recast.

Proposed comment 43(c)(5)(ii)(B)-2 provided illustrative examples for how to determine the consumer's repayment ability based on substantially equal monthly payments of principal and interest for interest-only loans.

Commenters did not focus on the calculation for interest-only loans. The Bureau considers the Board's interpretation and implementation of the statute to be accurate and appropriate. Accordingly, § 1026.43(c)(5)(ii)(B) and associated commentary are adopted as proposed.

43(c)(5)(ii)(C)

Proposed § 226.43(c)(5)(ii)(C) implemented the statutory requirement in TILA section 129C(a)(6)(C) that the creditor consider “any balance increase that may accrue from any negative amortization provision when making the repayment ability determination.” The statute does not define the term “negative amortization.”

For such loans, proposed § 226.43(c)(5)(ii)(C) provided that a creditor must determine the consumer's repayment ability using (1) the fully indexed rate or any introductory interest rate, whichever is greater; and (2) substantially equal, monthly payments of principal and interest that will repay the maximum loan amount over the term of the loan remaining as of the date the loan is recast. The proposed payment calculation rule for negative amortization loans paralleled the general rule in proposed § 226.43(c)(5)(i), except that proposed § 226.43(c)(5)(ii)(C)(2) required the creditor to use the monthly payment amount that repays the maximum loan amount over the term of the loan that remains after the loan is recast, rather than requiring the creditor to use fully amortizing payments, as defined under § 1026.43(b)(2). The proposed rule used the terms “maximum loan amount” and “recast,” which are defined and discussed at § 1026.43(b)(7) and (b)(11), respectively.

The Board proposed that the term “negative amortization loan” have the same meaning as set forth in § 226.18(s)(7)(v), which provided that the term “negative amortization loan” means a loan, other than a reverse mortgage subject to § 226.33, that provides for a minimum periodic payment that covers only a portion of the accrued interest, resulting in negative amortization. As defined, the term “negative amortization loan” does not cover other loan types that may have a negative amortization feature, but which do not permit the consumer multiple payment options, such as seasonal income loans. Accordingly, proposed § 226.43(c)(5)(ii)(C) covered only loan products that permit or require minimum periodic payments, such as payment-option loans and graduated payment mortgages with negative amortization. [114] The Board believed that covering these types of loans in proposed § 226.43(c)(5)(ii)(C) was consistent with statutory intent to account for the negative equity that can occur when a consumer makes payments that defer some or all principal or interest for a period of time, and to address the impact that any potential payment shock might have on the consumer's ability to repay the loan. See TILA section 129C(a)(6)(C).

In contrast, in a transaction such as a seasonal loan that has a negative amortization feature, but which does not provide for minimum periodic payments that permit deferral of some or all principal, the consumer repays the loan with fully amortizing payments in accordance with the payment schedule. Accordingly, the same potential for payment shock due to accumulating negative amortization does not exist. These loans with a negative amortization feature are therefore not covered by the proposed term “negative amortization loan,” and would not be subject to the special payment calculation requirements for negative amortization loans at proposed § 226.43(c)(5)(ii)(C).

For purposes of determining the consumer's ability to repay a negative amortization loan under proposed § 226.43(c)(5)(ii)(C), creditors would be required to make a two-step payment calculation.

Step one: maximum loan amount. Proposed § 226.43(c)(5)(ii)(C) would have required that the creditor first determine the maximum loan amount and period of time that remains in the loan term after the loan is recast before determining the consumer's repayment ability on the loan. See comment 43(c)(5)(ii)(C)-1; s ee also proposed § 226.43(b)(11), which defined the term “recast” to mean the expiration of the period during which negatively amortizing payments are permitted under the terms of the legal obligation. Proposed comment 43(c)(5)(ii)(C)-2 further clarified that recast for a negative amortization loan occurs after the maximum loan amount is reached (i.e., the negative amortization cap) or the introductory minimum periodic payment period expires.

As discussed above, § 1026.43(b)(7) defines “maximum loan amount” as the loan amount plus any increase in principal balance that results from negative amortization, as defined in § 1026.18(s)(7)(v), based on the terms of the legal obligation. Under the proposal, creditors would make the following two assumptions when determining the maximum loan amount: (1) The consumer makes only the minimum periodic payments for the maximum possible time, until the consumer must begin making fully amortizing payments; and (2) the maximum interest rate is reached at the earliest possible time.

As discussed above under the proposed definition of “maximum loan amount,” the Board interpreted the statutory language in TILA section 129C(a)(6)(C) as requiring creditors to fully account for any potential increase in the loan amount that might result under the loan's terms where the consumer makes only the minimum periodic payments required. The Board believed the intent of this statutory provision was to help ensure that the creditor consider the consumer's capacity to absorb the increased payment amounts that would be needed to amortize the larger loan amount once the loan is recast. The Board recognized that the approach taken towards calculating the maximum loan amount requires creditors to assume a “worst-case scenario,” but believed this approach was consistent with statutory intent to take into account the greatest potential increase in the principal balance.

Moreover, the Board noted that calculating the maximum loan amount based on these assumptions is consistent with the approach in the 2010 MDIA Interim Final Rule, [115] which addresses disclosure requirements for negative amortization loans, and also the 2006 Nontraditional Mortgage Guidance, which provides guidance to creditors regarding underwriting negative amortization loans. [116]

Step two: payment calculation. Once the creditor knows the maximum loan amount and period of time that remains after the loan is recast, the proposed payment calculation rule for negative amortization loans would require the creditor to use the fully indexed rate or introductory rate, whichever is greater, to calculate the substantially equal, monthly payment amount that will repay the maximum loan amount over the term of the loan that remains as of the date the loan is recast. See proposed § 226.43(c)(5)(ii)(C)(1) and (2).

Proposed comment 43(c)(5)(ii)(C)-1 clarified that creditors must follow this two-step approach when determining the consumer's repayment ability on a negative amortization loan, and also provided cross-references to aid compliance. Proposed comment 43(c)(5)(ii)(C)-2 provided further guidance to creditors regarding the relevant term of the loan that must be used for purposes of the repayment ability determination. Proposed comment 43(c)(5)(ii)(C)-3 provided illustrative examples of how to determine the consumer's repayment ability based on substantially equal monthly payments of principal and interest as required under proposed § 226.43(c)(5)(ii)(C) for a negative amortization loan.

In discussing the ability-to-repay requirements for negative amortization loans, the Board noted the anomaly that a graduated payment mortgage may have a largest scheduled payment that is larger than the payment calculated under proposed § 226.43(c)(5)(ii)(C). The Board solicited comment on whether or not the largest scheduled payment should be used in determining ability to repay. The Bureau received one comment on this issue, from an association of State bank regulators, arguing that the rule should use the largest payment scheduled. However, the Bureau does not believe that a special rule for graduated payment mortgages, which would require an exception from the statute, is necessary to ensure ability to repay these loans. It is unlikely that the calculated payment will be very different from the largest scheduled payment, and introducing this added complexity to the rule is unnecessary. Also, the one comment favoring such a choice did not include sufficient data to support use of the exception and adjustment authority under TILA, and the Bureau is not aware any such data.

Final Rule

The Bureau did not receive comments on the proposed method for calculating payments for negative amortization loans. The Bureau believes that the method proposed by the Board implements the statutory provision accurately and appropriately. Accordingly, § 1026.43(c)(5)(ii)(C) and associated commentary are adopted substantially as proposed, with minor changes for clarification.

43(c)(6) Payment Calculation for Simultaneous Loans

43(c)(6)(i)

The Board's proposed rule provided that for purposes of determining a consumer's ability to repay a loan, “a creditor must consider a consumer's payment on a simultaneous loan that is—(i) a covered transaction, by following paragraphs (c)(5)(i) and (ii) of this section” (i.e., the payment calculation rules for the covered transaction itself).

Proposed comment 43(c)(6)-1 stated that in determining the consumer's repayment ability for a covered transaction, the creditor must include consideration of any simultaneous loan which it knows or has reason to know will be made at or before consummation of the covered transaction. Proposed comment 43(c)(6)-2 explained that for a simultaneous loan that is a covered transaction, as that term was defined in proposed § 226.43(b)(1), the creditor must determine a consumer's ability to repay the monthly payment obligation for a simultaneous loan as set forth in proposed § 226.43(c)(5), taking into account any mortgage-related obligations.

The Bureau did not receive comments on this specific language or the use of the covered transaction payment calculation for simultaneous loans. For discussion of other issues regarding simultaneous loans, see the section-by-section analysis of § 1026.43(b)(12), .43(c)(2)(iv) and .43(c)(6)(ii).

The Bureau considers the language of proposed§ 226.43(c)(6)(i) to be an accurate and appropriate implementation of the statute. Accordingly, the Bureau is adopting § 1026.43(c)(6)(i) and associated commentary substantially as proposed, with minor changes for clarity. The requirement to consider any mortgage-related obligations, presented in comment 43(c)(6)-2, is now also part of the regulatory text, at § 1026.43(c)(6).

43(c)(6)(ii)

For a simultaneous loan that is a HELOC, the consumer is generally not committed to using the entire credit line at consummation. The amount of funds drawn on a simultaneous HELOC may differ greatly depending, for example, on whether the HELOC is used as a “piggyback loan” to help towards payment on a home purchase transaction or if the HELOC is opened for convenience to be drawn down at a future time. In the proposed rule, the Board was concerned that requiring the creditor to underwrite a simultaneous HELOC assuming a full draw on the credit line might unduly restrict credit access, especially in connection with non-purchase transactions, because it would require creditors to assess the consumer's repayment ability using potentially overstated payment amounts. For this reason, the Board proposed under § 226.43(c)(6)(ii) that the creditor calculate the payment for the simultaneous HELOC based on the amount of funds to be drawn by the consumer at consummation of the covered transaction. The Board solicited comment on whether this approach was appropriate.

Proposed comment 43(c)(6)-3 clarified that for a simultaneous loan that is a HELOC, the creditor must consider the periodic payment required under the terms of the plan when assessing the consumer's ability to repay the covered transaction secured by the same dwelling as the simultaneous loan. This comment explained that under proposed § 226.43(c)(6)(ii), the creditor must determine the periodic payment required under the terms of the plan by considering the actual amount of credit to be drawn by the consumer at or before consummation of the covered transaction. This comment clarified that the amount to be drawn is the amount requested by the consumer; when the amount requested will be disbursed, or actual receipt of funds, is not determinative.

Several industry commenters objected that it is difficult to know the actual amount drawn on a HELOC if it is held by another lender. One commenter suggested finding another way to do this calculation, such as by adding 1 percent of the full HELOC line to the overall monthly payment. Two banking trade associations said that the full line of credit should be considered, and if the consumer does not qualify, the line of credit can be reduced in order to qualify safely. One bank stated that creditors regulated by Federal banking agencies are bound by the interagency “Credit Risk Guidance for Home Equity Lending” (2005) to consider the full line of credit, and this will create an uneven playing field.

Other industry commenters supported use of the actual amount drawn at consummation. Both Freddie Mac and Fannie Mae stated that the Board's proposal for considering the actual amount drawn at closing was consistent with their underwriting standards. In addition, an association representing one state's credit unions stated that requiring consideration of a 100 percent draw would be onerous and inaccurate. It also asked that we make clear that the creditor does not have to recalculate a consumer's ability to repay if the amount drawn changes at consummation.

The Bureau believes that requiring consideration of 100 percent of a home equity line of credit would unnecessarily restrict credit availability for consumers. Available but unaccessed credit is not considered in determining ability to repay a mortgage when the consumer has other types of credit lines, such as credit cards. Although HELOCs are secured by the consumer's dwelling, and thus differ from other types of available but unaccessed credit, this difference does not seem determinative. Any potential dwelling-secured home equity line of credit that a creditor might grant to a consumer could simply be requested by the consumer immediately following consummation of the covered transaction. The fact that the potential credit line has been identified and enumerated prior to the transaction, rather than after, does not seem significant compared to the fact that the consumer has chosen not to access that credit, and will not be making payments on it. As with the rest of the ability-to-repay requirements, creditors should apply appropriate underwriting procedures, and are not restricted to the legally mandated minimum required by this rule, as long as they satisfy that minimum.

The requirements of the 2005 “Credit Risk Guidance for Home Equity Lending” do not change the Bureau's view of this issue. The Guidance covers home equity lending itself, not consideration of HELOCs as simultaneous loans when determining ability to repay for senior non-HELOCs. The requirement to consider the entire home equity line of credit controls only a bank's granting of that line of credit. For this reason, the Bureau does not believe that banks following this guidance will be disadvantaged. In addition, the Bureau will not be implementing the suggested alternative of adding 1 percent to the calculated monthly payment on the covered transaction. The Bureau is not aware of any data supporting the accuracy of such an approach.

In regard to the comments concerning difficulty in determining the amount of the draw and the monthly HELOC payment, the Bureau as discussed above in the section-by-section analysis of § 1026.43(c)(2)(iv) has added language to comment 43(c)(2)(iv)-4 providing more specific guidance in applying the knows or has reason to know standard. In addition, language has been added to comment 43(c)(6)-3, regarding payment calculations for simultaneous HELOCs, making clear that a creditor does not need to reconsider ability to repay if the consumer unexpectedly draws more money than planned at closing from a HELOC issued by a different creditor. In addition, the regulation language has been clarified to state that the creditor must use the amount of credit “to be” drawn at consummation, making clear that a violation does not occur if the creditor did not know or have reason to know that a different amount would be drawn.

The Board also solicited comment on whether or not a safe harbor should be given to those creditors who consider the full HELOC credit line. However, commenters did not focus on this possibility. The Bureau believes that although a creditor may choose to underwrite using the full credit line as a means of considering ability to repay in relation to the actual draw, a safe harbor is not warranted. Because the full credit line should always be equal to or greater than the actual draw, appropriate use of the full credit line in underwriting will constitute appropriate compliance without a safe harbor.

In addition to the amount of a HELOC that needs to be considered in determining ability to repay, the Board also solicited comment on whether the treatment of HELOCs as simultaneous loans should be limited to purchase transactions. The Board suggested that concerns regarding “piggyback loans” were not as acute with non-purchase transactions.

Consumer and public interest groups opposed limiting the consideration of HELOCs to purchase transactions. Several consumer advocacy groups suggested that if only purchase transactions were covered, the abuses would migrate to the unregulated space. Some commenters said they did not see a reason to exclude the cost of a simultaneous loan when it is extended as part of a refinance. Industry commenters did not focus much on this issue, but an association representing credit unions supported limiting consideration to purchase transactions in order to reduce regulatory burden on credit unions and streamline the refinancing process.

The Bureau believes that requiring consideration of HELOCs as simultaneous loans is appropriate in both purchase and non-purchase transactions. In both situations the HELOC is a lien on the consumer's dwelling with a cost that affects the viability of the covered transaction loan. The Bureau recognizes that a simultaneous HELOC in connection with a refinancing is more likely to be a convenience than one issued simultaneously with a purchase transaction, which will often cover down payment, transaction costs or other major expenses. However, the final rule accommodates this difference by allowing the creditor to base its ability-to-repay determination on the actual draw. The Bureau did not receive and is not aware of any information or data that justifies excluding actual draws on simultaneous HELOCs in connection with refinances from this rule.

For the reasons stated above, the Bureau considers the language of proposed§ 226.43(c)(6)(ii) to be an accurate and appropriate implementation of the statute. Accordingly, the Bureau is adopting § 1026.43(c)(6)(ii) and associated commentary as proposed, with minor changes for clarity.

43(c)(7) Monthly Debt-to-Income Ratio or Residual Income

As discussed above, TILA section 129C(a)(3) requires creditors to consider the debt-to-income ratio or residual income the consumer will have after paying non-mortgage debt and mortgage-related obligations, as part of the ability-to-repay determination under TILA section 129C(a)(1). The Board's proposal would have implemented this requirement in § 226.43(c)(2)(vii). The Board proposed definitions and calculations for the monthly debt-to-income ratio and residual income in § 226.43(c)(7).

With respect to the definitions, proposed § 226.43(c)(7)(i)(A) would have defined the total monthly debt obligations as the sum of: the payment on the covered transaction, as required to be calculated by proposed § 226.43(c)(2)(iii) and (c)(5); the monthly payment on any simultaneous loans, as required to be calculated by proposed § 226.43(c)(2)(iv) and (c)(6); the monthly payment amount of any mortgage-related obligations, as required to be considered by proposed § 226.43(c)(2)(v); and the monthly payment amount of any current debt obligations, as required to be considered by proposed § 226.43(c)(2)(vi). Proposed § 1026.43(c)(7)(i)(B) would have defined the total monthly income as the sum of the consumer's current or reasonably expected income, including any income from assets, as required to be considered by proposed § 226.43(c)(2)(i) and (c)(4).

With respect to the calculations, proposed § 226.43(c)(7)(ii)(A) would have required the creditor to consider the consumer's monthly debt-to-income ratio by taking the ratio of the consumer's total monthly debt obligations to total monthly income. Proposed § 226.43(c)(7)(ii)(B) would have required the creditor to consider the consumer's residual income by subtracting the consumer's total monthly debt obligations from the total monthly income. The Board solicited comment on whether consideration of residual income should account for loan amount, region of the country, and family size, and on whether creditors should be required to include Federal and State taxes in the consumer's obligations to calculate the residual income.

Proposed comment 43(c)(7)-1 would have stated that a creditor must calculate the consumer's total monthly debt obligations and total monthly income in accordance with the requirements in proposed § 226.43(c)(7). The proposed comment would have explained that creditors may look to widely accepted governmental and non-governmental underwriting standards to determine the appropriate thresholds for the debt-to-income ratio or residual income.

Proposed comment 43(c)(7)-2 would have clarified that if a creditor considers both the consumer's debt-to-income ratio and residual income, the creditor may base its determination of ability to repay on either the consumer's debt-to-income ratio or residual income, even if the determination would differ with the basis used. In the section-by-section analysis of proposed § 226.43(c)(7), the Board explained that it did not wish to create an incentive for creditors to consider and verify as few factors as possible in the repayment ability determination.

Proposed comment 43(c)(7)-3 would have provided that creditors may consider compensating factors to mitigate a higher debt-to-income ratio or lower residual income. The proposed comment would have provided that the creditor may, for example, consider the consumer's assets other than the dwelling securing the covered transaction or the consumer's residual income as a compensating factor for a higher debt-to-income ratio. The proposed comment also would have provided that, in determining whether and in what manner to consider compensating factors, creditors may look to widely accepted governmental and non-governmental underwriting standards. The Board solicited comment on whether it should provide more guidance on what factors creditors may consider, and on how creditors may include compensating factors in the repayment ability determination.

In addition, the Board solicited comment on two issues related to the use of automated underwriting systems. The Board solicited comment on providing a safe harbor for creditors relying on automated underwriting systems that use monthly debt-to-income ratios, if the system developer certifies that the system's use of monthly debt-to-income ratios in determining repayment ability is empirically derived and statistically sound. The Board also solicited comment on other methods to facilitate creditor reliance on automated underwriting systems, while ensuring that creditors can demonstrate compliance with the rule.

As discussed above in the section-by-section analysis of § 1026.43(c)(2)(vii), industry commenters and consumer advocates largely supported including consideration of the monthly debt-to-income ratio or residual income in the ability-to-repay determination and generally favored a flexible approach to consideration of those factors. In response to the Board's proposal, some consumer advocates asked that the Bureau conduct research on the debt-to-income ratio and residual income. They requested a standard that reflects the relationship between the debt-to-income ratio and residual income. One industry commenter recommended that the Bureau adopt the VA calculation of residual income. Another industry commenter suggested that the Bureau adopt the same definitions of the debt-to-income ratio and residual income as for qualified residential mortgages, to reduce compliance burdens and the possibility of errors. One industry commenter asked that consideration of residual income be permitted to vary with family size and geographic location. The commenter suggested that the residual income calculation account for Federal and State taxes. Several consumer advocates suggested that the Bureau review the VA residual income guidelines and update the cost of living tiers. They affirmed that all regularly scheduled debt payments should be included in the residual income calculation. They noted that residual income should be sufficient to cover basic living necessities, including food, utilities, clothing, transportation, and known health care expenses.

One industry commenter asked that the Bureau provide guidance on and additional examples of compensating factors, for example, situations where a consumer has many assets but a low income or high debt-to-income ratio. The commenter suggested that the Bureau clarify that the list of examples was not exclusive. Consumer advocates recommended that the Bureau not permit extensions of credit based on a good credit history or involving a high loan-to-value ratio if the debt-to-income ratio or residual income does not reflect an ability to repay. These commenters argued that credit scores and down payments reflect past behavior and incentives to make down payments, not ability to repay.

The Bureau is largely adopting § 1026.43(c)(7) as proposed, with certain clarifying changes to the commentary. Specifically, comment 43(c)(7)-1 clarifies that § 1026.43(c) does not prescribe a specific debt-to-income ratio with which creditors must comply. For the reasons discussed above in the section-by-section analysis of § 1026.43(c), the Bureau is not finalizing the portion of proposed comment 43(c)(7)-1 which would have provided that the creditor may look to widely accepted governmental and non-governmental underwriting standards to determine the appropriate threshold for the monthly debt-to-income ratio or the monthly residual income. Instead, comment 43(c)(7)-1 provides that an appropriate threshold for a consumer's monthly debt-to-income ratio or monthly residual income is for the creditor to determine in making a reasonable and good faith determination of a consumer's repayment ability.

Comment 43(c)(7)-2 clarifies guidance regarding use of both monthly debt-to-income and monthly residual income by providing that if a creditor considers the consumer's monthly debt-to-income ratio, the creditor may also consider the consumer's residual income as further validation of the assessment made using the consumer's monthly debt-to-income ratio. The Bureau is not finalizing proposed comment 43(c)(7)-2, which would have provided that if a creditor considers both the consumer's monthly debt-to-income ratio and residual income, the creditor may base the ability-to-repay determination on either metric, even if the ability-to-repay determination would differ with the basis used. The Bureau believes the final guidance better reflects how the two standards work together in practice, but the change is not intended to alter the rule.

Comment 43(c)(7)-3 also clarifies guidance regarding the use of compensating factors in assessing a consumer's ability to repay by providing that, for example, the creditor may reasonably and in good faith determine that an individual consumer has the ability to repay despite a higher monthly debt-to-income ratio or lower residual income in light of the consumer's assets other than the dwelling securing the covered transaction, such as a savings account. The creditor may also reasonably and in good faith determine that a consumer has the ability to repay despite a higher debt-to-income ratio in light of the consumer's residual income. The Bureau believes that not permitting use of compensating factors may reduce access to credit in some cases, even if the consumer could afford the mortgage. The Bureau does not believe, however, that the rule should provide an extensive list of compensating factors that the creditor may consider in assessing repayment ability. Instead, creditors should make reasonable and good faith determinations of the consumer's repayment ability in light of the facts and circumstances. This approach to compensating factors is consistent with the final rule's flexible approach to the requirement that creditors make a reasonable and good faith of a consumer's repayment ability throughout § 1026.43(c).

The Bureau will consider conducting a future study on the debt-to-income ratio and residual income. Except for one small creditor and the VA, the Bureau is not aware of any creditors that routinely use residual income in underwriting, other than as a compensating factor. [117] The VA underwrites its loans to veterans based on a residual income table developed in 1997. The Bureau understands that the table shows the residual income desired for the consumer based on the loan amount, region of the country, and family size, but does not account for differences in housing or living costs within regions (for instance rural Vermont versus New York City). The Bureau also understands that the residual income is calculated by deducting obligations, including Federal and State taxes, from effective income. However, at this time, the Bureau is unable to conduct a detailed review of the VA residual income guidelines, which would include an analysis of whether those guidelines are predictive of repayment ability, to determine if those standards should be incorporated, in whole or in part, into the ability-to- repay analysis that applies to the entire residential mortgage market. Further, the Bureau believes that providing broad standards for the definition and calculation of residual income will help preserve flexibility if creditors wish to develop and refine more nuanced residual income standards in the future. The Bureau accordingly does not find it necessary or appropriate to specify a detailed methodology in the final rule for consideration of residual income.

The final rule also does not provide a safe harbor for creditors relying on automated underwriting systems that use monthly debt-to-income ratios. The Bureau understands that creditors routinely rely on automated underwriting systems, many of which are proprietary and thus lack transparency to the individual creditors using the systems. Such systems may decide, for example, whether the debt-to-income ratio and compensating factors are appropriate, but may not disclose to the individual creditors using such systems which compensating factors were used for loan approval. However, the Bureau does not believe a safe harbor is necessary in light of the flexibility the final rule provides to creditors in assessing a consumer's repayment ability, including consideration of monthly debt-to-income ratios. See comments 43(c)(1)-1 and 43(c)(2)-1.

Finally, the Bureau notes the contrast between the flexible approach to considering and calculating debt-to-income in § 1026.43(c)(2)(vii) and (7) and the specific standards for evaluating debt-to-income for purposes of determining whether a covered transaction is a qualified mortgage under § 1026.43(e)(2). For the reasons discussed below in the section-by-section analysis of § 1026.43(e)(2), the Bureau believes a specific, quantitative standard for evaluating a consumer's debt-to-income ratio is appropriate in determining whether a loan receives either a safe harbor or presumption of compliance with the repayment ability requirements of § 1026.43(c)(1) pursuant to § 1026.43(e)(2). However, the ability-to-repay requirements in § 1026.43(c) will apply to the whole of the mortgage market and therefore require flexibility to permit creditors to assess repayment ability while ensuring continued access to responsible, affordable mortgage credit. Accordingly, the final rule sets minimum underwriting standards while providing creditors with flexibility to use their own quantitative standards in making the repayment ability determination required by § 1026.43(c)(1).

43(d) Refinancing of Non-Standard Mortgages

Two provisions of section 1411 of the Dodd-Frank Act address the refinancing of existing mortgage loans under the ability-to-repay requirements. As provided in the Dodd-Frank Act, TILA section 129C(a)(5) provides that certain Federal agencies may create an exemption from the income verification requirements in TILA section 129C(a)(4) if certain conditions are met. 15 U.S.C. 1639c(a)(5). In addition, TILA section 129C(a)(6)(E) provides certain special ability-to-repay requirements to encourage applications to refinance existing “hybrid loans” into a “standard loans” with the same creditor, where the consumer has not been delinquent on any payments on the existing loan and the monthly payments would be reduced under the refinanced loan. The statute allows creditors to give special weight to the consumer's good standing and to consider whether the refinancing would prevent a likely default, as well as other potentially favorable treatment to the consumer. However, it does not expressly exempt applications for such “payment shock refinancings” from TILA's general ability-to-repay requirements or define “hybrid” or “standard loans.” [118] 15 U.S.C. 1639c(a)(6)(E).

The Board noted in its proposal that it reviewed the Dodd-Frank Act's legislative history, consulted with consumer advocates and representatives of both industry and the GSEs, and examined underwriting rules and guidelines for the refinance programs of private creditors, GSEs and Federal agencies, as well as for the Home Affordable Modification Program (HAMP). The Board noted that it also considered TILA section 129C(a)(5), which permits Federal agencies to adopt rules exempting refinancings from certain of the ability-to-repay requirements in TILA section 129C(a).

In proposing § 226.43(d) to implement TILA section 129C(a)(6)(E), the Board interpreted the statute as being intended to afford greater flexibility to creditors of certain home mortgage refinancings when complying with the general ability-to-repay provisions in TILA section 129C(a). Consistent with this reading of the statute, the proposal would have provided an exemption from certain criteria required to be considered as part of the general repayment ability determination under TILA section 129C(a). Specifically, the Board's proposal would have permitted creditors to evaluate qualifying applications without having to verify the consumer's income and assets as prescribed in the general ability-to-repay requirements, provided that a number of additional conditions were met. In addition, the proposal would have permitted a creditor to calculate the monthly payment used for determining the consumer's ability to repay the new loan based on assumptions that would typically result in a lower monthly payment than those required to be used under the general ability-to-repay requirements. The proposal also clarified the conditions that must be met in a home mortgage refinancing in order for this greater flexibility to apply.

The Board noted that TILA section 129C(a)(6)(E)(ii) permits creditors to give prevention of a “likely default should the original mortgage reset a higher priority as an acceptable underwriting practice.” 15 U.S.C. 1639c(a)(6)(E)(ii). The Board interpreted this provision to mean that certain ability-to-repay criteria under TILA section 129C(a) should not apply to refinances that meet the requisite conditions. TILA section 129C(a) specifically prescribes the requirements that creditors must meet to satisfy the obligation to determine a consumer's ability to repay a mortgage loan. The Board concluded that the term “underwriting practice” could reasonably be interpreted to refer to the underwriting rules prescribed in earlier portions of TILA section 129C(a); namely, those concerning the general ability-to-repay underwriting requirements.

The Board also structured its proposal to provide for flexibility in underwriting that is characteristic of so-called “streamlined refinances,” which are offered by creditors to existing customers without having to go through a full underwriting process appropriate for a new origination. The Board noted that section 1411 of the Dodd-Frank Act specifically authorizes streamlined refinancings of loans made, guaranteed, or insured by Federal agencies, and concluded that TILA section 129C(a)(6)(E) is most reasonably interpreted as being designed to address the remaining market for streamlined refinancings; namely, those offered under programs of private creditors and the GSEs. The Board stated that in its understanding typical streamlined refinance programs do not require documentation of income and assets, although a verbal verification of employment may be required. The Board further noted that TILA section 129C(a)(6)(E) includes three central elements of typical streamlined refinance programs, in that it requires that the creditor be the same for the existing and new mortgage loan obligation, that the consumer have a positive payment history on the existing mortgage loan obligation, and that the payment on the new refinancing be lower than on the existing mortgage loan obligation.

One difference the Board noted between the statute and typical streamlined refinance programs is that the statute targets consumers facing “likely default” if the existing mortgage “reset[s].” The Board indicated that, by contrast, streamlined refinance programs may not be limited to consumers at risk in this way. For example, streamlined refinancing programs may assist consumers who are not facing potential default but who simply wish to take advantage of lower rates despite a drop in their home value or wish to switch from a less stable variable-rate product to a fixed-rate product. The Board noted parallels between TILA's new refinancing provisions and the focus of HAMP, a government program specifically aimed at providing modifications for consumers at risk of “imminent default,” or in default or foreclosure. [119] However, the Board noted that underwriting criteria for a HAMP modification are considerably more stringent than for a typical streamlined refinance.

On balance, the Board interpreted the statutory language as being modeled on the underwriting standards of typical streamlined refinance programs rather than the tighter standards of HAMP. The Board concluded that Congress intended to facilitate opportunities to refinance loans on which payments could become significantly higher and thus unaffordable. The Board cautioned that applying underwriting standards that are too stringent could impede refinances that Congress intended to encourage. In particular, the statutory language permitting creditors to give “likely default” a “higher priority as an acceptable underwriting practice” indicates that flexibility in these special refinances should be permitted. In addition, underwriting standards that go significantly beyond those used in existing streamlined refinance programs could create a risk that these programs would be unable to meet the TILA ability-to-repay requirements; thus, an important refinancing resource for at-risk consumers would be compromised and the overall mortgage market potentially disrupted at a vulnerable time.

The Board noted, however, that consumers at risk of default when higher payments are required might present greater credit risks to the institutions holding their loans when those loans are refinanced without verifying the consumer's income and assets. Accordingly, the Board's proposal would have imposed some requirements that are more stringent than those of typical streamlined refinance programs as a prerequisite to the refinancing provision under proposed § 226.43(d). For example, the proposal would have permitted a consumer to have had only one delinquency of more than 30 days in the 24 months immediately preceding the consumer's application for a refinance. By contrast, the Board indicated that streamlined refinance programs of which it is aware tend to consider the consumer's payment history for only the last 12 months. [120] In addition, the proposal would have defined the type of loan into which a consumer may refinance under TILA's new refinancing provisions to include several characteristics designed to ensure that those loans are stable and affordable. These include a requirement that the interest rate be fixed for the first five years after consummation and that the points and fees be capped at three percent of the total loan amount, subject to a limited exemption for smaller loans.

43(d)(1) Definitions

In the Board's proposal, § 226.43(d)(1) established the scope of paragraph (d) and set forth the conditions under which the special refinancing provisions applied, while proposed § 226.43(d)(2) addressed the definitions for “non-standard mortgage,” “standard mortgage,” and “refinancing.” The Bureau believes that paragraph (d) should begin with the relevant definitions, before proceeding to the scope and conditions of the special refinancing provisions. The rule finalized by the Bureau is accordingly reordered. The following discussion details the definitions adopted in § 1026.43(d)(1), which were proposed by the Board under § 226.43(d)(2).

Proposed § 226.43(d)(2) defined the terms “non-standard mortgage” and “standard mortgage.” As noted earlier, the statute does not define the terms “hybrid loan” and “standard loan” used in the special refinancing provisions of TILA section 129C(a)(6)(E). Therefore, the Board proposed definitions it believed to be consistent with the policy objective underlying these special provisions: Facilitating the refinancing of home mortgages on which consumers risk a likely default due to impending payment shock into more stable and affordable products.

43(d)(1)(i) Non-Standard Mortgage

As noted above, the statute does not define the terms “hybrid loan” and “standard loan” used in TILA section 129C(a)(6)(E). The Board proposed definitions it believed to be consistent with Congress's objectives. Proposed § 226.43(d)(2)(i) substituted the term “non-standard mortgage” for the statutory term “hybrid loan” and would have defined non-standard mortgage as any “covered transaction,” as defined in proposed § 226.43(b)(1), that is:

  • An adjustable-rate mortgage, as defined in § 226.18(s)(7)(i), with an introductory fixed interest rate for a period of one year or longer; [121]
  • An interest-only loan, as defined in § 226.18(s)(7)(iv); [122] or
  • A negative amortization loan, as defined in § 226.18(s)(7)(v). [123]

Proposed comment 43(d)(2)(i)(A)-1 explained the application of the definition of non-standard mortgage to an adjustable-rate mortgage with an introductory fixed interest rate for one or more years. This proposed comment clarified that, for example, a covered transaction with a fixed introductory rate for the first two, three or five years that then converts to a variable rate for the remaining 28, 27 or 25 years, respectively, is a non-standard mortgage. By contrast, a covered transaction with an introductory rate for six months that then converts to a variable rate for the remaining 29 and1/2years is not a non-standard mortgage.

The Board articulated several rationales for its proposed definition of a non-standard mortgage. First, the Board noted that the legislative history of the Dodd-Frank Act describes “hybrid” mortgages as mortgages with a “blend” of fixed-rate and adjustable-rate characteristics—generally loans with an initial fixed period and adjustment periods, such as “2/23s and 3/27s.” [124] The Board also stated that the legislative history indicates that Congress was concerned about consumers being trapped in mortgages likely to result in payments that would suddenly become significantly higher—often referred to as “payment shock”—because their home values had dropped, thereby “making refinancing difficult.” [125]

The Board interpreted Congress' concern about consumers being at risk due to payment shock as supporting an interpretation of the term “hybrid loan” to encompass both loans that are “hybrid” in that they start with a fixed interest rate and convert to a variable rate, but also loans that are “hybrid” in that consumers can make payments that do not pay down principal for a period of time that then convert to higher payments covering all or a portion of principal. By defining “non-standard mortgage” in this way, the proposal was intended to increase refinancing options for a wide range of at-risk consumers while conforming to the statutory language and legislative intent.

The proposed definition of “non-standard mortgage” would not have included adjustable-rate mortgages whose rate is fixed for an initial period of less than one year. In those instances, the Board posited that a consumer may not face “payment shock” because the consumer has paid the fixed rate for such a short period of time. The Board also expressed concern that allowing streamlined refinancings under this provision where the interest rate is fixed for less than one year could result in “loan flipping.” A creditor, for example, could make a covered transaction and then only a few months later refinance that loan under proposed § 226.43(d) to take advantage of the exemption from certain ability-to-repay requirements while still profiting from the refinancing fees.

The Board expressed concern that under its proposed definition, a consumer could refinance out of a relatively stable product, such as an adjustable-rate mortgage with a fixed interest rate for a period of 10 years, which then adjusts to a variable rate for the remaining loan term, and that it was unclear whether TILA section 129C(a)(6)(E) was intended to cover this type of product. The Board solicited comment on whether adjustable-rate mortgages with an initial fixed rate should be considered non-standard mortgages regardless of how long the initial fixed rate applies, or if the proposed initial fixed-rate period of at least one year should otherwise be revised.

The proposed definition of non-standard mortgage also did not include balloon-payment mortgages. The Board noted that balloon-payment mortgages are not clearly “hybrid” products, given that the monthly payments on a balloon-payment mortgage do not necessarily increase or change from the time of consummation; rather, the entire outstanding principal balance becomes due on a particular, predetermined date. The Board stated that consumers of balloon-payment mortgages typically expect that the entire loan balance will be due at once at a certain point in time and are generally aware well in advance that they will need to repay the loan or refinance.

The Board solicited comment on whether to use its legal authority to include balloon-payment mortgages in the definition of non-standard mortgage for purposes of the special refinancing provisions of TILA section 129C(a)(6)(E). The Board also requested comment generally on the appropriateness of the proposed definition of non-standard mortgage.

Commenters on this aspect of the proposal generally urged the Bureau to expand in various ways the proposed definition of non-standard mortgage and either supported or did not address the proposed definition's inclusion of adjustable-rate mortgages, interest-only loans, or negative amortization loans. One consumer group commented that it supported the Board's proposed definition of non-standard mortgage. Other consumer group commenters stated that the Bureau should use its exemption and adjustment authority under TILA to include balloon-payment loans within the scope of proposed § 226.43(d). In addition, one industry commenter stated that creditors should have flexibility to refinance a performing balloon-payment loan within the six months preceding, or three months following, a balloon payment date without regard to the ability-to-pay requirements. In contrast, one industry commenter stated that balloon-payment loans should not be included in the definition of non-standard mortgage, because consumers are generally well aware of the balloon payment feature in a loan, which is clearly explained to customers. This industry commenter further stated that during the life of a balloon-payment loan, its customers often make regular payments that reduce the principal balance and that balloon-payment loans do not make it more likely that a consumer will default.

While the Bureau agrees that many consumers may need to seek a refinancing when a balloon loan payment comes due, given the approach that the Bureau has taken to implementing the payment shock refinancing provision in § 1026.43(d), the Bureau is declining to expand the definition of non-standard mortgage to include balloon-payment mortgages. As discussed in more detail in the supplementary information to § 1026.43(d)(3), as adopted § 1026.43(d) provides a broad exemption to all of the general ability-to-repay requirements set forth in § 1026.43(c) when a non-standard mortgage is refinanced into a standard mortgage provided that certain conditions are met. The point of this exemption is to enable creditors, without going through full underwriting, to offer consumers who are facing increased monthly payments due to the recast of a loan a new loan with lower monthly payments. Thus, a key element of the exemption is that the monthly payment on the standard mortgage be materially lower than the monthly payment for the non-standard mortgage. As discussed in the section-by-section analysis of § 1026.43(d)(1) below, the Bureau is adopting a safe harbor for reductions of 10 percent. Balloon payments pose a different kind of risk to consumers, one that arises not from the monthly payments (which often tend to be low) but from the balloon payment due when the entire remaining balance becomes due. The provisions of § 1026.43(d)(1) are not meant to address this type of risk. Accordingly, the Bureau declines to expand the definition of non-standard mortgage to include balloon-payment loans. The Bureau believes, however, that where a consumer is performing under a balloon-payment mortgage and is offered a new loan of a type that would qualify as a standard loan with monthly payments at or below the payments of the balloon-payment mortgage, creditors will have little difficulty in satisfying the ability-to-repay requirements.

Consumer group commenters and one GSE commenter argued that the definition of non-standard mortgage should accommodate GSE-held loans. These commenters stated that these loans should receive the same income verification exemption as Federal agency streamlined refinancing programs. These commenters noted that while the GSEs are held in conservatorship by the Federal government, GSE-held loans should be treated the same as FHA for purposes of streamlined refinance programs, which are ultimately about reducing the risk to the taxpayer by avoiding default by consumers who could receive lower-cost mortgage loans. Consumer group commenters further urged that GSE streamlined refinance programs should be subject to standards at least as stringent as those for the FHA streamlined refinance program.

In addition, one of the GSEs questioned the policy justification for the differences between sections 129C(a)(5) and 129C(a)(6)(E) of TILA. TILA section 129C(a)(5), which applies to certain government loans, permits Federal agencies to exempt certain refinancings from the income and asset verification requirement without regard to the original mortgage product, in contrast to TILA section 129C(a)(6)(E), which as discussed above applies only when the original loan is a “hybrid” loan. This commenter noted that consumers with certain types of mortgage loans, such as fixed-rate and balloon-payment loans, may have to go through a more costly and cumbersome process to refinance their mortgages than consumers with government loans.

The Bureau declines to adopt regulations implementing TILA section 129C(a)(5). The Bureau notes that TILA section 129C(a)(5) expressly confers authority on certain Federal agencies (i.e., HUD, VA, USDA, and RHS) to exempt from the income verification requirement refinancings of certain loans made, guaranteed, or insured by such Federal agencies. The scope of TILA section 129C(a)(5) is limited to such Federal agencies or government-guaranteed or -insured loans. The Bureau also declines to expand the scope of § 1026.43(d) to include GSE refinancings that do not otherwise fall within the scope of § 1026.43(d). While accommodation for GSE-held mortgage loans that are not non-standard mortgages under § 1026.43(d) may be appropriate, the Bureau wishes to obtain additional information in connection with GSE refinancings and has requested feedback in a proposed rule published elsewhere in today's Federal Register. However, the Bureau notes that to the extent a loan held by the GSEs (or a loan made, guaranteed or insured by the Federal agencies above) qualifies as a non-standard mortgage under § 1026.43(d)(1)(i) and the other conditions in § 1026.43(d) are met, the refinancing provisions of general applicability in § 1026.43(d) would be available for refinancing a GSE-held loan.

Industry commenters and one industry trade association commented that special ability-to-repay requirements should be available for all rate-and-term refinancings, regardless of whether the refinancings are insured or guaranteed by the Federal government or involve a non-standard mortgage. One industry trade association stated that such special ability-to-repay requirements should incorporate similar standards to those established for certain government loans in TILA section 129C(a)(5), including a requirement that the consumer not be 30 or more days delinquent. For such loans, this trade association stated that other requirements under TILA section 129C(a)(6)(E) regarding payment history should not be imposed, because the consumer is already obligated to pay the debt and the note holder in many cases will already bear the credit risk. Other commenters stated that because a rate-and-term refinancing would offer the consumer a better rate (except in the case of adjustable rate mortgages), there is no reason to deny the creditor the ability to improve its credit risk and to offer the consumer better financing. Several industry commenters and one GSE noted that streamlined refinancing programs are an important resource for consumers seeking to refinance into a lower monthly payment mortgage even when the underlying mortgage loan is not a non-standard mortgage, and urged the Bureau to considering modifying proposed § 226.43(d) to include conventional loans where the party making or purchasing the new loan already owns the credit risk.

The Bureau declines to expand the scope of § 1026.43(d) to include rate-and-term refinancings when the underlying mortgage is not a non-standard mortgage, as defined in § 1026.43(d)(1)(i). The Bureau believes that the statute clearly limits the refinancing provision in TILA section 129(C)(6)(E) to circumstances where the loan being refinanced is a “hybrid loan” and where the refinancing could “prevent a likely default.” The Bureau agrees with the Board that TILA section 129C(a)(6)(E) is intended to address concerns about loans involving possible payment shock. Where a consumer has proven capable of making payments, is about to experience payment shock, is at risk of default, and is refinancing to a mortgage with a lower monthly payment and with product terms that do not pose any increased risk, the Bureau believes that the benefits of the refinancing outweigh the consumer protections afforded by the ability-to-repay requirements. Absent these exigent circumstances, the Bureau believes that creditors should determine that the consumer has the ability to repay the mortgage loan. The Bureau does not believe that a consumer who receives an initial lower monthly payment from a rate-and-term refinancing actually receives a benefit if the consumer cannot reasonably be expected to repay the loan. Also, the Bureau notes that some of the scenarios identified by commenters, such as offering a consumer a better rate with a rate-and-term refinancing where the creditor bears the credit risk, would be exempt from the ability-to-repay requirements. A refinancing that results in a reduction in the APR with a corresponding change in the payment schedule and meets the other conditions in § 1026.20(a) is not a “refinancing” for purposes of § 1026.43, and therefore is not subject to the ability-to-repay requirements. As with other terms used in TILA section 129C, the Bureau believes that this interpretation is necessary to achieve Congress's intent.

Several other industry commenters urged the Bureau to broaden the definition of non-standard mortgage to include refinancings extended pursuant to the Home Affordable Refinance Program (HARP) and similar programs. One such commenter indicated that under HARP, a loan can only be refinanced if the consumer is not in default, the new payment is fully amortizing, and both the original and new loans comply with agency requirements. This commenter stated that HARP permits consumers who would not otherwise be able to refinance due to a high loan-to-value ratio or other reasons to refinance into another loan, providing a consumer benefit. The commenter indicated that HARP loans do not meet all of the proposed ability-to-repay requirements and that the Bureau should use its authority to provide that HARP and other similar programs are exempt from the ability-to-repay requirements, as they promote credit availability and increasing stability in the housing market. The Bureau acknowledges that HARP refinancings and the payment shock refinancings addressed under TILA section 129C(a)(6)(E) are both intended to assist consumers harmed by the financial crisis. Although both types of refinancings are motivated by similar goals, the Bureau does not believe that expanding § 1026.43(d) to include all HARP refinancings is consistent with TILA section 129C(a)(6)(E) because HARP refinancings are not predicated on the occurrence of payment shock and a consumer's likely default. For example, a consumer with a mortgage loan that will not recast and who is not at risk of default may qualify for a HARP refinancing if the consumer's loan-to-value ratio exceeds 80 percent. The Bureau strongly believes that § 1026.43(d) should be limited to instances where a consumer is facing payment shock and likely default.

While not limited to the prevention of payment shock and default, the Bureau acknowledges that extensions of credit made pursuant to programs such as HARP are intended to assist consumers harmed by the financial crisis. Furthermore, these programs employ complex underwriting requirements to determine a consumer's ability to repay. Thus, it may be appropriate to modify the ability-to-repay requirements to accommodate such programs. However, an appropriate balance between helping affected consumers and ensuring that these consumers are offered and receive residential mortgage loans on terms that reasonably reflect consumers' ability to repay must be found. To determine how to strike this balance, the Bureau wishes to obtain additional information in connection with these programs and has requested feedback in a proposed rule published elsewhere in today's Federal Register.

Accordingly, the definition of “non-standard mortgage” is adopted as proposed, renumbered as § 1026.43(d)(1)(i). In addition, comment 43(d)(2)(i)(A)-1 also is adopted as proposed, renumbered as 43(d)(1)(i)(A)-1.

43(d)(1)(ii) Standard Mortgage

Proposed § 226.43(d)(2)(ii) would have substituted the term “standard mortgage” for the statutory term “standard loan” and defined this term to mean a covered transaction that has the following five characteristics:

  • First, the regular periodic payments may not: (1) Cause the principal balance to increase; (2) allow the consumer to defer repayment of principal; or (3) result in a balloon payment.
  • Second, the total points and fees payable in connection with the transaction may not exceed three percent of the total loan amount, with exceptions for smaller loans specified in proposed § 226.43(e)(3).
  • Third, the loan term may not exceed 40 years.
  • Fourth, the interest rate must be fixed for the first five years after consummation.
  • Fifth, the proceeds from the loan may be used solely to pay—(1) the outstanding principal balance on the non-standard mortgage; and (2) closing or settlement charges required to be disclosed under RESPA.

Proposed limitations on regular periodic payments. Proposed § 226.43(d)(2)(ii)(A) would have required that a standard mortgage provide for regular periodic payments that do not result in negative amortization, deferral of principal repayment, or a balloon payment. Proposed comment 43(d)(2)(ii)(A)-1 clarified that “regular periodic payments” are payments that do not result in an increase of the principal balance (negative amortization) or allow the consumer to defer repayment of principal. The proposed comment explained that the requirement for “regular periodic payments” means that the contractual terms of the standard mortgage must obligate the consumer to make payments of principal and interest on a monthly or other periodic basis that will repay the loan amount over the loan term. Proposed comment 43(d)(2)(ii)(A)-1 further explained that, with the exception of payments resulting from any interest rate changes after consummation in an adjustable-rate or step-rate mortgage, the periodic payments must be substantially equal, with a cross-reference to proposed comment 43(c)(5)(i)-3 regarding the meaning of “substantially equal.” In addition, the comment clarified that “regular periodic payments” do not include a single-payment transaction and cross-referenced similar commentary on the meaning of “regular periodic payments” under proposed comment 43(e)(2)(i)-1. Proposed comment 43(d)(2)(ii)(A)-1 also cross-referenced proposed comment 43(e)(2)(i)-2 to explain the prohibition on payments that “allow the consumer to defer repayment of principal.”

One consumer group commenter stated that it supported the exclusion of negative amortization, interest-only payments, and balloon payments from the definition of standard mortgage. In addition, several other consumer groups commented in support of the Board's proposal to exclude balloon-payment loans from the definition of standard mortgage. These commenters stated that balloon-payment products, even with self-executing renewal, should not be permitted to take advantage of an exemption from the general underwriting standards in § 1026.43(c). Consumer groups expressed concern that, in cases where the consumer does not have assets sufficient to make the balloon payment, balloon-payment loans will necessarily require another refinance or will lead to a default. The Bureau agrees with the concerns expressed by such commenters and believes that it is appropriate to require that balloon-payment loans be underwritten in accordance with the general ability-to-repay standard, rather than under the payment shock refinancing provision in § 1026.43(d). Accordingly, the Bureau is not expanding the definition of standard mortgage to include balloon-payment mortgages.

The Bureau received no other comment on this proposed definition. Accordingly, the Bureau is adopting the definition of standard mortgage as proposed, renumbered as § 1026.43(d)(1)(ii)(A). Similarly, the Bureau received no comment on proposed comment 43(d)(2)(ii)(A)-1, which is adopted as proposed and renumbered as 43(d)(1)(ii)(A)-1.

Proposed three percent cap on points and fees. Proposed § 226.43(d)(2)(ii)(B) would have prohibited creditors from charging points and fees on the mortgage loan of more than three percent of the total loan amount, with certain exceptions for small loans. Specifically, proposed § 226.43(d)(2)(ii)(B) cross-referenced the points and fees provisions under proposed § 226.43(e)(3), thereby applying the points and fees limitations for a “qualified mortgage” to a standard mortgage. The points and fees limitation for a “qualified mortgage” and the relevant exception for small loans are discussed in detail in the section-by-section analysis of § 1026.43(e)(3) below.

The Board noted several reasons for the proposed limitation on the points and fees that may be charged on a standard mortgage. First, the limitation was intended to prevent creditors from undermining the provision's purpose—placing at-risk consumers into more affordable loans—by charging excessive points and fees for the refinance. Second, the points and fees limitation was intended to ensure that consumers attain a net benefit in refinancing their non-standard mortgage. The higher a consumer's up-front costs to refinance a home mortgage, the longer it will take for the consumer to recoup those costs through lower payments on the new mortgage. By limiting the amount of points and fees that can be charged in a refinance covered by proposed § 226.43(d), the provision increases the likelihood that the consumer will hold the loan long enough to recoup those costs. Third, the proposed limitation was intended to be consistent with the provisions set forth in TILA section 129C(a)(5) regarding certain refinancings under Federal agency programs.

The Board requested comment on the proposal to apply the same limit on the points and fees that may be charged for a “qualified mortgage” under § 226.43(e) to the points and fees that may be charged on a “standard mortgage” under § 226.43(d). The Bureau received no comments on this proposed points and fees threshold, which is adopted as proposed, renumbered as § 1026.43(d)(1)(ii)(B). See the section-by-section analysis of § 1026.43(e)(3) below for more specific information regarding the limitations applicable to “points and fees” for qualified mortgages and refinancings under § 1026.43(d).

Proposed loan term of no more than 40 years. Proposed § 226.43(d)(2)(ii)(C) would have provided that, to qualify as a standard mortgage under proposed § 226.43(d), a covered transaction may not have a loan term of more than 40 years. The Board stated that this condition was intended to ensure that creditors and consumers have sufficient options to refinance a 30-year loan, for example, which is unaffordable for the consumer in the near term, into a loan with lower, more affordable payments over a longer term. This flexibility may be especially important in higher cost areas where loan amounts on average exceed loan amounts in other areas.

The Board noted that loans with longer terms may cost more over time, but indicated that it was reluctant to foreclose options for consumers for whom the lower payment of a 40-year loan might make the difference between defaulting and not defaulting. The Board also noted that prevalent streamlined refinance programs permit loan terms of up to 40 years and expressed concern about disrupting the current mortgage market at a vulnerable time. The Board specifically requested comment on the proposed condition to allow a standard mortgage to have a loan term of up to 40 years. The Bureau received no comment on this proposed condition, which is adopted as proposed, renumbered as § 1026.43(d)(1)(ii)(C).

Proposed requirement that the interest rate be fixed for the first five years. Proposed § 226.43(d)(2)(ii)(D) would have required that a standard mortgage have a fixed interest rate for the first five years after consummation. Proposed comment 43(d)(2)(ii)(D)-1 provided an illustrative example. The proposed comment also cross-referenced proposed comment 43(e)(2)(iv)-3.iii for guidance regarding step-rate mortgages.

The Board articulated several reasons for requiring a minimum five-year fixed-rate period for standard mortgages. First, the Board noted that a fixed rate for five years is consistent with TILA section 129C(b)(2)(A)(v), which requires the creditor to underwrite a qualified mortgage based on the maximum interest rate that may apply during the first five years. The Board indicated that Congress intended both qualified mortgages and standard mortgages to be stable loan products, and therefore that the required five-year fixed-rate period for qualified mortgages would also be an appropriate benchmark for standard mortgages. The Board further stated that the safeguard of a fixed rate for five years after consummation would help to ensure that consumers refinance into products that are stable for a substantial period of time. In particular, a fixed payment for five years after consummation would constitute a significant improvement in the circumstances of a consumer who may have defaulted absent the refinance. The Board specifically noted that the proposal would permit so-called “5/1 ARMs,” where the interest rate is fixed for the first five years, after which time the rate becomes variable, to be standard mortgages.

The Board requested comment on the proposal defining a standard mortgage as a mortgage loan with an interest rate that is fixed for at least the first five years after consummation, including on whether the rate should be required to be fixed for a shorter or longer period and data to support any alternative time period. One consumer group commenter stated that the use of adjustable-rate mortgages should be limited in the definition of standard mortgage. This commenter stated that adjustable-rate mortgage loans contributed to the subprime lending expansion and the financial crisis that followed. In particular, this commenter expressed concern that adjustable-rate mortgage loans were utilized in loan-flipping schemes that trapped consumers in unaffordable loans, forcing such consumers to refinance into less affordable mortgage loans. This commenter indicated that standard mortgages should be limited to fixed and step-rate loans and, in low or moderate interest rate environments, adjustable-rate mortgages with a 5-year or longer-term fixed period. However, this commenter urged the Bureau to consider permitting shorter-term adjustable-rate mortgages to be standard mortgages in high interest rate environments because in such circumstance, an adjustable-rate mortgage could potentially reduce the consumer's monthly payments at recast, which may outweigh the risks of increased payments for some consumers.

The Bureau is adopting the requirement that a standard mortgage have a fixed interest rate for the first five years after consummation as proposed, renumbered as § 1026.43(d)(1)(ii)(D). The Bureau agrees with the Board that the intent of TILA section 129C(a)(6)(E) appears to be to facilitate refinances of riskier mortgages into more stable loan products, and accordingly, believes that a standard mortgage should provide for a significant period of time during which payments will be predictable, based on a fixed rate or step rates that are set at the time of consummation. The Bureau believes that five years is an appropriate standard in part because it is consistent with the statutory requirement for a qualified mortgage under section 129C(b)(2)(A)(v). The Bureau believes that predictability for consumers is best effectuated by a single rule that applies in all interest rate environments, rather than a rule that depends on the interest rate environment in effect at the time of the refinancing. Further, given that § 1026.43(d) provides an exemption from the general ability-to-repay requirements in § 1026.43(c), the Bureau believes that it is important that a refinancing conducted in accordance with § 1026.43(d) result in a stable loan product and predictable payments for a significant period of time.

In addition, the Board solicited comment on whether a balloon-payment mortgage of at least five years should be considered a standard mortgage under the refinancing provisions of proposed § 226.43(d). The Board noted that in some circumstances, a balloon-payment mortgage with a fixed, monthly payment for five years might benefit a consumer who otherwise would have defaulted. The Board further noted that a five-year balloon-payment mortgage may not be appreciably less risky for the consumer than a “5/1 ARM,” which is permitted under the proposal, depending on the terms of the rate adjustment scheduled to occur in year five.

As discussed above, several consumer groups stated that balloon products, even with self-executing renewal, should not be permitted to take advantage of an exemption from the general underwriting standards in § 1026.43(c). Consumer groups expressed concern that, in cases where the consumer does not have assets sufficient to make the balloon payment, balloon-payment mortgages will necessarily require another refinance or will lead to a default. For the reasons discussed in the supplementary information to § 1026.43(d)(1)(ii)(A) above, the Bureau is not expanding the definition of “standard mortgage” to include balloon-payment mortgages.

Proposed requirement that loan proceeds be used for limited purposes. Proposed § 226.43(d)(2)(ii)(E) would have restricted the use of the proceeds of a standard mortgage to two purposes:

  • To pay off the outstanding principal balance on the non-standard mortgage; and
  • To pay closing or settlement charges required to be disclosed under the Real Estate Settlement Procedures Act, 12 U.S.C. 2601 et seq., which includes amounts required to be deposited in an escrow account at or before consummation.

Proposed comment 43(d)(2)(ii)(E)-1 clarified that if the proceeds of a covered transaction are used for other purposes, such as to pay off other liens or to provide additional cash to the consumer for discretionary spending, the transaction does not meet the definition of a “standard mortgage.”

The Board expressed concern that permitting the consumers to lose additional equity in their homes under the proposed refinancing provisions could undermine the financial stability of those consumers, thus contravening the purposes of TILA section 129C(a)(6)(E). The Board requested comment, however, on whether some de minimis amount of cash to the consumer should be permitted, either because this allowance would be operationally necessary to cover transaction costs or for other reasons, such as to reimburse a consumer for closing costs that were over-estimated but financed.

The Bureau received only one comment on this aspect of the proposal. An association of State bank regulators agreed that the rule should generally restrict the use of the proceeds of the standard mortgage to paying off the outstanding balance on the non-standard mortgage or to pay closing or settlement costs. However, they urged the Bureau to provide an exemption that would permit loan proceeds to be used to pay for known home repair needs and suggested that any such exemption require the consumer to provide verified estimates in advance in order to ensure that loan proceeds are used only for required home repairs.

The Bureau is adopting the limitation on the use of loan proceeds as proposed, renumbered as § 1026.43(d)(1)(ii)(E). The Bureau declines to permit the proceeds of a refinancing conducted in accordance with § 1026.43(d) to be used for home repair purposes, for several reasons. First, the Bureau believes that such an exemption would be inconsistent with the statutory purposes of TILA section 129C(a)(6)(E), which is intended to permit refinancings on the basis of less stringent underwriting in the narrow circumstances where a consumer's non-standard mortgage is about to recast and lead to a likely default by the consumer. The Bureau believes that permitting a consumer to utilize home equity for home repairs in connection with a refinancing conducted pursuant to § 1026.43(d) could further compromise the financial position of consumers who are already in a risky financial position. The Bureau believes that it would be more appropriate, where home repairs are needed, for a creditor to perform the underwriting required to advance any credit required in connection with those repairs. In addition, the Bureau believes that such an exemption could be subject to manipulation by fraudulent home contractors, by the creditor, and even by a consumer. It would be difficult, even with a requirement that the consumer provide verified estimates, to ensure that amounts being disbursed for home repairs actually are needed, and in fact used, for that purpose.

43(d)(1)(iii)

Proposed § 226.43(d)(2)(iii) would have defined the term “refinancing” to have the same meaning as in § 1026.20(a). [126] Section 1026.20(a) defines the term “refinancing” generally to mean a transaction in which an existing obligation is “satisfied and replaced by a new obligation undertaken by the same consumer.” Official commentary explains that “[w]hether a refinancing has occurred is determined by reference to whether the original obligation has been satisfied or extinguished and replaced by a new obligation, based on the parties' contract and applicable law.”See comment 20(a)-1. However, the following are not considered “refinancings” for purposes of § 1026.20(a): (1) A renewal of a payment obligation with no change in the original terms; and (2) a reduction in the annual percentage rate with a corresponding change in the payment schedule. See§ 1026.20(a)(1) and (a)(2), and comment 20(a)-2.

The Board requested comment on whether the proposed meaning of “refinancing” should be expanded to include a broader range of transactions or otherwise should be defined differently or explained more fully than proposed. The Bureau received no comments on this proposed definition. Accordingly, the Bureau is adopting the definition of refinancing as proposed, renumbered as § 1026.43(d)(1)(iii).

43(d)(2) Scope

In the Board's proposal, § 226.43(d)(2) addressed the definitions for “non-standard mortgage,” “standard mortgage,” and “refinancing,” while proposed § 226.43(d)(1) established the scope of paragraph (d) and set forth the conditions under which the special refinancing provisions applied. The Bureau believes that paragraph (d) should begin with the relevant definitions, before proceeding to the scope and conditions of the special refinancing provisions. The rule finalized by the Bureau is accordingly reordered. The following discussion details the provisions adopted in § 1026.43(d)(2), which were proposed by the Board under § 226.43(d)(1).

Proposed § 226.43(d)(1) would have defined the scope of the refinancing provisions under proposed § 226.43(d). Specifically, proposed § 226.43(d) applied when a non-standard mortgage is refinanced into a standard mortgage and the following conditions are met—

  • The creditor of the standard mortgage is the current holder of the existing non-standard mortgage or the servicer acting on behalf of the current holder.
  • The monthly payment for the standard mortgage is significantly lower than the monthly payment for the non-standard mortgage, as calculated under proposed § 226.43(d)(5).
  • The creditor receives the consumer's written application for the standard mortgage before the non-standard mortgage is “recast.”
  • The consumer has made no more than one payment more than 30 days late on the non-standard mortgage during the 24 months immediately preceding the creditor's receipt of the consumer's written application for the standard mortgage.
  • The consumer has made no payments more than 30 days late during the six months immediately preceding the creditor's receipt of the consumer's written application for the standard mortgage.

Proposed comment 43(d)(1)-1 clarified that the requirements for a “written application,” a term that appears in § 226.43(d)(1)(iii), (d)(1)(iv) and (d)(1)(v), discussed in detail below, are found in comment 19(a)(1)(i)-3. Comment 19(a)(1)(i)-3 states that creditors may rely on the Real Estate Settlement Procedures Act (RESPA) and Regulation X (including any interpretations issued by HUD) in deciding whether a “written application” has been received. This comment further states that, in general, Regulation X defines “application” to mean the submission of a borrower's financial information in anticipation of a credit decision relating to a federally related mortgage loan. See 12 CFR 1024.2(b). Comment 19(a)(1)(i)-3 clarifies that an application is received when it reaches the creditor in any of the ways applications are normally transmitted, such as by mail, hand delivery, or through an intermediary agent or broker. The comment further clarifies that, if an application reaches the creditor through an intermediary agent or broker, the application is received when it reaches the creditor, rather than when it reaches the agent or broker. Comment 19(a)(1)(i)-3 also cross-references comment 19(b)-3 for guidance in determining whether or not the transaction involves an intermediary agent or broker. The Bureau received no comments on this proposed comment, which is adopted as proposed, renumbered as 43(d)(2)-1.

43(d)(2)(i)

Proposed § 226.43(d)(1)(i) would have required that the creditor for the new mortgage loan also be either the current holder of the existing non-standard mortgage or the servicer acting on behalf of the current holder. This provision was intended to implement the requirement in TILA section 129C(a)(6)(E) that the existing loan must be refinanced by “the creditor into a standard loan to be made by the same creditor.”

The Board interpreted the statutory phrase “same creditor” to mean that the creditor refinancing the loan must have an existing relationship with the consumer. The Board explained that the existing relationship is important because the creditor must be able to easily access the consumer's payment history and potentially other information about the consumer in lieu of documenting the consumer's income and assets. The Board also noted that this statutory provision is intended to ensure that the creditor of the refinancing has an interest in placing the consumer into a new loan that is affordable and beneficial. The proposal would have permitted the creditor of the refinanced loan to be the holder, or servicer acting on behalf of the holder, of the existing mortgage. The Board further explained that the existing servicer may be the entity conducting the refinance, particularly for refinances held by GSEs. By also permitting the creditor on the refinanced loan to be the servicer acting on behalf of the holder of the existing mortgage, the proposal was intended to apply to a loan that has been sold to a GSE, refinanced by the existing servicer, and continues to be held by the same GSE. The Board solicited comment on whether the proposed rule could be structured differently to better ensure that the creditor retains an interest in the performance of the new loan and whether additional guidance is needed.

Several commenters urged the Bureau to impose a specific period following a refinancing under § 226.43(d) during which the creditor must remain the current holder of the loan. Consumer group commenters suggested that to be eligible for the non-standard mortgage refinancing the creditor should be required to maintain full interest in the refinanced loan for a minimum of 12 months. These commenters expressed concern that the lack of such a retention requirement would permit creditors to refinance loans that are likely to fail without performing the robust underwriting that would otherwise be required for a new loan. If such loans were to be immediately sold to a third party, consumer groups indicated that it could invite abuse by creditors with an incentive to sell riskier loans without providing full value to the consumer. An association of State bank regulators urged the Bureau to adopt a two-year holding period during which the creditor must remain the current holder of the loan.

One industry commenter indicated that the Bureau should broaden the scope to permit a subservicer of the loan to be the creditor with respect to the standard loan. Another industry commenter stated that the scope should be expanded to allow a creditor to refinance a non-standard mortgage that it did not originate or is not servicing. This commenter indicated that due to the volume of requests for refinancing received by some creditors, consumers may benefit from more timely refinancing if a third-party creditor is eligible to use non-standard refinancing provisions.

The Bureau is adopting this requirement as proposed, renumbered as § 1026.43(d)(2)(i). As discussed in more detail below, as adopted § 1026.43(d) provides a broad exemption to all of the ability-to-repay requirements set forth in § 1026.43(c) when a non-standard mortgage is refinanced into a standard mortgage provided that certain conditions are met. Section 1026.43(d)(2)(i) is adopted pursuant to the Bureau's authority under section 105(a) of TILA. The Bureau finds that this adjustment is necessary to effectuate the purposes of TILA by ensuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay, while ensuring that consumers at risk of default due to payment shock are able to obtain responsible, affordable refinancing credit from the current holder of the consumer's mortgage loan, or the servicer acting on behalf of the current holder. To prevent unscrupulous creditors from using § 1026.43(d) to engage in loan-flipping, and to ensure that this exemption is available only in those cases where consumer benefit is the most likely, the Bureau believes that it is important that the creditor of the standard loan be the holder of, or the servicer acting on behalf of the holder of, the non-standard loan. In such cases, the Bureau agrees with the Board that the creditor has a better incentive to refinance the consumer into a more stable and affordable loan. Therefore, the Bureau declines to extend the scope of § 1026.43(d) to cover cases in which the creditor of the non-standard loan is not the current holder of the nonstandard loan or servicer acting on behalf of that holder.

The Bureau believes that the combination of this restriction and the other protections contained in § 1026.43(d) is sufficient to prevent unscrupulous creditors from engaging in loan-flipping. Therefore, the Bureau does not believe that it is necessary to impose a specified period during which the creditor of the standard mortgage must remain the holder of the loan. As discussed in the section-by-section analysis of § 1026.43(d)(2)(vi) below, the Bureau has conditioned use of § 1026.43(d), for non-standard loans consummated after the effective date of this final rule, on the non-standard loan having been made in accordance with the ability-to-repay requirements in § 1026.43(c), including consideration of the eight factors listed in § 1026.43(c)(2). The Bureau believes that this will help to ensure that creditors cannot use the refinancing provisions of § 1026.43(d) to systematically make and divest riskier mortgages, or to cure substandard underwriting on a non-standard mortgage by refinancing the consumer into a loan with a lower, but still unaffordable, payment. TILA section 130(k)(1) provides that consumers may assert as a defense to foreclosure by way of recoupment or setoff violations of TILA section 129C(a) (of which TILA section 129C(a)(6)(E) comprises a subpart). 15 U.S.C. 1640(k)(1). This defense to foreclosure applies against assignees of the loan in addition to the original creditor. Therefore, given that the non-standard loan having been originated in accordance with § 1026.43(c) is a condition for using the refinancing provision in § 1026.43(d), a consumer may assert violations of § 1026.43(c) on the original non-standard loan as a defense to foreclosure for the standard loan made under § 1026.43(d), even if that standard loan is subsequently sold by the creditor.

In addition to believing that imposition of a holding period is unnecessary, the Bureau has concerns that imposition of a holding period also could create adverse consequences for the safety and soundness of financial institutions. In some circumstances, a creditor may need for safety and soundness reasons to sell a portion of its portfolio, which may include a residential mortgage loan that was made in accordance with § 1026.43(d). However, such a creditor may not know at the time of the refinancing that it ultimately will need to sell the loan, and may even intend to remain the holder the loan for a longer period of time at the time of consummation. The Bureau has concerns about the burden imposed on issuers by a holding period in such circumstances where the creditor does not or cannot know at the time of the refinance under § 1026.43(d) that the loan will need to be sold within the next 12 months.

43(d)(2)(ii)

Proposed § 226.43(d)(1)(ii) would have required that the monthly payment on the new mortgage loan be “materially lower” than the monthly payment for the existing mortgage loan. This proposed provision would have implemented the requirement in TILA section 129C(a)(6)(E) that there be “a reduction in monthly payment on the existing hybrid loan” in order for the special provisions to apply to a refinancing. Proposed comment 43(d)(1)(ii)-1 provided that the monthly payment for the new loan must be “materially lower” than the monthly payment for an existing non-standard mortgage and clarifies that the payments that must be compared must be calculated according to proposed § 226.43(d)(5). The proposed comment also clarified that whether the new loan payment is “materially lower” than the non-standard mortgage payment depends on the facts and circumstances, but that, in all cases, a payment reduction of 10 percent or greater would meet the “materially lower” standard.

Consumer groups and an association of State bank regulators supported the adoption of a 10 percent safe harbor for the “materially lower” standard. In contrast, industry commenters opposed the requirement that payment on the standard mortgage be “materially lower” than the payment on the non-standard mortgage. These commenters urged the Bureau not to adopt the 10 percent safe harbor proposed by the Board and stated that the 10 percent safe harbor would become the de facto rule if adopted. These commenters expressed concerns that the “materially lower” standard would unduly restrict access to credit for many consumers and suggested that the Bureau instead adopt a standard that would permit more consumers to qualify for the non-standard refinancing provisions. Several commenters indicated that the Bureau should adopt a five percent safe harbor rather than the proposed ten percent. One industry commenter recommended that the Bureau permit reductions of a minimum dollar amount to satisfy the rule, particularly in cases where the monthly payment is already low. Finally, one industry commenter asked the Bureau to provide guidance regarding the meaning of “materially lower” when the reduction in payment is less than 10 percent.

The Bureau is adopting as proposed the requirement that the payment on the standard mortgage be “materially lower” than the non-standard mortgage and the safe harbor for a 10 percent or greater reduction, renumbered as § 1026.43(d)(2)(ii) and comment 43(d)(2)(ii)-1. The Bureau agrees with the Board that it would be inconsistent with the statutory purpose to permit the required reduction to be merely de minimis. In such cases, the consumer likely would not obtain a meaningful benefit that would help to prevent default. As discussed in the section-by-section analysis below, § 1026.43(d)(3) exempts refinancings from the ability-to-repay requirements in § 1026.43(c), provided that certain conditions are met. Given that § 1026.43(d) provides a broad exemption to the ability-to-repay requirements, the Bureau believes that it is important that the reduction in payment provide significant value to the consumer and increase the likelihood that the refinancing will improve the consumer's ability to repay the loan. Accordingly, the Bureau is adopting the 10 percent safe harbor as proposed. The Bureau declines to adopt a dollar amount safe harbor because the appropriate dollar amount would depend on a number of factors, including the amount of the loan and monthly payment, but notes that reductions of less than 10 percent could nonetheless meet the “materially lower” standard depending on the relevant facts and circumstances.

43(d)(2)(iii)

Proposed § 226.43(d)(1)(iii) would have required that the creditor for the refinancing receive the consumer's written application for the refinancing before the existing non-standard mortgage is “recast.” As discussed in the section-by-section analysis of § 1026.43(b)(11) above, the proposal defined the term “recast” to mean, for an adjustable-rate mortgage, the expiration of the period during which payments based on the introductory fixed rate are permitted; for an interest-only loan, the expiration of the period during which the interest-only payments are permitted; and, for a negative amortization loan, the expiration of the period during which negatively amortizing payments are permitted.

The Board explained that the proposal was intended to implement TILA section 129C(a)(6)(E)(ii), which permits creditors of certain refinances to “consider if the extension of new credit would prevent a likely default should the original mortgage reset.” This statutory language implies that the special refinancing provisions apply only where the original mortgage has not yet “reset.” Accordingly, the Board concluded that Congress's concern likely was prevention of default in the event of a “reset,” not loss mitigation on a mortgage for which a default on the “reset” payment has already occurred.

However, in recognition of the fact that a consumer may not realize that a loan will be recast until the recast occurs and that the consumer could not refinance the loan under proposed § 226.43(d), the Board also requested comment on whether it would be appropriate to use legal authority to make adjustments to TILA to permit refinancings after a loan is recast.

Consumer groups urged the Bureau to expand the scope of the non-standard refinancing provisions to apply to applications filed after the initial recast of a non-standard loan has occurred. These commenters stated that the intent of the proposal is to avoid “likely default” and indicated that for some consumers, notification that the consumer's interest rate has adjusted and their payment has increased may be their first notice that their payment has gone up and increased their likelihood of default. One consumer group commenter stated that these consumers may be better credit risks than those consumers whose loans have not yet recast and they would clearly benefit from a materially lower monthly payment.

Several industry commenters similarly urged the Bureau to modify the provisions to apply to applications for refinancings received after recast of the non-standard loan. One of these commenters stated that the timing of the application is irrelevant to the consumer's ability to repay or the consumer's need to refinance. One industry commenter stated that processing an application and assessing a consumer's ability to repay a new loan may require additional time well before the recast date. This commenter urged the Bureau to expand the scope of the non-standard refinancing provisions to include refinancings after a loan is recast that are in the best interests of consumers.

For the reasons discussed below, the Bureau is adopting § 1026.43(d)(2)(iii), which provides that § 1026.43(d) applies to the refinancing of a non-standard mortgage into a standard mortgage when the creditor receives the consumer's written application for the standard mortgage no later than two months after the non-standard mortgage has recast, provided certain other conditions are met. The Bureau believes that the best reading of TILA section 129C(a)(6)(E) is that it is intended to facilitate refinancings for consumers at risk of default due to the “payment shock” that may occur upon the recast of the consumer's loan to a higher rate or fully amortizing payments. The Bureau acknowledges that the statutory language contemplates that such recast has not yet occurred. However, the Bureau does not believe that Congress intended to provide relief for consumers facing imminent “payment shock” based on how promptly the consumer filed, or how quickly the creditor processed, an application for a refinancing. For example, the periodic rate on a mortgage loan may recast on July 1st, but the higher payment reflecting the recast interest rate would not be due until August 1st. In this example, a consumer may not experience payment shock until a month after the consumer's rate recasts. Additionally, it may take a significant amount of time for a consumer to provide the creditor with all of the information required by the creditor, thereby triggering the receipt of an application for purposes of the ability-to-repay requirements. The Bureau does not believe that Congress intended the special treatment afforded by TILA section 129C(a)(6)(E) to hinge on paperwork delays such as these. The Bureau agrees with the arguments raised by commenters and believes that the purposes of TILA are best effectuated by permitting consumers to submit applications for refinancings for a short period of time after recast occurs. The Bureau has determined that permitting a consumer to apply for a refinancing within two months of the date of recast strikes the appropriate balance between the language of the statute and the practical considerations involved with submitting an application for a refinancing in response to payment shock. Pursuant to its authority under TILA section 105(a), the Bureau finds that modifying § 1026.43(d) to apply to extensions of credit where the creditor receives the consumer's written application for the standard mortgage no later than two months after the non-standard mortgage has recast ensures that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay while ensuring that responsible, affordable mortgage credit remains available to consumers at risk of default due to higher payments resulting from the recast.

43(d)(2)(iv)

Proposed § 226.43(d)(1)(iv) would have required that, during the 24 months immediately preceding the creditor's receipt of the consumer's written application for the standard mortgage, the consumer has made no more than one payment on the non-standard mortgage more than 30 days late. Proposed comment 43(d)(1)(iv)-1 provided an illustrative example. Together with proposed § 226.43(d)(1)(v), proposed § 226.43(d)(1)(iv) would have implemented the portion of TILA section 129C(a)(6)(E) that requires that the consumer not have been “delinquent on any payment on the existing hybrid loan.”

Although TILA section 129C(a)(6)(E) contains a statutory prohibition on “any” delinquencies on the existing non-standard (“hybrid”) mortgage, the Board interpreted its proposal as consistent with the statute in addition to being consistent with the consumer protection purpose of TILA and current industry practices. In addition, the Board noted its authority under TILA sections 105(a) and 129B(e)—which has since transferred to the Bureau—to adjust provisions of TILA and condition practices “to assure that consumers are offered and receive residential mortgage loan on terms that reasonably reflect their ability to repay the loans and that are understandable and not unfair, deceptive, or abusive.” 15 U.S.C. 1604(a); 15 U.S.C. 1639b(e); TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2).

The Board provided several reasons for proposing to require a look-back period for payment history of 24 months, rather than a 12-month period. First, the Board noted that consumers at risk of default when higher payments are required might present greater credit risks to the institutions holding their loans, even if the institutions refinance those loans. Second, the Board noted views expressed during outreach by GSE and creditor representatives that consumers with positive payment histories tend to be less likely than other consumers to become obligated on a new loan for which they cannot afford the monthly payments. The Board solicited comment on the proposal to require that the consumer have only one delinquency during the 24 months prior to applying for a refinancing, particularly on whether a longer or shorter look-back period should be required.

In addition, under the proposal, late payments of 30 days or fewer on the existing, non-standard mortgage would not disqualify a consumer from refinancing the non-standard mortgage under the streamlined refinance provisions of proposed § 226.43(d). The Board stated that allowing delinquencies of 30 or fewer days is consistent with the statutory prohibition on “any” delinquency for several reasons. First, the Board noted that delinquencies of this length may occur for many reasons outside of the consumer's control, such as mailing delays, miscommunication about where the payment should be sent, or payment crediting errors. Second, many creditors incorporate a late fee “grace period” into their payment arrangements, which permits consumers to make their monthly payments for a certain number of days after the contractual due date without incurring a late fee. Accordingly, the Board noted that the statute should not be read to prohibit consumers from obtaining needed refinances due to payments that are late but within a late fee grace period. Finally, the Board indicated that the predominant streamlined refinance programs of which it is aware uniformly measure whether a consumer has a positive payment history based on whether the consumer has made any payments late by 30 days (or, as in the proposal, more than 30 days).

Proposed comment 43(d)(1)(iv)-2 would have clarified that whether a payment is more than 30 days late depends on the contractual due date not accounting for any grace period and provided an illustrative example. The Board indicated that using the contractual due date for determining whether a payment has been made more than 30 days after the due date would facilitate compliance and enforcement by providing clarity. Whereas late fee “grace periods” are often not stated in writing, the contractual due date is unambiguous. Finally, the Board stated that using the contractual due date for determining whether a loan payment is made on time is consistent with standard home mortgage loan contracts. The Board requested comment on whether the delinquencies that creditors are required to consider under § 226.43(d)(1) should be late payments of more than 30 days as proposed, 30 days or more, or some other time period.

Consumer groups supported the Board's proposal to identify late payments as late payments of more than 30 days. However, they stated that the requirement that consumers not have more than one delinquency in the past 24 months to qualify for a refinance under § 1026.43(d) was overly stringent and that the appropriate standard would be no delinquencies in the past 12 months.

Several industry commenters similarly urged the Bureau to adopt a 12-month period rather than the proposed 24-month period in which a consumer may have one late payment. These commenters stated that permitting only one 30-day late payment in the past 24 months is too restrictive and would require a creditor to overlook a recent history of timely payments. In addition, one industry commenter stated that the standard for defining a late payment should be late payments of more than 60 days.

The Bureau is adopting this provision generally as proposed, renumbered as § 1026.43(d)(2)(iv), with one substantive change. The Bureau is adopting a 12-month look-back period rather than the 24-month period proposed by the Board. The Bureau believes that reviewing a consumer's payment history over the last 12 months would be more appropriate than a 24-month period, and agrees that a 24-month period may unduly restrict consumer access to the § 1026.43(d) refinancing provisions. The Bureau believes that the requirement that a consumer's account have no more than one 30-day late payment in the past 12 months will best effectuate the purposes of TILA by ensuring that only those consumers with positive payment histories are eligible for the non-standard refinancing provisions under § 1026.43(d). Section 1026.43(d)(2)(iv) is adopted pursuant to the Bureau's authority under section 105(a) of TILA. The Bureau finds that this adjustment is necessary and proper to effectuate the purposes of TILA by ensuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay, while ensuring that consumers at risk of default due to payment shock are able to obtain responsible, affordable refinancing credit.

The Bureau also is adopting comments 43(d)(1)(iv)-1 and 43(d)(1)(iv)-2 generally as proposed, with conforming amendments to reflect the 12-month look-back period in § 1026.43(d)(2)(iv), and renumbered as 43(d)(2)(iv)-1 and 43(d)(2)(iv)-2. The Bureau has made several technical amendments to the example in comment 43(d)(2)(iv)-1 for clarity. As proposed, the examples in the comment referred to dates prior to the effective date of this rule; the Bureau has updated the dates in the examples so that they will occur after this rule becomes effective.

43(d)(2)(v)

Proposed § 226.43(d)(1)(v) would have required that the consumer have made no payments on the non-standard mortgage more than 30 days late during the six months immediately preceding the creditor's receipt of the consumer's written application for the standard mortgage. This provision complemented proposed § 226.43(d)(1)(iv), discussed above, in implementing the portion of TILA section 129C(a)(6)(E) that requires that the consumer not have been “delinquent on any payment on the existing hybrid loan.” Taken together with proposed § 226.43(d)(1)(iv), the Board believed that this is a reasonable interpretation of the prohibition on “any” delinquencies on the non-standard mortgage and is supported by the Board's authority under TILA sections 105(a) and 129B(e)—which has transferred to the Bureau—to adjust provisions of TILA and condition practices “to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans and that are understandable and not unfair, deceptive, or abusive.” 15 U.S.C. 1604(a); TILA section 129B(a)(2), 15 U.S.C. 1639b(a)(2).

The Board stated that a six-month “clean” payment record indicates a reasonable level of financial stability on the part of the consumer applying for a refinancing. In addition, the Board noted that participants in its outreach indicated that a prohibition on delinquencies of more than 30 days for the six months prior to application for the refinancing was generally consistent with common industry practice and would not be unduly disruptive to existing streamlined refinance programs with well-performing loans.

Proposed comment 43(d)(1)(v)-1 provided an illustrative example of the proposed rule and clarified that if the number of months between consummation of the non-standard mortgage and the consumer's application for the standard mortgage is six or fewer, the consumer may not have made any payment more than 30 days late on the non-standard mortgage. The comment cross-referenced proposed comments 43(d)(1)-2 and 43(d)(1)(iv)-2 for an explanation of “written application” and how to determine the payment due date, respectively.

One industry commenter stated that the prohibition on late payments in the past six months should be amended to provide flexibility when the late payment was due to extenuating circumstances. The Bureau declines to adopt a rule providing an adjustment for extenuating circumstances, for several reasons. First, the existence or absence of extenuating circumstances is a fact-specific question and it would be difficult to distinguish by regulation between extenuating circumstances that reflect an ongoing risk with regard to the consumer's ability to repay the loan versus extenuating circumstances that present less risk. In addition, an adjustment for extenuating circumstances appears to be inconsistent with the purposes of TILA section 129C(a)(6)(E), which contemplates that the consumer “has not been delinquent on any payment on the existing hybrid loan,” without distinguishing between payments that are delinquent due to extenuating circumstances or otherwise. Furthermore, by defining a late payment as more than 30 days late, the Bureau believes that many extenuating circumstances, for example a payment made three weeks late due to mail delivery issues, will not preclude use of § 1026.43(d).

Accordingly, the Bureau is adopting this provision as proposed, renumbered as § 1026.43(d)(2)(v). Similarly, the Bureau is adopting comment 43(d)(1)(v)-1 generally as proposed, with several technical amendments for clarity and renumbered as 43(d)(2)(v)-1. As proposed, the examples in the comment referred to dates prior to the effective date of this rule; the Bureau has updated the dates in the examples so that they will occur after this rule becomes effective. Pursuant to its authority under TILA section 105(a), the Bureau finds that requiring that the consumer have made no payments on the non-standard mortgage more than 30 days late during the six months immediately preceding the creditor's receipt of the consumer's written application for the standard mortgage ensures that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay while ensuring that responsible, affordable mortgage credit remains available to consumers at risk of default due to higher payments resulting from the recast.

43(d)(2)(vi)

For the reasons discussed in the section-by-section analysis of § 1026.43(d)(3), the Bureau is adopting a new § 1026.43(d)(2)(vi) that generally conditions use of § 1026.43(d) on the existing non-standard mortgage having been made in accordance with § 1026.43(c), provided that the existing non-standard mortgage loan was consummated on or after January 10, 2014. For the reasons discussed in the section-by-section analysis of § 1026.43(d)(3), the Bureau believes that this provision is necessary and proper to prevent use of § 1026.43(d)'s streamlined refinance provision to circumvent or “cure” violations of the ability-to-repay requirements in § 1026.43(c). Section 1026.43(d)(2)(vi) is adopted pursuant to the Bureau's authority under TILA section 105(a). The Bureau finds that this adjustment is necessary to effectuate the purposes of TILA by ensuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay, while ensuring that consumers at risk of default due to payment shock are able to obtain responsible and affordable refinancing credit. Furthermore, the Bureau believes that this adjustment is necessary to prevent unscrupulous creditors from using § 1026.43(d) to engage in loan-flipping or other practices that are harmful to consumers, thereby circumventing the requirements of TILA.

43(d)(3) Exemption From Repayment Ability Requirements

Under specific conditions, proposed § 226.43(d)(3) would have exempted a creditor in a refinancing from two of the ability-to-repay requirements under proposed § 226.43(c). First, the proposal provided that a creditor is not required to comply with the income and asset verification requirements of proposed § 226.43(c)(2)(i) and (c)(4). Second, the proposal provided that the creditor is not required to comply with the payment calculation requirements of proposed § 226.43(c)(2)(iii) and (c)(5); the creditor may instead use payment calculations prescribed in proposed § 226.43(d)(5)(ii).

For these exemptions to apply, proposed § 226.43(d)(3)(i)(A) would have required that all of the conditions in proposed § 226.43(d)(1)(i) through (v) be met. In addition, proposed § 226.43(d)(3)(i)(B) would have required that the creditor consider whether the standard mortgage will prevent a likely default by the consumer on the non-standard mortgage when the non-standard mortgage is recast. This proposed provision implemented TILA section 129C(a)(6)(E)(ii), which permits a creditor to “consider if the extension of new credit would prevent a likely default should the original mortgage reset and give such concerns a higher priority as an acceptable underwriting practice.” As clarified in proposed comment 43(d)(3)(i)-1, the Board interpreted TILA section 129(a)(6)(E)(ii) to require a creditor to consider whether: (1) The consumer is likely to default on the existing mortgage once new, higher payments are required; and (2) the new mortgage will prevent the consumer's default. The Board solicited comment regarding whether these proposed provisions were appropriate, and also specifically solicited comment on whether exemptions from the ability-to-repay requirements, other than those proposed, were appropriate.

Several commenters expressly supported this proposed provision. An association of State bank supervisors stated that refinancing designed to put a consumer in a higher-quality standard mortgage before the existing lower-quality mortgage recasts should be given greater deference and further stated that it is sound policy to encourage refinancing where it protects both the economic interest of the creditor and the financial health of the consumer. Consumer groups commented that limited and careful exemption from income verification, provided that protections are in place, can help consumers and communities, while preventing reckless and abusive lending on the basis of little or no documentation. Civil rights organizations also stated that the streamlined refinance option would provide much-needed relief for consumers with loans that are not sustainable in the long term but who are not yet in default. These commenters also stated that minority consumers have been targeted in the past for unsustainable loans and that this provision could help to prevent further foreclosures and economic loss in minority communities, as well as for homeowners in general.

Other consumer group commenters stated that an exemption to the income verification requirement for refinancing into standard mortgages is problematic. One commenter stated that, because the refinance would be executed by the same creditor that made the original hybrid loan, income verification would not be difficult. This commenter urged the Bureau to encourage income documentation when implementing the Dodd-Frank Act.

Several industry commenters urged the Bureau to provide additional relief for refinancings made in accordance with proposed § 226.43(d), either by permitting the standard loan to be classified as a qualified mortgage or by providing exemptions from other of the proposed ability-to-repay requirements. One industry commenter stated that in addition to the proposed exemption for the verification of income and assets, refinancings conducted in accordance with § 226.43(d) also should be exempt from the requirements to consider the consumer's debt-to-income ratio or residual income, if the consumer is still employed and has not incurred significant additional debt obligations prior to the refinance. This commenter stated that overly rigid standards could significantly reduce the number of consumers who qualify for this exemption. Similarly, one industry trade association urged the Bureau to exempt refinancings from the requirement to consider the consumer's debt obligations, debt-to-income ratio, and employment. This commenter stated that the proposed requirement to consider these additional underwriting factors was seemingly in conflict with the purpose of proposed § 226.43(d) and would preclude consumers from taking advantage of beneficial and less costly refinancing opportunities. In addition, several industry commenters and one industry trade association commented that standard mortgages made in accordance with § 226.43(d) should be treated as qualified mortgages.

The Bureau agrees with the concerns raised by commenters that the proposed exemptions were drawn too narrowly. The Bureau believes that TILA section 129C(a)(6)(E) is intended to create incentives for creditors to refinance loans in circumstances where consumers have non-standard loans on which they are currently able to make payments but on which they are likely to be unable to make the payments after recast and therefore default on the loan. Accordingly, the Bureau believes that in order to create incentives for creditors to use the non-standard refinancing provision, TILA section 129C(a)(6)(E) must be intended to provide at least a limited exemption from the general ability-to-repay determination as adopted in § 1026.43(c). Otherwise, creditors may have little incentive to provide consumers at risk of default with refinancings that result in “materially lower” payments. The Bureau believes, however, that in implementing TILA section 129C(a)(6)(E) it is important to balance the creation of additional flexibility and incentives for creditors to refinance non-standard mortgages into standard mortgages against the likelihood of benefit to the consumer.

The Bureau notes that under the final rule as adopted, the availability of the non-standard refinancing provision contains several conditions that are intended to benefit the consumer. First, the special ability-to-repay requirements in § 1026.43(d) are available only if the conditions in § 1026.43(d)(2) are met. These conditions include limiting the scope of § 1026.43(d) to refinancings of non-standard mortgages into standard mortgages, which generally are more stable products with reduced risk of payment shock. The definition of standard mortgage in § 1026.43(d)(1)(ii) includes a number of limitations that are intended to ensure that creditors may only use the provisions in § 1026.43(d) to offer a consumer a product with safer features. For example, as discussed in the section-by-section analysis of § 1026.43(d)(1)(ii) a standard mortgage may not include negative amortization, an interest-only feature, or a balloon payment; in addition, the term of the standard mortgage may not exceed 40 years, the interest rate must be fixed for at least the first five years, the loan is subject to a limitation on the points and fees that may be charged, and there are limitations on the use of proceeds from the refinancing. Furthermore, § 1026.43(d)(2)(ii) requires that the monthly payment on the standard mortgage be materially lower than the monthly payment for the non-standard mortgage and, as discussed above, the Bureau is adopting a 10 percent safe harbor for what constitutes a “material” reduction.

The Bureau has concerns that, as proposed by the Board, an exemption only from the requirement to consider and verify the consumer's income or assets may create insufficient incentives for creditors to make refinancings to assist consumers at risk of default. For example, the proposal would have required creditors to comply with the requirement in § 1026.43(c)(2)(vii) to consider the consumer's debt-to-income ratio or residual income. Accordingly, notwithstanding an exemption from income or asset verification, the proposal would have required consideration of income, as well as consideration of all of the other underwriting criteria set forth in § 1026.43(c)(2).

The Bureau believes that in light of the safeguards imposed by other portions of § 1026.43(d), as discussed above, it is appropriate to provide an exemption to all of the ability-to-repay requirements under § 1026.43(c) for a refinance conducted in accordance with § 1026.43(d). The Bureau believes that a broad exemption from the general ability-to-repay determination is appropriate in order to create incentives for creditors to quickly and efficiently refinance consumers whose non-standard mortgages are about to recast, thus rendering them likely to default, into more affordable, more stable mortgage loans. The Bureau is aware that some consumers may nonetheless default on a standard mortgage made in accordance with § 1026.43(d), but those consumers likely would have defaulted had the non-standard mortgage remained in place. For others, the material reduction in payment required under § 1026.43(d)(2) and the more stable product type following refinancing may be sufficient to enable consumers to avoid default. The Bureau believes that a refinancing conducted in accordance with § 1026.43(d) will generally improve a consumer's chances of avoiding default. Section 1026.43(d)(3) is adopted pursuant to the Bureau's authority under TILA section 105(a). The Bureau finds that this adjustment is necessary to effectuate the purposes of TILA by ensuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay, while ensuring that consumers at risk of default due to payment shock are able to obtain responsible and affordable refinancing credit.

However, to prevent evasion or circumvention of the ability-to-repay requirements in § 1026.43(c), the Bureau is imposing one additional condition on the use of § 1026.43(d). Specifically, new § 1026.43(d)(2)(vi) conditions the use of § 1026.43(d), for non-standard mortgages consummated on or after the effective date of this rule, on the non-standard mortgage having been made in accordance with § 1026.43(c). The Bureau has concerns that absent § 1026.43(d)(2)(vi), a creditor might attempt to use a refinancing conducted in accordance with § 1026.43(d) to “cure” substandard underwriting of the prior non-standard mortgage. For example, without § 1026.43(d)(2)(vi), if a creditor discovered that it had made an error in consideration of the underwriting factors under § 1026.43(c)(2) for a non-standard mortgage, the creditor might consider conducting a refinancing under § 1026.43(d), in order to argue that the consumer may no longer raise as a defense to foreclosure the underwriting of the original non-standard mortgage. The Bureau believes that conditioning the use of § 1026.43(d) on the earlier loan having been made in accordance with § 1026.43(c) will better effectuate the purposes of TILA by ensuring that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay while preventing unscrupulous creditors from evading the ability-to-repay requirements.

New § 1026.43(d)(2)(vi) applies only to non-standard mortgages consummated on or after the effective date of this rule. For non-standard loans consummated before the effective date of this final rule, a refinancing under § 1026.43(d) would not be subject to this condition. The Bureau believes that non-standard mortgages made prior to the effective date, to which the ability-to-repay requirements in § 1026.43(c) did not apply, may present an increased risk of default when they are about to recast, so that facilitating refinancing into more stable mortgages may be particularly important even if the consumer could not qualify for a new loan under traditional ability-to-repay requirements. The Bureau believes that, on balance, given the conditions that apply to refinances under § 1026.43(d), refinances of these loans are more likely to benefit consumers than to harm consumers, notwithstanding the inapplicability of § 1026.43(d)(2)(vi). In addition, the concern about a creditor using § 1026.43(d) to “cure” prior violations of § 1026.43(c) does not apply to loans made before the effective date of this rule, as such loans were not required to be made in accordance with § 1026.43.

Proposed condition that the consumer will likely default. Proposed comment 43(d)(3)(i)-2 would have clarified that, in considering whether the consumer's default on the non-standard mortgage is “likely,” the creditor may look to widely accepted governmental and non-governmental standards for analyzing a consumer's likelihood of default. The proposal was not intended, however, to constrain servicers and other relevant parties from using other methods to determine a consumer's likelihood of default, including those tailored specifically to that servicer. As discussed in the supplementary information to the proposal, the Board considered certain government refinancing programs as well as feedback from outreach participants, each of which suggested that there may be legitimate differences in servicer assessments of a consumer's likelihood of default. The Board noted that it considered an “imminent default” standard but heard from consumer advocates that “imminent default” may be a standard that is too high for the refinancing provisions in TILA section 129C(a)(6)(E) and could prevent many consumers from obtaining a refinancing to avoid payment shock. Accordingly, the Board's proposal used the exact statutory wording—“likely default”—in implementing the provision permitting a creditor to prioritize prevention of default in underwriting a refinancing. The Board solicited comment on the proposal to use the term “likely default” in implementing TILA section 129C(a)(6)(E)(ii) and on whether additional guidance is needed on how to meet the requirement that a creditor must reasonably and in good faith determine that a standard mortgage will prevent a likely default should the non-standard mortgage be recast.

Two industry trade associations urged the Bureau to remove proposed § 226.43(d)(3)(i)(B) as a condition to the availability of the non-standard refinancing provisions. One of these commenters noted that a creditor would have to underwrite a consumer's income and assets to determine whether the consumer would likely default, which would defeat the purpose of the proposed provision. Several industry commenters also indicated that the “likelihood of default” standard is vague and accordingly subjects creditors to potential liability for waiving certain ability-to-repay requirements, and questioned the extent to which creditors would utilize the streamline refinance option in light of this potential liability. One such commenter urged the Bureau to eliminate this requirement or, in the alternative, to provide additional guidance regarding when a consumer is “likely to go into default.”

An association of State bank supervisors stated that there can be no quantifiable standard for the definition of “likely default.” These commenters further stated that institutions must use sound judgment and regulators must provide responsible oversight to ensure that abuses are not occurring through the refinancing exemption set forth in § 1026.43(d).

The Bureau is adopting the provision as proposed, renumbered as § 1026.43(d)(3)(i)(B), and is also adopting comments 43(d)(3)(i)-1 and 43(d)(3)(i)-2 as proposed. The Bureau believes that eliminating the requirement that a creditor consider whether the extension of new credit would prevent a likely default would be inconsistent with TILA section 129C(a)(6)(E), which expressly includes language regarding consideration by the creditor of “[whether] the extension of new credit would prevent a likely default should the original mortgage reset.” At the same time, the Bureau agrees with the association of State bank supervisors that it would be difficult to impose by regulation a single standard for what constitutes a likely default. Accordingly, the Bureau is adopting the flexible approach proposed by the Board, which would permit but not require creditors to look to widely-accepted standards for analyzing a consumer's likelihood of default. The Bureau does not believe that this flexible approach requires a creditor to consider the consumer's income and assets if, for example, statistical evidence indicates that consumers who experience a payment shock of the type that the consumer is about to experience have a high incidence of defaulting following the payment shock.

Proposed payment calculation for repayment ability determination. Proposed comment 43(d)(3)(ii)-1 would have explained that, if the conditions in proposed § 226.43(d)(1) are met, the creditor may satisfy the payment calculation requirements for determining a consumer's ability to repay the new loan by applying the calculation prescribed under proposed § 226.43(d)(5)(ii), rather than the calculation prescribed under proposed § 226.43(c)(2)(iii) and (c)(5). As discussed in the section-by-section analysis above, as adopted § 1026.43(d)(3) provides an exemption from the requirements of § 1026.43(c) if certain conditions are met. Accordingly, while the creditor is required to determine whether there is a material reduction in payment consistent with § 1026.43(d)(2)(ii) by using the payment calculations prescribed in § 1026.43(d)(5), the creditor is not required to use these same payment calculations for purposes of § 1026.43(c). Accordingly, the Bureau is withdrawing proposed comment 43(d)(3)(ii)-1 as unnecessary.

43(d)(4) Offer of Rate Discounts and Other Favorable Terms

Proposed § 226.43(d)(4) would have provided that a creditor making a loan under the special refinancing provisions of § 226.43(d) may offer to the consumer the same or better rate discounts and other terms that the creditor offers to any new consumer, consistent with the creditor's documented underwriting practices and to the extent not prohibited by applicable State or Federal law. This aspect of the proposal was intended to implement TILA section 129C(a)(6)(E)(iii), which permits creditors of refinancings subject to special ability-to-repay requirements in TILA section 129C(a)(6)(E) to “offer rate discounts and other favorable terms” to the consumer “that would be available to new customers with high credit ratings based on such underwriting practice.”

The Bureau received no comments on this provision, which is adopted as proposed and renumbered as § 1026.43(d)(4). The Bureau is concerned that the phrase “consistent with the creditor's underwriting practice” could be misinterpreted to refer to the underwriting requirements in § 1026.43(c). As this final rule provides an exemption under § 1026.43(d) for all of the requirements in § 1026.43(c), subject to the other conditions discussed above, the Bureau believes that additional clarification is needed to address this potential misinterpretation. Thus, the Bureau is adopting comment 43(d)(4)-1, which clarifies that in connection with a refinancing made pursuant to § 1026.43(d), § 1026.43(d)(4) requires a creditor offering a consumer rate discounts and terms that are the same as, or better than, the rate discounts and terms offered to new consumers to make such an offer consistent with the creditor's documented underwriting practices. Section 1026.43(d)(4) does not require a creditor making a refinancing pursuant to § 1026.43(d) to comply with the underwriting requirements of § 1026.43(c). Rather, § 1026.43(d)(4) requires creditors providing such discounts to do so consistent with documented policies related to loan pricing, loan term qualifications, or other similar underwriting practices. For example, assume that a creditor is providing a consumer with a refinancing made pursuant to § 1026.43(d) and that this creditor has a documented practice of offering rate discounts to consumers with credit scores above a certain threshold. Assume further that the consumer receiving the refinancing has a credit score below this threshold, and therefore would not normally qualify for the rate discount available to consumers with high credit scores. This creditor complies with § 1026.43(d)(4) by offering the consumer the discounted rate in connection with the refinancing made pursuant to § 1026.43(d), even if the consumer would not normally qualify for that discounted rate, provided that the offer of the discounted rate is not prohibited by applicable State or Federal law. However, § 1026.43(d)(4) does not require a creditor to offer a consumer such a discounted rate.

43(d)(5) Payment Calculations

Proposed § 226.43(d)(5) would have prescribed the payment calculations for determining whether the consumer's monthly payment for a standard mortgage will be “materially lower” than the monthly payment for the non-standard mortgage. Proposed § 226.43(d)(5) thus was intended to complement proposed § 226.43(d)(1)(ii) in implementing TILA section 129C(a)(6)(E), which requires a “reduction” in the monthly payment for the existing non-standard (“hybrid”) mortgage when refinanced into a standard mortgage.

43(d)(5)(i) Non-Standard mortgage

Proposed § 226.43(d)(5)(i) would have required that the monthly payment for a non-standard mortgage be based on substantially equal, monthly, fully amortizing payments of principal and interest that would result once the mortgage is recast. The Board stated that comparing the payment on the standard mortgage to the payment amount on which the consumer likely would have defaulted (i.e., the payment resulting on the existing non-standard mortgage once the introductory terms cease and a higher payment results) would promote needed refinances consistent with Congress's intent.

The Board noted that the payment that the consumer is currently making on the existing non-standard mortgage may be an inappropriately low payment to compare to the standard mortgage payment. The existing payments may be interest-only or negatively amortizing; these temporarily lower payment amounts would be difficult for creditors to “reduce” with a refinanced loan that has a comparable term length and principal amount. Indeed, the payment on a new loan with a fixed-rate rate and fully-amortizing payment, as is required for the payment calculation of a standard mortgage under the proposal, for example, is likely to be higher than the interest-only or negative amortization payment. As a result, few refinancings would yield a lower monthly payment, so many consumers could not receive the benefits of refinancing into a more stable loan product.

Accordingly, the proposal would have required a creditor to calculate the monthly payment for a non-standard mortgage using—

  • The fully indexed rate as of a reasonable period of time before or after the date on which the creditor receives the consumer's written application for the standard mortgage;
  • The term of the loan remaining as of the date of the recast, assuming all scheduled payments have been made up to the recast date and the payment due on the recast date is made and credited as of that date; and
  • A remaining loan amount that is—

○ For an adjustable-rate mortgage, the outstanding principal balance as of the date the mortgage is recast, assuming all scheduled payments have been made up to the recast date and the payment due on the recast date is made and credited as of that date;

○ For an interest-only loan, the loan amount, assuming all scheduled payments have been made up to the recast date and the payment due on the recast date is made and credited as of that date;

○ For a negative amortization loan, the maximum loan amount.

Proposed comment 43(d)(5)(i)-1 would have explained that, to determine whether the monthly periodic payment for a standard mortgage is materially lower than the monthly periodic payment for the non-standard mortgage under proposed § 226.43(d)(1)(ii), the creditor must consider the monthly payment for the non-standard mortgage that will result after the loan is recast, assuming substantially equal payments of principal and interest that amortize the remaining loan amount over the remaining term as of the date the mortgage is recast. The proposed comment noted that guidance regarding the meaning of “substantially equal” and “recast” is provided in comment 43(c)(5)(i)-4 and § 226.43(b)(11), respectively.

Proposed comment 43(d)(5)(i)-2 would have explained that the term “fully indexed rate” used for calculating the payment for a non-standard mortgage is generally defined in proposed § 226.43(b)(3) and associated commentary. The proposed comment explained an important difference between the “fully indexed rate” as defined in proposed § 226.43(b)(3), however, and the meaning of “fully indexed rate” in § 226.43(d)(5)(i). Specifically, under proposed § 226.43(b)(3), the fully indexed rate is calculated at the time of consummation. Under proposed § 226.43(d)(5)(i), the fully indexed rate would be calculated within a reasonable period of time before or after the date on which the creditor receives the consumer's written application for the standard mortgage. Comment 43(d)(5)(i)-2 clarified that 30 days would generally be considered a “reasonable period of time.”

Proposed comment 43(d)(5)(i)-3 would have clarified that the term “written application” is explained in comment 19(a)(1)(i)-3. Comment 19(a)(1)(i)-3 states that creditors may rely on RESPA and Regulation X (including any interpretations issued by HUD) in deciding whether a “written application” has been received. In general, Regulation X defines “application” to mean the submission of a borrower's financial information in anticipation of a credit decision relating to a federally related mortgage loan. See 12 CFR 1024.2(b). As explained in comment 19(a)(1)(i)-3, an application is received when it reaches the creditor in any of the ways applications are normally transmitted, such as by mail, hand delivery, or through an intermediary agent or broker. If an application reaches the creditor through an intermediary agent or broker, the application is received when it reaches the creditor, rather than when it reaches the agent or broker. This proposed comment also cross-referenced comment 19(b)-3 for guidance in determining whether the transaction involves an intermediary agent or broker.

Proposed payment calculation for an adjustable-rate mortgage with an introductory fixed rate. Proposed comments 43(d)(5)(i)-4 and -5 would have clarified the payment calculation for an adjustable-rate mortgage with an introductory fixed rate under proposed § 226.43(d)(5)(i). Proposed comment 43(d)(5)(i)-4 clarified that the monthly periodic payment for an adjustable-rate mortgage with an introductory fixed interest rate for a period of one or more years must be calculated based on several assumptions. First, the payment must be based on the outstanding principal balance as of the date on which the mortgage is recast, assuming all scheduled payments have been made up to that date and the last payment due under those terms is made and credited on that date. Second, the payment calculation must be based on substantially equal monthly payments of principal and interest that will fully repay the outstanding principal balance over the term of the loan remaining as of the date the loan is recast. Third, the payment must be based on the fully indexed rate, as defined in § 226.43(b)(3), as of the date of the written application for the standard mortgage. The proposed comment set forth an illustrative example. Proposed comment 43(d)(5)(i)-5 would have provided a second illustrative example of the payment calculation for an adjustable-rate mortgage with an introductory fixed rate.

Proposed payment calculation for an interest-only loan. Proposed comments 43(d)(5)(i)-6 and -7 would have explained the payment calculation for an interest-only loan under proposed § 226.43(d)(5)(i). Proposed comment 43(d)(5)(i)-6 would have clarified that the monthly periodic payment for an interest-only loan must be calculated based on several assumptions. First, the payment must be based on the loan amount, as defined in § 226.43(b)(5), assuming all scheduled payments are made under the terms of the legal obligation in effect before the mortgage is recast. The comment provides an example of a mortgage with a 30-year loan term for which the first 24 months of payments are interest-only. The comment then explains that, if the 24th payment is due on September 1, 2013, the creditor must calculate the outstanding principal balance as of September 1, 2013, assuming that all 24 payments under the interest-only payment terms have been made and credited.

Second, the payment calculation must be based on substantially equal monthly payments of principal and interest that will fully repay the loan amount over the term of the loan remaining as of the date the loan is recast. Thus, in the example above, the creditor must assume a loan term of 28 years (336 payments). Third, the payment must be based on the fully indexed rate as of the date of the written application for the standard mortgage.

Proposed comment 43(d)(5)(i)-7 would have provided an illustration of the payment calculation for an interest-only loan. The example assumes a loan in an amount of $200,000 that has a 30-year loan term. The loan agreement provides for a fixed interest rate of 7 percent, and permits interest-only payments for the first two years, after which time amortizing payments of principal and interest are required. Second, the example states that the non-standard mortgage is consummated on February 15, 2011, and the first monthly payment is due on April 1, 2011. The loan is recast on the due date of the 24th monthly payment, which is March 1, 2013. Finally, the example assumes that on March 15, 2012, the creditor receives the consumer's written application for a refinancing, after the consumer has made 12 monthly on-time payments.

Proposed comment 43(d)(5)(i)-7 would have further explained that, to calculate the non-standard mortgage payment that must be compared to the standard mortgage payment, the creditor must use—

  • The loan amount, which is the outstanding principal balance as of March 1, 2013, assuming all scheduled interest-only payments have been made and credited up to that date. In this example, the loan amount is $200,000.
  • An interest rate of 7 percent, which is the interest rate in effect at the time of consummation of this fixed-rate non-standard mortgage.
  • The remaining loan term as of March 1, 2013, the date of the recast, which is 28 years.

The comment concluded by stating that, based on the assumptions above, the monthly payment for the non-standard mortgage for purposes of determining whether the standard mortgage monthly payment is lower than the non-standard mortgage monthly payment is $1,359. This is the substantially equal, monthly payment of principal and interest required to repay the loan amount at the fully indexed rate over the remaining term.

Proposed payment calculation for a negative amortization loan. Proposed comments 43(d)(5)(i)-8 and -9 would have explained the payment calculation for a negative amortization loan under proposed § 226.43(d)(5)(i)(C). Proposed comment 43(d)(5)(i)-8 would have clarified that the monthly periodic payment for a negative amortization loan must be calculated based on several assumptions. First, the calculation must be based on the maximum loan amount. The comment further stated that examples of how to calculate the maximum loan amount are provided in proposed comment 43(b)(7)-3.

Second, the payment calculation must be based on substantially equal monthly payments of principal and interest that will fully repay the maximum loan amount over the term of the loan remaining as of the date the loan is recast. For example, the comment states, if the loan term is 30 years and the loan is recast on the due date of the 60th monthly payment, the creditor must assume a loan term of 25 years. Third, the payment must be based on the fully indexed rate as of the date of the written application for the standard mortgage.

Proposed comment 43(d)(5)(i)-9 would have provided an illustration of the payment calculation for a negative amortization loan. The example assumes a loan in an amount of $200,000 that has a 30-year loan term. The loan agreement provides that the consumer can make minimum monthly payments that cover only part of the interest accrued each month until the date on which the principal balance increases to the negative amortization cap of 115 percent of the loan amount, or for the first five years of monthly payments, whichever occurs first. The loan is an adjustable-rate mortgage that adjusts monthly according to a specified index plus a margin of 3.5 percent.

The example also assumed that the non-standard mortgage is consummated on February 15, 2011, and the first monthly payment is due on April 1, 2011. Further, the example assumes that, based on the calculation of the maximum loan amount required under § 226.43(b)(7) and associated commentary, the negative amortization cap of 115 percent is reached on July 1, 2013, the due date of the 28th monthly payment. Finally, the example assumes that on March 15, 2012, the creditor receives the consumer's written application for a refinancing, after the consumer has made 12 monthly on-time payments. On this date, the index value is 4.5 percent.

Proposed comment 43(d)(5)(i)-9 then stated that, to calculate the non-standard mortgage payment that must be compared to the standard mortgage payment under proposed § 226.43(d)(1)(ii), the creditor must use—

  • The maximum loan amount of $229,243 as of July 1, 2013.
  • The fully indexed rate of 8 percent, which is the index value of 4.5 percent as of March 15, 2012 (the date on which the creditor receives the application for a refinancing) plus the margin of 3.5 percent.
  • The remaining loan term as of July 1, 2013, the date of the recast, which is 27 years and 8 months (332 monthly payments).

The comment concluded by stating that, based on the assumptions above, the monthly payment for the non-standard mortgage for purposes of determining whether the standard mortgage monthly payment is lower than the non-standard mortgage monthly payment is $1,717. This is the substantially equal, monthly payment of principal and interest required to repay the maximum loan amount at the fully indexed rate over the remaining term.

The Board requested comment on the proposed payment calculation for a non-standard mortgage and on the appropriateness and usefulness of the proposed payment calculation examples.

The Bureau received no specific comment on the payment calculations for non-standard mortgages set forth in proposed § 226.43(d)(5)(i) and its associated commentary. Accordingly, the provision that is being adopted is substantially similar to the version proposed, renumbered as § 1026.43(d)(5)(i). The Bureau also is adopting the associated commentary generally as proposed. The Bureau has made several technical amendments to the examples in comments 43(d)(5)(i)-4, -5, -6, -7, and -9 for clarity. As proposed, the examples in the comment referred to dates prior to the effective date of this rule; the Bureau has updated the dates in the examples so that they will occur after this rule becomes effective.

The Bureau believes that it is necessary to clarify the provisions related to payment calculations for interest-only loans and negative amortization loans. The provisions adopted clarify that the payment calculation required by § 1026.43(d)(5)(i) must be based on the outstanding principal balance, rather than the original amount of credit extended. Accordingly, as adopted § 1026.43(d)(5)(i)(C)(2) requires the remaining loan amount for an interest-only loan to be based on the outstanding principal balance as of the date of the recast, assuming all scheduled payments have been made up to the recast date and the payment due on the recast date is made and credited as of that date. Similarly, § 1026.43(d)(5)(i)(C)(3) requires the remaining loan amount for a negative amortization loan to be based on the maximum loan amount, determined after adjusting for the outstanding principal balance. The Bureau has made technical amendments to the example in comments 43(d)(5)(i)-6, -7, -8, and -9 to conform to this clarification.

Additionally, the Bureau has added new comment 43(d)(5)(i)-10 to add an additional illustration of the payment calculation for a negative amortization loan. As adopted, comment 43(d)(5)(i)-10 provides an illustrative example, clarifying that, pursuant to the example and assumptions included in the example, to calculate the non-standard mortgage payment on a negative amortization loan for which the consumer has made more than the minimum required payment that must be compared to the standard mortgage payment under § 1026.43(d)(1)(i), the creditor must use the maximum loan amount of $229,219 as of March 1, 2019, the fully indexed rate of 8 percent, which is the index value of 4.5 percent as of March 15, 2012 (the date on which the creditor receives the application for a refinancing) plus the margin of 3.5 percent, and the remaining loan term as of March 1, 2019, the date of the recast, which is 25 years (300 monthly payments). The comment further explains that, based on these assumptions, the monthly payment for the non-standard mortgage for purposes of determining whether the standard mortgage monthly payment is lower than the non-standard mortgage monthly payment is $1,769. This is the substantially equal, monthly payment of principal and interest required to repay the maximum loan amount at the fully indexed rate over the remaining term. The Bureau finds that comment 43(d)(5)(i)-10, which is adopted pursuant to the Bureau's authority under section 105(a) of TILA, is necessary to facilitate compliance with TILA.

43(d)(5)(ii) Standard Mortgage

Proposed § 226.43(d)(5)(ii) would have prescribed the required calculation for the monthly payment on a standard mortgage that must be compared to the monthly payment on a non-standard mortgage under proposed § 226.43(d)(1)(ii). The same payment calculation must also be used by creditors of refinances under proposed § 226.43(d) in determining whether the consumer has a reasonable ability to repay the standard mortgage, as would have been required under proposed § 226.43(c)(2)(ii).

Specifically, the monthly payment for a standard mortgage must be based on substantially equal, monthly, fully amortizing payments using the maximum interest rate that may apply to the standard mortgage within the first five years after consummation. Proposed comment 43(d)(5)(ii)-1 would have clarified that the meaning of “fully amortizing payment” is defined in § 226.43(b)(2), and that guidance regarding the meaning of “substantially equal” may be found in proposed comment 43(c)(5)(i)-4. Proposed comment 43(d)(5)(ii)-1 also explained that, for a mortgage with a single, fixed rate for the first five years, the maximum rate that will apply during the first five years after consummation will be the rate at consummation. For a step-rate mortgage, however, which is a type of fixed-rate mortgage, the rate that must be used is the highest rate that will apply during the first five years after consummation. For example, if the rate for the first two years is 4 percent, the rate for the second two years is 5 percent, and the rate for the next two years is 6 percent, the rate that must be used is 6 percent.

Proposed comment 43(d)(5)(ii)-2 would have provided an illustration of the payment calculation for a standard mortgage. The example assumes a loan in an amount of $200,000 with a 30-year loan term. The loan agreement provides for an interest rate of 6 percent that is fixed for an initial period of five years, after which time the interest rate will adjust annually based on a specified index plus a margin of 3 percent, subject to a 2 percent annual interest rate adjustment cap. The comment states that, based on the above assumptions, the creditor must determine whether the standard mortgage payment is materially lower than the non-standard mortgage payment based on a standard mortgage payment of $1,199. This is the substantially equal, monthly payment of principal and interest required to repay $200,000 over 30 years at an interest rate of 6 percent.

The Bureau received no specific comment on the payment calculations for standard mortgages set forth in proposed § 226.43(d)(5)(ii) and its associated commentary. Accordingly, this provisions is adopted as proposed, renumbered as § 1026.43(d)(5)(ii). The Bureau also is adopting the associated commentary generally as proposed, with several technical amendments for clarity.

43(e) Qualified Mortgages

Background

As discussed above, TILA section 129C(a)(1) prohibits a creditor from making a residential mortgage loan unless the creditor makes a reasonable and good faith determination, at or before consummation, based on verified and documented information, that at the time of consummation the consumer has a reasonable ability to repay the loan. TILA section 129C(a)(1) through (4) and (6) through (9) requires creditors specifically to consider and verify various factors relating to the consumer's income and other assets, debts and other obligations, and credit history. However, the ability-to-repay provisions do not directly restrict features, term, or costs of the loan.

TILA section 129C(b), in contrast, provides that loans that meet certain requirements shall be deemed “qualified mortgages,” which are entitled to a presumption of compliance with the ability-to-repay requirements. The section sets forth a number of qualified mortgage requirements which focus mainly on prohibiting certain risky features and practices (such as negative amortization and interest-only periods or underwriting a loan without verifying the consumer's income) and on generally limiting points and fees in excess of 3 percent of the total loan amount. The only underwriting provisions in the statutory definition of qualified mortgage are a requirement that “income and financial resources relied upon to qualify the [borrowers] be verified and documented” and a further requirement that underwriting be based upon a fully amortizing schedule using the maximum rate permitted during the first five years of the loan. TILA section 129C(b)(2)(A)(iii) through (v). However, TILA section 129C(b)(2)(A)(vi) authorizes the Bureau to adopt “guidelines or regulations * * * relating to ratios of total monthly debt to monthly income or alternative measures of ability to pay * * * .” And TILA section 129C(b)(3)(B)(i) further authorizes the Bureau to revise, add to, or subtract from the criteria that define a qualified mortgage upon a finding that the changes are necessary or proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of TILA section 129C, necessary and appropriate to effectuate the purposes of TILA sections 129C and 129B, to prevent circumvention or evasion thereof, or to facilitate compliance with TILA sections 129C and 129B. [127]

The qualified mortgage requirements are critical to implementation of various parts of the Dodd-Frank Act. For example, several consumer protection requirements in title XIV of the Dodd-Frank Act treat qualified mortgages differently than non-qualified mortgages or key off elements of the qualified mortgage definition. [128] In addition, the requirements concerning retention of risk by parties involved in the securitization process under title IX of the Dodd-Frank Act provide special treatment for “qualified residential mortgages,” which under section 15G of the Securities Exchange Act of 1934, as amended by section 941(b) of the Dodd-Frank Act, “shall be no broader than the term `qualified mortgage,'” as defined by TILA section 129C(b) and the Bureau's implementing regulations. 15 U.S.C. 780-11(e)(4). [129]

For present purposes, however, the definition of a qualified mortgage is perhaps most significant because of its implications for ability-to-repay claims. TILA section 129C(b)(1) provides that “[a]ny creditor with respect to any residential mortgage loan, and any assignee of such loan subject to liability under this title, may presume that the loan has met the [ability-to-repay] requirements of subsection (a), if the loan is a qualified mortgage.” But the statute does not describe the strength of the presumption or what if anything could be used to rebut it. As discussed further below, there are legal and policy arguments that support interpreting the presumption as either rebuttable or conclusive.

Determining the definition and scope of protection afforded to qualified mortgages is the area of this rulemaking which has engendered perhaps the greatest interest and comment. Although TILA section 129C(a)(1) requires only that a creditor make a “reasonable and good faith determination” of the consumer's “reasonable ability to repay” a residential mortgage, considerable concern has arisen about the actual and perceived litigation and liability risk to creditors and assignees under the statute. Commenters tended to focus heavily on the choice between a presumption that is rebuttable and one that is conclusive as a means of mitigating that risk, although the criteria that define a qualified mortgage are also important because a creditor would have to prove status as a qualified mortgage in order to invoke any (rebuttable or conclusive) presumption of compliance.

In assessing the potential impacts of the statute, it is important to note that regulations issued after the mortgage crisis but prior to the enactment of the Dodd-Frank Act have already imposed ability-to-repay requirements for high-cost and higher-priced mortgages and created a presumption of compliance for such mortgages if the creditor satisfied certain underwriting and verification requirements. Specifically, under provisions of the Board's 2008 HOEPA Final Rule that took effect in October 2009, creditors are prohibited from extending high-cost or higher-priced mortgage loans without regard to the consumer's ability to repay. See§ 1026.34(a)(4). The rules provide a presumption of compliance with those ability-to-repay requirements if the creditor follows certain optional procedures regarding underwriting the loan payment, assessing the debt-to-income (DTI) ratio or residual income, and limiting the features of the loan, in addition to following certain procedures mandated for all creditors. See§ 1026.34(a)(4)(iii) and (iv) and comment 34(a)(4)(iii)-1. However, the 2008 HOEPA Final Rule makes clear that even if the creditor follows these criteria, the presumption of compliance is rebuttable. See comment 34(a)(4)(iii)-1. The consumer can still overcome that presumption by showing that, despite following the required and optional procedures, the creditor nonetheless disregarded the consumer's ability to repay the loan. For example, the consumer could present evidence that although the creditor assessed the consumer's debt-to-income ratio or residual income, the debt-to-income ratio was very high or the residual income was very low. This evidence may be sufficient to overcome the presumption of compliance and demonstrate that the creditor extended credit without regard to the consumer's ability to repay the loan.

The Dodd-Frank Act extends a requirement to assess consumers' ability to repay to the full mortgage market, and establishes a presumption using a different set of criteria that focus more on product features than underwriting practices. Further, the statute establishes similar but slightly different remedies than are available under the existing requirements. Section 1416 of the Dodd-Frank Act amended TILA section 130(a) to provide that a consumer who brings a timely action against a creditor for a violation the ability-to-repay requirements may be able to recover special statutory damages equal to the sum of all finance charges and fees paid by the consumer. The statute of limitations is three years from the date of the occurrence of the violation. Moreover, as amended by section 1413 of the Dodd-Frank Act, TILA section 130(k) provides that when a creditor, assignee, or other holder initiates a foreclosure action, a consumer may assert a violation of the ability-to-repay requirements as a matter of defense by recoupment or setoff. There is no time limit on the use of this defense, but the amount of recoupment or setoff is limited with respect to the special statutory damages to no more than three years of finance charges and fees. This limit on setoff is more restrictive than under the existing regulations, but also expressly applies to assignees.

In light of the statutory ambiguities, complex policy considerations, and concerns about litigation risk, the Board's proposal mapped out two alternatives at the opposite ends of a spectrum for defining a qualified mortgage and the protection afforded to such mortgages. At one end, the Board's Alternative 1 would have defined qualified mortgage only to include the mandated statutory elements listed in TILA section 129C(b)(2), most of which, as noted above, relate to product features and not to the underwriting decision or process itself. This alternative would have provided creditors with a safe harbor to establish compliance with the general repayment ability requirement in proposed § 226.43(c)(1). As the Board recognized, this would provide strong incentives for creditors to make qualified mortgages in order to minimize litigation risk and compliance burden under general ability-to-repay requirements, but might prevent consumers from seeking redress for failure to assess their ability to repay. In Alternative 2, the Board proposed a definition of qualified mortgage which incorporated both the statutory product feature restrictions and additional underwriting elements drawn from the general ability-to-repay requirements, as well as seeking comment on whether to establish a specific debt-to-income requirement. Alternative 2 also specified that consumers could rebut the presumption of compliance by demonstrating that a creditor did not adequately determine the consumers' ability to repay the loan. As the Board recognized, this would better ensure that creditors fully evaluate consumers' ability to repay qualified mortgages and preserve consumers' rights to seek redress. However, the Board expressed concern that Alternative 2 would provide little incentive to make qualified mortgages in the first place, given that the requirements may be challenging to satisfy and the strength of protection afforded would be minimal.

Overview of Final Rule

As noted above and discussed in greater detail in the section-by-section analysis below, the Dodd-Frank Act accords the Bureau significant discretion in defining the scope of, and legal protections afforded to, a qualified mortgage. In developing the rules for qualified mortgages, the Bureau has carefully considered numerous factors, including the Board's proposal to implement TILA section 129C(b), comments and ex parte communications, current regulations and the current state of the mortgage market, and the implications of the qualified mortgage rule on other parts of the Dodd-Frank Act. The Bureau is acutely aware of the problematic practices that gave rise to the financial crisis and sees the ability-to-pay requirement as an important bulwark to prevent a recurrence of those practices by establishing a floor for safe underwriting. At the same time, the Bureau is equally aware of the anxiety in the mortgage market today concerning the continued slow pace of recovery and the confluence of multiple major regulatory and capital initiatives. Although every industry representative that has communicated with the Bureau acknowledges the importance of assessing a consumer's ability to repay before extending a mortgage to the consumer—and no creditor claims to do otherwise—there is nonetheless a widespread fear about the litigation risks associated with the Dodd-Frank Act ability-to-repay requirements. Even community banks, deeply ingrained within their local communities and committed to a relationship lending model, have expressed to the Bureau their fear of litigation. In crafting the rules to implement the qualified mortgage provision, the Bureau has sought to balance creating new protections for consumers and new responsibilities for creditors with preserving consumers' access to credit and allowing for appropriate lending and innovation.

The Bureau recognizes both the need for certainty in the short term and the risk that actions taken by the Bureau in order to provide such certainty could, over time, defeat the prophylactic aims of the statute or impede recovery in various parts of the market. For instance, in defining the criteria for a qualified mortgage, the Bureau is called upon to identify a class of mortgages which can be presumed to be affordable. The boundaries must be clearly drawn so that consumers, creditors, and secondary market investors can all proceed with reasonable assurance as to whether a particular loan constitutes a qualified mortgage. Yet the Bureau believes that it is not possible by rule to define every instance in which a mortgage is affordable, and the Bureau fears that an overly broad definition of qualified mortgage could stigmatize non-qualified mortgages or leave insufficient liquidity for such loans. If the definition of qualified mortgage is so broad as to deter creditors from making non-qualified mortgages altogether, the regulation would curtail access to responsible credit for consumers and turn the Bureau's definition of a qualified mortgage into a straitjacket setting the outer boundary of credit availability. The Bureau does not believe such a result would be consistent with congressional intent or in the best interests of consumers or the market.

The Bureau is thus attuned to the problems of the past, the pressures that exist today, and the ways in which the market might return in the future. As a result, the Bureau has worked to establish guideposts in the final rule to make sure that the market's return is healthy and sustainable for the long-term. Within that framework, the Bureau is defining qualified mortgages to strike a clear and calibrated balance as follows:

First, the final rule provides meaningful protections for consumers while providing clarity to creditors about what they must do if they seek to invoke the qualified mortgage presumption of compliance. Accordingly, the qualified mortgage criteria include not only the minimum elements required by the statute—including prohibitions on risky loan features, a cap on points and fees, and special underwriting rules for adjustable-rate mortgages—but additional underwriting features to ensure that creditors do in fact evaluate individual consumers' ability to repay the qualified mortgages. The qualified mortgage criteria thus incorporate key elements of the verification requirements under the ability-to-repay standard and strengthen the consumer protections established by the ability-to-repay requirements.

In particular, the final rule provides a bright-line threshold for the consumer's total debt-to-income ratio, so that under a qualified mortgage, the consumer's total monthly debt payments cannot exceed 43 percent of the consumer's total monthly income. The bright-line threshold for debt-to-income serves multiple purposes. First, it protects consumer interests because debt-to-income ratios are a common and important tool for evaluating consumers' ability to repay their loans over time, and the 43 percent threshold has been utilized by the Federal Housing Administration (FHA) for many years as its general boundary for defining affordability. Relative to other benchmarks that are used in the market (such as GSE guidelines) that have a benchmark of 36 percent, before consideration of compensating factors, this threshold is a relatively liberal one which allows ample room for consumers to qualify for an affordable mortgage. Second, it provides a well-established and well-understood rule that will provide certainty for creditors and help to minimize the potential for disputes and costly litigation over whether a mortgage is a qualified mortgage. Third, it allows room for a vibrant market for non-qualified mortgages over time. The Bureau recognizes that there will be many instances in which individual consumers can afford an even higher debt-to-income ratio based on their particular circumstances, although the Bureau believes that such loans are better evaluated on an individual basis under the ability-to-repay criteria rather than with a blanket presumption. The Bureau also believes that there are a sufficient number of potential borrowers who can afford a mortgage that would bring their debt-to-income ratio above 43 percent that responsible creditors will continue to make such loans as they become more comfortable with the new regulatory framework. To preserve access to credit during the transition period, the Bureau has also adopted temporary measures as discussed further below.

The second major feature of the final rule is the provision of carefully calibrated presumptions of compliance afforded to different types of qualified mortgages. Following the approach developed by the Board in the existing ability-to-repay rules to distinguish between prime and subprime loans, the final rule distinguishes between two types of qualified mortgages based on the mortgage's Annual Percentage Rate (APR) relative to the Average Prime Offer Rate (APOR). [130] For loans that exceed APOR by a specified amount—loans denominated as “higher-priced mortgage loans”—the final rule provides a rebuttable presumption. In other words, the creditor is presumed to have satisfied the ability-to-repay requirements, but a consumer may rebut that presumption under carefully defined circumstances. [131] For all other loans, i.e., loans that are not “higher-priced,” the final rule provides a conclusive presumption that the creditor has satisfied the ability-to-repay requirements once the creditor proves that it has in fact made a qualified mortgage. In other words, the final rule provides a safe harbor from ability-to-repay challenges for the least risky type of qualified mortgages, while providing room to rebut the presumption for qualified mortgages whose pricing is indicative of a higher level of risk. [132] The Bureau believes that this calibration will further encourage creditors to extend credit responsibly and provide certainty that promotes access to credit.

The Bureau believes that loans that fall within the rebuttable presumption category will be loans made to consumers who are more likely to be vulnerable [133] so that, even if the loans satisfy the criteria for a qualified mortgage, those consumers should be provided the opportunity to prove that, in an individual case, the creditor did not have a reasonable belief that the loan would be affordable for that consumer. Under a qualified mortgage with a safe harbor, most of the loans within this category will be the loans made to prime borrowers who pose fewer risks. Furthermore, considering the difference in historical performance levels between prime and subprime loans, the Bureau believes that it is reasonable to presume conclusively that a creditor who has verified a consumer's debt and income, determined in accordance with specified standards that the consumer has a debt-to-income ratio that does not exceed 43 percent, and made a prime mortgage with the product features required for a qualified mortgage has satisfied its obligation to assess the consumer's ability to repay. This approach will provide significant certainty to creditors operating in the prime market. The approach will also create lesser but still important protection for creditors in the subprime market who follow the qualified mortgage rules, while preserving consumer remedies and creating strong incentives for more responsible lending in the part of the market in which the most abuses occurred prior to the financial crisis.

Third, the final rule provides a temporary special rule for certain qualified mortgages to provide a transition period to help ensure that sustainable credit will return in all parts of the market over time. The temporary special rule expands the definition of a qualified mortgage to include any loan that is eligible to be purchased, guaranteed, or insured by various Federal agencies or by the GSEs while they are operating under conservatorship. This temporary provision preserves access to credit in today's market by permitting a loan that does not satisfy the 43 percent debt-to-income ratio threshold to nonetheless be a qualified mortgage based upon an underwriting determination made pursuant to guidelines created by the GSEs while in conservatorship or one of the Federal agencies. This temporary provision will sunset in a maximum of seven years. As with loans that satisfy the 43 percent debt-to-income ratio threshold, qualified mortgages under this temporary rule will receive either a rebuttable or conclusive presumption of compliance depending upon the pricing of the loan relative to APOR. The Bureau believes this provision will provide sufficient consumer protection while providing adequate time for creditors to adjust to the new requirements of the final rule as well as to changes in other regulatory, capital, and economic conditions.

A detailed description of the qualified mortgage definition is set forth below. Section 1026.43(e)(1) provides the presumption of compliance provided to qualified mortgages. Section 1026.43(e)(2) provides the criteria for a qualified mortgage under the general definition, including the restrictions on certain product features, verification requirements, and a specified debt-to-income ratio threshold. Section 1026.43(e)(3) provides the limits on points and fees for qualified mortgages, including the limits for smaller loan amounts. Section 1026.43(e)(4) provides the temporary special rule for qualified mortgages. Lastly, § 1026.43(f) implements a statutory exemption permitting certain balloon-payment loans by creditors operating predominantly in rural or underserved areas to be qualified mortgages.

43(e)(1) Safe Harbor and Presumption of Compliance

As discussed above, the Dodd-Frank Act provides a presumption of compliance with the ability-to-repay requirements for qualified mortgages, but the statute is not clear as to whether that presumption is intended to be conclusive so as to create a safe harbor that cuts off litigation or a rebuttable presumption of compliance with the ability-to-repay requirements. The title of section 1412 refers to both a “safe harbor and rebuttable presumption,” and as discussed below there are references to both safe harbors and presumptions in other provisions of the statute. As the Board's proposal discussed, an analysis of the statutory construction and policy implications demonstrates that there are sound reasons for adopting either interpretation. See 76 FR 27390, 27452-55 (May 11, 2011).

Several aspects of the statutory structure favor a safe harbor interpretation. First, TILA section 129C(b)(1) states that a creditor or assignee may presume that a loan has “met the requirements of subsection (a), if the loan is a qualified mortgage.” TILA section 129C(a) contains the general ability-to repay requirement, and also a set of specific underwriting criteria that must be considered by a creditor in assessing the consumer's repayment ability. Rather than stating that the presumption of compliance applies only to TILA section 129C(a)(1) for the general ability-to-repay requirements, it appears Congress intended creditors who make qualified mortgages to be presumed to comply with both the ability-to-repay requirements and all of the specific underwriting criteria. Second, TILA section 129C(b)(2) does not define a qualified mortgage as requiring compliance with all of the underwriting criteria of the general ability-to-repay standard. Therefore, unlike the approach found in the 2008 HOEPA Final Rule, it appears that meeting the criteria for a qualified mortgage is an alternative way of establishing compliance with all of the ability-to-repay requirements, which could suggest that meeting the qualified mortgage criteria conclusively satisfies these requirements. In other words, given that a qualified mortgage satisfies the ability-to-repay requirements, one could assume that meeting the qualified mortgage definition conclusively establishes compliance with those requirements.

In addition, TILA section 129C(b)(3)(B), which provides the Bureau authority to revise, add to, or subtract from the qualified mortgage criteria upon making certain findings, is titled “Revision of Safe Harbor Criteria.” Further, in section 1421 of the Dodd-Frank Act, Congress instructed the Government Accountability Office to issue a study on the effect “on the mortgage market for mortgages that are not within the safe harbor provided in the amendments made by this subtitle.”

Certain policy considerations also favor a safe harbor. Treating a qualified mortgage as a safe harbor provides greater legal certainty for creditors and secondary market participants than a rebuttable presumption of compliance. Increased legal certainty may benefit consumers if as a result creditors are encouraged to make loans that satisfy the qualified mortgage criteria, as such loans cannot have certain risky features and have a cap on upfront costs. Furthermore, increased certainty may result in loans with a lower cost than would be charged in a world of legal uncertainty. Thus, a safe harbor may also allow creditors to provide consumers additional or more affordable access to credit by reducing their expected total litigation costs.

On the other hand, there are also several aspects of the statutory structure that favor interpreting qualified mortgage as creating a rebuttable presumption of compliance. With respect to statutory construction, TILA section 129C(b)(1) states that a creditor or assignee “may presume” that a loan has met the repayment ability requirement if the loan is a qualified mortgage. As the Board's proposal notes, this could suggest that originating a qualified mortgage provides a presumption of compliance with the repayment ability requirements, which the consumer can rebut with evidence that the creditor did not, in fact, make a good faith and reasonable determination of the consumer's ability to repay the loan. Similarly, in the smaller loans provisions in TILA section 129C(b)(2)(D), Congress instructed the Bureau to adjust the points and fees cap for qualified mortgages “to permit lenders that extend smaller loans to meet the requirements of the presumption of compliance” in TILA section 129C(b)(1). [134] As noted above, the 2008 HOEPA Final Rule also contains a rebuttable presumption of compliance with respect to the ability-to-repay requirements that currently apply to high-cost and higher-priced mortgages.

The legislative history of the Dodd-Frank Act may also favor interpreting “qualified mortgage” as a rebuttable presumption of compliance. As described in a joint comment letter from several consumer advocacy groups, a prior version of Dodd-Frank Act title XIV from 2007 contemplated a dual track for liability in litigation: a rebuttable presumption for creditors and a safe harbor for secondary market participants. [135] That draft legislation would have provided that creditors, assignees, and securitizers could presume compliance with the ability-to-repay provision if the loan met certain requirements. [136] However, the presumption of compliance would have been rebuttable only against the creditor, effectively creating a safe harbor for assignees and securitizers. [137] The caption “safe harbor and rebuttable presumption” appears to have originated from the 2007 version of the legislation. The 2009 version of the legislation did not contain this dual track approach. [138] Instead, the language simply stated that creditors, assignees, and securitizers “may presume” that qualified mortgages satisfied ability-to-repay requirements, without specifying the nature of the presumption. [139] The committee report of the 2009 bill described the provision as establishing a “limited safe harbor” for qualified mortgages, while also stating that “the presumption can be rebutted.” [140] This suggests that Congress contemplated that qualified mortgages would receive a rebuttable presumption of compliance with the ability-to-repay provisions, notwithstanding Congress's use of the term “safe harbor” in the heading of section 129C(b) and elsewhere in the statute and legislative history.

There are also policy reasons that favor interpreting “qualified mortgage” as a rebuttable presumption of compliance. The ultimate aim of the statutory provisions is to assure that, before making a mortgage loan, the creditor makes a determination of the consumer's ability to repay. No matter how many elements the Bureau might add to the definition of qualified mortgage, it still would not be possible to define a class of loans which ensured that every consumer within the class could necessarily afford a particular loan. In light of this, interpreting the statute to provide a safe harbor that precludes a consumer from challenging the creditor's determination of repayment ability seems to raise tensions with the requirement to determine repayment ability. In contrast, interpreting a qualified mortgage as providing a rebuttable presumption of compliance would better ensure that creditors consider each consumer's ability to repay the loan rather than only satisfying the qualified mortgage criteria.

The Board's Proposal

As described above, in light of the statutory ambiguity and competing policy considerations, the Board proposed two alternative definitions for a qualified mortgage, which generally represent two ends of the spectrum of possible definitions. Alternative 1 would have applied only the specific requirements listed for qualified mortgages in TILA section 129C(b)(2), and would have provided creditors with a safe harbor to establish compliance with the general repayment ability requirement in proposed § 226.43(c)(1). Alternative 2 would have required a qualified mortgage to satisfy the specific requirements listed in the TILA section 129C(b)(2), as well as additional requirements taken from the general ability-to-repay standard in proposed § 226.43(c)(2) through (7). Alternative 2 would have provided a rebuttable presumption of compliance with the ability-to-repay requirements. Although the Board specifically proposed two alternative qualified mortgage definitions, it also sought comment on other approaches by soliciting comment on other alternative definitions. The Board also specifically solicited comment on what criteria should be included in the definition of a qualified mortgage to ensure that the definition provides an incentive to creditors to make qualified mortgages, while also ensuring that consumers have the ability to repay those loans. In particular, the Board sought comment on whether the qualified mortgage definition should require consideration of a consumer's debt-to-income ratio or residual income, including whether and how to include a quantitative standard for the debt-to-income ratio or residual income for the qualified mortgage definition.

Comments

Generally, numerous industry and other commenters, including some members of Congress, supported a legal safe harbor while consumer groups and other commenters, including an association of State bank regulators, supported a rebuttable presumption. However, as described below, commenters did not necessarily support the two alternative proposals specifically as drafted by the Board. For instance, a significant number of industry commenters advocated incorporating the general ability-to-repay requirements into the qualified mortgage definition, while providing a safe harbor for those loans that met the enhanced standards. And a coalition of industry and consumer advocates presented a proposal to the Bureau that would have provided a tiered approach to defining a qualified mortgage. Under the first tier, if the consumer's back-end debt-to-income (total debt-to-income) ratio is 43 percent or less, the loan would be a qualified mortgage, and no other tests would be required. Under the second tier, if the consumer's total debt-to-income ratio is more than 43 percent, the creditor would apply a series of tests related to the consumer's front-end debt-to-income ratio (housing debt-to-income), stability of income and past payment history, availability of reserves, and residual income to determine if a loan is a qualified mortgage.

Comments in favor of safe harbor. Industry commenters strongly supported a legal safe harbor from liability for qualified mortgages. These commenters believe that a broad safe harbor with clear, bright lines would provide certainty and clarity for creditors and assignees. Generally, industry commenters argued that a safe harbor is needed in order: (i) To ensure creditors make loans, (ii) to ensure the availability of and access to affordable credit without increasing the costs of borrowing; (iii) to promote certainty and saleability in the secondary market, and (iv) to contain litigation risk and costs for creditors and assignees.

Generally, although acknowledging ambiguities in the statutory language, industry commenters argued that the statute's intent and legislative history indicate that qualified mortgages are meant to be a legal safe harbor, in lieu of the ability-to-repay standards. Industry commenters argued that a safe harbor would best ensure safe, well-documented, and properly underwritten loans without limiting the availability of credit or increasing the costs of credit to consumers. Many industry commenters asserted that a legal safe harbor from liability would ensure access to affordable credit. Other industry commenters argued that a safe harbor ultimately benefits consumers with increased access to credit, reduced loan fees and interest rates, and less-risky loan features. In contrast, various industry commenters contended that a rebuttable presumption would not provide enough certainty for creditors and the secondary market. Commenters argued that if creditors cannot easily ascertain whether a loan satisfies the ability-to-repay requirements, creditors will either not make loans or will pass the cost of uncertain legal risk to consumers, which in turn would increase the cost of borrowing.

Numerous industry commenters argued for a legal safe harbor because of the liabilities of an ability-to-repay violation and the costs associated with ability-to-repay litigation. Generally, commenters argued that a rebuttable presumption for qualified mortgages would invite more extensive litigation than necessary that will result in greater costs being borne by all consumers. Commenters emphasized the relatively severe penalties for ability-to-repay violations under the Dodd-Frank Act, including enhanced damages, an extended three-year statute of limitations, a recoupment or set-off provision as a defense to foreclosure, and new enforcement authorities by State attorneys general. In addition, assignee liabilities are amplified because of the recoupment and set-off provision in TILA section 130(k). Commenters asserted that the increased costs associated with litigation could make compliance too costly for smaller creditors, which would reduce competition and credit availability from the market. In particular, community bank trade association commenters argued that the Bureau should adopt a safe harbor for qualified mortgage loans and include bright-line requirements to protect community banks from litigation and ease the compliance burden. Ultimately, community bank trade association commenters stated that few, if any, banks would risk providing a mortgage that only has a rebuttable presumption attached.

Industry commenters generally believed that a rebuttable presumption would increase the incidence of litigation because any consumer who defaults on a loan would be likely to sue for recoupment in foreclosure. Commenters were also concerned about frivolous challenges in court as well as heightened scrutiny by regulators. In particular, a credit union association commenter supported a safe harbor because of concerns that a rebuttable presumption would cause credit unions to be faced with significant amounts of frivolous foreclosure defense litigation in the future. In addition to increased incidence of litigation, industry commenters and other interested parties argued that the estimated costs of litigation under a rebuttable presumption would be overly burdensome for creditors and assignees. Some commenters and interested parties presented estimates of the litigation costs associated with claims alleging a violation of the ability-to-repay requirements. For example, one industry trade association commenter estimated that the attorney's fees for a claim involving a qualified mortgage under a safe harbor would cost $30,000, compared to $50,000 for a claim under a rebuttable presumption. That commenter provided a separate estimation from a law firm that the attorneys' fees to the creditor will be approximately $26,000 in cases where the matter is disposed of on a motion to dismiss, whereas the fees for the cost of a full trial could reach $155,000. That commenter asserted that safe harbor claims are more likely to be dismissed on a motion to dismiss than the rebuttable presumption.

An industry commenter and other interested parties argued that the estimated costs to creditors associated with litigation and penalties for an ability-to-repay violation could be substantial and provided illustrations of costs under the proposal, noting potential cost estimates of the possible statutory damages and attorney's fees. For example, the total estimated costs and damages ranged between approximately $70,000 and $110,000 depending on various assumptions, such as the interest rate on a loan or whether the presumption of compliance is conclusive or rebuttable.

Industry commenters also generally argued that a safe harbor would promote access to credit because creditors would be more willing to extend credit where they receive protections under the statutory scheme. One industry trade association commenter cited the 2008 HOEPA Final Rule, which provided a rebuttable presumption of compliance with the requirement to consider a consumer's repayment ability upon meeting certain criteria, as causing a significant drop in higher-priced mortgage loan originations, and suggested that access to general mortgage credit would be similarly restricted if the final rule adopts a rebuttable presumption for the market as a whole. A large bank commenter similarly noted the lack of lending in the higher-priced mortgage space since the 2008 HOEPA Final Rule took effect.

In addition to the liquidity constraints for non-qualified mortgages, commenters argued that the liability and damages from a potential ability-to-repay TILA violation would be a disincentive for a majority of creditors to make non-qualified mortgage loans. Further, some commenters suggested that creditors could face reputational risk from making non-qualified mortgage loans because consumers would view them as “inferior” to qualified mortgages. Other commenters argued that reducing the protections afforded to qualified mortgages could cause creditors to act more conservatively and restrict credit or result in the denial of credit at a higher rate and increase the cost of credit. Many commenters argued that the most serious effects and impacts on the availability and cost of credit would be for minority, low- to moderate-income, and first-time borrowers. Therefore, industry commenters believed that a bright-line safe harbor would provide the strongest incentive for creditors to provide sustainable mortgage credit to the widest array of qualified consumers. Furthermore, one industry trade association commenter argued that not providing strong incentives for creditors would diminish the possibility of recovery of the housing market and the nation's economy.

Industry commenters also expressed concerns regarding secondary market considerations and assignee liability. Commenters urged the Bureau to consider commercial litigation costs associated with the contractually required repurchase (“put-back”) of loans sold on the secondary market where there is litigation over those loans, as well as the risk of extended foreclosure timelines because of ongoing ability-to-repay litigation. Industry commenters asserted that a safe harbor is critical to promote saleability of loans in the secondary market. In particular, they stated that clarity and certainty provided by a safe harbor would promote efficiencies in the secondary market because investors in securitized residential mortgage loans (mortgage backed securities, or MBS) could be more certain that they are not purchasing compliance risk along with their investments. Commenters asserted that without a safe harbor, the resulting uncertainty would eliminate the efficiencies provided by secondary sale or securitization of loans. By extension, commenters claimed that the cost of borrowing for consumers would ultimately increase. Large bank commenters stated that although they might originate non-qualified mortgage loans, the number would be relatively small and held in portfolio because they believe it is unlikely that non-qualified mortgage loans will be saleable in the secondary market. Generally, industry commenters asserted that creditors, regardless of size, would be unwilling to risk exposure outside the qualified mortgage space. One large bank commenter stated that the 2008 HOEPA Final Rule did not create a defense to foreclosure against assignees for the life of the loan, as does the Dodd-Frank Act's ability-to-repay provisions. Accordingly, industry commenters strongly supported broad coverage of qualified mortgages, as noted above.

Commenters asserted that the secondary market will demand a “safe harbor” for quality assurance and risk avoidance. If the regulatory framework does not provide a safe harbor, commenters asserted that investors would require creditors to agree to additional, strict representations and warranties when assigning loans. Contracts between loan originators and secondary market purchasers often require originators to repurchase loans should a loan perform poorly, and these commenters expect that future contracts will include provisions related to the ability-to-repay rule. Commenters assert that the risks and costs associated with additional potential put-backs to the creditor would increase liability and risk to creditors, which would ultimately increase the cost of credit to consumers. Furthermore, commenters contended that if the rule is too onerous in its application to the secondary market, then the secondary market participants may purchase fewer loans or increase pricing to account for the additional risk, such as is now the case for high-cost mortgages.

Commenters noted that the risks associated with assignee liability are heightened by any vagueness in standards in the rule. One secondary market purchaser commenter argued that a rebuttable presumption would present challenges because purchasers (or assignees) are not part of the origination process. It is not feasible for purchasers to evaluate all of the considerations that went into an underwriting decision, so they must rely on the creditor's representations that the loan was originated in compliance with applicable laws and the purchaser's requirements. However, assignees may have to defend a creditor's underwriting decision at any time during the life of the loan because there is no statute of limitations on raising the failure to make an ability-to-repay determination as a defense to foreclosure. The commenters argued that defending these cases would be difficult and costly, and that such burdens would be reduced by safe harbor protections.

Comments in favor of rebuttable presumption of compliance. Consumer group commenters generally urged the Bureau to adopt a rebuttable presumption for qualified mortgages. Commenters argued that Congress intended a rebuttable presumption, not a safe harbor. In particular, commenters contended that the Dodd-Frank Act's legislative history and statutory text strongly support a rebuttable presumption. Commenters noted that the statute is designed to strike a fair balance between market incentives and market discipline, as well as a balance between consumers' legal rights and excessive exposure to litigation risk for creditors. Commenters asserted that the purpose of the qualified mortgage designation is to foster sustainable lending products and practices built upon sound product design and sensible underwriting. To that end, a rebuttable presumption would accomplish the goal of encouraging creditors to originate loans that meet the qualified mortgage definition while assuring consumers of significantly greater protection from abusive or ineffective underwriting than if a safe harbor were adopted. Consumer group commenters contended that qualified mortgages can earn and deserve the trust of both consumers and investors only if they carry the assurance that they are soundly designed and properly underwritten. Many consumer group commenters asserted that a rebuttable presumption would provide better protections for consumers as well as improving safeguards against widespread risky lending while helping ensure that there would be no shortcuts on common sense underwriting. They argued that a legal safe harbor could invite abusive lending because consumers will have no legal recourse. Several commenters also asserted that no qualified mortgage definition could cover all contingencies in which such abuses could occur.

Some commenters argued that a legal safe harbor would leave consumers unprotected against abuses, such as those associated with simultaneous liens or from inadequate consideration of employment and income. An association of State bank regulators favored a rebuttable presumption because, although a rebuttable presumption provides less legal protection than a safe harbor, a rebuttable presumption encourages institutions to consider repayment factors that are part of a sound underwriting process. That commenter contended that a creditor should not be granted blanket protection from a foreclosure defense of an ability-to-repay violation if the creditor failed to consider and verify such crucial information as a consumer's employment status and credit history, for example. On this point, the rebuttable presumption proposed by the Board would require creditors to make individualized determinations that the consumer has the ability to repay the loan based on all of the underwriting factors listed in the general ability-to-repay standard.

Consumer group commenters observed that a rebuttable presumption would better ensure that creditors actually consider a consumer's ability to repay the loan. Consumer group commenters also asserted that the goals of safe, sound, sustainable mortgage lending and a balanced system of accountability are best served by a rebuttable presumption because consumers should be able to put evidence before a court that the creditor's consideration and verification of the consumer's ability to repay the loan was unreasonable or in bad faith. To that end, a rebuttable presumption would allow the consumer to assert that, despite complying with the criteria for a qualified mortgage and the ability-to-repay standard, the creditor did not make a reasonable and good faith determination of the consumer's ability to repay the loan. Without this accountability, commenters argued that the Dodd-Frank Act's effectiveness would be undermined.

Ultimately, consumer group commenters believed that a rebuttable presumption would not exacerbate current issues with credit access and availability, but would instead allow room for honest, efficient competition and affordable credit. Consumer group commenters generally contended that the fear of litigation and estimated costs and risks associated with ability-to-repay violations are overstated and based on misunderstanding of the extent of exposure to TILA liability. Consumer group commenters and some ex parte communications asserted that the potential incidence of litigation is relatively small, and therefore liability cost and risk are minimal for any given mortgage creditor. For example, consumer group commenters asserted that there are significant practical limitations to consumers bringing an ability-to-repay claim, suggesting that few distressed homeowners would be able to obtain legal representation often necessary to mount a successful rebuttal in litigation. Consumer groups provided percentages of borrowers in foreclosure who are represented by lawyers, noting the difficulty of bringing a TILA violation claim, and addressed estimates of litigation costs, such as attorneys' fees. Consumer groups provided estimates of the number of cases in foreclosure and the percentage of cases that involve TILA claims, such as a claim of rescission.

Furthermore, consumer group commenters argued that the three-year cap on enhanced damages (equal to the sum if all finance charges and fees paid by the consumer within three years of consummation) for violation of the ability-to-repay requirements limits litigation risk significantly. Commenters contended that, as a general rule, a court is more likely to find that the ability-to-repay determination at consummation was not reasonable and in good faith the earlier in the process a default occurs, and at that point the amount of interest paid by a consumer (a component of enhanced damages) will be relatively small. Commenters argued that the longer it takes a consumer to default, the harder the burden it will be for the consumer to show that the default was reasonably predictable at consummation and was caused by improper underwriting rather than a subsequent income or expense shock; moreover, even if the consumer can surmount that burden, the amount of damages is still capped at three years' worth of paid interest. In addition, consumer group commenters contended that the penalties to which creditors could be subject on a finding of failure to meet the ability-to-repay requirements would not be so injurious or even so likely to be applied in all but the most egregious situations as to impose any meaningful risk upon creditors.

Moreover, many consumer group commenters observed that creditors that comply with the rules and ensure that their loan originators are using sound, well documented and verified underwriting will be adequately protected by a rebuttable presumption.

Final Rule

As described above, the presumption afforded to qualified mortgages in the final rule balances consumers' ability to invoke the protections of the Dodd-Frank Act scheme with the need to create sufficient certainty to promote access to credit in all parts of the market. Specifically, the final rule provides a safe harbor with the ability-to-repay requirements for loans that meet the qualified mortgage criteria and pose the least risk, while providing a rebuttable presumption for “higher-priced” mortgage loans, defined as having an APR that exceeds APOR by 1.5 percentage points for first liens and 3.5 percentage points for second liens. [141] The final rule also specifically defines the grounds on which the presumption accorded to more expensive qualified mortgages can be rebutted. In issuing this final rule, the Bureau has drawn on the experiences from the current ability-to-repay provisions that apply to higher-priced mortgages, described above. Based on the difference in historical performance levels between prime and subprime loans, the Bureau believes that this approach will provide significant certainty to creditors while preserving consumer remedies and creating strong incentives for more responsible lending in the part of the market in which the most abuses occurred prior to the financial crisis.

In issuing this final rule, the Bureau carefully considered the comments received and the interpretive and policy considerations for providing qualified mortgages either a safe harbor or rebuttable presumption of compliance with the repayment ability requirements. For the reasons set forth by the Board and discussed above, the Bureau finds that the statutory language is ambiguous and does not mandate a particular approach. In adopting the final rule, the Bureau accordingly focused on which interpretation would best promote the various policy goals of the statute, taking into account the Bureau's authority, among other things, to make adjustments and exceptions necessary or proper to effectuate the purposes of TILA, as amended by the Dodd-Frank Act.

Discouraging unsafe underwriting. As described in part II above, the ability-to-repay provisions of the Dodd-Frank Act were codified in response to lax lending terms and practices in the mid-2000's, which led to increased foreclosures, particularly for subprime borrowers. The statutory underwriting requirements for a qualified mortgage—for example, the requirement that loans be underwritten on a fully amortized basis using the maximum interest rate during the first five years and not a teaser rate, and the requirement to consider and verify a consumer's income or assets—will help prevent a return to such lax lending. So, too, will the requirement that a consumer's debt-to-income ratio (including mortgage-related obligations and obligations on simultaneous second liens) not exceed 43 percent, as discussed further below.

Notwithstanding these requirements, however, the Bureau recognizes that it is not possible to define by a bright-line rule a class of mortgages as to which it will always be the case that each individual consumer has the ability to repay his or her loan. That is especially true with respect to subprime loans. In many cases, the pricing of a subprime loan is the result of loan level price adjustments established by the secondary market and calibrated to default risk. Furthermore, the subprime segment of the market is comprised of borrowers who tend to be less sophisticated and who have fewer options available to them, and thus are more susceptible to being victimized by predatory lending practices. The historical performance of subprime loans bears all this out. [142] The Bureau concludes, therefore, that for subprime loans there is reason to impose heightened standards to protect consumers and otherwise promote the policies of the statute. Accordingly, the Bureau believes that it is important to afford consumers the opportunity to rebut the presumption of compliance that applies to qualified mortgages with regard to higher-priced mortgages by showing that, in fact, the creditor did not have a good faith and reasonable belief in the consumer's reasonable ability to repay the loan at the time the loan was made.

These same considerations lead to the opposite result with respect to prime loans which satisfy the requirements for a qualified mortgage. The fact that a consumer receives a prime rate is itself indicative of the absence of any indicia that would warrant a loan level price adjustment, and thus is suggestive of the consumer's ability to repay. Historically, prime rate loans have performed significantly better than subprime rate loans and the prime segment of the market has been subject to fewer abuses. [143] Moreover, requiring creditors to prove that they have satisfied the qualified mortgage requirements in order to invoke the presumption of compliance will itself ensure that the loans in question do not contain certain risky features and are underwritten with careful attention to consumers' debt-to-income ratios. Accordingly, the Bureau believes that where a loan is not a higher-priced covered transaction and meets both the product and underwriting requirements for a qualified mortgage, there are sufficient grounds for concluding that the creditor had a reasonable and good faith belief in the consumer's ability to repay to warrant a safe harbor.

This approach carefully balances the likelihood of consumers needing redress with the potential benefits to both consumers and industry of reducing uncertainty concerning the new regime. To the extent that the rule reduces litigation risk concerns for prime qualified mortgages, consumers in the prime market may benefit from enhanced competition (although, as discussed below, the Bureau believes litigation costs will be small and manageable for almost all creditors). In particular, the Bureau believes that larger creditors may expand correspondent lending relationships with smaller banks with respect to prime qualified mortgages. Larger creditors may also relax currently restrictive credit overlays (creditor-created underwriting requirements that go beyond GSE or agency guidelines), thereby increasing access to credit.

Scope of rebuttable presumption. In light of the heightened protections for subprime loans, the final rule also carefully defines the grounds on which the presumption that applies to higher-priced qualified mortgages can be rebutted. The Bureau believes that this feature is critical to ensuring that creditors have sufficient incentives to provide higher-priced qualified mortgages to consumers. Given the historical record of abuses in the subprime market, the Bureau believes it is particularly important to ensure that consumers are able to access qualified mortgages in light of their product feature restrictions and other protections.

Specifically, the final rule defines the standard by which a consumer may rebut the presumption of compliance afforded to higher-priced qualified mortgages, and provides an example of how a consumer may rebut the presumption. As described below, the final rule provides that consumers may rebut the presumption with regard to a higher-priced covered transaction by showing that, at the time the loan was originated, the consumer's income and debt obligations left insufficient residual income or assets to meet living expenses. The analysis would consider the consumer's monthly payments on the loan, mortgage-related obligations, and any simultaneous loans of which the creditor was aware, as well as any recurring, material living expenses of which the creditor was aware.

The Bureau believes the rebuttal standard in the final rule appropriately balances the consumer protection and access to credit considerations described above. This standard is consistent with the standard in the 2008 HOEPA Final Rule, and is specified as the exclusive means of rebutting the presumption. Commentary to the existing rule provides as an example of how its presumption may be rebutted that the consumer could show “a very high debt-to-income ratio and a very limited residual income.” Under the definition of qualified mortgage that the Bureau is adopting, however, the creditor generally is not entitled to a presumption if the debt-to-income ratio is “very high.” As a result, the Bureau is focusing the standard for rebutting the presumption in the final rule on whether, despite meeting a debt-to-income test, the consumer nonetheless had insufficient residual income to cover the consumer's living expenses. The Bureau believes this standard is sufficiently broad to provide consumers a reasonable opportunity to demonstrate that the creditor did not have a good faith and reasonable belief in the consumer's repayment ability, despite meeting the prerequisites of a qualified mortgage. At the same time, the Bureau believes the rebuttal standard in the final rule is sufficiently clear to provide certainty to creditors, investors, and regulators about the standards by which the presumption can successfully be challenged in cases where creditors have correctly followed the qualified mortgage requirements.

Several commenters raised concerns about the use of oral evidence to impeach the information contained in the loan file. For example, a consumer may seek to show that a loan does not meet the requirements of a qualified mortgage by relying on information provided orally to the creditor or loan originator to establish that the debt-to-income ratio was miscalculated. Alternatively, a consumer may seek to show that the creditor should have known, based upon facts disclosed orally to the creditor or loan originator, that the consumer had insufficient residual income to be able to afford the mortgage. The final rule does not preclude the use of such oral evidence in ability-to-repay cases. The Bureau believes that courts will determine the weight to be given to such evidence on a case-by-case basis. To exclude such evidence across the board would invite abuses in which consumers could be misled or coerced by an unscrupulous loan originator into keeping certain facts out of the written record.

Litigation risks and access to credit. In light of the continuing and widespread concern about litigation risk under the Dodd-Frank Act regime, the Bureau, in the course of developing the framework described above, carefully analyzed the impacts of potential litigation on non-qualified mortgages, any qualified mortgages with a rebuttable presumption, and any qualified mortgages with a safe harbor. The Bureau also considered secondary market dynamics, including the potential impacts on creditors from loans that the secondary market “puts back” on the originators because of ability-to-repay litigation. The Bureau's analysis is described in detail in the section 1022(b)(2) analysis under part VII; the results of that analysis helped to shape the calibrated approach that the Bureau is adopting in the final rule and suggest that the mortgage market will be able to absorb litigation risks under the rule without jeopardizing access to credit.

Specifically, as discussed in the section 1022(b)(2) analysis under part VII, the Bureau believes that even without the benefit of any presumption of compliance, the actual increase in costs from the litigation risk associated with ability-to-pay requirements would be quite modest. This is a function of the relatively small number of potential claims, the relatively small size of those claims, and the relatively low likelihood of claims being filed and successfully prosecuted. The Bureau notes that litigation likely would arise only when a consumer in fact was unable to repay the loan (i.e. was seriously delinquent or had defaulted), and even then only if the consumer elects to assert a claim and is able to secure a lawyer to provide representation; the consumer can prevail only upon proving that the creditor lacked a reasonable and good faith belief in the consumer's ability to repay at consummation or failed to consider the statutory factors in arriving at that belief.

The rebuttable presumption of compliance being afforded to qualified mortgages that are higher-priced reduces the litigation risk, and hence the potential transaction costs, still further. As described above, the Bureau has crafted the presumption of compliance being afforded to subprime loans so that it is not materially different than the presumption that exists today under the 2008 HOEPA Final Rule. Indeed, the Bureau is defining with more particularity the requirements for rebutting this presumption. No evidence has been presented to the Bureau to suggest that the presumption under the 2008 HOEPA Final Rule has led to significant litigation or to any distortions in the market for higher-priced mortgages. As noted above, commenters noted the lack of lending in the higher-priced mortgage space since the 2008 HOEPA Final Rule took effect, but the Bureau is unaware of evidence suggesting the low lending levels are the result of the Board's rule, as compared to the general state of the economy, uncertainty over multiple regulatory and capital initiatives, and other factors.

Relative to the Dodd-Frank Act, the Bureau notes that the existing regime already provides for attorneys' fees and the same remedies against creditors in affirmative cases, and actually provides for greater remedies against creditors in foreclosure defense situations. Nevertheless, the incidence of claims under the existing ability-to-repay rules for high-cost and higher-priced loans and analogous State laws is relatively low. The Bureau's analysis shows that cost estimates remain modest for both loans that are not qualified mortgages and loans that are qualified mortgages with a rebuttable presumption of compliance, and even more so for qualified mortgages with a safe harbor.

The Bureau recognizes, of course, that under the Dodd-Frank Act ability-to-repay provisions, a consumer can assert a claim against an assignee as a “defense by recoupment or set off” in a foreclosure action. There is no time limit on the use of this defense, but the consumer cannot recover as special statutory damages more than three years of finance charges and fees. To the extent this leads to increased litigation potential with respect to qualified mortgages as to which the presumption of compliance is rebuttable, this may cause creditors to take greater care when underwriting these riskier products to avoid potential put-back risk from investors. The Bureau believes that this is precisely what Congress intended—to create incentives for creditors to engage in sound underwriting and for secondary market investors to monitor the quality of the loans they buy—and that these incentives are particularly warranted with respect to the subprime market.

At the same time, the Bureau does not believe that the potential assignee liability with respect to higher-priced qualified mortgages will preclude such loans from being sold on the secondary market. Specifically, in analyzing impacts on the secondary market the Bureau notes that investors are purchasing higher-priced mortgage loans that are subject to the existing ability-to-repay requirements and presumption of compliance and that the GSEs have already incorporated into their contracts with creditors a representation and warranty designed to provide investor protection in the event of an ability-to-repay violation. The Bureau agrees with industry and secondary market participant commenters that investors will likely require creditors to agree to similar representations and warranties when assigning or selling loans under the new rule because secondary market participants will not want to be held accountable for ability-to-repay compliance which investors will view as the responsibility of the creditor. For prime loans, this may represent an incremental risk of put-back to creditors, given that such loans are not subject to the current regime, but those loans are being provided a safe harbor if they are qualified mortgages. For subprime (higher risk) loans it is not clear that there is any incremental risk beyond that which exists today under the Board's rule. There are also some administrative costs associated with such “put-backs” (e.g., costs associated with the process of putting back loans from the issuer or insurer or servicer on behalf of the securitization trust to the creditor as a result of the ability-to-repay claims), but those costs are unlikely to be material for qualified mortgages subject to the rebuttable presumption and will not affect either the pricing of the loans or the availability of a secondary market for these loans.

In sum, the Bureau has crafted the calibrated presumptions to ensure that these litigation and secondary market impacts do not jeopardize access to credit. With regard to subprime loans, there is some possibility that creditors who are less sophisticated or less able to bear any litigation risk may elect to refrain from engaging in subprime lending, but as discussed below, the Bureau believes that there are sufficient creditors with the capabilities of making responsible subprime loans so as to avoid significant adverse impact on credit availability in that market.

Specific provisions. For the reasons discussed above, in § 1026.43(e)(1), the Bureau is providing a safe harbor and rebuttable presumption with the ability-to-repay requirements for loans that meet the definition of a qualified mortgage. As explained in comment 43(e)(1)-1, § 1026.43(c) requires a creditor to make a reasonable and good faith determination at or before consummation that a consumer will be able to repay a covered transaction. Section 1026.43(e)(1)(i) and (ii) provide a safe harbor and rebuttable presumption of compliance, respectively, with the repayment ability requirements of § 1026.43(c) for creditors and assignees of covered transactions that satisfy the requirements of a qualified mortgage under § 1026.43(e)(2), (e)(4), or (f).

Section 1026.43(e)(1)(i) provides a safe harbor for qualified mortgages that are not higher-priced covered transactions, by stating that a creditor or assignee of a qualified mortgage as defined in § 1026.43(e)(2), (e)(4), or (f) that is not a higher-priced covered transaction, as defined in § 1026.43(b)(4), complies with the repayment ability requirements of § 1026.43(c). Comment 43(e)(1)(i)-1 clarifies that, to qualify for the safe harbor in § 1026.43(e)(1)(i), a covered transaction must meet the requirements of a qualified mortgage in § 1026.43(e)(2), (e)(4), or (f) and must not be a higher-priced covered transaction, as defined in § 1026.43(b)(4).

For qualified mortgages that are higher-priced covered transactions, § 1026.43(e)(1)(ii)(A) provides a rebuttable presumption of compliance with the repayment ability requirements. That section provides that a creditor or assignee of a qualified mortgage as defined in § 1026.43(e)(2), (e)(4), or (f) that is a higher-priced covered transaction, as defined § 1026.43(b)(4), is presumed to comply with the repayment ability requirements of § 1026.43(c). Section 1026.43(e)(1)(ii)(B) provides that to rebut the presumption of compliance, it must be proven that, despite meeting the requirements of § 1026.43(e)(2), (e)(4), or (f), the creditor did not make a reasonable and good faith determination of the consumer's repayment ability at the time of consummation, by showing that the consumer's income, debt obligations, alimony, child support, and the consumer's monthly payment (including mortgage-related obligations) on the covered transaction and on any simultaneous loans of which the creditor was aware at consummation would leave the consumer with insufficient residual income or assets other than the value of the dwelling (including any real property attached to the dwelling) that secures the loan with which to meet living expenses, including any recurring and material non-debt obligations of which the creditor was aware at the time of consummation.

Comment 43(e)(1)(ii)-1 clarifies that a creditor or assignee of a qualified mortgage under § 1026.43(e)(2), (e)(4), or (f) that is a higher-priced covered transaction is presumed to comply with the repayment ability requirements of § 1026.43(c). To rebut the presumption, it must be proven that, despite meeting the standards for a qualified mortgage (including either the debt-to-income standard in § 1026.43(e)(2)(vi) or the standards of one of the entities specified in § 1026.43(e)(4)(ii)), the creditor did not have a reasonable and good faith belief in the consumer's repayment ability. To rebut the presumption, it must be proven that, despite meeting the standards for a qualified mortgage (including either the debt-to-income standard in § 1026.43(e)(2)(vi) or the standards of one of the entities specified in § 1026.43(e)(4)(ii)), the creditor did not have a reasonable and good faith belief in the consumer's repayment ability. Specifically, it must be proven that, at the time of consummation, based on the information available to the creditor, the consumer's income, debt obligations, alimony, child support, and the consumer's monthly payment (including mortgage-related obligations) on the covered transaction and on any simultaneous loans of which the creditor was aware at consummation would leave the consumer with insufficient residual income or assets other than the value of the dwelling (including any real property attached to the dwelling) that secures the loan with which to meet living expenses, including any recurring and material non-debt obligations of which the creditor was aware at the time of consummation, and that the creditor thereby did not make a reasonable and good faith determination of the consumer's repayment ability. The comment also provides, by way of example, that a consumer may rebut the presumption with evidence demonstrating that the consumer's residual income was insufficient to meet living expenses, such as food, clothing, gasoline, and health care, including the payment of recurring medical expenses of which the creditor was aware at the time of consummation, and after taking into account the consumer's assets other than the value of the dwelling securing the loan, such as a savings account. In addition, the longer the period of time that the consumer has demonstrated actual ability to repay the loan by making timely payments, without modification or accommodation, after consummation or, for an adjustable-rate mortgage, after recast, the less likely the consumer will be able to rebut the presumption based on insufficient residual income and prove that, at the time the loan was made, the creditor failed to make a reasonable and good faith determination that the consumer had the reasonable ability to repay the loan.

As noted above, the Bureau believes that the statutory language regarding whether qualified mortgages receive either a safe harbor or rebuttable presumption of compliance is ambiguous, and does not plainly mandate one approach over the other. Furthermore, the Bureau has the authority to tailor the strength of the presumption of compliance based on the characteristics associated with the different types of qualified mortgages. Accordingly, the Bureau interprets TILA section 129C(b)(1) to create a rebuttable presumption, but exercises its adjustment authority under TILA section 105(a) to limit the ability to rebut the presumption in two ways, because an open-ended rebuttable presumption would unduly restrict access to credit without a corresponding benefit to consumers.

First, the Bureau uses its adjustment authority under section 105(a) to limit the ability to rebut the presumption to insufficient residual income or assets other than the dwelling that secures the transaction because the Bureau believes exercise of this authority is necessary and proper to facilitate compliance with and to effectuate a purpose of section 129 and TILA. The Bureau believes this approach, while preserving consumer remedies, provides clear standards to creditors and courts regarding the basis upon which the presumption of compliance that applies to higher-priced covered transactions may be rebutted, thereby enhancing creditor certainty and encouraging lending in the higher-priced mortgage market. The Bureau finds this approach is necessary and proper to ensure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans, a purpose of section 129 and TILA.

Second, with respect to prime loans (loans with an APR that does not exceed APOR by 1.5 percentage points for first liens and 3.5 percentage points for second liens), the Bureau also uses its adjustment authority under TILA section 105(a) to provide a conclusive presumption (e.g., a safe harbor). Under the conclusive presumption, if a prime loan satisfies the criteria for being a qualified mortgage, the loan will be deemed to satisfy section 129C's ability-to-repay criteria and will not be subject to rebuttal based on residual income or otherwise. The Bureau finds that this approach balances the competing consumer protection and access to credit considerations described above. As discussed above, the Bureau will not extend the safe harbor to higher-priced loans because that approach would provide insufficient protection to consumers in loans with higher interest rates who may require greater protection than consumers in prime rate loans. On the other hand, an approach that provided a rebuttable presumption of compliance for all qualified mortgages (including prime loans which historically have a low default rate) could lead creditors to make fewer mortgage loans to certain consumers, which could restrict access to credit (or unduly raise the cost of credit) without a corresponding benefit to consumers. The Bureau finds that this adjustment providing a safe harbor for prime loans is necessary and proper to facilitate compliance with and to effectuate the purposes of section 129C and TILA, including to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans. [144]

43(e)(2) Qualified Mortgage Defined—General

As discussed above, TILA section 129C(b)(2) defines the requirements for qualified mortgages to limit certain loan terms and features. The statute generally prohibits a qualified mortgage from permitting an increase of the principal balance on the loan (negative amortization), interest-only payments, balloon payments (except for certain balloon-payment qualified mortgages pursuant to TILA section 129C(b)(2)(E)), a term greater than 30 years, or points and fees that exceed a specified threshold.

In addition, the statute incorporates limited underwriting criteria that overlap with some elements of the general ability-to-repay standard. Specifically, the statutory definition of qualified mortgage requires the creditor to (1) verify and document the income and financial resources relied upon to qualify the obligors on the loan; and (2) underwrite the loan based on a fully amortizing payment schedule and the maximum interest rate during the first five years, taking into account all applicable taxes, insurance, and assessments. As noted above, these requirements appear to be focused primarily on ensuring that certain mortgage products—no-documentation loans and loans underwritten based only on a consumer's ability to make payments during short introductory periods with low “teaser” interest rates—are not eligible to be qualified mortgages.

In addition to these limited underwriting criteria, the statute also authorizes the Bureau to establish additional criteria relating to ratios of total monthly debt to monthly income or alternative measures of ability to pay regular expenses after payment of total monthly debt, taking into account the income levels of the consumer and other factors the Bureau determines relevant and consistent with the purposes described in TILA section 129C(b)(3)(B)(i). To the extent the Bureau incorporates a debt-to-income or residual income requirement into the qualified mortgage definition, several additional elements of the general ability-to-repay standard would effectively also be incorporated into the qualified mortgage definition, since debt-to-income and residual income analyses by their nature require assessment of income, debt (including simultaneous loans), and mortgage-related obligations. As discussed above, the Board proposed two alternatives to implement the qualified mortgage elements. Both alternatives under the Board's proposal would have incorporated the statutory elements of a qualified mortgage (e.g., product feature and loan term restrictions, limits on points and fees, payment calculation requirements, and the requirement to consider and verify the consumer's income or assets). However, Alternative 2 also included the additional factors in the general ability-to-repay standard.

Comments

Qualified mortgage definition. As an initial matter, the majority of commenters generally favored defining qualified mortgages to reach a broad portion of the overall market and to provide clarity with regard to the required elements. Commenters agreed that clarity promotes the benefits of creditors lending with confidence and consumers receiving loans that comply with the basic requirements of an affordable loan. In addition, commenters generally agreed that a qualified mortgage should be broad, encompassing the vast majority of the existing mortgage market. Numerous commenters indicated that creditors believed that the difference between the legal protections afforded (or risks associated with) qualified mortgages and non-qualified mortgages would result in very little lending outside of qualified mortgages. Commenters asserted that a narrowly defined qualified mortgage would leave loans outside the legal protections of qualified mortgages and would result in constrained credit or increased cost of credit.

As discussed in the section-by-section analysis of § 1026.43(e)(1), commenters did not necessarily support the two alternatives specifically as proposed by the Board, but suggested variations on the definition of qualified mortgage that contain some or all of the Board's proposed criteria, or additional criteria not specifically included in either of the Board's proposed alternatives. For example, as described below, a coalition of industry and consumer advocates suggested a tiered approach to defining qualified mortgage, based primarily on meeting a specific back-end debt-to-income requirement, with alternative means of satisfying the qualified mortgage definition (such as housing debt-to-income, reserves, and residual income) if the back-end debt-to-income test is not satisfied. Similarly, one industry commenter suggested using a weighted approach to defining qualified mortgage, which would weight some underwriting factors more heavily than others and permit a significant factor in one area to compensate for a weak or missing factor in another area.

Consumer group commenters and some industry commenters generally supported excluding from the definition of qualified mortgage certain risky loan features which result in “payment shock,” such as negative amortization or interest-only features. Consumer group commenters also supported limiting qualified mortgages to a 30-year term, as required by statute. Consumer group commenters and one industry trade association strongly supported requiring creditors to consider and verify the all the ability-to-repay requirements. These commenters contended that the ability-to-repay requirements represent prudent mortgage underwriting techniques and are essential to sustainable lending. To that point, these commenters argued that qualified mortgage loans should represent the best underwritten and most fully documented loans, which would justify some form of protection from future liability. In addition, several consumer group commenters suggested adding a further requirement that when assessing the consumer's income and determining whether the consumer will be able to meet the monthly payments, a creditor must also take into account other recurring but non-debt related expenses. These commenters argued that many consumers, and especially low- and moderate-income consumers, face significant monthly recurring expenses, such as medical care or prescriptions and child care expense needed to enable the borrower or co-borrower to work outside the home. These commenters further argued that even where the percentage of disposable income in such situations seems reasonable, the nominal amounts left to low- and moderate-income consumers may be insufficient to enable such households to reasonably meet all their obligations. While one consumer group commenter specifically supported the inclusion of a consumer's credit history as an appropriate factor for a creditor to consider and verify when underwriting a loan, several commenters argued that the consumer's credit history should be not included in the ability-to-repay requirements because, although credit history may be relevant in prudent underwriting, it involves a multitude of factors that need to be taken into consideration. In addition, one association of State bank regulators also favored consideration of the repayment factors that are part of a sound underwriting process.

As noted above, some industry commenters also generally supported including the underwriting requirements as proposed in Alternative 2, with some adjustments, so long as the resulting qualified mortgage was entitled to a safe harbor. These commenters stated that most creditors today are already complying with the full ability-to-repay underwriting standards, and strong standards will help them resist competitive forces to lower underwriting standards in the future. Other industry commenters argued that the qualified mortgage criteria should not exclude specific loan products because the result will be that such products will be unavailable in the market.

Some commenters generally supported aligning the definition of qualified mortgage with the definition proposed by several Federal agencies to define “qualified residential mortgages” (QRM) for purposes of the risk retention requirements in title IX of the Dodd-Frank Act. For example, one commenter suggested that the required payment calculation for qualified mortgages be consistent with the QRM proposed requirement that the payment calculation be based on the maximum rate in the first five years after the first full payment required. An association of reverse mortgage lenders requested that a “qualified” reverse mortgage be defined to ensure that the Federal agencies finalizing the QRM rule are able to make a proprietary reverse mortgage a QRM, which would be exempt from the risk retention requirements. Lastly, numerous consumer group commenters argued that high-cost mortgages be excluded from being a qualified mortgage.

Quantitative standards. Some industry commenters supported including quantitative standards for such variables as debt-to-income ratios and credit score with compensating factors in the qualified mortgage definition. These commenters contended that quantitative standards provide certainty and would help ensure creditworthy consumers have access to qualified mortgage loans. One consumer group commenter argued that, without specific quantitative standards, bank examiners and assignees would have no benchmarks against which to measure a creditor's compliance or safety and soundness. One industry commenter favored quantitative standards such as a maximum back-end debt-to-income ratio because that would provide sufficient certainty to creditors and investors. One consumer group commenter supported including quantitative standards for the debt-to-income ratio because, without this, every loan would be open to debate as to whether the consumer had the ability to repay at the time of loan consummation.

As described further below, certain commenters and interested parties requested that the Bureau adopt a specific debt-to-income ratio requirement for qualified mortgages. For example, some suggested that if a consumer's total debt-to-income ratio is below a specified threshold, the mortgage loan should satisfy the qualified mortgage requirements, assuming other relevant conditions are met. In addition to a debt-to-income requirement, some commenters and interested parties suggested that the Bureau should include within the definition of a “qualified mortgage” loans with a debt-to-income ratio above a certain threshold if the consumer has a certain amount of assets, such as money in a savings or similar account, or a certain amount of residual income.

Some industry commenters advocated against including quantitative standards for such variables as debt-to-income ratios and residual income. Those commenters argued that underwriting a loan involves weighing a variety of factors, and creditors and investors should be allowed to exercise discretion and weigh risks for each individual loan. To that point, one industry trade group commenter argued that community banks, for example, generally have conservative requirements for a consumer's debt-to-income ratio, especially for loans that are held in portfolio by the bank, and consider many factors when underwriting mortgage loans, such as payment history, liquid reserves, and other assets. Because several factors are considered and evaluated in the underwriting process, this commenter asserted that community banks can be flexible when underwriting mortgage loans and provide arrangements for certain consumers that fall outside of the normal debt-to-income ratio for a certain loan. This commenter contended that strict quantitative standards would inhibit community banks' relationship lending and ability to use their sound judgment in the lending process. Some commenters contended that requiring specific quantitative standards could restrict credit access and availability for consumers.

Generally, industry commenters and some consumer group commenters believed compensating factors are beneficial in underwriting and should be permitted. These commenters generally believe compensating factors should be incorporated into the qualified mortgage criteria, such as in circumstances when a specified debt-to-income ratio threshold was exceeded. In their view, lending is an individualized decision and compensating factors can, for example, mitigate a consumer's high debt-to-income ratio or low residual income. One industry trade group commenter argued that the inclusion of compensating factors would allow for a broader underwriting approach and should include family history, repayment history, potential income growth, and inter-family transactions. One association of State bank regulators suggested that the rule provide guidance on mitigating factors for creditors to consider when operating outside of standard parameters. For example, creditors lending outside of typical debt-to-income standards can rely upon other assets or the fact that a consumer has a high income. Other industry commenters argued that the rule should provide for enough flexibility to allow for common-sense underwriting and avoid rigid limits or formulas that would exclude consumers on the basis of one or a few underwriting factors.

Another commenter stated that the rule should not set thresholds or limits on repayment ability factors. Instead, the rule should allow the creditor to consider the required factors and be held to a good faith standard. Such a rule permits individualized determinations to be made based on each consumer, local markets, and the risk tolerance of each creditor.

Final Rule

Section 1026.43(e)(2) of the final rule contains the general qualified mortgage definition. As set forth below, the final rule defines qualified mortgages under § 1026.43(e)(2) as loans that satisfy all of the qualified mortgage criteria required by the statute (including underwriting to the maximum interest rate during the first five years of the loan and consideration and verification of the consumer's income or assets), for which the creditor considers and verifies the consumer's current debt obligations, alimony, and child support, and that have a total (“back-end”) monthly debt-to-income ratio of no greater than 43 percent, following the standards for “debt” and “income” set forth in appendix Q.

While the general definition of qualified mortgage in § 1026.43(e)(2) contains all of the statutory qualified mortgage elements, it does not separately incorporate all of the general ability-to-repay underwriting requirements that would have been part of the qualified mortgage definition under the Board's proposed Alternative 2. In particular, the definition of qualified mortgage in § 1026.43(e)(2) does not specifically require consideration of the consumer's employment status, monthly payment on the covered transaction (other than the requirement to underwrite the loan to the maximum rate in the first five years), monthly payment on any simultaneous loans, or the consumer's credit history, which are part of the general ability-to-repay analysis under § 1026.43(c)(2). Instead, most of these requirements are incorporated into the standards for determining “debt” and “income” pursuant to § 1026.43(e)(2)(vi)(A) and (B), to which the creditor must look to determine if the loan meets the 43 percent debt-to-income ratio threshold as required in § 1026.43(e)(2)(vi). In particular, that calculation will require the creditor to verify, among other things, the consumer's employment status (to determine current or expected income) and the monthly payment on the covered transaction (including mortgage-related obligations) and on any simultaneous loans that the creditor knows or has reason to know will be made. In addition, although consideration and verification of a consumer's credit history is not specifically incorporated into the qualified mortgage definition, creditors must verify a consumer's debt obligations using reasonably reliable third-party records, which may include use of a credit report or records that evidence nontraditional credit references. See section-by-section analysis of § 1026.43(e)(2)(v) and (c)(3).

The final rule adopts this approach because the Bureau believes that the statute is fundamentally about assuring that the mortgage credit consumers receive is affordable. Qualified mortgages are intended to be mortgages as to which it can be presumed that the creditor made a reasonable determination of the consumer's ability to repay. Such a presumption would not be reasonable—indeed would be imprudent—if a creditor made a mortgage loan without considering and verifying core aspects of the consumer's individual financial picture, such as income or assets and debt. Incorporating these ability-to-repay underwriting requirements into the qualified mortgage definition thus ensures that creditors assess the consumer's repayment ability for a qualified mortgage using robust and appropriate underwriting procedures. The specific requirements for a qualified mortgage under § 1026.43(e)(2) are described below.

The Bureau notes that the final rule does not define a “qualified” reverse mortgage. As described above, TILA section 129C(a)(8) excludes reverse mortgages from the repayment ability requirements. See section-by-section analysis of § 1026.43(a)(3)(i). However, TILA section 129C(b)(2)(ix) provides that the term “qualified mortgage” may include a “residential mortgage loan” that is “a reverse mortgage which meets the standards for a qualified mortgage, as set by the Bureau in rules that are consistent with the purposes of this subsection.” The Board's proposal did not include reverse mortgages in the definition of a “qualified mortgage.” Because reverse mortgages are exempt from the ability-to-repay requirements, the effects of defining a reverse mortgage as a “qualified mortgage” would be, for example, to allow for certain otherwise banned prepayment penalties and permit reverse mortgages to be QRMs under the Dodd-Frank Act's risk retention rules. The Bureau believes that the first effect is contrary to the purposes of the statute. With respect to the QRM rulemaking, the Bureau will continue to coordinate with the Federal agencies finalizing the QRM rulemaking to determine the appropriate treatment of reverse mortgages.

43(e)(2)(i)

TILA section 129C(b)(2)(A)(i) states that the regular periodic payments of a qualified mortgage may not result in an increase of the principal balance or allow the consumer to defer repayment of principal (except for certain balloon-payment loans made by creditors operating predominantly in rural or underserved areas, discussed below in the section-by-section analysis of § 1026.43(f)). TILA section 129C(b)(2)(A)(ii) states that the terms of a qualified mortgage may not include a balloon payment (subject to an exception for creditors operating predominantly in rural or underserved areas). The statute defines “balloon payment” as “a scheduled payment that is more than twice as large as the average of earlier scheduled payments.” TILA section 129C(b)(2)(A)(ii).

The Board's proposed § 226.43(e)(2)(i) would have implemented TILA sections 129C(b)(2)(A)(i) and (ii). First, the proposed provision would have required that a qualified mortgage provide for regular periodic payments. Second, proposed § 226.43(e)(2)(i) would have provided that the regular periodic payments may not (1) result in an increase of the principal balance; (2) allow the consumer to defer repayment of principal, except as provided in proposed § 226.43(f); or (3) result in a balloon payment, as defined in proposed § 226.18(s)(5)(i), except as provided in proposed § 226.43(f).

Proposed comment 43(e)(2)(i)-1 would have explained that, as a consequence of the foregoing requirements, a qualified mortgage must require the consumer to make payments of principal and interest, on a monthly or other periodic basis, that will fully repay the loan amount over the loan term. These periodic payments must be substantially equal except for the effect that any interest rate change after consummation has on the payment amount in the case of an adjustable-rate or step-rate mortgage. The proposed comment would have also provided that, because proposed § 226.43(e)(2)(i) would have required that a qualified mortgage provide for regular, periodic payments, a single-payment transaction may not be a qualified mortgage. This comment would have clarified a potential evasion of the regulation, as a creditor otherwise could structure a transaction with a single payment due at maturity that technically would not be a balloon payment as defined in proposed § 226.18(s)(5)(i) because it is not more than two times a regular periodic payment.

Proposed comment 43(e)(2)(i)-2 would have provided additional guidance on the requirement in proposed § 226.43(e)(2)(i)(B) that a qualified mortgage may not allow the consumer to defer repayment of principal. The comment would have clarified that, in addition to interest-only terms, deferred principal repayment also occurs if the payment is applied to both accrued interest and principal but the consumer makes periodic payments that are less than the amount that would be required under a payment schedule that has substantially equal payments that fully repay the loan amount over the loan term. Graduated payment mortgages, for example, allow deferral of principal repayment in this manner and therefore may not be qualified mortgages.

As noted above, the Dodd-Frank Act defines “balloon payment” as “a scheduled payment that is more than twice as large as the average of earlier scheduled payments.” However, proposed § 226.43(e)(2)(i)(C) would have cross-referenced Regulation Z's existing definition of “balloon payment” in § 226.18(s)(5)(i), which provides that a balloon payment is “a payment that is more than two times a regular periodic payment.” The Board noted that this definition is substantially similar to the statutory one, except that it uses as its benchmark any regular periodic payment rather than the average of earlier scheduled payments. The Board explained that the difference in wording between the statutory definition and the existing regulatory definition does not yield a significant difference in what constitutes a “balloon payment” in the qualified mortgage context. Specifically, the Board stated its belief that because a qualified mortgage generally must provide for substantially equal, fully amortizing payments of principal and interest, a payment that is greater than twice any one of a loan's regular periodic payments also generally will be greater than twice the average of its earlier scheduled payments.

Accordingly, to facilitate compliance, the Board proposed to cross-reference the existing definition of “balloon payment.” The Board proposed this adjustment to the statutory definition pursuant to its authority under TILA section 105(a) to make such adjustments for all or any class of transactions as in the judgment of the Board are necessary or proper to facilitate compliance with TILA. The Board stated that this approach is further supported by its authority under TILA section 129B(e) to condition terms, acts or practices relating to residential mortgage loans that the Board finds necessary or proper to facilitate compliance.

Finally, in the preamble to the Board's proposal, the Board noted that some balloon-payment loans are renewable at maturity and that such loans might appropriately be eligible to be qualified mortgages, provided the terms for renewal eliminate the risk of the consumer facing a large, unaffordable payment obligation, which underlies the rationale for generally excluding balloon-payment loans from the definition of qualified mortgages. If the consumer is protected by the terms of the transaction from that risk, the Board stated that such a transaction might appropriately be treated as though it effectively is not a balloon-payment loan even if it is technically structured as one. The Board solicited comment on whether it should include an exception providing that, notwithstanding proposed § 226.43(e)(2)(i)(C), a qualified mortgage may provide for a balloon payment if the creditor is unconditionally obligated to renew the loan at the consumer's option (or is obligated to renew subject to conditions within the consumer's control). The Board sought comment on how such an exception should be structured to ensure that the large-payment risk ordinarily accompanying a balloon-payment loan is fully eliminated by the renewal terms and on how such an exception might be structured to avoid the potential for circumvention.

As discussed above, commenters generally supported excluding from the definition of qualified mortgage certain risky loan features which result in “payment shock,” such as negative amortization or interest-only features. Commenters generally recognized such features as significant contributors to the recent housing crisis. Industry commenters noted that such restrictions are objective criteria which creditors can conclusively demonstrate were met at the time of origination. However, one mortgage company asserted that such limitations should not apply in loss mitigation transactions, such as loan modifications and extensions, or to loan assumptions. That commenter noted that while negative amortization is not common in most loan modification programs, the feature can be used at times to help consumers work through default situations. The commenter also noted that deferral of payments, including principal payments, and balloon payment structures are commonly used to relieve payment default burdens. One bank commenter argued that the rule should permit qualified mortgages to have balloon payment features if the creditor is unconditionally obligated to renew the loan at the consumer's option, or is obligated to renew subject to conditions within the consumer's control.

For the reasons discussed in the proposed rule, the Bureau is adopting § 226.43(e)(2)(i) as proposed in renumbered § 1026.43(e)(2)(i), with certain clarifying changes. In particular, in addition to the proposed language, section 1026.43(e)(2)(i) specifies that a qualified mortgage is a covered transaction that provides for regular periodic payments that are substantially equal, “except for the effect that any interest rate change after consummation has on the payment in the case of an adjustable-rate or step-rate mortgage.” This language appeared in the commentary to § 226.43(e)(2)(i) in the proposed rule, but to provide clarity, the Bureau is adopting this language in the text of § 1026.43(e)(2)(i) in the final rule.

Notably, the Bureau is adopting in § 1026.43(e)(2)(i) the proposed cross-reference to the existing Regulation Z definition of balloon payment. Like the Board, the Bureau finds that the statutory definition and the existing regulatory definition do not yield a significant difference in what constitutes a “balloon payment” in the qualified mortgage context. Accordingly, the Bureau makes this adjustment pursuant to its authority under TILA section 105(a) because the Bureau believes that affording creditors a single definition of balloon payment within Regulation Z is necessary and proper to facilitate compliance with and effectuate the purposes of TILA.

In addition, like the proposal, the final rule does not provide exceptions from the prohibition on qualified mortgages providing for balloon payments, other than the exception for creditors operating predominantly in rural or underserved areas, described below in the section-by-section analysis of § 1026.43(f). The Bureau believes that it is appropriate to implement the rule consistent with statutory intent, which specifies only a narrow exception from this general rule for creditors operating predominantly in rural or underserved areas rather than a broader exception to the general prohibition on qualified mortgages containing balloon payment features. With respect to renewable balloon-payment loans, the Bureau does not believe that the risk that a consumer will face a significant payment shock from the balloon feature can be fully eliminated, and that a rule that attempts to provide such special treatment for renewable balloon-payment loans would be subject to abuse.

43(e)(2)(ii)

TILA section 129C(b)(2)(A)(viii) requires that a qualified mortgage must not provide for a loan term that exceeds 30 years, “except as such term may be extended under paragraph (3), such as in high-cost areas.” As discussed above, TILA section 129C(b)(3)(B)(i) authorizes the Bureau to revise, add to, or subtract from the qualified mortgage criteria if the Bureau makes certain findings, including that such revision is necessary or proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of TILA section 129C(b) or necessary and appropriate to effectuate the purposes of section 129C.

Proposed § 226.43(e)(2)(ii) would have implemented the 30-year maximum loan term requirement in the statute without exception. The preamble to the proposed rule explains that, based on available information, the Board believed that mortgage loans with terms greater than 30 years are rare and, when made, generally are for the convenience of consumers who could qualify for a loan with a 30-year term but prefer to spread out their payments further. Therefore, the Board believed such an exception is generally unnecessary. The Board solicited comment on whether there are any “high-cost areas” in which loan terms in excess of 30 years are necessary to ensure that responsible, affordable credit is available and, if so, how they should be identified for purposes of such an exception. The Board also sought comment on whether any other exceptions would be appropriate, consistent with the Board's authority in TILA section 129C(b)(3)(B)(i).

As noted above, commenters generally supported the 30-year term limitation. One commenter suggested the final rule should clarify that a loan term that is slightly longer than 30 years because of the due date of the first regular payment nevertheless meets the 30-year term requirement. One trade association commenter suggested that creditors be provided flexibility to originate 40-year loans in order to accommodate consumers in regions of the country where housing prices are especially high, but did not provide any information regarding the historic performance of 40-year loans or discuss how the Bureau should define high-cost areas in a way that avoids abuse. An association of State bank regulators also suggested that the rule permit loan terms beyond 30 years in high-cost areas and suggested that those areas could be determined based on housing price indices. That commenter, two large industry trade associations, and one mortgage company commenter argued that the 30-year term limitation should not apply to loan modifications that provide a consumer with a loan with a lower monthly payment than he or she may otherwise face. One such commenter noted that, as a general matter, the rule should clarify that modifications of existing loans should not be subject to the same ability-to-repay requirements to avoid depriving consumers of beneficial modifications.

For the reasons discussed in the proposed rule, the Bureau is generally adopting § 226.43(e)(2)(ii) as proposed in renumbered § 1026.43(e)(2)(ii). In response to commenter concern, the final rule clarifies in comment 43(e)(2)(ii)-1 that the 30-year term limitation in § 1026.43(e)(2)(ii) is applied without regard to any interim period between consummation and the beginning of the first full unit period of the repayment schedule. Consistent with the Board's analysis, the final rule does not provide exceptions to the 30-year loan limitation. Like the Board, the Bureau is unaware of a basis upon which to conclude that an exception to the 30-year loan term limitation for qualified mortgages in high-cost areas is appropriate. In particular, the Bureau believes that loans with terms greater than 30 years are rare and that, when made, generally are for the convenience of consumers who could qualify for a loan with a 30-year term.

The final rule also does not provide additional guidance on the 30-year loan term limitation in the context of loan modifications. The Bureau understands that private creditors may offer loan modifications to consumers at risk of default or foreclosure, and that such modifications may extend the duration of the loan beyond the initial term. If such modification results in the satisfaction and replacement of the original obligation, the loan would be a refinance under current § 1026.20(a), and therefore the new transaction must comply with the ability-to-repay requirements of § 1026.43(c) or satisfy the criteria for a qualified mortgage, independent of any ability-to-repay analysis or the qualified mortgage status of the initial transaction. However, if the transaction does not meet the criteria in 1026.20(a), which determines a refinancing—generally resulting in the satisfaction and replacement of the original obligation—the loan would not be a refinance under § 1026.20(a), and would instead be an extension of the original loan. In such a case, compliance with the ability-to-repay provision, including a loan's qualified mortgage status, would be determined as of the date of consummation of the initial transaction, regardless of a later modification.

43(e)(2)(iii)

TILA section 129C(b)(2)(A)(vii) defines a qualified mortgage as a loan for which, among other things, the total points and fees payable in connection with the loan do not exceed three percent of the total loan amount. TILA section 129C(b)(2)(D) requires the Bureau to prescribe rules adjusting this threshold to “permit lenders that extend smaller loans to meet the requirements of the presumption of compliance.” The statute further requires the Bureau, in prescribing such rules, to “consider the potential impact of such rules on rural areas and other areas where home values are lower.”

Proposed § 226.43(e)(2)(iii) would have implemented these provisions by providing that a qualified mortgage is a loan for which the total points and fees payable in connection with the loan do not exceed the amounts specified under proposed § 226.43(e)(3). As discussed in detail in the section-by-section analysis of § 1026.43(e)(3), the Board proposed two alternatives for calculating the allowable points and fees for a qualified mortgage: One approach would have consisted of five “tiers” of loan sizes and corresponding limits on points and fees, while the other approach would have consisted of three “tiers” of points and fees based on a formula yielding a greater allowable percentage of the total loan amount to be charged in points and fees for each dollar increase in loan size. Additionally, proposed § 226.43(b)(9) would have defined “points and fees” to have the same meaning as in proposed § 226.32(b)(1).

For the reasons discussed in the proposed rule, the Bureau is generally adopting § 226.43(e)(2)(iii) as proposed in renumbered § 1026.43(e)(2)(iii). For a discussion of the final rule's approach to calculating allowable points and fees for a qualified mortgage, see the section-by-section analysis of § 1026.43(e)(3). For a discussion of the definition of points and fees, see the section-by-section analysis of § 1026.32(b)(1).

As noted above, several consumer group commenters requested that high-cost mortgages be prohibited from receiving qualified mortgage status. Those commenters noted that high-cost mortgages have been singled out by Congress as deserving of special regulatory treatment because of their potential to be abusive to consumers. They argue that it would seem incongruous for any high-cost mortgage to be given a presumption of compliance with the ability-to-repay rule. However, the final rule does not prohibit a high-cost mortgage from being a qualified mortgage. Under the Dodd-Frank Act, a mortgage loan is a high-cost mortgage when (1) the annual percentage rate exceeds APOR by more than 6.5 percentage points for first-liens or 8.5 percentage points for subordinate-liens; (2) points and fees exceed 5 percent, generally; or (3) when prepayment penalties may be imposed more than three years after consummation or exceed 2 percent of the amount prepaid. Neither the Board's 2011 ATR-QM Proposal nor the Bureau's 2012 HOEPA Proposal would have prohibited loans that are high-cost mortgages as a result of a high interest rate from receiving qualified mortgage status.

As a general matter, the ability-to-repay requirements in this final rule apply to most closed-end mortgage loans, including closed-end high-cost mortgages. Notwithstanding the Dodd-Frank Act's creation of a new ability-to-repay regime for mortgage loans, Congress did not modify an existing prohibition in TILA section 129(h) against originating a high-cost mortgage without regard to a consumer's repayment ability (HOEPA ability-to-repay). Thus, under TILA (as amended by the Dodd-Frank Act), closed-end high-cost mortgages are subject both to the general ability-to-repay provisions and to HOEPA's ability-to-repay requirement. [145] As implemented in existing § 1026.34(a)(4), the HOEPA ability-to-repay rules contain a rebuttable presumption of compliance if the creditor takes certain steps that are generally less rigorous than the Dodd-Frank Act's ability-to-repay requirements, as implemented in this rule. For this reason, and as explained further in that rulemaking, the Bureau's 2013 HOEPA Final Rule provides that a creditor complies with the high-cost mortgage ability-to-repay requirement by complying with the general ability-to-repay provision, as implemented by this final rule. [146]

The final rule does not prohibit high-cost mortgages from being qualified mortgages for several reasons. First, the Dodd-Frank Act does not prohibit high-cost mortgages from receiving qualified mortgage status. While the statute imposes a points and fees limit on qualified mortgages (3 percent, generally) that effectively prohibits loans that trigger the high-cost mortgage points and fee threshold from receiving qualified mortgage status, it does not impose an annual percentage rate limit on qualified mortgages. [147] Therefore, nothing in the statute prohibits a creditor from making a loan with a very high interest rate such that the loan is a high-cost mortgage while still meeting the criteria for a qualified mortgage.

In addition, the final rule does not prohibit high-cost mortgages from being qualified mortgages because the Bureau believes that, for loans that meet the qualified mortgage definition, there is reason to presume, subject to rebuttal, that the creditor had a reasonable and good faith belief in the consumer's ability to repay notwithstanding the high interest rate. High-cost mortgages will be less likely to meet qualified mortgage criteria because the higher interest rate will generate higher monthly payments and thus require higher income to satisfy the debt-to-income test for a qualified mortgage. But where that test is satisfied—that is, where the consumer has an acceptable debt-to-income ratio calculated in accordance with qualified mortgage underwriting rules—there is no logical reason to exclude the loan from the definition of a qualified mortgage.

Allowing a high-cost mortgage to be a qualified mortgage can benefit consumers. The Bureau anticipates that, in the small loan market, creditors may sometimes exceed high-cost mortgage thresholds due to the unique structure of their business. The Bureau believes it would be in the interest of consumers to afford qualified mortgage status to loans meeting the qualified mortgage criteria so as to remove any incremental impediment that the general ability-to-repay provisions would impose on making such loans. The Bureau also believes this approach could provide an incentive to creditors making high-cost mortgages to satisfy the qualified mortgage requirements, which would provide additional consumer protections, such as restricting interest-only payments and limiting loan terms to 30 years, which are not requirements under HOEPA.

Furthermore, allowing high-cost mortgage loans to be qualified mortgages would not impact the various impediments to making high-cost mortgage loans, including enhanced disclosure and counseling requirements and the enhanced liability for HOEPA violations. Thus, there would remain strong disincentives to making high-cost mortgages. The Bureau does not believe that allowing high-cost mortgages to be qualified mortgages would incent creditors who would not otherwise make high-cost mortgages to start making them.

43(e)(2)(iv)

TILA section 129C(b)(2)(A)(iv) and (v) provides as a condition to meeting the definition of a qualified mortgage, in addition to other criteria, that the underwriting process for a fixed-rate or adjustable-rate loan be based on “a payment schedule that fully amortizes the loan over the loan term and takes into account all applicable taxes, insurance, and assessments.” The statute further states that for an adjustable-rate loan, the underwriting must be based on “the maximum rate permitted under the loan during the first 5 years.”See TILA section 129C(b)(2)(A)(v). The statute does not define the terms “fixed rate,” “adjustable-rate,” or “loan term,” and provides no additional assumptions regarding how to calculate the payment obligation.

These statutory requirements differ from the payment calculation requirements set forth in existing § 1026.34(a)(4)(iii), which provides a presumption of compliance with the repayment ability requirements for higher-priced mortgage loans, where the creditor underwrites the loan using the largest payment of principal and interest scheduled in the first seven years following consummation. The existing presumption of compliance under § 1026.34(a)(4)(iii) is available for all high-cost and higher-priced mortgage loans, except for loans with negative amortization or balloon-payment mortgages with a term less than seven years. In contrast, TILA section 129C(b)(2)(A) requires the creditor to underwrite the loan based on the maximum payment during the first five years, and does not extend the scope of qualified mortgages to any loan that contains certain risky features or a loan term exceeding 30 years. Loans with a balloon-payment feature would not meet the definition of a qualified mortgage regardless of term length, unless made by a creditor that satisfies the conditions in § 1026.43(f).

The Board proposed to implement the underwriting requirements of TILA section 129C(b)(2)(A)(iv) and (v), for purposes of determining whether a loan meets the definition of a qualified mortgage, in proposed § 226.43(e)(2)(iv). Under the proposal, creditors would have been required to underwrite a loan that is a fixed-, adjustable-, or step-rate mortgage using a periodic payment of principal and interest based on the maximum interest rate permitted during the first five years after consummation. The terms “adjustable-rate mortgage,” “step-rate mortgage,” and “fixed-rate mortgage” would have had the meaning as in current § 1026.18(s)(7)(i) through (iii), respectively.

Specifically, proposed § 226.43(e)(2)(iv) would have provided that meeting the definition of a qualified mortgage is contingent, in part, on creditors meeting the following underwriting requirements:

(1) Proposed § 226.43(e)(2)(iv) would have required that the creditor take into account any mortgage-related obligations when underwriting the consumer's loan;

(2) Proposed § 226.43(e)(2)(iv)(A) would have required the creditor to use the maximum interest rate that may apply during the first five years after consummation; and

(3) Proposed § 226.43(e)(2)(iv)(B) would have required that the periodic payments of principal and interest repay either the outstanding principal balance over the remaining term of the loan as of the date the interest rate adjusts to the maximum interest rate that can occur during the first five years after consummation, or the loan amount over the loan term.

These three underwriting conditions under proposed § 226.43(e)(2)(iv), and the approach to these criteria adopted in the final rule, are discussed below.

Proposed § 226.43(e)(2)(iv) would have implemented TILA section 129C(b)(2)(A)(iv) and (v), in part, and provided that, to be a qualified mortgage under proposed § 1026.43(e)(2), the creditor must underwrite the loan taking into account any mortgage-related obligat