Federal Reserve Board Proposal for "Ability to Repay" Regulation Opens Comment Period Through July 22, 2011
Important comment periods have now begun for creditors making loans subject to the Truth in Lending Act ("TILA").
As required under the Dodd-Frank Act, the Federal Reserve Board ("Board") recently proposed amendments to Regulation Z (collectively, the "Proposed Regulation"), which implements the TILA. The Proposed Regulation would implement Dodd-Frank's requirement that any creditor extending a loan for a "dwelling-secured consumer credit transaction" (which includes not only primary residential homes but also vacation homes and home equity loans) determine the borrower's ability to repay the loan. The rule does not apply to reverse mortgages, timeshare plans, home equity lines of credit, open-end credit plans, or temporary loans with terms of 12 months or less. The 474-page proposal is extensive, and key provisions are summarized below. Creditors should consider commenting on the "qualified mortgage" and prepayment penalty portions of the regulation before the July 22, 2011 deadline.
Complying with the Proposed Regulation
Under the Proposed Regulation, creditors are prohibited from making "dwelling-secured" mortgage loans unless they first make a reasonable and good faith determination, based on verified and documented information, that the borrower has a reasonable ability to repay the loan and any mortgage-related obligations (such as property taxes). To satisfy the new regulatory requirements, creditors must do one of the following:
Option 1: Meet the general ability-to-repay standard. They can do so by (1) considering and verifying eight underwriting factors, including: income and/or assets underlying the ability-to-repay determination; current employment status; monthly mortgage payment; monthly payment on any simultaneous mortgage; monthly payment for mortgage-related obligations (such as insurance and property taxes); current debt obligations; monthly debt-to-income ratio or residual income; and credit history; or (2) underwriting the payment for an ARM based on the fully indexed rate.
Option 2: Originate a "qualified mortgage," which is arguably exempt from liability (depending on how "qualified mortgage" is ultimately defined, see infra). Qualified mortgages are loans that do not contain negative amortization, interest-only payments, or balloon payments; do not exceed a 30-year term; are accompanied by points and fees of less than 3 percent of the total loan amount; are given to borrowers whose assets or income have been considered and verified, and whose debt-to-income ratio or residual income complies with Board guidelines and regulations; and are underwritten based on the maximum rate during the first five years, using a payment schedule that fully amortizes the loan over the loan's term, and factors in mortgage-related obligations.
Option 3: Operate in predominantly rural or underserved areas (for example, a community bank) in order to originate a balloon-payment mortgage. In addition, the loan term must be five years or more and otherwise meet the qualified mortgage definition, and the creditor must underwrite the mortgage based on the scheduled payment, except for the balloon payment.
Option 4: Refinance a "nonstandard" mortgage (what Dodd-Frank refers to as a "hybrid" mortgage), which is an interest-only, negative amortization ARM with a fixed interest rate for a number of years, into a "standard" mortgage, which has limits on loan fees and does not contain negative amortization, interest-only payments, or a balloon payment. The creditor must also consider and verify the factors listed in the general ability-to-repay standard, except the requirement to consider and verify the consumer's income and assets. In addition, the creditor must underwrite the standard mortgage based on the maximum interest rate that can apply in the first five years.
Prepayment Penalty Proposal
Dodd-Frank places extensive restrictions on the ability of creditors to impose a "prepayment penalty," including the amount of the penalty, the period during which a penalty may be imposed, and transactions to which a penalty may apply. Qualified mortgages are subject to even further restrictions because the cap on points and fees for qualified mortgages includes any prepayment penalties. Under the Proposed Regulation, a prepayment penalty is one where the creditor imposes a charge if the borrower pays any or part of the loan's principal before the principal is due. The Board expansively defines the scope of prepayment penalties to include interest payments due after a loan has been prepaid in full and any fee (such as a loan closing cost) that is waived unless the borrower prepays the loan. Creditors should consider submitting comments on the prudence of such an expansive understanding of "prepayment penalty," and whether such a reading will affect the availability of certain types of mortgage loans.
"Qualified Mortgage": Safe Harbor or Presumption of Compliance?
Dodd-Frank states that creditors may presume the ability-to-repay requirements are met if the loan in question is a "qualified mortgage." Under Dodd-Frank's definition of "qualified mortgage," the creditor is not required to consider and verify certain underwriting factors that would otherwise be required under the ability-to-repay considerations (such as the borrower's employment status, debts, and credit history, as well as the payment of any simultaneous loans). The Board is unsettled on whether the origination of a "qualified mortgage" gives the creditor an alternative to meeting the ability-to-repay requirements, thus offering the creditor a safe harbor from liability, or whether the creditor is entitled merely to a rebuttable presumption of compliance.
The Board has thus proposed two alternative definitions of "qualified mortgage." The first alternative limits "qualified mortgages" to certain loan terms, features, and costs, and requires that the loan be underwritten based on certain straightforward assumptions using certain verified information. Under this definition, qualified mortgages would give creditors a safe harbor for compliance with the general ability-to-repay requirements. The second alternative would require the creditor to consider and verify more information about the borrower's financial situation, and it entitles the creditor only to a rebuttable presumption of compliance. The Board acknowledges that if creditors of qualified mortgages are entitled only to a presumption of compliance, they are left with little legal certainty as to their liability exposure and thus have less incentive to extend qualified mortgages with loan fee limits. Creditors should consider submitting comments on the implications of treating qualified mortgages as offering creditors a safe harbor, as opposed to a mere rebuttable presumption of compliance, and whether this will affect creditors' incentives to extend qualified mortgages.
Statute of Limitations and Record Retention
TILA grants consumers a right to bring suit against a creditor for a TILA violation. In addition to actual damages, the consumer may be able to recover special statutory damages equal to the sum of all finance charges and fees the consumer paid, unless the creditor can show that its failure to comply with TILA is not material. Dodd-Frank extends the statute of limitations for violations of the ability-to-repay requirements to three years after the date of the violation. Additionally, there is no statute of limitations on a borrower's right to raise an ability-to-repay violation as a defense to foreclosure. To reflect the extension of the statute of limitations, the Board proposes to require creditors to retain all records documenting compliance with the ability-to-repay requirements for three years after consummation of the transaction.
Although the Board drafted the Proposed Regulation and is seeking comments, the final rule will be authorized by the newly created Consumer Financial Protection Bureau, which will have sole rulemaking authority for TILA as of July 21, 2011. Comments on the Proposed Rule are due by July 22, 2011.
Jones Day's Consumer Financial Products & Services team advises clients regarding the issues addressed in this Alert, including compliance and potential litigation issues raised by the Board's proposed "Ability to Repay" regulation.
Lawyer Contacts
For further information, please contact your principal Firm representative or one of the lawyers listed below. General email messages may be sent using our "Contact Us" form, which can be found at www.jonesday.com.
David F. Adler
Cleveland
+1.216.586.1344
Jeremy P. Cole
Chicago
+1.312.269.4093
Antonio F. Dias
Pittsburgh / Washington
+1.412.394.7240 / +1.202.879.3624
Gregory R. Hanthorn
Atlanta
+1.404.581.8425
Sydney McDole
Dallas
+1.214.969.3785
Richard S. Ruben
Irvine
+1.949.553.7565
Lee Ann Russo
Chicago
+1.312.269.4283
Jayant W. Tambe
New York
+1.212.326.3604
Lynsey M. Barron
Atlanta
+1.404.581.8559
Albert J. Rota
Dallas
+1.214.969.3698
Jones Day publications should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general information purposes only and may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at our discretion. To request reprint permission for any of our publications, please use our "Contact Us" form, which can be found on our web site at www.jonesday.com. The mailing of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship. The views set forth herein are the personal views of the authors and do not necessarily reflect those of the Firm.
