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Volume 2, Issue 2, 2002   Federal Reserve Bank of Dallas

Changes to Regulation Z Expand Loans Subject to HOEPA

The Home Ownership Equity Protection Act (HOEPA) was enacted in response to anecdotal evidence of abusive practices in the home equity lending market.

HOEPA applies to closed-end home equity loans, excluding home purchase loans and reverse mortgage loans, that bear rates or fees above a specified percentage or amount. Proceeds of closed-end home equity loans can be used for home improvements, debt consolidations or other purposes, at the borrower's discretion.

The regulation that implements HOEPA, Regulation Z, has undergone several changes, including how creditors determine if a loan is covered under the act. Compliance with the expanded HOEPA rules is mandatory as of Oct. 1, 2002.

The final rule PDF document contains the amendments to Regulation Z. A summary of the amended regulation follows, with the changes highlighted as .

Defining a High-Cost Home Equity Loan Under HOEPA

To determine whether a loan is covered by HOEPA, the regulation establishes two triggers. The triggers apply to the annual percentage rate (APR)—the cost of credit expressed as a yearly percentage rate—and the points and fees charged on a loan.

APR Trigger

  • First-lien home equity loans. A loan is covered by HOEPA if the loan's APR exceeds the yield of a Treasury security with a comparable maturity by more than 8 percentage points.
  • Subordinate-lien home equity loans. A subordinate-lien loan is covered by HOEPA if the loan's APR exceeds the yield of a Treasury security with a comparable maturity by more than 10 percentage points.

Points and Fees Trigger

Regardless of lien position, a home equity loan is covered by HOEPA if the total points and fees the consumer pays at or before loan closing exceed the greater of $480* or 8 percent of the total loan amount. Points and fees include all finance charges except interest. This also includes non-finance charges, such as closing costs paid to the lender or an affiliated third party.

Regulation Z changes require that premiums paid at closing for optional credit insurance—such as credit life, accident, health or loss-of-income insurance and other debt-protection products—be included in the points and fees trigger. One likely effect of this adjustment is that significantly more loans that include optional credit insurance will fall above the trigger established under Regulation Z and be deemed high-cost mortgage loans.

Once a loan has been deemed a high-cost mortgage, the loan becomes subject to certain disclosures, restrictions and limitations.

*Note: The $480 represents the dollar amount for 2002 (66 FR 57849, Nov. 19, 2001 PDF document). This figure shall be adjusted every Jan. 1 by the annual percentage change in the Consumer Price Index that was reported on the preceding June 1.

Disclosures for Loans Covered Under HOEPA

Changes made to Regulation Z affect the disclosures provided to consumers involved in a high-cost loan transaction.

  • In refinancings, the total amount borrowed must be disclosed to consumers and must state whether premiums or other charges for optional credit disability insurance are included.
  • In the limited circumstances where balloon payments are permitted, they must be disclosed to consumers along with the amount of the regular monthly payment.

The sample document below illustrates the disclosures required for HOEPA-covered loans. New language has been added to this disclosure form. The disclosure statements in brackets are provided to the consumer only when applicable. The disclosures must be in a conspicuous type size and must be provided to the consumer at least three days before becoming obligated on the mortgage transaction.

The disclosures required by HOEPA are in addition to the disclosures generally required by the Truth in Lending Act at or before closing.

Limitations for Loans Covered by HOEPA

Loans covered by HOEPA are subject to a number of restrictions. Changes in the regulation add a restriction on the use of due-on-demand clauses or call provisions by creditors that can force the consumer to refinance when a creditor exercises its right to call the loan or demand payment of a loan's entire outstanding balance. A loan transaction subject to HOEPA may not include the following:

  • Balloon payments. A payment schedule with regular periodic payments that when aggregated do not fully amortize the outstanding principal balance. In most cases, balloon payments are not allowed for a loan with a term of less than five years. The balloon payment prohibition does not apply to loans with maturities of less than one year if the loan is a bridge loan connected with the acquisition or construction of a dwelling intended to become the consumer's principal dwelling.
  • Negative amortization. A payment schedule with regular periodic payments that cause the principal balance of the loan to increase.
  • Advance payments. A payment schedule that consolidates more than two periodic payments of the loan and pays them in advance from the loan proceeds.
  • Increased interest rate. An increase in the loan's interest rate after default.
  • Rebates. Rebates of interest arising from a loan acceleration due to default calculated by a method less favorable to a consumer than the actuarial method.
  • Prepayment penalties. A penalty for paying all or part of the principal before the date it is due. This includes computing a refund of unearned interest by a method less favorable to the consumer than the actuarial method.
    Exceptions: Prepayment penalties are allowed if:
    • The penalty can be exercised during the loan's first five years;
    • The source of prepayment funds is not a refinancing by the creditor or an affiliate; and
    • At consummation of the loan, the consumer's total monthly debt does not exceed 50 percent of the consumer's total monthly income, as verified by the consumers' signed financial statement, a credit report and payment records for employment income.
  •   Due-on-demand clause. A clause that permits the creditor to terminate the loan in advance of the original maturity date and demand repayment of the entire outstanding balance.
    Exceptions: A due-on-demand clause is permitted if:
    • There is fraud or material misrepresentation by the consumer;
    • The consumer fails to meet the repayment terms; or
    • An action or inaction by the consumer adversely affects the creditor's security for the loan.

Prohibited Acts and Practices for Loans Covered by HOEPA

The changes to the regulation add a section containing new and existing prohibitions. A creditor extending a mortgage subject to HOEPA may not:

  • Pay loan proceeds solely to the home improvement contractor.
  • Sell or assign the loan without a disclosure that the purchaser or assignee could be liable for all claims and defenses that could be asserted against the creditor.
  • Refinance one HOEPA-covered loan with another to the same borrower within the first 12 months unless it is in the borrower's interest. Assignees are subject to the same restrictions while holding or servicing the HOEPA loan.
  • Engage in a pattern or practice of extending credit to consumers based on the collateral without regard to the consumer's repayment ability. Creditors are required to verify and document consumers' repayment ability.

  Finally, to prevent creditors from evading HOEPA requirements, which cover only closed-end loans, creditors are prohibited from wrongfully structuring a home-secured loan as an open-end credit.

Steps for Implementing Changes to Regulation Z (HOEPA)

  1. Read this article!
  2. Know that compliance with the expanded HOEPA rules is mandatory as of Oct. 1, 2002.
  3. Update your financial institution's compliance plan to reflect Regulation Z changes.
  4. Update consumer disclosure forms and disclosure platforms to comply with the Regulation Z changes.
  5. Train all personnel involved in the process of making, booking, servicing and selling closed-end home equity loans. Training should ensure that personnel understand what causes a loan to be covered by HOEPA, along with the disclosures, limitations and prohibited practices for these loans.
  6. Develop a system to monitor monthly changes in the yield on Treasury securities for use in determining if a loan is covered by HOEPA.
  7. Watch for annual adjustments to the points and fees trigger, which are made each fall.

e-Perspectives, Volume 2, Issue 2, 2002

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The views expressed are the authors' and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System. Articles may be reprinted on the condition that the source is credited and a copy is provided to the Community Development Office.

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