The Federal Reserve Board's March 28 staff commentary on the Truth-in- Lending Act has left some bankers scratching their heads.
The road map for compliance appears to require that - as interest rates change - banks disclose multiple worst-case monthly payment scenarios for high-cost mortgage borrowers.
A Fed lawyer said, however, that in most cases a single disclosure of the cost at the highest possible percentage rate will suffice.
But compliance officers complained in interviews this week that the Fed's explanation falls short, noting that their banks risk multi-million dollar lawsuits if they mess up Truth-in-Lending disclosures.
"Banks are in a dilemma," said Sai Huda, director of compliance at San Diego-based Advanta Mortgage Corp. "Do you follow the literal wording, make a series of disclosures and then deal with the customer confusion, but protect yourself from lawsuits? Or do you give one disclosure, make things easier on the consumer, and leave yourself open to get sued?"
The confusion stems from section 32 of the Fed's lending commentary. Regarding variable-rate mortgages, the commentary states, "The creditor must provide a maximum payment for each payment level, where a payment schedule provides for more than one payment level and more than one maximum payment amount is possible."
Mr. Huda said he reads the commentary as requiring bankers to disclose the payment for each possible rate for variable rate loans. For example, a loan that can adjust 1% yearly and 5% over its life, would require disclosure of the five worst-case payments, one for each possible hike in rates.
Consumers, who already struggle to understand the existing disclosures, would be even more confused if presented with more than one worst-case figure, Mr. Huda said.
Nessa Feddis, senior federal counsel with the American Bankers Association, agreed the wording is confusing. If a rule can be read in more than one way, she said banks risks lawsuits because there is no consensus on the proper disclosure.
But the Fed lawyer, who asked that her name not be used, said the commentary applies only to a little-used method to avoid negative amortization, a feature not permitted in high-cost mortgages. Negative amortization occurs when a bank hikes rates but borrowers do not increase their monthly payments. This means borrowers are not paying enough each month to cover the principal and interest due.
Some banks have tried to avoid the ban on negative amortization by requiring borrowers to make an extra payment each quarter. This special payment ensures that borrowers pay off all of the principal and interest payments due that quarter and thus avoid negative amortization. If banks didn't require these special payments, then borrowers would be stuck with a balloon payment, which isn't allowed in a high-cost mortgage.
As a result of the special charge, more than one maximum payment amount is possible - the regular payment and the special payment. The commentary simply seeks to ensure that banks, when confronted with more than one worst-case scenario, report it, the Fed lawyer said.
"All you have to do is give the payment that would occur if the rate rose as high as possible as quickly as possible," the Fed lawyer said. "Except for this rare situation, that's all that's needed."