Almost every night, a TV news magazine can be seen carving up unscrupulous business ventures, giving entire industries a black eye for the improper actions of a few. Before long, Congress responds with new legislation. So much for regulatory relief.
Today's example: the new Home Ownership and Equity Protection Act of 1994, which is on the President's desk for signature as part of larger community development legislation.
The act is designed to counter "reverse redlining," which Congress defines as "targeting of residents of the same communities for credit on unfair terms."
More precisely, Congress cited testimony in hearings that indicated "communities lacking access to traditional lending institutions are being victimized in this fashion by second mortgage lenders, home improvement contractors, and banks who peddle high-rate, highfee home equity loans to cash-poor homeowners."
Somewhere, a television producer responsible for a segment profiling an unscrupulous lender and a defenseless borrower must feel satisfied.
However, as you might expect, an entire industry, and derivatively, its customers, will now pay more for a new compliance burden because of the actions of a few. The act amends the existing Truthin-Lending Act to impose on finance' companies and other lenders an additional compliance burden that supplements an already bewildering assortment of consumer compliance laws.
For "high-rate" mortgage loans covered by the new act, Congress has mandated additional disclosures beyond those required by the federal Truth-in-Lending Act and the Real Estate Settlement Procedures Act. Furthermore, for such loans, Congress has prohibited certain contractual terms.
The key to analyzing the new act is the determination of its scope. The act covers certain home equity loans, which are closed-end (installment) loans secured by a consumer's principal dwelling, whether the loans are made for general or home-improvement purposes. The new act does not cover home equity lines of credit and loans to purchase homes.
Home equity loans are covered if they meet one of two triggering tests. First, if the annual percentage rate at consummation exceeds by more than 10 points the yield on Treasury securities having a comparable maturity, a high-rate mortgage loan is deemed to exist. The yield is measured on the 15th day of the month prior to the month in which the loan application was received.
Lenders should be able to determine in advance of making a loan the maximum rate that can be charged without triggering coverage under the act. However, within two years after regulations implementing the act become effective, the Federal Reserve Board may change the 10-point increment to anywhere between eight and 12 points.
Note that, while the act imposes new compliance burdens on lenders making mortgage loans above a certain rate, it does not set a cap on the interest rate that may legally be charged.
But the rate test is not the only way for a loan to become a highrate mortgage loan covered by the act. Alternatively, a high-rate mortgage loan results when the "total points and fees payable by the consumer at or before closing will exceed the greater of 8% of the total loan amount or $400."
For example, if a loan is $5,000 or less, it becomes a "high-rate" loan if all loan fees exceed $400, whether or not such fees exceed 8% of the loan amount.
To make matters more complicated, the act mandates that the $400 trigger be adjusted annually on Jan. 1 to reflect the percentage change in the consumer price index measured the preceding June 1.
To measure the eight-point or $400 threshold, "points and fees" are defined as all items in the finance charge, including all compensation paid to mortgage brokers and certain third-party charges. Thus, simply identifying the amount of points charged to the borrower is not enough. Lenders who pay points or fees to brokers need to add these payments to points paid by borrowers directly to brokers to assess the eight-point or $400 threshold.
Also, certain costs charged by a lender that are paid to third parties (such as appraisal fees) must be included as points and fees. Lenders must include those thirdparty costs which are not defined as reasonable, those third-party costs that are paid to a lender's affiliate, or those third-party costs for which a lender receives "direct or indirect compensation."
One wonders if discounts or commissions received from vendors such as appraisers, creditreporting entities, and others constitute "compensation" to a lender, thus automatically rendering the borrower's third-party payments a fee to be added into the high-rate mortgage loan calculation ,under the act.
If a lender makes two or more high-rate loans in any 12- month period, or one or more through a mortgage broker, such a lender is deemed a creditor under the Truthin-Lending Act.
This means that such a lender will not only have to comply with the provisions of the act described below for its high-rate mortgage loans, but such a lender will also have to comply with all other applicable parts of the Truth-inLending Act for all of its loans, including its high-rate loans.
If a high-rate mortgage is deemed to exist according to the standards described above, a lender must provide a specific new preclosing disclosure to borrowers not less than three business days prior to consummation.
This means that at least three business days must pass after providing the preclosing disclosure before a high-rate mortgage loan can close, unless a consumer verities that the money is needed immediately to meet a personal financial emergency.
The new preclosing disclosure must contain several elements. First, the preclosing disclosure must conspicuously state, in warning language mandated by the act, that the consumer is not required to complete the agreement just because the consumer has signed a loan application. In another mandated warning, the preclosing disclosure must add that if the loan is obtained, the consumer could lose his or her home and any money put into it.
In addition to the mandated warning sentences, the preclosing disclosure must contain the annual percentage rate and the amount of the regular monthly payment. In a variable-rate transaction, the preclosing disclosure must also state that the rate can increase and state the maximum monthly payment based on the rate cap.
No change may be made to the terms of the loan after the preclosing disclosure is delivered unless new preclosing disclosures are provided. These new preclosing disclosures can be made by telephone, provided the change to the loan terms was initiated by the consumer, the lender provides the modified preclosing disclosures in writing at closing, and the lender obtains borrower certification that the new disclosures were indeed provided by telephone at least three business days before consummation.
Next: Contract terms prohibited by the law.