More Regulation Z: Proposed Amendments

The Federal Reserve Board has published for comment proposed amendments to Regulation Z. The proposed amendments would implement the provisions of the Truth in Lending Act Amendments of 1995 (TILAA). Perhaps the most significant feature of the TILAA is the increased tolerances for to finance charge errors.

The TILAA was signed into law on September 30, 1995. Several provisions took effect immediately while others had a one year implementation date.

Finance charge tolerances: General
To implement the TILAA's new tolerance for mortgages, ?226.18(d) would be significantly revised. The old footnote 41, which stated the tolerances, would be incorporated into a new ?226.18(d)(2), retaining the existing tolerances for all closed end loans not secured by real estate.

A new ?226.18(d)(1) would be added to provide that for loans secured by real property or a dwelling, the finance charge should be treated as accurate if it is understated by no more than $100 or is overstated. The proposed regulation does not place a limit on overstatement of the finance charge.

Finance charge tolerances: Rescission, Refinancing, and Foreclosure
The driving force for the TILAA was the concern about the use by consumers (and their attorneys) of the restrictive finance charge tolerances to rescind transactions. The amendments provide a significantly larger tolerance for finance charge errors. However, the tolerance rules are no longer simple. There are different tolerances for different types of loans and different situations. The most important of these situations are rescission and foreclosure.

For rescission purposes, the disclosure must not be understated by more than 1/2 of one percent of the face amount of the note or $100, whichever is greater. There is no tolerance limit for overdisclosure. The law provides greater protection for consumers who are facing a foreclosure and raise Truth in Lending violations to rescind the transaction. The tolerance allowed for an understated finance charge is $35. An overstated finance charge would not enable the defendant to rescind. Note that the tolerance for finance charge errors do not apply to open end home equity loans. ?226.23(h)

For refinancings with no new advances and no existing loan consolidations, the tolerance is extended to one percent of the face amount of the note or $100, whichever is greater. In a refinancing of this type, the consumer is probablymotivated by a significant reduction in the interest rate or by converting the loan to a more desirable loan program. The law therefore severely limits the ability of the consumer to rescind such a favorable change. It also virtually eliminates the use of the threat of rescission to negotiate for a lower rate.

The act used the term "total amount of credit extended" rather than "amount financed." The Board has interpreted this to mean the face amount of the note rather than the amount financed, which is usually less than the note amount. This interpretation will generally provide a slightly greater tolerance for creditors. ?226.23(g)

The Board proposes to make related revisions to ?226.22 so that the APR tolerances reflect the new protections in the finance charge tolerances. This protection is based on the Board's interpretation of the legislative intent. The language in the act itself does not specifically address APRs.

Mortgage broker fees
The proposal contains language to implement the act's provision making all mortgage broker fees a part of the finance charge. Effective September 30, 1996, any charge imposed by a mortgage broker and paid by a consumer will be a finance charge. This will be the case without regard to whether the creditor required the use of the broker. The inclusion of this fee in the finance charge will also not be determined by whether the fee is paid directly to the broker or to the creditor for payment to the broker. It will be a finance charge, regardless. ?226.4(a)(3)

Fees for settlement agents would be treated differently from mortgage brokers. Fees charged by a third-party closing agent would be a finance charge only if the creditor required the use of the agent, required the particular service provided by the agent, or retained any portion of the fee. Under those circumstances, use of the agent would be a condition of obtaining credit. ?226.4(a)(2)

Debt cancellation fees
Having withdrawn proposed language to the Official Staff Commentary, the FRB is now proposing to amend Regulation Z. The purpose is to make the treatment of debt cancellation fees uniform in all states. The FRB's proposed treatment of these fees supports the act's underlying purpose of promoting credit shopping through providing consistent information about the cost of credit.

The proposal would treat debt cancellation fees in a manner consistent with the regulation's present treatment of credit insurance. The proposal first identifies the cost as a finance charge. ?226.4(b)(10). The proposal then provides a process to exempt the fee from the finance charge. The fee can be exempt from the finance charge if the purchase is voluntary, this fact is disclosed to the consumer in writing, the fee or initial premium is disclosed, and the consumer signs or initials an affirmative written request for the coverage. ?226.4(d)(3)

Worth noting here is the addition of the specific requirement that the disclosure to the consumer be in writing. The FRB has proposed revising ?226.4(d)(1)(i) to include this requirement. To further drive home the requirements for exempting insurance or debt cancellation premiums from the finance charge, the FRB is proposing another change to this section which may appear cosmetic but in reality carries a serious message. Paragraph 4(d)(1) would be titled "Voluntary credit insurance premiums," stressing the importance that the insurance in fact be voluntary and not in any way required.

"Information available to the creditor"
Section 226.17(c)(2) requires the creditor to base the disclosure on information known to the creditor and identify any estimates. The proposed regulation would clarify that the disclosure should be accurate at the time the creditor provides the disclosure to the consumer. A new paragraph ?226.17(c)(2)(ii) would be added to provide that the calculation of per diem or "odd days" interest would be accurate if it is based on information actually known to the creditor at the time the disclosure is prepared for consummation. Thus, a rescheduling of closing would not render the disclosure inaccurate or require the creditor to prepare new disclosures as long as the disclosures were correct when prepared.

ACTION STEPS

Prepare and submit a comment letter by June 21, 1996.
Meet with loan originators to learn whether consumers use mortgage brokers. If so, designate a loan staff task force to establish procedures for identifying and documenting mortgage broker fees.
Determine whether any loan departments or loan products offer debt cancellation fees. Determine how these are presently treated for purposes of Regulation Z.
Review your existing training materials for Regulation Z. You will need to revise the materials or obtain new materials for training when the revisions become final this fall.
Revise your audit procedures for checking finance charge calculations. You procedures should take into account new requirements for mortgage broker fees and new tolerances.