Tolerances: Some New Safety Zones

Finance Charge
Tolerances for finance charge errors have been significantly relaxed but only for loans secured by real estate or a dwelling. As the talk spreads about new tolerances, the careful compliance manager should remind staff that loans not secured by real estate or a dwelling are subject to the old familiar $5/$10 tolerances.

However, the new tolerances for real estate secured loans offer slightly more room for errors. At first glance, the new $100 tolerance looks spacious. The mortgage loan tolerance is contained in ?226.18(d)(1) which also provides that a disclosed finance charge that is greater than the actual finance charge is not a violation.

The familiar and much smaller tolerance for non-mortgage credit is contained in new ?226.18(d)(2). The strict requirements for accuracy on these loans remains in place. A disclosure that is greater than the actual finance charge by an amount that exceeds the tolerance is a violation for loans that are not secured by real estate.

Annual Percentage Rate
Expanded tolerances for finance charges will not provide full protection from disclosure errors unless the annual percentage rate is subject to similar tolerances. Accordingly, Regulation Z now contains several new provisions relating to APR tolerances.

First, ?226.22 is revised to provide a new tolerance for mortgage loans. New ?226.22(a)(4) ties the APR tolerance to the increased finance charge tolerance for real estate secured loans. The simple way to state this rule is: If the error in the APR results from the error in the finance charge and the finance charge is within the applicable tolerance, the APR is also within tolerance and is not a violation.

The rule gets more complicated. Section 226.22 contains cross references to ?226.23 to also reflect the way in which special tolerances for purposes of rescission may affect the calculations. The APR is within tolerances if the borrower is attempting to exercise the right to rescission and either of the new tolerances contained in the rescission rule, ?226.23(g) or (h) apply to the disclosure.

The rescission rule contains two rules for tolerances, one for general rescission purposes, and one applicable to the consumer's exercise of rescission when the lender has initiated foreclosure proceedings. The tolerance is calculated by the finance charge and then imputed to the APR.

The general finance charge tolerance for purposes of rescission is the greater of $100 or one half of one percent of the amount of the note (not the amount financed). The tolerance rises to 1% in a refinancing of a residential mortgage transaction with a new lender and there is no new advance or consolidation of existing loans. The APR is within tolerance if it is accurately calculated using the finance charge disclosed and the finance charge is within the applicable tolerance.

There is one caveat here: failure to disclose a mortgage broker fee gives the consumer the right to rescind. Even if the omitted fee provides an APR within otherwise applicable tolerances, omission of the broker fee is an absolute and insurmountable violation.

Finally, foreclosure places strict limits on the finance charge tolerance. When the creditor initiates foreclosure, the tolerance jumps back to $35. The APR tolerance will similarly be calculated from this reduced tolerance. Prudent banks will always consider that $35 is their tolerance limit and thus avoid or minimize the threat of rescission in a foreclosure action.

Copyright © 1996 Compliance Action. Originally appeared in Compliance Action, Vol. 1, No. 15, 10/96