Truth In Lending: The New Finance Charge

On September 16, 1996, the Federal Reserve Board issued final regulations to implement the Truth in Lending Act Amendments of 1995. These changes have the greatest impact on the finance charge elements. Although the tolerances have been increased for mortgage loans (loans secured by real property or a dwelling), there are new items that must now be included in the finance charge for any loan.

Third Party Charges
Often in the process of applying for credit, consumers incur or pay charges that are a part of the consumer's purchase and financing transaction but are not charged by or paid to the creditor. In the past few years, there has been a great deal of controversy over whether such "third party charges" are finance charges. The FRB's revisions provide clarification for treatment of these fees.

Determining whether third party fees are a part of the finance charge or are excludable depends on the answer to two questions. First, did the creditor require the use of the party that charged or imposed the fee? Second, did the creditor retain any portion of the fee? If the answer to either question is "yes," the fee or part of it is a finance charge.

Dealing with the first question, you have to determine whether you "required the use" of the third party. (Yes, this does have an ominous similarity to RESPA, doesn't it!) The test for whether you required the use of the third party is determined by whether you required the service. It is not dependent on whether you required a particular service provider. Thus, if you required the applicant to obtain an appraisal of jewelry before taking it as security for a loan, that appraiser's fee would be a finance charge. The fee is a finance charge even if you allowed the customer to chose the appraiser. The service and its related fee was a condition for obtaining credit. In short, the consumer could not get the loan without paying for the service.

The second question is within the bank's control. If the bank retains a portion of the fee, that retained portion is a finance charge. For example, in a real estate secured transaction, the fee for the appraisal of the property is not a finance charge. It is specifically excluded under ?226.4(c)(7). However, if the appraiser's fee is $225 but the bank charges the customer $250 and retains the extra $25, the $25 retained by the bank is a finance charge.

There is a hidden trap here. If the bank charges all applicants the same amount for an appraisal but uses appraisers who charge different fees, the bank is, in effect, retaining part of the fee for the less expensive appraisals. This becomes a finance charge even if the bank, in other situations, uses an appraiser who charges a higher fee and the bank pays the difference for that consumer.

Closing Agents
The FRB has added language to the definition of finance charge to clarify the impact of requiring a closing agent on the finance charge. The rule is designed to clarify when a creditor "requires" a service for which a fee is paid, making that fee a finance charge. Any one of three circumstances will convert fees charged or incurred by closing agents.

the charge is a finance charge if the creditor requires the particular services for which the consumer is charged. Thus, if the creditor requires the service although it does not specify the service provider, the fee is a finance charge. The effect of the requirement is that the customer could not have obtained credit without payment of that fee.
the fee is a finance charge if the creditor requires the imposition of the charge. For example, if the creditor required the closing agent to use a courier, the courier fee would be a finance charge. The fact that the closing agent was the party selecting and retaining the courier is not determinative. The important fact is that the creditor required the use.
if the creditor retains a portion of any third-party charge incurred or imposed by a closing agent, the portion retained by the creditor is a finance charge.

Mortgage Broker Fees
To implement the Truth in Lending Improvement Act's change to treatment of mortgage broker fees, the revisions to Regulation Z provide that fees charged by a mortgage broker are finance charges.

This inclusion of mortgage broker fees is absolute. It is not dependent on whether the lender required the use of the broker. Unlike other third party fees, the payment of the broker fee is the test, not whether the lender required the broker. Thus, a mortgage broker fee is a finance charge when the consumer voluntarily use a broker rather than coming directly to the lender.

Also, it makes no difference whether the consumer paid the broker directly or through the lender. In either situation, the fees paid are a finance charge to be included in the lender's calculations. In order to comply, loan originators will need to ask each applicant whether they used a mortgage broker and what fee they paid.

The burden of compliance proof will fall on the bank. It is therefore a good idea to request the customer or broker to produce some sort of written evidence of the broker fee.

This provision on mortgage broker fees is effective immediately because the Act established an effective date of September 30, 1996.

ACTION STEPS

Review your application fee and settlement charges to determine whether the bank is retaining any portion of settlement service fees. Make sure those retained fees are included in the finance charge.
Ask your lending staff to identify every settlement service that the bank requires as a condition of the loan. Review your Truth in Lending disclosure procedures and make sure that these fees are identified and included in the finance charge.
Meet with or send a memo to all loan staff to review these elements of the finance charge. Have them work through a few practice situations to be sure they understand how to identify these charges.
Instruct all lending staff to determine whether each applicant used a mortgage broker and to include any fees charged by the broker in the finance charge.
Revise your mortgage documentation checklist to include an indication that the loan originator has asked the customer whether the customer used a mortgage broker.